Anna 
Isabel Schnabel, a board member of the European Central Bank (ECB), has voiced her preference for a smaller balance sheet and a demand-driven approach for supplying liquidity to euro zone banks. As the era of low inflation and zero interest rates concludes, the ECB faces a crucial decision on whether to provide liquidity through lending or bond purchases.
Schnabel’s approach involves allowing banks to choose how much to borrow from the ECB, creating a “demand-driven” system. She argues that such a system is well-suited for the diverse euro zone, with its 20 countries varying in economic strength and separate banking systems. Schnabel suggests that a demand-driven system also helps limit the size of the central bank balance sheet, a consideration in the ongoing debate.
While advocating for a demand-driven approach, Schnabel acknowledges the possibility of a mix of different tools, indicating a willingness to explore compromises. In this complex debate, where her colleague Philip Lane supports supplying cash through bond purchases or longer-term loans, finding common ground may be essential for the stability of the euro zone financial system.
Schnabel argues that longer-term loans are preferable to asset purchases as they reach deeper into the banking sector. In contrast, cash from bond purchases tends to concentrate around a limited number of larger entities. The ECB board member’s proposal aligns with the preferences of policymakers from cash-rich northern euro zone countries.
The ongoing debate reflects differing views within the ECB, with Schnabel emphasizing that letting banks choose is beneficial due to uncertainties about precise demand. She estimates that the minimum size of the ECB’s balance sheet, currently at 7 trillion euros, would remain significantly larger than before the global financial crisis, driven by autonomous factors such as demand for banknotes and government deposits.
The central question in the debate revolves around two alternative systems: one with a “floor” under the money-market rate, akin to the Federal Reserve, and the other with a “ceiling” rate, resembling the Bank of England. Schnabel, supporting the latter option, emphasizes that any new auction of longer-term loans should be offered at market rates rather than subsidized rates, signaling a potential shift from past practices. The ongoing deliberations will shape the ECB’s approach to liquidity provision in the evolving economic landscape.
