MNI: ECB Taking Risks With Framework Review-Papadia, Demertzis

Plans to announce proposed changes to the European Central Bank’s operational framework long before their likely implementation are risky and unnecessary, the ECB’s former Head of Markets Francesco Papadia and former Dutch National Bank official Maria Demertzis told MNI.

With the ECB now set to announce the results of its operational framework review on March 13, it risks exposing its conclusions to scrutiny, prompting “a revision of the review, with a reputation loss for the ECB.” Alternatively, it could decide to play it safe and present only “vague conclusions, just to be adaptable to different future developments,” but this would be of limited utility, Papadia and Demertziz, now colleagues at Brussels think tank Bruegel, said in a joint email.

The framework review will determine whether the ECB shifts its current de facto floor system of interest rates, in which the overnight deposit rate is the main instrument for influencing short-term money market rates, to a corridor system between a floor set by a tiered deposit rate for banks’ reserves and a ceiling marked by the rate on fixed allotment repo operations. But its conclusions are unlikely to be applied before the excess liquidity accumulated during the period of unconventional monetary policy begins to subside, a process which could take three year or more. (See MNI SOURCES: New ECB Framework To Maintain Continuity)

If the ECB had to take a decision now on its future framework, then a hybrid approach between active and passive liquidity management would be preferable, Papadia and Demertziz said.

This should include a permanent portfolio of government and private securities held for monetary policy purposes, with some indication about its desirable size, long maturities for repo operations, fixed-rate full allotment auctions and a narrow corridor between ECB lending and borrowing facilities, they said.

Non-banks, currently unable to use the ECB’s facilities directly, should also be granted some access to lending and/or depositing facilities, the pair said.

“Such an approach would not represent a dramatic change with respect to the current set-up, except the granting of access to non-banks,” they said.

QE, QT

Quantitative easing in the wake of the global financial crisis had little impact on inflation, while quantitative tightening in recent years has similarly has “little to no impact” on monetary policy, they said, though they added that this may have owed something to the willingness of non-banks to take up the securities being sold by central banks.

“This means that the ECB can achieve the desired monetary policy stance just by changing interest rates while, at the same time, proceeding gradually with reducing its balance sheet,” Papadia and Demertzis said.

However, should this change, there may be a need for a rethink, they added.

“ECB counterparties don’t need now more precise information on the normalisation of the central bank balance sheet other than knowing that it will be very gradual, possibly consistent with the path implicit in market expectations.”

But the latest ECB survey of monetary analysts , published on Monday, still suggests that the point in time when the bank will need to choose between providing abundant or just sufficient liquidity remains in the future.