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Response of the ECB to COVID-19 crisis
The onset of the COVID-19 pandemic has precipitated an unprecedented crisis, profoundly impacting global public health, economies, and societal structures on an unparalleled scale. The COVID-19 crisis stands in contrast to the 2007-2008 Global Financial Crisis as it represents an exogenous shock to the real economy, stemming from measures implemented to mitigate the public health emergency, distinct from the internal financial origins of the preceding crisis that transposed repercussions onto the real economy. Following the measures implemented by all governments to counter the spread of COVID-19 across Europe, investors fled to safety, which caused the risk of fire sales in asset markets, illiquidity spirals, credit spikes and discontinuities associated with market freezes. The flight-to-safety also encouraged the fear that after the COVID-19 crisis was over, the stronger economies would emerge even stronger, while the weak economies would get even weaker. Thanks to the more stringent banking regulations implemented after the Global Financial Crisis, a financial crisis was avoided as banks could cope better with the crisis and complementary measures were taken by the EU and national governments.

Pandemic Emergency Purchase Programme (PEPP)
The Pandemic Asset Purchase Programme (PEPP) is an asset purchase programme initiated by the ECB to counter the detrimental effects to the Euro Area economy caused by the COVID-19 crisis.

To counter the COVID-19 crisis the ECB has established the Pandemic Emergency Purchase Programme (PEPP), in which the ECB is able to purchase securities from the private and public sector in a flexible manner,  with the purpose to prevent sovereign debt spreads to reach the same levels as during the European debt crisis. It is a quantitative easing unconventional monetary policy, based on the principles of the Asset Purchases Program (APP) which is a similar programme established by the ECB in mid-2014. Asset purchase programmes are intended to bring down risk premia or term premia. However, the PEPP is not entirely the same as the APP, as it can deviate from the capital key strategy followed by the APP. Second, the PEPP-envelope does not need to be used in full. The PEPP is established as a separate purchase programme from and in addition to the APP with the sole purpose to respond to the economic and financial consequences of the COVID-19 crisis. Following Philip R. Lane, chief economist of the ECB, the PEPP plays a dual role in the COVID-19 crisis: (i) ensuring price stability and at the same time (ii) stabilizing the market using the flexibility of the programme to prevent market fragmentation. National central banks are the main purchasers of the bonds under the principle of risk sharing: private bonds fall completely under the risk of national central banks, while only 20% of public bonds are subject to risk sharing. These purchases under the PEPP eventually follow the capital key used in the APP.

The flexibility to deviate from the capital key is key for the PEPP: because of the uncertainty caused by COVID-19 it was needed to prevent tightening financial conditions. They prevent yield spreads between the bonds of different member states, caused by the flight-to-safety of investors. The flexibility in asset purchases allows for fluctuations in the distribution of purchases across asset classes and among jurisdictions to prevent market fragmentation. Following this strategy, the PEPP distributed the money among countries in need. The APP follows the capital key strategy, from which no deviations are possible. This makes the APP not able to counter the crisis effectively. Margrethe Vestager, European Commissioner for Competition argued "We will need to distribute in order to recover together. These increasing asymmetries will otherwise fragment the single market to a level otherwise none of us is willing to accept,[...]." , as economists feared that the strong economies would come out of the crisis stronger while weak economies would deteriorate because of the crisis. The PEPP is thus a tool used by the ECB to purchase both private and public securities according to the specific needs of EU-countries caused by the COVID-19-crisis. The temporal flexibility from the capital key meant that the ECB could especially prevent the rise of Italian and Spanish yield spreads.

Assets eligible under the PEPP
Assets meeting the eligibility criteria of the APP were also eligible under the PEPP. However, the PEPP complemented the APP eligibility framework given the specificity of the PEPP-context of crisis requiring a more tailored response. Among the distinctions is that for the first time since the Greek government-debt crisis, Greek debt is given a waiver under the PEPP so that it could be purchased by the ECB under this programme. This waiver was given based on several considerations from the ECB: there was a need to alleviate the pressures stemming from the pandemic on the Greek financial markets; Greece was already and would be closely monitored by giving the waiver; and Greece regained market access. This proved to be controversial, as Greece is the eurozone's riskiest issuer. Non-financial commercial paper with a remaining maturity of at least 28 days was also eligible for purchase under the PEPP. The maturity criteria for public sector ranges form 70 days up to 30 years and 364 days. As the PEPP can deviate from the capital key strategy, there is also no hard limit on the 33% of a single security per issuer or 33% of a member state's total outstanding security.

Timeline of the PEPP and TLTRO announcements and purchases
On 12 March 2020, Christine Lagarde announced in a press conference a set of policy measures to support the European economy in the rising wake of the pandemic, saying that "all the flexibilities that are embedded in the framework of the asset purchase programme [...]" but at the same time she stated that the ECB "[...] is not here to close spreads." This left markets disappointed and let to a particular widening yield spreads in Spain, Italy and Greece. However, the Governing Council announced firstly to provide immediate liquidity through conducting additional LTROs; secondly, to provide more favorable terms on the TLTRO III operations outstanding in the period between June 2020 and June 2021; and thirdly, to announce an additional package of net asset purchases of €120 billion by the end of 2020 under the already existing APP.

A day later, on 13 March 2020, the WHO declared Europe the centre of the pandemic.

By March 17, a week after the press conference given by Ms. Lagarde, stock index plateaued while the interest rate spread kept on rising over 2.8%.

On 18 of March 2020, 6 days after the previous press conference, the ECB announced the launch of the PEPP worth €750 billion   to boost liquidity in the European economy and to contain any sharp increases in sovereign yield spreads. This announcement led to an immediate reboot in stock prices and came one day after the spike of sovereign risk spreads. The PEPP became effective as from 24 March 2020, six days after the announcement of the PEPP. By announcing the PEPP the ECB deviated from its pattern of prodding fiscal authorities into action before announcing any monetary stimulus. Together with the additional €120 billion announced on March 12, the PEPP amounted up to 7.3% of the euro-area GDP.

On 30 April 2020, the ECB Governing council introduced the Pandemic Emergency Longer-Term Refinancing Operations (PELTROs), with an interest rate of 25bp below the average rate applied in LTROs and for the first time negative.

On 4 June 2020, the ECB announced it would expand the PEPP by another €600 billion, as it became clear that the pandemic would continue to harm European economies increasing the total emergency package up to € 1.350 trillion. Following Carsten Brzeski, chief economist at ING, dents this ECB decision "[...] any further speculation about whether or not the ECB is willing to play its role of lender of last resort for the eurozone." The expansion showed that the ECB is committed to achieve the price stability objective. However the ECB reiterated that additional fiscal measures should be taken, as the PEPP cannot deliver economic recovery on its own.

Half a year later, on 10 December 2020, the ECB announced its final expansion of the PEPP worth another €500 billion, totalling the final PEPP to €1.850 trillion, corresponding to 15.4% of the euro-area GDP of 2019. At the same press conference, the ECB announced that it expected to extend the horizon for net purchases of the PEPP until at least the end of March 2022. In December 2021 the ECB announced that it would discontinue net purchases under the PEPP as from the end of March 2022 and that it intended to reinvest the principal payments from maturing securities at least until the end of 2024.

On 31 March 2022, at the end of the net purchases, the net purchases amounted to €1.718 billion euros, of which €1.665 billion is invested in public sector securities and €52 billion in private sector securities. Of the total €1.850 billion available under the PEPP, 93% of the full envelope wase used, due to indications of decreased financial stress in the Euro Area, mainly thanks to relaxation of COVID restrictions and the reopening of European markets.

Effects of PEPP on the Euro Area yield spreads
The PEPP effectively lowered the sovereign risk spreads in the Euro Area during the pandemic. The announcement of the PEPP by the ECB resulted in reductions of all Euro Area countries' sovereign yield spreads. The announcement effect accounts for the largest reduction of the yield spreads, an the effect is the largest in distressed countries. The announcement effect displays large cross-country variation across Euro Area member states, with the largest reduction observed in the Greek and Italian bond spreads in the week following the PEPP announcement. The ECB also successfully supported Euro Area governments' fiscal measures implemented to alleviate the negative consequences of the COVID-19 crisis. Therefore one could assume that without the PEPP debt levels across Euro Area countries would be unsustainable. Moreover, the PEPP and APP could serve as a counterbalance for the low and negative interest rates provided under the PELTRO, as they increase market values of the financial assets held by central banks. The EU proved capable of providing first aid measures in response to a crisis proving that the PEPP fits well into the economic policy objectives. The utilisation of unconventional tools by the ECB, such as the PEPP and the T-LTRO, has positive effects on the bank's balance sheet and they improved macroeconomic conditions. According to some scholars, unconventional monetary policies are not so unconventional anymore, but rather here to stay.

The highest impact of the PEPP announcement on the yield spread are observed in the yield spreads of heavily indebted countries such as Spain, Italy and Greece. Also after the announcement on 4 June 2020, both Italian and Greek yield spreads dropped. It is no coincidence that the impact is the most visible in these countries, as their GDPs are expected to decrease the most as a consequence of impact of the COVID-19 crisis.

Supports and critiques
On 13 March, after Ms. Lagarde stated that the ECB is "not here to close spreads", Italian sovereign yield spreads spiked. Italian prime minister Conte stated it would not accept formal and abstract interpretations of the situation. "[...] the job of the central bank should be not to hinder but to help such [containment] measures by creating favorable financial conditions for them [member states]." Lagarde then replied by stating that the ECB was "fully committed to avoid any fragmentation [...]." In the following week, the PEPP was welcomed by both the prime minister of Italy and Spain as well as by the president of France. They all mostly praise the action of the ECB, and put this as a question of European solidarity. Chief economist at Berenberg also welcomed the measures undertaken by the ECB, stating that "the authorities would not allow the pandemic shock to the real economy to trigger a financial crisis which, in turn, would exacerbate the economic damage." The governor of the Banque de France warned the ECB that it probably needed "[...] to go even further."

Following Italian lawmaker for the European Parliament Carlo Calenda there is widespread strong anti-German and anti-Dutch sentiment in the South of Europe, as it seems they "[...] are taking advantage of being strong in a Europe lacking solidarity." These comments are backed by Dutch MEP Paul Tang: "If we fail to take action at European level, we risk disintegrating the single market and intensifying the antagonism between North and South."

At the same time, the ECB risks being accused of financing governments if it let the PEPP last for multiple years.

PEPP challenged before the German Federal Constitutional Court
On May 5 2020, the Court ordered the Bundestag and the Bundesregierung to ensure the ECB had carried out a proportionality assessment of the vast purchases of government debt in the Public Sector Purchase Programme (PSPP) to ensure the economic and fiscal policy effects do not outweigh its policy objectives. The PSPP-implementing decision has been considered an act ultra vires by the ECB as it was too arbitrary and lacks reasoning in ints proportionality assessment. This ruling by the German Constitutional Court comes at a difficult time for the ECB as it was at the time considering expanding the PEPP. The ruling also reflects the mistrust within some parts of Germany in the ECB, which is seen there s an institution that bails out profligate Southern European countries. Moreover this ruling also highlights the vital problem on the euro area architecture, as the range of instruments can use to fulfil its mandate remains unclear. The ruling on the legality of the PSPP could have severe implications on the legality of the PEPP, as it the PEPP has characteristics in common with the PSPP. In March 2021, the PEPP was challenged before the German Federal Constitutional Court.

Long Term Refinancing Operations (LTRO)
The long term refinancing operations (LTRO) are regular open market operations providing financing to credit institutions for periods up to four years. They aim at favoring lending conditions to the private sector and more generally stimulating bank lending to the real economy, thereby fostering growth.

In December 2011 and January 2012, in the aftermath of the Global Financial Crisis, the ECB implemented two LTROs, injecting over €1000 billions of liquidity in the Eurozone financial system. They were later criticized for their inability to revive growth and to help truly revive the real economy, despite having stabilized the Eurozone’s financial institutions. Further, these operations were devoid of monitoring from the ECB regarding the use made of these liquidities and it appeared that banks had significantly used these funds to pursue carry-trade strategies, purchasing sovereign bonds with higher rates and corresponding maturity to generate profits, instead of increasing private lending.

These critics and deficiencies brought the ECB to instigate targeted long term refinancing operations (TLTROs), first in September and later in December 2014. These complementary programs imposed conditionality on the LTROs. The TLTROs provided low cost financing to participating banks, under the condition that they reached certain targets in terms of lending to firms and households. The participating banks were thus more incited to lend to the real economy. A third wave of TLTRO’s was announced on 7 March 2019, namely the TLTRO III.

COVID-19, TLTRO III and PELTROs

When the COVID-19 pandemic broke out and spread to the old continent, the ECB’s monetary policy response had to guarantee favorable borrowing conditions to firms and households of the euro area. For a significant portion of companies, especially the small and medium-sized, survival was basically at stake. Oftentimes, loans are indeed their only source of finance. In this context of uncertainty, a substantial segment of the ECB response was to adapt the existing TLTRO III, by providing banks with funding at favorable conditions, to further enhance access to credit for undertakings and households.

In this endeavor, the ECB had to ensure a high degree of participation from the banks. Hence, on 30 April 2020 the Governing Council of the ECB adopted a package of temporary measures that made several adjustments to the framework of its TLTRO III. An important feature of this response was that the ECB made temporary alterations to its collateral framework by widening the set of assets that could be mobilized as collateral in the liquidity-providing operations and by easing the requirements in this regard. Furthermore, a key change was that the ECB also reduced the interest rate applied to these open market operations to a rate going as low as -1% for the banks meeting the lending threshold of 0%. With the TLTRO III, the participating banks were thus enabled to borrow at lower interest rates than those paid on their excess reserve, that is to say, the liquidities held in their accounts in their respective central banks. This scheme was scheduled until June 2022. Furthermore, the banks’ repayment options were loosened, along with the participation modalities. Regarding the latter, the ECB anticipated future potential falls in the ratings of some assets, and therefore established that if the requirements of collateral eligibility had been met prior to April 7, 2020, these assets would remain eligible in the collateral framework, as long as their rating remained above or at a given threshold (credit quality step 5). The ECB also expanded bank’s borrowing allowance under TLTRO III from 30% to 50%, then up to 55% of their portfolio of loans to firms and households.

Another important facet of the ECB policy response was the launching of pandemic emergency long-term refinancing operations (PELTROs). These are complements to the multiple recalibrations of the TLTRO III. On 30 April, 2020, the ECB Governing Council announced these additional long-term loans programs. They are similar to the TLTRO III in their aim of ensuring liquidity in the market and smoothening borrowing conditions in these times of pandemic. For this purpose, the PELTRO’s also provide collateral easing measures and negative interest rates. On December 10, 2020, the ECB issued four additional PELTRO’s, taking place on a quarterly basis during 2021.

During the pandemic, these monetary responses proved essential to counter the loss of revenue suffered by firms and the spurt of demand for loans that naturally ensued. In their absence, a credit crunch would normally have taken place. Indeed, increase in demand traditionally translates in a rise of borrowing costs. However, ECB easing measures allowed banks to lend massively without an increase of the rates. Empirical evidence is paramount in order to properly assess if the effects on the real economy of those cheaper fundings offered to banks have indeed matched the intention of the European Central Bank (stimulate the granting of loans to undertakings and households). Reports from various member states central banks on the matter indicate that loans supply by participating banks has indeed expanded, in line with the ECB policy. Accordingly, thorough academic studies have confirmed the actual enhancement of financing conditions and the avoidance of credit scarcity. In fact, the credit to firms attained unprecedented levels when from March to May 2020, it increased by €250 billion on aggregate.

In addition, the massive involvement of banks in the TLTROs and PELTROs had an important positive side effect. There was a reduction in the issuance of bonds by banks, that usually showed a preference for central bank liquidity for their financing. This, in turn, prevented the cost of issuance of such bonds from surging, which suggests that even non-participating banks (to the TLTROs and PELTROs) benefited from it in parallel manners. The downward pressure on bonds yields also implies that banks having a bigger fraction of the assets side of their balance sheet composed of outstanding bonds were those that benefited the most from the TLTROs and their decrease of funding cost.

Furthermore, the question of “zombie firms” has been raised. These refer to unprofitable businesses that only survive by perpetuating their indebtedness. The pandemic, along with the accommodating funding costs (notably brought through the readjustment of the TLTRO III), could have led to an increased number of those under-competitive firms allowed to survive by successive credits. Yet, scientific studies have shown that this increase was very limited from 2019 to 2020.

Transmission Protection instrument (TPI)
The Transmission Protection Instrument (TPI) is a tool the ECB could use to ensure monetary policy decisions are smoothly transmitted across all euro area countries, introduced on July 21 2022. Under the TPI, the ECB would be able to purchase securities in the secondary market, to counter against "unwanted, disorderly market dynamics", self fulfilling crises market expectations that do not reflect reality , thus not justified by "country specific fundamentals." The TPI thus enables the ECB to control the difference between borrowing costs across the euro area, thereby reducing fragmentation risk across the euro area. By not letting interfere market dynamics that do not reflect economic reality, the ECB fulfils its secondary mandate under the TFEU, namely "to support the general economic policies of the Union." Although PEPP would remain the first line of defence to counter for transmission risks, the TPI should be seen as an addition to the ECB's toolkit.

Eligible securities under the TPI
Contrary to the PEPP and the APP, the TPI does not have an ex ante upper limit on the purchase of securities. Although the ECB has stated it would primarily buy only government bonds on the secondary market maturing between 1 and 10 years, the bonds purchased fall under the complete discretion of the ECB and does not necessarily follow the capital key, and private securities could be considered as well. However, there are four conditions that need to be met before securities are eligible for purchasing under TPI:

The conditions for government bonds to be eligible under the TPI draw heavily on the macroeconomic governance, and making sure that politicians do not take decisions that facilitate speculation. The decision by the ECB to support a country by using the TPI will depend on the severity of the risks a country faces. Government debt should thus be sustainable to be eligible for TPI purchases.
 * 1) Compliance with the fiscal framework of the EU and not be involved in the excessive deficit procedure;
 * 2) Absence of macroeconomic imbalances and not being involved in an excessive macroeconomic imbalance procedure, demonstrating that it is in compliance with the Commission's recommendations;
 * 3) Sovereign debt trajectory must be sustainable, assessed by the ECB and other relevant bodies;
 * 4) Stick to commitments made under the Recovery and Resilience Facility, proving that the government follows sound and sustainable macroeconomic policies.

If the aforementioned conditions are met, the ECB could decide to activate the TPI. Purchases will be ended under the TPI either due to increased transmission of monetary policy or the risks have proven to be country-specific. So far, the TPI has not been deployed yet.

Effects of and critiques on the TPI
The TPI enables the Governing Council to a more rapid increase in interest rate, the first raise in interest rates by the ECB in 11 years. and the unpredictable nature of market sentiment could justify the reason for ECB-intervention to stabilise the monetary union, more or less the same reasoning as for the PEPP.

However, the relationship between the PEPP and the TPI raises questions as the PEPP would remain the first line of defence against transmission risks. The creation of the TPI seems legally vulnerably: problems in the Euro Area are common and recurring, but it is not automatically the argument to invent a whole new anti-fragmentation tool. With the TPI, the ECB can put pressure on countries by assessing publicly if they are eligible for the TPI, that is assessing whether the government has conducted adequate fiscal policies and structural reforms to deserve the support of the ECB. This endangers the politic neutrality of the ECB. If ever deployed, the usage of the TPI will spark controversy as the conditions to be deployed are not watertight.

Paul de Grauwe's criticism
In "Towards monetary policies that do not subsidise banks" published in July 2023 and co-authored with Yuemei Ji, Paul de Grauwe criticizes the prevailing role of central bank reserves in monetary policy. Holding the John Paulson Chair in European Political Economy at the London School of Economics, de Grauwe presented his views on this matter in a lecture at the Bundesbank in September 2023.

De Grauwe states that major central banks are currently operating in a regime of abundance of bank reserves. This abundance, he argues, is a consequence of massive government bond-buying programs and a fundamental change in the operating procedures of these central banks. Since late 2021, in response to rising interest rates aimed at combating inflation, central banks have adopted a procedure of increasing interest rates by raising the remuneration on bank reserves. This approach has resulted in substantial interest payments to commercial banks. Due to past Quantitative Easing, bank reserves are now massive, leading to huge transfers of profits. Paul de Grauwe highlights the magnitude of these interest payments, comparing them to significant public expenditures:  the interests received by commercial banks to the yearly spending of the EU (€165 billion) to the interest payments of the ECB during the same period (€152 billion).

De Grauwe argues that these transfers lack economic rationale. Despite seigniorage gains traditionally returning to the government, he observes that central banks are transferring more than the total seigniorage gains to private banks, resulting in significant losses and effectively constituting a subsidy to banks at the expense of taxpayers.

Furthermore, the author raises concerns about moral hazard, noting that the provision of free interest hedging for banks by central banks may create ethical issues, as public authorities offer free insurance to private agents.

Questioning the economic rationale for these practices, de Grauwe states that the remuneration of bank reserves is not totally necessary for conducting monetary policy and that the regime of reserve abundance is a result of the oversupply of reserves created by central banks through the buying of large amounts of government bonds. Now, central banks cannot raise the interest rate without remunerating bank reserves, the equilibrium of demand (commercial blanks) and supply (central banks) being under the 0% rate. De Grauwe also states that the reserve abundance regime has altered the view of economists on the role of central banks : money base created by the central bank is now viewed as part of the public debt since central banks must pay a rate of remuneration on bank reserves. According to de Grauwe, this view is not inevitable and he suggests alternative operating procedures to address these issues : a gradual return to a regime of scarce reserves through Quantitative Tightening, raising minimum reserve requirements without paying interest on bank reserves, and implementing a two-tier system of reserve requirements to control the market rate while reducing transfers to commercial banks.