Central Banks: Roles of the Bank of Spain & ECB in Monetary Policy
The Bank of Spain and the European Central Bank
The central bank in Spain is the Bank of Spain, which oversees the banking system and regulates the money supply in the economy.
Functions of the Bank of Spain
The Bank of Spain has specific functions and responsibilities as a member of the European System of Central Banks (ESCB).
Specific Functions:
- Save and manage foreign exchange reserves and precious metals not transferred to the European Central Bank.
- Supervise the operation of credit entities and financial markets.
- Promote the proper functioning of the financial system.
- Put coins into circulation.
- Develop and publish reports and statistics related to their functions.
- Act as the state bank, performing treasury and financial services related to public debt.
- Advise the Government.
Functions as a Member of the ESCB:
- Define and implement monetary policy to control the money supply and ensure price stability.
- Carry out exchange operations.
- Promote the proper functioning of the payment system.
- Issue legal tender notes.
European System of Central Banks (ESCB)
The ESCB comprises the ECB and the central banks of all European Union member states. Its functions include:
- Defining and implementing the monetary policy of the euro area.
- Managing foreign exchange reserves of member countries and performing currency exchange operations.
- Promoting the proper functioning of payments and ensuring financial stability through adequate supervision of credit entities.
- Authorizing the issuance of legal tender notes in Europe.
The Eurosystem issues the Union’s banknotes, with the ECB authorizing the volume of issuance.
The Eurosystem
The Eurosystem is the monetary authority of the euro area, comprising the ECB and the national central banks of EU member states that have adopted the euro.
The ECB
The ECB was established on June 1, 1998, with its own legal status. It constitutes the core of the ESCB and the main component of the Eurosystem. Its mission is to ensure compliance with the functions of the Eurosystem in the euro area.
Balance Sheet of a Central Bank
Assets
The main asset items are:
- Gold reserves and foreign currency exchange, which are the possessions of a country used to meet currency demands.
- Credits to the banking system, guaranteeing financial security.
Liabilities
Liabilities consist of:
- Monetary Liabilities: The Monetary Base, which consists of the Central Bank’s monetary liabilities or high-powered money. It can be expressed as the sum of cash in the hands of the public plus bank reserves.
- Non-monetary Liabilities: Include deposits from the public sector, capital, and reserves of the Central Bank.
The Monetary Base, the Money Supply, and the Money Multiplier
The Central Bank estimates liquidity in the monetary base, which is the total assets of the Central Bank less monetary liabilities.
The Monetary Base: Autonomous and Controllable Factors
The European Central Bank typically uses financial titles or debt titles to regulate liquidity in the banking system through open market operations. These operations involve buying and selling government bonds, which the Bank of Spain uses to reduce or increase the money supply. Buying or selling government bonds on the open market can reduce or increase bank reserves. These open market operations are a crucial instrument available to a Central Bank.
The Money Multiplier
The money multiplier indicates how the amount of money varies with each euro of the monetary base.
Variation in money supply = Money Multiplier x Monetary Base
How the Central Bank Affects the Money Supply
The Central Bank affects the money supply in two ways:
- Altering the Monetary Base: To increase the money supply, the Central Bank buys securities through new ticket issuance.
- Modifying the Reserve Requirement: To increase the money supply, the Central Bank reduces the reserve requirement, allowing banks to use surplus assets to grant more credits, thereby increasing the money supply.