1. A Short Introduction to Monetary Policy Implementation in the Eurosystem
How the alchemists controls the money market and defines how much you should pay almost everything
Good afternoon to everybody. Today my topic is monetary policy implementation in the case of Eurosystem. Perhaps this is not the most important or interesting issue in the field of economics, but my bachelor thesis is related to this topic, and I chose that topic for that reason. Perhaps you do not need to how the Eurosystem implement monetary policy, but the monetary policy decisions affect to your wealth.

2. Outline The basic principles
Monetary policy framework in the case of Eurosystem
Unconventional framework
The Eurosystem consists of the ECB and the central banks of the member states that belong to the eurozone.
My intention is to explain how the central bankers enforce their decisions and why those decisions are effective. At first, I describe the boundary conditions and then the traditional framework. If I have enough time, I explain how that structure is adjusting to the current situation when nominal interest rate level is in zero rate bound.

3. The basic facts about monetary policy in the Eurosystem
The goal of monetary policy is given by legislation.
”The Governing Council of the ECB has to influence the level of short-term interest rates to ensure that price stability is maintained over the medium term”
"Price stability is defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. ” (but very close)
HICP measures the inflation. Basically, inflation means the increase of overall price level or the decrease the value of money.
Monetary policy is a part of the economic policy which operates through controlling the supply of money. Usually, the legislation gives mandate what is the main guideline of monetary policy decisions. In this case, the mandate is to maintain price stability.
Theoretically price stability is the flexible concept. In the case of Eurosystem, the quantitative definition gives a precise meaning of that. But the exact meaning is irrelevant to you because it says that if you have not to think the value of money, price stability is maintained.

4. The basic facts about monetary policy in the Eurosystem
The correlation between inflation and the money growth is almost one; theory suggests that inflation is driven by money growth
 the Eurosystem could affect to inflation.
Eurosystem cannot dictate price developments or/and do not want to dictate the supply of money. Therefore, it operates via intermediary and operation targets.
The operation target is overnight or short-term interest rate in the money market
Unfortunately, monetary policy cannot dictate the price developments. Even thought the correlation between inflation and monetary variables is strong. Therefore, the central bank has to choose the operation target, which is under control and affect to price developments. Usually, that target is the short-term interest rate. The Eurosystem formulates the decision which is an appropriate short-term interest rate level and provides enough liquidity to maintain that level.

5. Monetary Policy and Money Markets
Let me issue and control a nation’s money and I care not who writes the laws.”
Mayer Amschel Rothschild ( )
The power of central bank based on a structural demand of reserves
The counterparties have to keep a certain amount of its assets in a form of reserves
So because the amount of liquidity and the interest rate must match, then the Eurosystem provides just enough reserves to market in agreement with the structural demand
In my humble opinion, I just told everything that you should know. The Eurosystem actions are always related to price stability, and the primary tool is interest rate level. So the rest of my presentation is related to technical aspects.
The Eurosystem operates with counterparties in normal times, which are banking institutions. Those institutions have a structural shortage of reserves, and the central bank has a monopoly to supply those reserves. In the case of Eurosystem, the vast majority of that structural deficit is derived from minimum reserve requirement, which is declared by the central bank.

6. Open Market Operations
In normal times, the primary instrument is lending against collateral
The maturity of those operations is one week
Counterparties have to roll over the loans weekly
The Eurosystem is a wholesale operator; liquidity is provided to markets. Counterparties have to match their liquidy in the money markets
If the market price changes too much, the Eurosystem intervenes. If it not, the central bank is passive
Eurosystem conducts the supply of reserves via open market operations. The interest rate on those loans is the official rate, which is declared by the central bank. If I simplify that a lot, it just means a collateralized lending with a very short maturity against the high-quality collateral. Because those operations are not bilateral, the banking system has to reallocate the amount of reserves themselves. They do that because holding excess reserves is expensive. On the other hand, if that reallocation is not worked as central bank wants, the central bank intervenes in the market by increasing or decreasing the supply of reserves.

7. Monetary policy transmission
The whole idea of this framework is to keep the control of short-term interest rates (EONIA) in the central bank hands and let the markets do the rest.
The longer maturity interest rate, for example, Euribor, is linked to short-term interest rates, monetary policy actions affect to them as well.
The first fundamental theorem of welfare economics says that the market solution is the best way to organize the economic activity. So then the central bank does not want dictate more than it is necessary. The Eurosystem declares the official rates which have an enormous effect on the overnight interest rate, EONIA. The level of EONIA affects to other market rates, as you might see. Then if the Eurosystem changes the official rates, the EONIA shifts and Euribor rates vary also. You might know that a vast majority of consumer loans is linked to Euribor rates. That link is the essence of monetary policy transmission.

8. Zero lower bound
What happens if the central bank has to decrease the main refinancing interest rate to zero?
The lending rate could not go below zero because counterparty could withdraw loans to banknotes and earn positive interest
In zero rate bound, the usual framework is not applicable when the economy needs more monetary stimulus
The response for that situation is to broaden the variety of instruments inside the normal framework
The common framework is an elegant solution if the main official rate is positive. Then decreasing the official rates increases the aggregate demand and vice versa. But that structure is not applicable if the short-term interest rate level is close the zero rate bound because the central bank cannot lend with the negative interest rate. That is the essence of so-called zero rate bound. That is the reason why central banks have to reorganize the operation framework in recent years.

9. Unconventional monetary policy
Credit easing
Alleviate the conditions of central bank operations
Changing the operation structure from the money market to bilateral arrangements
Financing the supply of credit by reserves
Forward guidance
Quantitative Easing (QE)
In the zero rate bound, the central bankers have three kinds of options. First, they can increase the liquidity in the money markets or participate in financial markets. If those measures are aimed to improve the bank's ability to supply credit, the measures are credit easing. The main idea is to alleviate the banks risks which are related to refinancing activities and decrease the price of liabilities. Then bank´s expected return increases and they want to lend more. The increasing supply of credit and lowering market rates creates the expansionary effect to the real economy.
The second option is to affect to maturity premium with forward guidance. Practically the central bank tells what they do in the future. Then the effect is similar than in credit easing. If you know what the Eurosystem does in the future, you can do better estimates, and therefore, it alleviates the situation via lowering longer market rates.
The highest profile of unconventional measures is quantitative easing. It means that the central bank increases the quantity of reserves so much that the amount changes the structure of the financial markets. It is conducted via outright transactions, which means that the central bank changes the assets to money. That maneuver increases the value of assets and decreases the interest rate level via increasing the quantity of reserves. But because the central bank buys assets which dues in the future, that is only a different form of collateralized lending. Therefore, the result is similar. The only difference is that the central bank is the proactive party.

10. Conclusion Drastic times call for drastic measures
The play is same, but toys are different.
If interest rate implications are not desirable, it is not possible to deviate from the structural demand.
Direct government financing is not plausible
The maturity of monetary policy portfolio should be as short as possible.
In conclusion, I would like to say that the main idea is same. If the economy needs more monetary stimulus in the sense fo price stability, the Eurosystem provides more liquidity and alleviate the money market stance. But if that is not possible via interest rate, the central bank affect directly to the amount of money. The final thing what I want to say is not feasible to increase the supply of reserves below or above to structural demand if the interest rate implications are not reasonable. Therefore, the central bank cannot provide liquidity without the option of withdrawing.