Implementing monetary policy in times of crisis
The global financial crisis that was triggered in August 2007 necessitated strong policy responses, including extraordinary monetary policy action. At the time, the Eurosystem departed from its usual way of conducting monetary policy by adopting nonstandard measures to support the effective transmission of monetary policy decisions to the financial system and the real economy, and to the levels of inflation. Nonstandard measures have been part of the Eurosystem’s toolkit ever since.
For the Eurosystem, the need for taking nonstandard measures arose in 2007, when the policy rates set by the Governing Council of the ECB failed to be effectively transmitted to the economy as a whole. All the nonstandard measures taken by the Eurosystem since then have been in line with the operational monetary policy framework that was in place even before 2007. Moreover, the Eurosystem has adopted all nonstandard measures with the very objective that it pursues with its standard policy measures: to achieve price stability, which it has defined as an inflation rate of close to, but below 2%.
Besides, the Eurosystem's monetary policy framework generally provides for a number of mechanisms counterbalancing potential stress in the financial sector apart from nonstandard measures. To give a few examples:
- Eligible assets have been defined in a broad manner to facilitate bank refinancing with the Eurosystem.
- The range of counterparties defined as eligible for Eurosystem refinancing enables a large number of banks to obtain direct central bank funding if the interbank market were to become dysfunctional.
- Overnight liquidity can be obtained not only on the interbank market but also directly from the Eurosystem, against eligible assets, through the ECB’s marginal lending facility.
Which nonstandard monetary policy measures has the Eurosystem adopted since 2007?
The nonstandard measures taken by the Eurosystem since 2007 have amplified the stabilizing effect of its pre-crisis monetary policy instruments not just on the money market but on other financial markets as well. The main measures are as follows:
- Extension of the maturity of liquidity-providing operations:
Maturities of up to four years facilitate bank refinancing and support longer-term planning and lending.
- Changes in the allotment of funds:
Since October 2008, all refinancing operations have been conducted as fixed rate tenders with full allotment. This ensures that, subject to adequate collateral, counterparties have unlimited access to central bank liquidity. The current tender procedures are expected to remain in place at least until the end of the reserve maintenance period starting in March 2021.
- Collateral requirements:
The list of collateral eligible for Eurosystem refinancing operations was extended following the onset of the financial crisis, thus allowing banks to use a higher proportion of their assets to obtain central bank liquidity.
- Policy rates below the zero lower bound:
While the interest rate for main refinancing operations was lowered a number of times until it reached the zero lower bound, i.e. 0%, in March 2016, the interest rate for the deposit facility has since been reduced to –0.5%. Given banks’ high amounts of excess liquidity, money market rates have been staying close to the lower bound of the corridor that the policy rates create, which means that they have also been pushed below 0%. This has eased banks’ refinancing conditions and enabled them to pass on their cost advantages to their customers in the form of lower lending rates.
- Targeted longer-term refinancing operations:
Since September 2014, the Eurosystem has been offering targeted longer-term refinancing operations at particularly favorable conditions (e.g. with an interest rate below the main refinancing rate) subject to conditions that stimulate bank lending to the real economy.
- Currency swap agreements:
Since 2007, euro area banks have been able to obtain funding from the Eurosystem not only in euro but also in foreign currencies, such as U.S. dollars or Swiss francs, based on underlying currency swap agreements with other central banks. In 2011, six central banks or central banking systems – the Bank of England, the Bank of Canada, the Bank of Japan, the U.S. Federal Reserve System, the Schweizerische Nationalbank and the ECB – concluded currency swap agreements, enabling the participating central banks to obtain currency from each other. In 2013, the ECB also concluded a currency swap agreement with the People’s Bank of China. In times of crisis, currency swap lines are instrumental in safeguarding financial stability and in preventing market tensions from affecting the real economy.
- Sovereign bond purchases to reduce risk premiums:
In May 2010, the ECB launched a Securities Markets Programme (SMP), in response to tensions in some segments of the financial market, in particular in the euro area sovereign bond markets. In fall 2012, the SMP was replaced by outright monetary transactions (OMTs) to specifically support the sovereign bond markets of euro area countries subject to relevant European Stability Mechanism (ESM) programs, with secondary market purchases.
- Expanded asset purchase programme (APP):
Three successive covered bond purchase programmes (CBPP1-3) and an asset-backed securities purchase programme (ABSPP) were put in place to revive and support the respective refinancing markets, which are of great importance to European banks. Under the ABSPP, the Eurosystem purchases a broad range of simple and transparent securitized assets, with underlying assets consisting of credit claims against the euro area nonfinancial private sector. Under the CBPP3, the Eurosystem purchases a broad range of euro-denominated covered bonds issued by banks domiciled in the euro area.
In early 2015, the Eurosystem expanded its asset purchases to include bonds issued by euro area central governments, agencies and European institutions (public sector purchase programme – PSPP) to address the downward trend in inflation expectations. These purchases – technically referred to as quantitative easing (QE) measures – will be kept up until the inflation outlook has been robustly converging to a level sufficiently close to, but below, 2% within the Eurosystem’s projection horizon.
In June 2016, the Eurosystem added a corporate sector purchase programme (CSPP) to the APP framework. The CSPP comprises purchases of bonds issued by nonbank corporations established in the euro area. It aims at further strengthening the pass-through of the Eurosystem’s asset purchases to financing conditions in the real economy.
Financial instruments the Eurosystem buys under any of the above programs must meet certain minimum quality requirements.
- Forward guidance:
Since July 2013, the Governing Council of the ECB has been providing guidance on the future path of its monetary policy stance at its regular press conferences. This enables ECB policies to have an impact on interest rate expectations beyond the short horizon, i.e. to steer not only the very short-term money market rates but longer maturities as well.
- Two-tier system of reserve remuneration
For excess liquidity held on Eurosystem accounts, euro area banks are charged interest equivalent to the interest rate on the deposit facility, which currently equals –0.5%. To alleviate the direct cost of negative interest rates for banks, the ECB adopted a two-tier system for remunerating excess liquidity holdings in September 2019, thus exempting part of banks’ excess cash reserves from the negative deposit facility rate. The exempt volume was defined as an adjustable multiple of banks’ minimum reserve requirements. At present, this multiplier is set at 6.
Which nonstandard monetary policy measures has the Eurosystem adopted in response to the coronavirus pandemic in 2020?
In the face of the coronavirus pandemic spreading across the globe and taking a heavy human and economic toll, economic policymakers have again been challenged to pull out all the stops.
While drawing on the existing instruments (as described above), the Eurosystem’s monetary policymakers have also expanded their toolkit and eased the conditions for the nonstandard measures already in place.
- To enable banks to meet their immediate liquidity needs, the Eurosystem is offering additional long-term refinancing operations (LTROs) since spring 2020. In addition, pandemic emergency longer-term refinancing operations (PELTROs) were introduced to provide liquidity in 2020 and 2021 at an interest rate below the main refinancing rate and without conditions.
- At the same time, more favorable terms will be applied to targeted longer-term refinancing operations outstanding from June 2020 to June 2022. These measures have been designed to support above all those affected most by the spread of the coronavirus, in particular small- and medium-sized businesses.
- The list of eligible collateral accepted in Eurosystem refinancing operations was extended further. In particular, the framework for additional credit claims has been expanded to include bank loans to firms (even if the loans are small).
- The network of currency swap lines first created in 2011 was reactivated, enabling the Eurosystem to offer euro area banks U.S. dollar. This offer will remain in place as long as necessary to ensure the smooth functioning of U.S. dollar refinancing markets.
- The Eurosystem’s ongoing asset purchase programme (APP) was expanded further to provide for additional net purchases, until the end of 2020, in the amount of EUR 120 billion, with a view to supporting favorable financing conditions for the real economy in times of heightened uncertainty.
- On top of that, the Eurosystem launched a pandemic emergency purchase programme (PEPP) under which it will buy EUR 1,850 billion worth of eligible securities. This program will run until the pandemic has been overcome, and in any event at least until March 2022. Any asset classes that the Eurosystem has been buying in the past under the ongoing APP program will also be eligible for PEPP purchases. In short, the PEPP is a monetary policy measure aimed at countering coronavirus-related risks to the monetary policy transmission mechanism and the outlook for the euro area economy.