1. ECB’s Liquidity Policy An Update Gioè Massimo Lapage Christophe

2. Contents 1.Introduction 1.The Eurosystem 2.Monetary Policy 3.Key European Interest Rates 2.ECB’s Liquidity : Instruments and Objectives 1.Eurosystem Monetary Policy Operations 2.Example of Main Refinancing Operation-Allotment 3.Innovations and Adaptations to the Current Crisis 1.Trichet’s Enhanced Credit Support 1.Fixed Rate Tenders with Full Allotment 2.Collateral 3.Lengthening of Maturities of Refinancing Operations 4.Providing Liquidity in other Currencies 5.Outright Purchase of Covered Bonds Issued by Banks 2.Central Banks Cut the Main Interest Rate Together 3.Additional measures 4.Impact of ECB’s Innovations 1.On the Eurosystem Balance Sheet 2.On the Financial System, and the Real Economy 5.Fed 1.Bernanke’s Credit Easing – 3 Sets of Tools 1.Lending to Financial Institutions 2.Providing Liquidity 3.Buying Longer-Term Securities 6.Conclusion

3. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion Source : Wikipedia Eurozone

4. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion ECB’s Monetary Policy “ The primary objective of the ECB’s monetary policy is to maintain price stability. The ECB aims at inflation rates of below, but close to, 2% over the medium term.” Instruments of monetary policy: - Open Market Operations - Standing Facilities - Reserves Purpose of Instruments: The central bank manages the liquidity situation, influences money market interest rates and gives signals to the markets.

5. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion Source : www.ecb.int Key Interest Rates in Europe ‘ The stance of monetary policy, as reflected in short term interbank interest rate, can obviously be loosen through a decrease in key policy rate or through a looser liquidity supply, or through a combination of both.’

6. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion Source : ECB, Nov. 2008 Eurosystem Monetary Policy Operations

7. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion Reference Number: 20080042Min Rate: 4 % Transaction Type: REVERSE_TRANSACTION Marg. Rate: 4.03 % Operation Type: LIQUIDITY_PROVIDING % of All. at Marg. Rate: 57.9207 Procedure: STANDARD_TENDERTot Amount Allotted: 191000 mn Tender Date: 10/06/2008Weight. Avg. Allot. Rate: 4.18 % Start Date: 11/06/2008Tot Bid Amount: 202780.3 mn Maturity Date: 18/06/2008Tot Number of Bidders: 343 Duration (days): 7Min Rate (bids): 4 % Auction Type: VARIABLE_RATEMax Rate (bids): 4.32 % Allotment Method: MULTIPLE_RATE Main Refinancing Operation-Allotment Source : www.ecb.int

8. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion Trichet’s Enhanced Credit Support In order to respond to the current credit crisis, the ECB has adopted some new measures : the so-called ‘non-standard measures’. Purpose : have private banks lend  to maintain the availability of credit for households and companies at accessible rates.  Boost the economy, as far as the inflation is low.

9. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion 1. Fixed Rate Tenders with Full Allotment October 2008 – Complete switch from variable to fixed main refinancing rate. ECB’s Perspective : The new fixed rate full allotment tender procedure was designed to ensure the effectiveness of monetary policy transmission at a time when borrowing through interbank transactions had become abnormally elevated for many financial institutions. Bank’s Perspective : Thanks to this measure, they face less competition than before (Dutch auction with variable rate). Trichet’s Enhanced Credit Support

10. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion Reference Number: 20090055Fixed Rate: 1 % Transaction Type: REVERSE_TRANSACTION % of All. at Fixed Rate: 100 Operation Type: LIQUIDITY_PROVIDING Tot Amount Allotted: 442240.5 mn Procedure: STANDARD_TENDERTot Bid Amount: 442240.5 mn Tender Date: 24/06/2009Tot Number of Bidders: 1121 Start Date: 25/06/2009 Maturity Date: 01/07/2010 Duration (days): 371 Auction Type: FIXED_RATE Longer Term Refinancing Operation-Full Allotment Source : www.ecb.int

11. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion 2. Collateral ECB’s Perspective : The list of asset accepted by the ECB has been increased. Bank’s Perspective : Banks have easier access to loans. Trichet’s Enhanced Credit Support

12. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion 3. Lengthening of Maturities of Refinancing Operations April 2008 – First 6m operation (still with variable rate) June 2009 – First 12m operation (with full allotment and fixed rate) ECB’s Perspective : ECB has increased the maturity to 6 months and 1 year. They recommend banks to expand their longer-term assets rather than increase the availability of short-term liquidity… and to lend more easily to other sectors of the economy. Bank’s Perspective : Banks can resolve better the mismatch between the investment side and the funding side of their balance sheets. This is expected to make their liquidity planning horizon longer and less uncertain. Trichet’s Enhanced Credit Support

13. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion 4. Providing Liquidity in other Currencies, especially US Dollar and Swiss Franc December 2007 – First US Dollar liquidity providing measure October 2008 – Expansion toward selected foreign currencies ECB’s Perspective : ECB’s purpose is to avoid any shortages of foreign currencies. These operations are arranged via swap lines with the Federal Reserve and other CB’s. Bank’s Perspective : They can more easily respond to their need of foreign currencies, and thus lend more easily to euro area agents requesting especially US dollar and Swiss Franc. Trichet’s Enhanced Credit Support

14. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion 5. Outright Purchase of Covered Bonds Issued by Banks Target : Invest €60 billion (= 5% of the outstanding eligible covered bonds) ECB’s Perspective : Support the flow of credit Bank’s Perspective : Covered bonds allow banks to manage the maturity mismatch between their assets and liabilities. They find a market again for this instrument, after the significant losses experienced during 2008-2009. Trichet’s Enhanced Credit Support

15. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion Central Banks Cut the Main Interest Rate Together For the first time ever, different central banks (the ECB, the Fed, the Swiss Central Bank, the Bank of England and the Bank of Canada) decided to cut off the main interest rate together in order to give a big signal to the market. Example : October 8 th 2008, ECB decided to decrease the main refinancing interest rates by 0.5% during an unforeseen meeting.

16. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion Additional Measures Páramo added some measures : ▫Larger access of counterparties + Increased international cooperation ▫More coordinated actions both for interest rates and for the provision of liquidity ▫More information exchanged among major CB’s The ECB is acting as lender of last resort. BUT, these and the following measures are to be considered as temporary.  Banks cannot rely on it forever !

17. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion Impacts of ECB’s innovations 1.On the Eurosystem 2.On the Financial System, and on the Real Economy

18. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion 1. Impact of non standard-measures on the Eurosystem balance sheet The size of the Eurosystem balance sheet has significantly increased. In June 2007, just before the start of the crisis, total assets of the Eurosystem amounted to €1,176 billion. By November 2009, the size has increased by almost €600 billion.

19. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion 1. Assets 8 June 2007 20 November 2009 Gold and gold receivables179,936238,147 Claims on non-euro area residents in foreign currency143,867193,776 Claims on euro area residents in foreign currency25,58841,172 Claims on non-euro area residents in euro15,30117,071 Lending to euro area credit institutions in euro429,174649,482 Main refinancing operation207,00053,258 Longer-term refinancing operations150,002595,401 Marginal lending facility172773 Other claims on euro area credit institutions in euro14,05822,058 Securities of euro area residents in euro96,176326,084 General government debt in euro37,64336,195 Other assets234,603237,490 Total assets1,176,3461,761,476 - Full allotment measures are included in the longer-term refinancing operations - The covered bond purchase program increases the securities assets Source : www.ecb.int

20. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion -Banknotes in circulation have steadily increased - Current accounts and deposit facility have gone up Source : www.ecb.int 2. Liabilities 8 January 2007 20 November 2009 Banknotes in circulation629,296771,617 Liabilities to euro area credit institutions in euro185,711275,891 Current account185,565229.825 Deposit facility14346,065 Other liabilities to euro area credit institutions in euro201413 Debt certificates issued00 Liabilities to other euro area residents in euro51,054163,603 General government42,595155,395 Other liabilities8,4598,207 Liabilities to non-euro area residents in euro20,24062,084 Liabilities to euro area residents in foreign currency1573,589 Liabilities to non-euro area residents in foreign currency17,2629,702 Counterpart of Special Drawing Rights allocated by the IMF5,57850,906 Other liabilities72,995158,458 Revaluation accounts125,521192,254 Capital and reserves68,33172,959 Total liabilities1,176,3461,761,476

21. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion 2. Impact of Measures on Financial Markets and the Real Economy M1 – M3 growth rates Interbank market Access to credit for households and corporations Interest rates and yield curve

22. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion Growth of M1 and M3 Source : www.ecb.int The impact of the monetary base has strongly decreased.  More effort is required to affect the liquidity in the market !  More M1 injection

23. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion Spread between Euribor – 6 months and main refinancing rate Source : www.ecb.int The interbank credit market has followed the decrease of the ECB’s main interest rate after a considerable lag.

24. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion Long-term and short-term interest rates Source : www.ecb.int From flatter (and perhaps negative sloped) to more “normal” yield curves.

25. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion Source : www.ecb.int Loans to Non-Financial Corporations and to Household Purchase (flows in volume) Loans to firms and households decreased, even to negative territory.

26. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion Federal Reserve Similar overall objectives than ECB, perhaps a different loss function : Where β is a measure of the CB’s aversion to π. Similar measures adopted 3 sets of tools : ▫Lending to financial institutions ▫Providing liquidity ▫Buying longer-term securities

27. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion Source : www.bloomberg.com Federal Funds Target Rate The Fed adopted an aggressive monetary policy well before the ECB.

28. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion Bernanke’s Credit Easing (1) Group 1 ▫Enlarged the eligibility ▫Lowered the spread between the discount rate and the federal funds rate target from 100 to 25 bps ▫Increased the term of discount window loans ▫Created the Term Auction Facility ▫Created Term Securities Lending Facility ▫Created the Primary Dealer Credit Facility

29. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion Sources of Finance for Corporations Source : Trichet, 2009

30. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion Bernanke’s Credit Easing (2) Group 2 : ▫Purchased highly rated commercial paper ▫Provided liquidity for money market mutual funds ▫Increased collateral Group 3 : ▫Purchased longer term securities  Example : $100 billion in government-sponsored enterprise debt

31. 1. Introduction 2. Instruments and objectives 3. Innovations 4. Impact 5. Fed 6. Conclusion Conclusion ECB and Fed both have adopted similar measures which aim to the same final objective : inject more liquidity in the market. The Eurosystem balance sheet has expanded Banks don’t seem to lend enough either because they fear high credit risk or simply because there is low demand from companies and households. Exit Strategies : ▫Decrease non standard measures ▫Adjust level of key interest rate Better a late exit than a premature, but too late would increase the risk of high inflation in the future. New challenge for the ECB and the Fed

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33. Bibliography Bernanke B. (13 Jan. 2009), “Beyond the Federal Funds Rate: The Fed's Policy Toolkit” Bini Smaghi L. (19 Nov. 2009), “Monetary Policy in Challenging Times”, London Bofinger, Peter, “ Monetary Policy - Goals, Institutions, Strategies, and Instruments ”, Oxford University Press, 2001, pp. 293 – 367 González-Páramo J. M. (10 Nov. 2009), “The Response of the Eurosystem to the Financial Crisis”, Brussels González-Páramo J. M. (9 Sept. 2008), “Some Lessons from the Global Financial Turmoil”, London Trichet J.- C., (13 July 2009), “The ECB’s Enhanced Credit Support” ECB, Monthly Bulletin November 2009 ECB (Nov. 2008), “The Implementation of Monetary Policy in the Euro Area” www.federalreserve.gov www.ecb.int www.bloomberg.com www.eurostat.eu