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Our monetary policy instruments and the strategy review

To help keep prices stable, we need the right tools at hand. That is why we have introduced new monetary policy instruments in recent years. While these have been successful in helping to maintain price stability, and will remain part of our toolbox, we are keeping an eye out for any undesired side effects.

Why were our monetary policy instruments part of the strategy review?

We use our instruments to help keep prices stable

Our job is to keep prices stable. This means making sure that inflation – the rate at which the prices for goods and services change over time – remains low, stable and predictable.

To succeed, we seek to influence the “temperature” of the economy, making sure the conditions are just right. Not too hot, and not too cold. With the help of our monetary policy instruments, and mainly via the financial system, we influence the “financing conditions” of people, businesses and governments in the euro area.

For instance, by adjusting its interest rates the ECB can influence how expensive it is for people to borrow money. Think of shop owners who want a bank loan to grow their businesses, or people who want a mortgage to buy a house. By influencing how much it costs to borrow money, our monetary policy has an impact on how much we – as consumers or owners of businesses – spend and invest. This, in turn, affects how much things cost. So, by changing interest rates, we can influence prices and inflation.

Why did the ECB introduce new monetary policy instruments?

A toolbox full of different tools

Our interest rates are only one of several instruments that we use for our monetary policy. Think of a toolbox full of different tools that are used, also in combination, to help us steer inflation. In recent years we have added new instruments to our toolbox in response to big changes in the economy that have made our task of maintaining price stability more challenging.

A changing world has led to new monetary policy instruments

These changes are beyond the control of central banks, and they have changed how our economy works. They have led to a fall in the so-called “natural rate of interest” – the interest rate at which the economy runs smoothly and prices are stable. If central banks increase their interest rates above the natural rate, it restrains growth in the economy and inflation tends to fall. If central banks reduce their interest rates below the natural rate, it boosts growth in the economy and inflation tends to rise.

Because there is a limit to how low interest rates can go, a fall in the natural rate of interest means that central banks have less room to stimulate their economies using interest rate policy alone. This is one of the reasons why we, like other central banks around the world, have introduced new monetary policy instruments. They help us do our job better: keeping prices stable.

Our instruments work together

We have introduced four new monetary policy instruments to ensure that the positive impact of our monetary policy reaches people and businesses. These include:

  • our negative interest rates, which encourage banks to lend at low rates so that people and businesses can borrow cheaply;
  • our “forward guidance”, where we make clear our intentions for future monetary policy depending on how the economy develops;
  • our asset purchases, which help boost lending, spending and investment in the economy;
  • our “targeted longer-term refinancing operations”, where we lend money to banks at very favourable rates on condition that they lend this money on to people and businesses.

While each of our instruments is effective in its own way, they all work together to strengthen one another’s impact.

We will carry on using all of those instruments as necessary in the future. If needed, we can also develop additional tools to make sure we can deliver on our job of keeping prices stable.

We are watching out for any unintended side effects

Desired benefits and unwanted costs

We are also aware that our policy can have an impact on other parts of the economy. It is rather like medicine that is effective in treating a specific illness but can also have unwelcome side effects. Doctors therefore keep an eye on such effects and continuously assess whether the benefits still outweigh the risks.

We are continually on the lookout for undesired side effects

Similarly, the ECB looks out for any unintended side effects of our monetary policy instruments and assesses the desired benefits against unwanted costs. One side effect of very low interest rates is that people do not get much of a return on the money in their savings accounts. But people are not only savers. They are also homeowners, employees, entrepreneurs and taxpayers, for whom the economic effects of our very low interest rates have been mostly beneficial.

The only way to get back to higher interest rates is to have a growing economy and healthy inflation rates. That is what our monetary policy aims to do. Our strategy review analysis confirmed that the benefits of our monetary policy instruments for the economy as a whole have been greater than their costs. We will continue to look out for unwanted side effects in the future.

Assessing the efficacy, efficiency and potential side effects of the ECB’s monetary policy instruments since 2014
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