These in turn, through the monetary policy transmission mechanism, affect the price level." (ECB, 2007) Equal treatment and harmonization is a principle that holds that credit institutions must be treated equally regardless of their size or their location in the euro area. Simplicity and transparency are said to "ensure the intentions behind monetary policy operations are correctly understood. The principle of continuity aims at avoiding major changes in instruments and procedures, so that central banks and their counterparties can draw on experience when participating in monetary policy operations. The principle of safety requires that the Eurosystem's financial and operational risks are kept to a minimum. Cost efficiency means keeping low the operational costs to both the Eurosystem and its counterparties arising from the operational framework." (ECB, 2007) the following chart illustrates the primary transmission channels of monetary policy decisions.
Primary Transmission Channels of Monetary Policy Decisions
Source: ECB (2007)
Change in official interest rates takes place through the central bank providing funding to the banking systems and charging interest. The central bank can make full determination of this interest rate due to its monopoly power of issuance of money. The affects to banks and money-market interest rates is one of a direct nature in terms of money-market interest rates and of an indirect nature in terms of lending and deposit rates which the banks themselves set for customers. In terms of expectations of future official interest-rate changes and the affect on medium and long-term interest rates specifically, the longer-term interest rates are dependent, at least in part, on the expectations of the market concerning short-term rates future course. Also guided by monetary policy can be the economic agents' expectations related to future inflation and this has an influence on developments in prices. If the central bank has credibility of a high nature then it is able to firmly anchor price stability expectations and this enables economic agents to avoid increase of prices in anticipation of higher inflation and reduces the fear associated with deflation. In terms of the effect on asset, prices it is stated that: "The impact on financing conditions in the economy and on market expectations triggered by monetary policy actions may lead to adjustments in asset prices (e.g. stock market prices) and the exchange rate. Changes in the exchange rate can affect inflation directly, insofar as imported goods are directly used in consumption, but they may also work through other channels." (ECB, 2007) the impact of changes in interest rates are illustrated in the decision of households and firms. Consumption and investment are also affected by changes in asset prices via wealth effects and effects on collateral value. The example given is: "...as equity prices rise, share-owning households become wealthier and may choose to increase their consumption. Conversely, when equity prices fall, households may reduce consumption. Asset prices can also have impact on aggregate demand via the value of collateral that allows borrowers to get more loans and/or to reduce the risk premium demanded by lenders/banks." (ECB, 2007) the effect to the supply of credit is that higher interest rates bring on an increase in the risk that borrowers will not be able to pay back their loans and thus the bank is likely to cut back on the funds that are loaned to households as well as to firms. Changes in aggregate demand and prices are affected by changes in consumption and investment, which in turns changes the "level of domestic demand for goods and services relative to domestic supply." (ECB, 2007) it is related that when supply is exceeded by demand that "upward pressure is likely to occur..." As well as "changes in aggregate demand may translate into tighter or looser conditions in labor and intermediate product markets. This is turn can affect price and wage-setting in the respective market." (ECB, 2007)
III. ECB BASIC TASKS
The basic tasks of the Eurosystem are: (1) Definition and implementation of the monetary policy in the euro area; (2) the conduct of foreign exchange operations; (3) the holding and management of the official foreign reserves of the member states; and (4) the promotion of the smooth operation of payment systems." (the Monetary Policy of the ECB, 2004) the following illustrates the decision-making bodies of the ECB.
The Decision-Making Bodies of the ECB
Source: The Monetary Policy of the ECB, 2004
The Governing Council of the ECB is stated to "consists of the six members of the Executive Board the governors...
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