European Central Bank: Unconventional Monetary Policies

Unconventional Monetary Policies

• The European Central Bank (ECB) manages the single currency, ensures price stability, and conducts economic and monetary policy for the EU.
• The ECB was created in 1998, Christine Lagarde is the president, and its headquarters are located in Frankfurt, Germany.
• The Eurozone has experienced financial crises, including the subprime crisis (2008), public debt crisis (2010-2012), COVID-19 (2020-2021), and energy crisis (2022).
• Unconventional monetary policies began in 2008 because states became indebted to respond to the subprime crisis, leading to a second crisis.

2008 Crisis (Subprime)

• To address the 2008 crisis, the ECB used unconventional methods.
• The ECB set a key interest rate close to zero in the long term (LT).
• The ECB made massive purchases of securities on secondary markets.
• The ECB provided loans to commercial banks in the long term (3-4 years).
• The assets of the ECB increased because of this.
• The ECB intervenes in financial markets to regulate interest rates and liquidity.
• Refinancing operations such as Quantitative Easing (QE) are used as instruments.
• Funds were used to promote lending, stimulate the economy, and replace interbank loans that were no longer functioning due to a lack of confidence among institutions.

Public Debt Crisis (2010-2012)

• A public debt crisis refers to a situation where a country or public entity is unable to repay its debts or faces difficulties in doing so.
• The subprime crisis led to an increase in the deficit and a decrease in revenue.
• There was a decline in confidence in certain EU countries, such as Greece, and the ECB lends at very high rates.
• Greece experienced a prolonged economic recession, its GDP fell by 25%, and the unemployment rate reached nearly 27%.
• Policies were used to address this crisis:
  • Repurchasing securities on secondary markets to increase liquidity
  • Quantitative easing (QE)
  • Open market operations
• The ECB does not have the right to lend to states, which is prohibited by Article 123.
• The ECB and national central banks of member states are prohibited from directly financing governments by purchasing public debt.
• The ECB is prohibited from directly lending money to states by directly acquiring their obligations on the primary market.
• The ECB often purchases sovereign debt securities on the secondary market which are financial markets where securities are already in circulation.

Quantitative Easing (QE)

• QE is used during crises to stimulate economic activity and restore confidence among economic agents.
• An increase in liquidity via expansionary monetary policies leads to a decrease in interest rates, increasing the number of loans.
• This increases overall demand because consumers and businesses can borrow to finance their purchases or investments at lower rates.
• QE for the Eurozone:
  • Repurchasing debt securities by the central bank
  • Guaranteeing that Eurozone debt can be resold
  • Circumventing Article 123 of the Treaty on the Functioning of the EU
  • Reassuring lenders and lowering interest rates related to state debt
  • Reviving the economy with growth and inflation driven by demand

COVID-19 Crisis (2020-2021)

• In response to the COVID-19 crisis, the ECB implemented the pandemic emergency purchase programme (PEPP), which is a temporary program for purchasing securities.
• The PEPP aims to improve the financial conditions of the economy, like any securities purchase program (QE).
• PEPP has a direct effect on asset prices.
• PEPP has a rebalancing effect on financial institutions that are selling their assets to the ECB, and recover additional funds that are allocated to other assets, increasing the demand and the price of the assets.

Energy Crisis (2022)

• The energy crisis was a period of significant tensions and disruptions in the energy markets worldwide, resulting from the combination of factors.
  • Geopolitical factors such as the war in Ukraine and gas supplies
  • Climate factors such as heat waves and increased air conditioning use
• To help address the climate crisis, the ECB could:
  • Stop purchasing assets from companies involved in fossil fuel exploration or extraction (decarbonizing the economy).
  • Purchase bonds from companies using renewable energy sources (greening the economy).
  • Accept securities related to the decarbonization of the economy or renewable energies as collateral.

Federal Reserve System (FED)

• The goal of the FED is to maintain average growth of monetary aggregates and credit compatible with the potential for production growth, to target maximum employment, stable prices, and low long-term interest rates.
• The FED's support plan is similar to that of the ECB.

Limitations of Monetary Policy

• Keynes' liquidity trap occurs when interest rates are very low, leading to an absolute preference for money as people expect rates to rise.
• Monetary policy becomes totally ineffective.
• Communication is key to preventing economic actors from anticipating that rates will rise.

QE for the USA

• QE for the USA is when the central bank repurchases securities.

• A way to remove "toxic" assets from banks' balance sheets and improve the health of the banks where toxic assets are risky and potential payment defaults.

• QE is an injection of central bank money into the system, allowing for a potential increase in the money supply.

• A means to boost the economy to increase growth and demand-pull inflation

• A way to inflate the value of financial assets

• Recently, related to Trump's election, the FED plans a response to projected inflation above 2% due to his plan to increase taxes on imports.

Swiss National Bank (SNB)

• The SNB is independent and prioritizes price stability with consideration for the economic situation.
• The SNB is a public limited company under federal law established by special statute.
• The SNB has a monopoly on issuing banknotes.
• They analyze sources of risk for the financial sector, monitor payment systems, and oversee operations on securities that have systemic importance.

Negative Rates

• The Consumer Price Index (CPI) declines if there is a general decrease in prices.

Return to Negative Rates

• The objectives are to encourage investment and consumption, reduce the attractiveness of currency to lower yields and increase exports, and stimulate growth.
• Risks include:
  • terra incognita as unproven territory
  • decreased returns for financial institutions
  • bubble creation due to people turning to riskier investments
  • problems for pension funds (second pillar)
  • unsustainable government debt due to temptation of big investment
  • less room for central bank maneuver because they can't lower their policy rates further

Brief History of Exchange Rates

• The world previously used a monetary system based on gold despite aversion to gold standards.

• Gold is seen as a safe haven.

• Nixon abolished it because of lack of flexibility where currency supply was determined by gold reserves and the economy was dependent on gold discoveries.

• 3 objectives of a monetary system:

  • Internal balance (counter-cyclical tendency) with full employment, stable prices and a stable economy
  • Allocative efficiency leading to maximized global welfare
  • Financial stability avoiding crises and bubbles

• Gold Standard (1870-1914) used fixed exchange rates with everything based on gold.

  • Every currency value was defined fixed: 1 currency unit = x grams of gold
    • Critique: growth depended on gold discoveries.

• Gold reserves were also a gold standard where international payments were made in gold and BCs guaranteed gold convertibility which kept exchange rates the same.

  • Led to strong purchasing power for the USA and good times.

Fixed Exchange Rate System - BC Balance Sheet

• Assets: national securities, gold and currencies (international reserves)
• Liabilities: Currency in circulation (MM)
• BCs aimed to maintain exchange rate parity with gold.
• Money Supply increase: increase gold by selling abroad
• X < M leads to currency outflow needing gold so increases X leading to reduction in M.
• To decrease M; 1. raise interest rates, lower investments, decrease revenue.
• BTC Rebalancing: balancing current transactions, no autonomous monetary policy
• MM=gold in vaults if country respects it
• countries created excessive money leading to imbalance and need to give country's gold for armament.

WWI

• Financials led to monetary disorder and INFLATION

• Reduced gold due to international payments by gold

• Suspension of gold standard

• USA gained as winners so increased gold.

• 20th increased economic power due to immigration

• Led to technological innovation.

• 3 periods

  • Free Float (1919-1916) where GB and USA dominated trade
  • Gold Exchange standard where $ and pounds convertible
  • Fragile Gold standard leading to economic instability.

• England lowered reserves

• USa halted dollar to gold convertibility to boost economy to prevent protectionism

• Competitive devlauations to fav exports.

WWII; IMF needed to STABILIZE

• Bretton was created to stabilize
• Fixed system needs to be discussed via FMi to guarantee stability

SMI: International Monetary System

• $ was a reserve of international money.

• FMI makes sure of parity, and helps development.

• If more imports than exports, its too high.

• If more exports than imports, its too low.

• USA was policeman.

• USA had bases so dollar out there.

• Led to dollar issues.

• USA devalued.

• Sortie of FMI, entered G which helped guide it.

Float Exchange System

• BCs need less devisas.

• Change in flow helps balance.

• Makes adjustments.

• Exchange rates are volatiles, and firms do special things.

Flexible exchange systen

• not location precise.
• 24h
• nearly perfect.
• scriptural money is key
• Rate price of currency.

Types of interventions

• Importers/exports.

• Importers pay in money, and demand much.

• Capitaux

  • exporters have too much.

• Speculatros trade both

• cotation on value.

• Definition

  • Economic concept developed by Gustav Cassel
  • Helps compare currencies in countries
  • With principle of money for some products.
  • Calculate
    • with good standards
    • change rates is different.
    • Types of goods
    • international v noninternational for price
  • BM index
  • measures through BM
  • 1.107 v 1.246

Factors for rates

• balance

  • PPA.
  • interest changes
  • Inflation

• rate balance changes.

• Appreciation: values increases

• decrease leads to devaluation

• Example rates

• If high import, more demand

• Conclusion

• Nominal high will change.

Factors for instabilotes

• FPA for change
• Rate has to align
• In theory, commerce changes.

Factors affecting

• Eco growht

• Attracts. Inflation

• Lowers monet

• 3 theories for markets

  • Theory: Markets fix w exchange
  • Bullets of market.