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Financial Market (ECB (Road to ECB: (1993 – Maastricht Treaty – EU with 8…

- - - - ECB
        
        Executive Board
        
        Prepare governing council meetings
        
        Put into action monetary policy decision in the Euro area
        
        Manages ECB’s day to day business.
        
        General Council
        
        Prepare the ECB’s annual report
        
        Collect statistical data
        
        Establish accounting and report of operations undertaken by the NCB’s
        
        Advise countries who are seeking to join the Euro zone. Establish conditions of employment for ECB staff
        
        Governing Council
        
        Highest decision making body on monetary policy
        
        Formulates monetary policy on the key interest rates:
        
        MRO (Marginal refinancing operation)
        
        Marginal lending facility (what they use to lend to banks over night)
        
        marginal deposit facility (collects deposit from banks over night)
        
        Responsible for supervising banks. They meet twice a month to vote.
        
        Supervisory Board
        
        Carry out supervisory tasks. Propose decision to the governing council.
    - - Gives emergency credits to banks that are in trouble. It gave Greece money so that they would not close down
  - - - Study set up to achieve a common monetary policy in the Euro area.
  - - - Fixed exchange rates $1 = £1
        Currency markets $1 = £0.5
        
        The currency has become over valued.
        
        The CB will buy £'s using it's foreign reserves in order to increase the value of the exchange rates
        
        Foreign reserves go down
        
        This also leads to money supply decreasing
        
        This leads to an increase in the interest rates
    - - Fixed exchange rates $1 = £1
        Currency markers $1 = £2
        
        The currency is under valued
        
        The CB will sell £'s using it's foreign reserves in order to decrease the value of the exchange rates
        
        Foreign reserves go up
        
        Money supply goes up
        
        Interest rates go down
    - - Bretton Woods was the first attempt at a fixed exchange rate system
        
        failed in 1959 due to Deustchmark and French Franc
      - EMS was the 2nd attempt
        
        high german inflation caused increased inflation in non-german countries, leading to increased interest rates
  - - - Easily understood by the public
      - Highly transparent
      - If forecasts deviate from the objective then ECB uses monetary policy to bring inflation back to target
      - Avoids political interference as countries cannot tell them what to do
      - Directly targets the objective of price stability
    - - If the forecast is wrong then this reduces the effectiveness of the monetary policy
      - ECB works with complex models so the public may not always understand
      - Focuses on a single indicator (inflation). A fluctuating exchange rate could be just as bad.
      - Inflation is hard to control
- - - - Accountability - gives explanations for the action the CB takes
        
        Legal and political obligation to justify its decision to citizens
        
        The ECB publishes a quarterly report on the ESCB as well as a monthly bulletin and a weekly financial statement
        
        The central bank gives an annual report where it explains its policies to EU parliament and EU council.
      - Disclosure - how the central bank provides information to the public
        
        Economic disclosure – openness about the use of economic forecasts to make decisions, eg, inflation and GDP forecasts. It lets people know what the ECB is looking at in the economy.
        
        Procedural disclosure – information about the monetary policy strategy eg, releasing the meetings and voting records to show how the monetary policy decisions came about. Publications of the monthly rota of the central bank governors that voted in the governing council.
        
        Policy disclosure – prompt announcement of policy decisions followed by explanation
        
        Operational disclosure – how open the central bank is about the steps it uses to control monetary policy
        
        Political disclosure – openness about inflation targets, this depends on the degree of the central bank independence
      - Transparency - publics understanding of the monetary policy process, the public understands that the central banks goal is price stability
    - - Objectives
        
        Central bank strategy
        
        Communications (disclosure)
        
        Reporting by intermediaries
        
        public understanding
        
        Output (Decisions)
        
        Outcomes
        
        Behaviour
        
        .
        
        .
        
        Input (raw data)
        
        .
- - - - M2 – M1 + deposits that have a maturity for up to 2 years
      - M3 – M2 + repurchase agreements, money market fund shares + debt securities
      - M1 – Notes and coins in circulation + savings in current accounts
      - If growth in M3 deviates from its long-term average value then this is a signal of risk to price stability
  - - - Monetary transmission mechanism (MTM)
        
        Interest rates channel (Demand side)
        
        ECB
        
        Interest rates
        
        +
        
        Cost of household mortages
        
        Household consumption
        
        Cost of capital for companies
        
        Companies investment
        
        Lower interest rate = lower cost of capital and cost of mortgages = increased consumption
        
        Bank Lending channel (Supply Side):
        
        When the bank decrease interest rates it increases the supply of loans as it makes it cheaper and easier to lend. This means investment and consumption can increase which leads to an increase in GDP
        
        Stock and bond markets watch ECB so they know what future policy will be. Using QE to buy Gov bonds leads to increased money for banks. The banks can then lend out more to households and firms, this leads to increased stock market activity and thusly economic growth.
      - Will the ECB move interest rates up or down
      - how much will they move it + when will they move it
      - these are what the financial markets look for
- - - - market share is low
      - firms will not increase the price of goods when there is change in the exchange rate
      - import prices have a small impact on domestic prices
      - this is because they do not want to lose customers
    - - market share is high
      - firms will increase the price of goods when there is a change in exchange rate
      - this is because the loss of customers is small
      - import prices have a large impact on domestic prices
      - If