The Monetary Policy of the European Central Bank


Essay, 2009

18 Pages, Grade: 1,7


Excerpt


Inhaltsverzeichnis

I. LIST OF ABBREVIATIONS

II. LIST OF FIGURES

1. THE DEVELOPMENT OF THE EURO

2. THE INSTITUTIONAL FRAMEWORK
2.1 TASKS OF THE ECB

3. PRICE STABILITY

4. TRANSMISSION MECHANISM
4.1. INTEREST RATE VARIABLE
4.2. FOREIGN EXCHANGE RATE VARIABLE
4.3. ASSET PRICES VARIABLE
4.4. LOAN VARIABLE

5. QUANTITY THEORY OF MONEY

6. THE 2 PILLARS STRATEGY
6.1. ECONOMIC ANALYSIS
6.2. MONETARY ANALYSIS

7. THE OPERATIONAL FRAMEWORK
7.1. OPEN MARKET OPERATIONS
7.1.2. Longer term refinancing operations
7.1.3. Fine tuning operations
7.1.4. Structural operations
7.2. STANDING FACI LITIE
7.2.1. Marginal lending and deposit facility
7.3. MINIMUM RESERVE

8. HOW DOES THE ECB RESPOND TO THE CURRENT CRISIS?

9. CONCLUSION

BIBLIOGRAPHY

I. List of abbreviations

Abbildung in dieser Leseprobe nicht enthalten

II. List of figures

Figure 1:

Abbildung in dieser Leseprobe nicht enthalten

Source: Bloomberg, 2009

1. The development of the Euro

The national currency of each country in Europe was an indispensable element of national sovereignty and bank notes as an expression of national culture and trademark. With successive significance of bank notes as a means of payment in modern economic life central banks gradually gained a stronger role and monetary policy has become an integrated part of economic p olicy.1

In respect to this development the implementation of stage three of the EMU in 1999 was an important caesura in European history since a major part of European political independent countries gave up their sovereignty of monetary policy by adopting and agreeing on an irrevocable peg of their domestic currency to the Euro.2 This required a change to a new European monetary policy in the sector of European central banking. Thus, the ECB was founded and the NCB's of the MS integrated into a European central bank system.

It has never been achieved a similar integration process of a policy area in the EU as that of the common monetary and exchange rate policy. The EU has nowhere else been more authentically developed in its identity than in the area of the Euro and the ECB.3

Nowadays, the participating MS4 form a currency area that is considered as the second largest economic area behind the USA.5 This reveals the worldwide significance of European monetary policy that will be explained in the following. The first chapter will briefly comment on the institutional framework structure before the topic of price stability will be introduced. Chapter four and five will examine the transmission process and the monetary strategy of the ECB. In the sixth chapter monetary instruments will be closely described while chapter seven explains the use of instruments of the ECB to react to the current financial crisis. Concluding, a short assessment of European monetary policy will then frame the end of this paper.

2. The institutional framework

The ECB6 and the NCB's of all 27 MS form the ESCB. However the Eurosystem is a system of the ECB and the NCB's of these MS that have adopted the Euro.7 Article 105 of the EU Treaty refers to the ESCB but not to the Eurosystem since all nations in the ESCB are expected to join the Euro area in the near future. But its mandate is regulated in the EU Treaty and in the statutes of the ESCB and ECB. Therefore, the Eurosystem will co-exist as long as the Euro has not been introduced into all MS and identifies those central banks in the ESCB that are responsible for monetary policy within the Eur area.8

2.1 Tasks of the ECB

The ECB as supranational institution forms the core of the Eurosystem. This system is responsible for monetary policy and exchange transactions, as well as for the administration of currency reserves of its members and a frictionless functioning of the fare management system9 which are either carried out by the ECB itself or through the NCB's as functionally subordinated elements of the ECB. The ECB acts as an executive agency amid the Eurosystem by making centralized decisions for a consistent monetary policy but decentralized conductions through the NCB's.10 By doing s o, the Eurosystem has the priority to maintain price stability and to support economic policy within the community as far as price stability is not endangered.11

3. Price Stability

The paramount importance of price stability arises from numerous economic and social advantages of a stable currency in respect to the dangers of high inflati on.12 However, price stability is not clearly defined in the EU Treaty.13 T o approach this determination and to make monetary policy more transparent, the Eurosystem defines price stability with an inflationary increase of the HCPI below but close to 2 % on a year on year basis in the medium term within the EMU.14 Those roughly 2 % HCPI were determined by the governing council and depict a certain safety margin to avoid risks of deflati on.15

4. Transmission mechanism

The Eurosystem resolves monetary policy and has to be aware of monetary interventions that influence the monetary sector as well as the real economy. Hence, it depicts a complex transmission process of monetary policy to achieve price stability through monetary stimulus.16 This process implements two steps. First, when a central bank intervenes in the money market it changes conditions for loans and deposits of commercial banks, capital market interest rates and foreign exchange rates. Second, those market shifts eventually influence aggregated demand and price development where some economic variables are likely to play an important role in the transmission mechanism. While shortly explaining each variable the assumption follows an expansionary monetary policy.

4.1. Interest rate variable

A decrease in the official interest rate causes a decrease in capital market interest rates and thus the cost of capital.17 This is explained by the expectations theory of term structure where the long term interest rate is an average of the expected short term interest rate. Since inflation remains initially unchanged the real capital market interest rate decreases.

[...]


1 Cf. Scheller, H.P. K., 2004, p. 1 2

2 Cf. Europäische Zentralbank, 2004, p.9 ff.

3 Cf. Scheller, H.P. K., 2004, p. 1 2

4 Until now 16 out of 27 EU MS have met the convergence criteria of the EU Treaty to adopt the Euro

5 Cf. Europäische Zentralbank, 2004, p.9 ff.

6 The ECB was established in June 1, 1998, in Frankfurt / Germany

7 Cf. Gerdesmeier, D., 2004, p. 173

8 Cf. Görgens, E.; Ruckriegel, K. Seitz, F., 2004, p.6 2

9 Cf. Europäische Zentralbank, 2004, p. 10

10 Cf. Görgens, E.; Ruckriegel, K. Seitz, F., 2004, p. 63

11 Cf. Europäische Zentralbank, 2008, p. 28

12 Cf. Europäische Zentralbank, 2004, p. 4 2 f.

13 Cf. Görgens, E.; Ruckriegel, K. Seitz, F., 2004, p.166

14 Cf. Europäische Zentralbank, 2004, p. 5 2 ff.

15 Cf. Görgens, E.; Ruckriegel, K. Seitz, F., 2004, p. 169

16 Cf. Europäische Zentralbank, 2008, p. 63

17 Cf. Löchel, H., 1998, p. 37ff

Excerpt out of 18 pages

Details

Title
The Monetary Policy of the European Central Bank
College
Berlin School of Economics and Law
Grade
1,7
Author
Year
2009
Pages
18
Catalog Number
V138915
ISBN (eBook)
9783640486359
ISBN (Book)
9783640486526
File size
558 KB
Language
English
Keywords
Transmission Mechanism, 2 Pillars Strategy, Standing Facilities, Open Market Operations, Minimum Reserve
Quote paper
Dennis Sauert (Author), 2009, The Monetary Policy of the European Central Bank, Munich, GRIN Verlag, https://www.grin.com/document/138915

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