The ECB's monetary policy was confronted with extraordinary challenges as a result of the financial market crisis in 2007/08, the Great Recession in 2009, the EMU's second recession after 1999 and the outbreak of financing problems of governments in member countries in the same period. The ECB's monetary policy was deeply influenced by fiscal policy, or rather by the lack of a fiscal partner, and general economic policy in the EMU. It will be shown that monetary policy is embedded in macroeconomic processes and policies and in a macroeconomic regime is only one player among many. In this chapter monetary policy during the Great Financial Crisis and the Great Recession is analysed.

The financial market crisis and Great Recession in the EMU

In the United States, the real estate boom came to an end in 2007. An increasing number of subprime loans could not be paid back and gave their name to the biggest financial market crisis since the 1930s. However, real estate loans to households with low income and poor collateral were only the trigger of the financial market crisis. Any other segment could have caused the outbreak of the crisis as well. The financial system as a whole had become so fragile due to deregulation and innovation in previous years that a relatively small financial market segment, such as subprime mortgage credits in the US, could trigger a global crisis (Hellwig 2008; Goodhart& Tsomocos 2019).

The collapse of the market for securitized loans played a large role in the deepening crisis. Good examples of these are mortgage-backed securities and collateralized debt obligations (CDOs). Mortgage credits were sold by banks to investment banks or special purpose vehicles partly owned by the banks themselves. Service of these long-term credits would now go to the investment banks or special purpose vehicles. These credits were pooled and cut in tranches. The so-called waterfall principle meant that one tranche would suffer first when credits in the pool were not serviced. Only when the first-loss tranche was completely used up, would the next tranche suffer, and so on. Investors with different appetites for risk would buy the different tranches, wherein the most risky tranche earned the highest interest rate.