ECONOMIC AND MONETARY UNION

European Monetary Policy

LEGAL BASIS

Articles 98 to 124 of the EC Treaty;

Protocol accompanying the Maastricht Treaty on the statute of the European System of Central Banks (ESCB) and the European Central Bank (ECB): Articles 1 to 52.

OBJECTIVES

The primary objective of the ESCB under Article 105(1) ECT is to guarantee price stability.

Without prejudice to this objective, the ESCB supports the general economic policy in the Community, with a view to contributing to the achievement of the Community objectives laid down in Article 2 ECT. The ESCB acts in accordance with the principles of an open market economy with free competition, favouring an efficient use of resources.

ACHIEVEMENTS

A.  The guiding principles of ECB action

1.  The independence of the ECB

The essential principle of the ECB’s independence is set out in Article 108 of the EC Treaty and Article 7 of the Statute of the ESCB. When exercising powers and carrying out tasks and duties, neither the ECB, nor a national central bank (NCB), nor any member of their decision-making bodies may seek or take instructions from Community institutions or bodies, from any government of a Member State or from any other body. Respect for Article 108 is guaranteed by the form of the mandate entrusted to the members of the Executive Board and the Governing Council. (*5.2.0.)

The ECB’s independence is also maintained by the prohibitions referred to in Article 101 of the EC Treaty, which also apply to the NCBs: overdraft facilities or any other type of credit facility in favour of Community institutions or bodies, central governments, regional, local or other public authorities, other bodies governed by public law or public undertakings of Member States are prohibited. (*5.2.0.)

The independence of the ECB centres around the free choice of monetary policy instruments. The Treaty provides for the use of traditional instruments (Articles 18 and 19 of the Statute) and allows the Governing Council to decide by a majority of two thirds on the use of other methods as it sees fit (Article 20 of the Statute).

2.  The principles of accountability and transparency of the ECB

In order to ensure the credibility of the ECB, the Treaty (Article 113(3) ECT) and the Statute (Article 15) impose reporting commitments. The ECB draws up and publishes reports on the activities of the ESCB at least quarterly. A consolidated financial statement of the ESCB is published each week. The ECB addresses an annual report on the activities of the ESCB and on the monetary policy of both the previous and the current year to the European Parliament. In practice the ECB publishes Monthly Bulletins which provide an in-depth analysis of the economic situation and the outlook for price developments.

The ECB is also accountable to the European Parliament. Members of the ECB’s Executive Board regularly appear before the European Parliament. (*5.2.0.) However, the EP cannot give any instructions to the ECB and has no a posteriori control.

3. Voting rules in the ECB Governing Council (Article 11 of the Statute)

Voting in the Governing Council respects the ‘one member, one vote’ principle. Each member of the Governing Council therefore has one vote. Monetary policy decisions are taken by a simple majority of members eligible to vote; in the event of a tie, the ECB President has the casting vote.

As from the time when the number of members of the Governing Council exceeds 21, each member of the Executive Board will have one vote and the number of governors of national central banks eligible to vote, and thus the number of voting rights held by the NCBs, will be 15. The voting rights will be assigned and rotate as follows:

as from the time when the number of governors of national central banks exceeds 15 and until it reaches 22, the NCB governors will be allocated to two groups, according to a ranking of the size of their Member State’s share in the aggregate GDP at market prices and in the total aggregated balance sheet of the monetary financial institutions of the Member States which have adopted the euro. The shares in the aggregate GDP at market prices and in the total aggregated balance sheet of the monetary financial institutions will be assigned weights of 5/6 and 1/6, respectively. The first group will be composed of five governors with five voting rights and the second group of the remaining governors with the remaining votes;

as from the time when the number of NCB governors is 22, the governors will be allocated to three groups according to a ranking based on the above criteria. The first group will be composed of five governors and will be assigned four voting rights. The second group will be composed of half of the total number of NCB governors, with any fraction rounded up to the nearest integer, and will be assigned eight voting rights. The third group will be composed of the remaining governors and will be assigned three voting rights.

The Governing Council will adopt all the necessary measures to implement the rotation of voting rights by a majority of two-thirds of its members, both eligible to vote and not eligible to vote. In particular, the Governing Council may decide to defer the start of the rotation system until such time as the number of NCB governors is more than 18.

When carrying out their activities in the Governing Council, the governors of the national central banks must not defend national interests but must act in the collective interest of the euro zone. The minutes of the Governing Council meetings and the breakdowns of votes cast are not published.

B.  The ECB’s monetary policy strategy

1.  Overview

At its meeting on 13 October 1998, the ECB Governing Council agreed on the main elements of its monetary policy strategy: quantitative definition of price stability; an important role for the monitoring of the growth of the monetary mass identified by an aggregate; and a broadly based assessment of the outlook for price developments.

The ECB has opted for a monetary strategy based on two pillars, whose respective roles were clearly defined once again during the review of the monetary strategy on 8 May 2003.

2.  Price stability

Price stability was initially defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. It must be maintained over the medium term.

This definition was confirmed on 8 May 2003 and one important point was clarified: inflation rates below but close to 2% are to be achieved over the medium term. This underlined that a sufficient safety margin downwards was to be provided to guard against the risk of deflation and to allow for a possible measurement bias in data collection and differences in inflation rates within the euro zone.

3.  The first pillar of the monetary policy strategy

The first pillar of the ECB’s monetary policy strategy is economic analysis. This focuses mainly on the assessment of current economic and financial developments and the implied short- to medium-term risks to price stability. The economic and financial variables that are the subject of this analysis include, among others: developments in overall output; aggregate demand and its components; fiscal policy; capital and labour market conditions; a broad range of price and cost indicators; developments in the exchange rate, the global economy and the balance of payments; financial markets; and the balance sheet positions of euro area sectors. All these factors are helpful in assessing the dynamics of real activity and the likely development of prices from the perspective of the interplay between supply and demand in the goods, services and factor markets at shorter horizons.

4.  The second pillar of the monetary policy strategy

The second pillar of the ECB’s monetary policy strategy is monetary analysis. In this, the ECB singles out money from within the set of selected key indicators that it monitors and studies closely. This decision was made in recognition of the fact that monetary growth and inflation are closely related in the medium to long run. This widely accepted relationship provides monetary policy with a nominal anchor beyond the horizons conventionally adopted to construct inflation forecasts. Taking policy decisions and evaluating their consequences, not only on the basis of the short-term indications stemming from the analysis of economic and financial conditions but also on the basis of money and liquidity considerations, allows a central bank to see beyond the transient impact of the various shocks and avoids the temptation of taking an overly activist course.

In order to provide a benchmark for the assessment of monetary developments, the ECB announced a reference value for the monetary aggregate M3. This reference value refers to the annual rate of M3 growth that is deemed to be compatible with price stability over the medium term, and has stood at 4.5% since the start of the EMU.

C.  Implementation of the monetary policy: instruments and procedures

By establishing interest rates at which the commercial banks can obtain money from the central bank, the ECB Governing Council indirectly affects the interest rates throughout the euro zone economy, and in particular the rates for loans granted by commercial banks and for saving deposits.

The ECB uses a range of monetary policy instruments to implement its monetary policy.

1.  Open market operations

Open market operations play an important role in steering interest rates, managing the liquidity situation in the market and signalling the monetary policy stance through four categories of operations.

a.  Main refinancing operations

The main refinancing operations are the most important instrument of the monetary policy. They are regular liquidity-providing reverse transactions with a weekly frequency and a maturity of two weeks. They provide the bulk of liquidity to the banking system. The minimum bid rate for the main refinancing operations is the key ECB interest rates. It is within the limits of the rates of the deposit facility and the marginal lending facility. The level of these three key rates signals the orientation of the monetary policy of the euro zone.

b.  Longer-term refinancing operations

These are liquidity-providing reverse transactions with a monthly frequency and a maturity of three months. They represent only a limited part of the global refinancing volume and do not seek to send signals to the market.

c.  Fine-tuning operations

These ad hoc operations aim to deal with unexpected liquidity fluctuations in the market, in particular with a view to smoothing the effects on interest rates.

d.  Structural operations

These operations are mainly aimed at adjusting on a permanent basis the structural position of the euro system vis-à-vis the financial sector.

2.  Standing facilities

Standing facilities provide or absorb liquidity with an overnight maturity. Their interest rates bound overnight market interest rates. This rate is known as the EONIA (Euro Overnight Index Average). Two standing facilities are available to eligible counterparties:

The marginal lending facility enables counterparties to obtain overnight liquidity against eligible assets. The interest rate on this facility provides a ceiling for the overnight market interest rate;

The deposit facility enables counterparties to make overnight deposits with the euro system. The interest rate on the deposit facility provides a floor for the overnight market interest rate.

Both of these rates aim to ensure the smooth operation of the money market in situations of very high money supply and demand.

3.  Holding of minimum reserves

In accordance with Article 19(1) of the Statute, the ECB may require credit institutions established in Member States to hold minimum reserves with the ECB and national central banks. The aim of the minimum reserves is to stabilise the short-term interest rates on the market and to create (or enlarge) a structural liquidity shortage among the banking system vis-à-vis the euro system, making it easier to control money market rates through regular allocations of liquidity. The calculation methods and determination of the amount required are set by the Governing Council.

D.  Assessment

The euro, a visible symbol of European identity, became the second largest currency in the world when it was launched. It has become an international currency of investment and currency on the markets alongside the dollar and the yen.

Since it started operating, the euro system has had to deal with the depreciation of the euro (25% depreciation in relation to the dollar between the beginning of 1999 and the beginning of 2002) then with a lengthy appreciation in relation to the dollar from the beginning of June 2002, reaching new highs as a result of the global financial crisis that began in August 2007.

Inflation averaged 2.1% in 2007, a little above the level compatible with the definition of price stability. Since the end of 2007 inflation has showed a marked increase as a result of the global economic situation. The ECB has not resorted to short-term voluntarism in response to this increase, however, but is working to maintain price stability in the medium term, in accordance with its mandate.

ROLE OF THE EUROPEAN PARLIAMENT

In its resolution on the ECB’s 2007 annual report the EP points out that it has called for greater transparency in the ECB, and it also emphatically demands improvements in the ECB’s communications policy. As regards the ECB’s monetary policy strategy the EP takes the view that the two-pillar model is an appropriate method for measuring price stability.

CHANGES RESULTING FROM THE LISBON TREATY

The Lisbon Treaty does not provide for any significant changes to the implementation of Europe’s monetary policy.