Since its establishment in 1999, the ECB has been fulfilling the price stability priority assigned to it by Member States and has contributed to stabilising economic activity through countercyclical policies. Monetary policy in the euro area has been entrusted to the European Central Bank since 1 January 1999, when the euro was introduced as a single currency in the Member States (Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain since 1999; Greece since 2001; Slovenia since 1 January 2007). The euro area currently has a population of 312.7 million and accounts for 22% of global GDP, second only to the United States (28%).
Common Monetary Policy: A necessity for stability
It is worth recalling the benefits of economic and monetary union for its member countries:
- Promotes internal market development by facilitating trade and price comparisons, and eliminating the costs of foreign exchange transactions and exchange rate risk;
- Promotes greater integration of capital markets by broadening the range of financial instruments available for saving or investment and thus facilitating the financing of activities;
- Limits the European economy's exposure to imported inflation, as trade in goods and services with the outside world accounts for a smaller share of its GDP: the prices of imported goods have a limited impact on domestic prices.
During the debate on the adoption of a common currency and monetary policy, some economists were concerned about the risk that it might not be appropriate in the face of economic divergence between member countries and, in particular, in the event of asymmetric shocks. This is why participation in the Economic and Monetary Union was conditional on economic convergence rules concerning price stability, exchange rates, interest rate levels and the state of public finances. Moreover, since the introduction of the euro, the economic performance of euro area member countries has tended to converge. Thus, the ECB's monetary policy is spread over a relatively homogeneous economic group, which facilitates decision-making and guarantees greater efficiency.
Objectives and instruments of the European Central Bank
The European Central Bank is responsible for conducting monetary policy, carrying out foreign exchange operations, managing the official reserves of euro area member states and facilitating the smooth operation of payment systems. Its primary objective is to maintain price stability in the euro area, which is defined as annual inflation below 2% but close enough to this threshold to avoid the risk of deflation. An important secondary objective of the ECB is to promote economic and social progress, high levels of employment and the achievement of balanced and sustainable development, provided price stability is achieved.
The ECB's main instrument for achieving its objectives is the regulation of short-term interest rates, which affect bank and market interest rates as well as supply and demand conditions in various markets. Price stability should be prioritised, although promoting growth and employment is also an objective. The ECB's monetary policy is made more complex by the fact that it must take into account the impact of multiple variables on inflation and activity levels. This makes decisions extremely complex and requires taking into account the lags between changes in interest rates and their impact on the economy.
In addition, it is important that the central bank's actions are stable and independent in order to guarantee price stability and avoid using monetary policy to temporarily stimulate activity for political reasons. This explains why the credibility of the central bank and its communication with economic players is critical. Economic research has also shown that the ECB pursues two objectives simultaneously - price stability and supporting economic growth - which emphasises the complexity of its objectives.
.webp "Monetary policy performance")
ECB: Monetary policy performance
Since its inception, the European Central Bank has achieved a number of significant successes in conducting monetary policy and stabilising the eurozone. Let's take a look at these achievements:
- Lowering interest rates: Between 1999 and 2006, the refinancing operations rate averaged just 2.9% per year, almost three times lower than in the 1980s;
- Achieving the inflation target: Inflation remained very close to the 2% target between 1999 and 2006, confirming the successful fulfilment of the ECB's main objective;
- Counter-cyclical policy: The ECB changed interest rates in a counter-cyclical manner, raising them in periods of growth and lowering them in periods of slowdown, which helped to stabilise economic activity;
- Euro exchange rate control: The euro exchange rate has fluctuated since 1999, but has stabilised in recent years, remaining at a higher level than in 1999.
Nominal short-term interest rates in the euro area have remained at historically low levels since the introduction of the euro, with an average refinancing rate of 2.9% between 1999 and 2006. Inflation has remained very close to the 2% target during this period, indicating that the ECB's main objective has been achieved. Since its inception, the ECB has changed interest rates in a counter-cyclical manner, which has helped stabilise economic activity in the Eurozone. US Federal Reserve interest rates have followed the same pattern, but with a larger spread due to the more amplitude of US economic cycles.
One of the most contentious issues remained the euro exchange rate, which has fluctuated widely since 1999. The euro depreciated between 1999 and 2001, but then appreciated between 2001 and 2004, and since then the euro has relatively stabilised. Exchange rate policy can be determined by the Council, but so far this has not been done, leaving the ECB free to act. Changes in the exchange rate depend not only on the ECB's monetary policy, but also on economic developments such as the high US trade deficit and China's dollar indexation policy.
Reasons for monetary policy tightening
Some observers believe that European monetary policy is too restrictive despite the ECB's targets. Given that inflation is under control and economic conditions have improved, continuing to raise interest rates could undermine the economic recovery, especially as the euro appreciates. The ECB, however, believes that rates remain relatively soft and continues to monitor the transmission channels of its policy to achieve price stability.
In assessing inflation risks, the ECB pays close attention to the growth of the M3 aggregate, which includes money in the strict sense as well as liquid financial assets. The growth of this aggregate suggests that money and credit are in relative abundance in the euro area, while the net savings rate has been falling steadily since 1999. Financial markets have reached their highest level since early 2003, fuelled by the low level of interest rates in the euro area. The rise in property prices since 1999 has also been significant, causing the ECB to remain cautious.
Key conclusions on the ECB's monetary policy conclusion
The ECB has so far been successful in maintaining price stability by keeping key rates at historically low levels. The ECB's countercyclical policy is helping to stabilise economic activity in the euro area by compensating for the shortcomings of national fiscal policy. The number of jobs in the euro area increased by 14 million and the employment rate rose from 59.7% to 64.5%. The volatility of the euro exchange rate between 1999 and 2004 had a negative impact on economic activity, but this was due to international imbalances and the lack of a clear exchange rate policy.
Comments