François Villeroy de Galhau: Some thoughts about monetary policy,
the year to come, and the past ten years
Speech by Mr François Villeroy de Galhau, Governor of the Bank of France, at the 25th
Anniversary of the Euro50 Group event at the Bank of France, Paris, 28 November
2024.
* * *
Ladies and Gentlemen,
It is my pleasure to be in such good company to celebrate the 25th anniversary of the
Euro 50 Group. I would like to warmly thank Edmond Alphandéry for being - supported
by the late Alexandre Lamfalussy - the father, and still active Chair, of this so pleasant
child. Euro 50 is as old - or rather as young - as the euro itself. Let me start by
expressing a great satisfaction, which may be the best present for this anniversary: the
euro is a hugely popular success. 78% of euro area citizens and 74% of French citizens
i
support our single currency - even more than the 68% at the start. Since its
ii
introduction in 1999, the euro has become the second most important currency in the
international monetary system - and the ECB one of the most influential central banks
st
in the world. Yet, getting stronger throughout the challenging crises of the 21 century
has not always been plain sailing, and won't be in the next future. Today, I would like to
focus briefly about where we are and where we could be heading in the near future (I),
before coming back to the past ten years and what we learned on our unconventional
toolkit (II).
I. Where we are today, and where we could go in the year to come.
In the euro area, inflation reached its peak at 10.6% in October 2022 and exceeded 4%
for two years. But it receded quickly, and stood at 2.0% in October 2024. Beyond the
likely ups and downs in the coming monthly data due to base effects, victory against
inflation is in sight. The situation has however changed compared to the last months; so
has the balance of risks. As you know, the ECB has no dual mandate; yet, our price
symmetric
stability primary objective is , around the 2% target. In the euro area, inflation
persistence is no longer the only risk. There is equally the opposite risk that inflation
undershoots, especially if growth remains subpar. According to the latest actual inflation
data, the euro area could be sustainably at 2% inflation already early 2025. The
European economy is achieving a soft landing, but a take-off is not yet in sight. Hence
we will continue cutting rates, but let me try to put some lights on the way forward.
Which communication about the direction of the journey?
Communication about future policy is sometimes viewed as binary, while, in practice, it
belongs to a continuum ranging from full commitment to total silence.
On one end of the spectrum, forward guidance worked rather well in the lowflation
period. However, past experience tells us that central bankers should not be
unconditionally pre-committed, at least beyond a few quarters. On shorter horizons,
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date-contingent forward guidance might still be valid . On longer horizons, if needed,
state-dependent
(and hence more humble) forward guidance would be more
appropriate.
On the other end of the spectrum, the central bank can give no indications whatsoever.
With the recent inflation surge, the ECB shifted to a meeting-by-meeting and
datadriven approach, an evolution warranted by high uncertainty and inflation forecast
instability. This is still where our last monetary policy statement is, but now that we are
getting back to a more "normal" inflation regime, our communication could become
more "forward-looking".
Between these two ends of the spectrum, soft signaling could hence be now our
appropriate communication mode. By making clearer its reaction function, the central
bank can usefully influence market expectations of future policy. When Christine
iv
Lagarde said "the direction of travel is clear and what we have done starting in June
is the sensible approach and should be continued", this is a good example of soft
signaling. I believe that we could now adapt our language in this direction.
Till which destination?
On our terminal rate, it is obviously too early to tell. However as we should be in the
near future sustainably at 2% inflation, and with still a sluggish growth outlook in
Europe, there won't be any reasons in my view for our monetary policy to remain
restrictive : our interest rates should clearly go to the neutral rate R*. However, this
raises two questions:
Where is precisely R*? We don't know with enough certainty but most estimates
from the ECB and the Banque de France give a reasonable confidence range
between 2% and 2.5% . In other words, at 3.25% we still have a significant room
to remove the restrictive stance of our monetary policy.
Should we go further, below R*? I wouldn't exclude it in the future, if growth were
to remain subdued and inflation at risk of falling below target.
But as a pragmatist, let me stress that these two questions are not urgent: the first part
of the journey till the "confidence zone" of R* is clear and still significant; we will then
have time and additional data to adjust for the second part. And this brings me to the
pace of this first part.
Which pace to remove the restrictive bias?
The name of the game here is and remains full optionality, combining the two
dimensions of pace which are the frequency of rate cuts and their size . We'll discuss in
each of our next meetings, and look at data - be they actual or forecasts. That said, let
me give two indications:
th
Seen from today, there is every reason to cut on December 12 . Optionality
size
should remain open on the of the cut, depending on incoming data, economic
projections and our risk assessment.
Optionality also means that, for the following meetings, we shouldn't exclude any
of them for possible cuts. Stating so the obvious, I don't mean to precommit to cut
"back to back" in each of these meetings: this would be a renewed and excessive
Forward Guidance. We should stick, as we did in October, to what I call an "agile
pragmatism", data driven but not timid.
II. Some thoughts about our unconventional toolkit
Looking back now to the last 10 years, let me turn to some personal reflections on the
two broad sets of "non-conventional" instruments. It will be a focus of our next Strategy
Review. By the way, we should avoid the possible trap of the "immediate weather
forecast". In the previous 2021 Review, we were just exiting the period of lowflation and
even the risk of Covid deflation, and we were unconditionally positive about our
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nonconventional tools : "[The] assessment [conducted as part of the Strategic Review]
found that each of the instruments (including negative interest rates, forward guidance,
asset purchases and longer-term refinancing operations) has been effective in raising
output, employment and inflation, and that the different instruments have reinforced
each other." Let us be careful not to make a symmetrical one-sided assessment today:
as we are exiting an inflationary episode, some might be tempted to regard
unconventional tools as useless or counterproductive. This is not the case, and I will
discuss fine tuning them rather than calling them into question.
Balance-sheet tools
Central bank balance-sheet tools, like asset purchase programmes and LTROs were
designed in crisis times when conventional tools were unavailable due to the Effective
Lower Bound. We should primarily better distinguish their objectives: either to preserve
an effective monetary policy transmission when specific market segments were under
strain (equivalent to financial stability purpose), or to provide additional policy space
stance
when required (i.e. monetary purpose). And let me accordingly suggest five
lessons:
1. First, when it is about transmission or financial stability , there is no reason to
hold the purchased assets in the balance sheet till maturity. This was the case of
the BoE's purchases in the Gilts crisis in September 2022, or could be for the TPI
(Transmission Protection Instrument) of the ECB. There is no obligation to re-sell
at short notice - if so, the central bank would be under market dominance, and its
intervention less effective -; but there is an option open at any time.
2. Second, when it is about further easing the monetary stance , we should
distinguish whether we aim to provide liquidity (i.e. volumes) or to reduce long
term rates (i.e. prices). When the primary objective is to inject liquidity, it should
be done not through purchases of long-term bonds, but by lending short term or at
floating rates for LTROs. These were by the way a powerful and successful
innovation of the ECB, not used in the US. But the initial pricing of TLTRO III at
quasi-fixed rates had been a mistake, which had to be later recalibrated.
3. That leaves " core QE" - purchasing and holding long-term bonds - for the
purpose of reducing the term premium and therefore the long term yields. It
entails taking interest rate risk in central banks' balance sheet, and hence
possible losses as we have seen recently: we should however, if the purpose is
clear and warranted, be ready to accept such risks, while looking more closely at
the average maturity of the purchased portfolio. Let me stress, on a positive note,
that the exit of QE - quantitative tightening (QT) - has been proceeding smoothly
in the recent past, without provoking a reverse rise in long-term yields contrary to
what many had feared.
4. In our portfolio holdings, we should prioritize government and supranational
bonds to limit our direct balance sheet exposure to the nonfinancial corporate
sector. That being said, such programmes are not and should never be designed
to fund governments nor to help fiscal stimulus.
5. Fifth and finally, we should not condition one instrument on another. Doing so
creates communication issues if one programme has to be stopped. For instance,
using asset purchases to make forward guidance more credible can turn out to be
unwise, as we saw early 2022 when we had to gradually stop asset purchases
before being able to raise rates.
Negative interest rates
Negative interest rate policy, which prevailed until July 2022, remained the most
puzzling and mysterious unconventional tool for public opinion. General wisdom thinks
that nominal interest rates should always be positive. From a political economy
standpoint, a situation where borrowing money has no cost and can even bring a
retribution may create psychological distortions and wrong incentives, including on
fiscal discipline.
That said, the economic impact of such a policy is still debated but seems mostly
positive. Some ECB policy measures - like tiering - helped mitigate its potential
adverse side-effects on bank profitability and hence on the supply of loans. Overall,
negative interest rates should remain in our toolkit but for exceptional circumstances.
We should therefore act forcefully to avoid being dragged into negative territory,
another reason not to tolerate a persistent undershooting of inflation.
I will conclude by quoting Isaac Newton, who, acknowledging the contribution of his
predecessors, stated "If I have seen further, it is by standing on the shoulders of giants".
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Today, as central bankers, we stand on the legacy of the collective efforts, creativity
and credibility of the past 25 years. It was the great privilege in particular of our
Governing Council to be chaired successively by Wim Duisenberg, Jean-Claude
Trichet, Mario Draghi, and now for the second time by a French President with Christine
Lagarde. Rest assured that as grateful heirs, we'll remain a solid anchor in the
uncertain times which lie ahead. Thank you for your attention.
i
European Commission, Eurobarometer, May 2024
ii
The international role of the euro
ECB, , June 2024
iii
Villeroy de Galhau (F.), Monetary policy in uncertain times , speech, 15 February 2022
iv
Lagarde (C.), Interview - Bloomberg Television (12:40), Washington, 22 October 2024
v
Brand (C.), Lisack (N.), Mazelis (F.), " Estimates of the natural interest rate for the euro
area: an update", Box 7 of the ECB Economic Bulletin, Issue 1/2024; Grosse Steffen
(C.), Lhuissier (S.), Marx (M.), Penalver (A.), « How to Weigh Stars? Combining
Optimally Estimates for the Natural Rate » Banque de France mimeo; Schnabel (I.), "R
(ising) star?", speech, The ECB and its Watchers XXIV Conference session on:
Geopolitics and Structural Change: Implications for Real Activity, Inflation and Monetary
Policy Frankfurt, 20 March 2024.
vi
ECB, " An overview of the ECB's monetary policy strategy (europa.eu) ", ECB Strategy
Review Overview Note, 2021
vii
Newton (I.), Letter to Robert Hooke, 5 February 1675 (in Turnball (H.W.), The
Correspondence of Isaac Newton Volume I
, 1661-1675, Cambridge University Press,
1959)