The Role of the European Central Bank in Price Stability

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The European Central Bank is one of the most important banks in the world with over 17 member States (Howarth and Loedel 4). The Bank has a legal persona and is fully self-regulating of national and European financial institutions. It was established in 1998 with its headquarters located at Frankfurt in Germany.

Some of the core functions of this Central Bank are making sure that price stability is maintained mainly by defining the monetary policies of the union. It is also mandated to ensure a smooth running of all issues concerned with Economic and Monetary Systems of the union. The bank achieves its objective by ensuring that inflation is kept at the lowest levels ever achievable.

The Central Bank also takes part in other financial activities like participating in the stock capital market with billion of shareholders (Howarth and Loedel 6). It is responsible for setting the key interest rates for all the member states that lie within the zone and controlling the supply of money.

Other responsibilities are managing the foreign currency reserves and also buying and selling the currencies of the member states to keep the exchange rates balanced in the economy. In addition, they carefully monitor the price trends and project any risks or challenges which they are likely to pose to price stability (Sexton 379).

Bearing in mind the very sensitive responsibility carried by the bank it becomes critical for it to carry out its duties with a lot of skill.

One of the ways to determine the performance of an economy is to closely examine the economic indicators such as employment levels, stock market prices, changes in money supply, Gross Domestic Product, the extend to which industries are producing, issues of bankruptcy and considering the income levels of the citizens in a country.

Therefore, the indicators are important because they help economic analysts in predicting the economy’s performance in short term basis (Howarth and Loedel 12).

According to the article, levels of unemployment in the Euro-zone were noted to be increasing at an alarming rate. Figures were showing that joblessness in the zone had gone up to 10.9 % and the financial analysts were expecting that Central Bank would do something to rescue this situation and especially by reducing the interest rates (Minder and Ewing 5). The main cause of demonstrations according to the article was the issue of joblessness resulting from high interest rate.

This is so because, interest rates are costs at which businesses and consumers finance their spending and so borrowing becomes hard when the interest rates are high. Moreover, high rates deter businesses from investing or expanding their businesses, which results in unemployment. Unemployment leads in to the decline in the standards of living and may be other social injustices like insecurity due to theft and crime because people have no other means of living.

Interest rates and Quantity of money. Price level and Quantity of output.

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If interest rates increase from r1 to r2 the quantity of money in circulation decreases as indicated by the inward shift of the curve (Sexton 382). Increased interest rates also increase the cost of production by the firms and therefore the price of products rises. If prices of inputs increase, this will translate to a decrease in output given by firms.

It is also indicated that the government was struggling with debts and other deficits which is very unhealthy for an economy. Some of the causes of deficits and debts are when a country borrows a lot of money from other countries to invest, a situation which is mostly witnessed by the third world countries.

If the value of exports happens to increase at a slower rate than the value of imports which would mean the surplus changing into a deficit and may be if the states currency is overvalued, imports become cheaper and the quantity of imports increases and in such a case a fall in the quantity of exports is experienced because exports become less competitive.

In order to solve this, the governments in the Euro-zone would have to stop the selling of bonds, reduce borrowing, reduce their expenditures, or even increase taxes on the rich. Increasing taxes to all people when the economy is not performing worsens the situation in a country (Howarth and Loedel 14). This is because it widens the gap between the rich and the poor.

Economists state that as the price increases; demand of a good will decrease and vice versa

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Economists state that as the price increases; demand of a good will decrease and vice versa (Sexton 382). The monetary policy is one of the processes used by the central bank to regulate money supply credit in the economy and foster economic growth. If the Central Bank increases the interest rates on the loans given to commercial banks, this will discourage them and in turn increase their rates on any individual of the public who is borrowing.

This will imply an increase in poverty because loans will not be accessible to the citizens and so the amount of money held reduces. On the hand, the central bank can promote economic growth in a country by making loans available to the commercial banks which lend money to the citizens enabling them to invest and carry out other activities in building the economy.

In conclusion, the Central Banks play very important roles in the economy of any nation and therefore should work hard to ensure stability of prices by defining monetary policies which is very critical.

Reference List

Howarth, J. D. & Loedel, H. P. 2003. The European Central Bank: The New European Leviathan?. Palgrave Macmillan, New York.

Minder, R. and Ewing, J. 2012. Global Business: European Central Bank Opposes Higher. Web.

Sexton, L. R. 2012. Exploring Macroeconomics. McGraw-Hill, New York.

tutor2u. 2012. Aggregate Demand. Web.

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The Role of the European Central Bank in Price Stability

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