The financial crisis seriously hampered the eurozone money market and the transmission of monetary policy.
The ECB adopted several actions aiming at restoring the functioning of the market, providing liquidity and eradicating the risk of reversibility of the euro.
Although economic conditions have improved, eurozone underlying problems have not been fixed yet. The monetary policy stance has to remain very accommodative. Further actions are likely.
The financial and the debt crises seriously hampered the singleness of the eurozone money market and the transmission of monetary policy. The existence of a single monetary policy implemented through the distribution of liquidity to the banking sector under the principle of equal treatment implies that differences between bank lending rates and deposit rates among countries should reflect variations in underlying fundamentals, such as financial health of credit institutions in a particular country and the counterpart risks. This was no longer the case during the financial and debt crisis. The lack of confidence between credit institutions de facto cut off several banks from the money market. Due to the tight link between banks and sovereigns, the intensification of the debt crisis accentuated the disruption of the money market. In its acute phase, the crisis was indeed a balance of payment crisis: current account deficit countries did not receive enough capital to cover their financing needs.
Providing liquidity, eradicating the risks of reversibility: the ECB stepped in
The ECB tried to reunify and to re-establish the functioning of the money market, restoring at the same time the transmission of monetary policy, cutting drastically interest rates, providing liquidity at full allotment-fixed rate (FAFR) in all its refinancing operations and offering longer maturities, up to three years (end of December 2011 and end of February 2012). Under the FAFR framework the ECB loses the control of quantity of liquidity injected in the market (the financial institutions determine the amount), but it fixes the price of liquidity and distributes it to all counterparts, as a frozen market cannot efficiently allocate resources and determine prices.
The FAFR framework and the associated excess of liquidity that it generated did not manage, however, to restore the functioning of the money market. A low interest rate environment should have favoured a “search for yields” behaviour, inducing investors to transfer liquidity out from “safe haven” countries towards peripheral countries of the zone. However, this mechanism did not take place. The perceived risk of reversibility of the euro increased even further the capital inflows towards “safe haven” countries, Germany in primis.
BY Clemente DE LUCIA
To Read the Entire Report Please Click on the pdf File Below.
The ECB adopted several actions aiming at restoring the functioning of the market, providing liquidity and eradicating the risk of reversibility of the euro.
Although economic conditions have improved, eurozone underlying problems have not been fixed yet. The monetary policy stance has to remain very accommodative. Further actions are likely.
The financial and the debt crises seriously hampered the singleness of the eurozone money market and the transmission of monetary policy. The existence of a single monetary policy implemented through the distribution of liquidity to the banking sector under the principle of equal treatment implies that differences between bank lending rates and deposit rates among countries should reflect variations in underlying fundamentals, such as financial health of credit institutions in a particular country and the counterpart risks. This was no longer the case during the financial and debt crisis. The lack of confidence between credit institutions de facto cut off several banks from the money market. Due to the tight link between banks and sovereigns, the intensification of the debt crisis accentuated the disruption of the money market. In its acute phase, the crisis was indeed a balance of payment crisis: current account deficit countries did not receive enough capital to cover their financing needs.
Providing liquidity, eradicating the risks of reversibility: the ECB stepped in
The ECB tried to reunify and to re-establish the functioning of the money market, restoring at the same time the transmission of monetary policy, cutting drastically interest rates, providing liquidity at full allotment-fixed rate (FAFR) in all its refinancing operations and offering longer maturities, up to three years (end of December 2011 and end of February 2012). Under the FAFR framework the ECB loses the control of quantity of liquidity injected in the market (the financial institutions determine the amount), but it fixes the price of liquidity and distributes it to all counterparts, as a frozen market cannot efficiently allocate resources and determine prices.
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The FAFR framework and the associated excess of liquidity that it generated did not manage, however, to restore the functioning of the money market. A low interest rate environment should have favoured a “search for yields” behaviour, inducing investors to transfer liquidity out from “safe haven” countries towards peripheral countries of the zone. However, this mechanism did not take place. The perceived risk of reversibility of the euro increased even further the capital inflows towards “safe haven” countries, Germany in primis.
BY Clemente DE LUCIA
To Read the Entire Report Please Click on the pdf File Below.
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