benoit cœure : monetary policy in a low - growth environment speech by mr benoit cœure, member of the executive board of the european central bank, at the 4th frankfurt conference on financial market policy, organised by the sustainable architecture for finance in europe policy centre, goethe university, frankfurt am main, 28 october 2016. * * * since the onset of the crisis, the ecb has introduced a wide range of unconventional measures in order to meet its inflation objective, including negative deposit facility rates, targeted long term refinancing operations, and asset purchases. these measures were – and remain – necessary, and have been effective. but in the public debate, there is an increasing focus on the potential negative side effects of these measures and the rationale behind their deployment. this triggers two questions : why did we launch unconventional monetary policy in the first place? and how can we mitigate the potential risk of negative spillovers from monetary policy over the medium term? the answer to the first question is clear – these measures have been taken to react to the large negative shock caused by the global financial crisis, which has exacerbated a number of structural factors that have been driving down real interest rates even before the crisis. the unconventional measures are a reaction to the challenge of low global interest rates, not their cause. in my remarks today i will set out the challenges for monetary policy caused by structural factors such as low interest rates and low productivity growth. understanding the structural nature of these challenges is key to answering my second question on mitigating potential spillover risks from monetary policy in the future. the impact of low productivity growth on monetary policy to understand the structural challenges for monetary policy, it is useful to consider two interlinked concepts for the setting of monetary policy – potential output and equilibrium interest rates. understanding the interplay between these two concepts is at the heart of the current policy settings of the european central bank. how they evolve will determine the future path for inflation and at what stage monetary policy can eventually be normalised. potential output represents the level of activity where capital and labour are sustainably used. equilibrium nominal rates are the level of nominal interest rates where there is neither upward nor downward pressure on activity, and are composed of two parts : the real equilibrium rate and inflation expectations. actual levels of activity above potential put upward pressure on inflation and levels below potential put downward pressure. in similar fashion, setting actual interest rates below equilibrium rates stimulates economic activity, whereas setting interest rates above equilibrium

speaking, the “ fundamental ” asset price is equal to the net present value of the cash flows which the owner of the asset is entitled to receive. although it is easy to state in theory, this definition it is by no means easy to apply in practice for investors, regulators or central bankers. forming forecasts of highly uncertain cash flows that stretch far into the future is a challenge, which not only requires substantial expertise but is also subject to the great uncertainty about the future values of factors influencing the asset price. for example, in 2005 – with the information available at that time – it was hard to make an unambiguously agreeable case that high us housing prices would not be confirmed by good fundamentals in the future. although there were also warnings and some speculation on price drops. in the light of such complications, practitioners often resort to complementing fundamentals - based asset price assessments with comparing current prices with historical “ manias, crashes and panics ”. bis central bankers ’ speeches averages. if current prices exceed long - term averages by a sufficiently large margin, a warning signal is recorded that a bubble might be present and further analysis is triggered about whether it risks causing a crisis. i will come back to this later in my presentation. there are many reasons why the financial system may not value assets correctly, leading to bubbles and imbalances. investors have a tendency to look for information from the behaviour of other investors. so buying and selling “ herds ” 2 can develop in financial markets on the basis of very little genuine news. imperfections in credit markets3 can lead to boom bust cycles in money and credit quantities as well as asset prices. “ moral hazard ” could bring about excessive risk taking by financial intermediaries who try to exploit naive investors4, debt - holders or the depositor safety net provided by governments5. last but not least, the inherent human decision - making limitations6 mean that actual human beings often fail to take the rational choices usually assumed in the standard academic literature. regardless of why asset price bubbles arise, there is little doubt that they pose potential risks for financial stability, especially when they involve bank - provided debt finance. in terms of the ecb ’ s framework for the analysis of systemic risk7, asset price bubbles can contribute to the build up of financial imbalances which can unwind suddenly and cause the collapse of the banking system, with serious consequences for the real economy. we know that asset price bubbles and financial crises can cause severe economic di