An ECB Board Member Gave A Very Important Speech About What They Might Do Next

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A man uses his mobile phone to take a picture of the euro sculpture outside the head quarters of the European Central Bank (ECB) in Frankfurt, November 5, 2013. The ECB council will on Thursday and will decide whether they change the interest rates or not. REUTERS/Kai Pfaffenbach

Almost every month, prior to the ECB monetary policy meetings, people play the guessing game of whether the ECB will do more easing in some manner.

And every month the answer seems to be no.

But there are good reasons why the ECB might want to engage in further monetary stimulus: The economies in the Eurozone remain quite weak, some countries are in outright deflation, and the Euro is uncomfortably high, which makes exports expensive.

So the waiting game for more action continues.

And this weekend in Washington DC, ECB executive board member Benoît Cœuré gave a speech outlining what the ECB might do: The key idea is that the ECB might engage in its own QE program if conditions warrant.

Thank you very much for inviting me to open this session on whether central banks should continue to target longer-term bond yields in normal times. My first instinct when presented with this question was to provide a rhetorical answer and say that to continue targeting long-term bond yields one has first to have started doing it. And indeed, the ECB has so far only intervened in long-term bond markets, such as the covered bond market, to restore monetary policy transmission in malfunctioning market segments and help enforcing a given monetary policy stance. We have not so far resorted to a policy of targeted asset purchases that aim to alter the monetary policy stance — what is universally, if in my view inaccurately, referred to as quantitative easing. On second thoughts, however, this would be the wrong way to reply.

It would not only be wrong because we have recently made clear that asset purchases are an instrument that we are ready to use if we deem necessary. It would also be the wrong answer because the question of whether central banks should target longer-term bond yields provides a good focal point to reflect on what monetary policy is trying to achieve in the first place. In other words, instruments are just the tail that wags the dog.

As for what specifically the ECB might do on the asset purchase front, he says (see the bolded part at the bottom) that asset purchases could be done at the longer-part of the curve.

First, at its meeting last week the Governing Council confirmed our baseline scenario — that is, a prolonged period of low inflation followed by a gradual rise in inflation rates towards 2%. Further monetary easing is therefore not excluded, but remains contingent on outcomes. Second, if such easing is called for, the Governing Council is unanimous in its commitment to use also unconventional instruments within its mandate. The question we face is whether asset purchases would be the appropriate unconventional measure . And if we deem that asset purchases would be appropriate, the question then becomes how we could implement such a policy in way that is useful and that complies with our mandate.

This means, among other things, ensuring that any such purchases comply with the Treaty, keeping in mind that Article 18 of the ESCB Statute allows the ECB and national central banks to operate in the financial markets by buying and selling outright claims and marketable instruments. It also means guarding against operations that unduly distort market allocations or worse, that would have intended distributive effects. And it means designing a programme that is effective given the financial structure of the euro area — where, for instance, bank-based intermediation is pre-dominant and wealth effects through equity and real estate prices are less important transmission channels than, say, in the US. These considerations in turn imply thinking in terms of the three forms of interest rate differentiation that I described above.

First, vertical differentiation — the relevant maturities at which asset purchases should take place. In practice, purchases would naturally be linked to the interest rate maturities that are most important for firms’ and households’ investment and consumption decisions. In the euro area, this tends to be the intermediate to longer part of the yield curve.

Read the full speech here.

Not surprisingly, the Euro is slipping on the new, as it seems that ECB action might come sooner.