Monetary policy decisions

The main objective of the ECB is to maintain price stability in the euro area. To this end, the ECB uses interest rates – and since the crisis also other measures – to affect financing conditions in the economy. By steering financing conditions, the ECB can influence the overall level of activity in the economy and can ensure that the inflation aim is met.

In detail: how are interest rate decisions passed on to the economy and prices?

Key interest rates

The Governing Council of the ECB sets three key interest rates.

• The interest rate on the main refinancing operations. In these operations banks can borrow liquidity from the Eurosystem against collateral on a weekly basis, at a pre-determined interest rate.
• The rate on the deposit facility, which banks may use to make overnight deposits with the Eurosystem at a (pre-set) rate lower than the main refinancing operations rate.
• The rate on the marginal lending facility, which offers overnight credit to banks from the Eurosystem at an interest rate (also pre-set) above the main refinancing operations rate.

The rate on the deposit facility and the rate on the marginal lending facility define a corridor for the overnight interest rate at which banks lend to each other. The deposit facility rate acts as the floor of this corridor and the marginal lending facility acts as the ceiling.

Current and past rates

Non-standard measures

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. The ECB’s non-standard measures have responded to the challenges posed by the different phases of the crisis.

In the first phase of the financial crisis, 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.

In the second phase of the crisis, 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 ECB

• purchased debt securities (Securities Markets Programme)
• carried out very long-term refinancing operations (VLTROs)
• announced conditional Outright Monetary Transactions (OMT), which acted as a powerful circuit breaker against self-reinforcing fears in sovereign bond markets.

In the third phase of the crisis the ECB’s non-standard measures addressed the onset of a credit crunch and the risk of deflation. With short-term interest rates already close to zero, the ECB’s non-standard measures were intended to influence the whole constellation of interest rates that are relevant for financing conditions in the euro area.

The ECB’s measures included:

• a negative interest rate on the deposit facility;
• targeted longer-term refinancing operations (TLTROs), designed to support bank lending to businesses and households;
• an asset purchase programme (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 would warrant a change in the policy stance.