12 October 2013

Jean-Claude Trichet: Central banking in the crisis - Conceptual convergence and open questions on unconventional monetary policy

Delivering the 2013 Per Jacobsson Lecture in Washington, Trichet looked at why the financial system of the advanced economies had proved as 'fragile as a house of cards'. He summarised the major observations and guiding principles on monetary policy in present times

First, there is an underlying trend towards a degree of “conceptual convergence” among the Central Banks of the large advanced economies. This phenomenon is observed along many dimensions: conventional and unconventional monetary policy, communication, banking surveillance, macro-prudentials, forward guidance. This convergence, particularly impressive as regards the definition of price stability, might be interpreted as a collective response in time of crisis.

Second, the unconventional monetary policy, UMP, which has been playing a decisive role in the crisis, should be transitory and commensurate to the degree of dysfunctioning of the financial sector. In a medium and long term perspective, it is justified only if public and private partners are actively correcting their own weaknesses.

Third, the UMP and the conventional interest rates policy should be decided independently from one another and be fully flexible. This “principle of separation” in the handling of interest rates and UMP should be applied and communicated clearly for monetary policy to regain degrees of liberty which seem to have been partially lost. It is, in particular, necessary to avoid the unintended consequences of too long periods of large scale UMP and zero interest rates.

Fourth, forward guidance, FWG, should respect certain conditions to be effective and minimise possible counterproductive consequences: in particular being conditional on price stability, correcting, where necessary, biased market perceptions and being given by a highly “time consistent” Central Bank.

Our societies, our executive branches, our Parliaments, our private sector institutions are all tempted to ask independent Central Banks to take responsibility for all main economic objectives: price stability, naturally, but also growth and job creation. But Fiat currency relies upon the Central Banks’ credibility and their ultimate responsibility to be independent, to deliver stability and to preserve the people trust in their currency over time, without inflation and without deflation.

Confidence in a stable currency is certainly a necessary condition for all the other legitimate goals of society to be attained, and, more than all others, growth and jobs. But these other goals depend also decisively on courageous and bold structural reforms, on sound and sustainable public finances and on a healthy and resilient private sector respecting fully the values of integrity and risk awareness.

Paul Volcker and Jacques de Larosière reaffirmed recently, using practically the same words, that “monetary policy cannot resolve all problems” and that “any Central Bank should not be asked to do too much, to undertake responsibilities that it cannot reasonably meet with the appropriately limited powers provided” (Larosière J de -2013-, Volcker P - 2013).

If our advanced economies’ societies expect their Central Banks to substitute to the public authorities for their difficulty or failure to act and to the private sector for its difficulties to correct its weaknesses, not only they would be wrong but they would risk paving the way for the next acute episode of the present crisis.

Full speech

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