At this year’s European Banking Congress in Frankfurt, Bundesbank President Jens Weidmann emphasised that the ECB Governing Council’s communication on its expectations regarding an initial rise in interest rates have proven to be effective. Similar to securities purchases, Weidmann said, forward guidance can contribute to lowering long-term interest rates and thereby to stimulating the economy when standard monetary policy has limited room to manoeuvre. “Forward guidance” is how experts refer to a monetary policy instrument that central banks use to clarify how they would react to economic developments. The Eurosystem issued forward guidance for the first time in July 2013. 

By contrast, Weidmann is sceptical of the proposal that central banks should deviate from their usual behaviour and aim for inflation above their target. Such a policy would mean keeping interest rates low for longer than set out in the reaction function of the Governing Council. Amongst other things, this could aggravate the risks and side effects of a highly expansionary monetary policy. In this way, a highly expansionary monetary policy could “induce investors in search of yield to take on undue risks that could sow the seeds of financial imbalances,” Weidmann warned. He also made reference to the profitability of banks. Low interest rates would place a burden on banks that primarily generate their income from traditional deposit taking and lending operations. Safeguarding the profitability of institutions is not the responsibility of the central bank, he added. In the view of the Bundesbank president, an expansionary monetary policy remains justified. Inflationary pressures in the euro area are still subdued, he said.

Furthermore, Weidmann pointed out that the monetary policy strategy should always evolve in a way that best serves the mandate of the central bank. “I fully agree with Christine Lagarde,” he stated. In her speech, the President of the European Central Bank (ECB) had said that the Eurosystem’s monetary policy would undergo a strategic review. The Bundesbank president added that, in his opinion, such a review must also tackle the question of “how to handle long-term risks to price stability arising from financial imbalances”.

Lagarde calls for public investment

© Martin Lamberts / ECB

At the congress, Christine Lagarde also called on euro area governments to further develop domestic demand. Geopolitical uncertainties and tensions in foreign trade policy have had a negative impact on global trade, she said. In particular, she went on, the tariff conflict between the United States and China is currently putting a massive strain on global economic activity. This, she said, is also impacting on the euro area economy. As the second largest economic area in the world, the euro area must therefore be open to the world and confident in itself, urged Lagarde. Full use must be made of Europe’s potential to unleash higher rates of domestic demand and long-term growth. The fiscal policies of euro area countries play a key role in this context. Lagarde criticised the fact that “public investment in the euro area remains some way below its pre-crisis levels”, adding that “investment is a particularly important part of the response to today’s challenges, because it is both today’s demand and tomorrow’s supply”. According to the ECB president, investment needs are country-specific, but there is a cross-cutting case for investment in a common future that is more productive, more digital and greener. In this way, monetary policy could achieve its goal faster and with fewer side effects if other policies were supporting growth alongside it, said Lagarde.