monetary policy normalisation of major central banks and
TRANSCRIPT
Monetary policy normalisation of major central banks and
financial riskZsolt Darvas
Bruegel and Corvinus University of Budapest
Project LINK Meeting 2019
17-19 June 2019, New York
One-week interbank interest rates (%), 2 January 2000 – 14 June 2019
2
• Federal Reserve:
sizeable tightening since
late 2015
• Bank of England: some
tightening since late
2017
• Other 4: low interest
rates remain
• But temporary tightening
in 2011 by the ECB and
the Swedish central
bank
-2
-1
0
1
2
3
4
5
6
7
2000
2001
2002
2003
20
04
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
US dollar
British pound sterling
Japanese yen
Euro
Swedish krona
Swiss franc
Central bank balance sheet (% GDP)
3
• Sizeable differences in
pre-crisis balance sheet
sizes
• Even more so after
2008
• Switzerland: mainly
foreign currency
purchase
• Others: purchase of
various securities,
including government
bonds
0
20
40
60
80
100
120
140
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
20
16
2017
2018
Bank of England
Bank of Japan
European Central Bank
Federal Reserve
Sveriges Riksbank
Swiss National Bank
Monetary policy normalisation questions
• Interest rates: when to raise and up to what ‘new normal’?
• Central bank balance sheet: shrink or not? And to what level?
• Financial stability: expansionary monetary policies, and their normalisation, could create financial risks. Should monetary policy aim to support financial stability?
4
Outline
1. New normal in monetary policy
2. Lessons from monetary policy exit mistakes of Sweden, the US and the UK
3. ECB monetary policy exit when the inflation outlook is uncertain
4. Monetary policy and financial stability
5
1. New normal in monetary policy?
6
Secular decline in global real interest rates
7
Trends in short-term real interest rates (%), 1870-2016
Source: Del Negro, Marco, Domenico Giannone, Marc P. Giannoni and Andrea
Tambalotti (2018) ‘Global Trends in Interest Rates’, NBER Working Paper No. 25039
Explanations of the secular
decline in global real rates by
Del Negro et al (2018):
• Increase in the premium that
international investors are
willing to pay to hold safe and
liquid assets (scarcity of safe
assets in the context of a
global saving glut)
• Lower economic growth
Blanchard (2019): low interest
rates will likely prevail
-1
0
1
2
3
4
18
70
18
77
18
84
18
91
18
98
19
05
19
12
19
19
19
26
19
33
19
40
19
47
19
54
19
61
19
68
19
75
19
82
19
89
19
96
20
03
20
10
Japan Germany Italy
United States Canada United Kingdom
France
Central bank balance sheet
• No benchmark for ‘normal’ balance sheet
• Balance sheet depends on the way monetary policy is conducted, on the exchange rate regime, past monetary policy actions, central bank tasks, profit distribution
• Arguments in favour of larger balance sheet: • (1) Lower equilibrium interest rate → zero lower bound will likely be
reached more frequently → unconventional monetary policy would be usedmore regularly;
• Larger balance sheet could (2) improve monetary transmission, (3) provide safe assets, (4) reduce banks’ incentives for excessive maturity transformation
• Arguments against larger balance sheet: • It exposes the central bank to financial risk and undue political influence
8
2. Lessons from monetary policy exit mistakes of Sweden, the US and the UK
9
-1
0
1
2
3
4
5
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
20
19
Repo rate
3-monthtreasury billrate
10-yeargovernmentbond yield
QE
sta
rts
QE
en
ds
purc
ha
ses
incre
ased
pu
rch
ase
sre
du
ce
d
purc
ha
ses
reduce
dpurc
ha
ses
reduce
d
Sweden: premature monetary policy exit followed by massive easing
10
Swedish interest rates (%), 2 Jan 2008 – 14 June 2019 • The premature
2011 monetary
policy exit led to
high costs in terms
of excessively low
inflation, overly
high
unemployment
and a higher real
debt burden for
households
The Riksbank’s repo rate: actual & Riksbankforecasts, and the 10-year gov. bond yield (%)
11
• Apart from the short period
around 2010, the Riksbank
interest rate guidance
turned out to be grossly
inadequate
• Noteworthy that recently,
the 10-year government
bond yield has even fallen
despite the Riksbank’s
interest rate increase
forecast and the ending of
QE-1
0
1
2
3
4
5
6
200
6
200
7
200
8
200
9
201
0
201
1
201
2
201
3
201
4
201
5
201
6
201
7
201
8
201
9
202
0
202
1
202
2
Thick red line: actual repo rate
Blue dots: 10-year bond yield
Remaining lines: repo forecasts
Federal Reserve: ‘taper tantrum’ unnecessarily pushed-up the 10-year yield
• While QE3 was ongoing in the US, in early 2013 unemployment rate fell to 7.5%, nearing the 6.5% threshold which was announced earlier as the rate when the FED will start increase interest rates
• FOMC started to discuss “tapering” of QE in early May 2013: the 10-year yield increased from 1.7% to 3% in a few months –leading to a far larger tightening in financing conditions than the FED had intended
• Later, the 10-year yield has fallen back even below 1.7%, despite the actual tapering and ending QE and the first increase in federal funds rate in December 2015
12
US interest rates (%),2 January 2000 – 14 June 2019
13
0
1
2
3
4
5
6
7
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
Federal fundseffective rate
10-yeargovernment bondyield
Longer-run federalfunds rateprojection by theFOMC (median)
QE
1
QE
1 e
nds
QE
3
QE
2
QE
3 e
nds
QE
2 e
nd
s
tap
er
tantr
um
Bank of England: communication & forward guidance problems unnecessarily pushed-up the 10-year yield
• July 2013: BoE releases a statement (an unusual move in the absence of a policy change) clarifying current policy and questioning whether the expected future rates were in line with economic developments
• Aug 2013: BoE introduces forward guidance, linking increase in interest rate to unemployment falling below 7%
• Feb 2014: BoE updates forward guidance, unlinking it from unemployment following the decrease of the unemployment rate below 7%
• June 2014: Mark Carney suggests that the interest rates could reach 2.5% in early 2017
14
UK interest rates (%)2 January 2006 – 13 June 2019
15
0
1
2
3
4
5
6
2006
2007
2008
2009
2010
2011
2012
20
13
2014
2015
2016
2017
20
18
2019
Bank rate 10-year government bond yield
Bre
xit
refe
rendum
QE
1
QE
3
QE
2
QE
4
QE
1 e
nds
QE
3 e
nds
QE
2 e
nds
Confu
sin
g
sta
tem
ents
QE
4ends
Main conclusions from monetary policy exit experiences of Sweden, US and UK
• Premature exit has to be avoided
• Inappropriate forward guidance could cause non-intended monetary tightening (US, UK)
• Systematically mistaken forward guidance could be disregarded by markets (Sweden)
• Long-term interest rates have not increased when net asset purchases have been stopped; not even after the first few rate increases
16
3. ECB Monetary policy exit when the inflation outlook is uncertain
17
The ECB’s core inflation forecast has proved to be overly optimistic. Would it work this time?
18
• Despite stubbornly
predicting a sizeable
increase in core
inflation, core inflation is
stuck at around 1%
Note: ECB forecasts are available for the annual average
inflation. That’s why I use the 12 month average rate of
change for the actual data, which, in each December,
equals annual average inflation. In the chart the December
observation of each forecast curve corresponds to the
annual average inflation forecast numbers published by the
ECB. I have linearly interpolated this December annual
average forecast data and the actual inflation rate in the
month of the date of the forecast.
0.5
1
1.5
2
2.5
200
2
200
3
200
4
200
5
200
6
200
7
200
8
200
9
20
10
20
11
20
12
201
3
201
4
201
5
201
6
201
7
201
8
201
9
202
0
202
1
ECB staff macroeconomic projections for
euro-area core inflation (moving 12-month
average rate of change)
Thick red line: actual data (real time)
Remaining lines: forecasts
Labour force participation continues to expand – good news for the people, bad news for inflation
19
Labour force participation rate (age 15-64, % of population)
• While Americans were
fleeing the labour
market in 2000-2015,
there has been a
steady increase in
euro area labour force
participation65
70
75
80
199
7Q
1
199
9Q
1
200
1Q
1
200
3Q
1
200
5Q
1
200
7Q
1
2009Q
1
201
1Q
1
201
3Q
1
201
5Q
1
201
7Q
1
Euro area (19countries)
Japan
United Kingdom
United States
ECB deposit facility interest rate and 10-year government bond yields of four countries (%)4 January 2000 – 14 June 2019
20
Note: for asset purchases the announcement
dates are indicated; the actual changes to
purchased volumes took effect typically about 2
months later.
-1
0
1
2
3
4
5
6
7
8
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
20
17
2018
2019
Italy 10-year Spain 10-year
France 10-year Germany 10-year
ECB deposit facility rate
ECB President Mario Draghi's
"Whatever it takes" speech
Mo
nth
lyp
urc
ha
se
€80bn
Month
lypurc
hase
€60bn
Mo
nth
lyp
urc
ha
se
€6
0bn
Mo
nth
lyp
urc
ha
se
€3
0bn
Mo
nth
lyp
urc
ha
se
€1
5b
n,
the
nze
ro
ECB monetary policy normalisation
• Deteriorating economic outlook
• Inability to lift core inflation and systematic forecast errors undermine ECB credibility (see next two charts)
• Text of ECB press release has hardly changed:• “The Governing Council now expects the key ECB interest rates to remain
at their present levels at least through the first half of 2020, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.” (6 June 2019 ECB press release)
• What’s needed: more time, more monetary stimulus or a new inflation target?
21
Market-based five-year average headline inflation expectations in the next five years, January 2004 – June 2019
22-2
-1
0
1
2
3
4
5
2004
200
5
200
6
200
7
200
8
200
9
201
0
201
1
201
2
201
3
201
4
201
5
201
6
201
7
201
8
201
9
United Kingdom
United States
Euro area
Japan
Market-based five-year average headline inflation expectations in the five years starting in five years’ time, January 2004 – June 2019
23-3
-2
-1
0
1
2
3
4
5
200
4
200
5
200
6
200
7
200
8
200
9
201
0
201
1
201
2
201
3
201
4
201
5
201
6
201
7
201
8
201
9
United Kingdom
United States
Euro area
Japan
4. Monetary policy and financial stability
24
Financial stability risks
• Low interest rates can:• Encourage ‘excessive’ risk taking
• Encourage bank lending to less credit-worthy customers
• Increase the leverage of the corporate sector
• Create asset price bubbles (e.g. stock market and housing)
• Worsen banks’ profitability
• Monetary policy normalisation can:• Increase defaults
• Burst bubbles
• Spillovers from advanced to emerging/developing countries
25
Evidence for the euro area
• Darvas and Pichler (2018):• Some house price increases, but not comparable to earlier housing
boom periods• House price increase not boosted by credit growth (except Slovakia
and Belgium)• Difficult to identify bubbles
• ECB Financial Stability Review (May 2019):• Return of search for yield• Euro area banks struggle with low return on equity (share of non-
performing loans still higher than in the US, overcapacity, low cost-efficiency)
• Expected default frequencies of European (and also US) non-financial corporations are relatively low
26
Non-performing loans to total gross loans(%)
27
0
2
4
6
8
10
12
14
16
18
20
Q42005
Q42006
Q42007
Q42008
Q42009
Q42010
Q42011
Q42012
Q42013
Q42014
Q42015
Q42016
Q42017
Q42018
Italy
Spain
France
Germany
Japan
United Kingdom
United States
Should monetary policy aim to support financial stability?
• There are strong interactions between monetary policy and financial stability policy
• However, the interest rate (the main monetary policy instrument) is too broad and ultimately quite ineffective in dealing with the build-up of financial imbalances
• Problem is even more severe in the heterogeneous euro area
• Macroprudential policy should play a major role
• In several euro area countries certain vulnerabilities have already led to measures, like capital buffer for systemically important institutions, countercyclical capital buffers, debt-to-income ratio limits and loan-to-value ratio limits
28
Five main take-aways
1. The natural rate of interest might remain low, constraining monetary policy
2. Premature monetary policy exit involves major risks, while inadequate forward guidance could cause market turbulence
3. The inflation outlook in the euro area is very uncertain: more time, more stimulus or a new inflation target?
4. Monetary policy is unsuitable for addressing financial stability concerns; instead, macroprudential policy should have a major role
5. The large heterogeneity of the euro area makes the use of monetary policy for financial stability even less effective
29
