The European Central Banking

Frederick University

2014

The Eurosystem

The European System of Central Banks

The EurosystemThe 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 + RMoney 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)

200

800

160

640

128

512

1000 + 800 + 640 + 512 + …

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.