benoit cœure : the monetary policy of the european central bank speech by mr benoit cœure, member of the executive board of the european central bank, at barclays ’ european conference, tokyo, 26 march 2012. * * * introduction it is my pleasure to be here at barclays ’ european conference in tokyo. today i would like to provide a simple yet comprehensive description of the ecb ’ s actions during the crisis. faced with severe turbulence, all central banks had to take measures in real time and switch from central banking in “ standard operating mode ” to “ risk control and crisis management ” mode. we did so by keeping an eye fixed on our objective. this helped us to stay on course and provided continuity. i will start by presenting a simplistic model of monetary policy transmission. this is the sequence of events through which central banks ’ decisions transmit to economic magnitudes which have an impact on people ’ s welfare. i will then review the effectiveness of ecb ’ s monetary policy prior to the financial crisis, when the transmission mechanism was functioning according to the textbook definitions. this period was tranquil, economically speaking, although macroeconomic imbalances were quietly building up beneath the surface. i will then portray the crisis as a creating a break in the transmission mechanism. the crisis however was more than that : at some point we all feared that the whole financial system would stop functioning. but i will analyse it from the perspective of its implications for the chain of events on which monetary policy action depends. here, i will argue that the standard tool of central banks – changes to the short - term interest rate – can lose some of its potency if the sudden unravelling of imbalances threatens financial stability and impairs the transmission mechanism. but i will also claim that new untested instruments were deployed which largely replaced standard monetary policy interventions. this is perhaps the most relevant lesson we can draw from the crisis. monetary policy transmission let me briefly elaborate on the transmission mechanism of monetary policy. you can see here on slide 2 why the monetary transmission mechanism is so important for central banks. the ecb has a statutory objective of price stability, which has been defined as a year - on - year positive inflation rate below 2 %. within that range, the governing council aims at an inflation rate not too far from 2 %. we say : “ an inflation rate below, but close to, 2 % ”. however, in order to exert an influence on agents

standard deviation of inflation and the standard deviation of output growth which each economy has experienced since 1999. in this space, you want to be as close as possible to zero. why? because the lower - left part of the chart is populated by economies with low macroeconomic instability, i. e. low inflation volatility and low growth volatility. indeed, you can see that the euro area has been closer to zero than any other economy except one, switzerland – the dot to its left. the low variance of inflation rates in the euro area did not come at the expense of unsteady economic growth. low macroeconomic volatility has meant lower long - term interest rates and lower inflation compensation in financial contracts. my next slide [ 7 ] illustrates a standard technique to disentangle long - term euro area bond yields into premia remunerating investors for the risks they bear on long - dated securities. 1 two facts are noteworthy. the first fact is a steep decline – since pre - monetary union times – in the nominal yield paid on average by euro area governments to borrow at a ten - year maturity. this is the blue line in the chart. the second fact is that such a steep fall in ten - year yields has resulted from the three components which determine nominal interest rates : the real rate, the inflation expectation – which compensates investors for the average expected inflation over the life of the security – and the inflation risk premium – which compensates investors for inflation volatility. the real rate is the red line, and the two risk premia are visible as wedges between the nominal and the real rate. borrowing money in the euro area is cheaper today – in real and nominal terms – than it was a decade and a half ago, and the lower cost of borrowing is largely related to a less uncertain and a more predictable macroeconomy. the euro area has been a stable economy, not a static one. my next slide [ 8 ] shows the real per capita income progression of the euro area and the us since 1999. contrary to longstanding beliefs, the euro area ’ s dynamism has not lagged that of the us. see garcia, j. a. and t. werner ( 2010 ), “ inflation risks and inflation risk premia, ” ecb working paper no 1162. bis central bankers ’ speeches i would conclude that the euro and its guardian, the ecb, have made a solid contribution to low and stable borrowing conditions,