Speech by Piero Cipollone, Member of the Executive Board of the ECB, at an MNI Connect webcast

Today I would like to discuss the ECB’s balance sheet and its implications for our monetary policy.
In recent years, the monetary policy debate has mainly focused on our interest rate decisions. This is for good reason. In response to the biggest inflation shock in a generation, we embarked on the fastest tightening of monetary policy in the ECB’s history through rate hikes.
During this tightening phase, we used policy rates as the primary tool for setting our monetary policy stance, while normalising our balance sheet in a measured and predictable way. We initiated the gradual unwinding of our asset purchase programmes and recalibrated our targeted longer-term refinancing operations (TLTROs).[1] As a result, the size of our balance sheet has fallen by more than a quarter from its peak.
Policy rates remain our primary instrument and will therefore continue to attract the most attention. But we should not underestimate the important role that our balance sheet policies have played over time as a component of our overall monetary policy stance and in ensuring the smooth transmission of our monetary policy to the real economy. This still holds true today as we make our monetary policy less restrictive.
Inflation has now fallen substantially to levels close to 2%. Our latest projections foresee it converging towards our target over the medium term, and the risks to the inflation outlook – once sharply skewed to the upside – have now become more balanced.
At the same time, the euro area’s economic recovery remains weak – especially in the near term. The risks to the growth outlook are tilted to the downside and, if they materialise, may derail the recovery, with implications for the inflation outlook.
Against this background, the Governing Council has gradually been reducing the degree of monetary policy restriction by cutting policy rates towards neutral territory. While our direction is clear, we are very attentive to incoming information in view of the prevailing uncertainty about the economic environment. We continue to make decisions on a meeting-by-meeting and data-dependent basis. This gives us the option to adapt our interest rate path if necessary to ensure that inflation stabilises sustainably at our 2% medium-term target.
However, given the importance of financial conditions in determining the inflation outlook, we also need to consider the role played by the reduction of our balance sheet. In the tightening phase our rate decisions and balance sheet policies complemented each other, but they are now going in opposing directions.
This divergence has important implications across at least two dimensions.
First, it contributes to a steepening of the yield curve. Our rate cuts exert downward pressure primarily at the short end of the yield curve. At the same time, the gradual runoff of our asset purchase portfolios exerts upward pressure on long-term and, to a lesser extent, intermediate yields. This has been compounded by recent spillovers from the US.[2]
Second, it may affect credit supply. Declining levels of central bank liquidity could constrain banks’ ability to extend credit, resulting in tighter credit conditions and potentially slowing down the investment and consumption that are critical for economic recovery.
In setting the policy stance, we therefore need to consider the impact of the overall set of financial conditions resulting from our interest rate and balance sheet policies. In other words, we need to strike the right balance if we are to achieve our inflation aim without an undue negative impact on incomes and employment. A rate cut has a more contained easing effect when the balance sheet is simultaneously reduced. This has implications when discussing the appropriate policy rate path.
We also need to consider the potential risks to the transmission of our monetary policy. In the past, abundant levels of liquidity have acted as a safeguard against spikes in liquidity needs that emerged regardless of where our rates stood. With this in mind, we need to carefully monitor the transition from abundant to less ample excess liquidity, mindful of the potential implications for financial stability.
Today, I would like to take stock of the ECB’s experience with balance sheet policies, explaining why they remain a vital part of our monetary policy toolbox. I will then discuss the implications of the ECB’s balance sheet for our monetary policy in the current environment.
The ECB’s experience with balance sheet policies
At the ECB, balance sheet policies have served a dual purpose over time, allowing us to deliver on our price stability mandate amid exceptionally difficult circumstances.
First, during periods when interest rates approached their effective lower bound and inflation remained below target, the ECB used asset purchases to support an accommodative monetary policy stance.
For instance, the ECB launched its asset purchase programme (APP) in 2015 to stimulate the economy and inflation at a time when deflationary threats loomed large. Asset purchases and the associated provision of central bank liquidity worked in several ways – including through the portfolio rebalancing, exchange rate and credit channels – to generate a significant upward effect on both economic activity and inflation.[3]
Second, balance sheet policies have been pivotal to ensuring the smooth transmission of our monetary policy to the real economy, in both tightening and easing phases.
At times when we were lowering our policy rates, our TLTROs, launched in 2014, provided banks with long-term funding on favourable terms to incentivise them to lend to firms and households. This led to a persistent compression in lending rates and an increase in loan volumes over time.[4]
But balance sheet policies were also instrumental in ensuring the smooth transmission of monetary policy at times when we were increasing our policy rates. The announcement of our Transmission Protection Instrument (TPI) in 2022 allowed us to embark on the fastest rate hiking cycle in our history without sparking financial fragmentation in the euro area.
Of course, the stance and transmission functions of our balance sheet policies do not operate in isolation. There can be beneficial interactions between the two.
As rates increased, for example, euro area banks had sufficient liquidity to manage any maturity mismatches that arose. This – alongside strengthened regulation and supervision – helped them to emerge unscathed from the market turbulence in March 2023 that saw the collapse of three regional banks in the United States.
The proportionate use of balance sheet policies in an evolving economic landscape
The substantial expansion of the ECB’s balance sheet required careful monitoring of potential side effects. That is why the principle of proportionality lies at the core of how we use our balance sheet instruments.[5]
In its 2021 strategy review, the Governing Council assessed that its use of balance sheet measures – alongside negative interest rates and forward guidance – had indeed been proportionate, taking into account any side effects, for instance on inequality and the financial sector.[6]
Some concerns, however, require a more nuanced perspective.
For example, there is little evidence to suggest that excessive risk appetite may be attributable to larger central bank balance sheets. If this were the case, we should have seen less risk-taking in markets as central banks began to withdraw their market footprint.
But the opposite has been the case. Today equity markets are near all-time highs. This may be due to “animal spirits”[7], which have also been observed outside periods of central bank balance sheet growth. We saw them at play, for instance, during the dot-com bubble – a period when the cyclically adjusted price-to-earnings ratio hit its historic peak and central bank balance sheets were distinctly lean.
Moreover, as the Eurosystem gradually reduces its footprint in sovereign bond markets by reducing its holdings of euro area government bonds, concerns about the size of the balance sheet are becoming less and less justified (Chart 1).[8]

Chart 1
Size of euro area government bond market and the Eurosystem’s market footprint

(left-hand scale: EUR billions; right-hand scale: percentages)

Sources: Eurosystem and Centralised Securities Database.
Notes: The chart shows the evolution of the size of the euro area government bond market and splits it into outright holdings (yellow) and mobilised collateral (green), as well as what is not held or mobilised as collateral with the Eurosystem (blue). The Eurosystem market footprint is a relative measure, computed as the share of the Eurosystem’s euro area government bond (EGB) holdings compared with the nominal amount outstanding. Outright holdings are EGBs held by the Eurosystem via purchase programmes, adjusted by EGBs lent back via the securities lending against cash collateral facilities. Mobilised collateral includes EGBs mobilised as collateral for open market operations. The latest observations are for 31 January 2025.

Going forward, an evolving economic landscape suggests that balance sheet policies could be increasingly useful as monetary policy instruments. Let me highlight two developments that are particularly relevant here.
First, the non-bank financial sector has grown considerably over time and is becoming increasingly relevant in the funding of the real economy.
In the euro area, the financial assets of non-banks have more than doubled since the global financial crisis.[9] Compared with banks, non-banks are more responsive to monetary policy measures that influence longer-term interest rates, such as asset purchases.[10] Given that non-banks adjust their portfolios more actively in response to changes in interest rates, this also increases the need for sufficient liquidity in the system to facilitate these adjustments.
Second, geopolitical fragmentation means that the global economy is becoming more shock prone and subject to higher levels of uncertainty (Chart 2).

Chart 2
Global Economic Policy Uncertainty index

(index)

Source: Bloomberg.
Note: The latest observation is for December 2024.

In this environment, we need to remember that the euro area is subject to fragmentation risk. A key lesson from the sovereign debt crisis is that balance sheet policies have been instrumental in making the euro area a more “normal” jurisdiction from the perspective of monetary policy.
As we navigate an increasingly complex economic landscape, the transition from abundant to less ample excess liquidity represents an inflection point that also requires close monitoring.
In this environment, banks’ liquidity needs are met via a broad mix of instruments under our new operational framework. These include our short-term main refinancing operations (MROs) and three-month longer-term refinancing operations (LTROs) and will also include – at a later stage – structural longer-term credit operations and a structural portfolio of securities.[11]
However, the decline in excess liquidity warrants careful monitoring, as it could exert additional tightening pressures on financial and financing conditions, potentially exceeding the intended policy stance.
The implications of the ECB’s balance sheet for monetary policy in the current environment
It is in this context that I would like to talk about the implications of our balance sheet for monetary policy in the current environment.
The ECB’s balance sheet has been reduced at a faster pace than those of central banks in other major economies during their tightening cycles (Chart 3). So far, much of this decline can be attributed to banks’ repayments of TLTRO loans.[12]

Chart 3
Central bank total assets

(index = 100 at the start of the respective policy rate hiking cycles)

Sources: Bloomberg and ECB calculations.
Notes: The x-axis starts on 21 July 2022, 16 March 2022 and 15 December 2021 for the Eurosystem, Federal Reserve System, and Bank of England respectively. For the Bank of England, reserve balances are used as a proxy for the total balance sheet. The latest observations are for 12 February 2025.

Looking ahead, however, any further reduction in the size of our balance sheet will stem from the gradual unwinding of our asset purchase portfolios, as the Eurosystem no longer reinvests the principal payments from maturing securities.
As in the past, the normalisation of our balance sheet has implications for our monetary policy stance and the possible risks to monetary policy transmission.
The monetary policy stance
Let me start with the implications for our monetary policy stance.
Our reaction function for rate decisions is built around three well-known criteria: (i) the inflation outlook, (ii) the dynamics of underlying inflation and (iii) the strength of monetary policy transmission.
Inflation has fallen by around three-quarters from its peak in late 2022 (Chart 4). The disinflation process is well on track, and our staff projections see inflation averaging 2.1% this year, 1.9% next year and 2.1% in 2027.

Chart 4
Headline inflation

(annual percentage changes)

Source: Eurostat.
Note: The latest observation is for January 2025 (flash estimate).

Most measures of underlying inflation suggest that inflation will settle at around our 2% medium-term target on a sustained basis. In particular, the ECB’s measure of the persistent and common component of inflation (PCCI)[13] – a more forward-looking indicator of underlying inflationary pressures that tends to better predict future inflation – stood at 2.1% in December, and 2.0% when excluding energy.
Domestic inflation remains high, as wages and prices in certain sectors are still adjusting to the past inflation surge with a substantial delay. But our wage tracker is signalling a significant moderation in wage growth, and profits are partially buffering the impact on inflation.
It is the third leg of our reaction function – the strength of monetary policy transmission – that I would like to discuss in more detail, however.
As we cut interest rates, new borrowing for firms and households is becoming less expensive. But financing conditions continue to be tight – in part because our monetary policy remains restrictive and past rate hikes are still working their way through the economy.[14]
While credit continues to expand, lending to firms and households remains subdued by historical standards. In December, the annual growth rate of lending to firms was roughly two-thirds below its historical average.[15] Growth in housing loans increased gradually but also remained muted overall, at around one-fifth of its long-term average (Chart 5).[16]

Chart 5
Loans to firms and households

(percentage points)

Sources: ECB (BSI) and ECB staff calculations.
Note: The latest observations are for December 2024.

At the same time, the recent gradual recovery in lending has not kept pace with the nominal growth of the economy, as reflected in the continued decline of the loan-to-GDP ratio (Chart 6).

Chart 6
Ratio of bank loans to GDP

(percentages)

Sources: ECB (BSI), Eurostat and ECB staff calculations.
Note: The latest observation is for the third quarter of 2024.

While policy rates remain our primary instrument for adjusting our monetary policy stance, the normalisation of our balance sheet may also affect the stance through two key channels.
First, while our rate cuts exert downward pressure primarily at the short end of the yield curve, our quantitative tightening exerts upward pressure on long-term maturities and, to a lesser extent, intermediate ones. This serves to tighten financial conditions.[17]
Indeed, the runoff of the asset portfolios of central banks has arguably been one of several factors contributing to a steepening of sovereign yield curves in recent months – akin to a reversal of the duration risk channel previously associated with central banks through quantitative easing (Chart 7).

Chart 7
New duration risk absorbed by private investors

(EUR billions per basis point)

Sources: Bloomberg and ECB.
Notes: The chart shows the month-on-month change in the duration of government bonds held by private investors (i.e. investors other than the domestic central bank). Rates are approximated by weighted average maturity.

At its peak in early 2022, the impact of current and expected Eurosystem bond holdings in our asset portfolios lowered ten-year sovereign bond yields by around 175 basis points.[18] Due to quantitative tightening, however, the easing impact has now fallen to around 75 basis points and is expected to further reduce over time (Chart 8).

Chart 8
Impact of APP and PEPP sovereign bond holdings on ten-year sovereign risk premia

(basis points)

Source: ECB calculations.
Notes: The impacts are derived from an affine arbitrage-free model of the term structure with a quantity factor (see Eser et al., op. cit.) and an alternative version of the model recalibrated so that the model-implied yield reactions to the March PEPP announcement match the two-day yield changes observed after 18 March 2020. The model results are derived using GDP-weighted averages of the zero-coupon yields of the big-four sovereign issuers (DE, FR, IT and ES). The continuous line represents estimates based on real-time survey expectations. The dashed line is based on projections of the Eurosystem’s holdings of big-four sovereign bonds in the APP and PEPP as informed by the ECB’s December 2024 Survey of Monetary Analysts. The model abstracts from any potential holdings in a structural portfolio of securities. The latest observations are for January 2025 (monthly data).

According to ECB research, an expected €1 trillion reduction in bond holdings may raise long-term risk-free interest rates by about 35 basis points (Chart 9).[19]

Chart 9
Expected term premium impact from running down the asset portfolio by €1 trillion

(basis points)

Sources: ECB December 2024 Survey of Monetary Analysts (SMA) and Akkaya, Y. et al., op.cit.
Notes: The chart depicts the expected effect on the term premium of various assets with a ten-year maturity resulting from an expected €1 trillion decrease in the ECB’s bond holdings. Results are based on individual SMA responses from December 2022 until December 2023.

Second, an environment marked by declining levels of central bank liquidity may constrain banks’ ability to extend credit.
Research documents the strong relationship between loan supply and structural sources of liquidity, such as reserves obtained through credit easing programmes or those injected through quantitative easing interventions.
More specifically, a €1 change in non-borrowed reserves or credit easing reserves is associated with a corresponding change in credit of approximately 15 cents or 10 cents respectively.[20] In other words, a €500 billion drop in non-borrowed reserves – similar to the one expected in 2025 as a result of the decline in our APP and PEPP holdings – is associated with a €75 billion decline in credit supply, equivalent to about 0.6 percentage points of downward pressure on loans to the non-financial private sector.[21]
Accordingly, as central bank liquidity declines, we may see tighter credit conditions in the economy. This could slow down investment and consumption, with firms cutting back on capital expenditure and consumers reducing purchases of big-ticket items that require financing.[22]
Incoming data suggest that euro area GDP growth will remain subdued in the short term. Industrial production decreased notably in December and surveys indicate that manufacturing is continuing to contract, whereas services activity is expanding at a moderate pace (Chart 10).

Chart 10
Purchasing Managers’ Index

(diffusion indices)

Source: S&P Global.
Notes: “Output” and “New orders” correspond to the manufacturing and composite indices, and “Business activity” and “New business” to the services index. The latest observations are for January 2025.

Given the uncertain economic environment, we are yet to see a sustained rebound in investment (Chart 11).[23] And while we continue to expect consumption to be the main driver of the recovery, rising real incomes have not yet encouraged households to increase their spending in a commensurate manner (Chart 12).[24] In the face of subdued domestic demand, our latest staff projections forecast a slower economic recovery than had been forecast in the September projections.[25]

Chart 11
Detailed decomposition of euro area real GDP

(quarter-on-quarter percentage changes and percentage point contributions)

Sources: Eurostat and ECB staff calculations.
Note: The latest observations are for the fourth quarter of 2024 for real GDP, and for the third quarter of 2024 for the other components.

Chart 12
Real household disposable income and consumption

(second quarter of 2022 = 100)

Sources: Eurostat and ECB staff calculations.
Note: The latest observations are for the third quarter of 2024.

Moreover, geopolitical risks may create further headwinds for the recovery, which we will need to monitor carefully. Forthcoming findings from the ECB’s Consumer Expectations Survey (CES) suggest that consumers’ concerns about geopolitical risks are negatively affecting economic sentiment – leading to more pessimistic expectations, more elevated income uncertainty and, ultimately, a lower propensity to consume.
We are determined to ensure that inflation stabilises sustainably at our 2% medium-term target. As we gradually cut rates towards neutral territory, we need to be mindful of the fact that we now have two monetary policy tools working in opposing directions, given our ongoing quantitative tightening. This is a first in our history at the ECB.
We therefore need to ensure that we factor in the tightening of our balance sheet when calibrating our rate cuts to achieve our inflation aim. This is because the stance effects stemming from our rate cuts will be somewhat dampened by the tightening induced by the normalisation of our balance sheet.
This is an important consideration when discussing the appropriate policy rate path.
Risks to the transmission of our monetary policy
Similarly, we need to be mindful of the possible risks to the transmission of our monetary policy to the real economy in view of the prevailing uncertainty and potential risks to financial stability.
This cautious approach is crucial, especially given historical precedents where central banks faced unexpected challenges.
In late 2019, for instance, the Federal Reserve System was unexpectedly forced to temporarily reverse its balance sheet retrenchment due to liquidity challenges in financial markets.[26] In 2022 the Bank of England halted quantitative tightening and launched emergency gilt purchases to safeguard financial stability after pension funds’ liability-driven investment strategies exposed systemic risks.[27]
Recent bouts of market volatility also underscore that we should remain alert to the emergence of financial stability risks that may endanger transmission. Last August several factors converged to spark substantial market volatility.[28] The VIX, a market index that measures the implied volatility of the S&P 500 index, recorded its largest ever one-day spike (Chart 13).[29]

Chart 13
VIX index

(percentages)

Source: ECB staff calculations.
Notes: Long run average calculated since January 2000. The latest observations are for 7 February 2025.

Faced with such episodes of volatility, the further decline in our balance sheet must remain on a gradual and predictable path to avoid financial amplification effects.[30] This is especially important in an environment where euro area banks are already tightening their credit standards, especially for firms and consumer credit, due to higher perceived risks related to the economic outlook (Chart 14).[31]

Chart 14
Credit standards, demand for loans to firms and contributing factors

(net percentages)

Source: ECB (bank lending survey).
Notes: “Actual” values are changes that have occurred, while “expected” values are changes anticipated by banks. Net percentages for the questions on credit standards for loans are defined as the difference between the sum of the percentages of banks responding “tightened considerably” and “tightened somewhat” and the sum of the percentages of banks responding “eased somewhat” and “eased considerably”. Net percentages for the questions on demand for loans are defined as the difference between the sum of the percentages of banks responding “increased considerably” and “increased somewhat” and the sum of the percentages of banks responding “decreased somewhat” and “decreased considerably”. “Other financing needs” as unweighted average of “M&A and corporate restructuring” and “debt refinancing/restructuring and renegotiation”; “Use of alternative finance” as unweighted average of “internal financing”, “loans from other banks”, “loans from non-banks”, “issuance/redemption of debt securities” and “issuance/redemption of equity”. The net percentages for “Other factors” refer to an average of the further factors which were mentioned by banks as having contributed to changes in credit standards or changes in loan demand, respectively. The latest observations are for the fourth quarter of 2024 (January 2025 bank lending survey).

Our balance sheet policy instruments continue to be a crucial item in our toolbox. The expectation that we will use them if necessary protects the smooth transmission of our monetary policy and reduces the likelihood that we will need to use these tools in the first place.
Moreover, in an environment of heightened uncertainty, even in the context of excess liquidity, we need to remain prudent and be ready to step in should another shock emerge. We should maintain the flexibility to swiftly expand liquidity facilities if stressful conditions arise.
Conclusion
Let me conclude.
The ECB’s experience with balance sheet policies to date demonstrates their importance both for the monetary policy stance and for the transmission of our monetary policy to the real economy. They are a vital part of our toolkit.
While policy rates remain our primary instrument for adjusting the monetary policy stance, we should also consider the role played by quantitative tightening in influencing overall financial and financing conditions – be it through the yield curve or through the bank lending channel.
To strike the right balance, we should ensure that our rate decisions adequately compensate for the tightening induced by the reduction of our balance sheet.
Thank you.

Annexes

18 February 2025

Slides

In December 2021 the Governing Council decided to discontinue net asset purchases under the pandemic emergency purchase programme (PEPP) at the end of March 2022 and adjusted the path of net asset purchases under the asset purchase programme (APP). In addition, in October 2022 the Governing Council decided to recalibrate the third series of targeted longer-term refinancing operations (TLTRO III) as part of the monetary policy measures adopted to restore price stability over the medium term.
The tightening of policy expectations and long-term rates in the US over the fourth quarter of 2024 and the first weeks of 2025 has exerted upward pressure on euro area long-term yields.
See, for instance, Rostagno, M. et al. (2021), Monetary policy in times of crisis: A Tale of Two Decades of the European Central Bank, Oxford University Press; Arce, Ó. et al. (2020), “A Large Central Bank Balance Sheet? Floor vs. Corridor Systems in a New Keynesian Environment”, Journal of Monetary Economics, Vol. 114, October, pp. 350-67; Andrade, P. et al. (2016), “The ECB’s asset purchase programme: an early assessment”, Working Paper Series, No 1956, ECB, Frankfurt am Main, September; Rostagno, M. et al. (2021), “Combining negative rates, forward guidance and asset purchases: identification and impacts of the ECB’s unconventional policies”, Working Paper Series, No 2564, ECB, Frankfurt am Main, June; and Sims, E. and Wu, J.C. (2021), “Evaluating Central Banks’ tool kit: Past, present, and future”, Journal of Monetary Economics, Vol. 118, March, pp. 135-160.
Benetton, M. and Fantino, D. (2021), “Targeted monetary policy and bank lending behavior”, Journal of Financial Economics, Vol. 142, No 1, October, pp. 404-429; Altavilla, C. et al. (2020), “Mending the broken link: Heterogeneous bank lending rates and monetary policy pass-through”, Journal of Monetary Economics, Vol. 110, April, pp. 81-98; Barbiero, F. et al. (2024), “Targeted monetary policy, dual rates, and bank risk-taking”, European Economic Review, Vol. 170, November.
Proportionality is a fundamental principle of EU law that requires that any action taken by the ECB is suitable, necessary and proportionate to the objectives pursued. See Chiti, M.P. et al. (2020), “The Principle of Proportionality and the European Central Bank”, European Public Law, Vol. 26, No 3.
ECB (2021), “An overview of the ECB’s monetary policy strategy”, July; Altavilla, C. et al. (2021), “Assessing the efficacy, efficiency and potential side effects of the ECB’s monetary policy instruments since 2014”, Occasional Paper Series, No 278, ECB, Frankfurt am Main, September.
“Animal spirits” is a Keynesian expression referring to human psychological factors influencing investment decisions. See also Akerlof, G. and Schiller, R. (2009), Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism, Princeton University Press.
Historically, the main concerns surrounding a large market footprint have been that: (i) it exerts downward pressure on term and credit risk premia, thereby flattening the yield curve; (ii) it may increase collateral scarcity and thus lead to strains in repo markets; (iii) it may reduce the space to undertake monetary policy easing in the future in times of stress or when rates are at the effective lower bound; and (iv) it should not become larger than needed to steer rates.
Financial Stability Committee (FSC) high level task force on NBFI (2024), “Eurosystem response to EU Commission’s consultation on macroprudential policies for non-bank financial intermediation (NBFI)”, November.
Work stream on non-bank financial intermediation (2021), “Non-bank financial intermediation in the euro area: implications for monetary policy transmission and key vulnerabilities”, Occasional Paper Series, No 270, ECB, Frankfurt am Main, September.
ECB (2024), “Changes to the operational framework for implementing monetary policy”, 13 March.
All TLTRO III loans were paid back in full by the end of 2024.
Bańbura, M. and Bobeica, E. (2020), “PCCI – a data-rich measure of underlying inflation in the euro area”, Statistics Paper Series, ECB, No 38, October.
In addition, the aggregate lending rate can be influenced by composition effects. First, a loan’s price is only observed if the borrower is not discouraged and the lender does not reject the application. Second, a significant shift from riskier to safer borrowers can exert downward pressure on lending rates – without this rebalancing, rates would be higher. Evidence from both hard and soft data supports the presence of such downward pressure.
In December, the annual growth rate of lending to firms edged up to 1.5% – still well below the historical average of 4.3%.
In December, housing loans grew at an annual rate of 1.1% – significantly below the long-term average of 5.1%.
Recent evidence indicates that interest rates remain sensitive to quantitative tightening surprises even during periods of market calm and positive economic growth (see D’Amico, S. and Seida, T. (2024), “Unexpected Supply Effects of Quantitative Easing and Tightening”, The Economic Journal, Vol. 134, No 658, February, pp. 579-613; and Lloyd, S. and Ostry, D. (2024), “The asymmetric effects of quantitative tightening and easing on financial markets”, Economics Letters, Vol. 238, May).
The sovereign bond yield here relates to an average of the “big four” economies, i.e. Germany, France, Italy and Spain.
Akkaya, Y. et al. (2024), “Quantitative Tightening: How do shrinking Eurosystem bond holdings affect long-term interest rates?”, The ECB Blog, 14 November. Similar results are obtained in Costain, J., Barrau, G.N. and Thomas, C. (2024), “The term structure of interest rates in a heterogenous monetary union”, BIS Working Papers, No 1165, Bank for International Settlements, 1 February. Importantly, these results underscore that the estimated impact of quantitative tightening on long-term interest rates is broadly comparable in magnitude to the inverse effects of quantitative easing documented in previous studies (see, for example, Eser, F. et al. (2023), “Tracing the Impact of the ECB’s Asset Purchase Program on the Yield Curve”, International Journal of Central Banking, Vol. 19, No 3, August; and Altavilla, C. et al. (2021), “Asset Purchase Programs and Financial Markets: Lessons from the Euro Area”, International Journal of Central Banking, Vol. 17, No 4, October).
Altavilla, C., Rostagno, M. and Schumacher, J. (2024), “When banks hold back: credit and liquidity provision”, Working Paper Series, No 3009, ECB, Frankfurt am Main.
A similar quantification is obtained in Altavilla, C. et al., “Central Bank Liquidity Reallocation and Bank Lending: Evidence from the Tiering System”, Journal of Financial Economics (forthcoming). The findings of this paper highlight that a reduction in central bank reserves affecting banks with lower liquidity holdings can have significant contractionary effects on loan supply.
For theoretical and empirical evidence on how quantitative tightening affects the real economy, see Kumhof, M. and Salgado-Moreno, M. (2024), “Quantitative easing and quantitative tightening: the money channel”, Staff Working Papers, No 1090, Bank of England, August; and Altavilla, C. et al. (2024), op. cit.
In the third quarter of 2024, investment growth was entirely explained by an exceptional rise in Irish non-construction investment. Excluding Ireland, investment contracted by 0.6% in the third quarter. See Cipollone, P. (2025), “Interview with Reuters”, 6 February.
Baumann, A. et al. (2025), “Are real incomes increasing or not? Household perceptions and their role for consumption”, Economic Bulletin, Issue 1, ECB.
ECB (2024), “Eurosystem staff macroeconomic projections for the euro area, December 2024”, December.
Anbil, S. et al. (2020), “What Happened in Money Markets in September 2019?”, FEDS Notes, Board of Governors of the Federal Reserve System, 27 February.
Pinter, G. (2023), “An anatomy of the 2022 gilt market crisis”, Staff Working Papers, No 1019, Bank of England, March.
These included a weaker-than-expected US jobs report, diminished market liquidity during the summer break and a rapid unwinding of yen-funded carry trades.
Todorov, K. and Vilkov, G. (2024), “Anatomy of the VIX spike in August 2024”, BIS Bulletin, No 95, Bank for International Settlements, 29 October.
On the interaction between liquidity and the external finance premium, see Altavilla, C. et al. (2024), “Macro and micro of external finance premium and monetary policy transmission”, Journal of Monetary Economics, Vol. 147, Supplement, October.
See ECB (2025), “The euro area bank lending survey – Fourth quarter of 2024”, January.

 
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Banking systems are largely insulated from inflation, but vulnerabilities at some banks could lead to tradeoffs between containing inflation and protecting financial stability
Before the pandemic, investors worried about how persistently low inflation and interest rates would crimp bank profits. Paradoxically, they also worried about bank profitability when post-COVID reopening sent inflation and central bank interest rates soaring. The failure of Silicon Valley Bank and other US lenders in early 2023 appeared to validate these fears.
Our new research on the relationship between inflation and bank profitability helps us make sense of these concerns. Most banks are largely insulated from shifts in inflation—the exposure of income and expenses tend to offset each other. Yet some have significant inflation exposures, which may lead to financial instability if concentrated losses lead to wider panics in the banking sector. As several major central banks are reassessing their monetary policy frameworks in the aftermath of the post-pandemic inflation surge, a deeper understanding of the links between inflation and bank profitability can help design better monetary policy frameworks.
Our findings imply that central banks may need to consider financial stability when setting their policy stance to combat inflation.
Inflation matters
Does inflation matter for bank profitability? This question has received surprisingly little attention. We answer it by combining balance sheet and income data for more than 6,600 banks in advanced and emerging economies with nearly three decades of IMF economic data.
Most lenders appear largely hedged against inflation with both bank income and expenses rising with inflation to similar degrees. Income and expenses tied to borrowing and lending are exposed indirectly to inflation, because they primarily react to policy rates that fluctuate in response to inflation. In contrast, other income and expenses—revenues from non-traditional banking activities, services, salaries, and rent—are exposed directly to price changes.
At the country level, the impact of inflation on bank income and expenses individually varies widely across banking systems. Shifts in inflation are reflected in income and expenses much more rapidly in some countries than in others. But, again, since both income and expenses rise with inflation to similar degrees in most countries, most banking systems appear largely hedged to inflation.
Concentrated exposures
So, can inflation be a cause for concern?
Our research identifies specific vulnerabilities: some banks are particularly susceptible to inflation due to different risk management and business models. Outliers in both advanced and emerging market and developing economies stand to see large losses when inflation and interest rates spike.
Strikingly, 3 percent of banks in advanced economies and 6 percent of banks in emerging economies are at least as exposed to elevated interest rates as Silicon Valley Bank at the onset of its failure. Banks in emerging economies also appear more exposed to inflation directly, possibly due to more widespread price indexation.

Policy implications
Amid high inflation, tightening monetary policy, while necessary, could lead to meaningful losses for banks with large exposures. Customers and investors may then reassess risks across all banks, which could lead to panics and financial instability.
Strengthening prudential regulation and supervision, heightening required risk management at banks, improving transparency, and using granular risk assessments accounting for key factors our research highlights for a broad set of banks would all help to systematically contain inflation exposures.
Despite these improvements, if losses at individual banks leave room for wider contagion, central banks may need to balance raising rates to contain inflation against the potential for financial instability.
 
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Each year, the EIB Investment Survey provides a snapshot of the issues facing EU firms and their ability to invest and grow their business. While the survey looks at trends across the European Union, it also hones in on individual countries and provides detailed information on how companies are weathering challenges such as tighter financial conditions, the demands of climate change, and the need to innovate and improve digitalisation amidst growing uncertainty.
Highlights of the results for individual countries include:
Digitalisation and innovation:

Danish firms excel in innovation and the adoption of digital technologies. They are more likely to innovate than the average EU firm (49% vs 32%). Moreover, Danish firms are ahead of EU firms on the adoption of advanced digital technologies (84% vs. 74%), particularly medium and large firms and manufacturers.

Czech firms are innovative and use state-of-the-art technologies. The share of Czech firms that have innovated during the preceding financial year is above the EU average (48% vs. 32%). A higher share of Czech firms has adopted advanced digital technologies than EU firms (91% vs. 74%).
Italian firms’ investment in innovation and digital technologies is very close to their EU peers.

Climate change:

In Finland, almost all (99%) of firms have taken action to reduce greenhouse-gas emissions, which is higher than the EU average of 91%. Additionally, 49% of Finnish firms see the transition to stricter climate standards and regulations as an opportunity, compared to 27% on average in the European Union.

French firms outpace their EU counterparts when it comes to investing in climate mitigating measures. But they spend less in adaptation investment and insurance coverage: 12% of French firms are insured against climate risks vs. 21% in the EU on average.
Nearly half of Swedish firms (49%) view the transition to stricter climate standards and regulations as an opportunity over the next five years, significantly more than the 29% of EU firms.

Overall investment:

Investment in Croatia is 26% above pre-pandemic levels (in real terms), driven by the strong expansion in the private sector. Croatian firms are notably more positive than the EU average about the political, regulatory and economic climate.

The share of Dutch firms investing reached a peak of 97% in 2024, surpassing the EU average (87%). However, the share of firms expecting to increase rather than decrease their investment (9%) has declined steadily since 2022 (22%).

Looking ahead to the next three years, Spanish firms plan to invest in expanding capacity. More Spanish firms report capacity expansion as their investment priority than the EU average (42% vs. 26%).

Explore the survey results

The EIB Investment Survey is conducted annually and includes data from approximately 13 000 firms in all EU Member States plus a sample from the United States. Its main results, the EIB Investment Survey: European Union overview, were released in October 2024. The survey provides information on firm characteristics and performance, past investment activities and future plans, sources of finance and the financing issues businesses face.

Investment trends

The European Union overview publication looked at broader investment trends and found that while many EU firms were satisfied with their overall level of investment over the last three years, a significant share (14%) felt they still were not investing enough to meet current challenges and to transform their business to remain competitive.

The share of firms expecting to increase rather than decrease investment halved in 2024, falling to a net balance of 7%, from 14% in 2023.

The EU overview also highlighted some important disparities between EU firms and their US counterparts.

The share of EU firms investing in expansion is 6 percentage points below the share of US firms (26% in the European Union vs. 32% in the United States).
EU firms devote 37% of their investments to intangible assets, focusing less on land, buildings, and infrastructure than US firms do (14% of EU firms vs. 24% of US firms).

Looking ahead, EU firms expect to continue investment in replacing instead of expanding capacity. This contrasts sharply with US firms, where 47% said they expected to expand capacity in the next three years, compared to 26% in the European Union.

Supply chain resilience

EU firms are highly dependent on trade, either with other EU members or with countries beyond the European Union. Political and trade tensions threaten to disrupt supply chains, although those risks dissipated somewhat in 2024. However, EU and US firms remain concerned about disruptions to their logistics and transport and their ability to comply with new regulations, standards and certifications.
In response to trade shocks, EU and US firms have adopted similar strategies: building up inventories, investing in digital tracking of supplies and diversifying suppliers. Despite the challenge, EU firms are less likely to reduce their reliance on international trade by cutting the amount of imported goods and services used in production.

Only 7% of EU firms are willing to scale back imported goods and services used in production, vs. 14% of US firms.

Climate change

EU firms continue to lead in climate change investments, whether to prepare for extreme weather or to reduce carbon emissions. EU firms are also less likely to see the green transition as a risk than their US counterparts.

One in three EU firms (34%) say that the transition to stricter climate standards and regulations will pose a risk to their business over the next five years, compared to 42% of US firms.
27% of EU firms even see the green transition as an opportunity.

Investment barriers

EU and US firms share concerns about the business environment, and say they have not seen any significant improvement in recent years. Firms in both regions mainly worry about the availability of staff with the right skills and uncertainty about the future.

In the European Union, 46% of firms say that energy costs remain a major obstacle to investment.
EU firms are also more likely to perceive business regulations and the availability of finance as major obstacles than their US counterparts.

Download the complete survey here

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NEW YORK—The Federal Reserve Bank of New York’s Center for Microeconomic Data today released the January 2025 Survey of Consumer Expectations, which shows that inflation expectations were unchanged at the short- and medium-term horizons, and increased at the longer-term horizon. Commodity price expectations rose across the board, with the expected price change for gas, food, medical care, education, and rent all increasing. Labor market expectations were mixed, with job loss and job finding expectations both rising and unemployment expectations falling to the lowest level since July 2021. Household spending growth expectations also declined in January, hitting the lowest level seen in the last four years.
The main findings from the January 2025 Survey are:
Inflation

Median inflation expectations were unchanged at 3.0% at both the one- and three-year-ahead horizons. Median five-year-ahead inflation expectations rose by 0.3 percentage point to 3.0% in January. This increase was driven primarily by respondents with a high-school education or less. The survey’s measure of disagreement across respondents (the difference between the 75th and 25th percentile of inflation expectations) increased at the one- and five-year horizons and was unchanged at the three-year horizon.
Median inflation uncertainty—or the uncertainty expressed regarding future inflation outcomes—was unchanged at the one-year horizon, declined at the three-year horizon, and increased at the five-year horizon.
Median home price growth expectations rose by 0.1 percentage point to 3.2%. This increase was driven by respondents in the West census region. This series has been moving in a narrow range between 3.0% and 3.3% since August 2023.
Year-ahead commodity price expectations rose across the board, increasing by 0.6 percentage point for the price of gas to 2.6%, 0.6 percentage point for the price of food to 4.6%, 1.0 percentage point for the cost of medical care to 6.8%, 0.2 percentage point for the cost of college to 5.9%, and 0.5 percentage point for rent to 6.0%.

Labor Market

Median one-year-ahead earnings growth expectations increased by 0.2 percentage point to 3.0% in January. This series has been moving within a narrow range between 2.7% and 3.0% since January 2024.
Mean unemployment expectations—or the mean probability that the U.S. unemployment rate will be higher one year from now—decreased by 0.6 percentage point to 34.0%, the measure’s lowest reading since July 2021. The decline was driven by respondents with no college degree, those with an annual income below $100,000, and those above age 40.
The mean perceived probability of losing one’s job in the next 12 months increased by 2.3 percentage points to 14.2%. This increase was broad based across demographic groups, but most pronounced for those over the age of 60. The mean probability of leaving one’s job voluntarily in the next 12 months also increased by 1.7 percentage points to 19.9%. This increase was most pronounced for those with an annual household income below $50,000.
The mean perceived probability of finding a job in the next three months if one’s current job was lost increased by 1.3 percentage points to 51.5%. This increase was driven by those with an annual household income below $100,000.

Household Finance

The median expected growth in household income increased by 0.2 percentage point to 3.0% in January. The series has been moving in a narrow range between 2.8% and 3.1% since August 2023.
Median household spending growth expectations declined by 0.4 percentage point to 4.4%, its lowest reading since January 2021, but remains above pre-pandemic levels. The decline was broad-based across age, income, and education groups.
Perceptions of credit access compared to a year ago improved in January, with the net share of households reporting it is easier versus harder to obtain credit than one year ago increasing. Expectations for future credit availability also improved.
The average perceived probability of missing a minimum debt payment over the next three months decreased by 0.9 percentage point to 13.3%. This series remains above its 12-month trailing average of 13.0%.
The median expected year-ahead change in taxes at current income level increased by 0.2 percentage point to 3.2%, but remains well below its 12-month trailing average of 3.9%.
Median year-ahead expected growth in government debt increased by 0.1 percentage point to 6.0%. This reading is well below the series 12-month trailing average of 8.6%.
The mean perceived probability that the average interest rate on saving accounts will be higher in 12 months decreased by 0.2 percentage point to 25.0%.
Perceptions about households’ current financial situations compared to a year ago deteriorated in January, with the net share of households reporting a worse versus better situation compared to a year ago rising. Similarly, year-ahead expectations about households’ financial situations also deteriorated in January.
The mean perceived probability that U.S. stock prices will be higher 12 months from now increased by 0.5 percentage point to 40.3%.

About the Survey of Consumer Expectations (SCE)

The SCE contains information about how consumers expect overall inflation and prices for food, gas, housing, and education to behave. It also provides insight into Americans’ views about job prospects and earnings growth and their expectations about future spending and access to credit. The SCE also provides measures of uncertainty regarding consumers’ outlooks. Expectations are also available by age, geography, income, education, and numeracy.
The SCE is a nationally representative, internet-based survey of a rotating panel of approximately 1,300 household heads. Respondents participate in the panel for up to 12 months, with a roughly equal number rotating in and out of the panel each month. Unlike comparable surveys based on repeated cross-sections with a different set of respondents in each wave, this panel allows us to observe the changes in expectations and behavior of the same individuals over time. For further information on the SCE, please refer to an overview of the survey methodology here, the interactive chart guide, and the survey questionnaire.
 
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By Marinela-Daniela Filip, Daphne Momferatou and Susana Parraga-Rodriguez | At the heart of the euro area’s competitiveness challenges lies weak productivity growth. The ECB Blog looks at how this makes it more difficult to carry out monetary policy.

While companies in the euro area are getting more productive, they are doing so at a much slower pace than their competitors. Weak productivity growth is putting monetary policy in a difficult situation. When the economy struggles to grow and loses competitiveness this can increase inflationary pressures and reduce the space for monetary policy to manoeuvre. In this post we take a closer look how the loss of competitiveness affects monetary policy, where the issue has come from, and what can be done to reverse the trend.
How exactly does monetary policy interact with productivity?
In general, productivity growth – i.e. how many goods and services can be produced per hour worked – is a key determinant of the overall potential of an economy to grow. That, in turn, affects its natural rate of interest, which is an important factor for effective monetary policy. This is because a central bank raising its policy rate above the natural rate can cool down the economy. Lowering the policy rate below the natural rate can stimulate the economy. At the natural rate of interest, savings and investment are balanced and the economy can grow at its full potential without overheating and pushing inflation up or down too much. At this rate the economy can operate with price stability and full employment – an ideal state that sometimes is referred to as a “goldilocks economy”.
Higher productivity leads to higher potential output, which eventually leads to a higher natural interest rate. This gives a central bank greater scope to stimulate the economy in difficult times via lower rates while still keeping prices stable. It also makes the transmission of monetary policy to the real economy more effective, i.e. policy interest rates translate more directly into how restrictive or loose the financing conditions for people and businesses are.
However, when resources are not allocated efficiently and productivity is low, firms struggle to increase output. This low economic growth makes firms more sensitive to interest rate changes. Then, even small rate hikes by central banks to ensure price stability can further dampen growth, leading to a vicious circle. This is because low growth makes businesses more cautious about investment. Business sentiment may further deteriorate when high uncertainty and geopolitical tensions make energy and other raw materials more expensive. In such a situation, the room for monetary policy to manoeuvre shrinks.
And what about price stability in particular?
When input costs are growing fast, strong productivity growth can help the central bank to contain inflation. How? A sudden increase in input costs such as wages and energy can lead to cost-push inflation if not accompanied by corresponding productivity gains. And when higher prices lead to higher wage demands, this can create a wage-price spiral.[1] That is why the ECB looks at unit labour costs (ULC) when it assesses wage and price developments. ULC are essentially the labour compensation needed to produce one unit of output and are a widely used indicator of competitiveness. Overall, lower ULC are associated with greater competitiveness. ULC developments can be decomposed into the contributions of compensation per employee and productivity. Robust productivity growth can go hand-in-hand with higher wages without compromising competitiveness. Chart 1 shows how the interplay of labour compensation and productivity significantly affects ULC. But production costs can of course also increase due to other factors, such as energy. Likewise, firms may push prices when seeking to increase their profits.
During the post-pandemic recovery, for example, high commodity prices and supply bottlenecks led to strong price increases in the euro area, initially alongside higher profits, requiring the ECB to increase interest rates.[2] Over time, the price increases fed into higher wage demands so that workers could make up for their lost purchasing power. This led to strong ULC increases and weak productivity growth, but they were buffered by higher profits and a wage-price spiral was avoided.

Chart 1
Euro area ULC and components

Sources: Eurostat and ECB calculations.
Note: Data for 2024 refers to the first three quarters of the year. The evolution of unit labour costs (ULC) in 2020 and 2021 was affected by the job retention schemes.

When assessing euro area ULC developments, it is important to also look at what is happening in individual member countries. Differences in competitiveness are normal in a currency union when they reflect temporary adjustments to shocks or catching-up processes. But longer-term divergences can result in the euro area’s single monetary policy becoming less than optimal for individual countries.[3] Countries with their own national currency have the option to regain competitiveness by lowering policy interest rates and devaluing their currency, but this option is no longer available in a currency union. The ECB sets its monetary policy by looking at the euro area as a whole and thus cannot address the specific needs of each country. That’s why it’s important to close competitiveness and inflation differentials between euro area countries. It doesn’t just strengthen the European economies; it also helps the ECB to implement its monetary policy more effectively.
Why is euro area productivity falling behind anyway?
Productivity in the euro area has been slowing consistently over the past three decades, falling behind that of the United States (Chart 2). This is due in part to inefficient work and ineffective technologies and the slow increase in machinery and equipment used per worker. Lacklustre productivity compared to other economies can also be traced to the weaker performance of European “frontier firms”. These are the most technologically advanced and productive companies within a particular industry, especially in the information and communication technology sectors. This relative underperformance is closely linked to lower firm dynamism (generally the rate at which firms enter, grow and exit the market), less investment and breakthrough innovation, and slower adoption of digital technologies.[4]

Chart 2
Labour productivity gap between the euro area and the United States

(USD 2010, purchasing power parity per hours worked)

Sources: Bergeaud, A., Cette, G. and Lecat, R. (2016), “Productivity Trends in Advanced Countries between 1890 and 2012”, The Review of Income and Wealth, September; also long-term productivity database.
Notes: The euro area represents the aggregation of Germany, Spain, France, Italy, the Netherlands, and Finland. As explained in the paper, in 2012 these six countries together represented 84% of euro area GDP. Last observation available is 2022.

So, what can we do?
Low productivity growth in the euro area and the loss of competitiveness is amplified by additional challenges already on the horizon. The recent energy crisis demonstrated why Europe needs to be competitive, resilient and less dependent on other regions. Mario Draghi’s report on the future of European competitiveness and Enrico Letta’s report on empowering the Single Market rightly stress the urgent need for policies to boost competitiveness and resilience. Coordinated and combined efforts are needed to develop and swiftly adopt concrete policy proposals such as the ones included in the recently published Competitiveness Compass for the EU. As detailed above, a more competitive economy also matters for the ECB, as it can support monetary policy in keeping prices stable, stabilising the economy, and thereby increasing the living standards of all euro area citizens.
The views expressed in each blog entry are those of the author(s) and do not necessarily represent the views of the European Central Bank and the Eurosystem.
Check out The ECB Blog and subscribe for future posts.
For topics relating to banking supervision, why not have a look at The Supervision Blog?

See I. Schnabel (2023). The risks of stubborn inflation. Speech at the Euro50 Group conference on “New challenges for the Economic and Monetary Union in the post-crisis environment”.
E. Hahn (2023). “How have unit profits contributed to the recent strengthening of euro area domestic price pressures?” ECB Economic Bulletin Issue 4/2023.
M.D. Filip, D. Momferatou and R. Setzer (2023). “Inflation and competitiveness divergences in the euro area countries” ECB Economic Bulletin Issue 4/2023
See M.D. Filip, D. Momferatou and S. Parraga-Rodriguez (2025). “European competitiveness: the role of institutions and the case for structural reforms” ECB Economic Bulletin Issue 1/2025

 
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Prepared by Claus Brand, Noëmie Lisack and Falk Mazelis
Estimates of the natural rate of interest, or r*, show trends that are of fundamental significance for monetary policy, but are subject to important caveats. r* is defined as the real rate of interest that is neither expansionary nor contractionary. Measures of r* are typically constructed as an equilibrium value towards which interest rates tend to gravitate in the medium to long term, as aggregate saving and investment imbalances abate and the inflationary or disinflationary pressures that may have developed as a consequence of those imbalances dissipate. These measures are also informative regarding the risk of short-term interest rates becoming constrained by their effective lower bound. However, available measures of r* are fraught with measurement and model specification challenges and are highly uncertain, reflecting, to different degrees, model, parameter, filter and real-time data uncertainty. While estimates of r* provide complementary information for monetary policy decisions and aid communication on the stance of monetary policy, these cannot be seen as a mechanical gauge of appropriate monetary policy at any point in time. In conducting monetary policy, there is no alternative to taking decisions on the basis of a comprehensive analysis of the data and their macroeconomic implications. In the euro area, in particular, the focus of such an assessment is threefold: the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission.
Ranges of point estimates from different r* models indicate a very high degree of model uncertainty. Model uncertainty is the variability in estimates of r* that arises from using different models. Since r* is unobservable, economists rely on a range of models to estimate it. These models may incorporate different definitions of the benchmark rate, for example the instrument used by the central bank to conduct monetary policy. Different models may also rely on alternative determinants, such as measures of economic slack or the time horizons over which inflation eventually stabilises. Models can be clustered by type of measure – such as slow-moving equilibrium measures and cyclical inflation-stabilising measures. Slow-moving r* measures are anchored to long-run economic trends but may not capture short-term fluctuations. Cyclical r* measures reflect short-term dynamics and exhibit inflation-stabilising properties but can be sensitive to temporary shocks and are less stable. Balancing these trade-offs is challenging.

Chart A
Real natural rates of interest in the euro area

(percentages per annum)

Sources: ECB calculations, Eurosystem estimates, Federal Reserve Bank of New York and Consensus Economics.
Notes: Estimates displayed for survey-based, term structure-based and semi-structural measures are based on the same measures referred to in the box entitled “Estimates of the natural interest rate for the euro area: an update”, Economic Bulletin, Issue 1, ECB, 2024. The DSGE-based estimate is not included here. HLW-based measures, which do not ensure a stationary real rate gap, are displayed separately from other semi-structural measures. The latest observations are for the third quarter of 2024 for Holston, Laubach and Williams (2023), Grosse-Steffen, Lhuissier, Marx and Penalver (mimeo), and Carvalho (2023); and for the fourth quarter of 2024 for all other estimates.

Chart A shows a wide range of point estimates for the real natural rate. Following a modest post-pandemic increase, the updated range of point estimates of the real natural rate of interest for the euro area has remained broadly unchanged since the end of 2023 and is consistent with the estimates documented in Issue 1, 2024 of the Economic Bulletin.[1] We distinguish between four categories of measures. The median from survey-based measures is indicated by the red line. Measures shown by the dark blue area are derived from models of the term structure of interest rates. Those derived from semi-structural models are shown by the dark yellow area. Finally, three estimates derived from the Holston-Laubach-Williams (HLW) model are shown separately, by the light yellow area. The latter measures are not available for the fourth quarter of 2024.[2] Taking only the measures shown in the dark blue and dark yellow areas that were possible to update to the very end of 2024, the most recent estimates of real r* span a range between -½% and +½% (see the dark blue and dark yellow intervals corresponding to the fourth quarter of 2024 in Chart A).[3] The way to translate those measures into their nominal counterparts is measure-specific. Some of the models produce both real and nominal versions of r*, while others estimate only one version. In the latter case, the missing value must be derived by adding or subtracting the ECB’s 2% medium-term inflation target or the model-consistent medium-term inflation expectations from the model estimate. When the three estimates derived from versions of the HLW model are factored in, the range of real r* is -½% to 1% and the corresponding nominal range is 1¾% to 3%.[4] Referring only to those measures included in the dark blue and dark yellow areas for which an update to the end of 2024 is available, the estimates of the nominal r* from the most recent interval range between 1¾% and 2¼%. Given the estimation uncertainties highlighted in this box, such ranges should be viewed as merely indicative.
Natural rate estimates are further surrounded by uncertainties in model parameters. Point estimates typically display an outcome that is conditional on a single estimate of the model parameters – commonly the “most likely” value. However, the econometric methods used to estimate the model parameters generate a whole set of plausible alternative estimates. Bayesian estimation techniques, for example, concentrate on the probability distributions of parameters rather than on their fixed-point estimates. Embracing this approach allows the use of a distribution of values for each model’s r* estimate, which reflects the statistical uncertainty affecting the estimation of that model’s parameters. Taking one semi-structural model whose point estimate is included in the range shown in Chart A (the model by Brand and Mazelis, 2019), it can be seen that the parameter uncertainty surrounding each of the point estimates for r* can be quite large (Chart B, dark blue range).

Chart B
Parameter and filter uncertainty around the real natural rate estimates in the model by Brand and Mazelis

(percentages per annum)

Source: ECB calculations.
Notes: Estimates are based on Brand, C. and Mazelis, F., “Taylor-rule consistent estimates of the natural rate of interest”, Working Paper Series, No 2257, ECB, Frankfurt am Main, March 2019 (extended to include stochastic volatility in the output gap, a long-term interest rate, asset purchase effects and the effective lower bound). We employ the RISE toolbox for parameter estimation and regime-switching Kalman filtering, which enables the extraction of covariance matrices of unobserved states (see Maih, J. “Efficient perturbation methods for solving regime-switching DSGE models,” Working Paper, 01/2015, Norges Bank, 16 January 2015). Parameter and filter uncertainties are displayed as 95% uncertainty bands, calculated following the methods for statistical inference with the Kalman filter described in Chapter 13.7 of Hamilton, J.D., “Time Series Analysis”, Princeton University Press, 1994. Since computing the maximum likelihood estimate directly is impractical in our setting, we use the mode of the posterior distribution as an approximation. The filter uncertainty is based on the regime-specific covariance matrix of unobserved states from the predominant regime in the model, which features low volatility in the output gap and a policy rate that follows the Taylor rule. Considering regime-specific covariances or joint covariance matrices across different regimes would further enlarge the uncertainty ranges.

An additional source of uncertainty comes from the fact that r* is an unobservable variable that must be inferred from observable data – a challenge known as filtering. Since r* cannot be observed directly, we must deduce it from the economic data that we can measure. Accordingly, additional filter uncertainty is associated with obtaining an informative signal from the data. Like parameter uncertainty, the filter uncertainty range is time-varying. Cumulatively, parameter and filter uncertainty together can span up to several percentage points (Chart B, light blue range) even for a single model.[5]
Different data samples and revisions in backdata amplify the impact of filter uncertainty, leading to large ex post variations in in-sample point estimates of r* and adding yet another layer of uncertainty. Model-specific estimates of r* can vary significantly when observations are added or backdata are revised.[6] Chart C illustrates the considerable extent of this sensitivity using the widely referenced approach of Holston, Laubach and Williams (2023). Over time, as updates become available, revisions in previously obtained estimates can be as large as 1 percentage point. Most recently, end-of-sample point estimates have varied by similar magnitudes from one quarter to the next.

Chart C
Vintages of point estimates of the real natural rate of interest for the euro area from the model by Holston, Laubach and Williams

(percentages per annum)

Source: Federal Reserve Bank of New York.
Note: See Holston, K., Laubach, T. and Williams, J.C., “Measuring the Natural Rate of Interest after COVID-19”, Federal Reserve Bank of New York Staff Reports, No 1063, June 2023. The latest estimate, published for the third quarter of 2024, is also displayed at the lower end of the light yellow range in Chart A.

Despite the uncertainties involved, tracking broad movements in the natural rate over time provides qualitative insights into underlying economic trends. Notwithstanding the uncertainties associated with estimating r*, its trends contain information about developments in saving-investment imbalances that may create inflationary or disinflationary pressures, as well as about the extent to which the short-term interest rate might become constrained by the lower bound. The persistently low estimates of r* over the period 2015-22 displayed in Chart A, for example, reflect the persistent weakness in aggregate demand at the time and the low inflationary pressures that it generated. While in the post-pandemic environment estimates suggest some increase in r*, current estimates continue to be measurably below those prevailing before the global financial crisis, pointing to still lingering lower-bound risks in the event of sufficiently large disinflationary shocks.
The inherent uncertainties as well as conceptual shortcomings limit the usefulness of available natural rate estimates for conducting monetary policy in real time. Because of the multiple types of uncertainty and the focus on the short-term interest rate instrument – as opposed to broader measures of financing conditions, which can have a stronger impact on spending – the usefulness of r* as an indicator to support the calibration of the monetary policy stance is greatly limited, making it difficult to use as a rate-setting norm at policy meetings. Many models used do not construe r* as stabilising inflation in line with target but as merely indicating levels towards which interest rates gravitate over the longer term. As a function of historical shocks, such “equilibrium” interest rate measures are also largely backward-looking. By the time that equilibrium level is expected to be reached, the economy may well have already been exposed to further shocks, possibly causing the equilibrium rate of interest to drift and requiring monetary policy to offset these shocks. Furthermore, the connection between an r* defined in terms of the short-term interest rate instrument of monetary policy and the broader economy may itself change, as monetary policy transmission depends on a broader set of financing conditions – including the cost and availability of bank credit, and prices in a range of asset markets. The link between the short-term interest rate instrument and broader indicators for monetary policy is state-contingent and typically not stable. Accounting for these conceptual shortcomings and uncertainties is crucial for interpreting r* estimates.

The range reported in Chart A is also broadly consistent with the set of estimates published recently by the Bank for International Settlements. See Benigno, G., Hofmann, B., Nuño, G., Sandri, D, “Quo vadis, r*? The natural rate of interest after the pandemic”, BIS Quarterly Review, March 2024, pp. 17-30.
The HLW estimates are also shown separately, by the light yellow area, because of their methodological differences with respect to other semi-structural measures, shown by the dark yellow area. In particular, the family of HLW models (see Holston et al., 2017) posits a backward-looking relationship between the real interest rate gap, economic slack and inflation. Because of the inclusion of an accelerationist Phillips curve, the resulting r* estimate stabilises inflation around a random drift, i.e. an inflation level not necessarily close to the central bank’s inflation target. HLW-based approaches do not typically include an interest rate equation and thus have no mechanism to support a stationary real rate gap. Resulting estimates of persistently negative real rate gaps in the euro area are, however, challenging to reconcile with the inflation shortfalls observed over the period between the global financial crisis and the pandemic. Moreover, the marked flatness of the estimated Phillips and investment-savings curves amplifies filtering uncertainty, thus generating an “imprecision of the estimate” where, as acknowledged by Holston et al. (2017), “the average standard error for r* is very large, … and hence r* is barely identified”. On the theoretical foundations and econometrics of HLW, see Laubach, T. and Williams, J.C., “Measuring the Natural Rate of Interest”, The Review of Economics and Statistics, Vol. 85, No 4, November 2003, pp. 1063-1070, and Holston, K., Laubach, T. and Williams, J.C., “Measuring the natural rate of interest: International trends and determinants”, Journal of International Economics, Elsevier, Vol. 108, Supplement 1, May 2017, pages S59-S75.
Values reported in this box for both real and nominal r* are rounded to the nearest 25 basis point increment.
As a cross-reference, the HLW estimate for the euro area in the third quarter of 2024 published by the Federal Reserve Bank of New York was at 1.84% in nominal terms. For other HLW-type specifications tracked by the Eurosystem, see the approach explained by Carvalho, A., “The euro area natural interest rate – Estimation and importance for monetary policy”, Banco de Portugal Economic Studies, Vol. IX, No. 3, July 2023.
The wide dispersion is due in part to the relatively flat aggregate demand and Phillips curves embedded in semi-structural models used for estimating r* and is not specific to the Brand and Mazelis model. In comparison, the HLW estimates from the third quarter of 2024 mentioned earlier display an additional observability challenge, leading to a cumulative parameter and filter uncertainty range that is greater by an order of magnitude. Given uncertainty bands as large as +/- 10 percentage points, it is not clear whether the HLW estimate is ever different from 0% or any other interest rate level observed throughout the sample period. Fiorentini et al. (2018) demonstrate that flat aggregate demand and Phillips curves significantly increase filter uncertainty. See Fiorentini, G., Galesi, A., Pérez-Quirós, G. and Sentana, E., “The rise and fall of the natural interest rate”, Working Papers, No 1822, Banco de España, 2018.
All unobserved variable estimates suffer from the issue of data revisions and differences in data vintages. As highlighted by Orphanides and van Norden (2002), real-time estimates of the output gap are particularly unreliable as a result of substantial data revisions. See Orphanides, A. and van Norden, S., “The Unreliability of Output-Gap Estimates in Real Time”, The Review of Economics and Statistics, Vol. 84, No 4, November 2002, pp. 569-583.

 
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The gap between development financing needs and available resources could swell to USD 6.4 trillion by 2030 without a major overhaul of the financing system, according to a new OECD report.
The Global Outlook on Financing Sustainable Development 2025: Towards a more resilient and inclusive architecture shows that although total external finance to developing countries reached USD 5.24 trillion in 2022, it remained significantly below the USD 9.24 trillion estimated to be required annually to achieve the 2030 Agenda.
Financing needs have risen by 36% between 2015 and 2022, due in large part to climate change and geopolitical uncertainty, but resources provided have only increased by 22% over the same period – a 60% gap. Without an agreement this year on major reform of the international financing architecture, the report estimates that the financing gap will balloon to USD 6.4 trillion by 2030.

“The development financing gap is not insurmountable. The challenge lies in mobilising resources at scale, channelling financial assets into transformative investments such as clean energy transitions and sustainable infrastructure,” OECD Secretary-General Mathias Cormann said.
The report, published ahead of the upcoming Conference on Financing for Development in Seville, calls for updating the financing framework for post-2025 to redirect the capital available globally, starting with balancing ambition and practicality in addressing sustainable development priorities. Inclusive governance and policy coherence are critical to overcoming the hurdles, as disparities in decision-making structures and resource allocation undermine global trust and co-operation.
Despite a rebound from the COVID-19 pandemic, financing for sustainable development is still insufficient to meet growing needs, the report shows. While official development assistance (ODA) hit a record of USD 223.3 billion in 2023 among members of the OECD Development Assistance Committee (DAC), further commitments are required to ensure effective support to fill the needs of partner countries, particularly for investments in clean energy transition.
Remittances have been the dominant source of external financial flows to developing countries, a more than 30% increase since 2015 to reach USD 476 billion in 2023. However, transfer fees remain twice the level of the Sustainable Development Goals (SDGs) target of 3%, resulting in USD 16 billion in annual losses to households sending and receiving the money.
Strengthening domestic resource mobilisation is key for effective state functioning, but the tax-to-GDP ratio in low-income countries remains an average 11.44% in 2022, below the recommended 15% threshold. Meanwhile, debt levels in developing countries continue to rise. Between 2015 and 2024, the number of countries in debt difficulty and at high risk of debt distress increased from 16 to 24 and from three to 11, respectively.
As the economic gap between rich and poor nations has diverged rather than converged, the report calls for actions to renew the development financing system to better align money for sustainable development. For instance, there are already USD 461 trillion worldwide in financial assets — sufficient to cover the gap 115 times over — but the misalignment of these resources, including the USD 1.53 trillion spent on subsidising fossil fuels in 2022, needs to be redirected to achieve the 2030 Agenda.
To enhance accountability and transparency in resource allocation, the report also urges strengthening the global financing for development monitoring system to restore trust among all countries.
The Global Outlook provides a basis for the upcoming discussions at the Fourth International Conference on Financing for Development in Seville, where from 30 June countries will negotiate how to reform the global financing architecture for the implementation of the SDGs.
Download the report.

 
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The Federal Reserve Board on Wednesday released the hypothetical scenarios for its annual stress test, which helps ensure that large banks can lend to households and businesses even in a severe recession. Additionally, the Board released two hypothetical elements designed to probe different risks through its “exploratory analysis” of the banking system. The exploratory analysis will not affect bank capital requirements.
The Board’s annual stress test evaluates the resilience of large banks by estimating losses, net revenue, and capital levels—which provide a cushion against losses—under hypothetical recession scenarios that extend two years into the future. This year, 22 banks will be tested against a severe global recession with heightened stress in both commercial and residential real estate markets, as well as in corporate debt markets. The scenarios are not forecasts and should not be interpreted as predictions of future economic conditions.
In the 2025 stress test scenario, the U.S. unemployment rate rises nearly 5.9 percentage points, to a peak of 10 percent. The unemployment rate increase is accompanied by severe market volatility, a widening of corporate bond spreads, and a collapse in asset prices, including about a 33 percent decline in house prices and a 30 percent decline in commercial real estate prices.
Large banks with substantial trading or custodial operations are also required to incorporate a counterparty default scenario component to estimate potential losses from the unexpected default of the firm’s largest counterparty amid an acute market shock. In addition, banks with large trading operations will be tested against a global market shock component that primarily stresses their trading and related positions.
The table below shows the components of the annual stress test that apply to each bank, based on data as of the third quarter of 2024.
This year’s exploratory analysis includes two separate hypothetical elements that will assess the resilience of the banking system to a wider range of risks. One of the hypothetical elements examines how banks would react to credit and liquidity shocks in the non-bank financial institution sector during a severe global recession.
The second element of the exploratory analysis includes a market shock that will be applied only to the largest and most complex banks. This shock hypothesizes the failure of five large hedge funds with reduced global economic activity and higher inflation.
The exploratory analysis is distinct from the stress test and will explore additional hypothetical risks to the broader banking system, rather than focusing on firm-specific results. The Board will publish aggregate results for the exploratory analysis alongside the annual stress test results in June 2025.
As the Board previously announced, it plans to take steps soon to reduce the volatility of stress test results and begin to improve model transparency in the 2025 stress test. Additionally, it intends to begin the public comment process on its comprehensive changes to the stress test this year.

Make Full Screen

Bank1

Subject to global market shock
Subject to counterparty default

American Express Company

Bank of America Corporation
X
X

The Bank of New York Mellon Corporation

X

Barclays US LLC
X
X

BMO Financial Corp.

Capital One Financial Corporation

The Charles Schwab Corporation

Citigroup Inc.
X
X

DB USA Corporation
X
X

The Goldman Sachs Group, Inc.
X
X

JPMorgan Chase & Co.
X
X

M&T Bank Corporation2

Morgan Stanley
X
X

Northern Trust Corporation

The PNC Financial Services Group, Inc.

RBC US Group Holdings LLC2

State Street Corporation

X

TD Group US Holdings LLC

Truist Financial Corporation

UBS Americas Holding LLC

U.S. Bancorp

Wells Fargo & Company
X
X

1. The information listed in this table is based on third quarter 2024 data. Return to text
2. M&T Bank Corporation and RBC US Group Holdings LLC elected to opt into the 2025 stress test. Return to text

For media inquiries, please email media@frb.gov or call 202-452-2955.
 
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