Endogenous money

Endogenous money constitutes the cornerstone of post-Keynesian monetary theory, which underlines that the supply of money is determined by the demand for means of payment. An effective presentation of this theory has been proposed by Moore (1988), who differentiates between horizontalists and verticalists. The mainstream theory reflects the verticalist view and states that the money supply function is exogenous, independ- ent from money demand and controlled by the central bank. By contrast, according to endogenous money theory, which reflects the horizontalist view, the supply of money is demand determined, and the central bank can only control the rate of interest, not the quantity of money.

Exchange-rate pass-through

Policy makers define exchange-rate regimes in agreement with monetary policy. As Vernengo and Rochon (2000, p. 77) point out, "preferences over a specific exchange rate regime can be linked to macroeconomic policy, in particular to whether econo- mists prefer full-employment policies or whether they defend policies aimed at guar- anteeing price stability". As several countries are adopting flexible exchange rates to prevent chronic deficits in their balance of payment (many countries were forced by speculative attacks on their national currencies to abandon fixed exchange-rate regimes), understanding the pass-through effect - the effect of exchange-rate fluctuations on the rate of inflation - became crucial as well as controversial. Many central bankers, adopt- ing mainstream recipes, are targeting inflation in order to avoid the pass-through effect, considering that exchange-rate devaluations have had substantial impacts on domestic prices. In many cases, policy makers have focused primarily on price stability, leaving aside full-employment policies.

European Central Bank

The European Central Bank (ECB) was designed to be the monetary policy bridge from which the euro - the leading symbol of European unity and supposed guarantor of just that - is controlled. The ECB and the European System of Central Banks (ESCB) were established in Frankfurt am Main, Germany, in June 1998 in accordance with the "Maastricht Treaty" on European Union (EU). The ESCB comprises the newly founded ECB and the pre-existing national central banks (NCBs) of all EU member countries (currently 27). The subset of EU member countries that have actually adopted Europe's "single" currency (currently 18) together with the ECB form the Eurosystem, which is governed by the decision-making bodies of the ECB.

While still young, the ECB is a peculiar central bank both by its statutory set-up and actual policy practices. Modelled after the Deutsche Bundesbank, the ECB has tried hard to emulate the "stability-oriented" policy approach and successes of its German archetype and original inspiration - which itself became part of the Eurosystem with the euro changeover and is supposedly subservient to its new European master today. Accordingly, its mind-set and policy approach features a peculiar asymmetry: the ECB is quick to hike in view of perceived inflation risks but reluctant to ease in support of the economy.

Exchange-rate interventions

Exchange-rate interventions, also referred to as foreign exchange (forex) interventions, are operations by the central bank performed in the foreign currency market(s) with the aim of affecting (or "managing") the exchange rate of the national currency. By defini- tion, such transactions consist in purchases or sales of assets denominated in foreign currency and are undertaken continuously under fixed (or pegged) exchange-rate regimes to maintain the peg at the announced level. Yet forex interventions may also frequently occur under flexible (or floating) exchange-rate arrangements, to smooth out potentially abrupt exchange-rate adjustment especially when forex volatility is higher than usual.

Exchange-rate targeting

Orthodox economics considers the exchange rate as a nominal anchor against inflation to provide long-run macroeconomic stability (Snowdon et al., 1994). Along with this general position, after the breakdown of the Bretton Woods exchange-rate pegs, it was suggested that a target zone for the exchange rate would benefit from some flexibility and its maintenance would be less demanding than a strict peg (Williamson, 1985; Krugman, 1991).

By contrast, policy makers, especially in developing countries, tend to be more con- cerned with real variables, short-term dynamics and real exchange-rate targeting. In this respect, Chile was one of the first countries to adopt, in 1965, an exchange-rate rule based on purchasing-power parity (PPP), followed by Brazil in 1968. This rule deter- mined the nominal exchange rate that was changed at irregular intervals depending on the inflation-rate differential between Brazil and the United States (Calvo et al., 1995).

Efficient markets theory

Efficient markets theory, as formulated by Fama (1970, 1991), rejects the existence of unexploited profit opportunities in financial markets, arguing that the actions of profit-seeking traders will cause asset prices to reflect all available information. Acceptance of efficient markets theory implies nothing about whether financial markets coordinate investment and saving decisions in an orderly, socially optimal or stable manner, but only about whether it is possible for an investor to systematically "beat the market" (Tobin, 1984).

The weak form of efficient markets theory holds that knowing past asset prices will not enable an investor to follow a profitable trading rule. The semi-strong form holds that no publicly available information will enable an investor to beat the market, because all public information will have been already taken into account.

Effective lower bound

The effective lower bound, hereinafter used as a synonym for zero lower bound (ZLB) on nominal interest rates, describes a situation in which the policy-controlled short-run interest rate - to wit, the overnight repurchase agreement (repo) rate at which depository institutions borrow short-term funds from the central bank - is reduced to close to zero: to a level where it cannot be, for practical reasons, brought down any further.

In mainstream economics, the ZLB is deemed to pose a serious challenge to central banks, as it may push the economy into a "liquidity trap", which, in turn, cripples the effectiveness of monetary policy and renders the latter unable to achieve the macro- economic objectives of low and stable inflation and sustained economic growth. This is so as, once the ZLB on nominal interest rates has been reached, central banks have no other option but to substitute standard interest rate policies (based upon the control of the nominal short-term interest rate) with non-conventional monetary policy instruments, whose ultimate impact on economic activity is highly uncertain.

Euro-area crisis

The euro-area crisis burst at the end of 2009, when the newly elected Greek government discovered and announced that the Greek public deficit and debt were much higher, with respect to GDP, than the previous government had claimed. During 2010 a number of euro-area countries in the periphery of that area (Ireland, Portugal and Spain) came under much pressure, because financial markets participants feared that these countries' governments in one way or another were going to default and exit euroland. These pres- sures then extended to Italy as well, in light of its high public debt-to-GDP ratio and a rate of GDP growth close to zero. All these countries have thus been subsumed under the acronym "PIIGS" (formed by their initials), to convey the idea that their financial problems originate in their behaviour, characterized by a profligate fiscal policy and expenditure levels beyond available income.

European monetary union

The Treaty of Rome (1957) implementing the European Economic Community (EEC) did not provide for specific provisions to monitor the exchange rates of its member coun- tries' currencies. Only from the mid 1960s did European political leaders, confronted with the collapse of the international monetary system, consider ways to protect the EEC from the harm caused by growing exchange-rate instability. This led to the Werner Report of 1970, which proposed economic and monetary union over the next decade - a proposal that never materialized. As such, European authorities fell back on specific mechanisms to promote a (relative) stability of foreign exchange rates, notably via the European Monetary System (EMS), which operated from 1978 to 1998.