Question

How do the monetary policy tools of the European System of Central Banks compare to the monetary policy tools of the Fed? Does the ECB have a discount lending facility? Does the ECB pay banks an interest rate on their deposits?

Answer 1

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.
• Standing facilities- Standing facilities aim to provide and absorb overnight liquidity, signal the general monetary policy stance and bound overnight market interest rates. Two standing facilities, which are administered in a decentralised manner by the NCBs, are available to eligible counterparties on their own initiative.
• Minimum reserve requirements for credit institutions- The intent of the minimum reserve system is to pursue the aims of stabilising money market interest rates and creating (or enlarging) a structural liquidity shortage.

The Fed can use four tools to achieve its monetary policy goals: the discount rate, reserve requirements, open market operations, and interest on reserves. All four affect the amount of funds in the banking system.

• The discount rate is the interest rate Reserve Banks charge commercial banks for short-term loans. Federal Reserve lending at the discount rate complements open market operations in achieving the target federal funds rate and serves as a backup source of liquidity for commercial banks. Lowering the discount rate is expansionary because the discount rate influences other interest rate.

• Reserve requirements are the portions of deposits that banks must hold in cash, either in their vaults or on deposit at a Reserve Bank. A decrease in reserve requirements is expansionary because it increases the funds available in the banking system to lend to consumers and businesses. An increase in reserve requirements is contractionary because it reduces the funds available in the banking system to lend to consumers and businesses.

• Open market operations, the buying and selling of U.S. government securities, has been a reliable tool. As we learned earlier, this tool is directed by the FOMC and carried out by the Federal Reserve Bank of New York.

• Interest on Reserves is the newest and most frequently used tool given to the Fed by Congress after the Financial Crisis of 2007-2009. Interest on reserves is paid on excess reserves held at Reserve Banks. Remember that the Fed requires banks to hold a percentage of their deposits on reserve. In addition to these reserves banks often hold extra funds on reserve. The current policy of paying interest on reserves allows the Fed to use interest as a monetary policy tool to influence bank lending.

The ECB has a standard lending facility

The Eurosystem offers credit institutions two standing facilities:

• Marginal lending facility in order to obtain overnight liquidity from the central bank, against the presentation of sufficient eligible assets;
• Deposit facility in order to make overnight deposits with the central bank.

European Central Bank policymakers are increasingly leaning toward rewarding banks for lending to households and businesses but are mostly skeptical about giving lenders a reprieve from a charge on their idle cash