Monetary policy

What it means

Monetary policy is a central bank's management of the quantity and price of money in order to maintain price stability. In the euro area it is conducted by the European Central Bank together with national central banks, in Slovakia the National Bank of Slovakia, whose governor sits on the ECB Governing Council.

The ECB aims for inflation of 2% over the medium term, measured by the Harmonised Index of Consumer Prices, HICP. The target is symmetric, meaning the ECB considers persistent inflation significantly above or below the target equally undesirable.

The main instrument is the ECB key interest rates, which influence the rates at which banks borrow and deposit money. Supplementary tools include asset purchases, longer-term refinancing operations for banks and communication about the future course of policy.

How it works in practice

For businesses, monetary policy shows up mainly in the cost of credit. A change in ECB rates passes quickly into the interbank rate EURIBOR, on which interest on floating-rate loans, overdrafts and leases depends. When rates rise, financing becomes more expensive; when they fall, cheaper.

Monetary policy also affects deposit returns and the value of the euro against other currencies. Higher euro area rates can strengthen the euro, making imports cheaper and exports outside the euro area harder. Companies trading in dollars or other currencies feel ECB decisions through exchange rates too.

When planning investments and financing, it is worth following Governing Council meetings and ECB projections. A company with a large floating-rate loan may consider fixing the rate or hedging so that rising rates do not threaten its ability to repay.

What to watch out for

Monetary policy must be distinguished from fiscal policy, conducted by the government through taxes and spending. As a euro area member, Slovakia has no monetary policy of its own and cannot change interest rates or the euro exchange rate; it can respond to economic swings only with fiscal and structural measures.

The effects of monetary policy appear with a lag, often of one to two years. ECB decisions are made for the whole euro area, so they may not match conditions in Slovakia exactly. Slovak inflation can exceed the euro area average even with the same interest rates.