The traditional monetary trilemma limits policy choice to only two among the three dimensions: independent monetary policy, free capital mobility and exchange rate stability. However, the usefulness of exchange rate flexibility as the shock absorber has been increasingly questioned over time. A more sceptical view on the usefulness of flexible exchange rates has changed the trilemma into an “irreconcilable duo: independent monetary policies are possible  9  Gros, Daniel. (2011) What is holding Italy back?, CEPS Commentary, 8 November 2011. 10  Hassan F., G. I. P. Ottaviano (2013), Productivity in Italy: the great unlearning, VoxEU.org, 30 November. 11  Constâncio, 2015. ibid. 12  Stanley Fischer (2010): Myths of Monetary Policy, Israel Economic Review, 2010. 4  BIS central bankers’ speeches  if and only if the capital account is managed” (Ray, 2013) 13. Those who believe that exchange rate flexibility should not be abandoned, even in the cases of small open economies, have largely deflated their expectations of flexible exchange rates to act as shock absorbers 14. Therefore, the notion that “the global financial cycle constrains national monetary policies regardless of the exchange rate regime” has now become part of common knowledge. With supranational “one-size-fits-all” monetary policy, the role of national fiscal policy in stabilizing real activity and inflation has, accordingly, increased in euro-area member states. However, the configuration of single monetary policy, coupled with national fiscal sovereignty and the no bail-out clause, has generated suboptimal policies and frictions that threaten the monetary union.
BIS central bankers’ speeches  5  There are a couple of other difficulties related to the use of national policies. The shock absorbing capacity of fiscal policy is in too many instances limited by the narrow fiscal space existing before the crises. The recession has further eroded fiscal positions and fiscal rules have failed to tame unsustainable fiscal paths so that the ability of fiscal policies in the EU to deal with another blow of crises is quite limited. Also, a need for national macroprudential policy immediately opens the issues of harmonisation and coordination on the international level in order to avoid unintended consequences, which I will comment in more detail later on. Additionally, for macroprudential policy to be effective it must be intrusive, affecting the “normal behaviour” of agents and markets 19, yielding benefits in reducing long-term costs generated by the systemic risk that makes it hard to attenuate public interest thus creating a central bank’s legitimacy paradox 20. Unconventional expansionary monetary policy, which was pursued after reaching the zero lower bound, and out of the fear of “the risk of doing nothing” 21, may be risk-inducing by fuelling search for yield behaviour. Abundant liquidity and low borrowing costs have the capacity to generate bubbles, confirming a notion that rational individual decisions may lead to irrational social outcomes – albeit as a reaction to highly non-conventional policies.