first half of 2012 was not accompanied by an equivalent deterioration in those countries ’ fundamentals. at the same time, there was an acute risk that contagion would affect other euro area countries, pointing to systemic risks that were not limited to specific countries. a key factor driving those developments was fears in the markets regarding an involuntary break - up of the euro area – i. e. fears concerning the “ reversibility of the euro ” and the bis central bankers ’ speeches associated implicit exchange rate risk. this view was supported by model calculations which showed that, in july 2012, the spread that could not be attributed to fundamentals stood at up to 2 percentage points for italian and spanish two - year government bonds. there were also signs that international firms were hedging against the risk of individual member states leaving the euro area. britain ’ s financial supervision authorities were advising financial institutions to be prepared in the event of the euro area collapsing. moreover, spanish and italian banks lost their access to market - based financing instruments. between april and july 2012 spanish bank bonds to the value of €36 billion matured, but no more than €0. 5 billion of spanish bank bonds could be newly issued during that period. against that background, we had to conclude that, in individual parts of the euro area, the steering of monetary policy was not functioning fully, or was in part not functioning at all. the key interest rate had lost its key function, with considerable disruption of the transmission of monetary policy on account of the implicit exchange rate risk. this economic environment clearly pointed to a significant credit crunch and a severe decline in economic activity. there was a risk of an incipient deflationary spiral – a process involving continual declines in prices. price stability would then no longer have been ensured across the euro area. we in the governing council of the ecb discussed and debated at length the issue of what the european central bank should and had to do in such a situation in order to fulfil its tasks and responsibilities. effective action the instrument being considered had to be effective, in order to eliminate the unfounded fears regarding the reversibility of monetary union and the resulting interference with our monetary policy mandate. in setting up the omt programme, we learnt from our experience with the first bond buying programme from 2010 – the securities markets programme ( smp ) – and made the omts even more targeted. the omt programme differs from the smp in the following ways. first, there is strict

of credit market imperfections, limited asset - market participation or plain myopia is potentially sufficient. indeed in subsequent work ( curdia and woodford, 2010 ), woodford himself explores some of the ways that asset purchases might have traction, while andres, lopezsalido and nelson ( 2004 ) provide a particular model that embeds imperfect substitutability arising from limited participation within a dsge framework. both the federal reserve and the bank of england have bought longer - dated government and private assets, though with different emphases. 6 the federal reserve has purchased $ 1. 45 trillion ( 10 per cent of gdp ) worth of government sponsored enterprise debt and mortgage - backed securities guaranteed by them. in addition, the federal reserve has purchased $ 300 billion ( 2 per cent of gdp ) worth of us treasuries. the bank of england has bought nearly £200 billion ( 14 per cent of gdp ) of uk government bonds, together with a small quantity of corporate bonds. the bank of japan has also bought around ¥13 trillion ( 3 per cent of gdp ) of japanese government bonds since the crisis deepened in late 2008 ; that is to be compared with ¥20 trillion of purchases during their 2001 – 6 quantitative easing period. it is worth stressing that neither the federal reserve nor the bank of england has assigned a key role to the expansion of central bank liabilities in the transmission mechanism associated with these asset purchases. in current circumstances, it is plausible to believe that commercial banks would be willing to hold the extra claims on the central bank as liquid assets at, or near, the existing vector of interest rates, rather than lending them on and driving down loan rates. that is reflected in the fact that the ratio of the monetary liabilities of the banking system ( broad money ) to the monetary base has fallen sharply in both countries, as indeed it did in japan a decade earlier. in its communications, the bank of england has stressed the monetary impact of its asset purchases, but that has been on the quantity of monetary deposits in the banking system, not narrow money. have these policies been effective? or does eggertsson and woodford ’ s neutrality result apply? studies of japan ’ s earlier experience of quantitative easing suggested only rather modest effects. for instance, bernanke et al. ( 2004 ) found that although the falls in government bond yields following bond purchase announcements were statistically significant, they were typically just a few basis points in magnitude. nevertheless, over the