Aug 17, 2020

Vincent Grossmann-Wirth on the European Central Bank in a Post-COVID Economy

The ECB recognized the severity of the COVID crisis early on, and they have responded quickly and aggressively.
David Beckworth Senior Research Fellow , Vincent Grossmann-Wirth

Hosted by David Beckworth of the Mercatus Center, Macro Musings is a new podcast which pulls back the curtain on the important macroeconomic issues of the past, present, and future.

Vincent Grossmann-Wirth is the Deputy Head of Monetary Policy Implementation Division at the Banque de France. Vincent joins Macro Musings to discuss the European Central Bank’s response to the COVID-19 crisis and what may lie ahead for the central bank. Specifically, Vincent and David discuss how the ECB’s structure and operating system compares to the US Federal Reserve System, the various dimensions of the ECB’s response to COVID-19, and what the ECB’s review of its operating framework portends for the future of monetary policy.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to macromusings@mercatus.gmu.edu.

David Beckworth: Vincent, welcome to the show.

Vincent Grossmann-Wirth: Thank you. Hi David. Thanks for having me.

Beckworth: Well it's good to have you on. Now, technically Vincent, this is your second time on the show, even though your first time hasn't aired and I owe you a big apology. And you've been very gracious with me as a host. But you are one of those unfortunate souls who did a podcast with me right before COVID-19 broke out, and news cycle moves fast and basically your show got stuck in the pipeline. And I owe you big time, so we're making it up for that previous one. And we'll cover some of the same topics, but I appreciate you coming on for a second time, Vincent.

Grossmann-Wirth: Oh, thank you, no problem at all.

Beckworth: Yeah, and we have gotten to know each other because you listen to the show. We corresponded on email, on Twitter, and you do interesting work on the operations side of central banking. And we had one of your former colleagues, maybe he's still a current colleague, but Ulrich Bindseil on the show, who also works with the ECB in terms of operations and implementation of monetary policy, the monetary plumbing side, all those technical details. So you've got a very interesting job there at the ECB. And many of my listeners of course are focused on the US side of central banking, but we have a lot of international listeners as well, so it's good to get you on, kind of broaden our perspective, our scope. And today we'll do that by talking about the European Central Bank.

Beckworth: Before we get into that though, tell us about your career path. How did you get into central banking and end up at the French National Bank?

Grossmann-Wirth: First, thank you David for the introduction. I'm very glad to be on the show. So well, I started the macroeconomics training, I graduated in macro in Grenoble in the south east of France to what they now call Grenoble Alpes University, so in the Alps which has skiing which is also nice in this region. I really enjoyed studying macro there. The teaching actually was quite open with several kinds of approaches in Post-Keynesian and international economy courses. So that was a nice thing there to study and getting to know economic approaches. And in 2007, I had the chance to take a job at the French Embassy in DC, which was before the GFC, and so for two years I did some reporting for the Treasury and on the US policy responses to the crisis. And after that, I got a job back in France, in Paris, at the French Treasury where I did international forecasts, European affairs, and after a few years, I moved to Banque de France, it was in 2015. And eventually, in 2017, so three years ago, I started to work more on monetary policy implementation and to dig a bit deeper into the details of central banking variation.

Beckworth: Very interesting. I didn't realize you got to do a lot of skiing while you studies macro in college, that's awesome. So you were in the Alps skiing and thinking of macroeconomic theories as you went down the slopes, huh?

Grossmann-Wirth: Exactly.

Basics of the ECB

Beckworth: Yeah. Now let's talk about the ECB, because you're at the French National Bank, so it's one of the 19 member banks of the ECB. And I want to go through the structure of it with you, and then ultimately talk about where you are. But my understanding is there's three key parts to the EBC, and that's maybe a simplification on my side, but you can think of the Executive Board, the Governing Council, and then the 19 member banks. So the Executive Board is made up of members that would be equivalent to the Board of Governors at the Federal Reserve System, is that fair?

Grossmann-Wirth: Yes, I would say it's quite fair. The main decision-making body of the ECB and the whole Euro system, because it's a bit misleading but sometimes we use the term ECB for everything and sometimes we use it just to designate the institution in Frankfurt. But for the whole ECB, the main decision-making body is the Governing Council, which includes the members of the Executive Board and also the governors or presidents of each national central bank, each NCB, so that's the main decision-making body. And then the Executive board is also a decision-making body, but for more implementation-side of things and also of course the induction of decisions. But otherwise, the governors and the presidents of the national central banks, take part to the main decisions when meeting in Frankfurt, or right now, of course it has been the case for a while, by telecom.

Beckworth: Okay. So just for comparison's sake, the Executive Board is like the Board of Governors. So Christine Lagarde is at the Executive Board, Jay Powell is at the Board of Governors. You have a governing council, which is all the members of central banks, plus the Executive board members, and they vote on monetary policy. And in the US-

Grossmann-Wirth: Mm-hmm (affirmative).

Beckworth: ... we have the Federal Open Mark Committee, the FOMC, which is all the regional, well some of the regional Federal Reserve banks, plus the governors, and they vote. So that's the equivalent, I think. And then the member banks, so you got 19 at the ECB and we've got 12 here in the United States. So there's some similarities there, is that fair?

Grossmann-Wirth: Yes, yes indeed, yes.

Beckworth: Okay.

Grossmann-Wirth: Yes indeed, there are similarities. And it's also because in the euro area, it's very much organized in a federal fashion, as far a monetary policy is concerned. It's the case more than for all other dimensions, such as fiscal policing, which has remained for now because it was moving to but it has remained for now, more at the national level. There are some rules and procedures at the European level, but it's a bit less federalized, in some ways. So, if you look at monetary policy, actually there are many similarities between the two systems, yeah.

Beckworth: Yeah. Now that's useful framework, I think, for people that aren't familiar with the ECB, as to just kind of map it alongside the Federal Reserve System, but there are differences as well. And I want to start with one that's related to your line of work, and that is the actual implementation of monetary policy. So I mentioned earlier, we had Ulrich Bindseil on the show, and he was the head of market operations/monetary policy implementation, for the ECB as a whole. So for me, my initial thought is so he's like someone at the New York Federal Reserve Bank. But what he said on the show is it's not quite like that, because a lot of the implementation is done at the member bank. So for you, for example, so maybe talk us through that. How is implementation maybe a little bit different than at the Federal Reserve System?

Grossmann-Wirth: Yeah, I think it's what Ulrich has told you, which I wouldn't disagree with anyway. It's true that for the monetary policy implementation side, I think it's more decentralized in the Eurosystem. For the Fed, you know that better than I do, but the New York Fed is tasked with controlling and conducting monetary policy operations. So it's not in DC or in New York, but still, [in the US Fed system] there is one bank taking this common control, while in the euro area, these variations are more decentralized across the 19 national central banks, and the ECB also. But if you look, for example, at the Eurosystem balance sheet, so you see that the ECB account for a small share of it, it has moved now but like 500 billion I guess out of five trillion or something, so it's maybe not the precise numbers, but the other magnitude to this one.

[In the US Fed system] there is one bank taking this common control, while in the euro area, these variations are more decentralized across the 19 national central banks.

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Grossmann-Wirth: And the biggest national central banks, like the Bundesbank, Banque de France, Bank of Italy, and so on, their account's more than the ECB in the total balance sheet account. So this is consistent with the federal setup I just described, but yeah you're right that it's a bit more decentralized, I would say in the US. And then of course the decisions are quite centralized at the ECB level, even if all national central banks are involved in the decisions, but there is some level of centralization of course at the ECB level, so that we ensure everything is consistent across the euro area.

Beckworth: Yeah that makes a lot of sense when you think about the differences among the two economic regions. So we have one financial market, one US market here, so it makes sense that there's one central bank implementing it at the heartbeat of the US financial system-

Grossmann-Wirth: Yes, mm-hmm (affirmative).

Beckworth: ... in New York. But in Europe, you mean there's multiple financial markets, there's one in each country. So the German central bank has to interact with markets in its country, you have to interact in France, so it makes sense that implementation would more decentralized, given the different way the system is set up.

Grossmann-Wirth: Yeah exactly, and yeah it's also easier for us, Banque de France, to know our monetary policy counterparties better and to exchange with them and to provide equity and so on. I guess it's a bit easier than if it was done at the ECB level. Then again, the ECB is also doing monetary policy implementation, but more on the Asset Purchases Program as primary goal. That kind of thing. Of course, all the money sharing also is very strong at the ECB level, but for credit operation, for example, creditor management, it's very much in the national central bank.

Beckworth: Okay. So we hear a lot about the appointment of the head of the ECB, so Christine Lagarde, that was in the news, you know a lot of discussion of who's it going to be. And she gets the position, and there's politics in all these decisions that are made. But one thing that I haven't heard much about, and I'd love to hear from you, is how are the presidents or the heads of the national central banks appointed? So how is your boss at the Banque de France or the Bundesbank, how do they get appointed in each country locally?

Grossmann-Wirth: Yeah, they are usually appointed by the executive branch in each jurisdiction. It is a least the case in France where the governor is appointed for six years by a presidential executive order. Then you also have an opinion and base of power by the financial committees of both chambers of Parliament, so the Parliament is also involved of course. But yeah, the appointment is more on the executive branch side. And on the ECB side, so it's an eight year, nonrenewable term, and the decision is taken by a qualified majority vote of the European Council, so the body which is composed of head of states at the European level. So yeah, I'm not sure it's very different, European from the US process. There are some differences, of course, but I guess it's not too different.

Beckworth: Yes, there are a lot of similarities, as you mentioned. I would note, probably the biggest one in what you just described is the appointment of the member bank president. So where you are, it's done through the executive, who is elected to office. So indirectly, they're accountable, right? There's democracy, there's accountability, people get elected. If they don't like who they appointed to the national bank, maybe other reasons, they might choose to elect someone else. Where, in the United States, the regional bank presidents are actually chosen from the boards of those regional banks, with approval from the Federal Reserve System. And there's been some criticism here in the United States about that appointment process. So for example, how did John Williams end up at the New York Fed? How did Neel Kashkari end up at the Minneapolis Federal Reserve Bank? So there is some discussion about how we get our presidents appointed at the regional banks, where it sounds like, in Europe, it's a much more transparent process, done through elected officials, and therefore a little more accountability, a little more transparency. So that might be one big difference, but there is a lot of similarities overall, as you mentioned.

Beckworth: Let's move on though, and let's talk about the ECB in general here and what's been going on. So maybe walk us through what has the ECB done during this crisis? I mean walk us through what you think are the important developments and steps it has taken. You've recently written a blog post that we will link to, where you outline some of the steps. It's really informative, but maybe you could walk us through them?

Grossmann-Wirth: Yeah I think, I won't go into the details of each single measure but what is interesting maybe, especially for US listeners, is the type of operations which has been decided on. So yeah, we deployed quite quickly, I think, significant measures to support the provision of financing to the economy. And in the euro area, as you know, the banking system is quite important for the financing of the economy, so that can be one big difference with the US, where banks are of course important, but you also have a big place for market financing.

Beckworth: Yeah.

Grossmann-Wirth: A bit more than in Europe. And so that's while also our measures, and reforms really, ensures the credit operations, which have been adjusted and expanded. And also collateral-easing measures, which have been introduced also to ease the financing of the banking system. And then of course, one of the most known type of measures, which is the purchase of securities, especially sovereign but not only. So these are three main type of measures, and so yeah I can go a bit into the details.

Beckworth: Yeah, why don't you walk me through each one.

ECB's Credit Operations 

Grossmann-Wirth: So, the first type of measures, so of course it's kind of theoretical distinction because the first two interlinked quite closely but it's easier to distinguish them. So the first type of measures, the credit operations, we started by significantly easing our TLTROs. And so that's something which is quite important in Europe and in the euro area. We have this operation which are long-term, three-year operation with variable pricing, and this is an important tool for us to provide equity to banks. And on March 12th, and then again on April 30th, the ECB announced that it was further easing the conditions of this operation. So what we did is we introduced a special period, running from June 2020 to June 2021, during which the rates on the operation are reduced to 50 basis points below the difference, so this is right now, minus 1%. So banks can take equity for three years and, on this special period, at minus 1%. So this is a very aggressive policy indeed, and so that's one of the main measures we took on this side of the operations.

What we did is we introduced a special period, running from June 2020 to June 2021, during which the rates on the operation are reduced to 50 basis points below the difference, so this is right now, minus 1%.

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Grossmann-Wirth: But we also launched a number of new operations. The bridge LTROs we announced on March 12th also, where a series of 13 additional longer-term refinancing operations with a weekly standard procedures seek trade with [inaudible], and at the deposit facility rate, so minus 50 basis points. And so all these operations measures end on June 24th, 2020, but the purpose was to provide liquidity support and bridge to carry us into the new scheduled operations were launched with the relaxed requirements. So we announced the TLTROs, the targeted long-term operations, at the same time as we decided on an operation to bridge until they were launched.

Grossmann-Wirth: Then we also introduced new dollar operations, so this was also mid-March, and it was coordinated with other big central banks and was also very important on the dollar side of things to ensure that the tension would ease, essentially. And one important element, which was implemented in recent, I think ECB building, was that the frequency of the seven-day operation, which was increased to daily on March 20th, was also very important. So we had these operations essentially every day to be sure the tensions on dollar equity was announced.

Beckworth: Well, Vincent, let me ask you a question on that.

Grossmann-Wirth: Okay.

Beckworth: ... you're talking about dollar swap lines here, right?

Grossmann-Wirth: Mm-hmm (affirmative), yes.

Beckworth: So you actually implemented them at the level where you are, at the French National Bank? The ECB didn't, you actually operationalized the dollar swap lines from the Federal Reserve, is that correct?

Grossmann-Wirth: Actually, that is decided at the ECB level, the whole Eurosystem, and then it was implemented at the national central bank level. So we have this dollar facility, which we implement at Banque de France that policy trust members working on this-

Beckworth: Yep. Okay.

Grossmann-Wirth: ... and so they did it, but we were also involved in the discussion, which conducted to this decision of course. But this was decided for the whole Eurosystem.

Beckworth: So the ECB decides they're going to be a part of the dollar swap line, but then you and your office, you actually implement it. And then, depending on how much demand there is for it in Paris and Germany and other parts of the Eurozone, that determines the actual total size that's used, is that fair?

Grossmann-Wirth: Exactly, yes.

Beckworth: Okay. All right, and let me ask you another question about another facility you just mentioned, but I believe you were talking about the targeted longer-term refinancing operations, the TLTROs? Yeah, so just for our listeners, that TLTROs, T-L-T-R-O-S, stands for the targeted longer-term refinancing operations. They've been popular for people like me and other people who closely follow central banking, because they appear to be a very powerful way to provide stimulus to economy through central bank, even when you get very low rates. Because you're supercharging, you're letting the banks take at a negative rate, but the condition is they have to lend to the real economy, is that right?

Grossmann-Wirth: Yes, it is conditional to a rate approach of their eligible portfolio flow, yeah.

Beckworth: Yeah and the argument is you're letting the banks borrow at a rate lower than the other rates, it's really kind of supercharging the incentive for banks to take these things out, and then they can loan the funds to the real economy and hopefully it's a win-win for everyone. Banks aren't harmed by negative rates because their getting a great deal, and then the real economy is getting extra funding, so it's a great deal for them. And that hasn't been tried in the US yet, but that's at least the argument, is that right?

Grossmann-Wirth: Yes, yes, I agree. Being more on the Post-Keynesian side of the theoretical debate, I still wouldn't say that the terms are taken by the banks and then used to be lent, because they don't need the talk of equity to lend without previously having help.

Beckworth: Yeah, fair point. It's a signal.

Grossmann-Wirth: But still it is an incentive and it is also a decrease of the pricing of the liabilities to them, so it's an incentive for them to lend. And so yeah, we think it has been and still is very successful.

Beckworth: Yeah, so I know where you're coming from, as you said you're Post-Keynesian so you like to view this from the other side. The demand for loans would be met by this facility versus pushing the loans out the other way around.

Grossmann-Wirth: Yeah.

Beckworth: But another of looking at it, maybe from a more finance perspective is, you're preserving the spreads for banks, you're preserving net interest margins for banks-

Grossmann-Wirth: Exactly, yeah.

Beckworth: ... by offering this really low... so another way of saying this, given that there is demand for some kind of funding from banking, why not do it in a way that keeps banks profitable even in a negative interest rate environment?

Grossmann-Wirth: Yeah, exactly, exactly. And it's also why, I don't know if you wanted to talk about this or not, but before COVID-19 we introduced a measure which is called the tiering system, which is also useful to be sure that the excess equity, which is charged actually to banks at minus 50% now, doesn't have too much of an impact on net interest margin. So it's also important for the conduct monetary policy, for the transmission to the real economy, we don't have a negative impact.

Beckworth: Yeah.

Grossmann-Wirth: There are also other problems related to the business model of things and to the situation of the banking system, but yeah the monetary policy side, we want to be accommodative and be sure that the transmission of monetary policy is fully effective.

Beckworth: Yeah, and as you mentioned, banking is so much more important in Europe than the United States. We rely more on market finance bonds and other securitization more, where you truly rely on more bank intermediation, so it is a big deal. All right so let's go into your second area, I believe it was collateral, and I know it was closely tied to what we've been talking about.

ECB's Collateral Framework

Grossmann-Wirth: Yeah, exactly. So to take liquidity at the central bank, so it's the case in euro area, it's also the case in the US, you need this kind of refinancing operation, or repo is a bit less used but nonetheless. And so you have to put this collateral in exchange for liquidity, and we have to be sure that the first banks would have enough of collateral to take out new liquidity provided by the new measures. And we also have to make sure that the conditions were eased also on the collateral side. To summarize, what we did is we enlarged the scope of eligible credit banks. So the credit banks are just the bank loans that we accept as collateral. We can accept marketable assets, but we can also accept bank loans, so non-marketable. And so we enlarged it to include especially the government-guaranteed loans to corporate, so there have been many decision by the governments of the euro area to provide guarantees for loans and the decision to make sure that these loans would be eligible to operations.

We have to be sure that the first banks would have enough of collateral to take out new liquidity provided by the new measures. And we also have to make sure that the conditions were eased also on the collateral side. To summarize, what we did is we enlarged the scope of eligible credit banks.

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Grossmann-Wirth: Then we also introduced a series of other temporary measures, so I won't list everything, but we made that even smaller-sized credit claims were accepted. We also eased some of the limitations we had on some insecure debt instruments. And then the third type of collateral-easing measures is 20% regional reduction to collateral evaluation haircuts that we decided, 20% and then an additional 20% on credit claims. So the idea again was to make sure that the collateral was available and that the condition were eased in this difficult period for everybody from the corporate to the counterparties and all that.

Beckworth: Yeah.

Grossmann-Wirth: So that, yeah.

Beckworth: Well let's talk about your third area there, how you've responded to COVID and that's the asset purchases, and this has probably been the more controversial one, but tell us what the ECB has done so far.

ECB's Asset Purchases 

Grossmann-Wirth: Yeah so what we did, in a nutshell, is to increase the amount of asset purchases, and also we increased the flexibility of this purchase. First, it was 750 billion pandemic emergency purchase program, or PEPP, which was launched on March 18th, after first PEPP which I will keep here for the interest of time. And then the envelope was increased by 600 billion to 1350 billion on June 4th. And the horizon for the net purchases was also extended to end June 2021. So the amount was increased, the horizon was also increased, and maybe more importantly or as importantly we decided to conduct this asset purchasing in a flexible manner. So that means over time, across asset classes and also amongst jurisdictions. And this can be adjusted at any time. So I guess that's also the part you were referring to.

What we did, in a nutshell, is to increase the amount of asset purchases, and also we increased the flexibility of this purchase.

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Grossmann-Wirth: It's true that this had a very big impact on the market and it's, in a way, designed to ensure the transmission of monetary policy, but also to ensure that there is no fragmentation, financial fragmentation, in the euro area. And behind financial fragmentation of course you also have tension on the sovereign market which started to be a problem for the ECB and Eurosystem. And so this was also the way to make sure that there was no such financial fragmentation, that we also encountered in our history this before and we didn't want it to come back.

Beckworth: Yes and the ECB's been very aggressive. And if I'm looking at the numbers right, and I might be wrong here, but I'm looking at a chart that says the ECB's total asset as a percent of the Eurozone GDP started out about 40%, so 40% of GDP on the balance sheets of the ECB, and it's grown near 60%. The Federal Reserve similarly has grown quite a bit too, it's grown from in the 20s to the 30s. So I mean a lot of the central banks have rapidly expanded their balance sheets. But the ECB, at least in my view, was much quicker and more aggressive than it has been in the past, and maybe that's from the lessons learned, from more willingness to take things aggressive because it's a very serious crisis. But is that fair for me to say the ECB has been much more aggressive this time around than previous asset purchases?

Grossmann-Wirth: Yeah, I mean yeah it's true that it was very quick, I think it was very obvious, well not obvious but quite clear from the beginning that this was a major crisis. I think Christine Lagarde acted quite clearly, and so there was no doubt on the needs to act very swiftly. And then maybe also there is some learning by doing, you know?

Beckworth: Yep.

Grossmann-Wirth: On the assets purchase, we knew that we had to be very convincing, so what was done was very common thing, and it ensured that there was no market fragmentation and no tension related to this. So yeah no, I would agree that this time was quite quick.

Beckworth: Yeah. Let me switch gears here and talk now about the framework or maybe the mandate for the European Central Bank, and where it is and where it might be going forward. So in the United States, the Federal Reserve is doing a review of its policies, of its framework. The Fed has a dual mandate, but it implements it through an inflation-targeting regime. And they're reviewing that, as well as some other features of its framework. And we supposedly will hear very soon about that, and who knows maybe by the time the show comes out, they will have announced it. But we're supposedly hearing by the end of the year what they have concluded from this. And right before the crisis started, in fact we talked about this last time we recorded this, the ECB had just began its review of its policies, too, its framework. So maybe walk us through that. What is the ECB's current framework? What is it targeting? What is it aiming to do? And then how might that change? What are some of the things discussed at least by officials of what could change, if anything?

ECB's Mandate: Present and Future

Grossmann-Wirth: Yes, so yeah as you know the main primary objective of what we call the ESTB, but the ECB, is to maintain price stability, so that's quite clear. So that's why we often say that there is very important difference from the European side with its single objective mandate, and the US side with its dual objective. Actually when you look at the Treaty, you also have mentioned that without prejudice to this objective, the ECB shall support the general economic policies in the Union. So there are also some openings in the Treaty, but basically the primary objective is to maintain price stability. And yeah, when you say if it could change and you mention the review that we launched. So on the review.

Grossmann-Wirth: The review was announced, as you mentioned, so it was in January, but then there was the COVID crisis of course, and so the conclusion of the strategy review has now been postponed. It was initially in 2020 and it's now mid-2021, due to the Coronavirus pandemic. So that's on the timing. And on the topic which will be discussed. So of course the inflation target will be discussed in the modalities. The extensive formulation of price stability, the question of symmetrics will be discussed, or the type of target, I don't know. But we have to still have as a given which is the Treaty. We are not changing the Treaty.

Beckworth: Okay.

Grossmann-Wirth: So the primary objective of price stability will stay there.

Beckworth: So nominal GDP targeting is out of the question. There's no hope for that, huh?

Grossmann-Wirth: I mean it'd have to be, I don't remember the exact words of Christine Lagarde, but the idea was to have a very open decision, both on the type of topics and also to all stakeholders with meetings and concerns.

Beckworth: Yeah.

Grossmann-Wirth: So I won't excuse that nominal GDP targeting will be in the list. It could be interesting to discuss all kind of new ideas. But yeah, with this field, it's constrained on the price stability objective of course.

Beckworth: Yeah I mean it's easier to talk about in the United States because the Federal Reserve has a dual mandate, and nominal GDP targeting is easier to fit into that than a single mandate of price stability.

Grossmann-Wirth: Mm-hmm (affirmative), yeah. Exactly.

Beckworth: I mean if anyone at the ECB is listening right now and wants to find a way to sneak in nominal GDP targeting, I would say the one way you could argue it that a nominal GDP target is similar to a labor income or wage target. So that if you define price stability as wage stability and some kind of aggregate measure, then you could maybe sneak it in the back door. But I hear you, it's going to be difficult to make that fit into that framework. So the discussion then is really about what does price stability mean? Does it mean what it has in the past, which I think officially the statement was "close to but not 2%"? So I imagine the discussion is, "Do we tweak that? Do we allow for average inflation? Do we have symmetric inflation?" I mean let ask this question, would a price level target be something they would consider, or would that be too radical you think?

Grossmann-Wirth: The price stability mandate hasn't explicitly mentioned away targeting, so it could be a possible decision. I'm not saying at all that it could be an avenue which will be considered seriously, but at least it's more in the package.

Beckworth: It's more likely than nominal GDP targeting, but I mean price level targeting is really inflation targeting with make-up policy added to it. So I guess... I know you can't say a whole lot and you got to be careful what you say, but is make-up policy even an item on the table? Are they going to discuss that, or they just really kind of tweaking what price stability means on the margins?

Grossmann-Wirth: No again, I think the decision [about the ECB’s mandate review] will be very open. The idea is really to have a wide-ranging discussion on all kind of topics. It also will include other kind of considerations, like the impact of globalization, on prices, and on inflation, but also on activity. It's willing to [inaudible]. There will be… I mean if you go on the ECB website and you look at the reason for this strategy review, you also have a mention of the historically low interest rates and why it is like that and the limits to it and the instruments which could be used in this context. And of course there is this climate change aspect of things, which is quite different, which will also be very important.

I think the decision [about the ECB’s mandate review] will be very open. The idea is really to have a wide-ranging discussion on all kind of topics. It also will include other kind of considerations, like the impact of globalization, on prices, and on inflation, but also on activity.

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Grossmann-Wirth: But just to come back to your question, it's not that it won't be discussed at all. Even GDP targeting could be discussed and considered and looked at it, and in the context of the changes, in the way prices are disseminated, the way we understand prices, the way there is a link between the business cycle, properization, declining share of the wage in certain incomes, things like that. So there are many avenues to be considered. I was just mentioning in the beginning that we are not changing the Treaty, so it's not in our image to change the Treaty. So that's why I was putting in this caveat, but many things can be discussed. And you know a change in the Treaty is also not something which is totally excluded. So one day it could be the case, but now it's not in our horizon of time, for this review anyway.

Beckworth: Yeah, it's something that the ECB can do itself without getting a change in the Treaty, that's a more likely option. So okay, well that's interesting and we'll be watching. And the deadline, or the final date, is next year summer time or you said June, was it June next year?

Grossmann-Wirth: Yeah, it's mid-2021.

Beckworth: Mid-2021, okay. So we got about another year to go or so, and then we'll get an update. So we'll see what the Fed has to say by the end of this year, we got the ECB next year, and I don't know if you saw, Vincent, but about a month ago, there was a lot of chatter in the United Kingdom about nominal GDP target over there. Now I don't know if that means anything. But the finance ministry there, which actually sets the target or helps determine the target for the Bank of England, they're a little less independent, was seriously looking at a nominal GDP targeting, and I was very thrilled to hear that. And my-

Grossmann-Wirth: Yeah, yeah, but in England and Canada also there have been this situation quite a strong way for a while, I think.

Beckworth: Yeah, well I'll say this: I was sitting with a former Bank of Canada official that will remain unnamed and he told me they were very close, that one of their past reviews to actually adopting nominal GDP targeting, a lot of the people were on board, but a few top officials kind of axed it at the last minute. But yeah, they've looked at it and they've come very close to adopting it. But I think really what we would need to see is a Bank of Canada, maybe New Zealand central bank, Bank of England even better, if they would take the first step. If you see a smaller economy try it first, it works well for them, kind of like inflation targeting. Inflation targeting was first tried in New Zealand and Great Britain, Canada, they kind of were the avant-gardes, the leaders, they kind of showed the way. I think the same thing probably would be true with nominal GDP targeting. But we're getting off-track here because that's David Beckworth's soapbox, not the realities on the ground of the ECB.

Grossmann-Wirth: That's fine.

Beckworth: So let's go back to what actually is happening there and what you're actually doing. Now the reason I had you on the show, back in January, we did a recording back in January or February, before the COVID crisis kicked in, is because you did an interesting article where you looked at operating systems. So you looked at a floor system, you looked at a corridor system, and you mentioned earlier that there's a tier system that's kind of a hybrid between a floor and a corridor system. And why don't you tell us about what you found and maybe where do you think this conversation will go? Now I know this crisis has postponed this conversation probably for many years, because we got big, big balance sheets across the world in advanced economies, but I'd be still curious to hear your thoughts on this issue, number one, and then maybe number two where do you see this conversation going once it does start happening again, however long it may be in the future?

Comparing Monetary Policy Frameworks

Grossmann-Wirth: Yeah so, what I did at the time was to compare the Fed and the Eurosystem monetary policy operational frameworks, both before and after the crisis. So, at the time, global financial crisis that would be basis of course. So what I tried to do is presenting a framework of the congressional framework, in a way try to look at the different perspectives on the frameworks. And so I looked in particular at five aspects, five dimensions. The first, the congressional target. The second is the balance sheets, the liquidity position. Then there's the counterparty framework, the bank's which are counterparties of non-banks which there is a difference here which is quite important between the Eurosystem, with creditor institutions mostly, and in the US with primary dealers for some operation and depending on banks only for orders.

Grossmann-Wirth: Then the collateral framework. So we talked about that a bit, but there is also a pretty big difference on the collateral framework because in the Eurosystem it is quite broad and uniform, while on the Federal Reserve side it's a bit narrower, at least for the open market operations, and it can wider but on the specific types of operation. And also important: so on the fifth dimension would be the lender of lateral modalities. So the way central banks provide liquidity in a kind of idiosyncratic crisis on institution. And so what is interesting here is that to some extent in the Eurosystem this modality are now embedded in what operation we decided to take in this crisis. So we decided to launch peak rate full management operation on our credit operation. And with this actually we kind of covered this lender of lateral modality, even if we also have instruments, which is ELA which is more often an emergency lending facility.

Grossmann-Wirth: And on the Federal Reserve side, there was only, if I may say, the discount window with some stigma attached to it. And so they had to deploy a lot of other facilities during this time. So yeah I tried to put into perspective the different measures which were taken and have a framework to analyze them. And what is striking is that there are some important similarities in the way monetary policy changed because of the large excess of liquidity which was put into the banking system, which implied that the short-term interest rate was not anymore within the corridor but was either at the floor or even below the corridor. So, that's a common point for both the Eurosystem and the Federal Reserve. But at the same time, as I mentioned, on some type of operation, also on credit operation on one side versus the asset purchase on the other side, there were big differences. So yeah I tried to put that together and draw some conclusions on that. I don't want to be too long, but-

What is striking is that there are some important similarities in the way monetary policy changed because of the large excess of liquidity which was put into the banking system, which implied that the short-term interest rate was not anymore within the corridor but was either at the floor or even below the corridor.

Share this

Beckworth: No, this is good.

Grossmann-Wirth: ... I can keep going with the conclusion if you want.

Beckworth: Yeah, share your conclusions.

Grossmann-Wirth: Yeah but I will be short on the conclusions. It's not like revolutionary conclusion, anyway. But what was interesting to me is that you have to be aware of both the availability of lending facilities and the way they provide the liquidity, if there is some stigma or not and so on. And you have also to include, I have not discussed it, but the intraday credit and the payment's modality, which are also important to the mix. So that's something I don't fully develop in the article, but it pops up in some parts and I think it's still under study, even if there are some papers at the ECB and other places. But still it's important to put some input also on intraday credit and the way liquidity is provided.

Grossmann-Wirth: The second conclusion is that you also have to take care of the interaction between this liquidity provision and the change in the financial environment. So that's something which was pretty much common on the two sides, as far as the move to a six-year interbank lending is concerned. But at the same time, you also have the difference we mentioned between market-based finance on one side, to be short, and more banking side finance on the other side with still a move towards market-based finance even in Europe. So this kind of financial environment and even regulatory environment, especially on the liquidity side, is very important. And I know that you documented that also in your podcast with many people including Bill Nesden and other people discussing it on your podcast.

Grossmann-Wirth: And the third conclusion is that, at the end of this analysis, I didn't conclude on the superiority, in terms of simplicity and efficiency of a kind of a floor system versus the corridor system. It's, I think, in both cases, it's very easy now to think of the floor system as the easiest way to conduct monetary policy. It's even more the case now with the COVID crisis and the way the excess liquidity increased again. So, in a way, you could contort this kind of floor system view. But, in both cases actually, you have to monitor very closely liquidity conditions, because there can be some fragmentation in the money market, as we saw in the US. There are some impacts also of the articulation between monetary policy and regulatory measures. So anywhere you have to monitor very closely the money market. And it's still quite often, whether it is better to operate in a purely floor or even below floor system, and compared to a kind of corridor which anyway would be different now because we also have different instruments that we created. But in a system where the excess liquidity is a bit less on both. So yeah, to me it's quite open on this one, too.

Beckworth: Well you know where I stand on this question, Vincent. You know I come down firmly on the symmetric corridor side. And I liked your paper because it was a nice comparative study of different operating systems. And you mentioned the money market issue that comes out of this, that can be of concern. And how do you transition back? I mean that's another fair question. How would you get out of what we're in today into something that could actually work as a corridor system? I mean the answer is, at some point, you have to begin running down the balance sheets. But then the second question, I think you alluded to it earlier, well what do you do with your instruments? And the way I would answer that is: what you have to do is you have lower the interest on excess reserves, below the other overnight market interest rates, to the point where you actually get back to a corridor. But all of that I know is a long process, and it's a conversation that's been pushed down the road many years from now, given the huge size of our balance sheets.

Beckworth: But it will be interesting to watch, as I mentioned with Bill Nesden, what Canada does, because Canada was one of the best examples I believe of a symmetric corridor system. They made it through 2008; they temporarily went to floor system when the zero lower bound hit, then they went back to a corridor system afterwards. They have now vastly expanded their balance sheet, much more than 2008. And so the real, to me, interesting test will be if they can return to a symmetric corridor system. If they don't, maybe if they don't-

Grossmann-Wirth: Last one has fallen.

Beckworth: Yeah, the last one has fallen. And maybe the equilibrium in this world we live in, given the political constraints that are out there, is a floor system, which is not what I want to hear or think. But maybe given the realities of democracies and political economy realities, maybe you always do end up at a floor system, which would be unfortunate. But that's why I think it'll be interesting to watch Canada. Will Canada show that it's still possible to go back? Or is this kind of almost a force of nature that we all gravitate toward a floor system?

Beckworth: Well with that, our time is up. Our guest today has been Vincent Grossmann-Wirth. Vincent, thank you so much for coming on the show, it's been a real treat to chat with you.

Grossmann-Wirth: Thank you very much, David.

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