The Eurosystem –Challenges and Perspectives

Warwick Economic Summit University of Warwick14 February 2009

Ewald Nowotny Governor of the Oesterreichische Nationalbank (Austrian central bank)

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0.90.7

1.2

-0.1

-1.9

-2.8

-1.6

-2.4

0.40.2

1.7

-0.2

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

Euro area U.K. U.S.A. Japan

GDP Forecasts for the Euro Area, the U.K., the U.S.A. and Japan

(annual changes in %)

Source: European Commission.

2008 2008 200820082009 2009 2009 2009

2010 2010 20102010

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3.3 3.4 3.4

0.6

1.0

0.1

0.4

-1.4

1.8

1.1

0.7

-0.5

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

Euro area U.K. U.S.A. Japan

Forecasts of Inflation for the Euro Area, the U.K., the U.S.A. and Japan

(annual changes in %)

Source: European Commission.

20082008 2008 200820092009 20092009

2010 2010 20102010

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Forecasts for EU and Euro Area Countries

2009 2010 2009 2010 2009 2010

Euro area -1.9 0.4 -4.0 -4.4 9.3 10.2EU 27 -1.8 0.5 -4.4 -4.8 8.7 9.5

AT -1.2 0.6 -3.0 -3.6 5.1 6.1DE -2.3 0.7 -2.9 -4.2 7.7 8.1IE -5.0 0.0 -11.0 -13.0 9.7 10.7LV -6.9 -2.4 -6.3 -7.4 10.4 11.4PL 2.0 2.4 -3.6 -3.5 8.4 9.6SK 2.7 3.1 -2.8 -3.6 10.6 10.5UK -2.8 0.2 -8.8 -9.6 8.2 8.1

Source: Interim Forecast of the European Commission, January 2009

(annual change in %) (in % of GDP) (in %) GDP Government Deficit Unemployment rate

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Challenges for Monetary Policy I

- In contrast to the last few years:

No trade-off between short-run developments in inflation and

output.

- In the current crisis, inflation and output are behaving like after

a demand shock. Both are dropping significantly.

- Thus, the policy response is straightforward: decrease policy

rates.

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0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09

Euro area U.S.A. Japan U.K.

Central Policy Rates

in %

Source: Thomson Financial.

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Challenges for Monetary Policy II

Policy interest rates have decreased worldwide. However…

- slow effect on the real economy

- the pass-through to bank lending rates might be hampered because of the financial crisis

- a too-swift decrease of policy rates might signal panic

- what happens when the zero lower bound is reached

- difficulties in the implementation of monetary policy…

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Challenges for Monetary Policy Implementation

Persisting tensions in global money markets…

- Counterparty risks- Liquidity risks

… led to- volatile overnight rates- high term interest rate spreads- declining volumes, signs of rationing

Money markets crucial for the- implementation of monetary policy- derivative markets, interest rates for

households and firms

0

50

100

150

200

250

300

350

400

12/06 06/07 12/07 06/08 12/08

USD EUR GBP

Stress on Interbank Markets: Unsecured vs. Secured Three-Month Rates

in basis points

Source: Thomson Financial.

last value:09/02/2009

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ECB Liquidity Management: Stability within the Turmoil

Key challenge: Distribution of liquidity in the system when interbank lending is impaired

Pre-crisis ECB framework:- Large group of banks admitted to regular tender operations and

standing facilities- Broad range of collateral- Weekly and three-month open market operations

No need for special facilities. Alleviate strains in term funding markets by increasing term funding.

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After the Collapse of Lehman BrothersUnprecedented level of stress in financial and in particular interbank

markets.

Flexible reaction- Full allotment in tender operations- Wider range of eligible collateral- Temporarily significant involvement in intermediation

Alleviate stress in global markets- Stepped-up cooperation between central banks- Unlimited access to US dollars for euro area banks

Overall: Operational framework has passed the test well, has provided a maximum of continuity

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51 years after the signature of the Treaty of Rome, the euro remains one of the most tangible signs of Europe’s determination to forge a

common future and work together to secure peace and prosperity for our continent.

José Manuel Barroso – June 2008

Moreover, the crisis shows that there is more to the euro than its role as a means of transaction…

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The Euro Has Indeed Become a Global Player

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The Benefits of the Euro in the Financial Crisis

The euro protects Europe EMU shows that in turbulent financial waters, it is better to be on a large, solid

and steady ship rather than on a small vessel. Businesses were sheltered from exchange rate volatility. No competitive

devaluations.

With the single currency, Europe has been able to act swiftly, decisively and coherently Would it have been possible to protect separate currencies from

the fallout without the euro?

European authorities, parliaments, and central banks reacted immediately

Europe has shown that it is capable of taking decisions The crisis has improved popularity of the EU. People are more convinced of

the achievements and institutions of EU and EMU.

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Future Challenges for EMU and the Euro

In the short run Maintain price stability Return to the path of growth and stability in Europe, stimulate employment and

create jobs Overcome the financial crisis – maintain financial stability Redesign regulatory and institutional frameworks

In the medium to long run Cope with globalisation EU: implement the Stability and Growth Pact firmly and credibly, render

economies more productive, innovative, avoid competitive divergences, stimulate scientific and technological progress

Address ageing population Handle euro area enlargement optimally – increase from 11 members in 1999

to 16 members in 2009 Strengthen the euro area’s international role and the euro’s image