Next year marks the 20th anniversary of the Euro, the most important step in the European integration process since the Treaty of Rome. Six months prior to the official launch, the European Central Bank (ECB) was established to administer the new common currency in the eleven countries that originally designed the monetary union. Since then, eight more countries have joined the Eurozone, which is now formed by nineteen countries.
Despite being one of the most influential European institutions, most people only have a vague idea of what the ECB does. What is its main objective? Which responsibilities does the ECB have? How does it conduct monetary policy? How does ECB’s policies affect the real economy? In this series of articles, I aim to take a closer look at the ECB and the role it plays in the Eurozone’s economy.
The ECB is a financial institution that has as its main responsibility the management of the monetary base of the European Monetary Union (EMU). The monetary base includes the currency in circulation as well as cash reserves deposited at the ECB by commercial banks and other financial institutions. The ECB has an exclusive monopoly over the issuance of currency: it can print new euros (aka expand the monetary base) or take them out of circulation (aka contract the monetary base).
The ECB’s main objective is to maintain price stability in the Eurozone, understood as a yearly increase in the price level of below (but not far from) 2%. In order to meet this objective, the ECB makes use of a number of monetary-policy tools (I will look into this in the second part of this primer) that allows it to influence the price level of the euro area.
The shareholders of the ECB are the central banks of the Eurozone countries, which contribute to the ECB’s capital in proportion to their populations and the size of their economies. The decision-making process is guided by four main governing bodies, each of which has different responsibilities. The Executive Board is formed by the President, Vice-President and four other members and is in charge of implementing monetary policy. The Governing Council consists of the Executive Board and the governors of the central banks of the EMU. It is by far the most important body as it makes all decisions concerning monetary policy and banking supervision.
Note the difference: whereas the Governing Council sets the guidelines of monetary policy (for instance, it decides on whether to change its interest-rate target), the Executive Board enforces the decisions made by the Governing Council. The General Council includes the Governing Council plus the governors of the central banks of those EU countries that aren’t members of the Eurozone. Among other things, the General Council collects statistical information and elaborates the ECB’s annual report. Finally, the Supervisory Board monitors the banking system to ensure its robustness and resilience to financial shocks.
What are the main duties of the ECB? I have already mentioned some. Since 2013, the ECB, together with the national supervisory authorities of each country, oversees the financial system under the mandate of the Single Supervisory Mechanism. The ECB also collects statistics on the state of the economy, manages foreign reserves, undertakes foreign exchange operations and ensures the correct functioning of the clearing and payment systems within the Eurozone.
Yet the ECB’s most important responsibility is the conduct of monetary policy, which, as I said earlier, involves the use of several instruments aimed at accomplishing the price stability goal. In the next article, I will examine why price stability matters and which monetary-policy tools the ECB employs to achieve it.