Peter Praet: Providing monetary policy stimulus after the
normalisation of instruments
Remarks by Mr Peter Praet, Member of the Executive Board of the European Central Bank, at
the conference "The ECB and its watchers XX", Frankfurt am Main, 27 March 2019.
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The financial crisis and its aftermath ushered in the need for central banks across the world to
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broaden the means by which they achieve their statutory mandates. The ECB's responses to
the first two phases of the crisis, namely the immediate aftermath of the collapse of Lehman
Brothers and the euro area sovereign debt crisis, were largely centred on conventional tools
being used in unconventional ways. The key ECB interest rates remained the instrument for
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adjusting the monetary policy stance. Meanwhile, refinancing operations continued to be the
vehicle for providing reserves to the banking system, but by adopting fixed rate tender
procedures with full allotment, expanding the eligible collateral pool and offering additional
longerterm funding, we provided the banking system with the ample liquidity it was trying to secure in
an elastic manner. Unconventional tools - namely limited purchases of covered and sovereign
bonds (Securities Markets Programme), as well as the announcement of outright monetary
transactions (OMTs) - were used to promote and safeguard the smooth transmission and
singleness of our monetary policy.
Things changed during the third phase of the crisis. This phase was characterised by a
deleveraging process that fed into a renewed macroeconomic downturn, producing a pernicious
cycle of contracting credit growth and weak demand dynamics that required a forceful monetary
policy response. Additional accommodation was initially provided by further reductions in the key
ECB interest rates - eventually to negative levels - and the introduction of forward guidance on
their expected path, while targeted longer-term refinancing operations (TLTROs) were conducted
to support bank lending to the real economy. But with the deposit facility rate in negative territory
and limited scope for additional rate cuts, purchases of private and public sector securities
became the tool for adjusting the level of monetary accommodation.
Following its announcement in January 2015, our expanded asset purchase programme (APP)
was recalibrated a number of times in response to changes in the inflation outlook. These
recalibrations consisted of changes in the monthly purchase volumes, expansions in the list of
eligible asset classes and extensions of the minimum horizon over which purchases would take
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place. The aim of the APP was to prevent acute and persistent disinflationary pressures from
destabilising medium-term inflation expectations and potentially spiralling into outright deflation.
That intention was hard-wired in the conditionality - or, in academic parlance, the "policy rule" -
that governed the forward guidance on the evolution of the APP from its inception. The
programme was to continue at a pre-set monthly pace of purchases until the Governing Council
saw inflation on a sustained adjustment path towards levels below, but close to, 2% over the
medium term.
We've come a very long way since the APP was launched. Last December, we took a first step
on the path towards "normalisation" by completing the rotation of instruments from a
configuration relying on the pace and horizon of monthly bond purchases to one founded on
forward guidance on our policy interest rates as the principal instrument of monetary policy.
There is an important distinction to be made here between the normalisation of the hierarchy of
policy instruments and the normalisation of the monetary policy stance - that is, the degree of
monetary stimulus that we provide to the economy. The normalisation of instruments was
implemented in such a way as to preserve the degree of accommodation necessary for
continued inflation convergence even after the end of net asset purchases.
Rotation back to the "normal" instrument of monetary policy
When announcing our APP in January 2015, we made clear that we intended to conduct net
asset purchases until we saw inflation on a sustained adjustment path towards levels below, but
close to, 2% over the medium term. While further accommodation was initially provided by
additional cuts in policy rates into negative territory, the APP became the tool for adjusting the
level of monetary accommodation. In March 2016 we adjusted our forward guidance on the key
ECB interest rates to imply a sequencing between the interest rate policy and the net asset
purchases, thereby exploiting the complementarities between these two key components of our
monetary policy conduct. The APP enhanced the effectiveness of our forward guidance on policy
rates via the signalling channel, underscoring our commitment to keep rates low for as long as
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necessary to achieve the stated objective of our policy. In addition, the APP gave rise to a
portfolio rebalancing channel; this put downward pressure on longer-term interest rates, thereby
complementing the impact of forward guidance on short to medium-term interest rates. The
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APP, as well as the TLTROs, also resulted in a liquidity creation effect. In conjunction with our
negative interest rate policy, which increased the opportunity cost of holding reserves, the
abundance of liquidity in the system reinforced the compression of longer-term interest rates.
In assessing progress towards a sustained adjustment in inflation, the Governing Council was
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guided by three criteria: convergence, confidence and resilience. First, headline inflation needed
to be on a trajectory to converge to levels below, but close to, 2% by the end of a meaningful
medium-term horizon. Second, we needed to be confident that the upward adjustment in inflation
would be realised with a sufficiently high probability. Third, the convergence of inflation towards
our aim needed to be resilient to the ending of net asset purchases.
By June last year, substantial progress had been made on the inflation front in terms of our three
criteria. Inflation was projected to be on a gradual upward path, uncertainty around the inflation
outlook had narrowed sharply and the inflation trajectory was tested to be sufficiently robust to an
ending of net asset purchases. So the time had come to bring net asset purchases gradually to
an end. We therefore initiated a rotation away from net asset purchases and back to interest
rates as the principal instrument of monetary policy by signalling our intention to end net
purchases in December 2018, subject to incoming data, and by enhancing our forward guidance
on the key interest rates. We also expressed our intention to maintain our policy of reinvesting
maturing securities for an extended period of time after the end of our net asset purchases and in
any case for as long as necessary.
Our net asset purchases had borne fruit, and in December 2018 we assessed that they had set
inflation on a sustained adjustment path towards our aim, but that continued inflation
convergence still required significant monetary policy stimulus. Our successive downward
adjustments in the volume of monthly purchases had supported our confidence that inflation
convergence would be sustained even after the end of net asset purchases, underlining the
increasing role of the stock of acquired assets in determining the stance of our monetary policy.
In the process of rotating back to forward guidance on policy rates as our main instrument, it was
essential to preserve the degree of monetary accommodation required for continued inflation
convergence. To prevent the risk that our instrument rotation would leave expectations about our
key interest rates - which since March 2016 were expected to remain unchanged "for an
extended period of time, and well past the horizon of our net asset purchases" - without a
tangible anchor, we enhanced our forward guidance on interest rates when announcing our
anticipation that we would bring net purchases to an end. Specifically, we decided last June on a
new conditionality formula for our forward guidance that - by and large - mirrored the one we had
used for steering APP expectations. This conditionality consists of both date and state-contingent
legs. The smooth financial market reaction to the end of net asset purchases suggests that our
enhanced forward guidance had the intended effect.
Our reinvestment policy reinforces the effects of forward guidance on policy rates. Today, the
stock of securities acquired under the APP has reached such a sizeable level that our
reinvestment policy is sufficient to ensure the degree of continued duration extraction needed to
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keep a lid on term premia. Keeping the stock of securities constant also contributes to
maintaining favourable liquidity conditions. Ample volumes of excess reserves ensure that the
overnight interest rate stays close to the floor of the interest rate corridor, which is provided by
the deposit facility rate. This, together with forward guidance on the expected evolution of our
policy interest rates, reduces rate uncertainty across maturities and thus adds to the
compression of term premia brought about by the duration extraction channel.
Preserving significant monetary stimulus
At the beginning of March this year the Governing Council was faced with a delicate call. On the
one hand, the economic expansion was clearly losing steam and the sagging economy
threatened to slow the pace at which inflation was expected to climb back to our objective.
Indeed, for the first time in a number of projection rounds, the March staff projection exercise had
downgraded the inflation outlook uniformly throughout the horizon, including at the end point. On
the other hand, there was no doubt that underlying conditions had come a long way since the
start of our asset purchase programme, in terms of both the overall progress achieved and the
resilience of the economy to negative shocks. The weaker economic momentum had not
fundamentally undermined the conditions on which progress towards our aim ultimately
depends, but it was slowing the pace of inflation convergence.
In the light of the downward revisions to the macroeconomic outlook, additional measures were
needed to preserve the ample degree of monetary accommodation supporting inflation
convergence towards our aim. In March we adjusted our forward guidance on the key ECB
interest rates, our main instrument, while announcing some other measures to preserve
favourable lending conditions and the smooth transmission of monetary policy.
Long-term interest rates and, indirectly, financial conditions depend on market participants'
expectations of the path that monetary policy interest rates are likely to follow. Today, this path is
constrained on the downside, as the overnight interest rate - which underpins the whole term
structure of risk-free interest rates - is already negative. So, under current conditions, our
indications regarding the most likely evolution of the policy rates are a key instrument for setting
the monetary policy stance.
Our interest rate forward guidance consists of both date and state-contingent legs. The
statecontingent leg expresses the anchor of our policy-setting: keeping inflation stably on its sustained
path towards levels that are below, but close to, 2% over the medium term. It says that the policy
rates won't be raised until we are sufficiently confident that inflation will reach levels below, but
close to, 2% over the medium term.
We further define our forward guidance with additional wording which we refer to as the
datebased leg. Through that wording the Governing Council relays to the market information about its
expectation of the earliest date at which, given the likeliest path for inflation, the state-contingent
part might dictate a first rate increase. As such, it is not a stand-alone proposition. It is a
clarification about the rate path that we see as most consistent with the inflation outlook that we
face, and with our commitment to achieve our policy objective over the medium term. The
datebased leg of our forward guidance directly affects the formation of market expectations by
clarifying the course of interest rate policy over a well-defined period of time. It influences the
riskfree curve by truncating the left tail of the distribution of market expectations for policy rates.
In the run-up to our March meeting, the state-contingent part of our forward guidance with its link
to the evolving inflation outlook had already influenced investor expectations a great deal. As
investors had been revising their outlook, the point at which they expected a first rate increase
had also been extending dynamically into the future, as they were internalising the Governing
Council's commitment - expressed in the state-contingent part of forward guidance - to an
inflation-dependent "policy rule". The term structure of money market interest rates had been
shifting lower and flattening as a result. So, a gap had formed between the market-implied date of
a rate lift-off and the Governing Council's indications, under its time-bound component of forward
guidance, of the earliest date at which such a lift-off was likely to occur. Since June 2018 this
time-bound part of forward guidance had signalled that policy rates were very likely to remain at
present levels "at least through the summer of 2019". In March we assessed the risks to price
stability and concluded that recalibrating the date-based leg of our forward guidance was
necessary to preserve the appropriate degree of monetary accommodation. Therefore, we
decided to communicate that we now expect to keep our policy rates unchanged "at least
through the end of 2019".
Our reinvestment horizon is chained to our forward guidance on interest rates, as the full
reinvestment horizon is defined as "an extended period of time past the date when we start
raising the key ECB interest rates, and in any case for as long as necessary...". By extending the
earliest date for a rate increase, we effectively also pushed out the time over which
reinvestments are intended to continue. This will not only help to maintain favourable liquidity
conditions but also reinforce the downward effect of our rate forward guidance on the risk-free
curve by supressing term premia.
We also decided to launch a new series of quarterly TLTROs to help preserve favourable bank
lending conditions and support the smooth transmission of monetary policy. Bank funding
conditions - while still accommodative - could be affected by high refinancing needs resulting
from maturing bank bonds and outstanding TLTROs. According to ECB staff estimates, after
taking into account excess liquidity holdings, banks in the euro area face combined refinancing
needs of around EUR 800 billion from June 2020 to May 2021, amounting to around 20% of the
currently outstanding stock of debt securities issued by banks in the euro area. This could give
rise to "congestion effects" as banks try to issue large volumes of bank bonds in a short period of
time to replace maturing sources of funding. A rise in funding costs could affect banks' ability to
provide sufficient credit to the economy. Especially in the current environment, it is imperative to
preserve the favourable bank lending conditions that have been instrumental in spurring and
supporting the ongoing economic expansion and the gradual return of inflation towards our
objective.
The new series of TLTROs is intended to do just that. TLTROs are a flexible tool with a number
of parameters which can be calibrated to meet the needs of monetary policy at a given point in
time. Starting in September 2019, banks will be able to borrow funds with a two-year maturity on
a quarterly basis until March 2021. These operations will feature built-in incentives for credit
conditions to remain favourable and will help to preserve a smooth and efficient transmission of
our monetary policy to the real economy. Counterparties will be entitled to borrow up to 30% of
the stock of eligible loans as at 28 February 2019 at a rate indexed to the interest rate on the
main refinancing operations over the life of each operation, with further details on the precise
terms of the new operations to be communicated in due course.
Finally, we extended the fixed rate tender procedure with full allotment. This means that we will
continue to provide banks with a liquidity backstop against sufficient and adequate collateral.
These measures give us renewed confidence that growth will return to its potential level,
supporting the continued convergence of inflation towards our aim.
Concluding remarks
Our monetary policy is bearing fruit, and we remain confident that the labour cost pressures that
have strengthened and broadened amid high levels of capacity utilisation and tightening labour
markets will continue to support underlying inflation over the medium term. The process of
inflation convergence takes time. While the sluggishness of the transmission mechanism can in
part be attributed to the persistence of uncertainties related to geopolitical factors and the threat
of protectionism that still cloud the euro area economic outlook, persistent, patient and prudent
monetary policy creates the conditions for the fundamental economic relationships to prevail and
for inflation to converge to our aim in a sustainable manner.
In any case, we stand ready to adjust all of our instruments, as appropriate, to ensure sustained
inflation convergence towards levels below, but close to, 2% over the medium term. All our
instruments remain available following the return to rate forward guidance as our main policy tool.
The activation of any existing or new instruments always depends on our assessment of the
risks to price stability and our judgement of the effectiveness of those instruments in ensuring the
convergence of inflation to levels that are below, but close to, 2% in the medium term. In March
we judged that recalibrating the date-based leg of our rate forward guidance, complemented with
the announcement of a new series of TLTROs, was appropriate to respond to the weaker
economic momentum and the related slowdown in the pace of inflation convergence to our aim.
Monetary policy acts in full independence, but not in isolation. The mildly expansionary euro area
fiscal stance and the operation of automatic stabilisers are also providing support to economic
activity. Growth-friendly public finances based on sustainable fiscal plans and a sound
composition of taxes and expenditures are essential for macroeconomic stabilisation and lasting
economic prosperity. In order to reap the full benefits from our monetary policy measures, other
policy areas must contribute more decisively to raising the longer-term growth potential and
reducing vulnerabilities.
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I thank Danielle Kedan for her support in preparing this speech.
2
For further discussion on the phases of the crisis, see Praet, P. (2016), "The ECB and its role as lender of last
resort during the crisis", speech at the Committee on Capital Markets Regulation conference on the lender of
last resort - an international perspective, Washington DC, 10 February 2016.
3
For further discussion of the implementation and effects of the APP, see Hammermann, F., K. Leonard, S.
Nardelli and J. von Landesberger (2019), "Taking stock of the Eurosystem's asset purchase programme after
the end of net asset purchases", Economic Bulletin, Issue 2, European Central Bank.
4
See Coenen, G., M. Ehrmann, G. Gaballo, P. Hoffmann, A. Nakov, S. Nardelli, E. Persson and G. Strasser
(2017), "Communication of monetary policy in unconventional times", Working Paper Series, No 2080,
European Central Bank.
5
See Praet, P. (2018), "Challenges to monetary policy normalisation", speech at the SUERF conference entitled
"Sustainable Policy Responses: EU and US Perspectives", New York, 20 September.
6
For further discussion, see Praet, P. (2018), "Maintaining price stability with unconventional monetary policy",
speech given at the Council of the European Union, Brussels, 29 January
7
See Praet, P. (2017), "Maintaining price stability with unconventional monetary policy measures", speech at the
MMF Monetary and Financial Policy Conference, London, 2 October and Praet, P. (2018), "Assessment of
quantitative easing and challenges of policy normalisation", speech at The ECB and Its Watchers XIX
Conference, Frankfurt am Main, 14 March.