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Macroeconomics 03 Jul 2018

Keys to understanding the ECB's non-standard measures

At its meeting on June 14, the European Central Bank (ECB) set an expiry date for the asset purchase program: December of this year. The program, which started in March 2015, is now approaching its end. It forms part of the non-standard measures that Mario Draghi’s institution implemented during the toughest years of the economic crisis. What do they consist of?

When the members of the Eurosystem created the common currency, they did not provide the ECB with mechanisms to deal with a crisis such as that of 2008. Over the last decade, the ECB has had to implement a series of non-standard measures to mitigate the effects of the crisis in the Eurozone, restore the transmission channels of monetary policy, and maintain price stability set as inflation of close to 2% in the medium term.

Although some of these measures have been in place for a number of years, all of them were considered temporary. Their gradual withdrawal is linked to the economic situation returning to normal.

Some of these instruments are described below:

  • Forward guidance: the institution headed by Mario Draghi began to use this tool in July 2013. It was then that the ECB Governing Council announced that it expected these interest rates to be maintained at low levels for a long period of time. The purpose of this instrument is to offer financial markets, companies and consumers indications on the future direction of the monetary policy to be implemented by the institution, based on the inflation outlook.
  • Targeted longer-term refinancing operations (TLTRO): normally banks must return the money the ECB lends them within a period ranging from one week to three months. However, in the case of these TLTRO (which have the specific purpose of encouraging lending to businesses and consumers in the Eurozone), the maturity is longer, at four years. The first of this round of tenders (TLTRO I) was announced in June 2014 and consisted of eight auctions. There was then a second round of four auctions (TLTRO II), which began in March 2016. A number of incentives were created in implementing the second round of TLTROs. Banking institutions that loaned more to individuals and businesses could access finance under more advantageous conditions.
  • Negative interest rate in the deposit facility: the goal of this instrument is also to boost the flow of lending to individuals and businesses. The deposit facility is one of the three interest rates on which ECB can act. In the years leading up to the crisis, this interest rate was positive: in other words, the ECB paid the banks who kept their liquidity surpluses in the institution. In June 2014, due to the effects of the crisis on the Eurozone, it was decided to establish a negative deposit interest rate at -0.10 percent. In September of the same year, the deposit rate was cut to -0.20 percent and only two years later it was reduced once more to the current rate of -0.40 percent to encourage institutions to use their liquidity to finance households in Europe. At its last meeting, the ECB announced that these interest rates would remain unchanged at least until the summer of 2019.
  • Asset Purchase Program (APP): to bring inflation back to levels of close to 2%, on January 22, 2015 the ECB announced the start-up of the asset purchase program. The quantitative easing (QE) policy was the means of implementing this program (APP), which includes the purchase of a variety of assets: public debt, securities issued by supranational European institutions, corporate bonds, asset-backed securities and covered bonds. Under this mechanism, the ECB buys assets for a monthly amount that currently stands at €30 billion euros. These asset purchases influence financial conditions in the Eurozone, and basically economic growth and inflation. This ECB program has three objectives: first, to transmit monetary policy directly. The purchase of assets is tied to the loans that commercial banks grant to individuals and businesses, thus allowing the expansive policy to pass through to households. The second ECB objective is portfolio rebalancing, as the purchase of public and private sector assets allows investors to use the funds received for the assets they sell to the ECB to buy other assets, thus increasing the demand for these products and reducing their costs. Finally, through these purchases the ECB aims to signal to the markets that official interest rates will be kept low for an extended period of time. These signals reduce market volatility and uncertainty.

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