How economic and financial events have forced the ECB to switch from controlling inflation to the role of buyer of last resort

- "The ECB's "pragmatism" has forced it to change its monetary practice under the pressure of events, but each time lagging behind:
• it controlled inflation when there was no longer any inflation (1999-2008), and when the problem was excess liquidity, rising indebtedness and asset price bubbles;
• this would lead it to consider ways of controlling credit and asset prices when the banking crisis broke out, and when, instead of controlling liquidity, it had to act as lender of last resort (mid-2008/2009);
• the resulting rapid growth in liquidity and bank reserves then led the ECB (in 2009) to reflect on various exit strategies; the first stage was to be the curtailment of fixed-rate repos;
• but the sovereign debt crisis caused the ECB to forget the liquidity problem, especially since bank risks are increasingly correlated to sovereign risks, and to take on the role of buyer of last resort for public debts, potentially unlimited."
- "This represents a considerable change in the ECB's monetary practice. Initially, it thought that its role was to control inflation, and that the way to do so was to use the effect of interest rates on the supply of bank credit, which remains the normal channel for transmission of monetary policy in an economy financed mainly by credit, such as the euro zone."
- "Now, it believes that its main role is to prevent bankruptcies by banks and countries due to the dramatic effect they would have on the economy, on the euro financial markets, and on sentiment toward the euro in the rest of the world. This is not quantitative easing (the transition to a monetary base objective when interest rates are very low), but in fact the transition to an objective of financial stability. The important question is whether, once this objective has been chosen, it is possible to go back to the other more traditional objectives."
Natixis Flash Economics 332 20100629