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1. INTRODUCTIONThe European System of Central Banks (ESCB) is composed of the European Central Bank (ECB)

and the national central banks (NCBs) of all 27 European Union (EU) Member States.

Since not all the EU states have joined the euro, the ESCB could not be used as the monetary authority

of the eurozone. For this reason the Eurosystem (which excludes all the NCBs which have not adopted

the euro) became the institution in charge of those tasks which in principle had to be managed by the

ESCB. In accordance with the treaty establishing the European and the Statute of the European System

of Central Banks and of the European Central Bank, the primary objective of the Eurosystem is to

maintain price stability (in other words control inflation). Without prejudice to this objective, the

Eurosystem shall support the general economic policies in the Community and act in accordance with

the principles of an open market economy.


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The ESCB is assigned with carrying out central banking functions for the euro under the European

Community Treaty. However, as the ESCB has no legal personality of its own, and because of

differentiated levels of integration in the Economic and Monetary Union, the real actors are the

European Central Bank and the 16 National Central Banks of the euro area countries. They exercise the

core functions of the ESCB under the name Eurosystem.


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2. EUROPEAN CENTRAL BANKIn 1998, the European Central Bank was founded with the main purpose of serving as a central bank for

the 17 European Union countries. This also led to the use of the Euro as a common currency in these

countries. Its headquarter is actually in Frankfurt, Germany. The ECB is designed to be politically

independent from both European Union institutions and from euro zone countries. Although the ECB is

governed by European law directly and thus not by corporate law applying to private law companies, its

set-up resembles that of a corporation in the sense that the ECB has shareholders and stock capital.

2.1 Aims and Objectives of the European Central Bank

The main goals of the European Central Bank are to maintain price stability in the euro zone, to achieve

a low-level of unemployment and to facilitate economic growth with low inflation. The bank tries to

achieve its aims and objectives through the following policies:

ECB Monetary PolicyOne of the main duties of the European Central Bank is to design and implement the euro

zone monetary policy. It controls economic activity by influencing short-term interest rates

through its open market operations, thus, effectively controlling money supply in the market.

This in turn helps the European Central Bank to achieve its goal of keeping inflation rates

below 2% per year.

ECB Foreign Reserves and Foreign Exchange OperationsThe European Central Bank is not only responsible for the euro zone foreign reserves, but

also for foreign exchange operations and foreign exchange interventions. These interventions

are important to keep the euro from appreciating or depreciating too much against other

currencies.


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ECB Payment and Settlement SystemsIn order to have a reliable and effective financial system and a stable currency, the European

Central Bank ensures the smooth operation of the payment and settlement systems in the

euro zone.

ECB Financial StabilityThe European Central Bank monitors the development within the various financial markets

and identifies any problems or threats to the system which ultimately encourages financial

stability within the euro zone.

ECB BanknotesIn the beginning of 1999 the Euro became currency for 15 (now 17) European Union

countries. Both ECB and the national central banks of the participating countries can issue

euro banknotes, but in reality only the national central banks do this.


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3.THE EURO3.1 History

In the year 1989, the Commission President of the European Council put out a plan to launch the

Economic and Monetary Union which included the formation of the European System of Central Bank.

On 7 February 1992, an agreement was reached for currency union with the Maastricht Treaty so as to

create a single currency by January 1999. After tough negotiations, particularly due to opposition from

the United Kingdom, the Maastricht Treaty entered into force in 1993. The name euro was chosen for

the new currency in December 1995 as replacement of ECU. Two years after that, the European Council

decided to take up the Stability and Growth Pact, intended to guarantee budgetary discipline after the

creation of the euro. Moreover, to provide stability to the euro and the national currencies of countries

that had not yet entered the eurozone, a new exchange rate mechanism was set up. When the European

Central Bank was founded in 1998, it did not take on its full power until the creation of the euro on 1

January 1999.

The euro was launched primarily in non-physical form such as travellers cheques, electronic transfers,

bankingetc on 1 January 1999. The euro, thus, became the successor to the European Currency Unit

(ECU). On the same date, all bonds and other forms of government debts by the euro zone nations were

denoted in euro. Ten currencies of eleven European countries merged together and the euro came into

existence. This has been the most important step in the process of the European economic and politicalintegration years. Eleven European countries have denationalised their currencies and had agreed to

apply common monetary policy.New notes and coins were introduced on 1 January 2002.

3.2 The main reasons of why the Euro was introduced

For most EU countries today, majority of international trade is with other EU members; therefore, a

common currency has led to:

1. Removed exchange rate risks from the internal market.2. Cut the costs of transaction.3. Encouraged firms to engage in international trade.4. A stable monetary policy in the Eurozone.5. Forced EU states to adopt responsible economic policies that contain inflation and

increase real living standards.


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3.3 Overview of the Advantages and Disadvantages of the use ofthe Euro currency

Advantages:

Elimination of exchange-rate fluctuations Price transparency Transaction costs Increased trade across borders Increased cross-border employment Simplified billing Expanding markets for businesses Financial market stability Macroeconomic stability Lower interest rate Structural reform for European economies Unites Europe as one

Disadvantages:

Cost of transitioning 17 countries currencies as a single currency (including costs ofaccounting systems, software, printed materials, signs, vending machines, parking

meters, phone booths and every other type of machine that accepts currency.)

Training for employees, managers and consumers Countries cannot adjust interest rates Countries cannot adjust their exchange rates Restricted government spending Political shock Loss of cultural identity


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4.THE ROLE OF ECB IN PROMOTING THE EUROIn order to form a more perfect economic union, the establishment of a single financial market,

provide a high level of employment, promote convergence of economic performance, and secure

the benefits of sustainable and non-inflationary growth, 27 European countries have established

a common currency and a European Central Bank.

When speaking of a central bank, the first idea which probably comes to mind is that it is the

institution that issues money. And money is the instrument we use as a unit of account, a means of

payment and a store of value. Granted, the key objective of any central bank is to ensure that the value

of money is preserved over time. But there are many other lesser known aspects of modern central

banking. One of them is communication. A central bank should not only do what it says it does but also

explain what it is doing, thereby increasing the publics awareness and knowledge of the policies andservices it provides. From its early introductory stage up to now, the ECB has never stopped promoting

the euro currency throughout the years but has instead make use of different tools to ensure the growth

and credibility of the currency. They are discussed in more details below:

4.1 Advisory functionsThe ECB has an advisory role vis--vis the European Community and national authorities on matters

which fall within its field of competence, particularly where Community or national legislation is

concerned. In order to undertake the tasks of the ESCB, the ECB, assisted by the NCBs, has the task of

collecting the necessary statistical information either from the competent national authorities or directly

from economic agents. The ECB thus represents on one hand, the role model for its 17 NCBs and, on

the other hand, acts as a regulator to ensure that all its NCBs are following its demands. The General

Council of the ECB is responsible primarily for reporting on the progress made towards convergence by

EU Member States which have not yet adopted the euro, and for giving advice on the preparations

necessary for adopting the euro as their currency. In this way, it contributes to the advisory functions of

the ESCB and helps to collect statistical information. In addition, it is also a good method for the

promotion of the euro currency as being credible and successful among the EU Member States.


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4.2 Collection and compilation of statisticsThe ECB, assisted by the national central banks, collects a wide range of statistical information

necessary for the fulfillment of its tasks. Statistics are essential, for example for the monthly decision on

the key interest rates, because they mirror the current situation of the euro area economy.

The statistics found on the web page of the European Central Bank are updated around the 14th working

day of each month. They cover

data on outstanding amounts (stocks) of euro banknotes and coins in circulation transactions data (flows) on the banknotes and coins issued into circulation, returned from

circulation, sorted to check authenticity & fitness and sorted to unfit during the reporting period

the number of NCBs/commercial banks branches providing cash in the euro area

the value of euro collector coins not intended for circulation issued by the euro area MemberStates.

The ECB closely monitors the stock and circulation of euro banknotes and coins. It is the Euro systems

task to ensure a smooth and efficient supply of euro banknotes and to maintain their integrity.

4.3 International cooperationA number of issues (such as global imbalances and systemic macroeconomic and financial stability) that

are of relevance to the ECB's basic tasks (in particular monetary policy) have implications beyond the

euro area and therefore need to be addressed at international level. Against this background, the ECB

participates in meetings of international importance in which issues of relevance to the Euro system are

addressed in order to present the Euro systems views. The Statute of the European System of Central

Banks stipulates that the President of the ECB shall decide how the Euro system shall be represented in

the field of international cooperation.

4.3.1 TransparencyAn unconventional act from the ECB was that it provided real time detailed reports and analyses and

organized regular conferences with the press. It must be pointed that the ECB was among the first


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central banks implement that. By giving full details and summaries of each measure and event that

happened in the Euro area, the ECB ensured its credibility and enhanced transparency.

Furthermore, under its statues the ECB is independent from governmental or other influences when it

changes interest rates in order to fight inflation. Therefore, the ESCB enjoyed full independence and hadthe leeway in choosing the level of interest rates to achieve the stated goal. It could also suspend any

interventions if those would be an obstacle to achieving the main objective; maintaining price stability.

It is obvious that if the ECB would perform well, the level of confidence of the public in the bank would

increase. Thus in promoting the euro, the bank gives much importance to transparency.

4.3.2Public speeches and announcementsIn her speech on 12 November 1998, that is, before the introduction of the euro, Mrs S.

Hamalainen stated that the introduction of the euro marks a major milestone on the long road

towards European integration, a process which was initiated with the aim of ensuring peace and

stability in Europe. Apart from the political motives behind the implementation of Monetary

Union, the introduction of the euro will also have significant economic implications for the

participating countries. In order to ensure the success of Monetary Union in supporting growth

and employment, it is essential to maintain the credibility of the long-term stability of the euro.

The credibility of a currency is built up on many elements, some of which are beyond the

control of the central bank. She also discussed the building blocks which the European System

of Central Banks (ESCB) has on hand with respect to the establishment of a credible and

successful monetary policy. This proves that the ECB was already marketing the euro currency

and it also laid emphasis of the transparency in strategy and action by setting an unambiguous

overall objective.

4.4 Good FrameworkAll EU Member States form part of Economic and Monetary Union (EMU), which can be described as

an advanced stage of economic integration based on a single market. It involves close co-ordination of

economic and fiscal policies and, for those countries fulfilling certain conditions, a single monetary

policy and a single currency the euro. When the EU was founded in 1957, the Member States

concentrated on building a 'common market'. However, over time it became clear that closer economic


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and monetary co-operation was desirable for the internal market to develop and flourish further. But the

goal of achieving full EMU and a single currency was not given importance until the 1992 Maastricht

Treaty, which set out the ground rules for its introduction. These say what the objectives of EMU are,

who is responsible for what, and what conditions Member States must meet in order to adopt the euro.

These conditions are known as the 'convergence criteria' (or 'Maastricht criteria') and include low and

stable inflation, exchange rate stability and sound public finances.

Moreover, apart from making travel easier, a single currency makes very good economic and political

sense. The framework under which the euro is managed makes it a stable currency with low inflation

and low interest rates, and encourages sound public finances. A single currency is also a logical

complement to the single market which makes it more efficient. Using a single currency increases price

transparency, eliminates currency exchange costs, oils the wheels of the European economy, facilitates

international trade and gives the EU a more powerful voice in the world. The size and strength of the

euro area also better protect it from external economic shocks, such as unexpected oil price rises or

turbulence in the currency markets. But also , the euro gives the EUs citizens a tangible symbol of their

European identity, of which they can be increasingly proud as the euro area expands and multiplies these

benefits for its existing and future members.

4.5 Issuance of euro banknotes and ensuring their integrityOnly euro banknotes (and coins) have the status of legal tender in the euro area. The banknotes are also

used internationally. It is the Euro system's task to ensure a smooth and efficient supply of banknotes

and to preserve the general public's confidence in the currency. Ensuring the integrity of the euro

banknotes is achieved by conducting research into and development of security systems for euro

banknotes, by counterfeit deterrence and monitoring and by applying common quality and

authentication standards for banknote processing by NCBs, credit institutions and other professional

cash handlers, such as cash-in-transit companies. The introduction of euro banknotes and coins on 1

January 2002 has made travelling simpler within the euro area. Strict quality controls ensure that all

banknotes produced are identical in quality and appearance. Prices for goods and services can be

compared at a glance and payments can be made with the same money in all the countries.


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4.6 Contribution to prudential supervision and financialstability

Whereas direct responsibility for the pursuit of financial stability and prudential supervision hasremained with the national competent authorities, the Treaty has assigned to the Euro system the

important task of contributing to the smooth conduct of policies in these fields. This task - which

evolves in relation to market and institutional developments - comprises three main activities:

The monitoring of financial stability, which aims to identify sources ofvulnerabilities and assess the degree of resilience of the financial system in the

euro area.

The provision of advice to the competent authorities on the design and amendmentof financial rules and supervisory requirements.

The promotion of arrangements for maintaining financial stability and effectivelymanaging financial crises, including close cooperation between central banks and

supervisory authorities.

On account of its technical expertise, the ECB is frequently asked by both EU and national authorities to

help design and define the financial rules and supervisory requirements which apply to financial

institutions. The ECB sometimes contributes to the deliberations on its own initiative. Whether its

advice is sought or not, it nevertheless ensures that financial stability is taken into account as the latter

can have a big impact on the euro currency in terms of stability and value.


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5.EFFICIENCY OF ECB IN PERFORMING ITS ROLEThe ECB came into being during a particularly volatile period for global financial markets, and has, by

all appearances, succeeded in maintaining a stable Euro-zone money market. Quibbles can be made

regarding its ability to keep inflation within its target in the early years, and its lack of focus on growth

and unemployment rates, but overall, the ECB gets good marks for its performance to date.

Efficiency can be measures as follows:

- ECB should be efficient in delivering a stable and successful currency.- It should try to maintain price stability- A level of transparency should exist in the euro area- Finally, how ECB operates in times of crisis help us to determine its efficiency.5.1 Success of the Euro currency

Over the last 12 years, the euro has been successful not only at bringing down inflation; it has also

served as a defensive buffer during the crisis. When it was first launched in 1999 and then when the euro

cash changeover took place in 2002, the euro was met with a certain degree of criticism and scepticism.

Today, the euro is the single currency for 17 countries, with a total population of 330 million citizens.

The euro has proved to be a resounding success. Given that the average rate of inflation in the euro area

for the first 12 years of the currencys existence stands at just below 2%, the euro is as stable as the

deutschmark or the Austrian Schilling were earlier. And this is the case despite the testing times for

monetary policy experienced of lateas evidenced by the recent financial crisis and the earlier turmoil

in oil and commodity prices (for example, oil prices reached a peak of USD 145 per barrel). Even by

international standards, the euro fares well. Indeed, the regional differences within the euro area in terms

of rates of inflation and growth are more or less comparable with regional differences observed in theUnited States.


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5.1.1 Value of Euro till date

The price of the euro helps us to determine the efficiency of the currency, thus the European Central

Bank. The data on the US $ per euro have been used to better show stability in the currency, hence

efficiency. The diagram below depicts the dollar price in terms of euro from the introduction of the euroas a currency till date:

Source: Chart retrieved from the ECB Website

From 4th January 1999 till 4th April 2012 where we can note that the value of the euro was estimated at

US $ 1.1789 and US $ 1.3142, we can comment that US $ price of Euro rose by 11.47%. After the

introduction of the currency, it then experiences a drastic fall US $ 0.8252 on 26 th October 2000. We can

further notice that the euro continue to rise in value to reach its peak on US $ 1.5990 on the 15 th July

2008. An abrupt decrease in the price of the euro entails due to the crisis which happen in 2008. After

that, we can notice fluctuations in the value of the euro till date.

From the graphical illustration we can say that the ECB has been successful in promoting the

euro as it is now considered as the strongest currency of the world economy.

US $/

Year


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5.2 Price Stability

Price stability is defined as a year-on-year increase in the Harmonised Index of Consumer Prices

(HICP) for the euro area of below 2%.

The ECBs Governing Council has also clarified that, in the pursuit of price stability, it aims to maintain

inflation rates below, but close to, 2% over the medium term. The primary objective of the European

Central Bank is to maintain price stability within the Euro zone, which is the same as keeping inflation

low. The Governing Council defined price stability as inflation (Harmonised Index of Consumer Prices)

of around 2%. HCIP index measures consumer price inflation in the euro zone and is collected and

gathered by the Eurostat.

The diagram below shows inflation rate from 1999 till date:

Source: ECB- Statistical Data Warehouse-Inflation

The inflation rate in Euro Area was last reported at 2.6 percent in March of 2012. From January 2000 till

October 2007, inflation rate was stable ranging from 1.6% - 2.8%.However a record low of -0.70

percent in July of 2009 was noticed but increase dramatically to 2.5 % in March 2011.According to a

source, from 1991 to 2010the average rate of inflation has been around 2.24% which clearly prove that

ECB has been successful in keeping the inflation rate around 2%.

Inflation

Year


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The ECB has to be credible in delivering price stability over time. The ECB is a young

institution, but our track record over the past ten years has been widely recognised as being

more than satisfactory. Since the introduction of the euro, average annual HICP inflation rate

has been slightly above 2%, despite a succession of significant shocks.

5.3 Monetary Policy

With the introduction of the euro, a completely new monetary policy framework was introduced in

Europe, with the ECB conducting a single monetary policy for the entire euro area. Despite the

uncertainty that surrounded the transition to this new regime, the ECB and the euro have enjoyed a high

level of credibility since the very first days of Economic and Monetary Union, the level of credibility

that was inherent to the most credible national central banks of the now euro area. This achievement

owes much to the ECBs institutional framework, which gives a clear mandate to the ECB to safeguard

price stability in the euro area, and grants it full independence in doing so.

Price stability is a necessary condition to sustainable economic growth, job creation and social cohesion.

Central bank independence is a key for monetary policy to be credibly and effectively geared to price

stability.

What is important is that the monetary policy stance is permanently designed to deliver price stability in

the medium term, taking into account the medium and long term risks assessed by the economic and

monetary analysis. Overall, despite the different shocks the ECB had to cope with since its inception,

prices have remained stable over this period, average inflation being moderate and inflation volatility

being significantly lower in the euro area than it was before EMU.

The success of the ECBs monetary policy in delivering price stability and its determination to ensure a

firm anchoring of inflation expectations has provided significant support for other European Community

objectives, notably favorable financing conditions and macroeconomic stability, which in turn favourinvestment and sustainable economic expansion. Most euro area countries have benefited from

significantly better financing conditions than in the 1990s, a situation which has supported fiscal

consolidation. For instance, in the run-up to Stage Three of EMU, fiscal deficits were considerably

reduced, mainly due to falling interest payments, from an average of 5.2% of GDP between 1990 and

1998 to 3.4% between 1999 and 2007.


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The euro also helps to strengthen trade and financial linkages across euro area countries. There

is clear evidence that the introduction of the single currency and the associated increase in price

and cost transparency has fostered both intra and extra-euro area trade in goods and services.

The euro also helps to strengthen trade and financial linkages across euro area countries. There is clear

evidence that the introduction of the single currency and the associated increase in price and cost

transparency has fostered both intra and extra-euro area trade in goods and services [3].

In addition, the euro is acting as a catalyst for a single market in financial services and a gradual

portfolio reallocation away from holdings of domestic financial instruments and towards holdings of

financial instruments issued elsewhere within the euro area.

Monetary analysis can be used to assess the efficiency of the ECB towards the implementation

of its policies. Monetary analysis consists of a detailed analysis of monetary and credit

developments with a view to assessing their implications for future inflation and economic

growth. Monetary analysis is conducted at the ECB using a broad set of tools and instruments

that are continuously refined and expanded. The tools and instruments include a comprehensive

analysis of the developments of the monetary aggregates based on information stemming from

their components and counterparts.

The role of monetary analysis in the ECBs monetary policy strategy is founded on the robust

positive relationship between longer-term movements in broad money growth and inflation,

whereby money growth leads inflationary developments. Accordingly, the efficiency of the

ECB towards implementing its monetary and credit advances can be assessed through a

monetary analysis.

5.4 Transparency

Transparency means that the central bank provides the general public and the markets with all

relevant information on its strategy, assessments and policy decisions as well as its procedures

in an open, clear and timely manner. Thus, ECB considers transparency as a crucial factor for

the promotion of the euro and to maintain its position on the monetary market. This is true
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especially for their monetary policy framework. The ECB gives a high priority to

communicating effectively with the public.

Transparency helps the public to understand the ECB's monetary policy. Better public

understanding makes the ECBs policy more credible and effective. Transparency means thatthe ECB explains how it interprets its mandate and that it is forthcoming about its policy goals.

5.4.1 CredibleAccordingly, transparency has fostered credibility by being clear about its mandate and how it

performs its tasks. When the ECB is perceived as being able and willing to achieve its policy

mandate, price expectations are well anchored. Regular communication about a central banks

assessment of the economic situation is particularly useful. It is also helpful for central banks to

be open and realistic about what monetary policy can do and, even more importantly, what it

cannot do.

5.4.2 Self-disciplinedThe ECB has well-coordinated its actions plan towards the marketing of the EURO and thus, a

strong commitment to transparency imposes self-discipline on policymakers. It ensures that their

policy decisions and explanations are consistent over time. Facilitating public scrutiny of

monetary policy actions enhances the incentives for the decision-making bodies to fulfill their

mandates in the best possible manner.

5.4.3PredictableIndeed, the market is volatile to information. The ECB publicly announces its monetary policy

strategy and communicates its regular assessment of economic developments. This helps the

markets to understand the systematic response pattern of monetary policy to economic

developments and shocks. It makes policy moves more predictable for the markets over the

medium term. Market expectations can thus be formed more efficiently and accurately.


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If market agents can broadly anticipate policy responses, this allows a rapid implementation of

changes in monetary policy into financial variables. This in turn can shorten the process by

which monetary policy is transmitted into investment and consumption decisions. It can

accelerate any necessary economic adjustments and potentially enhance the effectiveness ofmonetary policy.

5.5 Expanding the Eurozone

The ECB has played a prominent role in the expansion of the Eurozone. Previously, only a few

of the euro area countries have been benefiting a level of price stability. It has been observed

that recession is currently threatening the worldwide economy and hence the Eurozone as well.

Thus, the last financial crisis has demonstrated that in turbulent financial waters it is better to be

on a large, solid and steady ship rather than on a small vessel. Therefore, a single currency has

been a factor of dynamism for the European economy. It protects incomes and savings, and

helps to bring down borrowing costs, thus promoting investment, job creation and prosperity

over the medium and long term.

The ECB, as a guardian of the EURO, has been able to bring low levels of inflation overall inthe euro area, lower than the levels in the individual countries before. The existing differences

are no bigger than if you compare differences in price levels, for example, between various

states in the United States, which is as you know similar in size to the euro area. The single

currency also enhanced price transparency, increased trade, and promoted economic and

financial integration within the euro area and with the rest of the world. On the other hand, the

European Commission has been providing fiscal stimulus corresponding to the current economic

downturn to needy member countries in order to boost up their economies.

However, since the euro crisis has crop up, the chance to save the euro is fading. The European

debt discussions always paint the alternatives as either bail out countries (really, bail out their

bondholders) or break up the euro. In fact, the euro and the European economic union would be


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stronger if countries can default. Some have even argued that the EU should have isolated

Greece from the Eurozone a year and a half ago when the crisis first erupted. The European

Central Bank (ECB) has bought sovereign debt from Greece, Portugal, Ireland, Italy and Spain.

It has lent even more money to banks whose main asset is the same sovereign debt. Deposits arefleeing those countries' banks, and lending from the ECB is making up the difference. At this

point, whether the ECB is really playing its role to unify Europe under the same currency is

nevertheless disputed.

5.6 The EURO Crisis

The biggest threat for the Eurozone is the contagion of the Greek sovereign debt crisis to the rest

of the system. If the Greek crisis could be isolated, it would barely matter for the Eurozone as a

whole. After countless crisis meetings of the European Council, however, it has to be admitted

that the European leaders have failed to isolate the Greek crisis and to stop the forces of

contagion.

5.6.1Fragility of the EurozoneWhy has it been so difficult to stop the forces of contagion? Government bond markets in a

monetary union are extremely vulnerable. The reason is that national governments in a monetary

union issue debt in a foreign currency, i.e. one over which they have no control. As a result,

they cannot guarantee to the bondholders that they will always have the necessary liquidity to

pay out the bond at maturity. This contrasts with stand-alone countries that issue sovereign

bonds in their own currencies. This feature allows these countries to guarantee that the cash will

always be available to pay out the bondholders.

The absence of such a guarantee makes the sovereign bond markets in a monetary union prone

to forces of contagion, in much the same way that banking systems that lack a lender of last

resort are prone to contagion. In such banking systems, solvency problems in one bank quickly

lead deposit holders of other banks to withdraw their deposits, setting in motion a generalised

crisis. The same risk exists in a monetary union when solvency problems in one country


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(Greece) lead bondholders to fear the worst in other bond markets and to sell the bonds there.

This triggers a liquidity crisis in these other markets only because there is a fear that cash may

not be available. The ensuing increase in interest rates then turns the liquidity crisis into a

solvency crisis. Any country can become insolvent if the interest rate is pushed high enough.Distrust can drive a country in a self-fulfilling way into a bad equilibrium.

5.6.2 Role of the ECB during the EURO Crisis

We have learned from the history of banking that a necessary condition to stabilize the banking

system consists of providing for a lender of last resort. This gives a guarantee to deposit holders

that the cash will always be available, and pacifies them most of the time. The nice thing about

this solution is that when deposit holders are confident that it will be used, it rarely has to be

invoked.

The solution to the contagion problems of the banking system is exactly the same solution for a

monetary union. Contagion between sovereign bond markets can only be stopped if there is a

central bank willing to be the lender of last resort, i.e. willing to guarantee that the cash will

always be available to pay out the bondholders. The only institution in the eurozone that can

perform this role is the European Central Bank.

Up until recently, the ECB has performed this role either directly by buying government bonds,

or indirectly by accepting government bonds as collateral in its liquidity provision to the

banking system. However, it has made it clear that it is unwilling to continue to do so. In fact,

since the eruption of the Greek crisis in May 2010, the ECB has reduced its balance sheet by

almost 200 billion thereby reducing liquidity in the system.

It made this reduction while the crisis escalated, and governments were scrambling to find the

cash to support Greece. The reluctance of the ECB to take up its responsibility as a lender oflast resort is the single most important factor explaining why the forces of contagion in the

Eurozones sovereign bond markets has not been stopped. However, several arguments have

been voiced to support the view that the ECB should not have a responsibility of lender of last

resort in the government bond markets.


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6.ARGUMENTIn 2007, during a French presidential campaign, the ECB has come under fire by Nicolas Sarkozy, who

criticised its interest rate policy, saying that it focused too much on inflation and too little on growth,

and also questioned its independent status. Eurozone finance ministers dismissed the French criticism at

a Eurogroup meeting on 7 May 2007 and urged the President-elect to respect the ECB's independence.

The critic was ignored, as Professor de Grauwe replied that if this critic is taken seriously, it could

"endanger the monetary union".

At the end of October 2011, after eight years in the top job, Jean-Claude Trichet passed the presidency

of the European Central Bank (ECB) to Mario Draghi.No doubt; Mr Trichet deserves credit for his

handling of the financial crisis of 2007-08 and the ensuing recession. Mr Trichet was successful earlier

on, too. For most of his term the euro has been a strong currency, at times reaching $1.60. Mr Trichet

takes pride in the ECBs effective monetary control over the rapidly growing euro area, which has

expanded from 11 members to 17 since its creation in 1999. Stung by a reference to German criticism of

the bank at a press conference in September 2011, the normally even-tempered Mr Trichet protested

vehemently that the ECB had conducted monetary policy impeccably, impeccably! The ECB had kept

inflation at 2% a year, in line with its target (below but close to 2%).

The ECB was prompt to respond to the funding dearth that started in August 2007 with big dollops of

liquidity, moving beyond the standard tools aimed at price stability. Many (though not Mr Trichet) think

the ECB erred in raising interest rates in July 2008, shortly before the crisis was amplified by the

collapse of Lehman Brothers. But it was then swift to bring rates down, from 4.25% at that time to 1%

half a year later (see figure below).


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Source: ECB; Thomson Reuters

The ECB also bought covered bonds (bank debt backed by loans) to ease banks funding difficulties,

although the purchases were far smaller than the quantitative-easing programmes in America and

Britain.


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7.CONCLUSIONAfter decades of planning, the euro was born on 1 st January 1999. Since then, the ECB has

successfully ensured the smooth transition from various European currencies to sole reliance on

the euro as the single currency of the European Monetary Union (EMU). Thus, the members of

the euro zone have been able to benefit from a more positive financial and economic

environment when compared to the pre-introduction of the euro as a currency. Eventually, the

euro has harmonized trade between member countries as exchange risk did not hinder trading

anymore. At start, a low level of interest rate was extended to the whole euro area at a rapid

pace and this ultimately helped banks to offer the best rate over the time.

Since the inception of the euro, the credibility of the ECB was often pointed out. However, if

we go deeply into the various roles of the ECB mentioned previously in the promotion of the

euro, we can note that the ECB has successfully managed to replace the previous individual

currencies with the euro to the same level of credibility. With the various agreements and a

more conceptualized monetary policy, the ECB has maintained its supremacy and holds an

important role along with the IMF and other transnational bodies.

During this research and from the previous graphical representation of the evolution of the euro

vis a vis the US Dollar, it can be concluded that the ECB has been efficient in its role. Likewise,

the euro has forged its way into the international monetary system from the beginning and has

strived among strong currencies such as the US Dollar and Japanese Yen. The efficiency of

ECB can be retraced back to the inflation rate. Maintaining inflation has led to a price stability


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of the euro in the EMU and the ECB has been operating with a high level of transparency

whereby this has fostered investments.

However, the credibility and efficiency of the ECB with regards to euro have been questioned

with the emergence of the euro and sovereign debt crisis. Furthermore, the Greece and Spain

financial chaos have pulled the ECB to trial. However, from the last speech of the new

president of the ECD, MR Draghi, it seems that the ECB would stick to its inflationist measures

rather than buying out the nations debt.

The ECB is the only institution that can provide lending of last resort quickly and in

convincing quantities. It would of course be much better if the ECB did not have to bail out

the European rescue mechanism, but in this case one has to choose between two evils. As long

as it is temporary, even a massive increase in the ECBs balance sheet constitutes a lesser evil

than a breakdown of the Eurozone financial system. However, this proposal is against the

Article 123 S1 of the TFEU which forbids direct ECB credit to public institutions so as to avoid

monetary financing of fiscal deficits.

As a concluding note, the ECB is still sticking to its stated objective, which is, maintaining the

strength, the trustworthiness and price stability of the Euro in the international monetary system.

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