Jürgen Stark: Adjusting monetary policy in a challenging environment
Speech by Mr Jürgen Stark, Member of the Executive Board of the European Central Bank,
at the "ECB and its Watchers XIII" conference, Frankfurt am Main, 10 June 2011.
* * *
1. Introduction
Ladies and gentlemen,
It is a great pleasure for me to be here today at the thirteenth in this series of conferences
entitled "The ECB and its Watchers".
The theme of this session is the return to normality. It assumes that we know what the "new
normal" will look like. What we do know is that it will be different from the "old normal", as the
crisis has changed the economic and financial environment in many ways. But it is still too
early to characterise what exactly the new normal will look like, also because the crisis is still
ongoing.1 Therefore, rather than talking about going back to normal, I prefer to talk about
adjustments to policies.
Indeed, during the period of acute financial stress we have seen many changes in the area of
economic and prudential policies. However, this is far less the case for the ECB's monetary
policy. Our main objective which is to maintain price stability for the euro area as a whole
over the medium term has remained unchanged. Of course, exceptional circumstances have
called for extraordinary measures. In response to the crisis, we lowered our key interest rates
in an unprecedented manner. We have also introduced a number of non-standard measures
to support the transmission of our interest rate decisions to the euro area economy. All these
measures have lent considerable support to economic activity, while remaining fully aligned
with our deep-rooted aim of maintaining price stability.
Now, economic recovery in the euro area is on a more self-sustained path. Looking ahead,
we expect the economy to further benefit from ongoing global growth and the still
accommodative monetary policy stance. At the same time, for some months by now, we
have been observing relatively high inflation rates and continued upward pressure on prices.
Overall, we see risks to price stability on the upside. This calls for strong vigilance. In this
respect, we stand ready to further adjust our still very accommodative monetary policy
stance. In the same vein, we will act in a timely manner as regards further steps to phase out
our non-standard measures. The concrete steps of adjustment will remain guided by our aim
of keeping inflation in the euro area below, but close to, 2% over the medium term for the
euro area as a whole.
In my contribution today, I will emphasise that the ECB conducts monetary policy "as usual".
In particular, after briefly recalling the motives for our April interest rate increase, I shall
elaborate on how the ECB deals with the particular challenges prevailing, namely
• inflation pressures stemming from commodity prices
costs of keeping interest rates low for too long
•
the adjustment to the monetary policy stance with some non-standard measures still
•
in place, and
divergent macroeconomic and financial developments in the countries of the euro
•
area.
2. Commodity prices and the outlook for price stability
On 7 April we increased our key interest rates by 25 basis points. This decision was the first
policy move since May 2009. It was mainly driven by upside risks to price stability, in
particular relating to further increases in energy and commodity prices. Continued upward
pressure on overall inflation is discernible in the early stages of the production process. It has
the potential to translate into inflation expectations, broad based second-round effects in
price and wage-setting and inflationary pressures over the medium term.
As mentioned, we continue to see upside risks to price stability. Signals from the monetary
analysis indicate that the underlying pace of monetary expansion is gradually recovering. At the
same time monetary liquidity remains ample. It could accommodate upward price pressures.
In addition, strong economic growth in emerging markets likely contributes further to
commodity price rises. Ample liquidity at the global level could support this development. The
monetary policy stance of many central banks around the world also remains very
accommodative. This creates an environment which is raising inflationary challenges, in
particular for emerging economies that shadow US monetary policy.
Is the fact that inflation is being driven mainly by commodity prices not a reason to be less
concerned about inflation in the medium term, as these such developments are usually
temporary only? Theoretically, it is possible to look beyond the volatility in inflation triggered
by first-round effects of commodity price changes if these are of a purely temporary nature.
However, the central bank also needs to consider policy action in case sustained upward
trends in commodity prices are seen as a risk to price stability over the medium term. We
have already observed in the past that commodity prices tend to follow a secular "trend"
reflecting amongst others things the fast growth in emerging economies.
Moreover, if transitory rises in commodity prices ran the risk of triggering second-round
effects, they may also have a more lasting impact on consumer price developments and
medium-term inflation expectations. Monetary policy then needs to avert temporary inflation
increases that lead to second-round effects in wage and price-setting behaviour, for instance
due to the indexation of wages and prices to past inflation.
Today's discussion on how to react to rising commodity prices reminds me of that prevailing
in the 1970s. In the aftermath of the oil price shocks of 1973 and 1979, inflation in the OECD
countries increased dramatically from already relatively high levels 5.7% in 1971 to
doubledigit numbers 14.8% in 1980. It seems evident that this evolution, which was later labelled
the "Great Inflation",2 was mostly driven by increasing oil prices.3 However, Germany - and
also Switzerland - was a notable exception.4 German inflation rose from 5.2% in 1971 to
5.4% in 1980. The Bundesbank chose to tighten its monetary policy stance. This policy
resulted in significantly higher real interest rates in Germany, compared to other OECD
countries. This helped the economy to grow in line with its potential. Moreover, on account of
the associated appreciation of the D-Mark, the oil price increase had a more limited direct
impact on inflation. Overall, the different inflation experiences of the 1970s clearly
demonstrate that the "Great Inflation" was not only the result of rising oil prices but to a large
extent driven by different monetary policies. Faced today with rising commodity prices we
should not forget this lesson, a fortiori in a context of globally loose monetary policies and
ample liquidity.
3. Costs of keeping interest rates low over a long period
Maintaining our medium-term focus is particularly important in the current environment.
Short-term volatility is extensive and uncertainty remains unusually high. Thus, central banks
need to avoid just looking at the short-term consequences of a somewhat tighter monetary
policy stance and take a longer-term perspective. This should include the costs and related
risks to price stability that may arise if interest rates are kept too low for too long.
The risks associated with keeping interest rates low for too long a period have been clearly
exposed and documented in several recent analytical contributions. The period prior to the
financial crisis has demonstrated that global policy accommodation for a protracted period of
time can inadvertently distort incentives and behaviour in the financial sector. Low interest
rates over too long a period foster an under-pricing of risk5, inducing excessive risk-taking.
And low interest rates delay and ultimately prevent the necessary repair of balance sheets. In
the end, this turns low interest rates into a curse. It does not only hinder strong and
sustainable economic growth but also compromises price stability over the medium term.
Nonetheless, the current global policy debate seems to favour the same asymmetric approach
that characterised the pre-crisis conventional wisdom, the so called Jackson-Hole consensus
- to which the ECB never subscribed - and which can be summarised in three elements:
1. aggressive policy easing when financial developments turn sour;
2. postponing the exit from low rates even when conditions improve, for fear of
harming the economic recovery;
3. no policy reaction to domestic and global liquidity over and above what is requested
by standard inflation forecasts at standard horizons.
Undoubtedly, this asymmetric approach at the global level contributed to the financial crisis.
In contrast to this, the two-pillar strategy of the ECB follows a more structured approach. It
currently indicates that improvements in monetary, credit and financial conditions require an
adjustment to the monetary policy stance. Empirical evidence shows that, also in the past,
monetary policy in the euro area reacted symmetrically to signals coming from monetary and
credit conditions.6 This symmetry has contributed to limiting financial imbalances and will
continue to provide a clear medium-term focus.
Does the above imply that the ECB is carefree as regards current economic developments?
Of course not. We are aware of the risks surrounding the current pace of economic
expansion. But easy money cannot and will not address the root causes of the crisis.
Homework needs to be done on the fiscal side. Governments need to strengthen decisively
public finances. We need a safer financial system. This requires improving the capital
position of banks and tighter regulation. Central banks can not be expected to continuously
prolong measures to compensate for lingering risks from the financial system.
4. Interest rates and non-standard measures
Do liquidity support measures constrain the conduct of monetary policy? Decisions on policy
interest rates and on non-standard measures are largely separated: as always, we set
interest rates to maintain price stability, while our non-standard measures support the
transmission of monetary policy.
Nevertheless, to some extent, the two decisions are also interlinked. The fixed-rate
full-allotment procedure in all refinancing operations, for instance, created large amounts of
excess liquidity, as observed, in particular, over the lifetime of the 1-year LTROs, driven by
strong demand from banks, which resulted in short-term money market rates (such as the
EONIA) falling below the rate of the main refinancing operations. Movements in the EONIA
have further trickled down the EONIA swap curve at different maturities. The money market
rate therefore does not unambiguously reflect the stance of monetary policy in the same way
as in the past.
The MRO rate will become more relevant again in the future, signalling our monetary policy
stance. This implies that the overnight rate will be close to the MRO rate. We already see
that interbank markets are performing better, as shown for instance by the decreasing
dependency of banks on ECB refinancing operations. Recourse to these operations has
declined significantly from close to €900 billion in June 2010 to around €430 billion today.
5. Monetary policy and heterogeneity
In public debates, viability of the euro has again been questioned on the ground that the
financial crisis has deepened the economic divide across member states. But the ECB's
monetary policy continues to be geared towards price stability in the euro area as a whole.
The single monetary policy of the ECB cannot address different economic growth or inflation
across regions of the euro area. Such macroeconomic heterogeneity is a normal feature
within a monetary union. Heterogeneity can even be a desirable feature when it reflects the
necessary adjustments to macroeconomic imbalances that have built up.
Macroeconomic diversity is an issue that national policy-makers should deal with, not the
ECB. Their primary contribution of course would be to avoid building up unsustainable
macroeconomic imbalances. Indeed, the bulk of the current imbalances in some euro area
countries reflect that countries have insufficiently internalised the participation in a monetary
union into domestic policies. To fully realise the benefits of EMU requires national policies to
adapt to EMU. This applies to the areas of fiscal policy (including taxation), structural
reforms, regulation and banking supervision. Without this, imbalances will inevitably reoccur,
challenging the proper functioning of EMU and thus of monetary policy. It is essential to put
in place a European framework that is incentive-compatible and credibly enforceable, to
avoid the re-emergence of significant imbalances. National policies should be fully guided by
the framework.
Does this then imply that monetary policy completely ignores developments in individual euro
area countries of the euro area? No, but specific national developments play a role for
monetary policy only to the extent that they have an impact on the medium-term outlook and
risks for price stability in the euro area as a whole.
Maintaining price stability for the entire euro area is the central contribution the ECB's
monetary policy makes with a view to supporting sustainable economic growth, job creation
and financial stability. Any other monetary policy would come at the cost of lower
mediumterm growth, for instance on account of higher longer-term interest rates or reduced
confidence on the part of economic agents.
6. Concluding remarks
Let me conclude.
For the main elements of the ECB's monetary policy strategy, there is no need for
adjustment as these elements have not changed during the crisis. We will do all that is
needed to ensure price stability over the medium term. We will change the monetary policy
stance whenever necessary. There is no pre-defined sequence as regards interest rate
decisions and the decisions on the phasing-out of non-standard measures.
Monetary policy will continue to be orientated towards the medium term, taking into account
macroeconomic effects that take place after the initial effect, including effects on the
incentive-structures of economic agents caused by keeping interest rates low over a long
period. In this respect, we rely on the structured approach provided by our two-pillar strategy.
Likewise, the ECB's single monetary policy will continue to be geared towards the euro area
as a whole, not just a small part of it.
The times of crisis have shown that we in the Governing Council of the ECB are strongly
determined to deliver what we are expected to deliver: price stability in the euro area in the
medium term. The continuation of well-anchored inflation expectations in the euro area
illustrates the credibility we have achieved in reaching our objective. For this objective, and
this one alone, the ECB can be held accountable.
For other policy areas, national policy-makers and authorities need to take full responsibility.
National authorities need to address outstanding imbalances urgently, by restoring fiscal
sustainability and by putting the financial sector on a healthy footing. Embarking on this path
would also ensure that the single monetary policy fits all.