The ECB s Fight against Low Inflation: On the Effects of Ultra-Low Interest Rates

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1 International Journal Fancial Studies Article The ECB s Fight agast Low Inflation: On Effects Ultra-Low Interest Rates Ad van Riet Direcrate Monetary Policy, European Central Bank (ECB), Sonnemannstrasse 20, Frankfurt am Ma, Germany; ad.van_riet@ecb.europa.eu The views expressed this article are those author and should not be reported as representg views ECB. Academic Edir: Nicholas Apergis Received: 14 December 2016; Accepted: 8 March 2017; Published: 7 April 2017 Abstract: Startg June 2014, European Central Bank (ECB) stepped up its monetary accommodation order counter a o prolonged period low flation euro area. This article fers a narrative monetary policy measures taken up December 2016 and a review effects ultra-low terest rates. The exceptional monetary stimulus transmitted economy broadly as tended. Moreover, it enhanced fancial capacity economic agents bear risks. At same time, ECB and European micro- and macro-prudential authorities remaed watchful untended side-effects an extended period very low or negative terest rates for fancial termediation, fancial stability and market disciple and ok preventive or corrective measures as appropriate. A jot plan action carried out by 19 member countries with aim speed up balance sheet repair, accelerate economic recovery and achieve higher productivity growth could have contributed a more effective euro area macroeconomic and fancial policy mix. Keywords: ECB monetary policy; quantitative easg; negative terest rates; fancial stability JEL Classification: E31; E5; G1; G2 1. Introduction Market terest rates all advanced economies have fallen record-low levels wake global fancial crisis 2008 affected by a variety both global and domestic facrs, cludg monetary policy. This article fers a narrative conduct and consequences ECB monetary policy from June 2014 December 2016 as euro area crisis had subsided, but a prolonged period low flation put medium-term price stability at risk. 1 The ECB responded this new challenge with a substantial additional monetary stimulus usg both standard and non-standard measures. These cluded reducg policy rates levels around zero lower bound, targeted longer term refancg operations for banks and large-scale asset purchases equivalent quantitative easg, 2 1 The primary objective monetary policy Eurosystem (comprisg ECB and national central banks those EU countries that have adopted euro) is mata price stability for euro area. Without prejudice this objective, it is called upon support general economic policies Economic and Monetary Union. The Governg Council ECB has defed price stability as a euro area flation rate below, but close, 2% over medium term (see (ECB 2011)). 2 The literature tends use quantitative easg for any program large-scale asset purchases that leads a rapid expansion central bank balance sheet. However, objective this monetary easg can be different. Some central banks targeted a particular growth rate monetary base. Ors like ECB actively sought relax credit conditions across fancial markets and revive malfunctiong credit markets. For latter case, credit easg appears a more appropriate formulation (see also (ECB 2015)). Int. J. Fancial Stud. 2017, 5, 12; doi: /ijfs

2 Int. J. Fancial Stud. 2017, 5, confirmg earlier forward guidance that monetary policy was expected rema accommodative for an extended period time. The stated objective was furr relax bank fundg costs and private borrowg constrats, address frictions monetary transmission and provide a major stimulus for credit growth, domestic demand and job creation order secure a sustaed return flation a medium-term path just below 2%. The article fds that ECB s exceptional monetary stimulus eased fancial conditions, revived credit growth and broadly transmitted economy as tended. The ECB broke through zero lower bound nomal terest rates June Settg its deposit facility rate modestly below zero represented unchartered terriry as ECB was first major central bank enter on this course, writg monetary hisry as it proceeded. Afterwards, large-scale asset purchases shifted down and flattened yield curve, leadg negative sovereign terest rates for several euro area countries over first part term structure. Several authors warned about possible adverse side-effects a protracted period ultra-low terest rates. A sustaed highly accommodative monetary stance could feed bank distermediation, fuel fancial vulnerabilities and cause economic disrtions. 3 Examg evidence up end-2016, article concludes that se were legitimate concerns and required ECB and or policymakers rema attentive untended consequences record-low terest rates gog forward. The European micro- and macro-prudential authorities, cludg ECB, this regard closely monired health fancial stitutions and potential systemic fancial risks and tervened with preventive or corrective measures aimed at preservg fancial soundness at secral or national level. Micro-supervision was tightened where necessary ensure resilience dividual fancial stitutions, while macro-prudential ols were employed deal with systemic fancial risks. The role that monetary policy could play preservg fancial stability is still debated. Some authors have argued that central bank could take account fancial stability concerns when decidg on optimal adjustment path for flation (see (Smets 2014)). This preventive role for monetary policy was justified because monetary stance affected general attitude wards risk, allocation credit and strength fancial cycle, facrs which turn fluenced ability mata price stability. The ECB s two-pillar monetary policy strategy this respect already corporated a detailed analysis money, credit and fancial conditions as a safeguard agast a o narrow focus on macroeconomic facrs determg short-term flation outlook (see (Fahr et al. 2013)). In addition, ECB adjusted composition and design its monetary stimulus over time with aim support centives for fancial termediaries origate credit and reby secure an effective monetary policy pass-through. The consequent improvement economic prospects and net wealth enhanced fancial capacity banks lend and households and firms borrow, which also mitigated fancial stability concerns gog forward even though economic agents assumed more risk. An appropriate macroeconomic and fancial policy mix for whole Economic and Monetary Union (EMU) also required that each 19 member countries contributed with sound complementary measures. A coordated euro area policy stance could have speeded-up balance sheet repair, accelerated economic recovery and promoted higher productivity growth, reby supportg an earlier reversal ultra-low terest rates. However, stitutional architecture EMU lacked effective ols secure this preferred outcome. The rest this article is organized as follows. Section 2 summarizes ECB s monetary policy measures and reviews empirical evidence ir tended transmission economy. Section 3 reviews untended side-effects extended period ultra-low terest rates. Section 4 considers complementary role non-monetary policies dealg with cyclical and structural challenges facg Eurozone. Section 5 concludes that coordated policy action by member 3 See IMF (2013), Adrian and Liang (2014), Borio (2014), Hannoun (2015), Arteta et al. (2016), Jobst and L (2016) and White (2016).

3 Int. J. Fancial Stud. 2017, 5, Int. J. Fancial Stud. 2017, 5, member countries could have supported ECB s fight agast low flation, shortened episode countries ultra-low could terest have rates supported and mitigated ECB sir fightadverse agast low side-effects. flation, shortened episode ultra-low terest rates and mitigated ir adverse side-effects. 2. The ECB s Monetary Policy Response Low Inflation 2. The ECB s Monetary Policy Response Low Inflation 2.1. The Monetary Policy Environment after Euro Area Crisis 2.1. The Monetary Policy Environment after Euro Area Crisis The euro area fancial, economic and sovereign debt crisis was halted mid-2012, and subsequent The euro months, area fancial, economic market volatility and sovereign gradually debt dissipated. crisis was The halted precedg mid-2012, turmoil and cast a subsequent long shadow months, as process fancial market repairg volatility balance gradually sheets was dissipated. slow and The precedg heterogeneity turmoil cast economic a long shadow and fancial as conditions process across repairg euro balance area countries sheets was persisted. slow andthis situation heterogeneity created economic challenges and for fancial ECB conditions ensurg across efficacy euro area and countries sgleness persisted. its monetary This situation policy, created which is challenges vital for its forability ECB provide ensurg a credible efficacy anchor and sgleness price stability. itsmoreover, monetary policy, steady which disflation vital for its euro ability area consumer provide aprices credible anchor annual price rate stability. far below Moreover, 2%, weak steady underlyg disflation price pressures, euro area consumer high degree prices an unutilized annual rate capacity far below and subdued 2%, weakmonetary underlyg dynamics price pressures, dicated an high extended degreeperiod unutilized low flation capacity and (Figure subdued 1). monetary dynamics dicated an extended period low flation (Figure 1). 4 4 Figure Figure Consumer Consumer price price flation flation euro euro area area (annual (annual percentage percentage changes). changes). Source: Source: Eurostat. Eurostat. Latest Latest observation: observation: December December Note: Note: HICP HICP = Harmonized Harmonized Index Index Consumer Consumer Prices. Prices. The monetary policy environment durg this period was characterized by both credit supply The monetary policy environment durg this period was characterized by both credit supply restrictions and credit demand constrats that hampered operation credit channel, restrictions and credit demand constrats that hampered operation credit channel, especially especially vulnerable member countries. On supply side, bankg secr was engaged vulnerable member countries. On supply side, bankg secr was engaged a drawn-out process creasg liquidity and capital buffers response tighter regulation a drawn-out process creasg liquidity and capital buffers response tighter regulation and reducg crisis legacy non-performg loans. Access bank fance was most constraed and reducg crisis legacy non-performg loans. Access bank fance was most constraed crisis-affected countries where retail bank lendg rates remaed relatively high, especially crisis-affected countries where retail bank lendg rates remaed relatively high, especially for small and medium-sized firms (see (Darracq Pariès et al. 2014)). Moreover, households and for small and medium-sized firms (see (Darracq Pariès et al. 2014)). Moreover, households and non-fancial firms facg a debt overhang needed considerable time resre sound balance sheets non-fancial firms facg a debt overhang needed considerable time resre sound balance (De Rougemont and Wkler 2014). Toger with high unemployment rates and uncertaty over sheets (De Rougemont and Wkler 2014). Toger with high unemployment rates and uncertaty economic outlook, this protracted debt deleveragg was holdg back private secr demand for over economic outlook, this protracted debt deleveragg was holdg back private secr demand new credit. for new credit. At same time, many euro area countries had embarked on fiscal consolidation order resre public debt sustaability and some pursued structural reforms revive economic 4 For earlier analyses ECB monetary policy as euro area crisis developed, see for example Fahr et al. (2013), Cour-Thimann and Wkler (2012), Durré et al. (2014), Praet et al. (2014) and Van Riet (2017). 4 For earlier analyses ECB monetary policy as euro area crisis developed, see for example Fahr et al. (2013), Cour-Thimann and Wkler (2012), Durré et al. (2014), Praet et al. (2014) and Van Riet (2017).

4 Int. J. Fancial Stud. 2017, 5, At same time, many euro area countries had embarked on fiscal consolidation order resre public debt sustaability and some pursued structural reforms revive economic dynamism. Although necessary strengn confidence future, short run, se public secr policies Int. J. Fancial Stud. 2017, 5, contributed broad-based weakness euro area economy. Toger with fallg commodity pricesdynamism. and subdued Although global necessary price pressures, strengn thisconfidence macroeconomic future, settg fueled short expectations run, se public secular stagnation, secr lowflation, policies contributed or even deflation broad-based 5, especially weakness when annual euro area rate economy. consumer Toger price with flation decled fallg 0.5% commodity sprg prices 2014 and (Figure subdued 1). global price pressures, this macroeconomic settg fueled expectations secular stagnation, lowflation, or even deflation The followg two sub-sections summarize monetary policy 5, especially when annual rate response this low flation consumer price flation decled 0.5% sprg 2014 (Figure 1). environment and review ma empirical evidence its tended transmission fancial The followg two sub-sections summarize monetary policy response this low flation conditions, environment credit growth and review and ma economy. empirical evidence its tended transmission fancial conditions, credit growth and economy The ECB s Monetary Easg Measures from June 2014 December The ECB s Monetary Easg Measures from June 2014 December 2016 The Governg Council ECB itiated June 2014 a comprehensive package measures, which wasthe expanded Governg and Council recalibrated ECB aitiated few times June over 2014 a comprehensive period up package December measures, 2016 (see timele which Table was expanded 1), provide and recalibrated additional a few monetary times over accommodation period up that December would 2016 support (see a pick-up timele Table 1), provide additional monetary accommodation that would support a both bank lendg and market credit, assist economic recovery and secure a sustaed return pick-up both bank lendg and market credit, assist economic recovery and secure a sustaed flation a medium-term level below, but close, 2%. return flation a medium-term level below, but close, 2%. First, First, ECB ECB cut cut its key its key terest terest rates rates two two small smallsteps steps June June and and September September 2014, 2014, brgg brgg ma refancg ma refancg rate down rate down 0.05%, 0.05%, margal margal refancg refancg rate rate 0.30% 0.30% and and deposit facility rate facility 0.20% rate (Figure 0.20% 2). (Figure Episodes 2). Episodes negative negative terest terest rates had rates been had been extremely rare rare modern hisry modern (Ullersma hisry 2002). (Ullersma Although 2002). Although eventuality had eventuality been debated had been for advanced debated for economies advanced around turn economies century around (see turn (Yates 2004)), century (see ECB (Yates was 2004)), first ECB major was central first bank major central break bank through break through zero lower bound. 6 zero lower bound. Therefore, it could 6 Therefore, it could not draw on previous experience with not draw on previous experience with this highly unusual this highly unusual monetary policy action. The negative deposit facility rate was expected fully monetary policy action. The negative deposit facility rate was expected fully transmit market transmit market terest rates and reduce centive for dividual banks place ir terest excess rates liquidity and reduce a safe account centive with for dividual ECB, rar banks than place money ir market excess or liquidity use it for a safe account lendg with purposes. ECB, rar than money market or use it for lendg purposes. Figure Figure 2. ECB 2. ECB key key terest rates rates and euro overnight terest rate rate (daily (daily data, data, percentages per annum). annum). Source: Source: ECB, ECB, Thomson Thomson Reuters. Reuters. ECB ECB key key terest terest rates rates 31 at December : 2016: margal lendg rate = lendg 0.25%; ma rate refancg = 0.25%; ma rate = refancg 0.0%; deposit rate facility = 0.0%; rate = deposit 0.4%. facility rate = 0.4%. 5 5 The ECB The (2014, ECB p. (2014, 66) views p.66) views deflation deflation as a broad-based as a broad-based and protracted and protracted fall fall price level price that level becomes that becomes entrenched flation entrenched expectations, flation rebyexpectations, reforcg negative reby price reforcg tendencies. negative price tendencies. 6 Arteta 6 Arteta al. (2016) et al. and (2016) Jobst and Jobst L (2016) and discuss L (2016) experiences discuss experiences Denmark, Hungary, Denmark, Sweden, Hungary, Switzerland Sweden, and Japan with negative Switzerland terest and rate Japan policies with negative addition terest thatrate policies euro area. addition that euro area.

5 Int. J. Fancial Stud. 2017, 5, Table 1. Timele ma ECB monetary policy decisions from June 2014 December June 2014 September 2014 January 2015 December 2015 March 2016 December 2016 ECB key terest rates (%): Margal lendg rate (MLR) Ma refancg rate (MRO) Deposit facility rate (DFR) Targeted longer term lendg operations for banks: TLTRO I Max. 4 years, at MRO TLTRO II Full 4 years, at MRO or up DFR Outright large-scale asset purchases APP: Private secr assets ABSPP, CBPP3 CSPP Public secr assets Forward guidance on monetary policy stance ECB key rates stay low or even lower; Ready for unconventional struments ECB key rates stay low or even lower; Eurosystem balance sheet rise be sizeable PSPP PSPP+ PSPP+ PSPP+ APP September bn per month ECB key rates stay low or even lower; APP until sustaed reversal flation APP March bn per month ECB key rates stay low or even lower; APP until sustaed reversal flation APP March bn per month ECB key rates stay low or even lower until well beyond APP horizon; APP until sustaed reversal flation APP March bn per month; APP from April December bn per month ECB key rates stay low or even lower until well beyond APP horizon; APP is state-contgent until sustaed reversal flation Note: TLTRO: targeted longer term refancg operations; APP: asset purchase programme; ABSPP: asset-backed securities purchase programme; CBPP: covered bond purchase programme; CSPP: corporate secr purchase programme; PSPP: public secr purchase programme (+ means that new public secr asset classes became eligible).

6 Int. J. Fancial Stud. 2017, 5, Int. J. Fancial Stud. 2017, 5, Second, ECB contued conduct its ma refancg operations as fixed-rate tenders with full allotment Second, for asecb longcontued as necessary conduct give its ma morerefancg certatyoperations about as ample fixed-rate availability tenders with bank refancg full allotment over afor medium-term as long as necessary horizon. give Moreover, more certaty it announced about a series ample availability targeted longer bank term refancg refancg operations over a medium-term (TLTRO I) at horizon. prevailg Moreover, ma it announced refancg a series rate (MRO), targeted longer be conducted term refancg operations (TLTRO I) at prevailg ma refancg rate (MRO), be conducted every quarter over a two-year wdow startg September 2014 (Figure 3). The amount that banks every quarter over a two-year wdow startg September 2014 (Figure 3). The amount that banks could borrow was derived from tal amount ir loans euro area non-fancial firms and could borrow was derived from tal amount ir loans euro area non-fancial firms and households households (excludg (excludg for house for house purchases). purchases). Sce Sce se se targeted targeted refancg refancg operations operations would would mature only mature September only 2018 September (with an 2018 option (with an early option repayment early repayment after twoafter years), two this years), conditional this conditional strument provided strument built- provided centives built- for centives banks crease for banks lendg crease lendg private secr. private secr. Third, Third, ECB ECB itiated itiated a a private secr asset asset purchase program (APP), which, ger with TLTROs, TLTROs, was foreseen was foreseen lead alead sizeable a sizeable expansion expansion Eurosystem Eurosystem balance balance sheet sheet back back large dimension large it had dimension earlyit had The early covered bond The purchase covered bond program purchase (CBPP3) program euro-denomated (CBPP3) securities euro-denomated issued by euro securities area credit issued stitutions by euro area was credit restarted stitutions Ocber was 2014, restarted targeted Ocber at makg 2014, bank targeted at makg bank fundg easier. The asset-backed securities purchase program (ABSPP) fundg easier. The asset-backed securities purchase program (ABSPP) focused on buildg up a broad focused on buildg up a broad portfolio simple and transparent struments and was launched portfolio simple and transparent struments and was launched November This addition November This addition sought stimulate banks and or fancial stitutions sought origate stimulate loans that banks subsequently and or fancial could be securitized stitutionsand origate sold loans ECB that at market subsequently conditions could be securitized exchange andfor sold central bank ECB money. at market conditions exchange for central bank money. Fally, Fally, Governg Council expressed its unanimous commitment use use additional additional unconventional struments with with its its mandate should it it become necessary furr address risk orisk prolonged o prolonged a period a period low flation. low flation. This could This could prciple prciple clude clude government government bond purchases bond purchases secondary market secondary provided market that provided sufficient that safeguards sufficient safeguards agast monetary agast monetary fancg fancg were made and were sovereign made and credit risks sovereign were not credit mutualized. risks were 7 This not communication mutualized. 7 This on non-standard communication measures on non-standard measures was consistent with and strengned forward guidance given sce was consistent with and strengned forward guidance given sce July 2013 keepg ECB s July 2013 keepg ECB s key terest rates at prevailg low levels or even lower for an key terest rates at prevailg low levels or even lower for an extended period time. extended period time. Figure Figure 3. ECB 3. ECB monetary monetary policy policy operations operations and and excess liquidity (billions (billions euro). euro). Source: Source: ECB. ECB. Latest Latest observation: 31 December Note: Tender operations clude ma, longer term and targeted observation: 31 December Note: Tender operations clude ma, longer term and targeted longer term refancg operations agast eligible collateral; outright portfolios clude public and private secr asset purchases market. 7 Followg opion Advocate General January 2015, European Court Justice confirmed June 2015 that ECB s earlier commitment undertake conditional Outright Monetary Transactions 7 (OMTs) secondary government bond markets where price formation was disrted by currency Followg opion Advocate General January 2015, European Court Justice confirmed June 2015 that ECB s redenomation earlier commitment risk falls with undertake realm conditional monetary Outright policy Monetary and was Transactions compatible (OMTs) with EU secondary law. government bond markets where price formation was disrted by currency redenomation risk falls with realm monetary policy and was compatible with EU law.

7 Int. J. Fancial Stud. 2017, 5, At end 2014, euro area consumer price flation fell just below zero, largely reflectg sharp fall oil prices (Figure 1). Market-based measures flation expectations over medium longer term horizons started shiftg down. These negative flation surprises came at a pot time when degree economic slack remaed sizeable and signaled risk second-round effects on wage and price formation. Furrmore, money and credit growth contued be subdued. Although some members were more positive on flation outlook over medium term, Governg Council made choice January 2015 itiate a quantitatively large expansion Eurosystem balance sheet. Focusg on assets with a strong transmission potential and available sufficient volumes mimize market price disrtions, it added public secr bonds issued by euro area central governments, recognized agencies, and European supranational stitutions APP (see (ECB 2015)). 8 Alger, Eurosystem set out buy outright a monthly amount 60 bn public and private secr securities (Figure 3), startg March 2015 and with tention contue until September 2016 and any case until a sustaed adjustment path flation was achieved back a level below, but close, 2% over medium term. The public secr purchase program (PSPP) was restricted marketable euro-denomated nomal and flation-lked bonds vestment-grade quality, with a remag maturity between two and 30 years and with yields at time purchase at least standg above ECB s deposit facility rate. The cross-country allocation monthly net asset purchases was guided by ECB s capital key. 9 To preserve market functiong, counter monetary fancg concerns and safeguard pari passu (equal) treatment with respect private credirs, tal amount public secr bond purchases was capped at 33% any given issue (after an itial limit 25%) 10 and an aggregate holdg limit 33% per issuer. 11 Moreover, Eurosystem observed a black-out period (durg which its secondary-market purchases were suspended, also for securities with neighborg maturities) allow for market price discovery around dates when new public secr bonds were issued primary market. Towards end 2015, consumer price flation euro area still sod only just above zero (Figure 1). Low flation persisted because slack economy and decle energy prices weighg on domestic price formation. However, fact that bank lendg rates were declg and private secr borrowg gared pace fered reassurg signs that exceptional monetary easg was effective. The expected economic recovery, pass-through past depreciation euro and disappearg base effect from earlier fall oil prices also signaled a pick-up annual rate future flation. Sce flation forecast neverless had be lowered and downside risks flation outlook prevailed, mostly due volatility global markets, a furr monetary expansion was still warranted. The ECB decided December 2015 cut deposit facility rate 0.3% while keepg constant two or policy rates (Figure 2). In addition, it extended period over which APP would run from September 2016 March 2017, or beyond if necessary, conditional on realizg a sustaed reversal flation a medium term level just below 2%. Moreover, it decided revest 8 The Eurosystem allocated 88% tal purchases bonds euro area governments and recognized agencies and 12% securities issued by European supranational stitutions located euro area. As from April 2016, allocation was adjusted 90% and 10%, respectively. 9 Government bonds euro area countries receivg EU/IMF fancial assistance (notably Cyprus and Greece), which did not meet mimum credit quality threshold, could benefit from a waiver, provided that ir adjustment program could be assessed as beg on track. After mid-2015, Eurosystem was able add government bonds issued by Cyprus PSPP. 10 The issue limit refers maximum share a sgle PSPP-eligible security that Eurosystem was prepared hold so as avoid havg a blockg mority case collective action clauses a bond contract would be activated an orderly debt restructurg. The origal issue limit 25% still applied for public debt securities contag a collective action clause that differs from model used by euro area governments as January 2013, unless it was confirmed that holdg 33% would not lead Eurosystem have a blockg mority. 11 The issuer limit refers maximum share a sgle issuer s outstandg securities that Eurosystem was prepared hold so as safeguard market functiong and price formation, as well as mitigate risk Eurosystem becomg a domant credir euro area governments.

8 Int. J. Fancial Stud. 2017, 5, prcipal repayments all securities bought as those matured, for as long as necessary, furr extend effective horizon APP and correspondg favorable liquidity conditions. The range eligible public secr bonds under PSPP was reby enlarged clude those issued by regional and local euro area governments. Durg first months 2016, followg turbulence global fancial markets, outlook for euro area growth and flation was aga revised down. To reforce momentum economic recovery and accelerate return flation a level consistent with price stability, ECB decided March 2016 provide anor round monetary stimulus. The margal lendg rate was reduced 0.25%, ma refancg rate put at zero and deposit facility rate set at 0.4% (Figure 2). The Governg Council expected mata ECB s terest rates at se low or even lower levels well beyond APP horizon. Moreover, it creased size its monthly net asset purchases 80 bn while raisg issuer and issue share limits for purchases securities issued by European supranational stitutions from 33% 50% ga additional flexibility implementation PSPP. In addition, it furr expanded scope APP by addg corporate bonds denomated euro and issued by non-bank corporations established euro area range eligible struments. The corporate secr purchase program (CSPP) started June 2016 and was aimed at strengng pass-through asset purchases corporate fancg conditions and credit growth. The ECB bought non-bank corporate bonds both primary and secondary markets across euro area countries conditional on yields at time purchase standg above its deposit facility rate. The program was diversified across whole universe eligible corporate securities coverg a range economic secrs outside bankg, credit ratgs at least vestment-grade and remag maturities between six months and 30 years. A black-out period was observed for public secr corporations when se issued new bonds primary market. Alongside CSPP, ECB furr enhanced its credit easg measures through a second series targeted longer term refancg operations (TLTRO II), each with a fixed terest rate at most zero and a maturity four years, be conducted every quarter from June 2016 March The conditions this longer term fundg were exceptionally favorable for banks that creased ir lendg private secr (excludg for house purchases) relative a particular benchmark. While negative terest rate applicable ECB s deposit facility effectively constituted a tax on banks holdg excess reserves, those that provided more credit economy were fered opportunity borrow from central bank at a subsidized, negative terest rate, which could be as low as deposit facility rate. This optimization ols helped avoid that costs monetary easg curred by bankg dustry would outweigh benefits. Facg a global rise long-term terest rates and seeg evidence a moderate, but firmg economic recovery, ECB aga recalibrated its non-standard measures December Sce underlyg flationary pressures stayed subdued (Figure 1), APP horizon was furr extended from March December 2017, or beyond if necessary. To mitigate a possible scarcity eligible bonds, after turn year, PSPP would also clude securities with a remag maturity one and up two years. When necessary reach tal PSPP volume for a country, purchases could also comprise those with a yield maturity below floor ECB s deposit facility rate, although this implied acceptg some costs. As from April 2017, monthly pace net asset purchases would be scaled back from 80 bn 60 bn alongside ongog revestments prcipal repayments from maturg securities bought under APP. This reduction was made contgent on furr progress wards a sustaed pick-up flation; case fancial conditions became consistent with this objective or economic outlook less favorable, Governg Council sod ready crease size and/or duration APP aga. These decisions troduced more flexibility APP and a state-contgent implementation guarantee a more sustaed presence market and a more lastg monetary transmission.

9 Council sod ready crease size and/or duration APP aga. These decisions troduced more flexibility APP and a state-contgent implementation guarantee a more sustaed presence market and a more lastg monetary transmission The Intended Effects ECB s Monetary Stimulus Int. J. Fancial Stud. 2017, 5, The comprehensive monetary stimulus measures implemented durg 2½ years from June The Intended December Effects2016 and ECB s Monetary forward Stimulus guidance a contued accommodative monetary stance have The comprehensive been strumental monetary preventg stimulus measures anor implemented economic downturn. durg 2The 1 2 years pass-through from June monetary 2014 policy December 2016euro and area forward economy guidance operated a contued as expected accommodative along three monetary mutually-supportive stance have transmission been strumental channels. preventg anor economic downturn. The pass-through monetary policy First, euro area very economy substantial operated monetary as expected easg along lowered three mutually-supportive terest rates and transmission hence price channels. credit. First, very substantial monetary easg lowered terest rates and hence price credit. The supply central bank liquidity bankg system (both through tender operations and The supply central bank liquidity bankg system (both through tender operations and outright asset purchases) and decle money market and deposit rates compressed bank outright asset purchases) and decle money market and deposit rates compressed bank fundg fundg costs. This turn created centives for banks supply new loans agast lower lendg costs. This turn created centives for banks supply new loans agast lower lendg rates rates and and easier easier credit credit conditions conditions as as creditworthess creditworthess borrowers borrowers was improvg. was improvg. Empirical studies Empirical studies showed showed that that news news non-standard non-standard monetary monetary stimulus measures stimulus from measures June 2014 from December June 2014 December 2015 significantly 2015 significantly lowered lowered bank lendg bank rates lendg fered rates fered non-fancial non-fancial firms, evenfirms, more even so more so vulnerable euro area euro countries area countries (Figure 4) (Figure and for banks 4) and withfor lessbanks capitalwith and more less non-performg capital and more non-performg loans (see (Altavilla loans (see et al. (Altavilla 2016)). et al. 2016)). Figure Figure 4. Composite 4. Composite bank bank terest terest rates ratesfor fornew loans non-fancial non-fancial corporations corporations (percentages (percentages per annum). annum). Source: Source: ECB. ECB. Latest Latest observation: December Note: The The composite cost cost bank bank lendg lendg combes combes short- short- and and long-term rates on new loans usg a 24-month movg average new new busess busess volumes volumes as as weights. The The cross-country dispersion displays mimum and and maximum range range over over a fixed a fixed sample sample euro euro area area countries. The The favorable monetary impacf this direct channel transmission was was also also evidenced by by quarterly quarterly euro euro area area bank bank lendg surveys (see (Köhler-Ulbrich et et al. al. 2016)). 2016)). Most Most banks banks on balance on balance reported reported that that negative deposit facility rate rate had had supported supported a furr a furr decrease decrease ir lendg ir rates lendg rates with with a positive a positive impact impact on lendg on lendg volumes volumes and that and y that expected y expected same impact same over impact period over ahead. More favorable fundg conditions wholesale markets and higher value collateral period ahead. More favorable fundg conditions wholesale markets and higher value posted by firms similarly translated a lower price credit fered by non-bank termediaries. collateral posted by firms similarly translated a lower price credit fered by non-bank The steady decle cost new borrowg as economic outlook became brighter furrmore termediaries. enhanced The demand steady for decle credit, whereas cost fallg new servicg borrowg costs on as outstandg economic variable-rate outlook debt became brighter expanded furrmore disposableenhanced come for borrowers. demand for credit, whereas fallg servicg costs on outstandg variable-rate debt expanded disposable come for borrowers.

10 Int. J. Fancial Stud. 2017, 5, Second, outright asset purchases targeted a reduction risk spreads terest rates. The prospect large-scale securities purchases over a long maturity spectrum, especially with regard public secr bonds, made eligible assets appear scarcer and had immediate effect removg a substantial amount credit and duration risk from economy, 12 while actual monthly purchases mostly ok out liquidity risk. The sellg counterparties (banks and non-banks) exchange received safe and readily available central bank money ir deposit accounts, which translated growg (excess) reserves held by bankg secr (Figure 3). The net risk extraction responded elevated market demand for safe and liquid assets and created centives for bank and non-bank vesrs alike shift more risky assets longer duration, cludg loans. 13 This process portfolio rebalancg generated spill-over effects across many asset markets and was an direct channel transmission through which monetary policy lowered sovereign and corporate bond yields, as well as contributed a deprecation euro exchange rate, a rise sck prices and an crease flation swap rates (Figures 5 and 6). Econometric event studies and news analyses suggest that anticipation, announcement and subsequent start PSPP significantly reduced government bond rates, notably furr along yield curve and more for vulnerable euro area countries (see (Altavilla et al. 2015; De Santis 2016)). On day announcement CSPP, yield spreads on eligible corporate bonds decled sharply and contued decle subsequent weeks. The prevailg low level fancial stress supported spill-overs or, non-eligible securities, showg how vesrs used ir improved risk-bearg capacity tegrate asset prices across targeted, as well as non-targeted market segments. Int. J. Fancial Stud. 2017, 5, Figure Figure 5. Euro 5. Euroarea area average government government bond bond yield yield curve curve (syntic (syntic yields yields percentages percentages annum per annum and and maturity maturity years). years). Source: Source: Bloomberg, Bloomberg, ECB. ECB. 12 Where short- medium-term yields decled below deposit facility rate (which, until January 2017 for maturity range one two years, made relevant sovereign bonds eligible for PSPP), ECB creased duration public secr bond purchases, which furr compressed term premia at longer horizons. 13 Adrian and Liang (2014), Dell Ariccia et al. (2016) and IMF (2016) review risk-takg channel monetary policy.

11 Int. J. Fancial Figure Stud. 5. Euro 2017, area 5, 12average government bond yield curve (syntic yields percentages per annum and maturity years). Source: Bloomberg, ECB. Figure Figure Asset Asset price price changes changes and and impact impact ECB ECB monetary monetary easg easg (changes (changes basis basis pots pots for bond for yields, bond yields, percent percent for exchange for exchange rates andrates sck and prices). sck Source: prices). Bloomberg, Source: Bloomberg, ECB calculations. ECB calculations. Note: The impact Note: The monetary impact easg monetary measures easg frommeasures June 2014from March June is estimated March 2016 withis econometric estimated with event studies, econometric newsevent analyses studies, and model-based news analyses counterfactual and model-based exercises counterfactual with a focusexercises on announcement with a focus effects. on See announcement also (Altavilla effects. et al. See 2015) also and (Altavilla (De Santis et al. 2016). 2015) EA, and DE, (De Santis FR, IT2016). and ES EA, = Euro DE, FR, Area, IT and Germany, ES = France, Euro Area, Italy and Germany, Spa, France, respectively; Italy NFC and Spa, = non-fancial respectively; corporations; NFC = non-fancial USD/EUR = corporations; nomal euro exchange USD/EUR rate = nomal U.S. euro dollar; exchange NEER rate = nomal U.S. effective dollar; exchange NEER = nomal rate effective euro; Euro exchange Sxx rate = Dow Jones euro; Euro Euro Sxx Sxx (broad) = Dow dex. Jones Euro Sxx (broad) dex. Third, two types forward guidance signaled that monetary stance would rema The broad-based asset price creases furrmore strengned capital position credit accommodative for as long as necessary deliver price stability. The Governg Council signaled termediaries, reduced ir leverage constrats and creased ir ability lend, whereas that ECB s key terest rates would rema low or could be even lower for an extended period higher collateral values enlarged capacity ir cusmers borrow and lowered cost time, well past APP horizon. In addition, it made tended net asset purchases under capital general. An important advantage steady narrowg risk spreads was also that APP conditional on realizg a sustaed adjustment path flation, later addg that it earlier cross-country differences terms access credit and cost capital and hence fancial could crease ir size and/or duration if economic outlook became less favorable or fancial fragmentation Eurozone dimished considerably (Figure 4). The macroeconomic impact this conditions tightened aga. quantitative monetary easg was estimated be broadly similar that a standard reduction policy rate by at least one percentage pot (see (Andrade et al. 2016)). Third, two types forward guidance signaled that monetary stance would rema accommodative for as long as necessary deliver price stability. The Governg Council signaled that ECB s key terest rates would rema low or could be even lower for an extended period time, well past APP horizon. In addition, it made tended net asset purchases under APP conditional on realizg a sustaed adjustment path flation, later addg that it could crease ir size and/or duration if economic outlook became less favorable or fancial conditions tightened aga. This signalg channel anchored longer term flation expectations, which orwise could have drifted furr below level consistent with ECB s defition price stability, as shown by counterfactual model simulations (Coenen and Schmidt 2016). Evidence from private secr surveys confirmed that expansion APP with public secr bonds was perceived as a sign easier monetary policy and generated expectations higher output growth and flation up two years ahead. The improved short-term flation outlook also contributed a re-anchorg longer term flation expectations (Andrade et al. 2016). More generally, by signalg higher expected flation, ECB promoted a reduction level real terest rates, which eased fancial conditions and supported asset valuations. The strengng busess sentiment and household confidence this context creased private centives spend rar than save while wearg a number adverse global shocks from seriously hurtg euro area economy.

12 easier monetary policy and generated expectations higher output growth and flation up two years ahead. The improved short-term flation outlook also contributed a re-anchorg longer term flation expectations (Andrade et al. 2016). More generally, by signalg higher expected flation, ECB promoted a reduction level real terest rates, which eased fancial Int. conditions J. Fancialand Stud. supported 2017, 5, 12 asset valuations. The strengng busess sentiment and household confidence this context creased private centives spend rar than save while wearg a number adverse global shocks from seriously hurtg euro area economy. Overall, Overall, transmission transmission monetary monetary easg easg measures measures worked worked broadly broadly as tended. as tended. The The monetary monetary stimulus stimulus helped helped spur spur a turnaround a turnaround volume volume bank bank lendg lendg non-fancial non-fancial private private secr secr from from a contraction contraction at at an an annual annual rate rate 1.75% 1.75% early early a modest modest expansion expansion at at an an annual annual rate rate about about 2.0% 2.0% late late The The recovery recovery bank bank borrowg borrowg was was broad-based, broad-based, coverg coverg both both households households and and non-fancial non-fancial firms firms (Figure (Figure 7) and 7) and extended extended all euro all area euro countries. area countries. The access The access bank loans bank at loans more at favorable more favorable borrowg borrowg conditions conditions moreover moreover improved improved for large, for as large, well as as well for smallas for and smallmedium-sized and medium-sized firms, as firms, also confirmed as also confirmed by half-yearly by half-yearly euro area euro survey area on survey access on fance access for fance enterprises. for enterprises. Meanwhile, Meanwhile, supported supported by monetary by monetary impact impact central bank central liquidity bank jections, liquidity jections, annual growth annual rate growth rate broad monetary broad monetary aggregate aggregate M3 rose steadily M3 rose and steadily stabilized and between stabilized 4.5% between and 5% 4.5% (Figure and 7), 5% ferg (Figure ample 7), ferg scope ample for output scope growth for output and flation growth rates and flation rise more rates satisfacry rise more longer satisfacry term levels longer without term skg levels without exuberant skg asset exuberant price creases. asset price creases. Accordg Accordg macroeconomic macroeconomic model model calculations calculations undertaken undertaken by by Eurosystem Eurosystem staff, staff, tal tal monetary monetary stimulus stimulus provided provided up up mid-2016 mid-2016 was was projected projected add add some some percentage percentage pots pots real real GDP GDP growth growth euro area euro when area cumulated when cumulated over over period 2015 period The decle The decle consumer consumer price flation price flation below zero was below halted zero was 2015, halted and annual 2015, and rate flation annual rate was forecast flation be was on forecast average at least be on 0.5 average percentage at least pot 0.5 higher percentage both pot 2016 higher and 2017 than both without 2016 and 2017 monetary than without easg. These monetary empirical easg. estimates These dicated empirical a significant estimates dicated monetary a boost significant monetary euro area economy. boost Market euro area formation economy. confirmed Market formation that by end-2016, confirmed that risk by end-2016, deflation had risk largely deflation disappeared. had largely This disappeared. translated a This steepeng translated a sovereign steepeng yield curve, sovereign also under yield curve, fluence also under global fluence trends and global adjustments trends and made adjustments APP made December APP December Figure 7. Broad monetary aggregate M3 and bank lendg non-fancial private secr (annual Figure 7. Broad monetary aggregate M3 and bank lendg non-fancial private secr (annual percentage changes). Source: ECB. Latest observation: December Note: Bank loans are adjusted percentage changes). Source: ECB. Latest observation: December Note: Bank loans are adjusted for loan sales, securitization and notional cash poolg. for loan sales, securitization and notional cash poolg. 3. Untended Side-Effects a Protracted Period Ultra-Low Interest Rates 3.1. Worries about Fancial Intermediation, Fancial Stability and Market Disciple To provide a meangful monetary impulse, several central banks cludg ECB have resorted negative policy rates and quantitative easg order push down sovereign yield curve ultra-low levels and even negative terriry at short- medium-term horizons. This extraordary constellation terest rates gave rise a number concerns about potential adverse side-effects

13 Int. J. Fancial Stud. 2017, 5, se unconventional monetary policies, particular for fancial termediation, fancial stability and market disciple. First, as stressed by McAndrews (2015), re are questions about central banks ability push and susta policy rate below zero, sce this unusual move may hamper functiong fancial markets, compress earngs fancial termediaries, constra monetary transmission and dampen ultimate economic impact monetary easg. The impact a monetary stimulus this kd could even reverse a contraction, suggestg that re is an economic lower bound for negative terest rates (Cœuré 2016). A second concern for central banks is associated with what Cecchetti (2016, p. 160) calls dark side monetary policy accommodation. The jection central bank liquidity engeer a very low nomal and real cost borrowg encourages fancial termediaries search for yield more risky markets. An abundant supply cheap credit and a reduced screeng borrowers could enable economic agents accumulate an unsustaable sck debt, which could fuel excess consumption and low-return vestments. Although easg fancial conditions overcomes credit rationg and is key liftg output growth and flation, risks from overextended private secr leverage for fancial stability and adverse effects misallocated credit for productivity growth weigh more heavily longer central bank matas its ultra-easy monetary stance (see also (Adrian and Liang 2014; Borio and Zabai 2016; White 2016)). Third, central bank purchases government bonds terfere with public debt management and raise complicated coordation issues with fiscal policy (Hoogdu and Wierts 2012). The concern is that quantitative easg disrts price signals along entire sovereign yield curve and weakens market centives for governments pursue sound public fances and progress with structural reforms. Although favorable net wealth effects broad-based repricg assets support private spendg, distributional implications unconventional monetary policies are significant and may underme public support for central bank dependence (see (De Haan and Eijffger 2016)). The followg sub-sections review euro area relevance se untended side-effects focusg on six issues: functiong fancial markets, come and wealth position households, pritability bankg dustry, challenge for stitutional vesrs, private secr s attitude wards risk and centives for governments mata fiscal disciple The Functiong Fancial Markets The first question that comes up when a central bank policy rate reaches zero bound is wher and how this low level will transmit fancial markets. Lack experience made monetary authorities hesitant uch zero, let alone pursue a negative terest rate as a feasible policy option (McAndrews 2015). Money market funds that promise a constant rar than variable net asset value are subject contractual obligations that assume a positive return. When y cannot deliver se returns, ir clients will run away, and ir existence is endangered. Their operational difficulties turn could hamper a proper functiong money markets. Furrmore, fancial contracts may have be amended allow for unusual situation credirs makg terest payments debrs rar than or way round. In addition, market frastructures and computer systems may have be adapted allow for it. Even when transient, legal and technical costs put up a barrier. As a result, zero lower bound on nomal terest rates was traditionally perceived as absolute floor for central banks. With short-term terest rate expectations truncated at zero, markets could only expect policy rates go up, and this translated an upward slopg forward yield curve. The ECB broke through zero le with its deposit facility rate and was able steer euro overnight terest rate wards a mildly negative level (Figure 2). The anchorg short-term terest rate expectations below zero not only drove down forward yield curve, but also triggered a flatteng. Rostagno et al. (2016) pot out that removg non-negativity constrat on future expected short-term rates rehabilitated standard ability monetary policy and forward guidance

14 Int. J. Fancial Stud. 2017, 5, fluence term structure a low terest rate world, at least up pot effective lower bound, exact position which was left open. Sce markets will try guess how much furr down central bank may want go, lower bound itself could be terpreted as a monetary policy parameter (see (Lemke and Vladu 2016)). As reported by Bech and Malkhozov (2016), negative terest rate on ECB s deposit facility smoothly transmitted money market and was accompanied by recedg cross-country spreads overnight rates. Money market functiong was affected different ways. Tradg activity was reduced somewhat as market participants tried avoid negative terest rate by movg struments with longer maturities, also driven by growg excess reserves and regulary demands placed on banks. Money market funds found a contractual solution deal with fallg return on ir net assets and experienced net flows, for example from large corporates that faced negative rates on ir overnight bank deposits. Banks ferg variable-rate mortgages (calculated as a small surcharge on money market rate) were a few cases forced apply contractual terms and had pay ir borrowers negative terest rate. From an operational pot view, however, re were no major obstacles applyg a negative deposit facility rate. Considerg capital markets, PSPP compressed sovereign bond yields ultra-low levels such that for short- medium-term maturities, y fell below zero (Figure 5). High-rated sovereign bonds even recorded negative yields on long-term bonds as term premia became negative. 14 Sce all vestment-grade public secr bonds member countries were eligible, start PSPP reduced sovereign credit risk and contributed a significant narrowg terest rate spreads relative German bund notably for longer durations (see (Altavilla et al. 2015; De Santis 2016)). The contuous presence Eurosystem as a buyer secondary market also compressed liquidity risk premia sovereign bond yields. Or than that, Eurosystem tried preserve market functiong and smooth price discovery by mostly carryg out a large number small-scale purchases on a daily basis, actg as a margal buyer and takg account tradg liquidity and market activity. Later on, a growg number market acrs had difficulty raisg secured short-term funds because steady flow PSPP purchases, as well as regulary requirements favorg high-quality liquid assets reduced remag pool sovereign bonds traditionally used as collateral repurchase agreements. Towards end 2016, some short-term government bond yields dropped well below ECB s deposit facility rate response this growg scarcity. The ECB and some national central banks refore made ir acquired government bonds available terested counterparties for securities lendg, also acceptg cash as collateral, order support bond and repo market liquidity and collateral availability. Also private secr securities bought under CBPP3 and CSPP were made available for securities lendg The Income and Wealth Position Households Borio and Zabai (2016) observe that positive terest rates are deeply rooted society reflectg fundamental role money as an unremunerated benchmark asset that serves as unit account economy. Given ir positive time preference, households expect receive a positive terest rate on ir savg deposits as compensation for postpong consumption from present future. A zero terest rate on savg deposits is regarded as unnatural and negative rates are seen as an unfair tax; even when corrected for low (expected) flation, negative real return y get may be well with normal boundaries given state economy. Moreover, ultra-low terest rates and attendant capital gas on fancial assets are generally perceived as leadg a redistribution come and wealth from savers borrowers or from poor rich without democratic legitimation. 14 Trade data show that mid-2016, wake safe-haven flows after Brexit referendum, a record 55% 7.3 trillion sck outstandg euro area government bonds recorded negative market yields.

15 Int. J. Fancial Stud. 2017, 5, The ma le defense available households avoid a punitive negative terest rate on ir registered savg accounts is convert m cash, a bearer strument, which fers not only convenience immediate payment services, but also anonymity. Given costs transport, srage and surance related hoardg a substantial amount currency and time savers have vest order handle cash, effective lower borderle for deposit rates may be slightly below zero before y would contemplate such a move (see (Cœuré 2016)). Given even larger amounts volved, threshold would be somewhat lower for large firms that want protect cash flow on ir bank accounts. An even lower limit likely applies countries where domant role currency retail payments has already been overtaken by aumated systems, as Sweden. However, accumulated negative returns a prolonged period below-zero terest rates may just tip balance between costs and benefits ward holdg more cash than deposits. Furrmore, banks might n keep part ir reserves form vault cash directly settle ir money market transactions with or banks stead usg a central bank account. Over time, market might develop necessary banknote warehousg services. A surge demand for banknotes escape (risk ) negative bank deposit rates was at least up end-2016 not visible Eurozone. Yet, member countries placg a legal limit on amount cash that ir citizens can carry, order prevent tax evasion, met with criticism. Similarly, ECB received some negative reactions on its decision discontue production 500 euro banknote and sp its issuance around end 2018, although it will always rema legal tender. The decision addressed concerns that this euro banknote with highest denomation could facilitate illicit activities. There was however no tention impose a carry tax on cash, abolish currency or troduce a depreciatg exchange rate banknotes relative electronic money bank accounts, as has been suggested academic literature as a way overcome zero lower bound on nomal terest rates (see for example (Buiter 2009; Kimball 2015)). The distributional effects monetary policy are wide-rangg and work through both fancial and macroeconomic channels (see (Deutsche Bundesbank 2016) and (Draghi 2016)). Savers are affected ir position as retail deposit holders, as owners bonds, shares and residential property, as well as ir function as employee and taxpayer. Concerng fancial come, euro area households on balance have seen ir terest earngs (as a share ir disposable come) decle markedly sce 2008 (see (Rostagno et al. 2016)). While this triggered a debate on apparent expropriation saver (Bdseil et al. 2015), on average, terest come households remaed positive and contued exceed debt terest payments, although balance between two was negative for euro area countries where mortgage debt was particularly high. Estimates suggest that additional monetary easg sce June 2014 on average created positive net wealth effects for all wealth groups, sce both bond prices and house prices rose until mid-2016, while equity values fell somewhat. The net benefits were neverless larger for richer households than for families without savgs form security holdgs. The distributional effects ultra-low terest rates can also be found on macroeconomic side. The monetary expansion helped improve corporate pritability and supported job creation. The brighter labor market situation reduced risk unemployment above all for low-skilled, poorer households and supported ir future come. These were also liquidity-constraed households with a relatively high margal propensity consume. Fally, fight agast o low flation countered an arbitrary redistribution wealth between generations, sce unexpected deflation would raise real value debt and young were net debrs, whereas old were net credirs The Pritability Bankg Industry A key concern with a negative terest rate policy and quantitative easg is that it could hurt health bankg secr with adverse consequences for monetary transmission. The flatteng yield curve implies a narrowg spread between (short-term) borrowg and (longer term) lendg rates and hence reduces fancial come from maturity transformation. At zero lower bound,

16 3.4. The Pritability Bankg Industry A key concern with a negative terest rate policy and quantitative easg is that it could hurt health bankg secr with adverse consequences for monetary transmission. The Int. J. Fancial Stud. 2017, 5, flatteng yield curve implies a narrowg spread between (short-term) borrowg and (longer term) lendg rates and hence reduces fancial come from maturity transformation. At banks zero are constraed lower bound, furr banks lowerg are constraed cost deposit furr fundg, lowerg whereas cost fierce competition deposit fundg, forces m whereas follow fierce competition markets reducg forces m rar than follow raisg markets lendg reducg rates an rar effort than fset raisg lower lendg net terest rates rate an effort margs fset by larger lower loan net volumes. terest rate A negative margs rate by larger remuneration loan volumes. on excess A negative reserves rate held by remuneration bankgon secr excess andreserves attractiveheld low by corporate bankg bond market secr rates and attractive engeeredlow by corporate centralbond bank could market also rates move engeered credit busess by for central largebank firmscould awayalso frommove bankscredit wards busess non-banks for large especially firms when away from latter banks are subject wards non-banks less tight regulation. especially Moreover, when outright latter are purchases subject public less tight secregulation. securities could Moreover, be subject outright dimishg purchases returns, public makg secr securities boost could value be subject bank asset dimishg holdgs dissipate returns, over makg time. boost value bank asset holdgs dissipate over time. As expected, bankg dustry was reluctant pass on negative money market rates retail deposit rates rates (apart (apart from from some some isolated isolated cases; see cases; Figure see 8). Figure Especially 8). banks Especially with abanks deposit-based with a fundg deposit-based structure fundg could not structure afford hurtg could not relationship afford hurtg with ir clients; relationship although with larger ir companies clients; and although stitutional larger companies vesrs were and stitutional confronted with vesrs slightly were negative confronted rates with on ir slightly banknegative accountsrates and retail on ir clients bank with accounts higherand transaction retail clients fees. with Moreover, higher transaction APP creased fees. Moreover, amount excess APP creased reserves charged amount with aexcess negative reserves deposit charged facility with rate, a negative which deposit bankg facility secr rate, as awhich whole had bankg hold, secr and also as a whole lowered had bond hold, yields and andalso tilted lowered term bond structure yields down. and tilted In addition, term structure conditional down. nature In addition, TLTRO conditional operations nature spurred competition TLTRO operations bank lendg. spurred Thesecompetition circumstances weighed bank lendg. on bankthese prit margs circumstances and weighed centives on bank for origatg prit margs new loans. and 15 centives for origatg new loans. 15 Figure 8. Distribution deposit rates rates for for non-fancial corporations and and households across across euro euro area banks area banks (x-axis: (x-axis: deposit deposit rates rates percentages percentages annum; per y-axis: annum; frequencies y-axis: frequencies percentages). percentages). Source: ECB. Observations Source: ECB. Observations refer Ocber refer Ocber Note: Deposit Note: rates Deposit on newrates busess on new as busess reportedas byreported dividual by banks. dividual Thebanks. dottedthe lesdotted show les weighted show averages weighted averages deposit rates. deposit rates. The ECB modulated composition and and design design monetary monetary easg easg measures measures over over time, time, ter alia ter alia avoid avoid that that negative negative terest terest rate would rate would turn turn from from a taxa on tax hoardg on hoardg excess excess reserves reserves a tax on fancial termediation (Rostagno et al. 2016). The exceptional monetary easg reduced cost bank fundg wholesale markets (especially previous crisis-hit countries), and 15 Some or European central banks and Bank Japan also set a negative terest rate on reserves, but ECB fered conditional four-year liquidity its second program longer term refancg mitigated impact on bank prits by applyg it only margal reserves as part a tiered system. The operations (TLTRO II) at a zero terest rate or with a subsidy for banks exceedg ir credit ECB refraed from this option because it was vital for policy rates pass through both fancial markets and bank cusmers. 15 Some or European central banks and Bank Japan also set a negative terest rate on reserves, but mitigated impact on bank prits by applyg it only margal reserves as part a tiered system. The ECB refraed from this option because it was vital for policy rates pass through both fancial markets and bank cusmers.

17 Int. J. Fancial Stud. 2017, 5, a tax on fancial termediation (Rostagno et al. 2016). The exceptional monetary easg Int. reduced J. Fancial Stud. cost 2017, 5, bank 12 fundg wholesale markets (especially previous crisis-hit countries), and ECB fered conditional four-year liquidity its second program longer term refancg operations (TLTRO II) at a zero terest rate or with a subsidy for banks exceedg ir growth credit growth benchmarks. benchmarks. As evidenced As evidenced by by euro area euro bank area lendg bank lendg survey survey July 2016, July most 2016, banks most acknowledged banks acknowledged that that TLTRO TLTRO II (as implemented II (as implemented from June from 2016) June fered 2016) fered a significant a significant boost boost ir pritability ir pritability (see (Köhler-Ulbrich (see (Köhler-Ulbrich et al. 2016)). et The al. 2016)). steepeng The steepeng yield curve yield latecurve 2016 also late relieved 2016 some also relieved stras some on bank stras terest on bank margs. terest margs. Those banks that ok opportunity APP sell ir eligible public secr assets Eurosystem also enjoyed significant capital capital gas. gas. The The subsequent subsequent decle decle longer longer term term terest terest rates and rates and general general rise asset rise prices asset prices vesrs as rearranged vesrs rearranged ir portfolios ir provided portfolios furr provided capital furr relief, especially capital relief, banks especially holdg abanks large portfolio holdg a large government portfolio bonds, government as reported by bonds, Andrade as reported et al. (2016). by The Andrade expansion et al. (2016). range The expansion eligible public range secr bonds eligible andpublic clusion secr bonds corporate and bonds clusion created additional corporate positive bonds created valuationadditional effects duepositive APP valuation and furr effects strengned due APP capital and position furr banks strengned owng se capital assets. position banks owng se assets. Furrmore, general easg fancg conditions and and favorable favorable net wealth net wealth effects effects from higher from higher asset prices asset prices improved improved economic economic outlook outlook and and demand demand for loans for from loans from private private secr, enablg secr, enablg bankg bankg secr secr expand its expand creditits busess. credit busess. Moreover, Moreover, higher collateral higher values collateral improved values improved debt affordability debt affordability borrowers and borrowers allowed many and allowed banks many reducebanks provisions reduce for non-performg provisions loans. non-performg Even whenloans. bank lendg Even when rates decled bank lendg and termediation rates decled margs and narrowed, termediation re was margs thus ample narrowed, scope re for banks was thus crease ample scope ir tal for banks prits. On crease aggregate, ir tal euro prits. areaon bankg aggregate, dustry was euro still area able bankg improve dustry itswas pritability still able improve 2015 (Figure its pritability 9), although 2015 data (Figure for first 9), although part 2016 data were for mixed. first part As markets 2016 assessed were mixed. near-term As markets outlook assessed for bankg near-term dustry outlook for be lessbankg benign, also dustry because be less non-performg benign, also loans because and structural non-performg overcapacity, loans bank and equity structural prices overcapacity, underperformed bank equity first prices half underperformed Later year, first half when economic Later outlook year, became when brighter, economic bank outlook share prices became staged brighter, a relatively bank share strong prices recovery. staged a relatively strong recovery. Figure 9. Change net come euro area significant bankg groups (decomposition change net come between 2014 and 2015 billions euro). Source: SNL Fancial and ECB calculations. Note: Based on data for a sample 83 euro area significant bankg groups The Challenge for Institutional Invesrs Not only banks, but also stitutional vesrs face difficulties an ultra-low terest rate environment. Life surance companies and pension funds will see value ir liabilities rise when y have discount m at a low, market-related terest rate, whereas valuation gas on ir assets are dependent on type strument. Life surers with a legacy liabilities ferg a relatively high long-term guaranteed return require a steady positive come flow on ir

18 Int. J. Fancial Stud. 2017, 5, vestments. Yet, return on ir maturg fixed-come struments will decle as se get rolled over at much lower coupons. A prolonged period much lower than expected yields could mean creasg fundg shortfalls and constitute a growg solvency threat. Pension funds with defed benefit schemes face a similar fundg challenge, particular those with a maturity mismatch between (medium-term) assets and (long-term) liabilities. While equity returns and capital gas should fer some compensation, this may not be enough provide for promised future pension and surance pay-outs when se are fixed nomal terms (see (McAndrews 2015)). Supervisors concerned with solvency implications ultra-low terest rates will exercise pressure on less capitalized stitutional vesrs raise pension contribution rates paid by employers and employees, collect higher surance premiums from ir clients or cut future entitlements so as cover gap between assets and discounted liabilities. In addition, y will urge those stitutional vesrs ferg guaranteed products transfer a larger share vestment risks pension plan members and surance policy holders. The subsequent crease mandary or personal retirement savgs followg this supervisory pressure shows that for some parts population, protracted low terest rates can also have opposite effect stimulatg domestic demand. Given growg importance stitutional vesrs for capital market fancg euro area, ir response changes economic and fancial environment is creasg relevance when analyzg propagation monetary impulses (ECB 2016a). On one hand, decle very low terest rates raised demand for higher-yieldg products fered by surance corporations and pension funds. This has allowed m play a greater role as fancial termediaries providg household mortgages or fundg firms that were returng capital markets. On or hand, national supervisors urged stitutional vesrs ir jurisdiction address ir regulary asset shortages or improve ir long-term pritability. Several occupational pension funds raised pension contribution rates so as avoid havg cut nomal pension entitlements (after havg suspended flation correction already for several years). Governments lowered guaranteed rate return on new life surance policies. Life surers also creasgly aimed at sellg more unit-lked products, return on which is directly lked performance fancial markets (see (ECB 2016b; ESRB 2016a)). Meanwhile, steepeng yield curve late 2016 reduced some pressure on stitutional vesrs The Private Secr s Attitude wards Risk Persistently negative nomal and/or real terest rates could encourage private secr build-up excess leverage and reach for higher returns more risky and less liquid assets. This endogenous risk assumption exposes private agents abrupt asset repricg and higher market volatility which, if ir risk-bearg capacity is weak, constitutes a danger for fancial stability (ESRB 2016a). Low or negative yield levels also hamper ability market participants accurately price risk sce y make standard net present value calculations less formative. This could lead disrtions vestment decisions and a misallocation savgs (ECB 2016b). A decle return on ir assets could push banks, particular those that are weakly capitalized, wards expandg ir balance sheets while acceptg excessive risk exposures. On liabilities side, y could crease share more volatile short-term market fundg relative stable deposits. On assets side, growg competition from with bankg dustry, as well as from non-banks may spur undercapitalized banks fer overly generous terest rate conditions and repayment terms order attract more lendg busess. Bettg for resurrection, y might shift ir credit portfolio especially wards low-quality borrowers who would normally not pass screeng process. The low terest rate environment may also prompt stitutional vesrs and asset managers take on more leverage and adjust composition ir portfolios wards higher yieldg, but more speculative categories vestment, with possible negative consequences for fancial stability. Non-fancial corporations could use opportunity very low cost capital acquire cheap

19 Int. J. Fancial Stud. 2017, 5, funds for high-risk vestment projects, which orwise would not have passed hurdle rate return. Although retail savers tend be rar conservative vesrs, a prolonged squeeze ir (after-tax) terest come could motivate m shift ir savg deposits wards potentially more lucrative destations. The general risk-on attitude could trigger a boom demand for housg, commercial real estate, low-quality capital goods, high-yield bonds, sub-prime equity and exotic securities, and drive up a wide array asset prices unsustaable levels. The overall effect, if not countered by tighter monetary policy and/or supervisory tervention, might be a more risk-prone fancial structure and a less productive capital sck, waitg for a sudden shift market sentiment or disappotg prits trigger a bust asset prices. Considerg euro area, many fancial stitutions have assumed more credit and duration risk and bought less liquid assets as y searched for more attractive returns an environment very low terest rates. The securities holdgs statistics for euro area show that vestment funds particular creased duration ir portfolios. Euro area surers and a lesser extent pension funds shifted ir assets more wards non-euro area government bonds, corporate bonds with lower credit ratgs and illiquid assets, such as property and frastructure (see (ECB 2016b)). Euro area banks with a deposit-based fundg structure faced downward pressure on ir net worth, because y were reluctant pass negative market terest rates on ir deposirs and still lowered ir lendg rates. Especially those with a smaller equity buffer responded by concentratg ir lendg busess on new risky borrowers, who used this credit crease vestment (see (Heider et al. 2017)). These high-deposit banks, compared low-deposit banks, extended more syndicated loans (which represent only a small fraction tal bank lendg) credit-constraed risky firms without chargg higher loan spreads, demandg more collateral or settg stricter loan conditions fset attendant extra credit risks. Accordgly, average quality ir syndicated loan portfolios deteriorated. By contrast, banks relyg more on market fundg and less on deposits gave more syndicated loans safer borrowers. Poorly capitalized banks might also be willg roll-over non-performg loans at very low terest rates and relatively favorable terms and conditions so as avoid havg record losses. (Acharya et al. 2016) fd evidence for this ever-greeng non-productive companies euro area, which implied a misallocation credit detriment more productive high-quality borrowers. After onset CSPP, non-bank corporations issug eligible vestment-grade bonds saw a strong decle yield spreads and ok opportunity issue more debt securities. A broadly similar spread contraction relative startg level was observed for bank bonds and junk bonds, even though se were eligible for CSPP, dicatg impact portfolio substitution. Accordgly, a wide range firms benefited from lower costs capital market fundg. Yet, this fdg also dicated that more risky firms gaed access market credit at lower costs than orwise. Their relatively strong debt issuance as bond yields decled over past few years suggested that less productive companies may have been able survive contested markets, despite realizg a lower return on ir assets than ir more pritable competirs. As regards asset price flation euro area, share prices (except for banks) and especially bond prices broke earlier record levels wake ECB s reforced monetary easg (Figure 6). Housg and commercial property markets some euro area countries showed relatively strong upward price dynamics specific regions and segments (also reflectg local facrs), which could yet quickly spread out or areas. The positive net wealth effects from higher asset prices could evaporate once terest rates reversed course. This exposure risg terest rates entailed risks for fancial stability (see (ECB 2016b; ESRB 2016a)). These concerns were mitigated by ongog gradual decrease ratio household debt disposable come sce 2013 while leverage ratio non-fancial corporations already recorded a decle between 2009 and 2014 and has sce been fairly constant. The more resilient balance sheets households and firms underpned

20 Int. J. Fancial Stud. 2017, 5, sustaability private consumption and vestment as ma drivers economic expansion euro area Public Debt and Fiscal Disciple Monetary policy terventions aimed at keepg terest rates low for a prolonged period stimulate not only debt-fanced private demand, but also borrowg for public spendg despite already high public debt--gdp ratios. Large-scale central bank purchases public secr bonds cocide with a strong private secr terest keepg m as safe and liquid assets, also for regulary purposes. With many price-sensitive buyers sovereign bond markets, who ger push yields down, governments generally face less market disciple and fact are given an centive accumulate more debt and postpone structural reforms ir economies. Moreover, a part terest payments is accrued by central bank and will return state form seigniorage payments (unless se prits are added reserves). The lower debt service costs and higher seigniorage come that governments enjoy, give a flatterg picture public debt sustaability (Hannoun 2015). When monetary policy goes reverse, governments will have refance a larger sck public debt at higher terest rates. The central bank curs valuation losses on its government bond portfolio, and it may have cut back its seigniorage payments (dependg on applicable accountg and provisiong rules). Fancial stitutions are also confronted with a rapid decle value ir government bond holdgs and thus a lower net worth, which could scare f vesrs and precipitate a fall ir bond and share prices. The government may even be obliged ject capital troubled banks. Under se circumstances, central bank could come under pressure from politicians prolong its public secr bond purchases and/or cap rise capital market rates, makg it creasgly difficult arrange an exit from unconventional monetary policy (Borio 2014). Havg mata an outsized balance sheet would expose central bank fancial risks and threaten its credibility as an dependent stitution (De Haan and Eijffger 2016). Forward-lookg public debt managers will aim reduce roll-over risk by issug relatively more long-term bonds at exceptionally low terest rates. This additional supply directly counters objective central bank s outright purchases flatten sovereign yield curve, showg how monetary policy and public debt management become tertwed (Hoogdu and Wierts 2012). To deal with this situation, Greenwood et al. (2014) argue that monetary and fiscal authorities should coordate ir bond market operations or that governments should abandon traditional prciples prudent fancg and issue more short-term treasury bills. Euro area governments have enjoyed a rapid decle margal cost capital market fundg sce mid-2012 and particular sce onset PSPP. Most governments were able issue debt at negative market rates for maturities up five years, and for core countries, negative bond yields covered horizons at least up ten years (see also Figure 5). The significance this fiscal space was visible a steadily declg euro area average nomal terest rate paid over outstandg sck debt securities (from 3.3% May % December 2016), as well as for new issuance over most recent 12 months (from 1.1% May % December 2016, with Germany, France and Nerlands reachg yields on newly-issued debt securities close 0% or below; see Figure 10). Moreover, Eurosystem received terest on its growg sck public and private secr bonds, which allowed extra seigniorage payments by national central banks ir governments unless se prits were added reserves. More generally, monetary stimulus supported nomal GDP growth and reduced unemployment rates, which furr improved public fances by lowerg primary expenditure and boostg tax revenues. The EU fiscal rules Stability and Growth Pact (SGP) focus on structural budget balance, and steadily fallg terest bill for euro area countries thus prciple facilitated a faster reduction structural overall deficit and public debt--gdp ratios. The SGP also constras government spendg growth excess trend GDP growth, that is without takg changes terest payments and cyclical unemployment benefits consideration. The euro area countries that still had meet

21 Int. J. Fancial Stud. 2017, 5, terest payments and cyclical unemployment benefits consideration. The euro area countries ir that still objective had ameet broadly ir balanced objective budget a over broadly medium-term balanced budget could over refore medium-term not use savgs could from refore lower not terest use costs savgs and fallg from lower unemployment terest costs ratesand as anfallg argument unemployment for steppgrates up public as an spendg. argument Several for steppg fiscalup policymakers public spendg. neverless Several decided fiscal policymakers slow downneverless or reverse decided pace deficit slow reduction. down or reverse The steady pace demand deficit from ir reduction. national The central steady bank demand for national from ir sovereign national bonds central facilitated bank public for national debt issuance sovereign andbonds may have facilitated weakened public fiscal debt disciple. issuance Ensurg and may compliance have weakened with EU fiscal fiscal rules disciple. paramount Ensurg compliance importance with guarantee EU fiscal rules sound is public paramount fancesimportance EMU, but guarantee gas evensound more significance public fances when EMU, national but gas central even banks more assume significance a largewhen quantity national credit risk central related banks ir assume owna governments large quantity on ir credit balance risk related sheets as part ir own quantitative governments easgon operations ir balance that sheets aim safeguard as part price quantitative stability. easg operations that aim safeguard price stability. Meanwhile, national national public public debt debt managers managers ok ok chance chance frontload frontload ir borrowg ir borrowg programs and programs lengn and lengn average maturity average maturity outstandg outstandg debt sodebt as so entrench as entrench hisrically hisrically low long-term low long-term terest terest rates. rates. Pritg Pritg from afrom large a vesr large vesr demand, demand, several euro several areaeuro countries area were countries able were issue able or place issue 50-year or place bonds 50-year (Belgium, bonds (Belgium, France, Italy France, anditaly Spa), and 70-year Spa), bonds 70-year (Austria) bonds (Austria) or even century or even bonds century (Belgium, bonds (Belgium, Ireland) Ireland) For2016. all euro For area all euro countries area countries ger, ger, average residual average residual maturity maturity outstandg outstandg amount amount government government debt securities debt securities creased creased from 6.4 years from 6.4 May years 2014 May years 6.9 December years December As a2016. consequence, As a consequence, public debt public management debt management strategies creased strategies creased supply duration supply risk duration for vesrs risk at for a time vesrs whenat a ECB time sought when extract ECB it sought through its extract PSPP. it Andrade through etits al. PSPP. (2016) Andrade exame et changg al. (2016) debt exame maturity structure changg durg debt maturity 2015 and structure conclude that durg despite 2015 and risg conclude average that maturity despite newly-issued risg average public maturity debt (net newly-issued redemptions), public debt PSPP(net on balance redemptions), still managed PSPP extract on balance a significant still managed amount extract duration a significant risk from amount economy. duration Givenrisk stitutional from economy. setup Given EMU, stitutional explicit coordation setup EMU, national explicit public coordation debt managers national with public ECB could debt managers not take place. with ECB could not take place. Figure 10. Government debt securities issued by euro area governments, average yield (x-axis: yield Figure 10. Government debt securities issued by euro area governments, average yield (x-axis: yield on debt securities issued over last 12 months December 2016 compared May 2014; y-axis: on debt securities issued over last 12 months December 2016 compared May 2014; y-axis: yield on sck debt securities December 2016 compared May 2014; percentages per yield on sck debt securities December 2016 compared May 2014; percentages per annum). annum). Source: ECB. Note: National data exclude Greece, Cyprus, Esnia and Luxembourg. The Source: ECB. Note: National data exclude Greece, Cyprus, Esnia and Luxembourg. The deviatg pattern deviatg for pattern Austria for may Austria be related may be related downgrade downgrade its credit its ratg credit from ratg AAA from AAA AA and AA its issuance and its issuance two relatively two relatively expensive expensive bonds with bonds an with ultra-long an ultra-long maturity maturity 30 and years. and 70 years.

22 Int. J. Fancial Stud. 2017, 5, The Complementary Role Non-Monetary Policies 4.1. The Advantages and Limitations Two-Pillar Monetary Policy Strategy The challenge facg ECB from was monir, manage and, where possible, mimize potential negative side-effects a prolonged monetary stimulus that was calibrated ensure medium-term price stability (Draghi 2015). The two-pillar monetary policy strategy this respect entailed a detailed forward-lookg analysis economic, as well as monetary conditions euro area, as impacted by exceptionally favorable terest rates. The macroeconomic implications for short-term flation outlook were always cross-checked with medium-term flation trend associated with money and credit growth. Giavazzi and Wyplosz (2015) take a critical view usefulness a cross-check with monetary formation, argug that it unnecessarily clouds analysis and confuses communication. Yet, impact ultra-low terest rates was visible particular easier fancial conditions and a rebound money and credit, which signaled a pendg revival output growth and flation. Furrmore, as economy recovered and money and credit growth gared pace, ECB s cross-checkg flation prospects would naturally lead a tighteng monetary stance when risks for fancial stability became more proment (see (Fahr et al. 2013)). The monirg euro area monetary and credit aggregates would this regard need be complemented with a detailed flow--funds analysis order fully capture possible divergences fancial conditions across countries and secrs. Any adverse consequences monetary easg for fancial stability local markets required appropriately targeted preventive and corrective policies doma or policymakers Safeguards for European Fancial System Followg global fancial crisis, a new prudential fancial architecture was established at European level enhance resilience fancial termediaries, reduce risk volatile fancial markets, secure stability fancial frastructures and promote a well-functiong tegrated euro area fancial system. The reforced regulary and supervisory framework for fancial stability Europe seeks ter alia more effectively counter excessive leverage and a mispricg risk. Although not set up for that purpose, it thus also has capacity conta systemic fancial risks from a long-lastg monetary expansion and an ample supply low-cost credit (see (Van Riet 2017)). The European Bankg Authority (EBA), European Insurance and Pensions Authority (EIOPA) and European Securities Markets Authority (ESMA) have functioned sce 2011 as coordars national micro-supervisory activities for banks, stitutional vesrs and securities markets, respectively. As from November 2014, ECB was put charge Sgle Supervisory Mechanism with objective protect safety and soundness euro area banks and bankg system. This new micro-prudential supervision function was legally separated from its monetary policy function order prevent conflicts terest. Under its new capacity, ECB actively cooperates with EBA and national bankg supervisors promotg bankg secr s resilience shocks. Many euro area banks were strugglg with new regulary requirements, a crisis legacy non-performg loans and competitive pressures, both from or banks and non-banks, while sluggish economy held back demand for loans and come growth. The euro area bankg dustry was refore called upon remove excess capacity, strengn its equity base, tackle legacy bad loans, achieve greater cost efficiency and make its busess model viable new steady-state tighter regulation, more subdued output growth and lower terest rates. For example, followg macro-fancial stress tests 2014 and 2016, Supervisory Board ECB urged a few large credit stitutions strengn ir balance sheets by raisg capital buffers. The pritability and solvency stitutional vesrs were equally challenged by ultra-low terest rates. Already 2013, EIOPA refore issued recommendations national micro-prudential authorities strengn ir oversight dustry. Among or facrs, regular stress tests

23 Int. J. Fancial Stud. 2017, 5, considered impact sustaed low terest rates on balance sheet occupational pension funds and surance companies (Bernardo 2016). National regulars specified remedial actions be taken, but also allowed some flexibility with regard discount rate be used for valug liabilities and extended usual deadles for redressg a shortfall compared available assets. Beyond bankg supervision, ECB contributes work European Systemic Risk Board (ESRB), an dependent body tasked with macro-prudential oversight EU fancial system. The ESRB is a forum for cooperation among stitutions that contribute preservg fancial stability across Europe and carries out a regular forward-lookg analysis system-wide risks, cludg those arisg from low terest rates (see (ESRB 2016a)). In November 2016, ESRB issued ficial warngs governments Austria, Belgium, Fland, Luxembourg and Nerlands (and three EU countries outside euro area) potg vulnerabilities ir residential real estate secrs that could disrupt fancial stability over medium term with negative economic repercussions (ESRB 2016b). The national competent authorities dispose a new suite macro-prudential ols conta fancial stability risks arisg bankg secr 16 ; and ECB can p m up if warranted The Contribution National Fiscal and Structural Policies Fally, relieve burden on sgle monetary policy, ECB repeatedly urged for 19 euro area governments put place an aggregate macroeconomic policy mix that was more appropriately attuned cyclical and structural needs EMU (Draghi 2014). Member countries with fiscal space could add a budgetary expansion central bank s monetary stimulus so as more effectively remove slack euro area economy, while those without budgetary room for maneuver should first resre sustaable public fances le with requirements SGP. The euro area fiscal stance turned expansionary and was more aligned with orientation monetary policy. However, composition across countries was suboptimal; some contributed less euro area stabilization n was feasible, whereas ors lacked fiscal space and still postponed consolidation. A euro area fiscal capacity would have been more conducive achievg fiscal policy goals at euro area level. Governments could also facilitate task central bank by raisg quality public fances (focusg more on public vestment and tax efficiency) and facilitatg public-private fancg EU vestment projects. In addition, y could itiate more decisive structural reforms labor, product and housg markets and a faster resolution non-performg bank loans and corporate solvencies enhance flexibility, competitiveness, deleveragg and busess environment. Although some se structural measures could volve fiscal costs and dampen domestic demand short run, y were vital reverse euro area s declg trend productivity growth and raise longer term return on capital (see also (Bdseil et al. 2015)). Such structural policy actions could also improve operation monetary transmission mechanism and enhance efficacy monetary policy (Van Riet 2006). These national contributions euro area macroeconomic policy mix would support ECB meetg its price stability objective and reby reduce need for prolongg or addg experimental monetary policy measures unknown terriry. Although stitutional architecture EMU does not foresee explicit monetary-fiscal-structural policy coordation, national governments have a shared responsibility support ECB s fight agast low flation. 16 For example, Slovakia announced an crease counter-cyclical capital buffer be mataed by banks from 0% 0.5% tal amount risk-weighted assets startg from 1 August 2017 based on an assessment strong credit growth that ter alia fuelled house price dynamics.

24 Int. J. Fancial Stud. 2017, 5, Conclusions After euro area crisis had subsided, Governg Council ECB still faced a series complex and evolvg monetary policy challenges. As market volatility abated, but deflationary pressures emerged, ma task as from June 2014 became design a sufficiently strong monetary stimulus that could reach market segments that were deprived credit at reasonable costs and counter risk a o prolonged period low flation. Lookg back over years sce June 2014, ECB exploited narrow room maneuver for standard terest rate policy by brgg ma refancg rate down zero and applyg a mildly negative terest rate on its deposit facility. At same time, it ok non-standard monetary stimulus measures form targeted longer term refancg operations and large-scale asset purchases. Alongside se concrete actions, ECB consistently signaled its tention mata an expansionary monetary stance for as long as necessary. As a result, sovereign yield curve was brought down, even reachg negative terriry up medium-term tenors, with significant spill-over effects or asset markets. Followg widespread relaxation fancg conditions, flow bank-based and market-based credit euro area economy turned positive aga while broad money growth stabilized at a more appropriate higher level. This substantial monetary easg was strumental preventg deflationary forces from takg hold and generatg a moderate, but firmg recovery output growth and flation. Meanwhile, protracted period ultra-low terest rates raised legitimate concerns about possible adverse impact on fancial termediation, stability fancial secr, soundness fiscal policies, speed economic restructurg and distribution come and wealth. One consequences ducg economic agents take more risks lendg and borrowg was ir growg vulnerability negative economic and fancial shocks. This untended side-effect was mitigated by two facrs. First, post-crisis reform European fancial architecture directly volved ECB micro- and macro-prudential policies. A tighteng prudential supervision constituted first le defense promotg a resilient fancial dustry and securg fancial stability. Second, ongog economic recovery and favorable net wealth effects creased fancial buffers economic agents. The fancial capacity households and firms bear downside risks accordgly strengned over time. Addressg challenge low flation was complicated by fact that euro area policy mix combes sgle monetary policy ECB with economic policies 19 member countries. To reap full benefits ECB s accommodative monetary stance, euro area governments could have implemented a jot plan action with aim speed up balance sheet repair, accelerate economic recovery and achieve higher productivity growth. This implicit monetary-fiscal-structural policy coordation could have shortened episode ultra-low terest rates and mitigated ir adverse side-effects, for example for come retail savers, solvency pension funds and allocation resources. In addition, it would have eased task European prudential supervisors secure resilience fancial stitutions and counter risks for fancial stability. Acknowledgments: Helpful comments and suggestions from Francesco Mongelli, Guido Wolswijk and anonymous referees are gratefully acknowledged. Conflicts Interest: The author declares no conflict terest. References Acharya, Viral V., Tim Eisert, Christian Eufger, and Christian Hirsch Whatever it Takes: The Real Effects Unconventional Monetary Policy. SAFE Workg Paper, No. 152, Goe University, Frankfurt am Ma, Germany. Adrian, Tobias, and Nellie Liang Monetary Policy, Fancial Conditions, and Fancial Stability. FRBNY Staff Report, No. 690, Federal Reserve Bank New York, New York, NY, USA, September, (revised July 2016).

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