Euro Zone: Its Conventional And Unconventional Monetary Policy

Euro zone: its conventional and unconventional monetary policy

Euro zone

The legitimate or adequate name is a euro zone but many know it as the Eurozone or euro zone, in 1999 Europe made a definitive decision with which it proposed a unique currency for all the countries of Europe, this is due to the fact that a unified currency will provideBetter advantages compared to the subsequent situation that each Member State had individually, this causes less risk in the costs of change and fluctuations, so that it is reinforced as a single market, it also implies better cooperation between the Member StatesWith more stable economies (Eurodämmerung: the twilight of the euro, 2012). This process initially covers more than 300 million citizens, decisively the advantages of joining the countries adopted the euro. Three years (2002) passed and as expected, tickets began to be printed and produced shiny coins, which initially replaced 12 coins (DW, 2008). For the present, the countries that are part of the euro area are: Germany, Austria, Belgium, Cyprus, Slovakia, Slovenia, Spain, Finland, France, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands and Countries andPortugal. Which are regularized by different agencies such as: the person in charge of the monetary policy of the Euro Zone (European Central Bank), the Eurozone Finance Ministers that constitute the Political Authority (European Commission), and the monetary authority of the Eurozonewhich is made up of all central banks and the European Central Bank (Euro or Eurosystem system).

(DataMacro, 2019)

From the European Union, Eurozone countries have achieved for many years greater certainty, better life opportunities, greater possibilities of choice, not to mention the opening of education, work and transport offered. In such a way that we see that the euro has offered considerable improvements for Europeans who get to achieve that stability that has not been resolved from the sequels of World War II. (European Commission, 2019)

MONETARY POLICY OF THE EUROZONA

Central banks or the Euro system usually make their monetary policies through conventional mechanisms, these mechanisms are established in such a way that the normal ones is to see them well defined in their own statutes or in their operating standards, it must be considered that since the beginning it has sufferedVariations due to financial crises which has affected monetary markets, the central banks of the developed countries of the euro zone which have known how to take exceptional ways through different measures, which are not categorized as conventional. This has caused developed countries to grow and therefore cause an increase in development before countries not so developed.

Conventional monetary policy

The main idea of the conventional economy is that the central banks carry out monetary policy through a monetary supply control system, but in practice the high monetary controls of developed countries use variations in the face of the official interest rate (in charge ofdetermine the orientation of monetary policy) to adapt monetary decisions and make them effective. In the Eurozone the European Central Bank an interest rate of main financing operations is always used.

Variations in official interest rates lead. With changes in official interest rates, banking institutions want to introduce or remove liquidity that affects economic growth levels.

European Central Bank

The European Central Bank was created from June 1, 1998, its main objective was to adapt monetary policy in the euro zone to promote an improvement in prices stability. The monetary policy in conjunction with its institutional framework is based on an experience structure that part of the central banks globally, which have had to face throughout history phenomena that the oil crisis brought as the stanflation in the70’s until prices stability compatibility with low inflation levels in the 80’s.

The Governing Council (main governing body of the area) intended to define through an objective impulse, with what in 1998 announced that to maintain a medium -term price stability with which the IAPC or harmonized price index is establishedof consumption as an annual increase which must not exceed the two percentage points. ECB (2003)

Therefore, the Governing Council proposes a low level of inflation but this was considered detrimental to the results of the objective, so the Council reached the resolution to modify its initial argumentation. The ECB has a strategy that is characterized by a double perspective which analyzes the evolution and behavior of prices which is also known as two pillars system. (Déniz, 2014)

First it is considered the pillar of economic analysis, which its primary objective is to study the behavior of prices in the medium and short term part of the variations of real activity.

As a second point we consider the monetary analysis as a pillar, which links growth with the inflation of money to the medium and long term in which the data thrown from the economic analysis is taken into account. (European Central Bank, 2003)

If this system of two pillars helps the decrease in uncertainty to monetary markets, reduce the error it can show about the behavior expected of prices, it is worth mentioning that the system. It depends on the adequate application of monetary measures. Deflation and inflation are products of the evolution of banks, which can cause social and economic well -being.

Monetary policy strategy of the European Central Bank

 

Unconventional monetary policy

The global crisis produced the manifestation of needs to resort to unconventional measures which cause an arrest in the face of a development of the crisis and reinforces the economy of the countries. Through normal circumstances, central banks use normal or conventional measures to face the shocks that affect the fulfillment of monetary policies, which can be: financial or price stability, production or full employment growth. In this way we see that the financial crisis has affected in such magnitude that the levels are approaching 0, so that it limits the capacity of an expansion through this route and exposes the use of unconventional measures for the resolution of irregularities thatmonetary and financial markets threaten. The sufficiency loss of conventional monetary policy instruments influences economic activities which is known as the liquidity trap. (La Caixa, 2013)

We must take into account the different financial tees of abruptly arrested the credit market, which affects future expectations and collaborates with the disruption of traditional monetary policy mechanisms, which are used to relate prices influences,Decisions on the interest rates of central banks and other relevant variables.

Some of the reasons why unconventional measures are directed to financial markets are: the rupture of the transmission mechanism, the difficulties of credit entities for the introduction of external markets, the contraction of credits to macro and micro economic levels, and the liquidity trap. Through this panorama, the Central Bank does not hesitate to go to injection in liquidity banks in large proportions, so that the differences in the financial market are reduced, it must also concisely help the credit market through the purchase of financial assets (Quantitative easing). (Hair)

Note: Quantitative Easing is a monetary policy that is executed aggressively through which banks buy considerable amounts of assets.

Monetary policy transmission mechanisms

 

Taylor rule

Taylor’s rule analyzes the relationship of variables with the proportion of interest rates, in this case for the zone, this rule is proposed by John B. Taylor, an economist who in 1993 exposes the standards of monetary police. The Taylor rule as we mention is a rule for monetary policies which relates the gross domestic product and the official interest rate given by monetary authorities with deviations that affect inflation, with respect to the potential level and objective level in respectively. This rule became a common or normal measure to qualify monetary decision making.

In 1980 and in the early 2000. On the other hand, we must take into account that the deviations of the interest rates of the Taylor rule before advanced economies are mentioned by many authors and economists in numerous countries. (Boris Hofmann, 2012)

This rule is backed by several assumptions such as:

1. The main instrument that demonstrates the participation of monetary authority is interest rate intervention.
2. Monetary authorities must reduce inflation and output fluctuations, requiring assumptions that are in accordance with the different parameters of the Central Bank.

    

The model raised to apply the Taylor rule in the euro area uses as a basis in the model proposed by economist John Taylor, also adding other variables proposed by different authors. This model seeks to prove if there is a relationship between the interest rates applied in the period, with respect to the interest rates obtained when applying the rule.

The proposed model for this analysis would be raised as follows:

it = r* + π* + β1 (πt – π*) + β2 (yt – y*) + β3 (mt – pt)

Where:

• IT = nominal interest rate.
• R* = nominal interest rate.
• β1 = Economy sensitivity to the inflation gap.
• (πt – π*) = inflation gap;πt represents the inflation of the period, and π* is the inflation inflation proposed by the Central Bank.
• β2 = sensitivity to the product gap.
• (yt – y*) = product gap, where YT is the logarithm of the production of the economy and* represents the potential product (maximum production where all production factors) of the economy are used.
• β3 = aversion from the economy to the logarithmic difference of the real balance of money except the price level.
• Mt = Logarithm of the money balance
• PT = Logarithm of the price added price

Within the BASO model proposed by Taylor, the variables that are handled for the model have been tested and applied in all works derived from the Paper proposed by the author, and are significant for regression. The real interest rate is related to the nominal interest rate, the product gap and the inflation gap allow to determine the level of the nominal interest rate that the Central Bank must apply to meet the proposed objectives (keep low inflation rates).

The real money balances and the added level of prices are variable proposed by economist José Hernández Conde of the University of Valladolid in his work entitled “The Taylor curve. Review and solutions ". According to Hernández, as the price level of the economy is given, the real money balance must be set by the monetary authority, and it should be used as a control variable within the model that allows minimizing the value of the loss functioncalculated by the author, which generates that my model is more efficient.

The present model seeks to predict the values that the nominal interest rate of an economy must take if it is handled under the Taylor rule, and compare them with the values established in the period, and analyze whether or not, or not, a relationship between the tworates.

To do this we must determine the level of significance of the variables, and analyze whether the model is acceptable and applicable within the euro zone in the period between 1961 and 2018.

Bibliography

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