Table Of ContentMonetary Policy in Times of Crisis
Monetary Policy in
Times of Crisis
A Tale of Two Decades of the European
Central Bank
Massimo Rostagno
Carlo Altavilla
Giacomo Carboni
Wolfgang Lemke
Roberto Motto
Arthur Saint Guilhem
Jonathan Yiangou
1
1
Great Clarendon Street, Oxford, OX2 6DP,
United Kingdom
Oxford University Press is a department of the University of Oxford.
It furthers the University’s objective of excellence in research, scholarship,
and education by publishing worldwide. Oxford is a registered trade mark of
Oxford University Press in the UK and in certain other countries
© Massimo Rostagno, Carlo Altavilla, Giacomo Carboni, Wolfgang Lemke,
Roberto Motto, Arthur Saint Guilhem, and Jonathan Yiangou 2021
The moral rights of the authors have been asserted
First Edition published in 2021
Impression: 1
All rights reserved. No part of this publication may be reproduced, stored in
a retrieval system, or transmitted, in any form or by any means, without the
prior permission in writing of Oxford University Press, or as expressly permitted
by law, by licence or under terms agreed with the appropriate reprographics
rights organization. Enquiries concerning reproduction outside the scope of the
above should be sent to the Rights Department, Oxford University Press, at the
address above
You must not circulate this work in any other form
and you must impose this same condition on any acquirer
Published in the United States of America by Oxford University Press
198 Madison Avenue, New York, NY 10016, United States of America
British Library Cataloguing in Publication Data
Data available
Library of Congress Control Number: 2021931190
ISBN 978–0–19–289591–2
DOI: 10.1093/oso/9780192895912.001.0001
Printed and bound by
CPI Group (UK) Ltd, Croydon, CR0 4YY
Links to third party websites are provided by Oxford in good faith and
for information only. Oxford disclaims any responsibility for the materials
contained in any third party website referenced in this work.
Preface
The first 20 years of the ECB’s lifetime offer a clear demonstration of how a central
bank can navigate macroeconomic insecurity and crisis.1 The ECB spent its first ten
years—those of the ‘Great Moderation’—wrestling with a severe dearth of data on
the newly formed monetary union and underdeveloped data-p rocessing capacity,
seeking to steer the economy through a fog of uncertainty and gain greater insight
into how the euro area was functioning. After Lehman’s demise, macroeconomic
insecurity became a worldwide condition afflicting all central banks, and the ECB—
operating in an incomplete currency union—suffered more than its fair share of it.
As the global economy in 2020 moves into a new phase of unheralded uncertainty,
we believe that a retelling of the ECB’s first 20 years holds multiple lessons of wider
significance for the central banking community and researchers of monetary policy.
We condense the facts and lessons of those first 20 years in this volume of monetary
policy in crises.
The volume ends in December 2018 on the eve of a decisive turn in the trajectory
of the economy. The year 2019 saw the euro area economy slowly crawling to a halt,
caught in the middle of international trade disputes, fears of a hard Brexit and the
growing influence of its entrenched structural frailties. The year 2020 will go down
in the history books as the year in which the euro area, ravaged by the Covid- 19
pandemic, lost in a couple of quarters probably as much output and income as it had
gained over the previous 15 years—and monetary policy was jolted into yet another
phase of extraordinary innovation and expansion. Do these events—based on what
we have observed so far in the first half of 2020—upend or reverse the conclusions we
have distilled out of the prior 20 years of ECB history? We believe not: there is, in
our view, full continuity and affinity among pre- and post- virus lessons along at least
three axes.
First, we believe that the slow and circumspect pace at which the ECB ventured
into policy normalization in 2018 has been vindicated ex post. Certainly, with a
more assertive type of forward guidance that signalled—already in 2018—higher
policy rates and a shrinking balance sheet in the near future, market rates would
have been pushed higher, creating some more space for bringing them back down
during the 2020 crisis. At the same time, the economy would have been in a worse
place than it was at the outbreak of the disease owing to the ensuing tightening of
financing conditions. It takes around 18–24 months for higher rates to translate into
1 The authors are from the European Central Bank. The views expressed in this volume are those of the
authors and do not necessarily reflect those of the ECB, its Executive Board or Governing Council, or the
European System of Central Banks.
vi Preface
weaker spending, incomes and inflation, and Germany and Italy ended 2019 without
positive growth as it was. In a higher- interest- rate world, they would have suffered a
deeper contraction, and pulled the whole euro area into a recession.
Second, it is our reading of the events that the monetary policy boldness we have
witnessed in the face of the 2020 crisis can only be understood in the context of the
decade that preceded it. The decisions taken to dislodge the too-l ow inflation en vir-
on ment that beset the euro area economy in the 2010s—and the institutional
Rubicons crossed—created a disposition towards pre-e mptive action, a playbook for
implementing unconventional policy in short order, and an understanding of trans-
mission in crisis that was instrumental in facilitating the ECB’s reaction to the
Covid- 19 shock. The 2016 version of TLTRO provided a tested infrastructure that
the ECB could simply re-p rogramme in coronavirus times, and utilize as a vehicle to
funnel the stimulus associated with negative rates straight to those firms struggling
for survival. The new Pandemic Emergency Purchase Programme (PEPP), unveiled
on the night of 18 March 2020, embodies and perfects the philosophy—elaborated
through the learning process that we describe in the volume—of combining rather
than separating instruments and intermediate policy objectives. Reflecting that phil-
oso phy, PEPP conflates two elements: a market functioning, backstop-t ype interven-
tion mode, on one hand, and a stance- supporting mission founded on duration
extraction, on the other. These two engines were activated with varying intensity
over the two phases of the post-p andemic emergency. The backstop engine was the
first to be ignited, when the top priority (in March and April) was to ensure financial
stability and lean against fragmentation amidst a market panic of unseen virulence.
The second engine took over when markets eventually calmed, and the clouds
shrouding the macroeconomic outlook—which were impenetrable to begin with—
started to dissipate, exposing the economic ruins that the shock might leave behind.
The PEPP’s double key facilitated a necessary pivot in monetary policy, from the
earlier interventions typical of a crisis-r elief programme and justified by market
functioning considerations, towards a steadier and more predictable configuration
geared toward re- anchoring medium- term inflation. The ‘inflation- gap’ approach to
calibrating the overall envelope of a purchase programme, inaugurated in 2015, was
redeployed as the ECB upscaled PEPP in June 2020.
Last, we quote verbatim a passage from an earlier draft of this volume which, with
hindsight, has become more relevant:
one cannot rule out more extreme scenarios than those faced by the ECB in the
years following the financial crisis, in which the economy sinks into an even
deeper and more lasting contraction, and ingrained disinflation takes hold.
Should the economy ever find itself in such a predicament, a more policy-e nabling
environment—including a comprehensive set of non-m onetary policies—would
Preface vii
be helpful for monetary instruments to exert the favourable effects that we
document in this book.
The sudden depression that wracked the economy in early 2020 has indeed
evoked the spectre of those extreme scenarios. We draw attention to Chapter 2 in
particular where monetary- fiscal policy interactions in the face of such shocks are
studied and translated into policy options. We also invite readers to review
Chapter 6, where we discuss the ‘missing role’ of fiscal policy in the euro area’s
institutional architecture, and how monetary and fiscal policies can best partner
when deflation risks loom. What has happened on those fronts since the pandemic
escalated in early March? A fact is worth some reflection: Europe has risen to the
occasion. Yet again, as in Mark Twain’s famous quip, ‘reports of the euro’s death
have been greatly exaggerated’. We note that, unlike in the aftermath of the 2008
crisis, the policy initiatives taken outside the monetary policy domain have been
as forceful as those decided within it. This time around, the ECB has not been left
alone. The Commission’s plan for a Next Generation EU Fund, in particular, comes
about as close as one could have imagined to the new and more intimate forms of
interaction between monetary and fiscal policy that our draft imagines. Faced with
shocks as dramatic as those that threatened the stability of the euro area and the
global economy between March and June 2020, Europe has ‘come of age’ alongside
the ECB.
* * *
The list of colleagues and friends to whom we are indebted for the realization of this
volume is too long to be reported exhaustively. First, we want to thank Fédéric
Holm- Hadulla for actively contributing to Chapter 5. We are also especially grateful
to Fabian Schupp and Andreea Vladu for their great support in implementing sev-
eral of the counterfactual yield curve scenarios that we document in Chapter 6, as
well as to Maarten Dossche, Jacob Hartwig, and Beatrice Pierluigi for contributing
with their analysis on savers and borrowers in Chapter 6. We owe a number of com-
mentators a large debt of gratitude. We are particularly indebted to Klaus Adam,
Nuno Alves, Ulrich Bindseil, Lorenzo Bini-S maghi, Tobias Blattner, Benoit Coeuré,
Miguel Boucinha, Vítor Constâncio, Mario Draghi, Eugenio Gaiotti, Felix Geiger,
Philipp Hartmann, Federic Holm-H adulla, Otmar Issing, Christophe Kamps,
Stephan Kohns, Luc Laeven, Philip Lane, Michele Lenza, Silvia Margiocco, Klaus
Masuch, Stefano Neri, Peter Praet, Wolfgang Schill, Torsti Silvonen, Stefano Siviero,
Frank Smets, Lars Svensson, Guido Tabellini, Carlos Thomas, Jean-C laude Trichet,
Oreste Tristani, Jens Ulbrich, Ignazio Visco, Thomas Vlassopoulos, Bernhard
Winkler, Andreas Worms, and Charles Wyplosz for their comments on an earlier
viii Preface
draft of this volume. We bear full responsibility for any remaining errors or
omissions. We thank Julian Schumacher for his empirical analysis of the ‘well past’
phrase used at times by the ECB in its forward guidance, as reported in Chapter 6;
Giovanni Trebbi for his contribution to the analysis of Taylor rules; and Lennart
Brandt, Andrea Cubells Enguidanos, Maria Dimou, Maria Eskelinen, Christopher
Greiner, Michele Marcaletti, Cornelius Nicolay, Ala Olaru, Christian Osterhold, and
Jonathan Öztunc for their outstanding research assistance. We are also very grateful
to Anita Gibb and Paul Williams for their precious editing suggestions.
July 2020
List of Figures
2.1 HICP inflation in the euro area and four largest euro area countries 60
2.2 ECB policy rates and M3 developments 76
2.3 SPF respondents’ distribution of long- term inflation forecast over
selected sub- periods 83
3.1 Inflation developments in the euro area and the US 112
3.2 Shocks’ contribution to (demeaned) euro area real GDP growth and
inflation 115
3.3 Counterfactual monetary policy in which the ECB does not let inflation
rise above 2% 118
3.4 Policy rate adjustments and shocks’ contribution to US GDP growth 120
3.5 Rate action, rate expectations, inflation overshooting, and ECB
communication over 1999–2008 123
3.6 Measures of medium- term inflation expectations and of output gap 124
3.7 Monetary and credit developments 128
3.8 Credit developments and unemployment 128
3.9 Credit flows and gross fixed capital formation in % of GDP 129
3.10 Loan origination, building permits, and house prices across countries 130
3.11 Counterfactual in which policy is assumed to disregard credit growth 131
3.12 Euro area correlation between HICP energy and core 136
3.13 Impulse response functions to an energy price shock in the two regimes 141
3.14 Macroeconomic volatility in the euro area and other advanced
economies 1999–2007 142
3.15 Real GDP per capita in the G3 economies 143
3.16 Inflation in the euro area, core inflation, core purged of the indirect
effects of non- core, and exchange rate 144
3.17 Exchange rate and euro area- US interest rate differential 145
3.18 Inflation in the US, core inflation, and exchange rate 146
3.19 Macroeconomic stability in the euro area and United States 148
3.20 Estimates of the natural rate of interest for the euro area 152
3.21 Hypothetical distribution of inflation outcomes centered around
alternative inflation focal points 154
3.22 Shocks’ contribution to euro area risk premia 159
