ECB Brief: Shift from PEPP to APP Tempting But Not Necessarily Simple

9 June 2021

By David Barwick – FRANKFURT (Econostream) – Though the European Central Bank’s Governing Council will probably avoid any discussion tomorrow of the winding down of its pandemic emergency purchase programme (PEPP), such a discussion seems likely to occur before at least some members are ready for it.

As the discussion will coincide more or less with the conclusion of the ECB’s strategy review, an appealing solution from the perspective of some Council members would be to simply shift the burden currently borne by the PEPP to the asset purchase programme (APP).

Such an outcome is far from just a theoretical possibility, with some major private financial institutions already having pencilled in the scenario of a passing of the torch from PEPP to APP. Indeed, an expansion of APP purchases from currently €20 billion per month on the face of it seems a relatively simple way of allowing the PEPP to expire according to plan next March without forgoing the monetary stimulus of the latter.

The ECB has, deliberately or not, encouraged such speculation. After promising to reinvest PEPP proceeds in every introductory statement, ECB President Christine Lagarde invariably notes in the very next breath that net buying under the APP will run for as long as necessary.

But Executive Board members, who are relatively close to the work of ECB committees on such questions, have played their cards close to their chest so far when it comes to the specifics of a potential transition.

Isabel Schnabel recently appeared uncomfortable at the idea that the APP would eventually simply inherit the characteristics of the PEPP, calling these ‘separate programmes [that] serve different purposes.’

The PEPP would end after having offset the pandemic-related downward shift of projected inflation, whilst the APP was one of the ECB’s ‘other tools to bring inflation back to our aim’, she said.

Non-Board members of the Governing Council have naturally chimed in. Bank of Latvia Governor Martins Kazaks not long ago said that ‘[i]f the inflation outlook remains like the current forecast when PEPP ends, I think we would certainly discuss increasing APP’, and Yannis Stournaras from Bank of Greece has suggested that a winding down of PEPP would be more of a switch to another programme of asset purchases, so that ‘[w]e have to think about a smooth transition from PEPP to APP.’

Simply moving money around may not do it. François Villeroy de Galhau, who heads Banque de France, has been more forthcoming, sharing a vision in which ‘net purchases under the APP will continue, possibly with adaptations’. ‘On the basis of our experience with the PEPP, we may add supplementary flexibilities in terms of allocation and/or volume’, he said.

The latter aspect is a key point, because the uniqueness of the PEPP has much to do with its vaunted flexibility. Monetary authorities’ public comments reveal them to be generally enamoured of this characteristic, and the Eurosystem has compiled data showing that the PEPP’s higher flexibility makes it markedly more effective than the APP - a perhaps unsurprising finding given that the flexibility amounts to a relaxation of significant constraints applied to the APP.

A problem is that among other things, the flexibility some might wish to transfer wholesale from the PEPP to the APP crucially allows purchases to diverge from the key used to calculate national central banks’ respective share of the ECB’s capital.

To be sure, the rules of the PEPP dictate that ‘the benchmark allocation across jurisdictions will be the Eurosystem capital key of the national central banks’. This appears to be of limited practical relevance, given the ECB also affirms that ‘[a] flexible approach to the composition of purchases under the PEPP is nonetheless essential...’.

The APP clearly lacks this flexibility, based on rules the ECB self-imposed in designing the programme, just as the APP – in contrast to the PEPP – is also prohibited, for example, from breaching sovereign bond issue and issuer limits.

Even so, the APP has provoked German sensibilities, always acute with respect to ECB monetary policy, with court challenges the result. It was precisely the constraints the ECB had embedded in the APP that swayed the outcome in its favour.

Were the relatively unfettered PEPP not anchored in time to the duration of the pandemic or the crisis phase thereof, its legal vulnerability would be a more questionable proposition.

With that in mind, some Governing Council members would understandably be uncomfortable about changing the APP’s framework so fundamentally. Even if they are in the minority, overriding their principled objections could create the public impression that expediency had trumped proportionality within the Eurotower.

A German revolt would be one reasonably certain outcome.

Still, a probably substantial number of those involved in the ultimate decision would favour allowing deviations by the APP from the capital key. Given the potentially quite long life of the APP, they can argue that the commitment could be retained to wind up respecting the key at the very end, whenever that will be.

Whether the APP can be endowed with key aspects of the PEPP’s flexibility is an open question for  now. In any case, the inevitably lively discussion on this point is yet to come. Despite the public positioning of some, as of recently there had been no formal discussion at the level of the Council on the potential continuation in effect of the PEPP via the APP.