The global risk outlook has become more challenging amid increased trade and economic policy uncertainty.
This letter was submitted to G20 Finance Ministers and Central Bank Governors (FMCBG) ahead of the G20’s meeting on 23-24 April.
As his term as FSB Chair nears its conclusion on 1 July 2025, Klaas Knot reflects on the progress made in addressing global challenges to financial stability and outlines priorities for the future. The letter notes the challenging global risk outlook, with increased trade and economic policy uncertainty reflected in large price swings and heightened volatility in global financial markets. The letter calls on market participants and financial supervisors and regulators to remain vigilant.
Recent episodes of financial market turmoil, rapid technological advancements, and the growing threat of climate change, all underscore the need for vigilance and international cooperation.
The FSB has played a critical role in enhancing the resilience of the financial system.
The letter emphasises the importance of implementing reforms and highlights the need for sustained global coordination to address emerging risks and ensure a resilient financial system.
 
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Global growth is expected to decline and downside risks to intensify as major policy shifts unfold
Executive Summary:
Following an unprecedented series of shocks in the preceding years, global growth was stable yet underwhelming through 2024 and was projected to remain so in the January 2025 World Economic Outlook (WEO) Update. However, the landscape has changed as governments around the world reorder policy priorities. Since the release of the January 2025 WEO Update, a series of new tariff measures by the United States and countermeasures by its trading partners have been announced and implemented, ending up in near-universal US tariffs on April 2 and bringing effective tariff rates to levels not seen in a century (Figure ES.1). This on its own is a major negative shock to growth. The unpredictability with which these measures have been unfolding also has a negative impact on economic activity and the outlook and, at the same time, makes it more difficult than usual to make assumptions that would constitute a basis for an internally consistent and timely set of projections.
Given the complexity and fluidity of the current moment, this report presents a “reference forecast” based on information available as of April 4, 2025 (including the April 2 tariffs and initial responses), in lieu of the usual baseline. This is complemented with a range of global growth forecasts, primarily under different trade policy assumptions.
The swift escalation of trade tensions and extremely high levels of policy uncertainty are expected to have a significant impact on global economic activity. Under the reference forecast that incorporates information as of April 4, global growth is projected to drop to 2.8 percent in 2025 and 3 percent in 2026—down from 3.3 percent for both years in the January 2025 WEO Update, corresponding to a cumulative downgrade of 0.8 percentage point, and much below the historical (2000–19) average of 3.7 percent.
In the reference forecast, growth in advanced economies is projected to be 1.4 percent in 2025. Growth in the United States is expected to slow to 1.8 percent, a pace that is 0.9 percentage point lower relative to the projection in the January 2025 WEO Update, on account of greater policy uncertainty, trade tensions, and softer demand momentum, whereas growth in the euro area at 0.8 percent is expected to slow by 0.2 percentage point. In emerging market and developing economies, growth is expected to slow down to 3.7 percent in 2025 and 3.9 percent in 2026, with significant downgrades for countries affected most by recent trade measures, such as China. Global headline inflation is expected to decline at a pace that is slightly slower than what was expected in January, reaching 4.3 percent in 2025 and 3.6 percent in 2026, with notable upward revisions for advanced economies and slight downward revisions for emerging market and developing economies in 2025.
Intensifying downside risks dominate the outlook. Ratcheting up a trade war, along with even more elevated trade policy uncertainty, could further reduce near- and long-term growth, while eroded policy buffers weaken resilience to future shocks. Divergent and rapidly shifting policy stances or deteriorating sentiment could trigger additional repricing of assets beyond what took place after the announcement of sweeping US tariffs on April 2 and sharp adjustments in foreign exchange rates and capital flows, especially for economies already facing debt distress. Broader financial instability may ensue, including damage to the international monetary system. Demographic shifts and a shrinking foreign labor force may curb potential growth and threaten fiscal sustainability. The lingering effects of the recent cost-of-living crisis, coupled with depleted policy space and dim medium-term growth prospects, could reignite social unrest. The resilience shown by many large emerging market economies may be tested as servicing high debt levels becomes more challenging in unfavorable global financial conditions. More limited international development assistance may increase the pressure on low-income countries, pushing them deeper into debt or necessitating significant fiscal adjustments, with immediate consequences for growth and living standards. On the upside, a deescalation from current tariff rates and new agreements providing clarity and stability in trade policies could lift global growth.
The path forward demands clarity and coordination. Countries should work constructively to promote a stable and predictable trade environment, facilitate debt restructuring, and address shared challenges. At the same time, they should address domestic policy and structural imbalances, thereby ensuring their internal economic stability. This will help rebalance growthinflation trade-offs, rebuild buffers, and reinvigorate medium-term growth prospects, as well as reduce global imbalances. The priority for central banks remains fine-tuning monetary policy stances to achieve their mandates and ensure price and financial stability in an environment with even more difficult trade-offs. Mitigating disruptive foreign exchange volatility may require targeted interventions, as outlined in the IMF’s Integrated Policy Framework. Macroprudential tools should be activated as needed to contain the buildup of vulnerabilities and to provide support in case of stress events. Restoring fiscal space and putting public debt on a sustainable path remain an important priority, while meeting critical spending needs to ensure national and economic security. This requires credible medium-term fiscal consolidation plans. Structural reforms in labor, product, and financial markets would complement efforts to reduce debt and narrow cross-country disparities. As Chapter 2 explains, countries’ age structures are evolving at different rates, with important consequences for medium-term growth and external imbalances. In addition, as Chapter 3 documents, migration policy shifts in destination countries have sizable spillover effects, disproportionately affecting emerging market and developing economies.
Read full outlook here.
 
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Amid trade tensions and high policy uncertainty, the path forward will be determined by how challenges are confronted and opportunities embraced
Blog post by Pierre-Olivier Gourinchas | The global economic system under which most countries have operated for the last 80 years is being reset, ushering the world into a new era. Existing rules are challenged while new ones are yet to emerge. Since late January, a flurry of tariff announcements by the United States, which started with Canada, China, Mexico and critical sectors, culminated with near universal levies on April 2. The US effective tariff rate surged past levels reached during the Great Depression while counter-responses from major trading partners significantly pushed up the global rate.

The resulting epistemic uncertainty and policy unpredictability is a major driver of the economic outlook. If sustained, this abrupt increase in tariffs and attendant uncertainty will significantly slow global growth. Reflecting the complexity and fluidity of the moment, our report presents a range of forecasts for the global economy.

Our World Economic Outlook’s reference forecast includes tariff announcements between February 1 and April 4 by the US and countermeasures by other countries. This reduces our global growth forecast to 2.8 percent and 3 percent this year and next, a cumulative downgrade of about 0.8 percentage point relative to our January 2025 WEO update. We also present a global forecast excluding the April tariffs (pre-April 2 forecast). Under this alternative path, global growth would have seen only a modest cumulative downgrade of 0.2 percentage point, to 3.2 percent for 2025 and 2026.
Finally, we include a model-based forecast incorporating announcements made after April 4. Over that period, the United States temporarily halted most tariffs while raising those on China to prohibitive levels. This pause, even if extended indefinitely, does not materially change the global outlook compared to the reference forecast. This is because the overall effective tariff rate of the United States and China remains elevated even if some initially highly tariffed countries will now benefit, while policy-induced uncertainty has not declined.
Despite the slowdown, global growth remains well above recession levels. Global inflation is revised up by about 0.1 percentage point for each year, yet the disinflation momentum continues. Global trade was quite resilient until now, partly because businesses were able to re-route trade flows when needed. This may become more difficult this time around. We project that global trade growth will dip more than output, to 1.7 percent in 2025—a significant downward revision since our January 2025 WEO Update.

However, the global estimate masks substantial variation across countries. Tariffs constitute a negative supply shock for the implementing jurisdiction, as resources are reallocated towards the production of less-competitive items with a resulting loss of aggregate productivity and higher production prices. In the medium term, we can expect tariffs to decrease competition and innovation and increase rent-seeking, further weighing on the outlook.
In the United States, demand was already softening before the recent policy announcements, reflecting greater policy uncertainty. Under our April 2 reference forecast, we have lowered our US growth estimate for this year to 1.8 percent. That’s 0.9 percentage point lower than January, and tariffs account for 0.4 percentage point of that reduction. We also raised our US inflation forecast by about 1 percentage point, up from 2 percent.
For trading partners, tariffs are mostly a negative demand shock, driving foreign customers away from their products, even if some countries can benefit from the trade diversion. Consistent with this deflationary impulse, we have lowered our China growth forecast for this year to 4 percent, a 0.6 percentage point reduction, and inflation is revised down by about 0.8 percentage point.

Growth in the euro area, which is subject to relatively lower effective tariffs, is revised down by 0.2 percentage point, to 0.8 percent. Both in the euro area and China, stronger fiscal stimulus will provide some support this year and next. Many emerging market economies could face significant slowdowns depending on where tariffs settle. We have lowered our growth forecast for the group by 0.5 percentage point, to 3.7 percent.
Dense global supply chains can magnify the effects of tariffs and uncertainty. Most traded goods are intermediate inputs that cross borders multiple times before being turned into final products. Disruptions can propagate up and down the global input-output network with potentially large multiplier effects, as we saw during the pandemic. Companies facing uncertain market access will likely pause in the near term, reduce investment and cut spending. Likewise, financial institutions will reassess borrowers’ exposure. The increased uncertainty and tightening of financial conditions could well dominate the short term, weighing on economic activity, as reflected in the sharp decline in oil prices.
The effect of tariffs on exchange rates is complex. The United States, as the tariffing country, may see its currency appreciate as in previous episodes. However, greater policy uncertainty, dimmer US growth prospects, and an adjustment in the global demand for dollar assets—that has so far been orderly—can weigh down on the dollar, as we saw since the tariff announcements. In the medium term, the dollar may depreciate in real terms if the tariffs translate into lower productivity in the US tradable goods sector, relative to its trading partners.
Risks to the global economy have increased, and worsening trade tensions could further depress growth. Financial conditions could tighten further as markets react negatively to the diminished growth prospects and increased uncertainty. While banks remain well capitalized overall, financial markets may face more severe tests.
Growth prospects could, however, immediately improve if countries ease their current trade policy stance and forge new trade agreements. Addressing domestic imbalances can, over a period of years, offset economic risks and raise global output while contributing significantly to closing external imbalances.  For Europe, this means spending more on infrastructure to accelerate productivity growth. It also means boosting support for domestic demand in China, and stepping up fiscal consolidation in the United States.

Our policy recommendations call for prudence and improved collaboration. The first priority should be to restore trade policy stability and forge mutually beneficial arrangements. The global economy needs a clear and predictable trading system addressing longstanding gaps in international trading rules, including the pervasive use of non-tariff barriers or other trade-distorting measures. This will require improved cooperation.
Monetary policy will also need to remain agile. Some countries may confront steeper trade-offs between inflation and output. In others, inflation expectations may become less-well anchored, with a new inflation shock following closely after the prior one. Countries that encounter resurgent price pressures will require forceful monetary tightening. For others, the negative demand shock will warrant lower policy rates. Monetary policy credibility will be important in all cases, and central bank independence remains a cornerstone.
The increased external volatility from tariff adjustments and a possibly prolonged risk-off environment, may be difficult to navigate for emerging markets. Our Integrated Policy Framework emphasizes that it is important to let currencies adjust when driven by fundamental forces, as is the case now, and spells out the specific conditions where it is advisable for countries to intervene.
Fiscal authorities face starker trade-offs with high debt, low growth and rising financial costs. Most countries still have too little fiscal space and need to implement gradual and credible consolidation plans, while some of the poorest countries, also hit with reduced official aid, could experience debt distress.
New spending needs are further weighing on fiscal fragilities. Calls for support will increase for those at risk of severe dislocation from the shocks. Such support should remain narrowly targeted and incorporate automatic sunset clauses. The experience of the last four years suggests that it is easier to open the tap of fiscal support than to close it.
Some countries, especially in Europe, face new and permanent increases in
defense-related spending. How should these be financed? For countries with sufficient fiscal space, only the temporary part of the additional spending—that is, temporary support to help adapt to the new environment or the initial bulge in spending to rebuild defense capabilities—should be financed by debt. For all other countries, new spending needs should be offset by spending cuts elsewhere or new revenues.
We should not lose sight of the need for stronger growth. Governments should continue to engage in fiscal and structural reforms that help mobilize private resources and reduce resource misallocation. They should also invest in the digital infrastructure and training necessary to benefit from new technologies such as artificial intelligence.
Finally, we should ask ourselves why our global system warrants remapping—and recognize that decades of deepening trade ties fostered rapid but uneven economic growth. In many advanced economies, there is an acute perception that globalization unfairly displaced many domestic manufacturing jobs. There is some merit to these grievances, even if the share of manufacturing employment in advanced economies has been in a secular decline in countries running trade surpluses, like Germany, or deficits, like the United States.
The deeper force behind this decline is technological progress and automation, not globalization: in both countries the output share of manufacturing has remained stable. Both forces are ultimately beneficial but can be very disruptive to individuals and communities. It is a collective responsibility to ensure the right balance between the pace of progress or globalization and addressing the associated dislocations.

This requires that policymakers think well beyond the reductive lens of compensating transfers between ”winners” and ”losers,” be it of technological revolutions or globalization. In this, unfortunately not enough has been done, pushing many to embrace a zero-sum worldview whereby the gains of some only come at the expense of others. Instead, it is important to better understand these root causes so that we can build an improved trading system that delivers more opportunities. This objective is enshrined in our Articles of Agreement, which ask us “to facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income.”
Global integration is not an objective in and of itself. It is a means to an end, important insofar as it supports improved living standards for all.
—This blog is based on Chapter 1 of the April 2025 World Economic Outlook, “Policy Uncertainty Tests Global Resilience.”
 
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New targeted amendments to existing EU funding programmes will support faster, more flexible and coordinated investments in Europe’s defence technological and industrial base (EDTIB). Under a new Regulation to stimulate defence-related investments within the EU budget proposed today by the Commission, the EU will strengthen its defence Readiness 2030 and to implement the ReArm Europe plan.
The proposed changes will enhance the ability of the EU and Member States to develop, scale up and innovate in key defence capabilities, while streamlining access to EU funds for defence-related projects.
The proposal broadens the scope of the Strategic Technologies for Europe Platform (STEP) to cover defence-related technologies and products, particularly those identified as priority capabilities in the recent White Paper for European Defence – Readiness 2030. This approach ensures that STEP effectively supports the development of cutting-edge technologies essential for the EU’s defence preparedness, by awarding selected projects under the European Defence Fund, Horizon Europe, and the Digital Europe Programme with a STEP Seal. The extended scope of STEP is also expected to boost investments in critical technologies for defence under cohesion policy funded by the EU budget, in particular under the specific objectives in the European Regional Development Fund (ERDF) and Cohesion Fund (CF). This approach ensures that STEP effectively supports the development of cutting-edge technologies essential for the EU’s defence preparedness.
Through the Horizon Europe regulation, the reach of the European Innovation Council (EIC) will include start-ups working on dual-use and defence-related innovations. The objective is to foster a dynamic innovation ecosystem that speeds up the development and deployment of cutting-edge dual-use and defence technologies, like AI and cybersecurity.
The Digital Europe Programme (DEP) should also expand to include dual-use applications. This will offer crucial support for defence technologies, particularly in developing and operating AI Gigafactories. These factories are vital for scaling up the production of advanced technologies with dual-use capabilities that are relevant to both civilian and defence sectors.
Building on the recent Commission proposal under the Cohesion policy mid-term review, the Regulation introduces additional flexibility in using EU funding to bolster a robust and competitive European defence industry. In particular, the Regulation includes a ‘landing clause’ within both the European Defence Fund (EDF) and the Act in Support of Ammunition Production (ASAP). This provision allows Member States, on a fully voluntary basis, to transfer resources allocated to them under cohesion policy funds to these two programmes. The duration of ASAP is also extended until 31st December 2026.
Lastly, support for military mobility and dual-use digital infrastructure is enhanced through changes to the Connecting Europe Facility (CEF). First, it will create more favourable conditions for Member States to transfer cohesion funds to CEF for dual-use transport infrastructure projects. Second, it will expand the CEF digital programme to support dual-use digital capacities, like cloud, AI, and 5G systems among others.
Next Steps
This package of proposed amendments will complement the Omnibus Defence Simplification Package, expected to be presented by the Commission in June 2025. It will further streamline EU regulations and processes to enable faster and more efficient defence investment and cooperation across Member States.
Background
This initiative aligns with the objectives of the joint White Paper for European Defence – Readiness 2030. It sets a clear pathway for the EU to support the development of the defence capabilities needed to protect its citizens, safeguard its values, and respond to a rapidly changing geopolitical environment.
 
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Risks have risen as financial conditions tightened, with key vulnerabilities ahead
Capital markets are essential for driving economic activity, providing mechanisms for raising funds and allocating resources efficiently. The stability of these markets and the financial institutions that intermediate them are therefore macro-critical, especially when market volatility and economic uncertainty are high, as they are now.
In the latest Global Financial Stability Report, we assess that global financial stability risks have grown significantly, driven by tighter financial conditions and heightened trade and geopolitical uncertainty. Our assessment is supported by three salient and forward-looking vulnerabilities in the financial system:

Capital markets have become increasingly concentrated—for example, the United States makes up nearly 55 percent of the global equity market, up from 30 percent two decades ago—and valuations of some assets remain stretched despite the recent sell-offs. Further asset price corrections suggest the need for close attention given the highly uncertain economic backdrop.

Nonbank financial institutions, or NBFIs, have become more active in channeling savings toward investments since 2008, and their nexus with banks has continued to grow. Further sell-offs could strain some financial institutions, and the ensuing deleveraging in the sector could exacerbate market turmoil.

Sovereign debt levels continue to rise, seemingly outpacing growth in market infrastructure tasked with ensuring smooth market functioning. Core government bond markets may see elevated volatility, especially those in countries with high debt levels. Riskier emerging markets, which have seen their sovereign bond spreads rise during the recent market turmoil, may find it more challenging to refinance their debt or fund additional government spending.

In all these areas, banks play a critical role. They lie at the heart of the financial system, not only because of their core lending function but also because of their key role in facilitating the growth of capital markets. Large international banks are important market-makers in securities and derivatives. They are also major providers of leverage to various NBFI segments, with the ability to lend directly against asset portfolios, through credit lines, or facilitate leverage indirectly through repos and derivatives.
Globally systemically important banks, or G-SIBs, and other leverage providers, such as clearing houses for derivatives, use various tools to protect themselves against the risk of failure of a given NBFI entity, including collateral requirements and arrangements to reduce gross exposures. However, they can’t control how much a client borrows elsewhere. Consequently, the nexus between banks and NBFIs have risen in recent years—for example, in the United States, NBFI borrowings have reached 120 percent of banks’ common equity tier 1 capital.

Increasing nexus between banks and nonbanks
Though expanded financial intermediation by nonbanks positively affects the economy, excessive growth predicated on borrowing from traditional banks may make both types of lenders more susceptible to potential contagion risks. Among other NBFI segments, this Global Financial Stability Report discusses how certain hedge funds, a key type of NBFI, may see their highly leveraged trading strategies backfire in volatile markets. This could lead to a deleveraging in which they sell assets into a falling market, in turn causing losses for banks that provided their leverage.
Another segment of NBFIs that has seen substantial growth is the private credit segment, which typically lends to smaller corporate borrowers. As private credit continues to grow, banks have become willing partners through joint ventures or by providing loan facilities. With global growth forecast to slow (see World Economic Outlook), the repayment ability of borrowers could deteriorate, leading to losses to both private credit funds and partner banks.
Debt is also increasing in a very different sector—government. Sovereign debt now accounts for 93 percent of global economic output, up from 78 percent a decade ago, and financing costs have increased in both nominal and real terms. Because government bonds are cornerstone instruments in capital markets, disruptions in this market could pose a threat to financial stability.
Growth-enhancing fiscal consolidation is key to alleviating this risk, as the Fiscal Monitor indicates. Another critical aspect is ensuring that the market remains liquid and well-functioning. For advanced economies, such resilience depends on governments moderating the large amounts of bond issuances on the one hand, and ensuring bank and nonbank broker-dealers have the capacity to intermediate them on the other. In emerging markets, the credibility of debt management frameworks is essential. This means it will be key to strengthen the capacity of institutions, have clear targets and strategies for issuing and redeeming bonds, and carefully calibrate the currency composition of bonds.
Policy recommendations
Nonbanks boosting leverage doesn’t necessarily negate the benefits they provide to the economy if guardrails ensure they can weather adverse shocks. For a start, enhanced reporting requirements should help supervisors develop a systemwide view of their activities and discern between which provide helpful financial intermediation and which take excessive risk or are poorly governed. It is crucial to strengthen policies that mitigate leverage and interconnectedness vulnerabilities, building on the Financial Stability Board’s and other standard-setting bodies’ minimum standards or recommendations.
Banks, as the foundation of the system, must be resilient to adverse shocks, including those stemming from their increasing interconnections with nonbanks. Full, timely, and consistent implementation of Basel III and other internationally agreed bank regulatory standards would ensure a level playing field across jurisdictions and guarantee ample and adequate capital and liquidity. Exposure of banks to NBFIs need to be managed prudently.
With rising sovereign debt levels, resilience in bond market functioning can be built up by policies that promote the central clearing of bonds and the reduction of counterparty risks, at the same time further bolstering the resilience of central clearing. It’s also important to ensure that key intermediaries in government bond markets are sound and operationally resilient.
For emerging markets, credible frameworks to meet government financing needs can strengthen bond markets. Other helpful tools include IMF-World Bank Medium-Term Debt Management Strategies for rolling over debt and assessing its currency composition and financing cost. Emerging economies may also consider ways to develop domestic markets for government bonds, as increased bond demand from long-term domestic investors has helped contain financing costs and external pressures in recent years.
—This blog is based on Chapter 1 of the April 2025 Global Financial Stability Report, “Enhancing Resilience amid Global Trade Uncertainty.”
 
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By Fédéric Holm-Hadulla and Sebastiaan Pool | Central banks usually seek to align very short-term interest rates in the money market with their own policy rate. But money market rates fluctuate also for reasons other than policy. This blog shows that monetary policy is more effective if such fluctuations are small.

Discussions about monetary policy usually centre on whether interest rates should go up, down or stay the same. The complexities of how monetary policy is carried out in practice often go unnoticed. We look behind the scenes to explore a key aspect in this regard: the way central banks manage fluctuations in short-term money market rates and how this matters for the effectiveness of monetary policy.
A primer on monetary policy transmission and implementation
When the ECB adjusts its policy interest rates, it sets in motion a chain reaction in the financial system and the economy that helps it steer demand and eventually control inflation. Economists usually refer to this process as the monetary policy transmission mechanism. The initial link in this chain is the money market, where banks and other financial institutions lend and borrow money for short periods of time.
Central banks implement their policy by aligning very short-term interest rates in the money market with their policy rates. They do this with a set of tools and technical procedures collectively known as the operational framework. However, central banks typically do not fully control money market rates. In fact, these may fluctuate also for reasons unrelated to policy – for instance, owing to the ups-and-downs in banks’ daily liquidity needs.
In more detail, central banks provide money – or reserves – to banks and accept their deposits. Further, they set the interest rates applying to these transactions. This creates natural bounds on how much short-term money market rates would typically fluctuate: if market rates are higher than the ECB lending rate, banks would come to the ECB to borrow, as this would be cheaper than taking up money from other commercial banks in the market. In turn, if market rates are below the rate banks get from depositing reserves with the ECB, again they would rather come to the ECB to park their money at a higher return. Within this band between the ECB’s rates for lending and deposits, market rates are determined by the supply of and demand for reserves.[1]
This system ensures that central banks have a certain degree of control over market rates. Following a recent review of how monetary policy is implemented, the ECB decided to narrow the ‘width’ of this band (for additional detail on the new framework, see also this recent blog by Claudia Buch and Isabel Schnabel). The ECB did this to “limit the potential scope for volatility in short-term money market rates”. At the same time, it kept some distance between the ECB rates to “leave room for money market activity and provide incentives for banks to seek market-based funding solutions”.
How does short-rate volatility influence transmission?
In Holm-Hadulla and Pool (2025), we present empirical evidence for why, as part of this balancing act, limiting volatility in short-term interest rates is an important consideration.
The rationale is that volatility in short-term rates creates uncertainty, and uncertainty typically leads to a preference for maintaining the status quo when it is costly to change current practice (Dixit, 1991). Banks, for example, would usually transmit a change in money market rates into the interest rates on the loans they grant to their customers. But if volatility is very high, they will be less certain that the change in money market rates will last. Hence, banks may also be less willing to alienate for instance a long-standing customer with abrupt and frequent changes in borrowing costs. Instead, with high volatility, banks will be more inclined to just wait and see.
This is indeed the pattern we observe in the data: as short-rate volatility rises, bank lending, output and the economy-wide price level become significantly less responsive to monetary policy. To see this, we compare how these variables respond to a change in the monetary policy stance when volatility is relatively low and when it is relatively high. Chart 1 illustrates the impact of volatility for the case of an unexpected interest rate hike (the results also hold for a surprise rate cut). It shows that the reduction in bank lending to firms and households is more than twice as strong with low than with high volatility. Moreover, this dampening effect also appears at the later stages of monetary policy transmission, including the medium-term effects on output and prices. For instance, for a 25-basis-point exogenous increase in policy rates, we estimate that the price level would, over the medium term, decline by more than half a percent in a low-volatility environment, while the effect is reduced to less than a quarter percent in a high-volatility environment.
A reduced effectiveness of monetary policy would then require stronger action from the ECB to achieve its objectives; and it may mean that policy rates – during periods of low inflation – will more often hit their lower bounds. Moreover, we observe that, in years in which volatility is high on average, it also swings around a lot from month to month (so it is not constantly high, but instead very high in some months and quite moderate in others). This further complicates monetary policy: central banks cannot simply assume that a situation of high volatility and weak transmission will persist. Instead, whenever they decide on monetary policy, it is uncertain how money market volatility will evolve. This, in turn, raises the risk of over- or underreactions to changing economic circumstances. Vice versa, containing money market volatility thus facilitates monetary policymaking.

Chart 1
Effect of an unexpected policy rate hike at different short-rate volatility levels

Percentages

Source: Holm-Hadulla and Pool (2025). Impact of an exogenous 25 basis point interest rate hike. High (low) volatility defined as one standard deviation (ca. 7 basis points) above (below) average. Circles are point estimates, whiskers are the 90 percent confidence intervals.

How did we come up with the findings?
Our research strategy starts from a technique called local projections to study the economic impact of unexpected changes in monetary policy, or “shocks”. We measure the shocks via the immediate financial market moves after monetary policy announcements. We then feed these into an empirical model, which uses historical data to see how economic indicators in the euro area tend to react to monetary policy over time. This helps us better understand the causal link between policy decisions and economic outcomes. Compared to earlier studies, a main novelty is that we allow the impact of monetary policy to differ, depending on how volatile short-term money market rates are in the period leading up to the shock. In doing so, we also ensure that the measured volatility is not itself an outcome of the current economic conditions, which could lead us to confuse the direction of causality. In particular, we focus on changes in volatility that have come as a side effect of other structural changes in the conduct of monetary policy, as opposed to reflecting current conditions.
Why does controlling volatility matter for policy?
To summarise, central banks face an interesting balancing act. With more scope for short term interest rates to move around, there is in principle more room for market forces to work, which often makes economic outcomes more efficient. However, if market rates fluctuate a lot, key actors in the economy may become more reluctant to respond to changes in monetary policy and this complicates the central bank’s task of controlling inflation. This balancing act is likely to become more prominent over the coming years: as central banks gradually reduce their supply of liquidity, market rates should become more sensitive to changes in commercial banks’ liquidity demand. The changes in the operational framework announced in 2024, including the narrower range between the ECB lending and deposit rates, will contribute to smoothening the transition to this new environment.
The views expressed in each blog entry are those of the author(s) and do not necessarily represent the views of the European Central Bank and the Eurosystem.
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References:
Dixit, A. (1991). Analytical approximations in models of hysteresis. The Review of Economic Studies, 58(1), 141-151.
Holm-Hadulla F. and S. Pool (2025). Interest rate control and the transmission of monetary policy. ECB Working Paper No. 3048.

For ease of exposition, we abstract from a few additional complexities. First, the ECB has more than one lending rate. Second, the ECB can influence short-rate volatility also by injecting a lot of liquidity into the economy, for instance through asset purchases, which makes money market rates insensitive to the usual day-to-day changes in the demand or supply of reserves. Third, for reasons related to the interplay between banks and other financial institutions and owing to certain regulations, key money market rates have tended to settle somewhat below the ECB’s deposit rate in recent years.

 
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Member states’ representatives (Coreper) approved today the Council’s position (‘negotiating mandate’) on one of the Commission’s proposals to simplify EU rules and thus boost EU competitiveness. This proposal aims to increase the EU’s investment capacity to mobilise around €50 billion in additional public and private investments in support of certain EU policies, notably related to the Competitiveness Compass, the Clean Industrial Deal, defence industrial policy and military mobility. The proposed changes further seek to make it easier for Member States to contribute to the ‘Invest EU’ programme and simplify administrative requirements.

“Simplification of existing legislation is indispensable for boosting EU competitiveness. In the turbulent times we are living, today’s agreement in the Council is a first step towards unlocking additional investment opportunities that will certainly strengthen our economic position in the global arena.”
– Adam Szłapka, Minister for the European Union of Poland

The proposal forms part of the ‘Omnibus’ packages adopted by the Commission at the end of February 2025 with a view to simplifying existing legislation in the field of sustainability and EU investments. This proposal amends the ‘Invest EU’ regulation to help mobilise around €50 billion of investments by increasing the size of the EU guarantee and facilitating the combined use of the ‘Invest EU’ guarantee with existing capacity available under three legacy programmes: the European Fund for Strategic Investment (EFSI), the Connecting Europe Facility (CEF) debt instrument and the so-called ‘InnovFin debt facility’, an initiative launched by the EIB group in support of research and innovation. Moreover, the proposal increases the attractiveness of the ‘Invest EU’ member state compartment and reduces the administrative burden caused by reporting requirements, especially for SMEs.
Next steps
Following today’s approval of the Council’s negotiating mandate by Coreper, the presidency is enabled to enter interinstitutional negotiations (trilogues) with a view to reaching a provisional agreement with the European Parliament on this proposal.
Background
In October 2024, the European Council called on all EU institutions, Member States and stakeholders, as a matter of priority, to take work forward, notably in response to the challenges identified in the reports by Enrico Letta (‘Much more than a market’) and Mario Draghi (‘The future of European competitiveness’). The Budapest declaration of 8 November 2024 subsequently called for ‘launching a simplification revolution’, by ensuring a clear, simple and smart regulatory framework for businesses and drastically reducing administrative, regulatory and reporting burdens, in particular for SMEs. On 26 February 2025, as a follow-up to EU leaders’ call, the Commission put forward the above proposal, as one of two ‘Omnibus’ packages, aiming to simplify existing legislation in the field of EU investment programmes. On 20 March 2025, EU leaders urged the co-legislators to take work forward on the first two Omnibus packages as a matter of priority and with a high level of ambition, with a view to finalising them as soon as possible in 2025.
The proposal intends to improve the ‘Invest EU’ programme by increasing the EU guarantee by €2.5 billion (from €26.2 billion to €28.6 billion) and by enhancing the combination of available support from the EU budget with the ‘Invest EU’ programme and its three legacy programmes: the EFSI, the Connecting Europe Facility (CEF) debt instrument and the so-called ‘InnovFin’ debt facility, an initiative launched by the EIB group in support of research and innovation. Each of the two measures is expected to mobilise €25 billion of additional public and private investments.
Furthermore, the proposal aims to increase the attractiveness of the ‘Invest EU’ member state compartment, which focuses on specific national priorities. The proposal also aims to reduce the administrative burden of implementing partners, financial intermediaries and final recipients, with an estimated cost saving of €350 million. In particular, the proposal revises the definition of SME and reduces the number of indicators on which implementing partners will need to report for small-size operations not exceeding €100,000. It also reduces the frequency of reporting obligations from implementing partners, going from semi-annual to annual reporting.
 
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From Monday to Saturday, Commissioner Valdis Dombrovskis, in charge of Economy and Productivity, Implementation and Simplification, Commissioner Jozef Síkela, in charge of International Partnerships, and Commissioner Maria Luís Albuquerque, in charge of Financial Services and the Savings and Investments Union, are attending the 2025 Spring Meetings of the World Bank Group (WBG) and the International Monetary Fund (IMF) in Washington, D.C.  
Commissioner Dombrovskis will represent the European Commission at the sessions of the International Monetary and Financial Committee (IMFC) at the International Monetary Fund (IMF), and at the G7 and G20 Finance Ministers and Central Bank Governors meetings, where discussions will focus, amongst others, on support to Ukraine and on the impact of tariffs on the global economy. The Commissioner will hold several bilateral meetings on the margins of the Spring Meetings with his counterparts from the US, Ukraine, China, Japan, South Korea, and the United Kingdom. On Wednesday 23 April, Commissioner Dombrovskis will deliver a keynote speech at the Atlantic Council focusing on Europe’s competitiveness in the context of increasing geopolitical and trade tensions. Following the Spring meetings, Commissioner Dombrovskis will be in New York on 28 and 29 April, where he will engage in a series of high-level meetings with top officials from major financial institutions and global companies and visit the New York Stock Exchange, where he will meet with its President, Lynn Martin.
Commissioner Síkela will present and promote the EU’s Global Gateway Strategy as a strategic, mutually beneficial approach to development – focused on partner-driven priorities, combining investment into infrastructure with human development investments like education, training, healthcare – and helping create a conducive investment climate for private-sector engagement. He will represent the EU at the Plenary Session of the World Bank Development Committee and hold high-level bilaterals with government representatives, UN leaders, the IMF, and global investors, along with public appearances and private investor outreach to strengthen international cooperation in sustainable development under the EU’s leadership.
Commissioner Albuquerque will hold high-level meetings with government representatives, major institutional investors, nonprofit organisations and trade associations. On Wednesday, she will meet with the Governor of the People’s Bank of China (PBOC), Pan Gongsheng, and will participate at the Hudson Institute – Central & Eastern European Strategy Summit and in the Institute of International Finance (IIF) Global Outlook Forum. On Thursday, Commissioner Albuquerque will meet with India’s Finance Minister, Nirmala Sitharaman, and join a discussion on “The Future of Finance: Making Finance Work for the Economy” at Johns Hopkins University SAIS. On Friday, she will meet separately with US Treasury Secretary, Scott Bessent, to discuss financial regulatory matters, and with the Federal Reserve Chair, Jay Powell. Additionally, the Commissioner will participate in the US Treasury Regulatory Roundtable, which will address ongoing work on financial regulatory policies and explore the changing boundaries between bank and non-bank financial intermediaries.
 
Compliments of the European CommissionThe post European Commission | Commissioners Dombrovskis, Síkela and Albuquerque attend the 2025 Spring Meetings in Washington, D.C. first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.