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

Abstract: Global Financial Crisis erupted as a sub-prime mortgage market crisis in US and became a full-fledged global crisis after the fall of Lehman Brothers. Thus, the effects of financial crisis spread to all over the world. In the Eurozone, the financial crisis became more challenging as it provoked the sovereign debt problems of some countries and triggered a sovereign debt crisis. Sovereign Debt Crisis was the first crisis in the Eurozone after forming a monetary union and put the viability of the union under risk. In this tranquil environment, European Central Bank (ECB) responded the crisis with set of monetary policy tools- conventional and unconventional. ECB pursued unconventional monetary policy parallel to its conventional monetary policy tool- policy rate. It provided liquidity support to markets, purchase public and private assets and guide markets about future short-term interest rates in the context of unconventional monetary policy. The aims of using these policies are similar for all central banks: alleviating the financial market tensions and stimulating aggregate demand. This study evaluated the effectiveness of these policies on the basis of these aims. The study finds out that ECB has been effective on depressing the financial market stress but ECB has not been effective on stimulating the aggregate demand.

Keywords: Unconventional monetary policy, Policy effectiveness, ECB, global financial crisis, sovereign debt crisis.

JEL Classification: E44, E52, E58

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). …

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