Vítor Constâncio: Role and effects of the ECB non-standard policy
measures
Remarks by Mr Vítor Constâncio, Vice-President of the European Central Bank, at the ECB
Workshop "Monetary Policy in Non-Standard Times", Frankfurt am Main, 11 and 12 September
2017.
* * *
Our two-day workshop on non-standard monetary policy measures is coming to a conclusion.
Similar workshops have become a regular part of our annual conference schedule here at the
ECB for almost ten years now. They keep offering novel insights and help to deepen our
understanding on the transmission and optimal conduct of non-standard measures. This
workshop was no exception. In my concluding remarks, I will share personal takeaways
regarding some of the non-standard measures deployed by the ECB since the beginning of the
global financial crisis. These policies include the provision of liquidity on demand at fixed rate full
allotment since October 2008; facilities to provide medium-term liquidity to banks against
collateral in a series of long-term refinancing operations (LTROs); the Outright Monetary
Transactions (OMT) programme; the use of forward guidance in our monetary policy
communication as well as the large-scale asset purchase programme (APP) and the use of
negative interest rates. The workshop papers provide a rich set of analysis relevant for many of
these non-standard measures that I will refer to in my remarks.
Credit easing programmes
Banks play a predominant role in the euro area financial system, so it was particularly important
to support banks' credit provision after the turbulence caused by the global financial crisis.
Research on the bank lending channel and the effectiveness of our credit easing programme is
particularly welcome and was well represented at our workshop. Let me briefly review two
contributions with particular relevance for the euro area:
The paper by Boeckx and co-authors studies the response of bank lending to firms to credit
easing measures. They find a positive effect for the most constrained banks, provided that they
have a sufficiently high capital buffer. Poorly capitalised banks do not respond to the credit
support measures. These findings underscore the interactions between prudential regulation and
monetary policy and gives further justification for setting up the SSM and the regular stress
testing exercise, ultimately serving not only financial stability but also the effectiveness of euro
area monetary policy.
The paper by Cahn and co-authors is on the effects of the Additional Credit Claim (ACC)
framework, decided on 8 December 2011, to address bank funding concerns in several euro
area countries. Credit claims are loans that banks can pledge as collateral with the ECB to
obtain liquidity in our refinancing operations. As you may recall, at the end of 2011 we decided to
offer the euro area banking sector two additional LTROs with a maturity of 3 years and an
interest rate as low as 1 percent, fixed over the maturity of the operation. But that alone would not
have been sufficient. Banks also needed collateral to access the operations. While overall
collateral buffers were sufficient, the distribution of eligible collateral between banks was highly
uneven. The ACC framework comes into play here. It allowed NCBs to temporarily accept an
expanded list of credit claims as collateral in their refinancing operations. Specific risk mitigation
measures were put in place to keep the overall risk of the collateral pool unchanged. I interpret
the results of Cahn and co-authors as supportive for our decision in December 2011. The paper
shows that the ACC made a crucial difference for banks' lending behaviour. SMEs that were
previously served by only one bank, i.e. the part of firms most vulnerable to a tightening of credit,
benefitted the most from the introduction of the ACC framework. The findings clearly show the
importance for policy makers to understand the constraints under which lending decisions are
being made; although collateral appeared to be sufficient when we launched the 3-year LTROS.
Without ACCs, many firms would not have benefitted from the liquidity injection.
Besides the bank lending channel, our credit easing policies also influenced the euro area
economy through the exchange rate channel. The nominal exchange rate is one of the asset
prices that we pay particular attention to because of its impact on the inflation rate. Dedola and
co-authors (2016) document the effectiveness of our balance sheet policies on the exchange
rate and their transmission to prices and economic activity in a careful empirical analysis. It is
notable that the authors find significant exchange rate effects predominantly emanating from a
reduction in international financial distortions achieved by our liquidity policies. It is an open
question whether their results will change were they to redo their exercise in a follow-up study for
APP-related balance sheet changes. For this exercise to be feasible, further data points are
however needed.
The Outright Monetary Transactions Programme
By mid-2012, the global financial crisis had morphed into a sovereign debt crisis in the euro area.
In stressed countries, interest rate spreads had grown excessively and monetary conditions
became tight despite the easy stance of monetary policy. The problem was a liquidity crisis: a
general distrust among market participants about the future ability of distressed sovereigns to roll
over their debt. The crisis had self-fulfilling features: under low interest rates sovereigns were
solvent, but the high interest rates demanded by market participants and the ensuing
deterioration of the economic outlook indeed threatened the sustainability of some of the
stressed sovereigns.
The OMT programme was designed to diffuse such tensions. It offers conditional liquidity
insurance by promising outright purchases of sovereign bonds with maturities up to 3 years on
the condition that the countries meet domestic economic conditions laid out by an agreement
with the European Stability Mechanism. The credibility and the potential 'fire-power' of the ECB
have made the programme successful. Without actually spending one euro to this day, the
programme has contributed to the steep decline of sovereign spreads by as much as 2
percentage points. The evidence analysed by ECB researchers in Altavilla, Giannone and Lenza
(2016), suggests that this helped ensure a more uniform transmission of our exceptionally easy
interest rate policy and led to substantial increases in credit growth, activity and prices in
stressed countries, with some positive spill-overs to core countries.
These events and the success of the different policy actions have drawn renewed attention to the
relevance of macroeconomic frameworks that can help us understand situations with multiple
equilibria and devise appropriate policy responses. I am encouraged to see new quantitative
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macroeconomic models incorporating such frameworks,
See e.g. Corsetti-Dedola, 2016 for a framework with self-fulfilling sovereign debt crises and
Gertler and Kiyotaki, 2016 for a framework with systemic bank runs.
some with the help of ECB researchers, and see some potential for future policy-relevant
research in this area.
Forward guidance
Let me now turn to the most "standard" instrument in the central bankers' toolkit of non-standard
measures: "forward guidance" about the future conduct of monetary policy. Its emphasis is on
the management of expectations, as opposed to the current setting of a monetary policy
instrument. Most frequently it has been related to the future course of policy rates, but the ECB
also provides forward guidance in relation to its asset purchases. In fact, ECB's forward
guidance currently links the lift-off date for interest rates to the end of net asset purchases by
stating that "we expect the key ECB interest rates to remain at their present levels [...] well past
the horizon of our net asset purchases."
The effectiveness of forward guidance is however, a hotly debated topic, both in academia and in
policy circles. In standard dynamic stochastic general equilibrium (DSGE) models, forward
guidance is extremely effective, under the usual assumptions of forward-looking rational
expectations, coupled with the central bank's ability to commit to future actions. So much so that
the lower bound on nominal interest rates in these models becomes a trivial constraint: the
central bank can maintain the full effectiveness of monetary policy by setting an appropriate
future lift-off date. This is a consequence of the models assuming that consumer behaviour is
determined by standard Euler equations that impose a strong present impact on consumption
resulting from the future behaviour of interest rates. However, economists and policy makers
around the world including myself, are much more sceptical about the power of forward guidance
alone to deliver stable macroeconomic outcomes in relation to the predictions of the standard
models. This became known in the literature as the "forward guidance puzzle" (a term coined by
Del Negro, Giannoni, and Patterson, 2015). Naturally, forward guidance helps but it certainly does
not possess the powerful grip on the economy that it shows in the standard theory. Furthermore,
its marginal effectiveness is certainly not increasing as the central bank extends the lift-off date
further in the future. Therefore, an effort to amend the standard theory is needed, and I am very
glad that some of the papers presented at this conference address this very issue.
At this point in time, there is a wealth of approaches to solve the problem created in DSGE
2
models.
See Del Negro, Giannoni, and Patterson, 2015, Gabaix (2016), Garcia-Schmidt and Woodford
(2015), McKay, Nakamura and Steinsson (2016), Werning (2015), for example.
Among these, I find the solutions of McKay and co-authors (2016) and Gabaix (2015 and 2016)
particularly useful. Heterogeneous agents, credit constraints and precautionary savings limit the
reaction of consumers to future interest rate movements. Gabaix introduces behavioural agents
with myopic capacity to perfectly anticipate the future, a hypothesis reflected in a discounted
Euler equation that avoids the "forward guidance puzzle" and illustrates the advantages of
considering shorter horizons implied by behavioural cognitive impairments.
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The approach of Angeletos and Lian (2016) is also promising.
Their work is related to earlier contributions by Morris and Shin (1998, 2002) and Woodford
(2003) and is similar in spirit to Adam and Marcet's work (2011) on "internal" vs "external"
rationality.
It relaxes the assumption of 'common knowledge,' which typically goes hand in hand with the
assumption of rational expectations. The paper points out that the puzzlingly strong effects of
forward guidance arise through general equilibrium mechanisms, such as the feedback loop
between aggregate spending and inflation. Assuming a lack of common knowledge attenuates
the general equilibrium effects. Sufficiently strong information frictions qualitatively solve the
forward guidance puzzle through anchoring the response of expectations to changes in policy.
This is clearly another intuitive and welcome development in the theory of monetary
macroeconomics.
What do these findings imply for the practice of forward guidance? As policy makers, we know
that many of the conditions that the standard models presuppose are often not met in practice.
We are also acutely aware of the challenges that arise when attempting to effectively
communicate the conditionality of promises on the future path of interest rates. We understand
the advantages of a consistent and clear communication strategy - indeed, inconsistent or
vague promises about the future course of monetary policy often introduce additional noise and
raise rather than reduce economic uncertainty. My answer therefore is that we will continue using
forward guidance to some extent, but knowing that it is an imperfect tool and therefore only as
one of the various non-standard measures that we can activate when deemed necessary.
Large Scale Asset Purchases
Large-scale asset purchases, especially purchases of sovereign bonds since early 2015, have
been one of our most salient non-standard measures in the euro area. The Eurosystem has
already purchased more than 2 trillion euros of public and private assets and we intend to
purchase assets at a monthly pace of 60 billion euros until December 2017, or beyond, if
necessary, and in any case until the Governing Council sees a sustained adjustment in the path
of inflation consistent with our inflation aim. The programme was instrumental in eliminating
deflation risks, contributes to the ongoing recovery and helps us bring inflation closer towards our
objective.
The APP in the euro area has drawn attention to particular transmission channels of large-scale
asset purchases over and above the standard portfolio rebalancing and signalling channels.
Another classic channel through which the programme exerts its influence is the so-called
'duration channel,' which also appeared in multiple papers presented at the workshop. According
to this view, the public-sector purchase programme can best be understood as a swap of
longterm sovereign debt for short-term - actually overnight - central bank deposits by the
Eurosystem. This swap influences asset prices because the central bank eliminates duration
risk from the private market. Suggestive evidence on this channel in action in the euro area was
described in Altavilla and co-authors (2016). The ECB researchers analysed the intraday
development of government bond prices during the January 2015 press conference, when the
details of the programme were announced. Surveys conducted before the announcement
suggested that market participants expected the maximum maturity of eligible assets to be
around 10 years. Instead, the eligible assets included bonds with maturities up to 30 years. The
researchers could separately identify the impact of this duration surprise, because its
announcement came somewhat later than the announcement of the overall size of the
purchases, (which was also somewhat larger than expected). They confirmed that the duration
announcement reduced yields all across the maturity spectrum - and not just for assets with
maturities over 10 years - in line with the predictions of the duration channel.
The paper by De Graeve and his co-author (2016) presented at this workshop confirms, for the
United States, that reducing the outstanding maturity of sovereign debt through asset purchases
does indeed reduce long-term interest rates. This is consistent with recent euro area
observations. Their paper also draws attention to an important condition for the effectiveness of a
public-sector purchase programme: governments' maturity policy should not undo the impact of
the maturity reduction through increasing the relative supply of long-term government bonds.
U.S. evidence cautioned about this effect: Greenwood and co-authors (2014) estimated that the
Treasury's active maturity extension programme offset around one-third of the duration supply
impact of Quantitative Easing (QE) between 2007 and 2014. Early euro area evidence suggests
comparable numbers. ECB researchers in Andrade and co-authors (2016) find that during the
period when APP reduced the ten-year equivalent government supply in the euro area by 4.5
percent of GDP, euro area treasuries increased it by around 1.9 percent. So they could have
offset around 40 percent of the impact. This requires further monitoring, and points to the
importance of co-ordination with national treasuries.
I would also like to use this opportunity to draw your attention to ongoing modelling work at the
ECB. We are working to incorporate financial frictions and an effective asset purchase
programme into our euro area wide structural macroeconomic model, the New Area-Wide Model
(Coenen and co-authors, 2017). Similar efforts apply to the New Multi-Country Model that is now
being developed and includes a more granular treatment of the financial sector. The New Area-
Wide Model aims to take into account the importance of bank-based financing in the euro area as
well as the importance of open economy considerations. The estimated model finds a relevant
role for both financial imperfections and shocks emanating from the financial sector in explaining
business cycle fluctuations and propagation in the euro area. The APP is effective in the
framework, because the central bank can temporarily improve the balance sheet constraints of
financial intermediaries, which then leads to better credit conditions, improving the economic
outlook and raising the inflation rate. The ensuing lower term premium, furthermore, depreciates
the exchange rate to satisfy an arbitrage condition between the local and foreign long-term
sovereign debt markets. This exchange rate channel increases consumer prices, with marginal
impact on output, not unlike those identified by Dedola and co-authors (2017). This new version
of the framework will continue to help us form a consistent view about conjunctural
developments and will be applied to analyse the quantitative impact of alternative policy
scenarios.
So what have I learned about QE programmes and specifically the APP? A key question is how
large a balance sheet the ECB should maintain in the long-term. This issue is broader than just
the question about a possible "permanent QE" addressed in the paper by Harrison (2017) from
the perspective of its contribution, to a reduction in the frequency of zero lower bound episodes.
He concludes that the contribution would be small and therefore dismisses the case for what he
calls "permanent QE".
The debate about the size of the central banks' balance sheets however, refers mainly to other
objectives. In the 2016 Jackson Hole Symposium, two papers by Duffie and Krishnamurthy and
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by Greenwood, Hanson and Stein,
See Duffie, D. and A. Krishnamurthy, (2016), "Pass-through efficiency in the FED's new
monetary policy setting", presented at the 2016 Jackson Hole Symposium of the Federal
Reserve Bank of Kansas City and Greenwood, R., S.G. Hanson and J. C. Stein, (2016), "The
Federal Reserve's balance sheet as a financial tool", presented at the 2016 Jackson Hole
Symposium of the Federal Reserve Bank of Kansas City.
stressed the importance of the U.S. Federal Reserve's Reverse Repurchase agreement
Programme (RRP) through which it repos against cash securities on its balance sheet. The first
group of authors advocate the continued use of this programme in order to involve more
counterparties and to affect several interest rates beyond the overnight rate, thereby contributing
to a better transmission of monetary policy. The decline in size and importance of the unsecured
interbank money market affects the pass-through to other maturities.
A second set of objectives relates to central banks keeping a large balance sheet as a way to
steer the supply of safe assets, particularly through the same RPP, to create very short-term
safe assets. This fosters greater financial stability by avoiding unsuccessful private sector
attempts in fulfilling that role and amplifying risks in financial markets as seen before the crisis.
This is an important issue as the attempt to create safer private assets was behind the
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expansion of a shadow banking sector that played a significant role in the crisis.
See Constâncio, V., (2017), "The future of monetary policy frameworks".
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Finally, a third objective was recently expressed by the President of the New York FED
See William, D., (2017), "The U.S. Economic Outlook and the Implications for Monetary Policy",
speech on 7 September 2017 available in.
that it would be justified to keep a balance sheet with a sufficient size in order to enable the use
of bank reserves' remuneration and the RRP as ways to steer short-term rates, instead of using
open market operations only as was previously the case.
In the euro area, some similarities regarding the transmission via the unsecured interbank
market may justify in the future, reflections on these new aspects of conducting monetary policy.
Meanwhile, the predominantly bank-based nature of the European financial system allows us the
possibility of going back to a "leaner" balance sheet, with lending to banks remaining the main
channel for managing liquidity and steering short-term interest rates. Asset purchase
programmes would be in any case a potential tool to be applied again in future contingencies, if
necessary.
Negative interest rates
The ECB was the first major central bank to introduce negative policy rates. The rate of the
ECB's deposit facility was lowered to -10bps in June 2014 and reached -0.40bps in March 2016.
Negative rates stimulate the economy via the usual channels: they lower real yields and bank
lending rates at various maturities, encouraging borrowing and real activity. In this context,
negative policy rates have been an effective tool in the euro area, lowering not only short-term
rates but also rates at longer maturities via expectations. I agree with both keynote speakers in
our workshop that the transmission of rate cuts in negative territory may be different from
conventional rate cuts. Let me briefly outline why.
While banks enjoy valuation gains on securities they hold on their balance sheet, as with any
other rate cut, they may face a squeeze in their interest rate margin in the future for their loans,
new and/or old, depending on whether the loans are fixed or floating rates. Such a loan margin
squeeze may occur because a significant part of banks' funding costs is unlikely to fully reflect
the central bank's move to negative rates: for a variety of reasons, banks' retail deposits are
essentially floored at zero, as was also emphasised in the keynote speech by Eggertsson. If
banks cannot adjust the rates they pay their customers for their deposits as a reaction to falling
loan rates, their profitability could decrease, leading to lower bank equity which in turn, could lead
to lower lending, potentially hindering the pass-through of policy. This mechanism points to the
importance of banks' balance sheet structures for the transmission of negative rates: banks' with
large securities holdings and relatively small retail deposit shares are more likely to benefit from
negative rates than are banks with relatively small securities holdings and a higher retail deposit
share.
Work conducted by ECB economists, Demiralp and co-authors (2017), explores this exact point.
They identify banks' exposure to negative rates by their exposure to excess liquidity conditional
on each banks' business model and find that banks have reacted to negative interest rates by
granting more loans, reducing their reliance on wholesale funding and by acquiring non-domestic
government bonds. Interestingly, banks classified as investment banks, i.e. those with largest
securities holdings and smallest retail deposit share are the one most active in granting more
loans. Overall, Demiralp and co-authors (2017) conclude that negative rates have led to a more
expansionary stance of monetary policy as well as an empowerment of the ECB's APP, as
banks' desire to adjust their balance sheets has contributed to lowering interest rates in financial
markets.
Similar findings were reported by Basten and Mariathasan at this workshop in their paper on the
impact of negative rates on banks in Switzerland. The Swiss National Bank (SNB) introduced
negative rates in December 2014 and lowered rates to a record low of -0.75bps in January 2015.
The paper by Basten and Mariathasan (2016) is a very welcome contribution to the emerging
literature on the effect of negative rates in that it uses a very detailed dataset, notably comprising
supervisory data and a convincing identification, constructed around the institutional specificities
of the implementation of negative rates in Switzerland. This puts the authors in a position to
answer a variety of questions regarding the impact of negative rates on Swiss banks. Just like
Demiralp and co-authors (2017), they find that negative rates have been overall expansionary.
With the help of their comprehensive dataset, they are able to point out that banks have been
able to more than offset the compression of their interest rate margin by lending to customers
formerly not served. This expansion is in line with the predictions of the risk taking channel of
monetary policy and in line with what Heider and co-authors (2017) find in the case of the
syndicated loan market in the euro area.
At the same time, I do not challenge the view that there can be an effective lower bound, or a
reversal rate, as it was called by Brunnermeier in his work with Koby, under which an interest
rate cut would turn contractionary. However, where this lower-bound lies is still unknown, we
have every reason to believe that it is still below the current rates in the euro area or in
Switzerland. Once this lower bound is reached, however, perverse outcomes may materialise
because the interest rate cut does not reach retail bank deposit holders as Eggertson pointed
out. I share these concerns: negative rates are a tool that needs to be closely monitored. We are
happy with the experience and we think the evidence accumulated so far points to the negative
side effects being dominated by the positive aspects of the policy, which means that this is a
new instrument in the central banks' toolkit to be used in exceptional circumstances.
Conclusions
Let me conclude. The non-standard measures that the ECB had to use in order to face the
challenges of the crisis and the threat of too low inflation have been successful to avoid the worst
for the European Monetary Union. From innovative liquidity facilities to asset purchase
programmes and negative deposit rates, non-standard measures proved crucial to avoid
deflation and foster the economic recovery. We have not yet achieved our main goal of inflation
being below but close to 2 percent. We share with other advanced economies the puzzle of
wage and prices not responding to strong growth as usual. By keeping a sufficient degree of
monetary policy accommodation we can be confident that our goal will eventually be reached, in
accordance with our mandate..
I thank the presenters, the discussants, the organisers and the audience for this successful
workshop. Non-standard measures are going to be part of our toolkit for some time to come, and
some of them might even be deemed standard measures at some point, so I can promise you
that we will continue to organise similar events. I am looking forward to seeing further
contributions on the ongoing debates, further analysis on the potential costs of non-standard
measures and new results related to relevant questions like the impact of non-standard
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measures on inequality that I recently addressed.
See Constâncio, V., (2017), "Inequality and macroeconomic policies".
I look forward to your future work to foster our understanding of the non-standard times that
continue to challenge all of us.
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1
See e.g. Corsetti-Dedola, 2016 for a framework with self-fulfilling sovereign debt crises and Gertler and Kiyotaki,
2016 for a framework with systemic bank runs.
2
See Del Negro, Giannoni, and Patterson, 2015, Gabaix (2016), Garcia-Schmidt and Woodford (2015), McKay,
Nakamura and Steinsson (2016), Werning (2015), for example.
3
Their work is related to earlier contributions by Morris and Shin (1998, 2002) and Woodford (2003) and is similar
in spirit to Adam and Marcet's work (2011) on "internal" vs "external" rationality.
4
See Duffie, D. and A. Krishnamurthy, (2016), "Pass-through efficiency in the FED's new monetary policy setting",
presented at the 2016 Jackson Hole Symposium of the Federal Reserve Bank of Kansas City and Greenwood,
R., S.G. Hanson and J. C. Stein, (2016), "The Federal Reserve's balance sheet as a financial tool", presented at
the 2016 Jackson Hole Symposium of the Federal Reserve Bank of Kansas City.
5
See Constâncio, V., (2017), "The future of monetary policy frameworks".
6
Se