Christine Lagarde's era (2019 – )
In July 2019, EU leaders nominated Christine Lagarde to replace Mario Draghi as ECB President. Lagarde resigned from her position as managing director of the International Monetary Fund in July 2019 and formally took over the ECB's presidency on 1 November 2019.
Lagarde immediately signalled a change of style in the ECB's leadership. She embarked the ECB on a strategic review of the ECB's monetary policy strategy, an exercise the ECB had not done for 17 years. As part of this exercise, Lagarde committed the ECB to look into how monetary policy could contribute to address climate change, and promised that "no stone would be left unturned." The ECB president also adopted a change of communication style, in particular in her use of social media to promote gender equality, and by opening dialogue with civil society stakeholders.
The onset of the COVID-19 pandemic precipitated an unprecedented crisis, profoundly impacting global public health, economies, and societal structures on an unparalleled scale. The crisis led to renewed tensions in European sovereign bonds markets, marked by a growing spreads between the interest rates paid by Eurozone member states, which spurred concerns about the Euro area crisis.
On 12 March 2020, the ECB announced a set of policy measures such as an additional package of net asset purchases of €120 billion by the end of 2020 under the already existing APP, and more favorable terms on the TLTRO III. During the press conference, Christine Lagarde declared that the ECB "[...] is not here to close spreads." This particular statement triggered a sudden negative reaction on financial markets, with a widening of yield spreads in Spain, Italy and Greece.
On 19 March 2020—less than one week after Lagarde's unfortunate statements on the spreads—the ECB announced by surprise the launch of the Pandemic Emergency Purchase Programme (PEPP) worth €750 billion to boost liquidity in the European economy and to contain any sharp increases in sovereign yield spreads. This announcement led to an immediate reboot in stock prices and came one day after the spike of sovereign risk spreads.
The PEPP was designed as a typical "quantitative easing" policy, under which the ECB is able to purchase securities from the private and public sector in a flexible manner. The purpose of the PEPP was to stabilize sovereign bonds yields to low and stable levels, thus preventing self-fulfilling panics in financial markets as was the case during the Euro area crisis.
The PEPP was established as a separate purchase programme alongside the pre-existing Asset Purchase Programme (APP) with the sole purpose to respond to the economic and financial consequences of the COVID-19 crisis, and in particular prevent market fragmentations. While very similar, contrary to the APP, the ECB decided to allow itself to deviate from the capital key. This temporal flexibility from the capital key meant that the ECB could more effectively prevent the rise of Italian and Spanish yield spreads.
Assets meeting the eligibility criteria of the APP were also eligible under the PEPP. However, the pool of assets eligible under the PEPP was broader than the usual ECB collateral eligibility framework. For instance, Greek sovereign bonds could be purchased by the ECB under this programme, despite having a credit ratings below the usual investment grade requirement. This waiver was given based on several considerations from the ECB: there was a need to alleviate the pressures stemming from the pandemic on the Greek financial markets; Greece was already and would be closely monitored by giving the waiver; and Greece regained market access. Non-financial commercial paper with a remaining maturity of at least 28 days were also eligible for purchase under the PEPP.
On 4 June 2020, the ECB announced it would expand the PEPP by another €600 billion, as it became clear that the pandemic would continue to harm European economies. Half a year later, on 10 December 2020, the ECB announced its final expansion of the PEPP worth another €500 billion, totalling the final PEPP to €1.850 trillion, corresponding to 15.4% of the euro-area GDP of 2019.
In December 2021, the ECB announced that it would discontinue net purchases under the PEPP as from the end of March 2022 and that it intended to reinvest the principal payments from maturing securities at least until the end of 2024.
On 31 March 2022, at the end of the net purchases, the net purchases amounted to €1.718 billion, of which €1.665 billion is invested in public sector securities and €52 billion in private sector securities. Of the total €1.850 billion available under the PEPP, 93% of the full envelope wase used, due to indications of decreased financial stress in the Euro Area, mainly thanks to relaxation of COVID restrictions and the reopening of European markets.
Overall, the PEPP programme was widely welcomed by market participants and European policy makers. However in March 2021, a group of German economists and lawyers filed a lawsuit against the PEPP at the German Federal Constitutional Court.
On 30 April 2020, the ECB Governing council introduced additional measures to support the economy during the COVID-19 pandemic, including PELTROs and new modalities for the TLTROs.
First, the ECB made several adjustments to the framework of its TLTRO III. A key change was that the ECB also reduced the interest rate applied to these open market operations to a rate going as low as −1% for the banks meeting the lending threshold of 0%. With the TLTRO III, the participating banks were thus enabled to borrow at lower interest rates than those paid on their excess reserve. Another key change was thet ECB's decision to expand bank's borrowing allowance under TLTRO III from 30% to 50%, then up to 55% of their portfolio of loans to firms and households.
Second, the ECB introduced pandemic emergency long-term refinancing operations (PELTROs). The market operations are similar to the TLTRO III, but are conduced in a more frequent basis in order to ensure smooth liquidity provision to the market.
During the pandemic, these monetary responses proved essential. In their absence, a credit crunch would normally have taken place. Indeed, increase in demand traditionally translates in a rise of borrowing costs. Reports from various member states central banks on the matter indicate that loans supply by participating banks has indeed expanded, in line with the ECB policy. Accordingly, thorough academic studies have confirmed the actual enhancement of financing conditions and the avoidance of credit scarcity. In fact, the credit to firms attained unprecedented levels when from March to May 2020, it increased by €250 billion on aggregate. Furthermore, analysts observed that even non-participating banks (to the TLTROs and PELTROs) benefited from it in parallel manners.
The Transmission Protection Instrument (TPI) is a tool the ECB could use to ensure monetary policy decisions are smoothly transmitted across all euro area countries, introduced on 21 July 2022. Under the TPI, the ECB would be able to purchase securities in the secondary market, to counter against "unwanted, disorderly market dynamics", self fulfilling crises market expectations that do not reflect reality, thus not justified by "country specific fundamentals." The TPI thus enables the ECB to control the difference between borrowing costs across the euro area, thereby reducing fragmentation risk across the euro area. By not letting interfere market dynamics that do not reflect economic reality, the ECB fulfils its secondary mandate under the TFEU, namely "to support the general economic policies of the Union." Although PEPP would remain the first line of defence to counter for transmission risks, the TPI should be seen as an addition to the ECB's toolkit.
Contrary to the PEPP and the APP, the TPI does not have an ex ante upper limit on the purchase of securities. Although the ECB has stated it would primarily buy only government bonds on the secondary market maturing between 1 and 10 years, the bonds purchased fall under the complete discretion of the ECB and does not necessarily follow the capital key, and private securities could be considered as well. However, there are four conditions that need to be met before securities are eligible for purchasing under TPI:
Compliance with the fiscal framework of the EU and not be involved in the excessive deficit procedure;
Absence of macroeconomic imbalances and not being involved in an excessive macroeconomic imbalance procedure, demonstrating that it is in compliance with the commission's recommendations;
Sovereign debt trajectory must be sustainable, assessed by the ECB and other relevant bodies;
Stick to commitments made under the Recovery and Resilience Facility, proving that the government follows sound and sustainable macroeconomic policies.
The conditions for government bonds to be eligible under the TPI draw heavily on the macroeconomic governance, and making sure that politicians do not take decisions that facilitate speculation. The decision by the ECB to support a country by using the TPI will depend on the severity of the risks a country faces. Government debt should thus be sustainable to be eligible for TPI purchases.
If the aforementioned conditions are met, the ECB could decide to activate the TPI. Purchases will be ended under the TPI either due to increased transmission of monetary policy or the risks have proven to be country-specific. So far, the TPI has not been deployed yet.
The TPI enables the Governing Council to a more rapid increase in interest rate, the first raise in interest rates by the ECB in 11 years. and the unpredictable nature of market sentiment could justify the reason for ECB-intervention to stabilise the monetary union, more or less the same reasoning as for the PEPP.
However, the relationship between the PEPP and the TPI raises questions as the PEPP would remain the first line of defence against transmission risks. The creation of the TPI seems legally vulnerably: problems in the Euro Area are common and recurring, but it is not automatically the argument to invent a whole new anti-fragmentation tool. With the TPI, the ECB can put pressure on countries by assessing publicly if they are eligible for the TPI, that is assessing whether the government has conducted adequate fiscal policies and structural reforms to deserve the support of the ECB. This endangers the politic neutrality of the ECB. If ever deployed, the usage of the TPI will spark controversy as the conditions to be deployed are not watertight.
As a consequence of the COVID-19 crisis, the ECB extended the duration of the strategy review until September 2021. On 13 July 2021, the ECB presented the outcomes of the strategy review, with the main following announcements:
The ECB announced a new inflation target of 2% instead of its "close but below two per cent" inflation target. The ECB also made it clear it could overshoot its target under certain circumstances.
The ECB announced it would try to incorporate the cost of housing (imputed rents) into its inflation measurement
The ECB announced an action plan on climate change
The ECB also said it would carry out another strategy review in 2025.
