Doing so is normalization, lifting our foot from the accelerator pedal. In my view, we could be there before the end of the year, after another significant step in September. Only beyond R* could tightening—actively pushing the brakes—begin; we will then have to discuss and decide, based on our assessment of actual inflation and the future outlook, focusing in particular on its core part and on wage developments. The US is obviously closer to tightening due to several differences in the nature of inflation there. But have no doubt that we at the ECB would if needed raise rates further beyond normalization: bringing inflation back to 2 % is our responsibility; our will and our capacity to deliver on our mandate are unconditional. III. How to remunerate massive excess liquidity when it coexists with positive rates? Let me come to another issue that we practitioners must now confront: how to remunerate massive excess liquidity when it coexists with positive interest rates? This will be a new situation for most of us, and especially for the euro area. While excess liquidity was negligible until 2008, it currently stands at more than € trillion, as a legacy of our APP and PEPP assets purchase programs, but also, for one third, our TLTROs. Yet, our reserve remuneration system was designed at a time of negligible excess liquidity. The system already showed its limits in the past, when having to coexist with negative interest rates.
Being gradual is less important than being orderly As William Brainard famously argued more than 50 years ago, gradualism is appropriate in a situation where we face large uncertainty. viii However, the Brainard principle was formulated before monetary economics understood the importance of inflation expectations. Research at Banque de France shows that a central bank facing instrument uncertainty is bound to be overly cautious if it fails to appreciate that being gradual runs the risk of moving inflation expectations adversely. ix We can be gradual, but we should not be slow and delay normalization until higher inflation expectations force us into aggressive interest-rate hikes. What remains essential however is to be orderly, in order to avoid undue market volatility and ultimately economic volatility. Like a gradual normalization, an  Page 6 sur 8 orderly one has a time dimension, as we should avoid putting risks on financial stability through unnecessarily brutal interest rate changes. x But it also has a cross-country dimension, as it also implies avoiding within the euro area unwarranted country-specific spikes in borrowing costs that only emerge from the echo chamber of financial markets. In this respect, our new Transmission Protection Instrument (TPI) is a very powerful tool for an orderly path forward. II.C. How to deal with surprises: a reaction function So far, so good about being orderly or predictable… but uncertainty means surprises, and we have had to deal with many bad ones on inflation figures.