Market Analysis

The European Central Bank (ECB) should primarily utilize quantitative easing (QE) programs during times of crisis, as their associated costs may be more significant compared to other available tools, according to Executive Board member Isabel Schnabel.

“Asset purchases can be a powerful tool when financial markets are in turmoil,” Schnabel stated in a speech in Tokyo on Tuesday. “Outside these periods, however, central banks need to carefully assess whether the benefits of asset purchases outweigh the costs.”

Schnabel emphasized that “the effectiveness of QE in stimulating aggregate demand is state-dependent,” and noted that “QE can come with costs that might be higher than those of other policy instruments.”

The ECB initiated large-scale asset purchases in 2015 to counteract sluggish inflation. A separate program was launched during the Covid-19 pandemic. At its peak, the ECB's holdings amounted to around €5 trillion ($5.4 trillion), predominantly in government debt.

In 2023, policymakers began reducing assets while simultaneously raising interest rates to control rising prices. This reduction will speed up mid-year when reinvestments of some pandemic holdings conclude.

Recently, ECB officials agreed on a new framework for future policy implementation, which maintains the current interest rate steering system while allowing banks more input on their required liquidity levels. This framework includes a new “structural” portfolio of bonds, though specifics are still being finalized.

Next year, the ECB’s monetary policy strategy will undergo a scheduled review, potentially including the QE approach.

Schnabel, who oversees market operations at the central bank, identified two broad lessons from recent experiences:

Central banks might face future shocks that require a more patient approach to achieving inflation targets near the effective lower bound, particularly after balance sheet crises.

The costs of asset purchases can be minimized by using them more selectively and stopping them sooner. Examples include the ECB’s commercial paper purchases in 2020 and the Bank of England’s interventions during the LDI crisis.

She also highlighted that in a bank-based economy like the euro area, measures such as targeted longer-term refinancing operations can provide substantial economic support during disinflationary shocks and instability, with a smaller and less persistent impact, as they can be reversed more quickly if conditions change.

Paraphrasing text from "Bloomberg" all rights reserved by the original author.