The European Central Banking Frederick University 2014

The Eurosystem The European System of Central Banks The Eurosystem The European Central Bank (ECB) The National Central Banks (NCBs)

Why a system instead of a single CB? Builds on existing competencies of the NCBs Geographically large euro area National diversity

Major Tasks of the Eurosystem Monetary policy Foreign exchange operations Operation of the payment systems Hold and manage foreign reserves

Other tasks of the Eurosystem Advisory functions Collection and compilation of statistics Contribution to prudential supervision and financial stability Insurance of euro banknotes International cooperation

Objectives and tasks of the ECB Price stability Defining Eurosystem policies Deciding, coordinating and monitoring the monetary policy operations Adopting legal acts Authorizing the issuance of banknotes Intervention in the foreign exchange markets International and european cooperation

Other responsibilities of the ECB Statutory reports Monitoring financial risks Fulfilling advisory functions of community institutions and national authorities Running the IT systems Strategic and tactical management of the ECB’s foreign reserves

Tasks of the NCBs Execution of monetary policy operations Operational management of the ECB’s foreign reserves Management of their own foreign reserves Operation and supervision of payment systems Joint issuance of banknotes together with the ECB Collection of statistics and providing assistance to the ECB Functions outside the ESCB

Monetary policy Philosophy of the European central banking Short run vs. long run in macroeconomics Long run neutrality of money Inflation – a monetary phenomenon

Money supply and monetary base Definition: The monetary base (MB) is the total amount of a currency that is either circulating in the hands of the public, or on the commercial bank deposits held in the central bank’s reserves: Banknotes and coins in the hands of the public Reserves of the commercial banks in the central banks MB = C + R Money supply (MS): Banknotes and coins in the hands of the public Deposits at the commercial banks MS = C + D

The Money Tree Deposit Multiplier – Maximum increase in money supply as a result of the increase in the reserves of the banking system

The Deposit Multiplier € 1000 new reserves enter Commercial Bank “А” Reserves (safety) Loans (income) … dm = ΔD/ ΔR

The Money Multiplier mm = MS/MB MS = C + D = C x D/D + D = D (C/D + 1) MB = C + R = C + rrD + er = = C x D/D + rrD + er x D/D = = D (C/D + rr + er/D) mm = (C/D + 1)/(r + er/D + C/D)

Money multiplier vs. deposit multiplier Deposit multiplier Dm = 1/rr Shows the maximum increase in the MS as a result of an increase in reserves Money multiplier Mm = (C/D + 1)/(rr + er /D + C/D) Shows the actual increase in MS as a result of an increase in reserves

Instruments of the monetary policy open market operations, standing facilities, minimum reserve requirements for credit institutions.

Standing facilities The Eurosystem offers credit institutions two standing facilities: Marginal lending facility in order to obtain overnight liquidity from the central bank, against the presentation of sufficient eligible assets; Deposit facility in order to make overnight deposits with the central bank. The interest rates on the marginal lending and deposit facilities normally provide a ceiling and a floor for the overnight market interest rate.