The ECB has a set of instruments at its disposal to keep prices stable.
In addition to setting the level of the key interest rates, the ECB may use other monetary policy instruments:
It can also create new instruments, if needed, to address new challenges (such as during the COVID-19 pandemic).
When key interest rates are close to 0%, the ECB has less room for manoeuvre to use this instrument to increase inflation. It can lower interest rates into negative territory but only up to a certain limit, as depositors would withdraw their money from banks if deposit rates were very negative.
This is one of the reasons why the ECB uses other monetary policy instruments.
When interest rates are close to this lower bound, the other instruments need to be used in a very forceful or persistent manner. This is to prevent inflation from remaining below the ECB’s target for too long.
On other occasions, the ECB can use the additional instruments to enable financial markets to function normally and transmit monetary policy to everyone in the economy, across all euro area countries.
The ECB chooses the most appropriate instrument for each economic situation. It can also choose a combination of instruments. When deciding, it considers not only the benefits of each instrument, but also the undesirable effects it may have.
The ECB’s financial asset purchase programmes, such as public or private debt securities purchases, help to support financing conditions for everyone in the economy, including governments. Examples are the asset purchase programme (APP), which started in 2015, and the pandemic emergency purchase programme (PEPP), established in 2020.
Lending to banks at favourable conditions, for example with longer maturities and attractive interest rates, supports bank lending to households and firms. One such example are the targeted longer-term refinancing operations (TLTROs), which the ECB has conducted since 2014.
The ECB’s forward guidance on future policy, in particular on key interest rates, helps people to understand how borrowing costs are likely to develop in the future. They can take this into account in the decisions they make today. This instrument was first used in 2013, when the ECB stated that it expected key interest rates to remain at present or lower levels for an extended period of time.