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Vitor Constâncio Profile picture
@VMRConstancio
Aug 22, 2019 • 4 tweets • 1 min read • Read on X
This is the crucial issue, questioning the mainstream belief that monetary policy can do eveything and that fiscal policy should be totally passive. Unconventional monetary policy was effective to mitigate the crisis and to start a recovery. A new downturn questions its limits
The interest rate (or cost of capital) channel, shows diminishing returns and the expectations channel cannot by itself significantly move the economy. So, CB promises in the context of price level targeting or long term averaging of inflation don’t work. We need fiscal policy.
The exchange rate channel could only lead to currency wars that are destructive and self-defeating. Forward guidance depends on the expectations channel. QE was effective to lower yields when policy rates were near zero, still works, but also with diminishing returns.
Negative policy rates can be tweaked but cannot go down much further for the well-known reasons that @LHSummers sums up quite well

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More from @VMRConstancio

Vitor Constâncio Profile picture
Feb 21
The ECB announced that it will take a decision in March on the very important issue regarding the future operational framework to use a policy rate to influence the interbank overnight rate. The decision is also linked to the issue of the future size of the balance sheet. 1/11
I fear a mistake may be made if the decision departs from a “floor system” that has been quite approximately followed by the ECB since 2088 and then in a full-fledged way since 2015. Instead of the volatility of the Eonia until 2008, the floor system worked perfectly (slide) 2/ Image
A few decision-makers seem to consider that market rate volatility around the policy rate are a good thing. Markets like volatility for profitability in other contexts. In this case, the deviations only show that the CB is not able to attain its targeted market rate 3/
Read 11 tweets
Vitor Constâncio Profile picture
Jul 24, 2023
Disinflation momentum in the Euro Area has broadened. That will be reflected in the future wage/price decisions, contributing to a future decrease in core inflation that, wrongly, has been taken as the proxy target of monetary policy 1/ Image
The DB index of the ECB’s Governing Council indicates an increase in divergence of views about the future, according to public statements of its members 2/ Image
The PMI composite (manufacturing and services) for Germany turned more negative, indicating a more visible negative growth in the biggest EA economy 3/ Image
Read 5 tweets
Vitor Constâncio Profile picture
Jul 6, 2023
A missed debate in the ECB’s Sintra Forum was about the desirable size of the CB’s balance sheet. The paper dealing with the issue missed the point by using as the sole criterium the maximising of the reserves supply net convenience value 1/ecb.europa.eu/pub/conference…
The convenience value is the price premium that very liquid and safe assets (e.g. AAA sovereign bonds) can get in the market. The paper took the view that the balance-sheet size doesn’t matter to MP when the policy rates are above the effective lower bound. This view is wrong 2/
As it’s known, conventional monetary policy targets the interbank market rate for 24h. In a corridor system, the CBs have a lending facility rate (the discount window in the US) and a lower deposit facility rate (the IOR in the US), and the policy should be in the middle 4/
Read 14 tweets
Vitor Constâncio Profile picture
Jun 28, 2023
The Sintra ECB Forum started this year with an excellent paper, presented by Silvana Tenreyro, on “Monetary policy in the face of supply shocks:the role of inflation expectations”. Theory and mainstream models give an exaggerated role to expectations in the inflation process 1/
Woodford (2003) wrote that monetary policy is mostly about managing expectations and that hardly anything else matters. The models made expectations endogenous with rational expectations but the mechanisms that would operate in reality were never really well explained 2/
The use of the Euler equation in the main models, implied that higher (lower) inflation expectations would reduce (increase) real interest rates and so intertemporal optimization would entail frontloading (postponing) of consumer expenditures. 3/
Read 7 tweets
Vitor Constâncio Profile picture
Mar 31, 2023
As predicted, euro area inflation in March tumbled to 6.9% from 8.5% in February (see the Eurostat table). I expect a similar decrease for April. This means that inflation is on its way down to the level implicit in the ECB projections, close to 3% by December this year 1/
These results come from the drop in international prices and the delayed effect of monetary policy. Interest rate changes take time to produce their effect on the economy. Decisions now must be taken thinking about future inflation, i.e. the 3% in Dec and lower in 2024 2/
Market commentariat makes 2 mistakes: a) “But “core inflation” is still too high”; b) So, “more rate hikes are needed”. The target of policy is headline inflation (what counts for consumers). “Core” inflation only matters if it is a good predictor of future headline inflation 3/
Read 7 tweets
Vitor Constâncio Profile picture
Mar 20, 2023
The battle of Cocos. Swiss authorities made a mistake with consequences and potentially a host of court cases. They wiped out $17 billion of Additional Tier 1 bonds ( or Contingent Convertible Bonds or Cocos).These were invented after the 2008 crisis to shore up banks’ capital 1/
Cocos are perpetual bonds (traded in the market though) that can be wiped out if the capital of a bank comes below a certain percentage around 6%. They earn a higher interest while alive and that was the incentive to get an easy capital equivalent tool without voting rights. 2/
Bank regulation (Basel III) accepted Cocos or AT1 as part of Tier 1 bank capital, as good as equity for loss absorbing. AT1 should be called-in only after equity was wiped out and the bank capital comes below the percentage mentioned in the AT1 bonds contract 3/
Read 7 tweets

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