Peter Praet writes: Konrad Adenauer, Germany’s first chancellor after World War II, famously said: “Why should I care about the things I said yesterday?”
We at the European Central Bank noticed that our monetary policy was no longer having the effect on private borrowing costs to which we were accustomed. It was obvious that the lending channels in the banking system had become dysfunctional; excessively restrictive borrowing conditions were suppressing demand. In response, the ECB did precisely what any central bank would have done: we acted to restore the relationship between our monetary policy and the cost of borrowing.
In June, we introduced a series of targeted longer-term refinancing operations (known as TLTROs) to provide funding for banks at very low fixed rates for a period of up to four years. Our programs to purchase asset-backed securities and covered bonds were tailored to help lower funding costs from banks to customers.
Together, these measures address the root causes of impaired bank lending,facilitating new credit flows to the real economy.
At the same time, inflation has continued trending down. In November, annual inflation in the euro area fell to a cyclical low of 0.3%, largely owing to the sharp fall in oil prices since the end of the summer.
Falling oil prices and the prospect of a prolonged period of low inflation also seem to have affected inflation expectations. Given the potency of the recent oil-price shock, the risk is that inflation may temporarily slip into negative territory in the coming months. Normally, any central bank would welcome a positive supply shock. After all, lower oil prices boost real incomes and may lead to higher output in the future.
That is why the ECB Governing Council has reiterated its unanimous commitment to use additional unconventional instruments within its mandate should it become necessary to address a prolonged period of low inflation, or should the monetary stimulus fall short of our intention to move our balance sheet toward its size in early 2012.
If we were to judge that the economy is in need of further stimulus, one option could be to extend the ECB’s outright asset purchases to other asset classes.
An important criterion for the choice of additional measures should be the extent of their influence over broad financing conditions in the private economy. For example, purchases of bonds issued by euro-area non-financial corporations (NFCs) would probably have some direct pass-through effect on firms’ financing costs.
It would be a different matter if we were to decide to buy bonds issued by euro-area sovereigns – the only market where size would generally not be an issue.
The effectiveness of interventions in the sovereign-bond market will also rest on the state of the banking sector. Higher capital ratios, lower exposure to bad loans, and more transparent balance sheets increase the chances that the ECB’s quantitative impulses will be transmitted to the wider economy.
That is why the completion of the ECB’s comprehensive assessment of banks’ balance sheets and the start of Europe-wide banking supervision will help revitalize sluggish lending in the euro area.
A decision to purchase sovereign bonds would also need tofactor in the institutional specificities of the euro area, including the limits set by the EU Treaty.
