Akira Mamizuka Johnnie McBride Lester Leung

1. April 13, 2010 Akira Mamizuka Johnnie McBride Lester Leung European Monetary Policy D E U T S C H E B A N KE U R O Z O N EDISCUSSION Letica Thomas Matteo Zanella Robert Shaw STRICTLYPRIVATEANDCONFIDENTIAL

2. The Euro Zone: Objectives and Participants Objectives • To maintain price stability and facilitate the movement of goods, financial assets and people within the Euro Zone • Price stability, healthy fiscal condition, stable exchange rate prior to joining the group, low long-term interest rates • In doing so, they enact the decisions made centrally by the ECB Map & Participating Countries E U R O Z O N E M O N E T A R Y P O L I C Y Source: European Central Bank website. 1

3. The Euro Zone: Roles of the National Central Banks How the system operates • The Eurosystem takes account of the principle of decentralization • The national central banks (NCBs) perform almost all operational tasks of the Eurosystem • In doing so, they enact the decisions made centrally by the ECB Execution of monetary policy operations: • NCBs carry out the actual transactions, such as providing the commercial banks with central bank money Management of ECB's foreign reserves: • Execution and settlement of the market transactions necessary to invest the ECB's foreign reserves Management of national foreign reserves: • NCB operations are subject to approval from the ECB, if such transactions may affect exchange rates or domestic liquidity conditions Operation of payment systems: • Each NCB operates and supervises its own national payment system, which are all interlinked and form the payment system for the euro Joint issuance of banknotes with the ECB: • Both the ECB and the NCBs are issuers of euro banknotes, which are put into circulation by the NCBs Collection of statistics: • ECB requires a wide range of economic and financial data to support the conduct of its monetary policy How National Central Banks collaborate in setting Monetary Policy E U R O Z O N E M O N E T A R Y P O L I C Y Source: European Central Bank website. 2

4. Mission and Political Mandate: Compare and Contrast Federal Reserve European Central Bank • The Eurosystem, which comprises the European Central Bank and the national central banks of the Member States whose currency is the euro, is the monetary authority of the euro area. • Primary objective is the maintenance of price stability for the common good. Acting also as a leading financial authority, we aim to safeguard financial stability and promote European financial integration. In pursuing our objectives, we attach the utmost importance to credibility, trust, transparency and accountability. • We aim for effective communication with the citizens of Europe and the media. We are committed to conducting our relations with European and national authorities in full accordance with the Treaty provisions and with due regard to the principle of independence. We jointly contribute, strategically and operationally, to attaining our common goals, with due respect to the principle of de-centralization. • We are committed to good governance and to performing our tasks effectively and efficiently, in a spirit of cooperation and teamwork. • The Federal Reserve System is the central bank of the United States. It was founded by Congress in 1913 to provide the nation with a safer, more flexible, and more stable monetary and financial system. The Federal Reserve's duties fall into four general areas: • conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates • supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers • maintaining the stability of the financial system and containing systemic risk that may arise in financial markets • providing financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation's payments system E U R O Z O N E M O N E T A R Y P O L I C Y 3

5. Mission and Political Mandate: Compare and Contrast ECB Differs in that: ECB is a part of the Euro-System which works in tandem with the Central banks of all of the countries using the Euro Answers to many constituents with different amounts of influence • Represents 16 countries but board is run seated by elite few Focuses on consolidation strategy where the FRB is already organically centralized • Fed is a more established operating body with purpose driving committees instead of location based division • *86 years older (1913 v 1999) More layers in dealing with country banks, ECB, and Euro system officials • Focuses on stabilization efforts where FRB keeps flexibility at the forefront of its goals. E U R O Z O N E M O N E T A R Y P O L I C Y 4

6. Current Economic conditions in the Euro Zone Current Inflation and GDP E U R O Z O N E M O N E T A R Y P O L I C Y 5

7. Current Economic conditions in the Euro Zone GDP Forecast – EIU Data • In Q3 2009 EU27 registered its first quarter-on-quarter expansion since Q1 2008 • The 0.3% increase slowed to just 0.1% in Q4 2009, providing evidence of the weak recovery • This pattern is expected to continue with the withdrawal of stimulus measures until end of 2010 • In 2011 GDP is expected to accelerate and in 2013-14 economic growth should return close to its trend rate of around 2%. E U R O Z O N E M O N E T A R Y P O L I C Y 6

8. Current Economic conditions in the Euro Zone Inflation Forecast – EIU Data • Inflation in the EU27 registered considerable volatility in 2008-09 due to soaring commodity prices followed by the effects of the crisis (from 3.7% to 1%) • In the near term, three dynamics will impact consumer prices: • Energy prices: energy component of the index stood 5.1% higher, as oil prices in 2010 are expected to double from 2009, this effect is likely to be maintained. • Industrial goods: even though inflation in this category rose to 1.9%, weakness in the pricing power of goods manufacturers is expected to • Labor: with further falls in employment and a weakening of labour's bargaining power, more subdued wage inflation is all but inevitable. This will be most notable in the services component of the price index. • Wide variations in inflation exist within the EU27: inflation in the new EU12 will remain higher (3.2%) than in the euro area or the old EU15 (0.5). • In the euro zone inflation is expect to rise only slightly in 2010 and in the following years to be close to but below 2%, the definition that the monetary authorities have of price stability. E U R O Z O N E M O N E T A R Y P O L I C Y 7

9. Recent policy stance of the ECB ECB short-term rate • Based on EIU Country Data, ECB short-term rate has been fluctuating between 1% and 4.3% the past ten years. The equilibrium real interest rate calculated below is also based on data from the past 10 years. E U R O Z O N E M O N E T A R Y P O L I C Y 8

10. Recent policy stance of the ECB ECB versus Taylor’s rule Taylor’s rule suggests 1.58%, which is .58% higher than actual ECB rate. i = r* + π + a1(π –π*) + a2(y–y*) i = short term interest rate = 1% r* = “equilibrium” real interest rate = 2.5 π = inflation rate = .8% π* = target inflation =.7% y = growth rate of real GDP = .1% y* = target growth rate = .5% a1, a2 = (positive) parameters [1/2?] = .5, .5 i = 1.132+.6+.5(.8-.7)+.5(.1-.5) = 1.58 Source: Expected GDP, inflation, and interest rate growth http://www.eucommerz.com/index.php?/article/0148_eu_gpd_growth/51/202/ http://www.actionforex.com/latest-news/european-economy/euro-zone-inflation-to-remain-below-ecb-target-even-into-2010-2009033183565/ http://www.tradingeconomics.com/Economics/Interest-Rate.aspx?Symbol=EUR E U R O Z O N E M O N E T A R Y P O L I C Y 9

11. Eurozone Rates versus United States Rates The United States Short-term Interest Rate The US short-term interest rate will remain lower than the ECB’s • Although the United States economy is rebounding, unemployment has remained high, particularly for those who have been unemployed for six months. “The relatively modest pace of recovery, the continued high rate of unemployment, subdued inflation trends, and well-anchored inflation expectations together suggest that the need for highly accommodative monetary policies will not diminish soon,” Federal Reserve Governor Daniel Tarullo said on April 8. The ECB short-term interest rate will remain low • The ECB was on the verge of increasing the interest rates as a result of solid economic growth throughout much of Europe. However, the Greece debt crises halted any of those actions as the European Union has been forced to help bail out the nation once agreements can be made to stabilize the Greece budget. • “Greece is keeping the ECB in wait-and-see mode,” said Carsten Brzeski, an economist at ING Group in Brussels. “The indirect impact from the Greek case is that we will see more fiscal tightening from several euro-zone members earlier than the ECB thought, which has a deflationary impact and is slowing down the recovery.” Source: (http://www.businessweek.com/news/2010-04-08/). The ECB Short-term Interest Rate E U R O Z O N E M O N E T A R Y P O L I C Y Source: http://www.businessweek.com/news/2010-04-08/ 10