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What is monetary policy and what is it used for?

Monetary policy

What is monetary policy?

Monetary policy concerns the decisions taken by a central bank, within its mandate, to influence the cost of borrowing and the amount of money in the economy.

In the euro area, the most important decision of the European Central Bank (ECB) is usually to set the key interest rates. If necessary, the ECB may decide to use other instruments.

Inflation target 2%

What is monetary policy used for?

Monetary policy is used to influence changes in the prices of the goods and services we consume.

The ECB’s primary objective is to maintain price stability in the euro area. This means making sure prices do not increase a lot or have large fluctuations, i.e. ensuring that inflation is low and stable.

The ECB sets monetary policy aiming for 2% inflation over the medium term.

When setting monetary policy, the ECB also takes into account concerns over economic growth and employment, financial stability and climate change, provided they do not harm price stability.

Who is responsible for monetary policy?

 

Who is responsible for monetary policy?

The authority responsible for monetary policy in the euro area is the Eurosystem — the ECB and the national central banks of the 19 euro area countries, which includes the Banco de Portugal.

The Governing Council of the ECB sets monetary policy for the euro area as a whole.

  • The Governing Council includes the six members of the ECB’s Executive Board, plus the governors of the national central banks.
  • It usually meets every six weeks to take monetary policy decisions.
  • The members of the Governing Council base their decisions on the interests of the euro area as a whole, not on the interests of their countries of origin.

The Executive Board of the ECB implements the Governing Council’s decisions, giving the necessary instructions to the national central banks.

  • The Executive Board includes the President of the ECB, the Vice-President and four other members.

The national central banks implement monetary policy in the euro area countries in accordance with the Executive Board’s instructions.

As part of the Eurosystem, the Banco de Portugal has monetary policy responsibilities:

  • It participates in formulating monetary policy:
         - The Governor is a member of the Governing Council;
         - The Bank’s staff take part in technical committees that assist the Governing Council;
  • It implements monetary policy in accordance with the Executive Board’s instructions:
         - It interacts with commercial banks established in Portugal;
  • It monitors the effects of monetary policy on the national banking system and the Portuguese economy. The Bank carries out studies to understand these effects and help improve the design and implementation of monetary policy.

  

How does the ECB decide what to do?

The central bank does not influence the prices of goods and services directly.

The central bank makes use of monetary policy instruments (e.g. key interest rates) to try to influence household and business spending and thereby the prices of goods and services. It may take several quarters until a monetary policy decision is fully reflected in prices.

Therefore, before making decisions, the ECB has to be well informed about what is happening to economic growth, employment and inflation and what is likely to happen in the future.

The ECB makes decisions based on an integrated analysis of all information. The reasons behind each decision are explained in “Monetary policy statements at a glance”.

 

Why is monetary policy important for citizens?

Monetary policy affects our daily lives, whether we are aware of it or not.

It affects the decisions we make about how much to spend, save or borrow.

Trusting that prices will remain stable helps us make better decisions. It means that we can be sure that, with the same amount in euro, we can buy tomorrow practically the same we bought today.

Price stability creates better conditions for economic growth and job creation, increasing the well-being of citizens.