Interesting remarks from Benoît Coeuré, Member of the Executive Board of the European Central Bank, at the SNB-IMF Conference “Monetary Policy Challenges in a Changing World”, Zurich today. The discussion centres of the risk of bubbles when interest rates are artificially low, and exacerbated by other unconventional monetary strategies, why investment property is attractive in these conditions, and how macroprudential should be used to manage these unintended consequences in the context of growth. An edited version follows:
In recent years, there has been an intense discussion, both at the national and the international level, about the potential financial market implications of unconventional monetary policies. At the international level, policy makers have been particularly concerned with the surge in capital inflows, and the resulting exchange rate appreciation pressures in emerging markets. More recently, amid monetary policy normalisation in the United States and additional monetary policy easing in the euro area, including through the launch of the public sector purchase programme (PSPP), a new, but conceptually related discussion has emerged on the global financial market implications of diverging monetary policy cycles. At the national level, the main concerns were spillovers to equity and real estate markets, and the worries about the emergence of asset price bubbles as a result of unconventional policy measures.
Monetary policy always has unintended consequences, no matter where it is pursued. By altering short-term interest rates, central banks affect the inter-temporal decisions of households. Inter-temporal redistribution is at the heart of monetary policy that is aimed at ensuring price stability, and it thus has effects on the income distribution of savers and spenders.
But monetary policy also affects the distribution of income along the intra-temporal and spatial (cross-country) dimension. Changes in short-term interest rates affect consumption, savings and wealth in different ways, depending on the characteristics of individual households in different jurisdictions. But all these effects can be considered temporary, indirect and unintended, i.e. a side effect of a strategy that is aimed at ensuring price stability in the economy.
That said, it would be a logical fallacy to conclude that all domestic spillovers are acceptable. Bubbles are a case in point. Bubbles are a possible, but not an inevitable result of unconventional monetary policies. And if they are welcome at all, then only in a severely constrained, second-best world. But in this case, we should ask ourselves how we can overcome the constraints that prevent better policy outcomes, rather than settling for bubbles to temporarily mask the constraints.
Facing the threat of a persistent low-growth and low-inflation environment and a binding floor on standard policy rates, many central banks have resorted to unconventional measures. These measures were aimed at further pushing down nominal interest rates along the maturity spectrum to track the secular decrease in the natural, “Wicksellian” real rate of interest. Thereby, they helped induce firms and households bring forward their investment and consumption spending in comparison with that in a no policy-change scenario and, ultimately, bring the natural rate back to more normal levels.
I am convinced that there is no alternative for us than acting this way in order to deliver on our mandate. Yet, there is a danger associated with the temporary, yet potentially extended period where low interest rates are needed to stimulate investment and consumption. With real interest rates below potential growth, private agents may just borrow to purchase assets in limited or rigid supply (e.g. real estate property). In this dynamically inefficient world with structurally weak growth prospects, this may actually become an attractive way for savers to generate returns on their savings that investments in the productive sector are unable to generate.
In this case, we end up with a “rational bubble”. While unconventional monetary policy is not a necessary condition for this type of bubble to emerge, it may render it more likely – and more violent in the event of its materialising. So what are the consequences of such bubble?
In the short-term, it may indeed generate a temporary boost to the economy. And for a while this boost would be difficult to distinguish from the regular workings of asset purchase programmes, which actually embed asset price increases as a desired effect, which passes on the initial impulse to broader financing conditions via portfolio rebalancing. But this boost would ultimately be very costly. Not only does it does it come with welfare decreasing macroeconomic instability, but it also brings about an arbitrary redistribution of wealth that may, in the worst case, undermine social cohesion and trust that the central bank is acting within its narrow price stability mandate. And moreover, it can create financial stability risks elsewhere, generating negative spillovers from what should otherwise be a normal international adjustment process.
Against this background, it would be wrong to treat bubbles as a welcome replacement therapy to a sustainable growth model. Instead, macroeconomic and structural policies have to set the necessary conditions so that investment in productive sectors becomes attractive again and investment in bubble-prone areas is discouraged, so that total factor productivity is increased and the natural rate of interest ultimately reverts to what is normal.
We take monetary policy decisions with a view to attaining our primary objective of price stability. Thereby, we establish a stable nominal anchor for the private sector, which in turn is a fundamental precondition for overall macroeconomic stability. Without prejudice to this objective, we take financial stability risk seriously and monitor closely whether severe imbalances are emerging in the financial sector. In this context, we consider the financial stability risks related to our policy measures to be contained. Should risks emerge, macro-prudential policy is best suited to safeguard financial stability. Macroprudential instruments can be targeted more efficiently to those sectors and countries where systemic risks may be materialising. Finally, we encourage national authorities to do whatever is in their power to place the euro area on a more dynamic growth path, thereby creating attractive investment projects that generate high, but fundamentally justified, returns. These are the conditions for unconventional monetary policies policies to bring economies back to a stable and sustainable growth path, both at home and abroad.
