The ECB’s primary objective is price stability, defined as an annual inflation rate close or below 2% over the medium term. To this end, the ECB uses interest rates and, since the 2008 crisis, other non-standard measures to affect financing conditions in the eurozone economy.

In the years following the sovereign debt crisis, the three key policy rates (deposit, refinancing, and marginal interest rates) were gradually lowered to zero, and even to negative levels. Initially lowered from 0% to -0.1% in June 2014, the deposit rate has been further reduced to -0.5% in September 2019. The interest-rate policy was complemented by a range of non-conventional instruments since 2014, which aims to stimulate lending activity by creating favorable financing conditions, and in turn boost inflation that has remained below the 2%-target. These instruments include the targeted longer-term refinancing operations (TLTROs) that provides financing to credit institutions.

Another non-conventional instrument has been the Quantitative Easing (QE) through which the ECB purchases debt securities on the bond market. In March 2015, the ECB launched an Asset Purchase Program (APP), targeting public and corporate securities. Net securities purchases averaged €60bn per month between 2015 and 2018. After a brief pause decided in late 2018, the program resumed in September 2019, at a monthly pace of €30bn. From March 2015 to February 2020, €2.7tr of securities have been purchased by the ECB under this program.

In response to the Covid crisis in March 2020, the ECB launched the Emergency Pandemic Purchase Program (PEPP) that had an initial envelope of €750bn which gradually increased to €1850bn. The PEPP was complemented by other policy measures, including the extra purchases of €120bn under the APP, and several waves of long-term refinancing operations, providing financing to credit institutions for periods of up to four years. These measures led the Eurosystem’s balance sheet to reach a record-high of €8.82tr in May 2022, up from €4.7tr in February 2020, before the crisis began.

The return of inflation since the 2021 spring has forced the ECB to gradually adjust its monetary policy. The first reaction occurred in December 2021, when the Governing Council announced the discontinuation of net purchases under the PEPP from March 2022, although it plans to reinvest the principal payments from maturing securities purchased under the program “until at least the end of 2024”. After ending net purchases under the APP in June 2022, the Governing Council decided to raise the three key ECB interest rates by 50 basis points (bps) – the first hike since July 2011 -, putting an end to its negative interest rate policy in place since 2014. As inflation continued to increase and peaked at 10.6% in October 2022, several other rate hikes followed, bringing the refinancing rate to 4.5% as of September 2023.

This 450-bps policy rate increase so far has been complemented by several measures to reduce the size of the Eurosystem’s balance sheet, as part of the Quantitative Tightening (QT). A first measure has been to allow early repayments from the LTROs from October 2022. As of September 2023, European banks have repaid close to € 1.7 tr borrowed from the ECB, out of € 2.2 tr borrowed from the ECB via LTROs.

Additionally, the Governing Council has started reducing its asset holdings. From the beginning of March 2023 to the end of June 2023, the APP portfolio declined by € 15 bn per month on average, as the Eurosystem did not reinvest all the principal payments from maturing securities. Since July 2023, it decided to stop reinvesting redemptions under APP. This decision has led to reduce security holdings by €25 bn per month on average.

These measures have contributed to reducing the size of the Eurosystem’s balance sheet. As of September 2023, total assets amounted to €7.07tr, down from their peak of €8.82 tr in May 2022. However, this reduction is still insufficient to absorb the “excess liquidity” circulating in eurozone banks. The latter are defined as capital reserves held by banks or financial institutions above amounts required by regulators. Estimated at around €3.7 tr in September 2023, such excess reserves are challenging the effective transmission of the ECB monetary policy, raising questions about the appropriate pace of balance sheet reduction.

The Eurofi papers presented below detail the positive and negative aspects of the ECB monetary policy, before the COVID-19 crisis, and in the context of high inflation since 2021.