MFS - Lesson 4 - 28 September 2022

Monetary
and Financial Statistics
LESSON #4
Monetary and Financial Statistics
Postgraduate Program in Statistical Systems 2022|2023
Lesson 4: 28 September 2022
A brief incursion into monetary policy
1. Money and inflation
a. What is inflation?
b. Why does inflation matters?
2. Defining monetary policy
3. The monetary policy toolbox
a. Standard measures
b. Non‐standard measures
c. The response to the pandemic
Postgraduate Program in Statistical Systems, 2022|2023 2
Money and inflation
MFS aims to serve monetary policy
 MFS are an indispensable input for central banks to formulate their

monetary policy decisions
 As explained in lesson #1, the development of the statistical function in
central banks was triggered by the need for timely data and the autonomy
that central banks should have to produce this information, with a view to
feeding monetary analysis
 Thus, given that the main objective of MFS is to serve monetary policy,
we will make a brief incursion on this topic
Money and inflation
 Money is an integral part of our daily lives

 Money is also at the heart of central banking. Central banks conduct
monetary policy with the aim of maintaining price stability – this means
preserving the value of money by keeping inflation under control
 Inflation is generally linked to increases in the amount of money in the
economy
 In turn, monetary policy, affects the “price” of money in the economy –
i.e. the interest rates on deposits and loans of households and firms
What is inflation? (I)
 Prices of products can change over time, as both supply and demand
change
 A good harvest increases the supply of corn and its price may decrease,
while a bad harvest leads to scarce supply and rising corn prices
 Fashions and consumption trends increase demand for popular brands
and products, which may drive up their prices, while the prices of less
popular products may fall
 As well as supply and demand, the amount of money in circulation also
has an impact on prices
What is inflation? (II)
 The greater the amount of money circulating in the economy, the higher
the risk of wide‐ranging increases in prices. This would change the general
price level in the economy, and that is precisely what inflation is about
 Inflation is the general increase in the overall price level of goods and
services typically bought by citizens (or “households”, to use the
statistical term)
 It is measured as the average price change over a given period of time for
a basket of goods and services that are typically bought in the economy.
In the euro area, it is measured as changes in the HICP compared with the
same period one year earlier (“year‐on‐year” changes)
Inflation: we had already forgotten about it
 Inflation has not been a problem for central banks in the euro area for
many years
 Since November 2021 we have
observed successive monthly
maximums in the value of
inflation in the euro area since
its creation (in January 1999).
Prior to November 2021 the
highest value was registered in
July 2008 (4.1%) Source: Eurostat
Why does inflation matters? (I)
 Inflation affects us all, because increases in the general price level mean
that the value of money decreases
 High inflation is usually bad for people because it erodes their
“purchasing power”, but it is also harmful for the economy as a whole and
can reduce economic activity. Society also suffers because high inflation
can increase inequality. Households with low or fixed incomes are often
hit hardest because they are less likely to safeguard themselves against
inflation
 When there is high inflation and a weak economy (no growth and high
unemployment) we have stagflation
Why does inflation matters? (II)
 But falling prices and “negative” inflation rates are not good either
 The opposite of inflation is deflation, which is a sustained and general fall
in the overall price level. This is just as harmful and costly to the economy
as inflation
 Continuously falling prices create a vicious circle for the economy. If we
expect prices to fall, we tend to postpone today’s purchases to take
advantage of lower prices tomorrow. And if everybody does this, the
economy could grind to a halt. If businesses are not able to sell their
products and services, they may need to lay off staff. When people lose
their jobs, they spend even less
Why does inflation matters? (III)
 Stable prices are therefore best for the economy, and this is why the ECB
and the vast majority of central banks around the world have the task of
maintaining price stability
 However, price stability does not mean that prices do not increase at all.
Rather, it means a positive but low inflation rate, with small, gradual
increases in the general price level
 Price increases should be small enough not to create problems for
people and businesses but large enough to create a sufficient buffer for
the economy against deflation
Why not aiming for an inflation of 0%?
 For instance, in a severe downturn – what experts call a recession –

inflation tends to fall as the economy contracts. And if inflation is already
too low when a recession hits, there is a risk that it will fall below zero
 In addition, positive but low inflation acts as a buffer for small
measurement uncertainties. Hence, by aiming for slightly positive
inflation, central banks have a safety margin against deflation
A few words about monetary policy
Defining monetary policy
What is monetary policy?
 Monetary policy can be defined as the actions a central bank takes to

control the money supply of a country (or economic territory) and the
cost of loans
 Monetary policies are generally categorized as either expansionary or
contractionary
 Expansionary policies are used to accelerate the economy by making
capital easily accessible
 Contractionary policies are used to fight inflation and slow economic
growth when necessary
Inflation target of the ECB’s monetary policy
The Governing Council of the ECB considers that price

stability is best maintained by aiming for 2% inflation
over the medium term
This the current target for inflation after the review of ECB’s monetary
policy strategy that was published on 8 July 2021
Why citizens should care about monetary policy?
 Monetary policy is important for all citizens because its primary objective
is to keep prices stable
 How people expect prices to evolve in the future influences how they
spend, borrow and invest in the present
 Therefore, price stability is important for the decisions we daily take
 If we know that prices will not vary much over time, we can plan and
invest better
 It is therefore crucial that citizens understand the decisions taken by
central banks and what they mean to them
Who takes monetary policy decisions in the euro area?
 In the euro area, the authority responsible for monetary policy is the
Eurosystem, formed by the ECB and the NCBs of the euro area countries
 Decisions are taken by the Governing Council (GovC) which brings
together the Executive Board of the ECB and the Governors of the NCBs
 The meetings take place every 6 weeks (for monetary policy decisions)
and always deliberate taking into account the interests of the euro area as
a whole and not the interests of each country
 It is the NCB that in each country put decisions into practice, which
requires monitoring the effects of monetary policy on the banking system
and on the national economy of the respective countries
Decisions are taken in this room
ECB main building

Frankfurt‐am‐Main
Does monetary policy affect directly prices?
 The central bank decisions do not directly influence prices (only the price
of money to lend to banks)
 Through the various instruments of monetary policy (which we will talk
about next) it tries to influence household and business spending and
thus the prices of goods and services
 When a monetary policy decision is taken it is not expected that this will
have an immediate effect in prices. It can take several quarters before a
decision is fully reflected in prices
The monetary policy toolbox
Primary monetary policy instrument
 The primary monetary policy instrument is the setting of ECB key

interest rates to provide or absorb liquidity to/from banks
 Changes in the official interest rates set by central banks affect the
interest rates charged by commercial banks to lend money to their
clients, thus influencing consumption and investment
Low Credit Inflation
Increase in Higher
becomes increases
interest more
money economic
in the long
rates supply growth
attractive term
High Slows or
Decrease in
Constricts eliminates Inflation
interest credit
money
economic reduces
rates supply
growth
Key ECB interest rates
Currently the key ECB interest rates are the following:

Eurosystem’s lending operations
 Main refinancing operations rate 1.25% to banks once a week
0.0% between 16.03.2016 and 26.07.2022
A kind of “counter” where banks
 Marginal lending facility rate 1.50% can borrow money for a day
 Deposit facility rate 0.75%

Surplus funds that banks deposit
overnight in their central bank
Negative between 11.06.2014 and 26.07.2022
Key ECB interest rates over time
Source: ECB
The rate on the deposit facility and the rate on the marginal lending facility define a floor and a ceiling for the
overnight interest rate at which banks lend to each other. This creates an interest rate corridor for money markets
Something already forgotten happened on the 21st of July
 On 21 July 2022 the ECB’s Governing

Council has raised interest rates for the
first time in 11 years and again on the 8th
of September
 When setting the key interest rates the
ECB does not set directly the interest rates
that a citizen pays on his loan or receive
on his deposit. But it will influence them
 Check the diagram…
Key ECB interest rates vs. banks’ interest rates
The influence of official ECB interest rates on the rates that commercial banks charge/pay
on loans and deposits vis‐à‐vis their customers is very evident in the charts above
What influences the monetary policy decisions? (I)
 Over the long term, inflation and the increase in the amount of money
circulating in the economy should be related
 Central banks therefore monitor growth in money volumes in order to
cross‐check identified risks to price stability
 To this end, the Eurosystem has defined 3 different measures of money –
known as monetary aggregates. These aggregates are derived from the
balance sheet of Monetary Financial Institutions
 Lesson #7 will be entirely dedicated to monetary aggregates. For now,
let's just talk about them without going into much detail
A whiff of monetary aggregates
 Monetary aggregates are defined in terms of the liquidity of the

underlying assets – i.e. how quickly and easily an asset can be converted
into cash or used to make payments
 M1 – The narrowest and most liquid measure of money is M1, which
comprises money used for payments
 M2 – The broader aggregate M2 contains M1 as well as other short‐term
deposits
 M3 – The broadest monetary aggregate is M3. In addition to M1 and M2,
it includes marketable instruments
What influences the monetary policy decisions? (II)
 Analysing developments in monetary aggregates (in particular M3) is an

integral part of the monetary analysis that – alongside analysis of
economic developments – supports the monetary policy decisions of the
ECB’s Governing Council
 Similarly, the analysis of the credit granted by banks to households and
companies can also be useful for monetary policy decisions, since it
provides information on the spending and funding of the private sector
What happens when the interest rates are not effective?
 Before the crisis, the ECB provided a pre‐set amount of credit to banks
through auctions, in which banks put up collateral to guarantee the loans
 Banks would also lend to and borrow from each other in the interbank
market to fulfil their liquidity needs
 Since the financial crisis began in 2007, the ECB has introduced several
non‐standard monetary policy measures which have responded to the
challenges posed by the different phases of the crisis
Non‐standard monetary policy measures (I)
 In the 1st phase of the financial crisis (2007‐2008), the primary aim of the
ECB’s non‐standard measures was to provide liquidity to banks and to
keep financial markets functioning
 As the interbank market dried up in autumn 2008, and banks could no
longer rely on borrowing from each other, the ECB amended its approach
and provided unlimited credit to banks at a fixed interest rate
 The amended approach came to be known as fixed‐rate full allotment.
The maturity of these operations was extended considerably.
Furthermore, the range of eligible assets that could be used as collateral
in refinancing operations was expanded
Non‐standard monetary policy measures (II)
 In the 2nd phase of the crisis (2009‐2010), which took the form of a
sovereign debt crisis, the ECB’s non‐standard measures aimed to address
markets’ malfunctioning and to reduce differences in financing conditions
faced by businesses and households in different euro area countries
 The non‐standard measures taken were the following:
 Purchase of debt securities (Securities Markets Programme – SMP)
 Carried out very long‐term refinancing operations (VLTROs)
 Announced conditional outright monetary transactions (OMT), for
purchasing euro area sovereign bonds in secondary markets, which
enabled to address severe distortions in government bond markets
Non‐standard monetary policy measures (III)
 In the 3rd phase of the crisis (2014→) the ECB’s non‐standard measures
addressed the onset of a credit crunch and the risk of deflation. The ECB’s
measures included:
 Negative interest rate on the deposit facility
 Targeted longer‐term refinancing operations (TLTROs), i.e. long‐term loans to
banks at very favourable rates, on the condition that banks lend this money to
people and businesses
 Asset purchase programmes (APP), involving private and public sector securities,
to put downward pressure on the term structure of interest rates
 Forward guidance, which means communicating how the ECB expects its policy
measures to evolve in the future and what conditions may change it
QE increased the balance sheet of ECB and NCBs
 The APP materialized in a gigantic amount of net purchases of securities

by the Eurosystem
 In July 2022, the amount of
securities in the Eurosystem's
portfolio resulting from the APP
exceeded 3 trillion euros
 As we will see in Lesson #7, APP
led to a huge increase of the
balance sheet of ECB and NCBs
Quantitative easing
How quantitative easing works
The ECB started buying assets from commercial banks in March 2015 as part
of its non‐standard monetary policy measures. Asset purchases, also known
as quantitative easing or QE, are one of the tools that the ECB use to support
economic growth across the euro area and bring inflation to the 2% target
Let's see in a visual way how QE works (source: ECB)
Non‐standard measures in response to the pandemic
 In response to the pandemic the ECB reinforced some non‐standard

monetary policy measures to keep the financial sector liquid and ensure
supportive financing conditions for all sectors in the economy (families,
firms, banks and governments). A few examples of those measures:
 Complemented the APP with €1,850 billion of the so‐called pandemic emergency
purchase programme (PEPP)
 Increased the amount of money that banks can borrow from the Eurosystem
 Expanded the list of assets that banks can use as collateral
 Made less strict the calculation of the value of those assets (known as a “haircut”)
 Made less strict the amount of funds, or “capital”, that banks are required to hold
as a buffer for difficult times
Questions?
Luís Teles Dias
ldias@novaims.unl.pt

MFS - Lesson 4 - 28 September 2022

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

MFS - Lesson 4 - 28 September 2022

Uploaded by

Copyright:

Available Formats

Monetary

 MFS are an indispensable input for central banks to formulate their

 Money is an integral part of our daily lives

 For instance, in a severe downturn – what experts call a recession –

 Monetary policy can be defined as the actions a central bank takes to

The Governing Council of the ECB considers that price

ECB main building

 The primary monetary policy instrument is the setting of ECB key

Currently the key ECB interest rates are the following:

 Deposit facility rate 0.75%

 On 21 July 2022 the ECB’s Governing

 Monetary aggregates are defined in terms of the liquidity of the

 Analysing developments in monetary aggregates (in particular M3) is an

 The APP materialized in a gigantic amount of net purchases of securities

 In response to the pandemic the ECB reinforced some non‐standard

You might also like