ECB's crisis management

and its end

Fritz Breuss

International Conference:

‘Financial Integration in Europe’

CIDEEFF – Lisbon School of Law,

University of Lisbon

8 and 9 May 2017

2

Overview

• The “Great Recession 2009”- A big challenge for fiscal and monetary policy

• Policy reaction to the crises- Fiscal policy – consolidation after Keynesian crisis management

- Monetary policy – ECB the only expansionary player

+ The dominant role of the ECB – ECB the “Multitasker”:- Monetary policy + Troika partner + Banking Union supervisor (SSM)

• ECB’s policy in comparison- interest rates – QE

- monetary policy in the crisis – ECB, Fed, BoJ

• Successes and failures of ECB’s crisis policy- how much of the recovery is due to ECB policy?

• When will ECB scale back its “exceptional degree of

monetary policy accommodation”?

The “Great Recession 2009”

3

• Global Financial Crisis (GFC 2008)

• The “Great Recession 2009” with the

biggest drop in real GDP since WW II

• A big challenge for fiscal and monetary

policy

4Source: Oxford Economics

The “Great Recession 2009“ and its overcoming(Real GDP, relative to the pre-crisis year 2007)

5

Quelle: Oxford Economics

“Heterogeneity” in the Eurozone(Real GDP, relative to the pre-crisis year 2007)

Policy reactions to the crises

6

• Fiscal policy – consolidation after a

Keynesian crisis management

- Euro crisis in the PIIGS

• Monetary policy – ECB the only

expansionary player in the euro area

- From conventional to unconventional measures

- Problem: to make a common policy for a

multi-country monetary union!

Fiscal Policy

7

• Recovery from the Great Recession from 2009 to 2011

mainly due to expansionary Keynesian fiscal policy.

• After the outbreak of the Euro crisis (starting with

Greece in Spring 2010, followed by Ireland, Portugal,

Spain and Cyprus) fiscal policy in most Euro area

countries changed its stance towards consolidation and

hence stopped being a headwind for further recovery.

• Fiscal policy (with governments undertaking the process

of balance sheet repair) between 2013 and 2015

basically neutral

8

Fiscal policy and its limits(Public debts in the Euro area periphery, in % of GDP)

Source: European Commission – AMECO database

0

20

40

60

80

100

120

140

160

180

Euro area

Greece

Italy

Ireland

Spain

Portugal

Cyprus

GFC

9Source: ECB (2017b), p. 35

Euro area

Monetary Policy

10

• Euro area – ECB (mandate): 1 target and 3 instruments

• Target (EU Treaty, Article 127):

“The primary objective of (monetary policy) the European System of Central Banks

shall be to maintain price stability.” (ECB‘s definition = „below but close to 2%“)

Secondary objective: “Without prejudice to the objective of price stability, the ESCB shall

support the general economic policies in the Union with a view to contributing to the

achievement of the objectives of the Union as laid down in Article 3 (e.g. growth, full

employment etc.) of the TEU””.

• 3 instruments for monetary policy:

- interest rates (conventional)

- asset purchases (QE – unconventional)

- forward guidance

ECB’s policy in comparison

11

• Interest rate reaction – conventional policy

• Quantitative easing (QE – asset purchase)

reaction – unconventional policy

• Monetary policy in the crisis:

ECB, Fed, BoJ

12

The dominant role of the ECB – ECB the “Multitasker”:(1) Monetary policy

+ Troika partner + Banking Union supervisor (SSM)

(2) Troika partner (The „Institutions“)

Since the outbreak of the “Euro crisis” in 2010 the “troika” (European

Commission, ECB, IMF) are supervising and supporting the programme

countries (Greece, Ireland, Portugal, Spain and Cyprus) with several rescue

mechanism (lastly by ESM).

(3) Banking Union supervisor

Since November 2014 - under the Single Supervisory Mechanism (SSM)

Regulation - the ECB has been assigned specific powers in the field of

macroprudential policies. In particular, the ECB is responsible for assessing

macroprudential measures adopted by national authorities in the countries

subject to ECB Banking Supervision.

ECB as multitasker

Source: Oxford Economics. 13

Interest rate reaction(Central bank’s policy rates, in %)

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an B

roth

ers

Fo

reca

st

14

ECB’s Interest rate policy after the crisis(in %)

Source: ECB; MRO = Main refinancing operations; MLF = Marginal lending facility; DFR = Deposit facility; EONIA = General: Euro OverNight Index

Average: weighted average overnight rate for interbank operations calculated by the European Central Bank.

Source: Oxford Economics15

QE reaction(Quantitative easing measures, in % of GDP)

Le

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an

Bro

the

rs

Fo

reca

st

16

ECB’s QE measures(Cumulative holdings of Securities by the APP, in €bn)

Source: ECB, Wierzbowksa (2017)

CBPPABSPP

PSPP

SMP

APP = ECB’s expanded asset purchase programme (whole QE measures)

17

Monetary policy in the crisis

Sources: Constancio (2015) and Breuss (2017)

APP (QE) 3/2015-12/201712/2015 Interest rate increase

ECB’s APP programme 2015/17(its version of QE)

• APP (ECB’s expanded Asset Purchase Programme: GC 22/01/2015) consists of:

- ABSPP (Eurosystem’s asset-backed securities purchase programme (9/2014)

- CBPP3 (Third covered bond purchase programme (CBPP3) (9/2014)

- PSPP (Public sector purchase programme) (3/2015)

- CSPP (Corporate sector purchase programme) (3/2016)

• 9 March 2015: Start of APP (QE programme) – until Sept. 2016

- purchase of €60 bn per month (PSPP: gov. bonds on secondary market)

• 3 December 2015: Extension of APP from Sept 2016 to March 2017

• 10 March 2016: Further extension of APP:

- from April increase from €60bn to €80 bn (until March 2017)

- from June additionally to gov. bonds, also (non-bank) corporate bonds (CSPP)

• 9 March 2017: Changes and extension of APP:

- from April until end of December 2017 reduction from €80 bn to €60 bn

Source: ECB Website

18

19

Source: ECB (2017b), p. 52

Eurosystem holdings of instruments of the QE programme

• APP (ECB’s expanded asset purchase programme: GC 22/01/2015) consists of:

- ABSPP (Eurosystem’s asset-backed securities purchase programme (9/2014)

- CBPP3 (Third covered bond purchase programme (CBPP3) (9/2014)

- PSPP (Public sector purchase programme) (3/2015)

- CSPP (Corporate sector purchase programme) (3/2016)

Holding of assets in ECB‘s QE programme: March 2017

Source: ECB Website

20

ABSPP CBPP3 CSPP PSPP APP

€ mil. 24,190 214,446 75,455 1,457,652 1,771,743

Until end of 2017: APP = € 2.28 bn

21

Intended and unintended effects of QE

Avoid Improved

deflation transmission

Boost stock Distortion Wealth, income ECB's compe-

markets of prices distribution tences

Stimulate

the economy

QE

Inflation

target 2%

Credit stimulus,

reduce interest Investment,

consumption, GDPEmployment

DJI, DAX,

Euro Stoxx,

Financial

markets,exchange rates

Debtors vs

saversIllegal gvt.

financing

Unintended

Intended

*) On 16 June 2015, the European Court of Justice (ECJ) ruled in Case C-62/14 Gauweiler and others that the

OMT program (never activated by the ECB, but a forerunner of QE) is compatible with EU law.

*)

Successes of ECB’s crisis policy

22

• Draghi Speech (London: 26/07/2012)

“Within our mandate, the ECB is ready to do whatever it

takes to preserve the euro. And believe me, it will be

enough.”

• Draghi plus OMT announcement:

Relief for government financing (government

bond yields went down)

• Credit easing – easing in financing conditions

(credit growth recovered); financial costs fall

• Success primarily on the financial markets

23

Draghi’s “… whatever it takes…” (26/7/2012)(Government bond yields, 10 years, in %)

Decline but still a big dispersion in the Euro area

Source: MACROBOND

Le

hm

an

Bro

the

rs

24

Impact of ECB measures on key financing conditions(contributions in basis points and percent)

Source: Constancio (2017)

APP = Expanded asset purchase programme; DFR = Deposit facility; NEER = Nominal effective exchange rate

25Source: ECB (2017b), p. 53

Source: ECB (2017b), p. 34 26

27

Bank loans to private sector(annual percentage change)

Source: Praet (2017)

Failures of ECB’s crisis policy

28

• ECB lost control over inflation

• Targeting the “wrong” inflation

- “modest” success of ultra-expansionary monetary policy to

light up inflation!

• Stimulated not the economy (= not mandate of the ECB!)

but the stock market- “modest” success of ultra-expansionary monetary policy to

stimulate the economy (GDP)!

• QE – no influence on €-USD exchange rate

• „The distributional impact of ECB’s policy”(ECB, 2017b, p. 48 ff.) – historically low interest rates

• New imbalances in the TARGET2 system

-1,0

-0,5

0,0

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EMU

2.62%

2.18%

1.73%

1.16%

29

ECB’s failure (I): Lost control over inflation(HICP inflation rate, in %)

Source: ECB

March 2017

8 MS > 2% < 11 MS

-1,0

-0,5

0,0

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Core% Headline% Target%

EMU

30

ECB’s failure (II): Targeting the “wrong” inflation(HICP: core and headline inflation rates, in %)

Source: ECB

HICP: 1999-2016

Core 1.53

Headline 1.72

Core = HICP exluding energy, unprocessed food

31Source: Oxford Economics

Crude Oil Price determines Eurozone inflation(% changes)

-60,0

-40,0

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100,0

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4

ECB HICP InflationWorld Oil Price (Brent)

Source: ECB 32

Euro exchange rate – QE weakens the Euro (USD per EUR)

3/2015 – start QE

33Source: MACROBOND

ECB’s policy stimulated stock markets(Stock market indices: 1M2007=100)

QE

3/2

01

5

MR

O 6

/20

14

Germany

Greece

34Source: ECB (2017b), p. 49; Rösl-Tödter (2017), p. 7.

The distributional impact of

ECB‘s policy

in the Euro area

Financial repression

Financial repression

German savers lost

€65 bn p.a. (2010-2014)

Source: ECB: TARGET2 Balances = total claims minus total liabilities 35

TARGET2 Balances – Impact of ECB’s APP(QE)(Euro)

3/2015 – start APP

Germany

Spain

Italy

Greece

Finland

France

Austria

How much contributed the ECB to the

recovery since mid-2014?

36

• Draghis thesis (2017):

• The usual growth drivers have failed:- world trade growth slowed down (from 6% pre-GFC to 3 ½%)

- fiscal policy stopped being a headwind

- structural reforms absent (no supply side impulse)

• Two “exogenous” factors can explain the

resilience of the recovery:

- the collapse in oil prices in 2014-15, and

- ECB‘s monetary policy (1/2 of the extra GDP growth since

mid-2014 is attributed to the ECB)

How much “extra-GDP” 2014-2017? = +0.3% p.a.

37Source: Simulations with the Oxford Economics World Macro model

ECB’s policy accommodation to the crisisAdditional growth rates of CPI inflation and real GDP growth

Simulation inputs: MRO +0.25% 2009-2017; QE no activity 2009-2017 (fixed interest rates)

Impact of MRO p.a.

On: 2009-2014 2015-2017

CPI -0.04% +0.41%

GDP +0.10% -0.14%

Impact of QE p.a.

On: 2009-2014 2015-2017

CPI +0.35% +1.35%

GDP +0.21% +0.29%

ECB's policy elasticity (2009-2017)

CPI GDP

MRO 0.48 0.08

QE 0.07 0.03

Which sequencing of ECB’ policy?

QE tapering before interest rate hike?

38

• ECB’s Forward guidance

* ECB council (9 March 2017):

- Key interest rates: “The key ECB interest rates are kept unchanged. We continue to

expect them to remain at present or lower levels for an extended period of time, and well past

the horizon of our net asset purchases” (after 2017)

- APP (QE): “Regarding non-standard monetary policy measures, we confirm that we will

continue to make purchases under the asset purchase programme (APP) at the current monthly

pace of €80 billion until the end of this month and that, from April 2017, our net asset purchases

are intended to continue at a monthly pace of €60 billion until the end of December 2017, or

beyond, if necessary.”

- Conclusion: The ECB will likely end the APP before hiking rates (Raising rates - while continuing

the APP - would reduce the effectiveness of the APP)

* Draghi Speech (2017):

“ .. too early to scale back monetary policy accommodation”.

Why: Concerning inflation (primary target) “too soon to declare success”. ----> Forecasts4 criteria to confirm a sustained adjustment of inflation:

(1) headline inflation must be below but close to 2% over the medium-term

(2) inflation must be durable around 2%

(3) inflation must be self-sustained (even without monetary stimuli)

(4) relevant metric = euro area inflation (not inflation in individual euro area countries)

• Fed versus ECB

• What tells the Taylor rule?

Source: ECB (2017a), p. 15 39

Date of release 2017 2018 2019 2017 2018 2019

ECB staff projections March 2017 1.7 1.6 1.7 1.8 1.7 1.6

ranges [1.4-2.0] [0.9-2.3] [0.8-2.6] [1.5-2.1] [0.7-2.7] [0.5-2.7]

ECB: core inflation March 2017 1.1 1.5 1.8

European Commission February 2017 1.7 1.4 - 1.6 1.8 -

OECD March 2017 1.2 1.4 - 1.6 1.6 -

IMF April 2017 1.7 1.5 1.5 1.7 1.6 -

Oxford Economics April 2017 1.6 1.6 1.9 1.7 1.5 1.4

Simple average 1.6 1.5 1.7 1.6

HICP inflation GDP growth

Comparison of forecasts for Euro area

HICP inflation and real GDP growth

Core inflation = headline (HICP) inflation excluding energy and food.

Source: Oxford Economics 40

Fed‘s dual mandate:

* max. employment (U<6.5%)

* stabilizing prices (P=2%)

ECB’s single mandate:

* Price stability (P close, but <2%)

6.5%

2%

41Sources: Fed and ECB

Timing of QE Tapering and hike of interest rates

US-Fed again ahead of the ECB

??

??

??19/0

6/ 2

01

3 B

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ke

„ta

pe

ring

“

42

What tells us the

Taylor rule?(interest rates in %)

USA-Fed

Euro area-ECB

Source: Own estimation (1Q1999-4Q2017)

R = r*+p% + α*(p%-2)+β*(PO-gap)+λR(-1)

43

Conclusions

• The GFC 2008/09 and the “Great Recession 2009” plus Euro

crisis called for a quick reaction

- Keynesian fiscal response mitigate the recession but made

public debts unsustainable – limits for further stimuli

- Monetary policy became increasingly expansionary

* from conventional to unconventional measures

• ECB took over a dominant role- ECB-Multitasker: Monetary policy/Troika partner/Banking Union - SSM

- Challenges in the Eurozone – recession/deflation/Euro crisis

- Successes (interest rates) and failures of the ECB (lost control over inflation)

- Ultra-expansionary policy stance no (big) stimulus for the real economy

but for financial markets and relief for government financing

- “De-Cashing” could help conventional policy!

• Monetary policy in the crisis and its end- Forward guidance

- Quantitative easing (QE) – “cosi fan tutti”

- “Moderate” success of ultra-expansionary monetary policy

(from the “New Normal” to the “New Mediocre”)

- ECB lagging behind Fed in “disembarking” from “exceptional degree of

monetary policy accommodation” (QE “tapering” and hike interest rates)

44

References

• Bernanke, B. S. (2015), The Courage to Act: A Memoir of the Crisis and its Aftermath, W.W. Norton & Company:

New York, 2015.

• Breuss, F. (2017), „The Crisis Management of the ECB”, in: Nazaré da Costa Cabral, José Renato Goncalves,

Nuno Cunha Rodrigues (Eds.): The Euro and the Crisis: Perspectives for the Eurozone as a Monetary and a

Budgetary Union, Series: Financial and Monetary Policy Studies, Vol. 43, Springer-Verlag, Heidelberg, 2017,

199-221.

• Constancio, V. (2015), “2015 US Monetary Policy Forum Panel discussion on Central Banking with Large

Balance Sheets”, Vice-President European Central Bank, New York, 27 February 2015.

• Constancio, V. (2017), “Effectiveness of Monetary Union and the Capital Markets Union”, Speech by Vitor

Constancio, Vice-President of the ECB, at the EUROFI Conference, Malta, 6 April 2017.

• Claeys, G., Leandro, A., Mandra, A. (2015), “European Central Bank Quantitative Easing: The Detailed

Manual”, Bruegel Policy Contribution, Issue 2015/2, March 2015.

• Draghi, M. (2017), “Monetary policy and the economic recovery in the euro area”, Speech by Mario Draghi,

President of the ECB, at The ECB and Its Watchers XVIII Conference, Frankfrut am Main, 6 April 2017.

• ECB (2017a), Economic Bulletin, Issue 2/2017.

• ECB (2017b), Annual Report 2016, Frankfurt a.M., April 2017.

• Kireyev, A. (2017), The Macroeconomics of De-Cashing, IMF Working Paper WP 17/71, March 2017.

• Praet, P. (2017), “European Monetary and Financial Outlook”, Presentation by Peter Praet, Member of the

Executive Board of the ECB, at the 26th Annual Hymann P. Minsky Conference on the State of the US and World

Economy, Washington, D.C., 19 April 2017.

• Rösl, G., Tödter, K.-H. (2017), “The Financial Repression Policy of the European Central Bank: Interest Income

and Welfare Losses for German Savers”, ifo DICE Report, Spring, Vol. 15, 1/2017, 5-8.

• Williamson, St. D. (2015), “Current Federal Reserve Policy Under the Lens of Economic History: A Review

Essay”, Federal Reserve Bank of St. Louis, Working Paper Series, No. 2015-015A, July 2015.

• Wierzbowksa, A. (2017), “Monetary policy and bank lending in euro area since the outset of the global financial

Crisis”, unpublished paper.