Welcome, we are proud to have you at the man and banking seminar of the Central Bank of Argentina. This event usually attracts 300–400 people, but this year we have 1,700 registered. The theme is fiscal deficits, monetary policy, and inflation, with fiscal dominance at the center. We have policy makers, academics, and private sector decision makers. Our first panel is on central bankers with Neel Kashkari, President of the Minneapolis Fed, and Pablo Hernandez de Cos, former Governor of the Bank of Spain. Also, tomorrow President Javier Milei will join us off-agenda. Panels in English if needed; no Q&A from the audience. Let's start with panel one.
Thank you. I'm Neel Kashkari, president of the Minneapolis Federal Reserve Bank. I want to thank Governor Basili and Dr. Hernandez de Cos. I'll discuss US monetary policy, starting with historical context. The US Constitution was ratified in 1788, but it took until 1913 to create the Federal Reserve, and until 1979 to establish modern independent monetary policy. Key is credibility, supported by institutional independence from the executive branch. In the 1970s, stagflation resulted from the Fed not aggressively raising rates due to political pressure. Paul Volcker became chair in 1979, raised rates to 20%, causing a severe recession but bringing inflation down from 12% to under 4% by 1983. This established credibility that has underpinned prosperity for 40 years. After COVID, inflation surged due to supply chain disruptions, fiscal stimulus, and the Ukraine war. We raised rates to over 5%, and inflation has fallen while the labor market remained strong. The most important factor was keeping long-run inflation expectations anchored. Looking ahead, further modest rate reductions may be appropriate. Lessons: low stable inflation is a precondition for prosperity; achieving it may require short-term pain; institutional structures should endure economic and political cycles.
Thank you very much, President Basili and President Kashkari. I will discuss the European perspective on fiscal-monetary interactions. The European monetary union was designed with an independent ECB focused on price stability, and national fiscal policies coordinated through rules: no monetary financing, a 3% deficit limit, and 60% debt-to-GDP cap. However, fiscal policy has been procyclical, and debt levels have risen well above 60% in many countries. The framework also missed other imbalances like housing bubbles. During the pandemic, there was effective implicit coordination through monetary easing and the Next Generation EU funds. In the inflation episode, the ECB raised rates sharply, and inflation expectations remained anchored. The fiscal response was sometimes too expansionary, complicating monetary policy. Sovereign spreads did not rise dramatically due to higher growth in high-debt countries, longer debt maturities, and credibility of the framework. New fiscal rules were approved this year. A key missing element is a supranational fiscal capacity to allow automatic countercyclical policy.
Context on which there's been a risk of very high risk appetite by investors at the global level, but then I think we have also to take into account two other factors that are more related to the ECB policy actions that to me have also played a very significant role precisely in order to avoid such developments in terms of the spreads and the increase in the spreads between member states. The first one, which also by the way how monetary policy has been working in the US, is that the reduction of the balance sheet that could have been an origin for the increase in the spreads has been done in a very predictable and gradual way precisely because it was the first time that many central banks were doing QT, and we were to a certain extent worried about the reaction of the markets to these developments, and we wanted to be very predictable and very gradual precisely in order to avoid these problems also in terms of liquidity in the market. And then second, and this is very specific to Europe, the European Central Bank announced in July 2022 this Transmission Protection Instrument with the main objective of trying to guarantee that monetary policy is transmitted equally in all individual countries within the European monetary union. So the objective is that the transmission of monetary policy is done in a homogeneous way in order to preserve the transmission across the whole European monetary union. How does the TPI work? Well, basically the European Central Bank can announce possible interventions in the market by buying bonds of individual countries, or of course moving from announcements to actually buying those assets in order precisely to restore confidence and prevent destabilizing rate spirals, in particular in a context of European monetary union in which there is a lack of a common fiscal action that could be particularly relevant. And also very much linked to the framework that was defined at the very beginning in order to ensure that market discipline was there, so that we avoid the kind of movement to a fiscal dominance regime. The European Central Bank set some limits and conditions in order for the ECB to be able to purchase under the TPI. The first is that the instrument can only be used in countries that pursue sustainable fiscal and macro policies, and the second that the ECB cannot counter persistent tensions that are due to country fundamentals. So in other words, the interventions of the ECB try to counteract the increasing spreads that are not based on fundamentals, and only if the country that is affected is pursuing sustainable fiscal and macroeconomic policies. Well, the fact that there was the forceful action of the ECB has not triggered a significant increase in sovereign spreads between member states is to me critical. It has been absolutely critical, kind of a precondition for the ECB to be able to increase rates to such a large extent and so avoid the anchoring of inflation expectations and ensure price stability. Well, the reality is that given all the evidence that I was providing before on the problems in terms of the implementation of the fiscal framework, a new fiscal framework has been approved, and it was approved by the European Council at the beginning of this year. I'm not going to enter into the details, maybe later in the discussion I can be a bit more explicit, but the main elements of the new framework is that it puts all the focus on sustainability. So there is a debt sustainability assessment that of course requires trying to anticipate what evolution of r minus g is for each individual country, which I think is a very positive development in terms of the fiscal framework because it recognizes how growth and growth-enhancing reforms, including of course structural reforms, affect fiscal sustainability. It also provides a kind of an incentive not only for fiscal consolidation of individual countries, which of course is critical in order to guarantee fiscal sustainability, but also creates an incentive for structural reforms in individual countries. And there is also an intermediate target that is defined under a kind of expenditure rule that has been also very positive in other fiscal regimes precisely because an expenditure rule doesn't mean that countries are setting a kind of a ceiling for expenditure. It is simply that when one country is defining the budget for the next year, and assuming for example that the initial position is a fiscal balance position, if it wants to increase expenditure over what the evolution of nominal GDP would say, it will have also to provide a tax increase in order to finance this additional increase in expenditure that is not linked exclusively to the evolution of the economy. In the end, of course, to what extent this sustainability focus plus expenditure rule will provide for a more sustainable fiscal policy in individual member states in Europe will depend very much on its effective implementation. And this is why it is now absolutely critical, in particular in the first year of its application, that it will be 2025, it is absolutely critical that all countries comply with the new fiscal framework. Let me say what I think this will mean in the following two years, and also very much related again with the interaction with monetary policy. Given the elevated levels of public debt in many countries, the implementation of this new framework will result clearly in a restrictive fiscal policy, and this has already been estimated at around 0.5 percentage points of GDP of fiscal consolidation in each year in the next even five years. And you have to take into account that this will be happening in a context in which the macro projections that are provided for example by the European Central Bank in September are compatible with the ECB reaching its 2% medium-term inflation target in a stable manner already in 2025 and of course also in 2026. So one of the questions that is already emerging in Europe is to what extent the implementation of this new fiscal framework, which as I was saying will require a fiscal restriction in the next four or five years, will put inflation below our target for a while. That's one of the big questions. Well, in this regard, I think what it is important to say is that when you use any macro model, it is true that 0.5% of fiscal adjustment for Europe would mean lower growth in the short run and also lower inflation. But if you allow for the monetary policy reaction, in the end the impact on the economy is not considered sufficiently significant. We have also to take into account that it is very important the composition of the adjustment. We have not only to look at whether the structural deficit is going to be reduced, but also to what extent this is going to be done through revenues or expenditures, and we know that the composition of the adjustment might matter precisely in terms of the impact on growth and also on inflation. We have all these NGEU funds that I was mentioning before and that will be present till 2026. Precisely they can be used to compensate for the negative impact of the restriction of individual national fiscal policies on the macro economy. And of course I think it's also important to emphasize, because this is one of the main motivations of the fiscal framework, as I was mentioning, that if this fiscal restriction in the following years is accompanied with adequate structural reforms, they could also imply higher potential output growth and lower r minus g, helping fiscal sustainability in this way. And let me just mention what I consider the main missing element of the current fiscal monetary framework in the European context, which is related to the lack of a central fiscal capacity. In the end we don't have a central fiscal capacity. This means that it is very difficult to achieve the right policy mix at each cyclical moment in time. The Draghi report, the so famous Draghi report, this is a report that has been published a few weeks ago, made a strong point about using common fiscal instruments in order to finance some public investment needs very much related to climate change, digitalization, and defense, for example, that can be considered clearly common public goods. And well, if we combine on the one hand the need for having an instrument, a fiscal instrument that would provide the right policy mix, monetary and fiscal, in each moment in time, with this more structural element that is considered in the Draghi report, this is something that we have to consider if we want to have a European monetary union that works properly. And with this, I will end. Thank you.
Thank you, thank you very much both of you for your presentations. Let me bring some questions up. If you have questions for each other, you have to ask for my permission. Let me start with the institutionality. Given the announcement of the Nobel Prize, and this is something that you both touch upon, it was very interesting to hear the governance for how you as a board member of one of the Feds within the Fed system make your decisions. You mentioned you look at the country as a whole and you don't have a constituent that you need to report to. But Pablo, what about the ECB? When you were governor of the Bank of Spain, you sit there and your constituency is probably much better defined than in the case of the Fed system, where you even have a series of different regions or states that are not even evenly distributed. But in the case of the European Central Bank, you clearly represent the Spanish interest, and maybe what accommodates in terms of policy for Europe as a whole does not necessarily accommodate Spain very comfortably. How do you deal with that conflict of interest in that role?
Yes, well, the conflict of interest is solved legally. When you are appointed governor of one individual central bank, the contract that you sign very explicitly says that when taking your positions on monetary policy, you have to think for the euro area as a whole. And I have to confess that in my six years of experience as governor of the Bank of Spain, I have always had the feeling that this has always been the fact. So all governors, 20 governors of the individual central banks, of course the board members, the six members that are seated in Frankfurt, are always thinking about the euro area as a whole. What might have had also some potential conflict of interest that you mentioned, but it has probably had other consequences. There has always been discussion in Europe to what extent the minutes, the accounts of the monetary policy discussions, had to be published including the individual positions of the governors. And to me, I've always been against this publication with individual names precisely because it can trigger a discussion on what a governor of an individual central bank may be doing. The monetary policy in such a specific context that is the right one for the euro as a whole might not be particularly good for the individual country and might receive a lot of pressure. But in terms of the real conversation and the real actions that the Governing Council has had during my term as governor, this mandate of looking at the euro area as a whole has always been fulfilled by all members of the council.
It's interesting because you mentioned that during the last cycle of increasing interest rates in Europe, one of the concerns was that it would translate into higher spreads, higher financing costs for the government and for the companies in each of the countries, and successfully that didn't happen this time around. But there were other periods in which that discussion was much more challenging. There was a period in which Spain was included into a group of countries that people refer to as PIGS, and the cost of financing was not the same for each of these countries. I wonder whether that institutionality, that governance, was ever challenged. Whether some regions in Spain maybe decided, 'You know what, why don't we print our own currency?' Or why didn't you get a call from the governor of the Bank of Italy saying, 'Pablo, these rates are killing us, we have to do something about it?' Well, the reality is that maybe Spain is very specific. Let me complement the question with the whole membership of the euro question. When Spain decided to become a member of the euro, it must have gone through tough decisions in terms of independence on policy, adjustments that it had to go through. Giving up a currency is probably a very complex decision.
Yes, no, the reality is that the support of Spanish citizens to the European monetary union has always been very high, including during the global financial crisis and the European sovereign debt crisis. And to me, this is a combination of two factors: one is a more historical, political, sociological dimension, and the second is a more economic one. The first one is the fact that Spanish history, for us, Europe to a certain extent in the image of all citizens, is freedom, is democracy. And this is still the case, it is very strong, the perception that to a certain extent the connection and moving to democracy in our case was also very much related to forming part of Europe. And then the second one is more an economic reasoning behind this disposition. The Bank of Spain by the way contributed a lot to this perception, which is that most, if not all, the problems that the Spanish economy was facing during the global financial crisis were of a structural nature, and therefore one could not say that monetary policy could solve them. They required... Spain reached a current account deficit of above 10% right before the global financial crisis. Debt-to-GDP ratios of the private sector, of both households and corporates, was well above the euro area average. Housing prices, all the estimates that we had, were showing a clear overvaluation. These were issues that could not be solved by monetary policy, but to a certain extent the problems of the Spanish economy were due to the loss of competitiveness during our first years in the European monetary union. And this message, I think, was understood by citizens, and they were putting the pressure on politicians in Spain, and not so much on the monetary policy that was decided by the European Central Bank. And again, I think the Bank of Spain made a huge effort in providing this analysis to citizens, and I think it was also very good to keep the cohesion and the support of Spanish citizens to the European project.
Going a little bit more into fiscal dominance and combining the experience in the US and in Europe, in particular the QE period and the unwinding. In Argentina, we had a period of QE but for different reasons. We had an increase in the size of the balance sheet of the central bank as a way to finance the treasury, as opposed to having the policy rate as a main objective. Given your experience, what you've seen in both Europe and the US, where this policy stance has gone through different political mandates, and you mentioned a deeper interaction or more coordinated interaction with the treasuries particularly during crisis periods. Has the role of the QE implementation ever shifted? Or did you ever feel like politicians were tempted with shifting it towards 'here's a tool for accessing financing that will contribute towards containing spreads' like in the case of Spain? How did that interaction play?
In the case of the US, QE has been a decision of the Federal Reserve and the Federal Open Market Committee as we looked at the data and the goals that we were trying to achieve. The modern-day implementation was created in the financial crisis when the federal funds rate had already been taken to zero, and the question was we were facing a potential deflationary shock and very high unemployment. If you're facing low inflation and high unemployment, we're missing on both sides of our dual mandate. We need to provide more stimulus for the economy, and so using quantitative easing was a tool to try to drive long rates down to provide more stimulus. But then once we got through that period, four or five years later, the Federal Reserve actually on its own started to unwind it and did the first quantitative tightening, shrinking the Federal Reserve's balance sheet until around 2019. And then we've been doing that again just as the ECB has in recent years. I would say a couple things. One is that the shocks, the financial crisis and COVID, were obvious and identifiable to everybody in the world. It was not an invention of any politician. These were real, and that's what motivated us. And the data that we were looking at, the inflation data, the unemployment data, that was also very clear, and so it was easy to explain why we were doing this given the situation that was obvious to everybody around. And then when we made the decision to now unwind quantitative easing and turn to quantitative tightening, it was in a context of very high inflation that everybody could see, everybody could feel. So I would just say the decisions have always been made by the Federal Reserve officials, and it's always been made in a manner consistent with the clear objectives that we have identified that we're trying to establish, and that's what enabled us to do it and have it not be used for other purposes.
