KJ Somaiya Institute Of Management Studies & Research

Monetary Policy (Italy)

Economics Assignment

Shivam Awasthi PGDM-IB Roll No 36

Monetary Policy And Liquidity Management Operations

The Bank of Italy helps to draft monetary policy for the Euro area as the Governor is a member of the Governing Council of the European Central Bank (ECB).The Bank also plays a role in implementing monetary policy in accordance with the principles of operational decentralisation and subsidiarity established in Europe.

Objectives And Strategies

The primary objective of the Eurosystem is to maintain price stability, as laid down in Article 105 of the Treaty establishing the European Community. For this purpose, the ECBs Governing Council has declared that the inflation rate should be kept below, but close to 2% over the medium term. To achieve price stability, the central bank influences market conditions and therefore short-term interest rates. Changes induced in money market interest rates and the transmission mechanisms of monetary policy are used to help the banking system meet its financing requirements. These requirements partly relate to the supply of banknotes for bank customers and are partly induced by the Eurosystem, which obliges banks to hold minimum reserves.

Instruments
The Eurosystem uses a set of instruments to implement monetary policy, namely: 1. Open market operations; 2. Standing facilities; 3. Minimum reserves.

Open Market Operations

The Eurosystems open market operations can be divided into the Following four categories according to their aim, regularity and the procedures followed: main refinancing operations, longer-term refinancing operations, fine-tuning operations and structural operations. Main refinancing operations The main refinancing operations are the most important open market operations conducted by the Eurosystem. They play a pivotal role in steering interest rates, managing the liquidity situation in the market and signaling the stance of monetary policy (through the main refinancing rate set by the Governing Council).

Monetary Policy - Italy

Main functions are Publication of liquidity needs, Main refinancing operations are executed through standard tenders. The Eurosystem may execute its tenders in the form of fixed rate or variable rate tenders.

Longer-term refinancing operations In addition to the weekly main refinancing operations, the Eurosystem also executes monthly longer-term refinancing operations with a three-month maturity. These operations aim at providing longerterm liquidity to the banking system. This is deemed useful in order to prevent all the liquidity in the money market from having to be rolled over each week or every two weeks, and to give counterparties access to longerterm refinancing. Main functions are Eurosystem acts as a rate taker ,Provision of additional liquidity.

Fine-tuning operations The Eurosystem may also carry out open market operations on an ad hoc basis, i.e. fine-tuning operations. The frequency and maturity of such operations are not standardized. Fine-tuning operations can be liquidity-absorbing or liquidity- providing. They aim at managing the liquidity situation and steering interest rates in the money market, in particular to smooth the effects on interest rates of unexpected liquidity fluctuations in the money market. Fine-tuning operations are also important to support the normal functioning of the markets and to provide liquidity in highly exceptional circumstances, as was the case after the terrorist attacks in the United States on 11 September 2001. Structural operations The operational framework also provides the Eurosystem with the possibility of conducting structural operations. Such operations seek to adjust the structural liquidity position of the Eurosystem vis--vis the banking system, i.e. the amount of liquidity in the market over the longer term. These operations could be conducted using reverse transactions, outright operations or the issuance of debt certificates.

Standing facilities
The Eurosystem offers two standing facilities, the marginal lending facility and the deposit facility at the central bank; both instruments have overnight maturity and are available to counterparties on request. The Bank of Italy manages these operations with banks in Italy.

Minimum reserves
The ECB requires banks to hold deposits in accounts with the NCB as minimum reserves, which earn the same rate of interest as the main refinancing operations with the Eurosystem. The Bank of Italy assesses the amount of the reserve due from each bank in Italy and applies the penalties laid down by the ECB for non-compliance

Monetary Policy - Italy

Central Bank Liquidity And The Liquidity Needs Of The Banking System
To sum up, the operational framework is the set of instruments and procedures which a central bank uses to steer interest rates, manage liquidity in the money market and signal monetary policy intentions through the ECBs key interest rates set by the Governing Council. The euro area banking system on account of its need for banknotes and the obligation to fulfill reserve requirements, in particular has an aggregate liquidity deficit and is reliant on refinancing from the Eurosystem. In this environment, the Eurosystem acts as a supplier of liquidity and can thus steer money market interest rates and transmit monetary policy impulses across the euro area.

Monetary Policy - Italy