Independent Central Banking in times of crisis

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1 Independent Central Banking in times of crisis The Eurosystem CEMLA: XI Meeting of Central Bank Legal Advisers Santiago, Chile

2 Content A.The Eurosystem s response to the crisis B. The Eurosystem Framework C. Conclusions Seite 2

3 A. The Eurosystem s response to the crisis I. Monetary policy measures (1) Interest rate cuts (2) Expanded liquidity provision II. Additional temporary measures: Expansion of eligible collateral III. ELA IV. Sovereign bonds purchase programmes Seite 3

4 A. The Eurosystem s response to the crisis I. Monetary policy measures (1) - Interest rate cuts 4.50% 4.00% 3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Eurosystem: Key interest rate (main refinancing rate) Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct % 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Jan-07 USA: Key interest rate Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11 Aug-11 Jan-12 Jun-12 Nov-12 Apr-13 Sep % 0.50% 0.40% 0.30% 0.20% 0.10% 0.00% Jan-07 Japan: Key interest rate Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11 Aug-11 Jan-12 Jun-12 Nov-12 Apr-13 Sep-13 Seite 4

5 A. The Eurosystem s response to the crisis I. Monetary policy measures (2) - Expanded liquidity provision October 2008: Change to fixed rate tender with full allotment Special-term refinancing operations Since 2007: supplementary longer-term refinancing operations (LTROs) with maturities of three, six and twelve months December 2011 and February 2012 Big Bertha : Two threeyear LTROs (more than 1000 billion EUR) Since January 2012: Reduction of the minimum reserve ratio from 2 % to 1 % Seite 5

6 A. The Eurosystem s response to the crisis II. Additional temporary measures: Expansion of eligible collateral Admission of new collateral, e.g.: Debt instruments issued by credit institutions Credit threshold / minimum rating requirement for eligible collateral lowered from A- to BBB- In the sovereign debt crises bonds issued or fully guaranteed by Greece, Portugal, Ireland, Cyprus did not meet this (low) minimum rating requirement Suspension of the minimum rating requirements Sovereign bonds issued by these Member States were accepted as collateral although the bonds were rated lower than BBB- Seite 6

7 A. The Eurosystem s response to the crisis III. Emergency Liquidity Assistance (ELA) Temporary short term provision of liquidity to credit institutions Temporary illiquid (not insolvent) Liquidity problem cannot be solved via monetary policy refinancing with Eurosystem (e.g. due to a lack of Eurosystem eligible collateral) Lender of last resort Competence of NCBs on own responsibility and liability Losses are not shared with other Eurosystem NCBs ECB Governing Council can object provision of ELA in case of interference with objectives and tasks of Eurosystem, including the prohibition of monetary financing (Art ESCB Statute) Seite 7

8 A. The Eurosystem s response to the crisis IV. Purchase programmes (1) - Securities Markets Programme (SMP) May 2010: Introduction of SMP in the context of the sovereign debt crises in some euro area Member States Rise of interest rates of sovereign bonds of some Member States due to high government debts and/or high actual government budget deficits SMP = Secondary markets purchases of sovereign bonds of Member States affected by sovereign debt crises Objectives of SMP: Removal of malfunctions of certain euro area debt securities markets Restoration of the monetary policy transmission mechanism Provision of time for governments to restore public finances Seite 8

9 A. The Eurosystem s response to the crisis IV. Purchase programmes (1) - Securities Markets Programme (SMP) But: SMP undermined fiscal discipline of Member States Lack of market discipline: Governments did not restore public finances September 2012: Stop of SMP due to its limits concerning fiscal discipline Securities holdings acquired under the SMP as at 31 December 2012: Issuer country Nominal amount (EUR billion) Book value (EUR billion) Ireland Greece Spain Italy Portugal Total Average remaining maturity (in years) Seite 9 Source: ECB press release from 21 February 2013

10 A. The Eurosystem s response to the crisis IV. Purchase programmes (2) - Outright Monetary Transactions (OMTs) ECB-President Draghi on 26 July 2012: Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough. September 2012: Announcement of the OMT programme OMT = Outright transactions in secondary sovereign bond markets without ex ante quantitative limits No official decision till now No purchases till today Seite 10

11 A. The Eurosystem s response to the crisis IV. Purchase programmes (2) - Outright Monetary Transactions (OMTs) Main features of OMT: Conditionality as a lesson learned from SMP Purchases require a financial stability and reform programme, e.g. an European Stability Mechanism (ESM) macroeconomic adjustment programme Purchase of low rated sovereign bonds of programme countries Purchases only as long as a programme country is on track with the financial stability and reform programme Focused on bonds with a maturity of between one and three years Seite 11

12 I. Characteristics of the Monetary Union: The concept of the Treaty of Maastricht (1) Transfer of the monetary sovereignty to the Eurosystem (2) Fiscal policy remaining in national competence and responsibility (3) The stability and growth pact (4) Reliance on market discipline and no bail out-clause II. The limited mandate of the Eurosystem (1) Objective of the Eurosystem (2) Independence of the ECB and the NCBs (3) Limited set of instruments (4) The prohibition of monetary financing Seite 12

13 I. Characteristics of the Monetary Union (1) - Transfer of the monetary sovereignty to the Eurosystem EU-Member States = sovereign states = Masters of the Treaty To establish the Monetary Union the participating EU-Member States have transferred their monetary sovereignty to the Eurosystem Treaty of Maastricht But: Transfer of limited and restricted competences Principle of conferral under EU-law: Eurosystem shall act only within the limits of the competences transferred upon it by the Member States Seite 13

14 I. Characteristics of the Monetary Union (2) - Fiscal policy remaining in national competence Only monetary policy is communitarized (supernationalized) Competences concerning monetary policy were transferred to the Eurosystem Monetary policy = task of independent Eurosystem Fiscal policy remains in the competence and responsibility of the participating Member States Fiscal policy = task of democratically legitimised governments and parliaments Seite 14

15 I. Characteristics of the Monetary Union (3) The stability and growth pact Limit on national competence concerning fiscal policy: The participating Member States shall avoid excessive government deficits. Limits on government deficit (3% of GDP) and debt (60% of GDP) But in practice: Stability and growth pact was not enforceable and there was no political will to comply with its rules Germany Italy Greece Deficit ,3 % 4,4 % 5,2 % Debt % 106 % 100 % Deficit % 3 % 10 % Debt % 127 % 157 % Seite 15 Source: Eurostat

16 I. Characteristics of the Monetary Union (4) - Reliance on market discipline and no bail out-clause Budgetary discipline in the Monetary Union shall be ensured by the market Market interest rate has disciplinary effect concerning Member States budgets Prohibition of monetary financing (Art. 123 TFEU) and no bail outclause (Art. 125 TFEU) shall ensure that the Member States remain subject to the logic of the market when they enter into debt Market discipline as an incentive to conduct a sound budgetary policy Seite 16

17 I. Characteristics of the Monetary Union (4) - Reliance on market discipline and no bail out-clause No bail out-clause in Art. 125 TFEU: The Member States shall not be liable for or assume the commitments of another Member State. According to the European Court of Justice (Pringle case) Art. 125 TFEU prohibits the Member States from granting financial assistance as a result of which the incentive of the recipient Member State to conduct a sound budgetary policy is diminished. But according to the European Court of Justice financial assistance is allowed if the recipient remains responsible for its commitments to its creditors and if the conditions for the assistance force the recipient to implement a sound budgetary policy. Seite 17

18 I. Characteristics of the Monetary Union (5) - Conclusion Characteristics of the Monetary Union limited and restricted mandate of the Eurosystem (1) price stability as primary objective (3) limited set of instruments (4) prohibition of monetary financing Seite 18

19 II. The limited mandate of the Eurosystem (1) - Objective Primary objective of Eurosystem = price stability Only secondary objective: Without prejudice to the objective of price stability, the Eurosystem shall support the general economic policies in the Union. Objective of Eurosystem is limited Difference to Fed: no multiple objective Objectives of the Fed: Maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate longterm interest rates (Section 2A Federal Reserve Act). Seite 19

20 II. The limited mandate of the Eurosystem (2) - Independence of the ECB and the NCBs EU and Member States must not influence or instruct the ECB or an NCB in the performance of their tasks Correlation between limited mandate and independence due do the justification of independence in the context of democratic legitimacy Only monetary policy is transferred to EU by democratically legitimised national governments and parliaments Only monetary policy = task of independent central banks Fiscal policy = task of Member States Seite 20

21 II. The limited mandate of the Eurosystem (3) - Limited set of instruments Open market and credit operations require adequate collateral Reasons: Monetary Policy in principle should be risk free Loss sharing in the Eurosystem possible but not the rule Purchases of sovereign bonds in the financial market: Permissible to provide liquidity and affect interest rates Art ESCB Statute: To achieve the objectives of the Eurosystem and to carry out its tasks, the ECB and the NCBs may buy and sell outright claims and marketable instruments. Limit for any purchase of sovereign bonds: The prohibition of monetary financing Seite 21

22 II. The limited mandate of the Eurosystem (4) - The prohibition of monetary financing Art. 123 TFEU: Overdraft facilities or any other type of credit facility with the ECB or with the NCBs in favour of ( ) central governments ( ) shall be prohibited, as shall the purchase directly from them by the ECB or NCBs of debt instruments. Wording: Prohibition of purchases made in the primary market EU-Regulation 3603/1993: Purchases made on the secondary market must not be used to circumvent the objective of Article 123 TFEU Objectives of the prohibition of monetary financing: (a) Prohibition of monetary financing achieves budgetary discipline (b) Particular relevance in the Monetary Union: Prevention of risk transfer between Member States Seite 22

23 II. The limited mandate of the Eurosystem (4) - The prohibition of monetary financing (a) Prohibition of monetary financing achieves budgetary discipline Purchases made on the secondary market should not aim to lower solvency risk premium for certain Member States Market interest rate / solvency risk premium has disciplinary effect concerning Member States budgets Purchases of sovereign debt Circumvention of the fiscal accountability of the Member States Undermining of market discipline as an incentive to conduct a sound budgetary policy (compare the SMP case) Seite 23

24 II. The limited mandate of the Eurosystem (4) - The prohibition of monetary financing (b) Particular relevance in the Monetary Union: Prevention of risk transfer between Member States Loss sharing in the Eurosystem: Losses from purchased sovereign bonds are shared between NCBs Losses from purchased sovereign bonds would affect national budgets Risk of redistribution of solvency risks between tax payers of the Member States of the Eurosystem Decisions concerning such redistributions must be made by governments and parliaments Seite 24

25 II. The limited mandate of the Eurosystem (4) - The prohibition of monetary financing Compliance with the primary objective price stability Purchase of sovereign bonds = in the long run more difficulties to achieve the primary objective price stability Experiences of many countries with monetary financing and inflation If Central Banks run high risks and play a major role on the secondary market for sovereign bonds it will be more difficult to take measures to achieve price stability Risk for the credibility of Central Banks Seite 25

26 II. The limited mandate of the Eurosystem (4) - The prohibition of monetary financing Comparison between ESCB and Fed concerning purchase programms Purchase of bonds of central government of currency area Purchase of bonds of certain States of currency area in trouble Rating of purchased bonds Redistribution of solvency risk / risk sharing between States Prohibition of monetary financing Eurosystem (SMP) Fed (-) (+) (+) (-) BBB+ till B AA+ / AAA (+) (-) (+) (-) Seite 26

27 C. Conclusions ECB-President Draghi at Harvard University (9 October 2013): Many commentators on this side of the Atlantic looked at the euro area and were convinced it would fail. They mistook the euro for fixed exchange-regime, when in fact it is an irreversible single currency. It is irreversible because it is born out of the commitment of European nations to closer integration. This commitment of European nations to closer integration has its roots in the status of the European Union as a legal community and in the rule of law. To make this statement credible the Eurosystem must act within its mandate and respect its rules. Whatever it took during the crisis the Eurosystem will have to return as soon as possible to its mandate as agreed by the Member States to preserve its credibility which is key for Central Banks also in times of crises. Seite 27

28 Thank you for your attention! Seite 28

Non-standard monetary policy in the euro area Economics Roundtable discussion (8 September 2017)

Non-standard monetary policy in the euro area Economics Roundtable discussion (8 September 2017) Gillian Phelan Outline Monetary policy action Interest rate policy Non-standard measures Monetary policy