ecb watchers 2014 frankfurt march 12 th
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Monetary policy beyond maintaining price stability Lucrezia Reichlin London Business School and CEPR. ECB watchers 2014 Frankfurt March 12 th. Key problems in the euro area today. Inflation: declining, expectations below target, ECB forecast negative surprised - PowerPoint PPT PresentationTRANSCRIPT
Monetary policy beyond maintaining price stability
Lucrezia ReichlinLondon Business School and CEPR
ECB watchers 2014Frankfurt
March 12th
Key problems in the euro area today
• Inflation: declining, expectations below target, ECB forecast negative surprised
• Banks’ fragility and in the process of deleveraging (AQR)• Legacy debt (banks and sovereigns)• Financial segmentation causing heterogeneity in
financial conditions and impairment of monetary policy transmission
• Finally the recovery is there but nominal GDP weak• Weak M3 and credit
2000
Q1
2000
Q3
2001
Q1
2001
Q3
2002
Q1
2002
Q3
2003
Q1
2003
Q3
2004
Q1
2004
Q3
2005
Q1
2005
Q3
2006
Q1
2006
Q3
2007
Q1
2007
Q3
2008
Q1
2008
Q3
2009
Q1
2009
Q3
2010
Q1
2010
Q3
2011
Q1
2011
Q3
2012
Q1
2012
Q3
2013
Q1
2013
Q3
-6-4-202468
101214
Euro Area
Loans (HH+NFC) GDP M3YoY growth rates.Sources: ECB, OECD
Nominal GDP, credit and M3
2010
Mar
2010
Jun
2010
Sep
2010
Dec
2011
Mar
2011
Jun
2011
Sep
2011
Dec
2012
Mar
2012
Jun
2012
Sep
2012
Dec
2013
Mar
2013
Jun
2013
Sep
2013
Dec
2014
Mar
2014
Jun
2014
Sep
2014
Dec
0
0.5
1
1.5
2
2.5
3
3.5
Euro Area inflation and SPF forecasts (ECB)
InflationExpectation
Forecast: Average of forecasts - Harmonised ICPPoint forecast - Target period ends 12 mafter survey cycle begins
1999Jan 2000Dec2002Nov2004Oct 2006Sep2008Aug 2010Jul 2012Jun-2
-1
0
1
2
3
4
5
6
Countries: Inflation (YoY HCPI, ECB)
Germany Spain FranceItaly Euro area
Inflation
Mar
11
Jul 1
1No
v 11
Mar
12
Jul 1
2No
v 12
Mar
13
Jul 1
3No
v 13
0.0
0.5
1.0
1.5
2.0
2.5
3.0
Mar
11
Jul 1
1No
v 11
Mar
12
Jul 1
2No
v 12
Mar
13
Jul 1
3No
v 13
Mar
11
Jul 1
1No
v 11
Mar
12
Jul 1
2No
v 12
Mar
13
Jul 1
3No
v 13
Mar
11
Jul 1
1No
v 11
Mar
12
Jul 1
2No
v 12
Mar
13
Jul 1
3No
v 13
ECB systematically surprised
% year-on-year
2011 2012 2013 2014
ECB forecastEurostat flash (October)
Sources: ECB, Eurostat
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Q2
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
Non performing loans / total loans
France Germany Italy SpainSource: FRED, IMF
Growing non performing loans
2003
Mar
2003
Sep
2004
Mar
2004
Sep
2005
Mar
2005
Sep
2006
Mar
2006
Sep
2007
Mar
2007
Sep
2008
Mar
2008
Sep
2009
Mar
2009
Sep
2010
Mar
2010
Sep
2011
Mar
2011
Sep
2012
Mar
2012
Sep
2013
Mar
2013
Sep
0100200300400500600700800900
1000
Germany
NFC HH MFIs Gov
100 = nominal GDPSource: calculation on ECB data
2003
Mar
2003
Sep
2004
Mar
2004
Sep
2005
Mar
2005
Sep
2006
Mar
2006
Sep
2007
Mar
2007
Sep
2008
Mar
2008
Sep
2009
Mar
2009
Sep
2010
Mar
2010
Sep
2011
Mar
2011
Sep
2012
Mar
2012
Sep
2013
Mar
2013
Sep
0100200300400500600700800900
1000
Spain
NFC HH MFIs Gov
100 = nominal GDPSource: calculation on ECB data
2003
Mar
2003
Sep
2004
Mar
2004
Sep
2005
Mar
2005
Sep
2006
Mar
2006
Sep
2007
Mar
2007
Sep
2008
Mar
2008
Sep
2009
Mar
2009
Sep
2010
Mar
2010
Sep
2011
Mar
2011
Sep
2012
Mar
2012
Sep
2013
Mar
2013
Sep
0100200300400500600700800900
1000
France
NFC HH MFIs Gov
100 = nominal GDPSource: calculation on ECB data
2003
Mar
2003
Sep
2004
Mar
2004
Sep
2005
Mar
2005
Sep
2006
Mar
2006
Sep
2007
Mar
2007
Sep
2008
Mar
2008
Sep
2009
Mar
2009
Sep
2010
Mar
2010
Sep
2011
Mar
2011
Sep
2012
Mar
2012
Sep
2013
Mar
2013
Sep
0100200300400500600700800900
1000
Italy
NFC HH MFIs Gov
100 = nominal GDPSource: calculation on ECB data
Total liabilities as % GDP not declining
In this situation ….. divine coincidence
Achieving price stability would help financial stability as well by easing the debt burden and facilitating the macro adjustment
Problems:-- how to do it at the ZLB-- the fundamental problem of the adjustment in the euro – financial balkanization in response to shocks – is the key problem for both price and financial stability … the euro area is facing a specific problem which has to be addressed creatively but it is facing difficult tradeoffs between stability and moral hazard … the ECB has to experiment with new tools and clarify its view on those tradeoffs
HOW HAVE THESE TRADEOFFS BEEN DEALT WITH BY THE ECB EXPERIENCE SINCE THE CRISIS?
ECB since the crisisnon-standard tools
PHASE 1: • First wave of market segmentation drying up of the non
domestic inter-bank market • The ECB responded by substituting for intra-euro area market
transactions via the LTRO (financial stability and price stability objective)
• Successful on both grounds (loans resilient, financial sector survived) but increasingly clear that insolvent banks were kept artificially alive
ECB since the crisisnon-standard tools
PHASE 2: • As the euro crisis developed, the flight to quality took the
form of non domestic investors withdrawing financing to either sovereign or banks.
• This led to a situation in which sovereigns had to intervene to save the banks while domestic bank took increasingly more domestic sovereign debts.
• The link between the sovereign and banks was exacerbated by the emergence of redenomination risk which led banks to hold domestic assets to match their increasingly domestic liabilities combined with side effects of the LTRO which created incentives to hold government bonds to use as collateral
2006
Q1
2006
Q2
2006
Q3
2006
Q4
2007
Q1
2007
Q2
2007
Q3
2007
Q4
2008
Q1
2008
Q2
2008
Q3
2008
Q4
2009
Q1
2009
Q2
2009
Q3
2009
Q4
2010
Q1
2010
Q2
2010
Q3
2010
Q4
2011
Q1
2011
Q2
2011
Q3
2011
Q4
2012
Q1
2012
Q2
2012
Q3
2012
Q4
2013
Q1
2013
Q2
2013
Q30%
1%
2%
3%
4%
5%
MFIs (excl. ESCB): Government securities/total assets
CEPR recessions Extra EA Other EA DomesticSource: ECB
Increasingly banks become holder of domestic government bonds
2006Jan
2006May
2006Sep
2007Jan
2007May
2007Sep
2008Jan
2008May
2008Sep
2009Jan
2009May
2009Sep
2010Jan
2010May
2010Sep
2011Jan
2011May
2011Sep
2012Jan
2012May
2012Sep
2013Jan
2013May0%
2%
4%
6%
8%
10%
12%
MFIs (excl. ESCB): Domestic gov. bonds/total assets
Germany Spain France ItalySource: ECB
Effect is larger in the periphery but home bias is pervasive
ECB since the crisisnon-standard tools
… PHASE 2: • The consequence was the banks-sovereign “vicious
loop” leading to correlation between banks and sovereign risk
• This, combined with delayed banks’ deleveraging in view of the AQR and the accumulation of non-performing loans …
lead to both price stability and financial stability problems
ECB since the crisisnon-standard tools
… PHASE 2:
In this situation LTRO2 was less effective than LTRO1 both for stimulating the economy via supporting bank lending and for dealing with financial stability issues essentially driven by solvency issues (not dealt with) and disruption of geographical financial diversification
…. FEW OBSERVATIONS
1. Weak loans:a puzzle given aggressive ECB action?
2001Jan 2003Jan 2005Jan 2007Jan 2009Jan 2011Jan 2013Jan-25000
-15000
-5000
5000
15000
25000
35000
45000
55000
80
85
90
95
100
105
110
115
120
Loan flows (6m MA) and industrial production
NFCIndustrial production (right)Source: ECB
1999W012000W432002W332004W232006W122008W022009W442011W330
200000
400000
600000
800000
1000000
1200000
1400000
Main refinancing operationLonger-term refinancing operations
2003
Jan
2003
Apr
2003
Jul
2003
Oct
2004
Jan
2004
Apr
2004
Jul
2004
Oct
2005
Jan
2005
Apr
2005
Jul
2005
Oct
2006
Jan
2006
Apr
2006
Jul
2006
Oct
2007
Jan
2007
Apr
2007
Jul
2007
Oct
2008
Jan
2008
Apr
2008
Jul
2008
Oct
2009
Jan
2009
Apr
2009
Jul
2009
Oct
2010
Jan
2010
Apr
2010
Jul
2010
Oct
2011
Jan
2011
Apr
2011
Jul
2011
Oct
2012
Jan
2012
Apr
2012
Jul
2012
Oct
2013
Jan
2013
Apr
2013
Jul
2013
Oct
2014
Jan
-1
0
1
2
3
4
5
6Real interest rates
Germany Spain FranceItaly
Lending rates to NFC (Up to 1 year)-CPI.Source: ECB
2. Although liquidity was provided especially in the periphery, nominal and real lending rates remain heterogenous
3. The second recession was specific to the euro area – the US avoided it
The Euro Area had a second crisis – not the USQ
1-20
05
Q2-
2005
Q3-
2005
Q4-
2005
Q1-
2006
Q2-
2006
Q3-
2006
Q4-
2006
Q1-
2007
Q2-
2007
Q3-
2007
Q4-
2007
Q1-
2008
Q2-
2008
Q3-
2008
Q4-
2008
Q1-
2009
Q2-
2009
Q3-
2009
Q4-
2009
Q1-
2010
Q2-
2010
Q3-
2010
Q4-
2010
Q1-
2011
Q2-
2011
Q3-
2011
Q4-
2011
Q1-
2012
Q2-
2012
Q3-
2012
Q4-
2012
Q1-
2013
Q2-
2013
-8
-6
-4
-2
0
2
4
6
YoY real GDP growth
CEPR recessions Italy Spain US Euro AreaSource: OECD
4. And, unusually in historical experience, the second recession was driven by the periphery
19821 19834 19853 19872 19891 19904 19923 19942 19961 19974 19993 20012 20031 20044 20063 20082 20101 20114-6
-4
-2
0
2
4
GDP YoY growth rate contibutions
France Germany Italy Spain Others Others (included Spain)Euro Area
Sources: Eurostat, national banks, ECB Area Wide Model
Mostly driven by the peripheryUnusual in historical perspective
A key factor in explaining these four facts ….
• In a monetary union, a key feature of the adjustment process is that, in response to a negative shock, financial integration goes into reverse (not the same as flight to safety, rather everybody goes home!)
• Both the home bias in government bonds and in the inter-bank funding are part of this story
• The LTRO can address the inter-bank problem by replacing non-domestic funding but tools to deal with the home bias in sovereign market have not been tried although the banking union project when completed would help
Need new non standard policies but again no contradiction between price stability and financial stability, rather tradeoffs which have to do with interaction between monetary and fiscal issues
A quantitative exercise and a proposal
The quantitative exercise: what have been the BIG changes in banks’ balance sheets?
The proposal:Create incentives for banks to hold geographically diversified sovereign
Banks’ balance sheets: big changes since 2008Liabilities: funding stress is from non-residents from 2008
Banks’ balance sheets: big changes since 2008Assets: shift from loans to government bonds since 2011
Garicano-Reichlin’s Proposal
In this context regulation on sovereign bonds and their risk weighting can be used as a monetary policy toolSovereign bonds are not risk free but market pricing is distortedA possible solution• Impose as a rule that, for sovereign bonds to have a risk free weighting, they
must be held by banks in certain constant proportions, for example relative to GDP.
• Although a transition regime will need to be established to avoid hurting banks in the periphery, such proposal would, by dramatically reducing the exposure of banks to their own sovereigns, help to break the link between banks and sovereign risk.
• We also anticipate that such a regulatory initiative bias could help to encourage the emergence of the market driven creation of a euro area safe asset