eu-escb

ESCB, European System Central Bank

On 1 June 1998, a new institution—the European Central Bank (ECB)—was set up to implement the single monetary policy in euro. Its headquarters are in Frankfurt. The ECB and the national central banks (NCBs) of all the EU Member States together form the European System of Central Banks (ESCB).

The tasks of the ESCB
The basic tasks of the ESCB are to define and implement the monetary policy of the Community, conduct foreign exchange operations under the Community's foreign exchange policy and hold and manage the official foreign reserves of the Member States. It should be noted that, in the field of foreign exchange policy, there is shared responsibility. The European Council of Ministers formulates general orientations for exchange rate policy vis-à-vis non-Community currencies that are compatible with the ESCB's primary objective of price stability. It also determines the arrangements for negotiating and entering into foreign exchange agreements after consultation of the ECB (Article 109). The ESCB is in charge of the daily management of foreign exchange operations.

In addition to the single monetary policy, the ESCB is also responsible for ensuring the smooth operation of payment systems and contributing to the effectiveness of the policies implemented by the competent authorities for prudential supervision of credit institutions and the stability of the financial system.

Organization of the ESCB
The ESCB is a federal, decentralized system, in which decisions are taken centrally by the ECB Governing Council. The ECB's decision-making bodies are the Governing Council, the Executive Board and the General Council.

–The Governing Council comprises the governors of the euro area national central banks, a president and a vice-president who also chair the Executive Board, and the other members of the Executive Board. The Council takes the necessary decisions to ensure that the ESCB performs the tasks entrusted to it. It formulates monetary policy, notably the intermediate monetary aggregate, where appropriate, and key interest rates. Each member of the Council has one vote, the president having the casting vote in the event of a tie. Decisions are taken by simple majority.

–The Executive Board is headed by the President and Vice-President of the ECB and includes four other members appointed by the Heads of State or Government on a recommendation from the European Council after consultation of the Governing Council. Their term of office is eight years in principle and is non-renewable. The Executive Board implements the monetary policy determined by the Governing Council and, in so doing, gives the necessary instructions to the NCBs. It is in charge of the day-to-day management of the ECB.

–The General Council is the body that brings together, within the ECB, the central bank governors of all Member States, whether they are part of Monetary Union or not.

The ESCB's operating principles
The primary objective is price stability. Without prejudice to this objective, the System supports the general economic policy of the Community. Experience gained in recent decades has shown that the countries with the lowest inflation rates have had the comparatively lowest interest rates and, consequently, more sustained investment and job creation. Policies based on a trade-off between inflation and unemployment have failed, leading to higher levels of both.

Definition of Sinngle Monetary Policy
On 13 October 1998, the ECB Governing Council presented the main elements of its price stability-oriented monetary policy strategy. The Governing Council announced its quantitative definition of the ESCB's primary objective, namely the maintenance of price stability. This was defined as a year-on-year increase in the Harmonized Index of Consumer Prices (HICP) for the euro area of below 2%. Furthermore, the Governing Council outlined the two main pillars of the strategy that it will use to achieve the objective of price stability. First, a prominent role was assigned to money. This role is signalled by the announcement of a quantitative reference value for the growth of a broad monetary aggregate. The Governing Council has decided to publish a reference rate for monetary growth rather than a range. In effect, the fact of publishing a growth range would have risked causing incorrect interpretations by the general public by giving the impression that interest rates would be automatically modified should monetary growth exceed the limits of this range. Second, in parallel with the analysis of monetary developments in relation to the reference value, there is an assessment of the outlook for price developments and the risks to price stability in the euro area. This evaluation is based on a broad range of economic and financial indicators.

At its meeting on 1 December 1998, the ECB Governing Council specified the details of the quantitative reference value for monetary growth.

The reference value refers to the broad monetary aggregate M3. M3 consists of currency in circulation plus certain liabilities of Monetary Financial Institutions (MFIs) resident in the euro area and, in the case of deposits, the liabilities of some institutions that are part of central government (such as Post Offices and Treasuries). The liabilities included in M3 are: overnight deposits, deposits with an agreed maturity of up to two years, deposits redeemable at notice up to three months, repurchase agreements, debt securities with an initial maturity of up to two years, units/shares of money market funds and money market paper.

The reference value for monetary growth must be consistent with—and serve—the achievement of price stability. Furthermore, the reference value for monetary growth must take into account real GDP growth and changes in the velocity of circulation of money. The derivation of the reference value is based on the contributions to monetary growth resulting from the achievement of the ultimate objective of price stability (year-on-year increases of below 2%), and from the assumptions made for potential GDP growth (2-2.5% per annum) and the velocity of circulation (a trend decline of about 0.5-1% each year).

Taking account of these two factors, the Governing Council decided to set the first reference value at 4.5%.

The ESCB monitors monetary developments against the reference value on the basis of three-month moving averages of the twelve-month growth rates for M3. This prevents erratic monthly outturns from distorting the information contained in the aggregate, thereby reinforcing the medium-term orientation of the reference value.