ECB’s Villeroy: Risks of Doing Too Much Versus Too Little ‘Now at Least Symmetric’

25 September 2023

By David Barwick – FRANKFURT (Econostream) – European Central Bank Governing Council member François Villeroy de Galhau on Monday said that the risks of monetary policy tightening going too far had reached the point of symmetry versus the risks of not going far enough.

In a speech at an ECB – CEPR – Banque de France Conference in Paris, Villeroy, who heads the Banque de France, said, ‘The risk of doing too much needs to be balanced against the risk of not doing enough. In my judgement, these risks are now at least symmetric.’

Were the ECB to fail to tighten sufficiently, inflation would persist above target and expectations could dis-anchor, but this was a manageable risk, given that the ECB could always just tighten further, he said.

‘But in the risk of doing too much, with the economy falling into recession and causing a sharp deceleration of inflation, we would then have to rapidly reverse course’, he said. ‘Hence, “testing until it breaks” is not a sensible way to calibrate monetary policy. This suggests that we should now focus on the persistence of policy rather than the constant pushing of rates higher – duration rather than level.’

This however does not imply inactive monetary policy, he said. Simply keeping interest rates at their current level would reduce price pressures over time, he said.

‘In the same way that there is a risk of doing too much in the future, there is the opposite risk of easing too early’, he continued. ‘If markets fully incorporate our persistent strategy, they shouldn’t expect rate cuts before a sufficiently long period of time; then markets will endogenously extend the duration of elevated rates, contributing to the appropriate calibration of the stance.’

The ECB must in any event continue to be data-dependent, and needs in particular to watch oil price developments, he said. The current rebound of these was still far from being like the commodity price shock of 2021-2022, ‘but we have to monitor its possible effects on inflation expectations and wages: underlying inflation remains our key indicator’, he said.

Villeroy said monetary authorities had ‘growing confidence’ in their ability to restore price stability by 2025. As long as they expect this to occur, they can also seek to avoid a hard landing for the economy, he suggested.

That much of the impact of previous tightening measures remained in the pipeline was confirmed by the fact that expiring fixed-rate loans would be renewed at higher rates, he argued.

‘This process takes time and we at the Banque de France estimate that there could be still between 40 and 50bp of increase in lending rates to non-financial companies yet to come’, he said.

A ‘useful lesson’ of the recent past was that the ECB’s dependence on forward guidance with respect to interest rates ‘was perhaps excessive in principle in the face of exceptionally large and unexpected shocks, and too rigid in its substance’, he said.

Still, he didn’t exclude a ‘certain return to forward guidance, but seen as more indicative, more state-dependent… and more modest – i.e. less powerful as an instrument’, he said.