The monetary conditions index for the euro area

This box describes the monetary conditions in the euro area using an index that summarises information from indicators of the monetary conditions in the main sectors of the euro area economy: households (interest rates on loans for house purchase), companies (rates on loans of up to EUR 1 million), general government (synthetic ten-year bond yields), the banking sector (3M EURIBOR) and the rest of the world (the effective exchange rate of the euro vis-à-vis 38 main trading partners). The index is estimated in two variants: as the weighted average of the interest rate component and the exchange rate component  (weighted 6:1¹  in favour of interest rates; the weighted series) and as the principal component of all the input series (the factor series).

Chart 1 shows the real monetary conditions index, which contains ex ante real interest rates together with the real effective exchange rate. Between start of the period under review and approximately mid-2006 we can see an easing of the monetary conditions, reflecting a narrowing of the spread of individual interest rates against the 3M EURIBOR. The rise in nominal interest rates starting in late 2005 had a lagged effect on the real monetary conditions. The same goes for the falls in nominal rates in late 2008 and late 2011. The lowering of ECB rates to zero as from the end of 2011 was initially reflected in an easing of the real monetary conditions due to both falling real rates and a weakening exchange rate. Between the start of 2013 and the start of 2014, however, the real indices are signalling a tightening of the monetary conditions linked with appreciation of the euro, a fall in inflation expectations and a temporary rise in government bond yields (lasting until the start of 2014).

Chart 1 (Box) Real monetary conditions index for euro area
In late 2014 and early 2015, the indices are signalling a halt in the easing, or even a tightening, of the monetary conditions due to a fall in inflation expectations in the euro area 
(source: ECB, EC; CNB calculation)


During 2014, all nominal components of the interest rate component of the index acted in the direction of monetary policy easing, although this was counteracted by a fall in inflation expectations. This fall accelerated at the end of the year and, together with a temporary appreciation of the euro, started to act against a further easing the monetary conditions. At the end of the period under review, the factor index was thus signalling a halt in the easing of the monetary conditions due to the higher weight of the exchange rate in the index, while the weighted index was indicating a tightening due to the real interest rate component.

The effect of inflation expectations on the monetary conditions is apparent from the difference between the curves in Chart 1 and Chart 2, which shows the nominal monetary conditions indices for the euro area. Of primary interest here is the end of the period under review, when the nominal index was signalling a further easing of the monetary conditions while a decline in inflation expectations was fostering a real tightening.

Chart 2 (BOX) Nominal monetary conditions index for euro area
Unlike the real indices, the nominal indices are signalling an easing of conditions at the end of the period under review due to a fall in nominal interest rates and the effective exchange rate 
(source: ECB, EC; CNB calculation)


The aforementioned indices do not include the effects of the ECB’s non-standard monetary policy tools, which are difficult to quantify for monetary conditions index purposes. These tools are reflected in the size and structure of the ECB balance sheet (see Chart 3). In it, we can see growth in assets as a result of two extraordinary longer-term refinancing operations (LTROs) conducted in December 2011 and March 2012. However, these facilities were subsequently gradually repaid. This caused the ECB’s balance sheet to shrink again, a process that corresponds to the phase of autonomous tightening of the monetary conditions in Chart 1. To increase its balance-sheet total to the early-2012 level, the ECB therefore introduced a series of programmes last year (TLTROs, CBPP3, ABSPP) and started purchasing public assets under the EAPP in March 2015.

Chart 3 (BOX) Main asset items of Eurosystem consolidated balance sheet
In 2014 and 2015, the ECB introduced a series of programmes, including public asset purchases, to further ease the monetary conditions
(EUR billion; source: ECB)

¹The weights are based on European Commission estimates (http://ec.europa.eu/economy_finance/db_indicators/conditions/index_en.htm).