What is monetary policy? Presentation of conventional monetary policy and quantitative easing. The presentation also includes a (brief) history of the monetary policies of some major central banks: European Central Bank, Fed Reserve System, Bank of England and, Bank of Japan.

1. Monetary
policy
Jérémy Morvan
Assistant professor
Université de Bretagne Occidentale

2. Introduction
• To manage a bond portfolio, a fund manager has to anticipate changes in
interest rates
• The credit market is the largest financial market (money market + sovereign &
corporate bond market)
• To anticipate interest rates, it is necessary to capture the main variables involved
in the formation of interest rates
• Expected inflation (𝐶𝑃𝐼)
• Expected growth (𝑌)
• …
• Central banks are major players on money markets
• How do central banks act?
• What are the goals of central banks?
• What is quantitative easing?

3. Monetary policy
Monetary policy
in normal market conditions

4. Monetary policy
• Definition
4
The central bank's interventions in the money market and with financial institutions aimed at
achieving price stability and/or economic growth objectives
For the ECB, The first objective is to control inflation at the level of 2% per annum

5. Monetary policy
• Definition
5
Higher
interest rates
Lower demand
Lower inflationary
pressures
Lower
interest rates
Higher demand
Higher inflationary
pressures
The main function of a central bank is to control the money supply (monetary policy) in order to
guarantee price stability by controlling inflation.
By playing credit terms, the central bank influences the inflation rate

6. Monetary policy
• Definition
6
The goal is to influence the money market
→ The announcement of an intervention may suffice
Refinancing operations are punctual, announced, reduced
→ The amounts are limited not to disturb money market
Influence
Intervention
Taux courts
Short market rates are the target
Monetary policy has an inertia of 12-24 months

7. Monetary policy
• Three pillars of the ECB monetary policy
7
Operations by a central bank to give (or take) liquidity in its currency
to (or from) banks
Open market
operations
Marginal lending facility : to obtain overnight liquidity from the central bank, against
the presentation of eligible assets;
Deposit facility : to make overnight deposits with the central bank
Standing
facilities
Euro area banks are required to hold an amount of funds as
reserves in their current accounts at their national central bank
Minimum reserve
requirements

8. Monetary policy
• Open market operations by the ECB
8
One-week liquidity-providing operations in euro with
guarantee
Main refinancing
operations
Main ECB’s
key rate
Three-month liquidity-providing operations in euro with
guarantee
Long term
refinancing
operations
Refinancing operations in order to smooth unexpected
liquidity variations
Fine-tuning
operations
Refinancing operations in order to adjust the euro banking
system's liquidity position
Structural
operations
Frequency

9. Monetary policy
• Standing facilities
9
The deposit facility rate defines the interest banks receive for depositing
money with the central bank overnight
Floor rate
of the money market
Marginal lending
facility
The marginal lending rate is the rate payed by banks that receive
overnight credit from a national central bank against eligible assets
Ceiling rate
of the money market
Deposit facility

10. Monetary policy
• Minimum reserve requirements
10
The central bank requires credit institutions to hold deposits on accounts with their
national central bank
Very low interest rate
(0,05%)
Bank balance sheet security Creation of a liquidity deficit that requires
banks to refinance with the ECB
Reserve
requirements

11. Monetary policy
• Short-term rates are the main target of conventional monetary policy
11

12. Monetary policy
• Assessment
12
Strenghts Limitations
Growth is not
(always) a primary
objective
Debt market
development
Exceptional
market
circumstances
Strengh economic
growth
Inflation control
Normal market
conditions

13. Unconventional monetary
policy
Monetary policy
in the event of a major financial crisis

14. Unconventional monetary policy
• Quantitative easing
• QE is an unconventional monetary policy in response to the limits of monetary policy
under exceptional market conditions
14
Key rate cut > 50 bp
Multiple key rate cuts
Very large refinancing volume
Lower quality of eligible assets
Risk of deflation
Major economic crises
Collapse
of the banking sector

15. Unconventional monetary policy
• Definition
15
Quantitative easing (QE) is a monetary policy in which a central bank purchases government and/or
corporate securities directly from the market in order to lower interest rates and increase the money
supply
The central bank purchases
financial assets
The financial volume is much larger than for
conventional monetary policy

16. Unconventional monetary policy
• Mid-term rates are the main target of the QE
16
Monetary policy
Unconventional
monetary policy

17. Unconventional monetary policy
17
• Operations by the ECB
Fixed rate full allowment
Fixed-rate refinancing operations with an expanded list of
assets eligible as collateral in Eurosystem credit operations
Liquidity
injection in euro
and foreign
currencies
Several securities purchase programmes (SMP, OMT,
CBBP, ABS PP)
Negative deposit rate
Incentives for banks to provide more loans
Very LTRO and Targeted LTRO
Refinancing operations with a maturiy of 36 months
from dec. 2011 to feb. 2012 (amount > 1000 GEUR)

18. Unconventional monetary policy
• ECB’s asset purchase programmes
18
Interventions by the Eurosystem in sovereign and corporate debt securities
markets in the euro zone to ensure depth and liquidity in those market
segments (amount : 210 GEUR from may 2010 to dec. 2012)
Securities market
programme (SMP)
Failure due to a limited
refinancing volume
On July 26, 2012, Mario Draghi (chairman of the ECB) announces that
the ECB will repurchase all the sovereign debt of the euro area if
necessary
Pressure on the most exposed
sovereign debts lifted (Spain and Italy)

19. Unconventional monetary policy
• ECB’s asset purchase programmes
19
The ECB buys assets directly
to give cash to the banks
Outright Monetary
Transactions
(OMT)
Target: euro sovereign bonds with a maturity of 1 to 3 years with a pari
passu clause on an unlimited amount
Expanded asset
purchase programme
(2015-2016)
Target: corporate bonds (third covered bond purchase programme
(CBPP3) and asset-backed securities purchase programme
(ABSPP)
Public sector
purchase programme
(PSPP)
Target: sovereign debt of the euro area and international
organizations and development banks in the euro area

20. Unconventional monetary policy
• Assessment
20
Strenghts Limitations

21. Unconventional monetary policy
• The growth does not only depend on low interest rates
• Unemployment, optimism, international trade…
• Deflationary context
• Lower global growth (BRIC)
• Lower oil prices (BRIC...)
• The QE does not create inflation because the cash does not circulate in the
economy
• Banks have few opportunities in a depressed economic environment and prefer
to put money at negative rates
• The ECB tries to lower the euro
• Toward a currency war?
21

22. Money market rates
and key rates

23. Money market rates
• In the euro area
• The Main Refinancing Operations (MRO) rate is the main ECB’s key rate
• Two money market indices
• Euro Overnight Index Average (EONIA) is the weighted average of all overnight unsecured
lending transactions in the euro interbank market
• Euro Interbank offered rate (E3M) is the averaged interest rates at which Eurozone banks
offer to lend unsecured funds to other banks with a maturity of 3 months
• A money market with a low exposure to the currency risk
• Non-European operators testing the institutional resistance of the ECB

24. -1,00
0,00
1,00
2,00
3,00
4,00
5,00
6,00
30/12/98
30/12/99
30/12/00
30/12/01
30/12/02
30/12/03
30/12/04
30/12/05
30/12/06
30/12/07
30/12/08
30/12/09
30/12/10
30/12/11
30/12/12
30/12/13
30/12/14
30/12/15
30/12/16
Taux(%) Evolutions of the euro money market rates (EONIA and E3M) and the ECB’s MRO rate
E3M Main refinancing operations Eonia
Internet Bubble
Imported inflation (rise of
the BRIC countries)
Internet crash
Higher key
rates (july)
European debt crisis
Subprime crisis
Deflation riskSeptember 11
attacks

25. Money market rates
• In the United States
• The effective federal funds rate (EFFR) is calculated as a volume-weighted
median of overnight domestic unsecured borrowings in U.S. dollars by depository
banks
• The Fed conducts open market operations so that the EFFR reaches more or less
that Fed funds target rate
• A major money market is the US
• First political power
• First economic power
• USD is the main currency

26. 0
2
4
6
8
10
12
Evolution of the effective Fed funds rate and the Fed funds target rate
Fed funds target rate Effective Fed funds rate
End of the
Reaganomics
Clinton’s economic
recovery plan
Internet bubble
Russian financial
crisis (sept)
11 september
attacks
Imported inflation
(rise of the BRIC countries) Subprime crisis
Internet crash
Deflation risk

27. 0,000
1,000
2,000
3,000
4,000
5,000
6,000
7,000
Evolution of the Fed funds target rate (Fed) and the main refinancing operations rate (ECB)
Fed funds target rate Main refinancing operations

28. Money market rates
• In Great Britain
• The base rate is the rate that the Bank of England charges banks and financial
institutions for overnight credit
• Two interbank rates
• As the EURIBOR for the euro, the LIBOR are interbank offered rates in GBP
• LIBOR1D is an overnight rate
• LIBOR3M is a rate for interbank loans in GBP with a maturity of three months
• A specific history due to an evolution strongly bound to the global banking sector

29. 0,000
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000 Comparative evolution of the LIBOR1D, LIBOR3M and the BoEBR
BOEBR LIBOR1D LIBOR3M
Lower inflation:
easing of rates British government is forced to
withdraw the GBP from the
European Exchange Rate
Mechanism (ERM)
Soros' Quantum Fund began
a massive sell-off of pounds
(15 sept.)
Creation of the
LIBOR (jan.)
Imported inflation (rise
of the BRIC)
Subprime crisis
Outbreak of the
crisis (aug.)
Bankruptcy of Lehman
Brothers (sept)
Internet Bubble
Russian financial crisis
Deflation risk

30. Money market rates
• In Japan
• The basic loan rate is the standing facility rate for refinancing operations with
the Bank of Japan in JPY with a maturity of 1 day (no collateral is needed for
these overnight loans)
• The call rate is an overnight interbank rate
• A money market with a string link with
• The yen/US-dollar exchange rate
• The oil price (imports) and the global economic growth (exports)
• A market with low rates since the bursting of the housing bubble in 1993

31. 0,000
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
01/01/53
01/01/54
01/01/55
01/01/56
01/01/57
01/01/58
01/01/59
01/01/60
01/01/61
01/01/62
01/01/63
01/01/64
01/01/65
01/01/66
01/01/67
01/01/68
01/01/69
01/01/70
01/01/71
01/01/72
01/01/73
01/01/74
01/01/75
01/01/76
01/01/77
01/01/78
01/01/79
01/01/80
01/01/81
01/01/82
01/01/83
01/01/84
01/01/85
01/01/86
01/01/87
01/01/88
01/01/89
01/01/90
01/01/91
01/01/92
01/01/93
01/01/94
01/01/95
01/01/96
01/01/97
01/01/98
01/01/99
01/01/00
01/01/01
01/01/02
01/01/03
01/01/04
01/01/05
01/01/06
01/01/07
01/01/08
01/01/09
01/01/10
01/01/11
01/01/12
01/01/13
01/01/14
01/01/15
01/01/16
Evolution of monetary policy of the bank of Japan
Basic loan rate (ex official discount rate)
Iranian Revolution
(jan. 1979)
1973 oil crisis
End of the gold convertibility
(aug. 1971)
1979 oil crisis
First currency
war
(JPY/USD)
2nd currency
war (JPY/USD)
Housing
bubble
Housing
bubble crash
Imported
inflation (the
rise of the
BRIC
countries)
Subprime crisis and low
global economic growth

32. Conclusion
“If I turn out to be particularly clear, you've probably
misunderstood what I've said.” (Alan Greenspan)

33. Conclusion
• In long time, monetary policies change
• Monetary policies are increasingly linked
• The stance of central banks changes: the position of the central bank may be
political (before the independence of central banks), monetary (under normal
market conditions), insurance (lender of last resort or buyer of last resort)
• The means of action change
• Speech
• Increasing refinancing volume (with or without collateral)
• Erratic variation of the intervention rate (50 bp and more… or 0 bp)
• Negative key rate
• Central banks’ purchases

34. Conclusion
• In long time, monetary policies change
• Their goals change
Monetary
policy
CPI
Economic
growth
Exchange
rate

35. References
Books & papers
Bernanke Ben S. (2015), The Courage to Act, W.W. Norton & Company, 610 pp.
Clarida Richard, Gali Jordi, Gertler Mark (2000), "Monetary Policy Rules and Macroeconomics Stability: Evidence
and Some Theory", Quarterly Journal of Economics, (115)1, 147-180
Greenspan Alan (2007), The Age of Turbulence, Penguin, London, 531 pp.
Hetzel Robert L. (2002), "German Monetary History in the Second Half of the Twentieth Century: From the Deutsche
Mark to the Euro", Federal Reserve Bank of Richmond Economic Quarterly, (88)2, 29-64
Reinhart, Carmen M., Rogoff Kenneth S. (2013), "Shifting mandates: The Federal Reserve’s first centennial ",
American Economic Review, 103(3), 48-54
Reischauer Edwin O. (1970), Japan, the story of a nation, Knopf, New York, 448 pp.
Web sites
www.bankofengland.co.uk
www.boj.or.jp
www.ecb.europa.eu
www.federalreserve.gov