Transcript The ECB and the crisis lessons learned

The ECB and the crisis:
what are the lessons?
Lucrezia Reichlin
London Business School and CEPR
London School of Economics
20 November 2013
Outline
• What is special about the ECB?
• How much did the specific characteristics of
the euro area framework limit its effectiveness
during the crisis?
• Is there a general lesson beyond the
experience of the euro area?
What is special about the ECB ?
• No fiscal backing
• Limitation of mandate
• No supervisory responsibilities until recently
ECB action
TWO PHASES:
1. Global financial crisis 2008
2. Sovereign crisis and second recession 2011
PHASE 1
1. Global financial crisis 2008
• characterized by “sudden stop” involving
inter-bank transactions with non domestic
financial institutions
(run on the foreign part of inter-bank market –
stable retail)
• ECB acts as a liquidity provider of last resort
through the banking sector
THE ECB RESPONSE: MARKET OPERATION APPROACH
TO LENDER OF LAST RESORT
While the ECB has not adopted the rhetoric of “quantitative
easing”, it has expanded its balance sheet, increasing
reserves on the liabilities side against (largely) conventional
assets (repos) on the asset side
• Liability side: allow increasing recourse to deposit
facilities
• Asset side: expand scope of repo operations
 The ECB largely dealt with banks by applying the pure
version of the Bagehot rule
 ECB was the most conventional but also the most
aggressive of the central banks
1998W53
1999W16
1999W32
1999W48
2000W12
2000W28
2000W44
2001W08
2001W24
2001W40
2002W04
2002W20
2002W36
2002W52
2003W16
2003W32
2003W48
2004W12
2004W28
2004W44
2005W07
2005W23
2005W39
2006W03
2006W19
2006W35
2006W51
2007W15
2007W31
2007W47
2008W11
2008W27
2008W43
2009W07
2009W23
2009W39
2010W02
2010W18
2010W34
2010W50
2011W14
2011W30
2011W46
2012W10
2012W26
2012W42
2013W06
Euro Bn
THE SIZE OF THE LTRO - PROVIDING BANKS WITH
LIQUIDITY
1400
1200
1000
LTRO1: up to
one year maturity
800
600
400
200
0
Main refinancing operation
Source: ECB
Longer-term refinancing operations
ECB INTERMEDIATION: THE EA, THE US AND
THE UK
35
30
Total assets
as % of GDP
US
25
Eurozone
UK
20
~X2.0
15
10
~X3.0
5
0
00
01
02
03
04
05
06
07
08
09
Source: National Sources, GS Global ECS Research
As of end of January 2012 (using 2011 GDP figures)
Source: GS Global ECS Research
10
11
12
Robustness of the framework:
what have we learned?
• At the inception of the euro some questioned
the robustness of the framework
• Would have the ECB been capable of act in
response to a financial crisis?
Tommaso Padoa Schioppa 2003:
``the framework is in place to act as a liquidity
provider: market operation approach to lender
of last resort’’
INDEED THIS WORKED
1/2/2007
2/19/2007
4/10/2007
5/29/2007
7/16/2007
8/31/2007
10/18/2007
12/5/2007
1/25/2008
3/13/2008
5/5/2008
6/20/2008
8/7/2008
9/24/2008
11/11/2008
12/31/2008
2/18/2009
4/7/2009
5/28/2009
7/15/2009
9/1/2009
10/19/2009
12/4/2009
25/01/2010
12/03/2010
29/04/2010
16/06/2010
03/08/2010
20/09/2010
05/11/2010
23/12/2010
09/02/2011
29/03/2011
18/05/2011
05/07/2011
22/08/2011
07/10/2011
24/11/2011
12/01/2012
29/02/2012
19/04/2012
07/06/2012
25/07/2012
11/09/2012
29/10/2012
14/12/2012
05/02/2013
25/03/2013
Symptoms : stabilization in 2nd part of 2009
money market rates and spreads
6.000
2.000
5.000
1.800
1.600
4.000
1.400
3.000
turmoil
Source: European Banking Federation
Lehman
Spread (right)
“Greek crisis”
EURIBOR 3m
contagion
2.000
1.000
-1.000
EUREPO 3-months
1.200
1.000
0.800
0.600
0.400
0.000
0.200
0.000
United States
NBER recessions dates
Euro area (17 countries)
CEPR recessions dates
Q1-2013
Q4-2012
Q3-2012
Q2-2012
GDP growth, QoQ
Q1-2012
Q4-2011
Q3-2011
Q2-2011
Q1-2011
Q4-2010
Q3-2010
Q2-2010
Q1-2010
Q4-2009
Q3-2009
Q2-2009
Q1-2009
Q4-2008
Q3-2008
Q2-2008
Q1-2008
Q4-2007
Q3-2007
Q2-2007
Q1-2007
Q4-2006
Q3-2006
Q2-2006
Q1-2006
RECOVERY IN 2009Q2
Source: OECD
1.5
1
0.5
0
-0.5
-1
-1.5
-2
-2.5
-3
-3.5
OVERALL CONCLUSIONS OF QUANTITATIVE ANALYSIS:
ECB NON STANDARD POLICIES 2008:9-2011:4
• Rapid and effective response to a liquidity
crisis. Followed the Bagheot rule:
providing unlimited liquidity against
collateral
• Financial stability function: avoided the
melt-down
• Monetary policy function: some macro
effects (see various papers …)
12
But limits which become clear in phase 2
Limits especially amplified by
• characteristics of the euro area financial
markets (banks dominated financial sector;
large cross-border banks)
and
• lack of action on the solvency front
PHASE 2
WHAT WAS THE PROBLEM IN PHASE 2?
1.
2.
3.
4.
Banks not fixed in phase 1 (see chart)
Collateral deteriorates
Some banks became structurally dependent on the ECB
Sovereign problem starts gradually to emerge as a result of
weak economic conditions and/or fiscal consequences of
banking crisis
…. Sovereign crisis erupts in 2010 and then 2011
BANKS’ SOLVENCY PROBLEMS NOT FIXED
Bank capital to assets ratio (%)
12
10
8
6
4
2
0
2000
2001
2002
Source: World Bank
2003
2004
2005
GBR
2006
USA
2007
EMU
2008
2009
2010
2011
2012
AND INCREASING PRESSURES ON GOVERNMENT FINANCES
Government debt/GDP
Source: ECB
180
160
140
120
100
80
60
40
20
0
2007
Germany
2009
France
Greece
Ireland
2012
Italy
Euro area 17
Domestic / Total deposits
2013Jan
2012Oct
2012Jul
2012Apr
2012Jan
2011Oct
2011Jul
2011Apr
2011Jan
2010Oct
2010Jul
2010Apr
2010Jan
2009Oct
2009Jul
2009Apr
2009Jan
2008Oct
2008Jul
2008Apr
2008Jan
2007Oct
2007Jul
2007Apr
2007Jan
2006Oct
2006Jul
2006Apr
2006Jan
FACING THIS SITUATION THE FINANCIAL SYSTEM BECOMES
FRAGMENTED – STRONG HOME BIAS
MFI (excl ESCB) Domestic deposits / Total deposits
0.78
0.76
0.74
0.72
0.7
0.68
0.66
0.64
BANKS INCREASINGLY HAVE INCENTIVES TO BUY GOVERNMENT BONDS
OF THEIR OWN SOVEREIGN
Loans – retail (share of tot assets)
Germany
Spain
France
Italy
2007
30.04
58.28
23.04
37.81
2008
29.89
54.36
22.98
36.53
2009
31.16
52.51
23.26
36.24
2010
27.91
51.69
23.63
38.75
2011
27.91
47.53
23.19
37.50
2012
28.71
43.37
24.37
35.20
Jul 2013
30.53
43.69
23.46
34.85
Gov. Bonds – domestic (share of tot assets)
Germany
Spain
France
Italy
2007
1.91
2.55
2.11
4.84
2008
1.69
2.92
1.94
4.47
2009
2.15
4.41
2.09
5.29
2010
2.59
4.56
1.94
6.29
2011
2.40
5.33
1.82
6.02
2012
2.96
6.79
2.26
8.33
Jul 2013
3.12
9.09
2.10
10.12
CONSEQUENCE
• Correlation between bank risk and sovereign risk
• Difficult to distinguish banks’ debts from sovereign
debt
ECB RESPONSE TO THE SOVEREIGN CRISIS AND ITS
EFFECTIVENESS
• Intervention on sovereign bond market
Trichet 2010 and 2011 : SMP1 (Greece) and SMP2 (Italy)
Draghi: OMT
• More of the same on liquidity:
Draghi 2012: LTRO2
The LTRO remains main tool
Initially designed to deal with liquidity became a tool to
address the solvency problem of banks and sovereign
Lend to undercapitalized banks against collateral
…. Keep insolvent banks alive
….. Provide incentive for banks to acquire government
bonds to use as collateral
less loans, more domestic government bonds in
balance sheet
1998W53
1999W19
1999W38
2000W05
2000W24
2000W43
2001W10
2001W29
2001W48
2002W15
2002W34
2003W01
2003W20
2003W39
2004W06
2004W25
2004W44
2005W10
2005W29
2005W48
2006W15
2006W34
2007W01
2007W20
2007W39
2008W06
2008W25
2008W44
2009W11
2009W30
2009W49
2010W15
2010W34
2011W01
2011W20
2011W39
2012W06
2012W25
2012W44
2013W11
Euro Bn
More of the same
1400
1200
1000
800
600
400
200
0
Main refinancing operation
Longer-term refinancing operations
BANKS BECOME INCREASINGLY DEPENDENT ON THE
ECB: SPAIN AND ITALY ONLY AFTER 2011q3
Spain
%
Portugal
Ireland
Greece
Italy
Net ECB Lending
(as % of total banking system assets)
Neth'lands
France
Jan-08
Germany
Latest
-5
Source: National Central Banks
0
5
10
15
20
25
BANKS, GOVERNMENT AND EURO-SYSTEM LIABILITIES:
substitution but very little adjustment of size in total
EA liabilities (normalized by
GDP)
Euro Area liabilities
100%
90%
6
80%
5
70%
4
60%
50%
3
40%
2
30%
1
20%
10%
2000Q1
2000Q4
2001Q3
2002Q2
2003Q1
2003Q4
2004Q3
2005Q2
2006Q1
2006Q4
2007Q3
2008Q2
2009Q1
2009Q4
2010Q3
2011Q2
2012Q1
2012Q4
0
MFIs excluding ESCB
General Government
0%
Eurosystem
MFIs excluding ESCB
General Government
Eurosystem
Some key fiscal issues
• Close relationship between sovereign and the banking sector implies that
market assessment of fiscal solvency involves consolidation of government
and bank balance sheets
• In such a situation the provision of liquidity by the ECB through normal
operations can become close to government financing, e.g.:
– by continuing to roll over liquidity provision at its regular operations in
large amounts at fixed rates, the ECB can sustain banks with solvency
problems (which should be the responsibility of fiscal authorities);
– by accepting newly issued government debt instruments as collateral,
the ECB can provide indirect financing to governments
• ECB IS PARTY TO THE PROCESS OF ADDRESSING SOVEREIGN DEBT
TENSIONS – INCREASING TENSIONS BETWEEN DEBTOR AND CREDITOR
CONTRIES
Macro Effects?
2003M01
2003M05
2003M09
2004M01
2004M05
2004M09
2005M01
2005M05
2005M09
2006M01
2006M05
2006M09
2007M01
2007M05
2007M09
2008M01
2008M05
2008M09
2009M01
2009M05
2009M09
2010M01
2010M05
2010M09
2011M01
2011M05
2011M09
2012M01
2012M05
2012M09
2013M01
2013M05
2013M09
Correlation between sovereign and bank’s
risk reflected in retail rates
Retail interest rates
(i.r. on loans to NFC, new business, all maturities)
7.00
6.50
6.00
5.50
5.00
4.50
4.00
3.50
3.00
2.50
2.00
Source:
Eurostat
Germany
Spain
France
Italy
LOANS VOLATILITY: larger drop in the second cycle,
conditionally to real economy
55
120
45
115
35
110
25
105
15
100
5
95
-5
90
-15
85
-25
80
2001Jan
2001Jul
2002Jan
2002Jul
2003Jan
2003Jul
2004Jan
2004Jul
2005Jan
2005Jul
2006Jan
2006Jul
2007Jan
2007Jul
2008Jan
2008Jul
2009Jan
2009Jul
2010Jan
2010Jul
2011Jan
2011Jul
2012Jan
2012Jul
2013Jan
Euro billions
Loan flows (6m MA) and industrial production
Source: ECB
NFC
Households
Industrial production (right)
The 2011 recession in historical perspectives
Sources: Eurostat,
national banks, ECB
Area Wide Model
GDP YoY growth rate contibutions
4
2
0
-2
-4
France
Germany
Italy
Spain
Others
Others (included Spain)
Euro Area
20131
20121
20111
20101
20091
20081
20071
20061
20051
20041
20031
20021
20011
20001
19991
19981
19971
19961
19951
19941
19931
19921
19911
19901
19891
19881
19871
19861
19851
19841
19831
19821
-6
KEY LESSONS
• LLR function designed to deal with liquidity – not solvency
• In a financial crisis liquidity and solvency issues difficult to
distinguish ex-ante
• Non standard monetary policy implies assuming credit risk
in central bank b/s. This is a fiscal issue
• This is okay provided that liquidity policy is complemented
with action on solvency – essentially fiscal
• In a debt crisis banks’ debt and sovereign debt
indistinguishable – need to deal with both
• In absence of action on this monetary policy function also
impaired and banks are key in the transmission mechanism
What if …
• Some have argued that the ECB should have
done pure QE
• But could the ECB have solved the debt
problem of Italy and Greece?
General question
CAN THE CB BUY ALL GOVERNMENT DEBT?
• Under fiat money no limitation for a LLR but the
creation of base money has fiscal implications
• The b/s capacity of the CB is its fiscal capacity (if
liability backed by collateral the limit is the
potential loss; if backed by government debt the
limit is future taxes)
• What matters is the consolidated b/s of
governments and banks and whether this is
compatible with price stability
END