SPEECH
The pandemic emergency: the three challenges for
the ECB
   
Speech by Philip R. Lane, Member of the Executive Board of the ECB, at the Jackson Hole
Economic Policy Symposium, Federal Reserve Bank of Kansas City "Navigating the Decade
Ahead: Implications for Monetary Policy"
27 August 2020
Today, I will discuss the monetary policy measures taken by the ECB in response to the pandemic shock,
take stock of the progress to date and outline the main challenges that lie ahead.[1]
The pandemic: the three challenges for the ECB
The nature of the pandemic shock called for an extraordinary policy response. From the outset, there were
three challenges for the ECB: (i) to stabilise markets; (ii) to protect credit supply; and (iii) to neutralise the
pandemic-related downside risks to the inflation path. Tackling the first pair of challenges is needed in
order to achieve the inflation aim, since it is problematic to run an effective monetary policy under
conditions of market instability or a credit crunch.
As is shown in Chart 1, the ECB adopted a comprehensive package of crisis measures over a number of
months in order to address these three challenges.[2]
Chart 1
Overview of the ECB policy measures taken since the outbreak of the COVID- 19 crisis
Our flagship policy initiative has been the pandemic emergency purchase programme (PEPP) that was
announced on 18 March. The PEPP was designed to play a dual role, both contributing to market
stabilisation and enabling a substantial easing in the monetary policy stance.[3]
The market stabilisation role of the PEPP was facilitated by its design, which allowed flexibility in the
composition of purchases over time, across asset classes and among jurisdictions.[4]
The significant drop in yields upon the announcement of the PEPP vividly illustrated the importance of
central banks in underpinning market stability in the event of a large adverse shock.
The additional asset purchases under the PEPP also serve to ease the monetary policy stance. In
response to the substantial pandemic-related downward revision to inflation outlook in the June staff
projection round, we expanded the size of the PEPP envelope by €600 billion to a total of €1,350 billion
and extended the minimum expected horizon for net purchases by half a year, to at least the end of June
2021.[5]
In addition to stabilising markets and ensuring a sufficiently-accommodative monetary policy stance, it has
also been imperative to limit the risk of a credit crunch. The maintenance of credit supply could not be
taken for granted, since the pandemic was likely to both reduce the credit quality of potential borrowers
and increase the funding costs facing banks in the absence of central bank intervention. To counter this
threat, we substantially eased the conditions under which banks can obtain liquidity under our targeted
long-term refinancing operations (TLTROs), which strengthened the incentives for banks to continue
lending to the real economy.[6]
We also eased collateral requirements to make sure that banks could make full use of these operations.
The set of measures was designed to work as a package, in order to ensure that all three challenges
posed by the pandemic shock were tackled simultaneously.[7]
Chart 2 shows that the measures have resulted in a sizeable expansion of the ECB's balance sheet,
illustrating the value of central banks being ready to commit their balance sheets to fight risks to their
policy aims, especially in the event of a major shock to the real economy and the financial system.[8]
Chart 2
Eurosystem balance sheet in 2020
(percentages of euro area GDP in Q4 2019, cumulative changes relative to January 2020)
Source: ECB.
Notes: "MROs" stands for "main refinancing operations", "LTROs" for "longer-term refinancing operations", "APP" for
"asset purchase programme", "TLTROs" for "targeted longer-term refinancing operations" and "PEPP" for "pandemic
emergency purchase programme". Monthly data. The latest observations are for July 2020.
Taking stock
Almost six months after the introduction of our measures, the evidence suggests that the policy package
has stabilised markets, protected credit provision and supported the recovery.[9]
Of course, across all dimensions, fiscal policies have also played a vital role and there have been powerful
complementarities between monetary and fiscal policies during this period. I will return to the fiscal policy
contribution later on.
Since its announcement in March, the PEPP has acted as a powerful market-stabilising force. In the euro
area, sovereign yields play a pivotal role in the transmission of monetary policy, since these affect the
funding costs of corporates, households and banks (as well as governments, of course). Chart 3 shows
that the decline in the GDP-weighted average sovereign yield has been substantial. The reduced
dispersion in sovereign bond yields is also due to the profound change in the European fiscal landscape,
as reflected in the far-reaching agreement at the July European Council meeting.
Chart 3
Euro area sovereign yields
(cumulated changes since 1 February 2020, percentage points)
Sources: Bloomberg and ECB calculations.
Note: The latest observations are for 21 August 2020.
The stabilisation of markets is also visible in the balance of payments data as shown in Chart 4. In relation
to foreign assets, the initial retrenchment has been reversed, with increasing net purchases of foreign
assets by domestic investors in both less vulnerable and more vulnerable countries. In relation to foreign
liabilities, the scale of net selling by foreign investors of the debt securities issued by more vulnerable
countries has steadily declined, with a return to net inflows in the June data.[10]
Chart 4
Cross-border portfolio investment flows
(monthly flows as a percentage of each group's aggregate GDP)
Sources: ECB and Eurostat.
Notes: Data recorded on the basis of the Sixth Edition of the IMF Balance of Payments and International Investment
Position Manual (BPM6). Averages calculated from January 2008 to June 2020. "Less vulnerable" countries are Austria,
Belgium, Finland, France, Germany and the Netherlands; "more vulnerable" countries are Greece, Italy, Portugal and
Spain.
Chart 5 shows that loans to firms have held up well so far and have even been increasing in the past
months. Credit supply has been supported by our refinancing operations, especially through the €1.3
trillion take-up under the June round of the TLTRO-III programme. The continued flow of credit to the real
economy has been facilitated by forceful fiscal action, which has included measures to limit the
pandemicrelated losses suffered by many firms and the introduction of sizeable government guarantees
programmes.[11]
Chart 5
Euro area loans to firms
(indices, with T=100 for period of peak in economic activity)
Sources: ECB and ECB calculations.
Notes: Non-financial corporation (NFC) loan data deflated by the HICP. Derivation of interquartile range and median for
recessions and severe downturns based on quarterly data from Q1 1980 to Q2 2020 for France, Germany, Italy and
Spain. Recessions defined by business cycle chronologies. Severe downturns defined as periods of one or more quarters
of real GDP declining by 1 percent or more quarter-on-quarter (whether part of a recession or not). The latest
observations are for Q2 2020.
By successfully countering a tightening in financing conditions and by protecting credit supply, the
measures taken in response to the pandemic have provided critical support to the outlook for the economy
and inflation and have helped to limit tail risks around the baseline scenario. According to internal
estimates, the package of measures is projected to increase output by around 1.3 percentage points and
inflation by around 0.8 percentage points cumulatively between 2020 and 2022. These estimates are
conservative, since these do not fully capture the benefits gained by avoiding the adverse feedback loops
between the real economy and financial markets that would have emerged in the absence of a prompt and
comprehensive policy response.
Reaching our inflation aim: a two-stage approach
The pandemic crisis represents a significant negative shock to the inflation outlook, since the
disinflationary pressures arising from greater economic slack are likely to outweigh any inflationary forces
stemming from negative sectoral supply shocks.[12]
Chart 6
The future inflation path
Source: ECB.
Notes: "AD" (the blue line) represents the expected inflation path before the pandemic shock. The initial negative impact
of the pandemic shock - in the absence of additional monetary policy accommodation - is captured by the downward shift
in the expected path from "A" to "B". The "BE" path (the yellow line) illustrates a transition path of inflation that is even
lower than originally envisaged. By providing additional monetary policy accommodation, the central bank can aim
towards the upper region of the "BCDE" zone, so that the adjustment is closer to the "BCD" path.
Chart 6 shows a stylised sketch of the choice facing the ECB in terms of the monetary stance. Before the
onset of the pandemic, inflation was expected to rise gradually towards the inflation aim, represented by
the "AD" path (the blue line). The initial negative impact of the pandemic shock - in the absence of
additional monetary policy accommodation - is captured by the downward shift in the expected path (the
drop from "A" to "B").
One option would be to simply accept that convergence to the inflation aim will take more time and that
inflation will be even lower than originally envisaged during the transition path, as illustrated by the "BE"
path (the yellow line).[13]
However, this option is costly in terms of the implied higher path for real interest rates and the slower
economic recovery that results. It is also risky, since a longer phase of even lower inflation might become
entrenched and contribute to a downward drift in inflation expectations, which would make it even more
difficult to deliver the inflation aim over the medium term. A substantial weight should be attached to these
risks in the context of the euro area, in view of the already-low pre-pandemic inflation rate and the long
interval of below-target inflation.
It follows that, for the ECB to deliver on its mandate, the more effective and safer option is to aim towards
the upper region of the "BCDE" zone by providing additional monetary stimulus, so that the adjustment is
closer to the "BCD" path. This is the line of reasoning behind the design of the PEPP, with a temporary
phase of additional asset purchases intended to restore momentum to inflation dynamics.
Accordingly, the monetary policy challenge consists of two stages. The first stage is to counteract the
negative shock to the expected inflation path caused by the pandemic: through an intense temporary
phase of additional monetary accommodation, the PEPP (in combination with the other monetary policy
instruments) is designed to accomplish this first-stage task. Once the negative shock has been sufficiently
offset, the second stage is to ensure that the post-pandemic monetary policy stance is appropriately
calibrated in order to ensure timely convergence to our medium-term inflation aim. To these ends, the ECB
Governing Council stands ready to adjust all of its instruments, as appropriate.
Especially in an environment of low inflation and low interest rates, monetary and fiscal policies have the
potential to reinforce each other. In particular, in relation to the price stability mandate, the scale of the
monetary policy adjustment required to neutralise the negative pandemic shock to inflation dynamics and
sustain the subsequent convergence to the inflation aim depends on the extent of the fiscal support for the
economic recovery.
All euro area countries have taken significant fiscal measures in response to the pandemic crisis. Over the
near-term and medium-term, national governments will need to continue supporting their economies to
recover from the severe pandemic shock. The recently-agreed €750 billion EU recovery fund - the Next
Generation EU initiative - puts in place a shared budgetary instrument that both complements and
supports national fiscal actions. An ambitious, high-quality and coordinated fiscal stance is central to
securing a strong recovery across the euro area and constitutes a vital complement to the support
provided by monetary policy.
Finally, the emerging lessons from the policy response to the pandemic shock will also feed into our
monetary policy strategy review. The strategy review will be an important focus for our work over the next
year.
[1]
I am grateful to Ine Van Robays and Leopold von Thadden for their contributions to this speech.
[2]
I discussed the ECB's response to the pandemic crisis in more detail in a recent speech. See Lane, P.R. (2020), "The ECB's
monetary policy response to the pandemic: liquidity, stabilisation and supporting the recovery", 24 June.
[3]
Since the ECB was already an active purchaser of both sovereign and private-sector securities, the PEPP could be rolled out quite
quickly. On 12 March, the ECB had already expanded the size of its long-established asset purchase programme (APP) with an
additional EUR 120 billion allocated for the rest of 2020. The 18 March launch of the PEPP was in recognition that a temporary and
flexible programme was better suited to respond to the exceptional nature of the pandemic shock, rather than just relying on a
mechanical expansion of the APP.
[4]
See also Lane, P.R. (2020), "The market stabilisation role of the pandemic emergency purchase programme", The ECB Blog, 22
June.
[5]
See also Lane, P.R. (2020), "Expanding the pandemic emergency purchase programme", The ECB Blog, 5 June.
[6]
Unconditional liquidity operations were also offered, in order to ensure a well-priced liquidity backstop for the banking system. This
includes the pandemic emergency longer-term refinancing operations (PELTRO) programme that serves to support liquidity conditions in
all segments of the euro area financial system and preserve the smooth functioning of money markets. Furthermore, at the international
level, we provided euro liquidity facilities through a variety of agreements with central banks outside the euro area, while the existing
network of swap lines with the other major central banks was also reactivated, which enabled euro area banks to obtain foreign-currency
liquidity if needed.
[7]
In addition, a number of supervisory measures offered temporary capital, liquidity and operational relief to banks, to ensure that
banks could continue to fulfil their role in funding the real economy.
[8]
Before the pandemic shock, sizeable policy accommodation was already in place with short-term yields at record low levels, forward
guidance indicating that rates would be kept low or lower, net asset purchases under the APP restarting in autumn 2019, our continued
reinvestment policy, and the third series of the TLTROs (TLTRO-III).
[9]
See also footnotes 2 and 4.
[10]
See also Lane, P.R. (2020), "The macroeconomic impact of the pandemic and the policy response", The ECB Blog, 4 August.
[11]
See also Haroutunian, S., Hauptmeier, S. and Leiner-Killinger, N. (2020), "The COVID-19 crisis and its implications for fiscal
policies", Economic Bulletin, Issue 4, ECB.
[12]
See also footnote 6.
[13]
For simplicity, this post-pandemic inflation path is represented here as a parallel shift, but it might well be that inflation would recover
more slowly in the post-pandemic economy in the absence of additional monetary accommodation.
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