The role of the ECB in the crisis

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1 The role of the ECB in the crisis Boris K. Kisselevsky Deputy Head of Press and Information DirCom, Warsaw, 6 July 2012

2 Three-pronged response to the crisis: ECB response EU response National responses 2

3 ECB s institutional context EMU rests on four fundamental constitutional pillars EMU Price stability orientation of the central bank Indepedence of the central bank Montaray financing prohibition No bail-out clause

4 ECB s financial structure context The euro area economy relies on bank funding Source: Haver, BofA Merrill Lynch Global Research, corporate balance sheets

5 ECB standard and non-standard measures In exceptional circumstances, the ECB took exceptional monetary policy measures, with a separation between: Standard measures: on key ECB interest rates Non-standard measures: to support the effective transmission of interest rate decisions to the wider euro area economy, in a context of a dysfunctional situation in some financial market segments and the financial system. Three main phases ( next slides) 5

6 Non-standard measures taken by the Eurosystem Phase 1: As money markets froze up (due to US subprimes) ECB was first to react, lending unlimited amounts overnight to banks on 9 August 2007 Why? Because of the critical role of money markets: The smooth transmission of the monetary policy intentions to money market rates depends on the functioning of the interbank market (where banks exchange liquidity). Through the money markets, the ECB influences the outlook for price stability. 6

7 Non-standard measures taken by the Eurosystem Phase 2: After the collapse of a US financial institution, which threatened the stability of the financial system, and thereby the economy and price stability Enhanced credit support Fixed-rate full-allotment Expansion of eligible list of collateral (that the Eurosystem takes against liquidity lent to banks) Longer-term liquidity provision (up to 1 year versus 3 months normally) Liquidity provision in foreign currencies Covered Bond Purchase Programme Some measures were taken already in late 2007, most in October Some have been phased out and then reintroduced. 7

8 Non-standard measures taken by the Eurosystem Phase 3: Sovereign debt crisis, with some euro area countries at the epicentre since May 2010 Government bonds play an essential role in the transmission of monetary policy, in three ways: Liquidity channel: large use of government bonds as collateral in financial transactions (e.g. repos) Price channel: Prices of fixed-income assets (e.g. corporate bonds) determined by the government-bond based yield curve Balance sheet channel: valuation of assets (government bonds and others) matter for strength of balance sheet, with consequences for financing conditions 8

9 Non-standard measures taken by the Eurosystem Phase 3 (continued): Sovereign debt crisis - ECB s response Address dysfunctions in some debt market segments affecting the transmission Purchases of bonds in a Securities Markets Programme No direct purchases of government bonds as monetary financing of governments is prohibited by the Treaty Purchases are sterilised: the money injected is reabsorbed 9

10 Non-standard measures taken by the Eurosystem Phase 3 (continued): The sovereign debt crisis in perspective This crisis vindicates the long-time calls by the ECB for a strong E pillar in Economic and Monetary Union, with strengthened governance in Europe: macroeconomic surveillance fiscal surveillance: enhanced Stability and Growth Pact; fiscal compact with rules enshrined in the primary legislation. The ECB s intervention in bond markets is very different from the actions of the US and UK central banks 10

11 SMP is not QE 11

12 Extension of non-standard measures Measures taken in the second half of 2011, following the intensification of the sovereign debt crisis Extension over time of full-allotment at a fixed interest rate (currently until at least end-june 2011) Additional US dollar liquidity-provision with maturity of around 3 months Covered Bond Purchase Programme 2: EUR 40 billion between November 2011and October 2012 Additional longer-term refinancing operations, for the first time up to 3 years (on 21 December 2011 and 29 February 2012) Extension in the list of eligible collateral: credit claims including on Small and Medium-Sized Enterprises 12

13 3 year LTRO as the Big Bertha Two 3-year operations (1) 489 bln, 523 counterparties; (2) 529 bln, 800 counterparties Exceptionally serious situation in Nov 2011 Drying-up of inter-bank markets Dangers of a credit crunch 13

announcement on 8 December 2011 of the two three-year LTROs.

14 Impact on money markets Reduced tensions in money markets Reduced credit risk Euro area money market spread and CDS for financial and non-financial volatility corporations Note: The vertical green line denotes the announcement on 8 December 2011 of the two three-year LTROs. The two vertical red lines mark the allotment of the two LTROs on 21 December 2011 and 29 February 2012 respectively. Source: ECB Monthly Bulletin, march 2012

15 Impact on ECB balance sheet Quelle: ECB, Letzte Daten: 26..März

but differentiated between NCBs Note: End-of-period data. Latest observation: October 2011.

16 but differentiated between NCBs Note: End-of-period data. Latest observation: October For the Central Bank of Ireland the monthly data are for a somewhat broader item than the T2 balance reported annually in its Annual Report (the difference of about 17 billion euros was subtracted to obtain the data shown at end-october 2011). Source: Bindseil, Cour- Thimann and Konis: 2012

17 Target 2 imbalances natural part of monetary union Cross- border payments and settlements for Eurosystem net out each day- each NCB has a single claim vis-à-vis the ECB Reflects mainly funding stress (outflows) and extraordinary support Target 2 claims do not reflect per se a measure of financial risk exposure of NCBs

18 Summary on the non-standard measures, to be explained to the public Fixed rate-full allotment policy 3 month, 6 month and 12 month refinancing operations Widening of eligibility of collateral requirement USD swap lines with the Federal Reserve Covered Bond Purchase Programme and Securities Markets Programme Two 3-year Long Term Refinancing Operations

19 Back to basics: price stability indeed Euro area inflation HICP and inflation expectations 6.0 HICP excluding unprocessed food and energy Consensus Economics forecast six to ten years ahead SPF five years ahead Upper bound of definition of price stability 5-year BEIR 5 years ahead 4.0 Stage Three of EMU Sources: ECB, Eurostat and Consensus Economics Forecast. Note: Last observation refers to December 2011 for the HICP headline (flash) and November for core HICP. The latest Consensus Economics Forecast and the latest SPF survey correspond to October Longer-term inflation expectations from Consensus Economics Forecasts refer to a horizon of six to ten years, while those from the Survey of Professional Forecasters refer to five years ahead. Consensus inflation expectations until December 2002 are constructed as a weighted average of the five largest euro area countries which together account for more than 80% of euro area GDP. 19

20 Conclusion ECB s operational framework ensured the necessary flexibility to respond to the crisis This flexibility strengthens ECB s credibility to deliver price stability, as reflected in continuous anchoring of inflation expectations Non-standard measures have been essential in supporting the transmission process, notably unlimited provision of liquidity at fixed interest rate to banks Exceptional intervention by Eurosystem cannot be maintained forever Support transmission But need to avoid distortions in financial incentives with longer-term adverse consequences for the economy and price stability Cannot be a substitute to governments 20

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The ECB s Strategy in Good and Bad Times Massimo Rostagno European Central Bank

The ECB s Strategy in Good and Bad Times Massimo Rostagno European Central Bank The views expressed herein are those of the presenter only and do not necessarily reflect those of the ECB or the European