Monetary Operations in the European Economic and Monetary Union

• Author: Charles A. Enoch, Paul L. Hilbers, and Arto Kovanen
• Position: Assistant Director in the IMF's Monetary and Exchange Affairs Department/Deputy Division Chief in the IMF's Monetary and Exchange Affairs Department/Economist in the IMF's Monetary and Exchange Affairs Department

The European Monetary Institute and Europe's national central banks have made good progress in preparing a "menu" of efficient, market-based monetary instruments from which the European Central Bank, to be established by July 1, 1998, will choose. The next step will be to address the remaining issues and test the selected options.

THE MAASTRICHT TREATY created the European Monetary Institute (EMI) as a transitional institution to coordinate the preparatory work on monetary policy for the third stage of European Economic and Monetary Union (EMU) and the introduction of the euro, set to begin January 1, 1999. An important part of the EMI's mandate has been the development of an operational framework for monetary policy for the European System of Central Banks (ESCB), which will consist of the European Central Bank (ECB) and the national central banks of the European Union's (EU's) member states.

The EMI has essentially played an advisory role. Where a consensus has been reached, it has made recommendations that will be taken by the governing council of the ECB. Where a consensus has not developed, the EMI's role has been to identify and clarify issues and prepare a "menu" of options from which the ECB will choose.

The EMI has established a remarkable amount of common ground, and its publications have fleshed out the proposed framework for monetary policy in a fair degree of detail. The EMI has also been able to broaden areas of consensus and pursue important technical work. Its careful and balanced approach has enhanced the transparency and the credibility of the monetary unification process.

Monetary policy instruments

The design of EMU's monetary instruments reflects the EU's desire for decentralization. National central banks retain an important role in executing monetary policy, and decisions regarding the implementation of policy will be taken by the ECB governing council. This council, which is expected to meet monthly, will be composed of the governors of participating national central banks and the ECB Executive Board.

Open market operations. The main instrument of monetary operations will be weekly open market operations, which will play a pivotal role in steering interest rates, managing financial system liquidity, and signaling the stance of monetary policy. These liquidity-providing operations will furnish the bulk of refinancing to the financial sector and will serve as the main instrument to manage liquidity (Table 1).

[ SEE THE GRAPHIC AT THE ATTACHED RTF ]

Longer-term refinancing operations will be executed monthly and will provide only a limited portion of the ESCB's liquidity. Developments in the longer-term operations are not intended to signal the market about the authorities' policy stance, so the ESCB will normally act as a pricetaker in these monthly refinancing tenders (that is, these operations will usually be executed as variable interest rate tenders). The mere fact that the ESCB will be creating a monetary instrument with this maturity and without any intention to create a signal, however, suggests that this market may come to provide an undiluted, and thus important, signal of market conditions.

The ESCB may also conduct operations to adjust the structural position of the banks vis-à-vis the ESCB, if, for example, there is a lasting shift in currency demand. If necessary, fine-tuning operations-which may also include currency swaps-may be carried out to manage fluctuations in the market. They would be conducted on a short-term, ad hoc basis, through bilateral operations or quick tenders with a limited number of counterparties.

Standing...