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Overview of the Monetary Policy Framework
The European System of Central Banks
The European System of Central Banks (ESCB) consists of the European Central Bank (ECB) and the national central banks of the EU Member States The activities of the ESCB are carried out in accordance with the Treaty establishing the European Community (Treaty) and the Statute of the European System of Central Banks and of the European Central Bank (ESCB/ECB Statute). The ESCB is governed by the decision-making bodies of the ECB. In this respect, the Governing Council of the ECB is responsible for the formulation of monetary policy, while the Executive Board is empowered to implement monetary policy according to the decisions and guidelines laid down by the Governing Council. To the extent deemed possible and appropriate and with a view to ensuring operational efficiency, the ECB shall have recourse to the national central banks to carry out the operations which form part of the tasks of the ESCB. The ESCB monetary policy operations are executed on uniform terms and conditions in all Member States
Objectives of the ESCB
The primary objective of the ESCB, as defined in Article 105 of the Treaty, is to maintain price stability. Without prejudice to the primary objective of price stability, the ESCB has to support the general economic policies in the European Community. In pursuing its objectives, the ESCB has to act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources.
ESCB monetary policy instruments
In order to achieve its objectives, the ESCB has at its disposal a set of monetary policy instruments; the ESCB conducts open market operations, offers standing facilities and requires credit institutions to hold minimum reserves on accounts with the ESCB.
Open market operations
Open market operations play an important role in the monetary policy of the ESCB for the purposes of steering interest rates, managing the liquidity situation in the market and signalling the stance of monetary policy. The ESCB has available five types of instruments for the conduct of open market operations. The most important instrument is reverse transactions (applicable on the basis of repurchase agreements or collateralised loans). The ESCB may also use outright transactions, the issuance of debt certificates, foreign exchange swaps and the collection of fixed-term deposits. Open market operations are initiated by the ECB, which also decides on the instrument to be used and the terms and conditions for their execution. They can be executed on the basis of standard tenders, quick tenders or bilateral procedures With regard to their aim, regularity and procedures, the ESCB open market operations can be divided into the following four categories (see also Table 1):
The main refinancing operations are regular liquidity-providing reverse transactions with a weekly frequency and a maturity of two weeks. These operations are executed by the national central banks on the basis of standard tenders. The main refinancing operations play a pivotal role in pursuing the purposes of ESCB open market operations and provide the bulk of refinancing to the financial sector.
The longer-term refinancing operations are liquidity-providing reverse transactions with a monthly frequency and a maturity of three months. These operations aim to provide counterparties with additional longer-term refinancing and are executed by the national central banks on the basis of standard tenders. In these operations, the ESCB does not, as a rule, intend to send signals to the market and therefore normally acts as a rate taker.
Fine-tuning operations are executed on an ad hoc basis with the aim of managing the liquidity situation in the market and of steering interest rates, in particular in order to smooth the effects on interest rates caused by unexpected liquidity fluctuations in the market. Fine-tuning operations are primarily executed as reverse transactions but can also take the form of outright transactions, foreign exchange swaps and the collection of fixed-term deposits. The instruments and procedures applied in the conduct of fine-tuning operations are adapted to the types of transactions and the specific objectives pursued in the operations. Fine-tuning operations are normally executed by the national central banks through quick tenders or bilateral procedures. The Governing Council of the ECB will decide whether, under exceptional circumstances, fine-tuning bilateral operations may be executed by the ECB itself.
In addition, the ESCB may carry out structural operations through the issuance of debt certificates, reverse transactions and outright transactions. These operations are executed whenever the ECB wishes to adjust the structural position of the ESCB vis-à-vis the financial sector (on a regular or non-regular basis). Structural operations in the form of reverse transactions and the issuance of debt instruments are carried out by the national central banks through standard tenders. Structural operations in the form of outright transactions are executed through bilateral procedures.
Standing facilities
Standing facilities aim to provide and absorb overnight liquidity, signal the general stance of monetary policy and bound overnight market interest rates. Two standing facilities are available to eligible counterparties on their own initiative subject to their fulfilment of certain operational access conditions (see also Table 1):
Counterparties can use the marginal lending facility to obtain overnight liquidity from the national central banks against eligible assets. Under normal circumstances, there are no credit limits or other restrictions on counterparties' access to the facility apart from the requirement to present sufficient underlying assets. The interest rate on the marginal lending facility normally provides a ceiling for the overnight market interest rate.
Counterparties can use the deposit facility to make overnight deposits with the national central banks. Under normal circumstances, there are no deposit limits or other restrictions to counterparties' access to the facility. The interest rate on the deposit facility normally provides a floor for the overnight market interest rate.
The standing facilities are administered in a decentralised manner by the national central banks.
Minimum reserves
The ESCB's minimum reserve system applies to credit institutions in the euro area and primarily pursues the aims of stabilising money market interest rates and creating (or enlarging) a structural liquidity shortage. The reserve requirement of each institution is determined in relation to elements of its balance sheet. In order to pursue the aim of stabilising interest rates, the ESCB's minimum reserve system enables institutions to make use of averaging provisions. Compliance with the reserve requirement is determined on the basis of the institutions' average daily reserve holdings over a one-month maintenance period. Institutions' holdings of required reserves are remunerated at the rate of the ESCB's main refinancing operations.
Counterparties
The ESCB monetary policy framework is formulated with a view to ensuring participation of a broad range of counterparties. Institutions subject to minimum reserves according to Article 19.1 of the ESCB/ECB Statute may access the standing facilities and participate in open market operations based on standard tenders. The ESCB may select a limited number of counterparties to participate in fine-tuning operations. For outright transactions, no restrictions are placed a priori on the range of counterparties. For foreign exchange swaps conducted for monetary policy purposes, active players in the foreign exchange market are used. The set of counterparties for these operations is limited to those institutions selected for ESCB foreign exchange intervention operations which are located in the euro area.
Underlying assets
Pursuant to Article 18.1 of the ESCB/ECB Statute, all ESCB credit operations (i.e. liquidity-providing operations) have to be based on adequate collateral. The ESCB accepts a wide range of assets underlying its operations. A distinction is made, essentially for purposes internal to the ESCB, between two categories of eligible assets: "tier one" and "tier two" respectively. Tier one consists of marketable debt instruments fulfilling uniform euro area-wide eligibility criteria specified by the ECB. Tier two consists of additional assets, marketable and non-marketable, which are of particular importance for national financial markets and banking systems and for which eligibility criteria are established by the national central banks, subject to ECB approval. No distinction is made between the two tiers with regard to the quality of the assets and their eligibility for the various types of ESCB monetary policy operations (except that tier two assets are normally not used by the ESCB in outright transactions). The assets eligible for ESCB monetary policy operations can also be used as underlying assets for intraday credit. Furthermore, ESCB counterparties may use eligible assets on a cross-border basis, i.e. they may borrow from the central bank of the Member State in which they are established by making use of assets located in another Member State.
Modifications to the monetary policy framework
The Governing Council of the ECB may, at any time, change the instruments, conditions, criteria and procedures for the execution of ESCB monetary policy operations.
The passage cited above is drawn from the Banque de France's statement on Monetary Policy.
