Unconventional Monetary Policies in the US and the Euro Area: How Successful

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Monetary policy is the macroeconomic policy by the central bank. It involves the management of the money supply and interest rate and used by the government of countries to achieve macroeconomic objectives such as inflation, consumption, growth, and liquidity. The central bank which served in euro area” ECB” and in the US “Fed”, is responsible for making such a policy. Generally monetary policy is divided into two categories 1.conventional monetary policy 2. Unconventional monetary policy by the economists. As a conventional monetary policy, central banks change the short interest rate to gain the macroeconomic objectives. For instance, Specifically, When a nation’s economy slips into recession like what happened during 2007-2009, the conventional monetary policy couldn’t act well because of their usefulness limitation; as the result, the central banks use the measures of unconventional monetary policy to come up these severe economic situations.

Unconventional Monetary Policy in the Euro Area

The ECB is a key player to stabilize the euro area economy. It makes monetary policies to consolidate the fiscal situation to support governments in financial crisis to guarantee price stability. Conventional measures or unconventional ones to ease financing condition and ensure recovery for the euro area economy. In the following, I will explain the evolution of ECB’s monetary policies during Global crisis 2008 and afterward.

Forward Guidance

“If a central bank gives forward guidance, it means it is providing information about its future monetary policy intentions, based on its assessment of the outlook for price stability. (ECB, 2017).” Because the central banks only have direct control over the short-term rate it could help them to influence long-term interest rate and also might influence inflation/deflation expectations. Since July 2013, ECB starts to forward guidance after the clarifications of its intention to maintain interest rate in low level and after that, it is using in the other occasion to make the future path clear regard to the asset purchase program or interest rate. The policy target should always be aligned with the current situation also future perspectives, especially for price increases. (ECB, 2017). When inflation is extremely low, the ECB can decline its interest rates to get inflation back up. But if interest rates are presently at very low points, it is tough for ECB to diminish them more and it still is rational, then other policy tools like Forwarding guidance are required. To make everyone have a better understanding of how borrowing costs are likely to develop in the future and help to give the economy the kick-start it needs regards to price stability across the euro area. (ECB, 2017).

Negative Interest Rate

James Chen (2018), noted that a negative interest rate is a negative interest charged by the banks.it means that depositors must pay money instead of receiving it on their deposits to put their money on banks.it leads to lend money more freely by bank also to invest, lend and spend money by individuals and businesses.

Federico et al. (2017)wrote in their article that since 2007 crisis many central banks have lowered key interest rate to near zero.to diminish the damaging result from crisis contains low growth and low inflation, and also arouse economic ECB launched negative rate program. Benefits could be increase load demand increase asset quality and reduced riskiness of loans. ECB adopt negative interest rate, with the aim of preventing deflationary spiral which characterized by demand decrease and less production that leads to low prices and therefore producers fire their workforce and unemployment rate will rise up then with increased bad debt financial institutions start to collapse. Julia(2018) Although it would be useful to control the post-crisis situation by stimulating the economy, there is critics regard to lending to riskier borrowers (‘risk-shifting’) Heider et al. (2017) and ‘search for yield’ Rajan (2013)

Asset Purchase Program (APP)

When the interest rate is close to its threshold there is no meaning to decline it anymore and still be effective. Then the European Central Bank implement the new unconventional monetary policy to decline the risk of the prolonged low-interest rate and bring it back to approximately 2%. This policy is called expanded Asset Purchase Program (APP) and consist of all public and private securities purchases terminated in December 2018. APP not only is a good instrument to maintain the price stability in the euro area, as the main ECB target, but also can provide the environment for access to credit, boost investment, and create jobs which can result in economic growth. (ECB, 2015). It works by buy bonds and securities on the secondary market, therefore there is no risk for the price forming in the primary market. These security and bonds are consist of the corporate sector, asset-backed securities, covered bonds, and public bonds that shares and volume are depicted in the chart below provided by ECB.

ECB (2016) explained that the Asset purchase program stimulates investment and consumption by making the financial condition better for households and firms in two ways: First (direct pass-through): private assets (asset-backed and covered bonds) are linked to the loans granted by banks so, the increased demand for them will lead to increase their prices and on the other hand increase the demand for bank’s loans. The increased demand for loans leads to decrease the lending rate for firms and households. Second (portfolio rebalancing) investors like pension funds, households, and banks choose to take funds in exchange for assets sold to ECB and invest them in other assets which will lead to increasing demand for assets and pushes prices up and yield down.it encourages banks to lend to companies or households with low borrowing cost. as well as investors use the extra funds to buy higher-yielding assets outside the euro area, this may also lead to a lower euro exchange rate, which tends to put upward pressure on inflation.

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Targeted Longer-Term Refinancing Operations (TLTROs)

According to the article from ECB on (2016), it is refinancing operations that provide loans to banks with a long maturity, and banks have given additional incentives to lend on the funds received. The first series launched in 2014 and because of its successful results the second series, which has four operations, one each quarter, started in June 2016, until March 2017.

The amount that banks can borrow from ECB is linked to the number of loans they have on their balance sheet, it means those banks which are active in granting loans to the real economy can borrow more than the other banks. Although the loan growth is recovered in the euro area, it still is low. Then the expectation from the second series TLTRO is to boost economic activity by encouraging lending to business and consumers in times of market certainty because under this program, the loan maturity time is longer than four years than the normal time of one to three weeks, which provides funding certainty. ”In conjunction with all other measures TLTRO II leads to return inflation rates to the objective of close but below 2% over the medium term “(Mario Draghi)

Unconventional Monetary Policy US

Fed cut the funds rate to zero lower bounds to gain economic recovery meanwhile the global financial crisis. This dramatic cut wasn’t enough. The number of unemployment and bankruptcy was making the economic situation worsen. Therefore the Fed adopt two unconventional monetary policy to stimulate the economy called forward guidance and quantitative easing.

Forward Guidance

During the great recession, Fed launched forward guidance to publicly commit to maintaining the federal funds rate at its zero lower bounds as long as it needed. Actually, the commitment was even bolder than that the fed committed to keeping the fed funds rate at zero even after the economy started to recover.

Quantitative Easing

Series of the program through which the fed bought over three trillion dollars of long-term financial securities from private investors. Securities like treasuries and mortgage-backed securities. These purchases represented a massive expansion of the Fed’s balance sheet. the intent of both policies was to put downward pressure on long-term interest rates.

Advocates of these policies said that by lowering long-term interest rate borrowing cost for households and companies would fall. Encouraging them to spend more money the additional spending would kick-start the economy, creating a positive spiral upwards in which greater demand encourage companies to produce more and hire more worker which would, in turn, lead to even more demand. Critics feared that the policies would debase the US dollar and cause inflation to soar.

The Effectiveness of Policies:

Since the goal of both policies was to reduce the longer-term interest rate, the obvious place to start looking is longer-term interest rates did the policies reduce long-term interest rates and not just rates on treasuries but also the interest rate on things that households and companies care about, like mortgages and corporate loans. Effectiveness is examined with a series of event studies which slightly differ from each other but all admit they were successful in reducing long-term interest rates. this helped to push interest rates on mortgages and corporate loans down in low levels. it encourage consumer spending and corporate investment because it was cheaper for households and companies to borrow money. This increased spending lowered unemployment and raised GDP.

As an answer to Critics about fear of the US dollar debase and soaring inflation, on the first counts the critics were right, the US dollar weekend because of the policies but the weakening of the dollar wasn’t a bug of the policies but they are a feature when the dollar weekend the US sells more to other countries. The rising net exports create additional demand for the US made products and increases our unemployment. On the second counts, the critics were wrong. inflation didn’t take off as a result of QE.as evidence the inflation remained below 2% for the next decade.


When the economy slips into recession like what happened during 2007-2009, the conventional monetary policy couldn’t act well because of their usefulness limitation; as the result, the central banks use the measures of unconventional monetary policy to come up these severe economic situations. These means recover the economy after crisis and diminish the damages such as unemployment rate, currency debase, decreased demand which leads to decreased production of the product, business collapse and helps to bring back the inflation into the low level and near the central banks objective.

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