European Central Bank: Functions and Monetary Policy
ECB: European Central Bank
The European Central Bank (ECB) was created to support the euro and ensure price stability. The ECB and the national central banks of EU member countries form the European System of Central Banks (ESCB), with the ECB’s bodies defining and implementing monetary policy in the countries that adopted the euro.
ESCB Functions
- Define and implement monetary policy in the euro area.
- Conduct foreign exchange operations.
- Hold and manage official reserves of participating members.
- Ensure the smooth operation of payment systems in the eurozone.
- Banking supervision and contribute to financial system stability.
- Authorize the issue of banknotes.
ECB Governance
The European Central Bank has three main organs: the Executive Committee, the Governing Council, and the General Council.
Monetary Policy
Monetary policy refers to actions taken by monetary authorities to control the money supply and/or interest rates. Achieving these objectives requires coordinated fiscal policies, income policies, and structural reforms.
Ultimate Objectives
- Balance the money supply.
- Control interest rates.
- Manage exchange rates.
Monetary policy influences economic activity and prices. The money supply is directly generated by issuing euro banknotes and coins and controlling the banking system. Most countries prioritize controlling inflation or maintaining price stability.
Expansionary Monetary Policy
Increases the money supply and lowers interest rates, allowing banks to extend more credit, boosting investment, consumption, production, and employment.
Contractionary Monetary Policy
Reduces the money supply, increasing cash shortages and decreasing investment and consumption.
Instruments of Monetary Policy
a) Open Market Operations
The central bank buys or sells public debt to commercial banks, providing or reducing liquidity.
b) Reserve Requirements
Banks are required to maintain reserves as a function of deposits, determined by a coefficient.
c) Credit Facilities
Tools based on interest rates for entities meeting Eurosystem conditions.
Inflation and Deflation
Inflation
A continuous, generalized rise in prices of goods and services. Causes include excess aggregate demand, increased production costs, and poor economic structure.
Effects of Inflation
- Loss of purchasing power.
- Decreased competitiveness abroad.
- Increased uncertainty.
Currency
Banknotes and deposits held in a specific currency unit.
Payment System
Agreements governing balances produced between countries due to international trade.
Deflation
A continuous and widespread decline in prices of goods and services.