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Monetary policy in the euro area's neighbouring countries

SAFE Policy Center Lecture, Frankfurt am Main, 23.02.2016

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For countries neighbouring the euro area, conducting an independent monetary policy has become more difficult since the onset of the financial crisis in 2008. This is particularly true of small open economies with both strong trade links to the euro area and currencies prone to increased pressure in times of crisis, for example Switzerland, the Czech Republic, Denmark and Sweden. With the exception of Denmark, these countries chose to continue pursuing an independent monetary policy following the introduction of the euro. The experiences of these countries, both shared and divergent, provide three conclusions about monetary policy in such economies.

First, it is possible for a small open economy neighbouring a large currency area to conduct an independent monetary policy. Such a policy allows a central bank to address the specific needs of its own economy and to ensure price stability in the medium term. Conventional and unconventional monetary policy measures have helped to absorb the shocks of the euro crisis.

Second, the room for manoeuvre using standard monetary policy measures can be rapidly exhausted in times of severe crisis, and conventional interest rate policy measures can reach their limits. The central banks of these four countries neighbouring the euro area succeeded in regaining a certain room for manoeuvre by deploying unconventional monetary policy measures, namely negative interest, foreign exchange market interventions and quantitative easing programmes.

Third, despite the expanded set of instruments available, the extent of what monetary policy can achieve is not unlimited. On the one hand, the effects of monetary policy measures can wane with duration and dosage, especially when the solution to structural problems lies in adjustments to economic policy. And on the other, when it comes to unconventional measures, central banks must continually weigh the short-term benefits against long-term costs, and adjust their monetary policy accordingly.