Page 5 of 14  1.2 The cyclical causes The primary mission of central banks, and of the European Central Bank (ECB) in particular, is to ensure price stability, notably by “smoothing” fluctuations in the economic cycle. They do this by setting the level of shortterm interest rates. In 1998, the ECB established a quantitative definition of price stability that it went on to clarify in 2003: to maintain inflation rates below, but close to, 2% over the medium term. More recently, other central banks have adopted this 2% inflation target, for example the US Fed in 2012 or the Bank of Japan in 2013. Our monetary policy has pursued this inflation target since 1999, with tangible results: inflation has remained close to target at an average of 1.7%. Page 6 of 14 Source: Eurostat  In the past decade, however, euro area inflation has been too low: 1.3% on average between 2011 and 2019, and 1.3% today [Core inflationv is also at 1.3%]. This weakness in inflation, which can be observed in the majority of advanced economies, has reignited the debate over the 2% target. Some, such as one of my great predecessors, Jacques de Larosière, say we should be content with the current 1%. Others, on the contrary, such as Olivier Blanchard, former chief economist at the IMF, are arguing for a higher target of up to 4%, which would leave more room to lower interest rates at the bottom of the cycle. It is tempting simply to ignore these arguments.
I will start with the domestically focused banks before moving on to the globally active banks and, in particular, the crisis at Credit Suisse. Domestically focused banks  For the domestically focused banks, the operating environment has changed markedly over the past year. Interest rates have risen significantly and there are signs of a slowdown in the real estate market. Overall, the domestically focused banks have benefited until now from the rise in interest rates. This rise has helped to restore their interest rate margins. The banks have been able to increase their profits and strengthen their capital buffers. At current interest rate levels, domestically focused banks’ profitability is likely to continue to improve. An unexpected upward interest rate shock in the future, however, would likely have a negative impact on these banks. First, in this scenario their interest expenses would increase faster than their interest income. This is because interest rates on many outstanding loans are fixed for several years. By contrast, rates on deposits are likely to react faster to a further interest rate rise. Second, higher interest rates could lead to credit losses in mortgage lending. This constitutes a significant risk for domestically focused banks because mortgages are often their main line of business. Against this backdrop, the results of our stress tests are crucial: Thanks to their capital buffers, most banks should be able to cope with such a scenario.