Mario Draghi: President's address at the 16th ECB and its Watchers
Conference
Speech by Mr Mario Draghi, President of the European Central Bank, at the conference "The
ECB and Its Watchers XVI", Frankfurt am Main, 11 March 2015.
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Summary
In January, the ECB decided to expand its asset purchase programme to include
government bonds after it became clear that there was a need for more monetary stimulus.
Asset purchases are unconventional, but not unorthodox, and they have been part of the
ECB's toolkit from the start. By deploying this tool, the ECB underlined its ability and
determination to stabilise euro area inflation in line with its objective.
The impact of the programme and the ECB's previous monetary policy measures is visible:
Bank lending rates to companies started to decline in the third quarter of last year,
marketbased measures of inflation expectations have reacted positively to the ECB's balance sheet
expansion over recent months, and euro area long-term sovereign yields have fallen - in
spite of the renewed crisis in Greece. This suggests that the asset purchase programme may
be shielding other euro area countries from contagion, which also helps the ECB achieve its
monetary policy goals across the euro area.
The euro area economy grew more than expected in the fourth quarter and unemployment
fell to its lowest level since August 2012 in January. While this cannot exclusively be
attributed to the ECB's monetary policy, it certainly supports the recovery. Even though
inflation is expected to remain very low or negative in the months ahead mainly due to the
sharp drop in oil prices, it is expected to move closer the ECB's policy target over the coming
years to reach 1.8 per cent in 2017 - conditional on the full implementation of all policy
measures.
The beneficial impact of the ECB's asset purchases on financing conditions will increase the
benefits of governments' structural reforms, rather than reducing incentives for reforms.
Firms will be encouraged to increase investment, bringing forward the economic recovery.
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Ladies and Gentlemen,
Since the last Watchers' conference in March 2014, we have reached deeper in our
monetary policy tool box. The means have changed quite substantially, as dictated by
circumstances, but the end has not. To be able to deliver on our medium term price stability
mandate, we needed to adapt and expand our monetary policy tools.
I would like to open this conference by elaborating on what has changed, how it has
changed, and how this helps us to fulfil our mandate.
Reaching deeper into the monetary policy toolbox
At the time of the last Watchers' conference policy rates were already moving towards zero
and we had reached a point where there was little room for manoeuvre with the standard
instrument of monetary policy. We did eventually reach the effective lower bound later in the
year by lowering incrementally the corridor of policy rates in June and September.
When a central bank's ability to steer the overnight rate is limited, it can still alter its monetary
stance by means of directly influencing expectations. This is the context in which the ECB
introduced forward guidance in 2013. Our forward guidance was effective in flattening the
money market curve and decoupling it from the curve in the United States. But its power
becomes more limited, as the horizon over which the policy rate is intended to be at the
effective lower bound extends beyond the forecast horizon. Moreover, forward guidance by
the ECB was not and could not, in Paul Krugman's words, "credibly promise to be
irresponsible".
What this means is that when the need for additional monetary stimulus arose, the ECB
could no longer rely solely on acting in the money market, counting on transmission from the
money market to other market segments, and from those to the real economy.
Like other major central banks, we therefore had to intervene directly in markets beyond the
money market to have a more direct impact on the various channels of monetary policy
transmission. And the way to do that was to purchase assets in those other markets.
Unconstrained monetary policy is key
Asset purchases are nothing new. They have been available and have been routinely used
by central banks ever since these institutions came into existence, and that was long before
the crisis started. Incidentally, asset purchases have formed part of the ECB's toolkit from the
start: outright purchases of marketable instruments - which include government bonds -
have always been listed in our statute as part of our monetary policy toolbox. And the
legitimacy of using public sector bond purchases in the pursuit of medium-term price stability
was unanimously confirmed by the Governing Council on 22 January.
Asset purchases are unconventional, but they are not unorthodox. They are in fact eminently
orthodox. And they are in a central bank's toolbox for a reason. Independence is essential for
the central bank's credibility. But equally essential is that the central bank has the means, i.e.
the policy instruments, to achieve its mandate. Together they allow the central bank to
achieve price stability, which in turn boosts its credibility.
Our decision in September to make use of asset purchases had significant effects. But still,
when we announced the purchase of asset-backed securities (ABSs) and covered bonds,
there were some in the market place who doubted our commitment and the effectiveness of
our monetary policy. They thought we might be hampered either by there being a limited
availability of assets that we could purchase in the market or by legal or political obstacles to
our ability to expand the range of assets, should it become necessary. If we were so
constrained, that would affect our credibility because our ability to anchor expectations relies
in part on the fact that we are free to set the appropriate monetary stance.
In this context, the decisions we took in January to expand the range of our asset purchases
must have assuaged those concerns. We can deploy - and we are deploying - monetary
policy in a way that can - and will - stabilise inflation in line with our objective.
How the expanded asset purchase programme is working its way into the real
economy
As its name indicates - the expanded asset purchase programme is just an extension of the
programme that we announced in September as part of a more comprehensive easing
package. This package has been effective in improving the pass-through from liquidity
injections into private sector borrowing costs: bank lending rates to non-financial corporations
started to decline in the third quarter of last year, coinciding with the first targeted long-term
refinancing operation (TLTRO) and our announcement to purchase ABSs and covered
bonds, and also following the repair of banks' balance sheets during the comprehensive
assessment.
Furthermore, model-based estimates indicate that - controlling for other developments -
market-based measures of inflation expectations have reacted positively to the progressive
expansion of our balance sheet over the last few months. There is thus good reason to
believe that as our balance sheet grows more substantially under the expanded asset
purchase programme, it will support a rebound of these measures.
Second, our policy announcement was largely anticipated. On 1 January 2015, 60% of
surveyed experts attached a 65% or higher probability that we would announce a public
sector securities purchase programme at our January meeting. And, according to various
surveys, expectations were already quite high in autumn last year.
These anticipation effects show up in the financial data. According to estimates, the impact of
the asset purchase programme has accounted for most of the fall in euro area long-term
sovereign yields since August last year. The same applies for movements in other financial
markets metrics, such as the fall in long-term corporate bond yields of non-financial
corporations.
Beyond anticipation effects, the announcement of the expanded programme of asset
purchases itself also led to substantial further falls in longer-term sovereign yields. For
instance, from just before our announcement on 22 January to the close of business the day
after, German 20-year maturity yields fell by almost 25 basis points and Italian 20-year
maturity yields fell by almost 35 basis points.
We also saw a further fall in the sovereign yields of Portugal and other formerly distressed
countries - in spite of the renewed Greek crisis. This suggests that the asset purchase
programme may be shielding other euro area countries from contagion, which also helps us
achieve our monetary policy goals across the euro area.
The reductions in sovereign yields seem to have passed through into other fixed-income
assets, as well as to equities and the exchange rate. Yields on covered bonds and corporate
bonds declined in tandem with longer-term sovereign yields - even though corporate bonds
are not included in our purchase programme.
Such spillover effects are associated with portfolio rebalancing, which is one of the channels
through which the asset purchase programme reaches the real economy: our purchases
reduce returns on safer assets. This encourages investors to shift to riskier, higher yielding
assets. Pension funds, banks and other market participants that we buy securities from are
likely to substitute these for other long-term assets, thereby eventually pushing up prices
more broadly.
We are aware that our measures may entail some financial stability risks. But currently these
risks are contained. And should they emerge, macroprudential policy is best suited to
address them.
Experience with large-scale asset purchase programmes in other jurisdictions shows that the
portfolio balance channel works. For instance, model-based estimates show that as a
consequence of the Bank of England's quantitative easing programme, insurance companies
and pension funds invested less in gilts and more in corporate bonds,1 leading to price
increases of both investment grade and non-investment grade corporate bonds.
Drawing inferences from the experience in other jurisdictions is certainly helpful to gauge the
potential impact of our own programme.
Much has been said about the different conditions - meaning much lower bond yields -
under which we are starting our expanded asset purchase programme from those under
which other central banks did so. It is claimed that this reduces the impact on bond yields.
But, in fact if one standardises the size of the various programmes and takes into account
anticipation effects, the overall impact of our programme on bond yields was comparable in
size to that observed in other jurisdictions such as the US and the UK.
Conditions also differ because financial structures differ. In the euro area, corporate debt
financing mainly takes place via banks, as opposed to capital markets in the United States.
There is, however, no reason, once the transmission channel is not impaired by banks' poor
balance sheets, why this difference should impede the effectiveness of a broad-based asset
purchase programme that works through a multitude of channels. The programmes of both
the Bank of England and the Bank of Japan were effective and the respective economies are
almost as bank-based as the euro area.
One criticism is that we should have implemented our asset purchase programme much
earlier. But it is not that we have not been acting last year. In a speech in Amsterdam in April
last year I laid out three contingencies that would warrant a monetary policy reaction. These
were, first, an unwarranted tightening of monetary policy stance (e.g. from developments in
short-term money markets) that could be tackled through more conventional measures.
Second, a further impairment in the transmission of our stance, in particular via the bank
lending channel, for which a targeted LTRO or an ABS purchase programme might be the
right response. And third, a worsening of the medium-term outlook for inflation, which would
warrant a more broad-based asset purchase programme.
As these contingencies materialised we acted, first in June with the announcement of the
TLTRO and ABS purchase programme. Then, as medium to long-term inflation expectations
started to drift downward in the summer and the risks of a too prolonged period of low
inflation were rising, we broadened our asset purchase programme with covered bonds in
September and public sector securities last January.
Summing up, market reactions both before and after our announcement, as well as
experience in other jurisdictions show that the asset purchase programme can work. What is
the evidence that the easing of financial conditions is finally starting to affect the real
economy?
The expanded asset purchase programme and the outlook for growth and inflation
Developments are pointing in the right direction. The so-called surprise index that compares
actual macroeconomic data with consensus estimates of market analysts shows that on
average the latest news is positive.
The slowdown in growth has reversed. Euro area real GDP rose by 0.3% quarter on quarter
in the last quarter of 2014, which is somewhat higher than previously expected. Survey
evidence points to further improvements in economic activity at the beginning of this year so
that the economic recovery should gradually broaden and strengthen. And in January, the
euro area unemployment rate dropped to the lowest level observed since August 2012.
Of course, these improvements cannot and should not solely be attributed to our monetary
easing. But our monetary policy is certainly supporting the recovery.
This is also reflected in the ECB staff macroeconomic projections that we published last
week. In those projections, expectations for real GDP have been revised upwards, both for
2015 and 2016, relative to the previous exercise. These upward revisions are mainly driven
by the favourable impact of lower oil prices, the weaker effective exchange rate of the euro -
and the impact of our recent monetary policy measures. The latter have had a very
substantial impact on what we call "market-based technical financial assumptions", such as
interest rates, exchange rates and stock prices, with the effect being especially large on
longterm interest rates.
Annual HICP inflation, in turn, is expected to remain very low or negative in the months
ahead and to start increasing gradually later this year. The ECB staff projections for inflation
this year have been revised downwards to 0.0%. This mainly reflects the sharp drop in oil
prices at the end of last year.
But there is good reason to believe that the effect of this shock will not extend beyond 2015,
in part because our monetary policy decisions have significantly decreased the risk of
second-round effects.
Accordingly, the inflation projection for 2016 has been revised slightly upwards to 1.5%; and
for 2017 inflation is expected to be 1.8%. This expected pick-up in inflation is supported by
the favourable impact of our recent monetary policy measures on aggregate demand, the
impact of the lower euro exchange rate and the assumption of somewhat higher oil prices in
the years ahead.
The ECB staff projections fully incorporate the estimated impact of our policy measures.
They are thus conditional on the full implementation of all the announced measures. And this
is indeed what we have started doing last Monday.
Conclusion
Let me conclude. Our recent monetary policy measures are a valid and effective tool to bring
inflation closer to our policy goal. They can support a faster and more sustained recovery.
This will especially be the case if they fall on fertile ground. Governments can create a more
investment-friendly environment by swiftly, credibly and effectively implementing structural
reforms. The beneficial impact of our asset purchases on financing conditions, rather than
reducing the incentives for reforms, will actually increase the benefits of such reforms, as
firms will be encouraged to increase investment, bringing forward the economic recovery.
Effective, price-stability oriented monetary policy and structural reforms work hand in hand.