European Central Bank - Essay Example

Introduction A look at the performance and stature of the European central bank will reveal to the discerning observer that this bank is one of the most important central banks in the world. It is tasked with the role of managing the monetary policy of the sixteen member states of the Eurozone, the region that has adopted euro as their common currency. The bank is located in Frankfurt, Germany and was established in 1998. It was set up by the European Union and it effectively replaced the European Monetary Institute. But the design and importance of the central bank can be seen as accruing directly from the Germany Bundesbank. In fact, it seems that the bank has been fashioned along the lines of Bundesbank. The bank was the result of the Treaty on European Union, which is also referred to as Treaty of Maastricht. Despite the fact that the bank was established on June 1998, it started operating six months later on 1 January 1999. This was when the euro was introduced as the bank had been set up with the euro in mind. The euro, as indicated above, came after the establishment of the European central bank. It is the official currency that has been adopted by a total of 16 members of the European Union, out of the twenty seven that are members. The states which have adopted this currency as their official currency belong to what is referred to as the Eurozone. The countries are Austria, Belgium, and Cyprus among others. There have also been cases where the currency is used by non-member countries since its inception in 2004. This is with or without formal agreements with the member states of the European Union. It is estimated that about 237 million Europeans are currently using this currency. About 175 million people have adopted euro or currencies that are pegged to this. This is especially so in Africa, where the bank has a following of over 150 million presence. For the few years that the euro and the European central bank have been in operation, their performance can only be described as a success story. When the euro was introduced, many people had the impression that it is going to increase the rate of inflation. That maybe explains the reason why some of the states were initially reluctant to adopt it. But the opposite has been achieved. The central bank, which is mandated to manage the euro for the nations that share this currency, has been able to control the rate of inflation and maintain it at a point below but close to two percent. The success story that is the euro and the European central bank is attributable to several factors. Some of them are prudent financial management and successful control of the inflation rate. Objectives of the Study Throughout this study, the writer will be guided by one major objective. That is the analysis of the factors that have led to the success of the European central bank and the euro in general. To achieve this, the writer will be guided by various specific objectives. It is through the address of these specific objectives that the writer will effectively address the major objective of the study. The specific objectives are as outlined below: 1. successes of the European central bank 2. factors leading to this success 3. challenges facing the European central bank 4. successes of the euro 5. factors leading to this success 6. challenges faced by the euro 7. performance of the economy of the Eurozone Performance of the Eurozone's Economy Some of the successes of both the euro and the European central bank can be reflected in the successes of the economies of the Eurozones. Tumpel (2009) is of the view that there have been palpable changes in the economy of these nations as soon as they adopt the euro and come under the jurisdiction of the European central bank. One of the areas that these economies have excelled in is the creation of employment (Noyer, 2007). Over the course of the past ten years, the employment rates at these economies have increased. The improvement may be conceptualised as a reflection of the progress that has been made as far as employment structural reforms and the subsequent wage moderation policies are concerned. The number of people that were employed in these economies since the introduction of the common currency and the European central bank has risen by 15.7 million by the end of the year 2008 (Trichet, 2008). In the preceding nine years before the euro and the central bank took effect, the number of people that were employed was a mere 5 million (Trichet, 2008). This was the lowest that the region had recorded since the 1980's. One of the chief reasons why the Eurozone has performed this way is the "relatively low trend growth in labour productivity" (Tumpel, 2009). In the 80's decade, the labour productivity in this region increased by 2.3%. In the following decade of 90's, this plummeted to 1.8% (European Commission, 2008). Between 1999 and 2007, the rate plunged even further; it was 1.2% (European Commission, 2008). When this is contrasted with the growth experienced in the United States of America, one will not fail to appreciate the glaring differences. In the U.S, the growth was acceleration rather than a deceleration. It rose from 1.2% to 1.6% and eventually attained the highs of 2.1% within the same duration that was previously described for the European Union. But perhaps the main question now that the data has presented is "what has led to these growth rates" it is important to note that these rates were recorded when the euro and the European central bank were in operation. As such, majority of the improvements, if not all of them, can be attributed to these two developments. After the adoption of the euro, there were deliberate and specific policies that aimed at increasing the rate of employment in the economy, especially as far as unskilled labour is concerned (Tumpel, 2009). This led to a declivity in the labour productivity growth. Another reason why this growth has been attained is the slackening of the total factor of productivity growth. This is the gauge of technological progress and improvements as far as organisation and efficiency of production are concerned (Issing, 2009). During the 1980's decade, this attribute grew by 1.6%. This is before it declined to 1.1% in the 90's. Between 1999 and 2007, this plummeted to a mere 0.7% (Tumpel, 2009). Successes of the Euro and the European Central Bank One of the major successes of this currency is price stability (Noyer, 2007). Since the introduction of the euro and the mandate of the European central bank, the rate of inflation has stayed generally at the range where the central bank wants it to be. This is slightly below but near two percent (Noyer, 2007). This is over the medium term, as opposed to long or short term. Those people in the economies that use the euro need not worry anymore about the purchasing power of their hard earned cash. The stability of the rate of inflation can be seen to transcend behavioural patterns of the price of commodities. Inflation expectations among the public have been low. This is very important in order to avert panic reactions from the masses which are usually as a result of speculation and which lead to negative effects on the economy. A case in point to illustrate this attribute is the recent increase in oil prices. People did not panic and inflation did not rise. Another success of the euro, according to Trichet (2008), is the convergence of long-term market interest rates. This convergence has been in the direction of those of the best performers as far as credibility and low interest rates are concerned (European Commission, 2008). To many economies, like that of Italy, this trend has led to considerable decrease in the costs of financing. This attribute is an opportune environment for growth and employment in these economies (European Commission, 2008). Today, the market interest rates for this zone have been maintained below 4% (European Commission, 2008). This rate has never been attained for the last fifty years. A third success of the euro is the improved resilience of the Eurozone economies against financial crises (Trichet, 2008). Between the 1970's and mid-1990's, many economies of this union experienced volatility as far as their interest rates were concerned. This is before the introduction of the single currency and the mandate of the European central bank. Recently, there has been volatility in the financial markets and in the economy in general. For example, after the 9/11 terrorist attacks on American soils, the world markets and especially the stock exchange rates suffered a blow. The current economic meltdown is another case in point. If there were no single currency in operation at the time, major turbulence in the European economy would have been caused. The above scenario should not be misconstrued to mean that external factors no longer have effects on the Eurozone economies. What it means is that the economies seem to have a resiliency level that is admirable. They are able to recover quickly due to the single economy and the operation of the European central bank. The successes of the euro can be seen as a reflection of the successes of the European central bank. This is because this bank has been mandated with the major task of managing the euro for the member states. As such, the performance of the euro is determined by the decisions and policies that are implemented by the European central bank. How Has the European Central Bank and the Euro Attained these Successes The major reason for this success can be attributed to the institutional and operational framework in which monetary policy in the Eurozone is developed and implemented (Noyer, 2008). The European Central Bank is independent from the member states. The independence entity of this organisation is enshrined in the Treaty that was mentioned in the introduction of the paper; the treaty that led to the establishment of the same. What this means is that the member states cannot influence the operations of this bank (Noyer, 2008). This is together with the other thirteen participating national central banks. Institutionally, operationally and financially, these organisations are autonomous from the European community institutions and national governments that are members of the same. This independence ensures that the bank is able to operate without undue interference from these organisations. The policies that it makes on the implementation of the euro are not interfered with by the partisan interests of the member states' governments. Another reason for the success of the bank and in extension the success of the euro is the clear and transparent monetary policy framework (European Commission, 2008). The bank has a clear definition of price stability. This is maintenance of the inflation rate below but close to the two percent mark. European Central Bank has also adopted a medium term monetary policy (Noyer, 2008). This policy is supported by what Trichet (2008) refers to as two-pillars. One pillar is composed of the examination of the cyclical, economic and financial indicators that are related "to the main determinants of short term inflation" (Noyer, 2007). The second pillar is involved with the examination of how money behaves and credit aggregates (Tumpel, 2009). This has the effect of providing a perspective of inflation in the long term. Cross-checking the outcomes of these two forms of analysis lead to an effective policy formulation that leads to the success of the institution and the currency. Conclusion Despite the successes of the euro and the European central bank, there are some challenges that the two are facing and which at times lead to the derailment of the goals and achievements of the two. The first is the felt need to raise the economic growth in a manner that is sustainable in the long-term (Trichet, 2008). The economic performance of all the Eurozone members has not been uniform. This is despite the benefits that are inherent in the single currency. There is also the need to reform some parts of the euro economy systems. For example, there is need to reform the labour sector (Issing, 2009). This is in order to enhance the quality and incentives of the supply of the same, together with the flexibility riding on it. The Eurozone's tax and benefit systems and especially the combination of the two, are a source of disincentive to take up employment or to work for longer durations in many Eurozone members. But despite these and few other shortcomings, the euro and the European central bank have been a success. References European Commission. (2008). Preserving and consolidating the success of the euro and the performance of the Eurozone. 16th May 2008. Issing, O. M. (2009). "The ECB's two pillars of success." Project Syndicate, 23(3), 26. Noyer, C. O. (2007). "Is the euro a success story" retrieved from http://docs.google.com/gviewa=v&q=cache:BCokj5QQIHEJ:www.bis.org/review/r070523b.pdf+european+central+bank%2Bsuccess&hl=en&gl=ke&pid=bl&srcid=ADGEESiEHyoBg0I38v-8yZL2SxMDfFL7aoI4oYE0HAHxQeI_4cQEJaKyd1tusi7kNIV4f4nHLHRqNm33K-7LYbS8fa8N_rq2o4LNlY0tx_ZoPuOVqROZncMDVDpCETtQjNGdX8NFtuJf&sig=AFQjCNELkJNXkptzAvsf7jnHqMdw3eidhw; on 11 November, 2009. Trichet, J. C. (2008). "The successes and challenges of the euro." Retrieved from http://www.ecb.int/press/key/date/2005/html/sp050114.en.html; on 12 November, 2009. Tumpel, F. O. (2009). "The success story of the euro and the European Central Bank." Washington Post, 23rd April, 2009. 46. Read More