For reasons discussed previously, this post presents and briefly discusses a number of variables pertaining to the activity of the ECB from its inception until now. Particular focus is put on the more recent events of the last quarter and a brief comparison is made with the state of affairs when last I considered any of these variables.
The post is divided in 4 parts:
- First, I consider the ECB’s most orthodox policy tools, the policy rates.
- Secondly, I review the structure of the ECB’s balance sheet.
- This is then followed by a more indepth consideration of the elements pertaining to different forms of direct financial market intervention,
- Lastly, I provide a brief review of the recent developments in Target2 balances.
Following these considerations, I conclude that
- The negative deposit rates introduced recently are probably not triggering the flow of cash onto the economy that was desired.
- Today, the main driver of the balance sheet on the asset side are the government bonds purchased to relief financial pressure, which replaced the long-term borrowing.
- The ELA provided to Greece is quite visible on the assets of the ECB.
- The main liability counterpart to these bond purchases are cash created, bank deposits and revaluation. This means that the ECB is creating money that is not finding its way into the real economy. So inflation fears seem misplaced.
- There is still a lot of scope for ECB intervention in troubled countries. Greece is altogether absent from the PSPP. Portugal represents a very small fraction of the PSPP. The OMT as not been triggered.
- The election of the present Greek government had a clear effect on Target2 balances, but one that is not particularly large overall.
It is my opinion that within the scope of what it can do, the ECB is already doing plenty. It sure can do more and with a clear mandate it could and would do so. But the mandate is necessary and getting it will take a very big crisis.
Policy Rates: The Deposit Facility Goes Negative
The last change to the ECB’s policy rates took place on September 10th 2014, when it decided to lower the Deposit Facility from -0.1% to -0.2%, the MRO from 0.15% to 0.5% and the Marginal Lending Facility to 0.3% from 0.4%.
Although the Keynesian logic for a low lending (by the ECB) rate is fairly well established at this point, the logic for a negative borrowing (by the ECB) rate (the Deposit Facility) is simple and fairly mechanic even if at the time it was very controversial. If financial markets (money markets in macro jargon) are intermediated by commercial banks, then the supply of cash is only vertical, in the Keynesian way, for financial operators. For consumers in the real economy, the supply of money might very well become upwards slopping and some of the central bank policy may be “lost in transmission”, so that an increase in the central bank’s balance sheet may not necessarily lead to an increase in base money (M0). This is particularly true in times when banks are attempting to consolidate and reorganise their balance sheets because of some financial crisis.
By lowering the interest rate at which banks lend to the monetary policy authority (the deposit facility), the central bank undermines the banks’ cash hoarding motivation that balance sheet consolidations create, by making it less profitable for them to park their cash with it. In principle this means that the banks will then put their money elsewhere, hopefully in the interbank market or lending it to the real economy. Whether the assumption is correct or not can be easily observed.
From the figure above and given a correlation coefficient of -0.39 and a R square of 15%, I would surmise that more is amiss than can be fixed by deposit rates. The next sections, particularly the latter two will make this plain.
Structure of ECB Balance Sheet
I last discussed the composition of the ECB’s balance sheet at the beginning of February 2012. Since then there were some important changes to the ECB’s balance sheet.
On the asset side, the most important issues are the growths experienced by the accounts of “Securities held for monetary policy purposes” and the “Longer-term Refinancing Operations” (LTRO). Starting in 2012, the latter experienced a 2-front boom of enormous proportions starting with the 36-month LTRO announced on December 8th 2011 and pushing the ECB’s balance sheet to its historical high of over EUR3tn at its peak in 2013W26. From that stage onwards, the support provided by that programme was subsequently maintained in the weaker form of the Target LTROs (LTRO) announced on June 5th 2014. One of the problem of the LTROs (in whatever form they are) is that because they are loans to banks, they only offer temporary relief, not a permanent solution. They provide liquidity to banks, but not an exit out of toxic assets. More importantly, whatever is borrowed must be repaid back (even if only very much later), so not a whole lot can be done with the cash.
Having failed to provide the stimulus needed, the ECB then moved on to outright asset purchasing (not to be confused with the OMT, which has so far not been used) programmes covered by the account “Securities held for monetary policy purposes”. Starting in 2015, these began expanding increasingly fast with the addition of another three new programmes. For now suffice it to say that this expansion caused the holdings under the account, which were worth EUR587.519bn in the last week of 2014 (only slightly more than the EUR582.132bn of the last week of 2012 or the EUR586.050bn of the last week of 2013) to expand to EUR816.872bn in week 24 of 2015.
In comparison to the state of affairs in week 4 of 2012, the main asset categories remained fairly unchanged. The main expansion appears to be in the “Securities of euro area residents denominated in euro”, which comprises “Securities held for monetary policy purposes” and “Other securities”. “Securities held for monetary policy purposes” is where all QE programmes go into, so it matters. The next section will look into this in more detail. For now suffice it to say that the overall “Securities of euro area residents denominated in euro” account went from 23% of the ECB’s balance sheet to 33%. “Claims on non-euro area residents denominated in foreign currency” has become slightly more important, while “LTRO” and “Other assets” became a little bit less relevant (from 25% to 16% and from 13.1% to 9.4%, respectively).
One last ECB account that is relevant in the present Greek crisis is “Other claims on euro area credit institutions denominated in euro” which also contains the Emergency Liquidity Assistance (ELA) that the ECB provides the financial sector of a country that struggles to find assets to use as repo of a quality usually acceptable to the ECB in its main refinancing operations. ELA is effectively the means through which banks can still borrow from the ECB even if their balance sheet is filled up with assets that aren’t really worth as much as they should be. As we can see, the 5.45% of the ECB’s balance sheet it is now worth is a recent development, consistent with the account’s tendency to expand in times of crisis. In the latest case, the crisis is Greece and the increase is motivated by Greek bank’s needs to have the cash on hand to provide depositors with the cash they need to fulfil the bank-run and the capital flight that are happening.
The liability counterpart of this narrative has been mainly two-fold. On the one hand, it has been clearly accompanied by a steady rise in the amount of “banknotes in circulation”. Although it still faced jumps on 2007Week52, 2014Week5 and on 2014week15 and 2015Week5. As a result, this account went from being responsible for 30% of the balance sheet in 2012Week51 to 42% on week 24 of 2o15.
Other liabilities that also seem to matter are the Deposits and Current Accounts held by financial institutions with the ECB. These seem to have been the destination of the funds provided by the successive waves of LTROs, and probably account for the failure of these interventions to revive the Euro-Zone economy. Lastly, it is important to notice that the LTROs interventions as well as the more recent QE also coincide with a strong positive revaluation accounts, which accounts for
“unrealised gains related to price movements, foreign exchange rate movements and market valuation differences related to interest rate risk derivatives are disclosed. This item also includes the unrealised gains of euro area NCBs that have arisen due to the change from national accounting rules to harmonised accounting rules for the Eurosystem.“
Basically, the interventions of the ECB seem to cause its assets to gain value.
Securities Held for Monetary Policy Purposes
Having slowly emptied its conventional key rates options in the pursuit of its monetary policy the ECB as been actively pursuing different versions of unorthodox quantitative interventions. The first three of these were the first and second Covered Bond Purchasing Programme (CBPP1 and CBPP2) and the Securities Market Programme (SMP). Beyond these old programmes, the ECB initiated a 3rd iteration of CBPP (CBPP3) as well as an Asset Backed Securities Purchasing Programme (ABSPP) on September 4th 2014 (with further details on October 2nd 2014) and the Public Sector Purchasing Programme (PSPP), announced on January 22nd 2015 and coming into effect on March 9th 2015.
The 2 figures immediately below illustrate the net purchases (purchases net of redemptions and or sales) conducted through these programmes and the subsequent stock of assets held under each intervention account. The first figure shows how dominant the SMP and PSPP were.
Historically, the top asset purchase plans were the SMP and CBPP1, until the last six months quickly saw CBPP3 and the PSPP quickly outpace the other programmes.
The Old Programmes: SMP, CBPP1 & CBPP2
The ECB’s original intervention was carried out under the SMP the CBPP1 and the CBPP2. All of these programmes encountered some qualitative success but quantitatively struggled to stem the collapse of financial markets and/or the fall of inflation consistent with a contraction of aggregate demand. As a result most of these programmes were stopped in 2012, in favour of the OMT.
The New Programmes: PSPP, ABSPP & CBPP3
The main addition to the ECB’s less orthodox QE intervention tools is the PSPP, which totals between EUR9.8bn and EUR16.6bn per week for a total of EUR170.2bn since its inception in March 2015.
Fortunately, the ECB is fairly transparent about its holdings of these assets and discriminates them nicely in its website for everyone to see. As can be seen from the image below, Germany, France Italy and Spain have been the main benefactors of these ECB asset purchases. Portugal comes in at a distant 9th place. Also interesting, because of its absence, is Greece. Finally, there seems to be a focus on medium to long term bonds of 6yr to 12yr maturity on the part of the ECB.
In comparison to the PSPP, the ABSPP and the CBPP3 are considerably smaller. If nothing else, this is probably due to the smaller scale of these markets.
Unfortunately, a breakdown of holdings by nationality of origin is not available for the latter two of the most recent programmes, in a manner similar to what is done for the PSPP.
With regards to the intra-Eurosystem net creditors and debtors, the main developments since I last considered this issue at the end of 2012 is the large decrease of Bundesbank credit provided in 2013 and 2014, which started increasing again since the beginning of 2015. The decrease coincided with the aftermath of the OMT stabilization, whilst the recent increase is motivated by the Greek crisis, as can be attested by the worsening of the Bank of Greece’s debtors position to the rest of system. This is consistent with the remarks about ELA made previously.
A Concluding Remark
On the eve of what may be one of the most damaging economic and financial crisis Europe has ever faced, the ECB has endowed itself with the necessary tools to shield its remaining members from the speculative onslaught that may soon befall them. Whether it is through the existing PSPP or by triggering OMT, the fallout from Greece is now perfectly within the scope of management of the ECB. As others have noted, and regardless of whether it is right or wrong, this is why Greece can’t play hard ball and the Greek Finance minister ought to know better than do as much, whether he is right or not.