yves mersch : the european central bank and the federal reserve – an ocean apart? speech by mr yves mersch, member of the executive board of the european central bank, at harvard university, boston, massachusetts, 12 october 2016. * * * interest rates on both sides of the atlantic seem to be trapped near zero. at first glance, looking only at the short term policy rates, one might think that both the federal reserve ( fed ) and european central bank ( ecb ) are facing very similar circumstances and challenges. below the surface, however, the differences are pronounced. in the euro area monetary policy continues to be highly accommodative, aiming to steer inflation back to levels in line with our definition of price stability. in the us, which is at a different stage of the business cycle, interest rate normalisation has so far been slower than expected. it is worth taking a closer look at the details to understand the unprecedented actions of central bank on either sides of the ocean in recent years. to do so, it is useful to divide the crisis into three separate phases. the first phase was the global financial crisis after the collapse of lehman brothers just over eight years ago. central banks worldwide faced a largely common challenge to avert a collapse in aggregate demand. the second phase centred on sovereign debt, a problem which only affected the euro area. in the third phase, which is still in place today, stubbornly low global inflation and anaemic growth are compounding domestic challenges. the first phase : combating a systemic shock the first phase of the crisis had its origin in the us. in 2006, many experts considered the subprime crisis to be a minor incident with only local impact, but then it escalated into a financial crisis of systemic proportions that propagated to the whole advanced world. many banks experienced a sudden stop in their access to money markets, and the ensuing liquidity squeeze in interbank markets affected credit provision across the united states and euro area. the effects on the real economy were immediate and large. both regions went through severe recessions. but the respective central banks and fiscal authorities responded promptly and decisively. the federal reserve quickly cut its target for the fed funds rate to close to zero, then embarked on a series of large - scale asset purchases of us government bonds and mortgage - backed securities. likewise, the ecb cut its main refinancing rate by more than 300 basis points between october 2008 and may 2009. to ease the liquid

whereas it is most likely that the slowdown in productivity had already startedbefore the crisis but was masked by the credit - fuelled boom. for example, in 2007 the euro area ’ s output gap was estimated by international institutions such as the imf, the oecd and the european commission to be negative – somewhere between – 0. 2 % and – 0. 6 %. the most recent estimates put the output gap in the region of positive2. 7 % to 3. 4 %, a significant downward revision to views of potential. at the same time as potential growth has been declining, the share of global factors driving inflation seems also to have been increasing. in large part, the common global trend can be explained by the decline in price of energy and other commodity prices. but low global inflation goes beyond weakness in domestic demand and falling energy and commodity prices. in recent years there has been a growing understanding of the role of global demand factors on domestic inflation. 6 for example, it has been observed that changes in the degree of slack in oecd economies are having a smaller impact on inflationary pressures than it has in the past. 7 in part this changing 5 / 7 bis central bankers'speeches correlation is a result of the success of monetary policy in anchoring inflation expectations. but structural factors are also playing a role : higher import volumes as a result of advanced globalisation have increased the importance of international prices relative to domestic prices, forcing domestic mark - ups to be less sensitive to the state of the domestic economy. this may imply that monetary policy has to react more aggressively to counteract shocks. so in combination, central banks may be facing a two - pronged challenge to their mandates : a situation where, due to the role of global inflation, more stimulus is needed than in the past to deliver their domestic mandates ; and where, due to the falling equilibrium interest rates, their ability to deliver that stimulus is more constrained. that would certainly offer one explanation for why monetary policy has needed to stay accommodative for so long across advanced economies. this does not make monetary policy ineffective. as we have seen in the euro area, even with a low equilibrium rate central banks can still steer conditions in the wider economy by targeting directly the constellation of interest rates that matter for borrowers. but one nonetheless cannot deny that the fall in the equilibrium rate poses a challenge for central banks. this challenge for monetary policy has been recognised, with a number of innovative solutions proposed by