For instance, Holston et al (2016), whose main results are shown in Figure 1, used a semi-structural approach to filter the data on output, inflation and short-term interest rates to extract highly persistent components of the natural rate of output, its trend growth rate and the natural rate. To increase flexibility and face new challenges, we thus recommend changing the definition of price stability in the following way: “below but close to 2 percent over the medium term” (generally defined as 18 months to 3 years) should become “around 2 percent, on average, over the long run” (ie a much longer time horizon than 18 months to 3 years). What is the sense in communicating about things that we do not know? In a recent interview, Rehn said fostering responsible investment is consistent with the ECB’s mandate to … However, it would be very difficult to put in place this type of policy in the euro area given that using such a strategy, which would lead to announcing a target level of interest rate for a given country, would not be compatible with maintaining the pretence of market discipline over the public finances of member states. The ECB signals that it will become the first global central bank to adopt "Sustainable Easing" into its monetary policy framework. Naturally, one solution would be for the ECB to relax this rule, a risk that it appears at the time of writing unwilling to take. The governing council of the ECB is the group that decides on changes to monetary policy… For instance, other measures such as the level of underemployment or the inactive working-age population give a different labour market picture. Note: updated estimates as of November 20184. If the cost of falling prices is very high, then we must avoid the problem by overshooting in the other direction. The ECB, together with the national central banks of euroarea Member States, - This, in turn, might explain why in recent years lower interest rates for a prolonged period, and the massive use of unconventional monetary policy tools, have not resulted in a strong surge in inflation. This will help prevent too-rapid reversals of policies and could have helped to avoid the erroneous 2011 interest rate increases and more generally the current persistence of low inflation. The ECB’s limited remit might well be the weakness of the institutional arrangement, but the practice of macro-prudential policies will show if this limitation is severe or if cooperation between the ECB and national authorities, under the watch of the European Systemic Risk Board, ensures the proper implementation of the various macroprudential tools. In particular, carefully-set limits on ratios such as the loan-to-value ratio and the debt-to-income ratio could help to tame financial imbalances (see the literature review in Claeys and Darvas, 2015). It would also be important to define tolerance bands around the 2 percent target as a way of having a clear accountability framework. In a framework in which inflation is targeted, Monetary policy and financial stability are intrinsically linked. As far as negative rates as concerned, next time it is needed to relax the ECB’s monetary policy stance, the ECB could try to go deeper into negative territory than it has so far (at time of writing the deposit rate is fixed at -0.4 percent). Overall, given the limitations of the estimation methods – in real time in particular – and the fact that cyclical arguments also play a role in the current situation – even if they fail to explain why the decline in long-term real rates preceded the crisis – it is difficult to conclude anything definitive from these estimates of the neutral rate. However, our understanding of the effects of asset purchases, for example, is not complete. The inflation index current targeted (the Harmonised Index of Consumer Prices, HICP) is affected by supply shocks, such as oil-price shocks, that monetary policy cannot affect directly. DECISION (EU) 2020/506 OF THE EUROPEAN CENTRAL BANK. In the short-run however, there was still sufficient scope for monetary policy to smooth out fluctuations around the independent path of potential output by affecting cyclical unemployment (the difference between observed unemployment and the NAIRU), and thus inflation. But as central banks contemplate fundamental changes in their approach, they should be mindful of possible disruptions in their operational environment. However, recent data released by the ECB (2018) shows that cash hoarding by banks has increased significantly as a result of negative deposit rates – even if the sums at stake are still marginal compared to the overall amount of excess reserves. We recommend that the ECB makes a clear distinction between the two variables and remains accountable only for its ability to manage core inflation. Second, this also means that to achieve the same objectives as in the past, monetary policy could be, or even must be, more expansionary than previously. Closer coordination with national macroprudential authorities and greater harmonisation in the use of macroprudential policies are however strongly recommended, as it is now acknowledged that financial and monetary policies are closely interlinked. We would therefore not exclude exploring the possibility of using instruments that have not been used during the crisis: for instance, helicopter money (ie direct injections of cash into the economy by the central bank) or targeted longer-term refinancing operations with negative rates below the deposit rate. Drehmann et al (2012) argued that this could often be the case given that financial cycles are much longer than traditional business cycles. Other more targeted (and country-specific) tools should be deployed to avoid the build-up of financial stability risks. It might very well be that the large imbalances that developed in the early 2000s no longer pose an immediate threat, and that the financial system is better and more tightly regulated. The Eurosystem’s monetary policy operations are executed under uniform terms and conditions in all member states. In micro-founded models, such as the Ramsey model or New Keynesian models, household preferences (their patience represented by the discount rate, and their inter-temporal elasticity of substitution for consumption) also determine the equilibrium rate in the long run. The ECB can only apply those tools in order to seek to influence lenders’ behaviour – as categorised by Blanchard et al (2013) – but cannot apply tools aimed at controlling borrowers’ behaviour, such as loan-to-value ratios and debt-to-income ratios7. But these solutions might be too extreme and, most importantly, highly unpopular in some member states. We explore this in the next section. The substantial variability in unemployment has had less effect on inflation, which has remained anchored at relatively low levels in the US and the euro area, despite large swings in the economic cycle. This paper provides a comprehensive view of the ECB’s monetary policy over these two decades. This implies that the ECB would need to rely more heavily on these unconventional tools. As had widely been expected, the central bank announced changes to its package of non-conventional monetary tools. As suggested by Rogoff (2015), the current low-rate environment could more simply be the result of the “debt super-cycle”. If the neutral real rate is indeed around zero in the euro area, even if inflation is around the 2 percent target, the ECB’s steady-state policy rate would have to be around 2 percent. This lack of knowledge implies that policies cannot be designed to fit only one set of outcomes but should instead prepare for the possibility of many and different outcomes. Therefore, should monetary policy directly target financial stability? (2018) ‘Reflections on Dwindling Worker Bargaining Power and Monetary Policy’, Luncheon Address at the Jackson Hole Economic Symposium, Meinusch, Annette, and Peter Tillmann (2016) ‘The macroeconomic impact of unconventional monetary policy shocks’, Journal of Macroeconomics 47(A): 58-67, Merler, Silvia (2015) ‘Squaring the cycle: capital flows, financial cycles, and macro-prudential policy in the euro area’, Working Paper 2015/14, Bruegel, Nelson, Benjamin, Gabor Pinter and Konstantinos Theodoridis (2015) ‘Do contractionary monetary policy shocks expand shadow banking?’ Bank of England Working Papers 521, Bank of England, Nessén, Marianne, and David Vestin (2005) ‘Average inflation targeting’, Journal of Money, Credit and Banking 37(5): 837-863, Posen, Adam (2009) ‘Finding the Right Tool for Dealing with Asset Price Booms’, speech at the MPR Monetary Policy and the Economy Conference, London, 1 December, Rajan, Raghuram G. (2006) ‘Has finance made the world riskier?’ European Financial Management 12(4): 499-533, Reifschneider, David, and John C. Williams (2000) ‘Three Lessons for Monetary Policy in a Low-Inflation Era’, Journal of Money, Credit and Banking 32(4): 936-966, Rogoff, Kenneth (2015) ‘Debt supercycle, not secular stagnation’, remarks at Closing Panel, Rethinking Macro Policy III, International Monetary Fund, Washington DC, 16 April, Rogoff, Kenneth (2016) The Curse of Cash, Princeton University Press, Sandbu, Martin (2018) ‘The devastating cost of central banks’ caution’, Financial Times, 7 August, Solow, Robert M. (1956) ‘A contribution to the Theory of Economic Growth’, The Quarterly Journal of Economics 70 (1): 65-94, Stein, Jeremy C. (2014) ‘Incorporating financial stability considerations into a monetary policy framework’, speech at the Federal Reserve Board, Washington DC, 21 March, Svensson, Lars E.O. This rate is defined as the equilibrium rate between demand and supply of funds compatible with full employment of capital and labour resources, and with price stability (ie inflation around the central bank’s target). We describe how the macroeconomic environment in which central banks operate is changing and posing new challenges. Agur and Demertzis (2018), for instance, showed that the effect of monetary policy on financial stability varies in direction depending on the part of the financial cycle the economy is at. Changing the definition to make it two-sided, around 2 percent, is a way of correcting for that without having to go very far from what is currently communicated. Even if the framework has improved in recent years, there is a good chance that the ECB will have to step in once again from a stabilisation perspective. We acknowledge that the ECB in its exercise of monetary policy has neither the mandate nor the tools to make and pursue redistribution policies. What else can be done? (2014) ‘Inflation targeting and “leaning against the wind”’, International Journal of Central Banking 10(2): 103-114, Yellen, Janet (2017) ‘Transcript of Chair Yellen’s June 14 2017 Press Conference’, available at https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20170614.pdf, Weale, Martin, and Tomasz Wieladek (2016) ‘What are the macroeconomic effects of asset purchases?’ Journal of Monetary Economics 79: 81-93, Wolff, Guntram (2017) ‘German wages, the Phillips curve and migration in the euro area’, Bruegel Blog, 29 November, available at http://bruegel.org/2017/11/german-wages-the-phillips-curve-and-migration-in-the-euro-area/, Copyright © Bruegel 2020 Bruegel: Rue de la Charité 33-1210 Brussels - Belgium - Contact Rehn told Central Banking that he would like the ECB to replace its. However, monetary policy does have implications for wealth redistribution, at the very least between lenders and savers, and monetary policy should therefore be implemented in awareness of what shape this redistribution takes. By contrast, in the current regime, credible monetary policy implies medium-term expectations are anchored at the target and therefore the change in the real rate will not help as much. This has two main implications. Transformation of the Chinese economic model and the fall in the oil price have already resulted in a reduction in emerging markets’ excess savings. The Federal Reserve became a monetary policy framework pioneer when chair Jerome Powell unveiled the US central bank’s move to average inflation targeting (AIT) on August 27. Figure 2: Phillips Curves (x-axis quarterly unemployment in percent, y-axis year-on-year quarterly inflation in percent), 2.3 The interaction between price stability and financial stability. Monetary tightening for reasons of financial instability might have other unintended effects, especially in open economies. Overview. First, the potential long-term decline in neutral rates of interest in advanced economies could reduce the space for central banks to make policy-rate cuts. This discussion received an important impetus after the then Fed Chair Janet Yellen acknowledged it was a relevant issue in one of her last press conferences (Yellen, 2017). Our suggestion to change the definition of price stability in such a way shares some characteristics with the discussion on increasing the inflation target (Blanchard et al, 2010). 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The ECB is currently reviewing its monetary policy framework, with the inflation target a major topic. 6 Cerutti et al (2015) showed that the use of macro-prudential policies can be associated with relatively greater cross-border borrowing, suggesting that countries might face issues of avoidance. They found evidence of variation over time in the neutral rate of interest in all economies they examined (the UK, US, Canada and the euro area), with a clear downward trend since the 1960s, which accelerated after 2008. The natural next step to the logic is that if one were to aim to achieve something higher than 2 percent – say 4 percent as Blanchard et al argue – within the two-year horizon, it would help achieve 2 percent on average over the longer run. The ECB also very quickly provided long-term lending to European banks with favourable conditions through long-term refinancing operations and targeted longer-term refinancing operations. These are important ingredients in improving the clarity of the current definition of price stability. A spokesman for the central bank declined to comment. 5 The typical length of the business cycle in the euro area since the 1970s has been quite variable but has been on average around 9-10 years according to the CEPR business cycle dating committee (see https://cepr.org/content/euro-area-business-cycle-dating-committee). Communication, similarly, needs to inform why the policy choices made protect monetary policy objectives in a range of possible outcomes. 7 Macroprudential policies are relatively new, especially in advanced economies, so evidence of their effectiveness is still limited. In order to achieve its primary objective, the Eurosystem uses a set of monetary policy instruments and procedures. This revised consensus statement is one of the key products of the review. A strong fall in the neutral rate would reduce significantly central banks’ margin for manoeuvre. However, given the massive purchases between March 2015 and the end of 2018, if QE had to be activated again, this rule would limit drastically the possible purchases because the holdings of bonds of major countries are already approaching the 33 percent limit (Figure 3). Nominal yields have been on a downward path since the beginning of the 1980s (Claeys, 2016). First, fiscal policy in the monetary union is much more constrained than outside of it because the risk of default is higher given the prohibition of monetary financing. 4.2 What should the ECB do if price stability and financial stability diverge? The article reflects the author's opinions, and not necessarily the views of CGTN. The Governing Council of the European Central Bank has interpreted this as meaning that the year-on-year increase in consumer prices should be below, but close to, 2% over the medium term. These are the direct responsibility of governments where we also believe they belong. For example, in the case of a deflationary shock, medium term expectations will increase above the target, and thus real rates will decrease which will help eliminate the effects of the shock. We believe that these recommendations will already increase policy space and give greater flexibility in order to help prevent bad outcomes (like deflation) persisting for prolonged periods. A further problem in targeting financial stability with monetary tools is that monetary policy tightening might not actually have the desired effect of reducing financial imbalances. As pointed out by Svensson (2014), Swedish monetary policy at the beginning of the 2010s was a bad example of a central bank trying to implement an aggressive “leaning against the wind” policy, which led to high costs in terms of economic activity and a major undershooting of its inflation target. Several conclusions can be drawn about the evolution of monetary policy frameworks after the crisis. Changing the definition of price stability, although an important step towards providing the ECB with a more flexible framework, might not be sufficient given the possible limitations of the ECB’s tools (discussed in section 3.2). DECISION (EU) 2020/506 OF THE EUROPEAN CENTRAL BANK. Price stability could be defined as inflation of around 2 percent, The role of core inflation should be emphasised as the only definition of price stability that monetary policy can affect. The EU Treaty makes price stability the primary mandate of the European System of Central Banks (ESCB, ie the ECB and national central banks)1, but it also requires the ESCB to “promote the smooth operation of payment systems”2 and to “contribute to the smooth conduct of policies pursued by the competent authorities relating to the prudential supervision of credit institutions and the stability of the financial system”3. Whatever the explanation, factors beyond the control of central banks might be preventing a stronger recovery and tighter labour markets from translating into higher wages and inflation. Monetary Policy. Price stability is the main objective of monetary policy in the euro area. The problematic interaction between nineteen different fiscal policies and a common monetary policy, the lack of a stabilisation tool and differences in national macro-prudential frameworks would all suggest significant reforms are needed in these realms to strengthen the overall resilience of the system. They furthermore amend the Eurosystem monetary policy counterparty framework with respect to the treatment of confirmed breaches of minimum own funds requirements and breaches of the obligation to report information on capital ratios within the required deadlines. Postponed to mid-2021 because of diverging national interests, macroprudential supervision is shared between the variables. 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