The impact of the ECB’s monetary policy measures taken in response to the COVID-19 crisis

• Prepared by John Hutchinson and Simon Mee Published as part of theECB Economic Bulletin, Issue 5/2020.
• Since March 2020 the severity of the economic and financial implications stemming from the coronavirus (COVID-19) crisis has become increasingly apparent.
• These measures have supported liquidity and funding conditions in the euro area economy, averted the most adverse feedback loops between the real economy and financial markets, and shored up confidence.

The impact of policy measures on financial conditions

• This box examines the impact of the ECBs response to the crisis, concentrating on asset purchases and the targeted longer-term refinancing operations (TLTRO III).
• The sharp decline in stock and bond market indices, combined with the increase in market-based financing costs for firms, contributed to a marked tightening of financial conditions between mid-February and mid-March 2020.
• In this environment, there was a very tangible risk of adverse liquidity spirals and an overshooting of asset price corrections in many markets, which would endanger financial stability and impede the transmission of monetary policy.
• Policy measures aimed at releasing the balance sheet constraints of the private sector are particularly effective in periods of heightened market stress.
• In this vein, the announcement of the PEPP halted the tightening in financial conditions which had prevailed.
• This is particularly relevant in the euro area, where banks play a key role in financial intermediation.
• The provision of central bank liquidity comes in the form of targeted and non-targeted programmes.
• This followed the March 2020 decision to increase the maximum amount that counterparties are entitled to borrow in TLTRO III operations.
• The PELTROs serve as a backstop by helping to ensure sufficient liquidity and smooth money market conditions in response to the crisis.
• Evidence from event studies, which examine the financial market reaction to the PEPP announcements, suggests a higher PEPP elasticity compared with the PSPP elasticity, thereby indicating some possible underestimation of the yield impact.
• [6] Therefore, in the absence of the PEPP, sovereign yields could have escalated to even higher levels.

The macroeconomic impact

• By counteracting the tightening of financial conditions that confronted the euro area economy in the face of the COVID-19 crisis, the ECBs policy measures have been providing crucial support to the real economy and, ultimately, to price stability.
• This support operates across two broad dimensions: (i) underpinning the medium-term growth and inflation outlook, and (ii) removing tail risks around the baseline scenario.
• At the same time, while monetary policy typically acts with a transmission lag, the positive impact on consumer and business confidence created by acting swiftly and decisively during a crisis should not be overlooked and can accelerate and support the transmission of monetary policy to growth and inflation.
• Chart B Estimated impact of the ECBs decisions since March 2020 (PEPP, scaling-up of the APP and TLTRO recalibrations) on the central tendency of inflation and economic activity