christian noyer : the power of monetary policy speech by mr christian noyer, governor of the bank of france and chairman of the board of directors of the bank for international settlements, at the paris europlace financial forum, tokyo, 25 november 2014. * * * two weeks ago, i had the privilege to chair in paris our triennial banque de france symposium. governor kuroda made us the great favor to participate. at that symposium, one speaker remarked that, during the financial crisis, central banks in most countries had been ( quote ) “ the only game in town ” ( end quote ). and he went on wondering whether this would still be the case in the future. this observation captures the essence of my remarks today. i would like to talk about the power of monetary policy in the current – low inflation – environment. central banks have been all powerful and decisive in fighting off the biggest financial crisis of the last 70 years. and they succeeded in avoiding a prolonged recession and the collapse of our financial system. today, however, they are facing a different challenge. growth has been disappointing in many parts of the world and forecasts have been constantly revised downward. even more worrisome for central banks, inflation has persistently undershot our definition of price stability. for the euro area, it has declined from 2. 5 % in 2012 to 0. 3 % in annual terms, as of last september. this drop in inflation has occurred despite the most accommodating monetary conditions ever witnessed in europe. so one may ask whether monetary policy will be as successful in the post crisis era as it has been during the crisis ; and whether it will manage to avoid the perils of persistently low inflation. i will concentrate my remarks on the euro area, taking advantage of being in tokyo to draw some lessons from the japanese experience, and, i should say in the presence of deputy governor nakaso, from the deep expertise of the bank of japan. one may harbor doubts about the power of monetary policy for two reasons. the transmission mechanism may be impaired ; and the equilibrium interest rate may be so low ( or even negative ) that it becomes impossible to reach. the first point speaks for itself. the eurozone has suffered from acute segmentation and severe impairment in its money and credit markets. those failures have been addressed aggressively through a set of measures i will detail in a moment. results have been significant. the so - called target 2 balances have been reduced by half

, which means that banks across the euro area do not rely, to the same extent, on the network of central banks to intermediate their operations. we have now completed with success and credibility the first asset quality review in our banking system, and the new single supervisory mechanism has been made operational last week. those measures will be essential in restoring a well functioning credit channel and eliminating the remaining differences in financial conditions across the eurozone. let me now come to the second point : the equilibrium interest rate and why it matters for monetary policy. the concept is familiar to economists since the great knut wicksell. the “ natural ” or equilibrium interest rate is expressed in real terms. it equals savings and investment at full employment and price stability. it provides a central guidepost for assessing the monetary stance. for instance, if the market rate is above the equilibrium rate, there is excess saving, as well as insufficient consumption and investment. as a consequence, inflation falls. the equilibrium interest rate is not stable. it has fallen significantly since the financial crisis, possibly to negative levels. to maintain price stability and avoid persistently low inflation, market rates must be reduced as well. in normal circumstances, this can be achieved by lowering the policy rate, with subsequent effects on the yield curve. however, when the bis central bankers ’ speeches policy rates get to zero – the so - called zero lower bound – this “ conventional ” approach to monetary policy is not available anymore. to avoid an involuntary tightening of monetary policy, central banks must resort to unconventional measures. as i will describe in a moment, a wide array of such unconventional tools have been deployed in the euro area. low equilibrium interest rates can be temporary or permanent. in truth, we don ’ t really know. we do know, however, that very low inflation, if allowed to persist, can only aggravate the situation, because, everything else being equal, low inflation increases the real interest rate. in turn, higher real interest rates tend to depress economic activity and bring even lower inflation. this is the kind of spiral, possibly leading to deflation that monetary policy must seek to control and avoid. the process may become even more self - sustaining if it negatively affects inflation expectations. over the last months, inflation expectations in the euro area have dropped to 1. 2 % at a one - year horizon and 1. 5 % at a two - year horizon. more worrisome, long - term expectations – up to now extremely well - anchored