Hearing at the Committee on Economic and Monetary Affairs of the European Parliament

SPEECH

Introductory statement by Mario Draghi, President of the ECB, to the ECON Committee of the European Parliament

Brussels, 23 September 2019

introduction

Madame President,

Honorable members of the Committee on Economic and Monetary Affairs,

Ladies and gentlemen,

I would like to start by congratulating you all on your election and you, Madam Chair, on your recent appointment as chair of the committee.

It is a pleasure to appear before this committee during this new Parliament and before the end of my term as President of the ECB.

The legitimacy of the independence of the ECB, as enshrined in the EU Treaties, is essentially based on our responsibility. And the treaties have given this Parliament a central role in the accountability of the ECB.

The hearings before this committee play a vital role here. As president, I found them extremely beneficial.

When I appeared before the ECON Committee for the first time in December 2011, the euro area was plagued by financial instability. it was entering a second recession, which ultimately resulted in sustained disinflation and, at times, increased risks of outright deflation.^[1] The euro area has come a long way since the crisis, partly thanks to the support provided by the ECB's monetary policy. The unemployment rate in the euro area was 7.5% in July this year, its lowest level since July 2008.

In recent years, the ECB has clearly and repeatedly expressed its willingness and determination to achieve the main objective of price stability, as defined in the Treaties. This state of preparedness and determination have been essential to deal with the economic crisis and the risks to our goal.

It is with this same determination that two weeks ago, the Governing Council of the ECB decided to act in response to the persistent deficit of inflation in relation to its objective.

I am happy to be able to discuss these decisions with you today. I will first review the main developments in the euro area economy since my last appearance before this committee. I will then present the monetary policy decisions taken by the Governing Council in the light of the economic outlook. At the request of the Committee, I will conclude by drawing lessons from the last eight years that may be relevant when discussing the political responses to the challenges ahead.

The economic outlook for the euro area

Since my last hearing before this committee at the beginning of the year, growth momentum in the euro area has slowed down more than expected. Real GDP growth is now expected to be 1.1% in 2019, down 0.6 percentage point from the December 2018 workforce forecast and 1.2% in 2020, down from 0, 5 point compared to the December forecast.

This slowdown is mainly due to the weakness of international trade in an environment of persistent uncertainties related to protectionist policies and geopolitical factors. These factors are increasingly affecting the economic climate, particularly the manufacturing sector, which is more trade-oriented and exposed to foreign influences.

Of course, countries with a relatively large manufacturing sector are more vulnerable to any reversal of the global economic cycle. Germany, for example, accounts for 28% of the euro area's GDP, but not less than 39% of the manufacturing value added of the euro area. As a result, Germany is today one of the eurozone members most affected by the downturn.

While the euro area services sector continues to show resilience, we must not be content with its ability to remain robust to negative contagion effects. The weaker the manufacturing industry continues, the greater the downside risks for other sectors of the economy.

In the future, recent data and forecasting indicators – such as new export orders in the manufacturing sector – do not show any compelling signs of a rebound in growth in the near future and the balance of risks weighing on the growth outlook remains downward.

In the context of this longer weakness in the euro area economy, both actual and expected inflation have been consistently below levels consistent with the medium-term objective of the ECB Governing Council.

Global inflation remains well below 2%, while inflation excluding the more volatile components of food and energy has hovered around 1% for a long time. Core inflation remains subdued, as the weaker economic outlook may cause a lag in the price pass-through of wages. In particular, firms absorb increases in labor costs into their profit margins rather than passing them on to their customers. At the same time, the indicators of inflation expectations are weak. Although the probability of deflation remains limited, the medium-term expectations of the market for inflation are based on values ​​that do not correspond to our objective of inflation.

Since my last hearing, we have been downgrading the inflation outlook for the entire projection horizon, first in the March 2019 workforce projections, and then again in March. September, due to the decline in economic activity and energy prices. Inflation is expected to average 1.2% in 2019, 1.0% in 2020 and 1.5% in 2021, well below the medium-term objective of the Governing Council, which is less than 2%, but close to this one.

The ECB's response to current prospects

Thus, when the Board of Governors met two weeks ago, it faced a slower and longer-than-expected slowdown, persistent and significant risks to growth prospects and a further delay in the convergence of inflation towards our goal. A vigorous monetary policy was therefore essential.

As part of our mandate, we have decided to put in place a comprehensive set of measures to ensure that inflation progresses sustainably toward our goal.

We lowered the deposit facility interest rate from -0.40% to -0.50%. This rate constitutes an anchor point for short-term market interest rates, which serve as a benchmark for many types of loans and financial instruments. The lowering of the deposit facility rate helps to further improve the borrowing conditions of households and businesses. Negative rates also encourage banks to lend to the real economy instead of retaining cash, thereby supporting the asset purchase program (APP) rebalancing channel.

The impact of the reduction in the deposit facility rate is reinforced by our enhanced forward guidance on the likely direction of our monetary policy in the future. More specifically, we have specified that our key rates should remain unchanged "at their current or lower levels until we see the inflation outlook converging robustly towards a level sufficiently close to but less than 2%, in our projection horizon, and this convergence has always been reflected in the dynamics of underlying inflation". This improved focus clearly indicates rate expectations by linking our policy to tighter conditions for inflation prospects.

The statement by the Board of Governors that we want inflation to reach a level that close enough atbut below that, 2% reaffirm what we said after the July monetary policy meeting: that the values ​​of recent realized and projected inflation are too low and inconsistent with the medium-term inflation target of Board of Governors. Although the new wording of the forward-looking forecasts reflects the prospective orientation of the ECB's monetary policy framework, we have added two safeguards to ensure that the normalization of key interest rates only begins when inflation is sustainably achieved in order to reach our goal. medium-term objective. The phrase "to converge vigorously"Means that the Governing Council wants to ensure that the convergence process is sufficiently mature and realistic before it starts raising policy rates. The reference to the inflation outlook being "always reflected in the dynamics of underlying inflation"Means that the trajectory of realized inflation should underpin our outlook for inflation.

Our improved forecasts help to reduce uncertainty about expected interest rate developments in the short to medium term and will help ensure that financial conditions adapt to the dynamics of the future. l & # 39; inflation. In addition, by maintaining the easing bias on rates, we indicate that we still have room to reduce rates further, if necessary.

We have also decided to restart net asset purchases at a monthly rate of 20 billion euros from November. These purchases should last as long as necessary to strengthen the accommodating impact of our key rates and end shortly before we start raising the ECB key rates. In addition, we reiterated our intention to continue to fully reinvest the principal of payments made on matured securities under the APP for an extended period following the date on which we begin to raise interest rates and, in any event, as long as necessary. maintain favorable liquidity conditions and a wide margin of monetary maneuver.

Net purchases and the long reinvestment horizon reinforce the accommodating impact of our other measures, further easing the financing costs of businesses and households in the euro area. In addition, these measures reduce long-term interest rates by mitigating the excessive tightening that would otherwise result from reducing the average maturity of our portfolio. Finally, net purchases also testify to our willingness to use all instruments in pursuit of our objective of price stability, which can have a considerable effect on the formation of inflation expectations.

In addition to the policy measures I have just outlined, we have also decided to modify the terms of the new series of targeted longer-term refinancing operations (TLTRO III) announced in June. Banks can now obtain this long-term financing at lower rates and in the longer term. It will also help to ensure that our accommodating policies fully cover the financing costs of households and businesses.

Finally, we have also announced a two-tier system for reserve compensation, in which some of the banks' excess reserves will be exempt from our negative rates. The two-tier system is designed to strike a balance between two outcomes: it seeks to preserve banks' incentives to apply the stimulus generated by the negative interest rate of their reserves, while mitigating the negative effects that these negative rates could have on banks' behavior in lending by affecting their profitability. The euro area needs financial intermediaries to remain engaged and active in monetary transmission, and the new two-tier system will ensure that banks' ability to provide loans to their clients on favorable terms remains intact.

The different elements of this comprehensive package will reinforce each other by supporting favorable financing conditions for businesses and households, which will support investment and consumption. The increase in business and household spending, in turn, will support the dynamics of inflation and ensure their sustainable convergence towards our goal.

Overall, given the outlook and uncertainties we face, monetary policy must remain very accommodative for an extended period. The steps we took at our last meeting underscore our determination and willingness to provide the monetary incentives needed to achieve our goal of price stability. We remain ready to adjust all our instruments if the inflation outlook justifies it.

Looking back, looking to the future: achievements and future direction of the Economic and Monetary Union

Conventional and unconventional measures taken by the ECB over the past decade have reduced deflationary risks, restored the functioning of the monetary policy transmission mechanism and provided vital support to the euro area economy .

But the ECB does not operate in a vacuum and other economic policies also matter. Let me remind you of my first appearance before this committee in 2011. At that time, half of my introductory remarks concerned the functioning of the Economic and Monetary Union (EMU) and the need for other European decision-makers to take action. ;to act.

I will conclude my closing statement by highlighting some of the lessons learned from these eight years, which I hope will help us meet the challenges ahead.

When comparing the reaction of the euro area to the crisis with that of the other advanced economies, it is obvious that the latter were able to achieve a better mix of macroeconomic policy at the time, thanks to decisive in both the fiscal and the financial fields.

The Governing Council reaffirmed our commitment to ensure that inflation achieves our objective in a sustainable manner and that we remain ready to adjust all our instruments. At the same time, a better policy mix, including fiscal policy, structural reforms and prudential measures, can help achieve this goal more quickly and with fewer side effects.

We will continue to monitor, as we have always done, the possible side effects of accommodative monetary conditions. It is essential to remain vigilant and use micro and macroprudential policy tools available as needed. I will tell you more about this at the hearing in my capacity as Chair of the European Systemic Risk Board.

The low-yield environment must be understood in the context of the prolonged decline in real yields seen since the 1980s. And this trend is not unique to the euro area. It largely reflects more structural factors, such as slower productivity growth, which can be reversed through an ambitious structural reform agenda.

In other words, we need a coherent economic strategy in the euro area that complements and strengthens the effectiveness of monetary policy.

This is why the members of the Governing Council unanimously agreed that fiscal policy should make a more decisive contribution. Given weaker economic prospects and continued downside risks, governments with fiscal space that is facing a slowdown should act effectively and expeditiously. When the sustainability of public finances is assured, the potential effectiveness of a countercyclical fiscal policy is enhanced in the current environment, as fiscal multipliers are higher in a low interest rate environment. At the same time, governments in countries with high public debt should pursue prudent policies and achieve the objectives of structural equilibrium.

Another key difference from other advanced currency unions such as the United States is the lack of a central fiscal instrument to act counter-cyclically at the federal level.

I fully recognize the political difficulties related to the construction of such an instrument in the euro area. Similar difficulties also exist when discussing the completion of the banking union and the establishment of a genuine Capital Markets Union.

At the same time, we must remain fully committed to the goal of real economic and monetary union. Ignoring the need to address the latest institutional weaknesses of EMU would seriously undermine what has already been achieved through the commitment and hard work of all involved. As I explained to this committee eight years ago, we must show "a clear trajectory for the future development" of EMU and thus define the "expectations of citizens and financial markets". ".

Let me take a longer-term perspective to draw the last lesson. While the fiscal stance of the euro area was not comparable to that of other advanced economies, the ECB's response was quite comparable to that of other major central banks.

Due to its independence, the ECB has been able to adapt its reaction and reaction function to the policy. Preserving this key asset will enable the ECB to adapt to future circumstances and ensure the effectiveness of its measures. This is all the more important as the opportunity and relevance of the central bank's independence are increasingly challenged around the world.

As I said in my introduction, the best way to preserve the independence of the ECB is to ensure a level of accountability that matches that of the central bank. Over the last eight years, our accountability practices have evolved and intensified to respond to the quest for control that emerged from the crisis.^[2] I have always appreciated the ability of this Parliament to respond to the demands, support and concerns of citizens and channel them constructively in our discussions here. And I would like to personally thank you for that.

I am confident that this Parliament – and this committee in particular – will continue the good work it has done during my term as President of the ECB. This will further enhance the effectiveness of the ECB's actions and citizens' confidence in the EU project.

Thank you for your attention. I am now at your disposal for questions.