The third question is whether OMTs are a form of quantitative easing (QE). The answer is: no. First of all, QE is meant to ease the general credit conditions which are considered by the central bank to have become tight in a situation in which the short-term interest rate cannot be reduced further. OMTs are meant instead to restore homogeneous credit conditions throughout the euro area, but not necessarily to ease credit conditions in the aggregate. In the euro area as a region, there are currently no clear signs of deflation fears (see slide 11) that would justify QE. In addition, the channels of transmission are different. QE is expected to act on risk premia (primarily term premia) by subtracting long-duration securities from the market and replacing them with base money, which has a very short duration. This would reduce term premia and bid up the price of long-dated securities. The aim of OMTs however is not to create an excess demand for duration in the market, but to counteract redenomination risk and squeeze redenomination premia out of bond prices. In fact, OMTs focus on relatively short maturities, where premia associated with break-up risk are most evident. Finally, QE would need to be tailored to the specificities of the euro area, where two-thirds of the external financing of non-financial corporations is extended by banks and which does not have access to actively traded credit markets. Conclusions Let me conclude. The effectiveness of monetary policy relies on the control of monetary and credit conditions.
In normal times, when risk factors are contained and can be diversified away, the interest rate channel, working through inter-temporal arbitrage, is the prime conduit of monetary policy (see slide 2). It sets the floor for term borrowing costs. Parsing longer-term yields into two components – the average level of the short-term policy interest rate expected over the term to maturity of the asset, and the risk premia – expectations of monetary policy pin down the first component. The mechanism through which this occurs is the inter-temporal financial arbitrage I just described. Term and liquidity premia are the additional returns that investors demand as a compensation for their reluctance to bear interest rate risk over long-duration assets, and for their decision to forgo liquidity services – I am abstracting here from credit risk, to which I will return later. When markets are properly functioning, non-depository institutions – dealers, hedge funds, investment banks – provide immediacy by offering lenders and borrowers their capacity to take positions on both sides of the market. Their ready availability to take positions as lenders and borrowers supports market liquidity, namely the ease with which a lender can liquidate a position before maturity. When market liquidity is secure, lenders are willing to engage in finance, trades in long-duration assets are active and the liquidity premia are contained. And, most importantly, they are steady. With a steady premium, the expectations  2  There are two reasons for idiosyncratic fluctuations of reserve demand by individual banks.