Academic journal article Business and Economics Research Journal

Unconventional Monetary Policies in the Eurozone: Considering Theoretical Backgrounds and Policy Outcomes

Academic journal article Business and Economics Research Journal

Unconventional Monetary Policies in the Eurozone: Considering Theoretical Backgrounds and Policy Outcomes

Article excerpt

1. Introduction

The evolution of central banks rested upon restoring financial stability. In particular, the foundation of the Federal Reserve aimed to address escalating interest rates and prevent banking failures. Following 1930s' banking collapses central banks implicitly or explicitly intervened in the markets. However, with the monetarist critiques -especially Friedman's-the role of central banks began to change and focus on price stability. This view was verified with the time inconsistency problems of discretionary policies. Then it was widely accepted that central banks should only focus on price stability. European Central Bank (ECB) was designed in accordance with these views and focused on price stability (Art. 2 of Treaty of EU). ECB shall also support economic activities but without prejudice to the objective of price stability (Art.105.1).

However; after the Global Financial Crisis, financial stability function of the central banks began to appear again. From the beginning of the first shock, all central banks considered financial stability and tried to avert the slump. In this regard, they reacted initially by reducing the policy rate. But this was not enough.1 Then central banks enabled to unconventional monetary policies such as liquidity support, asset purchases or forward guidance.

ECB has also been using unconventional monetary policies since the beginning of the financial crisis. Moreover; the crisis provoked sovereign debt problems of some Eurozone countries and triggered the sovereign debt crisis therein. Sovereign Debt Crisis, especially after spreading to Italy and Spain, put the viability of EU under risk. So; ECB have also used these policies to depress financial pressures that occurred after the Sovereign Debt Crisis. However, ECB is bounded by its mandate-price stability. In these premises, ECB have used these polices within price stability mandate- to repair the transmission mechanisms distorted after the financial crisis. ECB utilized these policies in order to use monetary policy tools effectively to fulfill price stability mandate. This is a parallel and supportive approach but differed from the other central banks. Others- namely FED and BOE- used unconventional monetary policies sequential to the conventional policy. Once the nominal interest rate hits the zero-lower bound, Central Banks expand balance sheets and provide more policy accommodation. But ECB started to use unconventional monetary policies even it had a room for further interest rate cut (See Trichet, 2013 and IMF,2013).

The aim of this study is to analyze the policy performances of the unconventional monetary policies used by the ECB. With this aim, the following section will put forth the theoretical background of these policies. Then in the third section, the policies that are used during Global Financial Crisis and Sovereign Debt Crisis would be analyzed with their reflections on balance sheets and monetary aggregates. The fourth section is devoted to policy performance of these policies on the basis of two dimensions: calming the financial market stress and reviving the real economy. Finally, the fifth section will cover the concluding remarks.

2. Unconventional Monetary Policies: Theoretical Background

During financial crisis, implementing monetary policy is a more complex process. First, the demand for reserves of credit institutions in financial markets rises due to the increase in counterparty risk. This would pose difficulty to the Central Banks in controlling the money market rates in return. Second, the transmission channels are disrupted as a consequence of soaring financial tensions. Therefore; monetary policy impulse could not be transmitted to the financial assets. Third, especially proportional to the size of the shock and its effects on the real economy, curtailing policy rate to stimulate demand could not be sufficient as the policy rate hits the zero-lower bound (Ceccionni et. …

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