Monetary policy instruments

Operational Framework

In order to achieve its primary objective, the Eurosystem uses a set of monetary policy instruments and procedures. This set forms the operational framework to implement the single monetary policy (see instruments).

Monopoly supplier of monetary base

The Eurosystem is the sole issuer of banknotes and bank reserves in the euro area. This makes it the monopoly supplier of the monetary base, which consists of

  • currency (banknotes and coins) in circulation,
  • the reserves held by counterparties with the Eurosystem, and
  • recourse by credit institutions to the Eurosystem’s deposit facility.

These items are liabilities in the Eurosystem’s balance sheet. Reserves can be broken down further into required and excess reserves.

In the Eurosystem’s minimum reserve system, counterparties are obliged to hold reserves with the national central banks (NCBs). Beyond that, credit institutions usually hold only a small amount of voluntary excess reserves with the Eurosystem.

By virtue of its monopoly, a central bank is able to manage the liquidity situation in the money market and influence money market interest rates.

Signalling the monetary policy stance

In addition to steering interest rates by managing liquidity, the central bank can also signal its monetary policy stance to the money market. This is usually done by changing the conditions under which the central bank is willing to enter into transactions with credit institutions.

Ensuring proper functioning of the money market

In its operations, the central bank also aims to ensure a proper functioning of the money market and to help credit institutions meet their liquidity needs in a smooth manner. This is achieved by providing both regular refinancing to credit institutions and facilities that allow them to deal with end-of-day balances and to cushion transitory liquidity fluctuations.

Guiding principles

The operational framework of the Eurosystem is based on the principles laid down in the Treaty on the Functioning of the European Union. Article 127 of that Treaty states that in pursuing its objectives, the Eurosystem "(…) shall act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources (…)".

In addition to the principles set out in the Treaty on the Functioning of the European Union, the operational framework follows several guiding principles.

Operational efficiency

The most important principle is operational efficiency. It can be defined as the capacity of the operational framework to enable monetary policy decisions to feed through as precisely and as fast as possible to short-term money market rates. These in turn, through the monetary policy transmission mechanism, affect the price level.

Equal treatment and harmonisation

Another principle is that credit institutions must be treated equally irrespective of their size and location in the euro area. The harmonisation of rules and procedures helps to ensure equal treatment by trying to provide identical conditions to all credit institutions in the euro area in transactions with the Eurosystem.

Decentralised implementation

One principle specific to the Eurosystem is the decentralised implementation of monetary policy. The ECB coordinates the operations and the national central banks (NCBs) carry out the transactions.

Simplicity, transparency, continuity, safety and cost efficiency

Simplicity and transparency ensure that the intentions behind monetary policy operations are correctly understood. The principle of continuity aims at avoiding major changes in instruments and procedures, so that central banks and their counterparties can draw on experience when participating in monetary policy operations. The principle of safety requires that the Eurosystem’s financial and operational risks are kept to a minimum. Cost efficiency means keeping low the operational costs to both the Eurosystem and its counterparties arising from the operational framework.