Bellagio event in Paris - 11 January 2024
International monetary spillovers: financial and intellectual linkages
Speech by François Villeroy de Galhau,
Governor of the Banque de France
Press contact:
It is a great pleasure to welcome the Bellagio group in Paris. The 80th
anniversary of the D-day Landings this year is an important reminder that
American and European histories are so closely inter-twined. Today this relation
materialises through tight economic and financial linkages, the subject of my talk
this afternoon.
1. Financial interlinkages and global monetary policy spillovers
In a globalized world, economies are linked through trade and financial flows.
While these linkages help when domestic demand falters or domestic savings
are scarce, they can also transmit adverse developments across borders. This
is the essence of international risk sharing, which if taken to the limit would imply
a common global cycle. Due to global value chains, spillovers and co-
movements in goods production have indeed risen over recent decades.
However, there is less commonality in the production of services. The rising
share of services in overall production has offset the increased integration of
goods, so that the co-movement of economic activity between countries has not
increased.1 The disruptions caused by Covid and Russia's unjustified invasion
of Ukraine have shown the fragility of extended supply chains. Noticeably, there
had already been some retrenchment in globalization indicators following the
Great Financial Crisis, as shown in Figure 1 (Slide 2). However, fewer spillovers
do not necessarily imply less volatility. In autarky, countries depend entirely on
their own industries and there is less ability to adjust to domestic shocks.
On the financial side, the globalized economy features similar patterns. On the
one hand, increased openness implies rising exposure to the global financial
cycle2. On the other hand, improved policy credibility and better monetary policy
frameworks have allowed more countries to have freely floating exchange rates
and independent monetary policy to meet domestic objectives.
However, monetary policy still generates important financial3 and trade4
spillovers. As a group of countries tightens monetary policy, their currencies can
appreciate and potentially generate inflation spillovers to the countries on the
other side of that appreciation5. In the case of a global inflationary shock, it is
important to avoid 'reverse currency wars' as countries seek to escape
inflationary depreciation. But coordination does not mean that the pace of
monetary tightening must be equal across all economies, as each has its own
specificities. For example, relative to the US, fiscal policy has been less
expansionary across Eurozone economies, and the euro area also features a
stronger predominance of bank credit relative to market credit, which can be
important for the transmission of monetary policy.6
But monetary policy works also through market expectations of future policy
rates, which can change quickly and are formed within a global market, creating
an additional channel for spillovers. When one central bank makes a move,
markets' attention turns to its peers in search for cues on their likely next
decisions. Indeed, there are strong mutual interdependencies between US and
euro area yields over time: going beyond simple correlations, estimates based
on Granger-causality tests suggest that causality runs both ways (Figure 2, Slide
3). Interestingly, this two-way causality holds for rate expectations at short to
medium term maturities - the typical monetary policy horizon, as shown by
Figure 2 (Slide 3); and at longer maturities, causality mainly runs via the term
premium. The latter is consistent with the dominance of global macro-financial
factors as drivers of the term premium component of long-term rates.
While spillovers between the US and the euro area are mutual, their intensity is
asymmetric.7 US factors explain a larger share of variations in euro area yields
than the opposite, as shown by Figure 3 (Slide 4). And this share varies across
assets: US spillovers exert a larger impact on stock prices than on bond yields,
for example. At the same time, there seems to be rising sensitivity of euro area
rates to US news of late, amid sustained yield volatility on both sides of the
Atlantic. With inflation largely driven by common global factors such as energy
prices over recent years, it seems that markets use US data as a leading
indicator for inflation releases in other countries, implying that rate expectations
adjust in tandem.
2. Intellectual spillovers
Global interdependence is not only about economic or financial linkages, but
also about ideas flowing across borders, "intellectual spillovers".
As the issuer of the main international reserve currency and home of the largest
and most liquid financial market, the US has a prominent position in shaping
global financial markets. This is particularly true for US monetary policy, which
is an important driving force of the global financial cycle.8 Several
unconventional monetary policy measures first put in place in the US were later
adopted by other countries, such as large-scale asset purchases or interest rate
forward guidance. Reflecting the US central role, most of the economic literature
first uses US empirical applications before applying it to other countries. There
are however counter-examples to this. A conference hosted by the Banque de
France in October showed that there is active research using euro area data
and there are clearly lessons to draw from the euro area for other central banks.
In fact the direction of spillovers is not just one way. The inflation-targeting
framework was pioneered by the Reserve Bank of New Zealand and the
Riksbank, among others. And the ECB, from its inception, opted for a 2%
numerical inflation reference in the definition of price stability that is now the
standard worldwide. Fixed-Rate Full Allotment (FRFA), Targeted Longer-Term
Refinancing Operations (TLTROs), Negative Rates, or measures aimed at
restoring monetary policy transmission such as the Pandemic Emergency
Purchase Programme (PEPP), were all novelties that the ECB brought into
mainstream central banking.
This reciprocity is also visible in the growing interactions between the ECB and
the Federal Reserve at all levels. This greatly helps overcome the Atlantic
barrier. Let me for example mention the Research area, where frequent
exchanges are taking place among staff, and the now established practice of
bilateral video conferences on topics of relevance to both institutions. While I
welcome these growing interactions, let me also stress that more needs to be
done to facilitate publication of euro area research in US-based reviews and its
broader dissemination through appropriate citations.
3. International cooperation
Central banks have made bold progress in collectively managing spillovers,
particularly during crises. One good case in point is the development of a
network of standing currency swap arrangements across central banks to
provide emergency liquidity, which contributes to foster global financial stability.
Likewise, the strengthening of the Basel Framework helps reduce adverse
spillovers, and the banking turmoil of early 2023 underlines the importance of
fully implementing the Basel III rules. Furthermore, in order to ensure financial
stability, central banks strive to act efficiently in many areas. We are doing more
than simply safeguarding the past and fixing problems. Marked progress has
been made to secure payment systems and infrastructures, supervise financial
institutions while closely monitoring vulnerabilities and assessing new risks such
as those stemming from Non-Bank Financial Institutions (NBFIs), crypto-assets
and the emergence of Decentralized Finance (DeFi). Let me add that, within
their mandate, cooperation between central banks should be strengthened to
promote climate mitigation policies across their fields of intervention.
The BIS, an international financial institution owned by central banks, is a good
example of a well-functioning and efficient multilateral organisation. Trust,
cooperation and respect among members are three building principles of the
BIS that are key ingredients for effective international cooperation.
Finally, central banks are very active in promoting research and steering global
networks such as the International Banking Research Network9 and the Network
of Central Banks and Supervisors for Greening the Financial System, for which
Banque de France has a leading role. Looking forward, central banks likely need
to consider the effects of artificial intelligence, which will require a strengthening
of international cooperation.
To conclude, spillovers can take very different forms and can change
substantially over time. The Bellagio Group is ideally positioned to discuss these
issues due to its unique composition, with central bankers, Treasury officials and
academics around the table. For this reason in particular I very much value our
discussions at the Bellagio Group.