How the european central bank increases or decreases the money supply of the economy?
The European central bank (ECB) has 3 main ways to increase/decrease the money supply and :
1) Open market operations
The main instrument for the ECB for controlling the liquidity on the market is “open market operations”. Their aim is to achieve a balance between liquidity demand and liquidity supply at a specified interest rate. Open market operations are usually set up for a predefined period of time. In the case of open market operations commercial banks frequently exchange their securities (as collateral) against money from the ECB.
The most important open market operations are called “the main refinancing operations“: Once a week the ECB offers (as part of a standard tender*) a predefined amount of money for a duration of one week. The interest rate results from the bids of the commercial banks. However participating commercial banks must offer at least the main refinancing rate, which is set by the ECB. The main refinancing operation is not only important for liquidity purposes but also for influencing the interest rates. The ECB can lower/increase the main refinancing rate that commercial banks have to pay. If banks can borrow for a cheaper rate, they can lend to customers at a lower rate (money supply increases) main refinancing operations
Longer-term refinancing operations (as part of a standard tender*)
Once a month the ECB offers, as part of its longer-term refinancing operations, a predefined amount of money for a duration of 3 months. Contrary to the main refinancing operations there is no minimum interest rate. With its longer-term refinancing operations, the ECB intends to provide some kind of long term liquidity to the commercial banks. That way the longer-term refinancing operations act as a relief for the main refinancing operations (cause it’s one more way of providing liquidity).
*a standard tender is a special auction of the ECB which is held within 24 hours after announcing it.
Fine-tuning operations
These operations are usually conducted on an ad-hoc basis in case of liquidity fluctuations (to smooth the effect of fluctuations on interest rates). The duration of fine-tuning operations is usually not standardized. Instruments for providing liquidity in the course of fine-tuning operations are quick tender* (so the ECB offers money), foreign exchange (FX) swaps or the ECB buys instruments on a bilateral basis.
*a quick tender is a special auction of the ECB which is held within ~1 hour after announcing it. The ECB requests a number of commercial banks to bid on the interest rates for which it will provide money to the commercial banks (liquidity)
Structural operations
These operations are usually also conducted on an ad-hoc basis. For some structural operations, the durations are standardized, for others not. Instruments for providing liquidity in the course of structural operations are tender (so the ECB offers money – standardized) or the ECB buys instruments on a bilateral basis (non-standardized).
2) Captial requirement for commercial banks
The central bank can lower/increase the capital requirement that commercial banks are required to hold. (Basel IV) If the commercial banks have a lower capital requirement they can lend more.
3) Standing facilities (overnight operations)
While open market operations or capital requirement adjustments are conducted on the initiative of the ECB, the standing facility operations are conducted on the initiative of the Commercial Banks.
Deposit facility
Means that commercial banks can make overnight deposits at the ECB for a specified deposit facility rate (currently -0.50%)
Marginal lending facility
This means that commercial banks can conduct overnight lendings (if they want to and in exsecurities) at the ECB for a specified lending facility rate (currently +0.25%).