international spillovers and the ecb ’ s monetary policy klaas knot cf40, piie, euro50 group – “ the dollar, the euro and the renminbi in the new geopolitical environment ”, march 27th, 2021 introductory remarks – talking points 1. • setting the stage in my remarks, i want to discuss the international setting within which monetary policy inevitably will have to be assessed. in that regard, i will also focus on the role of international spillovers in the conduct of ecb ’ s monetary policy. • to set the stage, let me review the recent developments in the us. then i will address the question how higher us inflation expectations and bond yields affect euro area financing conditions and how this relates to the ecb ’ s policy response. 2. • us financial market developments perhaps the most widely debated topic within financial markets over the last weeks centers around the effects of the fiscal package passed by the biden administration. as a result, market participants have taken into account the possibility of a high inflation scenario once again. this is – amongst others – reflected in the slope of the us yield curve, as measured by the spread between 10 - year and 2 - year rates. this spread currently resides at its steepest level since 2015. • the recent steepening is, in fact, a story of two tales. in the short end of the curve the federal reserve ’ s commitment to keep front - end rates lower for longer plays an important role. simultaneously the upward pressure on the longer end signals a brighter economic outlook, which is – at least in part – driven by the surprisingly large fiscal stimulus package. • decomposing the recent yield curve dynamics – as done here on chart 1 – confirms that inflation expectations ( corrected for the inflation risk premium in light blue ) have been increasing substantially in the short end. in combination with the fed ’ s forward guidance, this has led to a fall in real rate expectations ( depicted in grey ). • chart 1 also shows that the increase of the longer end of the curve, where inflation expectations are arguably better anchored, was instead largely driven by an increase in the real term premium ( blue ) and the inflation risk premium ( in dark blue ). • first, the observation that real term premia increased is consistent with the fact that the fiscal stimulus will be, by and large, deficit - financed. international spillovers and the ecb ’ s monetary policy — 1 • second, recall that the inflation risk premium is the

economy, and we are confident in our ability to do so. to be sure, decisions about when and how quickly to proceed will require a careful balancing of the risk of withdrawing support before the recovery is firmly established versus the risk of allowing inflation to rise above its preferred level in the medium term. however, this delicate balancing of risks is a challenge that central banks face in the early stages of every economic recovery. i believe that we are well equipped to make those judgments appropriately. in addition, when the time comes, our ability to clearly communicate our policy goals and our assessment of the outlook will be crucial to minimizing public uncertainty about our policy decisions. why did the fed and the treasury act to prevent the bankruptcy of some major financial firms? the final question is as difficult as it is important : why did the fed and the treasury act to prevent the bankruptcy of some major financial firms, such as the investment bank bear stearns and the insurance company american international group, or aig? we must answer that question not only because the decisions have been controversial, but also because it bears on the steps we need to take as a country if we are to avert a repetition of the crisis. as a general rule, my strong preference is that any firm that cannot meet its obligations should bear the consequences of the marketplace. but recent circumstances have been truly extraordinary. consider the situation on september 16 of last year, when the insurance conglomerate aig faced pressures that threatened to force it imminently into bankruptcy. at that time, the strains in the global financial system were unprecedented and extreme, and the confidence of financial market participants in the system was rapidly eroding. the investment bank lehman brothers had filed for bankruptcy the day before, and the mortgage giants fannie mae and freddie mac, after suffering losses that threatened their solvency, had effectively been taken over by the government just two weeks earlier. as waves of panic and fear washed over the markets, the fed and the treasury became very concerned about the stability of a number of other major financial firms. large, complex financial institutions tend to be highly interconnected with other firms and markets, and aig was more interconnected than most. for example, aig had insured many billions of dollars of loans and securities held by banks around the world, and its failure would have rendered those insurance contracts worthless, imposing large losses on the global banking system. in addition, banks had extended more than $ 50 billion in credit to the company, much of which would