Monetary policy involves influencing interest rates and exchange rates to

benefit a country’s economy. This is done by a central bank controlling the

supply of money in the economy.
However, if each EU country operated its own monetary policy, then

 the single market would be much less effective

 trade could be disrupted
 the benefits would be fewer

For this reason, under EMU, monetary policy is closely coordinated, and
within the euro area it is centralized and independent.

Role of national governments

National governments control other economic policy areas. These include

 fiscal policy that concerns government budgets

 tax policies that determine how income is raised
 structural policies that determine pension systems, labour- and capital-
market regulations

However, the EMU brings more economic integration, especially in the euro
area. As a consequence, economic policy-making becomes a matter of
common concern to all EU countries. To ensure the smooth operation of the
EU economy as a whole, it is important that all  countries coordinate their
economic and fiscal policies with the common objective of stability and
growth.

A single currency supports the single market

As well as bringing the benefits of economic stability, the EMU and the single
currency also support a more effective single market which benefits people
and enterprises. If national economic policies discourage the free movement
of goods, services, capital and labour, then these benefits, including jobs and
growth, would be reduced. Therefore, economic policy-making in EU countries
should act to support the single market.
A single banking system is the mirror image of a single currency. Since bank
deposits make up  the vast majority of money, a currency can only be truly
single  if confidence in the safety of bank deposits is the same whichever
country a bank operates in. This requires single bank supervision, single bank
resolution and single deposit insurance.
This is also crucial to address the bank sovereign negative feedback loops
which were one of the main causes of the recent global economic crisis.
The treaty defines the instruments for managing EMU. These instruments
cover the main economic activities described above.

Monetary policy
Monetary policy for the euro area is managed through the European Central
Bank (ECB) and the national central banks of the euro area countries, which
together make up the Eurosystem.
Decisions on monetary policy in the euro area can only be taken by the
governing council of the ECB, made up of

 the governors of the national central banks of the euro area  countries
 the members of the ECB’s executive board

These decisions are made free from outside influence. EU countries outside
the euro area coordinate their monetary policy with the ECB within the
European system of central banks.
The treaty lays down the ECB’s mission which is to ensure price stability
within the euro area. The ECB aims to keep price inflation in the euro area
below but close to 2% over the medium term. This 2% inflation target is
considered optimal for promoting growth and employment.
For more details, visit the dedicated pages on the website of the ECB

The Stability and Growth Pact

Economic policy-making in EU countries is coordinated in the Council. The
Stability and Growth Pact (SGP), laid down in the Treaty, is a central element
of this coordination. The SGP helps enforce fiscal discipline within EMU and
ensure sound and sustainable public finances.
The SGP requires

 government deficits to be less than 3% of GDP

 government debt to be less than 60% of GDP
For more details, visit the pages dedicated to the stability and growth pact

TSCG/Fiscal Compact
The Treaty on Stability, Coordination and Governance in the Economic and
Monetary Union (TSCG) was formally concluded on 2 March 2012, and
entered into force on 1 January 2013. It was part of the broader policy
response to the euro area crisis. The TSCG is an intergovernmental Treaty
and is thus not part of the Union legal order. The Contracting Parties had to
introduce in their domestic legal order by 1 January 2014 the necessary
transposing provisions.
The Fiscal Compact per se is one part of the TSCG (Title III). Within the Fiscal
Compact, Article 3 requires a balanced budget rule to be enshrined in national
legislation alongside national surveillance (by an independent monitoring
institution) and a correction mechanism (in case of deviation). More detailed
features of this requirement were presented in a 2012 Commission
communication setting common principles.
Out of the 25 Contracting Parties to the TSCG (all Member States except the
UK, the Czech Republic and Croatia), 22 are formally bound by the Fiscal
Compact (the 19 euro area Member States plus Bulgaria, Denmark and
Romania). The Fiscal Compact runs alongside the other requirements
concerning fiscal policy and governance included in the Stability and Growth
Pact as enhanced by the Two-Pack and Six-Pack.
Based on the mandate granted in the TSCG itself, the Commission has
published in February 2017 - after extensive consultation of the Member
States concerned - a Report assessing the compliance of the national
provisions adopted by each of them in relation to the Fiscal Compact
(specifically, with Article 3(2) of the TSCG). It is accompanied by
a Communication from the Commission putting in perspective the origin of the
Fiscal Compact and its possible incorporation into EU law, as well as with
country annexes for each of the 22 Contracting Member States.
To date, all Contracting Member States have significantly adapted their
national fiscal frameworks as a result of the Fiscal Compact requirements.
On 6 December 2017, the Commission put forward a proposal to incorporate
the TSCG into EU law in order to increase democratic accountability and
legitimacy across the Union. This incorporation was already foreseen by the
intergovernmental treaty with the deadline of 1 January 2018. Bringing the
thrust of the Fiscal Compact within the EU legal framework would ensure the
more effective monitoring of the implementation and enforcement of fiscal
rules at both EU and national level.

The broad economic policy guidelines

Wider coordination is achieved through annual cycles of economic policy
discussions between EU countries and EU institutions. This policy
coordination is consolidated into the broad economic policy guidelines (BEPG)
which are adopted by the EU Council on the basis of a Commission
recommendation. The BEPG are updated annually and cover the coming
three years.
The BEPG are non-binding guidelines for the EU and each Member State
aimed at promoting macroeconomic stability, sustainable finances, structural
reform and the smooth functioning of EMU. The guidelines serve the aim of
the European Semester of economic policy coordination, as they frame the
scope and direction for EU countries’ national reform programmes (NRP) and
serve as reference for the development for Country Specific
Recommendations (CSR).

European Monetary Policy

The European Central Bank
The European Central Bank (ECB) oversees EU monetary policy.

Activities of the ECB

1. Ensuring that EU prices are stable, that is below 2% but also close to 2% to
avoid the danger of deflation

2. Managing EU interest rates and money supply

3. Providing liquidity to the system when needed

When a European country joins the euro-area its central bank cedes much of its power
to the ECB.

Long run neutrality of money

The underlying economic philosophy of the ECB is that, in the long run, real income and
the level of employment - that is, the real economy - is not determined by the money
 supply. The main objective of monetary policy is to achieve short term price stability as
this is seen as the way to provide an economic framework for supply side growth.

The policy instrument used is short term interest rates.

Monetary Policy in Europe

The ECB meets on a monthly basis to determine two things:

1. The level of interest rates across the euro area  - the 19 countries that share the
euro

2. The quantity of money in circulation

The primary purpose of the ECB is to control euro-area inflation so that the value of the
euro remains constant and strong. It also provides liquidity into the system when
needed. If an EU country joins the euro area, its central bank cedes most of its power to
the ECB.

EU monetary institutions are fundamentally anti-fiscal, and greatly influenced by the

monetarist view. Europe’s view can be summarised as:

 Fiscal policy is less useful than monetary policy to help stabilise the macro-
economy.

 Too much borrowing will harm the stability of the Euro, hence the Stability Pact.

 Fiscal policy is less useful than supply-side policy to help create long-term
growth.

Asymmetric inflation target

Unlike the Bank of England's inflation target, which is symmetrical, the ECB target is
asymmetrical. This means that while inflation cannot rise above 2%, there is no figure
which it is must not fall below. Critics argue that this creates an in-built recessionary
bias, with no specific policy intervention required if deflation occurs. In the UK, the target
is 2% +/- 1, so that an inflation rate of less than 1% triggers a monetary stimulus.

Euro area interest rates

Euro-area interest rates remained fairly stable from 1999 until 2009, but rates on the
main deposit facility began to fall from 2009, moving into negative territory from 2014,
reflecting deflationary conditions across the euro-area.
ECB Key Interest rate - 1999 - 2016Source:
ECBwww.economicsonline.co.uk01/01/199917/03/200011/05/200106/06/200313/12/200615/10/200813/05/200908/05/2013-
20246ECB Interest rates

ECB key rate - Deposit facility

Even before the financial crisis, the one-size-fits-all approach had been running into

difficulty. This was largely because of increasing differences in the performance of the
various euro area countries, including differences in growth rates, fiscal deficits, trade
balances, and house prices.

The poor macro-economic performance of the

Euro area

In recent years growth rates in the EU have lagged behind those of the USA and the
UK.

The poor growth record of the euro area may be down to the inflexible economies of its
member countries, rather than monetary policy. In other words, the underlying problems
of Europe are more to do with poor supply-side performance than ineffective demand-
side policy.  The ECB itself recognises that growth problems are more down to national
governments failing to come to terms with globalisation, that with ineffective monetary
policy.

In addition, the ECB has been generally reluctant to reduce interest rates to deal with
sluggish growth, mainly due to fears about raising inflationary expectations. However,
the financial crisis of 2008-09 has forced the ECB to reduce interest rates to a
historically low level, at 1.5%, and continued to reduce them in repsonse to the
deepening economic downturn.

Critics argue that, unless the economy is flexible, a fiscal or monetary stimulus to help
the financial crisis may simply drive up prices.

In addition, a fiscal stimulus could also lead to balance of payments problems, and if

funded by borrowing, could crowd-out the private sector.

The Stability Pact was established to provides a constraint against a fiscal stimulus,

although the depth of the financial crisis has caused debt levels to rise well above those
set down in the pact. The ongoing sovereign debt crisis has put the whole Euro-system
at risk as it battles to form a fiscal union which would give power to the EU itself to
control national budgets.