KEYNOTE LECTURE AT THE INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES (ICMB),
GENEVA, 28 APRIL 2009
HOW ARE UNCONVENTIONAL MEASURES IMPLEMENTED?
1 Direct Quantitative Easing
2 Direct Credit Easing
3 Indirect (or Endogenous) Quantitative/Credit Easing
3 Indirect (or Endogenous) Quantitative/Credit Easing
The measures described above foresee the direct acquisition by the central bank of the assets, in exchange for central bank money. This implies that the central bank directly holds the assets, until maturity or resale, and thus the risk on its balance sheet. An alternative way is to increase the size of the balance sheet by lending to banks at longer maturities, against collateral which includes assets whose markets are temporarily impaired. This policy affects directly the yield curve over the horizon at which policy operations are conducted or committed to be conducted. For instance, monetary policy operations with maturity of 6 months directly affect the 6 months interbank money market. This is particularly the case if the operations are conducted at a fixed rate, full allotment. The horizon of the yield curve which is affected may be lengthened to the extent that the central bank commits to conduct such type of tenders for a given period of time. For instance, if the central bank commits to conduct 6 months refinancing operations with fixed rate tenders for 2 years, the yield curve over the two and a half year horizon is likely to be influenced.
The increase in the monetary base is determined endogenously by the banking system, based on banks’ preference for liquidity and thus on the state of stress of the banking system. In normal conditions, when financial markets function properly, the size of the central bank balance sheet would be such that the overnight rate would coincide with the short term refinancing rate of the central bank and excess reserves are negligible. Under stress, the size of the central bank balance sheet would increase, on the basis of banks’ increased demand for excess reserves, to the point that the overnight rate would be lower than the short term main refinancing rate.
Another aspect of such a policy relates to the quality of the collateral. By enlarging the pool of the collateral accepted for the refinancing operations with the central bank, the financing conditions by banks to these sectors are facilitated, which should be reflected in the credit spreads that banks charge in particular to the corporate sector. This technique also enables the counterparties of the central bank to choose the collateral to use in their refinancing operations. In times of market stress there will be a natural tendency for banks to use a greater amount of assets of a lower quality. The overall collateral deposited with the central bank will vary endogenously, depending on the state of stress of the financial markets. The eligibility of certain categories of assets for monetary policy operations will facilitate their creation and trade among market participants.
In the euro area, the ECB decided to adopt a ‘fixed-rate full-allotment’ procedure: since October 2008 eligible counterparties in the euro area have had access to unlimited liquidity for periods ranging from one week up to six months at a fixed rate. At the same time, we implicitly eased monetary conditions further by expanding the list of assets eligible as collateral in Eurosystem refinancing operations. The Eurosystem accepts a broad range of assets as collateral in all its credit operations. This feature of the Eurosystem’s collateral framework, together with the fact that access to Eurosystem open market operations is granted to a large pool of counterparties, has been key to supporting the implementation of monetary policy in times of stress. The in-built flexibility of its operational framework allowed the Eurosystem to provide the necessary liquidity to address the impaired functioning of the money market without encountering widespread collateral constraints throughout much of 2008. It was only towards the end of the year that, in the light of the extension of refinancing for terms longer than overnight in euro and in US dollars as well as the recourse to fixed rate full allotment tender procedures, the Governing Council decided to expand the list of eligible collateral on a temporary basis until the end of 2009.
In 2008 the average amount of eligible collateral increased by 17.2%, compared with 2007, to a total of €11.1 trillion. As regards the composition of collateral put forward, the average share of asset-backed securities increased from 16% in 2007 to 28% in 2008, overtaking uncovered bank bonds as the largest class of assets put forward as collateral with the Eurosystem. Uncovered bank bonds accounted on average for slightly less than 28% of the collateral put forward in 2008. The average share of non-marketable assets increased from 10% in 2007 to 12% in 2008. By contrast, the average share of central government bonds dropped from 15% in 2007 to 10% in 2008.
In my opinion, these changes to our monetary policy implementation can be better characterised as ‘endogenous credit easing’ rather than ‘quantitative easing’, since the main aim is to relax banks' collateral and funding liquidity constraints, so that they will expand credit supply. Moreover, it is a policy that has been implemented at above-zero level of the short term nominal interest rates.
It should also be emphasised that, given the importance of the banking channel in providing credit to the economy, the unconventional policy measures that would best suit the euro area are likely to differ in terms of scope and depth from those in the US or other advanced economies where a more market-based financial system prevails, a consideration that is too often overlooked. This is the main reason why our policy response so far has been tailored to the specific nature of Europe’s financial structure. A few figures will give an idea of the differences in the financial systems of the US and the euro area. For example, at the end of 2007, the stock of outstanding bank loans to the private sector amounted to around 145% of GDP in the euro area, but only to 63% in the United States. By contrast, outstanding debt securities – a measure of the depth of financial markets – amounted to 81% of GDP in the euro area as against 168% in the United States.
The ECB operations have eased financing conditions for the private sector and allowed banks to refinance loans more easily than would otherwise have been the case. The evidence on the extent of these policy measures on market interest rates and money market conditions is quite encouraging. While the spread between the three-month Euribor and the EONIA is now at levels well below 100 basis points as well as at comparable levels or below the corresponding spreads seen in the US and the UK, ECB refinancing operations are also down from a peak of €857 billion at the beginning of the year to 676 billion last Friday. There is also mounting evidence that the Eurosystem’s policy measures have been effective in averting a dramatic contraction in credit volumes, though credit developments certainly need a close monitoring in the period ahead.
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