European central bank

The Central Bank, which monitors and controls the Euro, the common currency which is used by 18 European states. It has been carrying out this role since 1999. There had been 197 central banks already in operation prior to this. The role of a central bank was originally to act as the government’s banker then, later on, became dedicated to funding military exploits before the 1850s and subsequently to maintain financial and economic stability.   (Pollard, 2003)

 The current main function of a central bank is to regulate and monitor the impact of monetary policies. Keeping this in mind the central bank system as exemplified by the European central bank has a tremendous amount of independence so that it can do its job within the purview of governmental regulations.  The independent functioning of the European Central Bank, as well as other nationalized banks, has been ensured with the amendments to the 1993 Maastricht Treaty.  (Pollard, 2003)

 The main function of the European Central Bank is to monitor and regulate the euro’s purchasing power and thus help maintain the stability related to price in the euro area. The European economy is the second-largest after the US economy. Besides this, the ECB is responsible for the production of currency for all its affiliated countries as well as its distribution. The decisions regarding use of fixed exchange rate are taken by a different wing of the Economic Union executive (ECOFIN). They also provide financial services to the governments of the member countries(Pollard, 2003)

 A. How did the European Central Bank come into being?

The ECB was established as part of a dream for the greater union and integration of European countries which started   by centralising the banking and introducing a common currency.  The foundation for the establishment of a union of the European countries was laid in the year 1957 when six countries—Belgium, France, Germany, Italy, Luxembourg, and the Netherlands became signatories to the Treaty of Rome, which lead to the establishment of  the European Economic Community.  The treaty’s main aim was the establishment of a custom union between the signatories which would involve regulation and management of monetary and fiscal issues. Following meetings of the various finance and economics ministers, a committee of central bank governors was established in 1964 to oversee the implementation of monetary policies in the member state. (Pollard, 2003)

 The journey towards the establishment of a monetary union between the different EU member countries was not an easy one with several obstacles and several changes which created roadblocks and which did not make this a smooth process. This included the problems with the fixed rate exchange system (which collapsed) and oil crisis as well as other changes in the European Union including additions and introduction of a new fixed rate exchange system. However, in spite of these changes and turbulences, the countries stayed on the path to achieving economic unity and developing common banking and economic policies.

 Couple of proposals both in the 1970s as well as subsequently in the 1980’s advocated the process of creating an economic union in three steps.  These steps were furthered by the passage of a law in 1987 called the Single European Act which aimed at the creation of free market in all the countries of the EU, with free movement of goods, services and capital.

 Ultimately, all these influences and events led to the establishment of a European overarching agency that would oversee the monetary policy and establish a dedicated currency for Europe. And the final seal for the establishment of European Union’s European Central Bank  was the signing of the amendments to the original Treaty of Rome, in Maastricht  In December 1991, which enabled the integration of economic and monetary aspects of Europe countries. This was the Maastricht Treaty and it came into effect in November 1993 (Pollard, 2003). The ECB was established or came into operation when there was a transfer of banking from the national central banks of 11 EU stated to the EC In January 1999. It held its first meeting on June 1 1998.

 Slovenia, Cyprus and Malta joined. Greece was accepted in2001. Austria, Sweden and Finland had joined in 1995. Estonia had joined in 2011 and Latvia in 2014. The countries which joined the ECB formed part of the euro area.

 

 B. What is special about the European Central Bank?

 Around 25 independent countries have willingly united their monetary and fiscal systems under a common umbrella with a single currency, the Euro. Each country’s national banking representative would be a part of the committee and their feedback would go into decisions taken. The ECB and its affiliated national banks from the different members in the EU umbrella comprises the Eurosystem.  (Pollard, 2003)

C. Criteria for being part of the ECB and the European Banking community:

Before adopting the euro as a currency and being a part of the European Banking community, member countries have to fulfil set of criteria called the convergence criteria.  These criteria specify the economic and legal requirements required for the member countries to participate in the EMU of the EU.

1. At the time of joining, the states should exhibit a reasonably high degree of price stability, which comes close to the three most performing member states of the European Union. It should also have an average rate of inflation which does not exceed 1.4 % of the best performing member states

 

2. The governmental budget deficit should not be in excess of that stipulated by the European Central Bank i.e. should be fiscally stable

 

3. Respect of the exchange rate rules of the ECB ~  Treaty The member state should respect and follow the fluctuation margins which are provided for the exchange rate mechanism of the European Monetary Sytem and should not manipulate its currency’s central rate against the Euro on its own within the same period of two years before being considerd to be a part of the EMS.

 

4. The long term interest : This would be defined on the basis of performance of long term governmental bonds and securities. (www.ecb.europa.eu, 2014)

D. Challenges faced by the European Central Bank:

One of the greatest challenges faced by the ECB has been in dealing with the consequences of the global economic crisis. This was more so as it was caught at the beginning of the implementation of the European monetary integration project. The crises was compounded by the mortgage episode in the US, and the Great Recession led to world-wide devastating impact on the world financial systems leading to rapid loss of liquidity as a result of the bankruptcy of the lehmann Brothers.

 

Its impact on the European systems was a prolonged and deeply entrenced recession. This led to challenges as to how monetary policies could be used to inject life into a draggy economy when there were already limits in place on the use of central bank action.

 

It was more challenging for the ECB as it is answerable to not one but around 20 national banks of component countries and findings solutions to all as per their specific situation would be too complex. The ECB, however, stood up to the challenge by injecting huge amounts of liquidity into a market at a time when investor confidence was very low and the financial distrust which was spreading very fast would have lead to the collapse of the market. (De Molina, 2013)

 

 

 

 

List of References:

De Molina, J. L. M. (2013). THE EUROPEAN CENTRAL BANK’S RESPONSE TO THE CRISIS. [e-book] pp. 11-30. Available through: http://www.bde.es http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/InformesBoletinesRevistas/BoletinEconomico/13/Jul/Files/art4e.pdf [Accessed: 25 Mar 2014].

Pollard, P. (2003). A Look Inside Two Central Banks: The European Central Bank and the Federal Reserve. [online] Retrieved from: http://research.stlouisfed.org/publications/review/03/01/Pollard.pdf [Accessed: 25 Mar 2014].

 

www.ecb.europa.eu. (2014). ECB, ESCB and the ecosystem. [online] Retrieved from: http://www.ecb.europa.eu/ecb/orga/escb/html/convergence-criteria.en.html [Accessed: 25 Mar 2014].

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