Most countries have their own central bank, which issues currency, defines monetary policy and ensures the proper functioning of the banking system. In Europe, however, adopting the Euro necessitated the creation of a European Central Bank (ECB). What is its role? How does it coordinate with the national central banks in each country?
What is a central bank?
A central bank provides banking services to the government and other banks. It also provides indicators on the country’s economy, through statistics pertaining to the currency, loans, savings and other financial information. In addition, it sets the benchmark interest rate, which banks use to refinance their operations. The world’s oldest central bank is the Bank of Sweden, established in 1656. The Bank of England followed soon after in 1694, while the Bank of France was established in 1800.
ECB: a bank at the European scale
Created in 1998, the European Central Bank (ECB) serves as the central bank for the entire Eurozone. It defines monetary policy for all countries within the zone and manages Europe’s single currency.
The ECB operates completely independently of all European governments.
Regulating the economy and prices
The ECB’s primary objective is to “maintain price stability”, while supporting “the Union’s general economic policies”.
For the ECB, the objective of maintaining price stability translates in reality to an increase in prices close to, but under 2%.
To do so, the central bank adjusts the benchmark interest rate, which is the rate at which commercial banks can borrow from the central bank. Lowering the interest rate stimulates greater consumption, which in turn initiates a trend towards higher prices. Conversely, raising the interest rate slows down consumption and prices.
Exceptionally, the central bank can also change the amount of currency in circulation. It is generally considered that excess currency can lead to inflation, while an insufficient amount can restrict economic growth.
The primary objective of the European System of Central Banks […] shall be to maintain price stability.Article 127, paragraph 1, of the Treaty on the Functioning of the European Union.
Managing and coordinating the Eurozone
The ECB also works to:
- Define and implement monetary policy in the Eurozone
- Conduct foreign exchange operations
- Hold and manage the official foreign exchange reserves of each country
- Issue bank notes in the Eurozone
- Collect and centralize statistics from national authorities and economic agents
- Audit credit institutions in member States
National central banks and the ECB: who does what?
The ECB defines policies for the Eurozone. It ensures that the different national central banks carry out decentralized operations in a consistent way.
The national central banks are responsible for performing monetary policy operations in their respective countries. They carry out the actual transactions, supply currency to commercial banks, manage foreign exchange reserve operations for the ECB as well as their own foreign exchange reserves and contribute to the proper functioning of financial markets and payment instruments. They mint coin currency. Depending on the country, they may also perform specific functions attributed on a country-by-country basis: for example, the Bank of France performs special debt assistance activities.