From a broader perspective, the introduction of the PEPP – and the subsequent increase of its initial envelope in early June – led to a period of gradual easing of financial conditions in the euro area, not only for sovereign debt, but also other market segments such as corporate debt. In addition, according to analysis by the Banco de España, the PEPP is having a markedly favourable impact on GDP growth and inflation in the euro area.1 Against the current backdrop of uncertainty surrounding the pandemic’s severity and duration, the best contribution that economic policy can make is to instil confidence and certainty. When it comes to monetary policy, this means ensuring accommodative financial conditions for all economic agents for as long as necessary. In view of how the pandemic 1  See Aguilar et al. (2020). 4  is unfolding and its economic effects, we clearly need more time (and the attendant volume) now than we projected just a few months ago (as you know, the PEPP runs until June 2021). Further, as was true of the first wave, it is highly likely that the second wave’s economic impact will be uneven across the various euro area countries, aside from the fact that the general government fiscal position is also very different. Therefore, retaining the PEPP’s flexibility is essential to head off problems of financial fragmentation that hinder the transmission of our monetary policy. In addition to the PEPP, another instrument that may be recalibrated in the near term are our TLTROs.
This would not be problematic if nominal rates could fall as far as necessary; for example, with expected inflation of 1%, to achieve a real interest rate of, let’s say, -2%, the nominal rate would have to be lowered to -1%. The problem is that nominal interest rates cannot drop as far into negative territory as sometimes would be necessary. Were central banks to set interest rates of -5%, for example, commercial banks would endure negative yields on a large part of their assets, which would adversely affect their profitability and, ultimately, their financial intermediation  2  The concept, determinants and implications for monetary policy of the natural rate of interest are discussed in Galesi et al. (2017). Holston et al. (2017), for example, estimate that in 2016 the natural rate was positive, but very close to zero, in the United States. 4 See, for example, Fiorentini et al. (2018). 3  7  capacity. This would have an attendant negative impact on credit supply, economic activity and inflation. There is therefore a lower bound on nominal interest rates. Should central banks lower interest rates below this bound, the effect on the economy may be contractionary rather than expansionary, owing to the adverse effects on the financial system as a whole.5 The level of this lower bound on interest rates is not directly observable and varies over time based on the financial sector’s situation. In any event, it represents the floor for central bank interest rate cuts.