Monetary Policy of the ECB

7/29/2019 Monetary Policy of the ECB

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1

Markus A. Schmidt

Directorate Monetary Policy

Monetary policy of the ECB, itsMonetary policy of the ECB, its

concepts and toolsconcepts and tools

Frankfurt am Main, 20 September 2011


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The views expressed are those of the presenter and

should therefore not necessarily be viewed and not be

reported as representing the views of the European

Central Bank.

Disclaimer


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The ECBs monetary policy Principles of the ECBs monetary policy

Economic Analysis

Monetary Analysis

The monetary transmission process

ECBs

response to the crisis

Outline


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Economic Analysis

Monetary Analysis


ECBs


Anything else?

Outline


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ECBs monetary policy objective Article 127 of the Treaty of the Functioning of theEuropean Union: The primary objective of the ESCB [Eurosystem] shall beto maintain price stability Without prejudice of the objective of price stability, the

ESCB [Eurosystem] shall support the general economic

policies with a view to contributing to the achievement ofthe objectives of the Union as laid down in Article 3 of the

Treaty on European Union.


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ECBs quantitative definition of price stability The Governing Council [GovC] of the ECB in October2008 defined price stability as

a year-on-year increase of

the Harmonised Index of Consumer Prices [HICP]

for the euro area

below 2%.

Price Stability is to be maintained over the medium term. The GovC aims to maintain inflation rates at levelsbelow, but close to, 2% over the medium term.


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Why below, but close to, 2%?

Below in order to fully reap the benefits of pricestability.

Close to

to ensure an adequate margin

that

avoids risks of deflation,

addresses implications of inflation differentials among euro area

Member States and

takes possible small measurement bias in HICP into account.


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Why is price stability important

Inflation is

hampering the price mechanism (absolute-relative confusion,

permanent-transitory confusion),

is affecting the allocation of income (debtors vs. creditors, wage-

lag hypothesis) in case of non-anticipated inflation,

causes a decrease in efficiency, even if inflation is anticipated,

results in sub-optimal holdings of money,

reducing households

purchasing power.


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Inflations consequences for purchasing power

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P

urchasingpowerof

100Euro(2011)

0

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40

60

80

100

120

P

urchasingpowerof

100Euro(2011)

1% 2% 3% 4% 5%Annual inflation rate of...

Source: ECB calculations.


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Inflation and inflation expectations

Source: Bloomberg, ECB and ECB calculations.

Latest observation: September 2011, end-of-month data (inflation swaps) and monthly data (HICP), percentage points.

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

Dec-0

4

Jun-0

5

Dec-0

5

Jun-0

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Dec-0

6

Jun-0

7

Dec-0

7

Jun-0

8

Dec-0

8

Jun-0

9

Dec-0

9

Jun-1

0

Dec-1

0

Jun-1

1-1.0

0.0

1.0

2.0

3.0

4.0

5.0

Long-term inflation expectation (5y5y forward inflation swap rate)Medium-term inflation expectation (5y spot inflation swap rate)

Short-term inflation expectations (1y spot inflation swap rate)

HICP (annual growth rate, percentage points)


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Institutional safeguards

Clear mandate: Price stability as primary objective

Independence

from political influence

Clear allocation ofresponsibilities

Strategic safeguards

Credible commitment

towards mandate

Consistent framework for analysis and decision-making

Clear and transparent communication

Safeguards for sound monetary policy


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Full set of informationFull set of information

Analysis ofeconomic

dynamics andshocksAnalysis of

monetary trends

Governing Council takes

monetary policy decisions based

on an overall assessment of the

risks to price stability

Primary objective of price stabilityPrimary objective of price stability

crosschecking

Economic

analysis

Monetary

analysis

The ECBs monetary policy strategy


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Key principles of the ECBs monetary policystrategy

Forward-looking nature

Medium-term orientation

Broad-based analysis

Cross-checking of analyses


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Economic Analysis

Monetary Analysis


ECBs


Anything else?

Outline


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Economic Analysis

The Economic Analysis aims at identifying short- tomedium-term risks to price stability. Forward-looking assessment of relevant information from avariety of indicators

(e. g. business cycle, wages,

exchange rate, asset prices, financial yields, fiscal policy,

etc.).

Quarterly macroeconomic projections for inflationand growth in the euro area, prepared by staff of theEurosystem/ ECB


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Economic Analysis

The scope of the Economic Analysis are factors determiningsupply-

and demand-conditions

on

goods markets,

services markets, and

factor markets [capital markets, labour markets].

It investigates shocks to the economy, the resulting dynamicprocesses as well as the perspectives stemming from that.


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Economic Analysis

Among the indicators relevant for Economic Analysis are

price indicators,

expenditure components,

production indicators,

sentiment indicators,

labour market indicators and

financial market indicators.


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Economic Analysis

Monetary Analysis


ECBs


Anything else?

Outline


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Monetary Analysis

The Monetary Analysis aims at identifying medium- to longer-term risks to price stability. The basis of Monetary Analysis is the conviction thatinflation is always a monetary phenomenon, at least

in the long-run.

Money has leading indicator properties for inflation in theeuro area in the medium- to long-run.

Regular monitoring of money and credit developmentscontributes to identifying emergence of unsustainabledevelopments in asset prices.


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Monetary Analysis

M

t

M*

P

t

P*

P

tt

M

M*

M*

M*P*

P*

P*


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Monetary Analysis

Monetary Analysis is mainly based on balance sheet dataof the money-issuing sector, i.e. so-called MonetaryFinancial Institutions [MFIs].

Assets Liabilities

Overnight deposits

Currency in circulation

Marketable instruments

Other short term deposits

Longer term liabilities

Holdings of central government

LoansCredit to general government

Credit to private sector

Securities

Securities

Net claims on non-euro arearesidents

Loans

Securities


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Credit is the main source of monetary dynamics

Source: ECB.

Latest observation: July 2011, monthly data, annual growth rates, percentage points.

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14

Loans to the private sector (adjusted for securitisation) M3


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Economic Analysis

Monetary Analysis


ECBs


Anything else?

Outline


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Monetary transmission in normal times

Overnight rate mirrors official key interest rate overmaintenance period. ECB influences money market conditions by setting keyinterest rates and managing the liquidity situation in the

banking sector by benchmark allotment.

Banks with liquidity surplus lend to those with deficits overinter-bank money market.

Government bonds play an important role as collateral and for the pricing of fixed income securities, henceavailability is important.


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Steering money market conditions

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7

Main refinancing operations Marginal lending facility Deposit facility Eonia (monhtly average)

% %

Source: ECB.

Latest observation: August 2011, monthly averages of daily observations


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Steering money market conditions

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Long-term interest rate (10 y) Short-term interest rate (3 m) Eonia (monhtly average)

% %

Source: ECB.

Latest observation: August 2011, monthly averages of daily observations


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Economic Analysis

Monetary Analysis


ECBs


Anything else?

Outline


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The financial turmoil and the money market

Source: Bloomberg and ECB calculations.

Last observation: 15 September 2011, daily observations

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7

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Jul-0

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Jan-0

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Eurepo (3M) Euribor (3M) Depo-Repo-Spread (3M, RHS)

% bp


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Impairment of the monetary transmission process


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The ECBs response to the crisis Immediate response on 9 August 2007

Allowed banks to draw full amount of what they needed on

overnight basis against collateral at the prevailing main refinancing

rate (ca

95 bn)

In the following months

Supplementary refinancing operations with 3 and 6 months maturity

Intra-maintenance period frontloading

More frequent fine-tuning operations

Provision of US dollar liquidity against euro-denominated collateral


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100.0

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08/08/07 11/08/07 14/08/07 17/08/07 20/08/07 23/08/07 26/08/07 29/08/07 01/09/07 04/09/07 07/09/07 10/09/07

[EUR billions]

Daily current accounts Reserve requirements

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11/07/07 14/07/07 17/07/07 20/07/07 23/07/07 26/07/07 29/07/07 01/08/07 04/08/07 07/08/07

[EUR billions]

Daily current accounts Reserve requirements

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10/12/08 14/12/08 18/12/08 22/12/08 26/12/08 30/12/08 03/01/09 07/01/09 11/01/09 15/01/09 19/01/09

Daily current accounts Deposit facility Reserve requirements

EUR [billions]

Pre-crisis benchmark allotment Pre-Lehman frontloading

Post-Lehman ample liquidity

Reserve requirement

Reserve holdings

Recourse to deposit facility

EUR billions

Liquidity management measures

Source: ECB.


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Decline in key interest rates by 325 bp in 7 months

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Aug-07

Oct-07De

c-07Feb-08

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c-08Feb-09

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c-09Feb-10

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c-10Feb-11

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Aug-11

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6

Main refinancing operations Marginal lending facility Deposit facility Eonia (monhtly average)

% %

Source: ECB.

Last observation: August 2011, monthly averages of daily observations.


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Short-term(floating rate and up to 1 year)

Long-term(over 5 years)

affected loans-rates, too!

Source: ECB and ECB calculations.

Last observation: July 2011

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Small loans to NFCs Large loans to NFCsLoans for house purchase (over 5 and up to 10 years) Loans for house purchase (over 10 years)Consumer credit Other lending

Eonia (monhtly average)% %

0

1

2

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8

9

10

Jan-07

M

ar-07

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ay-07

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M

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ar-10

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ay-10

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ar-11

M

ay-11

Jul-11

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1

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9

10

Small loans to NFCs Large loans to NFCs Loans for house pruchase

Consumer credit Other lending Eonia (monhtly average)

% %


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Further responses enhanced credit support ECBs enhanced credit support consisted of mainlybank-based measures to support the flow of credit beyond

standard interest rate channel

Fixed-rate full allotment

Expansion of collateral

Longer-term liquidity provision

Liquidity provision in foreign currencies

Financial market support through purchases of covered bonds


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Temporary improvements

Against background of improved money market conditionsECB introduced exit strategy

from non-standard

measures, as they were temporary by nature

Non-continuation of purchases of covered bonds

Partly withdrawal of liquidity provision in foreign currency

Non-continuation of long-term liquidity provision

No pre-determined sequence between the exit from non- standard measures and interest rate actionAssessment of risks to price stability primary criterion


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5-year sovereign CDS spreads

Source: Bloomberg.

Last observation: 14 September 2011, daily observations.

0

500

1000

1500

2000

2500

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3500

4000

4500

Jan-0

7

Mar-0

7

May-0

7

Jul-0

7

Sep-0

7

Nov-0

7

Jan-0

8

Mar-0

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May-0

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Jul-0

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Sep-0

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Nov-0

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Jan-0

9

Mar-0

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May-0

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Jul-0

9

Sep-0

9

Nov-0

9

Jan-1

0

Mar-1

0

May-1

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Jul-1

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Sep-1

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Nov-1

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Jan-1

1

Mar-1

1

May-1

1

Jul-1

1

Sep-1

10

500

1000

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4500

DE FR IT ES IE PT GRbp bp


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ECBs response to the sovereign debt crisis ECB introduced the Securities Markets Programme [SMP] to safeguard the well-functioning of the

transmission process by conducting interventions in euroarea debt securities markets.

Purchases ensure depth and liquidity in dysfunctionalsecurities markets and are conducted on secondary marketsonly.


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ECBs response to the sovereign debt crisis ECB re-introduced some non-standard measures thathad been phased-out earlier.

Fixed-rate full allotment in 3M refinancing operations

Temporary 6M refinancing operations

Fixed-rate full allotment in USD (new)


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Monthly Bulletin The ECBs monetary policy stance during thefinancial crisis (January 2010)

The ECBs response to the financial crisis

(October 2010) Asset price bubbles and monetary policy

revisited (November 2010)

Literature


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The Monetary Policy ofthe ECB

Literature


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The European CentralBank, the Eurosystem,the European System of

Central Banks

Literature


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Price Stability: Why is itimportant for you?

Literature


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Markus A. Schmidt

Directorate Monetary Policy

Monetary policy of the ECB, itsMonetary policy of the ECB, its

concepts and toolsconcepts and tools

Frankfurt am Main, 20 September 2011

Documents

Monetary Policy of the ECB