Otherwise, 5  households and firms would simply withdraw money from the banking system and hold cash. This ‘zero lower bound’ is another constraint on monetary policy and one that had not been envisaged when the monetary policy framework for the euro area was designed. In response, the ECB embarked upon a range of non-standard measures. First, following the example of several other central banks, the Governing Council pushed the overnight deposit rate into negative territory and the rate on the main refinancing operations down to zero. Second, the ECB launched, and then extended, an asset purchase programme, pushing down long-term sovereign bond yields and lowering borrowing costs for the private sector as well. Third, the ECB began offering banks a series of targeted long-term  refinancing operations on favourable terms, aimed at prompting them to lend to the private sector. These measures were aimed at stimulating economic activity, staving off the threat of deflation and pushing inflation back up towards its target of below, but close to, 2%. These unconventional policy measures have been instrumental to provide additional accommodation to the economy and prevent a self-sustaining fall in inflation. However, although economic activity has firmed, inflation still has not converged with the ECB’s objective. Underlying inflation pressures remain subdued. The Governing Council continues to hold that such an accommodative monetary policy stance must remain in place until a sustained adjustment in the path of inflation has been achieved. Until now, we do not have sufficient evidence that we have reached this critical point.
Economic activity began to recover in mid-2013. Since then, real GDP in the euro area has expanded steadily, if moderately, until by the second half of 2015 it had reached its pre-crisis level. However, the unemployment rate in the euro area remains relatively high, though it has fallen from a peak of above 12% in 2013 to below 10% today. Against the backdrop of a tentative recovery, and with euro area banks having to clean up their balance sheets and restrict lending, inflation in the euro area began a prolonged downward trend. Inflation in the euro area fell to 0.4% in 2014, zero in 2015 and just 0.2% last year. At these rates, inflation was considerably below the ECB target. Indeed, by mid2014 disinflationary pressures in the euro area were clear. The concern was that Inflation expectations, which were firmly anchored until then, could lose their moorings. This would lead to a self-sustained deflationary spiral that would further weaken the euro area economy. At this stage, the conduct of monetary policy ran into another constraint. As we have seen, by May 2009 the Governing Council had cut the main refinancing rate to 1.0%. The main refinancing rate was lowered to 0.25% in November 2013, while the rate on the ECB’s overnight deposit facility was reduced to zero. The Governing Council now faced a dilemma: although the economic situation demanded further monetary stimulus, official interest rates could not fall much further. Nominal interest rates cannot fall far below zero.