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Markus A. Schmidt
Directorate Monetary Policy
Monetary policy of the ECB, itsMonetary policy of the ECB, its
concepts and toolsconcepts and tools
Frankfurt am Main, 20 September 2011
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The views expressed are those of the presenter and
should therefore not necessarily be viewed and not be
reported as representing the views of the European
Central Bank.
Disclaimer
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The ECBs monetary policy Principles of the ECBs monetary policy
Economic Analysis
Monetary Analysis
The monetary transmission process
ECBs
response to the crisis
Outline
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The ECBs monetary policy Principles of the ECBs monetary policy
Economic Analysis
Monetary Analysis
The monetary transmission process
ECBs
response to the crisis
Anything else?
Outline
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ECBs monetary policy objective Article 127 of the Treaty of the Functioning of theEuropean Union: The primary objective of the ESCB [Eurosystem] shall beto maintain price stability Without prejudice of the objective of price stability, the
ESCB [Eurosystem] shall support the general economic
policies with a view to contributing to the achievement ofthe objectives of the Union as laid down in Article 3 of the
Treaty on European Union.
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ECBs quantitative definition of price stability The Governing Council [GovC] of the ECB in October2008 defined price stability as
a year-on-year increase of
the Harmonised Index of Consumer Prices [HICP]
for the euro area
below 2%.
Price Stability is to be maintained over the medium term. The GovC aims to maintain inflation rates at levelsbelow, but close to, 2% over the medium term.
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Why below, but close to, 2%?
Below in order to fully reap the benefits of pricestability.
Close to
to ensure an adequate margin
that
avoids risks of deflation,
addresses implications of inflation differentials among euro area
Member States and
takes possible small measurement bias in HICP into account.
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Why is price stability important
Inflation is
hampering the price mechanism (absolute-relative confusion,
permanent-transitory confusion),
is affecting the allocation of income (debtors vs. creditors, wage-
lag hypothesis) in case of non-anticipated inflation,
causes a decrease in efficiency, even if inflation is anticipated,
results in sub-optimal holdings of money,
reducing households
purchasing power.
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Inflations consequences for purchasing power
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P
urchasingpowerof
100Euro(2011)
0
20
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60
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P
urchasingpowerof
100Euro(2011)
1% 2% 3% 4% 5%Annual inflation rate of...
Source: ECB calculations.
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Inflation and inflation expectations
Source: Bloomberg, ECB and ECB calculations.
Latest observation: September 2011, end-of-month data (inflation swaps) and monthly data (HICP), percentage points.
-1.0
0.0
1.0
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3.0
4.0
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Dec-0
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Jun-0
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5
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Jun-0
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Dec-0
7
Jun-0
8
Dec-0
8
Jun-0
9
Dec-0
9
Jun-1
0
Dec-1
0
Jun-1
1-1.0
0.0
1.0
2.0
3.0
4.0
5.0
Long-term inflation expectation (5y5y forward inflation swap rate)Medium-term inflation expectation (5y spot inflation swap rate)
Short-term inflation expectations (1y spot inflation swap rate)
HICP (annual growth rate, percentage points)
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Institutional safeguards
Clear mandate: Price stability as primary objective
Independence
from political influence
Clear allocation ofresponsibilities
Strategic safeguards
Credible commitment
towards mandate
Consistent framework for analysis and decision-making
Clear and transparent communication
Safeguards for sound monetary policy
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Full set of informationFull set of information
Analysis ofeconomic
dynamics andshocksAnalysis of
monetary trends
Governing Council takes
monetary policy decisions based
on an overall assessment of the
risks to price stability
Primary objective of price stabilityPrimary objective of price stability
crosschecking
Economic
analysis
Monetary
analysis
The ECBs monetary policy strategy
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Key principles of the ECBs monetary policystrategy
Forward-looking nature
Medium-term orientation
Broad-based analysis
Cross-checking of analyses
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The ECBs monetary policy Principles of the ECBs monetary policy
Economic Analysis
Monetary Analysis
The monetary transmission process
ECBs
response to the crisis
Anything else?
Outline
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Economic Analysis
The Economic Analysis aims at identifying short- tomedium-term risks to price stability. Forward-looking assessment of relevant information from avariety of indicators
(e. g. business cycle, wages,
exchange rate, asset prices, financial yields, fiscal policy,
etc.).
Quarterly macroeconomic projections for inflationand growth in the euro area, prepared by staff of theEurosystem/ ECB
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Economic Analysis
The scope of the Economic Analysis are factors determiningsupply-
and demand-conditions
on
goods markets,
services markets, and
factor markets [capital markets, labour markets].
It investigates shocks to the economy, the resulting dynamicprocesses as well as the perspectives stemming from that.
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Economic Analysis
Among the indicators relevant for Economic Analysis are
price indicators,
expenditure components,
production indicators,
sentiment indicators,
labour market indicators and
financial market indicators.
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The ECBs monetary policy Principles of the ECBs monetary policy
Economic Analysis
Monetary Analysis
The monetary transmission process
ECBs
response to the crisis
Anything else?
Outline
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Monetary Analysis
The Monetary Analysis aims at identifying medium- to longer-term risks to price stability. The basis of Monetary Analysis is the conviction thatinflation is always a monetary phenomenon, at least
in the long-run.
Money has leading indicator properties for inflation in theeuro area in the medium- to long-run.
Regular monitoring of money and credit developmentscontributes to identifying emergence of unsustainabledevelopments in asset prices.
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Monetary Analysis
M
t
M*
P
t
P*
P
tt
M
M*
M*
M*P*
P*
P*
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Monetary Analysis
Monetary Analysis is mainly based on balance sheet dataof the money-issuing sector, i.e. so-called MonetaryFinancial Institutions [MFIs].
Assets Liabilities
Overnight deposits
Currency in circulation
Marketable instruments
Other short term deposits
Longer term liabilities
Holdings of central government
LoansCredit to general government
Credit to private sector
Securities
Securities
Net claims on non-euro arearesidents
Loans
Securities
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Credit is the main source of monetary dynamics
Source: ECB.
Latest observation: July 2011, monthly data, annual growth rates, percentage points.
-2
0
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14
Jan-00
Jul-00
Jan-01
Jul-01
Jan-02
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Jul-03
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Jul-05
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Jul-06
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Jul-07
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Jul-08
Jan-09
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Jul-10
Jan-11
Jul-11
-2
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8
10
12
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Loans to the private sector (adjusted for securitisation) M3
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The ECBs monetary policy Principles of the ECBs monetary policy
Economic Analysis
Monetary Analysis
The monetary transmission process
ECBs
response to the crisis
Anything else?
Outline
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The monetary transmission process
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Monetary transmission in normal times
Overnight rate mirrors official key interest rate overmaintenance period. ECB influences money market conditions by setting keyinterest rates and managing the liquidity situation in the
banking sector by benchmark allotment.
Banks with liquidity surplus lend to those with deficits overinter-bank money market.
Government bonds play an important role as collateral and for the pricing of fixed income securities, henceavailability is important.
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Steering money market conditions
0
1
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3
4
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6
7
Feb-00
Aug-00
Feb-01
Aug-01
Feb-02
Aug-02
Feb-03
Aug-03
Feb-04
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Feb-05
Aug-05
Feb-06
Aug-06
Feb-07
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Feb-08
Aug-08
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Aug-09
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Aug-10
Feb-11
Aug-11
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7
Main refinancing operations Marginal lending facility Deposit facility Eonia (monhtly average)
% %
Source: ECB.
Latest observation: August 2011, monthly averages of daily observations
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Steering money market conditions
0
1
2
3
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Feb-00
Aug-00
Feb-01
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Feb-02
Aug-02
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Aug-03
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Aug-06
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Feb-10
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Aug-11
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Long-term interest rate (10 y) Short-term interest rate (3 m) Eonia (monhtly average)
% %
Source: ECB.
Latest observation: August 2011, monthly averages of daily observations
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The ECBs monetary policy Principles of the ECBs monetary policy
Economic Analysis
Monetary Analysis
The monetary transmission process
ECBs
response to the crisis
Anything else?
Outline
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The financial turmoil and the money market
Source: Bloomberg and ECB calculations.
Last observation: 15 September 2011, daily observations
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1
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Jan-0
7
Mar-0
7
May-0
7
Jul-0
7
Sep-0
7
Nov-0
7
Jan-0
8
Mar-0
8
May-0
8
Jul-0
8
Sep-0
8
Nov-0
8
Jan-0
9
Mar-0
9
May-0
9
Jul-0
9
Sep-0
9
Nov-0
9
Jan-1
0
Mar-1
0
May-1
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Jul-1
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Sep-1
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Nov-1
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Jan-1
1
Mar-1
1
May-1
1
Jul-1
1
Sep-1
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120
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210
Eurepo (3M) Euribor (3M) Depo-Repo-Spread (3M, RHS)
% bp
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Impairment of the monetary transmission process
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The ECBs response to the crisis Immediate response on 9 August 2007
Allowed banks to draw full amount of what they needed on
overnight basis against collateral at the prevailing main refinancing
rate (ca
95 bn)
In the following months
Supplementary refinancing operations with 3 and 6 months maturity
Intra-maintenance period frontloading
More frequent fine-tuning operations
Provision of US dollar liquidity against euro-denominated collateral
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100.0
120.0
140.0
160.0
180.0
200.0
220.0
240.0
260.0
280.0
300.0
08/08/07 11/08/07 14/08/07 17/08/07 20/08/07 23/08/07 26/08/07 29/08/07 01/09/07 04/09/07 07/09/07 10/09/07
[EUR billions]
Daily current accounts Reserve requirements
100.0
120.0
140.0
160.0
180.0
200.0
220.0
240.0
260.0
280.0
300.0
11/07/07 14/07/07 17/07/07 20/07/07 23/07/07 26/07/07 29/07/07 01/08/07 04/08/07 07/08/07
[EUR billions]
Daily current accounts Reserve requirements
100.0
150.0
200.0
250.0
300.0
350.0
400.0
450.0
500.0
10/12/08 14/12/08 18/12/08 22/12/08 26/12/08 30/12/08 03/01/09 07/01/09 11/01/09 15/01/09 19/01/09
Daily current accounts Deposit facility Reserve requirements
EUR [billions]
Pre-crisis benchmark allotment Pre-Lehman frontloading
Post-Lehman ample liquidity
Reserve requirement
Reserve holdings
Recourse to deposit facility
EUR billions
Liquidity management measures
Source: ECB.
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Decline in key interest rates by 325 bp in 7 months
0
1
2
3
4
5
6
Aug-07
Oct-07De
c-07Feb-08
Apr-08
Jun-08
Aug-08
Oct-08De
c-08Feb-09
Apr-09
Jun-09
Aug-09
Oct-09De
c-09Feb-10
Apr-10
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Aug-10
Oct-10De
c-10Feb-11
Apr-11
Jun-11
Aug-11
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2
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4
5
6
Main refinancing operations Marginal lending facility Deposit facility Eonia (monhtly average)
% %
Source: ECB.
Last observation: August 2011, monthly averages of daily observations.
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Short-term(floating rate and up to 1 year)
Long-term(over 5 years)
affected loans-rates, too!
Source: ECB and ECB calculations.
Last observation: July 2011
0
1
2
3
4
5
6
7
8
9
10
Jan-07
M
ar-07
M
ay-07
Jul-07
Sep-07
Nov-07
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M
ar-08
M
ay-08
Jul-08
Sep-08
Nov-08
Jan-09
M
ar-09
M
ay-09
Jul-09
Sep-09
Nov-09
Jan-10
M
ar-10
M
ay-10
Jul-10
Sep-10
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M
ar-11
M
ay-11
Jul-11
0
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3
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10
Small loans to NFCs Large loans to NFCsLoans for house purchase (over 5 and up to 10 years) Loans for house purchase (over 10 years)Consumer credit Other lending
Eonia (monhtly average)% %
0
1
2
3
4
5
6
7
8
9
10
Jan-07
M
ar-07
M
ay-07
Jul-07
Sep-07
Nov-07
Jan-08
M
ar-08
M
ay-08
Jul-08
Sep-08
Nov-08
Jan-09
M
ar-09
M
ay-09
Jul-09
Sep-09
Nov-09
Jan-10
M
ar-10
M
ay-10
Jul-10
Sep-10
Nov-10
Jan-11
M
ar-11
M
ay-11
Jul-11
0
1
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3
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9
10
Small loans to NFCs Large loans to NFCs Loans for house pruchase
Consumer credit Other lending Eonia (monhtly average)
% %
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Further responses enhanced credit support ECBs enhanced credit support consisted of mainlybank-based measures to support the flow of credit beyond
standard interest rate channel
Fixed-rate full allotment
Expansion of collateral
Longer-term liquidity provision
Liquidity provision in foreign currencies
Financial market support through purchases of covered bonds
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Temporary improvements
Against background of improved money market conditionsECB introduced exit strategy
from non-standard
measures, as they were temporary by nature
Non-continuation of purchases of covered bonds
Partly withdrawal of liquidity provision in foreign currency
Non-continuation of long-term liquidity provision
No pre-determined sequence between the exit from non- standard measures and interest rate actionAssessment of risks to price stability primary criterion
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5-year sovereign CDS spreads
Source: Bloomberg.
Last observation: 14 September 2011, daily observations.
0
500
1000
1500
2000
2500
3000
3500
4000
4500
Jan-0
7
Mar-0
7
May-0
7
Jul-0
7
Sep-0
7
Nov-0
7
Jan-0
8
Mar-0
8
May-0
8
Jul-0
8
Sep-0
8
Nov-0
8
Jan-0
9
Mar-0
9
May-0
9
Jul-0
9
Sep-0
9
Nov-0
9
Jan-1
0
Mar-1
0
May-1
0
Jul-1
0
Sep-1
0
Nov-1
0
Jan-1
1
Mar-1
1
May-1
1
Jul-1
1
Sep-1
10
500
1000
1500
2000
2500
3000
3500
4000
4500
DE FR IT ES IE PT GRbp bp
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ECBs response to the sovereign debt crisis ECB introduced the Securities Markets Programme [SMP] to safeguard the well-functioning of the
transmission process by conducting interventions in euroarea debt securities markets.
Purchases ensure depth and liquidity in dysfunctionalsecurities markets and are conducted on secondary marketsonly.
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ECBs response to the sovereign debt crisis ECB re-introduced some non-standard measures thathad been phased-out earlier.
Fixed-rate full allotment in 3M refinancing operations
Temporary 6M refinancing operations
Fixed-rate full allotment in USD (new)
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Monthly Bulletin The ECBs monetary policy stance during thefinancial crisis (January 2010)
The ECBs response to the financial crisis
(October 2010) Asset price bubbles and monetary policy
revisited (November 2010)
Literature
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The Monetary Policy ofthe ECB
Literature
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The European CentralBank, the Eurosystem,the European System of
Central Banks
Literature
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Price Stability: Why is itimportant for you?
Literature
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Markus A. Schmidt
Directorate Monetary Policy
Monetary policy of the ECB, itsMonetary policy of the ECB, its
concepts and toolsconcepts and tools
Frankfurt am Main, 20 September 2011