Beginners Handbook
The European Central Bank (ECB) - What is it?
So what is the mission of the European Central Bank?
The European Central Bank’s most important mission is to maintain trust in the euro as a currency, by controlling the amount of money that circulates in the economy to keep the average prices of goods and services stable. Beyond that, the ECB is also in charge of supervising big banks.
The primary mandate of the European Central Bank is to ensure “price stability”. Broadly speaking, this means the central bank is in charge of ensuring that people and companies trust the currency.
The EU treaties also stipulate a more general, secondary mandate for the ECB. Namely that it should support the general economic policies of the EU with a view to contributing to its objectives as laid in Article 3 of the Treaty on the European Union (1). These objectives include, among others, full employment, improvements to the quality of the environment, economic and social cohesion, social justice and protection. The Treaties clearly state that this secondary mandate must be “without prejudice” to the primary mandate. In other words, the ECB must strictly prioritise its price stability mandate over any other objectives.
Why do we care about price stability?
Just like with any situation that is stable, stable prices means predictability, which allows people to plan their future with confidence and make well-informed decisions. Businesses and citizens will be more likely to make investments or purchases, knowing that prices will not vary excessively. In the reverse situation, if price levels are unstable, citizens will exercise more caution, businesses will make less investments, and fewer jobs will be created, thus creating economic stagnation. The fact that your coffee that costs you 2 Euros today does not suddenly cost you 5 Euros tomorrow is due to price stability.
Indeed, if all prices were to increase (a process economists call “inflation”), and this happened too much and too quickly, people would consider using a different currency to the euro, such as foreign currencies, or even alternative means of payment like cryptocurrencies. Ultimately, the stability of the system depends on the trust people have in the currency, which excessive inflation may undermine.
The opposite phenomenon, when prices go down, is called deflation. People often assume that a general decrease in prices is a good thing because it gives citizens greater purchasing power. However, the problem is that when prices in shops go down, wages also go down, as companies expect a reduction in income from sales. While deflation increases the value of money, conversely it also increases the real value of debt. So while prices and incomes may fall, debt does not. In periods of deflation, firms will be getting lower revenue and consumers will likely get lower or stagnant wages. If a business has a falling revenue and a household a declining income, then the debt repayments become more of a burden. The same goes for governments: if prices and incomes fall, so does revenue from tax. This leaves less money for spending and investment.
This is why the central bank has to be able to fight both excessive inflation and deflation. In practice, the European Central Bank has defined “price stability” as a rate of inflation that stays close but below 2%. The ECB closely monitors inflation and does its best to keep it close to the 2% level.
Beyond the monetary policy role, the ECB also carries out a number of other tasks, such as the supervision of the biggest European banks, collecting statistics, and overseeing payments systems.
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