Governor Olli Rehn of the Bank of Finland delivered a speech at the Bank of Japan Institute for Monetary and Economic Studies Conference in Tokyo, highlighting the enduring challenges faced by monetary policy. The conference, celebrating its 40th year, provided a platform to address both old and new challenges in the field.
Governor Rehn focused on two perennial challenges in monetary policy: inflation expectations and the current policy stance. He emphasized the importance of anchoring inflation expectations, as steering inflation towards target levels relies heavily on shaping these expectations.
In the euro area, the inflation outlook has remained stubbornly high for an extended period. Although most long-term inflation expectations are around the 2% target, certain indicators have shown a slight increase, necessitating continued monitoring. Governor Rehn highlighted the risks associated with persistently high inflation rates, as they can lead to adaptive inflation expectations, which must be avoided.
Drawing from recent research and analysis, Governor Rehn stressed the need for a deeper understanding of the formation of inflation expectations, including a psychological interpretation of survey data. By delving into the micro-level intricacies, central banks can gain valuable insights into expectation formation and survey behavior.
Regarding the current policy stance, Governor Rehn acknowledged the global common denominators influencing central banks. He highlighted Professor Obstfeld’s work on the importance of global factors in determining real rates and the potential risks of collective tightening policies among central banks, which could reinforce each other. The unprecedented extent and pace of monetary policy tightening globally, including the European Central Bank’s rate increases, have had a significant impact on the euro area’s financing and monetary conditions. However, uncertainties remain regarding the transmission of these policies to the real economy.
Governor Rehn also addressed recent events in financial markets, emphasizing the resilience of the euro area banking sector. Banks have strong capital and liquidity positions, surpassing minimum requirements and pre-financial crisis levels. However, ongoing vigilance is necessary to identify potential risks.
Communication and forward guidance were another key aspect discussed by Governor Rehn. He highlighted the importance of central banks consistently communicating their objectives and outlining the elements of their monetary policy reaction functions. The Bank of Japan’s decision to conduct a broad-perspective review of monetary policy was commended as an excellent opportunity for effective communication.
Governor Rehn concluded his remarks by emphasizing the prevailing uncertainty and the need for a data-dependent approach in determining the appropriate monetary policy stance. The Governing Council of the European Central Bank will continue to monitor the inflation outlook, underlying inflation dynamics, and the strength of monetary policy transmission. Governor Rehn emphasized the requirement for a sustained decline in underlying inflation before considering any policy easing measures.
The speech by Governor Olli Rehn highlighted the ongoing challenges in monetary policy and the importance of effective communication and data-driven decision-making in addressing them.