WATFE Gibran, 1 February 2015
Last week, the European Central Bank (ECB) announced the launch of a massive program to buy sovereign bonds of euro area member states. Although this decision has already received considerable public attention, it is not the first time that the ECB buys sovereign bonds. What is new is the scale on which the ECB will buy securities. In fact, 60 billion Euro worth of sovereign (public) and covered (private) bonds will be purchased per month between March 2015 and at least until September 2016.
ECB going beyond its mandate?
Critics of the ECB’s unconventional measures argue that the ECB goes beyond its mandate of maintaining price stability. The ECB and the proponents of the asset purchases argue instead that the euro area can only be saved from deflation by using this measure. In fact, inflation is influenced by numerous factors. Among these are stable growth of credit volume and bond yields that maintain the sustainability of government debt. These intermediary indicators have become subject to extensive impact evaluation in recent years. What do these studies tell us for the possible impact of the new QE programme? Does this operation make economic sense?
Asset purchases and bond yields
First of all, the empirical evidence suggests that asset purchase programmes considerably lowered sovereign bond yields. By creating demand for previously illiquid bonds, the value of these bonds rises, and their yields decline in turn. This works either directly by the purchase of sovereign bonds, or indirectly by purchasing other kinds of bonds that influence the yields of sovereign bonds (e.g. covered bonds). In fact, the announcement of the Outright Monetary Transactions (OMT) programme alone led to a large decrease of yields on Greek sovereign bonds. Apart from that, the actual purchases during the Securities Markets Programme (SMP) and the Covered Bond Purchase Programme (CBPP), also have been found to have lowered yields making it easier for governments to refinance themselves on the financial markets. The QE programme therefore seems to be promising in further stabilizing or lowering governments refinancing costs.
What about other measures?
A partial alternative to the purchase of assets, the largest part of the non-conventional arsenal of policy instruments during the crisis period was made up of direct or indirect liquidity provision to banks. Next to lowering the interest rate to unprecedented lows (and the deposit rate even to a negative -0.15%), these consisted of the prolongation of the Longer-Term Refinancing Operations (LTROs) including Targeted-LTROs to directly influence credit growth. Moreover, competitive bidding had been suspended and collateral eligible for obtaining these funds had been widened. This had only little effect on both bond yields and bank lending. Instead these instruments helped easing tensions on the money market. Although legally and politically the ECB seems to fare better in using liquidity-providing instruments, the purchase of assets actually proved to be more effective in ensuring a stable functioning of the euro system.
Politically, using liquidity instruments is much less contentious and therefore a widely accepted instrument of the ECB. But those who are concerned about the ECB violating its mandate must know that the empirical evidence suggests that using the full arsenal of monetary policy instruments would be more effective in restoring a more balanced monetary and economic path of the euro area.