30 September 2022

ECB's de Guindos: Policy mix of the future: the role of monetary, fiscal and macroprudential policies

I am very pleased to participate in this conference to mark the centenary of Lietuvos bankas. Building on the ECB’s recent strategy review and our reflections on the policy mix, I will outline my views on the interplay between monetary, macroprudential and fiscal policy.

Academic research points to the need for monetary and fiscal policy to work together in times of crisis. This runs contrary to previous wisdom suggesting fiscal policy should mainly support economic outcomes by playing the role of an “automatic stabiliser.” For example, in recessions, government expenditure would automatically increase and tax revenue would automatically decrease. It has become evident that strong, discretionary countercyclical fiscal policy is needed in a crisis. Furthermore, research shows fiscal policy is particularly effective close to the lower bound of interest rates. In this way, fiscal policy not only effectively stabilises the economy, but also contributes to the ECB’s objective of maintaining price stability. Structural fiscal policy^[1] could also help raise the natural or equilibrium real rate of interest^[2]. This rate of interest has been falling in recent decades and has made the pursuit of price stability much more challenging for central banks. Complementarity between monetary and fiscal policy was greatly effective following a long period of too low inflation. But how is this interaction in an inflationary environment? Or more generally, how does the level of inflation affect the fiscal-monetary policy mix?

Macroprudential policy addresses risks to financial stability. Our strategy review acknowledges that financial stability is a necessary condition for price stability. With an impaired transmission mechanism in times of financial turmoil, maintaining price stability is not possible. At the same time, monetary policy itself can have implications for financial stability. Accommodative monetary policy can reduce credit risk and prevent debt deflation. But it could also trigger excessive risk taking or encourage higher leverage in the financial system. In times of monetary policy tightening, the converse arguments apply.

We therefore decided to implement a new integrated analytical framework, which takes financial stability considerations explicitly into account in our monetary policy decisions. Our focus is threefold: detecting impairments to the transmission mechanism, such as fragmentation risk, monitoring a possible build-up of financial imbalances, and identifying how far macroprudential policy addresses financial imbalances.

Let me summarise how I see the complementarities between fiscal and macroprudential policies with monetary policy:

• Fiscal and macroprudential policy should be the first lines of defence for economic stabilisation and fostering financial stability, respectively. This leaves monetary policy to focus exclusively on price stability.

• The importance of both fiscal and macroprudential policy has recently increased. Fiscal policy became more important because of its role in times of crises, and its enhanced effectiveness at the lower bound. Macroprudential policy became more relevant given its capacity to contain the potential side effects of monetary policy – both in the accommodative and tightening phases.

• Both fiscal and macroprudential policy need to be strongly countercyclical: this entails building up “buffers” during good times^[3] for use in bad times.^[4] While sovereign debt must be sustainable to be used countercyclically, macroprudential capital buffers need to first be built up so that they can be released when risks materialise....

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