what the future holds – benefits and limitations of forward guidance speech at the european banking congress 22. 11. 2019 | frankfurt am main | jens weidmann 1 introduction 2 clarifying the reaction function 3 lower for longer 4 achieving price stability in the euro area 5 conclusion 1 introduction ladies and gentlemen, more than 200 years ago, french scientist pierre - simon laplace proposed that the universe was essentially deterministic and, hence, predictable. some being – later called a demon – with sufficient information and calculating power would be able to know all the states of the universe : past, present and future. in today ’ s financial markets, laplace ’ s demon could easily earn a fortune. but despite all the progress in computing, it has never come into existence. still, some people may dream of its possibility. brazilian author paulo coelho once quipped that everything was possible : “ from angels to demons to economists to politicians ”. financial market participants are no demons : they carefully monitor every word uttered by central bankers, because failing to anticipate the central bank ’ s next move could be costly. for a long time, central bankers were reluctant to provide hints on their expected future course of action or communicate openly. a good example is former fed chair, alan greenspan, who once told congress : “ if i seem unduly clear to you, you must have misunderstood what i said ”. [ 3 ] and according to otmar issing, central banking was “ presented as an esoteric art ”. over time, monetary policy has clearly become more of a science and less of an art. economists have formulated reaction functions, which are supposed to summarise how central banks respond to economic conditions. often, relatively simple rules such as a common taylor rule are considered. of course, monetary policymaking is much more complex than that. but just for the sake of argument, i would ask you to think of such a standard rule when it comes to the reaction function. central banks have also increased transparency and extended communication in order to enhance their accountability to the public and make monetary policy more effective. in the wake of the financial crisis, as policy rates approached zero, more and more central banks switched from dipped beam to full beam : using forward guidance, they began to shed light on their reaction function. by indicating that they would withdraw the monetary policy stimuli later than the public expected at the time, central banks attempted to further reduce longer - term interest rates when policy rates had already reached low levels

in order to insulate banks from weak public finances, we need not only appropriate supervision but also suitable regulation ; regulation that will prevent banks from taking on excessive risk through state financing. such regulation should, for instance, include upper limits for lending to governments. it should also encompass appropriate capital backing for government bonds – which is another proposal made by stefan gerlach, incidentally. but the single supervisory mechanism and suitable regulation are just two elements of a banking union, and there are also other means available for severing the link between sovereigns and banks. the third tool in this respect is a european recovery and resolution mechanism for banks that has access to “ european ” funds. in this context, it is necessary that any such mechanism ensure that investors are first in line to bear the risk of their investment decision. taxpayers must be spared the burden of other people ’ s investment decisions – at the national level and even more so at the european level – for as long as there is no proper balance between liability and control. ladies and gentlemen, i have very briefly highlighted a few arguments in favour of european banking supervision – the “ why ”, so to speak. now, let us take a look at the “ how ”. 3. european banking supervision – the “ how ” the establishment of the single supervisory mechanism will see wide - ranging banking supervisory functions being transferred to the ecb. at least seventeen countries will give up their sovereignty in supervisory matters to the ecb ; the ecb will be directly responsible for the supervision of the most systemically important banks domestically and at european level. nevertheless, national legal systems and national market structures will still be of utmost importance for the welfare and success of these banks. given the multitude of different s gerlach, a schulz, g wolff ( 2010 ), banking and sovereign risk in the euro area. centre for economic policy research, discussion paper, no 7833. bis central bankers ’ speeches supervisory traditions, legal systems and people involved in supervision, the ssm will only be successful if appropriate governance and transparent cooperation and task - sharing are installed. one of the “ hot ” topics when swiftly organising a banking supervisory function for the ecb is future cooperation between the ecb and the national supervisors. organising a european banking supervisory mechanism in such a short time firstly means building upon existing structures. secondly, supervision will only be successful if the ecb is able to benefit from cross - border comparisons, taking into account the macroeconomic and microeconomic knowledge and