NEWS Release - Maintaining price stability with unconventional monetary policy - Speech by Peter Praet, Member of the Executive Board of the ECB, at the Council of the European Union, Brussels, 29 January 2018
Responding to the crisis in the euro area
The crisis that erupted in 2008 sparked a sharp downturn in the global financial cycle[1]. In the preceding years, over-optimistic growth expectations had taken hold in a number of advanced economies. Despite slowing productivity growth, agents overestimated future income growth and borrowed against it, accumulating excessive levels of debt.
At the same time, financial liberalisation and deregulation encouraged financial leverage and rapid credit growth. The ten years since that eruption has been a changeable period of deleveraging and de-risking, with a number of different phases.
The first phase was the immediate liquidity crisis triggered by the turning of the global financial cycle and the subsequent collapse of Lehman Brothers. Market funding came to a sudden stop for many financial institutions. The ECB’s response was to lower its main refinancing rate to the then record low of 1% in May 2009, to expand the range of eligible collateral for our refinancing operations and to provide liquidity elastically to the banking sector, at both increasingly long durations and against a wider range of collateral.
The second phase was the sovereign debt crisis of 2011-12, which was intensified by the bank-sovereign nexus. Bank funding markets fragmented along national lines and banks in vulnerable countries lost access to wholesale funding. It led to a serious disruption of the monetary transmission mechanism and prevented our accommodative policy stance from reaching the economy.
Our policy response was twofold. First, we carried out two three-year refinancing operations at the end of 2011 and beginning of 2012. Second, we announced our conditional Outright Monetary Transactions in summer 2012, which acted as a powerful circuit breaker against self-reinforcing fears in sovereign bond markets. But the sovereign debt crisis nonetheless left the economy with a damaging legacy and paved the way for the third phase of the crisis.
As the euro area entered into a prolonged slump, banks in many parts of the euro area embarked on a slow process of deleveraging, mainly by reducing lending. A credit crunch was looming: by end-2013 loans to the private sector were falling by more than 2% per year. By mid-2014, the economic recovery was losing momentum and the weakness in aggregate demand was starting to depress inflation expectations. The sharp fall-off in oil prices that began in late summer exerted further disinflationary pressures.
Given the weak underlying trend in inflation, we saw a growing risk that low inflation could de-anchor inflation expectations and unleash a deflationary spiral. Short-term interest rates that were already close to zero hampered our ability to use conventional monetary policy instruments. The ECB had to resort to a new approach to ease its monetary stance, based more on directly influencing the whole constellation of interest rates that are relevant for the financing conditions of the economy. This strategy was articulated in three measures.
The first was the launch of a negative interest rate policy, as we lowered the interest rate paid on our deposit facility to -0.1% in June 2014. The second instrument was our targeted longer-term refinancing operations (TLTROs), which are specifically designed to support bank lending to the private sector. The third instrument was our asset purchase programme (APP) involving private and public sector securities, which helped further depress the term structure of interest rates by compressing risk premia out along the yield curve.
These instruments were complemented by the use of forward guidance, where we started to communicate about our expectations of future policy, along with the conditions that would warrant a change in the policy stance.
A solid and broad-based economic expansion with subdued price pressures
Our monetary policy strategy has borne fruit. We have now seen 18 quarters of positive growth and the short-term economic indicators all point to a continued economic upswing with above-trend growth. The breadth of the expansion is notable: the dispersion of growth rates across both countries and sectors is at its lowest level for two decades.
The euro area recovery has so far been mostly home-grown, with monetary policy creating the conditions for a virtuous circle between rising income and spending in both the corporate and the household sector. Annual growth in employment has reached its highest level since before the crisis and the unemployment rate fell to 8.7% in November, the lowest rate for nearly nine years.
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