Publication - The ECB’s announcements of non-standard measures and longer-term inflation expectations - By Peter Karadi[1]
Stable and well-anchored longer-term inflation expectations bolster the ability of the European Central Bank (ECB) to achieve its medium-term inflation objective. This article assesses the effectiveness of non-standard monetary policy measures in guiding longer-term inflation expectations in an environment where standard interest rate policy approaches the lower bound.
This causal channel is identified by looking at the change in five-year-ahead inflation expectations following announcements of non-standard measures in the period since 2013. The results suggest that non-standard measures, and in particular the asset purchase programme (APP), were conducive to preventing a potential unanchoring of longer-term inflation expectations.
Under normal circumstances, the ECB uses its key interest rates to maintain price stability in the euro area, i.e. an annual rate of increase in the Harmonised Index of Consumer Prices that is below, but close to, 2% over the medium term. The unrestricted room to manoeuvre and consistent inflation performance help keep longer-term inflation expectations well anchored. However, as the interest rate approaches its effective lower bound, there is the risk that longer-term inflation expectations may become unanchored. In order to mitigate this risk and stabilise inflation, the ECB deployed non-standard monetary policy measures. This article assesses whether those measures were effective in driving longer-term inflation expectations.[2]
Identifying the causal effect of monetary policy
To identify the causal impact of non-standard measures on longer-term inflation expectations, it is important to control for reverse causality. Monetary policy actions not only cause changes in expectations, but can also endogenously respond to such changes or other factors influencing inflation expectations.
In order to control for such an endogenous response, the analysis is performed in two steps. The first identifies the component of non-standard monetary policy measures which, from the perspective of the private sector, is unrelated to movements in longer-term inflation expectations. This component is captured by the surprise change in a monetary policy indicator within a narrow intraday window around the time of relevant policy announcements. These high-frequency surprises are free from any reverse impact, because it is highly unlikely that news unrelated to monetary policy will reach the market systematically within the same narrow window. In the second step, all policy surprises are cumulated over three months to obtain a quarterly measure. The causal impact of monetary policy on longer-term inflation expectations is then assessed by analysing the relationship between the quarterly change in longer-term inflation expectations and the cumulated policy surprises.
It is necessary to clarify beforehand that the analysis described here is useful for identifying the causal impact, but it is not well suited to assessing the overall impact of non-standard monetary policy measures on financial markets and longer-term inflation expectations. The surprises do not capture a substantial part of the impact of those policy measures, namely the component that was incorporated in private sector expectations between Governing Council announcements. For example, ten-year German Bund yields declined by 1.2 percentage points between June 2014, when the ECB announced to launch a series of targeted longer-term refinancing operations (TLTROs) and preparatory work for outright purchases of asset-backed securities, and March 2015, when the implementation of APP was initiated. A substantial part of that decline is likely to be attributable to the policy intervention. However, only around 0.1 percentage point of the decline occurred around the time of the ECB’s press conferences.
The rest of this article describes in more detail the data employed in the analysis and the construction of the surprise component of non-standard measures, before presenting the results of the regression analysis.
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