Outright Monetary Transactions Research Articles

Not All Shocks Are Created Equal: Assessing Heterogeneity in the Bank Lending Channel

We provide evidence that the yield impact of unconventional monetary policy is not a sufficient statistic to measure the strength of the bank lending channel of unconventional monetary policy. As a laboratory, we study three major positive events in the European sovereign debt crisis—the Greek debt restructuring (private sector involvement (PSI)), outright monetary transactions (OMT), and quantitative easing (QE)—using credit registry and security-level bank balance sheet data from Portugal, a country that was directly exposed to all three events. Even though the price of sovereign debt increased by substantially more after the PSI and OMT announcements, only QE led banks to reduce their net sovereign debt holdings and had statistically and economically significant effects on lending to firms and households. The differential effect on banks’ behavior reflects two forces. First, lower bank capitalization levels during the PSI and OMT episodes as well as disincentives to sell sovereign bonds because of their collateral value in the European Central Bank’s long-term refinancing operation facilities reduce the effectiveness of the recapitalization channel. Second, only QE involved direct asset purchases by the central bank and thereby induced a portfolio rebalancing channel from sovereign debt to loans. This paper was accepted by Victoria Ivashina, finance. Funding: The contribution by G. Nogueira to this paper has been prepared under the Lamfalussy Fellowship Program sponsored by the European Central Bank. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2023.00104 .

Central bank policies and financial markets: Lessons from the euro crisis

In a novel econometric framework, we identify differences and significant asymmetries in financial markets' responses to the European Central Bank (ECB)'s various policy interventions during the eurozone crisis. Dollar liquidity interventions reduced stress in bond markets and improved economic sentiment, as reflected in higher equity prices. In contrast, the ECB's euro liquidity provisions and monetary stimulus measures delivered modest results. In both these cases, government bond spreads typically did decline but the risk of large spread increases and equity losses also increased. Only the Outright Monetary Transactions (OMT) intervention had a substantial expansionary effect. The results emphasize the importance of unambiguous monetary policy for driving market expectations.

The ECB’s Transmission Protection Instrument and Fiscal Stability

Abstract The ECB’s Transmission Protection Instrument (TPI) supports the effective transmission of the monetary policy stance throughout the euro area, which is a precondition for the ECB to deliver on its price stability mandate. If activated, the Eurosystem would purchase securities issued in jurisdictions that experience a deterioration in financing conditions not warranted by country-specific fundamentals. The TPI thereby complements other tools to counter risks to the transmission mechanism such as the Pandemic Emergency Purchase Programme (PEPP) reinvestment flexibility and the Outright Monetary Transactions (OMT) programme.

Dynamics of the public-debt-to-gdp ratio: can it explain the risk premium of treasury bonds?

We examine the relationship between the risk premium markets demand to hold the Treasury Bonds of a given country and the sustainability of the public finances of the country. We inquire to what extent do markets use the dynamic evolution of the public-debt-to-gdp ratio as an indication of the likelihood of a public debt default. Specifically, our empirical research design involves the following steps: (i) we use the dynamic equation of the public-debt-to-gdp ratio to build forecasts of future values of this ratio in the eurozone countries; (ii) we then use these forecasts in a regression to see how important they are to explain the risk premium implicit in the treasury bond yields. We find that projections of future values of the public-debt-to-gdp ratio do impact current 10 year bond spreads. According to our regressions, markets seem to give more weight to forecasts with a horizon smaller than 10 years. Our results suggest that agents use a relatively simple mechanism to forecast the public debt-to-gdp ratio, a mechanism which can be used while updated forecasts from international organizations are not yet available. On the other hand, according to our estimations, euro area sovereign debt markets ceased to significantly discriminate countries based on their public debt prospects after the 2012 ‘Whatever It Takes” speech and the announcement of the Outright Monetary Transactions (OMT) program—suggesting that these events had a significant calming effect on the markets.Supplementary InformationThe online version contains supplementary material available at 10.1007/s10663-022-09547-8.

The past, present and future of euro area monetary-fiscal interactions

The EU’s Treaties were designed to limit the interaction between fiscal and monetary policies. However, over the last decade, the introduction of the ECB’s Outright Monetary Transactions (OMT) programme and its sovereign bond purchase programmes has created some strong linkages between monetary and fiscal policies in the Eurosystem. The ECB’s monetary policies have improved fiscal debt sustainability and reduced the probability of sovereign default. However, there may need to be limits to the ECB’s purchases of sovereign bonds. This paper discusses the interactions between fiscal and monetary policies in the euro area and describes how the arguments raised by the European Court of Justice in the Weiss and Gauweiler cases suggest there may be hard limits on the size of the Eurosystem’s sovereign bond holdings. These limits may undermine the positive impact of the OMT announcement and force the ECB into some difficult choices in the coming years.

Трансформация денежно-кредитной политики ЕС в условиях финансовой нестабильности

Challenges the European economy began to face 12 years ago raised the question about actions European Central Bank (ECB) have to undertake to maintain the financial sustainability, considering its objective to ensure price stability while coping with a changed economic environment. Provision that the ECB is obliged to take efforts to ensure financial stability as well as potentially serious consequences of crisis’ impact on the banking system and industrial production, led to an expansion of its role beyond standard monetary policy measures, with the unconventional steps being taken in addition to conventional to combat the adverse impact of the financial crisis. While reducing the interest rate, ECB also provided a cheap financial capital for banks via fixed-rate “Long Term Refinancing Operations” (LTROs), and three “Covered Bond Purchase Programmes” (CBPP). Purchases of debt securities were also conducted via “Securities Market Programme” (SMP) and, later, with then ECB’s President Mario Draghi declaring that ECB will do “whatever it takes to preserve the euro”, possibility of their increase was announced with the start of “Outright Monetary Transactions” (OMT) Programme. A mere announcement of the OMT was enough to calm financial markets, as none of the eurozone countries applied for financial support within this programme’s framework. Then ECB proceeded with a full-fledged quantitative easing, starting to buy sovereign bonds under its Public Sector Purchase Programme (PSPP), having spent 2.6 trillion € on its implementation. Understanding that a monetary union without an efficient banking union is unacceptably dangerous, the European Banking Union, under which supervision of largest eurozone banks has transferred directly to the ECB, was progressively established. While ECB’s anti-crisis policies achieved their goals, prolongation of the strategy it adopted may create new risks for the financial stability of the euro area, such as excessive dependence of credit institutions on monetary support and excessive inflationary risks under a zero interest-rate policy. Still, EU institutions’ coordinated financial management played an important role in overcoming the existing turbulence, with fiscal and monetary policy measures reinforcing each other.

Judicialization of Economic and Monetary Union: between a rock and a soft place?

The European Central Bank has been active since the sovereign debt crisis that struck European Union Member States by putting in place several asset-purchasing programmes such as Outright Monetary Transactions and Public Sector Purchase Programme. As much as these decisions have proven the pivotal importance of this institution within the monetary union, they have also spurred controversy on potentially having exceeded the competences attributed to the Union. The german federal constitutional court heard challenges to both and requested the Court of Justice to decide on their validity within the framework of a preliminary ruling. The decision of the former court to declare the Public Sector Purchase Programme ultra vires —in this way countering the preliminary ruling decision— as well as its argumentation could produce many institutional consequences to both the European Central Bank and Court of Justice of the European Union. Finally, it has shown the limits of European Union integration and will inevitably propel discussions on which way to go in the future: it is time for this discussion to come out from courtrooms into the public sphere.
 Received: 11 November 2020Accepted: 26 May 2021

Lender of last resort, buyer of last resort, and a fear of fire sales in the sovereign bond market*

AbstractWe document the mechanism through which the risk of fire sales in the sovereign bond market contributed to the effectiveness of two major central bank interventions designed to restore financial stability during the European sovereign debt crisis. As a lender of last resort via the long‐term refinancing operations (LTROs), the European Central Bank (ECB) improved the collateral value of sovereign bonds of peripheral countries. This resulted in an elevated concentration of these bonds in the portfolios of domestic banks, increasing fire‐sale risk and making both banks and sovereign bonds riskier. In contrast, the ECB's announcement of being a potential buyer of last resort via the Outright Monetary Transaction (OMT) program attracted new investors and reduced fire‐sale risk in the sovereign bond market.

Purchase of government bonds by a supranational central bank: its impact on business cycles

The euro area emerged from the euro crisis without meeting the conditions presented by the theory of optimum currency area. The decisive policy that ended this crisis was the Outright Monetary Transactions policy. Besides, the quantitative easing policy supports the economy of the euro area after this crisis. To examine the impact of these supranational monetary policies on the business cycles in the euro area, which is not covered by optimum currency area theory, we use a Kaldorian two-country model featuring a monetary union and imperfect capital mobility. We find that an increase in government bond purchases is a stabilizing factor, whereas an extreme increase in the degree of counter-cyclical fiscal policy is a destabilizing factor. Nevertheless, as long as the fiscal and monetary policies of two countries are not extremely active, but active to a certain extent, the equilibrium point becomes locally stable. Furthermore, even if the business cycles are not synchronized, the purchase of government bonds of a particular country is effective in stabilizing the business cycles of both countries. From these results, we suggest that the euro area satisfies the metacriteria of an optimum currency area through the implementation of a government bond purchase system by a supranational central bank system.

The Law and Norms of the European Central Bank as Sovereign Lender of Last Resort: Crystallising Endogenous Authority

Authority of the European Central Bank (the Bank) over its operational norms in the eyes of market actors – Exogenous and endogenous authority and legitimacy – The reconciliation by the Bank and the Court of Justice of the EU (the Court) of the pre-existing norm and political-economic reality with Article 123 TFEU – Sovereign lender of last resort – Eurozone Crisis – Outright Monetary Transactions (OMT) – Public Sector Purchase Programme (PSPP) – Pandemic Emergency Purchase Programme (PEPP)

Not All Shocks are Created Equal: Assessing Heterogeneity in the Bank Lending Channel

We provide evidence that the strength of the bank lending channel varies considerably across three major events in the European sovereign debt crisis - the Greek debt restructuring (PSI), outright monetary transactions (OMT), and quantitative easing (QE). We study how lending responds to each shock using detailed bank, firm, and household data from Portugal, a country that was directly exposed to the three events. While the price of sovereign debt securities increased in all three events, banks reduced sovereign debt holdings and realized accumulated capital gains only after QE. As a result, lending to final borrowers reacted more strongly to QE than to the PSI or OMT events. Our results suggest that asset purchases were more effective than signalling events at stimulating the bank lending channel. JEL Classification: E52, E58, G18, G21

The relative pricing of sovereign credit risk after the Eurozone crisis

We investigate whether riskier European countries compensate their debtholders properly by paying sufficiently higher bond yields than those of safer European countries, during and after the sovereign debt crisis of 2010–2012. Using the relative pricing between credit default swap (CDS) spreads and bond yields, we show that an inconsistent cross-sectional relationship between sovereign default risk and sovereign bond yields emerges during the crisis period for all European countries. However, after the announcement of the Outright Monetary Transaction (OMT) program by the European Central Bank, the consistent cross-sectional relationship between default risk and bond yields is restored for the Eurozone countries only, a result likely due to a reduction in transaction costs.

How have the European central bank\u2019s monetary policies been affecting financial markets in CEE-3 countries?

This paper aims to contribute to the growing pool of literature on the spillover effects of the European Central Bank’s (un)conventional monetary policies on the exchange rate, sovereign bond and equity markets of the Czech Republic, Hungary and Poland (CEE-3 countries), which are collectively known as the CEE-3 countries. The study is conducted using daily data from January 2010 to September 2019. Our results indicate that the financial markets of the CEE-3 countries have been strongly influenced by the nonstandard measures enacted by the European Central Bank, particularly those involving purchases of euro-area sovereign debt. The strongest spillover effects were identified for the Securities Markets Program, while the effects from the Outright Monetary Transactions program turned out to be the most durable. At the same time, the financial markets of the CEE-3 countries were found to have been largely unaffected by interest rate changes enacted by the European Central Bank.

The evolution of European economic institutions during the COVID-19 crisis.

This article argues that the incomplete economic and institutional integration of the euro area has exposed the monetary union to increasing economic divergence, which could be deepened by the COVID‐19 crisis. We discuss how monetary and fiscal measures implemented at the onset of the pandemic have contributed to mitigate the economic consequences of lockdowns, but provided limited insurance to narrow economic gaps across member countries. However, EU countries agreed on July 21, 2020 to develop, for the first time, countercyclical fiscal transfers financed by common debt issuance. We discuss the potential of this instrument to contribute to improve the resilience of the eurozone.

What were they thinking? Firms' expectations since the financial crisis

PurposeThis paper explores how firms formed their expectations about the availability of bank finance since the financial crisis. Various expectations hypotheses that incorporate backward and/or forward-looking elements and inattention are tested. From a policy perspective, the most important hypothesis is whether policy announcements have a direct impact on the expectations of companies.Design/methodology/approachThe analysis is based on a large sample of euro area companies from the ECB “Survey on the Access to Finance of Enterprises” between 2009 and 2018. Ordered logit models are used to relate individual replies on expectations to firms' information available at the time of the forecasts. The model controls for the business cycle and firms' structural characteristics. Using a difference-in-differences approach, we test how policy announcements may affect expectations.FindingsFirms update what otherwise look like adaptive expectations on the basis of new information. The hypothesis of rational expectations is rejected. Moreover, we do not find evidence of inattention or of a wave of pessimism/optimism. The analysis of expectations around the time of the ECB Outright Monetary Transactions program provides some evidence of forward-looking expectations.Originality/valueThe paper contributes to the literature on expectations by using a novel survey in eleven countries. In the multi-country setting, country-specific business cycle effects and waves of pessimism or optimism are better controlled for. The policy announcements of summer 2012 provide for a natural experiment to test the direct impact of such announcements on expectations, an issue of relevance for the monetary policy transmission to economic activity.

‘We Serve the People of Europe’: Reimagining the ECB's Political Master in the Wake of its Emergency Politics

AbstractIn the wake of the Euro crisis, the mission statement on the European Central Bank's (ECB) website was changed from ‘Our mission is to serve Europe's citizens’ to ‘Our mission is to serve the people of Europe’. This article situates this discursive shift within a broader change of the ECB's self‐presentation in public discourses and explores its meaning in terms of political theory and public law. The article argues that the shift represents a response to the perceived necessity of reimagining the ECB's foundation of legitimate governmental authority following its exercise of emergency powers during the Euro crisis. The discourse emphasizes an organic link between the ECB and ‘the people of Europe’ as a political subject able to authorize previously unauthorized governmental practices such as the outright monetary transactions programme. It reflects, furthermore, a new governing philosophy that stresses flexibility and discretion rather than strict adherence to rules in the ECB's exercise of power.

Givers or Recipients? Co-Movements between Stock Markets of CEE-3 and Developed Countries

In this paper, time-varying co-movements between the stock markets of Poland, the Czech Republic, Hungary, and the capital markets of developed countries in stable and crisis periods are studied. The parameters of the VAR-AGDCC-GARCH (Vector Autoregressive- Asymmetric Generalized Dynamic Conditional Correlation-Generalized Autoregressive Conditional Heteroscedasticity) model are estimated, and volatility spillovers are calculated. The evidence suggests that the level of correlation between stock return shocks of Central and Eastern European countries increased significantly in the period of financial turmoil and was high in the period of the US sub-prime crisis, as well as during the euro area sovereign debt crisis. After the announcement of the OMT (Outright Monetary Transactions) program, the evolution of the stock market indices in Central and Eastern Europe countries (CEECs) have followed different paths. An analysis of the volatility spillovers indicates that CEECs are the recipients of volatility. In the period of 2004–2019, they received much volatility—from Germany and the US, in particular. They also received much volatility from Spain during the euro area sovereign debt crisis. After 2012, volatility transmission to Poland, the Czech Republic, and Hungary dropped significantly.

Tracing leadership: the ECB’s ‘whatever it takes’ and Germany in the Ukraine crisis

Political scientists face problems when assessing a leader’s impact: how can we know that a policy outcome or institutional change is caused by leadership? This article argues that in addition to relying on comparisons and counterfactuals, we need to trace the causal mechanisms by which leadership affects outcomes. Therefore, the article proposes a way to trace leadership and applies it to two cases of EU crisis management: the European Central Bank’s role in announcing Outright Monetary Transactions in the eurozone crisis, and Germany’s role in shaping the EU’s response to the Ukraine crisis. Systematic process-tracing shows that both actors provided leadership ‘by default’. However, while the ECB had to combine the provision of knowledge with unilateral action in order to overcome the eurozone crisis, Germany could use manifold bargaining-based strategies and thus became the EU’s de facto agenda setter and main representative in managing the Ukraine crisis.

Economic Constitutionalism in the EU and Germany – The German Constitutional Court, the European Court of Justice and the European Central Bank between Law and Politics

Abstract The relationship between the European Union (EU) and its member states has recently been the subject of several legal proceedings in the German Federal Constitutional Court (GFCC) and the European Court of Justice. The backdrop to the underlying controversies were policies instituted by the European Central Bank (ECB) dealing with the economic and monetary situation in various member states in the context of the sovereign debt crises to influence interest rates, combat deflationary tendencies and keep inflation under but close to the ECB’s 2% inflation target. Especially so-called outright monetary transactions (OMTs) and the corresponding OMT-program and a particular high volume public sector asset purchasing program (PSPP) announced by the ECB have been controversially discussed. Legally, the controversies are about the prohibition for the ECB to finance debt held by the EU or member states (Article 123 TFEU) and about the delineation of economic policy (Article 119 et seq. TFEU), which lies in the hands of the members states, and monetary policy (Article 127 et seq. TFEU), which is exclusively in the hands of the ECB. The GFCC in its decisions propagated a restrictive approach emphasizing the role of the member states and pointing to the doctrines developed by it around ultra vires acts and so-called identity review. This paper attempts to shed some light on this controversy and argues that beyond the legal controversy lies a deeper problem of the relationship between judicial and political decision-making that the GFCC should exercise restraint in exercising its functions and remember its own doctrine of “open constitutional norms” developed in a different context but applicable here as well.

Monetary Policy, Product Market Competition and Growth

In this paper we argue that monetary easing fosters growth more in more credit‐constrained environments, and the more so the higher the degree of product market competition. Indeed, when competition is low, large rents allow firms to stay on the market and reinvest optimally, no matter how funding conditions change with aggregate conditions. To test this prediction, we use industry‐level and firm‐level data from the euro area to look at the effects on sectoral growth and firm‐level growth of the unexpected drop in long‐term government bond yields following the announcement of the Outright Monetary Transactions programme (OMT) by the European Central Bank. We find that the monetary policy easing induced by OMT contributed to raising sectoral (firm‐level) growth more in more highly leveraged sectors (firms), and the more so the higher the degree of product market competition in the country (sector).