François Villeroy de Galhau: With economic recovery underway in
Europe, what monetary policy?
Speech by Mr François Villeroy de Galhau, Governor of the Bank of France, at a lunch-debate at
the Centre des Professions Financières, Paris, 28 September 2017.
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Accompanying slides
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Ladies and gentlemen ,
It is a pleasure to be here with you for this lunch-debate of the Centre des Professions
Financières. I would especially like to thank your chairman Michel Pébereau for his kind
invitation. Today, I am delighted to be able to speak to you on a highly topical subject:
monetary policy in Europe in the context of economic recovery. The prospect of a very
gradual normalisation of our monetary policy gives rise to concerns and expectations. I
will begin by focusing on what our accommodative monetary policy has already achieved
today, before talking about prospects for the future.
I. What is the situation today?
Economic recovery in the euro area is here [slide]. It is robust and broadly based across
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countries and sectors. Our latest ECB forecasts confirm this: growth should stand at 2.2% in
the euro area in 2017, i.e. a significant upward revision of 0.3 point compared with June's
forecast of 1.9%. This means that for the second consecutive year, euro area growth will be
comparable to that of the United States. And that, according to Eurosystem calculations, the
output gap will return to close to zero by the end of the year ( 0.6%), even though France's
situation is less favourable due to its growth lag (output gap of around 1.4% according to our
calculations).
The non-standard monetary policy that we have been conducting since 2014 is contributing to
this acceleration of growth in the euro area, by supporting domestic demand and by fostering
very favourable financing conditions. In concrete terms, this acceleration results in more jobs -
over 6 million jobs created in the euro area since the start of 2013 - and in a pick-up in
investment. Corporate investment in particular, decisive for supply capacities, is clearly
recovering: up 4.7% in 2015, 6% in 2016, and is expected to be up 4% in 2017 and 2018). [slide]
This improvement in investment is underpinned notably by ongoing growth in lending to the
private sector, at 2.5% year-on-year in August 2017 for firms and at 2.7% for households, with
interest rates moreover remaining very low. This growth in lending is over twice as high in
France, which incidentally leads us to be very vigilant at the High Council for Financial Stability.
We are also observing favourable developments in inflation, which is gradually moving back
towards our target of 2% over the medium term [slide]. After peaking at the start of 2017, the
inflation rate stood at 1.5% year-on-year in August. Over 2017 as a whole, euro area inflation
should reach 1.5%, against just 0.2% in 2016; for the coming years, we foresee inflation at 1.2%
in 2018 and at 1.5% in 2019 - with a change in composition: less "energy" inflation, more
underlying inflation. This represents a first success: our monetary policy measures have
succeeded in warding off the risk of deflation which was still threatening the euro area last year -
we mustn't forget that inflation was declining, standing at 0.2% in April 2016.
That said, despite the progress made towards our target, it is still too slow. The underlying trend
in inflation is still not strong enough to support prices in the medium run. Underlying inflation,
excluding energy and food, has admittedly increased - rising from 0.8% in the first quarter of
2017 to 1.2% in July and August 2017 - but it still remains at subdued levels, despite the strong
recovery in activity and employment.
A significant factor is the relatively low nominal wage growth. Among the cyclical factors, I would
like to mention two in particular: first, persistent slack in the labour market - the unemployment
rate has fallen sharply in the euro area, to stand at 9.1% in July 2017, but it is still too high; [slide]
second, backward looking wage bargaining, which means that low past inflation is feeding
through to wages today. The influence of these two causes should nevertheless diminish with
the recovery in economic growth and inflation.
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Structurally, many studies suggest that the Phillips curve, i.e. the relationship between inflation
and fluctuations in economic activity or unemployment, appears to have flattened since the
1980s [slide]. Inflation seems less responsive to changes in economic activity in advanced
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countries, notably because of globalisation, which appears to exert downward pressure on
inflation via the decline in imported goods prices and competition from low-wage countries. But a
flatter Phillips curve does not call into question this relationship: we are in no doubt about the way
we are heading: the recovery and job creations will lead to higher wages and, ultimately, more
inflation. But we nevertheless remain less certain as to the speed of this adjustment. We are
both confident about the effectiveness of our monetary policy and willing to be patient regarding
the time it will take.
II. What prospects for the future?
Let me now turn to the consequences for our monetary policy. You are well aware that we at the
ECB's Governing Council will decide this autumn on the re-calibration of our policy instruments
beyond the end of the year - and, I quote Mario Draghi, "probably the bulk of these decisions will
be taken in October". We are now faced with a simple requirement, in line with our mandate to
maintain price stability, and the progress towards our inflation target: we have to reduce the
intensity of our net asset purchases, while maintaining overall a substantially accommodative
monetary policy.
As regards our asset purchases, we have to reduce their intensity in a pragmatic manner, as
we already decided successfully in December 2016. I insist on the word "pragmatic" because,
while keeping the current rules, we should on the one hand exploit the margins of flexibility of the
programme and on the other hand hold in reserve an additional purchasing capacity - if needed.
That said,
monetary policy is not limited to QE, and QE is not limited to net asset
purchases: we can keep a substantial degree of monetary accommodation even if we reduce
our monthly flow of net purchases.
1/ On QE, the academic literature provides consistent evidence that the impact of asset
purchase programmes on the yield curve and asset prices is primarily driven by the total stock
of assets held by the central bank (the so called "stock effect"), rather than by the flow of
transactions conducted over a given period ("flow effect"). In-house studies of the effects of the
PSPP find that holding a stock of bonds equivalent to 10% of GDP lowers the 10-year yield by
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about 45 bps in the euro-area. By contrast, flows of purchases have no significant additional
impact. These results imply that our current programme lowers the 10-year euro-area
government bond yield by about 100 bps. These effects are of similar magnitude than results
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obtained for the programmes conducted in the United States and the United Kingdom.
According to these studies, what matters is the extent to which and for how long central banks'
holdings reduce the availability of assets by removing them from the market. This implies that we
can continue to exert downward pressure on the yield curve by keeping our stock of asset
holdings at a high level for a prolonged period.
Let me first state the obvious: even if we reduce the monthly flow of net purchases, we will
continue to increase the size of our balance sheet. And let me add as a second consideration for
later: in any case, the Eurosystem will remain in the coming years a major buyer of
eurodenominated bonds thanks to our reinvestment commitment, which we took in December 2015
and which was perhaps not widely enough noticed: the repayments that we will obtain when
bonds reach their maturity date will be fully reinvested, thus keeping the size of our asset
holdings unchanged.
Most importantly, our monetary policy is based on a set of instruments [slide]:
it is not a solo,
but a quartet. On top of QE, we play with our policy interest rates, our forward guidance and the
provision of liquidity to financial institutions.
2/ Perhaps the most unconventional policy is the use of negative interest rates. I insist on the
fact that this measure is the most unconventional because for most people, nominal interest
rates are positive. It is true that negative interest rates have their limitations; I have already
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stressed them in the past. And at our Governing Council's meeting in Tallinn last June, we
clarified these limitations in our forward guidance stating that we do not intend to lower our
deposit facility rate below its current level of -0.40%. But slightly negative interest rates have their
virtues, even if they are not very popular among bankers. First, by removing the zero lower bound
constraint on expectations of future short-term interest rates, they contribute to easing financial
conditions by lowering rates along the curve, with a positive impact on the demand for credit by
firms. Second, the negative deposit facility rate (DFR) positively interacts with asset purchases.
Indeed, the portfolio rebalancing effect of QE is reinforced by the negative DFR, as banks with
excess liquidity holdings have a stronger incentive to reduce these holdings and put their
reserves to work. The truth of the matter is that we have not so far seen significantly detrimental
consequences of negative rates on the profitability of banks, notably thanks to the favourable fact
that the slope of the yield curve has remained positive.
3/ Our forward guidance provides further indications as to the future path of our monetary
policy; and by steering expectations, it has an impact on the yield curve. Our forward guidance is
clear as to the sequencing: "we expect [the key ECB interest rates] to remain at their present
levels for an extended period of time, and well past the horizon of our net asset purchases."
There is no doubt within the Governing Council about this sequencing. In all events, we should
not consider raising interest rates until we have reached a sustained adjustment in the path of
inflation.
4/ The fourth instrument is the provision of liquidity to financial institutions. In October 2008, we
introduced the fixed-rate full allotment policy in all our regular refinancing operations. It was
designed in order to guarantee banks' access to liquidity - and this policy is still active today, for
both 1-week or 3-month operations. The maturity of this liquidity provision was then extended
with the launch of 3-year long-term refinancing operations (LTROs) and, later, targeted
longerterm refinancing operations (TLTROs). The latest series of TLTROs provided banks with up to
4year funding at attractive rates - as low as -0.4% - in order to further ease financing conditions.
In September 2017, a total of EUR 760 billion is still lent to euro area banks through TLTROs,
which is substantial, over 7% of euro area GDP.
Before I conclude, let me add a few words on the recent evolution of the euro. A number of
factors play a role; monetary policy is only one of them. The sharp appreciation of the euro has
notably been stemming from the significant reappraisal of growth prospects for the euro area, as
well as from the geopolitical context. The impact of the strong euro on growth is currently offset
by the strength of domestic demand in the euro area; but the recent appreciation of the euro
exchange rate has led us to revise down slightly the outlook for inflation. Let me recall that the
exchange rate of the euro is not a policy target of the ECB. But the exchange rate remains an
element that we closely monitor owing to its possible implications for the medium-term outlook
for inflation.
I would like to finish by insisting on one word: confidence, but confidence without complacency.
Confidence, because our monetary policy is effective and the economic recovery is robust. But
confidence without complacency, because monetary policy is not the only game in town. It must
be supplemented by national reforms, particularly in France where the current acceleration of
reforms is positive. It must also be supplemented at the European level by strengthening the euro
area: in order to lastingly boost growth, we must complete Monetary Union by invigorating
Economic Union. All those who legitimately reject overloading monetary policy - on both sides of
the Rhine - must now firmly support a stronger economic union. Thank you for your attention.
1
I would like to thank P. Andrade, P. Antipa, G. Cette, M. Dujardin, O. Garnier, A. Lojschova and B. Mojon for their
help in preparing this speech.
2
Eurosystem staff macroeconomic projections for the euro area, September 2017.
3
See e.g. Blanchard (O.), Cerutti (E.), and Summers (L.) (2015) "Inflation and Activity - Two Explorations and their
Monetary Policy Implications," National Bureau of Economic Research Working Paper No. 21726, November.
4
Guilloux-Nefussi (S.) (2016) "Globalization, Market Structure and Inflation Dynamics, " Banque de France
Working Papers 610.
5
See e.g. Andrade et al. (2016) and Arrata and Nguyen (2017) for the euro area.
6
See e.g. D'Amico and King (2013) for evidence associated with programmes conducted in the US and Joyce et
al. (2010) in the UK.
7
See speeches of August 2016 (Handelsblatt conference), September 2016 (annual CERS conference) and April
2017 (conference at Columbia University).