Dr. Constantin Gurdgiev:

I thank the committee for this opportunity. I agree with most of what my predecessors have said. The committee has my slides and members can look through them as we go along. I do not intend to cover all of them. I will move fairly quickly to cover as much of the ground as possible.

I want to touch on the background first, because this is important in the case of QE. There are two sides to the background. The first is the monetary side - in other words, the monetary environment to date. This is quite abnormal, and complicates significantly our ability to analyse the effects of QE across the eurozone and in Ireland in particular. The zero-bound policy rates, which have been mentioned previously, create a certain prevention and distortion in terms of analysing how quantitative easing transmits into the real economy. In addition, we have severe market fragmentation. This was caused partially by the previous quantitative easing programme deployed by the ECB, particularly the long-term refinancing operations, LTROs. In part, this was what triggered the programme parallel to the current programme of quantitative easing - that is, the targeted long-term refinancing operations, TLTRO, programme. We have unconventional monetary policies which are deployed by a number of the national central banks at the same time within the euro system. A great example of this, which I imagine we will touch upon presently, is the emergency liquidity assistance in Greece, but it applies to other banks as well. Another factor is unconventional European Central Bank policies, including those I have referred to, the LTRO and TLTRO programmes, as well as other asset purchases and so on. Finally, we have the big-gun items on the monetary policy side, which complicate but in some ways support the quantitative easing effects as well. Most notable among these are the outright monetary transactions, OMT, which amount to the whatever-it-takes so-called claim by Mr. Draghi in the past.

That is the monetary environment. It is difficult to disentangle it from the direct effects of QE. I will not discuss the real environment in depth but I would be happy to provide the committee with a link to a longer paper of mine on the matter. We have an environment featuring what is known as secular stagnation. This is affecting not only Ireland but the entire group of advanced economies from Japan all the way to the United States. Basically, it is a premise that the demand for investment is going to be low. It is low, and it does not matter what we do on the monetary side - in other words, it does not matter how much QE we generate - because borrowing and lending in the economy are going to be subdued none the less. The reason is the direct effect on the lack of demand for new investment. In other words, companies are simply not going for new credit and are not funding investment through credit. There is a lack of new credit creation in the system as well. This arises from a number of sources on the supply side, such as weaknesses in the banks' balance sheets and so on. This relates to the severe debt overhang in the real economy. We have external and domestic demand weaknesses. Demand for exports and consumption is weak. Finally, we also have increased risk aversion among investors. This is not surprising in itself because companies have seen how they and their counterparts have been dealt with by the banks in a crisis environment and, simply and frankly, they have no wish to get more into debt unless it is really necessary. Secular stagnation causes a significant drag on the potential effectiveness of quantitative easing in terms of real policy.

That said, quantitative easing has two channels through which it transmits into the real economy, at least in theory, and into the markets as well. The first channel is the ex-antechannel. This channel operates when the European Central Bank issues forward guidance about future policies. In the case of quantitative easing, this can be traced back to April 2014.

That is an important date for us because that is where that effect starts. It was amplified during the period from 21 January to 6 March. The latter is the period between the official announcement of the quantitative easing, QE, programme by the ECB and the deployment of first purchases by the bank in the markets themselves. That is the ex antechannel.

The second channel, which is equally important, is the ex post channel. This channel relates to what happens in the economy once the ECB begins buying assets, as it did after 6 March this year. It must be borne in mind that in conjunction with that, we have one targeted long-term refinancing operation, LTRO, programme, which attempts to address, in part, the fragmentation in the markets and which runs in parallel with QE.

I will start with the ex-antetransmission channel. Here we can see some of the positive effects of QE. These are very strong and some were mentioned by the previous speakers. I will deal first with the effect on the yields in the eurozone government debt markets. Between 21 January and 6 March of this year, there was a significant decline in yields across the eurozone, especially when account is taken of the adverse effects of the Greek crisis and others events in the news. On average, yields declined between seven and 50 basis points during the period in question. Maturity, bond quality and bond ratings come into play in this regard but this is a significant average over a short period. There has been a high impact, as expected, at the longer duration of the yield curve. In other words, 20 and 30-year securities and AAA-rated bonds have declined by 21 to 25 basis points on average and old bonds with 20 and 30-year maturities have declined by between 40 and 50 basis points on average. This is a very significant effect. Interestingly enough, the significance of effect rises in respect of lower quality bonds. As a result, countries such as Ireland have benefited more than have countries such as Germany, France, etc. Since April 2014, when the forward guidance period on QE started, through March of this year until purchases began to be made, there was an average of more than two percentage points decline on yields relating to eurozone bonds of upper maturity.

The immediate inflation effects are not yet apparent. However, the five-year, five-year swap rate, in other words, the expected inflation by the markets from five years from today to five years thereafter, or a five-year to ten-year horizon, has dramatically increased. This is the measure which the ECB monitors closely in terms of targeting inflation. There has been very significant uplift in this area in recent months. There has been some positive effect on inflation expectation, if not on inflation itself.

On ex post measures, this is, as already stated, the second channel. Dr. Kinsella mentioned one of these measures, namely, the so-called portfolio effects, in other words, the changes that happen in the composition of portfolios by investors in the markets once the ECB starts purchasing bonds. In addition to this, there are also supply and demand changes. The ECB has taken very significant quantities of bonds out of the secondary markets. These are not newly issued bonds. The ECB does not buy them from governments but rather from investors directly. It is expected that the ECB is going to take up to approximately 30% of all outstanding bonds of high-quality maturity in the German markets, over 20% in the Spanish markets and over 20% in the Italian markets, which will have a very significant impact. That impact has been present in the markets since April. The first impact of this activity is reduced liquidity in the markets. We have seen the explosion, in terms of the spreads of quoted bonds, between the bid and ask prices being quoted in the markets. That is not a good sign. In effect, the ECB purchases are clearly priming the bubble in terms of bond prices in the markets themselves. In other words, current yields do not correspond to the realities of the risk assessment. If, for example, members look at the Euromoney Country Risk assessments of sovereigns such as Germany, Italy and France - the larger ones - and also of Ireland, they will see that the quality of sovereign risk has not been commensurate with the uplift in bond prices. In other words, a bubble is developing there. This is very much consistent with the evidence from the investment markets.

Euromoney Research Group's survey, which includes data collected up to April of this year, of 1,924 institutions and bond investors indicates that 80% of the latter are concerned about the development of price bubbles in the bond markets and 62% of them expect things to get even worse. Another survey carried out on behalf of the Financial Timescontains exactly the same findings. The decline in the inventories of the market makers, namely, those who hold inventories of bonds they are ready to sell into the markets, has been approximately 80%. This means that the surplus of bonds available for transactions has shrunk significantly. This is causing major problems in the context of the front-running of bubbles in the markets themselves. As a result, the average quality of the bonds outstanding in the markets is also slipping. There has been a decline in quality and investors are now being incentivised, by the purchases being made by the ECB, to shift into lower quality bonds and assets. This, in turn, bids up the valuations of stock markets and, for example, government related bonds, which are not eligible for purchasing under QE, so government agencies, companies, development banks and so on are benefiting from the uplift without a corresponding improvement in their risks. What I am saying is that there is a mispricing of risk taking place in the market.

I will now deal with some of the Irish evidence relating to the real economy. This is also an ex postchannel. In other words, it is a channel that is currently open as the ECB is buying those bonds. First, let us consider the interbank markets premium. The chart I have provided covers the difference between the 12-month EURIBOR rate - the interbank market rate - and the overnight Eonia rate, and members can see that we are currently at near historical lows. On average, the current period is just about the second lowest ever. As members can see, we are trending along those lows and slightly below the average for that period. What does this mean? It means that we still have more ex anteeffects than ex posteffects. We are yet to see the full effect of QE on the interbank market but there has been a very strong response since the announcement of QE. This means the markets are pricing in future QE but they are not yet pricing in actual QE. The effect is reasonably pronounced and positive overall. What do I mean by positive? Basically, I mean that the markets are currently incentivising the banks to seek longer-term funding in the interbank market. This is more stable, higher quality funding and it should translate into banks issuing longer-term loans on more favourable terms to companies and households. That should be the effect but if members look at the next slide, they will see that good news for banks does not equal good news for the real economy. It is apparent from the data that in terms of the quantum of new loans issued, there has been a small, fragile uplift in terms of the number of loans to the corporate sector. However, there has been absolutely no movement away from the downward trend in respect of the issuance of debt to the household sector. The slide includes Central Bank data up to April but we do not yet have any for the subsequent months.

QE has had no effect on lending to households in Ireland but it has had a very strong effect in respect of the lending to corporates, a matter to which I will refer in a moment. There are questionable terms of lending composition and evidence that the uplift is not down to SMEs obtaining new credit but rather to the larger corporates obtaining it. The quality of that credit from the point of view of the borrower is not necessarily good and I will also discuss that matter further in a moment. The slide shows that larger loans significantly dominate smaller ones. The pre-crisis average of loans in excess of €1 million was 75.3%, whereas the current rate in this regard stands at 96%. The March-April average was 90.2%. This is not exactly a good thing. There has been nothing spectacular from QE on this front and a lot of questions are arising. In the first instance, we do not know how much of that is down to QE as opposed to the other measures, including targeted LTROs, which have been introduced. Second, we do not know how much of what is happening is due to the post-crisis bounce. In other words, the fall was very significant and the recovery should also be significant. The third aspect relates to how sustainable all of this is and whether it represents a new trend.

I am coming close to finalising my arguments in respect of all of these matters. One way of examining the quality of lending is to consider for how long companies and households are being offered a fixed rate. The ideal is to have the real economy operating on the basis of longer term as opposed to shorter-term rates. This is not happening. Proportionately, we are closer to the shorter-term rate at the back of the curve. We are still at crisis levels in the context of short-term borrowings dominating long-term borrowings and this is a significant problem from the point of view of seeking to move forward. The banks are being given incentives to lend long but they are lending short. This is a major issue. There are two big risks emerging as a result of QE and these are already in play. The first of these relates to the debt overhang - the biggest problem for the Irish economy - which remains unaddressed as a result of QE. In fact, it is potentially being made worse by QE.

What does that mean from the point of view of households and companies, the real economy? It simply means that quantitative easing, QE, superficially reduces the rates of interest charged on the loans-----