SPEECH

Modern monetary analysis

Speech by Philip R. Lane, Member of the Executive Board of the
ECB, at the Bank of Finland's International Monetary Policy
Conference

Helsinki, 26 June 2024

Introduction

My aim today is to discuss the modern role of monetary analysis at the ECB." I will first review how
monetary analysis has advanced over the twenty-five year history of the euro. Second, I will discuss
how monetary analysis contributed to the assessment of financing conditions during the pandemic.
Third, I will explain how monetary analysis has informed the diagnosis of the post-pandemic surges in
inflation. Fourth, I will examine the contributions of monetary analysis to the calibration of the tightening
cycle. Finally, I will speculate on the future role of monetary analysis.

The evolving role of monetary analysis

The initial monetary policy strategy of the ECB was based on a two-pillar framework to identify risks to
price stability: economic analysis and monetary analysis. The two analytical domains essentially

provided complementary perspectives on the economy.2]

For the monetary pillar, the ECB's Governing Council initially chose to emphasise the quantity of money
among the key indicators to be closely monitored and established a reference value for the growth of a

broad monetary aggregate (M3).

This approach was in line with the views of early-day monetarists who considered money growth the
primary source of inflation. Milton Friedman famously captured this in the adage that "inflation is always
and everywhere a monetary phenomenon". In an admittedly restrictive interpretation of Friedman's

statement, this is reflected in the quantity identity Mv=PY.4! This school of thought saw money as an
imperfect substitute for a wide range of financial and real assets. A policy-induced injection of money
into the economy would trigger complex and inter-related portfolio rebalancing across asset categories.
This rebalancing would then lead to widespread changes in asset prices, yields and spreads across the
economy. These mechanisms are well described in the classic 1988 monetarist account of transmission

by Karl Brunner and Alan Meltzer.

Especially after the end of the Bretton Woods system in 1973, some stability-oriented central banks -
most notably the Deutsche Bundesbank - were looking for a substitute anchor, and these monetarist
considerations played a significant role in the conduct of monetary policy throughout the 1970s, 1980s
and 1990s. The result of that intellectual legacy was the prominent role that the ECB assigned to a

reference value for money growth as an anchor back in 1998.5] Deviations from that reference value

and the associated "monetary overhang/shortfall" were, at the time, generally considered to signal risks
to price stability.

However, a consistent record of difficulties within central banks in interpreting swings in monetary
aggregates and in relying on them for predicting inflation at the horizons relevant for monetary policy
contributed to a declining emphasis on money in policy making. As early as 1983, Bank of Canada
Governor Gerald Bouey famously quipped "/ would not say that we abandoned M1; I would say that M1

abandoned us, because of changes in banking practices" Even though Bouey was speaking about
M1, the same instability problem applied to M3.

Moreover, by the time Michael Woodford came to write his seminal text Interest and Prices in 2003,
there was a wide-spread view that it was not necessary to incorporate money in modern

macroeconomic models. 21 Rather, the monetary policy stance could be summarised by the setting of

interest rates alone. Accordingly, money was all but removed from the modern monetary economics
synthesis.

Against this background, the ECB conducted a review of its monetary policy strategy in 2003. This
resulted in a revised approach to monetary analysis under the monetary pillar, with the adoption of a
broader view of the role of money in the economy and the financial system. The long-term empirical
relation between money and inflation had consistently been proven unhelpful in quantifying the scale of
price pressures on a meeting-by-meeting basis. This realisation led to the discontinuation of the earlier
practice of reviewing the reference value for M3, with a shift towards treating money aggregates as
indicator variables rather than intermediate targets for monetary policy. The 2003 strategy review also
clarified that monetary analysis served as a tool for cross-checking the short to medium-term

indications from the economic analysis, from a medium to long-term perspective 10]

After 2003, two significant developments led to an increased focus of monetary analysis on monetary
policy transmission. First, the global financial crisis and the euro area sovereign debt crisis highlighted
the vulnerability of the transmission mechanism. This, in turn, prompted policymakers to place greater
reliance on monetary analysis in navigating the resulting challenges. Second, the adoption of
unconventional monetary policy tools by the ECB of required monetary analysis to broaden its scope to
better understand the many new transmission channels that the adoption of unconventional
instruments had set in motion, including the analysis of potential side effects of those measures.
Overall, the shift in focus of monetary analysis towards monetary policy transmission represented a
natural evolution in line with the changing monetary policy landscape.

These developments were incorporated in monetary analysis during the latest strategy review
conducted in 2021. In the new framework, "economic analysis" and "monetary analysis" no longer
represent distinct perspectives on inflation. Instead, the interrelations between economic developments
and monetary and financial developments are explicitly integrated into the overall assessment of

inflation risks and the formulation of monetary policy.)

Accordingly, monetary analysis has expanded from a narrow focus on the quantity of money to the
wider mechanism by which monetary policy actions transmit to the financing conditions faced by

households and firms in the real economy.12] This approach often employs monetarist concepts,

formalised within modern structural models, to analyse changes in spreads and asset prices linked to
portfolio rebalancing across imperfectly substitutable financial assets, including money and money-type

assets.{3]

Monetary analysis played a particularly salient role in policy decision-making when the policy rate
approached the effective lower bound. This period saw a significant expansion of liquidity in the
financial system through central bank lending programmes and outright asset purchases, underscoring
the importance of informed decision-making based on monetary analysis.

In the quantity identity (MV=PY), the traditional emphasis had primarily been on the growth rate of
money, M. However, the bi-variate relation between inflation and money growth had not only always
been elusive but also weakened over time, before disappearing altogether in the first decade of the

2000s (Chart 4)04) Past studies had found a significant and stable relation between broad money
growth and inflation across several economies and monetary regimes. However, this relation was
observed at very low frequency over extremely long periods, limiting the degree to which it can be used

in practice at the meeting-by-meeting frequency required for policy decisions." Moreover, research
incorporating recent experiences finds that structural shifts in banking and the financial system have

destabilised the relation between money supply and inflation."

Precisely for these reasons, since the global financial crisis, the importance of the bank lending channel
and other transmission mechanisms has become more prominent. Monetary analysis has adapted by
increasing the emphasis on analysing the credit-creation process, its relation with liquidity conditions
and the various frictions affecting the financial system. All these elements affect the transmission of
monetary policy to the real economy and thereby contribute to inflation dynamics.

Chart 1
Money growth and inflation

(annual percentage changes)

== M3 annual growth
== HICP inflation

20
15

10

5
1971 1981 1991 2001 2011 2021

Sources: ECB (BSI), Eurostat and ECB calculations.

The latest observations are for 2024 Q1.

From this perspective, it would be overly reductive to interpret the rise of money growth during the
pandemic and the subsequent rise in inflation that is shown in Chart 1 as a causal relation. In fact, the
strong money growth in the early phase of the pandemic was driven by the build-up of liquidity buffers,

which is not inherently inflationary." This is consistent with the view that the surges in inflation in 2021
and 2022 were mostly related to supply-side factors, such as global supply bottlenecks and increases
in energy and commodity prices, rather than an increased stock of money. This view is further
reinforced by the nature of the inflation shock which involved large relative price movements, whereas
money-induced inflation should have been associated with a more uniform increase in prices across
categories. I will return to the pandemic episode later in this speech.

The wider availability of timely granular information on balance sheets, lending rates and deposit rates
for euro area monetary financial institutions has offered increasingly detailed insights into bank-based
transmission. We now have evidence that firm and bank balance sheet constraints can amplify the

contraction in credit availability brought about by policy tightening."8] More recently, the availability of
loan- and transaction-level information on banks and firms has further enhanced the analysis of the
monetary policy transmission mechanism along several dimensions, including: heterogeneity in the
transmission of monetary policy across regions and sectors, the impact of monetary policy on bank

risk-taking, and the sources of changes in credit developments.4

Financing conditions during the pandemic

The pandemic period was marked by extraordinarily high liquidity demand, triggering a global dash for
cash by investors. Lockdowns, social distancing measures and travel restrictions led many firms to
experience a reduction in consumer demand and to reduce or halt their operations. This triggered a
substantial decline in revenue for businesses across a wide range of sectors. However, firms still had to
meet operating expenses and short-term obligations, such as the maintenance of inventories,
payments to suppliers, salaries, taxes and fixed operational expenses. These needs showed up very
clearly in the replies by banks to the ECB bank lending survey (BLS), which documented a surge in
loan demand by firms to finance working capital, while financing needs linked to investment weakened

considerably (Chart 2).!20

Chart 2
Financing needs for inventories and working capital and loan demand by enterprises

(net percentages)

<== Loan demand
=== Inventories and working capital
Fixed investment

80

60

40

20

40

-60
Q1 2015 Q2 2016 Q3 2017 Q4 2018 Q1 2020 Q2 2021 Q3 2022 Q4 2023

Source: ECB (BLS).

Notes: Net percentages for the questions on demand for loans are defined as the difference between the sum of
the percentages of banks responding "increased considerably" and "increased somewhat" and the sum of the
percentages of banks responding "decreased somewhat" and "decreased considerably". The net percentages for
responses to questions relating to contributing factors are defined as the difference between the percentage of
banks reporting that the given factor contributed to increasing demand and the percentage of banks reporting that
it contributed to decreasing demand.

The latest observations are for Q1 2024.

In this environment, employment and total hours worked declined at the sharpest rates on record, with
many employees being furloughed or having their working hours reduced. Consequently, salary
incomes were dented. Banks across the euro area faced rising funding costs due to a climate of
heightened uncertainty in the market and concerns about borrower creditworthiness. This led to a

reassessment of risk, affecting not only banks but also the broader financial markets, as evidenced by
the increase in corporate bond yields. In the absence of countervailing measures, banks would have
struggled to secure funding, which would have limited their ability to meet the high demand for
emergency loans, potentially crippling their lending capacity. Accordingly, it was crucial for our
monetary policy to maintain favourable financing conditions and the effective transmission of monetary
policy, in order to avert a monetary squeeze that would have exacerbated adverse effects from the
pandemic on the economy and price stability.

The experience gained over the preceding decade allowed us to respond swiftly and decisively,
deploying essentially two types of instruments. The first type was intended to maintain an
accommodative monetary policy stance and, in parallel, stem the tide of an impending meltdown in
financial markets as investors were pulling back from riskier assets. Here the main measures were the
recalibration of the asset purchase programme (APP) and the introduction of the pandemic emergency

purchase programme (PEPP).21[22] The second group of instruments was deployed to ensure that the
accommodative impulse would reach the broader economy. Notable examples include the
recalibrations of the targeted longer-term refinancing operations (TLTROs) for banks at attractive

conditions.25] These term credit operations were aimed at expanding the quantity of central bank
reserves, subject to the condition that banks would lend them on and keep credit flowing to the
economy. As a facilitating measure, the targeted lending programme was accompanied by a temporary
easing of collateral and regulatory constraints.

The interplay between policies to keep the risk-free curve low and steady across maturities, and
instruments to unclog the transmission pipes worked as intended. The economics of the portfolio
rebalancing channel learned during the first wave of the APP net purchases, over the period 2015-
2018, as well as the experience of the portfolio movements during the sovereign debt crisis, were
instrumental for the design of the PEPP. The portfolio rebalancing channel is the key mechanism

through which central bank asset purchases transmits monetary policy to the broader economy. 4] This
channel functions through the principle of imperfect substitutability among financial instruments,

coupled with investor preferences for certain assets, known as preferred habitats. !25]

Monetary analysis studied how portfolio allocations can change directions both across instruments and
between euro-denominated domestic assets and foreign assets. Within the euro area, the APP had led
to a rebalancing of bank exposures from sovereign securities towards corporate securities and from

bonds to real-sector loans, easing financing conditions to corporates and households in the process. 24]
The shift towards foreign assets had been more pronounced among foreign investors, who were the
main selling sector counterpart in the APP during the pre-pandemic period, but it was also evident

among euro area investors (Chart 3).!24] This had played a significant role in explaining the limited
effect that the APP had on the expansion of broad money supply before the pandemic, a phenomenon
that was similarly observed during the third round of quantitative easing in the United States (Chart 4).
In other words, the APP had exerted robust monetary transmission even in the absence of a strong
expansion in the money supply, because the exchange rate channel had become a powerful substitute
for the traditional money-creation mechanism that worked through the liability side of bank balance
sheets.

Chart 3
Net portfolio investment in debt securities by euro area non-MF Is

(12-month flows in EUR bn)

= Total
@ Net purchases by euro area non-MFls of debt securities issued by non-euro area residents

tm@ Net purchases by non-euro area residents of debt securities issued by euro area general government
@ Net purchases by non-euro area residents of debt securities issued by euro area non-MFls other than general government

400

-400 i
-600

-800
2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

Sources: ECB (BPS) and ECB calculations.

Notes: As is common in the monetary presentation of the balance of payments, the b.o.p. items correspond to the
non-MFI sector and display the sign that matches the related monetary flows, i.e. monetary inflows are shown with
a positive sign and monetary outflows are shown with a negative sign.

The latest observations are for April 2024.

Chart 4
Sources of money creation

Euro area United States

(annual percentage changes and contributions) I (annual percentage changes and contributions)

= M3 = M2
© Loans to firms and households © Business, mortgage and consumer loans
@ Net external monetary flows @ Net external monetary flows
® Eurosystemnet purchases ®@ Fed net purchases of securities
Other counterparts Other counterparts
15 30

10 20

5 10
I fl I I I

AT ill = aE I ° a

6
2013 2015 2017 2019 2021 2023

WLU
mn" wn

i Ht HU wy

-10
2013 2015 2017 2019 2021 2023

Sources: Left panel: ECB (BSI) and ECB calculations; right panel: Federal Reserve Board/Haver Analytics, Bureau
of Economic Analysis and ECB calculations.

Notes: Panel a: Figures for M3 are adjusted for the operational incident in TARGET2 which inflated the September
2022 figures for OFI deposits and loans, reversing them in October and November 2022. Panel b: Net external
monetary flows (which are the exchanges between the non-MFI sector and the rest of the world) are obtained by
subtracting the contribution of deposit-taking institutions and central bank (where available) to the US b.o.p. They
display the sign that matches the related monetary flows, i.e. monetary inflows are shown with a positive sign,
monetary outflows are shown with a negative sign. The latest observation for that series is for Q1 2024, but the
monthly flow for April 2024 is kept equal to that of March 2024. As required by the monetary framework,
Eurosystem purchases includes securities issued by euro area non-MFls.

The latest observations are for April 2024.

The long-standing internal monetary analysis of the factors explaining the setting of bank lending rates
was critical in the recalibration of existing TLTROs during the pandemic. In particular, the pricing of the
new wave of TLTROs following the outbreak of the pandemic relied on the accumulated evidence that
the unconventional policies deployed by the ECB had lowered various components of bank funding

costs in the aftermath of the euro area sovereign debt crisis (Chart 5), (28) Empirical estimates indicate
that, in the absence of the recalibration of the targeted lending programme, the ability of banks to
supply credit would have been severely affected. Importantly, the lower amount of lending to firms

would have led to a significantly larger decline in employment by firms.22]

Chart 5
Lending rate to non-financial corporations and its components

(percentages per annum)

m Realised lending rate @ Cost of credit risk

= OS 3Y @ Money market and ECB borrowing
tm@ Bank bonds Residual

@ Deposits

2
2004 2008 2012 2016 2020 2024

Sources: ECB (BSI, MIR), Bloomberg, Moody's and ECB calculations.

Notes: The chart decomposes the realised lending rate on new loans to non-financial corporations (blue line) into
contributions from bank cost components. The residual between the realised lending rate and the various cost
components identifies a measure of intermediation margin. Deposits, bank bonds and money market and ECB
borrowing are expressed as spreads vis-a-vis the base rate (i.e., the three-year overnight index swap (OIS), black
line), weighted by their respective importance in banks' funding mix. The latest observations are for April 2024.

The post-pandemic surges in inflation

The combination of extraordinarily high liquidity needs and our monetary policy measures to maintain
favourable financing conditions boosted broad money growth. As a result, credit to firms and central
bank purchases became the main sources of money creation. This composition reflected the broad
division of tasks in the support given to the euro area economy, with the support to the corporate sector
mostly channelled via bank credit (whose conditions were eased by monetary policy, government
guarantees and regulatory measures) while the support to households was mostly channelled via the
government sector. The latter, and thus the liquidity needs of the economy, explain the marked impact
of central bank purchases on money growth in the early stages of the pandemic. In contrast to the
2015-2018 period, these purchases occurred alongside an increase in government borrowing. Such
borrowing prevented the bond scarcity that large-scale asset purchases can imply, thereby averting the
usual financial outflows to the rest of the world (Chart 4, left panel).

As economic activity resumed and lockdown restrictions were lifted, emergency liquidity needs declined
and money growth also slowed. By October 2020, the three-month annualised growth rate of M3 had
dropped to 7.5 per cent, which was about one-third of the 21.9 per cent rate seen at the peak of the
lockdowns, and just somewhat above the historical average. The growth rate continued to decrease
until mid-2022 even in the face of increased borrowing prompted by liquidity demands from the energy

crisis. Shortly after we started hiking rates in July 2022, M3 growth even dipped into negative territory
before recovering somewhat in the second half of 2023.

Inflation began to rise just as money growth slowed down. Initially, these price increases were
concentrated in specific sectors, particularly affecting energy and food prices, rather than showing a
broad-based increase across all goods and services, which would have been more consistent with a
monetary origin for the inflation surge (Chart 6). These heterogeneous price increases align with the
view that inflation was largely due to specific cost-push shocks passing through to the wider
consumption basket. This perspective is supported by structural analyses identifying energy and food

price shocks together with supply chain disruptions as the main culprits of the inflationary pressures. (29)
It is also consistent with the interpretation that the robust money growth during the early stages of the
pandemic was a result of accumulating liquidity reserves, which in turn were not inherently inflationary.
Taken together, the evidence indicates that the recent inflation surge is primarily attributable to rising

commodity prices and global supply constraints, rather than an expanding money supply.24)

Chart 6
Headline inflation, money growth and commodity prices, and headline inflation and
subcomponents

Headline inflation, money growth _IHeadline inflation and
and commodity prices subcomponents

(left-hand scale: annual percentage changes; (annual percentage changes)
right-hand scale: index in USD)

HICP - Food incl. alcohol and tobacco
HICP - Energy

HICP - Services

HICP - Overall index

HICP - Overall index
Energy commodity prices (right-hand scale)
M3

Non-energy commodity prices (right-hand scale)

16 160 HICP - All-items excluding energy and food
14 140 50
12 120
10 100 40
8 80
6 60 30
4 40 20
2 20
° o 10
2 -20
4 40 0
6 60
8 -80 10
2019 2021 2023
-20
2019 2021 2023

Sources: ECB (BSI), Eurostat, World Bank and ECB calculations.

The latest observations are for April 2024.

The surge in borrowing by firms, which peaked during the second quarter of 2020 amid the initial
lockdowns, was primarily driven by need for working capital and precautionary reasons. Borrowing by
firms closely matched their increases in cash reserves. Since this borrowing was not for investment
purposes, it did not stimulate aggregate demand.

Household behaviour points to a similar message. Government aid to households served to cushion
their reduced income rather than to increase spending: fiscal transfers only covered part of the
slowdown in household income over the pandemic period. Most of the excess savings accumulated
during the pandemic resulted from falling consumption, which was much larger than the drop in income
(Chart 7, left panel). This decline in consumption was partly forced by the reduced consumption
opportunities due to the pandemic restrictions but it is likely to have also reflected precautionary
behaviour related to uncertainty about the future. The latter led to an increased preference for liquidity,

and indeed a large part of household excess savings were accumulated in the form of overnight

deposits, especially in the initial phases of the pandemic (Chart 7, right panel).[22]

Chart 7
Savings over the pandemic period

Sources of savings Uses of excess savings
(quarterly flows in EUR bn compared to the (percentage points of disposable income and
same quarter of two years before) percentage point contributions; changes with

respect to the corresponding quarter in 2019)

== Gross savings © Currency and deposits
© Consumption (-) © Loan repayments
Compensation of employees ® Housing investments
@ Net gov. transfers © Other financial assets
Mi Other income @ Excess savings
400 14

6
4
2
-200 = -
SNmMernmMerameraae
ooooocooooc oc oo oc"? -2
Seeere2e22Rh8S8RRRRRS 2020 2020 2020 2020 2021 2021 2021 2021
RRARRARAKRARKRAKRRAAT ao@ @ a4 ai @ @ a

Sources: ECB (QSA), Eurostat and ECB calculations.

Notes: right side: The chart compares the ratio of savings to disposable income and its contributions, to the same
ratio and contributions in the corresponding quarters in 2019.

The latest observations are for 2021 Q4.

Consumption only started to approach its pre-pandemic level by the middle of 2021, but households
continued to express their willingness to maintain a higher level of savings or financial investments, a
considerable part of which remained in overnight deposits. This composition also reflected the

flattening yield curve and the low opportunity cost of holding those deposits. !$3]

Chart 8
Individual consumption of selected goods and services and corresponding price
developments

(left-hand scale: chain-linked EUR bn; right-hand scale: annual percentage changes)

= Real food expenditures = Real energy expenditures = Real other expenditures
== Price index (right-hand scale) m= Price index (right-hand scale) w= Price index (right-hand scale)
750 12 260 50 6,000 6
250 40 5.500 5
700 8
240 30 5,000 3
650 4 230 20 4500 2
220 10 4,000 0
600 0
210 0 3,500 -2
550 4 200 -10 3,000 -3
BR5g5e2e2N BR5ggee2e2N 885s5ec¢e2q
SFRARRARRAS SFRRARRARAAS S2RRRRRARA

Sources: Eurostat and ECB calculations.

The latest observations are for 2022.

As energy and food prices began to rise, households moderated their accumulation of deposits but also
reduced the real consumption of those products (Chart 8). The configuration of falling consumption and
rising prices for energy and food is consistent with supply shocks driving energy and food prices rather

than reflecting a surge in domestic demand.4I In addition, falling consumption also indicates that the
excess deposits accumulated during the pandemic did not lead to households being insensitive to more
expensive and energy and food bills.

Chart 8 also shows that, as the economy reopened and uncertainty receded, household consumption
volumes of items other than energy and food rebounded towards pre-pandemic levels despite the price
increases in those items in the course of 2021 and 2022. While the configuration of rising consumption
and rising prices might suggest some role for domestic demand, consumption of these items remained
clearly below the previous trend. It is certainly the case that, for a given surge in supply-driven inflation,
excess savings allowed households to cut consumption by less than if the supply shock had happened
at a time when excess savings were lower.

The coexistence of high inflation and only a moderate consumption recovery serves to underline the
scale of supply-driven cost pressures during 2021 and 2022: only a dramatic monetary and/or fiscal
tightening would have been needed to eliminate the inflation surge by reducing domestic demand
sufficiently (involving a severe drop in domestic incomes) to match the reduction in supply capacity.

Overall, although real private consumption and investment have rebounded in the post-pandemic
period, these have not reached the levels projected in mid-2021 when excess savings were at their

highest, and real private consumption continues to trail the forecasts made before the pandemic. In this

context a dramatic recession would have been required to fully avoid an inflation surge. 25]

The tightening cycle

Monetary analysis has been central to the regular assessment of the state of the monetary policy
transmission, which has been a key guiding principle in calibrating the speed and scale of the monetary
policy tightening over the last couple of years. 38]

Focusing on the propagation of that tightening impulse through the banks, both the rate hikes that
started in July 2022 and the sustained upshift in the yield curve that preceded and accompanied that
process led to a significant rise in bank funding costs, initially driven by bonds and subsequently by
deposit rates (Chart 9). The latter adjusted with a lag, owing to the atypical interest rate configuration
during the negative rate period, but eventually aligned with our policy signal (Chart 10).

Chart 9
Bank funding costs

(percentages per annum)

ees Interbank rate == Composite funding cost
= Deposit rate ee= Bank bond yields
5
4
3
2
1
0
-1
Jan-22 Oct-22 Jul-23 17 June 2024

Sources: ECB (BSI, MIR, CSDB, MMSR) and ECB calculations.

For monthly data, the latest observations are for April 2024, for daily data, the latest observations are for 17" June.

In parallel, loan volumes in the euro area have experienced a marked decline since late 2022. After
dropping sharply, credit flows have remained stagnant for both loans and bonds (Chart 11, left panel).
The pronounced decline in credit compared to previous hiking cycles (Chart 11, right panel) was largely
due to the sharp increase in interest rates, which has significantly dampened demand, as also reflected
in the ECB bank lending survey (BLS). Initially, credit demand showed some resilience, primarily driven
by the liquidity needs of firms during the peak of the energy crisis. However, it began to contract in the

last quarter of 2022 and continued to do so for several months after the last rate hike in September
2023. The primary drivers behind the weakness in demand were elevated interest rates and reduced
recourse to credit for financing investments, which reflects the "cost of capital" channel of monetary
policy (Chart 12).

Chart 10
Transmission to deposit rates

(percentages per annum)

= ECB relevant policy rate
- Overnight deposits

= Time deposits up to 2 years Firms
6 6
5 5
4 4
3 3
2 2
1 a 1
0 0
I 1
1999 2002 2005 2008 Jan-22 Aug-22 Mar-23 Oct-23
Households
6 6
5 5
4 4
3 3
2 2
1 oS ee) 1
0 i)
1 4
1999 2002 2005 2008 Jan-22 Aug-22 Mar-23 Oct-23

Sources: ECB (MIR, FM) and ECB calculations.

Notes: The ECB relevant policy rate is the MRO for the 1999-2008 panels and the DFR for the panels starting on
2022.

The latest observations are for April 2024.

Chart 11

Firm debt financing (left side), and comparison of slowdown in loan dynamics to past

regularities (right side)

Firm debt financing

Comparison of slowdown in loan
dynamics to past regularities

(12-month flows in EUR bn)

© Borrowing from banks
@ Netissuance of debt securities
600

500

ohh

Jan-19 Jan-20. Jan-21. = Jan-22)- Jan-23

40

Ss

30

Ss

20

Ss

10

Ss

Jan-24

(x-axis: years, y-axis: growth rate of credit in
deviation from its growth rate at the start of the

cycle (t), in pp)

Range of past hiking cycles
ee= Current hiking cycle
= = =~ = Counterfactual conditional only on policy rate changes

8

+3
+2
t+
t+2
+3

+1

Sources: ECB (BSI, CSEC) and ECB calculations.

Notes: MFI loans are adjusted for sales and securitisation and cash pooling. The seasonal adjustment of the net
issuance of debt securities is not official. The dotted line corresponds to a BVAR counterfactual for lending
volumes, taking December 2021 as the latest observation and projecting volumes conditional on the path of
monetary policy rates. The type of BVAR used is the one used by Giannone, D,, Len