What Is Leitzins?
Leitzins refers to the key interest rate set by a central bank at which it conducts transactions with commercial banks. It is a fundamental instrument of monetary policy, used to influence financial conditions and achieve macroeconomic objectives such as price stability and sustainable economic growth. In the Eurozone, the European Central Bank (ECB) is responsible for setting the Leitzins, primarily targeting an inflation rate of 2% over the medium term.35,34
History and Origin
The concept of a central bank-determined key interest rate, or Leitzins, has evolved significantly over time. Following World War II, many central banks established or redefined their primary interest rates. In Germany, the Deutsche Bundesbank (and its predecessor, the Bank deutscher Länder) utilized discount and Lombard rates as key instruments. By the late 1980s, these traditional instruments gave way to new approaches, with repurchase agreements (Wertpapierpensionsgeschäfte) becoming increasingly prominent.
With the introduction of the euro in 1999, the responsibility for setting the Leitzins in the Eurozone transferred from national central banks to the European Central Bank. The ECB's monetary policy strategy, last reviewed in July 2021, aims to maintain price stability by keeping inflation at a symmetric 2% target over the medium term. This framework guides its decisions on the Leitzins and other policy tools.,
33
32## Key Takeaways
- The Leitzins is the primary interest rate set by a central bank, influencing the cost of money for commercial banks.,
31 It serves as a crucial tool for monetary policy, aiming to achieve price stability and support economic growth.,
3029 In the Eurozone, the European Central Bank (ECB) sets three main Leitzins rates: the main refinancing operations rate, the deposit facility rate, and the marginal lending facility rate.,
28*27 Changes in the Leitzins ripple through the financial system, affecting commercial bank lending rates and savings accounts.
*26 Central banks adjust the Leitzins based on economic data, including inflation outlook, economic growth, and the strength of monetary policy transmission.
25## Interpreting the Leitzins
The Leitzins serves as a signal of the central bank's monetary policy stance. When the central bank raises the Leitzins, it indicates a restrictive (or "tightening") monetary policy. This makes it more expensive for commercial banks to borrow money from the central bank, which in turn typically leads to higher interest rates for loans to businesses and consumers. The aim is to slow down economic activity and curb inflation. Conversely, a reduction in the Leitzins signals an expansive (or "easing") monetary policy, making borrowing cheaper and encouraging spending and investment to stimulate the economy.,
24
23The effects of Leitzins changes on the broader economy often occur with a time lag, typically around one year for significant impacts on economic growth and inflation. T22he relationship between the official Leitzins and the effective cost of funding in the economy can be influenced by factors beyond the central bank's direct control, such as credit and risk premia.
21## Hypothetical Example
Consider a scenario where the Eurozone economy is experiencing higher-than-desired inflation. In response, the European Central Bank (ECB) might decide to raise its key Leitzins rates. Suppose the main refinancing operations rate is increased by 25 basis points.
This increase directly affects the cost at which commercial banks can borrow liquidity from the ECB for one week. As their cost of funds rises, commercial banks are likely to pass on these increased costs to their customers. For a small business seeking a loan for expansion, the interest rate offered by its bank would likely be higher than before the Leitzins increase. Similarly, for an individual looking to take out a new mortgage, the interest rates on variable-rate loans would tend to rise. This higher cost of borrowing is intended to temper demand, discourage excessive spending, and thereby help bring inflation back down towards the ECB's target.
Practical Applications
The Leitzins is central to how central banks manage a nation's or economic bloc's money supply and economic stability. Its practical applications are broad, influencing various aspects of the financial system:
- Controlling Inflation: By adjusting the Leitzins, central banks can influence borrowing costs. Higher rates make borrowing more expensive, which can reduce aggregate demand and help to cool inflationary pressures. Conversely, lower rates stimulate economic activity. The ECB, for instance, has adjusted its Leitzins multiple times in recent years to counter rising inflation, with decisions typically made every six weeks.,
2019 Managing Liquidity: The Leitzins plays a key role in the execution of open market operations, where the central bank either injects or absorbs liquidity from the financial system. For example, the ECB uses its main refinancing operations to steer short-term money market rates in line with its Leitzins decisions.,
1817 Influencing Exchange Rates: Changes in the Leitzins can impact the attractiveness of a currency to foreign investors. Higher interest rates may draw in foreign capital, potentially strengthening the currency, while lower rates might have the opposite effect.
*16 Affecting Consumer and Business Lending: The direct transmission of Leitzins changes to commercial bank rates means it profoundly impacts everything from mortgage rates to business investment loans. When the ECB cuts its rates, new borrowing becomes less expensive for firms and households, stimulating loan growth.
15## Limitations and Criticisms
While the Leitzins is a powerful tool, its effectiveness can face limitations and criticisms. One significant challenge is the "zero lower bound" (ZLB), where nominal interest rates approach or reach zero. Below this point, conventional monetary policy through rate cuts becomes less effective, as central banks face limitations in pushing rates further into negative territory without potentially distorting financial markets or encouraging cash hoarding.
14The transmission mechanism of the Leitzins to the broader economy can also be impaired, particularly during times of crisis. The link between the official Leitzins set by the central bank and the ultimate loan rates offered by commercial banks to businesses and households can weaken, making it harder for central banks to achieve their desired economic outcomes. This can be influenced by factors such as banks' lending behavior and their ongoing deleveraging processes.
13Furthermore, the impact of Leitzins changes on the real economy often occurs with a significant delay, making precise real-time management challenging. External shocks, such as global trade disputes, can introduce substantial uncertainty into the economic environment, complicating central bank decision-making and potentially rendering rate adjustments less impactful or even counterproductive if not carefully calibrated.
12## Leitzins vs. Federal Funds Rate
While both the Leitzins (specifically the ECB's main refinancing operations rate) and the Federal Funds Rate are key policy rates set by major central banks, they operate within different monetary policy frameworks and have distinct characteristics.
The Leitzins in the Eurozone refers to the primary interest rates set by the European Central Bank (ECB), most commonly associated with the main refinancing operations rate. This is the rate at which commercial banks can borrow money from the ECB for a short period, typically one week, against collateral. The ECB also sets rates for its deposit facility and marginal lending facility, which define the floor and ceiling for overnight market rates. The ECB explicitly sets these rates to steer monetary policy.,
11
10In contrast, the Federal Funds Rate in the United States is the target rate set by the Federal Open Market Committee (FOMC) of the Federal Reserve (Fed). It is the interest rate at which commercial banks lend their excess reserves to other banks overnight to meet reserve requirements. Unlike the ECB's Leitzins, the Federal Funds Rate is not a rate at which the central bank directly lends or borrows, but rather a target rate that the Fed influences through open market operations, by adjusting the supply of reserves in the banking system. The effective Federal Funds Rate is the actual market rate at which these overnight transactions occur.,
9
The key distinction lies in how these rates are implemented and their direct nature. The ECB's Leitzins are direct rates for specific central bank operations, while the Federal Funds Rate is a target rate influenced indirectly by the Fed's market operations. Both serve the overarching goal of maintaining price stability and fostering sustainable economic growth in their respective economies.
FAQs
What are the main Leitzins rates set by the ECB?
The European Central Bank (ECB) sets three main Leitzins rates: the interest rate on the main refinancing operations (MRO), the rate on the deposit facility, and the rate on the marginal lending facility. The MRO rate is the primary rate at which banks can borrow funds for one week, while the deposit facility rate is for overnight deposits and the marginal lending facility rate is for overnight borrowing.,
8
7### How often does the ECB change its Leitzins?
The ECB's Governing Council typically meets every six weeks to discuss and decide on monetary policy, including potential adjustments to the Leitzins. These decisions are based on an assessment of the inflation outlook, economic developments, and the effectiveness of current policy measures.,
6
5### What happens to my savings when the Leitzins changes?
When the Leitzins is raised, commercial banks' costs of borrowing from the central bank increase. This often leads to commercial banks raising their own lending and deposit rates, which can result in higher returns on savings accounts and fixed-term deposits. Conversely, a cut in the Leitzins usually means lower interest rates for savers.,
4
3### How does the Leitzins affect the Eurozone economy?
Changes in the Leitzins directly influence the cost of borrowing for commercial banks. This, in turn, impacts the interest rates that banks offer to businesses and households for loans and mortgages. Lower Leitzins rates encourage borrowing and spending, stimulating economic activity, while higher rates dampen demand to control inflation. This mechanism helps the ECB manage the overall money market and economic conditions in the Eurozone.,[21](https://positivemoney.org/eu/update/how-does-the-ecb-set-interest-rates/)