Banca d'Italia and SUERF workshop
'The effectiveness of monetary policy in a low interest rate
environment'
Welcome address by Daniele Franco
Senior Deputy Governor of the Bank of Italy
Rome, 18 November 2020
I am happy to welcome you all to the Banca d'Italia and SUERF's joint Workshop on
'The effectiveness of monetary policy in a low interest rate environment'.
As you may know, we had scheduled this workshop to take place in June, but we
had to postpone it, because of the pandemic. We also had to move to a virtual setting
and rely on video connections.
The workshop addresses issues that are now at the top of policymakers' agendas
around the world. The pandemic has led to the worst recession in recent history, and the
scars that it will leave on the global economy are likely to prolong the low interest rate
environment. Monetary policy is playing a key role in supporting the recovery and its
contribution will remain fundamental in the coming years. The discussion on strategies,
targets and tools remains open.
Today and tomorrow, we will have the opportunity to embark on a wide-ranging
debate on the challenges ahead. In my remarks today, I will touch upon a few of them.
To begin with, I think we can all agree that the pandemic crisis has further exacerbated
the effects of some ongoing long-term trends. Some of these trends have already been
in place since the Great Financial Crisis and its aftermath. I am mostly referring to the
drop in the natural rate of interest1 and to the subdued inflation dynamics. These trends
are due to structural changes in macroeconomic relationships and imply a need both to
reassess theoretical frameworks and to review the monetary policy strategy and tools.
In this respect, the first session deals with monetary policy strategy in such a low
interest rate environment. This of course calls into question the issue of the appropriateness
of the current inflation target, which is indeed one of the main items on the table in
the Eurosystem's monetary policy Strategy Review. I will not comment further on the
Strategy Review, since it is still ongoing.
Another important theme in the "post-pandemic" environment will be the
interaction between fiscal and monetary policy. As we know, fiscal policy worldwide
was boldly expansionary during the most acute phase of the pandemic crisis. In the EU,
an unprecedented joint response of Member States will contribute significantly to the
recovery in the years to come.
In the current circumstances, a sizeable fiscal stimulus is necessary, in order to
sustain aggregate demand. However, that very same stimulus raises new challenges, as it
will result in a record increase in public debts around the globe.
Although I firmly dismiss the risks of fiscal dominance, nevertheless monetary policy
cannot ignore the impact of fiscal policy, as is made clear by the second paper of the
session.
These considerations take me to tomorrow's first session, which will focus on
'structural changes' in monetary policy transmission. Indeed, the historically high levels of
public and private debt may well have an impact on the transmission of monetary policy
through channels such as the interest rate exposure,2 which in the current environment
may lead to significant wealth and income effects.
One could argue that high levels of debt boost the monetary policy transmission
mechanism via a 'leverage' effect, but at the same time generate the risk of higher
volatility and, ultimately, may have financial stability implications.
The repayment of this high debt burden is currently being made easier by the low
nominal interest rates regime, an aspect emphasized by Olivier Blanchard in his AEA
presidential lecture last year.3 However, the persistence of low medium- and long-term
interest rates cannot be taken for granted. Moreover, episodes of financial turmoil, due
to market perceptions or to a change in fundamentals, can happen, creating a negative
feedback loop between market expectations and macroeconomic fundamentals.
This allows me to touch upon the topic of the instruments of monetary policy, which
will be the focus of the concluding session of the workshop. The unconventional policies
adopted by central banks around the world in the last decade have proved effective, as
a copious amount of evidence suggests.4 The experience gained with the new monetary
policy tools in the last decade must guide our choice of the unconventional instruments
that central banks should retain in their toolbox.
Undoubtedly, many of the instruments deployed in recent years will remain in use
in the near future. At the same time, we are now better equipped than in the past to
mitigate the undesired side effects of some instruments, as in the case of the two-tier
mechanism for the remuneration of excess reserves.
A final point that I would like to touch upon concerns the governance of economic
research at the present time.
Economic research is part of the monetary policy toolbox. Sound economic research
is a precondition for the independent assessment of the most appropriate monetary
policy stance.
As Governor Visco remarked (2016), 'monetary policy cannot wait until sufficient
information accumulates that may cast full light on the new mechanisms at work'.5
This issue has been evident in recent years, when we all faced the great challenge of
'conduct[ing] both policy and research in real time', as the former ECB President Draghi
once said.6 Precisely because of that, timely and high quality economic research has
become increasingly important within central banks, since there is a compelling need to
assess the impact of new policies as they are deployed. In this respect, I see two main
challenges for central banks in the coming years.
First, in the face of the great uncertainties on the shape, timing and features of the
recovery ahead, we must keep producing research in 'real time', making use of a broad
range of modelling tools and of more sophisticated datasets.
Secondly, our research should not only be timely, but also seek the highest quality
standards. Quality is needed to make policy credible for both experts and the general
public alike. Clarity in communicating our results is also crucial. At the same time, the
complexities of the current economic environment urge us to keep enlarging the range
of research topics covered, in order to better understand the drivers of the structural
changes affecting the real economy as well as financial markets.
In light of the above, it is of the utmost importance to strengthen international
collaboration with other central banks, universities, think tanks and industrial bodies in
order to generate and nurture new and better ideas. We are therefore delighted that this
workshop has been co-organized by Banca d'Italia together with SUERF. Through a wide
range of events and publications bridging research and policy, SUERF is an outstanding
meeting point for the profession to foster a fruitful dialogue between central banks,
financial sector practitioners and academic institutions.
* * *
We can now start delving into the core topics of our research workshop. We do so
with one of the most prominent and renowned researchers in macroeconomic theory,
monetary economics and monetary policy.
I am delighted to introduce our keynote speaker, Professor Jordi Galí: professor at
Universitat Pompeu Fabra and at the Barcelona Graduate School of Economics; director
of the Center for Research in International Economics; and research fellow or research
associate at the CEPR, NBER, Econometric Society and European Economic Association.
He is very well known in the central banking community for his groundbreaking
contributions to dynamic macroeconomic models, the determinants of inflation and the
conduct of monetary policy.
We are looking forward to his insights. Jordi, the floor is yours.
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