ECB monetary policy and quantitative easing: 1st part

 

In these last days is becoming increasingly topical the debate about the different powers in terms of monetary policy between the ECB on the one hand and the Bank of England and the Fed (as well as the Bank of Japan) on the other.
The ECB is being asked by many parties to step up purchases of government bonds of countries "not virtuous" in order to support prices and reducing rates. The Bank of England and the Fed can use instead the tool of "quantitative easing",  printing money to buy securities.
I wonder, who is right in the debate? Like every aspect of life, both systems have their pros and their cons.
It should then analyze the different strategies used.
We start then, in this first part, with the ECB's monetary policy.
The European Central Bank, according to the Treaty establishing the European Community (Art. 105, par.1) has one goal in mind and clearly preeminent: the pursuit of price stability. So, the german obsession for the control of the inflation has been transferred by the Bundesbank to the ECB.
The ECB Governing Council  has also set in 1998 (confirming in 2003) the quantitative objective, namely to keep inflation below or close to 2%. Below to control and prevent the increase; close to prevent prices from moving towards deflation, when inflation is zero or negative, that is destructive as hyperinflation.
To achieve price stability the ECB acts on the level of  money market interest rates.
The success of the Central Bank's monetary policy is based on so-called "transmission mechanism of monetary policy." In the short term a change in the money market interest rates triggers a series of reactions and mechanisms by the economic operators who will have an effect on prices in the medium term.
Everything comes through the banking system need for funding.
The Central Bank, through its decisions, affects money market conditions and therefore the level of short-term rates and then transmits them to the banking system. So, if the central bank wants to drain liquidity because it believes that inflation is directed towards an increase, it can raise, with the instruments at its disposal, the money market interest rates, making less affordable to individuals and businesses financing through debt. Or  changing the liquidity in the system, always to get an impact on the monetary market.Actually the adjustment of prices triggered by monetary policy is a process not immediate; in the short term we could see unexpected shocks to the price level (think of a sudden increase in prices of raw materials) that could cause some volatility. But the theory adopted by the ECB expects, although in the medium term, the variation of prices caused by the  impulses of monetary policy will be permanent.
But how ECB works in pursuing its monetary policy?
Managing liquidity in the money market through:
1. Open market operations;
2. Standing facilities;
3. Reserve requirements for credit institutions.

Open market operations

Transactions initiated by the ECB, and are divided into:
A) main refinancing operations, conducted through weekly auctions, fixed rate (the ECB sets the interest rate at which finance the banking system) or variable (minimum rate is generally fixed, but the auction allocates funds from the rates higher), with a pledge to guarantee assets (especially bonds); are reverse transactions  and serve only to provide liquidity to the financial sector.
B) long-term refinancing operations, with monthly auctions and a maturity of three months, to refinance the banking system in the longer term, so that the entire liquidity in the money market is not renewed every week (through these operations the Eurosystem doesn.t want to send signals to the market about its monetary policy, and are reverse transactions).
C) Fine-tuning operations, executed on an ad hoc basis, with no standardized rate or maturity, are made to  absorb the effects on interest rates caused by unexpected liquidity fluctuations, through "fast"auctions (even a day between the announcement and the execution); operations are conducted through reverse transactions (liquidity drain and enter), fixed-term deposits (liquidity only drain) and foreign exchange swaps.Sometimes outright transactions
D) structural operations, which serve to adjust the structural positions of liquidity to the banking system.


 Standing facilities

Occur at the request of lenders, and are divided into:
1) The marginal lending facility (with rates generally higher than the market rate) . The banks obtain overnight liquidity.
2) Deposits facility, so different from the reserves which banks must hold at the central banks (with a rate generally lower than the market rate, and paid by the Central Bank to banks). The banks can use such facility to make overnight deposits.
Those operations provide and absorb "overnight" liquidity, which generally have a term of one day. So that banks can finance temporary liquidity needs (on their own initiative) a day through the "marginal lending facility," always providing appropriate guarantees securities. And those who have excess liquidity can pour it on Marginal Deposits, sensing a rate of interest.

As we expressed the ECB's monetary policy? Not considering the operations that enter or drain liquidity in the money market, the main operation performed is "main refinancing".
The Central Bank's reference rate, currently at 1.25%, is the rate at which the ECB is carrying out these refinancing operations, and regulates the liquidity in the market. This rate signals to the market the orientation of monetary policy as it indicates the conditions under which the ECB is willing to transact with the market.
The other two key rates for the ECB's monetary policy are the rates set out in "transactions tocounterparties", which represent the maximum and minimum values ​​for the overnight market interest rates, the rate at which banks lend money in a period of 24 hours and the level of which is influenced by monetary policy of the ECB. The rate on the "Deposit facility" (currently 0.50%) is the minimum because if not, the banks would have greater convenience to hold excess reserves with the Central Banks rather than lend to other banks, the rate on "Marginal Lending" (currently 2%) is the upper limit of the overnight interbank rate because otherwise the banks would tend to borrow at the Central Bank rather than from the banking system. Within this corridor the ECB rules, with its monetary policy, the overnight rate.


But then, when the ECB is buying bonds on the secondary market, as is happening nowadays with the Italian and Spanish titles, how can it do that without create monetary base? In the face of purchases (outright purchase of eligible marketable debt instruments, as expressed by the decision of ECB Governing Council in the "temporary securities markets programme" in 2010) that would provide liquidity to the market, it  performs an operation of "sterilization," or cancel the stimulative effect of the monetary base with an opposite operation; it drains liquidity from the system, and does so through the reserves and deposits that credit institutions holds with the Eurosystem. Therefore the monetary base is safe.
So the goal is not to affect the liquidity or interest rates, but to support, in exceptional circumstances like the present, the prices of bonds down and then put a stop to rising interest rates.