ECB – BSE Voice

Future paths for monetary policy in a world of lower inflation

Recap of Professor Jordi Galí’s ECB Forum presentation by Maximilian Magnacca Sancho ’21 (ITFD)

The stage for ECB Forum 2020 — Photo by ECB on Flickr

On November 11, 2020 the first day of the ECB Forum on Central Banking began with three exciting talks on how shifts in the global economy have changed the game for central banks worldwide. Among the distinguished guest speakers at the Forum was UPF, CREi, and Barcelona Graduate School of Economics Research Professor, Jordi Galí. While the ECB had him slated to speak on the “Inflation Objective, Structural Forces, and Central Bank Communication,” Professor Galí spent his presentation focusing predominantly on inflation targeting at central banks and whether it should be revised going forward.

Watch the ECB Forum panel discussion with Jordi Galí, Volker Wieland, and Annette Vissing-Jørgensen, chaired by Philip Lane on YouTube

His presentation spoke directly to an ongoing debate amongst academics and financial-market watchers, as there have been structural changes in the economy since the last update of the ECB’s policy in 2003. Structural changes are a normal function of an economy as it progresses along with society, though it has some troublesome side effects. Most concerningly, they reduce the effectiveness of policy in alleviating economic downturns by influencing the transmission mechanisms of monetary policy. This raises the challenge for policymakers in picking the best policy.

These structural changes ultimately centre around one crucial variable that is influenceable by central banks. The Steady-State Real Interest Rate, colloquially known as R*. Central banks will be constrained by this rate and hit the zero lower bound sooner if they withhold from changing the inflation target – as argued by Jordi Galí in his presentation. A lower R*, as is being observed, necessitates a higher inflation target so that monetary policy (done through a changing of the interest rate) will have less incidence of the zero lower bound and thus reducing the chance of ineffectiveness.

Source: The Optimal Inflation Target and the Natural Rate of Interest

Download Jordi Galí’s presentation slides

This is obviously an urgent issue faced by policymakers worldwide during the ongoing COVID-19 crisis from the forefront of monetary economics research, yet what Professor Galí was able to do was bring it back to the basics of economics. He emphasised how the models are built on assumptions, and if assumptions change – as the data indicate they have – then the framework for thinking about these issues need to be updated.

In this spirit, Professor Galí proposed three potential policy changes for central bankers to consider in light of the ECB strategic review: he proposed more countercyclical fiscal support; changing to average inflation targeting; or a higher inflation target from its current position of “below or at 2%”. He acknowledged the challenges and potential pitfalls of all these policies, while also speaking to their potential improvement upon the current policy.

It was great to see a Barcelona GSE professor invited to speak at such a prominent and interesting event held annually and frequented by policymakers and academics working on some of the most challenging issues in central banking. It highlights the quality of research that is being done at Barcelona GSE and the quality of the professors conducting that research being sought after by policymakers.

Maximilian Magnacca Sancho ’21 is a student in the Barcelona GSE Master’s in International Trade, Finance, and Development.

This post was edited by Ashok Manandhar ’21 (Economics).

EU Banking Union: What it is and What it is Not

Arturo Pallardó ’15 (Master in Economics) and Christopher Gandrud (Lecturer, City University London) have put together a summary of the European multilevel bank regulatory structure.

banking union

The health of the European banking system has come back into the media spotlight. The recent fall in bank shares; the creation of the Italian “bad bank”; and Britain’s demands to shield its banks from rules governing the euro region; suggest that the debate on the design and functioning of the European banking regulatory architecture will be on the table in the following months.

Given the complex and evolving nature of European banking regulation, there is much confusion about what has already been established and what plans are being discussed. We hope to clarify the current and proposed state of the European bank regulatory architecture. We differentiate which rules and institutions form the so-called “banking union” and which rules are part of the more general EU single market for financial services.

You can read the full summary on bankingunion.eu, a website run by Arturo that curates content and fosters debate on the European banking union’s evolution.

Follow the authors on Twitter @bankingunion_eu and @chrisgandrud

New banking union website by Arturo Pallardó ’15

Economics alum Arturo Pallardó ’15 has created a new website to follow the evolution of the European banking union.

Arturo Pallardó (Master in Economics ’15) is the creator of the @bankingunion_eu Twitter account and has just launched a new website to follow the evolution of the European banking union. Here he tells Barcelona GSE Voice readers about the project:

As expressed by the European Central Bank, the construction of a banking union emerged from the financial crisis of 2008 and the subsequent sovereign debt crisis: “It became clear that, especially in a monetary union such as the euro area, problems caused by close links between public sector finances and the banking sector can easily spill over national borders and cause financial distress in other EU countries”.

However, this European project is still under construction. The ultimate goal of this www.bankingunion.eu website is to gather and structure banking union-related documents, from legislative acts to research papers, while fostering the debate on those issues that are unfinished.

Meanwhile, in the current beta version of the web the reader will find different interviews with academics, researchers and professionals discussing some of these banking union topics.

Visit www.bankingunion.eu

Follow @bankingunion_eu on Twitter

Connect with Arturo on LinkedIn

ECB Outright Monetary Transactions – Master Projects 2014

Editor’s note: This is the first post in a series that will showcase Barcelona GSE master projects by students in the Class of 2014. The master project is a required component of every master program.

An Evaluation of the ECB’s Outright Monetary Transactions

Authors:

Madalen Castells, Alexandros Georgakopoulos, Edgar Giménez Trill, Jesse Lastunen, and Karolos Lymperakis-Pitas

Master Program:

International Trade, Finance and Development

Project Summary:

Since early 2009, the euro crisis has influenced most countries of the European Monetary Union (EMU), contributing to persistent low economic growth, high unemployment, steeply rising public financial costs and several problems with the region’s banks. As a result, a wide variety of policy measures have been adopted to address these problems. The central actors have included not only individual member states but also the European Central Bank (ECB), European Commission (EC) and International Monetary Fund (IMF).

While the success of many of the policies in recent years have been contested by different parties, the ECB’s Outright Monetary Transactions (OMT) program initiated in the summer of 2012 has been widely welcomed. Our paper attempts to understand and investigate OMT’s claimed success, motivated especially by the recent efforts to discontinue the policy. The implications with regard to the continuation of the program are potentially enormous, both economically and in terms of the social welfare of European citizens. Altogether, our motivation stems from the catastrophic consequences of the crisis, mixed success of most mid-crisis policy responses, and the uncertain destiny of OMT – perhaps one of the most crucial policy initiatives adopted in Europe after 2008.

Our research questions build on the uncertain contribution of OMT to the declining bond spreads in the peripheral euro nations. We ask whether OMT was responsible for the decline in their spreads after mid-2012, why this might be the case, and whether the policy can be successful in the future. The underlying policy question is simply whether European legislators should resume OMT. Our study is based on two steps: we first examine the ”theory and practice” of the program, also conducting a compact literature survey on other research studying its effectiveness, and then turn to quantitative methods. Our quantitative analysis consists of a regression study and the application of the synthetic control method to examine OMT’s effect on declining bond spreads in the periphery. In the process, we also analyze the nature and dynamics of the post-Lehman hikes in peripheral bond spreads.

Our results suggest, firstly, that the post-Lehman takeoff in sovereign bond spreads in the periphery was largely induced by fears of sovereign default that were separated from ”normal” associations between spreads and economic fundamentals. In particular, the synthetic control countries we construct based on spread determinants in the peripheral countries do not experience any such increases in their spreads. Our regression analysis also indicates that the mid-crisis evolution of peripheral spreads differs strikingly from the values predicted based on the stable period between 2000 and 2008. Furthermore, countries outside the periphery do not suffer from the pronounced association between spreads and fundamentals.

Secondly we find that OMT was very likely to be responsible for the rapid decline in peripheral spreads after mid-2012. The synthetic control countries we construct are not significantly affected by OMT, and some actually experience slight upward trends in their spreads after the policy is announced. The method lends strong support to OMT’s role in the declines in peripheral spreads. Similarly, the regression analysis suggests that post-OMT trends in spreads approach the stable values predicted based on the pre-crisis period. In most peripheral countries, OMT also breaks up the upward trend predicted based on the period before OMT.

Our results broadly validate earlier studies by Krishnamurthy et. al (2013) and Altavilla et al. (2014) regarding OMT’s effect, and Arghyrou and Kontonikas (2011), De Grauwe and Yi (2012) and Di Cesare et al. (2012) regarding the panic-driven nature of the increased peripheral bond spreads during the crisis. Although we consider that further research regarding the suggested long-term costs of OMT is needed, we strongly believe that the benefits of the policy outweigh the hypothetical concerns, and OMT should therefore be resumed by European policymakers. In particular, OMT had the intended effect of reducing bond spreads and stabilizing monetary policy in the European Monetary Union, and there is no indication that actually implementing bond purchases through the program will be necessary.

Read the full project report or view slides below:

[slideshare id=36828144&doc=ecb-outright-monetary-transactions-slides-140710051915-phpapp02]