In the light of these considerations, it was agreed at the EMI that, regardless of the final choice of the monetary policy strategy, monetary aggregates would be accorded a prominent role in the overall monetary framework adopted by the ESCB.
However, the EMI also noted that certain technical pre-conditions would have to be met before this 'prominent role' could be translated into an explicit, publicly announced monetary target, guideline, benchmark or monitoring range. Specifically, such targets or ranges would only be meaningful guides to monetary policy if the relationship between money and prices - as encapsulated in a 'demand for money' equation - was expected to remain sufficiently stable.
In this regard, several existing empirical studies point towards the
stability of the demand for euro area-wide monetary aggregates. However,
these studies are necessarily only preliminary. The reliability of these
results in the face of the uncertainties raised by the transition to Stage
Three is unknown. Future shifts in the velocity of money are certainly
possible - perhaps even likely. They cannot be predicted with certainty.
Moreover, it is not clear whether those aggregates that have the best
results in terms of stability are sufficiently controllable in the short-
term with the policy instruments available to the ESCB. In these
circumstances, relying on a pure strategy of strict monetary targeting is
simply too risky.
Against this background, the ESCB will have to design a monetary policy strategy of its own. The chosen strategy will show as much as possible continuity with the successful strategies that participating NCBs conducted in the Stage Two. At the same time the ESCB's strategy will take into account to the extent needed the unique situation created by the introduction of the euro.
4. The new monetary policy instruments and procedures for the euro area
Having a well-designed monetary strategy is vital. But we must also be able to implement it successfully at an operational level. What instruments are available to implement this strategy?
The ECB will have a complete set of monetary policy instruments at its disposal. These instruments have been selected on the basis of their efficiency for transmitting monetary policy and their neutrality across market participants.
Three types of instruments are available to the ESCB: open market operations, standing facilities and a minimum reserve system. I will briefly present these instruments in the remainder of my speech.
4.1 Open market operations
Open market operations include, first, a weekly main refinancing operation, which will take the form of a reverse repurchase transaction with a maturity of two weeks. The main refinancing operation will be based on a tender procedure. The tender may be a fixed rate tender, with counterparties bidding amounts, or a floating rate tender, where counterparties propose bids including both amounts and interest rates.
Second, there is the monthly longer term refinancing operation, which has a maturity of three months and will always take the form of an interest rate tender. This is because the ECB will avoid signalling its monetary policy stance through these particular operations.
The ECB will also conduct fine-tuning operations, through the
national central banks of the euro area or, in exceptional circumstances,
on its own account. Fine tuning operations will be conducted whenever
liquidity or money market conditions warrant. Fine tuning operations may
take the form of reverse repurchase transactions (that is, the same type of
transaction as that used in the main refinancing and the longer term
refinancing operations, but with no pre-set start date nor a pre-set
maturity), foreign exchange swaps or the taking of fixed-term deposits.
Fine tuning operations in the form of reverse repurchase operations may be
executed either through quick tenders or bilaterally. In both cases, these
operations will involve a limited set of eligible counterparties that have
an appropriate track record of activity in the money market. The other
types of fine tuning operations will also be executed with a limited number
of eligible counterparties, which will be selected ex ante by the ECB. In
some countries, there will be a rotation scheme, which will aim at giving
the opportunity to all eligible fine tuning counterparties to participate
in fine tuning operations.
Finally, open market operations may also be conducted whenever structural reasons, such as the longer-term evolution of liquidity profiles, warrant it. These so-called structural operations may take the form of outright purchases or sales of securities or the issuance of debt certificates by the ECB.
4.2 Standing facilities
The ECB will operate two overnight standing facilities, which will be
available to all credit institutions at national central banks of the euro
area, provided that, when using the marginal lending facility, they have
sufficient collateral. The rate of the marginal lending facility will
constitute the upper bound of collateralised overnight money market rates.
The deposit facility will be remunerated at a rate that will constitute the
lower bound of overnight money market rates.
When using the marginal lending facility, or, for that matter, when
entering in liquidity-providing open market operations in the form of
reverse transactions, counterparties have to post assets with their
national central bank (or the ECB in the exceptional case when the ECB
conducts fine tuning operations on its own account). These assets are meant
to act as guarantees for credits received from the European System of
Central Banks. A list of eligible assets has been drawn up for this
purpose. The list comprises a wide variety of assets and has two sub-sets.
First, the so-called tier one assets, which are selected by the ECB
according to uniform criteria relating to their credit standing in the
whole euro area. Second, the so-called tier two assets, which have been
selected by the ECB because they are of particular importance for certain
national banking systems of the euro area, in order to promote a certain
degree of continuity at the start of the Stage Three of EMU. Two principles
of equal treatment are applied, however. First, the credit standing of tier
two assets is as high as that of tier one assets. Second, both tier one and
tier two assets may be used by any credit institution in the euro area,
irrespective of its location.
In addition, a set of risk control measures has been elaborated to ensure that, for any counterparty, the amount of assets provided is always sufficient. Risk control measures cover the assets' price and credit risks, taking account of the asset type, its characteristics and the maturity of the transaction. The ECB's risk control measures have been elaborated with careful attention to the best market practices in this area. They include the deduction of haircuts from the assets and the imposition of initial margins to the credit amount. Another feature of the risk control framework is the regular revaluations of the assets, which will, in most cases, take place daily and may trigger margin calls, most often to be settled through delivery of additional assets.
4.3 Minimum reserve system
The ECB will also apply a minimum reserve system to credit
institutions of the euro area. Two main monetary policy objectives have
been assigned to the minimum reserve system. The first objective is to
stabilise money market interest rates through the averaging mechanism,
whereby the fulfilment of minimum reserve requirements is based on average
reserve holdings over monthly periods of time. During the maintenance
period, this allows the banking system to absorb liquidity shocks. The
reduced volatility of money market rates will reduce the need for frequent
fine tuning operations, which will mean that markets are less distorted by
central bank interventions than they would otherwise be. The second
objective of the minimum reserve system is to enlarge the demand for
central bank money, so as to enlarge the liquidity deficit of the banking
system vis-а-vis the ESCB. This will safeguard the role of the European
System of Central Banks as a provider of liquidity to the banking system.
Reserve requirements will be calculated by applying a reserve ratio
of 1.5% to 2.5% to the deposits, debt securities and money market paper
issued by credit institutions, except for residual maturities above two
years. Although repurchase agreements are included in the reserve base,
they will be subject to a zero reserve ratio. In 1999SCHD-MAY.DOCf[pic]1 T-
-#"+ !-+ 1999PROT10.DOCfter-bank liabilities and liabilities vis-а-vis
the ESCB will not be subject to reserve requirements. An allowance of the
order of E 100,000 will be deducted from reserve requirements, so that
credit institutions with a small reserve base will not have to hold minimum
reserves.
Reserve holdings will be remunerated up to the required reserve level, at the rate of the main refinancing operation (as averaged over a month). It may be argued that a less than full remuneration of minimum reserves would increase the interest rate elasticity of central bank money demand. This notwithstanding, the ECB has decided in favour of a full remuneration of minimum reserves in view of the distortion to efficient markets that a less than full remuneration would have implied. As a result of the full remuneration of minimum reserves, the European Central Bank has also decided not to exempt any credit institution from the minimum reserve system.
4.4 Procedures
The ECB will have many counterparties and be subject to close public scrutiny. It has therefore set up procedures for informing its counterparties and the public about its monetary policy instruments in a robust and transparent manner.
The ECB will inform its counterparties and the public through a document detailing its monetary policy instruments and procedures and through the regular publication of various materials on its Internet site.
General Documentation
The ECB has produced a document describing its monetary policy instruments and procedures in detail. This is called "General Documentation on ESCB Monetary Policy Instruments and Procedures". A revised version of this document was published recently. This revised version includes all the newly specified elements of the monetary policy framework of the ECB, including for instance the minimum reserve system. This document also includes a calendar for the standard tender operations in 1999 (both main refinancing and longer term refinancing operations). Calendars of standard tender operations will be published by the ECB every year.
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