The monetary policy setting in the Eurozone

The Maastricht Treaty was signed the 7th of February 1992 by the members of the so-called “European Community”, which became by then the “European Union”. It ended a long road to achieve a monetary union at the European level, and a single currency, the euro. Inspired by federal states such as the United States or Germany, the Treaty established a structure, the European System of Central Banks (ESCB) and especially the European Central Bank (ECB) at its head, which are formally in charge of the conduct of the monetary policy of the Eurozone since January 1999. The ECB is a young institution compared with central banks such as the Federal Reserve (Fed) in the United States. While the latter on the one hand is often characterized by its “flexibility and its capacity to adjust” (Sardoni and Wray, 2006:451), the ECB on the other hand has a reputation of extreme caution and of obsession with low inflation.

What more precisely characterize the monetary policy of the European Union, and how is it decided and executed? In order to answer these questions about monetary policy setting, we will first draw the main features of the structure of monetary policy-making in the ESCB. Then, we will move on to the policy objectives and strategies of the ESCB and of its main institution, the ECB. Finally, we will tackle the issue of evaluating the monetary policy of the European monetary union after more than a decade of existence.

[...] Some critics even say that the decentralization of the ESCB is excessive in comparison with federal states such as Germany and the US, because the power of NCBs in monetary policy setting is too great. The ESCB is governed by two key decision-making bodies, the Governing Council of the ESCB and the Executive Board of the ECB. The former is in charge of the determination of the Eurozone’s monetary policy while the latter is responsible for its implementation and is an intermediary with the NCBs. [...]

[...] Otherwise, there is a temptation for political officials to use the positive effects on growth and employment of expansionary monetary policies in the short term without consideration for the high levels of inflation it involves in the medium term. In this regard the ECB is “probably the world’s most independent central bank” (Baldwin and Wyplosz, 2009:503). Indeed, the article 108 of the Treaty establishing the European Community states that “Community institutions and bodies and the governments of the Member States undertake to respect this principle [of central bank independence] 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.” The ECB enjoys at the same time institutional, functional, financial and personal independence. [...]

[...] The rationale behind this strict policy of price stability is that inflation is not desirable in itself, so it must be the reflection of a deeper problem, typically large public budget deficits. Indeed, government finance their public policies borrowing money to the financial markets, and when they are not able to do so anymore, by running the printing press. There is a fear that this situation is like “letting the wolf enter into the (Baldwin and Wyplosz, 2009:494). Still, complete stability of prices is not desirable either, because wages tend to increase over time, and prices should follow this trend. [...]