Monetary Policy Tools of European Central Bank

Monetary Policy Tools of European Central Bank

 

 

 

 

 

 

“The basic prescription for preventing deflation is straightforward, at least in principle: Use monetary and fiscal policy as needed to support aggregate spending, in a manner as nearly consistent as possible with full utilization of economic resources and low and stable inflation. In other words, the best way to get out of trouble is not to get into it in the first place”. 
                                                                                                                                                                Ben Bernanke 

 

 

 

 

 

 

                                                                                                                           Prepared by:

Nino Burnadze

Salome Lortkipanidze

 

 

 

Table of content:

 

Introduction  

 

European Central Bank:

• Creation of ECB
• Decision-making bodies of ECB
• Responsibility of ECB
• Primary goals and objectives

 

  

Monetary Policy:

• What is Monetary Policy?
• Primary goals of MP of ECB

 

Main Part  

 

Monetary Policy Tools of ECB:

• Open Market Operations, Standing facilities, Minimum Reserves
• MP instruments’ main aims

 

Conclusion

• Simplicity and transparency behind monetary policy operations

 

 

 

 

 

 

INTRODUCTION

 

ECB

The European Central Bank (ECB) is the sixth of the seven institutions of the European Union (EU) as listed in the Treaty on European Union (TEU). It is the central bank for the euro and administers the monetary policy of the euro area comprises the 17 European Union countries that have introduced the euro since 1999.

ECB was established in June 1, 1998. The bank is headquartered in Frankfurt, Germany. The current President of the ECB is Mario Draghi, former governor of the Bank of Italy.

The staff of the ECB is truly European; its members come from all 27 countries of the European Union.

 

INDEPENDENCE

 

When performing Eurosystem-related tasks, the ECB and the national central banks must not seek or take instructions from Community institutions or bodies, from any government of an EU country or from any other body. Likewise, the Community institutions and bodies and the governments of the Member States must not seek to influence the members of the decision-making bodies of the ECB or of the NCBs in the performance of their tasks.

 

The Eurosystem is also functionally independent. The ECB and the NCBs have at their disposal all instruments and competencies necessary for the conduct of an efficient monetary policy and are authorized to decide autonomously how and when to use them.

 

DECI S ION-MAKING BODIES OF THE ECB

 

 

• Governing Council

 

• Executive Board

 

• General Council

 

 

 



The Governing Council

 

 

 

 

The Governing Council is the main decision-making body of the ECB. It consists of:

• The six members of the Executive Board, plus
• The governors of the national central banks of the 17 euro area countries.

Responsibilities

• To adopt the guidelines and take the decisions necessary to ensure the performance of the tasks entrusted to the Eurosystem;
• To formulate monetary policy for the euro area. This includes decisions relating to monetary objectives, key interest rates, the supply of reserves in the Eurosystem, and the establishment of guidelines for the implementation of those decisions.

Meetings and decisions

The Governing Council usually meets twice a month at the Eurotower in Frankfurt am Main, Germany.

At its first meeting each month, the Governing Council assesses economic and monetary developments and takes its monthly monetary policy decision. At its second meeting, the Council discusses mainly issues related to other tasks and responsibilities of the ECB and the Eurosystem.

While the minutes of the meetings are not published, the monetary policy decision is explained in detail at a press conference held shortly after the first meeting each month. The President, assisted by the Vice-President, chairs the press conference.

 

The Executive Board

 

The Executive Board consists of:

• The President
• Vice-President and
• four other members

All members are appointed by the European Council, acting by a qualified majority.

Responsibilities

• To prepare Governing Council meetings;
• To implement monetary policy for the euro area in accordance with the guidelines specified and decisions taken by the Governing Council. In so doing, it gives the necessary instructions to the euro area NCBs;
• To manage the day-to-day business of the ECB;
• To exercise certain powers delegated to it by the Governing Council. These include some of a regulatory nature.

 

 

 

The General Council

 

The General Council comprises

• The President of the ECB;
• The Vice-President of the ECB; and
• The governors of the national central banks (NCBs) of the 27 EU Member States.

In other words, the General Council includes representatives of the 17 euro area countries and the 10 non-euro area countries.

The other members of the ECB's Executive Board, the President of the EU Council and one member of the European Commission may attend the meetings of the General Council but do not have the right to vote.

Responsibilities

The General Council can be regarded as a transitional body. It carries out the tasks taken over from the European Monetary Institute which the ECB is required to perform in Stage Three of Economic and Monetary Union on account of the fact that not all EU Member States have adopted the euro yet.

The General Council also contributes to:

• The ECB's advisory functions;
• The collection of statistical information;
• The preparation of the ECB's annual report;
• The establishment of the necessary rules for standardizing the accounting and reporting of operations undertaken by the NCBs;
• The taking of measures relating to the establishment of the key for the ECB's capital subscription other than those laid down in the Treaty;
• The laying-down of the conditions of employment of the members of staff of the ECB; and
• The necessary preparations for irrevocably fixing the exchange rates of the currencies of the "EU Member States with derogation" against the euro.

 

MONETARY POLICY

Monetary policy is the process by which the monetary authority of a country control the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability.

The primary objective of the ECB’s monetary policy is to maintain price stability. The ECB aims at inflation rates of below, but close to, 2% over the medium term.

To maintain price stability is the primary objective of the Eurosystem and of the single monetary policy for which it is responsible. This is laid down in the Treaty on the Functioning of the European Union, Article 127 (1).

"Without prejudice to the objective of price stability", the Eurosystem shall also "support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union". These include inter alia "full employment" and "balanced economic growth".

The Treaty establishes a clear hierarchy of objectives for the Eurosystem. It assigns overriding importance to price stability. The Treaty makes clear that ensuring price stability is the most important contribution that monetary policy can make to achieve a favorable economic environment and a high level of employment.

 

Monetary policy instruments

Open market operations can be divided into:

 

• Main refinancing operations; these are regular liquidity-providing transactions with a frequency and maturity of one week;

 

• Longer-term refinancing operations; these are liquidity-providing transactions with a monthly frequency and a maturity of three months;

 

• Fine-tuning operations; these can be executed on an ad hoc basis to manage the liquidity situation in the market and to steer interest rates. In particular, they aim to smooth the effects on interest rates of unexpected liquidity imbalances;

 

• Structural operations can be carried out by the Eurosystem through reverse transactions, outright transactions and issuance of debt certificates.

 

The Eurosystem also offers two standing facilities, which set boundaries for overnight market interest rates by providing and absorbing liquidity:

 

• The marginal lending facility, which allows credit institutions to obtain overnight liquidity from the national central banks against eligible assets;

 

• The deposit facility, which can be used by credit institutions to make overnight deposits with the national central banks in the Eurosystem.

 

Finally, the Eurosystem requires credit institutions to hold Minimum Reserves in accounts with the national central banks. Each credit institution must keep a certain percentage of some of its own customer deposits (as well as of some other bank liabilities) in a deposit account with the relevant national central bank on average over a reserve maintenance period of around one month. The Eurosystem pays a short-term interest rate on these accounts. The purpose of the minimum reserve system is to stabilize money market interest rates and create (or enlarge) a structural liquidity.

 

 

Main aims of MP Instruments:

Open market operations play an important role in steering interest rates, managing the liquidity situation in the market and signaling the monetary policy stance.

Standing facilities aim to provide and absorb overnight liquidity, signal the general monetary policy stance and bound overnight market interest rates.

The intent of the minimum reserve system is to pursue the aims of stabilizing money market interest rates, creating (or enlarging) a structural liquidity shortage and possibly contributing to the control of monetary expansion.

 

CONCLUSION

Simplicity and transparency ensure that the intentions behind monetary policy operations are correctly understood. The principle of continuity aims at avoiding major changes in instruments and procedures, so that central banks and their counterparties can draw on experience when participating in monetary policy operations. The principle of safety requires that the Eurosystem’s financial and operational risks are kept to a minimum. Cost efficiency means keeping low the operational costs to both the Eurosystem and its counterparties arising from the operational framework.

 

Bibliography:

• http://www.ecb.int/ecb/html/index.en.html
• http://www.ecb.int/pub/pdf/other/escb_en_weben.pdf
• http://en.wikipedia.org/wiki/Discount_window
• http://www.ecb.europa.eu
• “The Economics of money, Banking and financial Markets” Frederic S. Mishkin 7^th Edition.