European monetary policy

European Central Bank © Fotolia/Oscity

The macroeconomic outlook of the Euro area continues to look bright in 2018. In Addition, the inflation rate is approaching the target level of close but under two percent. A change of the monetary policy of the European Central Bank (ECB) is therefore coming up. This adjustment needs to be carried out prudently with proper preparation to avoid financial turmoils with negative impacts on financing conditions of the real ecomomy.

The European Central Bank (ECB) is the central monetary policy force in the European Economic and Monetary Union (EMU). The ECB’s primary duty is to ensure price stability. Due to monetary policy, it intends to fix the inflation under two percent. After that, ECB's mandate is to support economic well-being in achieving a high rate of employment - as long as that does not jeopardize price stability.

The developments that followed the 2008 crisis presented new challenges for the ECB. On the one hand, liquidity problems in the banking sector required the ECB to intervene in order to sustain the payment system. On the other hand, the ECB had to deal with low inflation, which was moving further away from the target of just under two percent. Although it lowered interest rates many times, inflation in the Euro area stayed just above zero percent.

When it lowered key interest rates to 0.05 percent in September 2014, the ECB exhausted this monetary policy instrument without getting any closer to its goal of two percent inflation. At the same time, money supply growth (M3) remained below expectations, whereas the ECB decided in January 2015 to extend existing programmes to include an expanded asset purchase programme, or APP. It has since been buying bonds issued by central governments in the Euro area as well as supranational bonds issued by European institutions. In June 2016, the ECB started to buy bonds of the real economy as well (Corporate Sector Purchase Programme, CSPP). At the height of its expansionary monetary stance monthly asset purchased amounted up to 80 billion Euros.

In autumn of 2017, ECB decided to reduce its purchasing programe due to the start of the normalization of inflation. In June 2018, the ECB council decided to keep the current volume of asset purchases at 30 billion Euros, easing that down to 15 billion Euros starting in September 2018. The deposit facility, the main refinancing instrument and the marginal lending facility will stay their current levels of -0.4 percent, 0.0 percent and 0.25 percent. It is expected, that these levels will be constant beyond summer 2019.

The ECB’s monetary policy is pursuing the right goals from the perspective of the industrial sector, and it is using appropriate means to achieve those goals. The APP and other purchase programmes are improving the monetary preconditions for reviving the European economy. First, the Euro area struggled with dangerously low inflation and the threat of a period of stagnation like that experienced by Japan in the 1990s. Second, business loan volume was at an historic low and investment needed to unlock growth potential was missing.  The ECB’s monetary policy measures counteracted these developments as a side effect of creating price stability. Possible turnarounds should be initiated very smooth and with a sense of proportion.