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External Publication

Facing the lower bound: what will the ECB do in the next recession?

In responding to the global financial crisis, the ECB has pushed its monetary policy into unchartered territories . Today, it appears increasingly constrained by persistently low interest rates. This paper seeks to understand this challenge and assess whether its toolkit would allow the ECB to weather a European recession.

By: , and Date: March 27, 2020 Topic: European Macroeconomics & Governance

This paper was written in October 2019. It is a chapter of the report “The Euro in 2020, A Yearbook on the European Monetary Union”, edited by Fernando Fernández Méndez de Andés, available here.

In responding to the global financial crisis and its aftermath, the European Central Bank (ECB) had to push its monetary policy into unchartered territories. In the last decade it has expanded its toolbox significantly with the introduction of negative rates, generous refinancing operations for banks, forward guidance, large-scale asset purchases, and tools to restore the transmission mechanism in all EMU countries.

As a result, the situation has improved in the euro area: deflation risks have abated, the economic recovery that started in mid-2013 has accelerated, investment has picked up, and unemployment has fallen considerably in the euro area as a whole.

However, since mid-2018, signs of deceleration have been piling up, as the euro area
has been heavily affected by global trade tensions. Major euro-area countries, including Germany and Italy, might already be in a technical recession. After peaking at around 2% at the end of 2018, headline inflation has decelerated in recent months, market expectations have decreased to near their lowest historical levels, and core inflation is still stuck close to 1%. In addition to this cyclical challenge, it remains unclear what the
‘new normal’ of the post-crisis period really looks like, and how the ECB’s new and more traditional tools will fare in it.

Therefore, the most important question today is whether the ECB’s updated toolkit will be sufficiently robust and well-calibrated to fend off a new European recession.

One major issue is the impact that “low-for-long” (or even negative) interest rates will have on the economy. The ECB might not be able to indefinitely cut its policy rates without reaching a lower bound under which the transmission channel breaks down and its policy rates end up having an overall contractionary effect. Whether this threshold has already been reached is a point of contention, but it is clear that even if it has not, the
ECB might be approaching it.

Its most traditional instrument being constrained, the ECB has, since 2007, increasingly had to rely on unconventional policies to stimulate economic growth and to bring inflation back towards 2%. Due to their relative novelty, the effects these instruments have on the economy are still uncertain and their calibration is more difficult, especially now that government yields are already very low. Moreover, after restarting its sovereign debt purchases in November 2019, the ECB will very soon face its self-imposed limit on this crucial unconventional tool.

This means that its two most important tools to face recessions and deflationary pressures – rate cuts and quantitative easing – could become insufficient in the next crisis.

Beyond these constraints weighing on its main instruments, other factors of uncertainty might also impact the transmission of the ECB’s monetary policy to the real economy. These include the possible weakening of the link between unemployment and inflation (i.e. the Phillips curve) as well as the remaining incompleteness of the EMU. Beyond that, the thread of reversing globalization and indeed the digital transformation further complicate our understanding of the “new normal” that policy makers will be asked to manage.

The ECB will thus have to put in place a systemic approach to manage this uncertainty, by designing monetary policies which are flexible enough to produce good outcomes given a variety of unpredictable circumstances. Communication will be crucial for the ECB to manage expectations and achieve its objectives.

To this end, we make five key recommendations for the ECB to better prepare itself in the case of a new European recession: first, it must find a way to mitigate the potentially negative effects of its negative interest rate policy (NIRP); second, it must rethink the current issuer limit on its asset purchase program (APP); third, a review of its monetary policy framework is in order; fourth, it must be fully prepared to use outright monetary transactions (OMT); and finally, it should be ready to be innovative again if its current
toolkit is insufficient.

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Parliamentary Testimony

European Parliament

Strengthening the international role of the euro

Testimony before the European Parliament on the International Role of the Euro.

By: Guntram B. Wolff Topic: European Parliament, Testimonies Date: October 1, 2020
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External Publication

How Can the European Parliament Better Oversee the European Central Bank?

This paper, written at the request of the Committee on Economic and Monetary Affairs, assesses how the European Parliament holds the European Central Bank accountable. The same exercise is done for the Bank of Japan, in order to identify possible lessons for the ECB and the European Parliament.

By: Grégory Claeys and Marta Domínguez-Jiménez Topic: European Macroeconomics & Governance, Global Economics & Governance Date: September 23, 2020
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Past Event

Past Event

Bruegel Annual Meetings 2020 - Day 1

The Annual Meetings are Bruegel's flagship event which gathers high-level speakers to discuss the economic topics that affect Europe and the world.

Topic: Energy & Climate, European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: September 1, 2020
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Blog Post

Emerging market central banks and quantitative easing: high-risk advice

Central banks in emerging markets with weak currencies should not resort to unorthodox monetary tools such as quantitative easing as a response to the crisis triggered by COVID-19. Preferable alternatives include shifting public spending away from less pressing needs, moderately increasing public debt and falling back on official development assistance.

By: Marek Dabrowski and Marta Domínguez-Jiménez Topic: Global Economics & Governance Date: August 26, 2020
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Opinion

Credible emerging market central banks could embrace quantitative easing to fight COVID-19

Emerging economies are fighting COVID-19 and the economic sudden stop imposed by the containment and lockdown policies, in the same way as advanced economies. However, emerging markets also face large and rapid capital outflows as a result of the pandemic. This column argues that credible emerging market central banks could rely on purchases of local currency government bonds to support the needed health and welfare expenditures and fiscal stimulus. In countries with flexible exchange rate regimes and well-anchored inflation expectations, such quantitative easing would help ease financial conditions, while minimising the risks of large depreciations and spiralling inflation.

By: Gianluca Benigno, Jon Hartley, Alicia García-Herrero, Alessandro Rebucci and Elina Ribakova Topic: Global Economics & Governance Date: July 6, 2020
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Past Event

Past Event

The Euro area after COVID-19 - a conversation with Mario Centeno

At this event we will welcome Mario Centeno to talk about his time as President of the Eurogroup and reflect on the future of the Euro area.

Speakers: Mário Centeno and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: July 1, 2020
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Policy Contribution

Is the COVID-19 crisis an opportunity to boost the euro as a global currency?

The euro never challenged the US dollar, and its international status declined with the euro crisis. Faced with a US administration willing to use its hegemonic currency to extend its domestic policies beyond its borders, Europe is reflecting on how to promote it currency on the global stage to ensure its autonomy. But promoting a more prominent role for the euro is difficult and involves far-reaching changes to the fabric of the monetary union.

By: Grégory Claeys and Guntram B. Wolff Topic: European Macroeconomics & Governance, Global Economics & Governance Date: June 5, 2020
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Opinion

The Independence of the Central Bank at Risk

The ruling of the German Federal Constitutional Court (GFCC) of May 5 on the ECB’s monetary policy affects not only the relation of Germany to the European Central Bank (ECB) and the Court of Justice of the European Union (ECJ) but also the constitutional foundations of monetary policy.

By: Peter Bofinger, Martin Hellwig, Michael Hüther, Monika Schnitzer, Moritz Schularick and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: June 2, 2020
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Policy Contribution

COVID-19’s reality shock for external-funding dependent emerging economies

COVID-19 is by far the biggest challenge policymakers in emerging economies have had to deal with in recent history. Beyond the potentially large negative impact on these countries’ fiscal accounts, and the related solvency issues, worsening conditions for these countries’ external funding are a major challenge.

By: Alicia García-Herrero and Elina Ribakova Topic: Finance & Financial Regulation, Global Economics & Governance Date: May 28, 2020
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Past Event

Past Event

The Covid Crisis and European State Aid Rules: The Case for a Rational Approach

Considering a new approach to find the way out of the Great Financial Crisis.

Topic: European Macroeconomics & Governance Date: May 27, 2020
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Policy Contribution

European Parliament

The European Central Bank in the COVID-19 crisis: whatever it takes, within its mandate

To keep the euro-area economy afloat, the European Central Bank has put in place a large number of measures since the beginning of the COVID-19 crisis. This response has triggered fears of a future increase in inflation. However, the ECB's new measures and the resulting increase in the size of its balance sheet, even if it were to be permanent, should not restrict its ability to achieve its price-stability mandate, within its legal obligations.

By: Grégory Claeys Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: May 20, 2020
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Podcast

Podcast

Rebooting Europe: a framework for post COVID-19 economic recovery

COVID-19 has triggered a severe recession and policymakers in European Union countries are providing generous, largely indiscriminate, support to companies. As the recession gets deeper, a more comprehensive strategy is needed. This should be based on four principles: viability of supported entities, fairness, achieving societal goals, and giving society a share in future profits. The effort should be structured around equity and recovery funds with borrowing at EU level.

By: The Sound of Economics Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: May 15, 2020
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