A report on ECB interventions after the
financial crisis
Shirley van Dorst
Author: S.A.P.M. van Dorst Student number: 10572716 Supervisor: S. Singh
Date: 17 January 2017
Bsc: Economics and Business
Statement of Originality
This document is written by Student Shirley van Dorst who declares to take full responsibility for the contents of this document.
I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
Abstract
As of 2016, the Eurozone is slowly recovering from what seemed to be an everlasting economic crisis. This paper will focus on how the ECB has contributed to the recovery of the European economy. The framework of the Eurozone will be discussed, as well as the onset of the financial and sovereign debt crisis. This will be followed by a comprehensive report on the instruments and measures used by the ECB to counteract the devastating effects of the crisis. At last, the implications of the programmes will be briefly discussed. This paper shows the possibilities with regard to monetary policy within a monetary union in times of crisis and where price stability remains the primary objective.
Table of content
1. Introduction………...……… .4
2. The European Central Bank………...……….5
3. The financial crisis………..………....8
4. ECB interventions in times of crisis……….11
5. The implications of the ECB programmes………... 6. Conclusion………16
1. Introduction
The European Central Bank (ECB) was set-up in 1999 and conducts monetary policy for all nineteen member countries of the Economic and Monetary Union. The primary objective of the ECB is to maintain price stability (ECB, 2016). Normally the ECB tries to achieve this by influencing the short-term interest rates, but after the emergence of the financial crisis the ECB started to use other, more unconventional, instruments to help the European economy ‘recover’. This was done, partly because interest rates had almost come to their effective lower bound and there was not much scope to lower them any further. But on top of that, the crisis caused enormous panic in the financial market, calling for extreme measures to stabilize the economy again. The use of these unconventional policies caused a lot of uproar and debate and the viability of the entire euro project has often been called into question. Economists do not mutually agree on what is the best approach to stimulate the economy. Some think the ECB oversteps its authority. Klaas Knot, the president of de Nederlandsche Bank, for example has voted against several funding packages, implying that the ECB should not inject any more money into the economy (DFT, 2015). Meanwhile, others claim that not enough action has been taken by the ECB (La Monica, 2011).
However, when entering into the European Monetary Union the member countries agreed to give up their monetary authority and to transfer full control to the ECB. Consequently, the ECB has to act in the interest of the euro area as a whole, instead of taking individual interests of member countries into account in its decisions. What is advantageous for one country, might be detrimental for another. Nevertheless, exactly like the ECB should aim at price stability, it is in its mandate that it should consider what is best for the entire euro zone. These conditions also apply to monetary policy in times of crisis. This thesis will answer the
following question: which measures have been taken by the ECB after the financial crisis? This research is important for everyone who is interested in the actions taken by the ECB, and wants to know what the intentions were.
To answer the above question, I will conduct a descriptive research. Much research has been conducted by the ECB itself. Also I will use the Financial Crisis Inquiry Commission report on the financial and economic crisis by Aldo Barba (2011), to give a quick view on how the financial crisis could have emerged.
The paper is organized as follows. The next section briefly describes how the ECB is set up and what its goals and regular instruments are. In the third section, the emergence of the financial crisis is explained. The fourth section describes the measures taken by the ECB after
the financial crisis. The fifth section discusses the implications of the ECB programmes. The last section concludes the thesis.
2. The European Central Bank
This section describes the set-up of the ECB, followed by a description of its monetary goals and the instruments the ECB has at its disposal.
2.1 The set-up of the ECB
Before the monetary union was established there have been various economic partnerships between European countries. A monetary union had initially not been discussed, but over the years the idea came up and was finally realized in 1999.
One of the earlier arrangements between European governments was the European Economic Community, which was set up in 1957. Their goal was to facilitate trading practices, by creating a customs union where services, goods and money are able to move freely, had a common tariff policy and trade barriers between member countries were removed (ECB, 2016). In 1972 the EEC members introduced the ‘Snake in the tunnel’, a mechanism allowing their exchange rates to vary against each other by a maximum of 1.125% and vary against the US dollar by a maximum of 2.25% (Pilbeam, 2013). Although these prior arrangements did establish certain collaborations between various European countries, the first step towards an actual European monetary union is often referred to as the Delors Report, which was
presented in 1989. The content of the report has been extensively written about in “The Delors Report and European Economic and Monetary Union” by Niels Thygesen (1989). The report envisaged that in order to set up a monetary union, member countries should no longer conduct its own monetary policy, but transfer decision-making authority to the institutions of the Community. It was also emphasized that solely the convergence of monetary policy would not be enough, fiscal procedures and rules should also be in agreement with each other within a monetary union. At last, the report proposed that in order to be a well-functioning union, a logical consequence of irrevocably fixing the exchange rates would be to acknowledge one single currency for the entire union. The Delors report recommended the process towards the establishment of a monetary union to take place in three successive stages. Stage one started in July 1990. It can be seen as the convergence phase, as it was focused on closer economic coordination between the member countries. It started with the removal of all restrictions on capital transactions. Furthermore it led to the improvement of co-operation between central
banks, and the free use of the ECU (European Currency Unit; the forerunner of the euro). Stage two started in 1994 and was focused on the transition towards the monetary union. This stage let to the establishment of the European Monetary Institute (EMI), a ban on the granting of loans to national public-sector entities, increased coordination of monetary policies and the strengthening of economic convergence. Also the process leading to the independence of national central banks was set in motion, as well as other preparatory work for stage three. Stage three started in 1999 and at this time the conversion rates of the member countries became irrevocable fixed and the euro was introduced. Also, the European System of Central Banks started implementing a single monetary policy. Furthermore, the intra-EU exchange rate mechanism (ERMII) went in effect, and it was the moment of entry into force of the Stability and Growth Pact. The ECB was given full control over the formulation and implementation of the Eurozone’s monetary policy. The Eurozone consists of the countries that would adopt the euro as their currency. But at the same time there would be no
coordinated fiscal policy within the euro area. Eventually in 2002 the Euro coins and
banknotes were simultaneously introduced in all the Eurozone countries on January 1, 2002.
Another important step towards the European Monetary Union was The Maastricht Treaty, which was signed in 1992 and went into effect in 1993. It was the first step to creating the ESCB. The ESCB consists of the ECB and the national central banks of the 27 member countries of the European Union, regardless of whether these countries adopt the euro or not. The Treaty stated that “The primary objective of the European System of Central Banks (ESCB) shall be to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community.” (ECB, 2007). The treaty gave the ECB a unique level of independence. In addition, it defines the criteria that need to be met in order for other countries to be allowed to join the EMU, these are called ‘the convergence criteria’.
2.1 The instruments of the ECB
At the moment, the Eurosystem is formed by the ECB and the NCBs of the nineteen countries that have adopted the euro as their domestic currency. The main objective of the ECB is to maintain price stability. This is defined by the Governing Council as inflation below but close to 2%, which needs to be maintained over the medium term (ECB, 2016).
In this section I will give a description of the instruments the ECB has at its disposal to conduct monetary policy.
Interest rates
Interest rates can be divided into three different categories. The main refinancing rate, the deposit rate and the marginal lending rate.
By setting interest at a higher or lower rate, the ECB is able to influence consumption. In theory this works as follows: lower interest rates encourage the private market to borrow more, because borrowing becomes less expensive and thus the benefits of saving decrease.
Consequently, there will be more money available for consumption, and investments will also rise. Summarizing, low long-term interest rates are useful for stimulating economic growth and driving up inflation, because it increases the flow of private investment (Modigliani, & Sutch, 1996). When interest rates are set higher, it will work the other way around. So in short, when using its control over the interest rates, the ECB decides on the operational framework where it sets a target level for the overnight interest rate in the interbank money market and, thereafter, it will contribute to making it possible for banks to meet the reserve requirements at the previously set target interest rates (Febrero, Uxó, & Dejuán, 2015, p. 726).
Main refinancing rate
Within the European monetary union, the ECB is the only entity that has a unique form of independence over the monetary base. It can exercise control by carrying out open market operations and through the issuance of loans to banks. Open market operations directly affect money supply through the buying and selling of government securities in the open market, and is therefore one of the main instruments used by the ECB. Open market operations either expand or contract the amount of money that is circulating in the banking system. With the purchases of securities in the open market, the ECB injects money into the banking system and stimulates economic growth. In addition, it drives up the demand for securities which will also affect the interest rates. Contrary, open market sales shrink reserves and the monetary base, which will consequently decrease the money supply and raise short-term interest rates. These main refinancing operations are held once a week and are carried out by the use of tenders. At the moment the ECB uses a fixed rate, which is called the main refinancing rate and is currently set to zero. Any financial institution is allowed to participate, as long as it has an eligible collateral.
Long-term refinancing operations (LTROs) are another form of open market operations and take place on a monthly basis. Initially it had a maturity of three months, but in times of crisis
the ECB also introduced extended versions with maturities of three years. The interest rates for LTROs are approximately 1% (LTRO, 2016).
Deposit rate
The deposit rate is the rate financial institutions receive over the amount they deposit at the central bank. This is also used by the ECB as a tool to influence the economy. At the moment the deposit rate is -0.04%, which means that financial institutions are required to pay in order to hold their money overnight.
Marginal lending facility
The marginal lending facility can be used by financial institutions in order to receive short-term liquidity from the central bank. An eligible collateral is needed, in order to qualify for this. The rate is currently set at 0.25%.
In the assessment of the eligibility of an asset, the Eurosystem takes into account credit information from credit assessment systems belonging to one of the following sources: external credit assessment institutions, internal credit assessment systems of the member national central banks, on internal ratings based systems of counterparties, and rating tools from third parties. The ECB has the right to determine whether an issue, issuer, debtor or guarantor meets the requirements for high credit standards, which is done on the basis of information that the ECB considers relevant. At least one credit assessment of an issue from an eligible credit institution must meet the minimum credit threshold of the Euro system. All credit agencies must meet the general acceptance criteria. The Eurosystem reserves the right not to accept a credit institution. In addition, to guarantee that the private sector will be able to repay the loan in the future, the ECB will apply a haircut to the collateral. In other words, a reduction is applied to the value of the collateral at the time the loan is issued. The actual worth of the collateral at that moment is thus higher than the loan that is issued against it, which is to make sure that even if the collateral decreases in value over time it will still be able to provide for the repayment of the loan (ECB, 2016).
Influence expectations
It has been shown several times that the ECB is able to influence financial expectations of the market on upcoming interest rate decisions, by commenting on future economic or policy developments (Jansen, & De Haan, 2009). The ECB uses multiple channels of communication, like press conferences, publications, and interviews. After each Governing Council meeting a
press conference is given by the president of the ECB. During the conference information is given about the ECB’s current insights, plans and the direction it will to take in the future. The ECB uses its monetary stance to stabilize the market. For example by signaling that the Central Bank rates will remain around zero for a long time. Another well-known example is the “We will do whatever it takes”-speech by Mario Draghi, in which he assures that the ECB is willing to take every measure to maintain the euro area in its present form. This
immediately had a stabilizing effect on the financial markets. Over the years it has been found that the ECB has usually been consistent in their words and future deeds, and therefore the interest rate setting of the ECB can be predicted fairly well (Rosa, & Verga, 2007).
3. The financial crisis
The start of financial crisis is generally dated on 9 August 2007 when BNP Paribus
announced that investors would not be able to withdraw money from two of its funds due to a ‘complete evaporation of the liquidity in the market’. A complex system of subprime
mortgages, CDOs and mortgage-backed securities caused the entire financial system to collapse. Aldo Barba (2011), described extensively the ‘causes, domestic and global, of the current financial and economic crisis in the USA’ in his research for the Financial Crisis Inquiry Commission. In this section I will first give a description of the causes of the financial crisis in the US and then I will describe how this could have led to the European sovereign debt crisis.
3.1 Subprime mortgage crisis
The causes of the financial crisis already originated in the 2000s. The interest rates on US Treasury bonds had been low for some time and investors were looking for other investment opportunities. Investors increasingly started investing in mortgages, believing this would yield higher results. In order to meet this increase in demand, financial institutions started
securitizing mortgages, and accordingly mortgage backed securities were introduced to the market. Credit rating companies assigned high ratings to these securities, implying they were safe investments. The reasoning was as follows: the securities were backed with a mortgage on a house as collateral, and the housing prices were constantly increasing at that time and it was expected to continue to do so, implying that there would always be a safety guarantee for the mortgage backed securities. As a result, these mortgage backed securities were much sought after. Financial institutions started introducing new types of securities and changing the terms for people to get mortgages to keep up with the increase in demand. Now loans
were issued to people with less steady income and bad credit, and money could be borrowed without any guarantee (Barba, 2011). As a consequence, people obtained mortgage payments they could never keep up with. An important example of the new instruments that were created are Collateralized Debt Obligations (also known as CDOs). These CDOs were
extremely popular, but for a long time their risk has been underestimated. A CDO is a security that bundles together a range of different debt obligations and/or a package of loans into to a financial security that is divided up into various tranches with each tranche having different risk and return characteristics (Pilbeam, 2013). This made the matters more complicated and obscure, because the most dangerous tranches could be posed as if it were ‘safe’ assets while, in principle, they were not (Barba, 2011). Because of the complexity of the products that were now on the market, credit rating agencies did not recognize the dangers of the securities and were still categorizing them as safe investments (Barba, 2011). At the same time, the new lax lending requirements and the low interest rates at that moment, gave more people the
opportunity to buy expensive houses which drove up the demand for houses and the housing prices even more. This made it seem like the mortgage backed securities and CDOs became better investments too. But in the spring of 2006 the ever rising housing prices came to a full stop. In a chain reaction, a rise in interest rates led to borrower defaults, which subsequently led to many bank defaults and a crash in the housing and stock markets. As a result, people suddenly had mortgages that were way higher than their houses were actually worth. Big financial institutions stopped buying subprime mortgages and subprime lenders got stuck with bad loans. By 2007, some really big lenders had declared bankruptcy. In 2008, Lehman Brothers, filed for bankruptcy, being the largest bankruptcy filing in US history. This is often seen as the last drop to make the entire market panic, lose confidence and finally set off the financial crisis.
3.1 Sovereign debt crisis
Because many mortgage-backed securities were sold in Europe, the turmoil in the US housing sector quickly spread to European banks. Especially banks that had invested heavily in the American market had to suffer great losses. In the euro-area the sovereign debt crisis broke out between late-2009 and early-2010. In order to describe how the American crisis also affected the European economy, it is important to explain why European countries were often largely indebted and also very interconnected.
In the Euro Area the countries have one unified monetary policy that is set by the ECB. But meanwhile, every country retains fiscal authority. Fiscal policy involves decisions about government spending and taxation, while monetary policy is about the management of money and interest rates (Mishkin, Matthews, & Gioliodori, 2013, p. 11). Governments can only spent what is collected in taxes. All further spending must be borrowed, which is called deficit spending. Before entering the European Union, small economies like Greece were considered by investors to be risky, so these economies could only borrow money at high interest rates. But from the moment Greece got in the EU, it suddenly had access to amounts of money to borrow like it never had before. This was due to the fact that investors now believed that Greece would be backed up by the big economies of Europe at the moment they would default, because they were bound by a common currency now. This made an investment in Greece seem less risky for the private market, and borrowing rates dropped. As a result, Greece could adjust its fiscal policy, and it did. Spending was increased enormously,
generally for political reasons. This was done with borrowed money and for the repayment of the debt they had created, Greece started to use new borrowed money. This cheap credit all over Europe fueled enormous housing bubbles. And the economies of the European countries got all intertwined, because countries all started lending and borrowing to and from each other. This went on this way as long as credit was available. But the US financial crisis suddenly brought all borrowing to a hold. Greece could not borrow new money to pay old debt anymore and the government had accumulated large amounts of debts and deficits. Greece was not the only country that was in trouble, actually much of Europe had borrowed more money than it could ever repay. When it became clear that the deficits in Greece were much larger than it had ever reported, the confidence and trust in the market collapsed. Investors were worried that governments could not pay back their debt anymore and markets were distressed. Banks no longer lent any money to each other and it became extremely hard to maintain liquidity in the banking system. At the same time, investors feared that governments needed to inject money into the banking system. Rating agencies started downgrading the euro area banks and countries, and the crisis extended through the entire euro zone (Pelizzon, Subrahmanyam, Tomio, & Umo, 2013).
Another reason which is often cited for the sovereign debt crisis to could have happened is that the governance of the economic union has not been sufficiently articulated (ECB, 2016). In 2003 the Stability and Growth Pact was already not met by Germany and France, who were not willing to comply with the corresponding sanctions for breaching the debt and deficit criteria (ECB, 2016). This brought damage to the credibility of the pact, which made other
countries also feel less inclined to abide by it. It is the responsibility of governments to maintain financial stability, but due to the many cultural differences within the euro area and also differences in fiscal policy, financial stability is not defined the same way by each country. These differences and the fact that governments knew that having too large deficits did not immediately have to lead to sanctions, has contributed to the depth of the sovereign debt crisis too.
4. ECB interventions in times of crisis
After the emergence of the financial crisis, the central bank was confronted with many unexpected challenges. In this section I will give a description of the various, sometimes unconventional, measures the ECB has taken after the emergence of the financial crisis.
4.1 Long-Term Refinancing Operations (LTROs)
LTROs are loan like operations and are part of the open market operations. In these
operations, the ECB lends money to euro area banks and uses securities as collateral. The aim of the LTROs is to ease monetary and financial market conditions and thus help the market increase liquidity. Hereby encouraging banks to provide more credit to the economy, and eventually contribute to keeping money market interest rates at low levels. A LTRO works as follows: lenders sell the collateral to the ECB and commits to buying it at a predetermined date for a predetermined amount. The ECB thus provides liquidity to the banking system, but the programme has a fixed maturity in which stimulus has to be returned to the ECB in the end. Initially LTROs had a maturity of three to six months, and had a limited amount of liquidity available which was allocated to banks through a bidding process. But due to the financial disturbances by the crisis the auctions started providing unlimited liquidity and the maturity was extended to twelve months for the first time in May 2009. To respond to a further deteriorating crisis, the ECB announced the first three-year LTRO in December 201l (ECB, 2011). Furthermore, the variable rate tenders were abandoned and the average main refinancing rate of the ECB was now used as the cost of liquidity over the entire life of the loan (Fratzscher, 2016).
4.2 Fixed rate full allotment
In normal times, the ECB provided liquidity to the market through the use of auctions. Tenders determined the amount of liquidity that would be offered. But when disturbances in the market arose, the ECB decided that from 15 October 2008 all eligible financial institutions
within the euro area would have their bids fully satisfied. Thus the ECB would give financial institutions access to an unlimited amount of liquidity, as long as they were able to offer valid collateral, were financially sound and were willing to accept the fixed rate (González-Páramo, 2011). The ECB decided to continue this procedure for as long as necessary, and at least until the end of the Eurosystem’s last reserve maintenance period of 2017.
4.3 Currency swap lines
Currency swap lines have been established by the ECB since 2007 and have become another important instrument to maintain financial stability in the euro area. The currency swap lines help the banking system gain access to foreign liquidity (ECB, 2016). A currency swap line is an arrangement between the ECB and another central bank. The agreement allows a central bank to obtain foreign currency liquidity from the central bank that issues it. Normally this will be helpful when the domestic banks are in need of this foreign currency, and the central bank of that country wants to meet the demand. Due to the financial crisis and the following risk aversion subject to the European banking system, it became difficult for domestic banks to get access to foreign currencies. This was especially problematic if euro area banks got in trouble with the funding of their assets which were denominated in another currency. The ECB decided to intervene in order to prevent disruptions as extreme price movements, which could arise if banks suddenly had to sell their assets due to the inability to get any foreign currency. A currency swap line allows the ECB to provide the foreign currency to banks located in the euro area (ECB, 2016).
4.4 Collateral requirements
As a response to the crisis the ECB decided to extend their eligible collateral list (ECB, 2016). The eligibility is considered by the national central banks using specific criteria, which are laid out in the Eurosystem legal framework for monetary policy instruments. To restore the financial market liquidity, the ECB decided that a very broad range of assets would be accepted as collateral, that the same type of collateral would be accepted in all refinancing operations, and that there would be common eligibility criteria across the entire euro area, with loss sharing in case of a counterparty default (ECB, 2016).
Specific changes which have been made with respect to the acceptance of collateral are that the ECB currently accepts assets with a BBB-rating, even as temporary debt in US dollars, Japanese Yen and British Pound. Furthermore, the collateral requirements for sovereign debt from countries with an EU / IMF programme are modified, and the eligibility criteria of
asset-backed securities are temporarily broadened. At the same time, additional risk management measures are implemented, including differentiation based on degree of liquidity, maturity profile and creditworthiness.
4.5 Covered Bond Purchase Programme (CBPP)
The first CBPP was introduced in July 2009 to help stabilizing the covered bond market. This was necessary because the market faced many disruptions in terms of liquidity, issuance and spreads. The aim of the programme was fourfold. First, it was meant to reduce money market term rates; second, to form a primary source of funding for banks and other credit institutions in the euro area; third, to stimulate credit institutions to lend to households and enterprises; and, fourth, to improve market liquidity in important segments of private debt securities markets (ECB, 2016). In the CBPP, the ECB purchased covered bonds from the market. A covered bond differs from unsecured debt instruments, because it offers investors dual
protection against default. As the liability for a covered bond stays on the balance sheet of the financial institution that issues it and furthermore the creditors are protected by a pool of collateral in respect of which they have preferential rights should the issuer become insolvent (Bundesbank, 2017). The first CBPP in 2009 had a volume of 60 billion euro over the period of a year. In November 2011 the second was launched, CBPP2, and totaled with a volume of 16.4 billion euros at its end. The third CBPP was put into operation in October 2014 and was intended to improve the transmission of monetary policy. To reinforce this, an Asset-Backed Securities Programme (ABSPP) was established in combination with CBPP3.
4.6 Securities Market Programme (SMP)
The implementation of the SMP programme was just after the outbreak of the Sovereign debt crisis, when sovereign bond markets of some euro area countries became increasingly
dysfunctional. The SMP went into effect in May 2010. The ECB started doing direct
purchases of bonds on the secondary market. The bonds had to be held until maturity and the ECB did not commit to roll over the portfolio as bonds matured (Fratzscher, Lo Duca, & Straub, 2014, p.6). The aim of the programme is to repair the malfunctioning of certain markets and thereby to counteract disruption in the monetary policy transmission mechanism, which is in line with the ECB’s primary objective of price stability in the medium term (Bundesbank, 2016). At the same time it had to restore the liquidity of the markets that were dysfunctional and also restore the value of eligible collateral (Gibson, Hall, & Tavlas, 2016, p.46). Because the ECB is not allowed to get involved in any monetary financing practices,
the purchases of public and private debt securities in the SMP programme can only be made on the secondary market. The impact of the SMP on bond prices is believed to be in three different ways: through signaling, flow and stock channels (Ghysels, Idier, Manganelli, & Vergote, 2014). An important aspect of the programme is that the impact of the purchases in the SMP programme have to be ‘sterilized’. Sterilized means that the purchases must have no effect on the liquidity of the central bank, and so also the injection of the reserves remains the same amount. In other words, the monetary policy stance cannot be affected. This was
ensured by offsetting every liquidity-enhancing operation with a weekly liquidity-absorbing operation of the same amount (ECB, 2016). This was done by giving private banks the opportunity to invest central banks money at the ECB at the same time. In this way the net injection of central bank reserves remained unchanged. Initially purchases were only done in distressed markets like those of Greece, Portugal and Ireland. In the second execution of the purchases also Italian and Spanish Government bonds were included. The purchases were not much targeted at private markets (Eser, & Schwaab, 2013).
In September 2012 the Governing Council decided to replace the SMP programme with the Outright Monetary Transmission programme. From June 2014 the ECB stopped the weekly sterilization of the SMP programme, this brought about 120 billion euro of extra liquidity to the economy and should reduce interbank rates.
4.7 Outright Monetary Transactions (OMT) programme
In times when tensions within the euro area increased, confidence was lost and economic growth was still weak, the ECB decided to introduce a new instrument, the OMT. The mere announcement of the new instrument was enough to achieve its purpose, to calm the markets and it brought the yield of peripheral euro zone treasuries to relatively low levels (Fratzscher et al., 2014, p.6). Under the OMT programme the ECB makes outright purchases in secondary sovereign bond markets in the euro area. The transactions are focused on short-term
maturities, in particular on sovereign bonds with a maturity between one to three years. The programme is introduced to support monetary policy transmission and the singleness of the monetary policy and to avoid self-fulfilling bad equilibria (Draghi, & Constâncio, 2012). Just as in the SMP, also in the OMT programme the liquidity that is created by it must be fully sterilized. The programme started at September 2012. An important component of this
programme is that the Governing Council is completely independent and therefore guarantees that the purpose of the transactions is strictly for monetary policy. The Governing Council has the authority to decide when to start, continue or suspend the OMTs. OMTs are limited to
secondary markets, because the aim of the programme is to enhance liquidity of investors in particular, and not of the sovereign issuer. A special requirement of the programme is that governments must introduce fiscal reforms to restore the sustainability of their public finances. To guarantee they do so, the OMTs are conditionally attached to an appropriate European Financial Stability Facility/European Stability Mechanism (ESM) programme (ECB, 2012). This can take different forms, it could be a macroeconomic adjustment programme or a precautionary programme. The involvement of the IMF is sought for the design of country-specific conditionality and the monitoring of the execution of the program. Only if the conditions of appropriate fiscal and economic policies are met, according to how they are set out in the programme, a country qualifies for OMTs. The programme will be terminated by the Governing Council if the objectives of it are achieved or if the country is no longer implementing the required macroeconomic adjustments.
4.8 Targeted Long-Term Refinancing Operations (TLTROs)
The TLTROs work almost in a same manner as LTROs, except that in the TLTROs there was a fixed rate which was set 10 basis points above the main refinancing rate at the time of allotment. This differs from the LTROs, where the interest was based entirely on the main refinancing rate. Furthermore, the programme conditioned banks to grant loans to firms and households, excluding mortgage loans (Febrero, Uxó, & Dejuán, 2015, p. 733). Also the size of approximately 400 billion euros, was much smaller than of the LTROs. Banks could enroll in one of the two TLTROs in September 2014 or December 2014. The maturity of the
programme was four years, but after two years the participants were given the opportunity to terminate or reduce the amount of the TLTROs before maturity on a semi-annual basis (ECB, 2014). Banks were thus provided the opportunity to borrow money for a low fixed rate, which should give a positive stimulus to the economy and ease deflationary pressures in the
Eurozone. On 10 March 2016 the ECB announced four new TLTROs which would start from June 2016 to March 2017, at a quarterly frequency. The intention of the new TLTROs was still to incentivize bank lending to the real economy, but also to contribute to the increase of interest rates level to close to but below 2% (ECB, 2016).
4.9 Expanded Asset Purchase programme
On 22 January 2015, the ECB announced the expanded asset purchase programme. This is often referred to as a quantitative easing programme, as the ECB decided to no longer sterilize its purchases and thus increases the money supply. The programme was meant to address the
low inflation rates, which were far below 2%. It includes an asset-backed securities purchase programme (ABSPP), a third covered bond purchase programme (CBPP3), a public sector purchase programme and a corporate securities purchase programme (ECB, 2016). Asset purchases are an effective tool when the ECB is no longer able to use their control over the interest rates as an instrument, because the interest rates are already at their lower bound. The asset purchases will further ease the refinancing of the banking system, because it lowers the prices of financing for firms and households. This usually encourages consumption and investment, which should help get inflation back to a rate close to 2%. When the programme was introduced it would initially continue at least until September 2016, and the monthly amount of purchases would amount to 80 billion euros total (ECB, 2015). It was expected that the balance sheet of the ECB would expand with more than one trillion euros because of the implementation of the programme (Febrero, Uxó, & Dejuán, 2015, p. 721). At the end of 2016, the ECB announced to continue the programme for a longer period, at least until the end of 2017. However the total value of the bond purchases per month will decrease from April 2017 to an amount of 60 billion euros. If the ECB foresees that the economic situation will deteriorate, it will increase the programme in terms of size and/or duration (ECB, 2016).
5. The implications of the ECB programmes
The first exceptional decision of the ECB in order to counteract the effects of the crisis has been made already on 9 August 2007 (ECB, 2009). Meanwhile, many other instruments have been introduced and the crisis has passed several stages. Much research is done on the
implications of the ECB interventions after the crisis. In this section I will discuss the overall findings.
When considering the bigger picture, strong evidence is found that the unconventional instruments used by the ECB, in combination with the bold action taken by European governments, have eased conditions in money markets, which enabled banks to continue lending to businesses and households (Carpenter, Demiralp, & Eisenschmidt, 2014). This is because the interventions and newly introduced measures of the ECB ensured that credit remained available at accessible rates. This has been important for the maintenance of confidence in the financial markets and therefore had a serious role in stabilizing the credit flows and preventing the system from collapsing (ECB, 2009). Especially the long-term LTROs and the lowering of the deposit rate, have been helpful in reducing money market tensions (Szczerbowicz, 2014). Furthermore, the ECB programmes prevented banks from
suddenly needing to sell their assets and thus prevented disorderly deleveraging. Also, it gave governments and banks time to make needed adjustments, which has been helpful in
downsizing the crisis (Falagiarda, & Reitz, 2015).
The announcement alone of new unconventional policies by the ECB has had a positive impact on reducing the sovereign solvency risk of four distressed countries that were unable to repay their debt or failed to bailout over-indebted banks on their own (Falagiarda, & Reitz, 2015). These countries were Ireland, Portugal, Italy and Spain. By contrast, ECB
communication did not have the same effect on Greece. In addition, Falagiarda and Reitz (2015) found that events that took place during the period 2010-2012 have been more effective in reducing the spread relative to Germany in comparison with events which took place at the beginning of the crisis in 2008-2009. At last, the study found that announcements of operations regarding the SMP and OMT programmes were associated with a much stronger and significant reduction of the differential between domestic and German long-term bond yields than compared to other sorts of unconventional measures.
However, when considering each programme separately, not every programme has been equally effective in achieving the desired result of the ECB. The CBPP has been able to positively affect the sovereign spread as it intended to (Szczerbowicz, 2014). But with the implementation of the SMP, the ECB headed in a new direction where it mutualized debt and redistributed risk, by taking bonds of vulnerable governments on its balance sheet (Krampf, 2016). In their assessment of the SMP, Ghysels, Idier, Manganelli and Vergote (2014), found that the programme has been successful in temporarily driving down yields of the targeted countries and in modifying their volatility, and thereby protecting monetary policy
transmission in large parts of the euro area. On the other side, it was less successful in its goal of making governments find durable solutions to the crisis. Neither it was successful in
motivating the government to make macroeconomic adjustments and restore the sustainability of public finances (Cour-Thirmann, & Winkler, 2013). This clearly illustrated the limits of the programme. For this reason, macroeconomic adjustments became a condition to gain access to liquidity within the OMT programme. The study of Creel, Hubert and Viennot (2016) found that the pass-through of the ECB rate to interest rates has been effective, while in general the transmission mechanism of the ECB rate to volumes has been weak. Moreover, the effects of excess liquidity have not been the same for every country. In comparison to excess liquidity, the impact of the LTROs were weaker and concentrated exclusively on interest rates (Creel, Hubert, & Viennot, 2016).
One much criticized point of the unconventional policy programmes is the increasing balance sheet of the ECB. The study of Boeckx, Dossche and Peersman (2014) finds that output and prices increase after the unconventional policy actions that influence the size of the ECB’s balance sheet, and thus imply that the increase of the balance sheet can have a stabilizing effect. In contrast, Van Lerven (2016) finds in his study that Quantitative Easing by the ECB has not been able to deliver the desired effects, as the rising prices of financial assets did not lead to an increase in consumption. However, it should be noted that the programme has just been recently implemented and is still in operation. So the long-term effects are relatively uncertain.
6. Conclusion
After the financial collapse, many financial institutions had to reacquire liquidity. The ECB decided to intervene and create demand through various ways, aiming to restore the
functioning of the markets. These new measures took advantage of the flexibility of the ECBs conventional instruments, but also led to a massive expansion of its balance sheet. In this study the following question is answered: which measures have been taken by the ECB after the financial crisis? In this paper information is provided on the set up of the ECB, its goals and conventional instruments. Also an overview of the crisis has been given. This information was provided to create a broader understanding of the entire Eurozone and its monetary system. Subsequently, the measures taken by the ECB after the financial crisis are discussed, followed by a general overview of the implications of the programme.
The following measures have been introduced by the ECB after the financial crisis. Both LTROs and the TLTROs were extended to ease financial and monetary market conditions and to encourage bank lending to the real economy. Fixed rate full allotment and the lower
collateral requirements, made it easier for financial institutions to get access to liquidity. Currency swap lines ensured access to foreign liquidity. The purpose of the CBPP , the SMP and the OMT was to contribute to a better functioning of the monetary policy transmission channel. In addition, the OMT was also introduced to reduce the yield of peripheral euro zone treasuries. And at last, to address the low inflation rates in the Eurozone, the ECB introduced the expanded asset purchase programme. Summarizing, the ECB introduced many and often unconventional instruments but always maintained its objective of price stability. In general, studies confirm that the measures taken by the ECB proved to be useful in maintaining stability and ensured banking liquidity and the continuing of business lending. On the other hand, macroeconomic adjustments were not implemented to an extend as was desired. It is not
generally agreed on whether the increase of the ECB’s balance sheet should be considered problematic, or has been helpful in stabilizing the markets.
Further research could be done on whether the intended effects of each different ECB programme specifically was also achieved, but also on the undesired effects that arose. This will be important to assess the functioning of the ECB but also for future reference, to decide which programmes could be considered for use again.
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