The world of the ECB has turned upside down in just a few years. In the 2010s, one of the central bank's biggest challenges was to boost inflation, which was far too low. Then came the pandemic followed soon after by the Russian attack on Ukraine. Inflation exploded. Although the ECB has since brought inflation back under control, the monetary policy situation in this decade is completely different to that of the previous decade. The volatility of inflation is increasing. Structural components such as demographics and climate change are increasing inflationary pressure. The increasing use of artificial intelligence, on the other hand, has the potential to mitigate inflation.

The ECB is currently examining whether its monetary policy instruments are still suitable for this environment, and where adjustments are necessary. One of the points that is the subject of heated debate outside the central bank – and in some cases also within it – is the use of bond purchases. Beginning in 2015, the ECB used bond purchases, technically known as quantitative easing (QE), to increase inflation. In the previous year, inflation averaged just 0.4%. In December 2014, prices even fell by 0.2% year-on-year.

The best way to increase inflation is to actually cut interest rates, as this makes loans cheaper and thus boosts economic activity. The problem at the time was that the ECB's deposit rate was already in slightly negative territory. Further interest rate cuts would have led to even greater losses in the value of savings. In addition, the pressure on banks to grant loans to companies and private households with dubious creditworthiness would have increased.

So instead of cutting interest rates, the ECB opted for massive bond purchases. The idea: to push down yields at the long end and thus stimulate the economy. However, the plan did not work. Inflation remained low. At the same time, the ECB's balance sheet swelled. The consequences can now be seen years later in record losses at the ECB and the Bundesbank, amongst other things. It is true that losses are far less problematic for central banks than for commercial banks, as central banks cannot become insolvent. Nevertheless, they should avoid being in the red for too long. This can damage the image of the institution in the eyes of the public. This is something the ECB must avoid. After all, high inflation from 2021 has already led to a loss of confidence. And the plans to introduce the digital euro could also have the same effect on some people.

The ECB should therefore think carefully about when bond purchases are a meaningful instrument. A short-term intervention in crisis-ridden market phases, such as during the pandemic, is one such case, as they then stabilise the financial markets. Prolonged use to control inflation or the economy should be avoided, as the costs far outweigh the benefits. And the central bank should also communicate this so that the financial market realises that it cannot count on QE in such phases.

It is also problematic if everyone expects the ECB to resort to large purchase programmes. High spreads then lose their actual disciplining effect – for example on countries with high levels of debt. However, market expectations can also have positive effects. The ECB emergency Transmission Protection Instrument (TPI), for example, which was set up in 2022, has never been used. It is intended to ensure a uniform monetary policy in all euro countries. The central bank wants to resort to these bond purchases in the event of „unjustified, disorderly market developments“.

The wording is so vague that every market participant has a different view of when TPI could be used. As a result, the instrument prevented a greater widening of spreads during the government chaos in France in 2024, for example, without actually being activated. The vague wording has therefore proved its worth and should also survive the ECB's strategy review.