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What challenges are yet to be tackled?
Let me focus on three challenges for the ECB.
One of them relates to a prolonged period of low inflation... which will be followed by a gradual upward movement towards inflation rates below, but close to, 2 per cent later on. Of course, inflation remaining low for a prolonged period of time is a risk in itself. It implies that there is only a small safety margin away from zero. And it makes structural adjustment efforts more difficult. Hence, it is important to carefully assess the causes of low inflation... Any setbacks in the absorption of economic slack may give rise to further negative developments. Against this background, we will remain alert as to whether any indications on further downside risks to price stability emerge and we stand ready to act.
A second challenge we will be facing in the coming months is to make the Single Supervisory Mechanism really work. As I initially explained, the institutional reforms that have been adopted or are being adopted to establish a banking union constitute important progress. But to meet the ultimate objective of strengthening financial stability, implementation is key. And implementation is well under way: the Supervisory Board has held its first three meetings; a Framework Regulation has been prepared and is now the subject of a public consultation; and work is progressing on the supervisory model of the SSM with the Supervisory Manual.
One of the first major implementation tests is the comprehensive assessment, the health check of the euro area banking system, which is currently being conducted as a prelude to the SSM becoming operational. Here, the ECB is making good progress in establishing the new structures and ensuring that the exercise will be fair, transparent and stringent. But many more steps still lie ahead of us.
A final challenge relates to the macro-prudential arm of the SSM. As you know, the SSM Regulation gives the ECB the power to apply stricter macro-prudential measures than the national authorities if it deems them necessary. We can also advise on the calibration of instruments. This goes some way towards insuring against an inaction bias at the national level, thus improving the prospects for a more stable euro area financial system.
We will maintain a clear separation of objectives between the macro-prudential policy framework and monetary policy and a clear hierarchy, with price stability remaining the ECB’s overall primary objective. But we are very much aware that both policies may interact. As mentioned before, financial instability may undermine monetary policy’s ability to maintain price stability, both directly by its negative impact on credit provision, growth and inflation and indirectly by impairing the monetary transmission process. Conversely, a protracted low interest rate environment necessary to maintain overall price stability may create incentives to search for yield and lead to local bubbles in a heterogeneous monetary union.
In both cases, macro-prudential policy can be used to address financial stability concerns and facilitate our monetary policy conduct. In the first case, where the financial stability concerns are of a systemic nature affecting the whole euro area, those policies will have to be coordinated. In the second case, national macro-prudential authorities may take actions to reduce the risk of local financial imbalances.
In such a case, macro-prudential measures may exert cross-country spillovers that matter for monetary policy. For example, raising capital requirements in one jurisdiction may dampen lending in the whole euro area, while a tightening of loan-to-value ratios may simply shift lending between respective jurisdictions, leaving the euro area aggregate unchanged. A monetary authority may therefore have a legitimate interest in which macro-prudential measure is used.
Many of these questions are yet to be fully explored and we have to acknowledge that the macro-prudential policy framework is still in its infancy. We are in a learning process. The objectives, transmission mechanisms and effects are still being established, and this is an area where the ESRB’s systemic macro-prudential oversight is playing an integral role. Conferences such as today’s can provide crucial input here.
Overall, I am optimistic that macro-prudential policies, if properly coordinated at the European level, will strengthen our defences against future financial instability in the euro area, while also addressing some of the side effects that come from a single monetary policy.
Conclusion
Let me conclude. With the three challenges of: (i) ensuring price stability in the face of a prolonged period of low inflation, (ii) setting up the SSM and rebooting the banking system to support credit and growth, and (iii) establishing an effective macro-prudential policy framework to increase resilience in the face of future financial turbulence, the ECB will have its hands full in the coming year. We are committed to doing our job, but do not expect us to do the job of others. It is more important than ever that, in parallel, governments continue to pursue their structural reform agenda.