Lorenzo Bini Smaghi: From convoy to parting ways? Post crisis
divergence between European and US macroeconomic policies
Comments by Mr Lorenzo Bini Smaghi, Member of the Executive Board of the European
Central Bank, on the paper by Messrs Jean Pisani-Ferry and Adam Posen, at "The
Transatlantic Relationships in an Era of Growing Economic Multipolarity" conference,
Washington DC, 8 October 2010.
* * *
The paper is extremely interesting and stimulating. I will not discuss all the arguments, but
will rather focus on a few issues, mainly related to monetary policy, given my comparative
advantage. In the paper, Pisani-Ferry and Posen try to explain the differences in policies on
both sides of the Atlantic on the basis of underlying economic fundamentals and policy
preferences. I would like to make three main observations.
The first observation relates to the role that underlying economic conditions play in explaining
policy differences. I would like to add one element that has not been fully explored in the
analysis. It refers to the transmission of monetary policy in a post-bubble economy. In
particular, the flow of credit to the private sector in the euro area seems to differ from that in
the United States. Considering the overall amount of lending to households and non financial
corporations, supplied both by the banking sector and by the capital market, there has been
a recovery in the euro area in recent quarters (Chart 1). In the United States, credit to
households and to the corporate sector, by contrast, has been in negative territory for some
time (Chart 2). This might be explained by both demand and supply factors. As Pisani-Ferry
and Posen have shown, before the crisis US households and corporates had a higher debt
levels than their euro area counterparts and have had to progressively deleverage. On the
supply side, US banks are probably also deleveraging more quickly.
This difference in the flow of financing to the private sector partly explains the different
techniques followed in the implementation of monetary policy on the two sides of the Atlantic.
It may also explain the differences in the results achieved. To be sure, the ability to
consistently anchor inflation expectations throughout the crisis has enabled the ECB to
effectively reduce real interest rates in the euro area, as shown in Chart 3, and thus to
support economic activity.
The second point is about the lessons that central banks can learn from the past to guide
their future monetary policy. Pisani-Ferry and Posen cite three episodes in the past which
central bankers should look at carefully, namely the Great Depression, Japan's lost decade
and, more generally, previous experiences of post-financial crisis periods. We all certainly
take a great deal of interest in, and inspiration from, these episodes. Looking at other
postcrisis experiences, like that in Japan, some lessons can be learned. Let me mention three:
1. After a financial and housing bubble has burst (what about the primary commodities
bubble?), the growth potential is impaired, and possibly even reduced, for some
time. According to all major international institutions, this also applies to the current
period.
2. Monetary policy can smoothen the transition to the new steady state, but it cannot
by itself pull the economy back to the pre-crisis level, which was not in a sustainable
equilibrium, within a short period of time.
3. The recapitalisation and restructuring of the banking system is far more important
than monetary policy in avoiding a credit crunch.
There are, of course, other lessons to be learned from past episodes. But in my view, we
should also look at another important period of history, the period that preceded the crisis. In
my view, there is much more to learn from the decade that preceded the crisis than from
other experiences. To be sure, this crisis has confronted the economics profession with the
challenge of rethinking its analytical basis. Central banks cannot be immune from such an
exercise. We should not be afraid of taking a critical look at the recent past. Let me mention
seven lessons from the recent past that may be useful for the future.
1. The growth recorded in advanced economies that experienced large current account
deficits over the last decade was not sustainable. For macroeconomic policies to
continue to be aimed at the attainment of similar rates of growth in the future would
imply generating the same imbalances that led to the crisis.
2. Very low levels of interest rates for a prolonged period of time can result in a
misallocation of resources and encourage risk-taking that fuel asset price bubbles.
There is now increasing evidence of this correlation (see Charts 4 and 5). I consider
it not to be fair for central bankers to shift all the blame for the build-up of the bubble
before the crisis to only regulators and market participants.
3. The view that monetary policy should not look at financial market conditions and
should only intervene to counter the effects of the bursting of the bubble (i.e. what
has been labelled the "Greenspan put") has proved to be wrong.
4. Interest rates were kept too low for too long before the crisis, mainly on account of
fears that the economy would enter a Japanese-style deflation, fears that turned out
to have been mistaken. Risk management-type monetary policy aimed at avoiding
deflation is thus not without risk.
5. Monetary policy cannot by itself transform a jobless recovery into a job-generating
recovery. If anything, keeping the cost of capital excessively low may encourage
capital-intensive investment, rather than labour-intensive capital expenditure.
6. Core inflation is not a good predictor of headline inflation, nor of underlying
inflationary pressures emerging in a global economy.
7. It is very difficult to measure output gaps. This is not a new finding, but it tends often
to be forgotten. Looking at the period before the crisis, what looked like as a large
output gap in 2003 turned out to be a very small one a few years later. Therefore, it
is very dangerous to calibrate monetary policy mainly on the basis of this variable
(see Charts 6 and 7).
If we want to avoid repeating the mistakes of the past, we have to keep these lessons in
mind.
This leads me to the third point I would like to make. It relates to the position of central banks
in the institutional framework underpinning economic policy-making in our societies.
PisaniFerry and Posen argue that in countries where the relationship between the central bank and
the government is "unproblematic", the central bank is freer to go beyond its usual mission, in
particular with respect to the adoption of non-conventional measures.
In fact, the institutional framework underlying the ECB does not prevent it from taking
nonconventional monetary policy measures of the type that other central banks have done. The
ECB did not embark on large-scale purchases of government bonds of Member States
because it could not do so, but because we did not consider that to be an appropriate
instrument in conducting monetary policy. The non-conventional measures we adopted relied
more on the banking system, given its prominence in the transmission of monetary policy in
the euro area. I have shown previously that our measures have been as effective, if not more
effective, than others in providing liquidity to the financial system. Selected purchases of
government bonds were used only in exceptional circumstances, to address specific
problems in the transmission of monetary impulses.
It is clear that embarking on large-scale purchases of government bonds may affect the
relationship between the central bank and the fiscal authority. What I am not sure of is when
such a relationship can be characterised as "problematic" or "unproblematic". Reading the
paper, I gained the impression (perhaps wrongly) that a "problematic" relationship is one in
which monetary and fiscal policies are distinct, as is the case in the euro area. I would then
where
like to ask: "Just is the problem if monetary policy is kept distinct from fiscal policy,
and cannot be manipulated by the fiscal authorities to solve budgetary problems?" Perhaps it
is a problem for the fiscal authorities, because they would like to use the instrument of
monetary policy to inflate away the fiscal problems and have, instead, to resort to fiscal
measures that are subject to parliamentary approval and that all citizens are able to judge
and assess.
It seems to me that it is not a problem for the citizens at large, especially for the less wealthy,
that fiscal problems are not solved through the inflation tax or by keeping the rate of interest
on public debt instruments artificially low. To be sure, for the European population at large,
the role of the central bank should remain distinct from that of the fiscal authorities, and
monetary policy should remain firmly in the hands of the central bank. This is why the
prohibition of monetary financing of the government and the independence of the central
bank have been enshrined in the Treaty. It is the best way to ensure that budgetary problems
are addressed in a democratic way, rather than through the manipulation of the currency,
which has hidden distribution effects on the population. In Greece, Ireland and Spain, in
France and Germany, the governments are adopting budgetary policies in full awareness of
the fact that they cannot count on the inflation tax to solve their fiscal challenges, challenges
that all advanced societies have to face. Can we consider this to be a problem?
Let me conclude on a broader issue, related to the title of the conference: Transatlantic
Relationship in an Era of Growing Economic Multipolarity. At many of the conferences on
trans-Atlantic relations that I have attended in the past, participants often discussed the
decreasing relevance of these relations in the light of the new emerging global powers.
Interestingly, when we get to discuss monetary issues, trans-Atlantic relations remain
important. The reason is that they are the only relevant ones.
A great deal of attention seems to be devoted to potential - and I would add, minor -
differences and divergences between policies in Europe and the United States, while the rest
of the world is completely forgotten. The paradox of major emerging market economies
asking for a greater say in global governance, but at the same time shying away from
responsibility in monetary matters has thus far captured little attention. Many important
emerging market economies either do not have any monetary policy at all, because they
have pegged their exchange rate to the currency of an advanced economy, or impose capital
controls and restrict the international use of their own currency. This creates monetary
divergences that are much larger in scale than those we discussed today, with global
repercussions. Thus, rather than talking about "monetary wars", which makes little sense,
more attention should be devoted to what I would call a "monetary void" in the world
economy. As a result of such a void, many of the problems experienced by advanced
economies before the crisis, like very low levels of interest rates - especially in comparison
with the underlying rate of economic growth - are now migrating to emerging markets, with
potentially very critical consequences for both these economies and the global system. More
attention needs thus to be paid to these issues, and to their consequences with respect to
achieving a balanced and sustained recovery of the global economy.
Thank you for your attention.
Nominal GDP, debt financing - EA
Annual percentage changes, nsa
Source: EAA, ECB and Eurostat.
Note: * includes loans, ** includes loans, debt securities and
liabilities for direct pension commitments of employers (i.e. not
including other payables). The latest observation 2010 Q2 is
estimate from BSI data. *** Nominal GDP calculated as simple
annual growth rates. Latest observation: 2010 Q2.
Chart 2
Nominal GDP, debt financing - US
Annual percentage changes, nsa
Source: Board of Governors of the Federal Reserve System,
BIS.
Note: * includes credit market instruments (i.e. loans not
including other payables) and debt securities issues by
nonprofit organisations, ** includes loans, debt securities and
liabilities for direct pension commitments of employers (i.e. not
including other payables). Latest observation: 2010 Q1.
*** Nominal GDP calculated as simple annual growth rates.
Latest observation: 2010 Q2.
5-year real yield 5 years ahead in the EA and the US (%p.a.)
Source: Reuters, Bloomberg, FED staff calculations, ECB
calculations. Latest observation: 5 Oct 2010.
Note: 5-year 5 years ahead constant maturity zero-coupon yield
based on triple A inflation-linked bonds for euro area. 5-year
5 years ahead constant maturity zero coupon yield based on TIPS
for the United States.
Chart 4
Monetary policy and financial stability (i)
Corporate loans
Source: Maddaloni and Peydró-Alcalde (2010).
Monetary policy and financial stability (ii)
Mortgage loans
Source: Maddaloni and Peydró-Alcalde (2010).
Chart 6
Spring vintages of EA output gap estimates by IMF
Source: IMF (WEO)
Note: Output gaps are defined as the percentage deviation of actual
output from potential output
Spring vintages of US output gap estimates by IMF
Source: IMF (WEO)
Note: Output gaps are defined as the percentage deviation of actual
output from potential output