Forward guidance and "lower for longer": The case of the ECB

Applying simple policy rules to the interest rate decisions of the ECB since 2013, Tilman Bletzinger and Volker Wieland find out that these rules call for an increase in the policy rate in the course of 2016. However, the announcement of debt purchases till March 2017 effectively postponed the possibility of a rate hike until after that date. According to the authors this can involve significant risks.

Looking at the policy easing implemented by the European Central Bank (ECB) since summer 2013 when ECB President Mario Draghi took the unprecedented step of stating the Governing Council’s expectation for future interest rates more specifically, Bletzinger and Wieland compare the ECB interest rate decisions to various rules such as the Taylor rule and the simple rule by Orphanides and Wieland.

They authors investigate to what extent the policy easing mirrors the rate recommendations of these rule coming to the conclusion that ECB interest rate policy has been below the interest rate prescriptions from those rules. However, the announcement of debt purchases till March 2017 effectively postponed the possibility of a rate hike until after that date. Finally, the authors point out that a long period of low interest rates is likely to increase the risk of financial instability and asset-price driven boom-bust cycles and to create incentives for euro are members’ states’ governments to postpone consolidation and reform efforts. (16.02.16)