Moreover, gyrations on such a scale would not be healthy for an economy. The ECB has tailored its entire strategy towards flexibility. It targets inflation over a medium term, an undefined, vague concept, while its tolerance for deviations is similarly loosely worded to give the Governing Council maximum flexibility. The bank's guidance on future policy moves is also imprecise, so moving to a Fed-style average would actually reduce that cherished flexibility. Targeting average inflation over a period is messy.
It requires the central bank to define a time period and a specific inflation measure it looks at. Markets then hold the central bank accountable and price assets accordingly.
Such a framework either reduces the ECB's flexibility or, if it does not specify the terms of the framework, will leave markets confused, causing asset price volatility. The Fed's own difficulties also dissuaded the ECB. The Fed decided on Flexible Average Inflation Targeting last August but has been widely criticised for not defining how much of an overshoot would be allowed over what length of time. These lower forecasts represent in part the impact of ageing populations, but also reflect the falling trend in total factor productivity.
This affects monetary policy because slower growth in potential output reduces what is often referred to as the equilibrium interest rate. If the equilibrium rate falls, the margin above the effective lower bound becomes compressed, reducing the space in which central banks can operate to provide accommodative policy. One might reasonably ask why central banks did not identify this trend sooner. The answer seems to lie in an overreliance on pro-cyclical estimates of potential output.
Indeed, the revisions to estimates of potential growth have mostly occurred after the crisis, whereas it is most likely that the slowdown in productivity had already started before the crisis but was masked by the credit-fuelled boom. The most recent estimates put the output gap in the region of positive 2.
At the same time as potential growth has been declining, the share of global factors driving inflation seems also to have been increasing. In large part, the common global trend can be explained by the decline in price of energy and other commodity prices.
But low global inflation goes beyond weakness in domestic demand and falling energy and commodity prices. In recent years there has been a growing understanding of the role of global demand factors on domestic inflation.
For example, it has been observed that changes in the degree of slack in OECD economies are having a smaller impact on inflationary pressures than it has in the past.
But structural factors are also playing a role: higher import volumes as a result of advanced globalisation have increased the importance of international prices relative to domestic prices, forcing domestic mark-ups to be less sensitive to the state of the domestic economy.
This may imply that monetary policy has to react more aggressively to counteract shocks. So in combination, central banks may be facing a two-pronged challenge to their mandates: a situation where, due to the role of global inflation, more stimulus is needed than in the past to deliver their domestic mandates; and where, due to the falling equilibrium interest rates, their ability to deliver that stimulus is more constrained. That would certainly offer one explanation for why monetary policy has needed to stay accommodative for so long across advanced economies.
This does not make monetary policy ineffective. As we have seen in the euro area, even with a low equilibrium rate central banks can still steer conditions in the wider economy by targeting directly the constellation of interest rates that matter for borrowers.
But one nonetheless cannot deny that the fall in the equilibrium rate poses a challenge for central banks. This challenge for monetary policy has been recognised, with a number of innovative solutions proposed by academics. Let me mention two but also say upfront that I am not particularly convinced by any of them. One option that has been mooted is to allow nominal interest rates to go deeper into negative territory. Yet there is an effective limit to lowering rates since ultimately this conflicts with the ability of citizens to hold cash.
Therefore some scholars have called for the imposition of electronic money and the abolition of cash. As I have discussed at length elsewhere, I see serious problems with such an approach.
And perhaps even more importantly, it denies the crucial social function of cash. Another option proposed by some observers is for central banks to raise their inflation objectives and therefore to lift equilibrium nominal rates.
Leaving aside the debate about the costs of higher inflation, I am not sure that this idea is entirely convincing. The reason is that the mechanism through which it works is the signalling channel — people expect higher inflation, so inflation rises.
But at a time when inflation is low everywhere, and when central banks are running very accommodative monetary policies just to achieve that, one can question whether such signals would really be credible. I see a risk, in fact, that changing our strategy to rely on fuzzy concepts and unobservables would only end up damaging our credibility. So what we need today, in my view, is to shift the debate away from its narrow focus on monetary policy.
Rather than concocting more and more innovative solutions for central banks to get around the lower bound, we should focus instead on what other policy areas can contribute.
In a world of very low interest rates, monetary policy cannot be the only game in town — and we should not pretend it can be. In particular, we urgently need to press ahead with structural reforms to improve long-run economic growth, which will consequently lift equilibrium interest rates. In my view it is much better to provide monetary policy with greater room with a process that increases output and wealth than by ones that increase social costs.
At the same time, fiscal policy needs to become more effective at complementing monetary policy in managing cyclical fluctuations. In the current euro area context that means those countries with fiscal space should use it better, and going forward fiscal rules should be more rigorously enforced so that countries enter downturns with greater ability to carry out active stabilisation and invest into education and innovation, to name but a few.
For individual jurisdictions the exact policy mix will of course differ. In some cases the emphasis may be on increasing public investment, in others on more growth-friendly tax policy. Likewise structural reforms that aim at raising productivity have to be tailored towards domestic priorities. But given the common nature of the challenges for central banks, all countries would benefit from prioritising it.
And the positive spill-overs will clearly be larger if all act in unison. Roughly eight years of extremely accommodative monetary policies on both sides of the Atlantic might lead to the notion that the ECB and Fed have been confronted with similar or even homogenous challenges.
This would be a misapprehension. Major institutional and structural differences at the onset of the financial crisis explain why the clean-up efforts in the US were faster and more effective and the recovery was more sustainable.
After the institutional short-comings of Monetary Union had been painfully exposed, much progress has been achieved on the road to completion and further integration. However, this institutional reform package took time. Now, economic recovery, although still timid, is under way in the euro area.
But this finding cannot be taken as an excuse to rest on our laurels. More determined structural reforms need to be implemented to lift the growth potential and overcome the ultra-low interest rate phase. A more determined approach to tackle the problem of non-performing loans is necessary to tackle the remaining legacy of banking crisis.
When the macroeconomic ship is engulfed by a major storm, all hands — not just monetary policy — need to man the pumps. This, indeed, holds true on both sides of the ocean. Gordon, R. Ciccarelli and B. Measures of global economic slack are good predictors of national inflation in advanced countries, as shown empirically e. Borio and A. Clarida, J. Gali, and M. We are always working to improve this website for our users. To do this, we use the anonymous data provided by cookies.
It is especially responsible for the following fields:. Part of that is also the definition of price stability, the selective of indicators to analyse the risk of inflation etc. Furthermore the decision-making bodies are able to pass regulations, which are binding out of the Eurosystem.
Furthermore it coordinates the research and development activities of the Eurosystem, as well as the security and quality of the production of banknotes. Additionally there is an analyse center for counterfeit money to analyse and classify counterfeit banknotes in Euro, the central database for Euro- counterfeiting and the international research centre for counterfeiting prevention located at the ECB.
It is now represented in every meeting of the executive board of directors of the IMF, which deals with relevant topics for the economic- and currency union. On the European level, the ECB president is invited to the meetings of the Eurogroup, the informal gatherings of all ministers of finance of the Euro area.
The ECB can also take part at the meetings of the European council, whenever topics are discussed that have a direct linkage with the tasks and objectives of the Eurosystem. It issues instructions to the NCBs concerning the necessary transactions value, duration, point of time and proves, if these were performed successfully.
These systems offer the logistical support for the functional integrity of the Eurosystem and are conducted by the ECB. Inherent is the determination of the strategical portfolio direction, the tactical portfolio direction, as well as the determination of facility guidelines and the entire confines. The Fed follows a number of objectives, so that it is not possible to rank these goals after priority as possible with the ECBs objectives.
A definition of the objectives can be found in the Federal reserve act since in paragraph 2A. The monetary political tasks are so narrowly defined, but there are several ways, that the statutory objectives can be reached. The Fed can choose one goal arbitrary out of the number of goals. In summary it can be stated that the Feds task is to influence the money supply in such a way that the economy grows at stable prices without threatening the financial markets and an equalization in the American balance of payments can be reached.
Every liquidity resulting in transaction on the initiative of the ECB can be seen as an open market operation. The ECB uses open market operations to control interest rates including the variable overnight rates and liquidity, as well as to signal the position of its monetary policy in the Euro area. Add to cart. Table of contents List of figures List of abbreviations 1 Introduction 2 Institutions and bodies 2. It is especially responsible for the following fields: - The ECB Governing Council is reliable for the monetary policy in connection with the common currency and immobilizes the policies in the Eurosystem.
Gischer, Herz, Menkhoff S. Pollack, Mishkin - p. Bernanke, Mishkin Working Paper No. Walter , p.
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