In earlier remarks, I argued that in the vicinity of the effective lower bound, attempting to shorten the horizon by further easing financial conditions carries the risk of shifting the balance of the costs and benefits of a highly accommodative monetary policy stance by increasing potential side effects.6 At the current juncture, an important element in determining the appropriate length of the medium term is the risk of second-round effects that may entrench expectations of low inflation and thereby leave permanent scars on the euro area economy. However, this risk is mitigated by the emerging policy response in the euro area. For the first time, fiscal and monetary policy in the euro area are starting to act as true complements, thereby reinforcing each other’s effectiveness and paving the way for a sustainable recovery. Moreover, inflation expectations by households currently signal very limited risks of second-round effects. While financial markets currently price in significant risks of deflation over the next five years (see left chart on Slide 9), households have adjusted their expectations in response to the pandemic very differently: the share of people that expect inflation to increase more rapidly over the course of next year has increased markedly in April, from 20% to 36%, and in May still accounted for 32% (see right chart on Slide 9). So, given the already highly accommodative monetary policy stance, the growing complementarity between fiscal and monetary policy and the high uncertainty regarding secondround effects, our decision appears to be an appropriate and proportional course of action.

The logic is easy to see: a reduction in short-term risk-free rates typically leads yield-oriented investors to rebalance their portfolios towards riskier assets, either along the yield curve or across asset classes. This channel is even more powerful when rates are negative: it sets strong incentives for investors to move away from short-term assets so as to ensure non-negative income flows (see Slide 4). Market stress considerably weakens this portfolio rebalancing channel. And although markets have calmed gradually, both in the euro area and in the United States, stress indicators remain at an elevated level compared to the pre-crisis period (see Slide 5). In such conditions, two sets of policy measures tend to be most effective: those acting directly on banks’ funding conditions, and those, such as asset purchases, that alleviate investors’ balance-sheet constraints. The bank-based measures materially reduce the potentially adverse impact of tightening marketbased funding conditions on lending to firms and households. In the euro area, this risk is real: 3/7  BIS central bankers' speeches  banks still face considerably higher refinancing costs in markets than before the crisis, both for secured and unsecured borrowing. Our targeted longer-term refinancing operations (TLTRO III) address this wedge in our transmission process at its root. Provided banks maintain their lending to the real economy over the next year, they can benefit from rates as low as –1%. Given these highly favourable conditions, surveys point to significant take-up for TLTRO III, in the order of € 1.4 trillion.