02 September 2013

ECB/Cœuré: Outright Monetary Transactions, one year on

One year after the inception of the ECB's Outright Monetary Transactions (OMTs), financial markets in the euro area are in much calmer conditions and fragmentation is receding. Yet OMTs have created turmoil elsewhere: today, it is not government bond spreads but emotions that are running high.

Three issues:

First, the necessity of OMTs. At the time when OMTs were announced in August 2012, financial fragmentation had created widely divergent borrowing costs for firms and households across euro area countries. As a result, the transmission of monetary policy was severely impaired.

Liquidity was suddenly drying up in stressed countries, threatening to lead to a destructive downward spiral of abrupt deleveraging, fire sales and ultimately deflation. By contrast, there was a risk that abundant liquidity in core countries would unduly drive down financing conditions and fuel asset price bubbles.

As our main policy response to the crisis, we announced our decision to implement OMTs in a secondary government bond markets. The goal of OMTs is a narrow one: to eliminate unwarranted and self-reinforcing fears of a euro area breakup that have undermined our ability to effectively conduct monetary policy in the pursuit of price stability. In this respect, OMTs are an instrument tailored to the multiple equilibrium.

Second, the effectiveness of OMTs. OMTs were able to address the impairments to the transmissionmechanism of monetary policy, by reducing fragmentation and restoring the distributional neutrality of monetary policy. It has eliminated fears of disaster events and removed denomination risk from the market.

OMTs are an insurance device against redenomination risk, in the sense of reducing the probability attached to worst-case scenarios. As for any insurance mechanism, OMTs face a trade-off between insurance and incentives, but their specific design was effective in aligning ex-ante incentives with ex-post efficiency.

Finally, the robustness of OMTs. The relaxation of financial turmoil is, in itself, not sufficient for a positive assessment of OMTs.

In fact, for OMTs to be successful, they have to not only eliminate risk in the market, but they have to do so in a controlled and incentive-compatible way.

Full speech

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