 So let me see. Okay, so now I have a blue square. And yeah, as I see, it's running. Okay, so that looks good. Let's hope it works. Welcome to the European Central Bank podcast, bringing you insights into the world of economics and central banking. My name is Michael Steen. In our last episode, we looked at the economic impact of the coronavirus pandemic. Today, we wanted to explore how it is affecting financial markets and why that matters. For today's podcast, we're joined by executive board member, Isabel Schnabel, who oversees the market operations of the ECB for a conversation about how the virus is impacting financial markets. Isabel, thanks for taking the time. I'm very happy to do so. So you are at home, I think, from the video. Yes, yes, I'm at home. That's in Bonn. In Bonn. Ah, okay, my brother lives there. Working from home, how's that been for you? What I like about it is that I see my family more often. And actually, what is really nice is that one of my three daughters often comes by and brings me some coffee or some chocolate. So she's very kind to me. And I enjoy that very much. You joined the executive board in January 2020. So it's only been a few months, right? So this is a, having to adjust to this, this strange way of working during the crisis came after a very short introduction. Yeah, you're perfectly right. So actually that for me, that was a big change. I mean, I was coming, of course, from a completely different world from academia, where the whole rhythm of life and work is a bit different, I would say. And so then when I joined the ECB, the crisis was not yet there. And the big topic on the agenda was the monetary policy strategy review. And then suddenly the crisis hit and the whole situation kind of changed completely. We had to talk about the coronavirus, which is mostly obviously a health crisis. And as a central bank, that's not something we can tackle. But as we touched on with a conversation in the last episode with your colleague, Philip Lane, we do have a role to play to limit its economic fallout. We've seen some dramatic effects from the crisis so far with economies coming, you know, it's in some places more or less to a halt. People are talking about GDP figures falling. Now, there's also been this dramatic effect on financial markets. And one thing we wanted to touch on with you today was if you can talk us through that a little bit and also explain a little bit why are stable financial markets so critical? And what is it that I as a person or a normal citizen, why should I worry about stresses in financial markets? Yeah, so let me start by explaining what financial markets actually do. So what they basically do is they channel funds from those who have more funds than they need to those who need more funds than they have. In normal times, the prices in financial markets or the stock prices, the bond prices, they incorporate all the information and the expectations about the future developments. And they do so in a more gradual fashion. But when there is a crisis, everything becomes much more abrupt. So often the financial system does not work properly anymore. There is a lot of uncertainty. I mean, take the corona crisis, nobody really knows what is going to happen. I mean, we have certain scenarios, but the uncertainty is very large. And this then implies that the prices in financial markets become very volatile and many market participants become risk averse because they don't know what's coming. They may be reluctant to lend money to others or they try to sell their assets in the market. And that can then imply that the consumers or the firms that they can no longer consume or invest as they had planned. And if the firms, if they don't get any more loans, that could mean that they have to delay their investment plans or they have to stop hiring people. And in the extreme case, they can even go bankrupt. And that then again translates into losses at the banks or at the creditors of the firms. And what is very important to understand is that the financial system can amplify any shock that occurs in the real economy substantially. And this is something that we have also seen in the global financial crisis. And so any shock to the real economy can become much worse when the financial sector is involved. So and that's, yeah, so you suddenly see that companies can't borrow money, which means they can't necessarily afford to keep producing. But the reason they can't do that is also that their customers have fallen away. So we're in this very tricky situation. I mean, how would you describe the current situation? Is this actually a financial crisis, would you say? So I mean, many people tend to compare this crisis to the global financial crisis of 2008-2009. But I would say this crisis is very different from the crisis that we've seen at that time. Back then it was really a financial crisis. So it originated in the financial sector and it then turned into a full blown systemic crisis after Lehman Brothers collapse. And this all then resulted in the collapse of the financial system, which then turned into a deep recession in many countries. And this deep recession was then again reinforced by problems in the financial sector. So in a sense that this crisis, it's somehow the other way around. So the crisis originated in the real economy. And it was actually caused by a health crisis, which then caused this lockdown of the economy and also the disruption of global value chains. And I mean, the households stopped consuming certain goods or services so they can no longer go to restaurants or to the hairdresser. And the firms, they stopped their production and then experienced this dramatic collapse in their revenues, which exposed them to liquidity problems because they no longer earned any money. Then the governments reacted quite forcefully in many countries and provided liquidity guarantees. And of course, also the ECB reacted forcefully by providing liquidity to banks so that the banks could continue to lend. And the reason for doing that is, is what? From our point of view, as a central bank. The reason is that in crisis times, very often it becomes very difficult for firms or households to get funding. And it also becomes expensive. So interest rates tend to go up. And the funding that we provide is relatively cheap. And this ensures that there is an incentive for the banks to pass on this relatively favorable conditions to those who want to borrow. And this then also ensures that the firms and the households continue to invest and to consume, which is very important for the functioning of the economy. Okay, so a large part of the response there by the central bank is to essentially keep everything moving or to help get things moving again. Would you agree with that? Yeah, that's certainly true. I mean, what we have seen in this crisis is that there was a point in time where the financial markets were severely disrupted. So we saw that stock prices collapsed. We had a very high volatility. Then in such episodes, the investors tend to shift into what is called safe havens. So that means they tend to sell the riskier assets and they rush into safe and liquid assets, also potentially into cash. And that then of course implies that the interest rates on the risky assets go up. And it also implies that it becomes very difficult to issue new debt or new equity in the market. And so basically markets no longer function properly. And what I described before, this process of channeling savings to those who need them no longer works. So essentially there's a sudden shock and the markets are trying to sort of incorporate everything they think they know about the future, but they suddenly don't know anything. So maybe it's hopefully not going too far to say it's sort of a panic effect. And that then can mean that otherwise sound companies and firms find it hard to just finance themselves to carry on doing their businesses. Exactly. And then then of course means that these liquidity problems that they are facing can also then turn into solvency problems. And they may even go into default even though in normal times they would have a perfectly viable business model. And that has huge economic costs and has to be avoided if possible. And how would you say that the measures that we took are dealing with those problems? We took many measures, but I would like to focus on the two most important measures. On the liquidity side, the most important measure are the targeted longer term refinancing operations or as we call them the teltrose. Through these operations we provide liquidity to banks and we provide this liquidity at rates that can go as low as minus one percent, but only under the condition that the banks keep up their lending to the real economy. So we have a built-in incentive to maintain lending and if banks do that they get these very favorable conditions and this is why we call these operations targeted operations. And this brings me to the second measure which is also a temporary measure which is our new asset purchase program, the pandemic emergency purchase program, or in short the PAP. And just to remind you what happened in the middle of March when we started this program. So at that time we saw that the conditions in financial market deteriorated rapidly and the interest rates went up for many assets, but also for sovereign bonds and even for the safest ones. And at the same time, and this is also very typical, we saw that the spread on the sovereign bonds of different member states of the euro area widened sharply. And this implied that the financing conditions across the board tightened substantially, but especially so in particular countries which then also introduced a fragmentation across the euro area and this of course endangered the transmission of our monetary policy to all parts of the euro area. Okay, so let's just take a moment to unpack that a little bit. So we're talking about spreads between countries in terms of the yields on their sovereign debt. The spread is the difference. So one country has to pay more than another. That's kind of a state of affairs, right? But if it increases too much, that's something that you as a policymaker worry about. Exactly, because I mean, what we see in such periods is that the spreads widen very quickly. And this sharp widening is very unlikely to be driven by changes in economic fundamentals because the economic fundamentals, they change in a much more gradual fashion. What you see in such situation is dynamics that are driven also by kind of market panic. And this can become self-reinforcing. It can lead to dangerous spirals that then become self-reinforcing. And therefore, when we see that spreads widen very rapidly, this is also a sign that markets are not working properly. And then that is a reason for us to intervene. And we did this then relatively quickly and in a very forceful fashion with this new program, the PEP. That means that we as a central bank will actually step in to the market and buy the sovereign debt. It's not only sovereign debt, it's actually, so it's private and public assets that are bought. And so by intervening directly in the market, we are then able to counter these market disruptions to stabilize the financial conditions. And this is exactly what is then needed to also fulfill our mandate of price stability. And what is special about this particular program, and this is very important, is that it's designed as a very flexible program. So it's flexible across time. So we have defined an overall envelope of 750 billion euros. But we can decide when we're going to make use of this envelope. So we can shift this over time. We can also shift it across asset classes, and so across private and public bonds, but then also across jurisdiction. So if we see that there is fragmentation going on, it may be necessary to buy a bit more of a certain sovereign bond and a bit less of another one. And this flexibility increases the effectiveness of this program very substantially. Okay. And we, as you said already, we saw probably the worst point in terms of financial markets in say the middle of March. We're now talking in roughly the middle of May. How's it been going? How are you satisfied with the results so far? So I think it's fair to say that our measures were very effective in calming the situation. But we also have to be aware of the fact that we are not back to the situation where we were before the crisis. So it's still the case that spreads are higher than before the crisis. The interest rates on corporate bonds are still higher than before the crisis. Stock prices are still down, especially the stocks of banks. And so it's clear that we have not gone back to a normal situation. So the financial market data shows it very clearly that we are still in a crisis. So we cannot lay back and relax. But we have to be very aware of the fact that this crisis is not over. And there's one other thing we thought we might ask you about, which is looking more to global level and how central banks together around the world keep financial systems working smoothly. And that's something where we've put out a bunch of statements on this as have others on the activation of swap lines. So we thought we might just quickly ask you to tell us about swap lines. What are they and how do they help in these kind of times? Yes. So swap lines, these agreements between central banks and their way to provide each other with liquidity in each other's currency. So if we have a swap line with the Federal Reserve, that would mean that we provide them with euros and they provide us with US dollars. And that is very important because a central bank, of course, can only supply liquidity in its own currency. But sometimes market participants have the need for other currencies, especially the US dollar, which plays a very important role in global financial markets, but also the euro for many countries. Therefore, the major global central banks have set up a swap line network. So these are the Federal Reserve from the US, the Bank of England, the Bank of Japan, the Swiss National Bank, the Bank of Canada and the ECB. They run like these standing swap lines that can be activated quickly when needed. And then in addition to this global network, we also activated additional swap lines. So with Denmark, with Croatia and Bulgaria. I see. And the idea is that in normal times, the banks or the counterparties that needed, say they were in Europe, they needed dollars, they would find that through private means through another bank. But at a time of tension, they maybe can't. So we step in and say, okay, we'll facilitate that. So you can think of this as a backstop. So the pricing is typically in a way that it's not too attractive. So one wants to make sure that if possible, market participants go to the private market. But by providing this backstop, we also, of course, influence the prices in the private market. And I mean, ideally, you could say the swap lines are not even used because then they are there as a backstop. And they make sure that the foreign currency funding markets function properly. Well, Isabel, thank you so much for joining us from Bonn and for taking time out of your busy schedule to explain these things. And hopefully we'll see each other in the office sometime soon. Yes, I hope so. So thank you very much. It was a great pleasure. Thank you. This brings us to the end of this episode. We've discussed how a health crisis, such as the coronavirus pandemic can affect the financial system and how market turmoil can negatively impact the economy. The ECB has taken a number of decisive steps to ensure financial stability in the euro area and mitigate the impact of the crisis on our economy. Stay tuned for our next episode in which we'll discuss the role of banks and banking supervision in the coronavirus crisis. Check out the show notes for more information, including our web pages that explain the ECB's measures in response to the pandemic. We'd love to hear your feedback and thoughts for future episodes via social media. You can use direct messages and comments. You've been listening to the European Central Bank podcast with Michael Steen. If you like what you've heard, please subscribe and leave us a review. Until next time, thanks for listening.