ECB: The new normal for the monetary policy – ABN AMRO

Nick Kounis, Head of Financial Markets Research at ABN AMRO, explains that the ECB Chief Economist Peter Praet gave a speech yesterday (17 Oct) in Madrid and argued that ‘population ageing has contributed to a decline in the labour supply, a slowdown in productivity growth, and higher precautionary savings, thereby exerting downward pressure on potential growth and the so-called equilibrium real rate of interest’.

Key Quotes

“He also asserted that ‘demographic factors (are) expected to continue to exert downward pressure on real rates’. This would have two consequences for monetary policy according to Mr Praet. First, that ‘any given policy rate is less stimulatory with lower equilibrium rates’.”

“Second, ‘the policy rate is likely to hit the lower bound much more frequently than thought possible in the past’. This may mean that ‘recessions may last longer, and recoveries may be slower and shallower, with a higher risk throughout of missing the (price stability) objective’. He discusses various options to make monetary policy more effective in this environment, including raising inflation targets and price-level targeting.”

“In our view, a low (real) neutral interest rate (or r*) makes the case for a slower pace of interest rate increases when monetary policy normalisation starts.”

“Almost all estimates suggest it has fallen to very low levels over recent years.”

“So although current levels of short-term interest rates are for sure accommodative and will eventually need to rise, they may not need to climb as far as is sometimes assumed by just looking at history.”