erkki liikanen : eurosystem ’ s monetary policy and its transmission speech by mr erkki liikanen, governor of the bank of finland, at the rotman icpm forum, helsinki, 5 october 2015. * * * accompanying slides ( pdf ) can be found on the bank of finland ’ s website. [ slide 1 : title page ] welcome [ slide 2 : agenda ] [ slide 3 : i – eurosystem ’ s expanded asset purchase programme ( eapp ) : background ] [ slide 4 : decisive action by the eurosystem stabilised financial markets ] the financial crisis created great uncertainty and increased challenges from the monetary policy - making. not just the eurosystem but central banks around the world reacted by cutting policy rates, increasing their banking system ’ s liquidity and adopting so - called non - standard measures of monetary policy. in july 2012 the president of the ecb, mario draghi, committed to do “ whatever it takes to preserve euro ”. this came to mark a turning point for the crisis : markets calmed down and fears of euro area breaking down were removed. during the same month, in its monetary policy meeting, the ecb ’ s governing council cut the main policy rate to below 1 percent, and the deposit rate to zero. by mid - 2014 all crisis countries apart from greece were again able to borrow from private markets. [ side 5 : traditional monetary policy restricted by the zlb ] despite stabilisation of the financial markets, the operating environment of monetary policy remained challenging. inflation and expected inflation continued to slow down and short term money market rates increased, which meant that further monetary policy easing was needed to maintain price stability over the medium term. the policy rate is, indeed, the most straightforward tool the central bank has to steer market interest rates. by 2014 we, the governing council, had cut the policy rates almost to zero. the deposit rate was cut to negative in the june 2014 policy meeting. the sheer existence of a lower bound for policy rates complicates monetary policy decision making as it creates asymmetry : a central bank can always increase its policy rate to control inflation but the policy rate cut is limited by the zero bound even if inflation drops to very low levels. [ slide 6 : real interest rates increase if inflation expectations fall ] the zero lower bound creates a challenge, as falling inflation puts upward pressure on real interest rates. it is the real interest rates, and expectations of them – not the central bank ’

[ slide 18 : signalling : money market rates expected to remain low ] forward guidance has been credible in a sense that expectations on money market rates remain low well into the future. the money market rates are expected to remain zero at least until 2017. [ slide 19 : 2. signaling : transmission of low policy rates to provision of credit has improved ] further increase in accommodative monetary policy by asset purchases has worked itself through banks ’ retail interest rates. since the announcement of the purchase programme, the average interest rates of new corporate loan agreements have kept falling, especially in giips countries. as banks ’ expectations on the eurosystem ’ s monetary policy stance eased, the money market interest rates fell. for example, the 12 - month euribor declined by almost 50 basis points since mid - 2014, to 0. 15 %. almost 60 % of euro area corporate loans are linked to euribor rates. [ slide 20 : 3. portfolio balance : share prices have increased, recently increase in volatility ] the portfolio balance channel broadens the effects of asset purchases to the whole financial system. if a central bank purchases long - term debt securities, the average duration of debt securities on the market decreases. narrowing of the yield spread encourages investors to purchase bonds with even longer maturities, and long - term bond yields decline further. investors will also have to look for substitutes for government bonds they sell to the eurosystem. rebalancing investment portfolios is reflected in corporate bond yields and equities. a decline in yield of corporate bonds reduces funding costs and encourages investments. a rise in securities prices increases the wealth of securities holders and thus consumption. [ slide 21 : portfolio balance : effects of eapp on pension funds ] in the short run, a bond purchase programme lowers yields and increases the value of asset classes such as stocks. therefore, effectiveness of the portfolio channel depends partly on the ability of investors to sell their sovereign bond holdings to the eurosystem and invest in other securities. this is an issue that might be challenging to institutional investors such as pension funds, as rules limit their ability to invest in riskier assets. on the other hand, search for yield and higher returns might make some investors to take on excessive risk. central banks ’ asset purchase programmes are not the only reason for the globally low interest rate environment. in any case, medium term profitability of pension funds may be challenging in the low interest rate environment. for those companies that have in