Mario Draghi: The international dimension of monetary policy
Introductory speech by Mr Mario Draghi, President of the European Central Bank, at the ECB
Forum on Central Banking, Sintra, 28 June 2016.
* * *
In recent years central banks across advanced economies have been engaged in the same
task, namely raising inflation and inflation expectations back to levels consistent with price
stability. Each has faced conditions particular to its own jurisdiction. Each has deployed
measures appropriate to its own context. And each has acted to fulfil the mandate laid down
in its own constitution.
And yet, the fact that all central banks have faced a common challenge of low inflation is not
coincidental. There are global factors at play. And this begs the question, what is the best
way for us to deal with them?
At one extreme, central banks can take global conditions as entirely exogenous and set their
policies accordingly. At the other extreme is explicit coordination of monetary policies. In
between is a range of informal solutions.
Whatever one's views on these options, what is clear is that the question of the international
dimension of monetary policy is becoming more pertinent, since the common factors
affecting central banks are increasing.
The global drivers of inflation
Indeed, a growing literature suggests that globalisation has created a common factor in
inflation developments, which goes beyond fluctuations in energy or commodity prices.
Higher import volumes have increased the importance of international prices and wages
relative to domestic ones, making the global output gap more relevant.1
In that context there are two types of factors that are significant for the global low inflation
environment we face today: more cyclical factors that have put downward pressure on
prices; and more structural factors that have lowered the equilibrium real rate and slowed
down the response of the economy to monetary policy.
The first type of factors includes the large negative output gaps generated by the financial
crisis and its aftermath, which still average 1% among G7 economies today.2
This global slack has dampened in particular import and producer price inflation, both of
which have been weak for several years among advanced economies. Prices set by
producers in the euro area and those set by producers in trading partner countries are
indeed highly correlated.3
Also depressing global inflation has been the slump in demand for energy and commodities
linked to the slowdown in emerging markets. This has fed not just into lower headline
inflation, but also into lower underlying inflation through its effect on costs and imported
prices. Indeed, if one decomposes inflation for the average advanced economy, one finds
that since mid-2014 there has been a notable rise in the global component, linked largely to
oil and commodity price falls.4
These various factors may originate only in parts of the global economy - some originate
more in advanced economies, other more in emerging markets - but in an integrated world
they have global effects. Cyclical weakness has spilled over through various channels into a
similar challenge for all.
The second type of factors is more structural in nature. They concern the global forces that
have led to very low real equilibrium interest rates across advanced economies, and hence
made it more complicated for monetary policy everywhere to provide the appropriate boost to
global demand given an effective lower bound on nominal interest rates. In particular, this
has led many central banks in the advanced economies to engage in large-scale
unconventional policies.
That low interest rate environment is a consequence of a global excess of desired saving
over planned investment, which results from rising net savings as populations plan for
retirement; from increased demand for and lower supply of safe assets; from relatively less
public capital expenditure in a context of slowing population growth in advanced economies;
from the secular shift from industries intensive in physical capital to those more intensive in
human capital; and from a slowdown in productivity growth that reduces returns on
investment.5
Again, those factors may not be distributed homogenously across economies, but their
effects are global because they propagate through global financial markets. With
internationally mobile capital, the clearing interest rate that balances saving and investment
is more a global concept than a local one. And accordingly, estimates of the equilibrium
interest rate suggest that it is very low, possibly even negative, in the euro area, the US and
other advanced economies.6
None of this means that central banks should give up on pursuing their domestic price
stability mandates. We have demonstrated with our unconventional tools that it is possible to
engineer accommodative financial conditions even when the equilibrium interest rate is low.
And we have shown that this can be effective in supporting domestic demand and stoking
domestic price pressures even when disinflationary headwinds are blowing from the global
economy.
But the global nature of low inflation does have two important implications.
Coping with monetary policy spillovers
The first is that operating against persistent headwinds arising from abroad has forced
central banks to deploy monetary policy with more intensity to deliver their mandates, and
that in turn results in higher financial stability risks and spillovers to economic and financial
conditions in other jurisdictions.
Such spillovers are not necessarily all negative for the global economy. On the contrary, by
securing economic and financial stability in their own jurisdictions, advanced economies also
help stabilise other economies through trade and financial linkages. The empirical evidence
suggests that the net spillover effect of the measures taken during the crisis has been
positive, especially at times - such as after the Lehman crash - when countries have faced
common global shocks.7
At the same time, monetary policy has inevitably created destabilising spillovers as well,
especially when business cycles have been less aligned. The large exchange rates
fluctuations between major currencies, and the pressures some emerging economies have
experienced from capital flows, are testament to that. This is not so much a result of the
measures central banks have employed8, but rather of the intensity with which they have had
to be used.
These negative spillovers have led to a revival of interest in the topic of monetary policy
coordination.9
But formal monetary policy coordination is complex, for well-known reasons.10 Central banks
have national mandates, not global ones, and are accountable to their domestic parliament.
This does not mean, however, that we cannot achieve a better global solution than we have
today.
We have seen, for instance, how divergent monetary policies among major central banks can
create uncertainty about future policy intentions, which in turn leads to higher exchange rate
volatility and risk premia. That then has to be countered with more expansionary monetary
policy, increasing spillover effects for others. We also know that competitive devaluations are
lose-lose for the global economy, since they lead only to greater market volatility, to which
other central banks are then forced to react to defend their domestic mandates.
So we would all clearly benefit from enhanced understanding among central banks on the
relative paths of monetary policy. That comes down, above all, to improving communication
over our reaction functions and policy frameworks.
The global economy could also benefit from cooperation among spillover-initiating and
spillover-receiving economies on how to mitigate unwanted side effects.
One aspect that we need to understand better is how domestic monetary regimes affect the
transmission of foreign monetary policy shocks. There has been a debate in recent years as
to whether the famous "trilemma" of international macro has collapsed into a "dilemma",
whereby floating exchange rates no longer guarantee autonomy for domestic monetary
policy, and policy independence is only possible if capital flows are in fact managed.11 But
7
See Ammer et al. (2016), "International Spillovers of Monetary Policy" IFDP Notes. See Georgiadis (in press),
"Determinants of global spillovers from US monetary policy", Journal of International Money and Finance;
Feldkircher and Huber (2015), "The International Transmission of U.S. Structural Shocks - Evidence from
Global Vector Autoregressions", European Economic Review, vol. 81(C), pages 167-188; Kim (2001),
"International transmission of U.S. monetary policy shocks: Evidence from VARs", Journal of Monetary
Economics, vol. 48(2), pp. 339-372.
8
See Ammer et al. (2016, op cit.).
9
See Rajan (2016), "Towards rules of the monetary game", Speech at at the IMF/Government of India
Conference on Advancing Asia: Investing for the Future, New Delhi, 12 March 2016.
10
For a fuller discussion see Coeuré, B. (2014), "Policy coordination in a multipolar world", speech at the 5th
annual Cusco conference organised by the Central Reserve Bank of Peru and the Reinventing Bretton Woods
Committee: "70 years after Bretton Woods: Managing the interconnectedness of the world economy", Cusco,
22 July 2014.
11
See Rey (2015), "Dilemma not Trilemma: The global Financial Cycle and Monetary Policy Independence",
NBER Working Papers, no. 21162; Miranda-Agrippino and Rey (2015), "World Asset Markets and the Global
Financial Cycle", NBER Working Papers, no. 21722.
there is also evidence that exchange rate regimes still matter. Various recent studies support
the traditional view that exchange rate flexibility affords at least some degree of insulation
from global shocks.12
Another aspect is understanding the role of domestic policies more broadly in mitigating
negative spillovers. A large body of empirical work in recent years has shown that fiscal,
macro-prudential, regulatory and supervisory policies can help mitigate the adverse effects of
foreign monetary policy on domestic financial stability.13 Indeed, the experience with the
taper tantrum in 2013 showed how differences in domestic policy frameworks shaped how
severely different economies were affected by financial spillovers.14
In other words, it has become clearer since the crisis that the famous "Tinbergen principle"
which we apply at the domestic level also needs to be applied at the global level.
Policymakers need to have sufficient instruments to deliver on their objectives. And when
they do have them, they must use them.
The need for policy alignment
The second implication of the global nature of low inflation is that there is a common
responsibility for addressing its sources, whatever and wherever their origin.
Indeed, to the extent that the environment in which we operate is more affected by the global
output gap, and the global savings-investment balance, the speed with which monetary
policy can achieve domestic goals inevitably becomes more dependent on others - on the
success of authorities in other jurisdictions to also close their domestic output gaps; and on
our collective ability to tackle the secular drivers of global saving and investment imbalances.
In a recent speech in Brussels I made a similar point regarding the interaction between
monetary policy and other policies at the domestic level, such as fiscal and structural
policies.15 I maintained that central bank independence could best be described as
independence in interdependence, since monetary policy can always achieve its objective
eventually, but it will do so faster, and with less collateral effects, if the overall policy mix is
consistent.
What I am saying here is that the same applies at the global level. We may not need formal
coordination of policies. But we can benefit from alignment of policies. What I mean by
alignment is a shared diagnosis of the root causes of the challenges that affect us all; and a
shared commitment to found our domestic policies on that diagnosis.
Today, for instance, the way in which domestic policies respond to a shortage of demand
globally will vary: in some cases, the emphasis may be on increasing public investment; in
12
For a review see Frankel (2016), "International Coordination," presented at the 2015 Asia Economic Policy
Conference, Federal Reserve Bank of San Francisco.
13
See, for example, Blanchard et al. (2015), "Can Foreign Exchange Intervention Stem Exchange Rate
Pressures from Global Capital Flow Shocks?", NBER Working Papers, no. 21427; Forbes et al. (2015),
"Capital flow management measures: What are they good for?," Journal of International Economics, vol.
96(S1), pp. S76-S97; Afanasieff et al. (2015), "Implementing loan-to-value ratios: the case of auto loans in
Brazil (2010-11)," Central Bank of Brazil Working Paper Series, no. 380; Wong et al. (2015), "Using
macroprudential tools to address systemic risks in the property sector in Singapore", SEACEN Financial Stability
Journal, vol 4, pp. 27-41; Ostry et al. (2012), "Tools for managing financial-stability risks from capital inflows",
Journal of International Economics, vol. 88(2), pp. 407-421; Habermeier et al. (2011), "The effectiveness of
capital controls and prudential policies in managing large inflows", IMF Staff Discussion Note, SDN/11/14 ;Lim
et al. (2011), "Macro-prudential policy: What instruments and how to use them? Lessons from country
experiences", IMF Working Paper WP/11/238.
14
See Eichengreen and Gupta (2013), "Fed tapering and emerging markets", VOXeu.org.
15
See Draghi, M. (2016), "On the importance of policy alignment to fulfil our economic potential", 5th Annual
Tommaso Padoa-Schioppa Lecture at the Brussels Economic Forum 2016, Brussels, 9 June 2016.
others, on supporting private demand through more growth-friendly tax and regulatory policy,
and of course through monetary policy. The relative stance of stabilisation policies will differ
across countries depending on cyclical positions. But the sign of the effect on global demand
needs to be positive.
Similarly, structural policies that aim at raising participation and productivity may take
different forms in different places, but they need to achieve the same outcome, which is to
increase long-term growth rates and raise equilibrium interest rates.16 Here fora such as the
G-20 can play an essential role in bringing about the appropriate alignment of policies. It is
key that what is agreed in those fora is translated in the concrete policy actions.
The disappointing outcome of the G-20 commitment to raise global growth by 2% with
structural measures is one example of how intentions and actions can diverge. It contrasts
with the more successful example that was provided by coordinated global fiscal expansion
in 2008-09. Such fora of course cannot bind countries into specific actions. But mutual
recognition of their common interest can act as a form of coordination device.
That common interest today is a faster closing of the global output gap, more stable global
inflation, higher long-term global growth and greater global financial stability.
And such an improved policy mix would help reduce unwanted side effects of monetary
policy, since the burden of stabilisation would be better shared across policies. For instance,
in the current environment of global slack, the international spillovers from growth-friendly
fiscal policies are likely to be wholly positive, since they primarily boost domestic demand in
the home country. That is also true within regions, such as the euro area, where there are
different local output gaps.
The upshot is that, in a globalised world, the global policy mix matters - and will likely matter
more as our economies become more integrated. So we have to think not just about whether
our domestic monetary policies are appropriate, but whether they are properly aligned across
jurisdictions.
We have to think not just about the composition of policies within our jurisdictions, but about
the global composition that can maximise the effects of monetary policy so that our
respective mandates can best be delivered without overburdening further monetary policy,
and so as to limit any destabilising spillovers. This is not a preference or a choice. It is simply
the new reality we face.