ECB MONETARY POLICYPast, present and future

Óscar Arce

DG Economics, Statistics and Research. Banco de España

XV MEETING OF MONETARY POLICY MANAGERS

CEMLA-BCRD, Santo Domingo, República Dominicana

26-27 September 2019

2

THE EURO AREA HAS WITNESSED DISINFLATIONARY PRESSURES SINCE 2013

Source: Eurostat. Last observation: 2019 August.

-1

0

1

2

3

4

5

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

HICP INFLATION CORE INFLATION

INFLATION%

Eu

rop

ean

Sta

bili

ty M

ech

an

ism

Fir

st

EB

Astr

ess t

est

Leh

man

failu

re

US

tap

er

tan

tru

m

Eu

rop

ean

Fin

an

cia

lS

tab

ility

Facili

ty

Gre

ece

req

uests

fin

an

cia

lassis

tan

ce

UK

Bre

xit

refe

ren

du

m

2 %

3

PER CAPITA GROWTH IN THE EURO AREA HAS BEEN DISAPPOINTING SINCE 2012, WITH RISING DIVERGENCES ACROSS MEMBERS

Sources: Datastream and European Commission

85

90

95

100

105

110

115

07 08 09 10 11 12 13 14 15 16 17 18 19

EURO AREA UNITED STATES JAPAN

GROWTH OF THE REAL GDP PER HEAD OF POPULATION(2010 prices; 2007=100)

85

90

95

100

105

110

115

07 08 09 10 11 12 13 14 15 16 17 18 19

EURO AREA GERMANY FRANCE

ITALY SPAIN

4

OVER THE DIFFERENT PHASES OF THE CRISIS, THE ECB HAS DEPLOYED A PACKAGE OF MUTUALLY REINFORCING MEASURES

Source: European Central Bank. Last observation: Rates, 19 September 2019; Balance sheet: 12 September 2019.

-1

0

1

2

3

4

5

6

-1

0

1

2

3

4

5

6

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

DEPOSIT FACILITY RATE MROs RATE EONIA EUROSYSTEM BALANCE SHEET (right scale)

EUROSYSTEM BALANCE SHEET AND INTEREST RATES%

Dra

gh

i "W

hate

ver

it t

akes"

Fir

st

VL

TR

O

Fix

ed

-rate

full

allo

tmen

tte

nd

ers

Fir

st

forw

ard

gu

idan

ce

Exp

an

ded

AP

P

Secu

uri

ties

Mark

ets

Pro

gra

m

An

no

un

cem

en

texp

ecte

den

do

f A

PP

An

no

un

ced

new

packag

e

Exp

an

sio

nA

PP

to

EU

R 8

0b

n p

er

mo

nth

€ trn

5

THE ECB’S MONETARY POLICY RESPONSE HAS BEEN COMPARABLE TO THAT IN OTHER LARGE ADVANCED ECONOMIES

Sources: Datastream, European Central Bank and Banco de España. Last observations: Rates,19 Sep 2019; Balance sheet: Eurosystem,12 Sep 2019; FED, 11 Sep 2019; BoJ, 09 Sep 2019; BoE,

-1

0

1

2

3

4

5

6

07 08 09 10 11 12 13 14 15 16 17 18 19

EUROSYSTEM

FEDERAL RESERVE

BANK OF JAPAN

BANK OF ENGLAND

%

POLICY INTEREST RATES

0

20

40

60

80

100

120

0

10

20

30

40

50

60

08 09 10 11 12 13 14 15 16 17 18 19

EUROSYSTEM

FEDERAL RESERVE

BANK OF JAPAN (right scale)

BANK OF ENGLAND

% of GDP 2017

CENTRAL BANKS BALANCE SHEET

% of GDP 2017

6

THESE MEASURES HAVE BEEN EFFECTIVE AT EASING FINANCIAL CONDITIONS, SUCH AS YIELD CURVES…

Source: Rostagno, Altavilla, Carboni, Lemke, Motto, Saint-Guilhem, Yiangou (2019), forthcoming.

Notes: The chart shows the impact of ECB non-standard measures on the GDP-weighted aggregate of euro area sovereign bond yields.

UPWARD PRESSURES ON EURO AREA SOVEREIGN BOND YIELDSIN ABSENCE OF ECB’s NON-STANDARD MEASURES 2014-2018

% per annum

NEGATIVE INTEREST RATE POLICY (NIRP) FORWARD GUIDANCE (FG) APP

7

…WHICH IN TURN HAVE STIMULATED GROWTH AND INFLATION OVER THE PERIOD 2014-2018

CONTRIBUTION OF ECB NON-STANDARD MEASURES TO REAL GDP GROWTH

2014-2018

% per annum

Source: Rostagno, Altavilla, Carboni, Lemke, Motto, Saint-Guilhem, Yiangou (2019), forthcoming.

Notes: The chart shows the impact of ECB non-standard measures on macro variables based on a macroeconomic model withfinancial variables conditioning on the yield curve impact shown in the previous slide.

% per annum

CONTRIBUTION OF ECB NON-STANDARD MEASURES TO HICP INFLATION

2014-2018

8

ANALYSIS BY BANCO DE ESPAÑA STAFF CONFIRMS THE EFFECTIVENESS OF ECB BALANCE-SHEET POLICIES (APP, TLTRO)

Source: Banco de España. Estimated effects based on the model of Burriel and Galesi (2018).

• Accumulated effects over the period 2015-18: 2.4% for GDP, 1.8% for HICP.

9

IN 2019, WE FACE AGAIN THE THREAT OF A DISANCHORING OF INFLATION EXPECTATIONS…

Sources: Thomson Reuters and Banco de España. Last observation: 19 September 2019.

1,00

1,25

1,50

1,75

2,00

2,25

2,50

2,75

3,00

3,25

3,50

2011 2012 2013 2014 2015 2016 2017 2018 2019

EURO AREA UNITED STATES

FIVE-YEAR FORWARD BREAK-EVEN INFLATION RATE FIVE YEARS AHEAD

%

Dra

gh

i"W

hate

ver

it t

akes"

Neg

ative D

FR

Dra

gh

i's s

peech

at

Jackso

n H

ole

Exp

an

ded

AP

P

TL

TR

O-I

I an

d r

ate

cu

t

AP

P t

ap

er

an

d s

tro

ng

er

forw

ard

gu

idan

ce

Sin

tra s

peech

AP

Pexte

nsio

nan

d s

calin

g d

ow

n

An

no

un

ced

new

packag

e

AP

Pexte

nsio

nan

d s

calin

g d

ow

n

10

Sources: IHS Markit and CPB. Last observation: PMI, August 2019; Trade, June 2019.

• The world economy slowed down in the second quarter and high-frequency indicators point to a

continuation of this trend in the next months.

• World trade slowed down against a background of growing uncertainty over the trade policy of US and

China.

… IN A CONTEXT OF DECELERATING GLOBAL GROWTH AND RISING RISKS

48

49

50

51

52

53

54

55

56

2014 2015 2016 2017 2018 2019

MANUFACTURING. CONSUMER GOODSMANUFACTURING. INVESTMENTS GOODSMANUFACTURING. INTERMEDIATE GOODSSERVICES

GLOBAL PMI

Index

-2

-1

0

1

2

3

4

2017 2018 2019

WORLD TRADE GROWTHq-o-q, 3 month moving average

OTHERS AFRICACHINA LATIN AMERICAEMERGING ASIA EMERGING EUROPEEURO AREA JAPANUNITED STATES WORLD TRADE

%

46

48

50

52

54

56

58

60

62

2016 2017 2018 2019

GLOBAL UNITED STATES

EURO AREA EMERGING

MANUFACTURING PMI

11

• Generalized and recurrent downward revisions for growth, in 2019, for both advanced and emerging

economies.

Source: Consensus. Last observation: September 2019, except Emerging Asia excluding China (August 2019) and Eastern Europe (August 2019)

… IN A CONTEXT OF DECELERATING GLOBAL GROWTH

0

1

2

3

4

5

6

7

Jan 2

01

8

Ap

r 20

18

Jul 2

01

8

Oct

201

8

Jan 2

01

9

Ap

r 20

19

Jul 2

01

9

CHINA LATIN AMERICA

EMERGING ASIA EASTERN EUROPE

GDP PROJECTIONS FOR 2019EMERGING ECONOMIES

% y-o-y

0,0

0,5

1,0

1,5

2,0

2,5

3,0

Jan 2

01

8

Ap

r 201

8

Jul 2

01

8

Oct

201

8

Jan 2

01

9

Ap

r 201

9

Jul 2

01

9

UNITED STATES EURO AREA

UNITED KINGDOM JAPAN

GDP PROJECTIONS FOR 2019DEVELOPED ECONOMIES

% y-o-y

12

US-CHINA TRADE CONFLICT: THE EFFECTS ON THE GLOBAL ECONOMY ARE ALREADY MATERIALIZING

Source: Banco de España.

-0,60

-0,45

-0,30

-0,15

0,00

US China Euro area RoW World

TRADE CONFLICT ESCALATION: GDP IMPACT IN Q4 2021

Tariffs from May to end-2019 Add mild uncertainty effects

%, deviation from baseline

• The escalation of trade tensions between China and

the US entered a new phase in May 2019

• The increase in protectionism appears to be

significantly affecting global economic activity

through a variety of channels…

• …both direct (Demand, prices of goods)

• …and indirect (Confidence, risk aversion)

• We estimated the impact on the global economy

using the NiGEM macroeconometric model

• For the euro area, the impact on GDP is

roughly -0.2%, reflecting its high degree of

trade openness, rendering it more vulnerable

to the fall in global activity

• Impact of uncertainty difficult to gauge

13

BREXIT: UNCERTAINTY PERSISTS AS OCTOBER 31ST APPROACHES

Source: IMF WEO, April 2019.

• The UK economy has deteriorated further on

account of heightened uncertainty about how and

when it will leave the EU...

• The arrival of the new Cabinet in July increased the

likelihood of a no-deal scenario

• Despite some legal actions taken by the other

parties in UK Parliament to deter a no-deal beyond

October 31st, the timing and the outcome of such

measures are still largely uncertain

• In the last weeks, on the other hand, the UK

Government appears to have become more prone

to reaching an agreement.

• …all of the former notwithstanding, a no-deal path

would have a noticeable negative impact in the euro

area economy

-0,7

-0,6

-0,5

-0,4

-0,3

-0,2

-0,1

0

2018 2019 2020 2021 2022 2023

EU: GDP IMPACT OF NO-DEAL BREXIT

SCENARIO A: INCREASE IN TARIFFS WITH THE EU, NO TRADEAGREEMENT WITH THIRD PARTIES, MILD TIGHTENING OFFINANCIAL CONDITIONS

SCENARIO B: (A) + INCREASE IN IMPORT COSTS FOR HH ANDFIRMS, STRONG TIGHTENING OF FINANCIAL CONDITIONS

%, deviation from baseline

14

TURKEY HAS BOTTOMED OUT AND ECONOMIC CONDITIONS ARE GRADUALLY IMPROVING, BUT DOMESTIC RISKS PERSIST

CONFIDENCIAL

Sources: Central Bank of Turkey and Turkish Statistical Institute.

3,5

4,0

4,5

5,0

5,5

6,0

6,5

7,0

9

13

17

21

25

29

2018 2019

INFLATION Effective official interest rate

Lira/dollar (RHS)

EXCHANGE RATE, OFFICIAL INTEREST RATE AND INFLATION

% lira/dollar

-12

-10

-8

-6

-4

-2

0

2

4

6

8

10

12

14 15 16 17 18 19

EXTERNAL DEMAND INTERNAL DEMAND

REAL GDP (Y/Y) REAL GDP (Q/Q)

GDP GROWTH RATE AND CONTRIBUTIONS

%

Note: the weight of Turkey in Euro Area exports is around 2.5%

15

ECB MONETARY POLICY PACKAGE IN RESPONSE TO DETERIORATING GROWTH AND INFLATION OUTLOOK

The ECB adopted a comprehensive package of measures in its last policy meeting (12 September):

• 10 bps reduction of deposit facility rate (from -0.40% to -0.50%) with two-tier system

• Reinforced state-contingent forward guidance

• Reactivated APP: monthly 20 billion EUR starting from 1st of November and without a defined time limit

• Dropped the 10 bps spread on rate of TLTROs and extended the maturity from 2 to 3 years

16

MONETARY POLICY GOING FORWARD: REVIEW OF MONETARY POLICY STRATEGIES

• Several major central banks are conducting reviews of their monetary policy strategies

• There is room for including modification/clarification of the ECB’s price stability definition

• Current inflation aim: “below, but close to, 2 percent” over the medium term

• Possibility of introducing specific point target (e.g. 2 percent)…

• … with symmetric interpretation: both negative and positive (transitory) deviations

• Would allow to make state-contingent forward guidance more precise and effective

17

MONETARY POLICY GOING FORWARD: AN ENVIRONMENT OF LOW NATURAL INTEREST RATES

SOURCE: Banco de España Annual Report 2018, based on the model of Fiorentini, Galesi, Pérez-Quirós andSentana (2018). The bands for the euro area refer to confidence levels of 68% and 90%.

• The natural interest rate (r*) is a key determinant of policy interest rates

• Evidence of sustained decline in recent decades, reflecting different factors: demographics (e.g. Eggertsson & Mehrotra, 2014), low productivity growth (Gordon, 2015), safe asset scarcity (Caballero & Farhi, 2017), etc.

18

MONETARY POLICY GOING FORWARD: AN ENVIRONMENT OF LOW NATURAL INTEREST RATES

• A low (and falling) r* implies that the effective lower bound (ELB) may be more and more binding in the future

• If reversal rate (Brunnermeier & Koby 2018) higher than “switch-to-cash” ELB, conventional policy space may be even smaller

• No conclusive evidence that we are already at the reversal rate…

• … but if rates remain negative for long this may end up hampering bank-based monetary transmission (e.g. Arce et al. 2018)

• In this environment, rethinking MP strategy becomes an valuable option:

• Possibility of introducing “make up” strategies such as average inflation targeting

• Would be consistent with medium-term orientation of inflation aim

19

THE ROLE OF OTHER ECONOMIC POLICIES

• Monetary cannot be “only game in town”

• Completing Banking Union is a priority for further deepening the monetary union

and reducing vulnerabilities

• Further progress in the Capital Market Union project is needed to boost private-sector risk-sharing channels

- capital markets contribute to soften more than 40% of an adverse shock in a particular

US State, just 10% for euro area countries -

• Build a common fiscal stabilization capacity to smooth aggregate and country

specific shocks (public risk-sharing)

• Need for countercyclical fiscal policy in countries with fiscal space

• Need for structural reforms that raise competition and increase the potential growth

of the economy (Andrés, Arce and Thomas, 2017)

- Productivity growth in the euro area is low: between 2000-2018 total factor

productivity in the US increased by near 12%, only 5,7 % in the euro area -

• Positive synergies from joint implementation of monetary, fiscal and structural

policies (Arce, Hurtado and Thomas, 2016)

THANK YOU FOR YOUR ATTENTION