Distinguished members of the academic community,
Ladies and gentlemen,
It is truly an honour to speak before you today at the opening ceremony of the 30th edition of the International Economic Conference of Sibiu, an event that brings together seasoned experts from research centres and universities, highly esteemed researchers in the field of economics, and prominent professors each year.
Moreover, I am exceedingly grateful for the privilege to address you on behalf of the Governor of the National Bank of Romania, Mr. Mugur Isărescu, a successful researcher himself, who regrets not being able to attend in person, especially considering that this year marks the 10th anniversary of his receiving the honorary title of Doctor Honoris Causa from the Lucian Blaga University of Sibiu. As it happens, institutional commitments have required his presence abroad these days.
One of the messages he asked me to convene today is that he is delighted to be associated with such an acclaimed community, and I would like to express his deepest gratitude for your unwavering commitment to achieving outstanding academic standards. On his behalf, I convey his warm wishes and recognition for the Lucian Blaga University of Sibiu to continue setting an example of excellence in higher economic education in Romania and further organize insightful events such as the one we attend today.
Another message I must convene is that you should continue to count on the National Bank of Romania’s commitment to the partnership with Lucian Blaga University of Sibiu, built over decades. And, of course, our Sibiu Branch has been and will continue to be a meaningful part of this partnership.
As mentioned in the appreciations made at that time in the „Laudatio”, the Governor is a prominent scientist who has dedicated his life to the study of economics and the application of knowledge acquired through research in his professional endeavours at the National Bank of Romania. Furthermore, as emphasized 10 years ago when LBUS awarded him the honorary title, the Governor serves as a role model for the academic community in Sibiu, considering his scientific competence and the prestige he has both nationally and internationally.
I would like to reiterate this point as well, speaking as a colleague of his on the Board of Directors of the National Bank of Romania. For us, he represents both a benchmark of professionalism and dedication, demonstrating his ability to gather around him the brightest minds and inspire them to find the best solutions for the benefit of society.
It is a great privilege for me to speak here today on behalf of the Governor, and I would like to follow in his footsteps with a few personal observations on one of the topics he addressed during the ceremony that took place ten years ago, namely the need for the establishment of the Banking Union, as well as sharing some personal reflections on the Capital Markets Union project and its evolution over the past decade, along with several other topical subjects of interest, such as inflation and the challenges that central banks are facing.
In order to prepare for this speech, I researched the allocution delivered here by Governor Isărescu ten years ago. In his 2013 lecture, the Governor discussed the development prospects that Romania intended to achieve through its accession to the Banking Union, a project aiming at ensuring a more resilient banking sector, highlighting the architecture, benefits, challenges and perspectives of adopting the Banking Union. Established in 2014, the Banking Union represented a response to the financial crisis of 2008 and the Euro area sovereign debt crisis. The objective was to protect all consumers equally, enhance transparency, and increase the level of trust of foreign investors in banks while strengthening the principle of competitive neutrality.
The Banking Union is regarded as an important step towards a genuine Economic and Monetary Union in Europe and has two main pillars: the Single Supervisory Mechanism (SSM), through which all credit institutions are supervised by the European Central Bank in cooperation with national supervisory authorities, and the Single Resolution Mechanism (SRM), which ensures that banking crises can be managed in an impartial and efficient manner, with minimal costs for taxpayers and the real economy. Although important steps have been taken in the form of the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM), the Banking Union is still a work in progress 10 years later.
At the same time, a project that I see essential is that of the Capital Markets Union, which has become even more relevant in the context of tensions generated in global markets following the bankruptcy of several American banks in March 2023 and the issues in the Swiss banking system. Once again, we witnessed how trust is a fragile sentiment that can be easily weakened by shocks experienced by financial institutions during extraordinary events such as the COVID-19 pandemic, the war in Ukraine, the energy crisis, and so on. The current geopolitical context may lead to an increase in the frequency of such exogenous shocks and, consequently, an expansion of vulnerabilities that the regulators must prevent and manage.
By establishing a single capital market throughout the European Union, money flows, whether they are investments or deposits, will move more smoothly within the EU. This can translate into various benefits, including the possibility of obtaining loans at lower costs for companies, increased accessibility of financing for SMEs, providing incentives, and removing various obstacles that may limit depositors from making investments, among others.
Returning to the presentation, there was one particular headline that caught my attention: “The stability of the financial sector facilitates the implementation of monetary policy.” Well, after three severely challenging years, after dealing with a global pandemic, a supply-side shock and shortage, an energy shock and a war, I think we can all agree that the Romanian financial sector proved itself resilient and that the transmission of the monetary policy works, as we have witnessed already a reduction in the annual rate of inflation from a peak of 16.8% in November 2022 to a current value of 11.2%. Under the influence of the same external shocks, of course, but with contained inflationary expectations.
However, as the famous economist Milton Friedman wonderfully stated: “There are long and variable lags between changes in monetary policy and changes in the economy”. A brilliant comparison used by Friedman to illustrate this delayed effect is that of adjusting the temperature in a shower with a very long hose: it takes time for the hot water to arrive. Therefore, the temperature must be adjusted gradually. Transposing this principle into our activity, central banks must be extra careful with the timing and especially with the dosage when tightening the monetary policy, to avoid sudden swings in the economy from overheating to freezing.
In this regard, I strongly believe that the National Bank of Romania’s monetary policy was an adequate and balanced one, in line with that of the countries in the region. We took firm action since the early signs of inflationary pressures, tightening the monetary policy as early as October 2021 and used an optimal dosage without abrupt interest rate increases, contributing to the reversal of the inflation trajectory. “Graduality” we can clearly say now, was the middle name of our strategy. After 11 consecutive rate hikes, the National Bank of Romania decided at the beginning of this year to maintain the key interest rate at the level of 7%.
Another critical aspect: we did not exaggerate. The National Bank of Romania did not employ unconventional monetary policy tools, like forward guidance and did not adopt quantitative easing in the broad sense of the term, this "dangerous addiction" as Mervyn King, ex-BoE Governor, named it. We only acquired a minimal amount of bonds compared to our peers and with financial stability reasons behind: with the sole purpose of “unfreezing” the bond market during the pandemic, which was malfunctioning. Unlike other central banks in Central and Eastern Europe (such as those in Hungary or Poland) and the European Central Bank (which has purchased assets equivalent to over 40% of the Eurozone’s GDP), the National Bank of Romania has conducted government bond purchases amounting to only 0.4% of the GDP in 2021.
Another quote from Mervyn King that I particularly enjoy and I find highly relevant: “We, central bankers, have to keep the message simple: when too much money chase too few goods, the result is inflation.”
As was recently shown by the Governor in the presentation of the latest Inflation Report, the M1 monetary aggregate in Romania, the measure of narrow money (currency in circulation + overnight deposits), has decreased recently, primarily due to the transfer of demand deposits to time deposits, indicating that the measures taken by the National Bank of Romania have encouraged savings with longer-term horizons. So less money is starting to chase the goods.
The current inflation projection of the NBR shows inflation declining to the level of one digit starting from the third quarter of the current year. When it comes to the fight we are having against inflation, I will say it bluntly: even though we have won some major battles, and other victories will definitely come this year, I wouldn’t say that we have won the war on inflation: the war will continue and it could be a long-lasting one. During the latest press conference, the Governor emphasized the success of reducing inflation in a prudent manner, without sudden shocks to the economy. But we need to continue to stay prudent, as the environment in which we operate is characterized by significant uncertainty and is full of challenges.
As in sports, we have to continue to focus on the ball: there is still a long way to go before we get inflation back to the 2.5% target, and not only that the road is long and difficult, but it can also be a bumpy one. Similar to travelling, the last part of the journey can be the most difficult. It may sound counterintuitive, but the effort of bringing inflation from 5% to 2.5% can be higher than that of bringing it from 15% to 5%.
The good news is that after a difficult period, there are signs of normalization and the inflation rate will come down to single digits soon. For the end of 2024, the National Bank of Romania forecasts an inflation rate of 4.2%, slightly above the variation band of the target. The discussion about interest rate cuts is off the table for now. Until we don’t see the inflation going down near the target, inside the corridor, it is too early to declare that we have won the war and a potential discussion about monetary policy easing is premature. We need to see more progress into the disinflationary process before deciding on key rate cuts.
For the last three years, inflation has mostly come from shocks (pandemic, disruption of supply chains, war), yet now I see a different story unfolding: I fear increasingly evident structural factors will make the coming decade much different from the last one: war is inflationary, protectionism is inflationary, greening at least in the short and medium term is inflationary, nearshoring and friendshoring are inflationary, demographic changes can be inflationary, geopolitical bipolarity is inflationary, deindustrialization is inflationary, fiscal deficits are inflationary, the erosion of liberalism is inflationary. Some of the themes I just mentioned are as topical today for the central banks as the banking union was 10 years ago.
For example, “greening” the economy is a topic that we also actively review at the National Bank of Romania, both through the specialized analyses we publish and our membership in the Network for Greening the Financial System. It is important to mention that central banks do not have a clear mandate regarding climate objectives, their mandate is price stability. However, they can contribute to the transition towards a green economy as long as it does not jeopardize their primary objective. But that can prove to be a challenge when producing in a green manner is more expensive than the alternative, a tricky situation for central banks.
Moreover, since I have brought up the monetary policy strategy, I would like to address a few words on another hot topic on the public agenda: CBDC (Central Bank Digital Currency). In our institution, we are conducting a pilot program in a closed testing environment, we constantly strive to analyse the benefits of digital currencies in terms of efficiency, liquidity, and security, as well as the potential risks associated with the transmission of monetary policy and maintaining financial stability. One message needs to be clear: CBDCs will not replace cash, they might supplement cash, should they be implemented.
Along with structural factors that have a widespread effect, our economy displays particular vulnerabilities that pose risks to inflation, to the sovereign risk premium and, ultimately, to economic growth sustainability. Romania is among the states with the largest government deficit in the European Union, a major vulnerability. We are also the only country in the Excessive Deficit Procedure. We had the largest budget deficit in the EU before the pandemic, we came out of the pandemic with a consistent budget deficit. Romania needs sound policies, more than ever.
A balanced policy mix cannot be achieved with wide-open twin deficits. It is suboptimal for the monetary policy to work alone in bringing inflation down. Reducing the fiscal deficit is a must. Therefore, fiscal consolidation is imperatively needed. Further exploring the topic, the financing of the current account deficit remains achieved only partially by stable funding, so FDIs (foreign direct investments) and non-reimbursable European funds. In this context, the absorption of European funds remains essential, especially those under the Next Generation EU programme, to maintain Romania's macroeconomic stability, but also to increase the capacity to react in case of adverse developments.
However, we must acknowledge that the environment in which we operate is much more complex than 10 years ago, and the current geopolitical context further complicates the battle against inflation. The prolonged war in Ukraine leads to an exponential increase in uncertainties regarding economic activity, while the turbulence in the banking systems of the United States and Switzerland presents new challenges. On the other hand, the Romanian financial sector has demonstrated strong resilience, as confirmed by several factors, such as high levels of capitalization and liquidity indicators and a low rate of non-performing loans. This indicates progress compared to the situation we faced during the 2008 financial crisis: if back then the financial sector was part of the problem, during the pandemic, it proved to be part of the solution. I believe that the central bank managed to instil confidence in the market and remain a beacon of stability and trust. We will strive to continue on the same path.
I strongly believe that in these erratic times, the National Bank of Romania resembles a guiding lighthouse in the middle of a turbulent sea, demonstrating, through prudence and wisdom in handling unforeseen situations that it possesses the experience and the trustworthiness to build a better future.
I am eager to hear other captivating insights during today's discussions, as well as new perspectives on how we can better manage the challenges in this environment in which we currently operate and I hope the upcoming debates to be enlightening and fruitful for everyone involved.
Sibiu, 26 mai 2023