How the European Central Bank S Structure is Managed Finance Essay

The European Central Bank (ECB) is the main central bank for the 15 countries that are part of the European System of Central Bank (ESCB) or the Eurosystem. The ESCB or Eurosystem consist of the ECB and all the central banks of the member states (national central banks). It has the following basic responsibilities, "to define and implement the monetary policy of the community, to conduct foreign exchange operations in accordance with Article III of the Treaty, to hold and manage the official foreign reserve of the member states, and to promote the smooth operations of the payment systems" (Issing, 2008, p. 54). The ECB was established on June 1, 1998 in Frankfurt am Main. It's main responsibilities, according to the Europa.eu, are to manage the European Union's (EU) single currency, the euro, to safeguard price stability for the EU's citizens and for framing and implementing the EU's economic and monetary policy (European Union, 2010). Omar Issing further states in his book entitle The Birth of the Euro, that the ECB "has a monopoly on the issue of banknotes within the euro area ¦it is empowered to collect the statistical data necessary for the conduct of monetary policy" (Issing, 2008, p. 54). This monopoly enjoyed by the ECB is nothing short of the main focus of central banks in regulating the monetary system (money supply) of their country. But how does the ECB governs itself? How are decisions made by the ECB in achieving its objectives and responsibilities? And how does the ECB regulate the Eurosytem or ESCB?

Governance of the ECB is done through the main decision making bodies that comprised its operation the Governing Council, the Executive Board and the General Council. Firstly, the Governing Council is the ECB's highest decision-making body and it comprised six (6) members of the Executive Board and the 15 central banks governors of the Eurosystem, a total of 21 members (Issing, 2008, p. 67). These members meet twice a month via telephone conferencing and usually in the month of August. The central task of the Governing is to adopt guidelines necessary for the operations of the Eurosystem and to formulate monetary policy for its community. Therefore, a country, once they entered the Eurosystem their responsibility for monetary policy passes from their national central bank to the ECB. Thus the single important function of the Governing Council is to ensure that the central objective of the ECB, price stability is achieved and this is accomplished as a result of using a single index (the euro) for the entire European community (Issing, 2008, p. 68).

Secondly, the Executive Board of the ECB comprises six (6) persons: the President, the Vice-President and four other members. It is considered to be the "operational decision-making body" of the ECB. Also its primary responsibility is to implement the monetary policy as defined by the Governing Council. And like the Governing Council, the Executive Board is a collegial body. A collegial body is an entity whose power and authority is vested in its members. Thus each member of the Executive Board has one vote, which the President has the deciding vote if there is a tie (Issing, 2008, p. 70). Otmar Issisng the author of the Birth of the Euro was a former member of the Executive Board from 1998 to May 2006 in the capacity of Directorates General, Economics and Research.

Finally, the third decision-making arm of the ECB is the General Council. It comprises the President and Vice-President of the ECB and all the governors of the central banks of the member state. Other members of the Executive Board may sit with the General Council and participate in its operation but they cannot vote. The General Council assumes the role of the former European Monetary Institute (EMI) formed in Jan 1994 which had no monetary policy powers. Today nothing has changed concerning its mandate which now include providing monetary advice to European Union (EU) countries that have not yet joined and overseeing the functioning of the exchange rate mechanism (Issing, 2008, p. 75). How do these three bodies work together in making decision to satisfy its primary objective of price stability? What exactly is the ESCB? And what role they play in the ECB's monetary policy?

Otmar Issing states further that the functionality of the ECB's monetary policy rest on three pillars: prohibition of monetary financing, central bank independence and primacy of price stability (Issing, 2008, p. 54). These three pillars summarize how the ECB regulate the Eurosystem which essentially is its single monetary policy. The prohibition of monetary refers to the historical account where member states national central banks were pressured into buying up unlimited amount of government paper or granting direct credit to the public sector. These actions by the central banks increased the money supply or the amount of money in circulation which caused inflationary pressure in the community. Now ECB and the national central banks are prohibited from engaging into such actions (Article 101 of the Treaty) and a ban has also being placed on their ability to provide provision of credit to the public sector coupled with the direct purchase of public debt instruments (Issing, 2008, p. 55).

Another pillar of the monetary policy of the ECB and the national central banks concerns their independence found in Article 108 of the Treaty which is quoted:

When exercising the powers and carrying out the tasks and duties conferred upon them by this Treaty and the Statue of the ESCB, neither the ECB, nor a national central bank, nor any member of their decision-making bodies shall seek or take instructions from Community institutions or bodies, from any government of a Member State or from any other body. The community institutions and bodies and the governments of the Member states undertake to respect this principle and not to seek to influence the members of the decision-making bodies of the ECB or of the national central banks in the performance of their tasks" (Issing, 2008, p. 56)

This quotation sums up the importance of the ECB's independence from the respective government bodies or legislative powers from the different member countries. Therefore, persons working within the ECB would be subject to this independence as well. Such independence attributed to staff of the ECB is to ensure that contracts cannot be terminated prematurely, for example, members of the Executive Board have a term of office of eight years with no renewal. The ECB's independence is fundamental to the implementation and formulation of monetary policy (Issing, 2008, p.56).

The final pillar that contributes to the regulation of the Eurosystem is referred to as the primacy of price stability or in other words, the ECB primary responsibility is to maintain price a stable price throughout the Eurosystem. Why is this objective of price stability so important to monetary policy? If price stability is not maintained it will cause inflation and the contrary to this is deflation. Price stability here is defined as "a year-on-year increase in the Harmonized Index of Consumer Prices (HICP) for the euro area of below two per cent aim to maintain inflation rates close to two per cent over the medium term" (Issing, 2008, p. 115). Issing gives three important reasons for the importance of price stability as adopted by the ECB, namely, that central planning is based on the correct signals coming from prices in deciding on production and consumption, investing and saving issues. These correct signals from prices refer to changes in relative prices. Changes in relative prices consequently signal changes in relative scarcity which acts as a guide for participant in market activities pointing them in the right direction. Simultaneous shifts in prices cause difficulty in differentiating between shifts in relative prices and overall price increases. Such anomaly means that the economy is operating below performance or below potential which affects investment and household spending (Issing, 2008, p. 62).

As mentioned in the above, inflation or deflation causes changes in price and such changes can distort the distribution of income and wealth. This re-distribution of income and wealth is also affected by the tax system, specifically through transfer payments based on nominal values and adjusted values. Research done by Edmund Phelps, the 2006 Nobel laureate has shown that such effects can be substantial even at harmless levels of inflation (Issing, 2008, p. 62).

The final point based on the importance for price stability rest on the assumption surrounding the uncertainty of predicting the stability of future prices. Marketing intermediaries will hedge against this uncertainty as a precautionary measure which will lead to corresponding increases in nominal prices and not long-term interest rates. As a consequent of this action by marketing intermediaries financing for investment becomes more expensive and so does government borrowing (Issing, 2008, p. 63).

Conclusion

The ECB single most responsibility justifiably has been since its inception is to maintain price stability across the Eurosystem. It has been a challenge or a mammoth task by the ECB given the intricacies involved in the implementation and formulation of mechanism to complement and support this objective. The three pillar approach conceptualized by Otmar Issing has proven to be the one of the success factors capitalized by the ECB used to regulate the Eurosystem. There are many other areas worth mentioning that would underscore the importance of utilizing such an approach, but would extend beyond the bounds of this paper, for example, other monetary policy options considered (Taylor Rule, discretionary policy, inflationary targeting and others) and what are some of the instruments of monetary policy.

References

European Union. (2010, December). Europa. Retrieved from https://europa.eu/institutions/financial/ecb/index_en.htm

Issing, O. (2008). The Birth of the Euro. New York, NY: Cambridge University Press.

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