What Monetary Narrative After Forward Guidance?: Governor Francois Villeroy de Galhau

On October 11, 2022, Governor François Villeroy de Galhau of the Banque de France gave a lecture at Columbia SIPA on "What Monetary Narrative after Forward Guidance: How to Ensure New Predictability". This event was jointly organized by the Initiative on Central Banking and Financial Policy, the Center on Global Economic Governance (CGEG), and the MPA in Economic Policy Management at Columbia. Jan Svejnar, Director of CGEG, introduced the Governor and welcomed his second visit to Columbia.

"I posed the question at Jackson Hole and will answer it at Columbia," Governor Villeroy said as he started his lecture with the Jackson Hole Economic Policy Symposium in August, "Not having forward guidance does not mean, and cannot mean, not having a narrative and a monetary strategy." Against the backdrop of unusually high inflation and geopolitical uncertainty, Governor Villeroy discussed the “new predictability” of the European Central Bank (ECB) monetary policy. He justified ECB’s determination to reach the 2% interest rate target, proposed milestones toward balance sheet normalization, and shed light on the sensitive issue of monetary policy independence.

I. Deliver the 2% target in a determined way

As the inflation in the eurozone reached a record high of 10% last September, Governor Villeroy shared ECB's plan to address the high inflation and rebutted concerns of overreaction. He argued that neither the supply-side shock risk nor the recession risk should derail the ECB's plans. "It is our clear forecast and our will to bring inflation back towards 2% within 2-3 years." Following the recent 0.75% rate increase, he called for hiking the interest rate to near 2% by year-end and switching to a more flexible approach on a meeting-by-meeting basis.

II. No Forward Guidance but some milestones on the monetary path

Governor Villeroy presented a two-prong approach to the monetary policy framework and four indicators of monitoring progress on the path to normalization. He believed switching to meeting-by-meeting decisions is appropriate to avoid tying their hands in uncertain times.

“In my view, the right balance consists of explaining an intermediary step along our path. Beyond this intermediary step, I believe it would be useful for the euro zone to set out a few decision criteria, both on interest rates and on the size of our balance sheet,” he presented a pragmatic stance on balancing the “empiricist approach” relying on currently observable data and the “academist approach” purely looking forward for inflation forecast targeting.

To measure the progress of this framework, he offered four indicators of interest rates with robust data and visuals:

1. Actual inflation data with a focus on underlying inflation
2. Future inflation expectations of firms and households
3. Economic activities indicating growth and employment trends
4. A benchmark to measure the degree of tightening, based around forward real rates

Reaffirming his pragmatic stance, he gave some preliminary principles to guide the path to balance sheet normalization. While the primary tool of monetary policy is and should be the key interest rate, the Governor indicated his support for an orderly but flexible process of balance sheet drawdown. Calling for “a more cautious start followed by a gradual amplification,” he advocated for drawing down the emergency programs (TLTRO and PEPP) first and giving the most time to the APP holdings. 

III. A sensitive coordination issue

The last part of the lecture touched upon the sensitive coordination issue between central banks in the EU and the U.S. The Governor stressed that the ECB should and can run its own monetary policy. He elaborated on the collective doctrine to back up this stance before reflecting on the past lessons on misaligned exchange rates and overshooting. He concluded that the IMF should play a strong role and central banks should coordinate their communication.

Conclusion and discussion

Governor Villeroy concluded with an extension of his speech on “predictability and reactivity” at Jackson Hole, “Giving such partial predictability to markets is not being precommitted as with a precise and binding forward guidance; but it will help to align financial conditions with our target, and to avoid excessive volatility. And rest assured we will maintain two strong virtues for uncertain times: pragmatism – and data dependency – rather than pre-set ideology; international coordination – and in-depth dialogue – rather than fragmentation.”

After the lecture, Governor Villeroy had a dialogue with Patricia Mosser, Director of the Central Banking and Financial Policy Initiative and MPA in Economic Policy Management at Columbia SIPA. They discussed macro forecasting in the face of volatile core inflation and the importance and future of Central Bank independence. The Governor also engaged with students on topics ranging from Europe's structural transition to fighting the energy crisis and its growth prospects despite geopolitical challenges to supporting development in the global south.

The Banque de France also published the text of the Governor's speech.