Understand
the Economy and Banking

Monetary policy is defined as the set of actions taken by the European Central Bank (ECB) with the aim of keeping inflation low and stable (2% in the medium term), promoting economic growth and employment in the Eurozone.

Monetary policy instruments include:

Reference interest rates
The ECB sets three main rates:
• Interest rate on main refinancing operations (MRO rate).
• Interest rate on marginal lending operations (Marginal Lending Facility – MLF rate).
• Interest rate on deposits with the central bank.

Open market operations
Operations through which the ECB regulates liquidity in the banking system, mainly through weekly refinancing auctions (MROs) and long-term refinancing operations (LTROs).

Reserve requirements
Banks are required to hold a percentage of their deposits with the ECB, thus regulating the amount of money available for loans.

Asset purchases
Securities purchase programmes (such as the Asset Purchase Programme – APP) to influence long-term interest rates and stimulate the economy.

Price stability
The ECB works to keep inflation under control and to avoid periods of high inflation – or deflation, that is, price reduction – which can destabilise the economy. The aim of the ECB's monetary policy measures is to maintain an inflation rate of 2% in the medium term. Inflation is measured by the consumer price index (CPI).

Supporting economic growth
Maintaining price stability fosters conditions for economic growth and employment.

Financial stability
Ensures a stable and shock-resistant financial system.

Management of expectations
Monetary policy decisions influence expectations of inflation and economic growth, with impacts on investment and consumption.

Influence on the economy
Through the control of interest rates and liquidity, the ECB has the ability to stimulate or curb economic activity. When the ECB raises interest rates, which increases the cost of money, this is called restrictive monetary policy. Conversely, when the ECB reduces interest rates, which reduces the cost of money, this is called expansionary monetary policy.

Channels of transmission
Monetary policy influences money and credit market aggregates, which, by changing the demand for goods and services, are able to regulate the level of inflation. If the interest rate increases, the cost of money increases, business investments decrease, private savings increase, consumption and domestic demand decrease: therefore, prices decrease and inflation falls. A decrease in the interest rate determines exactly the opposite effect.

Response to crises
In times of economic or financial crisis, the ECB has the ability to adopt extraordinary measures, such as negative interest rate policies or (unconventional) asset purchase programmes, to regulate liquidity and stabilise the economy.