jose manuel gonzalez - paramo : non - standard monetary policy : five questions about the exit speech by mr jose manuel gonzalez - paramo, member of the executive board of the european central bank, on the occasion of the seminar at the european economics and financial centre, london, 6 november 2009. * * * introduction 1 i would like to thank the european economics and financial centre ( eefc ) for organising this conference and giving me the opportunity to speak in front of such a distinguished audience. this is the second time i have had the honour of participating in the eefc series of seminars ; the first time being back in september 2006. it is always a pleasure to be invited to address an audience again because it allows you to resume the dialogue already started. back in 2006 my speech focused on the many challenges that uncertainty poses for the design of monetary policy. today, i would like to focus on some questions related to the exit from the ecb ’ s non - conventional monetary policy. there is no need for me to recall the start of the crisis in early august 2007, when tensions originating in the us sub - prime mortgage market spread to international money and credit markets, nor its intensification in mid - september 2008, following the filing for bankruptcy protection by lehman brothers. while the full cost of the crisis has yet to be assessed, the output contraction and job destruction observed so far ( as well as the less readily measurable social costs ) have been on a scale unseen for more than half a century. in order to contain the impact of the crisis on the real economy and preserve price stability, central banks have engaged in an aggressive cutting of policy interest rates and have introduced a number of non - standard monetary policy measures. at the same time, governments have adopted large fiscal stimulus measures, while also making vast public funds available to provide support to their banking and financial industries. recent data suggest that the massive response to the crisis by public authorities is bearing fruit. the threat of a continuing free fall in activity in our economies has now receded and there are signs that the global slowdown may be bottoming out. however, the crisis has certainly not come to an end : uncertainty remains high and the economic data remain volatile. based on the information currently available, we expect the recovery to be gradual and, at least in the short term, to continue to rely on a number of temporary factors, such as past discretionary stimulus. even though the crisis is not yet over, during the last year we

supply in the economy. if demand is greater than the goods and services that can be supplied, prices will tend to rise. and vice versa. as such, when setting monetary policy, the mpc needs to make an assessment about current and future trends in supply, as well as demand. the discussions about economic growth we typically read about in newspapers and see on tv are normally posed in terms of demand. is gloom on the high street spreading? claims and counter - claims about the likely impact of the fiscal consolidation. but the mpc also needs to consider the prospects for supply. how quickly is the capital stock likely to grow? and, importantly, will the recent weakness in productivity persist or reverse? typically, the growth rates of factors determining the supply potential of our economy – population, the capital stock, structural productivity – are far less volatile than those of demand. as such, it is often natural for the main focus of policy to be concentrated on the prospects for demand. but judgements about supply also matter, particularly so in the aftermath of a deep recession. in recessions, demand typically falls by more than supply. an output gap opens up – the economy can supply more than is currently demanded. and unless that gap is closed, it will push down on costs and prices. the job of monetary policymakers is to loosen policy, so that demand is brought back into balance with supply and inflation remains close to target. exactly how expansionary policy should be depends critically on the size of the output gap. but assessing the size of the output gap is very difficult, for exactly the reasons we have been discussing today. early estimates of economic activity can be revised substantially, so it is hard to know just how weak demand and output really are. and it is equally difficult to know the extent to which the supply potential of the economy has been affected by the recession. 13 this difficultly greatly complicates the setting of monetary policy. indeed, in a series of influential papers, athanasios orphanides ( eg orphanides 2003 ) has argued that over - estimates of the size of the output gap played an important role in the policy mistakes that led to the period of persistently high inflation in the us in the 1970s and 80s. or indeed, if shocks to supply were instrumental in causing the recession. bis central bankers ’ speeches i hope that we are learning some of the lessons from the past. taken at face value, the depth of the recession might suggest there is considerable spare capacity