From the Eyes of Central Banks

Massimo Rostagno European Central Bank

Central Banking Series From the Eyes of the Central Banks

Madrid, November 15-16, 2018

The views expressed in this presentation are those of the presenter and do not necessarily reflect those of the ECB or the Eurosystem

Duration extraction: The Asset purchase program (APP) Rubric Projected evolution of the APP portfolio in maturity-adjusted terms (€bn 10-year equivalents)

Forward guidance

June 2018 extension announcement October 2017 extension announcement December 2016 extension announcement March 2016 extension announcement December 2015 extension and reinvestment announcement January 2015 announcement 2000 2000

Net asset purchases “We will continue to make net purchases under the asset purchase programme (APP) at the new monthly pace of €15 billion until the end of December 2018. We anticipate that, subject to incoming data confirming our medium-term inflation outlook, we will then end net purchases.

1500

1500

1000

1000

500

500

0 2015

2017

2019

2021

2023

Re-investments We intend to reinvest the principal payments from maturing securities purchased under the APP for an extended period of time after the end of our net asset purchases, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.”

0 2025

Source: ECB. Notes: The portfolio is computed in terms of book value. It is arbitrarily assumed that reinvestments of maturing securities held in the portfolio will last 2 years and that the portfolio will run off thereafter.

Latest observation: projections based on the June 2018 decision to extend the program until December 2018.

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Duration extraction: The Asset purchase program (APP) Rubric EONIA, realised and forward (percentages per annum)

Realised EONIA Latest forward (9 Nov 18) Latest forward adjusted for term premia

0.4

0.2

Net asset purchases “We will continue to make net purchases under the asset purchase programme (APP) at the new monthly pace of €15 billion until the end of December 2018. We anticipate that, subject to incoming data confirming our medium-term inflation outlook, we will then end net purchases.”

0.4

0.2

0.0

-0.2

Forward guidance

Re-investments “We intend to reinvest the principal payments from maturing securities purchased under the APP for an extended period of time after the end of our net asset purchases, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.”

0.0

-0.2

EONIA +10 bps

-0.4 2018

2019

2020

Rate guidance “We continue to expect the key ECB interest rates to remain at their present levels at least through the summer of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.”

-0.4 2021

Sources: Bloomberg, Consensus Economics, Thomson Reuters and ECB calculations.

Notes: For maturities up to 2020, term premia are calculated as the trailing 12m average gap between forward curves derived from interest rate surveys and those derived from the market. Results are extrapolated for longer maturities via a three-factor affine term structure model employing the 3m Euribor swap curve and interest rate surveys by Consensus Economics.

Latest observation: September 2018 for Bloomberg and Consensus surveys, 9 November 2018 for realised EONIA.

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And much earlier at present: September 2019 versus December 2019 Rubric EONIA forward curve estimated from OIS and survey-based expected lift-off (percentages per annum) Realised EONIA

Pre-Jun GovC forward (13 Jun 18)

Pre-Oct GovC forward (24 Oct 18)

0.4

0.4 Median expected lift-off date June 2019

0.2 Median expected lift-off date September 2019

0.0

-0.2

+10bps crossing December 2019

0.2

0.0

-0.2

EONIA +10 bps

-0.4 Jan.17

Jan.18

Jan.19

Jan.20

-0.4 Jan.21

Jan.17

Jan.18

Jan.19

Jan.20

Jan.21

Sources: Bloomberg, Thomson Reuters and ECB calculations.

Notes: The box-plot shows the median, as well as the 25th and 75th percentiles of expected DFR lift-off dates as indicated in the pre-June and pre-October GovC Bloomberg surveys.

Latest observation: 24 October 2018 for realised EONIA.

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Conditionality: Convergence Rubric Actual and projected HICP inflation

Sustained Adjustment

(year-on-year percentage change)

Sep-2018 MPE

Criteria:

HICP inflation 3.0

3.0



Convergence: Headline inflation is on course to reach levels below, but close to, 2% by the end of a meaningful medium-term horizon



Confidence: The upward adjustment in inflation has a sufficiently high probability of being realized on a sustainable basis



Resilience: And the path will be maintained even after the end of the net asset purchases

2.5

2.5 2% 2.0

2.0

1.5

1.5

1.0

1.0

0.5

0.5

0.0

0.0

-0.5

-0.5

-1.0 2013

-1.0 2014

2015

2016

2017

2018

2019

2020

Source: ECB staff projections and calculations.

Latest observation October 2018 (flash) for HICP inflation.

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Conditionality: Confidence Rubric Aggregate probability distribution of two-years ahead HICP inflation expectations

Sustained Adjustment

(density)

8%

Criteria:

Dec 2014 June 2018 Sept 2018 Pre-crisis benchmark (average 2006 - 2007)



Convergence: Headline inflation is on course to reach levels below, but close to, 2% by the end of a meaningful medium-term horizon



Confidence: The upward adjustment in inflation has a sufficiently high probability of being realized on a sustainable basis



Resilience: And the path will be maintained even after the end of the net asset purchases

8%

7%

7%

6%

6%

5%

5%

4%

4%

3%

3%

2%

2%

1%

1% 0%

0% -1.5 -1 -0.5

0

0.5

1

1.5

2

2.5

3

3.5

4

Source: ECB calculations..

Note: The density combines a range of predictive density functions of two-years ahead HICP inflation based on: the (B)MPE, the SPF, a large macro-finance BVAR model which incorporates Nelson-Siegel term structure factors, and the inflation-linked swaps. The shaded area denotes the range of values for inflation from 1.8% to 2%.

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Conditionality: Resilience Rubric Actual, projected HICP inflation and counterfactual inflation path without current policies

Sustained Adjustment

(year-on-year percentage change) Without policy contribution

Criteria:

Sep-2018 MPE

HICP inflation 3.0

3.0



Convergence: Headline inflation is on course to reach levels below, but close to, 2% by the end of a meaningful medium-term horizon



Confidence: The upward adjustment in inflation has a sufficiently high probability of being realized on a sustainable basis



Resilience: And the path will be maintained even after the end of the net asset purchases

2.5

2.5 2% 2.0

2.0

1.5

1.5

1.0

1.0

0.5

0.5

0.0

0.0

-0.5

-0.5

-1.0 2013

-1.0 2014

2015

2016

2017

2018

2019

2020

Source: ECB staff projections and calculations.

Notes: The orange range reflects the path of inflation in the absence of the policy contribution.

Latest observation October 2018 (flash) for HICP inflation

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Conditionality: Resilience Rubric Market reaction to communicating (anticipated) phasing out of net purchases

Sustained Adjustment

(bps) ECB GovC meeting June 2018

FED FOMC meeting June 2013

Criteria:

20

20

15

15

10

10

5

5

0

0

-5

-5

-10

-10

-15

-15

-20



Convergence: Headline inflation is on course to reach levels below, but close to, 2% by the end of a meaningful medium-term horizon



Confidence: The upward adjustment in inflation has a sufficiently high probability of being realized on a sustainable basis



Resilience: And the path will be maintained even after the end of the net asset purchases

-20 EA 10y OIS

EA 10y term premia

US 10y OIS

US 10y term premia

Sources: Bloomberg, ECB, and Kim and Wright (2005).

Notes: The chart displays one-day changes of 10-year yields and premia for both the euro area and the US around policy meeting announcements

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Will a large securities portfolio impede normalization of the stance?

Rubric Projected evolution of the APP portfolio in maturity-adjusted terms

Estimated effect of APP re-calibration vintages on euro area 10Y term premium

(â‚Źbn 10-year equivalents)

(basis points)

June 2018 extension announcement October 2017 extension announcement December 2016 extension announcement March 2016 extension announcement December 2015 extension and reinvestment announcement January 2015 announcement 2000 2000

0

1500

1500

0

-25

-25

-50

-50

-75

-75

-100

-100

1000

1000

500

500

0 2015

APP as of June 2018 APP as of October 2017 APP as of December 2016 APP as of March 2016 APP as of December 2015 APP as of January 2015

2017

2019

2021

2023

-125 2015

0 2025

Source: ECB. Notes: The portfolio is computed in terms of book value. It is arbitrarily assumed that reinvestments of maturing securities held in the portfolio will last 2 years and that the portfolio will run off thereafter.

Latest observation: projections based on the June 2018 decision to extend the program until December 2018.

-125 2019

2023

2027

2031

Source: Eser, Lemke, Nyholm, Radde, Vladu (2017).

Notes: Euro area yields are proxied by the GDP-weighted long-term yield of the four largest euro area jurisdictions. The 10-year yield impacts are obtained from a Li-Wei model. Impacts are shown for different recalibration vintages. The marginal impact of each recalibration is given by the distance between the line referring to that vintage and the line referring to the vintage earlier in time.

Latest observation: August 2018.

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Will ample liquidity impede normalization of the stance?

Rubric The floor system and the stance

Excess liquidity and key interest rates (€bn; %) Excess liquidity (rhs) Excess liquidity forecast (rhs) DFR (lhs) MRO rate (lhs) EONIA (lhs) EONIA fwd (lhs)

5

2500

4

2000

3

1500

2

1000

1

500

0

0

-1 2015



The ample volume of excess liquidity has driven the overnight interbank interest rates to the floor of the Eurosystem monetary policy corridor



As a result, the Eurosystem monetary framework has been operating as a de facto floor system since 2014



Excess liquidity is currently projected to remain above satiation levels – i.e. an aggregate volume at which scarcity of banks’ free reserves will increasingly determine their price – well into the next decade



Even in these conditions, interbank money market interest rates and the swap curve will be controllable through appropriate shifts of the floor of the corridor

-500 2017

2019

2021

2023

2025

Source: ECB, Bloomberg.

Notes: The forecast of excess liquidity is based on a comprehensive simulation of the evolution of the Eurosystem balance sheet.

Latest observation: 9 November 2018

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Will ample liquidity impede normalization of the stance?

Rubric The floor system and the stance

Risk-free euro area short-term interest rates (%)

0.4

DFR

EONIA

GC German repo rate

DE 6M

OIS 6M

0.2 0

0.4



As a result, the Eurosystem monetary framework has been operating as a de facto floor system since 2014



Excess liquidity is currently projected to remain above satiation levels – i.e. an aggregate volume at which scarcity of banks’ free reserves will increasingly determine their price – well into the next decade



Even in these conditions, interbank money market interest rates and the swap curve will be controllable through appropriate shifts of the floor of the corridor



But: A necessary condition for an effective monetary policy conduct is that any change in the central bank’s policy rate is passed through, one for one (net of credit and term spreads), to all money-market rates



So: in order to ensure that, while normalizing the policy stance, it remains in control of the whole spectrum of the money market interest rates that matter for the economy, a central bank may consider more diversified structures for its liability side, including instruments www.ecb.europa.eu © that can be held by non-banks

0 -0.2

-0.4

-0.4

-0.6

-0.6

-0.8

-0.8

Source: ECB, Brokertec, MTS. Notes: Monthly observations.

Latest observation: October 2018.

The ample volume of excess liquidity has driven the overnight interbank interest rates to the bottom of the Eurosystem monetary policy corridor

0.2

-0.2

-1 Jan.13Oct.13 Jul.14 Apr.15Jan.16Oct.16 Jul.17 Apr.18



-1

11

Will the front-end money premium encourage maturity transformation?

Rubric Distribution of “money-like” instruments: United States Financial stability risks?

(% of total)



Jeremy Stein and co-authors have made a powerful argument that the central bank should maintain a large balance sheet and thus keep providing safe, liquid, short-term assets in order to crowd out private sector issuers and reduce their incentive to engage in excessive amounts of maturity transformation



Indeed, in the US, money market fund shares and other private money-like claims that do not fall under strict banking supervision regimes play a significant role

money market fund shares private sector short-term debt securities Treasury bills short-term deposits and currency 100%

100%

80%

80%

60%

60%

40%

40%

20%

20%

0% 2014Q1

0% 2015Q1

2016Q1

2017Q1

2018Q1

Source: Federal Reserve, ECB calculations.

Notes: Composition of non-financial sector holdings of short-term assets by instrument type based on the Fed Financial Accounts data and following Greenwood et al. (2016). The nonfinancial sector comprises households, NFCs, US general government, and the rest of the world. Short-term deposits refer to checkable deposits, other private sector short-term claims refer to the sum of repurchase agreements, commercial paper and private foreign deposits. Treasury bills are approximated by multiplying the holdings of total Treasury securities by the share of T-bills in outstanding marketable Treasuries.

12 Latest observation: 2018Q2.

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Will the front-end money premium encourage maturity transformation?

Rubric Distribution of “money-like” instruments: Euro Area Financial stability risks?

(% of total)

100%

money market fund shares/units private sector short-term debt securities AAA govt short term debt securities short-term deposits and currency

Jeremy Stein and co-authors have made a powerful argument that the central bank should maintain a large balance sheet and thus keep providing safe, liquid, short-term assets in order to crowd out private sector issuers and reduce their incentive to engage in excessive amounts of maturity transformation



Indeed, in the US, money market fund shares and other private money-like claims that do not fall under strict banking supervision regimes play a significant role



The euro area financial system is bank-centered and regulation is more effective in preventing excess maturity transformation in repo market

100%

80%

80%

60%

60%

40%

40%

20%

20%

0% 2013Q4



0% 2014Q4

2015Q4

2016Q4

2017Q4

Source: ECB, ECB calculations.

Notes: Composition of non-financial sector holdings of short-term assets by instrument type.

The non-financial sector comprises households, NFCs, general government, and the rest of the world. Short term deposits comprise overnight deposits and repos for households and NFCs, (estimated) overnight deposits for general government and deposits with a maturity of up to 1 year for the rest of the world. Private sector short-term debt securities are issued

by NFCs, MFIs, ICPF and OFIs and have an original maturity of up to 1 year. AAA gov’t short term debt securities refer to debt securities issued by AT, DE, FI, FR, LU and NL with 13 an original maturity of up to 1 year.

Latest observation: 2018Q2.

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Rubric

Thank you

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