Monetary policy: Euro Area - ECB

European Central Bank monetary policy instruments and operating targets

Operating procedure

The ECB uses 3 main official interest rates. The ECB deposit rate provides a lower bound or floor for the daily European Overnight Interbank Average (EONIA) market rate. The ECB marginal lending rate provides an upper bound or ceiling for the daily EONIA. The third main official interest rate relates to the ECB's main refinancing operations (MROs). MROs are weekly auctions to commercial banks of central bank money (alternatively referred to as bank reserves, reserve money, outside money, monetary base) using repurchase agreements of standard 1-week maturity (before March 2004 2-week maturity). In a fixed rate tender the ECB predetermines the repo interest rate, invites bids from commercial banks for their individual desired volumes of central bank money, and finally allocates central bank money proportionally to all bidding banks in such a way as to achieve a certain aggregate volume. In a flexible rate tender the ECB invites commercial banks to provide bids for different combinations of interest rates and volumes, subject to a lower bound for the interest rate (the minimum bid rate). The ECB allocates central bank money to commercial banks with interest rate bids above a selected rate (the marginal rate), in such a way as to achieve a certain aggregate volume. All successful banks pay the interest rate of their successful bids and the total effective interest rate for the flexible rate tenders is the weighted average rate (which normally exceeds the minimum rate and marginal rate).

Operating targets

Because the ECB rarely intervenes in the money market between the dates of its weekly MROs, the ECB effectively implements a so-called nonborrowed reserves operating procedure (at least on a weekly data frequency). However, in general, the ECB uses its instruments to aim for a desired average level of the EONIA market interest rate (interest rate operating procedure). The actual daily EONIA rate fluctuates between the ECB deposit rate and marginal lending rate due to unexpected fluctuations in reserve demand.

Given the averaging features of the system of reserve requirements, actual behavior of current reserve demand is a complex function of commercial banks expectations with respect to future reserve demand and supply movements.

European Central Bank monetary policy strategy

The primary objective of ECB monetary policy is defined by Treaty as "achieving price stability". The ECB has defined this monetary policy objective more explicitly as a target for inflation of below but close to 2% (May 2003), measured by the Euro Area HICP and measured over the medium term. In practice, the ECB follows what it refers to as a two-pillar strategy. The two pillars (the notional importance of each one having changed over time) consist of one: an analysis of the real economy and cost-related indicators of future inflation, and two: a monetary analysis based on recent Euro Area money growth and changes in money demand. Economist interpret this strategy as if the ECB tends to implement an inflation forecast strategy, focusing on expected developments in the rate of inflation one or two years in the future.

Note: In 1998 the ECB announced the quantitative definition of price stability as: "a year-on-year increase in the Harmonized Index of Consumer Prices (HICP) for the euro area of below 2% ... to be maintained over the medium term". Discussions persisted over whether this definition included negative inflation and/or whether a specific target value could be identified in the band 0-2%.

In the early years of the ECB the monetary pillar of the two-pillar strategy was regarded to be the dominant one. Accordingly, the ECB defined a medium run target or reference value for M3 money growth, using projections for potential output growth and the long-run velocity trend. In recent years, the role of M3 has clearly been downgraded due to perceptions of a difficult to explain trend change in velocity.

In December 2000, after lengthy discussions, the ECB started publishing its Staff economic "projections". These are conditional forecasts, assuming for example constant interest rates and are used to evaluate risks to the price stability goal. However, the ECB monetary policy strategy is not one of inflation (forecast) targeting.

On 4 July 2013 Mario Draghi changed ECB communication strategy by introducing forward guidance on the likely future path of ECB interest rates.

European Central Bank: Legislation, decisionmaking, transparency

The Treaty on Economic Union of 1992 (Maastricht Treaty) established the European System of Central Banks (ESCB) and the European Central Bank (ECB) as from 1 June 1998. The European Central Bank (within the framework of the Eurosystem) assumed responsibility for monetary policy in the euro area on 1 January 1999. The Treaty specifies (Art.105) that the primary objective of the ESCB is to maintain price stability. Secondary, and without prejudice to the objective of price stability, the ESCB is to support the general economic policies in the European Union (defined in Art.2), and act in accordance with the principles of an open market economy with free competition, favoring an efficient allocation of resources. Art.108 of the Treaty specifies that the ESCB (ECB and national central banks) must act independently and shall neither seek nor take instructions from any government body.

All monetary policy decisions are taken by the ECB's Governing Council. From January 1999 the Governing Council has had scheduled 'meetings' every 2 weeks on Thursday (sometimes in the form of teleconference calls). From November 2001 monetary policy was discussed in the first Governing Council meeting of every month (initially every two weeks). From January 2015 the ECB has moved to a 6-week cycle for monetary policy meetings. Following the monetary policy meetings, interest rate decisions are immediately published through a press release and these are usually, though not necessarily, accompanied by a press conference in which the ECB President provides more details of the discussion behind the interest rate decision. The Bank publishes a Monthly Bulletin, now Economic Bulletin, with a review of current economic developments in the euro area. The ECB provides an annual report to the European Parliament and holds regular presentations. As part of its transparency the ECB has taken upon itself to define its mandate price stability ("2% inflation in the medium term") and provide a publicly announced monetary policy strategy ("two-pillar framework").

Note: The ECB followed the temporary European Monetary Institute (established 1 January 1994).

HISTORICAL DATA, TABLES, SUPPLEMENTARY INFORMATION

Table European Central Bank Chairperson

ECB Unconventional Monetary Policy Actions/Programmes

Covered Bonds Purchase Programme #1 (CBPP1, announced 07May2009)

Started 02Jul2009. Ended 30Jun2010. Regular purchases of banks' covered bonds for a total of nominal E 60 bln. Designed to maintain functioning of specific market segments, i.e. underlying bank loan programmes, by securing banks' access to funding. Not a measure of quantitative easing because liquidity effects were sterilized by adjusting the volume ('benchmark allotment') of the ECB Main Refinancing Operations.

Note: Initial motivation by the ECB included a desire for further decline in (long term?) interest rates and apparently interpreted as such in the EONIA money market. Inconsistent with the policy of sterilizing liquidity effects.

Securities Market Programme (SMP, announced 10May2010)

Started 11May2010. Last purchases Feb2012, formally ended 06Oct2012. No specific target volume, cumulative purchases approx. E 220 bln, particularly in the period Aug2011-Feb2012. Designed to maintain a functioning market in sovereign bonds, some would say a last resort sell option for banks, in particular of the weak Euro area countries. Liquidity effects sterilized by liquidity-absorbing operations, i.e. offering fixed-term ECB deposits to banks. Liquidity-absorbing operations terminated Jun2014.

Covered Bonds Purchase Programme #2 (CBPP2, announced 06Oct2011)

Start 03Nov2011. Ended 31Oct2012. Between Nov2011 and Oct2012 purchases of nominal E 16.4 bln, well below its target of E 40 bln. As with CBPP1 liquidity effects sterilized.

Special 3-year Long Term Refinancing Operations (LTRO, announced 08Dec2011)

Two special LTROs (auction dates 21Dec2011, 29Feb2012) with a maturity of 36 months, volume approx. E 500 bln each. Interest rate equals average of MRO rates over the life of the LTRO and must be paid at the end (in many cases inaccurately reported as if a fixed rate of 1 percent). Designed as quantitative easing programme, to increase the volume of (excess) bank reserves, also accompanied by a reduction of the reserve requirement ratio from 2% to 1%.

Outright Monetary Transactions (OMT, announced 02Aug2012)

Supersedes the SMP. The ECB would, if necessary, purchase ex ante unlimited amounts of sovereign bonds, conditional upon the existence of a European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) programme for the relevant country. Although presented as a tool for monetary transmission and monetary policy, basically a government bail out mechanism, albeit with the objective of stabilizing financial markets during the euro area government bond and banking crisis. Liquidity created created through OMT to be fully sterilized.

Covered Bonds Purchase Programme #3 (CBPP3, announced 04Sep2014)

Started 20Oct2014

Asset-Backed Securities Purchase Programme (ASBPP, announced 04Sep2014)

Started 21Nov2014

Expanded Asset Purchase Programme (announced 22Jan2015)

Adds Public Sector Purchase Programme (PSPP) to existing CBPP3 and ASBPP. Initial combined monthly asset purchases of E 60bln, to run until at least Sep2016 in combination with perceived change in path of inflation. No mention of liquidity sterilization, therefore designed as true quantitative easing programme (following the Special 3-year LTRO of Dec2011).

European Central Bank. ECB Homepage

Central bank

• ECB, About the ECB.
  • General information about organisation, constitution, decision-making bodies.
  • ECB, The European Central Bank. March 2001.

Monetary policy tactics

• Sauer, S. and Sturm, J-E., Using Taylor rules to understand European Central Bank monetary policy, German Economic Review, vol.8 (3), August 2007: 375–398.
• Gerdesmeier, D. and Roffia, B., Empirical estimates of reaction functions for the euro area, Swiss Journal of Economics and Statistics, vol.140 (1) March 2004: 37-66. (ECB wp. 206 2003)
• Gaspar, V., Perez-Quiros, G. and Sicilia, J., The ECB Monetary Policy Strategy and the Money Market, International Journal of Finance and Economics, vol.6 (4) October 2001: 325-42. (ECB wp. 69 2001)
• Issing, O. The monetary policy of the Eurosystem, Finance & Development, vol.36 (1) March 1999.
  • Overview of ECB structure, objectives, instruments.
  • ECB, The single monetary policy in the Euro area: General documentation on Eurosystem monetary policy instruments and procedures. April 2002.

Monetary policy strategy

• Carstensen, K. and R. Colavecchio, Did the revision of the ECB monetary policy strategy affect the reaction function? wp. July 2004.
• Issing, O. The monetary policy of the Eurosystem, Finance & Development, vol.36 (1) March 1999.
• Overview of ECB structure, objectives, instruments.
• ECB Monthly Bulletin, The stability-oriented monetary policy strategy of the Eurosystem, January 1999: 39-50.
• Article describing the ECB's monetary policy strategy.