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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at a National consultation, Rome, 13 June 2020.
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The Italian economy: the outlook and the need for reform Speech by Ignazio Visco Governor of the Bank of Italy National consultation Rome, 13 June 2020 • The spread of the new coronavirus all over the world has led to an extremely serious public health emergency and an economic crisis without parallel in modern history. In order to contain the pandemic, in many countries it has been necessary to introduce measures to curtail people’s movements and social interaction, to suspend teaching in schools and universities and to temporarily close down many productive activities. The repercussions on global growth are severe. • Already in the first half of April, the International Monetary Fund estimated that global GDP would fall by 3 per cent in 2020, compared with an increase of the same amount forecast in January. At the start of this month, the World Bank estimated a decline of 5.2 per cent. Last week the OECD released scenarios indicating a fall of 6.0 per cent in the least unfavourable scenarios and of 7.6 per cent in the event of a second wave of contagion. It has been calculated that this year will see the most widespread fall in per capita income since 1870. • On 5 June, we presented a scenario analysis for the Italian economy as part of the Eurosystem staff macroeconomic projections. The analysis was based on alternative hypotheses regarding the duration and extent of the epidemic, its impact on the global economy and the financial repercussions. The baseline scenario is for GDP to fall by 9.2 per cent; in a second scenario based on more pessimistic hypotheses, consistent, among other things, with the need to counter possible new outbreaks, GDP would fall by 13.1 per cent. • All the scenarios indicate that the decline in GDP, both in Italy and worldwide, will be concentrated – and for the most part this has already occurred – in the first half of this year. However, a great deal of uncertainty surrounds the speed and intensity of the subsequent recovery and, in general, the outlook for the next two years. This is due to multiple factors. ‒ First of all, what happens next depends on non-economic variables, such as the course of contagion in different countries, including the possible appearance of new outbreaks, and the duration of the lockdown measures. Put simply, there is uncertainty about how long it will take and by what means the pandemic will be defeated. ‒ Second, there is uncertainty about the ability of the support measures adopted in the various countries to influence household confidence and consumption as well as firms’ expectations and investment. In other words, it is very difficult to foresee in this situation what resources will be required, how they will be employed, and how effective they will be. ‒ Finally, at a deeper level, we do not know how and how much this pandemic will end up shaping our behaviour, consumption patterns, and the allocation of potentially higher precautionary savings. We ask ourselves what new needs will emerge and what social mores will be definitively left behind. And we wonder about the possible consequences for how our society and productive activity is organized. It is very difficult to predict what shape these ‘new equilibria’ will take or what ‘new normal’ awaits us. • However, this heightened uncertainty must not become an excuse for inertia. It is, on the contrary, another reason to act immediately to strengthen our economy and to press on with a comprehensive package of reforms whose course, for the most part, has already been charted. Two weeks ago, in the Concluding Remarks that accompanied the publication of the Bank of Italy’s Annual Report, I recalled the words uttered by John Maynard Keynes 80 years ago, when he suggested ways of countering the economic difficulties of a great war. In a nutshell, Keynes’s idea was that the best short-term strategy was to come up with a good plan for the medium-to-long term (the same Keynes who to those suggesting that natural market forces should be left to run their course famously responded ‘in the long run, we are all dead’). • Only time will reveal the results of this endeavour, but a comprehensive plan makes the path ahead clearer, shapes expectations positively, and bolsters confidence. The impulse for reform can draw on a number of strengths that characterize our economy, which notwithstanding the last few difficult years have become increasingly apparent and which it is well to recall. Despite the delays and difficulties in many areas of the country, in recent months the network infrastructures have held up, enabling millions of workers and students to continue to work and study remotely during the most acute phase of the emergency. The manufacturing sector is flexible and, already since the sovereign debt crisis of 2011-12 has rapidly recovered competitiveness, bringing the balance of payments into surplus. Italy’s net external debt is practically nil. The real and financial wealth of households is high overall and their level of indebtedness among the lowest in the advanced countries, while those of firms are below the European average. In the private sector as a whole, debt amounts to 110 per cent of GDP, even lower than that of Germany (114 per cent) and half the level recorded in countries such as France (215 per cent) or the Netherlands (258 per cent). The financial system has become stronger in recent years and, despite the very serious effects of the double-dip recession, is in better shape now than it was on the eve of the financial crisis. • For more than 20 years now, our economy’s biggest problem has been low growth, in turn due to very weak productivity growth. ‒ It is well known that the demographic projections are not favourable: even taking account of the contribution of immigration (estimated by Eurostat to amount to more than 200,000 persons on average per year), the population aged between 15 and 64 will decline by more than 3 million in the next 15 years. Nevertheless, assuming that the trends of the last ten years continue in a similar vein, higher female labour market participation and the extension of working lives can enable employment to make a positive contribution to growth, of more than half a percentage point per year. ‒ To restore GDP growth to at least 1.5 per cent, the average annual level recorded in the ten years leading up to the global financial crisis, will accordingly require an average increase in labour productivity of almost 1 percentage point per year. • This objective is within our reach, but its achievement presupposes a break from the recent past; it calls for the resolution of those structural problems, which for too long now we have failed to address, and which have become increasingly pressing in a new technological context and a more integrated world. • Productivity gaps cannot be bridged through expansionary monetary or fiscal policies. Indeed, these are macroeconomic stabilization measures that are essential to achieving adequate levels of aggregate demand, facilitating full employment and preserving price stability, but they cannot, in and of themselves, raise productivity in the long term. • In this emergency phase, the measures in support of households and firms have been crucial to mitigating the economic and social costs of the crisis; they will continue to be so in the future, in order to support demand and thereby attenuate the impact of the transition by tackling social hardship and the rise of inequality. Now, however, it is essential to map out the path of reform that is best suited to raising growth potential, and to achieving the broadest possible consensus, being aware that, oftentimes, the costs of structural changes are immediate, while the benefits only develop gradually and not always rapidly. • Resources must be channelled to where the social returns are highest. The accumulated lag in traditional infrastructure must be overcome by upgrading it and making it more efficient, but it is possible to identify three macro-areas in which it appears equally urgent to intervene. • The first is the public administration, which must truly be at the service of citizens and firms. A substantial improvement in the quality and timeliness of public services is required: the oft-cited necessary simplification of procedures must be accompanied by the right allocation and mindful assumption of responsibilities on the part of civil servants, managers and officials, who need to be rewarded and motivated: we need a good bureaucracy, not an absent bureaucracy. We also need to speed up the justice system to ensure full compliance with the rules. There are two variables that have a profound impact on the functioning of any firm: technology and human resources. As for the former, what we have learnt from this crisis has shown the way forward, demonstrating the need to fast track the digitalization of all working processes and to rethink their organization. Regarding the latter, we now have a unique opportunity: the heavy turnover expected in the public administration in the coming years will make it possible to hire young, highly skilled and motivated workers from a variety of backgrounds, whose enthusiasm we must nurture and whose skills we must foster; we must invest in them and in the training of staff. • • The second area is innovation; the measures to facilitate it can be plotted along three main axes. ‒ First of all, the development of highly innovative infrastructure and sectors. For example, the fixed ultrafast broadband network still only reaches less than one fourth of Italian households, compared with 60 per cent on average in Europe, and is especially penalized in the South of the country. The European Commission ranks Italy nineteenth among the EU states for connectivity. The opportunities that will come from the inevitably faster transition to a more environmentally friendly economy with lower polluting gas emissions must be seized. ‒ A second point is the need to improve the quality of human capital, by tackling the underlying problems of schools and universities. Italy ranks second last in the European Union on the proportion of young people aged between 25 and 34 with tertiary education; it is ranked first for the share of young people aged between 15 and 29 who neither study nor work. Teacher quality and motivational levels are of vital importance. In many cases, school and university buildings fall short on security; they should instead be comfortable and equipped with up-to-date technology. Moreover, it is necessary to understand that the problems related to education are not only on the supply side: households must also grasp the importance of investing in knowledge, not only in school but also as a lifelong pursuit. ‒ Finally, it is necessary to invest in ensuring the high-quality of Italy’s research. The State spends about €8 billion in its university system, half of what countries similar to Italy do, relative to GDP. Even just the reallocation of a modest portion of the government budget would lead to a marked improvement in the training of young researchers and in fostering innovation. This would strengthen Italy’s ability to tap into the European resources allocated to research; it would also benefit the productive sector, which puts barely 0.9 per cent of GDP into research, compared with 1.7 per cent, on average, in OECD countries. The hiring of new researchers, envisaged in the decree issued on 19 May, marks a significant break with the past. The third area to consider concerns the preservation of Italy’s natural, historic and artistic heritage, which constitutes this country’s very identity. The crisis in the tourist sector has made its economic importance immediately apparent. This sector must be preserved and access to it made safe, increasing the use of new technologies so that, after the pandemic, it can once again contribute to growth, even more so than before. • The public resources needed to finance these measures and to promote the productive use of private funds must come from a restructuring of the public budget, the recovery of the tax base, a reduction in the risk premium on government bonds, and the pragmatic and judicious use of European funds. • Excluding interest payments, Italy’s public expenditure is in line with the average for the euro area as a whole, even if the share of pension expenditure is higher and destined to increase further, driven by an ageing population, as in many other countries of the European Union. Tax revenues are also broadly aligned with the average of the other countries, even if the tax wedge on labour is higher. Where Italy differs most from the other advanced economies is in the extent of its underground and illegal economy and tax evasion, which translates into an excessive tax burden for those who always play by the rules. The resulting injustices and profound distortionary effects reverberate on the economy’s ability to grow and firms’ capacity to innovate; they generate rents that damage the efficiency of the productive system. A comprehensive rethinking of the tax system that also takes account of the changes in the social welfare system must adopt the objective of reducing the tax levy on the factors of production. • The sustainability of the public debt is not in doubt, but its high ratio to GDP is being maintained by the low growth potential of the country and is, at the same time, an obstacle to economic growth. Economic growth and prudent fiscal policies to encourage investment should, instead, reinforce each other, in a virtuous circle that our country is capable of activating, favouring a reduction in the burden of debt servicing costs. • Italy’s difficulties are amplified in the South of Italy. First and foremost the business environment needs to improve in the southern regions, above all as regards guaranteeing legality. The technology gap is even greater, public policies are less effective: 75 per cent of unfinished works are located in these regions, of which only 30 per cent are public works. The South of Italy is fast becoming poorer, in part owing to the emigration of its youngest and most highly-educated people to the Centre and North of the country. It is a trend that has immediate social costs and negatively impacts growth prospects. • There have been numerous attempts to deal with ‘the Southern question’ over the years, with interventions that have been as differently structured as the results have been disappointing. The development of the South is essential to the development of the country: about one third of the Italian population lives in the southern regions, producing almost a quarter of Italy’s GDP. Measures to support growth in the regions that are lagging behind must not distort the incentives for firms and workers, preventing the employment of the most productive resources. It is necessary to act on the factors underlying the delays – it is not enough to try to compensate for them with monetary transfers. The effects on the southern economy of efforts to reform the public administration, schools and infrastructure can be extremely significant. * * * • Lastly, allow me to express my most sincere wish that these national consultations may conclude with concrete actions that allow us to take the steps forward that the country needs, now more than ever before, making the most of the opportunities offered by the new European programmes that have already been approved or are now being drawn up. • European funds can never be free of charge: the debt of the European Union is the debt of all the member countries and Italy will always make an important contribution to the funding of common initiatives, because it is the third largest economy in the EU. The benefits of European support measures should be valued not only because of the considerable financial advantage that characterize them, but also – and above all – for the opportunity to frame the national effort within a common development strategy. This is the only way to respond to the global challenges facing us, not only those of a geopolitical, technological and environmental nature but also, as we have learnt the hard way in recent months, to public health challenges.
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the EuroScience Open Forum 2020, Trieste, 4 September 2020.
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Economic growth and productivity: Italy and the role of knowledge Ignazio Visco Governor of the Bank of Italy EuroScience Open Forum 2020 4 September 2020 1. I would like to thank Professor Stefano Fantoni for his kind invitation and the conference organisers for their determination in setting up this event during these very difficult times. In this presentation, I will focus on the well-known role of human capital and innovation as determinants of economic growth and consider how crucial delays in the field of knowledge may have translated, in Italy, into the slow growth of gross domestic product (GDP) that we have observed in the last 30 years or so. 2. There is no need to emphasise how serious the public health emergency caused by the rapid spread of the new coronavirus all over the world has become. Over 25 million of people are estimated to have been affected and close to one million have lost their lives. Italy was the first western country in which the epidemic took hold, in early 2020. The toll has been very high, with more than 250 thousand people affected and 35 thousand deaths. 3. The drastic measures adopted to contain the propagation of the virus – which have included the limitation of people’s movements and social interaction, the suspension of teaching in schools and universities, and the temporary closure of many productive activities – have hit the Italian economy profoundly. As the latest figures suggest, by mid-2020, GDP had returned to the level observed in early 1993 (slide 1 in the accompanying presentation). In per capita terms, GDP dropped down to values recorded in the late 1980s. 4. The reason for this huge jump of about 30 years back in the past is twofold. The first is, of course, the striking extent of the collapse of the economy due to the pandemic: in the second quarter of this year, in particular, GDP fell by almost 13 per cent with respect to the previous quarter. As a result, in just three months GDP lost more than during the whole 2008-2013 period, which includes the double-dip recession related to the global financial crisis and the euro-area debt crisis, which had already been the worst slump in peacetime since Italy’s unification in 1861. The second reason why we went so far back in the past is that, since the 1990s, Italy’s GDP growth has been extremely weak. While other advanced countries have suffered similar or even worse declines of GDP in the second quarter of 2020 (‑9.1 per cent in the United States, ‑9.7 in Germany, ‑13.8 in France, ‑18.5 in Spain), no one has recorded such a huge jump back, because past growth has been much more robust elsewhere. GDP has returned, for instance, to the level observed in 2014 in the United States, 2010 in Germany, 2002 in France and in Spain. 5. Tackling the difficulties created by the pandemic all over the world is clearly the most urgent issue. With its diffusion, the prospects of long-lasting negative consequences for economic activity, employment and the distribution of incomes have become more daunting. Not surprisingly, the global response of governments, central banks, and supervisory authorities in the majority of countries has been immediate and extraordinary. Central banks, in particular, have used a wide array of instruments to make monetary conditions more accommodative, counter the tensions in financial markets and support lending to households and firms, avoiding a credit crunch. The support of fiscal and monetary policy to aggregate demand will necessarily continue in the foreseeable future, also to counter the substantial increase in precautionary saving brought about by the surge in uncertainty produced by the pandemic. 6. For Italy, however, addressing the problems that have restrained growth for about 30 years is equally important. To this purpose, as I have argued many times, it is essential to implement reforms aimed at creating a more business-friendly environment, by raising the quality and efficiency of public services, increasing the level of public investment, improving civil justice, reducing the administrative and bureaucratic burdens that hamper private investment, lowering the weight of tax evasion, corruption and other criminal activities. These reforms would yield important results but, for an advanced country like Italy, they would not be sufficient. 7. When a country approaches the technological frontier, its income and wages no longer allow for a development strategy based only on cost and price competition. In this context, economic growth depends on the capacity to incorporate and foster innovation, which requires adequate spending on new technologies, and on the quantity and quality of investment in education, from primary school to university. The delays accumulated in innovation and education and their interrelation with the structure of the productive system are most likely at the root of Italy’s weak economic growth. Innovation 8. A long-standing problem whose importance has increased in Italy in the more recent decades is the very low level of spending in research and development (R&D). The latest figures indicate that, in 2018, R&D expenditure as a share of GDP stood at just 1.4 per cent, against 2.4 per cent in the average of the OECD countries, and less than half of the level recorded in advanced economies like the United States and Germany (slide 2). A comparison with China is also instructive: in the year 2000 the incidence of R&D on GDP was 0.1 percentage point lower than in Italy, at 0.9 per cent; 18 years later it was almost a full percentage point higher, at 2.2 per cent (an even more impressive increase if we consider the striking growth of Chinese GDP). 9. Although the problem concerns both the public and private sectors, the gap with developed countries is larger in the latter, where the share of R&D expenditure is 0.9 per cent, about half of the OECD average (1.7 per cent). The overall “investment in knowledge” of firms has been conveniently summarised in one single indicator by the OECD, called “spending in knowledge-based capital”, which includes expenditures for software, R&D, copyrights, design, marketing research, firm-specific training and organisational know-how. This indicator sees Italy among the lowest-ranked countries in the OECD (slide 3). 10. The low private and public spending in R&D is reflected in the smaller number of researchers compared to the main advanced countries. In Italy, they are only 5.5 for each thousand of workers against almost 9 for the OECD. The number of patents, normalised by the size of GDP, reflects these deficiencies, standing at less than half with respect to the average for the OECD countries. 11. Despite these limitations, the quality of the research produced in Italy bears comparison with the main European countries. For example, the share of Italian journal articles ranking among the top 10 per cent of the most cited publications in all fields of knowledge is higher than the shares of countries like France and Germany (and higher that the average share for the European Union). In science, the field-weighted citation impact of publications by authors working in Italy is higher not only than those by authors in France and Germany but also than those by authors in the United States (slide 4). The Italian research system also stands out for its high productivity: its total number of publications in all fields of knowledge normalised by the amount of spending in R&D is, for instance, twice as high as in France and Germany. Human capital 12. Low spending in research is matched by insufficient investment in education, which depresses the level of knowledge and competence of the labour force – what economists usually refer to as human capital. This problem has both a quantitative and qualitative dimension, whose importance has increased as Italy has moved closer to the technological frontier. 13. With regard to the quantitative dimension, data show that Italians do not attend school long enough. Italy is in the penultimate place in the OECD for the share of people between 25 and 34 years with a tertiary qualification, at 28 per cent, against an average of 44 per cent for the OECD countries, with values above 60 per cent for Canada, Japan and South Korea. It is the first for the incidence of population between 15 and 24 years who are not in education, employment or training (so-called NEET): for people aged 20-24, in particular, this share stands at 28.4 per cent, more than twice the average share for OECD countries (slide 5). 14. While the low incidence of young people in employment and training depends mostly on the persistent weakness of the Italian economy, the responsibility for the low number of those in education is also shared by households, who do not invest sufficiently in education. A key contribution to address this problem could come from an enlargement of the supply of tertiary level programmes with a professional content, which are more suitable for students who would not attend more traditional courses. Professional tertiary programmes are still underdeveloped in Italy, a phenomenon that explains a large part of the Italian gap. 15. The qualitative dimension of the education problem concerns the fact that Italian students seem not to be learning enough. The Programme for International Student Assessment (PISA) documents, at each round, that 15-year-old Italian students fall below the OECD average in reading, mathematics and science – a disappointing outcome for a country that would need to grow faster that the main advanced economies in order to catch up their level of income per capita (slide 6). An in-depth look at the latest data (for the year 2018) shows that this dismal performance is largely the result of the delays in Italy’s Mezzogiorno: while the North-West and the North-East of the country perform above the OECD average, the South and the Islands fall worryingly below (slide 7). 16. These gaps translate into analogous gaps for Italian adults. The Programme for the International Assessment of Adult Competencies (PIAAC) carried out by the OECD between 2013 and 2016 indicates that, at each age cluster, Italian adults perform invariably worse than the average adult in the OECD (slide 8). In particular, it reveals, for our country, a widespread lack of those skills – reading and understanding, applying logic and analysing – that respond to modern life and work needs. For example, in literacy proficiency, about 70 per cent of Italians appear to be unable to understand long and articulated texts adequately (a result that makes Italy one of the worst performers among the OECD countries participating in the test, in which this share is, on average, about 50 per cent). In the numeracy test, a similar share turns out to be unable to successfully carry out relatively complex reasoning about quantities and data (against about 50 per cent in the OECD average). 17. Financial competencies are also low in the international comparison. According to the survey conducted by the Bank of Italy at the beginning of 2020 as part of an international programme started by the OECD, Italy ranks 23rd out of 26 countries according to a synthetic score that measures three areas of financial literacy: knowledge, behaviour and attitudes. Italy’s score is lower even than that of non-OECD countries with very modest levels of GDP per capita. These findings suggest that the gap in financial literacy with other countries is attributable only in part to lower levels and quality of education or to other unfavourable social or economic conditions and suggests that there is plenty of room for improvement across all the areas of financial literacy. 18. One of the reasons for the gaps that I have just described is linked to the modest level of spending in education, which is especially low at the tertiary level (slide 9). In 2016 the incidence of expenditure on tertiary education on GDP was 0.9 per cent in Italy, one of the lowest shares in the OECD. More effective and, in some cases, additional spending is required in many aspects. In primary and secondary education, the preparation and motivation of teachers are essential and should be adequately nurtured. Buildings and infrastructures are often obsolete and, at times, have problems with their overall security, when they should instead be technologically adequate and comfortable. 19. However, the obstacles to a better education are not only related to the supply side. Demand for skilled workers has proved to be weak as well. The ratio between the earnings of workers with a tertiary education with respect to those with upper secondary education is lower in Italy with respect to the OECD (or the EU) average (slide 10). This is a paradoxical result, which we highlighted many years ago: a lower endowment of human capital, like in our country, should in fact determine a higher return, as this production factor is in shorter supply (slide 11). 20. In part, the paradox could be explained by the specialisation of Italian firms in traditional sectors and by the predominant role of small firms, for which the demand of highly educated workers is typically weaker. The relatively low earnings of these workers, however, could also be the result of a vicious circle between demand and supply of human capital, triggered by the strategy of firms. Indeed, they may have reacted to the perception of a generally low quality of education with a generalised offer of low wages, which, in turn, would not have been sufficient to foster higher investment in education by families. In addition, the difficulties in finding suitable skills in the labour market could have resulted in firms consolidating their low propensity to invest in new technologies, thereby containing the need for skilled labour. 21. Low returns and low demand for skilled workers are among the reasons that encourage a high number of Italians, especially highly educated young people, to migrate abroad. Between 2009 and 2018, 816,000 Italians moved their residence in a foreign country (against 333,000 who repatriated to Italy); in 2018 out of the 157,000 Italians who emigrated, about 30 per cent had tertiary education while 25 per cent had upper secondary education. 22. A large collective effort is required to reverse this vicious circle. Albeit low in the international comparison, highly educated workers still preserve a sizeable earning advantage with respect to less educated workers; moreover, they show a lower risk of remaining unemployed and generally have more stable careers. Families and students should therefore understand the importance of investing in knowledge, not only at school but also throughout their whole lives. Additional investment by the State should aim at modernising the infrastructures as well as at improving the training and motivation of teachers. Private firms also have a key role to play. Their reaction to the huge transformation induced by technological progress and globalisation during the 1990s was a demand for lower labour costs, instead of higher and adequate investment in the new technologies. This would have spurred the demand for highly-skilled labour possibly triggering a virtuous cycle of demand and supply of high education, to the benefit of the business sector as well as that of society at large. The structure of the production system 23. Innovation and education are shaped by, and in turn shape, the structure of the productive system, which is extremely fragmented in Italy. A single observation well summarises this problem. According to the latest available data (for the year 2016), 25,000 medium-large firms (with more than 50 employees) produce almost half of the value added of the industrial and non-financial service sector, with almost 6 million employees; the other half is produced by 4.3 million small firms, with 6 million employees and 4.8 million self-employed workers. In France, Germany and Spain, the share of value added produced by large companies is higher and the incidence of self-employed workers, small businesses and their employees is lower (slide 12). 24. Literature has emphasised the possible role of institutional factors in hampering the dimensional growth of firms. Regulation, for instance, can be more severe for larger firms or may prevent them from entering specific markets (such as in professions or in retail trade); tax evasion may be easier for smaller firms, reducing the incentives to expand their economic activity. More recently, many studies have also focused on the importance of the quality of management practice. Their role is twofold. On the one hand, the quality of management depends on the size of firms; small firms, for example, have more difficulties in attracting the best managers. On the other hand, managers determine firms’ performance, including their ability to grow. 25. Small firms around the globe are usually family-owned. In Italy, however, their managers are mostly selected within the local market and often coincide with the firms’ owners or with their relatives. Family firms and small firms typically rely less on good managerial practices, such as team working, performance-related pay, or workers’ participation in the decision making process. According to well-known international surveys, the average quality of managers is, in Italy, lower than that in the top-performing countries, a result that reflects not only the scarce diffusion of high quality management, but also the lower level and quality of education in general. 26. The “dwarfism” of the Italian productive system is strictly interrelated to the ability of firms to introduce good managerial practices, adopt new technologies in order to develop innovation of products and processes, and invest in human capital. These features of our industries profoundly affect the average productivity of the economy. Larger Italian firms are often more productive than the corresponding French and German firms, but the very numerous group of smaller firms, which are much less productive than those of the main competitors, brings the average down (slide 13). Had Italy had the same firm size structure as Germany, its average labour productivity would have been more than 20 percentage points higher, surpassing the German level. Differences in the sectoral composition between the two countries have a much smaller role in explaining the low productivity of Italian firms: had Italy had the same industry composition of Germany, its labour productivity would have increased, ceteris paribus, only by 3 per cent. Italy’s old delays and its recent dismal economic performance 27. A weak capacity to innovate, a low level of human capital, and a predominant weight of small firms characterised Italy even when its economic growth was rapid and outpaced that of most of the other developed countries. We should not forget that, after the Second World War, Italy started a rapid process of catching-up growth with respect to the United States (usually identified as the country at the technological frontier). This process came to a halt in the late 1980s and, since the mid-1990s, the gap between the two economies has been widening (slide 14). In a country with a similar product specialisation such as Germany, instead, the process of catching-up with the United States was interrupted only temporarily, between the early 1990s and the mid-2000s, a period characterised first by the German reunification and then by a sharp rise in US productivity growth, but it resumed thereafter. 28. Two factors have contributed to halting Italy’s catching-up and triggering its long-lasting decline. First, as I have already mentioned, when an economy approaches the technological frontier and its income and wages converge to those of the most developed countries, an autonomous capacity to innovate is needed to fuel economic growth. Second, the world has dramatically changed in the last 30 years, due to both the globalisation of markets and the information-technology revolution, with the latter that is now driving the digital transformation of our economies and personal lives. 29. In this new context, the importance of innovation and knowledge has grown. Consider, for example, the quality of management: since the information-technology revolution, this factor has become highly correlated with productivity growth. More in general, Italy has paid the price of the delays that we have documented with respect to the main advanced countries in terms of innovation capacity, human capital, and fragmentation of the productive system. 30. With the recent development of digital technologies, Italy has unsurprisingly started to accumulate a new delay. This is similar to the one observed in the 1990s with reference to the rise and diffusion of information and communication technologies. Today as back then, also given their size, Italian firms seem unable to take advantage of the adoption of the new digital technologies, which require adequate skills and managerial capacities. As a consequence, not only is the production of digital goods and services low, but their use by firms and households is also modest. The index that summarises the level of digitalisation in Europe (the Digital Economy and Society Index, DESI) places Italy in 25th place in the European Union this year (slide 15). The gap with respect to the other countries is especially large in the use of Internet services as well as in the digital skills of the population. 31. As a result of these dynamics, GDP per capita has slowed down since the mid-1990s and, after the double-dip recession due to the global financial crisis and the euro-area sovereign debt crises, has never been fully recovered (slide 16). Labour productivity (measured by GDP per hour worked) started to stagnate in the mid-1990s and its weakness persists today. 32. The key variable underlying the dynamics of GDP per capita and labour productivity is the so-called total factor productivity: the component of production that is not explained by the stocks of labour and physical capital employed in the production process. Changes in this variable measure, albeit imperfectly, the gains in the efficiency of production due, for example, to organisational changes, new technologies or a better quality of human or physical capital not captured by the statistical measurement of accumulated capital (slide 17). 33. The current economic crisis has shown that, in the short term, economic growth depends on several, often unpredictable, factors. In the long run, instead, productivity improvements are the key ingredient for economic development and the most important factor explaining cross-country differences in income and GDP (slide 18). It is for this reason that, in order to restore a path of sustainable growth, measures necessary to undertake the urgent problems created by the current pandemic crisis need to be flanked by interventions aimed at addressing the obstacles that hamper innovation. Why GDP growth matters 34. As most economists do, I have focused on GDP and its determinants. This indicator has been subject, not only in recent years, to various criticisms concerning its ability to grasp all the material aspects that define the conditions of an economy and the fact that it neglects non-economic and intangible factors which, however, contribute significantly to the well-being of a country. Several projects have been undertaken in the past to provide a more comprehensive measure of welfare. In the early 1970s, for example, Nordhaus and Tobin built a new indicator (the “measure of economic welfare”) which adjusted GDP by including non-market activities, reclassifying government expenditures based on their impact on households’ access to key public services (such as transport, health and education) and calculating amenity losses due to environmental pollution. However, their conclusion was that the broad picture of secular progress, which GDP conveys, remains valid even after the correction of its deficiencies. 35. Similarly, in the early 1980s Amartya Sen argued that a proper assessment of well-being should take into account people’s access to education, health, civil rights, freedom of opinion, as well as to economic factors, such as income and consumption. The practical implication was the construction of the so-called “human development index”, built by the United Nations, which integrates per capita GDP with other indicators to measure the degree of well-being achieved in the various countries. 36. More recently, high emphasis has been placed on the social costs of income inequality, the impact of digitalisation and the environmental sustainability of production. A set of guidelines for a comprehensive measure of well-being and social progress has been recommended in the OECD Report Beyond GDP (which described the results achieved by an expert group led by Joseph Stiglitz, Jean-Paul Fitoussi and Martine Durand). Experimental indicators are currently being produced in several countries under national initiatives. In Italy an “index of equitable and sustainable well-being” (BES), which is based on both hard and soft indicators covering twelve dimensions (such as health, education, safety, work and leisure balance, social relationship, politics and institutions, environment) is now computed and regularly updated. 37. Despite its limitations, GDP per capita appears to have a very strong link with the fundamental variables for the well-being of a country. Considering data for almost 200 countries referring to the year 2018, there is in fact a very high correlation (of over 90 per cent) with the human development index (slide 19). This close relationship does not arise only from the fact that GDP per capita is one of the three main components of this index. Correlation is in fact high also with the other two variables, life expectancy (i.e. the average lifespan expected at birth) and level of education as measured by the United Nations (which is the simple mean between the average years of schooling for audults and the expected average years of schooling for children; slide 20). The relationship with the latter in particular should not be surprising: on the one hand, a higher income allows, on average, a larger share of the population to study; on the other hand, higher levels of education tend, as we have discussed, to increase production efficiency and the level of GDP. The link with life expectancy depends on the fact that rising levels of GDP per capita are associated, among other things, with better nutrition, higher hygiene conditions and more effective health systems. 38. There is one dimension in which GDP, however, does not perform well as a measure of well-being, which stems from its impact on the environment. Data also show, in fact, a dangerous correlation between GDP per capita and carbon emission, which are harmful both for the health of human beings and for the planet (slide 21). This cost of economic development can no longer be borne. In the absence of more adequate incentives for “green” investment, more stringent regulation, or higher taxation of the most polluting energy sources, the rise of greenhouse gas emissions would lead to a worrying increase in the temperature of the planet. 39. The main climatic models predict that, absent changes, the global temperature would overcome the 1.5 degree threshold, with, according to the United Nations Intergovernmental Panel on Climate Change, catastrophic effects for our planet. This is a problem that, of course, goes well beyond national borders. Yet, the speed at which the temperature is rising and the apparent inexorability of this trend are such that a quick and strong response from all countries is required. Scientific research has a clear role to play in addressing this unprecedented challenge. It is time to direct increasing resources and efforts to address these side effects of economic development. Knowledge is once again the key asset in which we need to invest to make further economic progress, while protecting the environment. * * * 40. Recovering the path of GDP growth that Italy interrupted 30 years ago is a question with implications that go beyond the mere economic sphere. They affect the health of its citizens, the quality of their leisure time, their overall standard of living. The urgency of the problems posed by the pandemic should not make us lose sight of this longer-term issue. In order to overcome this challenge, our economy needs an intense technological and cultural transformation. SLIDES Italy’s GDP is back to the level recorded in 1993 GDP in some advanced countries (quarterly data; indices: 1993=100) Source: Eurostat, U.S. Bureau of Economic Analysis Spending on R&D is low… Spending on research and development as a share of GDP in 2018 Source: OECD and so is investment in knowledge… Business investment in knowledge-based capital as a share of GDP in 2015 Source: OECD …but the quality of research is relatively high Field-Weighted Citation Impact of scientific publications in 2015-16 Source: Anvur, Scopus Italy has a very high share of NEETs… Share of the population not in employment, education or training, for different age clusters in 2018 Source: OECD and school results are below the OECD average… Results of the OECD PISA tests Source: OECD …a problem mostly concerning our Mezzogiorno Results of the OECD PISA tests in 2018: the North-South divide Source: OECD Competences are low also for adults Results of the OECD PIAAC tests in 2013-16 (score) (1) Minimum score 0, maximum score 500 Source: OECD Sweden Norway Denmark Estonia Belgium Australia New Zealand Italy Finland Korea United Kingdom Latvia Canada Austria Luxembourg Netherlands EU 23 OECD members Switzerland Poland OECD - Average Israel Spain France Slovak Republic Turkey Germany Portugal Czech Republic United States Ireland Lithuania Hungary Mexico Colombia Chile Luxembourg Ireland Italy Czech Republic Slovak Republic Slovenia Latvia Hungary Lithuania Portugal Poland Germany Spain Iceland Mexico Japan Israel France Belgium Estonia Sweden Finland Netherlands Korea New Zealand United Kingdom Austria Turkey Australia Norway Colombia Canada United States Chile Spending in tertiary education is insufficient Total expenditures in tertiary education as a percentage of GDP in 2016 2,5 2,0 1,5 1,0 0,5 0,0 Source: OECD Source: OECD Returns to higher education are modest… Earnings of workers with tertiary education with respect to workers with upper secondary education, for different age clusters in 2017 (percentages) 25_64 25_34 …with an Italian paradox: low supply and low returns Relative earnings Relative earnings of workers with tertiary education and share of population with tertiary education (aged 25-64) in 2017 ITA ITA Share of population with tertiary education Source: OECD The weight of small firms is predominant… Value added shares by firm size in 2016 Employment shares by firm size in 2016 0_9 10_19 Germany 20_49 France 50_249 250+ 0_9 10_19 Spain Italy Germany 20_49 France 50_249 250+ Spain Italy Source: Eurostat …but only large firms bear the international comparison Average value added per worker by firm size in 2016 (thousands of euro) Total 0_9 10_19 20_49 Germany Italy France Source: Eurostat 50_249 250+ Spain Italy’s catching up halted in the 1990s GDP per capita and GDP per hour worked with respect to the United States GDP per capita GDP per hour worked Germany Italy Germany Source: OECD and Penn World Table Italy A new delay is emerging in the development and utilisation of digital technologies Digital Economy and Society Index and its components in 2019 Source: European Commission The stagnation of productivity has continued even after the double-dip recession of 2008-2013 Economic growth and productivity (indices: 1970=100) GDP Labour productivity Source: AMECO Per capita GDP Productivity growth is the key to long-term growth… Average growth rates of GDP, labour productivity, hours worked and total factor productvity (TFP) 3,0 2,5 2,0 1,5 1,0 0,5 0,0 1970-1985 1985-1995 1995-2007 2007-2014 2014-2018 -0,5 -1,0 -1,5 GDP Labour productivity TFP Hours worked Source: AMECO …and the variable that best explains crosscountry differences in GDP per capita GDP per capita GDP per capita and labour productivity in 2017 (thousand of 2011 US dollars) USA ITA ρ = 0.98 Source: Penn World Table Labour productivity GDP per capita highly correlated to the human development index… HDI Human development index and GDP per capita in 2018 (ranking positions) ρ = 0.95 GDP per capita Source: United Nations …as well as to its main components: life expectancy and education Life expectancy and GDP per capita in 2018 (ranking positions) Education and GDP per capita in 2018 (ranking positions) Education Life expectancy ITA ρ = 0.84 ρ = 0.84 GDP per capita GDP per capita Source: United Nations But it is also correlated to carbon emissions Carbon emissions per capita Carbon emissions per capita and GDP per capita (ranking positions) ρ = 0.89 GDP per capita Source: United Nations Designed by the Printing and Publishing Division of the Bank of Italy
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the Italian Banking Association Executive Committee Meeting, Rome, 16 September 2020.
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Keynote speech by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at a webinar organized by the City of London Corporation, 15 October 2020.
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Build Back Better – Mobilising Private Finance for a Green Recovery Keynote speech by Luigi Federico Signorini, Banca d’Italia City of London Corporation, 15 October 2020 That climate change is one of the key challenges of this century there can be little doubt. To what extent humankind will be able to rise to this challenge depends on several actors, each playing their role. Let me start by listing three of them: • individuals; • governments; • the market and financial authorities, including central banks. The list is not, of course, exhaustive: it is meant to provide a background for what I shall say when developing this meeting’s theme, emphasising among other things the role of central banks and financial supervisors. At the end, I am going to add some words on the Bank of Italy’s own sustainable investment policies. A premise is in required. Whatever the eventual route to climate action, full awareness among the general public must be the starting point, at least in democratic countries that use the market to allocate economic resources. People’s awareness drives their choices as consumers, voters and investors. It thus ultimately shapes the performance of the whole cast of actors. Awareness of climate change, and of the need for action to tackle it, has rapidly increased in countries around the world, with Europe at the forefront. In the latest Eurobarometer1 survey, the majority of respondents in 19 countries think climate change is one of the most serious problems facing the world today. In all but one country, respondents are now more likely to think this way than they were in 2017. Even in the US, where opinions on climate change are divided, 59 per cent of the population considers climate change a major threat.2 Individual behaviour matters a great deal, and many people (especially, but by no means only, the young) make conscious pro-environment choices nowadays about Eurobarometer (2019), ‘Special Eurobarometer 490 – Climate change’. PEW Research Center (2019), ‘A look at how people around the world view climate change’. issues that were just a fringe concern a generation ago. This applies to all sorts of things, from sorting rubbish to changing light bulbs to choosing a motor vehicle – or, for that matter, a vehicle for financial investment. Retail investors, in fact, are also increasingly interested in climate-friendly financial products. This is as true in my country3 as in other parts of Europe.4 However, besides reflecting personal preferences, people’s behaviour also responds to incentives, and is constrained by rules. Here is where the government actor enters the stage. As Governor Visco5 recently observed, defining policy action to pursue climate objectives is the primary responsibility of governments. In a democratic polity, it is for elected officers to decide on the ultimate balance of the benefits and costs of any environmental policy. Seen from an economist’s point of view, one key issue for governments to decide on is finding ways to make agents internalise climate externalities. Progress on this front, while undeniable, has only been partial. Carbon taxation (the economic theorist’s favourite tool, as it makes fewer demands on the government’s information set and relies more on market decisions), covers just a tiny fraction of global emissions.6 Most existing carbon pricing systems rely on cap-and-trade, a framework that is prone to extreme price volatility and corner outcomes, and is therefore often regarded as second best. Still, even in Europe, where this system is widespread, the market for allowances only covers about 40 per cent of emissions. The current crisis has further and significantly lowered fuel prices. If price-based market allocation is to help achieve the Paris targets, more action is needed on the fiscal and regulatory side. Governments can also fund low-carbon projects directly, as envisaged for instance in the ‘Next Generation EU’ plan.7 However, the size of the investments needed is likely to go far beyond whatever governments will directly fund. According to Commission estimates, the European plan to become carbon-neutral by 2050 requires €350 billion of additional investments in 2021-2030.8 In contrast, the whole EU budget expenditure for 2020 amounts to €155 billion.9 While national governments spend much more, achieving the global climate targets must realistically assume that private finance will play a central role. Doxa (2019), ‘Risparmiatori italiani e cambiamento climatico’. ISS ESG (2020), ‘European Sustainable Finance Survey’. Ignazio Visco (2019), ‘Sustainable development and climate risks: the role of central banks’. 3-4 per cent, according to World Bank (2019), ‘State and Trends of Carbon Pricing 2019’. Some 37 per cent of Next Generation EU funds will be spent directly on European Green Deal objectives. European Commission (2020), ‘Stepping up Europe’s 2030 climate ambition. Investing in a climate-neutral future for the benefit of our people’, COM (2020) 562 final. European Commission (2020), ‘Draft amending budget No 8, 28 August 2020’. In fact, market appetite for greener finance has not been lacking recently. The size of the sustainable asset management industry is expected to reach $45 trillion by the end of 2020,10 almost twice the amount in 2016.11 Green finance instruments have grown very rapidly in response to strong demand.12 Issues of green bonds exceeded $200 billion in 2019, with a possible new record in 2020; the total outstanding amount has reached $1 trillion.13 According to one source, the net inflows in US sustainable investment funds hit a record $20.6 billion in 2019, nearly four times as much as in the previous year.14 The number of institutional investors that signed the UN Principles of Responsible Investment has soared to 2,829, accounting for $90 trillion of assets under management; by subscribing, those investors have committed to seeking appropriate disclosure on ESG issues from the entities in which they invest.15 As an aside, it is welcome news for my country that one top data provider has recently placed Italian sovereign bonds among the least risky in the euro area after adjusting for transition and physical risks, and for economic resilience.16 This is linked to the fact that, as of 2020, the country has achieved all the European energy and climate targets.17 To ensure that the drive towards sustainability in finance is itself sustainable, much remains to be done. For agents to make informed choices about climate issues, good data and sound analytical tools are essential. The situation is hardly satisfactory. ‘Currently, there are neither widely accepted rules for ESG data disclosure by individual firms nor agreed auditing standards to verify the reported data… ESG-score providers rely heavily on voluntary disclosure by firms and on subjective methodologies to select, assess and weight individual ESG indicators. This adds to the arbitrary nature of the scores. As a result, ESG scores of individual firms differ greatly across rating agencies if compared, for example, with credit ratings’.18 J.P. Morgan, ‘Why COVID-19 Could Prove to Be a Major Turning Point for ESG Investing’, July 1, 2020. The Global Sustainable Investment Alliance (GSIA), Global Sustainable Investment Review 2018. A recent survey by Ipsos on a panel of 19,964 adults across 28 countries showed that two-thirds (69 per cent) say they have made changes to their consumer behaviour out of concern over climate change: 17 per cent made a lot of changes and the other 52 per cent made a few changes. https:// www.ipsos.com/sites/default/files/ct/news/documents/2020-01/global-advisor-climate-changeconsumer-behavior.pdf. Bloomberg NEF (2020). Financial Times (2020), ‘Record sums deployed into sustainable investment funds’. UN PRI (2020), ‘A blueprint for responsible investment’. FTSE Russell (2020), ‘FTSE Climate Risk-Adjusted EMU Government Bond Index’. The FTSE Climate EMU Government Bond Index (EGBI) integrates the performance of fixed-rate, investment-grade sovereign bonds, adjusting the EGBI weights according to each country’s relative exposure to climate risks. European Environment Agency (2019), ‘Trends and projections in Europe 2019. Tracking progress towards Europe's climate and energy targets’. Ignazio Visco (2019), cit. ECB Board member Isabel Schnabel recently argued that ‘mispricing’ in climaterelated market outcomes exists ‘as a result of informational market failures that stem primarily from the absence of a clear, consistent and transparent globally agreed taxonomy accompanied by disclosure requirements’.19 Considering the vast amount of investment at stake, there is also the risk of ‘greenwashing’. (Not to mention the bubbles based on fads or misleading labels, which may emerge in green finance as easily as in many other markets; but better information can only do so much about this). Several initiatives may improve the situation. A dedicated task force created in 2015 by the Financial Stability Board has been promoting voluntary climate-related disclosure by companies; it has seen progress, though its own assessment is that results remain disappointing. More recently, the Network for Greening the Financial System, a voluntary gathering of central banks and financial supervisors, has been active in promoting ways to bridge data gaps. As is well known, in Europe the main initiative to improve climaterelated information is the EU taxonomy, which sets out detailed criteria for identifying economic activities that contribute to the EU’s climate (and other sustainable) objectives.20 How data are used to assess risk is also a matter for concern. The characteristics of conventional models (e.g. widespread assumptions about the distribution of shocks or the linearity of impacts) may fail to take account of certain unique features of climate risks.21 Prudential authorities are increasingly asking financial intermediaries to improve their models and integrate climate risks into them.22 In May, the NGFS published its guide for integrating climate-related and environmental risks into prudential supervision.23 The ECB recently consulted on a ‘Guide on climate-related and environmental risks’,24 which explains how supervisors expect banks to consider climate-related and environmental risks in their governance, risk management frameworks, and business strategy. It is good to preserve a distinction between general climate policies, which are the responsibility of governments, and actions to ensure the proper management of climate risks, which are an integral part of financial authorities’ remit. A discussion is ongoing on a differential prudential treatment of bank exposures, based on the climate implications Schnabel I. (2020), ‘When markets fail – the need for collective action in tackling climate change’. Financial products distributed in the EU will have to demonstrate that the underlying investments are taxonomy-compliant in order to be labelled as ‘sustainable’. To foster the adoption of the EU taxonomy, companies subject to the EU Non-Financial Reporting Directive will be required to disclose whether, and to what extent, their activities are taxonomy-aligned. See I. Monasterolo (2020), ‘Climate Change and the Financial System’ Annu. Rev. Resour. Econ. 2020. 12:299-320. Thomä J., Chenet H. (2017), ‘Transition risks and market failure: a theoretical discourse on why financial models and economic agents may misprice risk related to the transition to a low-carbon economy’, Journal of Sustainable Finance & Investment. Network for Greening the Financial System (2020), ‘Guide for Supervisors. Integrating climate-related and environmental risks into prudential supervision’, Technical document, May. Public consultation on the draft ECB Guide on climate-related and environmental risks. https://www. bankingsupervision.europa.eu/legalframework/publiccons/html/climate-related_risks.en.html. of the activities they finance. My view is that a ‘green supporting factor’ is justified to the extent that there is evidence that green (brown) loans carry a lower (higher) risk for the lender;25 not as a general policy incentive, which is best pursued through other tools, such as taxes or subsidies. Economists and central bankers are also debating the extent to which climate considerations should enter monetary policy strategies. It is not possible to discuss this point here at any significant length. Let me just observe, very briefly, that climate events can powerfully affect key macroeconomic variables such as output, consumption, investment, productivity and inflation.26 Macroeconomic climate risks are no easier to treat than the corresponding micro risks, because of the marked uncertainty that surrounds them, of the possibility of rare, high-impact events that are notoriously difficult to model, and of all the nonlinearities involved. The central banks’ macro modelling toolkit will need to be enriched in this respect. Besides monetary policy portfolios, central banks also own a significant amount of non-policy financial assets. Should climate considerations have a place in their management? There are two reasons for answering this question in the affirmative. One is reputation and good citizenship: central banks’ investment must be seen as beyond societal reproach. The second is that central banks, as long-term investors, need to take the long-term sustainability of their investments seriously into account. In doing so, central banks should strive, in my view, to keep their investment policies as politically neutral and market-neutral as possible. Political neutrality is ingrained in their institutional position, and a necessary companion to their independence. While bound in Europe to ‘support the general economic policies in the Union’, central banks should not be seen as taking upon themselves the role of democratically accountable institutions, or as passing judgment on one particular government’s policy. Market neutrality cannot be strict: climate-oriented investment does, after all, imply by definition a departure from market neutrality; but this should be kept to a minimum, avoiding unnecessary discretionary or discriminatory choices. (Similarly, central banks’ monetary policy, while precisely designed to affect certain market variables, usually strives to stay away from unduly influencing market allocation beyond what is inherent in the policy itself). Therefore, it is my view that central banks’ climate-related investment policies should be based, to the extent possible, on predetermined, objective and transparent criteria. Since 2019, the Bank of Italy has been using ESG criteria for the investment of its non-monetary equity portfolio, while broadly preserving neutrality and diversification. We do not invest in companies that operate mainly in sectors not compliant with the L.F. Signorini (2019), ‘Climate risk and prudential regulation'. Network for Greening the Financial System (2020), Climate Change and Monetary Policy: Initial takeaways. Technical document. product-based exclusions of the United Nations Global Compact.27 We overweight those with the best ESG profiles, based on an external provider’s ratings.28 In 2019, after the ESG strategy had been introduced, the carbon footprint of our equity portfolio dropped by 30 per cent compared with the previous year. We are committed to further improving the environmental footprint of our investments, by applying sustainability criteria to a larger section of our portfolio. The Bank of Italy discloses on a regular basis both its operational principles for ESG investment, and the results in terms of its carbon footprint. We acknowledge that the current ESG ratings are an imperfect measure of climate risk, and support the development of more consistent, comparable and forward-looking data and scores.29 We also support research on sound climate-risk assessment methodologies (such as scenario analysis, and stress testing for transition and physical risks), participating in Eurosystem-wide developments. President Lagarde confirmed yesterday that the Eurosystem, as part of its ongoing strategic review, is considering whether to consider climate change profiles in its operations.30 We favour any progress towards enhanced international cooperation in climate matters among regulators, supervisors and standard-setters. The Bank of Italy is an active member of the Network for Greening the Financial System. As this audience knows, the UK and Italy share the responsibility of promoting international climate cooperation through the upcoming COP26. * * * The awareness is growing worldwide that, if the goal of keeping the warming of the planet within safe boundaries is to be achieved, urgent action is needed to accelerate the transition towards net-zero global emissions. Every actor must play their part. Markets have proved themselves ready to embrace green finance, given the right incentives. Change cannot just be legislated into existence, but public policy has a key role, including providing a stable climate-friendly regulatory framework. Financial authorities should promote the adoption of sound climate-risk assessment practices, and support the production of adequate data; while staying within their mandates, they can significantly contribute to achieving the common goal. This is the agreement, approved in 2004, which establishes the principles that companies should follow in the areas of human rights, labour, environmental sustainability and measures to prevent corruption. Companies in all sectors can adhere to this agreement, except those involved in the production of tobacco and controversial weapons. The provider was carefully selected through a qualitative comparison of methodologies and a comparative statistical analysis across several providers. Lanza A., Bernardini E. and Faiella I. (2020), ‘Mind the gap! Machine learning, ESG metrics and sustainable investing’, Banca d’Italia, Occasional Papers, June 2020. Reuters (2020), ‘ECB to review make up of bond buys in green push’, 14 October 2020. Designed by the Printing and Publishing Division of the Bank of Italy
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Statement (virtual) by Mr Ignazio Visco, Governor of the Bank of Italy and Governor of the Constituency of Albania, Greece, Italy, Malta, Portugal, San Marino and Timor-Leste, at the 102nd Meeting of the Development Committee (Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources to Developing Countries), Washington DC, 16 October 2020.
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Ignazio Visco: Statement - meeting of the Development Committee Statement (virtual) by Mr Ignazio Visco, Governor of the Bank of Italy and Governor of the Constituency of Albania, Greece, Italy, Malta, Portugal, San Marino and Timor-Leste, at the 102nd Meeting of the Development Committee (Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources to Developing Countries), Washington DC, 16 October 2020. * * * The world-wide spread of the new coronavirus has led to an extremely serious public health emergency and an economic crisis unparalleled in modern history. In order to contain the pandemic, many countries had to introduce measures that curtailed people’s movements and social interactions, and temporarily put a stop to many productive activities. The repercussions for global growth have already been extremely severe. This year we will see a sharp and widespread fall in per capita incomes. The longer term impact of the crisis remains surrounded by a great deal of uncertainty, as it is difficult to say how much and in what way the pandemic will ultimately shape households’ behavior and consumption patterns, what new needs will emerge and which social habits will be abandoned definitively. While the international business cycle has somewhat improved over the summer – with recovery beginning in many countries – the pandemic has continued to spread. As a result, uncertainty at the global level remains very high all over the world, curtailing consumption and investment. The sharp rise in savings observed in many countries in the last few months, which is in large part caused by precautionary motives, could restrain aggregate demand for a long time, slowing recovery. A prolonged slowdown in capital accumulation may dampen productivity growth, potentially exacerbated by a retreat from global value chain, which would affect longterm perspectives. It is especially important to limit the diffusion of the crisis within the financial sector to avoid additional negative feedback loops. In 2020 the amount of people living in extreme poverty will increase for the first time in 25 years. The number of food-insecure people could double. Countries affected by fragility, conflict and violence, especially in Sub-Saharan Africa, may be most strongly hit. The social and economic consequences of this crisis call for continuing action at all levels. It must be recognized that the impact of the pandemic has been uneven among workers, with job losses and unemployment concentrated among low-skilled and low-paid workers. Unequal access to health and education across and within countries and a consequent drop in human capital accumulation may worsen the impact on future generations. We praise management for the role the World Bank Group (W BG) is playing in this regard, having quickly conveyed substantial resources to help the poorest and the most vulnerable, supporting the health sector, and providing liquidity to the business sector in low-income countries. Even more than in other episodes of widespread crisis, the W BG must provide countercyclical support while promoting long-term growth. These two objectives are not contradictory. Indeed, it is necessary to help address the ongoing short-term financing needs of client countries in the fight against the Covid-19 shock while simultaneously promoting sustainable growth. Interventions in some areas – such as health or social safety nets – emerge as key priorities. However, education and sustainable infrastructure must not be overlooked, as these sectors shore up resilience to environmental, economic and social vulnerabilities. Needs arising from the consequences of the shock are huge, and financing a comprehensive economic recovery plan – targeting both poverty reduction and inclusive, sustainable growth – is challenging. Only by working together is it possible to come out of the crisis faster and better: 1/2 BIS central bankers' speeches international coordination is more important than ever. The World Bank Group’s financial resources have recently been boosted by the IBRD and IFC capital increase and the very successful IDA replenishment. This calls for doubling the effort to coordinate with other multilateral development banks, international financial institutions, and the donor community and to leverage all sources of finance — including from the private sector. In this respect, W BG operations should be informed by a clear understanding of the reasons behind private sector retrenchment from developing countries. It is crucial to assess the extent to which retrenchment results from heightened uncertainty about the length and the depth of the crisis, which might call for a better use of guarantees or blending instruments. At the same time, putting the most appropriate economic policies in place is one of the most effective ways of de-risking. While policies aimed at protecting domestic industries to the detriment of FDI flows may have short-term employment benefits, they may entail larger medium-term costs in terms of innovation, technology transfer, and eventually growth potential. We encourage the W BG to support the adoption of long-term oriented policies in its dialogue with partners and to develop new financing strategies that can support the implementation of the SDGs. We believe it is critically important in these unprecedented times to demonstrate the unwavering support of the global community to the poorest countries and we look forward to the review by Executive Directors of the decision concerning the 2020 IDA transfer by December 2020. An extension of the Debt Service Suspension Initiative (DSSI) by 6 months is warranted by the continued liquidity pressures. This decision could be re-examined by the time of the 2021 IMF/W BG Spring Meetings and a further extension by six months could be considered if required by the economic and financial situation. All official bilateral creditors should implement this initiative fully and in a transparent manner. We strongly encourage private creditors’ participation in the DSSI on comparable terms when requested by eligible countries. We recognize that debt treatments beyond the DSSI may be required on a case-by- case basis. In this context, we welcome the agreement reached in principle at the G20 on a “Common Framework for Debt Treatments beyond the DSSI”. We welcome progress achieved in the ongoing review of IDA voting rights. We urge Executive Directors to conclude the review by November 2021 and to agree on a simpler system that would ensure a progressive alignment between contributions and voting rights, while safeguarding the voting power of recipient countries. We reaffirm our commitment to a 5-year shareholding review and the Lima principles. Nevertheless, we do not necessarily believe a shareholding realignment is required at each review. As the current review comes only two years after the conclusion of the 2018 capital increase, with the capital subscriptions process in the IBRD and IFC having just begun, we support the completion of the 2020 IBRD shareholding review at this stage with no realignment. Similarly, we support the completion of the IFC shareholding review without further analytical work. Confronting these unprecedented challenging times requires dedication and strong discipline in the use of available resources. We thank President Malpass, and all W BG management and staff for their exceptional effort on the front lines of the response to the economic consequences of the pandemic. Flexibility in the use of budgetary resources has been instrumental in this endeavor. As we continue to face the inevitable cost pressures resultant from a much larger portfolio and operations in more difficult contexts, it is important to maintain budgetary discipline. This is even more relevant for the IFC, whose budget coverage ratio has deteriorated, suffering particularly from adverse effects in financial markets. 2/2 BIS central bankers' speeches
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Welcome address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 2nd Bank of Italy and Bocconi University - BAFFI CAREFIN Conference "Financial Stability and Regulation", Rome, 22 October 2020.
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Ignazio Visco: Financial stability implications of the pandemic Welcome address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 2nd Bank of Italy and Bocconi University – BAFFI CAREFIN Conference “Financial Stability and Regulation”, Rome, 22 October 2020. * * * It is a pleasure for me to open the second conference on “Financial Stability and Regulation” organised by Banca d’Italia and the Baffi Centre for Applied Research on International Markets, Banking, Finance and Regulation. This event could not take place in March in Rome as we had all wished. But it is taking place today with its original programme, albeit in a virtual format. I want to thank the organisers at Bocconi and at the Bank for their efforts, the contributors to the five sessions, and the keynote speakers. The papers that will be presented today and tomorrow will cover financial stability and regulatory issues that have been hotly debated over recent years. The keynote lectures will address forward-looking issues on the implications of Fintech competition on payment systems, the determinants of the low price-to-book ratios observed in the banking sector, and the challenges to central banking and financial stability created by climate change. In these brief remarks I will focus on the financial stability implications of the outbreak of the current pandemic. This is of course a topic not explicitly covered in the sessions of this conference. Last November, when the call for papers was closed, nobody could have anticipated the events that would then unfold. But this does not mean that the discussions that will take place during this event will have no relevance to current financial and policy developments. On the contrary, many of the topics that will be covered in this conference – like the pro-cyclicality of loan loss provisioning requirements, the challenges associated with the rapid adoption of new technologies in the banking sector, the effects of bank dividend pay-out policies, or the implications of rising corporate solvency risk on banks’ balance sheets – have been and will continue to be at the heart of the debate on the policy response to the Covid-19 crisis in the coming months. The spread of the Covid-19 disease and the necessary lockdown and social distancing measures adopted to contain it have triggered a contraction of the global economy of unparalleled magnitude. The reaction to the uncertainty and risks surrounding the initial stages of the Covid-19 outbreak led to serious liquidity strains in global financial markets. The traditional flight-to-quality behaviour among investors during stress episodes was followed by an unprecedented “dash for cash” in which even US Treasuries became illiquid. The lockdown measures adopted in many countries in the following weeks halted economic activity in several sectors, triggering massive increases in (observed and disguised) unemployment and plummeting corporate sales. Without policy intervention, a credit crunch would have unfolded and households’ and firms’ cash shortfalls would most likely have led to a large wave of defaults. The prompt and massive response of monetary and fiscal authorities prevented an immediate liquidity crisis, which would have had profound economic and financial stability consequences. Central banks reacted swiftly to market turmoil in March by deploying a wide array of emergency liquidity facilities and new asset purchase programmes. Further lending support was also provided through the introduction of funding facilities for banks conditional on them granting new loans to the real economy. Most governments introduced measures to assuage firms’ and households’ liquidity needs, such as debt moratoriums and temporary lay-off assistance, and to facilitate their access to new financing, such as loan guarantee programmes. Bank supervisors in turn used the flexibilities embedded in Basel III regulation and accounting standards to increase banks’ headroom to absorb losses and continue financing the economy. 1/3 BIS central bankers' speeches The policy response has been effective in achieving its short-term objectives. Markets have stabilised. Credit is flowing to firms and households, sustained to a large extent by exceptionally generous loan guarantee schemes. Economic activity is recovering. Growth forecasts have improved slightly, although there is still substantial uncertainty, driven mostly by the evolution of the global health crisis. But, while this crisis is not over, it has already created some “legacies” of its own, which could threaten financial stability in the medium term. First, authorities will soon have to make difficult decisions about the extension or phasing-out of some lending support measures. On the one hand, an early removal of lending support could have a destabilising cliff effect on credit supply conditions, holding back the pace of economic recovery. Even viable firms, especially those with high leverage, could face credit rationing problems. On the other hand, the extension of support measures could give rise to an undesirable allocation of credit towards unviable firms, which will eventually weigh on growth prospects. This is a dynamic trade-off. At the current juncture, where uncertainty is high and recovery still weak, downside risks from an early removal loom large and would call for a cautious extension of expiring measures. Going forward, the appropriate modulation of exit strategies must take careful account of the evolution of underlying sanitary, economic and financial developments. Second, non-financial firms’ indebtedness is expected to increase significantly, giving rise to debt overhang problems. In the wake of the first stage of the crisis, it had to be ensured that firms were able to obtain financing to cover cash shortfalls created by lockdowns. Speed in the delivery of funds to hundreds of thousands of cash-strapped small firms – as we observed in Italy – was key. In several jurisdictions this was achieved by designing policies, such as loan guarantees, that made use of the existing bank lending “infrastructure”. Yet, as corporate revenue losses are unlikely to be recouped entirely, this bridge financing may lead to a permanent increase in leverage for some firms. This creates challenges in the medium term; it could lead to generalised debt overhang problems that would reduce firms’ investment, weaken competitiveness and hamper economic growth. Therefore, capital-strengthening measures by governments to reduce non-financial firms’ leverage and increase their debt servicing capacity seem to be necessary. Several options have been proposed and, in some countries, already implemented, such as direct cash transfers, purchase of equity stakes or subordinated debt instruments by special purpose vehicles with public capital, and fiscal incentives to favour private equity injections into firms. The challenges are nevertheless substantial. An efficient use of public funds calls for the establishment of procedures which effectively separate, in a fast-moving environment, those firms deserving of support from the non-viable ones. This will undoubtedly be a demanding task; at the same time policy measures should be tailored to account for the differences between the governance of (often very) small firms, mostly managed by their owners, and larger firms (often joint stock companies), run by managers on behalf of shareholders. Losses from public investment in firms’ equity should be minimised, if not completely fended off, while at the same time avoiding excessive and intrusive interventions in business governance and decisions. Third, how to ensure the resilience of the banking system in the face of a likely surge in credit losses is a crucial question. Banks entered the pandemic crisis with much stronger capital and liquidity positions than before the global financial crisis, not least because of the regulatory reforms in the aftermath of the latter. As a result, there has been some room for supervisory authorities to release macroprudential buffers and to provide a flexible interpretation of microprudential requirements, with the aim of allowing banks to absorb losses and sustain the flow of credit to all borrowers, including the most vulnerable ones; an important contribution to banks’ resilience has come also from supervisors’ recommendations to abstain from paying out dividends or undertaking share buybacks. As further credit losses are expected to materialise 2/3 BIS central bankers' speeches over the coming months, several banks have already started to increase their provisions substantially. A prudent approach to provisioning in the current phase is certainly desirable. Looking ahead, it is crucial that supervisors and regulators reach a difficult balance between avoiding pro-cyclical credit restrictions and maintaining safe and forward-looking risk management practices. That said, the scale of the current crisis could nevertheless require extraordinary interventions in the banking sector. Banks have to continue to manage non-performing loans (NPLs) effectively, so that they do not build up in balance sheets, hindering efforts to strengthen capital and undermining market and consumer confidence. In Europe there is a discussion around initiatives aimed at setting up or improving the functioning of special purpose vehicles focused on the management of NPLs (asset management companies, or “bad banks”). Proposals that also include the possibility of private investors participating in the capital of these companies could be looked upon favourably. Moreover, this unprecedented shock could potentially have some banks among its victims. Unresolved issues with the crisis management framework in Europe, then, should be addressed promptly. This comprises harmonising the liquidation procedures for small and medium-sized intermediaries, including through the possibility of using common funds to conduct orderly liquidations, and finalising the creation of a backstop to the Single Resolution Fund as part of the crisis management framework. Finally, we are left with the need to address the moral hazard, in particular on non-bank financial intermediation, created by the expectation of a “central bank put”. With the outbreak of the Covid-19 pandemic, investor risk aversion has increased rapidly, leading to a surging demand for cash and to the exit from equity and fixed income markets in search of short-term, risk-free assets. Large price swings have been observed in many asset classes, volatility has increased enormously and redemptions in open-end funds have been at record high levels. Central banks have had to introduce extraordinary asset purchase programmes, special liquidity operations and US dollar funding facilities to restore market functioning and maintain the efficient transmission of monetary policy measures. These interventions have been effective, but the expectation of public intervention in the event of systemic market disruption could create moral hazard, and subsequently result in making further disruption more likely. As a consequence, progress needs to be made to introduce or reinforce the macroprudential framework for nonbank financial intermediaries (NBFIs), in particular investment funds and insurers. Macroprudential stress testing, which aims at identifying possible transmission channels and feedback effects among financial firms and markets, is still at a preliminary stage in the nonbank sector. It could represent a useful tool to assess how shocks originating in one part of the financial system can spread to other components. Further NBFI areas that need additional investigation include: minimum liquidity buffers; rules to reduce structural liquidity transformation; possible additional requirements for synthetic and traditional leverage; concentration and interconnectedness. * * * To conclude, the extreme macroeconomic shock triggered by the Covid-19 outbreak is testing the resilience of the global financial system and the ability of policy makers to respond to tail events, highlighting the strengths of the current regulatory framework but also some of its vulnerabilities. It is also accelerating trends that are likely to reshape the financial industry in the future. The coming months will be challenging for our societies, and the following years will see substantial structural transformations. Complex decisions with far reaching consequences will have to be taken by authorities and intermediaries all over the world. Experience in the use of existing policies is growing, but new risks are also emerging. Research and discussion fora like this conference, in which fresh ideas and experiences are exchanged among academics and policymakers, will be ever more important. Therefore, I wish you all two very fruitful and constructive days of open discussion. 3/3 BIS central bankers' speeches
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Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 96th World Savings Day (online event), organized by the Association of Italian Foundations and Savings Banks, Rome, 30 October 2020.
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Ignazio Visco: 2020 World Savings Day Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 96th World Savings Day (online event), organized by the Association of Italian Foundations and Savings Banks, Rome, 30 October 2020. * * * The cyclical situation, savings, and the economic policy response Following the unprecedented contraction in the spring, the global economy recorded a better than expected strengthening in the summer. As a result, at the start of this month, the International Monetary Fund revised its estimates upwards for this year. However, the decline in economic activity is the sharpest since the Great Depression, with a reduction in GDP in the order of 4.5 per cent. The intensity with which the spread of the pandemic has picked up again in recent weeks, particularly in Europe, and the associated high levels of uncertainty risk producing further slowdowns in production and in the demand for goods and services in the short term, with negative consequences on the outlook for the global economy next year as well. In Italy, the return to growth in the third quarter was also much more marked than we had forecast in July. This was due to the strong recovery of the industrial sector, where production in August returned to pre-epidemic volumes. On the other hand, the slowdown in services seems to have persisted, despite the positive trend in holiday spending in the summer, which was mainly of domestic origin. The strengthening of productive activity would not have been possible without robustly expansionary economic policies, which also led to a marked improvement in conditions on the financial and credit markets. Nevertheless, the resurgence of the epidemic threatens to undermine the results achieved so far: an increase in cases of infection – even if countered by less drastic measures than those adopted in the spring – risks negatively impacting household and business confidence and consumption. The greater pessimism of consumers recorded since the start of the crisis has led to a considerable increase in their propensity to save. In the second quarter, the ratio between savings and gross disposable income, close to 20 per cent, was almost double its 2019 average, mainly because of the decline in purchases of goods and services following the halt in certain sectors of activity. Our estimates suggest, however, that savings have remained high in recent months too, both for precautionary reasons, linked to a decline in disposable income and to fears of job losses, and as a result of the persistent risk of infection and the consequent health concerns, which discourage certain types of consumption, especially relating to travel, tourism and leisure activities. Although they have decreased over time in relation to disposable income, Italian household savings, the main source of funding for investment, have historically been one of our economy’s strengths. However, in a phase like the current one, dominated by uncertainty and weak cyclical conditions, unless the increase in the propensity to save is accompanied by a sufficient recovery in investment and production, there may be a decrease in aggregate demand and income, in turn fuelling further growth in saving for precautionary reasons and thus triggering a vicious cycle. There appears to be a concrete risk that the propensity to save will remain high in the next few quarters, holding the recovery back. This is confirmed by the surveys conducted by the Bank of Italy between the end of August and the beginning of September: the intention to save seems widespread, including households that do not expect a drop in income. The share of households intending to spend less on essential goods (for example, food) in shops and non-essential goods (such as hotels and eating out) is not only higher among households that have had a 1/7 BIS central bankers' speeches drop in income since the start of the pandemic, but also tends to increase as the number of infections grows in the region of residence. Government measures to protect jobs have so far limited the impact on income and employment, but the overall stability of the unemployment rate since the beginning of the year does, however, reflect the rise in ‘discouraged workers’, with the number of jobseekers going down by 300,000. Although the total number of hours of authorized wage supplementation is half the size of the second quarter peak, it is still particularly high. The worsening of the epidemic could have new and serious repercussions on the already fragile conditions of the labour market. While the reallocation of workers among firms and sectors must not be obstructed, the seriousness of the crisis calls for continued adequate protection for as long as necessary. At the same time, the social safety net system can be revised to increase coverage, simplicity of access and fairness. Going forward, as far as the macroeconomic conditions allow, the extraordinary measures in defence of jobs could be progressively reduced and limited to the sectors hardest hit by the crisis, also taking account of healthier firms needing to reorganize themselves in response to the changing socio-economic outlook. Simplifying the rules governing the labour market and extending the reduction of the tax wedge could encourage firms to hire more workers. To ensure that the increase of job opportunities is permanent, the capacity of the economy to grow must also expand. The risk that the pandemic could worsen and have negative repercussions on demand does not affect Italy alone. The savings rate has doubled across the whole euro area, reaching values that are even higher than those in Italy. The European Commission’s surveys indicate that consumers’ saving intentions have reached the highest levels for the last 20 years. In the most exposed sector, namely services, there are already signs of another slowdown in demand, with repercussions on prices. In the euro area, the recent fall in inflation to negative values largely reflects trends in energy prices. Nevertheless, core inflation fell to its lowest level yet in September, just above zero, as a result of the weakness of transport and tourism – spending items that are closely linked to the course of the pandemic. The risk of deflation is lower than it was six months ago but it cannot be ignored. It stands at 20 per cent today, based on option prices, compared with more than 40 per cent in mid-March. For the professional forecasters surveyed by the European Central Bank (ECB), the likelihood of deflation is still much lower. However, the share of forecasters that do not expect inflation to exceed 1.5 per cent five years forward is equal to 35 per cent, against around 10 per cent recorded on average between mid-2014 and end-2018. That is why the ECB’s Governing Council reconfirmed the need to maintain its very accommodative monetary policy stance at its meeting yesterday, with securities purchases continuing to be conducted in a flexible manner. At the same time, in light of the risks to economic activity being tilted firmly to the downside and based on the new macroeconomic projections being prepared for the December meeting, it will recalibrate its monetary policy instruments as appropriate to respond to the rapid unfolding of the economic and financial situation. In particular, financing conditions must remain expansionary to contribute to the economic recovery, supporting demand and employment, thereby counteracting the negative impact of the pandemic on growth in prices and to foster the convergence of inflation towards its aim in a sustained and symmetrical manner. Making determined progress in the health field is still the key factor in coping with the pandemic and the crisis it has generated. In the meantime, economic policies at global level must maintain a decidedly expansionary tone in order to support households and firms. In an environment of extremely low interest rates, common to all the advanced countries, fiscal policies play a 2/7 BIS central bankers' speeches particularly important role. From this perspective, the European spending package to help the ‘Next Generation EU’ must enable the rapid distribution of the resources envisaged to individual countries, to be used for timely and effective structural programmes. Financial intermediation The climate of uncertainty that has spurred an increase in saving is also reflected in banks’ balance sheets. In the twelve months ending in September, households’ deposits rose by 5.6 per cent (almost €50 billion), and those of firms by 24.4 per cent (€70 billion). In the latter case, the increase is in large part attributable to the Government’s credit support measures, which have enabled firms to accumulate the funds they will require to meet their liquidity needs in the coming months, as the economic effects of the health crisis persist. Once the emergency is over, banks must be ready to finance the recovery; the focus must therefore remain fixed on their capital strength as much as on the quality of loans made. In this regard, banks can build on the progress made in recent years and on the extraordinary measures taken by the Government and the supervisory authorities to handle the crisis. Between 2007 and 2019, despite the double-dip recession that struck the Italian economy and thanks to regulatory reforms, the common equity tier 1 (CET1) ratio almost doubled, to 14 per cent. In the first six months of this year, it rose further, by almost 1 percentage point. The profits for 2019, capitalized following the recommendations of the supervisory authorities on the distribution of dividends, were crucial, as were the measures imposed by the European regulator. However, the crisis has begun to have an impact on the return on equity and on reserves, which fell considerably in the first half of the year, mainly due to higher loan loss provisions. Banks’ ability to support their capitalization level through profitability will remain under pressure in the near future too. Credit quality has been improving since 2015. The flow of new non-performing loans (NPLs) remains at historic lows. The ratio of the stock of NPLs to total loans, gross of write-downs, has fallen to 3.1 per cent, around two thirds lower than its peak. Disposals made on the secondary market up until now, along with those that are expected to be completed in the final months of the year, will enable banks to go through with the plans made at the start of 2020, before the outbreak of the pandemic. Italian banks are enjoying the fruits of their labours in the management of NPLs, spurred in part by the regulation and the supervisory activities of recent years. Specific structures were created to implement the reduction plans presented to the supervisory authorities; thanks to improvements in information quality, banks are now able to better assess the actions to be taken, through internal management and selling on the market, to address loan deterioration; it is therefore possible for potential purchasers to make valuations more accurately and quickly. The breadth and depth of the economic crisis that we are experiencing will nevertheless result in an increase in business insolvencies. Our studies indicate that in 2020, the deterioration in their financial situation will lead to a sharp increase in the probability of insolvency: the share of financial debt owed by the riskiest borrowers could exceed 20 per cent, compared with a prepandemic level of 13 per cent. In the coming years, the evolution of firms’ riskiness will inevitably depend on cyclical developments, which are now extremely uncertain, and on the range and effectiveness of measures that may be introduced to encourage them to reduce their financial leverage. In the next few months, banks will be called upon to do their utmost in that which is the essence of banking: support worthy entrepreneurial projects, recognize without delay any losses arising from exposures that are highly likely to become insolvent, and restructure loans to debtors in difficulty. Compared with the past, banks find themselves facing new restrictions, both accounting and regulatory, in recognizing losses and classifying loans. These are obligations 3/7 BIS central bankers' speeches designed to ensure stable and effective lending; they are, as is well known, particularly strict in countries such as Italy that are characterized by delayed payment of commercial debts and particularly lengthy civil proceedings, although the latter have improved in recent years. In the absence of measures that can make decisive inroads on these fronts, the burden of the restrictions on our country’s banks is therefore still greater than the European average. Supervisory authorities can take advantage of the room for flexibility to ward off the procyclical effects on credit supply, which would lead to a further deterioration in credit quality. Flexibility is nonetheless limited by the need not to delay the emergence of highly probable losses, bringing forward a part of the loan loss provisions before insolvencies become evident. Efforts should be made to counter the risk that banks could accumulate an excess of NPLs on their balance sheets that have not been adequately written down. Being proactive in recognizing losses may enable banks to avoid finding themselves in situations similar to those they experienced immediately after the sovereign debt crisis, when it was only after decisive action from the Bank of Italy’s supervisory function – and considerable resistance from banks – that significant increases in loan loss provisions were actually effected. I recall that in 2012, in this very venue, I highlighted the need to raise the coverage ratio for nonperforming loans, which had fallen to worrying levels (below 40 per cent). Shortly before that, we had launched a series of targeted inspections intended, among other things, to assess the adequacy of the provisioning policies. In part owing to this supervisory action, the downward trend in the coverage was reversed, though with markedly varied results. The average increase exceeded 5 percentage points over the following two years. Despite the overall stability in the flow of non-performing loans, in the first half of this year, Italian banks increased their loan loss provisions by 53 per cent on average compared with the same period of 2019. The write-downs were mostly used to raise the coverage ratio for performing loans, whose riskiness increased owing to the deteriorating economic outlook. The ratio between the write-downs recorded up to last June relating to loans to households and firms benefiting from the debt moratoria, which are facing greater uncertainty as to how their riskiness will evolve, and the gross exposures to these counterparties combined, is equal to 1.2 per cent, one third higher than the average for all loans to households and firms. The growth in loan loss provisions, however, was highly uneven and largely driven by the actions of some large credit institutions. Several banks, both significant and non-significant, show coverage ratios for performing loans that are well below the banking system average. These gaps must be closed. Special attention will have to be devoted to the banks that are, on average, more exposed to the firms that have benefited from the moratoria and to the sectors that have been hit hardest by the effects of the pandemic. Obviously, this must not be done indiscriminately, and it will be necessary to work in careful coordination with the support measures introduced by the Government. The Bank of Italy is monitoring this issue closely. The idea currently being discussed at European level of creating a network of NPL-handling national asset management companies (AMCs) should be considered favourably. To enable these companies to operate effectively against the backdrop of a macroeconomic shock such as the one caused by the pandemic, however, it would be necessary to reconsider the criteria used so far, in light of the State aid guidelines, to determine sale prices. Account should also be taken of the fact that ‘market’ prices can reflect yields that are typical of situations marked by the presence of information asymmetries and high buying power. As I have often noted, including recently, the action and interventions of the Bank of Italy are designed to ensure that intermediaries are able to operate on the market by responding to loan applications effectively against a backdrop of sound and prudent management. In some cases, however, exiting from the market becomes inevitable. When this occurs, it is important that the crisis be managed in an orderly fashion, avoiding repercussions for the funding of the economy 4/7 BIS central bankers' speeches and for financial stability. Therefore, it would be beneficial to see an EU initiative that lays down harmonized procedures that can ensure the orderly exit from the market of small and mediumsized banks. The US Federal Deposit Insurance Corporation could serve as a model, to be adapted to the specific features of the European context. Banks are facing a number of challenges – in particular regarding innovation, rationalization of the cost structure and, more broadly, the recovery of profitability – that the pandemic makes even more relevant today. In an environment marked by interest rates that will presumably be low for a very long time and by fierce competition on the digitalization of the services being provided, banks will have to be able to rethink their business models, with adequate technological investments and without neglecting the establishment of sufficient protection against the connected cyber risks. Of course, the challenges are not restricted to the banking sector. In recent years, the asset management industry has experienced strong growth, with positive effects on the stability of the financial system as a whole. This has benefited firms, which have embarked on a process to expand their sources of funding, and savers, who have been able to diversify their investments further. However, the current crisis has shown that, especially when leverage and the degree of maturity transformation are high, potentially systemic risks may emerge in the investment fund industry. While banking sector regulation was made significantly more stringent in the years that followed the global financial crisis, only now is the question of adapting the rules for the nonbank sector being tackled firmly. It is necessary to continue to work at international level, in particular within the Financial Stability Board, to acquire the tools, including macroprudential ones, that can help to deal with the risks that may arise in this sector. This is an issue that Italy’s forthcoming presidency of the G20 intends to prioritize among the financial issues. Technology, finance and payments In Europe, the pandemic has led to a sharp acceleration in the spread of digital payment instruments with a high technological content. According to a recent survey conducted by the ECB, some 40 per cent of the population in the euro area have decided since March to reduce the use of cash for day-to-day purchases, notwithstanding the increased demand for mediumand high-denomination notes, likely connected to the heightened uncertainty. These changes are having a significant impact on Italy as well: even over the summer, when the risk of infection was low and the social distancing measures were very limited, the use of payment cards rose, especially for those with a higher technological content such as contactless cards, and the use of cash decreased. Based on the experience of other European countries, the change in consumer habits towards a more and more frequent use of digital payment instruments can be expected to continue, though probably still at a gradual pace. New technologies can bring tangible benefits to the financial system and to users: they foster the efficiency of intermediaries and improve risk selection and diversification and they contribute to expanding the range of services available to households and firms, to enhancing their quality and to reducing their costs. The need for an adequate control system, however, cannot be ignored if the emergence of risks to users and to the integrity and security of the financial system is to be avoided. In the payment services market, innovation has thus far favoured the use of instruments associated with private currencies issued by banks or by operators that are in any case closely supervised. In the future, and indeed the near future, there are likely to be even more innovative instruments available, namely ‘stablecoins’, which are a type of crypto-assets whose value is guaranteed by adequate collateral issued by companies operating on a regional or even a global scale. This phenomenon raises delicate questions regarding IT risks, personal data processing and management, the correct functioning of the payment system, financial stability and the transmission of monetary policy. There is also the risk of tax evasion, money laundering and the 5/7 BIS central bankers' speeches financing of terrorism. The complexity and global nature of these issues make regulation at international level essential. The attention of regulators, central banks and supervisory authorities is at a maximum. The finance ministers of the leading European countries recently published a joint declaration on the risks stemming from the possible introduction of stablecoins by non-bank operators. The European Commission has proposed regulations to be applied to issuers of these instruments and to operators providing related services. The proposal contains a broad range of rules on, among other things, own funds requirements and rules for managing liquidity and for interoperability with traditional payment systems. It also envisages additional obligations for issuers and providers of services connected with crypto-assets guaranteed by collateral defined as significant. Negotiations have just begun. In order for the distribution of such instruments to take place in conditions of reasonable safety both for users and the financial system, the principle whereby the same activities are subject to the same regulatory safeguards must be respected, regardless of who performs them, the European standards for the security of payment systems must be upheld, savers must be protected and any abuses must be prevented. When drawing up the definitive regulatory framework, the implications for financial and monetary stability will have to be assessed. The ECB recently published a report on the possibility of issuing a digital euro. This study, approved by the Governing Council, is the result of the work of a high level Eurosystem task force. Specifically, in a world in which retail digital payments are the norm, the possibility has been considered of issuing an instrument for making payments in central bank money, which by its very nature is secure. Issuing a digital currency also poses several questions of a legal, technical and economic nature. Current investigations concern, among other things, the laws necessary for this instrument to be legal tender. We are also committed to resolving, by means of experimentation within the Eurosystem, some technical issues linked, for example, to creating solutions for offline payments. We are also assessing the potential impact on the financial system’s structure, on banks’ profitability and on the transmission of monetary policy. The Bank of Italy is committed to guaranteeing the security and the financial inclusion of less competent IT users during the transition towards a more digital economy. Important innovations are currently being made in the TARGET Instant Payment Settlement (TIPS) infrastructure, managed by the Bank of Italy, which will allow users to make transactions on their mobile phones in real time and will considerably increase the number of financial intermediaries connected to this system. The initiatives of our new Directorate General for Consumer Protection and Financial Education include the commitment to promoting financial education to cope with the current environment, in which the use of digital channels for using payment, investment and lending services is growing steadily. Strengthening and coordinating our initiatives relating to technological innovation for the financial sector and the functions linked to retail payment services – from cash circulation to monitoring digital payment services and instruments – is promoted in the Bank of Italy by a department dedicated to the integrated management of these activities. The dialogue with operators takes place firstly via the ‘FinTech Channel’, which provides advance knowledge of new projects in order to assess their compliance with legislation and identify potential problems, and secondly via the processes for authorizing market access. Our plans for collaborating with industry and for supporting projects that can bring systemwide benefits, for selecting contributions from experts and independent firms, and for research and analyses in tandem with institutions and universities will all be reinforced by the creation of the ‘Milano Hub’ centre, due to start by the end of the year. * * * The better than expected recovery in economic activity observed over the summer shows how 6/7 BIS central bankers' speeches the Italian economy maintains a considerable ability to recover and is proof of the effectiveness of the monetary and fiscal policies introduced to protect households and firms and to boost aggregate demand. Nevertheless, there is the risk that the repercussions of the health crisis for the global economy, for the euro area and for Italy may be with us for some time to come, even after the emergency is over. This is due to the impact of the effects of the uncertainty over the economic outlook on savings and on aggregate demand, of the difficulties we will encounter when coming out of a phase of too low inflation, of the need, which will emerge in any case, for a broad reallocation of resources between sectors and firms, and of the needs linked to the digital revolution, to the new ways of working and producing, to the transition to a low-carbon economy and to the challenges facing the financial system. It is precisely for this reason that we cannot focus solely on responding to the emergency. Italy must deal with the structural problems that have been holding back growth for almost three decades and whose resolution has been made more urgent by the crisis. The areas requiring intervention are well known, as we have recalled on various occasions this year too. They concern the quality and timing of the services provided by general government; innovation in all sectors, with sufficient investment, not only from the public sector, in new generation infrastructures, human capital and more environmentally-friendly technology; and the protection and enhancement of our natural, historical and artistic heritage. The opportunity provided by the availability of common financial resources at European level must be seized rapidly, and will make it possible to sustain production, incomes and employment long after the relief measures, which are also made necessary by the crisis. The Government has announced its intention to begin reducing the debt-to-GDP ratio next year and bring it back to pre-pandemic levels by the end of the decade. If growth exceeds expectations over the next few years, the ratio could decrease more quickly, with a more marked improvement in the primary surplus. The public debt is sustainable, but if it remains at high levels, it leaves us exposed to the risks and shocks stemming from financial market tensions or from any further economic shocks. Achieving the Government’s objective assumes the efficient use of the funds borrowed to deal with the crisis, as well as those made available by European programmes. We must make a considerable effort, though one that is within our country’s reach, to increase: innovation and production capacity; the safest and most sustainable investments for our savings; the employment opportunities offered by our economy; and labour market participation, especially on the part of young people and women. 7/7 BIS central bankers' speeches
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Opening remarks by Mr Daniele Franco, Deputy Governor of the Bank of Italy, at the 2020 Banca d'Italia and Federal Reserve Board Joint Conference on Nontraditional Data & Statistical Learning with Applications to Macroeconomics, virtual event, Rome, 11 November 2020
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Nontraditional Data & Statistical Learning with Applications to Macroeconomics Welcome address by Daniele Franco Senior Deputy Governor of the Bank of Italy Rome, 11 November 2020 Ladies and Gentlemen, I am glad to open this virtual conference jointly organized by Banca d’Italia and the Federal Reserve Board. I would like to welcome all the participants from more than 60 countries. 1. This conference is about the impact of digital activities on economic analysis. An astonishing amount of digital activity is occurring at any given moment. This explosion stems from the aggregate action of 4.5 billion internet users, a number that is projected to rise even further in the coming years. Since the outbreak of COVID-19, technology has played an even greater role in our daily lives. This development has increased the production of data. In fact, data are constantly being generated by our clicks, reactions on social media, shares, streaming of videos, digital transactions, digital recordings of our personal and work activities, digital circulation of scientific texts, and so on and so forth. These data can give us a better understanding of the state of the economy at both the micro and macro level, provided – obviously – that we have access to them. Data ownership is therefore extremely important. As recently highlighted in The Economist (‘Who owns the web’s data?’, 22 October 2020), we are now experiencing a sort of ‘digital feudalism’, where a handful of big tech companies have full control over data. Tech companies such as Facebook, Amazon, and Google have reached an impressive position, becoming some of the biggest companies in the world. In this process, they have caught up with longer-standing titans like Apple and Microsoft. The use of data is actually one of the world’s biggest businesses. We see this in the market capitalization of some companies, like Alphabet (the owner of Google) and Facebook. Even once the value of their cash, physical and intangible assets, and accumulated R&D has been stripped out, their capitalization remains huge. These developments are causing increasing concerns among policymakers, from both a political and economic point of view. As to the former, the big techs’ business model depends on network effects to influence users and sell more advertising, which may result in collective behaviour that can harm public discourse. Economic concerns stems from the fact that the size of big tech firms may shrink competition. 2. Banca d’Italia has always based its decisions on the data. Micro-level statistical information on firms has been collected since the early 1950s. Back then, only a few aggregate statistics were available. We began by surveying the balance sheets of a small group of firms, an activity that was progressively expanded until it became what is now the Survey on Industrial and Service Firms. These days, we collect detailed data on about 5,000 firms. At the beginning of the 1960s, the Bank began surveying household finance. Nowadays, this survey allows us to evaluate income and wealth distribution at the micro level in order to analyse individual preferences and the determinants of their economic decisions. In recent years, we have interviewed a sample of more than 8,000 households in each survey; about 50 per cent of them were part of a panel. In 2016, Banca d’Italia started its project on Big Data and Machine Learning applications. We wanted to fine-tune the accuracy of our economic analysis by combining all available skills ranging from economics to statistics, from computer science to engineering, and from mathematics to applied physics. This year we have stepped up our action by strengthening the team with new resources from universities and by widening our data collection from private companies.1 3. The COVID-19 pandemic has radically transformed our lives in a number of different ways. Direct personal contacts have been partly replaced by online events. Most meetings around the world are now organized via multiple IT applications. This has allowed many of us to keep working in safety. It has also reduced both travelling cost and carbon emissions. These changes have been made possible by the progress of IT in many areas, from core technology advances – like further doublings of basic computer power every 18 months – to successful investment in complementary innovations, like cloud infrastructure. One of the most important developments is the wave of recent improvements in artificial intelligence, especially machine learning. Such as, for example, Immobiliare.it, Mutuionline.it, Twitter, Indeed, Dow Jones, etc. Machine learning represents a paradigm shift from the first wave of computerization. Historically, most computer programs were created by accurately codifying human knowledge, mapping inputs to outputs as prescribed by the programmers. In contrast, machine-learning systems use categories of general algorithms (e.g. neural networks, random forest and gradient boosting) to figure out mappings and are typically driven by voluminous amounts of data. By employing huge data sets and big data processing resources, machines have made impressive progress. For instance, error rates in labelling the content of photos on ImageNet, a dataset of over 10 million images, have fallen from over 30 per cent in 2010 to as low as 2.2 per cent in 2019. This has, inter alia, big implications for the identification of fake banknotes, which is part of our central bank work. The exponential growth of digital data, such as images, videos and speeches, from numerous sources (e.g. social media, Internet-of-Things, etc.) is driving the search for tools that allow us to extract relevant information from disparate kinds of data. Private companies have played an important role in collecting and organizing behavioural microdata on firms and households. In this respect, we can mention a recent paper on the economic impact of COVID-19 by Professor Raj Chetty and his team at Opportunity Insights.2 Using anonymized data from a large number of private companies, Professor Chetty and his co-authors develop a publicly accessible platform, which measures some important macroeconomic variables such as spending, employment, and other outcomes both at a very high frequency, and at a very granular level. Their work shows how new nontraditional data can be used to obtain quasi-realtime insights into the effects of the COVID-19 pandemic. Along the same lines, a recent study by colleagues of Banca d’Italia, Banque de France and the Bundesbank points to the role of nontraditional data and indicators for a rapid assessment of the implications of the pandemic.3 4. Banking and financial industries have been profoundly impacted by these developments. Central banks are now using big data to improve their capacity to carry out their missions: monetary policy, banking supervision and payment system oversight. Over the next two days, we will hear about several studies applying new data sources to different issues relevant to central bank activities. Some papers focus on the new data and tools available to improve the trade- offs between the objectives for inflation, employment/growth and financial stability. Others show the advantages provided by machine learning methods for estimating and ‘The Economic Impacts of COVID-19: Evidence from a New Public Database Built from Private Sector Data’, NBER Working Paper No. 27431 DOI 10.3386, June 2020. Professor Raj Chetty is 2013 John Bates Clark Medal and is a prominent member of the Harvard faculty. See G. Veronese, C. Biancotti, A. Rosolia, R. Kirchner and F. Mouriaux (2020), ‘COVID-19 and Official Statistics: A Wakeup Call?’, Banca d’Italia, Deutsche Bundesbank and Banque de France. Forthcoming in Proceedings of the 8th IMF Statistical Forum: Measuring the Economics of a Pandemic. forecasting macroeconomic variables and the relevance of nontraditional sources of information, especially when it is impossible to run a classical survey, as was the case during the COVID-19 pandemic. Besides its long history of cooperation with commercial banks, with Istat (our National Statistical Institute) and other public institutions, Banca d’Italia has already started to collect nontraditional data from social media, newspapers, payment platforms and on real estate and home mortgages. The harnessing of larger data sets, faster computational power, and more advanced analytical techniques is spurring progress on a range of micro- and macroeconomic problems. At Banca d’Italia, we approached the data deluge by building a multidisciplinary team of economists, statisticians, econometricians, mathematicians, engineers and IT specialists. By connecting these data experts with their frontline colleagues, we began to identify projects that can increase both the accuracy and performance of our policy action. 5. The Big Data revolution poses some fundamental challenges. Let me briefly mention two of them. First, big data can lose their statistical relevance if they are not used in a methodologically sound way. Such data typically target only a particular layer of the population; increasing the sample size will not improve the accuracy of estimates if the estimation methods do not correct for this kind of distortion. Social media data for example, like many other internet-based sources of big data, are usually based on a biased sample of the population. Second, the availability of a huge amount of data raises the importance of its integrity, confidentiality and privacy. Personal data protection is central to our societies. The sheer amount of personal data now available, and the growing ease with which individual information can be connected across databases, have far-reaching implications for privacy and freedom. Indeed, this has prompted the development of regulations concerning the treatment of digital data (think of the GDPR or the CCPA in California).4 Rules on data management are sometimes different across jurisdictions and data domains. Ideally, one would like to have global standards. Therefore, international cooperation is to be encouraged as far as possible. Furthermore, the adoption of machine learning and artificial intelligence requires as input huge amounts of granular and unstructured data, which should be collected through close collaboration between public institutions and private companies. We also need specific platforms or data lakes to store and analyse such data so as to preserve The General Data Protection Regulation (GDPR) is the European Union law on data protection and privacy; the California Consumer Privacy Act (CCPA) is the statute aimed at enhancing privacy rights and consumer protection for residents of California. privacy and security. This can be done through a collectively trusted cloud where all actors, both public and private, can operate to gain insights for their core business. The availability of privacy-preserving algorithms or the use of federated learning, recently suggested by researchers at Google, could provide the enabling technology. Federated learning allows machine learning algorithms or artificial intelligence on data to be distributed on different servers, avoiding any data exchange. This will require further investment from both the public and the private sector. It will also require tighter cooperation between the private sector, which typically owns most of the new data, and the public sector, which uses such data for policy reasons and for the common good. 6. The challenges generated by big data and machine learning technologies require continuous organizational and technological innovation in the institutions that want to use them effectively and fairly. Banca d’Italia has taken several steps in recent years to enhance its ability to collect, store and exploit huge amounts of data, using state-of-theart hardware and software. Other institutions are doing the same. Let me conclude my talk by thanking, once again, all the speakers and participants for joining us today. We hope to welcome you here in person in the future. Special thanks go to those who have contributed to organizing the workshop, which brings together leading economists, statisticians, artificial intelligence and machine-learning specialists, data scientists from about 60 central banks, 57 universities, 24 government agencies, 7 multilateral organizations, and 20 private companies. This will ensure a broad variety of perspectives and a lively discussion. I am sure that you can count on having two interesting and productive days. Designed by the Printing and Publishing Division of the Bank of Italy
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Keynote speech by Mr Ignazio Visco, Governor of the Bank of Italy, at The Global Foundation - Rome Roundtable 2020 "Which way the world after the pandemic? Our inclusive human future", Virtual meeting, 16-17 November 2020.
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Ignazio Visco: The G20 under Italy’s leadership in 2021 Keynote speech by Mr Ignazio Visco, Governor of the Bank of Italy, at The Global Foundation – Rome Roundtable 2020 “Which way the world after the pandemic? Our inclusive human future”, Virtual meeting, 16-17 November 2020. * * * Your Excellences, Ladies and Gentlemen, it is a great pleasure to join the 2020 virtual edition of the Rome Roundtable meeting. I would like to thank the Secretary General Steve Howard for giving me the opportunity to address such a distinguished group of guests and the Chairman Rob Knott for his kind introduction. Next year Italy will chair the Group of Twenty (G20) for the first time since it started its gatherings in 1999. Our Presidency, not unlike the one that is about to conclude, takes hold under exceptional circumstances. The Covid-19 pandemic, a human tragedy, has triggered an economic collapse that is unprecedented in recent history. According to the latest IMF projections, global activity will contract by 4.4 per cent this year, the worst result since World War II. At the time of the global financial crisis, in their Statement at the 2009 Pittsburgh Summit, G20 Leaders designated the Group to be the “premier forum for our international economic cooperation”. Global financial stability was then in danger; that crisis had sizeable costs, but coordinated actions succeeded in halting a more costly spiral and, also through the work of the Financial Stability Board (FSB), making our financial systems more resilient. Today’s pandemic crisis brings to the fore another extremely dangerous challenge that must be addressed with ever closer cooperation across countries. We now realise that the risks of a global health crisis have been substantially underestimated. They are by no means the only ones: environmental sustainability, poverty eradication, trade openness, financial stability and knowledge transfer all contain elements of a global public good, whose provision may fall dangerously below desirable levels if national interests and market outcomes are not mediated through the balance of a truly multilateral, consensus-based and far-sighted approach. * * * Three keywords embody the overarching priority themes of the Italian G20 Presidency: People, Planet, and Prosperity. The agenda of the Italian G20 Finance Track, the work stream led by Finance Ministers and Central Bank Governors, will then be inspired by those three words. As a cross-cutting issue I want to emphasise inclusion, and remind you that three years ago, under the Italian Presidency, the G7 adopted the Bari Policy Agenda on Growth and Inequalities as a general framework intended to facilitate and promote “inclusive growth”. In June 2018, at the Global Foundation’s Rome Roundtable Meeting, I had the chance to discuss the extraordinary achievements made possible by the openness of the global economy and technological progress over the last decades. However, I stressed that these secular forces were unequal in their benefits: economic backwardness, extreme poverty and high mortality rates are still dramatic problems in many developing countries, especially in Sub-Saharan Africa, and too many people, even within our prosperous economies, have been left behind. The Covid-19 pandemic comes as an abrupt shock that may erase years of progress in terms of poverty reduction and exacerbate inequalities and exclusion. The amount of people living in extreme poverty will increase for the first time in 25 years, by a number that the World Bank estimates could be above 100 million in 2020 and up to 150 million by next year. The impact of the pandemic has been uneven among workers, with job losses concentrated mainly in lowskilled and low-paid areas of the workforce; it is especially severe on women and the young. 1/5 BIS central bankers' speeches Unequal access to health and education, and a consequent drop in human capital, may further worsen the impact on current and future generations. The health crisis has therefore been at the core of this year’s G20 meetings and will remain at the top of the agenda of the Italian Presidency. Indeed, it is no coincidence that our country will also host the 2021 Global Health Summit. G20 Finance and Health Ministers will continue to work together to ensure that research on vaccines and treatments and their production and distribution are adequately resourced and properly organised, with the common goal of reaching all parts of the world in the most effective way. On the economic policy side, the response to the dramatic consequences of the pandemic has been prompt and massive on all fronts: fiscal, monetary and financial. Economic activity had come to an abrupt halt in several sectors, triggering sharp increases in (observed and disguised) unemployment, a collapse of business sales and severe liquidity strains, which disproportionately affected small and medium enterprises and brought important financial market segments to the verge of collapse. Most governments introduced measures to relieve households’ and firms’ liquidity needs, such as debt moratoriums and temporary lay-off assistance, and to facilitate their access to new financing, such as loan guarantee programmes. Central banks deployed a wide array of emergency liquidity facilities and new asset purchase programmes, as well as funding facilities to support the essential role of banks in financing the real economy. With this objective in mind, bank supervisors used the flexibilities embedded in regulation and accounting standards so as to increase banks’ headroom to absorb losses. These actions have achieved their short-term objectives, setting the stage for the subsequent recovery. The multi-front policy response to the Covid-19 crisis has prevented the drying-up of liquidity and avoided an immediate credit crunch that could have led to a large wave of defaults, warding off a deflationary spiral with probable profound economic and financial stability consequences. Unlike other crisis episodes, in which credit crunches have been a problem, the policy mix has contributed to banks acting as part of the solution to the crisis, rather than as amplifiers of the initial shock. Interventions have been devised in the spirit of close and constructive cooperation. G20 Finance Ministers and Central Bank Governors, together with the major international organisations, worked in close contact, participated in several scheduled and unscheduled (virtual) meetings and exchanged information on a continuous basis. As mandated by Leaders in March, a list of key principles and commitments for a coordinated response to the crisis was laid down under the Saudi Presidency. The Action Plan was endorsed in April and updated in October, coherent with the idea that – as a “living document” – it must regularly take into account ongoing developments and our progressive understanding of health and economic challenges. A vital part of the plan is the support provided to low income countries in the form of free resources for addressing the health crisis. Through the Debt Service Suspension Initiative (DSSI), by mid-October official creditors suspended debt-service payments of about 5 billion dollars from 46 countries who requested it. Multilateral development banks committed additional resources to the value of 75 billion dollars to eligible countries. A Common Framework was endorsed last week to facilitate an orderly debt treatment of DSSI-eligible countries, and is now being submitted for the approval of Leaders. These initiatives will remain under the lens of the Italian Presidency, as part of a broader effort to deal with debt-related issues, enhance global financial safety nets, and improve mechanisms for financing development. * * * The policy response to the global economic jolt caused by the pandemic will necessarily continue to be at the centre of our agenda. The recovery that took hold in the third quarter of the 2/5 BIS central bankers' speeches year, although vigorous, is partial and fragile. The resurgence of infections and – sadly – deaths in many parts of the world will most likely cause a deceleration, and in many countries a reduction, of economic activity in the coming months. Uncertainty about epidemiological developments and economic prospects, feeding households’ and firms’ anxiety, reduces their propensity to consume and invest; there is a concrete risk that high precautionary savings will continue to weigh on aggregate demand. Recent news on vaccine development offer reason for cautious optimism; efforts must be further encouraged. Fiscal and monetary authorities should continue to provide support, readily adapting their action to the evolving situation. Withdrawing support too early and failure to act timely, if needed, could jeopardise recovery, exacerbate social disruptions and, ultimately, prove self-defeating. In particular, the severity of the crisis requires that adequate protection reaches the households and firms that are most affected. At the same time, in a context of rising firm debts, highly uncertain economic prospects and increasing risks in the post-pandemic world, we face the challenge of preserving the financial system’s capacity to support the real economy without compromising its stability. The Covid-19 crisis will inevitably lead to a significant increase of non-financial firms’ indebtedness and related debt overhang issues. Measures to support firms’ recapitalisation might be necessary to avoid a generalised debt overhang problem. It should also be considered that in the last ten years the financial system has become increasingly reliant on non-bank financial institutions for supporting economic growth. This has brought benefits but may also amplify some vulnerabilities, especially in short-term funding markets where these institutions obtain and supply liquidity to provide credit to the real economy. In March substantial stress was experienced, with large and persistent imbalances in the demand and supply of liquidity that was only eased by considerable public – mainly central bank – interventions. In this field, as a starting point, our Presidency will promote a stocktaking analysis of the lessons learnt during the pandemic to understand which features of the existing regulatory framework for banks may need to be amended. One focus will be on the flexibility incorporated into the prudential standards (concerning for instance the use of bank capital and liquidity buffers); another will be on potential sources of pro-cyclicality, like those stemming from the way rating downgrades are dealt with under existing financial rules and from the accounting standards’ approach to the quantification of expected credit losses. It will also be important to look at the adequacy of existing crisis management frameworks. Coordination will be required on how to address the financial stability risks arising from a possible wave of corporate insolvencies, as well as on identifying the conditions that must eventually lead to the unwinding of current emergency measures, so as to avoid unintended effects across sectors and jurisdictions. And a spotlight will be turned on non-bank financial intermediation. As I already mentioned, the rapid expansion of this sector has widened financing options, but this year’s crisis has shown that the non-banking sector can also be a source of systemic risk. The issue of a more effective regulation has gained due relevance only recently, and it is necessary to accelerate work to develop and adopt tools which improve our ability to monitor and prevent those risks. * * * Engaging with a balanced and inclusive recovery requires long sightedness on the challenges and opportunities raised by pre-existing as well as newly emerging structural transformations. I would like to emphasise two of them in particular. 3/5 BIS central bankers' speeches The first is the growing role of digitalisation in the economy, in finance and in society at large, which was certainly expected but is rapidly being accelerated by the pandemic. We must avoid it resulting in new forms of exclusion and we must work to ensure that its benefits are widely shared. In particular, the shift towards digital financial services offers new opportunities but, if not effectively governed, also poses new challenges. Unequal access to finance may worsen the impact on current and future generations. The outcome crucially depends on the development and accessibility of digital infrastructures, the degree of financial and digital literacy and the adequacy of governance, including in the fields of regulation and supervision. We should make the most of the lessons learned from the pandemic crisis and exploit them to “bounce forwards” towards a more inclusive and a more resilient post-pandemic world. The common goal is to make sure that no one is left behind, contrasting both the risk of exclusion and that of irresponsible financial behaviour, such as over-indebtedness, induced by disguised access to digital services. We see two main, complementary areas of intervention. One is raising digital and financial awareness and competences of individuals and firms, delivering educational contents also through digital means. This is an essential tool for people’s empowerment, active citizenship, financial inclusion, resilience and well-being. Households and businesses endowed with higher financial literacy will be better able to cope with the income strains they have to face during crises. Building up more substantial financial cushions in good times would make them better placed to cover living expenses in more difficult ones and avoid needing to resort to heavy borrowing. As co-chair of the G20 Global Partnership for Financial Inclusion, the Bank of Italy is fully committed to delivering on the thorough multi-annual agenda that was endorsed by the G20 last month. This will also regard the other area of intervention that implies fostering more innovative regulatory and supervisory approaches so as to steer and encourage the development of inclusive and responsible digital financial services while granting an adequate protection to final customers, not least from cyber risk. This must be done as we adapt to an environment in which the use of digital channels for using payment, investment and lending services is steadily growing. Thus, under the Italian G20 Presidency we will continue to work on the cross-border dimension along the Roadmap that is being defined by the FSB. The second structural challenge we should focus on is climate change. Absent more forceful measures to flatten the climate curve, global warming is expected to go far beyond the threshold of 1.5 Celsius degrees that, if surpassed, would bring about potentially catastrophic consequences for the planet, as is acknowledged by the United Nations Intergovernmental Panel on Climate Change. Europe, China, Japan and South Korea have pledged to achieve carbon neutrality by 2050, an unprecedented transition in such a short time span. The temporary contraction of global energy demand induced by measures to contain the spread of Covid-19 reduced world emissions by 8 per cent in the first half of this year, a pace unparalleled in history and which cannot be maintained with the production technologies prevailing today. But urgency to restore pre-crisis output levels should not undermine our commitments. It is necessary to make the growth and sustainability objectives complementary, in planning new infrastructures as well as in the maintenance of existing ones. We should avoid, to any possible extent, using stimulus packages to finance technologies that lock our energy systems into a fossil fuel-dependent future. A lot can be achieved also in the financial sector, where mechanisms could be engineered to ensure that market allocation takes account of the environmental impact and climate-related risks. There is no lack of demand by 4/5 BIS central bankers' speeches investors: after the outbreak of Covid-19, amid market mayhem, we observed preferences skewed towards “sustainable assets”. This tendency must be encouraged through properly designed regulation and the adequate provision of information, and also by preventing the risk of “green washing” practices in the provision of sustainability scores by the rating industry. There needs to be a coherent approach, activating all levers – incentives, taxes and regulation – to deliver on our goals. Italy, which will also co-host, along with the United Kingdom, next year’s Conference of the Parties (COP26) under the United Nations Framework Convention on Climate Change, will strive to bring “climate cooperation” to the centre of debate also within the G20. We are aware that there is some contention around how to deal with this issue, but we are also firmly convinced that there cannot be any more room for complacency. * * * I discussed some of the issues that will be focused on by the Italian G20 Presidency in the coming year, in particular within the Finance Track, with no ambition to be either exhaustive or detailed. Our agenda will be kept flexible enough so as to adapt to the rapidly evolving health and economic situation. Next year, the global economy is expected to advance along a slow and very uncertain path of recovery and so far we have merely succeeded in picking the proverbial low-hanging fruit; the end point will be a “new normality” that is hard to prefigure in sufficient detail at the moment. All policies must contribute to averting downside risks, by means of a far-sighted and cooperative approach. Striving for the global common good, the signature byword of the Global Foundation, is also at the root of the G20 and must be its lighthouse. Multilateralism has suffered major setbacks in recent years, but in the current emergency the G20 has proven again that it can make a difference. With the 2021 Presidency of the Group, Italy now carries the full burden of responsibility for ensuring that it will live up to the expectations of all communities. 5/5 BIS central bankers' speeches
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Welcome address by Mr Daniele Franco, Deputy Governor of the Bank of Italy, at the Bank of Italy and SUERF workshop "The effectiveness of monetary policy in a low interest rate environment", Rome, 18 November 2020.
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Banca d’Italia and SUERF workshop ‘The effectiveness of monetary policy in a low interest rate environment’ Welcome address by Daniele Franco Senior Deputy Governor of the Bank of Italy Rome, 18 November 2020 I am happy to welcome you all to the Banca d’Italia and SUERF’s joint Workshop on ‘The effectiveness of monetary policy in a low interest rate environment’. As you may know, we had scheduled this workshop to take place in June, but we had to postpone it, because of the pandemic. We also had to move to a virtual setting and rely on video connections. The workshop addresses issues that are now at the top of policymakers’ agendas around the world. The pandemic has led to the worst recession in recent history, and the scars that it will leave on the global economy are likely to prolong the low interest rate environment. Monetary policy is playing a key role in supporting the recovery and its contribution will remain fundamental in the coming years. The discussion on strategies, targets and tools remains open. Today and tomorrow, we will have the opportunity to embark on a wide-ranging debate on the challenges ahead. In my remarks today, I will touch upon a few of them. To begin with, I think we can all agree that the pandemic crisis has further exacerbated the effects of some ongoing long-term trends. Some of these trends have already been in place since the Great Financial Crisis and its aftermath. I am mostly referring to the drop in the natural rate of interest1 and to the subdued inflation dynamics. These trends are due to structural changes in macroeconomic relationships and imply a need both to reassess theoretical frameworks and to review the monetary policy strategy and tools. In this respect, the first session deals with monetary policy strategy in such a low interest rate environment. This of course calls into question the issue of the appropriateness of the current inflation target, which is indeed one of the main items on the table in See ex multis Neri, S. and Gerali, A. (2019), ‘Natural rates across the Atlantic’, Journal of Macroeconomics, 62. the Eurosystem’s monetary policy Strategy Review. I will not comment further on the Strategy Review, since it is still ongoing. Another important theme in the “post-pandemic” environment will be the interaction between fiscal and monetary policy. As we know, fiscal policy worldwide was boldly expansionary during the most acute phase of the pandemic crisis. In the EU, an unprecedented joint response of Member States will contribute significantly to the recovery in the years to come. In the current circumstances, a sizeable fiscal stimulus is necessary, in order to sustain aggregate demand. However, that very same stimulus raises new challenges, as it will result in a record increase in public debts around the globe. Although I firmly dismiss the risks of fiscal dominance, nevertheless monetary policy cannot ignore the impact of fiscal policy, as is made clear by the second paper of the session. These considerations take me to tomorrow’s first session, which will focus on ‘structural changes’ in monetary policy transmission. Indeed, the historically high levels of public and private debt may well have an impact on the transmission of monetary policy through channels such as the interest rate exposure,2 which in the current environment may lead to significant wealth and income effects. One could argue that high levels of debt boost the monetary policy transmission mechanism via a ‘leverage’ effect, but at the same time generate the risk of higher volatility and, ultimately, may have financial stability implications. The repayment of this high debt burden is currently being made easier by the low nominal interest rates regime, an aspect emphasized by Olivier Blanchard in his AEA presidential lecture last year.3 However, the persistence of low medium- and long-term interest rates cannot be taken for granted. Moreover, episodes of financial turmoil, due to market perceptions or to a change in fundamentals, can happen, creating a negative feedback loop between market expectations and macroeconomic fundamentals. This allows me to touch upon the topic of the instruments of monetary policy, which will be the focus of the concluding session of the workshop. The unconventional policies adopted by central banks around the world in the last decade have proved effective, as a copious amount of evidence suggests.4 The experience gained with the new monetary policy tools in the last decade must guide our choice of the unconventional instruments that central banks should retain in their toolbox. Auclert, A. (2019) ‘Monetary Policy and the Redistribution Channel’. American Economic Review, 109 (6): 2333-67. Blanchard, O. (2019) ‘Public Debt and Low Interest Rates’. American Economic Review, 109 (4): 1197-1229. For a review of the research on unconventional monetary policies carried out at the Bank of Italy, see Neri, S. and S. Siviero (2019) ‘The non-standard monetary policy measures of the ECB: motivations, effectiveness and risks’. Banca d’Italia, Occasional Paper 486. Undoubtedly, many of the instruments deployed in recent years will remain in use in the near future. At the same time, we are now better equipped than in the past to mitigate the undesired side effects of some instruments, as in the case of the two-tier mechanism for the remuneration of excess reserves. A final point that I would like to touch upon concerns the governance of economic research at the present time. Economic research is part of the monetary policy toolbox. Sound economic research is a precondition for the independent assessment of the most appropriate monetary policy stance. As Governor Visco remarked (2016), ‘monetary policy cannot wait until sufficient information accumulates that may cast full light on the new mechanisms at work’.5 This issue has been evident in recent years, when we all faced the great challenge of ‘conduct[ing] both policy and research in real time’, as the former ECB President Draghi once said.6 Precisely because of that, timely and high quality economic research has become increasingly important within central banks, since there is a compelling need to assess the impact of new policies as they are deployed. In this respect, I see two main challenges for central banks in the coming years. First, in the face of the great uncertainties on the shape, timing and features of the recovery ahead, we must keep producing research in ‘real time’, making use of a broad range of modelling tools and of more sophisticated datasets. Secondly, our research should not only be timely, but also seek the highest quality standards. Quality is needed to make policy credible for both experts and the general public alike. Clarity in communicating our results is also crucial. At the same time, the complexities of the current economic environment urge us to keep enlarging the range of research topics covered, in order to better understand the drivers of the structural changes affecting the real economy as well as financial markets. In light of the above, it is of the utmost importance to strengthen international collaboration with other central banks, universities, think tanks and industrial bodies in order to generate and nurture new and better ideas. We are therefore delighted that this workshop has been co-organized by Banca d’Italia together with SUERF. Through a wide range of events and publications bridging research and policy, SUERF is an outstanding meeting point for the profession to foster a fruitful dialogue between central banks, financial sector practitioners and academic institutions. * * * Visco, I. (2016): ‘Quantitative models and methods for monetary policy decisions: limits and new perspectives’, Lectio magistralis on the occasion of his receiving an honorary degree in Statistics and Decision Making at the University of Naples – Federico II, 19 December. Draghi, M. (2016), ‘Researching the Macroeconomic Policies of the Future’, Welcome address at the first ECB Annual Research Conference, Frankfurt am Main, 28 September 2016. We can now start delving into the core topics of our research workshop. We do so with one of the most prominent and renowned researchers in macroeconomic theory, monetary economics and monetary policy. I am delighted to introduce our keynote speaker, Professor Jordi Galí: professor at Universitat Pompeu Fabra and at the Barcelona Graduate School of Economics; director of the Center for Research in International Economics; and research fellow or research associate at the CEPR, NBER, Econometric Society and European Economic Association. He is very well known in the central banking community for his groundbreaking contributions to dynamic macroeconomic models, the determinants of inflation and the conduct of monetary policy. We are looking forward to his insights. Jordi, the floor is yours. Designed by the Printing and Publishing Division of the Bank of Italy
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Welcome address by Mr Ignazio Visco, Governor of the Bank of Italy, at the Fourth Annual Workshop ESCB "Research Cluster 2", online conference, 23 November 2020.
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Ignazio Visco: Welcome address - “Research Cluster 2” Welcome address by Mr Ignazio Visco, Governor of the Bank of Italy, at the Fourth Annual Workshop ESCB “Research Cluster 2”, online conference, 23 November 2020. * * * It is my pleasure to open this fourth Workshop of the “Research Cluster 2”, which every year brings together economists working in the European System of Central Banks in the fields of international economics, fiscal policy, labour economics, competitiveness and governance of the European monetary union. Research clusters were introduced three years ago with the purpose of fostering interactions and collaboration among economists based in national central banks and the ECB. This welcome initiative helps to spur an increasing number of joint studies, encouraging the development of a common view of the problems affecting our economies. If fostering interactions among researchers is important in normal times, it is all the more important in times of crisis and uncertainty, when decision-making processes strongly need timely and high-quality studies, which can benefit from broader cross-country perspectives. Today, with the diffusion of Covid-19, we are unfortunately living through one of the worst such periods in our lifetime. The impact of the pandemic on our societies and economies has been unlike anything we have experienced in recent memory. Its human and social costs are continuing to mount, with almost 60 million cases confirmed globally and 1.4 million deaths officially registered. In early October the IMF estimated that world GDP would fall by 4.4 per cent this year, a severe contraction that, in the case of Europe, nearly doubles in magnitude. These estimates do not incorporate the effects of the resurgence of the virus and of the measures put into place to address it. Recent news on vaccine development offer reason for cautious optimism, but it will take time until widespread immunity is achieved. The outlook remains largely dependent on the evolution of the health crisis, which is likely to continue to weigh on global economic activity well into the next year. The response of central banks, supervisory authorities and governments in the majority of countries has been extraordinary since the early stages of the crisis. Central banks have implemented a wide array of instruments, including new asset purchase programmes and liquidity facilities, to make monetary conditions more expansionary, counter the tensions in financial markets and support the essential provision of credit to households and firms. The response of governments has also been vigorous. In Europe, in particular, the budgetary plans designed to repair the economic and social damage brought about by the pandemic are a significant step not only to kick-start recovery, but also to make further progress in the institutional design of the European Union. Safeguarding the welfare of the “Next Generation EU” requires European funds to be made available promptly and efficiently allocated in order to promote sustainable growth. The policy measures adopted in the past months have contributed to mitigating the costs of the crisis, supporting the real economy and preventing the unfolding of a credit crunch. Without them, the strengthening of productive activity observed globally over the summer would not have been possible. Tackling the situation created by the pandemic, still an international emergency, remains our most urgent priority until a vaccine is distributed to a substantial fraction of the population. As the impact of the pandemic has unfolded, the entire scientific community has worked tirelessly to understand, predict and suggest ways to contrast its negative effects. New studies have benefitted from a revitalisation of the interdisciplinary approach and strengthened interactions among researchers across various fields. In economics, for example, the 1/3 BIS central bankers' speeches incorporation of key features from basic epidemiological models into otherwise standard macroeconomic frameworks have produced new insights into the interactions between health and economic decisions. Some of the papers included in this workshop provide good examples of our attempts to answer key questions about the consequences of the pandemic. The first invited lecture, in particular, will propose an innovative way to quantify the welfare cost of policy responses, accounting for their distributional impact and discussing trade-offs and complementarities between public health objectives and economic results. The first session of the workshop will feature both theoretical and applied works on the impact of the pandemic on several features of the economy, such as productivity, production networks, employment, inflation and income inequality. While not directly related to the pandemic, the other two sessions will touch upon important issues that the current crisis has brought into the spotlight and that are most likely to remain at the heart of the policy debate in the coming months. I would like to briefly touch on three of them. The second session considers the role of fiscal and monetary policy in macroeconomic stabilisation, their interdependences and the extent to which they should coordinate. There is a fair concern that if monetary policy were to end up replacing fiscal policy by using money, instead of taxes or debt, to finance fiscal measures, then it would compromise the independence of central banks, with a substantial loss of the strength and credibility needed to counter inflation successfully in the future. However, as I have recently argued, we should not overemphasize these risks today. Failure to continue acting in accordance with fiscal policy to support households and firms and raise aggregate demand to the levels needed to regain convergence towards our price stability objective could even threaten independence for the opposite reason. Not only should we not end up being accused of failing to fulfil our duties, but we should explicitly recognise that cushioning the consequences of such a huge shock goes beyond the possibilities and instruments of fiscal or monetary policy alone. A coordinated effort is required and its effective implementation in the majority of countries is a major achievement. A further relevant topic that will be discussed in the third session of the workshop refers to the long-term consequences of the crisis on the structure of our economies. It is difficult to predict how the world will look after the pandemic wanes, which changes in consumption habits will persist, how production and labour will be re-organised. A substantial reallocation of capital and labour in the near future across sectors and firms, however, is likely. These adjustments may be painful and lead to temporarily higher unemployment, discouragement and low labour market participation, inefficient matches of workers with firms. Several contributions to the workshop discuss instruments that might favour or hamper these adjustments. In particular, the second invited lecture provides an insightful review of the long process of labour market reforms experienced by our economies, with a focus on the role of temporary jobs. A last issue concerns the urgency to restore pre-crisis output levels and to achieve a satisfactory growth pace in Europe. A few papers in the programme analyse the key role, in this perspective, of firms’ innovation strategies and workers’ efforts. The effectiveness of these key drivers of potential output needs to be enhanced significantly, in Italy as well as in other European countries, by sustained public and private investment in modern infrastructures, in green technologies, in education and research. Following the political agreement reached two weeks ago, the opportunity to achieve growth objectives through a prompt, targeted and effective use of the resources allocated for the “Next Generation EU” must not be squandered. * * * 2/3 BIS central bankers' speeches Let me conclude by thanking the organisers and the scientific committee for having put together a rich and interesting programme, and let me welcome all the presenters, moderators and other participants to the event. The fact that so many central banks are represented here today bears witness to our commitment to continue producing high-quality research, share its results and keep interactions and intellectual spillovers alive. It is extremely unfortunate that this edition of the workshop will only allow for “virtual” interaction, without the social networking and informal conversations that animate in-person meetings. I hope, however, that this will be one time in which, contrary to a well-known empirical finding, intellectual spillover effects will not decay with spatial distance, but rather will prove to be as rich as ever. I therefore wish all the participants in this workshop two very constructive days of open discussions and fruitful exchanges. 3/3 BIS central bankers' speeches
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Speech by Ms Alessandra Perrazzelli, Deputy Governor of the Bank of Italy, at the Singapore FinTech Festival 2020 – Economic Summit, 7 December 2020.
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Digitalization and financial services innovation in the Italian G20 Presidency Agenda Speech by Alessandra Perrazzelli Deputy Governor of Deputy Governor of the Bank of Italy Singapore FinTech Festival 2020 – Economic Summit, 7 December 2020 Thank you for inviting me to speak at this very important event. The Italian G20 Presidency officially took off on December 1. Three keywords embody the overarching priority themes of the Presidency: People, Planet, and Prosperity. These ‘three Ps’ will inspire the agenda of the G20 Finance Track work streams led by Finance Ministers and Central Bank Governors. We must aim to foster a transformative recovery from the pandemic to a more inclusive and sustainable economy and society, levering on new technologies and digitalization, to bring a brighter future for all. The Italian Presidency will bring a renewed focus on green and sustainable finance issues (which also figure in the agenda of this event), in particular with initiatives aimed at promoting better quality data and a broader and more comparable climate-related financial disclosure. As to digitalization and financial services innovation – the main theme of this Singapore Festival - taking over from Governor Alkholifey, I confirm that these will continue to be important cross-cutting issues in the G20 Finance Track workprogram also under the Italian Presidency. As a first example, following up on the G20 Action Plan developed under the Saudi Presidency for sustaining the recovery after the pandemic, the Italian Presidency will promote a discussion in the G20 on the role of new technologies and digital transformation as drivers of productivity gains which can lead to more inclusive and resilient growth. A priority will be to define a menu of policy options providing evidence on best practices for supporting the digital transformation and generating productivity returns. A second example concerns digitalization applied to infrastructure. The Italian Presidency considers a priority to continue to work on the InfraTech Agenda endorsed under the Saudi Presidency, by focusing on best practices for delivering high-quality and high-impact technological solutions enabling infrastructure resilience, and for addressing disparities between urban and rural areas to reach universal access to connectivity networks. A third example refers to the G20 work stream on financial inclusion. The shift towards digital financial services, further accelerated by the pandemic, has created new opportunities but also new challenges. Leveraging on better and more advanced technology, we must work to ensure that benefits are widely shared, by improving financial access for underserved and vulnerable groups, and small and medium enterprises, and to avoid that the increased use of digital means might be a source of exclusion for some categories, due to the lack of digital infrastructure or digital skills. Under the Italian Presidency, the Global Partnership for Financial Inclusion will identify the gaps in digital financial inclusion, uncovered by the crisis, and explore viable solutions to address them, by looking at the state of development and accessibility of digital infrastructure, the degree of financial and digital literacy, the adequacy of the regulatory and supervisory framework. Digitalization and financial services innovation also set the stage for some key priorities identified by the Italian Presidency for the work on financial regulation, coordinated by the FSB in collaboration with the Standard Setting Bodies. As the pandemic has increased the use of digital financial services and remote work tools, an important objective is to promote safety and resilience of the financial system by strengthening cybersecurity in the financial sector. Following up on the Cyber Incident Recovery and Response (CIRR) toolkit developed by the FSB under the Saudi Presidency, the Italian Presidency will focus on cooperating to achieve greater harmonisation in specific areas such as reporting of cyber incidents. The Italian Presidency is also engaged to achieve more efficient and secure crossborder payment systems, building upon the Roadmap for enhancing cross-border payment arrangements and infrastructures developed under the Saudi Presidency and facilitating the achievement of its 2021 committed deliverables. Related to this, we will continue the review of regulatory, supervisory and oversight challenges of global stablecoins and of remaining financial stability concerns. Let me briefly recall the recent developments and arguments underlying the G20 objective to improve cross-border payments and the Italian Presidency commitment to take it forward in 2021. The pandemic has led to a sharp acceleration in the spread of digital payment instruments in many countries of the world. For example, in the second quarter of this year the number of mobile payments transactions processed by Chinese banks increased by 25 per cent with respect to the same period of 2019. In the US, survey evidence suggests that nearly one in five respondents plan to increase the use of mobile payments due to COVID-19. In the euro area, around 40 per cent of consumers have decided to reduce the use of cash for their daily shopping since March, partly because of the fear of being infected by the virus via banknotes or proximity to the cashier. In Italy, the use of payment cards rose and the use of cash decreased even over the summer, when the risk of infection was low and social distancing measures were very limited. These trends suggest that the change in consumer habits towards an increasing use of digital payment instruments, which started well before this crisis, will continue in the years to come, potentially at a faster pace than what we have observed before. Recent advances in technology and innovation, such as distributed ledger technologies (DLT) and multilateral platforms, create the potential for new payment infrastructures and instruments for cross-border payments. DLT, in particular, could represent a break with the way in which payment infrastructures have traditionally worked, i.e. a model in which information is centralized at a single trusted entity. In fact, DLTs enable operators to record a chain of transactions and exchange messages to initiate transactions directly and in one online register, the distributed ledger, which is shared by all users. This could reduce the costs of accessing payment infrastructures, fostering competition and cheaper payment services for all. In sum, technological innovation and the potentially long-lasting effects of pandemic on our behaviour may have profound consequences for the way we will pay and transact in the future, even in the near future. The FSB Roadmap to enhance global cross-border payments is a complex multiannual project, spanning 19 areas of intervention (the socalled “building blocks”) grouped in five “focus areas” dealing with regulatory and infrastructural aspects, with the objective of achieving an improvement of international payments in terms of cost, speed, transparency and accessibility. Actions to be completed by end-2021 have already been committed while the milestones envisaged beyond 2021 are more indicative and can be adjusted as needed. The Roadmap builds on important early actions, such as a “tech sprint” on harmonising payment standards implementation as well as steps on applying AML/CFT standards consistently and comprehensively. It also includes early analyses on emerging developments particularly in innovations such as new multilateral platforms, stablecoins, central bank digital currencies, which the Italian Presidency has identified as more sensitive areas that would deserve a broader and more in-depth discussion in the G20 setting. In this context, so-called “stablecoins” have the ambition to facilitate payments, especially cross-border retail ones. Given the central role of payment services in promoting financial inclusion1, the potential benefits from the diffusion of stablecoins could be significant for the 1.7 billion people globally who are still unbanked or underserved with respect to financial services. At the same time, the payment network of a global stablecoin could have a disruptive impact on monetary sovereignty and be a source of financial instability. Thus, the spread of stablecoins will require close scrutiny and adequate regulatory initiatives at the global level to safeguard the stability of the payment and the financial systems and sustain economic growth. In addition to the potential threats to the financial stability and the monetary sovereignty, so-called stablecoins raise delicate questions regarding IT risks, personal data processing and management, privacy, the correct functioning of the payment system and the transmission of monetary policy. There are also the risks of tax evasion, money laundering and the financing of terrorism, which may have profound consequences for wealth inequality, peace and well-being of our civil society. The cross-border nature of these issues makes international coordination and information sharing essential to address effectively these risks. The Financial Stability Board has recently published ten recommendations to promote a coordinated and effective regulation, supervision and oversight of so-called global stablecoins. These recommendations, which are the outcome of the discussion among FSB member authorities, highlight the importance of regulation, supervision and oversight that is proportionate to the risks, and stress the value of flexible, efficient, CPMI, 2020, Payment aspects of financial inclusion in the fintech era, April. inclusive, and multi-sectoral cross-border cooperation, coordination, and information sharing arrangements among authorities that take into account the evolving nature of stablecoins arrangements and the risks they may pose over time. Many jurisdictions are preparing to create new regulatory frameworks or adapting existing ones to the potential diffusion of so-called stablecoins. Examples include the public consultation by the Monetary Authority of Singapore for the revision of its Payment Services Act, the Swiss FINMA stablecoin guidelines, the regulatory proposal “Market in crypto-assets” by the European Commission and the Interpretive Letter clarifying banks’ responsibilities in providing services to stablecoin issuers, published by the US Office of the Comptroller of the Currency (OCC). The application of technologies such as blockchain or DLT could also have an impact on the way central banking is carried out. Currently, many central banks across the globe are considering whether to introduce a new digital form of central bank money (Central Bank Digital Currency – CBDC). However, there is a number of options in the way central banks can structure a CBDC, each of which brings different risks and opportunities. For example, the introduction of a wholesale-only CBDC could improve the efficiency and the risk management of the interbank payment systems but there are no clear evidences if and how this solution will be more advantageous than current account settlement systems. Likewise, a retail CBDCs directly available to end-users could provide access to simple and costless ways of paying, fostering financial inclusion, but at the same time could have undesired side effects on banks’ business models, financial stability and monetary policies. We are still at the beginning of the development of CBDCs and further analysis will be required in order to tackle all key feasibility and operational challenges. In this respect, the Eurosystem is currently evaluating all possible options for a European CBDC in order to be ready to introduce, if needed, a “digital Euro”. For this purpose, experimentation activities on possible different design solutions of the digital Euro will be launched shortly to better understand its technical feasibility as well as its ability to meet the needs of potential users. A digital Euro will be complementary to cash and to current European initiatives in the field of retail payments and will be carefully designed having in mind the potential implications on privacy, safety/security, monetary policies and financial stability. For the time being, it is hard to predict if CBDC will prove to be a successful payment instrument and which CBDC solution will prevail in the long run. What is certain, however, is that in the near future CBDCs will coexist with traditional payment instruments and that customers will have access to a broader and diversified range of different payment solutions that could involve traditional cash as well as innovative retail CBDCs. Against this background, the Italian G20 Presidency will promote work in two main areas: i) a harmonized implementation of FSB recommendations to address financial stability risks from so-called stablecoins, and ii) the development of measures necessary to effectively address other issues, such as such as money laundering and terrorism financing, data privacy, cyber security, consumer and investor protection and competition. On these works I have two more specific remarks: • First, the obstacles to achieving harmonized approaches in regulating stablecoins across jurisdictions, risks associated with diverging regulatory frameworks and possible cross-border regulatory gaps need to be clearly identified in order to avoid a negative impact on financial stability and to limit regulatory arbitrage. Through the work of the FSB, the Italian Presidency will promote a harmonized implementation of international standards applicable to stablecoins in national jurisdictions, in accordance with the FSB Report. • Second, stablecoins arrangements need to be assessed also against those risks that could fall outside the mandates of financial authorities. We therefore need to investigate what kind of measures could be adopted to properly manage AML, operational and cyber security, consumer protection, market integrity, data privacy and competition risks. In this respect, the Italian Presidency, in collaboration with relevant standard setting bodies, such as FATF, CPMI and IOSCO, will support the completion of the revision of existing standards and principles, and assess the need for further guidance. Focusing on the initiatives currently being undertaken at EU level, the European Commission on 24 September 2020, has adopted a new digital finance strategy and a new retail payments strategy. The main priorities of the digital finance strategy focus on removing fragmentation in the Digital Single Market; adapting the EU regulatory framework to facilitate digital innovation; promoting a data-driven finance and addressing challenges and risks with digital transformation. The digital finance strategy includes legislative proposals on crypto-assets and on digital operational resilience (to prevent and mitigate operational and, more specifically, cyber-risk). It also envisages a mediumterm roadmap including the review and potential amendment of other key areas of the regulatory framework in order to strengthen the EU internal market and its ability to compete in the digital financial arena. This medium-term roadmap tries to address issues such as the interoperability of digital identities for easing customer on-boarding processes in financial services; moreover, building on the PSD2 open banking framework, the EC will investigate the possibility of broadening the scope of data access initiatives to pave the way towards open finance. The strategy on retail payments - consistent with the strategy envisaged by the ECB and the Eurosystem - sets key priorities for retail payments in Europe over the next four years. Its main objectives are increasing digital and instant payment solutions with pan-European reach, supporting innovative and competitive retail payments markets, improving the interoperability of retail payment systems and the efficiency of international payments. The European legislator is therefore responding via all these initiatives to the changes that are affecting the financial market. I refer in the first place to changes to the market structure: new players are entering the financial market, both agile start-ups and Big Techs. The regulator here also played a pivotal role: the entrance of new players was in fact enabled by the new EU regulatory framework on retail payment services (the Payment Services Directive 2), which transferred ownership of client data from banks to clients and transformed financial data into a commodity accessible for both financial and non-financial entities. Thus, both market and regulatory drivers have created a more competitive landscape that can lower costs and be beneficial for consumers but, at the same time, poses risks for financial stability, competition and data protection that should be carefully assessed by legislators and competent authorities. This evolution is accelerated by the way technology and digitalization are changing business models and the way services are offered in the financial market. Digital platforms and technologies such as cloud and APIs (application programming interfaces) allow the commingling of payment and financial services with services or products from other sectors, disintermediating banks and other traditional players and transforming them in “white label” service providers. Crowdfunding and invoice trading platforms are developing and becoming more competitive in providing funding to the real economy. The increase of instant lending, also due to the availability of large data sets and the use of AI/ML, will allow clients to know the outcome of a request in real time and will probably require a rethinking of traditional business processes and of the role of back offices. For incumbents, these evolutionary trends will imply a growing pressure on profitability, the reconsideration of their business models and ever-increasing investments in R&D and in the adjustment of current IT infrastructures. So far, many traditional players are coping well with this challenge by not entrenching themselves in defensive positions but rather opening towards partnerships and collaborations with new Fintech start-ups and Big Techs (so called “coopetition”). “Coopetition” will be a key strategy for each player of this new financial scenario in order to leverage on existing strengths and to develop services and products fit for the new market. Of course, this new cooperative model will be effective only if an open ecosystem and a level playing field are ensured for both incumbents and newcomers, so that everyone can access and compete on the digital platform economy. In an already transforming technological and business environment, the COVID-19 pandemic came along and forced a rapid and large-scale reorganization of the offering of services and products. In a short period of time, social distancing and lockdown measures were introduced and the shift towards digitalization, which was already happening before the pandemic, received a boost. Social distancing has further stressed the importance of digitalization in the economy and has driven a rapid increase in the use of digital financial services and e-commerce. However, to reap the benefits of the growth of digital financial services in the post-COVID era, it will be necessary to close the digital divide at both national and international level by ensuring equal access to digital infrastructure as well as promoting financial and digital literacy. It is only fostering an inclusive financial and digital environment that we will fully exploit the potentialities of the digital economy to contribute to the wellbeing and prosperity of society as a whole. From a market perspective, compared to incumbents, in the aftermath of the pandemic, Fintech firms may be better placed to react and meet the evolving needs of customers because they are by nature more agile and can rapidly adapt to a changing environment by delivering new and tailored solutions. Traditional intermediaries, which were already managing to find the right balance between innovation and legacy, are now facing even more difficulties with the pandemic and will need to reset and reposition themselves against the backdrop of a faster-paced digitalization and of the next economic recovery. In this new world, supervisors and regulators will need to adopt policy tools that allow staying abreast of technological and market developments while overlooking the evolution of the sector and managing new macro and micro prudential risks. In order to do so, many jurisdictions have set up new institutional mechanisms called “innovation facilitators”, which include sandboxes and innovation hubs, that are meant to provide national authorities with new fora for knowledge-sharing with market operators and to support new firms or incumbents with Fintech-related issues. In addition, the cross-sectoral and cross-border nature of Fintech innovations will require different authorities to coordinate within and across countries to deliver holistic solutions to new phenomena such as AI or stablecoins, which will require a harmonized global response to prevent loopholes and regulatory arbitrage. In order to cope with these challenges, the Bank of Italy has recently launched its Milano Hub initiative, a new form of innovation facilitator that aims to be a link between authorities, firms and the academia and to foster wide private and public initiatives that help the transition to digital of the Italian financial system. The Milano Hub is another step in the journey of the Bank of Italy in the Fintech world, which started in the beginning of 2017 with the setup of the Bank of Italy’s Innovation Hub (‘Canale Fintech’) and was followed this year by an internal reallocation of competencies related to financial innovation that was meant to create a dedicated Fintech unit and to leverage potential synergies with other Bank of Italy’s functions (especially oversight on payment services and currency circulation). The hub will leverage on its location in Milan, the main financial center in Italy with a European and global projection, and will be open to the participation of public authorities at both national and international level. Cooperation with global hubs such as the one recently launched by the Monetary Authority of Singapore and the Bank for International Settlements will be a key element in the future success of initiatives like Milano Hub and will help fostering the development of global solutions to the challenges posed by innovations. As an example, we are planning to launch through the Milano hub, in close collaboration with the BIS Innovation Hub, a new TechSprint initiative which will take place under the Italian G20 Presidency, following in the footprints of the very successful exercise conducted under the Saudi G20 Presidency. In conclusion, in all jurisdictions innovation facilitators will play an important role in testing the impact of innovation in a closed environment and in encouraging the spread of responsible innovation in the financial system. Thanks to these new instruments, policymakers will be able to “cross the river of Fintech by feeling the stones” and to address one by one regulatory and supervisory concerns raised by new Fintech models.
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Welcome address by Mr Luigi Federico Signorini, Deputy Governor of the Bank of Italy, at the CEPR International Macroeconomics and Finance (IMF) Programme Meeting Webinar, 10-11 December 2020.
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Welcome address Luigi Federico Signorini, Deputy Governor of the Bank of Italy CEPR International Macroeconomics and Finance (IMF) Programme Meeting Webinar, 10-11 December 2020 Ladies and gentlemen, It is my privilege to open this meeting of the CEPR’s international finance and macro group. In these unusual times, one must forgo the benefits of informal, realworld interaction. We are now all of us well accustomed to making the most of virtual discussions. Nevertheless, I do hope that we shall soon be able, and have the opportunity, to welcome you here in Rome in person. Globalisation is one of the key themes for this group. For over two decades, starting from the mid-eighties, the world saw cross-border movements of goods and (especially) capital increase apace, much faster than GDP. It was not, of course, the first instance of such a sustained process. It had happened during the ‘Belle Époque’ of globalisation, between 1870 and the outbreak of the First World War, and again after the Second. Often, increased exchanges went hand-in-hand with accelerating economic growth, the dissemination of productivity-enhancing technology, the spread of new cultural models, and an internationally open mind-set, especially among the élites—in a knot of reciprocal causation links that is not easy to disentangle. Globalisation was even stronger last time. At the onset of the global financial crisis, world exports amounted to more than a quarter of global GDP, against 13 per cent just before the Great War. Even more importantly, this time globalization went beyond Europe, North America and other traditionally advanced economies, unleashing powerful forces for economic development in much of continental Asia, for instance, and contributing to an astonishing reduction in global poverty. After embracing globalisation, each in its own way, the two largest countries in the world started a process of convergence with advanced economies that scarcely anybody would have thought possible fifty years ago. Many other economies did the same. Institutions and the rules for multilateral cooperation, strengthened after the end of the Cold War, accompanied and supported this process. Eras of globalisation, however, seem to end abruptly. The Belle Époque waltzed unconscionably into the Great War. The post-WW2 era came to an end with the dissolution of Bretton Woods, the oil crisis and stagflation. The latest period of globalisation closed with a global financial crisis. However, support for it had already been weakening for some time, in advanced countries at least, in connection with a growing sense of lopsidedness, unfairness and alienation among many people. Whatever the objective economic details this time (and they are not as one-sided as they are sometimes understood to be), one is tempted to search for similar undercurrents of estrangement during the years that led to the end of the two previous episodes. There are deep and difficult questions about globalisation reversals, which include but are not limited to economic issues. They cannot be discussed here to any meaningful extent. So let us just look at the facts. International tensions over trade, capital flows and exchange rates have emerged forcefully in the past few years. Multilateralism has been in retreat. The return to a strategic use of customs duties, the difficulties world leaders find in agreeing on shared policy goals, and the problems encountered by the WTO are all signs of this process. Few economists welcome them. The pandemic is now placing globalisation at an even more anxiety-generating crossroads. One cannot deny that increased flows of people and goods accelerated cross-country contagion. In the short term, as our virtual conference exemplifies, global mobility has shrunk dramatically. In the longer term, a question mark hangs over the international division of labour, with many pointing to a potential trade-off between efficiency and resilience (or safety), and potential tensions between the winners and losers of reshoring. If people and governments become convinced once again that it is but a zerosum game, the consequences can be serious. However, as so often in the economics of exchange, it is not a zero-sum game. Good economic reasoning and creative research must be key ingredients of the conversation. This seminar will benefit from the insights provided by many first-rate economists, and address a number of interesting questions. One paper, for instance, discusses how the switch from a multilateral to a bilateral approach to trade affects the transmission of monetary policy. Another provides evidence on the link between trade, commodity prices, financial markets and monetary policy, through a comparison of the global transmission of Chinese and US monetary policy. (A pity, though, that the euro area is not covered). Other topics include the impact of capital flows on the real economy, the implications of a dominant currency for monetary cooperation, the effect of a country’s banking structure on the current account, and the way tax havens affect firms’ riskiness. It is a rich menu. Thanks are due to the organisers, presenters and discussants; to the keynote speaker; to all of you. Interaction among researchers is important at all times; it is all the more important in times of heightened material, intellectual and policy uncertainty. I wish you two very constructive days of discussion. Designed by the Printing and Publishing Division of the Bank of Italy
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Welcome address by Mr Ignazio Visco, Governor of the Bank of Italy, at the Bank of Italy / CEPR / EIEF conference on "Ownership, Governance, Management and Firm Performance", Online event, 21-22 December 2020.
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Welcome address Ignazio Visco Governor of the Bank of Italy Bank of Italy / CEPR / EIEF conference on “Ownership, Governance, Management and Firm Performance” Online event, 21-22 December 2020 • It is my pleasure to open this conference on “Ownership, Governance, Management and Firm Performance” organised by the Bank of Italy together with the Centre for Economic Policy Research and the Einaudi Institute for Economics and Finance. This conference bears witness to the Bank of Italy’s interest in productivity, the main force behind aggregate economic growth and welfare improvements. • The slowdown of labour productivity observed since the financial crisis of 2008-09 clearly has a global dimension. Many, possibly complementary, explanations of this phenomenon have been advanced. Demographic developments and the evolution of technical change are certainly crucial determinants of the trends in capital intensity and total factor productivity. On the demand side, the imbalances between saving and investment propensities fuelled by financial instability and protracted uncertainty are often mentioned as culprits of the possible entry into a secular stagnation mode. • Against the background provided by the most likely reasons behind this sluggish trend, the policy debate has focused on the identification of possible remedies to contrast it. Increasing and improving physical infrastructures, investing in knowledge and skills development, favouring innovation through the adoption of new technologies and supporting the reallocation of resources between firms and sectors are all triggers than can help to revitalise our economies. And even if the choice of whether and how to become more efficient is ultimately made at the firm level, there is no question that the public sector plays a key role in creating an adequate environment for “doing business”. • However, we are realising more and more that the evolution of total factor productivity depends on how production is organised, how technology is adopted, and how different skills are dynamically combined. Therefore, corporate governance and management functions are key ingredients of the production process. It is not surprising that much more attention has recently been devoted to their role in determining firm performance and, eventually, contributing to economic growth. In this respect some of the issues discussed in this conference seem to me to be especially important: – Ownership and governance shape attitudes toward risk, affecting the propensity to invest and innovate as well as access to external finance, with significant effects on firm size. They also define the “incentive scheme” under which economic agents operate within firms. Indeed, one research topic that has received wide scholarly attention is family ownership. In general, family firms are characterised by lower agency exchanges and conflicts, resulting, on one side, in more information sharing between owners and managers and yet, on the other side, in more conservative decisions, often leading to less innovation and lower firm growth. – Entrepreneurs play a key role, especially in new businesses, in introducing new products, processes and organisational approaches. However, they face the difficult task of choosing the appropriate managers. The potentially limited pool of talented managers can make for a lack of managerial skills, which is often behind the poor performance of even promising firms. – Modern management practices deal with the design of monitoring and incentive schemes that are conducive to an efficient organisational structure. Much of the productivity gaps, across firms both within and between countries, has recently been attributed to differences in management practices. What has, perhaps surprisingly, emerged is that their quantitative effects are comparable to those brought about by differences in R&D investments, in the adoption of information and communication technologies or in the level of education and skills of employees. • These issues require special attention from both policy-makers and the academic community and are particularly relevant for the Italian economy. We know how extraordinarily large the number of small and very small enterprises in Italy is. We also know that the share of Italian family-owned businesses is similar to that of other European countries. However, the incidence of family management is remarkably higher in Italy. In the selection of managers, family background, social and political connections often appear to hold more weight than competence, managerial skills and education. This also tends to hamper corporate performance due to the lack of openness to external talent and modern management practices, leading to lower firm efficiency and weak propensity to innovate. • The recent pandemic – a human tragedy with enormous costs for the economy and society at large – has impacted firms by inducing substantial and rapid changes in the business environment and in their activity. Even if we still do not have a sufficient understanding of the lasting effects on sectors of activity and production patterns, there is no question that companies with a greater ability to adapt and swiftly re-deploy resources will experience higher chances of survival. In these extremely uncertain times, intangible capabilities – such as creativity, innovative thinking, and openness to change – will be crucial factors, highlighting the central importance of managers in leading the firm through the storm. There is indeed some very recent evidence to show that better-managed Italian firms have been able to adjust their organisational processes and activities more rapidly, thus containing the economic losses caused by the pandemic. • I would finally observe that drawing policy implications in the field of corporate governance is very difficult. Policy makers can affect the general environment in which firms invest and produce, but private firms operating in a market economy independently take corporate governance decisions. The productivity-enhancing effects of good entrepreneurs and managers hinge on there being a sufficient pool of skilled individuals in the population at large. Therefore, investing in human capital may provide firms with the edge needed to excel in challenging environments. However, the ability of both firms and individuals to grow and emerge needs to be adequately fuelled. In this respect, market and labour regulation, the organisational culture and the recognition received by workers for their efforts and merit play a crucial role in providing incentives to invest in human capital. More generally, they foster a more efficient allocation of talent in the economy, with positive welfare effects for the economy as a whole. • The studies included in the programme address many of these key issues. The conference will also cover other topics of long-standing interest in the field, such as the increasingly debated importance of promoting female participation in leadership positions. The first invited lecture, in particular, will overview the critical points in pursuing gender diversity on corporate boards and its implications for the future of the economy. The second invited lecture will discuss the trends emerging in the labour market, focusing on the rising importance given to, among the other talents required of managers, cognitive skills and the ability to coordinate the activities of their staff. • Let me conclude by thanking the organisers and the scientific committee for having put together such a rich and interesting programme and let me welcome the lecturers, presenters, moderators and all the other participants to this event. Although the circumstances only allow for a “virtual” format of the conference, I wish you all fruitful interactions and thought-provoking discussions during these two days. Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Welcome address by Mr Ignazio Visco, Governor of the Bank of Italy, at the Bank of Italy workshop on "The crisis management framework for banks in the EU. How can we deal with the crisis of small and medium-sized banks?", online event, 15 January 2021.
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Welcome address Ignazio Visco Governor of the Bank of Italy Bank of Italy workshop on: “The crisis management framework for banks in the EU. How can we deal with the crisis of small and medium-sized banks?” Online event, 15 January 2021 • It is my pleasure to open this workshop on “The crisis management framework for banks in the EU. How can we deal with the crisis of small and medium-sized banks?” As is well known, in 2015 the Bank Recovery and Resolution Directive (BRRD) introduced a new crisis management regime for the European Union. The purpose of the directive was to tackle the “too-big-to-fail” problem and eliminate the need for bail-outs with public funds in the event of bank failures. • The focus of this reform – in line with the Key Attributes of Effective Resolution Regimes for Financial Institution published by the FSB in the aftermath of the global financial crisis of 2007-08 – was on systemically important banks, i.e. those banks whose failure would likely threaten financial stability and have severe repercussions on the real economy at home and abroad. During the global financial crisis, as well as in previous crisis episodes, the bail-out of such institutions was very costly for governments and, ultimately, taxpayers. Therefore, the solution envisaged at the global level was to internalise the losses through the implementation of the “bail-in”, the main tool underpinning the new resolution framework. By shifting the cost of the crisis from taxpayers to investors and creditors, the framework also intended to reduce moral hazard and restore the level playing field for larger and smaller banks, by eliminating the implicit subsidies enjoyed by the former. • However, less attention has been paid so far to banks that are not systemic, namely the small and medium-sized banks that, in the European Union, represent the vast majority. So far, our understanding has been that the new resolution regime is only applicable to a small subset of banks and banking groups: in the euro area only around 200 banks out of a total of about 3,000 as of end-2019. Any crisis among the remaining banks should therefore be dealt with via national insolvency procedures. • Yet small and medium-sized banks contribute to a great extent to the financing of the economy. Less significant institutions (LSIs) hold 19 per cent of the total assets of the banking sector in the euro area; in some countries – such as Austria, Germany, Ireland and Luxembourg – this share rises to over one-third. • In addition, small and medium-sized banks could be those suffering the most from the economic consequences of the pandemic. Could this create an unprecedented “too-many-to-fail” problem, difficult to address within the current framework? A recent Bank of Italy analysis confirms that the effect of the pandemic on Italian banks’ credit risk exposure could be higher among less significant institutions than among significant ones, due to the different sectoral composition of the loan portfolios of the two groups. • National insolvency procedures are very heterogeneous across EU member States. For example, some countries have special regimes applicable only to banks, while others have ordinary insolvency regimes applicable to all kinds of firms; some implement judicial-based frameworks while others administrative-based frameworks. This variety creates a level-playing-field problem, as creditors and depositors may be treated differently across the Union, thus fuelling financial fragmentation. • A greater degree of harmonisation of the national insolvency procedures for non-systemic banks is therefore necessary to strengthen the Banking Union and the single market. How, then, can we bring this about? And, most importantly, how should any new EU framework be shaped? • The main objective of any revision of the current framework should be to avoid disorderly piecemeal liquidations, with the consequent unnecessary destruction of value. In Europe this objective is actively pursued in the field of insolvency procedures for non-financial firms, for which harmonisation efforts are ongoing. It should also be pursued, a fortiori, in the banking field, where it is crucial not only to avoid destroying value, but also to preserve public confidence in the banking system. • Disorderly liquidations may have instead become more likely in recent years, due to several factors. Technological progress and changing customer habits are inducing banks to downsize their branch network: a key effect of this phenomenon is the reduced appetite of banks for acquiring ailing institutions. The economic crisis is also creating “overcapacity” in the EU banking sector, which, on average, struggles to remunerate capital, further diminishing returns on mergers and acquisitions. Under these conditions, the “franchise value” of ailing banks is small and potential buyers are often willing to enter into a deal only at negative prices. • As is well known, piecemeal liquidation would lead to the immediate disruption of the bank’s core activities. Assets would have to be disposed of quickly at fire sale prices and collateral would have to be enforced; non-insured liability holders would have to face long delays to obtain only partial reimbursement; borrowers – especially small enterprises – could be exposed to liquidity constraints, which could then evolve into solvency problems. Confidence in other banks could be shaken, amplifying the risks for the economy at large. Unsurprisingly, disorderly piecemeal liquidation has so far been largely untested. • At present, there is nothing in the EU crisis management framework to prevent the difficulties of a non-systemic bank from evolving into a disorderly piecemeal liquidation. This fundamental weakness of the framework has not gone unnoticed. In the Financial Sector Assessment Program for the euro area, the IMF called for a common legal framework for liquidation featuring “purchase and assumption” transactions (a transfer of business – assets and liabilities, business branches and legal relationships) supported by a European deposit guarantee scheme. The IMF argued that a transfer of assets and liabilities, instead of a piecemeal liquidation, would reduce the destruction of value and ensure a level playing field for creditors. • Ensuring that adequate and proportionate solutions exist to manage the failure of banks, while preserving their franchise value, is among the objectives that the European Commission intends to pursue, as part of the agenda for the completion of the Banking Union. This would be a key step to increasing the effectiveness and efficiency of the crisis management and deposit insurance frameworks. • One fundamental question concerns the sources of funding to finance a transfer strategy, be it in resolution or in liquidation. Under the current BRRD framework, a successful resolution strategy premised on the bail-in tool requires adequate levels of eligible liabilities (Minimum Requirement for own funds and Eligible Liabilities, MREL), preferably subordinated, to avoid losses being imposed on depositors and other retail creditors. • However, most medium-sized banks (not to mention smaller ones) are not equipped to tap capital markets in order to issue MREL instruments. Around 70 per cent of the significant banks under the direct supervision of the ECB are not listed, 60 per cent have never issued convertible instruments, and 25 per cent have not even issued subordinated debt. These shares rise sharply, of course, for smaller institutions. Requiring these banks to issue MREL-eligible liabilities to non-retail investors would therefore force them to resort to the wholesale market, obtain a credit rating and change their funding structure significantly. It could therefore have a strong impact on banks’ margins and even force some of them out of the market, since issuance costs could prove too high to bear. • One possibility to overcome these problems is to finance the transfer of assets and liabilities of the failed bank to a viable third party with the support of a deposit guarantee scheme, as suggested by the IMF. Bail-in would then be applicable only to banks able to tap capital markets to build up enough MREL without radically modifying their funding structure, in line with the original aim of the reform, which was to address the “too-big-to-fail” problem. For all other banks, the deposit guarantee scheme would be responsible for ensuring an orderly exit from the market, without unnecessary destruction of value and spillover effects. • A number of legal constraints in the European framework currently hinder this possibility and should therefore be removed. I have already advanced this consideration years ago, also mentioning the role played in the United States by the Federal Deposit Insurance Corporation. The Bank of Italy has contributed to identifying some of these constraints and has put forward proposals, drawing also from the US experience, which has successfully managed a large number of crises of small banks. • The resulting differentiation between larger banks – subject to MREL and bail-in – and smaller banks – subject to a different and less costly treatment – could be justified on the basis of the proportionality principle, as well as with reference to the objective of preserving the valuable business model of small institutions that rely extensively (if not almost exclusively) on deposit taking and credit lending. Non-systemic banks would actually struggle to survive should their creditors start moving to larger banks because risks are perceived to be substantially lower. The proposed policy would then contribute to preserving some bio-diversity in the EU banking system, which would be beneficial for financial stability as a whole. • Indeed, this would be in line with the original aim of addressing the “too-big-to-fail” problem. Larger banks would have to pay the price for their size, consistently with the higher systemic risk they pose in the event of failure and in line with other strands of the regulatory framework, such as the capital requirements, which are more stringent for larger banks. • With regard to the risk of moral hazard that the different treatment of smaller banks could generate, the argument that uninsured depositors or senior bondholders should participate in absorbing losses in order to fend off this risk seems a feeble one. In the case of smaller banks, in fact, these are often individual households and small firms, who are not able to adequately monitor financial intermediaries. Forcing them to do so, even supposing this were possible, would entail substantial inefficiencies, not to mention the risk of triggering bank runs. Moreover, we must also bear in mind that imposing losses on the creditors of small and medium-sized banks in the absence of adequate MREL buffers would end up hitting their deposits, with possible negative spillover effects on other small banks. • Today’s workshop provides an important opportunity to discuss these issues and explore views and suggestions that, hopefully, will contribute in a constructive way to the debate on how to improve the crisis management framework for small banks. So let me thank all the presenters, discussants and panellists who will share their views with us and provide useful insights on how to foster a safer financial system and a better economy. Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 27th Congress of ASSIOM FOREX (the Italian financial markets association), 6 February 2021.
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27th ASSIOM FOREX Congress Speech by the Governor of the Bank of Italy Ignazio Visco 6 February 2021 The economic situation and the outlook The ongoing pandemic and the uncertainty over the public health, social and economic situation continue to affect consumption and investment decisions, with significant repercussions for the production system, employment and income. The marketing authorization of the first vaccines, granted at the end of 2020, gives hope that the health emergency can be countered effectively over the course of this year. However, the risks for the coming months still appear very substantial. The main one is that the containment of COVID-19 may prove to be more difficult than expected. Moreover, it is not clear whether the changes that the pandemic has caused in consumer habits, in the organization of society and of production, and in the way people work will persist. The G20’s cooperative response has made it possible to limit the economic impact of the health emergency. Italy, which has taken over the G20 presidency for this year, will have the opportunity to work towards reaffirming a multilateral approach. Global economic activity will be supported by the latest expansionary measures adopted by some advanced countries and by China’s robust recovery, which is also being facilitated by sizeable public investment. These factors, together with the agreement reached by the European Union and the United Kingdom last December, led the International Monetary Fund to revise its growth projections for the world economy for 2021 slightly upwards, to 5.5 per cent, after the contraction of 3.5 per cent recorded in 2020. In Italy, the marked increase in production activity in the third quarter of 2020 demonstrated that the economy retains the capacity to bounce back. However, the second wave of infection, the resulting restrictions put in place to contain its spread, and heightened uncertainty led, as in other EU countries, to a new drop in GDP in the fourth quarter, equal to 2 per cent on the third quarter and to 6.6 per cent compared with the year-earlier period. The experience gained so far has made it possible to limit its impact on the economy, in part thanks to more targeted containment measures and an improvement in the response capacity of the health system. After the strong but partial recovery in the number of hours worked in the summer months, employment is now being affected by the sudden worsening of the economic situation. Since the beginning of 2020, the pandemic has had a significant impact on income and inequality. Among those affected were above all self-employed workers and payroll employees with fixed-term contracts, especially young people and women, who account for a higher share of employment in the sectors most exposed to the crisis. The policies implemented to alleviate its economic effects – such as wage supplementation schemes, the lengthening of the duration of unemployment benefits and the income support measures for selfemployed workers and households in difficulty – have been effective overall, mitigating the shortcomings of the welfare system, due above all to the excessive fragmentation of the instruments available. The surveys conducted by the Bank of Italy at the end of November suggest that consumption expenditure is being held back by fears of infection, besides the precautionary motive based on economic and financial considerations. The share of households that expect to spend less than their annual income in the next twelve months has increased; a non-negligible share (about 20 per cent) of the households anticipating a decrease in their income also reported that they expect to save. Over the course of the month, about 80 per cent of households spent less on tourism and restaurant services compared with November 2019, and reduced the frequency of purchases in clothing stores; two thirds decreased their spending on personal care services. The contraction for this set of consumption items was greatest in the regions hit hardest by the spread of the epidemic. These indications confirm the importance of a far-reaching and lasting strengthening of the healthcare system and suggest that a fully successful vaccination campaign will be crucial to a stable recovery. The worsening of the health emergency was also reflected in firms’ assessments of investment conditions, which started to deteriorate again, albeit slightly, in late 2020, especially in some segments of the service sector marked by the presence of a high number of small and micro firms with a limited ability to deal with shocks. Our projections point to a recovery in production starting in the spring, although this central scenario hinges crucially upon the progressive attenuation of the epidemic over the course of the coming months. In addition to this, a robust recovery of the economy will require the reactivation of significant plans for investment; in this respect, a key role will be played by the benefits stemming from a rapid and full implementation of the measures still being drawn up as part of the Next Generation EU programme. However, it is likely that consumption will pick up slowly, especially in services, owing to the gradual manner in which the uncertainty that drove the propensity to save will be reabsorbed. In the current circumstances, measures providing economic and financial relief to households and firms remain indispensable. The urgent need to address today’s problems must, however, be accompanied by reflections on how to conduct the inevitable progressive reduction of support measures in the future. The necessity of guaranteeing protection for workers and preventing healthy firms from exiting the market must be reconciled with the need not to hinder the automatic reallocation of resources towards the firms and sectors with the best growth potential. This process is indispensable to foster the efficiency gains that are fundamental to economic growth. As uncertainty about the economic outlook diminishes, the use of support instruments can gradually be made more selective. Access to broad-spectrum instruments that are significantly more generous than ordinary ones can be revised to make them conditional on firms’ ability to retain their workers and, at the same time, the general freeze on terminations can be eased. It will be possible to return progressively to firms’ sharing the costs of these instruments. When calibrating these measures, it will be important to consider the particular conditions of the various sectors of the economy. Measures to support firms’ liquidity will have to be gradually readjusted to prevent a credit squeeze as the economy begins to pick up again. These measures must not, however, compromise the timely emergence of bad quality loans on banks’ balance sheets, nor should they facilitate the prolonged survival of firms that, independently of the pandemic crisis, would not be able to remain on the market. Firms’ capital strengthening must continue, by means of effective and easy-to-use tools. The contribution of fiscal policy has been crucial to containing the economic fall-out from the public health emergency. However, we cannot cultivate the illusion that the public debt can increase indefinitely. In relation to GDP, it has already risen to levels only previously seen in the wake of the First World War. Fiscal policies must have the clear medium-term objective of guiding the debt ratio back to a downward slope. This goal is within our reach: the low interest rates observed in recent years have reduced the average cost of the debt to historical lows and its residual maturity is a protection against temporary external shocks, but the crucial question remains that of economic growth. Once the pandemic is behind us, achieving stable and sufficiently high growth rates, in line with those in the years prior to the global financial crisis, will allow us to reduce the weight of the debt with budget adjustments that are not excessively onerous. To relaunch the economy, the public spending plans for the green and digital transition must be accompanied by reforms to make Italy more business-friendly: private investment, company growth, and greater innovative capability within the industrial system also depend, to a high degree, on a significant improvement in the services provided by general government. Given the unfavourable demographic outlook, productivity growth must be accompanied by a significant increase in activity rates. On the one hand, it will be necessary to accommodate the current trends by extending working lives and, on the other, we must facilitate participation in the labour market for those segments of the population, especially women and young people, that today remain on the margins of productive activity, above all in the South of Italy. In this regard too, we can only reiterate the importance of removing the lags in the levels of education and learning that exist today. The year that has just ended was characterized by very erratic movements in the financial markets: in the early months of 2020, the yield spread between Italian and German ten-year government bonds repeatedly went above 250 basis points. The consistent approach of the economic policies adopted at national and EU levels led to a reduction of tensions and a sustained decline of market interest rates. A decisive part was played by the resolute and swift action of monetary policy – with new purchase programmes whose flexibility allowed incisive and vigorous action in jurisdictions where the financial tensions caused by the spread of the pandemic had been greatest – and the decision to establish the Next Generation EU programme for the joint funding of individual countries’ investment and development plans by means of issuing European debt securities. The yields on Italian ten-year government bonds have gradually fallen to very low levels and the yield spread with the German Bund has, in the last few days, fallen below 100 basis points, reaching its lowest level since the beginning of 2016. The set of measures adopted to support liquidity has also made it possible to preserve favourable conditions for accessing bank credit on the part of households and firms and to reduce the cost of bond and equity funding. Faced with the effects of the public health emergency, which are expected to last longer than predicted last autumn, at its January meeting, the ECB Governing Council reconfirmed that its very accommodative monetary policy stance and its continued presence on the market are still essential in order to support the economy and prices in the euro area, also by bolstering confidence and reducing uncertainty. The Council also confirmed that any tightening of financial conditions that is not consistent with containing the impact of the pandemic on price stability will be countered resolutely. Banks Thanks also to the economic support measures adopted by the Government, Italian banks have kept credit supply standards relaxed in response to firms’ rising demand for funds. The growth in lending to non-financial corporations remained robust in the fourth quarter, still driven by the ample recourse to public guarantees. The average cost of new loans remains at very low levels. The financial aid measures, the supervisory authorities’ guidelines on the use of the flexibility built into the rules for classifying loans, and the expansionary monetary policy stance have all contributed to keeping the non-performing loan rate low. The disposal of NPLs continued, equalling almost €30 billion in 2020, surpassing initial projections. This development was supported by legislation that has enabled banks to convert a portion of their deferred tax assets into tax credits when such assets are sold. Because of the ongoing restrictions on economic activity, rendered necessary to contain the risk of infection, the Government has extended the moratoriums introduced in March 2020 until next June. This measure, also taking account of the clarifications recently published by the European Banking Authority, will make it possible to continue to contribute generously to satisfying firms’ liquidity needs. It is nonetheless essential that moratoriums continue to be a tool to help debtors make it through temporary difficulties, and are not used to conceal clear and irreversible crises. Never before have banks been called upon to perform their role with such skill, acting swiftly to improve the outlook for firms facing temporary distress and to set aside adequate provisions for expected losses, in line with the new accounting standards. Since the start of the year, the new European rules with which credit institutions and non-bank financial intermediaries must comply have further refined the definition of default for prudential purposes. As we have explained, the ‘new’ definition of default does not entail any substantial changes in reports to the Central Credit Register. Instead, it affects the way in which financial intermediaries have to classify their customers’ positions to calculate their capital requirements. As the experience of the four Italian banks that chose to switch to the new system as early as 2019 has shown, the new framework seems to have had a limited impact on the stock of non-performing loans. To reduce the impact to a minimum, we have asked intermediaries to launch a suitable informational campaign on the new rules and to engage one-on-one with their customers more frequently. The goal is to prevent any defaults not connected to any actual situations of distress and to handle such situations effectively. The latest data available show that, at the end of September 2020, the NPL ratio had fallen to 2.7 per cent net of loan loss provisions (5.5 per cent gross of provisions). The downward trend is likely to be interrupted owing to the impact of the current crisis, which, however, is making itself felt more slowly and less intensely than in the past, thanks to firms being in a stronger position when the crisis first hit and to the support measures mentioned earlier. The heightened uncertainty about changes in the macroeconomic outlook calls for a great deal of caution in interpreting the estimates put forth by a number of parties on the possible increase in NPLs. Although it is expected to rise, the non-performing loan rate should nonetheless stay well below the peaks reached during the euro-area sovereign debt crisis. In the medium term, the deterioration in banks’ balance sheets will depend on how quickly our economy is able to exit from this current difficult phase. The build-up of bad debt until 2015 was the result of two severe recessions that occurred in rapid succession. Serious deficiencies in the procedures used by intermediaries to manage NPLs have also had an impact, although important steps forward have been taken in the last five years, in part thanks to the development of the secondary market. While some slight progress has been made, considerable improvement is still needed in the legal and judicial system’s ability to handle the caseload of business insolvencies swiftly and efficiently: to do this, the persistently large gap with other European countries must be closed. It is important that we monitor the actual impact of the reforms that, with the new Corporate Crisis and Insolvency Code, will take effect in the second half of this year. The prudential rules and supervisory expectations based on a calendar provisioning approach seek to ensure that NPLs do not accumulate in banks’ balance sheets without adequate write-downs. In many countries, including ours, the high levels of NPLs – despite the prompting, the targeted inspections and the prudential interventions by the supervisory authorities – were among the main causes of banking crises in the last few years. The effect of this approach on banks’ balance sheets may not prove trivial over the short term, but it is manageable overall. In any case, its impact on intermediaries’ income statements is temporary and will basically disappear over the course of the credit recovery cycle. The capital strengthening of Italian banks continued in 2020. The ratio between common equity tier 1 and risk-weighted assets (CET1 ratio) rose by about 1.2 percentage points, to 15.1 per cent. The capitalization of the profits from the 2019 financial year that were not distributed, in accordance with the recommendations of the European Systemic Risk Board, were a significant contributory factor. These recommendations sought to improve intermediaries’ capacity to absorb losses and to guarantee an adequate flow of credit to the economy. Last December, both the ECB and the Bank of Italy reiterated the need for extreme caution in dividend distribution policies on 2020 earnings. These profits were in part fuelled by considerable government support for firms and households, which also helped to soften the impact of the crisis on credit institutions’ balance sheets. The recommendation is temporary in nature; in these very unusual times, it is necessary to maintain a sufficient degree of capitalization of profits. Banks’ profitability has indeed been significantly affected by the pandemic. Despite essentially stable operating profits, in the first nine months of 2020, the annualized return on equity fell to 2.4 per cent, about two thirds lower than in the same period of 2019. Unusual, one-off events that affected the balance sheets of some large intermediaries contributed to the aggregate decline in profits. In particular, in expectation of a deterioration in asset quality in the future, banks have considerably increased the loan loss provisions for performing loans for which the probability of default has risen. Over the next few months, banks will be called on to manage effectively and with determination the effects of the crisis on credit quality, enhancing the instruments at their disposal to stave off an excessive build-up of non-performing loans and, looking forward, the pro-cyclical effects on credit supply. The European Commission’s recent communication points to initiatives that could be useful to strengthen the secondary market for NPLs, but it falls short regarding the possibility of establishing asset management companies with public support, a tool that, as we have long stressed, is extremely useful, especially during economic downturns. Small and medium-sized banks could feel the effects of the pandemic crisis to the extent that they have greater exposure to firms that do business in the most impacted sectors. This problem is layered on top of the ‘structural’ ones tied to there being fewer opportunities to exploit economies of scale and to diversify, and to the restrictions on accessing capital markets. Given these considerations, which we too have recalled repeatedly, the development of a harmonized banking crisis management framework at European level is necessary and urgent, in order to foster the orderly exit of these intermediaries from the market. It remains crucial that banks be headed by individuals whose professionalism and integrity are beyond reproach. The recent measures issued by the Government finally implement the relevant European legislation; they strengthen, in line with international standards, the requirements and eligibility criteria for bank officials; and they constitute an important step forward in defending the stability of the system and the interests of investors, be they small shareholders or bondholders of credit institutions. The action taken by the supervisory authorities to ensure sound and prudent management must of necessity be complemented by the conduct and competence of bank executives: it is they, first and foremost, who must guarantee the proper functioning of internal controls, an adequate monitoring of risks, and a medium and long-term strategic vision apt for facing the challenges posed by the difficult economic phase. The new legislation represents an opportunity, starting with the upcoming shareholders’ meetings convened to make new appointments, to renew and enhance banks’ managerial human capital, not just for the largest banks. The markets and the G20 Finance Track The banking sector is helping to sustain the economy in this phase of the public health emergency; it will need to continue providing its support during the recovery as well, with a complementary role to that of public sector and monetary policy interventions. However, the banks’ role will not only be to lend to firms, but also to help them access alternative funding sources, especially for risk capital. Action is needed to increase trust in the possibility of using savings profitably, so that they can be invested in instruments that allow the firms with the best prospects to be funded. The underdevelopment of Italy’s equity market compared with those of the other main economies stems from the small average size of firms and from their historically low propensity to seek a listing. In recent years, however, there has been an increase in firms’ initial public offerings, especially for small and mediumsized companies and those that are more high-tech. The dynamism of firms, the incentives introduced by the legislator and the simplified listing procedures adopted by the market are all contributory factors. Once the effects of the crisis have faded, both firms that now need to strengthen their financial structure and those that plan to raise capital on the market to begin new activities will be able to take advantage of this trend to grasp in full the opportunities that the economic recovery will offer them. The diversification of firms’ funding sources and the expansion of investment opportunities for savers are favoured by the process for integrating the European Union’s financial markets, which must continue. The more intermediaries and market infrastructures are able to increase the efficiency of their organizations and to adopt strategic guidelines open to innovation, the greater the benefits for Italy’s financial marketplace. The Borsa Italiana group, to which Italy’s market infrastructures belong, is on the eve of an important operation to transfer its entire shareholding from the London Stock Exchange Group to the Euronext Group, a pan-European federated infrastructure. This operation is currently being examined by the Italian and European authorities. Italian market operating and post-trading companies, in part due to their importance in the group’s capital and financial structure, will be able to provide significant strategic input for the new ownership set-up and to seize the opportunities that may come from the wider range of services provided and a greater presence on European financial markets. In 2021, the merger between SIA and Nexi will come to fruition; these two operators play a central role in the national payments industry. At a time when Europe is strongly committed to creating open, secure and sustainable digital finance, a new Italian hub has emerged that can make a significant contribution at European level to the soundness and innovation of payment infrastructures. An open and competitive context is crucial so that efficiency gains for financial operators translate into lower costs for the end-users. As part of the G20 Finance Track, which brings together Finance Ministers and central bank Governors, Italy’s presidency will promote analyses to evaluate, in light of the crisis caused by the pandemic, the adequacy of the financial regulation reforms introduced since 2008 and problems in the field of non-banking intermediation too, in order to identify any corrective measures that might be necessary. Among the other priorities is that of ensuring the timely implementation of the Roadmap on Enhancing Cross-Border Payments, agreed upon last year to make the cross-border payment system more efficient, with a view to alleviating its fragmentation and to providing cheaper and faster services, especially for remittances. The debate will also continue on private and public digital currencies that might appear on the global scene. The digitalization of finance must be suitably governed, as it provides considerable opportunities but also brings new risks, such as that of excluding the most vulnerable. This includes the initiatives designed to ensure protection for customers and for their data. For retail payments, especially for remote card transactions, strong customer authentication solutions have been adopted to give further support to the development of e-commerce. It is important for the new provisions to be correctly and rapidly implemented by online financial operators and retailers. The work of a dedicated G20 platform (Global Partnership for Financial Inclusion) will also focus on the theme of financial inclusion and aims to capture the existing gaps, also by refining the tools for measuring them, and to find the most appropriate solutions to remedy them. There will also be a significant focus on the issue of environmental sustainability. Finance must necessarily be an active part of strategies to counter climate change, acting rapidly, decisively and with farsightedness while at the same time incorporating the risks it brings in its evaluations. Best practices in terms of environmental sustainability, social commitment and corporate management have positive effects on firms’ economic and financial equilibrium, on risk management and, ultimately, on the well-being of all citizens. Investors’ growing interest is leading to a marked expansion in sustainable finance and thus expanding the availability of capital for funding the transition towards a low-carbon economy. This trend has to be supported by better corporate information; firms that lag behind in increasing their transparency will find it difficult to attract capital. Correctly identifying and quantifying the exposure of their assets to climate risks is also essential for managing them more accurately and effectively. *** The pandemic, with its terrible toll, is not yet behind us, and much uncertainty remains about the course it will take. Considerable efforts are still required to tackle the health emergency and support the hardest hit businesses, workers and households. Our economy has demonstrated its capacity to recover. Italy must now find the cohesion it needs to return to the path of development, exploiting the opportunity provided by the EU’s pandemic response and addressing the structural problems that hold it back in the formation of a common strategy, one that has at its centre the challenges of environmental sustainability and the digital transition. The components of the National Recovery and Resilience Plan, together with a broader recalibration of national policies, must aim to increase growth potential, defining the projects and their management in such a way as to permit their rapid realization, within the tight deadlines set out in the European programme and in accordance with the detailed operational guidelines of the European Commission. This is no small challenge for the public administration. As much as it is vital for modernizing the production sector, if it is not accompanied by reforms that tackle the problems hindering development and private investment, the Plan’s implementation risks being insufficient to guarantee a lasting increase in the pace of growth. It is not just a matter of formally adhering to the recommendations of the European Commission, but rather of dealing concretely with problems that have been debated for years. The combination of the boost to potential GDP growth, made possible by a careful and targeted use of Next Generation EU funds, and the prolonged expansionary effects of monetary policy, offers Italy the opportunity to aggressively tackle its high debt-to-GDP ratio as well. Thanks to its relatively high residual maturity, the cost of the debt will remain low for a prolonged period of time, even after market and official rates have started to rise again. In these circumstances, if, as we have shown we can, the country succeeds in returning to a path of steady growth, the debt-to-GDP ratio could fall rapidly from the high point reached owing to the crisis. Renewed confidence in the quality of policies and in the economic outlook could enable a further narrowing of the yield spread between Italian and German ten-year bonds, which is still close to double that of Spain and Portugal. As the economy improves, an appropriate strategy to gradually rebalance the public accounts could strengthen these confidence effects and further accelerate the reduction in the debt-to-GDP ratio. The present difficulties must not prevent us from looking to the future. Certainly, there are risks in the near term. Yet by cultivating a longer-term vision, it is possible to do better than the trend projections suggest. Mindful, decisive and effective answers are required for today’s very serious problems, greatly exacerbated by the pandemic but also reflecting existing structural gaps. Closing these gaps will require a collective commitment, on the part of all firms operating in our economy, including those in the financial industry represented here, but also by the institutions on which economic policy action depends. Extraordinary relief measures have been the necessary response for dealing with the most acute phases of the crisis. Once the emergency is over, the measures designed to alleviate the difficulties of those hardest hit must constitute a bridge towards the realization of the reforms and investment that will enable the country to return to the path of growth from which it has strayed for too long. Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Speech by Mr Daniele Franco, Senior Deputy Governor of the Bank of Italy, at the Global Investor Roundtable of the Global Foundation, Rome, 3 February 2021.
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‘The G20 agenda in 2021, under Italy’s leadership’ Global Investor Roundtable of the Global Foundation Speech by Daniele Franco Senior Deputy Governor of the Banca d’Italia Rome, 3 February 2021 1. Ladies and Gentlemen, it is a great pleasure to contribute to the 2021 Global Investor Roundtable of the Global Foundation. Let me thank the Secretary General Steve Howard for inviting me and for his kind introduction. Governor Visco addressed the Rome Roundtable last November and illustrated the prospects for the Italian Presidency of the Group of Twenty (G20). I will update you on recent developments. I would like to start off by saying a few words about the context in which Italy began its Presidency. 2. We all know that the current global crisis is one of unprecedented magnitude. Since the inception of the pandemic, more than 100 million individuals have been diagnosed with COVID-19 worldwide; almost 30 million cases have been recorded in Europe. More than 2 million people have died because of it, about one third of them in Europe. The pandemic, combined with the containment measures introduced to curb the spread of the virus, plunged the world economy into one of the deepest recessions in recent history. In 2020, despite a short spell of recovery during the summer, world GDP declined by about 3.5 per cent, the largest contraction since WWII. Economic losses in the euro area and the UK have been particularly severe. Fiscal and monetary authorities responded swiftly with massive expansionary interventions. The measures were aimed at strengthening the healthcare systems, at supporting firms’ and households, and at preserving orderly monetary and financial conditions. The short-term objective of mitigating the immediate consequences of the pandemic was achieved, preventing the drying-up of liquidity, avoiding an immediate credit crunch that could have led to a large wave of defaults, and taming deflationary pressures that would have scarred the economic fabric of our economies and generated financial instability. 3. According to the latest projections released by the IMF, global economic activity will surpass pre-pandemic levels by the end of 2021, with world GDP growing by 5.5 per cent. The forecast has been revised positively, in light of expectations that vaccines would remove current restrictions in the second half of the year. However, projections are heterogeneous across world regions, owing to the differences in the access to healthcare, the effectiveness of relief measures, the exposure to cross-country spillovers, and structural characteristics. Furthermore, large uncertainty still surrounds the evolution of the epidemic, reflecting new waves of contagion, new variants of the virus and the distribution of vaccines. In this context, the timing and the effectiveness of the distribution of vaccines is of paramount importance to reinforce the confidence of households and firms, a crucial ingredient for a balanced, sustained and inclusive recovery. 4. Policy-makers are now confronted with the need to speed up and strengthen the recovery. Inclusion is important: the pandemic has exacerbated inequalities. The betteroff are more likely to work from home and be better equipped to study from home. This task is challenging. First of all, it is important that the phasing-out of the measures is designed carefully, avoiding that a premature removal of support holds back the pace of the recovery, while still preventing a possible misallocation of resources. At the same time, setting the stage for a long-lasting recovery requires tackling some structural global challenges, some of which have lacked a determined policy response since even before the pandemic. 5. It is under these exceptional circumstances that last December Italy assumed the Presidency of the G20, laying out its priorities on the basis of three pillars: People, Planet and Prosperity. The Finance Track of the G20 is focused on current developments and policy actions. We are closely monitoring progress on the commitments and objectives laid out in the Action Plan, endorsed last April by the G20 Leaders to provide a coordinated response to the crisis, and updated in October. As a living document, the Action Plan will be updated again, taking into account the evolution of the health and economic situation. We are building on the excellent results achieved under the Saudi Presidency. In the meeting of the G20 Finance and Central Bank Deputies on January 25th-26th, the Italian Presidency received broad consensus on the priorities, initiatives and work plans of the different working groups: the Framework Working Group (FWG), the Infrastructure Working Group (IWG), and the International Finance Architecture (IFA) Working Group. The Framework Working Group will focus on three objectives: ensuring that the policy mix remains appropriate to address the economic consequences of the pandemic crisis; exploiting the opportunities of the digital transformation to boost productivity; monitoring global risks, including those arising from non-economic factors, such as climate-related ones. The work program of the Infrastructure Working Group in 2021 is built around four pillars: resilience and maintenance, digitalization, sustainability, and social inclusion. While infrastructure investment is an important lever for supporting the post-COVID recovery, the common goal is to look beyond the short term and embark on an infrastructure agenda that can contribute to a lasting broad-based prosperity. As for the International Finance Architecture Working Group, we need to preserve international financial stability whilst transitioning from the emergency response to the crisis towards the recovery stage. The work of this group will focus on four main areas: debt, global financial resilience, the financing needs of vulnerable countries, and the implications of the rise of digital currencies for the International Monetary System. 6. The G20 Finance Track also strives to sustain the recovery by developing long-term strategies to foster the transformation towards greener, more digital and inclusive societies. Today – looking beyond the current situation – I would like to touch upon three of the most pressing challenges that the world economy is facing in the coming years. They are core themes of the agenda of the Italian Presidency: climate change, future potential pandemics, and financial inclusion. Some of these were policy priorities even before the COVID-19 pandemic. The shock has nevertheless brought about some swift structural transformations, together with new opportunities, that make it all the more urgent to address these issues in a coordinated and effective manner, without any complacency. 7. Protecting our planet means building more resilient societies and tackling the climate challenge. The natural environment is being threatened by the effects of climate change, with increasing repercussions on our economies. Last year, together with 2016, was the warmest on record. We must curb the carbon footprint of human activities. This is going to be expensive and complex under many dimensions, from the technical to the political. Based on alternative scenarios regarding the timeline and the intensity of the introduction of risk mitigation policies, defined by the Network for Greening the Financial System (NGFS), a worldwide group of about 70 central banks and supervisors, the picture that emerges warrants resolute action. To allow a smooth transition to net zero CO2 emissions by 2070, keeping the rise in global temperature within 2°C, in line with the Paris Agreement goal, policy response must be prompt, extensive and coordinated. Delays and hesitation would only force more costly and brutal adjustments in the future. An ambitious Green Agenda is at the core of the Italian G20 Presidency. We believe the Finance Track should bring sustainability back to the centre of the policy agenda, making the climate challenge a cross-cutting priority across all of its activities. At the G20 level, we have been exploring the issues related to sustainable finance and climate change since 2016. The Italian Presidency has proposed to re-establish the Sustainable Finance Study Group which will take stock of the recent developments on sustainable finance and climate risks, with the ultimate goal of suggesting a ‘sustainable’ growth path. The urgency of the recovery could renew momentum and reshape our economic model around a low-carbon strategy: improving energy efficiency, deploying renewables and energy storage and developing carbon capture technologies. The works of the group under the Italian Presidency will mainly focus on improving the quality, availability and comparability of data to assess climate-related issues and, more generally, sustainability, financial risks, and opportunities. The group could also investigate the areas of future action to achieve the sustainable development agenda of the United Nations, in particular access to modern forms of sustainable energy and natural capital conservation and restoration. The transition to a zero-emissions economy can be fostered by the financial system, given its key role in the allocation of resources. Several analyses show that incorporating Environmental, Social and Governance (ESG) factors in investment strategies does not hamper their financial performance. The risk-adjusted returns to sustainable investment are indeed often higher than those achieved using traditional financial models. During the recent market turmoil, the preferences of financial investors for sustainable investments have proven resilient. Another important venue to discuss all possible instruments to reach carbon neutrality, including ‘climate cooperation’, will be this year’s Conference of the Parties (COP26), under the United Nations Framework Convention on Climate Change. The coincidence of Italy being President of the G20 and co-chair of the COP26 (the other chair is the UK, which is President of the G7) may allow us to bring forward the climate change agenda on many fronts simultaneously, such as the involvement of the private sector in the financing of the green agenda. 8. The COVID-19 pandemic and the ensuing global health crisis have clearly highlighted the costs of extreme health emergencies. The risk of another pandemic is high. In 2018, in an article for the World Health Organisation (WHO), Larry Summers and two distinguished public health scholars wrote that: ‘Few doubt that major epidemics and pandemics will strike again and few would argue that the world is adequately prepared’.1 Evidently, last year we were not prepared. A broad-based global effort to improve prevention, surveillance, preparedness is of the utmost importance, in a ‘health for all’ perspective. Fan, J., D. Jamison and L. Summers (2018) ‘Pandemic risk: how large are the expected losses?’ Bulletin of the World Health Organization, 96:129-134. While massive efforts are under way in a strict health policy sense – in developing and distributing vaccines, testing capacity and treatments, strengthening disease surveillance networks and global protocols for health emergencies – a deficiency in funding has emerged. The current architecture does not allow a timely mobilization of resources to respond to pandemics and support global preparedness. Achieving this goal cannot be the responsibility of one country in isolation or of a single institution alone as health is cross cutting and multi-sectoral in nature and is at the centre of economic resilience. Approving the proposal of the Italian Presidency, in the first G20 Finance and Central Bank Deputies meeting of January 25th-26th, the G20 Members agreed to establish a High Level Independent Panel (HLIP) on financing the global commons for pandemic preparedness and response. The Panel will leverage the WHO’s assessment of gaps in pandemic preparedness and the ongoing international initiatives to enhance it. It will interact with the main relevant global health actors and will identify the specific gaps in the financing system and propose solutions to meet them on a systematic basis. It will consider how to optimally leverage resources from the public, private and philanthropic sectors and International Financial Institutions. The Panel ensures broad regional and gender balance, and comprises eminent individuals. Its conclusions are supposed to be an input for the Joint G20 Meeting of Finance and Health Ministers scheduled for next October. 9. Providing access to affordable and useful financial products – transactions, payments, savings, credit and insurance – is key to support development and growth. If accompanied by financial literacy, it allows individuals and companies to generate income, to manage volatile cash flow, to plan investments and to strengthen resilience to income fluctuations and shocks. The G20 has been very active in promoting the goal of ‘not leaving anyone behind’ in the access to finance, in particular through the Global Partnership for Financial Inclusion (GPFI). In 2021 the GPFI, of which Italy is one of the newly appointed Co-Chairs, will focus on digital financial inclusion of both individuals and micro, small and medium-sized enterprises (MSMEs). The shift towards digitalization in services represents a great opportunity for expanding access to finance; at the same time, it can increase financial exclusion unless it is supported by appropriate literacy, both financial and digital, and by adequate governance. Digital transformation enhances financial inclusion if it effectively reaches the most vulnerable and financially underserved, including micro and small enterprises, and if these individuals and businesses are equipped with the financial competences that allow them to make informed decisions. We must ensure that a wider access to digital financial infrastructure does not translate into irresponsible financial behavior, which can, in turn, endanger growth and financial stability. To fulfil the work plan commitments, the G20 Presidency mandated some Implementing Partners (IPs) – including the OECD, the SME Finance Forum and the World Bank – to provide analyses and stock-tracking reports on the gaps and opportunities, in terms of digital financial inclusion, that emerged during the pandemic crisis. As to policy response, we will concentrate on two main areas. One concerns raising digital financial awareness for both households and MSMEs. The other one aims to foster innovative regulatory and supervisory approaches that encourage the development of inclusive and responsible digital financial services while granting adequate protection to final customers, including from cyber risk. The 2021 GPFI’s focus on digital financial inclusion will also take into account remittances and the most effective actions needed to support them, also in times of crisis. 10. I have briefly touched upon three themes of the agenda of the G20 Finance Track under the Italian Presidency. All three challenges – climate change, preparedness in health policy and financial inclusion – must find adequate and coordinated responses in order to advance onto a ‘sustained’ and ‘sustainable’ recovery path. Great uncertainty still surrounds the evolution of the epidemic and the related economic developments; the outlook is nevertheless positive. It is therefore essential that we enter a new phase in which our tasks move toward a more far-sighted policy perspective. We must address the legacies of this unprecedented crisis and some structural long-standing challenges, for the prosperity of our communities. The G20 is the proper world forum for that. Global issues – such as climate change and pandemics – require global solutions. Designed by the Printing and Publishing Division of the Bank of Italy
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Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the First G20 Finance Ministers and Central Bank Governors Meeting, Session II, press conference, 26 February 2021.
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First G20 Finance Ministers And Central Bank Governors Meeting SESSION II 26 February 2021 SESSION II PRESS CONFERENCE Remarks by Governor Visco Good afternoon, Today we had a very productive session on financial stability and financial inclusion. All delegates provided valuable contributions to the discussion and expressed broad support for the Italian G20 Presidency’s priorities in these areas. We had a more in-depth discussion on the lessons learned during the pandemic from a financial stability perspective. This is the first initiative of the work programme agreed with the Financial Stability Board for 2021. We focused on the main areas that will be covered in its assessment, namely financial institutions’ use of capital and liquidity buffers, the impact of pro-cyclicality on financial and prudential standards, and the functioning of operational resilience arrangements and crisis management frameworks under the strain of the pandemic. With the pandemic still ongoing, we acknowledge that any assessment of lessons learned will inevitably be preliminary and tentative. But it is important to start this work now, in order to understand whether the regulatory reforms introduced after the global financial crisis are working as intended, and whether they have contributed to enhancing the resilience of the SESSION II -FIRST G20 FMCBG MEETING Page 2 of 5 banking sector under the first major test presented by the pandemic. The analysis will help to identify policy issues of international relevance and assess whether some adjustments to the existing framework may be necessary. The initial findings will be discussed by Finance Ministers and Central Bank Governors (FMCBG) in July and the final report will be delivered to the G20 Summit in October. The Italian Presidency’s finance agenda for 2021 includes a number of other key priorities, among which an initiative to strengthen the resilience of nonbank financial intermediaries and work to implement the G20 roadmap on enhancing cross-border payments. These issues were not discussed today. We will provide you with more detailed information on these items as they are taken up in future G20 FMCBG meetings. Today we also focused on financial inclusion. The outbreak of the COVID-19 pandemic appears to have disproportionately affected the most vulnerable individuals and firms across the globe, with many of them experiencing severe losses of income and proving unable to withstand the financial distress because of low or inexistent liquid reserves. We shared the need to analyse and address the gaps that emerged during the crisis, also in relation SESSION II -FIRST G20 FMCBG MEETING Page 3 of 5 to the acceleration of digitalization in payments and financial services. The new sources of finance and new payment channels can help to make headway with financial inclusion, but there is also a shared understanding about the risk of new forms of exclusion that needs to be adequately addressed. Digital infrastructures, financial and digital literacy, and customer protection are all necessary and complementary elements that will play a part in shaping the transformation towards a more resilient and inclusive financial system, leveraging the opportunities offered by technology. We all agreed that the G20 has a shared responsibility to facilitate a more equal and widespread access to responsible financial products and services as an essential pillar to support strong, sustainable, balanced and inclusive growth. Finally, concerning work on climate-related issues, a consensus was reached on an important new initiative as Finance Ministers and Governors agreed to relaunch the Sustainable Finance Study Group chaired jointly by China and the US (and possibly transform it into a working group). A detailed work plan of the Group will be SESSION II -FIRST G20 FMCBG MEETING Page 4 of 5 finalized in the coming weeks. The FSB will also work on data availability and disclosure standards for companies. We are now ready to take your questions. SESSION II -FIRST G20 FMCBG MEETING Page 5 of 5
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Speech by Mr Piero Cipollone, Deputy Governor of the Bank of Italy, at the BIS - Committee on Payments and Market Infrastructures Conference "Pushing the frontiers of payments: toward faster, cheaper, more transparent and more inclusive cross-border payments", online, 19 March 2021.
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The Italian G20 presidency and the cross-border payments agenda Piero Cipollone Deputy Governor of the Bank of Italy Pushing the frontiers of payments: toward faster, cheaper, more transparent and more inclusive cross-border payments BIS - Committee on Payments and Market Infrastructures Conference 19 March 2021 I would like to thank the Committee on Payments and Market Infrastructures (CPMI) for inviting me to join this conference on ‘Pushing the frontiers of payments’. The Italian Presidency of the G20 greatly values the CPMI’s commitment to moving the G20 roadmap forward on cross-border payments. The breadth of topics and speakers at this conference proves that progress in international payments architecture can only come from the wide-ranging and collective endeavour of private sector participants, public authorities and academics. The Italian G20 Presidency calls on world leaders to safeguard the ‘three Ps’ - People, Planet and Prosperity. ‘People’ represents the view that we have to tackle inequalities and promote equal opportunities, because no one should be left behind. ‘Planet’ underlines the idea that it is no longer possible to ignore the risks our planet is facing, and that we have to make an effort to achieve a safe balance between people and nature. ‘Prosperity’ means pursuing economic well-being and a better quality of life, which implies making new technologies and the digital transformation an opportunity for all. The gist of what I am going to say is that enhancing cross-border payments is a concrete and major step towards achieving robust, sustainable and equitable growth. And by doing that, we will considerably contribute to each of the ‘three Ps’. Let me briefly explain this in some detail. First: in this era of FinTech and high frequency trading, we can say that cross-border payments have lagged behind the rest of the global financial system. As the FSB’s and CPMI’s analyses have documented, fund transfers across different jurisdictions can still be difficult to arrange and remain slow, costly, opaque and less secure. These inefficiencies are ultimately borne, above all, by individuals and small and medium-sized enterprises (SMEs). For them, transaction fees (as a percentage of the payment being made) are normally higher than those borne by larger corporations, especially for smaller payments, and execution times are slower. The lack of transparency on costs, speed and security, and the complexity of the legal aspects (such as compliance checks or dispute resolution) only add to the burden that they have to bear. Access to payment services is especially difficult for disadvantaged people, for the unbanked and for those poorly literate in IT services (i.e. who do not make use of more advanced IT services). The pandemic crisis has only made things worse. According to the World Bank, in 2020, the crisis may have pushed more than 100 million people back to poverty; poverty rates have increased for the first time in the last 25 years, back to levels last seen in 2017.1 What is worse, it is jeopardizing future prospects for poverty reduction by adversely affecting longer-term productivity growth. For migrant workers, a vital financial service is the possibility to send remittances to their families in the home country. For low- and middle-income countries, remittance flows are a crucial source of external financing, greater than official development assistance and more stable than private capital flows.2 Between 2010 and 2019, remittance flows each year grew on average by more than 5 per cent, reaching $717 billion, of which $548 billion were to low- and middle-income countries. The cost of sending remittances has declined over the last 10 years, but it still stands at about 7 per cent on average: this is well above the G20 commitment in 2011 to reduce the cost to 5 per cent and the UN Sustainable Development Goal target of 3 per cent by 2030.3 For SMEs, the challenges for cross-border payments are no less daunting. Transaction costs are proportionally higher for smaller payments. Opacity over execution times, processing chains and dispute resolution is another major concern. The riskiness of cross-border payments for small companies is magnified by the inadequacy, or even lack, of their liquidity management or of foreign‑exchange hedging and trade finance services. This is my first point: enhancing cross-border payments is vital for People. Second: in our efforts to redesign the global payments ecosystem, we have to be conscious of its link with the environment, which goes in both directions. Extreme World Bank (2021), ‘Global Economic Prospects’, January 2021, World Bank Group. See World Bank’s data on remittances, available at https://www.knomad.org/data/remittances. See FSB, Financial Stability Board (2020), ‘Enhancing cross-border payments’, Stage 1 report to the G20 (technical background report). natural events may cause breakdowns in single nodes of the payment chain and have an impact on international trades and funds transfers. Without electricity, it is not possible to use electronic payment tools, such as credit and debit cards, or mobile services, or wire transfers, and electronic cross-border payments cannot be replaced by cash. The exposure of international payments to climate risk can be mitigated by the actions envisaged in the G20 roadmap, if the payment system community manages to shorten transaction chains, ease interlinking among infrastructures, increase execution speeds and extend operating hours. In terms of the environmental footprint of payments, the impact of a single payment may be negligible, but it has to be multiplied by the sheer size of the number of transactions that are being made globally on any given day. Studies on the environmental sustainability of payment tools and systems are still in their infancy but, interestingly, there is evidence that payments architectures may differ considerably in their energy intensity. Recent research carried out at the Bank of Italy shows that the carbon footprint per transaction in 2019 for TIPS (TARGET Instant Payment Settlement), the Eurosystem’s platform for the continuous settlement of instant payments, was a tiny fraction of the amount of CO2 emitted by other distributed-ledger-based networks during 2018.4 The reason is that a centralized system tends to absorb less energy than a decentralized one, in which a lot of such energy is spent on generating trust and consensus among network participants.5 In this regard, I also think it was wise of the G20 to decide that four out of the five focus areas of the G20 roadmap aim to enhance the existing payments ecosystem. Over the short term, leveraging on existing systems makes it easier for payment services providers to ensure continuity for their business plans, while allowing them to contribute to addressing the challenges identified by the Roadmap. This is my second point: an appropriate design of payment systems is good for the Planet. My third and final point is that enhancing cross-border payments is a pathway to Prosperity, as it clearly raises the potential for the growth of our economies and for job creation. Easier and less costly access to international funds transfers improves the participation of consumers in the markets for goods and services and the integration of SMEs into global value chains and e-commerce platforms. It also facilitates the management of liquidity and currency risks by large corporations, the international mobility of workers and the countercyclical role of remittances. The way for public and private sectors to jointly achieve these goals is to fully harness the opportunities offered by technology and regulation. The advances in digital and web-based services, as well as the continuous diffusion of mobile communication systems, will profoundly reshape the infrastructures of domestic payment systems. Great benefits can be unlocked by a See P. Tiberi, ‘The Carbon Footprint of the Target Instant Payment Settlement (TIPS) System: A Comparative Analysis with Bitcoin’, Bank of Italy, forthcoming. See I. Visco, ‘The role of TIPS for the future payments landscape’, a speech delivered by the Governor of the Bank of Italy at the online conference on the ‘Future of Payments in Europe’, organized by Deutsche Bundesbank on 27 November 2020. Published in Central Banking 5.1.2021. joint public and private sector commitment to achieving a wider availability of safe and sound services, a better alignment of regulatory frameworks, a greater consistency in industry standards and market practices, the enhancing of interlinking facilities and the development of new payment infrastructures and arrangements. The agenda on cross-border payment is ambitious and we are fully committed to it in our G20 presidency. Let me conclude by illustrating those themes that we at the Bank of Italy are thinking about. The first is the respective roles of businesses and governments in driving structural change in the payments ecosystem. This will be one of the themes of the G20 international conference on cross-border payments that will take place at the Bank of Italy on 27-28 September 2021. In an ever-changing financial environment, we need to strike the right balance between the private sector’s drive for innovation and the role of public authorities in safeguarding the public good. The responsibility for ensuring that infrastructures and arrangements meet the needs and preferences of end-users and intermediaries lies primarily with private market forces. Nonetheless, the authorities’ role is of the utmost importance: to ensure infrastructures’ safe and sound operation, to counter competitive distortions and market failures, to promote growth-enhancing innovation and to provide public goods. In the field of payments, this has often led public authorities to resort not only to regulation and oversight but also to investment in key infrastructures. The second theme at the centre of our reflections at the Bank of Italy, which is also attracting much attention in many international fora, is what type of architecture for cross-border payments platforms could complement or partially replace the correspondent banking network. One option is to make ‘local’ systems interconnected so that participants can clear and settle payments across systems (in one or more currencies) without participating in each of them. Another option is to build up cross-border and/or multicurrency payment platforms allowing each participant to clear and settle payments across jurisdictions and/or currencies with their counterparties. Our own thinking is that, while we are debating, we should bear in mind the need to achieve results quickly. That is why we are investigating how far we can go using the currently available infrastructure. An example of a payment system that can be used in various ways for providing quick and safe cross-currency solutions for instant payments is TIPS. From May 2022, following an agreement between the Riksbank and the Eurosystem, Swedish banks will be able to settle their instant payments in krona in real time in TIPS. Moreover, investigations are currently underway to explore the common instant payment infrastructure in order to provide a cross-currency solution for instant payment. A further step, currently at the ‘Proof of concept’ stage, could be a direct interconnection between two systems for processing instant payments, namely TIPS and the BUNA platform. This would be an example of cross-currency, cross-continent payment systems integration, a path that could in the future become a sort of new frontier for central banks and private systems operators. Cooperation is key for countering the consequences of the pandemic at a lower cost. Luckily, it seems that multilateralism is regaining vigour. This is essential as polarization, distrust and inequalities are still pervasive in our societies. Payments across jurisdictions are the bread and butter of future growth and prosperity, as they are a fundamental condition for the international mobility of goods and services, capital, and people. Let us join forces to enhance them to the best of our ability. Designed by the Printing and Publishing Division of the Bank of Italy
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Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the second G20 Finance Ministers and Bank Governors Meeting, 7 April 2021.
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Ignazio Visco: Press Conference Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the second G20 Finance Ministers and Bank Governors Meeting, 7 April 2021. * * * Good afternoon, Today we discussed sustainable finance and two specific topics relating to financial regulation. On sustainable finance, the discussion concerned the work plan of the Sustainable Finance Study Group, which we decided to reactivate at our February meeting and which is co-chaired by China and the United States. The Group has made rapid progress in the last few weeks and, following the inputs of the Presidency, has agreed to focus its work this year on three areas: the first is sustainability reporting; the second is related to the metrics for classifying and verifying investment sustainability; and the third concerns how to enhance the contribution of International Financial Institutions to the goals of the Paris Agreement. In addition, the Group will develop a multi-year roadmap on sustainable finance to address the most pressing issues relating to sustainable development. This will help in prioritizing its activity, which will initially be focused on climate but will subsequently look at sustainability more broadly. Ministers and Governors concurred on the importance of this agenda and agreed that the Study Group should be upgraded to a fully fledged Working Group. As regards financial regulation, today we discussed two documents submitted by the FSB: a report on the COVID-19 support measures and the main issues concerning their future evolution, and the final evaluation report on the effects of too-big-to-fail reforms. The first report shows that in the current and still uncertain circumstances most of the COVID-19 support measures remain in place, and their withdrawal is generally not imminent. Authorities tend to view the potential risks to financial stability arising from the early removal of support measures as significant, and as being greater than those associated with a late withdrawal. We, Ministers and Governors, shared the main message of the report, which is that the persisting uncertainty over the evolution of the pandemic and the uneven pace of the recovery across countries call for a state-contingent and data-driven approach when deciding whether to adjust or end the support measures. This should be done in a gradual and targeted way, in order to minimize long-term financial stability risks. We also agreed on the need to maintain an internationally coordinated approach in responding to the pandemic, with the support of the Financial Stability Board (FSB), to ensure that the financial sector continues to support the recovery while preserving financial stability. The second document we discussed is the final report on the effects of too-big-to-fail reforms, which updates the interim analysis, also in light of the experience of the pandemic. The key message, on which we concurred, remains that the ‘too-big-to-fail’ reforms for banks are working as intended, reducing moral hazard and systemic risk with no material side effects. We agreed to work on filling some remaining gaps, concerning the information available to public authorities for financial stability risk monitoring and some residual obstacles to resolvability. We also concurred on the need for a system-wide approach to monitor risks that have moved 1/2 BIS central bankers' speeches outside the banking system. We are therefore committed to strengthening the resilience of nonbank financial intermediation, building upon the FSB’s ‘Holistic Review’ of the March 2020 turmoil and on the further work that the FSB will conduct under the Italian G20 Presidency and beyond. We are now ready to take your questions. 2/2 BIS central bankers' speeches
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Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the Ordinary General Meeting of Shareholders, Rome, 31 March 2021.
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Ignazio Visco: Address Shareholders at Ordinary General Meeting of Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the Ordinary General Meeting of Shareholders, Rome, 31 March 2021. * * * Ladies and Gentlemen, The unprecedented global crisis caused by the COVID-19 pandemic continues to take a heavy toll on the economy and on the social fabric. The containment measures in place require restrictions on production activities, limitations on personal mobility, and prolonged periods in which in-person learning in schools and universities is suspended. As with last year, arrangements were made to ensure that the Meeting of Shareholders could be held regularly and with no risk. The pressure on the healthcare systems is still high. The launch of the vaccination campaigns in Italy and in the rest of the world induces cautious optimism about the future. Nevertheless, uncertainty remains high concerning the course of the health-related crisis and, consequently, the economic outlook. In 2020 and in the early months of 2021, the Bank of Italy’s Board of Directors approved 34 extraordinary contributions – amounting to about €85million – in the form of charitable donations, most going to projects that could be rolled out immediately to boost the national health system’s ability to counter the spread of the virus. An initiative in favour of the families of the doctors and nurses who lost their lives to COVID-19 is at an advanced stage. Since the onset of the crisis, the Eurosystem has approved monetary policy measures of exceptional magnitude to counter its impact on the economy and on inflation, to preserve favourable financing conditions for households and firms, and to assuage tensions in the financial markets. We will continue to act decisively for as long as necessary. The composition of the Governing Board has changed this year. On 13 February, Daniele Franco took on the role of Minister of Economy and Finance: we wish him well at his new job and thank him for the important work he has done for the Bank of Italy. Luigi Federico Signorini was appointed to replace him as Senior Deputy Governor. Late November of last year saw the passing of Vincenzo Desario, who served as the Bank’s then Director General from 1994 to 2006, and was later made Director General Emeritus. He joined the Bank in 1960, where he enjoyed a long career, first as a supervisory inspector, before becoming Central Manager for Supervision. We remember him fondly, thankful for the personal and professional legacy he has left us. The reallocation of the Bank of Italy’s shares continued in 2020 with the transfer of about 8 per cent of the capital. Considering all the transactions that have taken place since the start of the process to reform the Bank’s ownership structure (Law 5/2014), 48 per cent of the capital has been transferred. Of the 172 current shareholders, 145 acquired their shares after the law was passed (6 insurance companies, 8 pension funds, 11 social security institutions, 40 banking foundations and 80 banks). The nominal value of the shareholdings exceeding the 3 per cent capital limit stands at around €1.5 billion, corresponding to almost 20 per cent of the capital; it was around 27 per cent at the end of 2020 and around 65 per cent on 31 December 2013. In greeting the new Shareholders, even those that are not physically present at today’s Meeting, on behalf of the Board of Directors and of the Governing Board, we confirm our desire to see the redistribution of the shareholdings continue at a fast pace, in accordance with the limits set by 1/5 BIS central bankers' speeches law. The broadening of the shareholder base is among the goals of the reform. We view favourably the participation of social security institutions in the Bank’s capital, of which they now hold 19 per cent. The entry of pension funds, permitted by the reform law, would increase the weight of social security institutions. The monetary policy measures that have been adopted within the Eurosystem to mitigate the economic impact of the pandemic are reflected in the Annual Accounts submitted today for your approval. Total assets reached an unprecedented size at the end of 2020: the balance sheet total neared €1,300 billion, up by €336 billion compared with 2019. This increase adds to the growth of €429 billion recorded in the previous five years. Therefore, since the end of 2014, total assets have risen by almost 150 per cent, owing to the exceptional growth in banks’ long-term refinancing operations and the purchases of public sector securities and private sector bonds for monetary policy purposes. Following five years of uninterrupted growth, the Bank of Italy’s profitability decreased compared with 2019, while remaining very high compared with the previous years. The impact on income of the significant rise in balance sheet volumes was more than offset by the impact of the reduction in interest rates. The gross profit before tax and transfers to the general risk provision nevertheless remains above €10 billion, well above the level recorded two years ago. The net profit is €6.3 billion, down by €2 billion compared with 2019. The impact of the Eurosystem’s monetary policy on the Bank of Italy’s annual accounts In 2020, the Governing Council of the ECB confirmed its very accommodative monetary policy stance. The extraordinary measures concerned both refinancing operations and the monetary policy asset purchase programmes and had a significant effect not only on the size but also on the composition of the Bank of Italy’s balance sheet. Besides introducing new refinancing operations to deal with the pandemic (pandemic emergency longer-term refinancing operations, PELTRO), the conditions applied to the third series of targeted longer-term refinancing operations (TLTRO3) were made even more favourable to counterparties. Overall, through these operations, the Eurosystem has granted euro-area banks more than €2,000 billion in funding since the start of the health emergency (€415 billion to Italian banks). This year too, targeted refinancing operations will continue to play a key role in supporting banks’ liquidity. The asset purchase programme (APP) was strengthened by adding a temporary envelope of further asset purchases of €120 billion for 2020 to the monthly purchases of €20 billion already envisaged. The Bank of Italy’s net purchases for the year totalled €46 billion. The full reinvestment of the principal payments from maturing securities will continue for as long as necessary and in any case for an extended period of time, as the ECB Governing Council has announced many times and reiterated most recently on 11 March. In March 2020, we agreed to introduce a new public and private sector asset purchase programme, the pandemic emergency purchase programme (PEPP), with an initial envelope of €750 billion, which was subsequently raised to €1,850 billion following the increases decided in June and December 2020. The Bank of Italy purchased €116 billon during the year. The horizon for net purchases under the PEPP was extended to at least the end of March 2022, and the horizon for the reinvestment of principal payments from maturing securities is set to continue until at least the end of 2023. At its meeting held on 11 March 2021, based on a joint assessment of financing conditions and the inflation outlook, the Governing Council decided to step up significantly the pace of purchases to be conducted under the PEPP until the end of June compared with those made in the first months of the year. The Governing Council will in any case continue to purchase flexibly according to market conditions. 2/5 BIS central bankers' speeches The balance sheet At the end of 2020, the Bank of Italy’s total assets amounted to €1,296 billion. Of this, 70 per cent is ascribable to monetary policy operations (compared with 40 per cent in 2014): securities reached €539 billion, up by €155 billion compared with 2019, of which €473 billion are Italian government securities. Refinancing operations, totalling €374 billion, rose by €154 billion. Compared with the previous year, the value of the gold reserves rose by €15 billion, to €122 billion, increasing by almost 50 per cent compared with ten years ago. In line with Eurosystem accounting rules, this appreciation is recorded in the revaluation account on the liability side and does not contribute to the Bank’s net profit. Investment assets other than those held for monetary policy purposes rose by €8 billion, to €148 billion; of these, 86 per cent are public sector securities, 10 per cent are equity and investment fund shares, and the remaining 4 per cent consist of other financial assets. Investment criteria that take into account environmental, social and governance (ESG) best practices, which were introduced in 2019 for the management of equity portfolios, were extended to other types of financial instruments. Applying these criteria has made it possible to achieve, in the last two years, risk-adjusted returns that exceeded the corresponding benchmarks, especially during the phases of strong turbulence that affected the financial markets in connection with the pandemic. Together with the other central banks of the Eurosystem, we agreed on a common stance on the climate-related sustainability of euro-denominated investment not connected with monetary policy operations. In doing so, the Eurosystem is contributing to the achievement of the European Union’s climaterelated objectives, in line with the provisions laid down in the EU Treaties. Moreover, by recognizing the importance of providing the market with adequate information on environmental risks and on the activities that affect the climate, the Eurosystem’s central banks are promoting the production and dissemination of reliable data and of statistical and accounting standards that are as suitable and homogenous as possible at global level. On the liability side, the deposits of credit institutions almost tripled, from €102 billion to €299 billion, owing above all to the sizeable liquidity provided by the Eurosystem through monetary policy operations and to its more homogeneous distribution among euro-area countries. After widening substantially between March and June, at a time of turbulence on the financial markets, the Bank of Italy’s negative balance on the TARGET2 European payment system partly recovered in the final months of 2020, ending the year at €516 billion, for a total increase of €77 billion. The improvement reflected the recovery of capital flows to Italy and the disbursement of the first instalments of loans to the Italian public sector from the European Commission under its instrument for temporary Support to mitigate Unemployment Risks in an Emergency (SURE). The negative balance improved more markedly in the early months of 2021: the monthly average for March was around €490 billion. The value of banknotes in circulation continued to increase: reported in the Bank’s balance sheet in proportion to its share in the ECB’s capital, their value reached €224 billion, €22 billion more than at the end of 2019. Eurodenominated general government deposits also rose from €24 billion to €44 billion, owing to the higher amount entered in the Treasury payments account. Profitability, risks and organizational measures Future developments regarding the Bank’s balance sheet, as well as its profitability, will continue to be influenced by those in monetary policy measures and by the overall state of the economy. The gross profit for 2020, before taxes and transfers to the general risk provision, was equal to €10.2 billion, lower by €0.6 billion compared with 2019. 3/5 BIS central bankers' speeches The main contributors to the profit were: net interest income of €8.5 billion; the net result of the pooling of the Eurosystem’s monetary income, amounting to €1.8 billion; realized gains of €1.3 billion; and income from equity shares and participating interests of €0.6 billion. Operating expenses and write-downs brought the total down by €1.9 billion and €0.2 billion, respectively. The decrease compared with 2019 is attributable to a reduction of approximately €1 billion in net interest income owing to the increase in interest expense on refinancing operations and the decline in yields on securities denominated in euros and in foreign currency; this was partially offset by higher interest income on securities held for monetary policy purposes, driven by the exceptional increase in such holdings. Realized gains rose by €0.4 billion, owing mainly to the disposal of equity and investment fund shares in the course of rebalancing the Bank’s investment portfolio. Transfers to the provision for general risks amounted to €2.5 billion, €1.0 billion more than in 2019. The allocation is consistent with the objective of progressively strengthening the financial buffers against the significant growth in the size of the Bank’s balance sheet and in its overall risk exposure, ascribable mainly to monetary policy assets. Taxes, amounting to €1.4 billion, increased compared with 2019, when they stood at just over €1 billion. Operating expenses remained largely stable. Excluding charitable donations, operating expense fell by a total of around 4 per cent owing to the decrease in staff costs, mainly due to the decline in severance payments during the year, and in costs associated with the physical presence of staff in the workplace such as, for example, business trips and utilities. In 2020, the Bank’s staff, numbering 6,671 at the close of the year, worked an average of almost 60 per cent of working days remotely (compared with 4 per cent in 2019); the percentage rises to over 90 per cent when considering only the period between mid-March and the end of April. The Bank’s IT infrastructure and equipment and its organizational and flexible governance arrangements, and the staff’s dedication and ability to adapt to the new working conditions made it possible for the Bank to respond quickly to the challenges posed by the pandemic. The Bank was always able to ensure the delivery of essential services to the public, whilst maintaining its high level of quality. The public was encouraged to use online channels to access information services, such as data contained in the Central Credit Register and the Interbank Register of Bad Cheques and Payment Cards. Activities that require the physical presence of staff in the workplace, mainly banknote production and distribution as well as collection and payment services on behalf of the State, were adapted to ensure they can be carried out safely, thereby guaranteeing business continuity. The experience acquired over the course of the emergency has laid the groundwork for defining a new ‘hybrid’ model of work organization in which physical presence in the workplace must be integrated with remote working. We are hard at work on this task. As regards organizational arrangements, the reform initiated to consolidate supervision on the conduct of banking and financial intermediaries, strengthen customer protection tools and increase financial education levels for the public was implemented, and a new directorate general dedicated specifically to these tasks was established. Furthermore, the tasks relating to monetary circulation and those regarding retail payment instruments have been integrated into a single directorate general, with an emphasis on technological developments. To support the financial system’s adoption of digital technologies and foster their safe use for financial stability purposes, the Bank of Italy has launched Milano Hub, its new innovation centre. The features of the Eurosystem’s payment systems were improved during the year. In this respect, the Bank acts as sole service provider for the development and management of the TARGET Instant Payment Settlement (TIPS) platform. The platform, which offers an innovative and safe solution for the instant settlement of retail payments, is able to increase the speed of not just payments between individuals and firms, but also those with government bodies. 4/5 BIS central bankers' speeches As usual, further information on the activities of the Bank and on the organizational and management measures implemented in 2020 will be available in the Report on Operations and Activities of the Bank of Italy, to be published in May, on the occasion of the presentation of the Annual Report. More information on the Bank’s commitment to the issue of environmental sustainability may be found in the yearly Environment Report, available on the Bank’s website. Proposal for the allocation of the net profit Dear Shareholders, Pursuant to Article 38 of the Statute, acting on a proposal of the Governing Board and after hearing the opinion of the Board of Auditors, I present for your approval the Board of Directors’ proposal for the allocation of the net profit. On behalf of the Board of Directors and the Governing Board, I would like to take this opportunity to thank the Board of Auditors for their diligent and accurate work. Under the dividend policy in force, the amount paid to the Shareholders is kept within a range of €340 million to €380 million, provided that the net profit is sufficient and without prejudice to the Bank’s capital adequacy. The difference between the upper limit of the range and the dividend paid to the shareholders may be allocated to the special item for stabilizing dividends, until this item reaches a maximum amount of €450 million. Accordingly, from the net profit of €6,286 million, we propose allocating €340 million as a dividend to the shareholders, the same amount allocated in each of the last six years and equal to 4.5 per cent of the capital. Therefore, we propose allocating €40 million to the special item for stabilizing dividends, which would then amount to €200 million. Pursuant to the Statute, shares exceeding the 3 per cent threshold are not entitled to a dividend. Therefore, the dividend actually due to the Shareholders would amount to €273 million. The dividend corresponding to the shares exceeding the threshold, equal to €67 million, would be allocated to the ordinary reserve. As a result, the remaining profit for the State would be equal to €5,906 million which, in addition to taxes for the year amounting to €1,409 million, would bring the total amount allocated to the State to around €7,315 million. The total amount allocated to the State over the last five years would therefore reach €25 billion, in addition to taxes amounting to €6.5 billion. 5/5 BIS central bankers' speeches
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Statement by Mr Ignazio Visco, Governor of the Bank of Italy and Governor of the Constituency of Albania, Greece, Italy, Malta, Portugal, San Marino and Timor-Leste, at the 103rd Meeting (virtual) of the Development Committee (Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources to Developing Countries), Washington DC, 9 April 2021.
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Ignazio Visco: Statement - meeting of the Development Committee Statement by Mr Ignazio Visco, Governor of the Bank of Italy and Governor of the Constituency of Albania, Greece, Italy, Malta, Portugal, San Marino and Timor-Leste, at the 103rd Meeting (virtual) of the Development Committee (Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources to Developing Countries), Washington DC, 9 April 2021. * * * Over a year ago, the world was hit by an exceptional and unexpected shock. The Covid-19 pandemic triggered a profound economic crisis that rapidly became global, causing an unprecedented fall in per capita incomes and an increase in food insecurity, poverty, and inequality—particularly in the poorest countries. Since the pandemic’s outbreak, uncertainty has been curtailing consumption and investment, dampening productivity and potential growth. Monetary and fiscal policies have helped contain the negative impact of the crisis. Today the economic outlook seems to be improving at last, thanks also to the rollout of vaccines made possible by exceptional achievements and cooperation in the scientific research community. However, the recovery is still fragile, subject to a large degree of uncertainty and downside risks. Delays in the distribution of vaccines, limited fiscal space, high indebtedness, and vulnerability to undesired capital flow volatility could impinge on many emerging and developing economies. Granting equitable and timely access to safe, effective and affordable vaccines must remain a priority. As long as the virus continues to spread uncontrollably in any part of the world, no country will be safe. The global pandemic requires a global response, involving stronger multilateral cooperation, increased funding, and laying the foundations for preparedness and resilience. We praise the World Bank Group (W BG) Management and staff for their hard work in building a rapid emergency health response, and we urge them to persevere in close coordination with COVAX, GAVI, and other Multilateral Development Banks in helping countries purchase and deploy Covid-19 vaccines. National vaccination programs are being rolled out based on the readiness assessments prepared by the W BG and the W HO, which also provide indications on where to channel resources to address weaknesses in national health systems. Such efforts may be impeded by the uncertainty surrounding vaccine availability. We encourage IFC and MIGA to play a galvanizing, entrepreneurial role in improving vaccine manufacturing capacity at the national or regional level, in coordination with other DFIs and partners in the private sector. International coordination, sharing of pandemic plans, and collaborative disease monitoring and diagnosis are necessary steps toward long-term health preparedness and resilience. In service of health as a global public good, we should marshal resources with the help of the private sector. In this regard, the High-Level Independent Panel on Financing the Global Commons for Pandemic Preparedness and Response, established under the Italian Presidency of the G20, will consider practicable solutions to ensure sustainable financing for pandemic prevention, surveillance, preparedness, and response. The Covid-19 crisis has aggravated debt vulnerabilities in many low-income countries. We welcome the G20’s decision on the DSSI final extension and commend the IMF and the World Bank for the support they have been providing toward a successful implementation of this initiative. The international community must now turn its attention to the “Common Framework for Debt Treatments beyond the DSSI”, introduced by the G20 to help countries address structural debt issues. We also expect the IMF and the W B to work in a complementary and effective manner, making the most of their respective areas of expertise to facilitate concrete application 1/3 BIS central bankers' speeches of the Common Framework, whose success strongly depends on improving the quality and availability of debt information in both debtor and creditor countries. We reiterate our call for the private sector to take part in the DSSI and wish to emphasize the importance of constructive engagement by private sector creditors to achieve the comparable treatment necessary for the application of the Common Framework. So far, W BG actions have rightly focused on saving lives, protecting the poor and the most vulnerable, and providing liquidity to the business sector. Now, we urge a long-term perspective and we therefore welcome the W BG’s GRID (Green, Resilient and Inclusive Development) framework. Raising productivity, creating job opportunities, increasing resilience to shocks, and contrasting growing inequality and poverty all require pursuing a profound transformation of our economies and societies. It is crucial to exploit the potential of new digital technologies. They can make private firms and the public and financial sectors more efficient, innovative, and resilient. The greater amount of data made available by digital technologies must inform and improve our investment projects and policy making. Investment in infrastructures and education must be part of the digital transformation. The G20 Italian Presidency aims to promote infrastructures as a way to foster social inclusion, reduce geographical disparities, and improve environmental sustainability. Actions to address climate change and environmental degradation are paramount to promoting sustainable growth and protecting the most vulnerable. We need to favor energy transition, prioritize green transport and sustainable urban systems, invest in resilient infrastructures and their long-term maintenance, promote climate-smart agriculture techniques, and protect biodiversity. Deep, structural economic transformation requires significant financial resources at a time when countries are facing fiscal constraints and debt overhang. Therefore, there is a need to mobilize all sources of finance and use them effectively. This includes domestic resources, development financing, and private sector capital. We call on the W B to continue supporting partner countries in reshaping their tax systems and reforming expenditures and subsidies in order to raise domestic revenues and increase public expenditure efficiency. The W B must remain committed to providing high net positive financial flows, in particular to low-income countries. What has been done in the past months is remarkable, but more can be achieved in extraordinary times with extraordinary measures. The W B and other MDBs could temporarily stretch lending volumes and implement further balance sheet optimization measures while preserving their rating. We also reiterate the importance of mobilizing more private sector capital in low-income countries to close their financing gaps and support sustained long-term growth. To this end, the Sustainable Finance Study Group, re-established by the G20 Italian Presidency and just upgraded to a working group, will explore ways to enhance the role of the financial system in supporting the achievement of the objectives envisaged by the UN 2030 Agenda and the Paris Agreement, ensuring a just transition towards a low-carbon and more inclusive economy. We also urge IFC and MIGA to take stock of the Covid-19 crisis and to reflect on 3additional actions and tools to respond effectively to the huge challenges faced by the private sector in developing countries. In recognition of the critical role of the International Development Association (IDA) to address growing financing needs in IDA countries, we welcome the decision to advance IDA20 by one year. It will be an opportunity to strengthen IDA’s financial capacity and to better support its clients, in particular African and fragile countries. We call for a reinforced use of IDA’s own balance sheet to unlock additional resources for IDA countries. We look forward to a successful completion of the IDA20 replenishment by the end of 2021 and expect it to be ambitious and capable of delivering concrete results. Therefore, it is essential to conclude the review of IDA 2/3 BIS central bankers' speeches voting rights by November 2021 by agreeing on a simpler system to ensure a progressive alignment between contributions and voting rights, while safeguarding the voting power of recipient countries. Given the complexity and global nature of the challenges ahead of us and the significant financing needs, only enhanced multilateralism and cooperation among IFIs, national authorities and development partners—including through an effective use of country platforms—can truly make the difference. 3/3 BIS central bankers' speeches
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Welcome address by Mr Piero Cipollone, Deputy Governor of the Bank of Italy, at the 2nd Bank of Italy and LTI Workshop "Long-term investors' trends - theory and practice", Rome, 8 April 2021.
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Piero Cipollone: Long-term investors’ trends - theory and practice Welcome address by Mr Piero Cipollone, Deputy Governor of the Bank of Italy, at the 2nd Bank of Italy and LTI Workshop “Long-term investors’ trends - theory and practice”, Rome, 8 April 2021. * * * I would like to welcome you all to the second Banca d’Italia and LTI joint Workshop on “Long-term investors’ trends: theory and practice”. The workshop addresses issues that are important for euro-area economies and their financial systems, never more so than today as we seek to recover from a severe economic shock. While the pandemic has temporarily forced us to forgo informal interactions, I am confident that we will be able to make the most of our discussions. I hope that the efforts under way to prevent and eradicate COVID-19 will allow me to welcome you in person in the near future. I am glad that this workshop is co-organized with LTI, a very important institution that aims to promote long-term investment in the real economy. We believe in the importance of long-term investment A well-functioning financial system, where agents take a long-term view, is essential for sustainable and inclusive growth. The benefits of long-termism are more apparent than ever. The CFA Institute, the global association of investment professionals, estimated that between 1996 and 2018, companies listed in the US S&P 500 index forewent earnings amounting to about 80 billion US dollars annually because of short-termism.1 According to the McKinsey Global Institute, companies with longer-term orientations experienced 47 per cent higher cumulative revenue growth than their peers between 2001 and 2014, with less volatility.2 Firms and money managers are increasingly aware of the importance of focusing on the longterm. Prominent investors3 often complain that companies are overly focused on quarterly results.4 In fact, some jurisdictions have been debating whether to lift the quarterly reporting requirement for listed firms. Large pension schemes (such as the Japanese government pension investment fund, the California teachers’ pension system and the Universities Superannuation Scheme in the UK) have publicly stated that they prefer to partner with asset managers who focus on long-term sustainability. A Long-Term Stock Exchange has recently been launched in the United States. Companies that list their shares on this exchange are required to publish a series of policies that focus on longterm value creation, such as aligning executive compensation with long-term performance and explicitly asking boards of directors to oversee long-term strategies. Many investors now embrace environmental, social and governance (ESG) criteria, which naturally leads them to focus on long-term sustainable returns. The Bank of Italy has undertaken several initiatives to favour a long-term sustainable approach to finance In 2019 the Bank of Italy integrated ESG factors into the management of its equity portfolio, not only to meet its social responsibility goals but also to lead investors by example. 1/4 BIS central bankers' speeches We ran a backward test over a ten-year horizon before implementing the new strategy and found that the new portfolio would have had both higher returns and lower volatility than the previous one. These findings, confirmed by several studies, may reflect the fact that the sustainability assessment introduces a forward-looking long-term element in otherwise predominantly backward-looking financial models. Furthermore, companies that adopt good ESG practices appear to have a competitive advantage resulting from innovation and lower operational, legal and reputational risks. We have also applied sustainability criteria to the management of our foreign reserves. In 2019, we used an external fund managed by the BIS to invest in green bonds denominated in US dollars. Later on, we started to manage green bonds in-house and we assigned an ESG benchmark to the managers of our US dollar-denominated corporate bond portfolio. We also apply ESG criteria to ourinternally managed euro-denominated corporate bond portfolio and are implementing low-carbon investments for the Bank of Italy’s pension fund. The Bank of Italy has also promoted several initiatives in the field of financial education. Short-termism does not only affect firms and professional money managers. We all have cognitive and behavioural biases that sometimes induce us to make poor decisions. One common bias is to be much more oriented to the present than to the future, and therefore to make choices that favour the short-term over the medium- and long-term horizon. Another tendency is to be overconfident, which sometimes leads us not to consults experts (for example, professional financial advisors) when instead we should. The Bank of Italy has launched financial education initiatives to combat these biases: we participated in pilot projects to bring financial education to schools and we conducted the Survey on the Financial Literacy of Italian Adults, looking at three factors: knowledge, behaviour and savers’ attitudes. In 2021, we started a new survey to measure the financial literacy of micro, small and medium enterprises, as part of an international project coordinated by the OECD for the Italian Presidency of the G20, within the Global Partnership for Financial Inclusion. Allow me to briefly recall the topics that will be discussed in today’s workshop Today we will have an opportunity to discuss a wide range of topics that are relevant not only to long-term investment but also to the unprecedented health crisis we are experiencing. The role of non-bank financial intermediation (the so-called NBFI sector) has become increasingly important since the Great Financial Crisis, also because of a prolonged phase of deleveraging in the banking sector. This is a topic that will be touched on today and has been at the forefront of discussions that are currently taking place in the major international regulatory policy fora. Within the NBFI sector, investment funds and insurance companies represent a vital source of finance for non-financial corporations (both equity and debt). The stability of these corporations’ financing sources is, in turn, a pre-requisite for their undertaking of investments, especially in activities such as research and innovation that have the potential to generate high growth. Therefore, a long-term orientation of investment funds and insurance companies is essential to guarantee such stability. The COVID-19 crisis and the associated episodes of financial turbulence, especially those experienced in March 2020 with the so-called “dash-for-cash” episode, has revealed significant fragilities in the NBFI sector. Spikes in volatility and illiquidity, whose effect can be significantly amplified by excessive leverage and liquidity mismatches, can quickly disrupt the provision of non-bank finance to the corporate sector and to the real economy. Central banks and governments intervened promptly after the March 2020 episode in order to avoid wide scale economic damage and undesired consequences for both price and financial 2/4 BIS central bankers' speeches stability. But central bank and public support cannot, and should not, be taken for granted: we must ensure that the NBFI sector becomes more resilient in its own right, independently of any support. To this end, international authorities are already working, under the leadership provided by the FSB, on building a macro-prudential framework to strengthen the NBFI sector’s resilience to shocks. The recent Archegos episode is just the latest example of how urgent it has become to reach this objective. The rapid adoption of new financial technologies (FinTech) has the potential to expand direct access to finance, increase the effectiveness and efficiency of investment processes, and generate substantial savings for investors. The COVID-19 crisis has accelerated the adoption of new financial technologies, a topic we will also talk about today. This poses several challenges for central banks, including the Bank of Italy. As recent events (GameStop/RobinHood) have highlighted, the mass adoption of financial technology, which is certainly a positive development, can also create risks for financial stability, investor protection and market integrity. Financial regulation, therefore, must also mitigate these risks so as to avoid hindering the pace of innovation. Our role in financial education is even more important at a time when small investors are empowered with sophisticated new tools that allow them to manage their savings autonomously. As a micro- and macro-prudential authority, the Bank of Italy is called on to stimulate and favour the adaptation of the business models of all intermediaries under our supervision to the increasing pace of technological adoption, to ensure that they remain safe, sound and supportive of the real economy despite the competitive pressures put on them by new players. We are a major participant on financial markets both as an investor and as a provider of technology (e.g., payment and settlement platforms). We need to keep abreast of new technologies and integrate them into our processes. An essential pre-requisite for good regulation and for playing a pro-active role in the rise of FinTech is a thorough understanding of the innovation processes taking place in the market, which today’s presentations will help us to develop. I would like to make one final comment on the current low interest rate environment. One of the biggest challenges of the current investment landscape, especially for long-term investors such as pension funds and insurance corporations, is the low interest rate environment that has prevailed since the Great Financial Crisis. Low interest rates have been determined not only by highly accommodative monetary policies, made necessary by the rapid succession of unprecedented crises (including the current one), but also by real and structural factors that we are still striving to fully understand. I am sure that today’s research contributions will help us to make a step forward in this direction. To conclude The word ‘April’ comes from the Latin verb “aperire", which means “to open". It is commonly believed that the word refers to the season when trees and flowers begin to ‘open up’ or blossom. Similarly, I hope that this April workshop can open up new discussions on several topics that are highly relevant for investments and for policy-making and lead to the blossoming of new ideas. For this, I want to thank LTI, the organizers, the keynote speakers, the presenters, the discussants, and all of you in advance. I wish you a pleasant and constructive day of discussion. 1 www.cfainstitute.org/en/advocacy/policy-positions/short-termism-revisited 3/4 BIS central bankers' speeches www.mckinsey.com/featured-insights/long-term-capitalism/where-companies-with-a-long-term-viewoutperform-their-peers# 3 Such as Warren Buffett, JPMorgan Chase’s Jamie Dimon and BlackRock’s Larry Flink. 4 www.ft.com/content/5bc1580d-911e-4fe3- b5b5-d8040f060fe1 4/4 BIS central bankers' speeches
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Remarks (via prerecorded video) by Mr Ignazio Visco, Governor of the Bank of Italy, at the roundtable on financing carbon neutrality, BOAO Forum for Asia Annual Conference, 20 April 2021.
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Ignazio Visco: Remarks on financing carbon neutrality Remarks (via prerecorded video) by Mr Ignazio Visco, Governor of the Bank of Italy, at the roundtable on financing carbon neutrality, BOAO Forum for Asia Annual Conference, 20 April 2021. * * * Let me start by thanking the Boao Forum for Asia for the kind invitation to this conference and let me express my regret for the impossibility of joining you in person in Boao. In these remarks, I will discuss the importance of international cooperation in supporting the transition to net carbon neutrality and I will briefly describe the related activities that we are carrying on within the Group of Twenty. Climate change and the pandemic are the most important global problems of our times. There is no need to remind this audience that the growing use of fossil fuels is pushing greenhouse gas concentrations to levels that, unless forceful measures are taken, by the end of this century will lead to a rise in the temperature of the planet that would bring catastrophic consequences for our ecosystems. Many of the root causes of climate change, such as deforestation and the loss of habitat, by increasing the chance of contact between people and wildlife also increase the risk of pandemics. As the United Nation’s One Health approach recognises, our health is closely connected to the health of the planet. Climate change is, in particular, a classic example of a negative externality: carbon emissions represent a cost that spills over onto other markets besides the one in which they originated. But in this case, as pointed out by Professor Nordhaus in his Nobel lecture, externalities are particularly thorny due to their global nature, which puts them outside the domain not only of markets but also of national governments, just like the pandemic is doing in these days. Close international coordination is therefore needed. We must bear in mind that stopping climate change requires first of all a strong and consistent political determination: national governments are the only institutions that can provide incentives to “green” investments, levy taxes on carbon emissions, and introduce regulations limiting the amount of allowable emissions. But finance can go a long way towards helping and reinforcing this process, channelling more resources towards green investments. For these reasons, the Finance Track of the G20 has put sustainable finance among its top priorities. There is a lot that can and needs to be done. – Filling data gaps and improving firms’ disclosure is crucial in order to correctly assess climate-related financial risks and to facilitate their integration in investment strategies. – Central banks can cooperate by establishing a common framework to measure climate-related risks and to integrate them into their risk management practices. In this perspective, central banks should also lead by example, by disclosing their climate-related exposure and explaining how they take climate risks into account in their investment strategies. – Reliable scenario analysis is essential: the standardised scenarios prepared by the Network for Greening the Financial System provide a promising common reference framework for the assessment of macro-financial risks related to climate change. – National governments should then play a decisive role: besides underlining the importance of carbon pricing schemes, let me reiterate the need for removing environmentally harmful subsidies, thereby promoting a reallocation of capital towards green investment. This year Italy is not only chairing the G20, but is also partner with the UK Presidency, which is also leading the G7, for the next COP26. We are therefore strongly committed to building a consensus among the members of the G20 in order to bring concrete and ambitious results to COP26, making this year a turning point in the fight against climate change. – Within the G20, the Financial Stability Board has been given the task of reporting on disclosure and data gap. The IMF has also been asked to consider climate issues in 1/2 BIS central bankers' speeches preparing a new Data Gap Initiative and, together with the OECD, to prepare a report on the role of taxation in tackling climate change, which will be discussed during a High-Level Tax Symposium to be held in July. – Under our initiative, the G20 has revived the Sustainable Finance Study Group. We have proposed China and United States to co-chair this group, and we are very grateful for their decision to accept this responsibility. The group, which is being upgraded to a fully-fledged working group, has made rapid progress in the last weeks and is now focusing its work on three areas: sustainability reporting; the metrics for classifying and verifying investment sustainability; the way to enhance the contribution of international financial institutions to the goals of the Paris Agreement. In the first half of May the study group will organise a G20 Finance Roundtable with the private sector. The purpose of this event will be to offer an in-depth perspective from a range of private sector stakeholders on the agenda for this year and to provide specific suggestions to feed into the G20 Roadmap to advance the sustainable finance agenda. This will lead the way towards the Venice Climate Summit, which will also be held next July, in which we will explore ways of scaling up dedicated finance to support global and consistent policies to pursue a just transition towards a carbon-neutral economy. Let me conclude by saying that I am grateful for the fact that there has been a large recognition across all countries of the importance of this agenda. The transition to net-zero emissions is essential if we want to reduce the risks that climate change poses to the wellbeing of the present and future generations. By continuing to work together, central banks, supervisory authorities and the financial sector at large will be able to provide a key contribution to reaching our climate goals. 2/2 BIS central bankers' speeches
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Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Asian Development Bank's 54th Annual Meeting of the Board of Governors, Virtual event, 4 May 2021.
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Raising the Bar on Climate Ambition: Road to COP 26 Remarks by Ignazio Visco Governor of the Bank of Italy Asian Development Bank – 54th Annual Meeting of the Board of Governors Virtual event, 4 May 2021 • Climate change and the pandemic are the most important global problems of our times. The two phenomena are related, as many of the root causes of climate change, such as deforestation and the loss of habitat, by increasing the chance of contact between people and wildlife, also amplify the risk of new pandemics. • Arresting climate change requires achieving net-zero greenhouse gas emissions at a global scale by mid-century. It is an urgent task: acting later can be extremely costly and may turn out to be ineffective. But shifting economic development towards a sustainable path is a difficult process and all human activities have to facilitate it. A successful transition requires, therefore, strong global cooperation. • This transformation is more demanding for emerging and developing economies, characterised by an increasing thirst for energy driven by industrialisation and rising consumption. Many of them are still heavily reliant on coal to produce energy. In addition, they still need to provide energy access to almost one billion people living without electricity – a daunting task to undertake while at the same time decarbonising the economy. • The current economic recovery provides a one-time chance to foster the necessary changes. As the G20 Finance Ministers and Central Bank Governors recently recognised, we need to shape the recovery by investing in innovative technologies and promoting just transitions toward more sustainable economies and societies. • In this perspective, Multilateral Development Banks can provide a key contribution. Since 2017, they have been granting developing countries almost 200 billion dollars per year, partly going to climate mitigation and adaptation projects. Within the G20 Sustainable Finance Working Group, a work stream has been created to enhance the alignment of this contribution with the goals of the Paris Agreement. • Sharing best practices for classifying and monitoring sustainable investments will help to identify how they can effectively catalyse private resources and support climate finance. Indeed, most investment will necessarily be privately financed, and this will require putting in place adequate institutional and regulatory frameworks, as well as appropriate and predictable carbon prices. • Multilateral Development Banks can also play a pivotal role in further expanding the use of debt-for-nature swaps. These can improve biodiversity and the provision of ecosystem services, while increasing carbon dioxide natural removals, which are strongly needed to achieve net-zero targets. These are some of the key issues on the agenda of the Venice Conference on Climate to be held this July. • Since the Paris Agreement was signed five years ago, the climate emergency has considerably worsened. The close international cooperation that has been taking place over the last few months is the hoped-for premise that this year will be a turning point in the fight against climate change. The G20, by discussing the tools available for a transition to net-zero emissions, will pave the way for the next COP26, where new country commitments to reduce carbon emissions will be taken, hopefully transforming good intentions into concrete actions. Designed by the Printing and Publishing Division of the Bank of Italy
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Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the G20 TechSprint 2021 – Presentation Event, Rome, 7 May 2021.
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Ignazio Visco: The G20 TechSprint 2021 on sustainable finance Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the G20 TechSprint 2021 – Presentation Event, Rome, 7 May 2021. * * * I am very pleased to share with you today the presentation of this year’s G20 TechSprint initiative. The world is currently facing some very difficult challenges – the attempt to end the pandemic, the effort to eradicate extreme poverty, the fight against climate change – and the G20 is working intensely to address them, by identifying and implementing shared, coordinated and equitable responses. This year Italy holds the Presidency of the G20 at a time in which the world economy is slowly recovering from the devastating impact of the Covid-19 crisis. The Italian Presidency aims at addressing this challenge by steering and encouraging global policy makers to strengthen cooperation and step up their efforts to promote a transformative recovery leading to a more inclusive and sustainable economy and society. In order to foster this recovery, both national and international policymakers must pay particular attention to two main factors: technological progress and climate change. The former is rapidly transforming our economies and societies. In the financial sector, in particular, new entrants such as Fintech and Insurtech companies are shaking up the market with new business models, new processes and products. As a response to these entrants, financial services firms are looking to modern technologies such as machine learning and artificial intelligence to increase automation, deliver cost reductions, increase efficiency and gain a competitive advantage. These technological solutions and the use of digital platforms have lowered entry barriers for alternative payment providers and pose new challenges for existing service providers such as banks or credit card circuits. These rapid changes are also affecting financial regulation and supervision because digitalisation, if left unregulated and insufficiently supervised, may lead to increased vulnerabilities and higher risk of IT failures, outages and cyber-attacks. The recent pandemic has accelerated our reliance on technology and we have witnessed the potential of new technologies to provide benefits for consumers, but we have to keep working to contain the risks they may pose. Technology can also provide new and intelligent solutions to the other main factor that is transforming the world’s economy: climate change. Climate change is increasingly affecting individuals in every single country to an extent that is likely to be even greater tomorrow than it is today. It is a global challenge that goes beyond national borders, as greenhouse gas emissions are, by nature, geographically pervasive. The past six years have been the warmest on record for our planet. The number of disasters caused by natural hazards is rising, resulting in hundreds of billions of dollars of damages in 2020 alone. Human-induced global warming has resulted in these events becoming increasingly severe and frequent. Addressing climate change is therefore as urgent as ever. In this context, various sectors of the global economy are starting to become more aware of the roles they can play. The financial system is beginning to support the transition towards a “greener” economy. Investment funds are gradually reorienting their portfolios towards more sustainable companies, which have also proved to be more profitable and resilient. We are seeing some savers change their preferences, opting for instruments such as green bonds or social bonds. Central banks are also playing an increasing role, not only through their financial portfolios, but also through their actions as regulators and supervisors. Governments and legislators are working towards adapting frameworks and practices to address the multifaceted risks posed by climate change and supporting a shift to more sustainable sources of energies. However, while there is considerable consensus on the need for climate action, much more can 1/2 BIS central bankers' speeches and needs to be done. Filling data gaps and improving firms’ disclosure is crucial in order to correctly assess climate-related financial risks and to facilitate their integration into investment strategies. Reliable scenario analysis must be produced and climate stress testing of the resilience of financial intermediaries should be regularly enforced. Central banks can participate in the establishment of a common framework to measure climate-related risks and to integrate them into their risk management practices. National governments should then play the decisive role with a more appropriate calibration of incentives for sustainable investment, taxation and regulation of carbon emission and the removal of fossil fuel subsidies. A significant contribution to the solution of these challenges could also come from technological innovation. Technological advancements have always played a crucial role in the selection of more efficient ways of delivering services and products; they can certainly provide great support to the creation and sustainability of new low-carbon business models. To leverage on the potential synergies between digitalisation, finance and the transition to net zero emissions, the Bank of Italy, also through its new innovation centre located in Milano, and the Bank for International Settlements Innovation Hub have organised, within the framework of the Italian Presidency of the G20, an international contest, the TechSprint 2021, which we have just launched. This is a global competition in the form of a long hackathon, where we seek out the potential of modern technologies, combined with new data and other innovations, to solve some of the most pressing challenges in green finance. We are inviting the international community of innovators, start-up creators, developers, data scientists, and designers to investigate and develop the best solutions to some issues in the field of sustainable finance, which will allow us all to achieve better and greener economies. Initiatives like the TechSprint are essential in encouraging bright, and often young, individuals as well as the most ambitious and able firms to take up a challenge that is both global and very complex. Thus, these competitions are not only a way of bringing together people from the public and private sectors to focus on shared challenges, but it is also a way to put entrepreneurs and scientists in the driving seat, guiding governments and public authorities in the realisation of the future of finance. As public authorities, we are approaching this initiative with curiosity and with an open mind, as we look forward to seeing what new technological solutions will be envisaged. In this spirit, let me conclude by thanking the participants in this launch event as well as all those individuals and firms that will take part in this competition. I am confident that, through ambitious ideas and the combination of technology and creativity, we will be on the right path to finding the solutions to improve our fragile ecosystem. 2/2 BIS central bankers' speeches
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Keynote address by Ms Alessandra Perrazzelli, Deputy Governor of the Bank of Italy, at the G20 TechSprint 2021 – Presentation Event, Rome, 7 May 2021.
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Alessandra Perrazzelli: Launch of the G20 TechSprint on green finance and sustainable economy Keynote address by Ms Alessandra Perrazzelli, Deputy Governor of the Bank of Italy, at the G20 TechSprint 2021 – Presentation Event, Rome, 7 May 2021. * * * It is an honour to participate in the launch of an initiative like the G20 2021 TechSprint and I am very happy for the global recognition of the importance of this competition to find new solutions that meet our social and environment protection goals. Let me begin by thanking the Minister of Economy and Finance Daniele Franco and the Governor of Banca d’Italia Ignazio Visco for their presence and messages: as they have underlined, the Italian Presidency of the G20 and its ambitious agenda “People, Planet, Prosperity” is an important opportunity to support the transformation occurring in our economies and to ensure that innovative tools and technologies will become the basis for a more resilient, sustainable and greener growth. I would also like to thank Benoit Coeurè and Andrew McCormack representing the Bank of International Settlements for the strong engagement and close collaboration in successfully organising this event. As reminded by the previous speakers, the use of new digital technologies and solutions (such as distributed ledger technology or artificial intelligence) may contribute significantly to meet sustainability goals in financial products and services and make green finance an integral part of the daily lives of people and businesses. This phenomenon, called Green Fintech, is growing rapidly and is becoming a driving force for the creation of a more environmental-friendly financial system. There are a number of ways in which Fintech and Green Finance can interact. For example, the use of artificial intelligence or machine learning algorithms can help in measuring the sustainability and the societal impact of investments. Moreover, Fintech solutions applying Big Data analytics may help financial firms in coping with the large amount of information related to ESG factors and in taking decisions that direct capital flows towards more sustainable assets and projects. From the demand side, the digitalisation of distribution channels and the spread of platforms can help investors to access green and sustainable investment products while artificial intelligence can facilitate the offering of personalized financial services. It should not be forgotten, however, that new technologies may also have a significant impact on energy consumption and that there could often be a trade-off between innovation and environment. The crypto-asset industry is a good example of this delicate balance: on the one hand, the adoption of crypto-assets and related technologies could improve the speed and efficiency of financial intermediaries and infrastructures but, on the other hand, it can worsen their carbon footprint because of the energy consumption of some of the underlying processes (such as mining). The answer, however, is not to block the development of these new technologies but, conversely, to trust even more scientists and innovators and support them in improving the environmental and sustainability profiles of their solutions. In order to support the development of efficient technological solutions combining innovation in finance and sustainability, new policy instruments such as innovation facilitators could play an important role. In fact, innovation hubs may allow the identification of use cases where innovative technologies can help to channel investments into sustainable objectives and to assist the transition to a greener economy. Innovation facilitators also help supervisors and regulators in getting to know innovation from up-close and may ease the design of rules that provide the right incentives for the development and diffusion of “climate-friendly” technologies. 1/2 BIS central bankers' speeches In this respect, it is worth saying that, at Bank of Italy – in addition to our “Fintech Channel” (a web window through which operators can communicate with the central bank on any financial innovation issue) – we have recently launched in Milan a new innovation facilitator (called Milano Hub) aimed at fostering collaboration and knowledge sharing between public sector authorities and different stakeholders (market operators, academics, etc.) and facilitating, among others, the development and spread of safe and sustainable Fintech solutions. That said, I am convinced that this G20 2021 TechSprint, the projects and the technological solutions it will attract, will help in making this year a turning point in the transition towards a greener and more sustainable finance. I expect a successful global hackathon that will attract a wide variety of participants from every country of the planet. Since in Italy this year we are celebrating the 700th anniversary of Dante, let me say that I hope that this competition will attract modern Ulysses that, as Dante recalls in the 26th canto of the Inferno, are craving for “worth and knowledge” and are eager to discover new lands. At this moment of our history, we need more than ever that the brightest and most ambitious minds will set to work on the challenges that our society and institutions are facing. It is a great pleasure for me to wish you a fair competition. Might all of you bring their best. May the best team win! 2/2 BIS central bankers' speeches
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Welcome address by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy, at the G20 RBWC Workshop "Towards a more resilient international financial architecture", Online event, 10 May 2021.
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The global financial cycle, capital flows, and policy responses Remarks by Luigi Federico Signorini Senior Deputy Governor of the Bank of Italy G20 RBWC Workshop Towards a more resilient international financial architecture Online event, 10 May 2021 The COVID-19 crisis gave rise to a synchronised sudden capital stop in March 2020, whose magnitude exceeded that observed during the Global Financial Crisis. Fortunately, this episode was short-lived and concentrated in the early stages of the pandemic. The pressure on emerging market capital flows eased after the unprecedented policy interventions carried out by both advanced economies (AEs) and emerging market economies (EMEs). An important factor in the scale of the outflows seen at the outset of the pandemic was the shift that had occurred over the previous decade in the composition of capital flows, towards non-bank financial intermediaries (NBFIs), and in particular, investment funds. This is the first of two main points I want to make. NBFIs tend to be more volatile than other sources of finance, such as bank lending and foreign direct investment. This was apparent during the March 2020 ‘dash-for-cash’ stage. Investment funds accounted for around half of the portfolio outflows observed, even though they (by some accounts) only represent a third of the stock of global portfolio liabilities. Why has NBF intermediation and cross-border activity grown so much? Several factors have contributed, but let me mention just two that are especially relevant to global flows: – first, the Basel reforms adopted after the global financial crisis led banks to deleverage, thereby reducing non-core assets and cross-border lending; – second, low interest rates in developed markets encouraged investors to diversify their assets by investing in emerging markets, often through dedicated funds (or through increased allocations to emerging markets by globally active funds). The growth of market-based finance is, on balance, a welcome development, notably because it increases the diversification of funding sources. This is particularly important for those countries and systems, such as Italy and much of continental Europe, that are overly dependent on banks. While funds may increase the size and liquidity of markets in peacetime, they are also known to be a potential channel for shock amplification in the event of stress. Because of redemption pressures coming from end-investors, fund managers may find themselves forced to sell assets, contributing to price-liquidity spirals. This mechanism is exacerbated when funds are allowed to run on a mismatch between redemption rules and the liquidity of their portfolios; not surprisingly, open-end funds behaved more procyclically than other investors did during the March turmoil. Moreover, while funds provide greater diversification for end-investors, they typically display little diversity in their own strategies within each investment class. State-of-the-art strategies are likely to be similar across many funds; besides, as managers are compensated relative to benchmarks, they tend to replicate the investment strategies adopted by peers. The resulting herd behaviour will further amplify shocks and cause contagion. Herding is, however, very much inherent in ETFs and passive funds, which have been shown to increase the sensitivity of peripheral markets to global shocks.1 Finally, algorithmic and high-frequency trading, widely used by asset managers, tends to increase market efficiency during normal times, but may break down during high volatility episodes, increasing the procyclicality of prices and liquidity.2 The Bank of Italy had long been advocating for international financial standard setters to tackle some of these vulnerabilities. This was largely ignored until the COVID crisis made them obvious to all, when investment funds played a crucial role in market disruption and, specifically, in capital flow reversals.3 NBFI reform is now very much on the FSB’s agenda. The Italian presidency of the G20 has made it one of its key priorities in the Finance track. While some issues are still controversial, progress has been palpable in some key areas, and I am confident that a more comprehensive approach is gradually developing. This was my first main point. My second point concerns the policy responses during the pandemic, which proved effective in dealing with large and volatile capital flows. As is well known, the actions taken by AE authorities after the outbreak of the pandemic, including the introduction of swap agreements by major central banks, contributed to improving global financial conditions; as investors’ risk appetite returned, EMEs’ capital inflows recovered and tensions on foreign exchange (FX) markets eased. The point to which I would like to draw your attention is that a number of EME policy makers also played a crucial role during that episode, as shown for instance in a joint paper by the Bank of England and the Bank of Italy.4 To mitigate the impact of the COVID-19 shock on the real economy and financial sector, they used a variety of tools, including monetary policy, FX interventions, macroprudential measures (MPMs) and capital flow management measures (CFMs). ‘How ETFs Amplify the Global Financial Cycle in Emerging Markets’, N. Converse et al. (2020), FED International Finance Discussion Papers. IOSCO Research Report on Financial Technologies (Fintech), February 2017. ‘Capital flows during the pandemic: lessons for a more resilient international financial architecture’, C. Maurini, A, Moro, V. Nispi Landi, A. Schiavone et al. (2020). Banca d’Italia, Occasional Paper No. 589. F. Eguren Martin, M. Joy, C. Maurini, A. Moro et al. (2020), ‘Capital flows during the pandemic: lessons for a more resilient international financial architecture’, Banca d’Italia, Occasional Paper No. 589 In the early stages of the COVID crisis, EME central banks intervened heavily in FX markets, trying to stem currency depreciation. Interventions were later scaled down, as market tensions and exchange rate pressures receded. Interestingly, a few EME authorities used both conventional and, I believe mostly for the first time, unconventional monetary policy instruments. As regards macro-prudential measures, several EMEs relaxed their overall prudential stance, mainly by easing capital and liquidity buffers counter-cyclically. Again, I believe this was the first time EMEs had extensively resorted to MPMs to stabilise the economy, proving that these instruments have become part of their policy toolkit. By contrast, capital flow measures played a minor role in the recent episode. Many EMEs relaxed CFMs on inflows, mostly to reduce banks’ FX needs stemming from prudential requirements, and in some cases to increase liquidity in domestic bond markets. Unlike in previous crises, only a few countries tightened CFMs to curb outflows. Policymakers’ response to the sudden stop in March 2020 highlighted the complementarity of different policy tools when a severe external shock hits an open economy, and will offer ample material for reflection and research. Tobias Adrian will give us glimpse of the Fund’s efforts to develop an Integrated Policy Framework (IPF) that would jointly consider monetary policy, FX intervention, MPMs and CFMs. This is an ambitious and welcome project that will offer guidance on the optimal selection of policy tools and their calibration, depending on the nature of the shocks as well as on the cyclical and structural characteristics of individual countries. We at the Bank of Italy shall be happy to contribute to the debate, following our well-established tradition of research on the issue of the optimal choice of policy tools.5 For instance, P. Angelini, S. Neri, and F. Panetta (‘Monetary and Macroprudential Policy’, Banca d’Italia, Working Paper No. 801 (March, 2011)) show that MPMs are useful when financial or housing market shocks are a key source of instability; by contrast, in ‘normal’ times, the benefits of MPMs are modest. V. Nispi Landi, (‘Capital Controls, Macroprudential Measures and Monetary Policy Interactions in an Emerging Economy’, Banca d’Italia Working Paper No. 1154 (December 2017)), explores the interaction of capital controls and MPMs with monetary policy in EMEs and shows that, assuming banks are indebted in foreign currency, capital controls and MPMs can mitigate the adverse effects of an increase in the foreign interest rate, depending on the source of shocks. Designed by the Printing and Publishing Division of the Bank of Italy
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Welcome address by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy, at the G20 Sustainable Finance Working Group Private Sector Roundtable, online event, 17 May 2021.
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Luigi Federico Signorini: G20 Sustainable Finance Working Group Private Sector Roundtable Welcome address by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy, at the G20 Sustainable Finance Working Group Private Sector Roundtable, online event, 17 May 2021. * * * Welcome, and a good day to you all. I am happy to open the Private Sector Roundtable, an event promoted by the G20 presidency and by the Chinese and American co-chairs of the Sustainable Finance Working Group. The Roundtable will focus on the role of finance in helping fight climate change and promoting lowcarbon transition. The G20 Finance Ministers and Central Bank Governors recently recognised the need to ‘shape the current economic recovery by investing in innovative technologies and promoting just transitions toward more sustainable economies and societies’. Low-carbon transition is urgent and must be accelerated: the later we act, the greater the costs. It requires an unprecedented and unremitting effort. While quantitative estimates vary, the investments needed for transition are certainly huge; they need to be sustained for a long time. Governments have a central role in that they need to point the way by adopting an appropriate policy framework. A clear and credible path for government regulatory and fiscal action is also a prerequisite for efficient choices on the part of private finance. Indeed, while many governments will directly invest their own money in many countries and MDBs will play their part, it is likely that the private sector will be called upon to finance most transition investment. There will be no transition without a general awareness of the need for it and a willingness, even a desire, to finance it. There are in fact quite a few encouraging signs. Since last year, we have seen an explosion of ‘net-zero commitments’ in the private sector—though such commitments (I am told) are still confined to one sixth of publicly listed companies globally. At the same time, the appetite of ultimate investors and asset managers for ‘green’ investment is growing fast. I am sure many in the audience will have a clear perception of this fact. However, the path is still fraught with difficulties. On the market side, while sustainable finance is increasingly popular, it suffers from a lack of clear definitions and standards. ‘Greenwashing’ is a danger; good data, an agreed taxonomy, and adequate company disclosure are necessary. Global consistency is important, as fragmentation of standards across jurisdictions is confusing for investors and costly for companies. Standards are currently being drafted in many countries and regions. It is therefore important to strive for an early global understanding, before national choices become entrenched. To some extent, every country will choose its own path to decarbonise, depending on national circumstances. However, climate change knows no boundaries. Tackling it is a global challenge that calls for strong international cooperation. With appropriate coordination, every country’s effort is reinforced by the actions of all the others. That is why the Italian Presidency of the G20 chose climate change as one of its key priorities, with a focus on data and disclosure in the Finance track. We are also happy that unanimous agreement was reached at the latest meeting of FMs and CBGs to upgrade the Sustainable 1/2 BIS central bankers' speeches Finance study group to a working group. In order to start this Roundtable with a clear picture of the available options, we asked the International Energy Agency to share their views on how the transition is evolving from a real economy perspective. This is important for identifying the right policies to achieve climate objectives, while at the same time ensuring energy security and affordability for all. It is particularly important in the context of today’s Roundtable to clarify the role of the private sector. I am now pleased to introduce Mechthild Wörsdörfer, Director of the Sustainability, Technology and Outlooks department of the International Energy Agency, as our keynote speaker today. Ms Wörsdörfer will present the main results of the IEA’s new flagship publication, ‘Net Zero in 2050: A roadmap for the global energy sector’, which will be out tomorrow. I wish you all a very instructive and constructive discussion. Ms Wörsdörfer, the floor is yours. 2/2 BIS central bankers' speeches
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Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at a meeting for the presentation of the Annual Report 2020 - 127th Financial Year, Bank of Italy, Rome, 31 May 2021.
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The Governor’s Concluding Remarks Financial Year 127th financial year Annual Report Rome, 31 May 2021 th The Governor’s Concluding Remarks Annual Report 2020 - 127th Financial Year Rome, 31 May 2021 Ladies and Gentlemen, The pandemic has had a very high cost in terms of human lives the world over. Keeping it under control has called for restrictions on individual freedoms and has deeply affected all of our lives. Many people have lost their jobs; our interpersonal relationships and the ways in which we study, produce and work, and spend our free time have changed. From an economic perspective, the ensuing recession is the worst since the end of the Second World War. In 2020, global GDP declined by 3.3 per cent, with uneven effects across the various geographical areas, productive sectors, firms, and households. There was an even greater decline, of almost 9 per cent, in world trade, characterized by the temporary halt of production chains and a sharp fall in tourism flows. Job losses hit young people, women and temporary workers the hardest. For the first time in over twenty years, it is estimated that the number of people living in extreme poverty has begun to climb again, today accounting for about 10 per cent of the population according to the World Bank, with an increase of more than 100 million people in the last year. Without the decisive and rapid economic policy responses, the damage would have been more serious. Cooperation between countries and coordination among the monetary and fiscal authorities marked a clear change of direction compared with the recent past. By last March, governments had approved spending increases, tax reductions and loan guarantees, valued at more than $16 trillion, equivalent to 15 per cent of global GDP, with the immediate objective of strengthening health systems and supporting household income and credit to firms. The prompt provision and exceptional quantity of liquidity provided by the central banks staved off tensions in the markets and restored broadly accommodative financial conditions. The measures enacted prevented a generalized tightening of credit, thus averting the risk of a spiralling crisis. Thanks to the extraordinary efforts made, first and foremost by the scientific community, to develop vaccines and treatments for the virus, many countries are gradually nearing the end of the health emergency. The effectiveness of the vaccination campaigns that began at the end of 2020 and the still very accommodative economic policies led the International Monetary Fund to revise its global growth estimates for this year upwards in April, to 6 per cent (Figure 1). This scenario is nonetheless still subject to high levels of uncertainty, linked above all to the course of the pandemic and to the uneven pace of vaccination campaigns around the world, which could lead to marked divergences in economic performance and to sudden movements of capital. The global scale of the risks calls for close international cooperation, assigning an important role to the Group of Twenty (G20), which Italy is chairing this year for the first time since it was set up in 1999. We will only be able to exit the crisis securely and definitively, from both a health and a socio-economic perspective, if progress is made by all countries. The economic policy responses must continue in a coordinated and coherent way; the support measures for households and firms must be withdrawn gradually and only when the economic situation has been sufficiently consolidated and uncertainty significantly reduced. Economic policies in the euro area The continuation of the pandemic and the effects of uncertainty on consumer demand and investment decisions are still holding back economic activity in the euro area. Net of temporary factors, price changes remain very moderate. GDP growth is expected to regain momentum in the second half of the year and, according to the latest estimates, to exceed 4 per cent on average in the two years 2021-22, after contracting by 6.6 per cent in 2020. This scenario assumes further progress in vaccination campaigns and a decline in infections; it continues to depend on maintaining the interventions to support the economy. While consumer prices are recovering, mainly due to the increase in commodity prices, the medium-term outlook for consumer price growth is still weak: expectations that ample spare capacity will persist for a long time are restraining both wage growth and the return of inflation to levels consistent with the price stability objective. The extraordinary measures taken by the Governing Council of the European Central Bank (ECB) swiftly counteracted the economic repercussions of the public health crisis. Since March 2020, additional funds amounting to almost €1,500 billion have been provided to banks on very favourable terms and there have been net purchases of public and private securities worth roughly the same amount, mostly in order to cope with the pandemic emergency. These interventions have helped to maintain a monetary stance consistent with the inflation aim; they have allowed intermediaries to satisfy the economy’s funding requirements and governments to access the necessary The Governor’s Concluding Remarks Annual Report 2020 BANCA D’ITALIA resources to support households and firms without the emergence of market tensions (Figure 2). The lessons of the global financial crisis of 2008-09 show that a premature reduction in monetary stimulus increases risks to the economy and to price stability. The uncertainty over the timing and intensity of the recovery requires that financing conditions remain accommodative for a long time: large and lasting increases in interest rates are not justified by the current economic outlook and must be countered, including with the full deployment of the existing securities purchase programmes. In addition to curbing the impact of the pandemic, the expansionary monetary policy stance is still designed to ensure that inflation, after many years of weak growth, returns to and stays at levels close to 2 per cent as soon as possible. The actions taken by the supervisory authorities have also been geared towards limiting the severity of the recession. Changing the timing of the entry into force of certain prudential rules has preserved the ability of banks to lend and to absorb losses at this delicate juncture; temporary measures on reserves and capital requirements have countered the potentially procyclical effects of regulation. Banking supervision is now balancing the need to ensure that banks continue to provide the necessary support to the economy with that of adequately safeguarding against risks. Following its suspension in 2020, the regular supervisory review and evaluation process whereby supervisors determine bank-specific capital requirements has now resumed. Under the coordination of the European Banking Authority, stress tests are being carried out to assess the solidity of intermediaries, including in a particularly adverse economic scenario. Though in a less rigid form than that decided for last year, the recommendation to limit profit distribution has been renewed until September. The extraordinary fiscal policies swiftly adopted by governments have greatly limited the fallout from the recession. The European Union’s response has differed from the inadequate ones provided during the global financial crisis and subsequent sovereign debt crisis. At the onset of the emergency, the suspension of the application of the Stability and Growth Pact, the temporary easing of restrictions on State aid and greater flexibility in the use of cohesion funds permitted all the Member States to adopt highly expansionary policies. In the euro area as a whole, net borrowing increased by 6.6 percentage points of GDP (Figure 3). Public debt as a share of GDP rose in all European countries; with the exit from the emergency, the stronger the recovery, the faster GDP will return to the levels prevailing before the pandemic crisis. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2020 The Union’s decisive intervention in support of Member States has taken an innovative approach that envisages the deployment of very substantial resources. It was decided to use a specially designed instrument to finance the measures to counter unemployment risks adopted in the various countries. Even if it does not constitute a common income support mechanism, nor does it presuppose a harmonization of national social insurance schemes, this instrument has nonetheless enabled recipient countries to reduce direct recourse to the market, to limit their debt burden, and to take advantage of very long maturities. The agreement on the Next Generation EU (NGEU) programme is of special significance. With this instrument, the European Union will be able to raise up to €750 billion on the market for loans and transfers to Member States (with over €200 billion going to Italy) to finance commonly agreed spending and reform plans. Together with monetary policy, this agreement has been decisive in sustaining the confidence of economic operators and the financial markets. The architecture of the economic and monetary union At the beginning of 2020, the ECB Governing Council launched a review of its strategy in response to the changes observed in the economy over the last two decades. All the main aspects of the conduct of monetary policy are being considered, from the definition of price stability to the symmetry of the objective and how to ensure it is achieved. Under our mandate, account will also be taken of the importance of protecting employment, safeguarding financial stability and combating climate change, while respecting the roles of the various authorities. The quantitative definition of the price stability objective today consists of an inflation rate below, but close to, 2 per cent, to be pursued over the medium term. Both our surveys of households and firms and the listening events conducted in the Bank of Italy in February and March of this year indicate that this definition is difficult to interpret and is sometimes misunderstood. A numerical objective of 2 per cent, with a symmetrical assessment of the upward and downward deviations, would be clearer and would strengthen the anchoring of medium and long-term expectations. The topics covered in the review include the interaction between fiscal policies and the single monetary policy. In the current circumstances, the Eurosystem should continue to provide its support during the recovery, making it easier to implement the structural interventions needed to create a more favourable environment for a return to stable and sustainable growth. The Governor’s Concluding Remarks Annual Report 2020 BANCA D’ITALIA The Governing Council is determined to adopt all the measures necessary to fulfil the mandate of price stability and the preservation of financial stability. Without prejudice to the independence from governments as established in the Treaties, at times of profound crisis a close harmony between the actions of governments and monetary authorities is crucial. The response to the pandemic is clear proof of this. During the economic recovery phase, ensuring the maintenance, extended over time, of the monetary stimulus could foster a more solid revival, with positive effects on employment and income, and a stronger anchoring of inflation expectations. In the United States, the Federal Reserve’s new strategy envisages that, following a protracted phase of low inflation, monetary policy will likely aim for a growth in prices that is moderately above the target for some time. The reasons for this seem commendable: how to pursue them in the euro area will be assessed, taking account of the contextual and institutional differences. There has long been the conviction that Europe’s economic architecture is incomplete in areas other than monetary policy. The debate, which was already wide-ranging prior to the launch of the single currency, has continued between economists and in the institutions, fuelled in part by the reports that drew up ambitious reform projects in the wake of the sovereign debt crisis. Nowadays, the need for a joint budgetary capacity has become even more evident. The launch of the Next Generation EU programme, which only partly has such characteristics, testifies to the awareness that common shocks require the use of a European instrument able to flank the single monetary policy. Nevertheless, a joint response may also be necessary in the event of asymmetric shocks, so as to strengthen national policies where the room to manoeuvre is reduced, or to supplement them if individual countries’ actions are weak because they do not consider the possible implications for other countries. As has happened in the past, the seriousness of the crisis has overcome any doubts or inertia. Even if the programmes launched over the last year do not resolve the problem of the economic and monetary union being incomplete, the more they are used effectively, the more they will be a reference point for creating permanent mechanisms that function in a more agile way. This is a path fraught with difficulties: the countries that will benefit most from the resources made available, which include Italy, have a twofold responsibility: they must seize this decisive chance to resolve their structural problems and demonstrate with concrete results the importance of a stronger and more cohesive Union. A joint budgetary capacity, accompanied by a review of the rules on national public finances, should be based on the possibility of a stable debt issuance, guaranteed by autonomous sources of revenue. This would, among BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2020 other things, provide the markets with a financial instrument with a high credit rating, making it easier to diversify the portfolios of European banks and to integrate capital markets, increasing the effectiveness of monetary policy and allowing the euro to assume in full its role as an international currency. A debt issued under a European fiscal policy would be very different from the pre-existing debt of individual countries, which would continue to be a national responsibility. Nevertheless, the joint management of a part of the liabilities issued in the past by each country, for example through an amortization fund, would also make it possible to swiftly provide the European government bond market with the depth and liquidity that it is currently lacking. Proposals of this kind have been criticized for fear that they might lead to systematic transfers of resources to countries with the highest debts, a fear that can be dispelled by an explicit definition of the mechanisms designed to prevent this. It would clearly not be a question of cancelling national liabilities, but of reducing the fragmentation and volatility that today characterize the sovereign debt market in the European Union. Government action and economic activity in Italy The epidemic first struck Italy back in February last year. In the first half of 2020, GDP fell by almost 12 per cent compared with the previous six months. As in the rest of the world, the subsequent waves were more severe than was generally anticipated; however, the impact on the economy was smaller than in the spring, owing to the easing of the new restrictions and the adaptation of firms and workers to social distancing requirements. Developments during the year highlighted the economy’s ability to recover but also their heavy dependence on trends in infection and support policies. Government action succeeded in blunting the repercussions of the pandemic on households and the production system. The impact on employment was mitigated by the extension of wage supplementation to all categories of firms and by the temporary restrictions on dismissals. Faced with a drop in GDP of almost 9 per cent, public transfers limited the fall in households’ disposable income in 2020 to 2.6 per cent in real terms (Figure 4). Government guarantees on new loans, moratoriums on outstanding debts, and more favourable financing conditions for banks within the Eurosystem, enabled the liquidity needs of businesses to be met: loans increased by more than 8 per cent, compared with a contraction of 2 per cent in the years of the global financial crisis and of 7 per cent during the European sovereign debt crisis. The Governor’s Concluding Remarks Annual Report 2020 BANCA D’ITALIA Most of the budgetary support measures targeted the hardest hit sectors. The Government provided a considerable amount of resources: subsidies, tax credits and contributions to businesses and the self-employed exceeded €20 billion in 2020; tax deferrals and reductions were approved worth more than €25 billion. The support has continued this year with resources comparable to those deployed in 2020. Taken together, the measures succeeded in combating rising inequality (Figure 5); they also prevented healthy firms, severely impacted by the pandemic, from being forced to shut up shop. As uncertainty subsides, public intervention must become more selective, focusing on the sectors that will continue to struggle due to the public health crisis and seeking to avoid subsidizing companies that have no chance of survival, while guaranteeing support for their workers. Production is now regaining momentum. Over the coming months, as the vaccination campaign proceeds, the recovery could accelerate. According to our latest surveys, firms are already planning a decisive increase in investment; households appear more cautious, but with the normalization of the health situation and less uncertainty, the high levels of savings accumulated could gradually translate into a rise in consumption. On average this year, GDP could expand by more than 4 per cent. Firms The production system has faced the crisis triggered by the pandemic in better shape than it was in during the financial crisis. Since then, weaker firms have exited the market and resources have been reallocated, albeit insufficiently and with delays, thereby leaving only the most competitive firms with the soundest financial structures to succeed, especially in the manufacturing industry. The COVID-19 crisis has caused a drastic drop in production and revenues, creating imbalances for the firms hit hardest by the restrictions on activity, thus worsening the situation for those businesses that were already weak prior to the pandemic. It has been a significant, but not generalized, phenomenon: in 2020, the financial balance of the sector as a whole (i.e. the difference between the change in financial assets and that in financial liabilities), fuelled in part by the support measures, was positive by €38 billion, three times more than the year before (Figure 6). A sizeable part of the loans received is held by firms in the form of deposits and other liquid assets, which can be used in the coming months to finance the upswing in production and planned investment. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2020 Potentially fragile firms account for about one sixth of total jobs. For those with the ability to recover, there is justification for offering them capitalization support measures. In light of this, the recent boosting of tax incentives to encourage an increase in net worth is important, especially for small and medium-sized enterprises. Larger firms will have access, under certain conditions, to the funds allocated through the ‘Patrimonio Rilancio’, a special capital enhancement instrument recently set up, which is run by Cassa Depositi e Prestiti. Banks are and will continue to be the main financing channel for firms. However, corporates should seize the opportunities, which are better now than in the past, provided by the ample liquidity available to investors in the capital markets, to bridge the gap vis-à-vis firms of the other main European economies. Since the beginning of 2020, net issues of debt securities and listed shares by Italian companies have amounted to €16 billion, compared with €101 billion for French firms and €87 billion for German firms. The completion of the capital markets union would help to diversify financing sources, but it is an objective that at present is made challenging both by differences in legislation across Member States in key areas, such as bankruptcy, corporate and tax laws, and by the limited availability of comparable information on companies. For the capital market to develop in Italy, external and internal constraints on the production system must be removed. As is well known, one particularly important factor is the extremely small size of most Italian firms, whose growth is frequently hampered by the lack of good management practices, in addition to an unfriendly business environment. Although Italy can count on a growing segment of dynamic and innovative firms, which are responsible for the country’s improving competitiveness on international markets over the last ten years and which has made an important contribution to our return to a net creditor position after thirty years, the production system still has its weak points (Figure 7). The number of micro‑businesses with modest levels of productivity remains extremely high, while the incidence of medium and large firms is lower, although their efficiency is comparable to those of the neighbouring major economies. Non-financial services firms with fewer than 10 employees account for almost 50 per cent of all workers, which is double the figure for France and Germany. Their specialization in traditional activities and their small size reduce the demand for skilled workers, creating a vicious cycle of low wages and limited job opportunities, which discourages investment in training. Despite the progress made, spurred in part by economic policies, private-sector research and development spending remains much lower than in France and Germany, and below the average for the advanced countries. The Governor’s Concluding Remarks Annual Report 2020 BANCA D’ITALIA Closing the large gap in how Italy’s civil justice system functions compared with those of the other European countries would improve the efficiency of resource allocation in the production sector, thereby also stimulating investment in financial instruments issued by firms. The length of credit recovery procedures via the court system is almost double the EU average. In addition to the complexity of procedures, the system is weighed down by the limited degree of specialization of judges and the incomplete digitalization of their activity. The substantial differences between courts in terms of the duration of legal proceedings, a matter of much discussion for many years, suggest that organizational factors play a significant role in this problem. Households and employment Public transfers to households reached very high levels in 2020, increasing by more than €30 billion net of pensions. This exceptional support required a marked expansion of social shock absorbers, also to reach people not otherwise covered. The reduction in the number of persons in employment was much smaller than that in the number of hours worked, but it was nonetheless significant owing to the fall in fixed-term hires and the sharp drop in new businesses. Young people and women, who are widely employed in the service sectors hit hardest by the crisis, such as those linked to tourism and leisure, were especially penalized. Consumption declined by 10.7 per cent, four times the reduction in disposable income (Figure 8). Our surveys indicate that, unlike what typically occurs in a recession, the contraction in spending was significant even for households that declared they did not experience financial difficulties: the restrictions on commercial activities, fear of infection and increased uncertainty about the economic outlook all contributed. The share of income devoted to savings exceeded 15 per cent, double that recorded in 2019. The end of the health emergency and the economic revival will initiate a recovery in the number of hours worked and in income. Given the magnitude and nature of the crisis, and in view of the intensification of the processes of digitalization and decarbonization under way, it is not easy today to foresee all the ramifications of the structural changes that the productive system will have to address. Yet one of the main issues will be how best to facilitate the redeployment of workers currently employed in activities that are bound to be downsized. Those who lose their jobs must continue to receive support. It will be necessary to remedy the significant weaknesses in the social welfare system’s design and reach, which persist despite the reforms of recent years, and which BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2020 have been laid bare by the pandemic, requiring the adoption of extraordinary interventions. Moreover, we are still far from the definition of a modern system of active labour policies, capable of accompanying people throughout their working lives: in Italy, one unemployed person in ten receives assistance through an employment centre, compared with seven in ten in Germany. It is not only a question of the resources allocated, which in any case are modest in Italy; above all, it is about raising and harmonizing the standards of the services provided throughout the country. It will be necessary, in particular, to strengthen in-house company training schemes and increase knowledge and skills, also when it comes to using new technologies, which are still largely lacking. The need to raise what economists, using the undoubtedly reductive expression, call human capital, is something I have returned to again and again and which I consider absolutely vital for our country. Education and culture are fundamental for ensuring active participation in social and economic life, reinforcing respect for the rules and promoting the consolidation of shared values. The possibility for businesses to leverage qualified workers and managers depends on adequate training. Accelerating entry into the labour market and encouraging lifelong learning depends on the overall quality of education and training systems. In Italy, more than 3 million young people between the ages of 15 and 34 are neither employed nor engaged in education or training; this is almost one quarter of the total, the highest share among European Union countries (Figure 9). This must be taken into account when redefining the priorities for economic and social development and directing efforts towards the construction of a truly knowledge-based economy, the main instrument available to an advanced country to consolidate and increase the wellbeing of all. The role of public intervention in boosting development In modern economies, the State has roles that go well beyond the minimum ones of public order, defence and the administration of justice. In response to ‘market failures’ or for the purposes of social equity, the State regulates private economic activity; it directly produces or finances basic services such as education and health; it provides for the building of infrastructures and supports research and development; and it defines and manages the social welfare system. By means of the public budget, the State performs a function of macroeconomic stabilization. Before the pandemic, public spending net of interest payments amounted to 45 per cent of GDP in Italy. Efficiency in the use of such a sizeable amount of resources and the capacity to secure them with the least The Governor’s Concluding Remarks Annual Report 2020 BANCA D’ITALIA distortionary instruments both help to determine Italy’s potential growth. There is considerable room for improvement in the quality of infrastructures and public services, in the distribution of the tax burden, made unfair by high levels of tax evasion and avoidance, and in the effectiveness of the social welfare network, fragmented by the stratification of regulatory interventions. The severe recession caused by the pandemic has restored State action to a central role, both in emergency interventions in favour of households and firms and in drawing up and implementing a strategy for recovery and for boosting development. The breadth of the response to the crisis has reignited the debate over the role of the public sector in the economy. Nevertheless, the need for a State that is more effective in carrying out the functions already entrusted to it must not be confused with the need to extend its tasks. Past experience suggests that public production of market goods and services brings with it non-negligible risks of ‘State failure’, especially if it is not subject to market discipline or if it is not accompanied by institutional rules and safeguards that guarantee its autonomy and accountability. The contrast between State and market is misleading, as they are actually complementary. A healthy economy needs them both: the former provides good rules and high-quality public services, and intervenes in areas where social returns are high but private business is insufficient, and the latter generates dynamic and innovative firms able to promote their work and to be rewarded for the quality of their output. This complementarity is not limited to the State and the market; it also embraces the many organizations that in the modern world, and increasingly so in Italy, are non-profit making and, often thanks to voluntary work, contribute to the wellbeing of the community. The NGEU programme offers us the chance to improve how the public sector works, and to stimulate private enterprise and modernize the economy. Without undue emphasis, we can agree with the argument that the opportunities Italy will be able to offer future generations depend on the success of the reforms and measures of the National Recovery and Resilience Plan (NRRP) which will implement the programme. The NRRP’s analysis of the structural weaknesses of Italy’s economic and institutional system is agreed with across the board. The objectives and missions into which it is divided address the challenges posed by climate change and some of the most obvious lags in Italy: innovation, digitalization, education and research and the network and transport infrastructures (Figure 10). Measures to reinforce labour policies and the social welfare and the health systems are envisaged. The NRRP includes measures worth more than €235 billion over six years: this is an impressive plan that needs to be transformed into executive projects, BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2020 calls for tender, and public works. The design challenge and the commitment necessary for it to be effectively realized are considerable. The disbursement of European funds is conditional upon the availability of evidence on how interventions are progressing and on the objectives achieved, to be provided by continuous monitoring. The discipline thus imposed on general government, accompanied by the hiring of specialized staff, could have positive and lasting repercussions on its functioning and on its planning and operational capabilities. The reform agenda is equally ambitious and must also be implemented according to a strict timetable. Measures are identified to improve the working of general government, expedite judicial proceedings, simplify legislation and remove the limits on competition – all areas in which the need for a change of pace has been apparent for some time. To these can be added the announced reforms of the tax system and of social safety nets which, while not included in the plan, are among the areas in which the Government intends to intervene. Unity and awareness of the absolute necessity of stepping up to the commitments made is required of all the actors involved: policymakers, institutions, social partners and citizens. Reducing regional disparities in economic and social development, which are even more evident today after a decade of stagnation, is a key priority of the plan. The investments and reforms can prove especially beneficial in areas where accessibility to infrastructures is most lacking, and where the quality of public services and the dynamism of private initiatives is less satisfactory. To the more than €80 billion that the plan assigns to modernizing and developing Italy’s southern regions can be added the allocations from the Fund for Development and Cohesion, European structural funds, and other programmes, taking the total of available funds to more than €200 billion between 2021 and 2030. Setting aside differing visions of the role of the State, Regions and local government in implementing the interventions, valid solutions must be identified to ensure that these are effective. The planning and execution phases, together with the outcomes, must be constantly monitored, with a clear assignation of responsibilities to overcome shortcomings and delays, so as to avoid a repeat of past errors when the resources available were not always used fully and well. The country will be called on to make a lasting commitment, extending beyond the time horizon of the NGEU, to give concrete expression to the reforms. Some areas, such as healthcare, welfare, education, justice and research, could require a greater routine deployment of funds. At least in part, this can be addressed through a different composition of the budget and with the higher revenues expected from faster growth. We must nonetheless be aware that the more is asked of the State, the greater general willingness there The Governor’s Concluding Remarks Annual Report 2020 BANCA D’ITALIA must be to bear the costs: we have already made the mistake in the past of relying on the public debt to fund structural increases in public expenditure. The future tax reform must be accompanied by a renewed commitment to combat tax evasion; despite the progress made in recent years, the extent of this phenomenon continues to damage our economy. The macroeconomic impact of the plan will depend not only on the resources utilized but also on the quality of the interventions to be funded, the efficiency with which they are realized, and their ability, together with the reforms that accompany them, to create an environment that is conducive to private initiative and to influence firms’ investment decisions. Even if any overall assessment is clearly difficult to make, a number of simple exercises described in the Annual Report show significant potential. The medium-term impact of the demand effects, considering the stimulus for private investment activated by synergies with public capital, could raise the level of GDP by between 3 and 4 percentage points by 2026. Significant additional effects, of up to 6 points in a decade, can derive from the reforms and plans to foster research and innovation. Overall, an effectively executed plan, both in terms of the realization of the investments and implementation of the reforms, could raise potential annual growth of the Italian economy by a little under 1 percentage point on average over the next decade, enabling our economy to deliver levels of GDP growth not recorded for years. The importance of ensuring that the NRRP promotes investment, employment and productivity over the longer term is underlined by the expected reduction in the working-age population in the next twenty years; combating its unfavourable impact, in addition to tackling unemployment, will require higher labour market participation rates among women and young people, who remain 13 and 14 percentage points below the EU average, and the gradual lengthening of working lives in accordance with the current legislation. One contribution could come from mechanisms which reward firms that hire young people and women and from resources dedicated to bolstering childcare services. The phase of stagnation in productivity that has inhibited the economy's development for so long must also be interrupted. At the end of this year, the debt-to-GDP ratio will be close to 160 per cent, a level not recorded in Italy since the end of the First World War and almost 60 percentage points above the euro-area average. The high public debt constitutes a structural vulnerability: it exposes Italy to the risk of financial shocks, creates underlying uncertainty that impacts on borrowing costs and discourages private investment. All the more reason that the European funds must deliver considerable and lasting progress. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2020 Thanks to an average residual maturity of more than seven years, average borrowing costs will continue to benefit well into the future from the exceptionally low interest rates registered in recent years. Even with a pace of economic expansion close to that recorded in the decade preceding the financial crisis, the gap between growth and average borrowing costs should remain positive for several years. In these conditions, a progressive improvement of budget balances, such as to deliver a primary surplus of a little over 1 per cent of GDP, would enable the debt-to-GDP ratio to return to 2019 levels in the space of a decade. Faster growth is within our reach and would enable us to speed up the reduction of the debt-to-GDP ratio. The banks and the financial system In 2020, banks’ balance sheets continued to strengthen. In the last five years, the common equity tier 1 ratio (CET1) rose by more than 3 percentage points, to 15.5 per cent. The ratio of non-performing loans to total loans, net of provisions, fell to 2.2 per cent, 7.6 points below the peak of 2015. For the main groups, classified as significant for the purposes of the Single Supervisory Mechanism, the distance from the average of the other countries in terms of capitalization and loan quality was practically eliminated (Figure 11). The number of insolvencies that emerged as a result of the health crisis has so far been curbed by the measures – such as debt moratoriums and state-guaranteed loans - issued since March of last year and recently extended by government decree to the end of 2021. Since the last quarter of 2020, however, new non-performing loans are increasing, albeit only slightly. They may continue to rise in the coming months, although to a lesser extent than in previous crises. This is indicated by an average increase in the amount of loan loss provisions on performing loans of almost one third, which reflects the deterioration of credit risk; this rise is accompanied, however, by considerable differences in the ways banks classify and value loans. When these differences cannot be justified by a careful analysis of the credit rating of individual positions, they will have to be smoothed in the next few months; all banks should accordingly adopt prudent policies. The extension of the moratoriums will widen the gap with the other European countries as regards the use of measures of this kind – on the one hand, they can benefit debtors but, on the other, they render banks’ balance sheets less transparent. Therefore, banks must use all the information at their disposal to correctly classify any suspended loans so that losses come to light promptly, thus removing any doubts in investors’ minds about the real quality of banks’ loan portfolios. The Governor’s Concluding Remarks Annual Report 2020 BANCA D’ITALIA Intermediaries can use their excess capital to adjust their classifications and loan loss provisions: at the end of last year, the CET1 ratio was, on average, more than 6 percentage points higher than currently requested by the supervisory authorities. These resources can also be channelled toward supporting firms that are in difficulty but have a real chance of resuming regular debt repayments; their identification is not an easy task but it is a crucial one at this juncture. The share of forborne exposures to total loans, equal to 3 per cent at the end of 2020, is probably going to increase. Last year, the average return on equity (ROE) fell by 3 percentage points, to 1.9 per cent, mainly owing to the rise in loan loss provisions. Low interest rates, high costs, and greater competition fuelled by the application of digital technologies to the provision of financial services have shrunk profits. The dividend distribution recommendation and intense talks between the banks and the supervisory authority meant that a good part of the profits earned in 2019 and 2020 contributed to capital strengthening. Reorganizing production and distribution processes to improve the supply of banking services and reduce costs was already a priority before the outbreak of the pandemic, it has now become a necessity. A number of banks, mostly smaller ones following a traditional business model, have structural weaknesses. In some cases, this is due to inadequate corporate governance and weak internal controls, while in others it is because of their reduced capacity to access the capital markets and take advantage of economies of scale and scope. These banks urgently need to review their business models. Possible actions to take immediately to support profitability include: making commercial agreements with other operators, creating consortiums and, last but not least, mergers and acquisitions. Future crises of individual banks will be managed in such a way as to ensure their exit from the market in the most orderly manner possible, even if the rigid and incomplete European regulatory framework for failing small- and medium-sized banks makes this difficult. The need, arising from the pandemic, to reduce personal interactions with customers has encouraged an acceleration in the adoption of the new technologies. Last year saw an increase in online bank transfers and card transactions, electronic payments, and in the share of banks allowing their customers to manage loan applications remotely. Nevertheless, investment in IT is still low. It is necessary to accelerate the upgrading of infrastructures, while simultaneously adapting skills and organizational structures. The banks that have recently invested more heavily in technologies to assess credit risk were those that increased lending to firms the most following the outbreak of the pandemic. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2020 The new technologies are revolutionizing the entire value chain of the finance industry, well beyond the perimeter of the banking system, with innovations that could lead to better risk measurement and management, expand the potential customer base and deliver significant reductions in costs. It is not possible to predict what the new market configuration will be, but it is clear that the new equilibrium in the credit intermediation and asset management industries will be different from today. Banks unable to prepare for change and to adapt rapidly are destined to lose ground fast. Innovative start-ups (FinTech), major technology firms (Big Tech), large retail chains and electricity and telecoms providers can now also offer financial services to their customers. Competition is particularly fierce in the payments sector, where innovation has been encouraged by European rules that now enable the provision of new services thanks to the possibility, for third-parties, to access customer accounts, subject to prior consent (open banking). About half of the investments in technological innovation planned for the next two years by banks and financial intermediaries involve this type of project. More than by margins on payments, these developments are being driven by the immense wealth of information they contain, which can help to improve traditional services and introduce new ones, such as those aimed at small and mediumsized enterprises to optimize their management of liquidity and payment flows. Technological innovation is also destined to change credit supply. The use of advanced techniques to evaluate creditworthiness is expanding, based on a multiplicity of inputs, including unstructured data. Algorithm-based evaluations cannot completely replace the judgement of analysts, but if complemented by the qualitative data acquired by intermediaries, they will be an increasingly important component, especially in specific niche markets. At the same time, we cannot ignore the cyber risks that the digital revolution brings with it. Criminal activities and the use of malware are on the rise and can undermine IT systems and cause economic damage to financial intermediaries and their customers. Moreover, some operating risks are becoming more serious, for example those connected with the growing use of outsourcing – often to a small number of operators that are not subject to supervision – of important stages in production processes, whose malfunctioning can then affect the system as a whole. We should not underestimate the risk of fraud, discrimination, and the improper use of personal data in applications that make use of big data and artificial intelligence. To address these risks, the supervisory authorities are committed to defining the rules and procedures, not to holding back the changes under way, but rather to ensure that innovation does not constitute a source of instability or financial exclusion. Safeguarding against cyber risks calls for the cooperation of authorities and operators. In the forums of cooperation, there is a swift The Governor’s Concluding Remarks Annual Report 2020 BANCA D’ITALIA exchange of information and analyses concerning the principal threats so that awareness-raising campaigns can be planned for this type of risk. The transition to a sustainable economy is also destined to produce significant changes in the financial industry. It offers banks the opportunity to improve their profit profiles and, at the same time, to contribute to the emissions reduction objectives. The financing of eco-sustainable projects and the issuance of green bonds, for example, can achieve an increase in earnings and, going forward, a reduction in the cost of raising funds. Banks can also benefit from the development of consultancy services for firms that intend to raise funds for initiatives with a positive environmental impact and from the placement of asset management products geared to this segment of the market. In this case too, banks must be prepared to manage the effects of the transition on risks, in particular credit risk. Firms that are not able to direct their products and production processes towards environmental sustainability will find it more and more difficult to stay on the market. We are working actively, also internationally, to foster the development and adoption of procedures and methodologies that will allow banks to correctly measure and manage the financial risks posed by climate change. In Italy, the development of the markets and expansion of sources of funding for firms would benefit from a more active role being played by institutional investors in asset management. At the end of last year, 35 per cent of households’ total financial assets were entrusted to insurance companies, investment funds and pension funds, compared with the euro-area average of 41 per cent (Figure 12). The share of managed assets invested directly in instruments issued by corporates was about one fourth, against a euro-area average of more than half. Although numerous regulatory and fiscal measures were adopted in the last decade to channel a greater proportion of massive financial savings towards small and medium-sized enterprises, the results have been modest, mostly reflecting the scarcity of bond issues. The further development of funds specialized in unlisted securities and credit funds is, however, desirable, thus allowing investors to lower the risks involved in holding less liquid assets. Although still modest by international standards, in 2020, the assets of closed-end securities funds grew by 12 per cent, with funding mainly coming from private equity funds and those specialized in direct loan disbursements and in the purchase of loans originating with other financial intermediaries. Last February, we started to issue authorizations for the establishment of funds that comply with the legal requirements for individual alternative savings plans, which aim to increase the flow of resources towards unlisted companies. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2020 At the end of April, Euronext, which owns a number of European securities markets, completed the acquisition of the Borsa Italiana group. The entry of a number of Italian companies in a federated European group, is an opportunity for our financial marketplace to develop the services it can offer to issuers, financial intermediaries and savers, thereby also helping to increase the European dimension of capital markets. The Bank of Italy’s actions and the G20 Presidency The pandemic has profoundly affected work practices in the Bank too. To cope with the emergency, we adopted extraordinary measures with the aim of protecting people’s health and ensuring the performance of our institutional activities to serve the public, in line with the measures taken by the Government. The recourse to remote working was on a large scale: in 2020, almost 60 per cent of total staff worked from home on average, exceeding 90 per cent between mid-March and the end of April; in 2019, the figure was 4 per cent. This sudden change was made possible by the continuous investment in IT infrastructure, by the digitalization of processes and by the adoption of instruments and systems designed to guarantee business continuity. Above all, the men and women working in the Bank have demonstrated their utmost commitment to serving the public competently, with integrity and with the capacity to adapt. The tasks that have to be performed on site - mainly connected with the production and distribution of banknotes, auctions for the placement of government securities, other services for the public and logistic support, as well as supervisory inspections - have been recalibrated to be carried out safely, with the adoption of health protocols and additional preventive and protective measures. As in all organizations, we in the Bank of Italy are reflecting on how to build on the lessons learned from the crisis. Agile work, which has no rigid time or space constraints, can help to make institutional actions more effective and organizational processes more efficient and resilient; it makes a better work-life balance possible. The progress made in terms of flexibility and adaptability must now be consolidated, at the same time mitigating the risks stemming from more fragmented activity and a possible reduction in information sharing, in the relationship dynamics and in the opportunities for training and professional development that arise from interactions in the workplace. I will now briefly outline some of the Bank of Italy’s initiatives in the fields of environmental sustainability and technological innovation. For detailed The Governor’s Concluding Remarks Annual Report 2020 BANCA D’ITALIA information on all the activities carried out in this difficult year, including that on the Bank’s internal organizational reforms, I refer you to ‘The Bank of Italy’s Annual Accounts’ published at the end of March and the ‘Report on Operations and Activities of the Bank of Italy’, which we are publishing today together with the Annual Report. Our commitment continues on the environmental front with numerous initiatives for energy efficiency and the use of renewable sources and of sustainable products and mobility. Between 2010 and 2019, the Bank’s CO2 emissions fell by about 60 per cent; we estimate that, compared with the previous year, they fell by almost 30 per cent in 2020, above all because of the decrease in business travel, in commuting and in paper consumption. Last year, we extended the application of sustainability criteria to investment in non-EU equity markets and to corporate bond management, which had already been adopted in the Italian and euro-area equity segment; there have also been purchases of green bonds issued by supranational agencies. In the forthcoming ‘Carta degli investimenti sostenibili’ (sustainable investment charter), we will set out the principles guiding the management of financial investment and the lines of action that will continue to make our commitment to sustainability concrete. As well as continuing to innovate in order to increase the effectiveness of our functions, we are committed to supporting the adoption of digital technologies by financial system operators. Our new innovation centre, the Milano Hub, has begun working with the goal of promoting digital evolution in the financial sphere among public and private institutions and of encouraging the attraction of investment and talent. Drawing on its expertise, the Bank of Italy will provide practical support for the study and development of projects proposed by industry, the academic world and research centres that can bring benefits to Italy’s financial system and economy. In this way there will be a wider range of instruments fostering innovation, which already includes the FinTech Channel through which operators can interact with the Bank on various themes, including regulatory ones. In collaboration with the Ministry of Economy and Finance, we are involved in coordinating the G20 Finance Track’s work. This proceeds from the awareness that international cooperation is essential to provide effective responses to all global challenges, from those connected with the pandemic to those linked to climate change and digitalization. Given the exceptional challenges experienced worldwide during the pandemic, encouraged by Italy’s Presidency, the G20 set up a panel of independent high-profile experts tasked with identifying the shortcomings BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2020 in the system for financing the prevention, monitoring and response to pandemics. Concrete proposals for overcoming them will be put forward in a framework of cooperation among States, the World Health Organization and the other international organizations. As regards climate change, the Finance Track aims, among other things, to achieve a better alignment of the loans and transfers of international financial institutions with the objectives of the 2015 Paris Agreement, to improve the quantity, quality and comparability of the corporate data on climate risks, and to increase those available to supervisors and investors on the exposure of financial institutions to the same risks. The International Conference on Climate, to be hosted by the Italian Presidency on 11 July in Venice, will be an important moment for discussing these issues, also in light of the United Nations’ ‘Conference of the Parties’ (COP26), chaired by the United Kingdom in partnership with Italy, to be held in Glasgow at the end of November. As part of the proposals under the aegis of the G20, together with the Bank for International Settlements, we have also recently launched an international competition (TechSprint) to find the most promising projects for technology applied to sustainable finance. A roadmap has been prepared for the development of cross-border payments, with the aim of making them cheaper, faster, transparent and inclusive. This envisages drawing up quantitative objectives at global level on how to extend the connections between local systems, on easing regulatory and operational frictions and on innovative technologies. The analysis of the regulatory and supervisory implications regarding global stablecoins and further research into the use of digital currencies and their possible issuance by central banks are part of this sphere. In this regard, the Bank of Italy is involved in the Eurosystem in analysing and testing possible solutions for the introduction of a digital euro. This is a development that must be defined carefully in terms of both timing and modes, also based on the outcome of the recently concluded public consultation. The use of the TIPS platform set up by the Bank on behalf of the Eurosystem to settle instant payments in the euro area could be a fundamental part of this. The G20 work on cross-border payments intersects with that on financial inclusion, an area in which the Bank is particularly active as co-Chair of the Global Partnership for Financial Inclusion. The analyses under way are designed to find the best practices in the area of consumer protection and financial and digital education to contain the risks of the barely inclusive digitalization of financial services that emerged during the pandemic. *** The Governor’s Concluding Remarks Annual Report 2020 BANCA D’ITALIA The intensity and speed with which the pandemic has hit the global population have been exceptional; the human, social and economic costs have been and continue to be severe. Nevertheless, the response of those working in healthcare structures, in public and private research and in the pharmaceutical industry has been equally swift and intense. In addition, the interventions of fiscal and monetary policies have been extraordinarily wideranging, in all corners of the globe. The pandemic crisis has not become a financial crisis, there has been no shortage of humanitarian aid for the most vulnerable countries, and governments have aimed to alleviate the suffering of the weakest population segments, counteracting the increase in inequality. In many countries, especially in the advanced ones and in Italy too, following the extremely sharp decline in production and in income last year, there are now signs of economic recovery, which in some cases are quite significant. Yet progress is still broadly unequal on both the healthcare and the economic front. Even where the outcome has been more encouraging, caution is still required. In many emerging and developing countries, the epidemic is not slowing down and there are serious delays in the vaccination campaigns, or even no campaigns at all. In a highly interconnected world, the risks of the pandemic will not be truly overcome for anyone until they have been eliminated for everyone. Coordination at international level and of fiscal and monetary policies remains fundamental. EU governments have introduced unprecedented countercyclical measures and subsidies. Support for the economy will be maintained until there is a clear return to a stable growth trajectory; to this end, the success of the investment and the reforms envisaged by the national plans associated with the exceptional innovation represented by Next Generation EU will be crucial. In the euro area, the monetary policy stance must remain highly accommodative, in the knowledge that we are still a long way from inflation rates consistent with price stability in the medium term. Maintaining favourable conditions for funding the economy over a prolonged period is necessary to consolidate the improvement under way in the confidence of firms and households. For some countries, following the halt caused by the measures restricting economic activity and the fears of infection, vigorous growth in consumption is predicted. A robust recovery in demand in the second half of this year is therefore possible, conditional upon the continuation of the favourable outlook linked to the vaccination campaign and a good start to the NRRP. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2020 The latter must be part of a collective effort, aimed at overcoming Italy’s structural weaknesses and the specific factors of the anaemic economic growth of the last two decades. If, as we have fully understood by now, there are no simple solutions to our problems, now is the time to step up our commitment. The interventions included in the NRRP and the thorough reform programme connected to it must be made as concrete as possible. The security and rapidity of their execution and the efficacy and transparency of the financial commitments must be guaranteed. They are undoubtedly exceptional as regards digitalization, innovation, the ecological transition and sustainability; of equal importance are the provisions for education and research, social inclusion and healthcare; the pursuit of the overarching priorities of rebalancing regional gaps, supporting the younger generations and achieving gender equality will extend beyond the NRRP. The challenge ahead is a formidable one. It is vital that firms and households take it up with conviction and confidence: a future built on public subsidies and incentives is unthinkable. It will take time to understand what the new ‘equilibriums’ of social life and economic development will look like after the pandemic and the digital and green transitions. We are all called on to cultivate greater and more widespread prosperity, adequate protection for those who will be most affected, and clarity about the costs to be borne and progressively reduced. What is certain is that the stimulus, which is partly artificial, of today’s extraordinary and exceptional macroeconomic policies, will end. The freeze on dismissals, State guarantees on loans and debt moratoriums, will also cease. Gradually but steadily, the burden of public debt on the economy must be lightened. We must be prepared for the changes we know are coming and stand ready to respond to unexpected events and developments, as the epidemic that has left no one unaffected has made so painfully clear. As Alessandro Manzoni wrote about events relating to the terrible plague of the seventeenth century: ‘To extinguish the light is a very good means to prevent our seeing what is unpleasant, but not a good means to shew us what we desire to see.’ The role of the State will certainly have to evolve in the provision of services for the development of the economy and the health and security of citizens, and in actions to reduce inequalities, increase opportunities, and safeguard the most vulnerable. Its action will increasingly have to supplement, rather than be alternative to, that of companies operating in the market. Firms will have to grow in terms of both size and capital; it is in their own interest to do so. New investment is also necessary to rapidly replace the capital that the acceleration of the digital transition and the need for environmental sustainability is making increasingly obsolete. It will then be possible to offer new opportunities to the young people who believe most in their own training. The commitment of The Governor’s Concluding Remarks Annual Report 2020 BANCA D’ITALIA families must not be lacking: once this difficult crisis has passed, the answer to the exceptional number of young people on the margins of the labour market can only lie in investment in education, regular training, culture and knowledge. To support investment, the high level of financial savings accumulated by households will have to be managed effectively and fairly. Banks, and the entire financial sector, must respond promptly and prudently to the new technological and environmental challenges. There will undoubtedly be other opportunities to discuss this in depth. What I would like to stress once again here is how important it is for these changes to take place – in credit and in payments, in asset management and in consultancy services – with foresight, in a stable and clear regulatory framework, also and above all at European level, with decisive steps forward, including those necessary for the prevention and resolution of banking crises. After the pandemic, a new era must begin, one of intense multilateral cooperation, in which widespread injustice is reduced and new opportunities are created. Europe's responsible and balanced input must not be lacking. To respond to the economic and social impact of the health crisis, serious for all countries and especially dire for some of them, courageous decisions have been taken and new common instruments introduced. This is the real strength of a union; the premises for coming out of the crisis with renewed energy, all together, are encouraging; expectations must not be disappointed. We have often recalled that in order to reap in full the advantages of the single currency, to avoid going backwards, we must move towards a fiscal union, with a genuine political union in mind, and with common rights and duties for all citizens of the European Union. We must build on the good things that were done during this emergency and on the good things imagined previously – in the wake of another emergency – with the proposals to transition to a ‘genuine economic and monetary union’. Italy has a responsibility to show all the other countries the benefits that can come from this. NGEU and NRRP are more than just empty acronyms; their contents, both aspirational and substantive, are decisive. This is why it is essential that the extraordinary resources that the programme offers us, along with the others that will become available, be spent well, so as to restore the prospect of stable economic development. In this lies tangible evidence of the importance of Europe for us and of Italy for Europe. Only in this way will we succeed in grasping the true significance of Jean Monnet’s idea, of a Europe forged in crises, the ‘sum of the solutions adopted for those crises’ and, finally, lend meaning to the enlightenment of Gaetano Filangieri’s vision of Europe as the ‘home of peace and reason’. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2020 FIGURES Figure 1 GDP growth forecasts (2019=100) Emerging economies: October 2019 forecasts Emerging economies: April 2021 forecasts Advanced economies: October 2019 forecasts Advanced economies: April 2021 forecasts Source: International Monetary Fund. Figure 2 Yields on 10-year government bonds (per cent) 2.5 2.5 Italy 1.5 1.5 0.5 Spain 0.5 France -0.5 -0.5 -1 Oct. 19 Germany Jan. 20 Apr. 20 July 20 Oct. 20 Jan. 21 Apr. 21 -1 Source: Bloomberg. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2020 Figure 3 Public deficit in the euro area and in Italy (per cent of GDP) Italy Euro area 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Sources: Istat and European Commission. Figure 4 Public deficit and change in household disposable income and in GDP in Italy (per cent of GDP and percentage changes) -2 -2 -4 -4 -6 -6 -8 -10 GDP Disposable income -8 Deficit -10 Source: Based on Istat data. Note: Percentage changes compared with previous year, computed using chain-linked volumes for GDP and household disposable income in real terms. The Governor’s Concluding Remarks Annual Report 2020 BANCA D’ITALIA Figure 5 Loss of labour income during the pandemic in Italy (households, by income quintile of labour income; percentage changes) -2 -2 -4 -4 -6 -6 -8 -8 -10 -10 -12 -12 Without social safety nets With ordinary social safety nets With ordinary and COVID-19 extraordinary social safety nets -14 -16 -14 -16 Sources: Based on data from Istat’s labour force survey. Note: Estimated average percentage losses in labour income in the first half of 2020 compared with the fourth quarter of 2019, for households with at least one person employed in the initial period; households are distinguished by quintile of equivalized labour income in the fourth quarter of 2019. Figure 6 Firms’ financial balance in Italy (billions of euros) -20 -20 -40 -40 -60 -60 -80 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 -80 Source: Bank of Italy, Financial accounts. Note: Difference between the annual change in financial assets and that in financial liabilities. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2020 Figure 7 Net international investment position (per cent of GDP) Germany Italy -20 -20 France -40 -60 -60 Spain -80 -100 -40 -80 -100 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 Sources: Bank of Italy and Eurostat. Figure 8 Propensity to save and change in consumption spending and in households’ disposable income in Italy (per cent and percentage changes) -5 -5 -10 -10 -15 Consumption spending Disposable income Propensity to save -15 Source: Based on Istat data. Note: Ratio of saving (gross of depreciation and net of changes in pension fund reserves) to gross disposable income; percentage changes compared with previous year, computed using chainlinked volumes for spending on consumption and for disposable income in real terms. The Governor’s Concluding Remarks Annual Report 2020 BANCA D’ITALIA Figure 9 Young people not employed and not enrolled in an education or training programme (per cent) EU IT GR BG ES RO SK HU HR IE FR CY CZ PL BE LT EE LV PT FI DK AT MT DE SI LU SE NL Source: Eurostat. Note: Share of individuals between 15 and 34 years of age that are not employed and not enrolled in an education or training programme out of the total population in the same age bracket; data for 2020. Figure 10 Share of population with more than basic digital skills (per cent) Italy France Germany Spain EU-28 16-24 25-34 35-44 45-54 55-64 65-74 Total (16-74) Source: Eurostat. Note: Data for 2019. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2020 Figure 11 Gap between Italian and other SSM significant banks (weighted averages; percentage points) Ratio of non-performing loans to total loans -2 -2 -4 -6 -4 Common equity tier 1 ratio -6 Source: Consolidated supervisory reports and European Central Bank. Note: Gaps between Italian ‘significant’ banking groups and those of the other Single Supervisory Mechanism member countries; non-performing loans as a share of total loans (net of loan loss provisions); end-year data; the data for 2020 are provisional. Figure 12 Assets under management (per cent) Assets under management as a share of households’ financial assets Main financial assets of institutional investors in 2020 Italy France Germany Euro area Italy France Italian government securities Investment funds Securities issued by resident firms Germany Euro area Foreign government securities Securities issued by non-resident firms Source: Bank of Italy and European Central Bank. Notes: (1) The assets under management figure includes shares in investment funds, insurance policies, pension funds and supplemental pensions plans, excluding severance pay; includes residents’ holdings of foreign funds; the comparison between the different countries is affected by heterogeneities in the classification of severence pay. (2) Excludes asset management companies. The Governor’s Concluding Remarks Annual Report 2020 BANCA D’ITALIA Printed by the Printing and Publishing Division of the Bank of Italy Rome, 31 May 2021 Printed on EU-Ecolabel certified paper (registration number FI/011/001)
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Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Green Swan 2021 Global Virtual Conference, 4 June 2021.
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Ignazio Visco: The conference messages in light of the G20 Presidency programme Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Green Swan 2021 Global Virtual Conference, 4 June 2021. * * * Let me start by thanking the conference organisers – the Bank for International Settlements (BIS), the Banque de France, the International Monetary Fund (IMF), and the Network for Greening the Financial System (NGFS) – for their kind invitation.I also wish to express my heartfelt congratulations for the organisation of this event: the valuable contributions provided by the participants, along with their commitment and support, are powerful allies in the fight against climate change. This conference confirms that there is now widespread awareness of the importance of the problem: climate change is having an evident effect on all our countries, threatening economic growth, development and financial stability. The changes that are taking place to the environment also threaten our health, as demonstrated by the tragedy of the Covid-19 pandemic with which we are still struggling: many of the root causes of climate change, such as deforestation and loss of habitat, by increasing the chance of contact between people and wildlife, amplify the risk of new future pandemics. Contrasting these risks and shifting economic development towards a sustainable path requires strong and consistent political determination and the involvement of all human activities. The first step is to transform our energy systems: we need to implement clean and efficient technologies at unprecedented speed and scale. But no country can tackle this problem alone, as carbon emissions know no border. Climate change is a particularly dangerous example of a negative externality: pollution is a cost that spills over not only into other markets besides the one in which it originated, but also into other countries, reducing the effectiveness of national policies. Close international coordination is therefore essential. Achieving net-zero emissions requires first of all the cooperation of all national governments. We must indeed bear in mind that governments are the key players in this context: they are the only institutions that can levy taxes on carbon emissions, introduce regulations to curb their amount and provide incentives to green investments. Yet, finance can also go a long way in helping and reinforcing this process, channelling resources towards sustainable investments. The Group of Twenty (G20) is the ideal forum in which global cooperation can take place. G20 country members account for 80 per cent of global greenhouse gas emissions: achieving the “decarbonisation” of their economies would therefore be a giant leap in the fight against climate change. In the rest of these remarks, I would like to briefly summarise the main activities that we are carrying out within the Finance Track of the G20. In doing so, I will also discuss the main messages that I see stemming from this conference through the lens of the work of the G20. They will be a very useful contribution to the steering of G20 activities. The G20 initiatives on sustainable finance The work of the Italian Presidency of the G20 is articulated around the three pillars of People, Planet and Prosperity. In line with this vision, contrasting climate change is a key 1/7 BIS central bankers' speeches priority. In this perspective, the Finance Track is tackling the issue of how to redirect financial flows to support the transition towards a low-carbon and more sustainable economy and society. The first step has been to revive the Sustainable Finance Study Group, proposing the United Stated and China, the largest advanced and emerging economies (and the largest greenhouse gas emitters) as co-chairs. We are very grateful for their decision to accept this responsibility. In April we agreed to elevate it to a permanent working group (i.e. SFW G), as designing an effective transition towards net-zero will remain a priority for the G20 for many years to come. This Group has made rapid progress and has taken several initiatives to promote sustainable finance, including some supporting biodiversity conservation. These initiatives are in line with the international priorities stemming from the United Nations COP26 on climate change and the COP15 on biodiversity, both to be held this year, and help prioritise these key policy issues. In particular, the Group has proposed a sustainable finance roadmap that will be instrumental in future years to address the priorities defined by the G20. The roadmap covers four areas: (1) market development and alignment of financial flows to climate goals; (2) information on sustainability risks and opportunities;(3) management of climate and sustainability risks; (4) public finance and incentives. The work will be developed by the Group in a transparent way, allowing for flexibility and adaptation as international works and priorities evolve over time. One week ago the Group hosted a Sustainable Finance Roundtable, a public event involving the private sector. The event offered an in-depth perspective on the agenda, providing two new insights. First, there is growing interest to improve reporting even on other sustainability issues such as biodiversity, in line with the findings of recent reports, such as the Dasgupta Review and, if I may add it, the Italian Fourth Report on the State of Natural Capital. Risks associated with biodiversity loss are, in fact, closely related to those concerning climate change and, in the same way, could have significant economic and financial implications. Second, special attention should be devoted to setting achievable conditions for small and medium-sized firms regarding the disclosure of climate-related risks, which should consider the principles of proportionality and cost-efficiency. The Group’s deliverables for 2021 are expected to focus on three main areas: sustainability disclosure and reporting; the metrics for classifying and verifying green investment; the alignment of the operations of international financial institutions with the goals of the Paris Agreement. These and other topics will be discussed during two special initiatives of the Italian Presidency, t h e High-Level Symposium on Environmental Taxationon 9 July and the Venice Conference on Climate on 11 July. The Symposium will focus on fiscal policy, and in particular carbon pricing, in the fight against climate change and will elaborate on theIMF/OECD joint report on “Tax Policy and Climate Change”. The report provides two main messages: (1) a proper pricing of carbon emissions is still a missing piece in the policy mix required to achieve climate neutrality; (2) concerns around carbon leakage, competitiveness and free riding may induce countries to resort to Carbon Border Adjustments (CBAs). Let me elaborate on these messages. The existing explicit and implicit carbon taxes and emissions trading systems align very poorly with the net-zero targets.According to the IMF/OECD report,55 per cent of emissions from energy use across G20 countries remain completely unpriced. The World Bank estimates that most emissions are currently priced at 10 dollars or less per ton of CO2, with a global average 2/7 BIS central bankers' speeches carbon price of only 2 dollars; the International Renewable Energy Agency, in also considering existing fossil-fuel subsidises, comes to the conclusion that the effective price is actually negative. To limit global warming, the report finds that high emitting countries should price carbon at least 75 dollars per ton by 2030. Other simulations suggest even higher carbon prices, with estimates varying depending on the stringency of the target and on the hypotheses on the effectiveness of carbon removal technologies. There is an urgent need to remove the current distortions in carbon pricing (starting from the phasing-out of fossil fuels subsidies) and to start encompassing unpriced emissions as well as to increase the price of those that are covered by a pricing mechanism. To this aim, a useful tool would be a regular stocktaking of countries’ average carbon prices and of the share of emissions covered in order to facilitate the achievement of a harmonised global level for the carbon price. CBAs have important potential benefits but also face several operational hurdles: from the difficulty in evaluating the emissions embodied in trade flows, to their compatibility with international trade rules and the risk of giving origin to a “green protectionism”, which could heighten geopolitical tensions, negatively affecting global trade and investment. The concerns around carbon leakage, competitiveness and free riding should therefore be addressed in an efficiently coordinated arena: a common carbon price floor applied to all emissions, in particular, is suggested as a reasonable alternative to CBAs. The Venice Climate Conference will connect the dots between public policies and the role of private finance in the transition to net-zero, with the aim also to provide a contribution to the next COP26. The work will gravitate around four areas: (1) the role of governments and international institutions in implementing global policies for climate change; (2) the initiatives of multilateral development banks in mobilising climate finance and providing support for the alignment of financial flows with the Paris targets; (3) the actions of financial regulators for monitoring and mitigating climate risks; (4) the role of private finance in increasing its commitments to climate and transition finance. The Presidency has taken other initiatives to enhance the G20 leadership on the mobilisation of private finance. Let me mention three of them: we have asked the IMF to consider climaterelated data needs in preparing a new Data Gap Initiative; we have invited the FSB to report on both disclosure and data gaps focusing on climate-related financial risks; we have proposed to examine how to scale-up digital finance to promote sustainable economic growth. The demand for more and better data to measure the impact of climate change on the economy and the financial system is strong. A new international cooperation initiative is being studied in which G20 countries are responsible for collecting, compiling, reporting and disseminating data, while the IMF and other international organisations would provide methodological advice on data harmonisation and on the reporting framework. The FSB initiatives will focus on climate-related financial risks by promoting firm-level disclosures, metrics for the assessment of climate-related vulnerabilities and best practices on regulatory and supervisory tools to identify climate-related risks to financial stability. The FSB is also working with the G20 SFW G to define a roadmap focusing on climate-related financial risks, in order to accelerate the works already underway and to avoid duplications. Finally, the G20 Presidency promotes the use of digital finance to help market participants in considering sustainability risks. Harnessing big data, artificial intelligence, remote sensing and other similar innovative technologies can help to collect and process a very large amount of datasets, increasing transparency and accessibility of information. The recent launch of the G20 TechSprint 2021by the Bank of Italy and the BIS Innovation Hub will also be important to this end, by encouraging entrepreneurs and start-uppers to develop solutions for data collection and verification, climate risks assessment and connecting sustainable projects and investors. We 3/7 BIS central bankers' speeches have received more than 70 high-level applications, a very important result given the complexity of the topics. Data issues Let me now dedicate few minutes to one of the key issues in both this conference and the work of the G20, the question of data availability. Improving the assessment of climate-related financial risks and facilitating their integration into investment strategies requires closing data gaps by enhancing disclosure by firms. The quality of information on climate-related risks seems to be lower than those of a financial nature, such as market and credit risks. This problem is partly due to the wide range of definitions of sustainability risk used by financial investors. In the case of credit risk, for example, the common definition considered in the market leads to a high correlation of credit scores across rating agencies. In the case of sustainability risk, on the other hand, there are very diverse definitions, spanning from those more concerned with its short-term financial effects to those more attentive to the long-term impact of sustainability. As a consequence, ESG scores show a much lower correlation across score-providers. A common definition of sustainability is a necessary ingredient to improving corporate disclosure. Disclosure standards, based mostly on voluntary practices, are highly heterogeneous in quantity and quality. According to the “Global Outlook for Sustainable Investment 2021” by the OECD, ESG data cover about 95 per cent of listed firms in terms of market capitalisation in the United States and 89 per cent in the European Union. Data availability, however, is limited to large corporations. Smaller firms, which are often less polluting than larger ones, could lose the opportunity to raise capital at lower cost, unless they improve their sustainability disclosure. To ease the disclosure burden, smaller firms should resort more intensively to digital innovation, which can provide creative and efficient solutions by leveraging on big data and artificial intelligence. To increase the diffusion of sustainability information, the contribution of private sector actors is essential. Greater attention to the environment is primarily in their own interest. Today the fate of firms depends not only on their productivity, but is also closely connected to the societal and environmental welfare of its stakeholders. Indeed, consumers and investors are increasingly more attentive to sustainability issues. The initiative of the International Financial Reporting Standard (IFRS) to establish a Sustainability Standards Board is a move in the right direction for creating a global, verifiable and credible reporting system on sustainability. But to ensure that all firms disclose information on sustainability by respecting a set of minimum standards both in terms of reporting and harmonisation, regulation will play an essential role. Members of the G20 will have to continue working together over the coming years to agree on basic principles which can make disclosed data comparable across countries, allowing the market to verify the alignment of investment with sustainability targets (the so-called “taxonomies”) and preserving the flexibility required to adapt them to region or country-specific features. In this regard, I fully share Mark Carney’s endorsement of a widespreadmandatory reporting in line with the recommendations of the FSB’s Task Force on Climate-related Financial Disclosures. Greater disclosure would also considerably help central banks to integrate climate risks in their monetary policy operations, as suggested at this conference by Jens Weidman and many others. Higher quantity and quality of information on sustainability is also key to ensuring the market works more effectively. Informational efficiency on sustainability will allow market discipline to function: trustworthy issuers with leading sustainability practices will benefit from 4/7 BIS central bankers' speeches more favourable financing conditions and the laggards will be either penalised or induced to taking more credible or ambitious steps towards the transition. The market mechanism could also be a powerful tool to prevent green washing. As this risk materialises, the reputational cost for unfair behaviour would be costly and would help to single out falsely misleading actors and instruments. The role of supervisory authorities and central banks A final issue that I would like to touch on concerns the role of supervisory authorities and central banks. The task of supervisory authorities is complicated by the fact that there is no widely accepted methodology yet to assess climate-related risks and verify whether financial firms take these risks into account in their lending practices. For this purpose, the main tool is a reliable scenario analysis, the only methodology capable of simplifying the high complexity of the uncertainty surrounding climate-related events and policy responses. The standardised climate scenarios prepared by the NGFS is, in my view, very promising for providing a common reference framework for assessing macro-financial implications of climate change. While scenario analysis is the key ingredient for performing climate sensitivity analysis of financial vulnerability (commonly referred to as “climate stress tests”), we should be aware of the limitations and potential “oversimplification” related to this tool. It would therefore be advisable to consider the possibility that the impact of climate-related risks is larger than suggested by this analysis, especially if transition and physical risks reinforce each other, as Prof. Robert Engle has explained during the conference. Climate-related risks also affect credit and market risks making it difficult to measure their true extent. This task is challenging as it requires the combination of data on bank exposures with estimates of the effects of a “disaster”, in other words a low probability event with very large negative consequences (in the case of physical risk), and of a significant change in climate policy (in the case of transition risk). The complexity of assessing “default probabilities” and “losses given default” makes cooperation among authorities especially valuable. The first results of this cooperation are the two NGFS reports, which analyse the transmission channels of climate change and can then support supervisors and central banks. Further results will emerge from shared experiences, as we have done so far in our mutual discussions on sustainable investment strategies. As firm data disclosures and scenario analyses improve, this will allow financial intermediaries to make a regular and wider use of these tools into climate stress testing and sensitivity analyses, as already emphasised during the conference, and will become obviously required by supervisors. The role of central banks in this area is multifaceted. Central banks could lead the market by example, by disclosing their climate-related exposure and the methodologies used to integrate climate risks in the investment and risk management practices for their own portfolios, in line with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). The Bank of Italy, in particular, since 2019 has published consistent (i.e. TCFD-aligned) carbon metrics of its own equity portfolio and included climate risk consideration in several avenues. We have also integrated ESG scores in our investment strategy, taking away two main lessons which I would like to share with you. First, from a risk/return perspective, the good performance of ESG investments that we had already observed in 2019 has been confirmed in 2020, showing the resilience of our new portfolio to the outbreak of the pandemic (compared to the standard non-ESG benchmark, we recorded an extra performance of our euro area equity portfolio of more than 2 per cent, with a lower volatility). Second, integration strategies such as narrow exclusions or tilting are to be preferred with respect to tout court exclusions or 5/7 BIS central bankers' speeches penalising measures, as they allow for the taking advantage of wider diversification and more opportunities from transitioning firms. Overall, our experience provides an example of how financial markets might play an effective role in supporting the low-carbon transition, reinforcing the initiatives that regulators and policy makers are taking. With regards to monetary policy, we must be aware that climate change and the transition towards net-zero affect the transmission channels, for example by determining the trend growth of key variables. Therefore, we need to integrate climate and sustainability variables into our macro-financial models, as rightly stressed in this conference by Francois Villeroy de Galhau. How exactly to do this, however, is still an open question. With the possible exception of the oil market, we only have a superficial understanding of the energy market and of the way climate change affects the rest of the economy. In this respect, I welcome the announcement given during this conference of the creation of a new joint initiative for a “Central Bankers and Supervisors Climate Training Alliance”, with the active role of the BIS and the NGFS, for training and developing skills on climate-related scenario modelling. The role of climate change in monetary policy is currently under consideration within the ECB strategy review. I think that while we should certainly contribute to assess and counter climate risks, we should be prudent in the active use of our monetary policy instruments for this purpose, carefully considering the costs and benefits of our actions with reference to the efficacy of the transmission mechanism and the effects on economic activity and carbon emissions. A more climate-oriented purchase of assets is currently hampered by the fact that climate-related data and climate-aware instruments are still underdeveloped. As for the latter, the outstanding value of green bonds is very limited, around 3.5 percent globally. Within the euro area, green bonds represent less than 2 and 7 percent of the eligible instruments for Eurosystem purchase programs of government and corporate bond, respectively. In sum, the thinness of the green bond market and the low liquidity of its secondary market would envisage a still limited room for monetary policy interventions in this realm. But there is no question that this room must and will increase over time and with that the ability of the ECB to incorporate the greening of the economy in the pursuing of our price stability mandate. Going forward, supervisors and central banks need to continue discussing how tackling climate-related financial stability risks requires policy instruments or approaches that go beyond existing ones. But while macroprudential and monetary policies may play an important role in the path to net-zero, it should be clear that what central banks can do directly for climate change remains limited compared to what the governments can obtain and must do. *** Let me conclude. A widely mentioned report by the International Energy Agency found that in order to limit the rise of the global temperature to 1.5 °C – the threshold that if surpassed would bring catastrophic consequences for people and the planet – no new oil and gas fields or coal mines should be developed by today; annual investment in the energy sector will have to more than double by 2030; there should be no sales of new internal combustion engine passenger cars by 2035; and the global electricity sector should reach net-zero emissions by 2040. Even though some of these results may sound overly extreme or even provocative, we cannot hide the fact that the transition to net-zero will imply high costs. The global demand for energy, for example, has not reached a plateau and, without a sufficient increase in production, consumer prices will necessarily rise. Returns in highly polluting sectors will worsen as the market for their products shrinks, and some firms will exit the market, even though greener firms will enter in their place. If we want to limit the climate-related risks for our economies we cannot postpone our actions. All the available analyses show that a delayed and disorderly transition will hamper future 6/7 BIS central bankers' speeches economic growth threatening global financial stability with self-reinforcing effects. On the opposite, prompt and clear policies can limit risks and help countries attracting the resources needed to finance their low-carbon transition. Most studies suggest that the economic impact of the “green transformation” will be positive in the long run. The short run, however, will see a significant reallocation of labour across sectors and regions. The transition will be especially tough for developing economies, as they face an increasing thirst for energy, driven by industrialisation and rising consumption. These difficulties add to those caused by the pandemic crisis, which is already reversing the progress made over the last few years in the fight against extreme poverty and energy poverty. I believe that a lot, therefore, needs to be done to ensure not only a transition to netzero, but also a just transition. Adequate investment in skills, active labour market policies and modern social protection systems will be crucial to make sure that nobody is left behind. The progressive phasing out of fossil-fuel subsidies – often regressive in nature – can increase the fiscal space of developing countries and provide them with fresh resources, which can then be directed to improving the energy access of the most vulnerable. The recourse to innovative financial instruments such as debt-for-nature swapscould help to reduce the debt of developing economies and to raise funds for conservation projects and increasing the stock of carbon dioxide natural removals. In moving towards a greener world and a safer planet we must not repeat the mistakes made when globalisation took place: the impact on the most fragile workers and vulnerable segments of the population should be always accounted for in the design of climate policies. This will not be forgotten by the G20, whose Finance Ministers and Central Bank Governors recently stated that shaping the recovery from the pandemic “provides a unique opportunity to develop forward-looking strategies investing in innovative technologies and promoting just transitions toward more sustainable economies and societies, with particular attention to the most affected segments of the population and in line with the Paris Agreement”. 7/7 BIS central bankers' speeches
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Closing keynote address by Mr Ignazio Visco, Governor of the Bank of Italy, to the "2021 IIF G20 Conference - The G20 Agenda Under the Italian Presidency", organized by the Institute of International Finance, live-streamed event, 17 June 2021.
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Ignazio Visco: Closing keynote address – “2021 IIF G20 Conference - The G20 Agenda Under the Italian Presidency” Closing keynote address by Mr Ignazio Visco, Governor of the Bank of Italy,to the “2021 IIF G20 Conference - The G20 Agenda Under the Italian Presidency”, organized by the Institute of International Finance, live-streamed event, 17 June 2021. * * * Let me start by thanking the conference organisers for their kind invitation. This year Italy is chairing the Group of Twenty (G20) for the first time since it was founded in 1999. Our Presidency began under exceptional circumstances, at a time when the COVID-19 pandemic, a human tragedy of global proportions, had triggered an economic collapse that is unprecedented in recent history. Today the world is facing multiple challenges: not only that of protecting public health, but also of ensuring environmental sustainability, continuing to eradicate extreme poverty, maintaining trade openness and financial stability. All of these issues contain elements of a global public good, whose provision may fall dangerously below desirable levels if national interests and market outcomes are not mediated by a truly multilateral and far-sighted approach. The G20 is the ideal forum in which global cooperation can be achieved. In the rest of these remarks, I would like to summarise some of the activities that we are carrying out within the Finance Track of the G20, by delving deeper into the work on financial regulation and digital cooperation, which was discussed in the last two panels of this conference. COVID-19 and the global economy The global economy is recovering: the latest OECD projections for world GDP growth have been revised upwards for both this year and the next, thanks to continued progress in the vaccination campaigns. Cooperation between countries and coordination among monetary and fiscal authorities have set the stage for the recovery, marking an important change of direction. According to the IMF, the global economic contraction recorded last year would have been three times worse without such swift and worldwide policy support. Nonetheless, the World Bank also warns us of the disproportionate burden falling on the poorest and most vulnerable countries: the pandemic has sadly reversed earlier gains in extreme poverty reduction and has exacerbated food insecurity for millions of people. The global outlook, though improved, is uneven across the world’s regions. In advanced economies, speedy vaccinations provide a way out of the health emergency, allowing the reopening of contact-intensive activities. In emerging economies, instead, slow progress in vaccinations and fresh outbreaks hinder growth, especially where the policy space is narrower. The fact that today’s conference is taking place online reminds us that we are not out of the woods yet. Risks have become more balanced, but uncertainty regarding the timing and path of the global recovery remains substantial. Continuing uncertainty depends not only on health developments, but also on the difficulty in gauging the changes that have been unleashed by the pandemic. The extent of the economic damage it has inflicted, notwithstanding strong policy support, will become more evident as these measures are gradually unwound. The large dislocations in supply and demand it has caused, which are especially marked in some sectors, coupled with the pickup in commodity prices, will complicate the assessment of the inflationary outlook for some time. Many of the challenges ahead of us predate the crisis but are now starker than ever before. For example, digitalisation accelerated with the pandemic, changing the way we live, work 1/4 BIS central bankers' speeches and spend. These challenges also provide opportunities to revive productivity growth, which has long been faltering worldwide, and can help to reduce inequalities. Much will depend, however, on the effectiveness of the policies that will be implemented during the recovery. In April, the G20 Finance Ministers and Central Bank Governors, together with the major international organisations, updated the Action Plan (“a living document”), to steer the global economy, ensuring that economic policy responses continue in a coordinated and coherent way. We will need to closely monitor the increasingly divergent recovery paths – which may well entail an asynchronous unwinding of monetary and fiscal support measures – and take international policy spillovers into account. Avoiding unintended cliff effects calls for careful actions, first and foremost within each jurisdiction. Reducing policy support too soon could jeopardise the recovery, exacerbate social disruptions and, ultimately, prove self-defeating. In this respect, it will be critical to preserve the financial system’s lending capacity without compromising its stability. The risk that corporate insolvencies will soar once measures have been lifted needs to be monitored. Financial regulation The financial sector faced the pandemic from a stronger position across most countries, due to the regulatory reforms agreed after the global financial crisis. It remained resilient during the health emergency, continuing to provide credit to the economy. Vulnerabilities persist, however, and must be addressed, particularly in the non-bank financial intermediation (NBFI) sector, where regulation remains less stringent. Looking ahead, regulatory and supervisory authorities will focus their attention on completing the remaining elements of the reform agenda, including Basel III, resolution frameworks, and NBFI regulations. At the same time, they will look into ways to apply the lessons that have emerged from the pandemic on the functioning of the regulatory framework, such as those concerning the usability of capital buffers, the role of countercyclical elements in prudential regulation, and potential sources of pro-cyclicality. The resilience of the NBFI sector must be strengthened. The first initiatives concern the NBFI segment of Money Market Funds, where policies need to address vulnerabilities stemming from liquidity transformation and from the potential cliff effects produced by regulations. Other initiatives will be explored to tackle the risks due to liquidity misalignments in the assets and liabilities of open-ended funds. Mitigating climate-related financial risks also requires coordinated action. The G20 Finance Track aims to encourage a better alignment of both public and private financial commitments with the objectives of the 2015 Paris Agreement. The re-established G20 Sustainable Finance Study Group – now elevated to a fully-fledged Working Group (SFW G) – aims at developing a roadmap of actions involving financial institutions, international organisations and standard-setting bodies, and investors. The High-Level Symposium on Environmental Taxation and the Conference on Climate organised by the Italian Presidency in Venice, respectively on 8 and 11 July, will provide important opportunities for discussing these issues and assessing the actions and commitments needed in the run-up to the COP-26. Coordinated action is also needed to strengthen the monitoring, measurement and management of climate-related financial risk. The Financial Stability Board (FSB) coordinates the work on identifying and filling the data gaps, and promoting higher quality and comparability of information between jurisdictions, firms, and financial institutions. Financial firms’ valuations of sustainability risks could be improved if they were supported by the implementation of disclosure requirements or guidance, based on the recommendations issued by the FSB’s Task Force on Climate-related Financial Disclosures. Further cooperative efforts are needed to speed up convergence towards a baseline international reporting standard for disclosing climate-related risks. 2/4 BIS central bankers' speeches In May, the G20 SFW G hosted a Sustainable Finance Roundtable, a public event involving the private sector. The event provided two new insights. First, there is growing interest in the need to improve reporting, including on other sustainability issues such as biodiversity. Second, special attention should be devoted to setting achievable conditions for small and medium-sized firms regarding the disclosure of climate-related risks, which should in any case consider the principles of proportionality and cost efficiency. Financial inclusion and international digital cooperation The shift to digital financial services deserves close attention since it offers new opportunities but, if not carefully governed, could also generate undesirable consequences. Not only may it lead to new forms of exclusion, making access to finance more unequal, but it may also favour irresponsible financial behaviour, such as over-indebtedness. We must work together in the G20 to ensure that the benefits of digitalisation are widely shared. The outcome will depend, crucially, on the development and accessibility of digital infrastructures, the degree of financial and digital literacy, and the adequacy of governance, especially in the fields of regulation and supervision. There are two main and complementary areas of intervention. One concerns the digital and financial competences of individuals and firms, which must be raised through education, an essential tool for people’s empowerment, active citizenship and well-being. As co-chair of the G20 Global Partnership for Financial Inclusion, we have made a full commitment to delivering on the multi-annual agenda recently endorsed by the G20. The second area revolves around fostering more innovative regulatory and supervisory approaches to steer and encourage the development of inclusive and responsible digital financial services, while granting adequate protection to customers, not least from cyber risk. Our work programme also gives priority to initiatives such as the G20 Roadmap, coordinated by the FSB, aimed at promoting the development of cross-border payments, to make them cheaper, faster, more transparent and inclusive. A key output of the Roadmap is the identification of a set of qualitative and quantitative targets in the four main areas of costs, speed, access, and transparency. On 27–28 September, the Bank of Italy will host an international conference in which we will take stock of the Roadmap one year after its launch. The roles played by businesses and governments in the payment system will be an important issue for discussion. In this rapidly changing environment, we need to strike the right balance between the private sector’s drive for innovation and the role of authorities in safeguarding the public good. The Roadmap is also tackling the challenges posed by global stablecoins for regulation, supervision, and payment-system oversight. In this context, steps must be taken to ensure that the regulatory initiatives in some jurisdictions and the revisions envisaged by the standard-setting bodies are consistent with the FSB recommendations and to ascertain whether the latter are still up to date. The G20 will also consider issues related to central bank digital currencies and their possible cross-border use. Their development comes with a host of technological, legal and economic issues, which warrant careful examination. Central bank digital currencies and global stablecoins are closely interrelated: they share a transactional purpose and may complement or substitute one other. It is therefore important to maintain a holistic view of the payments sector. Central banks will proceed carefully and in line with their mandates of price stability and guardians of the currency. *** Let me conclude with a final thought. The IIF mission is to support regulatory, financial and economic policies that are, of course, in its members’ broad interest, but that ultimately 3/4 BIS central bankers' speeches hinge on global financial stability and economic growth. I have recently emphasised that the contrast between the State and the market is misleading, as they are actually complementary. A healthy economy needs them both: the former provides good rules and high-quality public services, and intervenes in areas where social returns are high but private business is insufficient, and the latter generates dynamic and innovative firms able to promote their work and to be rewarded for the quality of their output. The private sector must continue to be the engine of innovation and job creation, helping not just to exit the pandemic, but also to build toward a more sustainable future, with the key contribution of the financial industry. In the G20 we will continue our endeavours to set the stage for a market that works effectively and efficiently. 4/4 BIS central bankers' speeches
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Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, panel discussion of the Andrew Crockett Memorial Lecture by Mark Carney (online event), Bank for International Settlements, 28 June 2021.
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Ignazio Visco: Back to the future of money Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, panel discussion of the Andrew Crockett Memorial Lecture by Mark Carney (online event), Bank for International Settlements, 28 June 2021. * * * Let me first thank the BIS for the kind invitation and let me congratulate Mark Carney for providing, as usual, a very insightful perspective on a key question for the future of central banks. I will start with a quote: “Looking to the next few decades, technological advances combined with fairly dramatic economic and social changes could create conditions for the emergence of new, virtual forms of money and credit. On the positive side these digital forms of money could help to create more efficient and more global economies and societies. On the negative side tomorrow’s new forms of money could make it easier to engage in anticompetitive behaviour; exacerbate exclusion and inequality; foster economic volatility; facilitate criminal activity; and even undermine the effectiveness of macroeconomic policy.” These are not sentences written a few years ago, when we started to give special attention to the development of instruments such as crypto-assets, stable-coins and central bank digital currencies. It is the opening of the foreword to a book titled The Future of Money, published in 2002, which brought together a series of papers presented at an “OECD Forum for the Future” meeting held in Luxembourg exactly 20 years ago. In all honesty, as the OECD Chief economist, back then I was more concerned with the pressing conjunctural and structural economic and policy problems that we were facing at the time, globally and within the OECD member countries. In the Economics Department, longer-term issues such as those implied by ageing societies or global warming were obviously examined in depth and discussed in our policy fora, as were the implications of globalisation and the ICT revolution for our economies and our societies. However, we still considered the “future of money” too distant to be of major concern. We gladly left it to a small Advisory unit to the Secretary General (led by Wolfgang Michalski) that organised, within the OECD, discussions with experts and policy makers on longer-term economic, social and technological developments and their consequences for policy making. Re-reading that book today, with the benefit of hindsight, three issues in particular stand out as the most striking: First, a prediction was made with absolute certainty, that “money’s destiny is to become digital”. It is worth noting that, although 2001 is certainly not that far in the past, at the time Facebook did not exist, Apple had yet to introduce its first smartphone, Google was still an infant company and Amazon, despite being seven years old, was far from being the giant tech company it is today. Therefore, even though the necessary technology was not yet in place, the prediction was made, based simply on the consideration that the long-term evolution of money had been, for centuries, one of ever-greater abstraction, along a trend of increasing disassociation from a precise physical materialisation, one that digitalisation would make final. Second, the costs for consumers of not having a digital money were considered at length. They included not only the traditional ones related to the handling of physical cash, but also others, for example the impossibility of obtaining discounts on cash payments as a consequence of the contracts between merchants and credit card companies, or the absence of those innovations and new start-up firms that would be encouraged by digital money. In particular, the availability of a digital money was seen as an especially effective way of reducing the very high costs of remittances and of counteracting the costs of financial exclusion (for example for those who do not have a bank account). The book, 1/3 BIS central bankers' speeches therefore, very forcefully called on public authorities to introduce digital money as soon as technologically possible. Third, the risks of the possible disintermediation of the banking system were not elaborated on, nor was the consequential diminished role of banks in providing credit to the economy, given the possibility for the public to open a deposit at the central bank. The potential loss of effectiveness of monetary policy, which may be due to the diffusion of alternative private digital money, was also not greatly considered, even if it was strongly argued (by Michel Aglietta) that any extreme decentralisation of payments was a no-goer. In fact, it was predicted that: “Whatever form the centralisation of payments may take, the control of money will remain in the hands of central banks”. The risks of bank disintermediation and the challenges for monetary policy are, however, not only central to today’s analysis, but have also been discussed at length in the past. Economic historians and central bankers have extensively examined the relationship between public and private money. For example, in Marcello De Cecco’s book on Money and the Empire (1975) we read of the substantial efforts of English banks to prevent the Bank of England from collecting deposits during the XIX century. On the other hand, in 1999, at the Jackson Hole Symposium held by the Federal Reserve Bank of Kansas City, discussing old and new challenges for central banks, Mervyn King speculated that (in a world of electronic transactions in real time) without the centralisation of settlements “central banks, in their present form, would no longer exist, nor would money”. Even more than the “end of money”, the consequence would have been the potential “end of monetary policy”, with the return to a pure exchange economy or the loss of central banks’ monopolistic supply of base money that technology would have made possible. But the importance of a centralised system built around an outside money issued by the central bank, which preserves its value and acts as a lender of last resort, and an inside money, issued by the banking system in connection with its role of maturity transformation, has emerged forcefully during the pandemic. I would therefore like to focus on three questions. One striking feature of the pandemic crisis is that banks, thanks to the progress made after the global financial crisis, have been an important stabilisation factor. In many countries, for example, the banking system has been the vehicle through which government support measures (such as guarantees and moratoria) have reached households and businesses. On the other hand, some types of money-market mutual funds have experienced severe problems. They required the central bank to step in and are now under scrutiny. Would similar problems have also emerged for providers of private money-like assets? Even more striking has been the importance of monetary policy. Not only have prompt and exceptional liquidity provisions preserved accommodative financial conditions, consequently preventing a generalised tightening of credit and averting the risk of a spiralling crisis, but also the measures enacted by central banks have allowed governments to access the financial resources needed to support households and firms without market tensions emerging. Absent a monetary authority, would issuers of stable-coins have been able to maintain the stability of the financial system? And would they have been able to preserve the value of their currencies in both normal times and during a crisis? A third, fundamental, question concerns inflation. Central banks have guaranteed price stability for many decades, even during the pandemic crisis, despite consumer price changes having flirted with deflation in recent years as well as the fact that, in the euro area, we are still struggling to bring inflation back to our medium-term target. Our monopoly power over the supply of base money and our credibility have been key in this respect. But what would happen to inflation in an economy in which there is wide circulation of private money beyond the control of central banks, for example due to a significant presence of digital currencies denominated in a foreign currency or in a 2/3 BIS central bankers' speeches basket of different currencies? We are now quite close to where, two decades ago, the OECD expected us to be, as money appears inevitably to be becoming digital. And central banks and other public authorities alike are asking themselves the aforementioned questions, attempting to govern the opportunities and risks arising from digital money by adopting new regulations and new approaches. In Europe, the European Commission is drafting a new directive to regulate issuers and service providers of crypto-assets, while the European Central Bank is currently considering the possibility of starting a formal investigation phase on a digital euro. Similar initiatives are ongoing in most other jurisdictions: most of the monetary authorities around the world are working today on the possible development of a central bank digital currency, ranging from mere conceptual research to preliminary experiments, proofs-ofconcept or pilot projects. *** Let me conclude. In 1999, in a speech on Hayek and currency competition, Otmar Issing asserted that money is like a language: a convention that facilitates the interaction among individuals when they produce, trade and consume. As money becomes digital, a new monetary language will gradually emerge and international coordination will be essential so that, as we do today, we can all continue to speak a common language. But money is not just language, it is also substance. Its key ingredient is trust. Preserving it – in a world that, as Mark Carney clearly described, is becoming more “decentralized” and polarized – must therefore be our polestar when we regulate private forms of money or design a new digital outside money. This is why this year, under the Italian Presidency, the G20 will continue to consider the technological, economic, legal, regulatory and oversight issues related to global stable-coins as well as potential benefits and risks from central bank digital currencies, also in relation to their possible cross-border use. The close interrelation between stable-coins and central bank digital currencies – due to their common transactional and store-of-value purposes, which are such that they may either complement or replace each other – warrant the importance placed on maintaining a holistic view of the payments sector. The late Curzio Giannini, my former colleague and author of one of the most insightful books on the history of central banks (The Age of Central Banks, 2011, 2004 in Italian), argued that “in the case of money, the definition moves around the concept of payment technology: the set of conventions, objects and procedures that make possible the extinction of the relevant obligations of the exchange activity”. We need to keep proceeding carefully with the examination of these conventions, objects and procedures, in line with our mandates of price stability and as guardians of the currency. After all, physical, electronic or virtual, the efficiency and stability of what we call “fiduciary money” is ultimately dependent on trust, on confidence – which indeed shares the same etymological root with “fiduciary”. And this is ultimately what we have to preserve. 3/3 BIS central bankers' speeches
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Welcome address by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy, at the Annual Conference of the global forum on productivity co-organised by the Italian G20 Presidency, 8 July 2021.
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Annual Conference of the global forum on productivity co-organised by the Italian G20 Presidency Welcome address by Luigi Federico Signorini Senior Deputy Governor, Bank of Italy 8 July 2021 Ladies and gentlemen, • I am happy to welcome you to this conference, promoted by the OECD Global Forum on Productivity and the Italian G20 presidency. I am sure today’s contributions will increase our understanding of productivity growth and distribution, especially in light of the changes brought about by the pandemic. • Productivity gaps are ubiquitous. There are always substantial differences across firms in terms of both productivity levels and dynamics. The most innovative firms can sometimes realise enormous efficiency gains in a short period. Significant gaps exist even within narrowly defined sectors in almost all advanced economies. • Italy is no exception: over the last 20 years, firms in the top decile of productivity distribution have accounted for roughly 50 per cent of Total Factor Productivity growth in manufacturing, and for more than 80 per cent in services. • Productivity dynamics (and differentials) may even be underestimated in many industries, because measuring output in physical or constant price terms is often challenging in view of continuous quality improvements that are not fully accounted for by market prices. • Productivity gaps reflect differences in firms’ propensity to innovate, to hire skilled workers and to adopt new advanced technologies. Such propensities tend to come together. Let me take another piece of evidence from my country: in Italy, firms in the top decile of the labour productivity distribution are about 60 per cent more likely to adopt advanced digital technologies than those at the bottom. They also employ at least twice as many graduates, as a share of the workforce, as all other firms up to the 7th decile. • The digital transformation has accelerated in recent years, changing the way firms produce, grow and compete. The pandemic has supplied further proof of how essential digital assets and skills are to our economies and societies. Human and physical capital has allowed work and (crucially) education to continue throughout lockdowns. • Pushed even further by the exigencies of the Covid crisis, businesses are going digital faster than ever before. According to Italian survey-based data, during the last year one out of five firms has adopted for the first time digital systems of internal communication or improved them, one out of ten has introduced or expanded on-line sales, and one out of seven has invested in cloud services and infrastructures to support remote working. • During the lockdowns, many of us worked from home. Central banks, including my own, mostly followed this trend. I must say that I was genuinely surprised, first, by the way we were able to engineer an almost instantaneous, seamless transition to remote working arrangements; and second, by the fact that many tasks could in fact be performed remotely in such an efficient way. While there are pros and cons to remote working, and some degree of physical interaction is likely always to remain valuable for most tasks, the ‘new normal’ will surely see a different mix of home and office hours with respect to the old. • This was one clear instance where investment in digital technologies had not yet released all its potential. I should add in passing that certain society-level efficiency gains (e.g. fewer hours wasted in commuting, less traffic congestion, less pollution) may never show in productivity statistics at the firm level. • Swift technological progress can have disruptive effects on market dynamics. New leaders emerge and incumbent firms are often displaced in a relentless process of creative destruction. • Market leaders pave the way for progress by pushing the frontier. There are two ways for society as a whole to reap the full productivity benefits of innovation: diffusion from pioneers to followers, and resource reallocation from laggards to front-runners. Both are likely to be necessary. Regulation and public policies can make a lot of difference on both counts. I shall touch very briefly on some potentially policy-relevant issues, among the many for which today’s discussion will certainly provide valuable and thought-provoking material. • Rapid innovation usually requires a certain amount of resource reallocation to deploy its potential. Physical and financial capital, entrepreneurship and labour should therefore find ways to move across firms and industries without unjustified friction. Rules and institutions are extremely important in this respect. • Let me make first one comment on the capital market. Given the vital role of business birth and growth for employment creation and innovation, institutions are needed that can efficiently channel resources towards promising, high-potential firms. As growthoriented finance requires specialised skills and contracts, the activity of dedicated financial intermediaries is important. It needs strengthening, especially in Europe, where, despite some significant growth in the last decade, the presence of such intermediaries is still too thin. Venture capital and private equity can sustain business dynamism by selecting valuable projects, financially supporting entrepreneurial activities and helping start-ups to navigate the early stages. Their development can be supported by policies, such as tax breaks; one must acknowledge, however, that here policy can do little, at least directly, if firms continue to have little appetite for such services. • Reallocation inevitably also depends on the process of creative destruction that pushes unviable firms out of the market. Sound insolvency regimes are required to ensure fast, effective and fair liquidation and reorganisation procedures, thus preventing assets from becoming trapped in unproductive uses. This is a difficult issue, as in many societies financial default is traditionally associated with social stigma and a sense of personal failure. The length and wastefulness of bankruptcy procedures is also an issue in some jurisdictions; Italy is a well-known example. Minimising the trauma and cost of bankruptcy for both debtors and creditors should be the key priority for any insolvency law reform. In an ideal world, default would be synonymous, not with failure, but with a fresh start and a clean slate. • Labour market institutions are also central to ensuring that the reallocation of labour resources can happen in a reasonably smooth way, while protecting workers from socially unacceptable insecurity. Societal values may differ somewhat in this respect across the world; we Europeans pride ourselves on a model that offers a high degree of social protection. This need not be a brake on labour reallocation, however, if protection is properly designed. The key is finding the right mix between protecting workers and protecting existing jobs. In societies that treasure social protection, effectively and reliably ensuring the welfare of workers that lose their jobs, while preserving the incentives for them to search for new job opportunities, is an essential precondition for allowing the labour market to adapt. • While some reallocation across firms and industries is necessary for increasing productivity economy-wide, the diffusion of innovation among existing firms is also extremely important. In many cases, it can be less disruptive, painful and polarising than reallocation. • Fast technological progress, especially if coupled with network externalities, can easily generate winner-takes-all dynamics, which in turn may further increase productivity gaps across firms and raise difficult competition issues. Laggards may be discouraged from investing in R&D, since they lose the hope of competing with the top performers; leaders may divert resources from innovation to unproductive uses, such as defensive strategies for maintaining their rent. Under the right conditions, diffusion can mitigate such effects. • One key element for the diffusion of innovations is the availability of adequate human capital, especially in view of the markedly knowledge-intensive nature of the current innovation process. A highly skilled and well-trained workforce is not just a productivity driver per se. It is a necessary condition both for the adoption of new technologies in the first place, and for the effective unfolding of their effects on firms’ productivity. • Supporting investment in human capital is therefore another crucial policy aim. The education system needs to provide students with a continuously updated set of skills; to make them alert and adaptable to knowledge-based innovation; and to enable them, ultimately, to make the most of the fast changing demands of the labour market. Designing an effective education system, including lifelong learning opportunities, and providing the right incentives to teachers and students alike, should also therefore be very much on everybody’s agenda. Designed by the Printing and Publishing Division of the Bank of Italy
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Introductory remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Annual Conference of the Global Forum on Productivity, co-organised by the Italian G20 Presidency, Venice, 9 July 2021.
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Ignazio Visco: Introductory remarks - Annual Conference of the Global Forum on Productivity Introductory remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Annual Conference of the Global Forum on Productivity, co-organised by the Italian G20 Presidency, Venice, 9 July 2021. * * * It is a pleasure to join Minister Franco and Secretary General Cormann in welcoming you to this important initiative, promoted by the OECD Global Forum on Productivity together with the Italian Presidency of the Group of Twenty (G20) to discuss recent developments in productivity and the challenges ahead The OECD has a long and outstanding reputation for producing high quality studies on productivity and the determinants of cross-country differences in growth performances. As Chief Economist of the Organization, I had the privilege and honour of contributing to this research programme more than 20 years ago. At that time, our efforts were directed towards obtaining a deeper understanding of the “new economy” and of the impact of information technologies (ICT) on society at large. To this end, the OECD significantly intensified its research activity, the collection and diffusion of comparable cross-country data and benchmarking analyses aimed at identifying best practices among member countries. The lessons learnt back then were published in several reports, starting from the book on “The Sources of Economic Growth in OECD Countries”, issued in 2003, and the various editions of “Going for Growth”, which are still highly relevant today. The new research presented at this edition of the Global Forum on Productivity confirms that, analogously to the case of “the new economy” debate in the late 1990s, obstacles to the diffusion of new technologies play a critical role in explaining the disappointing growth performance experienced at least since the global financial crisis. In particular, they help explain why, despite the new digital revolution, the dynamics of aggregate productivity have been so sluggish. To be fully exploited, the new digital technologies require adequate availability and composition of skills in the workforce, good managerial practices and, often, appropriate economies of scale. These factors are creating a divide between a few fast growing large firms and many small ones struggling to keep up, which is preventing our economies from taking full advantage from technological progress. These are critical issues, whose relevance can hardly be overstated. The troubled macroeconomic context in which the digital revolution has been taking place since the global financial crisis has also played a role in explaining the stagnation of productivity. We have learnt that deep recessions, especially if accompanied by severe financial distress, may have long-lasting effects on potential output, in particular through a reduction in the speed and quality of capital increase. Coupled with adverse structural developments, such as the ageing of populations in large parts of the world, the global financial crisis and the euro-area sovereign debt crisis have pushed down equilibrium interest rates, reducing the room for an effective monetary policy response to the low-growth, low-inflation environment. We are now fully aware that, when confronted with recessions of such a magnitude, a joint and strong effort on the part of both monetary and fiscal policy is necessary to prevent structural damages to the economy. Today, we have just faced another global recession of unprecedented nature and size, which hit our economies in the middle of the digital and green revolutions. The pervasive adjustments forced by these two structural changes, together with the legacy of the pandemic, which is still threatening our countries, are pushing the global economy into 1/3 BIS central bankers' speeches uncharted territories. It is still hard to understand what the “new normal” will look like, but I believe that both governments and central banks can do a great deal to prevent the pandemic shock from leaving permanent scars. It is of the utmost urgency to prepare our economies for the future, making possible the stronger, inclusive and sustainable growth pursued over the years, with mixed success, by the G20. Indeed, “People, Planet and Prosperity” are the priorities of the Italian Presidency of the G20. The global policy response to the crisis, thanks to the close international cooperation that the G20 strongly promotes, has already obtained important results. The joint action of fiscal and monetary policies has avoided a generalized tightening of credit, averting the risk of a spiralling crisis. It has attenuated the impact of the emergency on the corporate and household sectors, preventing the destruction of viable physical, intangible and human capital. It has also been key in directing resources to strengthening health-care infrastructures, including for the development of vaccines. Thanks to the policy support and the vaccination campaigns, the recovery is now gaining strength. Economic forecasts are being revised upward. However, progress is uneven, and less developed and emerging economies are still facing major difficulties in curbing the pandemic. The health crisis will not be over until vaccines are accessible to all countries. Diverging health and economic patterns would not be acceptable, as they would put the global economy and the whole society at risk. In such an uncertain environment, a coordinated effort is still needed to support the recovery, until idle productive capacity, which remains sizeable, is fully reabsorbed. At the same time, we must pave the way for the upcoming future, by strengthening potential growth and favouring the structural transformations that will take place. *** Somewhat surprisingly, some studies suggest that, contrary to recent crisis episodes, the pandemic shock could have a positive impact on productivity. The available data tentatively confirm that, thanks to the extensive support they have received, firms are reacting swiftly, recovering a large fraction of the investments deferred during the emergency. Stronger accumulation and the need to adjust productive processes to the challenges of climate change and the opportunities offered by new digital technologies may entail a more intense innovative activity. The managerial changes imposed by the spread of the virus, which forced even smaller and more conservative firms to experiment with new forms of labour organization and the benefits of digital technologies, should spur further innovative efforts. As in the case of the oil shocks of the 1970s and early 1980s, the pandemic could then be followed by a period of strong investment, an extensive reorganization of production processes and, ultimately, faster productivity growth. These potentially positive developments, however, will need to be supported by suitable policies aimed at removing the obstacles that have delayed the diffusion of new technologies and of organizational innovations over the last few years. Otherwise, they might lead to higher market concentration and much smaller welfare benefits. A critical role will be played by public investment in digital infrastructures and, even more importantly, in human capital. The “human side of productivity” has to be taken seriously. Improving the supply of human capital through effective education remains a priority in many countries. Nevertheless, increasing the years of schooling is not the only target our policies should focus on. Expanding the availability of specific skills, which are often acquired during the working career, through on the job training and lifelong learning, is also key, particularly in light of the intense reallocation processes that the digital and green transitions will entail. Finally, yet no less importantly, we should address with greater determination the wide set of frictions that prevent individuals, notably women and minorities, from pursuing their comparative advantage, too often causing a considerable misallocation of talents. Most of the topics and policy challenges that I have just mentioned are being discussed in 2/3 BIS central bankers' speeches this conference and I am looking forward to the contributions from the upcoming high-level panel discussion among G20 policymakers, to whom I am pleased to give the floor with no further hesitation. 3/3 BIS central bankers' speeches
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the Italian Banking Association - Annual Meeting Virtual Conference, 6 July 2021.
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Ignazio Visco: Speech - Annual Meeting of the Italian Banking Association Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the Italian Banking Association Annual Meeting Virtual Conference, 6 July 2021. * * * Recent economic and financial developments In Italy, thanks to the successful vaccination campaign and the improvement in public health, the economic recovery is consolidating. In our next Economic Bulletin, to be published on 16 July, we will present a detailed update of our projections. According to current assessments, growth is expected to strengthen decisively in the second half of this year; it may rise to around 5 per cent on average for the year, so that more than half of the fall in GDP recorded in 2020 can be made up. As also indicated by the firms taking part in our surveys, growth could be encouraged by the lively trends in investment; consumption may recover more slowly, with a gradual reduction in the high saving rates caused by the pandemic; and goods exports are likely to benefit from the acceleration in foreign demand. With the support of fiscal policy, including measures with EU funding, and if monetary and financial conditions continue to be favourable, the expansionary phase should consolidate and remain buoyant for the next two years. There is still great uncertainty nevertheless. This scenario assumes that the vaccination campaign will continue at its current pace and that the spread of the virus will be further contained. Any delays in the implementation of the relaunch measures under the National Recovery and Resilience Plan (NRRP) could weaken the outlook for aggregate demand and employment, in part due to the adverse effects on business and household confidence. The favourable growth forecasts are based on the assumption that credit access conditions remain relaxed. In the first five months of this year, lending continued to increase apace, although slightly more slowly than before. Business demand for credit, for the most part backed by state guarantees, reflected not only the need to restructure debt and precautionary reasons, but also the intention of funding the recovery of investment. Guaranteed loans have been fundamental to supporting economic activity. The Government’s decision to extend the guarantees to the end of the year to facilitate the exit from the health emergency will allow firms to have continued access to medium-term loans at very low interest rates and allow banks to satisfy the demand for credit with a lower impact on their own capital requirements. The reduction of the percentage guaranteed by the State aims to concentrate banks’ attention on the creditworthiness of firms applying for loans. The steep increase in lending and the reduction in consumption have led to a significant rise in deposits. Last May, firms had deposits of almost €460 billion and those of households amounted to €900 billion, respectively 16 and 7 per cent more than twelve months previously. Business deposits, whose strong growth reflects the demand for liquidity during the pandemic crisis, are destined to shrink when the emergency is over. Banks could contribute to the necessary rebalancing of the financial structure of firms by proposing asset management products to their customers, in strict compliance with the laws to protect retail investment, which would allow them to direct resources towards productive activity, including in the form of risk capital. Banks and credit quality Banks’ capital conditions remain sound: the common equity tier 1 ratio remained broadly stable 1 / 10 BIS central bankers' speeches in the first quarter of this year, after rising from 14 to 15.5 per cent in 2020. Similarly, the flow of new non-performing loans (NPLs) in relation to total loans did not change, remaining at 1.1 per cent, 0.2 points above the minimum reached in the third quarter of last year. The stock of NPLs rose slightly on banks’ balance sheets, by 1.5 per cent. The increase, which is concentrated in the category of past due exposures or overdrafts of more than 90 days, reflects the entry into force of the new framework for identifying exposures in a state of prudential default, established some time ago, which integrated the rules on capital requirements, the guidelines of the European Banking Authority (EBA) and a delegated regulation of the European Commission. I addressed this issue extensively in February at a hearing before the Parliamentary Committee of Inquiry into the Banking and Financial System, where, in response to the fears raised by several parties, I stated that the effects of these changes would only have a moderate impact, also thanks to an appropriate customer communication campaign. The information collected from a sample of large Italian banks that had started applying the new rules at the beginning of the year indicates that, despite the adverse economic situation, the impact on banks’ balance sheets has actually been small: loans that were reclassified immediately after the adoption of the new criteria raised the ratio of NPLs to total loans by 0.2 percentage points. In addition, so far customer complaints have not indicated any reasons for concern regarding the application of the new rules. In the first quarter, the return on equity (ROE) rose to 9 per cent, from 1 per cent in the same period of 2020. In addition to the higher profits from trading activity, favoured by the sharp decline in risk premiums on government bonds, the increase in ROE reflects the reduction in loan loss provisions, which was concentrated in those banks that had written down the most loans in the first quarter of last year. In the next few months, it is likely that new loan losses will emerge and ROE will return to lower levels. However, the increase in new NPLs is expected to be smaller than that observed in previous recessionary periods owing to the support measures adopted by the Government, the low interest rates linked with the still very expansionary monetary policy stance, and the positive economic outlook. Signs of a deterioration in credit quality stem from the trend in loans made to borrowers for whom a significant increase in credit risk was observed (classified as ‘Stage 2’ according to international accounting standards), which at the end of March had reached 10.3 per cent of the total, compared with 8.7 per cent at the end of 2019. For Italian banks classified as ‘significant’ for supervisory purposes, the share was 11.2 per cent, almost 4 percentage points higher than the average for the corresponding European banks. A correct classification of loans and the consequent adjustment of loan loss provisions are essential as they preserve the transparency of balance sheets, thus avoiding any sudden increases in write-downs if defaults were to increase. However, there are still considerable differences in this respect between both significant and less significant banks. In order to verify the extent to which these disparities are justified by objective factors (portfolio composition, actual creditworthiness of borrowers, and different contractual terms and conditions), the European Central Bank and the Bank of Italy have initiated in-depth investigations, with a particular focus on lending to firms in the sectors hit hardest by the pandemic. Under Decree Law 73/2021, passed in May (‘sostegni bis’), the moratoriums granted by law were extended to the end of 2021, for the principal amounts only and at the borrowers’ request. By mid-June, loans subject to this measure were equal overall to just under €130 billion. Over time, the amount of loans that can no longer benefit from the favourable treatment provided for in the EBA guidelines is gradually increasing. Banks will therefore have to assess the current or future financial difficulties of borrowers on a case-by-case basis and, if necessary, classify loans in the 2 / 10 BIS central bankers' speeches ‘forborne’ category. In addition to correctly classifying loans, banks need to take steps to distinguish between borrowers in temporary difficulties but with good chances of recovery from those who are unlikely to be able to stay in business. For the former, it is desirable to restructure their loans in order to encourage the recovery of their activity. This would also benefit their ability to access the capital markets and attract valuable industrial partners to support their revival. In the coming years, the management of NPLs, including decisions on whether to dispose of them on the market or to keep them on the balance sheet, will also be influenced by the reforms planned for the civil justice system. As we know, increasing the efficiency of the judiciary and reducing the length of proceedings is one of the objectives of the NRRP. The Plan provides for the recruitment of specialized staff to be employed in dedicated administrative offices to support the work of judges, the further digitalization of the system and the simplification of procedures (including enforcement procedures), and the introduction of incentives to make more frequent use of alternative dispute resolution mechanisms. These reforms provide an important opportunity to improve the institutional environment for business activity, with benefits for the process of reallocating resources within the economy. The difficulties caused by the pandemic are exacerbating the pressure on the banking sector, which has been driven – in Italy and elsewhere – to review its business models to make them more sustainable and suitable for the profound changes under way. Banks are also responding to these challenges through restructuring plans and possible mergers and acquisitions. We are following this process closely, including within the Eurosystem, not to guide its outcome in any way according to pre-established programmes, but to ensure that it produces stronger banks that are therefore better able to support the economy and foster its return to a path of sustained and high growth. Similarly, we are engaged in the assessment of possible solutions to crisis cases involving some medium-sized and large banks, which are currently dealing with recovery and consolidation processes made all the more difficult by the tough economic conditions of the last few years. Smaller banks In the Italian banking system there is no shortage of small and medium-sized banks able to compete on the market, thanks to their capacity to innovate, to tap into distribution channels that meet customers’ needs, and to their local economic knowledge combined with constant vigilance against risks. In some instances, encouraging signs of dynamism have come from the creation of new banks based on innovative business models, with streamlined operational structures and limited costs, as well as advanced IT systems. Elsewhere, traditional intermediaries, which have understood ahead of time the need to deliver sufficient efficiency gains to stay on the market, have adopted solid and far-sighted industrial plans, or have opted to scale up their operations through mergers and acquisitions. Even so, the number of small banks struggling to adapt to the changing external environment nonetheless remains significant. The problems are mostly – though not solely – concentrated among those characterized by traditional commercial banking models. The emergence of crises in the near future cannot therefore be ruled out. Indeed, the effects of the recession add to structural difficulties linked to operational models that are no longer sustainable and to lacunae in corporate governance, which we have urged banks to address in repeated calls to action that have often not been adequately heeded. At the end of 2020, the operational costs of the almost 60 less significant commercial banks in Italy (whose share of deposits was equal to 8 per cent) absorbed on average around threequarters of revenues. In several cases, the cost-to-income ratio was such as to leave only a small portion of ordinary proceeds to cover credit risk, innovative investment, capital remuneration and capital strengthening. As I have remarked on many occasions, banks whose 3 / 10 BIS central bankers' speeches cost-to-income ratio is too high must quickly decide on and enact an efficiency recovery plan. Last November, we asked the majority of less significant banks, including all the most problematic ones, to conduct a self-assessment exercise on their development prospects. This enabled us to identify areas of, at times, serious fragility for some intermediaries, the pressing nature of which top management was not always fully cognizant. These banks will shortly receive our considerations regarding the actions they should take. In the absence of any clear prospect for a recovery, and given the inertia of management bodies and shareholders, we may have to take, as we have done in recent months, steps to protect depositors in order to defuse crises that, once they have erupted, would be difficult to reverse. Paths to recovery must often be paved with a reduction in costs, including those for personnel. Overstaffing is a common feature of many traditional commercial banks and becomes more problematic in the case of smaller ones. While larger intermediaries have, for some time now, undertaken a rationalization of staffing structures (reducing the number of workers by around one fifth in the last ten years), smaller banks find it difficult to reduce staff beyond a certain threshold, also in order to safeguard critical functions. Without effective cost-cutting initiatives, the only option left to weaker banks in terms of revenue is to merge with other, more efficient, intermediaries, failing which the risk of exiting the market becomes a concrete one. Past and even recent experience has shown that the interventions of the Interbank Deposit Protection Fund can be an effective tool for managing crises at small and medium-sized banks to which, based on the current interpretation of EU rules, the resolution procedure does not appear to apply. The priority assigned to deposit guarantee funds for recoveries in liquidation (the super-priority) can make it impossible to comply with the ‘least cost’ principle, whereby a preventive or alternative intervention must cost less than the reimbursement of insured depositors. For banks with total assets of below €5 billion, an additional instrument is available in the form of a State aid scheme to support sales of assets and liabilities under liquidation; introduced by the ‘Relaunch Decree’ of May 2020 and later approved by the European Commission, it can be accessed until November this year but at conditions that make its use complex and subject to uncertainty. In addition to its renewal next year, greater automatism in its application would be a welcome development. Corporate governance structures The adoption of robust corporate governance structures to ensure an appropriate composition of administration and control bodies, healthy internal dialogue and highly qualified management, is a prerequisite for the definition of suitable long-term strategies. The new ministerial decree on the suitability requirements for members of management bodies raises the required standards on a number of fronts: integrity and propriety, professionalism and competence, time commitment, independence of mind, and conflicts of interest. Banks must take advantage of the upcoming renewal of governance bodies to reap the considerable benefits of a careful selection of their members. Shareholders, who are responsible for making the appointments, shoulder a specific responsibility that is also in their own interest: they must exercise their voting rights, in the awareness that the objective of a fair economic return on capital invested cannot be achieved without the scrupulous administration of the intermediary by the management bodies. The Bank of Italy is also strengthening the measures falling within its own sphere of competence for the organization and corporate governance of banks. There has already been a significant improvement in the quality, composition and functioning of the boards of directors of Italian 4 / 10 BIS central bankers' speeches banks, but there are still plenty of opportunities for improvement, which must be exploited. The hiring of competent managers with different profiles in terms of age, gender, training, geographical provenance and duration of term must be actively encouraged. By stimulating debate and dialogue in decision-making processes, diversity within the management bodies can combat the risk of blinkered thinking and concentrations of power. In an increasingly competitive and complex world, this reinforces banks’ capacity to pursue effective strategies. On the issue of gender diversity, the banking system’s response to the supervisory expectations published in 2015 has been unsatisfactory; the number of women on boards of directors at numerous banks continues to be especially low and compares unfavourably with the other main European countries. Recently issued provisions have therefore made the requirements more stringent, establishing shorter timelines for adapting to the minimum mandatory gender quotas on management and control bodies. The provisions favour a composition of boards capable of reaping the benefits that, including in risk management, can stem from greater diversity. In the short term, it can also provide an opportunity to achieve, through the renewal of the bodies, a lowering of the average age and duration of terms of the members. In calibrating the regulation, account was taken of the request by small banks for graduality in reaching the target quota, given the greater gap these banks must bridge. Further non-binding guidance is aimed at increasing the efficacy of the role that, in practice, the less-represented gender can play on boards. The new provisions also act on other, no less important, fronts. They recall the centrality of issues of strategic importance, such as decisions on FinTech, environmental, social and governance (ESG) factors, and lending policies; they require the adoption of ethical standards for all personnel; they reinforce controls; and they envisage the adoption of policies to manage dialogue between administrators and shareholders. Cooperative credit groups To enable cooperative credit banks to continue to perform their critical role of financing small and medium-sized enterprises prudently and effectively, in 2016, the legislature chose to encourage the creation of banking groups that would bring together small banks throughout Italy. Contrary to what many, on more than one occasion, have charged, the creation of these groups does not conflict with either the member banks’ mutualistic nature, which is preserved, or their need to maintain close ties with their borrower firms and local communities. In fact, the idea was conceived precisely so that these key characteristics could continue to be of importance in a changing world, yet placing them within a structure capable of tackling the problems that have long limited the sector’s potential, such as geographical and operating constraints, low profitability, weak corporate governance, and difficulty in accessing capital markets. The two cooperative banking groups that were formed are pursuing the objectives set by the reform: more effective and uniform organizational and risk management standards have been introduced, internal control functions have been strengthened, procedures for selecting members of the management body have been improved, and steps have been taken to reduce internal fragmentation and enhance efficiency. The exercise of the management and coordination powers under the cohesion contracts has already permitted parent companies to intervene quickly on numerous occasions, through mergers or capital support, including by providing loans, when a cooperative credit bank has found itself in difficulty or involved in unlawful acts. The guidance of the parent company has also played a crucial role in drawing up the strategies for reducing non-performing loans, the ratio of which to total loans, net of loan loss provisions, has almost been halved, from 6.9 to 3.6 per cent since the formation of the groups, though it is still higher than the system average. In the coming days, the results of the in-depth assessment of the two cooperative banking groups recently completed by the Single Supervisory Mechanism will be published. This 5 / 10 BIS central bankers' speeches exercise, which involved months of dialogue between the banks and the supervisors, is perhaps the most significant sign of the entry of these groups to the ranks of the significant banks. The Bank of Italy will continue to follow these banks. The switch to supervision at ECB level reflects the fact that Italian cooperative banks, by joining forces, created two major national groups. This does not mean that the fate of the cooperative banking movement has been entrusted to a ‘remote’ supervisor, unaware of its history and functions. The Bank of Italy, as an integral part of the new supervision, helps to ensure that the prudential supervision of the affiliated cooperative credit banks is conducted while taking account of the special nature of these banks recognized under national law, whilst as far as possible maintaining standards of interpretive and applicative continuity compared with the past. We collaborated with the Ministry of Economy and Finance, the cooperative banking groups and Federcasse to better understand the problems linked to the reform and to support the cooperative credit system in adapting to the new regime. When necessary, we simplified the rules applicable to cooperative banking groups and their affiliates, to the extent permitted by the laws in force; we remain open to dialogue. The legislature chose the formation of groups as the instrument for enabling the cooperative movement in the banking sector to face the changes in the economy and in society from a secure position. What is sometimes perceived as tightening supervisory criteria is nothing more than requiring that the new groups be founded on processes, structures and internal regulations suitable for tackling the challenges that all banks face, not just the cooperative credit ones. This requires a greater ability to accurately estimate the risks and manage them appropriately. In these first few years of operation especially, the parent companies are called upon to play a particularly decisive role. The proportionality principle set out in the cohesion contracts ensures that the parent companies’ powers are appropriately calibrated and, specifically, that the ‘degrees of freedom’ of the individual cooperative credit banks are adjusted for their levels of risk. By contributing to increasing risk sensitivity, supervision will work towards ensuring that these degrees of freedom are built on solid ground. Opportunities and risks associated with digital finance Just like in the real economy and in the labour market, the spread of new technologies tends to profoundly alter the demand and supply of financial products and services, increasing market contestability, giving banks the chance to reduce costs and improve operational efficiency. A broader and more informed use of information technologies offers an opportunity that all banks should seize, especially those that must swiftly return to sustainable profitability levels. Digitalization could radically change the structure of the financial system, opening the door to the entry of new operators, creating new ways of interacting with customers and stimulating process and product innovation. For banks, the possible applications, in addition to making it possible to reduce regulatory compliance costs and make back-office operations more efficient, allow them to fully exploit the enormous mass of data (structured and unstructured) they have access to in order to offer products better suited to customers’ needs. The use of technology may also contribute to making the entire credit cycle more efficient (from origination to monitoring, and from restructuring to recovery). Innovations should, however, be planned over time; it is especially important to have staff that are adequately trained and open to change. Delays and uncertainties in the transition to digital finance could make it difficult to catch up in the future, so much so that they could compromise slower banks’ ability to compete successfully in the market. I have pointed out on more than one occasion that innovation, besides offering enormous opportunities, also exposes banks to risks. Fraud, cyber attacks and the improper use of artificial intelligence constitute threats against which banks must defend themselves. Furthermore, credit 6 / 10 BIS central bankers' speeches institutions are increasingly outsourcing significant parts of their operations to third parties, running the risk of losing full control of operational risk. This issue is one upon which international regulatory bodies have been focusing, partly in light of the trend of relying upon just a handful of operators to supply certain services. The Financial Stability Board and the Basel Committee recently published documents for consultation in this area. In Europe, the Commission has opened negotiations on a proposal for a directive and a regulation to improve digital resilience in the financial sector (Digital Operational Resilience Acts, DORAs). The proposal seeks to encourage the development of safe and reliable digital services by strengthening and harmonizing IT security, governance structures and the management of risks stemming from the use of third parties to provide these services. Collecting data on these issues, which we began to do last year, will allow us to better quantify and identify the risks that the new EU legislation will seek to address. The Bank of Italy has a long-standing commitment to supporting and promoting innovation in the financial sector. A few years ago, we opened the FinTech Channel, one of the first tools for communicating with industry through which we have been able to provide clarification and to understand the needs of the firms that operate in the FinTech sector. A few months ago, with the birth of our new innovation centre, Milano Hub, we created an environment in which operators, academics and enterprises can engage in debate and discussion, share their analysis and research and offer support in the development of innovative projects capable of producing widespread benefits. The ministerial decree just published, which governs the conditions and procedures to be followed in testing FinTech solutions (the regulatory sandbox), is another step forward in promoting innovation whilst continuing to safeguard against risk. This is, however, a delicate step, which requires that the utmost care be taken in striking the proper balance between the interests of operators and of customers. In the coming months, the Bank of Italy, Consob and Ivass will be working hard to further define the new regulatory framework. We will move ahead gradually, ensuring close coordination between the authorities involved. Financial risks stemming from climate change Assessing and managing the financial risks stemming from climate change is one of the main challenges facing regulators, supervisors and financial intermediaries. All the players involved are called upon to put their best efforts into ensuring that the financial sector is able to accurately assess the magnitude of the current and future exposure to such risks, so as to seize the opportunities connected with the decarbonization of the economy. Yesterday the Bank of Italy published its Responsible Investment Charter, in which it has taken on three commitments: to promote environmental, social and governance (ESG) sustainability, with initiatives to encourage the disclosure of adequate information on sustainability by issuing firms, banks and other financial system players; to continue to integrate ESG principles into the management of its investment portfolios by favouring the investments with the best profiles; and to publish information and analyses on sustainable finance and to communicate the results achieved regarding its investments on a regular basis. Correctly measuring the risks connected with climate change requires above all the availability of reliable and comparable data in order to assess the possible impact of transition and physical risks on financed sectors and activities. It is here that regulatory authorities at European and international level are currently focusing their efforts. The issue of data availability is a priority for the Italian presidency of the Group of Twenty (G20), which has asked the International Monetary Fund (IMF) to include climate change in the preparation of a new Data Gaps Initiative and the Financial Stability Board to draw up a report on the availability of data to monitor climate-related risks for financial stability. A first version of this report will be presented this week at the G20 Finance Ministers and Central Bank Governors Venice Meeting. 7 / 10 BIS central bankers' speeches The results of the pilot project recently conducted by the EBA also point to the importance of bridging the data gap as soon as possible. Steps in this direction will be taken once the technical standards relating to the ‘third pillar’ obligations concerning banks’ exposures to physical and transition risks, currently in the consultation phase, have been finalized. The inclusion of this information in the balance sheets is essential to enable all stakeholders (shareholders, creditors, consumers) to monitor and stimulate sound risk management on the part of financial intermediaries. At the same time, supervisory authorities are working hard to encourage banks to make the appropriate organizational arrangements to measure, monitor and manage climate-related financial risks. Last year, a specific guide was issued within the Single Supervisory Mechanism to define supervisors’ expectations in this area. Moreover, banks were asked to carry out a self-assessment of their level of compliance with the expectations formulated in the guide, and to set out detailed adjustment plans if delays in compliance were to emerge. A thorough examination of these plans will be one of the elements to be considered in next year’s supervisory review and evaluation process. Furthermore, in 2022, significant banks will undergo stress tests specifically devised to assess the intensity of the financial risks stemming from climate change, following the analyses already being conducted by the European Central Bank and the national authorities on the impact of such risks on the overall stability of the financial system. Therefore, financial intermediaries are expected to show a strong commitment to measuring and managing climate-related risks. Regulation With the presentation of a proposal by the European Commission, negotiations will soon be stepped up for the transposition in the European Union of the latest agreements reached within the Basel Committee and known as Final Basel III. This step marks the completion of a process begun more than ten years ago which, in light of the experience gained with the global financial crisis, led to a significant revision of international regulatory standards. The Committee announced that it does not intend to propose further reforms in the near future, so as to enable financial intermediaries to operate in a stable regulatory environment. The crisis brought about by the pandemic has been a challenging testing ground for the reforms completed up until now. It is fair to say that, so far, the test has been passed. Higher capitalization levels and the large liquidity and capital buffers have enabled the banking system to take on a global shock of exceptional magnitude effectively, while ensuring adequate lending to the hardest hit households and firms. The regulatory framework proved sufficiently flexible to undergo rapid adjustments when necessary. The Basel Committee’s decision, taken following the outbreak of the pandemic, to delay by one year the time frame for the implementation of the Final Basel III rules was both wise and appropriate. It is now necessary to proceed according to the pre-set schedule, keeping the European regulatory framework as consistent as possible with the international standards. The negotiations will be complex and their goal will be to reconcile several needs: not to penalize European banks compared with those from other jurisdictions; to take into account the specific features of our continent’s banking system when there is a well-founded and robust case for justifying deviations from global standards; and to leverage in full the proportionality of rules without weakening them. In the coming months, the European Commission will formulate a proposal to revise the European framework for bank crisis management and deposit insurance, without however changing the current institutional set-up, in particular with regard to the creation of a common European deposit guarantee scheme, the missing pillar of the Banking Union. 8 / 10 BIS central bankers' speeches As regards crisis management, one possibility being considered is to expand the range of banks that can be subject to resolution; in evaluating its costs and benefits, attention must be paid to the difficulties that smaller financial intermediaries tend to encounter when raising on the market the liabilities necessary to meet the minimum requirement for own funds and other eligible liabilities and to access the Single Resolution Fund’s support for banking crises. Over the medium term, it will be necessary to harmonize the regulatory framework for the liquidation of minor banks, which at the moment is a piecemeal system made up of the different procedures adopted by the individual Member States. In light of the shortcomings of the current system, we have underlined on several occasions the need to identify crisis management mechanisms for non systemic intermediaries as soon as possible. To this end, it is important to reinforce the capacity of national deposit guarantee schemes to intervene through purchase and assumption transactions both before and during liquidation. In the short term, it is crucial that the EU institutions ensure flexibility in the use of the State-aid assisted liquidation scheme for small banks that, as I recalled earlier, based on the conditions laid out by the European Commission, has lost the automatism envisaged in the original proposal by the Italian authorities. Nevertheless, it remains necessary to complete the Banking Union by establishing a common deposit guarantee scheme that is not limited to providing liquidity support to the national schemes and is complementary to the latter. Within the single market, depositors should all benefit from the same effective level of protection, countering fragmentation risks and enhancing overall trust in the European banking system. The fact that it has not been possible to achieve a breakthrough on this aspect, at a time when cohesion has instead been growing on other fronts, is regrettable. We must continue in our efforts to ensure that the European institutional architecture relating to the banking system can provide its essential contribution to the construction of a stronger and more cohesive Economic and Monetary Union. *** In the coming years, banks will be engaged on several fronts, all of them very challenging: managing the transition towards a new post-pandemic normal, rethinking their business models in light of the digitalization process, and accurately measuring and monitoring the financial risks stemming from climate change. The Bank of Italy will contribute by working at national and international level to establish supervisory rules and practices that reconcile several needs, namely those of ensuring the stability of individual financial intermediaries and of the system as a whole, stimulating and governing the adoption of new technologies, and not burdening banks with excessive regulatory requirements. We are paying the utmost attention to the issue of the costs and proportionality of regulation as well as to the suggestions and ideas coming from the industry. Nevertheless, the objective of not weighing down the activity of financial intermediaries, especially the smaller ones, comes up against two limits. On the one hand, the increase in the complexity of the environment in which banks operate poses concrete risks, relating in particular to the adoption of new technologies and to climate change, which must be managed effectively, by large banks as well as by small ones. On the other hand, it remains indispensable to protect the interests of depositors, regardless of the size of the financial intermediary to which they entrusted their savings. The action of supervisors must be complemented by that of financial intermediaries, stimulated by the awareness that each of the challenges that await banks must be addressed in a timely and resolute manner. This was underlined effectively almost one century ago by Bonaldo Stringher in his Report to the General Meeting of Shareholders of the Bank of Italy on 31 March 1927, when he recalled that the main guarantee of banks’ solidity ‘comes from the ability, alertness and, above all, straightforwardness of the men who conduct the business of the banks’. By continuing to operate in a fair and far-sighted manner, banks will contribute to 9 / 10 BIS central bankers' speeches supporting our definitive exit from the pandemic crisis and to the recovery of our econo 10 / 10 BIS central bankers' speeches
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Welcoming remarks by Mr Piero Cipollone, Deputy Governor of the Bank of Italy, at TIPS Webinar, Bank of Italy, 12 July 2021.
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Piero Cipollone: TIPS (TARGET Instant Payment Settlement) - the new Eurosystem market infrastructure service – Banca d’Italia as service provider and manager of the business relationships with the financial community Welcoming remarks by Mr Piero Cipollone, Deputy Governor of the Bank of Italy, at TIPS Webinar, Bank of Italy, 12 July 2021. * * * It is a great pleasure to welcome you here today to this seminar on TARGET Instant Payment Settlement (TIPS), the Eurosystem market infrastructure for the settlement of instant payments in central bank money. The seminar will illustrate the architecture and functioning of the platform developed by the Bank of Italy on behalf of the Eurosystem, and its contribution to retail payments market innovation in Europe. TIPS was launched in 2018 and allows transactions to be settled in central bank money across Europe within seconds. In launching TIPS, the Eurosystem acknowledged that the capacity to transfer funds in a matter of seconds is a powerful one, and has great potential with respect to traditional credit transfers. The implementation of the system was carried out by the 4CBs – the central banks of France, Germany, Italy and Spain, which are the providers of the Eurosystem Market Infrastructures. The Bank of Italy, in particular, was responsible for developing the service and it was also entrusted with the task of operating the platform. From the 4CBs’ perspective, TIPS represents a break with the past as well as increasing awareness of the fact that digitalization is blurring the lines between wholesale and retail. Before TIPS, Eurosystem projects such as TARGET2 and TARGET2-Securities (T2S) were designed to promote integration and harmonization of market infrastructures within the euro area, meeting the needs of financial market operators, depositories and large custodian banks. With TIPS, the Eurosystem has provided the European financial community with an infrastructure designed to support the provision of innovative, customer-friendly retail payment solutions for the benefit of European citizens. In fact, TIPS was developed with the aim of fostering the integration of retail payment services and of eliminating barriers due to a lack of interoperability between different settlement platforms based on the SEPA Instant Credit Transfer (SCT Inst) Scheme – i.e. the standard TIPS (TARGET Instant Payment Settlement) – the new Eurosystem market infrastructure service: Banca d’Italia as service provider and manager of the business relationships with the financial community Welcoming remarks by Piero Cipollone Deputy Governor of the Bank of Italy TIPS Webinar Bank of Italy 12–13 July 20212 for pan-European instant payments developed by the European Payments Council at the request of the Euro Retail Payments Board. Building TIPS required the fulfilment of a number of particularly challenging technical requirements: - virtually instant payment execution (with processing times per payment not exceeding 5 seconds); - the capacity to handle a large volume of processed payments (over 43 million transactions per day); – very high availability and resilience (reaching 99.9% service availability, and the capacity to restart within 15 minutes in a site disaster scenario); - extreme scalability of the system from a performance viewpoint (the ability to sustain a doubling of the volume of payments over a year). 1/3 BIS central bankers' speeches As Governor Visco recently said, what makes TIPS really unique and unlike any other settlement platform is its distributed architecture in all layers, from application to infrastructure.1 This architecture is based on ‘industry standard’ and open-source software. The design is meant to ensure very high levels of stability that make service interruptions and software bugs very unlikely. The strengths of this powerful platform lie in its ability to process millions of transactions per day, requiring just a few seconds for each one, and operating all year round with an extremely low environmental impact. The presence of redundant servers allows the settlement engine to process payments without storing any information. This avoids the creation of ‘bottlenecks’ in the processing flow and enables TIPS to be very fast and to achieve system resilience. It is worth emphasizing that this architecture differs from distributed-ledger systems (such as the Bitcoin network, based on a block chain) which need to generate trust and consensus among a distributed community by means of an expensive and energy-intensive global validation process. In the case of TIPS, the recognition and guarantee of the transactions comes from the trust provided by the Eurosystem (a typical task for a central bank). This also allows TIPS to be ‘green’. As shown in recent research carried out by the ICT Operations Directorate of the Bank of Italy, the TIPS carbon footprint in 2019 was almost 40,000 times smaller than the amount of CO2 emitted by other distributed-ledger-based networks such as Bitcoin.2 This is because, absent the need to generate trust and consensus among all the network participants, there is no energy dissipation. Due to its characteristics, this infrastructure has great potential. Although TIPS was primarily designed for instant payment settlement in euros, it is a multicurrency system. This feature means that the Eurosystem does not only aspire to provide yet another market infrastructure, but also has the ambition of supporting the market by promoting closer cooperation, including with non-euro central banks. Indeed, TIPS is currently attracting considerable interest in the international community of central banks. In April 2020, the Riksbank concluded an agreement with the Eurosystem to use the TIPS technical platform for the settlement of instant payments in Swedish krona as of May 2022, and is currently working with the Bank of Italy and the ECB to implement the so-called RIX-INST instant payment service. The phase of the project currently under way was preceded by another phase of gap analysis that permitted the identification of all functional enhancements required to allow Riksbank to access the TIPS platform. The most notable outcomes of this gap analysis activity were the definition of a new settlement model, alternative to the one defined on the basis of the SCT Inst scheme and called Single Instructing Party.3 The upcoming onboarding of the Swedish banking community gave rise to the idea of exploiting the common instant payment infrastructure in order to provide a cross-currency solution for instant payments. This solution will initially involve only the euro and krona communities but, in the near future, it will of course be available for all other currencies joining TIPS. Indeed, the agreement concluded with Riksbank last April can represent a starting point for broader initiatives, which may ultimately result in interconnecting other currencies and other currency areas. The Danish krone is the next in line. Indeed, Danmarks Nationalbank has expressed interest in joining TIPS by November 2025.4 The connection to TIPS will allow Danish banks and providers of payment services to settle payments in both currencies within seconds. Enabling the TIPS platform to process cross-currency instant payments is a response to the burgeoning consumer and business needs arising from the growth of cross-border e-commerce, tourism and migration flows, and must be read as part of the broader G20 initiative to address the key challenges often faced by cross-border payments. In October 2020, the G20 endorsed a roadmap describing the necessary elements of a response to these challenges, in the form of a 2/3 BIS central bankers' speeches set of 19 building blocks. One of the building blocks (number 13) seeks to enhance the existing payments ecosystem by pursuing interlinking of payment systems for cross-border payments. In this regard, the Bank of Italy is conducting a feasibility study for interlinking TIPS with Buna IPS, the cross-border and multi-currency payment system owned by the Arab Monetary Fund. The findings of the feasibility study should pave the way for a deeper level of cooperation with noneuro central banks. Cross-border payments is not the only area where digitalization is posing challenges. The safety of central bank money and changing consumer attitudes to digital means of payment is another. To ensure that consumers continue to have unfettered access to central bank money in a way that meets their needs in the digital age, the ECB decided to advance work on the possible issuance of a digital euro and started a preliminary analysis of potential solutions for the technical implementation of a central bank digital currency (CBDC) from the perspective of the Eurosystem. In this context, the Bank of Italy is currently cooperating with the ECB and the euroarea national central banks to assess the potential of TIPS as a possible technical solution for a digital euro. Indeed, with its speed, cost-efficiency and high scalability, TIPS is best placed to meet the basic requirements laid down by the Eurosystem for a digital euro,5 allowing the processing of one billion transactions per day and the management of hundreds of millions of accounts. Important innovations are under way in TIPS. The ECB and the Bank of Italy are in the process of developing a roadmap to upgrade TIPS from an evolutional, operational resilience, and financial perspective. The roadmap will identify priority action areas and set objectives, balancing the need to enable TIPS to handle new business cases and to ensure its operational resilience, also in view of the increase in the volume of transactions as a result of the reachability measures’ implementation. *** By way of conclusion, please allow me to express my gratitude to all the Bank of Italy and ECB colleagues who will make contributions to this seminar, and who will share their knowledge and experience with you. I am sure that this exchange of information will prove extremely useful for understanding the complexity of the current transformation of the payment industry but also just how committed the Eurosystem is to supporting the digitalization of the European economy and to actively encouraging innovation in retail payments. Once again, let me extend our welcome to everyone who has joined us here today. I wish you a very successful seminar. 1 See I. Visco, The role of TIPS for the future payments landscape, presentation at the virtual conference ‘Future of Payments in Europe’, Deutsche Bundesbank, November 2020. 2 See P. Tiberi, ‘The Carbon Footprint of the Target Instant Payment Settlement (TIPS) System: A Comparative Analysis with Bitcoin’, Bank of Italy, May 2021. 3 For a general overview of the SIP model, see the document ‘Explainer on SIP settlement model’ from the European Central Bank’s website, on the TIPS page. 4 See European Central Bank, ‘Denmark to join Eurosystem’s TARGET services’, press release (MIP news), Frankfurt, December 2020. 5 See ECB, Report on a Digital Euro, Frankfurt, October 2020 3/3 BIS central bankers' speeches
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Opening remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Enhancing Digital and Global Infrastructures in Cross-border Payments webinar, 27 September 2021.
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Ignazio Visco: Opening Remarks on infrastructures in cross-border payments digital and global Opening remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Enhancing Digital and Global Infrastructures in Cross-border Payments webinar, 27 September 2021. * * * I am pleased to open this webinar on “Enhancing Digital and Global Infrastructures in Crossborder Payments”, organized by the Bank of Italy in the context of the Italian G20 Presidency initiatives. Its primary aim is to support the activities that are being carried out within the G20 Roadmap on the enhancement of global cross-border payments that was published last October. These activities have been a top priority on the G20 agenda since last year and we are committed to their advancement. This two-day discussion intends to take stock of the progress made in implementing the Roadmap and gather views on the way forward from a variety of parties, including policymakers, industry participants and academics. The approaching end of the G20 Italian Presidency is the ideal time for a comprehensive check-up. Cross-border payments are considerably slower, more expensive, less transparent and less accessible than domestic ones. To an extent, this reflects the large number of stakeholders involved and the need to encompass more than one single time zone, currency, jurisdiction and regulatory framework. Yet, in recent years, international payments have become increasingly important for the world economy, reflecting the expansion of international trade, and especially e-commerce, of international tourism and business travel, of migration and remittances. Progress in cross-border payments is thus more necessary than ever. The improvement of cross-border payments has been at the top of the international agenda for many years. Consider, for example, the action plan launched by the Financial Stability Board (FSB) in 2015 to assess and address the decline in correspondent banking, the 2015 Targets on remittances set by the United Nations as part of the Sustainable Development Goals, and the work carried out by the BIS Committee on Payments and Market Infrastructures (CPMI) on Correspondent banking and Cross-border retail payments. Despite these initiatives, however, the efficiency of cross-border transactions has actually worsened in recent years compared to domestic payments, where the improvements have been enormous, reflecting in particular the introduction of fast payments in several jurisdictions. Only cross-border payments between highly integrated regional areas or within monetary unions seem to have benefitted so far from the major advantages offered by digital innovation, in particular by the supply of fast payments services. Against this background, in 2020 the G20 Saudi Presidency launched an ambitious and challenging plan to enhance cross-border payments at the global level and mandated the FSB to develop a Roadmap, which was, as I mentioned, eventually published last October. Given the complexity of the challenge, the Roadmap is necessarily a multiannual project and will require progress to be made on many separate, yet often interdependent, fronts. The work plan has been structured around 19 pillars or “building blocks”, aimed at paving the way for a favourable global payments ecosystem, taking into consideration a very broad range of legal, regulatory and operational issues. This year, under the G20 Italian Presidency, substantial progress has been achieved by the groups responsible for these building blocks, despite the difficulties caused by the Covid-19 1/3 BIS central bankers' speeches pandemic. Possibly the most substantial progress has been that of setting out specific quantitative targets for the cost, speed, transparency and accessibility of global cross-border payments. These targets aim to build a shared commitment to a common vision and to obtain specific outcomes which will form the basis of actions that will need to be carried out in the future. They were the focus of a public consultation that ended in July. Work is now well under way in taking on board the feedback from this public consultation and in drafting the final recommendations that will be published next month. Tomorrow’s roundtable will take stock of the progress in implementing the Roadmap and discuss the main challenges ahead. The G20 Roadmap encompasses a wide set of initiatives, which cover legal, regulatory and operational issues. With respect to the latter, two main focus areas have been identified: the first is devoted to improving existing payment infrastructures and arrangements by strengthening the existing links (or building new ones) between the various payment systems and reducing settlement risks. the second covers emerging payments infrastructures and explores the potential of new multilateral platforms, global stablecoin arrangements and central bank digital currencies. The first solution would consist in interlinking existing payment systems. It would represent a fast, almost readily-available way to improve the efficiency of cross-border payments. Its viability is already demonstrated by a number of thriving initiatives. A recent experiment carried out by the Arab Regional Payments Clearing and Settlement Organization and the Bank of Italy consists of interoperating TIPS, the Eurosystem platform for instant payments, and BUNA, the cross-border and multi-currency instant payment system owned by the Arab Monetary Fund. It will be illustrated tomorrow in the session on “Payments without frontiers: leveraging existing infrastructures”. Interlinking existing systems is arguably today the most attractive solution for several reasons: the jurisdictions engaged in the interlinking may continue to process payments according to their own legacy standards; costly migrations to common messaging and data formats are mitigated; and, as I mentioned earlier, this solution is almost ready for use as-is, as it can be implemented within a reasonable time frame and at a relatively limited cost. At the very least, it may be adopted to significantly improve the efficiency of cross-border payments in the immediate future, while new, potentially more efficient, solutions are being developed. Let us turn now to the new solutions, those which aim at building comprehensive multilateral platforms. These solutions have the potential of exploiting economies of scale and – at least in highly integrated regions – are likely to represent the natural evolution of interlinking arrangements among existing systems. While potentially attractive, new multilateral platforms may still raise a number of challenges and risks, which are likely to be magnified when moving from regional platforms to a larger, possibly global, scale. These challenges and risks include the need of reaching consensus among a wide range of stakeholders, the complexity of governance arrangements, and the concentration of operational and cyber risks. At the same time, the increasing digitalization of our economies – including the development and potential introduction of central bank digital currencies – offers large potential opportunities, ones that have yet to be fully explored. These risks and opportunities will be considered later today in the panel session on “New Payment Infrastructures” and in the session that will follow, which will take a closer look at some operational facets of two new technologies, namely, DLTs and CBDCs. Whatever the technical solutions may be, it is essential that the public and private sectors 2/3 BIS central bankers' speeches cooperate closely. Indeed, the quality of the service offered to the end users depends crucially on such cooperation. Reaching the optimal balance between public intervention and private initiative is not a trivial point, and raises a number of sensitive issues. We could ask, for example, whether central banks and other public authorities should limit themselves to promoting a gradual convergence towards new legal, regulatory and technical standards, or whether they should take a more central role as developers and operators, so as to deal with potential market failures and neglected collective needs. The panel session on “Enhancing cross-border payments: public/private interaction” will cover these and other related issues. We are all very well aware that several challenges have to be successfully addressed in order to deliver the ambitious goals of the G20 Roadmap. I am sure that this webinar will cast light on a number of them, but it will only be a single step on a “long and winding road”. Other initiatives will need to be carried out before truly positive results are to be obtained. In this vein, the Bank of Italy will soon host another webinar, co-organized with the Monetary Authority of Singapore, which will focus on the challenges and anticipated benefits of interlinking existing payment systems that already allow the processing of fast payments. This webinar will take place on 22 November. It goes without saying that all of you will be invited. To conclude, let me thank the organizing committee for putting together such a rich and interesting program, and let me welcome panelists, presenters, discussants and all other participants. I am confident that, even though we cannot meet in person in these continually difficult times, the discussions of these two days will be intense and thought-provoking and will deliver new and useful insights. I am now pleased to leave the virtual floor to the Managing Director of the IMF,Ms Kristalina Georgieva, to whom I wish to express special thanks for being with us today and sharing her thoughts and insights on this most crucial issue. 3/3 BIS central bankers' speeches
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Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Official Monetary and Financial Institutions Forum (OMFIF)-Sustainable Policy Institute symposium, webinar, 30 September 2021.
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Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the press conference of the Fourth G20 Finance Ministers and Central Bank Governors meeting, Washington DC, 13 October 2021.
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Statement by Mr Ignazio Visco, Governor of the Bank of Italy and Governor of the Constituency of Albania, Greece, Italy, Malta, Portugal, San Marino and Timor-Leste, at the 104th Meeting of the Development Committee (Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources to Developing Countries), Washington DC, 15 October 2021.
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bank of italy
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Address by Mr Ignazio Visco, Governor of the Bank of Italy, to the Association of Italian Savings Banks (ACRI), Rome, 21 October 2021.
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Ignazio Visco: 2021 World Savings Day Address by Mr Ignazio Visco, Governor of the Bank of Italy, to the Association of Italian Savings Banks (ACRI), Rome, 21 October 2021. * * * The way out of the pandemic The economic policies implemented since March of last year by the Government, the Eurosystem and the European Union enabled Italy to deploy sizeable resources to counter the very severe recession caused by the pandemic, and to do so without repercussions for the cost of borrowing, notwithstanding the limited fiscal space available on the eve of the crisis. In addition to strengthening the healthcare system, the measures focused above all on supporting household income and guaranteeing the necessary liquidity to firms. However, they were only partly able to mitigate the fall in consumption, investment and production, also owing to the restrictions on mobility introduced to curb infections. These trends were reflected in strong growth in the savings rate, although it was uneven and concentrated among the less severely affected households, while the public debt rose sharply in 2020, from 135 to 156 per cent of GDP. Over the course of this year, with the successful rollout of the vaccination campaign and the continuing support of economic policies, production has recovered at a higher than expected pace. Thanks also to the competitive capacity that Italy has reclaimed in recent years, exports have benefited from the strong revival in world trade; household consumption has been boosted by the progressive improvement in health conditions; and firms’ investment has displayed a more pronounced cyclical strengthening compared with the most recent recessions. In 2021, GDP is forecast to grow by around 6 per cent; the debt-to-GDP ratio is expected to start decreasing as early as this year, marking a significant improvement compared with the forecasts made even just a few months ago. The outlook remains heavily dependent on the continued, substantial support of economic policies, which can now be more targeted than in the emergency phase and especially geared to stimulate the supply potential of the economy. These developments encourage cautious optimism regarding the speed of the exit from the crisis and point to a rapid return to pre-pandemic levels of activity, albeit with non-negligible sectoral and distributional differences. However, global risks are having an impact, especially those connected with the delays in vaccination campaigns in many emerging and developing countries. In addition, difficulties have emerged, including in the euro area, in the procurement of commodities and intermediate goods, in part due to the very speed of the recovery, with steep rises in energy prices, especially those of gas. The effects of supply bottlenecks, which are starting to be felt in Italy as well, should be considered as temporary, even though they could weigh on production and prices for longer than initially expected. The legacy of the two previous crises For Italy, a return to pre-pandemic levels of economic activity is not a sufficient goal. Indeed, the crisis struck after a long period of slow growth and before the effects of the double-dip recession, due to the global financial crisis and the sovereign debt crisis, had been fully reabsorbed. Between 2007 and 2013, GDP had fallen by 8.5 per cent and the subsequent recovery had been very slow. In 2019, GDP was still almost 4 percentage points lower than in 2007, employment had only regained 2007 levels thanks to the strong expansion in fixed-term contracts, and geographical differences had begun to widen again. 1/7 BIS central bankers' speeches The stagnation in productivity observed since the mid-1990s, the double-dip recession, and the modest recovery that followed caused Italy to fall behind the other advanced countries. GDP per capita, which in 1995 was about 10 per cent higher than the average for the 19 countries that currently belong to euro area, in 2019 was almost 10 per cent lower than the average for those same countries. As we know, this indicator does not consider non-market activities or the social and environmental impact of the production of goods and services; moreover, it does not shed any light on the distribution of income. Despite these shortcomings, which can be addressed by using this metric in conjunction with other appropriate and specific indicators, a country’s GDP per capita is closely correlated with variables such as life expectancy, educational attainment, the quality of nutrition and hygiene, and the effectiveness of health systems. Overall, this indicator constitutes a basic quantitative benchmark against which to assess the degree of economic development of a country. In the years preceding the health crisis that has struck us so hard, there had been significant improvements in the allocation of resources, in the financial conditions of firms and banks, and in firms’ competitiveness in the international markets, also following the exit of the weakest ones from the market. These developments had increased the production system’s capacity to withstand shocks, but were not sufficient to relaunch productivity growth. The most important factors explaining the modest recovery between 2014 and 2019 included, without doubt, insufficient capital accumulation, which is beset by unresolved structural issues. After dropping by just under 30 per cent between 2007 and 2013, in 2019, gross investment was still about 20 per cent less than what it was in 2007; as a share of GDP, it was 4 percentage points below the euro-area average. In addition to compressing domestic demand, weak investment also curbed technological and infrastructural upgrading. This reduced the margins for growth in wages, income and private consumption. It also hampered the decrease in the ratio of public debt to GDP, which – after rising by almost 30 percentage points between 2007 and 2013, to 132 per cent – stabilized at around 135 per cent in the period up to 2019. The decline in the public sector component accounted for about one fourth of the overall contraction in investment. However, it was apparent that private savings also had difficulty finding viable investment opportunities in the real economy. It is therefore necessary to create the conditions that enable savings, both domestic and foreign, to locate suitable private investment opportunities; similarly, public sector resources, including those made available through the EU, must be used to lay solid foundations for a return to a stable path of strong growth. Household savings and the strengthening of firms’ financial structures Since the outbreak of the pandemic, bank deposits by households and firms have grown by over €200 billion. The increase has reflected both the restrictions on mobility imposed to curb the spread of the virus and the heightened uncertainty concerning the economic outlook; both factors have served to spur precautionary saving and to restrain capital accumulation. Part of this liquidity will naturally dwindle once consumption and investment begin to increase again; we have seen the first signs of this in recent months, with a slowdown in deposits and the decline in the propensity to save, which is, however, still above pre-pandemic levels. Between the end of 2019 and March of this year, the financial assets held by households increased by €135 billion (or over €200 billion if changes in share prices are also taken into account). Most importantly, the deposits and cash component expanded, reaching about one third of the total, a historically high figure, but assets directed towards investment fund units and savings managed by insurance companies also rose. Compared with the European average, Italian households invest a smaller portion of their financial wealth in pension funds (3 per cent, compared with 10 per cent), instead preferring to 2/7 BIS central bankers' speeches allocate a larger share to investment funds and to ‘shares and participating interests’ (respectively, 15 and 21 per cent, compared with 10 and 18 per cent). Just a small portion of investments in funds, however, are used to finance resident firms: domestic shares and bonds make up 5 per cent of the total assets of these funds, compared with 34 per cent in France and 14 per cent in Germany. Among the direct investments in ‘shares and participating interests’, those in listed shares account for 2.4 per cent of financial wealth, half of the observed euro-area average. However, investment in participating interests, usually focusing on small, unlisted firms, is significant. This portfolio composition is largely a reflection of the structure of Italy’s productive sector, characterized by numerous small firms, where owners and managers frequently coincide, and by the relatively limited number of listed companies. Italy’s market capitalization-toGDP ratio is less than 25 per cent, compared with almost 100 per cent in France, 50 per cent in Germany and 40 per cent in Spain. The meagre offering of liquid and negotiable instruments by Italian firms curtails the role that the market could potentially play in financing the economy. This is a function typically performed by institutional investors and financial intermediaries such as open-end investment funds, which make their decisions on how to allocate their portfolio based on the principles of risk diversification and holding highly liquid shares. If savings are to be effectively directed towards supporting resident firms, action must be taken especially on the supply side of financial instruments. This would improve the likelihood of attracting foreign investment, thereby also reaping the benefits expected to arise from the development of a truly single capital market in the European Union. Some modest progress has been made recently. In 2019 and in 2020, despite the crisis, the value of bonds issued by Italian firms, while still low by international standards, was equal to around €47 billion, compared with an average of €35 billion for the previous five years. The number of initial public offerings reached a historic high of 33 in 2019, and decreased to 21 in 2020, a figure nevertheless in line with the 2014–18 average. Additional important steps forward must be taken to increase the capitalization and size of firms and to enhance their ability to innovate. What is needed is a streamlining of tax incentives, which have built up over time, so as to ensure that the framework of reference is stable for small investors, institutional investors and companies. Measures to increase protections for savers and investors are being taken alongside those to expand the range of financial instruments offered by firms. Fairness and transparency in dealings between intermediaries and customers in and of themselves contribute to attracting investment. While on the one hand, we have on more than one occasion emphasized how important it is that players in the asset management industry conduct themselves in full compliance, and not just formally, with the laws and regulations, we are equally aware of the critical role played by the various oversight authorities that are responsible in this area. Through the creation of the Directorate General for Consumer Protection and Financial Education, the Bank of Italy has laid the foundations for strengthening its supervision to guarantee transparency and fairness in dealings between intermediaries and customers in the supply of banking products and payment services, to ensure more effective support for the industry’s alternative dispute resolution body, namely the Banking and Financial Ombudsman, and to expand the financial education programmes targeting students and adults. These are initiatives designed not only to improve the public’s ability to invest their savings efficiently, but also to raise awareness of the risks associated with the different financial instruments. As regards crypto-assets, the Bank of Italy is dedicated to limiting the risks that could arise from an uncontrolled spread of these instruments, whose market capitalization at global level tripled in 2021, reaching $2,500 billion. We have informed the public about the dangers of these digital assets whose value is intrinsically unstable and that can also facilitate illegal transactions. For assets that, instead, seek to maintain a stable value over time (known as ‘stablecoins’) and that, 3/7 BIS central bankers' speeches given their characteristics, could be used to make payments, we are contributing to the discussions on defining a European regulatory framework that envisages, among other things, redemption rights and rules for ensuring the issuer’s ability to satisfy requests for reimbursement without having to make sudden sales of securities. We have also contributed to defining the ten recommendations on these assets adopted by the Financial Stability Board (FSB) and recognized by the Group of Seven (G7) regarding the regulatory and supervisory implications. We are fully committed, in forums for international cooperation, to guaranteeing that innovation in private digital payments is secure; within the context of the G7, we have also reiterated that no stablecoin project can go forward until it has adequately satisfied the legal, regulatory and supervisory requirements. Limited recourse to the capital markets by firms hinders capital strengthening and exposes them to the risk of imbalances in their financial structure. Although the quality of bank loans has not yet been affected by the crisis, thanks in part to the economic support and recovery measures, since the end of 2019, the amount of lending against which banks have recorded a significant increase in credit risk (those classified as ‘Stage 2’ in the IFRS 9 hierarchy) grew by 40 per cent. In light of these developments, we call upon banks to continue to carefully assess the outlook for borrower firms and to make prudent and timely provisions. The high level of indebtedness of some firms, especially in the sectors hardest hit by the crisis, could make debt restructurings necessary to give those firms capable of overcoming the difficulties caused by the pandemic sufficient time to meet their obligations. Procedures and conditions for transforming a portion of the debt into equity will also need to be considered. Our legal system provides for a variety of debt restructuring tools and procedures for distressed firms (recovery plans, debt restructuring agreements, compositions with creditors), but delayed, expensive and drawn-out judicial proceedings lessen their effectiveness. To encourage corporate restructurings, last August the Government introduced a ‘negotiated composition for the resolution of distressed firms’. Firms will be able to enter into negotiations, assisted by an independent expert who will act as a mediator, to reach an agreed solution with creditors. Having an expert on hand, being able to begin the process soon after economic and financial imbalances emerge and applying purely out-of-court solutions could help reduce the obstacles to recovery, especially for small firms. Just like other creditors, banks will be invited to actively participate in the negotiations. Further improvements to the regulatory framework for crisis management will be possible with the transposition, now under way, of the 2019 European directive that harmonizes the legal arrangements for restructurings. An increase in recourse to out-of-court solutions could also help reduce the courts’ work load. Action is still needed, however, to significantly cut the length of liquidation proceedings for firms that are no longer able to remain in the market. Overly lengthy proceedings have a negative impact on the functioning of the credit market and hinder the reallocation of resources to the production sector, with adverse effects overall on productivity, on the ability to attract foreign investment and on economic growth. Greater variety in firms’ sources of financing, accompanied by effective protection of savers, and a better functioning of civil justice would surely favour the use of household savings in support of productive activity. Nevertheless, the further strengthening of Italian firms’ capacity to innovate and grow is still necessary to attract domestic and foreign capital. The National Recovery and Resilience Plan Over the next few years, until 2026, investment in Italy will benefit from funds disbursed under the Next Generation EU programme, requiring the implementation of reforms and investment that can lay the foundations for relaunching growth and facing the challenges posed by climate change and the digital revolution. Italy has been allotted €205 billion: €191.5 billion from the 4/7 BIS central bankers' speeches Recovery and Resilience Facility, the main component of the NGEU programme, and €13.5 billion from the REACT-EU programme. This is one quarter of the €807 billion allocated overall by the European Union (€750 billion at 2018 prices); Italy’s share of the funds actually used could be even higher, since not all countries have as yet indicated whether they intend to fully utilize the loans to which they are entitled (the funds earmarked for Italy amount to more than one third of those requested so far). The National Recovery and Resilience Plan, set out under the NGEU programme, envisages interventions worth more than €235 billion: European resources are flanked by national ones from the Complementary Fund set up last May (over €30 billion). The Plan will support recovery in the short term, but its success will be measured by its ability to tackle the structural obstacles that hinder growth and to mobilize private resources, which for too long have struggled to find an outlet in our production system. Tangible and intangible infrastructure projects, together with the ambitious reforms to which Italy is committed to achieving, can expand the opportunities for private investment, increasing the efficiency and profitability of capital. The effective execution of the Plan will be able to boost firms’ confidence in the possibility of undertaking a path of growth and sustained demand, thereby encouraging a return to structurally higher levels of investment. It will be equally important that the expansion and technological innovation programmes of firms, which today are searching for new equilibriums because of the pandemic, can count on a skilled labour force suited to the new production context. The Plan includes numerous interventions designed to improve the quality of public education, but firms themselves can do a great deal by focusing more decisively on training for human resources. With this in mind too, they should be encouraged to attain the scale required to bear the costs of investing in the knowledge needed to approach the technological frontier. Policies to support the ecological and digital transition, which are at the heart of the European strategy, will provide a strong stimulus for upgrading production systems through the adoption of new technologies, the development of new production processes, and investment in the skills necessary to deal with change. A window of opportunity has opened for raising the quality of the production system and of public intervention to the levels needed to relaunch productivity. It is on the latter that the longer-term outlook for growth ultimately depends, especially in a country like Italy, which will have to deal with a marked decline in the working age population from the end of this decade. Over longer time horizons, this decline could turn out to be even worse than was forecast in the demographic projections drawn up prior to the pandemic, given the trend in the birth rate, which has fallen further since last year. For this reason, carrying out the Plan in full is an opportunity that Italy cannot miss, especially for young people, to whom Italy has only given limited job opportunities in the last 25 years, forcing many, and often the best qualified, to build their future abroad. The public debt and growth Reviving growth is also the key to reducing the public debt, an element of inherent fragility in our economy, as it exposes us to the risk of financial shocks and creates underlying uncertainty, which in turn affects borrowing costs and discourages private investment. Recourse to indebtedness is crucial for countering crises such as the one we are experiencing, but measures to support demand cannot be used to stimulate economic activity on a permanent basis. Debt can be used to finance investment that is vital for production, and in Italy there is certainly no lack of areas where more spending is required, starting with infrastructure, innovation and education. It can be used in adverse economic conditions in order to fund social safety nets, and in emergency situations, such as those caused by the pandemic, to allow extraordinary interventions to be made. Nevertheless, as a rule, debt cannot be used to cover current expenditure. 5/7 BIS central bankers' speeches The share of spending on pensions will continue to grow over the next twenty years because of demographic dynamics; for the same reason, health and welfare could also require an extension of the services provided. If Italy decides to maintain or extend the perimeter of public intervention, it will be necessary to ensure that such measures have adequate coverage, without financing permanent increases in deficit spending, as has instead happened in the past. Financing conditions, which are expected to remain relaxed, together with greater long-term growth, may lead to a decrease in the debt burden. It is not possible, however, to rely solely on a cost of debt maintained indefinitely at the current exceptionally low levels, which also reflect the extraordinarily expansionary stance of monetary policy. To prevent the instability risks experienced in the past from resurfacing, once the crisis is over, it will be necessary to step up the pace of recovery, including by rebuilding adequate primary surpluses. *** The European Union and the European Central Bank have countered the crisis with exceptional means and instruments, also facilitating the use of enormous national budget resources by individual countries. This was a far more incisive response than the insufficient one provided during the global financial crisis and above all during the subsequent sovereign debt crisis. The pandemic has nevertheless further highlighted the limits of the current European arrangements, which do not provide for a common fiscal capacity. A sufficiently broad capacity, with the possibility of borrowing to finance investment projects or of activating social safety nets and common welfare programmes, would allow a European fiscal policy to stand alongside monetary policy action in countering wide-ranging economic shocks. European debt would also be a supranational financial instrument with a high credit rating, which would facilitate the diversification of intermediaries’ portfolios and the integration of European capital markets, thereby improving the effectiveness of monetary policy. In order to swiftly guarantee liquidity and market depth for this new instrument, there could be a pooling of part of the debts of individual countries by means of a redemption fund that would withdraw national instruments by issuing European securities. This part should at least include the debt contracted by all member countries over the last two years in order to cope with the effects of the pandemic. Fears that this kind of mechanism could lead to systematic transfers of resources to more indebted countries are understandable, but they can be dispelled by the adoption of adequate technical measures. The urgency of the times enabled us to overcome our fears and resistance during the pandemic. The NGEU programme is unprecedented in both size and purpose; it is financed by EU debt, guaranteed by its own revenues and mainly aimed at countries in greatest difficulty. It is, however, a temporary instrument: the path towards a permanent modification of the EU’s architecture through the establishment of a permanent European fiscal capacity has yet to be mapped out. This is why I recalled in May that the countries that will benefit most from the resources made available by the NGEU programme have a twofold responsibility: to seize this historic opportunity to resolve their structural problems and to demonstrate with concrete results the importance of a stronger and more cohesive Union, making it more likely for further steps to be taken regarding European public finances. The Government plans to use most of the room for manoeuvre provided by the improvement in the current legislation scenario to undertake new expansionary measures, as set out in the Draft Budgetary Plan approved two days ago, with partially permanent effects on the public deficit. According to the Government’s plans, thanks to higher GDP growth, the debt-to-GDP ratio will in any case decline more than was forecast only a few months ago. If the economy’s performance continues to be better than forecast, it will be important to exploit this to reduce the deficit. Through responsible management of public finances, Italy can speed 6/7 BIS central bankers' speeches up the decrease in the debt-to-GDP ratio, thereby limiting a significant source of risk. In this way, it can be shown that, if correctly employed to remove obstacles to growth, temporary and ample support for the economy favoured by common policies is not at odds with but rather reinforces euro-area stability, with benefits for all the Member States, particularly for our society and our economy. 7/7 BIS central bankers' speeches
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Welcome remarks Mr Ignazio Visco, Governor of the Bank of Italy, at the awards ceremony for the G20 TechSprint on green and sustainable finance, organized by the Bank of Italy and the Bank for International Settlements, Milan, 25 October 2021.
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Ignazio Visco: Awards ceremony for the G20 TechSprint on green and sustainable finance Welcome remarks Mr Ignazio Visco, Governor of the Bank of Italy, at the awards ceremony for the G20 TechSprint on green and sustainable finance, organized by the Bank of Italy and the Bank for International Settlements, Milan, 25 October 2021. * * * I am delighted to welcome you to this awards ceremony for the second G20 TechSprint on Green and Sustainable Finance organized by the Bank of Italy and the Bank for International Settlements. I would like to thank Benoit Cœuré, Andrew McCormack and the whole team from the Singapore BIS Innovation Hub for their invaluable cooperation in all the steps of our TechSprint. TechSprints are technological competitions designed to spur innovation, collaboration and creative solutions to daunting problems. Our G20 TechSprint had a very ambitious goal. It was designed to help financial markets in sharpening their assessment and selection tools for channeling funds towards green and sustainable finance, leveraging on the latest technologies. Fintech and innovators were summoned to put forward their best solutions. I am very pleased that the improvement in the public health situation, following remarkable progress in the vaccination campaign, allows me to be here in Milan to acknowledge the achievements of the 21 brilliant finalist teams who have offered valuable technological contributions in a very special area. Indeed, finding ways to foster appropriate green and sustainable finance to invest in the crucial fight against climate change has been one of the key priorities of the Italian Presidency of the G20 this year. The urgency of acting to stop climate change and of mitigating its consequences is plain to see. The increase in the intensity and frequency of extreme weather events has obvious, and major, social, as well as economic, consequences. Central banks and supervisory authorities, international institutions and market participants have therefore been paying significant and increasing attention in recent years to developing a better understanding of the implications of climate change for the financial sector and financial stability. In fact, climate change-related financial risks pose both micro- and macroprudential concerns, but analysis and research are still at an early stage. Although there is broad consensus within the scientific community on the trends and causes of climate change, the timing and magnitude of future climate outcomes remain uncertain. This range of possible future physical outcomes arising from climate change is crucial to understanding “climate risks” (or better again, “climate uncertainties”). Climate and econometric models that integrate different climate scenarios and their potential economic impacts to assess these risks are being developed and refined, but measuring the economic costs of climate change (and of climate policies) is a work in progress. We can assess the immediate costs of more frequent and intense natural disasters, but most of the potential costs lie beyond the typical horizon of economic and financial analyses. Climate change risks can unfold through the economy, especially if the transition to net zero emissions proves poorly designed or hard to coordinate globally, with ensuing disruptions to international trade. Financial stability concerns arise when asset prices adjust too quickly, reflecting unforeseeable realisations of transition or physical risks. However, it is unclear how much today’s asset prices reflect the extent of the policy actions required to limit global warming to 2˚C or their impact on the economy and the financial system. A major challenge for financial investors is then how to align the incentives to channel 1/2 BIS central bankers' speeches entrepreneurship towards productive and beneficial activities such as technological innovation and, at the same time, prevent unproductive destructive activities that damage the environment. This is why we believe that interacting with start-ups and fintech in such endeavour could be very useful, and why we are today in Milan where our financial innovation centre, the Bank of Italy’s Milano Hub, has recently started to operate. Indeed, we are convinced that this interaction may bear considerable fruits in several areas. Currently, we are looking for contributions in the field of artificial intelligence in improving the provision of banking, financial and payment services to businesses, households and the public administration. The proposals should focus on financial inclusion, sound consumer protection, and data security. To conclude, this TechSprint seems to me a well-designed contribution to foster innovation in an area, such as the fight against climate change, where both data and methodological gaps prevent accurate and sound data-driven solutions. It attempts to spur the public and private sector to identify profitable cooperative solutions aimed at achieving sustainable development goals. Winners should go well beyond the prizes, towards the pursuit of reliable and sound solutions for sustaining the development of a solid green finance market. And we encourage all finalists to continue to refine their proposals, because financial authorities and market players avidly await new technological solutions to bridge the present informational gaps. If fostering interaction and competition among companies is important in normal times, it is even more so in times when problems are more urgent, when decision-making processes need timely and high-quality studies, which can benefit from broader cross-country perspectives. These international awards are a way of encouraging both competition and cooperation. The aim is to not only recognise the extra talent of the winning teams, but also to get to know that of the other participants. This is why we arranged this awards ceremony. Therefore, I would like to salute also those teams who have not won any prize and reassure them that there will be many more opportunities in future months. As a final word, let me take this wonderful opportunity to thank our colleagues and organizers from the BIS and the Bank of Italy for their ceaseless patience and hard work in taking up an exceptional organizational challenge. Thank you all. 2/2 BIS central bankers' speeches
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Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Singapore FinTech Festival, virtual, 10 November 2021.
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Ignazio Visco: An overview of the work of the G20 under the Italian presidency Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Singapore FinTech Festival, virtual, 10 November 2021. * * * I would like to thank Ravi Menon for his kind invitation to this FinTech Festival and the staff of the Monetary Authority of Singapore for their very helpful assistance. In these remarks, I will provide a brief overview of the work and the main results achieved this year by the Group of Twenty (G20) under the Italian Presidency, with special reference to its Finance Track. Italy took up the G20 Presidency at a critical time, not only due to the pandemic, but also because multilateralism had suffered major setbacks in previous years. This bout of inwardorientation in economic relations is perhaps best exemplified by the trade tensions between the United States and China, but is certainly not limited to this, with Brexit being another important example. This “crisis of multilateralism” has its deepest roots in the prolonged inattention given to the side effects of globalisation and technological progress. These phenomena, despite their positive impact on welfare and their contribution to the reduction of cross- country inequalities, have caused significant losses for segments of populations, not least within advanced economies, that were unprepared for these changes and found themselves unprotected during the process. The start of our G20 Presidency in December 2020 also coincided with the transitioning to the new administration in the United States. Since then, multilateral dialogue has been reignited across many dimensions and this momentum has positively impacted our G20 Presidency, facilitating the achievement of several important results. The key challenges that all our economies are currently facing continue to be related to the pandemic and to its direct and indirect consequences. This is the main reason why many people have been pushed into poverty, unemployment has increased, and both public and private debt have risen. The unequal distribution of vaccines in all regions, especially in the least developed ones, remains a major risk factor for the global economy. In order to help the weakest economies address the health crisis, debt service payments for 50 countries have been suspended since 2020, and the Italian Presidency has succeeded in extending this provision until the end of this year. Moreover, a consensus has been reached for a general allocation of Special Drawing Rights by the IMF (for 650 billion dollars), which will allow low-income countries to receive further support. The G20 has also supported the ACT-A program (Access to COVID-19 Tools Accelerator) promoted by the World Health Organization (W HO) and in particular its “vaccine pillar”, COVAX, aimed at ensuring wide access to tests and vaccines. In addition to tackling the emergency, possible tools to strengthen prevention and preparedness against future global health threats have been envisaged. We have established a High Level Independent Panel to elaborate proposals on how to ensure the prompt, adequate and coordinated mobilisation of funding. One of its main recommendations has concerned the creation of a new Global Health Threats Board, bringing together representatives from Health and Finance Ministries and international organisations. This proposal has received strong support from all the relevant international institutions, in particular the W HO, although not all G20 members are yet on board. It was therefore decided to establish a task force to develop possible coordination arrangements, which we hope will deliver a shared solution next year. The most visible result probably concerns taxation. The July agreement reforms the architecture of international taxation, addressing the issues posed in this field by globalisation and digitalisation. On one hand, it sets the rules for the reallocation of taxing 1/3 BIS central bankers' speeches rights on excess profits of the largest multinationals to jurisdictions in which they have significant economic engagement, irrespective of their physical presence; on the other hand, it sets a common framework for the introduction of a minimum level of taxation on the profits of multinationals. In October we also approved an ambitious timeline for implementation by 2023. This agreement will contribute to stabilising the international tax system, ensuring a greater degree of fairness. While in the short term global economic prospects depend mostly on the evolution of the pandemic, in the long term the reduction of greenhouse gas emissions will be fundamental. Italy therefore insisted on including the fight against climate change in this year’s priorities, one of the most defining issues of our time that has often been overlooked by the G20 in the past. This year our Presidency relaunched the Sustainable Finance Study Group, which has now been transformed into a permanent G20 working group, with the United States and China – the two largest economies and greenhouse gas emitters – agreeing to co-chair it. This group is set to be a coordination centre to mobilise financial resources, using the new Sustainable Finance Roadmap to best reflect the priorities set by future G20 Presidencies. The Italian Presidency has also promoted the development of a global baseline for disclosing and reporting sustainability information; it has focused on metrics for classifying and verifying sustainable investment; and it has called on international financial institutions to align their operations with the aims of the Paris Agreement. Other initiatives to further promote sustainability include: the request to the IMF and the international organisations of the Interagency Group on Economic and Financial Statistics to consider climate-related data needs in preparing a new Data Gap Initiative; the work carried out by the Financial Stability Board to both address data gaps on climate-related financial risks and enhance disclosures; the proposal to examine how to scale-up digital finance to promote sustainable growth; and the analytical review of specific solutions to achieve climate neutrality, including carbon pricing. Digitalisation also received ample consideration in our agenda. In July the G20 Menu of Policy Options on Digital Transformation and Productivity Recovery was endorsed. It provides an overview of measures to revive productivity growth, with a particular focus on digital platforms, digital skills and intangible assets. This Menu will contribute to future discussions within the G20 and will eventually serve as a guide for effective policies and regulations, to ensure that the benefits of digitalisation and innovation are fully exploited and evenly shared. As part of our drive to foster the development of new technologies, in May the Bank of Italy and the Bank for International Settlements (BIS) Innovation Hub, through its Singapore centre, launched a new G20 TechSprint, following an analogous initiative last year by the Saudi Arabian Presidency. Our international hackathon received about 250 draft proposals and 99 full applications from 25 countries; 21 teams advanced to the final stage and the 3 most promising solutions for the proposed challenges, which concerned green and sustainable finance, won the competition. These 3 teams are now competing in the Global FinTech Hackcelerator organised by the Monetary Authority of Singapore at this Festival. I am recording this message before the announcement of the winners, so I wish them all the best of luck. Our attention to the opportunities offered by digitalisation has gone hand in hand with a focus on the challenges that it poses to financial inclusion. The digitalisation of payments and financial services has accelerated sharply during the pandemic. In lower income countries, many citizens can access basic financial services only through online providers. Without comprehensive financial awareness and better consumer protection, consumers, not only in less developed countries, may find themselves exposed to risks due to digitalisation. The Global Partnership for Financial Inclusion, co-chaired by Italy and Russia, has therefore 2/3 BIS central bankers' speeches delivered a Menu of policy options, focusing on two complementary areas, financial consumer protection and financial education. The Menu distils best practices as well as practical examples from different countries’ experiences during the pandemic. Other initiatives will need to be realised to continue carrying out the G20 Financial Inclusion Action Plan established last year, including on micro, small and medium-sized enterprises and on the collection of more granular and gender-disaggregated data to inform policymaking and best support the transition towards a more inclusive financial system, attenuating the risk of a “digital divide”. Another related work stream is the Roadmap for enhancing cross-border payments, a detailed multi-year plan for making transactions cheaper and faster, endorsed by the G20 Saudi Presidency last year. Currently, cross-border payments are considerably more expensive, slower and less accessible than domestic ones. Yet, in recent years, they have become increasingly important for the global economy, reflecting the expansion of international trade, especially e-commerce, international tourism and business travel, migrations and remittances. This year, advancing the implementation of the Roadmap, we have developed a set of quantitative targets necessary for measuring progress in the main areas of intervention, strengthening our commitment to deliver on our goals. In this regard, I take this opportunity to share with you that the Bank of Italy will participate in the BIS Innovation Hub’s “Nexus proof-of-concept” to develop a model for connecting multiple national instant payment systems. In dealing with innovative payment arrangements, we have paid special attention to two important challenges: global stablecoins and central bank digital currencies. On the former issue, the Financial Stability Board has defined ten recommendations for the regulation, supervision and oversight of global stablecoin arrangements which jurisdictions need to implement; the G20 has reiterated that no stablecoin project can be started until these tools meet the necessary legal, regulatory and oversight requirements. On the latter issue, we have initiated an exchange of views within the G20, even if the issuance of a digital currency is, ultimately, a national choice that does not require explicit international cooperation. Indeed, many central banks are already conducting their own experimentations in this area. However, we believe that openly discussing the economic and financial effects stemming from the potential cross-border use of central bank digital currencies in a setting like the G20 will ultimately be beneficial to everyone. Our Presidency has also focused on two other areas concerning financial stability. On one hand, we have analysed the performance of the financial system during the pandemic, the first true test of its resilience since the global financial crisis: we concluded that the regulatory reforms implemented over the last ten years have been effective in making the financial system more robust, although some regulatory issues and gaps remain to be addressed. On the other hand, we have given priority to the work aimed at strengthening the resilience of the non-bank financial intermediation sector, whose structure keeps evolving due to technological, especially digital, innovation. We are therefore committed to implementing the related work plan of the Financial Stability Board (FSB). In particular, as a first important step to addressing the vulnerabilities of non-bank intermediation, the G20 has endorsed the package of policy proposals delivered by the FSB to enhance the resilience of money market funds. Let me conclude by saying that I am grateful for the fact that there has been widespread recognition across all countries of the relevance of this agenda. As we pass the baton to the Indonesian Presidency, I would like to thank our fellow policymakers for their unwavering support and willingness to share their expertise. Our progress demonstrates the importance of overcoming our political divisions for the well-being of our people. 3/3 BIS central bankers' speeches
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Introductory remarks by Mr Ignazio Visco, Governor of the Bank of Italy, to "Economics, History and Economic History in Stefano Fenoaltea's Cliometrics", Associazione per la storia economica and Fondazione Luigi Einaudi di Torino Symposium in honor of Stefano Fenoaltea, online workshop, 12 November 2021.
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Ignazio Visco: Stefano Fenoaltea and the Bank of Italy Introductory remarks by Mr Ignazio Visco, Governor of the Bank of Italy, to “Economics, History and Economic History in Stefano Fenoaltea’s Cliometrics”, Associazione per la storia economica and Fondazione Luigi Einaudi di Torino Symposium in honor of Stefano Fenoaltea, online workshop, 12 November 2021. * * * I wish to praise the Associazione per la Storia Economica and Fondazione Luigi Einaudi for the organisation of this symposium in honour of Stefano Fenoaltea, who passed away suddenly a year ago. And I thank the organisers, Alberto Baffigi and Giovanni Vecchi, for inviting me to deliver the opening address today, which I give with pleasure but also with great sadness. As Governor of the Bank of Italy, I will reminisce on the ties that linked Stefano to the Bank for several decades. However, I would first like to offer some succinct memories of my personal relations with Stefano, which date back to several decades ago. Stefano had a significant impact on my own early career, as he was instrumental in my going to Philadelphia in 1972 to pursue a PhD in economics at the University of Pennsylvania. I had just won a Bank of Italy scholarship, but I was late in applying to different graduate programs in the US. Federico Caffè, my professor and thesis adviser in Rome, suggested checking with Stefano, then a young assistant professor at Penn, while also applying to Chicago. I do not know how Caffè, and other Italian economics professors of the time, knew about Stefano and his whereabouts in that period, as Stefano had mostly grown up and studied in the US, eventually obtaining a PhD in economic history at Harvard. However, it was already obvious that Caffè thought very highly of his work and Stefano, in turn, showed great respect for the older professor. He was extremely kind in providing me with all the necessary information for my application, and making sure that my reference letters were properly compiled and addressed (all this through letter exchanges and notwithstanding the inefficiencies of the Italian postal service, at a time when making overseas telephone calls was rather costly). Eventually, I was accepted to both graduate schools and chose Philly over Chicago not only for the more favourable (in theory) weather prospects, the Keynesian vs monetarist touch, the econometrics taught by Larry Klein, but also, in fact I would say especially, due to the quality assurance and encouragement provided by Stefano. So, newly married, having just arrived with my wife at Penn in late July, I immediately called Stefano, who very kindly invited us over for dinner. Once there, he launched into a lecture about the requirements of the school, the need to work hard, indeed very hard, as the completion of a PhD there would be extremely demanding, about thinking twice before deciding that my wife should stay in the US with me while I was so heavily involved in completing my education, etc. All this in a gentlemanlike manner, but, I would say, not as pleasant as I might have hoped. In the end it all worked out for the best, but we still remember, and in later years we also discussed this with Stefano himself, the feeling of slight uneasiness we felt upon leaving his house. Well, Stefano was indeed special, an extremely gentle and reserved person – I read Deirdre McCloskey describing him as “aristocratic” in her moving obituary – and yet at the same time a very harsh and demanding one. Once you got to know him, you discovered a genuine treasure. The problem was that this process was not quick, nor easy. And his character, his statements and answers were crucial for the way he chose to pursue his US academic career. He was always recognised as a stellar researcher, but his attitude as a cooperative and helpful faculty member was at times questionable and questioned, to say the least. I did not interact much with him as a scholar, not even during my time at Penn, even though we exchanged papers and books over the years. Our interests did indeed seem a bit distanced, 1/4 BIS central bankers' speeches without much overlap. He seemed to pay little attention to the macroeconomic, monetary and policy issues I have mostly been working on over the years. For my part, I found his methodological work very insightful but did not have the time, or perhaps the patience, to follow him in his extremely detailed reconstructions of possible “estimates” of measures of economic activity, and possibly of well-being, essential to ensure the high quality historical studies that he considered necessary, and worth being involved with. However, I remember his contributions in the 1970s rather well, having read them both at Penn and in Rome, attending some of his seminars and discussions on railroads and real value added, slavery and causality. And he engaged, alla pari, with giants of his field such as Robert Fogel and Douglass North. Indeed, he used his extreme fluency in economic theory, and especially with the neoclassical tools of the field, to provide substantial new insights, correct misinterpretations and suggest new perspectives. I still recollect how interesting, and unconventional to say the least, I found his paper on real value added and the measurement of industrial production published in 1976 in the NBER Annals of Economic and Social Measurement. It triggered a debate with Christopher Sims who, arguably, did not quite grasp Stefano’s main point: that in the context Stefano was interested in, an appropriate measure of real value added should reflect changes in relative prices, and not just the physical flows of goods and services. Stefano returned to this issue over time, most recently in the fascinating second chapter of his last book Reconstructing the Past (Fondazione Luigi Einaudi, 2020), where he discussed “le regole dell’arte”, the rules of the trade he recommends we follow in “reconstructing economic growth”. I refer in particular to section 2.4 where he sets out his Rule 4: “Deflate all current-price values with the same deflator!” It is a deep, not easy chapter to read, even if written in his usual crystal-clear English, where the neo-classical theory of his craft seems to me to come to terms with the legacy of the classical economists. I also remember reading his considerations on the minor role of railroads in the Italian post unity decades and their factual importance for growth in the United States (helping to properly interpret Fogel’s “provocative”, as he defined it, major contribution). Indeed his insufficiently quoted 1973 paper on the methodology of counterfactual analysis in the Journal of European Economic History is a true masterpiece. Obviously, other will say much more, and much more effectively, on his contributions to economics and economic history: the symposium’s program is rich and well-focused on Fenoaltea’s main topics of study. However, before briefly talking about what he did with and for the Bank of Italy, I would like to make one final consideration. Stefano Fenoaltea was, as I said, very demanding as a scholar, indeed a first-class economist and “data scientist”, even if he would have certainly objected to my use of both terms. Both economic theory and proper measurement were prerequisites, in his view, to approaching economic history with sufficient confidence. And at times, though gifted with an exquisite, entertaining and amusing personality, he could be harsh in his judgments and appear rude in his statements. I suppose that this was his way of giving value to what he considered to be absolutely necessary in carrying out research that would stand the test of time and of new ideas. He was indeed a very logical, sophisticated thinker, a true, uncompromising, researcher. But as an academic, and a teacher, for a long time, at least during the time of his US peregrinations, he appeared to me to be rather unsettled, senza pace. So, I was indeed very surprised to discover how good and how appreciated a teacher and student adviser he ended up being in his second academic life in Italy, in Brescia and in Rome. It was indeed somewhat of a surprise, although I should probably have expected it, for me also to find that he had written a thoughtful, clear, acute textbook of lectures in political economy, complete with exercises and very thought-provoking problem sets. Unpublished in paper form, it 2/4 BIS central bankers' speeches is easy to find it on the web (Lezioni di economia politica). The tools of the art, the approach, are obviously neo-classical, but the way they are used, the awareness of their strengths and weaknesses, is an original and thoughtful contribution in itself. Take, for example, the fundamental idea that the study of economics cannot do without ethics. He emphasises this idea in the concluding paragraph, in the 2001 edition, where he argues that such an important point had been clear for some decades, but often forgotten. Translating from Italian, these are his lines: Only a few biased ideologues could argue that the market made ethics absolutely irrelevant; rather, economics teaches us what can be done by appealing to interests rather than ethics, thus preserving the use of ethics for cases in which they are indispensable. If we want to save oil, for example, it is useless to appeal to the conscience of citizens, it is enough to increase the price of petrol and diesel; if we want to protect the environment from petty pollution by the public we can only educate citizens to be conscientious. The memory of Stefano’s long engagement and fruitful collaboration, and friendship, with the Bank of Italy and its researchers is also vivid. Starting from the late 1980s Stefano Fenoaltea actively participated in the work on the research project that Carlo Azeglio Ciampi promoted for the centenary of the Institute in 1993, with Pierluigi Ciocca as a mentor and Franco Cotula as Head of the newly created Historical Research Office. These studies were published in the Historical Series of the Bank of Italy and can now all be accessed online on the Bank’s website. Over the years Stefano was heavily involved in the reconstruction of value added data, especially on industrial production and eventually also at the territorial level, for several benchmark years, starting from the crucial 1911 that would cause a good deal of controversy among Italian economic historians. His works were published as chapters of our Historical series books, two of them edited by Guido Rey, the former President of the Italian national statistical institute. He was also a substantial contributor to the Bank’s Historical Research Papers (now the Economic History Working Papers). Over the last twenty years and until his untimely death, while engaged in the project for the reconstruction of regional statistics, Stefano further developed his fruitful collaboration with the Bank of Italy, in a more organic way and on an even closer basis. He joined the Scientific Committee of the Historical Research Papers, contributed to the planning of the Seminars in Economic History and reviewed many studies. He was a regular point of reference for (often scientifically severe) confrontation and exchanges of ideas, for reflections on the economic history of the country, on the methodologies of analysis, on the interpretation of the results. He also contributed with his constructive criticism to the success of another major historical economic research project carried out in the Bank under the direction of Professor Gianni Toniolo for the 150th anniversary of Italy’s Unification. Furthermore, he significantly helped to foster the development of the relationships between economists and economic historians of the Bank and the Italian and international academia. As I said, during his long-lasting collaboration with the Bank, our Economic History Working Papers were a primary tool Stefano chose for disseminating the preliminary results of his works of statistical reconstructions as well as other contributions. Over the last decade he continued on almost a daily basis to frequent the offices of the Economic History Division where he had a workstation at his disposal. It is also, therefore, on the Bank’s premises, that he developed and matured the thoughts related to the latest scientific production collected in his last work, Reconstructing the Past, which I previously mentioned. In this book he once again advanced his strong criticism of the interpretation that ascribed the economic acceleration observed during the Giolitti era to a take-off, a big spurt, mostly determined by domestic developments. He fought for an alternative interpretation until his very last writings, against his “neo-gerschenkronian” opponents, as he labelled them. 3/4 BIS central bankers' speeches He thoroughly revised the foundations upon which the different interpretations of Italian growth in the fifty-year post-Unification period rest (finally saying, in a 2017 paper, “it turns out we were all egregiously in error”). He then wrote pages defined as “scripta senectutis” (“Spleen: The Failures of the Cliometric School”, Banca d’Italia,Economic History Working Papers, 44, March 2019, and Annals of the Fondazione Luigi Einaudi, 55/2, 2019). There he proceeded to denounce some aspects of failure for economic historians (a methodological critique that probably not a single “new economic history” scholar can avoid having to deal with), and that Stefano wanted to exhibit as a Lutheran reformation for cliometricians, writing: “... and to a church door I nail these theses: that we cliometricians have failed as economists, that we have failed as historians, that we have failed as economic historians”. Clearly, this is too harsh a statement, certainly with reference to his own contributions. And there is much more, in this “Spleen” paper on the failures of the cliometrics school, about the methodological needs of the discipline, of economic history as well as economics at large, that those few lines suggest. Indeed, this seems to be the proper complement of his other methodological piece on counterfactual analysis written at the start of his career, which I mentioned before. This, notwithstanding the excessive harshness of his choice of words (which we also find in his latest book, and about which I remember often complaining to Stefano himself, who never objected much, but rather continued in the way he knew would also catch the attention of his readers). Stefano always refrained from claiming that there were absolute truths out there to be discovered, but instead emphasised the importance of cultivating the art of doubt. As he often mentioned how important his classical education had been to him, it therefore seems appropriate to me now to recall the final verses of a well-known poem by Eugenio Montale, “Non chiederci la parola”, “Don’t Ask Us for the Word”), a poem also dear to Federico Caffè: “N on domandarci la formula che mondi possa aprirti, / sì qualche storta sillaba e secca come un ramo. / Codesto solo oggi possiamo dirti, / ciò che non siamo, ciò che non vogliamo.” (in Valeriu Raut’s English translation: “Don’t ask us for the phrase that can open worlds, / just a few gnarled syllables, dry like a branch. / This, today, is all that we can tell you: / what we are not, what we do not want.”). To conclude, I believe that, for many reasons, Stefano Fenoaltea’s tireless scientific commitment could not fail to be in tune with the research activity at the Bank of Italy, where the importance of historical research, statistical reconstructions, methodological rigour in the use and interpretation of historical sources have always been recognised, even though, perhaps, not always practiced to the extent Stefano would have wished and required. It is indeed my belief that a good, dare I say profound, knowledge of economic history should always provide a solid background for the activity of economists confronted with the responsibilities of central banking. We will, then, keep reading his books and papers, recommending that they be read and commented, and look forward to further analysis of his contributions. And we will always be grateful to him for his legacy to the Bank. 4/4 BIS central bankers' speeches
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Introductory remarks by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy and President of the Insurance Supervisory Authority (IVASS), at the IVASS – Insurance Summit, Rome, 18 October 2021.
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Luigi Federico Signorini: Ensuring a prosperous future for people and the planet Introductory remarks by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy and President of the Insurance Supervisory Authority (IVASS), at the IVASS – Insurance Summit, Rome, 18 October 2021. * * * The title of this event recalls the three overarching priorities of the Italian G20 Presidency: ‘People, Planet, Prosperity’. While the Rome G20 Leaders Summit is still a few days ahead of us, the Finance Track concluded its work under our Presidency last week. It therefore seems appropriate for me to give you a brief summary and evaluation of the main legacies of a year of very intense work on the financial sector issues that we followed most closely. I shall do that presently. ‘Planet’, as we shall see, also has a bearing on insurance, and this will be the theme of the last part of my speech. First, however, let us take stock of the current circumstances of the global economy. Italy took over from Saudi Arabia as the G20 presiding jurisdiction while the world was still in the middle of the Covid crisis. In most developed countries, the dramatic lockdown of the first (‘spring’) wave had given way to more targeted measures for the ‘autumn’ wave, with a much lower cost in terms of lost output. However, global activity was still a long way from prepandemic levels. Furthermore, little progress had been made in many low-income and developing countries. The recovery in 2021 in developed countries has been as astonishingly fast as the recession in 2020 was deep. The rapid spread of vaccination has led to a gradual easing of those preventive measures that were based on a drastic limitation of physical contact. By now, the measures still in force are no major impediment to normal economic activity. Contrary to the worst fears about ‘scarring’, firms have resumed investing and consumers consuming. Far fewer bankruptcies have emerged so far than was expected. This recovery, while still uneven and exposed to risks, is a testimony both to human ingenuity, which produced effective vaccines in an unprecedentedly short time, and to the fundamental resilience of market economies. Yet it was also the result of extraordinary public intervention, which supported households’ disposable income and companies’ balance sheets and thus avoided the worst (though it did so at the cost, consciously incurred, of a one-off increase in public debt); and of monetary and other financial policies, which reacted promptly and forcefully to the mother of all exogenous crises, ensuring that financial meltdown and a 2008-style downward spiral were avoided. Last week, the IMF released their updated projections on global growth. They now expect an expansion of 5.9 per cent this year and 4.9 per cent in 2022. For Italy, the IMF’s projection for growth this year has improved from 4.9 to 5.8 per cent, while for 2022 it has been confirmed at 4.2 per cent. Our own expectations are similar. Many advanced countries (and, among the emerging ones, China) have already reached, or are about to reach, pre-crisis output levels. In Italy, we expect this to happen in the first half of 2022. There is unavoidable uncertainty about such projections. The latest crisis was utterly unprecedented. One can never rule out the possibility, for instance, that the pandemic will take another nasty turn, or that investor attitudes will suddenly change. And some delayed bankruptcies may well occur with the end of moratoria and other provisions. 1/5 BIS central bankers' speeches Meanwhile, fast growth has resulted in production and distribution bottlenecks, which may yet restrain further expansion, and have already pushed prices higher. We discussed this issue at length during the G20 meeting last week, and there was agreement that such bottlenecks are still likely to be transitory. This means that the markedly higher inflation rates that have recently been observed throughout the developed world can also be expected to recede over time, in part given the absence, so far, of wage pressures. As Governor Visco said in his introductory statement to the press conference that followed the G20 meeting, “inevitably, the widespread uncertainty surrounding the current situation requires central bank governors to monitor price dynamics closely”. He also said that “economic policies should remain supportive for as long as necessary”. Last year’s crisis hit disadvantaged groups such as low wage earners, women, and the young in a disproportionate way. It also hit small enterprises and the self-employed, though with an extremely variable intensity. Certain industries, especially in services, suffered a much heavier shock than average. There is evidence that in many countries, including Italy, fiscal support has been broadly effective in countering the sharp increase in inequality that would otherwise have emerged. Differences remain, however. An even deeper and more worrying rift has opened across countries worldwide. Low-income countries are lagging far behind in terms of vaccination rates and, given a limited policy space, have not been able to act as promptly as advanced countries on the fiscal side. For these countries, the IMF’s 2021 growth projections stand at just 3.0 per cent, compared with prepandemic rates of around 5.0 per cent. This glaring disparity has been, very naturally, at the centre of the G20’s deliberations for the whole term of our presidency. Richer countries understand that this situation is not only unacceptable in terms of fairness; it is also a danger for all in terms of health and prosperity. Persisting economic divergences could put global recovery at risk, not least by contributing to financial market tensions and undesired capital flow volatility. The G20 has promoted a number of initiatives to free up resources for vulnerable countries to address the pandemic, including a suspension of debt service, until end-2021, and the setting up of a common framework for the treatment of distressed debt of certain eligible countries. In October, Ministers and Governors reiterated their commitment to making progress in its implementation. There are many other areas that the G20 Finance track (i.e. Finance ministers and central bank governors, FMCBG) have considered this year, so I need to be selective. Let me mention two that were among the key priorities of the Italian presidency. The first area concerns the resilience of the non-bank financial intermediation sector, a.k.a. market-based finance (or, as it was once known, ‘shadow banking’): this sector mainly consists of asset managers, i.e. investment funds. Market-based finance has grown far more rapidly than traditional banking after the global financial crisis, and currently accounts for more than half of total financial assets. We had been pointing out for years that the growing size, increased concentration and ever faster operational speed of market-based finance required an overhaul of the regulation of the sector. More specifically, we had long argued that in the supervision of market-based finance there is a need to go beyond traditional conduct rules to include rules that address financial stability concerns. Thanks to the reforms implemented after the global financial crisis, the banking sector has been able to face the financial stress produced by the pandemic with stronger capital and liquidity buffers, and has managed to provide critical lending support to the economy. Post-financial crisis regulatory reforms had touched on the non-banking financial intermediation sector to a much lesser extent. 2/5 BIS central bankers' speeches We feel that our position was vindicated during last year’s turmoil. Some segments, such as money market funds (MMFs), experienced significant trouble in March, with a liquidity stress (the ‘dash-for-cash’) that caused an increase in redemptions. The pandemic crisis has therefore exposed certain structural vulnerabilities in non-bank finance that should have been obvious to start with, including excessive liquidity transformation and potentially procyclical mechanisms. Orderly conditions were re-established thanks to extraordinarily massive central bank intervention. Preventive safeguards seem to us to be required in order to lessen the need for such intervention and avoid moral hazard. All those issues were thoroughly analysed by the FSB in its November 2020 ‘holistic review’, which concluded that work was needed to address certain clearly identified weaknesses. Last week, the G20 FMCBG endorsed a package of policy options to enhance MMF resilience, ‘as a first step’. The package provides all jurisdictions with a framework for assessing and addressing vulnerabilities in their MMFs, and an agreed set of policy tools. Frankly, we would have gone further. Like many other central banks, we had favoured the adoption of global mandatory standards rather than a menu of options. Nevertheless, we consider this agreement as a first important milestone. Discussion and reflection within the FSB have resulted in a common framework that will help authorities to frame and explain their actions. Under the framework, some action is required in all jurisdictions, on the basis of local circumstances. Global reviews are envisaged in due course, with the aim to assess the appropriateness of the measures adopted by each jurisdiction and, in the longer term, to evaluate the need for further steps at the global level. Work will continue in a number of directions. Better data and analyses are needed to improve the authorities’ understanding of NBFIs and their interconnections. The FSB will examine suitable policy approaches to address vulnerabilities in areas of market-based finance other than MMF regulation, such as open-ended funds, margining practices, and short-term funding markets. It will be incumbent on future G20 presidencies to carry on the work that has been started this year. A second key policy area for the Italian G20 presidency, under the ‘Planet’ label, has been sustainable finance. Let me emphasise that this is a completely new item on the ‘Finance Track’ agenda. Our presidency has come at a time of rapidly growing global awareness of the challenges posed by climate change, at all levels: policymakers, public opinion, financial investors. While insurance was not directly involved in the G20 deliberations, climate change is central to the industry’s future. We responded by making this issue one of our core priorities. Climate policy and energy transition are mainly a task for general government. They require above all political choices about taxation, subsidies and regulation. There is, however, also a financial regulation side to it, and that is what central bank governors within the Finance track have concentrated on this year. Several issues have emerged, including data, modelling and risk management. The net-zero transition will require huge investments, and private finance must be a substantial part of this. In recent years, ‘sustainable’ finance has been growing significantly. Today it represents a clear market trend. This is a good sign that private finance can be mobilised for the purpose of climate action. However, efficient market allocation of investment requires adequate information. In this respect, the situation is hardly satisfactory. Sustainable financial investment currently relies on (i) company disclosure practices that are neither harmonised nor, consequently, easily auditable, and (ii) scoring systems that are heterogeneous, largely subjective and sometimes opaque. It is well known, for instance, that ‘green’, or rather, ‘ESG’ company scores differ across agencies much more than credit ratings, due to profound conceptual and methodological differences across providers (and also because 3/5 BIS central bankers' speeches of different weights placed on the individual components, E, S and G). In such a challenging informational environment, confusion is bound to arise and ‘greenwashing’ is a risk that should not be taken lightly. Hence the importance of high-quality, granular, and internationally comparable data. Let me point out that this issue is extremely relevant for insurers as institutional investors. The quality of information is but one aspect. Another issue for financial authorities and central banks is an adequate consideration of environmental hazards in financial institutions’ risk management, supervisors’ rules and practices, and economic modelling. Again, insurance companies and insurance regulators are very much part of this process; I shall go back to this point in a minute. Many central banks and supervisory authorities, the Bank of Italy and Ivass among them, are striving to improve their actions accordingly. The G20 Sustainable Finance Study Group (SFSG) was revived under the Italian Presidency. We succeeded in having the United Stated and China – the two largest economies and the biggest polluters – agree to co-chair it on our invitation. The Group, which has now been made permanent, has taken several useful initiatives. A report on the activities carried out by the Group in 2021 covers three priority areas: (i) strengthening the comparability and interoperability of approaches to align investments with sustainability goals; (ii) overcoming informational challenges by improving reporting and disclosure; and (iii) enhancing the role of international financial institutions in supporting the goals of the Paris Agreement and of the United Nations Agenda 2030. For each priority, the report identifies the main challenges and puts forward a set of recommendations to overcome them. Furthermore, the SFSG agreed on a G20 Sustainable Finance Roadmap, a multi-year agenda that is intended to drive G20 work on sustainable finance over the coming years. Further initiatives completed under our Presidency include a request to the IMF and other international organisations to consider climate-related data needs in preparing a new Data Gap Initiative; and the reports delivered by the Financial Stability Board to enhance both disclosures and address data gaps on climate-related financial risks. There is still much to do. Again, we would have ideally wanted more: a clearer commitment to carbon pricing and/or other effective means for achieving global de-carbonising goals. Nevertheless, within the narrower realm of finance and financial regulation, we think that the results we did obtain are important. The international community, as represented by the G20, has officially agreed to take the first steps along the right path, and has given clear indications of its commitment to continue addressing the topic. I do not need to explain to this audience that climate change, and more generally ESG risks, are a challenge for the insurance sector too. Insurance companies are exposed both to transition risk, chiefly as institutional investors, and to physical risk, mainly with regard to the coverage they offer. They also have a role to play in mitigation and adaptation to climate change. Therefore, climate change for insurance companies is both a risk to be managed and an opportunity to be taken. There is a substantial European insurance agenda with respect to the regulation and supervision of insurance. As this audience knows, less than a month ago, on 22 September, the European Commission adopted a proposal for amending the Solvency II Directive. As today’s conference is mainly to do with the priorities of the G20 and its three overarching keywords, I shall concentrate on sustainability issues within this proposal; we must leave a fuller account of, and comment on, it for another occasion. Let me however state very briefly that our overall assessment of the 4/5 BIS central bankers' speeches Commission’s proposal is mainly positive at this stage. The proposal appears to contain several elements that are potentially useful for mitigating the issue of procyclicality and unwarranted volatility of requirements. The determination of the relevant parameters, however, will be the subject of subsequent delegated regulation; therefore, it is not yet possible to evaluate the overall effect of the package. We shall continue to offer our contributions at both the European and the national level. We are ready to support the government on a number of technical aspects that deserve attention. Going back to ‘Planet’, the Commission’s proposal envisages the following actions: (i) to include in the Own Risk and Solvency Assessment (ORSA) the consideration of risks relating to climate change, which will be considered as material/significant and will need to be treated specifically, including through the use of quantitative scenarios; (ii) to mandate EIOPA to recalibrate Natural Catastrophe (‘Nat Cat’) parameters at least every three years; and (iii) to mandate EIOPA to consider, by June 2023, a dedicated prudential treatment of exposures relating to assets or activities associated substantially with environmental and/or social objectives. These actions are largely welcome. In relation to the last point, however, let me reiterate here, as both a banking and an insurance supervisor, a position that I have already expressed on a number of occasions. Prudential regulation should remain strictly risk-based. We should only introduce reductions in capital absorption for ‘green’ investments on the basis of sound evidence of that they carry a reduced risk. Direct incentives intended to speed up the transition to ‘net zero’ should be channelled not through prudential waivers, but through different means, such as taxes and subsidies. The climate risk element in the revision of Solvency II does not come out of the blue. For some time now, supervisory action in Europe has been pursuing three priorities: (i) integrating ESG risks into the regulatory and supervisory framework, by means of sensitivity analyses and stress test climate risk scenarios; (ii) improving data availability, public disclosure of relevant metrics by reporting entities, and transparency on risks arising from climate change; and (iii) discussing options for how insurers could address the protection gap issue in the context of climate change and contribute to climate change mitigation and adaptation. Surveys conducted by Ivass on the Italian insurance system in 2020 and 2021 highlighted, among other things, that (i) the ESG criteria adopted by the insurers were as heterogeneous as those prevailing elsewhere, and that (ii) coverage of climate risks is marginal. This suggest that both the threat and the opportunities I just mentioned still need to be tackled. Starting in 2022, these surveys will be conducted on an annual basis. It will be, among other things, a way to increase awareness in the industry. Finally, Ivass is part of an EIOPA pilot project, supported by the European Commission, aimed at identifying the main areas of climate risk and the critical factors in the insurance protection gap; this gap extends to many EU countries, albeit to varying degrees. Italy is exposed to natural disasters more than many other countries, yet the degree of insurance coverage is comparatively low. A larger role for the insurance sector, within an enhanced framework for cooperation between the public and private sector, may be useful. Many technical and political aspects, however, need to be carefully considered. Initiatives such as today’s conference, where our planet features prominently in the headline, are a good starting point for such a conversation. 5/5 BIS central bankers' speeches
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Welcome address by Mr Piero Cipollone, Deputy Governor of the Bank of Italy, at the virtual conference jointly organized by the Bank of Italy and the Irving Fischer Committee of the Bank for International Settlements, Rome, 19 October 2021.
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Data Science in Central Banking Welcome address by Piero Cipollone Deputy Governor of the Bank of Italy Banca d'Italia and the Irving Fischer Committee (BIS) Rome 19 October 2021 Ladies and Gentlemen, I am delighted to open this virtual conference on Data Science in Central Banking, jointly organized by Banca d’Italia and the Irving Fischer Committee of the Bank for International Settlements. I would like to welcome all the participants joining us today from some sixty countries. 1. Introduction For the last two years, we have lived through a dramatic period as the COVID-19 pandemic has swept the globe. Never before as in these dark days has Data Science in the form of big data and machine learning (ML) algorithms proved so helpful in the war against Coronavirus. The lack of biological knowledge on this virus has spurred the data science community to step up and contribute to the fight against COVID-19. Scientists from many different disciplines and public organizations have acknowledged the importance of data analytics by open sourcing the virus genome and other datasets in the hope of a swift data-driven solution. In this four-day conference we will endeavour to share among institutions and academia the newest and most interesting applications of Data Science and machine learning to sharpen our analytical capacity to cope with new and rapidly evolving economic equilibria. 2. The role of Data Science in central banking activities Data Science is an interdisciplinary field that combines computer science, statistics and business domain knowledge aimed at generating insights from noisy and often unstructured data. It integrates mathematics with scientific methods and computing platforms. Still a young field, it has quickly developed over the last few years. Its main driver is the astounding volume of data stored by private companies and public authorities, which can now be treated more easily with new algorithms to extract the information hidden among them. Nonetheless, at the Bank of Italy, Data Science is not completely new. We do have a sound history of basing our decisions on data. In 2016, we established a multidisciplinary team to address the potential benefits and hidden risks of embracing the technological challenges of artificial intelligence (AI) and machine learning (ML) fuelled by the advances in big data, which continue to evolve at an incredible speed. A gargantuan amount of digital activity is occurring every day. In fact, data are constantly generated by our internet activities. This explosion stems from the aggregate actions of about 4.7 billion active internet users worldwide 1. These numbers are projected to rise even further in the coming years. According to SeedScientific 2, at the dawn of 2020 the total amount of data in the world was around 44 zettabytes, tantamount to 44∙1021 bytes, which is the number of cells we could count in more than 1,400 human beings. This astonishing amount of data can give us a better understanding of the state of the economy at both the micro and the macro level, provided that we able to extract the signal from the noise. As of January 2021. See https://seedscientific.com/how-much-data-is-created-every-day/ Banca d’Italia has constantly striven to be at the cutting edge in developing software and hardware platforms, enabling big data analytics 3 for statistical and economic applications. The rise of Data Science started at the beginning of 2010 when high-quality models for image recognition were created, computational power achieved sufficient growth, and people in many scientific areas realized the full potential of such an approach. Data Science glues together machine learning and data processing. The former is a collection of tools, which allows us to learn from the given data and to extract patterns and interactions between series and values. The latter describes the possible set of actions in relation to the data itself: collection, manipulation, preparation, and visualization. It is important to flag a few differences between Data Science and the classical Econometrics we study at University. Unlike Econometrics, which concentrates on solving non-linearity bias problems in a typical linear framework, Data Science is about improving our ability to work with non-linear relationships in the system. Another difference is that Econometrics concentrates on methods such as robustness, while machine learning algorithms became popular for their outstanding predictive performance 4. 3. Data Science at the Bank of Italy Banca d’Italia is organizing, along with the Federal Reserve Board, the Sveriges Riksbank, the University of Pennsylvania and the Imperial College, a series of webinars on ‘Applied Machine Learning, Economics, and Data Science‘ (AMLEDS) 5. The aim of these webinars is to foster the integration of data science tools into economics and policy-related issues and to promote closer cooperation on issues related to data science, big data and machine learning techniques applied to policy questions. Such cooperation has intensified during the pandemic, leading to many important initiatives such as a series of conferences on non-traditional data organized by the Federal Reserve Board and the Bank of Italy (for example, this year’s conference is going to be hosted by the Bank of Canada in November). This new world has, of course, set many challenges for central banks and public institutions: on one level, central banks have had to devise specific organizational structures to have a consistent and more efficient approach to the big data and machine learning tools used by each institution. At the same time, they have had to increase their data production, leveraging on non-traditional data to get more timely and high-frequency indicators of economic activity, which are important during unprecedented shocks like the COVID19 pandemic. 4. The challenges and risks of Data Science We need to exert extreme caution when employing these new tools. Let me briefly go over some of them. First, big/web data might lose their statistical relevance when they are employed in an unsound way. Such data typically entail selection bias because of the features of the population; increasing See, for example, ‘Big data processing: Is there a framework suitable for economists and statisticians?’, 2017 IEEE International Conference on Big Data (Big Data), 2017, pp. 2804-2811, doi: 10.1109/BigData.2017.8258247. ‘Weaving Enterprise Knowledge Graphs: The Case of Company Ownership Graphs.’ I am thinking of Extreme Gradient Boosting (XGBoost), which owes its wide popularity to its dominance over several machine learning algorithms rather than to its mathematical properties. AMLEDS are a series of webinars open to all those in the world who are interested in applied machine learning, big data, and natural language processing for economics and in how these techniques and data science can be applied to social science. the sample size will not shrink the sampling error if the estimation algorithm does not correct for this kind of distortion. Second, the availability of a huge amount of data raises the importance of its integrity, confidentiality and privacy. Personal and company data protection is central to our societies. The sheer amount of personal data now available, and the growing ease with which individual information can be merged across databases, have far-reaching implications for privacy, competition and freedom. Indeed, this has prompted the development of regulations concerning the treatment of digital data (think of the GDPR or the CCPA in California). Rules on data management often differ across jurisdictions and data domains. Therefore, international cooperation is to be encouraged as far as possible. Technologies enabling the processing of personal data are already available. In 2019, Google made available its differential privacy library, which allows sensitive data to be processed privately. To reach these welfare-improving goals, further investment from both the public and the private sector are required. Close cooperation between the private sector, which typically owns most of the new data, and the public sector, which uses (or would like to use) such data for policy reasons and for the common good, will also be essential. This is why central banks have always made great efforts when it comes to collecting and analysing data. Throughout its history, Banca d’Italia has drawn extensively on data published by the National Statistical Institute and other national and international agencies. It has also been an active producer of statistics, not only on banking, financial and fiscal variables, but also on firms and households. Banca d’Italia has been collecting micro-level statistical information on companies since the early 1950s. These data are now enriched with non-traditional sources such as social media, blogs, newspapers, and private company datasets6. 5. Conclusions Let me conclude my talk by thanking, once again, all the speakers and participants for joining us today, even in this virtual fashion. We hope to welcome you here in Rome in person in the near future. Special thanks go to those who have helped to organize this workshop, which brings together leading economists, statisticians, artificial intelligence and machine-learning specialists, data scientists from about fifty-five central banks and fifteen participants from Universities and government agencies. This guarantees a broad variety of perspectives and a lively discussion. I am sure that you are going to have a very interesting and productive workshop. Such as the real estate website, immobiliare.it, and the mortgage website, mutuionline.
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Speech by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy and President of the Insurance Supervisory Authority (IVASS), at a conference to mark the 53rd edition of Credit Day, organized by the Associazione Nazionale per lo Studio dei Problemi del Credito (National Association for the Study of Credit Problems), Rome, 4 November 2021.
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Luigi Federico Signorini: Banks and the years of Basel III Speech by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy and President of the Insurance Supervisory Authority (IVASS), at a conference to mark the 53rd edition of Credit Day, organized by the Associazione Nazionale per lo Studio dei Problemi del Credito (National Association for the Study of Credit Problems), Rome, 4 November 2021. * * * 1. Banks and the crisis Overall, the Italian banking system coped well with the pandemic shock– as did those of many other countries. This is different from what happened during the great financial crisis, when the financial turmoil spilt over into the real economy almost everywhere in the world, mostly through the banking channel, highlighting the fact that global prudential standards had not kept up with developments in finance. In contrast, in the last eighteen months, banks have managed to continue supporting the productive system and have helped to mitigate the very severe effects of the crisis. Fears of a credit crunch which, based on the experience of the last crisis, were widespread at the start of the pandemic, proved groundless. Banks were able to satisfy the increased demand for funds stemming from firms’ greater liquidity needs, especially in the sectors hardest hit by the measures restricting mobility and productive activities. Since the start of the pandemic, loans to firms increased constantly up to March of this year, for a total amount of €70 billion; subsequently, as activities began to recover more generally, lending naturally declined by around €7 billion. The countercyclical role of the banks has been supported by the actions of governments as well as monetary and supervisory authorities. Immediately after the onset of the pandemic, the adoption of generous and effective credit support measures – mainly in the form of government guarantees with high coverage ratios for new loans and generalised moratoriums on existing loans – allowed firms to benefit from favourable credit conditions and enabled banks to limit the capital absorption of new loans. The scope for flexibility agreed by European and national regulatory and supervisory authorities further facilitated banks’ action during the crisis. The ample liquidity of banks, facilitated by exceptionally expansive monetary policy, also allowed them to support the economy, both in the most difficult months, during the initial acute phase of the pandemic, and when the recovery finally began. The liquidity coverage ratio and the net stable funding ratio, the two measures introduced by Basel III, were, on average, well above the regulatory minimums and they have remained so. Bank funding, more than 60 per cent of which is made up of deposits by resident customers (and which grew significantly as a result of the pandemic) has been more than sufficient to finance loans. Market funding, while limited in volume terms, has continued to be available at very low interest rates. In the face of a dramatically worsened economic outlook, which suddenly heightened the risk of insolvency for firms, the banking system quickly increased its loan loss provisions, although with some differences between banks. Profits in 2020 were inevitably affected, though capital ratios were not. Dividend distribution was very prudent, mainly owing to the recommendations issued by the European Systemic Risk Board, the Single Supervisory Mechanism and the Bank of Italy, supported by granular supervisory action. Public loan guarantees contributed to limiting riskweighted assets. At the end of June this year, the CET1 ratio was 15.2 per cent on average, more than one percentage point higher than at the end of 2019. In the first half of 2021, banks’ profits returned to growth, both because the cost of credit risk went down considerably, mainly thanks to the sizeable provisions made in 2020, and as a result of the positive trend in trading profits. Average ROE reached 8.9 per cent on an annualised basis. 1/8 BIS central bankers' speeches Some improvements are probably transitory and, as a result, overall profitability in 2021 could be lower than in the first half of the year. The ROE expected by financial analysts for the main Italian banks stands at around 6 per cent, a similar level to that recorded in 2019. The gradual phasing out of the support measures, moratoriums and guarantees will surely bring to light cases of repayment difficulties. However, it is to be expected that the deterioration in credit quality will be much less marked than it was in previous crises. Banks have started paying out dividends again since the supervisory authorities, having carefully assessed the improving economic outlook, withdrew the exceptional restrictions they had previously recommended. In any case, we expect the banks to preserve adequate capital in relation to risks; it is essential that they continue to adopt a prudent approach to loan loss provisions. 2. The Basel reforms The regulatory reforms introduced in recent years by the Basel Committee – known collectively as Basel III – contributed to the capacity of Italian and international banks to tackle the crisis of 2020. These reforms led to a significant strengthening of banks’ capital and liquidity, increasing market confidence in their soundness and their capacity to absorb unexpected large-scale shocks. The work is not over. Mainly because of the massive interventions of the central banks, the resistance of banks’ balance sheets to severe market turmoil has not been fully put to the test. It will be necessary to complete the implementation of Basel III with the last remaining measures, including the crucial revision of the prudential treatment of the trading book. The Committee’s recently published preliminary analyses confirm that the banks have continued to carry out their role of providing support to the real economy during the most acute phases of the crisis, not least thanks to the reforms. It seems natural at this point to look back at the path taken over the years in establishing international prudential standards. This is particularly important at a time when Europe is getting ready to launch the last piece of those reforms. On a more personal note, doing so gives me the opportunity to give an account of my participation in the Basel Committee, which lasted a good 13 years. In fact, I became a member in the summer of 2008, on the very eve of the collapse of Lehman Brothers. I left it just a few weeks ago. 2.1 From the first Concordat to Basel III The Basel Committee was established in 1974 at the initiative of the Group of Ten, at a time – unsurprisingly – of a crisis: that of a German bank, the Herstatt Bank, which involved banks in many countries and exposed the risks connected with international banking activity conducted without common rules. Since the first Concordat was issued in 1975, the Committee – comprising representatives of central banks and banking supervision institutions – has introduced the international standards in progressive steps. Initially, the aim was managing the risks incurred in cross-border banking activity; then it increasingly extended to spreading regulatory best practices and ensuring minimum regulatory standards at global level. Basel rules are not binding within a jurisdiction until they are transposed into national law; their effectiveness therefore essentially rests on the Committee’s reputation and on market and peer pressure on national parliaments. The successive agreements (Basel I in 1988; Basel II in 2004; and Basel III between 2010 and 2017) changed in line with developments in banking activity and with the mounting complexity of the financial world; they have also become increasingly broad in scope and prescriptive in content. This was probably inevitable, but it has made the process of implementing the standards at national level more complex and sometimes open to question. It is likely that the expansion of the Committee to the leading emerging economies, which was also inevitable, had a similar effect. Today there are about 30 member countries, and they differ from each other much more than the initial group of countries did. 2/8 BIS central bankers' speeches The first agreement, implemented in the main jurisdictions in 1992, marked a shift from ‘structural’ supervision, in many countries (including Italy) based on authorisations and administrative controls, to the ‘prudential’ kind. Since then, the aim of ensuring the sound and prudent management of banks has mainly been pursued by requiring bank to maintain a minimum ratio of capital to risk-weighted exposures, rather than through direct and discretionary action by the authority. Basel I divided credit exposures into four broad classes, with coefficients increasing as the counterparty’s theoretical riskiness rose. This was meant to provide banks with sufficient resources to withstand unexpected losses, and discourage excessive risk-taking. In Italy, the transition from structural to prudential supervision was marked by the new Consolidated Law on Banking. There were two main shortcomings to Basel I: (i) it only covered credit risk; and (ii) the weighting scheme was insufficiently granular, as it was based merely on the legal nature of the counterparty and made no attempt at approximating borrowers’ risk at the individual level. In order to surmount the first shortcoming, the Market Risk Amendment was adopted in 1996. It introduced minimum requirements for market risks and included a new class of capital instruments for coverage (‘Tier 3’). The MRA also marked a conceptual turning point: faced with the variety and complexity of the statistical and mathematical tools needed to assess market risk, banks were allowed for the first time to use their own internal models to calculate their capital requirements, subject to validation by the supervisory authority. Basel II sought to remedy the second shortcoming by introducing the three-pillar framework of rules that is still in place. The first pillar provides for quantitative capital requirements in relation to three risk categories (credit, market and operational risk); banks can compute the requirements using either a standardised approach or their own internal models. The second pillar, which is of a more qualitative nature, requires banks to have their own risk assessment and capital adequacy control process, and entrusts the supervisory authority with the task of verifying that this process is satisfactory. The third pillar leverages market discipline, with stringent public disclosure requirements for capital, risk exposure, and management and control systems. In the process of defining more risk-sensitive requirements, Basel II also sought a better alignment of objectives between banks and supervisors, creating incentives to refine internal risk management procedures. At that time, I was not working in supervision. However, it seemed to me from the outset that, given the innumerable and complex modelling choices to be made by the banks, each one reasonable and plausible in itself, these incentives could yield to the more powerful one of saving capital, thus leading to a potential systematic bias. I do not want to be misunderstood: I am not talking here about breaking the rules, but only about the incentive, when faced with technically justified alternatives, to choose the less capital-expensive option. The bias could be more or less marked depending on the bank’s larger or smaller risk appetite, possibly also on the prudence of the supervisor. The latter could, in any case, only devote to the validation of the banks’ extensive and complicated internal models resources that, while highly qualified, were much more limited than those employed by the banks themselves. Despite the safeguards that were put in place, therefore, the possibility of an inadequate evaluation of risks was not to be underestimated, especially with reference to the most advanced and often opaque models, those relating to trading activities or complex financial products. It is not clear whether the weaknesses of the Basel II rules contributed to causing the global financial crisis: at its onset, the rules had only recently been approved and their transposition into the different legal systems was at best partial. However, the same issues would come to the fore in the subsequent discussion of Basel III, as we shall see presently. In any case, the crisis clearly signalled the existence of certain significant gaps in the standards. The first was the quantity and quality of capital requirements, which proved to be insufficient. For example, during the crisis it became clear that some of the liabilities included in the regulatory definition of capital – such as hybrid instruments – were only capable of absorbing losses in the 3/8 BIS central bankers' speeches event of default, and that they could trigger contagion. Neither of these facts would be helpful from the point of view of protecting stability. The market itself immediately began to refer to stricter definitions of capital, focusing on equity capital alone. The second gap was the imbalance in prudential treatment between credit and financial risks, especially striking as the latter were at the root of the crisis. There were also no liquidity requirements, nor any limits to concentration risk. In some cases, such as in Italy, the effects of those gaps were mitigated by stricter supervisory practices and approaches. For example, we placed more stringent limits than elsewhere on the capital savings that could be achieved through the application of internal models. Experience has given us no reason to regret those choices. While a full analysis of all the direct and indirect causes of the crisis is complex and certainly beyond the scope of this speech, it is a fact that the sparks that ignited the crisis appeared in places where the supervisory ‘touch’ had, in the end, become too ‘light’. Given the traumatic experience of the crisis, the Committee started to work on the development of new standards and the first Basel III text was published in 2010. The key elements of the reform were the following: (i) more capital, including through additional buffers, graduated according to the systemic importance of the bank, and also targeted at macroprudential risks; (ii) capital of a better quality, i.e., made up of instruments that would effectively be able to absorb unexpected losses without triggering a default; (iii) new requirements for risks that had previously been ignored, such as the Credit Valuation Adjustment for derivative transactions; (iv) liquidity requirements; and (v) limits on leverage. I would like to say a little more on the last two aspects, namely liquidity and leverage. Liquidity transformation is as intrinsic to banking as leverage, yet liquidity risk had been left out of international standards up until the great crisis. The safeguards introduced with Basel III ensure both greater short-term resilience (through the liquidity coverage ratio, LCR) and a better balance of maturities over the medium term (through the net stable funding ratio, NSFR). Based on the experience of the old Italian rules on maturity transformation, we had argued for a more structured NSFR requirement, that would cover maturities of more than one year more precisely, but we were unable to gain enough support. The two requirements, as approved, were nevertheless a decisive step forward. The leverage ratio, i.e., a minimum ratio between equity capital and non-weighted assets, was introduced as a backstop to risk-sensitive requirements. It is by definition a rough measure, as it is not calibrated to the riskiness of assets, and is not therefore expected to be binding on banks’ operations in most circumstances. Its function is to act as a safeguard of last resort, obviously in relation to overly aggressive internal models as well. I have already spoken about the logical possibility of bias in internal models; its actual relevance is borne out by the benchmarking exercises that have been conducted over the years at various levels, both in Europe and worldwide. They have revealed considerable and hard-to-justify differences in the capital requirements obtained by applying the internal models of different banks to an identical portfolio. I would add here that the problem of supervising models could become even more complex in the future with the spread of techniques for measuring credit risk based on artificial intelligence and machine learning, which may be effective for the purpose of practical operations, but whose internal logic is often opaque. Basel III essentially recognises, and with good reason in my opinion, that no model, however granular and technically advanced, and regardless of any bias, can fully account for the complexity of banking risks; that some form of model risk is therefore fundamentally unavoidable; and that if we accept the existence of such limits to knowledge, it is better to use several 4/8 BIS central bankers' speeches measures, each one imperfect, than to strive for an impossible perfection. Hence the need to make use of various measures that complement one another and offset one another’s limitations; hence the Committee’s choice to add the Leverage Ratio to the risk-based metrics and then an output floor, as we shall see shortly. 2.2 The completion of Basel III The final version of Basel III, adopted at the end of 2017, concluded the post-crisis review process. It dealt with ‘model risk’, reviewed the standardised treatment for credit risk and finetuned the rules on securitizations. At the same time, completely new and stricter rules were adopted for market risks, and those for operational risks were simplified. Let me now list the main elements of this set of innovations. 1. The final set of Basel III rules does not allow internal models to apply to loan portfolios for which the use of statistical criteria is problematic because of too few observations, series that are too short or distributions that are hard to characterise. It sets input floors for key parameters and it introduces an output floor, that is, a limit on the capital savings that banks can attain by using internal models with respect to the requirements based on the standardised method. (I add here that, in the discussion on this, we would have preferred the output floor to be more rigorously calibrated, in light of the experience of Italian supervision, which had always discouraged particularly aggressive modelling in banking system practices). 2. It increases the robustness of the standardised method for credit risk and its sensitivity to risk. This is intended to make it, on the one hand, a sufficiently risk-sensitive alternative to internal models, and on the other hand, a credible parameter for calibrating the output floor. 3. It strengthens the requirements associated with less transparent securitisations, encouraging simple, transparent and comparable ones. 4. As regards market risk, Basel III completes a process that began immediately after the financial crisis with temporary regulatory interventions (‘Basel 2.5’). The trading-book rules have now been entirely rewritten (‘fundamental review’). It took ten years to define this revision, which may seem too long, and perhaps it is; yet the discussion of this part of the standards proved to be particularly difficult, both in technical terms and in terms of negotiation. This was the case because banks’ activities in this sector are complex, opaque and often idiosyncratic, given the increasingly fast (and not always beneficial) progress in financial engineering; and because, allow me to say this, different national experiences, needs and priorities clashed. Unlike credit risk (where, for all innovations, the basic conceptual framework has remained unchanged), there is a radically new approach to market risks. This makes it hard to express a fully informed opinion, which will require more time. Yet the criteria inspiring the new rules, namely (i) stricter limits on the use of internal models and (ii) greater sensitivity to risk, appear to be eminently reasonable. 5. Finally, there has also been a thorough overhaul of the prudential treatment of operational risk. The new approach simplifies the prudential rules by means of a unique, standardised method that links the capital requirement to the size of operations and to the past history of each bank’s op-risk losses. The use of internal models has rightly been discontinued, as experience has shown that such models are not very robust. It should, however, be recognised that using capital requirements alone to cover op-risk remains a rather unsatisfactory choice. Exposure to this type of risk depends a great deal on the organisation of processes and on the business culture, and no model can easily convert these facts into quantitative requirements. There is therefore no alternative to using supervisory instruments to pursue further strengthening of the ability of banks to control and manage the relative risks. Given the progress of technology and the ever-greater recourse to outsourcing, these risks are highly likely to increase in the near future. There is reflection at all levels on how to tackle them; I doubt whether further tightening capital requirements would be the most 5/8 BIS central bankers' speeches efficient response. 2.3 Changes to the Committee’s modus operandi The way the Committee operates and interacts with the market has also changed over time. As I have said, its participation base was broadened to include the big emerging economies. Its activities became more transparent, and the market was afforded many opportunities for making comments while the Basel III rules were being drawn up. Many consultation documents and impact studies have been published: for banks and supervisors alike, the Quantitative Impact Studies have in fact become valuable tools for measuring the effects, intended or otherwise, of the proposed prudential rules. Alongside the drawing up of standards, a considerable amount of the Committee’s work now involves verifying their application, country by country, by means of peer reviews. This makes it possible to disseminate best practices and contributes to a more level playing field across different legal systems and banks, by limiting, for the latter, the margins for circumventing regulations and, for the former, the possibilities for using regulatory leverage to attract business and defend national flagship companies, as has happened in the past. There are, however, some drawbacks. The monitoring procedure, and specifically the fact that it includes attributing an overall final score (to sovereign jurisdictions), may give the false impression that the Committee, which is simply a producer of technical standards and counts on voluntary participation, wishes de facto to impose its choices. It appears, in other words, to assume a role as global legislator on banking issues but with no mandate to do so. We have sometimes made the proposal, as yet unheeded, to use a grading system only for the assessment of technical aspects, individually considered, based on objective and quantitative evidence. This would increase the usefulness of peer reviews, making their technical and impartial nature clearer to everyone (the public, political entities and the media) and reducing the risk of prompting reactions that bear little relation to prudential issues. 3. Completing Basel III in Europe A few days ago, the European Commission published its proposal (known as the ‘CRR3-CRD6 package’), which formally starts the process of transposing the final version of the agreement into EU law. For the most part, the proposal transposes the new standards into European legislation, although some European ‘specificities’ remain. The output floor is introduced, as expected; at the same time, the main existing deviations from the Basel standards are confirmed, including preferential treatment for exposures towards SMEs and for funding infrastructure projects. To guard against the unwanted effects of unilateral decisions on the competitive position of European banks, the Commission’s proposal expressly provides for a review of European rules in some areas (for example, market and counterparty risk) over the next few years, to be conducted also in light of the actual degree of global convergence. For other areas where the Basel III rules allow for different options (operational risks), choices are proposed that take account of the stance that the other main jurisdictions are expected to adopt. On the subject of ‘adjustments’ with respect to the Basel III standard, however, the Commission’s proposal goes further. For example, it has a mechanism that would allow banks that adopt internal models for credit risk to alleviate the impact of the output floor on a temporary basis. There is also a proposal to postpone the deadline for applying the new rules for another two years, even though it had already been delayed by the Committee owing to the effects of the pandemic. Some additional mechanisms for gradual change would mean that certain rules would not be fully implemented until 2032, some 24 years since the Lehman crisis. The negotiation that will lead to the definitive European rules is beginning now. Let me recall the 6/8 BIS central bankers' speeches statement issued in September by the vast majority of governors and heads of supervision in EU Member States, which urged EU institutions to uphold the letter and spirit of the agreements: ‘The EU should stick to the Basel Agreement’, just as the title of the message says. Except, perhaps, for safeguard clauses in the event of blatant non-compliance on the part of others, which should, however, be verified using reasonable criteria, as not even the European Union will fully apply these standards. I hope that the discussions over the next few months will not be an occasion for reopening the debate on the prudential treatment of individual risks. The pandemic crisis has confirmed what the great financial crisis had already taught us, namely how important it is to have a financial system that is robust, adequately capitalised and fully aware of the complexity of the risks. *** To sum up, let me say that the 13 years I spent on the Basel Committee, which coincided with the lengthy gestation and then the birth of Basel III, were a testing experience for me professionally, but at the same time an extremely rewarding one. That the previous system of standards had serious shortcomings I believe was, and is, clear to everyone. Correctly identifying these shortcomings and finding remedies for them has not been easy: there are no exact sciences in this field. Despite the support provided by the specialists’ careful technical work on each risk individually considered, the overall assessment can never be simply the sum of individual analyses: not even in a formal sense, as no risk is independent of any other. We can only count on experience, on reasoned discussion, on an open dialogue with industry and with the market, and on real or hypothetical tests. The difficulty was exacerbated by the presence on the Committee of countries with very different priorities and banking systems, different supervisory practices and a different degree of openness, both domestically and abroad. I benefited from the old tradition of Italian supervision, which instilled in me a scepticism of solutions that are too mechanical, a rationally limited faith in the capacity of the financial market to correct itself, perseverance in examining all risks, and a cautiousness that makes it unadvisable to put one’s faith in just one methodology, however elegant and intellectually attractive, and preferable to use several imperfect yet complementary instruments instead. For instance, in the discussions about the output floor, liquidity requirements and the quality of core capital, Italy’s experience was invaluable, and I believe I can say that in some way, whether big or small, it contributed to the collective outcome. The discussions have often been tough, and compromises have sometimes only been achieved after exhausting negotiations. Interaction with industry, which is indispensable if we want to devise rules that are realistic and robust, has nevertheless sometimes had to contend with selfinterested resistance and exaggerated fears. The result is arguably not ideal, and I have given a couple of examples where we would have liked more far-reaching solutions; on the whole, however, it is a fundamental step forward. History teaches us that nothing is final; those who come after us will surely have to grapple with new problems and devise solutions that we have not been able to look for or find. Nevertheless, the fact that the banking system was ‘part of the solution and not part of the problem’ in 2020, as has been endlessly repeated over the last few months, suggests that that some good has come of it. One last word on the Italian banking system. At the Basel negotiating table, we never forgot its peculiarities. This was not to play advocate for Italian banks, as that is a job for others. It is rather so that the actual features of risk incurred by the banking system in each country were considered in an even-handed and balanced way, even when they were so specific, as in the DTA case, as to make it difficult sometimes for us to explain and for others to understand them. Some significant results have been achieved, though not everything we would have wished for. Yet the most important message I wish to convey is a different one. Italian banks, too, sometimes complain about the additional requirements that Basel III has entailed and still entails. 7/8 BIS central bankers' speeches However, Basel III did correct two distortions that were clearly to their relative disadvantage: the imbalance between credit risk and trading risk requirements, and an excessive tolerance of aggressive models. This is one more reason for me to conclude by saying that I believe it is in the common interest to proceed, hopefully on a global level too, with transposing the Basel rules into law as swiftly and faithfully as possible. 8/8 BIS central bankers' speeches
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Remarks by Ms Alessandra Perrazzelli, Deputy Governor of the Bank of Italy, at the Workshop on Italy's attractiveness, Dubai EXPO, Dubai, 24 November 2021.
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Alessandra Perrazzelli: Italy is back on track - recovery, resilience and attractiveness Remarks by Ms Alessandra Perrazzelli, Deputy Governor of the Bank of Italy, at the Workshop on Italy’s attractiveness, Dubai EXPO, Dubai, 24 November 2021. * * * I would like to thank the organizers for inviting me to this workshop on Italy’s attractiveness. In my short speech, I will focus on three aspects: the economic outlook for the Italian economy; the medium-term growth prospects and risks; and the great opportunity represented by the National Recovery and Resilience Plan (NRRP), which is the plan Italy has designed and is implementing in the context of the Next Generation EU (NGEU) Fund, the European recovery package to support Member States hit by the COVID-19 pandemic. The economic outlook The Italian economy returned to growth early this year. After a modest expansion in the first quarter, GDP rose markedly in the following two – by 2.7 per cent in the second quarter (on the previous period) and, according to the preliminary estimate, by 2.6 per cent in the third – boosted by domestic demand and, to a lesser extent, by external trade. The progress in the vaccination campaign contributed to strengthening consumer and business confidence and allowed a faster reopening of production and commercial activities. Households increased spending on goods and, above all, services. Firms expanded their capital accumulation plans, benefitting from favourable financing conditions and abundant liquidity. Recovery was diffuse amongst the main sectors, with industrial activity now standing above pre-pandemic levels. Consumer price inflation has recently reached high levels (3.2 per cent in annual terms last October), prompted mostly – as in the euro area as a whole – by factors that we assess as transient, notably the surge in commodity prices, which may continue in the coming months but is not expected to extend into the medium term. So far, the recent contractual agreements do not suggest any strong upturn in wage growth, in a context where margins of spare capacity in the labour market are still ample. That said, inflation developments and the related expectations, as well as uncertainties on the monetary policy responses by the main central banks, are reflected in higher financial markets volatility; in the recent weeks sovereign spreads of some euro-area countries, Italy is Back on Track: Recovery, Resilience and Attractiveness Remarks by Alessandra Perrazzelli Deputy Governor of the Bank of Italy Workshop on Italy’s attractiveness Dubai EXPO 24 November 2021 2 including Italy, recorded a marked increase, in connection with fears about a possible reduction in monetary accommodation. Government policies adopted during the pandemic to support households and firms’ access to credit contributed to mitigating the impact on the quality of bank assets. Indeed, banks’ nonperforming loan ratio remained stable at historically low levels, and the gradual phasing out of the support measures, which is now being implemented in the context of the economic recovery, is occurring without tensions. Banks, on their side, should continue to carefully assess the borrowers’ repayment capacity and to make prudent and timely provisions. The gradual recovery in the real estate market continues, in line with the current economic condition and with no signs of overvaluation. The medium-term growth prospects and risks Looking ahead, prospects remain favourable. In its latest assessment, the European Commission projects Italian GDP growth to exceed 6 per cent this year, 4 per cent next year and to remain above 2 per cent in 2023, with output regaining its pre-crisis level in the first half of 2022, which is earlier than previously anticipated. Our own expectations are similar. We 1/2 BIS central bankers' speeches envisage strong domestic demand to sustain economic recovery. A significant contribution to growth is expected to come from investments, thanks both to fiscal policy measures – with the use of national and EU funds – and to financing conditions that, based on current market forward rates, are set to remain favourable. This macroeconomic scenario remains subject to non-negligible risks. In the short term, the new worsening of the pandemic – although much less severe than in the past waves and currently more pronounced in other countries of the euro area – could lower household and business confidence and delay the recovery of contact-intensive sectors. A longer persistence of supplyside bottlenecks could exert a more pronounced impact on production and inflation. Further elements of uncertainty relate to the international economic cycle. In the medium term, it will be crucial to ensure a significant reduction in the debt-to-GDP ratio through higher growth and steady fiscal consolidation. The opportunities offered by the National Recovery and Resilience Plan Over the longer horizon, economic prospects for Italy may benefit substantially from policies aimed at fostering growth potential. The NRPP, engaging 205 billion euro of EU funds (with additional 30 billion of national resources), sets out a coherent package of reforms and investments that are meant to address, among other things, the challenges posed by climate change and the digital transition. It represents an important opportunity to increase the quality of our productive system and public institutions. According to our estimates, the measures envisaged by the NRRP could raise Italy’s GDP by more than 2 per cent by 2024, an outcome consistent with interventions that are strongly concentrated in public investment spending. Over a ten-year horizon, we assess that the reforms and the incentive plans for research and innovation laid out in the NRRP could boost productivity and thus increase GDP by between around 3 and 6 percentage points. Let me conclude. The Italian economy is under a fast and firm recovery from the sharpest contraction since the Second World War. To reap the gains envisaged by the NRRP and stand ready to cope with ongoing global challenges it is of paramount importance that, in a context of relaxed financing conditions for households, firms, and sovereign, the investment plans and reforms are implemented in a prompt, effective and efficient way. 2/2 BIS central bankers' speeches
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bank of italy
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Speech by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy and President of the Insurance Supervisory Authority (IVASS), at the Bank of Italy, Florence, 3 December 2021.
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Conversing about Dante Civic passion, public life, economic reasoning1 Speech by Luigi Federico Signorini Senior Deputy Governor of the Bank of Italy Bank of Italy, Florence Branch 3 December 2021 Dante and the economy For this speech, I intend to draw inspiration from several passages of the Commedia2 to formulate some arguments as an economist, which I will use towards the end to make a couple of free observations about one of today’s great problems. I hope that you will forgive me my unavoidable incursions into a field that is not mine and I shall try not to go beyond the bounds of this task. I leave discourses on literature to others. At best, I can invoke my passion for the subject, certainly not my competence. It is clear that the science of economics in the modern sense did not exist in Dante’s day, although of course the economy as a fact did exist. It was not that economic reasoning was entirely lacking, at least from Aristotle onwards, rather that the analytical tools potentially available to observers at that time were very different from those of today. Today, through the lens of a subject that came into being several centuries later, we see it in a different way. If we look through this lens, one fact stands out. Dante seems not to have noticed the impressive acceleration that society was experiencing at that time. Or better, to the extent that he did notice, he only saw the negative aspects.3 “La gente nòva e i subiti guadagni” I would like to thank Alfredo Gigliobianco for helping me to write this text, Paolo Angelini and Ivan Faiella for reading it and making suggestions, and Ignazio Visco for his many useful remarks. Ignazio Visco set out a broad overview of the transformations of the economy and of economic thinking in Dante’s time in a recent speech (‘Notes on Dante’s economy and events of our times’, Banca d’Italia, 2021). I deal with a less ambitious topic here: the reading of some extracts chosen from the Commedia, in the spirit of the title of this conversation (“‘/Civic passion, public life, economic reasoning”), using some of the intellectual instruments available to economists seven hundred years on. In Dante’s radical refusal of the mercantile society emerging at that time, M. Romanelli (L’economia di Dante. Mercato, profitto, dono, Longo, 2021) sees an intellectual position that is anything but unaware or reactionary, but rather dictated by a ‘grand project for the regeneration of humanity’. We do not disagree; if anything, we express doubts, as befits economists, over Romanelli’s positive assessment of this vision. (“The new people [newly rich] and the rapid gains”)4 aroused his indignation. Fiorenza (the poetic name for Florence) “dentro della cerchia antica” (“within the ancient circle”, that is to say of the golden days of Cacciaguida, Dante’s forefather) “si stava in pace” (“dwelt in peace”), because it was “sobria” (“sober” i.e. content with a modest way of life); the problems all begin when people start to desire more material goods.5 At the beginning of the fourteenth century, Florence was on the verge of becoming the economic and cultural centre of Europe. The extent to which economic development counts in the creation of an environment favourable to cultural development is sometimes underestimated. Certainly, the issue never even occurred to Dante. Over the course of a century, the wealth of his city, which came from extraordinary growth in trade and manufacturing, nourished Humanism and the Renaissance, and bred and attracted some of the most celebrated artists and intellectuals of all time. Yet Dante focused on the offensive ”puzzo” (“stench”) of people from rural areas who were invading the town.6 He did not grasp the contribution that these new arrivals could make in terms of work and ingenuity, nor did he perceive the multiplier effect of urban development on economic and cultural growth. After all, the very concept of development as we understand it today was missing. Nobody living at that time, if they were literate, could fail to notice the civic renaissance of Europe following the ”etadi grosse” (“crude [dark] ages”),7 but if they had ever wondered, they would probably have said that the most they could aspire to was a return to the magnificence of the Roman imperial age. Actually, on observing the course of human history, perhaps the metaphor of a fall (from an earthly paradise or from the golden age)8 might have come to mind more naturally than that of an ascent – obviously without prejudice to the expectation of a dramatic and glorious conclusion to the story of the material universe in the forms of Christian eschatology. In this context, the principles inspiring the government of society had to try to establish an ideal order, not to promote growth; they were static and axiomatic, not dynamic or empirical. So it was for Dante.9 Avarice It could be said that it is easy to perceive the limits of this point of view when you have seven extra centuries of experience and thinking behind you. This is true, in the sense that we know more nowadays, but not in the sense that this line of reasoning no longer Inferno, XVI, 73. Here and elsewhere, the English translation is taken from The Divine Comedy of Dante Alighieri, edited and translated by Robert M. Durling, New York-Oxford, Oxford University Press, 1996-2011. Paradiso, XV, 97ss. Paradiso, XVI, 49-57. Purgatorio, XI, 93. Purgatorio, XXVIII (especially 94-96 and 139-141), where the two myths become one. Not everyone would agree with such an outright statement. It seems to me that it is written clearly, especially in the Commedia and in the De Monarchia. Yet I am certainly not qualified to have the last word on the subject. It is to be taken for what it is: the impression of a keen but not expert reader. presents any difficulties. Certain concepts remain fairly counterintuitive for human beings in the twenty-first century too. Let us look at the theme of greed or avarice, symbolised by the famous she-wolf, which appears in the first canto of the Commedia and returns several times.10 In Dante’s view, those who wish to become rich are despicable because they are greedy, they do not obey the Commandments and they are stained with a capital sin: that is all. Those who see making money as their only purpose in life were not liked then and are not liked now. The economist, however, tends to make some distinctions. It is one thing to behave as Ebenezer Scrooge does in Dickens’ A Christmas Carol. It is quite another to pursue one’s legitimate interests honestly when carrying out any business activity, as we probably all do, whether in production or in trade. A cardinal concept of economics as a science is precisely that, in looking to their economic interests, a person contributes to society’s economic well-being. (There are exceptions, as we shall see later on). This concept, which is hard to understand and easy to misunderstand, was established, as everyone knows, by Adam Smith in his masterpiece The Wealth of Nations: “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest”.11 There are two elements at the heart of this. The first was already clear to Aristotle, who was a cultural cornerstone in Dante's day.12 Everyone needs other people in society: the poet (definitely) needs the shoemaker, while the shoemaker (hopefully) needs the poet. This interdependence arises from specialisation, which makes the production of all goods more efficient. The second is that trade is advantageous to both parties. Aristotle at most caught the odd glimpse of this,13 as he was more interested in the fairness than in the efficiency of trade. Trade is still often perceived as a battle a contest in which, if one of the two participants earns something, the other one inevitably loses. Smith demonstrated that it is not really like that. If the baker parts with a loaf in exchange for a shilling, he does so because it benefits him. The same goes for the customer: if he pays a shilling, it is because he finds it more convenient than mixing the dough and baking the loaf himself. The baker earns money from his business activity, but at the same time provides the customer with an efficient service. If we broaden the analysis from the individual to the community and include competition, we can conclude that an economic order based on decentralising decisions and on each person pursuing their own legitimate interest increases everyone’s well-being. That is all, yet the modern science of economics springs from this basic insight. Inferno, I, 49ss.; Purgatorio, XX, 10 (“Maladetta sie tu, antica lupa!”, “A curse be on you, ancient she-wolf”); and perhaps also Purgatorio XIV, 50. Many commentators see something more than just the sin of avarice in the cupidity of the she-wolf; here, purely for illustrative purposes, I adhere to a circumscribed interpretation of the relative symbolism. The Wealth of Nations, Book I, Chapter 2. Although his vast and systematic work is often considered as the founding act of economics, Smith was not actually the first to set out this concept. Anders Chydenius from Sweden was ahead of him here, and his pamphlet ‘The National Gain’, was published a few years before Smith’s book. However, the history of thinking is dotted with similar ideas, from ancient times onwards. Nicomachean Ethics, V. If nothing else, Aristotle, albeit in his own somewhat convoluted way, eventually took up the cudgels for the right of private property, considering it from the point of view of incentives (Politics, II, 5; and elsewhere). Contrary to the caricature that is sometimes drawn, homo oeconomicus is not inherently selfish, greedy or deaf to the things of the spirit. We can assume that people maximise profits in the sense that we expect that in their business, they will seek to garner resources as best they can: resources to live, to support their families and perhaps even to enjoy life. If they are as greedy as the she-wolf, they will amass them shamelessly but, if instead, they are generous and sensitive, they will also help others, support worthy causes or sponsor art and culture and what have you. The actions of homo oeconomicus are to be seen as a means, not an end; each person decides their own end, and as long as the means is honest, it is the end, not the means, that is subject to a moral judgement. Could Dante have grasped similar concepts regarding the role of incentives in promoting economic activity? Poggio Bracciolini, another illustrious Florentine writer, got there just over a century later, during the full flowering of Humanism; in a dialogue of his on avarice, he had one of his interlocutors argue as follows: Quod si ita est, ut omnes cupidiores pecuniae appellentur avari, censebuntur rei hoc nomine fere omnes. Omnia enim ab omnibus agenda suscipiuntur pecuniae gratia, ducimurque omnes lucri cupiditate, neque eius parvi, quod si sustuleris, negocia operaque omnia penitus cessabunt. Quis enim quicquam aget, remota spe utilitatis?… Illam sequuntur omnes, illam appetunt. Nam sive rem militarem, sive mercaturam, sive cultum agrorum, sive artes has, quas vocant mercenarias, consideres; sive etiam quas appellant liberales; videtur singulis praeposita esse ingens pecuniae cupido... Quid enim, ne de vilioribus exercitiis loquar (quorum late patet finis), leges in vita tractantes aliud ducit, quid aliud trahit nisi pecuniae cupiditas non parva, et uberior lucrandi facultas? Quid item medicos, quid reliquos qui se ad liberalium artium studia conferunt? Confer te ad sanctiores disciplinas, philosophiam, theologiam: sciendine causa an plurimum lucrandi tanta ponitur in his edocendis opera?… Quicquid inter mortales tractari vides, quicquid periculorum suscipi, eo spectat ut inde aurum atque argentum excudatur. Est enim peropportuna ad usum communem et civilem vitam pecunia, quam necessario Aristoteles inventam tradit ad commercia hominum resque mutuo contrahendas… Si unusquisque neglexerit operari quicquid excedat usum suum, necesse erit, ut omittam reliqua, nos omnes agrum colere… Videte quantum a vestra opinione dissentiam. Sint aliqui prae ceteris avari, praeter hanc communem avariciam cupidi: vos extimatis e civitatibus hos abici oportere; ego contra advocari in illas, tamquam opportuna adminicula ac sustentacula populorum…. Cum enim affirmas plura mala avariciam peperisse, ego et plura bona. If all those who want a little more money were to be called greedy, well then, we should consider everyone, or almost everyone guilty of this crime. Everything that people do, they do for money; we are all governed by the desire to earn, and not just a little if possible; and if earnings were to be eliminated, all trade and business would cease. Nobody would undertake anything if there were no hope of turning a profit. Everyone pursues this hope and everyone cultivates it. Consider military activity, trade and agriculture; consider the so-called mercenary trades; consider even those that are said to be liberal professions: and you will see that a great desire for money prevails in all of them. What else indeed (if we do not want to mention the humblest jobs, whose goal is obvious), what else attracts lawyers if not the desire for money, and no small desire at that, and the possibility of more substantial profits? And what about doctors? And all the other professional people? Look then at the more sacred disciplines, philosophy and theology: in your opinion, do people study them so much out of love for knowledge or for money? Everything that people do, all the risks they undertake are for this purpose: making gold and silver out of it. Money is anything but an evil from the point of view of collective well-being and civic life. Aristotle says this too, that money was a necessary invention for trade. If nobody exerted themselves to earn more than the bare minimum, we would all have to cultivate the fields, not to mention other things... You see how far removed I am from your opinion. If some people are more motivated than others by profit, you would like to drive them out of civilised society; I on the other hand would invite them in, because I believe them to be essential to support the people. And since you say that avarice has given rise to innumerable misfortunes, then I say to you that it is also the fount of many good things.14 Envy A similar line of reasoning can be followed for envy. The envy that Dante had in mind is that which leads to suffering over the happiness of others and to desiring the downfall and ruin of the successful15 (just think of Sapia, who revelled in the defeat of her fellow citizens in Siena).16 Another kind of envy, which economists do not dislike, is that which drives a person, following the example of others, to procure – through work and resourcefulness – what they are lacking. The benefits of benign envy cannot be too difficult to identify if Hesiod had already observed them in the seventh century BCE. In the preamble to Works and Days we find this passage: οὐκ ἄρα μοῦνον ἔην Ἐρίδων γένος, ἀλλ᾽ ἐπὶ γαῖαν εἰσὶ δύω: τὴν μέν κεν ἐπαινέσσειε νοήσας, ἣ δ᾽ ἐπιμωμητή: διὰ δ᾽ ἄνδιχα θυμὸν ἔχουσιν. ἣ μὲν γὰρ πόλεμόν τε κακὸν καὶ δῆριν ὀφέλλει, σχετλίη: οὔτις τήν γε φιλεῖ βροτός, ἀλλ᾽ ὑπ᾽ ἀνάγκης ἀθανάτων βουλῇσιν Ἔριν τιμῶσι βαρεῖαν. τὴν δ᾽ ἑτέρην προτέρην μὲν ἐγείνατο Νὺξ ἐρεβεννή, θῆκε δέ μιν Κρονίδης ὑψίζυγος, αἰθέρι ναίων, γαίης ἐν ῥίζῃσι, καὶ ἀνδράσι πολλὸν ἀμείνω: ἥτε καὶ ἀπάλαμόν περ ὁμῶς ἐπὶ ἔργον ἔγειρεν. εἰς ἕτερον γάρ τίς τε ἰδὼν ἔργοιο χατίζει πλούσιον, ὃς σπεύδει μὲν ἀρώμεναι ἠδὲ φυτεύειν οἶκόν τ᾽ εὖ θέσθαι: ζηλοῖ δέ τε γείτονα γείτων εἰς ἄφενος σπεύδοντ᾽: ἀγαθὴ δ᾽ Ἔρις ἥδε βροτοῖσιν. καὶ κεραμεὺς κεραμεῖ κοτέει καὶ τέκτονι τέκτων, καὶ πτωχὸς πτωχῷ φθονέει καὶ ἀοιδὸς ἀοιδῷ. So there was not just one birth of Strifes after all, but upon the earth there are two Strifes. One of these a man would praise once he got to know it, but the other De avaricia, in ‘Prosatori latini’, pp. 260-262, 266, 270, 274. Purgatorio, XVII, 115ss. Purgatorio, XIII, 106ss. is blameworthy; and they have thoroughly opposed spirits. For the one fosters evil war and conflict – cruel one, no mortal loves that one, but it is by necessity that they honor the oppressive Strife, by the plans of the immortals. But the other one gloomy Night bore first; and Chronus’ high-throned son, who dwells in the aether, set it in the roots of the earth, and it is much better for men. It rouses even the helpless man to work. For a man who is not working but who looks at some other man, a rich one who is hastening to plow and plant and set his house in order, he envies him, one neighbor envying his neighbor who is hastening towards wealth: and this Strife is good for mortals. And potter is angry with potter, and builder with builder, and beggar begrudges beggar, and poet poet.17 Material and spiritual goods The time has now come to enter Purgatory, because Dante’s cantos on envy (XIII, XIV and XV) lend themselves to further, interesting, considerations. The character who introduces us to the theme is Guido Del Duca, a nobleman from Romagna. It is he who utters the famous lines ”le donne e’ cavalier, li affanni e li agi” (”the ladies and the knights, the labors and the leisures”), echoed by Ariosto at the beginning of his epic poem Orlando Furioso. Well then, in Canto XIV, Guido declares unequivocally that he has been very envious during his lifetime. Yet how he says it initially defies comprehension. He refers to the human desire for goods for which there is a “mestier di consorte18 divieto” (“where sharing must be forbidden”). “Where sharing must be forbidden”? It is not just we twenty-first century Italians that remain nonplussed; the passage must have seemed opaque back then too. Even Dante himself does not seem to apprehend its meaning immediately. So much so that in the next canto, he asks Virgil for an explanation: what is this “sharing” and “forbidden” to which Guido refers? And Virgil explains: Perché s’appuntano i vostri disiri dove per compagnia parte si scema, invidia move il mantaco a’ sospiri.19 “Because your desires point to where sharing lessens each one’s portion, envy moves the bellows to sighing.” The crux is in the words “dove per compagnia parte si scema” (“where sharing lessens each one’s portion”). They mean this: you sinners, you worldly people, set your hearts on goods which, if divided with others (“per compagnia”, “[by] sharing”), give lesser enjoyment, because each person's part shall be smaller (“parte si scema”, “where sharing lessens each one’s portion”). There is, then, no possibility of sharing (“con-sorte”, [common lot]: “è mestier di consorte divieto”, “where sharing must be forbidden”). Of what goods do we Works and Days, 11-26 (translated by Glenn W. Most, Cambridge, Massachusetts – London, England, Harvard University Press, 2006). This is the reading given by Petrocchi’s critical edition of the Commedia, in preference to the traditional (Crusca) “consorto”, though the latter is corroborated by numerous manuscripts. Be that as it may, the word should not be understood in the modern Italian sense of ‘consorte’ (‘consort, spouse’), but rather in the abstract one of “consortium, sharing”. Lines 49-51. speak? Of the lion’s share of goods that are the subject of economists’ analyses, such as houses, cars or chickens: if I share my chicken with you, I will only have half left. Dante stigmatised, in short, the desire for worldly goods, for all worldly goods.20 Whoever possesses them does not want to share them, because they would obtain a smaller benefit. Spiritual goods are another matter entirely. God’s love, as Virgil explains later on in an elegant doctrinal passage that anticipates the terse harmonies of the Paradiso, is in no way diminished when shared with others. On the contrary, the more “table companions” there are to enjoy this good, the more enjoyment each of them will derive. Those who desire the love of God simply have to ask for it, and no one will contest them: E quanta gente più là sù s’intende, più v’è da bene amare, e più vi s’ama, e come specchio l’uno a l’altro rende.21 “And the more people bend toward each other up there, the more there is to love well and the more love there is, and, like a mirror, each reflects it to the other.” Envy has no place here. Rivalry, exclusion, public goods Now, some six and a half centuries after Dante wrote these verses, economists (not, I believe, inspired by the poet but one never knows…) began to wonder whether, speaking of economic goods, it is always true that “per compagnia parte si scema” (sharing lessens At the end of Canto XIV (148-150): Chiamavi ‘l cielo e‘ntorno vi si gira, mostrandovi le sue bellezze etterne, e l’occhio vostro pur a terra mira… “The heavens call and wheel about you, showing you their eternal beauties, and your eye still gazes on the earth…” And afterwards, in Canto IX of the Paradiso (10-12): “Ahi anime ingannate e fatture empie, che da sì fatto ben torcete i cuori, drizzando in vanità le vostre tempie! “Ah, deluded souls, wicked creatures who twist your hearts away from such a good, directing your faces toward emptiness!” Even before this, in Canto XI of the Purgatorio, that of the prideful, Oderisi da Gubbio had warned about fame (100-102): Non è il mondan romore altro ch’un fiato di vento, ch’or vien quinci e or vien quindi, e muta nome perché muta lato. “The clamor of the world is nothing but a breath of wind that comes now from here and now from there, and changes names because it changes directions.” Yet on fame, as on many other things, Dante’s thoughts were not easily reconcilable (Inferno IV, 76-78) XVI (66) XXIV, 46-51; and there may be more passages to consider). That in the Commedia one finds everything and the opposite of everything is part of its centuries-long appeal. Lines 73-75. each one’s portion). In 1954, Paul Samuelson (who would later win the Nobel Prize for Economics) formalised the concept of rival goods.22 A good is defined as “rivalrous” if its enjoyment by one party is diminished when another party consumes the same good. We are in the classic chicken-sharing situation, and the consideration is precisely that which Dante has Virgil utter. Samuelson, however, unlike Dante, also identified a category of (worldly) goods that are “non-rivalrous”. For example, national defence or street lighting. If I benefit from a street lit at night, I do so without preventing my fellow citizens from enjoying the same good. These are non-rivalrous economic, worldly goods. If the two could meet, Samuelson would tell Dante that there are not only spiritual goods outside the sphere of envy. On the other hand, it is interesting how Dante, in warning his contemporaries against this capital sin, highlighted a characteristic of worldly goods, or rather of many of them, which is their rivalrous nature – something which would only be formalized many centuries later by economists. Although commentators have identified the probable origin of Dante’s thinking (Saint Augustine plays on the same theme in The City of God),23 nobody, that I know of, has emphasised the link between the moral foundation of Cantos XIV-XV and economic analysis. In 1959, Richard Musgrave described another category, non-excludable goods, which partly overlaps with the previous one of non-rivalrous goods.24 To obtain a loaf of bread from the baker, the customer must pay up, because otherwise the baker keeps it: he or she can “exclude” the customer’s enjoyment of it. But there is no way of excluding the passer-by from the benefit of public street lighting. In this second case, those who produce the good are unable to recoup the costs and realise a profit by imposing a price for its use. If a good is non-rivalrous in the way intended by Samuelson and non-excludable à la Musgrave, it is what is called a “public good”. It is clear why Dante is interested in these matters: from rivalry and excludability comes envy, a capital sin. But what about the economists? I think it is intuitive (there are, of course, formal ways to demonstrate it in the abstract world of economic theory) that to produce a “public good” relying solely on market forces, in other words on individual trades between producers Paul A. Samuelson, “The Pure Theory of Public Expenditure”, Review of Economics and Statistics, 36(4): 387-389 (1954). As is well known, Saint Augustine contrasts two cities, we would say two communities. The city of men seeks worldly satisfactions, while the city of God aspires to higher things. Within this broad vision, the author compares Cain and Abel to Romulus and Remus. The latter were both anxious to claim the glory of the foundation of Rome. “Ambo gloriam de Romanae rei publicae institutione quaerebant; sed ambo eam tantam, quantam si unus esset, habere non poterant. Qui enim uolebat dominando gloriari, minus utique dominaretur, si eius potestas uiuo consorte minueretur. Vt ergo totam dominationem haberet unus, ablatus est socius, et scelere creuit in peius, quod innocentia minus esset et melius”, De Civitate Dei, XV, 5 (“Both desired to have the glory of founding the Roman republic, but both could not have as much glory as if one only claimed it; for he who wished to have the glory of ruling would certainly rule less if his power were shared by a living consort. In order, therefore, that the whole glory might be enjoyed by one, his consort was removed; and by this crime the empire was made larger indeed, but inferior, while otherwise it would have been less, but better”; Saint Augustine, The City of God, translated by Marcus Dods, New York, Random House, 1950). Richard Musgrave, A Theory of Public Finance, New York, McGraw-Hill, 1959. and users, is problematic. Adam Smith’s idea, which is applicable to all the other goods, does not hold here. Somehow, the community of users, the State, must intervene. Thinking about non-rivalrous and non-excludable goods takes us a long way. If you allow me, we shall now make a small digression toward the attendant consequences, which as we shall see matter greatly. Even if the path leads us away from Dante for a while, and closer to the issues of today. Up to now, I have spoken about national defence and public lighting, classic examples from the 1950s, but the question of the public nature of goods does not end there. If you look at the Wikipedia entry for this in English, you will find listed, among other things, the production of knowledge and of official statistics, flood control systems, and lighthouses (yes, lighthouses that signal to ships the position of certain points on the coastline; as to why Wikipedia mentions them, we shall see that shortly). One of the greatest challenges of our century is the preservation of the environment, and specifically the prevention of global warming. Strictly speaking, in this case we are talking about “common” rather than “public” goods and the question is slightly different too, not so much about how market incentives do not lead to their production in sufficient quantities but rather that they do not impede their excessive exploitation. (The good that is not produced in sufficient quantity is, if you like, the absence or reduction of pollution). There is no need to enter into the details. Let’s just say that, in general, this is about goods or other utilities whose utilisation rights cannot be easily exchanged on the market because, in one way or another, there is no “ban on sharing”: all of humanity benefits or would benefit from a reduction in greenhouse gas emissions; however, given the difficulty of exchanging them at individual level, for similar goods the customary theoretical presumption that the market alone can ensure their efficient allocation falters. How to supply public goods Well then? There are various solutions, none of them perfect; one does not always exclude the other. Over the course of this brief conversation, I will just hint at them briefly. The first solution is simply that the government must take responsibility for the public good. This is frequently adopted: the town council looks after street lights and the State looks after national defence. One variant is that the public authorities purchase the good or service from the private sector rather than producing it directly; this often delivers better operational efficiency. (This variant does not seem advisable for defence). The fact remains that the how and how much of a service, together with the distribution of the burden of the cost among the citizenry, depend on the authorities’ decisions, in which citizens only have an indirect say when there are elections (as long as they live in a democratic regime). Furthermore, in the absence of a world super-state, this solution is not easily applied to global public or common goods. The second solution is imposing taxes or granting subsidies that simulate the damage or benefit for citizens ensuing from the non-rivalrous or non-excludable consequences of private business, such as pollution or research. This solution provides the market with theoretically correct incentives (even if the tax or subsidy is only an approximation, not always easy to compute, of the effect of the activity in question on well-being), and then lets it produce the good in the most efficient way. The carbon pricing that is under discussion nowadays falls into this category. Problems arise here too in the case of a global common good, since not all countries are willing to introduce the same measures (taxes, for example). The third solution is to establish rules, such as on anti-emissions standards. This is clearly a direct and potentially effective approach, but the inevitable inflexibility of laws may create inefficiency. For example, imposing the same obligations to reduce emissions on all firms is equivalent to a poor allocation of resources if this reduction is far costlier for one firm than for another. It follows that the rigidity of the rules is sometimes tempered by market mechanisms, for instance through the concept of freely tradable ”emission permits”. The State decides the total amount of emissions tolerated and provides for an initial distribution of the relative quotas; private firms can then trade them against payment. Those who are able to reduce emissions at low cost will take advantage of the chance to sell their shares to firms for which a reduction is more expensive. The overall reduction will not change, but the cost of achieving it will fall. This shows that the fourth solution, i.e. relying to a certain extent on the market, is not actually entirely excluded, even in the case of public goods. Ronald Coase, another Nobel prize winner for Economics, went so far as to argue that, in the absence of transaction costs and provided that property rights are clearly defined, there is no good to which the market cannot assign an efficient price. His paper on lighthouses is famous (that is why Wikipedia mentions them), in which he tries to demonstrate that for a certain period in England, the coastal lighthouse service, apparently the most public of public goods, was actually supplied by private companies for profit. It should be pointed out that the details of this story are not uncontroversial. Above all, however, the absence of transaction costs required for the validity of Coase’s ”theorem” is a very demanding condition. Put simply, it assumes that it is possible to stipulate a private agreement instantly and at no cost, according to which all the stakeholders (potentially millions or billions of people) voluntarily “buy” (for example) the polluter’s renunciation of the right to pollute. Difficult? Impossible? In a literal sense, yes, of course. Let us consider, though, another element of the ongoing debate on global warming. As we know, the emerging countries complain because the advanced countries want to impose strict limits on their emissions, having themselves pumped countless megatonnes of CO2 into the atmosphere from the beginning of the industrial revolution until today.25 The emerging economies say that they are only willing to adopt certain standards in exchange for cash transfers from the rich countries that are insisting on imposing them. In fact, the Paris Agreements already included this sort of idea and the most recent negotiations have further advanced the debate. Think about it: if we look closely, this is basically the application of a version of Coase’s theory, in which a few dozen governments try to negotiate on behalf of billions of people. Anyone interested in a simple quantitative summary in graphic form can consult Hannah Ritchie, for example, “Who has contributed most to global CO2 emissions?”, ourworldindata.org (2019). Will it work? Let us hope so, even though we still do not know. One way or another, in order to find a global solution for the problem of greenhouse gas emissions, especially given a world order based on independent and sovereign jurisdictions, a combination of various tools will be needed: public investments, rules, incentives, and market solutions. * * * If I had told you that I was going to talk about Dante and global warming, you would definitely have thought of the blazing flames of the Inferno. Not so. If you look, you can find everything, or nearly everything in Dante; if I have convinced you, there is even a foretaste of the twentieth-century economic theory on non-rivalrous goods. Starting from the intellectual world of the Commedia, we have taken a perhaps unexpected path, which has led us from the capital sins punished in Inferno or expiated in Purgatorio to some of the most important and less intuitive topics of economic theory, and lastly to the debate on the most passionately felt global issue of our time. I will conclude with two thoughts. The first is that global common goods require some form of global governance, and Dante would have agreed with this unhesitatingly. His political view was based on a universal empire that was supposed to ensure peace and good governance for humanity (even though the horse he had backed, Henry VII of Luxembourg, failed to cross the finish line, to his great disappointment). Dante was certainly fooling himself in thinking that the solution consisted in attributing supreme authority to just one man.26 Just as he did not understand the power of the market, neither did he take democracy into consideration,27 and the two do have something in common (doing without a single, all-powerful decision maker, the idea of the ”wisdom of the crowd” (as we might call it today) and peaceful mechanisms for correcting errors). In fact, Aristotle, the revered ”master of those who know”,28 would have been able to teach him something about it. (On the political front, Although he tried to justify it by showing, as the economist would say, that incentives are correct: the universal monarch, with nothing left to desire on earth beyond what he already has, namely, supreme power, can certainly devote himself to justice (Monarchia, I, XI; Convivio, IV). Seen through modern eyes, this argument can only leave us somewhat sceptical. Like the market, democracy can only prosper in a framework of rules that are sufficiently certain, protective and observed. Whatever incipient popular government Dante saw around him seemed to be a harbinger of unrest and bloody factional battles, or at best, of unwarranted, even laughable ambitions (“I’ mi sobbarco!”, “I’ll take it on”) and of a pathologically unstable legislative framework (“a mezzo novembre non giunge ciò che tu d’ottobre fili”, “what you spin in October does not reach to mid-November”: Purgatorio, VI, 135; 143-144). This was clearly not just an abstract idea: the violence of the clashes between factions left a profound mark on his life, as he was exiled, theoretically sentenced to death and his goods were confiscated when his political faction fell from power. This dense fog of public ills and personal suffering prevented him from seeing further ahead. After all, nobody can judge Dante while taking for granted the constitutional guarantees typical of a modern liberal democracy. Inferno, IV, 131. however, Dante had another intuition that was ahead of its time, namely the advantages of the division of powers,29 but that is a conversation for another day). I do not know whether we should hope for a universal empire to be established one day; we can certainly hope that common solutions to common problems are found in time and in good faith. The second thought is that, when we think about bigger problems, it helps to rely on broader visions. No one viewpoint allows us to see the full picture; no single discipline has the final say. So, as has happened this evening, it is a good thing for economists not to lose sight of literature and for literary scholars not to lose sight of economics. Purgatorio, XVI, 106-108, where Marco Lombardo condemns the end of the separation between spiritual and temporal power, with arguments that would be called ”checks and balances” in modern parlance. The topic of the relationship between the two powers is broadly covered in the third book of Monarchia. Dante was certainly not the first to discuss it; this intellectual dispute had provided theoretical weapons for the struggle between papacy and empire for at least two centuries; he did, however, put forward some original arguments (A. Sparano, Dall’ἀγαθόν alla vita sufficiens, Rome, Aracne, 2017, Ch. 3.2). Designed by the Printing and Publishing Division of the Bank of Italy
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 28th Congress of ASSIOM FOREX (the Italian financial markets association), Parma, 12 February 2022.
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28th ASSIOM FOREX Congress Speech by the Governor of the Bank of Italy Ignazio Visco Parma, 12 February 2022 Economic outlook, inflation and monetary policy In 2021, the world economy recovered more than expected. Economic activity delivered a positive surprise in Italy as well, with GDP growing by 6.5 per cent. In recent months, growth has been curbed by the new wave of infections, but it is expected to pick up again starting in the spring with the gradual improvement in the health situation. At global level, according to the latest scenario published by the International Monetary Fund (IMF), GDP will expand by 4.4 per cent in 2022, half a percentage point less than was forecast in October. In the short term, risks are mainly on the downside; besides being influenced by the course of the pandemic, these risks stem above all from the ongoing geopolitical tensions and the impact they could have on the cost of commodities, especially energy products, and on trade in intermediate inputs along global value chains. According to our latest estimates, Italy’s GDP growth will near 4 per cent this year on average, and will then slow in the next two years. Since the second half of 2021, a significant, and for the most part unexpected rise in inflation has been observed in several countries. On the supply and cost side, this has been due above all to the steep increase in fossil fuel energy prices, supply chain bottlenecks and the rise in international transport costs. In the United States, a role was played by the strong growth in demand and the rise in wages, in part connected with the exit of many previously employed persons from the labour force. Pressures on the final prices of goods and services will likely be stronger than initially estimated, but should abate in 2023. In the euro area, twelve-month inflation reached 5.1 per cent in January, the highest level since the start of the monetary union. Rising energy prices contributed directly for more than half of this figure: even net of the most volatile components, the increase recorded since the second half of 2021 has largely reflected higher energy costs. Differently than in the United States, consumer price pressure due to the recovery in production activity, which today is not far from 2019 levels, has been modest so far. The rise in natural gas prices has been exceptional; though they declined after peaking in December, in Europe they are still almost seven times what they were in early 2020. This is a far more pronounced rise than that recorded in the United States, a clear sign of the very serious difficulties, in both industrial and international policy terms, experienced in Europe. Oil prices, which as early as last spring had recouped the drop recorded in 2020, continued to rise, against a backdrop of high volatility. The pass-through of the increases in energy commodities to retail electricity and gas prices is spurring the governments of euro-area countries to take measures aimed primarily at mitigating the repercussions for households and firms. In Italy, an intervention equal to more than €5 billion in 2021 made it possible to limit the increases in electricity and gas bills by around one third for customers in the ‘protected market’ (mercato tutelato), which were equal to 12 and 10 per cent, respectively, as a yearly average. Owing to the widespread adoption of fixed-price plans in the ‘free market’ (mercato libero), the overall increase in electricity and gas prices in 2021 was likely less marked for households as a whole. However, the rise in costs intensified early this year: despite the further support measures approved in December, electricity and gas bills are expected to rise by 55 and 42 per cent respectively in the first quarter of this year compared with the last three months of 2021. As we know, the government has already adopted some additional measures and is considering new ones. The Eurosystem staff projections published last December indicated that inflation would be above 3 per cent on average in 2022, reflecting the sharp rise in energy prices. It was, therefore, expected to decrease over the course of the year, eventually returning to just below the ECB’s objective of 2 per cent. This level is in line with the expectations reported in January by the participants in the Survey of Professional Forecasters and with the indications implied by the prices of index-linked financial assets, which – while factoring in the latest unexpected rise in prices – continue to signal inflation expectations of around 2 per cent from 2023 onwards. However, price dynamics in recent months have differed from the December forecast, and tensions on the energy front have not let up yet. Though it is likely that the projected slowdown will be confirmed in the coming months, in the short term, the risks of a de-anchoring of expectations and of entering into a wage-price loop, of which there is nevertheless currently no evidence, must be monitored carefully. The rise in energy commodity prices is currently leading to a negative change in the terms of trade and, therefore, to a reduction in purchasing power in the euro area. In 2021 as a whole, the loss associated with the deterioration in the terms of trade was limited to around 1 per cent, though it rose over the course of the year, surpassing 2 per cent in the fourth quarter. This is essentially a tax, probably temporary for the most part, whose distortionary effects may be offset, where possible, by drawing on the public purse. The rise in costs, however, must not turn into a prolonged inflationary spiral. Last week, the Governing Council of the ECB therefore confirmed its December decision to discontinue net asset purchases under the pandemic emergency purchase programme (PEPP) at the end of the current quarter. To ensure a step-by-step reduction in the pace of total net asset purchases, at that time, it had been decided to increase those conducted under the asset purchase programme (APP) from the current monthly pace of €20 billion to €40 billion during the second quarter of 2022, €30 billion during the third quarter, and to then continue at a pace of €20 billion, ending the purchases shortly before the first rise in the key ECB interest rates. This sequence is aimed at guaranteeing an orderly and controlled reduction of monetary stimulus. At the moment, I do not believe that the overall picture underlying this stance has changed significantly, though it must be recognized that, in the short term, there has been an increase in the risk of consumer prices growing faster than expected and production activity growing more slowly. At the Council’s March meeting, these developments and their possible consequences will have to be analysed and discussed in depth. In any case, the monetary policy stance remains expansionary, though the gradual normalization will continue at a pace consistent with the economic recovery and changes in the outlook for prices. At the same time, as indicated by the findings of the ECB’s monetary policy strategy review presented last July, it is crucial that the decisions be incremental and carefully thought through, also to avoid creating any uncertainty that could destabilize the financial markets and the economic recovery. Flexibility will remain a further key element of monetary policy: alongside a constant monitoring of inflation, the Governing Council stands ready to counter risks stemming from an unwarranted fragmentation of financial conditions across euro-area economies. In any case, the main response to the rise in energy prices – a clear, unexpected supply-side shock – should not come from monetary policy, especially in the absence of a wage-price loop and given inflation expectations that remain firmly anchored to the central bank’s objective. While both monetary and fiscal policy may counter the inflationary effects of energy costs, only the latter is able to act directly on these costs, offsetting – at least to a certain extent – the loss in disposable income and limiting their impact on the economy. Looking beyond the cyclical horizon, the necessary transition to a sustainable economy may bring about significant effects on economic activity but also on the relative prices of energy produced from various sources, with a possible impact on inflation rates. The eventual reduction of net carbon emissions to zero requires an increase in the ratio of fossil fuel energy costs to renewable energy costs, but it is still unclear how this might be achieved, including, for example, in terms of what impact a gradual increase in taxation will have on the former and what impact technological progress and greater investment will have on the latter. When taking into account the broader effects of the measures adopted to facilitate the transition, it cannot be ruled out that the repercussions for economic activity might be deflationary, at least for some time to come. The increases in the relative prices of fossil fuel energy sources, which are necessary to respond to the momentous challenge of climate change, must not occur in an uncontrolled way: they can be calibrated through the adoption of adequate measures, for example, under a suitable tariff policy. Nevertheless, this signals the importance of swiftly coming up with a strategy, particularly at European level, that considers the problem of the diversification of energy sources, their storage and the identification of common resources for managing energy crises. Only this way will it be possible to coherently address a problem that will be difficult to solve through cyclical economic policies. The Italian economy: growth and the public accounts Since the start of the pandemic crisis, our economy has demonstrated that it has a strong ability to recover, sending encouraging signals about its underlying conditions. Industrial production had already returned to pre-pandemic levels last spring, GDP is expected to return to these levels by mid-2022, and employment towards the end of the year. The economy has benefited greatly from the support measures which, by protecting the production system and employment during the most acute stages of the pandemic, allowed economic activity to recover rapidly once the containment measures were eased. In the current context of progressive recovery, limited emergency measures may still be warranted, for example in order to address the energy crisis or if the number of COVID cases continues to hold back consumption and production, such as in the services connected with tourism, restaurants, and leisure activities. However, generalized stimulus measures could lead to price tensions, besides the risks for the public accounts. Efforts must now, above all, be concentrated on facilitating the structural changes that have been accelerated by the pandemic itself. Employment policies, both active and passive, can play an important role. The social safety net system has undergone sweeping reforms in the last decade and today universal access is guaranteed. Although the design of the income support instruments could be improved, they are comparable to those in force in the major European countries in terms of structure and resources. However, they lag behind in worker training and upskilling policies and, ultimately, in actively developing new business initiatives. In this regard, rapid improvements are needed, also given the firm restructuring and worker reallocation processes that will follow the double (green and digital) transition. Italy spends significantly less than Germany and France on training and job-seeker support, but it is not simply a question of increasing resources: we need to rationalize our set of policies and services in order to develop a system that is fit for purpose in all parts of the country. The strong recovery of the economy has been decisive in halting the increase of the public debt-to-GDP ratio, which might have fallen to around 150 per cent at the end of 2021 (from about 156 per cent in 2020), a level that is markedly lower than that forecast at the beginning of last year and also than the official government assessments published last autumn. Given that the primary balance is better than expected but still broadly in deficit, the fall in the debt burden compared with 2020 is the result of the large differential, which is negative by more than 5 percentage points, between the average cost of the debt and nominal GDP growth. This result, even though the circumstances that produced it were exceptional both in terms of the recovery of activity levels after the deep recession and of the extremely expansionary monetary conditions, clearly shows the importance of economic growth in gradually bringing down the debt burden. Compared with the current legislation scenario, the budget raises net borrowing by about 1.3 per cent of GDP on average in each of the three years 2022-24. In a phase that is still characterized by high uncertainty about how the pandemic will play out, an expansionary budget was deemed necessary to limit the risk of a premature reduction of fiscal stimulus having negative repercussions on potential growth. As the recovery consolidates, it will nevertheless be necessary to rebalance the structure of the public accounts gradually and steadily, also to avoid stoking tensions on the government bond market. The need to place securities worth €400 billion every year continues to expose us to high risks. In more recent years, these risks have been mitigated by the ECB’s very substantial asset purchase programmes intended to counter deflationary pressures and the economic fallout from the pandemic crisis. Over the next decade, the gap between the average debt burden and GDP growth will gradually have a less positive effect on the debt ratio, due to the inevitable normalization of the growth rate of the economy and of short- and long-term interest rates. In addition, the ageing of the population will exert upward pressure on current primary expenditure. To counterbalance these trends, it will be necessary, on the one hand, to increase growth potential and, on the other, to improve the primary balance gradually and in structural terms. Both of these approaches could help to steadily reduce the yield spread between Italian government securities and those of the other major euro-area countries. The greater the rate of growth, the lower the adjustment of the public accounts needed to facilitate the gradual reduction of the debt-to-GDP ratio. Istat’s most recent population projections for the next 20 years suggest a fall of almost one fifth of the population aged between 15 and 64 years, i.e. a drop of almost 7 million people compared with the current level. In the longer term, therefore, healthy growth rates could only be achieved by a large increase in labour market participation and employment levels and a sharp acceleration in productivity compared with the disappointing trend of the last quarter century. The importance of implementing promptly, fully and effectively the investments and the reforms set out in the National Recovery and Resilience Plan (NRRP), as defined under the Next Generation EU programme (NGEU), has clearly emerged. The NRRP addresses the main structural weaknesses of the country in the context of a European strategy that takes on the challenges posed by climate change and the digital revolution and that will require an increase in public and private investment, upskilling of workers and the enhancement of the technological and organizational capacities of firms and the public administration. According to the assessments I outlined in my Concluding Remarks last May, the investments planned under the NRRP could raise the level of GDP by more than 3 percentage points by 2026. A further impact, of up to 6 points in a decade, could arise from the reforms and the plans to incentivize research and innovation. This would add almost 1 percentage point to Italy’s economic growth potential. These estimates are obviously subject to a high degree of uncertainty. Actually carrying out the planned projects will require an exceptional effort in order to meet the 527 intermediate and final targets (of which 100 targets this year alone) – the condition for the disbursement of the European funds. While this task is extraordinarily difficult, we must also recognize that the country cannot afford to dissipate the great opportunity that the NGEU programme offers to Italy and to all the EU economies to help them emerge from the crisis with the prospect of more rapid, sustainable and inclusive growth. Europe has given proof of its cohesion and farsightedness in designing a common strategy that looks to the future of the new generations. However, the double transition will require a great capacity to adapt and very substantial investments on the part of all our countries, and far beyond the time horizon of this programme. The commitment and the spirit of cooperation shown in these circumstances must be renewed, strengthening the role of the European Union in guiding and encouraging the transformations under way. Changes in the financial industry: opportunities and risks The changes under way in the economic system are also affecting the structure of the financial system. The transformations imposed by technological change, especially by digital innovation, are profoundly altering the organizational structures of intermediaries and how they distribute financial services. The supervisory authorities are increasingly engaged in identifying and monitoring the risks that these changes may generate, reassessing the adequacy of the boundaries of their mandate, carrying out controls on a broader and more diversified range of entities and activities, and coordinating supervisory rules and practices with other authorities at national and international level. The Bank of Italy currently supervises 54 banking groups and 167 stand-alone banks, 284 asset management operators (investment firms, asset management companies and fixed capital investment companies), 153 other financial intermediaries and 51 payment or electronic money institutions. These are flanked by hundreds of EU entities subject to supervision in their home countries, which can operate under the freedom to provide services. Traditional banks and financial companies are making ever more use of digital distribution channels. The number of intermediaries managing the whole life cycle of a product entirely at a distance – marketing, acquiring new customers, providing services – is on the increase. Business models that envisage collaboration between different kinds of financial intermediaries or between intermediaries and non-financial corporations are spreading; there is a marked rise in the use of ‘platforms’ that give techno-financial conglomerates the chance to offer customers access to a growing variety of services, such as the outsourcing of corporate functions, including key ones. The asset management industry is dominated by open-end funds (with more than €1,200 billion of assets under management), especially by investment funds incorporated abroad, which represent almost 80 per cent of the total undertakings for collective investments in transferable securities (UCITS) located in Italy. Of these funds, known as ‘roundtrip’ funds, nearly two fifths are owned by Italian groups that have transferred most of their managed assets to other EU countries, mainly for industrial, regulatory or tax reasons (especially to Ireland and Luxembourg). Closed-end alternative funds mainly reserved to professional investors – credit, private equity and venture capital funds – have increased strongly, though with a still modest amount of assets under management. The greater recourse to technological innovations may bring significant benefits to operators, intermediaries and, looking ahead, to firms and households as well. Intermediaries in particular will be able to exploit the advantages linked to digitalization in order to reduce their costs and improve the quality of the services they provide. Using digital solutions makes it possible to broaden the range of products and better define their features according to customer needs, to improve creditworthiness assessment, and to promote inclusion, guaranteeing easy access to financial services at low cost for those who make little or no use of the traditional system. Alongside the opportunities provided, the digital transition also poses considerable challenges for intermediaries and the regulatory and supervisory authorities. The former have to increase investment in order to limit financial, operational and reputational risks. The latter, which continue to coordinate closely within the forums for international cooperation, are engaged in updating the regulatory framework and the monitoring tools designed to balance the need to promote innovation with preserving the overall stability of the system and protecting savings. Digitalization has increased exposure to cyber attacks, fraud and the misuse of personal data. Italian banks reported 14 serious incidents in 2021, up from 4 in 2018. The damage was contained thanks in part to the effectiveness of the regulatory and supervisory safeguards to counter technological risks; however, intermediaries must continue to strengthen protection, given the greater technological content of their business and in order to deal with the intensification of cyber threats. The negative implications for the stability of the financial system linked to the growing use of new technologies must be resolutely countered, without reducing their adoption. The outsourcing of IT services to a limited number of operators not subject to supervision increases the danger that if service is interrupted by one or more suppliers, it could have systemic consequences, hence the need to come up with new kinds of supervision and intervention. The spread of applications that make use of artificial intelligence, supporting both internal processes and the supply of services to users, produces several qualitative and quantitative benefits (in areas ranging from back-office processes to the analysis and management of credit, cyber and operational risks, and from marketing to financial investment advisory services). Nevertheless, this means that intermediaries have to monitor the processes adequately, offsetting the complexity and opaqueness of the algorithms and preventing the mechanical adoption of such processes from jeopardizing the interpretability of the results of the analysis and from leading to uses that may also be involuntarily wrong. These risks are flanked by those caused on the one hand, by an unchecked development of increasingly significant phenomena such as decentralized finance – which, by using distributed ledger technology (DLT) and smart contracts, allows transactions to be carried out without using an intermediary or a ‘centralized’ process – and on the other hand, by the growth of crypto-asset markets, especially those other than stablecoins (which must nonetheless comply with important legal, regulatory and supervisory requirements – as reiterated by the G7 Finance Ministers and central bank governors). The marked volatility of the value of instruments traded on crypto-asset markets – whose capitalization at global level has halved in the last few weeks compared with the peak of around $3,000 billion reached last November – not only creates serious dangers for investors, as we have pointed out many times, but may also have significant implications for financial stability in the future. In this context, the action of supervisory authorities aims to ensure the efficacy of the rules guaranteeing the protection of investors, the correct functioning of market infrastructures and the security of the financial system and of the economy as a whole. The principle inspiring regulatory and supervisory action is the one according to which the same regulatory safeguards must be applied to the same activities, regardless of who carries them out. In cases where the use of more innovative technologies does not allow adequate legislative and supervisory requirements to be applied, the authorities are called upon to inform the public of the dangers encountered when investing in these instruments or using them as a means of exchange, and they must also adopt the initiatives necessary for avoiding any direct or indirect exposure of supervised entities to these markets. An important initiative for adapting the regulatory framework is under way in the European Union, in which we are active participants. The Regulation on Markets in Crypto-Assets (MiCAR) for governing crypto-asset markets and digital services is being finalized, as is a pilot regime for defining temporary deviations from European legislation in order to allow the controlled provision of trading and settlement services for financial instruments via DLT-based market structures. In order to promote the balanced development of digital services, by ensuring adequate limits on the risks stemming from greater use of technologies, a new digital operational resilience act (DORA) is upcoming. This will strengthen and harmonize the safeguards for technical security and corporate governance in the financial sector; there will also be a European regime for the direct supervision of critical providers of ICT services. The revised Payment System Directive (PSD2) and the Directive on Security of Network and Information Systems (NIS) are currently being reviewed to strengthen the security measures for electronic payments and to raise the level of IT security by means of requirements for market operators and general government, within a framework of cooperation among Member States. Lastly, the revision of the Regulation for the electronic identification systems provided to private citizens and firms (electronic IDentification, Authentication and trust Services, eIDAS) aims to guarantee the availability of reliable, secure digital identities that are fully interoperable between different countries, thereby contributing to the fight against money laundering and the financing of terrorism, including in processes managed entirely at a distance. Exchanging information in the event of attacks, disseminating best practices, developing risk assessment methodologies, organizing simulations and promoting communication campaigns for the general public all complement the regulations for combating threats to IT security. We are contributing to these activities, presiding, together with the Italian Banking Association, over the computer emergency response team for the financial sector (CERTFin), in which the other sectoral authorities and the most important financial and technological operators participate. Yet cyber risks cut across all boundaries at geographical, sectoral and individual organization level and therefore require collective action. From this point of view, international cooperation both between private entities and between authorities is of crucial importance. There are ongoing and important market initiatives that could favour the development of innovative financial services for the benefit of citizens and firms, and contribute to Italy’s digitalization strategies. At the start of this year, the merger began between NEXI and SIA, two important Italian groups that operate in the payments sector, especially in card transactions, clearing services for national and European interbank services, and connectivity services for the financial system. The new entity thereby acquires a leading position on the European scene. The significant expansion in terms of size and geography it intends to pursue will require careful monitoring of the risks. We are following the implications of these developments closely, in terms of both prudential supervision and payment systems oversight, activating appropriate forms of cooperation with foreign authorities when necessary. Following its acquisition of Borsa Italiana in April 2021, Euronext is now proceeding with organizational and business integration, which for Italy involves both the equity and government bond markets and the guarantee systems for trade and for securities settlement. Among the projects designed to strengthen the pan-European nature of the infrastructures managed, one important one is awarding the former Cassa di Compensazione e Garanzia, now rebranded as Euronext Clearing, the central counterparty services for all the trading in shares and in derivatives on financial instruments and on commodities managed by the group. Euronext’s primary data centre will move to Italy. In this case too, together with Consob, we are closely following the regulatory and supervisory implications of the new projects, via close contact with the supervised firms and the controlling shareholder. The changes associated with the digitalization of financial services are accompanied by those caused by the environmental transition. The need to make the global economy more sustainable requires a strong commitment from governments, supervisory authorities, central banks and intermediaries in order to face the challenges posed by such a transition. Those operators able to integrate sustainability objectives into the production and provision of financial services will be able to improve their ability to compete effectively on the market. The regulatory and supervisory authorities, for their part, will continue to adopt coordinated actions designed to encourage intermediaries to equip themselves with suitable safeguards in order to address the ongoing changes more effectively. In the last few days, the ECB has begun a stress test on climate-related risks that will involve almost all the significant banks. The exercise comprises three modules of increasing complexity, the last of which – for the biggest and most well-equipped intermediaries – requires banks to draw up projections for their financial and profitability situation under various climate-related scenarios, including very severe ones. Given the current unavailability of data, exposures towards small and medium-sized enterprises will be excluded from the exercise. Looking ahead, however, smaller firms will also have to provide intermediaries with detailed information about their carbon footprint in order to continue to have access to bank lending with no penalties. The results of the stress test, which should be seen above all as a chance for banks and supervisors to develop the skills necessary for managing climate change risks, will have no direct implications for the capital requirements set by the supervisor, but could contribute to the Supervisory Review and Evaluation Process (SREP). The need to prepare banks and the other supervised intermediaries for the management of these risks is a priority for our supervisory action too. Italian banks The improvement in the cyclical situation, together with the support measures still in force, has had a positive impact on the condition of Italian banks. As at the end of last September, their capital situation remained solid: the ratio of common equity tier 1 to risk-weighted assets (CET1 ratio) was 15.2 per cent, i.e. 1.3 percentage points above pre-pandemic levels. The rise was due both to the increase in capital and the decrease in risk-weighted assets, also following the disbursement of loans backed by public guarantees. Once the extraordinary needs connected to the pandemic were over and the supervisory authorities’ recommendations on dividends and share buy-backs had been lifted, the extraordinary distributions of profits referring to 2019-2020 conducted by some banks since last October have not had a significant impact on their capital adequacy. The ECB and the Bank of Italy are engaged in verifying that distribution policies remain geared to prudence, also in light of the uncertainty that still affects the macroeconomic outlook. In the first nine months of 2021, annualized ROE more than doubled year-on-year, reaching about 8 per cent. The recovery in profitability has been confirmed by the preliminary results for the full year disclosed by listed banks in recent days. The rise was largely due to the flow of loan loss provisions – which were very in high in 2020 – being halved, reflecting the strong rebound of the Italian economy recorded last year. Credit quality continued to improve, also benefiting from the support measures. While increasing slightly, the flow of new non-performing loans remained low in the fourth quarter, standing at 1.3 per cent of total loans, well below the highs recorded during the global financial crisis and the sovereign debt crisis. Moreover, the stock declined further: net of provisions, the ratio of non-performing loans to total loans was 1.9 per cent in September, 0.3 percentage points lower than at end-2020. In this phase, supervisory authorities are focused on lending for which repayment has been suspended and on that backed by state guarantees. As at the end of last year, banks had granted non-financial corporations loans backed by the guarantee schemes activated by the Guarantee Fund following the pandemic for a total of about €150 billion. No particular tensions on the credit quality front have been recorded for these loans: according to the latest supervisory reports, referring to the end of September, a mere 0.5 per cent are classified as non-performing. As regards the moratoriums provided for by the ‘Cure Italy’ decree and discontinued at the end of last year, the gradual phasing-out of the measures to support the economy might lead to an increase in the flow of non-performing loans over the coming months, with the consequent need to enter the corresponding losses in the profit and loss statement. However, the growth in insolvencies will likely be well below that registered during previous recessions. At the end of 2021, loans to firms that were still benefiting from these moratoriums amounted to around €33 billion, less than one fourth of the total granted since March 2020. In September, the latest date for which more detailed information is available, loans with an expired moratorium and those for which the moratoriums were still active had a default rate of 2.4 and 4.6 per cent respectively, compared with 0.9 per cent for loans that did not benefit from any support measures. For a sample of banks that fall under our direct supervision, we have conducted an in-depth analysis of the main exposures for which moratoriums were activated, in order to verify the accounting and prudential classifications and ensure the correct evaluations. About 20 per cent of the exposures examined had potential classification issues. The results were communicated to the banks concerned for careful re-examination. An ad hoc statistical survey initiated last summer of all less significant banks will enable us to intervene further with requests for additional information, including through on-site inspections, and we will send warning letters should it emerge that banks are underestimating these risks. We therefore now have a situation that does not seem to require any new generalized government measures. Two years on from the start of the pandemic, banks can assess for themselves the possibility of restructuring their loans to firms that are able to overcome temporary difficulties, by analysing individual exposures and taking on the related risk. Although the banking system as a whole is not in a bad condition, there are still some cases of fragility, mainly concerning small and medium-sized banks with a traditional business model. For many of these, low credit quality adds to the difficulty of curbing costs and responding to the challenges of technological innovation. Last year, as I announced at this very meeting, we conducted a survey on a broad sample of the banks under our supervision, asking them to provide a self-assessment of the sustainability of their business models. The responses returned a diverse picture. Most banks have balanced financial conditions, together with a sufficiently clear and informed view of the trends, risks and opportunities of the current market situation. For a non-negligible number of them, there were some uncertainties at strategic level and some weaknesses around their ability to generate adequate income flows, sometimes associated with low capitalization. In our experience, the corrective action requested by the Bank of Italy is all the more effective the faster the banks react. For some of the less proactive banks with managerial shortcomings, the weaknesses could result in a crisis in the absence of suitable corrective measures; therefore, they were asked to make a rapid assessment of possible options to prevent deterioration and to return to the path of full sustainability. These issues will remain central to discussions with the Bank of Italy in the months to come and more incisive interventions could be made if there are any uncertainties and delays in taking the necessary corrective action. The European Commission is currently revising the Bank Recovery and Resolution Directive (BRRD). In the public consultation, together with the Ministry of Economy and Finance, we underlined the importance of a greater harmonization of the national insolvency rules for non-systemically important banks in order to avoid disorderly liquidations that might provoke an unjustified loss of value and contagion risks. Taking inspiration from the experience of the Federal Deposit Insurance Corporation in the United States, and in line with the crisis management arrangements traditionally adopted in Italy in the years preceding the adoption of the BRRD, greater scope for intervention by deposit guarantee funds would be desirable to facilitate the transfer of assets, liabilities, branches and legal relationships from the bank in liquidation to a third-party acquirer. To this end, it would be necessary to remove the priority accorded to the funds for recoveries in liquidation (the super-priority rule), which makes it difficult, and often impossible, to comply with the least cost criterion. * * * The unexpected increase in inflation recorded in the euro area in the last few months is largely the result of a supply-side shock. If no wage-price spirals are triggered and if expectations remain firmly anchored to the ECB’s inflation objective, as is happening at the moment, the effect of the energy price rises will mostly be reabsorbed in 2023. As the recovery consolidates, a gradual normalization of monetary policy therefore remains the most appropriate strategy. The expected slowing down of net asset purchases by the ECB over the course of this year and their eventual suspension are not such as to warrant a significant worsening in financing conditions on the bond market in Italy. The burden of public debt has fallen markedly and it will probably be about 10 percentage points lower compared with forecasts that put it close to 160 per cent of GDP at the end of 2021. The downward trend must continue over the coming years. A small rise in market rates will have no significant effects on the cost of the debt, whose average duration is just under eight years. If fiscal policy is able to ensure a gradual rebalancing of the accounts and the NRRP is promptly, fully and effectively implemented, any increase in interest rates will be offset by the economy’s return to paths towards higher and long-lasting growth. The success of the NRRP will also be crucial in allowing Italy to overcome the challenges posed by the digital and the green transition, from which no sector of the economy is exempt. For banks and financial intermediaries in particular, investment in technology and effective management of risks, including those linked to climate change, are not merely instruments for tackling the growing competition; they are fundamental levers for lowering brokerage costs, increasing the quality of services on offer, improving profitability and, ultimately, giving the economy the support it needs. Designed and printed by the Printing and Publishing Division of the Bank of Italy
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Keynote speech by Ms Alessandra Perrazzelli, Deputy Governor of the Bank of Italy, at the Arab Monetary Fund-Basel Committee on Banking Supervision-Financial Stability Institute (AMF-BCBS-FSI) high-level virtual session, Abu Dhabi, 8-9 December 2021.
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Alessandra Perrazzelli: The post Covid-19 banking system Keynote speech by Ms Alessandra Perrazzelli, Deputy Governor of the Bank of Italy, at the Arab Monetary Fund-Basel Committee on Banking Supervision-Financial Stability Institute (AMFBCBS-FSI) high-level virtual session, Abu Dhabi, 8-9 December 2021. * * * Introductory remarks It is a pleasure to join this seminar on the post Covid-19 banking system. I truly believe that the cooperation at international level among Authorities is key to achieve a global coordination of the supervisory agenda. In my speech, I will focus on three main aspects: lessons learned from the pandemic; SSM supervisory priorities in the medium term; crisis management framework. 1. Lessons learned from Covid-19 In the first 20 months after the pandemic outbreak, the banking system proved very resilient and able to support the economy. The lending activity in the euro area even increased in 2020, despite a sharp decrease of annual GDP over the same period; at the same time, bank capital position and asset quality remained robust. The resilience of the banking sector has also been confirmed by the outcome of the recent EU-Wide Stress test that, together with other elements, is considered in the annual review process (i.e. SREP). This has been the result, in my opinion, of three main factors, that proved to work very well. Firstly, the government support measures. As we know, the governments immediately intervened to dampen the adverse effects of lockdowns, by allowing banks to continue to support lending, mainly via moratoria and public guarantees. Secondly, the level of cooperation among European Authorities and Central Banks. On the supervisory side, the SSM took a number of measures to grant temporary relief to banks, by allowing them flexibility to make use of capital and liquidity buffers. We also asked banks to refrain from distributing dividends, via a recommendation withdrawn only last October; in addition, national macro-prudential authorities released or reduced capital buffers, while the European legislators issued a Covid-19 banking package to facilitate bank lending. The level of cooperation has been massive and key for the success of the measures. Thirdly, Basel III regulatory reforms and supervisory action.The banking sector entered the pandemic in a much better shape than in the past (greater capital buffers, reduced burden of legacy stocks of non-performing loans, improved risk management frameworks). This is the result of both the regulatory reforms put in place in the aftermath of the great financial crisis and the achievements of the first seven years of single supervision within the euro area. 2. Focus on supervisory and regulatory priorities for 2022 The effects induced by Covid-19 crisis have not yet become fully apparent on banks’ balance sheets, and may only do so once public support measures will be entirely phased-out. Therefore, we need to stay ready to promptly react to face the challenges ahead for the banking system in the medium term. Accordingly, the SSM has formulated several strategic objectives (i.e. “the SSM Supervisory Priorities”) to be pursued throughout 2022-2024 time span. Our first area of priority is to ensure that banks emerge healthy from the pandemic. It is indeed essential that banks do not loosen their credit standards in this phase and keep sound 1/4 BIS central bankers' speeches provisioning policies and procedures, in order to ensure timely identification of distressed counterparties. In the meantime, I believe the banking system should continue to support the real economy, especially those companies are experiencing difficulties but still have the chance to get back profitable and sustainable. In addition, it is important that supervised institutions are prepared to deal with potential shocks in interest rates and sovereign spreads, leading to a change in the asset valuation. Second area of priority is to tackle emerging risks. In particular urgent and decisive actions are needed to enhance our efforts on climate-related and environmental risks. The intensification of the climate crisis puts pressure not only for the financial sector, but for the economy as a whole. As the transition to a greener economy has already begun, most European banks are starting to integrate climate risk into their risk management frameworks, but progress is still too slow. When it comes to our role, the SSM issued well-defined and clear supervisory expectations on climaterelated and environmental risks; next year a targeted micro-prudential stress test exercise will be run. In addition, another emerging risk is represented by cyber-attacks. While banks have successfully shifted to a remote working environment, the Covid-19 has increased cyber risk threats and challenged banks’ IT resilience; it is of utmost importance that banks proactively strengthen risk management practices in this field. Finally, another area of priority is to address structural weaknesses of the banking sector. These are not strictly related to the pandemic crisis, as they were already clear even before its outbreak, but they have been undoubtedly intensified by the Covid-19. In particular, this is the case of the deficiencies in governance and profitability. Further, the sustainability of banks’ business model still represents one of the most relevant supervisory concern to date. This is why banks should thoroughly grasp the growth opportunities offered by the digital transformation. Digitalisation challenges remain a key priority in supervisors’ agenda. The pandemic crisis boosted the ongoing digital transformation of banks, stemming from a wide range of root causes, such as a widespread low profitability associated to structural inefficiencies and growing competition with new and agile Fintech actors. Nowadays, the rising of the open banking paradigm reduces the advantages banks historically had on the most traditional and less complex banking services. However, pursuing a digitalization path clearly means to make large upfront investments. As a result, it is not surprising that the SSM is shedding lights on banks’ risks associated to digital transformation, often regarded as a panacea for reinventing unviable business models. Beyond keeping on dealing with the more traditional risks, supervisors should assess new and emerging risks linked to the new scenario – namely ICT and strategic risks – giving them a more specific weight in their ordinary assessments. In my opinion, while remaining neutral on the market players’ single choices, we should encourage the banking system in taking advantage of the opportunities of Fintech and promoting digitalization. Then, we will be in the position of ensuring the level playing field, assessing business models or the proposals of new services and products from the banking sector in a homogeneous way: competition in laxity as well as unnecessary binding constraints must be avoided. 3. Crisis management The EU and global framework for dealing with banking crises improved dramatically in the aftermath of the 2007/2008 global financial crisis. The focus of the reforms at FSB level mainly pointed to the systemically important banks, in line with the original aim of addressing the “too-big-to-fail” issue. At European level, the international standards set out by the FSB were adopted through the Bank Recovery and Resolution Directive (BRRD), which established a harmonised and efficient crisis management regime, in particular for large banks able to build up enough TLAC/MREL without radically modifying their funding structure. 2/4 BIS central bankers' speeches After six years from the implementation of the BRRD in the EU, the resolution planning activity of the European Resolution Authority is well on track, while the MREL buffers have been built by the significant banks. Moreover the resolution plans are quite advanced and the policy framework by the EBA and SRB is in place. Focusing on cross border banking groups, the effective cooperation between resolution authorities is of paramount importance. Additional improvements are needed, in particularly to ensure that the resolution decisions of the home authorities are recognised cross border and TLAC/MREL instrument issued in third countries can be actually bailed-in. In this vein, improvements are warranted also to efficiently handle the crisis of small and medium-sized banks, which are, in number, the majority of the EU banks. Beside a too-big-tofail issue there could be a “too-many-to-fail” problem, especially in the context of the economic crisis due to the pandemic, that is likely to hit harder this kind of banks. In this context, there is broad consensus that the crisis management framework should be improved. At the EU level, the European Commission is working on a review of the framework. For these banks the resolution procedure in EU is quite unfeasible as they do not pass the i.e. ‘public interest test’ or are not able to tap capital markets to issue adequate levels of lossabsorbing liabilities; in the Euro Area, around 70% of the significant banks are not listed, 60% have never issued convertible instruments, and 25% have not even issued subordinated debt. I believe that the most fitting solution is a harmonized orderly liquidation regime for small and medium-sized banks, preceded on a transfer strategy with external funding support where needed. The US and Italian experiences, each with its own peculiarities, offer some useful insights, as the vast majority of crisis were managed with the sale of assets and liabilities supported by the Federal Deposit Insurance Corporation and by the deposit guarantee scheme. A crucial issue relates to the funding arrangements strategy. The ultimate challenge is to find the right balance between reducing moral hazard and ensuring adequate financing to resolve crises, protect depositors and the other creditors, while preserving the public confidence and the financial stability. In the context of crisis management the digitalisation process deserves attention; in particular, digital platforms are increasingly used to market or distribute, even crossborder, financial products and services, including deposits. These platforms, while useful to improve the institutions’ funding, may pose important implications for the financial stability as well as for depositor protection, also considering the lower customer fidelity for the so distributed products; this kind of deposits tends to be volatile and may rapidly decrease when the institution is perceived as weak. These conditions increase the need of a prompt intervention by Supervision and Resolution Authorities as soon as the weaknesses of the bank appear as well as further analysis on the possible implication for crisis management regulation. In conclusion, identifying an adequate framework for managing the crisis of small and medium sized banks as well as for banks with innovative business model is crucial and particularly urgent at present time, also considering that this kind of bank could be those suffering the most from the pandemic. 4. Conclusions The pandemic confirms and reinforces the perception of some ‘traditional’ risks and structural inefficiencies in the banking and financial sector. At the same time, the widespread use of digital solutions emphasizes the need to strengthen the supervisory approach and to review the regulatory framework to take into account the swift changes in the financial environment, also from a crisis management angle-point. Cooperation is crucial to tackle the challenges ahead. 3/4 BIS central bankers' speeches 4/4 BIS central bankers' speeches
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Speech by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy and President of the Insurance Supervisory Authority (IVASS), at the EUROFI High Level Seminar 2022, Paris, 23 February 2022.
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Luigi Federico Signorini: Outcomes of Italy’s G20 Presidency Speech by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy and President of the Insurance Supervisory Authority (IVASS), at the EUROFI High Level Seminar 2022, Paris, 23 February 2022. * * * Good afternoon, ladies and gentlemen. I do appreciate this opportunity to discuss some key steps taken during Italy’s G20 Presidency in 2021. To keep this speech within reasonable limits, I need to be selective. I shall briefly recap the main outcomes of the work of the G20 Finance Track, and then focus on the results obtained in two areas of direct concern for financial markets, i.e.: (i) strengthening the resilience of non-bank financial intermediation (NBFI), and (ii) preparing the financial sector for a world that is starting to fight climate change seriously. Italy took up the G20 Presidency in the midst of the pandemic crisis, at a time when global economic activity was suffering from the resurgence of infections and remained well below its pre-Covid levels. Many low-income and developing countries in particular were lagging far behind in their recovery. In this context, the Italian Presidency defined three overarching priorities for the Financial Track of the G20: to provide quick, strong and cooperative action to step up the policy response to the pandemic, and to lay the groundwork for a more resilient global health system in the future; to resume the discussion on climate change within the G20, profiting from the new attitude of the US administration in favour of multilateralism as well as from the swift rise of interest in the topic at the global level; to secure an agreement on international taxation. On the first issue – the response to Covid and future preparedness for global health emergencies – in 2020, thanks to the extraordinary public support extended to households and firms in many jurisdictions, as well as to the prompt coordinated response of monetary and other financial policies to the crisis, the world economy had recorded a strong recovery. Contrary to what happened at the time of the global financial crisis of 2008, a financial meltdown was avoided this time and the financial system continued to provide critical support to the real economy. A return of the pandemic weighed on the world economy in the winter of 2021. However, continued strong, coordinated policy action, and the experience accumulated during the first wave of the pandemic, ensured that the economic fallout from the second and further waves was more subdued. The rapid roll-out of vaccines in developed countries led to a gradual lifting of restrictions on economic activity and to a resumption of investment and consumption with far fewer bankruptcies than expected, although at the cost – consciously incurred – of a one-off increase in public debt. Many advanced countries have now reached, or are close to reaching, pre-crisis output levels. Under the Italian Presidency, the G20 also took action to help the weakest economies that had been disproportionally hit by Covid-19. It provided support to multilateral mechanisms, ensuring wide access to tests and vaccines. In addition, to address the structural weaknesses highlighted by the pandemic, it established a new Panel on prevention and preparedness that advanced proposals to improve the mobilisation of funding and enhance coordination between Health and Finance Ministries and international organisations. Work to deliver a shared solution on these issues will continue in the next few months under the Indonesian Presidency. The G20 also agreed to extend the suspension of debt service payments for 50 countries until 1/5 BIS central bankers' speeches the end of the year, and to renew efforts to operationalise the common framework for the treatment of the distressed debt of some eligible countries. While the latter has encountered some difficulties, last October G20 Ministers and Governors reiterated their commitment to make progress. The G20 also agreed to make 650 billion dollars available in additional reserves through a general SDR allocation, with rechannelling options to allow low-income countries to receive further support. On the second issue – the fight against climate change – our Presidency began at a time of swiftly rising awareness of the issues raised by climate change among savers, investors, financial market operators and the public at large. The attitude of G20 delegations was (and is) also changing. It is no surprise that countries differ widely in their priorities and sensitivities on this issue, but there appeared to be a worldwide surge in the feeling that a conversation on actions needed had to be held within the G20 framework in a multilateral format. The Italian Presidency, of course, cannot claim to be the prime mover of any of these global developments. However, I think we can fairly say that the Presidency quickly sensed the new spirit, and saw the opportunity to channel it into a concrete discussion of steps to take. Under our Presidency, the Sustainable Finance Study Group has been re-established and upgraded to a fully-fledged Working Group, under the co-leadership of the United States and China. There was also an important financial-market side to this endeavour; I shall come back to this in a moment. On the third issue, international taxation, to address the issues posed by globalisation and digitalisation, the G20 reached an important agreement on a minimum level of taxation and rules for the reallocation across jurisdictions of taxes on excess profits of multinationals. Work on the operationalisation of the framework is ongoing, with a commitment to full implementation by 2023. Let me now turn to achievements of more direct concern for the financial markets, and focus on two key priority areas of the Italian Presidency. The first area concerns strengthening the resilience of what was once known as ‘shadow banking’, and is now called the non-bank financial intermediation (NBFI) sector, or sometimes ‘market-based finance’. Since the global financial crisis, market-based finance has grown rapidly, and today accounts for almost half of total financial assets. This is by no means a bad thing in itself: it makes the financial system more diverse and thus potentially more efficient and resilient. However, NBFI comes with its own risks, which need the regulators’ and supervisors’ attention. With its expansion, certain vulnerabilities of NBFI – concentration, interconnectedness, liquidity mismatches – have also been growing in importance. We had been stressing for years the need for rethinking the supervisory framework for NBFIs; to go beyond traditional conduct supervision and embrace a financial stability perspective. Bolstered by the reforms implemented after the global financial crisis, the banking sector entered the pandemic with stronger capital and liquidity buffers, which supported its ability to provide continued critical lending to the economy. Post-financial crisis regulatory reforms have affected the non-banking sector to a much lesser degree. The events of March 2020 confirmed the concerns about NBFI. They exposed structural faultlines in the non-bank sector that helped to amplify market stress and increase procyclicality. These include liquidity mismatches in money-market funds and open-end investment funds invested in less liquid assets. The disorderly unwinding of highly leveraged positions by some non-bank entities contributed to amplifying the effects of the liquidity stress (the ‘dash for cash’), with spill-overs affecting even markets for traditionally safe and liquid government bonds. Orderly market conditions were only re-established after massive central bank intervention. 2/5 BIS central bankers' speeches These issues have been thoroughly analysed by the Financial Stability Board (FSB). In a ‘Holistic Review’ published in November 2020, the FSB identified certain weaknesses of the non-bank sector that needed to be addressed. The FSB has laid out a work plan to strengthen regulatory safeguards, with the aim of limiting the need for central bank intervention and avoiding moral hazard. Under the Italian Presidency, the G20, based on the FSB work, endorsed a package that provides jurisdictions with a framework for assessing and addressing vulnerabilities in their MMF sector, and with an agreed menu of policy tools. Some reforms are already being envisaged in the main jurisdictions, such as the EU and the US. Global reviews will be conducted jointly by the FSB and IOSCO by end-2026, with the aim of assessing the appropriateness of the measures adopted by all jurisdictions and evaluating the need for further action at the global level. Ideally, we would have liked to see the G20 to take an even bolder step and adopt from the start a set of global mandatory standards for MMFs, thus further enhancing the resilience of the sector and limiting the room for market fragmentation and regulatory arbitrage. We recognised, however, that jurisdictions were not yet prepared to go all the way to global standards. In our capacity as the G20 Presidency, we worked hard to ensure that a first, important agreement was reached. We also ensured that there was a commitment to reconsider the matter over time, on the basis of the results achieved. Looking ahead, work on NBFI will continue in a number of directions. Better data and analyses are needed to improve our understanding of NBFI vulnerabilities and of appropriate policy tools. The FSB is committed to examine suitable policy approaches to address vulnerabilities in openended funds, margining practices and short-term funding markets. It will be incumbent on the current and future G20 presidencies to steer this work. The second area, as I said earlier, concerns the role of financial markets in catalysing the flow of funds needed to enable the climate transition. The good news is that the interest of private capital for sustainable investment is growing at a fast pace. The less good news is that the efficient allocation of climate-friendly capital is hindered by insufficient availability of granular, reliable, internationally comparable information. Sustainable financial investments rely on (i) company disclosure practices that are neither harmonised nor easily auditable, and (ii) scoring systems that are heterogeneous across different financial providers, largely subjective and sometimes opaque. As a consequence, the risk of confusing information and misleading claims (‘greenwashing’) is not immaterial. Another important issue for financial authorities is the need for adequate consideration of environmental risk in financial institutions’ risk management, in supervisory rules and practices, and in economic modelling. Many central banks and supervisory authorities, including the Bank of Italy, are making efforts to improve their actions, also benefiting from the exchange of experiences at international level. The G20 Sustainable Finance Working Group has undertaken several important initiatives. In its 2021 Report, it set practical recommendations in three priority areas: (i) strengthening the comparability and interoperability of approaches; (ii) improving reporting and disclosure; and (iii) enhancing the role of international financial institutions in supporting the goals of the Paris Agreement and of the United Nations Agenda 2030. As a key legacy of the Italian Presidency, the Group developed the first G20 multi-year Roadmap on sustainable finance to guide future works at international level. This year, the Indonesian Presidency are promoting new analyses on sustainable finance, building on the work plan detailed in that Roadmap. Further initiatives under our Presidency included requesting the IMF and other international 3/5 BIS central bankers' speeches organisations to consider climate-related data needs in preparing a new Data Gap Initiative, and the Financial Stability Board to report on disclosure challenges and data gaps on climate-related financial risks. The FSB was also requested to develop its own Roadmap to tackle climaterelated risks for financial stability, to provide a coordination mechanism for standard setting bodies and international organisations to improve firm-level disclosures, data availability, methods and scenarios for vulnerability analyses, and regulatory and supervisory practices and tools. Let me just add that, while enhancing sustainable finance is very important, fighting climate change is first and foremost a job for general public policy. As I mentioned earlier, within the G20 framework we were and are committed to promoting fruitful cooperation on actionable policy proposals. A key focus should be the design of a global carbon pricing system, including setting up carbon tax plans and removing fossil fuel subsidies. In these first months of 2022, the recovery has become increasingly vulnerable to downside risks, including new, negative developments in the pandemic, inflation, increases in energy and food prices, and bottlenecks in the manufacturing and transportation of goods, as well as unfavourable geopolitical developments. It is important for the G20 to maintain a cooperative approach aimed at minimising the risk that heterogeneity in recovery strategies may result in an undesirable spill-overs. Let me spend my last few minutes on a question that may legitimately be asked, and that many of us, involved in lengthy discussions often stretching over several meetings, might have asked themselves. Within the G20 framework, are we actually doing what is needed? Are we addressing the most important economic and financial issues in an efficient, effective way? Despite all the frustration that we might feel at times, when consensus proves hard to reach, and despite the failures that do occur from time to time, I think we can give a positive answer to these questions. First, whatever the concrete details of the agreements that political leaders are actually able to reach (and, as I have argued, we do count the results of the Italian Presidency as genuinely meaningful achievements), and even when agreement proves elusive, the G20 maintains its value as a multilateral forum where the leaders of the major world economies can frankly talk to one another about the key economic and financial issues of the day. At the very least, this provides a framework within which mutual trust can be pursued, whatever the difficulty of the times. But it is especially useful in a crisis. It has repeatedly proven its value when there is a recognised, urgent need to provide coordinated responses, as happened in 2008-9, and occurred again in the last couple of years, including in 2021, when the G20 acted to secure funds for vaccines and suspend the debt service for the most vulnerable economies. Second, the G20 has promoted a format for discussion and coordination of policies in some key areas. One good example is the work of the Financial Stability Board. Established at the time of global financial crisis, it started with the overhaul of the regulatory and supervisory regimes of the financial system, in particular of the banking sector. It has since moved on to assess and address emerging risks from a variety of sources, including most recently crypto-assets, nonbank financial intermediation and climate-related financial risks. It is now taken for granted that there is an international dialogue on all these issues and a ‘Board’ that coordinates actions by the Standard Setting Bodies and gives policy advice to national authorities. No wonder the FSB is now considered a successful example to be possibly followed in other areas, health for instance. Yet, this is the result of discussions we had and efforts we made, not something that sprang up spontaneously. Finally, I would say that G20 discussions and commitments, once they are reflected in hard-toearn consensus on communiqués, do work as a focal point for peer pressure and for international reputation. Any country can easily fall short of, or even renege on, their 4/5 BIS central bankers' speeches commitments, which in the end do not have the force of law. However, this does not mean that doing so comes at no cost, and the difficulty experienced in finding consensus on any commitment proves that this is indeed the case. 5/5 BIS central bankers' speeches
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Opening remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at an event marking the conclusion of the first call for proposals by Milano Hub, Milan, 28 February 2022.
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Ignazio Visco: Milano Hub- results of the 2021 call for proposals Opening remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at an event marking the conclusion of the first call for proposals by Milano Hub, Milano, 28 February 2022. * * * Good afternoon. I am delighted to welcome you to this event marking the conclusion of the first call for proposals by Milano Hub, the innovation centre through which the Bank of Italy intends to provide concrete support to digital developments in the financial market. This first call focused on the contribution of artificial intelligence to improving the provision of banking, financial and payment services. The importance of this field is apparent in the many Fintech and non-Fintech initiatives that rely on technological solutions based on artificial intelligence. We have seen this not only when performing our institutional functions but also through our dialogue with the market within the two other innovation incubators, the Fintech Channel and the regulatory sandbox. Based on some market estimates, investment in artificial intelligence in Europe currently amounts to more than $20 billion and is set to exceed $50 billion in 2025. The banking and manufacturing sectors are among the trendsetters and yet – according to analyses conducted by the European Commission and the European Investment Bank – Europe lags behind both the US and China in the development and use of artificial intelligence. Artificial intelligence systems allow business processes to be modernized, strengthen risk management processes, and promote the supply of new products. At the same time, they can give rise to new risks that must be carefully monitored. We must, for example, ensure that the mechanical adoption of complex and at times opaque algorithms do not generate distortions and improper uses of data. Acknowledging the need for a common legal framework to regulate the use of artificial intelligence, last year the European Commission began discussions on its definition. Specific provisions on the financial sector are contained in the framework proposal, which will help ensure an increasingly intensive yet balanced use of the applications developed by industry. It is from this fertile and promising new ground that we put out the call for proposals for our hub. The market response has been more than positive with over 40 projects presented by Italian and foreign operators. The initiatives, which were submitted to a panel of experts for evaluation, were notable in most cases for their variety, novelty and the wealth of topics explored. This experience has proven that Milano Hub can be a key forum for interacting with the market and supporting the development of innovative solutions based on approaches that take due account of the need to balance opportunities and risks. Before announcing the winners, I wish to thank all of you who answered this call for proposals and who took up this shared challenge. Special thanks go to the members of the panel who assessed the projects, for their commitment to carrying out a difficult task with great speed and professionalism, and to all our colleagues in the Bank of Italy who enabled us to reach our goals in just a few short months. I wish you every success in your future endeavours and hope that cooperation between the supervisory authorities, Fintech companies, supervised intermediaries and research centres can continue to make progress and to be intensified over time. 1/1 BIS central bankers' speeches
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Speech by Ms Alessandra Perrazzelli, Deputy Governor of the Bank of Italy, at an event marking the conclusion of the first call for proposals by Milano Hub, Milano, 28 February 2022.
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Milano Hub – Results of 2021 Call for Proposals Speech by Alessandra Perrazzelli Deputy Governor of the Bank of Italy 28 February 2022 Welcome everyone. I am very pleased to be here today to present the results of Milano Hub’s inaugural 2021 Call for Proposals on artificial intelligence and to announce the names of the 10 projects that - after a rigorous review process - will participate in the Bank of Italy’s innovation centre. How did we get here? We received 40 projects submitted by 62 different operators: financial intermediaries, start-ups, service providers, universities, industry associations, research centres, consulting firms and law firms (slide 1). The call was answered by young start-ups (less than two years old) and by Italian and foreign banking, finance, insurance and commercial groups, including some listed companies. Universities also feature prominently: 22 per cent of the projects submitted hail at least in part from the world of academia. The response to the call for proposals has been very positive. It has served as a further source of stimulation for the Bank of Italy in helping the financial system to face the challenges posed by the technological innovation process. The results of the call only go to show that innovation knows no boundaries, drawing together participants from across the financial ecosystem, regardless of size. This is also confirmed by the discussions we have had with the market through our other two innovation incubators: the FinTech Channel and the regulatory sandbox. In 11 cases, the applications were submitted jointly by two or more applicants, often from different economic sectors (slide 2). These are projects that require the input of a variety of professionals, or that involve operators with traditional business models turning to Fintech companies or specialized service providers for their know-how to improve processes and to adapt products. Breaking it down geographically (slide 3), 66 per cent of the projects come from the North of Italy, 18 per cent from the Centre, and 11 per cent from the South and the Islands; the remaining 5 per cent were submitted by foreign applicants. Our interaction with these operators has shown that, while the distribution is uneven, nonetheless throughout the country there are plenty of even small entities with a significant wealth of knowledge and high-quality human capital that we should be tapping into increasingly. The projects submitted (slide 4) stand out for their high quality and variety. This fully reflects the dynamism and complexity of the artificial intelligence sector, which is undergoing a period of strong expansion throughout the world. The proposals received focus mainly on innovative payment methods, anti-money laundering regulations, asset management and tokenization of financial instruments. In addition, there are projects involving RegTech solutions and risk measurement and management tools, specifically for environmental, social, and governance (ESG) risk. What awaits us? The Bank of Italy plans to form a group of experts to support each of the projects selected. This represents a significant commitment on the Bank’s part, offering the assistance of expert staff, usually for a period of six months, to help develop and design the solutions proposed. Starting in March, the teams will begin their work of consulting with the applicants. To ensure transparency, the list of the 10 winning projects and a brief description of each project will be published on the Bank’s website. An ancient Chinese proverb states ‘A journey of a thousand miles begins with a single step’. We have taken many steps these last few months. Today’s event marks another stage in a journey that began some time ago, one that I won’t pretend has been smooth sailing all the way but which I nonetheless believe opens up exciting new horizons. So I have faith; we, along with our market operator partners, are searching for solutions that could have positive externalities, not just for the applicants, but for the entire system. The results of the 2021 Call for Proposals show that the path we have chosen is the right one. The collaboration between Milano Hub and the other two innovation incubators, the Fintech Channel and the regulatory sandbox, are sure to strengthen this process. Finally, allow me to reiterate what the Governor stated at the start of today's event: I would like to thank all the members of the Project Evaluation Panel, the consultants and all the colleagues who, in various ways, have contributed to the success of this event. I hope that the opening of the Milano Hub will prove to be another example of our country’s ability to ‘pull together’. MILANO HUB Results of the 2021 Call for Proposals Alessandra Perrazzelli 28 February 2022 The Hub’s three areas of operation 40 projects submitted by a total of 62 entities (applicants + participants) Fintech hub Innovation Research & Development hub Applications received hub Places available 9 universities 1 association Number of projects SLIDE 1 Joint initiatives 11 joint applications Joint initiatives R&D hub 5 out of 10 applications in this area were for joint initiatives with universities, Fintech companies, law firms, etc. Fintech hub 6 out of 25 applications in this area were for joint initiatives with universities, Fintech companies, law firms, etc. SLIDE 2 Geographical distribution Considering the registered office of the 62 entities (applicants + participants) North 66% Centre 18% South and Islands 11% 1 application Foreign 5% SLIDE 3 Main reference area of the projects Breakdown of the 40 projects Payments 15.0% 22 Deposits and Lending 6 Payments 5 Security 3 RegTech 2 Investment and Wealth Management 1 Crowdfunding 1 Decentralized Finance Crowdfunding 2.5% Investments and Wealth Management 5.0% RegTech 7.5% Decentralized Finance 2.5% Security 12.5% Deposits and Lending 55.0% Percentage breakdown SLIDE 4 Designed by the Printing and Publishing Division of the Bank of Italy
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Welcome address (virtual) by Mr Ignazio Visco, Governor of the Bank of Italy, at the 3rd Bank of Italy and Bocconi University conference "Financial stability and regulation", 17 March 2022.
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Ignazio Visco: Welcome address – “Financial stability and regulation” conference Welcome address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 3rd Bank of Italy and Bocconi University conference “Financial stability and regulation”, online event, 17 March 2022. * * * Ladies and gentlemen, friends and colleagues, I am delighted to welcome you to the third biennial conference on “Financial Stability and Regulation” organised by the Bank of Italy and Bocconi University. The conference takes place at a particularly difficult time: while we are still facing the complexities of the gradual phasing out of the policies implemented during the pandemic, new risks have dramatically taken centre stage. The Russian invasion of Ukraine has changed the macroeconomic scenario almost overnight. In the current situation, even financial stability faces significant risk from potential energy supply disruptions and their consequences for the real economy and intermediaries, as well as from dislocations in financial markets. Amidst such profound uncertainty, amplification mechanisms may arise from multiple channels, due to the close interconnections within the global financial system. Looking forward, beyond the dramatic events we are currently witnessing, technology as well as the transition to an economy with net-zero carbon emissions will continue to shape the evolution of markets and of both traditional and new financial service providers. While this evolution has the potential to make the financial industry more effective in supplying the services required by households and firms, intermediaries and investors need to learn how to manage the risks arising from digitalisation and climate change. On the regulatory and supervisory front, national and international authorities responsible for financial stability are themselves “proactively adapting”, by developing new approaches and instruments to identify, monitor and manage new risks. These issues will be discussed in depth during this conference, and I am sure it will provide an excellent opportunity to gain new insights from academic research. At the same time, the experience of policymakers and the challenges they face may help guide researchers towards the specific questions that it is of the utmost importance they address. In these brief opening remarks, I would like to mention some research questions raised by the interaction between monetary policy, financial stability and macroprudential policies, which I think should be explored over the coming years. In its recent strategy Welcome address Ignazio Visco Governor of the Bank of Italy 3rd Banca d’Italia and Bocconi University Conference, “Financial Stability and Regulation” Online event, 17 March 2022 2 review, the ECB has highlighted that “the preparation of monetary policy deliberations will be enhanced with additional information on financial stability considerations.” While macroprudential policies are and will remain the first line of defence against financial stability risks, we aim at basing our monetary policy decisions on a more systematic assessment of the risks to output and inflation created by the accumulation of financial vulnerabilities, of the extent to which macroprudential measures can mitigate these risks, and of the design features of monetary policy tools that minimise side effects on the financial sector. Taking proper account of these financial stability considerations will require the contribution of research along two main dimensions. First, further progress is necessary on the development of macro-financial models capable of underpinning the joint analysis of monetary and macroprudential policies. The global financial crisis of 2007–08 spurred a vast research agenda on macro-financial linkages, providing us with new analytical tools to calibrate macroprudential measures and to evaluate their impact. Work in this direction should be expanded to build integrated frameworks for the assessment of the 1/2 BIS central bankers' speeches trade-offs and complementarities between price stability and financial stability over different time horizons, and of the interactions between monetary policy and macroprudential policy. We need to better understand, in particular, the nonlinearities associated with episodes of financial instability, the potential lack of synchronicity between the real business cycle and the typically longer financial cycle, and the extent to which each policy influences the effectiveness of the other. Second, we have to expand our knowledge of the impact of monetary policy on the non-bank financial intermediation sector. The share of financial intermediation performed by non-banks has risen sharply over the last few decades at a global level. On one hand, these institutions are increasingly becoming an important channel for the transmission of monetary policy during normal times. On the other hand, they could also seriously threaten its functioning in situations of stress, requiring central banks to turn to extraordinary (direct or indirect) interventions, such as those that were implemented in March 2020. Non-bank financial intermediaries are not currently subject to a macroprudential framework, nor have explicit access to central bank facilities. Understanding how monetary policy measures may affect their behaviour is therefore particularly relevant from a financial stability perspective. Several other important issues should also be better investigated. As the balance sheets of banks and non-banks differ markedly in terms of exposure to duration and market risks, their response to monetary policy measures may also be expected to diverge. Distinct responses are likely to depend on whether monetary policy tools affect the short or the long end of the yield curve. The transmission of monetary policy through non-banks could depend on the stringency of micro and macroprudential policies on the banking sector due to leakages from the regulated to non-regulated parts of the financial sector. Finally, expectations of central bank support in case of systemic market turmoil could feed risk-taking behaviour among non-bank financial intermediaries, and increase the sensitivity of their response to monetary policy changes. Let me conclude. When we organised the first edition of this conference in April 2018, we aimed at establishing a venue for discussing financial stability issues, macroprudential policies and financial sector regulation on solid analytical and empirical grounds. Based on the excellent program of this third edition, I would say that this objective has once again been well achieved. I would like, therefore, to thank the speakers, the discussants, the chairpersons and the organisers at Bocconi University, whose partnership in this initiative has been so fruitful, as well as the Bank of Italy’s staff. I wish you all very fruitful and constructive discussions. 2/2 BIS central bankers' speeches
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Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at "The ECB and Its Watchers XXII" conference, hybrid event, 17 March 2022.
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The interaction between monetary and fiscal policies in the pandemic crisis and beyond Remarks by Ignazio Visco Governor of the Bank of Italy The ECB and Its Watchers XXII Hybrid event, 17 March 2022 Coordination between fiscal and monetary policy has been a key factor at a global level over the last two years, to contrast the consequences of the pandemic crisis and to support the recovery as the state of emergency began to subside. In these brief remarks, I will first focus on the similarities and, more specifically, the differences between the policy mixes implemented in the United States and in the euro area, and then on how I see the situation evolving in light of the Russian invasion of Ukraine. In essentially all countries, following the outbreak of the pandemic, governments stepped in to strengthen health systems and support household income and credit to firms; fiscal policies everywhere were strongly facilitated by the accommodative stance of monetary policy. In the US, however, fiscal measures were especially bold: the public debt-to-GDP ratio rose by 25 p.p. in 2020-21, to over 130 per cent. In the euro area, instead, the debt ratio increased by 15 p.p., to slightly less than 100 per cent, despite a much deeper decline of nominal GDP in 2020 (by 4.8 per cent, against 2.2 in the US) and a slower recovery last year (7.5 versus 10.1 per cent in the US); it was, until the outbreak of the Russia-Ukraine war, on a steady downward trend. At the same time, concerns over the impact of structural changes to growth potential led to the launch of the recovery and resilience programmes associated with the Next Generation EU initiative. The extraordinary support to households provided by the US fiscal policy is particularly evident when comparing the dynamics of GDP to household disposable income (Figure 1): in 2020, just as the former recorded its sharpest collapse in real terms in the entire postWorld War II period (-3.4 per cent), real household disposable income grew by over 6 per cent, its largest rise since the mid-1980s. In the euro area, on the other hand, it declined, even though by a much smaller extent than GDP (-0.6 versus -6.4 per cent). The different dynamics of household disposable income across the two economies translated into very diverse effects on consumer and aggregate demand and consumer price inflation. In the US, GDP returned to its pre-crisis trend at the end of last year, but aggregate data hid a somewhat elevated degree of heterogeneity between sectors: while demand in the service sector was (and still is) restrained by pandemic-related factors, the goods sector increasingly showed signs of overheating (Figure 2). In the spring of 2021, for example, personal consumption expenditure in the durable goods sector was already more than 30 per cent higher than its pre-crisis level. Even in the euro area, goods purchases were less affected by lockdowns and fears of contagion, but their growth rates remained relatively contained and, at end-2021, consumption expenditure in this sector was still lower than its modest pre-pandemic trend. Pressures on consumer prices have been intensifying in the US since the spring of last year, with headline inflation peaking at 7.9 per cent last February (Figure 3); core inflation played a key role throughout this process: in April 2021 it had already risen to 3 per cent and, last month, it had reached 6.4 per cent, the highest in 40 years (the picture remains essentially the same if we look at the personal consumption expenditure price index, which rose to above 6 per cent in January, with its core component increasing to 5.2 per cent). Headline inflation also rose in the euro area, to 5.8 per cent in February, but energy and food took the lion’s share, as the growth of the “core” component was more than 3 percentage points lower (2.7 per cent). * * * Before the Russian invasion of Ukraine, to understand the economic outlook on both sides of the Atlantic and how the policy mix should have evolved accordingly, three key factors were especially important. The first factor is related to the developments in the energy market. Oil prices rose, gradually but steadily, at the global level from the lows of the most acute phase of the health emergency: on the eve of the war, they were 60 per cent higher than in January 2020 (for both the US and Europe). Gas prices in the US recorded similar dynamics, almost doubling with respect to January 2020 (Figure 4). But it was the cost of European gas, strongly dependent on supply from Russia, that really skyrocketed: between September 2021 and February 2022 it averaged at over 8 times the value of January 2020; after the outbreak of the war it was even higher, with a peak of 20 times the level of January 2020, before returning somewhat closer to the previous average in the last few days. This is particularly worrying due to the special role of gas in determining retail prices not only for heating and industrial uses, but also for electricity at large. It is consequently important to assess the effects of Europe’s energy crisis on consumer prices, also beyond their direct effects on headline inflation. A significant share of the rise in core and food inflation, in fact, is due to higher energy prices; in particular, we may estimate that, absent the energy shock, headline inflation in February this year would have been 3.5 percentage points lower, at a level, therefore, only slightly above the ECB’s 2 per cent target. The failure of inflation forecasts in 2021 has been repeatedly highlighted: however, indirect effects stemming from the increase in the costs of production – mostly due to unpredictable geopolitical factors that are outside the realm of economics – explain almost entirely the upward surprises recorded on core inflation in the euro area in the second half of the year. The energy shock has also relevant consequences for aggregate demand in energy importing economies, where it translates into a drag on domestic resources. In the euro area, the deterioration of the terms of trade, mostly due to the rise of energy prices, has reduced the purchasing power of domestic incomes (which includes all sectors of the economy) by about 1 percentage point in 2021, and is expected to have an even larger impact in 2022. The repercussions of the energy shock are likely to be especially severe for households. In the euro area, should gas and oil prices remain at the exceptionally high levels currently implied by future contracts, the increase in consumer prices would cumulatively curtail their disposable income by around 4 percentage points in 2021 and 2022. These losses are asymmetrically distributed across families, hitting more heavily the less well-off who typically devote a larger portion of their incomes to energy purchases. The second key factor is related to the labour market. In the US the growth of nominal wages (measured as average hourly earnings) amounted to more than 4 per cent last summer, nearing 6 per cent in January 2022 (Figure 5). In the euro area, instead, the increase in wages (as measured by negotiated wages, which tend to grow broadly in line with actual earnings, but are much less volatile) still remains below 2 per cent. The substantial slackening that we continue to observe in the intensive margin of labour utilisation – in the third quarter of 2021 hours per worker were still almost 2 per cent less than on the eve of the pandemic – and the low level of vacancy rates – which does not suggest any potential signal of a mismatch between the supply and demand of labour – have not pointed so far to the possibility of a worryingly persistent acceleration of nominal wages. It goes without saying that this is a factor whose evolution will have to be closely monitored. The third factor concerns inflation expectations. In the US, longer-term expectations (beyond five years) do not show clear signs of a de-anchoring, providing an encouraging perspective on the possibility, for the Fed, of bringing actual inflation down without implementing surprising and abrupt changes in the monetary stance, which could trigger a recession (Figure 6). In the euro area, the process of the gradual re-anchoring of longer-term expectations from the lows observed in the last few years is being completed, even if a relatively large percentage of analysts continues to predict inflation to be somewhat below our 2 per cent (symmetric) target in five years. Given these developments – while in the US the Federal Open Market Committee decided it wise to quickly reduce asset purchases and implemented an effective line of communication aimed at preparing the public for the lift-off of the target range for the federal funds rate – in the euro area a gradual normalisation of monetary policy was deemed to be the most appropriate stance. From the evidence that I have briefly summarised, I strongly believe that monetary policy in the euro area has not been behind the curve. Indeed, I would venture to say that the re-anchoring of inflation expectations, after a rather long period during which the ECB has successfully countered material deflationary risks, also bears witness to the success of the new monetary policy strategy completed in July of last year. And there is certainly good reason to believe that, given wage prospects and the state of expectations, headline inflation will progressively converge to 2 per cent as the serious disturbances generated by the dramatic evolution of the Russia-Ukraine war fade away. The rise in energy prices (which has also been accompanied by price increases of other commodities, most prominently food) is, in fact, a clear and unexpected supply-side shock, one that may admittedly last for some time. In addition, as I have observed, it is likely to have important negative effects on aggregate demand and, in turn, on the medium-term inflation outlook. While both monetary and fiscal policy may, in principle, counter the inflationary effects of energy costs, only the latter is able to directly influence these costs, also offsetting the loss in disposable income – at least in part and to the extent that it does not jeopardise debt sustainability – and limiting their impact on the economy. That said, the main response to what is essentially a tax cannot come from monetary policy, especially in the absence of a wage-price loop and with inflation expectations re-anchoring to the central bank’s objective. However, these issues emphasise the importance of swiftly designing a strategy, particularly at the European level, that, while in the short run helps to curb the unjustified spike in energy prices, on a more structural basis takes into consideration the issue of energy source diversification, energy storage and the identification of common resources for managing energy crises. It is a challenge that, today, goes hand in hand with the one posed by climate change and its resolution is essential also for avoiding uncontrolled and dangerous increases in the relative prices of fossil fuels. * * * The Russian invasion of Ukraine implies some very important changes in the economic outlook of the euro area and in the assessment of risks. Further increases of energy prices will not only affect the short-term inflation outlook, but will also determine significant headwinds to domestic demand, while the announced sanctions and the sharp deterioration of Russia’s economic conditions will weaken external demand and cause potential risks to financial stability. Household and business confidence may be strongly shaken. This would result in a worsening of the prospects for GDP growth and, in turn, greater downside pressures to inflation in the medium-term, which could follow the large price increases observed so far and, perhaps, still to come over the rest of the year. The ECB staff has made some new baseline projections available – which were discussed by the Governing Council last week – built on the assumptions that disruptions to energy supplies and impacts on confidence are only temporary, while global supply chains are not significantly affected. Overall, GDP growth is projected to 3.7 per cent in 2022 and 2.8 per cent in 2023, a downward revision of, respectively, 0.5 and 0.1 percentage points compared to December 2021. On the other hand, inflation is set to average 5.1 per cent in 2022, increasing markedly since December, and 2.1 per cent in 2023. The outlook has severely worsened since the cut-off date used in the projections. Looking beyond the short-term volatility of oil and gas prices, whose fluctuations follow the unfolding of the conflict and of diplomatic efforts, there are grounds to believe that these projections are already outdated. It is clear that households will be hard hit by the energy (and food) price shock, particularly those in the lower income brackets, with higher propensity to consume and lower savings buffers. The situation of elevated uncertainty will affect the less liquidity-constrained households, whose precautionary savings are likely to rise, in line with historical regularities, negatively affecting consumption. The dramatic increase in uncertainty also suggests that, in the current circumstances, focusing on scenarios analysis is a more useful and wiser approach than relying on point projections. The war also considerably increases the tail risks. Here I am primarily referring to the worrying possibility of gas shortages pushing energy prices further up or forcing for some time gas and electricity rationing, disrupting production. But market integration and multilateral cooperation also risk being very much affected. What we are living through is a profound, as well as dramatic, watershed, which may lead to economic patterns that are now difficult to define. In this respect, I believe that the public discussion that has followed the ECB Governing Council’s latest decision about the perceived prevalence of a hawkish tone lacks focus. By acknowledging the situation of high Knightian uncertainty that we are facing we decided that we could not commit our actions beyond the very short term. Even proceeding along the path of gradual monetary policy normalisation, we chose to keep all our options open, as it is clear that we are not yet in a position to fully assess the economic implications of this unprecedented situation. On one hand, second-round effects on nominal wages and longer-term inflation expectations have to be closely monitored; on the other, the effects on real activity and incomes, and through them on aggregate demand and price developments, obviously have to be taken into account. Our contribution – and responsibility – in such difficult times is not to increase but instead to reduce uncertainty. To this end, another aspect that plays a very important role is the commitment that, within our mandate and under stressed conditions, flexibility will remain an element of monetary policy whenever the emergence of threats to the transmission mechanism of monetary policy jeopardises the attainment of price stability. Indeed, guaranteeing a smooth functioning of financial markets and assessing the implications of our decisions on financial conditions with great care are necessary conditions for delivering on our medium-term price stability mandate. Our decisions remain intertwined with those of the fiscal authorities. As I mentioned, a supply-side shock should be tackled predominantly by fiscal policy which could shield the economy by diminishing the transmission of price increases from energy to consumer goods and limiting the loss in disposable income. The de facto coordination between fiscal and monetary policy, which has worked well in the last two years to counteract and contain the economic and financial consequences of the pandemic crisis, is still necessary today. I believe that if fiscal policy is effective in attenuating the impact on households and businesses of the incredible leap in energy prices and if monetary policy proceeds with caution, absent the second-round effects that I already mentioned, we will be able to successfully continue the gradual normalisation of our monetary policy stance started at the end of last year. This said, fiscal policies should remain focused on increasing growth potential, while preserving the good health of public balances, two closely interconnected objectives. The relevance of the former is magnified by the challenges that will characterise the next decade, including the inevitable normalisation of the growth rate of the economy and of short- and long-term interest rates as well as the ageing of the population. Regarding the second objective, countries with high public debt will have to progressively improve their primary balance. Of course, an immediate end to the Russian aggression in Ukraine could quickly put an end to the escalation of energy prices, bringing inflation down and helping us to put the economy back on a growth path. In expressing solidarity with the Ukrainian people, I believe I speak for everyone when I say that peace is the result we all hope for. FIGURES Figure 1 Real disposable income and GDP (annual data; percentage changes) United States Euro area Source: US Bureau of Economic Analysis and Eurostat (real disposable income for the euro area in 2021 is estimated). Figure 2 Demand in the goods and service sectors a. United States (monthly data; indices: Jan. 2020 = 100) Goods sector Service sector Jan-2019 Jan-2020 Jan-2021 Jan-2019 Jan-2022 Jan-2020 Jan-2021 Jan-2022 b. Euro area (quarterly data; indices: 2019q4 = 100) Goods sector Service sector 2019q1 2019q3 2020q1 2020q3 2021q1 2019q1 2021q3 2019q3 Source: US Bureau of Economic Analysis and estimates based on Eurostat data. Note: dashed lines show pre-pandemic trends. 2020q1 2020q3 2021q1 2021q3 Figure 3 Contributions to consumer price index inflation (monthly data; percentage changes and percentage points; year-on-year growth) United States Euro area Source: US Bureau of Labor Statistics and Eurostat. Figure 4 Gas prices (daily data) 01jan2020 01jul2020 01jan2021 European gas (TTF; in euros) 01jul2021 01jan2022 US gas (Henry Hub; in dollars) Source: Refinitiv. Figure 5 Wages (monthly data; percentage changes; year-on-year growth) Euro area negotiated wages US average hourly earnings Source: US Bureau of Labor Statistics and ECB. Figure 6 Longer-term inflation expectations (per cent of respondents) United States Euro area median median 1.5 2.5 1.5 2.5 Source: Survey of Professional Forecasters, Federal Reserve Bank of Philadelphia, February 2022; Survey of Professional Forecasters, ECB, February 2022; euro area data exclude one outlier. Designed by the Printing and Publishing Division of the Bank of Italy
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Speech by Mr Piero Cipollone, Deputy Governor of the Bank of Italy, at the conference "Second Digital Day. At the roots of sustainability. Die jurnada globalny de les liberties tecnologiche para a digital humanismus", organized by the University of Florence, Florence, 11 March 2022.
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The Role of Central Banks for Green Finance Second Digital Day Speech by Piero Cipollone Deputy Governor of the Bank of Italy Università di Firenze, 11-12 March 2022 I would like to thank the organizers for inviting me to this workshop. The recent geopolitical events have caused heavy losses in terms of human lives and have shown our vulnerability as countries, societies and individuals. We never would have imagined reliving such terrible days in the heart of Europe. Our first thoughts are for all those who are suffering because of the war. There are many reasons for concern. This terrible war will leave many wounds for many years to come. Let’s hope that we will at least be able to maintain the progress achieved so far towards a new model of sustainable economic development, which is more inclusive and more responsible for the environment and future generations. This ambition is closely connected to the way we produce energy, following a path that increasingly depends less on fossil fuels and is more reliant on green sources. However, the sustainability of energy systems calls for careful planning that is difficult to reconcile with the urgency we are facing in these days. Climate change has become a leading issue in public debate and in the policy agenda. The consequences of global warming are affecting several areas of the planet in a broad and uneven way, with greater effects on some regions and on the most vulnerable people, both in the advanced and the developing countries. According to preliminary estimates, extreme weather events in 2021 caused global insured losses of USD 105 billion, the fourth highest since 1970.1 Last July flooding in Germany, Belgium and nearby countries, caused up to USD 13 billion in insured losses, economic losses of above $40 billion in Germany, and at least 180 people died. Climate risks mainly materialize through two channels: firstly as a result of an increase in mortality and morbidity and damage to infrastructures and the properties of firms and households, caused by climate-related events (physical risk); and secondly through the consequences for the economic and financial system stemming from the transition to a low-carbon economy (transition risk). Swiss Re: https://www.swissre.com/dam/jcr:a1d7045d-f557-4e16-a365-4acd699b5a07/nr-20211214sigma-full-year-preliminary-natcat-loss-estimate-2021-en.pdf 2015 marked an turning point with the Paris Climate Agreement, since then 191 governments have committed to contain the global warming well below 2°C, preferably to 1.5 °C, compared to pre-industrial levels but the pledges are still not enough to reach the target. European policy initiatives In 2018, the European Union launched the Action Plan on Sustainable Finance,2 that places environmental sustainability at the centre of its policies, to redirect capital flows towards sustainable investment, manage financial risks stemming from sustainability issues, and foster financial and economic transparency. The policy program was reinforced in early 2019 with the launch of the European Green Deal,3 a programme of legislative initiatives and investment plans for the next ten years, with the aim of achieving net zero greenhouse emissions by 2050. This long-term green strategy has been further enhanced by the measures taken in response to the coronavirus pandemic: more than one third of the investments from the Next Generation EU4 fund will be devoted to the environmental objectives. Finally, the Green Deal was strengthened only last year by the plan “Fit for 55”,5 reflecting a new level of ambition that enhances the target of reducing net greenhouse gas emissions by at least 55 per cent by 2030, compared with 1990 levels. The European Commission has estimated that in the period 2021-2030 the achievement of the current climate and energy targets for 2030 will require investments in the energy sector (excluding transport) of EUR 336 billion per year, equal to 2.3 per cent of GDP.6 Therefore, a strong involvement of the banking and financial industry is required, both to raise awareness of climate risks and to mobilize resources for the transition. The role of policy makers and central banks Promoting sustainable growth and tackling climate change will require strong political determination and a firm commitment by all countries. National governments have the primary responsibility for achieving this objective. In fact, they can provide incentives to allocate capital to green investments, levy taxes on carbon emissions, regulate the amount of emissions and reach international agreements on shared targets for emissions.7 European Commission, COM/2018/097 final, “Action Plan: Financing Sustainable Growth”. European Commission, COM/2019/640 final, “The European Green Deal”. European Commission, COM/2020/456 final, “Europe's moment: Repair and Prepare for the Next Generation”. European Commission, COM/2021/550 final, “Fit for 55: delivering the EU's 2030 Climate Target on the way to climate neutrality”. European Commission, “Contribution to the Green Deal and the Just Transition Scheme”. Available at: https://europa.eu/investeu/contribution-green-deal-and-just-transition-scheme_en I. Visco, “Roundtable on Financing Carbon Neutrality”, BOAO FORUM FOR ASIA - Annual Conference, April 2021. Needless to say, central banks also have a role to play. They examine sustainability profiles, and in particular climate risks, as they can affect the ability to pursue their institutional goals of price and financial stability and supervisory tasks. Climate risks call for a change of paradigm, expanding the horizon of empirical and theoretical analysis to better understand and integrate the effects of climate change into macro-financial models and policy tools. In the euro area, central banks are actively working to integrate climate change considerations with their mandates. Last year, the Eurosystem central banks agreed on a common stance for climate change-related sustainable and responsible investment principles for euro-denominated non-monetary policy portfolios. The common agreement promotes disclosures and understanding of climate-related risks. Furthermore, the European Central Bank, the ECB, announced the new monetary policy strategy committing to an ambitious roadmap. Climatic factors will be included in macroeconomic models to monitor the transmission of monetary policy and in monetary policy operations in the areas of disclosure, risk assessment, the collateral framework and corporate sector asset purchases. Finally, the ECB has also started to include climate and environmental risks in its banking supervision mandate. In the last couple of years, the ECB has clarified its expectations relating to climate risk management and disclosure, conducted a review on banks’ self-assessment of their practices and recently it has launched a supervisory climate-risk stress test. In order to promote the smooth operation of payment systems, the Eurosystem developed important market infrastructure for payment settlement such as the TARGET Instant Payment Settlement, TIPS, allowing instant payments in central bank money. This solution also has a remarkable green side: its carbon footprint is lower than that of cryptocurrencies and other infrastructures. This difference could be very large for cryptocurrencies owing to the large energy consumption necessary to generate consensus among crypto network participants.8 More recently, the ECB has started the investigation phase for the introduction of a digital euro, one element of attention will be the possible positive side effect of reducing the ecological footprint of banknotes and cryptocurrencies. Climate change is a global issue, thus policies aimed at addressing its consequences should also be global and coordinated. Since 2017, central banks and supervisors have collaborated in the Network for Greening the Financial System, the NGFS, an international coalition aimed at strengthening the management of climate and environmental risks and at mobilizing capital for green and low-carbon investments. Currently, the Network counts almost 100 members worldwide, supervising all global systemically important banks and two thirds of global systemically important insurers. The Network has published a select set of guidelines based on the best practices and experiences shared by the members and on analytical work on green finance. In particular, P. Cipollone, “TIPS (TARGET Instant Payment Settlement) - the new Eurosystem market infrastructure service: Banca d’Italia as service provider and manager of the business relationships with the financial community”, Welcoming remarks, TIPS Webinar Bank of Italy, 12-13 July 2021; Financial Stability Board, “Assessment of Risks to Financial Stability from Crypto-assets, Report”, 14 February 2022. it has worked on climate scenarios supporting forward-looking risk assessment in a comparable way across different jurisdictions. The role of the financial sector The financial sector, given its pivotal role in capital allocation, can be key in influencing the transition to a low-emissions economy. Therefore, banks and other financial intermediaries should include sustainability in their investment decision-making processes, favouring a forward-looking approach in which sustainability risks and opportunities are fully priced. The persistent uncertainty created by the pandemic has not diverted the attention of investors away from sustainability issues. Sustainable investment flows increased significantly with the outbreak of the pandemic and the pace of growth remained high throughout 2021. Sustainable finance bonds issued in 2021 amounted to more than USD 1.6 billion, pushing total issues to USD 4 trillion.9 Sustainable investments also increased in the equity sector; new flows in 2021 reached over USD 550 billion, bringing the assets managed according to sustainability strategies to a total of approximately USD 2,740 billion.10 Investment strategies against climate change: net-zero strategies and thematic portfolios While governments are making more ambitious commitments in accordance with the Paris Agreement, companies and institutional investors also increased their efforts to achieve carbon neutrality by 2050, pledging new targets. Companies aim to reduce greenhouse gases emissions by setting transition plans that redesign their processes and products and deal with potential stranded assets. Asset managers, asset owners and public investors are developing new investment approaches to manage climaterelated risks and harness the transition opportunities. Two relevant examples of these approaches are net-zero strategies and thematic investments. Net-zero strategies make it possible to decarbonize investments, reaching net-zero greenhouse gas emissions by 2050. The feasibility of a net-zero target depends on both companies’ effectiveness in abating their emissions and the asset allocation decisions based on their decarbonization pathways. In the real world, portfolio decarbonization strategies do not immediately avoid emissions from the economic system but they provide incentives for companies by adjusting the relative prices of assets, risk premia and the cost of capital. Thematic investments represent a further stream of action, allocating capital to developing new technologies and enabling activities such as renewable electricity production, the improvement of Bloomberg, “ESG by the Numbers: Sustainable Investing Set Records in 2021”. Available at: https:// www.bloomberg.com/news/articles/2022-02-03/esg-by-the-numbers-sustainable-investing-setrecords-in-2021 Morningstar Manager Research, "Global Sustainable Fund Flow: Q4 2021" in review, January 31, 2022. energy efficiency and the electrification of the transport systems, which support the energy transition needed to achieve carbon neutrality. The data challenge Climate and environmental data are crucial for investors to set their portfolio strategies and manage the related risks. Persistent data gaps may hinder the development of green finance, limit efficient market allocation and raise doubts about the greenness of investments. The three main data issues regard their availability, reliability and comparability.11 Some policy initiatives can be particularly effective to address the data issues, such as the convergence towards a common set of disclosure standards, an accepted minimal green taxonomy, and the development of well-defined metrics, certification labels and methodological standards.12 In the EU, the Commission’s proposal for a Corporate Sustainability Reporting Directive would improve the quantity, quality and comparability of information on corporate sustainability and therefore make it easier to find data for environmental, social and governance (ESG) investments.13 The framework developed by the Task Force on Climate-related Financial Disclosure, the TCFD, is probably the main example of a common standard in this area. Its recommendations are currently supported by over 2,600 organizations, including 1,069 financial institutions, responsible for assets of $194 trillion. Last December, the Network for Greening the Financial System published its “Guide on climate-related disclosure for central banks” based on the Task Force’s framework, and in the next few months, Banca d’Italia will publish its first report on sustainable investments and climate risk, based on those guidelines.14 Finally, green taxonomies may represent an effective solution against greenwashing and improve data reliability and comparability, as they provide specific technical criteria to distinguish between green and brown activities. It is crucial to detect improper practices, because they discourage investors from including sustainability among their investment criteria and undermine the development of green finance. Banca d’Italia results Central banks’ initiatives for integrating environmental and climate considerations in their mandate have elicited growing public interest. According to a recent report issued by Positive Money, a not-for-profit organization, Banca d’Italia is among the most virtuous NGFS, "Progress report on bridging data gaps", May 2021. NGFS, "Progress report on bridging data gaps", May 2021. It would amend the existing reporting requirements of Directive 2014/95/EU (Non-Financial Reporting Directive, NFRD). Task Force on Climate-related Financial Disclosures, "2021 Status Report", October 2021. G20 Central Banks in a rank based on its green policies and monetary and prudential initiatives. This important result highlights Banca d’Italia efforts on environmental risks and sustainable finance, such as research activities, promotion of these topics across the financial sector as well as initiatives that seek to share the Bank’s experience and results (including investment activities) in order to lead by example.15 Since 2019, Banca d’Italia has integrated ESG criteria into its non-monetary portfolios with the traditional financial objectives of return, risk and liquidity in managing its investments, amounting to EUR 196 billion at the end of 2021. The inclusion of ESG criteria seeks to enhance the social responsibility of companies, to generate positive effects on the socio-economic environment and, at the same time, to improve financial and reputational risk management.16 The integration of sustainability criteria is implemented within the investment process, which first considers strategic asset allocation. This rests on an asset and liability management approach in order to preserve the value of the financial resources over the long run and in adverse scenarios.17 The sustainability factors are applied in the second stage of the investment process across all asset classes held for investment purposes. The commitment to sustainability was reaffirmed in 2021 with the Responsible Investment Charter, which represents the Bank’s official framework providing guidance on its sustainable investment strategies. The Charter defines the Bank’s broad vision of sustainability (including all ESG aspects) and the principles and criteria that inspire its investment activity. It also identifies its perimeter of application and draws up the lines of action to make the Bank’s commitment concrete. The Charter applies to the financial portfolio and foreign exchange reserves over which the Bank has full decision-making autonomy. It does not apply to monetary policy portfolios, whose management is the responsibility of the Eurosystem. In the last three years, Banca d’Italia has progressively applied ESG criteria to its investments, adopting different strategies per asset class. For equity investments in Italian and euro-area stocks, amounting to about EUR 16 billion, the strategy is based on both financial and sustainability considerations. The two portfolios are managed to achieve a lower carbon intensity and a higher ESG score with respect to their benchmarks. The exposure to the US and Japanese equity markets, with a market value of about €2.7 billion, is through collective instruments linked to ESG benchmarks, D. Barmes and Z. Livingstone, “The Green Central Banking Scorecard: How green are G20 central banks and financial supervisors?”, Positive Money, 2021. Available at: https://positivemoney.org/ publications/green-central-banking-scorecard/ P. Cipollone, “Long-term investors’ trends: theory and practice”, Welcome address at the Banca d’Italia and LTI Workshop, 2021; E. Bernardini, M. Fanari and F. Panfili, “L’impegno per la sostenibilità degli investimenti finanziari”, in A. Scalia, “La gestione dei rischi finanziari e climatici”, Bancaria Editrice, 2022. M. Fanari and G. Palazzo, “The strategic asset allocation of the investment portfolio in a central bank”, Evolving Practices in Public Investment Management, Proceedings of the Seventh Public Investors Conference, 2018; D. Di Zio, M. Fanari, S. Letta, T. Perez, G. Secondin, “L’allocazione strategica e la sostenibilità degli investimenti della banca centrale”, Markets, Infrastructures, Payment Systems, 14, December 2021. As part of the investments in government bonds, there is a small but not negligible thematic portfolio of green bonds, financing projects with environmental sustainability objectives. For all asset classes, the Bank assesses their sustainability results annually.18 Finally, the Bank has also adopted an environmental policy to reduce the ecological footprint of its activities. Overall, in 2020 the Bank reported a 28 per cent decrease in total carbon dioxide emissions compared with the previous year, a 5.6 per cent reduction in electricity consumption and a 14.5 per cent reduction in water consumption, mainly as a consequence of remote working.19 Together with the ECB and the other Eurosystem central banks, Banca d’Italia contributes to reducing the environmental impact of the production, distribution, recirculation and disposal of euro banknotes. In line with central banks’ best practices, in 2020, 90 per cent of shredded banknotes was sent to waste-to-energy plants or installations for the production of secondary solid fuel. Conclusions Let me conclude by saying that green finance is also an intellectual challenge, requiring us to add the new knowledge and information stemming from other scientific fields to our typical financial and economic background. The urgency of addressing climate issues is increasingly felt by financial institutions, investors, and governments, which hold the primary responsibility in leading change. Central banks are all contributing and will further innovate their actions. In this journey, still very long, and fraught with obstacles, all players are aware of having to play their part, without delays and half measures. I. Faiella, E. Bernardini, J. Di Giampaolo, M. Fruzzetti, S. Letta, R. Loffredo and D. Nasti, “Climate and environmental risks: measuring the exposure of investments”, Markets, Infrastructures, Payment Systems, 15, December 2021. Bank of Italy, "Environment Report 2021". Available at: https://www.bancaditalia.it/pubblicazioni/ rapporto-ambientale/2021-rapporto-ambientale/Environment_Report_2021.pdf?language_id=1 Designed by the Printing and Publishing Division of the Bank of Italy
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Statement by Mr Ignazio Visco, Governor of the Bank of Italy and Governor of the Constituency of Albania, Greece, Italy, Malta, Portugal, San Marino and Timor-Leste, at the 105th Meeting of the Development Committee (Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources to Developing Countries), Washington DC, 22 April 2022.
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Ignazio Visco: Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the transfer of real resources to developing countries Statement by Mr Ignazio Visco, Governor of the Bank of Italy and Governor of the Constituency of Albania, Greece, Italy, Malta, Portugal, San Marino and Timor-Leste, at the 105th Meeting of the Development Committee (Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources to Developing Countries), Washington DC, 22 April 2022. *** Today's meeting falls at a tragic time. Our first thought goes to the Ukrainian people, forced to abandon their regular lives, their homes and their land, their families and friends. We grieve the tragic loss of life and massive human suffering that have accompanied Russian military aggression against Ukraine, which threatens the rulesbased international economic and financial system. We commend the World Bank Group (WBG) for its swift intervention in support of the Ukrainian government and people, using its convening power to gather the resources of the international community. We appreciate the WBG's efforts to work closely with the UN and other key partners in supporting those fleeing the war. The shocking events in Ukraine are having huge, negative impacts on the world economy, which had just started to recover from the upheavals of the Covid-19 pandemic. It will take time to assess the war's human, moral, and economic cost. The background paper for the Development Committee confirms our fears, presenting updated assessments of the immediate economic and social impact, the manifold medium- and long-term effects, and the acute risks for the poor and most vulnerable. Shortages of key staples, extraordinary increases in energy and food prices, mounting trade costs, and disruptions in supply chains are already putting developing countriesespecially the poorest-under enormous pressures. We agree that the WBG, in collaboration with other relevant multilateral institutions, must promptly address food insecurity in Africa, Central Asia, and the remaining least developed economies. This should include actions to increase food supply and avoid export restrictions, also through the support to regional integration and transportation infrastructure. Creating jobs and helping the private sector develop are necessary complementary objectives. History demonstrates that abrupt food price increases often trigger economic setbacks and political instability, which in turn augment fragility, poverty, conflict, and violence. We acknowledge the WBG staff's dedication to the increasing number of countries affected by conflict and we encourage further efforts to strengthen effective delivery of services to local communities and vulnerable groups. IDA20 provides the most ambitious financing package thus far, made possible by continued strong donor support and additional balance sheet optimization measures. IDA is now well equipped to provide a substantial increase in financing for FCV countries, crisis response, and regional projects, along with aid to refugees and host 1/3 BIS - Central bankers' speeches communities. Nevertheless, IDA countries will likely face the spillovers of the war in 2 Ukraine; given their increased exposure to mounting risks, it is critical to preserve IDA's capacity to support them. The financing options of the medium-term WBG response, as outlined in the Roadmap paper, must be carefully assessed. Donors' fiscal constraints can only worsen as the compounding crises continue to weigh on the global economy. Prioritizing balance sheet optimization measures and aggressive portfolio management, while enhancing selectivity and building on comparative advantages and division of labor among development partners, can increase our joint effectiveness and outcome orientation. The use of available resources must be appropriately balanced between short-, medium- and long-term needs. We very much look forward to the Independent Review of MDBs Capital Adequacy Frameworks, commissioned by the G20. Already on the rise before the pandemic, debt vulnerabilities in emerging and developing economies are reaching alarmingly elevated levels. The slowing in global growth following the COVID-19 shock has increased the risk of countries falling into debt distress. The war in Ukraine may only aggravate macroeconomic fragilities with the shock on food prices, as well as – and also as a consequence of – the rise in the costs of energy and fertilizers. We support the WBG and IMF's initiatives in the areas of fiscal debt management, access to long-term development finance, and debt resolution. Debt transparency is a precondition to effective debt management and key to achieving and maintaining debt sustainability. We encourage the WBG to boost its work with both debtors and creditors and to monitor results. We thank the WBG and the IMF for their support to G20 efforts to implement the Common Framework, as well as their endeavours to provide technical assistance to debtor countries. We look forward to substantial progress in implementing country cases. The consequences of the war in Ukraine should not make us lose sight of a sustainable and inclusive development reform agenda. The global community, the G20, international financial institutions and all multilateral actors must multiply their efforts in climate change mitigation and adaptation; pandemic prevention, preparedness and response; and digitalization. In the short term, the war could have a negative impact on energy transition. High oil and gas prices and risks to their future availability are leading some countries to intensify their demand for coal. In many economies the security of energy supplies – including from fossil fuels – has become a priority. It should be reiterated that the direction of environmental policies has not changed and the medium- and long-term plans to reduce carbon emissions remain valid. It must be clear that any setbacks are temporary and that pursuing net-zero targets in the appropriate time frame is still the priority, notwithstanding the question of how to integrate these targets into the need for energy security. We urge the WBG to continue to contribute to this agenda with its convening power and its work on Country Climate and Development Reports and Paris Alignment. While the pandemic is far from over, the window is narrowing in which to address important questions related to Prevention, Preparedness and Response (PPR) for 2/3 BIS - Central bankers' speeches future health threats. We commend the Bank for its work in providing focus on PPR in IDA and for its active participation in the work of the G20 Joint Finance and Health Task Force. Collaborating effectively with the World Health Organization (WHO) is important to building consensus around a new instrument to help fill the sizable gap in pandemic PPR financing. Digitalization is at the core of a green, resilient, and inclusive development. The WBG paper on Digitalization and Development provides a comprehensive, well-structured approach to advancing this 3 agenda and increasing its development impact. We appreciate its clear message that the public and private sectors can work together to generate a conducive environment for digitalization. Private capital mobilization is paramount to addressing the financing needs of developing countries. Therefore, the WBG should continue to strengthen its One WBGApproach, synchronizing the IFC and MIGA's work in creating innovative instruments and strategies with the World Bank's work enabling and supporting that mobilization. In the years following the end of the Cold War, a peace dividend had emerged. This dividend was – and still is – significant, offering greater resources for investment, establishing peaceful scientific and technological advances, and allowing for a larger circulation of people, goods, services, technologies, and capital. Until the pandemic, globalization and technological progress have facilitated the strong reduction of extreme poverty, contributing to convergence in per capita income across countries. But this came alongside significant losses in terms of job security and welfare for non-negligible segments of the population, which would have required appropriate rebalancing measures. The war in Ukraine is a profound and dramatic change which may interrupt this process and, possibly, lead to different equilibria that are still difficult to envisage today. But the pandemic has taught us that the global community – including international financial institutions – can promote successful cooperation within a collaborative and multilateral framework. As tensions and fractures threaten this framework, restoring peace, preserving multilateral dialogue and relaunching a truly cooperative spirit are essential. 3/3 BIS - Central bankers' speeches
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Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at a meeting for the presentation of the Annual Report 2021 - 128th Financial Year, Rome, 31 May 2022.
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The Governor’s Concluding Remarks Financial Year 128th financial year Annual Report Rome, 31 May 2022 th The Governor’s Concluding Remarks Annual Report 2021 – 128th Financial Year Rome, 31 May 2022 Ladies and Gentlemen, The invasion of Ukraine by Russia at the end of February marks a dramatic watershed in recent history. It has triggered a grave humanitarian crisis, leading to the re-emergence of tensions between different parts of the world that seemed to have been permanently reduced, if not completely allayed, in the last thirty years. Our first thought today goes to the people of Ukraine, to those who have lost their lives, to those who have been forced to abandon their homes, and to those who have had their daily existence turned upside down. The war has also abruptly worsened global economic growth prospects, at a time when the damage caused by the pandemic has not yet been completely repaired. Uncertainty has dramatically increased the world over, affecting the pillars supporting the international economic and financial framework in place since the Cold War, namely the peaceful coexistence between nations, market integration and multilateral cooperation. The economic outlook and the impact of the war in Ukraine The progressive worsening of geopolitical tensions has significantly accentuated the rise in energy prices associated with the recovery of economic activity after the public health crisis. Above all, this has been reflected in the price of gas in Europe which has risen on average to about €90 per megawatt-hour since last September, with peaks of around €200, compared with just over €10 per megawatt-hour in the months preceding the pandemic (Figure 1). The increase was much smaller in the United States, rising from almost $10 to around $20 per megawatt-hour. Although Russia only accounts for 2 per cent of world trade, it is one of the main exporters of oil and gas, fertilizers, and, along with Ukraine itself, cereals. According to market quotations, the prices of these products are likely to remain very high in 2022, going down only slightly over the next two years. Higher food prices and supply difficulties risk hitting, above all, the most vulnerable sections of the world population and those countries that most depend on food imports. The conflict in Ukraine is slowing the world economy significantly and the recent measures adopted in China to counter new outbreaks of the virus are exacerbating this trend, rekindling the global value chain problems already seen in 2021. The International Monetary Fund estimates an increase in global GDP of 3.6 per cent for this year, almost 1 percentage point down on January’s projections and about 1.5 points lower than those for October. Inflation, which in all economies largely reflects increases in commodity prices, is expected to remain high and then to fall in 2023. This scenario is based on relatively favourable hypotheses as regards prices and supplies of food and energy, hypotheses that are closely tied to how the conflict in Ukraine will develop and to the consequent sanctions against Russia. The risk of a more marked slowdown in the economy should not be overlooked, also because of the still uncertain development of the pandemic. The cyclical outlook also deteriorated in the euro area, which is particularly exposed to the economic effects of the conflict. The most recent estimates suggest that GDP growth will be less than 3 per cent this year, well below what was forecast a few months ago; an increase already largely acquired thanks to the strong recovery in 2021, and that therefore implies only a modest expansion of the economy over the course of this year. There is a significant risk of a less favourable trend. As for the other economies that import energy products, the supply shock has serious repercussions on demand as well: the worsening of the terms of trade negatively affects the resources available to households and firms, curbing consumption and investment. In addition, the widespread decline in confidence and the fragility of international trade are contributing to the weakening of the outlook. In April, consumer prices recorded an increase of 7.4 per cent compared with the same month last year, driven by the price rises for energy and, to a lesser extent, for food (Figure 2). Net of these components, inflation stood at 3.5 per cent, in turn influenced by the transmission of higher energy costs to the final prices of other goods and services. In the United States though, core inflation, at 6.2 per cent, is only 2 percentage points below overall inflation, mainly as a consequence of demand overheating. The latest forecasts of the main international institutions and private analysts indicate that price growth in the euro area will remain high this year and then fall considerably in 2023, returning to levels consistent with the European Central Bank’s definition of monetary stability, namely inflation at 2 per cent in the medium term (Figure 3). The expectations of market The Governor’s Concluding Remarks Annual Report 2021 BANCA D’ITALIA operators, inferred from the quotations of financial assets index-linked to consumer prices, are in line with this profile. The uncertainty of these forecasts is far greater than a year ago. In the last few months, the size and persistence of the price rises have been underestimated, including in central bank projections. Given the faster than expected recovery in global demand, the emergence of supply bottlenecks has driven up the prices of intermediate goods everywhere. However, in the euro area, the main factor has been the exceptional increase in energy prices that began at the end of the summer in relation to the geopolitical tensions. The worsening of these tensions, culminating in Russia’s attack on Ukraine, is the main reason for the persistence and spread of the inflationary pressures we are witnessing today. The worsening of the terms of trade and the loss of purchasing power will tend to hold down final demand, easing the pressure on prices. However, we should not overlook the risk of an increase in inflation expectations above the medium-term objective and the start of a wage-price spiral. At the moment, expectations are not very far from the 2 per cent objective and, unlike what has happened in the United States, wage growth in the euro area has been moderate so far, even if very high wage demands have been advanced in some countries (Figure 4). If these ended in one-off increases in wages, the risk of starting a vicious circle of inflation and wage growth would be reduced. The economic outlook has therefore changed considerably in the last few months. Given that the risk of deflation, which had called for the introduction of unconventional monetary policy measures, has been averted, and the impact of the pandemic on final demand has faded, the negative key rates policy can now be left behind. A raise in these rates, which the ECB Governing Council might decide to start in the summer, should proceed by taking account of the uncertain evolution of the economic outlook. Financing conditions for households and firms, which are today exceptionally accommodative, will remain favourable; according to current market quotations, short-term interest rates in the euro area will stay negative in real terms for several years to come. The Governing Council stands ready to adjust all its instruments to pursue its medium-term inflation aim. During the pandemic crisis, flexibility in the design and conduct of asset purchases was crucial to counter tensions on the financial markets; it remains a key element in our strategy in the event that malfunctions in the monetary transmission mechanism risk compromising the pursuit of price stability. To address rapidly evolving needs, particular attention will have to be paid to ensuring that the monetary policy normalization process takes place in an orderly manner and to preventing the BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2021 emergence of any market fragmentation that is not justified by the economic fundamentals. The action of the Eurosystem is still intertwined with that of the fiscal authorities. The increase in commodity prices cannot be directly countered by monetary policy. What monetary policy can do is ensure price stability in the medium term, maintaining the anchoring of inflation expectations and countering pointless wage-price spirals. Temporary fiscal interventions, carefully calibrated to protect the soundness of the public finances, are able to limit rises in energy prices and to support the income of the households most in difficulty, in both cases reducing pressures to increase wages. This allows for a more gradual normalization of monetary policy, mitigating the risks of a recessive impact on the economy. In Italy, the expansion of GDP in 2021, equal to 6.6 per cent, amply surpassed expectations, mainly reflecting strong investment and the recovery of exports. Although the energy deficit has doubled, the current account side of the balance of payments has remained broadly positive, thus helping to strengthen the positive net international investment position. The wide gap between nominal GDP growth and the average cost of the debt led to positive results for the public accounts. After the significant rise in 2020, the debt‑to-GDP ratio fell by more than 4 percentage points to less than 151 per cent, while one year ago, when a much higher deficit had been forecast, an increase to about 160 per cent was expected. Italy’s economy, together with that of Germany, is among the worst hit by the increase in the price of gas, because of the high share of imports from Russia and the importance of the manufacturing industry, which makes intensive use of gas. In January, our forecasts indicated that GDP would return to pre-pandemic levels about half way through this year and that there would be a solid expansion of above 3 per cent on average in the two-year period 2022-23. The war has radically accentuated the uncertainty over these prospects. Production activity weakened in the first quarter, also affected by the resurgence of the virus, and it should strengthen moderately this quarter. In April, we calculated that the protraction of the conflict in Ukraine could mean about 2 percentage points less growth overall, for this year and the next. The most recent forecasts of the main international organizations are similar. However, more adverse developments cannot be ruled out. If the war should lead to an interruption in the supply of gas from Russia, GDP could decline on average over the two years. Inflation reached 6.8 per cent in March, its highest point since the start of the 1990s; it fell by half a percentage point in April, thanks to the recent The Governor’s Concluding Remarks Annual Report 2021 BANCA D’ITALIA measures on fuel, electricity and gas. Until now, there has been no sign of price pressures being transmitted to salaries, partly because of the characteristics of Italy’s collective bargaining system, designed to limit the repercussions of increases in inflation due to energy shocks. Other factors include the still incomplete recovery in terms of the number of hours worked, the reduction of profit margins observed in 2021, and the government measures to reduce the impact of the energy crisis on household and business incomes. The increase in imported commodity prices is an unavoidable tax for the country. Government action can redistribute the effects of inflation between households, factors of production, and present and future generations, but it cannot wipe out the overall impact. As regards households, interventions calibrated according to their general economic condition rather than individual incomes are more effective in countering the repercussions of inflation on inequality. Among other things, targeted measures enable the role of prices to be better preserved as an incentive to invest in renewable sources and to save energy. Despite the deterioration of the economic outlook, the most recent assessments by the European Commission indicate that the debt-to-GDP ratio will continue to decline both this year and the next. In the last few weeks, we have nevertheless observed an increase in the yield spread between Italian government securities and the corresponding German Bund which, for ten-year bonds, has repeatedly gone above 200 basis points. This sudden increase does not reflect any abrupt changes in the underlying economic conditions: the net international investment position is robust, Italy’s producers are successfully competing on the outlet markets, and the level of household and business indebtedness is low by international standards. The increase does, however, call attention to the structural fragility represented by the high level of public debt; it confirms the need to continue firmly on the path towards gradually strengthening the public accounts. Although varying in severity across countries, the economic consequences of the war in Ukraine, like those of the pandemic, are affecting the whole of Europe. There was a common response to the pandemic, which included the Next Generation EU (NGEU) programme. The Commission has now proposed to expand it with the REPowerEU programme to put an end to dependence on fossil fuel imports from Russia. European initiatives could prevent unfavourable shocks from exacerbating the differences between national economies and financial market fragmentation risks, ensuring a fiscal policy stance that is more suited to conditions in the euro area. The main beneficiaries of the NGEU programme, of which our country is undoubtedly BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2021 one, are responsible for demonstrating, in a concrete way, what milestones a stronger and more cohesive Union can achieve. There has been discussion for some time about the advisability of completing the institutional framework of the Economic and Monetary Union by endowing it with an adequate common budget. This would have a stabilizing effect and guarantee the supply of European public goods to be offset by own resources or debt issuance. This innovative approach could help resolve the asymmetry between the many different national fiscal policies and the single monetary policy, although this would require amending the Treaties, which is a long process with uncertain results. Without involving Treaty changes, one possible – and less ambitious – solution could be to set up an instrument to be used as needed, avoiding having to create ad hoc programmes each time, as happened after the sovereign debt crisis and during the pandemic. In this way, confidence would be bolstered in Europe’s capacity to intervene promptly when necessary. The new instrument could finance common projects of an exceptional nature or help with the macroeconomic stabilization of the European area in response to a shock of a certain size. Following the example of the NGEU programme, funds would be raised via the issuance of EU debt and then transferred to the member countries to be employed judiciously and for uses agreed at European level; the servicing of this debt would be guaranteed by adequate own revenues. This innovation could accompany the ongoing reform of the Stability and Growth Pact. Today, there seems to be a consensus not only on the need to renew the Pact, but also on some of the desirable characteristics of the new system of rules. It should continue to guarantee the sustainability of public debt, while taking account of the differences in macroeconomic and structural conditions between the various countries. To ensure simplicity and transparency, the role of unobservable items, such as the structural deficit or potential GDP, should be limited as much as possible. Starting with these points of agreement, which are also clearly present in the proposals for reform advanced by the governments of some euro‑area countries, a framework of rules that is simpler and more flexible, but which preserves budgetary discipline, could be centred on medium-term programmes agreed with the European Commission and approved by the Council of the European Union. These programmes, based on realistic macroeconomic projections and subject to independent validation, should indicate debt objectives and time horizons for their achievement, specific to each country, going beyond the uniform criterion of reducing the debt-to-GDP ratio in line with the current rules; they should also set out a multi-year profile for net borrowing consistent with these objectives. Deviations from this profile that are not due to any unforeseen macroeconomic factors, would be The Governor’s Concluding Remarks Annual Report 2021 BANCA D’ITALIA subject to corrective mechanisms similar to those currently contained in the excessive debt procedure. If the budget instrument I have alluded to were to be introduced, access to common resources could be bound to compliance with these programmes. As we have argued on more than one occasion, there are also very sound reasons for adopting forms of common management for a part of the national debt issued in the past – for example, the component relating to the pandemic emergency – by means of a European fund that would buy a share of existing public sector securities, financing itself on the market. While I am well aware of the political difficulties that such an initiative would encounter, it must be underlined once again that it would make a significant contribution to strengthening the stability of the euro area as a whole and to creating a supranational public sector bond market of adequate depth and liquidity, with positive effects also for the completion of the banking union and the capital market union. The activity of this kind of European fund would be structured in such a way as to avoid the systematic transfer of resources from one country to another and to maintain the incentives to conduct fiscal policy responsibly. The risks for the international scenario beyond the short term The governance of globalization and international equilibria have been under consideration for some time now, driven by the serious shocks that have hit the world economy one after another in the last 15 years, by the distributional consequences of this process in various countries, as well as by the gradual changes in the relative demographic, economic and political importance of the advanced and emerging countries (Figure 5). The war in Ukraine risks diverting the course of this essential rethinking and leading us towards a world divided into blocs, with fewer movements not only of goods, services and financial capital but also of technologies, ideas and people. With the end of the Cold War, over the last thirty years, the opening up of trade and technological progress have generated profound changes. Billions of people that had hitherto been excluded have had access to global markets, resulting in an unprecedented expansion. Today, world GDP is two and a half times what it was in 1990, per capita GDP has increased by 75 per cent and international trade has more than quadrupled (Figure 6). In some areas of the world, particularly in the emerging countries of Asia, the economic development and the improvement in living conditions have been extraordinary. Despite the increase in the world’s population – from five to eight billion, more than 90 per cent of which in the emerging and developing economies – the number of people living in extreme poverty has BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2021 declined considerably, from almost two billion to below 700 million, with the exception of sub-Saharan Africa. Efficiency gains, generated by exploiting economies of scale, differences in productivity and in the availability of production factors between countries and economic areas, have been increased by the organization along global value chains in which around half of international trade took place, prior to the pandemic. At the same time, capital flows have continued to support economic integration, ensuring a better allocation of resources and greater risk diversification. This process has not been without uncertainties and difficulties. The way in which capital moves has changed, and the role of non-banking financial intermediation has grown considerably since the global financial crisis. While the riskiness of the banking component has been attenuated by a wide‑ranging reform of the rules and by micro- and macro-prudential policies, the increasing diversification in sources of funding for the economy has been accompanied by episodes of marked volatility. The lengthening of value chains has accentuated firms’ financing needs; for those operating in emerging economies and less developed countries, the large share of foreign currency debt has increased their vulnerability to external shocks. The reproduction on a global scale of just-in-time organizational planning models has heightened the fragility of production chains and the risks of an international propagation of local production difficulties. Globalization has also leveraged the regulatory differences between countries, especially regarding the taxation of profits, environmental sustainability and protecting workers. Furthermore, despite the significant reduction in per capita income gaps between countries, the inequalities in wealth and income distribution have increased sharply within many economies, especially the advanced ones, giving rise to calls for greater social protection and undermining trust in the benefits of globalization and technological progress, in part because of the lack of adequate national policy responses. The repeated external shocks, as well as amplifying income volatility, have increased the uncertainty over individual economic prospects and contributed to generating widespread insecurity. The pandemic, with the marked fall in international trade and the supply chain bottlenecks for some intermediate goods, and the Russian invasion of Ukraine, with its repercussions for energy and food supplies, could push towards a reorganization of international trade that favours the resilience of supply, especially in strategic sectors. In this situation, trade could be concentrated within areas comprising countries that are politically like‑minded or united by regional economic agreements. The Governor’s Concluding Remarks Annual Report 2021 BANCA D’ITALIA However, a division of the world into blocs would risk jeopardizing the mechanisms that have stimulated growth and reduced poverty at global level. A reshaping of the dense network of interdependencies among countries would be difficult to achieve without tensions or marked adjustments in the prices of goods, services, and financial and real assets, even if it were spread out over time. The allocation of global savings would inevitably be less efficient, and the funding of the public and private debt of individual countries would be more difficult. A fragmentation along borders drawn by political security considerations, albeit necessary ones, could have extremely negative consequences for smaller economies, especially emerging and low-income ones that do not benefit from participation in consolidated regional economic areas. In a world divided into blocs, we would also and above all lose that wealth of mutual trust, however fragile and uncertain, that, as well as being indispensable for nations to co-exist peacefully, is an irreplaceable foundation for tackling the key challenges for future generations. Limiting global warming, fighting against extreme poverty and combating pandemics are formidable objectives that no country can face alone. The experience of Italy’s G20 Presidency last year showed that, despite considerable and increasing difficulties, acting in concert can achieve important results, although it must be acknowledged that it is made more arduous by the altered political context. A change of direction that aims to blend the benefits of globalization with policies framed to limit its negative consequences is indispensable. It must be based on an open discussion of the rules and governance of the global economy, which leads to a new international balance, taking account of the greater importance of emerging countries and the need to guarantee fundamental respect for the founding principles and values of peaceful coexistence among nations. Otherwise, the most vulnerable and the poorest social groups and countries would pay the highest price of a disorderly ‘deglobalization’, although there would be no shortage of pressures on advanced economies, and on Europe in particular. More than half of the increase that is forecast for the world’s population, of two billion over the next thirty years, will be in Africa: a steady and sustainable development in this continent’s economies is crucial for reducing extreme poverty and guaranteeing a substantial improvement in the social and economic prospects for those living there, as well as for averting the emergence of migration flows that would be difficult to manage in terms of scale and size. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2021 Difficulties, trends and challenges for the Italian economy The restructuring that took place in the decade prior to the pandemic enabled Italian firms to face the crisis from a relatively sound financial position. A recovery in competitiveness has been underway for some time. The financial system, which has also become stronger, is capable of providing the production sector with adequate support. The renewed confidence in Italy’s economic outlook had fostered a return to growth in investment and facilitated the recovery, which is now being impacted by the consequences of the war in Ukraine. The progress made, though partial, indicates that the Italian economy can overcome the weaknesses that are slowing its development, in order to end the stagnation in productivity, counter the effect of demographic trends on labour supply and reduce the weight of public debt, which has risen considerably with the pandemic crisis (Figure 7). The National Recovery and Resilience Plan (NRRP) is a crucial tool for successfully tackling this challenge. The Plan, which is on a significant financial scale, marks a sharp break with the past in drawing up economic policies. It sets out a comprehensive strategy for modernizing Italy, combining reform plans and public investment with private investment, thereby helping to bring about the digital transition and the ecological or ‘green’ one. It introduces profound innovations to how measures are implemented, by setting specific targets, also for programmes managed at local level, outlining the interventions needed to overcome the regulatory obstacles that could hold back their achievement and establishing milestones and targets, supported by an extensive monitoring system. The NRRP does not cover all the interventions needed or Italy’s financial commitment; it is flanked by other significant reforms to be implemented, such as that of the tax system, and resources allocated by the national budget to spending programmes with similar objectives. However, it does provide an opportunity to close the accumulated lags in tangible and intangible infrastructures in a short space of time, to boost R&D, to improve the education system and to step up investment in new technologies, which are all key factors for accelerating productivity and strengthening our economy’s growth potential. To ensure its success, the design and implementation of the reforms will have to be capable of profoundly changing the landscape in which economic activity takes place; the Plan’s innovative approach could become common practice for public interventions. The fact of having drawn clear lines for industrial development based on green and digital technologies and on support for research and innovation could contribute to reinforcing and expanding the most dynamic segment The Governor’s Concluding Remarks Annual Report 2021 BANCA D’ITALIA of the production system. There is no lack of entrepreneurial excellence; the productivity of medium-sized and large Italian firms and their ability to reach international markets are comparable to those of similarly sized French and German firms, but their share of employment and of value added is still insufficient. In Italy, firms with more than 250 employees, which on average have better managerial and organizational resources and a greater capacity for bearing the costs of innovation and adapting to the green transition, account for less than one quarter of persons employed, about half the figure for France and Germany (Figure 8). The action aimed at improving the functioning of public services and the regulation of economic activity is an integral and in many ways essential part of the Plan. Regulatory interventions are expected in many areas, as are suitable resources to support the digitalization of government entities, enhance the skills of public sector employees and organize judicial offices more effectively. The measures implemented in previous years have enabled some progress to be made: digital access to government and local authority services has expanded considerably, and the number of pending court cases has fallen by one fourth since 2015. However, the complexity and instability of the rules, the unwieldy nature of administrative proceedings and the shortcomings in the functioning of the public administration and the justice system continue to be substantial. These are factors that are still limiting the willingness to invest in our country, and in the South in particular, undertaking large-scale business initiatives. Drafting the legislative and regulatory measures included in the Plan requires considerable commitment in order to ensure compliance with the deadlines agreed upon with the European Commission. Of the interventions to be completed in the first half of this year, the enabling law for reforming the Public Procurement Code is particularly important. Over the next few months, the process for approving the law on competition will need to be completed, allowing the numerous associated acts to be implemented. Progress has also been made with the tax system: the recent revisions of personal income taxation have corrected clear anomalies in the structure of marginal effective tax rates, and the fight against tax evasion has benefited from the introduction of regulatory and technological innovations, such as electronic invoicing. The inclusion of future interventions in a comprehensive reform, the need for which has been pointed out many times, would make it possible to design the system in a less distorted way, give it stability and make further inroads in fighting evasion. The sustainability of the public accounts will in any case have to be preserved, providing for full coverage of the measures adopted. Limiting ourselves to intervening on individual BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2021 aspects of taxation would fuel the process of regulatory stratification. The uncertainty stemming from frequent modifications ‒ not always especially consistent from one to the next or over time, and with retroactive effects ‒ and from the lack of continuity in the interpretative guidelines and in the case law is a severe barrier to economic activity. Overcoming the factors that hinder productivity growth has become even more necessary given the demographic projections, which point to a downward trend in the labour force that can only partly be countered by an improvement in the migration balance and by an increase in labour market participation. Istat’s most recent projections show that over the next 15 years, the population aged 15 to 64 will fall by 13 per cent (about five million people, half of whom in the South); the cohort of those aged between 24 and 70, useful to account for the projected increase in the years spent in education and work, will decrease by just under three million. Over the last ten years, the lack of suitable work opportunities has driven almost one million Italians to move abroad, many of whom are highly educated; by contrast, there are increasingly fewer people, often with low skill levels, who transfer from abroad to Italy. Adequate policies for planning migration flows, training and integration are lacking. The labour market participation rate is among the lowest in Europe, especially in Southern Italy. The participation rate for women, equal to 55 per cent in Italy compared with an average of 68 per cent for Europe, is 18 percentage points lower than that for men (Figure 9). To narrow the gap, among other things, the obstacles that mothers face in re-entering the work force after having children must be removed. The NRRP funding for services for families is a first step in this direction. Employment opportunities and the choice of whether to participate are closely connected with educational attainment, which should be raised quantitatively and qualitatively starting from secondary school, where there is still a high rate of abandonment and learning outcomes are unsatisfactory. Despite the progress made, there is still a big gap between the percentage of Italian university graduates and those of other European countries, even for the youngest population cohort: 28 per cent of those aged between 25 and 34 held university degrees in 2021, 13 percentage points below the European average. The interventions and the effective use of NRRP funds for schools’ physical and digital infrastructures, for bolstering STEM programmes, and for improving the selection and training of teachers can all help to increase both the demand for and the supply of high-quality education. Those most in need of this are students from less advantaged geographical and family backgrounds and young immigrants, for all of whom education surveys continue to show severe difficulties, which worsened considerably during the The Governor’s Concluding Remarks Annual Report 2021 BANCA D’ITALIA pandemic. It is increasingly necessary for these survey findings to be used in framing targeted and consistent corrective measures. In order to achieve the hoped-for results, it is crucial for the structure of the Italian economy to open to change, by taking advantage of the programmes and reforms envisaged under the Plan to increase firms’ propensity to expand and to invest in innovation and in enhancing human capital. This is particularly needed in the regions of the South, where more than one third of the population resides but that only produces just over one quarter of the national GDP, and where the average per capita GDP is 45 per cent lower than in the Centre and North. The ever-widening geographical gap in the development of the economy reflects, along with the widespread inadequacy of public action, the limited importance of and the lags in the private production sector in the South. This is partly explained by how entrenched organized crime is in this area, something which in turn imposes costs on firms and distorts the functioning of the market and of competition. From now until 2030, according to the official assessments, in addition to the €80 billion envisaged under the Plan, the South can count on additional resources of around €120 billion from the European structural funds and the Development and Cohesion Fund. These are substantial allocations, the use of which should kick-start the southern economy, such as to contribute to increasing the productive potential of the entire country. The high public debt exposes our economy to considerable risks, including those connected with market volatility. Looking ahead, consistently higher growth rates than in the past will be needed to significantly reduce the debt. There will also have to be adequate surpluses net of interest expense, in part to take account of the expected increase in the expenses connected with the ageing of the population. Against this backdrop, the use of debt to fund new public programmes – apart from what is necessary to address true emergency situations – must be avoided. The main investment programmes are being launched and the NRRP reforms are still underway. The crisis triggered by the war in Ukraine does not call for a review of the Plan’s strategies, and if anything has made accelerating the green transition more urgent. The difficulties associated with higher energy and commodity prices can be overcome with specific financial allocations, as is already happening. This is not only a question of combating climate change as part of a common global strategy, but also of achieving greater energy security by reducing dependence on imported fossil fuels, increasing the diversification of supplies, raising energy efficiency and using more renewable resources. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2021 These are the targets of the REPowerEU plan recently presented by the European Commission, which proposes that the Member States include new programmes in their NRRPs, to be funded mainly by common resources. Eliminating administrative red tape for the building of photovoltaic and wind plants and developing the required infrastructure are key elements of the European strategy. In Italy, it is imperative to continue with the interventions to simplify the authorization procedures and to foster the development of systems for accumulating energy and of transmission networks. These measures will allow the southern regions to exploit their comparative advantage in the production of energy using renewable sources, with benefits in terms of attracting production investment, which will also be stimulated by incentives, reforms and the improvement in public services and infrastructure envisaged in the Plan. Success in promoting social and territorial cohesion and the digital and green transitions are essential to boosting trust in Italy’s prospects for development and to combating the increased uncertainty caused by international tensions. Finance and innovation The financial system will need to provide an adequate flow of private funds that, alongside public funds, can support the investments needed for Italy to develop in a balanced and long-lasting way. Italian intermediaries are now in a position to provide expertise and resources to help tackle the challenges posed by digitalization and the green transition effectively. They have proved this by taking part in the collective effort undertaken by the national and European monetary and fiscal authorities to overcome the repercussions of a shock as far-reaching as that caused by the pandemic. At the end of 2021, the ratio between the common equity tier 1 and risk-weighted assets (CET1 ratio) of Italian banks stood at 15.3 per cent, up by 1.3 percentage points compared with two years before. The ratio of non-performing loans to total loans was down, net of loan loss provisions, to 1.7 per cent, almost half of what it was at the end of 2019 (Figure 10). For significant institutions, both indicators are essentially in line with the average levels for the other intermediaries directly supervised by the ECB. The less significant institutions have made similar progress. The non-performing loan rate, which remained low during the pandemic, has only been slightly affected by the gradual phasing out of the debt moratoriums: around two thirds of the firms that had benefited from them have already returned to paying debt servicing costs in full. The quality of loans backed by public guarantees shows no signs of worsening for now: The Governor’s Concluding Remarks Annual Report 2021 BANCA D’ITALIA during the grace period that is still in force, almost all firms have continued to pay the interest component. The Bank’s focus on a correct classification and valuation of loans continues to be supported by targeted analyses. Although profitability has returned to pre-pandemic levels, it is still low, including by international standards. Last year, the return on equity, net of extraordinary components, of Italian significant institutions was 5.4 per cent, more than 1.5 percentage points lower than that of the other significant banks. The average profitability of Italian less significant institutions with traditional business models is 1 percentage point lower than that of the larger banks. The steps to increase efficiency levels and the commitment to reviewing their business models must therefore not fall short of the mark. This situation, which is not negative on the whole, is exposed to new risks stemming from the conflict in Ukraine. Direct exposures to counterparties resident in Russia, Belarus and Ukraine, which are concentrated in the two largest groups, are low. However, the indirect effects of the conflict are more difficult to assess. The marked increases in energy prices are affecting firms’ financial conditions. Banks’ exposure to those operating in the sectors hit hardest by the price rises is not negligible, even though it should be noted that, on average, their default probability as reported by banks before the war was lower than for other sectors. A protracted conflict and heightened frictions in global value chains could also lead to a more pronounced cyclical slowdown than is currently expected and to a subsequent worsening of the financial situation of households and firms, making it necessary to operate prudently when classifying loans, booking loan loss provisions and distributing earnings. The deterioration of the cyclical situation could create serious problems for the banks more geared to typical credit intermediation, particularly for some small and medium-sized ones that are already finding it difficult to keep costs down and are struggling to benefit from economies of scale, to diversify their revenue sources and to raise the capital needed to invest in new technologies. The Bank of Italy’s supervisory action remains focused on encouraging these intermediaries to adopt a corporate governance able to define and implement business plans that are credible and consistent with the challenges posed by the market situation; it is up to the management bodies to act without delay, including on the front of possible mergers, to minimize the risk that situations of difficulty turn into irreversible crises. A process to strengthen the role of institutional investors in the allocation of private savings has long been underway in the Italian financial industry. More than one third of households’ financial wealth is currently invested in BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2021 asset management products; the gap with the euro-area average has narrowed significantly over the last ten years (Figure 11). A sizeable share of savings is managed by open-end funds, for a total amount of €1,300 billion, compared with €1,400 billion worth of bank deposits of households and firms. A small share of the resources managed by funds is invested in securities issued by Italian firms, to the tune of 5 per cent, compared with 34 per cent in France and 14 per cent in Germany. These differences for the most part reflect the structure of the Italian production sector, which has a relatively high number of small firms that make less recourse to capital markets to fund their business. The expertise of specialized asset managers investing in innovative sectors and in turnarounds could play an important role in selecting and financing firms with greater potential for growth. The assets managed by alternative funds specialized in purchasing securities issued by small and medium‑sized firms, typically less liquid, and in financing companies that need to be restructured more than tripled between 2015 and 2021 (from €9 billion to €30 billion). The growth was spurred by tax and legislative incentives. However, assets under management are still low compared with the euro-area average, which is 6 per cent of GDP, three times the figure for Italy. The growth of non-bank finance must take place in stable conditions. The risks of financial investment cannot be wiped out but they must be better understood by investors and overseen prudently and carefully by the companies managing them. Even when they are small, asset management companies must adopt corporate governance structures and possess adequate expertise in order to act in the interest of their customers. The ongoing update of the regulatory framework and of monitoring tools is aimed at fostering an orderly and transparent evolution of this sector. The focus of the Financial Stability Board and of other forums for international cooperation, which was rekindled by Italy’s G20 Presidency last year, remains high. The pandemic crisis has created strong momentum for the digitalization of all segments of the financial industry. In credit intermediation, new technologies are now embedded in every step of the loan origination process. In retail payments, there has been an increase in consumer preference for using cards rather than cash for purchases at physical points of sale, especially if they have contactless technology (Figure 12). For innovative products, processes and distribution channels to take hold, customer and personal data protection measures must be strengthened. In setting them up, the authorities benefit from dialogue with customers and market players. A significant rise in financial literacy is a necessary condition The Governor’s Concluding Remarks Annual Report 2021 BANCA D’ITALIA to ensure that customers’ ability to choose is improved and supervisory rules and actions are better able to protect consumers. The use of distributed ledger technologies (DLT) can enhance efficiency in the supply of financial services and afford significant benefits to customers. The reduction in payment times and in the costs connected to the issuance and circulation of financial instruments is spurring a widening in the pool of investors and deepening the markets for assets that have not been considered very liquid so far. On this front, in Italy as in other European countries, pilot initiatives are being designed in connection with the forthcoming introduction of an EU regulation establishing a pilot regime for market infrastructures based on DLT. These technologies are used for the issuance and trading of crypto-assets. The latter term, for which internationally agreed taxonomies are still lacking, refers to a highly heterogeneous set of instruments. An important distinction should be made between crypto-assets whose issuance is backed by real or financial assets (known as ‘fully-backed stablecoins’) and those for which there are no such underlying assets. The former, if adequately regulated and when issued by clearly identified entities, can maintain a relatively stable value over time and provide services to the economy. The latter – including algorithmic stablecoins, which have stabilization mechanisms based on automated rules that adjust supply based on changes in demand – have no intrinsic value, are highly volatile and, as a result, are exposed to significant risks of a run; they are mostly used for speculative purposes. Depending on their characteristics, crypto-assets can therefore have different levels of riskiness, something that regulation must take into account when laying down the rules governing them. A step in the right direction is the European Commission’s proposal for a regulation addressing these markets (Markets in Crypto-Assets Regulation, MiCAR), which sets out common rules for the issuance and offer of crypto‑assets to the public as well as the requirements for the provision of related services, such as their purchase, custody and sale. Some issues, however, remain open, such as the possibility for customers to access crypto-asset markets without going through regulated entities. We are aware of additional risks – that are often not fully understood by customers – arising from the use of unhosted wallets, i.e. electronic wallets that enable the automated exchange of crypto‑assets without the involvement of service providers, and from the possibility of obtaining financial services through smart contracts, i.e. software made available directly by unregulated entities (decentralized finance, or DeFi). An orderly development of these phenomena cannot happen without setting out standards and practices that can act as a benchmark not only for supervised intermediaries but also for all the other players involved. We are BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2021 stepping up the in-depth analyses necessary to enhance the transparency and the reliability of these new forms of financial intermediation, in order to share them with the other supervisory authorities. Regardless of the differences among crypto-assets, we must be well aware that even DLT instruments issued by clearly identified entities are private sector liabilities and, as such, are characterized by the risk of insolvency. The only instrument in circulation that is free of this risk is cash issued by central banks. It is on the basis of this awareness that the Bank of Italy is involved in the work being carried out at Eurosystem level to consider the introduction of a digital euro. A digital currency issued by a central bank would represent an anchor for the public’s trust in money, which would act as a complement to cash and the existing electronic means of payment as well as to the development of reliable private-sector digital instruments. For this to be possible, the digital euro will have to meet users’ expectations in terms of ensuring personal data protection, security and ease of use, fostering innovation and accompanying the digital transformation of the economy. A decision on the possibility of issuing it will be taken in the coming years based on the outcome of the work currently underway. Innovations such as electronic identification systems and advanced data analysis methods are helping the fight against money laundering and terrorist financing. They make it possible to verify the identity of customers remotely and to carry out in-depth checks on financial flows. At the same time, FinTech companies – which often experience a rapid expansion in their operations – sometimes struggle to implement anti-money laundering rules properly. Their difficulties are greater when they operate across several markets, for which the sectoral rules have not yet been fully harmonized. The utmost attention must be paid to these risk profiles. Going forward, setting rules that are directly applicable across the EU and the introduction of a common supervisory system would make it possible to overcome many of the current difficulties. In an ever more digitalized and interconnected environment, and even more so when there are international tensions, cyber-risks become particularly significant, including those stemming from the use of third-party service providers, which can threaten the stability of both individual entities and the system as a whole. The need to guarantee the security of IT systems calls for adequate and careful organizational choices on the part of financial intermediaries’ management and control bodies, as well as an overhaul not only of the supervisory toolkit but also of the regulatory framework. In Europe, a proposal for a regulation – the Digital Operational Resilience Act (DORA) – lays down harmonized rules and robust and uniform measures for The Governor’s Concluding Remarks Annual Report 2021 BANCA D’ITALIA digital operational resilience in finance, including through the introduction of an oversight framework for critical ICT service providers. In our dialogue with market players, we promote the development of technologies with the potential to yield the greatest benefits to the public. A regulatory sandbox was launched last year, upon the initiative of the Ministry of Economy and Finance and in cooperation with the relevant supervisory authorities, providing a dedicated environment for supervised intermediaries and specialized players in the banking, financial and insurance sectors to test technologically advanced products and services, also with a view to assessing their compatibility with current regulations. This initiative, which was well received by the market, is being carried out alongside the other activities underway at Milano Hub, the Bank of Italy’s innovation centre. Following the first call for proposals on artificial intelligence, ten projects have been selected and are now in the development phase and benefiting from the support of the Hub, which provides technical expertise, answers queries about regulatory issues and provides support in organizing presentations and other events. The supervisory rules and activities concerning financial intermediaries and the markets are helping to ensure that the financial system’s support to the green transition is provided while limiting climate-related risks to individual entities and to overall stability. The supervisory authorities are guiding and encouraging financial intermediaries to accelerate their adoption of management and organizational instruments that are better suited to monitoring these risks, and to disclose accurate information to the market on the activities conducted. Central banks have been moving in that direction for quite some time as well. A few weeks ago, we published our first Report on sustainable investments and climate-related risks, which documents the Bank of Italy’s methodologies and choices and the results achieved in the management of the portfolios it holds for purposes other than monetary policy. In line with what was done by the ECB for significant institutions, we have recently published our supervisory expectations concerning the way in which the banking and financial institutions that we directly supervise will need to integrate climate and environmental-related risks into the control strategies and systems and the information they disclose to the markets. Moreover, both at EU and at Basel Committee level, the possibility of modifying prudential regulation to take account of these risks is being assessed. This is being done cautiously, out of an awarenes of the difficulty in measuring them. In the asset management industry, the new regulation on sustainable finance disclosure entered into force last year. For funds marketed in Europe that wish to promote environmental and social initiatives or whose goal is BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2021 sustainable investment, reinforced transparency disclosure requirements are envisaged. The availability of comparable and reliable data is an essential condition for financial intermediaries to measure and manage risks, for the supervisory authorities to carry out their guidance and control tasks, and for investors to make informed decisions. Action is still needed to improve the European taxonomy for sustainable investment, whose implementation criteria were drawn up last year, and to carry out in-depth analyses of how to harmonize at global level the definitions adopted in the various jurisdictions. It will be necessary to establish principles to verify developments in climate-related risks, set up accounting standards for disclosing information on carbon emissions and prepare recommendations on regulatory and supervisory approaches. Italy provided a decisive boost in this direction during its G20 Presidency. At the same time, to avoid what is known as greenwashing, it will be crucial to identify clearly the entities responsible for carrying out the checks and to establish auditing rules for the ‘sustainability reports’ that are similar to those in force for ordinary financial statements, as provided for in the proposal for a Corporate Sustainability Reporting Directive (CSRD). Furthermore, an accurate analytical framework will need to be developed to take into account the heightened uncertainty that characterizes both the models that quantify the impact of human activity on climate and those that aim to estimate the consequences of climate changes on social welfare. * * * Two years ago, during the most difficult phase of the pandemic, we wondered about its short-term social and economic consequences; there was extraordinarily high uncertainty and it seemed hard to foresee the equilibria and the new ‘normal’ that would emerge in the longer term. Last year, on recalling the exceptional breadth and efficacy of the measures implemented to counter the impact – and not only the economic one – of the public health crisis, we underlined how, in a deeply interconnected world, it could not be said that the risks of the pandemic had been overcome unless it were truly so for everyone. We reiterated the crucial role of international coordination. On the economic front, the recovery in production exceeded the forecasts. In some countries, the measures for macroeconomic stabilization eventually created demand pressures that, given the supply constraints, caused a marked rise in inflation. In the second half of 2021, after years of excessive moderation, consumer prices returned to robust growth in Europe too, not because of excess demand but because of the higher prices of imported energy products. Monetary policy cannot counter the increase in commodity prices, but it must aim to ensure price stability in the medium term. The economic The Governor’s Concluding Remarks Annual Report 2021 BANCA D’ITALIA situation, which has changed profoundly in the space of a few months, makes it appropriate to move past the policy of negative key interest rates. Given the uncertainty of the economic outlook, the rates will have to be raised gradually; it will be easier if pressures for wage increases linked to the rise in inflation prove limited, in part thanks to the fiscal measures designed to curb the higher energy prices and support the income of the hardest hit households. The funding conditions for the economy will in any case remain broadly favourable. Italy’s high public debt reduces the margins available. Fiscal interventions must be clearly targeted and well calibrated to maximize their efficacy and to keep their costs down. The increase in recent weeks of the yield spread between Italian and German bonds confirms that the public debt is still a source of significant vulnerability; it reminds us, if ever we needed reminding, that we must not let our guard down, aiming in the medium term for a primary surplus and a stable increase in the economy’s potential growth. The positive interplay between monetary policy and fiscal policy over the last two years shows the importance of continuing to pursue the completion of the institutional framework of the Economic and Monetary Union, endowing it with a common budget instrument and simplifying the rules applied to national budgets. Through the NGEU programme and the suspension of the Stability and Growth Pact, Europe delivered a coordinated and adequate response to the pandemic shock. We can build on this turning point. As the main beneficiary of the programme, Italy has a responsibility to show that using European resources to support individual Member States can bring benefits to the European Union as a whole. The NRRP has taken on features and proportions capable of achieving the goal of closing the serious gaps accumulated in Italy in education and research, in gender equality and in support for youth employment, and in the quality of infrastructures and public services. The prospect of a development strategy based on green and digital technologies and on support for innovation will be able to help strengthen and expand the most dynamic sectors of our production system, as well as the financial industry. This will bring about profound changes, also to the way in which work is organized. One legacy of the pandemic is certainly the recognition of the possibilities opened up by digital technologies in terms of agile and other forms of remote work. Here at the Bank of Italy too, these new ways of working have taken hold, and are applied, where possible, with flexibility and sound judgment. They do not replace, but rather complement in-person work, which retains a central role in the direct transmission of knowledge, in the training of junior colleagues, and in building trust among staff. There BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2021 will be no change in the resolve with which we will continue to carry out our duties in the service of our country and as part of the Eurosystem. In the NRRP, bridging the geographic divide has become a cross-cutting priority. The financial resources that will flow into the South of Italy are significant: we must all be aware that they will only bear the expected fruit if the State and its institutions continue to effectively counter criminal behaviour, intimidation, violence and collusion. The example set by Giovanni Falcone and Paolo Borsellino is always before us – judges and extraordinary figures embodying the State’s renewed, if disputed, power. Those of us who were there thirty years ago remember the emotion and grief generated across the country by their sacrifice and that of Falcone’s wife and of their security staff. The younger generations bear witness to this shared collective memory. We now find ourselves dealing with a new crisis caused by Russia’s invasion of Ukraine. The plight of the population of that country, which can only be mitigated by a swift end to the war, is compounded by serious consequences for prices and the supply of energy and food products. In the short term, the countries that will be hit hardest are European ones, which are more dependent on Russian gas, and the poorest ones, which are already struggling to secure the necessary supplies of agricultural commodities and fertilizers. The conflict could have potentially very serious effects – albeit difficult to predict – on longer-term international equilibria, on market openness and on trade, not only of goods and capital, but also of information and knowledge. Europe, which has always aimed for a rules-based global order, would stand to lose more than others in a world dominated by division and conflict. Since the end of the Cold War, economic globalization has generated indisputable benefits, with a sharp reduction in extreme poverty at world level, though with a marked increase in inequality in the distribution of income and wealth within many countries. Even before the Russian attack on Ukraine, discussions were underway on how to correct the most obvious shortcomings of globalization, while at the same time retaining the benefits achieved over the last thirty years. Global problems such as pandemics and greenhouse gas emissions can only call for global responses. Writing after the adoption of the Bretton Woods Agreement, Luigi Einaudi stated: ‘In the past, international cooperation has always benefited the poor more than the rich. Let it be so this time too. Yet it will only be so if we steadfastly desire it.’ Even before that, in the midst of the Second World War, he had underlined how ‘the nation states are becoming less and less influential in the face of growing economic interdependence on a planetary The Governor’s Concluding Remarks Annual Report 2021 BANCA D’ITALIA scale’ and that open borders are builders of prosperity, because: ‘international free trade means peace’. It is hard to put it any better: international cooperation must not falter. The necessary reflections on the governance of globalization must not be overshadowed by the distrust and tensions engendered by the ongoing conflict. What must, instead, be nurtured with the utmost determination, by keeping the lines of dialogue open, is the hope that this war, which we unequivocally and categorically condemn, draws swiftly to a close. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2021 FIGURES Figure 1 Gas prices Europe (EUR) United States (USD) Source: Refinitiv. Note: Title Transfer Facility (TTF) prices for European gas and Henry Hub for US gas. Figure 2 Contributions to consumer price growth (percentage changes and percentage points) non-volale components −1 euro area food and energy −1 non-volale components −1 −1 United States food and energy Sources: Based on Eurostat and U.S. Bureau of Labor Statistics data. Note: 12-month percentage changes. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2021 Figure 3 Forecasts for consumer price growth in the euro area (per cent) Consensus Economics Internaonal Monetary Fund Sources: Consensus Economics and International Monetary Fund, April 2022. Figure 4 Wage growth (percentage changes) United States euro area Sources: European Central Bank and U.S. Bureau of Labor Statistics. Note: Annual percentage changes of quarterly data; negotiated wages net of one-off payments for the euro area, and the Employment Cost Index for the United States. The Governor’s Concluding Remarks Annual Report 2021 BANCA D’ITALIA Figure 5 Advanced and emerging economies: share of world GDP (per cent) advanced economies emerging economies of which: China Source: Based on International Monetary Fund data. Figure 6 World population and per capita GDP (1990=100) per capita GDP populaon Sources: Based on World Bank and Maddison Project data. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2021 Figure 7 Labour productivity in the private sector (1995=100) Germany France euro area Italy Source: Based on Eurostat data. Note: Value added per hour worked, in real terms. Figure 8 Distribution of employment by firms’ employee size class (per cent) France Italy Germany 0−9 10−19 20−49 50−249 250+ Source: Based on Eurostat data. Note: Firms in the non-agricultural private sector, excluding financial firms and insurance companies. The Governor’s Concluding Remarks Annual Report 2021 BANCA D’ITALIA Figure 9 Difference between male and female activity rates (percentage points) Italy European Union Germany France Source: Based on Eurostat data. Figure 10 Capitalization and credit quality of Italian banks (per cent) non-performing loans as a share of total loans (right-hand scale) common equity er 1 rao Source: Supervisory reports. Note: Non-performing loans as a share of total loans (net of loan loss provisions); end-of-year data; the data for 2021 are provisional. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2021 Figure 11 Assets under management as a share of households’ financial assets (per cent) euro area Italy Sources: Bank of Italy and European Central Bank. Figure 12 Cash payments preference indicator and share of contactless payments in Italy (per cent) preference for cash share of contactless payments Source: Bank of Italy. Note: Based on a representative sample of cards in use; the indicator of preference for cash is the ratio of withdrawal amounts from ATMs to the sum of these withdrawals plus the value of card payments at Points of Sale (POS); the ratio of contactless payments to the total of payments made with cards is calculated based on the value of the transactions. The Governor’s Concluding Remarks Annual Report 2021 BANCA D’ITALIA Printed by the Printing and Publishing Division of the Bank of Italy Rome, 31 May 2022
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Opening speech by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy and President of the Insurance Supervisory Authority (IVASS), at the 17th Meeting of the Ottawa Group, Rome, 7 June 2022.
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17th Meeting of the Ottawa Group Opening speech by Luigi Federico Signorini, Senior Deputy Governor of Banca d’Italia Rome, 7 June 2022 It is my privilege to welcome you to the 17th Meeting of the Ottawa Group, jointly organised by the Banca d’Italia and Istat. As you know, the meeting should have taken place two years ago. However, the health emergency hit just before the scheduled date and we had to change our plans. I am very pleased that we are now here together and ready for a fresh start. The issues that will be discussed during the next few days are, of course, the centre of attention of consumer price experts and central bankers. Many of these issues, however, are also of great interest to the public at large, such as how to account for new consumption trends; how to handle (and benefit from) digitalisation; how to develop more comprehensive measures of the cost of living, especially ones encompassing housing costs. This, I think, makes your work particularly valuable. Prices and the pandemic Much more than economics and statistics, of course, have changed because of the Covid-19 pandemic: our health and that of our loved ones, our housing needs, our way of working, our consumption patterns, our social relationships. All of these, however, have had significant repercussions for the work done by economists and statisticians. Economic policy makers have had to change the way they approach, and perhaps even the way they think about, economic facts; the full impact will only become clear over time. Certain features of the recession triggered by the health emergency were in fact unprecedented. We had never experienced such a sharp economic downturn in peacetime, and, moreover, one that was due entirely to a mandated lockdown (plus further limitations to mobility due to people’s subjective fear of infection). Well, almost entirely, to be sure: but the traditional factors (expectations, demand, real interest rates), the ones that usually drive econometric models, played only a minor role this time. I am making this point because it is one that is all-important for econometricians and forecasters. Forecasting is always tough, but the Covid-19 crisis has made this job even harder. Think, first, of the simple fact that our analysts (and their models) had never seen fluctuations of this magnitude; with even just a modicum of nonlinearities, predictions were bound to fail. Second, consider a fact the possibility of which simply had not occurred to anyone: services were hit much harder than manufacturing, usually the most cyclical sector. I could go on and on about how many differences there were, compared with previous recessions. However, in my view, the most important fact by far is the one that I have already mentioned: that this time, the sudden halt in the economy was due almost entirely to extra-economic, explicit constraints. This is why many forecasters, drawing on the experience of past recessions and using quantitative models trained on them, underestimated the resilience of our economies in the aftermath of this crisis. It was a bit like predicting traffic flows at a crossroad controlled by traffic lights. When the light is red, cars stop. When the light turns green, cars move. If your predictions are based on sophisticated models that have never heard of traffic lights and have been estimated over complex roundabouts and multi-lane intersections, you just don’t get that simple fact. It is even technically difficult to devise ways to put red lights into standard models by way of ad-hoc dummies and add-ons. In fact, as restrictive measures were lifted, economic activity resumed instantly in many sectors, not least in this country. This surprised many observers, and is perhaps a lesson to keep in mind. So much for econometrics and forecasting; let us turn now to statistics proper. The pandemic has posed a huge challenge for the field of statistics, above all, because of the novel constraints it imposed on data collection. Especially in the initial stages of the crisis, the lack of good quality and timely data was a key source of uncertainty. It made it hard to assess current economic conditions and track the economy in real time. The production of all official statistics was heavily affected by the lockdowns. Conducting surveys of households or firms suddenly became all but impossible in many cases—at least using traditional means. Data on prices were among those that became difficult to collect. During lockdowns, physically going to the points of sale to record actual prices was, more often than not, out of the question. For certain components of the index, moreover, there were actually no exchanges taking place. Many prices had to be imputed for an extended period of time: in April 2020, the share of imputed prices was 32 per cent in the euro area, and as much as 40 per cent in Italy. Another significant challenge was that the lockdowns changed the distribution of consumption between goods and services, and many sub-categories within those two broad categories. A substantial share of the items included in the consumer price index were from sectors which were either de jure or de facto inactive, such as tourism, recreation or air travel. By contrast, consumption of other goods and services increased. A notable example was food, whose prices surged in the euro area, because of diverted demand, hoarding and (occasionally frantic) precautionary buying. The question was, to what extent should indices reflect this (presumably temporary) shift? Faced with these difficulties, standard practices on the updating of weights for cost-of-goods indices had to be revised.1 Eurostat issued new guidelines requiring the national statistical institutes to update the HICP weights for 2021 based on information for 2020, contrary to the standard practice of updating by relying on consumption patterns for the t-2 year. Measuring inflation in the time of Covid 19 Given the difficulties, producers of statistics, including statistical institutes and central banks, proved to be rather creative and resilient. Technology was an ally, notably in allowing staff to work remotely and enabling non-standard ways of gathering information. As in other fields (work practices, retail commerce, payments), the need to overcome the difficulties created by the pandemic unleashed innovative solutions that had actually been available for some time, but had remained unused, or under-used. Notably, new price data sources, such as scanner data and web-scraping, are now increasingly used to compile consumer price indices. With hindsight, one wonders why statisticians had not done much more of that before. Challenges remain, like the proprietary nature of many data and the difficulty of subjecting them to satisfactory statistical standards of quality. None is necessarily unsurmountable, however; my impression is that the world of price statistics has now changed for good, and that the pandemic has been a powerful accelerating factor. Right in the middle of the pandemic, moreover, the ECB conducted its strategy review, which it concluded in July 2021. The reason why I mention it in this context is that a key point of the strategy review was re-thinking the price reference, and that might have been another challenge for (European) statisticians. In fact, not a lot was changed—and I think, rightly so. The review confirmed that the harmonised index of consumer prices, or HICP, remains the appropriate price measure. However, it did recommend that an extended HICP should be computed over time, to account for owner-occupied housing (OOH). Let me emphasise the phrase ‘over time’. Some time will actually be required to construct such a harmonised index. As this audience knows very well, the issue of incorporating OOH into the HICP (yes, we speak in acronyms here, as in many other fields) is not straightforward. It is indeed, in principle, desirable for representativeness and cross-country comparability, but at the same time it faces non-trivial implementation challenges. Currently, there is considerable crosscountry heterogeneity in the way (if any) OOH is included in national inflation indices, and all approaches have their pros and cons. More analysis and exchange of views on this topic is crucial, and this workshop offers a good opportunity for discussion about it.2 Moreover, the implementation of any new price index incorporating OOH needs to be well managed. In particular, information should be communicated carefully as the existing HICP would continue to serve as the main reference for monetary policy purposes. Integrating OOH into the consumer price index is not the only challenge for price statisticians beyond the pandemic. Several other key issues are linked to technological and market developments, such as the explosion of e-commerce, the increasing numbers The rental equivalence approach matches up the characteristics of the owner-occupied housing stock with equivalent rental properties and calculates what it would cost, at current rental prices, to rent the whole stock of owner-occupied housing. The net acquisitions approach measures the costs associated with the household sector acquiring new residential housing. Implementations of this approach typically include all money spent on the net acquisitions of dwellings by the household sector including self-builds, spending on major renovations and repairs and the various service costs associated with acquiring new homes. of product varieties and the faster pace of product and outlet replacement. Specifically, the eternal issue of how to account for quality changes is being exacerbated by the increased speed of innovation. On the other hand, I see the growth in e-commerce as an opportunity, as well as a challenge, for price statisticians. We must find innovative ways to collect price data on innovative trade channels, and this is indeed a problem. But the solution(s), if smart and creative enough, might lead to data collection techniques that are at the same time more efficient and more comprehensive than those used in the past. I do see that many of these challenges appear in the programme of this workshop, and look forward to the results of your discussions. Price stability during the war: the role of energy In talking about prices these days, one cannot overlook the issue of the sudden increase in inflation we have been seeing. Over the past few months, the euro area has witnessed a rise in energy prices that can only be compared with the oil shocks of the 1970s. The price of natural gas has seen the fastest growth. This has pushed inflation well beyond our target. Initially, the increase was largely due to idiosyncratic factors and pent-up demand in the aftermath of the pandemic, which caused bottlenecks in shipping, and other input-related bottlenecks. Since the end of last year, however, the surge in energy prices has mainly been due to the escalation of geopolitical tensions that culminated, on 24 February, in the military invasion of Ukraine by Russia. In May, euro-area consumer price inflation reached 8.1 per cent on a 12-month basis, the highest value recorded since the Economic and Monetary Union was launched. In the same month, (harmonised) Italian inflation was 7.3 per cent. This is not the right place to debate the underlying causes of inflation in full; still less the policy action or actions that are required. Let me just note that more than 5 percentage points of the increase in the HICP can be directly attributed to the more volatile components of the index (energy and food). The Bank’s staff, however, estimate3 that energy prices also had an indirect impact, as they are now starting to pass through to services and goods, though only partially and rather slowly for the moment. For example, 2.4 percentage points of the 7.5 per cent euro-area food inflation are due to the pass-through of the energy shock (in Italy, 1.5 percentage points out of 6.5). Developments in core inflation deserve very careful monitoring. We should watch out for possible second-round effects. See Corsello and Tagliabracci (2022). Among Italian companies included in the latest wave of our quarterly Survey on Inflation and Growth Expectations, conducted between February and March, 86 per cent reported having been affected by higher energy costs, compared to 70 per cent in the previous wave. Estimates by the Bank’s staff,4 exploiting the fact that some firms responded just before the outbreak of the conflict and others just after it, confirm the intuition that the Russia-Ukraine conflict led firms to revise upward their expectations about both HICP inflation and their own prices, and downward their confidence about the near-term economic outlook. Governments in several euro-area countries adopted measures to cushion the impact of surging energy prices on households’ and businesses’ budgets. Italy is one of them. Less affluent households, which have a relatively larger share of consumption devoted to energy, benefitted comparatively more.5 Sizeable funds have also been allocated to supporting gas-intensive companies. While most governments have understandably tried to mitigate the immediate impact of exceptionally high increases in energy prices, I think that it is important to keep in mind that relative prices are a key factor in steering our economies away from fossil fuels and towards renewables and energy efficiency, in the interest of both energy security and climate transition. Looking ahead, it is worth considering measures that would at least partly compensate those who suffer the most from energy price increases, while at the same time preserving as much as possible of the price signal to both households and firms. Prices perceptions/expectations and price setting Agents’ behaviour depends crucially on their inflation perceptions and expectations. Households’ decisions in terms of consumption and savings ultimately depend on real rates. Inflation expectations also guide price and wage formation, and may matter for financing, investment and hiring decisions. As a result, they play an important role in macroeconomic models and other forecasting tools.6 Thus, it is crucial for a central bank to monitor these expectations, as a precondition to be able to influence them when needed. The Banca d’Italia has a long-standing tradition of collecting inflation perceptions and expectations from a variety of economic agents in its surveys. Consumers’ expectations appear to be systematically higher than realised inflation. This upward bias could partly be due to the way data on households’ beliefs are gathered. Well-designed hypothetical survey questions, however, can elicit unbiased answers. In our longstanding Survey on Household Income and Wealth, we use probabilistic questions See Tagliabracci (2022). See Corsello and Riggi (2022) and Curci, Savegnago, Zevi and Zizza (2022). See ECB (2021a). instead of asking for a point estimate, as in the European Commission survey. We find that households provide values that are in line with official releases.7 Concerning firms, in our quarterly Survey of Inflation and Growth Expectations we ask companies to provide point estimates for both nationwide HICP inflation at different horizons, and own selling price changes. We see this survey as particularly valuable because quantitative price expectation surveys for businesses are scarce—a surprising fact, given that firms ultimately set the prices of goods and play a key role in wage setting, either through their associations (collective bargaining), or on an individual basis.8 Concerning property price developments, our Housing Market Survey, conducted quarterly on a large sample of real estate agents, enables us to monitor current and expected house prices, as well as rents, and more generally to follow the main trends of the housing market.9 We also devote considerable research efforts to using price expectations data. Topics include how inflation expectations form, to what extent they are anchored, how inflation expectations influence agents’ decisions (including pricing decisions), and how best to derive estimates of agents’ inflation expectations from market data.10 In 2018, the Eurosystem set up the Price-setting Microdata Analysis Network (PRISMA), with a view to improving our understanding of price-setting behaviour, and gaining new insights into a key element of monetary policy transmission. PRISMA exploits various sets of granular data, including those underlying official price indices such as the Consumer Price Index, as well as scanner data and online prices. Microdata on prices are useful for studying the price-setting process, such as frequency, size and distribution of monthly price changes, a line of research that would not be possible using aggregate indices only. A recent, interesting example of what one can do with such data is a Banca d’Italia paper that singles out those individual prices that change only infrequently. Almost by definition, such prices generally have a lot of inertia, and in fact they had barely changed for years. However, with the recent surge in inflation they are now displaying a distinct, if still moderate, upward trend. (Other prices are much more volatile, and it is more difficult to extract obvious signals from them).11 Another paper based on the PRISMA dataset, on quality adjustment, will be presented in this meeting.12 Let me emphasise in closing that I am mentioning this Network, not only because of the interesting topics it has been addressing, but also because it is a good example of cooperation between national statistical institutes and central banks. Individual price See Rondinelli and Zizza (2020). See Bartiloro et al. (2019), Bottone and Rosolia (2019), Bottone et al. (2022), Coibion et al. (2020), Conflitti and Zizza (2021), Rosolia (2021). See Guglielminetti et al. (2021). See the papers in footnotes 7 and 8, as well as Bottone et al. (2021), Bulligan et al. (2021), Cecchetti et al. (2021), Corsello et al. (2021), Neri (2021), Pericoli (2019). See Conflitti (2022). See Goldhammer et al. (2022). records have now been made available in many euro area countries, and they often cover a significant share of the official indices. A veritable gold mine for price statisticians; and, if I am not mistaken about the growing availability and importance of micro data based on non-traditional sources, just the start of a potential gold rush. *** To conclude, let me thank the organisers from Istat and the Banca d’Italia for putting together such a rich and interesting programme. Let me also reiterate my warmest welcome to all the participants, both to those physically attending and to those following remotely. I am certain that the discussions over the next few days will be very fruitful, and they will enrich us with many new valuable insights. References Aprigliano, V., Borin, A., Conteduca, F.P., Emiliozzi, S., Flaccadoro, M., Marchetti, S. and S. Villa (2021) “Forecasting Italian GDP growth with epidemiological data”, Banca d’Italia, Questioni di Economia e Finanza no. 664. Bartiloro, L., M. Bottone and A. Rosolia (2019) “The Heterogeneity of the Inflation Expectations of Italian Firms along the Business Cycle”, International Journal of Central Banking, 15(5), 175-205. Bottone, M., Conflitti, C., Riggi, M. and A. Tagliabracci (2021) “Firms’ inflation expectations and pricing strategies during Covid-19”, Banca d’Italia, Questioni di Economia e Finanza no. 619. Bottone, M., Tagliabracci, A. and G. Zevi (2022) “Inflation expectations and the ECB’s perceived inflation objective: novel evidence from firm-level data”, Journal of Monetary Economics, forthcoming. Bottone, M., Tagliabracci, A. and G. Zevi (2021) “What do Italian households know about the ECB’s target?”, Economics Letters, 207(C). Bulligan, G., Corsello, F., Neri, S. and A. Tagliabracci (2021) “De-anchored long-term inflation expectations in a low growth, low rate environment”, Banca d’Italia Questioni di Economia e Finanza no. 624. Cecchetti, S., Fantino, D., Notarpietro, A., Riggi, M., Tagliabracci, A., Tiseno, A. and R. Zizza (2021) “Inflation expectations in the euro area: indicators, analyses and models used at Banca d’Italia”, Banca d’Italia Questioni di Economia e Finanza no. 612. Coibion, O., Gorodnichenko, Y. and T. Ropele (2020) “Inflation Expectations and Firm Decisions: New Causal Evidence”, The Quarterly Journal of Economics, 135(1), 165–219. Conflitti, C. (2022) “Sticky and flexible prices: what are they telling us about current inflation?”, Banca d’Italia, manuscript. Conflitti, C. and R. Zizza (2021) “What’s behind firms’ inflation forecasts?”, Empirical Economics, 61(5), 2449-2475. Corsello, F., Neri, S. and A. Tagliabracci (2021) “Anchored or de-anchored? That is the question”, European Journal of Political Economy, 69(C). Corsello, F. and A. Tagliabracci (2022) “Assessing the pass-through of energy prices to core and food inflation in the euro area”, Banca d’Italia, manuscript. Corsello, F. and M. Riggi (2022) “Inflation is not equal for all: Italian inflation by household expenditure”, Banca d’Italia, manuscript. Curci, N., Savegnago, M., Zevi, G. and R. Zizza (2022) “Effetti distributivi dell’inflazione e delle misure governative nel 2021-22”, Banca d’Italia, manuscript ECB (2021a) “Inflation expectations and their role in Eurosystem forecasting”, Work stream on inflation expectations, Occasional Paper Series no. 264. ECB (2021b) “Inflation measurement and its assessment in the ECB’s monetary policy strategy review”, Work stream on inflation measurement, Occasional Paper Series no. 265. Goldhammer, B., Conflitti, C., Rumler, F. and M. Maier (2022) “Is there a measurement bias from quality adjustment in Austria and Italy?”, manuscript presented at the 17th Meeting of the Ottawa group, Rome, June 2022. Guglielminetti, E., Loberto, M., Zevi, G. and R. Zizza (2021) “Living on my own: the impact of the Covid-19 pandemic on housing preferences”, Banca d’Italia, Questioni di Economia e Finanza no. 627. Locarno, A. and R. Zizza (2020) “Forecasting in the time of Coronavirus”, Banca d’Italia, Covid Notes. Neri, S. (2021) “The macroeconomic effects of falling long-term inflation expectations”, Banca d’Italia, Temi di Discussione no. 1357. Pericoli, M. (2019) “An assessment of recent trend in market-based expected inflation in the euro area”, Banca d’Italia, Questioni di Economia e Finanza no. 542. Rondinelli, C. and R. Zizza (2020) “Spend today or spend tomorrow? The role of inflation expectations in consumer behavior”, Banca d’Italia, Temi di Discussione no. 1276. Rosolia, A. (2021) “Does information about current inflation affect expectations and decisions? Another look at Italian firms”, Banca d’Italia, Temi di discussione no. 1353. Tagliabracci, A. (2022) “Perceived macro and micro effects of the Russia-Ukraine conflict: evidence from an Italian business survey”, Banca d’Italia, manuscript.
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Welcome address by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy and President of the Insurance Supervisory Authority (IVASS), at the annual meeting of the Centre for Economic Research (CEPR) - International Monetary Fund (IMF) Programme, Rome, 9 - 10 June 2022.
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Welcome address Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy Annual Meeting of the CEPR-IMF Programme, 09-10 June 2022 It is my pleasure to open the annual meeting of the International Macroeconomics and Finance Group of the CEPR. It is a double pleasure, in that this is the second time this week that I have had the opportunity to welcome people attending an international meeting in person. It is a nice sign that we may finally be going back to some normality after unpleasantly exceptional times. I am also particularly happy because of the very distinguished group of researchers that are gathering today here at the Bank. There are elements of normalisation in the financial and especially monetary arena as well. Obviously, nothing can be the same as before the pandemic, but one hopes that the world’s economies will gradually be able to find a ‘new normal’ after the shock. We still face hard challenges, and the ongoing war in Ukraine, on Europe’s very doorstep, certainly adds to the political and economic uncertainty. I would like to take the opportunity of addressing this floor in order to raise some issues that in my opinion deserve particular attention at the current juncture. Some of them are related to topics that will be discussed during your workshop. The first issue concerns financial stability, and has to do especially with non-monetary financial institutions. The size of the NBFI sector has increased significantly over the last few decades, and together with other developments, such as increased concentration and (possibly) decreased diversity, this may pose novel challenges to policymakers and supervisors. We had been drawing attention to the implied potential risks for years, and in a way we felt vindicated, in the spring of 2020, by an episode of market turmoil that was only contained thanks to massive central bank intervention. International fora, such as the G20 (particularly during our Presidency, in 2021) and the FSB, have been debating the issue; certain steps have been taken; but my feeling is that progress has been too slow so far. This point seems especially relevant in the current environment, where markets are again facing increased volatility and wider credit spreads in a context of high leverage – though to a much lesser extent than two years ago, for what we can see. Research on the effects of monetary policy normalisation on the risk-taking channel for investment funds, pension funds, and insurance companies and on the risk of liquidity stress in markets is, I think, necessary for improving our understanding of how to preserve financial stability in the current context. The second issue is the potential spillover effects of monetary normalisation on emerging markets. The ‘taper tantrum’ of 2013 exposed the vulnerability of emerging markets to tightening global financial conditions. This time, most analysts expect the effects to be more benign, given the increased resilience of some key emerging economies and the favourable (for them) commodity prices, but we do not really know to what extent this might remain a cause of financial vulnerability. There are very good papers in this workshop on global fund flows and emerging markets, on the currency structure of corporate debt, on exchange rates, and on the effects of foreign monetary policy on inflation in emerging countries. It might be interesting to see these issues through the lens of monetary policy normalisation as well. The final issue I would like to mention is the transmission of monetary policy through the lending channel. A tightening of credit standards by banks might amplify the impulse from monetary policy normalisation. One interesting way to look at this issue is to consider the heterogeneity of banks in terms of (say) market power, screening processes, balance‑sheet strength, and possibly other factors. A further aspect that has become increasingly relevant is the role of macroprudential policy. Conceptually, macro‑pru tools have strong complementarities with monetary policy, but we still know too little of the way they work in practice, given the relative novelty of their systematic use. There are excellent papers in the programme, both theoretical and empirical, on the transmission of monetary policy in an environment with heterogeneous banks and on the link between monetary and macroprudential policies. What lessons can we learn about the effects of monetary policy normalisation on the lending channel, and on the interactions between the monetary stance and what we might call the ‘prudential stance’? These are just a few of the many interesting topics that the workshop will address. Others include the impact of multinationals on inflation co‑movements around the world, the role of a safe asset for international financial stability, and the functioning of central banks’ swap lines at the beginning of the pandemic. It is a rich menu; we shall learn a lot. I would like to thank the organisers for their efforts; the presenters and discussants, and the keynote speaker, for their contributions; all of you for being here to take part in this debate. Fostering interaction among researchers is important at all times: it is all the more important in unusual times such as the ones we are living in. I wish you two fruitful days of discussions and exchanges.
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Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the "Analysis: Institutional Forum", Milan, 16 June 2022.
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Inflation and long-term interest rates Address by Ignazio Visco Governor of the Bank of Italy Analysis: Institutional Forum Milan, Thursday, 16 June 2022 I would like to thank Professor Pinardi for his kind invitation, which gives me the opportunity to discuss with you the sudden shift in the economic outlook following Russia’s attack on Ukraine, above all with reference to what is happening on the inflation front, and to how the European Central Bank (ECB) is responding to these changes. Inflation trends in the euro area and in the United States Inflation has been increasing sharply at global level for several months now, following the rise in energy prices on the international markets, especially those for oil and gas. How these price rises came about and how important they are in relation to other factors nevertheless differs widely across countries, in particular if we compare the situation in the United States with that in the euro area. The prices of the two main types of crude oil, i.e. WTI, which is traded on the United States market, and Brent, sold on the European one, have recorded similar increases. Compared with the situation on the eve of the pandemic, both types have doubled in price and are today around $120 a barrel. Generally, there have been bigger increases in the price of gas but while in the United States the price has gone from just under $10 to around $30 per megawatt hour on average in the first half of June, in Europe it has risen from just over €10 to more than €80 per megawatt hour. Furthermore, while in the United States the rise has been gradual, on our continent previously unimaginable highs were reached during the most acute phases of geopolitical tensions: up to €180 in December and, somewhat shockingly, almost €230 in March. These are very significant developments given that the price of gas plays a key role, not only for heating our homes and other domestic uses, for example cooking our food, but also for production of electricity. Another important difference between the two regions of the world regards the economic policy response given in 2020-21 to the pandemic crisis. While almost all countries took fiscal measures on a massive scale to strengthen their health systems and support households and businesses, the measures adopted by the United States were particularly wide‑ranging: over the two years, the debt-to-GDP ratio increased by 25 percentage points, to 130 per cent, against an average increase of 15 points in euro-area countries (this, despite the greater dip in nominal GDP in 2020 and its slower recovery in 2021). The exceptional level of support given in the United States had an unexpected effect on household disposable income which, in 2020, recorded the strongest rate of growth since the mid-1980s, rising to 6.2 per cent, against a drop in GDP of 3.4 per cent. In the euro area, instead, household disposable income actually declined, by 0.6 per cent, though to a lesser extent than GDP (‑6.4 per cent). The United States economy overheated in a phase in which global supply had not yet recovered because of the successive pandemic waves, and this also created bottlenecks for intermediate goods in the international supply chains, with adverse effects on production in many countries. The different trends in aggregate demand between the two regions is reflected in clear differences in their labour markets. In the United States, all the main metrics (average hourly earnings, the employment cost index and the wage growth tracker calculated by the Federal Reserve Bank of Atlanta) do in fact indicate wage growth that is clearly above 5 per cent. On the other hand, in the euro area the growth in negotiated wages stands at around 2 per cent, even if there is no lack of calls for bigger increases. The moderate wage growth is the result of persistently ample margins of idle capacity in the euro area, where the number of hours worked has still not returned to pre-pandemic levels, and of the low level of vacancies, indicating the absence of an excess of labour demand. In the face of these trends, consumer price inflation has progressively accelerated. Both in the United States and in the euro area, inflation peaked in May at 8.6 per cent and 8.1 per cent, respectively (the second figure is based on a still preliminary estimate). However, the trend of the core inflation index, excluding food and energy products, was different: in the United States, it was equal to 6 per cent in May (after peaking at 6.5 per cent in March), whereas in the euro area it was below 4 per cent. The inflation forecasting errors On the basis of these considerations, the Eurosystem estimates that inflation, also taking account of the preliminary assessments of price growth in May, will be around 7 per cent on average this year. In 2023, inflation is already expected to settle at a considerably lower level, falling to around 3.5 per cent, before returning to around 2 per cent in 2024. These projections are subject to a high degree of uncertainty, as the most recent developments also suggest. Indeed, in the last two quarters, the forecasting errors made by the ECB and by the Eurosystem’s staff were much higher than in the past. Our analyses indicate that the direct effects of the forecasting errors relating to energy prices – which are the main exogenous variables, whose changes are inferred from the prices of futures contracts – explain over 60 per cent of the overall error made in forecasting inflation; the share rises to 80 per cent when indirect effects are also taken into account (e.g. those on sectors such as transport). These results confirm the validity of the models used, though they draw our attention to the quality of the forecasts employed as inputs, which include, among others, in addition to energy prices, developments in world trade. There has undoubtedly been a general underestimation of the effects that the excess demand in the United States, particularly in the durable consumer goods sector, would have on the rest of the world via energy prices and, together with the impact of the measures adopted to counter the pandemic, via supply chain bottlenecks. Even more significant, however, has been the underestimation of the geopolitical tensions, with the sharp drops in gas supplies from Russia – observed as early as the beginning of last year – attributed first (and probably mistakenly) to the cold winter in that country and then to pressures by the Russian Government in connection with the Nord Stream 2 pipeline. But the most important factor has, of course, been the outbreak of the war: while the prices of futures had continued to predict descending oil and gas prices up to the end of last year, the conflict has left not only current but also expected prices at very high levels. The repercussions of rising energy prices for inflation, which were therefore to be considered as temporary owing to the widespread expectations of base effects soon turning negative, instead became more persistent. The risks of a de-anchoring of inflation expectations and of a price-wage spiral The worsening of the terms of trade and the loss of purchasing power caused by rising energy prices will tend to hold down final demand in the euro area, moderating the pressure on prices. However, the risk that long-term inflation expectations rise to levels that are not consistent with the ECB’s definition of price stability, as well as that of a price-wage spiral, must be monitored closely. Today, inflation expectations over the longer-term forecasting horizons do not diverge significantly from 2 per cent. The most recent forecasts of the main international institutions and private analysts concur with those of the Eurosystem in indicating that price growth in the euro area will remain high this year and then fall decisively in 2023, later returning to levels of around 2 per cent; the prices of financial assets linked to consumer prices confirm the anchoring of long-term expectations. We are aware of the fact that an assessment of the risk of a de-anchoring of expectations from the inflation aim based exclusively on their current level would be dangerous. Given that economic theory and historical experience show that a de-anchoring could occur abruptly and in a non-linear way, it is crucial to consider carefully the risk that long‑term inflation expectations could rise suddenly. Expectations must therefore be assessed not only in terms of their long-term convergence towards the price stability objective, but also based on their responsiveness to shocks and their dispersion. Indeed, these metrics provide indications of how firmly the expectations are anchored. As regards their responsiveness, the expectations obtained through surveys and from financial assets linked to consumer prices continue to show a relatively low sensitivity to macroeconomic surprises, including those regarding inflation. The dispersion of expectations relating to price growth also remains moderate overall: in fact, the ECB’s Surveys of Monetary Analysts indicate that a high and growing share of those interviewed expect inflation in the euro area to be in line with the 2 per cent objective in the long term. Deviations from that level, including small ones, are only expected by a minority of respondents. As I said, the possible triggering in the area of a price-wage spiral is a second risk, which is not independent of the first risk, and which must be monitored carefully. While wage dynamics in the euro area have so far remained moderate, it would be imprudent to observe current developments without asking oneself what might happen in the future. In this respect, several reasons lead to the conclusion that a price-wage spiral is less likely than it was in the past. It is also worth clarifying that wage increases requested and granted on the basis of changes in productivity – and in any case where the profit margins make it feasible – do not create problems on the inflation front. Instead, wage increases aimed at mechanically – or rather, automatically – keeping up with price increases serve no purpose, as they trigger, in turn, further rises in inflation. First of all, nowadays, monetary policy is transparent in its goals and credible, as shown by the resilience of inflation expectations. Secondly, aggregate demand in the euro area remains relatively weak, and a significant recovery over the next few months seems improbable. In addition, the structural characteristics of the labour market, especially the differences in the salary indexation mechanisms, make price-wage spirals less likely. Finally, the single currency itself lowers the odds that any accelerations in prices could lead to marked depreciations of the euro exchange rate, which in turn would fuel further increases in wages and in inflation. The monetary policy response The normalization of the ECB’s monetary policy has been underway since last December when, given the progress made in economic recovery and in the convergence of expectations towards the inflation target, the Governing Council announced the start of the reduction in net financial asset purchases. This process was accelerated in the early months of this year: having concluded the purchases under the pandemic emergency programme at the end of March, and despite the greater downside risks to growth caused by the Russian invasion of Ukraine, the steady increase in current and expected inflation has led us to bring forward the end of net purchases under the asset purchase programme to the beginning of July. In early June, the Council also announced that the key interest rates – with that on banks’ deposits with the Eurosystem being exceptionally negative – will be increased by 25 basis points in its July monetary policy meeting and that, if the medium‑term inflation outlook persists or deteriorates, a larger increment could be appropriate in September. A gradual but sustained path of further increases in the key interest rates will continue after that date, but its pace will depend on incoming economic and financial data and on how they will alter our assessment of the medium-term outlook for prices. In this regard, one trend that we are continuing to monitor very closely is expectations regarding the future movements of official rates: in recent days, the short-term real interest rate curve shifted sharply upwards, signalling widespread perceptions of a particularly hawkish stance on the part of the ECB; this perception is not, in my view, warranted, given the attention we will continue to pay to the evolving cyclical outlook, which continues to be highly uncertain. The increase in short-term interest rates has accentuated the rise, underway for some months now, of long-term rates, which play a key role in the economic activity of firms and households. Compared with the first ten days of December, on the eve of the change in monetary policy made by both the Federal Reserve and the ECB, the 10-year interest rates rose by 185 basis points in the United States, by 200 in Germany and by 230 on average in the euro area. It seems difficult to reconcile the relative size of these rises with a situation in which core inflation in the euro area is more than 2 points lower than in the United States and wage growth is over 3 points lower. This is therefore a development that we will have to monitor carefully in the coming months to ensure that financial conditions do not tighten excessively, including a disproportionate increase in long-term interest rates, also considering, if necessary, a recalibration of the path of increases in the key interest rates, which is not predetermined but depends on the evolution of the economic and financial situation. The pace of monetary policy normalization has to balance two risks. If it is too gradual, inflation could become rooted in expectations and in wage-setting processes, with the risk of compromising the credibility of the central bank and forcing it to adjust its stance, with more marked repercussions for economic activity and employment. On the other hand, if the pace is too fast or its announcement wrongly interpreted, markets could overreact and the tightening of financial conditions could be stronger than necessary, with risks to financial stability, economic activity and, ultimately, price developments, which have only recently been forecast to reach 2 per cent in the medium term. If on the one hand, abandoning the policy of negative key interest rates can no longer be precluded, on the other hand, I believe it to be crucial that, as announced, the normalization of monetary policy continues in a gradual fashion, and with great attention paid to the uncertain evolution of the economy and of financial conditions. Only in this way will we be able to preserve and consolidate the wealth of credibility that we have built up over time. The risk of market fragmentation in the euro area On top of its vulnerability to the risk of general financial tensions, the euro area, being a monetary union, is exposed to the equally dangerous risk of unjustified capital market fragmentation along national borders. This possibility, which has arisen in the past, is amplified by the incompleteness of the European Union. It is a risk that does not concern only those countries that it affects, but that, given the economic and financial interconnections between Member States, may rapidly reverberate throughout the euro area. Fragmentation leads to many serious problems from an ‘operational’ standpoint. In fact, it hampers the proper and homogeneous transmission of monetary impulses to all countries and, in this way, makes it impossible to pursue price stability for the area as a whole. As early as last December, the Governing Council stated that flexibility in the use of its instruments would remain a key element of monetary policy whenever there are threats to monetary policy transmission. President Lagarde clarified that this included the possibility of deploying existing instruments or introducing new ones to prevent the risk of market fragmentation within the euro area from materializing. The pandemic in particular confirmed that, under stressed conditions, flexibility in the design and conduct of financial asset purchases successfully countered the impaired transmission of our monetary policy, making our efforts to stabilize the economy and inflation more effective. In recent months we have witnessed a progressive materialization of the risk of market fragmentation. The marked increase in the spreads on Italian and Greek government bonds as well as, to a more limited extent, in other euro-area countries, is a cause for concern. These are tensions that do not appear to be explained by the changing macroeconomic outlook. For Italy, especially, our analyses indicate that a spread between the yields on Italian and German ten-year government bonds of less than 150 basis points would be justified by the fundamentals and, in any event, levels above 200 basis points would not. In recent weeks, the widening has intensified, accompanied by a progressive increase in market volatility. It is in light of these developments, in many ways unjustifiable, that we must view the decision, taken only yesterday, by the ECB Governing Council to apply flexibility under the Pandemic Emergency Purchase Programme (PEPP) and to ask the Eurosystem committees to accelerate the completion of the design of a new anti-fragmentation instrument. The first instrument – which takes advantage of the opportunity to flexibly reinvest the assets held under the PEPP – is already part of the monetary policy arsenal. Its use at this time is fully justified. Much of the tension dragging on the economy has sprung from the effects of the pandemic crisis: from the mismatch between supply and demand, which creates procurement problems and fuels inflation, to the sharp rise in national public debt, to the need to normalize monetary conditions which had become extremely accommodative in order to address the most acute phase of the crisis and to stimulate the recovery. The war in Ukraine has also caused GDP growth to fall compared with what had been expected based on the boost given by the NGEU programme, conceived precisely as Europe’s response to the effects of the pandemic crisis. The second instrument, currently being designed, will serve to increase – and to lay lasting, solid foundations for – the ECB’s capacity to ensure that the impact of monetary policy is as uniform as possible across the entire euro area. I would like to clarify two aspects of this decision and these instruments. First: their aim is purely one of monetary policy, intended to facilitate the pursuit of price stability; they have no other purpose, much less that of financing imprudent and unsustainable fiscal policies. Second: the gradual normalization of monetary policy and the action taken to fight fragmentation are fully complementary. The former cannot proceed in an orderly fashion without the latter; in order to defend the appropriate monetary policy stance, we must prevent malfunctions or interruptions in its transmission mechanism. * * * I am convinced that the ECB’s determination will also contribute to restoring order to the markets. This will help investors to more carefully and accurately access the real condition of our economy. Looking ahead, there are clear signs of improvement. The debt-to-GDP ratio is falling and, according to the European Commission’s most recent assessments, it will continue to decrease this year and next. Thanks to the high average residual maturity (close to 8 years), the average interest rate on government bonds should remain lower than the nominal GDP growth rate, while interest payments should stay low in the coming years as well. The net international investment position is positive; Italian producers are successfully competing on export markets; household debt is the lowest among the main countries of the European Union and that of firms is below the average; conditions in the banking sector have improved in terms of the volume of non-performing loans and profitability, while capitalization, though down a little on last year, remains at high levels. Today it is up to us to maintain and build on the strengths of our economy and keep the public accounts under control. In emergency conditions, financing current expenditure with deficit spending may make it possible to focus more carefully on the need for social justice and on protecting those who have been hit particularly hard by the crisis and by the changed situation. Budgetary deviation is a macroeconomic stabilization tool, but it cannot become the norm: a high and persistent deficit is not sustainable, it inevitably translates into an increase in the debt-to-GDP ratio. The way to achieve lasting progress is through economic development, enhancing the skills of the labour force and investment. Considerable progress can be made through the investment programmes and the reforms envisaged by the National Recovery and Resilience Plan. The NRRP provides enormous funding for goals that must undoubtedly be shared across the political spectrum, namely accelerating the ‘twin’ green and digital transition, providing greater support for education and research, and remedying the development lags in the South. The nation is on the right path: our success in completing the main investment programmes, which are now all in the start-up phase, and the related reforms, which are not ‘dictated by Brussels’ but are in our own interest, will be essential to strengthen the growth potential as well as to counter the risks, including of a financial nature, determined by heightened global uncertainty. The European Union continues to be a vital resource for our country. This has been clearly proven by the show of solidarity during the pandemic, including through a number of concrete decisions, by the European institutions, by the leaders and by the peoples of the Member States. There are no enemies in Brussels, let alone in Frankfurt. The fears and prejudices that surfaced with the double crises of the last decade must be definitively rejected. We must engage in dialogue and take decisions consistent with the path that we have forged together towards an innovative and more sustainable economy. We must do this in order to overcome the uncertainties and the problems posed by this very difficult economic situation; it is essential in order for us to be able to face the challenges, in many ways totally unexpected ones, that we find before us at the global level.
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Speech by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy, at the Centesimus Annus Pro Pontifice Foundation, Venice, 11 June 2022.
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Sustainable investment choices: emergencies and transition Speech by Luigi Federico Signorini Senior Deputy Governor of the Bank of Italy Centesimus Annus Pro Pontifice Foundation Venice 11 June 2022 Καὶ τὸ τρίτον τῆς γῆς κατεκάη, καὶ τὸ τρίτον τῶν δένδρων κατεκάη, καὶ πᾶς χόρτος χλωρὸς κατεκάη. A third of the land was burned up, along with a third of the treesand all green grass. Revelation 8:7 Your Most Reverend Excellency, Ladies and Gentlemen, A few months ago, when, at the kind insistence of your Chair, I accepted the invitation to take part in this event, the topic I had indicated was ‘Climate transition: the role of finance and of financial supervision’. Times have changed. Over the last hundred days, we have seen the horrendous daily spectacle of indefensible aggression and war play out before our very eyes. We have seen, albeit from far away (now that every part of the world is, whether it likes it or not, an eyewitness to what happens in every other part of the world), human suffering and material destruction on a scale that we no longer believed was possible in Europe after the days of Sarajevo and Srebrenica. The economic consequences of the conflict, while indirect, have been felt here at home too: a slowdown in GDP, a surge in prices, and supply chain insecurities. I therefore felt it necessary to change the topic of this conversation as well so that it better reflects current developments. And you will forgive me for also choosing to add a verse from Revelation as an epigraph, to symbolise the anxieties of today and tomorrow. Indeed, the emergency situation of the last few months has blended with the emergency of the century – climate change and the need for a transition towards sustainable development. If the Book of Revelation speaks of the mystery of the end of time to a believer, to a secular person the verse that I have quoted serves as a dramatic and quite literally effective reminder of the challenge threatening humanity and the planet, its ‘common home’, for which it must care.1 Provided we are farsighted in discerning the ends, and wise in choosing the means, a reaction is possible and, therefore, necessary. Contrary to what is often heard, the consequences of the war, especially the issue of energy supplies, must not cause us to stray from the charted course – or at most only for short stretches. They should actually strengthen our resolve to walk this path to the very end. If sound individual and collective choices are made, the economy and finance can prove to be powerful instruments for leading us forward. I shall try to tell you what criteria economic policy choices should follow, in my opinion. But I would like to start with a brief outline of the current situation. Given the limits to my knowledge, the point of view of this speech will be above all ours, that is to say Italian and European. I shall defer to another occasion – should it arise and should I feel able to seize it – to elaborate on how the perspective that I put forward could be extended to the rest of the world, above all to those ‘peoples and countries which have little weight in the international market, but which are burdened by the most acute and desperate needs’.2 The economy during the emergency Global imbalances between supply and demand are subjecting energy prices to pressures not seen since the 1970s. In May of this year, oil prices in the world markets rose by 65 per cent year-onyear. In Italy, electricity and gas prices in the wholesale market had more than doubled. There were similar trends in other European countries, which share our dependence on Russian gas. While fossil fuel prices have risen everywhere, the rise in gas prices was less pronounced in the United States, though it has been accelerating in the last few months (with year-on-year increases of 53 per cent in February and 175 per cent in May). These developments, which stem from the difficulties that fossil fuel supply is encountering in keeping up with the rapid growth in demand following the exit from the pandemic crisis, were exacerbated by Russia’s invasion of Ukraine and the resulting fears of a contraction in the world supply of energy commodities. Russia is one of the world’s main producers of hydrocarbons: in 2020, it accounted for 17 per cent of the supply of natural gas, 12 per cent of crude oil, and 5 per cent of coal. Following the outbreak of the war, the economic outlook has worsened, although the vigorous growth recorded in Italy in 2021, which intensified progressively, ensured that 2022 started at a relatively high level, and the economic system has so far shown considerable resilience. Based on the latest data, another very small increase was recorded in the first quarter. So what will happen next? At a time like this, making predictions is even harder than usual. In April’s Economic Bulletin, in the Annual Report published at the end of May, and in the recently released projections conducted as part of the Eurosystem coordinated exercise, the Bank of Italy formulated scenarios – updated as the situation evolved – based on developments in Ukraine. The most optimistic scenario in April’s Economic Bulletin assumed a rapid conclusion to the conflict, which unfortunately did not materialise. The central scenario formulated at the time and its successive refinements continue to project positive growth in both 2022 and 2023. Compared with the prewar forecasts, however, the new growth projections are down by almost 1 percentage point per year. A more adverse scenario takes into consideration a temporary interruption in the flow of natural gas from Russia, to be offset only in part by other sources: the impact on GDP is projected to be significant, and activity in some very energy-intensive sectors could be affected by interruptions in production. The sharp acceleration in imported fuel prices has considerably widened the deficit in the energy balance of the balance of payments, which in turn led has led to a worsening in the current account balance. For now, the energy balance deficit remains smaller than in the early 1980s.3 In any case, the strong positive net international investment position that Italy has built up over the last decade, thanks to the enhanced international competitiveness of its production system, means it is less vulnerable than in that earlier period. The impact of the crisis on prices instead remains significant. Inflation, measured according to the EU’s harmonized definition, exceeded 8 per cent in the euro area and 7 per cent in Italy in May. The dynamics of energy prices directly account for about half the change in the consumer price index observed since the beginning of the year.4 However, it also pushes the prices of other goods upwards, owing to the energy costs incurred by firms across all sectors. Medium-term inflation expectations, both those obtained through surveys and those implied by market trends, are largely consistent with the Eurosystem’s objective for the time being, but they have increased, and are the focus of intense scrutiny. Italy’s energy supplies and the measures adopted Russia is Europe's main hydrocarbon provider. In 2021, the European Union’s imports from Russia accounted for 27, 40 and 46 per cent of its total consumption of crude oil and other petroleum products, of natural gas and of coal respectively.5 Italy’s dependence on Russian gas (39 per cent) is in line with that of Europe; that on Russian coal is higher still (56 per cent), but coal plays a limited role in the energy mix of our country.6 Gas instead meets 52 per cent of residential demand (mainly for heating) and 84 per cent of thermoelectric power generation, i.e. 50 per cent of total electricity production.7 The impact on the energy costs borne by final consumers, and particularly on poorer households, is therefore greater than for countries with a more diversified electricity production mix. A complete interruption of Russian exports to Italy would mean substituting about 30 billion cubic metres of gas every year (just under half of the country’s total imports) by relying on other providers. Alternatively, it would mean reducing demand, which is dominated by thermoelectric power generation (44 per cent) and, for the remaining part, is divided almost equally between residential and non-residential uses (the latter encompassing both industry and services) Most Russian gas comes to Italy via pipelines and is therefore difficult to replace. Importing gas by sea, which is more flexible, requires regasification plants, of which there are currently not many. The Government is trying to increase both the supply of gas from other providers linked by pipelines (Algeria and Azerbaijan) and Italy’s ability to import liquefied natural gas from Qatar, Egypt and, in the longer term, the Republic of Congo and North America, by building new floating storage and regasification units, which are easier to make operational compared with land-based terminals.8 Moreover, some coal power plants could be reactivated, reversing the decision to close them all down by 2025. In the longer term, this would also be accompanied by an increase in the number of renewable energy power plants.9 In addition, as early as the second half of 2021, the Government adopted measures to limit price growth by reducing excises and other measures specifically targeting vulnerable households (e.g. by increasing the amount of ‘energy bonuses’ to be paid and expanding the range of those eligible for them). To contain demand, temperature limits for air conditioning and heating have been set for public buildings, although they are not always easily to implement and check. More drastic provisions to reduce demand have not been adopted for now, such as those proposed by the International Energy Agency (IEA) in April.10 Such measures include stepping up the use of remote working, limiting air travel, and also measures reminiscent of those adopted after the first oil shock (reduced speed limits on motorway and car-free Sundays11). What to do now There are four objectives: reducing the excessive dependence on energy supplies; mitigating the financial consequences of rising energy prices on households and firms, especially the most vulnerable ones; averting inflation; and doing all of the above while, as far as possible, staying the course on the climate transition. Climate transition, emergencies and energy security Let us begin with the latter, which remains the fundamental compass for steering medium-term action. I believe I am preaching to the choir when I say how important this is. The environmental, economic and human risks linked to rising temperatures are well known, and it is not an issue that can be deferred to future generations.12 We have recently been reminded of the urgency of taking action by, among other things, the extreme heat wave that hit vast areas of India and neighbouring Pakistan in March and April, exposing more than one billion people to temperatures well above 40°C, with the hottest part of the year still to come. Even though our climate is more temperate, the rising trend in the temperatures of our major cities, borne out by Istat data, is easily confirmed by our daily personal experience.13 To counter the rise in temperatures due to the greenhouse effect, humanity must reduce net greenhouse gas emissions, first and foremost those of CO2. Ever more ambitious and binding objectives have been proclaimed over the years at European and international level.14 To achieve them, three elements are necessary: well-designed rules, targeted (public and private) investment decisions, and consumption choices consistent with these goals. Underpinning all this, in a country based on a democratic system and a market economy, is an awareness of the problem on the part of citizens and consumers, ‘a growing ecological sensitivity’,15 without which the right incentives cannot be created, either for public authorities or the private economic system.16 The investment needed must be borne largely by the private sector, on account of both the amount, which is presumably well above the public sector’s spending capacity, and of the tendency of market mechanisms to promote its efficiency. Hence the question of ‘green’ finance and the rules needed to make it a reality, the original topic of my talk (which has in any case been addressed by other speakers here today). About this I will only say, very briefly,17 that ‒ in addition to investors’ acceptance (and there seems to be no lack of this, given the rapid development of ‘green’ investment instruments in recent years) ‒ for environmental finance to expand in a sustained manner, access to data of sufficient quality (taxonomies, audits and so on) is essential; the lack of it would undermine efficient selection and lead to a considerable risk of greenwashing. It is also important that banks and institutional investors become aware of the need to manage environmental risk effectively, among others. Efforts are being made on both fronts, especially at European level.18 Let me make an observation on this point, however, that I think is fundamental. In a market economy, even more than taxonomies and prudential rules, what really counts are relative prices, a key tool for allocating resources efficiently. As is now widely acknowledged, it would be quite difficult for a transition strategy to work without carbon pricing: without, that is, incorporating into the price of fossil fuels the damage that they cause to the ‘common good’,19 i.e. in economic jargon, the negative externalities associated with their use.20 Rendering human activity ‘climate neutral’ ‒ a prerequisite for limiting the temperature increase to 1.5-2°C, pursuant to the solemn commitment made with the signing of the Paris Agreement21 ‒ means setting prices that encourage a more efficient use of energy, and, in particular, choosing a relative price that makes fossil fuels less affordable than alternative fuels, thereby favouring the development of low-emission technologies. We would ideally like carbon pricing to follow a gradual and predictable path, the result not of exogenous and unpredictable factors, but rather of explicit economic policy decisions (rates, grants, market rules), carefully evaluated, credible and (not least) consistent at global level. A gradual and predictable path will make it easier for investment and consumption decision makers to further the transition. A fiscal component (which is only one of the possible ways to achieve carbon pricing22) is useful for redistributing the cost of the transition and mitigating its impact on households, firms and the worst affected areas.23 Global cohesion is important in order to avoid unfair competition and the leakage of emissions from one jurisdiction to another: carbon knows no borders. Clearly, we cannot realistically wait for anything but an imperfect approximation of the ideal path I have outlined: this must not distract us from our goal, but should rather make us aware of the obstacles to be overcome. In particular, there have been numerous experiences of how difficult it is to reach a global agreement; not even in the course of Italy’s G20 Presidency, during which a great deal of progress was made nonetheless,24 was it possible to reach agreement on a series of specific and detailed measures. Hence the proposals for a ‘climate club’ composed of those countries most determined to proceed, for countervailing duties at the borders, and other similar measures. Nor can we forget that it is a lot to ask of any system of government, democratic or otherwise, to make a credible commitment for decades to a strategy that in theory offers great long-term advantages but, by considerably raising prices, could prove to be unpopular in the short term. All the more reason, bearing in mind that the same optimal price, that which correctly incorporates the externalities associated with emissions is subject to uncertainty in its calculation, while the technical instruments to achieve it give rise to differences of opinion, and it is therefore inevitable that we will have to move forward, at least in part, by trial and error. This already complex situation was made even more difficult by the sudden, sharp rise in fossil fuel prices between 2021 and 2022, following the economic and political tensions with which we are all familiar. A rise that was neither desired nor foreseen, and certainly not ‘optimal’ in its timing, manner or extent, and with such a heavy and unexpected impact on households and firms. Various governments, including Italy’s, have taken action to mitigate the immediate effect on citizens’ well-being. Energy services are, in many respects, a primary asset; an increase in their prices weighs more heavily on the budgets of less well-off households, exacerbating ‘energy poverty’;25 and, in any case, it is not easy to adjust for in the short term. This latter point is also true for energyintensive companies, which, in the face of a shock that impacts different economies asymmetrically, would find themselves, in the absence of any relief, having to tackle at least a temporary crisis of competitiveness. With all this, it would be rather short-sighted not to recognise that the price shock, along with uncertainties concerning supply chain security, is triggering a reaction that, in a more or less short space of time, could result in energy savings and/or a conversion to alternative resources. Raise your hands those of you who, if you have had the chance to, have not thought in recent weeks about reducing your future consumption of fossil energy sources at home or in the office, for example by installing solar panels or using other renewable sources? How much will be saved and how long it will take, we do not know; but it would be surprising if the effects were insignificant. In the years following the two great oil shocks, Italy became one of the most energy efficient countries in the OECD: between 1970 and 1995, the energy intensity of Italian GDP fell by almost 30 per cent. After the exogenous shock, energy prices remained high in Italy, in part due to it having among the highest taxes on energy products in the EU.26 The prices were a key signal for improving energy productivity, which had stalled prior to the oil crisis.27 There are certainly some differences between now and then; among other things, the energy component of GDP has continued to fall over the last thirty years, in part due to the growth in services to the detriment of manufacturing; moreover, at this moment in time, we do not know how permanent the increases that we are experiencing will be. The example of the 1970s cannot therefore be interpreted as a qualitative estimate of the possible effects of the current shock. However, there are also more than a few similarities; qualitatively speaking, the effects could be considerable. All this, provided that it is recognised that, aside from emergency measures taken to smooth temporary ‘bumps’, public intervention aimed at mitigating the effects of the crisis should, more than it already has, take the form of income relief for those most affected and of support for the transition, rather than fighting price increases. We must certainly help those in difficulty, but we should also leave the signal of relative prices to function to the extent reasonably possible, just as we essentially did in the 1970s. We must also remember, and we should remind the public, that in order to achieve the climate transition goals, fossil fuel prices still have to rise, and rise a lot, no matter how much the estimates of the exact end point may vary. This action must be accompanied (as we have already started to do) by every possible incentive, including regulatory ones, to turn to alternative sources, with a view both to accelerating the transition and making it affordable for everyone. Looking ahead, it would be good to help households that are or are at risk of being in a situation of energy poverty, not by offering permanent subsidies for the use of fossil energy sources, but by giving them a real opportunity to reduce energy waste and switch to renewable sources. It is not an umbrella to shelter ourselves indefinitely from higher carbon fuel prices that we need, but rather a sturdy pair of boots for making the leap towards decarbonisation as soon as possible. Mitigation actions are also limited by the need to keep the public finances stable. All the more reason to avoid generalised relief and focus on subsidies for those who really need them. The climate transition strategies and those for eliminating energy dependence do not conflict with one another; on the contrary, they are mutually reinforcing as they both presuppose a sharp decrease in the use of fossil fuels and a sharp increase in renewable energy. The only exception to this convergence of goals could be a temporary increase in the use of coal, the most polluting of the fossil energy sources. It may be an acceptable compromise if limited to the short term: ‘until greater progress is made in developing widely accessible sources of renewable energy, it is legitimate to choose the less harmful alternative or to find short-term solutions’.28 Some economists fear that an increase in the consumption (and the price) of coal may encourage excessive future investment in this form of energy production, which would then affect future choices. We must certainly be careful to avoid any conduct, especially public conduct, that pushes us in this direction; but, all things considered, it seems to me an unlikely scenario. That coal is considered unsustainable in the long term, also because of its serious effects on local pollution, is something we all know; it is therefore difficult to believe that substantial long-term private investment in this sector can be decided on the basis of expressly, credibly temporary measures. Prices and inflation The 1970s saw a marked reduction in the energy intensity of GDP, but also a period of high and variable inflation, which did not abate for many years and only with great difficulty. Inflation is in the headlines again at the moment, after several years of being seemingly moribund, and households are beginning to feel its effects. Do we need to push the analogy with those days to the point of believing that a hike in the inflation rate is inevitable? Not at all; but two clear conceptual distinctions are required, as are consistent choices. The first distinction is between relative and absolute prices. The energy transition calls for an increase in the relative prices of fossil fuels; the general level of prices is (at least as an initial approximation) entirely indifferent. In fact, the increase in fossil fuel prices is actually leading to generally higher prices: in part (as I said at the beginning) directly, because of the proportional impact of energy prices on the general index, and in part indirectly, through the sectoral interdependencies in production, which mean that energy prices are incorporated into the cost of products that use energy as input, and the increase thus spreads to other components of the index. So? Here we need the second distinction, between a one-off increase in prices and prolonged inflation. We need to start from the point set out very clearly by the Governor in his Concluding Remarks a few days ago. The external rise in energy prices is a kind of ‘unavoidable’ tax that weighs on the economy of importing countries, technically through a worsening in the terms of trade. The Governor said that ‘government action can redistribute the effects of inflation between households, factors of production, and present and future generations, but it cannot wipe out the overall impact’. For this reason, this tax is reflected in a one-off increase in price levels; given the same nominal income, everyone comes out poorer. Inflation would be unleashed if, under the illusion of being able to recoup at individual level the purchasing power that the community as a whole has lost, everyone (households, firms) tried to redefine their nominal income from time to time, thereby causing what the Governor defined as a ‘pointless wage-price spiral’ while talking about European monetary policy. Pointless, because by impacting firms’ costs, also affected by higher energy costs, a wage increase would in turn spark a new round of price rises, and vice versa, in a symmetrical way. There is a risk that this process, once started, will not stop. The experience of the 1970s shows that prolonged inflation is not an unavoidable consequence of an external shock to input prices. It is what happened in Italy at that time, because we were unable to protect ourselves against the monetary illusion. It was different in other European countries, and the effect of the oil shock seemed more like a one-off increase in prices than the triggering of an inflationary process that was then difficult to tame.29 We must build on that experience, both because of what it teaches us to do because we did it right (letting the mechanism of relative prices work) and because of what it teaches us not to do (unleash a ‘pointless spiral’). The premises are there. One thing that needs to be considered in the specifically Italian context is that, unlike then, wage negotiations now use inflation forecasts calculated net of the effect of energy goods (the ‘unavoidable’ tax) as a parameter, thereby reducing automatic mechanisms; as the Governor stated, the protection of the most vulnerable can and must be compatible with maintaining price stability. The medium-term inflation expectations are still close to the target of European monetary policy, but they are growing, and require our attention. Nowadays, monetary policy not only has its traditions of independence, but also institutional guarantees for that independence, intended to pursue price stability, explicitly as their first objective. It has now left behind those long drawn-out periods when deflation was the enemy. It cannot do anything about the increase in the prices of energy commodities that comes from outside, but it must take care that the risk of a one-off growth in prices does not turn into an inflationary spiral. Here I refer again to the Concluding Remarks: ‘the economic outlook has therefore changed […] the negative key rates policy can now be left behind … The Governing Council stands ready to adjust all its instruments to pursue its medium-term inflation aim’. The four objectives I have set out (energy security, mitigating the effects of the crisis, monetary stability and climate transition) can therefore all be pursued at the same time, as long as the collective choices are well thought out. *** Ladies and gentlemen, The challenge posed to humanity by climate change is immense, and requires a response at planetary level. There are many and varied instruments to be used to meet it. In this conversation, as befits my profession, I have given you some arguments of an economic nature to consider and judge. Others have made technical, administrative and corporate contributions. Nevertheless, I believe that none of us are under the illusion that the problem can be solved at a purely technocratic level. The natural laws, those laws in which the legal system is embedded, and also the laws of economics, albeit far less precise, cannot be ignored; and yet, especially in an open society such as ours, the essential prerequisites for effective and long-lasting action are, above all else, the awareness and willingness to act of civil society: of citizens, voters, consumers, investors and those who influence public opinion. Today I have responded to the invitation of an association that is inspired by the social doctrine of the Catholic church. For the broad swathe of humanity that identifies with religious principles, the teaching of those who interpret them is of enormous importance in shaping shared values; by which in turn, in the ways and forms of every religious tradition, it is influenced.30 The Holy Father made his authoritative voice heard in the Laudato si’ encyclical, which is cited here several times. Among other things, I was struck by its references to the teaching of exponents of other denominations and religions, especially Patriarch Bartholomew.31 The emergence and consolidation of an active concern for the fate of the ‘common home’ is not confined to the Christian religion, nor is it limited to the Abrahamic religions (Judaism and Christianity always have to contend, among other things, with the Biblical mandate to ‘subdue the earth’,32 and with the need to understand this expression differently from twenty-five or thirty centuries ago, when it was impossible to conceive of a ‘subduing’ of creation that would seriously call into question its equilibria33). To give a completely different example, the strengthening of an ‘ecological’ vision of the world has certainly been no less natural in the Buddhist tradition, which does not place man at the heart of a divine project, but more strongly emphasises the links with other living beings and nature as a whole (esho funi, the non-duality of life and its environment, ‘two but not two’).34 Each in their own language, religions put the emphasis above all on a personal ‘conversion’35 or ‘enlightenment’.36 As I said, widespread awareness is essential; society as a whole will not change its course if the tiller of its people does not move. Yet this is not enough. For the individual approach to trigger incisive collective action, collective tools are required. There are two main pathways: politics and economics. It is not my place to talk about the former. As regards the latter, I notice that religious figures who proclaim the need for a social good sometimes view the market with a certain diffidence: ‘When nature is viewed solely as a source of profit and gain, this has ... serious consequences for society’.37 What then is left? The integrity of personal conduct, ‘giving things up’ and ‘sobriety’.38 Without taking anything away from the moral and social value of responsible individual behaviour, I believe that, in order to respond to the challenge of our society, it is useful, indeed indispensable, to leverage market forces as well. The market is a means, not an end. It has no ‘vision of nature’; it should be neither hypostatised nor ‘idolised’.39 We are the market, we consumers and entrepreneurs; its values are ours. It has laws that should not be cast aside if we truly want to pursue the common good; yet at the same time it represents a method, the least imperfect that has been invented so far, for allocating resources based on individual preferences, as well as on the rules and incentives instituted by the State.40 It responds powerfully to the price system and it should be exploited.41 Just as the opening of the emerging countries to the market economy (the Governor recalled this a few days ago, somehow echoing, if I may say so, the Centesimus annus42) has made it possible for humankind to take giant steps towards ‘eliminating poverty’,43 wise and farsighted policies for tackling the new challenge of the century should see the market as a powerful ally to be recruited, not as an adversary to be defeated. Thus, in answer to the noble-minded appeal ‘that we may protect the world and not prey on it, that we may sow beauty, not pollution and destruction’,44 we can give an increasingly effective response, thanks to the work of willing men and women. ------------------------------------------- Notes 1. Encyclical letter Laudato si’ of the Holy Father Francis on care for our common home (2015), paragraph 164. 2. Encyclical letter Centesimus Annus of the Holy Father John Paul II on the one hundredth anniversary of Rerum Novarum (1991), paragraph 58. 3. C. Giordano and E. Tosti, ‘An assessment of Italy’s energy trade balance’, Banca d’Italia, Questioni di Economia e Finanza (Working Papers), forthcoming 4. F. Corsello and A. Tagliabracci, ‘Assessing the pass-through of energy prices to core and food inflation in the euro area’, Banca d’Italia, 2022. 5. European Commission, ‘In focus: Reducing the EU’s dependence on imported fossil fuels’, 20 April 2022. 6. G. C. Blangiardo, ‘Attività conoscitiva preliminare all’esame del Documento di economia e finanza 2022: audizione del Presiente dell’Istat’, (Preliminary fact-finding inquiry relating to the examination of the 2022 Economic and Financial Document: testimony by the President of Istat), 14 April 2022 (only in Italian). 7. Ministry of Ecological Transition, 'La situazione energetica nazionale nel 2020' ('The national energy situation in 2020'), July 2021 (only in Italian). 8. Coordination initiatives among European countries would make it possible to achieve more effective results. According to a study by the Fondazione Eni Enrico Mattei, a sudden interruption in gas supplies from Russia would lead to a further rise in energy prices, but if electricity flows were optimised within the EU, it would not force Italy to ration gas demand (see F. Del Grosso, I. Livi, F. Pontoni and E. Somenzi, ‘Crisi russo-ucraina: analisi di scenario per il sistema elettrico italiano’ (‘Russia-Ukraine crisis: a scenario analysis for the Italian electric system’), Fondazione Eni Enrico Mattei, Brief, 2, March 2022, only in Italian). 9. In Italy in 2020, the installed renewable energy capacity amounted to 56.6 gigawatts (GW). The medium-term growth target for this capacity is laid out in the integrated national energy and climate plan (NECP) and in the national long-term strategy for reducing greenhouse gas emissions. According to the NECP, 4 GW of capacity would need to be added every year for the next ten years; this becomes 7 GW in the national long-term strategy, given the new decarbonisation targets set out in the European Green Deal. These increases are much higher than the yearly 0.8 GW installed in the period 2013-2020. Despite a marked growth in applications for connecting to the grid, the scope for renewable energy development projects is limited by an adverse environment in terms of authorisation processes and the mismatch between production (located mostly in the South and Islands) and demand (mainly from the North), an imbalance that requires sizeable investments in energy storage technologies. 10. IEA, A 10-point plan to reduce the European Union’s reliance on Russian natural gas, Paris, March 2022. 11. In November 1973, the Rumor Government raised fuel prices and imposed strong limitations on the use of private means of transport, a reduction in speed limits, and ordered public businesses to end their working day earlier. 12. Laudato si’, 169 et seq. 13. According to data that have just been published, last May was Italy’s second warmest in more than two centuries (+1.83 °C above the average for the period 1991-2020), and the warmest ever in the Centre and North. 14. The Paris Agreement adopted in 2015 at the close of the 21st Conference of the Party was the first global and legally binding agreement on climate change. In 2018, the European Commission set out a long-term development strategy for the EU based on the decarbonisation of its energy system (A Clean Planet for all. A European strategic long-term vision for a prosperous, modern, competitive and climate neutral economy, COM 773 final, 28 November 2018). In 2019, the European Council approved the target of climate neutrality by 2050 and the European Commission presented the Green Deal (see European Commission, The European Green Deal, COM(2019) 640 final, 12 December 2019). In July 2021, the Commission adopted the ‘Fit for 55’ package, which is a series of legislative proposals setting out the measures through which climate neutrality is to be achieved, with an intermediate objective of a reduction of 55 per cent by 2030 compared with the levels of 1990 ('Fit for 55': delivering the EU's 2030 Climate Target on the way to climate neutrality, COM(2021) 550 final, 14 July 2021). The same year, Regulation (EU) 2021/1119 came into effect, confirming the climate neutrality objective and introducing the intermediate objective of reducing net greenhouse gas emissions by at least 55 per cent by 2030 (see also Laudato si’, 164-165). Laudato si’ (166) deplores the fact that practical action has not yet lived up to the promises of international cooperation agreements, as do many other documents. 15. Laudato si’, 55. 16. Laudato si’, 55; see also ibid., 206: ‘This is what consumer movements accomplish by boycotting certain products. They prove successful in changing the way businesses operate, forcing them to consider their environmental footprint and their patterns of production. When social pressure affects their earnings, businesses clearly have to find ways to produce differently. This shows us the great need for a sense of social responsibility on the part of consumers’. 17. For further details, please refer to some of my recent speeches: ‘Climate transition, finance and prudential rules’, 3 March 2022 (only in Italian); ‘Conversing about Dante. Civil passion, public life, economic reasoning’, 6 December 2021; and, 15 October 2020. Without going into much detail, the second touches upon the merits of advanced countries making cash transfers to the emerging ones in exchange for achieving certain climate-related targets. 18. Among the numerous initiatives undertaken at European level, regarding supervision, the European Central Bank published a ‘Guide on climate-related and environmental risks’ in November, which sets out the expectations concerning: (a) the methods for integrating climate-related and environmental risk into the business strategy and model, corporate governance processes and the risk management framework of the significant banks within the Single Supervisory Mechanism (SSM); and (b) the information to be publicly disclosed. In line with the initiative of the ECB and the other national supervisory authorities, the Bank of Italy prepared an initial set of ‘Supervisory expectations on climate-related and environmental risks’ for all intermediaries subject to the Bank’s authorisation and supervision. 19. Laudato si’, 23, 156 et seq. 20. This refers to the matter of ‘collective goods’ (or in economic terms, ‘public goods’) ‘which cannot be safeguarded simply by market forces’ (Centesimus annus, 40), but can at least in part be traced back to these forces with measures that incorporate the collective value into individual prices. Allow me to refer once again to the observations made light-heartedly, in my ‘Conversing about Dante’. 21. As stated in Article 2 of the Agreement: ‘This Agreement […] aims to strengthen the global response to the threat of climate change […] holding the increase in the global average temperature to well below 2°C above pre-industrial levels and pursuing efforts to limit the temperature increase to 1.5°C above pre-industrial levels, recognizing that this would significantly reduce the risks and impacts of climate change”. 22. Mechanisms that set an appropriate market price for greenhouse gas emissions through the trading of emission allowances, such as the European Union Emissions Trading System (EU ETS) for large energy-intensive European installations, also have a role to play. These prices have also been rising recently, exerting pressure on the costs of generating electricity from coal and gas: in May, emission allowance prices increased by 60 per cent over the previous year, exceeding €85/tonne. 23. An interesting examination of the distributive and welfare effects of a hypothetical carbon tax and of the various ways of redistributing the revenues can be found in I. Faiella and L. Lavecchia, ‘Households’ energy demand and the effects of carbon pricing in Italy’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 614, 2021 and in F. Caprioli and G. Caracciolo, ‘The distributional effects of carbon taxation in Italy’, Banca d’Italia, mimeo, 2022. 24. In 2021, the Italian G20 Presidency placed the issue of sustainability and fighting climate change at the heart of its agenda. The Finance Track, made up of the finance ministers and central bank governors of the member countries, was particularly active. For the first time, a permanent Sustainable Finance Working Group was established to launch a series of initiatives and to develop a roadmap for increasing the financial world’s contribution to the sustainability goals. The Financial Stability Board (FSB) was also asked to develop a roadmap for addressing climate-related sustainability risks, with the goals of: (a) improving data availability and promoting uniform standards for the disclosure of non-financial data on climate-related risks; and (b) refining the methods for assessing the vulnerabilities of the financial sector connected with climate change. The commitment to these issues is apparent from the focus on them in the numerous statements of the ministers and central bank governors, and in the ‘G20 Rome Leaders’ Declaration’ adopted in October 2021. 25. Faiella I. and L. Lavecchia, ‘La povertà energetica in Italia’, Politica Economica, no. 1, pp. 2776, 2015. 26. According to Eurostat data, in 2020, Italy taxed final energy consumption (expressed as tonnes of oil equivalent) at €350 per unit compared with an EU27 average of €232. 27. Paolo Malanima, ‘Transizione energetica e crescita in Italia. 1800-2010’, ISMed–CNR, 2011. 28. Laudato si’, 165. 29. When comparing consumer price inflation trends in Germany and Italy in the decade 197180, it is noticeable that, while the ‘creeping’ inflation that began at the end of the 1960s was common to both countries, their paths clearly diverged after the oil shock of 1973. According to data from the Bank of International Settlements (Consumer prices), the average inflation differential between the two countries went from just over 1 percentage point in the three years 1971-73 to over 12 points in the years 1974-80. Inflation only returned to single figures in the mid-1980s in Italy; it was not until the 1990s that it was stably below 5 per cent, when the prospect of a European currency was drawing nearer. 30. ‘Christianity, in fidelity to its own identity and the rich deposit of truth which it has received from Jesus Christ, continues to reflect on these issues in fruitful dialogue with changing historical situations. In doing so, it reveals its eternal newness’ (Laudato si’, 121). 31. Laudato si’, 7-9. 32. ‘Be fertile and multiply; fill the earth and subdue it. Have dominion over the fish of the sea, the birds of the air, and all the living things that crawl on the earth’ (Genesis 1:28, New American Bible). 33. ‘Although it is true that we Christians have at times incorrectly interpreted the Scriptures, nowadays we must forcefully reject the notion that our being created in God’s image and given dominion over the earth justifies absolute domination over other creatures’ (Laudato si’, 67). ‘In our time, the Church does not simply state that other creatures are completely subordinated to the good of human beings’ (Laudato si’, 69). 34. Ikeda Daisaku, Per una società globale sostenibile ogni persona è protagonista del cambiamento (For a sustainable global society, each person is a protagonist of change), the Italian Buddhist Institute, Soka Gakkai, 2012, p. 48. 35. Laudato si’, 216-221. 36. Nichiren Daishonin, Raccolta degli insegnamenti orali, 2008. 37. Laudato si’, 82. 38. Laudato si’, 113, 223. 39. Centesimus annus, 40-41. 40. Centesimus annus, 41. See also Centesimus annus, 34: ‘It would appear that, on the level of individual nations and of international relations, the free market is the most efficient instrument for utilizing resources and effectively responding to needs’. John Paul II added that ‘however, this is only the case for ‘solvent’ needs and for ‘marketable’ resources. Many – of course not all – of the steps to be taken for the climate transition consist of acts of investment and consumption that imply monetary transactions; for these acts, including environmental externalities in market prices makes it possible to exploit their potential for allocating resources efficiently’. 41. With his permission, I quote here a comment by a Christian friend and colleague who read this in advance: ‘Here the argument seems to be: the market has some mechanisms for guiding conduct consistent with pursuing the individual and collective good. Willingness, morality, sobriety and giving things up can help but they are not the founding elements of a project designed to achieve collective well-being. A Catholic [...] would disagree with this, because the incentives (that [...] always end up with a monetary dimension) do not complete the information set based on which people choose what conduct to adopt. The founding values of a society determine the shape of the utility function and therefore, with the same price signals and constraints on resources, they generate different behaviour. This is why I believe that real Christians [...] insist on values so much. In micro-economics, we assume that preferences are a pre-economic datum from which we begin our analyses. The Catholics tell us that perhaps we should work on this pre-economic datum’. In reality, we do not disagree at all. Willingness, both individual and collective, is a fundamental element of the project. Whether or not you are a believer, if you care about the fate of the planet, you must work on what the economists see as exogenous preferences. The market is nothing more than an instrument for realising these preferences; but it is a powerful instrument. 42. 'Recent experience has shown that countries which did this (i.e. which isolated themselves) have suffered stagnation and recession, while the countries which experienced development were those which succeeded in taking part in the general interrelated economic activities at the international level’ (Centesimus annus, 33). 43. Laudato si’, 175. 44. Laudato si’, 246 (paraphrased).
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the Annual Meeting of the Italian Banking Association (ABI), Rome, 8 July 2022.
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Italian Banking Association - Annual Meeting Speech by Ignazio Visco Governor of the Bank of Italy ABI Rome 8 July 2022 The economic situation and monetary policy The global economy is experiencing a period of great uncertainty. Russia’s attack on Ukraine is having serious repercussions on manufacturing and on trade and is driving up inflation, which in Europe in particular reflects the continuing and exceptional rises in energy commodity prices, and to a lesser extent, of food prices. The outlook is also being affected by the ongoing difficulties in international supply chains for intermediate goods, recently made worse by the restrictions introduced in China to counter the spread of COVID-19 cases. There is the risk of a sharp slowdown in some advanced economies, above all in the United States, where the containment of inflation, also caused by a considerable increase in aggregate demand and in labour costs, requires a particularly vigorous monetary policy response. Global economic activity in any case remains exposed to possible resurgences of the pandemic. In the Eurosystem’s projections of early June, euro-area growth in 2022 was lowered to 2.8 per cent from the 4.2 per cent forecast in December. This increase had already largely been achieved thanks to the strong recovery in 2021, and implies an expansion lower than 1 per cent over the course of this year. GDP is currently being driven by the full re-opening of business activities, especially in services, which are also benefiting from the impetus provided by the strong resumption of tourism; the negative effects of the energy shock on household spending are mitigated by the ample availability of savings, by fiscal measures and by the gradual recovery of the labour market. In June, consumer prices increased by 8.6 per cent in the euro area compared with the same month last year. Their growth continues to be fuelled by the rise in oil prices and above all gas prices that, following further cuts in supplies from Russia, have risen sharply from €80 to more than €180 per megawatt hour since mid-June; they stood at around €30 one year ago, when flows from Russia had already declined, and at just over €10 before the pandemic. Net of the most volatile components, inflation has reached 3.7 per cent, since it, too, is influenced by the transmission of higher energy costs to the final prices of other goods and services. Inflation is likely to remain very high on average this year; it is expected to fall markedly in 2023 and then return to around 2 per cent in 2024. The latest forecasts from the leading international institutions and private analysts, as well as those inferred from the prices of financial assets indexed to consumer prices, confirm that long-term expectations remain broadly in line with the European Central Bank’s (ECB) definition of monetary stability. Nevertheless, in the current environment of high inflation, a gradual normalization of monetary policy, which had been calibrated to contain deflationary and recessionary pressures during the most serious phase of the pandemic crisis, is needed. The risk that, in the long run, exceptionally high price increases will eventually impact expectations or trigger a price-wage spiral should be countered, although wage growth, despite having strengthened, remains moderate for the time being. The ECB Governing Council therefore decided to end its net asset purchases from the end of last week. In addition, it announced its intention to raise the key interest rates by 25 basis points at the meeting on 21 July; an even larger increase could be appropriate in September if the medium-term inflation outlook does not improve. The pace of the subsequent gradual but sustained process of interest rate increases will depend on the new economic and financial data and on how they will affect the prospects for prices. Partly because of the unjustified perception of a particularly aggressive monetary policy stance, the first half of June was characterized by a sharp upward revision of expectations for key interest rate rises and by an abrupt increase in long-term interest rates, which play a key role in the economic activity of firms and households. Tensions have overwhelmed the markets for public and private bonds and spread to the equity market. The considerable widening of yield spreads between the government bonds of euro-area countries perceived as being more vulnerable and German bonds points to growing risks of market fragmentation along national borders. Given these trends, at an extraordinary meeting on 15 June, the Governing Council decided that reinvestments under the pandemic emergency purchase programme (PEPP) would be conducted flexibly, and announced the acceleration of work to create a new tool designed to counter fragmentation. These measures aim to ensure as homogeneous a transmission of monetary policy as possible across euro-area countries, ensuring the smooth normalization needed to bring inflation back into line with the price stability objective. The announcement of the Council’s decisions contributed to a sudden and significant reduction in public bond spreads; the peak of around 250 basis points reached in the spread between Italian and German ten-year government bond yields shortly before mid-June is inconsistent with the fundamentals of Italy’s economy. The context is still one of high volatility: it therefore remains crucial to prevent financial conditions from becoming excessively tight, as this would have serious repercussions for financial stability, for economic activity and, ultimately, for medium-term price growth. It is essential that monetary policy action be combined with a clear determination on the part of the fiscal authorities to keep the public finances on an even keel. Geopolitical tensions are having a marked impact on the Italian economy too, which, together with that of Germany, is one of those most dependent on commodity imports from Russia. In January, we expected output growth to be above 3 per cent on average in the years 2022-23; in the June baseline scenario, in which war-related tensions are assumed to persist throughout 2022 but with no suspension of gas supplies from Russia, growth has been revised downwards, by 2 percentage points for the two years as a whole, close to the values of the euro area. Inflation, which in June exceeded 8 per cent in Italy as well (four fifths of which due to the direct and indirect effects of energy and food prices), is holding back growth by significantly compressing incomes in real terms, only partly offset by fiscal measures. In an adverse scenario featuring a halt in supplies from the third quarter of this year, only partially replaced by other sources, GDP would contract on average in the years 2022-23, and return to growth in 2024. The direct effects of an interruption on the more energy-intensive sectors, further increases in commodity prices, a more marked slowdown in foreign trade, a deterioration in confidence and an increase in uncertainty would all contribute to the worsening of the macroeconomic situation. Substantial support to economic activity is in any case coming from the measures outlined in the National Recovery and Resilience Plan (NRRP), which is being implemented according to the set deadlines. In the coming weeks, the European Commission will assess whether the 45 milestones and targets agreed for the first half of 2022 have effectively been achieved, which is linked to the disbursement of a new €21 billion tranche of funding. For this period, the Plan envisaged progress on major reforms, such as the code of public contracts and public employment, as well as the launch of several investment programmes. The difficulties encountered in awarding a number of tenders have not compromised the ability to stick to the timeframe and achieve the expected results. In the coming months, the commitment to implementing complex reforms, such as those for competition and the justice system, will need to be flanked by a gradual acceleration in investment programmes. If local authorities have difficulty in planning and implementing measures, it will be important to make timely use of the technical support instruments already envisaged. Rising energy prices and problems in the supply of raw materials pose further challenges. These difficulties, which are being countered by specific compensation measures already partly introduced, do not require a radical review of the Plan, nor do they imply a slowdown in its implementation. On the contrary, they make it even more urgent to step up the measures relating to the green transition, also by using the additional resources made available by the REPowerEU programme. Banks Italy’s banks are responding to this difficult cyclical situation from a position of substantial equilibrium. At the end of March, the CET1 ratio was equal to 14.6 per cent; despite the resumption of dividend payments, it remains higher than it was before the outbreak of the pandemic. In the first quarter, the annualized return on equity came to 6.4 per cent, less than in the corresponding period of last year, but slightly higher than the level recorded for 2021 as a whole. The new non-performing loan (NPL) rate, computed on an annualized basis and adjusted for seasonal effects, fell by 0.2 per cent in the first three months of this year, to 1 per cent; in the absence of significant disposals, the stock of these loans net of loan loss provisions and, again, relative to total loans, remained broadly unchanged. By contrast, losses on the securities portfolio associated with market volatility are on the rise. Credit supply conditions have become less favourable in recent months, although lending to the non-financial private sector continues to grow, albeit at a moderate pace for firms. The liquidity position of the latter nevertheless remains good. Possible liquidity needs associated with the economic fallout of the war could also be met through State-guaranteed loans; in fact, the new credit support measures taken by the Government after the outbreak of the conflict in Ukraine extended the application window for these loans until the end of this year, in line with the EU’s State Aid Temporary Framework. The rise in interest rates is not expected to halt credit growth. The impact on banks’ profitability should be positive overall, owing to the increase in net interest income, whose performance will depend on the maturity structure of individual banks’ assets and liabilities, with quite significant differences among intermediaries. Over the medium term, the amount of additional loan loss provisions corresponding to the rise in NPLs should be more than offset by the positive impact of higher interest rates on net interest income. A fall in Italian government bond prices has a direct impact on regulatory capital, even when the corresponding losses are not recorded in the income statement. If we consider the stock of onbalance-sheet securities recorded at market value at the end of May, it can be estimated that an increase of 100 basis points along the entire yield curve would lead to a reduction of around 20 basis points in the CET1 ratio. The withdrawal of the support measures put in place to address the pandemic crisis is ongoing, with no significant repercussions on credit quality. Although it is increasing, the share of loans classified as NPLs that have benefited from moratoriums remains relatively low, while that of loans for which banks have recorded a significant increase in credit risk since origination (classified as ‘Stage 2’ according to international accounting standards) is diminishing. The data on delays in payments on performing loans do not show signs of a significant deterioration for now. The quality of State-guaranteed loans to the firms hit hardest by the pandemic, which can be requested until the end of June, also continues to be good. The new NPL rate is still low, although for loans granted in the early stages of the pandemic, the grace period during which firms were permitted to make just interest payments is now ending. The preliminary data also suggest that only a few borrowers have availed of the recently introduced possibility of requesting an extension. Direct exposures to the countries affected by the war have remained broadly stable; the intermediaries with which these claims are concentrated have reviewed their accounting classifications and increased their loan loss provisions accordingly. The ECB and Banca d’Italia have urged banks to carry out in-depth analyses of the solvency outlook for the firms hardest hit by the consequences of the conflict, in particular those most impacted by the extraordinary increase in energy costs. Recognizing the heightened risks involved, many banks have started to increase loan loss provisions on these exposures as well. As I recalled earlier, there is a real risk of a contraction in economic activity. Policies for the distribution of profits and for provisions must take due account of the heightened uncertainty and the considerable downside risks to macroeconomic developments. Supervision, crisis management and banking union Over the past few years, Banca d’Italia’s supervisory action on the less significant banks has aimed at identifying the most fragile intermediaries ahead of time and requesting increasingly intensive remedial actions to prevent their economic and financial conditions from deteriorating. This has led to more robust small and medium-sized banks overall, as witnessed by the general improvement in capitalization levels and the reduction of risks, which have also benefited indirectly from support measures for access to credit introduced by the Government to address the effects of the pandemic crisis. At the end of 2020, we had conducted a survey on the sustainability of the business models of a large sample of less significant banks, followed in 2021 by actions tailored to the conditions of the individual banks involved. While the situation is balanced for most banks, elements of fragility remain in some cases, especially in relation to banks’ ability to generate income flows suited to managing risks, funding innovative investments and remunerating capital. For some less proactive banks with deficiencies in management, the weaknesses identified may jeopardize the sustainability of their business model to the point that they may become non-viable; in these instances, they have then been called on to make a rapid assessment of options to overcome the crisis, including through possible mergers with other banks. In recent years, a special public fund has been established to support the orderly winding-up of banks with total assets of below €5 billion, which can only be availed of until next November. In view of the approaching deadline, new instruments need to be found to finance the restructuring of the most fragile institutions, when possible preventing crises and the resulting negative externalities for the whole sector. While it is still desirable for operators to enter the market that are specialized in bank restructuring and equipped with the capital resources and professional skills necessary to support their revitalization, this need could also be met by the banking system itself setting up a dedicated vehicle funded at market conditions and supported by public entities. Supervisory activities pay the utmost attention to the adequacy of corporate governance, to the professional profile of managers, and to the appropriateness of the time that directors spend on performing their duties. Corporate governance systems that value professional skill sets, are open to innovation, and are capable not only of facilitating the formulation of strategies consistent with the new competitive scenario but also of adequately monitoring new risks, are indispensable for the stability of individual intermediaries and that of the banking system as a whole. On the other hand, weaknesses in these areas, especially shortcomings in mechanisms for balancing powers and decision-making processes, have been one of the main causes of banking crises in recent years. Corporate governance surveys suggest that there is room for improvement in the levels of diversification of boards of directors by gender and expertise. In the less significant banks, women are particularly under-represented in senior management roles and their numbers must be increased, also in line with Banca d’Italia’s most recent provisions and recommendations. There is, moreover, a clear need to strengthen the capacity to innovate and to safeguard against the related risks by increasing the presence of IT experts; critical scrutiny of managerial proposals and efforts to discuss key issues thoroughly also need to be stepped up. The need to strengthen corporate governance, to formulate and implement appropriate strategic plans and to pursue greater efficiency and better risk management at group level, while maintaining strong local ties, underpinned the choice of the legislature to launch the cooperative credit banks reform of 2016. Six years later, despite several initial difficulties and an unfavourable cyclical situation, the new groups have reduced their share of non-performing loans, lowered cost-to-income ratios, and almost completely closed the profitability gap that was separating them from the banking system average. At the same time, they have continued to support the local economies where they operate and increased their market share in terms of financing to households and firms. They have played a prominent role in putting public support measures in place to counter the effects of the pandemic crisis. Banca d’Italia remains open to dialogue with the cooperative credit banking groups in order to identify areas where supervisory practices and regulation can be simplified so as to take due account of their particular features. The completion of the banking union, which currently rests on the two pillars of the Single Supervisory Mechanism and the Single Resolution Mechanism, cannot neglect the establishment of the third pillar, a single deposit insurance scheme with a full loss-absorbing capacity when it is completely phased in. However, in the current political, economic and financial environment, it has become clear that it is not possible at present to find a balance between the different positions of the Member States. The Euro Summit statement of 24 June therefore took note of the Eurogroup’s decision of 16 June to focus its work on banking union in the coming months solely on the review of the regulatory framework for bank crisis management. The current framework still does not provide effective tools for small and medium-sized banks: these banks are excluded from the application of the resolution procedure due to failure to pass the ‘public interest test’ and, in the absence of other solutions and in the event of a crisis, would be destined for piecemeal liquidation, unsuitable for ensuring an orderly market exit. The inefficiency of the current situation is compounded by the limited room for manoeuvre available to deposit guarantee funds, which risk being unable to provide sufficient support to ensure the transfer of assets and liabilities to a potential buyer, thereby avoiding corporate dismantling and serious consequences for unprotected creditors, for customers and for employees. The Eurogroup has specifically agreed that the main elements of the review should be: a harmonized rewriting of the concept of public interest in order to extend the application of the resolution procedure to more banks, including smaller ones; finding more sources for resolution funding, which is necessary to make the above-mentioned extension feasible, through a greater involvement of guarantee funds and a ‘least cost criterion’ test based on common criteria at European level but managed by national authorities; and the harmonization of specific elements of Member States’ insolvency regimes to make them consistent with the European framework. The European Commission has been invited to consider the submission of a proposal and the colegislators called upon to complete the relative work by the beginning of 2024. As part of this general approach, some important aspects still need to be defined, starting with the expansion in the number of banks that can access the resolution framework. It will also have to be made clear how the minimum requirement for own funds and eligible liabilities (MREL) will apply to small and medium-sized banks, which, as a result of the abovementioned expansion, would be destined for resolution. Given their limited capacity to place financial instruments on the capital market, applying a bail-in to these banks, even at the minimum 8 per cent of total liabilities needed to access the single resolution fund, would ultimately affect depositors as well as senior creditors. In our assessment, a reasonable extension of the range of banks that can access the resolution procedure could be feasible, provided that there is an extension of the intervention capacity of the deposit protection fund made possible by removing the super-priority, potentially accompanied by a reduction in the minimum bail-in required to access the resolution fund. By facilitating compliance with the least cost criterion test, this removal would also improve the ability of the funds to intervene (alternatives to repaying protected deposits) to support the disposal of assets and liabilities in national liquidation procedures. These considerations are confirmed by the results of an impact analysis conducted last year by the European Banking Authority at the request of the Commission. The analysis pointed out that, under realistic loss scenarios, a significant number of intermediaries (including some of the banks for which, in the event of a crisis, a resolution procedure would be triggered) would currently not be able to undergo a minimum bail-in of 8 per cent of liabilities without affecting depositors. Initial estimates made by Banca d’Italia confirm that, if the scope for resolution were extended, it would be difficult for less significant Italian banks to comply with the obligation to bail in the minimum required under the current European rules without creating losses for depositors. For the many smaller banks that would remain outside the scope of resolution, the same estimates highlight the limits of deposit protection funds in helping to fund disposals of assets and liabilities in liquidation. Given the difficulty in overcoming the least cost criterion test, the removal of the super-priority and maintaining the possibility for funds to continue carrying out the alternative measures, already provided for by European legislation, seem to be the conditions necessary for preventing the crises of small banks from having to be managed via piecemeal liquidations. Also in connection with the revision of the crisis management framework, the Commission has launched a public consultation in recent weeks on a possible reform of the regulatory framework for State aid for banks in difficulty. The objective – of which the Eurogroup has taken note – is to assess the extent to which the current rules have helped to preserve financial stability, while minimizing distortion of competition and the burden on taxpayers. There will also be an assessment as to whether there is scope for simplifying the rules and improving their interaction with the crisis management framework. It is desirable for the rules to remain reasonably flexible in order to safeguard a proper balance between financial stability and protecting competition. The challenges ahead The pandemic crisis was the first test bench we were able to use to assess the current macroprudential framework in a period of stress. The authorities responded in a timely manner using a number of tools. In some cases, they intervened by fully or partially releasing the countercyclical capital buffer (CCyB) or by cancelling scheduled increases to it. In other cases, the systemic risk buffer (SyRB) or the capital buffers for systemically important institutions were reduced or cancelled. In countries like ours, where the conditions of the financial cycle in the years preceding the outbreak of the pandemic were not such as to justify the build-up of capital buffers, there was less room for manoeuvre. Therefore, there is now a need to expand the macroprudential space available to the authorities, with the aim of increasing the amount of capital buffers that can be released in the face of large and disruptive systemic shocks that could go beyond normal cyclical fluctuations. Moreover, borrower-based instruments, such as limits on the loan-to-value ratio, should be harmonized, even if only minimally, based on the recommendations already issued by the European Systemic Risk Board. Last March, we sent the results of the public consultation to the European Commission, publishing them on Banca d’Italia’s website as part of the periodic review of macroprudential provisions. It is important that the design, activation and calibration of these instruments remain the responsibility of the national authorities, given the heterogeneity of national credit and real estate markets. Within its field of competence, the ECB can at the same time foster their consistent use across countries. The difficult cyclical situation should not induce banks to reduce their efforts to respond to structural challenges, in particular those posed by the ‘twin’ green and digital transitions. Lowering our guard on these aspects would mean making up for lost time over the next few years, trying to catch up with the competition, rather than anticipating it and adjusting to the new rules. I have often pointed out that it is essential to increase investment in new technologies, innovate products and processes, and upgrade the skills of bank managers and employees in order to respond to the competitive pressures from other market participants (regulated and nonregulated) and to increase efficiency. There is still a long way to go, but there are encouraging signs coming from our surveys. Last year, a survey of banks showed that the use of artificial intelligence applications, even if still limited, is growing. These applications make risk estimates for customers more precise and speed up assessments of creditworthiness, favouring faster loan disbursement. The survey also indicated that while banks are aware of the need to adopt models that can be easily understood, they are not as alert to the need to strengthen their corporate governance arrangements against risks arising from outsourcing their assessment activities. Safeguards should also be strengthened to ensure that individual rights are adequately protected and that the methodologies used do not result in discriminatory practices. The provision of online credit is increasing. At the end of last year, the share of banks offering loans to households and firms via digital channels was 44 and 25 per cent respectively. The capacity to lend remotely and the use of digital tools to assess customers’ creditworthiness allowed banks with a higher rate of technological innovation to increase their market share during the pandemic crisis. However, the recent acceleration in the use of new technologies has exposed us to greater risks, as witnessed in some major cyber incidents. With the outbreak of the conflict in Ukraine, risks are increasing again and so, together with Consob, IVASS and Italy’s Financial Intelligence Unit (UIF), we promptly warned the banks that they needed to raise their guard against potential attacks. Against this backdrop, we have also urged banks and the main technology service providers to conduct a risk assessment linked to the use of software from Russia. So far, there has been no evidence of any successful cyber attacks on the financial market that can be directly related to the conflict. Of the 12 incidents reported in 2021, eight were reported in the first six months, of which 5 were associated with a single attack on an external service provider. That episode highlights the risks involved when outsourcing is concentrated around a small number of operators. In 2020, Banca d’Italia intensified its controls in this context, making specific and repeated surveys and on-site inspections of its suppliers. The Bank also undertook target investigations of the financial market’s payment systems and infrastructures. As I recalled in the last Concluding Remarks, some crypto-assets are not backed by any real or financial assets. They have no intrinsic value and are subject to very high volatility, as the episodes we have recently observed have indeed shown. Other crypto-assets are, instead, backed by real or financial assets. If these assets are duly regulated and issued by clearly identifiable entities, they could also potentially be useful, under specific conditions, as a means of payment. They can also be distinguished by differing levels of transparency, liquidity of reserves, and disclosure of their valuation processes. They are, however, suitable for regulation within a system similar to that applied to more traditional instruments that perform a similar function. The time needed to introduce new rules is not always compatible with the rapid dissemination of new technologies. While waiting for the subject to be at least partly regulated by European legislation (on which a first agreement at a political level has been reached in the last few days), we recently published a communication on our website explaining the necessary conceptual distinctions, alerting the public to the possible risks, and giving professional operators some indications of possible safeguards to reduce these risks. We will continue to work together with the other supervisory authorities, and with Consob in particular, to contribute to putting regulations in place at all levels and to applying them in practice, with the aim of promoting genuine innovation and avoiding the dangers arising from the less than genuine variety. This is a task that will become more complex in the near future because it will involve the construction of a comprehensive informational and analytical framework. Last November, we disclosed the results of our in-depth analysis of the characteristics and risks associated with the development of open banking, through which banks can now share customer information with third parties if those customers are in agreement. Although the use of these services is still relatively limited, the number of providers involved is not negligible. Technological risks for intermediaries, including those arising from possible cyber attacks, are matched by the need for adequate customer protection and for safeguards against money laundering. This is of particular importance at a time when new technologies are being developed and put into use. Further problems could arise from the establishment of third parties outside the European Union. The ECB is about to communicate the results of the climate-related stress test exercise conducted on a sample of 104 significant banks (of which 10 are Italian). Along with the thematic review, deep-dive analyses of commercial real estate exposures and future targeted inspections, the exercise contributes to the ongoing dialogue between supervisory authorities and intermediaries to strengthen their capacity to manage this new type of risk. This exercise is unlike those previously conducted since, in addition to making the classic projections, it also involves collecting a vast amount of qualitative and quantitative information on data availability, on the level of preparedness of banks in designing appropriate scenarios and conducting climate-related stress tests, and on how the results are integrated into their business strategies. The intermediaries have provided a large amount of data and information, but much work remains to be done to fully take account of the effects of climate change in their models and their medium and long-term development plans. As a supervisory authority, we will continue to advise banks along this path, providing them with clear guidance and verifying that it is followed precisely. The banks’ unwavering commitment to the prevention and combating of money laundering is essential to ensure both the integrity of the financial system and the sound and prudent management of intermediaries. Banca d’Italia regularly asks supervised entities to monitor developments and emerging risks. Alongside traditional risks, connected, for example, with tax crimes and corruption, new ones are emerging: the pandemic has in fact provided additional opportunities for organized crime, exposing the economic and financial system to illegal and fraudulent behaviour, sometimes linked to the misuse of government support measures for the economy. Innovative technological solutions, too, while helping to strengthen the safeguards and controls on financial flows, also open up new scenarios in which crime can occur, exploiting the weaknesses of a regulatory framework not yet fully harmonized at European level and not yet in step with rapid technological developments. The complexity and continuous evolution of these risks require effective and timely supervisory action. Banca d’Italia decided to strengthen its action by creating an autonomous structure, the Anti-Money Laundering Supervision and Regulation Unit, which reports directly to the Governing Board. The reform will also allow the Bank to interact more effectively in the new European system under development. *** In many countries, and certainly in the euro area, the high inflation that we continue to observe is one of the main economic consequences of the conflict in Ukraine. The ECB Governing Council is determined to bring it back down to levels in line with its objective of price stability. Reassuring signs that this could be achieved through a gradual normalization of monetary policy and without causing a sharp slowdown in the economy can be found in the medium to long-term inflation expectations, which remain broadly anchored to the target, and in wage growth, which at this time does not appear to point to the start of a wage-price spiral. For central bank action to be effective, it is crucial that there is no amplification of the cost of money in individual jurisdictions due to financial market reactions that are not justified by country fundamentals. If this occurs, it can be counteracted by decisively using, as in the past, all the tools possessed by the central bank and, if necessary, by employing new ones. For monetary policy to be fully successful, however, there must be a shared commitment, in practice, in the proposals and in the requests for fiscal action, to keep the public debt on a path that continues to ensure its full sustainability. It will also be essential to continue strengthening, via appropriate and wellbalanced structural reforms, the development capacities of the euro-area countries. The Italian economy is expected to grow in line with the euro area in 2022-23. The risks at global level are, however, significant. During this delicate phase, the contribution that the financial system is called upon to provide with regard to the allocation of credit flows and support to the economy is particularly important. To fulfil these tasks, we must tackle the challenges posed by the difficult and uncertain cyclical situation head on, as well as those arising, on a structural level, from the digital transition and the financial effects of climate change. Banks must continue to pay close attention to the principles on which sound business management is based: prudence in provisioning and distribution decisions; monitoring of traditional and new risks; transparency and fairness vis-à-vis customers; and improving efficiency and cost containment, including through the necessary investment in technological innovation. The experience of recent years shows that Italian intermediaries have the capacity to overcome the challenges they face today; they should apply it assiduously and with foresight.
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Welcome address by Mr Paolo Angelini, Deputy Governor of the Bank of Italy, at the Bank of Italy and Long Term Investors (LTI) Workshop "Long-term investors' trends: theory and practice", Rome, 11 July 2022.
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‘Long-term investing and sustainable finance: challenges and perspectives’ Welcome address by Paolo Angelini Deputy Governor of the Bank of Italy Banca d’Italia and LTI Workshop ‘Long-term investors’ trends: theory and practice’ Rome 11 July 2022 1. Introduction I am glad to welcome you to the third Banca d’Italia and LTI joint Workshop on ‘Long-term investors’ trends: theory and practice’. We held the previous edition online. This year we can again benefit from being here in person. However, thanks to one of the few positive consequences of the COVID-19 epidemic, we will also have remote interaction, to broaden participation as much as possible. I am very happy about our continued collaboration with LTI. Directing investments toward longterm objectives contributes to durable, sustainable and inclusive economic growth and to the stability of the financial system. Today, I would like to focus on the issue of sustainability, which is also the topic of two interesting contributions in this workshop. Banca d’Italia has long been active on this front. Since 2010 we publish an annual Environment Report, documenting the ecological footprint of the Bank and our efforts to reduce it. Last year, during the Italian Presidency of the G20, the Bank played a leading role in defining an ambitious multi-year agenda for sustainable finance and the fight against climate change.1 One of the cornerstones of the agenda is the attempt to redirect financial flows to support the transition towards a sustainable economy. We took several initiatives aimed at addressing the need for highquality, granular, and internationally comparable data.2 In 2022, the Bank also became a member of the Steering Committee of the Network for Greening the Financial System (NGFS). Internally, we set up a Climate Change and Sustainability Committee, which helps define the Bank’s financial strategy, and a permanent hub of experts to stimulate and coordinate analyses and policy initiatives across the various directorates involved.3 There are important challenges – also of a theoretical nature – on the road to sustainability, which need to be addressed by policymakers, academia, and industry players. I shall elaborate on some of these issues, mainly from the perspective of the financial investor, without the pretense of being exhaustive.4 2. Sustainable finance: key challenges There is a general consensus that we need to improve the quality, comparability and availability of non-financial data. The most widespread metrics are the so-called ESG scores, intended to assess how well a firm is faring in addressing environmental, social and governance challenges. They are attributed by rating agencies and data providers to a broad range of issuers and financial instruments, and are intuitive to interpret. However, they suffer from several problems. To begin with, they are far from transparent and not easy to compare. Since there are not yet widely accepted rules for ESG data computation and disclosure, firms’ non-financial reports do not follow pre-defined standards, and therefore do not lend themselves to the calculation of harmonized indicators and statistics. Moreover, ESG score providers rely on subjective methodologies to select, assess and combine individual indicators. As a result, there is a considerable heterogeneity across the scores assigned by different agencies to the same firm. The problem is compounded by the lack of transparency of the methodologies, which are typically proprietary. One of the papers presented in today’s workshop proposes a new methodology that addresses this problem by trying to filter out the noise in ESG scores. The situation improves somewhat if one looks at the separate scores for each individual letter of the ESG acronym. Yet, measurement error can be substantial even when focusing on a single indicator. Consider for instance carbon emissions, a crucial one. Data consistency for an individual firm across various ESG data providers is almost perfect for Scope 1 emissions (direct emissions from owned or controlled sources); it is still very high for Scope 2 (indirect emissions from the generation of purchased electricity, steam, heating and cooling consumed by the reporting company), but it drops dramatically for Scope 3 (all other indirect emissions that occur in a company’s value chain).5 The latter are often a very important source of emissions, but their calculation presents formidable technical challenges because it requires vast amounts of data on several different phenomena, such as e.g. waste generation, employee commuting, purchases of carbon-intensive goods and fuel consumption by distributors. As a result, data on Scope 3 emissions are still unreliable. Another significant issue is the lack of accountability: the framework to ensure the reliability of firms’ non-financial disclosure is still largely incomplete. The picture is complicated by the multiplicity of actors involved – rated firms, rating companies, manufacturers of investment products, final buyers such as institutional investors and retail savers – each with their own incentive structures. This mix of factors is conducive to attempts at altering external perceptions. Unfortunately, corporate misconduct regarding ESG practices is already a serious issue, as witnessed by the popularity gained by the neologism “greenwashing”. Progress is being made, with Europe arguably at the forefront. In 2021 the European Commission brought forward a legislative proposal for a Corporate Sustainability Reporting Directive (CSRD), which builds on the Non-financial reporting directive (NFRD). The new law shall significantly increase the number of firms in scope, oblige them to report in compliance with European sustainability reporting standards, and shall also introduce a regime of mandatory auditing of nonfinancial information, which is clearly crucial for ensuring its reliability. The European Financial Reporting Advisory Group (EFRAG) has started to draft standards for sustainability reporting. The European Securities and Markets Authority (ESMA) released a Sustainable Finance Roadmap for the period 2022-24, which includes transparency in sustainability reporting among its top priorities. At the international level, the Financial Stability Board (FSB) created a Task force on Climate-related Financial Disclosures (TCFD) to develop recommendations on the types of information that companies should disclose to support investors, lenders, and insurance underwriters in appropriately assessing and pricing risks related to climate change. Last March the International Sustainability Standards Board (ISSB) released two draft sustainability standards for public comment. Another emerging issue concerns small and medium-sized enterprises (SMEs). Only a relatively small set of firms, typically large or listed, are required by law to publish non-financial reporting. This choice follows proportionality principles, but it may result in inadequate sustainability information for SMEs, creating various risks. On the one hand, large firms may have an incentive to move some of their environmentally harmful activities to small contractors located outside the radar of public markets, authorities and financial intermediaries; the above-mentioned difficulties with the accounting of Scope 3 emissions leave room for such behaviour. On the other hand, environmentally conscious small firms may have difficulties signaling their type, and end up in a pooling equilibrium in which small becomes a synonym for ‘non-green’. On this front, banks may have an important role to play: they could exploit their customer relationships with SMEs and collect key sustainability data, both to improve their risk management and to help firms in their transition efforts. This task would be particularly important in Italy, where SMEs account for a large share of the non-financial sector. The best way for banks to set and achieve decarbonization targets for their loan portfolios is not to divest from carbon-intensive firms, but to help these firms – and all firms in general – to invest in credible transition plans towards net-zero emissions. The available evidence suggests that banks need to speed up their efforts on sustainability, but that change is indeed happening.6 Banks committed to ESG principles, such as those adhering to the Net-Zero Banking Alliance, or to the Science-Based Target initiative (SBTi),7 appear to be redirecting financial resources from brown to green firms.8 Overall, the results of these efforts are mixed, but hopefully the mechanisms will gradually improve. Also because of data constraints, the evidence mostly concerns large borrowers, and little is known about the effects of banks’ sustainability commitments on loans to small enterprises. Another key issue concerns the profitability of sustainable investment. To date, most of the empirical evidence suggests that solid ESG practices improve the operational performance of firms by encouraging innovation, long-termism and a more efficient use of resources, and that sustainable economic activities are not only less exposed to climate, transitional and reputational risks, but also more profitable.9 From a financial investment perspective, advantages have accrued both to investors, in the form of larger risk-adjusted returns, and to green issuers, in the form of a lower cost of capital.10 However, sustainable investment may become less of a win-win proposition going forward. In the past, the surging demand for sustainable bonds and stocks may have boosted their performance. This factor will eventually taper off as a new equilibrium is reached. In principle, other things being equal, a sustainable investment should be relatively less risky, and hence carry a lower return. Indeed some recent studies find evidence of higher stock returns for companies with higher carbon emissions, after controlling for several other factors that may affect returns.11 This is an area where our understanding (especially of risks) could be significantly enhanced by new theoretical contributions, such as that provided by one of today’s papers, which deals with the pricing of climate-related risks. An important question is whether ESG investing is just a move on the risk-return frontier or whether, by contrast, investors concerned with sustainability should stand ready to accept lowerthan-warranted risk-adjusted returns (e.g., with a negative alpha or off the efficient frontier). In other words: should an ESG-aware investor be willing to abandon the standard risk-return paradigm and value sustainability as a third, independent argument of the investor’s objective function, similarly to what is done in certain niche areas such as philanthropic investment, or impact investment? 12 There are reasons to doubt that this willingness would achieve the desired results (absent regulatory interventions), as the efforts of the responsible investors could be thwarted by the strategies of arbitrageurs and other traders focused solely on the risk-return paradigm. Recent theoretical contributions show that ESG investors can partially crowd other private investors out of green assets and into brown assets.13 Such crowding out may create positive alpha for brown portfolios and negative alpha for green ones. To avoid frustrating the efforts of responsible investors, public policies should ensure that in the long-run green investments remain at least as profitable as brown ones on a risk-adjusted basis. One way to do this is to internalize the carbon externality by imposing sufficiently high taxes on carbon emissions, for example, through global carbon pricing, as advocated by Nobel-prize winner William Nordhaus. An alternative – or complement – could be to provide public subsidies to green firms and investments; this could be considered if a fast green transition were to generate high social costs – this is probably where the E and the S of the ESG acronym are most closely related.14 Be that as it may, ESG awareness should not end up in a wealth transfer from sustainabilityconscious investors to other operators; in such a scenario the global warming problem would not be tackled, while society could be lulled into a deceptive conviction of doing something about it. 3. Sustainable investment at the Bank of Italy The Bank of Italy has been working on investment sustainability for some time. In 2019 we started to incorporate ESG criteria in the selection of our non-monetary policy portfolios (equity and corporate bonds), following guidelines later formalized in a Sustainable Investment Charter.15 Last May, we published our first annual report on sustainable investing at the Bank, which follows TCFD recommendations.16 The report also discusses various methodological changes to the portfolio selection process introduced in 2022. A particularly important one is the adoption of forward-looking criteria. So far, the ESG indicators used to guide our investment choices (to ‘tilt’ our portfolios towards sustainable firms) have been backward-looking measures of certain quantities (ESG scores, carbon intensity) at previous dates. However, as I argued above, if investment strategies are to sustain the green transition, they must be directed toward those issuers that make credible long-term plans and commitments to reduce their environmental footprint. For this reason, we added companies’ de-carbonization plans to the standard indicators. Specifically, we tilt our portfolio allocation in favour of companies that have adopted a transition plan compliant with the criteria set forth by the SBTi. Moreover, the Bank will set up a thematic investment portfolio made of companies enabling the transition, such as those in the infrastructure, renewables, energy efficient solutions and green building sectors. While we argue in the report that each one of the letters of the ESG acronym deserves attention, the choice to focus on SBTi transition plans underlines the belief that today there are reasons to give some pre-eminence to the E, and in particular to the measures of carbon intensity.17 The use of forward-looking indicators opens up new problems and questions. For instance, should the distinction between brown and green firms be based on a firm’s current carbonic footprint or (also) on the existence and credibility of its transition plan towards decarbonization? can we make sure that firms stick to their transition plans? What should be done if they do not? How to discriminate between deviations forced by events outside the control of the firm, and those due to a deliberate but covert choice to disown the plan? We are also initiating a dialogue with the companies we invest in, aimed at gathering information on sustainability strategies and on the results achieved so far. The objective is twofold: on the one hand, to strengthen our understanding of sustainability risk and reduce the portfolio’s transition risk; on the other hand, to meet our strategic goal of contributing to spread the ESG culture, and nudge firms we invest in to consider adopting a pro-active stance on de-carbonization. We are constantly monitoring how the risk-return profile of our portfolio evolves in response to the implementation of our sustainable investment strategy. To sum up, in its role as investor Banca d’Italia faces problems and makes choices that have many points in common with those of private investors. For this reason, our interest in the issues that I mentioned in this paragraph and in the previous one is all but academic. We stand ready to adjust our approach as knowledge evolves. 4. Concluding remarks My choice to focus on sustainability issues did not do justice to the various strands of work represented in today’s workshop, which are equally important. Let me therefore conclude with a few remarks on the topics addressed by these papers. Two contributions are about investment funds. In recent years investment funds have been among the key drivers of the expansion of non-bank financial intermediaries (NBFIs), which in turn account for virtually the entire growth in financial assets in the euro area since 2008. Today NBFIs hold more than half of total financial assets in the euro area. For central banks, the analysis of NBFIs is therefore very important. Recently, the non-bank sector has been carefully considered by the ECB in its Strategy Review,18 which focused its analysis on how NBFIs affect the transmission of monetary policy. As NBFIs also have relevant implications for financial stability, they are constantly monitored by the FSB.19 Some of their fragilities became very apparent during the episodes of financial turbulence connected to the COVID-19 crisis. Central banks and governments intervened promptly, avoiding an escalation. However, these episodes rekindled efforts to improve the macroprudential framework, to ensure that NBFIs, and particularly investment funds, become more resilient to shocks. According to the International Monetary Fund, boosting the resilience of investment funds is a financial stability priority.20 One of today’s presentations is about a possible new macroprudential tool: a joint stress-testing instrument that would yield an assessment of the stability of the investment fund sector and of the potentially destabilizing interconnections with banks. The other paper on investment funds will discuss how the money-market-fund reforms undertaken in the US spilled over to other jurisdictions by generating large re-allocations of money. This is another topic at the forefront of policy discussions: international cooperation aimed at avoiding regulatory arbitrage is a prerequisite of any effort to strengthen investment funds. The programme of the workshop includes several other very interesting contributions that use state-of-the-art technology (including machine learning) to analyse asset-pricing topics such as sovereign risk, the interplay between market inefficiencies and long-term investments, and the impact of macroeconomic trends on equity markets. All of these topics are important to central banks. Correctly interpreting the evolution of market prices is essential for the conduct of monetary policy: central banks need to understand how their decisions affect asset prices, which in turn are a key source of timely information about agents’ expectations. In particular, disentangling risk premia from agents’ expectations continues to be a top priority in the research agendas of central banks. For example, we constantly monitor inflation swaps and other inflation-linked instruments to check the anchoring of expectations to the ECB’s medium-term target.21 But the prices of these instruments are significantly affected by timevarying risk premia, which need to be accurately estimated in order to draw policy conclusions. This kind of exercise is more important than ever in the current environment of elevated inflation pressures. I am confident that this workshop will yield new insights on several topics that are highly relevant for investments and for policy-making. I want to thank LTI, the organizers, the keynote speaker, the panelists, presenters, discussants, and all of you in advance. I wish you a pleasant and constructive day of discussion. Notes 1. Ignazio Visco (2021) “The G20 Presidency programme on Sustainable Finance”. Remarks by Ignazio Visco Governor of the Bank of Italy, OMFIF Sustainable Policy Institute symposium webinar, 30 September 2021. 2. During the Italian presidency, the IMF and the Interagency Group on Economic and Financial Statistics were asked to consider climate-related data needs in preparing a new Data Gap Initiative. The Financial Stability Board was requested to make recommendations on how to improve climate-related financial risk disclosures and close data gaps. The G20 Sustainable Finance Study Group (G20 Sustainable Finance Working Group, 2021 Synthesis Report), co-chaired by China and the US, was re-established. The Study Group quickly gathered inputs provided by international organizations and delivered a Synthesis Report, which proposes a set of recommendations to make progress in three main areas: 1) improving the comparability and interoperability of approaches to align investments to sustainability goals; 2) overcoming information challenges by improving sustainability reporting and disclosure; 3) enhancing the role of international financial institutions in supporting the goals of the Paris Agreement. 3. Our work covers the sustainability-related aspects of monetary policy, supervision, regulation, financial stability, financial education, market operations and payment systems. We also actively contribute to the analysis of these issues ongoing at the European and international level. 4. For a broader perspective see Ignazio Visco, op. cit.; Luigi Federico Signorini (2022), “Sustainable investment choices: emergencies and transition”, speech by Luigi Federico Signorini Senior Deputy Governor of the Bank of Italy, Centesimus Annus Pro Pontifice Foundation, Venice, 11 June 2022. 5. Guido Giese, Zoltán Nagy, and Linda-Eling Lee (2021) “Deconstructing ESG Ratings Performance: Risk and Return for E, S, and G by Time Horizon, Sector, and Weighting” The Journal of Portfolio Management, vol. 47, issue 3, February. See also Timo Busch, Matthew Johnson and Thomas Pioch (2020) “Corporate carbon performance data: Quo vadis?” Journal of Industrial Ecology, 26, 350-363. The authors compute correlation coefficients among individual firms’ carbon emissions scores provided by different data providers. Whereas correlations for Scope 1 and 2 emissions lie systematically above 0.90, those for Scope 3 are in the range 0.40-0.60, and as low as 0.20. See also Frederic Ducoulumbier (2021) “Understanding the importance of Scope 3 emissions and the implications of data limitations” The Journal of impact & ESG investing, vol. 1, issue 4. 6. See the climate stress test results recently released by the ECB. See also Cristina Angelico, Ivan Faiella, Valentina Michelangeli (2022) “Il rischio climatico per le banche italiane: un aggiornamento sulla base di un’indagine campionaria” Banca d’Italia, Note di stabilità finanziaria e vigilanza N. 29, giugno 2022. 7. The industry-led, UN-convened Net-Zero Banking Alliance brings together banks worldwide representing about 40% of global banking assets, which are committed to aligning their lending and investment portfolios with net-zero emissions by 2050. The SBTi initiative is a no-profit organization that promotes best practices and provides technical assistance and audit services to companies who set ambitious emission-reduction targets. 8. See, e.g., Marcin Kacperczyk and José Luis Peydró (2021) “Carbon Emissions and the BankLending Channel” CEPR Discussion Paper Series, DP16778. 9. See the meta-study by Clark G., Feiner A. and Viehs M. (2015) “From the stockholder to the stakeholder: How sustainability can drive financial outperformance” University of Oxford and Arabesque Partners. 10. The so-called Greenium. See, e.g., Sebastian Meyer, Karim Henide (2021) “Searching for ‘Greenium’” IHS Markit. See also Danilo Liberati and Giuseppe Marinelli (2021) “Everything you always wanted to know about green bonds (but were afraid to ask)”, Occasional Papers, 654, Banca d’Italia. 11. Patrick Bolton and Marcin Kacperczyk (2020) “Carbon Premium Around the World” CEPR Discussion Papers, 14567. 12. See Pástor, Ľ., Stambaugh, R.F. and Taylor, L.A. (2021) “Sustainable investing in equilibrium” Journal of Financial Economics, 142(2), pp. 550-571. 13. See Pástor, Stambaugh and Taylor (2021), op. cit.; Abiry, R., Ferdinandusse, M., Ludwig, A. and Nerlich, C. (2022) “Climate Change Mitigation: How Effective is Green Quantitative Easing?” CEPR Discussion Paper No. DP17324. The extent of the crowding out effects is influenced by the correlation between the returns on green and brown assets and the dispersion in ESG preferences. 14. Although the evidence on the effect of carbon pricing on the real economy is not conclusive, some empirical analyses find very small or nil negative effects on economic activity and job creation. See Metcalf, G. E. and J. H. Stock (2020), “The Macroeconomic Impact of Europe’s Carbon Taxes” NBER Working Papers 27488, National Bureau of Economic Research. 15. Banca d’Italia (2021) Responsible Investment Charter of the Bank of Italy. 16. Banca d’Italia (2022) Rapporto sugli investimenti sostenibili e sui rischi climatici, May 2022. 17. Carbon intensity measures are relatively easy to collect, compute, harmonize, compare and audit (the emphasis is on the adverb, in light of the issues with Scope 3 emissions I discussed above). Furthermore, they are directly related to the largest threat currently faced by the environment. 18. Isabel Schnabel (2021) “The rise of non-bank finance and its implications for monetary policy transmission” Annual Congress of the European Economic Association (EEA), Frankfurt am Main, 24 August 2021. Work stream on non-bank financial intermediation (2021) “Non-bank financial intermediation in the euro area: implications for monetary policy transmission and key vulnerabilities” ECB Occasional Paper Series, 270 / September 2021. 19. The FSB created a system-wide monitoring framework to track developments in NBFIs in response to a G20 Leaders’ request at the Seoul Summit in 2010. 20. Kristalina Georgieva (2021) “Financial Stability Priority: Boosting the Resilience of Investment Funds” IMF Managing Director Launch event for “Investment Funds and Financial Stability” paper. 21. Fabio Panetta (2022) “Patient monetary policy amid a rocky recovery” Speech by Fabio Panetta, Member of the Executive Board of the ECB, at Sciences Po, 24 November 2021.
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Speech by Ms Alessandra Perrazzelli, Deputy Governor of the Bank of Italy, at the International Finance & Banking Society IFABS 2022 Naples Conference, University of Naples "Federico II", Naples, 7 September 2022.
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International Finance & Banking Society IFABS 2022 Naples Conference Speech by Alessandra Perrazzelli Deputy Governor of the Bank of Italy Challenges for the evolving financial system: the balance between resilience and adaptability University of Naples ‘Federico II’ 7 September 2022 1. The financial system and innovation technologies – recent developments: Risks and Opportunities 2. Intermediaries looking for a balance between resilience and adaptability: 3. 4. – ‘Coopetition’ – New business models The main drivers of innovation in the financial system (deep dive analyses in the Bank of Italy): – Artificial Intelligence (AI) – Machine Learning (ML) and credit scoring – Digital currencies – Crypto-assets and Defi Artificial Intelligence (AI) – Machine Learning (ML) and credit scoring – Regulation – Innovation facilitators – Research and Academia 1. The financial system and innovation technologies – recent developments: FinTech is – with climate change – one of the structural trends most affecting and shaping the global financial system. Digitalization is leading to profound changes in demand and supply for financial products and services. Innovation technologies are reshaping business models, developing new payment and financial services, restructuring the value-chains, and influencing consumers’ habits and producers’ organizational structures. Moreover, COVID-19 has been a catalyst for this change, pushing financial institutions to increase their investments in innovation technologies. Intermediaries are increasingly using new technologies, such as artificial intelligence, cloud storage and computing, and robotics to reduce costs and offer new services. The spread of internet connections and mobile devices, the increased availability of information about users and the lower cost of automatic data processing are opening up the financial sector to innovative business models. Newcomers – such as FinTech companies, third-party providers, start-ups and Big Techs – have arrived in the financial sector, changing relationships with clients and offering tailored-made products. Let’s think about payments, which were once the preserve of banks and credit card companies and are now shifting outside the ‘regulatory perimeter’, or about lending, as the number of non-bank platforms increases and Big Techs are expanding their supply, especially in some countries (China, Kenya). This greater competition can yield greater efficiency, lower prices and revenue diversification. Consumers are increasingly interacting with banks through digital channels. They require simple, fast and cheap solutions. The use of apps and digital platforms to pay, borrow, invest or underwrite insurance contracts is growing. In particular, young customers (e.g. the millennials and generations Y and Z) require progressively more customized and integrated services usable through apps and ‘super-apps’. Digitalization can increase the financial inclusion of previously underserved groups of consumers, easing their access to financial services. Public institutions and authorities are leveraging digital innovations to fulfil their mandates, including combating money laundering and terrorism financing and preserving financial and monetary stability. Alongside important opportunities, digitalization poses considerable challenges for traditional intermediaries and for regulatory and supervisory authorities. The former need to keep up with the increased competition, as mentioned before, and with new kinds of risks, as well as the evolution of the traditional ones, such as cyber and operational risks, associated with the digitalization of financial services. I am also thinking about governance, profitability, capital adequacy, compliance and financial stability in a broader perspective. Moreover, many of these risks are cross‑sectoral in nature, and they therefore require coordination and cooperation with other international fora and standard-setting bodies. One example is how digitalization makes financial and payment services more efficient, but increases their vulnerability to operational risk and in particular to cyber‑attacks on the critical infrastructures powering payment systems and financial markets, including up‑and‑coming DLT-based infrastructures. The vulnerability of financial and payment systems to hacking and theft increases financial crimes, such as money laundering and other illegal activities, at cross-border level as well. The authorities need to reconcile the promotion of innovation with the need to safeguard consumers and investors, avoid the exclusion of or discrimination against less digitalized users, ensure the proper functioning of market infrastructures and payment systems, and preserve the safety and stability of the financial system and the economy as a whole. Over the next few years, these challenges may call for a profound reshaping of our supervisory methodologies and toolkit and for substantial investments in new skills. It is extremely important that supervisors develop proper competencies to understand the risks (IT, operational, reputational, but also in terms of strategic/business model risk) that may arise for the supervised entities. 2. Intermediaries looking for a balance between resilience and adaptability: In this challenging environment, reaching a balance between adaptability and resilience is becoming an extremely important task for the financial system as a whole. In preparing this speech and reflecting on the terms ‘resilience’ and ‘adaptability’, I recalled how the natural sciences often define intelligence as the ability to ‘adapt’ to new situations and to change behaviour on the basis of the ‘obstacles’ in the external environment. Therefore, being ‘resilient’ to the difficulties in the external environment and ‘adapting’ in order to be able to take advantage of opportunities also arises in contexts very different from the financial system, and probably not by chance. The financial system is probing its own ability to adapt to new situations, such as those emerging with the spread of technological innovation, by developing new forms of cooperation and competition, new business models, and striking a balance between adaptability and resilience. ‘Coopetition’ Focusing on financial intermediaries, there is no doubt that technological innovation is one of the main drivers of evolution in the industry. Technological innovation allows the bank to be part of a broader and more interconnected ecosystem, based on the interaction and sharing of projects and information with innovative companies. A rich and complex ecosystem, where players may set up several forms of relationships: from direct competition – with the consequent general reduction in traditional sources of income for incumbents – to forms of more or less advanced cooperation, on the basis of the choices of each intermediary. The ultimate aim is reaching customers through new and diversified channels, with innovative services becoming faster, easier, cheaper and more accessible. As the Bank of Italy, in our role as Supervisor of the financial system, we are indeed interested in understanding how intermediaries are moving, in order to fully assess the impact of new technologies on the sound and prudent management of the institutions and, more broadly, on the financial stability of the whole system. In this regard, we observe that many strategic plans of the main Italian banks have digitalization as one of their pillars. Through solutions (mainly based on cloud technologies, BigData, Machine Learning and Artificial Intelligence), they are developing many projects, referring to several areas, such as consultancy for investments, customer due diligence, anti-money laundering and payment services. In order to carry out the transformation projects, the main Italian banks are mostly adopting two operating methods: 1. on the one hand, the progressive strengthening of strategic skills in the IT sector, through the internalization of higher added value professionals and the creation of centres of excellence; 2. on the other hand, the search for strategic agreements with leading and established IT and FinTech companies, aimed at the construction of platforms and infrastructures. In a national and system-wide perspective, as highlighted in the recent survey by the Bank of Italy,1 FinTech technologies are spreading in the Italian financial industry: expenditure on FinTech technologies for 2021-2022 has grown compared with the previous two-year period and – above all – the number of investors and projects has also increased, suggesting a higher rate of adoption of innovative technologies within the financial system. It is worth noting that intermediaries have developed an investment model that also involves direct investment in FinTech companies; in addition, 80 per cent of the projects covered by the survey are developed with the collaboration of third-party companies/ institutions or by entrusting them with the entire implementation of the project. For intermediaries, the use of collaborations and partnerships mainly responds to the need to acquire advanced technologies – not otherwise available internally – and to speed up the implementation of the project and reduce the time to market of the initiatives. Business models In this context of strong innovation, the search for a balance represents one of the main challenges that operators are facing, also in light of new business models that may emerge. Trends like open banking and the rise of a platform economy are changing banking value chains. New technologies, from DLTs and smart contracts to cloud computing, make it possible to entirely digitalize new processes from end to end and enable the creation of new business models. New players are usually well positioned to leverage on data and advanced technologies to increase their footprint in the financial landscape. 2021-FINTECH-INDAGINE.pdf (bancaditalia.it) Let’s think about Open banking – an open and digital ecosystem that allows the exchange of data and information, not only of a financial nature, between the operators that are part of it.2 Why is this topic important for micro-prudential supervision? Given its innovative nature, it raises several points of attention for financial entities that should be properly understood by supervisors. Focusing on the strategic dimension, Open Banking is pushing intermediaries to develop and adopt new business models in order to extend revenue opportunities. It is in the interest of all stakeholders to understand the key factors of the innovative approaches that prove to be successful.3 Let’s also look at new business models that could emerge from the digital platforms, namely technical infrastructures linking customers with financial institutions that are rapidly emerging as key actors in the financial landscape. ‘Platformization’ often implies that the bank-customer relationship is mediated by other regulated or unregulated entities managing the platform. Examples include marketplaces (e.g. deposit marketplaces) or even e-commerce portals distributing financial services, which are ancillary to their core business; Big Techs play a significant role in this space. Many authorities and stakeholders are addressing this issue, striving to increase their knowledge of this important phenomenon, raising interest from different perspectives. Today I want to focus on one perspective: the microprudential one. The EBA published a first Report4 in September 2021, providing an initial taxonomy of the main business models observed. A crucial finding of this analysis is that regulators and supervisors do not yet have sufficient information on platforms and on their relationships with banks. Thus, properly and systematically mapping the use of digital platforms by supervised entities and, more generally, the platformization of the financial ecosystem, are indeed essential. In a business model perspective, platforms can help financial intermediaries, specifically the traditional ones, in providing new products and services to their clients and/or increasing their customer experience, thus representing a way to support the viability and sustainability of business models.5 In the meantime, the reliance on digital This paradigm is usually associated with the use of the Open API, which allows an application to have access to the data of financial intermediaries and which therefore allows the exchange of information between different operators (financial intermediaries, technical suppliers, other non-financial parties) The functioning of the ecosystem is even more complex due to the presence of TPPs with the freedom to provide services without establishment, located in other jurisdictions than the European Union, and of Big Tech companies that are currently acting as purely technical service providers, but that might decide to have a bigger role in the financial ecosystem. https://www.eba.europa.eu/sites/default/documents/files/document_library/Publications/ Reports/2021/1019865/EBA%20Digital%20platforms%20report%20-%20210921.pdf For example, digital platforms facilitate access to financial services, the matching of customer preference (e.g. in terms of ‘search for convenience’), support economies of scale, and leverage on network effects, reducing the need for physical premises. Digital platforms also allow innovative business models to be developed that should be monitored and understood by the supervisors. platforms to promote and distribute services introduces strong interdependencies, emphasizing operational, reputational and concentration risks. 3. The main drivers of innovation in the financial system (deep dive analyses in the Bank of Italy): Here at the Bank of Italy, we pay considerable attention to the abovementioned changes experienced in the financial system. We analyse the impacts and the main drivers of innovation, leveraging on the dialogue with operators, analysis, and supervisory and regulatory activities. In this regard, I would like to provide you with some references about AI-ML, digital currencies and DeFis. Artificial Intelligence (AI) – Machine Learning (ML) and credit scoring In the credit market, digitalization involves all stages of the lending process. The growing availability of data on households and businesses and the adoption of advanced techniques based on AI can mitigate information asymmetries between borrowers and lenders, and can improve credit risk assessment. The spread of the internet allows intermediaries to offer traditional financing through digital channels and new services, such as instant lending, based on the automated assessment of creditworthiness. Digitalization also promotes the development of online platforms for loan origination. However, the use of advanced analytical techniques may present risks. The reduced transparency of customer evaluation procedures can generate unlawful discrimination based, for example, on gender or age, with consequent legal and reputational risks for intermediaries. Furthermore, the reliability of the algorithms depends on numerous hypotheses that need to be continually verified. Unchecked biases originating in the various steps of the algorithms’ learning processes can lead to excessive risk for loans. Intermediaries need to exercise constant control of the results produced by these techniques, and we will continue to pay attention to monitor these risks. Digital currencies Moving to the retail payment system, a big change is ongoing, pushed by the diffusion and the implementation of new technologies: in the advanced economies, but also elsewhere; the use of physical cash is declining while digital payment tools are increasing. The demand for and diffusion of international digital assets also used for payments (digital currencies) issued by the private sector, including stablecoins, are rising too. They can bring opportunities on the one hand, but on the other hand they are raising concerns, as their issuers cannot guarantee the certainty of the value of the payment instrument they offer to consumers. Central banks, including the ECB in collaboration with national central banks, are also analysing and considering issuing their own digital currency (central bank digital currency, CBDC) in order to satisfy the emerging and changing needs of people and corporates for digital forms of money. As a central bank, we are actively involved, and we are also assessing the related opportunities and risks. One risk associated with the diffusion of new forms of digital money is that monetary sovereignty could be jeopardized, as these new tools may be used intensively, especially in cross-border payments. In this regard and based on our research,6 in a situation where the stablecoin is widely used, the macroeconomic effects of a standard monetary policy shock (e.g. an unexpected reduction in the monetary policy rate) could be greater or smaller than in a (benchmark) cash economy, depending on how the supply of stablecoin responds to the shock. The less responsive the supply of stablecoins, the more limited the change in overall liquidity following the shock and the associated macroeconomic effects of the monetary policy impulse. The paper also shows that tight regulation of the assets backing the stablecoins and/or the introduction of a CBDC could contribute a great deal to restoring the monetary policy transmission mechanism. This is an example of how research can be relevant and supportive for our functions, identifying the best solutions and predicting the trends, especially in an environment where technologies are introducing significant and fast changes. I believe that, in fields like this one, research, both internal and in cooperation with academia, can be paramount. Crypto-assets and Defi Another important driver of innovation in the financial system is represented by distributed ledger technologies (DLTs). Authorities are currently addressing the trade‑offs relating to the potential diffusion of DLTs and their applications. On the one hand, the use of DLTs can provide significant benefits to financial intermediation, for example by reducing the time and costs of cross-border payments and of trading activities of securities issued using these technologies. However, some applications of DLTs, such as crypto-assets and DeFi, create significant risks regarding, for example, tax evasion, money laundering and terrorist financing, the management and processing of personal data, the correct functioning of the payment system, financial stability and the transmission of monetary policy. The complexity and global nature of these issues make regulatory initiatives at the international level indispensable. An orderly development of crypto‑asset and DeFi ecosystems will benefit from the definition of standards and practices that can act as a benchmark not only for supervised intermediaries but also for all the other players involved. Interest in DLTs and their potential is growing at a fast pace, and a real challenge now for authorities and standards setters is striking a balance between protecting customers, financial stability, market integrity and favouring the adoption of useful, transformative technologies. In order to achieve this balance, knowledge is the first step. As a financial supervisor and overseer of market infrastructures, we are actively engaged in collecting structured https://www.bancaditalia.it/pubblicazioni/temi-discussione/2022/2022-1366/index.html The paper evaluates the domestic and international macroeconomic effects of a monetary policy shock in a standard, mainly cash-based economy and compare it with that in a counterfactual scenario where digital currencies, considering both stablecoins and CBDCs, are more important than cash in providing liquidity services. information on the current activities and the prospective projects of the different players involved. We are continuing to investigate the most significant implications of DLTs for financial intermediaries and infrastructures. As an example, earlier this year, we published some research7 on the interoperability between existing DLT infrastructures for the settlement of transactions involving digital assets. At the same time, we felt the need to provide some useful references to consumers, intermediaries, providers and operators of digital infrastructures in the run-up to the finalization of a European regulatory framework and also afterwards, as the new rules will obviously not cover each and any potential issue. This is why we released a ‘Communication on Decentralized Technology in Finance and Crypto-assets’ in June. The purpose of the communication is twofold. First, to draw the attention of these entities to both the opportunities and risks connected with the use of such technologies in finance and with activities and services relating to crypto-assets. Second, to guide regulated firms in identifying safeguards to mitigate the risks associated with the use of decentralized technologies and/or with crypto-assets. 4. The Bank of Italy’s approach and strategy for FinTtech Regulation As a prudential Authority, we know that regulation plays a crucial role in pursuing the adaptability and resilience of financial markets. Thus, we are actively working at international level to design and implement a robust regulatory and oversight framework to support the public goals that I mentioned earlier. This is the case of the Communication on crypto-assets published by the Bank of Italy to which I referred before. Let me give you another example. In Europe, the co-legislators have recently agreed over the last months on the Regulation on Markets in Crypto-assets (MiCA) and the Regulation on a pilot regime for market infrastructures based on distributed ledger technology. These two regulations represent an attempt to design a comprehensive framework for digital assets. Indeed, the MiCA defines a clear set of rules for crypto-issuers, identifies a clear taxonomy for digital assets, and sets up a supervision architecture including a sanctions regime. With the pilot regime, we allow intermediaries to experiment with new technical solutions for trading digital assets. In both regulations, the co-legislators have tried to achieve a delicate balance between sufficiently flexible rules which do not curb innovation but are adequate for mitigating risks. https://www.bancaditalia.it/pubblicazioni/mercati-infrastrutture-e-sistemi-di-pagamento/ approfondimenti/2022-026/N.26-MISP.pdf Innovation facilitators In order to answer the challenges posed by technology, the Bank of Italy is implementing a clear strategy to support financial institutions and promote the development of a sound and responsible innovation ensuring financial stability and consumer protection. In this contest, resilience and adaptability, the two key words of our conference, play a pivotal role. Let me explain. Our FinTech strategy is based on a twofold approach: 1) implementing a set of innovation facilitators able to cover the entire ‘product life‑cycle’; and 2) promoting dialogue with all stakeholders in order to share good practices and sound common standards. The set of innovation facilitators is composed of three different initiatives: the FinTech Channel, Milano Hub and the regulatory sandbox. The FinTech Channel is the point of contact through which operators can dialogue easily and informally with the Bank of Italy. They can present projects in the fields of financial services and payments, based on innovative technology, or propose technological solutions designed for banks and financial intermediaries. Since its establishment in 2017, the Fintech Channel has received over 120 requests for support. These initiatives involve companies in all phases of their life-cycle (30 per cent developed and 70 per cent start-ups or projects), relating to a broad scope of activities (NPL-credit management, open banking, RegTech, crypto-assets, digital lending) through several and innovative technologies for artificial intelligence, distributed ledger technologies (DLT) and so on. These initiatives are emblematic of the adaptability of the financial sector in Italy. Milano Hub is the innovation centre created by the Bank of Italy to support the digital evolution of the financial market and encourage the attraction of talent and investments. Milano Hub engages innovators in a physical and virtual place in which the Bank of Italy – while respecting its institutional role – aims to accelerate the development of projects and to promote the quality and safety of specific innovations through a series of consulting services, mentorships and educational components for financial intermediaries, startups and research centres. Last year, we launched the first initiative under the ‘Milano Hub umbrella’. It was represented by the ‘Call for Proposals on artificial intelligence’. We selected 10 projects after a rigorous review process and set up a group of experts to support each of the projects selected, usually for a period of six months, to help develop and design the solutions proposed. Now we are finalizing the second call for proposals, and we count on launching the new initiative in the weeks to come. Moreover, in 2021, in close cooperation with the other two Italian supervisory authorities (IVASS and Consob) and with the involvement of the Ministry of Finance, we set up the regulatory sandbox. This facilitator is a controlled environment where supervised entities and FinTech operators will be able to test technologically innovative products and services in the banking, financial and insurance sectors for a limited period of time. The tests will take place in close liaison with the supervisory authorities and will eventually benefit from a simplified transitional regime. Through the sandbox, the supervisory authorities aim to support the growth and development of the Italian FinTech market, thanks to the introduction of innovative models in the banking, financial and insurance sectors, while guaranteeing adequate levels of consumer protection and competition, and safeguarding financial stability. At the same time, the supervisory authorities can observe the latest technological developments and identify the most appropriate and effective regulatory interventions to facilitate the development of FinTech, thereby limiting the spread of potential new risks from the outset. By participating in the sandbox, operators can test innovative products and services in constant dialogue with the supervisory authorities, and can also request that the applicable regulations be waived for the purposes of the test. The Bank of Italy has selected 11 projects so far and we started the experimentation phase at the beginning of the summer. Research and Academia The second pillar of our strategy is a constant and constructive dialogue with market participants. This is a unique and privileged perspective for monitoring changes and trends in the financial market. All the information gathered is a great asset for understanding market dynamics and increasing the awareness of the operators’ needs and strategies, so as to intercept phenomena of interest promptly. Moreover, the dialogue with market participants encourages best practices, i.e. defining common standards and principles in order to encourage the development of sound and sustainable operating models, also with regard to the ‘economic impact’ and to ensure an adequate level of interoperability (and ‘interoperability standards’) between various technological solutions to support decentralized finance and crypto‑asset operations. The goal is to identify and support virtuous and adequately monitored innovation in the financial and payments system, in order to mitigate the risks that it may entail and to maximize the benefits it may provide to the advantage of the economic system and its components: consumers, households, firms and public administration bodies. To this end, the Bank of Italy, together with two Italian universities, is finalizing an initiative for developing common standards for smart contracts. This project aims at establishing a collaboration to promote standards and guidelines for smart contracts relating to the banking, financial and insurance sectors. Indeed, the development of smart contracts must take into account both the technological and the regulatory component, and requires a holistic approach benefiting from contributions deriving from legal, economic and computer science perspectives. The Bank of Italy intends to define standards and guidelines to be implemented according to an ‘open approach’ in order to favour as much sharing as possible, in order to maximize their adoption by potential users and to facilitate their dissemination at both domestic and international level. Conclusion Failure to innovate could undermine our financial and economic system’s competitiveness, posing a serious threat to our enterprises, public administration and households. This is a challenge that we cannot ignore. We are ready to do our utmost to support responsible innovation, where resilience and adaptability are the opposite sides of the same coin.
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Welcome address by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy, at the 5th Bank of Italy-CEPR workshop on labour market policies and institutions, Rome, 15 September 2022.
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Welcome address Luigi Federico Signorini Senior Deputy Governor of the Bank of Italy 5th Bank of Italy-CEPR workshop on labour market policies and institutions Rome, 15 September 2022 It is my pleasure to open the fifth Bank of Italy-CEPR conference on “Labour market policies and institutions”. As in previous editions, we are fortunate enough to have many excellent research papers. The programme covers many recent advances in the field of labour economics and brings together both well-established and younger economists at the frontier of research. The conference will cover a broad range of issues. Let me spend a few minutes on some of them. In this context, I can only mention them very briefly; there will be no attempt to do justice to the vast literature that exists on several of these topics (nor would I be the right person to do so). It will simply be the occasion for me to point at some of the papers in this workshop’s rich programme, and at some ideas we are pursuing in our own research1. Current labour market developments in the US and the euro area At this highly uncertain juncture, certain factors (first and foremost the sharp rise in inflation) are common to many economies; others are not. At the moment, the conditions of the labour market differ rather significantly between the two sides of the Atlantic. The US labour market has been very tight for some time, even after the reversal of the Fed’s monetary policy. After the COVID crisis, the surge in labour demand was not matched by supply; if anything, labour market participation, already on a downward trend, dropped further during the pandemic, and has not fully recovered yet. The vacancy-tounemployment ratio is at a historic high. Firms are experiencing increasing turnover and hiring difficulties and, as we shall learn from one of the papers that will be presented in this conference, this can have a significant impact on investment decisions, employment growth and profits.2 I wish to thank Gaetano Basso and Marta de Philippis for assistance in preparing this speech. T. Le Barbanchon, J. Sauvagnat and M. Ronchi, Hiring Difficulties and Firms’ Growth. In the euro area, and Italy is no exception, labour market conditions, despite a significant (and welcome) recovery, appear less tight than in the US for the time being. While demand actually surged and created labour shortages in some sectors, labour supply has gradually returned to its pre-pandemic level; the unemployment rate is at historical lows, but hours worked have not recovered everywhere.3 The causes of these differences are debated. For the US, at least two points are worth mentioning. First, income support programmes, particularly generous during the pandemic, may have increased workers’ reservation wage, at least temporarily, though the evidence is mixed.4 Second, the adjustment of employment during the pandemic occurred mainly through firing and re-hiring, rather than through job retention programmes, as was predominantly the case in Europe. Therefore, during the recovery, many workers had to be matched with new jobs, not always a smooth process. There is also the question of whether dismissals coupled with temporary income support measures may have encouraged some workers to retire early and if so, whether such retirement decisions are forever. In Europe, job retention schemes are more widespread, and, during the pandemic, extending them was a natural choice in many countries. This may have led to a smoother reversal of layoffs when the health situation improved. Looking ahead, however, it could make workers’ reallocation across firms and sectors less easy, a key issue if the developments of the past few years have accelerated structural change. Time will tell which effect prevails. While the general forces at play may be reasonably known in qualitative terms, rigorous quantitative research is needed to assess their factual relevance and thus to inform the policy debate. I understand, for example, that one paper in this workshop looks at the implications of poor matching efficiency for firms’ productivity differentials.5 This is important. In the US, the imbalance between supply and demand has fuelled steep nominal wage growth. In the euro area, a less tight labour market and certain features of country-specific wage bargaining systems have so far slowed down pay rises: wage indexation – which still exists, though in different forms, in some countries – now plays a more limited role than in the past. In Italy, specifically, collective bargaining agreements nowadays are typically multi-year in duration; furthermore, wages are negotiated based on the price dynamics expected at the time of renewal. This eases immediate cost pressures and delays – at least – the onset of a wage-price spiral like the one that plagued the country more than a generation ago. It was then an inflation-entrenching mechanism: experience shows that, For instance, in Germany, hours worked are still 1.3 per cent below their level at the end of 2019. Among others, see K. Coombs, A. Dube, C. Jahnke, R. Klunder, S. Naidu and M. Stepner, Early Withdrawal of Pandemic Unemployment Insurance: Effects on Earnings, Employment and Consumption, American Economic Review, Papers and proceeding, 2022; A. Dube, Early withdrawal of pandemic UI: impact on job finding in July using Current Population Survey, blog post; N. Petrosky-Nadeau and R. Valletta, UI Generosity and Job Acceptance: Effects of the 2020 CARES Act, FRB SF Working paper, 2021; E. Forsythe, L. Kahn, F. Lange, and D. Wiczer, Where have all the workers gone? Recalls versus reallocation in the COVID recovery, NBER Working paper, 30387, 2022. L. Coraggio, M. Pagano, A. Scognamiglio and J. Tag, JAQ of All Trades: Job Mismatch, Firm Productivity and Managerial Quality. once it starts, such a spiral is difficult to stop. Having said that, right now policymakers must act promptly and forcefully to counter inflation so that, looking ahead, workers’ purchasing power is effectively and durably protected. Otherwise, this arrangement will be difficult to sustain. The Eurosystem has clearly indicated its determination to do what is needed. Structural issues Ageing and migration In the euro area, labour force participation increased considerably in the past few decades. Various factors contributed to this development, including higher statutory retirement ages and the inflow of migrants, which typically have high participation rates.6 Going forward, longer life expectancy calls for longer working lives. Given the current and projected age structure of the population, however, it seems rather unlikely that increased labour supply among the elderly will fully offset the impact of ageing on the labour force in the next decades. From an economic standpoint, sustained migration can balance the effect of demographics on the labour force and ease the pressure on the labour market. This is already apparent in certain segments of employment, where migrant labour predominates. The issue of migration is highly politically charged in many countries, and it is not appropriate for me to take a stand on the broader political issue. What I think I can say here is that, whatever one’s political preferences, the structure of migration policies can, in practice, make a significant difference in terms of the labour market. Experience appears to show that policies designed to foster cultural and social inclusion and to attract foreign workers who are highly attached to the labour market can increase the efficiency of job matching for.7 A key issue in the debate about migration is the effect of migrant labour on local employment and wages, even if only in the short run; one of the papers in this workshop argues that much depends on competitive conditions in the labour market.8 See F. Carta, F. D’Amuri and T. M. von Wachter, Workforce Aging, Pension Reforms, and Firm Outcomes, NBER Working paper, 28407, 2021; F. Carta and M. De Philippis, Working Horizon and Labour Supply: the Effect of Raising the Full Retirement Age on Middle-aged Individuals, Bank of Italy working paper, 1314, 2021; N. Bianchi, G. Bovini, J. Li, M. Paradisi and M. Powell, Career Spillovers in Internal Labor Markets, Review of Economic Studies, forthcoming; M. De Philippis, The Dynamics of the Italian Labour Force Participation Rate: Determinants and Implications for the Employment and Unemployment Rate, Bank of Italy Occasional Papers, 396, 2017. See M. Foged, J. Nielsen Arendt, I. Bolvig, L. Hasager, G. Peri, Language Training and Refugees’ Integration, NBER Working paper, 26834, 2020. Another recent paper (H. Rapoport, S, Sardoschau, A. Silves, Migration and Cultural Change, IZA Discussion paper series 14772, 2021) makes the interesting point that cultural influences seem to run more from the host to the home country than vice versa; in other words, that, as an effect of migration flows, societal values change more in the country of origin of migrants than in immigration countries. M. Amior and J. Stuhler, Immigration and Monopsony: Evidence Across the Distribution of Firms. Women Women can be another large untapped source of labour supply, especially in Italy, the country in the European Union with the lowest female labour force participation rate. This is surely economically wasteful (not to mention other, non-economic considerations). What keeps (or drives) women out of the labour force? The evidence points to the role of motherhood and stresses the importance of supporting female employment after maternity leave.9 In Italy, the probability of exiting the labour market almost doubles just after childbirth and remains steadily higher for the following 15 years.10 Well-designed policies to improve the material conditions of maternity/parenthood are important. In the context of Next Generation EU, the Italian National Recovery and Resilience Plan makes an attempt in this direction by expanding the availability of childcare facilities for children aged between 0 and 6.11 The adoption of more flexible working hours and of family-friendly workplace arrangements, while fostering a better work-life balance for everybody, in practice may specifically favour female labour market participation.12 In this respect, remote working can definitely help. In 2021, almost 14 per cent of employees in Italy worked remotely, up from 2 per cent in 2019;13 this share was especially high for women with children aged 0 to 14. Protecting the vulnerable: dual labour markets, minimum wages, safety nets Trade-offs between flexibility/efficiency on the one side and security/equality on the other are a perennial focal point for the debate on labour market policies. In practice, institutions try to balance different aims in different ways, and with varying degrees of success. Today and tomorrow we are having an academic debate: so my intent here is not to state the Bank’s policy preferences, if any, but to recall, in a very sketchy way, the conceptual framework for some of the interesting papers that will be presented on this subject; or rather, collection of subjects. One of the subjects is the following. In many countries, policy dilemmas have led to the emergence of dual labour markets, with a strongly protected core and a less protected fringe. Temporary or seasonal, or otherwise flexible jobs may be an efficient way to respond to certain features of the production process or, sometimes, to accommodate workers’ preferences. At the same time, discontinuous careers may imply long periods See H. Kleven, C. Landais and J. Sogaard, Children and Gender Inequality: Evidence from Denmark, American Economic Journal: Applied Economics, 2019; A. Casarico and S. Lattanzio, Behind the Child Penalty: What Contributes to the Labour Market Costs of Motherhood, CESifo Working Paper, 9155, 2021. M. De Philippis and S. Lo Bello, The Ins and Outs of the Gender Employment Gap: Assessing the Role of Fertility, Bank of Italy working paper, forthcoming. In particular, the objective is to increase the number of available places for children aged 0 to 6 in childcare facilities and pre-schools by more than 260,000 units. See also Welcome address by Luigi Federico Signorini to the Bank of Italy - CEPR Conference on Labour market participation: Forces at work and policy challenge, 2018. Based on data from Istat, Italian Labour Force Survey, 2019 and 2021. without pay and, often, with little social-security protection;14 they may entail human capital losses that further reduce career prospects. Temporary workers who would like to have a permanent job may not be able to find one because employers try to avoid higher hiring/firing/regulatory costs. The right balance of job protection in various segments of the labour market is a much-debated policy issue. Perhaps less often discussed is the role of market competition (or lack thereof) in determining the equilibrium in the labour market. Interestingly, one paper in this workshop argues that the degree of market power that employers enjoy influences their ability to shift demand uncertainty onto workers by forcing them to accept less protected types of employment.15 Another lively debate concerns statutory minimum wages, an institution that exists in many countries to protect low-wage workers. Italy, as many in the audience will know, has no statutory minimum wage; the constitutional right to “proportioned and sufficient” pay has so far been enforced by the courts indirectly, through reference to collective bargaining clauses. From an economic point of view, the level of the statutory minimum wage is critical: there is, once again, a trade-off between protecting the most vulnerable and avoiding negative employment effects. And, once again, the degree of market competition does appear to matter. In fact, a paper to be presented today argues that the terms of the trade-off depend on the degree of product and labour market power that the employer enjoys.16 In turn, Professor Lindner’s influential contributions explore the issue of the extent to which wage increases can be passed on by firms to consumers via higher prices.17 One final theme is the design of social safety nets. The concern here is to ensure protection from poverty without discouraging participation in the labour market. Market incentives are obviously central to this debate. As an example, a paper that will be presented tomorrow shows that the design of child benefits affects women’s employment.18 Professor Hoynes’ research has also highlighted the labour supply implications of inwork credits, as well as their impact on poverty, health and well-being.19 See F. D’Amuri, I lavoratori a bassa retribuzione in Italia: evidenze descrittive e indicazioni di policy, in C. dell'Aringa, C. Lucifora and T. Treu, Salari, produttività, disuguaglianze. Verso un nuovo modello contrattuale?, Il Mulino, 2017. A. Bassanini et al., Labor Market Concentration, Wages and Job Security in Europe. S. Lo Bello and L. Pesaresi, Equilibrium Effects of the Minimum Wage: The Role of Product and Labor Market Power. See P. Harasztosi and A. Lindner, Who Pays for the Minimum Wage?, American Economic Review, 2019. M. Fjællegaard Jensen and J. Blundell, Income Effects and Labour Supply: Evidence from a Child Benefits Reform. Among many contributions, see N. Eissa and H.W. Hoynes, Taxes and the labor market participation of married couples: the earned income tax credit, Journal of public Economics, 2004; H. W. Hoynes, and J. Rothstein, Universal basic income in the U.S. and advanced countries, NBER Working Paper 25538, 2019; M. Bitler, H. W. Hoynes and D. W. Schanzenbach, The social safety net in the wake of COVID-19, NBER Working paper, 2020; A. Aizer, H. Hoynes and A. Lleras-Muney, Children and the U.S. Social Safety Net: Balancing Disincentives for Adults and Benefits for Children, Journal of Economic Perspectives, 2022. Concluding remarks Time constraints only allowed me to mention a few of the many rich papers and topics in this conference. There is a lot more on the menu. I am sure you can count on two very fruitful days of discussions. Let me conclude by thanking the organisers for their efforts, the presenters and the keynote speakers for their contributions, and all of you for being here to take part in this debate.
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Welcome address by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy, at the launch event for the "Programme for Strengthening the Central Bank Capacities in the Western Balkans with a view to the integration to the European System of Central Banks - Phase II", Rome, 21 September 2022.
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Welcome address Luigi Federico Signorini Senior Deputy Governor of the Bank of Italy Programme for Strengthening the Central Bank Capacities in the Western Balkans with a view to the integration to the European System of Central Banks. Phase II Project launch event Rome, 21 September 2022 Ladies and gentlemen, It is my pleasure to welcome you to Rome and to the Bank of Italy for the second EU-financed project of technical cooperation between the central banks of the ESCB and the Western Balkans. We are delighted to host the kick-off meeting of this new programme, and the first meeting of its Steering Committee. Not only because of geographical proximity, Italy has always had strong cultural, economic and financial ties with the Western Balkans, their peoples and their institutions. At the Bank of Italy, we believe in cooperation among institutions and countries, and in promoting institutional dialogue, in line with the key values of peace, liberty, democracy and the rule of law on which the European identity is based. Through institution building, people who share these aims can meet and exchange ideas, experience and knowledge. This is particularly necessary in times of crisis. We are witnessing right now something we had not seen for a long time and thought, or hoped, was no longer possible: war in Europe, again. Crises, in fact, have always left European institutions stronger in the end. Each of the crises that have hit Europe, like much of the world, since 2008 (the international financial crisis, the sovereign debt crisis, the COVID-19 pandemic, now Russia’s aggression towards Ukraine) has sparked common responses. The ESCB has done its part. Difficult times also tend, if anything, to reinforce the Union’s desire to deepen its ties with neighbouring European countries, with a view to eventual integration. The launch of this project allows us to strengthen our long-lasting commitment to the Western Balkans. Many of the ESCB’s central banks are taking part in this initiative. The support of the European Union is fundamental; the fact that this project is set in the wider framework of EU accession makes it particularly significant. In the last few years, the Bank of Italy has taken part in several cooperation projects aimed at the Western Balkans. This has included single-country initiatives, such as the Twinning programmes with the Bank of Albania, and the regional ESCB programme we are discussing today. In Phase I, as you are surely aware, we organised several training events (on banking supervision, payment systems and monetary policy) and bilateral activities (with the central banks of Kosovo and Serbia). We are happy to provide our continued support in Phase II. We plan to offer four training events, eight bilateral activities and one internship; we also expect to cooperate in events organised by other NCBs. The enlargement of the EU is a challenging process. It requires a clear engagement on the part of domestic institutions, including of course central banks, towards building the institutional and technical foundations for monetary policy, the exchange rate regime and financial supervision. Our colleagues from the central banks of Albania, Bosnia-Herzegovina, Kosovo, Montenegro, North Macedonia and Serbia have left no doubt as to their full commitment. On our part, we at the Bank of Italy and the whole ESCB stand ready to play our role. We are confident that the project we are starting today will reinforce our common determination. On behalf of Governor Visco and the other members of the Board of Bank of Italy as well, I would like to thank all the participants in the project and in this meeting, and the Deutsche Bundesbank in particular, for all their efforts in the preparation of the project; and I wish you all every success. Designed by the Printing and Publishing Division of the Bank of Italy
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Welcome address by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy, at the legal conference on "An EU Legal Framework for Macroprudential Supervision through Borrower-Based Measures", Rome, 23 September 2022.
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Welcome address Luigi Federico Signorini Senior Deputy Governor of the Bank of Italy An EU Legal Framework for Macroprudential Supervision through Borrower-Based Measures Rome, 23 September 2022 Ladies and gentlemen, This seminar takes place while the European Commission is working on improving the EU macroprudential framework for the banking sector. A legislative proposal may be submitted by the Commission to the European Parliament and to the Council in the first half of 2023. The purpose of this seminar is to stimulate a debate on the initiatives foreseen by the Commission in the field of borrower-based measures (‘BBMs’). Allow me to start this discussion with a few considerations on the current situation, and some very tentative reflections about possible choices for the future.1 Macroprudential policy and monetary policy Macroprudential policy has been defined as the use of primarily prudential tools to limit systemic risk.2 Central to this definition is the notion of systemic risk—the risk of disruptions to the provision of financial services as a result of the impairment of all or parts of the financial system, which can cause serious negative consequences for the real economy. By mitigating systemic risk, macroprudential policy ultimately aims to reduce the frequency and severity of financial crises, contributing to overall macroeconomic stability. Macroprudential policy seeks to increase the resilience of the financial system to aggregate shocks by building buffers that absorb their impact, thereby preserving its ability to provide credit to the economy. It can limit the build-up of systemic vulnerabilities over time, by reducing the procyclical feedback between asset prices and credit developments and by containing unsustainable increases in leverage and volatile funding. In addition, I wish to thank Emilia Bonaccorsi, Federica Ciocchetta, Wanda Cornacchia, Alessio de Vincenzo and Giuseppe Napoletano for their valuable input and comments. IMF 2013, IMF-FSB-BIS 2016. in the structural or ‘cross-sectional’ dimension, macroprudential policy can seek to control the build-up of vulnerabilities within the financial system that arise through both interlinkages between financial intermediaries and individual institutions playing a critical role in key markets, which can make them too important to fail. To the extent that macroprudential policy reduces systemic risks and creates buffers, it helps monetary policy achieve its goals in the wake of adverse financial shocks. Thus, macroprudential policy can reduce the burden on monetary policy to ‘lean against’ adverse financial developments, thereby creating greater room for manoeuvre for the central bank to pursue price stability. In such circumstances, monetary and macroprudential policies reinforce each other in a rather obvious way.3 Circumstances, however, are not always the same. Monetary policy is common to all euro-area countries and markets and is necessarily conducted in a ‘one-size-fits-all’ manner. It may therefore have undesired side effects on specific markets, or countries, where specific conditions prevail. Macroprudential policy, on the other hand, can, by nature, be made more targeted to address such situations. When monetary policy is loose, for instance, macroprudential measures can be used to mitigate the risk of localised bubbles in certain markets. This is not just a theoretical possibility. In 2021, with monetary policy still very accommodating, several Member States tightened their macroprudential policies to mitigate the risk of localised overheating, especially (though not exclusively) in property markets. This condition does not mean that the two would then work against each other. On the contrary, as long as they are well coordinated, they are still complementary: in such a situation, macroprudential measures facilitate the use of monetary policy, which is more powerful and wide-ranging but also blunter, by mitigating its side effects-just as the targeted complementary probiotic that doctors sometimes prescribe can make an antibiotic treatment more effective. Much of this tailoring has a geographical dimension, because market conditions differ across countries, owing e.g. to residual national regulation or persistent fragmentation in certain markets (e.g. bank lending); nothing more so, however, than measures targeting the real estate market, which is inherently defined by geography—a feature that no legal harmonisation can change. In the case of real estate, given the heterogeneity that may exist within countries, policy-makers may even want to consider measures to be applied on a sub-national basis. In general, national authorities seem to be best placed to evaluate the need for many macroprudential measures. As long as fragmentation remains significant in the relevant markets, a key responsibility for initiating and calibrating macroprudential policy should therefore remain at the national level; for the real estate sector, fragmented by definition, this will probably always be the case. However, there needs to be a common framework, common rules and some centralised checks to ensure coordination, not least with monetary policy, to avoid unwanted spillovers, and to ward off ring-fencing. Visco, 2014 and 2015. Effectiveness of macroprudential policy While macroprudential measures of some kind were occasionally used by supervisors even before the name existed, it is only since 2013 that a systematic framework for such measures has been available in the European Union. The situation is similar in other major jurisdictions. There is therefore only a limited amount of experience and data that research can draw upon to study its effectiveness in quantitative terms; the literature is not yet extensive. That said, what empirical evidence is available does suggest that macroprudential policy instruments, by and large, work as intended. Various studies confirm that measures that restrict lending are generally effective in curbing house prices and credit growth.4 The ECB has recently analysed the impact of capital buffer releases on bank credit supply in the European Banking Union during the pandemic, and found that capital relief measures had positive effects on lending, especially for banks that were close to the combined buffer requirement.5 This finding supports the idea that releasing regulatory capital buffers during periods of stress can mitigate procyclical pressures in the banking system. Capital-based measures make the banking system more robust by reducing banks’ leverage and probability of default; BBMs do the same indirectly, by strengthening borrowers’ resilience.6 Income-based tools (the debt-service-to-income ratio, or DSTI, and the debt-to-income ratio, or DTI) mainly reduce the probability of default, while collateral-based tools (like the loan-to-value ratio, or LTV) act primarily through reducing loss given default. The effect is stronger when LTV, DSTI and DTI caps are imposed jointly. The adoption of more prudent lending standards as a result of BBMs has been found to improve the quality of banks’ mortgage loan portfolios, thereby supporting the capital position of banks. The empirical evidence, however, is not clear-cut in all respects. Some research finds little or no effects of BBMs on lending growth, house prices or household indebtedness.7 Much depends on calibration. Sometimes policies are deliberately calibrated not to be binding at the time of adoption, but to prevent undesired developments later on.8 Moreover, BBMs may affect specific groups, such as banks, borrowers or countries, even Cerutti et al., 2017; Eller et al., 2020. Couaillier et al., 2021. The regulatory capital relief measures considered in the analysis include the reduction of the Combined Buffer Requirement (CBR), as well as the frontloading of new rules on the composition of the Pillar 2 Requirement (P2R), allowing banks to partly use Additional Tier 1 and Tier 2 (instead of CET1) instruments to meet these requirements. In particular, credit volumes increased by 3.1 per cent after the regulatory capital relief measures, while interest rates on loans to firms eased by 7 basis points. Ampudia et al., 2021. See, for Romania, Neagu et al., 2015. This seems to have been the case with the UK Financial Policy Committee’s decision in 2014 to recommend a loan-to-income (LTI) flow limit calibrated to a level that would have no impact on mortgage lending in a central scenario, but would prevent a significant increase in lending at very high LTI multiples (Bank of England, 2014; see also, for Poland, Łaszek et al. 2015). when there is no clear overall effect. These heterogeneous effects are mainly attributable to the introduction of differentiated LTV limits by category of borrowers.9 While several papers investigating the effects of LTV or DSTI caps use a multi-country framework, and policy dummies or macroprudential indices to operationalise the definition of macroprudential policy,10 single-country studies provide a more focused analysis on the impact of these measures. For instance, both one paper on Israel11 and one on Sweden12 found that the introduction of an LTV limit did not reduce the number of borrowers accessing credit; but it did encourage borrowers to borrow less and to buy cheaper and lower-quality houses. There is also some evidence of unintended consequences, such as spillovers (banks shifting risk to other business areas), and circumvention. For example, when Ireland introduced LTV and LTI limits in February 2015, banks appear to have increased their risk-taking in lending to companies and holdings of securities, two asset classes not targeted by the measure.13 In Spain, following a similar measure, appraisers appeared to have started to overvalue property in order to lower LTV figures on loan applications.14 Completing the legal toolkit The current legal framework harmonises capital-based macroprudential measures. It establishes definitions and parameters, as well as rules and procedures for the allocation of responsibilities between national and European authorities. Such measures are subject to a system of EU-level surveillance and, in some cases, authorisations. That system was set up at the very beginning of the European macroprudential experience. National authorities initiate the procedure for national measures. Within the euro area, the ECB reviews them and may ‘top them up’ (i.e. make them more restrictive), while it has no power to ‘level them down’.15 The ECB has defined and published the procedure that it follows when reviewing the national measures.16 A differentiated impact was observed in Israel (Tzur-Ilan, 2017) for the segment of the population investing in housing (but not for primary residence), with a sharp reduction in the value of houses bought after different LTV limits were imposed on different categories of buyers (first-time buyers, non-first-time buyers and investors who own two or more homes). Similarly, in Ireland (Kinghan et al., 2016a and 2016b), the introduction of differentiated LTV caps had heterogeneous effects based on borrower income. See for instance Cerutti et al., 2017; Ahuja and Nabar, 2011. Tzur-Ilan, 2017. Bentzen et al., 2018. Acharya et al., 2018. Montalvo and Raya, 2018. Article 5(2) SSM Regulation (Council Regulation (EU) No 1024/2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions, OJ L 287, 29.10.2013, p. 63). Regulation of the European Central Bank of 16 April 2014 establishing the framework for cooperation within the Single Supervisory Mechanism between the European Central Bank and national competent authorities and with national designated authorities (SSM Framework Regulation) (ECB/2014/17), Articles 101-105 (OJ, L 141, 14 May 2014, p.1). In contrast, BBMs are not harmonised in the relevant legislation. They are thus left to national discretion, in terms of both design and calibration. I have just argued that the case for maintaining the main responsibility for macroprudential policy at the national level is even stronger for measures targeting the real estate market. However, there may also be a case for some degree of coordination or, at least, harmonisation of definitions and statistical reporting requirements. The European Systemic Risk Board (ESRB) has already taken certain steps in this direction. Since 2013, the ESRB has listed LTV, LTI and DTI requirements among the instruments that can be used to prevent and mitigate excessive credit growth and leverage.17 In 2019, the ESRB issued a Recommendation on closing real estate data gaps to provide guidance on the methodology underlying common indicators, specifically targeting the residential real estate market.18 Notwithstanding those initial steps, laws and practices still differ considerably within the EU. The Commission observes in its Consultation document that “[w]hile several Member States are already using BBMs based on national law, a complete set of BBMs is not available in all Member States. This could affect the ability to address systemic risk and create cross-country inconsistencies and difficulties with reciprocity”.19 At the very least, as the ESRB recently stated, common rules on BBMs “could increase the transparency and comparability of macroprudential actions across Member States and thus strengthen overall confidence in the measures”.20 Common definitions and a common taxonomy are needed to harmonise statistical reporting, with a view to ensuring comparability and improving policy analysis. Given persistent differences in local conditions, statistical harmonisation in my view should not go as far as to prevent national authorities from gold-plating reporting requirement. A more granular set of indicators might sometimes be needed to inform national policy decisions in a satisfactory way, though efforts should certainly be made to establish a fully harmonised core set. Should any common taxonomy only be designed for data reporting, or should it also shape the legal framework for BBMs? Not just the calibration, but the very definition of LTV and DSTI limits differ across Member States. To simplify compliance, common Recommendation of the European Systemic Risk Board of 4 April 2013 (ESRB/2013/1) (OJ C 170, 15.6.2013, p. 1). Recommendation of the European Systemic Risk Board of 21 March 2019 amending Recommendation ESRB/2016/14 on closing real estate data gaps (ESRB/2019/3) (OJ C 271, 13.8.2019, p. 1). European Commission, Targeted consultation on improving the EU’s macroprudential framework for the banking sector, p. 10. According to the ESRB, “in some Member States, either legally binding BBMs are missing completely (Greece, Poland) or the set of available instruments is not sufficient to ensure that sources of systemic risk can be mitigated effectively any time in the future (Germany, Finland, Hungary, Liechtenstein, Netherlands, and Norway)” (ESRB, Review of the EU Macroprudential Framework for the Banking Sector - March 2022, Response to the call for advice, p. 13). ESRB, Review of the EU Macroprudential Framework for the Banking Sector - March 2022, Response to the call for advice, p. 15. definitions of the numerator and of the denominator of each ratio would surely be helpful.21 EU legislation is needed if one wants to get there.22 The choice, however, is not entirely straightforward. On the one hand, greater homogeneity in the legal design of measures would reinforce integration by facilitating cross-border lending, and by making reciprocation easier. As things stand now, intermediaries may be subject to different types of BBMs, depending on the Member State(s) where they operate, which significantly complicates cross-border business. On the other hand, local real estate market conditions and regulations do differ, which would call for some country-level flexibility. In a relatively new field, it could also be argued that experimentation with new regulatory ideas, within practical limits, should not be ruled out. An optimal regulatory choice, then, would need to balance different concerns and proceed step by step, perhaps by standardising at the outset the definitions of the more common measures, but (at least temporarily) allowing for some latitude in tailoring national measures to specific needs. Common guidance, as provided for in the case of capital-based measures, would be helpful. Doing nothing now would be a missed opportunity; on the other hand, full convergence might be better regarded as a longer-term aim. A further step would be to set common rules, quantitative limits and procedures, like the ones that exist for capital-based measures. This might be difficult, and possibly unnecessary, right now. What is needed is that the authorities keep an eye on concrete developments, to ensure that harmful spillovers, fragmentation or ‘ring-fencing by other means’ do not emerge;23 and take action if they do. One last comment: wherever the legislative process ends up, along the scale from purely statistical to full legal harmonisation, the rules on BBMs should be as cross-cutting and ‘activity-based’ as possible, i.e. applicable to all lending contracts, whatever category the lending institution belongs to. This is necessary to avoid regulatory arbitrage between the banking and non-banking sectors.24 * * * As the ESRB highlighted “for example, six countries (Denmark, France, Ireland, Malta, Netherlands, Norway and Sweden) use gross income to define income-related measures, while other Member States use income in net terms. Three countries (Austria, Finland and Slovenia) use a broad definition of collateral value for the purpose of the LTV limits, while in other countries this is restricted to real estate.” (ESRB, Review of the EU Macroprudential Framework for the Banking Sector - March 2022, Response to the call for advice, p. 13). Banca d’Italia used gross income to define income-related measures when it issued its rules on BBMs last February. Under Article 513 of the CRR, “harmonised definitions” of BBMs “and the reporting of respective data at Union level are a prerequisite for the introduction of such instruments” (paragraph (1)(d)). Hartmann, 2015. In that respect, the legal acts already available are the Mortgage Credit Directive (Directive 2014/17/EU of the European Parliament and of the Council of 4 February 2014 on credit agreements for consumers relating to residential immovable property and amending Directives 2008/48/EC and 2013/36/EU and Regulation (EU) No 1093/2010) and the Consumer Credit Directive (Directive 2014/17/EU of the European Parliament and of the Council of 4 February 2014 on credit agreements for consumers relating to residential immovable property and amending Directives 2008/48/EC and 2013/36/EU and Regulation (EU) No 1093/2010). These, as I said at the outset, are very provisional reflections (and, as such, they should not be taken as an official statement of the position of Banca d’Italia). I am sure that the discussions in this seminar will help clarify some of the economic and legal issues I have briefly mentioned, and provide intellectual food for further thoughts about the best path ahead. Let me conclude by thanking the organisers, not least for having put together such a distinguished panel of speakers, and all the participants. I wish you all a very fruitful discussion. REFERENCES Acharya, V., Bergant, K., Crosignani, M., Eisert, T. and McCann, F. (2018), “The Anatomy of the Transmission of Macroprudential Policies: Evidence from Ireland”, Working paper presented in several meetings but not published. Ahuja, A. and Nabar, M. (2011), “Safeguarding Banks and Containing Property Booms: Cross-Country Evidence on Macroprudential Policies and Lessons from Hong Kong SAR”, IMF Working Paper Series, No 11/284, International Monetary Fund, December. Ampudia, M., Farkas, M., Lo Duca, M., Perez Quiros, G., Pirovano, M., Runstler, G., Tereanu, E., “On the effectiveness of macroprudential policy”, ECB Working Paper N. 2559, May 2021. Also in www.suerf.org/policynotes SUERF Policy Brief, N.159. Angelini P., Nicoletti Altimari S. and Visco I (2012), “Macroprudential, microprudential and monetary policies: conflicts, complementarities and trade-offs”, Occasional Papers Series, N.140, Banca d’Italia, November. Angelini, P., Neri, S. and Panetta, F. (2014), “The Interaction between Capital Requirements and Monetary Policy”, Journal of Money, Credit and Banking, Vol. 46, N.6, September, pp. 1073-1112. Bank of England – Financial Policy Committee meeting June 2014 https://www.bankofengland. co.uk/-/media/boe/files/record/2014/financial-policy-committee-meeting-june-2014.pdf Bentzen, C., Andersen, H. and Hviid, S. (2018), “Impacts of 2016 guidelines on mortgaging of homes”, Danmarks Nationalbank Analysis, N.18, November. Burlon, L., Gerali, A., Notarpietro, A. and Pisani M. (2018), “Non-standard monetary policy, asset prices and macroprudential policy in a monetary union”, Journal of International Money and Finance, vol. 88, pp. 25-53. Cerutti, E., Claessens, S. and Laeven, L. (2017), “The use and effectiveness of macroprudential policies: New Evidence”, Journal of Financial Stability, Vol. 28, issue C, pp.203-224. Couaillier, C., Lo Duca, M., Reghezza, A., Rodriguez d’Arci, C. and Scopelliti, A. “Bank Capital Buffers and Lending in the Euro Area during the Pandemic.” ECB Financial Stability Review, November 2021. ECB (2021), “The role of financial stability in the ECB’s new monetary policy strategy”, Financial Stability Review, November. Eller, Markus, Martin, Reiner, Schuberth, Helene and Vashold, Lukas, (2020), Online supplement to “Macroprudential policies in CESEE – an intensity-adjusted approach”, Focus on European Economic Integration, issue Q2/20. Fahr S. and Fell J. (2017), “Macroprudential policy: closing the financial stability gap”, Journal of Financial Regulation and Compliance, Vol. 25, Issue 4, November, pp. 334-359. Hartmann P. (2015), “Real Estate Markets and Macroprudential Policy in Europe”, Journal of Money, Credit and Banking, Supplement to Vol. 47, No. 1 (March–April 2015). IMF, 2013, “Key Aspects of Macroprudential Policy” IMF-FSB-BIS, 2016, Elements of Effective Macroprudential Policies - Lessons from International Experience Kinghan, C., Lyons, P., McCarthy, Y. and O’Toole, C. (2016a), “Macroprudential Measures and Irish Mortgage Lending: Insights from H1 2016”, Economic Letter Series, Vol. 2016, N.6, Central Bank of Ireland. Kinghan, C., McCarthy, Y. and O’Toole, C. (2016b), “The Effects of Macroprudential Policy on Borrower Leverage”, Economic Letter Series, Vol. 2016, N.8, Central Bank of Ireland. Keller A. (2013), “The Possible Distributional Effects of the Loan-to-Value Ratio and its Use as a Macro-prudential Tool by the European Systemic Risk Board, Journal of International Banking Law Review. 28, 7, pp. 266-270. Łaszek, J., Augustyniak, H. and Olszewski, K. (2015) “FX mortgages, housing boom and financial stability – a case study for Poland (2005-2015)”, NBP Working Paper Series, Vol. 1, N.243, Narodowy Bank Polski, pp. 87-103. Lewis V. and Roth M. (2019), “The Financial Market Effects of the ECB’s Asset Purchase Programs”, Journal of Financial Stability, Vol. 43, August, pp. 40-52. Montalvo, J.G. and Raya, J.M. (2018), “Constraints on LTVs as a macroprudential tool: a precautionary tale”, Oxford Economic Papers, Vol. 70, N. 3, pp. 821-845. Neagu, F., Tatarici, L. and Mihai, I. (2015), “Implementing Loan-to-Value and Debt Service-To-Income measures: A decade of Romanian experience”, Occasional Papers, N.15, National Bank of Romania, November. Thiemann M., Stellinga B. (2022), “Between technocracy and politics: How financial stability committees shape precautionary interventions in real estate markets”, Regulation & Governance, John Wiley & Sons Australia. Tzur-Ilan, N. (2017), “The Effect of Credit Constraints on Housing Choices: The Case of LTV limit”, Discussion Paper Series, No 2017/03, Bank of Israel, February. Visco, I. (2014), “The challenges for central banks”, Central Banking. Visco, I. (2015), “Eurozone challenges and risks”, Central Banking.
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Keynote address by Mr Ignazio Visco, Governor of the Bank of Italy, at the conference on "The multiple role of the central banks: new frontiers of the monetary policy", organised by the Fondazione CESIFIN and the Florence School of Banking and Finance of the European University Institute, Florence, 30 September 2022.
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Monetary policy and inflation: recent developments* Ignazio Visco Governor of the Bank of Italy September 2022 In the last year or so, inflation has been sparked almost everywhere by the exceptional increases in the prices of energy commodities. However, the ways in which these increases have taken place and their relative weight with respect to other factors differ widely across countries, in particular when comparing the United States and the euro area. – The most important difference between the two economies probably concerns the fiscal response to the pandemic crisis in 2020-21. Although many countries took budgetary measures on a massive scale to strengthen their health systems and support households and businesses, the measures introduced by the US Administration were exceptionally strong. Over those two years, the debt‑to‑GDP ratio rose by almost 25 percentage points, to over 130 per cent, against an average increase of less than 15 points in euro‑area countries, to around 95 per cent. The support given in the United States had an astonishing effect on households’ disposable income, which, in 2020, recorded its highest rate of growth since the mid-1980s, with a 6.2 per cent increase in real terms, against a drop in GDP of 3.4 per cent. In the euro area, instead, household disposable income fell, by 0.6 per cent, though to a much lesser extent than the decline in GDP (6.4 per cent). The inflationary effects of the ensuing overheating of the US economy were amplified by the still partial recovery of global supply due to the recurring pandemic waves, contributing to the creation of bottlenecks in the international supply chains of intermediate goods, with adverse effects on production in many countries. – A related striking difference concerns the state of the labour market. In the United States, the unemployment rate was just 3.7 per cent last month, almost 3 percentage points less than in the euro area in July. The job openings rate (the number of job openings divided by the sum of employment and job openings) was as high as 7 per * The considerations and references contained in this note constitute the background material for the concluding remarks made by the author at the CESIFIN/EUI Workshop (in Italian) on “The Multiple Role of Central Banks: The New Frontiers of Monetary Policy”, Florence, 30 September 2022. I thank Michele Caivano, Nicola Pellegrini, Massimo Sbracia, Alessandro Secchi and Roberta Zizza for their contributions and suggestions. cent in the United States (in July), twice the level recorded in the euro area (in the second quarter).1 As it turns out, in the United States there are two job openings for each unemployed person, while in the euro area two unemployed persons compete for less than one opening. As a result, all the main indicators (employment cost index, average hourly earnings and the Atlanta Fed’s wage growth tracker) suggest a wage growth close to or above 5 per cent (on a yearly basis) in the United States, a level that is difficult to reconcile with a 2 per cent inflation target. In the euro area, on the other hand, contractual earnings have so far continued to increase at a pace of around 2 per cent. – In the United States, the greater impact of these demand factors has been accompanied by a lower contribution of supply factors. As in the euro area, oil prices are 20 per cent higher than a year ago. Over the same period, however, gas prices have increased by an astonishing 150 per cent in the euro area to around €200 per megawatt hour, a level at which they have been hovering, with very wide oscillations, since mid-June, against 50 per cent in the United States, to less than $30 per megawatt hour (Figure 1). This is particularly worrying because gas plays a key role not only in heating and other domestic uses but also in producing electricity. These differences notwithstanding, headline inflation recorded similar dynamics in the two economies and progressively increased to above 8 per cent both in the United States and in the euro area. However, the trend of core inflation (which excludes food and energy products) was different. In the United States it went above 6 per cent at the beginning of this year and was still 6.3 per cent in August, while in the euro area it was only slightly above 2 per cent at the start of the year and, in August, its level was still 2 percentage points lower than in the United States (Figure 2). The differences in the relative weight of demand factors and in the dynamics of core inflation explain why, in the face of headline inflation reaching similar values, monetary policy normalisation has proceeded with different timing and speed in the two economies. These differences also suggest that assuming that the ECB will follow the Fed blindly in the coming months could be a serious misjudgement. In emphasising the supposed mistake made by the ECB in delaying the change in its monetary policy stance, many commentators have pointed to some errors in inflation projections. While in mid-2021 headline inflation was still below 2 per cent and core inflation was less than 1 per cent, since late last year, inflation has been unexpectedly high in the euro area. In particular, the forecast errors in consumer price growth made by the ECB and Eurosystem staff during the first two quarters of 2022 (Figure 3) have been much larger than those observed in the past (more recently mostly of the opposite sign).2 Some have even argued that these very large errors call into question the credibility of An intense debate about vacancies and unemployment (the so-called Beveridge curve) has been triggered in the United States (where long data series are available for vacancies) following Blanchard et al. (2022); see also Figura and Waller (2022) and Bok et al. (2022). For an evaluation of the ECB forecasting errors since 2001, see Kontogeorgos and Lambrias (2019). A more recent analysis is in ECB (2022). central banks,3 even though other international institutions and private forecasters have made similarly large mistakes. The observed size of the errors may cast doubt on the reliability of the models used for the projections, resulting in a calling for the use of less formal frameworks and more judgmental assessments (although all forecasting models include judgmental factors). We must not forget that econometric models are nothing more than simplified approximations of reality. They cannot mechanically take into account all specific non‑linearities in financial or commodity markets or regime changes in behaviours resulting from health or geopolitical shocks. When defining economic policy measures, they should therefore be used carefully, integrating them with external information and qualitative assessments. However, while they can be subject to continuous checks and improvements as well as better used, we cannot dispose of them, as they are especially useful for a disciplined organisation of the evaluations on which policy measures are based.4 This said, our analyses indicate that the effects of energy prices – the most important exogenous variables, whose changes are inferred from the quotes of futures contracts – explain, directly and indirectly (i.e. via their effects on production costs), 65 per cent of the overall error made in forecasting inflation. This share rises to 80 per cent when the effects of food prices, the other volatile component of the harmonised index of consumer prices, are also taken into account.5 These results suggest that the functioning of the economy has not changed dramatically in the last year or so and that the framework used for projections remains valid overall. They do draw our attention, however, to the quality of the forecasts used as inputs. A key problem has been a generalised underestimation of geopolitical tensions, with the sharp drop in gas supplies from Russia observed since early last year, attributed first (and probably mistakenly) to the effects of a particularly cold winter and then to pressures by the Russian Government in connection with the Nord Stream 2 pipeline. But the most important factor has, of course, been the Russian invasion of Ukraine: while the quotes of futures had continued to factor in descending oil and gas prices up to the end of last year, the conflict has pushed not only current but also expected prices to extremely high levels. Gas prices provide a significant example. At the end of September 2021, when the spot price of gas had risen to €100 per megawatt hour, the quotes of futures had predicted a decline to well below €50 by June 2022. As it turned out, instead of declining by more than 50 per cent, gas prices increased by almost 100 per cent, averaging, as already pointed out, at about €200 since the second half of June. In general, while the repercussions of rising energy prices on inflation were considered as temporary before the outbreak See for example El-Erian (2022) and Wheeler and Wilkinson (2022). For a critical review of quantitative models, forecast errors and their evaluation at the time of the global financial crisis, see Visco (2009). Between mid-February and mid-May 2022, due to the Russian aggression in Ukraine, the price of wheat (and of other agricultural commodities) increased by over 60 per cent. During the summer, following better-than-expected harvests in the United States and, then, the agreement between Russia and Ukraine to allow exports of grain and other agricultural products to resume from selected Black Sea ports, wheat prices gradually declined, approaching their pre-war levels. of war, owing to the expectations of base effects soon turning negative, they instead became persistent. These considerations are emblematic of the difficulties in predicting macroeconomic variables, particularly when driven by non-economic phenomena, like mounting geopolitical tensions. We will have to take this into account if and when, symmetrically, a tendency to make forecast errors of the opposite sign emerges due to the attenuation of these tensions, hopefully in a short time but unfortunately still very uncertain today. Given the information available, the claims that the Governing Council of the ECB has wrongly delayed the re-balancing of its monetary policy appear unjustified. The normalisation of the monetary stance has been under way since last December when, against the background of an improvement in the economic outlook and the rise of medium-term inflation expectations towards the price stability target, the Governing Council announced the start of the reduction of net purchases under its quantitative easing programmes. In the early part of this year, the process gained speed, avoiding, however, potentially dangerous cliff-effects of too sharp a drop, and was completed on the 1st of July. A few weeks later, we started raising the key official rates by a significant size (50 basis points in July and 75 in September), aimed at frontloading the exit from their highly accommodative levels. This radical change in monetary stance mirrors a corresponding sharp change in the economic and inflationary outlook. First, the pandemic fears that drove the economy into recession – not only in Europe – and reduced inflation temporarily to below zero have been overcome. Thanks to the non-conventional monetary policies adopted by the Governing Council, especially its quantitative easing programmes, the risks of deflation have thus dissipated. Moreover, the euro area has been hit by an energy shock of extraordinary magnitude, far greater than the oil price shocks that hit the world economy in the 1970s. The ensuing marked rise in actual inflation cannot be ignored by the central bank: the risk that it could cause an increase in inflation expectations and in turn lead to a futile and damaging spiral between prices and wages should be countered decisively. It is therefore crucial, at this stage, to carefully monitor inflation expectations and the dynamics of wages and profits. Indicators of future inflation measured on the basis of inflation-linked swaps continue to suggest that price dynamics will remain elevated in the near future, at around 5 per cent in mid-2023, and then decline rapidly and persistently to levels just above the 2 per cent target (Figure 4).6 As inflation risk premia are currently estimated to be slightly above zero, the actual medium-term inflation expectations implicit in swap rates could, substantially, be in line to our target. Survey-based expectations provide a broadly similar picture. According to the median respondent in the ECB Survey of Monetary Analysts conducted in late August, inflation is expected to stand at 4.4 per cent, on average, in 2023 and at 2.1 per cent in 2024. At the same time, the median household participating in the ECB Consumers Expectations Surveys foresees inflation at 5 per cent in the next 12 months and at 3 per cent at 3-year See Neri et al. (2022). horizon. This latter level stands somewhat above those of market participants and economic experts, possibly reflecting a greater relevance of backward‑looking elements in the expectation formation mechanism of households. A more granular analysis shows that the upward revision of inflation expectation (over all horizons) has been more intense for less affluent households. The share of the most volatile inflation components, namely energy and food items, in these households’ consumption basket is, however, much higher and may lead them to revise their expectations more frequently and significantly. In other words, the observed rise in expectation from household surveys may simply mirror what is happening in the energy and food sectors, and may therefore be reversed as soon as pressures on the price of these items diminish. Moving on to wages, even though requests have been made in some countries for increases greater than those recorded in recent years, their growth in the euro area remains, as already mentioned, around 2 per cent (net of one-off components). In addition, the ECB forward-looking wage tracker points to a very gradual acceleration of wages in the last part of 2022 and in 2023 (Figure 5), although some tension may arise in countries where wages (especially minimum wages) react almost mechanically to actual inflation. My reading of these data makes me confident that, at the moment, there is no evidence that medium-term expectations are drifting away from the price stability objective, nor are there signs of pernicious spirals between prices and wages. Indeed, the high level of inflation expectations in the coming quarters, reflecting the standard price growth inertia and the persistence of energy prices at very high levels, rapidly declines in the subsequent years, in line with the Eurosystem/ECB’s projections as well as most others.7 Should energy prices prove to be higher than what is currently projected, their negative demand effects via purchasing-power and wealth losses would probably contribute to curbing actual and expected inflation and, in turn, wage requests. In any case, we pay close attention not only to the current levels of price and wage expectations, but also to their prospective dynamics. An assessment of the risk of a de‑anchoring of expectations from the inflation target based merely on their current level could, in fact, be dangerous.8 Since a de-anchoring could occur abruptly and non‑linearly, expectations must be assessed both in terms of their convergence towards the price stability objective as well as their responsiveness to shocks and their dispersion. From this perspective, the evidence is less clear. On one hand, expectations from market data and surveys continue to show a relatively low sensitivity to inflation surprises. On the other hand, in many surveys the distributions of expected inflation tend to be skewed towards high inflation and show an increase in uncertainty, suggesting a greater, though still moderate today, risk of a sharp upward shift of the entire distribution.9 Although these features of expected inflation could be a mere consequence of the repeated upward surprises in actual inflation related to the unforeseen persistence of the energy Looking forward, inflation dynamics are therefore not likely to be persistent. On this issue, see however Schnabel (2022). See Visco (2022). See Neri et al. (2022), Hilscher et al. (2022), Reis (2021) and (2022). shock, these developments need to be monitored carefully. However, the fact that the “expectations curve” is downward sloping is reassuring for anchoring, as medium to long-term inflation expectations remain well below current inflation levels. While the normalisation of monetary policy should continue with the aim of gradually reabsorbing the ample accommodation created since 2014, the Governing Council is currently faced with a difficult dilemma. Rising inflation is now being accompanied by a sudden deterioration in the economic growth outlook, reflecting the loss of purchasing power of incomes (Figure 6). In this context, excessively rapid and pronounced rate hikes would end up increasing the risk of a recession. Moreover, should the deterioration of the economic outlook turn out to be worse than expected, an excessive front-loading in the normalisation of key rates could ex post result disproportionate, something that could seriously undermine public confidence in our ability to make well-considered decisions and that would paradoxically make it more difficult to maintain price stability over the medium term. This is a risk that deserves to be considered carefully, along with that of letting inflation remain excessively high for too long. A further concern is related to risks to financial stability. In the current context, these risks are amplified by the rapidly deteriorating economic environment, both in the euro area and beyond. Moreover, the marked rises in official rates being announced by all major central banks may create spillover effects that are difficult to quantify but are likely not to be negligible.10 The risk of financial instability is particularly relevant in the Economic and Monetary Union, whose incomplete architecture – especially its decentralised fiscal policy and the delays in completing the banking and the capital markets unions – exposes it to a possible fragmentation of financial markets along national borders. If this risk were to materialise, we would see severe repercussions in all euro area countries, leading to a tightening of financing conditions well beyond what is deemed appropriate for curbing high inflation. For this reason, the Governing Council is ready to continue to exploit the flexibility in its asset purchase programme related to the pandemic emergency and to resort to its new Transmission Protection Instrument, to prevent financial markets tensions from counteracting any progress made in price stability and hindering economic growth. The uncertainty surrounding the economic and inflation outlook makes it very difficult to predetermine the possible terminal point of official rates. One shortcut that is often considered is based on the so-called natural rate of interest (usually referred to as r star).11 This is, in the Wicksellian definition, the level of the real interest rate at which investment equals savings, and the economy’s resources are fully employed; if prices were fully flexible, at this rate inflation would be equal to its target.12 This is therefore an equilibrium concept that provides an extremely simplified description of the functioning of the economy and of monetary policy. For example, the credibility of the central bank is irrelevant in this framework, as are the level of uncertainty and inflation expectations, as well as the stance of fiscal policy or the debt‑to‑GDP ratio. On this point, see Obstfeld (2022). See, for example, Lane (2022b) and Reis (2022). See Wicksell (1898) and Woodford (2003). Furthermore, taking into account the dynamics of the process that leads to the longer‑term equilibrium is a crucial challenge. Finally, to further complicate matters, the natural rate is unobservable and a wide variety of methods to estimate it provides a large range of different results.13 In some speeches delivered earlier this year, for example, members of the Governing Council of the ECB estimated r star in a range between below ‑2 per cent and slightly above 0 per cent.14 An update of those estimates would now place its level in a range between ‑1.3 and ‑0.2 per cent.15 By adding to those values the inflation target of 2 per cent, it follows that the “neutral” policy rate (the one at which, in the medium-term equilibrium, monetary policy is supposed to be neither accommodative nor restrictive) would be in a range between 0.7 and 1.8 per cent and could already have been achieved (or be close to being achieved) by the ECB with its latest rate hike (or the ones that will soon be taking place). But it is clear that there is no close relationship between this rate and the level to be achieved to ensure inflation expectations consistent with maintaining the target of an average inflation around 2 percent over the medium term. How much, then, should we further raise official rates? Two further problems affect this decision. – First, a high level of uncertainty also surrounds the extent to which current inflation can be curbed by the central bank. Rate hikes, in particular, would not affect the part determined, directly and indirectly, by the energy shock, which is overwhelming. In addition, it is difficult to say ex ante what terminal level of official rates would reassure households and businesses about the determination of the central bank to reducing inflation, thus minimising the risks of a de‑anchoring of expectations and preventing the emergence of spirals between prices and wages. – Second, high uncertainty also influences the distribution over time of the effects of rate hikes on inflation and growth. Putting together the econometric evidence we have, in the euro area a rate hike exerts its largest effect on inflation after one or two years; however, it also has its largest impact on GDP growth after about a year and a half. In the current juncture, this suggests that any rate hikes we implement now are likely to have their largest effect on inflation when the economy has already slowed down significantly, running the risk of triggering or exacerbating a recession and, assuming that energy prices continue to be the main driver of consumer price growth, without having had a previous visible effect on inflation. These go from pure time-series applications, to semi-structural econometric frameworks in which the natural rate is a latent variable, to fully structural, though extremely simplified, models (such as overlapping-generations or dynamic stochastic general equilibrium models of the New Keynesian tradition). For a recent survey and estimates of r star for both the United States and the euro area, see Neri and Gerali (2019). See, for example, Lane (2022a) and Panetta (2022). The variety of methodologies used by the ECB is reported in Panetta (2022) and described in the references mentioned therein. For recent considerations on the relevance and use of the natural rate see Hernández de Cos (2022) and Villeroy de Galhau (2022). Even if long-term inflation expectations are still anchored and wage growth remains moderate, the high level of inflation and the need to increase the extremely low values achieved by short-term interest rates in real terms require policy rates to continue to rise. The high uncertainty surrounding the economic prospects, however, suggests prudence in setting the “pace” of the rate hikes and strongly advises against committing to a pre‑determined terminal point for official rates. Our future decisions will therefore continue to follow a meeting-by-meeting approach and will be data-dependent – meaning, however, that they will not simply be dependent on current data, but will instead continue to assume a forward-looking orientation, based on the economic perspectives of the euro area as a whole, over the medium-term. As in other tightening cycles, we will have to discover the terminal rate by proceeding gradually. This does not mean that quantitative assessments cannot be made, based on the experience accumulated to date; on the contrary, they would be certainly useful for estimating the effects of rate increases on aggregate demand and changes in the costs and prices of goods and services.16 However, we will have to take these assessments into account together with the information that will gradually become available on inflation expectations and on the evolution of labour income and profits. In any case, today I do not see any obvious reason to tie our hands with hypotheses of extraordinarily high increases, such as those that can be sometimes read, in some cases extrapolating the more recent decisions or the experience of other countries. * * * To conclude, since the introduction of the euro, we have always shown our willingness to invest greatly in the analytical capacity of the ECB and the national central banks of the euro area, as well as the readiness to adjust our tools to account for all the factors affecting the pursuit of price stability preservation. Today, the main threat to this objective comes from the energy shock, mostly a consequence of the conflict in Ukraine, which has sparked an exceptional rise in inflation, not only within the euro area. It has recently been argued that high inflation and repeated errors in our projection exercises have called into question our credibility. However, public confidence in our determination to maintain price stability is not measured by the level of current inflation, which is mainly caused in the euro area by the unprecedented energy shock. Nor is it determined by the forecasting errors, which do not signal a major failure of the quantitative models used in the Eurosystem, but instead are the result of the intrinsic unpredictability of geopolitical tensions lying outside the economic realm. Our credibility is measured, rather, by the anchoring of medium-term inflation expectations,17 a key factor that also helps to prevent the triggering of dangerous price-wage spirals. High inflation warrants continuing the normalisation of monetary conditions, but at a pace and to a level that will have to be determined meeting-by-meeting, based on the See, for example, Hernández de Cos (2022). See Reis (2022) and Schnabel (2022). flow of new data and on updated perspectives. Worrying signals, however, come from the sharp deterioration in the economic growth outlook, whose ultimate cause is still the energy shock and its consequences on the purchasing power of incomes and on firm profits. Ensuring the containment of the effects of this shock will require not only an incisive and appropriate response from monetary policy, but also the shouldering of responsibility on both sides of the labour market and the contribution of budgetary policy. It must be understood that, as it was with the oil shocks of the 1970s, the current energy shock is an unavoidable burden for the euro area as a whole, and especially for the countries most affected, such as Italy undoubtedly is. Any attempt to completely counteract its impact on the incomes of labour and capital would be in vain and would inevitably end up having negative repercussions on inflation. To prevent this outcome, budgetary policy can redistribute the effects of the shock between consumers, production factors, present and future generations, with targeted and temporary interventions in support of the households and businesses most affected. The redistributive and allocative consequences of what happens on the energy front, in fact, cannot be ignored. If, however, it were to be decided that the redistribution should weigh most heavily on future generations by issuing public debt, we would run the risk of loading them with unfair burdens and of further fuelling both current and expected inflation. For Italy, this would also entail the risk of derailing public debt (as a share of GDP) from its current descending path – a path that is necessary for preserving the possibility of a swift return to strong and durable economic growth. References Blanchard O., Domash A., and Summers L.H. (2022), “Bad News for the Fed from the Beveridge Space”, Peterson Institute for International Economics, Policy Brief, no. 7, July. Bok B., Petrosky-Nadeau N., Valletta R.G., and Yilma M. (2022), “Finding a Soft Landing along the Beveridge Curve”, Federal Reserve Bank of San Francisco, FRBSF Economic Letter, no. 24, August. ECB (2022), “What Explains Recent Errors in the Inflation Projections of Eurosystem and ECB staff?”, Economic Bulletin, 3, April. El-Erian M.A. (2022), “The Fed’s Historic Error”, Project Syndicate, February. Hernández de Cos P. (2022), Monetary Policy in the Euro Area: Where Do We Stand and Where Are We Going?, Bank of Spain, remarks at the XXI Congreso de Directivos CEDE, Bilbao, September. Hilscher J., Raviv A., and Reis R. (2022), “How Likely is Inflation Disaster?”, CEPR Discussion Paper, no. 17244. Kontogeorgos G., and Lambrias K. (2019), “An Analysis of the Eurosystem/ECB Projections”, ECB Working Paper, no. 2291, June. Lane P. (2022a), The Monetary Policy Strategy of the ECB: The Playbook for Monetary Policy Decisions, European Central Bank, remarks at the Hertie School, Berlin, March. Lane P. (2022b), Monetary Policy in the Euro Area: The Next Phase, European Central Bank, remarks at the Annual Meeting 2022 of the Central Bank Research Association (CEBRA), Barcelona, August. Neri S., Bulligan G., Cecchetti S., Corsello F., Papetti A., Riggi M., Rondinelli C., and Tagliabracci A. (2022), “On the Anchoring of Inflation Expectations in the Euro Area”, Bank of Italy, Occasional Papers, no. 712. Neri S., and Gerali A. (2019), “Natural Rates across the Atlantic”, Journal of Macroeconomics, no. 62. Obstfeld M. (2022), “Uncoordinated Monetary Policies Risk a Historic Global Slowdown”, Peterson Institute for International Economics, Realtime Economic Issues Watch, September. Panetta F. (2022), Small Steps in a Dark Room: Guiding Policy on the Path out of the Pandemic, European Central Bank, remarks at the at an online seminar organised by the Robert Schuman Centre for Advanced Studies and the European University Institute, Frankfurt, February. Reis R. (2021), “Losing the Inflation Anchor”, Brookings Papers on Economic Activity, Fall. Reis R. (2022), “The Burst of High Inflation in 2021-22: How and Why Did We Get Here?”, London School of Economics, unpublished, June. Schnabel I. (2022), Monetary Policy and the Great Volatility, European Central Bank, speech at the Jackson Hole Economic Policy Symposium, Federal Reserve Bank of Kansas City, August. Villeroy de Galhau F. (2022), Ethics of Currency: A Possible Guide for Central Bankers?, Michel Camdessus Central Banking Lecture, IMF, Washington D.C., September. Visco I. (2009), The Financial Crisis and Economists’ Forecasts, Bank of Italy, remarks at the Inauguration of the Academic Year 2008-09, La Sapienza University, Rome, March. Visco I. (2022), Inflation and Long-Term Interest Rates, Bank of Italy, remarks at Analysis Institutional Forum, Milan, June. Wheeler G., and Wilkinson B. (2022), “How Central Bank Mistakes after 2019 Led to Inflation”, The New Zealand Initiative, Research Note, July. Wicksell K. (1898), Interest and Prices, MacMillan, London, 1898. Woodford M. (2003), Interest and Prices: Foundations of a Theory of Monetary Policy, Princeton University Press, Princeton NJ. FIGURES Figure 1 Gas prices Europe (euro) United States (dollars) Source: Refinitiv. Note: Title Transfer Facility (TTF) quotations for European gas and Henry Hub for US gas; latest observations: 29 September 2022. Figure 2 Headline and core inflation in the euro area and in the United States euro area headline core −2 −2 −2 United States headline core Source: Eurostat and U.S. Bureau of Labor Statistics. Note: latest observations refer to August 2022. −2 Figure 3 ECB/Eurosystem projections errors for euro area headline inflation (percentage points; 4 quarters ahead projection errors) −2 −2 −4 −4 Note: dashed lines denote an interval around zero of plus/minus two standard deviations of projection errors realized in 2003-2020; latest observation: 2022 Q2. Figure 4 Market-based inflation expectations (per cent; inflation swap rates) 5.5 5.5 4.5 4.5 3.5 3.5 2.5 2.5 1.5 spot 1.5 years ahead Source: based on Refinitv. Note: spot and forward one-year rates implicit in inflation swaps, relative to the horizons shown on the x-axis; based on the quotations of 29 September 2022. Figure 5 Euro area forward-looking wage tracker (annual percentage change) Percentage share of workers covered by agreements that have not expired (right side) Percentage share of workers covered by new agreements signed that have not expired (right side) Forward-looking wage tracker Wage tracker Weighted average of agreements signed in 2022 Signed in 22Q1 Signed in 22Q2 Signed in 22Q3 Weighted average of agreements 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Source: P. Lane, Cantillon Lecture, 45th DEW Annual Economic Policy Conference, 17 September 2022. Note: euro area aggregate based on Germany, Italy, the Netherlands and Spain. Calculations based on micro data on wage agreements provided by Bundesbank, Bank of Italy, the Dutch employer association (AWVN) and Bank of Spain. Figure 6 Recent evolution of expected GDP growth in 2023 (annual percentage growth) 2.5 2.5 United States 1.5 1.5 euro area .5 .5 United Kingdom −.5 Jan−22 Apr−22 Jul−22 −.5 Oct−22 Source: Consensus Economics. Note: expected GDP growth in the monthly issues of Consensus Forecasts since the beginning of 2022; latest observation: September 2022.
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Speech by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy, at the Tenth Annual Meeting of the International Federation of Finance Museums, Rome, 4 October 2022.
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The impact of digitalization on financial education and inclusion Luigi Federico Signorini Senior Deputy Governor of the Bank of Italy Tenth Annual Meeting of the International Federation of Finance Museums 4 October 2022 I am delighted to welcome you to the Tenth Annual Meeting of the International Federation of Finance Museums, hosted this year by the Bank of Italy together with the Museum of Saving. The theme for this year’s meeting is the impact of digitalisation on financial outreach, education and inclusion. Digitalisation in finance has spawned a host of innovative products and channels, and is a new challenge for financial education; at the same time, it offers new tools for making education more effective. Our common goal is to rise to the challenge, and to make good use of the tools. As a challenge, digitalisation perhaps only exacerbates certain inherent difficulties in financial education that those involved in it know well. I would like to take this opportunity to share with you a few thoughts on why these difficulties exist, and what can be done to overcome them1. In so doing, I shall make reference to the experience of the natural sciences, and the recent specialised subject of ‘Science of Science Communication’. This discipline2 looks for the factors that may undermine the effectiveness of scientific information and education and proposes methods to mitigate these effects.3 Most of its contributions relate to physics, chemistry, biology and medicine; however, there is little doubt that similar issues are also relevant for the economy and finance. It is true that interpreting the picture of a black hole calls for different skills from those required to read a bank statement. However, if we turn our attention from the skills to be taught to the method for teaching them, many similarities become apparent. Whatever the subject, all popularising and educational activities consist in attracting your attention to a complex concept and explaining it in words that you can understand. In this sense, teaching you how to wash your hands correctly (and why it matters), how to calculate compound interest (and why it may be useful), or how people have come to the conclusion the earth is round (and why it’s good to know) are not such different tasks, if one looks at the cognitive obstacles that come up and the methods that can be used to overcome them. A further, important similarity consists in the fact that many of the messages that both scientific communication and financial education would like to convey concern the rational evaluation of the risks and benefits of technology. Think of biotechnologies, artificial intelligence, nanotechnologies—but also of the technology of finance. In each case, individuals and societies face trade-offs between risks and opportunities: whether to eat less meat, vaccinate our children, install a cellular radio tower in the neighbourhood; and similarly, how much to save and in what form, whether to buy insurance or borrow money, or what the implications of a higher public debt are (a technology that shifts the cost of some public goods from one generation to the next). Individuals (or societies) may well have different preferences or needs concerning the ultimate effects of those technologies. However, well-known cognitive shortcuts may result in biased or inconsistent choices with respect to one’s own deep preferences. The aim of scientific education is not to tell people what their preferences should be, but how to make the best use of the available information when choosing between technical alternatives that are not easy to understand. The problem of economic (and financial) education ‘The problem of economic education’ is the title of a long article, published in July 1893 in the Quarterly Journal of Economics, which begins with this sentence: ‘The fact that there is a wide divergence between many of the practical conclusions of economic science, as laid down by its professional exponents, and the thought of the public at large, as reflected in current discussion and in legislation, is one with which all are familiar’.4 The author (Simon Newcomb, an American mathematician) goes on to comment on many examples of false beliefs, prejudices and misunderstandings, in particular on the advantages and disadvantages of free trade between nations,5 which hinder the dialogue between economists and public opinion. The latter point is a good example of a ‘divergence’ that persists. More than a century later, in 1996, Paul Krugman again went through the nature of the cognitive obstacles that stand in the way of understanding the theory of comparative advantage.6 I will get back to Krugman’s article later. First, however, let me point out that, although the popularisation of the natural sciences has a much longer and richer history, attempts to make economics more accessible or to introduce the study of economics into school curricula have not been lacking. In recent years, the great financial crisis of 2008 further raised the general awareness of how good communication and financial education for non-experts is important. Most central banks are now actively engaged in financial education and/or the popularisation of economics,7 with a variety of aims, including the protection of consumers of financial products.8 At the Bank of Italy, financial education is now established as one of its key functions. With a view to exploiting synergies, a few years ago we created a Department responsible both for promoting financial education and for supervising the transparency and fairness of intermediaries. This rising awareness extends beyond the world of central banks. In a recent book, Economics for the Common Good (2017), Jean Tirole makes a strong appeal to economists to engage in public debate. Financial education, he says, should go beyond equipping people with skills that are useful for making personal financial decisions. It should try to explain what the use of finance is, and why it is necessary to achieve the common good. It is no easy task. Finance is an even trickier issue than comparative advantage as a subject for reasoned discussion of pros and cons. Many will harbour deep suspicions as to the usefulness of the financial industry itself, and they will often be unwilling to accept the opinion of ‘experts’ (in inverted commas) about its products. In the words of Andrew Haldane, a former chief economist at the Bank of England, a ‘great divide’ in trust separates the vast majority of people who buy financial services and the minority of those who produce them.9 Two things, besides its sheer complexity, make finance an especially tricky subject, and may ultimately reinforce the public’s scepticism. One is the potential confusion or overlap between independent, scientific opinion, and the concrete financial advice people receive from persons that are as much salespersons as advisers. The other is that even academic or institutional economists disagree about many things, so what is the truth? Financial education should therefore (a) recognise that being, and being perceived as, free from even the slightest suspicion of conflict of interest is a key prerequisite for being credible; (b) exploit synergies with conduct regulators, in order to find ways to ensure minimum standards for professional advice; and (c) concentrate on basic, counterintuitive but robust, ‘round earth’-type concepts, like the surprising effects of compound interest, the non-obvious advantages of diversification and the often overlooked trade-off between risk and return. So, start by proving the flat-earthers wrong, and keep the finer points of non-Euclidean space geometry for the curious and willing. Is such an approach too basic to be worthy of institutional effort? No, it is not; surveys on the level of financial knowledge among the general public provide ample evidence of this. How to explain oneself well In a 2009 paper entitled ‘Le vie della divulgazione scientifica’ (‘How to popularise science’), Piero Angela – the dean of Italian popularisers, who passed away on 13 August and whose great professional and civil merit we cannot but honour and commemorate on this occasion – said that those who want to explain complex concepts need two qualities: to ‘be engaging’, i.e. able to capture an audience’s attention, and to ‘be clear’, i.e. avoid the use of specialised language or words that are not in common use.10 These qualities, difficult as they may be to teach or put into practice, are prerequisites. Failing to master them, or using them in an amateurish or ‘excessive’ way, can cause collateral damage that outweighs the benefits of the educational endeavour. We therefore need to discuss them in some detail before moving to the third and final step: how to ‘be convincing’, i.e. how to overcome the cognitive obstacles that are the main subject of the Science of Science Communication. Be engaging As all teachers know, those who have a spontaneous interest in a topic will learn and master it better than those who are either uninterested or driven by a secondary motive (such as avoiding a bad grade). Distinguishing between popularisation and education in the stricter sense may be useful. Popularisation aims to generate interest and curiosity, and is often pursued through promoting one-off or short-term activities, such as visiting a museum or watching a documentary. Education aims to provide the basic skills needed to form opinions, interpret information or use tools and techniques in an efficient way; it requires a longer and more structured learning process. Well-managed popularisation is thus a way to provide the interest that helps make educational activities successful: the goal is to make a subject as attractive as it is objectively important.11 Conversely, poor popularisation may reduce the effectiveness of education,12 just like poorly taught mathematics in school could result in a lifelong lack of interest in scientific topics. With all that, the fact remains that some topics are perceived to be inherently more interesting than others. Is economics more or less likely to be engaging than the natural sciences? There is, in fact, no obvious answer. On the positive side, money being almost ubiquitously necessary for survival and material needs, most of us, whatever our higher aspirations, may be curious to understand both how the ‘wealth of nations’ is formed, and, on a more personal level, how our income is determined or our wealth can be wisely managed and invested. We are confronted with some of these issues on an almost daily basis, and certainly more frequently than with those relating to the life cycle of dolphins or the origin of galaxies. On the negative side, while curiosity about dolphins is usually unalloyed in those that nurture it, issues about the economy, both personal and general, may be a source of anxiety, a reminder of problems to be solved, or of strife and conflict. Finance, which mainly deals with uncertainty and the future, may also suffer from human beings’ instinctive preference for the short term—a feature whose evolutionary rationale I shall not venture to discuss, but whose existence is plain. Akerlof and Shiller say: ‘when we discuss the power of compound interest with our young students, their eyes glaze over. They see that they might live a much better retirement, but they find it hard to imagine what the difference in retirement would be. They cannot visualize their older selves well enough to know what they will want to spend. […] It is as if they cannot attach any clear meaning to the ultimate purpose of saving, of providing for the future’.13 Anna Maria Lusardi, in her pioneering work on educating citizens about social security choices, finds this lack of interest a major obstacle to financial education.14 Her work is quoted by Akerlof and Shiller as evidence of people’s non-rational indifference towards their own financial future.15 There are a few more problems that hinder the popularisation of economics: for example, finance museums have fewer ‘wonders’ to showcase than science museums; they are rarely capable of producing what popularisers call the ‘wow effect’.16 What can we do? Lack of interest in economics and finance (not to mention mistrust of those who work in these fields) should be a driver rather than a barrier, and encourage us to look for innovative ideas. There is no shortage of inspiring success stories,17 which show that providing high-quality, engaging financial popularisation is possible by e.g. creating connections to history, art and other subjects. The way we designed our museum, and the decision to place it alongside the financial education directorate, are meant to foster synergies between popularisation and education. And yes, we are working hard to ensure that our museum will contain some objects that are unusual and interesting enough to elicit a few ‘wows’ from visitors! Be clear Once one has managed to capture the public’s interest, the next challenge one faces is language, or, more generally, any factors that can make communication easier, or more difficult, to understand. Besides the right choice of words, this requires alertness to the fact that many concepts that experts take for granted may be quite unfamiliar to those outside the discipline. Clarity and simplicity, however, often come at a cost. When you try to make complex concepts accessible by using basic vocabulary, metaphors or other logical stratagems, even if you succeed in making the recipient understand the general way in which a certain phenomenon works, you may have to pay the price of a blurred perception of its actual complexity.18 In some cases, it is a fair price to pay; in others, it is a risky shortcut, given all the side effects it produces. The ‘easiness effect of science popularisation’ comes up in a number of empirical studies.19 Beyond undue simplification, there may be undue generalisation: some people who read popularised science material, having understood the specific message, tend to overestimate their general knowledge of the subject. When subsequently confronted with specific choices, they may be overconfident, and underestimate the need for competent advice.20 Here too, the issue is potentially more dangerous when the subject is medicine or finance, rather than (say) cosmology. What can we do? The literature also provides hints as to how to minimise side effects, for instance by following the simplified explanation of a given phenomenon with clear warnings about its inherent complexity, the loss of accuracy resulting from popularisation, and the existence of any alternative explanations. With this issue in mind, the Bank’s financial education programme for schools provides, alongside simplified reading material for students, more advanced, topic-specific Teacher’s Guides; we also have a comprehensive programme of courses for teachers. The approach must be different for museums, where the attention span of visitors is typically shorter. Our plan is to offer visitors additional material (brochures, apps or web channels) at various points along the way for those who wish to explore an issue further. As I just mentioned, another trap to avoid is for science communicators to over-rely on previous knowledge by recipients. Numbers, and in general everything to do with statistics and mathematics, are a case in point. Experts often assume everyone has some knowledge of what for them are very basic skills, such as the concept of probability or the cancelling of fractions. In fact, mastery of such skills is rare. In the preface to his book The Road to Reality, Roger Penrose tells the story of a friend whom he used to tutor in mathematics and who, faced with simple fractions, was completely unable to cancel them because she kept picturing the nominator and the denominator as ‘two separate things’.21 This fact is also relevant to financial education and to the protection of banks’ customers. As I have said on other occasions, the rules that provide for transparency on (various definitions of) annual percentage rates of interest are not particularly useful to those consumers – a non-negligible share, according to surveys – who are not fully familiar with the concept of interest rates itself. What can we do? In 1948, Maria Montessori, one of the most renowned Italian educators, wrote that ‘a person without mathematical training today is like an illiterate person was when everything depended on literary culture’.22 Nearly 80 years have passed, during which the truth of this concept has (if anything) increased, as has the awareness of the need to introduce statistics and probability into school curricula as early as primary school. The ‘fear of maths’ is one big reason why too many people are unable to appreciate, not just the beauty of some scientific truths, but also the usefulness of economic and financial calculations.23 Having said that, until everybody gets enough statistics training at school, there is no alternative to carefully crafting teaching materials or museum explanations that do not assume a mathematical mind, and suggest intuitive, possibly entertaining ways of understanding quantitative issues or solving practical problems, including financial ones.24 One final word about the need to ‘be clear’. In designing our Museum, we found the interaction between economists with little grasp of communication, and good popularisers with only a smattering of economics, extremely useful, interesting—and, at times, fun. Be convincing Let us go back to Krugman’s dismay at people’s inability to understand comparative advantage. The frustrating fact here is that a counterintuitive concept cannot be explained even to people who are keen to understand, and educated enough to follow the experts’ explanations. ‘What I am concerned with – he writes – are the views of intellectuals, people who do value ideas, but somehow find this particular idea impossible to grasp’.25 The problem in this case is not that the communicators are insufficiently clear or engaging. The problem is that the listener has pre-formed convictions, alternative ‘truths’ that are perceived as intuitive and obvious, and clash with those of the expert. This is what makes the latter’s arguments unpersuasive. The Oxford Handbook of the Science of Science Communication (2017) lists many sources of alternative ‘truths’. They may be classified into four areas: 1) Naïve science. Psychologists have long theorised that human beings innately possess some sort of pseudo-explanation for (almost) every phenomenon. In recent years, many empirical studies have found evidence of folk physics, folk biology, folk economics and so on. An article published in Scientific American in 2006 puts it as follows: ‘Folk astronomy, for example, told us that the world is flat, celestial bodies revolve around the earth, and the planets are wandering gods who determine our future. Folk biology intuited an élan vital flowing through all living things, which in their functional design were believed to have been created ex nihilo by an intelligent designer. Folk psychology compelled us to search for the homunculus in the brain – a ghost in the machine – a mind somehow disconnected from the brain. Folk economics caused us to disdain excessive wealth, label usury a sin and mistrust the invisible hand of the market’. Experts aver that ‘a fascinating feature of naïve theories is their ability to survive empirical disconfirmation’.26 That is why scientific communication cannot just dole out scientific truths, but must find a way to dry up the sources of intuitive ‘truths’. This is what financial education programmes inspired by behavioural economics attempt to do: if folk economics is a form of cognitive distortion,27 the evolutionary outcome of a very long period in human history during which trade and finance were often a zero-sum game,28 then education should not just aim to teach skills, but also to challenge the instinctive suspicion that prevents us from seeing the potential benefits to all parties of a mortgage, a financial investment, an insurance product or – back to Krugman – free trade. 2) Disputes and hype in science. It is perfectly normal for scientists to disagree on the explanation of a given phenomenon. The inexact science of economics is second to none in this respect. Scientific communication, especially the sort that aims to help you in making informed choices, should mostly be about the ABCs of disciplines, and therefore largely unaffected by disputes at the frontier of knowledge. However, if you assume that truths about nature must be immutable, coherent and all-encompassing, disagreement between experts is a potential source of mistrust even for the most basic facts of science. A specific problem arises when the public becomes aware of some ‘resounding breakthrough’, which makes the headlines as a result of an ambitious researcher, or a journalist of a sensationalist bent trying to gain visibility, even if what is presented may only consist in preliminary findings described in a working paper. That hype can prove harmful to scientific dissemination, and sometimes even to people’s health, was shown clearly by an article published in 1998, which suggested a correlation between the measles, mumps and rubella (MMR) vaccine and some forms of autism.29 It took as long as 12 years for the article, which had been recognised as not just wrong but also fraudulent, to be taken out of circulation.30 By then, however, fear and suspicion had become rooted across broad sectors of the population—and, one surmises, this fact contributed to the suspicion towards vaccines during the recent pandemic. Based on other case studies too, such as that on mad cow disease, the scientific community has responded with strategies that make it faster to ‘delete’ fake theories.31 3) Fake news. If it is hard enough to keep the spread of erroneous information within the scientific community under control, the challenge becomes quite daunting on the Web and in the media generally. A 2019 report prepared for the European Parliament finds that about half of European citizens say they are unable to distinguish between fake and trustworthy science news, and recommends that the school system take upon itself the task of educating minds on how to recognise ‘false truths’.32 4) Antagonistic cultural meaning. As shown by several Science of Science Communication studies, in fact the credibility of science is not systematically in doubt. On the contrary, ‘the number of issues that actually display the science-communication problem is orders of magnitude smaller than the number that do not, but plausibly could’.33 In fact, in the vast majority of cases, the public does not mistrust the opinion of experts. Almost no one – regardless of educational attainment or political or religious persuasion – differs with the assessments of experts regarding the best way to build an airplane. The issue typically arises in connection with certain topics, such as global warming or the risk-benefit ratio of vaccines, which are more easily influenced by interests, values and cultural identities.34 Economics and finance are more exposed to this risk than other fields. Whether they come from our brain, our community’s values, social media, or even the scientific community itself, prejudices are multiplicative—in the sense, first, that failing to remove even just one can nullify the whole communication effort; second, that even when they are conceptually independent, they tend to interact and reinforce one another. What can we do? Despite evidence that it is not always impossible to change (erroneous) epistemological beliefs, including through short-term educational measures,35 there still remain ‘a host of interdependent complexities for science communication, many of which we are only beginning to understand empirically’.36 The conclusion that the Science of Science Communication has reached so far is that there cannot be a popularising or educational solution that fits all topics and all audiences; that if we ignore the existence of cognitive obstacles, rely on a one-way style of communication and do not ask ourselves what the target audience’s knowledge, opinions and prejudices are, we are bound to fail.37 The interdependency of channels can work in the communicator’s favour, too. When the person or institution that sends a message is perceived as independent, authoritative and credible, the ‘drag’ of impeding factors decreases. One hopes that central banks will often fit the bill in most people’s eyes. This is, I believe, one important reason why they are natural candidates for taking on an educational role. Does digitalisation help or hinder financial education? The digitalisation of finance creates both benefits and risks for consumers.38 Innovation allows the financial and payments industry to offer new products (and thus serve a broader range of needs), to lower costs, and to improve accessibility. One scarcely remembers that to carry out the simplest banking operations, like checking the balance of one’s account or making a money transfer, there was once no alternative to taking the time to go to a physical bank branch and queue up at a teller. Or that POS or online electronic payments did not exist. However, innovation also enables agents to create complex and often opaque products, whose risk structure is difficult to understand and whose economic rationale is not always obvious. The greater ease in making payments, borrowing money or investing savings that technology affords is itself not an unmixed blessing, in that it may be conducive to hasty, imprudent or uninformed choices. Hence the need to improve all areas of consumer protection, and to increase customers’ ability to understand risks and rewards, to assess the suitability of products for their particular needs, and more generally to exploit the undisputed advantages of innovation while avoiding its pitfalls. Financial education itself, like all kinds of education, can leverage on new technologies that make it possible to reach a much vaster public, to tailor didactic content to specific needs, to use novel teaching tools, and to design efficient and effective surveys to test the results achieved. It must, on the other hand, avoid the risk of turning the digital divide, geographical or generational as it may be, into another source of financial exclusion.39 The Bank of Italy has taken on the challenge of digitalisation in its educational projects. Our financial education portal, ‘Economics for everyone’, has been online since the end of 2019, and has over 50,000 hits per month. The portal’s content is supplemented by interactive and multimedia tools meant to encourage the general public to engage and identify with it, especially people who are less expert, and to stimulate them to learn more about personal finance. Let me now conclude by mentioning two facts that could make educational challenges even more complex in a digital environment. The first is linked to the well-known ‘cognitive bubble’ and ‘echo chamber’40 effects. The web contains all sorts of information, including academic debates that were once confined to academia, or technical advice that was once the preserve of a selected few. In principle, abolishing the barriers to the circulation of information is a good thing. However, to make sense of the almost infinite amount of information available, a finite mind needs criteria and filters. When choosing from an enormous menu, both human inclination and the logic of search engines tend to act selectively and confirm initial bias. While in theory everyone can access all information, in practice self-contained bubbles may emerge (naturally or by deliberate action), whereby many web users receive information, whether genuine or fake, that tends to reinforce their views, and conversely, they become relatively insulated from information that might put them into question. Breaking vicious circles generated by fake or biased information is thus one key challenge for effective science communication. The second challenge concerns the ever greater complexity of whatever is offered on the market. The precise way cars, phones, or medical treatments actually work has long been beyond the comprehension of most customers, but the phenomenon is very much on the increase. While it was once conceivable for a car user to understand the practical working of a carburettor or a spark plug, nowadays a car’s many electronic parts are a black box, even to a specialised mechanic, and almost all repair is based on automated diagnosis and replacement. As products become more complex, simplification, the key to popularisation or basic education campaigns, becomes, if I may, more difficult. Linked to this is the growing invisibility and abstract nature of innovation: in certain cases, such as bio- or nanotechnologies, this has led to suspicion, fuelled conspiracy theories and made the various online information channels even more fervid. Finance, which is a form of social technology, is no exception: innovations make it more efficient, but also further removed from the possibility of its advantages and risks being understood correctly by non-experts. The gradual dematerialisation of monetary and financial instruments, the depersonalisation of the procedures involved in disbursing loans, the fact that physical bank networks are becoming rarer, in short, the growing ‘invisibility’ of finance, risks fortifying old suspicions and encouraging the spread of emotional reactions ranging from pessimism to repulsion. The last claim, admittedly, begs the question of why then some people are so attracted to crypto-assets, which are even more ‘invisible’ than comparable traditional instruments-and much, much riskier, when unbacked or algorithmic. This seems yet another worthy topic for digital-era financial education, and – quite possibly – for educational financial museums. I wonder whether the next speakers will have any thoughts to offer on this matter. Thus, because of digitalisation, the educational challenge is simultaneously becoming easier and more complex. Perhaps we need to cultivate methods of teaching that, besides basic technical literacy, aim to augment ‘epistemic understanding’,41 i.e. the critical thinking that helps in selecting sensible theories and reliable sources, in finance just as elsewhere. This concludes my introduction. I am sure that today’s keynote lecture, the round table and the afternoon session on research will provide rich food for thought on all these topics. Note Thanks are due to Giovanni Iuzzolino for his valuable input. ‘Ironically, those communicating science often rely on intuition rather than scientific inquiry, not only to ascertain what effective messaging looks like but also to determine how to engage different audiences about emerging technologies and get science’s voice heard. For decades, one plausible explanation for this state of affairs was the relative absence of empirical work in science communication. This is no longer a problem’. Kahan D, Scheufele D. A., Jamieson, K. H. (2017), Introduction: Why Science Communication?, in Kahan D, Scheufele D. A. and Hall Jamieson, K. (eds.) The Oxford Handbook of Science of Science Communication, Oxford University Press, New York, p. 1. Although the first attempts at spreading knowledge about science go back a long way (the Natural History Museum in London was established in 1753), the broad popularisation of science in all the forms available to us today has taken place in the last few decades. In 1985 the Royal Society of London, the oldest scientific institution of the modern world, published its ‘Bodmer Report: The Public Understanding of Science (A report by a Royal Society ad-hoc Group’, 1985, London). Newcomb, S. (1893), ‘The problem of Economic Education’, The Quarterly Journal of Economics, Vol. 7, No. 4 (July, 1893), pp. 375-399. https://www.jstor.org/stable/1882282. ‘One of the most marked points of antagonism between the ideas of the economists since Adam Smith and those which governed the commercial policy of nations before his time is found in the case of foreign trade. Before such a thing as economic science was known arose the theory of the "balance of trade" […] An immediate corollary from this view was that trade between two nations could not be advantageous to both, because the values which each exported to the other could not both be greater than those received from the other. This doctrine was denied by the Physiocrats, and shown to be wholly fallacious by Adam Smith’. Newcomb, S. (1983), p. 377-378. Krugman, P. (1996), Ricardo’s difficult idea, Paper for Manchester conference on free trade, March 1996 https://web.mit.edu/krugman/www/ricardo.htm. According to a survey we conducted last year on 152 central bank and monetary authority websites from around the world, as of May 2021, 83 of them carried out financial education activities, often as part of specific national strategies, and 43 museums had been founded to educate the public about monetary and financial issues. A key objective is improving the general awareness of central banks’ functions and tools. In 2006 the then-president of the Federal Reserve Bank of Boston wrote: ‘In carrying out this very important responsibility, we employ the carrot as well as the stick, as the saying goes. The stick is regulation and supervision, and the carrot involves our convening abilities and, increasingly, our capabilities in the areas of economic education and financial literacy’. Cathy E. Minehan, (2006), ‘The Role of Central Banks in Economic and Personal Finance Education’, https://www.bostonfed.org/news-and-events/speeches/ the-role-of-central-banks-in-economic-and-personal-finance-education.aspx. ‘To borrow from the title of a recent book by Nobel Laureate economist Joe Stiglitz, these results suggest to me a Great Divide: A Great Divide between the views of financial insiders and outsiders, between the perceptions of producers and consumers of financial services, between the silent majority who buy and the vocal minority who sell financial products, between the echo chamber of the elites and the voting chamber of wider society. They underscore just how far finance still has to travel to regain its social licence. This “Great Divide” is my jumping-off point. I want to discuss the crucial role finance plays in society and why. I want to discuss the progress made, so far, in restoring trust in finance. And I want to discuss what further progress might be needed to narrow that trust deficit. That may call for the financial sector to seek new ways to define and communicate its purpose, its contribution to wider society, to act as an antidote to the short-term demands of shareholders and executives’. Andrew G. Haldane (2016), The Great Divide, New City Agenda Annual dinner, 18 May 2016, pp. 2-3. https://www.treccani.it/enciclopedia/le-vie-della-divulgazione-scientifica_(XXI-Secolo)/ (only in Italian) Evidence has become available of the synergies between popularisation and. See Wang S, Liu XF, Zhao YD. ‘Opportunities to Learn in School and at Home: How can they predict students’ understanding of basic science concepts and principles?’ International Journal of Science Education, 2012; 34(13):2061–88; Xi WJ, Tan MC. ‘Effects of science popularization of first aid knowledge and skills using new media among community residents’, International Journal of Clinical and Experimental Medicine, 2019; 12 (5):5269–78; and Cheng MM, Su CY, Kinshuk, ‘Integrating Smartphone-Controlled Paper Airplane into Gamified Science Inquiry for Junior High School Students’, Journal of Educational Computing Research, 2021; 59(1):71– 94. Sometimes bad popularisers present scientific findings as if they were a form of superior witchcraft whose motives are only intelligible to its initiates. When science is perceived as inaccessible sorcery, anyone who is not a scientist may be pushed towards irrational positions and hopes […]: if science becomes pseudo-magic, why not choose real magic?’ Parisi, G. (2021), In un volo di stormi. Le meraviglie dei sistemi complessi, Mondadori, Milano, p. 108. Akerlof, G.A. and Shiller, R.J. (2009), Animal Spirits. How human psychology drives the economy, Rizzoli, Milan, First Edition, p. 166. Lusardi, A. and Mitchell, O. (2005), ‘Financial Literacy and Planning: Implications for Retirement Wellbeing’, De Nederlandsche Bank Working Paper 78, December 2005. Akerlof, G.A. and Shiller, R.J. (2009), cit., pp. 171-172. Furthermore, it is far less common for economics and finance to announce new discoveries or inventions to the public than is the case for the natural sciences: ‘Much of the time the transactions work fairly smoothly. This is why microeconomics is often a story of the dog that did not bark in the night, which in turn explains why non-economists are often unaware of any microeconomic problems’, Avinash Dixit (2014), Microeconomics: A Very Short Introduction, Oxford University Press, p. 2. Such as, among others, the successful publication by William Goetzman, Money Changes Everything. How Finance made Civilization possible (2006) or the ‘Money and Beauty’ exhibition held in Florence just over ten years ago. For the general point, see Ogawa, Masakata (2006), ‘Exploring possibility of developing indifferent public-driven science communication activities’, Journal of science education in Japan 30.4 (2006): 201-209. One of the most recent books on the art of science popularisation offers a compelling comparison between the simplification required by popularisation in order to be understood by the lay public and Heisenberg’s famous uncertainty principle, according to which whatever is gained by increasing the precision with which we measure the position of a particle is lost in terms of the accuracy with which we can measure its initial speed and vice versa. Gouthier, D. (2019), Scrivere di Scienza. Esercizi e buone pratiche per divulgatori, giornalisti, insegnanti e ricercatori di oggi, Codice Edizioni, Torino pag. 51. Scharrer L, Rupieper Y, Stadtler M and Bromme R. (2017), ‘When science becomes too easy: Science popularization inclines laypeople to underrate their dependence on experts’, Public Understanding of Science, 26(8):1003-1018. doi:10.1177/0963662516680311. J. Kruger and D. Dunning (1999), ‘Unskilled and unaware of it: How difficulties in recognizing one’s own incompetence lead to inflated self-assessments’, Journal of Personality and Social Psychology 77, 1121 (1999). Francisco, Frederico & Gonçalves-Sá, Joana (2019), ‘A Little Knowledge is a Dangerous Thing: Excess Confidence Explains Negative Attitudes Towards Science’, SSRN Electronic Journal, 10.2139/ ssrn.3360734. Roger Penrose, La strada che porta alla realtà (The Road to Reality), in the ‘collana Saggi’, translation by Emilio Diana, Rizzoli, Milano. Maria Montessori, Dall'infanzia all'adolescenza, Garzanti, Milan 1949 (the French edition had the title ‘De l'enfant à l'adolescent’, 1948). ‘A great many people find financial issues difficult and boring. That is a weak foundation for making good financial choices. At least some of those problems originate in the mental block many people encounter when it comes to mathematics. Finance is a numbers game. And research by the Department for Business, Innovation and Skills suggests there are an incredible 17 million adults in the UK whose standards of mathematics are no higher than those of a primary school child. The way maths is taught may be part of the problem here. For many, maths is a turn-off because it seems unrelated to their everyday lives; it lacks real-world relevance. Sad to say, payday lenders have a greater resonance to many people than Pythagoras’s theorem. The abstract nature of mathematics, as taught, leads many children to tune out or switch off entirely. Others conclude that they simply do not have “a maths brain”. This is an educational scar that can last a lifetime’, Andrew G. Haldane (2016), The Great Divide, cit. pp. 11-12 ‘Part of the solution may come from making maths relevant to people’s lives, to link it to real-world decisions. And what better set of real-world decisions than financial ones: how to draw up a monthly budget of debits and credits; how to make sense of an Annual Percentage Rate on a loan; how to decide between competing savings, pensions and mortgage products. These are big financial decisions that, if flunked, can have big social, as well as financial, consequences’, Andrew G. Haldane (2016), The Great Divide, cit. p. 12. ‘My objective in this essay is to try to explain why intellectuals who are interested in economic issues so consistently balk at the concept of comparative advantage. Why do journalists who have a reputation as deep thinkers about world affairs begin squirming in their seats if you try to explain how trade can lead to mutually beneficial specialization? Why is it virtually impossible to get a discussion of comparative advantage, not only onto newspaper op-ed pages, but even into magazines that cheerfully publish long discussions of the work of Jacques Derrida? Why do policy wonks who will happily watch hundreds of hours of talking heads droning on about the global economy refuse to sit still for the ten minutes or so it takes to explain Ricardo?’, Krugman, P. (1996), cit. p.1. Anderson, C. and Lindsay, J.J. (1998), ‘The development, perseverance and change of naive theories’, Social Cognition, vol. 16, no. 1, 1998, pp. 8-30, specifically p. 13. https://www.scientificamerican.com/article/folk-science/ – Naïve science may be seen as an example of Kahneman’s ‘thinking fast’, i.e. instinctively avoiding spending energy on searching for the right answer to a problem, when the benefit of that answer is underestimated: ‘Several forms of cognitive bias such as proximal thinking, myside bias, and the availability heuristic (see Kahneman, 2011) can be linked to directional goals. Directional goals seem to be evoked when individuals are not motivated to take the time and effort to be reflective and actively assess the viability of nonpreferred conclusions. Recent research suggests that such effort may be necessary to employ reasoning based on accepted scientific conclusions: Individuals who accept a scientific perspective must inhibit the previously accepted nave conception to give scientifically accurate answers’, Gale M. Sinatra, Dorothe Kienhues & Barbara K. Hofer (2014), ‘Addressing Challenges to Public Understanding of Science: Epistemic Cognition, Motivated Reasoning, and Conceptual Change’, Educational Psychologist, DOI: 10.1080/00461520.2014.916216, p. 8. Paul H. Rubin, 2003, ‘Folk economics’, Southern Economic Journal, 2003, 70(1), 157-171 Wakefield A.J., Murch S.H., Anthony A., Linnell J., Casson D.M., Malik M., Berelowitz M., Dhillon A.P., Thomson M.A., Harvey P., Valentine A., Davies S.E. and Walker-Smith J.A., ‘Ileal-lymphoid-nodular hyperplasia, non-specific colitis, and pervasive developmental disorder in children’, The Lancet, 28 Feb 1998;351(9103):637-41 Godlee F., Smith J. and Marcovitch H., ‘Wakefield's article linking MMR vaccine and autism was fraudulent’, in British Medical Journal, vol. 342, 2011, p. c7452, DOI:10.1136/bmj.c7452 ‘The challenge of correcting misinformation and retracting incorrect or fraudulent scientific findings involves communication that should include prompt reaction, issuing detailed retractions, widely disseminating retraction, linking the retraction or correction to the misinformation, and developing monitoring and alert systems’, Chan S. Man-pui, Jones, C. and Albarricìn D. (2017), ‘Countering False Beliefs: An Analysis of the Evidence and Recommendation of Best Practices for the Retraction and Correction of Scientific Misinformation’, in Kahan D., Scheufele D. A. and Hall Jamieson, K. (eds.) The Oxford Handbook of Science of Science Communication, Oxford University Press, New York, p. 342. ‘In order to educate scientifically literate students, one needs scientifically literate teachers... Relevant training and professional development opportunities for teachers should equip them with the necessary competences to develop scientifically literate students.’. Siarova, H., Sternadel, D. & Szőnyi, E. 2019, ‘Research for CULT Committee – Science and Scientific Literacy as an Educational Challenge’, European Parliament, Policy Department for Structural and Cohesion Policies, Brussels, p. 51. Kahan, D. (2017), ‘On the Sources of Ordinary Science Knowledge and Extraordinary Science Ignorance’, in Kahan D, Scheufele D. A. and Hall Jamieson, K. (eds.) The Oxford Handbook of Science of Science Communication, Oxford University Press, New York, p. 36. ‘The cultural antagonistic meanings that transform positions on societal risks into symbols of groups allegiance disable the faculties ordinary individuals normally use to discern what is known by science and thus pollute the science communication environment’, Kahan, D. and Landrum, A.R. (2017), A Tale of two vaccines, cit. p. 169. A similar case, which has been studied extensively in the literature, is the human papillomavirus (HPV) vaccine, which is administered to teenage girls and which in several countries led to a storm of controversy, a rejection of vaccination mandates, and a low take-up ratio. Several empirical studies have found that the different propensity to vaccinate one’s own children is not explained by the level of scientific literacy – on the contrary, ‘the individuals who are highest in science comprehension are likely to be the most polarized’ – but above all by the values of one’s social group: ‘those who prize both traditional gender roles and also the autonomy of the individuals to make their decision about how to provide for the wellbeing of themselves and their families, tended to perceive that the vaccine’s risks outweighed its benefits’. Kahan, D. and Landrum, A.R. (2017), A Tale of two vaccines, cit. p.166. Kienhues, D., Bromme R. and Stahl E. (2008), ‘Changing epistemological beliefs: The unexpected impact of a short‐term intervention’, British Journal of Educational Psychology, 78.4 (2008): 545-565. Kahan D, Scheufele D. A., Hall Jamieson, K. (2017), ‘Conclusion – On The Horizon: The Changing Science Communication Environments’, in Kahan D, Scheufele D. A. and Hall Jamieson, K. (eds.) The Oxford Handbook of Science of Science Communication, Oxford University Press, New York, p. 466. ‘Old habits die hard, and many efforts by bench scientists to communicate with public audiences are still guided by the faulty expectation that there are monocausal explanations for most science communication failures, and – as a result – silver bullet approaches to fixing them. Unfortunately, there is little (social) science to support these expectations about problems or solutions’, Kahan D, Scheufele D. A. and Hall Jamieson, K. (2017), Conclusion - On The Horizon: The Changing Science Communication Environments, cit. p. 464. OECD (2021), G20/OECD-INFE Report on supporting financial resilience and transformation through digital financial literacy, www.oecd.org/finance/supporting-financial-resilience-and-transformation-throughdigitalfinancialliteracy.htm Global Partnership for Financial Inclusion (GPFI) (2020), G20 High-Level Policy Guidelines on Digital Financial Inclusion for Youth, Women and SMEs. www.gpfi.org/sites/gpfi/files/saudiG20_youth_women_SME.pdf OECD (2018), G20/OECD Policy Guidance on Financial Consumer Protection Approaches in the Digital Age. OECD (2021), Digital delivery of financial education: design and practice. www.oecd.org//financial/education/digitaldelivery-of-financial-education-design-and-practice.htm ‘Digital tools can support the effective delivery of financial education and help policy makers address the needs of target audiences through tailored approaches. They can better support money management skills while reinforcing financial literacy core competencies, and can also be used to address some of the most common behavioural biases that consumers experience when dealing with financial decisions’. Sunstein, C.R., #Republic: Divided democracy in the age of social media, Princeton University Press, 2017. ‘Sam may know quite a few facts about evolution (having done a fine job of memorizing them for an exam), yet altogether fail to understand evolution because he has no grasp of how these facts fit together […] This is also what makes it appealing to think that “scientific literacy” properly so-called involves not just a few bits of knowledge or true beliefs, but some measure of understanding’, Huxster, et al., (2018), ‘Understanding “understanding”’’ in Public Understanding of Science, p. 758.
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bank of italy
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Speech by Mr Piero Cipollone, Deputy Governor of the Bank of Italy, at the international conference "Future of Central Banking" organised by the Bank of Lithuania and the Bank for International Settlements (BIS) on the occasion of the centenary of the Bank of Lithuania, Vilnius, 29 September 2022.
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The experience of 10 years of data in Central Banking - from gathering real-time data and big data to challenges like storage or skills Piero Cipollone Deputy Governor of the Bank of Italy International Conference "Future of Central Banking" Vilnius, Lithuania, 29 September 2022 Ladies and Gentlemen, I am delighted to open this Session on “Central bank as a pool of real-time data: the ‘Whys’ and the ‘Hows’” jointly organized by Lietuvos bankas and Bank for International Settlements on the occasion of the 100th Anniversary of Lietuvos bankas. I would like to thank the organizers for the kind invitation. 1. Introduction I would like to share the Bank of Italy’s experience in central banking, using real-time data – also known as big data, Nontraditional data or Alternative data – for policy purposes with all the challenges involved. As we all know, we live in a data-empowered era where we can plan a trip and Google can estimate our travel time by recommending the best route based on both current and past traffic data or where Netflix can suggest us movies or shows we might like based on its data from people with similar preferences. Our lives have become not only more data-driven but also more and more data-producers, generating more data than ever before. This combined with greater and greater computing power and ad-hoc technology enables private companies and government institutions to use that new data for different purposes efficiently. 2. The role of big data in central banking activities Central banks have always used market data and macroeconomic data based on surveys to make projections about economic activity, inflation and unemployment, to then guide their monetary policy decisions. The Bank of Italy has always given a very high priority to the collection and use of granular data for economic analysis. For example, it started conducting a well-structured Survey on household income and wealth (SHIW) in the early sixties; at a time, when only in the US a similar effort was done. Bank of Italy was also one of the pioneers in Europe in creating a Central Credit Register, the information archive on household and firms' debts at a loan by loan granular level. Besides the collection of data and production of statistics on banks and the broader financial sector for which it is legally responsible, the Bank runs a large number of surveys and collects granular data from firms, households and the public administration. We do have a sound history of basing our decisions on data. It is not a surprise therefore that the Bank of Italy was early on very eager to look at the potential offered by the huge increase in the availability of information coming from the ICT revolution with the Web at its center, i.e. the phenomenon of digitalization. Some activity in big data started in the early 2000’s; for example, we were using data from Google Trends as soon as Google made them available.1 However, it was overall a very scattered activity, mainly performed at the initiative of individual researchers. The real step forward was made in 2016 when this activity was elevated to a strategic priority of the Bank. We set up a multidisciplinary team to address the potential benefits and hidden risks of embracing the technological challenges of artificial intelligence (AI), machine learning (ML) and natural language processing (NLP) fueled by the advances in big data, which continue to evolve at an incredible speed. It is then that we started to collect in a systematic manner data from a variety of non-traditional sources, such as social media, newspapers, and credit card transactions. These new sources of data have changed the data landscape and enriched economic analysis with more disaggregated and more timely economic information. It is important to stress that we see these sources of data as complementary to traditional sources of structured data, based on surveys, which remain of foremost importance since they allow us to collect high-quality and reliable data within a clear methodological and theoretical framework built to analyze specific phenomena. In any case, the role of the non-traditional and unstructured data has been growing over time and certainly, the pandemic crisis was a big push for us to use it even more, given the exceptional circumstances and the impossibility to run surveys to gather data by national institutions. It was great that we had already some experience and some alternative data in our hands to be able to run some analyses without using survey data. At this stage, I would say that big data and ML techniques have already transitioned from a supporting role to a symbiotic relationship with more traditional statistical analysis. Still, we do recognize that we are only at the beginning of the journey and that the potential remains huge and largely unexploited. 3. Data Science at the Bank of Italy Data Science is an interdisciplinary field that combines computer science, statistics and business domain knowledge aimed at generating insights from noisy and often unstructured data. It integrates mathematics with scientific methods and computing platforms. Albeit a young field, it has quickly developed over the last few years. Its main driver is the astounding volume of data stored by private companies and public authorities, which can now be treated more easily with ML algorithms to extract the information hidden among them. See D’Amuri and Marcucci (2017), “The predictive power of Google searches in forecasting US unemployment”, International Journal of Forecasting, Volume 33, Issue 4, https://doi.org/10.1016/j. ijforecast.2017.03.004, which was published as a working paper version in 2009. In the age of Big Data, economic analysis should be addressed with different tools. Among the data we are going to use, I would mention the following: 1) government data, such as electronic invoices and Tax records; 2) corporate data, such as data from Google or other private companies such as retailers; 3) unstructured data, such as textual data from social media, newspapers, job searching platforms, people and goods mobility, FinTech apps, etc. The necessity to exploit nontraditional data with special algorithms is unavoidable for addressing the present economic conundrums. For example, Raj Chetty2 shows how big data gathered from private companies in the US can be fruitfully used to understand and solve some of the most important social and economic problems in a particular period of stress like the recent pandemic. Taking advantage of big data can ultimately improve macroeconomics policymaking: i) by answering new questions and producing new, accurate and more granular indicators; ii) by offering a painstaking and detailed description of the economic scenario through innovative data sources; iii) slashing the time lags in statistics production, therefore, contributing to a timelier nowcasts/forecasts of existing indicators. Again, Raj Chetty shows that with real-time data like card payment transaction data securely merged with other individual data, we can design a new system of real-time national accounts that can be useful for diagnosing issues in the economy. Big data can open new pathways for macro policy and macro modelling. We can fine-tune our policies based on the current state of the economy and evaluate the observed impacts of those policies in real-time. The spread and usage of Bbg data, right now, cannot replace official statistics. The two data sources should be seen as complementary. Both outputs should be compared to ensure the robustness of new indicators vis-à-vis existing time series that can serve as a benchmark to validate those new indicators. At the Bank of Italy, we use big data and machine learning to support our routine economic and statistical analysis and to carry out research projects. So far, this activity has focused on three main areas: 1) indicators for now-casting and forecasting, 2) expectations of households and firms and 3) sentiment and confidence indicators. The main purpose has been to enrich the information set and create new real-time indicators and models to improve our analysis of the economy and the ability to anticipate future trends. Some prominent examples are the following. Angelico et al.3 (2022) use social media such as Twitter to measure inflation expectations for Italy. Using NLP techniques, the authors isolate the signal from the noise due to advertisements on tweets related to price(s) and inflation. They show that Twitter-based A few days ago Raj Chetty from Harvard gave a talk titled “The Economic Impacts of COVID-19: Evidence from a New Public Database Built Using Private Sector Data” at AMLEDS (Applied Machine Learning, Economics, and Data Science) webinar (https://sites.google.com/view/amleds/home) presenting the latest results of his work on the economic tracker https://opportunityinsights.org/wpcontent/uploads/2020/05/tracker_paper.pdf. Angelico C., J. Marcucci, M. Miccoli, e F. Quarta (2022), “Can We Measure Inflation Expectations Using Twitter?”, Journal of Econometrics, Volume 228, Issue 2, 259-277, https://doi.org/10.1016/j. jeconom.2021.12.008. indicators of inflation expectations are not only significantly correlated with the traditional survey-based or market-based measures, but for the survey-based measures they are also informative in sample and they have predictive power even out of sample. We also use Twitter to create sentiment indicators towards banks and analyze their relationship with deposit growth. Indeed, Accornero and Moscatelli (2018) show that a Twitter-based indicator of sentiment toward banks improves the predictions of a standard benchmark model of depositor discipline based on financial data.4 Astuti et al. (2022) use Twitter to analyze the most actively discussed topics related to the COVID-19 pandemic and build a real-time indicator for the average sentiment of the users.5 Aprigliano et al. (2022) analyze around 2 million articles from four main Italian newspapers and compute a text-based sentiment indicator that closely mimics the confidence indicators for households and businesses from our NSO.6 They also compute a daily Economic Policy Uncertainty (EPU) index both for the general economy and for specific sectors or topics. They use these indicators to nowcast the economic activity in Italy showing that using a Bayesian Model Averaging technique their indicators greatly reduce the uncertainty surrounding the short-term predictions of the main macroeconomic aggregates, especially during recessions. They also employ these indices in a weekly GDP tracker, achieving sizeable gains in forecasting accuracy. We also use credit and debit card transaction records to build models and indicators for the short-term forecast of economic activity. Ardizzi et al. (2019) analyze the reaction of consumer expenditure in Italy (measured using daily data on debit card payments at the POS) to daily EPU, built using textual data from news and the social network Twitter. The authors show that an increase in EPU temporarily reduces debit card payments and raises the ratio of ATM withdrawals to POS payments, signaling an increase in the preference for cash. We make large use of online ads on the real estate from the largest platform in Italy (the website www.immobiliare.it, the equivalent of Zoopla or Zillow in the UK and US), to follow developments and prices in the housing market. Loberto et al. (2022) show the potential of this new database7 to study the real estate market, while Guglielminetti et al. (2021) show the impact of COVID-19 on housing demand for Italian households.8 Accornero M. and Moscatelli M., “Listening to the Buzz: Social Media Sentiment and Retail Depositors' Trust” (2018). Bank of Italy Temi di Discussione (Working Paper) No. 1165, http://dx.doi.org/10.2139/ ssrn.3160570 Astuti, V., Crispino M., Langiulli M., and Marcucci, J., (2022), “Textual analysis of a Twitter corpus during the Covid-19 pandemics”, Bank of Italy Occasional Paper No. 692, http://dx.doi.org/10.2139/ ssrn.4154474. Aprigliano V., Emiliozzi S., Guaitoli G., Luciani A., Marcucci J, Monteforte L., (2022), “The power of text-based indicators in forecasting Italian economic activity”, International Journal of Forecasting, https://doi.org/10.1016/j.ijforecast.2022.02.006. Loberto, M., Luciani, A., and Pangallo, M., «What do online listings tell us about the housing market?» (2022). Forthcoming in the International Journal of Central Banking (https://dx.doi.org/10.2139/ ssrn.3176962). Gulielminetti E., Loberto M., Zevi G., and Zizza R. (2021). “Living on my own: the impact of the Covid-19 pandemic on housing preferences”, Occasional Paper 627, Bank of Italy (https://dx.doi.org/10.2139/ ssrn.3891671). Benetton et al. (2022) give new empirical evidence on house prices and climate change adaptation concentrating on the city of Venice.9 We also use ML algorithms for statistical production and for data quality management. Recently, La Serra and Svezia (2022) received the 2022 IFC Young Statistician award for implementing a Machine Learning algorithm for anomaly detection in insurance assets granular reporting.10 La Ganga et al. (2022) apply supervised ML to spot quality degradation on Non-Performing Loans data.11 4. The challenges and risks of Data Science Using big data and nontraditional data we need to cope with many challenges. First, big data imply significant costs. The management of big data requires investments: you need special IT infrastructures to ingest, store and process nontraditional data together with traditional one that has become too big to efficiently handle in a classical data warehouse. There are organizational costs because you have to put together different skills and hire or create those skills internally. Second, there is always an issue of representativeness and some form of selection bias because big data are the result of data collection for a purpose usually unrelated to a specific research question. Very often big data are related to an unknown population where some strata are heavily represented, while others are not represented at all. That is why, it is always important to validate externally the results obtained from big data, using what is known from surveys and other traditional sources. At this stage, we should still gravitate toward new measures that are not too different in the aggregate from the official measures, but that have other dimensions that are not found in official statistics, such as being timelier, higher frequency, having greater geographic and sectoral details, in two words, more granularity. However, this is something that is going to change in the future, as it is very likely that what we now consider non-traditional data will play an increasingly relevant role into official statistics. Big data often include sensitive data like personal data or privately owned data. Data collection is a big issue as access to data is not always easy, in particular, because most central banks are not endowed with a broad mandate to collect data, beyond that of the financial sector for which we have legal responsibility. This issue is of key importance for the future: there is not a general framework governing the access of public authorities and especially statistical authorities to privately held data. The result of this regulatory gap is fragmentation of approaches, and a lack of standards and clarity about the rights and obligations of private and public counterparties. It is something that needs to be discussed. Benetton M., Emiliozzi S., Guglielminetti E., Loberto M. and Mistretta A, (2022), “Do House Prices Reflect Climate Change Adaptation? Evidence from the City on the Water”, Bank of Italy, mimeo. La Serra V. and Svezia E., (2022), “Statistical matching for anomaly detection in insurance assets granular reporting”, IFC Conference - Basel 25-26 august 2022 (https://www.bis.org/ifc/events/ifc_11thconf/ ifc_11thconf_young_statistician.pdf). La Ganga B., Cimbali P., De Leonardis M., Fiume A, Meoli L., and Orlando M., (2022), “A decision-making rule to detect insufficient data quality: an application of statistical learning techniques to the non-performing loans banking data” Bank of Italy Occasional paper 666 (https://dx.doi.org/10.2139/ssrn.4032815). Concerning the issues of privacy and confidentiality, we have very well-established methods and processes derived from decades of experience in dealing with personal or firm-level data, which are related to a large extent to our supervisory and financial stability tasks. The Bank of Italy runs a very sound Data Risk Analysis on each new dataset to safeguard the security and privacy of its sensitive data to avoid data breaches and intellectual property theft. For example, we ran a gender wage inequality internal research relying on widely agreed cryptographic protocols. Finally, a big challenge concerns the preservation of data over time. While we keep producing a huge amount of data, we have not yet agreed on a shared set of criteria for making these data accessible in the future. Technology-neutral standards must be established to ensure data availability for future generations. Cooperation and, whenever possible, coordination between statistical agencies, governments, academia and private companies is equally crucial, especially across different jurisdictions. 5. International cooperation and collaboration Dealing with big data will require not only further investment from both the public and the private sector but also tighter cooperation between the private sector, which typically owns most of the new nontraditional data, and the public sector, which uses such data for policy reasons and the common good. It will be also important to cooperate with other public authorities, which have many administrative data that can be helpful to measure the state of the economy, and with academia and other central banks to set up common standards. We are currently involved in many projects and activities with other central banks and academia to foster collaboration and create a network of researchers interested in data science, ML and big data for economic policy. Since 2019 we have organized a series of conferences with the Federal Reserve Board and the Bank of Canada on “Non-traditional Data, Machine Learning and Natural Language Processing in Macroeconomics” where both researchers from academia and from CBs and NSOs can present their work on these topics. At these conferences, we have both the academic and scientific programs where research papers are presented and discussed, in addition to a closed-door day, where central bankers and researchers from NSOs, government agencies and international organizations talk about different issues related to nontraditional data and ML applications. This year’s conference is jointly organized with FRB, Bank of Canada and Sveriges Riksbank and it will be held in Stockholm on October 3-5.12 We are also collaborating with the Bank of England and with the BIS through the Irving Fisher Committee to organize workshops and conferences on the topic.13 The program is available at the link https://www.riksbank.se/en-gb/press-and-published/ conferences/2022/conference-on-non-traditional-data-machine-learning-and-natural-languageprocessing-in-macroeconomics/ See the IFC and Bank of Italy Workshop on “Data Science in Central Banking” which was held in Rome in October 2021 (https://www.bis.org/ifc/events/211019_ifc_bdi.htm) and in Basel in February 2022 (https://www.bis.org/ifc/events/220214_ifc.htm). To create a network and foster scientific collaboration, jointly with the FRB, the Sveriges Riksbank, the University of Pennsylvania and the Imperial College of London we are also organizing a series of webinars on “Applied Machine Learning, Economics and Data Science” (AMLEDS). From September to June we host a monthly webinar, where researchers working on data science and ML applied to economics and finance present their work.14 More than 3,000 researchers from academia, CBs, and NSOs around the globe and from different disciplines are registered. Finally, yet importantly, we have organized a special issue for the Journal of Econometrics on “Machine Learning for Economic Policy” jointly with the European Central Bank, the Federal Reserve Board, the Bank of England, the Bank of Canada, and the King’s College London. The special issue will gather a selection of papers, which use machine learning and big data for policy purposes. 6. Conclusions The Bank of Italy is at the forefront in this area and it is firmly committed to researching these issues and to cooperating with other national and international institutions with the aim of better serving our societies. Let me conclude my talk by thanking, once again, all the organizers for having me here and all participants for joining us today. So far, we have invited among others Serena Ng (Columbia), Francis X. Diebold (University of Pennsylvania), Matthew Gentzkow (Stanford), Nick Bloom (Stanford), Héléne Rey (LBS), Bryan Kelly (Yale), Jianqing Fan (Princeton). On September 23 2022, we hosted Raj Chetty (Harvard) talking about “The Economic Impacts of COVID-19: Evidence from a New Public Database Built Using Private Sector Data”.
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Special address by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy and President of the Insurance Supervisory Authority (IVASS), at the Insurance Summit 2022 "From pandemic to warflation: a key role for the insurance industry", organised by ANIA, Rome, 10 October 2022.
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Luigi Federico Signorini: Special address - Insurance Summit 2022 Special address by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy and President of the Ivass, at the Insurance Summit 2022, Rome, 10 October 2022. *** I wish to thank ANIA for inviting me to open this high-level event. I shall start with an overview of recent economic and financial developments and prospects in Italy. Economic developments In the second quarter of 2022, the Italian GDP grew by 1.1 per cent with respect to the previous three months, well above expectations, and showing remarkable resilience given the circumstances. Both industrial and services production increased. Domestic demand was the driving force: household consumption growth was strong (2.6 per cent quarter-on-quarter); gross fixed investments decelerated, but still rose by 1.7 per cent quarter-on-quarter, pulled both by machinery and construction expenditure. The contribution of net foreign demand was slightly negative. As the Ukrainian crisis drags on and intensifies, economic prospects are worsening worldwide. On the basis of high-frequency data (PMI, business and consumer confidence, gas and electricity consumption, motorway traffic) we expect economic activity to have decreased slightly in the third quarter, though more strongly in manufacturing; the service sector appears to have continued to grow, mainly owing to a good tourist season. The negative impact of the high energy prices and the global slowdown are expected to weigh more heavily on economic activities as from the last quarter of the year. We are putting the finishing touches to our updated economic projections, which will be published on 13 October. With respect to our July Economic Bulletin, growth forecasts are not expected to change much for this year, while they will be significantly reduced for the next. Still, in our baseline projection, the change in GDP is expected to remain positive in the average of 2023, as the economy is seen to be returning to growth in the second half of the year. In an adverse scenario, however, which assumes a stronger, more protracted impact of the war on energy availability and prices, as well as on world trade and uncertainty, the economy would continue to contract for a few more quarters, and GDP would fall in the average of 2023. Needless to say, the uncertainty surrounding such projections is high. Very much depends on developments in the Ukraine war and prospects for the energy markets, on which at the current juncture it is next to impossible to make predictions. Consumer inflation, pushed by its more volatile components, reached 9.5 per cent yearon-year in September, a figure not seen in more than three decades. The general index mainly reflects the direct and indirect effects of energy prices, as well as the increase of food prices. Energy prices kept increasing, by 45 per cent year-on-year. Even core inflation, however, reached 4.4 per cent, owing to the acceleration of both services and non-energy industrial goods. 1/4 BIS - Central bankers' speeches Inflation expectations for 2023 and beyond vary depending on sources and methods used to measure them, but have been on the increase. According to the September wave of Consensus economics, inflation projections for Italy in 2023 stood on average at around 4.3 per cent, more than one point higher than the in previous month's estimates. Our own inflation scenarios will be unveiled on 13 October, together with the growth scenarios. Despite these developments, in August contractual wage growth was broadly stable, at 1.0 per cent year-on-year in the non-agricultural private sector. Looking ahead, forceful action to reduce inflation is essential to preserve the purchasing power of households and avoid 'pointless wage-price spirals' 1. Price stability is the lodestar of central banks. Central banks all over the world have started a normalisation of monetary policy. Many governments in Europe have adopted measures to mitigate the immediate impact of exceptionally high increases in energy prices on household and firm balance sheets. While it makes sense to smooth temporary peaks, it is important to remember that energy prices had to go up to achieve our stated long-term goal of climate transition; the current turbulence makes that goal even more vital. Relative price signals should, by and large, be preserved, also to help balance demand and supply in the current circumstances. Better to concentrate the limited public-budget resources available on income relief for the most affected households, and on investment in renewables and energy efficiency. Collectively, there is no escaping the 'unavoidable tax' 2 imposed on us by higher fossil fuel prices – except by reducing our dependence on fossil fuels. Keeping prices low through debt-financed subsidies is illusory in the long run, and would shift the financial and environmental burden once again to the next generations, which will inherit from us a heavy enough burden anyway. Financial developments Since the end of July, there has been a marked deterioration in financial conditions worldwide. Real rates increased at all maturities and share prices fell, amid rising volatility. Risk premia on European asset classes have gone up relatively more, owing to the stronger impact of the war in Ukraine. Tensions emerged in some key currency markets, including the yen and the British pound markets. Financial markets remain exposed to a variety of risks. Stock and bond markets are volatile, and exposed to changes in investor sentiment; in this context, the importance of preserving confidence in the government bond market, with a credible long-run strategy for the public finances, is, I think, well understood. Private credit risk may also increase because of weakening growth and increasing debt servicing costs. Tensions on commodities markets have increased and may remain elevated. High natural gas prices have already started to spill over to substitutes (coal for instance, and also elements used in the production and storage of renewable energy such as lithium and nickel), and to energy-intensive commodities. 2/4 BIS - Central bankers' speeches A protractedly deteriorating macroeconomic environment might affect Italian firms' vulnerability. On the other hand, in Italy stability risks stemming from households appear limited overall, thanks to low indebtedness; the increase in energy prices, though, is making its impact felt on the most vulnerable ones. Bank credit to the Italian private sector continued to expand at a robust pace in recent months. The Italian banking system is facing the risks linked to the current situation from a stronger position than on the eve of previous crises. Banks' asset quality remains good on average, and the new non-performing loan ratio is still low, although the share of Stage-2 (i.e., riskier) performing loans has started to increase. Banks' capitalisation, while coming slightly down in the first half of the year, is higher than before the pandemic. With all this, banks remain highly exposed to cyclical risks, and should cautiously factor in all uncertainties when making their risk and capital management decisions. Insurance The impact of the market turmoil on Italian insurers' solvency ratio has remained modest until now. In the market-consistent framework on which prudential standards are based, (risk-free) interest-rate increases act on both sides of insurers' balance sheet. The fair value of assets decreases, but so does also the present value of technical provisions, the main liability in their balance sheet. At the end of June, Italian insurers' average solvency ratio had declined by just three percentage points with respect to the end of 2021, remaining at a robust 257 per cent. Available updates confirm this assessment: based on our high-frequency monitoring of capital adequacy and liquidity, this position had not substantially changed by August. However, as the share of domestic government bonds in insurers' balance sheet is high compared to European peers, insurers are significantly exposed to fluctuations in the country's sovereign spread. The surge in yields and higher inflation did affect the profitability of Italian insurance companies, both for the life and the non-life business. Net unrealised gains have turned negative since May. Combined with a decreasing life premium income, this fact is driving the current profitability of the life sector below zero. The non-life business was significantly affected by inflation via higher claims expenses in the motor insurance sector. On the liquidity side, our monthly monitoring indicates a gradual increase in the ratio of insurance surrender to premium income, the former having increased by 10 per cent to the latter's 7 per cent. While there are no reasons for immediate concern, companies should monitor liquidity developments carefully and be prepared to possible shifts of policyholders' sentiment. Substantially positive interest rates are not, in themselves, bad at all for the insurance industry's viability. Quite the contrary: as long as rates stayed low or negative, it had become difficult to pursue the traditional life business model, as there was in fact little space for offering the genuine insurance element in life insurance products – the transfer of financial and demographic risk from the insured to the insurer. Companies 3/4 BIS - Central bankers' speeches also had an incentive to adopt a potentially risky behaviour in search for yield. Monetary normalisation is therefore fundamentally welcome. The transition, however, might be tricky, as the surge in interest rates is sizable, market volatility is high, and uncertainties abound. ESRB Warning In this context of increased uncertainty, a few days ago the European Systemic Risk Board (ESRB) issued a warning on vulnerabilities in the Union financial system. The ESRB considers it necessary for private sector institutions, market participants and relevant authorities to continue to prepare for materialisation of tail-risk scenarios. The warning, though mainly addressed to the banking industry, states that "[f]inancial stability risks beyond the banking sector should also be addressed. This requires tackling vulnerabilities and increasing the resilience of non-bank financial institutions and market-based finance. Where macroprudential tools are not available, authorities may need to make use of their supervisory powers to mitigate the consequences of the materialisation of financial stability risks and ensure that markets do not become impaired. Relevant authorities should also continue to monitor risks closely and enhance supervisory dialogue with supervised non-bank financial institutions where needed. [-] By ensuring that their risk management practices adequately reflect the deterioration in the risk environment and by heeding supervisors' guidance and expectations, non-bank financial institutions themselves can further strengthen their resilience and help prevent tail risk scenarios from materialising. For insurers, this means paying close attention to market and liquidity risks, which could materialise in a scenario of increased market volatility and high uncertainty." Ivass is carefully monitoring the heightened risks faced by the market as a whole as well as those borne by individual insurers. Enhanced dialogue with supervised undertakings is in place, in line with both our long-standing supervisory approach and the above-mentioned ESRB warning. As highlighted in my concluding statement to the 2021 Ivass Annual Report, by ensuring that their risk management practices adequately reflect the risks they face, and by carefully heeding supervisors' guidance and expectations, insurers can further strengthen their resilience to exogenous shocks. They can thus help households and firms to absorb the impact of the current market turmoil and the Italian economy at large to get back on track of long term, sustainable growth. 1 Ignazio Visco, Considerazioni finali. 2 Ibid. 4/4 BIS - Central bankers' speeches
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Speech by Mr Piero Cipollone, Deputy Governor of the Bank of Italy, at the Conference "Central Bank Digital Currencies: Threat or Opportunity?", London School of Economics, London, 28 October 2022.
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The implementation of CBDCs by central banks: challenges, risks and opportunities Piero Cipollone Deputy Governor of the Bank of Italy Conference “Central Bank Digital Currencies: Threat or Opportunity?” London School of Economics, October 28th Ladies and Gentlemen, I would like to thank the organizers for inviting me to this conference to talk about the implementation of CBDCs by central banks. Today I will focus on three aspects of the CBDCs: risks, challenges and opportunities. In addressing this relevant topic, I will present the point of view of a central banker and I will share with you my experience on the ongoing activities related to the digital euro project, taking place within the Eurosystem. The digital euro project is now in the investigation phase, which started just one year ago and is intended to end in September 2023. Then, if so decided by the Governing Council, the realization phase would begin, which would last another three years. Let me give you just a brief update on the digital euro project. First of all, I would like to highlight that the digital euro would complement cash, not replace it, by allowing central bank money to also be used in digital form. We are these days at the "halfway point" of the investigation phase, and several key aspects of the project have already been discussed over the past year. Even if important milestones have been reached so far this has no bearing on whether or not will be decided by the ECB decision bodies to move to the realization phase or to issue a digital euro. We have reached by now important milestones, however this has no bearing on whether or not the ECB decision bodies will decide to move to the realization phase or to issue a digital euro. 1. Risks: the main risk for a central bank is that of doing nothing When thinking about the risks associated with the CBDC, I am inclined to think that the main risk for a central bank would be that of not to consider the possibility of issuing a CBDC. Indeed, in designing a CBDC in the interest of citizens in a fast evolving scenario, we should be able to look at the future, also considering how the financial system could evolve. Innovation and digitization are radically changing the financial system and the world of payments. A global transformation of the financial sector has been underway for several years at the level of both instruments and infrastructure. In some cases, incumbents in the financial sector are participating in this digital revolution, joined by new entrants with a greater vocation in innovation. If we focus on retail payments, people increasingly pay digitally; the use of cash in payments is already declining, and this trend is likely to continue in the future. Households and businesses accept private money (e.g., deposits, electronic money) because they are confident of being able to convert it at any time, and at par, with risk-free public money, represented only by cash so far. If the digitization trends were to persist and accelerate, digital payments would be more adapted than cash to satisfy user needs. In this scenario, it would be too risky if the central banks continued to offer only cash and the only digital forms of money available to citizens were private ones. In such a world, central bank money would lose its key role in payments, and it would not be possible to ensure the complementarity and convertibility of public and private money. The entire monetary and financial sector would be deprived of its anchor – central bank money – and would be exposed to potential instability. Moreover, a public digital currency would be an anchor for digital innovation, complementing the potential spread of private digital currencies. This is the case, for example, with cryptocurrencies and in particular with the so called ‘stablecoins’. They are, de facto, not convertible at par with central bank money, as we have experienced in recent crisis, could be inefficient as means of payment and are vulnerable to the redemption risk, amongst other things. Focusing on the case of the euro area, this would accentuate the risk of a little competition in the payments market currently dominated by few players. In addition, this scenario would raise risks about the euro area autonomy and privacy in payments. It could even endanger European sovereignty. Moreover, many large economies could issue CBDCs with benefits in terms of efficiency, scalability, liquidity and safety that would support their attractiveness internationally. They would have the potential to facilitate cross-border payments, which may enhance their role as a global payment unit. In such a context, for a large economy, as in the case of the euro area, not issuing a CBDC could undermine the international role of the currency itself, thus creating additional risks to sovereignty. In sum, in this historical conjuncture the higher risk is that of not investigating the issues and doing nothing. At the same time, we are conscious that issuing of a CBDC has to be assessed in any aspect in order to preside potential risks. We must be vigilant and we have to understand and preside all potential risks of issuing a digital euro. 2. Challenges Central banks are largely sailing into unchartered waters, with new territories to explore when designing a CBDC. To map out the best way forward, as central bankers, we would face many challenges associated with the design of a CBDC. I would now focus on this aspect by sharing the experience gained in participating in the activities of the investigation phase of the digital euro project. I will also mention the interconnections between the various aspects of this complex project. We can bring the challenges together in four main areas: i. the economic of CBDC; ii. the legal issues; iii. the technological issues given the fast innovation in this sector (eg DLT) and the associated security risks; iv. the organizational issues and the impact on the internal structure of central banks. i. The economic of cbdc The main focus here is on the adoption rate of digital euro. A too high large adoption rate might endanger the financial stability; a too low adoption rate might be insufficient to maintain the central bank footprint in the economy. Thus the challenges of the economic of cbdc require a) the analysis the potential impact on the role of supervised financial intermediaries and on the transmission of monetary policy and financial stability and b) the ability to meet the end-user needs including privacy issues and the integration with existing retail payment schemes/systems; The introduction of a CBDC can influence the transmission of monetary policy and financial stability through several channels that are mainly related to the substitution of commercial bank deposits with a public digital currency. In the Euro Area, as in all modern economies, banks grant loans and issue deposits, thereby performing maturity and liquidity transformation services that improve the allocation of households’ consumption across time and firms’ capital across productive activities. These activities are essential for the well-functioning of the economy and are key components of the transmission of monetary policy and the stability of the financial system. If households and firms were to substitute a large share of their deposits with the digital euro, or they were to use the digital euro as a safe heaven in time of stress, banks would need to replace a some of their stable funding and lose customer information that are essential to perform their activities. The Eurosystem’s ability to support the economy through the banking system may be weakened, with broad macroeconomic implications. Deposits, as all forms of money, perform the dual function of means of payment and store of value. The key to prevent undesirable effects without sacrificing the benefits is to design the digital euro in such a way that it is used primarily as a means of payment and not as a store of value. We are working on two main fronts to achieve this goal. First, we are developing quantityand price-based tools – including effective limits to the amount of digital euro individual users can hold and penalising remuneration on individual users’ digital euro holdings above a certain threshold – to limit bank disintermediation. Second, we are implementing a frictionless integration of the digital euro infrastructure with bank deposits through funding and defunding services of digital euro holdings. In this way, users will not need to transfer large amounts of their liquid savings from bank deposits to digital euros in order to use the CBDC for their daily activities. The strong involvement of the private sector is a key success of digital euro. In fact, a public digital currency can benefit from experience and best practices in the market as well as the end user orientation of supervised intermediaries which Eurosystem neither has nor intends to cover. Given those considerations, the external stakeholders engagement in the construction of the project is crucial and, therefore, it has been intensified. A structured process has already been undertaken with the involvement of the Euro Retail Payments Board, through a number of dedicated sessions to receive feedback from the market on the most important points of the project. This dialogue is in addition to the work of the Market Advisory Group (MAG), a group of 30 senior business professionals with proven experience and a broad understanding of the euro area retail payments market experts, which was established at the start of the investigation phase, and is playing an important advisory role for the Eurosystem by bringing in the industry's point of view. In particular, the MAG places great emphasis on the value that a digital euro could bring to all the players who are part of the euro area's diverse payments ecosystem. Digital euro needs to be adopted by people for a central bank to be able to achieve its objective. Thus the possible issuance of a CBDC must take in duly consideration not only the financial system (the supply side) but also the potential users. On this point the Eurosystem has always in mind that: to be accepted, a digital euro should provide a benefit to users. A research (a first round of focus groups was held across all the Euro Area Countries at the end of 2021) has shown that what customers value most are the following characteristics: privacy, broad acceptance, ease of use, low cost, high speed, security and consumer protection, while merchants are looking for low cost, ease of use and integration with existing systems. Privacy protection is key for end-users that should be able to choose how much information they want to disclose, being always in compliance with the applicable law.The Eurosystem is exploring options that could allow the digital euro to replicate some cash-like features and enable greater privacy for low-value transactions. For other transactions, the baseline will be to provide people with a level of privacy equal to that of current private digital solutions, avoiding the full anonymity. Widespread distribution should also benefit those parts of the population that have previously had no or insufficient access to financial services, thereby enhancing financial inclusion. On all these aspects the collaboration with the European co-legislators is crucial, also considering that they are responsible for possible legislative changes. A possible issuance of the digital euro is a common endeavor. The integration with the existing payment ecosystem is also a key element in the digital euro design. In the end user’s perspective, the possibility to decide without any friction which payment means to use is a prerequisite for improving the efficiency of the whole sector. Moreover, the adoption of a digital euro depends on how easily its users will be able to include this new form of central bank money in their payment habits. The evidences of the recently published results of the focus groups showed that people prefer a means of payment that offer them an easy and frictionless user experience. This element has been taken in duly consideration in the current investigation phase of the digital euro. I would like to mention, as an example, the design of a smooth funding and defunding process to manage the end-users’ digital euro position (meaning the transfer of money from or to a commercial bank account, for instance), with some additional features like an automatic funding and defunding. This would favor a convenient and customizable experience and the successful uptake of this new form of central bank liability. ii. The legal issues The introduction of a digital euro would give rise to several legal issues related to Central Bank Law, Monetary Law as well as, more generally, the EU legislative framework on payments. The activities of all central banks are governed by so-called “central bank laws” (which in the case of monetary unions can have the form of a treaty) which prescribe the central bank’s mandate. Consequently, the legal basis for the Eurosystem to issue a digital euro has to be detected in its mandate. According to the EU primary law, the basic tasks to be carried out through the Eurosystem shall be, among others, to define and implement the monetary policy of the Union and to promote the smooth operation of payment systems. It is also specifically provided that the European Central Bank has the exclusive right to authorise the issue of euro banknotes within the Union and that the European Central Bank and the national central banks may issue such notes. The Eurosystem power to open accounts for market participants in order to conduct its operations could also be relevant in this respect. The whole set of tasks, duties and powers conferred upon the Eurosystem have to be assessed to find out the legal basis for the issuance of a digital euro. A second category of core legal issues relate to Monetary Law, that provides the legal foundations for the use of monetary value in society, the economy and the legal system. According to the basic principle of monetary law it is for a sovereign State to determine its own currency system, establishing the official monetary unit and the official means of payment, whose issuance is a monopoly of the State. As far as the Euro area is concerned, the Treaty on the Functioning of the EU provides that the banknotes issued by the European Central Bank and the national central banks shall be the only such notes to have the status of legal tender within the Union. And a similar provision exists concerning the legal tender status of euro coins. While primary EU law introduces the concept of legal tender, it does not elaborate on its scope and legal effects. The issuance of a digital euro would therefore imply the assessment concerning its possible legal tenderness and it could be the occasion to harmonize accross the euro area the effects of this legal status. A digital euro introduction would impact on a legislative framework which already knows digital payments and a wide set of subjects, instruments, services and infrastructures related to such payments. Therefore efforts should be put in place to smoothly accommodate the new tool within the existing landscape. This means that the Payment Service Directive, the Payment Account Directive and the E.Money Directive need to be analysed in order to verify if and how they may encompass a digital euro. Similar checks would be appropriate in relation to the Settlement Finality Directive. Another piece of legislation which calls for the highest attention is that one concerning AML/CFT. Legal assessment would start from the mapping of the existing relevant legislation and, considering the features and objectives of the digital euro, will elaborate on any requested amendment to the current legislation. In this respect, a secondary law act is supposed to be drawn up to regulate the conditions for the issuance of a digital euro by the Eurosystem, adopted on the basis of Article 133 of the TFEU, according to which without prejudice to the powers of the European Central Bank, the European Parliament and the Council, acting in accordance with the ordinary legislative procedure, shall lay down the measures necessary for the use of the euro as the single currency. Such measures shall be adopted after consultation of the European Central Bank. iii. The technological issues When dealing with the design of a retail CBDC, new technologies, such as blockchains, are at the horizon, bringing along both opportunities and risks which need to be carefully evaluated. The design of a CBDC requires taking many decisions. How ownership is assessed – through identity or through knowledge? How money is represented – through accounts or tokens? What is the governance model – centralised, distributed, or decentralised? How the ledger is accessed – through intermediaries or directly, without any intermediation at all? Balancing functional requirements requires solving complex problems which might be not self-evident at first sight: an example is the trade-off between the privacy-preserving characteristics of a CBDC with the need for auditability, arising from anti-money laundering and contrast to financing of terrorism requirements. All these design decisions – ownership, money representation, governance, access, privacy, and many others – are often intertwined in a “Gordian knot” that requires bold decisions and a holistic approach to be untied. Failing to do so might produce technical solutions which are unfit for the purpose or unappealing for the citizens. Cybersecurity implications of a retail CBDC design are also particularly relevant. Universality of access implied by its retail nature considerably widens the attack surface of the system, compared to traditional central-bank run systems, traditionally open only to intermediaries. Risks originating from potential programmability features of a digital currency require a careful balance of flexibility and security constraints; one could ask , for instance, whether the concept of programmable money is compatible with the requirement of unicity of public money. The capability of undue creation of central bank money in case of successful attacks, with no physical constraints to the amount of creatable money, means that financial losses are potentially unlimited, raising concerns also in terms of cyber-warfare. Lack of expertise on the market leads to skills shortage and a complex recruitment process. Other relevant technical challenges are related to the openness and interoperability features that a CBDC should exhibit; these requires building solutions that rely as much as possible on widely accepted standards and technologies, without imposing options which could restrict the access of intermediaries and value-added service providers, hindering the financial innovation and creating artificial competition barriers. iv. Organizational issues The relevant organizational impacts of introducing a CBDC should not be underestimated. This would entail the need to adapt the central banks organizational setup in the light of their new dual role, trying to exploit the information synergies and taking into account specialization and coordination needs as well as addressing the management of the digital euro and the related impact on the central banks related task. With reference to the digital euro project, I will only mention some of the organizational impacts. Some interventions on existing structures and/or the creation of new coordination and dedicated units could be envisaged, taking into account the design features and the modalities that would be adopted to issue and manage the digital euro. Moreover, the coordination between the management of cash and, if so decided, the future digital euro should be foreseen. In fact, central banks – that have traditionally only managed cash (as public money for retail usage) – will possibly be entrusted to contemporarily manage the two forms of central bank money; this would also have repercussions on the skills of the human resources. The much higher engagement in designing, developing and operating large-scale high tech payment systems will result in increased dedicated staff. A mix of resources (experts in IT, payment systems operation and supervision, financial stability and monetary policy, budget – just to mention few of them – will likely be required. Their expertise will also scouring in non-traditional fields for central banks like distributed systems, cryptography, blockchains. In the case of the Eurosystem, we would have a further organizational challenge. As for the cash, the digital euro would have a supranational nature. Therefore, the governance process within the Eurosystem, saying the distribution of tasks and responsibilities among the ECB and the NCBs, could be reconsidered. As regards, in particular, the technological infrastructures, in order to preserve the strategic autonomy and the operational independence, central banks, should ensure the capability to autonomously develop and operate digital systems built upon new and often disruptive technologies. Information Technology activities, which are traditionally thought of as supporting functions, are growing out of their niche to become core, leading to the internalization of tasks that are now often outsourced. 3. Opportunities In relation to the opportunities, I think that the CBDC is itself an opportunity for monetary systems and for the society. Given what has been discussed so far, CBDCs could bring wide benefits, but the ultimate consequences for the well-being of individuals in society depend on how central banks will address the associated challenges. The issuance of a CBDC would be critical to preside the risks I have already mentioned especially in preserving the role of central bank money as a safe asset at the heart of the system. In addition, I want to mention two other opportunities of issuing a CBDC, as for the financial inclusion and the cross-border payments. Finally I want to mention talk an additional opportunity that is a big one for the Eurosystem as to favor a pan euro-area reach. i. Promote access to and use of financial services, thereby enhancing the financial inclusion of disadvantaged groups The issuance of a CBDC could promote access to and use of financial services, thereby enhancing the financial inclusion of disadvantaged groups, specifically by ensuring an access to a digital payment mean to the unbanked and underserved, who are traditionally unwilling to use private financial products due to distrust in financial institutions, high service costs, and socioeconomic reasons. A digital euro could provide these people with the ability to pay electronically both in stores and online, track their spending, and build a payment history. This could encourage them to demand for more complex products such as savings, loans and insurance. The more the digital euro is integrated into existing payment systems, the greater the benefits will be. On an international level, it could enhance the efficiency of remittances, which are still far more expensive and slower than domestic payments. Furthermore, a CBDC has the potential to offer improved security as it would rely on some form of identification to initiate payments, making it harder for fraudsters and thieves to carry out illegal activities. ii. Contribute to the improvement of cross-border payments CBDCs could open the way for innovations that improve international payments. They can make use of the fact that retail users have direct claims on central bank money to simplify the monetary architecture. However, design features matter for their overall impact in the cross-border context and whether CBDCs will serve the broader public interest. The multi-currency dimension is also a relevant aspect for the digital euro. The experience already garnered by the Eurosystem within the TARGET services context clearly suggests that building a multi-currency ledger comes certainly with some costs, but implies as well a number of significant benefits, such as harmonization, interoperability, flexibility and even potential cost savings. In addition, it is worth highlighting that the possible provision of a digital euro also involves the European Commission and it is also potentially relevant for EU countries that are not part of the eurozone. For this reason, it seems also important to consider the needs, expectations and concerns of those countries. iii. Favor a pan-euro area reach while promoting of a level playing field When looking at the Euro area case we have an additional opportunity. As stated in the Eurosystem’s retail payment strategy, one of the mail goals is to support the creation of a pan-European solution for retail payments at the point of interaction (POI), covering physical shops and e-commerce. There is currently no European solution for those payments, which still highly rely on international card schemes and – for e-commerce – on global big tech providers. The digital euro, if issued, could enable the achievement of this important goal, by ensuring a pan-European reach. This would be a key element, as emerged within the focus groups, the ability to “pay anywhere”. Indeed, the respondents from all countries and different identified groups perceive this as one of the most relevant features of a digital euro. The payment segments identified as a ‘priority’ in the initial releases of the digital euro (eCommerce, point-of-sale, person-to-person and payments from or to government institutions) would help addressing the criticalities associated with the currently limited pan-euro area retail payment solutions. In addition, there is also the competition issue in the payment sector. Usually private players tend to dominate and create positions of competitive advantage by exploiting the benefits of the network effect. The formation of these dominant positions can develop rapidly and create risks of market abuse behavior. A CBDC could therefore be a benefit as it could improve an efficient and competitive payments market, reducing the possibility for a private company to create a dominant position. 4. Wholesale CBDC: a hint Since wholesale and retail CBDC are complementing each other by addressing the different needs of different users, let me now touch upon the implementation of a wholesale CBDC. On the retail side, providing the public with highly convenient and secure means of payment helps to underpin confidence in money by enabling private forms of money to be converted, at par, into risk-free central bank money. On the wholesale side, central banks supply the ultimate means of payment for financial institutions, which helps to reduce risks in the financial system. I would first take the opportunity to clarify that wholesale CBDC is not new in the euro area, since central bank money has been available to the banks in digital form for wholesale transactions for decades, through the Target Services platform. Moreover, the Eurosystem is conducting an effort to integrate and modernize its wholesale settlement infrastructures (T2, T2s and TIPS) to ensure they remain ‘fit for purpose’, and resilient to cyber threats. The consolidation of T2 and T2s platforms, and the creation of a Eurosystem Collateral Management System to simplify processes involving multiple jurisdictions, are the most prominent examples of this effort. Undoubtedly, the use of distributed ledger and cryptography is favoring the development of new business models, services and user experience. Large segments of finance are involved: payments with stablecoins (the so-called Decentralized Finance), issue and circulation of securities, the cross-border payments domain. Faced with this great ferment, institutions are confronted with new challenges and called to promote technological innovation, while ensuring market integrity, investor protection and, ultimately, financial stability. In this regard, the Eurosystem is carefully assessing the merits of providing the possibility to settle the cash leg of DLT-based transactions in central bank money, the safest and most liquid settlement asset. More generally, we are considering how to address market needs in case the market shows concrete interest for wholesale financial transactions based on DLT. To better understand what the concrete market needs are, the Eurosystem recently conducted a market outreach including banks, financial market infrastructure operators and Fintechs. The outcome of this engagement suggests that expectations are widespread of a significant industry uptake of DLT. However, such expectation is not universal, and views are mixed on the relative merits of DLT compared with existing technologies, as to the timeframe in which DLT's uptake is expected to take place. Apart from that, benefits of DLT could take time to materialize due to the lack of a harmonized legislative framework that can facilitate initiatives in that direction. In the EU, an important stimulus is provided by the recently introduced Regulation on a Pilot Regime1, which could provide the Eurosystem with the occasion to support the market in its search for even more efficient payment tools. When considering the possible way forward, also in light of the uncertainties I mentioned, I would argue that an "incremental” approach presents a number of advantages. In particular, in the immediate future, a “trigger” or “bridge” solution, – i.e. a solution for integrating DLT platforms with the existing infrastructures – could be adopted for the settlement of the cash–leg of a tokenized transaction. A wholesale CBDC service based on DLT (i.e. a tokenized CBDC) could possibly be developed down the road, if market developments so require2. The DLT Pilot Regime will temporarily lift some regulatory requirements and will allow financial market institutions to experiment with the supply of trading and settlement services using the DLTs. The trigger solution, in fact, would be a relatively inexpensive option to quickly respond to emerging market needs, keeping the settlement in central bank money within the scope of Target Services, until the questions that are arising from current experiments with the DLT are definitely answered. Moreover, the use of the trigger solution would reduce the risks of fragmentation of the liquidity needed on the ‘cash-side’ of the settlement systems. Other central banks have experimented with trigger solutions . More recently, at Banca d’Italia, we successfully experimented with a trigger solution centred on TIPS, the Eurosystem’s instant payments platform. The model to which Banca d’Italia is committed provides a DLT-agnostic protocol to synchronize the asset-leg and the cash-leg, making an instantaneous DVP transaction possible on a 24/7 basis. This work was carried out in cooperation with Algorand, which provides one of the most advanced blockchain solutions for financial services currently available on the market. The results of our experiments were reported in a recent paper, published in the Banca d’Italia “Markets, Infrastructure, Payment Systems” series, arousing considerable interest and requests for collaboration, as happened by BIS Innovation Hub and the Bank of England. 5. Conclusions The challenge of central banks, and of other public institutions, is to participate in the innovation process and contribute to the creation of instruments that can guarantee trust in the financial and payments system today and in the future. I think it is essential that the institutions, in order to allow this transformative action, also perform a propulsive function, together with an action to address and contain risks, continuing to operate on the technological frontier to effectively respond to the growing demand for efficiency coming from financial intermediaries, citizens and businesses. Thank you for your attention. Designed by the Printing and Publishing Division of the Bank of Italy
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Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Official Monetary and Financial Institutions Forum (OMFIF) virtual dialogue, 3 November 2022.
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Ignazio Visco: Italy and the euro area in difficult and uncertain times Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Official Monetary and Financial Institutions Forum (OMFIF) virtual dialogue, 3 November 2022. *** Let me thank David for his kind invitation and the Official Monetary and Financial Institutions Forum for organising this event. In these opening remarks, I will provide a brief overview of the outlook for the Italian economy and discuss my views on the current and future stance of monetary policy. I think it is useful to start with an assessment of the global economic prospects. In recent months, two main well-known facts are characterising the international economic and financial situation. First, uncertainty is growing considerably, as it is increasingly evident that the global economy is being heavily affected by the consequences of Russia's aggression in Ukraine. The most obvious repercussions are being observed on the energy market. The price of the gas delivered in Europe, in particular, has recorded unprecedented fluctuations for about a year, rising to 340 euros per megawatt hour two months ago, from less than 20 euros at the beginning of 2021. Since the end of August, as European countries have achieved their storage targets, it has fallen back up to around 100 euros. Futures prices, however, suggest that it will remain high for the whole of next year. Food prices on world markets have also been hit, even though tensions eased somewhat after the agreement between Russia and Ukraine at the end of July, which unlocked grain deliveries from the Black Sea ports. The unilateral suspension of this agreement decided by Russia in the last few days provides a further, dramatic confirmation of the great uncertainty connected with the developments of the conflict in Ukraine. Second, inflation is surging rapidly. Globally, it has risen from less than 5 per cent in 2021 to around 9 per cent this year. In response to these pressures, in almost all advanced countries and in many emerging and developing economies, central banks have begun to tighten monetary conditions in order to counter the increase in current and expected inflation, and the possible start of a spiral between prices and wages. As a consequence of these two facts, growth prospects are recording a widespread worsening. According to the last projections by the International Monetary Fund (IMF), the growth rate of the global economy will decrease from the 3.2 per cent estimated for this year to 2.7 per cent in 2023, almost a percentage point lower than was expected last April. Despite these deteriorating prospects, however, aggregate demand is holding up. In Italy we can actually observe a better-than-expected resilience, for example in the service sector, also thanks to the continuing recovery of tourism flows, and in the labour market. In this highly uncertain framework, the Bank of Italy's latest Economic Bulletin presented two projection scenarios for the Italian economy. The first assumes that gas flows from Russia to Italy remain on average at the levels observed in recent months and that the prices of raw materials are in line with those of recent futures contracts. In this scenario, GDP growth would fall from close to 3.5 per cent in 2022 to less than 0.5 per cent in 2023. GDP, in particular, would decline in the last quarter of this year, and then gradually recover from the second quarter of 2023. 1/5 BIS - Central bankers' speeches The weakness of economic activity would reflect both that of consumption – which would diminish, following the decrease in the purchasing power of households – and that of investments in machinery and equipment – which would decelerate due to high uncertainty and the increase in financing costs. The worsening of international trade would also have an impact, as real exports would grow much more slowly after increasing at a rate of more than 10 per cent, both in 2021 and 2022. The second, more adverse scenario, assumes that energy supplies from Russia to Europe are permanently shut off starting in the final quarter of this year and are gradually, albeit only partially, replaced with alternative sources next year; oil and gas prices are therefore projected to rise to around 50 per cent more than was contemplated in the first scenario. These developments would be accompanied by a further slowdown in world trade and a sharp rise in uncertainty. In this case, Italian GDP would fall by over 1.5 per cent next year, while inflation would exceed 9 per cent, 2.5 percentage points more than in the first scenario. Both of these scenarios were drawn up before the publication, earlier this week, of Italy's GDP growth in the third quarter, which was substantially better than expected (an increase of 0.5 per cent quarter-on-quarter, against widely held expectations of a negative figure). These new data suggest that growth should, ceteris paribus, be somewhat higher this year and this effect would mechanically carry on to the next year. These new relatively surprising data confirm that, in a difficult context like the current one, macroeconomic projections, albeit detailed like those referring to these two scenarios, are to be intended as purely indicative and are closely linked to the assumptions on prices and availability of raw materials, which are, in turn, largely determined by developments in the conflict in Ukraine. In any case, the risks for economic growth are still tilted downwards. They stem from geopolitical tensions as well as from the outlook for other economies, first and foremost the US economy, where, also due to the strong tightening of monetary conditions, many indicators suggest a possible contraction in economic activity in the next 12 months. Further negative effects could derive from a potentially sharp slowdown in China, mainly connected with the fragility of the construction sector. The persistence of inflation at high levels for longer than currently expected would obviously be a further negative risk for the purchasing power of households' incomes. Despite the worsening outlook, Italy's debt-to-GDP ratio continues to improve. It is currently estimated at around 145 per cent in 2022, 5 percentage points less than in 2021 and 10 points less than the peak achieved in 2020: about half of the increase recorded due to the pandemics has therefore been recovered. Over the next three years, the debt-to-GDP ratio should continue to fall, although likely at a more moderate pace. Several factors will affect the future dynamics of public debt. General government net borrowing is currently projected on a descending path. In the latest assessment by the Italian Ministry of Economics and Finance, it would settle at about 5 per cent of GDP this year and just above 3 per cent next year (against over 7 per cent in 2021 and 9.5 per cent in 2020). The increase in yields on government securities will raise debt-servicing costs in nominal terms. However, the high average residual maturity of the debt (close to 8 years) will slow the 2/5 BIS - Central bankers' speeches transmission of higher interest rates to debt servicing costs. For example, this year the average cost of debt has remained quite stable, at 2.5 per cent, despite yields rising from less than 0.5 per cent to above 3 per cent for 10-year bonds. Due to the necessary normalisation of monetary conditions in the euro area, the cost of debt servicing is set to increase further. It is worth pointing out that as interest rates are rising to contrast the growth in inflation, this would not worsen servicing costs in real terms insofar as real interest rates will not substantially move up in the medium term. Indeed, the rise in prices would push up the denominator of the debt-to-GDP ratio, an effect that is currently dominating the dynamics. It is nevertheless important to outline a realistic path for continuing the gradual recovery in the high levels of public debt to GDP that started last year. It would be an important signal of credibility for financial markets, which could translate into lower sovereign risk premiums. The budgetary margins that will become available and those created with the moderation of the dynamics of other expenses will make it possible to provide financial support to the economy. Temporary and targeted support, with interventions aimed at households and firms in greater difficulty, will not compromise the state of the public finances and will also help to contain pressures on inflation. Let me now turn on the euro area. In its latest projections, released in early September, the ECB revised GDP growth estimates to 0.9 per cent in 2023, from 3.1 per cent in 2022; with a month of additional data, the IMF has revised them down to 0.5 per cent, signalling a substantial halt. Consumer price developments are no less concerning: inflation rose to 10.7 per cent in October. Net of energy and food, the most volatile components, core inflation rose to 5.0 per cent. More than 60 per cent of the increase in consumer prices recorded in the last twelve months has been caused, directly and through the effects on production costs, by the increases in energy prices. This share rises to almost 80 per cent if we also take into account the effects of food prices not relating to energy, but which have also been affected by the conflict in Ukraine. The growth of consumer prices in the euro area is projected to be above 8 per cent on average in 2022; it would then gradually fall to below 6 per cent over the course of next year and converge towards a value close to the ECB's 2 per cent target in the second half of 2024. Expectations derived from the prices of inflationlinked swaps as well as those based on surveys carried out in October, such as those conducted by the ECB on monetary analysts or those of other private institutions, provide a similar picture. The expectations of households, as suggested by the ECB survey, display slightly higher values: 5 per cent by the end of 2023 and 3 per cent over a 3-year horizon. This could reflect not only a greater weight of backward-looking elements in the formation of households' expectations, but also the large weight of the most volatile components of inflation in the consumer basket of less well-off households. Wage dynamics in Italy and in the euro area have so far remained contained. In our country, the growth trend in contractual wages was less than 1 per cent in the second quarter, 0.3 percentage points more than at the beginning of the year, mainly due to the renewal of contracts in the public sector. Net of one-off components, contractual wages accelerated on average for the area in the second quarter, to 2.5 per cent. The growth in labour costs could intensify in the final part of this year and in 2023, due to the increase in the minimum wage in some countries and those that will likely be granted to contain the loss of 3/5 BIS - Central bankers' speeches purchasing power of workers' incomes. However, the marked weakening of economic activity and the modest share of inflation-linked wages in the area as a whole may limit, as of now, the risks of a spiral between prices and wages. Last Thursday, the ECB Governing Council raised official interest rates by 0.75 percentage points, bringing the overall increase since 21 July to 2 points. In this way, a substantial step forward was taken in the reabsorption of monetary accommodation, driving the rate on banks' deposits with the Eurosystem a long way from the negative levels that had been necessary to hinder the risk of deflation and limit the fallout of the pandemic crisis. Based on market participants' expectations, one-year real rates are still very low and would barely become positive by the end of next year. The decision to modify the terms and conditions of the third series of targeted longer-term refinancing operations (TLTRO-III) was justified by the need to ensure that the contribution of this instrument is also consistent with the broader normalisation process of monetary policy. The recalibration intends to strengthen the transmission of official rate increases to the conditions of bank loans and to remove the constraints on the process of reducing the Eurosystem's balance sheet through the early repayment of TLTRO-III operations. We postponed the discussion on the timing and methods of a gradual review of the reinvestment of the repaid capital on maturing securities as part of the financial asset purchase programmes, while maintaining the flexibility associated with the renewal of those under the pandemic emergency programme (PEPP). In fact, we will have to continue to carefully assess the effects of our decisions on financial stability. The yield spreads between the government bonds of the euroarea countries most exposed to market fluctuations and the German ones, which have been increasing since the beginning of 2022, narrowed after the announcement, in June, of the activation of flexibility in the reinvestment of the securities purchased under the PEPP and the approval, in July, of the new instrument against the risk of fragmentation (Transmission Protection Instrument, TPI). The Italian spread on ten-year government bonds, which in recent weeks had been affected by political uncertainty and increased risk aversion in the markets, has fallen more recently to just over 210 basis points, a level still considerably higher than those prevailing in other euro-area countries hit, like Italy, by the sovereign debt crisis ten years ago. For its decisive and persistent decrease to be achieved, prudence on the public budget and policies aimed at restoring the country on a high path of growth remain crucial. *** To conclude, the costs of inflation require a decisive intervention by monetary policy aimed at averting the danger of de-anchoring expectations and triggering a spiral between prices and wages that would amplify the negative effects on our economies due to geopolitical uncertainty and the energy crisis, and increase their duration. The ECB's official rates have therefore been increased by 2 percentage points since July, starting from the extraordinarily low levels they had reached while dealing first with the consequences of the global financial crisis and the sovereign debt crisis, then with those of the pandemic. The rapid deterioration of the euro-area economic outlook that we are observing, which is affected above all by the exceptional rise in energy costs, requires us to continue this action. Its pace, as well as the "terminal level" that it will need to 4/5 BIS - Central bankers' speeches reach will have to be discussed meeting-by-meeting, based on the flow of new data and on the revised outlook for growth and inflation. Specifically, we need to strike the right balance between the risk of prolonging unacceptably high inflation and the risk to the medium-term outlook for inflation posed by the rapidly deteriorating economic situation, as we must also be aware that, in the event of a more serious worsening of economic conditions, financial stability risks would further endanger price stability. Starting from the very low values which had been necessary first during the global financial crisis and the euro-area debt crisis and then during the pandemics, interest rates have not yet reached a level consistent with the achievement of our 2-per-cent inflation target over the medium term. The need to continue our action is therefore clear, but the reasons for a more gradual, though progressive, approach are gaining ground, notwithstanding the current high level of observed inflation. Designed by the Printing and Publishing Division of the Bank of Italy. 5/5 BIS - Central bankers' speeches
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Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 98th World Savings Day, organized by the Association of Italian Foundations and Savings Banks (ACRI), Rome, 31 October 2022.
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Ignazio Visco: 2022 World Savings Day Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 98th World Savings Day, organized by the Association of Italian Foundations and Savings Banks (ACRI), Rome, 31 October 2022. *** The economic cycle and monetary policy The uncertainty surrounding the international economic and financial situation has increased considerably in recent months. Global economic activity is heavily affected by the consequences of the Russian invasion of Ukraine. The most tangible impact can be observed on the energy market: the price of gas supplied to Europe recorded unprecedented fluctuations, reaching €340 per megawatt hour, from under €20 in early 2021. It has gradually decreased to around €100 since the end of August, after the main European countries met their storage targets, but futures prices suggest that it will remain high throughout next year. Global food prices have also been affected, though the tensions eased at least partially after the agreements reached in late July between Russia and Ukraine to unblock grain deliveries from Black Sea ports. The worsening in growth prospects is widespread. The International Monetary Fund estimates that global economic growth will slow from 3.2 per cent this year to 2.7 per cent in 2023, almost 1 percentage point below the April forecasts. In the euro area, GDP growth is expected to fall from 3.1 per cent in 2022 to 0.5 per cent next year, coming to a virtual halt and marking a downward revision of almost 2 percentage points in just six months. Rising commodity prices have also had an extraordinary impact on consumer prices. Global inflation rose from below 5 per cent in 2021 to around 9 per cent this year. In response to these pressures, central banks in almost all advanced economies and in many emerging and developing economies have started to tighten monetary conditions to counter the rise in current and expected inflation, as well as the risk of price-wage spirals. Given this climate of high uncertainty, the Bank of Italy's latest Economic Bulletin included two forecasting scenarios for the Italian economy. The first scenario assumes that the flows of gas from Russia to our country will remain at the average levels recorded in recent months and that the developments in commodity prices will be in line with those implied by recent futures contracts. In this scenario, GDP growth would drop from 3.3 per cent estimated for 2022 to 0.3 per cent in 2023. GDP would fall in the second half of this year before gradually picking up again from the second quarter of 2023 onwards. The overall weakness in economic activity would reflect both that of consumption, which would decrease as a result of the decline in households' purchasing power, and that of investment in machinery and equipment, which would slow down owing to the uncertainty and the increase in financing costs. Worsening international trade would also play a role. 1/9 BIS - Central bankers' speeches The second, more adverse scenario assumes a complete halt in Russian gas flows to Europe starting from the current quarter and significantly higher energy commodity prices. At the same time, international trade would slow down more markedly. In this case, GDP would contract by 1.5 per cent in 2023 and inflation would exceed 9 per cent, about 2.5 percentage points higher than in the first scenario. In light of the current challenging environment, the point estimates of these two scenarios are purely indicative and strongly dependant on the assumptions made on commodity prices and availability, which largely depend on developments in the conflict in Ukraine. In any case, the risks to growth are tilted to the downside and, not only for Italy, depend on geopolitical tensions and the economic outlook in the United States, where, also owing to the strong tightening of monetary conditions, many indicators anticipate a possible GDP contraction in the coming months. Further negative repercussions could arise from a possible abrupt slowdown in the Chinese economy, mainly in connection with the fragility of the construction sector, and from inflation remaining persistently high for longer than currently expected. Inflation in the euro area came close to 10 per cent in September, mainly driven by the exceptional rise in energy prices (over 40 per cent year-on-year). Inflation reached 4.8 per cent net of the most volatile components – energy and food – which are the most affected by the conflict in Ukraine. Almost two thirds of the overall increase in consumer prices over the past twelve months appear to have been caused by the increases in energy prices, both directly and through the impact on production costs. This share rises to around four fifths if we factor in the impact of food prices which, although not energy-related, have also been affected by the conflict in Ukraine. According to the European Central Bank (ECB) staff projections published in September, consumer prices in the euro area will grow by over 8 per cent on average in 2022 before gradually decreasing to below 6 per cent in 2023 and converging to levels close to the 2 per cent inflation objective in the second half of 2024. A similar picture emerges from the expectations implied by inflation-linked swap prices and from the surveys conducted in October, such as the ECB's survey of monetary analysts and polls by other private entities. Conversely, households' expectations as captured in the ECB's survey are slightly higher, at 5 per cent over the next twelve months and at 3 per cent at the three-year ahead horizon. This is likely due to a more backward-looking approach in the formation of expectations and to the considerable weight of the most volatile components of inflation in the consumption basket of the less well-off households. Wage growth – in Italy and in the euro area as a whole – has remained moderate so far. In Italy, negotiated wages net of one-off components grew at an annual rate of 0.9 per cent in the second quarter, 0.3 percentage points higher than at the beginning of the year, mainly owing to the renewal of public sector contracts. Negotiated wages also accelerated in the euro area on average, reaching 2.5 per cent. Labour costs are expected to rise later this year and the next, as wage increases could be granted to offset the loss in workers' purchasing power, in some countries also in connection with minimum wage rises. Hence, there are currently no clear signs of a significant de-anchoring of inflation expectations from the price stability objective. The sharp weakening in economic 2/9 BIS - Central bankers' speeches activity and the modest share of inflation-linked wages in the euro area as a whole also seem to be containing the risk of a sustained and widespread price-wage spiral. The process of normalizing monetary conditions underway since late 2021, which involved the finalization of the asset purchase programmes and the decision to start raising monetary policy rates, is aimed at decisively countering the possibility of the two aforementioned risks materializing. Last Thursday, the ECB Governing Council raised the key interest rates by 0.75 percentage points, bringing the overall increase since 21 July to 2 percentage points. This has been a substantial step forward in the reabsorption of monetary accommodation, significantly moving the Eurosystem deposit facility rate away 6 from the negative levels that had been necessary to counter the risk of deflation and to limit the fallout from the pandemic crisis. According to market participants' expectations, oneyear real interest rates are still very low and may turn barely positive from the end of 2023 onwards. The decision to change the terms and conditions of the third series of targeted longerterm refinancing operations (TLTRO III) was justified by the need to ensure that the contribution of this instrument, too, is consistent with the broader monetary policy normalization process. This recalibration aims to strengthen the pass-through of key interest rate increases to bank lending conditions and to remove deterrents to the Eurosystem's balance sheet reduction process through the early repayment of TLTRO III operations. The ECB Governing Council postponed the debate on the timing and arrangements of a gradual review of the reinvestment of principal payments from maturing securities under the asset purchase programmes, while maintaining the flexibility associated with the reinvestment of those under the pandemic emergency purchase programme (PEPP) over the coming months. Key interest rate increases will need to continue to mitigate the risk that the persistently high inflation caused by the sequence of supply-side shocks will feed into the expectations of households and firms, thus driving price rises and leading to greater wage increases. However, the pace at which the rates will grow and their end point cannot be predetermined on the basis of projections or pre-established scenarios, which in this phase are merely indicative. The heightened uncertainty requires a gradual approach and a careful assessment of the adequacy of the monetary stance, based on the data as they become available. Nonetheless, the risk of a worse-thananticipated economic outlook should not be underestimated, as this would make an excessively fast-paced normalization of key interest rates a disproportionate measure. This is a risk that the Governing Council will need to take into account over the coming months, as well as the risk that inflation remains too high for too long. The Governing Council will also need to continue to assess the effects of its decisions on financial stability carefully. The yield spreads between the ten-year government bonds of the euro-area countries most exposed to market fluctuations and the corresponding German Bund, which had been widening since the beginning of the year, have narrowed since the ECB announced in June that it would use flexibility in reinvesting the assets purchased under the PEPP, and in July that it had approved the new Transmission Protection Instrument (TPI). The Italian yield spread, which had been affected by political uncertainty and heightened risk aversion in the markets over the past few weeks, has declined to 210 basis points in recent days, which is still 3/9 BIS - Central bankers' speeches considerably higher than in other euro-area countries equally affected by the sovereign debt crisis of ten years ago. In order to lower the yield spread decisively and persistently, fiscal prudence and policies designed to put the country back on a high growth path remain crucial. Savings in Italy: uncertainty and economic growth In the current economic climate, savings trends reflect opposing pressures. On the one hand, savings are supported by households' precautionary response to the high uncertainty surrounding the economic outlook; on the other hand, they are weakened by attempts to maintain adequate levels of consumption in the face of sharply rising price pressures. In Italy, in line with the trends observed in the other major euro-area countries, households' propensity to save has continued to decline, a trend under way since the second quarter of 2021, after the exceptional upturn recorded in the most acute phase of the pandemic, when it rose, with wide fluctuations, from less than 10 per cent at the end of 2019 to 18 per cent in early 2021. For households as a whole (i.e. including producer households), the propensity to save stood at 11 per cent in the second quarter of 2022, around 2 percentage points lower than in the last quarter of 2021. In absolute terms, households' savings neared €35 billion in the three months ending in June, still 13 per cent higher than before the outbreak of the pandemic (after almost doubling in the months immediately thereafter), despite taking into account the price hikes recorded by the consumption deflator. In the first six months of this year, the decline in real terms slightly exceeded 16 per cent, as a result of prices rising by more than 3 percentage points. However, aggregate trends mask considerable heterogeneity within the sector. Indeed, the capacity to save varies greatly among households: for many low-income households, savings might have been zero or negative. Savings were likely concentrated in upper middle-income households, whose share of expenditure for essential goods, for which price increases have been particularly steep, is relatively small. In June, owing to the sharp fall in asset prices, the value of households' financial wealth fell by almost €350 billion compared with the end of 2021, to around €4,900 billion. Conversely, real wealth – consisting mainly of real estate – amounted to €6,250 billion, up by €50 billion, thus returning to the levels prior to the 2018-21 downturn. This improvement reflects both gradually rising house prices and new investment in real estate. Taking into account the slight increase in financial liabilities (around €10 billion), net household wealth decreased to around €10,150 billion, 8.2 times disposable income (compared with 8.4 times at the end of 2019). Net of the increase in the consumption deflator, real net wealth declined by more than 6 per cent compared with the end of 2021, with about half of that decrease due to inflation. The heightened volatility in the markets has affected the composition of households' financial assets. Deposits and cash continued to grow, albeit at a slower pace, and reached one third of total assets by the end of June, their highest level in more than 20 years. After a prolonged downturn, the share of direct investment in medium- to long- 4/9 BIS - Central bankers' speeches term bonds increased slightly in the first half of 2022, driven by the rising opportunity cost of holding more liquid assets. This partly offset the decline in the share of assets held in the form of equity and other shareholdings (in Italy, these consist mainly in family ownership stakes of small and medium-sized enterprises), which was linked to the fall in financial market prices. Bonds, equity and other shareholdings together account for slightly less than 30 per cent of total financial assets. Investment in asset management products, although declining, remained positive in the first half of the year; its share amounts to more than one third of total financial assets. This expansion, underway since the early 2010s, was driven by investment fund subscriptions and purchases of insurance policies; investment in pension funds remained limited. Growth in this sector could be fostered through a more widespread use by institutional investors of alternative investment funds specializing in the valuation and selection of complex projects, such as corporate restructuring. These funds, which operate over a medium-term horizon, can play a crucial role for the financing of smaller firms, especially when it comes to expanding the scale of operations and investing in innovation. Given the high uncertainty surrounding the economic outlook, diversifying investments adequately, with the necessary focus on risk mitigation, is even more expedient to protect savings from rising inflation and seize any opportunities that may arise in the sectors benefiting from higher interest rates. Initiatives aimed at helping savers to make informed decisions and, more generally, to raise their level of financial literacy remain crucial in this regard. This is all the more urgent for those financially vulnerable segments of the population most affected by the impact of inflation on the purchasing power of their incomes. The Bank of Italy is strongly committed to working on this issue, also with initiatives catered to young people and adults throughout Italy, such as those held during the fifth edition of the Month of Financial Education, which draws to a close today. The financial sector and the allocation of resources for economic activity In Italy, banks continue to play a key role for the allocation of savings to economic activity and investment. Bank borrowing accounts for approximately 17 per cent of the total liabilities of non-financial corporations, versus 6 per cent of loans from other financial corporations and 4 per cent from bond markets, while equity and other shareholdings amount to almost 50 per cent. In the current economic climate, bank lending to firms has continued to grow: in the twelve months ending in September, it accelerated to 4 per cent, from 1 per cent in January 2022, partly as a result of the higher costs associated with the energy shock. In order to maintain sound balance sheets, banks need to manage rising credit risks carefully, including through regular provisions. They can thus avoid the inevitable tightening of credit supply conditions associated with the increasing riskiness of borrowers, early signs of which are already visible, turning into a severe credit crunch. Italian banks enter this phase from a position of overall balance, which has clearly improved since the financial crises of over a decade ago. Non-performing loans (NPLs) 5/9 BIS - Central bankers' speeches have declined further; NPL sales have continued and new NPL rates have remained very low by historical standards. Net of loan loss provisions, their share of total lending was down to 1.5 per cent at the end of June; for significant institutions the gap with the European average has been almost completely closed. The ratio of common equity tier 1 to total risk-weighted assets (CET1 ratio), albeit 50 basis points down in the first half of this year (to 14.8 per cent), remains above 2019 levels. This decline was mainly due to profit distributions by some large financial intermediaries, the depreciation of assets measured at fair value, and the phasing out of temporary measures introduced in 2018, when the IFRS9 accounting standard became effective. Profitability is high by historical standards: the annualized return on capital and reserves rose to 9 per cent in the first half of this year, driven by strong net interest income growth and, to a lesser extent, by cost savings and still low loan loss provisions. While there are currently no major signs of deteriorating bank asset quality, estimates based on the latest macroeconomic scenarios published by the Bank of Italy point to a potentially much larger flow of new NPLs next year. The growth in insolvencies will likely be driven by the cyclical slowdown and have a stronger impact on lending to firms that are more exposed to energy price increases. Although some banks may face greater difficulties, especially in a highly adverse scenario, our latest assessments suggest that the system as a whole should be able to absorb the shock. Given this situation, we expect banks to promptly review the scenarios used for loan classification and to account for expected losses without delay. A proper accounting and prudential classification will not only increase the transparency of financial statements, it will also improve risk management. Any provisions made in view of an expected increase in the probability of debt defaults, in compliance with international accounting standards, will dilute the impact of deteriorating credit quality. At the same time, thanks to the profits made over the year, capital strengthening is helping to counter the impact of worse-than-expected macroeconomic developments. Cooperative credit banks (BCCs) have historically played a very important role in the intermediation of savings, particularly with regard to the financing of smaller firms. This role did not cease following the reform – if anything, it was strengthened, though concerns were raised on more than one occasion. Over the almost four years since the establishment of cooperative banking groups, their market share of loans to firms has remained stable at 10 per cent, or almost 20 per cent if we only take into account loans to small and micro firms. In addition, the average loan size has held broadly stable, suggesting that the typical customer base of BCCs has remained unchanged. By strengthening the technical profiles of these banks, the reform has therefore allowed them to maintain over the challenging last few years their role in supporting businesses in the regions where they are established. Between the end of 2018 and June 2022, the NPL ratio of cooperative banking groups declined from 6.0 to 1.8 per cent, net of loan loss provisions, and the coverage ratio increased by almost 18 percentage points, to 68 per cent. The cost-to-income ratio fell by more than 11 percentage points, to 64 per cent, and the return on capital and reserves rose above the average value for the other significant Italian banks in the first half of this year. The CET1 ratio is up by 3 percentage points from 2018, to 19 per cent. Considerable progress has been made in the area of corporate governance and 6/9 BIS - Central bankers' speeches management standards. The establishment of cooperative banking groups has also allowed for safer, faster and smoother handling of any vulnerabilities of individual subsidiaries. The reorganization of cooperative credit has undoubtedly required BCCs and their parent companies to make significant strategic, organizational and operational changes, with start-up costs and new costs that in part stem from being held by intermediaries qualified as significant for supervisory purposes. However, these changes took place in a regulatory and supervisory environment that is sensitive to the peculiarities of BCCs, i. e. limited individual size and complexity. More specifically, those with a balance sheet surplus of up to €5 billion have special corporate governance and variable compensation rules, in accordance with proportionality criteria that have recently been revised to broaden their scope. For all of them, the Bank of Italy has lifted the requirement to submit individual reports on the self-assessment of liquidity and capital adequacy and streamlined disclosure requirements for the use of external providers. Internal controls are also inspired by the proportionality principle, as intermediaries can make their control functions nimbler, provided this is consistent with their risk profile, scale and operational complexity. As is the case for the banking industry, the asset management industry is also enjoying favourable conditions overall. In the first six months of 2022, the decline in asset prices led to a contraction in investment fund assets, though net funding remained slightly positive. In keeping with the expectations regarding interest rates and inflation, there was an increase in equity fund subscriptions matched by bond fund redemptions. Investors continue to show an appetite for sustainable investment funds: in the first half of the year, Italian funds whose mission includes pursuing environmental, social and governance (ESG) objectives recorded new subscriptions, while the rest of the funds registered outflows. Italian funds, including alternative funds, have low liquidity and leverage risks on average, something which should limit the consequences of possible further market turbulence. The collection and allocation of savings will benefit from investment in new technologies. As I have mentioned on several occasions, innovations based on distributed ledger technologies (DLTs) have the potential to reduce intermediation costs, to the benefit of investors and firms. However, innovation is not without risk. It is necessary to distinguish between a given technology and the crypto-assets that use it: with regard to the latter, we have repeatedly raised savers' awareness, emphasizing the need to clearly distinguish between crypto-assets backed by real or financial assets and those which, on the contrary, have no intrinsic value. In addition, last June, we sent a communication to all supervised entities, overseen payment operators and technology service providers, highlighting the need for adequate safeguards to mitigate the risks associated with the use of DLTs ('Communication by Banca d'Italia on Decentralized Technology in Finance and Crypto-assets', June 2022). Further clarity will be provided following the final approval of the European Union's Markets in Crypto-assets Regulation (MiCAR). Common rules for issuing and offering these instruments to the public and requirements for the provision of services related to them will foster the protection of users and the integrity and stability of the financial system, while creating the conditions for the opportunities afforded by technology to be 7/9 BIS - Central bankers' speeches seized in Europe as well. The regulation on a pilot regime for distributed ledger-based market infrastructures (the so-called DLT pilot regime), which was published last June, will also make it possible to test new ways of issuing and circulating financial instruments under the supervision of Consob and Banca d'Italia. The preliminary results of a survey we have conducted over the past months point to a growing interest in the potential of DLTs and crypto-assets on the part of financial intermediaries, which are carrying out research and testing in ever increasing numbers, with a particular focus on the provision of services such as the safekeeping of assets, the reception and transmission of orders, and the exchange between crypto-assets and currencies. Pending the introduction of specific rules, our job is to ensure that this is done within the boundaries of the existing regulations and by adequately monitoring risks. *** The costs of inflation call for decisive action by the ECB Governing Council to avert the danger of it being passed on to expectations, triggering a wage-price spiral and the connected risk of increasing its duration and amplifying its negative impact on our economies. Since last July, the key interest rates have been raised by 2 percentage points, starting from the extraordinarily low levels that had resulted from the need to address first the consequences of the global financial crisis and of the sovereign debt crisis, and subsequently those of the pandemic. The rapid deterioration of the economic outlook, which is mainly affected by the exceptional rise in energy costs, still requires progressive action, taking careful account of the risk of inflation being unacceptably high for longer than expected and also considering, with the same level of attention, the possible repercussions of changes in cyclical conditions. Aware though we are of the risks to financial stability and the implications for the preservation of price stability in the event of a more severe, unexpected deterioration in economic conditions, we can certainly discuss the pace at which to raise policy rates, but I believe that there should be no doubt as to the direction taken or of the fact that interest rates have not yet reached a level consistent with achieving the inflation objective of 2 per cent over the medium term. Following the necessary normalization of monetary conditions, the cost of debt servicing is set to rise. This makes it all the more important to set out a realistic path to continue the process of gradually reducing the high public debt-to-GDP ratio initiated in the past two years. This would be a decisive signal of credibility for the markets, which would translate into lower sovereign risk premiums, thereby limiting the interest expense and reducing the effort needed to achieve the fiscal targets. While the redistributional and allocative consequences of higher energy costs cannot be ignored, the scope for supporting households and firms is likely to be much more limited than in the last two years. Additional room for manoeuvre may be gained by reducing other expenditure. Temporary and targeted measures geared towards the most distressed households and industries may help to contain the fall in real income and, through this channel, the inflationary pressures associated with wage demands, without compromising the fiscal balance. 8/9 BIS - Central bankers' speeches Over the last two years, the reduction in the debt to GDP ratio has benefited from the faster-than-expected economic recovery and has been facilitated by the increase in prices, which has been as unwelcome as it has been widespread and protracted. Today, however, we can only hope for and seek a rapid reduction in the 'inflation tax', for the sake of economic stability, the protection of savings and to provide respite to those most affected by the exceptional rise in energy costs. Care should be taken not to repeat the mistakes of forty and more years ago, when persistent inflation due to the futile wage-price spiral became associated with many years of excessive deficits, ultimately leading to the financial and currency crisis, of which we are marking the 30th anniversary this year. It remains essential to direct public resources to support economic growth. Italy is now benefiting from the strong boost provided by the substantial resources made available under the Next Generation EU (NGEU) programme and to be used for the investments and reforms laid out in the National Recovery and Resilience Plan. The funding obtained already stands at €46 billion. A further €21 billion will be received soon, in the form of both grants and loans provided at a low interest rate. Achieving fully and without delay this ambitious but realistic plan could lead to a significant increase in the growth potential of our economy. Italy, which is the main beneficiary of the resources provided under the NGEU programme, has the responsibility to demonstrate tangibly the progress that a stronger and more cohesive European Union can achieve. After years of stagnation, our economy can return to a vigorous and steady development path founded on upgrading and expanding infrastructure and on accumulating capital, and not just physical capital. This objective is within our reach; the greater the determination and ability to achieve it we can demonstrate, the more public investment can be combined with the renewed strength of private investment, necessarily fuelled by the savings built up over time by Italian households through their hard work. 9/9 BIS - Central bankers' speeches
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bank of italy
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Speech by Mr Paolo Angelini, Deputy Governor of the Bank of Italy, at the Associazione Nazionale per lo Studio dei Problemi del Credito, Milan, 15 November 2022.
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The financial risks posed by climate change: information gaps and transition plans Speech by Paolo Angelini Deputy Governor of the Bank of Italy Associazione nazionale per lo studio dei problemi del credito Milan, 15 November 2022 1. Introduction The consequences of climate change affect the financial system in several ways. The materialisation of the related risks – physical and transitional – can cause damage to buildings and companies, and the obsolescence of entire production chains. The potential negative effects on the stability of individual intermediaries and of the financial system are the main reason why central banks and supervisory authorities have long included environmental sustainability in their work programmes.1 Furthermore, ensuring the adequate management of these risks is instrumental to allocate the resources for the transition towards a sustainable economy. Awareness of the importance of climate-related and environmental risks is growing among the banks in the Single Supervisory Mechanism (SSM); all significant banks have begun to consider how to integrate these risks into their activities. The progresses of the works are heterogeneous. While no bank is fully in line with the ECB’s expectations on this matter,2 progress is ongoing on several fronts. Banks have so far mainly worked on data collection and exercises to assess transition risks. Physical risk management practices instead are generally less advanced. Only few intermediaries have started to consider other environmental risks, such as biodiversity loss and pollution. Overall, Italian banks seem to be moving in step with those of other European countries.3 In my remarks I will briefly survey some key elements of the legal and regulatory framework on ESG practices and risks which have a bearing on intermediaries and The concept of sustainability in finance conventionally includes the three dimensions of environmental, social and corporate governance (ESG). Although the three aspects are closely connected, this speech focuses mainly on the environment. ECB (2022), “Supervisory assessment of institutions’ climate-related and environmental risks disclosures”, March. Angelico, Faiella and Michelangeli (2022), “Climate risk for Italian banks: an update based on the Regional Bank Lending Survey”, Bank of Italy, Notes on Financial Stability and Supervision, n. 29. non-financial firms. I will argue that excessive reliance on sectoral sustainability data by lenders (banks and investors) can lead to incorrect allocation of finance, to the detriment of the overall transition process. Intermediaries and companies should join forces to assemble data at the individual company level. This appears particularly necessary and urgent in Italy, given the comparatively high share of small businesses that will not be subject to sustainability reporting obligations. I will then focus on transition plans. In short, a transition plan is a detailed description of actions that a company commits to implement over a multi-year horizon, in order to comply with a given environmental objective, for example that of the Paris Agreement. The SSM encourages banks to adopt transition plans. I will argue that overreliance on the thrust that financial intermediaries (banks and institutional investors) can give to the transition process should be avoided, and that transition plans of non-financial corporations should be a key point of attention. Finally, I will argue that it is essential to clarify the relationship between the investors’ traditional objectives, typically expressed in terms of risk and return, and the environmental objectives defined in the transition plans. The potential conflict between the two might become a serious obstacle to the contribution that the financial system can provide in the fight against climate change. 2. Regulatory initiatives to improve climate risk reporting The regulation of environmental, social and governance (ESG) risks of financial and non-financial companies is still in the making. At the European level, this work is at an advanced stage, especially in comparison with the other main jurisdictions. In what follows I will focus on some important measures, without claiming to be complete. The Corporate Sustainability Reporting Directive (CSRD), first published by the European Commission in April 2021, is due to enter into force on 1st January 2024. Starting on that date all companies, both financial and non-financial, that fall within the scope of the directive (essentially large companies and, from 2026, listed SMEs) have to prepare a non-financial statement (NFS) according to the sustainability standards set by the European Financial Reporting Advisory Group (EFRAG).4 The CSRD expands significantly the pool of companies subject to regulation and introduces much more detailed reporting requirements than those prescribed by the Non-Financial Reporting Directive (NFRD) currently in force. Banks will be affected by these changes both as users of better information on client companies and, in case they are also subject to the new directive, as providers of more accurate information on their own risks. A second important element is the proposal of the Corporate Sustainability Due Diligence Directive (CSDDD). This directive will introduce the obligation for large companies, both financial and non-financial, to identify, prevent, mitigate and account The so-called "double materiality" approach will be adopted, meaning that ESG reporting must cover both the impact of environmental issues on the company and the impact of the company on people and on the environment. for the negative externalities they generate in terms of human rights and environmental impact. In particular, intermediaries should refrain from investing in counterparties that have adverse impacts on the environment and human rights; alternatively, they should define (potentially very costly) measures to mitigate and reduce impacts. The directive would have implications for the entire “value chain” of large companies, e.g. for supplier companies not belonging to the group, regardless of their size.5 Lastly, the CSDDD should introduce the obligation for large companies to prepare a transition plan consistent with the Paris Agreement. For banks, this obligation is also included in the proposed revision of the CRR3/CRD6 prudential framework, at an advanced stage of negotiation. Albeit still in an embryonic stage, another important aspect concerns the non-financial reporting audit framework. The Roadmap for Addressing Climate-Related Financial Risks by the Financial Stability Board proposes to define such a framework. In Europe the CSRD will make the certification of non-financial declarations mandatory starting from 2024; it will be initially set to less stringent criteria, a more stringent approach is envisioned from 2028. Currently companies subject to NFRD publish audited sustainability data in some European countries only, among which Italy. Regarding reporting requirements for banks under the Third pillar, the second Capital Requirements Regulation for banks (CRR2) provides that large financial institutions6 that have issued securities listed on a regulated market of any of the Member States must publish information on ESG risks every six months. The technical document for the implementation of this legislation prepared by the EBA requires banks to publish more detailed qualitative and quantitative information than those currently reported under the NFRD.7 As for timing, the EBA has adopted a transitional regime. The banks concerned will be required to publish a first set of data in the first months of next year, with reference date end 2022. Based on the current text of the CRR3 proposal, this obligation will be extended to all banks from 2025, according to criteria of proportionality that are still being defined. Regarding transition risks, banks will have to publish, among other things, their exposures towards the ten high-emissions sectors defined by the European legislation8 and towards the top twenty most polluting companies worldwide, as well as measures of energy efficiency of their real estate collateral. Regarding physical risks, banks will have to provide For banks, the "value chain" includes only the companies they lend to. SMEs are also excluded. “Large financial institutions” are defined as those that meet any of the following conditions: (a) they have been identified as institutions of global or national systemic relevance; (b) they are among the top three banks nationwide based on total assets; (c) their total individual or consolidated assets are equal to or greater than 30 billion euros. EBA (2022), “Final draft implementing technical standards on prudential disclosures on ESG risks in accordance with Article 449a CRR”, January. The sectors are as follows: a) agriculture, forestry and fishing; b) mining and quarrying; c) manufacturing; d) electricity, gas, steam and air conditioning supply; e) water supply; sewerage, waste management and remediation activities; f) construction; g) wholesale and retail trade; repair of motor vehicles and motorcycles; h) transportation and storage; i) accommodation and food service activities; l) real estate activities. Sectors a)-h) and l) are identified by Commission Delegated Regulation EU/2020/1818. Sector i) was added by the EBA following discussions with experts. data on exposures to counterparties located in high risk geographical areas (identified through specialised databases), as well as an estimate of the impacts of climate risks on regulatory capital, and a description of the risk management methodologies adopted. From 2024 banks will also need to report indicators of the alignment of their assets to the European Taxonomy, such as the Green Asset Ratio (GAR)9, the Banking Book Taxonomy Alignment Ratio (BTAR) and greenhouse gas emissions.10 This will require granular information on the environmental performance of client firms. The adoption of this complex body of legislation, and more generally the push given by the European legislator to the fight against climate change, have many implications for the financial system. In what follows I will examine two of them, without any claim to exhaustiveness. 3. The problem of sustainability data Granular sustainability data are at present insufficient. This helps explain the delay of most banks in aligning with the expectations of the SSM, and hinders the ability of the financial system to support the environmental transition. With the the approval of the CSRD, the number of Italian companies subject to the obligation to draw up the NFS will significantly increase, from a few hundreds under the NFRD regime to 4-5.000.11 Once the phase-in is completed, the companies subjected to the directive will publish the bulk of the data needed by the intermediaries to fulfil their reporting obligations. However, this leaves out most SMEs, which in Italy account for about two thirds of value added and about 80 percent of the workforce. Both shares are more than 10 points higher than the respective European averages. For micro-enterprises the differential in terms of workforce rises to 15 points.12 The regulation does not neglect SMEs completely. The G20 working group on sustainable finance recommended the International Financial Reporting Standards (IFRS) Foundation to consider issuing sustainability reporting guidelines for SMEs, mirroring the IFRS The GAR (requested both in the Third pillar and the NFS) is calculated as the ratio between the credit or other financial instruments that finance economic activities aligned with the European Taxonomy and total assets. In the numerator, in the context of loans to businesses, only loans and debt securities to entities included in the perimeter of the NFRD and in the future CSRD are considered (therefore excluding SMEs). It seems questionable that there is no indicator that excludes SMEs from the denominator as well. The BTAR, requested only in the Third pillar, differs from the GAR since the numerator also includes Taxonomy aligned exposures towards companies that are not subject to the NFRD (i.e. SMEs). Scope 1 emissions are those generated directly by the production activity of the company through the direct use of fossil fuels. Scope 2 emissions stem from use of energy produced outside the corporate perimeter (e.g. by electricity companies). Scope 3 emissions occur throughout the company's value chain, both downstream and upstream of its production process. See Lavecchia et al. (2022), “Data and methods for the evaluation of climate and environmental risks in Italy”, Banca d’Italia, Occasional papers, n. 732, November. European Commission (2019), “2019 SBA Fact Sheet – Italy”. accounting standards for SMEs.13 In 2024 the EFRAG will publish simplified standards for listed European SMEs, to be used by unlisted SMEs on a voluntary basis. However, these developments will take time. In the meantime, as I mentioned above, the Third pillar regulation mainly leverages information at the sectoral level, requiring banks to publish their exposures to companies belonging to the ten high-emissions sectors defined by European legislation. In Italy these sectors contribute 61 percent to GDP, higher than the EU average of 56 percent. The entire manufacturing sector is classified as high-emissions. Such emphasis on highly aggregated sectoral data creates the risk that intermediaries seeking to reduce their carbon footprint indicators might reduce credit to companies belonging to high-emissions sectors indiscriminately, treating them all as unsustainable. A similar risk could also arise with reference to market instruments (shares and bonds), should sectoral data play an increasing role in the choices of other financial intermediaries. Excessive reliance on sectoral data in orienting lending and investment choices would not be justified. First, subsectors with extremely heterogeneous environmental footprints can coexist within a sector. For example, the “agriculture, forestry and fishing” sector, labelled as high-emissions, includes both the forestry subsector, which produces negligible emissions, and that of livestock, notoriously responsible for very high emissions. Second, even companies producing identical goods can have very different emissions, depending on the production processes adopted (e.g. reliance on renewables, more advanced machinery). Companies that have adopted state-of-the-art technologies will have “incompressible” emissions in the short term, while others will have room to invest. Should the financial industry help the laggards improve or focus on the best performers? Finally, even companies that at moment present the same high-emission levels may have developed very different transition plans; a company seeking funding to carry out an ambitious and credible decarbonisation plan should be assessed by lenders differently from one that carries on with ordinary production strategies and policies. A second risk determined by these complex information problems is that companies not subject to environmental disclosure requirements might adopt a wait-and-see approach. This choice, while understandable, might turn out to be short-sighted. Today, companies at the forefront in the field of sustainability have a strong advantage to make their choices known to the market and to customers. A policy of poor transparency could be assimilated to an inadequate sustainability performance, with the negative consequences described above. Furthermore, scope 1 and 2 emissions of SMEs are included in the calculation of scope 3 emissions of the large companies they sell intermediate products to. Large companies will therefore tend to transmit down their value chain the pressure to adopt more sustainable production models; the CSDDD could contribute to this trend, for the reasons mentioned in the previous paragraph. The Bank of Italy actively worked on this issue during the Italian Presidency of the G20. See Visco (2021), “The G20 Presidency program on Sustainable Finance”, speech delivered at the OMFIF Sustainable Policy Institute symposium on 30 September 2021. These considerations suggest a few conclusions. First, sectoral data, albeit useful for many purposes, should be interpreted and used with caution by intermediaries in their investment and financing choices, and by the Supervisory Authority for its control activities. This conclusion is supported by microdata-based evidence which confirms that important heterogeneities exist within sectors and subsectors.14 European regulation could at least refer to more granular sectoral classifications.15 Second, there is a strong need for data at the individual company level for the purpose of providing credit and planning investment. Finally, committing to ambitious sustainability investment and adopting reporting practices is in the very interest of SMEs, at least the more dynamic and forward-looking ones. Various private initiatives have been launched in Europe to set up information platforms on the environmental sustainability of non-financial companies.16 However, SMEs seem reluctant to join, due to the high costs for data collection and processing and lack of standardisation.17 Therefore, actions at national level could be considered. The newly established Sustainability Coordination Table promoted by the Ministry of Economy and Finance, which involves the Ministry of Environment and Energy Security as well as the supervisory authorities (Bank of Italy, Consob, Covip and Ivass) could launch initiatives involving intermediaries, non-financial companies and their associations, among others. Similar initiatives have already been launched in other countries.18 For example, the experimental database built by Accetturo et al. (2022), "Credit supply and green investments", mimeo, shows that among companies belonging to the high-emission sectors according to the EU definition, those that are investing to improve their sustainability performance are about 10 percent of the total; this share falls to 4 percent among companies in other sectors. This evidence suggests that among high-emission companies there is a greater awareness and willingness to tackle environmental issues. Furthermore, there is considerable heterogeneity across the various high-emission sectors: for example, the aforementioned share is close to 50 percent in the energy supply sector. Schober and Silberbach (2022), "Modeling effects of carbon taxation on corporate ratings in the German power market" (2022), mimeo, find that the effect of an increase in carbon taxation on the probability of default of German electricity generation companies can change sign depending on the type of technology and fuel used in the production process. The EBA relies on the EU regulatory framework; at the moment, a more granular sectoral breakdown is not foreseen. Starting from the Third pillar disclosure for 2023, banks will have to add to sectoral data the amount of exposures that contributes to climate change mitigation and the value of the GAR, thus providing a measure of the alignment of their portfolio with the taxonomy. However, given the large share of companies not subject to the CSRD in Italy, this approach is unlikely to change the picture that will emerge from sectoral data. The European Commission proposes to set up the European Single Access Point (ESAP), aimed at guaranteeing simple and free access to financial and sustainability information made public by large or listed European companies. At a later stage, other companies would participate on a voluntary basis. See article 9 Amendment to Directive 2013/34/EU of the Proposal for a Directive of the European parliament and of the council amending certain Directives as regards the establishment and functioning of the European single access point. See Moeslinger, Fazio and Eulaerts (2022), “Data platform support to SMEs for ESG reporting and EU Taxonomy implementation”, Publications Office of the European Union. In Germany, the Green and Sustainable Finance Cluster provides a forum for discussion among intermediaries, companies, regulators, scientists and academics interested in the strategy for sustainable finance. A broadly similar role is performed in the Netherlands by the Sustainable Finance Platform, and by the Observatory for Sustainable Finance in France. In the realm of data, two types of initiatives could be considered. First, the associations of intermediaries and those of non-financial companies could cooperate towards the standardisation and collection of sustainability information. Harmonised templates for data collection could be developed, extremely simplified for micro-firms, more articulated for SMEs. This work would not start from scratch, as many banks have already developed similar templates. Complementary initiatives could involve public bodies that collect detailed data on gas and electricity consumption for all Italian households and businesses, or other public entities that have data on the energy efficiency of buildings at the individual real estate units’ level.19 Some of these databases already cover the totality – or at least a large portion – of their populations, are systematic and well-organised, but are not accessible for analysis purposes or to financial intermediaries, mainly because of confidentiality constraints. These problems do not seem unsolvable. Confidentiality issues do not arise with aggregated data. The entities that hold information at granular level could therefore make themselves available to publish – or to produce for the benefit of other interested parties – suitably aggregated data.20 Furthermore, confidentiality problems could be solved if the entities that hold the granular information granted access to intermediaries with a proxy from their clients. Through this mechanism, intermediaries as well as other entities (e.g. professional data providers) could have an efficient single point of access to accurate, detailed and verified information on individual energy consumption, in compliance with data protection regulations. The harmonised collection of microeconomic data on sustainability would have several advantages. Companies borrowing from many banks would avoid having to deal with a multiplicity of differentiated requests. Banks would reduce or avoid the use of estimated data provided by professional data vendors. Data comparison would be facilitated. Greenwashing could be tackled more effectively. The data could also be very useful for economic policy purposes. Faced with the energy shock, European governments must balance public finance constraints with the need to provide relief to needy families and energy-intensive businesses. However, effective targeted policies are hard to design without adequate information. Looking beyond the current critical phase, this information would be equally important for designing and evaluating the policies needed to reach the climate goals that governments are committed to achieving. Individual data on gas and electricity consumption are available in the Integrated Information System managed by Acquirente Unico, a company of the GSE group. Data on the energy efficiency of buildings is contained in the Information System on Energy Performance Certificates created by the National Agency for New Technologies, Energy and Sustainable Economic Development (ENEA). Relevant obstacles to sharing confidential data among public entities have been removed by Law 205/2021, which converted Law Decree 139/2021. The law established that independent authorities and public administrations can access personal data if necessary for the fulfilment of a task carried out in the public interest or for the exercise of powers attributed to them. 4. The transition plans The topic of transition plans is relatively new. As already mentioned, the European legislation that should introduce the obligation to draw up plans both for intermediaries and for non-financial companies (the CSDDD and the CRR3/CRD6 package) is still on the drawing board. In spite of this, many of the world’s large financial institutions and non-financial companies have voluntarily committed to reduce their carbon footprint.21 A conceptually similar approach, which implements the so-called tilting strategies, is common among asset managers. Such an approach adds new goals, such as reducing the carbon footprint, or improving the overall ESG score, to the traditional objectives of portfolio management, which are typically based on the paradigms of risk-return, time horizon, and the liquidity of the investment. To this end, various providers have developed ad hoc indexes that –compared to the standard market indices – feature a larger proportion of companies with relatively low emissions, or relatively high ESG scores. Savers can mandate asset managers to invest their funds in portfolios replicating these indices. Following a similar approach, last July the ECB announced a gradual decarbonisation path for its corporate bond portfolios.22 In parallel, the SSM is encouraging banks to adopt transition plans consistent with the Paris Agreement and to put pressure on the financed companies if they do not meet their transition objectives, up to the last resort of cutting off funding.23 The transition plans of intermediaries, together with the tilting approach adopted by the asset management industry, can represent a powerful tool for managing and mitigating climate risks. However, we should be mindful that we are moving our first steps this area. One issue that needs to be clarified is the consistency between the aforementioned traditional objectives of an intermediary that manages clients’ funds – be it a bank or an asset manager – and the objectives of sustainability. There is empirical evidence that good ESG practices are associated with good operational performance of companies, as they encourage innovation, a long-term orientation, and the efficient use of resources. Sustainable investing has thus so far produced advantages both for investors, in the form of higher risk-adjusted returns, and for issuers, in the form of lower external financing costs.24 Initiatives that involve banks include the industry-led, UN-sponsored Net-Zero Banking Alliance (NZBA), which accounts for around 40 percent of global banking assets. Participating banks commit to bring emissions financed by their assets to net zero by 2050. The NZBA is part of the Glasgow Financial Alliance for Net Zero (GFANZ), which involves all major types of financial firms. See the press release by the ECB, “ECB takes further steps to incorporate climate change into its monetary policy operations”, 4 July 2022. Elderson (2022), “Banks need to be climate change proof”, The ECB Blog. The so-called greenium. See for instance Meyer and Henide (2021), “Searching for ‘Greenium’”, IHS Markit; Liberati and Marinelli (2021), “Everything you always wanted to know about green bonds (but were afraid to ask)”, Banca d’Italia, Occasional papers, n. 654, Bank of Italy. This picture will likely change in a more or less distant future. In recent years, the bond and share prices of sustainable companies may have benefited from the strong growth in demand from investors increasingly sensitive to environmental issues. However, in principle, other things equal, a sustainable investment should be relatively less risky, and therefore less profitable.25 But investors might be reluctant to accept lower yields. Also, we cannot rule out that sustainability objectives might also eventually conflict with a risk-adjusted return target.26 In summary, it cannot be excluded that at some stage the traditional investment objectives conflict with the transition plan and the related decarbonisation objectives adopted by an intermediary, or a retail investor. Should this turn out to be the case, which goal should be sacrificed? At the moment there is neither a theoretical nor an empirical answer to this question. However, some preliminary considerations seem warranted. First, there are reasons to doubt that investors would be willing to spontaneously prioritise sustainability at the expense of profitability. Even if some were, their choices would likely be insufficient to achieve the desired result. As shown by some recent theoretical analyses, the efforts of “responsible” investors could be thwarted by the arbitrage strategies of other investors focused exclusively on the risk-return paradigm, who would therefore invest in firms not interested in sustainability standards. There is therefore a risk of “carbon leakage”: responsible investors would give up their yield to the benefit of other investors, with limited effects in terms of progress on the climate front;27 yet another instance of the “waterbed effect” which mars economic policies in many areas. This lack of clarity about the potential conflict of objectives may have contributed to some recent developments. Following a series of controversies over its sustainability stance, BlackRock has announced plans to allow retail investors to vote on controversial corporate issues.28 Some large US banks that are members of the Glasgow Financial Alliance for Net Zero (GFANZ) are reconsidering their decarbonisation targets, due to concerns about litigation risk29. If not addressed, the conflict of objectives could represent Bolton and Kacperczyk (2020), “Carbon Premium Around the World”, CEPR Discussion Papers, n. 14567, find that firms with higher greenhouse gas emissions are characterised by relatively high equity returns. This could happen, for example, if efforts to combat climate change were to fail, consequently weakening the demand for sustainable investments. See Pástor, Stambaugh and Taylor (2021), “Sustainable investing in equilibrium”, Journal of Financial Economics, n. 142(2), pp. 550-571; Abiry, Ferdinandusse, Ludwig and Nerlich (2022), “Climate change mitigation: How effective is green quantitative easing?”, CEPR Press Discussion Paper, n. 17324. See Masters (2022), “BlackRock opens door for retail investors to vote in proxy battles”, Financial Times, November 3rd. See Morris, Brian and Walker (2022), “US banks threaten to leave Mark Carney’s green alliance over legal risks”, Financial Times, 21 September. For this reason, the signatories of the initiative in the latest GFANZ progress report will no longer be required to respect the criteria of the Race To Zero Campaign promoted by the United Nations, which also includes commitments from governments and public institutions. Until August, the two initiatives will move in a coordinated manner, with the condition for GFANZ participants to also respect the stringent criteria of Race to zero. a serious obstacle to the financial system’s contribution to the fight against climate change. Secondly, a strategy to promote an orderly transition of the economic system towards the Paris goals should be multi-pronged. While the thrust of the SSM goes in the right direction, it would be necessary to leverage the entire financial system, including the asset management and insurance sectors. Above all, action should also target non-financial companies, at least large ones and those with high emissions, prompting them to adopt ambitious and credible transition plans. The investment choices of these companies – such as the producers of electricity, currently characterised by extremely high emissions – will be the first to determine the fate of the transition. Banks and other intermediaries could decide to achieve the decarbonisation objectives of their assets declared in the transition plans by reducing loans to these companies. However, without huge investments in these sectors it will not be possible to produce electricity mainly from clean sources and to electrify transport and heating. It is therefore desirable that lenders might be able to discriminate between the various companies on the basis of their transition plans, thus allowing companies that carry out investments aimed at this purpose to find the necessary financial resources easily and at low cost. As argued above, European legislation does adopt such a multi-pronged approach. By introducing mandatory transition plans for all companies, financial and non-financial, the CSDDD aims to bring about a virtuous convergence of the entire economic system towards the principles of the Taxonomy and the Paris goals. In this context, the problem of the conflict of objectives could be assuaged, but might not disappear. Investors interested only in yield could look outside Europe (the aforementioned carbon leakage problem). Also, it remains to be seen whether this virtuous convergence will actually take place. The current energy crisis is resulting in huge profits for energy companies that use fossil fuels, and government subsidies for the consumption of energy. This reminds us that today’s technology does not allow an accelerated transition to low-carbon energy sources; that the investments required are enormous; that the demand for energy cannot be easily reduced without radical changes in consumption habits and lifestyles which the populations do not seem willing to accept, especially in advanced countries. In such an uncertain framework intermediaries and non-financial companies should liaise to align climate change mitigation policies and climate risk management, with a greater offer of consultancy by intermediaries and greater transparency by companies. Initiatives regarding transition plans could be promoted by the Sustainability Coordination Table mentioned in the previous paragraph. In this case as well, the path has been traced by other countries.30 In the UK an ad hoc task force on transition plans was created recently. It involves representatives of business, financial institutions, regulators, and civil society, and works with international bodies including the GFANZ and the ISSB. 5. Conclusions The transition towards a low carbon emissions economy brings risks and opportunities for the financial sector. Intermediaries must prepare by accounting for physical and transition risks in their lending and investing processes. To this end, they must improve the quantity and quality of the information used internally and communicated to the market. This is required by the European legislation, but it is also in line with sound business practice. Sustainability initiatives by authorities and individuals encounter many obstacles. International standard setters – the ISSB, EFRAG – are still working on non-financial reporting models, so reliable data are not yet available. While among the most advanced in the world, the environmental regulation in Europe is still in the making; it will mainly concern large and listed companies only, leaving the others out of the spotlight. The very concept of overall emissions is still uncertain due to considerable difficulties in the definition and measurement of scope 3 (those connected to the entire production process). Due to the shortcomings in corporate sustainability reporting, intermediaries make extensive use of data purchased from specialised suppliers. For the same reason, the latter often obtain data at the firm level through estimates based on sector averages, which cannot fully reflect the specifics of individual companies. Furthermore, each supplier uses proprietary and relatively opaque methodologies. As a result, sustainability indicators for the same company can significantly differ across suppliers. Finally, sustainability data is typically unaudited; the legislation that will introduce a review system is still under study. These undisputable difficulties on the data front collide with the environmental emergency and with the need to accelerate progress in the field of climate risk management by intermediaries; therefore, they cannot justify a wait-and-see attitude. This is true in general, but particularly for Italy, due to the high share of medium and small businesses that, not being required to produce sustainability information, risk being labelled a priori as unsustainable. Intermediaries intending to reduce the carbon footprint indicators of their assets could indiscriminately reduce credit to SMEs without data. A similar risk arises for companies belonging to high-emission sectors identified by European legislation, in spite of evidence indicating that individual companies within the sectors and subsectors may have very different environmental policies and carbon footprints. These considerations suggest that work to improve the environmental footprint and the related reporting is in the interest of SMEs themselves, at least the more dynamic and forward-looking ones, and that a joint effort by companies and intermediaries is advisable for the collection and sharing of sustainability data at the individual company level, for both lending and investment purposes. A theme related to that of data concerns transition plans. The issue is gaining attention within the financial community due to a growing awareness that successful environmental risk management (as well as the making or breaking of the ecological transition) crucially depends on the strategic choices of companies, rather than on their current carbon footprint. In this context, an approach that places excessive reliance on the financial system should be avoided. Merely pushing banks to adopt decarbonisation objectives for their assets in the hope that this will be sufficient to drive the economy towards the Paris goals appears to be a risky approach. A more robust strategy should be multi-pronged: it should broaden the pressure to the entire financial sector but also, and more importantly, to the non-financial companies, at least the largest ones and those with high emissions. These firms should adopt realistic and ambitious decarbonisation plans, and intermediaries should challenge and finance these plans. This approach would also enable a better focus on the technological constraints conditioning the transition, which must be taken into account. Europe has indeed adopted such multi-pronged approach: the CSDDD is expected to introduce mandatory transition plans for all companies, financial and non-financial, bringing about a virtuous convergence of the entire economic system towards the principles of the Taxonomy and the Paris goals. It remains to be seen whether this virtuous convergence will actually take place. The current energy crisis is resulting in huge profits for the fossil fuels industry, and government subsidies for energy consumption. This reminds us that today’s technology does not allow an accelerated transition to low-carbon sources; that the investments required are enormous; that the demand for energy cannot be easily reduced without radical changes in consumption habits and lifestyles which the populations do not seem willing to accept, especially in advanced countries. In this context, it will also be necessary to address the issue of the potential conflict between the traditional objective of investment – maximising risk-adjusted returns – and the transition plans of investors and banks. So far, ESG investment has been rewarded with similar returns as traditional investment. However, it does not seem possible to rule out that, in the future, transition plans might collide with the maximum return objective. In this case, what goals should be sacrificed? If not openly recognised and managed, this conflict may stoke greenwashing and represent a serious obstacle to the contribution of the financial system to policies to combat climate change. The Bank of Italy has started a dialogue with Italian financial intermediaries aimed at understanding their degree of preparation for the ecological transition path traced by the European legislator, and at listening to their point of view on the forthcoming ESG obligations, as well as on any critical issues encountered in the process. We trust that this dialogue will soon be extended to other interested parties. Designed by the Printing and Publishing Division of the Bank of Italy
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Speech by Ms Alessandra Perrazzelli, Deputy Governor of the Bank of Italy, at the Collegio Carlo Alberto, University of Turin, Turin, 2 December 2022.
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Alessandra Perrazzelli: Financial technology, financial inclusion and competition policy - legal and economic approaches Speech by Ms Alessandra Perrazzelli, Deputy Governor of the Bank of Italy, at the Collegio Carlo Alberto, University of Turin, Turin, 2 December 2022. *** FinTech is shaping the global financial system, leading to profound changes in demand and supply for financial products and services. Innovation technology, alongside important opportunities, poses considerable challenges for traditional intermediaries and for regulatory and supervisory authorities. There is no doubt that technologies, such as artificial intelligence, cloud storage and computing, robotics, platforms and distributed ledgers technologies (DLTs), are one of the main drivers of evolution in the industry; the operators are increasingly using them to reduce costs and offer new services. The spread of internet connections and mobile devices, the greater availability of information about users and the lower cost of automatic data processing are opening up the financial sector to innovative business models. Newcomers – such as FinTech companies, start–ups and Big Techs – have arrived in the financial sector, changing relationships with clients and offering tailoredmade products. Technological innovation allows financial institutions to be part of a broader and more interconnected ecosystem, based on the interaction and sharing of projects and information with multiple innovative companies. In this respect, players may set up several forms of relationships: from direct competition – with the consequent general reduction in traditional sources of income for incumbents – to forms of more or less advanced cooperation, based on the choices of each intermediary. The ultimate aim is to reach customers through new and diversified channels, with innovative services becoming faster, easier, cheaper and more accessible. The outlook for intermediaries In this context, intermediaries need to keep up with the increased competition and with the risks, such as cyber and operational risks, associated with the digitalization of financial services. I am also thinking about governance, profitability, capital adequacy, resilience and compliance in a broader perspective. Innovation is changing banking value chains. Indeed, new technologies make it possible to entirely digitalize financial processes from end to end, reduce costs and increase efficiency. In particular, we observe that newcomers are usually well positioned to leverage data and advanced technologies in order to increase their footprint in the financial landscape. At the same time, we observe that many strategic plans of the main Italian banks have digitalization as one of their pillars. Through different technologies (mainly based on 1/7 BIS - Central bankers' speeches Cloud computing, Big-Data, Machine Learning and Artificial Intelligence), they are developing several projects for different areas, such as consultancy for investments, customer due diligence, anti-money laundering and payment services. In order to carry out their transformation projects, the main Italian banks are mostly adopting two operating methods: 1. on the one hand, the progressive strengthening of strategic skills in the IT sector, through the internalization of better value-added professionals and the creation of centres of excellence; 2. on the other hand, the search for strategic agreements with leading and established IT and FinTech companies, aimed at the construction of platforms and infrastructures. From a national and system-wide point of view, as highlighted in the 2021 survey by the Bank of Italy,1 FinTech technologies are spreading in the Italian financial industry; expenditure on FinTech technologies for 2021-2022 has grown compared with the previous two-year period and – above all – the number of investors and projects has also increased, suggesting a higher rate of adoption of innovative technologies within the financial system. It is worth noting that intermediaries have developed an investment model that also involves direct investment in FinTech companies; in addition, 80 per cent of the projects covered by the survey are developed in collaboration with third-party companies /institutions or by entrusting them with the entire implementation of the project. For intermediaries, the use of collaborations and partnerships mainly responds to the need to acquire advanced technologies – not otherwise available internally – and to speed up the implementation of the project and reduce the time to market of their initiatives. Central Banks' perspective In this context, the authorities need to reconcile the promotion of innovation with the need to safeguard consumers and investors, avoid the exclusion of or discrimination against less digitalized users, ensure the proper functioning of market infrastructures and payment systems, and preserve the safety and stability of the financial system and the economy as a whole. Over the next few years, these challenges may call for a profound reshaping of our supervisory methodologies and toolkit and for substantial investments in new skills. It is extremely important that supervisors develop appropriate competencies to understand the risks (IT, operational, reputational, but also in terms of strategic/business model risks) that may arise for the supervised entities. As the Bank of Italy, in our role as Supervisor of the financial system, we are of course interested in understanding how intermediaries are moving, in order to fully assess the impact of new technologies on the sound and prudent management of the institutions and, more broadly, on the financial stability of the whole system. From this perspective, we are looking at and interacting with the market, focusing on new technologies and trends. 2/7 BIS - Central bankers' speeches Let us think about Open banking – an open and digital ecosystem that allows the exchange of data and information, not only of a financial nature, between the operators that are part of it.2 Open Banking allows intermediaries to develop and adopt new financial services, thereby extending revenue opportunities. Given its innovative nature, it may raise some points of attention for financial entities that should be properly understood by supervisors. Another significant innovation is Artificial Intelligence (AI), the use of which is also increasing. One example is its impact on the credit market. The growing availability of data on households and businesses and the adoption of advanced techniques based on AI can mitigate information asymmetries between borrowers and lenders, and can improve credit risk assessment. The spread of the internet allows intermediaries to offer traditional financing through digital channels, and new services, such as instant lending, based on the automated assessment of creditworthiness. Digitalization also promotes the development of online platforms for loan origination. However, the use of advanced analytical techniques may create risks. The reduced transparency of customer evaluation procedures can generate unlawful discrimination based, for example, on gender or age, with consequent legal and reputational risks for intermediaries. Furthermore, the reliability of the algorithms depends on numerous hypotheses that need to be continually verified. Unchecked biases originating in the various steps of the algorithms' learning processes can lead to excessive risk for loans. As an authority, we need to constantly check the results produced by these techniques, and we will continue to focus on monitoring these risks. Another important driver of innovation in the financial system is represented by distributed ledger technologies (DLTs), which are attracting great interest from operators and authorities. Their use cases are increasing and spreading, for example to payments, including cross- borders ones, P2P transfers, asset trading, clearance and settlement, lending, and KYC and identity verification. DLTs will increasingly underpin ecosystems' financing by allowing the storage of financial transactions in multiple places at once. Moreover, institutional investors and funds, are gradually increasing the share of digital assets in their portfolios, broadening access to financing and growing the potential of blockchains and DLTs to disrupt 'established markets'. In this respect, forecasts suggest that worldwide spending on blockchain solutions will continue to grow in the coming years, reaching almost US $20 billion by 2024.3 In this respect, the banking industry plays an important role. Regarding the use cases, it is worth highlighting that, in 2021, cross-border payments and settlements were the largest individual blockchain application. From the domestic point of view, according to the regular FinTech survey performed by the Bank of Italy, DLT projects set up by Italian financial institutions in 2021 have been constant overall in number compared with the previous survey, but they focused significantly more on smart contract applications (up from 42per cent in 2019 to 85 per cent in 2021). 3/7 BIS - Central bankers' speeches Given the increasing interest, the authorities at international level are currently addressing the trade-offs relating to the potential diffusion of DLTs and their applications. Some applications of DLTs, such as crypto-assets, create risks regarding, for example, tax evasion, money laundering and terrorist financing, with negative spillover effects on the management and processing of personal data, the correct functioning of the payment system, intermediaries' resilience, financial stability and the transmission of monetary policy. In the meantime, the use of DLTs can provide significant benefits to financial intermediation, for example by reducing the time and costs, improving security and operating continuously. A challenge now for authorities and standard setters is striking a balance between protecting customers, financial stability, market integrity and favouring the adoption of useful, transformative technologies. The complexity and global nature of these issues make regulatory initiatives at international level indispensable. An orderly development of crypto-asset and DeFi ecosystems will benefit from the definition of standards and practices that can act as a benchmark, not only for supervised intermediaries but also for all the other players involved. The recent collapse of FTx, one of the most important crypto-exchanges, followed by that of BlockFI, a crypto-lender, have highlighted a poor and weak internal control system. In particular, based on the latest available data and information, poor risk management, conflicts of interest, misuse of clients' funds and lack of disclosure are the emerging weaknesses that require a clear answer from a policy perspective in order to protect investors and ensure financial stability. The crypto-assets market may pose considerable challenges to European regulators and supervisors in the forthcoming years. Accordingly, as central bankers, we need to remain vigilant to ensure that the regulatory framework is adequate to address both current and emerging risks and challenges. At this stage, as already highlighted by the Financial Stability Board and other international bodies, the level of interconnectedness between the traditional financial system and crypto-asset providers is low and the financial sector has not suffered large losses because of the significant correction of crypto-assets' market value or because of the defaults of some major crypto players. For this reason, we need to be proactive and stand ready to react. At European level, legislators are trying to find some answers to the challenges and risks stemming from cases like these. I am referring to MiCAR, the regulation that introduces – for the first time – a clear set of rules to deal with crypto-assets. MiCAR represents an important step forward in this field, although it will enter into force in the first semester of next year. In the run-up to the finalization of a European regulatory framework and also afterwards, as the new rules will obviously not cover each and every potential issue, we felt the need to provide some useful references for consumers, intermediaries, providers and operators of digital infrastructures. This is why we released a 'Communication on Decentralized Technology in Finance and Crypto-assets' in June. The purpose of the communication is twofold: 4/7 BIS - Central bankers' speeches 1. to draw the attention of these entities to both the opportunities and risks connected with the use of such technologies in finance and with activities and services relating to crypto-assets; 2. to guide regulated firms in finding safeguards to mitigate the risks associated with the use of decentralized technologies and/or with crypto-assets. We want to help our financial system to seize the opportunities offered by these technologies. The Bank of Italy, together with two Italian universities and open to any others that want to take part, has already started an initiative for developing common standards for smart contracts. This project aims at establishing a collaboration to promote standards and guidelines for smart contracts relating to the banking, financial and insurance sectors. Indeed, the development of smart contracts must take into account both the technological and the regulatory component, and requires a holistic approach benefiting from contributions deriving from legal, economic and computer science perspectives. The Bank of Italy intends to define standards and guidelines to be implemented according to an 'open approach' in order to encourage as much sharing as possible, in order to maximize their adoption by potential users and to facilitate their dissemination at both domestic and international level. I believe that, in order to achieve the right balance between opportunities and risks, knowledge is the first step. As a financial supervisor and overseer of payment systems and market infrastructures, we are actively engaged in collecting structured information on the current activities and the future projects of the different players involved. We are continuing to investigate the most significant implications of DLTs for financial intermediaries and infrastructures. As an example, earlier this year, we published some research4 on the interoperability between existing DLT infrastructures for the settlement of transactions involving digital assets. We are paying particular attention to the benefits that can stem from the use of these technologies in our functions too. For example, as part of the work concerning the possible introduction of the digital euro, specific tests are underway to verify how best to integrate the DLT solutions proposed by the industry with the market infrastructures used by the Eurosystem for managing payment and settlement systems (trigger solutions). Given the abovementioned interest by operators and the need for a deeper understanding on the part of the authorities, last week, we launched the second Call for Proposals focused on DLTs for Milano Hub, the innovation centre created by the Bank of Italy to support the digital evolution of the financial market and to encourage the attraction of talent and investments. The theme of the call for proposals focuses on technological solutions based on DLTs for banking, financial, insurance and payment services. The Second Call has the potential to foster the safe and sound development of DLTs in our financial system, through the reliability of governance, robustness of regulation mechanisms, interoperability, certainty and security of operations from a technical and legal point of view, as well as customer protection. 5/7 BIS - Central bankers' speeches Applications can be sent from 15 December 2022 until the closing date of 31 January 2023. Like last year, projects can be submitted by Italian and foreign operators, such as: 1. non-bank/financial firms (e.g. technology solution providers) or combinations thereof; 2. banking, financial and insurance intermediaries or combinations thereof; 3. universities, research institutes, other bodies or combinations thereof. I hope project proposals will also come from this conference's participants. Milano Hub engages innovators in a physical and virtual place in which the Bank of Italy – while respecting its institutional role – aims to accelerate the development of projects and to promote the quality and safety of specific innovations through a series of consulting services, mentorships and educational components for financial intermediaries, startups and research centres. We have recently closed Milano Hub's first 'Call for Proposals', which was based on artificial intelligence'. The feedback was extremely positive, and I believe the second call will be even better, benefiting from the experience we have gained. It was a significant step forward for a constant and constructive dialogue with market participants. This is a unique and privileged perspective for monitoring changes and trends in the financial market. All the information gathered is a great asset for understanding market dynamics and increasing the awareness of the operators' needs and strategies, so as to intercept phenomena of interest promptly. Moreover, the dialogue with market participants encourages best practices, i.e. defining common standards and principles in order to encourage the development of sound and sustainable operating models, also with regard to the 'economic impact' and to ensure an adequate level of interoperability (and 'interoperability standards') between various technological solutions. The goal is to identify and support virtuous and adequately monitored innovation in the financial and payments system, in order to mitigate the risks that it may entail and to maximize the benefits it may provide to the advantage of the economic system and its components: consumers, households, firms and public administration bodies. To this end, collaboration with Academia and research centres is key. Conclusion Failure to innovate could undermine the competitiveness of our financial and economic system, posing a serious threat to our enterprises, public administration and households. This is a challenge that we cannot ignore. We are ready to do our utmost to support responsible innovation, where resilience and adaptability are opposite sides of the same coin. 1 2021-FINTECH-INDAGINE.pdf (bancaditalia.it) 2 This paradigm is usually associated with the use of the Open API, which allows an application to have access to the data of financial intermediaries and which therefore 6/7 BIS - Central bankers' speeches allows the exchange of information between different operators (financial intermediaries, technical suppliers and other, non-financial parties). 3 See Statista. 4 https://www.bancaditalia.it/pubblicazioni/mercati-infrastrutture-e-sistemi-di-pagamento /approfondimenti/2022-026/N.26-MISP.pdf 7/7 BIS - Central bankers' speeches
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Opening speech by Ms Alessandra Perrazzelli, Deputy Governor of the Bank of Italy, at an international conference on Alternative Dispute Resolution schemes in the banking, financial and insurance sectors, Rome, 19 December 2022.
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Alessandra Perrazzelli: Ten years after the Alternative Dispute Resolution (ADR) Directive - a comparative overview of banking and financial ADR Opening speech by Ms Alessandra Perrazzelli, Deputy Governor of the Bank of Italy, at an international conference on Alternative Dispute Resolution schemes in the banking, financial and insurance sectors, Rome, 19 December 2022. *** It has been more than 13 years since the founding of the Banking and Financial Ombudsman in October 2009, and I am delighted to open this international conference on Alternative Dispute Resolution schemes in the banking, financial and insurance sectors, which is a follow-up to a previous and important meeting held in 2017. The Banking and Financial Ombudsman is an alternative resolution system for disputes arising between customers (consumers and non-consumers) and intermediaries concerning the provision of banking and financial services. The Bank of Italy was tasked with setting up the ABF by the Government, supplying it with resources and taking care of every aspect of its functioning, though obviously leaving the decisionmaking to the members of the Panels in order to ensure and safeguard its impartiality and independence. The idea of establishing an Ombudsman actually goes back to the 2005 law 'on savings'. The expectation that banks and other financial intermediaries would have to join an alternative dispute resolution system for customers was therefore part of a regulatory framework designed to strengthen consumer protection systems, and thus also the protection carried out by the Bank of Italy, under the assumption that the stability of the financial system as a whole and of intermediaries requires substantial fairness in relations between intermediaries and customers. Following the transposition of the European Directive on ADR (2013/11/EU), in 2015 the Bank of Italy was appointed as the national competent authority tasked with the monitoring the proper functioning of the system and verifying compliance with the quality requirements envisaged by the Directive. There have been considerable changes since the ABF was founded, both in the Bank of Italy, with the creation of a Directorate specifically devoted to consumer protection (as well as to financial education), and in the ABF system. Three Panels were set up initially in 2009, followed by a further four at the end of 2016 in order to increase the capacity for and the rapidity of responses to customer needs and to step up consumer protection. The Ombudsman has received over 210,000 complaints and adopted more than 200,000 decisions since it was founded. The Panels awarded more than €150 million to complainants between 2015 and 2021. 1/4 BIS - Central bankers' speeches The average time for processing a complaint, excluding suspension periods, has fallen considerably and takes significantly less time than the civil justice system, down from more than 300 days in 2015 to around 130 days in 2021. The decisions of the ABF Panels are often referred to by the civil courts and when cases are submitted to ordinary courts, the Ombudsman's rulings are almost always upheld. I don't want to take up too much of your time, so let's turn to the Conference: I would like to look briefly at the topics under discussion today, all of which are very interesting. I have had several opportunities to talk about the impact in Italy, like in many other countries, of the spread of digital technologies in financial intermediation. Prior to the pandemic, there had already been a steady growth in the use of alternative payment systems to cash – especially cards – because of both rapid technological developments and regulatory interventions to support payment efficiency and security. The revised regulatory framework and the impact of the pandemic have given further impetus to the spread of highly technological digital payment instruments. The technological acceleration and the increase in competitive supply, in part owing to the entry of new operators, has spurred traditional intermediaries to review their business models and their strategic positioning in an ever more 'crowded' industry, by testing new solutions and expanding their range of services to the benefit of the final customer. As Governor Visco pointed out a few weeks ago, the Bank of Italy is supporting the digital development of the market according to the regulatory standards of security, inclusiveness and transparency. Consumer protection, as well as the integrity and stability of the financial system, is a crucial element in promoting this development, ensuring that the strength and speed of the digital transition translate into benefits for the economy as a whole and for its individual players: households, firms, investors and general government bodies. In this new ecosystem, characterized by the development of open banking and of crypto-assets, consumer protection needs are evolving, and ADR systems are also called upon to think about possible new paradigms for the forms of protection provided, as is the case for the supervisory authorities in this sector. The ADR Directive has enabled minimum levels of harmonization between countries to be achieved: aligning it with the new context of reference will be an important response to pressures from digitalization, and pursuing an international dialogue will be fundamental (especially via the Fin-Net network of the European Commission that connects the ADR systems operating in the banking, financial and insurance sectors and is therefore an important forum for cross-border discussions). The evolution underway also requires discussion between all the national competent authorities, at both national level, thanks to the coordination board at the Ministry of Economic Development and, as we said before, in international fora too. 2/4 BIS - Central bankers' speeches Dialogue between ADR and the civil justice system is also very important (in Italy there has long been a successful collaboration with the Scuola Superiore della Magistratura, which I truly believe could be interesting at international level too). A comparison of various ADR systems in terms of structure, operations and customer care, but also of functions could provide some interesting insights. The international situation increasingly shows that ADR entities perform important functions (apart from resolving individual disputes): consultancy, financial education, data aggregation and putting pressure on the market. Given the changes in the ecosystem, it is also interesting to understand if and how these functions have evolved. We are always on the lookout for new insights and trends arising from international debate and are ready to intercept potential best practices to provide us with inspiration (subject, of course, to internal regulatory constraints). We also firmly believe in the exchanging of experiences (which now that the pandemic has eased, we have an opportunity to promote). The delicate topic of the effectiveness of ADR systems (a quality requirement set by the ADR Directive) is particularly interesting. It will also be fascinating to see what is surfacing from the latest academic debate on this and to understand how leveraging technology, especially artificial intelligence applied to alternative dispute resolution systems, could help to improve their effectiveness. The ABF has made ample use of technology since it was founded: its procedures are completely digitalized, and it has had a portal since 2018 that allows people to communicate with the system online; work is underway to open the portal to intermediaries as well to make the procedures even more efficient. The Bank of Italy is experimenting with the use of artificial intelligence at the ABF: work is underway on the AbefTech project that aims to apply machine learning and text analysis techniques to help with the work of the Banking and Financial Ombudsman; this project follows a similar AI tool (called EspTech) already implemented for managing the complaints submitted to the Bank of Italy. Of course this in no way means that machines will replace the 'judges', but we believe that it can improve the assistance given to the Panel members in making decisions. Let's see what comes out of the debate, also regarding the risks of potential errors or even biases in decisions that are partly automated. Lastly, another very important topic is the connection between the work done by ADR systems and the work assigned to the supervisory authorities for consumer protection. It will be interesting to understand and see how ADR systems can help to strengthen the wealth of data available to the sectoral supervisory authorities when carrying out their supervisory functions. I think some useful ideas will emerge here that we can discuss together. We see the Ombudsman (together with the managing of customer complaints) as a very important part of consumer protection, flanked by supervision (in both its regulatory aspects and its interventions), and by financial education: dialogue between these three different functions is fundamental. International debate can be useful in identifying good practices in this area too. 3/4 BIS - Central bankers' speeches I hope the challenges that ADR systems in the financial and insurance sectors will have to tackle will also be outlined during the upcoming debate and that we can take away some interesting ideas on the policies to be implemented. I am referring to the new aspects of customer protection to be safeguarded in relation to the development of new Fintech operators and smart contracts, the relationship between individual and class actions, the regulation of an ecosystem that hosts different types of ADR, the growth of cross-border complaints and the integration of the access channels of the various ADR systems borrowing from some exemplary international experiences. It only remains for me to 'formally' open the conference, and to greet and thank all the participants. The floor now goes to the General Counsel of the Bank of Italy: Marino Perassi. Thank you all 4/4 BIS - Central bankers' speeches
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Remarks by Mr Paolo Angelini, Deputy Governor of the Bank of Italy, at the Roundtable on "New Frontiers in Banking and Capital Markets", University La Sapienza, Rome, 15 December 2022.
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Net zero pledges of financial firms: trade-offs and problems1 Remarks by Paolo Angelini Deputy Governor of the Bank of Italy Round table on New Frontiers in Banking and Capital Markets University La Sapienza Rome, 15 December 2022 1. Introduction Today I would like to focus on the so-called transition plans. In short, a transition plan is a detailed description of actions that a company commits to implementing over a multi-year horizon in order to comply with a given set of environmental objectives. For instance, adhering to the Paris Agreement implies a commitment to drive net emission of greenhouse gases down to zero by 2050. A number of the world’s largest companies have voluntarily adopted transition plans enshrining a commitment to reduce their carbon footprint. In the financial sector, probably the best-known initiative is the Glasgow Financial Alliance for Net Zero (GFANZ), which involves sub-alliances for banks, asset managers and insurance companies; for these firms the objective is to reduce the emissions financed by their portfolios of assets. Following a similar approach, last July the European central bank announced a gradual decarbonization of its corporate bond portfolios, as part of a broader set of measures aimed at mitigating climate-related financial risks on the Eurosystem balance sheet and incentivizing issuers to improve disclosure and reduce future carbon emissions.2 In parallel, the Single supervisory mechanism is encouraging banks to adopt transition plans consistent with the Paris Agreement and to pressure the companies they finance to meet their transition objectives, up to the last resort of curtailing credit.3 This discussion builds on some of my remarks in “The financial risks posed by climate change: information gaps and transition plans”, Associazione nazionale per lo studio dei problemi del credito, Milan, 15 November 2022. See “ECB takes further steps to incorporate climate change into its monetary policy operations”, 4 July 2022. Elderson (2022), “Banks need to be climate change proof”, The ECB Blog. The topic of transition plans is relatively new. In the EU, the current legal, regulatory and statistical frameworks rely mostly on historical emissions; the legislation that should introduce the obligation to draw up such plans both for financial and non-financial companies – the Corporate sector due diligence directive (CSDDD) and, for banks, the CRR3/CRD6 package – is still on the drawing board, but is making progress. The transition plans of financial intermediaries (banks and institutional investors) can represent a powerful tool both for managing climate risks and for steering the economy on a sustainable path. However, we are moving our first steps in this area. In what follows I will discuss two issues and draw some conclusions. 2. Current vs expected emissions An intermediary can implement a net zero transition plan in many ways. To simplify, consider two opposite alternatives. The first would entail changing the composition of its portfolio by moving from high to low carbon intensity sectors/firms, identified based on their current emissions. This is the so-called “exclusion” strategy, according to the usual taxonomy of sustainable investment.4 The second (the so-called “best-inclass” strategy) would entail overweighting firms that, despite being carbon intensive, have committed to an ambitious and credible decarbonization plan over the coming decades. The first approach, if applied on a vast scale, would suffer from a fallacy of composition: it would be feasible for the individual intermediary, but not at the aggregate level, short of a “miracle” in the form of a technological breakthrough allowing carbon intensive firms to transition without financial support, or a quick and radical change in households consumption patterns that causes a fall in demand for high carbon products and services. The second approach avoids this problem and appears capable of providing carbon intensive firms the finance they need to implement their transition plans. Figure 1 reports data for EU listed non-financial companies, aggregated by sector. For each sector, the horizontal axis measures the current carbon intensity; the vertical axis reports the expected decline in carbon intensity over the next decade, as envisioned in each firms’ published commitments. The figure shows that firms in the more carbon intensive sectors plan to reduce their emissions relatively more aggressively. This suggests that these firms, arguably the most exposed to transition risk, will need substantial flows of finance in the coming years for their transition plans to succeed. The figure also highlights that financial firms could face a difficult choice: in the short-to-medium term financing the transition might even entail an increase in the carbon footprint of their portfolios. While this might seem at odds with a net zero pledge, it could be worth doing. Consider e.g. firms operating in the business of power generation, often characterized by very high emissions. Their investment choices will Global Sustainable Investment Alliance (2021), “Global sustainable investment review”. be key to electrify transports and heating, and will likely determine the fate of the transition. Intermediaries should discriminate between the various companies on the basis of their transition plans, thus allowing committed companies find the necessary financial resources easily and at low cost, relative to less climate-aware firms. To this end, intermediaries will increasingly need new skills, capable of screening and monitoring long-term investment projects aimed at improving sustainability. Figure 2 shows that there is a positive relationship between sectoral greenhouse gas emissions and the share of firms in each sector that made sustainable investments. In the three highest emission sectors, that account for 55 per cent of total emissions, on average 16 percent of firms made investments aimed at increasing their own sustainability, against a sample average of 10 percent. This suggests that the abovementioned exclusion strategy may be a poor choice for financial intermediaries not only as a means to support the transition, but also to mitigate transition risk in their own portfolios. There is increasing awareness that portfolio decarbonization – especially if carried out in a non-forward-looking manner – may actually be ineffective to decarbonize the economy as well as to manage transition risk. Recent initiatives aimed at developing forward-looking tools and metrics, the so-called portfolio alignment tools, build on non-financial firms transition plans.5 Progress on this crucial front is ongoing.6 Overall, a trade-off between simplicity and effectiveness emerges. Decision-making processes relying on forward-looking information, such as transition plans, offer the most effective incentives and do not suffer from the pitfalls often marring those based on historical information. At the same time, they introduce complexity and uncertainty: at present the legal framework, the statistical apparatus and the reporting requirements for firms largely rely on historical, backward-looking data; only a relatively small group of large non-financial firms worldwide has elaborated transition plans;7 furthermore, reliance on transition plans is warranted only if they are ambitious and credible (and possibly validated). 3. Possible trade-offs between sustainability and returns A second important theme concerns the relationship between the environmental objectives of firms and their traditional business objectives. This issue can be framed within the academic debate about whether firms should stick to a narrow mandate – maximize profits to the benefits of shareholders – or rather be concerned with a broader set of targets – loosely speaking, maximize the welfare of stakeholders. In the latter See e.g. Portfolio Alignment Team (2021), “Measuring Portfolio Alignment – Technical considerations”, April. Various bodies, e.g. the Task Force on climate-Related Financial Disclosures, have been publishing guidelines for transition plans. See also OECD (2022), “OECD Guidance on Transition Finance: Ensuring Credibility of Corporate Climate Transition Plans”, Green Finance and Investment, OECD Publishing, Paris. See CDP (2022), “Are companies transparent in their transition? 2021 transition plan disclosure”, March. case, firms should internalize their negative externalities, including those related to their greenhouse gas emissions.8 This yet unsettled debate has important implications for net zero transition plans. The empirical evidence suggests that so far sustainable investment strategies have reaped some (modest) extra returns relative to the traditional approach, while sustainable bonds have been producing (modestly) lower yield.9 This apparent contradiction can be explained by a surge in demand for financial assets labeled as “sustainable” due to investors’ increasing sensitivity to environmental issues. However, this is a temporary phenomenon. But in the new equilibrium sustainable assets should carry lower transition risk, and hence a lower return, which investors might be reluctant to accept. Also, we cannot rule out that sustainability objectives might eventually conflict with a risk-adjusted return target. After all, internalizing externalities is costly, and brown firms might keep a competitive advantage in terms of pure profits. In summary, it cannot be excluded that at some stage the transition plan and the decarbonization objectives adopted by an intermediary might conflict with the traditional investment objectives. If this turned out to be the case, what should be done? A recent report published by the Glasgow Financial Alliance for Net Zero (GFANZ) provides a tentative answer: the choice should be explicitly addressed in a financial firm’s transition plan. In particular, the plan should include a statement detailing, inter alia, how the institution “plans to address potential conflicts between its net-zero ambitions and profit-making opportunities.”10 This amounts to saying that the preference for sustainability should be an argument of the intermediary’s utility function, at par with the return and risk preferences. In other words, the intermediary should explicitly state if, and to what extent, it is willing to sacrifice return for sustainability, should a sacrifice turn out to be necessary. In the seventies M. Friedman argued that the purpose of a corporation and its managers is exclusively the maximization of the value of the firm, to the benefit of shareholders. This theory advocates a clear distinction between this narrow mandate of the firm and the broader objectives of society; the latter, grounded on ethical and social principles, should be pursued by the government. A debate on this theory has emerged in recent years, as the growing concern on ESG issues by the public have prompted many leading firms to embrace a broader set of targets than profitability and adopt sustainable policies. For instance, according to C. Mayer (2018), “Prosperity: Better Business Makes the Greater Good”, Oxford University Press, managers should balance a mix of objectives and address the related conflicts of interest by allocating the value created by the firms among shareholders and the other stakeholders, to the benefit of society in the long term. Hart and Zingales (2017), “Companies Should Maximize Shareholder Welfare Not Market Value”, Journal of Law, Finance, and Accounting no. 2 support the thesis which gives the title to their work, if this is consistent with the firm’s shareholder preferences. Broccardo, Hart, Zingales (2020), “Exit vs Voice”, European Corporate Governance Institute – Finance Working Paper no. 694, argue that if the majority of shareholders is socially responsible, “voice” achieves the socially desirable outcome in companies that generate externalities; whereas in the case they are the minority “exit” (divestment and boycott) is a more effective strategy. However, the latter policy is not socially optimal. The so-called greenium. See for instance Meyer and Henide (2021), “Searching for ‘Greenium’”, IHS Markit; Liberati and Marinelli (2021), “Everything you always wanted to know about green bonds (but were afraid to ask)”, Banca d’Italia, Occasional papers, n. 654, Bank of Italy. GFANZ (2022), “Financial Institution Net-zero Transition Plans”, version for public consultation, June, p. 23. This recommendation does not appear in the final version of the report, released last November. This line of reasoning has potentially wide implications for financial intermediaries’ behavior and for the design of their transition plans. First, it seems doubtful that net zero pledges can be credibly announced without mentioning the potential trade-off with returns. To my knowledge, to date few if any intermediaries have been explicit about this potential trade-off. One possible reason is that many of them have a fiduciary duty towards their clients, and have not yet asked, let alone received, a mandate to sacrifice returns for sustainability, should this become necessary. An investor trusting her savings to a fund manager, or an insurance company, has probably been attracted by the win-win narrative emerging from the data thus far (sustainable investing is good for the planet as well as for the investor’s wallet), but might well change her investment choices if conditions changed. In that case, the intermediary would have to follow its client’s guidelines. Furthermore, whereas many investors express a demand for sustainable assets, others do not; intermediaries featuring both investor types among their clients can hardly make pledges on behalf of the latter. In sum, net zero pledges by financial intermediaries should be more appropriately viewed as conditional commitments, as they could be incompatible with a sacrifice in terms of return which might at some stage materialize and which the intermediary’s shareholders, or its clients, might be unwilling to accept. Unless this issue is addressed, the net zero pledge framework set up by the financial industry in recent years might be at risk of unraveling, if and when difficulties materialize. Some recent developments give food for thought.11 Second, there are reasons to doubt that investors would be willing to prioritize sustainability at the expense of profitability. Even if some were, recent theoretical analyses suggest that their efforts could be undermined by opportunistic investors focused solely on the risk-return paradigm, who would invest in companies not interested in sustainability standards. There is therefore a risk of “carbon leakage”: responsible investors would give up their returns to the benefit of other investors, with limited effects in terms of progress on the climate front;12 this might be yet another instance of the “waterbed effect” which mars economic policies in many areas. 4. Conclusions A strategy to promote an orderly transition of the economic system towards the Paris goals should be multi-pronged. For instance, some large US banks that are members of the GFANZ are reconsidering their decarbonization targets, due to concerns about litigation risk. Vanguard Group has recently announced the intention to pull out of Net Zero Asset Managers Initiative (part of GFANZ), explaining it wants to demonstrate independence and clarify its views for investors. Following a series of controversies over its sustainability stance, BlackRock has announced plans to allow retail investors to vote on controversial corporate issues. See Pástor, Stambaugh and Taylor (2021), “Sustainable investing in equilibrium”, Journal of Financial Economics, n. 142(2), pp. 550-571; Abiry, Ferdinandusse, Ludwig and Nerlich (2022), “Climate change mitigation: How effective is green quantitative easing?”, CEPR Press Discussion Paper, n. 17324. First, to reduce the risk of elusion and waterbed effects it is necessary to leverage the entire financial system: banks, asset managers, insurance sectors. But excessive reliance on the financial sector to induce the transition should be avoided. Decarbonising financial portfolios and decarbonising economies are two sides of the same coin. Simply cutting exposures to high emission firms will not help progress towards a sustainable economic development, and is unlikely to reduce transition risk in the intermediaries’ portfolios. Furthermore, intermediaries should be explicit and transparent with their customers and shareholders about the possible trade-offs between returns and sustainability objectives, and take a stand on this issue. In particular, it seems doubtful that net zero pledges can be credibly announced without mentioning what line of action would be taken should environmental and return objectives happen to clash. Net zero pledges by financial intermediaries should more appropriately be viewed as conditional commitments, as they might be incompatible with a sacrifice in terms of return which might exceed some yet unspecified threshold. To my knowledge, to date few if any intermediaries have been explicit about this potential trade-off. If not addressed, this ambiguity might represent a serious obstacle to the financial system’s contribution to the fight against climate change and to an effective approach to transition risk management. Second, a multi-pronged strategy should put non-financial companies at the center, beginning with the large ones and those with high emissions, prompting them to adopt ambitious and credible transition plans. This choice rests with shareholders; public policies should encourage them via incentives and/or penalties; financial intermediaries can also play a role on this front. The European legislation does adopt such a multi-pronged approach. By introducing mandatory transition plans for all large companies, financial and non-financial, the CSDDD aims to bring about a virtuous convergence of the entire economic system towards the principles of the Taxonomy and the Paris goals. The draft CSDDD also features specific mandatory provisions to link the corporate manager remunerations to sustainability indicators. This seems a step in the right direction. In the EU context the risk of waterbed effects is assuaged, but might not disappear. Investors interested only in expected returns could look outside Europe. In such an uncertain situation financial intermediaries and non-financial companies should liaise to align climate change mitigation policies and climate risk management, with a greater consulting role by intermediaries and greater transparency by companies. A promising area for cooperation is sustainability data, where massive gaps are recorded. Overall, a greater role for public policies, especially in non-EU jurisdictions, seems necessary for a successful transition. FIGURES Figure 1 Current emission intensity and expected emission reduction (European firms) a) Full sample b) Detail for lower intensity sectors Source: own elaborations on MSCI ESG Research data. Note: For each sector (GICS Classification) the chart shows on the x-axis the current carbon intensity (CO2e/revenue in USD mln) and on the y-axis the expected change in carbon intensity, calculated as the difference between the expected carbon intensity in 2032, based on company published commitments, and the current carbon intensity. Current and expected emissions are the most recent ones reported by the companies (2020 or 2021); revenues refer to 2021. The analysis is based on European non-financial companies included in the EMU MSCI index, as of 30 September 2022. Figure 2 Emission intensity and propensity to invest in “green” technologies Source: elaborations on an experimental dataset of Italian non-financial limited liability companies built by Accetturo, Barboni, Cascarano, Garcia-Appendini, Tomasi (2022). Credit supply and green investments. Mimeo. Note: Each dot represents for each sector the share of firms that are classified as investing in sustainable technologies (“green firms”; vertical axis) against the total greenhouse gas sectoral emission measured in million tonnes of CO2-equivalent (horizontal axis). Since the x-axis is in logarithmic scale, the black line is a linear interpolation of data. Sectors are based on the NACE rev.2 (ATECO 2007) one-digit classification. For the section “C - Manufacturing” the classification breaks down into 11 sub-sectors. Carbon emissions relate to 2013, “green” investment propensity was recorded over the 2015-2019 period.
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Speech by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy, at the 54th Credit Day, Rome, 3 November 2022.
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Luigi Federico Signorini: 54th Credit Day Speech by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy, at the 54th Credit Day, Rome, 3 November 2022. *** The economic and monetary situation 1. We are living through difficult times. A series of violent shocks, of a kind not seen in Europe for a very long time (the pandemic, the war unleashed by Russia, the hike in energy prices, the uncertainty of their supplies), has taken our societies by surprise. It has caused unprecedented human and economic damage; it has led to extraordinary fluctuations in real and nominal variables; and it has confounded both analysts and forecasting models. 2. During the pandemic, the fiscal policies adopted in many European countries managed to mitigate the impact of these shocks on households and firms, at the price of a sizeable increase in government debt. Monetary policy accompanied and supported the fiscal expansion driven by the emergency and averted the outbreak of financial crises in times of heightened market volatility by injecting liquidity into the system to an unprecedented extent. 3. Following the easing of the health restrictions, the rebound of the economies, not least that of Italy, has been remarkable. Our country seems to have demonstrated an underlying robustness, even in the most recent period. Despite being affected by problems in the sourcing of energy and commodities, as well as by all the other consequences of the ongoing crisis (difficulties in international trade, deteriorating confidence), economic activity rose by 6.7 per cent in 2021, exceeding its pre-pandemic level in the fourth quarter of the year. It continued to expand in the first half of this year, albeit at a slower pace. 4. According to the preliminary estimate released by Istat on 31 October, GDP increased slightly (0.5 per cent) in the third quarter too, once again surprising analysts, who had, at most, expected stagnation. The upturn was supported by the growth in services, the economic activity of which is more difficult to predict than it is for the manufacturing industry, given the reduced availability of effective and timely indicators, such as energy consumption and goods transport. Tourism and leisure activities, which were hit hardest by the public health emergency, have continued to recover. Consumption appears to have been temporarily driven by the savings accumulated during the pandemic. 5. Italy's economy will inevitably be influenced by the worsening of the international outlook. Global economic activity is, in fact, slowing down and growth estimates for next year have been progressively revised downwards by leading international institutions. The deterioration in the outlook continues to be affected by higher inflation, marked uncertainty over the Ukraine conflict, worsening financial conditions and the weakening economy in China. 1/8 BIS - Central bankers' speeches 6. Nevertheless, despite the challenging situation, based on the projections in the latest issue of the Bank of Italy's Economic Bulletin – which will likely be revised slightly upwards in light of the new data – the baseline scenario assumes a slight growth on average for the year 2023; only in a stressed scenario (with a total freeze on Russian gas imports) would there be a decrease on average over the year. However, economic uncertainty remains exceptionally high because of the extreme and unpredictable nature of some risks, especially those linked to the war. 7. The surge in inflation, which has reached levels unmatched for decades in the advanced economies, is of grave concern. According to the latest available data, the increase in consumer prices exceeded 8 per cent in the United States in September and, based on a preliminary estimate, neared 11 per cent in the euro area in October. In Italy, inflation is running at an even faster pace than the average: according to the harmonised definition, it was 12.8 per cent in October. 8. In response to the strong acceleration in prices, central banks have started a normalisation of monetary conditions in order to reabsorb the high degree of accommodation decided upon to offset the effects of the pandemic. This is necessary to keep inflation expectations anchored and bring inflation back in line with the definition of medium-term price stability adopted in the leading advanced economies. 9. In the euro area, following the end of its net asset purchases, the ECB Governing Council started increasing its key interest rates, by 2 percentage points overall since July, thus bringing the deposit facility rate back from negative values to 1.5 per cent. The Council has announced that it expects to raise them again at its next meetings, at a pace and to a level that will be determined on the basis of new data and on revisions to the inflation and growth outlooks. Markets and non-bank intermediaries 10. The normalisation of monetary policy, which is necessary to give a firm and unequivocal signal on inflation, is coinciding – in this difficult global situation – with heightened market volatility and occasional episodes of illiquidity. 11. Over the past few months, following the onset of the war and given the concerns over the procurement of some strategic commodities, severe tensions have been observed in the energy (gas, oil) and commodity (nickel) markets, with spikes in volatility similar to those observed on the financial markets at the outbreak of the pandemic. Some intermediaries have had to post considerable resources to meet margin requirements on their derivative positions, given the high and extremely volatile prices. This resulted in severe turbulence and, in one instance, in the temporary closure of the market. Non-financial firms that use commodity derivatives to hedge against risks and not for speculative purposes have also been affected. 12. The growth in government debt, coupled with the prospect of interest rates recovering from the exceptionally low levels reached during the pandemic, has stoked tensions in the sovereign bond market, especially for bonds issued by countries that are more fragile and/or have the highest debt-to-GDP ratios. Since the spring, the spread between Italian and German government bond yields has widened, with peaks close to 250 basis points; this has been partly reversed in the last few weeks. Liquidity 2/8 BIS - Central bankers' speeches conditions in the secondary market for government securities have become less relaxed; this trend, which emerged at the end of last year, is common to other countries. 13. Tensions have also spread to government securities considered to be at low credit risk, such as UK gilts, whose yields soared when the government announced an exceptionally large fiscal expansion. The rise in yields was amplified by the demand for collateral on leveraged positions and derivatives of a number of defined-benefit pension funds (which use these investment strategies to balance expected pension payments with the performance of returns on their assets). In order to cope with such demand, pension funds would have had to sell large amounts of government securities under challenging market conditions, which could have triggered a destructive spiral. Only the emergency intervention of the Bank of England – which temporarily suspended its planned quantitative tightening and introduced extraordinary measures – was able to restore orderly conditions. 14. Private sector bond spreads also widened in the main currency areas. The gap between euro-area and US risk premiums has extended, due to the greater exposure of European firms to the energy crisis. The spread on BBB-rated bonds of euro-area nonfinancial corporations is now close to 250 basis points, well above the long-term average. Looking ahead, the main rating agencies and markets seem to expect a deterioration in credit risk, although the corporate default rate has not increased significantly so far. Any downgrades would mainly affect investment grade corporate bonds close to the BBB rating threshold, which would be exposed to the risk of forced sales by investors with mandate restrictions. 15. Anumberoffinancial stability risks lurk inthesectorswithalarger shareofnon-bank financial intermediaries, which in recent years have grown to the point of holding around half of global financial assets. These intermediaries often have features that can cause them to amplify market tensions, for instance a structural mismatch between the duration or liquidity of assets and liabilities. No regulatory intervention can completely eliminate the possibility of spirals forming on the market because of pro-cyclical behaviour on the part of investors. However, from a macro-prudential perspective, actions can be taken on the structural amplification mechanisms inherent to collective investment instruments in order to mitigate their effects on financial stability. 16. Last year, I took the opportunity provided by this event to look back at the banking regulation reform that followed the financial crisis of 2008. I argued that, although imperfect, as is everything human (and not yet complete), the reform has genuinely strengthened the banking system, enabling it to play a stabilising role during the most recent turmoil. This is a statement which I believe can be confirmed by the far-frompeaceful events that have occurred in the past year. 17. I wish I could say the same for the reform of non-bank financial regulation, which has not made sufficient progress yet. Important steps forward have been taken, also at the instigation of the Italian G20 presidency in 2021, especially with regard to money market funds. However, although the international discussion has started, it is moving far too slowly on other fronts, most notably open-end investment funds. We never tire of repeating that faster and more decisive progress is needed in this area. 3/8 BIS - Central bankers' speeches 18. Protecting market stability in the event of severe stress cannot be a task left solely to the ex post intervention of central banks: not only in light of the well-known moral hazard problems, but also because of the risk of causing tension between the needs of market stabilisation and the primary objective of monetary policy, i.e. price stability. Financial stability must also be able to rely on ex ante safeguards consisting of a sound, robust and resilient non-bank financial intermediation system. 19. This issue is particularly relevant at a time like this, when central banks are moving away from the ultra-accommodative monetary policies of the recent past, as the British gilt episode clearly shows. Regardless of the fiscal policy issues that triggered it, the episode stems from a structural mismatch between the maturities of the assets and those of the liabilities of local pension funds. In order to avoid its destabilising potential, the Bank of England was forced to act in a way that made the implementation of its monetary policy exit strategy more complicated. Easing such trade-offs would help make the simultaneous pursuit of monetary and financial stability more effective. Banks 20. The banking system is also affected by the normalisation of monetary policy. 21. The impact of the new stance will be visible firstly – and to some extent it already is – on net interest income. Long hindered by low interest rates and a flat yield curve, traditional banking is making a comeback as a significant contributor to profitability. In the first six months of this year, when policy rates had not yet been changed but tightening expectations were already being incorporated, at least in part, into market rates, Italian banks' net interest income rose by 9 per cent compared with the same period a year earlier. The increase in policy rates and in the slope of the yield curve will lead to further net interest income growth, at least in the short run. 22. This positive effect is likely to fade as rate hikes feed into interest expenses as well. Some 20 per cent of total bank bonds outstanding will mature in the coming year. These securities have already seen their secondary market yields rise substantially since the beginning of this year, in line with money market yields. Furthermore, bond funding is set to increase in compliance with MREL requirements and to replace, at least in part, TLTRO III refinancing operations. 23. However, the effect of this on net interest income is expected to be positive overall. Our estimates, which incorporate the Bank of Italy's most recent macroeconomic projections, suggest that net interest income could rise on average by around one fifth per year over 2022-24. 24. Secondly, the increase in interest rates has a negative impact on the valuations of securities held for trading. This will weigh on the income statement, in terms of profit or loss from trading, and directly on capital, in terms of unrealised losses on assets measured at fair value, which affects 'other comprehensive income'. However, the total accounting impact should be limited, as the share of securities held by banks in their trading books is not very high. 4/8 BIS - Central bankers' speeches 25. Thirdly, interest rate hikes, especially if coupled with an economic downturn, may affect debt service payments and, as a result, the quality of bank loans. This effect normally lags behind somewhat, and there are no clear signs of it so far. At a later stage, however, we may reasonably expect an increase in loan losses. Our economists estimate that they could double in 2023-2024 compared with this year. Around half of this increase would be attributable to higher lending rates for households and firms, the other half arising directly or indirectly from the cyclical slowdown. Given the very low starting point, this increase, though not negligible, would leave the level of loan loss provisions still far from the peaks reached following the financial and sovereign debt crises. 26. All in all, even taking into account the fact that operating costs – which have fallen significantly in recent years – are expected to rise again, reflecting the spike in inflation, and with all the uncertainty surrounding any forecast in these unsettled times, there are now the conditions for the Italian banking system to achieve adequate profitability in the near future. 27. Despite the uncertain economic outlook, bank lending to firms has accelerated since the spring of last year, reflecting both the higher working capital requirements, stemming from higher input costs, and lower bond issuance. However, this trend must also be assessed in light of the price increases. The latest surveys of banks and firms point to a tendency to tighten credit supply policies, which banks expect to continue in the latter part of the year. 28. The level of capitalisation of the Italian banking system is now adequate overall. The ratio of common equity tier 1 to risk-weighted assets (CET1 ratio) stood at 14.8 per cent in June. The depreciation of government bonds measured at fair value is likely to have a manageable impact on capital: our estimates suggest that an upward parallel shift of 1 percentage point in the yields on these bonds would reduce the CET1 ratio by around 20 basis points. 29. The European Systemic Risk Board (ESRB) has recently signalled heightened vulnerabilities in the financial system throughout the European Union, identifying three major risks to financial stability: a worsening macroeconomic outlook associated with tighter financing conditions; a sudden slump in asset prices; and the fallout of a worsening economic outlook on asset quality and on profitability in the banking system. 30. In such uncertain times, maintaining a sound capital position is key to preserving the ability of the banking system to support the real economy even if and when risks to financial stability materialise. Prudent choices are of the essence, such as accounting for expected losses without delay and the timely adjustment of capital levels to deal with adverse scenarios. In the coming months, supervisors will pay the utmost attention to ensuring that banks act in line with these principles, also based on the ESRB's warning. 31. As I mentioned earlier, the implementation of the Basel reforms is still incomplete. We now need to update the European rules, thus fully enacting the last reform package. It is now one year since the European Commission published its legislative proposal. In implementing the new prudential rules, it preserves some of the specificities of the current rules, including the seniority of loans to small and medium-sized enterprises. 5/8 BIS - Central bankers' speeches Once again I express the hope, as I did on this very occasion a year ago, that the debate on the prudential treatment of individual risks will not be reopened, and that the overall compliance of European rules with international standards is ensured, in line with what was requested in September last year in a letter signed by the vast majority of governors and supervisors of EU Member States. Beyond the economic cycle: banks and technological innovation 32. The cyclical challenges facing the banking system in the coming months should not overshadow the longer-term ones. 33. These challenges are quite serious, but I would not dream of announcing here the imminent death of the commercial bank model, so often dreaded, proclaimed or threatened in the past, based on the presumed pincer movement of competition from new technologically fierce intermediaries and the strict regulation of the banking sector. For banks, innovation is certainly nothing new, and so far this announcement has been greatly exaggerated, as they say. Wherever innovation poses a challenge, there are opportunities for the farsighted and lucky entrepreneur, including the banking entrepreneur, just like everyone else. Nevertheless, we should bear in mind that there are challenges, which do pose serious risks if overlooked, and require targeted responses. 34. To emphasise the complexity of the decisions we face, I shall mention but one example, without overlooking its problematic aspects: the deployment of artificial intelligence and machine learning, and the use of big data to measure creditworthiness. When these technologies began to spread, many thought they would sweep away the banks, which were slow in embracing the new techniques and unable to make full use of their wealth of customer information, to the benefit of non-bank operators with formidable databases and proven processing capabilities. 35. While this has not yet happened, or at least not on a large scale, what is to say it will not happen in the future? A recent report published by the Bank of Italy shows that the use of innovative data analytics by Italian banks for assessing creditworthiness, though still relatively uncommon, is expanding.1 Recourse to these techniques will require adequate investment in human and technological resources. Evidence shows that they can improve both the effectiveness and the operational efficiency of the assessment techniques, especially for standardised small-amount funding. 36. However, banks that have chosen or will choose this path should also be aware that it is not without its pitfalls, as the report I mentioned earlier highlights. The difficulty in interpreting the results of algorithmic selection involves, in the absence of specific safeguards, the risk of losing control over the determinants of decisions. It makes it more difficult to explain to customers why their application for credit was unsuccessful. The risk of unfair discrimination against individuals or categories of customers must be dealt with, also in view of forthcoming regulatory interventions regarding artificial intelligence. These difficulties do not only affect banks, but apply to anyone who uses similar techniques to grant credit. Banks have the cultural resources to deal with them, but if they want to take up the challenge, they need to be adequately equipped. 6/8 BIS - Central bankers' speeches 37. In general, much remains to be done to adapt banks' business models to the numerous challenges of technological innovation. Operators know they can rely on the active support of the Bank of Italy, using the now well-known tools (the Fintech Channel and Milano Hub, together with our collaboration with the Italian Ministry of Economy and Finance and the other authorities in the regulatory sandbox), as well as the whole range of supervisory and regulatory activities. 38. Here I must also remind you that it is essential to keep cyber risks under control. Such risks have presumably increased with the outbreak of the conflict in Ukraine. It is therefore all the more necessary for them to be closely monitored by both banks and the main, often concentrated, technology service providers they use. *** 39. Let me conclude by going back to the most pressing current issues. 40. The sharp rise in inflation requires the full attention of economic policymakers. If it is not stopped in a timely manner, it risks devaluing incomes and depleting savings. To counter this, all policies need to work together, with monetary policy at the forefront. Should price expectations lose the anchor of stability, even the easing of exogenous cost pressures, though desirable, would not be sufficient to halt the process. 41. For the central bank, price stability is the primary, constitutionally imperative objective. The ECB has taken the path to calibrated but firm monetary normalisation and has announced that this path will continue. This will not be easy due to the new challenges, the inherent complexities of monetary policy interventions, affected by 'long and variable' delays, the uncertainties of the global macroeconomic outlook, and the potential fragilities underlying financial markets. 42. In Europe, rising interest rates and the gradual phasing out of quantitative easing require careful and forward-looking policies on the part of everyone to avoid the emergence of tensions and possible fragmentation. The Governing Council stands ready to use all the flexibility necessary in reinvesting securities under the pandemic emergency purchase programme (PEPP), and has set up a dedicated monetary policy transmission protection instrument (TPI) that will be activated, if necessary, in the event of fragmentation not due to imbalances in the public finances or in the macroeconomic conditions. 43. Policies will have to be consistent at national level. As far as Italy is concerned, I can only repeat the words spoken a few days ago by Governor Visco: 'This makes it all the more important to set out a realistic path to continue the process of gradually reducing the high public debt-to-GDP ratios initiated in the past two years.' 44. Banks must not fail to support the economy with prudent lending. The conditions are already in place: sound balance sheets, adequate capital, and non-performing loans amounting to a fraction of what they were ten years ago. If we had been able to foresee at that time today's situation, which has resisted and is indeed stronger despite two 7/8 BIS - Central bankers' speeches crises of historic proportions, we would probably have been quite amazed. Praise should go to those who led the banks, to the market that spurred them on, and perhaps (if I may say so), to some extent, to the authorities that regulated and supervised them. 45. What we need today, however, is not self-congratulation but a renewed commitment, and the awareness that bank credit is still an irreplaceable tool for keeping the economic engine of a society running, as long as it is used with competence, caution, a willingness to embrace the new, and a deep-rooted sense of reality. 1 'Artificial intelligence in credit scoring: an analysis of some experiences in the Italian financial system', Questioni di Economia e Finanza (Occasional Papers), 721, October 2022. 8/8 BIS - Central bankers' speeches
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Speech by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy, at the presentation of the new Italian translation of "A Monetary History of the United States, 1867-1960" by Milton Friedman and Anna Jacobson Schwarz, Istituto Bruno Leoni, Rome, 17 October 2022.
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A Monetary History of the United States, 1867-1960 by Milton Friedman and Anna Jacobson Schwarz Speech by Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy1 Istituto Bruno Leoni Rome, 17 October 2022 I would like to thank Professor Alberto Mingardi and the Istituto Bruno Leoni for their kind invitation. Milton Friedman is one of the giants of 20th-century economics, and the book he wrote with Anna Schwartz has been commented upon, discussed, criticised and praised so often and with such authority, that being invited to talk about it causes dismay long before one can feel flattered. Ben Bernanke, ex-chair of the Federal Reserve and recently honoured with the Nobel Prize for Economics, though diverging from Friedman in significant aspects of his thinking, has not only been profoundly influenced by him but has often professed his admiration for him and acknowledged his intellectual debt to him.2 In order to compose this speech to the best of my ability, I thought I would begin by briefly remarking on how opinions have changed on the topics covered by Friedman and Schwartz (F&S) in their classic book, from when it first appeared to the present day, with some specific references to Italy. These things are well-known, but it might be useful to go over them again together. I then thought of presenting, in the spirit of F&S, some simple evidence to start with, should someone with more time and skill than me want to write a reasoned ‘Monetary history of the euro’. As we shall see, the preliminary evidence leads to questions rather than providing answers. I shall conclude with some observations, which I shall say straight off are neither a comment on the evolution of the ECB’s monetary policy – regarding which I defer to the official statements of its representatives and of the Governing Council, starting with Governor Visco – nor do they express the Bank of Italy’s official position: they are simply a set of personal thoughts on possible future analytical studies. The history of economic thought is a constant back and forth. When F&S published their Monetary History in 1963, their position was quite an isolated one (although of Without associating them with the opinions expressed here, I would like to thank Emilia Bonaccorsi di Patti, Giuseppe Ferrero, Stefano Pietrosanti and Alessandro Secchi for helping me to write this speech, as well as Paolo Angelini, Sergio Nicoletti Altimari and Ignazio Visco for their reading and comments. See Friedman’s monetary framework: some lessons, Federal Reserve Bank of Dallas. course it was in no way ignored). The intellectual climate of the post-war period had seen, especially in English-speaking countries, the almost uncontested domination of Keynes-inspired economic thinking, rising out of the rubble of the Great Depression, and which seemed to be the main route for rebuilding the global economy out of the even greater destruction of the war. Two beliefs were central to this: (1) that, by itself, the economic system has no natural tendency to make full use of resources; and (2) that public intervention is therefore necessary, and can in fact be effectively fine-tuned to achieve a socially optimal result. The conceptual revolution of Keynes’ General Theory (1936) had been swiftly followed by its formalisation by J. Hicks in 1937,3 paving the way for the new approach to become firmly established in the academic world and producing a huge outpouring of literature, which continued after the war. Especially after A.W. Phillips’ 1958 article, in which the famous curve that correlated (wage) inflation and unemployment appeared,4 a belief was consolidated in the existence of a permanent trade-off that could be exploited for economic policy purposes. Theoretical developments had also revolutionised the practical approach to the State’s intervention in the economy, and in doing so prompted the deployment of academic economists as consultants to governments in order to draw up pro-active policies, far more so than in the past. Belief had spread far and wide, also and perhaps above all outside the academic world, that the ‘experts’ had all the necessary tools at their disposal to reduce unemployment, including in the long term, by means of appropriate macroeconomic policies. As regards money, the thinking was at the embryonic stage; the most important thing was for it to be ‘cheap’.5 In Italy, this alignment took place somewhat later. Immediately after the Second World War, the classic orthodoxy embodied first and foremost by Einaudi,6 and then by people like Bresciani Turroni, Corbino and Del Vecchio was still dominant; the institutional J. R. Hicks, ‘Mr. Keynes and the "Classics"; A Suggested Interpretation’, Econometrica Vol. 5, No. 2 (April 1937), 147-159. More precisely, if we may recall it here, several curves, referring to different periods and with quite a few hints that the relationship was anything but stable. The article ended with the following words: ‘These conclusions are of course tentative. There is need for much more detailed research into the relations between unemployment, wage rates, prices and productivity’. More than sixty years on, it cannot be said that the author’s wish has not come true; there must be thousands of empirical papers on the Phillips curve. Those who pursued this thread were not discouraged by the curve often turning out to be unstable and by its basic non-existence in the long term (see A. W. Phillips, ‘The Relation Between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom’, 1861-1957, Economica, Volume 25, Issue 100, November 1958, pp. 283-299). Of course Phillips was neither the first nor the last person to look at the relationship between the labour market and wage growth, always a central issue when building a complete dynamic model of the economy. However, the extraordinary fortune of his ‘reduced form’, which he himself recognised as needing a great deal of additional theoretical and empirical detail, remains noteworthy. ‘The sole role assigned to monetary policy was to keep interest rates low’, say F&S (exaggerating slightly) (Monetary history, p. 841). Einaudi is well-known for clearly wanting to distance himself from the pre-General theory Keynes in his article ‘Il mio piano non è quello di Keynes’, published in Riforma Sociale (March/April 1933, 129-142). In his essay, Einaudi criticised Keynes’ book The Means to Prosperity; he highlighted the supply-side causes of the crisis – destruction and poor allocation of resources due to the aftermath of the shock of the first world war – and reiterated that, given these constraints, any monetary expansion would mainly have led to inflation. framework that shaped the ‘economic miracle’ was built on this intellectual platform, firstly via the stabilisation of the lira, and then through membership of the common European market. Later on, however, the landscape changed completely, with a new generation of economists.7 The global tendency towards intervention for macroeconomic regulation was accompanied, together with the changes in the political situation, by a uniquely Italian approach to development planning (or ‘programming’).8 Your speaker today studied economics at an Italian university in the 1970s, and can bear witness to how the economics taught at that time was of a wholly Keynesian stamp. It was a mature and systematic Keynesianism, which had of course lost something of the brilliant, clever, daring, eclectic and iconoclastic imprint of the founder of this school and was conscious of its orthodox academic status. I think that the atmosphere of that time is neatly summarised by this extract from a book by Eric Roll,9 not only in honour of this occasion but also because it is a textbook that I studied at university back then: For those who have learnt their economics since the end of World War II and to whom the currently used terms and the concepts to which they relate are commonplace, it is almost impossible to imagine the sense of emancipation bordering on revelation with which the generations that preceded them greeted the emergence of what became known as the ‘New Economics’. … “[I]t is now easier to see the ‘great divide’ that separates the economics of the period up to the thirties from what came after.” (p. 481) [F]or at least over thirty years after the appearance of Keynes’s General Theory, the status of economics, largely of the kind associated with his name and general approach, increased steadily until it reached a position of authority, both as a branch of social science and as a perceived tool for the better ordering of human affairs, unparalleled in its history and unequalled by any of the other of the non-physical sciences. (p. 560). In practice, a construction that seemed to rest on such solid foundations was already wobbling (perhaps in this case, too, these movements hit Italy’s academic world with a certain delay). I quote Roll once again: Yet in the latter phase of this period, the authority of the views of economists begins to be doubted, to the point that uncertainty starts to creep into the pronouncements of economists themselves, both about practical matters and about the limits of understanding of their whole intellectual apparatus (p. 560). Some doubts had in fact emerged as early as the 1960s, when fine-tuning the economy had turned out to be more difficult in practice than expected, creating a tendency on the one hand for frequent ‘stop & gos’ and on the other hand for a ‘creeping’ increase The most illustrious representative of this group was perhaps Federico Caffè. His Lezioni di politica economica (Lectures on economic policy), which shaped generations of Italian economists, began to appear in 1966. Those who had him as a teacher recall his extraordinary intellectual openness, including towards positions far removed from his own. Ignazio Visco, who has allowed me to quote him on this, tells me that ‘he (Caffè) got on very well with Friedman and wrote him a letter to get me into Chicago University; my application was accepted, but I decided to go to the ‘Keynesians’ (at that time) at Penn...’ Yet Caffè’s position was clear. However, a line of thinking that was attentive to monetary aggregates and to price stability did stay alive. Guido Carli wrote in his autobiography that ‘the Bank of Italy had always paid special attention to credit and to the multiplier: it was a legacy from Einaudi’s time as governor, from the works of Mortara and from the young Baffi’ (50 anni di vita italiana, Laterza, Bari, 2a ed., 1996, p. 260). Eric Roll, Storia del pensiero economico, Boringhieri, Turin, 1977. in inflation.10 In the United States, using the budget for countercyclical purposes11 and attempting to exploit the supposed trade-off between inflation and unemployment eventually also created tension with the role of the dollar as the gold-pegged linchpin of the international monetary system. The inconvertibility of the dollar declared in 1971 (which put an end to the Bretton Woods system and removed the admittedly imperfect anchorage it gave), the oil shock of 1973 and the advent of stagflation in the wake of these two events could not be dealt with using the orthodox instruments of those times. They seriously undermined the belief that the Phillips curve could be used for economic policy purposes; and, in terms of what interests us here, in the space of a few years, they stimulated new thinking on the management of money as an anchor for stability. It would not be even remotely possible here to go over the intellectual and political debate set off by those events. It also took on ideological connotations that were perhaps ill justified, the remnants of which have not yet entirely disappeared, especially in non-specialised publications. The fact remains that, confronted with an apparently uncontrollable inflation, and with the theoretical ideal pegging to gold lost, the economy had to go back and look at money from the fundamental point of view of ensuring price stability. A Friedman-style approach, though revised and adjusted in light of the evolution of conceptual tools and of practical experience, came back into fashion. It is worth recalling that, although nowadays the fundamental link between monetary policy and price stability sounds obvious, and in certain cases (as in that of the ECB) it is enshrined in the Statute of the central bank, at that time this concept was ‘far from being the conventional wisdom’:12 it was decidedly marginal compared with the mainstream. On a practical level, the reversal of this trend was came about in the United States following the appointment of Paul Volcker as Chair of the Federal Reserve in 1979. Under his leadership, both the conduct and the communication of monetary policy changed profoundly.13 With inflation by then in double figures, Volcker’s Fed applied a monetary restriction that caused a sudden rise in the level and the volatility of interest rates. If, on the one hand, the Federal Reserve recognised the worth of low inflation and even acted aggressively on rates in the event of excessive price increases, this tendency was swiftly reversed when the public’s attention was instead focused on unemployment growth (M. Goodfriend, ‘How the World Achieved Consensus on Monetary Policy’, Journal of Economic Perspectives, Vol. 21, No. 4, 2007; C. D. Romer and D.H. Romer, ‘Does Monetary Policy Matter? A New Test in the Spirit of Friedman and Schwartz’, NBER Macroeconomic Annual, Vol. 4, 1989). F&S had already warned in their Monetary History that: ‘If [this] interpretation has any validity, it leads to the somewhat paradoxical conclusion that confidence in the efficacy of monetary policy in the 1950s was inversely related to monetary stability. As that confidence has grown, it has produced a growing instability in the stock of money. Hopefully, the process is not explosive but self-limiting’. (p. 838) At that time, however, this was clearly a minority opinion. And, it has to be said, for the needs of the war in Vietnam. Bernanke, cit. M. Goodfriend, cit. It stood firm against lively intellectual discussions, major social protests and a political attempt to block it.14 At the cost of a significant but temporary recession, inflation fell from almost 14 to 3 per cent in the space of three years.15 This action was and still is a subject for debate,16 yet it set a fundamental precedent, above all because of the firm way in which it was conducted. As a matter of fact, the Fed was not the first central bank to make such a move. As early as 1974, the Bundesbank had adopted a resolute approach to the fight against inflation, implementing a monetary policy based on controlling the quantity of money and communicating the target in order to steer expectations.17 The evolution of monetary policy was mirrored by an evolution in academic thinking, for which the two fundamental references were the articles by Kydland and Prescott and by Barro and Gordon.18 The problem was defining optimal monetary policy principles in a pure fiat regime. Under certain circumstances, the action of a central bank may be vulnerable to dynamic inconsistency, thus distorting inflation upwards. The literature provides a variety of solutions ranging from strict rules for money supply growth to the introduction of ‘constitutional’ constraints to specify the purposes of central bank action and protect its independence. These issues are well-known and need not be discussed here. What matters for our purposes is that money was essentially seen as the determining factor for price development, and not as being auxiliary to macroeconomic stabilisation policy. In this strand of literature, the rate of price increases, for a given level of real growth, is determined in the long term by the money growth rate (a concept which, incidentally, Ethan Harris, in the reconstruction of the recent history included in his work on Bernanke’s Federal Reserve (E. Harris, Ben Bernanke’s Fed: The Federal Reserve after Greenspan, Harvard University Press, Boston, MA, 2008, p. 46) mentions a draft law designed to force through an easing of monetary policy, a congressional resolution with the same aim, various calls by members of Congress for Volcker to resign, and numerous attempts by the public and by representatives of various industries to intimidate the central bank, including the farmers’ siege of the Fed’s main building in Washington DC in 1979. The Federal Reserve under Volcker remained steady even in this tense atmosphere; this capacity to stand its ground set a precedent that would later be followed by Greenspan during the presidency of Bush senior. The peak in the annual growth rate of the consumer price index was 13.6 per cent in June 1980; the index went down to 2.9 per cent in June 1983. It rose slightly later on and then stood at between just under 4 and just over 5 per cent in the following ten years (source: Bureau of Labor Statistics, index of consumer prices excluding food and energy products, average for urban areas, which can be consulted at ). As examples of contrasting points of view, see B. Friedman, ‘What Remains from the Volcker Experiment’, Federal Reserve Bank of St. Louis Review, Vol. 87 March/April Part 2, 2005; M. Goodfriend and M. King, ‘The Incredible Volcker Disinflation’, Journal of Monetary Economics, Vol. 52, No.5, 2005. Specifically, in 1974, the Bundesbank began to implement a policy of setting a target in terms of monetary aggregates, supported by a transparent communication of this target to guide the expectations of people and firms, with the aim of tempering the uncertainty caused by the end of Bretton Woods (O. Issing, ‘Why Did the Great Inflation Not Happen in Germany?’ Federal Reserve Bank of St. Louis Review, March/April, Part 2, 2005). Germany’s success in combating inflation was not entirely due to pursuing monetary objectives, which moreover were not always achieved; to name but one, the lack of a wage-indexation system was an important factor, as was the revaluation of the exchange rate, which is after all linked to monetary policy. F. E. Kydland and E. C. Prescott, ‘Rules rather than Discretion: The Inconsistency of Optimal Plans’, Journal of Political Economy, 85, 3, 1977; R. J. Barro and D. B. Gordon, ‘Rules Discretion and Reputation in a Model on Monetary Policy’, Journal of Monetary Economics, 12, 1, 1983. would be quite intuitive if money as a means of payment had immutable characteristics); monetary policy is considered scarcely effective, or even counterproductive as a cyclical stabiliser. Under the pressure of the dramatic events of the early 1970s, economic theory therefore reacted by questioning the paradigms of that time. In 1976, among other things, Friedman was awarded the Nobel prize in economics. The examples of the Bundesbank and the Federal Reserve and their successful fight against inflation inspired other central banks to claim their independence as the keystone for effective action against inflation. In Italy, as late as 1974, Governor Guido Carli had to recognise, in a famous remark, that the central bank’s refusal to fund the public sector’s deficit through the creation of money would, given the institutional framework and historical circumstances of the time, be tantamount to a ‘seditious act’:19 in other words, money was under a fully-fledged fiscal dominance regime20 (although the Bank did try to regain a certain degree of autonomy by placing purchased securities on the market and, indirectly, by capping bank loans). In the Concluding Remarks for the year 1975, Governor Paolo Baffi had already cited the Bundesbank – whose anti-inflation mandate was defined by law – as an ideal.21 In 1981, under Governor Ciampi, in a different political and social scenario, there was a change of regime: what was known as the ‘divorce’ between the Bank of Italy and the Treasury removed the central bank’s obligation to act as residual purchaser of government securities. This finally gave full and actual independence to the Bank, which was now able to adopt a rigorous anti-inflation monetary policy.22 See Concluding Remarks for the year 1973, 31 May 1974, p.32. Reading the book by F&S offers a curious parallel with William Harding’s reply, as Chairman of the Federal Reserve in 1919, to those who reproached the institution for failing to raise the discount rate when it was necessary (the issue had, in fact, been the subject of lively discussion within the Board): “The Board felt that it was its duty to cooperate with the Treasury authorities. Failure to cooperate would have been tantamount to an undertaking by the Board to dictate the policies of the Treasury…” (p. 302). The issue is, indeed, the object of debate (see E. Gaiotti and A. Secchi, ‘Monetary policy and fiscal dominance in Italy from the early 1970s to the adoption of the euro: a review’, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 141, 2012). Many (including Toniolo and Carli himself) emphasised the context: the exceptional political and social tensions prevailing in Italy at that time would not have permitted any other choice of monetary policy. All of this is undoubtedly true and, in this regard, we can refer to a few brief comments on the evolution of the strategy implemented by the Bank of Italy between the 1970s and the 1980s to tackle the political and social changes underway, which are contained in a recent speech I gave (‘Luigi Einaudi’s Considerazioni finali’, Banca d’Italia, 2021). Nevertheless, that the choice was deliberate, perhaps even made independently, and justified by the circumstances prevailing at the time, does not, in my opinion, alter its substance; that is (in the definition of fiscal dominance used by Gaiotti and Secchi, borrowed from Sargent) ‘a coordination scheme in which the fiscal authority acts first and independently sets its current and future deficits and surpluses, thus determining the overall amount of revenues that must be raised either through bond sales or seigniorage; the monetary authority operates under the constraints imposed by private demand for government bonds and the need to ensure the solvency of the fiscal authority’. See Concluding Remarks for the year 1975, 31 May 1976, p.43. Governor Ciampi said that ‘The reinstatement of the government budget as an economic policy instrument may be considered to form the apex of a triangle that represents the elements necessary for the restoration of a sound currency; the other two corners are the consistency of behaviour affecting wage determination and the independence of money creation from the centres of expenditure.’ (Concluding Remarks for the year 1981, 31 May 1982, p.24). The main legacies from that period were therefore a renewed focus on price stability as the lodestar of monetary policy, and the importance of central banks’ independence. These fundamental concepts are still alive in essence. However, with regard to how they were applied, in the years following the great disinflation, pursuing quantitative money growth targets gradually became less relevant empirically, in theory and in central bank practice. As intuitive as it may seem in the abstract, starting in the late 1980s, the relationship between prices and the quantity of money actually became rather elusive. The reasons why this relationship petered out are disputed. Presumably, they include innovations in finance and in payment systems, which flourished at a time of deregulation and influenced the relationship between nominal income and the desired cash balances (‘velocity of money’), and the substitutability of financial instruments (definition of ‘money’). At the same time, an increasingly globalised economy kept production costs down by boosting the quantity of low-cost labour incorporated in a product, thereby easing inflationary pressures, the money supply being equal. The monetary policy stance thus changed tack again, although it did not entirely reverse its course. I shall not dwell on the theoretical developments: in an attempt to find common ground between the Keynesian and the monetarist approaches, while still highlighting the importance of price stability as an objective of monetary policy and the need to solve the issue of inter-temporal consistency through institutional mechanisms to ensure the independence and credibility of the central bank,23 there is now less emphasis on monetary aggregates24 and monetary policy has regained its cyclical stabilisation function through interest rate manipulation (the Taylor Rule).25 In 1989, the central bank of New Zealand was the first to adopt an inflation targeting strategy, and many others followed, in one form or another.26 In the United States too, the instability of money demand resulted in the Fed taking short-term interbank rates as the operational target of monetary policy instead of the growth rate of the M1, M2 or M3 monetary aggregates. The focus on monetary aggregates survived for a while in Europe. At its inception, the ECB was influenced by the Bundesbank’s monetarist tradition. While constant money growth was no longer pursued, and the objective of monetary policy, in accordance with the Treaty and the Statute, was defined in terms of the inflation rate (initially ‘below 2 per cent’), in line with the other major central banks, monetary aggregates retained a significant role as a signal of inflationary pressures (the ‘first pillar’ of the analysis). In fact, M. Goodfriend, cit. M. Woodford, ‘How Important is Money in the Conduct of Monetary Policy?’, NBER Working paper, 13325, 2007. See, for example, J.B. Taylor, ‘Discretion Versus Policy Rules in Practice’, in Carnegie-Rochester Conference Series on Public Policies, 39, North-Holland, 1993. See also Taylor’s preface to A Monetary History, discussed here today. For a review, see L. Leidermann, L.E.O. Svensson (Eds.), Inflation targets, London, CEPR, 1995. in Europe, they seemed to keep their information content on future inflation for longer.27 As for M3, the ECB explicitly defined a benchmark growth rate (4.5 per cent). Starting in 2001, however, immediately after the launch of the monetary union, M3 began to grow systematically more than the benchmark rate, while prices continued to record steady and limited growth. It was now money demand that appeared to have become unstable. In 2003, the ECB redefined its price stability target as inflation ‘below, but close to, 2 per cent’ and reduced the role of the ‘first pillar’ to cross-checking the results of economic analysis.28 Looking back though, what has actually happened to monetary aggregates in the long run, nearly a quarter of century since the establishment of the monetary union? Adopting an F&S-style approach, what can we say about the relationship between quantities of money and inflation? What can the most recent events teach us? I shall only give a few examples; for ‘A Monetary History of Europe since 1999’ we would need another Friedman and another Schwartz, and I am certainly not up to the task.29 The data I am going to present are therefore only food for thought. First, however, let us briefly review the operational procedures that have been used over time to enforce the ECB’s monetary policy. In a modern monetary system, the central bank provides two types of money: cash (currency in circulation) and reserves. The amount of cash supplied to households and firms is entirely dependent upon their demand: central banks meet the demand for cash in a perfectly elastic way. Those who require banknotes go to a bank or to an ATM and convert bank money into cash; the bank obtains cash freely from the central bank in exchange for reserves. The other type of money issued by central banks is in the form of reserves, which are exchanged by intermediaries whenever bank deposits are transferred, or returned to the monetary authority when depositors request cash. Their importance lies in their link with bank deposits. In the euro area, refinancing operations were the main tool for providing the banking system with reserves up until 2015. Until October 2008, the Eurosystem provided reserves via variable-rate, fixed-quantity liquidity tenders. The quantity was set in an essentially passive manner, by estimating banks' liquidity needs based on past deposit balances. K. Masuch, S. Nicoletti Altimari, H. Pill and M. Rostagno, ‘The Role of Money in Monetary Policy Making’ in Background studies for the ECB’s evaluation of its monetary policy strategy, 19, 2003. The focus on quantities shifted from the relationship between money and the price of goods and services to that between credit and asset prices, with a view to preventing financial crises. This is a broad issue which, among other things, relates to the thinking on the macroprudential instruments designed to mitigate the side effects of monetary expansion and on the first experiments in utilising them. It would not be possible to deal with it here. The literature, however, abounds with quality work, though recently the focus on monetary aggregates has waned. For an accurate retrospective account, see for example P. Hartmann and F. Smets, ‘The first twenty years of the European Central Bank: monetary policy’, European Central Bank, Working Paper Series, 2219, 2018. In 2008, the Eurosystem switched to fixed-rate tender procedures with full allotment. This means that, since 2008, banks have been able to request any amount of reserves, as long as they have sufficient collateral: the supply of reserves provided through these operations is perfectly elastic. In line with the flexible inflation targeting strategy – common to all the major countries, broadly speaking – the quantity of money was not therefore directly controlled by central banks but was determined endogenously based on money market conditions (including, of course, policy rates). In January 2015, when interest rates were close to their lower bound, the Eurosystem (like other central banks) switched to an explicit quantitative easing strategy. Once again, the quantities involved are not the monetary aggregates, but rather refer to financial asset purchase programmes. They mainly act by lowering medium- and long-term interest rates by purchasing public and private bonds at various maturities. However, when a central bank purchases assets, it also creates reserves. When securities sold to central banks were previously owned by households or firms, the increase in reserves is also coupled with an increase in bank deposits. Growth in the monetary aggregate is no longer an indirect consequence of policy rates driven by money demand, but a direct consequence of central bank purchases. Monetary accommodation has generated a substantial increase in the monetary base, especially after the adoption of the quantitative easing strategy [Figure 1]. Central bank reserves increased by around 400 per cent during the sovereign debt crisis and by 1700 per cent between January 2015 and May 2022. Deposits by households and firms grew much less, but still significantly: between 2015 and 2022, the narrow M1 aggregate, which also includes currency in circulation, increased by 92 per cent (10 per cent per year on average). The broader M3 aggregate grew by 52 per cent.30 Inflation, as measured by the harmonised index of consumer prices, having remained well below 2 per cent in 2020, rose to 3 per cent in 2021 and then accelerated again in the first half of 2022 to 7.5 per cent [Figure 2]. Today, it is close to 10 per cent. From a qualitative point of view, Figure 2 suggests that there is a correlation between the Divisia M331 monetary aggregate and inflation, with the former preceding the latter; however, this correlation is uneven and has broad variations, and it is not obvious how these variations should be treated analytically in this context. To provide some exploratory evidence, the colleagues who helped me prepare these notes have plotted a pair of correlograms in Figure 3 showing the co-movement of inflation and growth in the Divisia M3 monetary aggregate for two different sub-periods. They confirm both the existence of a correlation A substantial part of the asset purchases under the APP and the PEPP did not directly involve the portfolios of households and firms, and a large part of the increase in reserves is linked to refinancing operations, specifically T-LTROs. Divisia monetary aggregates combine monetary sub-components based on their transaction services. Specifically, sub-components are weighted by their yields, which are ‘inverse’ indicators of the transaction service. The difference between M1 and Divisia M1 is normally minimal, as the M1 sub-components’ yields are relatively low and stable. Conversely, there are more obvious differences between M3 and Divisia M3, especially until 2015 when the yields on the longer-lasting monetary sub-components were significantly higher. in the most recent period and its instability over time. There is no correlation between Divisia M3 growth and lagged inflation in the period 2001-12, while the correlation is significant in the subsequent period and peaks at one year approximately.32 When reading these data, we cannot disregard the concrete conditions under which inflation picked up, especially the post-pandemic bottlenecks and above all the violent shock of the war and the soaring energy prices. These data are therefore not to be taken as evidence of causal relationships. Movements in variables, especially in the most recent period, have been unusually sudden and affected by exceptional factors. The lags hypothesised by monetary policy are, as we know, long and variable, and there are countless omitted variables. Of this evidence, we can only say with certainty that, rightly or wrongly, it has been used very little in more recent times. I am only showing it today to encourage better-founded and more in-depth analyses. The idea that inflation is 'always and everywhere' a monetary phenomenon did not originate with Friedman,33 nor is it limited to a world where the legal tender is paper-based. The relationship between the quantity of money and prices has been addressed by writers on monetary matters since the Middle Ages. In a trivial sense, this relationship is obviously true: since the absolute level of prices is defined in relation to a numéraire, without money, we cannot even talk about inflation. In a pure barter economy, there are only relative prices. Slightly less trivially, however complex and misunderstood the mechanisms that generate seasonal, cyclical and secular variations in V may be, and however controversial the definitions of income (or transactions) and money, the fact remains that PY=MV is, conceptually, an identity. The problem arises when we want to derive a theory and a prescription for economic policy from this identity. We then need to specify the magnitudes in an operational way and establish a direction of causality. To be as succinct as possible, the conclusion of the book by F&S is threefold: (1) the velocity of money is ‘extremely’ stable (or rather inertial, as we would describe it, in the sense that it moves very slowly and regularly at low frequencies: pp. 923ss.); (2) despite the profound changes in the monetary regime that occurred over the century examined by the authors, and despite the different impact of many events (both economic and institutional), of peace and war on the main components of money (currency in circulation, deposits, reserves), the previous statement remains true overall (pp. 930ss.); and (3) variations in the quantity of money are often Following an approach common to many studies on modern business cycle theory, cross-correlations have been computed on their cyclical component rather than on raw time series. This choice stems from the need to obtain results that are not affected by components relating to different frequencies, such as seasonality or long-term growth. We use the methodology proposed by M. Baxter and R.G. King in ‘Measuring Business Cycles: Approximate Band-Pass Filters for Economic Time Series’, Review of Economic and Statistics, Vol. 81, No. 4 1999, which, in summary, exploits the properties of moving averages and some findings of frequency theory to extract the cyclical components relating to the sought-after frequencies from the raw series. In any case, using percentage changes in time series instead of filtered data does not substantially affect the results. Who did not actually formulate it in his book with A. Schwartz but in a different publication of the same year: M. Friedman, Inflation: Causes and Consequences, Asian Publishing House, 1963. ‘independent’ (i.e. exogenous) and the predominant direction of causality is from money to nominal income (pp. 944ss.). Nowadays, these statements are difficult to take without a pinch of salt. If nothing else, innovation and the diversification of payment methods have made the velocity not only presumably more unstable, but also harder to define and measure. The exogenous nature of money, implied in the full version of the sentence referenced above, is a complex and perhaps insufficiently thought out issue nowadays: ‘Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output’ (my emphasis). As we have seen, depending on the historical circumstances and the ultimate objectives of monetary policy, central banks can choose intermediate targets in terms of quantity or rate (or something else), and the technical characteristics of monetary policy operations vary. In the first two decades of this century, interest rate targets have largely been predominant, at least until they hit the effective lower bound of nominal rates. However, at least in principle and notwithstanding the infinite complications of reality, the symmetrical and dual nature of the choice appears obvious.34 Even if it is the interest rate curve that we want to influence, and, operationally speaking, deciding the quantity is left to the market, quantities are ultimately decided indirectly by central banks through the demand expressed by the market at the policy rate. The irreducible freedom of those who have the power to create it is inherent to the concept of fiat money. The question, therefore, is not so much whether the central bank can influence quantities autonomously, but rather whether quantities make sense as an operational objective or, at least, as a signal to be considered. As we have seen, how this problem has been addressed has changed repeatedly – and quite radically – over time. Between the late 1970s and the early 1980s, the conversion to quantitative rules of some of the world’s leading central banks was the instrument through which they overcame post-oil-shock inflation. While the quantitative zeal of that time may appear simplistic, perhaps even dogmatic today, we need to consider that the monetarist narrative, together with the contemporaneous theoretical rationalisation of having a ‘conservative’ and independent central banker, was likely a key factor in strengthening central banks’ resolve to pursue their stabilisation policies, despite the significant costs and highly vocal opposition. Simplistic and dogmatic attitudes waned considerably in the 1990s, as more flexible inflation targeting strategies gradually took hold. At the turn of the century, although the ECB’s initial strategy continued to acknowledge the primacy of the monetary ‘pillar’ in a formal sense, at least for signalling purposes, the information content of the aggregates appeared to decrease over time and the focus on them diminished. After all, for twenty years, inflation had been so moderate – also owing to global factors independent of monetary policy in Europe and elsewhere – that it was difficult to identify robust econometric relationships between prices and monetary aggregates. At the end The issue of the equivalence between rules based on the interest rate and rules based on the quantity of money is addressed at length by John Taylor in his foreword to this edition of A Monetary History of the United States (pp. XIIss.). of that period, no one was looking at the statistics on monetary aggregates any more. If anything, they were looking at those on credit and were mostly concerned with avoiding unwanted credit tightening measures. However, perhaps looking afresh at A Monetary History might make one wonder whether a total disregard for the quantity of money is as one-sided an attitude as was the obsessive focus on it of the previous generation. Unlike F&S, we believe that V is far from being ‘extremely’ stable; that it depends – besides on the economic cycle, as F&S also recognised35 – on technology, custom, opportunity cost, and on many other factors we do not grasp very well. Yet precisely because we do not grasp them very well, and because we have observed sharp changes in one direction, we cannot rule out that, if the underlying conditions change, equally strong changes could occur in the opposite direction. While the global ‘reserve army of labour’ has long kept inflation down in the advanced countries, thereby preventing the inflationary potential inherent in the strong global accumulation of liquidity in recent years from materialising, an equally exogenous factor such as an energy price shock could trigger it. The sizeable monetary expansion that followed the outbreak of the pandemic – let this be stated clearly to avoid any ambiguity – was essential at that time to avert a destructive financial deflagration. That said, no one ever denied it could have side effects. The main concern of yesteryear was potential financial and real-estate ‘bubbles’. Today, considering that various kinds of exogenous events have led to sudden rises in consumer prices, the risk that the large money balances held by the private sector could contribute to accommodating inflation must be averted. Perhaps, thinking back to the energy shock of fifty years ago, one can venture to say that inflation, if not always and everywhere a ‘monetary phenomenon’ in a causal sense, is generally a ‘money-enabled phenomenon’. The touch paper for this was (in Europe) energy and commodity prices; that said, the fuel is there, and it must not catch fire. The change of course in the monetary policies effected by the central banks of the advanced countries must be seen, I believe, from this perspective too. I would like to conclude with a methodological consideration. Paradoxically, a book that has fuelled the debate on monetary theory and policy like few others is neither a theoretical book nor a manual containing policy prescriptions. It is an economic history book. Even more than that: it is a book in which history is narrated in words and where the quantitative aspect is only present in the form of very simple – and almost boring, if you will – tables and charts. Reading it today, what is striking – in a text that contains the bold general conclusions I have just discussed – is the complete absence of econometrics (there is only one slightly cryptic reference, on pages 903-04, to an attempt at quantitative validation, which is in any case abandoned). This absence, however, is countered by the meticulous reconstruction of the concrete conditions against which See for example pp. 757 and following, 924-25. Despite their overall conclusion that we succinctly summarised earlier, F&S devote considerable effort to discussing the interpretation of changes in V that are not easily ascribable to cyclical reasons. See for example, with respect to the period after the Second World War pages 873 and following and 888 and following. history was unfolding, backed by an extensive, even monumental array of sources. Wars and peace treaties, laws and political movements, monetary and real markets, bank profits and failures; institutional changes and power struggles; practical debates, among financiers, within the central bank, in Congress and in public opinion, reconstructed precisely and passionately; individual characters; and fascinating hypotheses on what might have happened if a given public figure had not died prematurely or if a given dispatch had been sent one day earlier. All this makes for compelling reading (at least in some parts: I shall not claim that the reader’s attention never lets up for the almost one thousand pages of the book). In the end though, what is the epistemological status of the conclusions that may be drawn from a huge mass of data and observations that is reasoned, but not super-systematic and untramelled by rigorous quantitative scrutiny? I do not have a clear-cut answer. I will only say, and this is nothing new, that the book makes one ponder the comparative virtues of an approach of this kind compared with the one that is not only dominant by far today, but is also considered indispensable to reach conclusions – be they positive or normative – that may be called scientific. Formalised theory and rigorous econometric methods force us to formulate hypotheses in a precise and coherent way and make it possible to test them against Popper’s falsification principle. However, the price to pay, in the realm of economic science, is a ‘flattening’ or hyper-simplification of reality as well as (on the part of the least aware among us) a certain disregard for the concrete history of facts. This may create an illusion as to the general validity of the results obtained and can even blind us with respect to the evidence presented. On may conclude, rather obviously, that both approaches are useful and necessary, and both may be fruitful in great hands but perhaps barren in the hands of others. However, since econometrics has made huge strides in the meantime, and can now make use of more complex and flexible models than were previously available, I may perhaps add, as a valediction, that the quantitative evidence to which I have alluded during this presentation deserves a little more attention – both qualitative and econometric – than it has received in the recent past. In any case, what is needed is an open mind, a focus on concrete facts, and perhaps a touch of eclecticism, the latter being something with which, after all, the art of central banking has never been able to dispense completely. Figure 1 - Cash and monetary base (cash + reserves) (monthly data) Levels (billions of euros and index number) Annual growth rates (%) Figure 2 - Divisia M3 and consumer prices (HICP) in the euro area (monthly data) Levels (Jan-2001=100) Divisia M3 headline HICP (r.h.s.) Annual growth rates (%) core HICP (r.h.s.) Divisia M3 headline HICP (r.h.s.) core HICP (r.h.s.) Figure 3 - Co-movements between Divisia M3 and consumer prices (HICP) in the euro area Cross-correlation between the annual growth of Divisia M3 (t) and that of the headline HICP (t+h) Jan 2001 – Dec 2012 Jan 2013 – June 2022
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 29th Congress of ASSIOM FOREX (the Italian financial markets association), Milan, 4 February 2023.
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Ignazio Visco: Speech - 29th ASSIOM FOREX Congress Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 29th Congress of ASSIOM FOREX (the Italian financial markets association), Milan, 4 February 2023. *** The economic situation The global economy is slowing down; uncertainty remains very high, even though the latest indicators are better than expected. Despite the recovery forecast for China, according to the International Monetary Fund's latest projections, the global GDP growth rate should stand at 2.9 per cent this year, down from 3.4 per cent in 2022; world trade growth will go down from 5.4 to 2.4 per cent. The weakening of the international economic situation is mainly due to the fallout from Russia's aggression against Ukraine and the relative geopolitical tensions. Inflation remains high at global level, driven by the exceptional increases in the prices of energy commodities and food products. On the one hand, this continues to lower the purchasing power of wages and the real value of accumulated household savings and, on the other hand, to call for a tighter stance for monetary policies. European countries meeting the natural gas storage targets, the milder weather and the fall in demand have all supported a broad reversal of the increases in energy commodity prices in recent months. The economies of Italy and the euro area are also decelerating, in the wake of results that were generally better than expected throughout 2022. GDP growth came close to 4 per cent in Italy, almost half a point more than the average for the euro area. The recovery in services, particularly marked in the summer, more than offset the decline in industrial and agricultural production recorded in the second half of 2022. The baseline scenario presented in the Bank's January Economic Bulletin, which is necessarily indicative given the persistence of highly uncertain geopolitical conditions, shows that, following the decline of 0.1 per cent recorded in the fourth quarter of 2022, growth in the economy is likely to fall to 0.6 per cent this year. It will become stronger over the next two years because of the acceleration in exports and, thanks to waning inflationary pressures, in domestic demand. Inflation, which was equal to 8.7 per cent on average in 2022 on a harmonized basis, is projected to decline by 2 percentage points this year and more markedly so next year, to then go down to 2 per cent in 2025. According to preliminary estimates, GDP rose marginally in the euro area in the last quarter, at a time of significant variations across countries. According to the baseline scenario drawn up by Eurosystem staff in December, GDP growth is limited to 0.5 per cent in 2023 and will then return to close to 2 per cent next year. As a reflection of the assumption, partly outdated, of persistently strong pressures stemming from the rises in commodity and intermediate goods prices, and of sizeable wage increases, following the 8.4 per cent recorded for the whole of 2022, the slowdown in inflation was expected to be weak and uncertain. The rise in prices exceeded 6 per cent this year and would remain at well over 3 per cent in 2024. 1/11 BIS - Central bankers' speeches However, the signs that inflation growth was contained, recorded in the final months of last year, were confirmed in January; according to preliminary estimates, inflation went down from its peak of 10.6 per cent in October to 8.5 per cent, even though the core component (i.e. net of energy and food products) steadied, at 5.2 per cent, owing to the usual lag in the pass-through of rises in energy prices. The price of gas delivered to Europe, set at €124 per megawatt hour on average in 2023 and at €98 in 2024 in the technical assumptions included in the Eurosystem projections, continued the downward trend that started at the end of August, going below €60. The bottlenecks in the global supply of intermediate goods have also eased considerably. Given these recent trends, the short-term inflation expectations are falling sharply on the financial markets. Yields on inflation-linked swaps indicate that the expected inflation rate twelve months ahead is 2.3 per cent, less than half of the levels at the end of November, when the Eurosystem staff projections had just been finalized. Longerterm inflation expectations remain at levels consistent with the 2 per cent medium-term price stability target, net of risk premiums. At the same time, the anchoring of inflation expectations is confirmed by the results of the January survey of analysts. There has been a decline in the inflation expectations of firms and households too. Wage growth has stepped up slightly since October. Although there seem to be requests for sizeable wage increases in a number of countries, in order to recover most of the losses in purchasing power caused by the energy shock, there are currently no signs of a price-wage spiral being triggered in the euro area as a whole, which would increase the persistence of inflationary pressures and broaden the scope of the monetary policy response. Monetary policy ... On Thursday, the ECB Governing Council raised the key interest rates by 50 basis points, bringing the overall increase to 300 points. It also confirmed that they will need to continue rising to support the return of inflation to its medium-term price stability target and announced that it intends to raise them by another 50 basis points in March. In any case, decisions on the pace of any further increases will continue to be made based on the inflation outlook, which is defined according to incoming information as it becomes available. Since late last year, the Governing Council has gradually recalibrated the other monetary policy instruments to ensure that their contribution is consistent with the monetary policy stance implied by the key interest rates. In particular, it announced in December that the assets held in the monetary policy portfolio would be reduced at a measured and predictable pace, through the partial reinvestment of the principal payments from maturing securities. From March 2023 onwards, the reinvestments relating to the asset purchase programme (APP) launched in 2014 will decline by €15 billion per month until the end of the second quarter of 2023 and the subsequent pace will be determined by cyclical developments and market performance. The full reinvestment of the securities purchased under the pandemic emergency purchase programme (PEPP) will instead continue until at least the end of 2024 in a flexible way with a view to countering, along with the new transmission protection instrument (TPI), any risks of unwarranted fragmentation of financial markets along national lines. 2/11 BIS - Central bankers' speeches The turning point in the monetary policy stance that started in December 2021 was indispensable. The Governing Council had responded to both the deflationary pressures stemming from the global financial crisis and the euro-area sovereign debt crisis and to the risks arising from the pandemic by adopting extraordinarily expansionary measures. As these factors waned, it became inevitable that the key interest rates and liquidity would return to more balanced values. Since the end of 2021, the increase in energy prices, initially gradual, has become more substantial and prolonged because of Russia's invasion of Ukraine, thus calling for an accelerated normalization of monetary policy, though this was by no means unexpected. In this regard, important steps forward have been taken. Since the beginning of the gradual reduction of monetary accommodation, one-year overnight index swaps have picked up from negative levels to 3.3 per cent, while ten-year ones have gone from barely positive values up to 2.6 per cent. In real terms, using index-linked swap rates as a deflator, the interest rates currently stand at about 0.9 and 0.3 per cent respectively, from around -4 and -2 per cent at end-2021. Monetary tightening can now continue with suitable caution and with careful consideration of the implications for the economy and for the inflation outlook of the measures already adopted as well as of the information on how they develop. In any case, it remains essential to continue to balance the risk of an excessively gradual recalibration, which could cause inflation to become entrenched in expectations and in wage-setting processes, with the risk of monetary conditions becoming too tight. This in turn would result in significant repercussions for economic activity, financial stability and, ultimately, medium-term price developments. As I have recently said, I believe equal weight should be assigned to both risks, in line with the symmetrical price stability objective which we must achieve to fulfil our mandate. However, price stability does not depend on monetary policy alone, but also on firms' business strategies, agreements on labour costs and fiscal policy. In order to bring inflation back to its target, it is crucial for representative of workers and employers in all euro-area economies to make responsible decisions, to ensure that price and wage dynamics remain consistent with preserving monetary stability. In real terms, wage growth is limited by the performance of productivity. Especially in Italy, where both productivity and real wages have stagnated for too long, the investments and the reforms envisaged under the National Recovery and Resilience Plan will play a fundamental role in creating a more favourable business environment. Price stability also requires that public finances be kept under control in all countries. Balanced policies are required, not only to prevent demand from overheating and inflation from declining more slowly, but also to stave off the risks associated with a negative perception, even if not entirely warranted, of the sustainability of public finances. Fiscal policies, through temporary and targeted measures, can certainly help ease the effects of inflation on the weakest sections of the population; however, this should be done through a redistribution among income earners, both from labour and capital, and without knock-on effects for future generations. In Italy, a prudent fiscal policy has helped reduce the yield spread between Italian and German ten-year bonds; it is currently below 190 basis points, which is still well above the value that would be warranted by Italy's macroeconomic fundamentals and around double that of Spain and Portugal. 3/11 BIS - Central bankers' speeches - and its impact on government, corporate and household debt At present, the hikes in key interest rates are broadly manageable for Italy's public finances, since the average cost of debt is increasing gradually, thanks to its high average residual maturity. Italy's government has prudently planned to gradually narrow the deficit throughout the current three-year period, aiming for a primary surplus next year, to bring it to 1.1 per cent of GDP in 2025; nominal GDP growth itself supports the fall in the debt burden. Against this background, the planned reduction in the Eurosystem's securities reinvestments which, as I recalled earlier, will take place at a measured pace and announced ahead of time, is not likely to have a significant impact on the placement or yield of government bonds. The debt of Italian firms and households remains low by international standards, despite firms largely resorting to guaranteed loans since the onset of the health emergency and mortgages growing strongly over the last few years. Overall, it stands at 112 per cent of GDP, compared with an average of 168 per cent for the euro area. The financial stability of our economy is also benefiting from the improvement in corporate capital structures, a process that started in the early years of last decade and was only temporarily interrupted by the pandemic-related crisis. By last September, the debt of non-financial corporations had declined to below 70 per cent of GDP, more than 13 percentage points lower than its peak during the sovereign debt crisis. Higher capitalization levels and reduced reliance on bank borrowing mean that leverage (i.e. the ratio of financial debt to the sum of financial debt and equity at market value) has fallen from 50 to 41 per cent since 2011. Over the same period, bank debt as a share of total financial debt has dropped from 67 to 52 per cent. The situation of firms is inevitably affected by surging energy prices, the slowdown in economic activity, rising interest rates and less favourable access-to-credit conditions. Their ability to service debt remains strong, though, thanks to the rebound in profitability and the reduction in leverage, coupled with smooth liquidity conditions overall. During the pandemic, Italian firms built up their bank deposits significantly, reinforcing a trend that had been under way for some time. The historically high level of cash holdings (28 per cent of GDP) and a lower ratio of net interest expense to operating profit (6.4 per cent) appear to be able to limit the impact of credit tightening. While subject to a high degree of uncertainty, our scenario analysis shows that firms' vulnerability is likely to remain limited overall, unless the economic cycle and debt servicing costs deteriorate far more than expected. Even in an adverse scenario, with a significant reduction in gross operating income and a substantial increase in the cost of funding, we expect the share of debt of particularly vulnerable firms to remain well below the levels seen in serious crisis situations in the past. However, there are no significant signs of deterioration in credit quality so far at the aggregate level. Likewise, the risks stemming from the state of household finances, which are also affected by the worsening economic outlook, remain limited overall. Over the past decade, debt has remained broadly unchanged, at just above 40 per cent of GDP. The increase in mortgages as a share of total loans in past years was observed mostly on the fixed-rate side. In 2022, as fixed-rate borrowing became more expensive, variablerate mortgages gained pace until they accounted for the majority of new loans. 4/11 BIS - Central bankers' speeches Meanwhile, though, the share of capped-rate schemes has been rising, in a trend that helps soften the blow of rate hikes. As with firms, large cash holdings help mitigate the risks to households: last September, deposits and currency in circulation exceeded €1,600 billion, a historically high level, including in real terms, and accounting for over one third of total household financial assets. Looking ahead, despite the erosion caused by rising inflation, accumulated wealth seems sufficient to enable households to service their debt, even in an adverse scenario where real income declines and interest rate hikes are much greater than expected. As long as fiscal policies continue to be cautious, the threat of a widening of the spreads and its negative effects on the real economy, as well as on the public accounts, should remain limited. Therefore, the risks posed by rising key interest rates should prove manageable, even for private finance. With this in mind it is therefore still crucial, in an environment of price stability, to aim for sustained growth driven by reforms and by public and private investment. The banking sector Despite the cyclical slowdown, the main indicators of the health of the Italian banking system are still positive overall. Credit quality remains good: last September the nonperforming loan ratio net of loan loss provisions was 1.5 per cent; for the significant banks it was, at 1.2 per cent, substantially in line with the average for the Banking Union countries. The flow of new non-performing loans remains low at around 1 per cent of total loans. The liquidity margins fell slightly following the initial repayments of the targeted longer-term refinancing operations (TLTRO) but remain well above the minimum reserve requirements. Profitability is driven by the increase in net interest income and by loan loss provisions that are still particularly low. In the first nine months of 2022, return on equity (ROE) rose by 0.7 percentage points year-on-year, reaching 8.7 per cent. The common equity tier 1 capital (CET1) ratio, which fell by around half a percentage point to 14.6 per cent, continues to be higher than pre-pandemic levels and is only marginally lower than the EU average. The more dramatic decline experienced by the significant banks is mainly due to the extraordinary distributions of earnings made by the major banks. Given that the lending rates have risen at a faster pace, the higher market yields benefit those banks with a traditional business model, whose profits have been squeezed by low net interest income in recent years. In 2022, the spread between the interest rates applied by banks on new loans to households and firms and the marginal cost of funding widened by almost 1 percentage point to 2.2 per cent. Along with the growth in lending, this contributed to the significant increase of almost 12 per cent in net interest income recorded in the first three quarters of 2022. Based on historical patterns, revenues generated by traditional banking activities should continue to grow in the years to come. Inflation lessens the real value of debt, reducing the probability of default by borrowers with fixed-rate loans and whose revenues do not suffer significantly from the increase in prices. Far and away the largest portion of firms' debt, however, is variable rate and 5/11 BIS - Central bankers' speeches some sectors are especially vulnerable to rising energy prices. Looking ahead, we therefore cannot rule out an increase – perhaps even a significant one – in loan loss provisions: according to analyses conducted consistent with the Bank of Italy's baseline macroeconomic scenario, they could increase, from under half a percentage point to almost one point of total loans this year and the next. This is still only half of the peak reached in the two years 2013-14 as a result of the sovereign debt crisis, a level which was even higher than that projected in an adverse scenario. This year and the next, the profitability of banks should nevertheless remain positive for intermediaries as a whole, even though the number of those reporting losses could increase, a situation that we will be following closely. These signs are consistent with market expectations. Since last summer, coinciding with the beginning of the ECB's rate increases, the main analysts have revised the one-year ahead profitability forecasts upwards for the eight major listed Italian banking groups (which account for more than two thirds of the sector's total assets). According to the most recent data, ROE is forecast to be close to 8 per cent on average this year and the next; three banking groups are expected to report a profitability close to or above 9 per cent and none should end the year with a loss. Beyond having an effect on income statements, the rising interest rates have also had a direct impact on banks' supervisory capital, reflecting the drop in the prices of sovereign and non-sovereign bonds, valued at market prices. An upward shift of 150 basis points in the yield curve against end-year levels would cause the CET1 ratio to fall by around 80 basis points. Given that this estimate does not incorporate any risk mitigation strategies drawn up by banks, for example by using hedge derivatives, the effect on the capital ratios would thus be manageable. The growth in net interest income might be lower than expected if the higher market rates pass through to the rates on banks' liabilities more rapidly than they did in the past. Moreover, the cost of funding may be affected by a rebalancing towards relatively costlier instruments, such as time deposits or bonds. As early as last summer, sight deposits by households and firms started to decline, in line with depositors' attempts to protect the purchasing power of their savings, though we have not yet seen a significant rise in the returns offered by banks on this form of funding. Going forward, the rebalancing of banks' liabilities may also be influenced by their need to issue new bonds to replace, at least in part, the funding obtained in the past through the ECB's TLTROs and to comply with the minimum requirement for own funds and eligible liabilities (MREL). Finally, if the cyclical conditions turn out to be worse than expected, this would affect credit quality, leading to a higher share of loan losses. Against the backdrop of these risks, the Bank of Italy is conducting ad hoc studies focusing on issues such as credit, liquidity and refinancing. We are continuing to assess the quality of the loans that benefited from the support measures adopted during the pandemic. So far, the non-performing loan rate for the credit benefiting from the state guarantees has remained low, notwithstanding the fact that for most of such credit the principal grace period, i.e. the stage where only interest payments were to be made, has already elapsed. Special attention is also being devoted to the intermediaries most exposed to the firms that are being hit hardest by the rise in energy costs. At the moment, it does not appear necessary to re-enact wide-ranging support measures of the kind conceived to tackle the pandemic crisis. Any loan renegotiations may be 6/11 BIS - Central bankers' speeches granted on a voluntary basis by the intermediaries following a case-by-case assessment. Last summer we conducted an ad hoc survey on banks' refinancing plans, also in light of the forthcoming TLTRO maturity dates. The survey found that Italian banks intend to repay these sums by drawing in part on their excess reserves with the Eurosystem and on the sale of liquid assets; just over half would be replaced with alternative sources of funding, most of which obtained on the market or through deposits. A new survey to be carried out soon will ask the banks to update their plans in light of the changed market conditions and the decisions adopted in October by the ECB's Governing Council on the cost of longer-term refinancing operations. The replacement of the latter will also benefit from the forthcoming roll-out of the new EU legislation on covered bank bonds, for which we have recently begun the consultation process. The new rules lay the foundation for the establishment of a single market for these liabilities, thereby broadening the pool of potential buyers. The Bank of Italy will authorize the issuance plans following an assessments of banks' capacity to ensure their orderly implementation based on sound and prudent management criteria and an adequate level of protection for investors. Finally, the Supervisory Review and Evaluation Process (SREP) for the less significant institutions (LSIs) that we supervise directly is nearing completion. Through it, we will set the Pillar 2 capital requirements with which each bank must comply this year. Also owing to the exceptional uncertainty marking the short-term outlook, the requirements will be set at a higher level than in the past, almost completely closing the gap with significant banks that has existed so far. Investment funds and the markets While it squeezed the profitability of Italian investment funds, the significant adjustment in financial asset prices that took place in the asset management sector following the outbreak of the war and the rise in interest rates was absorbed in an orderly manner, without unleashing sizeable disinvestments. Net inflows held stable, while they decreased in the rest of Europe. Consistent with the rise in interest rates, there were outflows from the bond fund segment, offset by an increase in investments in equity funds. The outlook for fund flows, and hence for the fees that banks charge in exchange for distributing investment products, is uncertain. On the one hand, investment funds' business might be buoyed by investors' appetite for higher returns to at least partly offset the impact of inflation. On the other hand, the ongoing risk of further, sudden adjustments in financial asset prices encourages investment in safer instruments which, given the changed market conditions, do nevertheless offer satisfactory returns. The outflows from bank deposits that I mentioned earlier have been therefore accompanied by sizeable investments in government securities on the part of households. Higher rates and the cyclical slowdown also increase liquidity, market and credit risks for these intermediaries. However, Italian open-end funds are generally in a position to cope with them. Leverage is low, the duration of assets under management is short and 7/11 BIS - Central bankers' speeches the degree of liquidity (defined as the ratio of current account holdings to equity) is high by historical standards. The share of high-yield bonds, which are more vulnerable than higher-rated bonds, has also declined in recent months. In the asset management segment, corporate governance aspects (such as strategic planning capacity and the adequacy of internal controls) are particularly important for sound and prudent management. For this reason, we are placing special emphasis on these aspects in the SREP that we are conducting on asset management firms. We will further fine-tune our methodologies next year to better assess the risks arising from the outsourcing of critical functions and technological innovation. Assets managed by alternative funds - those investing in real estate, unlisted companies or loans - have continued to increase; at over €100 billion, they now account for almost one third of the total assets of Italian investment funds. Growth in this sector may allow firms to broaden their sources of financing and enable investors to diversify their portfolios. Owing to particularly tight national regulations, alternative funds are typically closed, which helps to mitigate liquidity risk. However, they are more leveraged, which amplifies their interconnections with the rest of the financial system. Specifically, real estate investment funds have a relatively high level of debt, mainly visà-vis banks, which makes them potentially a greater source of contagion compared with other funds. Also in light of the strong growth in the assets managed by these funds, driven by those investing in commercial property, we are conducting ad hoc analyses, the results of which will help us better assess the risks to the stability of individual intermediaries and to the system as a whole. The long-standing uncertainty surrounding global geopolitical and economic developments has been reflected in financial markets, which have recorded heavy losses. Tensions in Europe are also affected by the relatively limited depth of some market segments, especially when compared with those in the United States, as well as by continued high fragmentation along national borders, above all in retail activities. The legislative proposals on corporate insolvency law, on listing – especially for small and medium-sized enterprises – on regulated markets and on reducing reliance on thirdcountry central clearing counterparties, submitted by the European Commission at the end of last year as part of the Capital Markets Union initiatives, are all steps in the right direction. We must move forward along this path, promoting the development of markets, fostering integration and further diversifying the sources of financing for the European economy, thereby strengthening its capacity to respond to adverse shocks. Last year, heightened volatility and the resulting tensions hit the crypto-asset markets particularly hard. The global capitalization of these assets fell sharply from around $2.4 trillion to $800 billion. Both a widespread reduction in the exposure of institutional investors to these highly risky instruments and the bankruptcies of some major market participants, in turn due to serious shortcomings in risk management processes and fraudulent conduct, contributed to this contraction. The collapse of the crypto-asset market, while leading to significant losses for some investors, has not had systemic consequences due to its limited interconnections with traditional financial intermediaries, the payments system and the real economy. Our 8/11 BIS - Central bankers' speeches surveys show that only a small share of households in Italy, estimated at around 2 per cent, hold these instruments, with modest amounts on average. The exposure of Italian intermediaries to these markets is also very limited. As I have already pointed out in the past, the risks associated with the very high volatility in the crypto-asset markets highlight the need for an appropriate set of rules and checks to prevent this sector from developing uncontrollably. Specifically, a distinction should be made between highly risky instruments and services that divert resources from productive activities and collective well-being, such as crypto-assets with no intrinsic value, and those that can bring tangible benefits to the economy, such as reducing the costs of cross-border payments and making the financial system more efficient. The spread of the latter can be fostered by developing rules and controls similar to those already enforced in the traditional financial system; the former, instead, must be strongly discouraged. The Bank of Italy is focusing on the need to identify areas in which new distributed ledger technologies (DLTs) can contribute to the overall stability of the financial system and to customer protection. In our Communication of June 2022, we reminded banks of the opportunities and risks associated with the use of these technologies and of cryptoassets, encouraging them to implement measures to mitigate these risks. Last November, we published Milano Hub's second call for proposals on the application of DLTs to banking, financial, insurance and payment services. This project aims to disseminate best practices among market participants in order to promote, above all else, the reliability of DLT governance, the robustness of settlement mechanisms and of internal risk management controls, and the technical and legal certainty and security of operations. The call was closed a few days ago: 81 participants, with several applications from other European countries and Southeast Asia, submitted 56 projects, which are currently being evaluated. We are also working on developing technological solutions and defining a comprehensive framework of standards at European and global level to facilitate the safe use of DLTs and their applications. We have devised a 'trigger' solution that allows the use of central bank money for settling trades in securities on DLT-based platforms. In close contact with CONSOB and the Ministry of Economy and Finance, we have also begun the processes for the authorization and supervision activities envisaged in the Markets in Crypto-Assets Regulation (MiCAR) and the pilot regulation for market infrastructures based on DLTs. At global level, we have contributed to setting the standards for the prudential treatment of bank exposures in crypto-assets published by the Basel Committee last December. Within the Financial Stability Board, we are participating both in developing the general recommendations for these markets and in updating the recommendations for global stablecoins, which will be published in mid2023. Technological innovation, in addition to the risks arising from the creation of new financial instruments, increases the exposure of financial institutions and market infrastructures to cyber risks. The extensive use of outsourcing of IT services and the high concentration of this market led to an increase in the number of banks subject to cyber attacks in 2022 compared with the previous year, although the number of individual events declined. Supervisory action to mitigate the interconnection risks caused by outsourcing services to external providers, which has already been 9/11 BIS - Central bankers' speeches strengthened in the last few years, could have additional tools at its disposal thanks to the recent adoption of the new European Digital Operational Resilience Act (DORA). More generally, the action of the Bank of Italy and the other competent authorities is aimed at making advanced cyber risk self-assessment tools available to financial intermediaries and market infrastructure managers. To this end, CONSOB, IVASS and the Bank of Italy have recently implemented the European TIBER-EU model, developed by the Eurosystem, adopting the Guida TIBER-IT for their respective areas of competence. This guide provides a methodology that can be adopted on a voluntary basis by financial entities to verify and enhance their own capabilities in terms of protection against, detection of and response to cyber attacks. The three authorities provide support to those that decide to undergo the test and verify their compliance with the requirements of the national framework and, if necessary, carry out activities to ensure mutual recognition in other European jurisdictions. *** The Russian invasion of Ukraine has forced us to tackle a very difficult cyclical phase, characterized by extremely high uncertainty. In the euro area, the high level of inflation is hitting households hard, especially those who are less well-off, which spend a large part of their income on food and energy; it is also a heavy burden on firms, which are witnessing the erosion of their competitiveness. Also as a result of these developments, the growth outlook for the euro area has deteriorated. At this time, the task of the central bank is particularly delicate. The decisions of the ECB Governing Council implemented since the end of 2021 have been intended to counter the danger of high inflation influencing expectations and triggering a wage-price spiral. Action will have to continue to strike the right balance between the risk of doing too little, leaving inflation high for too long and thus affecting expectations and monetary stability, and of doing too much, leading to a fall in income and employment and undermining financial stability, with repercussions for price dynamics that are no less serious. Balancing these two risks, the Governing Council decided the day before yesterday to raise its key interest rates by 50 basis points, announcing that it would raise them by the same amount in March and would assess the pace of any further rises at a later date. It confirmed that future decisions on interest rates will continue to be adopted based on new evidence relevant to the prospects for inflation. The burden of dealing with the many consequences of this crisis cannot, as has often happened in the past, fall on monetary policy alone. Forty years ago, in his Concluding Remarks for 1981, Governor Ciampi reminded us that 'monetary stability is a shared responsibility, a good that is never definitively acquired'. It was true then for Italy, and it is true today for the euro area: at a time of high uncertainty, the choices of all stakeholders – European authorities, national governments and representatives of workers and employers – must complement one another, taking account of the contribution that their individual actions make to the final outcome. In Italy, fiscal policy can continue to mitigate the effects of higher energy prices by redistributing resources, through targeted and temporary measures, in favour of the 10/11 BIS - Central bankers' speeches worst hit households and firms. On the other hand, it is necessary to avoid repeated deferrals in the process of fiscal consolidation, which would increase the burden on future generations, which are already weighed down by the very high public debt. Prudence and a sense of responsibility in the management of the public finances should be accompanied by resolve and effectiveness in delivering the investments and reforms included in the National Recovery and Resilience Plan, making full use of the resources of the Next Generation EU programme. The success of the green and digital transition underpinning this Plan may produce a double dividend in terms of higher economic growth and lower yield spreads between Italian government bonds and those of other major European countries, which will make it less difficult to reduce the debt-toGDP ratio. However, lasting and balanced growth cannot be achieved without the efficient allocation of resources and the provision of increasingly better services to firms and households, that is to the real economy, for which the support of banks and financial markets is, and will continue to be, fundamental. 11/11 BIS - Central bankers' speeches
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Text of the Bishnodat Persaud Lecture by Mr Ignazio Visco, Governor of the Bank of Italy, at the Warwick Economics Summit 2023, University of Warwick, Coventry, 11 February 2023.
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Monetary policy and the return of inflation* Ignazio Visco Governor of the Bank of Italy The Warwick Economics Summit 2023 Bishnodat Persaud Lecture Coventry, United Kingdom, 11 February 2023 Introduction and some history Inflation is back. After at least three decades of moderate-to-very moderate consumer price changes in advanced economies, inflation has returned to levels that are severely affecting the lives of households and firms, their decisions to consume and to save, to work and to invest. Last year, average inflation for the world economy was almost 9 per cent, more than 7 per cent in advanced countries and almost 10 per cent in emerging and developing economies. During the year it peaked at between 9 and 11 per cent in the United States, the euro area and the United Kingdom, well above the targets of central banks (fig. 1). In this lecture, I will mainly consider the recent developments of inflation in the euro area and the monetary policy response that has been taking place since the autumn of 2021. The high inflation that we are observing is by no means a new phenomenon, although perhaps one that had been increasingly considered a phenomenon of the past. Indeed, even higher inflation peaks were recorded in many advanced economies in the 1970s and the early 1980s. A close look at the dynamics of inflation since 1970 suggests a possible periodisation for the last 50 years. The years of high inflation. The 1970s and 1980s were characterised by two oil shocks, which pushed consumer price inflation above 20 per cent in countries like the United Kingdom and Italy, and to 15 per cent in the United States. To make things worse, following the spikes due to higher oil prices (initially linked to the Yom Kippur war in 1973 and subsequently as a result of the Iranian revolution in 1979), and notwithstanding some key differences in its manifestation across countries, inflation turned out to be very persistent. In Italy and the United Kingdom, for example, high inflation lasted until the counter-shock of 1986;1 in the United States, consumer price growth remained above * I wish to thank the organisers of the Warwick Economics Summit 2023 for their invitation and for setting up an impressive programme and Avinash Persaud who kindly asked me to deliver the Bishnodat Persaud Lecture. I am also grateful to Pietro Rizza, Massimo Sbracia and Alessandro Secchi for their contributions and suggestions. In 1986, when Saudi Arabia decided to increase production to raise its market share, oil prices collapsed returning to their 1974 values (1973 when adjusted for the changes in the US general price level). 5 per cent until what became to be known as the “Volcker disinflation” brought it back under control, by means of a very restrictive monetary policy that caused a double-dip recession in 1981-83 and a large surge in unemployment. Where inflation lasted longest, multiple factors caused it to persist, including high wage growth, often spurred by explicit or implicit indexation mechanisms, which gave rise to wage-price spirals; strongly expansionary fiscal policies, in many cases already taking place before the two shocks had occurred; the scarce attention paid to (the anchoring of) inflation expectations; and the lack of independence of central banks.2 The Great Moderation. In the 1990s and until the Global Financial Crisis of 2007-08 the picture changed substantially. In advanced countries, the lessons learned in previous years led to an increased autonomy granted to central banks and to closer attention paid to inflation expectations and wage dynamics within the framework of (flexible) inflation targeting.3 Even more importantly, globalisation and the strong progress in information and communication technologies (the “ICT revolution”) favoured a solid economic expansion in a low inflation environment. Economic growth was, of course, not always high,4 not all countries managed to take full advantage of these changes,5 and, most importantly, benefits were not equally shared among households, with many left behind without adequate safety nets; yet, inflation overall was moderate (hence the label of “Great Moderation” usually given to these years). The Great Recession and its legacy. From 2008 to 2019, first the global financial crisis and then the euro area sovereign debt crisis triggered strong financial and economic turbulence and intense disinflationary pressures. Negative inflation rates were observed, for the first time in many years, both in the United States and in the euro area. The decline in real interest rates seemed unstoppable and many observers put forward the possibility of a new phase of secular stagnation.6 Central banks responded by implementing a series of non-standard monetary measures, the most well-known being quantitative easing (QE), that is the massive purchase of securities in the open market to maintain favourable financing conditions across the whole term structure of nominal interest rates and spur economic activity, countering the risks of deflation. The return of inflation. The last three years have seen the arrival of a new shock and the return of an older one. In early 2020, the outbreak and spread of the Covid-19 pandemic shook the world economy. Many countries recorded a sharp and sudden collapse of GDP and employment, as a consequence of both the unprecedented implementation of “lockdown measures” to contain infections and the deep surge in uncertainty that For a recent and detailed description of those years as well as of the following periods see Bernanke (2022) and the references cited therein. See, among many others, Leiderman and Svensson (1995) and Bean (2003). In Europe, for example, a series of difficulties, including the legacies of the high inflation period and the consequences of the reunification of Germany, led to the 1992-93 crisis of the European Monetary System and to a deep recession in the most affected countries. Germany and Italy, among others, lagged behind in terms of growth of both productivity and GDP, even if the former was able to engineer a strong comeback just before the start of the global financial crisis. During those years the debate was initiated by Summers (2013, 2014), who resurrected and adapted the theory of secular stagnation first put forward by Hansen (1938). For a thorough discussion see also Pagano and Sbracia (2018). affected households’ and businesses’ saving and investment decisions. The response of economic policies was equally swift and extraordinary, aimed at strengthening health systems and supporting households and businesses. When the pandemic waves seemed to become less critical, in part thanks to the success of vaccination campaigns, during 2021 energy prices started to increase. They began accelerating mid-year, reaching extremely high levels for natural gas in Europe, where it was mostly imported from Russia. This phenomenon gained in intensity and persistence with Russia’s invasion of Ukraine, and called for an acceleration in the process of monetary policy normalisation. Different sources of inflation Even though inflation is currently affecting many economies in an apparently similar manner, its underlying sources are different across countries, especially so if we compare the euro area and the United States. First, while fiscal policies were expansionary everywhere during the acute phase of the pandemic, measures in the United States were especially bold: the public debt-to-GDP ratio rose by 25 percentage points in 2020-21, to over 130 per cent. In the euro area, instead, the increase was limited to 15 percentage points, to slightly less than 100 per cent, despite a much deeper decline of nominal GDP in 2020 (by 4.8 per cent, against 2.2) and a slower recovery in 2021 (7.5 versus 10.1 per cent). The exceptional support provided to US households is particularly evident when comparing the dynamics of GDP and disposable income (fig. 2): in 2020, just as the former recorded its sharpest collapse in real terms in the entire post-World War II period (-3.4 per cent), real disposable personal income grew by over 6 per cent, its largest rise since the mid-1980s. In the euro area, instead, household real disposable income declined, even though by a smaller extent than GDP (-0.6 versus -6.4 per cent). Second, the different dynamics of household disposable income across the two economic areas translated into very diverse effects on demand. In the US, GDP returned to its pre‑crisis trend at the end of 2021, but aggregate data hid an elevated degree of heterogeneity between sectors: while demand in the service sector was restrained by pandemic-related factors, the goods sector increasingly showed signs of overheating (fig. 3). In the spring of 2021, for example, personal consumption expenditure in the durable goods sector was already more than 30 per cent higher than its pre-crisis level. The fast recovery in US demand, in a phase in which supply elsewhere was still constrained due to the pandemic waves, caused bottlenecks in the global value chains to drove up the prices of intermediate goods everywhere. In the euro area, demand for both goods and services remained below pre-pandemic trends up until the end of 2021. Third, the labour market appears to be much tighter in the United States than in the euro area. The US unemployment rate still stands at just 3.4 per cent, a value last seen only in the late 1960s and about half the level of the euro area (6.6 per cent). More importantly, the difference between the number of vacancies in the US non-farm sector and the number of people who are unemployed is, today, over 5 million, i.e. there are many more jobs available than there are people looking for them, while in the euro area the opposite is true, with the number of unemployed exceeding the number of job vacancies by about 6 million. Unsurprisingly, the annual change of US nominal wages (measured by the employment cost index) surpassed 4 per cent as early as in the third quarter of 2021, approached 6 per cent in 2022, and today still stands above 5 per cent, a level that is difficult to reconcile with an inflation target of 2 per cent (fig. 4). In the euro area, on the other hand, in spite of current requests for sizeable wage increases in some countries, wage growth has so far remained moderate, around 3 per cent, and there are no clear signs of a wage-price spiral as a whole. Fourth, the energy shock had a very different role on both sides of the Atlantic. Since the second half of 2020, oil prices rose gradually in both the United States and the euro area.7 The price of the natural gas delivered in the United States increased much more sharply, rising from around $10 per megawatt hour before the pandemic to a peak of over $30 last summer, before sliding back below $10 (fig. 5). However, it was the price of the natural gas delivered in Europe that recorded the most extraordinary dynamics, dwarfing even the 1973 oil price increase (which itself had increased four-fold): from slightly above €10 per megawatt hour in early 2020, it rocketed to €180 before the war, soaring to a peak of €350 last summer and then stabilising at around €60 over the past few weeks. A further major problem then emerged, i.e. the extreme volatility of gas prices, the result of a “bullwhip effect”, which is the response of demand to uncertain supply, consisting of ordering more, ordering earlier and replenishing gas stocks. As a result of these dynamics, US consumer price inflation increased from below 2 per cent in February 2021 to a peak of over 9 per cent last June (fig. 6). Core inflation (i.e. net of energy and food products) took the lion’s share of this increase, peaking at almost 7 per cent last year. In the euro area, on the other hand, the increase in the price of food (another consequence of the war in Ukraine) and energy was responsible for the largest share of the rise in headline inflation, with energy costs increasing by about 40 per cent since last spring. Considering the combination of direct and indirect effects, in 2022 about 60 per cent of headline inflation was attributable to higher energy prices. However, when discussing the high level of headline inflation reached within the euro area, some commentators have paid less attention to the size and persistence of the energy shock, instead pointing the finger at the supposed delays of the central bank in exiting from QE and initiating monetary tightening.8 Critics of this hypothetical mistake have also highlighted the errors in the inflation projections made by the ECB/Eurosystem staff in 2022 (fig. 7). The forecast errors in predicting consumer price changes during last year were indeed sizeable and much larger than those observed in the past.9 Some have even argued that these large errors call into question the very credibility of the ECB, although other international institutions and private forecasters have made similarly large mistakes. From pre-pandemic levels around $60 per barrel, oil prices in the US and the euro area, as measured by the prices, respectively, of the blends West Texas Intermediate and Brent rose at similar rates to over $80 in October 2021, peaked at above $120 in early 2022 and have returned since late last year to around $80. An important example, which focuses not only on the ECB but especially on the Federal Reserve, is Reis (2022). For the projections one-quarter (four-quarters) ahead, the forecast errors made in 2022 were, on average, five (seven) times higher than the standard deviation of previous forecast errors. While the observed size of the errors may understandably cast doubt on the reliability of the models used for the projections, our analyses for Italy indicate that the effects of energy prices – the most important exogenous variables in the forecasting model, whose changes are usually inferred from the market price of futures contracts – explain, directly and indirectly (i.e. via their effects on production costs), 70 per cent of the overall error made in forecasting inflation in 2022.10 This share rises to 80 per cent when the effects of food prices, the other volatile component of the consumer price index, are also taken into account. Critics also forget that, in June 2021, the euro area headline inflation was still below 2 per cent and the core inflation below 1 per cent: therefore, at the time, the ECB Governing Council was still concentrating on how to increase inflation durably, in the wake of its successful battle against deflation. These results suggest that, although all models should be (and are) subject to continuous checks and improvements, the functioning of the economy has not changed dramatically over the last year. They do draw our attention, however, to the quality of the forecasts used as inputs. Undoubtedly the effects of supply bottlenecks, although much less significant than in the United States, were underestimated. The key problem, however, has been the generalised underestimation of the recent geopolitical tensions. The sharp drop in gas supplies from Russia observed since early 2021 was in fact (probably mistakenly) attributed at first to the effects of a particularly cold winter in Russia and subsequently to the political pressure from the Russian government to accelerate the opening of the Nord Stream 2 gas pipeline. As a consequence, up until the end of 2021, futures quotations had continued to factor in declining gas prices for the months following the 2021-22 winter. The Russian invasion of Ukraine a year ago has, instead, dramatically changed this picture, triggering a sharp rise in volatility and pushing both current and expected gas prices to the extremely high levels that I have just described. Monetary policy in the euro area As inflation had started to show worrying signals, at the end of 2021 the ECB Governing Council began the process of monetary normalisation, announcing the reduction of net purchases under its quantitative easing programmes. In the early part of last year, the process gained speed, avoiding, however, the potentially dangerous cliff-effects of too sharp a drop, not least in view of the major uncertainty caused by the Russian invasion of Ukraine. It was completed on the 1st of July. A few weeks later, we started raising the key official interest rates by a significant size, with the aim of frontloading the exit from their highly accommodative, indeed still negative, levels. Important steps forward have already been taken. Following last week’s monetary policy decision, the overall increase of official rates since July has reached 300 basis points and has been fully transmitted to market interest rates. Since the start of the reduction of monetary accommodation, one-year risk-free rates (measured by overnight index swaps) Focusing on the projections formulated, for 2022, by the Bank of Italy staff in December 2021, the energy component of the harmonized consumer price index (net of the impact of exchange rates) accounts directly for about 60 per cent of the error; the indirect effect, computed by simulating the response of the non‑energy component to the observed variation of the energy component, explains another 10 per cent of the error. have picked up from negative levels to 3.4 per cent, while ten-year rates have increased from barely positive values to 2.7 per cent. In real terms, using the inflation-linked swap (ILS) as a deflator, interest rates currently stand at about 0.9 and 0.3 per cent respectively, from around -4 and -2 per cent at the end of 2021 (fig. 8). Another look at the role of supply and demand factors and a first measure of the effects of monetary tightening can be obtained through a quantification of the structural drivers of euro area and US inflation expectations, as measured by ILSs, obtained by breaking down their daily fluctuations into domestic and global shocks (fig. 9).11 Leaving the technicalities aside, results show that, since the start of the war in Ukraine, inflation expectations (5-year ILS) in the euro area increased mostly in response to supply shocks; the much smaller contribution of demand shocks rose progressively over the course of 2022, reflecting improved business cycle conditions. Results also document strong spillover effects of US monetary policy on euro area inflation expectations since the second half of 2022 and initial signs that the ECB’s monetary policy tightening is having the desired soothing effects on the economy. In the United States, on the other hand, inflation expectations had been steadily sustained by domestic demand until the end of last October, and have since been reined in by contractionary monetary policy effects. Other preliminary signs of the success of the ECB monetary strategy can be found by looking at headline inflation, which came down from its peak of 10.6 per cent in October 2022 to 8.5 per cent in January 2023, although the core component has remained steady at 5.2 per cent, owing to the usual lags in the pass-through of increased energy prices. On a 3-month annualised basis, which offers the most faithful representation of the impulses that have been predominantly driving inflation recently, the deceleration of prices has been even more marked (fig. 10). Given the previous historical excursus, and despite the current encouraging signs around the inflation situation, we may wonder whether the euro area will experience the long persistence of inflation observed in many countries during the 1970s. I believe that this is very unlikely, not only because of substantial improvements in monetary policymaking, but also and above all because of the numerous structural changes that have taken place in our economies since then. First, the euro area today is well integrated into a global economic system which certainly has a greater capacity to absorb inflationary shocks through positive technological spill‑overs and improved import competition. Second, in the 1970s, the oil shocks were preceded and followed by a substantial instability of exchange rates that, for countries like Italy and the United Kingdom, caused large rises in imported inflation. In the euro area today, however, this is much more limited by the increased stability of the common currency. Hoynck and Rossi (2023), in particular, decompose the fluctuations of index-linked swaps for both the euro area and the United States by means of a Bayesian VAR model disentangling the effects of seven shocks: supply, demand and monetary policy shocks in the two economies and a global risk shock. Key changes have also taken place in product and labour markets. In most countries, such as Italy, following the negative experience of the wage-price spirals of the 1970s and 1980s, automatic indexation to previous price changes has been completely superseded. For the euro area as a whole, the share of wages and salaries directly linked to inflation is low, mitigating the risk of a sharp acceleration. The framework within which monetary policy is conducted today has also changed dramatically. Indeed, the ECB has a firm mandate to preserve price stability and acts accordingly. Monetary policy is transparent in its objectives and is credible, as is also shown by the resilience of inflation expectations. The context in which fiscal policies operate has also changed and nowadays, it would be unthinkable to maintain excessive and prolonged fiscal deficit as it occurred, for example, in Italy during the 1970s and 1980s. Money and prices, wages, expectations and catching-up After 25 years of low and stable inflation, many observers have questioned the connection between money and prices as well as that between inflation and real economic activity.12 This includes attempts to protect labour incomes and accumulated savings from the loss in purchasing power generated by the energy shock, giving rise to “second-round” effects. On the first issue, the persistence of low inflation during the 2010s, despite the extensive liquidity created by central banks, may seem at odds with Milton Friedman’s famous quote that “inflation is always and everywhere a monetary phenomenon”. Indeed, “too much money chasing too few goods” did not result in too much inflation during those years.13 Clearly, it must be acknowledged that Friedman’s words, besides being a statement on the long-run neutrality of money, can be interpreted either as an innocuous truism or as a causal relation between money supply and the level of prices that may hold, albeit with variable lags, on horizons that are not necessarily long. Some say that the breadth and persistence of the inflationary consequences of the energy shock may have found fertile ground in the abundant liquidity created before and after the pandemic. According to this view, this may have resulted in a fully-fledged cumulative increase in the general level of prices, spurring persistent inflation, rather than being limited to a change of relative prices. In any case, the crucial point is what will happen next. I see no compelling reasons for inflation not to return to target, notwithstanding the still abundant (and excessive) liquidity present in the economic system. The latter will be gradually reduced through the actions of monetary policy. At the same time, it will be crucial to consider how society at large will react to the shocks that have materialised in the last two to three years. A notable example is King (2022). The issue has been widely investigated in recent times. Among others, Borio, Hofmann and Zakrajšek (2023) find that the strength of the link between money growth and inflation depends on the inflation regime and, namely, it is one‑to-one when inflation is high, while virtually non-existent when it is low. In a similar vein, in Cadamuro and Papadia (2021) monetary aggregates are only relevant for inflation in unsettled monetary and inflationary conditions. With respect to the second issue, let us remember that the debate on the flattening of the Phillips curve is in full swing. There is some evidence of a significant reduction in the slope of the curve compared with estimates relating to the second half of the last century, although not to levels that would result in a complete disconnect.14 The drop in the slope might be linked to the structural changes discussed above, and especially to the wage bargaining process and to the pricing behaviour of firms in globally integrated markets.15 Whatever the underlying reason, if the unemployment and the output gaps have a smaller effect on inflation, preserving price stability may have to hinge strongly on maintaining well-anchored inflation expectations. Following a supply shock, in particular, expectations that remain firmly anchored to the inflation target may succeed in containing wage growth, helping to bring inflation back to the central bank target, with a limited impact on economic activity. However, we may observe that, after a substantial hit to their purchasing power, such as the one generated by the extreme hike in energy prices, wage earners may first attempt to catch up with the increase in the overall consumer price level. This would reflect both the direct and the indirect effects of the energy shock, the former on the cost of energy‑related goods and services purchased by households, the second resulting from the pass-through of higher energy costs, first to the producer and then to the retail prices of other goods and services in the consumer price basket. In such a situation, the organisation and results of the bargaining process between labour and firms will clearly be crucial. In several countries in the 1970s and 1980s, formal and de facto mechanisms of price indexation were at work. This helped to propagate inflation shocks over time, calling for very restrictive monetary policy measures. As I was, at the time, involved in econometric modelling at the Bank of Italy, paying special attention to the effects of price indexation and inflation expectations, I would just like to recall the main results of our investigations. Basically, changes in unemployment appeared to have a significant, even if not exceptional, impact on nominal wages, though a permanent trade-off between unemployment and wage inflation was ruled out by the data. Expected inflation only influenced wage changes in the short term, but wages caught up quite rapidly with respect to previous errors in anticipating inflation. Eventually, all that mattered were past actual price changes. As this took place with rather short lags and with producer prices marking up on unit labour costs – while reflecting the pass-through of the increase in the prices of imported production inputs due to negative supply shocks and exchange rate depreciations – a prolonged wage-price spiral was a rather obvious consequence, calling for a strong and, at times intricate, monetary policy reaction.16 See, for example, Blanchard, Cerutti and Summers (2015), Blanchard (2016), Hazell et al. (2022) and Leduc and Wilson (2017). See, among others, Del Negro et al. (2020) and Ratner and Sim (2022). For the case of Italy, some recent empirical studies points to either increased strategic complementarity in price setting, due in turn to higher sensitivity of demand elasticity to prices (Riggi and Santoro, 2015) or to the weakening of workers’ bargaining power (Lombardi, Riggi and Viviano, 2021) as key factors behind the flattening of the Phillips curve. See, Visco (1984) and Gressani, Guiso and Visco (1988). The many changes that took place after those years of high inflation included a general withdrawal of formal indexation mechanisms. In the bargaining process, more attention was possibly paid to the links between real wages and productivity, while nominal wages, rather than looking at past inflation, tended to be evaluated in terms of new, much more moderate, inflation trends. This led to the consideration that, in order to maintain this moderation, it would be crucial to keep short-to-medium term inflation expectations under check. The firm anchoring of longer-term expectations was a clear indicator of the credibility of monetary policy in achieving this goal. The situation that we are currently in is consistent with this picture. In the euro area, short-term inflation expectations derived from financial market prices are falling sharply. Inflation-linked swap rates indicate that the expected inflation rate twelve months ahead is 2.4 per cent (fig. 11). At the same time, the initial signs of a decline in inflation expectations are confirmed overall by the surveys among firms and households. On the other hand, longer-term expectations, net of risk premia, remain at levels consistent with our 2 per cent price stability target, and tail-risks of excessive inflation are gradually dissipating (fig. 12).17 The anchoring of inflation expectations is also supported by the results of the January ECB surveys of analysts. The credibility that the ECB has gained over time has not been lost and is currently paying off. However, we may ask whether this will be enough in light of the substantial losses of purchasing power due to the energy shock, which, as I have said, has been extremely violent in Europe, especially so for the price of the natural gas imported from Russia. In short, the question now is what can be done to avoid a return to the old model of catching up with those losses and propagating them through second round effects and wage-price spirals (though certainly mitigated today by the very limited presence of automatic indexation mechanisms). Monetary tightening in the current environment There is no question that the restriction of the euro area monetary stance must continue to ensure that a temporary increase in inflation caused by a supply shock does not become a more persistent phenomenon sustained by demand factors. There is also high uncertainty, not only over the global economic picture, but especially over geopolitical developments. These have highly significant consequences for the evolution of energy prices, currently back at considerably lower levels than the peaks observed last year (and also much lower than the cap on natural gas prices unilaterally established by the European Union in December). These levels are reflected in the current mood of financial markets and the substantial lowering of short-term inflation expectations. Yet we have seen how volatile gas prices have been and it is still extremely difficult to assess to what extent the dramatic conflict in Ukraine will bear on the euro area economy. Following the ECB Governing Council’s latest decision, the pace of any further rate hike will then continue to be decided on the basis of incoming data and their impact on the inflation outlook. See Neri et al. (2022). It will also remain essential to continue balancing the risk of a too gradual recalibration, which could cause inflation to become entrenched in expectations and in wage‑setting processes, with that of an excessive tightening, which would result in significant repercussions for economic activity, financial stability and, ultimately, medium-term price developments. In line with our symmetrical price stability objective, equal weight should be given to both risks. In particular, I am concerned about statements that seem to give a (much) higher weight to the risk of doing too little. It is true that inflation is still currently above our target, and especially so if we look at various measures of core or underlying inflation, and I do understand that it would come at a cost for the economy if this led to the need for a stronger and more prolonged restriction of monetary policy. However, the costs linked to the risk of doing too much must not be considered less important, as we have learned from the experience in the aftermath of the great financial crisis.18 Nor must we ignore the fact that, if the consequence of doing too much were to be an overshooting below our target, nonlinear amplifications stemming from firms’ balance sheets could start to bite. Today, disinflation is obviously needed, but given the levels of private and public debts that prevail in the euro area, we must be careful to avoid engineering an unnecessary and excessive rise in real interest rates. Indeed, I am convinced that the credibility of our actions is preserved not by flexing our muscles in the face of inflation, but by continually showing wisdom and balance. To this end, careful quantitative evaluations of the risks I just mentioned and their effects is crucially needed. On the same note, I do not believe that a recession is inevitable for reducing inflation. Recent developments in the euro area and in the United States as well as surveys and market expectations are comforting in this perspective, as inflation is predicted to decline rapidly to 2 per cent in the context of a temporary slowdown. Communicating a strong commitment to bringing inflation down to target in a speedy manner is fundamental, but doing so by minimising the costs for the real economy is not any less important. In fact, not only is the ECB required by the Maastricht Treaty to contribute, without prejudice to price stability, to the achievement of the wider objectives of the European Union, but also the social consequences of our actions, and the political reactions, including those on the fiscal front that could result in further pressures on public debts, should not be ignored. All this, of course, without any concession to instances of “fiscal dominance”, in the spirit of working independently but maintaining a dialogue with euro-area governments. A cautious approach is also advisable due to a series of considerations. The first is related to the high level of economic uncertainty and the Brainard principle, which states that when the central bank is uncertain about the effects of its actions, it should move conservatively.19 An exception to this principle is in the case of substantial uncertainty around the persistence of inflation. More recent studies, in fact, suggest that when persistence is high, a strong monetary reaction may be required,20 so as to avoid high price growth becoming entrenched in agents’ mind-sets. While this possibility should See Rostagno et al. (2021), chapter 4. Brainard (1967). See Ferrero, Pietrunti and Tiseno (2019). be carefully monitored, the most recent data on market- and survey-based inflation expectations – including their fall at short horizons and their further declining profile ‒ may call into question, at least temporarily, the persistence of inflation in the euro area at the current high levels, reinforcing the arguments in favour of gradual monetary normalisation. The second concerns the “long and variable lags” of the monetary transmission process. Credit dynamics are especially relevant in this respect. On a 3-month (annualised) basis, the growth of loans to firms in the euro area was virtually nil in December (0.3 per cent) from an almost double-digit expansion in October (9.8 per cent and 4.5 in November). Although this deceleration is the natural (and desired) consequence of monetary normalisation, both its size and speed require us to be cautious in our decisions on the magnitude and time distribution of interest rate hikes. This observation is all the more relevant when taking into account the fact that credit growth is negative in real terms and that the additional tightening in credit conditions signalled by the Bank Lending Survey may point to a further slowdown in lending dynamics. The potential risks to financial stability also require a good dose of caution. The unprecedented coordinated rises in official rates around the world may create spillover effects that are difficult to quantify but may not be negligible, as I have previously suggested. Financial instability risks are particularly relevant in the Economic and Monetary Union, whose incomplete architecture – especially its decentralised fiscal policy and the delays in completing the banking and the capital markets unions – exposes it to a possible fragmentation of financial markets along national borders. For this reason, the Governing Council will continue to exploit the flexibility in its asset purchase programme related to the pandemic emergency and stands ready to resort to its new Transmission Protection Instrument, to prevent financial markets tensions from counteracting any progress made in price stability and hindering economic growth. Finally, as I have mentioned, in the current uncertain environment, models and forecasts should necessarily be taken cum grano salis, in particular when determining the “terminal” level of key interest rates. This does not mean that quantitative assessments cannot be made; on the contrary, they remain very useful for estimating the effects of rate increases on aggregate demand and changes in the costs and prices of goods and services. However, their insights have to be assessed together with the information that will gradually become available on inflation expectations and on the evolution of labour incomes and profits. Conclusions During the pandemic, central banks’ interventions, as well as fiscal measures, have been crucial in supporting households and businesses and alleviating tensions in financial markets. The size of the interventions may be up for debate, and in hindsight may have been excessive in some economies, or should perhaps have been halted somewhat earlier. However, central banks and fiscal authorities have been key in preventing a temporary crisis from triggering permanent destructions on the supply side as well as creating long‑lasting scars in aggregate demand, under conditions of extreme uncertainty. We are now confronted with a new critical situation and the revival of a character that many thought had left the scene, in the new context of globalised markets, continuous technological progress and independent central banks. Non-negligible inflation is back, a result of both the recovery of final demand having met bottlenecks in supply and of the unprecedented skyrocketing of energy prices, caused by worrying geopolitical developments culminating in the dramatic aggression of Ukraine. The former factor has been especially visible in the US economy; the latter has played a crucial role in Europe, where the dependence on imports of natural gas from Russia was particularly high. Both have resulted in a tightening of monetary policy. In the euro area this has especially intended to counter the likelihood of second-round effects following such a major supply shock. It may still be too early to conclude that there is a tendency for relatively high inflation to become entrenched in wage negotiations and in the formation of individual producer and consumer prices. Indeed, on the whole, inflation expectations seem to have remained well anchored, and central banks stand fully committed to delivering price stability. However, the experience of the 1970s and 1980s suggests that a straightforward achievement of this goal also hinges on firms’ business strategies, responsible agreements on labour costs and prudent fiscal policies on the demand side (but sufficiently supportive of supply conditions). The energy shock has, in fact, caused a change in the terms of trade, a “tax” on the euro area economy that cannot be returned to sender and that cannot be eliminated through what would become a fruitless race between prices and wages, a race to which monetary policy would readily react, nor through excessive and permanent increases in public debt, which would put the burden on the younger and future generations. To make up for the loss of purchasing power, the only solution could be to rely on sustained productivity growth, although targeted and temporary fiscal measures to alleviate the burden on more severely hit households and firms should obviously not be excluded. If the current reduction in headline inflation, reflecting the return of gas prices in Europe to more moderate levels, is followed by a similar, although lagged tendency in underlying inflation, the supply shock will have proved to have been temporary, albeit longer lasting than expected, also as a further negative result of the dramatic events in Ukraine. But this is obviously too early to say. I have argued that the extreme uncertainty we are living through today must inevitably imply, for the time being, a continuing tightening of monetary policy to avoid the possibility of relevant second-round effects reverberating across the euro area. However, this same uncertainty also suggests we move gradually and prudently, with official rates continuing to rise in a progressive but measured way, on the basis of the incoming data and their use in the assessment of the inflation outlook. I also believe that we should be very careful in providing a quantitative evaluation of the effects of preferring one or the other of the two opposite risks of doing too much or too little. It seems to me that there is no reason a priori to prefer erring on the one side or the other. The monetary framework is indeed currently centred around the symmetric target of a 2 per cent headline inflation to be maintained in the medium term. If signs of a wage-price spiral were to appear and inflation expectations were to become insufficiently anchored, further and significant tightening of monetary policy would certainly be justified. I do not think, however, that we should rely solely on monetary policy. The contribution of all policies, including perhaps some new versions of old‑fashioned income policy recipes, could substantially help to prevent demand from overheating and inflation from declining more slowly. There is significant evidence that this worked well in some countries at some crucial stage. In Italy, it came at the end of a long process that began in the early 1980s when Carlo Azeglio Ciampi, then governor of the Bank of Italy, emphatically remarked that “Central banks autonomy, reinforcement of budgetary procedures and a code for collective bargaining are a prerequisite for monetary stability”.21 Ciampi (1981), p. 183. See also Visco (1985). References Bean C. (2003), “Asset Prices, Financial Imbalances and Monetary Policy: Are Inflation Targets Enough?”, BIS Working Papers, No. 140. Bernanke B. (2022), 21st Century Monetary Policy: The Federal Reserve from the Great Inflation to COVID-19, W.W. Norton & Co, New York, NY. Blanchard O. (2016), “The Phillips Curve: Back to the ‘60s?”, American Economic Review, 106, 5, pp. 31-34. Blanchard O., E. Cerutti and L. Summers (2015), “Inflation and Activity: Two Explorations and their Monetary Policy Implications”, IMF working paper, No. 230. Borio C., B. Hofmann and E. Zakrajšek (2023), “Does Money Growth Help Explain the Recent Inflation Surge?”, BIS Bulletin, No. 67. Brainard W.C. (1967), “Uncertainty and the Effectiveness of Policy”, American Economic Review, 57, 2, pp. 411-425. Cadamuro L. and F. Papadia (2021), “Does Money Growth Tell Us Anything about Inflation?”, Bruegel Working Paper, No. 11. Ciampi C.A. (1981), “Final Remarks”, Bank of Italy, Abridged Report, May. Del Negro M., M. Lenza, G.E. Primiceri and A. Tambalotti (2020), “What’s Up with the Phillips curve?”, Brookings Papers on Economic Activity, Spring, pp. 301-357. Ferrero G., M. Pietrunti and A. Tiseno (2019), “Benefits of Gradualism or Costs of Inaction? Monetary Policy in Times of Uncertainty”, Working papers, No. 1205, Bank of Italy, Rome. Friedman M. (1963), “Inflation: Causes and Consequences”, lecture at the Asia Publishing House for the Council for Economic Education, Bombay, 1963; reprinted in Friedman M. (1968), Dollars and Deficits: Inflation, Monetary Policy and the Balance of Payments, Prentice-Hall, Englewood Cliffs, NJ, 1968, pp. 21-46. Gressani D., L. Guiso and I. Visco (1988), “Disinflation in Italy: An Analysis with the Econometric Model of the Bank of Italy”, Journal of Policy Modeling, 10, pp. 163‑203. Hansen A.H. (1938), Full Recovery or Stagnation?, W.W. Norton & Co, New York, NY. Hazell J., J. Herreño, E. Nakamura and J. Steinsson (2022), “The Slope of the Phillips Curve: Evidence from US States”, Quarterly Journal of Economics 37, 3, pp. 1299‑1344. Hoynck C. and L. Rossi (2023), “The Drivers of Market-Based Inflation Expectations in the Euro Area and in the US”, mimeo, Bank of Italy, Rome. King M. (2022), “The Great Repricing: Central Banks and the World Economy”, The Bancor Award Lecture, 24 November. Leduc S. and D.J. Wilson (2017), “Has the Wage Phillips Curve Gone Dormant?” Economic Letter, No. 30, Federal Reserve Bank of San Francisco. Leiderman L. and L.E.O. Svensson, eds., (1995), Inflation Targets, CEPR, London. Lombardi M.J., M. Riggi and E. Viviano (2021), “Bargaining power and the Phillips Curve: A Micro-Macro Analysis”, Working papers, No. 1302, Bank of Italy, Rome. Neri S., G. Bulligan, S. Cecchetti, F. Corsello, A. Papetti, M. Riggi, C. Rondinelli and A. Tagliabracci (2022), “On the anchoring of inflation expectations in the euro area”, Occasional papers, No. 712, Bank of Italy, Rome. Pagano P. and M. Sbracia (2018), “The Productivity Slowdown and the Secular Stagnation Hypothesis”, in: L. Ferrara, I. Hernando, D. Marconi, eds, International Macroeconomics in the Wake of the Global Financial Crisis, Springer (Financial and Monetary Policy Studies), Berlin. Ratner D. and J. Sim (2022), “Who Killed the Phillips Curve? A Murder Mystery”, Finance and Economics Discussion Series, 2022-028, Board of Governors of the Federal Reserve System, Washington. Reis R. (2022), “The Burst of High Inflation in 2021-22: How and Why Did We Get Here?”, Discussion paper, No. 17514, CEPR, London. Riggi M. and S. Santoro (2015), “On the Slope and the Persistence of the Italian Phillips Curve”, International Journal of Central Banking, 11, 2, pp. 157-197. Rostagno M., C. Altavilla, G. Carboni, W. Lemke, R. Motto, A. Saint Guilhem and J. Yiangou (2021), Monetary Policy in Times of Crisis: A Tale of Two Decades of the European Central Bank, Oxford University Press, Oxford, UK. Summers L. (2013), Speech at the IMF Fourteenth Annual Research Conference in Honor of Stanley Fischer, Washington D.C., 8 November. Summers L. (2014), “U.S. Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound”, Business Economics, 49, 2, pp. 65-73. Visco I. (1984), “Inflation Expectations: The Use of Survey Data in the Analysis of their Formation and Effects of Wage Changes”, mimeo, Bank of Italy, Rome; paper presented at the OECD Workshop on Price Dynamics and Economic Policy, 6-7 September. Visco I. (1985), “Inflation, Inflation Targeting and Monetary Policy: Notes for Discussion on the Italian Experience”, in L. Leiderman and L.E.O. Svensson, eds., Inflation Targets, CEPR, London, pp. 142-168. Visco I. (2022), “Monetary Policy and Inflation: Recent Developments”, SUERF Policy Note, No. 291. FIGURES Figure 1 Inflation (monthly data; annual percentage changes) US UK EZ IT Source: Eurostat, Istat, UK Office for National Statistics and US Bureau of Labor Statistics. Note: EZ denotes the euro area (changing composition after 1999 and weighted average of the 11 countries partecipating to the start of Third Stage of the Economic and Monetary Union prior to that date). Figure 2 Disposable income and GDP (annual data; percentage changes) United States euro area -2 -2 -4 -4 -6 -6 disposable income -2 GDP -4 -6 Source: Eurostat and US Bureau of Economic Analysis. GDP -2 disposable income -4 -6 Figure 3 Demand in the goods and services sectors (monthly and quarterly data; indices: Jan. 2020 / 2019 Q4 = 100) Goods sector Services sector United States euro area United States euro area Source: US Bureau of Economic Analysis and estimates based on Eurostat data. Note: dashed lines show pre-pandemic trends. Figure 4 Nominal wage growth (quarterly data; annual percentage changes) United States euro area Source: ECB and US Bureau of Labor Statistics. Figure 5 Natural gas prices (daily data) Europe (euro) United States (dollars) Source: Refinitiv. Note: Title Transfer Facility (TTF) quotations for European gas and Henry Hub for US gas. Figure 6 Headline and core inflation (monthly data; annual percentage changes) United States euro area -2 -2 headline core -2 headline core -2 Source: Eurostat and US Bureau of Labor Statistics. Figure 7 ECB/Eurosystem projections errors for euro area headline inflation (percentage points) 1 quarter ahead projection errors 4 quarters ahead projection errors -2 -2 -2 -2 -4 -4 -4 -4 Source: Bank of Italy and ECB. Note: dashed lines denote an interval around zero of plus/minus two standard deviations of projection errors realized in 2003-2020; latest observation: 2022 Q4. Figure 8 Real interest rates in the euro area (per cent) Term structure, spot rates Term structure, 1-year forward rates -1 -1 -1 -1 -2 -2 -2 -2 -3 -3 -3 -3 -4 -4 end−2021 -5 mid−2022 9 February 2023 -6 -6 1 year 3 year 5 year 7 year 9 year 2 year 4 year 6 year 8 year 10 years -4 -5 -5 -4 end−2021 -5 mid−2022 9 February 2023 -6 -6 spot 2y fwd 4y fwd 6y fwd 8y fwd 1y fwd 3y fwd 5y fwd 7y fwd 9y fwd Source: based on Bloomberg and Refinitiv data. Note: nominal OIS interest rates deflated by the corresponding inflation‑linked swap rates. Figure 9 Drivers of changes in inflation expectations (daily; cumulative percentage changes) euro area United States 1.6 1.4 1.2 0.8 0.6 0.4 0.2 -0.2 -0.4 -0.6 -0.8 -1 -1.2 -1.4 -1.6 -1.8 /0 31 /22 /0 28 /22 /0 28 /22 /0 26 /22 /0 24 /22 /0 5/ 21 22 /0 20 /22 /0 17 /22 /0 14 /22 /0 12 /22 /1 10 /22 /1 08 /22 /1 2/ 05 22 /0 03 /23 /0 2/ /0 31 /22 /0 28 /22 /0 28 /22 /0 26 /22 /0 24 /22 /0 5/ 21 22 /0 20 /22 /0 17 /22 /0 14 /22 /0 12 /22 /1 10 /22 /1 08 /22 /1 2/ 05 22 /0 03 /23 /0 2/ 1.6 1.4 1.2 0.8 0.6 0.4 0.2 -0.2 -0.4 -0.6 -0.8 -1 -1.2 -1.4 -1.6 -1.8 Source: C. Hoynck and L. Rossi (2023), “The Drivers of Market-Based Inflation Expectations in the Euro Area and in the US”, mimeo, Bank of Italy, Rome. Note: 5-year inflation swap rates. Figure 10 Inflation (monthly data; 3-month annualised percentage changes) US UK EZ -5 -5 Source: Eurostat, UK Office for National Statistics and US Bureau of Labor Statistics. Note: EZ denotes the euro area. Figure 11 Market-based inflation expectations in the euro area (daily data; per cent) 1−year 10−year -2 -2 Source: Bloomberg. Note: 1-year and 10-year inflation-linked swap rates. Figure 12 Inflation tail risks in the euro area (daily data; per cent) ∏>3 ∏<1 ∏<0 ∏>4 Source: based on Bloomberg data. Note: probabilities inferred from inflation options; π<0 (π<1) is the probability of inflation being smaller than 0 (1) on average in the next 5 years; π>3 (π>4) is the probability of inflation being larger than 3 (4) on average in the next 5 years; 50-days moving averages.
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the Frankfurt School of Finance & Management, Frankfurt am Main, 1 March 2023.
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Monetary policy and the return of inflation, questions and charts* Ignazio Visco Governor of the Bank of Italy Frankfurt School of Finance & Management Frankfurt, Germany, 1 March 2023 After at least three decades of moderate consumer price changes in advanced countries, inflation has returned to levels that are severely affecting the lives of all citizens (fig. 1). In this note, I will discuss five key issues that often take centre stage in the current macroeconomic debate. The first concerns the nature of the current inflation and its different sources in the two main advanced economies. The second is the claim that, in the euro area, monetary policy reacted too late to the acceleration in consumer prices. The third, closely related to this, focuses on whether or not the ECB made policy mistakes or forecasting errors and, if so, why these occurred. The fourth considers the supposed ineffectiveness of monetary policy and the channels through which it operates. The last issue tackles monetary policy prospects and asks whether, in the fight against inflation, the ECB should prefer to run the risk of doing too much rather than the risk of doing too little. 1. What is the nature of current inflation? What are the differences between the United States and the euro area? Even though inflation is currently affecting many economies in an apparently similar manner, its underlying sources are different across countries, especially so if we compare the United States, where demand factors have been crucial in triggering the acceleration of prices, with the euro area, which has mostly been hit by a supply shock. First, while fiscal policies were expansionary everywhere during the acute phase of the Covid-19 pandemic, in the United States they were especially bold: the public debt-to-GDP ratio rose by 25 percentage points in 2020-21, to over 130 per cent. In the euro area, * This note mostly follows the Bishnodat Persaud Lecture that I gave on 11 February 2023 at the University of Warwick, during the Warwick Economics Summit. I wish to thank Jens Weidmann for the kind invitation to deliver this presentation at the Frankfurt School of Finance & Management and Rebecca Kelly, Pietro Rizza, Massimo Sbracia and Alessandro Secchi for their contributions and suggestions. instead, the increase was limited to 15 percentage points, to slightly less than 100 per cent, despite a much deeper decline of nominal GDP in 2020 and a slower recovery in 2021. The exceptional support provided to US households is particularly evident when comparing the dynamics of GDP and disposable income (fig. 2): in 2020, just as the former recorded its sharpest collapse in real terms in the entire post-World War II period (-3.4 per cent), real disposable personal income grew by over 6 per cent, the largest rise since the mid-1980s. In the euro area, instead, household real disposable income declined, even though by a much smaller extent than GDP (-0.05 versus -6.3 per cent). Second, the different dynamics of household disposable income across the two economies translated into different effects on demand. In the United States, GDP returned to its pre‑crisis trend at the end of 2021, but aggregate data hid a large heterogeneity between sectors: while demand in the services sector was restrained by pandemic-related factors, the goods sector increasingly showed signs of overheating (fig. 3). In the spring of 2021, for example, personal consumption expenditure in the durable goods sector was already more than 30 per cent higher than its pre-crisis level. The fast recovery in US demand, in a phase in which global supply was still constrained due to the waves of the pandemic, caused bottlenecks in the international value chains, which drove up the prices of intermediate goods everywhere. In the euro area, instead, in the third quarter of last year (the latest for which we can estimate the decomposition of consumption) demand for both goods and services was still below the pre-pandemic trends. Third, the labour market has been much tighter in the United States than in the euro area. The US unemployment rate still stands at just 3.4 per cent, a value last seen only in the late 1960s and about half the level of the euro area (6.6 per cent). The difference between the number of vacancies in the US non-farm sector and the number of people who are unemployed is, today, over 5 million, i.e. there are many more jobs available than there are people looking for them, while in the euro area the opposite is true, with the number of unemployed exceeding the number of job vacancies by about 6 million. Unsurprisingly, the annual change of US nominal wages (measured by the employment cost index) surpassed 4 per cent as early as in the third quarter of 2021, approached 6 per cent in 2022, and today still stands above 5 per cent, a level that is difficult to reconcile with an inflation target of 2 per cent (fig. 4). In the euro area, on the other hand, in spite of current requests for sizeable wage increases in some countries where labour markets are particularly tight, wage growth has so far remained, on average, moderate, at around 3 per cent, and there are no clear signs of a wage-price spiral as a whole. Fourth, the energy shock had a very different role on the two sides of the Atlantic. Since the second half of 2020, oil prices rose gradually in both the United States and the euro area. The price of the natural gas delivered in the United States increased much more markedly, rising from around $10 per megawatt hour before the pandemic to a peak of over $30 last summer, before sliding back below $10 (fig. 5). However, it was the price of the natural gas delivered in Europe that recorded the most extraordinary dynamics, dwarfing even the 1973 oil price increase (which itself had increased four-fold): from slightly above €10 per megawatt hour in early 2020, it rocketed to €180 before the war, soaring to a peak of €350 last summer and then falling sharply, hovering around €50 in the last few days. This extreme volatility of gas prices was also the result of a “bullwhip effect”, which is the response of demand to uncertain supply, consisting of ordering more, ordering earlier and replenishing gas stocks. As a consequence of these dynamics, US consumer price inflation increased from below 2 per cent in February 2021 to a peak of over 9 per cent last June (fig. 6), declining up to 6.4 per cent in January 2023. Core inflation (i.e. net of energy and food products) took the lion’s share of the rise, with a peak of 6.6 per cent last September and still in January at 5.6 per cent. In the euro area, on the other hand, headline inflation reached a record high of 10.6 per cent last October, from less than 1 per cent in February 2021, followed by a return to 8.6 per cent last January. Core inflation progressively rose, up to 5.3 per cent in January, reflecting the usual lags in the pass-through of energy prices. The upsurge in the latter was responsible for the largest share of the acceleration in consumer prices: considering the combination of both their direct and indirect effects, in 2022 about 60 per cent of headline inflation was attributable to higher energy prices. If we also add the effects of the rise in food prices, another consequence of the conflict in Ukraine, this share increases to 70 per cent. 2. Did the ECB respond too late to the acceleration in consumer prices? Is monetary policy “behind the curve” in the euro area? The Governing Council of the ECB began the process of monetary “normalisation” at the end of 2021, when it judged that the progress in economic recovery and towards the medium-term inflation target was sufficient to allow for the start of a step-by-step reduction in the pace of asset purchases. Why did we not start earlier? And why did we not begin to raise official rates before July 2022? To answer these questions, it is useful to recall what the inflation situation was in June 2021, when we were about to conclude the ECB strategy review. While in the United States headline inflation was already above 5 per cent and core inflation was 4.5 per cent, pushed by the demand factors discussed above, in the euro area, despite already higher gas prices, headline inflation was still below 2 per cent and core inflation was less than 1 per cent. High inflation, therefore, seemed to be a phenomenon mostly concentrated in the United States. The main problem the Governing Council was tackling in that period was still how to increase the dynamics of consumer prices durably and sustain a rapid re-anchoring of inflation expectations from excessively low levels. The situation began changing in September 2021, when gas prices went from the already high level of €50 per megawatt hour to about €100 (a “supply shock”). At that time, however, futures quotes predicted gas prices would remain at around that level during the winter season and then decline very sharply, to well below €50 by June 2022. The prediction of declining gas prices implicit in futures contracts remained more or less unchanged until late December 2021. With such a steep fall in gas prices in sight, inflation could not stay at high levels for long and, in fact, was projected to return swiftly to 2 per cent and below. As it turned out, instead of declining by more than 50 per cent as expected at the end of September, gas prices increased by almost 100 per cent, averaging an unprecedented level of €200 during the summer of 2022. The Russian invasion of Ukraine had transformed a temporary shock into a persistent one, warranting an acceleration of the monetary normalisation. In the early part of 2022, in fact, the process gained speed. However, we managed to avoid the potentially dangerous cliff-effects of too sharp a swing in our stance, not least in view of the major uncertainty caused by the conflict in Ukraine. The end of our purchases was anticipated to the 1st of July and, shortly after, we started raising our key official interest rates by a significant size, with the aim of frontloading the exit from their highly accommodative, indeed still negative, levels. 3. Did the ECB make policy mistakes or forecasting errors? And, if so, why? When discussing the high level of headline inflation reached in the euro area, some commentators have paid less attention to the sudden occurrence of the energy shock, its size and its persistence, pointing the finger instead at the delays of the central bank in initiating its monetary tightening. Critics citing this hypothetical mistake have also highlighted the large errors in the inflation projections made by the ECB/Eurosystem staff in 2022 (fig. 7). The forecast errors in predicting consumer price changes over the last year were indeed sizeable and much larger than those observed in the past. Some have even argued that these large errors call into question the very credibility of the ECB, although other international institutions and private forecasters have made similarly large mistakes. While the observed size of the errors may understandably cast doubt on the reliability of the models used for the projections, our analysis for Italy (with similar results for the analysis conducted by the ECB on the forecasts for the euro area as a whole) indicates that the effects of energy prices – the most important exogenous variables in the forecasting model, whose changes are usually inferred from the market price of futures contracts – explain, directly and indirectly (i.e. via their effects on production costs), 70 per cent of the overall error made in forecasting inflation in 2022. This share rises to 80 per cent when the effects of food prices, the other volatile component of the consumer price index, are also taken into account. These results suggest that, although all models should be (and are) subject to continuous checks and improvements, the functioning of the economy has not changed dramatically over the last year. They do draw our attention, however, to the quality of the forecasts used as inputs. Undoubtedly, the effects of global supply bottlenecks were underestimated, although demand in the euro area did not contribute greatly to them in any case. The key problem, however, was the generalised underestimation of the recent geopolitical tensions. The sharp drop in gas supplies from Russia observed since early 2021 was in fact (probably mistakenly) attributed at first to the effects of a particularly cold winter in Russia and subsequently to the political pressure from the Russian government to accelerate the opening of the Nord Stream 2 gas pipeline. The new shock caused by the Russian invasion of Ukraine a year ago has, instead, dramatically changed this picture, triggering a sharp rise in volatility and pushing both current and expected gas prices to extremely high levels, fuelling inflation. It may indeed be argued that an earlier rise in interest rates might have reduced the market uncertainty (and might have more effectively managed the initial rise in inflation expectations). On one hand, this claim is debatable, since it neglects to consider that the consequences of the uncertainty generated by the Russian invasion also needed to be properly evaluated and addressed. On the other, even if we suppose it to be true, I doubt that a few months’ delay in the actual implementation of the decision to halt asset purchases and start raising official interest rates would have had substantial consequences on the evolution of consumer prices in the euro area, which, as I have mentioned, mostly reflect the costs of energy and food. 4. Is the ECB’s monetary policy ineffective? As is widely agreed, monetary policy affects the real economy, and inflation, with “long and variable” lags. While monetary actions and communications tend to affect financial markets’ interest rates and asset prices almost immediately, their transmission to the financing conditions of households and businesses and, subsequently, to consumer prices, tends to be much more gradual as economic agents revise their decisions to consume and to invest slowly and, in some cases, infrequently. The initial conditions of the economy – including the level of debt, the degree of economic uncertainty, and many other domestic and global factors – also have important consequences on the distribution over time of the effects of a change in the monetary stance on inflation and growth. Empirical evidence for the euro area shows that, on average, a change in key rates exerts its largest impact on GDP growth after about a year and a half and its maximum effect on inflation after one to two years. Therefore, most of the economic impact of the rate hikes that have been implemented so far is yet to be felt, suggesting that a degree of prudence is warranted, as their full results are about to be seen. However, the initial effects of our policy measures are already discernible. Following our latest monetary policy decision, the overall increase of official rates since July has reached 300 basis points and has been fully and smoothly transmitted to market interest rates. Since the start of the reduction of monetary accommodation at the beginning of 2022, one-year risk-free rates (measured by overnight index swaps) have picked up from negative levels to 3.6 per cent, while ten-year rates have increased from barely positive values to 3.0 per cent. In real terms, using the inflation-linked swap (ILS) as a deflator, they currently stand at about 0.7 and 0.5 per cent respectively, from around -4 and -2 per cent at the end of 2021 (fig. 8). The fact that long-term interest rates started increasing well before our first key rate hike should not come as a surprise. It is indeed proof of the credibility of our actions and our commitment to guaranteeing price stability, and it supports my claim as to the possibly limited effects of starting the rise in interest rates a few months earlier, notwithstanding the uncertainties linked to the war. Further signs of the effectiveness of the Governing Council’s actions are found in the dynamics of inflation expectations, whose levels are an important anchor for wage dynamics and actual inflation. In the euro area, short-term inflation expectations derived from financial market prices are falling sharply. ILS rates indicate that the expected inflation rate twelve months ahead now stands at 2.9 per cent, down from a peak of almost 9 per cent recorded in late August 2022 (fig. 9). The initial signs of a decline in inflation expectations are also broadly confirmed by surveys of firms and households. At the same time, longer-term expectations, net of risk premia, remain at levels consistent with our 2 per cent price stability target, and tail-risks of excessive inflation are gradually dissipating (fig. 10). The anchoring of inflation expectations is also supported by the results of the January ECB surveys of analysts. A quantification of the structural drivers of euro area and US inflation expectations, as measured by ILSs, obtained by breaking down their daily fluctuations into domestic and global shocks (fig. 11), confirms the different role of supply and demand factors on the two sides of the Atlantic and provides a measure of the effectiveness of the monetary tightening. The results of this analysis – which focuses on the effects of changes in policy, demand and supply with respect to historical regularities – show that, since the start of the war in Ukraine, the inflation rate predicted over a five-year horizon increased mostly in response to supply shocks in the euro area; the much smaller contribution of demand shocks rose progressively over the course of 2022, reflecting improved business cycle conditions. Results also document strong spillover effects of US monetary policy on euro area inflation expectations since the second half of 2022 and confirm the initial signs that the ECB’s monetary policy tightening is having the desired soothing effects on the economy. In the United States, on the other hand, inflation expectations had been steadily sustained by domestic demand until the end of last October, and have since been reined in by contractionary monetary policy effects. The credibility that central banks have gained over time has not been lost and indeed is currently paying off. 5. Should the ECB prefer running the risk of doing too much compared to the risk of doing too little? There is no question that the tightening of the euro area monetary stance must continue to ensure that a temporary increase in inflation caused by a supply shock does not become a more persistent phenomenon sustained by demand factors. This said, in early February the Governing Council of the ECB assessed that the risks to the inflation outlook have become more balanced, while reiterating that uncertainty remains very high. In this context it has raised its key rates by 50 basis points and has announced the intention to raise them by a further 50 basis points in March. In any case, the pace of any further rate hike will continue to be decided on the basis of incoming data and their impact on the inflation outlook. It will remain essential to continue balancing the risk of a too-gradual recalibration (doing too little), which could cause inflation to become entrenched in expectations and in wage‑setting processes, with that of an excessive tightening (doing too much), which would result in significant repercussions for economic activity, financial stability and, ultimately, medium-term price developments. In line with our symmetrical price stability objective, I believe that equal weight should be given to both risks. On the one hand, doing too little would come at a cost for the economy if this led to the need for a stronger and more prolonged restriction of monetary policy. On the other hand, however, the costs linked to the opposite risk may be relevant if “doing too much” were to determine an undershooting of the target and possibly even lead to serious debt-deflation phenomena, triggering nonlinear perilous amplifications. In the face of both of these risks, the central bank decisions should continue to be characterised by wisdom and balance and be guided by careful quantitative evaluations of incoming data. When it comes to reducing inflation, a recession is not always inevitable. Communicating a strong commitment to bringing inflation down to target in a speedy manner is fundamental, but doing so by minimising the costs for the real economy is not any less important. A cautious approach is also advisable due to a series of other considerations. The first is related to the high level of economic uncertainty and the Brainard principle, which states that when the central bank is uncertain about the effects of its actions, it should move conservatively. An exception to this principle is the case of uncertainty around the persistence of inflation: when persistence is high, in fact, a strong monetary reaction may be required to avoid high inflation becoming entrenched in agents’ mind-sets. While this possibility should be carefully monitored, data on market- and survey-based inflation expectations – including their recent decline at short horizons and their decreasing profile ‒ and the marked deceleration of prices on a 3-month annualised basis (fig. 12), may call into question the persistence of inflation at high levels in the euro area, reinforcing the arguments in favour of gradual monetary normalisation. The second concerns the “long and variable lags” of the monetary transmission process that I have already mentioned. Credit dynamics provide signals that are especially relevant in this respect. On a 3-month (annualised) basis, the growth of loans to firms in the euro area was negative in January (-1.3 per cent) from an almost double-digit expansion in October (9.8 per cent). Although this deceleration is the natural (and desired) consequence of monetary normalisation, both its size and speed require caution on the magnitude and time distribution of future interest rate hikes. The potential risks to financial stability also require a good dose of caution. The unprecedented coordinated rises in official rates around the world may create spillover effects that are difficult to quantify but may not be negligible. Financial instability risks are particularly relevant in the Economic and Monetary Union, whose incomplete architecture – especially its decentralised fiscal policy and the delays in completing the banking and capital markets unions – exposes it to a possible fragmentation of financial markets. Finally, in the current uncertain environment, models and forecasts should necessarily be taken cum grano salis, in particular when determining the “terminal” level of key interest rates. Quantitative assessments are still useful, but their insights have to be assessed together with the information that will gradually become available on inflation expectations and on the evolution of wages and profits. * * * The monetary policy tightening started by the ECB in December 2021 has been crucial to respond to the risks stemming from high and rising inflation. Even before exerting its effects on aggregate demand, it has operated by contributing to containing inflation expectations, avoiding an increase to excessively high levels. This anchoring of expectations has therefore laid the foundations for preventing the occurrence of wage-price spirals. Low and stable inflation expectations, however, do not completely eliminate the risk of “second-order effects”. To this end, labour and business in all euro-area countries must continue to behave responsibly. It has to be fully understood that the energy shock is like a tax on the euro area economy, which unfortunately cannot be returned to sender and cannot be circumvented through a fruitless race between wages and prices nor through an excessive and permanent increase in public debt. Wage negotiations, therefore, cannot go back in time to when they were purely backward-looking. Making up for the loss of purchasing power must, rather, rely on achieving sustained productivity growth, although targeted and temporary fiscal measures to alleviate the burden on more severely hit households and firms should obviously not be ruled out. Today, gas prices in Europe are returning to more moderate levels and their volatility is declining, setting the stage for the convergence of inflation, over the medium term, to the ECB’s target of 2 per cent. In this context, the pricing strategies of businesses will play a central role. In particular, we will have to closely monitor whether, after the pass-through of the higher energy costs observed in 2022, firms will allow final prices to reflect the most recent declines, which would imply a less intense tightening of financial conditions. This will be a key step to achieve a durable reduction of underlying inflation. In this phase, monetary policy should not be left to work alone. The contribution of all policies, including perhaps some new versions of old-fashioned income policy recipes, could help to favour a more rapid convergence of inflation to the ECB target. The return to price stability will greatly benefit from fiscal policies and negotiations between workers and firms operating in the same direction as monetary policy. FIGURES Figure 1 The return of inflation (monthly data; annual percentage changes) US UK EZ IT Source: Eurostat, Istat, UK Office for National Statistics and US Bureau of Labor Statistics. Note: EZ denotes the euro area (changing composition after 1999 and weighted average of the 11 countries partecipating to the start of Third Stage of the Economic and Monetary Union prior to that date). Figure 2 Disposable income and GDP (annual data; percentage changes) United States euro area -2 -2 -4 -4 -4 -6 -6 -6 disposable income -2 GDP -4 -6 Source: Eurostat and US Bureau of Economic Analysis. GDP -2 disposable income Figure 3 Demand in the goods and services sectors (monthly and quarterly data; indices: Jan. 2020 / 2019 Q4 = 100) Goods sector Services sector United States euro area United States euro area Source: US Bureau of Economic Analysis and estimates based on Eurostat data. Note: dashed lines show pre-pandemic trends. Figure 4 Nominal wage growth (quarterly data; annual percentage changes) United States euro area Source: ECB and US Bureau of Labor Statistics. Figure 5 Natural gas prices (daily data) Europe (euro) United States (dollars) Source: Refinitiv. Note: Title Transfer Facility (TTF) quotations for European gas and Henry Hub for US gas. Figure 6 Headline and core inflation (monthly data; annual percentage changes) United States euro area -2 -2 headline core -2 core -2 Source: Eurostat and US Bureau of Labor Statistics. headline Figure 7 ECB/Eurosystem projections errors for euro area headline inflation (percentage points) 1 quarter ahead projection errors 4 quarters ahead projection errors -2 -2 -2 -2 -4 -4 -4 -4 Source: Bank of Italy and ECB. Note: dashed lines denote an interval around zero of plus/minus two standard deviations of projection errors realized in 2003-2020; latest observation: 2022 Q4. Figure 8 Real interest rates in the euro area (per cent) Term structure, spot rates Term structure, 1-year forward rates -1 -1 -1 -1 -2 -2 -2 -2 -3 -3 -3 -3 -4 -4 -5 -5 -6 -6 1 year 3 year 5 year 7 year 9 year 2 year 4 year 6 year 8 year 10 years -6 -4 -5 end 2021 mid 2022 27 February 2023 end 2021 mid 2022 27 February 2023 spot -5 -6 2y fwd 4y fwd 6y fwd 8y fwd 1y fwd 3y fwd 5y fwd 7y fwd 9y fwd Source: based on Bloomberg and Refinitiv data. Note: nominal OIS interest rates deflated by the corresponding inflation‑linked swap rates. -4 Figure 9 Market-based inflation expectations in the euro area (daily data; per cent) 1 year 10 year -2 -2 Source: Bloomberg. Note: 1-year and 10-year inflation-linked swap rates. Figure 10 Inflation tail risks in the euro area (daily data; per cent) ∏>3 ∏<1 ∏<0 ∏>4 Source: based on Bloomberg data. Note: probabilities inferred from inflation options; π<0 (π<1) is the probability of inflation being smaller than 0 (1) on average in the next 5 years; π>3 (π>4) is the probability of inflation being larger than 3 (4) on average in the next 5 years; 50-days moving averages. Figure 11 Drivers of changes in inflation expectations (daily; percentage changes) 1.6 1.4 1.2 0.8 0.6 0.4 0.2 -0.2 -0.4 -0.6 -0.8 -1 -1.2 -1.4 -1.6 -1.8 /0 31 /22 /0 28 /22 /0 28 /22 /0 26 /22 /0 24 /22 /0 21 /22 /0 20 /22 /0 17 /22 /0 14 /22 /0 12 /22 /1 10 /22 /1 08 /22 /1 05 /22 /0 03 /23 /0 2/ 1.6 1.4 1.2 0.8 0.6 0.4 0.2 -0.2 -0.4 -0.6 -0.8 -1 -1.2 -1.4 -1.6 -1.8 United States /0 31 /22 /0 28 /22 /0 28 /22 /0 26 /22 /0 24 /22 /0 21 /22 /0 20 /22 /0 17 /22 /0 14 /22 /0 12 /22 /1 10 /22 /1 08 /22 /1 05 /22 /0 03 /23 /0 2/ euro area Source: C. Hoynck and L. Rossi (2023), “The Drivers of Market-Based Inflation Expectations in the Euro Area and in the US”, mimeo, Bank of Italy, Rome. Note: 5-year inflation swap rates; changes with respect to 3 January 2022. Figure 12 Inflation (monthly data; 3-month annualised percentage changes) US UK EZ -5 -5 Source: Eurostat, UK Office for National Statistics and US Bureau of Labor Statistics. Note: EZ denotes the euro area.
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Speech by Mr Paolo Angelini, Deputy Governor of the Bank of Italy, at the conference "The New Frontiers of Digital Finance", organised by Commissione Nazionale per le Societa e la Borsa (Consob), Rome, 10 March 2023.
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Conference “The New Frontiers of Digital Finance” Paolo Angelini Deputy Governor of the Bank of Italy Digital Finance and markets infrastructures Consob Auditorium Rome, 10 March 2023 Let me thank President Savona and Consob for inviting me today to talk about technological innovation in payments, securities clearing and settlement systems, i.e. the market infrastructure that is the backbone of our financial system. “Traditional” digital innovation has been doing a lot for financial markets infrastructure I would argue that this is probably the sector least affected, thus far, by the latest technological developments that inspire today’s seminar. The adoption of digital technologies for financial market infrastructures started with the dematerialization of securities in the sixties. Trading on digital platforms began to replace trading floors (the “pits”) in the eighties. In the nineties, real time gross settlement systems (RTGS) led to a revolution in wholesale payments worldwide, bringing added security to market transactions at affordable costs, thanks to their ability to effect a huge increase in efficiency (a rise in the velocity of circulation of central bank money). The next step was to eliminate counterparty risk in securities transactions via the adoption of delivery versus payment (DVP).1 The emergence of fast electronic communication networks allowed investors to use real-time data for algorithmic and high-frequency trading,2 which in Europe now account for about 70 per cent of all equity trades. Nowadays, reflecting a widespread dematerialization process, almost all financial assets are in digital form and traded through electronic platforms; all wholesale payments are initiated and settled online. For example, the European large value payment system, TARGET2, settles average daily transactions worth about 2.5 trillion euro, one sixth of Settlement systems implementing DVP perform a simultaneous transfer of the cask leg and the security leg of transactions on the counterparties’ respective accounts. Algorithmic trading implements order and trade decisions electronically and autonomously (without the input of a human operator). High-frequency trading is a subset of algorithmic trading in which orders are submitted and trades executed at high speed, usually microseconds, and a very tight intraday inventory position is maintained. the euro area’s annual nominal GDP;3 it can work jointly with TARGET2-Securities (T2S), allowing DVP of the cash and security legs of transactions. So I would argue that, as far as market infrastructure is concerned, the digital revolution has already silently happened.4 This said, the innovation pipeline is by no means empty. In the time allotted I shall review some recent developments of the “traditional” type, and devote some remarks to the debate on DLT-based infrastructure. In Europe, the RTGS world has been evolving rapidly. In 2018 the Eurosystem launched TARGET Instant Payment Settlement (TIPS). TIPS enables participating banks and their clients – corporates and households alike – to transfer funds within seconds, around the clock, 365 days a year. The Eurosystem charges banks well below one cent per transaction. The project’s quality is widely acknowledged, as witnessed by the Sveriges Riksbank’s decision to join TIPS with its currency, and by the intention to follow suit announced by the central banks of Norway and Denmark. Another prominent project is the consolidation of TARGET2 and T2S platforms, which will go live in ten days. While the project is not revolutionary, it will enhance and modernize the services offered by TARGET2. The new system features the ISO 20022 messaging standard (as in T2S and TIPS), a centralised liquidity management that will make it more cost-effective and efficient,5 and can facilitate payments in several currencies, if other central banks decide to join the system. A third example is the creation of the Eurosystem Collateral Management System (ECMS), a multi-year project that started in December 2017 and is expected to go live in April next year. The ECMS will replace the current fragmented and decentralised structure for the management of collateral – de facto a patchwork of domestic systems. It will allow participants to assess and move collateral on a domestic and cross-border basis, and to settle monetary policy operations; it will be integrated with the other Eurosystem infrastructures, especially TARGET2 and T2S, creating an infrastructure that works seamlessly across the euro area. TARGET2 was launched on 19 November 2007 and has since been operated by Banca d’Italia, Deutsche Bundesbank and Banque de France on behalf of the Eurosystem. In 2015 Target2 securities (T2S) was added to TARGET2, implementing a safer and more efficient securities settlement. It should also be acknowledged that, at least in some specific instances, the digital revolution has been a mixed blessing. Consider e.g. algorithmic and high-frequency trading: in normal conditions they may improve market liquidity and facilitate price discovery, but in periods of stress they may fuel investor risk aversion and market instability, or generate “flash crashes” – episodes of sudden and large price changes typically reversed shortly afterwards. A centralised liquidity management tool will function via the so-called “Main Cash Account” (MCA) that participants can open with a national central bank. This account will be linked to the participant’s dedicated cash accounts for the new real-time gross settlement (RTGS) system, T2S and TIPS. The MCA will also offer a dashboard for a centralised overview of liquidity positions and advanced liquidity management tools, with a higher level of automation. The liquidity held on dedicated cash accounts will be considered for minimum reserve purposes without the need for the accounts holder to transfer the balances back to the MCA. The “new” digital innovation: what to expect from DLT-based technologies? Today much of the debate among market operators and public institutions centres on the novelties brought about by Distributed Ledger Technologies (DLTs) like blockchains. In turn, much of this interest revolves around the crypto markets. This theme lies outside my focus today. Let me mention however that Banca d’Italia is actively engaged in the international fora that are working to define global regulatory standards for these markets, including the Financial Stability Board, the Basel Committee on Banking Supervision and the Committee on Payments and Market Infrastructure. At the national level, waiting for the coming into force of the European Markets in Crypto-Assets Regulation (MiCAR), we have been liaising with Consob, repeatedly warning retail investors of the risks of this unregulated world. Last June we issued a Communication on DLT and crypto–assets proposing principles and benchmarks for supervised intermediaries and entities falling within the scope of payment system oversight.6 Coming to DLTs use for financial market infrastructure, two main types of claims have been made. According to early-hour proponents of DLTs, the technology has the potential to do away with financial intermediaries and their trust-building role: the very key features of the technology – the distributed nature of the ledger, the “impossibility” for any single user to tamper with the records once validated – pave the way to a world with a greatly diminished role for intermediaries. This “decentralized finance” (DeFi) view emphasizes the self-tending nature of DLTs, i.e. their ability to work without a subject in charge of managing the system. In this context, reference is often made to the so-called permissionless DLTs. A different view holds that DLTs can improve the efficiency of financial market infrastructure, reduce the time needed for reconciliation and back-office activities, offer high performance and programmability thanks to the use of so-called ‘smart contracts’. In this case the emphasis is not on the DLT governance but rather on the benefits that can stem from the technology, independently of whether or not a financial intermediary is in charge of it. Let me express some scepticism about the former view. One way or another, counterparty risk would find its way into a fully decentralized large scale trading and settlement system.7 This is because these systems, to be scaled up, need in practice some centralized infrastructure (e.g. exchanges) to provide various services (e.g. storage of tokens and cryptographic keys, trade, conversion into other tokens or hard currency, …). In other words, DeFi, beyond a certain operational scale, is forced to reintroduce the infrastructure that it was supposed to eliminate. And several episodes have shown that this infrastructure is prone to various risks (cyber and fraud risk in Communication by Banca d’Italia on Decentralized Technology in Finance and Crypto-assets, Rome, June 2022. See e.g. the insightful discussion by F. Schar, “Decentralized Finance: On Blockchain- and Smart Contract-Based Financial Markets”, Federal Reserve Bank of St. Louis REVIEW, second quarter 2021, 153-174. particular), just like the traditional one. Once this is acknowledged, DeFi schemes lose most of their appeal.8 The second view cannot be easily dismissed. It is undisputable that DLTs have useful features.9 Market participants are showing high interest in the topic: last December the Bank of Italy (through our Milano Hub, the innovation centre created to support the digital evolution of Italian financial system) launched a specific call for proposals on DLT applications in finance, insurance and payments. We received 57 projects, submitted by 82 participants. We are currently evaluating them. While the majority of projects comes from Italian entities, a non-negligible share comes from other European countries and Southeast Asia.10 So the issue becomes an empirical one: is large scale DLT adoption in financial market infrastructure feasible? If so, do the advantages outweigh the costs? I believe these are important questions. While it is not for central banks to answer them, I think that they provide a strong motivation for the central banking community’s interest in the DLT. Let me be more specific. A key motivation has to do with the safety of market infrastructure. Without adequate solutions for the DVP settlement in central bank money of the tokens traded on DLTs, the latter could never achieve the level of safety that is typical of traditional securities trading and settlement systems. For instance, TARGET2 offers efficient and secure settlement in central bank money, but it would be unable, without the development of ad hoc interfaces (or the issuance of central bank money in the form of tokens) to simultaneously settle the cash leg of financial transactions happening on a DLT. Financial intermediaries are successfully issuing securities on DLT and settling trades in DVP mode using tokenized commercial bank money. These exciting developments offer an opportunity to test the DLT and get practical feedback about its benefits (and disadvantages). In my view, however, DVP in central bank money is no longer optional for market participants. Few if any would trust a large market infrastructure that would The list of snags could go on. Permissionless DLT systems must continuously generate enough fees for anonymous validators to ensure the integrity of the ledger in the absence of a central authority. Ultimately, this creates significant inefficiencies and risks for users. For example, when the value of Luna went to zero in the recent Terra-Luna collapse, the incentive for miners to validate transactions evaporated (as they were remunerated in Luna units), and the blockchain stopped for several hours. A similar problem could materialize for any blockchain managing securities. See P. Lee, “Has tokenization’s time finally come?”, Euromoney, March 03, 2023. In DLTs based on proof of work, mining is highly energy- and hardware-intensive; this has tended to concentrate mining activity, with the attendant risk of collusion and forks. DLTs relying on proof of stake tend to concentrate decisions on few holders of governance tokens, reintroducing the governance problems that are typical of traditional intermediaries. Banca d’Italia is actively promoting research on the topic of ‘smart contracts’ including their implications on cyber-security. A Memorandum of Understanding was recently signed with Roma Tre University and Università Cattolica del Sacro Cuore. This is just one of many possible examples of the ferment around new technologies in finance. According to a market sounding recently conducted by the ECB among banks, financial market infrastructure operators and new fintech firms, about 70% of participants expect a significant industry uptake of new technologies, such as DLTs, in the next 5 to10 years; views are mixed on the relative merits of DLTs compared with existing technologies, as well as on the expected timing of DLT adoption. See ECB, “Potential use of new technologies for the settlement of wholesale financial transactions in central bank money”, December 2022. bring us back to the seventies, when the term Herstatt risk (a form of counterparty risk) was coined. But this is what would happen if the cash leg of the DVP were settled in commercial bank money. For this reason, the central banking community is working to develop a form of central bank money (to be kept distinct from the better-known retail central bank digital currency) to settle trades involving a large-value DLT-based leg. Indeed, I would argue that such solution is a necessary condition – although certainly not a sufficient one – for a safe widespread adoption of DLT in market infrastructure. The Eurosystem is currently exploring two main architectural models: a wholesale CBDC service fully based on DLTs, with tokenized central bank money issuance (so‑called “cash on DLT”) and an interface component integrating DLT platforms with current (centralized) TARGET services (so-called “trigger/bridge solutions”). With the caveat that this is genuine work in progress, the first model (cash on DLT), however ingenious, presents operational complexities and could increase the overall liquidity needs of the system. Furthermore, the presence of two segregated wholesale settlement systems (the traditional Target RTGS and a multitude of DLT-based CBDCs, one for each tokenized market/security) would stoke risks of liquidity fragmentation, jeopardizing the optimization effort undertaken by the Eurosystem with the T2-T2S consolidation project mentioned above. The second model would create a “technological bridge” between the settlement system in central bank money and one or more external private DLT platforms handling tokenized digital assets. Compared to the first model, such a solution would not create risks of liquidity fragmentation; by leveraging the existing TARGET infrastructure it would reduce adaptation costs and implementation time, and would likely be less vulnerable to operational risk. Banca d’Italia has successfully experimented a version of this second model, centred on TIPS. In a nutshell, the prototype provides a DLT-agnostic protocol to synchronize the asset-leg and the cash-leg of a tokenized asset, making an instantaneous delivery‑versus‑payment transaction possible on a 24/7 basis. The paper documenting the results of our experiments raised considerable interest and various requests for collaboration.11 Concluding remarks To conclude, I believe that, concerning large-scale DLT adoption for financial market infrastructure, the jury is still out. The DVP settlement in central bank money requires actions by central banks, and is still under investigation. Solid evidence about actual benefits of DLT adoption for financial market infrastructure (in terms of R. La Rocca, R. Mancini, M. Benedetti, M. Caruso, S. Cossu, G. Galano, S. Mancini, G. Marcelli, P. Martella, M. Nardelli and C. Oliviero, “Integrating DLTs with market infrastructures: analysis and proof‑of‑concept for secure DvP between TIPS and DLT platforms”, Banca d’Italia, Markets, Infrastructures, Payment Systems series, no. 26, July 2022. increased efficiency, security, …) is not yet available. Actually, a prominent project to move a securities exchange to the DLT technology was recently brought to a halt by the Australian Securities Exchange (ASX), after seven years of work and a sunk cost of about €250 million. On the other hand, according to market estimates, global spending on blockchain-based solutions, while currently negligible, has been steadily growing (from $ 1 billion in 2017 to 19 billion in 2022). Market interest in asset tokenization is also growing, and several pilots have been successfully completed. DLT developments may have been held back by the lack of a sound legislative framework. In the EU, an important stimulus could come from the DLT Pilot Regime Regulation, which aims to foster innovation in the processing of tokenized securities. Banca d’Italia is cooperating with the Italian Ministry of Finance and Consob for a swift implementation of the Regime in Italy. We stand ready to work with the market in the search for improvement.
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Text of the Robert Mundell Distinguished Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 95th International Atlantic Economic Conference, Rome, 23 March 2023.
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Inflation expectations and monetary policy in the euro area* Ignazio Visco Governor of the Bank of Italy 95th International Atlantic Economic Conference Robert Mundell Distinguished Address Rome, 23 March 2023 After a long period of moderate, perhaps even insufficient, consumer price changes, inflation has returned to levels that are severely influencing the behaviour of households and firms (fig. 1). While its underlying sources are different across the major advanced economies, since late 2021 most central banks have progressively tightened their monetary policy stance to ensure a timely return to price stability. In the current macroeconomic debate, inflation expectations are in the spotlight. A proper monetary policy response aimed at anchoring these expectations to central bank targets is, in fact, key to minimising the risk of a wage-prices spiral that would lead to higher and more persistent inflation. This is especially important in the face of large shocks such as those caused by the major increase in gas prices in Europe over the last two years or so. As an “external tax”, the consequent decline in the terms of trade cannot be undone but instead should be rapidly absorbed, ideally redistributing it in order to protect the most fragile members of the population. Generalised backward-looking attempts at recovering the losses in purchasing power generate the real risk of protracting the high inflation rates resulting from the rise in energy prices. This may, in turn, affect inflation expectations and give rise to second round effects that must inevitably be countered with more restrictive monetary policy measures. Therefore, the crucial question that central banks are facing today is what the most appropriate conduct of monetary policy should be in these complex and highly uncertain times. To tackle this question, I will first very briefly review the crucial role of inflation expectations in the monetary transmission mechanism. I will then consider the issues related to their measurement and interpretation. In light of these theoretical and empirical considerations, I will discuss the recent evolution of inflation expectations in the euro area and will finally draw some conclusions for the current and possible future conduct of the ECB monetary policy. * I thank Katherine Virgo and the International Atlantic Economic Society for the kind invitation to deliver this lecture. For their very useful contributions and comments, I also thank Rebecca Kelly, Pietro Rizza, Tiziano Ropele, Massimo Sbracia and Alessandro Secchi. Inflation expectations and the monetary transmission mechanism Monetary policy affects the real economy and inflation with “long and variable” lags, to use Milton Friedman’s famous expression, and through a complex system of channels known as the monetary transmission mechanism. While central banks’ actions and communications affect financial markets’ interest rates and asset prices almost immediately, their transmission to the financing conditions of households and businesses and, subsequently, to consumer prices, tends to be much more gradual. In this process, a key role is played by inflation expectations, namely economic agents’ beliefs or predictions about the future evolution of prices.1 Expectations, in fact, shape the behaviour of households and businesses, which, in turn, influences overall price dynamics. In response to the expectation that there will be a broad increase in the prices of goods and services, for example, workers may pre-emptively request higher wages and firms set higher prices. Under certain conditions, this may turn into a self-fulfilling prophecy, fuel actual inflation and make it dangerously persistent. In macroeconomic models, the role of expectations is typically summarised by the so-called augmented Phillips curve. As is well known, while the original Phillips curve examined the relationship between wage growth and unemployment in the UK in the 1950s, later studies focused on consumer price inflation and unemployment. The main idea underlying this relationship is straightforward: in a booming economy, high employment and demand cause workers to demand higher wages and firms to raise their prices (and vice versa in a contracting economy).2 This relationship is obviously a reduced form of more structural ones modelling the behaviour of business and labour in the determination of production, consumer prices and wages. With respect to wage inflation, as early as the 1950s, macroeconometric models attempted to account for the role played by previous inflation in the bargaining process, in efforts directed either at catching-up with actual inflation (also through explicit indexation clauses) or at anticipating future price changes extrapolating them from past data.3 In this sense, the notion of an augmented Phillips curve was not new, but the aspects that had been neglected before were the importance given to forward-looking behaviour and, therefore, the role of expectations in shaping actual economic dynamics. Expected inflation, therefore, became the main additional factor in “modern” augmented Phillips curves.4 Much has been added and debated over the last forty years, which I do not intend to discuss here. As a general statement, however, I would say that, while the curve was “alive For a discussion on the role of expectations in modern monetary policy, see Bernanke (2007), for the United States, and European Central Bank (2021a), for the euro area. See Phillips (1958) and Samuelson and Solow (1960). See, among others, Klein and Goldberger (1955) and De Menil and Enzler (1972), as well as Ando and Brayton (1995). See Phelps (1967), Friedman (1968) and Lucas (1976). For a modern perspective on the Phillips curve, see Hazell et al. (2022). and kicking” from the 1950s to the late 1980s, since then there has been progressively deep uncertainty as to its empirical relevance, possibly also due to the perceived increasing effectiveness of central banks in stabilising inflation. In particular, a substantial reduction in the response of wage and price inflation to demand pressures in goods and labour markets (measured by the “output gap” or the deviation of the actual rate of unemployment from its “natural” rate) is often considered to have occurred in the years known as the “Great Moderation”, even if there appears now to be some evidence of a possible reversal of this trend.5 In any case, the augmented Phillips curve remains a useful tool for policymakers, informing their decisions about monetary and fiscal policy, with the goal of leading, in turn, to more stable and predictable economic outcomes. The role played by anticipated inflation is therefore examined with care, even if – especially in the case of the recent major supply-side shocks – the attempts of wages to catch up with previous price “surprises” and the movements in price mark-ups continue to be worthy of attention. As far as central banks are concerned, inflation expectations are of primary importance, especially for the setting and assessment of the monetary stance. In fact, although money is normally borrowed and lent at a nominal interest rate, what matters most for consumption and investment decisions is the real interest rate, namely the nominal return adjusted for expected inflation. Its gap with respect to the “natural” or equilibrium real rate is also often considered a crucial variable that should inform monetary policy makers working towards maintaining price stability.6 In particular, as consumption and investment decisions span over longer horizons, it is suggested that central banks should not only seek to set the current level of the short-term rate of interest but also monitor ‒ and in some cases provide guidance on ‒ its expected future values, thus influencing long-term real interest rates. It goes without saying that, quite apart from its role as a reference point, the natural rate of interest (like the natural rate of unemployment or the potential level of output) is not observed and very hard to estimate with a reasonably restrained quantitative approximation. In any case, these considerations provide additional proof that inflation expectations, in contributing to determining real interest rates, are a crucial ingredient for the identification of the most appropriate stance for monetary policy. In general, credibility in its pursuit of price stability and, in turn, the anchoring of longer-term inflation expectations, is one of the most precious assets of any central bank. When expectations are firmly anchored to the central bank’s target, monetary policy can protect price stability from supply and demand shocks, and address their effects in labour, goods and financial markets over time in a swift and efficient manner, with lower costs in terms of economic activity. On the The low inflation observed in the last few years even in the face of strong labour markets has stimulated a wave of papers testing the decline (possibly to zero) of the slope of the Phillips curve. See, for example, Coibion and Gorodnichenko (2015), Blanchard (2016), Del Negro et al. (2020) and the references cited therein. For some limited evidence on the reversal, see Hobijn et al. (2023). See Wicksell (1898), Woodford (2003) and, for a recent discussion on the difficulties in using this concept as a guide for monetary policy, Visco (2022). contrary, when inflation expectations become de-anchored, a stronger monetary policy reaction to any shock is required, with possibly elevated costs for the real economy. Indeed, the need to enhance credibility and guarantee a solid anchoring of inflation expectations underlies one of the most important developments in central banking over the last few decades, namely the increasingly widespread adoption of the monetary policy framework known as (flexible) inflation targeting. The existence of a clear and credible anchor for inflation expectations has proved to be a fundamental ingredient to keep actual inflation closer to the price stability objective.7 Measuring inflation expectations Despite their key role for monetary policy, measuring, and sometimes interpreting, inflation expectations is not simple. First, the large variety of data that has become available over the years has confirmed that there is no one, single measure of inflation expectations, since different economic agents ‒ households, firms, professional forecasters, market operators ‒ all have heterogeneous perceptions about the future dynamics of prices. A second challenge is connected with understanding how inflation expectations affect economic decisions and what their formation mechanism is, including which variables provide insights into their evolution. The availability of direct data on inflation expectations has recorded substantial progress in the last three decades, building on the seminal surveys and research produced after World War II and until the 1980s. Notwithstanding the initial poor designs, the qualitative (or “tendency”) rather than quantitative nature of many of the responses, the prevalence of short time horizons and the lack of information other than the average of individual expectations, many important insights have been obtained over the years. These ranged from initial attempts to derive the best possible measures for modelling their formation to tests for their unbiasedness, efficiency and rationality. Among the best known were (and still are), for the United States, since 1946 the quantitative Livingston Survey of professional economists and since 1948 the qualitative survey of households conducted by the University of Michigan (which became semi-quantitative in 1966 and fully quantitative in 1977). In Europe, the oldest surveys were the monthly review of the tendency of entrepreneurs’ expectations undertaken since 1950 by the IFOInstitute of Munich, and the twice-yearly semi-quantitative survey of Italian businessmen conducted by the economic magazine Mondo Economico. In 1961, a monthly survey of consumer expectations was instituted in the UK by the Gallup Poll, and in 1971 monthly surveys of manufacturing enterprises of member countries started being co-ordinated and published by the Commission of European Communities.8 For the United States see Bernanke (2022); for the euro area see European Central Bank (2021b). For early reviews of the literature, discussions of measurement problems, estimates of formation mechanism and tests of rationality, see Visco (1984), Holden et al. (1985), Pesaran (1987). For the euro area, information on inflation expectations can be inferred from the surveys currently conducted among professional forecasters (the ECB Survey of Monetary Analysts, the ECB Survey of Professional Forecasters, Consensus Economics, Euro Zone Barometer, among the others), households (the ECB Consumer Expectations Survey, European Commission) and firms (European Commission). While the surveys of professional forecasters and, more recently also the ECB Consumer Expectations Survey, provide quantitative expectations for horizons up to many years ahead, those for firms are mostly qualitative in nature, refer to relatively short horizons and to producer rather than consumer prices. An exception in this respect are the surveys conducted by the Bank of France and the Bank of Italy, which are at the forefront in the quantitative assessment of firms’ expectations.9 In what follows I will draw on results gathered by some of these surveys. An important step forwards for the analysis of inflation expectations has been made, more recently, with the availability of data from financial markets. In January 1997, in particular, the United States began issuing Treasury Inflation-Protected Securities (TIPS).10 This is now the largest component of the global inflation-index bond market, which includes securities whose prices are explicitly linked to nationally-recognised inflation measures. The inflation-linked swap (ILS) rates, which are quoted for horizons that span from the very short term (one month) to the very long term (30 years), are a further source of market-based expectations. An ILS is an agreement between two parties to swap, at a pre-established future date, a floating rate linked to an inflation index (future realised inflation) to a fixed rate coupon in the same currency. The fixed-rate coupon, which is set at the beginning of the contract, reflects genuine inflation expectations plus a timevarying unobservable inflation risk premia. Between survey- and market-based sources, the advantage of the former is that they report the genuine expectations of participants directly, while the latter, as just mentioned, are always influenced by risk premia, which complicate their interpretation. While inflation risk premia can be estimated on the basis of theoretical models, the uncertainty that surrounds these estimates is usually non-negligible. In addition, surveys often include participants’ views on the economic outlook and financial market developments, which can be used to deepen the understanding on the drivers of inflation expectations. The main drawbacks of the surveys, instead, are related to their low frequency and the large lags with respect to market data, which instead provide information continuously and in real time. Another potential limitation is the relatively small size of the sample of The Bank of Italy’s Survey on Inflation and Growth Expectations, in particular, builds on the progress made with the Mondo Economico survey (see Visco, 1984). It was launched in 1999 and conducted first with the newspaper Il Sole 24 Ore and, from 2018, by the Bank of Italy alone. The survey currently gathers, from a sample of 1,500 firms with at least 50 employees, quantitative expectations for consumer price inflation ‒ over one-year, two-years and three- to five-years horizons – in their own selling prices as well as their views on the macroeconomic outlook. The earliest recorded inflation-indexed bonds were issued by the Commonwealth of Massachusetts in 1780. Emerging market countries began issuing inflation-index bonds in the 1960s and, in the 1980s, the United Kingdom was the first major developed country to introduce “linkers” to the market. For an overview see PIMCO (2023). participants and of the number of forecast horizons considered. The “quality” of the answers is also difficult to assess. Some studies, in fact, claim that market-based sources could be more reliable as investors “have more skin in the game”.11 Since the early 1970s, especially since what is known as the “rational expectations revolution”, many studies have attempted to provide causal evidence on the extent to which expectations, specifically towards inflation, affect agents’ economic decisions. In the past few decades, in particular, improvements in the availability of data have prompted a proliferation of empirical studies on this issue, spurred on, too, by the fact that monetary authorities have paid greater attention and devoted more time and energy to future-oriented communication policies. Understanding the effects of inflation expectations is not an easy task, as there are not many sources of exogenous changes allowing us to derive causal implications. Inflation expectations seem indeed to have proved to be a relevant factor in shaping economic decisions, such as households’ consumption of durable and non-durable goods as well as firms’ pricing strategies, capital accumulation expenditure and labour demand.12 This has allowed us to obtain some insights into how inflation expectations filter into economic decisions. However, much more still needs to be understood, as unexplained heterogeneity in the responses to changes in inflation expectations remains significant: in some cases, for example, higher expected inflation leads agents to increase their spending, in other cases it leads them to contract it.13 These opposite results might reflect the perception of the difference in the drivers causing the rise in expected inflation, for example due to a positive demand change as opposed to a negative supply shift. Moreover, the specific economic environment in which agents operate, be it a high- or a low-inflation regime, could shape the effects of inflation expectations differently. This naturally calls for a deeper understanding of the formation mechanism of inflation expectations. In many models, the dominant approach relies on the full-information rational expectations paradigm that became popular in the 1970s and 1980s, replacing, to an extent, schemes that relied on (and at times tested) extrapolative, adaptive and regressive mechanisms of the formation of expectations. Empirically, however, this paradigm has had limited support throughout the years. According to some econometric evidence, individuals used information efficiently before the first oil shock of the 1970s and inefficiently thereafter, possibly as a consequence of the large shock that hit inflation and led to some confusion between permanent and transitory effects.14 Even more recent survey-based evidence appears increasingly at odds with the full-information rational expectation assumption.15 See, for example, Romanchuk (2018). See Coibion et al. (2020), Rondinelli and Zizza (2020) and Fabiani et al. (2006). See, e.g., Weber et al. (2022). See Visco (1984) and Cukierman (1986). For a review of recent studies see Coibion et al. (2018). Several established empirical facts about survey-based inflation expectations for both households and firms are difficult to reconcile with the full-information rational expectations paradigm: the presence of systematic biases in expectations; the predictability of ex-post forecast errors; the large amount of cross-sectional disagreement over future inflation. Furthermore, it has been shown that agents form inflation expectations based on several different factors, including some that in principle should not matter in the case of full rationality, such as their previous buying experience, their exposure to low or high inflation environments and various socio-economic characteristics.16 All these considerations led to a departure from the full-information rational expectations paradigm only a few years after its ideation. A stream of studies has, in particular, maintained the assumption of rational expectations but proposed deviations from the full-information assumption due to data gathering and elaboration rigidities that naturally create heterogeneity in beliefs. Examples are the sticky information approach, in which agents update their knowledge infrequently because acquiring information is costly, and the rational inattention approach, which instead assumes that agents actively decide not to pay attention to all the news available to them. In this vein, at the end of the 1970s, Cukierman and Wachtel developed a macro-economic framework in which expectations are formed rationally, but at the same time people in different markets have different views about the future rate of inflation because they are exposed to different information.17 Other authors have, instead, put aside the rationality assumption and incorporated the insights gained from the behavioural economics literature resorting to forms of adaptive learning. According to these scholars, agents experience cognitive limitations and thus rely on ad-hoc forecasting models to form expectations that are updated in every period using observed data, or embedding sources of systematic biases, such as optimism and pessimism or overreaction and underreaction to news.18 In light of the high uncertainty around the most appropriate approach for the analysis of inflation expectations, central banks currently base their assessments and their decisions on a large set of different macroeconomic models, which include forward- and backward-looking components. This constellation specifically allows us to take into account inflation expectation mechanisms based on extrapolation as well as to consider the risks implicit in models that lead to a mechanical return to “normality” or to forms of mean reversion. The recent evolution of inflation expectations in the euro area With all these caveats in mind, let us analyse the recent dynamics of inflation expectations, building on the aforementioned array of data available for the euro area. Short-term inflation expectations derived from financial market prices – the most updated data source – fell sharply from the peak observed in the second part of 2022 (fig. 2). However, See D’Acunto et al. (2021) and Malmendier and Nagel (2016). See Cukierman and Wachtel (1979). See Visco and Zevi (2021). their dynamics remain very volatile. The increase observed between February and the beginning of March due to renewed fears on the persistence of inflation, has indeed been recently followed by a drop caused by the recent elevated tensions in financial markets. ILS currently indicate that inflation is expected to stand at 3.5 per cent in early 2024 and then quickly fall to levels very close to 2 per cent. According to the same data source and on the basis of our estimates of inflation risk premia (which tend to be larger at longer horizons), annual price changes should stand at 2 per cent also in the long term (fig. 3).19 This evidence is substantially in line with what experts are saying. The results of the ECB Survey of Monetary Analysts conducted in early March suggest that inflation in the euro area will be at 5.6 per cent in 2023, 2.5 in 2024 and 2.0 in 2025 as well as in the long run. The anchoring of long-term inflation expectations is also confirmed by the results of the Survey of Professional Forecasters conducted in early January, which signals that they have decreased slightly to 2.1 per cent. Indications of a decline in inflation expectations, in particular at longer horizons, also emerge from the ECB Consumers Expectations Survey (ECB-CES). However, the median household still foresees inflation at relatively high levels: slightly less than 5 per cent in the next 12 months and, despite the sharp decline from the previous round, at 2.5 per cent between two and three years ahead (fig. 4). These values stand somewhat above those of market participants and economic experts, possibly reflecting a greater relevance of backward-looking elements in the expectation formation mechanism of households. A more granular analysis provides support to this conjecture, as it shows that the upward revision of inflation expectations (over all horizons) has been more intense on average for the less affluent households whose consumption basket includes a relatively higher share of the most volatile inflation components, namely energy and food items.20 In other words, the observed higher expectations from household surveys may, in large part, mirror what is happening in the energy and food sectors, and may therefore be subject to reversal as soon as pressures on the price of these items decrease. The most recent results of the ECB-CES point in this direction. As far as firms are concerned, the evidence is scanter and more mixed. According to the qualitative results of the survey conducted by the European Commission, firms’ intentions to increase their own selling prices over the following three months fell in January to their minimum since around early 2021 (fig. 5). Even the firms that participated in the 2022Q4 round of the Survey on Inflation and Growth Expectations conducted by the Bank of Italy reported, on the whole, forecasts of a deceleration in their sales prices, but maintained relatively high inflation expectations for a prolonged period of time. Our evidence suggests that they were particularly affected by the information, provided to the survey participants, about the latest data published on actual inflation, which was still very high and turned to be a major extrapolative factor at that time. However, the See Cecchetti et al. (2022). See De Fiore et al. (2022) and Neri et al. (2022). fact that for both firms and households the “expectations curve” is downward sloping is somewhat reassuring evidence against the risk of de-anchoring, as medium- to long-term inflation expectations remain well below current inflation levels. Close attention must indeed be paid not only to current levels of (short-term) price (and wage) expectations, but also to their prospective dynamics. An assessment of the risk of a de‑anchoring of expectations from the inflation target based merely on their current level could, in fact, be misleading. Since a de-anchoring could occur abruptly and non‑linearly, expectations must be assessed both in terms of their convergence towards the price stability objective as well as their responsiveness to shocks and their dispersion. From this perspective, evidence is mixed. On the one hand, expectations from market data and survey responses over the last two years have shown a relatively low sensitivity to inflation surprises in general. Indeed, the increase in long-term inflation expectations observed after the conclusion of the ECB strategy review in July 2021 seems more to reflect a re-anchoring to the 2 per cent inflation target than an upward de-anchoring.21 On the other hand, in many surveys the distributions of expected inflation have shown an increasing skewness towards high consumer price changes and a rise in uncertainty, suggesting a greater, albeit still currently moderate, risk of an upward shift in the entire distribution (fig. 6).22 Similar evidence emerges from the analysis of inflation options, which currently suggest that, in the next 5 years, the probability of inflation remaining on average (slightly) above target tends to be higher than the opposite. Although these features of expected inflation could merely be a consequence of the repeated upward surprises in actual inflation related to the unforeseen persistence of the energy shock over the last two years, they should nevertheless be monitored carefully. Inflation expectations and the ECB monetary policy As I have recently observed,23 evidence suggests that long-term inflation expectations in the euro area are substantially anchored (reflecting the overall credibility of monetary policy) and short- to medium-term expectations, while still remaining very volatile, are clearly on a downward trend. Similarly, the risk of wage-price spirals seems so far to be contained, although the requests for elevated wage increases in some euro-area countries, where the labour market is tighter, should be continuously and carefully assessed. In this context, the pricing strategies of companies will also play a central role. In particular, we will need to closely monitor whether, after the pass-through of the much higher energy costs observed in 2022, firms will allow final prices to reflect the most recent and substantial See Neri et al. (2022). See Reis (2021). This section mostly follows two recent lectures given at the University of Warwick (Visco, 2023a) and at the Frankfurt School of Finance & Management (Visco, 2023b). On those occasions, I also focused on the nature of the current inflation and its different sources in the euro area and in the United States, on how the Russian invasion of Ukraine transformed a temporary cost-push shock into a persistent one, leading to an acceleration of monetary normalisation and on how the same dramatic event is at the root of the ECB/Eurosystem forecasting errors observed over the course of 2022. cost reductions, which would imply a less intense tightening of financial conditions. This will be a critical step in achieving a lasting reduction in underlying inflation. A quantification of the structural drivers of inflation expectations in the euro area, as measured by ILS and obtained by breaking down their daily fluctuations into domestic and global shocks, confirms that the role of supply factors remains very important, but also suggests that the contribution of demand factors is gaining weight (fig. 7). This analysis focuses on the effects of changes in policy, demand and supply with respect to historical regularities. The results show that, since the start of the war in Ukraine, the inflation rate predicted over a five-year horizon has increased mostly in response to supply shocks; the much smaller contribution of demand shocks rose progressively over the course of 2022, reflecting improved business cycle conditions. Over the last year, very strong spillover effects of US monetary policy on euro area inflation expectations were registered. However, since the second half of 2022, we have received confirmation that the ECB’s monetary policy tightening is having, over time (and, I would add, with lags that, as expected, are relatively long and perhaps also variable…), the desired effects. The recent drop in energy prices, in particular that of natural gas, as well as the loosening of the bottlenecks, are therefore likely to reduce inflation expectations and, consequently, also facilitate the return of actual inflation to 2 per cent. The monetary tightening is already having a clearly visible impact on credit and money dynamics too. On the one hand, the 3-month (annualised) growth of loans to firms in the euro area became negative in January (-1.3 per cent; fig. 8), from a peak of almost 13 per cent last August, while loans to households also continued to decelerate. On the other hand, M3 is slowing down markedly (3.5 per cent in January on an annual basis, from 6.3 last September) and M1 growth became negative in January (-0.7 per cent, a historical minimum). When assessed in real terms, the dynamics of both aggregates are in deeply negative territory and at historical minima. If protracted, the fall in money, and the related freezing of funds in more illiquid forms of savings, could limit consumption and investment, helping to dampen short-to-medium term inflation expectations. This would further reinforce the reasons for a cautious conduct of monetary policy. Indeed, while the Brainard principle states that when the central bank is uncertain about the effects of its actions, it should move conservatively,24 an exception to this principle is the case of uncertainty around the persistence of inflation. When persistence is high, in fact, a strong monetary reaction may be required to avoid high inflation becoming entrenched in agents’ mind-sets.25 While this possibility should be carefully monitored, data on market- and survey-based inflation expectations – including their recent decline at short horizons and their decreasing profile, the marked deceleration of headline prices on a 3-month annualised basis observed since last October and the weakness of credit and money dynamics, may call into question the persistence of inflation at high levels in the euro area and suggest a more gradual monetary normalisation. In this respect, it will be crucial to observe a gradual fading away of the effects of the past shocks, also in the measures of underlying inflation. See Brainard (1967). See Ferrero et al. (2019). In this context, and with the aim of ensuring a timely return of inflation to the 2 per cent symmetric medium-term target, a week ago, the Governing Council of the ECB further raised its three key policy rates by 50 bps, bringing the overall increase since last July to 350 points and the deposit facility rate (the flagship rate in a regime of excess liquidity) to 3 per cent. Since the beginning of March, we have also been reducing the assets held in the monetary policy portfolio at a measured and predictable pace, through the partial reinvestment of the principal payments from maturing securities. This was intended to ensure that the contribution of this monetary instrument is also aligned with the monetary policy stance implied by the key interest rates. Looking forward, the Governing Council has reinforced the importance of a datadependent approach to the subsequent policy rate decisions, taking into account the elevated level of uncertainty brought about by recent financial market tensions. The Council’s reaction function and its future decisions will be guided by the evolution of the inflation outlook, in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission. With risks to medium-term price stability increasing sharply in 2022, the pace and scale of the adjustment of the official interest rates has been unprecedented. As the hiking cycle is progressing further, the ECB Governing Council will need to find the right balance between two risks: the risk of stopping too early before the “job is done”, which could cause inflation to remain persistently elevated and entrenched in price and wage setting processes, and that of overtightening monetary conditions, which would result in significant repercussions for economic activity, financial stability and, ultimately, medium-term price developments. Given the high volatility observed in financial markets over the last few weeks, including the shocks generated by the dismal bank developments in the United States and in Switzerland, and considering the substantial amount of tightening in the pipeline, a cautious approach should guide future monetary policy decisions, also from a financial stability perspective. This does not mean that monetary policy will be subject to financial dominance; quite on the contrary. It simply reflects the fact that price and financial stability are two strictly intertwined goals, as also the recent drop in market-based inflation expectations clearly signals. This also explains why effective regulation and diligent supervision are needed, as are backstops for crises. Monetary policy, however, should not be, nor should it be perceived as being, the only game in town. Indeed, as we have seen, inflation expectations do not only reflect the actions of the central banks: the return to price stability and the anchoring of inflation expectations will, in particular, greatly benefit from fiscal policies and negotiations between workers and firms operating in the same direction as monetary policy. What I stated at the beginning of this lecture must therefore be fully understood: the energy shock is like a tax on the euro area economy, which unfortunately cannot be returned to sender and cannot be circumvented through a fruitless race between wages and prices, nor through an excessive and permanent increase in public debt. From this perspective, labour and business in all euro-area countries must continue to behave responsibly. Wage negotiations should not go back in time to when they were purely backward-looking. Making up for the loss of purchasing power must instead rely on achieving sustained productivity growth. At the same time the pricing strategies of businesses will play a central role. In particular, we will have to closely monitor whether, after the pass-through of the higher energy costs observed in 2022, it will now work in reverse, with firms’ mark-ups reflecting the most recent declines, a key step to achieving a durable reduction of underlying inflation. Finally, although targeted and temporary fiscal measures to alleviate the burden on more severely hit households and firms should obviously not be ruled out, their financing should not put the progressive reduction of public debt at risk, and avoid further increasing its burden on the future generations. This is crucial not only to restore the necessary conditions for robust and lasting growth, but also to guarantee a timely return to the price stability target, the statutory objective of the central bank and an outcome that would be more difficult and costly to achieve in the event of excessive government transfers. References Ando A. and Brayton F. (1995), “Prices, Wages, and Employment in the US Economy: A Traditional Model and Tests of Some Alternatives” in R. Cross (ed.), Natural Rate of Unemployment: Reflections on 25 years of the Hypothesis, Cambridge, Cambridge University Press, Cambridge, UK, pp. 256-298. Bernanke B.S. (2007), “Inflation Expectations and Inflation Forecasting”, Address delivered at the Monetary Economics Workshop, National Bureau of Economic Research – Summer Institute, Cambridge, Mass., 10 July. Bernanke B.S. (2022), 21st Century Monetary Policy: The Federal Reserve from the Great Inflation to COVID-19, W.W. Norton & Co, New York. Blanchard O. (2016), “The Phillips Curve: Back to the ‘60s?”, American Economic Review, Vol. 196, No. 5, pp. 31-34. Brainard W.C. (1967), “Uncertainty and the Effectiveness of Policy”, American Economic Review, Vol. 57, No. 2, pp. 411-425. Cecchetti S., Grasso A. and Pericoli M. (2022), “An Analysis of Objective Inflation Expectations and Inflation Risk Premia”, Economic Working Papers, No. 1380, Bank of Italy, Rome. Coibion O. and Gorodnichenko Y. (2015), “Is the Phillips Curve Alive and Well after All? Inflation Expectations and the Missing Disinflation”, American Economic Journal: Macroeconomics, Vol. 7, No. 1, pp. 197-232. Coibion O., Gorodnichenko Y. and Kamdar R. (2018), “The Formation of Expectations, Inflation, and the Phillips Curve”, Journal of Economic Literature Vol. 56, No. 4, pp. 1447-1491. Coibion O., Gorodnichenko Y. and Ropele T. (2020), “Inflation Expectations and Firm Decisions: New Causal Evidence”, Quarterly Journal of Economics, Vol. 135, No. 1, pp. 165-219. Cukierman A. (1986), “Measuring Inflationary Expectations: A Review Essay”, Journal of Monetary Economics, Vol. 17, No. 2, pp. 315-324. Cukierman A. and Wachtel P. (1979), “Differential Inflationary Expectations and the Variability of the Rate of Inflation: Theory and Evidence”, American Economic Review, Vol. 69, No. 4, pp. 595-609. Del Negro M., Lenza M., Primiceri G. and Tambalotti A. (2020), “What’s Up with the Phillips Curve,” Brookings Papers on Economic Activity, Spring, pp. 301-357. D’Acunto F., Malmendier U., Ospina J. and Weber M. (2021), “Exposure to Grocery Prices and Inflation Expectations”, Journal of Political Economy, Vol. 129, No. 5, pp. 1615-1639. De Fiore F., Goel T., Igan D. and Moessner R. (2022), “Rising Household Inflation Expectations: What are the Communication Challenges for Central Banks?”, BIS Bulletin, No. 55, May. De Menil G. and Enzler J.J. (1972), “Prices and Wages in the FR-MIT-Penn Econometric Model”, in O. Eckstein (ed.), The Econometrics of Price Determination, Board of Governors of the Federal Reserve System – Social Science Research Council, Washington, DC, pp. 277-308. European Central Bank (2021a), “Inflation Expectations and their Role in Eurosystem Forecasting”, Occasional Paper, No. 264 (Work stream on inflation expectations, ECB Strategy Review). European Central Bank (2021b), “The ECB’s Price Stability Framework: Past Experience, and Current and Future Challenges”, Occasional Paper, No. 269 (Work stream on the price stability objective, ECB Strategy Review). Fabiani F., Druant M., Hernando I., Kwapil C., Landau B., Loupias C., Martins F., Mathä T., Sabbatini R., Stahl H. and Stokman A. (2006) “What Firms’ Surveys Tell Us about Price-Setting Behavior in the Euro Area”, International Journal of Central Banking, Vol. 2, No. 3, pp. 3-47. Ferrero G., Pietrunti M. and Tiseno A. (2019), “Benefits of Gradualism or Costs of Inaction? Monetary Policy in Times of Uncertainty”, Economic Working Papers, No. 1205, Bank of Italy, Rome. Friedman M. (1968), “The Role of Monetary Policy”, American Economic Review, Vol. 58, No. 1, pp. 1-17. Hazell J., Herreño J., Nakamura E. and Steinsson J. (2022), “The Slope of the Phillips Curve: Evidence from U.S. States”, Quarterly Journal of Economics, Vol. 137, No. 3, pp.1299-1344. Hobijn B., Miles R.A., Royal J. and Zhang J. (2023), “The Recent Steepening of the Phillips Curve”, Chicago Fed Letter, No. 475. Holden K., Peel D.A. and Thompson J.L. (1985), Expectations. Theory and Evidence, Macmillan, London. Hoynck C. and Rossi L. (2023), “The Drivers of Market-Based Inflation Expectations in the Euro Area and in the US”, mimeo, Bank of Italy, Rome. Klein L.R. and Goldberger A.S. (1955), An Econometric Model of the United States, 1929-1952, North Holland, Amsterdam. Lucas R.E.J. (1976), “Econometric Policy Evaluation: A Critique,” Carnegie-Rochester Conference Series on Public Policy, Vol. 1, No. 1, pp. 19-46. Malmendier U. and Nagel S. (2016), “Learning from Inflation Experiences”, Quarterly Journal of Economics, Vol. 131, No. 1, pp. 53-87. Neri S., Bulligan G., Cecchetti S., Corsello F., Papetti A., Riggi M., Rondinelli C. and Tagliabracci A. (2022), “On the Anchoring of Inflation Expectations in the Euro Area”, Occasional papers, No. 712, Bank of Italy, Rome. Pesaran M.H. (1987), The Limits to Rational Expectations, Basil Blackwell, Oxford. Phelps E.S. (1967), “Phillips Curves, Expectations of Inflation and Optimal Unemployment Over Time”, Economica, Vol. 34, No. 135, pp. 254-281. Phillips A.W. (1958), “The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957”, Economica, Vol. 25, No. 100, pp. 283-299. PIMCO (2023), “Inflation‑Linked Bonds (ILBs)”, Understanding Investing, PIMCO Europe Limited. Reis R. (2021), “Losing the Inflation Anchor”, Brookings Papers on Economic Activity, Fall, pp. 307-379. Romanchuk B. (2018), Breakeven Inflation Analysis, BondEconomics, Montréal Quebec. Rondinelli C. and Zizza R. (2020), “Spend Today or Spend Tomorrow? The Role of Inflation Expectations in Consumer Behaviour”, Economic Working Papers, No. 1276, Bank of Italy, Rome. Samuelson P.A. and Solow R.M. (1960), “Analytical Aspects of Anti-Inflation Policy”, American Economic Review, Vol. 50, No. 2, pp. 177-194. Visco I. (1984), Price Expectations in Rising Inflation, North-Holland, Amsterdam. Visco I. (2022), “Monetary Policy and Inflation: Recent Developments”, SUERF Policy Note, No. 291, October. Visco I. (2023a), “Monetary Policy and the Return of Inflation”, Bishnodat Persaud Lecture, Warwick Economics Summit 2023, University of Warwick, Coventry, UK, 11 February. Visco I. (2023b), “Monetary Policy and the Return of Inflation, Questions and Charts”, Lecture delivered at the Frankfurt School of Finance & Management, Frankfurt, 1 March. Visco I. and Zevi G. (2021) “Bounded Rationality and Expectations in Economics”, in R. Viale (ed.), Routledge Handbook of Bounded Rationality, Routledge, London, pp. 459-470. Weber M., D’Acunto F., Gorodnichenko Y. and Coibion O. (2022), “The Subjective Inflation Expectations of Households and Firms: Measurement, Determinants, and Implications”, Journal of Economic Perspectives, Vol. 36, No. 3, pp. 157-184. Wicksell K. (1898), Interest and Prices, MacMillan, London. Woodford M. (2003), Interest and Prices: Foundations of a Theory of Monetary Policy, Princeton University Press, Princeton. FIGURES Figure 1 The return of inflation (monthly data; annual percentage changes) Source: Eurostat, Istat, UK Office for National Statistics and US Bureau of Labor Statistics. Note: EA denotes the euro area (changing composition after 1999 and weighted average of the 11 countries participating to the start of Third Stage of the Economic and Monetary Union prior to that date). Figure 2 Market-based inflation expectations in the euro area (per cent) Inflation-linked swaps, spot rates (daily data) Inflation-linked swaps, 1-year forward rates Source: Bloomberg. Figure 3 Long-term inflation expectations in the euro area (per cent) Inflation-linked swaps, 5-year, 5 years forward (monthly data) Surveys among experts (quarterly and irregular data; median) Source: Bloomberg, ECB Survey of Monetary Analysts (ECB-SMA) and ECB Survey of Professional Forecasters (ECB-SPF). Note: (1) Inflation expectations and inflation risk premia are computed on the basis of the “fitted” ILS 5-year, 5 years forward (Cecchetti et al., 2022) therefore they do not necessarily add up to the “actual” data shown in the figure. – (2) The ECB-SPF is conducted quarterly, the ECB-SMA shortly before each monetary policy meeting of the ECB Governing Council; in ECB-SPF “long term” is defined as 4 calendar years ahead in Q1 and Q2 rounds and 5 calendar years ahead in Q3 and Q4 rounds; in ECB-SMA “long term” is defined as the horizon over which the effects of all shocks will vanish and should be interpreted as around 10 years. Figure 4 Consumers’ inflation expectations in the euro area (monthly data; per cent; median) Source: ECB Consumer Expectations Survey. Note: Inflation expectations 12 months ahead and between 2 and 3 years ahead. Figure 5 Firms’ pricing intentions in the euro area (monthly data; percentages) Source: European Commission. Note: Pricing intentions refer to the balance of the responses “increase” and “decrease” to the question on expected own price dynamics over the next three months. Figure 6 Inflation tail risks in the euro area (per cent) Survey-based probability distributions (ECB-SMA, long-term expectations; average) Probabilities from inflation options (daily data; 5 years horizon) Source: Bloomberg and ECB Survey of Monetary Analysts (ECB-SMA). Note: (1) ECB-SMA “long term” is defined as the horizon over which the effects of all shocks will vanish and should be interpreted as around 10 years. – (2) Probabilities inferred from inflation options; π<0 (π<1) is the probability of inflation being smaller than 0 (1) on average in the next 5 years; π>3 (π>4) is the probability of inflation being larger than 3 (4) on average in the next 5 years; 50-days moving averages. Figure 7 Drivers of changes in inflation expectations (daily data; percentage changes) Source: Hoynck and Rossi (2023). Note: 5-year inflation swap rates; changes with respect to 3 January 2022. Figure 8 Credit and money growth in the euro area Credit to firms (3-month annualised percentage change) M1 and M3 (12-month percentage changes) Source: ECB.
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at The International Association for Research in Income and Wealth (IARIW)-Bank of Italy conference on "Central Banks, Financial Markets and Inequality", Naples, 31 March 2023.
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Ignazio Visco: Inflation, monetary policy and inequalities. Some thoughts Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the IARIW-Bank of Italy Conference on "Central Banks, Financial Markets and Inequality", Naples, 31 March 2023. *** The return of inflation is severely affecting our daily lives as well as our economies, posing difficult challenges to central banks, and economic policy in general. In fact, inflation leads to pervasively heterogeneous distributive effects. One hundred years ago, John Maynard Keynes emphasised this by writing: "Each process, Inflation and Deflation alike, has inflicted great injuries. Each has an effect in altering the distribution of wealth between different classes, Inflation in this respect being the worse of the two". The social influences of inflation also featured prominently in the classical study of German hyperinflation in the 1920s by Costantino Bresciani Turroni. Milton Friedman apparently agreed with this, as he is often quoted as having said that "inflation is the cruelest tax of all". Clearly, the effects of high and prolonged inflation cannot be compared to the dramatic consequences of hyperinflation. Nor is analysing the redistributive effects of inflation simple and straightforward. The impact it has on the distribution of earnings may not be the same as its impact on the distribution of household incomes which, in turn, may differ from its effect on the distribution of wealth. The picture is complicated still further if we take into account factors such as the consequences of long spells of unemployment on human capital accumulation and future incomes. That said, the upsurge in inflation recorded since 2021 has undoubtedly hit poorer households disproportionately, not least because price increases have affected items, such as energy and food, that weigh heavier on these households' shopping cart, and that cannot easily be substituted with an alternative. However, we must note that, while the excess demand created by the very generous budgetary measures introduced to counter the negative consequences of the pandemics can be considered, given the ensuing bottlenecks in supply, the root of the rise in inflation in the United States, it has also gone hand in hand with stronger wage growth for lower incomes and higher employment. This has, on average, tended to compensate the negative effects of inflation on households at the bottom of the income distribution. It remains to be seen to what extent this compensation has been uniform across all poorer households. In any case, economic policies can be quite an effective tool for reducing the undesired redistributive effects of inflation. Recent data for Italy suggest that the impact on the income distribution of the wave of inflation observed since June 2021 was successfully mitigated by the budgetary measures the Government has implemented. In addition, the provisions targeting the less well-off have been the most effective. Other studies for Italy show that, by the end of 2021, the poorest households – those in the first quintile of the expenditure distribution – were hit by a higher inflation rate (5.3 per cent, almost 1/6 BIS - Central bankers' speeches two percentage points higher than that of the top quintile). Nevertheless, the rate of growth of their total labour income far outpaced, in real terms, that of the richest households (7 per cent, against a mere 0.8). The distribution of income and wealth across the population is also significant for the decision making process of central banks. It plays an important role in the transmission of monetary policy measures. At the same time, we are aware that monetary policy may contribute to shaping these distributions at business cycle frequencies, with potentially important feedback loops on its effectiveness. There is no shortage of review studies on monetary policy and inequality, so let me focus on only a few points. First, we need a sufficiently good understanding of the channels through which inequality affects the transmission of shocks across the economy. One lesson we have certainly learned in the last two decades (or perhaps something that has been "rediscovered" after the storm that followed the calm of the Great Moderation) is that the heterogeneity in the effects of economic shocks is of substantial importance. There is clear evidence that the collapse of real estate prices in the United States which followed the burst of the Global Financial Crisis, and the ensuing marked recession affected households very differently, depending on the composition of their balance sheets and their sources of income. The distribution of layoffs was also extremely uneven across sectors, occupations and skills. These heterogeneities, in turn, translated into very different effects on expenditure among households, depending on their propensity to consume – a point that has always been a concern of the Bank of Italy. My second point refers to the development of new models that account for these differences. The new class of heterogeneous agent new-Keynesian models, developed in the last few years by Gianluca Violante and other economists, combines heterogeneous agents with nominal rigidities. This increasingly substitutes the assumption of a representative agent present in the dynamic stochastic general equilibrium (DSGE) workhorse models that have been widely used to study the effects of macroeconomic shocks. The aggregation of heterogeneous households and firms implicitly matters, together with liquidity constraints and various kinds of buffers and rigidities, in the "old-style" macro-econometric models that are still, by necessity I would say, widely used in generating our forecasting scenarios. Allowing more explicitly for these characteristics, these new models definitely contribute to improving our understanding of the ways in which monetary policy operates. In traditional DSGE models, given the assumption of the representative agent, monetary policy affects the economy mainly through its direct impact on intertemporal substitution, in other words lowering interest rates increases aggregate demand by making consumption today more convenient than consumption tomorrow. In models with heterogeneous agents, however, we find ourselves observing a lesson we learned a few decades ago, that the indirect effects taking place via changes in demand and employment outweigh the direct effects of interest rate changes on the propensity to save. Thus, the shape of income distribution plays a significant role in the impact of monetary policy on the economy. In the last few years, research conducted at the Bank of Italy based on this class of models has shown, for example, that a higher propensity of households to save, 2/6 BIS - Central bankers' speeches possibly due to perceived greater risks of unemployment, may imply stronger effects of monetary policy. This would certainly not appear in models built around the representative agent, because the latter, fully insured over time, would save and consume regardless of their employment status. More in general, and this is my third point, models with heterogeneous agents allow for a deeper understanding of the effects of aggregate uncertainty as well as its interactions with idiosyncratic uncertainty and non-linearities, such as the presence of an effective lower bound for interest rates. Another study carried out at the Bank of Italy in particular shows that the reduction in output that follows a shock to the economy is much higher in the presence of macroeconomic uncertainty due, in large part, to heterogeneities between households. These are not just academic curiosities, even if they require more in-depth study and testing. They are clearly relevant today, as central banks are in search of the right balance between two risks. On one hand, easing monetary restrictions too early could cause inflation to remain persistently elevated and entrenched in price and wage setting run-ups. On the other hand, ending the restrictive stance too late (or making it far "too strong") could lead to significant negative repercussions for economic activity and financial stability, resulting in medium-term excessive disinflation. As I have mentioned, monetary policy is not only affected by inequality but also affects it in various ways. For example, lowering interest rates reduces the debt burden and the returns on savings and may lead to higher asset prices. Over time, it tends to spur economic activity and push up labour demand, as well as wages and consumer prices. Depending on expectations and on the shape and position of a complex relation such as the Phillips curve, it may lead to higher inflation. It is clear that, by taking any one of these channels in isolation, the effects of monetary policy look very uneven, as they would, for example, influence debtors in one direction and savers in the opposite one. Since these mechanisms also work in reverse, this may explain why central banks are criticised both when they lower and when they raise interest rates. What is perhaps especially interesting for the discussion generated during this conference is that, both when monetary policy becomes more restrictive and when it becomes more expansionary, central banks always continue to claim that they do not contribute to increasing inequality! However, to a certain degree we may find that this claim is to some extent supported by literature. Indeed, once all the channels mentioned above have been aggregated, losses and gains may appear more or less evenly distributed across households. At the Bank of Italy, for example, we have extensively analysed the consequences of the ECB's accommodative monetary policy in 2011-12, following the very dismal consequences of the euro area sovereign debt crisis. If anything, the expansionary stance during those years contributed to reducing income inequality in Italy, mainly by supporting the employment and wages of low-income households. The response of households' net worth was, however, slightly U-shaped along the wealth distribution: richer households benefitted more than the average from the expansionary policy, thanks to their capital gains, but poorer households also enjoyed a larger advantage, 3/6 BIS - Central bankers' speeches due to their higher leverage. The different response of income and wealth inequality highlights the fact that we need to be more precise when defining exactly the "inequality of what" we are analysing. The recent pandemic emergency has shown the importance of another channel through which monetary policy may affect inequality, albeit largely indirectly. Focusing on the first wave of infections, simulation results show that the public policies implemented in Italy to support workers and households during the first half of 2020 were successful. The post-transfer Gini index of the labour income distribution remained, in fact, almost constant compared to pre-crisis levels, instead of rising by several percentage points, as would have occurred in the absence of any intervention. Actual data on household incomes have later confirmed these early assessments. Monetary policy seemingly plays no part in this story. However, we should remember the severe tensions that arose in financial markets in March 2020. It is therefore reasonable to argue that introducing those public measures would have been much more difficult, even impossible, without the extraordinarily expansive monetary policy that was put in place, including the introduction of the ECB's Pandemic emergency purchase programme and the strengthening of the Asset purchase programme. Although the "fiscal dominance" alarm bell may now be ringing for some of you, these considerations do not suggest that central banks have become dependent on national governments, but rather highlight the importance of the complementarities between fiscal and monetary policies. These complementarities not only concern the response to the deflationary pressures that we observed before and during the pandemic, but also affect, as we speak, the fight against inflation. The experience of Italy, in this respect, is particularly insightful. In this country, the "conquest of inflation" took a long time, as we lived through the two dismal decades of the 1970s and 1980s. It has to be acknowledged that the economy was then subject to very severe shocks (and if there is one thing that I have learned during my long experience in central banking, it is that we may only dream of steady states and the like!). Following the conflicts of the "hot autumn" of the late 1960s, a weak Italian economy, and society, had to face the collapse of the Bretton Woods fixed exchange rates system and the two major oil shocks that followed the Yom Kippur war and the Iran revolution. Disinflation took place via a long process that only began in the early 1980s, with the strengthening of the central bank's autonomy and the independence of monetary policymaking. This in itself, however, was not sufficient. Fiscal policy remained strongly expansionary, with public debt rising apparently without constraint, and de jure or de facto wage indexation mechanisms fuelling wage-price spirals (the automatic redistributive consequences of the scala mobile, the formal indexation scheme, strongly contributing to the run-ups). Consequently, inflation remained persistently high. Only in the mid1990s, with a more cautious fiscal policy and the income policy agreements that took place following the major crisis of the European Monetary System, did the restrictive stance of monetary policy succeed in bringing inflation down, a necessary condition to Italy's participation, since 1999, in the Economic and Monetary Union. 4/6 BIS - Central bankers' speeches Times and conditions are obviously very different now but, based on that experience, I cannot help observing that, today, swiftly restoring price stability not only depends on the ECB's action, but also hinges on prudent fiscal policies, on responsible strategies among businesses and on reasonable agreements regarding labour costs. All of which is, obviously, easier said than done. But I believe that we must try harder to achieve it. My final thoughts concern measurement. Measuring the distribution of income or wealth poses a number of conceptual and practical challenges. Today, we have a multiplicity of sources, which range from household surveys to various administrative archives. Each source has its own pros and cons. As far as surveys are concerned, it is well known that they are affected by selective non-response and underreporting, which clearly cause problems for the measurement of inequality. The Bank of Italy has a long tradition in the field, as its Survey on Household Income and Wealth (SHIW) goes back to the early 1960s. Over time, we have made extensive efforts to correct for these biases using calibration techniques and satellite data sources. This has enabled us to address several important issues with greater confidence, as shown in one of the papers presented at this conference, on the financial fragilities of Italian households during the last twenty years. Much effort is currently devoted to developing timely estimates of inequality. Recent studies by the Eurosystem have made progress in constructing distributional financial accounts, which allow us to go beyond aggregate statistics. This distributional information is timely, available at higher frequency, and consistent with the national accounts. While these results are promising, more must undoubtedly be done, and, as I understand it, more is indeed in the pipeline. We also need distributional data on leverage, net savings and investment across non-financial corporations, and it is good to know that a pioneering production process has been initiated, as has been presented in another paper during this conference. The Bank of Italy's membership of the International Association for Research in Income and Wealth since its creation in 1965 bears witness to the attention we give to the measurement of income and wealth, covering both the aggregates and their distribution. Since its first Presidency, under Simon Kuznets, this Association has played a key role in the conceptual advancement of national accounts and in the analysis of the distribution of income and wealth. We are pleased to have actively contributed to both the organisation and the content of this conference, the third ever held in Italy. *** Let me conclude. Inequalities must be taken into account by central banks, as they are intrinsically related to inflation and because they affect, and are affected by, monetary policy. Nevertheless, addressing inequalities remains primarily a responsibility of governments. Only governments possess, in fact, the democratic legitimacy to assess how much redistribution is needed. Only governments can apply the most suitable tools, including taxation, transfers, access to education and the provision of other public services, not to mention market regulation. 5/6 BIS - Central bankers' speeches I therefore believe that including inequality in the mandate of monetary policy would be unwarranted. However, objectives such as improving financial inclusion and financial literacy are becoming increasingly more important to the realm of central banks' activities. These are indeed important components of a stable and well-functioning financial system, and may have the beneficial side effect of reducing the inequalities of income and wealth. We must also remember that, when monetary policy decisions are implemented, there will inevitably be individuals, households or businesses who perceive they are being hit harder, and some actually will be. Therefore, in pursuing our price stability mandate, we should not shy away from recognising that our measures also have consequences, at business cycle frequencies, on the distribution of incomes and wealth. This is so both when the threats we face are due to an overheated economy as well as when they stem from unemployment plainly being too high. Indeed, central banks contribute to the achievement of stable financial conditions and act in order to maintain price stability, often in the face of shocks that are as hard to foresee as they are to master. If they succeed, this will result in an economic environment more conducive to robust, sustainable and inclusive growth. The task is not an easy one: we need vision and knowledge, courage and solid efforts to better understand the complexities of the real world. As we proceed in this endeavour, we certainly need good models and good data, the subject matter of this conference and more to come. 6/6 BIS - Central bankers' speeches
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Speech by Mr Piero Cipollone, Deputy Governor of the Bank of Italy, at the International Conference, Roma Tre University, Rome, 14 April 2023.
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Piero Cipollone: Towards PSD3 - the dynamics of digitalized payment systems Speech by Mr Piero Cipollone, Deputy Governor of the Bank of Italy, at the International Conference Roma Tre University, Rome, 14 April 2023. *** Good Morning everyone, I would like to thank the organizers for inviting me to this conference to talk about the path towards PSD3. The payments sector is a key component of the European single market. Because of its lingering fragmentation along national borders, it has been the focus of several technical and regulatory interventions aimed at improving harmonization among Member States. During this journey, PSD2 has been a landmark: it has brought about greater harmonization and competition in payment services. However, two more milestones need to be achieved before we can claim the creation of a single EU retail payments market: to complete the job and thereby allow innovation to be as disruptive as it was meant to be in PSD2 and to embed in the regulation the dramatic changes in the technological landscape since PSD2 came into force. As for completing the job, three hurdles need to be overcome: first, the lack of full harmonization and complete application of the rules across Member States; as a matter of fact, the payment services framework still needs to be fully aligned with other EU policies and legislation: I am referring in particular to the General Data Protection Regulation - GDPR, the Electronic Money Directive - EMD2 and the Market in CryptoAssets Regulation - MiCAR. The cost of payment services is the second obstacle; it can be further reduced by fostering stronger competition within and across Member States. Third, the role of technological providers (including BigTechs) in the payments sector still needs to be clarified. As regards the technological shift, we should consider that PSD2 entered into force in Italy in 2018; back then, worlds such as smart contracts, DeFi, consensus mechanism, Dao and DLTs did not even exist and, when they did, they were unknown to most of us. Today they are part of everyday jargon and they have made their way into important legislation. As a matter of fact, the Pilot Regime entered into force on March 23. This is a legal framework that supports those who want to use DLTs to issue, trade, regulate and store assets. With the decree enacted on March 17, Italy was able to make the needed adjustment to its domestic legislation so that our financial industry can take advantage of the Pilot Regime. This new technological landscape offers many opportunities to develop new payment solutions that can improve general welfare. Whether this potential will be realized or not it depends on the way we design PSD3. However, because of the new technological infrastructure underlying the payment ecosystem, we cannot proceed with the same 1/4 BIS - Central bankers' speeches mindset that guided us in the past. On the contrary, we need to be creative and to approach the drawing board with three pillars in mind: i) how to solve the eternal question of whether to regulate entities, activities, or both; ii) the fact that the whole ecosystem is evolving continuously and swiftly; and iii) the need to promote publicprivate partnerships aimed at designing pro-innovation regulations; let me now elaborate on them. To answer the first question about who or what should we be regulating, I think we should first and foremost grasp the profound implications of the new technological environment; for me, the most striking feature is that the supply chain of a payment service is increasingly being fragmented among specialized and interdependent actors caught up in the structure created by the technology, even in absence of any contractual relationship. To make clear what I am trying to say, let's recall that before PSD2 came into existence, the main actors in the field of payment services were traditional PSPs (banks, electronic money institutions and payment institutions) and the regulations were centred on these entities. The PSD2 has contributed to bringing the exclusivity of the bank-customer relationship to an end; it allows new players such as Third Party Providers (TPPs) to offer new services to their customers, namely open banking services, without having any contractual relationship with the incumbent Payment Services Providers on whose books these customers hold their savings. As a matter of fact, PSD2 laid out a regulatory framework establishing that PSPs have to grant access to payments accounts to TPPs through technology solutions, known as Application Programming Interfaces – APIs. Here we can clearly see the innovative and disruptive potential of PSD2 and how it was able to foresee well in advance the technological leap that the payment industry could make for the benefit of the whole financial world: as a matter of fact, in the 'open' system, the technological standards replace the traditional 'private rules' (such as the agreements typical of card schemes) and become technological law themselves. This is why, in the context of open banking, agreements are not only unnecessary but are even forbidden; it's the 'API law' that regulates relationships between parties that do not know each other and that can only trust each other thanks to the digital guarantee offered by technological standards: this is also the path that will lead open banking towards open finance. These technological interdependences will be equally strong for payment solutions and financial services developed on blockchain platforms (I am referring in particular to emoney tokens as defined in the MiCA regulation). We then need to ponder the consequences of this new technological paradigm on our regulatory framework: the traditional supervisory and/or oversight approach, which postulates responsibilities that can clearly be traced back to specific entities, is no longer fit to meet the challenges posed by the new fragmented ecosystem of entities. It is therefore important to go beyond the 'single entities dimension' and to consider how to factor the relationships between subjects, infrastructures, tools and services into the 2/4 BIS - Central bankers' speeches new regulatory framework. One way forward is to think about a product-oriented approach, whereby all entities involved in the supply chain of payment services, such as the provision of digital wallets for payment transactions, need to comply with the core principles underpinning the oversight of payments systems, including beyond their reciprocal contractual relationship. This approach is in line with the new Eurosystem oversight framework for electronic payment instruments, schemes and arrangements (PISA), applicable as of November 2022, which is important because it introduces two significant innovations. First of all, it goes beyond the traditional notion of a 'funds transfer', embracing instead that of a 'value transfer', thereby extending the oversight scope to digital payment tokens (e.g. crypto-assets used within a scheme and stablecoins). The framework also targets not only traditional payment schemes but also 'arrangements', (e.g. the aforementioned digital wallets) thereby bringing the complex dimensions that characterize the new digital ecosystems under the overseer's competencies. This somewhat lengthy discussion about who and what should be on the regulator's radar brings me to my second pillar, which is the need to constantly bear in mind that we are dealing with a very dynamic ecosystem. Therefore, while we are looking at the current supply chains, and in particular at their single components, we also need to monitor how they evolve over time and, more importantly, whether new ones are established with the aim of providing new services or old services in an innovative way. I have in mind, for example, all micro-payments, machine initiated payments, and payments in real time using online services. Continuous monitoring of the current ecosystem is therefore pivotal to designing regulations that are flexible enough to be 'future-proof' so to speak, in an attempt to accommodate the continuous flow of innovation. Finally, and this is my third pillar, we must ask ourselves whether we, as regulators, are fully equipped to achieve the daunting task I have tried to sketch out so far or whether a closer interaction with payment industry might be useful. To be frank, we do not know a great deal about how to regulate areas where the boundaries among activities and subjects are blurred; these are uncharted waters for us and a more prudent approach is needed. Therefore, in addition to the rules on entities and activities and to the oversight framework on payments systems and services, it might be wise to rely on 'soft' regulations based on the definition of standards and practices developed according to a logic of public-private collaboration; this collaborative mode could ensure a sufficient degree of adherence with respect to ongoing technological development. A practical example of this approach is represented by the Protocol that the Bank of Italy has signed with two Italian Universities – Roma Tre and Cattolica di Milano – to explore the role of smart contracts in DLTs and to provide a basis for the development of technical standards and rules to be shared with those who, like the developers of the algorithms, are outside the traditional perimeter of intervention of the regulatory and control authorities; the first results of this work (a taxonomy of DLTs and the relative smart contracts) will soon be made public to collect observations and suggestions from 3/4 BIS - Central bankers' speeches all interested parties in order to be able to proceed to the most important phase for defining 'good principles'. To conclude, the retail payments industry is an incubator of innovation. Central banks and supervisory authorities can play a key role in ensuring that the positive externalities of innovation benefit consumers and businesses alike. The Bank of Italy is actively involved in this process by monitoring market developments, interacting with market operators and supporting the early adoption of digital technologies by the financial market. In this context – particularly with regard to interaction with the market – the activities of the Bank of Italy's innovation facilitators are noteworthy, especially those of the Comitato Pagamenti Italia (Italian Payments Committee, CPI), managed by the Bank of Italy, which recently launched three technical working groups dedicated respectively to: (i) PSD2 Review, (ii) Open Banking and (iii) Public Collections and Payments. The CPI is the reference forum within which the national community can define strategic orientations and actively participate in defining the solutions under discussion in the European arena, including those that are the subject of today's conference and that concern, through the PSD2 review, the future of the European payments industry. 4/4 BIS - Central bankers' speeches
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Statement by Mr Ignazio Visco, Governor of the Bank of Italy and Governor of the Constituency of Albania, Greece, Italy, Malta, Portugal, San Marino and Timor-Leste, at the 107th Meeting of the Development Committee (Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources to Developing Countries), Washington DC, 12 April 2023.
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Ignazio Visco: Inflation, monetary policy and inequalities. Some thoughts Statement by Mr Ignazio Visco, Governor of the Bank of Italy and Governor of the Constituency of Albania, Greece, Italy, Malta, Portugal, San Marino and Timor-Leste, at the 107th Meeting of the Development Committee (Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources to Developing Countries), Washington DC, 12 April 2023. *** After more than a year, the world continues to be shaken by the unlawful and unjustified Russian aggression to Ukraine. We strongly support and admire the Ukrainian people for their spirited and courageous resistance, and we commend the World Bank Group (WBG) for its continued support to Ukraine, including through the careful assessment of damage and needs. The global economy has shown more resilience than expected. Available indicators suggest that the slowdown, though substantial, is smaller than anticipated until a few months ago. Still, we are dealing with an extremely uncertain environment, and growth and inflation continue to be adversely affected by the war. Recent banking distress episodes and the subsequent tensions, though contained by the appropriate response of domestic authorities, make the outlook for the global economy and financial stability more uncertain and prone to downside risks. These episodes indicate the importance of sound regulation and close monitoring of intermediaries' exposure to, inter alia, interest rate and liquidity risks. This is true not only for banks but also for non-bank financial institutions, which neither benefit from a comparable regulatory and supervisory framework nor have access to central bank emergency liquidity assistance. The response to short-term developments should not come at the expense of the attention to longer-term issues. Because of compounded crises, many developing countries are facing setbacks in fighting extreme poverty and achieving shared prosperity. Learning losses, insufficient physical and digital investments, subdued productivity growth, and weak institutions are all constraints on output growth, contributing to debt vulnerabilities. The WBG is the key development partner to low- and middle-income countries. Over the last years, it has supported the immediate needs of the most vulnerable – badly hit by Covid-19, and the energy and food crises – while maintaining focus on long-term development goals. Now it must further integrate global challenges – like climate change, pandemics, fragility, and conflict – into its core development agenda to eradicate extreme poverty. Through its country engagements and its power as global convener, the WBG should provide technical assistance, combine financing and knowledge support effectively, and properly engage at the regional, national, subnational as well as sectoral level. 1/3 BIS - Central bankers' speeches Against this background, we welcome the Report on the Evolution of the WBG and commend management and the Board of Directors for their effort over the last months. The Development Committee paper presents a structured set of options to strengthen the WBG, giving a clear sense of the remarkable amount of work that has been produced so far and the complexity of the agenda we have ahead. We agree with the proposed mission statement which retains the Twin Goals – of eradicating extreme poverty and boosting shared prosperity – and recognizes the importance of addressing global challenges in an increasingly difficult economic context. We support the proposal to renew analytical products to better integrate global challenges into country partnership frameworks while maintaining the country ownership at the heart of the WBG model. It is also critical to provide greater emphasis on private sector development and domestic resource mobilization. Streamlining and consolidating such products will reduce the burden on the WBG's budget and on client countries. Further adjustments to the operating model are central to the WBG Evolution agenda. We expect clear and concrete proposals for strengthening knowledge delivery and outcome orientation to be discussed at the Annual Meetings in Marrakech. It should be made clearer how the many different groups producing relevant research and analytics point to a unitary vision for operations and engagements at the country, regional, and global levels. Impact evaluation and adaptive management have to become part and parcel of the WBG's modus operandi and accountability to all stakeholders. We urge the WBG to delve into a new framework for partnerships with client countries, other international financial institutions, and national agencies. Enhanced collaboration and division of labor based on comparative advantages are key to increasing development impact on communities and to optimal use of scarce public resources. A similar programmatic effort is needed to strengthen the internal collaboration among World Bank, IFC and MIGA (the so called "One WBG approach"). This requires overcoming a silo-type attitude across the Group by favoring information sharing, better exploiting diversity in skills and perspectives, and incentivizing staff to work together, including through metrics to monitor progress. The One WBG approach is a necessary condition for increasing private capital mobilization, a fundamental lever to matching developing countries' needs. The WBG has to take more effective action, including pushing for reforms of the business environment and triggering a significant expansion of the private investor base and available bankable projects. On the financial side, we are glad to see the remarkable initial results of the Capital Adequacy Frameworks review, designed, and launched under the G20 Italian Presidency. We should swiftly proceed with the proposals to remove the Statutory Lending Limit from the Articles of Agreement, lower the equity-to-loans ratio, and launch a pilot on Hybrid Capital with private investors. These measures, together with Management's decision to increase the limit for shareholder guarantees, would enable 2/3 BIS - Central bankers' speeches about $50 billion of additional lending over 10 years. Looking ahead, we invite the WBG to consider the implementation of all the other CAF recommendations, including the work aimed at strengthening and improving the usability of the GEMs database. In a similar vein, the Evolution agenda should trigger a better use of Trust Funds (TF) and Financial Intermediary Funds (FIF). With its thorough knowledge of FIFs, the WBG can help donors identify ways to better leverage their financial resources within each institution. We are confident that all of these actions will allow significant expansion of lending capacity, to better respond to development needs. We reaffirm our active engagement with IDA to support the poorest and most fragile countries. Concessional resources should continue to be directed to low-income countries, and we encourage management to explore additional balance sheet optimization measures, as well as any strategic use of IDA capital to smooth the financing resulting from current frontloading. The WBG Evolution discussion must be framed and developed within enhanced multilateralism. We cannot allow political tensions to draw new divisions across opposing blocs. This would generate large welfare losses, especially for emerging and developing economies, and seriously damage our ability to address major development challenges, as well as contain social and economic difficulties originating from digital and energy transitions. We should all work to keep the exchange of ideas and knowledge fluid and constructive, and to ensure that cooperation among countries remains strong. 3/3 BIS - Central bankers' speeches
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Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the ordinary general meeting of shareholders, Rome, 31 May 2023.
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Ignazio Visco: Address - ordinary general meeting of shareholders Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the ordinary general meeting of shareholders, Rome, 31 May 2023. *** Ladies and Gentlemen, The international situation continues to be marked by profound uncertainty. Geopolitical tensions and the repercussions of Russia's aggression against Ukraine led to a slowdown in global economic activity and contributed to the return of inflation. In 2022, the Governing Council of the European Central Bank (ECB) accelerated the process of monetary policy normalization, which had already started at the end of 2021, by intervening on purchases of securities held for monetary policy purposes, on interest rates and on the conditions applied to refinancing operations. The decisions taken have also been reflected in the Annual Accounts submitted to you today and will affect those of the coming years. We are keeping a close eye on the ongoing market tensions. The euro-area banking sector, thanks to capital strengthening policies and other prudential safeguards introduced for all European banks after the global financial crisis, is well capitalized. However, if necessary, the Eurosystem stands ready to act with all available tools to maintain the effectiveness of the monetary policy transmission mechanism and to preserve financial stability. Monetary policy and its impact on the Bank's Annual Accounts The Eurosystem's net asset purchases under the pandemic emergency purchase programme (PEPP) and the asset purchase programme (APP) ceased at the end of March and at the end of June 2022 respectively. The Governing Council of the ECB has decided that the full reinvestment of the principal payments from maturing securities purchased under the PEPP will continue until at least the end of 2024. Conversely, for the APP, the outstanding amount will be reduced, at a 'measured and predictable' pace, by €15 billion per month from the beginning of March to the end of June of this year, to be recalibrated over time to ensure consistency with the monetary policy strategy and stance. From July 2021 until the end of 2022, the key ECB interest rates were increased by a total of 250 basis points, bringing the rate on the main refinancing operations to 2.5 per cent, the marginal lending facility rate to 2.75 per cent and the Eurosystem's deposit facility rate to 2 per cent at 31 December. Over the last two months, the ECB has decided on two further rate increases of 50 basis points each. Since November, the interest rate conditions applied to the third series of targeted longer-term refinancing operations (TLTRO III) have also been made less advantageous for banks to ensure that they are consistent with the broader ongoing normalization process. This change in conditions led some counterparties to repay early 1/6 BIS - Central bankers' speeches the liquidity obtained in past years, leading to a reduction in the Eurosystem central banks' balance sheets after years of strong growth. The balance sheet At the end of 2022, the Bank of Italy's balance sheet assets stood at €1,477 billion, down by 4 per cent compared with 2021. Ten years ago, ahead of the APP and PEPP purchase programmes, the balance sheet total amounted to around €600 billion. Therefore, its size is very large compared with the past; however, as a result of the ongoing normalization process, it is set to decline, at a faster pace from the current year onwards. Securities purchased for monetary policy purposes continue to account for the bulk of the assets. This amount had reached €696 billion at the end of the year, of which about €630 billion was made up of Italian government securities. Compared with 2021, the total increased by €30 billion. Assets held for investment purposes amounted to €147 billion compared with €150 billion in the previous year; 84 per cent of these were public sector securities, 12 per cent were shares and investment fund shares, and the remaining 4 per cent were other financial assets. By contrast, refinancing operations decreased by €97 billion and stood at €356 billion at the end of the year. The reduction was largely due to early repayments of TLTRO III operations as a result of the recalibration of remuneration conditions mentioned earlier. On the liability side of the balance sheet, these repayments were reflected in a decline in credit institutions' deposits, which fell from €406 billion to €246 billion. The decrease in deposits was countered by the €94 billion increase in the Bank of Italy's negative TARGET balance, which reached €684 billion. The growth was mainly attributable to net sales of public sector securities by foreign investors and Italian residents' investment in foreign securities. The outflows were partially mitigated by the increase in Italian banks' net funding abroad and the disbursement of the second tranche of funds under the Recovery and Resilience Facility. The TARGET debt decreased in the early months of 2023; in March, it averaged around €660 billion. Main drivers of the 2022 net profit and expectations for the future The Bank's gross profit, before tax and transfer to the general risk provision, decreased significantly, from €9.2 billion to €5.9 billion, mainly due to the €1.5 billion contraction in net interest income and the higher write-downs on securities valued at market price, especially in US dollars, by a further €1.5 billion. The rise in the key ECB interest rates led to an immediate increase in the cost of balance sheet liabilities, mainly bank deposits and the negative TARGET balance. There was no corresponding increase in the yield on monetary policy assets, which are less sensitive to growth in interest rates, as they consist mainly of fixed-rate securities with medium to long-term maturities. 2/6 BIS - Central bankers' speeches This asymmetry negatively affects the net interest income, which after the decrease in 2022 is set to decline further in the coming years. The Bank of Italy will face negative gross profits in the next few years – like the ECB and other Eurosystem central banks have already done this year – before profits gradually return to growth. Monetary policy is indeed designed to fulfil its statutory mandate of price stability, although this may lead to a temporary deterioration in financial results. To better address these contingencies and to preserve its financial independence, the Bank of Italy has strengthened its capital in recent years – marked by strong monetary expansion – partly thanks to particularly high profits. In 2022, taking into account the size and composition of the balance sheet and in view of the negative profit projections associated with the increase in reference rates, the general risk provision was increased by €2.5 billion, half a billion more than in 2021, reaching €35.2 billion. The financial buffers built up so far are therefore more than sufficient to cover the gross losses that – on the basis of current market expectations regarding interest rate developments – are expected for 2023-24. Taxes for the year amounted to €1.3 billion, slightly above the 2021 level (€1.2 billion). The 2022 financial year therefore ended with a net profit of €2.1 billion, a decrease of €3.9 billion compared with the previous year. The Bank of Italy – an institution constantly evolving to serve the public Today is the last General Meeting of the Shareholders that I chair as Governor. In November, I will leave my position as head of this institution, which I joined in 1972. Over these eventful 12 years at the head of the Bank of Italy, I have witnessed major changes in how the Bank performs its functions. It has taken up new tasks, its responsibilities have grown. Its role in Europe has expanded significantly. Discussing ideas and sharing decisions within the ECB, which have been the distinctive features of monetary policy since the introduction of the euro, have become equally important in the area of banking supervision since the establishment of the Single Supervisory Mechanism (SSM) in November 2014. European regulations and national laws define the Bank's functions and provide for its independence and autonomy, preventing possible interference, including that from the shareholders of its capital. The private-style corporate structure which the Bank has had since its foundation was updated at the end of 2013 by raising the capital from €156,000 (300 million lire), as established by the 1936 Banking Law, to €7.5 billion. This reform extended the range of eligible shareholders and set a limit on individual ownership and the amount of dividends; the concentration of shares was therefore resolved. The last Meeting of Shareholders prior to the reform had 60 participants, now there are 173 participants; the majority of the capital is held by non-banks. Banking supervision is now highly integrated with insurance supervision, overseen by the Institute for the Supervision of Insurance (IVASS): the Governing Board of the Bank of Italy, with two additional members of the IVASS Board of Directors, is responsible for decisions of external relevance. In the euro area, the Bank of Italy is the national 3/6 BIS - Central bankers' speeches competent authority for both the European Single Supervisory Mechanism and the Single Resolution Mechanism, which act in a coordinated manner, while fully respecting each other's autonomy; the Bank is also responsible for implementing macroprudential policies to safeguard the stability of the financial system. Over time, the Bank functions have expanded into the areas of banking and financial customer protection, financial education, the supervision of cash handlers and combating money laundering. In this latter area, not least to ensure effective coordination with the new European Anti-Money Laundering and Countering the Financing of Terrorism Authority, the activities of the Financial Intelligence Unit for Italy were strengthened in 2022 and the new Anti-Money Laundering Supervision and Regulation Unit was formed. The Bank's role in Europe as a technology-intensive service provider in the areas of payment systems, markets and statistics has been further consolidated. We have been driving the development of the European infrastructure for settling transactions in central bank money (the TARGET system) and play a primary role in its operation; we are testing out banknote security features that will benefit the entire Eurosystem; we oversee payment systems, services and instruments to ensure adequate levels of security and efficiency, with benefits for customers. We are actively involved in the preparatory work for the possible introduction of a digital euro. Organizational and management structures have always been adapted promptly to changes in functions and in their working methods. The transition to a departmental model, associated with greater functional responsibilities and greater autonomy in resource management, has been completed. These changes reflected both new strategic policies and the need to react quickly to external changes. For example, by establishing the Directorate General for Consumer Protection and Financial Education we have demonstrated our focus on protecting consumers of financial services and raising their awareness. In recent years, we have strengthened the Bank's role as an accelerator for innovation and for the digital development of the financial market by complying with strict security, inclusiveness and transparency standards. With the establishment of an innovation centre based in Milan to support the development of innovative projects in the banking, insurance and financial sectors, we have created an informal channel for dialogue with operators. We fulfilled our legal mandate by establishing the regulatory sandbox – under the coordination of the Ministry of Economy and Finance and in cooperation with Consob and IVASS – which allows market operators to carry out tests in a controlled environment. The Italian Payments Committee, which we coordinate, defines possible strategies and application solutions for the entire domestic system. We strive to use the best corporate management practices. We introduced a new threeyear strategic planning system, with the aim of giving full prominence to the priority objectives in the allocation of resources. We are concluding a process of gradually integrating staff planning with that of IT, logistical and financial resources. The Bank's presence throughout the country has gradually been adapted to the changing demand for services and technology and to the increased demand for protection on the part of the public. We now have 38 branches, with partly different functions. The closure of local branches over time – from 97 in 2007 – addressed the need to ensure the greatest operational efficiency without reducing the quality of the 4/6 BIS - Central bankers' speeches services provided, partly thanks to the technological innovation introduced mainly in payment and currency circulation activities. We have strengthened our regional economic analysis – which is essential in an economy with marked local differences – and have developed public information services and financial education programmes for young people and adults. A substantial allocation of resources supports the Banking and Financial Ombudsman, which now has seven hubs after the addition of four new offices. Several of the Bank's branches cooperate in the assessment of loans eligible as collateral in monetary policy operations. The profound overhaul of processes facilitated by the widespread digitalization of activities has led us, on the one hand, to create tools that make it easier for the public to access services, and on the other hand, to save resources that can be partly allocated to our broadening tasks. Despite the expansion of our functions, the number of staff has fallen by 3.2 per cent over the past decade and total operating costs have decreased by 4.5 per cent in real terms. A comprehensive reform of staff management systems has been carried out in constant dialogue with the trade unions, and while challenging, it has strengthened the values that have always been at the core of our organization: merit, cooperation, decisionmaking skills and accountability. The more recent adoption of a hybrid work model is a conscious response to the challenges of innovation and organizational flexibility. The Bank was founded 130 years ago; since then, the world has undergone extraordinary changes, but it is my sincere belief that the Bank of Italy has always been able to keep pace with history. Even in the last twelve difficult years – I am proud to say this on behalf of our staff and of the current Governing Board, and with gratitude to the other previous seven members of the Governing Board for their commitment – the Bank has been able to keep up with institutional developments, technological progress and the changing needs of the public. All essential services to society, even during the most acute phases of the pandemic, have been provided effectively and without fail. The action of the Bank, which has always combined rigour in the performance of its institutional tasks with the utmost attention to costs, has shaped the size, composition and results of the annual accounts submitted to this Meeting of the Shareholders year after year. The Annual Accounts for 2022, which I am presenting today, continue to demonstrate the Bank's soundness, confirm the validity of previous decisions on prudential provisioning, and testify to its ability to perform its duties with adequate resources and with full independence and transparency. Proposal for the allocation of the net profit Dear shareholders, Pursuant to Article 38 of the Statute, acting on a proposal of the Governing Board and after hearing the opinion of the Board of Auditors, I present for your approval the Board of Directors' proposal for the allocation of the net profit. Under the current dividend policy, the amount paid to the Shareholders is kept within a range of €340 million to €380 million, provided that the net profit is sufficient and without prejudice to the Bank's capital adequacy. The difference between the upper limit of the range and the dividend paid to the Shareholders may be allocated to the special item for stabilizing dividends, until such item reaches a maximum amount of €450 million. Accordingly, from the net 5/6 BIS - Central bankers' speeches profit of €2,056 million, we propose allocating €340 million as a dividend to the Shareholders, equal to 4.5 per cent of the capital, the same amount allocated in each of the last few years. We propose allocating €40 million to the special item for stabilizing dividends, which would then amount to €280 million. As a result, the remaining profit for the State would be equal to €1,676 million which, in addition to taxes for the year amounting to €1,304 million, would bring the total amount allocated to the State to around €3 billion. Over the last ten years, the total amount allocated to the State would therefore equal €38.2 billion, in addition to taxes amounting to €12.8 billion. 6/6 BIS - Central bankers' speeches
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Welcome address by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy, at the conference on the use of surveys for monetary and economic policy, jointly organised by the Bank of Italy, the European Money and Finance Forum (SUERF), the European Central Bank and the European Investment Bank, Rome, 26 April 2023.
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The use of surveys for monetary and economic policy Welcome address by Luigi Federico Signorini Senior Deputy Governor of the Bank of Italy Rome, 26-27 April 2023 I am pleased to open the conference on the use of surveys for monetary and economic policy, jointly organised by the Bank of Italy, the European Money and Finance Forum (SUERF), the European Central Bank and the European Investment Bank. Let me first thank the organisers for putting together such a good programme, with top-level speakers from policy institutions and academia. Survey data have played and continue to play a key role in shaping our understanding of the economy and our ability to design effective policies. The Bank of Italy has a long tradition in this area. Following some even earlier experiments, we launched our Survey of Household Income and Wealth in the early 1960s. While there have been many changes since those early days, our SHIW is still very much alive; it has one of the longest continuous histories in this field. Soon afterwards, we started our annual Survey of Industrial and Service Firms, also still running. Over time, we have further expanded our toolbox, with higher-frequency surveys of firms and households, banks and real-estate agents. We have always prized our ability to collect pieces of data through surveys that are not provided by general statistics, but are meaningful for economic analysis in our fields of action. When I say ‘the ability to collect’, I do not only refer to legal freedom (or authority), or to practical means, which are just prerequisites. Even before Zvi Griliches’s famous 1985 critique1 – that while economists were increasingly using and even designing surveys, they were broadly uninterested in, and unaware of, the crucial steps of data collection and quality assessment – our surveys had always entailed, first, the close involvement of economic analysts at all stages and second, strong investment in statistical human capital, that is, both theoretical and practical expertise in statistics. We are proud that our experience spans decades. However, or perhaps I should say because of this, we are also keenly aware of the evolving challenges and opportunities. Zvi Griliches 1985. ‘Data and Econometricians-The Uneasy Alliance’, American Economic Review, vol. 75(2), pages 196-200. Among today’s challenges, one that I believe is common to many surveys around the world is that response rates have been declining for some time.2 Poor response rates drain budgets, as surveyors need to make more effort to enrol interviewees, and threaten the quality of the data, especially when the propensity to respond is correlated with the phenomena under investigation, like income and wealth. The usual statistical corrections are not always enough to do away with this kind of bias. This, moreover, is happening just as researchers and policymakers are looking for new, better and more comprehensive micro data. As societies become increasingly complex, and unprecedented shocks pose new questions for economic analysis, the need for timely and granular data grows ever more pressing. One is tempted to look for a response to both challenges in the proliferation of competitive alternative sources, such as administrative and unstructured (‘big’) data. The latter often have clear advantages in terms of timeliness, granularity and number of observations. Efficiency is also a consideration, as the marginal social cost of putting existing data to new uses is usually negligible. (The market price for accessing such data, of course, is not necessarily negligible in the case of proprietary data, especially if they possess monopoly value). On the face of it, there are limits to what statisticians can do with data that are not collected primarily for statistical purposes. The sample design, when the concept is at all applicable to such data, is often obscure. Coverage, accuracy, policy relevance and integrity are also typically unsatisfactory from the statistician’s point of view. However, given the phenomenal, ever-growing amount of data that is nowadays available somewhere in the global IT ecosystem, finding ways to overcome these difficulties is a challenge that statisticians should be eager to take on. One promising avenue (among many) is integrating administrative and/or unstructured data into surveys. Ideally, this would combine the richness and cheapness of the information contained in large databases with the methodological rigour of well-designed surveys. There are various possibilities. Administrative data, when they more or less cover the universe, can be (and are) used to improve the sampling design and correct any nonresponse bias. Unit-record linkage of surveys with administrative data (or sometimes even big unstructured data) can be used to populate certain survey variables, reducing the need for lengthy questionnaires and thus lessening the response burden. Data integration may also facilitate matching between surveys. Admittedly, exploiting such opportunities is not always an easy task; it may take time, and it should always be done with care. Integration of surveys with non-traditional data sources to produce multivariate indicators, such as the ratio of debt to income, may be challenging, since the two sources are likely to suffer from different quality issues. For instance, Britain’s Labour Force Survey (LFS) response rate halved from 2011 to 2021. The share of households responding to the US Current Population Survey (CPS) has decreased by about 20 percentage points over the last decade. The Bank of Italy’s Survey of Household Income and Wealth suffered a similar reduction between 2010 and 2020. The rest of Europe and Canada have seen similar trends. The linkage may be subject to respondents’ consent and thus introduce consent bias in lieu of nonresponse bias. Difficult negotiations among institutions, and/or payment to for-profit data owners, will often be needed to access such data. Privacy law or other confidentiality considerations will require adequate methods to protect the anonymity of respondents. And so on. There is little, however, that cannot be done with enough goodwill and ingenuity on all sides (assuming, that is, that finance is no constraint, given the savings that the use of external data may entail). Other opportunities for the development of surveys stem from advances in data collection techniques that enable statisticians to run mixed-mode surveys in a better way. In fact, the form of the interview (whether face-to-face, through the web, by telephone and so on) influences participants’ willingness to respond and the frankness or completeness of responses, and mixed approaches can improve participation rates if the mode is tailored to different groups’ preferences. While more research is needed to evaluate its effects more accurately, mixed-mode data collection may indeed be useful. Good distributional information remains essential for studying the transmission of shocks and underpins the decision-making of central banks and other institutions. Scientifically designed sample surveys have long been a key tool for measuring the policy-relevant dimensions of heterogeneity across populations of households, individuals, firms and so on. They are still invaluable as a way to answer meaningful analytical questions, and to tailor the data to the constantly changing needs of research and policy debate. While surveys face increasing costs and other challenges, these can be tackled at least in part by, among other things, making clever use of newly available massive data. Such usage can help enhance the value of surveys and make them fit for the 21st century, although it may also put a question mark over the survival of surveys as self-contained sets of information. As a data producer, the Bank of Italy is trying to exploit some of the new opportunities. The sampling design of the last wave of the SHIW has changed thanks to newly available administrative information on households’ income and indebtedness. This change has materially improved our ability to observe segments of the population that, though small, account for a high share of the target variables, such as wealth or debt. This helps to reconcile survey-based data with aggregate variables and to compute more accurate distributional statistics. Our Income, Consumption and Wealth joint project with the National Institute of Statistics (Istat) aims at creating a synthetic database for three different surveys,3 using statistical matching techniques that rely on a common set of administrative records. Together with the ECB, we have also started a Distributional Wealth Accounts project that is meant to bridge the gap between two survey waves by linking macro and micro data. Many similar experiments are taking place across the world, and this meeting is a good opportunity to exchange experiences, including beyond or between formal sessions. We look forward to the new and valuable insights that this conference will surely provide. Let me reiterate my welcome to all participants, including those following remotely. I wish you a fruitful two days of discussions. (1) the Survey on Income and Living Conditions (EU-SILC) for income; (2) the Household Budget Survey (HBS) for consumption; and (3) the Survey on Household Income and Wealth for wealth.
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Keynote remarks by Mr Piero Cipollone, Deputy Governor of the Bank of Italy, at the World Bank Global Payments Week 2023 "The Future of Payments", Marrakesh, 18 May 2023.
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Piero Cipollone: The future of payments and how to get there Keynote remarks by Mr Piero Cipollone, Deputy Governor of the Bank of Italy, at the World Bank Global Payments Week 2023 "The Future of Payments", Marrakesh, 18 May 2023. *** Ladies and gentlemen, I am honoured to address such a distinguished audience at the end of this important biennial conference on payments, organized by the World Bank and the Committee on Payments and Market Infrastructures (CPMI) of the Bank for International Settlements (BIS). The breadth of topics and the quality of the speakers are impressive. This speaks to the high value that the World Bank places on payments and financial market infrastructure. Normally, it is easier to speculate about the future than to figure out how to get there. I therefore want to talk about the steps central banks and payment system regulators and supervisors can take in the short term to drive change in the payments area. In so doing, I will also build on the results already achieved by the G20 Roadmap on crossborder payments. The payments ecosystem of the future Let's start by looking at the future. As public authorities, we want to enhance the payment options available to households, businesses and financial institutions because we know that this makes our economies more inclusive, productive and resilient.1 In the payments sector, the advances in digitalization and telecommunications are transforming the user experience, business models and infrastructure. Fintech operators, e-commerce providers and telecom companies have entered the scene.2 Digital wallets, instant payments and the integration of payment services into nonfinancial services are driving innovation. What will the payments ecosystem look like in ten years? It is hard to say, but it will certainly depend on us. Ideally, we are aiming for an economy where households and businesses can easily switch between payment solutions; where digital payments can be made in central bank digital currency or other forms of privately issued digital money; where instant settlement is the norm; where even the less well-off and less welleducated have access to payment solutions; where remittances and cross-border payments are as seamless as domestic payments; where financial and non-financial services can be easily bundled in new ways; where banks and non-bank providers work together and compete on a level playing field. This is our vision. Will it remain wishful thinking? Obviously, there are obstacles.3 For domestic payments costs and inclusion seem to be the key problems we are confronted with. Indeed many people who are unbanked or offline still have limited or no access to payments. Cross-border payments remain expensive and inefficient. The regulatory 1/4 BIS - Central bankers' speeches environment has yet to respond to the growing importance of international payments and to new forms of payments and providers. This brings me to what needs to be done now. For domestic payments many solutions are emerging to lower costs and enhance inclusion. Retail CBDC, stablecoins, tokenized deposits, fast payments are all good candidates. They compose an ecosystem that has not reached an equilibrium yet. It is likely that every jurisdiction will have a different configuration of this equilibrium, depending on its specific needs. My guess is that all these solutions will coexist, each caring for a specific use case. In this context, central banks need to make sure that a proper regulation is in place to avoid walled gardens, to foster competition and innovation in a safe environment for the benefits of households and firms. Speaking of safety, we need to spend some time thinking on how we can apply innovation and technology advancement to detect in real time the insurgence of bank runs. I am more concerned about cross border payments, to which I will now turn. A viable path A lot depends on us as central bankers. One specific responsibility central banks cannot shirk is to provide infrastructure services that market forces alone cannot afford to offer. The perfect solution would be a global platform accessible from all countries to make instant payments in all currencies. While we pursue this goal, let us bear in mind that there is a much simpler solution at hand, namely linking existing payment systems. Interlinking, in fact, means reusing existing infrastructure and reducing implementation times and costs. Fast payment systems have the greatest potential for interlinking. They operate on a continuous basis, allowing for a full overlap of operating hours for 24/7 access across jurisdictions. They generally have a high degree of semantic interoperability (i.e. they speak the same language) and process payments in a matter of seconds or minutes. However, interlinking many national systems entails a large number of bilateral connections. This drawback can be addressed by relying on existing regional platforms. A telling example is the recent experiment in which the Eurosystem's instant payments platform TIPS was linked with BUNA, the cross-border and multi-currency instant payment system owned by the Arab Monetary Fund. With a single link, we were able to connect the 19 TIPS countries with the 16 BUNA jurisdictions. In the continent that hosts this conference various regional solutions have proliferated. There are 5, possibly 6, regional payment systems. Thus linking all the African economies requires at most 15 connections. 2/4 BIS - Central bankers' speeches Building key payment infrastructure has traditionally been a direct responsibility of central banks; bilateral and multilateral cooperation among them can be a game changer. A sound cost-benefit analysis can be easily carried out. Building a fast payment system is doable in term of costs and time; the more so if established experiences are used as a blueprint, as it is only a matter of software and some standard hardware. The challenging part: creating the right regulatory environment Beyond the technical and semantic dimensions of interlinking, we have to ensure that the business models of the payment systems are also interoperable. This depends on the regulatory environment, industry standards and market practices. The G20 Roadmap on cross-border payments has already shed light on many business interoperability issues. A recent CPMI report on interlinking payment systems published last July provides a comprehensive overview of the many legal frictions; they range from currency regulations to the increased legal risks borne by interconnected systems, especially in terms of participant default, settlement finality, netting, novation and collateral enforcement provisions. Making cross-border payments also calls for a consistent implementation of anti-money laundering and countering the financing of terrorism regulations, mutually agreed data models and identifiers, and data exchange protocols that ensure data privacy and integrity across jurisdictions. For central banks, this is the most difficult part of the journey because our mandates and tools become less and less powerful as we move from technical interoperability to semantic and to business interoperability. We can still play an important role by using our power of advocacy, but we must recognize that governments and the private sector are in the driving seat. The G20 Roadmap on cross-border payments is an effective framework to facilitate cooperation between all stakeholders involved in interlinking arrangements. Given the importance of business interoperability, in the new phase of the Roadmap, the G20 tasked the CPMI with setting up a governance and oversight framework for the crossborder interlinking of payment systems. Here the World Bank has a major role to play for at least two reasons; first it has a global reach and therefore can support all countries included those that do not have other ways to tap into global knowledge; second it has the power to gather all the key players around the table: ministries of finance, prudential supervisory bodies, AML authorities, ministries of domestic affairs and data protection authorities. One might ask whether it is wise, for the international community to embark on such an undertaking now. My answer is definitely yes. In fact, ensuring good interoperability of business environments is a necessary condition for any kind of approach to crossborder payments, whether based on traditional or new technologies, such as distributed ledger technology and central bank currency (DLT and CBDC). *** 3/4 BIS - Central bankers' speeches Let me conclude. Progress in payment systems rests upon mutual trust and multilateral cooperation, both enabling conditions for advancing the G20 Roadmap. Central bank cooperation has a key role to play in developing payments infrastructures; the involvement of governments and private sector stakeholders is also essential to create a sound regulatory and market environment. If we take a holistic approach and focus our efforts on what is actually achievable, the payments sector will be even more capable of improving the prosperity of our economies while reducing inequality. 1 Cipollone P. (2021), The Italian G20 presidency and the cross-border payments agenda, speech at the CPMI Conference on 'Pushing the frontiers of payments', 19 March 2021. 2 McKinsey (2022), The 2022 McKinsey Global Payments Report. 3 Carstens A. (2020), Shaping the future of payments, BIS Quarterly Review, March 2020; Visco I. (2021), Opening remarks at the webinar "Enhancing Digital and Global Infrastructures in Cross-border Payments", organized on 27-28 September by the Bank of Italy during the Italian G20 Presidency; Cipollone P. (2022), Keynote speech at the Conference on Digital Platforms and Global Law, organized on 29 April 2022 by Unidroit in collaboration with Roma Tre University and the European Law Institute (ELI) in Rome. 4/4 BIS - Central bankers' speeches
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Introductory remarks by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy, at the 2023 Central Bank Gold Custodian conference, Rome, 18 May 2023.
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Introductory remarks Luigi Federico Signorini Senior Deputy Governor of the Bank of Italy 2023 Central Bank Gold Custodian Conference Rome, 18 May 2023 Half a century after the demise of the Bretton Woods system, in which gold still theoretically functioned as the ultimate monetary anchor, the metal continues to account for a significant share of official reserves. According to the World Gold Council, central banks hold around 17 per cent of all the gold that has been mined throughout history.1 IMF data show that gold accounts for more than 17 per cent of reserves.2 This share decreased from the early 1980s up to the Global Financial Crisis, but subsequently rose again.3 The year 2022 stands out. The total demand for gold was the highest on record since 1950 (1,135.7 tonnes). Several central banks contributed to this trend. The most active players were the Central Bank of Turkey, which reported an increase of 148 tonnes in its holdings,4 and the People’s Bank of China (62 tonnes).5 Egypt, Qatar, Iraq and India each reported net purchases of more than 30 tonnes. So much for Keynes’s ‘barbarous relic’.6 For some reason, gold still has an appeal. But why? According to the last annual central bank survey conducted by the World Gold Council,7 the reasons they hold gold are, in order of importance: 1) historical presence in the balance sheet; 2) price performance in times of crisis; 3) role as a store of value; 4) absence of default risk; 5) portfolio diversification; and 6) lack of political risk. Let me quickly elaborate on each of these factors. World Gold Council, Above-ground stocks, February 2023. Arslanalp, S., Eichengreen, B. & Simpson-Bell, C. 2023. Gold as International Reserves: A Barbarous Relic No More? IMF WP/23/14, Washington DC: USA. Data are taken from the International Monetary Fund’s International Financial Statistics (IFS), April 2023 edition. The percentage share of total foreign reserves held in gold is calculated by the World Gold Council. The value of gold holdings is calculated using the end-of-month LBMA Gold price published daily by ICE Benchmark Administration. The increase in gold holdings outlined by the Central Bank of Turkey should be read in light of the measures introduced by the Turkish President in December 2021 with the aim of preventing dollarisation in the country. Among the others, as reported by the FT, the government had signed contracts with five gold refineries to convert jewellery handed over under the programme into gold bullion that would contribute to the country’s central bank reserves. World Gold Council, Gold Demand Trends Full Year 2022, January 2023. ‘Treaty on monetary reform’, 1932. World Gold Council, You asked, we answered: the history, context and outlook for central bank gold buying, March 2023. The first is obvious (with so much gold held by central banks, any significant sale is bound to impact prices hugely), but of little use as an explanation for any increase. Default is impossible, though price movements are not. In fact, the price of gold fluctuates greatly: its annual volatility over the last 50 years has been around 19 per cent, compared with 15 per cent for global equity.8 Low storage costs per unit of value used to be one reason why precious metals functioned as a store of value for much of recorded history (from antiquity to Florence’s fiorino, Britain’s gold pound, France’s Napoléon), along with other features such as inalterability and (to an extent) intrinsic utility. However, the cost of physically storing gold is nowadays incomparably higher, per dollar or euro or pound sterling or franc, than holding costs for most substitutes available today; and, while transferring electronic money costs next to nothing, actually moving gold from one country to another, as in the textbook representation of the gold standard, is as cumbersome and costly as it has always been. Therefore, even gold’s use as a store of value must have something to do with history. Yet also, perhaps, with risk, especially super-tail risk. Electronic reserve assets can conceivably disappear in extreme circumstances; gold cannot. (You might theoretically conceive of a planetary catastrophe that would pulverise even gold, but in such circumstances this is not likely to be the most pressing of humankind’s problems). Which brings us to the more interesting reasons why central banks still hold significant amounts of gold reserves. Let’s start with ‘normal’ market risk. With regard to diversification benefits, as this audience knows very well, an ample empirical literature shows that gold has a low correlation with other traditional asset classes.9 According to a recent estimate,10 gold has shown a monthly correlation of 0.01 and 0.09 with the S&P 500 Index and the Bloomberg US Aggregate Bond Index respectively since 1970. Importantly, gold has often worked as a ‘safe haven’, a hedge against tail risk.11 This is also well documented in the literature.12 To mention but one familiar example, in 2022, a financially turbulent year, gold outperformed all the other major investible asset classes with the exception of cash, showing a return close to zero (in dollars) while everything else was deeply negative: specifically, global bonds lost 16 per cent,13 and global equity around 14 per cent,14 of their respective values. (The increased demand for gold that I mentioned earlier is an obvious factor). Source: Bloomberg data, annualised standard deviation of real returns in the period 1971-2022. Additional statistics, in nominal terms, are provided by the World Gold Council (link). For a comprehensive review, see O’Connor, F. A., Lucey, B. M., Batten, J. A. & Baur, D. G. (2015), ‘The financial economics of gold—A survey’, International Review of Financial Analysis, 41, 186-205. SSGA, Gold as a Strategic Asset Class, March 2023. BIS, What share for gold? On the interaction of gold and foreign exchange reserve returns, November 2020. See Panfili, F., Daini, F., Potente, F., & Reale, G. (2015). L’oro come ‘safe haven asset’? Evidenze empiriche basate su un confronto fra diverse attività finanziarie (only in Italian); and Baur, D. G. & McDermott, T. K. (2010). Is gold a safe haven? International evidence. Journal of Banking & Finance, 34(8), 1886-1898. Bloomberg Global Aggregate Bond Index. MSCI World Index. Political risk is linked to tail financial risk, but has features of its own. A recent study by the IMF15 investigates the reasons behind the steady rise in the share of gold holdings in official reserve assets since the Global Financial Crisis, particularly in emerging and developing economies.16 According to the study, reserve managers view gold as a hedge against economic and geopolitical risks; as a result, gold shares increase with political uncertainty. In addition, reserve managers in emerging markets tend to increase gold holdings in response to the risk of sanctions. Many of the largest year-on-year increases in individual central banks’ gold holdings appear to have occurred at times when those countries were, or thought they might become, subject to financial sanctions. The year 2022 again vividly illustrates the point. Russia’s aggression against Ukraine resulted in sanctions, whereby approximately half of the Russian Central Bank’s international reserves were frozen.17 Some countries sought to acquire alternative assets that were less exposed to sanctions. Gold is likely to have been a beneficiary.18 Whether or not this shield against political risk can work in practice, when needed, depends on several factors, such as physical location and access to markets for transactions. Moreover, if a country must sell gold, it will probably happen during a situation of global distress, and the amplified impact on price that is typical of such situations might even make the move self-defeating.19 More generally, gold has its drawbacks: it is, as I said, costly to store, transport, and secure; it doesn’t bear interest (though it can, to an extent, be lent out in the form of term deposits); and it is difficult to sell. How long gold will stay with us, we cannot tell. Even Keynes, in the end, agreed (how reluctantly I am not sure I know) to an indirectly gold-based system at Bretton Woods.20 Mises famously, if less successfully, argued in favour of the gold standard, and said that one was free to call it a barbarous relic, to the extent that one did not object to the application of the same term to every historically determined institution. From today’s perspective, it is less a question of first principles than one of practical costs and benefits, as well as prudent financial management. However, looking at the enduring attraction of gold, not just as an ornament but also in its incarnation as money, one cannot entirely escape the thought that there is something in this unusual chemical element that goes beyond the rational arguments Arslanalp, S., Eichengreen, B. & Simpson-Bell, C. 2023. Gold as International Reserves: A Barbarous Relic No More? IMF WP/23/14, Washington DC: USA. See Appendix. CEPR, In search of Russia’s foreign assets, January 2023. Nikkei, Gold snatched up by central banks at fastest pace in 55 years, February 2023. It is also possible to liquidate gold through alternative ways that are expected to exert a less meaningful influence on market price. In this respect, two viable approaches would be: 1) ‘off-market’ gold sales, which are executed directly between the parties and facilitated by an intermediary; and 2) gold swaps, where the metal is exchanged for foreign exchange deposits (or other reserve assets) with an agreement that the transaction be reversed at an agreed future date, at an agreed price. (Source: IMF). Speech at the House of Lords (23 May 1944), in Collected writings, Vol. XXVII, pp. 9ff. In fact, Keynes argued that the dollar standard established at Bretton Woods was the ‘exact opposite’ of the gold standard he had so forcefully criticised in the past, but he accepted that gold could serve a useful function as ‘a convenient common denominator’. for and against its monetary role. The sheer beauty, the fascination of its glow and durability – my predecessor, Salvatore Rossi, in a nice book of his called ‘Oro’, or ‘Gold’, says it all entails a bit of ‘mystery’. One thing is certain: those rare people who have the opportunity to catch a glimpse of the gold stored inside the vaults of a major central bank cannot but feel a sense of awe. A small, indirect reminder, perhaps, of the key responsibilities of gold custodians worldwide. APPENDIX Gold Holdings of the Official Sector, 1950-2021 Gold Holdings in Official Reserve Assets, 1999-2022
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Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at a meeting for the presentation of the Annual Report 2022 - 129th Financial Year, Rome, 31 May 2023.
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The Governor’s Concluding Remarks Financial Year 129th financial year Annual Report Rome, 31 May 2023 th The Governor’s Concluding Remarks Annual Report 2022 – 129th Financial Year Rome, 31 May 2023 Ladies and Gentlemen, Russia’s invasion of Ukraine continues to have heavy repercussions on the global economy, calling into question international economic and financial integration and the multilateral world order that took shape after the end of the Cold War. A return to the tensions and divisions between opposing blocs of countries poses a real threat to the sustainable and balanced development of all economies. As well as condemning the blatant violation of the sovereignty and territorial integrity of a free nation, it is essential, in spite of everything, to pursue international cooperation strongly, including in the economic and financial fields, and to seek dialogue that embraces the diversity of values across countries and cultures in keeping with the basic principles of peaceful coexistence. The Italian economy has demonstrated a reassuring capacity to react to the consequences of the war in Ukraine, just as it did when exiting the pandemic. Corporate restructuring processes over the last ten years, although incomplete and uneven across sectors and regions, have made our production system more robust. The acceleration of capital accumulation, the improvement in productivity after a long period of stagnation, and the recovery of international competitiveness are all encouraging signs that need to become stronger, in order to overcome the delays and underlying weaknesses that still prevent our economy from unlocking its full potential. Our ability to return to a less uncertain and more balanced structural growth path will depend on how well we are able to tackle climate change and the digital transition, and to deliver on the ongoing reform process. The international environment In 2022, global economic growth remained below 3.5 per cent, 1 percentage point less than expected on the eve of the outbreak of war. According to the International Monetary Fund (IMF), it is unlikely to reach 3 per cent this year (Figure 1). Inflation almost touched 9 per cent globally; in the advanced countries, it exceeded 7 per cent on average, the highest value for 40 years. In some economies, and particularly in the United States, the acceleration in prices was largely driven by a sharp rebound in consumption that began in 2021, while supply was still constrained by pandemic-related restrictions and, as regards international trade, by the resulting bottlenecks in the supply of commodities and intermediate inputs (Figure 2). In Europe, by contrast, inflation was fuelled mainly by higher energy prices, especially natural gas prices, which soared to unprecedented levels. After hovering around €20 per megawatt hour in early 2021, gas prices later edged up, accelerating over the summer, and exceeded €100 on average at the end of the year. This increase was due to the cuts in gas supplies from Russia, initially on account of the weather conditions, and later mostly as a means of political pressure in connection with the controversial opening of the Nord Stream 2 pipeline. With the outbreak of war, gas prices started to fluctuate dramatically, peaking at €350 in the summer of 2022, when all European countries were trying to replenish their stocks to secure minimum supplies for the winter. On average over the year, gas prices were more than six times higher in Europe than in the United States. A mild winter season, lower gas consumption following price increases, governments’ saving measures, and the fulfilment of gas storage targets all combined to bring prices down to below €30. The growth outlook for the world economy remains uncertain for the coming months. It is burdened by the ongoing conflict in Ukraine, as well as by doubts about the strength of the economic recovery in China after it decided to lift its severe pandemic restrictions at the end of last year. Along with energy prices, inflation is now falling both in Europe and in the United States. However, its core component, i.e. excluding food and energy, is still high and, for the time being, monetary policies remain tight to keep price growth under control over the medium term. The effects of these policies, which have been deployed almost simultaneously in all the main countries, may be compounded by risks of instability in the global financial system. These risks materialized last March with the failures of a number of banks in the United States and Switzerland, which led to a sharp increase in market volatility and significant portfolio reallocations. These tensions have largely ebbed away, also thanks to the firm and timely response of the authorities in those countries. However, financial bond yields in the advanced markets remain significantly higher than in early March, as opposed to corporate bond yields. The fallout of global tensions, weaker growth and tighter financial conditions is felt more strongly in the emerging and developing economies. The public finances, already burdened by the increase in the debt as a result of the pandemic, are more vulnerable. Around one fourth of emerging countries The Governor’s Concluding Remarks Annual Report 2022 BANCA D’ITALIA are currently regarded as high-risk by the IMF, as their sovereign spreads are now close to default levels. Even beyond the short term, uncertainty still abounds. In recent decades, cross-border trade and the organization of production on a global scale have made for a more efficient allocation of inputs. However, the pandemic has exposed the vulnerability of complex international supply chains, with potential sudden disruptions in intermediate input flows originating from critical hubs. The war in Ukraine and the subsequent energy crisis have made these weaknesses even clearer; several countries, not only in the advanced world, have embarked on policies to limit these disruptions. Rifts in international relations can have long-lasting effects and influence long-term business strategies, including manufacturing location decisions. Since the invasion of Ukraine, business surveys, both in Italy and abroad, show that a trend, though still moderate, is underway towards the regionalization and diversification of supply chains. In Italy at least, this trend is stronger among the firms more exposed to China. Public policies too should aim to protect and diversify the sourcing of commodities and essential intermediate inputs, though this kind of adjustment will take time and entail costs that cannot be ignored. It is hampered by the geographical distribution of primary resources and, at least in the short term, by the high level of specialization of certain production processes. This goal should be pursued without calling into question the foundations of a world order that is based on common rules and open to the movement of goods, services, capital, people and ideas. National security can be protected by steering clear of broad-based protectionism, which would reinforce the trend of rising barriers to trade and foreign direct investment that has emerged over the last five years (Figure 3). Not only would indiscriminate use of subsidies and restrictions in international trade distort competition in an attempt to influence firms’ location decisions, it could also spark new tensions, including in relations between countries sharing similar values, institutions and policies. In some cases, protectionist measures may even prove detrimental to the goal of increasing geographical diversification in sourcing. Over the past three decades, cross-border trade has made a fundamental contribution to the general and economic well-being of a large part of the world’s population. The number of people living in extreme poverty has fallen from almost 2 billion to less than 700 million; the share of the population suffering from malnutrition has dropped from over 25 per cent to below 15 per cent in the developing countries. Meanwhile, there has been a dramatic BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2022 improvement in literacy and an extension of life expectancy of more than ten years on average. The improvements were more palpable for those economies that were fully integrated into global trade and global value chains over this period. Instead, some countries, mainly in Sub-Saharan Africa, where most of the projected demographic expansion in the coming decades is concentrated, have only benefited marginally. In recent years, the explosion of regional conflicts, the increased frequency of natural disasters and the pandemic have held back progress. Globalization and the technological innovation that has expedited it have therefore created an extraordinary opportunity for development. In the advanced countries, however, the result has been less employment stability and, in some cases, greater inequality, which has not been properly addressed by public policies. A growing sense of insecurity and injustice has thus crept in among large sections of the population, whose incomes have struggled to increase. This feeling has been exacerbated by the continuous rise in the incomes of the population segment that is already much richer, particularly in English-speaking countries. Partly as a result of this, public opinion has become increasingly critical of opening up to international trade. It would be a mistake to underestimate the benefits of market integration, especially for an open economy like ours. Nor can we forget that the challenges we need to address today – from combating climate change to countering pandemic threats, from reducing poverty to managing migrant flows – are global in nature and can only be solved through orchestrated efforts worldwide. Externally, it is therefore necessary to preserve the functioning of multilateral institutions and reinforce international cooperation. Internally, however, it is crucial to introduce economic measures that can actually improve the wellbeing of all citizens, as well as to communicate them effectively in terms of tools and targets. European policies show that confidence in the benefits of international economic integration can indeed be strengthened. According to Eurobarometer surveys, public support for Europe’s integration process, which worsened in the decade preceding the vote on the United Kingdom’s exit from the European Union, has grown again in recent years (Figure 4). This has also reflected the measures taken to support the post-pandemic recovery, particularly the Next Generation EU (NGEU) programme. The Governor’s Concluding Remarks Annual Report 2022 BANCA D’ITALIA The economic situation and monetary policy in the euro area The effects of the conflict in Ukraine on the euro-area economy have been amplified by the marked dependence of many Member States on energy imports, especially natural gas. The rises in their prices, together with those of agricultural products, also mainly caused by the war, have affected households’ purchasing power, above all of the less well-off, and firms’ production costs. Yet if we look at 2022 as a whole, aggregate demand, production and employment continued in the recovery that began when the most acute phase of the pandemic emergency was over and that was supported by the considerable resources allocated by national governments and by the European Union. Since last autumn, however, economic activity has stagnated overall. Consumer price inflation has risen to 8.4 per cent on average over the year, reaching a peak of 10.6 per cent in the twelve months up to October (Figure 5). The increases in commodity prices have gradually passed through to the prices of other goods and services. More than three quarters of the growth in the overall consumer price index seems to be directly or indirectly attributable to the higher prices of energy and of food products. The delays in adapting the global supply of intermediate goods have contributed to the increase in production costs. Headline inflation has fallen since the final part of 2022, thanks to the sharp drop in energy costs, going down to 7 per cent in the spring of this year, but core inflation has continued to rise, standing at 5.6 per cent in April. This component includes items whose prices are reviewed less frequently; it is still responding, with some delay, to the higher prices of imported commodities, and it is expected to reflect their reduction in an equally gradual way. In 2022, wage pressures in the euro area remained limited overall: the growth in actual hourly pay stood at just over 3.5 per cent, thus remaining well below inflation. Requests for high salary increases have become more frequent recently, sometimes in tandem with a high level of conflict, especially in countries with lower unemployment. Thanks to the limited presence of automatic wage indexation mechanisms based on past inflation and to the one-off nature of a large part of wage increases, and with no widespread rises in profit margins, the risk of a wage-price spiral has remained low up until now. According to the latest projections, following an increase of 3.5 per cent in 2022, economic activity in the euro area will slow down considerably on average this year, and will then return to sustained growth. Inflation will come down over the next few months, reflecting above all the trend in the prices of energy products; in the scenario drawn up in March by the European Central Bank (ECB), currently being updated, it is projected to return to 2 per cent in the second half of 2025. The margin of uncertainty remains high. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2022 In line with the resolve to bring inflation back fairly rapidly to the target of 2 per cent, at the beginning of May, the ECB Governing Council confirmed its restrictive measures, though limiting the increase in the key interest rates to 25 basis points. The interest rate applied to deposits that banks hold with the Eurosystem rose from the negative levels recorded last July to 3.25 per cent. The Council reiterated that future decisions will continue to be guided, on a meeting-by-meeting basis, by an overall assessment of the medium-term inflation outlook in light of new economic and financial data, the performance of the core component and the intensity of monetary policy transmission to the economy. Leverage on key interest rates is still the main element for defining the monetary policy stance. To ensure full alignment with this stance, there was a more rapid repayment of the long-term refinancing provided to banks and a measured and predictable decrease in the assets held in the Eurosystem’s monetary policy portfolios was begun last March. The response of the Governing Council to the acceleration in prices has been fully in line with the gradual changes in the situation and in the data as they have become available. It should be remembered that, in June 2021, despite the rises in natural gas prices and the bottlenecks in the supply of intermediate products, headline inflation in the euro area had still not reached 2 per cent and core inflation was below 1 per cent. In the same period, inflation was around 5 per cent in the United States, largely due to the recovery in demand linked to the strong stimulus of fiscal policy. Not even the markets were signalling expectations of a prolonged acceleration in prices: in the euro area, the two-year inflation expectations derived from inflation-linked swaps equalled 1.5 per cent, compared with almost double that figure in the United States. The subsequent increase in euro-area inflation, which was extraordinary and mostly unexpected, was caused above all by the equally exceptional leap in energy prices. The extensive forecasting mistakes made by ECB and Eurosystem staff, and by almost all analysts, were mainly attributable to the general underestimation of the effects of geopolitical changes. At the end of 2021, when we announced the start of the monetary normalization process, which immediately led to a sharp rise in long-term interest rates, market prices continued to indicate expectations of a marked fall in gas prices (Figure 6). The Russian aggression against Ukraine transformed a temporary price shock into something far more intense and persistent. Despite all the uncertainties connected with the conflict, monetary normalization was swift. The termination of net purchases of financial assets was brought forward to the end of June. A resolute process was begun immediately afterwards to raise the key interest rates from the highly accommodative levels set in previous years The Governor’s Concluding Remarks Annual Report 2022 BANCA D’ITALIA to successfully counter the risk of deflation. In order to ensure that monetary policy is transmitted as evenly as possible across euro-area countries, it was decided to reinvest the securities purchased under the pandemic emergency programme in a flexible manner, and the new Transmission Protection Instrument (TPI), aimed at mitigating the risks of fragmentation of financial conditions, was introduced. Market yields have adapted quickly to the altered monetary policy stance. Since the start of the normalization process, one-year risk-free interest rates have picked up from barely negative levels to the current 3.7 per cent, while those at ten years have come from barely positive levels to 2.9 per cent (Figure 7). The effectiveness of the Governing Council’s actions is confirmed by the changes in inflation expectations, which are an important anchor for firms’ decisions on prices and for wage growth. Having reached almost 9 per cent at the end of August 2022, market expectations over a twelve-month horizon now stand at just below 3 per cent; signs of a fall in expectations are also emerging from surveys conducted on firms and households. Longerterm expectations, which are a measure of a central bank’s credibility, remain in line with the definition of price stability, while the risk of inflation being higher than the target for too long has gone down considerably compared with the peak of mid-2022 (Figure 8). Monetary tightening also affects credit dynamics. The cost of bank loans is rising sharply; the surveys of credit institutions and firms point to a marked reduction in demand and to much tighter credit access conditions. Having risen to almost 13 per cent (on an annual basis) in the three months ending in August 2022, the growth in loans to non-financial corporations in the euro area has recently come to a halt; this trend also concerns loans to households, albeit to a lesser extent. Although these developments are a necessary consequence of monetary normalization, care must be taken to prevent the intensity of its transmission from causing an excessive brake on consumption and investment. This is a tough challenge. The shock caused by the higher energy prices renders it necessary to search for a balance between the risk of insufficient tightening, which could lead to inflation becoming rooted in expectations and in processes for determining nominal income, and the risk of a disproportionate tightening, which could have overly acute repercussions for economic activity, and negative effects on financial stability and, ultimately, on medium-term price stability. The monetary policy stance must continue to be defined so as to guarantee a gradual, though not slow, return of inflation towards the target. The pace and the range of the adjustment of monetary conditions have already been unprecedented, just as the deflationary pressures of past years and the risks BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2022 linked to the pandemic had been, which had pushed us to take the key interest rates into negative territory, and then keep them there. The impact of our decisions on the economy and on prices should fully unfold over the next few months; after bringing the reference rates to restrictive levels, we now have to proceed with the right degree of graduality. As I have observed on more than one occasion, the rise in energy prices is in actual fact an unavoidable tax for the euro-area economy. The return of inflation to levels in line with the target will be faster and less costly if everyone – firms, workers and governments – contributes to this goal, thereby improving the effectiveness of an indispensable, though balanced, monetary normalization. Firms’ price strategies will play a fundamental role: just as in the phase when energy prices rose in 2022, the recent cost reductions should now be passed through to the prices of goods and services. A purely retrospective approach to labour market bargaining is to be avoided, as wage dynamics replicating those of past inflation would only translate into a futile wage-price spiral. A more sustained growth in productivity is instead needed to restore purchasing power. Any fiscal measures will have to be temporary and targeted; these interventions must be promptly removed when they are no longer indispensable, both because returning to the price stability target would be more difficult in the event of excessive public transfers and in order to not hinder the necessary transition to renewable energy sources. The architecture of the economic and monetary union The last few years have been of great significance for the prospects of the European Union. Above all, the importance of having a fully-fledged common economic policy, in addition to the single monetary policy, has come to the fore. However, we need to make further substantial progress to complete the journey we embarked on when we adopted the euro. During the difficult years of the sovereign debt crisis, the incompleteness of the monetary union and the inadequate economic governance had fuelled pervasive mistrust in the future of the euro. Those difficulties spurred the debate on the need to move towards greater integration. However, the major reforms outlined at that time, and in some cases initiated, lost momentum: the banking union is still incomplete, the capital markets union is still at a very early stage and no progress has been made towards achieving a fully-fledged fiscal union. Only the most recent and serious emergencies have helped us to overcome doubts and hesitations in a decisive way. The European policy response to the pandemic crisis has been strong and swift. As well as the massive coordinated The Governor’s Concluding Remarks Annual Report 2022 BANCA D’ITALIA efforts made to contain the spread of the virus and to purchase and distribute vaccines among countries, the European Union has used innovative instruments at a strictly economic level too: member countries were granted loans to mitigate unemployment risks, and the NGEU programme has made substantial resources available to national budgets to finance investments and reforms to support the economic recovery and for the twin green and digital transitions. There has also been a cohesive response to the energy crisis, including by integrating the REPowerEU plans, aimed at reducing energy dependency on Russia, into national NGEU plans. These measures are extremely important, not only because of their magnitude, but above all because they testify to the ability of EU institutions and Member States to assume shared responsibilities to face common challenges, first and foremost in the interest of future generations. However, despite having inherently structural effects, these measures are mostly temporary. If the national measures financed by these programmes are successful, they could be the first steps towards a fully integrated economic union. Aside from having an unprecedented opportunity to tackle long-lasting problems, the countries that benefit most from these resources – first and foremost Italy – must also demonstrate the real usefulness of such greater integration, providing tangible results. At the same time, however, we need to be aware that to complete the European project we must first overcome major institutional and political hurdles. An essential requirement for this lies in a renewed and firm commitment by all Member States to seeking common solutions to common problems. We need to increase and, on certain matters, restore trust between European citizens, keep the political dialogue alive and constructive, and reduce the seemingly widespread mistrust of the EU institutions. As for fiscal policies, the reform should rest on two key pillars: rethinking the rules and building an effective fiscal capacity, backed by own resources and, when necessary, by issuing debt. On the former pillar, a major step forward was taken with the presentation of the European Commission’s reform proposal in April, a proposal that goes in the right direction. It focuses on mediumterm fiscal sustainability and long-term economic growth, while making the rules less complex and more credible by involving national authorities in the fine-tuning process. The Commission’s proposal may not meet the expectations of all member countries, for various reasons. The goodwill of all is needed to find a viable and shared solution. The rules must be applied to a world that is marked by intricate interdependencies and unexpected shocks, where national fiscal outcomes cannot be assessed out of context. Yet compliance with the fiscal BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2022 rules and their credibility are in the interest not only of the Union as a whole, but also of each of its countries. They are crucial for Italy, aiming to reduce its overly high public debt over time, and consistent with the fiscal discipline recognized as necessary by our Constitution. The introduction of a supranational fiscal capacity, which is missing in the Commission’s reform proposal, would make it possible to manage both country-specific shocks and common adverse events, such as the pandemic and the energy crisis, more efficiently. If the current institutional and political challenges make it difficult to achieve a fully-fledged fiscal union in the near future, we could build on the tools put in place during the pandemic emergency pragmatically, for example by designing forms of joint financing for automatic stabilizers, as we did with the borrowing scheme for the measures to mitigate unemployment risks. To ensure that some European public goods – such as those in the digital, energy, environment and security sectors – are delivered in adequate amounts, we should devise instruments similar to those under the NGEU programme. The shocks that hit the European economy have left a burdensome legacy in terms of public debt. We must prevent it from becoming the cause of new crises. Wide and long-lasting spreads between the bond yields of the various EU Member States hamper economic convergence. As postulated by numerous proposals in recent years, the management at European level of part of the liabilities already issued by each Member State, with adequate safeguards to avoid systematic cross-border transfers of resources, would give the monetary union greater stability. Furthermore, as has been suggested on several occasions, a common public debt security, to be issued in connection with the functioning of the European fiscal capacity or determined by sharing part of the national liabilities, could act as a safe asset, typically attributed to government bonds in the other main economies, and could support reforms designed to bring the capital markets union to life. On this front, the proposals put forward by the Commission at the end of last year and the ongoing discussions – on insolvency law, listing of firms, especially smaller ones, financial markets and central counterparties – are heading in the right direction. However, we need to move fast to ensure that the European capital market can best contribute to the financial effort needed to successfully tackle the climate and digital innovation challenges, against a backdrop of enhanced financial stability. Lastly, the importance of completing the banking union cannot be ignored, by revising the current crisis management framework to make it faster and more effective, and by establishing a single deposit guarantee scheme. The recent episodes of instability outside the European Union clearly The Governor’s Concluding Remarks Annual Report 2022 BANCA D’ITALIA show the importance of achieving these goals. As soon as its reform is fully operational, the European Stability Mechanism – thanks to the resources at its disposal – will be able to play a key role by providing a backstop to the Single Resolution Fund. The stability of the financial sector The crises that have broken out in the United States and Switzerland serve to remind us that banking is an inherently risky business and that it is not possible to reduce the probability that a bank failure will occur to zero. The role of institutions, regulatory and supervisory authorities is to lower this probability as much as possible, by defining the rules and imposing safeguards. It is critical, when managing crises, to have appropriate tools available to limit their impact on and costs to society and to prevent isolated events from turning into systemic ones, with ripple effects on the economic and social outlook. In the US regional banking sector, the business models of the banks that were hit displayed serious weaknesses, with an excessive interest rate risk exposure and highly concentrated funding skewed towards large, and therefore uninsured, customer deposits. Poor corporate governance played a crucial role in these crises. Other factors likely contributed, including the failure to fully apply international regulatory standards to banks deemed non-systemic, lapses in supervision, the speed with which fears about the banks’ solvency spreads through digital channels and the ease with which new technologies allow depositors to transfer funds. In the European Union banking system, in part thanks to stricter regulations and a supervisory approach that focuses on business model sustainability, no signs of situations akin to those in the US have emerged. However, market turbulence serves as a warning of how quickly investor confidence can crumble and, as a result, how the risks to financial stability should never be underestimated. Rather, it underscores the need for a prudent, data-dependent monetary policy. Italy, like the other euro-area countries, has not witnessed unusual outflows of deposits. Since July of last year, when deposits peaked at almost €1,620 billion, this source of funding has fallen by 6 per cent, reflecting the natural reduction in the liquidity accumulated during the pandemic and customers’ pursuit of higher-yield investments, better able to shield savings from inflation. The reduction in deposits has had a modest impact on the liquidity coverage ratio and the net stable funding ratio, which remain well above the regulatory minimum requirements. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2022 Rising interest rates have caused the value of portfolio securities to fall. The unrealized losses on those securities that banks plan to hold until maturity (booked at amortized cost), estimated to have an average impact of 200 basis point on the CET1 ratio, would only materialize if banks were compelled to sell them before maturity. Less than 2 per cent of these unrealized losses are currently accounted for by banks with a relatively low liquidity coverage ratio. More generally, the well-developed mechanism that regulates the use of central bank asset-backed refinancing in the euro area helps to lower the probability that banks will have to liquidate their portfolio securities before maturity. Overall, the banking system is in a sufficiently good position. Last year, all the main balance sheet ratios were at satisfactory levels as a whole and in many cases they have improved. The share of non-performing loans has remained stable, at low levels and in line with the European average. Profitability, long compressed by low interest rates and high credit losses, has risen significantly, benefiting from the increase in net interest income. The capital position has also slightly improved. Yet uncertainty about the economic outlook warrants caution. We expect the cyclical slowdown and tighter credit standards to cause credit quality to deteriorate, which would have an impact on loan loss provisions, still low at the moment. Adjusting the interest rates paid to customers will cause funding costs to increase. The shift towards more expensive sources of funding as the third series of targeted longer-term refinancing operations gradually reach maturity, and as banks are required to comply with resolution requirements, is also expected to contribute to this increase. The stability of the Italian banking system is the result of an intense decade-long process of cleaning up balance sheets, improving efficiency, and strengthening corporate governance and internal controls. It is a result that many observers, including authoritative ones, had doubted could be achieved. It was not, however, without its challenges. More than a few times, prompt intervention has made it possible to overcome fragilities through mergers with other intermediaries, changes in ownership structures, comprehensive reviews and transformations of business models. In other cases, some of which were due to malfeasance, resolution or liquidation with purchase and assumption transactions was unavoidable (such cases accounted for 3 per cent of total system assets). Despite the restrictions imposed by the European regulatory framework, which I have discussed in the past, financial stability was never at risk. Depositors were protected. Where necessary, public resources were used, the total amount of which has nonetheless been particularly low by international standards (Figure 9). This does not mean that there are no weak or vulnerable banks. Compared with larger banks, the ratios for the less significant institutions are not always The Governor’s Concluding Remarks Annual Report 2022 BANCA D’ITALIA as good. There are many reasons for this, from the limitations that may result from the small size, to corporate governance systems that are sometimes not up to the task. To address these weaknesses, important reforms were introduced over the years regarding the popolari banks and the cooperative credit banks and, in recent years, among other things, we have considerably raised the Pillar 2 capital requirements set by supervisory authorities in addition to the minimum ones. We are now focusing on examining the sustainability of business models and the associated risks, also taking into account the impact of technological innovation on the financial system. Assessing governance structures continues to be crucial, since high-quality corporate bodies and executives serve as the primary guarantors of sound and prudent management. To be effective, supervisory action requires a strong regulatory framework fully aligned with the most rigorous international standards. In late 2021, the European Commission published its proposal for implementing the most recent Basel Accord, finally completing the review of banking regulations begun more than a decade ago. Negotiations between the Council and the European Parliament are currently underway. It is important that the new rules are finalized quickly and that they are fully applicable. Looking ahead, we must take advantage of the experience gained from the recent banking crises to assess whether some adjustments to the prudential regulations are needed. Discussion has centred around the scope of application of the standards, which are currently directed, in principle, only at internationally active banks, although they have been extended to smaller institutions within the European Union. The concept of systemic intermediaries needs to be better defined: the recent episodes show how even crises involving medium-sized, regional banks are capable of sparking contagion and generating significant turbulence in financial markets, and not just national ones. Further thought should also be given to the calibration of liquidity requirements, also taking into account that it is now much easier to transfer deposits thanks to digital finance, and to the prudential treatment of interest rate risk in the banking book. The changes occurring at global level mean that we must strengthen the rules governing the non-bank financial intermediation sector. The strong interconnection between the banking and the investment funds sectors, as well as the insurance sector, could amplify risks and influence investors’ decisions. In some countries, in the face of a reduction in uncovered deposits with banks, monetary market funds have recently registered a large inflow of funds. Work is being done at the Financial Stability Board, to which we are actively contributing, to promptly review the recommendations on liquidity BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2022 risks in the investment funds sector and to determine the actions to be taken to improve intermediaries’ management practices. Just as for banks, in the life insurance sector, higher interest rates could lead to a contraction in net inflows into fixed-income products. Italian insurance companies, as a whole, are sound and well capitalized and are capable of reacting to changing market conditions, primarily by once again prioritizing the pure insurance component of their product range. In one case, marked by specific weaknesses that were uncovered by supervisory action and by the failure to promptly undertake the recapitalization required by the supervisory authority, recovery and safeguarding measures were taken, including temporary suspension of early surrenders of policies. In the absence of guarantee funds to protect policyholders, negotiations are underway for a group of banks and insurance companies to take action to protect customers. We are closely following the matter in collaboration with IVASS and by liaising with government authorities. As I stated earlier, despite rigorous regulation and intensive supervision, it is not possible to fully exclude the possibility of bank failures occurring. The deposit guarantee schemes are a key piece of the crisis management system. Recent events have demonstrated the importance of also paying proper attention to the percentage of deposits that exceed the guaranteed amount. International and European regulations in the area of crisis management require large banks to have adequate liability buffers (in the European Union these are the minimum requirement for own funds and eligible liabilities, MREL) to absorb losses and to recapitalize a bank in the event of a crisis, thereby minimizing the fallout on uncovered deposits. It has, however, become clear in recent years that such buffers cannot be extended to all banks, given that smaller ones inevitably encounter problems in accessing wholesale capital markets. That is why in a number of crisis management models – especially in the United States – the role of protecting small banks’ deposits continues to be performed by deposit guarantee schemes in the form of financial support for purchase and assumption transactions. Following such a model, since 1980 the Federal Deposit Insurance Corporation has managed the failure of over 3,500 banks in an orderly fashion. The changes set out in the European Commission’s proposal for revising the rules on managing bank crises would enable the deposit guarantee schemes, with appropriate safeguards, to more easily help address them. More specifically, eliminating their preferential ranking in the priority of claims in bankruptcy – which we have advocated for some time – would enable these schemes to intervene effectively as a precaution or, in the event of a bank failure, to support purchase and assumption transactions. However, the difficulty that small and medium-sized banks have in accessing capital The Governor’s Concluding Remarks Annual Report 2022 BANCA D’ITALIA markets that I mentioned earlier should be borne in mind. For those subject to resolution, intervention by deposit guarantee schemes could be combined with requiring a smaller minimum amount of liabilities to be used in the event of a crisis. The option to temporarily lift restrictions that limit access to extraordinary sources of financing, albeit with appropriate safeguards to discourage its indiscriminate use, would strengthen the crisis management framework, making it possible to react swiftly to situations posing a systemic risk, which may also be set off by small banks. Access to such a ‘safety valve’ was crucial in the United States, where the triggering of the systemic risk exception enabled the FDIC to intervene freely, exceptionally protecting all depositors, and thereby reducing the risk of contagion. The outlook for the Italian economy The Italian economy has proven to be remarkably resilient and reactive in the face of the unprecedented shocks of the last few years. As early as the end of 2021, Italy’s GDP had already recovered the ground lost due to the collapse recorded in the quarters following the outbreak of the pandemic. It continued to grow throughout 2022, despite the difficulties caused by the war in Ukraine, with a 3.7 per cent increase that far exceeded expectations. The labour market fully recouped the plunge in employment, which had involved young people and women most of all. In the first quarter of this year, economic growth exceeded expectations once again. The forecasts available to date suggest an increase of GDP of around 1 per cent in 2023. The recovery was more pronounced in construction, supported by tax incentives to upgrade buildings, and in services, which resumed significant growth as the anti-contagion measures were lifted. Despite the difficulties experienced during the year, manufacturing production has stayed, on average, at 2019 levels. The renewed vibrancy of the economic system has translated into strong growth in exports and a robust recovery in investment. Since the fourth quarter of 2019, exports of goods have expanded by 11 per cent in volume, more so than in the other main euro-area countries. Over the past two years, investments have grown by more than 20 per cent, thus putting a clear end to the phase of prolonged weakness that followed the global financial crisis. These developments, while supported by generous public policy measures, are a reflection of the gradual progress that has been made. The restructuring of the production system provided firms with the tools to face the pandemic crisis and the energy shock from a stronger and more balanced BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2022 financial position than they had during severe crises in the past. Between 2007 and 2019, in contrast with the euro-area average, Italian firms’ debt dropped by nearly 7 percentage points, to 68 per cent of GDP (compared with an average of more than 100 per cent in the euro area). In the same period, household debt remained low overall, standing at 41 per cent of GDP in 2019 (15 percentage points less than the euro-area average), with a greater concentration among higher-income households, who are more equipped to sustain it. All this, together with the strength of the recovery, is reassuring, also in light of the weaknesses that still affect our economy and which, over the past few decades, have caused the per capita income gap with other advanced countries to widen progressively. This has been the subject of extensive discussion, including in this setting, and we observed that the prolonged stagnation in labour productivity reflected both the low efficiency of production processes and weak capital investment in the phase following the global financial crisis. In the last twenty-five years, GDP per hour worked rose by just 0.3 per cent per year, less than one third of the average figure for the other euro-area countries. The flexibility introduced in the labour market was not matched by investment in up-to-date technology; the quality of human capital is still insufficient. This benefited neither firms’ profitability nor hourly wages, for which growth, net of inflation, was among the weakest in Europe. Although hourly wage inequality among payroll employees in the private sector remained limited, the share of workers with very low annual compensation – conventionally, less than 60 per cent of the median, equal today to €11,600 per year – rose again, up to 30 per cent from 25 per cent at the turn of the century. As temporary and part-time positions have become more common, the number of people who today have a job for only part of the year has significantly increased. Atypical forms of contract have made employment more responsive to cyclical developments in the economy and, in many households, have facilitated an increase in the number of people employed, albeit with low wages. In 2022, as the recovery was being driven by labour demand, the conversion of fixed-term contracts into permanent ones increased significantly. In many cases, however, fixed-term employment goes hand in hand with long-term precariousness, with close to 20 per cent of young people still on fixed-term contracts even after five years of employment. Too many, not just the young, do not have official jobs or, if they do, are not offered adequate contractual conditions; as in the other major countries, introducing a well-designed minimum wage system could be the response to non-trivial demands for social justice. The Governor’s Concluding Remarks Annual Report 2022 BANCA D’ITALIA Raising incomes and creating better employment opportunities requires an improvement in the quality and capacity of production for the entire economic system, which is all the more necessary today in light of the ongoing demographic changes. In the coming decades, world population dynamics will continue to be highly unbalanced, with strong growth in the developing countries on the one hand and weak, or negative, growth in the advanced countries on the other hand; among the latter, Italy has one of the fastest ageing populations. In just three years, since 2019, the number of people conventionally defined as being of working age (15 to 64 years old) has fallen by nearly 800,000 units. Based on Istat’s demographic projections, by the year 2040, Italy’s resident population will decline by 2.5 million in the central scenario, and that of people between the age of 15 and 64 by more than 6 million (Figure 10). The improvement in the life and health conditions achieved in the past decades will allow quite a few people to work past the traditional retirement age of 64, in line with the current trends that are also reflected in the pension reforms. We will certainly need to create more jobs for young people and women, whose participation rates across the country are very low, with Italy’s South and Islands accounting for the lowest rates in Europe. Even in the best case scenario where the participation rates of young people and women rise progressively to catch up with the EU average, in the next twenty years, economic growth will not be able to rely on the endogenous expansion of the labour force: the effects of the decrease in the population in the central age groups may be mitigated in the medium term, besides by an extension of the working age, only by an increase in net migration (which in Istat’s baseline scenario is projected to amount to 135,000 people per year, more than double that of the past ten years, after averaging more than 300,000 in the previous decade). Managing migration flows will require well-designed training and integration policies, which are indispensable for absorbing migrants into the social fabric and production system. A recovery in birth rates, from the particularly low levels of 2021, albeit desirable, would strengthen labour supply only in the very long term. Italy’s outlook for economic growth, however, will to a large extent depend on its ability to return to levels of labour productivity that increase at a much faster pace than that observed over the past twenty-five years, and are at least equal to the average levels recorded in the other euro-area countries. Since 2015, clear progress has been made: despite the contribution from investment being nil, GDP per hour worked in the private sector is growing at a rate not far from the euro-area average. Bolstering this trend requires firms to continue to make investments in production to buoy the recent recovery and support technological innovation. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2022 Even if corporate restructuring has helped in strengthening the economy, some unusual features, which we have discussed on several occasions in the past, continue to affect its development. The size distribution of firms is still skewed towards small or very small family-run businesses. This problem is greater still in the construction industry and in some branches of the service sector, such as the professional and the hospitality segments which, since the second half of the 1990s, have recorded very low or even negative rates of productivity growth. Important regulatory changes such as the reduction of entry barriers and simpler procedures for starting up new businesses have stimulated competition and raised firms’ efficiency levels. This confirms the fact that it is necessary to persevere with the reform agenda and overcome the obstacles and disincentives to growing in size that still exist and are often embedded in the administrative and tax regulations. Tax evasion and the spread of the shadow economy continue to distort competition to the detriment of those companies with the highest potential. An innovative economy needs a well-qualified labour force, whose workers have adequate and continuously updated skills. The share of university graduates among people aged 25-34 years is still below 30 per cent, against the European average of over 40 per cent (Figure 11). The level of skills acquired is also often unsatisfactory, as shown by the surveys conducted by international organizations. In Italy, there is no lack of highly qualified young professionals or of dynamic, successful firms, but there are still too few of the latter decisively seeking to enhance their human capital and managerial skills, which are key to reaping the benefits of the new technologies and to increasing the competitiveness of their products and services on national and global markets. The firms that have embarked on this process are different from the others in terms of their growing market shares, greater capital intensity, higher profitability and better working conditions and remuneration. It is equally important to increase the quality of central and local government activities. In all the important areas – education, health, and justice – besides differences in terms of European averages, there are significant regional differences. Reducing these and making the necessary improvements will require monitoring systems and effective instruments to intervene in places where minimum quality standards are not being met. Delays in using digital technologies, the high average age of staff, and insufficient specialist skills contribute to these results. Italy’s National Recovery and Resilience Plan (NRRP) could stimulate significant progress in digitalizing general government’s administrative processes. The current staff turnover in the public sector presents an opportunity to acquire human resources with adequate professional skills in relation to the services that the State is committed to The Governor’s Concluding Remarks Annual Report 2022 BANCA D’ITALIA providing. Besides being an objective of the Plan, strengthening general government is a crucial factor in rapidly using the available resources to the full in all sectors. Lastly, our economy’s growth potential is hindered by a complex taxation system, which has often been adjusted but without a comprehensive plan. The government has expressed its intention to carry out a far-reaching reform and a draft enabling bill is currently being debated in parliament. A rebalancing to reduce the weight of taxation on the factors of production could stimulate employment and investment. The removal of measures that negatively affect firms’ choices as to their size and organization, while at the same time keeping those that incentivize capitalization, would contribute to increasing efficiency. Changes to personal income tax carefully taking account of the redistributional effects should be structured so as to consider the overall size and specific characteristics of social welfare programmes. Rationalizing the rules and simplifying requirements can provide certainty and stability to the system, keeping the administrative costs down. No intervention can realistically disregard the constraints of our high public debt nor the principles of progressivity of taxation and ability to pay that are enshrined in the Constitution. Reducing the size of the public debt is an economic policy priority regardless of European fiscal rules. A high public debt means that a large share of government revenue has to be spent on interest payments rather than being put to more productive uses; it poses serious problems of intergenerational equity; it makes it more difficult to adopt counter-cyclical measures; and it generates uncertainty for economic operators. The need to refinance it each year for huge amounts makes the country vulnerable to adverse market trends, even when the latter do not seem to be justified by the economic and financial fundamentals. The debt-to-GDP ratio decreased significantly in the early years of monetary union and then declined only marginally to just over 100 per cent in 2007, but with the dual financial and sovereign debt crises, it rose sharply, mainly because of low nominal growth and despite the continuing primary surpluses, remaining at around 135 per cent until the outbreak of the pandemic (Figure 12). In 2020, the collapse of production activity on the one hand, and the support measures for firms and households on the other, increased the ratio by a further 20 percentage points. Half of this increase has been reabsorbed in the last two years, thanks to the extraordinarily favourable differential between nominal growth and the cost of the debt. At the end of 2022, the ratio stood at 144 per cent. The reduction achieved in the early years of this century could have been greater, but today’s high levels are less the result of imprudent fiscal policies BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2022 than of the extremely severe crises that have occurred since 2007. Just as at the time of the launch of the single currency, Italy’s public debt-to-GDP ratio is today still more than one and a half times the average for the rest of the euro area. Whatever the reasons for these levels being reached, the priority is now to provide continuity to the consolidation process initiated over the past two years. To this end, given that the cost of the debt will gradually increase, partly as a consequence of the normalization of monetary policy, what we need to achieve is a return to significant primary surplus levels, such as those planned for the medium term in the latest Economic and Financial Document. Over the next few years, any increase in expenditure or reduction in revenue, including those prospected in reforms that have already been announced, such as tax reform and differentiated regional autonomy, will require adequate and stable structural budgetary coverage. Maintaining a prudent management of our public finances will send out a clear signal of credibility, and contribute to lowering the yields on Italian government bonds, bringing them closer to those of other main euro-area countries. In order to reduce the share of debt, it is essential to attain stable and sufficiently high growth rates. In contrast to what has happened in the past, an adequate level of expenditure and quality in public investment needs to be maintained, and it will be crucial for general government to be able to identify the best projects and have them implemented as scheduled and at the expected cost, so as to stimulate private investment decisions as well. We have often remarked on how the NGEU programme affords Italy an opportunity to generate new momentum in the economy and address the weaknesses I have again mentioned today. Furthermore, we should not underestimate the importance of the programme in making up for the considerable lags that have continued to build up in the South, have a profound impact on the prospects of the local population and translate into an unsustainable waste of human energies and resources that hold back the overall growth of Italy’s economy. Improvements to the NRRP are possible, though any proposals for changes need to take into account the tight schedule agreed with the European authorities. Constant liaising with the Commission will be absolutely necessary, as well as useful and constructive. There is no time to lose. While there is talk of presumed inadequacies in the general debate over its design, of a limited time frame for its realization and of possible shortcomings in implementing its measures, it has to be emphasized that the NRRP is a rare and, on the whole, sound attempt to define a strategic vision for Italy. Apart from the investments and other expenditure that it involves, this is a further The Governor’s Concluding Remarks Annual Report 2022 BANCA D’ITALIA reason why it is crucial to carry out its ambitious programme of reforms, all of which are long overdue. This is therefore a decisive turning point, but it also needs to be part of a broader long-term strategy to facilitate the transformation of our economy. This is made all the more necessary by the inevitable twin challenges that await us – inevitable if we are to counteract climate change and its dramatic consequences, as we are once again experiencing; and if we are to encourage a safe and comprehensive diffusion of technological, and above all digital, innovation. The timescale will have to be relatively long, covering several legislatures, and the objectives will need to be pursued with perseverance and far-sightedness, with widespread consensus among the population. Its success will depend on the extent to which public initiative can combine with an adequate response of the productive and financial system. New opportunities will be created, but considerable investment will also be required, together with an efficient allocation of savings and careful management of risks. The financial system will also have to play a part. In order to exploit the opportunities connected with financing the energy transition, intermediaries will need to incorporate adequate models for the assessment of climate risks into their operational processes. The aim is not to phase out the activities with a bigger carbon footprint altogether, but to help energy-intensive firms to significantly reduce their emissions whenever possible and appropriate. To go in that direction, it will be decisive for firms to provide intermediaries and investors with detailed and reliable information, and to make credible transition plans. Managing the implications of the digital transition effectively is a crucial challenge for the financial system. The Bank of Italy supports and promotes innovation by ensuring that market infrastructures are safe and efficient, that the regulatory framework and risk management processes are up to date, and by providing consumer protection and financial education. These safeguards are key to ensuring that Italy can make the most of the digitalization of the economy and of finance, thereby minimizing their risks. This area also includes the challenge posed to the Eurosystem by the possible introduction of a digital euro, which we are actively helping to develop. The ECB Governing Council will decide this autumn whether and how to proceed to the phase of defining the required technical and commercial solutions. A final decision on going ahead with a digital currency will in any case require the adoption of the necessary regulatory framework by the European Parliament and the Council of the European Union. * * * BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2022 At a time of deep uncertainty, with the distress caused by the emergency, we wondered three years ago what effects the pandemic would have on our behaviour, on the production system, on how we work and on our consumption habits. Recognizing that ‘we knew that we did not know’, we discussed new ‘equilibriums’ and a new ‘normality’, with profound doubts, and we talked about the crucial role that extraordinary budgetary interventions and sizeable and timely monetary policy measures would have in softening and diluting over time the consequences of the crisis. Now that the health crisis is over, the dramatic fall in demand has been recouped and ‘social distancing’ is a thing of the past, we find ourselves facing new challenges and new emergencies. It is of course legitimate to wonder to what extent these factors – ranging from the geopolitical tensions and risks to the economic and financial uncertainties and the return of inflation itself – are linked to those events and those responses. Counterfactual analyses are difficult in history, and not only in economic history, but a strong dose of humility is needed when conducting them: those interventions and measures not only helped to moderate the social and economic effects of the pandemic, they also certainly played a key role in making tangible the commitment and the hope expressed when we said then: ‘we will survive this together’. This is why we cannot forget those who sacrificed themselves in the sometimes unequal fight against infections. We cannot ignore how much the swift response of research benefited from the absence of impassable borders to the spread of knowledge. Neither can we fail to properly acknowledge the successes, including logistical ones despite various kinds of difficulty, achieved by the work relating to the production and distribution of vaccines, as well as the capacity for action, including at supranational level. Let us go back, though, to the tensions, to the uncertainties and to inflation. I have already talked about the last of these, underlining once again the importance of steering the monetary response on a straight course, but with the necessary graduality owing to the lingering uncertainty over the evolution of the main determinants of the acceleration in prices and over the behaviours that may prolong their duration and their effects. The phasing out of the extremely accommodative monetary conditions was of course necessary: in this case too, however, let us remember the success in countering the deflationary risks linked to the financial, global and sovereign debt crises in the euro area. Monetary normalization and credit tightening will bring us back to price stability; the repercussions for the euro-area economy will be smaller the more responsible the behaviour of all the parties involved: firms, trade unions and governments. The political, economic and financial consequences of the dramatic conflict still taking place in Ukraine, which is inconceivable in light of the The Governor’s Concluding Remarks Annual Report 2022 BANCA D’ITALIA lessons from the twentieth century and unacceptable because of the violation of the basic principles of the ensuing international law, look set to be deep‑rooted and long-lasting. They will need to be faced, not by abandoning but rather by strengthening the commitment to international cooperation. The great forces for change and the challenges of our time are global in nature, and the responses to them cannot be partial or not shared. Above all, we must give up the logic of the zero-sum game in the competition between nations, and not go back to the old models of winners and losers, but work to involve various actors – based on their history, values and perspectives – in leading future initiatives with the aim of generating widespread benefits for everyone. In the last fifteen years, Italy has had to deal with an almost unprecedented series of challenges and emergencies. I have often talked here about how they have been addressed, about the constraints that have slowed down our responses, about the delays and the mistakes made and about the successes achieved. I shall therefore not go into specific detail about the sequence of my memories, from the global financial crisis to the sovereign debt crisis and their prolonged effects, which once again, to use an effective expression common at that time, ‘caught us on the back foot’, following the delays accumulated at the end of the last century. The pandemic struck our country at a time when it had still not absorbed the damage inflicted by that double-dip crisis and when the slow and piecemeal adoption of the necessary reforms was still struggling to resolve the difficulties that hinder our growth. Nevertheless, Italy has overcome this third, extremely serious crisis, as well as the energy shock that followed Russia’s aggression against Ukraine, and has done so better than we expected. The rebalancing of the production structure at world level now forces us to strengthen our international standing and to avoid being pushed, as in the not so distant past, to the margins of the transformations underway. These are not merely emergencies to be tackled; they are factors that interact with unstoppable trends – environmental, demographic, technological – and that are destined to change the existing economic and social structures radically. The magnitude of these trends cannot help but generate uncertainty. When considering the associated risks, we are asking ourselves questions about the future in which today’s children and those not yet born will live, we wonder what to do, not only to respond to the fears and opposition connected to them, but also and above all to seize the opportunities they herald. New ways to organize work and society will emerge, together with new ways of life and new ways of working together. We will need to be aware of this, first and foremost at individual level, and rely on our curiosity, education and knowledge, as we have been saying for some time. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2022 As regards the ‘special institution’ that I have served in different roles for fifty years, and that I will leave this year, I am certain that it will continue to base its work on this awareness in the years to come as well. We always keep in mind the need to ground our assessments and decisions on data and analyses that are as broad and accurate as possible. As former Governor Bonaldo Stringher stated in 1900 – and as Gianni Toniolo reminds us in his book History of the Bank of Italy, covering its first fifty years, which he completed shortly before passing away so suddenly – this is for the sole purpose, together with and not in conflict with the State, of ‘improving the conditions for national economic activity and improving its lot’. Today, by sharing it within the Eurosystem, we are extending this purpose to the area of monetary and financial stability in which we have been sharing the responsibility of ‘governing the euro’ for the last 25 years. Indeed, as we have known for centuries, acquiring this awareness must also occur at a collective level. In the words of our ‘Supreme Poet’, Dante Alighieri: ‘the Philosopher says that man is by nature a social animal’, to pursue ‘a life of happiness ... no single individual is able to provide’. Problems such as reducing the public debt or adopting ways of life consistent with protecting the environment require society to understand and internalize them, not because ‘the EU is asking us to do it’ but because they shield us from risks and open up opportunities. This is why there needs to be a new collective reflection at all levels, in order to grasp their importance and to decide together how to manage their impact. The same can be said of openness to the world, which is so important for our economy and our culture, as we have known for centuries and despite our delay in reaping its benefits in the last few decades. However, we are not just ‘social animals’. As Yuval Noah Harari puts it, what distinguishes us is the capacity ‘not merely to imagine things, but to do so collectively’. This ability to imagine the future will be crucial. This is why we need to keep dialogue going, to strengthen cooperation as much as possible in a world where it is necessary to guarantee economic, health and welfare benefits to all, and to reduce disparities rather than increase them. It is really up to young people, who are less conditioned by the past, to imagine that world and identify its opportunities. They will have to be listened to and helped to grow by the other generations, with no constraints, in order to translate into realistic action the ideas they will be able to develop for a future world that is not poorer, but rather safer and fairer. The Governor’s Concluding Remarks Annual Report 2022 BANCA D’ITALIA FIGURES Figure 1 GDP growth forecasts (per cent) January 2022 forecasts April 2023 estimates and forecasts 2022 2023 World 2022 2023 Euro area 2022 2023 United States Source: International Monetary Fund. Note: Percentage changes on previous year. Figure 2 The return of inflation (percentage changes) United States United Kingdom Euro area Italy Sources: Eurostat, Istat, UK Office for National Statistics and US Bureau of Labor Statistics. Note: Twelve-month percentage changes. Euro area: changing country composition since 1999; weighted average of the 11 countries initially participating in the third stage of the Economic and Monetary Union, for the years before 1999. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2022 Figure 3 New barriers to trade and to foreign direct investment (number of new barriers) Barriers to trade (right-hand scale) Barriers to foreign direct investment Sources: Global Trade Alert and UNCTAD. Figure 4 Citizens’ trust in the European Union (per cent) Introduction of the Next Generation EU programme Brexit referendum Source: European Commission. Note: Percentage of EU citizens interviewed in the Eurobarometer’s half-yearly surveys who trust in the European Union. The Governor’s Concluding Remarks Annual Report 2022 BANCA D’ITALIA Figure 5 Consumer price growth in the euro area (percentage changes) Headline inflation Core inflation -2 -2 Source: Eurostat. Note: Twelve-month percentage changes. Figure 6 Market expectations for natural gas prices in Europe (euros per megawatt-hour) Sept-22 Mar-22 Dec-21 Sept-21 Source: Refinitiv. Note: Prices of natural gas futures in the Title Transfer Facility (TTF) market; start-of-month data. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2022 Figure 7 Long-term nominal and real interest rates in the euro area (per cent) Nominal -1 -1 -2 -3 -2 Real -3 Sources: Bloomberg and Refinitiv. Note: Ten-year interest rates; the real interest rates are obtained by deflating the nominal interest rates (overnight index swaps) using the rates of inflation-linked swaps with the same maturity. Figure 8 Long-term inflation expectations in the euro area (per cent) 2.5 2.5 Market 2.25 2.25 Experts 1.75 1.75 1,5 1.5 1.25 1.25 Sources: Bloomberg and European Central Bank. Note: Median of the long-term inflation expectations (4-5 years) of the experts interviewed for the quarterly Survey of Professional Forecasters; five-year, five years forward inflation-linked swap rates, net of an estimated inflation risk premium. The Governor’s Concluding Remarks Annual Report 2022 BANCA D’ITALIA Figure 9 Support measures for financial intermediaries: impact on public debt (per cent of GDP) Germany Spain Euro area France Italy 2008 2010 2012 2014 2016 2018 2020 2022 Source: European Commission. Note: Euro area, fixed composition (19 countries). Figure 10 Population aged 15-64 in Italy: projections (2022 = 100) Centre and North South and Islands Italy Source: Istat. Note: Central scenario. BANCA D’ITALIA The Governor’s Concluding Remarks Annual Report 2022 Figure 11 University graduates (percentage of the population aged 25-34) France Spain European Union Germany Italy Source: Eurostat. Figure 12 The public finances (per cent of GDP) Public debt Primary balance Italy -2 -2 -6 -8 1999 2002 2005 2008 2011 2014 2017 2020 Italy Euro area excluding Italy -4 -4 Euro area excluding Italy -6 1999 2002 2005 2008 2011 2014 2017 2020 -8 Source: European Commission. Note: Euro area excluding Italy, fixed composition (18 countries); primary balance: general government revenue minus expenditure net of interest expense. The Governor’s Concluding Remarks Annual Report 2022 BANCA D’ITALIA Printed by the Printing and Publishing Division of the Bank of Italy Rome, 31 May 2023 Printed on EU-Ecolabel certified paper (registration number FI/011/001)
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Welcome address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 3rd Finance and Productivity Conference, "Green Deal - reformation, evolution, and revolution", Rome, 8-9 June 2023.
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Ignazio Visco: Welcome address - 3rd Finance and Productivity Conference Welcome address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 3rd Finance and Productivity Conference, "Green Deal - reformation, evolution, and revolution", Rome, 8-9 June 2023. *** Ladies and gentlemen, distinguished guests and colleagues, I welcome you all today to the third Finance and Productivity conference organised by the Bank of Italy, together with CEPR, the Competitiveness Research Network (CompNet), the European Bank for Reconstruction and Development (EBRD) and the Halle Institute for Economic Research (IWH). The topic chosen for this year – "Green Deal: reformation, evolution, and revolution" – underlines the importance of the ongoing debate about the green transition and the quest for making our economic systems more resilient to climate shocks. The discussion around these topics has centred on strategies to achieve the goal of net zero greenhouse gas emissions, which requires a combination of economic disincentives for fossil fuels and the increased availability of present and future clean energy alternatives. Economists have the task of making an effective contribution to the evaluation of the effects of existing policies and collaborating in the design of measures based on the available evidence. Carbon taxation and emission quotas have proven to be useful instruments in discouraging the use of fossil fuels. They must be carefully calibrated to achieve the largest possible welfare gains, mitigating potential regressive effects and avoiding abrupt and ungoverned reallocations between green and brown sectors. The aim of public policies should not be to immediately phase out the activities with a bigger carbon footprint, but rather to help energy-intensive firms to steadily and significantly reduce their emissions to the largest extent and whenever possible. The transition to greener technologies also needs to be accompanied by appropriate policies. As renewable-energy power sources become more profitable, the streamlining of regulatory procedures and the deployment of grid-scale storage facilities are needed to safely increase their role in the power mix. Clean investments can also be encouraged among non-energy producers, tackling the constraints that lead firms to underinvest in the green transition or to prioritise short-term cost considerations over longer-term environmental and, ultimately, economic benefits. This conference contributes to this debate, envisaging a rich array of research papers encompassing a wide range of topics, which aim at shedding light on significant issues that seem especially important to me: Climate and energy-related events have a sizable impact on firm activity, with potentially disruptive effects on several levels, such as labour productivity, final demand, supply chain linkages, or energy source differentiation. Disentangling 1/2 BIS - Central bankers' speeches these channels is important in assessing how climate shocks shape the allocation of production factors and are mapped onto aggregate outcomes. Climate change has a profound impact on banks' balance sheets and lending practices. Localised climate shocks directly affect the value of assets used as collateral for loans, leading to a decrease in credit supply. The potential concentration of these risks among few entities and the possibility of these effects spreading to unaffected areas highlight the importance of prudent risk management practices within the banking industry. Financial markets can indeed accelerate the transition to a greener economy. Credit availability increases the probability of investment in cleaner technologies, especially in the wake of adverse climate events and higher carbon and fossil-fuel prices. A demand for credit oriented towards green investments requires sound and consistent policies (in particular targeted incentives), whose effectiveness is amplified by a greater environmental awareness among economic agents. Inherent firm-level characteristics also contribute to shaping the pace of the adoption of green technologies. Smaller and financially-constrained firms often invest in older and less environmentally friendly capital compared to larger firms. Corporate taxation can be leveraged to strengthen the incentives for green investments, potentially reducing aggregate carbon emissions while limiting the impact on economic growth. Greenwashing practices and unsubstantiated environmental disclosures can impede green transition efforts. Only high-quality granular data availability can help us understand the connection between firms' disclosures and the banks' propensity to lend to brown industries. We should also be aware of the misleading practice of divesting polluting plants from one company to the other, which on the surface may create the illusion of reducing emission levels, but in reality does not. During the conference these issues will be discussed in depth, offering an excellent opportunity to reflect on how research might inform decision-making processes and shape effective policies. The panel of experienced policymakers will share its views on the foremost challenges we face and the critical questions that demand attention from economic research. I am sure that the lecture of our special guest, Professor Aghion, will offer valuable insights into how innovation, public policies and civic values interact in the ongoing endeavour to combat climate change and mitigate the depletion of natural resources. Let me conclude by thanking the organisers and the scientific committee for having put together such a rich and interesting programme. Once again, I express my gratitude to the presenters, moderators and all the other participants in this event for their presence here today. I wish you all two days of very fruitful interactions and discussions. 2/2 BIS - Central bankers' speeches
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Speech by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy, at the Villa Mondragone International Economic Seminar, Round table on "Risks from inflation and opportunities from fragmentation", Monte Porzio Catone (Rome), 7 June 2023.
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Luigi Federico Signorini: Risks from inflation and opportunities from fragmentation Speech by Mr Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy, at the Villa Mondragone International Economic Seminar, Round table on "Risks from inflation and opportunities from fragmentation", Monte Porzio Catone (Rome), 7 June 2023. *** After the Second World War, multilateral institutions, such as the International Monetary Fund, the World Bank and the World Trade Organization (as it is now called), have provided a framework in which a rule-based system of international cooperation has flourished, though initially only in our part of the world. A similar framework for cooperation in other key fields has been provided by the WHO and other institutions. Starting about a generation after the war, and over another generation, the system expanded in stages. In the late 1970s or early 1980s, China began to experiment with a cautious, but rapidly accelerating, opening to a more market-oriented economy and to international trade (while pursuing, in parallel, a normalisation of diplomatic relations with the rest of the world). At the end of the 1980s, the Soviet bloc disintegrated, and with it the socialist planning system that had ruled its economy; many of the former Soviet bloc countries became free democracies as well. Soon after, India started to dismantle the so-called "Licence Raj" – a process that lasted for an extended period of time – and gradually embraced the idea of free markets as the driving force for development. Much of East Asia did the same, notwithstanding the great diversity of political regimes that existed then and still exists today. Globalisation accelerated, spurred by increasing economic freedom, lower international barriers and the revolution in information and communication technologies. Looking back, globalisation has been an enormous, though sometimes underestimated, force for improving prosperity worldwide. Those of my generation cannot have forgotten the destitution and hunger that were widespread half a century ago in what was then called the Third World, including much of Asia outside Japan; the recurring appeals to the rich world's conscience for mitigating the suffering this produced, amid a rapidly growing population; the political tensions and wars, sometimes arising from extreme economic disparities, and often stoked by superpower rivalries. Sure, poverty and malnutrition are still there. But the share of people suffering from malnutrition globally has decreased from 34 to 13 per cent in the past 50 years, while the world's population has more than doubled. Worldwide, economic inequality has been sharply reduced. Literally hundreds of millions have been lifted out of extreme poverty. Emerging economies have become a key driver of world growth. Opening up to trade and to the market economy has allowed demographic giants like China and India to become economic giants, too. In the years following the great financial crisis of 2008, the consolidation of the G20 as the key forum for the global coordination of economic policies seemed to mark the beginning of a new world order. The conviction spread that deeper economic and 1/3 BIS - Central bankers' speeches financial interdependencies would help create the right conditions for peaceful, shared development. Over time, however, the race towards integration started to lose momentum. Already for some years before 2020, quite a few people, especially in advanced economies, had become increasingly sceptical of, if not openly hostile towards, globalisation. Its benefits (such as the availability of goods and services at a low cost, the impetus to growth coming from emerging countries' demand) are widespread; therefore, in spite of their being vast and pervasive, they are barely noted and almost taken for granted. On the other hand, certain costs associated with international integration, especially if they are concentrated in specific population groups, are more salient. There has been a growing perception that the benefits of this process have been unevenly distributed in advanced countries. Reflecting this, and perhaps also the increased assertiveness of some large emerging economies, progress in the expansion of international trade and financial agreements had been stalling for years. The negative trend has been reinforced by the twin crises of this decade. The 2020 pandemic highlighted the physical fragility of flows of goods over long distances. Even more importantly, Russia's invasion of Ukraine in 2022 called into question the very principle of peaceful coexistence between nations within internationally recognised borders. It dispelled the illusion that economic interdependencies would deter the emergence of serious armed conflicts. In fact, the war actually showed that dependencies can be 'weaponised' to serve political goals. All this has highlighted strategic risks, fuelled dependence anxiety in many countries and caused mounting calls for self-sufficiency in key sectors within 'friendly' areas. Aiming to maintain the security of strategic supplies and to improve the resilience of value chains is understandable, indeed inevitable given the geo-political realities of today. Still, one should never forget the large advantages of an open world and the dangers of economic and political fragmentation. Re-shoring and 'friendshoring' (whatever that means) are sometimes difficult and often costly. The legitimate defence of national interests should not turn into indiscriminate protectionism. Ways to preserve as much openness as possible need to be sought. Let me quote Governor Visco: National security can be protected by steering clear of broad-based protectionism, which would reinforce the trend of rising barriers to trade and foreign direct investment that has emerged over the last five years. Not only would indiscriminate use of subsidies and restrictions in international trade distort competition in an attempt to influence firms' location decisions, it could also spark new tensions, including in relations between countries sharing similar values, institutions and policies. In some cases, protectionist measures may even prove detrimental to the goal of increasing geographical diversification in sourcing. Policy makers, let me add, should never underestimate the private sector's ability to selfadjust. Firms are indeed improving the resilience of their supply lines, e.g. by reshoring 2/3 BIS - Central bankers' speeches or nearshoring production, diversifying input suppliers and increasing inventories of critical goods. While some reduction in the growth of global trade has been observed, for now there are few signs of a total retrenchment. The EU, with its policy of 'open strategic autonomy', has embraced in principle the ideas of preserving as much openness as is possible and of pursuing, again as far as possible, an international order based on cooperation and accepted rules. Access to natural resources, technology transfer, the smooth functioning of global finance, dealing with migratory flows, reducing the levels of poverty are all issues that can hardly be addressed without the benefit of a multilateral framework. Global public goods require global responses. The twin crises of the 2020s, while in some cases putting into question the worldwide system of institutionalised, rules-based cooperation, have also highlighted its crucial importance for humankind. The challenge is to preserve dialogue within the G20 and the multilateral economic and financial organisations. Reforms are needed, in fact long overdue, to improve their functioning in order to increase their legitimacy and safeguard their role in the future. It is easier to reform the existing institutions than to dismiss them and try to build new ones. By definition, however, multilateralism cannot be preserved by the goodwill of one side alone. One cannot overlook the difficulties of the current situation, be blind to growing geopolitical differences or ignore the prospect of an increasingly polarised world. Much in this is highly political, therefore beyond the scope of this conversation. Concerning economic and financial institutions, one should be both realistic and hopeful. The goal, to quote Raghuram Rajan, should be to create (or rather, maintain) 'safe spaces in which countries, albeit with different values and systems, can interact regardless of their respective domestic policies or international tensions'. Looking ahead, this needs genuine engagement on all sides. 3/3 BIS - Central bankers' speeches
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Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the Annual Meeting of the Italian Banking Association (ABI), Rome, 5 July 2023.
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Ignazio Visco: Speech - Annual Meeting of the Italian Banking Association Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the Annual Meeting of the Italian Banking Association (ABI), Rome, 5 July 2023. *** Monetary policy and the economic and financial situation Based on the overall assessment of the price outlook, the dynamics of core inflation – i. e. net of the energy and food components – and the intensity of the transmission of monetary policy to the economy, the Governing Council of the European Central Bank (ECB) further raised the key interest rates in mid-June by 25 basis points, bringing that on deposits held by banks with the Eurosystem to 3.5 per cent, 4 percentage points higher than in July of last year. The Council also confirmed the discontinuation of the reinvestments under the asset purchase programme, reiterating its intention to continue those linked to the pandemic emergency purchase programme until the end of 2024. The decisions will continue to be based, meeting by meeting, on an assessment of the impact of new economic and financial data on the outlook for consumer prices in the euro area, in order to guarantee a sufficiently rapid return of inflation to the 2 per cent objective. Due in part to the marked tightening of financing conditions and the pronounced weakening of credit, caution will be needed to avoid unwanted repercussions on economic activity, on financial stability and on price stability in the medium term. Monetary policy can count not only on increases in the reference rates but also on keeping them at a level and for a period of time suitable for bringing inflation back to the target. Now that these rates are in restrictive territory, calibrating how long the monetary policy tightening lasts rather than excessively increasing its breadth would have the advantage of favouring a more informed analysis of the effects of the action taken so far. Above all, the evolution in the risk perception of banks will need to be monitored. Past crises have made it clear that this is an important driver of the intensity of a contraction in credit supply. The quality of loans in the euro area has been modestly affected so far by the worsening economic situation; the greater cost of debt triggered by the considerable increases in interest rates could however cause it to gradually deteriorate. The tightening would also be accentuated if the absorption of liquidity by the Eurosystem led to a swifter and larger than expected increase in bank funding costs. In Italy, the robust recovery of GDP caused by the full reopening of businesses after the end of the public health emergency is fading. At a time when the international outlook is weakening, tightened monetary policy aims to counter inflation and the support ensured by fiscal policy has to be reduced, achieving an adequate and stable economic growth will require a high level of public and private investment and the effective implementation of structural reforms. The capacity of households and firms to respond to unexpected and particularly violent shocks, such as those of the last three years, must form the basis for public actions designed to make our economy less rigid and slow. Over the next few years, the measures set out in the National Recovery and 1/11 BIS - Central bankers' speeches Resilience Plan (NRRP) are expected to give a considerable boost to economic activity; implementing its set of investments and reforms within the agreed time frame will be crucial. GDP returned to growth in the first quarter of this year, buoyed by the recovery in consumption and by the further expansion in investment. As in the rest of the euro area, the weakening of manufacturing activity was countered by the good results for private services; in this sector, non-negligible rises in final prices are associated with the healthy demand, especially in the tourism and leisure sector. Given the tighter financing conditions and the slowdown in global trade, we expect GDP to increase moderately over the next few quarters. According to the estimates published in mid-June, GDP growth could exceed 1 per cent over the year, and should stay at around this figure on average over the next two years. These are forecasts that are still highly uncertain and with risks mostly on the downside. Together with the conflict in Ukraine, which may lead to further rises in commodity prices and a decline in the confidence of firms and households, there are fears connected to the evolution of global economic activity, which could be affected to a greater than expected extent by the monetary tightening under way in the leading economies, as well as those linked to the risk of an excessive tightening of credit supply conditions. From December 2021 to May of this year, the interest rates on new loans to firms and on new mortgages for households went up in Italy by around 360 and 280 basis points respectively, to 4.8 and 4.2 per cent. The cost of bank funding is also on the increase, but the effects of the rises in the key interest rates on those on sight deposits are still very limited. This is partly attributable to the abundant liquidity accumulated by banks as a result of the accommodative measures adopted over the last decade by the ECB Governing Council to counter the risks of deflation, which remained in place during the pandemic. This may have led to less competitive pressure among banks in the overnight deposits segment, which should now gradually grow, with corresponding and more decisive increases in interest rates. In line with the central bank objective of achieving price stability in a reasonable time frame, tightening financing conditions for households and firms is helping to curb demand for credit. However, the surveys conducted on banks indicate that in Italy, as in the rest of the euro area, growth in lending is also affected by the resolute tightening of supply policies, mainly driven by greater risk aversion and concerns over growth prospects. Credit dynamics, which were broadly positive until last summer, have turned negative for both firms and households. The modest rise in interest rates on sight deposits is favouring a marked reallocation of savings towards more remunerative assets, particularly government bonds and, to a lesser extent, towards other kinds of deposits and towards bank bonds. The Eurosystem's reabsorption of excess liquidity and its effects on credit to the economy are also contributing to the gradual contraction in overnight deposits. Despite the altered circumstances and the persistence of great uncertainty over changes in the economic outlook, the situation of the Italian banking system is satisfactory overall. Profitability remained high in the first quarter; on an annual basis, 2/11 BIS - Central bankers' speeches the return on equity was just below 13 per cent, as it continued to benefit from the increase in net interest income and from loan loss provisions that are low also by historical standards. According to market analysts' expectations, the profitability of the main listed banking groups (which account for more than two thirds of the sector's total assets) should also remain high in 2023 as a whole. The CET1 ratio declined slightly in the first three months of the year, to 15.1 per cent, as a result both of the end of the transitional regime introduced in 2018 with the entry into force of the new accounting principles (IFRS9), which had spread the capital impact over five years, and of the distribution of profits. Nevertheless, the indicator remains more than one percentage point higher than was observed when the pandemic broke out; for the significant banks, it is essentially in line with the average for the other intermediaries directly supervised by the ECB. The liquidity indicators also stand at levels well above the regulatory minimums. The repayment of part of the funds obtained via targeted longer-term financing operations (TLTROs) has only marginally lowered them so far. As for the loan book, new non-performing exposures and their stocks remain at low levels. The improvement in the quality of loans observed over the last few years is due to the strengthening of firms' financial situations, as they have reduced their leverage ratio by around 10 percentage points since the peak reached in 2011, to 39.7 per cent. Contributory factors include the support measures introduced to mitigate the effects of the pandemic crisis and the increase in energy costs. The reduction in non-performing loans on banks' balance sheets has been helped by the growth of a secondary market, which has allowed disposals to continue even at times of economic slowdown. The greater capacity of intermediaries to select and manage credit risk has also played an important role, especially during the loan origination, partly in response to the stimulus provided by the supervisory authorities. Since 2014, following the sovereign debt crisis, the weight of financially sound firms in banks' loan portfolios has grown proportionally more than their share in the total assets of the whole corporate sector. Nevertheless, uncertainty over the outlook for the banking system remains high. The main risks stem from the cyclical slowdown and the medium-term effects of the increase in interest rates on customers' ability to service their debts. Some potential signs of these risks materialized in the first three months of this year: the ratio of the flow of loans in arrears – but not yet late enough to be classified as non-performing loans – actually doubled, on an annual basis, to 1.6 per cent of the total performing loans. Recently, however, the number of loans whose creditworthiness is reported by banks to have deteriorated significantly (i.e. those ranked as 'Stage 2' in the hierarchy provided by the international accounting standards) has decreased. This fall may be partly due to the improvement in the quality of those exposures that fell into this category immediately after the outbreak of the pandemic; we are monitoring their developments to detect any underestimation of risks by banks. A timely recognition of expected losses is also crucial to reduce the possible procyclical effects of the economic slowdown. Ensuring adequate coverage for non-performing loans, especially for less significant banks, is equally important. 3/11 BIS - Central bankers' speeches In addition to increasing loan losses, pressure on profitability could occur if the passthrough of higher official interest rates to the cost of funding, which is still gradual, accelerated more than expected. The replacement of low-cost funding, such as that from TLTROs, with more expensive instruments, and the need to issue new liabilities that meet the resolution requirements could also play a role. The risks posed by non-bank intermediaries remain limited, although they should not be underestimated. Net subscriptions to Italian open-end investment funds remained broadly unchanged in the first quarter; the few funds that recorded significant net outflows (above 10 per cent of the net asset value) had no difficulties with redemptions. In line with the context of rising interest rates, the liquidity of the funds decreased, although it remains satisfactory. Credit lines remained stable and indebtedness continued to be low. The risks for Italian alternative investment funds are also limited; leverage is on average lower than that of similar European funds and indebtedness towards banks is low. Real estate funds, which are mainly active in the commercial sector, are among the most leveraged funds. Although the likelihood of a sharp fall in prices in this market segment is much lower in Italy than in other European countries, a further decline in the value of commercial real estate would reduce the quality of bank lending to these intermediaries. Supervisory issues In recent years, once the most critical phase of the COVID-19 pandemic was over, new risk factors have emerged in connection with the escalating geopolitical tensions, the consequences of the energy crisis and the negative effects of climate change. It has thus become increasingly important for supervisory authorities and for intermediaries to use instruments that can capture potential vulnerabilities at an early stage. This is partly why the supervisory review and evaluation process places particular emphasis – more so than in previous years – on the reliability of internal procedures for assessing capital adequacy and liquidity conditions. A number of tailored investigations were carried out to gather additional information for assessment beyond that derived from regular supervisory reporting. In the first quarter of this year, similarly to what has already been done for significant banks, those banks and other intermediaries under the direct supervision of the Bank of Italy were requested to submit business plans updated considering the latest macroeconomic scenarios. Based on this information, analyses are now under way to assess the sustainability of business models and identify vulnerability factors, including cost dynamics, in good time. The results of these studies will be an important basis for our discussions with intermediaries. In the same period, also in view of targeted longer-term refinancing operations reaching maturity, we asked almost all less significant banks to update their funding plans, which the ECB already systematically gathers for significant banks. On 28 June, around €150 billion of the €300 billion outstanding TLTRO funding was repaid. In keeping with the plans, banks almost exclusively used excess liquidity, which has recently increased thanks to bond issuance and repo funding. Recourse to new central bank refinancing operations has been limited so far. 4/11 BIS - Central bankers' speeches Banks should draw more heavily on these refinancing operations to cover future repayments. Moreover, significant banks anticipate further issues of bonds – including retail bonds – and, to a lesser extent, an increase in customer deposits. Smaller banks claim that they will rely more on the latter. The idea of increasing deposit funding clashes with expectations of a further reduction (at the aggregate level) in this form of funding, which is already suffering from competition with alternative forms of investment. At present, the extensive availability of assets eligible as collateral for refinancing operations ensures that funding needs can be met, albeit probably at higher costs than anticipated. Non-bank intermediaries under our supervision are subject to rules that are in many cases stricter than those in force in other European countries. In addition to refining the supervisory review and evaluation process for these intermediaries as well, we regularly check the systemic importance of alternative investment funds, whose assets under management, although still limited, have doubled over the last ten years. We pay special attention to credit and real estate funds. Specific supervisory measures were taken for servicers to preserve the efficiency of the secondary credit market, which has played a key role in reducing non-performing loans on banks' balance sheets through securitization operations. Initial results reveal shortcomings in governance and control, as well as delays in updating recovery plans. The ongoing discussion aims to assess the adequacy of the remedial measures, also with a view to improving the quality of the information provided to the market on the performance of managed operations. Some of these operations are lagging behind the initial recovery plans, partly due to the suspension of enforcement proceedings during the most acute phases of the pandemic. As for government-guaranteed operations, the older ones have the largest deviations as their recovery plans were drawn up less rigorously. The recent rise in market yields has also increased the interest payable to holders of bonds, often at floating rates, issued by special purpose vehicles against nonperforming loans thus reducing the share of the collection used to repay the principal. At the end of 2022, the total amount of outstanding government-guaranteed senior bonds was around €12 billion. If we consider the few operations whose recoveries, according to the updated plans, would not be sufficient to fully repay the senior bonds, the total enforced guarantee could amount to around €220 million. However, this sum should be covered by the provision funded by fees paid by banks for granting the guarantee and by the amounts already earmarked in the public budget for this purpose, without the need for further government funding. Some recent regulatory reforms have addressed specific intermediaries' business lines, such as crowdfunding services, and specific products, such as covered bonds and securitizations. This has resulted in potentially more effective safeguards. However, to maintain a comprehensive overview of the risk exposure of supervised entities, we should always consider these operations as part of their overall corporate management. In this respect, we are committed to strengthening cooperation and dialogue between the various authorities involved. Financial services and technology 5/11 BIS - Central bankers' speeches Technological innovation is reshaping the financial services industry, making it possible for intermediaries to overcome the barriers created by the need for physical interaction with customers, to achieve cost savings, and to test new forms of cooperation with supervised and non-supervised entities. While intermediaries should seize these opportunities by adjusting their business models as needed, neither they nor the supervisory authorities should underestimate the risks of technological change. Last year, we conducted a survey of the digitalization strategies of the less significant banks to encourage debate on these issues. We found widespread awareness of the importance of investing in technological innovation, albeit only as a means to increase business volumes and revenues by reaching customers who cannot be served by the physical distribution network. The potential for development in terms of cost-cutting and of process and product innovation was less of a consideration. More marginal still was understanding the value of the information acquired in the context of financial intermediation. Developing good data processing and control capabilities is instead key, not only to responding promptly to information requests from the supervisory authorities, but especially to providing timely reports for corporate executives to make informed decisions. Digitalization fosters cooperation between financial intermediaries and technology service providers. This can result in efficiency gains for the financial industry and higherquality services for users, but authorities and operators alike need to improve their ability to assess the risks associated with this process. We are about to launch new supervisory reporting on outsourcing, which will allow us to gather information on supervised entities' contracting arrangements as well as valuable input for assessing the degree of concentration among the leading service providers and ultimately to minimize the impact of any incidents. On-site inspections of the main IT service providers used by the less significant banks have shown that there is more dialogue between the parties, which is essential both to monitor risks better and to design digitalization strategies. However, dialogue can only be truly effective once corporate executives have honed their IT skills: as of now, just half of the less significant banks reported having at least one director with specific expertise, and the share of control function employees with these skills remains low. These initiatives come ahead of the European Digital Operational Resilience Act (DORA), to be enforced as of 2025 to ensure that European supervisors adopt a shared approach to digital resilience across the entire financial services industry. They allow the Bank of Italy both to bring its experience to the authorities that are drafting secondary legislation and to better prepare banks for the 2025 deadline. We are working closely with the Ministry of Economy and Finance (MEF) and with CONSOB on the implementation of the European Markets in Crypto-Assets Regulation (MiCAR) in Italy. The regulation also classifies these financial instruments based on their different economic functions, introduces a harmonized legal framework for them, and therefore indicates how the roles and responsibilities should be distributed among the distinct supervisory authorities. However, we are aware that it will not solve all the problems stemming from the evolution of the markets, as unhosted wallets (i.e. digital wallets used to exchange 6/11 BIS - Central bankers' speeches crypto-assets without the involvement of an intermediary) and the development and application of smart contracts (i.e. computer programmes at the core of decentralized finance) remain outside its scope. This is also why, one year after the publication of our communication on Decentralized Technology in Finance and Crypto-Assets, in which we provided specific instructions for operators, we are assessing the outlook for these services and future market developments. As I have pointed out on several occasions, crypto-assets are only one of the applications of distributed ledger technology (DLT). The introduction of the DLT Pilot Regime in Italy, as well as in other EU countries, will allow operators to experiment with the use of DLTs in order to reduce the costs associated with the issuance, trading and settlement of financial instruments and to broaden the investor base for securities issued by Italian entities. This could bring tangible benefits to firms, especially mediumsized ones, in terms of better access to capital markets and diversification of funding sources. With this in mind, we are working closely with CONSOB to design secondary legislation and to facilitate the projects of market players. Within the Eurosystem, we are also testing some technical solutions, including one designed by the Bank of Italy, to ensure that DLT transactions can be settled in central bank money. Financial intermediaries are interested in developing open banking interfaces for thirdparty access to payment accounts, as laid down in the second Payment Services Directive (PSD2), and this is gradually fostering market competition, also thanks to new entrants. The European Commission's legislative proposal on open finance, published on 28 June 2023, could further boost competition because by using a wider set of customer data, operators will be able to develop new financial products and services. Moreover, while paying close attention to monitoring technological risks, intermediaries must continue to ensure adequate customer protection and effective anti-money laundering safeguards. The increasing amount of information generated and made available as a result of digitalization is contributing to a growing uptake of artificial intelligence (AI) applications in the financial industry as well, with potential consequences that are still extremely difficult to grasp. In this regard, it is worth mentioning the ongoing European negotiations to create a harmonized legal framework to regulate the development, marketing and use of AI in accordance with the EU's values and its Charter of Fundamental Rights. Although the regulation is cross-cutting in nature, it has several aspects that are also relevant to the financial industry; its spillover effects on intermediaries' operations and on customer protection will have to be assessed carefully. The Bank of Italy is well aware of the progress being made and it supports and promotes digital innovation in the financial system throughout the service production cycle, while monitoring the ensuing risks closely. Our work is focusing on the sustainability of business models, the security and efficiency of market infrastructures, updating the regulatory framework and the risk management processes, as well as on consumer protection and financial education on the new instruments and new ways of using those services made available by technology. Through ongoing dialogue with market operators (via the Fintech Channel, Milano Hub, our innovation centre, and the activities carried out within the regulatory sandbox), we 7/11 BIS - Central bankers' speeches support their projects from the design and development stages through to testing. In view of the growing interest in the use of DLT, Milano Hub's second call for proposals focused on the application of this technology to banking, financial, insurance and payment services. The large number of applications is evidence of its success. The 14 winners are now developing their projects with the multidisciplinary assistance of experts from the Bank of Italy. On the payment systems front, we have supported the MEF in its work within the European Council on the proposal for a regulation on instant bank transfers in euros, a milestone in the process of building an integrated, innovative, digital and competitive European payments industry. The regulation aims to overcome some of the obstacles to the widespread use of instant bank transfers, namely the fees currently charged for these transactions and the public's mistrust of this type of payment. Therefore, fees on instant transfers should not be higher than on traditional transfers in euros, and banks would be required to put systems in place for verifying that the payee's name matches the bank details as entered by the payer. Again on 28 June, the European Commission presented a proposal for a regulation on the possible introduction of a digital euro. The proposal describes the reasons and goals for a new form of central bank money available to the public and contains a broad set of rules regarding, among other things, the legal basis, the role of the Eurosystem and of credit institutions, and the use and protection of users' personal data. Negotiations have just begun. In order for the digital euro to play an anchoring role in the public's trust in central bank money, it must have the status of legal tender, on a par with banknotes, and the highest level of privacy compatible with the public interest, including the need to bar its use for money laundering and the financing of terrorism. Any decision to issue this new form of money will be taken by the ECB Governing Council once the necessary regulatory framework has been completed. The digital euro is an important project, not only to promote competition and innovation in the European payments system with lower costs for users, but also to preserve the euro area's strategic autonomy and monetary sovereignty. In order for it to be successful, it will be necessary to design incentives that encourage all stakeholders to join in: consumers and firms, because they will be using the digital euro, and banks and other institutions, because they will be distributing the new money and providing the associated services. The digital euro should be used as a payment instrument and not for saving purposes. We must therefore first consider the risks for monetary policy transmission and financial stability that could arise from substituting an excessive amount of bank deposits with digital currency. As a central bank liability, the digital euro will be a risk-free form of money like notes and coins, to be used alongside cash and other payment instruments already in use but without necessarily replacing them. The solutions under consideration include in particular the absence of any remuneration and a threshold for the amount of digital currency that a user can hold. The solutions will have to preserve banks' capacity to provide credit to the economy and, at the same time, avoid the possible uptake of high-risk instruments, such as some types of crypto-assets, as a means of payment. Supporting the climate transition 8/11 BIS - Central bankers' speeches Today the banking system is facing the challenge of the green transition. While in the medium term, the contribution of the financial system will be fundamental in achieving the decarbonization goals agreed at global level, it should be prepared, as of now, to manage climate and environmental risks. The recent flooding in Romagna and the surrounding territory reminded us how extreme weather events can not only cost human lives, destroy homes and disrupt the lives of people in the affected areas, but they can also have serious consequences for businesses and, hence, for the banks that provided them with funds. The areas in question generate around 3 per cent of the value added of the national non-financial private sector and a similar share of total bank loans. More generally, the Bank of Italy's estimates show that, in Italy, around one fourth of loans to non-financial firms are aimed at businesses in provinces at high risk of natural disasters. Of these, 58 per cent are covered by guarantees, which could, however, be exposed to the same risk as the loans; the coverage ratio falls to 38 per cent if only personal guarantees are taken into account. There is urgent need for action, in the first place to contain the risks. Follow-on interventions – funding of reconstruction work, infrastructure repairs, the suspension of various tax payments and utility bills, and loan repayment holidays – will certainly mitigate the economic impact of adverse climate events but they cannot be seen as the solution. The first line of defence must be to secure the country against flooding and landslides, bearing in mind that this is far costlier to achieve after the event has taken place. To this end, the NRRP has earmarked about €1.25 billion. The contracts for this work will be awarded by the end of 2023 and the delays signalled in the last report on the implementation of the NRRP must be prevented from becoming any longer. The private sector can also make an important contribution by stipulating insurance policies to cover damage caused by natural catastrophes. A significant expansion of this market could reduce the currently high cost of these policies. Italy is still very behind in this area: in the period 1980-2020, only 6 per cent of the losses connected with such events were covered by insurance on average, compared with 22 per cent in Europe. The lack of insurance cover seems to be prevalent among the smallest companies and those located in the South and Islands. As part of the coordination group on sustainable finance set up at the Ministry of Economy and Finance, in which we participate together with IVASS and the other authorities in the sector, we have launched an initiative to promote insurance protection against climate and other catastrophe risks, based on the public and the private sectors working together. Adequate insurance cover is also an important factor in risk mitigation for banks that lend to households and firms located in areas with high climate risks. However, in about three quarters of cases, banks are not aware that their borrowers are insured, which means that they might not take this into account when setting out their credit supply conditions. If confirmed by further evidence, it will be necessary to investigate in greater depth with banks and firms why this is the case, and to remedy the situation. We have asked banks and financial institutions for three-year action plans showing how they intend to meet the supervisory expectations we published in 2022. As is already the case for the significant banks, the evaluation of these plans will be included in the Supervisory Review and Evaluation Process (SREP), taking a proportionate and 9/11 BIS - Central bankers' speeches gradual approach. Such plans must be based on reliable data that are as accurate as possible. In this regard, we are participating in numerous international and national working groups. In particular, in the group chaired by the Ministry of Economy and Finance to which I referred earlier, action is being taken to reduce the information gaps and to improve the quality and availability of data on the environmental (and social and governance) aspects of the activities of both banks and their borrowers. At the moment, our contribution is based on an analysis of the difficulties faced by the largest banks – which, since last year, have been required to disclose information to the market based on the third pillar of the Basel framework – in retrieving sufficiently good quality data. Similar difficulties were experienced by the smaller banks and the other financial institutions that, according to the 2020 Regulation to facilitate sustainable investment, are required to publish their exposures using the EU's taxonomy, as defined in the 2021 Commission Delegated Act. Credit allocation will have to be based on forward-looking assessments, meeting as far as possible the demand of firms that commit to making investments to reduce their emissions. Therefore, at global and European level, ever increasing attention is being paid to the transition plans that firms will have to put in place. While work on this is still in its early stages, as recently highlighted in a report by the Network for Greening the Financial System, it is important to proceed swiftly. In any case, in order to support an adequate evaluation of their creditworthiness, it is in the interest of the firms themselves, even the smaller ones, to inform the market about their strategies to reduce emissions. *** The world economy is still in a state of great uncertainty stemming from Russia's invasion of Ukraine, the evolving geopolitical tensions, the doubts concerning the strength of China's economic recovery and the effects of the tighter monetary policy stances. The outlook for the Italian economy over the medium term will not be negatively affected if the recovery in labour productivity, which has been gradually increasing for about ten years, continues. Firms must therefore continue to increase investment, with an emphasis on innovation, and fully implementing the NRRP will provide a contribution to this. The Plan gives Italy the opportunity to generate new momentum in the economy and address the weaknesses that still hold it back. A financially stable environment, in which efficient and well-capitalized banks continue to contribute to credit allocation, will buoy the confidence of economic operators and enable them to better plan their consumption, savings and investment decisions. In recent years, Italian banks have handled successive waves of crises following the outbreak of the pandemic, starting from a stronger position than they had in past crises, which has allowed them to provide firms and households with the credit needed to make it through the most difficult phases. As in the rest of the banking union, intermediaries in Italy suffered only moderately from the tensions that arose following the failure of some US regional banks and Credit Suisse. This result is also attributable to the regulatory reforms introduced after the global financial crisis and to rigorous supervision. Europe must continue to follow this path, 10/11 BIS - Central bankers' speeches including: implementing the final Basel III Accord, honouring its original spirit as much as possible, and adopting faster and more effective crisis management mechanisms for all banks, bearing in mind, based on recent experience, how the failure of even relatively small banks can trigger a dangerous episodes of contagion. The job of commercial banks is basically to 'transform maturities'; this exposes them structurally to liquidity risk, which should be lowered by imposing appropriate regulatory requirements so as to prevent bank runs – whether physical or digital – and bank failures, possibly as part of a chain reaction. It is no coincidence that the banks that failed in the US regional banking sector were not subject to the Basel III minimum requirements. This does not mean that we should stop thinking about how to improve them by incorporating the lesson learnt from the recent crises, namely that deposit stability cannot and must not be taken for granted. This is a task that the Basel Committee is already tackling. At this time, in the euro area and in Italy, banks are having to face the likelihood of funding costs being much higher than they have been in recent years due to the necessarily tighter monetary policy stance. Interest rates have been raised, on a consistent and ongoing basis, with the aim of slowing inflation to a level consistent with the 2 per cent objective in a sufficiently short space of time, heading off any deanchoring of medium-term inflation expectations and countering the risk that core inflation remains too high for too long. The pass-through of the exceptionally higher energy prices to the end-use prices of goods and services has actually been much greater than in the past. The return of oil and natural gas prices to levels well below those observed prior to the Russian invasion of Ukraine should therefore herald a more marked deceleration in inflation in the coming months for the euro area as a whole. At the same time, the reaction of wages and profit margins to changes in the terms of trade varies greatly within the euro area; key interest rate variations will therefore have to be carefully calibrated in the coming months, based on incoming data and expectations concerning the timing of the return to price stability. However, there are currently no obvious reasons to believe that this result cannot be achieved with sufficient speed, beginning this autumn. While we must keep our guard up and stay on course, we must also exercise caution and patience in assessing and anticipating the effects of the monetary tightening under way since last year, which is well justified and must certainly continue. At the same time, it is certainly possible to contain the negative impact on economic activity and on aggregate demand and to keep it from exerting excessive downward pressures on prices in the medium term. In this regard, I do not understand and I still do not share the opinions, including some recently voiced, in favour of the risk of being more, rather than less, restrictive. I think we should be cautious to the right extent; a symmetrical approach, in line with the conclusions of the ECB's review of its monetary policy strategy, seems to me to be the best given the circumstances. It would also allow us to limit the impact on credit and preserve financial stability, which I spoke about earlier and which, as I observed, is itself a necessary condition for price stability and the resilience of our economies. 11/11 BIS - Central bankers' speeches
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Welcome address by Mr Piero Cipollone, Deputy Governor of the Bank of Italy, at the 6th Bank of Italy-Centre for Economic Policy Research (CEPR) workshop on "Labour market policies and institutions", Rome, 18 September 2023.
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Piero Cipollone: Welcome address - 6th Bank of Italy-CEPR workshop Welcome address by Mr Piero Cipollone, Deputy Governor of the Bank of Italy, at the 6th Bank of Italy-Centre for Economic Policy Research (CEPR) workshop on "Labour market policies and institutions", Rome, 18 September 2023. *** Ladies and gentlemen, distinguished guests and colleagues, I welcome you all today to the sixth edition of the workshop on labour market policies and institutions that marks another important building block in the long-lasting and fruitful cooperation between the Bank of Italy and the CEPR. The varied programme, which includes many excellent papers and brings together both well-established and younger labour economists, provides the perfect springboard to comment on the current economic situation and the pivotal role of the labour market. We are in the midst of uncertain times. The strong post-pandemic employment growth may soon come to an end, following the recent slowdown in economic activity in the euro area. Inflationary pressures, largely generated by the growth in commodity and intermediate goods prices and by shocks to global value chains, might have reached their peak in the past few months, but there are upside risks to their persistence. Despite strong demand for significant wage increases in certain countries, especially those with tight labour markets, overall wage growth has remained relatively modest up to this point, and real wages are still well below pre-pandemic levels. Restoring the lost purchasing power should be tied to achieving productivity growth. Uncertainty is not only about the short-term outlook. We are facing long-term structural shifts that will affect the functioning of the labour markets and the wellbeing of workers and households in the near future. The transition to a net zero emissions economy, automation, robotics and generative artificial intelligence will affect labour demand and its composition, with potentially significant effects on inequality. An ageing population will exert significant pressure on labour market participation in all advanced economies and will place a substantial burden on the sustainability of public finances due to fewer taxpayers and escalating old-age-related expenditures. The global context is also changing: the rise of new, competing, geopolitical blocs may trigger a process of deglobalization. In times of both short and long-term shocks, we need to make sure we balance the imperatives of economic dynamism with the need to address inequalities and protect vulnerable workers. This is where studying labour market institutions and understanding how to tailor the policy tools at our disposal becomes so important. Let me pick out some issues among those that will be discussed in the workshop. We have recently witnessed the pivotal role that the design of wage negotiation systems plays in shaping wage dynamics. Especially in the euro area, many aspects of the country-specific wage bargaining systems – such as the duration of wage agreements – induce (nominal) wage rigidities and the delayed response of wages to business cycle conditions. There is long-standing debate on whether and how to 1/3 BIS - Central bankers' speeches introduce greater flexibility into wage negotiations, for example by granting certain firms the possibility to deviate from national collective agreements. This would strengthen firms' resilience to shocks, albeit at the cost of potentially lower wages, highlighting the importance of protecting workers' welfare. Institutions also play a crucial role in shaping the redistribution to workers of the economic rents accruing to firms as a result of their monopsonistic power in the labour market. Firms might actually pay inefficiently low wages, or exert their power by only offering temporary and short-time contracts. Since the groundbreaking work of Nobel laureate David Card and his friend and co-author Alan Kruger, whom we miss very much, research has suggested that minimum wage policies can contribute to rebalancing the share of economic rents in favour of workers, and can trigger a favourable reallocation process, penalizing firms operating with monopsonistic inefficiencies. Policies that encourage firms to offer permanent and full-time contracts can serve as a safeguard for protecting workers. On the other hand, although the effect on aggregate employment is undetermined ex ante, these measures might lead to a decrease in employment levels within some firms. Meticulously designing policies to fit individual economic contexts is necessary. Once again, this means there is a great need for further research to inform policymakers on this topic. Welfare programmes are key for shielding workers and households from the negative effects of both temporary shocks and structural transitions. Government interventions have played a crucial role in safeguarding households and workers in the wake of the COVID-19 pandemic and during the recent inflationary pressures that have hit lowincome households harder. Nevertheless, designing such comprehensive programmes is no mean feat, in a world that is considerably different from the post-World War II era when the foundations of the modern welfare states were laid. Striking the right balance between incentivizing labour participation, providing a safety net against negative shocks and complying with budgetary rules requires thorough and realistic modelling frameworks, some of which will be discussed tomorrow by Professor Voena, one of the keynote speakers. There is little doubt that the long-term transformation of our economic systems will depend on technological progress, and the way it unfolds. Among the many challenges ahead of us, the recent advances in automation and digitalization will undoubtedly have an unprecedented impact on workers' prospects, overall welfare and inequality. In the past, labour market and political institutions were crucial in sharing the productivity gains among capital and labour, especially from post-World War II to the early 1970s. More recently, automation has generated losers, especially among those whose productivity has not been enhanced by the interaction between technology and their skills. Looking ahead, the impact of AI on workers' employment prospects may be different from what we have observed in the recent past, and even highly skilled workers may experience negative labour market outcomes. These concerns will be at the heart of Professor Acemoglu's keynote lecture today. I am not here to take a stance on all these issues, or more generally on the future of work. The real consequences of this new technological wave, however, are likely to challenge several aspects, not only of the labour market – such as the determination of 2/3 BIS - Central bankers' speeches wages and the rent-sharing between firms and workers – but also of the modern welfare state – such as unemployment insurance schemes. Brand new policies and institutions will be key in fostering competition, in favouring a smooth transition and in enhancing inclusive growth; minimum income schemes and training and lifelong learning programmes could be useful in supporting those workers most at risk of being displaced. The path ahead of us is not set in stone. Actively investigating these policy tools and questioning received wisdom is of the utmost importance today. For young (and less young) researchers, like many of you here today, the challenge is to provide strong empirical and theoretical evidence to support and guide the upcoming policy decisions. For those who are in charge of implementing these policies, a closer look at the recent advancements in economics and social sciences would be beneficial. Let me conclude by thanking the organizers for their hard work, the keynote speakers and the presenters for their valuable contributions, and each one of you for your presence here. I am sure there will be two very fruitful days of discussion for us all. 3/3 BIS - Central bankers' speeches
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