Five things you need to know about the ECB
10 July 2015
1. We are a European institution working for 340 million citizens
The European Central Bank (ECB) is the central bank for the euro, the currency of 19 European countries. Founded in 1998, it is an official institution of the European Union and is situated in Frankfurt am Main, Germany.
The main objective of the ECB is to keep prices stable in the countries that use the euro as their currency. It does this by designing and implementing monetary policy within the Eurosystem, which groups the ECB with the national central banks of the 19 euro area countries.
The ECB’s decisions have a direct impact on the euro area economy, which means they can touch the lives of the 340 million people who live there.
2. We aim for stable prices in the euro area
The ECB’s primary objective is price stability. This means the central bank aims to keep the rate at which prices rise (inflation) below, but close to, 2% over the medium term. This is seen as an acceptable inflation level for a central bank to aim at. Prices do not rise so fast that your savings disappear over time. Neither do they stagnate at a level where prices might begin to fall (deflation) which means people delay their purchases. That can cause the economy to lock up and lead to job losses and steeper falls in prices, in a self-perpetuating spiral.
Stable prices are important for people and firms to feel secure in making plans to invest for the future.
In common with other central banks, the standard way the ECB influences prices is by setting the short-term interest rate at which it lends money to commercial banks. By changing that interest rate the ECB seeks to influence the amount and cost of the credit that flows via banks to companies and households, i.e. into the broad economy. When the economy is in a downturn and inflation is lower than the ECB’s objective, a low interest rate (“easy monetary policy”) encourages the flow of credit by making it cheaper, which stimulates demand across the whole economy and, over time, brings inflation back to the ECB’s objective. When the economy is overheating and inflation is running above the objective, a high interest rate (“tight monetary policy”) has the opposite effect: it makes borrowing more expensive so that the economy and the rate at which prices rise can slow down.
During the financial crisis, which was marked by severe economic downturns and very weak inflation, the ECB and other central banks around the world have also used what economists call “non-standard” or “unconventional” monetary policy. An example of this is the asset purchase programme. When short-term interest rates are already very low or negative, a central bank can try to ease monetary policy further by reducing longer-term interest rates via purchases of assets like sovereign bonds. The decline in longer-term interest rates puts downward pressure on the cost of credit for households and companies. Additionally, central bank money is created to buy the bonds and this money is used by the institutions that sell the bonds to buy other assets. This bids up the price of these assets, increasing the wealth of the investors who own them and strengthening their incentives to spend. This, again, can bring the economy back to a sustainable growth path and to an inflation rate that is consistent with the ECB’s objective.
3. We contribute to a safer banking sector
Since November 2014, the ECB has taken on the additional task of directly supervising the biggest banks in the euro area. Together with national supervisors in the Single Supervisory Mechanism, the ECB reviews how banks conduct their activities. It can grant and withdraw banking licences as well as identify and address potential risks early on.
The ECB’s banking supervision seeks to ensure rules are applied in the same way across Europe. As banks in Europe are strongly interconnected, this harmonised supervision makes the banking sector more stable and therefore more trustworthy for citizens and companies.
4. We are an independent and accountable institution
The ECB’s tasks and responsibilities are set out in the Treaty on the Functioning of the European Union. As a supranational institution, the ECB acts in the interest of Europe as a whole; as a central bank, it is independent from any political or commercial influence. This is important as history shows that a central bank that follows political orders can lose sight of its objective of maintaining price stability.
Nevertheless, the ECB is accountable. There are regular public hearings between ECB representatives including the President and members of the European Parliament. In addition, the ECB pioneered the practice among major central banks of holding regular press conferences immediately after monetary policy decisions.
Those decisions are taken by majority vote in the Governing Council, the ECB’s main decision-making body, where the six members of the ECB’s Executive Board sit with 19 governors of national central banks (of which 15 at a time have voting rights, on rotation basis).
5. We make money for the euro area
Banknotes are produced across the whole euro area, under ECB oversight. Each one bears the signature of the ECB President – a sign of the pride we take in our work and something that draws us all together. The euro is one of the most tangible signs of European integration. It facilitates trade and business across borders, and greatly eases travel and day-to-day life in the euro area.