Shadow ECB Council Urges ECB to be Careful with Exit Strategy

At the meeting of the Shadow ECB Council in Frankfurt on 26 November there was unanimity that the ECB should not change its key interest rate any time soon. Members urged the ECB to proceed very carefully with any moves to withdraw liquidity support from the banking sector.

Forecasts made by Shadow Council members did not change significantly on average. The prevailing expectation is for a return to moderate growth in 2010 and 2011 and slightly higher but still low inflation into 2011. The prevailing view was that underutilized production capacities will keep exerting downward pressures on wages and prices for a long time. One member objected to this argument, noting that estimates of the economy?s production capacities were notoriously unreliable and not useful for forecasting inflation. Members expect a longer period of moderate to low growth due to the need to rein in government deficits.

Shadow Council macroeconomic forecasts

(Forecast means in %, previous forecasts in brackets)

20090.3 (0.3)- 3.9 (- 3.9)
20101.2 (1.1)1.1 (1.0)
20111.5 (1.5)1.5 (1.4)

(Last month?s forecasts in brackets)
Contributors:. M. Annunziata; E. Bartsch; J. Cailloux; J. Callow; M. Diron, G. Horn, S. King; .J. Krämer; T. Mayer; E. Nielsen; J.-M. Six
Assumptions: All forecasters assumed that the ECB would leave its key rate at 1% for the next six months, one assumed a rate cut to 0.75%.

Rate Recommendation

There was unanimity that the ECB should not change interest rates at the next policy meeting on 3. December and no member expects a rate hike to become appropriate within the next three months. In the month before, one member had expressed a bias toward lower rates and one other had expressed a bias toward higher rates.

Liquidity Provision to Banks

The Shadow council was unanimous in urging the ECB to proceed very carefully with any moves to withdraw liquidity from the financial system. The prevailing attitude was that the situation of the financial sector had stabilized but that many financial institutions were still in fragile shape and disturbances in the funding markets could let severe problems resurface. Therefore, the group did not support the call for an explicit road map, spelling out in detail when and how the ECB would withdraw the additional liquidity it has created.

For this reason, there was a consensus that the ECB should not levy a surcharge on the December long-term refinancing operation (LTRO). Members feared that this would be taken as a first of more steps of monetary tightening and could unsettle markets in an undesirable way. However, a sizeable number of members supported the idea of making the LTRO a floating rate tender, with the interest rate resetting to the new key interest rates, in case the ECB should hike rates within the next 12 months.

Supporters of such a move said that this would address the concern that banks might rush to take advantage of the potentially last cheap LTRO and take out an excessive amount of liquidity. This, they argued, would make it harder for the ECB next year, to drain the excessive liquidity without creating disturbances.

An equally large group was in favour of keeping the December LTRO at full allotment and fixed rate. These members did not think that the risk of a rush for liquidity was very big and argued that an unexpected change in conditions of the LTRO might unsettle markets during the difficult end-of-year period.

There was agreement that next year no more 1-year operations should be needed and also on the idea that 3-month and 6-month operations should be reverted to fixed-allotment, variable-rate tenders.

Members were sceptical regarding the idea that the ECB should spell out its exit strategy from the generous liquidity provision. They argued that is was not possible to know how the situation of the financial sector would develop, and thus, what kind of liquidity support would be needed.

Individual Votes

Members' individual votes for 3 September:
Jose AlzolaThe Observatory Groupno change
Marco Annunziata


no change
Elga Bartsch

Morgan Stanley

no change
Agnes Benassy-QuereCEPIIno change
Jacques Cailloux


no change
Julian CallowBarclays Capitalno change
Marie DironOxford Economicsno change
Gustav HornIMK Macroeconomic Policy Instituteno change
Stephen King


no change
Jörg Krämer


no change
Thomas Mayer

Deutsche Bank

no change
Erik NielsenGoldman Sachsno change
Jean-Michel SixStandard & Poor'sno change
Angel UbideTudorno change
Charles WyploszGrad. Institute. Genevano change

Frankfurt 27 November 2009
Norbert Häring
Non-voting Chairman

Background information

The ECB Shadow Council was founded in 2002 upon an initiative of Handelsblatt, the German business and financial daily. It is an unofficial panel, independent of the ECB/Eurosystem, and comprising fifteen prominent European economist?s drawn from academia, financial institutions, consultancies and research institutes. The Shadow Council usually convenes by telephone conference on a monthly basis (though in November it holds a physical meeting). Its discussions take place a week before the monthly official ECB Governing Council "policy" meetings, and are intended to formulate an opinion as to what monetary policy decision its members believe that the ECB's Governing Council ought to undertake, both at its forthcoming meeting and also on a three month horizon.

Shadow Council members are encouraged to submit their own economic projections for euro area activity and inflation on a monthly basis, which constitutes the panel's forecast consensus as published each month. The Shadow Council's discussions and recommendations differ from surveys of economists concerning the outlook for ECB interest rates because the Shadow Council recommendation expresses the majority view of its' members opinion about what the ECB should do, rather than what they forecast it to do (and hence the "normative" views as expressed by Shadow Council members on what they consider the ECB ought to do can and often do differ from what they might say they expect the ECB to do). This "normative perspective can, however, give an early indication of shifts in the balance of opinion in the expert community, as can be seen by comparing the historic recommendations of the Shadow Council against subsequent decisions undertaken by the ECB Governing Council.

Members of the Shadow Council base their recommendations on the ECB's objectives as defined under the EU Treaty, though Shadow Council members do not necessarily adopt exactly the ECB's specific interpretation of its mandate: most Shadow Council members consider that a medium term inflation objective of two percent with a symmetric tolerance band around it would be clearer, more realistic and more appropriate than the definition adopted by the Governing Council, which defines price stability as an inflation rate of "below, but close to, two percent", in the medium term.

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