EIB calculations.
Note: Last record, October 2020.
Figure 16
EU Harmonised Index of consumer prices and dispersion (annual rate, %, and interquartile quartile range, in percentage points)
Source: Eurostat and EIB calculations.
Note: Last record September 2020.
Major central banks entered the crisis with little leeway for lowering short-term policy rates. Figure 17 plots the interbank money market rates for the three major advanced economies. While the US Federal Reserve had embarked on tightening its monetary policy, the ECB and Bank of Japan were already deploying negative short-term rates close to the effective zero lower bound. Consequently, only the United States had some latitude to use standard monetary policy to support the economy. From February 2020 until October 2020, the effective federal funds rate decreased by 150 basis points in the United States.
Long-term rates also were already low prior to the crisis. Several structural drivers were already fuelling the downward trend in long-term interest rates (Figure 18). While monetary policy can be a contributor, demographic changes are a major cause. As the populations in advanced economies age, the balance between the various age groups in these populations shifts, affecting the overall supply of savings. Middle-aged individuals tend to save and provide funds to the rest of the economy, while the young and the old tend to spend more than their disposable income and demand funds. As a result, the real interest rate that balances the overall supply of savings with the demand for investment is affected by the relative size of these age groups (del Negro et al., 2018).
Long-term rates are most likely to remain low for longer, and might even drop further. While the rapid and unprecedented collapse of production, trade and employment may be reversed when the pandemic eases, historical data suggest that long-term economic consequences could persist (Jordà et al., 2020). Among these are a prolonged period of depressed real interest rates – akin to secular stagnation – that may linger for a long time. Chudik et al. (2020) estimate that the pandemic will likely drive long-term interest rates in the advanced economies about 100 basis points lower than their pre-COVID-19 lows over the next few years. This is because the crisis raises precautionary savings and dampens investment demand.
Figure 17
Short-term interest rates in selected advanced economies (% per year)
Source: Refinitv and EIB calculations.
Note: Last record October 2020.
Figure 18
Long-term interest rates in selected advanced economies (% per year)
Source: Refinitiv.
Note: Last record November 2020.
With increasing capital inflows and an appreciating exchange rate, Europe is perceived as resilient. Figure 19 plots net portfolio inflows in the euro area and the euro effective exchange rate. Since the start of the crisis, both have clearly been on a positive trend. From February 2020 until October 2020, the effective exchange rate of the euro, the exchange rate against a basket of currencies, increased by 7%. The stronger exchange rate partly reflected the trend in cumulative annual capital flows, which increased by more than 2% of GDP over the same period, with a shift from net outflows to net inflows. These developments suggest that during the crisis, the European Union’s performance, which was partly the result of the policy response, was perceived as credible and reassuring by international investors. Over the same period, the European Commission issued the first tranche of bonds to finance the SURE instrument (Support to Mitigate Unemployment Risks in an Emergency) and the recovery plan. The issuance was a major success, and was largely oversubscribed. This bodes well for the future of these bonds as a potential safe asset for investors, and also for the financing of the green transition.
A central bank with two arms
For the first time, the ECB acted both on monetary policy and on financial prudential policy. To ensure financial prudency, macro and micro policy measures were deployed. Following the global financial crisis, the ECB became in charge of the micro-supervision of euro area banks while the European Systemic Risk Board (ESRB) was created to coordinate macro-prudential policies across Europe. The COVID-19 crisis provided the first opportunity to coordinate these two types of policy intervention at the European level.
Figure 19
Net portfolio inflows and euro exchange rate (% GDP and index, 100=1999Q1)
Source: ECB and EIB calculations.
Note: Last record November 2020. An increase reflects an appreciation. Net portfolio inflows are reported using a 12-month moving average.
Figure 20
ECB lending to euro area credit institutions (in billions of euros)
Source: EIB Economics Department calculations based on IMF WEO.
Note: Last record 2019.
On the monetary policy side, the ECB deployed several measures to support banks’ liquidity. At the onset of the crisis, new non-targeted, longer-term refinancing operations were launched, the interest rates in targeted longer-term refinancing operations were lowered and collateral measures were eased (for a comprehensive presentation, see Lane, 2020). In June 2020, 742 European banks tapped the ECB’s TLTRO III for EUR 1.3 trillion. The multiyear loans are offered to banks at interest rates below the ECB’s main deposit rate, sometimes as low as minus 1% if certain conditions were met.[8] In net terms, after adjusting for the repayment of maturing loans, the June operation provided a liquidity injection of EUR 158 billion. From the start of the crisis until September 2020, liquidity injections for banks in the euro area almost tripled, increasing by almost EUR 1.2 trillion (Figure 20). The ECB also decided on a new series of non-targeted pandemic emergency longer-term refinancing operations (PELTROs) to support liquidity in the euro-area financial system and to help preserve the smooth functioning of money markets by providing an effective liquidity backstop.
The ECB also strengthened its asset purchase programme. At the beginning of the crisis, the ECB increased its asset purchase programmes by EUR 870 billion (more than 7% of the euro area’s 2019 GDP) until end-2020. The Pandemic Emergency Purchase Programme (PEPP), a new programme with an envelope of EUR 750 billion, was created, with eased conditions for eligibility. In June
