Monetary Policy During the Pandemic: Fit for Purpose?

Christophe Blot, Caroline Bozou and Jérôme Creel

In a recent Monetary
Dialogue Paper for the European Parliament, we review
and assess the different policy measures introduced by the ECB since the
inception of the COVID-19 crisis in Europe, mainly the extension of Asset
Purchase Programme (APP) measures and the development of Pandemic Emergency
Purchase Programme (PEPP) measures.

APP and PEPP have had distinct
objectives in comparison with former policies. APP has
been oriented towards price stability while PEPP has been oriented towards the
mitigation of financial fragmentation.

To this end, we start by analysing the effects of APP announcements
(including asset purchase flows) on inflation expectations via an event-study
approach. We show that they have helped steer expectations upward.

Then, we analyse the impact of PEPP on sovereign spreads and show that
PEPP has had heterogeneous effects that have alleviated fragmentation risk:
PEPP has had an impact on the sovereign spreads of the most fragile economies
during the pandemic (e.g. Italy) and no impact on the least fragile (e.g. the
Netherlands). However, sovereign spreads have not completely vanished, making
monetary policy transmission not fully homogeneous across countries.

On a broader perspective, we also show that overall macroeconomic
effects have been in line with expected outcomes since the mid-2000s: ECB
monetary policy measures have had real effects on euro area unemployment rates,
nominal effects on inflation rates and financial effects on banking stability. These
results are in line with recent estimates at Banque de France (Lhuissier
and Nguyen, 2021).

As a conclusion, an increase in the size of the PEPP program, as
recently decided by the ECB, will be useful if financial risks re-emerge.
Meanwhile, we argue that an ECB decision to cap the sovereign spreads during
the COVID-19 crisis would alleviate the crisis burden on the most fragile
economies in the euro area, where sovereign spreads remain the highest.