From the Central Bank to your wallet: understanding the impact of monetary policy on your finances.

Monetary policy is sometimes perceived as a technical matter, reserved for central banks and financial markets. Yet, its effects reverberate through all aspects of economic life. Decisions made by the European Central Bank (ECB) influence the level of interest rates, the cost of credit, the remuneration of savings, as well as the evolution of consumer prices. Understanding the mechanisms of monetary policy therefore helps to shed light on the economic, financial, and patrimonial choices faced by households and businesses alike.

I. A European Monetary Policy Serving Price Stability

1. The Mission of the European Central Bank

Since the creation of the euro, the European Central Bank has been responsible for defining and conducting monetary policy for the member countries of the euro area. Its main objective is price stability. This means it must maintain inflation at a level close to, but below, 2% over the medium term. This target was chosen to preserve purchasing power, guarantee economic predictability, and ensure confidence in the currency.

2. Coordination with National Central Banks

The ECB works in close collaboration with the national central banks of the member states that have adopted the euro. This organization, called the Eurosystem, allows monetary decisions to be implemented in a harmonized manner throughout the euro area, while taking into account the economic specificities of each country. Decisions are made by the Governing Council, composed of the six members of the ECB’s Executive Board and the governors of the national central banks.

3. Three Notions to Distinguish: Inflation, Deflation, and Disinflation

Inflation refers to a sustained increase in the general price level, measured in the euro area by the harmonized index of consumer prices. Deflation corresponds to a prolonged decrease in this same price level, which can encourage economic agents to defer their purchases and hinder growth. Finally, disinflation is a slowdown in inflation, in other words, a decrease in the rate of price increase, without entering negative territory.

II. The ECB’s Instruments for Controlling Inflation

1. The Central Role of Key Interest Rates

The ECB’s main lever of action is the adjustment of its key interest rates. Three main rates are distinguished:

source: afinancepourtous.com d’après BCE

The refinancing rate is the rate at which commercial banks can borrow short-term from the ECB.
The deposit rate corresponds to the remuneration banks receive when they place liquidity with the ECB for a very short period.
The marginal lending rate applies to emergency borrowings by banks over a 24-hour period.

2. A Transmission Mechanism to the Real Economy

By adjusting its key interest rates, the ECB influences the cost at which commercial banks can refinance themselves. This cost directly impacts the credit conditions offered to households and businesses. A rise in key interest rates makes bank financing more expensive, which encourages credit institutions to increase the rates applied to borrowers. Consequently, loans, particularly mortgage loans, become more costly, which can discourage demand, slow down consumption, and defer certain investments.

Conversely, when the ECB lowers its rates, the refinancing cost decreases. Banks are then able to offer loans under more attractive conditions, which stimulates credit demand, favors economic activity, and supports inflation when it is deemed too low.

Mortgage credit perfectly illustrates this mechanism. When a household wishes to acquire a property, it must finance part of it through a loan. However, banks do not constantly have funds available to lend to all their clients. They refinance themselves, either with the ECB or on the interbank market. If key interest rates are high, their cost of accessing liquidity increases. They then pass this additional cost on to the interest rates offered to borrowers. Thus, a rise in key interest rates mechanically slows down the dynamics of the real estate market.

This mechanism is at the heart of the ECB’s strategy: by making credit more or less accessible, it modulates the level of aggregate demand and influences the trajectory of prices. It is a powerful regulatory tool, particularly in periods of high inflation or, conversely, insufficient economic growth.

3. Indirect Effects on All Economic Decisions

Monetary policy also acts through the expectations of economic agents. When the ECB announces a future orientation of its rates, financial markets, businesses, and individuals adapt their behaviors. This is called expectation management, which constitutes an essential channel for transmitting monetary decisions. Furthermore, the stability of the financial environment, fostered by a coherent monetary policy, reinforces confidence and the fluidity of economic exchanges.

III. Unconventional Measures in Exceptional Periods

1. A Policy Adapted to Economic Crises

When key interest rates reach very low levels and growth remains insufficient, traditional instruments may lose effectiveness. In this context, the ECB may resort to so-called unconventional measures, designed to revive the economy by means other than rates.

2. The Example of Quantitative Easing

Quantitative easing is one such instrument. It involves massively purchasing financial assets, particularly government bonds, on secondary markets. This program aims to inject liquidity into the economy, lower long-term interest rates, and encourage the financing of private activity. It is a tool used in exceptional periods, notably after the 2008 financial crisis and during the Covid-19 pandemic.

3. Controlled and Temporary Use

These unconventional measures are designed to be temporary and targeted. Their implementation is based on a precise diagnosis of the macroeconomic situation. They are subject to rigorous monitoring, and their gradual withdrawal is envisioned as soon as economic conditions allow for a return to a more classic monetary policy.

Conclusion

Monetary policy plays a decisive role in the balance of the European economy. It influences financing conditions, the behavior of economic agents, price developments, and, more broadly, the dynamics of growth. By maintaining controlled inflation, the European Central Bank helps to create a stable economic environment, favorable to investment and consumption.

Last June, the ECB decided to temporarily suspend its rate-cutting cycle, after eight successive adjustments. This decision reflects progressively contained inflation, but also an uncertain economic context, in which prudence remains essential.

Following developments in monetary policy allows for better anticipation of its effects on financial markets, savings choices, financing strategies, and long-term economic trade-offs.

We follow these developments for you through our support, to help you make good use of them in your financial strategy. Would you like more information on this subject? Do not hesitate to contact us!

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Price Stability: Why Monetary Policy Directly Concerns You?