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The European Central Bank

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The European Central Bank

The Federal Reserve System works as the central bank of the United States and controls the monetary policy in the U.S. But do other countries have a similar system? How does it work precisely in Europe?

In this article, we will learn all about the European Central Bank, its importance for monetary policy, and its operations. Ready to learn? Start reading!

European Central Bank Overview

Let's start with a European Central Bank overview. The European Central Bank (ECB) works as the central bank in Europe for the member countries of the eurozone; those countries that have adopted the euro as their national currency. There are currently 19 countries in the eurozone.1

The European Central Bank is headquartered in Frankfurt, Germany. The main responsibility of the European Central Bank is to manage monetary policy and maintain price stability in the eurozone.

Importance of the European Central Bank

To understand the importance of the European Central Bank, we first need to understand how it developed over time. The European Central Bank was created in 1999 by 11 European countries1 who decided to adopt the euro as their national currency and agree to allow the European Central Bank to manage their monetary policy. After 1999, other European countries joined the eurozone, and the importance of the European Central Bank grew. Today it is one of the main monetary organizations in the world.

Although the United States still has the world's largest economy, the economy that the European Central Bank controls is roughly as big as the U.S. economy. Therefore, the monetary power the European Central Bank holds is comparable with the Federal Reserve System (FED) in the U.S.

The responsibilities of the ECB are very curial for the financial markets as well as the welfare of society. Since the economy controlled by the ECB accounts for a significant share of the world economy, it also has an enormous impact on the world economy.

The European Central Bank European Central Bank BuildingFig 1. - European central bank building

Functions of the European Central Bank

The functions of the European Central Bank are very crucial for the economy. Similar to the FED, the legal status of the ECB is not quite simple: it is not exactly a governmental institution, nor is it a private bank.

In fact, the counterpart of the FED in Europe is not the ECB but the local national central banks such as the Bank of Italy, Bank of France, etc. These national banks were the exact equivalent of the FED in Europe until 1999 since they used to control monetary policy in their country, just like FED controls monetary policy in the U.S.

These national banks are of course still active and responsible for the regulation of various financial services to local banks and institutions and manage the open-market financial operations in their countries. However, the national central banks in Europe do not control their own monetary policy anymore. Since they all use the euro now, only the ECB has the responsibility to regulate monetary policy in the eurozone.

The main decision-making body of the ECB is the Governing Council. The Governing Council of the ECB has six members2 of the Executive Board and the governors of the national central banks of the 19 countries in the eurozone. The Executive Board is appointed by the European Council.2

The ECB decides and manages monetary policy for the eurozone. The ECB has the following responsibilities:

  • decide the targeted inflation rate, as well as the way inflation is measured
  • control the supply of euros available in the financial markets by controlling the amount of euros available to eligible member banks
  • manage the interest rate through the supply of available euros in the market
  • establish and adopt necessary guidelines to support the economic activity level in the eurozone
  • manage exchange operations related to foreign financial markets
  • banking supervision through the adoption of decisions proposed by the Supervisory Board

European Central Bank Monetary Policy

European Central Bank monetary policy has significant importance in the European economy. The primary mandate of the European Central Bank is to maintain price stability in the eurozone.

The European Central Bank can decide the inflation target as well as the way inflation is measured.

In the past years, the annual inflation rate target has been 'maintaining 2% inflation over the medium term.'

Since the inflation target is symmetrical, inflation rates that are too low are also perceived negatively. The aim behind this is to protect the financial system from the risk of destabilizing deflation during a recession.

Even though price stability is the main mandate of the ECB, it has some secondary mandates with no prejudice to the mandate of price stability. Those secondary mandates include targets for full employment and environmental protection.

Operations of the European Central Bank

What are the operations of the European Central Bank? To maintain price stability in the eurozone and to keep inflation at the desired level, there are several economic instruments that the ECB controls or operates. The control of the interest rate is one of the main operations of the European Central Bank used to control the inflation level.

Another important operation of the European Central Bank is managing the supply of the euro. If prices increase for some reason - such as a sudden increase in demand or an unexpected decrease in supply - the ECB normally decreases the amount of available euros in the financial markets to balance the market. If the economy falls into a recession, meaning a decline in economic activity, the ECB would increase the amount of available euros in the market to bring the economic activity level back to its previous level.

Moreover, the ECB is the main institution responsible for banking supervision in the eurozone. To protect the soundness of the European banking system, the ECB operates the Single Supervisory Mechanism (SSM) together with national central banks.

The way the ECB operates is extremely important since, in times of economic crisis, its monetary policy affects the future of millions of people. When the global financial crisis of 2008 affected the European financial markets, the ECB decreased interest rates and ensured a steady supply of euros in the eurozone. Further, the ECB decided to take loans from the International Monetary Fund (IMF) to increase economic activity in European countries where necessary.


The European Central Bank - Key Takeaways

  • The European Central Bank (ECB) works as the central bank in Europe for the eurozone member countries.
  • The European Central Bank is headquartered in Frankfurt, Germany. The main responsibility of the European Central Bank is to manage monetary policy and maintain price stability in the eurozone.
  • The responsibilities of the ECB are very curial for the financial markets as well as the welfare of society. Since the economy controlled by the ECB accounts for a significant share of the world economy, it also has an enormous impact on the world economy.
  • The primary mandate of the European Central Bank is to maintain price stability in the eurozone. The European Central Bank can decide the inflation target. In the past years, the annual inflation rate target has been 'maintaining the 2% inflation over the medium term.'
  • To maintain price stability in the eurozone and to keep inflation at the desired level, there are several economic instruments the ECB can use. The control of the interest rate and the supply of the euro are important instruments that the ECB manages.




References

  1. European Commission. "What is the euro area?". https://ec.europa.eu/info/business-economy-euro/euro-area/what-euro-area_en
  2. European Council. https://www.consilium.europa.eu/en/european-council/role-nominations-appointment/

Frequently Asked Questions about The European Central Bank

The European Central Bank (ECB) works as the central bank in Europe for the eurozone member countries.


The main decision-making body of the European central bank is the Governing Council. The Governing Council of the ECB includes six members of the Executive Board and the governors of the national central banks of the 19 countries in the eurozone.

The primary mandate of the European Central Bank is to maintain price stability in the eurozone. 

The responsibilities of the ECB are very crucial for the financial markets as well as the welfare of society. Since the economy controlled by the ECB accounts for a significant share of the world economy, it also has an enormous impact on the world economy. 


The European Central Bank generates finance by maintaining price stability in the eurozone. They do this by controlling the interest rate and the supply of the euro. This helps to reduce uncertainty for borrowers and lenders, thereby facilitating the flow of credit.

Final The European Central Bank Quiz

Question

What is the European central bank?

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Answer

The European Central Bank (ECB) works as the central bank in Europe for the eurozone member countries.

Show question

Question

Who controls the European central bank?

Show answer

Answer

The main decision-making body of the European central bank is the Governing Council. The Governing Council of the ECB includes six members of the Executive Board and the governors of the national central banks of the 19 countries in the eurozone.

Show question

Question

What is the role of the European central bank?

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Answer

The primary mandate of the European Central Bank is to maintain price stability in the euro zone. 

Show question

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How important is the European central bank?

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Answer

The responsibilities of the ECB are very curial for the financial markets as well as the welfare of the society. Since the economy controlled by the ECB accounts for a significant share of the world economy, it also has an enormous impact on the world economy. 


Show question

Question

How does the European central bank generate finance?

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Answer

To maintain price stability in the eurozone and to keep inflation at the desired level, there are several economic instruments. The control of the interest rate and the supply of the euro are important instruments that the ECB manages.

Show question

Question

Which of the following is a function of the European Central Bank?

I. decide the targeted inflation rate

II. manage the interest rate 

III. supply the available euros in the market

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Answer

I only

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What is the primary mandate of the European Central Bank? 


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Answer

The primary mandate of the European Central Bank is to maintain price stability in the eurozone. 


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What is the annual inflation rate target?

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Answer

The annual inflation rate target has been  'maintaining the 2% inflation over the medium term.'

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Question

ECB is exactly a governmental institution.


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Answer

True

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ECB is a private bank.


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True

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Since the inflation target is symmetrical, the inflation rates that are too low are also perceived negatively. 


Show answer

Answer

True

Show question

Question

Even though price stability is the main mandate of the ECB, it has some secondary mandates with no prejudice to the mandate of price stability. The ECB has some economic targets for full employment and environmental protection.


Show answer

Answer

True


Show question

Question

The supply of the euro is an important instrument that the ECB operates.

Show answer

Answer

True

Show question

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If the prices increase for some reason, what would ECB normally do to balance the market.?

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Answer

decreases the amount of available euros in the financial markets

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In times of economic crisis, the way the ECB operates has no effect. 

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True

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The central bank in Europe is known as...

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The European Central Bank

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True or False: 20 countries are a part of the Eurozone.

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Answer

False

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The European Central Bank is headquartered in...


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Answer

Frankfurt, Germany

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The main responsibility of the European Central Bank is to...

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Answer

manage monetary policy

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What currency does the European Union use?

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Answer

Euro

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When was the ECB founded?

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Answer

1999

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What institution controls the monetary policy in Europe?

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Answer

European Central Bank

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What is the main decision-making body of the ECB?

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Answer

Governing Council

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True or False: The ECB cannot use inflation targetting.

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Answer

False

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True or False: The ECB and Fed are of comparable importance.

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Answer

True

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Why does the ECB control monetary policy?

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Answer

All the countries in the eurozone use the Euro.

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If the prices increase, then the ECB will...

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Answer

decrease the supply of euros

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During a recession, the ECB will...

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Answer

Increase the supply of euros

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Which institution is responsible for banking supervision?

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Answer

European Central Bank

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What did the ECB do during the 2008 financial crisis?

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Answer

Decreased interest rates

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True or False: The ECB manages exchange operations related to foreign financial markets.

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Answer

True

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True or False: The ECB does NOT establish and adopt necessary guidelines to support the economic activity level in the eurozone

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Answer

False

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True or False: The ECB manages the interest rate through the supply of available euros in the market

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Answer

True

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Question

What has the ECB been targetting for inflation?

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Answer

2%

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True or False: The ECB has no control over directly influencing inflation.

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True

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