Lecture 1A: Central bank mandates and the policy rate
A central bank's most watched decision is where it sets its policy rate: the interest rate at which banks can get money from, or park money at, the central bank. That one rate works through the whole economy: banks pass it on in mortgage, loan and savings rates, which changes how much people borrow and spend, which in time changes jobs and prices. Raising the rate is "tightening" (cooling the economy, pushing inflation down); lowering it is "easing" or "loosening". The stance of policy is simply how tight or loose it is right now.
A mandate is the job description the law gives the central bank: which goals it must pursue. This chapter compares the two mandates you need to know (Fed and ECB), the rates each one sets, and the committees that decide. Read it with one question in mind: if both banks face inflation above 2%, why would they not set the same rate?
The starting point: what the Fed and ECB did in September 2026
| Fed (16 Sept. 2026) | ECB (10 Sept. 2026) | |
|---|---|---|
| Decision | Rate up 25 bp to a target range of 3.75-4.00%, unanimous (12-0) | All three rates up 25 bp; deposit facility rate now 2.50% (second increase of 2026) |
| Inflation (August) | PCE 3.4% (core 3.0%) | HICP 3.3% |
Both raised rates by the same amount, because inflation in both places is above the 2% target. Yet the Fed's rate is about 1.25-1.5 percentage points higher than the ECB's. Why? Maybe inflation is different, maybe the economies are in a different state, maybe the "neutral" rate differs, or maybe their goals (mandates) differ. The course teaches you to answer this with data.
Mandates: what each central bank must achieve
A mandate is the goal a central bank is legally given.
| Fed: dual mandate | ECB: primary objective |
|---|---|
| Two goals of equal standing: maximum employment and stable prices (plus moderate long-term interest rates), set in the Federal Reserve Act. | One main goal: price stability. Only if that is not endangered, it also supports the EU's general economic policies. |
| Target: 2% PCE inflation over the longer run. In August 2025 the Fed stopped "average inflation targeting" (deliberately letting inflation run above 2% after a period below it). | Target: 2% HICP inflation over the medium term, symmetric: inflation below 2% is treated as just as bad as inflation above 2% (2021, reaffirmed 2025). |
The Fed must care about jobs and prices; the ECB first about prices. A question in the course is whether you can see that difference in how they actually set rates.
Both banks aim at 2% inflation, not at stable prices in the literal sense. Three everyday reasons. First, measured inflation overstates true inflation a little, because price indices do not fully capture quality improvements, so 2% measured is closer to stable in reality. Second, a bit of inflation leaves room to cut the real interest rate in a recession: with inflation at 2% a nominal rate of 0% already means a real rate of −2%, while at 0% inflation the central bank hits the zero lower bound sooner. Third, wages are hard to cut in money terms; with some inflation, a wage that does not rise still falls in real terms, which lets the labour market adjust without pay cuts.
The instrument: one short-term interest rate
Central banks steer the economy mainly with one very short-term interest rate. Why does a rate on overnight loans between banks matter for everyone? Because banks pass it on: when their own funding gets more expensive, they charge more on loans and mortgages and pay more on savings. That changes how much households and firms borrow and spend, which affects production, jobs and prices. This chain is called the transmission of monetary policy.
- Fed: the policy rate is the federal funds rate, the rate on overnight interbank loans of reserves without collateral ("unsecured"). The FOMC (Federal Open Market Committee; 8 meetings a year, 12 voting members) sets a target range 25 bp wide, now 3.75-4.00%. The rate actually paid in the market is the effective federal funds rate (EFFR), published daily by the New York Fed.
- ECB: it has three official rates. The deposit facility rate (DFR, 2.50%) is what banks earn when they park money at the ECB overnight. The main refinancing operations rate (MRO, 2.65%) is what banks pay in the ECB's regular weekly loans. The marginal lending facility rate (MLF, 2.90%) is what banks pay to borrow overnight from the ECB at any moment. The DFR signals the policy stance. The market rate is the euro short-term rate (€STR). Decisions are made by the Governing Council (the Executive Board plus the governors of the national central banks, with rotating votes) every six weeks.
Andere hoofdstukken van International Monetary Relations and Policy
- Lecture 1A: The basics and the course
- Lecture 1A: The interest rate corridor
- Lecture 1A: The Taylor rule and the Taylor principle
- Lecture 1A: Using the Taylor rule in practice
- Lecture 1B: The balance of payments
- Lecture 1B: Reading current accounts and trade wars
- Lecture 1B: The NIIP and valuation changes
- Lecture 1B: The NIIP-NII paradox
- Lecture 1B: Common mistakes and summary
- Lecture 2A: Why build the New Keynesian model
- Lecture 2A: Households: the Euler equation and labor supply
- Lecture 2A: Firms: demand, markups and sticky prices
- Lecture 2A: From marginal cost to the three equations
- Lecture 2A: How the model works: transmission and shocks