PARIS – The widespread introduction of unconventional monetary-policy measures by major central banks has been a defining characteristic of the global financial crisis. We have seen enhanced credit support, credit easing, quantitative easing, interventions in currency and securities markets, and the provision of liquidity in foreign currency – to name but a few of the measures taken.
Some view these measures as a continuation of standard policy by other means. Once nominal interest rates cannot be lowered further, central banks use other tools to determine the monetary-policy stance. They have reached the end of the road, so they shift into four-wheel drive: they expand their balance sheets and inject liquidity to influence the structure of yields and returns and thereby stimulate aggregate demand. But when central banks return to the road – that is, exit from the non-standard measures – they must retrace their path, first unwinding unconventional policy, and only then raising interest rates.
Let me suggest a different view. Say that key interest rates are to be set at levels considered appropriate to maintain price stability, drawing on regular, comprehensive assessment of economic and monetary conditions. Following standard practice, interest rates can be more or less significantly positive, very close to zero, or at zero.
But, whatever the level of nominal interest rates, the monetary-policy stance established in this way has often been poorly transmitted to the economy, particularly in times of acute crisis. During the financial crisis, market functioning was impaired, at times very profoundly. Non-standard measures helped to clear standard measures’ transmission path.
By this logic, if the transmission of standard measures is impeded in a significant way, non-standard measures can offer support. And, as for the exit, standard and non-standard measures can be determined largely independently. Policymakers are not obliged to unwind non-standard measures before considering interest-rate increases, or to push interest rates to the zero lower bound before considering unconventional measures. Standard measures depend on the medium- and long-term outlook for price stability, whereas non-standard measures depend on the degree of dysfunction of the monetary-policy transmission mechanism.
This second view has characterized the European Central Bank’s approach to monetary policy since the start of the financial crisis. The ECB’s first non-standard measure – unlimited supply of liquidity at fixed rates against appropriate collateral – was introduced in August 2007, when the minimum bid rate of its main refinancing operation was 4.25% – nowhere near the zero bound. Non-standard measures were required to ensure that the monetary-policy stance would be more effectively transmitted to the broader economy, notwithstanding the dislocations observed in some financial markets.
Obvious, unconventional measures, if not carefully monitored, might have the unintended consequence of creating an abnormally benign financial environment for markets, commercial banks, and sovereigns. This, in turn, could delay needed improvements in financial regulation, balance-sheet repair by banks, structural economic reform, and fiscal adjustment. As a result, non-standard measures must satisfy five conditions.
First, they must be as commensurate as possible with the degree of market dislocation and disruption of market that they aim to counter, which is always a matter of judgment. In most cases, the measures must be tailored to avoid the total disruption of markets. The ECB has never hesitated to increase or decrease the scope of its non-standard tools – in particular, the duration of the non-standard supply of liquidity – depending on the abnormality in the functioning of the financial system.
Second, the measures must be accompanied by forceful messages to commercial banks to address their medium-term recapitalization and balance-sheet-repair issues. To the extent that banks are, by far, the ECB’s main instrument for “non-standard” refinancing, this message is particularly important in Europe.
Third, the measures must be accompanied by equally forceful messages, when and where needed, to the governments concerned. When non-standard measures are required because of loss of confidence in sovereign debt, such messages must seek to avoid the measures’ failure by highlighting the risk of major additional difficulties in the future.
Fourth, in the case of Europe, the European Union institutions, as well as the member states, must be urged to strengthen economic governance, including through close monitoring of individual countries’ economic and budgetary policies. The ECB’s governing council has been highly vocal on this issue since the start of the crisis.
Finally, to the extent that the combined non-standard measures of the advanced economies’ central banks are creating a very substantial structural change in the global economy’s monetary and financial environment, it seems necessary to call for the appropriate reinforcement of global governance. As long as these central banks consider non-standard measures necessary, they are entitled to be vocal advocates of the necessary reforms of global finance; the necessary adjustment of global imbalances within the framework of the G-20; and the decisive contribution of multilateral lenders.
The ECB’s decision in December 2011 to launch its long-term refinancing operation, which supplies low-cost three-year financing to commercial banks, meets these five conditions. The LTRO’s duration, in particular, is appropriate, given the growing threat of major dysfunction in the European banking sector in October, November, and at the beginning of December last year. Moreover, ECB President Mario Draghi, my successor, made loud and clear the importance of reinforcing banks’ balance sheets, adjusting individual countries’ strategies, and improving governance in the eurozone and the EU as a whole.
In all of these domains, as well as at the global level, where reform is equally urgent, there is no longer any room for complacency.
Photograph of Jean-Claude Trichet: (c) European Central Bank/Andreas Böttcher