With economic recovery underway in Europe, what monetary policy?

The prospect of a very gradual normalisation of our monetary policy gives rise to concerns and expectations. I will begin by focusing on what our accommodative monetary policy has already achieved today, before talking about prospects for the future. 

I. What is the situation today?
Economic recovery in the euro area is here [slide]. It is robust and broadly based across countries and sectors. Our latest ECB forecasts² confirm this: growth should stand at 2.2% in the euro area in 2017, i.e. a significant upward revision of 0.3 point compared with June’s forecast of 1.9%. This means that for the second consecutive year, euro area growth will be comparable to that of the United States. And that, according to Eurosystem calculations, the output gap will return to close to zero by the end of the year (-0.6%), even though France’s situation is less favourable due to its growth lag (output gap of around 1.4% according to our calculations).
The non-standard monetary policy that we have been conducting since 2014 is contributing to this acceleration of growth in the euro area, by supporting domestic demand and by fostering very favourable financing conditions. In concrete terms, this acceleration results in more jobs – over 6 million jobs created in the euro area since the start of 2013 – and in a pick-up in investment. Corporate investment in particular, decisive for supply capacities, is clearly recovering: up 4.7% in 2015, 6% in 2016, and is expected to be up 4% in 2017 and 2018). [slide] This improvement in investment is underpinned notably by ongoing growth in lending to the private sector, at 2.5% year-on-year in August 2017 for firms and at 2.7% for households, with interest rates moreover remaining very low. This growth in lending is over twice as high in France, which incidentally leads us to be very vigilant at the High Council for Financial Stability.
We are also observing favourable developments in inflation, which is gradually moving back towards our target of 2% over the medium term [slide]. After peaking at the start of 2017, the inflation rate stood at 1.5% year-on-year in August. Over 2017 as a whole, euro area inflation should reach 1.5%, against just 0.2% in 2016; for the coming years, we foresee inflation at 1.2% in 2018 and at 1.5% in 2019 – with a change in composition: less “energy” inflation, more underlying inflation. This represents a first success: our monetary policy measures have succeeded in warding off the risk of deflation which was still threatening the euro area last year – we mustn’t forget that inflation was declining, standing at -0.2% in April 2016.
That said, despite the progress made towards our target, it is still too slow. The underlying trend in inflation is still not strong enough to support prices in the medium run. Underlying inflation, excluding energy and food, has admittedly increased – rising from 0.8% in the first quarter of 2017 to 1.2% in July and August 2017 – but it still remains at subdued levels, despite the strong recovery in activity and employment.
A significant factor is the relatively low nominal wage growth. Among the cyclical factors, I would like to mention two in particular: first, persistent slack in the labour market – the unemployment rate has fallen sharply in the euro area, to stand at 9.1% in July 2017, but it is still too high; [slide] second, backward-looking wage bargaining, which means that low past inflation is feeding through to wages today. The influence of these two causes should nevertheless diminish with the recovery in economic growth and inflation.
Structurally, many studies³ suggest that the Phillips curve, i.e. the relationship between inflation and fluctuations in economic activity or unemployment, appears to have flattened since the 1980s [slide]. Inflation seems less responsive to changes in economic activity in advanced countries, notably because of globalisation,⁴ which appears to exert downward pressure on inflation via the decline in imported goods prices and competition from low-wage countries. But a flatter Phillips curve does not call into question this relationship: we are in no doubt about the way we are heading: the recovery and job creations will lead to higher wages and, ultimately, more inflation. But we nevertheless remain less certain as to the speed of this adjustment. We are both confident about the effectiveness of our monetary policy and willing to be patient regarding the time it will take.
II. What prospects for the future?
Let me now turn to the consequences for our monetary policy. You are well aware that we at the ECB’s Governing Council will decide this autumn on the re-calibration of our policy instruments beyond the end of the year – and, I quote Mario Draghi, “probably the bulk of these decisions will be taken in October”. We are now faced with a simple requirement, in line with our mandate to maintain price stability, and the progress towards our inflation target: we have to reduce the intensity of our net asset purchases, while maintaining overall a substantially accommodative monetary policy.
As regards our asset purchases, we have to reduce their intensity in a pragmatic manner, as we already decided successfully in December 2016. I insist on the word “pragmatic” because, while keeping the current rules, we should on the one hand exploit the margins of flexibility of the programme and on the other hand hold in reserve an additional purchasing capacity – if needed.
Summary of the Speech by Mr François Villeroy de Galhau, Governor of the Bank of France, at a lunch-debate at the Centre des Professions Financières, Paris.
Source: http://www.bis.org/