European Central Bank (ECB)
The central bank of the European economies
What Is The European Central Bank (ECB)?
The European Central Bank (ECB) is the central bank for European Union (EU) member countries and is part of the European System of Central Banks (ESCB).
The European Central Bank is a key institution responsible for managing money-related matters in European economies. It plays a critical role in maintaining the value of money and ensuring economic stability.
The central bank, like the ECB, is like a guardian against high inflation. It creates monetary policies (called monetary policy) to control inflation. But it does more than that:
- Printing Money: Central banks print the currency in circulation.
- Interest Rates: They set and manage interest rates.
- Banking for the Government: They act as the government's bank.
- Supervising Banks: They oversee both government and commercial banks to ensure they follow rules.
The ECB is like the "head central bank" for EU countries. It's a crucial part of the Eurosystem, which oversees the EU's money matters. Eurosystem is the only authority that can issue Euro banknotes (those paper Euros you use). National Central Banks (NCBs) can issue Euro coins, but they need permission from the ECB.
European System of Central Banks (ESCB) is a group that includes the ECB and the NCBs of 27 European countries. It works together to keep the European economy in good shape.
In simple terms, the European Central Bank helps control inflation and keeps an eye on money in the European Union. It's part of a bigger team (ESCB) that ensures the Euro, the EU's currency, stays strong.
Key Takeaways
- The European Central Bank is a crucial institution responsible for the monetary policy in EU member countries and plays a key role in controlling inflation and maintaining the stability of the Euro.
- The ECB serves as the central bank for 27 EU nations, with its headquarters in Frankfurt, Germany.
- ECB helps the financial system of the member countries in turbulent times, offering expert guidance and recommendations to enhance their economic well-being.
- ECB plays a vital role in safeguarding price stability, employment levels, and fostering economic growth within these economies.
History of the European Central Bank
ECB is the central bank of the 27 EU nations. Therefore, the NCBs of these nations comply with its guidelines, orders, suggestions, etc.
It is the apex authority making monetary decisions and policies. The ECB is governed or controlled by two important bodies called the Governing Council and the Executive Board.
Its headquarter is situated in Frankfurt, Germany. This is called the Seat of the ECB. Earlier, the seat was in the Eurotower in Frankfurt, but now the building has changed. The ECB was established on 1st June 1998 to regulate inflation. The European Monetary Institute was the predecessor of the ECB.
It was established by the Treaty on the European Union (also called the Treaty of Maastricht), but the Treaty of Amsterdam amended this in May 1999. It was not an institution recognized by the EU until the Treaty of Lisbon was signed on 1st December 2009.
It was founded with only eleven nations as its members, but as the years passed, many countries joined.
- Greece joined as a member of the ECB in January 2001
- Slovenia joined in January 2007
- Cyprus and Malta in January 2008
- Slovakia joined ECB in January 2009
- Estonia in January 2011
- Latvia in January 2014
- Lithuania was included in January 2015
- Croatia joined the ECB in January 2023
Note
The ECB never used its powers until the Euro was adopted as a currency on 1st January 1999.
The First President was the former Dutch Central Bank and EMI President, Wim Duisenberg. Although his appointment was a controversial task, a gentlemen’s agreement was signed between France, Germany, Belgium, and the Dutch governments.
This agreement was signed because the French Government wanted Jean Claude Trichet to become the President of the ECB. Trichet replaced Duisenberg in November 2003.
Under Trichet’s reign, the ECB was able to keep inflation under check to around 2% per annum. However, it witnessed the Global Financial Crisis in 2008, followed by a European Debt Crisis in 2009.
The financial crisis in 2008, which started in the US, spread worldwide, and as a reason, the European Union countries also suffered through the crisis.
In 2009 the European debt crisis peaked, and the ECB played a major role in neutralizing the effect of the fire spreading all over Europe.
The European Central Bank, with the International Monetary Fund (IMF), helped many eurozone countries in debt-refinancing and supported indebted banks' bail-out.
It adopted an interest rate that incentivized investors in Northern eurozone members to lend to the South, whereas the South was incentivized to borrow because interest rates were very low.
It used an interest rate that incentivized the Northern eurozone investors, who lent to the Southern eurozone members. The Southern nations of the EU were also incentivized to borrow at low-interest rates.
The ECB never reacted to the debt crisis as expected, as it never executed a quantitative easing program because its legal framework did not allow it to do so.
But in a few months, the ECB, in its historic decision, released a Securities Market Program (SMP). SMP allowed it to purchase government bonds from the securities market, increasing the money supply in the EU member economies.
Organization Structure of the ECB
To understand the working and functioning, we need to understand the ECB's composition, structure, and people involved in making the European Central Bank function effectively.
As discussed earlier, ECB has a Governing Council and Executive Board, so we will discuss further information in this section. In the European Central Bank, the decisions and strategies are formulated by the 4 critical bodies, namely:
1. The Executive Board
This body works and makes decisions for the day-to-day functioning of the European Central Bank and members of the Eurosystem.
This body helps it become dynamic and helps it cope with the different ever-changing situations witnessed in the day-to-day functioning of the central banks. It takes decisions and implements the same regarding the changes in the debt and equity capital markets.
The body's composition is as follows:
Executive Board = President of ECB + Vice-President of ECB + 4 Members of Executive Board
The European Council appoints members for a tenure of 8 years.
"All the members are among persons of recognized standing and professional experience in monetary or banking matters by common accord of the governments of the Member States at the level of Heads of State or Government, on a recommendation from the Council, after it has consulted the European Parliament and the Governing Council of the ECB."
Source: Article 11.2 of ESCB Statute
2. The Governing Council
The Eurosystem is governed by this body, which is the prime decision-making body.
It has the following members:
Governing Council = 6 Members of The Executive Board + 20 Presidents of the NCBs.
This council takes strategic decisions of prime importance. The decisions taken are under independent capacity; also, all such decisions are taken regarding the monetary policy.
The council meets every 15 days a month and discusses the interest rate policy. The key interest rate policy is disclosed to the public. The motion is passed when votes are cast. The President has a casting vote if there is a tie while a motion is put for a vote.
3. The General Council
The composition of the council is the same as the Governing Council, but the work done here is a little different. Its work mainly consists of advisory, administrative, and secretarial work.
Note
This council meets quarterly, where discussions take place.
It prepares annual reports for the European Central Bank, monitors the functioning of Exchange Rate Mechanism II(ERM II), serves as a forum for monetary and exchange policies, and also collects statistical information.
4. The Supervisory Board
The supervisory board works to draft decisions for the Governing Council in compliance with the non-objection procedure.
This board consists of the following:
Supervisory Board = Chairperson + Vice-Chairperson + 4 ECB Representatives + 21 Representatives of National Supervisors
The chairperson is appointed for a tenure of 5 years, and the vice-chairperson is one of the members of the Executive Board.
Objectives of the European Central Bank
The European Central Bank has always maintained a 2% inflation growth per annum target. This is because higher inflation reduces the purchasing power of the individuals in an economy. Hence, it always ensures a low-level growth in the inflation of its member countries.
By keeping a low-level inflation growth rate, the economy will grow more efficiently by deeply leveraging full employment and gaining higher productivity levels across the Eurosystem.
High inflation reduces purchasing power, which slows down the economy, and jobs are cut, leading to unemployment and many worsening conditions of the economy.
It sets interest rates for the Eurosystem, by which various banks provide loans to people and businesses. High-interest rates reduce the borrowing power and the money supply in an economy and vice-versa.
The European Central Bank supervises the National Central Banks of the euro area, and NCBs, in turn, direct the commercial banks in its economy to comply with the guidelines given by the NCBs.
As mentioned earlier, the ECB works independently; because of this, there is not much need to consider the political environment of different economies. ECB can focus on maintaining price stability.
As with the increase in digital payments, ECB is attempting to give special consideration to the rising e-payments. This is becoming an integral part of every economy in the Eurosystem.
The financial systems of the eurozone go through turbulent times now and then; thus, the ECB tries to ensure such turbulent times do not make a huge impact on the European economies.
Roles of the ECB
A central bank is an apex authority that controls, operates, and directs an economy's banking system and monetary structure.
It is the supreme body because it occupies the topmost position in the monetary and banking system of the country.
1. Currency Authority
The European Central Bank has the sole authority to issue the bank notes used all over the eurozone.
ECB issues all the notes but does not produce Euro coins, as the NCBs produce them on their own. The limit of the issuance of the coins is established by it beforehand.
All the currency (legal tender) issued by the ECB is its monetary liability, i.e., it is obliged to back the currency with some assets of equal value to enhance public confidence.
2. Banker to the National Central Banks
ECB acts as a banker, agent, and financial adviser to the NCBs. In addition, it lends to the NCBs when they require funds or bail out in turbulent times.
It makes investments in economies, and it keeps account of all the member nations. It formulates an interest rate policy that needs to be complied with by the NCBs to maintain the money supply in their respective economies.
3. Authority to the National Central Banks
ECB acts as a supervisor and a regulator of the functioning of the NCBs, to ensure public confidence.
It acts as a custodian of the cash reserves of the NCBs. As the NCBs are required to keep some cash reserves with the ECB, in this way, it acts as a custodian.
Note
The European Central Bank also acts as a lender of last resort, which means when the NCBs are going through the inadequacy of funds, the NCBs approach is to advance a loan.
4. Maker of the Monetary Policy
This is the only institution that formulates the monetary policy, which has to be followed all over the Eurosystem. Monetary policy is concerned with the decisions taken by the central bank for price stability, availability of money, and credit in the economy.
A change in the interest rates by the central bank makes the commercial banks change the borrowing rate to the public corresponding to the central bank. The monetary policy attempts to keep inflation under 2% in the medium-long term.
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