One policy, many realities: why differences matter for monetary policy

Good morning everyone,

And welcome to Amsterdam. It is a pleasure to open the 29th Annual Research Conference of De Nederlandsche Bank.

And I mean that quite personally. I was trained as an economist, and I still have the privilege of being connected to academia as a professor at Maastricht University. So research has always been close to my heart. Of course, these days, I spend rather more time in meetings than writing papers. But that makes occasions like this all the more enjoyable.

Looking at the programme, I suspect the next two days will involve quite a lot of heterogeneity. Economists do have a remarkable ability to take a perfectly ordinary word like ‘different’ and turn it into an entire research agenda. But in this case, there is a good reason for that. Because for monetary policymakers, those differences matter.

We set one monetary policy for the euro area. One set of key interest rates. But that single policy enters an economy of around 360 million people, millions of firms, twenty-one countries, different financial systems, different fiscal positions and different economic structures. So, when we ask, ‘What does monetary policy do?’, typically the answer begins with two words economists are rather fond of: it depends.

And that, in essence, is what this conference is about. How heterogeneous-agent frameworks change our understanding of monetary-policy transmission, and what those insights mean for policy in practice.

For a long time, we have worked with representative households and representative firms. And we still do, often with good reason. Without it, economists would have to put the entire world into their models. Although, knowing economists, I am sure somebody is working on that.

But averages can hide a great deal.

Take households. Households differ in income, wealth, savings, debt, housing and job security. So an increase in interest rates can mean very different things to different people. For one household, it means a higher return on savings. For another, higher mortgage payments. And for someone else, the most important effect may come indirectly, through their job or wages.

Recent DNB work illustrates precisely this point for the Euro Area: monetary policy affects households through labour income, asset prices and interest payments, and the balance between those channels differs across households.

The same is true for firms. Companies differ in size, productivity, leverage, financing structures and exposure to shocks. An interest rate rise that one company barely notices can cause another to postpone investment altogether.

Countries differ too. Fiscal space, housing markets, banking systems and economic structures vary across the euro area. Recent inflation figures make this point. In October, inflation was too high across the board, but the differences across countries were substantial. For example, preliminary estimates put inflation at 3.3% here in the Netherlands, but at more than 6% in Lithuania.

So, an aggregate is never just an aggregate and these differences add up. And together, they also shape what monetary policy does to the economy as a whole. That is why heterogeneity is not some interesting detail at the edges of monetary economics. Increasingly, it is part of the core.

Let me turn to what this means for Europe. Recognising that heterogeneity matters for monetary policy does not mean that heterogeneity itself is a problem, or that we should aim for uniformity. Difference is not a defect. Our economies differ in their industrial structures, their specialisations, their technologies and institutions. Much of that diversity is a strength.

But differences can become more difficult when our markets are fragmented, countries have little room to respond to shocks, or resources cannot move to where they are most productive. The aim should therefore not be to make our economies identical, but to prevent those differences from standing in the way of adjustment and the effective transmission of monetary policy.

For me, three areas are particularly important to ensure this.

First, deeper European capital markets. Firms across Europe still face different financing conditions and many remain strongly dependent on domestic sources of finance. More integrated capital markets can broaden funding opportunities, improve private risk-sharing and help European savings reach productive investments across borders.

Second, sound fiscal frameworks. Fiscal resilience matters when countries are hit differently by shocks. Strong public finances provide governments with room to respond, while credible fiscal frameworks help prevent concerns about sovereign debt from interfering with the transmission of monetary policy.

And third, a stronger single market. Europe cannot fully exploit its diversity if goods, services, capital and labour cannot move easily to where they are most productive.

Taken together, these priorities are not about making European economies more alike. They are about strengthening the common foundations that allow diverse economies to thrive, adjust to shocks and respond effectively to our common monetary policy.

Let me conclude by saying how much I value conferences like these, bringing academics and policymakers together around questions relevant to central banking. Good research does not always give us a simple instruction. But it helps us test our assumptions, see what lies behind the averages and understand the trade-offs more clearly.

So I hope these next two days give us new evidence, some disagreement, plenty of debate, and perhaps even a few results that force us to change our minds. Because for researchers and policymakers alike, that is usually where progress begins.

Thank you, and I wish you an excellent conference.