The European Central Bank and monetary policy in the euro zone
23.03.2016 | Economy
Created in 1998, the European Central Bank (ECB) is the central bank for the 19 countries of the European Union whose currency is the euro. The headquarters of this federal institution are located in Frankfurt, Germany.
What are its objectives?
The main objective of the European System of Central Banks (ESCB) is to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Union, according to Article 127 of the Treaty on European Union. Note that price stability was quantified in 2003 by the Governing Council of the ECB: to maintain inflation at a level close to but below 2% in the medium term.
In summary, the ECB has 4 tasks:
- To define and implement the monetary policy of the Eurozone;
- To conduct foreign exchange operations;
- To hold and manage the official foreign reserves of the participating countries (portfolio management);
- To promote the smooth operation of payment systems.
What is its strategy?
Unlike other central banks, such as the Fed or the Bank of England, the ECB assigns a prominent role to the money supply as a tool for controlling inflation. Nevertheless, in the short term and in a context of low inflation, there is little relationship between monetary growth and inflation. Today, the monetarist approach has been relegated to the background and the ECB emphasises advanced macroeconomic inflation indicators (output gap, import prices, labour costs etc.) From a macroeconomic perspective, price stability assumes the maintenance of actual GDP (the demand for goods and services) at a level close to the potential GDP (the supply of goods and services). In the current context, respecting the ECB’s mandate requires stimulating demand by lowering interest rates and use of unconventional tools, such as quantitative easing.
How is it organised?
The ECB is headed by a governor, currently Mario Draghi, who leads an Executive Board composed of six members, appointed by the European Council and acting by a qualified majority to implement the policy for the euro zone in accordance with the decisions taken by the Governing Council and to manage the ECB.
The main decision-making body is the Governing Council, composed of the six members of the Executive Board plus the governors of the national central banks of the 19 euro zone countries. The Governing Council formulates monetary policy for the euro zone, is charged with fulfilling the ECB’s tasks, and adopts decisions relating to the supervisory framework.
In addition, the General Council, composed of the President and Vice-President of the ECB and the governors of the national central banks of the 28 member states of the European Union, has an advisory role with respect to the collection of statistics, the preparation of the ECB’s annual report, and taking measures relating to the establishment of the key for the ECB’s capital subscription, among other things.
Finally, a Supervisory Board, composed of a Chair, a Vice-Chair, 4 ECB representatives, and representatives of national supervisory authorities, is responsible for discussing, planning and carrying out the ECB’s supervisory tasks.
This range of entities enables it to fulfil its role as a vital link in the Eurosystem and in the Single Supervisory Mechanism.