FRANKFURT SCHOOL OF FINANCE & MANAGEMENT, CENTRE
FOR CENTRAL BANKING
Guest lecture by Pierre Wunsch, Governor, National Bank of Belgium
"Beyond hawks and doves: trying to get it right in an uncertain world"
-
8 May 2024 Frankfurt
Introduction
Good afternoon everyone,
I am very happy to be here today, at Jens' kind invitation, to share a few
thoughts on the art of conducting monetary policy in uncertain times. The
establishment of the Centre for Central Banking by Jens and Emanuel
Moench in Frankfurt is a great initiative. I very much look forward to the
centre's contributions to a better understanding of the complex linkages
between finance, central banking, and the real economy.
Since I joined the ECB's Governing Council in 2019 (and earlier as a
backbencher), I have felt privileged to know Jens, and have learned so much
from him.
At the beginning, our views may have appeared to contrast somewhat. You
might recall Jens being labelled as a "hawkish member" of the Council. My
institution, the National Bank of Belgium, was instead considered to be
rather "dovish". And indeed, divergences were not uncommon. In
September 2019, the Financial Times tagged Jens as - quote - "opposed in
principle" and myself as a - quote - "supporter" of Mario Draghi's "last big
stimulus".1
My journey through the world of central banking has taught me a few things,
and Jens has been instrumental in this. That's what my speech tonight is all
about. In fact, the working title of the speech has long been "The impact of
seating arrangements on monetary policy". Indeed, Jens and I share the
privilege of having surnames beginning with "W", meaning that we were
neighbours at the Council table for quite some time.
A key lesson learned from being in Jens' company is that giving central
bankers birds' names (hawks, doves, owls, parrots, you name it) is simplistic.
Let it be noted once and for all: we are all staunch supporters of price
stability. Delivering it is our mission. Our mandate is not dual; we don't do
trade-offs. What differentiates us, however, is our perception of risks, and
relatedly, our willingness to take risks.
That clarity of purpose has been a useful compass on my journey: I have not
had to balance multiple goals based on personal preferences. In fact,
maintaining inflation at 2% is simply about doing the right thing, conditional
on what we think we know about the state of the economy and its likely
evolution over the medium term. Under uncertainty, it amounts to managing
the risk of missing our goal.
Growth, of course, is in the background, but it is not the driver of our
decision. Indeed, we know that being extremely risk averse or, on the
contrary, reckless about inflation, invariably ends up killing economic
growth. Being too tight for too long or having to put the inflation genie back
into the bottle both lead to subpar growth or worse.
It should now be clear that, in my view, the "hawk/dove" dichotomy cannot
capture the true nature of monetary policymaking. Hence, the title of my
speech today: "Beyond hawks and doves: trying to get it right in an uncertain
world".
Throughout this lecture, I will reflect upon my evolving stance on the primary
drivers of monetary policy in recent years. I will also share some personal
thoughts on the medium-term trajectory of monetary policy. Finally, I will
discuss more fundamental questions around the limits of central bank
mandates. Acute crises and urgent issues have clearly tested those limits. I
will focus on the role of independent central banks in mitigating climate
change and interacting with fiscal policy.
Before COVID-19: a well-developed theory that had to be tested
Before the COVID-19 pandemic, things seemed reasonably simple, at least by
today's standards. Aggregate demand was seen as structurally weak. For a
host of reasons (population ageing, rising income inequality, etc.), ample
global savings appeared to be struggling to find sufficient opportunities for
profitable investment. Thus, equilibrium real interest rates (often referred to
as R* in our simple macro jargon) had to be very low, and inflation hovered
below official targets. There were even signs of de-anchoring of long-term
inflation expectations.
In such circumstances, the conventional wisdom from central bank
workhorse models (all of which belong to the class of so-called new
Keynesian models) prescribes an extremely stimulative monetary policy.
Indeed, in these models, imbalances stem from the demand side of the
economy. This means that monetary policy can always handle such
imbalances. Models describe a world of "divine coincidence" where closing
the output gap (bringing Y to Y*) also brings inflation back to target (that is,
pi to pi*). In the end, according to these models, our job is to align the stars
(Y with Y*, pi with pi* and R with R*).2
The problem, however, was that monetary policy had precious little room for
manoeuvre. Conventional instruments were squeezed between an already
low R* and the so-called effective lower bound on interest rates. That lower
bound reflects the fact that in an economy where money can be freely
converted into cash, the scope for negative nominal interest rates is
bounded by the marginal cost of hoarding cash, be it at home under a
mattress or in a bank vault.
Quite logically, the dominant view became that central banks had to provide
the required stimulus through means other than conventional instruments.
Beyond historically low (negative) policy rates, central banks sought to
influence longer-term interest rates through forward guidance and asset
purchases. They tried to boost the credit channel of monetary policy by
providing ample liquidity to commercial banks, hoping they would lend more
to their customers.
In hindsight, it is evident that this multipronged strategy of serial big
bazookas yielded suboptimal outcomes. Inflation remained stubbornly low,
while the side effects of that shock therapy became increasingly evident. I
will get back to these side effects later.
Monetary policy during COVID-19: no regrets
The COVID-19 pandemic erupted in this environment of chronically low
demand and limited policy space. The shock was deep, sudden, and involved
an unlikely combination of dislocated supply chains and suppressed demand.
The costs of such disruption could not possibly be insured ex ante by anyone.
Only governments could protect economies ex post against potentially huge
long-term consequences that far exceeded anything a Schumpeterian
creative destruction argument could justify. Instead, scarring was a clear and
present danger. As moral hazard was not a consideration either, the case for
protection was crystal clear.
Of course, the policy response had to be commensurate to the shock:
massive, quick, but reversible. Yet, policy space was not only limited on the
monetary side but also on the fiscal side, owing to historically high public
debt in many countries. In addition, rapid deployment and reversibility are
features of fiscal policy, not monetary policy, which only influences
macroeconomic outcomes with long and variable time lags.
The need for a large-scale macro stimulus in a context of limited policy space
brought the "policy mix" concept back to life. In normal times, independent
actions by central banks and treasuries often lead to tensions in the mix.
Typically, the central bank offsets the demand effect of fiscal policy if it sees
the latter as running against price stability. Thus, unwarranted fiscal stimulus
leads to tighter monetary policy, and vice versa. Game theorists would say
that monetary policy and fiscal policy are strategic substitutes: it is in the
best interest of policymakers to offset their respective impacts on aggregate
demand.
The situation created by the pandemic turned that game on its head. Both
monetary and fiscal policies had to be deployed to protect and stabilize the
economy. Monetary policy - through the PEPP and other programs -
effectively worked by creating the space required for fiscal policy to act.
With the onset of the pandemic, inflation further receded. As investors and
consumers were unable to respond to lower interest rates and cheap credit,
monetary policy could only be effective through the government's role as
the spender of last resort. It became in the best interest of the central bank
to fully accommodate and even further encourage fiscal stimulus. During the
pandemic, monetary and fiscal policies had temporarily become strategic
complements.
One fundamental point to emphasise is that the joint fiscal and monetary
expansion observed in response to the pandemic reflected the actions of
two separate sets of policymakers acting independently within their remits.
It was never the result of ex ante coordination or backdoor deal-making.
One general lesson from this peculiar episode is that quantitative easing (QE)
can be a potent tool in times of significant shocks and constrained policy
space. In fact, QE likely proved effective even when operating at the
effective lower bound in the sense that it contributed to maintaining
government debt servicing costs - denoted as "r" - below the rate of
economic growth "g". A negative differential between r and g improves
public debt dynamics and alleviates concerns over debt sustainability. If
anything, this episode should allay our apprehensions about the effective
lower bound.
2021: a change of heart in view of inflation and financial stability risks
By the end of 2020, it became clear that vaccines would help to pull us out of
the mire. Predictably, policy normalisation would occur sooner or later. That
meant the return of the usual interplay between monetary and fiscal policies
and with it, the emergence of a clear risk that delayed fiscal consolidation
would require faster and stronger monetary tightening.
Logically, I started questioning the wisdom behind our apparent
commitment to persistently low interest rates. I became particularly
uncomfortable with forward guidance that effectively tied us to such a
stance for an extended period. A series of dissents followed, related not only
to forward guidance but also to the extremely gradual unwinding of asset
purchases.
I first dissented on the revision of forward guidance in July 2021, in the wake
of the ECB's strategy review. You might recall that the revised guidance listed
three conditions that had to be met before the ECB could consider lifting
policy rates.3 On the topic of forward guidance, I felt close to Jens, who had
already highlighted several issues in 2019.4
I had two main concerns. Firstly, the revised guidance flew in the face of
proportionality when considering financial stability. Although the ECB had
explicitly recognised "financial stability [as] a precondition to price stability",
the revision seemed to contradict that statement.
Secondly, the stringent conditions for liftoff attached to the revised forward
guidance effectively tied our hands in a way that could soon prove
untenable. I saw the distinct risk of having to change course suddenly, taking
everyone by surprise. In the end, our credibility was in the balance and with
it, the very effectiveness of forward guidance itself, and of monetary policy
more generally.
My discomfort about the conditions attached to forward guidance related to
personal concerns about the weight of models in our strategic thinking.
Much of the latter indeed seemed to hinge on models predicting that
inflation would smoothly converge to 2%. But how reliable are models in
times of unprecedented disturbances and policy actions? What is the value
of model-based inflation predictions where the endpoint of 2% is essentially
assumed, and where convergence happens quite fast, especially if
expectations are rational? Besides, models are bound to miss regime shifts
and to struggle with the deep impact of tail events. And since the last
significant inflation surge had occurred in the 1970s, models arguably
underestimated the persistence of inflation when it started to climb.5
Incidentally, the false sense of knowledge resulting from an overreliance on
models was also at the core of the recent review of the Bank of England's
forecasting approach by Ben Bernanke. This review could also inspire us in
the Eurosystem.6 On the topic of forecasts in particular, a major issue is that
analysts tend to focus on the point estimate of inflation at the end of the
forecasting horizon, which is about two to three years ahead. The significant
uncertainty surrounding projections is only a second-order consideration.
This is an issue if, like me, you believe that policymaking is about risk
management.
One can think of two technical remedies: fan charts and alternative
scenarios. Fan charts have the important advantage of providing a broad
idea about projection uncertainty. However, fan charts are only as good as
the assumptions used to build them. For instance, many fan charts reflect
either past forecasting errors - which is not useful if uncertainty rises - or
normally distributed shocks calibrated against past empirical moments. Fan
charts also routinely ignore model uncertainty itself. In the end, alternative
scenarios reflecting various modelling assumptions and shocks might be
easier to communicate to the public and might better convey differences of
views among Governing Council members.
My second material dissent concerned the speed of disposal of the asset
portfolio accumulated through QE. I call to mind the additional year of
reinvestment under the Pandemic Emergency Purchase Programme (PEPP)
sanctioned in December 2021, setting gross purchases in stone until the end
of 2024. At the time of this decision, headline inflation was at 5% and core
inflation was at almost 3%, but indeed our inflation projection for the end of
the projection horizon was at 1.8%. Now, with the pandemic behind us and
monetary policy being normalised on multiple fronts, PEPP reinvestment is
being continued to honour an old promise. Fortunately, the impact of an
additional year of reinvestment is limited.
Overall, I disagreed with the revised forward guidance and the slow
unwinding of the accumulated portfolio of asset purchases out of concern
for inflation and financial stability. With regard to the former, while the
inflation spike reflected an energy crisis, it seems hard to deny that highly
accommodative monetary policy facilitated the rise in inflation.
With regard to financial stability, I was fearful that the serious side effects of
loose monetary policy - in the form of misallocations and financial
exuberance - had been underestimated. Uppermost in my mind were the
potential for over-investment in non-productive assets, the belief that
budget constraints were being taken lightly, an overly enthusiastic search for
yield, the risks of asset price bubbles, and excessive leverage. Let's not forget
that a long period of monetary policy accommodation had probably
increased the likelihood of a systemic financial crisis.7
One might well say that "there is no financial stability issue this time
around". I would reply along the lines of Rajan and Acharya who warned
against "[t]he dangers of forgetting the 2023 banking crisis". Time is too
short to elaborate on this here, but my sense is that the link with the
extremely accommodative monetary policy of the preceding years is clear.
Of course, the euro area was largely unaffected by the US banking turmoil
thanks to robust capital and liquidity buffers. But a change in sentiment
might have weighed on credit growth and contributed to disinflation. In such
a scenario, monetary policy tightening might have been less aggressive,
possibly leading to a pause in rate hikes, similar to the Fed in June 2023.8
This is a good example of how central bankers must navigate uncertain times
by remaining agile and avoiding pre-commitments to predetermined
policies.
To sum up, one should not underestimate financial stability risks going
forward.9 Particularly if policy rates have to be kept high for longer. And one
should keep in mind that, in principle, a central bank can only act when
financial stability issues are related to liquidity and not solvency issues.10 As a
consequence, prevention is, as always, better than cure.
I could not end a discussion of the side effects of super-accommodative
monetary policy without mentioning fiscal sustainability. There are two
issues here. The first is that low or negative nominal interest rates on public
debt, if maintained for too long, can encourage reckless spending trends. The
second is that from the perspective of the consolidated public sector balance
sheet, QE amounts to transforming long-term liabilities into overnight ones
(bank reserves). The resulting transfer of the interest rate risk away from
private sector balance sheets quickly becomes a costly proposition when
11
policy rates must be raised. Central banking today is a loss-making
operation, something the public and some academics have a hard time
accepting.
Here again, Jens' early warnings impacted my thinking. As early as mid-2020,
he reminded us that "large-scale purchases of government bonds are
associated with the risk of blurring the line between monetary and fiscal
policy".12
2022: I became a "hawk" in the eyes of analysts
And inflation ultimately came back with a vengeance! With the pandemic
behind us, a surprisingly strong recovery hit supply chains that were still
under stress, and price pressures inevitably unwound. I quickly called for
higher policy rates, a development that prompted many analysts to conclude
decisively that I had aligned myself with the hawkish camp.
In the face of mounting inflationary pressures, our workhorse models
supported a narrative of temporary developments that did not warrant a
policy shift. The accumulation of inflation forecast errors nevertheless
encouraged me to question openly the dominant view.13 In early 2022, I
characterised the return of nominal interest rates to zero or above by
yearend as a "no-brainer".14 By mid-2022, Russia's aggression in Ukraine had
propelled energy prices in Europe to historic highs.
As inflation continued to outpace expectations, the textbook-ish "look
through" advice appeared to be increasingly inadequate. I called for a hike of
at least 200 basis points to bring real rates to zero, a level at which monetary
policy was unlikely to harm economic prospects (monetary policy would be
considered broadly neutral), while signalling a clear resolve to deliver on our
mandate.15 Still, that judgment call had to be made under exceptional
uncertainty. Estimates of the neutral policy rate (R*) are notoriously
unreliable.16 As Fed Chair Powell succinctly put it, "we are navigating by the
stars under cloudy skies".17
By the end of 2022, I found myself contemplating the prospect of rates
reaching 3%. There was little doubt in my mind that inflationary pressures
had to be tackled by strong policy action.18 I entered 2023 convinced that
rates would reach the 4% threshold, which is where we are today.19
Summing up and preliminary conclusions
Before moving to the current policy landscape, let me briefly recap.
Firstly, we've seen that quantitative easing proves effective in addressing the
effects of tail economic shocks in a context of constrained policy space. QE
worked through the monetary-fiscal policy mix.
Outside times of acute crisis, QE might well be tantamount to pushing on a
string. Neither quantitative easing nor forward guidance proved effective in
steering inflation back to our 2% target. Besides, unconventional policies
have side effects in terms of inflation persistence, financial stability, and
fiscal sustainability.
Secondly, models may not always be the reliable compass on which we
should rely. We were led to believe that inflation was transitory, only to find
out it was not. This underscores the need for a critical re-evaluation of our
modelling frameworks and of the role of model-based projections in
policymaking. The Bank of England recently indicated a way forward that
we'd be well-minded to consider.
Thirdly, the costs and risks associated with the effective lower bound might
not be as serious as previously thought. On the one hand, the effective lower
bound did not prevent an effective response to an acute crisis such as
COVID-19. On the other hand, with inflation being a regressive tax felt by all
of us, the perceived cost of de-anchoring upward - say above 3% - is
arguably higher than the unease one might experience during prolonged
episodes of inflation in the 0-1% range.
Two policy conclusions can be drawn.
Firstly, central banks should engage in aggressive monetary accommodation
- through QE and forward guidance - when crises hit, and policy space is
scarce. Outside such circumstances, "shock and awe" strategies should be
avoided if inflation expectations remain reasonably well-anchored. This
realisation requires a recalibration of our policy toolkit.
By implication, we should also be prepared to tolerate some flexibility in
interpreting the point inflation target of 2.0%. This is to avoid mistakes such
as the decision to expand quantitative easing when inflation forecasts
hovered around 1.8% in late 2021.
Monetary policy at the current juncture
Thinking about monetary policy today is fraught with conceptual and
practical challenges. To name but a few, I would mention the rising
prevalence of supply shocks (or relative price disturbances, if you prefer),
heightened uncertainty over key economic relationships that we previously
took for granted (mainly the Phillips curve), and slow-moving transitions
(population ageing, digitalisation and the advent of AI, climate change, or the
shortening of global value chains).
Structural transformation means that the models at our disposal are
intrinsically uncertain; or rather, even more uncertain than before. In a
sense, the good old "Lucas critique" is back! As Bob Lucas warned us almost
50 years ago, trusting fixed parameters and functional forms reflecting past
behaviours can be misleading. Conventional wisdom might not be as wise as
it used to be, because "intercepts" might shift, and critical "slopes" might
have become steeper as a result of thus far unsuspected "non-linearities."
What might at first sound like a curiosity of modelling carries first-order
policy implications. A case in point is the traditional advice of "looking
through" supply shocks. The argument is simply that if inflation expectations
are anchored, the inflation effects of temporary supply shocks will
selfcorrect without any policy action. That prescription, which stems from
traditional new Keynesian models, partly explains why the ECB did not start
raising policy rates as soon as inflation emerged. Meanwhile, as we were
"looking through," real interest rates dived further into negative territory,
fuelling inflation.
As positive inflation forecast errors piled up, many struggled to understand
the drivers of inflation persistence. This is hardly surprising if the most
trusted models keep replicating a world of low and stable inflation where
actual policy is seen as having little effect on the process (the "flat Phillips
curve" view). Besides, many analysts and policymakers took comfort in
longterm inflation expectations remaining anchored at 2%.
This forces us to think harder about the role of inflation expectations in our
policy framework. In my view, we should not rest quietly on the fact that
some preferred measure of expected inflation is firmly tied to the official
target. Welfare reflects actual inflation, which everybody feels as the
painfully regressive tax it is. To put it bluntly, "we do not eat expected
inflation."
Of course, anchoring is crucial for macroeconomic stability as a deviation of
long-term inflation expectations from 2% would be a sign of waning
confidence in the credibility of monetary policy. And as COVID-19 showed,
such credibility is crucial to deploying an adequate response during crises.
However, stable long-term inflation expectations are only a necessary, not a
sufficient, condition for macroeconomic stability. It only tells us the
endpoint, not how we will get there.
So, to understand inflation persistence - what happens between now and
the fixed endpoint - we must look into the role of shorter-term
expectations and their effects on wage formation. In fact, new Keynesian
models tell us nothing else: long-term expectations play no role beyond their
influence on shorter-term expectations.20 And in fact, the textbook new
Keynesian Phillips curve features next-period inflation expectations.
Empirically, short-term expectations are a key driver of macroeconomic
dynamics. Recent evidence from wage growth data supports that view.21
Workers seem to take short-term inflation expectations into account in the
wage-bargaining process, in addition to past inflation; while longer-term
expectations play virtually no independent role. Indeed, if workers know that
they can renegotiate their wages every year or every other year, longer-term
developments are largely irrelevant. A similar reasoning holds for firms'
pricing behaviours.
The role of short-term expectations in price- and wage-setting behaviours
feeds into one of my concerns about inflation persistence: the emergence of
wage-price spirals. If short-term inflation expectations matter for wage- and
price-formation mechanisms, a rise in these expectations would encourage
workers to raise wage demands and firms to increase sales prices in a sort of
"tit-for-tat" game.22 A terms-of-trade shock makes such tit-for-tat dynamics
even more likely, as each agent has an incentive to transfer the impact of the
shock onto the other, even though the shock makes the entire economy
poorer.
Thus, placing a greater emphasis on short-term inflation expectations and
wage dynamics seems advisable in order to navigate the current climate.23
As the effects of energy shocks dissipate, firms have tended to reduce profit
margins in the face of persistent wage growth. While firms may have taken
advantage of the inflationary environment to increase prices (so-called
"greedflation"), they may also have anticipated that wages would ultimately
catch up with price increases. If so, margins would simply play a buffer role,
reflecting the greater rigidity of nominal wages compared to prices.
While such conjecture appears plausible, theoretical models struggle to
capture ongoing inflation dynamics. The formal debate revolves around the
specific form of the Phillips curve. For one thing, the stability observed in
long-term inflation expectations suggests that the curve did not shift
upwards. This means that monetary policy credibility has been preserved. An
upward shift in the curve would have meant higher inflation regardless of
the state of the real economy, and thus a greater likelihood of tit-for-tat
manoeuvres. As such, and as seen in the 1980s, central banks would have
had to regain credibility at the cost of causing a protracted slowdown in
economic activity, and most probably, a serious recession.
There has been even more debate around the shape of the curve, and
namely, its slope and curvature. Non-linearity could mean that the slope of
the curve depends on the level of inflation. This would be consistent with the
view that firms would feel less constrained by competition and would be less
hesitant to raise prices in an inflationary context (or one characterised by
strong demand24) compared to a low inflation (or depressed) environment.
This kind of conjecture would help explain the inflation surge as well as the
seemingly painless disinflation process observed so far.
Recent empirical evidence concerning the Phillips curve is consistent with
signs of a steepening trajectory.25 While models need time to adjust to a new
reality, microeconomic evidence points more clearly to an increase in the
frequency of price adjustments by firms.
That said, since the curve does not appear to have shifted upward, policy
credibility remains intact, and there is no case for maintaining tight
monetary conditions beyond those strictly necessary to stabilise the
economy. Not surprisingly, markets have already priced in rate cuts in the
short term. Looking at the €STR forward curve, a first cut is expected in June,
with one or two additional cuts envisaged by year end. A similar picture
emerges from the ECB's survey of monetary analysts.
Of course, uncertainty around such scenarios remains considerable.
Distributions of €STR forward rates around the baseline are wide. In
addition, the recent volatility in interest rates underscores the need for
caution when looking at market prices. After the last rate hike in September
2023, long-term rates plunged by about 90 basis points by the end of the
year due to expectations for monetary policy easing after
better-thanexpected inflation data. However, since the beginning of this year, long-term
rates paired back some of their earlier decline as expectations for rate cuts
moderated somewhat.
For central banks, dealing with uncertainty means remaining
datadependent. Now is not the time to commit to a preset course of action. It is
about using our discretion wisely... about getting it right, as information
about the state of the economy becomes available. Significant risks remain
around the trajectory of wage growth and inflation in wage-intensive
services. Despite recent signs of moderation, more will be known about the
dynamics of wages and services inflation at the June Governing Council
meeting.
Of course, data dependence also requires some willingness to take risks, as
uncertainty complicates the early detection of new trends.26 To be sure, the
road ahead is likely to be a bumpy one for services and core inflation.
Realtime inflation readings will likely be quite volatile over the next few months.
As wages are intrinsically more rigid than prices, wage growth is expected to
remain broadly constant this year. This would imply that real wages catch up
with their pre-pandemic levels. Of course, we still cannot exclude that
workers demand compensation for several years of depressed purchasing
power.
All in all, and although the outlook remains foggy, I see a path for initiating
rate cuts this year. Firstly, our inflation forecasts have recently become more
reliable. Secondly, we continue to predict a return of inflation to the official
target by end-2025. Thus, with no sign of de-anchoring in the longer term,
the costs of remaining tight for too long seem to outweigh those of a
premature loosening. This boils down to what I have recently described as
the Governing Council having to "make a bet" on inflation staying in line with
projections.27
One known unknown remains the role of the exchange rate and the risk of
importing inflation. While monetary policy tightening was remarkably
synchronous around the world, easing cycles appear unlikely to exhibit
similar synchronicity. Diverging economic conditions and policies on both
sides of the Atlantic might lead to significant effects from the dollar-euro
exchange rate.
The mandate under pressure on two main fronts
Before concluding, I would like to take a step back and discuss two matters
related to the boundaries of central bank mandates. The first pertains to the
evolving public discourse on climate change and its implications for
monetary policy. The second revolves around the interactions between fiscal
and monetary policies.
While these two considerations might appear to be orthogonal to one
another, they were joined at birth by the reference in the ECB's mandate to
Article 3 of the Treaty on European Union (TEU). Taken together, the ECB is
expected to support EU policies as long as price stability is not jeopardised.
For many, supporting EU policies means using our very deep pockets to tilt
relative prices in directions deemed desirable from a social welfare point of
view. Specifically, we could buy green assets to lower the funding costs of
decarbonisation. We could provide fiscal space to governments so they can
meet the ever-increasing demands on already stretched domestic budgets.
Let me say it loudly and clearly: be careful what you wish for! Pushing central
banks into the inherently political waters of tilting relative prices could open
Pandora's box: never-ending mission creep and ultimately, politicisation
would loom large.
Let me now take these issues on one at a time.
Climate change
On climate change, I have gone on the record on two key occasions in 2021
and 2023. As you might guess, Jens had already made interventions in
2019.28
There has been a growing chorus of voices calling on central banks to take a
more proactive role in addressing climate change. While I acknowledge the
criticali