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Focusing on the interest rate channel of monetary transmission, monetary policy operates by raising or lowering the interest rate in the economy. But the point of course is that there is no such thing as one interest rate to which all economic agents respond. There are at least three ways in which interest rates are differentiated in the euro area. There is vertical differentiation - different economic agents are sensitive to interest rates with different maturities. There is spatial differentiation - different interest rate curves provide the reference rates in different jurisdictions. And there is horizontal differentiation - within jurisdictions, different markets determine firms' and households' cost of borrowing.
What this implies is that the levels of medium- and long-term real interest rates across jurisdictions and markets will always be relevant to the formulation of monetary policy. The difference between normal and abnormal times is therefore not what we are trying to achieve - it is how we strive to achieve it.
In normal times, central banks affect this array of interest rates by steering the overnight interest rate and influencing expectations. We do the former through setting policy rates and the latter by communicating transparently our reaction function.
Monetary policy-making becomes more complicated, however, when short-term nominal rates reach the effective lower bound. Here, our ability to alter the monetary policy stance relies comparatively less on the level of the overnight rate, and comparatively more on influencing expectations, i.e. on the shape of the yield curve. This is why central banks have introduced forward guidance, which is enhanced communication on the expectations and reaction function of the central bank. It is essentially a natural extension of "normal" monetary policy.
Forward guidance influences the long-term interest rate by acting on both its determinants. It helps steer expectations about the level of future rates. And it lowers uncertainty about this level - that is, reduces the time-value of money or the term premium. Yet, as an instrument it also has natural limitations. A monetary policy committee cannot credibly commit to keep interest rates low beyond its horizon of visibility. This is reflected in the specific wording of our forward guidance, in particular the fact that it is outcome-contingent.
Hence, should further monetary accommodation be needed, it is reasonable to consider other operations aimed at lowering the term premium. This is where targeted asset purchases enter the toolset of monetary policy. Targeted asset purchases mean operations aimed primarily at impacting the level of the term premium across maturities and market segments.
At its meeting last week the Governing Council confirmed our baseline scenario - that is, a prolonged period of low inflation followed by a gradual rise in inflation rates towards 2 per cent. Further monetary easing is therefore not excluded, but remains contingent on outcomes. If such easing is called for, the Governing Council is unanimous in its commitment to use also unconventional instruments within its mandate. The question we face is whether asset purchases would be the appropriate unconventional measure, and within our mandate.
Unconventional monetary policy tools are less unconventional than the word implies. They are unusual, because they respond to highly unusual circumstances. They imply risks that have to be carefully weighed and mitigated. But fundamentally, unconventional tools are only a means for central banks to continue doing what they have always done: managing aggregate demand, by influencing the level of real interest rates and other monetary transmission channels, to maintain price stability.