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Speech by Vítor Constâncio, Vice-President of the ECB, at the 18th Euro Finance Week,
Frankfurt
The monetary policy measures adopted by the ECB
In order to bring inflation rates closer to the stated objective of price stability over the medium-term, and in order to support the aggregate recovery, our monetary policy continues pursuing its accommodative stance. Our main policy rates will stay low for a prolonged period of time, in line with our forward guidance. The asset purchase programme will keep our balance sheet expanding until we see a sustained adjustment in the path of inflation. When the global financial crisis intensified in September 2008, the interest rate on the ECB’s main refinancing operations for banks stood at 4.25 percent. By May 2009, the ECB had reduced this rate to 1 percent, while simultaneously cutting the rate on the deposit facility to 25 basis points. The significant decline of inflation since the later part of 2013 led us to further reduce interest rates during last year and the interest rate on the main refinancing operations currently stands at 5 basis points, whereas the interest rate on the deposit facility is -20 basis points. [...]
The point that monetary policy cannot affect the equilibrium real rate is important. In addition to the propensity to save, the equilibrium rate depends on the growth rate of potential output. If potential output grows slowly, the equilibrium rate will be low, and therefore the real rate necessary to achieve price stability will also be low, independently of what the central bank does. Unfortunately, the growth rate of potential output in the advanced economies appears to have decreased in the recent years. Labour productivity, defined as output per employee, grew at the same average annual rate of 1.7 percent in the euro area and in the U.S. for two decades, from 1981 to 2000. From 2001 to 2008, the average annual growth rate of labour productivity in the U.S. was lower, at 1.5 percent, and since 2008 it has been only 1.1 percent. The slowdown in growth of labour productivity in the euro area has been far more pronounced: the average annual growth rate of labour productivity dropped to 0.5 percent from 2001 to 2008 and stands at 0.2 percent since then. [...]
The ECB responded to the decline of the real equilibrium rate by reducing the policy rates, and consequently the real rates declined throughout the economy. Had the policy rates been cut less aggressively, real income and inflation would have been even lower today. Now think about the implications for retirement saving by an average household, had the ECB reduced rates less aggressively. The real interest rate would have been higher, but the household’s income would have been lower. Therefore, the amount that the household would have saved for retirement would probably have been smaller – not larger – than with the current, low ECB policy rates.
The other point related to savers is that any economic reasoning related to income must be done in real terms. [...] Recently, deposits have been around zero but the latest inflation rate is at 0.2 percent while real interest rates are even slightly above their levels of 2014. Nominal interest rates can only increase when our policies become successful in the medium-term and inflation is closer to our official target.
In addition to pursuing interest rate policy, the ECB has adopted a number of non-standard monetary policy measures since 2008, including a large scale asset purchase programme, targeting an improvement in financial conditions. The goal of our current monetary policy stance is to incentivise economic risk-taking, in the form of better financing conditions for households and firms. We are, of course, very much aware that side effects are also present, in particular in the form of excessive asset valuations or excessive risk-taking by market participants.
We are following these developments very closely, notably in relation to risks posed by asset valuations and the search for yield phenomenon. Our assessment at present, monitoring a range of asset markets, is that there are no signs of generalised overvaluations in the euro area. At the same time, the banking sector is more resilient, with higher capital ratios, and financial stability conditions are currently fulfilled in spite of the existent risks.
The external environment of the euro area has deteriorated since the asset purchase programme began. In particular, concerns about growth prospects in emerging markets and unfavourable developments in financial and commodity markets have signalled downside risks to the outlook for growth and inflation, relative to the latest ECB staff projection from September. Headline inflation is again at zero and core inflation has not consolidated a more positive development, which points to the need to reassess our policy stance in order to achieve our goals by 2017. Eurosystem staff is currently analysing the impact of the recent external events on the euro area, in particular on the speed of adjustment of the inflation rate to levels consistent with price stability. The next Eurosystem staff forecast, due in December, will help the Governing Council re-examine whether the current degree of monetary accommodation remains appropriate. Further monetary policy options are available should the Council determine that changes to the current policy stance are required. [...]
In recent years, much of the reform effort within the euro area appears to have taken place in the member states most adversely affected by the global financial crisis and its aftermath. [...]
While supply-side reforms are desirable, their objective is typically growth in the long-run. As such, supply-side reforms normally take time to produce positive effects. Furthermore, in the short-run, reforms can dampen aggregate expenditure, when they require costly adjustments up front, as has been recognised in the Stability and Growth Pact. For this reason and amid a tepid recovery, it is important for member states’ fiscal policy to be as accommodative as possible. [...]
The surplus situation also means that, for the euro area as a whole, there is fiscal space to be used to help closing the existent output gap resulting from lack of demand. This would put upward pressure on prices, speeding up the path towards normalisation. [...]
The problem is that there is no common European fiscal policy, which is also not foreseen in the Treaty. The overall fiscal stance is not discussed and there is no substantive effort to co-ordinate independent national fiscal policies. Many economists have pointed out that this constitutes a significant shortcoming of our monetary union design. Economic governance of the monetary union depends only on monetary policy without any concept of a macroeconomic policy mix.
This shortcoming provides the rationale for the proposal in the recent Five Presidents’ Report, that points for the creation of “an euro area-wide fiscal stabilisation function” in the longer term.
On the way to the “longer term”, one could envisage some steps to strengthen the European dimension of fiscal policy in the Eurogroup. Another initiative could be to expand the financial capacity of the Juncker Plan in order to really help to jump start investment at the level of the European Union. This would be consistent with the existent overall fiscal space.
A last important remark is that a more flexible overall fiscal policy does not require changing the existing framework of the Stability and Growth Pact that binds euro area Member States. As recently emphasised in a document by the European Commission, the Pact already envisages a certain degree of flexibility in the way its rules should be applied. One example is the notion of “structural budget balance” which Member States are obliged to meet. The structural budget balance is, in effect, the budget balance corrected for the effects of the business cycle. The objective of the correction is to allow fiscal policy to play its role in mitigating possible economic shocks. The scope of flexibility within the Stability and Growth Pact should thus be exploited in full.
Let me conclude.
The euro area has been experiencing a protracted period of low inflation and weak economic activity, with two recessions and a very slow recovery since the latter recession. Monetary policy has been and will continue to be accommodative, but monetary policy alone cannot respond to all the existing challenges. Recent developments only add to the urgency of addressing economic, social and demographic problems of the euro area. No complacency with mass unemployment should be tolerated. [...]