European Central Bank Executive Board member Benoit Coeure said some non-standard measures introduced during the financial crisis may be worth keeping once policy returns to normal.
“We may want to ask ourselves which elements of our current mode of operation have served us well, and not only as a crisis-management tool, and may therefore survive as a more permanent feature of the new steady state,” Coeure said in a speech in Geneva today.
The ECB has provided banks with unlimited liquidity for as long as three years to unlock markets and encourage lending. That’s pushed market rates down toward the deposit rate, which has served as the de facto benchmark. President Mario Draghi yesterday stirred a debate over whether that rate can be cut below zero, after policy makers lowered the main refinancing rate to a record low of 0.5 percent.
If policy makers decided in the future to continue to provide more liquidity than is needed and adjust the policy floor, “the volatility of the overnight rate would likely be squeezed to minuscule numbers,” Coeure said. “It could enhance the transmission of policy shifts throughout the term structure of money-market rates.”
A second advantage for the central bank would be the continued “capacity to disentangle interest-rate decisions from decisions concerning the scale of its own liquidity operations in order to remain resilient to large-scale liquidity shocks,” he said.
However, “there are drawbacks as well,” Coeure said. It would “require banks to be willing to hold reserves in excess of their needs,” which “is difficult to ensure” in a situation without financial stress.
Furthermore, “a system of permanent excess liquidity could potentially distort signals of liquidity and credit risk in the money market, as money-market activity could be compressed -- or suppressed altogether,” he said.
The ECB yesterday extended its policy of lending banks as much as they want by a year to mid-2014. Policy makers previously announced six-month extensions.
Coeure also said there could be “merits” in providing longer-term loans to match “the more structural long-term trends in the autonomous liquidity factors, most notably the growth in currency in circulation.”
“Expanding the range of maturities following the exit would probably go hand-in-hand with the decision to return to competitive auctions,” Coeure said. “But such a steady state framework would be nevertheless more robust to renewed bouts of perceived funding risk in the market.”
Coeure said the ECB’s monetary-policy stance “will remain accommodative for as long as needed,” echoing Draghi’s comments. While the “exit from non-conventional policies will come one day,” a “sound financial system is a necessary condition,” he said.
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