Speech by François Villeroy de Galhau,
Governor of the Banque de France,
Université Paris-Dauphine/House of Finance
Paris, 9 January 2020
"Low rates: what are the causes and what are the effects for France?"i
Press contact: Mark Deen (mark.deen@banque-france.fr), Déborah Guedj
(deborah.guedj@banquefrance.fr)
Ladies and gentlemen, dear teachers and students,
I am very happy to start the year with you here at Dauphine and to offer you
my warmest wishes. The New Year is often a time to make resolutions, but it is
also the perfect time to take stock. Among the surprises of 2019 was the
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extension of highly accommodative monetary policies when many expected
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or indeed hoped? to see a normalisation. So low rates are going to persist:
"low for longer"; an increasing number
of people are worried about the effect
this will have on banks, insurers, savers. It is perfectly legitimate for there to be
a debate around monetary policy, but the fact that even the general public is
now showing an interest is something altogether new. That is why I stand here
before you this evening, as one of the heads of the Eurosystem: to give an
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account of the underlying low rates they are not just the result of
causes
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monetary policy and then to assess their consequences: the positive effects
are still predominant, even if they have their limits, which I shall also talk to you
about later.
**
I. Low rates: why?
We need to start with an admission of humility. Contrary to a widespread
preconception, central banks do not bare full responsability for the low level of
interest rates. The downward trajectory of global nominal rates is part of a
trend that has been going on for nearly 40 years.ii
However, the decade since the financial crisis has marked a turning point.
Nominal rates have continued to decline and short-term rates have even fallen
into negative territory in the euro area since 2014, a radical development and
one that we share with Sweden and Switzerland, and with Japan since 2016.
In parallel, inflation has stabilised at a low level, dragging real interest rates
down in its wake. A long-term analysis of the global path of real interest rates
shows that current levels are historically low, and that, over the very long run,
global real long rates have instead remained between 2% and 4%.
1.1 Structural causes
To understand the origin of today's low real interest rates, we need to
consider
the concept of the natural or neutral rate of interest: in other words, the real
interest rate that would balance savings and investment in a context of full
This "R*" rate, described by the Norwegian
employment and stable prices.
economist Wickselliii in 1898, has been back in the spotlight recently. In the
euro area and the United States, R* is estimated to have fallen by between
150 and 200 basis points over the past 15 years.
The scale of this variation can only be explained by structural factors. Slower
growth in the working population and in total factor productivity have led to a
and this is estimated to account
slowdown in the trend rate of GDP growth,
for roughly a quarter of the decline.iv
Source: Bergeaud, Cette, Lecat, 2016
The other three quarters are estimated to stem from the increase in the supply
of savings coupled with reduced investment demand. The global savings
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glut is being fuelled by increased life expectancies, rising inequality older
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and wealthier individuals tend to save more and the accumulation of foreign
exchange reserves in emerging economies.
Source: IMF
Conversely, the decline in investment demand can be attributed to the rise
in the non-material economy, which requires more human capital than physical
investment, and no doubt to lower confidence in the future. The euro area in
particular has seen a rise in its saving ratio and a marked weakness in its
investment ratio since the financial crisis.
Source : Refinitiv Datastream
These trends, which can be observed the world over and have been going on
for a long time, are not, therefore, attributable to monetary policy: I shall
nonetheless turn now to the role of central banks.
1.2 The cyclical causes
The primary mission of central banks, and of the European Central Bank
(ECB) in particular, is to ensure price stability, notably by "smoothing"
fluctuations in the economic cycle. They do this by setting the level of short-
term interest rates.
In 1998, the ECB established a quantitative definition of price stability that it
went on to clarify in 2003: to maintain inflation rates below, but close to, 2%
over the medium term. More recently, other central banks have adopted this
2% inflation target, for example the US Fed in 2012 or the Bank of Japan in
2013.
Our monetary policy has pursued this inflation target since 1999, with tangible
results: inflation has remained close to target at an average of 1.7%.
Source: Eurostat
In the past decade, however, euro area inflation has been too low: 1.3% on
average between 2011 and 2019, and 1.3% today [Core inflationv is also at
1.3%]. This weakness in inflation, which can be observed in the majority of
advanced economies, has reignited the debate over the 2% target. Some,
such as one of my great predecessors, Jacques de Larosière, say we should
be content with the current 1%. Others, on the contrary, such as Olivier
Blanchard, former chief economist at the IMF, are arguing for a higher target of
up to 4%, which would leave more room to lower interest rates at the bottom of
the cycle. It is tempting simply to ignore these arguments. But I take this
debate over the inflation target very seriously, and it will be at the heart of the
"strategic review" that
the Governing Council, chaired by Christine Lagarde, is
to launch at the end of this month. Without prejudging the outcome, I would
like to put forward three qualifying criteria:

Our inflation target needs to be symmetrical: if our core target is perceived as
being an upper limit, we have less chance of achieving it.

It needs to be and we need to say to what extent and/or over which
flexible,
horizon: we cannot guarantee 2%, either all the time or straight away.

Last, it needs to be credible, and not just for the financial markets: we need to
communicate even more with households and businesses; they are the ones
that ultimately set prices and wages in the economy. We have to listen to
them, which means measuring their own inflation expectations, and choose
the most relevant inflation index. And at the same time we have to talk to them
better about our target: they believe us on the imperative of avoiding the two
opposite ills of inflation that is too high or deflation; but we have to recognise
that today they are less convinced than the economists of the need to boost
price growth from 1% to 2%. I believe the economic analyses and theories; but
I also believe that they only have a real-world impact if they are perceived,
accepted and assimilated by common sense and public opinion. This is the
focus of the related field of "behavioural economics" and the work of the Nobel
laureate Robert Schillervi.
To respect the mandate entrusted to us under the Treaties, one thing remains
certain: in the face of the too-low level of inflation caused by the cooling of the
economy since the end of 2018, it is our duty to maintain an accommodative
monetary policy to support economic activity. In September last year, the ECB
thus announced a package of measures, the most innovative of which is the
reinforcement of its forward guidance which gives visibility as to the future path
of short-term rates.
However, at our December meeting we noted the first signs of an economic
stabilisation, consisting in a relative reduction in trade-related uncertainties. If
this stabilisation is confirmed, it would need to be followed by a stabilisation in
monetary policy. Put another way, the low point observed in growth justifies
rates that are "low for longer", but not, at the present time, for longer".
"lower
II. Low rates: what are the effects?
2.1 Effective policies to support inflation and the economy
While these accommodative monetary policies are justified by their causes,
are they also effective in terms of their impact? Here too, we need to take
stock, both on an overall level and for each category of economic agent. From
a macroeconomic perspective, low rates and, more broadly, accommodative
policies, have indeed lent support to the economy. The IMF estimatesvii that
without monetary stimulus in advanced economies, world growth would have
been 0.5 percentage point lower in 2019 and 2020 respectively. In the euro
area, there have been several convergent estimates as to the impact of
monetary policy:viii between 2 and 2.5 percentage points for growth and a
cumulative impact of around 1.5 percentage point over four years for inflation.
The effects are similar for France. More growth thanks to low rates also means
less unemployment: the euro area has created more than 11 million jobs
between 2013 and 2019, of which 2-3 million are estimated to stem directly
based on the latter's
from the effects of monetary policy, contribution to
growth.
Eurostat
Source:
The effect of low rates can also be analysed according to financial profile of
economic agents. Households that need to borrow are winners thanks to the
historically low level of borrowing rates, especially in France. Their real estate
assets have risen in value, as have share prices. Households, including the
least well-off, are benefiting from the pick-up in employment. In contrast, the
returns on savings invested in fixed income products have naturally become
less dynamic. There are even sometimes fears that we will see negative rates
"tax on savings". In France, that remains and must
on deposits, a so-called
remain an intellectual hypothesis. Clearly, I think it is neither probable nor
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desirable that negative rates will be applied to private individuals except in
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the case of certain large fortunes or to SMEs.
Firms in the euro area, and especially SMEs and VSEs,ix have benefited from
easier access to credit at low rates: it should be noted, however, that on the
whole, they are no longer net borrowers, in other words they can completely
self-finance their investments; nonetheless, this historical, and perhaps
temporary, inversion is less evident in France.
Last, state governments are clear winners, and alongside them the
taxpayers, thanks to the savings on government interest payments. In the case
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of France for example which can borrow at negative rates at maturities of up
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to nine years interest payments, as a percentage of GDP, have been halved
in the 20 years since 1998,x whereas the level of debt [% of GDP] has been
multiplied by a factor of 1.6.
But this very gain has raised questions: are low rates responsible for the
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increase in government debt, as well as in private sector debt that of
households and firms? In France, they have undeniably facilitated the rise. But
the specific nature of France's situation makes it impossible to single
them out
as the central cause: rates are low across the euro area, and yet, on average,
the levels of debt carried by households, firms and state governments have
declined as a share of GDP, whereas in France they have increased.
This is more a justification for greater vigilance in our country. I shall turn now
to two current limits of monetary policy.
2.2 Two limits requiring vigilance
Financial stability
The first area where vigilance is required is regarding the consequences of low
rates for financial stability. It is important first to stress that the financial
sector's capacity to absorb shocks has been substantially reinforced since the
great 2008-09 crisis: balance sheets have been cleaned up and bank solvency
and liquidity have been improved thanks to the European and international
regulations known as Basel III, and to a considerable reduction in the weight of
non-performing loans. What is more, the effects of monetary policy include
some positive aspectsxi that are all too often overlooked by the banks: lower
financing costs; a reduced cost of risk due to the improvement in borrower
solvency. That said, while accommodative monetary policy is a benefit for
economic agents, prolonging it puts pressure on the profitability of financial
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players both banks and insurers alike. Recognising this does not mean
denouncing low rates: they have been put in place for the common good and
not just for the benefit of banks or insurers. But recognising it means accepting
the need to adapt: a solid financial sector in Europe constitutes an asset.
For insurers first, we support this urgent need for adaptation. Low rates have a
dual impact on them in that they lead to a revaluation of their commitments on
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the liability side via a reduction in the discount rate but also reduce the
returns on their investments on the asset side. Insurers therefore need to start
reassessing in depth both their product offering and their positioning. Similarly,
for banks, the first part of this adaptation has to come from their own
digitalisation and consolidation strategies. But part of it also falls to us: in
"tiering" system, which
September 2019 we decided to put in place a so-called
will reduce the cost of negative rates this year by close to EUR 4 billion for
European banks, of which around EUR 800 million will benefit French banks.
We are pursuing a macroprudential policy to encourage banks to manage their
risks prudently. This is the role of the Haut Conseil de stabilité financière
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(HCSF High Council for Financial Stability), which since 2018 has put in
place an additional countercyclical capital buffer (CCyB), and then in
December 2019 introduced recommendations for real estate lending which, if
necessary, will be transformed into binding rules.
France is not unique in this respect as several European countries have
already implemented macroprudential measures.
Yet we should not overestimate their effectiveness. In my view, monetary
policy cannot close its eyes to financial stability, as suggested by those purists
who favour a strict "principle of separation". Instead, I favour a form of
intelligent coordination, and that will be one of the challenges for our next
strategic review. Monetary policy must remain accommodative but it also has
to be more attentive.
The necessary follow-up with fiscal and structural policies
The second limitation is again a humble truth. As we have seen, monetary
- -
policy has gone beyond the call of duty. But it is not now less than ever
omnipotent, and it cannot perform miracles. Monetary policy has no influence
over the structural changes that are behind the exceptionally low level of the
natural interest rate. To fix the euro area's investment dearth -
both in the
-
private and public sector relative to its savings surplus, structural growth
policies are needed that boost innovation and productivity. It also means
making more appropriate and differentiated use of fiscal policies. In this
regard, the euro area is underusing its fiscal space: its public debt (84%) and
deficit (0.9%) are lower than those of the United States (106% and 5.6%) or
Japan (238% and 3% in 2019).
Source: IMF
Fiscal policy, especially in those European countries with a surplus, needs to
be exploited more actively and selectively. Germany has opened the debate;
the Netherlands have shown the way with the announcement of the creation of
an investment fund for the future. Low rates, here and elsewhere, can provide
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an opportunity to finance investments if and only if those investments
deliver increased potential growth: the ecological transition, digitalisation,
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education and research. For that, we need finally! to focus our fiscal
debate on the quality of our spending and investment, and not just on its
quantity.
At the European level, we have considerable borrowing
capacity: we should use it, as soon as we know how to choose these
priorities properly, beyond the success of the Juncker Plan or of InvestEU.
I shall conclude with a more "philosophical" consideration: interest rates are
also the price of time. My generation created the euro and tried to tackle the
financial crisis. Yours is inheriting a world that is equivocal, to say the least:
the positive explosion of innovation and interdependencies, but also that of
climate threats and inequality, and all with a worrying weakening, the world
over, in public governance. A low price of time is as much a threat as an
opportunity: a threat if we give in, in the short term, to the ease of abundant
liquidity and allow financial instability to grow; an opportunity if we use low
rates collectively to invest in the future, from the ecological transition to
education. You can count on our determination to act on the monetary side.
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But the battle is broader it is our political challenge, collectively, as
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Europeans and it is longer term: it will be the challenge of your generation. I
hope each and every one of you can contribute successfully to the fight. Thank
you for your attention.
References:
i
I would like to thank Chahinez Benmissi, Jean Boissinot, Adrian Penalver, Bérengère Rudelle and Giulia Sestieri
for their help in preparing this speech.
ii
For a general discussion of the topic, see GARNIER O., LHUISSIER S., and PENALVER A., "Taux d'intérêt
", Risques No. 120, December 2019.
bas, quelle responsabilité de la politique monétaire ?
iii
WICKSELL K., Interest and Prices, 1898.
iv
RACHEL L.; SMITH T., "Are Low Real Interest Rates Here to Stay?",
International Journal of Central Banking,
September 2017.
v
Excluding energy and food.
vi
See notably: Panel on "Behavioral Economics and Economic Policy in the Past and Future" Federal Reserve
Bank of Boston Conference: "Implications of Behavioral Economics for Economic Policy" Boston, Massachusetts,
speech by Janet L. Yellen, President and CEO, Federal Reserve Bank of San Francisco.
Or DUCA I; KENNY G.; REUTER A., "How do inflation
https://www.frbsf.org/our-district/files/0928.pdf
expectations impact consumer behaviour?", ECB Paper, August 2016.
vii
International Monetary Fund, Word Economic and Market Developments, Gita Gopinath, October 2019.
viii
tale of Two Decades: the ECB's Monetary Policy at
See notably ROSTAGNO et al. (2019), A 20; HARTMANN
and SMETS (2018).
ix
DE PASTOR R., "SMEs and VSEs in France: an improved financial situation and easier access to credit",
Bulletin de la Banque de France No. 226, December 2019.
x
INSEE
xi
ALTAVILLA C.; BOUCINHA M; PEYDRÓ J., "Monetary policy and bank profitability in a low interest rate
environment",
Economic Policy, Volume 33, Issue 96, October 2018, pp. 531-586.