Monetary inflation

Isabel Schnabel: COVID-19 and monetary policy: Reinforcing prevailing challenges

Retrieved on:

Wednesday, November 25, 2020

Macroeconomics, Economy, Money, Public finance, Interest rates, Macroeconomic policy, Monetary policy, Inflation, Monetary inflation, Real interest rate, Interest rate, Price stability

SPEECHCOVID-19 and monetary policy: Reinforcing prevailing challengesSpeech by Isabel Schnabel, Member of the Executive Board of the ECB, at The Bank of Finland Monetary Policy webinar: New Challenges to Monetary Policy StrategiesNine months into one of the most severe crises since World War II, we are still in the early stages of understanding the pandemics full ramifications.

Key Points:

SPEECH

COVID-19 and monetary policy: Reinforcing prevailing challenges

Speech by Isabel Schnabel, Member of the Executive Board of the ECB, at The Bank of Finland Monetary Policy webinar: New Challenges to Monetary Policy Strategies

Nine months into one of the most severe crises since World War II, we are still in the early stages of understanding the pandemics full ramifications.
Some sectors of our economies may never return to their previous size.
Central banks may have to change how they pursue their mandates in the face of evolving consumer preferences and changing technologies.
Predicting the direction and scope of these shifts for monetary policy is inherently difficult.
At the ECB, we are doing this as part of our ongoing monetary policy strategy review.

COVID-19 and risks to price stability

Let me explain each of these challenges in turn, starting with the meaning of price stability in times of low inflation.
In 2003, when the Governing Council conducted the last review of its monetary policy strategy, it defined price stability as being consistent with consumer price inflation of below, but close to, 2% over the medium term.
It agreed on this definition after a long period in which too high rather than too low inflation was the main predicament central banks were facing.
Over the past few years, however, inflation has fallen short of our aim.

Globalisation, for example, together with significant advances in the way manufactured goods are produced, has made many consumer goods cheaper over time.
An economy paralysed by the pandemic has pushed underlying inflation the rate of price change of less volatile goods and services to a new historical low of 0.2% in October (see slide 2).
Some of these price developments may prove temporary as the economy recovers from the crisis.
[3] A longer life expectancy can induce people to save more to smooth consumption over a longer period of time.

The parallel decline in trend productivity growth since the 1970s is likely to have added to price stagnation.
Higher output per hour is a necessary precondition for higher sustainable wages, incomes and, ultimately, prices.
But they can, and should, make sure that the operationalisation of their mandates the way they define and pursue price stability leaves no doubt that too low inflation is as much a concern to society as too high inflation.
Central banks can cater for such risks in their monetary policy frameworks by acting with the same determination to downward and upward deviations from their inflation aims.
This is why we are already today stressing our commitment to symmetry in our introductory statements summarising our monetary policy decisions.

The effectiveness of monetary policy in a low rate environment

When the pandemic broke out in late February, we honoured this commitment by reacting forcefully to the rapidly emerging downside risks to price stability.
The pandemic emergency purchase programme, or PEPP, has been at the heart of our policy response.
[4] By stabilising market conditions at a time of exceptional uncertainty and demand for safety, the PEPP acted as an important circuit breaker that stopped the pandemic from turning into a full-blown financial crisis (see slide 4).

Its strong impact on the economy was in line with a rich literature that suggests that monetary policy is most effective during periods of market turmoil or when the economy is in a severe recession.
[5] In these circumstances, a tightening of financial conditions damages the economy more severely due to a negative multiplier effect (see left chart slide 5).
Monetary policy that acts to offset a tightening in financial conditions is then highly effective.

[6] It is likely that this state-contingent effectiveness of monetary policy is also at play in current times.
Heightened uncertainty, in turn, is likely to weaken the willingness and ability of firms and households to take full advantage of historically loose financial conditions.
[7] In these situations, monetary policy cannot unfold its full potential.
An important question in this debate is whether and how monetary policy transmission changes in the vicinity of the effective lower bound, and how this might affect the interaction between monetary and fiscal policy also outside crisis times.
At the core of these models is the Euler equation, or the IS curve, which provides two fundamental hypotheses on which policy transmission is built.
The first is the interest rate hypothesis the belief that aggregate demand reacts linearly to changes in real interest rates.

Monetary policy and the interest rate hypothesis

The interest rate hypothesis needs closer inspection on three grounds.
[9] First, an emerging literature suggests that monetary policy transmission may not be linear in the level of the interest rate.
[12] All else equal, the lower the pass-through of interest rate changes to bank deposit rates, the smaller the effects of monetary policy on aggregate demand.
[15] Recent experience suggests that money illusion may not only change the nature of the interest rate channel, it may also expose central banks to widespread criticism.
[16] Many people may be surprised to learn that negative real interest rates are not a new phenomenon.

The expectations hypothesis

This bias in peoples perception brings me to the second hypothesis the expectations hypothesis.
When policy space is limited, expectations become the main driver of monetary policy transmission in New Keynesian models.
This is why many central bank scholars have been concerned about the gradual fall in market-based inflation expectations in recent years.
First, a large part of the fall in market-based inflation expectations can be explained by a fall in the inflation risk premium (see left chart slide 7).

Empirical evidence suggests that such indicators can often provide only little additional forward-looking information about inflation, even for a horizon of only one to two years ahead.
[17] This raises the question of whether inflation expectations of households and firms may be more relevant than those of the market for shaping macroeconomic outcomes in line with the expectations hypothesis.
[19] For example, in surveys a significant fraction of consumers report very high inflation expectations often in excess of 10%.
But a limited understanding of actual levels does not necessarily stop people from acting on their beliefs.

They find either no evidence of inflation expectations affecting consumption decisions or, more disturbingly, even suggest that higher inflation expectations could lower rather than raise consumption.
[21] One interesting pattern that can help explain these findings is that rising inflation expectations often seem to go hand-in-hand with expectations of lower incomes and lower economic growth (see right chart slide 8).
[22] These findings suggest that individuals are far from being as rational and forward-looking as our canonical models assume.
[24] Bounded rationality may hence limit the efficacy of policies geared towards boosting inflation expectations, all the more so as new empirical evidence highlights that most households are very hesitant about adjusting their long-term inflation expectations in response to news.
First, fiscal policy has become more important as a macroeconomic stabilisation tool, also once we leave the pandemic behind us.
New research demonstrates that trust has a tangible impact on households inflation expectations.

We know that people once inflation is low care more about employment, which is part of the US Federal Reserves mandate.
But it is much harder to explain why inflation of 2% is better than 1%.

Low inflation and the design and calibration of policy instruments

But what we learn from our analysis of how monetary policy transmission to the real economy may change in a low interest rate environment may ultimately also affect the way we calibrate and design our policy instruments, as well the horizon over which we want to achieve our inflation aim.
The first is that monetary policy faces constraints.
For example, we may not know precisely where the effective lower bound lies, but we know that there is one.
Exempting a portion of excess reserves from negative rates, or rewarding lending activities at rates below our main policy rate, have been effective instruments in stretching our boundaries.
The second challenge relates to the unintended side effects of monetary policy.
Money illusion, for example, may push house prices increasingly away from fundamentals, despite real interest rates not being extraordinarily low.
A third and complementary aspect is the horizon over which we want to bring inflation back to our aim.

Conclusion

Christine Lagarde: Monetary policy in a pandemic emergency

Retrieved on:

Thursday, November 12, 2020

Economy, Money, Macroeconomic policy, Monetary policy, Public finance, Recession, Monetary inflation, Fiscal policy, Inflation, Pan-European Pension, Macroeconomics, Central bank

SPEECHMonetary policy in a pandemic emergencyKeynote speech by Christine Lagarde, President of the ECB, at the ECB Forum on Central Banking Frankfurt am Main, 11 November 2020 Let me begin by welcoming all of you to this years ECB Forum on Central Banking.

Key Points:

SPEECH

Monetary policy in a pandemic emergency

Keynote speech by Christine Lagarde, President of the ECB, at the ECB Forum on Central Banking

Frankfurt am Main, 11 November 2020 Let me begin by welcoming all of you to this years ECB Forum on Central Banking.
Regrettably, we cannot be together in Sintra this time, but I trust that this virtual environment will be no less conducive to challenging ideas and productive debate.
The purpose of this years conference is to examine the challenges facing central banking in a shifting world.
Actually, the largest shift central banks are facing today may well turn out to be the pandemic itself.

A highly unusual recession

The deliberate shutdown of the economy triggered by the COVID-19 pandemic has produced a highly unusual recession.
In a regular recession, manufacturing and construction are typically hit harder by the cyclical downturn, while services are more resilient.
Compare our experience in the first half of this year with the first six months following the Lehman crash.
After Lehman, manufacturing contributed 2.8 percentage points to the recession and services contributed 1.7 percentage points.
But this year, the loss was 9.8 percentage points for services and much less, 3.2 percentage points, for manufacturing.
First, research finds that the recovery from a services-led recession tends to be slower than from a durable goods-led recession, as services create less pent-up demand than consumer goods.
[3] So, from the outset, this unusual recession has posed exceptionally high risks.
More than ever before, macroeconomic, supervisory and regulatory authorities have dovetailed and made each others efforts more powerful.

Policy responses to the pandemic

There are two main ways in which we have adapted the ECBs policy to the pandemic: via the design of our tools and via the transmission of our monetary policy.
The PEPP in particular has the dual function of stabilising financial markets and contributing to easing the overall monetary policy stance, thereby helping to offset the downward impact of the pandemic on the projected path of inflation.
The stabilisation function of the PEPP is ensured by its flexibility, which is crucial given the unpredictable course of the pandemic and its uneven impact across economies.
[5] At the same time, the nature of the pandemic also affects the transmission of monetary policy.
[6] In these circumstances, it is crucial that monetary policy ensures favourable financing conditions for the whole economy: private and public sectors alike.
Indeed, these are the times when fiscal policy has the greatest impact, for at least two reasons.
First, fiscal policy can respond in a more targeted way to the parts of the economy affected by health restrictions.
And in this way, by brightening economic prospects for firms and households, fiscal policy can help reinvigorate monetary transmission through the private sector.

The risk of an unsteady recovery

But regrettably the economic recovery from the pandemic emergency could well be bumpy.
We are seeing a strong resurgence of the virus and this has introduced a new dynamic.
So the recovery may not be linear, but rather unsteady, stop-start and contingent on the pace of vaccine roll-out.
In the interim, output in the services sector may struggle to fully recover.
Indeed, services were already showing a declining trend before the latest round of restrictions: the services PMI fell from 54.7 in July to 46.9 in October.
And while manufacturing has so far remained relatively resilient, there is a risk of the recovery in manufacturing also slowing once order backlogs are run down and industrial output becomes better aligned with demand.
In this situation, the key challenge for policymakers will be to bridge the gap until vaccination is well advanced and the recovery can build its own momentum.
Supervisory authorities are working to ensure that banks can continue to support the recovery by readying them for a potential deterioration in asset quality.

The outlook for monetary policy

So what is the role of monetary policy in this response?
Continued policy support is therefore necessary to achieve our inflation aim.
In these conditions, it is vital that monetary policy underpins inflation dynamics by supporting demand and preventing second-round effects, where the negative pandemic shock to inflation feeds into wage and price-setting and becomes persistent.
To that end, the best contribution monetary policy can make is to ensure favourable financing conditions for the whole economy.
First, while fiscal policy is active in supporting the economy, monetary policy has to minimise any crowding-out effects that might create negative spillovers for households and firms.
Second, monetary policy has to continue supporting the banking sector to secure policy transmission and prevent adverse feedback loops from emerging.
In other words, when thinking about favourable financing conditions, what matters is not only the level of financing conditions but the duration of policy support, too.
They are therefore likely to remain the main tools for adjusting our monetary policy.

Conclusion

Christine Lagarde: Monetary policy in a pandemic emergency

Retrieved on:

Thursday, November 12, 2020

Economy, Money, Macroeconomic policy, Monetary policy, Public finance, Recession, Monetary inflation, Fiscal policy, Inflation, Pan-European Pension, Macroeconomics, Central bank

SPEECHMonetary policy in a pandemic emergencyKeynote speech by Christine Lagarde, President of the ECB, at the ECB Forum on Central Banking Frankfurt am Main, 11 November 2020 Let me begin by welcoming all of you to this years ECB Forum on Central Banking.

Key Points:

SPEECH

Monetary policy in a pandemic emergency

Keynote speech by Christine Lagarde, President of the ECB, at the ECB Forum on Central Banking

Frankfurt am Main, 11 November 2020 Let me begin by welcoming all of you to this years ECB Forum on Central Banking.
Regrettably, we cannot be together in Sintra this time, but I trust that this virtual environment will be no less conducive to challenging ideas and productive debate.
The purpose of this years conference is to examine the challenges facing central banking in a shifting world.
Actually, the largest shift central banks are facing today may well turn out to be the pandemic itself.

A highly unusual recession

The deliberate shutdown of the economy triggered by the COVID-19 pandemic has produced a highly unusual recession.
In a regular recession, manufacturing and construction are typically hit harder by the cyclical downturn, while services are more resilient.
Compare our experience in the first half of this year with the first six months following the Lehman crash.
After Lehman, manufacturing contributed 2.8 percentage points to the recession and services contributed 1.7 percentage points.
But this year, the loss was 9.8 percentage points for services and much less, 3.2 percentage points, for manufacturing.
First, research finds that the recovery from a services-led recession tends to be slower than from a durable goods-led recession, as services create less pent-up demand than consumer goods.
[3] So, from the outset, this unusual recession has posed exceptionally high risks.
More than ever before, macroeconomic, supervisory and regulatory authorities have dovetailed and made each others efforts more powerful.

Policy responses to the pandemic

There are two main ways in which we have adapted the ECBs policy to the pandemic: via the design of our tools and via the transmission of our monetary policy.
The PEPP in particular has the dual function of stabilising financial markets and contributing to easing the overall monetary policy stance, thereby helping to offset the downward impact of the pandemic on the projected path of inflation.
The stabilisation function of the PEPP is ensured by its flexibility, which is crucial given the unpredictable course of the pandemic and its uneven impact across economies.
[5] At the same time, the nature of the pandemic also affects the transmission of monetary policy.
[6] In these circumstances, it is crucial that monetary policy ensures favourable financing conditions for the whole economy: private and public sectors alike.
Indeed, these are the times when fiscal policy has the greatest impact, for at least two reasons.
First, fiscal policy can respond in a more targeted way to the parts of the economy affected by health restrictions.
And in this way, by brightening economic prospects for firms and households, fiscal policy can help reinvigorate monetary transmission through the private sector.

The risk of an unsteady recovery

But regrettably the economic recovery from the pandemic emergency could well be bumpy.
We are seeing a strong resurgence of the virus and this has introduced a new dynamic.
So the recovery may not be linear, but rather unsteady, stop-start and contingent on the pace of vaccine roll-out.
In the interim, output in the services sector may struggle to fully recover.
Indeed, services were already showing a declining trend before the latest round of restrictions: the services PMI fell from 54.7 in July to 46.9 in October.
And while manufacturing has so far remained relatively resilient, there is a risk of the recovery in manufacturing also slowing once order backlogs are run down and industrial output becomes better aligned with demand.
In this situation, the key challenge for policymakers will be to bridge the gap until vaccination is well advanced and the recovery can build its own momentum.
Supervisory authorities are working to ensure that banks can continue to support the recovery by readying them for a potential deterioration in asset quality.

The outlook for monetary policy

So what is the role of monetary policy in this response?
Continued policy support is therefore necessary to achieve our inflation aim.
In these conditions, it is vital that monetary policy underpins inflation dynamics by supporting demand and preventing second-round effects, where the negative pandemic shock to inflation feeds into wage and price-setting and becomes persistent.
To that end, the best contribution monetary policy can make is to ensure favourable financing conditions for the whole economy.
First, while fiscal policy is active in supporting the economy, monetary policy has to minimise any crowding-out effects that might create negative spillovers for households and firms.
Second, monetary policy has to continue supporting the banking sector to secure policy transmission and prevent adverse feedback loops from emerging.
In other words, when thinking about favourable financing conditions, what matters is not only the level of financing conditions but the duration of policy support, too.
They are therefore likely to remain the main tools for adjusting our monetary policy.

Conclusion

Isabel Schnabel: The ECB’s independence in times of mounting public debt

Retrieved on:

Sunday, October 11, 2020

Economy, Money, Finance, Eurozone, Monetary policy, Multi-speed Europe, Debt, Euro, Government debt, Monetary inflation, Debt monetization, European Central Bank

The ECB gears its monetary policy to its price stability mandate, not to the indebtedness of Member States.

Key Points:

The ECB gears its monetary policy to its price stability mandate, not to the indebtedness of Member States.
The euro has been built on the principle of monetary dominance: the ECBs objectives are solely determined by its mandate as defined in the European Treaties.
This principle is buttressed by far-reaching political independence, the prohibition of monetary financing of public debt and a comprehensive fiscal framework.
Is the rising public debt jeopardising this independence?
There is no evidence of a systematic feedback loop from sovereign debt developments to monetary policy decisions.
The public debt ratio in the euro area is notably lower than it would have been in the absence of the bond purchases.
Moreover, a monetary financing of public debt would be expected to raise inflation expectations as was the case in the 1970s.
But would it not make sense to take on less public debt today to protect the ECBs independence in the longer term?
This would also afford the ECB more room for manoeuvre in the future, which would even strengthen its independence.

Isabel Schnabel: The ECB’s independence in times of mounting public debt

Retrieved on:

Saturday, October 10, 2020

Economy, Money, Finance, Eurozone, Monetary policy, Multi-speed Europe, Debt, Euro, Government debt, Monetary inflation, Debt monetization, European Central Bank

The ECB gears its monetary policy to its price stability mandate, not to the indebtedness of Member States.

Key Points:

The ECB gears its monetary policy to its price stability mandate, not to the indebtedness of Member States.
The euro has been built on the principle of monetary dominance: the ECBs objectives are solely determined by its mandate as defined in the European Treaties.
This principle is buttressed by far-reaching political independence, the prohibition of monetary financing of public debt and a comprehensive fiscal framework.
Is the rising public debt jeopardising this independence?
There is no evidence of a systematic feedback loop from sovereign debt developments to monetary policy decisions.
The public debt ratio in the euro area is notably lower than it would have been in the absence of the bond purchases.
Moreover, a monetary financing of public debt would be expected to raise inflation expectations as was the case in the 1970s.
But would it not make sense to take on less public debt today to protect the ECBs independence in the longer term?
This would also afford the ECB more room for manoeuvre in the future, which would even strengthen its independence.

Philip R. Lane: The ECB’s monetary policy in the pandemic: meeting the challenge

Retrieved on:

Wednesday, October 7, 2020

Economy, Macroeconomics, Money, Inflation, Macroeconomic policy, Quantitative easing, Monetary policy, Monetary inflation, Euro, Inflation targeting, European Central Bank

SPEECHThe ECB’s monetary policy in the pandemic: meeting the challengeSpeech by Philip R. Lane, Member of the Executive Board of the ECB, at the 62nd NABE Annual Meeting “Global Reset? Economics, Business, and Policy in the Pandemic” 6 October 2020 I will provide a brief assessment of the macroeconomic outlook, discuss the ECB’s monetary policy response to the pandemic crisis and explain our current monetary policy challenge.[1]The macroeconomic outlookCompared with the trough, this initial recovery phase is visible across a wide range of economic indicators.

Key Points:

SPEECH

The ECB’s monetary policy in the pandemic: meeting the challenge

Speech by Philip R. Lane, Member of the Executive Board of the ECB, at the 62nd NABE Annual Meeting “Global Reset? Economics, Business, and Policy in the Pandemic”

The macroeconomic outlook

Compared with the trough, this initial recovery phase is visible across a wide range of economic indicators.
[2] That said, the euro area economy is still operating far below its pre-pandemic level.
[3] Meanwhile, the resurgence in infection rates (and the associated public health measures) is posing renewed challenges, especially for those sectors most affected by social distancing.
[4] In this environment, many households are uncertain about future employment and wage dynamics, motivating them to save more for precautionary purposes.
Chart 1 shows that services sector activity has been disproportionately hit (also when compared with the global financial crisis).

This assessment underpins the baseline scenario of the September ECB staff macroeconomic projections.
Despite the recovery in the second half of the year, output at the end of 2020 is projected to remain about 5.2 percent below the level of output at the end of 2019.
This is illustrated by the alternative projection scenarios (the baseline projection is flanked by mild and severe scenarios), as shown in Chart 2.
In view of the uncertain economic and financial outcomes of the pandemic, the balance of risks is tilted to the downside.

Euro area HICP inflation has been declining for several months: after turning negative to minus 0.2 percent in August, the flash estimate for September signals a further decline to minus 0.3 percent in September.
We expect headline inflation to remain negative for the remainder of the year, before returning to positive territory in early 2021.
In parallel to the general economic outlook, there is considerable uncertainty surrounding this baseline projection, as indicated by the range of inflation outcomes that are spanned by the mild and severe scenarios for the inflation outlook in Chart 3.
I will turn to the implications of the inflation outlook for monetary policy later in this speech.
Chart 3 Realised and projected headline inflation (annual percentage changes)

The monetary policy response

An accommodative monetary policy configuration was already in place before the pandemic: in September 2019, the main policy rate (the deposit facility rate) was lowered to minus 0.5 percent and there was a resumption of net asset purchases at a rate of 20 billion per month under our baseline asset purchase programme (APP), with these measures reinforced by forward guidance that ties future monetary policy to the inflation outlook.
In addition, credit supply was supported by the third series of targeted longer-term refinancing operations (the TLTRO III programme).
In the initial response to the pandemic crisis, we adopted a comprehensive package of complementary measures, which are illustrated in Chart 4.
The additional quantitative easing provided by the PEPP programme also eases the overall monetary stance, acting to reduce economic slack and boost inflation dynamics over the medium term.

With the launch of the PEPP, our range of monetary policy measures currently consists of four main instruments: (a) the setting of our policy rates (with the deposit facility rate as the primary current margin); (b) the baseline asset purchase programme (APP); (c) the pandemic-specific temporary asset purchase programme (PEPP); and (d) the TLTRO III programme.
Our forward guidance about the future setting of our policy measures plays a central role in determining our overall monetary stance.
In relation to our policy rates, our current forward guidance links future rate-setting to the inflation outlook; in turn, net purchases and reinvestment under the APP are linked to the rate path.
In line with our forward guidance, market-based expectations of future policy rates and the future path of the APP have adjusted in response to changes to the inflation outlook.
Through these endogenous market responses, our forward guidance acts as an automatic stabiliser through the adjustment of monetary policy expectations and hence the entire spectrum of monetary conditions to changes in the inflation outlook.

The combination of our pre-pandemic and pandemic-specific monetary policy measures has successfully contributed to the stabilisation of markets and has thereby helped to ensure the smooth transmission of our monetary policy.
[7] As shown in Chart 6, the PEPP has also helped contain sovereign bond yields: today, the euro area GDP-weighted yield curve is back to its pre-crisis levels.
This is central to the transmission of our monetary policy, since sovereign bond yields are the basis for funding costs for households, corporates and banks (in addition to governments).

Credit supply has been supported by our TLTRO III operations.
The TLTROs were in high demand in June and September 2020, with a combined take-up of nearly 1.5 trillion.
Our estimates show that TLTRO III liquidity can be expected to boost loan volumes considerably, to the tune of 3 percentage points cumulatively by 2022.
In addition, the euro area bank lending survey indicates that TLTRO funding has been effective in easing the terms and conditions that banks apply in their lending.

It is apparent that, despite an increase in credit risk, the supportive conditions of the ECB funding have contributed to keeping the lending rate around the historically low levels it had reached before the pandemic crisis.
Chart 8 Lending rate to non-financial corporations and its components (percentages per annum)

Meeting the monetary policy challenge

Philip R. Lane: The ECB’s monetary policy in the pandemic: meeting the challenge

Retrieved on:

Wednesday, October 7, 2020

Economy, Macroeconomics, Money, Inflation, Macroeconomic policy, Quantitative easing, Monetary policy, Monetary inflation, Euro, Inflation targeting, European Central Bank

SPEECHThe ECB’s monetary policy in the pandemic: meeting the challengeSpeech by Philip R. Lane, Member of the Executive Board of the ECB, at the 62nd NABE Annual Meeting “Global Reset? Economics, Business, and Policy in the Pandemic” 6 October 2020 I will provide a brief assessment of the macroeconomic outlook, discuss the ECB’s monetary policy response to the pandemic crisis and explain our current monetary policy challenge.[1]The macroeconomic outlookCompared with the trough, this initial recovery phase is visible across a wide range of economic indicators.

Key Points:

SPEECH

The ECB’s monetary policy in the pandemic: meeting the challenge

Speech by Philip R. Lane, Member of the Executive Board of the ECB, at the 62nd NABE Annual Meeting “Global Reset? Economics, Business, and Policy in the Pandemic”

The macroeconomic outlook

Compared with the trough, this initial recovery phase is visible across a wide range of economic indicators.
[2] That said, the euro area economy is still operating far below its pre-pandemic level.
[3] Meanwhile, the resurgence in infection rates (and the associated public health measures) is posing renewed challenges, especially for those sectors most affected by social distancing.
[4] In this environment, many households are uncertain about future employment and wage dynamics, motivating them to save more for precautionary purposes.
Chart 1 shows that services sector activity has been disproportionately hit (also when compared with the global financial crisis).

This assessment underpins the baseline scenario of the September ECB staff macroeconomic projections.
Despite the recovery in the second half of the year, output at the end of 2020 is projected to remain about 5.2 percent below the level of output at the end of 2019.
This is illustrated by the alternative projection scenarios (the baseline projection is flanked by mild and severe scenarios), as shown in Chart 2.
In view of the uncertain economic and financial outcomes of the pandemic, the balance of risks is tilted to the downside.

Euro area HICP inflation has been declining for several months: after turning negative to minus 0.2 percent in August, the flash estimate for September signals a further decline to minus 0.3 percent in September.
We expect headline inflation to remain negative for the remainder of the year, before returning to positive territory in early 2021.
In parallel to the general economic outlook, there is considerable uncertainty surrounding this baseline projection, as indicated by the range of inflation outcomes that are spanned by the mild and severe scenarios for the inflation outlook in Chart 3.
I will turn to the implications of the inflation outlook for monetary policy later in this speech.
Chart 3 Realised and projected headline inflation (annual percentage changes)

The monetary policy response

An accommodative monetary policy configuration was already in place before the pandemic: in September 2019, the main policy rate (the deposit facility rate) was lowered to minus 0.5 percent and there was a resumption of net asset purchases at a rate of 20 billion per month under our baseline asset purchase programme (APP), with these measures reinforced by forward guidance that ties future monetary policy to the inflation outlook.
In addition, credit supply was supported by the third series of targeted longer-term refinancing operations (the TLTRO III programme).
In the initial response to the pandemic crisis, we adopted a comprehensive package of complementary measures, which are illustrated in Chart 4.
The additional quantitative easing provided by the PEPP programme also eases the overall monetary stance, acting to reduce economic slack and boost inflation dynamics over the medium term.

With the launch of the PEPP, our range of monetary policy measures currently consists of four main instruments: (a) the setting of our policy rates (with the deposit facility rate as the primary current margin); (b) the baseline asset purchase programme (APP); (c) the pandemic-specific temporary asset purchase programme (PEPP); and (d) the TLTRO III programme.
Our forward guidance about the future setting of our policy measures plays a central role in determining our overall monetary stance.
In relation to our policy rates, our current forward guidance links future rate-setting to the inflation outlook; in turn, net purchases and reinvestment under the APP are linked to the rate path.
In line with our forward guidance, market-based expectations of future policy rates and the future path of the APP have adjusted in response to changes to the inflation outlook.
Through these endogenous market responses, our forward guidance acts as an automatic stabiliser through the adjustment of monetary policy expectations and hence the entire spectrum of monetary conditions to changes in the inflation outlook.

The combination of our pre-pandemic and pandemic-specific monetary policy measures has successfully contributed to the stabilisation of markets and has thereby helped to ensure the smooth transmission of our monetary policy.
[7] As shown in Chart 6, the PEPP has also helped contain sovereign bond yields: today, the euro area GDP-weighted yield curve is back to its pre-crisis levels.
This is central to the transmission of our monetary policy, since sovereign bond yields are the basis for funding costs for households, corporates and banks (in addition to governments).

Credit supply has been supported by our TLTRO III operations.
The TLTROs were in high demand in June and September 2020, with a combined take-up of nearly 1.5 trillion.
Our estimates show that TLTRO III liquidity can be expected to boost loan volumes considerably, to the tune of 3 percentage points cumulatively by 2022.
In addition, the euro area bank lending survey indicates that TLTRO funding has been effective in easing the terms and conditions that banks apply in their lending.

It is apparent that, despite an increase in credit risk, the supportive conditions of the ECB funding have contributed to keeping the lending rate around the historically low levels it had reached before the pandemic crisis.
Chart 8 Lending rate to non-financial corporations and its components (percentages per annum)

Meeting the monetary policy challenge

Luis de Guindos: Interview with Market News International

Retrieved on:

Friday, October 2, 2020

Economy, Macroeconomics, Inflation, Money, Baseline, United States Office of Management and Budget, Monetary policy, Monetary inflation, Euro, European Central Bank

INTERVIEWInterview with Market News InternationalInterview with Luis de Guindos, Vice-President of the ECB, conducted by Luke Heighton on 29 September 2020 and published on 1 October 2020 1 October 2020 The September 2020 ECB staff macroeconomic projections appear to have added weight to the ECBs baseline scenario.

Key Points:

INTERVIEW

Interview with Market News International

Interview with Luis de Guindos, Vice-President of the ECB, conducted by Luke Heighton on 29 September 2020 and published on 1 October 2020

1 October 2020 The September 2020 ECB staff macroeconomic projections appear to have added weight to the ECBs baseline scenario.
So we expect to see a certain bounceback of the economy that will have a positive impact on inflation.
And finally, in 2022, we are projecting that the inflation rate will be on average 1.2-1.3%.
So, we are discounting that for the rest of the year the inflation rate will be negative or very close to zero.
But we are monitoring inflation continuously, and as always we are totally open to recalibrating our measures in accordance with our inflation projections.
If you look at the pandemic, there is a worrying increase in the number of outbreaks across Europe.
At the same time, most governments have rejected the idea of a lockdown like the one in March.
So governments are trying to combine the public health element of the pandemic with keeping economies open.
Regarding our baseline scenario, more than focusing on the average, people should be looking at the dispersion around the average.
This is relevant and makes a very clear point in favour of fiscal policy.
Some countries will clearly be below the average decline in GDP of 8%, but others will be well above.
And we also need to keep an eye on how fiscal policy is implemented at the national and European levels.
We extended the programme until at least mid-2021 and, if necessary, we could adjust and recalibrate it in the future.
Christine Lagarde recently described the coronavirus crisis as an opportunity to create the conditions for more inclusive, greener and more digital growth.
Would you like to see the ECB be more assertive, or more expansive, in its interpretation of its secondary mandate responsibilities?
We expect governments will start to apply fiscal policies and taxation policies to deal with climate change.

Luis de Guindos: Interview with Market News International

Retrieved on:

Friday, October 2, 2020

Economy, Macroeconomics, Inflation, Money, Baseline, United States Office of Management and Budget, Monetary policy, Monetary inflation, Euro, European Central Bank

INTERVIEWInterview with Market News InternationalInterview with Luis de Guindos, Vice-President of the ECB, conducted by Luke Heighton on 29 September 2020 and published on 1 October 2020 1 October 2020 The September 2020 ECB staff macroeconomic projections appear to have added weight to the ECBs baseline scenario.

Key Points:

INTERVIEW

Interview with Market News International

Interview with Luis de Guindos, Vice-President of the ECB, conducted by Luke Heighton on 29 September 2020 and published on 1 October 2020

1 October 2020 The September 2020 ECB staff macroeconomic projections appear to have added weight to the ECBs baseline scenario.
So we expect to see a certain bounceback of the economy that will have a positive impact on inflation.
And finally, in 2022, we are projecting that the inflation rate will be on average 1.2-1.3%.
So, we are discounting that for the rest of the year the inflation rate will be negative or very close to zero.
But we are monitoring inflation continuously, and as always we are totally open to recalibrating our measures in accordance with our inflation projections.
If you look at the pandemic, there is a worrying increase in the number of outbreaks across Europe.
At the same time, most governments have rejected the idea of a lockdown like the one in March.
So governments are trying to combine the public health element of the pandemic with keeping economies open.
Regarding our baseline scenario, more than focusing on the average, people should be looking at the dispersion around the average.
This is relevant and makes a very clear point in favour of fiscal policy.
Some countries will clearly be below the average decline in GDP of 8%, but others will be well above.
And we also need to keep an eye on how fiscal policy is implemented at the national and European levels.
We extended the programme until at least mid-2021 and, if necessary, we could adjust and recalibrate it in the future.
Christine Lagarde recently described the coronavirus crisis as an opportunity to create the conditions for more inclusive, greener and more digital growth.
Would you like to see the ECB be more assertive, or more expansive, in its interpretation of its secondary mandate responsibilities?
We expect governments will start to apply fiscal policies and taxation policies to deal with climate change.

Christine Lagarde: The monetary policy strategy review: some preliminary considerations

Retrieved on:

Thursday, October 1, 2020

Macroeconomics, Economy, Money, Inflation, Monetary policy, Phillips curve, Price stability, Monetary inflation, Disinflation, Full employment, Real interest rate, Stimulus

SPEECHThe monetary policy strategy review: some preliminary considerationsSpeech by Christine Lagarde, President of the ECB, at the “ECB and Its Watchers XXI”conferenceThis morning, I would like to speak to you about the ECBs strategy review, the reasons we are conducting it, and our expectations as a result of it.

Key Points:

SPEECH

The monetary policy strategy review: some preliminary considerations

Speech by Christine Lagarde, President of the ECB, at the “ECB and Its Watchers XXI”conference

This morning, I would like to speak to you about the ECBs strategy review, the reasons we are conducting it, and our expectations as a result of it.
Most importantly, the last decade has been defined by a persistent decline in inflation among advanced economies.
We need to thoroughly analyse the forces that are driving inflation dynamics today, and consider whether and how we should adjust our policy strategy in response.
This is why we have launched the ECB Listens programme, in which we will aim to listen to as many voices as possible.
But I will discuss the main issues we are looking at and some of the key questions we will be asking.
None of these issues can be considered in isolation and we need a well-rounded view of all elements in order to draw conclusions for the strategy review.

The inflation objective

I start with the inflation objective because it anchors the inflation process for the whole economy.
Since 2003, the ECB has used a double-key formulation to set our objective, defining price stability as a year-on-year increase in inflation of below 2%, while aiming for inflation of below, but close to, 2%.
[1] But in the current environment of lower inflation, the concerns we face are different and this needs to be reflected in our inflation aim.
But a persistent failure to meet the inflation aim can feed into inflation expectations and would call for a shorter policy horizon.
The wider discussion today, however, is whether central banks should commit to explicitly make up for inflation misses when they have spent quite some time below their inflation goals.
This is because the promise of inflation overshooting raises inflation expectations and therefore lowers real interest rates.
The third issue is the measure of inflation that lies behind our inflation aim.
Likewise, to get a better sense of the evolution of the HICP over the medium term, we need to complement our analysis also by looking at more cyclical and less volatile measures of inflation, such as underlying inflation.
But underlying inflation measures are more responsive to economic slack and tend to better predict inflation over the medium term.

The relationship between inflation and the real economy

If the anchor for inflation is the inflation aim, the Phillips curve the link between the real economy and inflation plays a central role in allowing central banks to steer inflation towards that aim.
But in the low inflation environment, prices appear to have become less responsive to the real economy.
[4] Broadly speaking, three factors might explain why inflation responded so weakly to improvements in the economy in the run-up to the pandemic.
The first possibility is that economic slack the amount of underused resources in the economy was larger than we thought.
The second possibility is that the relationship between slack and inflation was obscured by persistent structural forces.
And the third is that the anchoring of inflation expectations might have loosened, affecting where inflation settles when both demand and supply shocks have passed and slack converges at zero.
Since it is the distance from full employment that matters in terms of moving inflation in the Phillips curve, if that distance is underestimated inflation may remain subdued even as measured slack gets smaller.
How could they have weakened the link between the real economy and inflation and thereby require a revised approach to monetary policy?
In any event, structural factors can only have a lasting negative impact on inflation if they seep into inflation expectations.
This leads me to the third factor that may explain the apparent disconnect between the real economy and inflation.
In 2015 average perceived inflation among euro area households was just under 5%, while actual inflation was 0.3%.

Monetary policy transmission and effectiveness

As monetary policy everywhere has approached the lower bound, all major central banks have faced questions about their policy space and the traction of their tools on the economy.
Monetary policy is accommodative when the policy rate is below the natural rate, and restrictive when the policy rate is above it.
[16] This has required progressively lower policy rates in order to ease monetary policy or even to prevent an unchanged policy stance from becoming more restrictive.
The implicit assumption since 2008 has been that policy normalisation will mean returning mainly to interest rate policy and winding down unconventional policies.
This is a level that would probably have triggered reversal rate dynamics, a situation where a rate cut would become contractionary because it harms the business models of financial intermediaries and disrupts monetary policy transmission.
Fiscal policy empowers monetary policy by fostering demand, which brightens economic prospects for firms.
This encourages them to borrow and allows them to fully benefit from monetary policy stimulus.
And monetary policy makes fiscal policy more effective, because when monetary policy is at the lower bound and committed to staying there via forward guidance on rates and asset purchases fiscal multipliers are higher.
ECB analysis for the euro area finds that, while monetary policy was supporting inflation during this period, it was being offset by demand headwinds.
And, in disinflationary conditions when the economy is running short of its potential, the goals of each policy are naturally aligned.