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Monetary Policy in the Euro zone

Monetary Policy in the Euro zone. Vilas Abraham, Melissa Epstein, Augusto Giacoman, Ricardo Saias. April 13, 2010. The Euro Zone. Euro Zone Statistics # of countries: 16 Total GDP 2009: 7059 (Bill Euros) Population: 328, 597, 348 Unemployment: 10%.

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Monetary Policy in the Euro zone

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  1. Monetary Policy in the Euro zone Vilas Abraham, Melissa Epstein, Augusto Giacoman, Ricardo Saias April 13, 2010

  2. The Euro Zone Euro Zone Statistics # of countries: 16 Total GDP 2009: 7059 (Bill Euros) Population: 328, 597, 348 Unemployment: 10% A Look Inside Two Central Banks: The European Central Bank and the Federal Reserve, Patricia S. Pollard; EIU Country Data

  3. The European Central Bank Monetary Policy • Objective: to maintain price stability. • Strategy: Maintain year-on-year increase in the Harmonized Index of Consumer Prices (HICP) for the euro area of below 2%. • Monetary Tools • Open Market Operations • Standing Facilities • Reserve Requirements • Operations • Headquarter: Frankfurt, Germany • President: Jean-Claude Trichet • Founding Documents: Maastricht Treaty, Treaty of Amsterdam A Look Inside Two Central Banks: The European Central Bank and the Federal Reserve, Patricia S. Pollard

  4. The European Central Bank Comparison With The Fed The Fed, the Eurosystem, and the Bank of Japan: More similarities or differences? -Dieter Gerdesmeier, Francesco Paolo Mongelli, Barbara Roffia

  5. Economic Conditions In Euro Zone 2010 Projections show GDP to remain flat, minimal inflation http://www.actionforex.com/fundamental-analysis/weekly-forex-fundamentals/weekly-economic-and-financial-commentary-20100319109290/

  6. Recent Policy Stance of ECB Short Term Rates vs. Taylor Rate Taylor Rate Assumptions: r* = 2%, y* = 2%, a1 = 0.5, a2 = 0.5, ∏* = 2% • ECB has responded to Euro Zone’s economic decline by drastically cutting short term interest rates down to 1%. • This has been the appropriate response in order to stimulate growth • Response was not as extreme or as quick as the Taylor Rate recommends • Taylor rate dips below zero, which is not practical to implement Taylor rate suggests that ECB could reduce rates closer to zero Data: www.tradingeconomics.com

  7. US vs. Euro Zone Outlook • United States • ShortTerm Interest Rates – Next 6 Months • Issues • Inflation:Pressures in the US might force an increase in rates in the US. However, the Euro Zone is not recovering at the same pace altogether. • Unemployment: Dropped below 10% and has been steadily improving over the last several months. • Fed Reaction • The current consensus is that rates will be increased by the end of 2010 Euro Zone Short Term Interest Rates – Next 6 Months Issues • Inflation: Recent data shows that the core rate of inflation fell to 0.8, the lowest rate in two decades. • Sovereign Debt: Greece, Spain, Portugal, and Ireland have large budget deficits. Germany and France are much more fiscally sound. This makes for competing monetary goals within the EU. ECB Reaction • Given that the inflation is low and some national economies are still struggling, interest rates will likely be kept down for the foreseeable future. http://www.actionforex.com/fundamental-analysis/weekly-forex-fundamentals/weekly-economic-and-financial-commentary-20100319109290/

  8. US vs. Euro Zone Outlook Differences in outlook can be attributed to both circumstances and policy orientation Circumstances: • US has more control and oversight as a country than the Euro Zone can impose over its member countries. • Recent financial crisis was averted in different ways by the US and Euro Zone • Preferred share ownership of Banks in the US vs. direct ownership in some Euro-members (i.e. U.K., Belgium) Policy Orientation: • ECB is much more likely to use inflation as a key driver in decision making than the FED • The Fed is more eager to see a moderate level of short term interest rates, as it is one of their major objectives

  9. Takeaways/Summary Interest Rates • Have long term implications for GDP and Prices • At a record low for 11 months in a row • Parallel Taylor Rule’s Suggestions Inflation • Deflationary measures result in inflation falling to an all time low in February 2010 • Concern that economies are too weak to handle inflation Implications of Financial Crisis on Euro • Worries that Greece’s crisis could spread to other countries • Reduced confidence in the Euro? • ECB has scaled back lending to banks ECB should focus on monitoring Greece’s financial package and ultimate stability, while preventing other countries from secondhand impact of Euro volatility

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