Monetary Policy after the Great Recession “The financial crisis of 2008 and 2009 will leave a lasting imprint on the theory and practice of central banking. With respect to monetary policy, the basic principles of flexible inflation targeting--the commitment to a medium-term inflation objective, the flexibility to address deviations from full employment, and an emphasis on communication and transparency--seem destined to survive. However, following a Vallés Javier much older tradition of central banking, the crisis has forcefully reminded us that the Monetary Policy after responsibility of central banks to protect financial stability is at least as important as the responsibility to use monetary policy effectively in the pursuit of macroeconomic the Great Recession objectives.” Bernanke (2011), The Effects of the Great Recession on Central Bank Doctrine and Practice, speech at the Federal Reserve Bank of Boston 56th Economic Conference, Boston, Massachusetts October 18, 2011 Edited by FUNCAS Javier Vallés C/ Caballero de Gracia, 28 ISBN 978-84-15722-16-8 Madrid, 28013, Spain Recession the Great Monetary Policy after Tel. +34 91 5965481 +34 91 5965718 978-84-15722-16-8 Email: [email protected] www.funcas.ceca.es FUNCAS Social and Economic Studies 1 2014 MONETARY POLICY AFTER THE GREAT RECESSION Edited by Javier Vallés Banco de España FUNCAS Social and Economic Studies Funcas Madrid, Spain FUNDACIÓN DE LAS CAJAS DE AHORROS PATRONATO ISIDRO FAINÉ CASAS JOSÉ MARÍA MÉNDEZ ÁLVAREZ-CEDRÓN FERNANDO CONLLEDO LANTERO MARIO FERNÁNDEZ PELAZ AMADO FRANCO LAHOZ MANUEL MENÉNDEZ MENÉNDEZ PEDRO ANTONIO MERINO GARCÍA ANTONIO PULIDO GUTIÉRREZ VicTORIO VALLE SÁNCHEZ DIRECTOR GENERAL CARLOS OCAÑÁ PÉREZ DE TUDELA Printed in Spain Edit: FUNDACIÓN DE LAS CAJAS DE AHORROS (FUNCAS) Caballero de Gracia, 28, 28013 - Madrid (Spain) © FUNDACIÓN DE LAS CAJAS DE AHORROS (FUNCAS) All rights are reserved. The total or partial reproduction of any of its contents in any mechanical or digital medium is totally prohibited without the written consent of the owner. ISBN: 978-84-15722-16-8 ISBN: 978-84-15722-17-5 Depósito legal: M-17240-2014 Prints: Cecabank II Contents List of Contributors V Introduction and overview 1 PART I THE “NEW” MONETARY POLICIES IN THE ADVANCED ECONOMIES Ensuring the transmission of the policy signal: A review of the ECB’s monetary policy from 2007 to 2013 9 Peter Praet, Philippine Cour-Thimann and Florian Heider UK property market: Experience, risks and policy response 33 Jon Cunliffe, James Benford, Oliver Burrows and Tracey Wheeler Monetary policy after the Great Recession: Japan’s experience 73 Kazuo Momma and Shuji Kobayakawa An overview of recent changes in the Federal Reserve’s monetary policy 101 J. David López-Salido PART II SIMILARITIES AND DIFFERENCES AMONG THE POLICIES OF THE FOUR BIG CENTRAL BANKS The challenges for monetary policy in advanced economies after the Great Recession 135 Juan Carlos Berganza, Ignacio Hernando and Javier Vallés Unconventional monetary policies – recent experiences, impact, and lessons 181 Ángel Ubide III Contents PART III BALANCE OF RISKS AND THE INTERACTIONS WITH OTHER POLICIES Post-crisis monetary policy: Balance of risks 217 Jaime Caruana, Andrew Filardo and Boris Hofmann Macroprudential policy after the financial crisis 245 José María Roldán Monetary policy in emerging countries, international spillovers, and international monetary cooperation 259 Sonsoles Gallego and Pilar L’hotellerie-Fallois PART IV OPEN QUESTIONS IN THE EURO AREA Virtual unconventional policies. The euro area recovery and the role of ECB policy 291 Huw Pill Addressing weak inflation: The ECB’s shopping list 305 Gregory Claeys, Zsolt Darvas, Silvia Merler and Guntram B. Wolff IV Contributors James Benford Bank of England London, UK Juan Carlos Berganza Banco de España Madrid, Spain Oliver Burrows Bank of England London, UK Jaime Caruana Bank for International Settlements Basel, Switzerland Gregory Claeys Bruegel Brussels, Belgium Philippine Cour-Thimann European Central Bank Frankfurt, Germany Jon Cunliffe Bank of England London, UK Zsolt Darvas Bruegel Brussels, Belgium Andrew Filardo Bank for International Settlements Basel, Switzerland Sonsoles Gallego Banco de España Madrid, Spain V Contributors Florian Heider European Central Bank Frankfurt, Germany Ignacio Hernando Banco de España Madrid, Spain Boris Hofmann Bank for International Settlements Basel, Switzerland Shuji Kobayakawa Bank of Japan Tokio, Japan Pilar L’hotellerie Banco de España Madrid, Spain David López-Salido Federal Reserve Board Washington, D.C., USA Silvia Merler Bruegel Brussels, Belgium Kazuo Momma Bank of Japan Tokio, Japan Huw Pill Goldman Sachs New York, USA Peter Praet European Central Bank Frankfurt, Germany VI Contributors José María Roldán Spanish Banking Association Madrid, Spain Ángel Ubide Peterson Institute for International Economics Washington, D.C., USA Javier Vallés Banco de España Madrid, Spain Tracey Wheeler Bank of England London, UK Guntram B. Wolff Bruegel Brussels, Belgium VII Introduction and overview In mid-2014, more than six years after the onset of the Great Recession, the economy of advanced countries is strengthening. While in many of them the problems arising from the crisis endure (high public and private debt, high unemployment, banking system restructuring, significant idle capacity), the process of normalization has begun after a long period of exceptional monetary measures. Thus, in 2014, the Federal Reserve began to reduce asset purchases and in both the US and the UK the date the markets expect the official interest rates to rise moved up. For this reason, this is a good time to assess the role monetary policy played in the wake of the financial collapse of 2007–2008 and reflect on the challenges to be confronted in the future. Recall that the predominant paradigm before of the crisis (due to the period of Great Moderation in the previous two decades) was that monetary policy should remain passive in the face of the formation of bubbles and financial imbalances and that a liquidity trap was seen as more of a theoretical possibility than a real risk. However, in order to stabilize the financial system, especially after the Lehman collapse, central banks of major developed economies exercised their role as lenders of last resort, generating extraordinary liquidity and lowering the official interest rates to near zero in the first half of 2009. At that time, the so–called unconventional policy measures were launched in order to restore the monetary transmission mechanism, improve access to financing, and support recovery depending on the objectives and institutional idiosyncrasies of each central bank. Currently, due to differences in the recovery path of activity and the restructuring of the financial system, some countries, such as the US, are studying the most appropriate exit strategy to standardize the size and composition of the central banks’ balance sheets, and others, such as those in the euro zone, suggest intensifying expansionary monetary policy. In any case, the central banks of developed economies had to counterbalance any benefits of keeping interest rates low longer to avoid falling into a state of secular stagnation with the risks to macroeconomic and financial stability associated with prolonged expansionary monetary policy. In this context, it is crucial that other policies play a more active role in carrying out the necessary structural reforms and repairing the balance sheets of companies, families, and governments. Looking ahead, it seems clear that the arsenal of extraordinary measures after the crisis will teach lasting lessons on how to improve the performance of central banks, and it is possible that some of them could even become part of the regular set of instruments in “normal” times. Introduction and overview Shedding light on these questions is the purpose of this book edited by Funcas. The person who designed the contents and has driven the coordination amongst the contributing authors is Javier Vallés of the Banco de España. No doubt his knowledge of the subject and experience in these matters has been instrumental in presenting a recapitulation of top international authors in this issue. It is for these reasons that Funcas must express its appreciation for his coordination and supervision. This work has constantly benefited from his dedication and deep understanding of the matter, and, more importantly, his enthusiasm, which Funcas shares, for offering the reader a broad overview of the monetary policy pursued during the crisis and the challenges that come with nascent economic recovery. The contents are divided into four sections. The first four contributions in the introductory section describe the most relevant aspects of recent policies in the major central banks in advanced economies: the European Central Bank, the Bank of England, the Bank of Japan, and the Federal Reserve System. The particularity of this section is that all the authors have some responsibility in monetary policy implementation of their corresponding banks. The second set of articles compares the similarities and differences between the extraordinary measures undertaken by these banks and attempts to draw conclusions about the future of monetary policy. The third section presents the risks of maintaining the current expansionary monetary policy, analyzes spillovers on emerging economies, and discusses the relevance of macroprudential policy after the crisis. The final section focuses on the peculiarities of