THE EUROPEAN CENTRAL BANK’S MONETARY
POLICY FRAMEWORK BEFORE AND AFTER THE CRISIS
Philipp Hartmann5
This short note briefly characterizes the European Central Bank’s (ECB’s)
framework for monetary policy, describes whether and how it was
affected by the crisis starting in 2007, and discusses a few challenges for
the ECB’s monetary policy in the time ahead (please see Appendix for the
corresponding presentations, including figures and tables).
THE ECB’S MONETARY POLICY FRAMEWORK
The ECB’s monetary policy framework can be characterized through its
objective, policy strategy, and policy instruments.
The primary objective
of monetary policy is to maintain price stability. Price stability is defined
as a yearly increase of euro area consumer price inflation below but close
to 2 percent, which is to be achieved over the medium term. The
monetary policy strategy is a structured description of how monetary
policy decisions are made. It includes an economic analysis for the shortto medium term horizon and cross-checks its results with those of a
monetary analysis for the medium- to long-term horizon. The ECB uses
open market operations, standing facilities, and minimum reserve
requirements as policy instruments to ensure that short-term interest
rates are in line with a monetary policy stance that would maintain price
stability.
5
European Central Bank, Acting Head of Directorate General Research. Any views
expressed are the author’s own and should not necessarily be regarded as the views of
the ECB or the Eurosystem. This note considers information available until March 2014.
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New Issues in Monetary Policy: International Experience and Relevance for China
IMPLICATIONS OF THE CRISIS FOR THE ECB’S MONETARY
POLICY FRAMEWORK
The special circumstances for monetary policy that the crisis starting in
August 2007 created left the ECB’s primary objective and the basic
structure of its policy strategy unaffected. But policy instruments were
used in increasingly innovative ways, and some aspects of the policy
strategy were broadened and deepened to meet the unprecedented
challenges the crisis posed.
One purpose of having one primary objective for one policy and for
providing a quantitative definition of the objective is precisely to avoid
opportunistic changes in the objective or definition. The regular
verifiability of the achievement of an objective that is not changed in
response to specific circumstances allows the central bank to be
accountable and to maintain its credibility.
Moreover, the symmetric
nature of the ECB’s objective, which aims to prevent inflation rates that
are either too high or too low (including, obviously, deflation), means
that it is also adequate for situations of financial crisis.
The ECB’s monetary policy strategy, through its monetary pillar,
always means to identify some financial imbalances that could contribute
to the emergence of financial crises. The consideration of various
monetary and credit aggregates and their decomposition was further
extended with the crisis. Financial stability indicators were also added.
Moreover, more financial factors were incorporated into the economic
pillar of the strategy, allowing for a better consideration of macrofinancial linkages. A focal point of this broadening and deepening of the
ECB’s monetary policy strategy was the insight that in different phases of
the crisis different elements of the monetary policy transmission
mechanism in the euro area became severely impaired. Targeted
(unconventional) policies to address these impairments required an
increasingly granular analysis of the transmission mechanism.
Against the background of these impairments, conventional
monetary policy instruments, that is, changes in policy interest rates,
were not enough. In the first phase of the crisis (starting in August 2007)
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New Issues in Monetary Policy:
International Experience and Relevance for China
money markets were impaired and banks faced problems in wholesale
funding. This required, among other things, front-loading of liquidity
during the reserve maintenance period, lengthening of maturities in
liquidity-providing operations, and the provision of liquidity in foreign
currencies via swap agreements with other central banks. In the second
phase of the crisis (starting in September 2008) bank wholesale funding
became highly dysfunctional, economic uncertainty increased
tremendously, and the risk of a credit crunch emerged. In addition to
very significant interest rate reductions (325 basis points by May 2009),
the ECB responded to this through enhanced credit support, which
included the provision of any liquidity demanded by banks for which they
had eligible collateral at a fixed interest rate; an enlarged list of collateral
acceptable in its operations; and a further lengthening of maturities;
along with other actions. Moreover, it established a program of
purchasing covered bonds, a particularly important instrument for bank
funding in Europe. The third phase of the crisis (starting in May 2010) was
the sovereign debt crisis, in which certain secondary sovereign bond
market segments dried up; financing of small and medium-sized
companies became impaired (in particular in stressed countries); and at
some points, unfounded market fears of euro break-up scenarios
(redenomination risk) appeared.
Apart from further lowering interest
rates, the ECB responded through secondary market government bond
purchases (securities markets program), very long term refinancing
operations (with a maturity of three years), the announcement of a
program for outright monetary transactions (potential purchases of
short-term government bonds of countries under a macroeconomic
adjustment program), and additional credit claims in its collateral
framework.6
6
The ECB did not pursue quantitative easing policies of the type the US Federal Reserve,
the Bank of England, and the Bank of Japan implemented. When policy rates are at the
zero lower bound, quantitative easing substitutes for conventional interest rate policy.
The ECB’s unconventional monetary policies did not substitute for conventional policy
but complemented it. They were implemented to help the monetary policy stance
(continued)
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New Issues in Monetary Policy: International Experience and Relevance for China
Through these conventional and unconventional policies the ECB has very
much cushioned the adverse effects of the crisis on the economy,
maintaining its ability to steer the euro area inflation rate toward levels in
line with price stability.
