Asset purchases versus rate cuts

Before I finish, it is perhaps useful to consider an alternative scenario, in which our response to the COVID-19 crisis would have come from further cuts in short-term interest rates rather than from asset purchases. Informing this comparison, ECB staff analysis has shown that episodes of market stress are associated with a weaker pass-through of policy rate cuts to sovereign yields (Chart 12). In fact, longer-term sovereign yields become virtually unresponsive to rate cuts in stressed conditions owing to the subdued portfolio rebalancing effects I mentioned earlier and consistent with the evidence recorded after the spread of the pandemic and prior to the launch of the PEPP.

As a result, policy measures that operate primarily through the risk-free curve – like rate cuts – are unlikely to be as effective at the current juncture as they are in non-stressed conditions – whereas policy measures that directly intervene on sovereign yields may in fact become more effective as they directly compress relevant premia in this market segment. While we stand ready to cut policy rates in the future as market conditions normalise and if warranted by the medium-term inflation outlook, this evidence tilts the balance towards asset purchases as the more efficient tool in current circumstances.

Moreover, the PEPP has played a crucial role in market stabilisation by attenuating the severe financial stress resulting from the COVID-19 crisis and helped to avert a full-blown market panic. In this way, it has acted as a powerful circuit-breaker that mitigated the adverse knock-on effects of the public health emergency to the broader economy. For instance, the stabilising role of the PEPP on financial conditions has so far reduced the risk of viable firms being shut off from crucial funding markets and thereby forced to declare bankruptcy and engage in mass lay-offs. It has also supported the resilience of sovereign bond markets at a time when fiscal policy-makers confronted the major challenges of financing their response to the public health emergency and creating a backstop for their domestic economies.