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 System of Central Banks

Outline 1. Track Record 2. Growing Imbalances 3. First Phase of the Crisis 4. Second Phase of the Crisis 5. Completion of the Institutional Architecture 2

Outline 1. Track Record 2. Growing Imbalances 3. First Phase of the Crisis 4. Second Phase of the Crisis 5. Completion of the Institutional Architecture 3

Inflation and the Quantitative definition Inflation HICP inflation Long-term inflation expectations from SPF Upper bound of definition of price stability 5-year forward 5-years ahead BEIR Longer-term inflation expectations (Consensus Economics Forecasts, 6-10Y) 5.0 4.0 3.0 2.0 1.0 0.0 Stage Three of EMU 5.0 4.0 3.0 2.0 1.0 0.0-1.0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013-1.0 Inflation Mean: 2.0% in Line with Aim to Maintain it Below But Close to 2%

Quantitative Definition and Bond Yields Euro area Last observation: 19 October 2012 Source: ECB calculations Inflation Premium in Line with Definition, Zero Inflation Risk Premium 5

Quantitative Definition and Bond Yields 20 15 Portugal Ireland Spain Italy France Germany Convergence 10 5 0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 Sources: Bloomberg, Thomson Reuters Datastream and ECB calculations. Note: bond yields are 10-year government bond, endof-the-month (last value 22Nov 2012).

Growth Growth Performance Levels of GDP Per-Capital in EA, US (1999=100) Rates of Growth of GDP Per-Capital in EA, US 120 Euro area US 8.0 euro area euro area 1999-mid2012 US US 1999-mid2012 115 6.0 110 4.0 105 2.0 100 0.0 95-2.0 90-4.0 85 95 97 99 01 03 05 07 09 11 13-6.0 95 97 99 01 03 05 07 09 11 13 EA Per-Capital GDP Grew at 0.9% (Employment at 0.7%) US Per-Capital GDP Grew at 1.0% (Employment at 0.5%)

Outline 1. Track Record 2. Growing Imbalances 3. First Phase of the Crisis 4. Second Phase of the Crisis 5. Completion of the Institutional Architecture 8

The Structural Context Relative Competitiveness ULC relative to euro area average, 1998=100 130 Belgium Germany Ireland Greece Spain France Italy Luxembourg Netherlands 120 Austria Portugal Finland 110 100 90 80 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: European Commission. Note: ULCs are computed as the ratio between compensation per employee and real GDP per employed person.

The Structural Context Change in ULC between 1999 and 2007 (deviation from euro area) 40 30 20 10 0-10 Productivity (inverted sign) Compensation ULC -20 IE ES PT GR IT NL FR BE FI AT DE Source: European Commission. Note: countries ranked in descending order on the basis of cumulated ULC growth. Some Members Were Experiencing Excess Wage Growth

Outline 1. Track Record 2. Growing Imbalances 3. First Phase of the Crisis 4. Second Phase of the Crisis 5. Completion of the Institutional Architecture 11

First Stage of the Crisis Post-Lehman Free Fall Value of density function Forecast from January 2009 Forecast from March 2009 Forecast from July 2009 Forecast from September 2009 Forecast from December 2009 Forecast from January 2010 GDP annual growth rate Source: Eurozone Barometer and ECB calculations. Last observation: January 2010

First Stage of the Crisis ECB Response To Preserve Price Stability A Dramatic Financial Crisis Induces a Dramatic Recession Poses Downside Risks to Price Stability: Possibly Deflation (fall in Prices) Damages the Transmission Mechanism Standard Monetary Policy Response to Downside Risks to Price Stability Aggressive Reduction in the Policy Rate Non-standard Liquidity Measures Unlimited Volume of Liquidity Offered to Banks in Credit Operations Extended Collateral that Banks Can Use in Credit Operations Increased Range of Maturities for Credit Operations (1-6-12 Months) Credit Operations in Currencies different from Euro Purchase of Covered Bonds Issued by Banks 13

First Stage of the Crisis Post-Lehman: Standard Monetary Policy Response 6.0 5.0 9 Aug 2007 15 Sept 2008 7 May 2010 marginal lending rate 6.0 5.0 4.0 3.0 MRO rates (marginal/fixed) EONIA 4.0 3.0 2.0 1.0 deposit rate main refinancing rate/ minimum bid rate 2.0 1.0 0.0 2007 2008 2009 2010 2011 2012 Note: data in percent. The lower and the upper bound are the deposit facility and the marginal lending facility rate respectively Last observation: 22 November, 2012. 0.0

First Stage of the Crisis Liquidity Support and Systemic Stress Source: Euro area CISS from Hollo, Kremer and Lo Duca (2012): "CISS - A Composite Indicator of Systemic Stress in the Financial System", ECB Working Paper No. 1426. Balance sheet data from ECB. Own calculations. Note: Weekly data. Last observation: 9 Nov 2012. - Developments in the CISS can be decomposed into contributions from five stress subindices (relating to money market, bond market, equity market, financial intermediaries, FX market) and the overall contribution from the cross-subindex correlations. 15

First Stage of the Crisis The Eurosystem Balance Sheet EUR bn 1600 Beginning of the financial turbulence 9 Aug 2007 Intensification of the financial turbulence 15 Sep 2008 Initiation of gradual phasing out 3 Dec 2009 7 May 2010 Start of the sovereign debt crisis First 3-yr LTROs 22 Dec 2011 1600 1400 1400 1200 1200 1000 1000 800 800 600 600 400 400 200 200 0 0-200 -200-400 -400-600 -600-800 -800-1000 -1000-1200 Jan 07 Apr 07 Jul 07 Oct 07 Jan 08 Apr 08 Jul 08 Oct 08 Jan 09 Apr 09 Jul 09 Oct 09 Jan 10 Apr 10 Jul 10 Oct 10 Jan 11 Apr 11 Jul 11 Oct 11 Jan 12 Apr 12 Jul 12 Oct 12-1200 main refinancing operation 1-maintenance period refinancing operation 6-month longer-term refinancing operation 3-year longer-term refinancing operation fine-tuning providing operation deposit facility Source: ECB. Last observations: 18 November 2012. marginal lending facility 3-month longer-term refinancing operation 1-year longer-term refinancing operation covered bond purchase programme and securities markets programme fine-tuning absorbing operation liquidity needs

First Stage of the Crisis Value of density function 3.5 3 2.5 2 1.5 1 0.5 Jul09-4.5 Post-Lehman: Stabilisation Nov09-3.9 Sep09-3.9 May09-3.8 Mar09-2.5 Jan09-1.5 Forecast from Jan 09 Forecast from Mar 09 Forecast from May 09 Forecast from July 09 Forecast from Sep 09 Forecast from Nov 09 Forecast from Jan 10 Forecast from Mar 10 Forecast from May 10 Forecast from Sep 10 Forecast from Nov 10 May10 1.1 Sep10 1.5 Mar10 1.2 Nov10 1.6 Jan10 1.3 0-6 -5.5-5 -4.5-4 -3.5-3 -2.5-2 -1.5-1 -0.5 0 0.5 1 1.5 2 2.5 3 GDP annual growth rate Source: Eurozone Barometer and ECB calculations. Last observation: November 2010

Outline 1. Track Record 2. Growing Imbalances 3. First Phase of the Crisis 4. Second Phase of the Crisis 5. Completion of the Institutional Architecture 18

Second Phase of the Crisis Divergence of Bond Yields to Pre-Union Levels 20 15 Portugal Ireland Spain Italy France Germany 10 5 0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 Sources: Bloomberg, Thomson Reuters Datastream and ECB calculations. Note: bond yields are 10-year government bond, endof-the-month (last value 22Nov 2012).

Second Phase of the Crisis Spreads Surge Source: Source: Thomson DataStream Last observation: 22 November 2012

Second Phase of the Crisis Sovereign and Bank CDS Bank CDS 2000 1500 1000 500 0 Ireland Portugal Spain. 10Q1 10Q2 10Q3 10Q4 11Q1 11Q2 11Q3 11Q4 12Q1 12Q2 12Q3 12Q4 0 500 1000 1500 2000 Sovereign CDS Bank CDS 1500 1250 1000 750 10Q1 10Q2 500 10Q3 10Q4 11Q1 11Q2 250 11Q3 11Q4 12Q1 12Q2 12Q3 12Q4 0 0 250 500 750 1000 1250 1500 Sovereign CDS Bank CDS 700 600 500 400 300 10Q1 10Q2 10Q3 10Q4 200 11Q1 11Q2 11Q3 11Q4 100 12Q1 12Q2 12Q3 12Q4 0 0 100 200 300 400 500 600 700 Sovereign CDS Italy Germany U.S. 700 600 400 350 400 350 Bank CDS 500 400 300 200 100 0 10Q1 10Q3 11Q1 11Q3 12Q1 12Q3 10Q2 10Q4 11Q2 11Q4 12Q2 12Q4 0 100 200 300 400 500 600 700 Sovereign CDS Source: Source: Bloomberg, ECB and ECB calculations Note: Last observation: 19 November 2012 Bank CDS 300 250 200 150 100 50 0 10Q1 10Q3 11Q1 11Q3 12Q1 12Q3 10Q2 10Q4 11Q2 11Q4 12Q2 12Q4 0 50 100 150 200 250 300 350 400 Sovereign CDS Bank CDS 300 250 200 150 100 50 0 10Q1 10Q2 10Q3 10Q4 11Q1 11Q2 11Q3 11Q4 12Q1 12Q2 12Q3 12Q4 0 50 100 150 200 250 300 350 400 Sovereign CDS

Second Phase of the Crisis Tightening Credit Standards and Factors Behind Source: ECB

Second Stage of the Crisis Liquidity Support and Systemic Stress Source: Euro area CISS from Hollo, Kremer and Lo Duca (2012): "CISS - A Composite Indicator of Systemic Stress in the Financial System", ECB Working Paper No. 1426. Balance sheet data from ECB. Own calculations. Note: Weekly data. Last observation: 9 Nov 2012. - Developments in the CISS can be decomposed into contributions from five stress subindices (relating to money market, bond market, equity market, financial intermediaries, FX market) and the overall contribution from the cross-subindex correlations. 23

Second Stage of the Crisis ECB Response To Preserve Price Stability Break-up Fears Undermine Integrity of the Single Currency Induces a Dramatic Recession Poses Downside Risks to Price Stability: Possibly Deflation (fall in Prices) Damages the Transmission Mechanism Standard Monetary Policy Response to Downside Risks to Price Stability Aggressive Reduction in the Policy Rate Non-standard Liquidity Measures Resumption of 1-Year Long-Term Refinancing Operations Two 3-Year Long-Term Refinancing Operations New Covered Bonds Purchase Programme 24

Second Stage of the Crisis Weaker Policy Pass-Through

Second Stage of the Crisis Inversion of Sovereign Curve Signals Break-up Risk Source: Reuters and ECB calculation. Note: Last observation 19 November 2012

Second Stage of the Crisis OMT Announcement and Break-up Risk 28

Outline 1. Track Record 2. Growing Imbalances 3. First Phase of the Crisis 4. Second Phase of the Crisis 5. Completion of the Institutional Architecture 29

Completion of the Institutional Architecture Banking union : Breaking Bank-Sovereign Nexus Single supervision of euro area banks Single Supervisory Mechanism comprising the ECB and national supervisory authorities Expected gradual implementation in the course of 2013 Single resolution of euro area banks Harmonised bank recovery and resolution tools (all tools, including bail-in ready for use 2018) Plans for a single European Resolution Mechanism Harmonised deposit insurance schemes Fiscal union fiscal rules with real bite, possibly EMU fiscal capacity Economic union to avoid divergences in competitiveness Political union to strengthen democratic legitimacy and accountability Source: Towards a genuine economic and monetary union, Interim report, 12.10.2012 30

Thank You 31

Quantitative definition of price stability Definition of Price Stability (1998): ØYear-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2% over the medium term Clarification of the Strategy (2003): ØThe Governing Council will aim to maintain the euro area inflation rate below, but close to, 2% over the medium term 32

Why below, but close to, 2% Below 2%: Economic and social benefits of price stability (see slide on Why price stability ) Close to 2%: arguments in favour of tolerating a low positive inflation rate Ø Measurement bias in the HICP Ø Deflation and the zero bound on nominal interest rates Ø Inflation differentials within the euro area 33

The Fiscal Context % of GDP 2010 2011 2012 2013 Euro area Budget balance -6.2-4.1-3.3-2.6 Primary balance -3.7-1.5-0.5 0.2 Gross debt 85.4 88.0 93.6 94.9 United States Budget balance -11.2-10.1-8.7-7.3 Primary balance -9.1-7.8-6.5-5.1 Gross debt 98.6 102.9 107.2 111.7 Sources: IMF World Economic Outlook October 2012 34

MFI Lending Rates and Policy Transmission Spread between short-term cost of borrowing for NFCs and 6-month OIS swap rate (p.p.a.; three-month moving averages) Spread between long-term cost of borrowing for NFCs and 5-year OIS swap rate (p.p.a.; three-month moving averages) Sources: ECB, as well as the MIR and BSI databases. Last observation is Sept. 12. Notes: See note to Slide 1 for short-term cost of borrowing for NFCs. Sources: ECB and the MIR database. Last observation is Sept. 12. Notes: See note to Slide 1 for long-term cost of borrowing for NFCs.

Balance sheets and Non-Standard Measures 30 LTROs MROs SMP CBPP General government debt and other securitites Net foreign assets 30 Other assets Repos and other loans MBS Treasury - QE purchases Treasury held before start of QE Net foreign assets 25 25 20 20 15 15 10 10 5 5 0 Jun 07 Feb 10 Sep 12 0 Jun 07 Feb 10 Sep 12 Eurosystem Fed Note: Values are presented in percent of GDP. Last observation refers to 20 September 2012. Source: US Federal Reserve, ECB and ECB calculations 36