Excerpt
Index
1) Introduction
2) European Monetary Policy in General
3) Importance of Price Stability
4) Instruments to make Monetary Policy
5) Comparison with the Federal Reserve Bank in the U.S
6) Conclusion
Introduction
One of the most important objectives of the European Central Bank is the decision on its single Monetary Policy. The European Central Bank is the sole issuer of banknotes and bank reserves therefore the monopoly provider of the monetary base of an economy. This makes this institution the only one which has the needed instruments to make monetary policy. The ECB determined “price stability” as main intention of its policy because there is a contemporary consensus that inflation slashes the performance of economies strongly. The aim of this paper is to analyze why and how successful the European Central Bank has several instruments to achieve this important goal. The aim of this paper is to discuss the main goal of the European Monetary Policy and to analyze the instruments which can be used to maintain this goal. Finishing with a short evaluation about how successful the European Monetary Policy is.
European Monetary Policy in General
With the Introduction of a single Monetary Policy the member states of the European Union gave up a big part of their sovereignty. But with the introduction of the Euro as European currency, it was inevitable to introduce also a single monetary policy. This was a big and important step towards a unified Europe.
The European Central bank controls by its policy the cost of money, the supply of money and the availability of money. But the biggest problem of European monetary policy is that according to Monetary Theory, monetary and fiscal policy should always go together, in fact in Europe every state has its own fiscal policy and this policy is differing dramatically from state to state. To reach the general goals of monetary policy like employment and non-inflationary economic growth taxation has a very high importance. Regional inflation rates and growth dynamics still create divergence between the member states. This is the main critic point on the European monetary policy.
Importance of price stability
In article 105 (1) of the treaty establishing the European community “price stability” is determinate as main intention of the single European Monetary Policy (Eur-Lex). The aims of monetary policy are organized hierarchically; this means that price stability has overriding importance on all other objectives followed by the European central bank. After price stability is reached, the European Central Bank defines it at important to hold the employment rate high and to maintain economic growth constant. But this goal can only be achieved in a stable price environment. Generally leading economists assign such a high importance to a low inflation rate because of different motives. The Treaty establishes the maintenance of price stability clearly as the primary objective of the European Central Bank but it does not define exactly what is meant by price stability.
Therefore the European Central Bank had to find its own definition about what is defined as Price stability. Most economists of the ECB in 1999 concluded that a yearly increase in the Harmonized Index of Consumer Prices (HICP) on close to, but not over 2% can be defined as stable price environment. An increase over 2% would lead to a inflationary environment and an increase which is too high under 2% would cause in a deflation risk.
Since the “Great Inflation” of the 1970’s it is widely agreed that inflation has to be under control to maintain economic growth and to have low unemployment. Before this time period the paradigm of tradeoff between high inflation rates and economic activity developed by A.W. Philips (1957) in which most Economists trusted in the 1960’s gave Institutions the choice between different combinations of Monetary Policies. Philip’s believed that high inflation would lead people to invest money, because in this case it’s not productive to save capital anymore, this would result in an increase in output and higher wages. Thus considering this theory the negative effects of high inflation would be outweighed by the higher incentive to invest.
However this theory was well researched and proven by historical evidence, the Great Inflation proved that the relationship between high inflation rate and growth does not lead to the same result as stable prices do. In fact in the long run this relationship is negative. There are several evidences that the macro economical performance of a national economy diminishes when inflation increases (ECB Bulletin, 2008).
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