What can we expect from the ECB meeting on December 3?

News: At the European Central Bank’s next monetary policy meeting on December 3, Mario Draghi will announce the next measures to support inflation and revive the economy in the eurozone. Two main measures are expected and anticipated by the markets: the extension of the asset purchase program launched last March (Quantitative Easing, QE) and a cut in the deposit facility rate. What do these measures consist of and could they be effective?

Quantitative easing results in an increase in the size of the central bank’s balance sheet. The program launched by the ECB on March 9, 2015, is a €1.08 trillion plan, or €60 billion per month until September 2016, to combat the risk of deflation and influence medium- and long-term interest rates and the external value of the euro. Through this program, the ECB and the national central banks of the eurozone are able to create money and lower long-term rates by buying back government securities on the secondary market. This asset purchase program followed other unconventional policies in the eurozone, such as the extension of the maturity of long-term refinancing operations (LTROs), covered bond purchase programs, and the first sovereign bond purchase program in May 2010 (SHMPP). The total amounts granted under these unconventional policies are shown in the chart below:

Graph 1 – Size of the ECB’s balance sheet and amounts of its unconventional measures

Sources: European Central Bank, BSI Economics

This new quantitative easing program may be adjusted in terms of size, composition, or duration in order to achieve a more expansionary monetary policy. An extension and reinforcement are expected at the December 3, 2015 meeting.

This extension of QE should be coupled with a cut in deposit facility rates in order to facilitate the transmission of QE to the economy by speeding up the circulation of bank reserves. While this rate is already negative in the eurozone (-0.20%), a further cut could have positive effects on credit. This cut has already been anticipated by the market and could therefore boost the expected effects of QE.

Are these measures really effective? In a recent working paper[1] with Jérôme Creel and Paul Hubert (OFCE), we look at the effectiveness of conventional and unconventional policies during the financial crisis. We estimate the effects of the key interest rate and securities purchases under the ECB’s unconventional policies (SHMPP) on interest rates and new credit volumes in various markets: loans to non-financial corporations, loans to households, the sovereign market, the money market, and the deposit market. We show that unconventional policies have reduced interest rates in the money market, the sovereign bond market, and the non-financial corporate loan market. It therefore appears that unconventional policies have had direct effects but also indirect effects, restoring the effectiveness of the policy rate[2], which was ineffective before such policies were implemented.

However, in our view, these policies have had no effect on the volume of loans granted. This can be explained by the need for commercial banks to deleverage and reduce the size of their balance sheets by adjusting their risk-weighted asset portfolios. These behaviors are detrimental to the transmission of monetary policy: interest rates are falling, but credit is not picking up.

According to our findings, for an unconventional policy to be effective, it is important that it does not rely exclusively on the banking sector. By extending QE until 2017 and lowering the deposit facility rate, the ECB is focusing directly on securities purchases in order to bypass the banking sector. This bypass could therefore amplify the transmission of monetary policy to the real economy, which would bode well for avoiding deflationary risk in the euro area.