THE EUROPEAN CENTRAL BANK (ECB)

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Abbreviations

  • European Central Bank ( ECB )
  • European Economic Community ( EEC )
  • European Monetary System (EMS)
  • European Union (EU)
  • Economic and Monetary Union (EMU)
  • European Central Bank System (ESCB)
  • European Monetary Instıtute (EMI)

 

Abstract

With the passage of the European Money Union in the third stage, the central banks of the member countries of the Economic and Monetary Union began to move within the ECB’s programs and directives by transferring all the monetary policy authorities to the ECB. Therefore, the ECB has become the “sole monetary authority” in the Euro Area.

The ECB’s monetary policies, the financial means it pursues and the points it is targeting; I will investigate the use of Euro and its history.

  

  1. INTRODUCTION

The history of central banks is based on the 1660s. After the Second World War, with the independence of former colonies, the number of countries increased, the number of central banks has increased rapidly. The main objectives of the central banks in the first years were to balancing the budget and to financing the costs of the war.[1] Afterwards, “price stability” has become the main target.

When we look at Europe, the adventure started with Riksbank in Switzerland, the world’s first central bank, and continued with England, France and Germany banks. After steps Marjolin Memorandum (that is the first proposal for economic and monetary union of European Commission), European Economic Community and The European Monetary Cooperation Fund, the process of monetary integration came to the forefront. “The EMS was established by a Resolution of the European Council, and its operating procedures were laid down in an Agreement between the participating central banks”[2].

The ECB was originally set up to pursue price stability, with an eye also an economic growth and financial stability as subsidiary goals[3]. In this framework, the ECB has created monetary policies on behalf of the Eurozone. Shaping its own financial structure, it has been a “father bank” in Europe since 1998.

As a result, the ECB has become the sole responsibility of the “Single Currency Policy” in the Euro area[4].

  1. DEVELOPMENT

 A. HISTORY

The euro’s bank adventure begins in the 1950s. A series of necessary steps were taken for the European monetary union as early as 1952. “The first treaty that led the way to the foundation of union was the European Coal and Steel Community signed by Belgium, Germany, France, Italy, Luxembourg, Netherlands.” [5]

The same six countries later on established the European Economic Community (EEC) and the European Atomic Energy Community in 1958. Countries, Denmark, Ireland and United Kingdom, joined this community in 1973. Eight years later Greece also joined, followed by Spain and Portugal in 1986[6].

In March 1979, The European Monetary System (EMS) is created. In line with exchange rate mechanism objective to promote internal and external monetary stability, the EMS used the adjustment of monetary and economic policies as tools for achieving exchange rate stability. The exchange rate constraint greatly helped those participating countries with relatively high rates of inflation to pursue disinflation policies, in particular through monetary policy[7]. Although the EMS became the focal point of improved monetary policy coordination, its success in bringing about greater convergence of economic policies was rather limited.

In June 1988, The European Council authorised a committee of experts under the presidency of the Delors Committee to make proposals for the actualization of EMU. The following year, the Council of the European Union agrees that EMU will be passed in three stages.

With the establishment and planning of the EMU, it was ensured that some economic formations were collected in a single item on behalf of the Euro. Because EMI is the common market, it has been an area that share the same currency and a single monetary policy.

Now, we can look at some properties mentioned:

  • “The loss of the exchange rate as an adjustment mechanism to combat possible declines in competitiveness.
  • The impossibility of changing domestic interest rates.
  • The reduction of transaction costs.
  • A decrease in the uncertainties related to monetary, exchange rate and financial conditions.
  • The tendency towards the integration of both financial and goods markets.” [8]

In 1992, The Treaty on European Union (the “Maastricht Treaty”) was signed. Next year, Frankfurt am Main was chosen as the seat of the EMI and of the ECB, and a President for the EMI was nominated. The Treaty on European Union puts into practice in 1993.

The Madrid European Council decides on the name of the single currency and set out the scenario for its adoption and the cash changeover. In May 1998; Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland were considered to fulfil the necessary conditions for the adoption of the euro as their single currency; the Members of the Executive Board of the ECB were appointed[9]. After surviving the currency turbulence in 1992 and 1993, European leaders stayed the course toward monetary union.

Finally, The ECB and the ESCB were established in June 1998. “The European Monetary Institute, which was established in Frankfurt on June 1, 1994, to complete the preliminary preparations for the third stage of the objective Economic and Monetary Union (EMU), has been liquidated by delegating its duties to the ECB from 1 June 1998. With the establishment of the ECB, the responsibility for completing the transition preparations of the EMU and the European Central Bank System (ESCB) has passed to the ECB” [10].

The ECB Executive Council held its first meeting on 2 June 1998 under the direction of ECB President Wim Duisenberg. In October 1998, the ECB announced the strategy and the operational framework for the single monetary policy would be conducted from 1 January 1999 and then, ‘the new European currency that is the “Euro” , was officially launched on January 1, 1999.’ [11]

In 2002, the euro cash changeover realized: euro banknotes and coins were introduced and became sole legal tender in the euro area by the end of February 2002. In 2004, the NCBs of the ten new EU Member States joined the ESCB[12].

B. ORGANIZATIONAL STRUCTURE AND DECISION-MAKING BODIES

The ECB takes decisions as a result of the interaction of three different mechanisms. The first is the Executive Committee, the second is the Board Of Directors, and the third is the General Council[13]. The EMB’s decision bodies are composed of the Executive Committee and the Board Of Directors[14].

The Chairman, Vice-Chairperson and other members of the Executive Committee, after consultation with the European Parliament and the ECB Executive Council, have received the opinion of the heads of states and governments of the member states for eight years.

The task of the Executive Committee is to implement the decisions taken by the Board of Directors. The Board of Directors is the highest decision-making unit of the Central Bank.

ECB Executive Council is the highest decision-making body of the ECB. This council consists of the members of the Board of Directors and the heads of the national central banks of the member states participating in the Euro. The Executive Council, which is responsible for determining the monetary policy of the community, is the most important and top decision-making body of the Euro system. The Governing Council also sets out rules for the implementation of the monetary policy. The President of the EU Council and the representative of the EU Commission may attend meetings of the ECB Executive Council.

The members of the Council have been in office for five years and each member has one vote. It is because they do not act as if they are the representatives of their own countries while deciding on the monetary policy of the Council or the Eurosystem. The decisions of the state central banks as shareholders of the ECB (bank capital, foreign exchange reserves) are based on the share of each member in the ECB[15].

The annual accounts of the ECB are approved by the Governing Council. The Governing Council sets out the rules for standardizing the accounting and reporting of transactions carried out by National Central Banks.

ECB Executive Board is the European Central Bank’s operational decision-making unit. The Executive Board consist of the President of the European Central Bank, the Vice-President and four members. Candidates are selected by the EU Council, with the views of the EU Parliament and the Executive Council. Only members of the member states may be members of the Executive Board. Members have been serving for eight years and can not be reassigned[16].

No member of the Executive Board shall engage in any other business that provides or does not generate earnings, unless it receives exceptional permission from the Management Council.

The Executive Board is responsible for the implementation of the monetary policy and the day-to-day management of the ECB in consistency with the decisions taken by the Governing Council[17].

The ECB General Council consists of the President of the European Central Bank, the Vice-President and the Heads of the National Bank of the 27 member states of the European Union. The mission is to coordinate monetary policies between EPB members and EU countries other than monetary union. It is not a decision making body.

The General Council meets at least ten times a year in Frankfurt. The General Council may in some cases consult the public to be able to make a decision[18].

“Sub-Committees: Established by the Executive Council. These committees are bodies that assist in the functioning of the ECB decision-making mechanism. These bodies present their expertise in decision-making and decision-making in matters falling under their jurisdiction. These committees are run by senior experts. Subcommittees have come to the fore from members of the ECB and Euro area NCB. Representative committees may also be present from NCBs outside the euro area in the case of issues that concern the General Council. Sub-Committees report to the Governing Council through the Governing Board.” [19]

C. ESTABLISHMENT PURPOSE AND ROLE

All central banks in the world have a common point. They all make the protecting the value of money, decide when and how much new money will be printed, and set interest rates[20].

The main task of the European Central Bank was determined by the Maastricht agreement, which is responsible for the stability of the euro. Low unemployment and sustainable economic growth are also expected to be supported, but the main focus is on inflation. The European Central Bank explains this priority as:

“Price stability, economic growth and the fight against unemployment are all positively impacting all economic developments.”

The Central Bank, which conducts the monetary policy of an country, has two important objectives[21]:

The primary objective of the Central Bank is to maintain price stability. In line with this goal, the Central Bank is responsible for preventing large fluctuations in the value of money. Therefore, inflation has great significance.

The second target of the Central Bank is to create a stable conjunctural development in the country. This important sub-goal of the monetary policy is to avoid the recession. Conjunctural development is measured by the full use of national economy capacity.

The Central Bank follows these targets by raising or lowering loan prices, ie the economy penetrates. Thus, the Central Bank influences both inflation and conjunctural development.

If we ask: “what is the role of the ECB?”. The Central Bank has answered this question very nicely on its site:

“We constantly monitor the financial system to detect potential risks and vulnerabilities early on and assess what needs to be done. Macroprudential policies can stave off such risks – at the level of a country, a sector or a financial institution. For example, to help stave off a potential housing bubble, national authorities can require euro area banks to tighten their credit standards, e.g. ask customers to put more cash on the table when taking out mortgages. Such measures must be notified to the ECB, which can object, if necessary. The ECB can also demand banks to hold capital beyond the minimum requirements (the precise levels are laid down in EU rules) to strengthen their defences against possible shocks.”

“While these tools focus on the financial system as a whole, the ECB’s new banking supervision function watches over individual banks so that the banking sector remains safe, and, ultimately, to enhance financial stability in Europe.” [22]

D. BASIC TASKS

According to paragraph 2 of article 105 of the Treaty of Establishment,[23] basic tasks of the ECB are as follows:

  • To implement all kinds of monetary policy in cooperation with member banks’ central banks.
  • To protect the monetary stability of the union.
  • To provide the monetary cure.
  • To identify and carry out the monetary policy of the group.
  • Conserving and controlling reserves of member states.
  • To ensure that the payment system works smoothly[24].
  • All these activities are in cooperation with the structure of central banks of the member states called ‘European Central Bank System’.

E. MONETARY POLICIES

The Governing Council of the ECB at its meeting on 13 October 1998 agreed on a monetary policy in which possible the maximum degree would be maintained in the monetary policy strategies of the individual central banks of the eurozone. The single monetary policy of the ESCB is oriented exclusively on achieving price stability over the medium term. Its strategy comprises three main elements[25]:

  • The quantitative definition of the basic aim of the single monetary policy, i.e. price stability by means of the HICP index.
  • The primary task of money supply, which is expressed by quantifying the reference value of the rate of growth of the broad money aggregate.
  • The outlook for the development of prices and the risks to price stability in the eurozone.

The HICP (Harmonized Indices of Consumer Prices) index was created for measuring price convergencein the second stage of creating monetary union, and a high degree of harmonisation has been achieved in the eurozone countries. In its construction special attention was given to minimising errors in measurement so that a deviation from the “real” rate of inflation does not arise. Through the HICP index, the error in measurement is allegedly smaller than in the national price indices of the eurozone countries[26].

 

  1. CONCLUSION

In this article, we have read the long journey of European Monetary Union about the price stability and being a bank. To protect the price stability, ECB has to catch high employment and small number of unemployment targets. We understand there is a large pool for the euro which is used for the financial dimension.                          

Ali Affan AKGÜNDÜZ

 

 

REFERENCES

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