Debate about the Annual Report
Speech by Mario Draghi, President of the European Central Bank, at the plenary debate of the European Parliament on the ECB’s Annual Report 2017, Strasbourg, 15 January 2019
Mr President of the European Parliament,
Mr Vice-President of the Commission,
Honourable Members of the European Parliament,
I am very pleased to be here to discuss with you the ECB’s activities and your draft resolution on the ECB’s Annual Report 2017.
20 years ago, on 1 January 1999, the euro was officially introduced and the Eurosystem started its monetary policy operations. Establishing a single currency area between 11 European countries was a historic step for our continent and a quantum leap in economic integration. Its twentieth anniversary gives us an opportunity to reflect on its successes, but also to consider what still needs to be done for the euro to deliver its full benefits.
In this context, I would like to use my remarks to take a look back at the ECB’s monetary policy, to take stock of what we have learned and to highlight the challenges that remain. I will mostly focus on the past seven years, which coincide with my term as ECB President.
The evolution of the ECB’s monetary policy
The two decades in which the euro has existed could hardly have been more different. The first decade was the culmination of a thirty-year period of macroeconomic stability – the era known as the “Great Moderation”. The second decade then produced the worst economic and financial crisis since the Great Depression. Naturally, these periods required very different monetary policy responses and different tools to implement them.
As the pre-crisis period was characterised by moderate swings in the economic cycle, the ECB was able to ensure price stability mainly by adjusting its policy rates. But the crisis of 2008 fundamentally changed the economic and financial landscape in which the ECB operated. New instruments became essential to safeguard the effectiveness of our monetary policy and stabilise the euro area economy. This in turn required us to refine our approach to central bank communication and accountability.
When I arrived at the ECB in November 2011, the euro area faced a very challenging set of circumstances. The economy had bounced back from the post-Lehman crisis in a similar manner to other jurisdictions. But from 2010 onwards, a loss of confidence in the sustainability of sovereign debt had produced a vicious circle of rising borrowing costs, financial fragmentation, and contracting economic activity. Cuts in key ECB interest rates were not being passed on to firms and households to the same extent in every euro area country. We were witnessing a serious disruption in the monetary policy transmission mechanism which, if left untended, would have posed a profound threat to price stability.
The ECB responded with two sets of policies. First, central bank liquidity was made available to banks for up to three years, and the range of collateral that banks could use to access central bank money was expanded. This helped reduce fragmentation in banks’ funding conditions. Second, the ECB announced outright monetary transactions (OMTs) in the summer of 2012, which removed redenomination risk in government bond markets stemming from fears of a possible euro area break-up.
Yet the sovereign debt crisis left a deep scar on the economy. Unemployment rose steeply, firms cut back on investment and loan delinquencies increased. Even though financial fragmentation was diminishing, banks began to shrink their balance sheets and became less willing to lend. This produced a renewed cycle of contracting credit growth and weak demand dynamics. Inflation drifted downwards.
With inflation now well below our objective, the ECB faced a new type of policy challenge. We needed not only to repair the transmission problems created by deleveraging banks. We also needed to expand our policy stance to counteract deflationary pressures.
So in June 2014 we launched our targeted longer-term refinancing operations, which once more provided long-term liquidity to banks – but conditional on extending credit to the private sector. We introduced negative rates on excess reserves to further encourage banks to lend to households and businesses. And soon after, we announced our asset purchase programme (APP), buying asset-backed securities and covered bonds. Faced with a continued decline in inflation and a heightened risk of a de-anchoring of inflation expectations, in January 2015 we expanded the APP to include public sector securities.
Since then, both the size and duration of our asset purchases have been recalibrated in response to changes in the inflation outlook. Our asset purchases have also been complemented by further cuts in policy rates and the use of forward guidance. Communicating our expectations about future policy, along with the conditions that would warrant a change in the policy stance, has successfully contributed to reducing uncertainty around the expected future path of short-term interest rates, thereby helping to preserve accommodative financial conditions.
Supported by these policy measures, the euro area economy has steadily recovered. We have now seen 22 consecutive quarters of economic growth. There are 9.6 million more people in employment in the euro area than there were in the second quarter of 2013 (when the number of people in work fell to its lowest point during the crisis). The unemployment rate has declined to 7.9%, its lowest level since October 2008. And the employment rate of people aged 15-74 has risen from 54% in 1999 to 59% in the second quarter of 2018, the highest rate ever recorded in the euro area.
The main motor of the recovery has been the domestic economy, driven by a strengthening in domestic demand and improving labour markets. That underlying strength of the economy has underpinned our confidence that inflation would converge towards our inflation aim in a sustained manner. As such, since 2017 we have gradually reduced the monthly pace of net asset purchases. We decided to end our net purchases in December last year, confident that the sustained convergence of inflation to our aim would proceed.
At the same time, recent economic developments have been weaker than expected and uncertainties, notably related to global factors, remain prominent. So there is no room for complacency. A significant amount of monetary policy stimulus is still needed to support the further build-up of domestic price pressures and headline inflation developments over the medium term. Our forward guidance on the key ECB interest rates, reinforced by the reinvestments of the sizeable stock of assets we have acquired, continues to provide the necessary degree of monetary accommodation for the sustained convergence of inflation to our aim.
Lessons for monetary policy and the monetary union
So what have we learned from this experience? The ECB’s monetary framework rests on three elements: a clear mandate to achieve price stability; independence over the instruments we can use to achieve our mandate; and a strong accountability framework. The importance of each of these elements has been reinforced by the crisis.
First, we have seen that a well-defined mandate is vital for our credibility with the public, because it guarantees that the ECB will always act in the interest of the whole euro area, and will not be swayed by interest groups.
Second, we have seen that instrument independence is key to an effective monetary policy, since it allows the central bank to act quickly and flexibly to shocks, especially in exceptional times. Indeed, a well-equipped toolbox, comprising both standard and non-standard instruments, has proven indispensable in conditions where monetary policy transmission is impaired or where space for interest rate cuts is limited.
Third, we have seen the importance of a strong accountability framework, particularly when central banks have to use new tools that are not well-understood by the public. Central banks are powerful and independent, but they are unelected. This combination can only be squared if they are held accountable by elected authorities.
In light of this, we have stepped up our efforts to improve our communication and strengthen our accountability in recent years. The Governing Council has started to publish the accounts of its monetary policy meetings. The ECB and the European Parliament have increased the intensity and focus of their exchanges. All this has provided us with more opportunities to explain our decisions and demonstrate how the ECB is acting in accordance with its mandate, which is a fundamental pillar of its legitimacy.
The crisis has offered many lessons beyond monetary policy, too. The euro area entered the crisis with an incomplete institutional and regulatory framework, not only for the banking sector but also in other areas of economic policy.
The creation of the banking union and the European Stability Mechanism has strengthened the ability of EU authorities to intervene decisively in future crises. Reforms at national level, and the strong political commitment to the euro shown by European policymakers, were equally instrumental in strengthening the foundations of our common project. But the necessary changes took time, and it was time that the euro area lost in its recovery. Our monetary union is now in better shape, but further progress can and should be made.
As I had the opportunity to discuss during my regular hearing before the Committee on Economic and Monetary Affairs, and as your draft resolution points out, the priority now is to increase the resilience of the euro area. This would also strengthen the transmission of monetary policy in future downturns. Resilience depends on the euro area being able to use a broad policy mix involving monetary, fiscal, prudential and structural instruments.
Let me conclude.
The first two decades of the euro area have seen an evolution in the way the ECB conducts its monetary policy. Faced with unprecedented threats to price stability, the ECB adapted its policy instruments to continue delivering on its mandate. We will continue to do so if and when needed, in compliance with our mandate as defined by the EU Treaties, and with all the independence over our tools as defined by our legal framework.
Today, we can say that the euro area has emerged from a crisis so severe as to threaten at times its existence. We are out of it, primarily because of the resilience, the energy, and the entrepreneurial capacity of European citizens, as well as their trust in their leaders’ commitment to the euro. Our policy response and the important changes to the architecture of the EMU in the meantime also helped the euro area out of the crisis. In many ways we have a stronger monetary union today than we had in 2008. This is also reflected in the euro’s popularity among euro area citizens, which is currently at its highest level since it was introduced. But more work is still necessary to complete the EMU, so as to make it more resilient in the face of future crises.
To deliver its full benefits, the European Union requires permanent political commitment, at both national and European levels, and across policy areas.
In this respect I can testify to the essential role the European Parliament has played during the challenging years of the crisis. And I am certain that it will also be fundamental in carrying out the remaining work until the completion of the EMU.
The credibility of the ECB rests on its independence and this is based on its accountability with respect to its mandate, as enshrined in the EU Treaties. The European Parliament in holding the ECB to account gives legitimacy to its independence. And since this is my last hearing before this plenary as ECB President, let me thank all of you for how this process has been carried out during my mandate, for the valued interactions with you, and the opportunity you have given me to explain the ECB’s policies.
(Transcript provided by the European Parliament)
Mr President, first of all, I thank the rapporteur, honourable Member, Mr Mato, for his report. I certainly thank you for all the compliments the ECB has received and I will respond to the criticisms.
First of all, about the European Deposit Insurance Scheme (EDIS). The ECB has always been a supporter of EDIS, of the insurance. I want just to make three points about that. First of all, whatever the road is to EDIS, the final goal of having a fully mutualised EDIS should always remain in sight. Now the road to that goal is not going to be simple, we all know that. And so various steps and delays and compromises and negotiations are necessary. But the direction and the sense of final results should always be present. So what you decide about how to move ahead, will be really in your own judgment. The important thing is that, whatever you decide, we’ll never compromise over the final outcome.
The third point I want to make about EDIS is that there is no clear progress on this road unless there is convincing risk reduction everywhere. By the way, big progress has been achieved on that front already but more needs to be done. The ECB has shown in various places on various occasions that risk sharing also itself contributes to risk reduction, so the two arms of this journey towards the final goal of a fully‑neutralised insurance system should go hand in hand.
Several questions addressed the economic effects of the policy of the ECB. Comparisons were made with non‑euro parts of the world and with before the euro – how the world was beautiful, fantastic, before the euro. I’ve gone through these comparisons in a recent speech I gave. It was not fantastic, especially for the countries that complain most today about the euro; it was not fantastic at all before the euro.
Let me make a comparison with the United States, because someone raised that point. The employment rate in 1998 in the euro area at 19 was 59.8%, now it’s 67.3% – the highest ever in the euro area. In the United States, it was 73.9% in 1998, today it’s 70.6% so it went down, not up.
The jobs created in the euro area over this period of time have been 19.8 million. And the jobs created in the United States were 17.2 million. Of course we have to be careful about making these comparisons because the units have to be standardised and the same thing we get on the employment numbers, in millions.
So when I’m asked about the side effects of our monetary policy in the euro area, the response is that the main side effect between 2013 – when the situation was at its worst – and today, has been the creation of 9.6 million jobs, which is more than ever. That’s the main side effect.
Other questions related to the presence of financial stability risks. Well, it’s true that in certain localised areas over the euro area we observed that valuations are stretched in prime commercial real estate. Also in some areas of some countries in the residential real estate, in some segments of the bond market. But are any of these risks prone to generate systemic financial stability risk? The answer that we give so far is no. But of course we monitor all this very carefully. And the answer to these local situations cannot be a change in monetary policy. It has to be the use of macroprudential tools by the national governments. We’ve said this and, in fact, national governments have indeed responded, with their national instruments together with the ECB.
More generally, some questions addressed the role of the ECB and very rightly, as observed by the rapporteur, the ECB has its role but cannot fill all the roles that everybody else should fill. The ECB has a role which is limited to monetary policy, which is circumscribed by its mandate. It cannot do everybody else’s job.
In this sense, as I have said on a variety of occasions including this morning, not all its benefits have accrued to all the members of the euro area. Why is that? Because of two main reasons. Reforms are necessary in these countries whether they belong to the euro, or are outside the euro. You have got to make the reforms that are necessary. There is not a blueprint which is the same for all countries. It does change from country to country; each country has its own history. And so that’s the basic thing: no reforms, no growth.
But then there are also problems, also incompleteness in the Economic and Monetary Union. And the first incompleteness is to finish the things that had been decided already, namely the banking union. The second is to start to move fast on the capital markets union and the third is to build fiscal capacity. But if you do the first two things – and the European Parliament has really carried out a very positive and constructive role at each and every point in time of this discussion – if these two things are done, we are way better, even if the next steps on the creation of the fiscal capacity may take longer for pretty obvious political difficulties.
There was one question about what the ECB could do about certain specific loans that banks have lent to citizens. Generally, the ECB cannot do anything about that, it’s the national competent authority. Very often, these issues are a consumer protection issue, so it’s the national consumer protection authority that has to monitor the conditions of lending. But generally speaking – and this holds true also in other countries where the non‑performing loans (NPLs) problem is really very dramatic because of its social consequences – in non‑performing loans you always have two types of debtors: the ones who are normal or even strategic debtors and the ones who are part of a big social problem. For these problems, the response is not to change the payments culture but rather to help the poor people who cannot pay back. One should keep the two things separate. Don’t change, don’t affect, don’t damage, don’t harm your banking system, your financial system because the result of this will only be that they will not be able to lend as much as they could to the private sector of your economy, but rather help the poor people who cannot pay.
Now, one question that has been asked from several sides is if we are heading towards the next recession – and I will say something about that in a moment – does the ECB have the tools to address this? The answer is yes. The ECB has the tools to address this but keep in mind that our present monetary policy stance is very accommodative already. We have negative interest rates and they are expected to be like this for an extended period of time. And, even though we have decided to stop the net asset purchases, we also decided that the current stock will stay what it is for a considerable period of time. What does it mean? It means that, as bonds come to maturity, we repurchase the bonds. What does it mean in terms of numbers? It means that we will continue buying, by and large – at least this year or the next year – 15 billion euros of bonds a month, which was, by and large, what we had been buying in the last 3 months of last year.
There was perhaps more than one question about whether our monetary policy has helped equity. We went into some depth in trying to understand what the effects are of monetary policy on the distribution of income, distribution of wealth. It’s quite clear that each monetary policy decision has distributional effects. When we change interest rates we change distribution between creditors and debtors, or between young and old. But certainly the asset purchases, the quantitative easing (QE), have distributional impacts which are even more visible and direct because asset prices go up and the owners of assets are usually the wealthy ones.
So the question we ask ourselves is, is our policy worsening the distribution? If you consider all the effects, the answer is no. Why is that? It is true that it worsens the distribution in the short term. However, what is the factor that worsens the distribution more than any other factor? It’s the unemployment. Where the monetary policy of the ECB has been a success was in fostering strong employment growth, as I presented at the beginning of this response.
One question addressed the point of access by SMEs to credit. Has our policy prevented, restrained, or shrunk access by SMEs to credit? The answer is absolutely no. Both our corporate bond programme and our QE programme created space in the bank’s balance sheet for lending more to the SMEs. All data since 2013, since even when we started with the longer‑term refinancing operations (LTROs) – by the way the LTROs are not unconditional lending – and the targeted longer‑term refinancing operations (TLTROs), is lending to banks on condition they lend to firms, to the real economy. I don’t know where the fairy tale thing about EUR 29 out of a hundred actually came from.
In terms of another interesting irony of some of the questions, was that one hears that monetary financing of the deficit is now the solution to all problems. That’s one of the questions that was raised before. That is actually interesting. First of all, because when monetary financing was available, for the countries that actually vastly used monetary financing before the euro, the situation was very bad. They got very high inflation and they got unemployment higher than countries that did not use monetary financing.
What is actually quite paradoxical is that you hear this solution of monetary financing from people who were against monetary financing as an utmost crime until yesterday.
I think I have responded to most of the problems, and now one word about the outlook. If we take a snapshot of the situation as it is today, statically, we still see a situation where consumption is still expanding, relatively strong, investment still expanding, supported by our monetary policy, export growth is less, but still good. And the labour market keeps on being very strong.
However, all this is happening at lower and lower growth rates. And we have been receiving weaker data than expected now for a longer time than we had expected a few months ago. In other words, at the beginning we had lower data and we said – and we continue to say, by the way – that some of this weaker momentum was due to temporary factors, and specific to sectors and certain countries. For example, what happened to the car industry; this is one example which is a temporary drop.
But then we also said that there are also some more permanent causes of this slowing‑down. And the causes of this slowing‑down are going to stay. One of which is simply that 2017 was a pretty exceptional year when compared with historical averages. And so we return to a lower growth path.
But then the question that we should ask is, first of all, is this what is called a sag or is it heading towards a recession? And the answer we give is no, it’s a slowdown, which is not heading towards a recession, but it could be longer than was expected before. And on what does the length of this slowdown depend? To answer this question we have to go back and ask ourselves what are the factors that originally caused this weakening in growth. And the factors deal primarily with some slowdown in China, of course, but with what we call geopolitical uncertainties. And here, the natural question to ask is how long will these geopolitical uncertainties last. These geopolitical uncertainties put into question the pillars upon which the order, that was built after the Second World War, was constructed.
And they put into question the European Union. They have to do with Brexit. They have to do with trade tensions with China. They have to do with the denial of the multilateral system. And we notice, however, that some of these things get better and some others get worse.
The result of this, however, is that, at least for some time to come, there’s going to be a continuing uncertainty that changes nature, and this has a cost. And the cost is lower confidence – lower business confidence and lower consumer confidence. That’s why we are now assessing the situation, as I said. My impression is, Mr President, that I have responded to all questions. If I missed someone I apologise.