The ECB and Its Watchers XVIII

April 6, 2017

The statement that the monetary policy stance of the European Central Bank (ECB) was still appropriate was the key message Mario Draghi, President of the ECB, delivered at the eighteenth edition of the conference series “The ECB and Its Watchers”. At the event, which took place at the lecture hall building of Goethe University, the ECB President reaffirmed that the central bank would not need to deviate from its asset-buying program until at least the end of the year. Peter Praet, member of the Executive Board of the ECB, also underlined the status quo. The ECB’s chief economist reiterated the importance of sticking to the current policy plan to avoid the risk of reversing the success of its measures. Raising the deposit rate too early would render its other policies less effective, Praet said.

John B. Taylor, on the other hand, remained critical of the bond-buying program. “It’s time to speak about the end of the program,” the economist of Hoover Institution at Stanford University said. In view of the Federal Reserve’s monetary policy, Taylor, who developed the Taylor rule, illustrated how a more rule-oriented monetary policy could even strengthen the independence of a central bank. Currently, there is debate in the United States whether the Fed should introduce more transparency, explaining its monetary policy with regard to rules. Jan Hatzius, chief economist of Goldman Sachs, made the point that the impact of quantitative easing was very hard to determine. However, he was confident that the ECB should stick to its monetary strategy. “Stay on the course but the job is not yet done”, this is what the ECB could learn from the Fed according to Hatzius.

In the discussion on macroeconomic adjustment in the euro area Christoph Schmidt of the German Council of Economic Experts pointed out that it was time for the governments to reduce legacy debt and to restart the structural reform process. Meanwhile, the ECB should start tapering. Vitor Gaspar, Director of Fiscal Affairs of the International Monetary Fund (IMF), stressed the importance of having a well functioning financial system in the euro area and illustrated the complex interplay between reforms and fiscal policy. Marco Butti, Director-General for Economic and Financial Affairs at the European Commission, warned against too many governments relying too much on the expansionary monetary policy.

Regarding the international challenges for monetary policy, Thomas Laubach of the Federal Reserve as well as the Deputy Governor of the Bank of Japan, Hiroshi Nakaso, agreed on the point that most central banks were primarily oriented towards domestic objectives. International collaboration still seemed to be an exception. Laubach, an advisor to Fed chair Janet Yellen and a former Professor at Goethe University, stressed the need to foster clear communication between central banks. As a lesson from recent experiences, Philip Lane, Governor of the Bank of Ireland, emphasized the advantages of international coordination by sharing conjunctural assessment, thus gaining clarity about policy feedback rules.

How to deal with rules and uncertainty in monetary policy was one of the questions John Williams, President of the San Francisco Fed, and IMFS Professor Volker Wieland discussed in a debate moderated by the Financial Times journalist Sam Fleming. Williams appealed to include instruments of unconventional monetary policy as part of the regular toolkit in times of low inflation. He asked academics and researchers to rethink whether inflation targeting was the best way for central banks to achieve their objectives. Wieland pointed out that a setup with rules "could strengthen a central bank's decisions".



John Williams vs. Volker Wieland
“How to deal with rules and uncertainty”

John Williams, President of the San Francisco Fed, and Volker Wieland, IMFS Professor and member of the German Council of Economic Experts, discuss at “The ECB and Its Watchers” conference the advantages and problems of rules in central banking and how to deal with uncertainty.

Starting out with a historical view, John Williams, President of the San Francisco Fed, illustrated that the current level of real interest rates was the lowest in the post-war period. As this means less room for central banks to cut interest rates, Williams considers unconventional monetary policy measures to be part of the regular toolkit. “Central bankers and academics have to rethink whether inflation targeting was still the best way to achieve their objectives”, Williams demanded.

Volker Wieland, IMFS Professor and member of the German Council of Economic Experts, put the role of uncertainty in the limelight. Quoting Paul Krugman, Larry Summers and Fed Chair Janet Yellen, Wieland demonstrated how those researchers and also the Fed chair seemed to “totally ignore” the scale of uncertainty included in the models. In his view, this method was not satisfying. “Real interest rates have come down – the question is why?”, Wieland asked. In his opinion, the way the Fed was committed to inflation targeting didn’t seem appropriate.

Although Williams agreed on the fact that there was uncertainty, his take-away was different: “We have to incorporate that uncertainty”, Williams concluded. Remembering the financial crisis, Wieland raised the question whether there were indicators that showed that something was not optimal in monetary policy?” To him, this had been signaled by the Taylor Rule. The solution was not to be found in more fiscal policy. “Don’t destroy the flexibility of the economy”, Wieland requested. He argued that coming up with new schemes was not advantageous.

Williams gave a clear opinion that “we could do a much better job at the Fed” as far as transparency was concerned. In his view, Janet Yellen’s recent speech with allusions to rules “was a nod in that direction”. On the other hand, he described how the approach of the Fed was based on having diverse views at the Fed meetings in order to achieve a better outcome. Williams emphasized that “not having a rule opens a door for having a debate”. Meanwhile, in view of the political developments in the United States Wieland called for making legislation “more appetizing”, pointing out that in a setup “where you have rules, this could strengthen the central bank’s decisions