MONETARY POLICY IN THE EURO AREA: THE EXPERIENCE OF SPAIN

MONETARY POLICY IN THE EURO AREA: THE EXPERIENCE OF SPAIN Óscar Arce Associate Director General Economics and Research 14 July 2017 XXVI International Financial Congress St. Petersburg ADG ECONOMICS AND RESEARCH DG ECONOMICS AND STATISTICS

Disclaimer The views expressed here are those of the author and do not necessarily represent those of Banco de España or the Eurosystem Do not distribute without the author s permission 2

OUTLINE OF TALK The monetary policy of the European Central Bank Mandate, pre-crisis performance, response to crisis, current challenges The experience of Spain The pre-crisis boom, the crisis and the current recovery Some lessons from the crisis and the challenges ahead Both for the euro area and for Spain 3

THE MONETARY POLICY OF THE ECB The ECB has a price stability mandate: annual inflation rate in the HICP of below, but close to, 2% over the medium term Before the crisis, the ECB s main instruments were its key short-term nominal interest rates: Overnight facilities: Marginal Deposit Facility and Marginal Lending Facility, both forming a corridor for overnight interbank market rates Main refinancing operations - MRO (currently with a 7-days maturity) 4

PERFORMANCE OF MONETARY POLICY Before the crisis, remarkable record in terms of the inflation mandate (aver. rate 1:1999-12:2007 was 1.92 %) Since 2013, however, inflation has remained persistently well below target Euro area HICP vs 2% trend 110.0 % 105.0 100.0 95.0 90.0 85.0 80.0 75.0 70.0 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Euro area HICP 2% trend 5

THE MONETARY POLICY RESPONSE TO THE CRISIS: INTEREST RATES In the early stages of the crisis, the ECB cut its key policy rates, which soon reached levels close to zero. Indeed, the deposit facility rate stands now at -0.40%. Key ECB interest rates and interbank rates (EONIA), % 6.0 % 5.0 4.0 3.0 2.0 1.0 0.0-1.0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Eonia Lending facility rate Deposit facility rate MRO 6

THE MONETARY POLICY RESPONSE TO THE CRISIS: NON-STANDARD MEASURES The ECB also resorted to different non-standard measures, aimed at improving the transmission of monetary policy and steering expectations: Outright Monetary Transactions (OMT) (August 2012. following the whatever it takes statement): Conditional commitment to purchase gov t bonds if conditions deteriorated sufficiently Long-term refinancing operations (LTRO) under fixed-rate, full-allotment procedure: - Eurosystem banks could obtain as much (stable) liquidity as needed (against adequate collateral) at a fixed interest rate, against a context of a malfunctioning interbank market Asset purchase programmes (APP). Some key hallmarks: - Actual purchases of gov t bonds since February 2015 APP acquired a truly large scale (currently EUR 60bn/month) Forward guidance on future policy (e.g. interest rates) - When credible, allows to steer expectations of future interest rates 7

THE MONETARY POLICY RESPONSE TO THE CRISIS: NON-STANDARD MEASURES Balance sheet policies (LTRO, QE/APP ) have produced a sizeable expansion in the Eurosystem s balance sheet: CENTRAL BANKS' BALANCE SHEET ASSET PURCHASE PROGRAMME (APP) Monthly net purchases and cumulative purchases 50 45 40 % GDP 2016 % GDP 2016 120 100 90 80 70 18 % GDP 22% GDP 2.500 2.000 35 30 80 60 50 1.500 25 60 40 1.000 20 30 15 40 20 500 10 20 10 5 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 EUROSYSTEM FEDERAL RESERVE BANK OF ENGLAND BANK OF JAPAN (Right-hand scale) 0 0 3 6 9 12 3 6 9 12 3 6 9 12 2015 2016 2017 MONTHLY PURCHASES PUBLIC BONDS MONTHLY PURCHASES PRIVATE BONDS (COVERED BONDS, ABS, CORPORATE) TOTAL APP (Right-hand scale) 0 8

EFFECTIVENESS OF NON-STANDARD MEASURES: FINANCING CONDITIONS Overall, the non-standard measures have been effective at easing financing conditions in the real economy INTEREST RATES ON BANK LOANS 5.0 4.5 % NEW PHASE OF MONETARY STIMULUS SOVEREIGN SPREADS German BUND 10 years bp 700 600 OMT bp 4.0 3.5 500 3.0 400 2.5 300 2.0 1.5 200 1.0 2010 2011 2012 2013 2014 2015 2016 2017 NON-FINANCIAL CORPORATIONS UP TO ONE MILLION EURO NON-FINANCIAL CORPORATIONS ONE MILLION EURO AND ABOVE HOUESHOLDS 100 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 FRANCE ITALY SPAIN 9

EFFECTIVENESS OF NON-STANDARD MEASURES: MACROECONOMIC IMPACT These measures have also had a positive effect on GDP growth and inflation Accumulated effect in 2015-2017: 1.7 pp for GDP growth, 1.5 pp for inflation IMPACT OF THE ASSET PURCHASE PROGRAMME (APP) ON EURO AREA GDP AND INFLATION (a) GDP Y-O-Y GROWTH INFLATION % 4 3.5 % 3 3.0 2.5 2 2.0 1 1.5 1.0 0 0.5-1 0.0-2 -0.5-1.0-3 2010 2011 2012 2013 2014 2015 2016 2017 Projection -1.5 2010 2011 2012 2013 2014 2015 2016 2017 Projection ACTUAL AND MARCH 2017 ECB PROJECTION ESTIMATED PATH IN ABSENCE OF APP a Estimation based on Burriel and Galesi (2016), "Uncovering the heterogeneous effects of the ECB unconvetional monetary policy across euro area countries" Working paper 1631. Banco de España. 10

THE CURRENT OUTLOOK IN THE EURO AREA Despite all these extraordinary measures, the medium-term inflation outlook remains rather subdued Difficulties in achieving the inflation target largely due to the fact that nominal interest rates are close to their effective lower bound (ELB) IMF FORECAST (APRIL, 2017) AND ECB FORECAST (JUNE, 2017) GDP INFLATION 2.6 % 2.8 % 2.4 2.6 2.2 2.4 2.0 1.8 1.6 2.2 2.0 1.8 1.6 1.4 1.4 1.2 1.2 1.0 2017 2018 2019 2020 2021 2022 1.0 2017 2018 2019 2020 2021 2022 EURO AREA (IMF) EURO AREA (ECB) USA (IMF) 11

THE EXPERIENCE OF SPAIN Before 1999: The need to satisfy convergence criteria (to join the euro) led to strong falls in inflation, public debt and nominal interest rates Once inside the euro area, Spain experienced a loss of competitiveness and persistent positive inflation differentials UNIT LABOUR COSTS IN SPAIN RELATIVE TO THE EURO AREA HEADLINE INFLATION RATE (HICP) (y-o-y growth rate) 2000 = 100 6 % 120 5 115 4 110 3 105 2 100 1 95 0 90 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17(p) ULCs COMPENSATION PER EMPLOYEE -1-2 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 PRODUCTIVITY PER EMPLOYEE Euro area Spain 12

THE EXPERIENCE OF SPAIN and a build-up in financial imbalances Credit bubble in private sector, largely funded from abroad Important lesson: single monetary policy in a heterogeneous monetary union cannot address such imbalances DEBT RATIO. HOUSEHOLDS AND NON-FINANCIAL CORPORATIONS 230 210 190 170 150 130 110 90 70 50 % GDP 2007Q1= 100 250 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 SPAIN EURO AREA Real house prices Spain (right axis) 230 210 190 170 150 130 110 90 70 50 E NET INTERNATIONAL INVESTMENT POSITION (IIP) AND GROSS EXTERNAL DEBT POSITION (a) 0-20 -40-60 -80-100 -120 % of GDP 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 TOTAL NET IIP NET IIP EXCL. BE GROSS EXTERNAL DEBT (right-hand scale) 180 150 120 90 60 30 0 13

SPAIN DURING THE CRISIS The crisis in Spain was characterized, among other aspects, by: Collapse of (credit-fueled) bubble in the real estate market Disproportionately large job losses: largely construction sector, but also labor market disfunctionalities GDP in real terms Employment 110 Index 2008 Q1=100 110 Index 2008 Q1=100 105 105 100 100 95 95 90 90 85 85 80 80 75 75 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Euro area Spain Euro area Spain 14

LESSONS FROM THE CRISIS IN THE EURO AREA (I) The crisis in the Economic and Monetary Union (EMU) has illustrated the perils of an (inflation-oriented) monetary policy with insufficient economic union - Price stability is not sufficient to guarantee financial stability - Financial imbalances may emerge in a context of macroeconomic Great Moderation. The lack of a macroprudential framework, with a strong focus on systemic risk, limited the ability of governments to prevent the build-up of such imbalances. Also, at the onset of the crisis, national authorities were ill-equipped to tackle financial instability episodes - the diabolic banks-sovereign nexus exacerbated the crisis in certain vulnerable members in 2010-2012. 15

LESSONS FROM THE CRISIS IN THE EURO AREA (II) Some important advances since 2012: - Conditional Outright Monetary Transactions (OMT) by ECB offered a device to rule out perverse dynamics in sovereign debt markets - The set up of the basic ingredients of the Banking Union: Single Supervision Mechanism (SSM), Single Resolution Mechanism (SRM) Changes in the European Economic Governance System: The European Semester is currently an essential instrument to anchor fiscal policies and coordinate structural reforms (Strengthened Stability and Growth Pact and the new Macroeconomic Imbalance Procedure). However, much remains to be done to complete the economic union: Strengthen the Banking Union (e.g. deposit insurance scheme) Capital Markets Union: some timid efforts Fiscal Union: no progress so far 16

SOME REFLECTIONS ON MONETARY POLICY STRATEGY Despite all the extraordinary measures, the ECB is still struggling to fulfil its price stability mandate A notable difficulty for monetary policy is the effective/zero lower bound (ELB/ZLB) on nominal interest rates Low nominal rates largely reflect even lower (possibly negative) equilibrium real interest rates: Partly due to the financial crisis and the ensuing deleveraging (i.e. reduced demand for credit) in much of the industrialized world but also to more permanent factors (leading to low investment): demographic factors, stagnant productivity growth, etc. As a result, episodes of binding ELB may happen more frequently in the future 17

FINAL REMARKS (WITH VIEW ON RUSSIA S CURRENT DISCUSSION..) Inflation targeting (IT) is effective to deliver low and stable inflation in normal times BUT this is a not sufficient for macrofinancial stability: - Structural reforms are needed to improve economic efficiency and resilience -A sound fiscal strategy is also a necessary ingredient within any credible fiscal targeting framework - A macroprudential framework is necessary to address financial imbalances and systemic risk concerns The power of IT strategies may be more limited to raise inflation in the ZLB The risk of being trapped into the ZLB opens some legitimate questions: - What is the optimal inflation target, 2%, 4%..., and the relevant factors? - What are the merits of a price-level targeting (PLT) strategy vis-à-vis IT? - What is the role of central bank balance-sheet policies (even in normal times)? 18

THANK YOU FOR YOUR ATTENTION 19

BACKGROUND MATERIAL 20

SPAIN: ADJUSTMENT IN THE HOUSING SECTOR After the strong boom prior to the crisis, the adjustment in residential investment has concluded both in terms of quantities... and prices. RESIDENTIAL PRIVATE INVESTMENT (real terms) Spain Ireland Netherlands United States UK France Index 1997=100 240 220 200 180 160 140 120 100 80 60 HOUSE PRICES (real terms) Ireland United States (case Schiller) France Index 2007 Q1 =100 120 110 100 90 80 70 60 50 40 Spain United Kingdom Netherlands 40 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 30 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 21

SPAIN: ADJUSTMENT IN THE HOUSING SECTOR Since 2014 the construction is on a recovery track. Over the last 3 years, housing transaction show a positive trend based on the positive developments of the main determinants of the residential demand. Likewise, residential investment displays positive rates since the first quarter of 2014. 100 HOUSE PURCHASE TRANSACTIONS AND HOUSING INVESTMENT (4- quarter cumulated figures) Index maximum=100 110 90 80 70 60 50 40 30 Housing investment Sale - Purchase Transactions 05 06 07 08 09 10 11 12 13 14 15 16 HOUSE PRICE ADJUSTMENT Nominal adjustment Real adjustment Index 2007=100 100 Forecast 95 90 85 80 75 70 65 60 55 50 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 22

THE SOVEREIGN DEBT CRISIS IN SPAIN Large increase in fiscal deficit led to sovereign debt crisis in 2012, shared with other EMU members ( European Debt Crisis ) Aggravated by problems in banking sector and lack of banking union ( Banks-Sovereign Diabolic Loop ) Spreads receded following OMT announcement (July 2012), fiscal consolidation measures, and (since 2013) gradual economic recovery BALANCE AND STRUCTURAL BALANCE RISK PREMIUM RELATIVE TO 10-YEAR GERMAN BUND % of GDP 4 2 0-2 -4-6 -8-10 -12 07 08 09 10 11 12 13 14 15 16 17 18 7 6 5 4 3 2 1 0 BALANCE - SPAIN STRUCTURAL BALANCE - SPAIN SOURCES: AMECO and Banco de España. a The cyclically adjusted actual balance, net of temporary measures. 23

THE NATURAL REAL INTEREST RATES IN THE EURO AREA 4 3.5 3 2.5 2 1.5 1 0.5 0-0.5-1 euro area natural rate: estimates from Holston, Laubach and Williams (2017) 1972 1973 1975 1976 1978 1979 1981 1982 1984 1985 1987 1988 1990 1991 1993 1994 1996 1997 1999 2000 2002 2003 2005 2006 2008 2009 2011 2012 2014 2015 2017 24