Benoît Coeuré: Monetary policy in a fragmented world
Speech by Mr Benoît Coeuré, Member of the Executive Board of the European Central Bank,
at the 41st Economics Conference of the Central Bank of the Republic of Austria, Vienna,
10 June 2013.
* * *
I wish to thank A. Saint-Guilhem and O. Vergote for their contributions to this speech, and Frank Smets and
Oreste Tristiani for their comments. I remain solely responsible for the opinions contained herein.
Ladies and Gentlemen,
It is a great pleasure for me to speak here today at the Oesterreichische Nationalbank. In my
remarks, I would like to address an issue that central bankers don't consider as central to
their role even though it attracts much public attention: the distributional consequences of
central bank action.
More than five years have passed since the financial crisis started. This period has been a
time of particular economic hardship. The recession and the subsequent sovereign debt
crisis in the euro area have been accompanied by rising unemployment, lower incomes and
reduced household wealth as house prices have dropped in some countries. But the pain
was not evenly shared. Between 2007 and 2010 the distribution of income widened in OECD
countries and poorer households have been hit harder, especially in several euro area
countries.1 Taken together, these developments are a source of great concern to all
Europeans.
To be clear, the central bank's mandate is not to address rising inequalities or to steer the
distribution of income. In fact, the use of explicit redistributive monetary policy tools, such as
credit controls, was abandoned decades ago. Since then, central banks have been granted
goal independence and assigned a clear mandate to keep inflation low. To borrow from
T. Padoa-Schioppa, monetary policy is mandated to focus on stability rather than equity or
efficiency.2 In the given framework, the distributional consequences of monetary policy are
temporary, unintended, with a view to safeguarding price stability. Ensuring a fair distribution
of income and consumption, or promoting economic justice for society as a whole are issues
that lie outside the realm of monetary policy. They are the tasks of other economic and
financial policies.3
Since the beginning of the crisis, monetary policy has been acting, however, in a fragmented
world. And the fragmentations were along different fault lines.
In the euro area, fragmentations had a horizontal dimension (among individuals), a vertical
dimension (over time) and a spatial dimension (across participating countries). And they
1
See OECD, 2013. "Crisis squeezes income and puts pressure on inequality and poverty", New Results from
the OECD Income Distribution Database, 15 May 2013. It includes the comment: "In Spain and Italy, while the
income of the top 10% remained broadly stable, the average income of the poorest 10% in 2010 was much
lower than in 2007".
2
See T. Padoa-Schioppa: "Efficiency, Stability, and Equity: Strategy for the Evolution of the Economic System
of the European Community", Oxford University Press, 1987.
3
There are two main reasons why central banks should be shielded from distributive politics. The first one is
legitimacy: the degree of fairness in society should be decided by society itself through the mechanisms of
representative democracy. Although it is generally not the case, distributive policies can, however, be
delegated to unelected bureaucrats if they can be instructed to be fair behind the veil of ignorance. The
second reason is efficiency. Central banks' limited number of instruments should be directed at a limited
number of objectives, with a clear priority. For an assessment of why distributive policies are usually not
delegated to bureaucrats, see A. Alesina and G. Tabellini, 2007. "Bureaucrats or Politicians? Part I: A Single
Policy Task", American Economic Review, March, p. 169-179.
have significantly impaired the potency of our standard monetary policy actions. The crisis
measures of the ECB have accordingly acted on the horizontal, vertical and spatial
transmission impairments of monetary policy. Most importantly, our measures have
prevented catastrophic outcomes for the euro area economy. And these outcomes would
have had the biggest impact on the weakest in society.
Does all this - as the conference title asks - imply a changing role for central banks in
macroeconomic stabilisation? The answer is no. Monetary policy should aim at preserving
price stability, the primary mandate given to us by the EU Treaty. With regard to the
objective, there are no differences between monetary policy in normal and crisis times. Only
the intensity and the choice of instruments might require an adjustment.
Affecting intra-temporal and spatial allocations should remain the responsibility of
governments and other authorities. Rather than being redistributive, central banks in a
fragmented world should aim at repairing monetary policy transmission, and restoring
thereby the distributional neutrality of monetary policy.
I will structure my remarks along three lines. First, I will describe the distributional
consequences of monetary policy and the channels through which monetary policy can affect
the distribution of income in normal times. Second, I will consider the crisis period and the
role of non-standard monetary policy measures. And finally, I will look at the role of other
economic and financial policies.
Distributional consequences of monetary policy in normal times
Back in the 1960s, monetary policy in western European economies had explicit and legal
redistributive functions. For example, central banks used credit control measures to
complement more traditional instruments consisting of quantitative ceilings on lending rates
or controls over the volume of bank lending to the private sector. Direct control over credit
was thought at that time to better stabilise economic cycles and inflation. Yet credit controls
were also used for other policy purposes, such as to finance government debt at lower
interest rates than markets would allow, and to foster the allocation of credit to specific
sectors considered as priority activities - in short, to pursue an industrial policy.
Central banks came to realise that credit controls were not the best way to fulfil their stability
objective. What's more, they came with undesired side effects. In particular, quantitative
credit ceilings were negatively affecting competition, innovation and efficiency in the banking
sector.4 In some countries, the use of credit controls as one of the main instruments of policy
led to a rapid expansion in the money supply, persistent inflation and frequent balance of
payment crises.
Today, central banks conduct monetary policy by altering the short-term interest rate to affect
inter-temporal decisions on consumption and savings. This inter-temporal - or vertical -
redistribution is at the heart of the monetary policy, which aims at price stability. A change in
the policy rate is transmitted to other interest rates at various maturities through a long
sequence of inter-temporal arbitrages. Ultimately, any change in interest rates for consumers
and firms affects saving, investment and spending decisions through an inter-temporal
substitution effect.
Monetary policy also affects the distribution of income on the intra-temporal - or horizontal -
dimension. Changes in short-term interest rates impact on consumption, savings and wealth
in different ways, depending on the characteristics of individual households. But all these
effects can be considered as temporary, indirect and unintended, that is, a side effect of a
strategy which aims at ensuring price stability in the economy.
So let me briefly describe how monetary policy can, in principle, affect the distribution of
income. Let me start with the impact over the short term before taking a longer-term
perspective.
Over the short term, we can see three main channels through which monetary policy may
have distributional consequences.
First, monetary policy may act upon the cyclical component of the distribution of income. In
fact, income distribution may narrow during an economic expansion and widen during an
economic contraction, especially if labour markets are not functioning well and the burden of
adjustment is disproportionately felt by outsiders. Just think of the case where, for example,
an increase in unemployment and a decline in the labour force participation are felt
excessively by low-skilled workers.5 Hence, this cyclical pattern of the income distribution
would imply that an expansionary monetary policy shock would also contribute to a
narrowing of the income distribution.
Second, an unanticipated surge in inflation will lower the real value of nominal assets and
liabilities. This tends to redistribute wealth from lenders to borrowers. As a majority of net
borrowers are in the lowest part of the income distribution, an expansionary monetary policy
shock would help to narrow the income distribution.6
Third, a monetary policy shock may impact on the price of financial and real assets by
affecting interest rates and expectations. The distributional consequences depend on asset
ownership patterns. In general, households in the highest percentiles of the income
distribution tend to have greater financial wealth and a larger share of income derived from
financial assets. If an expansionary monetary policy has positive wealth effects, it would lead
to a widening of the income distribution. In the same vein, if financial markets are
fragmented, an expansionary monetary policy may contribute to widening the income
distribution by redistributing wealth from individuals who do not trade in financial markets to
those who trade frequently in financial markets and tend to have higher incomes.7 On the
other hand, however, a decline in house prices is hurting low and middle-income households
disproportionately, as their wealth tends to be concentrated in housing.8
So what about the empirical relevance of these various channels? Most studies9 find that the
impact of monetary policy on the income distribution via lower unemployment of low-skilled
5
See S. Carpenter and W. Rodgers III, 2004. "The disparate labor market impacts of monetary policy", Journal
of Policy Analysis and Management 23(4), p. 813-830.
6
For an estimation of this effect in the US, see M. Doepke, and M. Schneider, 2006. "Inflation and the
Redistribution of Nominal Wealth", Journal of Political Economy, vol. 114(6), p. 1069-1097.
7
For a description of the underlying theoretical model, see Stephen D. Williamson, 2009. "Monetary policy and
distribution", Journal of Monetary Economics, 55(6), p. 1038-1053.
8
See S. Bloom Raskin: "Aspects of Inequality in the Recent Business Cycle", Speech at the 22nd Annual
Hyman P. Minsky Conference on the State of the U.S. and World Economies, New York, NY, 18 April 2013.
9
See, for example, R. Ahrend, J. Arnold and C. Moeser, 2011. "The Sharing of Macroeconomic Risk: Who
Loses (and Gains) from Macroeconomic Shocks", OECD Economics Department Working Papers 877; Blank
R. and A. Blinder, 1986. "Macroeconomics, Income Distribution, and Poverty." In Fighting poverty: What
Works and What Doesn't, Cambridge, Harvard University press; Blinder A. and H. Esaki, 1978.
"Macroeconomic Activity and Income Distribution in the Postwar United States". Review of Economics and
Statistics 60 (November); Castañeda A., Díaz-Giménez J. And J.-V. Ríos-Rull, 1998. "Exploring the income
distribution business cycle dynamics", Journal of Monetary Economics 42 (August), 93-130. Cutler D. and
Katz L., 1991. "Macroeconomic Performance and the Disadvantaged", Brooking Papers on Economic Activity
(2); Romer C. D and D. H. Romer, 1998. "Monetary Policy and the Well-Being of the Poor", in Income
Inequalities: Issues and Policy Options (Federal Reserve Bank of Kansas City), 159-201, and also: Coibon
workers is more important than the redistributive effects from unanticipated inflation. This
means that monetary policy, by stabilising economic fluctuations, indirectly affects the
cyclical variation of the distribution of income. A recent study based on the new Eurosystem
Household Finance and Consumption Survey indicates that monetary easing during the
crisis allowed a substantial decline in the debt burden of mortgage-holding households. This
was particularly so in euro area countries under stress, as well as for some disadvantaged
groups of households, such as the unemployed and those with low income or temporary
labour contracts.10
Still, these effects are all temporary. It was Knut Wicksell who, in his pioneering work
"Interest and Prices", illustrated the inability of monetary policy to permanently affect output
and employment. His concept of the "natural rate of interest" distinguishes between the
market rate of interest, set by the central bank, and the natural rate of interest that would
balance investment and saving. As long as the market rate is less than the natural rate, firms
and households want to invest and spend more, causing prices to rise. Such a cumulative
inflation would continue until the central bank raises the market rate to match it to the
changing natural rate. Wicksell's analysis ultimately suggests that the real forces driving the
underlying natural rate of interest are outside the control of the monetary authority.
What does that imply at the current juncture? Since monetary policy cannot permanently
affect the inter-temporal price of saving, savers who are concerned by the low level of
longterm real interest rates should worry less about accommodative monetary policy than about
the development of structural factors, such as productivity, which are beyond the control of
central banks.
Does this imply that monetary policy has no long-run or permanent effect on the distribution
of income? Certainly not. In fact, in the long run, monetary policy can control inflation, both its
level and variability, as well as the variability of aggregate demand. In this regard, price
stability can foster a more even distribution of income through several channels.
First, high inflation generates uncertainty and discourages investment.11 The associated
reduction in wages relative to the return on capital would contribute to widening the income
distribution. Second, the uncertainty and reduced effectiveness of financial markets caused
by inflation and macroeconomic instability reduces investment in human capital. Third,
inflation and macroeconomic instability may harm poorer households disproportionately. This
is because poorer households, which have limited or no access to the financial system, are
unable to smooth consumption in response to adverse income shocks.12 In addition, poorer
households tend to hold a larger fraction of their financial wealth in cash, implying that they
are particularly vulnerable to higher inflation. Finally, inflation and macroeconomic volatility
may harm some sectors of the economy disproportionately, such as manufacturing or
exportoriented industries, in which wages tend to be relatively lower.
Overall, monetary policy aimed at low inflation and economic stability is the most likely to
lead to greater social equality over the longer term. In this sense, "compassionate monetary
policy is, most likely, simply sound monetary policy".13
Monetary policy during the crisis
Over the past five years we have experienced the deepest recession in euro area countries
since the end of World War II. The associated fall in activity was unprecedented: at the
trough reached in June 2009, euro area nominal GDP had declined by almost 5% on an
annual basis. The recovery has been sluggish for the euro area, which is now experiencing a
double-dip recession, with growth expected to recover only gradually. The implications for
the distribution of income cover the three dimensions which characterise the allocation of
resources.
vertical
On the (or inter-temporal) dimension, the income and wealth losses of the existing
generation are severe.14 In addition, young people are those most affected by
unemployment. To take two examples, youth unemployment in Spain was at 55% and in
Greece at 57% at the end of 2012. This seriously affects the lifetime income and wealth
prospects of this group and may cause a "lost generation" to emerge. Not only is
unemployment an immediate social loss, but it is a stressful life event that reduces individual
well-being in many persistent ways.15
On the horizontal (or intra-temporal) dimension, small and medium-sized enterprises (SMEs)
and low-income households were hit hardest by the crisis. Wage cuts and income losses, for
example, have been the largest for low-skilled, low-wage workers. According to Eurostat, the
dispersion of disposable income in the euro area as measured by its Gini coefficient has
risen by more than 3% between 2005 and 2011. Recent ECB surveys show how SMEs and
households reported increasing financing obstacles, with bank loans becoming harder to
obtain.16 In addition, recent data suggest that SMEs, if they can obtain a loan, face higher
costs of bank lending than large companies. In fact, interest rate spreads on SME loans
compared with those for large non-financial companies have widened to an average of
40 basis points since 2010.
spatial
Finally, the crisis has brought to the fore the (or geographical) dimension. Euro area
countries suffered different fates during the crisis. We have observed sharp cross-country
dispersion in the cumulated changes in real GDP since the start of the crisis. In 2012, real
GDP was around 20% lower than in 2007 in the country most affected, while it was around
10% higher in the country least affected by the crisis. The cross-country dispersion of
unemployment has also widened, with latest unemployment rates ranging from 4.8% in
Austria to 27% in Greece.
Spatial inequality has been magnified by the adverse feedback loop arising from the close
association between banks and their sovereign, which has led to fragmented financial
conditions across countries and, at the height of the crisis, to fears of a euro break-up. In
particular, banks' funding costs have remained persistently high in some countries despite
cuts in the ECB policy rate, implying heterogeneous financing conditions for households and
firms across countries. This was also shown by the increasing reliance of banks in stressed
countries on Eurosystem funding. Widening TARGET2 imbalances - that is, large
intracentral bank positions - is a well-known symptom of these developments.
So what did the crisis mean for monetary policy? First, we saw impairments to the traditional
inter-temporal arbitrage mechanism, which has curtailed the effectiveness of our standard
monetary policy. Second, horizontal and spatial fragmentation - that is, impairments across
banks, markets and countries resulting from structural impairments and from the adverse
feedback loop described above - have challenged monetary policy operating with a single
instrument. Furthermore, we observed a self-reinforcing relationship between the spatial- and
inter-temporal dimensions of fragmentation. For example, the lack of liquidity in the interbank
market impaired the price-finding mechanism along the yield curve. As a result, our monetary
policy impulses were not evenly transmitted across countries or adequately along the yield
curve.
How should monetary policy be conducted in such a fragmented world? First and foremost,
monetary policy should aim at repairing the transmission of monetary policy by reducing the
fragmentations in the economy and restoring distributional neutrality. Does this imply
fundamental differences between monetary policy in normal and crisis times? The answer is
no. Monetary policy acts within the same stability mandate, following the same long-term
objectives as in normal times.
It is only the choice of instruments and the intensity of monetary policy action that differ. In
this respect, it has been argued that reducing fragmentation can imply a redistribution of risk
in times of crisis.17 For example, by relaxing collateral requirements for their lending
programmes, central banks can insure against a tail event in which the borrower and the
collateral fail to cover the borrowed amount. The main insight here is that redistribution of risk
is not a zero-sum game, but that the overall risk in the economy, in our case in the monetary
union, can be reduced. I agree with this view, but I would also like to stress that any such
insurance provided by the central bank should come with appropriate safeguards to mitigate
moral hazard.18
Let me explain how the ECB acted in the crisis and how monetary policy in particular has
alleviated the fragmentations in the euro area following the principles outlined above.
First, in the wake of a widespread confidence crisis following the collapse of Lehman
Brothers which threatened to produce very adverse economic outcomes with strong
reductions in output, deflationary spirals and high unemployment, we made a series of policy
rate cuts. These limited the consequences the downturn could have had on the income of
households and firms across the euro area.
Our more recent rate cuts have narrowed the interest rate corridor between the deposit rate
and our main policy rate to 50 basis points. These rate cuts have further eased the financing
conditions of borrowers in the euro area and they have contributed to a decline in the
crosscountry heterogeneity in funding costs. Banks from stressed countries which participate most
in Eurosystem liquidity-providing operations will benefit from the lower interest rate charged
for these operations. This will, over time, translate into reduced financing costs and improved
access to credit for households and firms in stressed countries.
Second, apart from standard monetary policy, the ECB has also resorted to a number of
nonstandard measures. By re-directing credit to those segments where financial intermediation
ceased to function, the non-standard measures supported those areas most in need and
thereby countered the increasing heterogeneity. The announcement of outright monetary
transactions (OMTs) in particular has played a crucial role: it has improved the transmission
of monetary policy by removing the "tail risk" arising from redenomination concerns in certain
euro area countries.
Overall, while our non-standard measures were designed for the euro area as a whole, their
use has varied among counterparties and across countries. In this regard, our non-standard
measures restored the distributional neutrality of our monetary policy by mitigating distortions
in certain stressed asset classes or sectors. Their impact has prevented very adverse
economic outcomes for certain sectors and countries, and because of the effect this would
have had on the rest of the euro area, it has thereby also supported medium-term price
stability in the euro area as a whole.
Today we are clearly seeing signs of improvement in financial conditions. Spreads in
sovereign and corporate debt markets have fallen substantially. Deposits placed by the euro
area money-holding sector with banks in stressed countries have increased by about
€200 billion since August 2012. As a consequence, borrowing from the Eurosystem has
declined. TARGET2 balances of the national central banks in these countries have fallen by
more than €250 billion since their peak of around €1.09 trillion in August last year. And these
improvements largely reflect the removal of fears of a systemic collapse of the monetary
union that were previously being priced in by markets. They also reflect the reintegration of
euro area funding markets, against the backdrop of a continuing adjustment effort by
participating countries. Falling TARGET2 balances are the best proof that the distributional
consequences of non-standard monetary policy measures are unintended and temporary.
The role of other economic and financial policies
Economic divergences and heterogeneity remain high in the euro area. This concerns in
particular the fragmentation in some markets and diverse and weak loan growth across
participating countries. While monetary policy in this situation has alleviated the severity of
the downturn, let's not forget Wicksell's insights. Monetary policy cannot alter the level and
distribution of income in a durable way.
The distortions at the heart of the current vertical, horizontal and spatial fragmentation can
finally only be addressed by adequate economic policies outside the realm of monetary
policy. Indeed, other stakeholders have to take the leading role by continuing to address the
underlying structural weaknesses that are affecting our economies.
Let me mention three policy areas that I consider fundamental in this regard.
The first policy realm relates to policies aimed at the financial sector. Governments and
financial sector authorities need to further encourage the repair of banks' balance sheets.
Banks in the euro area finance the backbone of our economic system: households and small
and medium-sized companies.
The decision to establish a European Single Supervisory Mechanism (SSM) is an essential
institutional step overseeing such a process. The SSM will contribute to greater financial
integration, a level playing field and greater financial stability. It should be complemented by
a unified European framework for bank resolution and recovery, and with a Single Resolution
Mechanism with the authority to wind up banks in a timely and impartial manner. To
complement this, further efforts are essential for banks to build up sufficient capital, remove
legacy risks from their balance sheets and to make these balance sheets fit for lending.
Repairing the financial sector is the best way to ensure that the debt crisis does not bear a
permanent impact on income distribution, and hence that it does not impose a permanent
constraint on monetary policy.
The second policy area that I would like to mention is fiscal policy.
It is normally the role of fiscal policy (including in its tax dimension) to deliver any income
distribution that society would like to implement based on a normative prior. It is normally the
role of fiscal automatic stabilisers to cushion the economic and distributional impact of a
deep economic recession of the sort we are experiencing. I say "normally" because we are
not in normal times. Fiscal imbalances and weak sovereign balance sheets have prevented
fiscal policies from cushioning the large and protracted financial and economic shocks of the
past five years.
The lesson from this is clear. Running excessive fiscal deficits at the expense of future
generations can be very costly in times of crisis. Therefore, maintaining sustainable fiscal
budgets is a necessary condition to achieve distributional equality, both inter-temporally and
intra-temporally.
Let me finally mention the structural economic policy domain. Structural policies are key to
making an economy more flexible so that it can optimally and rapidly respond to negative
economic shocks and avoid the higher costs in terms of lost output and higher
unemployment associated with the slower and more protracted adjustments made by rigid
economies.
It is designed in such a way that it curtails rent-seeking behaviours in labour, product and
capital markets, structural reform will not only unleash competition and innovation but it will
also temper the distributional and social consequences of the needed adjustments. Structural
labour market policies are a case in point. They can help to prevent labour market
adjustments from falling disproportionately on outsiders, including the younger generation.
Conclusions
Let me conclude by listing the main arguments put forward in my remarks:

First, the role of monetary policy is clearly defined in the EU Treaty. The ECB has
been mandated by the people of Europe to maintain price stability over the medium
term. Fulfilling this mandate means preserving the value of money over time and
contributing to overall economic stability. This has the effect of shielding the
lowestincome groups and maintaining living standards for the entire population. Therefore,
monetary policy is neutral with regard to fairness and the allocation of resources.
But this neutrality can only be ensured if monetary policy transmission is not
impaired.

Second, and as a result, monetary policy in crisis times should aim at repairing
monetary policy transmission by reducing fragmentations in the economy and
restoring thereby distributional neutrality. There is, however, no fundamental
difference between monetary policy in normal and crisis times. The intensity and the
choice of instruments in a crisis might need to be adjusted, but monetary policy
should continue to act within the same stability mandate and following the same
long-term objectives as in normal times.

Third, the ECB's monetary policy actions have offset market dislocations and
thereby contributed to restoring distributional neutrality during the crisis. In
particular, non-standard measures have helped to eliminate tail-risks and, together
with the standard measures, have prevented very adverse outcomes for the euro
area that would have hit in a disproportionate way the weakest in society, and put at
risk price stability.

And finally, despite the temporary relief brought by our policies, there are limits to
what monetary policy can do. Steering income allocation within countries and across
countries is the responsibility of elected governments and other authorities.
Important work has been done, but in the current environment it is essential that
euro area governments continue their reform efforts, individually and jointly, keeping
in mind the need to curtail rent-seeking behaviour and protect the weakest in
society.
Thank you for your attention.