Monetary Policy

Monetary policy instruments

The Eurosystem uses a number of monetary policy instruments approved by the Governing Council of the European Central Bank (ECB) to achieve its monetary policy objectives. These instruments steer short-term interest rates, manage the liquidity situation in the banking system, as well as signal the general stance of monetary policy.

The operational framework of the Eurosystem consists of the following set of instruments:

  • Open market operations

Open market operations play an important role in steering interest rates, managing the liquidity situation in the market, and signalling the monetary policy stance. They are initiated by the ECB and are conducted against collateral. There are four types of open market operations, which differ in terms of objective, regularity and procedure.

Main refinancing operations (MROs) are regular reverse transactions that provide liquidity usually conducted on a weekly basis with a maturity of one week. They are normally executed in a decentralised manner by national central banks according to a pre-specified calendar. In normal times, these operations provide the bulk of liquidity to the financial sector and play a crucial role in fulfilling the objectives of the Eurosystem's open market operations. In October 2008 the ECB introduced a system of full allotment whereby all bids placed under this facility were met at a fixed rate announced by it.

Longer-term refinancing operations (LTROs) are reverse transactions that provide liquidity for a longer duration. Regular longer-term refinancing operations are conducted with a monthly frequency on the basis of standard tenders according to a pre-specified calendar and with a maturity of three months. The Eurosystem may also conduct other longer-term operations, with a maturity of more than three months. In recent years, such operations have had maturities of up to 48 months (the longest being the targeted longer-term refinancing operations, or TLTROs). Longer-term refinancing operations are aimed at providing counterparties with additional longer-term refinancing and can also serve other monetary policy objectives.

Fine-tuning operations can be conducted on an ad hoc basis to smooth the effects on interest rates caused by unexpected liquidity fluctuations. Fine-tuning operations are primarily executed as reverse transactions but may also take the form of foreign exchange swaps or the collection of fixed-term deposits. Fine-tuning operations are normally executed by the Eurosystem through quick tenders. The Eurosystem may select a limited number of counterparties to participate in fine-tuning operations.

Structural operations can be conducted whenever the ECB wishes to adjust the liquidity position of the Eurosystem vis-à-vis the financial sector. Structural operations can be carried out by the Eurosystem through reverse transactions, outright transactions and the issuance of debt certificates. The Eurosystem has conducted asset purchases to address the risks of a too-prolonged period of low inflation and to help overcome the limitations caused by the lower bound of interest rates, giving a further boost to lending, spending and investment in the economy.

  • Standing facilities

Standing facilities provide and absorb overnight liquidity, signal the general monetary policy stance, and bind overnight market interest rates. There are two standing facilities which credit institutions can use at their own initiative.

The marginal lending facility is available to credit institutions to obtain overnight liquidity against eligible collateral. The interest rate on the marginal lending facility normally provides a ceiling for the overnight market interest rate.

The deposit facility is available to credit institutions to make overnight deposits. The interest rate on the deposit facility normally provides a floor for the overnight market interest rate.

  • Minimum reserve requirements

Credit institutions in the euro area are obliged to hold a minimum amount of deposits, called minimum or required reserves, in accounts with their respective national central banks. The minimum reserve system is meant to stabilise money market interest rates and potentially create (or enlarge) a structural liquidity shortage. The amount credit institutions should hold is determined by certain elements of their balance sheet, in particular customer deposits with a maturity of up to two years.

The ECB does not require credit institutions to hold the total amount of required reserves in their account at the central bank every day. Rather, they should hold these required reserves on average, based on their daily holdings, over a maintenance period of about six weeks. The respective reserve maintenance periods start on the settlement day of the main refinancing operation following each Governing Council monetary policy meeting.

Until the maintenance period ending on 20 December 2022, the required reserves are remunerated according to the average interest rate of the main refinancing operations over the maintenance period. As from the maintenance period starting on 21 December 2022, the required reserves will be remunerated at the deposit facility rate.

Other monetary policy tools

Before the global financial crisis, the ECB mainly conducted monetary policy by setting key interest rates. However, since the financial crisis, the set of policy instruments was expanded. This allowed the Eurosystem to influence financing conditions faced by people and companies in difficult times when the malfunctioning of the financial system damaged the transmission mechanism of monetary policy. During these periods, short-term interest rates approached their “effective lower bound”, i.e., the level below which lowering them would no longer increase the level of economic activity. Accordingly, the toolbox was adopted to incorporate new tools such as the fixed rate full allotment liquidity to banks, negative interest rates, offering long-term loans to banks, purchasing private and public financial assets and providing forward guidance. 

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