ECB: European Central BankJohn-Paul Kivlin

Educational use only

Where do Euros Come From?

Outline

• What is a Central Bank• The ECB – History– Structure– Its purpose

• Compare and contrast with the FED

Central Banks

• Public institution – Issues currency– Regulates the money supply– Controls interest rates– Often oversees commercial banking system

Central Banks (cont.)

– Acts as lender of last resort• Lend to banking sector during time of crisis

– Designed to operate free of political interference

History of the ECB

History (cont.)

• ECB officially took over June 1, 1998 • Now 17 member states of the EU use the Euro

as currency

Structure

• European System of Central Banks (ESCB)– Comprises ECB and national central banks of all EU

members (euro or not)• Eurosystem– ECB and national central banks that have adopted

the euro• Euro Area– EU countries that have adopted the euro

ECB Structure

• ECB– Decision making by Governing Council– 6 members of the executive board– Governors of the NCB’s of the 17 euro area

countries• Governing Council Responsibilities– Adopt guidelines and ensure performance of tasks– Formulate monetary policy for euro area– Meet twice a month

ECB Executive Board

• Non-renewable term of 8 years• Removal only by incapacity or serious

misconduct• Decided by the Court of Justice of the

European Communities• ECB nor NCB allowed to take instructions from

any government of an EU state

Purpose of the ECB

• Manage Europe‘s central currency the Euro

• Maintain the euro’s purchasing power– Done to ensure price stability

ECB’s Main Tasks

• Implementation of monetary policies• Foreign exchange operations• Holding and management of official reserves• Promotion of smooth payment system

Monetary Policy

• Price stability using Harmonised Index of Consumer Prices (HICP)

• Inflation rate at or below 2%

• http://www.ecb.int/ecb/educational/pricestab/html/index.en.html

Monetary Policy (cont.)

• Decisions made by Governing Council• Implemented through:– Open market operations– Standing Facilities– Minimum reserve requirements

• ECB exclusive right to authorize banknotes– Member states can issue euro coins, amount must

be authorized by ECB 1st

Foreign Exchange Operations

• Foreign exchange interventions• Sale of foreign currency income• Commercial transactions

Reserves Management

• Foreign reserves portfolio– Ensure ECB has sufficient liquidity to conduct

foreign exchange operations with non-EU currencies

• Own funds portfolio– Provides ECB with income covering operating

costs and possible losses

ECB and the FED

• The FED has many primary tasks• The main purpose of the ECB is to maintain

price stability.• Other objectives are secondary

ECB and the FED

• U.S. obtains liquidity through sale of treasury bonds (also uses repo)

• European system does not have system-wide bonds, no system wide taxation authority

• Instead, member banks (1,000’s) bid for short-term repo contracts– Contracts: 2 weeks to 3 months

ECB and the FED

• Repo contract or repurchase agreement– Sale of securities with agreement that seller will

by back at later date– Repurchase price will be higher than the selling

price– This difference or interest sometimes referred to

as the repo rate

ECB and the FED

• Why would the ECB chose such a short term for the repo contracts?

ECB and the FED

• Short duration allows the continually adjustment of interest rates

• When repos come due, banks bid again– An increase of notes at auction increases liquidity

in economy– Decrease has opposite effect– Contracts are carried on asset side of ECB– Money is considered the liability of the ECB

Auctions

• Banks have to prove collateral in form of loans to other entities– Public debt of member states– Private banking securities

• EU has stringent membership requirements– Sovereign debt % of GDP– Done to ensure assets offered by member bank

are protected from inflation

ECB and the FED

• Crisis in 2008 revealed some weak sovereign debt– Greece, Portugal, Spain, Ireland

• This has impaired the borrowing ability• Not only in 4 members listed– Some securities issued from 4 members held by

other members• Hurting liquidity of economy

ECB and the FED

• ECB has temporarily moved bad debt from weak members balance sheets to ECB’s

• This monetization could threaten inflation– Strong member countries endure monetary

expansion to save weak members• ECB also has intervened to help market

collapse in U.S. in cooperation with FED

ECB Today

• Considering collective European bond issue– Similar to U.S. Treasury Bills

• Would need collective guarantee of member states solvency

• Germany has resisted the idea• Other analysis shows “Sickness of euro” due

to link between sovereign debt and NBS

References

• Eurpean Central Bank. ECB: European Central Bank Home Page.

• Wikipedia. "Federal Reserve System." Wikipedia, the Free Encyclopedia.

• http://www.new-ecb-premises.com/home_frame.html