Monetary Policy

In July 2019, the US Federal Reserve (Fed) lowered its interest rates to a range of 2.00 to 2.25 percent for the first time since December 2008. The ECB’s corresponding key interest rate (main refinancing rate) has been 0.00 percent since March 2016. In addition to this interest rate policy instrument, both central banks have relied on quantitative easing (QE) as an instrument of unconventional monetary policy since the financial crisis (Fed: 2008–2014; ECB since 2015). 

Fed on the Verge of a New Expansive Monetary Policy

While the ECB has kept the volume of securities under its bond program constant since December 2018, the Fed announced in July 2019 that it would end the curtailment of its QE program. The funds from maturing securities will then be reinvested in new assets, as the ECB is currently doing. If the Fed returns to a course of expansionary monetary policy in the medium term, it will have to start worrying about its credibility: the decisions it makes are in the crosshairs of hasty US policymaking. The more insistently Donald Trump lobbies Fed chief Jerome Powell, the more difficult it gets to justify further rate cuts on the basis of its mandate, which is to use its monetary policy resources to supplement fiscal policy and promote economic growth. However, it must not lose sight of its objectives, namely a maximum employment rate, stable prices, and moderate long-term interest rates.

Maintaining the Credibility of Central Banks

Christine Lagarde will take over as President of the ECB in November 2019, and already she, too, is confronted with ever louder calls for a continuation or even an intensification of expansive monetary policy. She acknowledges that these economic and political voices might undermine the independence of the ECB, and so she has already indicated in advance of assuming her post that the ECB will follow a new communication strategy. In contrast to the Fed, the ECB’s primary objective is price stability. As long as this is not jeopardized, the ECB is permitted to support European countries’ fiscal policy efforts to achieve balanced economic growth.

Does the ECB Also Pursue Fiscal Policy?

Compared to the Fed, the ECB faces an uphill struggle simply because it must contend with 19 euro area countries, all with different fiscal and economic growth positions. As part of its research activities, the ifo Institute also investigates the socio-political implications of the ECB’s monetary policy. For example, in their study of Target2 balances in the European System of Central Banks, ifo researcher Timo Wollmershäuser and his co-authors found that recession was mitigated by the fact that different European crisis countries took different approaches to using the opportunity to build up Target2 balances. 

The Future Role of the ECB

The activities of the ECB will continue to shape the common development of the European Union. As part of its summer and winter economic forecasts, the ifo Institute also analyzes current developments in European monetary policy. For example, the summer 2019 forecast already stated that outgoing ECB President Mario Draghi had set the initial course for his successor. The first increase in the key interest rate since July 2011 has already been postponed further into the future. The ifo forecasting team expects the ECB not to initiate a turnaround on interest rates until 2021. Until then, the newly announced refinancing transactions should avert liquidity bottlenecks at individual banks. This means the ECB will continue to play the role of a financial intermediary that protects troubled credit institutions from potentially expensive refinancing on the interbank money market.