Obrigado. It's the only word I know in Portuguese, but thank you for your very warm words of welcome. And it's my privilege to be back at this prestigious LSE. Thanks to you, Professor Ricardo Reis. You are, I said, really one of the most distinguished economists in monetary policy. We had many opportunities to work together in the G7, in the IMF, and elsewhere. And by the way, I have already had the pleasure of giving three lectures on monetary policy here at the LSE during my tenure as Governor of the Banque de France.
I have always been an independent central banker, but I am now still more than that. I'm a free man, as I passed the baton four months ago to my successor, Emmanuel Macron. Hence, I won't elaborate today about the ECB's current monetary policy in the face of the ongoing conflict. It's my rule of conduct, as this difficult task is now in the best possible hands around Christine Lagarde and my friends in the Governing Council.
But let me today, and perhaps still more interestingly, take the broad view with you and consider these last 11 years. It would be tempting, and not wrong, to sum them up in a simplistic way. Despite rising and unprecedented geoeconomic turmoil, central banks so far have been broadly successful in maintaining price stability and financial stability. But to be honest, many things changed below this surface.
Let me try to give some light in the present dark, or as it is the headline of my lecture, to bring some monetary clarity in the face of geoeconomic turmoil. I think we need for that to discuss two issues in depth. First, who is at present in the driver's seat? And this question would not have existed 11 years ago. I will come back to it. And second, what are the four new challenges facing central banks?
Let me start with this driver's seat question. In 2015, when I entered the central banking community, such a question would have appeared more than strange, incongruous. Independent central banks were at the front of the stage, and we kept repeating, like an exorcism, monetary policy cannot be the only game in town. This, in fact, revealed by contrast an illusion.
After its effectiveness against the Great Financial Crisis in 2009-12, monetary policy came to be expected, starting with politicians themselves. I stress it because I can witness it as well, not only to tackle stability but almost everything, including inequality or long-term growth, at little cost.
At present, obviously, the situation is different. Central bank dominance is challenged, and some powerful voices — I don't need to quote any name — promote the idea that governments, or more recently and certainly financial markets, should be in the driver's seat. Let me start with governments.
Starting in the US, the populist critique is today the loudest, but clearly for me also the least relevant. Central banks are then portrayed as technocratic institutions escaping democratic control and sacrificing employment and/or growth on the altar of price stability. Allow me to respond with a clear and double no.
No, independence is not a democratic anomaly. And it's very important to stress. On the contrary, independence was conferred by democracy itself and not self-conferred by central bankers. Attacking it is in contradiction with the law, and this is what is dangerous for democracy.
And no, independence is not an obstacle to reasonably low interest rates. On the contrary, it is a precondition for them, by making it possible to durably control inflation close to its 2% target. And so this populist critique is not only unfounded, it's counterproductive. And let me explain.
Monetary policy has evolved over this past 10 years. Alongside the traditional channel of credit demand, another decisive channel has emerged and developed: that of expectations. In a world shaken by repeated shocks, the effectiveness of monetary policy relies increasingly on the ability of central banks to anchor inflation expectations. That is on the credibility in the eyes of households and firms.
Therefore, weakening central banks' independence also means weakening one of the key foundations of price stability. And in this regard, let me strongly welcome the recent unanimous decision of the Fed to raise its policy rate and hence reaffirm its independence. I think it was a major step.
There are nevertheless, on this government's side, somewhat some more sophisticated ways. The recent attempt by the US Treasury to reduce long-term yields by announcing, as you saw, limited buybacks of long-term government bonds failed indeed. Was it due, as I am a free man, to poor execution or to poor inspiration?
Shortening the average maturity of the US sovereign debt would only enhance the monetary-fiscal nexus. It implies either monetary dominance on fiscal policy or, more probably, an increased fiscal dominance on monetary policy. Either way, it's definitely not the right way to reassure investors and markets.
Governments would be much wiser to put their own fiscal houses in order by restoring fiscal sustainability. And this is, by the way, true for many jurisdictions in Europe, including my own country.
This is about government. Let me come to this more subtle idea of market guidance instead of forward guidance. What do I mean here? This is a new and more subtle trend among central bankers themselves, starting with recent speeches of the Fed's Chair.
And let me spend one minute on this question of forward guidance. It has been practiced till 2022, and it was warranted as monetary policy was constrained by the effective lower bound, ELB. But it obviously had several drawbacks, and we must stress them with hindsight. It was overly ambitious, pretending to forge the future.
Forward guidance was understood — wrongly so — but it was understood as unconditional and difficult to adjust in a fast-changing environment. And hence, yes, it played a role in the delay of monetary tightening in 2022. Still more, as our ECB forward guidance at that time wrongly tied possible interest rate hikes to the end of asset purchases.
More structurally, there is this famous analysis of hall of mirrors mentioned by Kevin Warsh in his last Jackson Hole speech. What does it mean? If the central bank gives too clear an indication, markets lose their own analysis and information function and only send to the central bank a reflected image of its original message.
I think it's exaggerated. But in this new view, central bankers should be delighted that financial markets do their own work in place of monetary policy. This was, as you probably know, Kevin Warsh's perceived and perhaps somewhat misunderstood message in his press conference in July.
Christine Lagarde herself stressed positively in Sintra last June, I quote her, that markets adjust financial conditions in response to new data on their own. Monetary policy begins to take effect before we have made a decision, unquote.
I agree on the limits of forward guidance, but I don't think it should be replaced by an excessive market guidance. Markets are useful, but they can be wrong and overshoot. They tend to be volatile and nonlinear and to miss economic or financial signals for long periods and then react abruptly.
Their behavior does not help here and can create serious financial stability problems and crisis. A further issue is one more related to political economy. As I am in the, it would be quite difficult to explain to our fellow citizens that after giving independence to central banks, these are now powerless in the hands of financial markets.
So let us use markets, but let us not put them in the driver's seat. And this brings us back to a key role of central banks. But they need to be more nimble and agile. I will come back to it. And more humble.
Let me stress it with a simple but essential triangle, which we could call the golden triangle of trust. And let me elaborate a bit about this link between independence, mandate, and accountability. Each of the summits is important, and they are interdependent. We have already discussed independence.
Let me share some light on the mandate, which has also provoked an active debate in the last decade and a clarifying one, in my view. If you look at the closest thing to a consensus opinion in economics, or at least monetary policy at present, it is that central banks should focus on price stability and on inflation targeting, and this is really a consensus.
As early as 2013, Jean-Claude Trichet, one of my predecessors, rightly noted that what he called the conceptual convergence on the 2% medium-term target had already taken place. A decade later, it's not only a conceptual convergence, it's an operational one, as debates over the level and definition of the inflation target have faded.
First, the Eurosystem strategic review of 2021 clarified unambiguously that our 2% inflation target is symmetric. Inflation below 2% is off target.
Second, conversely, the 2022-23 inflation surge closed the debate on a higher inflation target, which was very active before the inflation surge, because it put a spotlight on the cost it would have socially and politically. And we are all aware of the huge political cost of inflation, but also the economic cost.
At higher levels, inflation attracts attention, becoming ingrained in price and wage setting and inflation expectations. And Ricardo, you worked on inattention, so I won't elaborate more, but these are figures in France of the link between the level of inflation and the level of attention. On the left panel, it's Twitter, on the right panel, it's the press. But you see there is something like a practical threshold of attention beyond 2%.
But beyond this core objective of price stability, there is ongoing debate about whether central banks should address other objectives. The Eurosystem has a single primary mandate of price stability, differently from the US Federal Reserve. Hence, in the euro area, some advocate broader mandates that would encompass growth or employment, US-style.
To give another example, the topic of inequality is discussed everywhere, and above all, climate change is a pressing concern. Critics are quick to interpret these debates as signs of a politicized mission creep diverting central banks from their core mission of price stability. In my view, this is largely a false debate. And let me explain why.
The clear focus on the primary price stability objective is fully warranted. Fully warranted, and I don't want to change it, but it does not contradict other considerations regarding economic activity.
The 2025 victory over inflation has shown that, provided monetary policy is credible and responsive, the short-run trade-off between activity and inflation is much easier to navigate today than the painful experience of the 70s led some to expect.
Similarly, concern about economic inequality does not put into question the harmful effects of inflation. And let me also stress it. Low-income households are the most sensitive to inflation, as they are the most exposed to its cost. They dedicate indeed a higher share of their income to consumption rather than savings, and they are directly exposed to CPI, especially on goods with more volatile prices such as food and energy.
Final and very important one on the last objective, which is climate-related risk. Our attention to climate, and I was very committed to that, stems from the increasing effect of climate risks again on price stability. So the primary mandate.
There are more and more, unfortunately, severe weather events with significant effects on activity and inflation, including the recent heat waves in Europe, including the UK. In addition, facilitating the green transition can help mitigate the inflationary impact of more traditional supply shocks, and we see it clearly in the latest oil shock we are living through this year.
The real risk to price stability would be to ignore the green transition. And if I look at the current conflict in the Middle East, it should be a sobering reminder. The intelligent answer to recurrent oil shocks is not subsidies for gasoline and demand, although there is a strong political pressure. The intelligent answer is the development of a non-fossil energy supply.
Let me now come to the third summit of the triangle about accountability. To put it loudly and clearly, independence stems from democracy, as I said, but independence must come back to democracy. And accountability means two key deliverables: being effective in results on the mandate and being clear in communication.
And this leads me to my second point about the four new challenges facing central banks. Where are we? If I look at inflation, we had a successful disinflation of 2024-25. There is at present an obvious short-term challenge for the euro area as well as for the UK: how to face the negative supply shock of the Middle East conflict, leading to both higher inflation and slower growth, and we all know this is the most difficult situation for monetary policy.
But let me today, as I said, take a broader view and insist on four more structural challenges, consistently with what I described as a golden aim of humble, nimble, and accountable central banks. And let me now go one step further and go from a triangle to a square. We'll see how sophisticated it is.
And this one I would call it the structural square, the two first corners of which are directly related to the two deliverables of accountability I just mentioned. First challenge: how to combine agility and predictability. Second challenge: how to communicate and steer inflation expectations in an era of distrust and social networks.
Third: should central banks start caring about money again? And fourth: how to preserve the value of non-conventional tools as we at present no longer use them. If you want an acronym to remember this square, you have MCU. And as you perhaps know, one of the possible meanings of this acronym in English is acute medical care unit, but we are not yet there.
But just to give you a reminder: how to combine agility and predictability? And this is a very serious challenge because abandoning forward guidance cannot mean returning to secrecy or unnecessarily adding to financial and economic volatility.
Central banks are not condemned — I say it really with a deep conviction — are not condemned to navigate between being on autopilot with forward guidance in the past or flying blind at present. I think it's time to return to an intermediate concept: the central bank reaction function, or to use Christine Lagarde's word in Sintra, framework guidance instead of forward guidance.
Central banks need to clarify not what they will do, because there is uncertainty, but how they think and will act in a readable way. And this means at least three simple truths. I will express it from an ECB perspective, but I think it's available for most advanced central banks at present.
These three simple truths are: A, that central banks have a firm, firm medium-term orientation to the 2% target, but they are not obliged to rush to come back to it in short notice. B, they look to trends and not only to data points, and this is also very important about the predictability. And C, central banks may therefore look through volatile price movements like energy, but if they focus much more on underlying inflation and possible second-round effects.
According to these three indications about our reaction functions, the Eurosystem rightly stresses that it is data-driven and acting meeting by meeting, and this is the case for most central banks. This is what I have for long been advocating as agile pragmatism: pragmatism because we look at data and trends, and agile because we must be ready to act quickly if necessary.
Hence, agile pragmatism cannot and shouldn't be interpreted by financial markets as a commitment to raise rates X times. I don't give any figures, but you can put them in the ECB case: to raise rates six times in the near future. And this is the only one remark I will make about the present monetary debate.
Market readings after the last ECB Governing Council have, in my view, a bit overshot. There is a more general lesson here. If agile pragmatism happened to be seen as unpredictable, there would be indeed increased risk of such market homemade interpretations.
And if we have purely market-driven expectations, they would then exert pressure on the central banks and create a situation of market dominance, the risk of which I stressed in my first part.
Let me give one more piece of positive news, which is a significant progress in agility through geoeconomic turmoil and uncertainty, and this is a broader use of economic scenarios. The ECB just published four of them, and here you have the last forecast as published in September.
And this is rather new. Let me say, since the Ukraine war and especially since last year, by design, the use of scenarios makes the conditionality of policy impossible to miss, by design. And it has other obvious benefits, such as testing the robustness of policy and better anticipating tail risk.
I now come to C, the second corner of my square: how to communicate and steer inflation expectations in an era of growing distrust and use of social networks. Let me here start with the easy part. Inflation expectations are, as I said, an increasing channel of effective monetary policy, which strengthens the case for independent and credible central banks.
And second, obviously, contrary to a long-prevailing approach by which central banks communicated in a very technical and a bit obscure way only with finance specialists. You all know this story about Alan Greenspan, the famous one when he told 20 years ago to a US congressman: 'Mr. Congressman, if you understood something from what I said, I must have missed my statement.'
But this was 20 years ago. Central banks now have to speak to all economic agents, including the general public, and in clear and simple wording. Because a better understood monetary policy is a more effective one, especially if you think of the expectation channel.
And over the last decade, the Banque de France, the Eurosystem, and most central banks worldwide have made considerable progress in this area. This is the easy part, as I said. But I then come to two more difficult questions.
First, inflation expectations by households are not completely rational, and they are not steered only by central bank commitment. Here I come to my next slide, issued by a recent Bank of France research. It shows that inflation expectations in the euro area — these are the two main countries — this is a gray line, is correlated to the actual perception of inflation, which is a light brown line. These are at least the expectations at the one-year horizon.
And this inflation perception significantly overstates the real figure of inflation, which is a black line. This is due mainly to two phenomena. Perception is overwhelmingly influenced by what we could call daily inflation, energy and food, rather than core inflation. And I already mentioned it: the consumption basket of the lowest-income households is overweight energy and food.
Second challenge about communication. While central banks communicate much more, they still communicate through traditional media, two words which distrust has increased still faster. Your generation of students is a proof of that, with perhaps, Ricardo, the exception of LSE students. Can I have a very short survey?
I will ask if you trust more papers or TV on one side, or if you trust more social networks or influencers, and there is no hierarchy of value. If you agree, who among you trusts more traditional — what I call traditional media — and who trusts more social networks and influencers? So the LSE is a very brilliant exception, but we are all aware it's an exception in your generation and also more and more for adults.
I am not an unconditional supporter of social media and networks, so I could apply to be an LSE student. We will gladly take — no, no, we will discuss. They can be an echo chamber amplifying inflation expectations as well as a perception of actual inflation.
But there, and this is also my deep belief, still more with the accelerated rise of AI, central banks need to invent new channels to reach all audiences, including younger ones or more popular ones, by making greater use of social media, content creators, or chatbots. It's a bet for sure, a significant bet, but an imperative one in my view.
And I can testify that even seasoned governors who are not especially gifted for social networks take them seriously. As Ben Bernanke famously said in 2015, and somewhat exaggeratedly, I quote him: 'Monetary policy is 98% talk and 2% action.' It's exaggerated, but let us talk where people listen, and everywhere where people listen.
Third corner, M. Should central banks start caring again about money? I refer here to a little-noticed part of the Fed Chair's last speech in Jackson Hole. I quote him: 'Money matters. It's not fashionable these days, but we should pay attention to money created by the central banks and money that comes from the banking and financial system.'
Kevin Warsh was not more explicit about what he means. But let us elaborate a bit. The last two decades have seen the gradual death of pure monetarism. If I oversimplify the definition, this is the steering of monetary aggregates as a key pillar of monetary policy.
The ECB abandoned it explicitly in its strategy review of 2025, and implicitly much earlier. For a long time, we had seen a decoupling between the evolution of aggregates and the evolution of inflation, due among other factors to the instability of the velocity of money and technological innovations.
I don't think, and you see it with this graph, it would be relevant to come back to the monetary base M0 or other monetary aggregates because it's very unstable and it's not telling much. But yes, money matters for central banks in another way. Technological disruption could significantly change the nature of money, and this is one pressing challenge for the central banking community.
The media's buzz is about so-called cryptocurrencies. This word appears for me as an oxymoron, and I'm ready to elaborate on them in the Q&A, an irrelevant oxymoron. But there is definitely a highly promising innovation with the tokenization of payments, be it in the form of stablecoins or of tokenized deposits.
By the way, the Fed, as other central banks, but starting with the Fed, will have to decide soon how to incorporate them in monetary aggregates. You are aware of this tokenization. Thanks to blockchain technology and smart contracts, tokenization combines a payment of cash with, and this is the other leg, the safe exchange of information and legal rights.
I believe it has a huge potential to improve complex payments such as cross-border ones or financial transactions. So I am positive on tokenization. I think it will develop significantly. Yet, it also carries potential contradictions and some threats.
First, a privatization and/or the increased Americanization — sorry to say it this way — of money, as more than 99% of global stablecoins are issued in dollars by private players. Second, the fragmentation of payments. And third, greater financial instability.
What is the right answer to these threats? Obviously, not to stop innovation or prohibit it. The issue would deserve a full speech of its own here in the LSE if I'm invited again, Ricardo. But let me only sum up the ECB strategy, which is an appropriate combination of three components.
First, to lead by sovereign innovation in the form of a central bank digital currency, so-called CBDC. One week ago, we could see the first direct access of tokenized financial transactions to central bank money with the so-called Pontes project. And here the ECB has been really a pioneer in innovation. We will see the retail digital euro in the next two years.
Second, I spoke of sovereign innovation. Second, also promote private innovation from European banks and in euros. They still lag behind here, but several projects are flourishing and will hopefully converge in the near future. And third, promote international cooperation to avoid innovative fragmentation.
If the innovation leads to many different monetary and tokenized silos, it will not be a progress. Don't forget that the first US dollar stablecoin issuer globally, Tether, is still registered, as you know, in El Salvador, which, if I may say it, probably is not the safest or the most strictly regulated financial place.
I come to my last and fourth corner about how to preserve the value of non-conventional instruments. Until 2021-22, towards the end of the ELB episodes, there was a consensus — believe me, there was a consensus — that non-conventional instruments had become part of the regular, almost conventional, monetary toolkit.
But since then, and amidst the recent inflation surge, this consensus has weakened. The view has gained traction that the cost of these unconventional instruments, beyond the financial losses they caused for central banks themselves, had been underestimated. Some suggested even that these instruments bore some responsibility for the return of inflation.
This latter view, let me say it clearly, is simply false. Inflation resulted from the sequence of two opposite shocks: the COVID pandemic, disinflationary, then the Russian invasion of Ukraine, inflationary, both of which were totally unpredictable.
So in my view, this debate about unconventional instruments deserves a less Manichean approach, because the use of non-conventional instruments depends on circumstances. Criticism voiced once they are no longer needed often overlooks what made them necessary in the first place.
And I add that the different instruments must be assessed separately. If we do so, a clear hierarchy emerges. My view is that greater caution is needed regarding two overreaching instruments. I don't exclude them, but I plead for greater caution: forward guidance, as already said, and yes, negative interest rates.
Negative nominal interest rates are poorly understood, to say the least, by our fellow citizens, and they are potentially destructive of what I would call moral cohesion. By contrast, the clearest contribution lies in balance sheet instruments like asset purchase programs and LTROs. They were designed in crisis times when conventional tools were constrained by the effective lower bound.
I would be ready to elaborate about the if and when of adequate use of these instruments,
But I still think they were useful and they could be useful in the future. That being said, such programs of QE are not and should never be designed to fund governments. They are designed towards our inflation target. It's probably obvious in this room. It's not obvious at all outside of this room. This misunderstanding has unfortunately been lasting from the inception of QE until today and you see it on many political scenes on both sides of the Atlantic.
Central banks are at present shrinking their balance sheets, but there are good reasons, including bank regulation, why the so-called new normal after this shrinking should involve a larger central bank balance sheet than before 2008.
The Federal Reserve has so far stated its intention to keep an ample instead of abundant until now an ample reserve regime and the Eurosystem should aim in the same ample direction through its future structural portfolio and longer-term credit operations. At present we still have an excess liquidity, a significant one of about 2.1 trillion euro.
But if we were to come to a situation of scarce liquidity in the euro area, or perceived as such by banks, this could trigger undue credit tightening as well as an uneven playing field vis-à-vis international banks. By covering the banking sector's liquidity needs, a system with ample reserves can both control the interbank interest rates more effectively and mitigate risks to financial stability.
Let me conclude and conclude with one of the most famous French writers and philosophers, Voltaire. And Voltaire was obviously not a specialist of monetary policy. But he wrote about three centuries ago. I will quote him in English: 'Uncertainty is not a pleasant condition, but certainty is ridiculous.' If you allow me one sentence in French quoting.
So we live in uncertain and somewhat unpleasant times. It would be wrong, even ridiculous, to pretend to have monetary certainty. But I've tried today to bring something more modest and useful, monetary clarity. To preserve stability and trust, we need independent central banks in the driver's seat. As I said, more than ever, but nimble, humble, and accountable.
Combining agility and predictability, communicated in an era of social media, dealing with new forms of money, is more art than science, is more open pragmatism than theoretical rigidity. But I am confident that the central banking community, thanks to its trustworthy cooperation, and this remains really a cross-border cooperation between Frankfurt and Basel and the IMF, thanks also to its fruitful dialogue with economic research. Dear Ricardo, dear LSE students, believe me, it was one of my great pleasures, this dialogue. The central banking community will once more be up to these challenges. I thank you for your attention.
