Jean-Claude Trichet: International interdependencies and monetary
policy - a policy maker's view
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, at the Fifth
ECB Central Banking Conference "The Euro at Ten: Lessons and Challenges", Frankfurt am
Main, 14 November 2008.
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Ladies and Gentlemen,
I would like to express my gratitude for having the opportunity to host this panel of
distinguished experts and colleagues. Dear Ben, dear Stanley, dear Ning, and dear
Guillermo: I greatly appreciate your willingness to participate in this conference despite the
tremendous challenges we are all currently faced with. I would also like to use this
opportunity to thank the conference organisers for a superb job and indeed all conference
participants for their important contributions.
It is perhaps unfortunate that the current crisis distracts our minds from the subject of the
Conference: the euro coming of age. In different conditions, I would have argued - as I did in
the past - that, far from suppressing growth and entrenching divergences, the euro has
spurred a spectacular drive of job creation virtually everywhere in the Union. By helping and
fostering a long-due redressing of economic priorities and processes, the euro has enabled
many countries participating in Monetary Union to do their best to compete successfully. We
see signs that this restructuring is spreading to other parts of the Union that have been less
successful so far in taking up the challenge.
Under normal circumstances, European Monetary Union - international integration in its
most intimate form - would have been the subject of these remarks.
With the current crisis in the background, however, I want to address a different form of
convergence and cooperation in the international arena, which involves central banks and
crisis management.
Of course, this brings me quite far. With ever stronger global integration of goods and
services trade and, in particular, financial markets there are increasingly stronger linkages
among the world regions. As a result, economic and financial crises in one world region
increasingly spill over to other regions. At the same time, corrective policy action in one
region creates conditions and economic incentives that are felt and are acted upon
elsewhere. How should policymakers around the world deal with this fact? In particular, is
there a case for international coordination of macroeconomic policies?
I will try to give a tentative answer to these important questions. I will argue that we need to
be careful with what we understand by international policy coordination. Policy coordination
does not mean, of course, a unique policy stance for the entire world. Coordinated policy
action is not a surrogate for domestic macroeconomic prudence. We are all convinced that
monetary policies geared towards domestic price stability, sound public finances and flexible
economic structures create the conditions for an international financial architecture that can
last.
Are there areas in which policy cooperation can help strengthen domestic macroeconomic
policies? My short answer is "Yes, there are". Before giving you concrete examples of
beneficial cooperation, let me take a brief theoretical detour, which will make clear why
aiming for a globally unified policy stance is undesirable, whereas other types of cooperation
are more promising. In an influential paper a few years ago Obstfeld and Rogoff questioned
the conventional wisdom that increased integration of goods and financial markets
strengthens the case for policy stance coordination.1,2 Their theoretical results even suggest
that the need for policy stance coordination decreases with the level of international
integration. The basic intuition is that integrated goods and financial markets provide a
powerful risk-pooling mechanism, leaving policymakers free to focus on minimising the
distortions that might hamstring their respective domestic economies. As I noted on previous
occasions, the path of policy over the business cycle in the euro area relative to the United
States has differed for a number of reasons - and this despite the common conviction that
the
maintaining price stability is prerequisite for sustainable job creation and economic
success. The most important reasons for different policy paths are differences in underlying
economic structures and differences in the timing, nature and duration of economic shocks.3
This being said, there is an interesting sideline in Obstfeld and Rogoff's paper, which seems
to me to be very relevant for the current situation and which would be a fruitful area for future
research. The result I mentioned earlier - that tight international linkages do not necessarily
strengthen the case for international policy coordination - holds for what I would define as
"normal times". In Obstfeld and Rogoff's words it holds "unless risk aversion is very high".4 In
the current generation of theoretical models, risk aversion is generally considered a constant
parameter. I think that recent years and months have taught us an important lesson: attitudes
toward risk not only vary over time - for example, following long-term trends - but they do so
by waves and oscillations around trends. Phases of excessive risk taking can be followed by
sudden reversals driven by abrupt global confidence shocks such as the one experienced in
mid-September 2008.
The entirely exceptional joined interest rate cuts on 8 October 2008 and - in similar tense
conditions - on 13 September 2001 have to be seen in this context. In both cases there was
extraordinary uncertainty about the economic outlook and there was strong evidence that
upside risks to price stability had diminished in many world regions at the same time. Joint
action was first and foremost predicated on the need to respond to the same shock, a shock
that was being transmitted around the globe with lags measurable in hours. This created the
room for interest rate cuts, in all cases consistent with the mandate of the respective central
banks. We chose to coordinate the timing of announcement because we wanted to mutually
reinforce our message of confidence to the markets.
That being said, reflecting upon our very close relationship, I see all the hours spent on
exchanging ideas with my fellow governors, reflecting on facts and prospects, has
progressively consolidated an element of intimate confidence that is a major asset for the
present and future. We have built a remarkable common ground of shared experience,
mutual understanding and trust - in which today's consultation does not need a long
preamble because it follows naturally from yesterday's discussion - that has facilitated action
in many directions.
We have intimately cooperated in ways that cannot be easily integrated into theoretical
models. For example, there is a continuous exchange of information that helps all of us to
better understand the nature of the crisis and its intricate international propagation patterns.
We have cooperated intimately as regards the provision of liquidity in order to restore the
normal functioning of interbank money markets around the world.
Since December 2007, the ECB, in cooperation with the US Federal Reserve System and
other central banks, has been conducting term auction facilities - so-called TAF operations -
in which it provides USD liquidity on behalf of the US Fed to euro area banks against ECB
eligible collateral. These operations do not have a direct impact on euro liquidity conditions
and are aimed at improving global funding conditions. In this respect I would like to stress
that to my knowledge this was the first joint action of that kind ever taken by central banks to
relieve pressures in the short term funding markets.
The world can count on a continuation of this fruitful cooperation among central banks and it
can also count on the fact that this cooperation occurs fully in line with our respective
mandates and, in exceptional times like these, can even strengthen their achievement.
I thank you for your attention.