Dinner speech by Peter Praet, Member of the Executive Board of the ECB, at the SNB Research Conference organised by the Swiss National Bank
Based on my own experience, the overarching challenge that was faced by major central banks in terms of their response to the recent financial crisis can be captured with two insights.
First, when the crisis intensified at a global level, we faced a trade-off we had not seen for a very long time, namely how to prevent the meltdown of the financial system without causing undue harm to the incentive constraints that are of vital importance for the functioning of market-based economies. [...]
Second, while a global meltdown had successfully been prevented, a second type of trade-off emerged, which is typical for balance sheet recessions. What essentially had happened is that banks, emerging painfully from a liquidity crisis, had started to deleverage actively in an attempt to structurally reduce liquidity needs by shedding excess exposures. The deleveraging was an additional downside force contributing to the slump. In this situation, a central banker is again torn between two priorities. [...]In other words, you would like banks to deleverage in an orderly way. At the same time, you face the danger that, at the aggregate level, any type of credit contraction will undermine demand severely, and a deeper contraction will make it difficult or impossible for the central bank to deliver on its price stability mandate. [...]
Euro-area specific remarks
Remark 4: The ECB hit the lower bound later than many other central banks, and when it did it was not the zero lower bound, but a negative lower bound. Similarly, it resorted at a late stage to large-scale asset purchases. [...]
Remark 5: Going forward, the effectiveness of monetary policy will improve with a more complete European Monetary Union.
[...] we need to bring together two different macroeconomic traditions.
A synthesis of these traditions is what we need for the euro area. One can call this “dynamic institutionalism”. Ideally, it should take the optimisation framework of macroeconomics and apply it to institutional design. Such an approach can make an important contribution to charting out the transition to new steady states – as identified, for example, by the Five Presidents’ report. It should do this in a way that respects the unique multinational nature of monetary union and upholds and preserves the mutual responsibility that each nation is expected to have vis-à-vis all the others.