The European Central Bank Faces New Challenges: Dealing With Low Inflation

We have noticed that the impact of monetary policy on private lending is no longer as effective as it used to be.

It is obvious that the various lending channels within the banking system have become chaotic, and the excessively severe loan conditions are pressing demand.

The ECB has responded like any other central bank: we have recombed the relationship between our monetary policy and the cost of borrowing to reduce the average lending rate of households and businesses.

In June of this year, we adopted a series of directional long term refinancing operations (TLTROs) to provide the banks with the maximum interest rate of 4 years.

This is to enable banks to ease the pressure on borrowers.

Another project to buy asset - guaranteed stocks / bonds is designed to further promote lower interest rate financing.

Together, the above measures have made a strong response to the root causes of the problem of bank loan dislocation, and therefore, the new credit flow flows to the real economy faster.

At the same time, preliminary evidence shows that these measures have brought some early substantive benefits to the euro zone economy.

Meanwhile, the euro area inflation rate continued to decline.

In November, as crude oil prices plummeted from the end of the summer, the euro area's annual inflation rate fell to a cyclical low of 0.3%. Core inflation (excluding more volatile energy and food prices) also means a weak aggregate demand.

In fact, the European Central Bank recently released a forecast for its macroeconomic forecast.

The prospect of a prolonged oil price and low inflation period also seems to have affected inflation expectations.

Taking into account the recent turmoil in oil prices, the risk is that inflation will temporarily slide into negative territory in the coming months.

Generally speaking, the central bank will welcome a positive supply blowout.

After all, low oil prices will boost real incomes and may boost future output.

But in order to achieve medium-term price stability, there must be a stable inflation expectation, and monetary policy is to deal with this risk of decoupling.

This is why the ECB Management Committee has repeatedly reiterated its unanimous commitment to use additional unconventional tools within its own appointments to respond when necessary.

The extension of the period, or the failure of monetary stimulus, will bring the European balance sheet closer to the beginning of 2012.

This may mean that the scope, path and composition of the measures will be changed early next year, and the ECB and central banks have also upgraded.

Therefore, further measures can be implemented in time if necessary.

If we feel that the economy needs further stimulus, one option will be to extend the European Central Bank's asset purchases directly to other asset classes.

But we must bear in mind that asset procurement is not an end in itself. They are a tool for monetary policy, not a goal.

An important factor in choosing additional measures is what impact these measures will have on the macro financing conditions of the private sector.

For example, buying bonds issued by non-financial institutions in the euro area may have some direct pmission effect on the financing cost of enterprises, but compared to other asset classes, the market for such bonds is relatively weak.

If you buy it

Sovereign bonds issued by the state are the only market that is not a problem. That is another matter.

The intervention of the market will send a strong signal: the European Central Bank will continue to maintain the loose monetary policy for a period of time.

The effect of intervention on the sovereign bond market is their ability to further reduce the cost of borrowing for families and businesses, and also depends on the state of the banking sector.

Higher capital reserve ratio, lower risk of bad debts and more pparent balance sheets will help the ECB quantify the scope of stimulus to a wider range.

This is why the ECB's comprehensive assessment of bank balance sheets and the whole European banking supervision program can help to activate the bad loans in the eurozone.

In particular, the continuous clarity and pparency of bank balance sheets, plus a more adequate banking sector, will create a more favorable lending environment.

But a decision to buy sovereign bonds must also build and integrate the institutional particularity of the euro area, including the conditions set out in the EU treaty.

We also treat these restrictions with great seriousness.