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Actions de crise et des banques centrales (document en anglais)

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Executive summary

Central bank is a public authority which has main duties:

- Implement monetary policies to keep stable economic growth.

- Provide stability of the financial system.

- Manage nation’s currency.

Central banks may have different log-run objectives but all have adopted the price stability as important goal in the long-run1.

To achieve those objectives, central banks uses standard monetary policies instruments as open markets, discount rate and reserve requirements operations.

Recently, financial crisis showed the weakness of the financial stability framework and the failure of central banks procedures to insure financial stability.

This paper review the main objectives of the monetary policy, describes the measures and instruments used by central bank to implement its monetary policies and discuss the actions taken by the European Central Bank and the Federal Reserve during the last financial crisis.

1. Monetary policy objectives

The term monetary policy refers to "the actions undertaken by a central bank, such as Federal Reserve, to influence the availability and cost of money and credit to help promote national economic goals "2

Harry Johnson defined the monetary policy as "a policy employing the central banks control of the supply of money as an instrument for achieving the objectives of general economic policy is a monetary policy"3

In normal conditions, central banks influence the economy and inflation by using acting on short term interest rates. The mechanism to affecting economic variables is called the monetary policy transmission mechanism.

The identification of the risks threatening price stability is a hard task. Central bank relies on a monetary policy strategy using many sources of information. Like other central banks, ECB defines its strategy using two main pillars: economic analysis and monetary analysis.

With economic analysis, ECB analyses the inflationary pressures using large number of economic indicators. Using the monetary analysis, ECB can derive the medium-term inflationary pressures from financial indicators. Using these two, central bank design and implement the right actions to ensure price stability4.

1.1. Monetary policy types

Monetary policy objectives can differ from large countries with independent monetary policy to small ones. From historical perspective, different types of monetary policy targets have been adopted by central banks: fixed exchange rate target, inflation target, monetary aggregate targets and price stability target. This paper outlines the two of those targets

Price stability target

ECB defines the price stability as the year-on-year increase in the harmonized index of consumer prices (HICP) for the euro zone below 2%. By maintaining this target, ECB aims to keep inflation rate below, but close to 2% in the medium term5.

Benefits of price stability can be summarized as:

- Improvement in the distribution of wealth.

- Reduction of inflation component in the nominal rates.

- Improvement of price transparency.

- Avoiding inflation and deflation.

Fixed exchange rate target

Mostly used by small countries, it consists of choosing an anchor currency and fixes the exchange rate to this stronger currency. By doing this, local central bank can control inflation rate using the benefit of the price stability of foreign central bank6.

Mixed target

Other objectives, as said before, can be found in literatures, one of those is the monetary aggregate target.

The FED log-run goal as defined in the Humphrey-Hawkins act passed in 1978 indicates full employment and economic growth with price stability7.

1.2. Monetary policy tools

Central banks have at their disposal instruments that can be used to influence economic variables and by consequence the economy level.

Using their monopoly, in issuing bank reserves and currency, central banks influences the money supply and in the meantime the conditions at which banks trades in the Money Market. A change in the Money Market interest rate influences economic variables such output and prices. This mechanism is called the Monetary Policy Transmission Mechanism (Fig 1).

The central bank actions can be categorized into two types: direct control and market control operations8. The last one is by far the widely used by central banks.

Market control operations rely on the transmission mechanism by using three main instruments:

Open market operations: play important role by influencing the short-term interest rates and liquidity in the market. Most common tools used are repo (reverse repo) operations, long term refinancing operations and ad-hoc operations.

Discount rate or standing facility: is the interest rate charged to commercial banks and depository institutions in combinations with market operations. It gives a signal on the general monetary policy and can affect Long-Term interest rates.

Reserve requirements: are the amount of fund in reserves hold by a bank or depositary institution Like direct control operations, reserve requirements tend to be ineffective and

Non-standard measures: Number of measures can be undertaken by central banks when there is a failure or impairment in the monetary policy transmission mechanism. Such measures include direct increase in a base or purchase of corporate bonds.

2. The financial crisis and the ECB actions

The financial crisis affected first the interbank compartment; most of banks were in wary to lend to other ones. They proffered to keep cash as deposit in central bank account; the amount of overnight deposit attained historical amounts.

ECB, like other central banks, have provided liquidity in the interbank in the early days of the crisis on August 2007. Its first main action was to inject 94.8 billion, with no penalty rate for banks, into the market to stabilize the credit market. Along the financial crisis, ECB acts as the Market Maker of


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