Monetary Policy in Euroland

Transcription

1 Monetary Policy in Euroland Asymmetric shocks Perfect asymmetry : positive shock in one country is offset by a negative shock in the other country. The ECB, which is concerned with price stability and employment in Eurozone as a whole, aggregates the numbers. As a result, aggregate inflation and unemployment are unchanged and no change in policies is called for. No stabilization and greater fluctuation of unemployment in the individual countries.

2 Asymmetric Shock France Germany P F S F P G S G D F Y F Y G Symmetric shocks The shock is exactly the same in both countries The ECB observes an increase in unemployment in Euroland as a whole and implements expansionary monetary policy. Although from the French point of view, the shock is the same as in the asymmetric case, the ECB is now capable of stimulating the economy in Germany and France The increase in unemployment is reduced by ECB response.

3 Symmetric Shock France Germany P F P G Y F Y G Monetary policy when shocks are not perfectly asymmetric Inflation S B A U n A B No stabilisation: asymmetric shocks S Unemployment Horizontal line: asymmetric shocks (no stabilization). AA line: symmetric shocks (full stabilization). Intermediate case: shocks have an asymmetric component. Stabilization is given by a line such as the SS line. Unemployment fluctuates between B and B. Too little stabilization from the point of view of the individual country. Degree of asymmetry determines slope of SS line. This may lead to conflicts between nations and ECB.

4 Have asymmetric shocks been important in Eurozone? Growth of real GDP in Euroland in 2003 (in %) Growth of real GDP in Euroland in 2002 (in %) % Growth 2 1 % Growth Portugal Netherlands Germany France Italy Euro area Austria Belgium Ireland Luxembourg Finland Spain Greece Germany Netherlands Italy Portugal Belgium Euro area France Luxembourg Austria Spain Finland Greece Ireland Wide range of experiences Inflation in Euroland in 2003 (in %) Inflation in Euroland in 2002 (in %) 5 5 4,5 4,5 4 3,5 4 3,5 3 2,5 2 1,5 1 0, ,5 2 1,5 1 0,5 0 Germany Austria Finland Belgium Euro area Netherlands Germany Belgium Austria France Luxembourg Finland Euro area Inflation Italy Spain Portugal Netherlands Greece Ireland Inflation France Luxembourg Italy Spain Portugal Greece Ireland

5 Output gap: measure of business cycle fluctuations Output gaps in the Eurozone in ,00 2,00 1,00 output gaps (in %) 0,00-1,00-2,00-3,00-4,00 Portugal Germany Luxembourg Netherlands Italy Euro area France Austria Finland Belgium Spain Greece Ireland Asymmetric shocks and housing prices Large inflation differences within Eurozone Combined with the same nominal interest rate in the Eurozone Create large differences in real interest rates

6 Average real interest rates in Eurozone countries ( ) 4,0 3,5 3,0 percent change 2,5 2,0 1,5 1,0 0,5 0,0 Austria Germany France Belgium Finland Greece Italy Netherlands Spain Portugal Ireland House price indices (% change over ) percent change Germany Belgium Italy France Netherlands Spain Ireland -50

7 Real interest rate and house prices (% change) IRE 150 E house prices (% change) NL I B F 0 D -50 0,0 0,5 1,0 1,5 2,0 2,5 3,0 3,5 4,0 real interest rate Monetary Policy Strategy of the ECB Definition of the objectives Instruments to achieve these objectives.

8 Governing Council: 1. The objectives price stability shall be defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. Thus target range of inflation is 0% to 2%. Recent clarification : inflation should remain below but close to 2% Price stability is to be maintained over the medium run The ECB, however, does not define what the 2. The instruments Two pillars First pillar: Money stock is reference value Implicit model: m + v = p + y m + v = p + y m = p* + y f - v f where p* is the target inflation rate, y f and v f are forcasted values Example (1999): y f =2%, v f =-0.5% m=4.5% (M3) The same procedure of that of the Bundesbank.

9 Second pillar: vague Wide range of other indicators wages energy prices exchange rate yield curve real activity fiscal indicators possibly other variables. Monetary Policy Strategy of the ECB: An evaluation Selection of the target Is inflation target of at most 2% too low? Two-pillar strategy

10 Selection of the target Inflation is the sole target, no formal reference to output stabilization. In interpreting its mandate, ECB has been influenced by the theory of flexible inflation targeting as developed by Svensson (1996, 2000). By stabilizing the price level, the central bank also stabilizes the output level Only if output fluctuates because of demand shocks In this view there is no need to target output explicitly. Shocks in aggregate demand and supply Demand shock Supply shock AS Price level AS Price level AS AD AD AD Normal Output Output Normal Output Output

11 When demand shocks occur, inflation targeting leads the ECB to implement restrictive monetary policy that shifts the AD curve back. This stabilizes both prices and output. If supply shock occurs; there is tradeoff between output and inflation stabilization. Restrictive monetary policy will lower inflation but also aggravate the output fall. ECB has made clear that when such a tradeoff occur it will choose for inflation stabilization. Is the inflation target of at most 2% too low? 1. Rapid technological progress changes the conventional measures of inflation The true inflation rate is overestimated by 0.5% to 1.5% a year due to quality bias. 2. Some inflation may be good for the economy It works as a lubricant and allows for more flexible adjustments in real wages. Argument is based on money illusion

12 Is the inflation target of at most 2% too low? 3 There is an increasing risk that inflation may drop below 0% at some point. Falling prices are dangerous and they can push the economy into a deflationary spiral (see Japan). With 2% EMU-average inflation target, deflation is likely to occur in some countries Costs and benefits of inflation Costs and benefits of inflation There is an optimal level of inflation, π*>0, which maximizes the net benefit from inflation TERRA INCOGNITA benefits costs 0 π* inflation

13 Benefits of inflation: lubricant and credibility Benefits of inflation. benefits The benefits of inflation include the credibility effect, and the lubricant effect The latter arises because positive inflation makes real wages less downward rigid (if wages are downward rigid in nominal terms) lubricant effect credibility bonus inflation ECB view (no lubricant effect) Costs and benefits of inflation Without the lubricant effect, the optimal level of inflation is π*=0. TERRA INCOGNITA 0=π* inflation

14 Summary 2% maximum inflation rate is too low. Low target more likely to be exceeded: credibility issue ECB should redefine its target to be 2-3%. It should allow some flexibility around this new target in a symmetric way. Bank of England: target = 2%, inflation below the target is seen as just as bad as inflation above the target Goal vs instrument independence: currently, the ECB enjoys both. 3,5 3,0 Inflation rate in euro area (HICP) Inflation rate (%) 2,5 2,0 1,5 1,0 0,5 0,0 Jan-99 May-99 Sep-99 Jan-00 May-00 Sep-00 Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04

15 Excessive reliance on the money stock? Bundesbank legacy Most central banks use inflation targeting nowadays Money stock is not a good predictor of inflation in low-inflation environment Measuring money stock in a world of financial innovation Since May 2003, the ECB has given less prominence to money stock Inconsistency between words and deeds: credibility issue 200% Inflation and money growth ( ) (average yearly changes) 6% Inflation and money growth ( ) (average yearly changes) 180% 160% 5% inflation 140% 120% 100% 80% 60% inflation 4% 3% 2% 40% 20% 1% 0% 0% 20% 40% 60% 80% 100% 120% 140% 160% money growth (M1) 0% 0% 2% 4% 6% 8% 10% 12% 14% money growth (M1)

16 Inflation vs money-stock targeting Instrument Intermediate target Ultimate target MS-targeting Interest rate Money stock Inflation Inflation-targeting Interest rate Inflation forecast Inflation Inflation targeting is superior to money stock targeting (see Svensson (1998)). The reason is that with inflation targeting the central bank uses information of all the variables (including the money stock) that will affect future inflation. The inflation forecast is then the best possible intermediate target. Instruments of monetary policy in Euroland Three types of instruments: Open market operations, Standing facilities (credit lines), Minimum reserve

17 1. Open market operations Buying and selling of securities with the aim of increasing or reducing money market liquidity. ECB uses system of tenders, called main refinancing operations. Governing Council sets the interest rate that will be applied in the main refinancing operations. This interest rate affects the market interest rates. ECB refinancing rate 6 5 interest rate (%) /01/1999 1/05/1999 1/09/1999 1/01/2000 1/05/2000 1/09/2000 1/01/2001 1/05/2001 1/09/2001 1/01/2002 1/05/2002 1/09/2002 1/01/2003 1/05/2003 1/09/2003 1/01/2004 1/05/2004 1/09/2004

18 2. Standing facilities Aim: to provide/absorb overnight liquidity. The Governing Council fixes the marginal lending rate (1% above the interest rate used for OMO). No borrowing limit if banks have collateral. The marginal lending rate acts as a ceiling for the overnight market interest rate. Banks can use also the deposit facility to make overnight deposits (1% below the interest rate used for OMO). 3. Minimum reserves By manipulating reserve requirements the ECB can affect money market conditions. ECB pays interest on minimum reserves. The ECB uses the minimum reserve requirements as an instrument to smooth short term interest rates.