luis m linde : monetary policy following the great recession presentation by mr luis m linde, governor of the bank of spain, of the papeles de economia issue : “ monetary policy following the great recession ”, fundacion de las cajas de ahorros, madrid, 13 june 2014. * * * let me first thank funcas for their kind invitation to inaugurate this presentation of the issue of the review papeles de economia espanola dedicated to “ monetary policy after the great recession ”. in my address i will briefly review the predominant view before the crisis. i will then discuss how the crisis has affected this consensus. finally, i shall conclude with some thoughts on two changes which, as a result of the foregoing, are already taking place in monetary policy conduct : how to structure its interaction with macro - prudential policy and the role of unconventional monetary tools. before the crisis before the crisis, low inflation, low price volatility and the high degree of economic stability attained in the advanced economies enabled a certain consensus to be forged on what the essential components of a successful monetary policy should be. monetary policy would be delegated to an independent central bank whose remit saw the maintenance of price stability as its main objective. this objective, in turn, could be translated into a more explicit goal in terms of inflation targets. to fulfil its mandate, the central bank would confine itself to controlling the short - term interest rate. its interventions would be transmitted to the real economy through three main channels : the long - term interest rate, inflation expectations and financial asset prices. the credit channel played a secondary role. indeed, in most of the macroeconomic models used by central banks, the private banking sector would play a marginal role, if any at all. the assumption of financial market efficiency and self - regulation meant that credit was not a central variable. the consensus then prevailing also had it that, in order to ensure financial stability, it sufficed to supplement price stability with regulatory and micro - prudential supervisory policy action geared to ensuring the strength of individual credit institutions. in step with this concept, the role of monetary policy in the face of potential risks to financial stability would be confined to cleaning up or repairing damage when such risks ultimately materialised. the federal reserve ’ s measures following the bursting of the “ dot. com ” bubble illustrate this type of conduct. the crisis from the summer of 2007 and, above all

the capital shortfall, meaning the banks that came below the threshold of 5. 5 %. but this is a measure of the strictness of the exercise that it had such an impact on the balance sheet of the banks, and it ’ s a usual measure of the impact of such types of exercises. but it ’ s also a measure of the resilience of the system because, in spite of this drop of €263 billion, the vast majority of banks stayed above 5. 5 % and were able to support such a shock, and still have a capital ratio above the threshold. and let me underline that the threshold of 5. 5 % is well above the regulatory minimum, because as you know the regulatory minimum for common equity capital ratio will be in 2018 4. 5 %, so we have chosen a more demanding threshold. and most of the banks were able to resist such a drop in their capital and stay above the threshold. that ’ s proof of the resilience of the system, and at the same time proof of the strictness of the exercise. the distribution of this drop in the capital ratio you have in this slide. i ’ m not going to comment in detail. just to underline that 75 % of the participating banks experienced a 0 to 6 percentage points impact on common equity tier 1 under the adverse scenario. now the capital shortfall itself, as i said, comes both from the aqr and from the stress test. and the distribution you have in this slide, 11. 2 % from the stress test and 10. 7 % from the aqr. this is the capital shortfall from the stress test, 11. 2 %, but in the previous slide you have seen that the drop in capital coming from the stress test corresponded to €182 billion, which is a component of the €263 billion that i highlighted just now. so this is then the composition. and what i said about the front - loading that the banks have done since july last year is disaggregated in this table. and you see that the overall amount of measures of different kinds, they are not just capital measures, but are measures that strengthen the balance sheet and help to clean and prepare the balance sheet for the exercise. gross equity issuances since then amount to €60 billion. cocos or contingent capital issuance instruments that count as additional tier 1 and satisfy our conditions amounted to another €32 billion. internal capital generation, either by