15 February 2016

Bruegel: The ECB’s quantitative easing programme - limits and risks

The ECB has made a series of changes to its APP to expand the universe of purchasable assets and have more flexibility in the execution of the programme. However this might not be enough to sustain QE throughout 2017. This extension also raises questions about its potential adverse consequences.

• The European Central Bank (ECB) has made a number of significant changes to the original guidelines of its quantitative easing (QE) programme since the programme started in January 2015. These changes are welcome because the original guidelines would have rapidly constrained the programme’s implementation.
• The changes announced expand the universe of purchasable assets and give some flexibility to the ECB in the execution of its programme. However, this might not be enough to sustain QE throughout 2017, or if the ECB wishes to increase the monthly amount of purchases in order to provide the necessary monetary stimulus to the euro area to bring inflation back to 2 percent. To increase the programme’s flexibility, the ECB could further alter the composition of its purchases.
• The extension of the QE programme also raises some legitimate questions about its potential adverse consequences. However, the benefits of this policy still outweigh its possible negative implications for financial stability or for inequality. The fear that the ECB’s credibility will be undermined because of its QE programme also seems to be largely unfounded. On the contrary, the primary risk to the ECB’s credibility is the risk of not reaching its 2 percent inflation target, which could lead to expectations becoming disanchored.

Executive summary

 

• The European Central Bank (ECB) has made a number of significant changes to the original design of its quantitative easing (QE) programme since the programme started in January 2015. The bank has expanded the list of national agencies whose securities are eligible for the Public Sector Purchase Programme (PSPP); it has changed the issue share limit (ensuring that the Eurosystem will not breach the prohibition on monetary financing), which was originally set at 25 percent, to 33 percent (at least for securities without collective action clauses); it has added regional and local government bonds to the list of eligible assets; it has announced that the programme would continue past September 2016, the previously-announced minimum end-date, to March 2017 “or beyond, if necessary”; and it has declared its intention to reinvest the principal payments on the securities purchased under the programme as they mature.
• As explained in Claeys et al (2015b), the programme’s original guidelines would have constrained the size and duration of the programme, especially if it was sustained throughout 2017. The changes to the design of the programme announced during 2015 greatly expand the universe of purchasable assets and should therefore delay the point at which limits will be reached. However, the decision to reinvest the principal payments as bonds mature, by increasing the monthly monetary purchase after March 2017, would also lead to the limits being reached sooner. In the same way, a decision by the ECB to increase the amount of PSPP purchases each month, for instance from €44 billion to €64 billion, would also frontload the purchases. In the end, because of the issue share limit, for a given set of securities there will always be a trade-off between larger monthly purchases and a prolonged programme.
• Further changes to the design of the programme will have to be implemented in order to increase the duration of the programme if the limit is binding in a major country before inflation is on the path towards 2 percent. These could include waiving the issue limit for AAA-rated bonds, or purchasing senior uncovered bank bonds as well corporate bonds. A more radical change could be to move away from an allocation of asset purchases between countries based on the ECB capital keys to an allocation based on the actual size of their outstanding debt.
• We also discuss the possible financial stability risks of a prolonged and large-scale QE programme, and conclude that the benefits of large-scale asset purchases outweigh their potential risks in terms of financial stability. However, micro- and macro-prudential policies should be used forcefully to prevent such risks from materialising.
• We also consider the potential effects that a prolonged asset-purchase programme could have on inequality. The increase in inequality observed in many advanced countries in recent decades is a long-term trend and primarily the result of deep structural changes. Our view is that the primary mandate of the ECB is to maintain price stability, and considerations of inequality are not within its purview, unless inequality prevents the transmission of monetary policy in some way. The ECB should therefore focus on fulfilling its price stability mandate by supporting the fragile recovery now taking place in the euro area. This is the best way for monetary policy to contribute to the avoidance of an increase in inequality.
• The fear that the ECB will lose its credibility solely because it is currently buying a large amount of sovereign bonds appears to be largely unfounded. The primary risk to the ECB’s credibility is the risk of not reaching its inflation target. In our view, the ECB should therefore try to find the right balance between the risk of breaching the monetary financing prohibition and the risk of not fulfilling its mandate because of the limits imposed on its own QE programme.

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