Quantitative easing

• KKR, a leading global investment firm, today announced the release of Dream Big, a new Insights piece by Henry McVey, Head of Global Macro and Asset Allocation (GMAA) and CIO of KKRs Balance Sheet.
• To position themselves for success in the low-rate environment that will likely persist over the next five to ten years, insurance company CIOs need to take a more innovative approach to sustaining returns:
  Now is the time for insurance executives to dream big, said Henry McVey.
• Henry H. McVey joined KKR in 2011 and is Head of the Global Macro and Asset Allocation team.
• KKRs insurance subsidiaries offer retirement, life and reinsurance products under the management of The Global Atlantic Financial Group.

• b'VANCOUVER, British Columbia, May 18, 2021 (GLOBE NEWSWIRE) -- The idea that the Bank of Canada can continue to finance government debt by printing money without a clear commitment to repayment, known as Modern Monetary Theory (MMT), poses enormous risks to the Canadian economy, finds a new study released today by the Fraser Institute, an independent, non-partisan, Canadian public policy think-tank.\n\xe2\x80\x9cModern monetary theory is a pipe dream, and if the federal government and Bank of Canada go down this road, the damage to the Canadian economy could be substantial,\xe2\x80\x9d said Steven Globerman, resident scholar at the Fraser Institute and author of A Primer on Modern Monetary Theory.\nAdvocates of MMT assert that a government that issues its own currency (like Canada and the United States, among others) cannot default on debt issued in its sovereign currency because it has the power to print as much currency as needed to pay off the public debt.\nIndeed, during the current COVID-19 crisis, Canada\xe2\x80\x99s central bank financed historically large shares of government bonds to encourage lending and investment\xe2\x80\x94a practice described as Quantitative\xc2\xa0Easing.
• If the Bank of Canada does not require the government to repay that debt once it matures, Quantitative Easing will have evolved into MMT.\n\xe2\x80\x9cThe Bank of Canada is facing an imminent test of its credibility and independence over the coming months,\xe2\x80\x9d commented Globerman.\nCrucially, where MMT has been tried in the past, it has resulted in inflation, sometimes even hyper-inflation, with devastating consequences for domestic economies.\nIn particular, the implementation of MMT in Latin America and Greece resulted in runaway inflation and a significant decline in standards of living.\n\xe2\x80\x9cThe arguments for MMT are really arguments for much higher levels of government spending financed by borrowing provided by the central banks, which has failed everywhere it\xe2\x80\x99s been tried,\xe2\x80\x9d Globerman said.\n'

• Ms Schnabel reviewed the financial market developments since the Governing Councils previous monetary policy meeting on 20-21 January 2021.
• The measurable rise in commodity prices had added to upward pressure on long-term nominal bond yields.
• The increase in long-term bond yields had been more muted in the euro area than in other advanced economies.
• A decomposition of the ten-year overnight index swap rate indicated that investors had hardly changed their views on the expected future path of short-term rates.
• Real ten-year risk-free interest rates had fluctuated over time but had fallen back close to the levels prevailing around the 9-10 December 2020 Governing Council meeting.
• Changes in the corporate default outlook mirrored expectations of a significantly improved growth outlook, contributing to favourable valuations in credit markets.
• In February, portfolio inflows into emerging markets had continued at a robust pace, although they had started to reverse during the week ahead of the current meeting.

The global environment and economic and monetary developments in the euro area

• Mr Lane reviewed the global environment and the recent economic and monetary developments in the euro area.
• In the March 2021 ECB staff macroeconomic projections for the euro area, global activity and trade had been revised up over the projection horizon after the global economy bounced back during the second half of 2020 at a faster pace than envisaged.
• Since the Governing Councils January monetary policy meeting, oil prices had risen by 23% and had climbed to USD 67.8 per barrel, close to pre-pandemic levels.
• In terms of the exchange rate, the euro had depreciated against the US dollar (-2.0%) but remained broadly stable in nominal effective terms (-0.3%).
• However, the recovery was expected to vary across the different GDP components and to rely quite heavily on fiscal support over the next two years.
• Zooming in on the latest economic developments, containment measures had had to remain stricter in the first quarter of 2021 than previously expected, holding back the near-term recovery but not really changing the overall path.
• Based on the latest PMIs for February, the divergence in manufacturing and services growth dynamics was expected to continue.
• Trade had weakened at the turn of the year, driven mainly by weak intra-euro area exports, notwithstanding continued growth in extra-euro area exports.
• The sell-off in bond markets had been synchronised and broad-based across major advanced economies, pointing to an important global factor.
• Indices of financial conditions assign different weights to developments in financial markets and their respective signals could therefore differ somewhat.
• Bank lending rates to firms remained close to historical lows, reflecting the continued pass-through of recent monetary policy accommodation.
• However, the decline in nominal rates in the euro area throughout 2020 had been counterbalanced by lower inflation expectations for much of this period, keeping real rates above pre-pandemic levels.
• As partly anticipated, a sizeable additional stimulus was foreseen for 2021 in response to new lockdown measures.

Monetary policy considerations and policy options

• Looking beyond the short-term weakness, euro area economic activity was expected to gain momentum in the course of the year.
• Accordingly, the March 2021 staff projections foresaw growth rebounding to 4.0% in 2021 and to 4.1% in 2022, before stabilising at 2.1% in 2023.
• The risks surrounding the euro area growth outlook over the medium term had become more balanced, although downside risks remained in the near term.
• In the overall context of a holistic and multifaceted approach to evaluating financing conditions (spanning the entire transmission chain of monetary policy), developments in risk-free interest rates and sovereign yields were particularly relevant.
• First, these market interest rates could be more directly influenced by the Governing Councils monetary policy measures, notably its asset purchases.
• The Governing Council should review the purchase pace on a quarterly basis at its monetary policy meetings, based on joint assessments of financing conditions and the inflation outlook.
• Furthermore, the flexibility of purchases over time, across asset classes and among jurisdictions would continue to support the smooth transmission of monetary policy.
• Flexibly implemented asset purchases were a suitable monetary policy instrument that remained more efficient than alternative tools for preserving favourable financing conditions in the current pandemic environment characterised by high uncertainty.
• Their benefits for achieving the ECBs price stability mandate also clearly outweighed any potential negative effects on other economic policy domains.

2. Governing Council’s discussion and monetary policy decisions

Economic and monetary analyses

• With regard to the economic analysis, members generally agreed with the assessment of the current economic situation in the euro area and the risks to economic activity provided by Mr Lane in his introduction.
• While the overall economic situation was seen to improve during 2021, uncertainty surrounding the near-term economic outlook remained, relating in particular to the dynamics of the pandemic and the speed of vaccination campaigns.
• Looking ahead, the ongoing vaccination campaigns, together with the envisaged gradual relaxation of containment measures, underpinned the expectation of a firm rebound in economic activity in the course of 2021.
• This was seen to constitute an upside risk to the global and, consequently, euro area economic outlook as embedded in the staff projections.
• Incoming economic data, surveys and high-frequency indicators pointed to continued economic weakness in the first quarter of 2021 driven by the persistence of the pandemic and the associated containment measures.
• Overall, members generally agreed with the baseline view for economic growth in the March 2021 staff projections and noted that it was broadly unchanged from the December 2020 Eurosystem staff projections.
• The potential emergence of financial amplification loops would then also affect the medium-term economic outlook.
• It was also recalled that economic developments continued to be uneven across economic sectors, as the containment measures affected the services sector more adversely than the manufacturing sector.
• On the other hand, the ongoing pandemic including the spread of virus mutations and its implications for economic and financial conditions continued to be sources of downside risk.
• This would allow the Next Generation EU programme to contribute to a faster, stronger and more uniform recovery and would increase economic resilience and the growth potential of Member States economies, thereby supporting the effectiveness of monetary policy in the euro area.
• On the other hand, it was pointed out that economic agents would likely look through the temporary rise in inflation.
• Turning to the monetary analysis, members concurred with the assessment provided by Mr Lane in his introduction.
• The prospect of increasing non-performing loans in the banking sector bore a risk of creating financial amplification loops, which ultimately could also cloud the medium-term economic outlook and give rise to financial stability risks.

Monetary policy stance and policy considerations

• With regard to the assessment of financial and financing conditions, there was broad agreement among members that financing conditions were to be assessed on the basis of a holistic and multifaceted set of indicators covering the entire chain of monetary policy transmission.
• Longer-term risk-free interest rates and sovereign bond yields in the euro area had increased since the Governing Councils early December meeting.
• Moreover, financing conditions for the non-financial private sector had remained very favourable overall, also on account of ample monetary policy support.
• The role of the targeted longer-term refinancing operations, which could shield banks somewhat from possible increases in market-based funding costs, was also underlined.
• Members concurred with Mr Lane that ample monetary stimulus remained necessary to preserve favourable financing conditions over the pandemic period in order to ensure a sustained convergence of inflation towards the Governing Councils aim.
• The focus of the Governing Councils December decisions had been on countering an unwarranted and premature tightening of financing conditions, rather than preserving any particular level.
• A possible misperception that the Governing Council was engaging in a form of implicit yield curve control had to be avoided.
• This would send a strong signal that the Governing Council wanted to lean against the tightening of financing conditions.
• Moreover, the view was put forward that the tightening might not be sizeable and persistent enough to affect broader financing conditions materially.
• It was important to provide reassurance that the Governing Council would maintain an accommodative monetary policy for as long as necessary and saw no risk of overheating in the euro area in the present environment.

Monetary policy decisions and communication

Speech by Philip R. Lane, Member of the Executive Board of the ECB, at Comissão do Mercado de Valores Mobiliários

25 February 2021

Introduction

• In my remarks today, I will set out some considerations for thinking about favourable financing conditions as the compass guiding monetary policy.
• First, I will explain the logic of employing the favourability of financing conditions as the compass for monetary policy.
• In assessing financing conditions, it is desirable to adopt a holistic approach, based on a multi-faceted set of indicators for both bank-based and market-based financing conditions.
• Accordingly, in the following sections, I next turn to the analysis of bank-based funding conditions, which is followed by the analysis of market-based financing conditions.

Favourable financing conditions as the compass

• The phrase favourable financing conditions intentionally puts the spotlight on a pivotal section of the transmission mechanism that links the basic monetary policy instruments controlled by central banks (policy rates, asset purchases and refinancing operations) to the ultimate objective of delivering the medium-term inflation aim.
• Under pandemic conditions, two threats to the efficiency of monetary policy can be clearly identified.
• First, frictions in financial intermediation may disrupt the transmission of monetary policy impulses to the financing conditions for key economic actors (households, firms and governments).
• In this context, a focus on preserving favourable financing conditions as the compass guiding monetary policy addresses both concerns.
• First, it emphasises that the central bank is committed to recalibrating its underlying policy instruments if it detects any threat to the favourability of financing conditions.
• Second, clear communication that the financing conditions directly relevant to households, firms and governments will remain favourable during the pandemic period reduces uncertainty and bolsters confidence, thereby encouraging spending and investment, and ultimately underpinning the economic recovery and inflation.

Chart 1

Realised and projected HICP inflation (year-on-year percentage changes, quarterly averages)
• In turn, vigorous inflation dynamics are only likely if the overall economic recovery is robust.
• The preservation of favourable financing conditions for an extended period of time helps to support inflation developments through multiple channels.
• [3] First, the commitment to preserving favourable financing conditions reduces financing uncertainty for banks, corporates, households and governments alike.
• Keeping favourable financing conditions in this environment could even accelerate the dynamics of the recovery, since better economic prospects combined with attractive financing conditions can fast-track consumption and investment.
• [4] In particular, in December, the Governing Council pledged that purchases under the PEPP will be conducted to preserve favourable financing conditions over the pandemic period.
• Overall, we need to assess indicators that provide information on the whole gamut of transmission from upstream stages to downstream effects.
• Other financial indicators also feed into the staff macroeconomic projections and are incorporated into the Governing Councils regular assessments of the appropriate monetary stance.

Bank-based financing conditions

• [5] The pandemic and the measures to contain the spread of the virus have severely disrupted economic activity and curtailed business revenues.
• The avoidance of adverse feedback loops between the real economy and financial markets is a central task for policy makers.
• In turn, banks have been able and willing to meet the strong demand for liquidity over the course of the pandemic.
• The euro area bank lending survey (BLS) confirms that high loan demand of firms was accommodated by banks, which met the demand for bridge financing despite the rapid worsening of economic prospects in the second quarter of 2020.
• Monetary, supervisory and fiscal policies have been central to supporting bank lending conditions since the onset of the pandemic in terms of volumes and lending rates, which are around historically low levels for both firms and households.
• [6] The favourable impact of the TLTRO III on bank lending conditions and lending volumes has been signalled clearly by banks in the BLS.

Chart 2

Changes in credit standards and demand for loans to euro area firms in 2020 (net percentages of banks reporting an easing (+)/tightening (-) of credit standards and an increase (+)/decrease (-) in loan demand; net loan flows in EUR billions)
• In the autumn, however, signals from the BLS pointed to a broad-based tightening in credit conditions, even though bank lending rates have remained at historically favourable levels.
• Banks attribute the tightening of bank lending conditions to the intensification of risks to creditworthiness and the prospect of possible loan losses in the future, especially as the pandemic has lasted longer than originally expected.
• While Chart 3 shows that the net tightening of credit standards on loans to firms remains moderate compared with the global financial and sovereign debt crises, it signals potential risks to future loan growth.

Chart 3

BLS bank lending conditions and loan growth to firms (left-hand scale: net percentages of banks reporting an easing (+)/tightening (-) of credit standards and an increase (+)/decrease (-) in loan demand; right-hand scale: percentages)
• It follows that the evolution of corporate vulnerabilities and their possible ramifications for the bank-intermediated financing conditions facing the real economy should be closely monitored.
• This adverse interaction would be reinforced if household spending were to weaken and thereby were to further dampen the prospects for firms.
• These upstream-downstream inter-connections underline the critical importance of market-based financing conditions for the entire economy, not just for those entities that directly raise funding in the capital markets.

Market-based financing conditions

• Even households and small businesses which finance themselves via banks rather than in the market incur changes in their cost of funding through the impact of market-based financing conditions on bank-based financing conditions.
• In addition, market-based financing conditions influence non-bank intermediation, since the costs and benefits to participants in this sector vary with shifts in returns on investment.
• [8] Ensuring that the risk-free yield curve remains at highly accommodative levels is a necessary (but not sufficient) condition for ensuring that overall financing conditions are supportive enough to counter the negative pandemic shock to the projected inflation path.
• As such, sovereign yields are a key element in determining general financing conditions in all sectors and jurisdictions across the euro area.

Chart 4

Bank and sovereign bond yields (daily; percentages per annum; x-axis: sovereign yields; y-axis: bank bond yields)

Chart 5

Corporate and sovereign bond yields (daily; percentages per annum; x-axis: sovereign yields; y-axis: corporate bond yields)
• In one direction, shifts in the OIS yield curve and the GDP-weighted sovereign yield curve are early indicators of changes in the downstream set of indicators.
• In the other direction, these yield curve indicators are responsive to re-calibrations of our primary monetary policy instruments.
• Our monetary policy measures can contribute to preserving the OIS yield curve and the GDP-weighted sovereign yield curve at favourable levels.
• Following a temporary disconnect at the onset of the pandemic in the spring of 2020, our monetary policy actions successfully restored a close co-movement between the OIS curve and the GDP-weighted sovereign yield curve, most notably through the market stabilisation function of the PEPP (Chart 6).

Chart 6

10-year GDP-weighted sovereign yield and 10-year nominal OIS rate in the euro area (percentages per annum)
• Chart 7 shows that there was a considerable lowering of the middle and long segments of these yields curves over the course of 2020.
• By mid-December, these curves were relatively flat compared to the short-term policy rate (the deposit facility rate).
• In the initial weeks of 2021, there has been a steepening of these curves.

Chart 7

Euro area risk-free OIS and GDP-weighted sovereign yield curves and the ECB’s deposit facility rate (y-axis: percentages per annum; x-axis: maturity in years)
• This assessment will vary over time, taking into account revisions to the economic and inflation outlook.
• The integrated nature of global financial markets also means that there are clear spillovers across different currency areas in terms of the underlying shocks driving bond yields.
• Such financial spillovers are especially consequential if economies are at different stages of the economic cycle.
• For any given level of nominal interest rates, a generalised increase in expected inflation provides a boost to inflation dynamics by reducing economy-wide real rates.
• Tracking the full set of inflation expectations across the range of economic actors (financial market participants, firms, households) is, of course, a demanding exercise.

Conclusions

• In this environment, ample monetary stimulus remains essential to preserve favourable financing conditions over the pandemic period for all sectors of the economy.
• By helping to reduce uncertainty and bolster confidence, this will encourage consumer spending and business investment, underpinning economic activity and safeguarding medium-term price stability.
• In particular, the purchases made under the PEPP will be conducted to preserve favourable financing conditions over the pandemic period.
• Accordingly, the ECB is closely monitoring the evolution of longer-term nominal bond yields.