## Mr Duisenberg reports on monetary policy in the euro area
Speech by the President of the European Central Bank, Dr Willem F Duisenberg, at the Year's reception organised by the Deutsche Börse, at the Chamber of Commerce and Indu Frankfurt/Main, on 25/1/99.
Thank you for the invitation to speak at this New Year's reception. 1999 is a special year in which the euro was launched, and the year in which it will have to become currency. This is the challenge which lies ahead.
The introduction of the euro was a very happy event for all involved. The euro is pres major financial markets around the globe. Currency trading in euro has commenced and fo weeks now shares have been denominated in euro on most European stock exchanges. Altho not yet embodied in the physical form of new banknotes and coins, there is no doubt tha currency is set to play an important role, both in the euro area and beyond.
The euro is a symbol of the achievements of Europeans in the pursuit of common goals unprecedented in European history. After years of intensive preparations and successfu towards convergence, the single monetary policy for the entire euro area is being dete the European Central Bank (ECB). The Governing Council of the ECB, which comprises t Governors of the 11 national central banks of the participating Member States plus members of the Executive Board of the ECB, has assumed this responsibility and is in c monetary policy decisions for the euro area. Decisions by the Governing Council w implemented via the Eurosystem - that is, the ECB and the 11 participating national banks (NCBs).
Indeed, the introduction of the euro marks the culmination of much successful preparat over a period of many years. This has been reflected in the very positive and confide which financial markets have received the euro in the first three weeks of Monetary Moreover, the enormous technical and logistical challenges posed during the chang weekend at the start of the year have been surmounted.
Monetary Union offers a unique opportunity to establish and maintain price stability w euro area. It promises a credible and lasting environment of price stability for almost people. Price stability is at the core of the 'stability culture' that we are seeki throughout Europe. By fulfilling the unequivocal commitment of the Governing Council ECB to maintaining price stability in the euro area, we shall ensure that the singl policy contributes as much as possible to economic welfare in the broadest sense.
At the same time, national fiscal authorities and general economic policies also demonstrate their commitment to the creation of this stability culture in Europe. In t the Stability and Growth Pact is a crucial element. Its aim is to foster the pursuit and sustainable fiscal policies in the euro area. In so doing, it can make a significan to the establishment of favourable conditions for sustained economic growth and employment in the medium to long term. It would be counterproductive if national fiscal started to discontinue their efforts in the light of the achievement of Monetary Uni currently positive price outlook. I am not fully convinced that consolidation efforts being undertaken with sufficient determination in all participating Member States.
Monetary policy alone - however well designed and implemented - cannot solve Euro economic problems. Appropriate structural reforms implemented by national governments a the utmost importance. Much progress is required in this broad area. Moreover, continu
moderation in both the public and private sectors would contribute to the reductio unacceptably high level of unemployment in many parts of the euro area.
Unemployment in the euro area is largely structural in origin. Implementing too lax a policy will not solve this problem, but rather exacerbate it over the medium term, a distorts investment and savings decisions, raises the risk premium in long-term interes undermines the allocative efficiency of the price mechanism. Only effective structura that improve the flexibility and efficiency of labour and goods markets can unemployment in a successful and lasting manner. I appreciate that such reforms are no easy, not least because the benefits which they yield occur mainly in the medium to l However, they are unavoidable. In those euro area Member States that have taken u challenge of structural reform, unemployment has fallen significantly. Other euro area States should and must take note: structural reform throughout the euro area is funda the success of Monetary Union and to improving Europe's economic performance. In respect, we may also be able to learn something by looking at the reasons behind employment growth and low unemployment in some of the Member States of the European Union and in the United States, in particular regarding the flexibility of labour mark incentives to create and accept new jobs.
Today, I shall describe the main features of the stability-oriented monetary policy str Eurosystem which underlie our single monetary policy. Against this background, I shall explain the recent monetary policy decisions adopted by the Governing Council of the Finally, I shall summarise how we currently see the outlook for maintaining price stabi euro area.
## I. The stability-oriented monetary policy strategy
The Treaty on European Union, commonly referred to as the 'Maastricht Treaty', assig European System of Central Banks (ESCB) the primary objective of maintaining price sta in the euro area. In order to steer expectations of future price developments, the Council has announced a quantitative definition of its primary objective. This clarifi Treaty's mandate is interpreted by the Governing Council and gives the public clear concerning its assessment of the success of the single monetary policy.
Price stability is to be maintained over the medium term. According to the published d price stability has been defined as a year-on-year increase in the Harmonised Index of Prices (HICP) for the euro area of below 2%. Neither would deflation - that is, a persi the price level - be consistent with price stability. The annual rate of inflation in available data of around 1%, measured on this harmonised basis, is consistent with the of price stability. The Eurosystem has therefore enjoyed the good fortune to assume over monetary policy in the euro area in an environment of price stability, owin successful process of disinflation and convergence achieved within Europe over the past
Monetary policy needs a forward-looking, medium-term orientation. This takes into acco fact that monetary policy affects the price level only with variable, usually unpredictable time lags. It is not able to control all short-term movements in the pri maintain price stability, we have chosen a distinct monetary policy strategy, one that special circumstances that exist at present as well as those likely to prevail in th future. The chosen strategy ensures as much continuity as possible with the former str the NCBs. At the same time, it gives due consideration to the unique situation which wi in the early years of Monetary Union.
The stability-oriented monetary policy strategy rests on two 'pillars'. The first prominent role for money. This is deemed to be important on account of the essentially origins of inflation over the longer term. The second pillar of the monetary policy s broadly based assessment of the outlook for price developments and the risks to price s the euro area as a whole. The Governing Council recognises that it is important, in pa the assessment of monetary growth, to look at a wide range of financial and other e indicators, including economic forecasts. This systematic analysis of all other information about economic and financial conditions will ensure that the Governing Co as well-informed as possible when taking monetary policy decisions.
Monetary developments can reveal useful information about future price developments thereby offer an important compass for the conduct of monetary policy. Therefore absolutely essential for any central bank entrusted with the task of keeping price analyse and monitor the developments of monetary aggregates closely.
Consequently, the Governing Council of the ECB has announced a quantitative reference for broad monetary growth as measured by M3, which should, under normal circumstances, some indication of future inflationary pressure. The choice of M3 as an aggregate is su empirical evidence regarding the long-run stability and leading indicator propertie aggregate. Moreover, conceptual arguments pointed to the considerable importance of in in the monetary aggregate those assets which have a high degree of substitutability wit definitions of money. Therefore, in addition to currency in circulation and deposits, or shares of money market funds and money market paper as well as short-term debt secu all of which are close substitutes for more traditional bank deposits, have also been this definition.
The first reference value for M3 growth has been set at an annual rate of 4½%. This value is consistent with the maintenance of price stability over the medium term, whil for sustainable output growth and the trend decline in the velocity of circulation of M the reference value for monetary growth, the Governing Council has taken account of factors and emphasised its medium-term orientation. First, the Governing Council is co to maintaining price stability according to the definition enshrined in the Treaty o Union. This requires increases in the HICP for the euro area of 'below 2%'. Secon Governing Council takes the view that a figure in the range of 2% to 2½% per annum f trend growth in real GDP in the euro area appears to be reasonable. Third, the unc concerning short-term developments in velocity linked to the start of Stage Three hav Governing Council to assume that the medium-term trend decline in velocity lies approx within a range of ½% to 1% each year. This range reflects historical experience over t years.
Substantial or prolonged deviations of current monetary growth from the reference value under normal circumstances, signal risks to price stability in the medium term. Moneta does not react to deviations of monetary growth from the reference value in a 'mechanis In the first instance, such deviations will be thoroughly analysed to infer any signal may offer about the prospects for price developments. If the deviation points to a thr stability, monetary policy will react in a manner appropriate to counter this threat, attempt to eliminate the deviation of monetary growth from the reference value in the sh
Although monetary data contain information which is vital for monetary policy decisionmonetary developments alone will not constitute a complete summary of all the eco
information necessary to take appropriate policy decisions. There is a clear need Governing Council to look at a wide range of other economic and financial indicators.
At the same time, relying on a single forecast that attempts to summarise all the i available from a wide range of indicators would be misguided. The Governing Council do react mechanistically to a single variable - whether this be a forecast, the exchang labour costs or fiscal indicators - but rather takes into account the complete picture available and meaningful leading indicators of future inflation. In this context, th Council analyses the economic reasons behind the projected risks to price stabil appropriate monetary policy response to a threat to price stability will depend on the n threat. The Governing Council can only understand the nature of the risk if it is prese full set of data. From these, it can attempt to identify the nature of the disturb stability. Having identified the threat, an appropriate policy response can be se implemented.
Internal forecasts of economic activity and inflation in the euro area can also contr success of an appropriately forward-looking monetary policy. However, the Eurosystem s not be judged on, or held accountable for, the accuracy of its internal forecasts. Thus of the forecasts cannot contribute to accountability. Rather, its performance in maint stability in the medium term should be used by the public to judge the success of the E
Allow me to say a few words on certain proposals made in the recent public debate, whi be deemed to suggest that the focus of monetary policy should be shifted towards ob other than price stability. Indeed, some recent suggestions seem to imply that the E should react more or less automatically to exchange rate movements or other specific such as unit labour costs.
The Eurosystem's monetary policy stance is not one of benign neglect with respect exchange rate. The Eurosystem's stability-oriented monetary policy strategy takes into the external value of the euro as one, potentially important, determinant of the outlo stability. Obviously, if a strong and abrupt appreciation of the euro were to occur, lead, all other things being equal, to downward pressures on price developments. In situation, there would be a stronger reason for lowering the ECB's interest rates, wh then, in turn, help to counteract part of the prior exchange rate movement.
However, monetary policy reactions to the exchange rate, or to any other variable, can mechanistic or automatic. According to its stability-oriented strategy, the Eurosystem to analyse carefully a wide set of indicators, the nature of any disturbances and their for the overall outlook for price developments in the medium term. In any case, it must in mind that the Treaty on European Union also requires the single exchange rate p respect the primary objective of price stability. Thus, the ECB cannot commit itself in any specific reaction with respect to the exchange rate.
I am sure you would agree with me that it would not necessarily be appropriate to ti monetary policy stance simply because the euro had depreciated, if, at the same time, w a recession with increasing downward pressures on prices. As such mechanistic react exchange rate developments could easily endanger price stability and destabilise e developments in the euro area, we deliberately excluded any kind of exchange rate ta target zones from our strategy.
In line with its clear mandate enshrined in the Treaty, and for sound economic reasons has to decide which monetary stance best serves the maintenance of price stability medium term and then act accordingly. At the same time, the Treaty also emphasises the sound fiscal policies. This clear separation of responsibilities is both efficient and
The Eurosystem is open, transparent and, above all, accountable for its performance. A its communication strategy, the Governing Council of the ECB regularly informs the about changes in its assessment of the monetary, economic and financial situation in area and about specific monetary policy decisions. The Governing Council meets every fo The first meeting in every month is immediately followed by a press conference and the of the President's Introductory Statement, which is a summary of the conclusions Governing Council with regard to its assessment of monetary, financial and other ec developments. This is similar to what other central banks call minutes. We are convin this very prompt delivery of information serves the interests of the public in an optim not think that many central banks publish their minutes only a few hours after the m their governing body. I am also convinced that it is in the public interest for the whole Governing Council to be presented, rather than the views of individual mem Moreover, the ECB has just published its first edition of the Monthly Bulletin, and wi an Annual Report. We shall also explain our policies on a regular basis in speec interviews, also making a presentation to the European Parliament at least four times a
## II. Recent monetary policy decisions and operations
Co-operation among European national central banks has always been close and, am participants in Stage Three, it has become increasingly so in recent years and months ordinated reduction of the key interest rates by all central banks of the euro area 1998 clearly demonstrated that Monetary Union had begun de facto before the start o Three. This co-ordinated measure contributed to the stabilisation of market expectation
The Governing Council of the ECB announced that the new level of the euro area-wide interest rate of 3% would prevail 'for the foreseeable future'. In other words, in the further disturbances to the economy or the emergence of new and unanticipated threats stability, this level of interest rate is considered to be consistent with the prima maintaining price stability over the medium term. Our announcement helped to resolve uncertainty at a time when the practical, technical and logistical tasks required by th weekend were uppermost in our minds and in those of market participants.
The first main refinancing operations of the Eurosystem were successfully settled. Whi due attention to the uncertainties related to the phasing-in of the new system, the de taken on the basis of the liquidity conditions prevailing in the euro area money ma whole. In addition to the refinancing operations, the Eurosystem offers standing facili can be accessed by credit institutions via the NCBs. The deposit and marginal lending constitute, in normal circumstances, the upper and lower bound for the overnight market rate.
As a transitional measure, the Governing Council of the ECB had narrowed the cor established by the interest rates on the Eurosystem's standing facilities from 4 Janua January 1999. The intention was to facilitate the necessary adjustments to the new in environment resulting from the transition to Stage Three.
At its last meeting, the Governing Council of the ECB confirmed its earlier assessme outlook for price stability. The Governing Council therefore decided that for the next refinancing operations the same conditions will apply as for the three main ref operations settled earlier this month. This means they will be fixed rate tenders cond interest rate of 3.0%
Furthermore, the Governing Council confirmed that it did not see a need for continu application of the narrow interest rate corridor beyond the date of 21 January 1999. decided to revert to the interest rates on the Eurosystem's two standing facilities, wh for the start of Stage Three. It set the marginal lending rate at a level of 4.5% and t at 2.0% with effect from 22 January 1999. This decision has to be seen against the back the experience with the functioning of the euro area-wide money market since the begin the year. Difficulties of some market participants with the functioning of the area-w market have diminished substantially over time. As a consequence, overall, the integrat euro area money market has therefore reached a satisfactory state only three weeks creation.
The first regular longer-term refinancing operation, which was conducted using paralle with three different maturities of one, two and three months, was also settled success January 1999. It was conducted as a standard variable rate tender, using the single rat procedure. In contrast to the main refinancing operations, these longer-term market o are not aimed at signalling the Eurosystem's monetary policy stance. The ECB anno standard allotment volumes in advance. Therefore, interest rates from these operations seen as indicators of market conditions.
## III. Regular assessment of monetary, financial and economic conditions
Finally, I should like to report on the Governing Council's regular assessment of financial and economic conditions. We consider the current monetary trend for the euro be compatible with continued price stability in the euro area. The 12-month growth ra broad monetary aggregate M3 decreased from 5.0% in October 1998 to 4.5% in November 199 The three-month moving average of M3 (covering the months September to November 1998 stood at 4.7%, i.e. very close to the reference value of 4½% per annum.
With respect to the broadly based outlook for price developments and risks to price financial market developments may be seen as indicating a favourable assessment of the monetary policy decisions of the Eurosystem, signalling that financial market participa the environment of price stability to continue. In this connection, I could mention the term interest rates at the start of 1999 to new historical lows and the fact that the shifted downwards.
Indeed, conditions for investment at the start of Monetary Union are favourable. This particular, to the currently prevailing low interest rate level, which significantly re of financing for investors. Economic growth in the euro area has become more broadly ba is reflected in private consumption and investment.
At the present juncture, the outlook for the euro area economy is still very much inf the uncertainties surrounding the evolution of the world economy in 1999. These uncer have adversely affected indicators of industrial confidence in the euro area and ha expectations of a slowdown in economic activity in the short term. In part, the det external environment, which has its origins in the Asian and Russian financial crises
high burden on overall growth prospects. The picture, however, is mixed. Order boo capacity utilisation point to a less optimistic outlook, while retail sales and the re employment and unemployment suggest more favourable trends. Consumer confidence als remained high until late 1998. In general, this pattern of mixed evidence appears to c the economic situation in the euro area around the turn of the year, and we shall c monitor developments carefully.
I should also like to emphasise that the Governing Council carries out a forward assessment of inflationary pressures and carefully assesses risks to price stabilit direction these may take. With respect to the latest data on the HICP, the annual in November 1998 showed a further slowdown to 0.9%, compared with 1.0% in the two previo months. This development was in line with previous trends. It was mainly due to lower percentage changes in the prices of food and a further reduction in energy prices. A contribution was also made by moderate wage increases. In combination with high ov productivity gains throughout the whole economy, a reduction in unit labour costs was r
On balance, the described overall economic environment and all available forecasts for not point to significant upward or downward pressure on price developments in the sho Nevertheless, factors contributing to risks to price stability on both sides need to account. On the one hand, downward risks relate to the global environment and po repercussions on the euro area, for example via import prices and further pressure on prices. These developments will be monitored closely. On the other, unexpected upward p on wages and a relaxation of the fiscal stance would clearly alter the general env Therefore, we shall also carefully monitor the outcome of ongoing wage rounds, the pl fiscal policy in 1999 and over the medium term, as well as the implementation of such compliance with the Stability and Growth Pact.
In summary, the current situation, which is characterised by monetary growth compatib continued price stability and the absence of immediate upward or downward pressure on developments, justifies maintaining the current monetary policy stance, with an ECB int of 3% for the main refinancing facility. Indeed, monetary policy in Stage Three started low interest rates by historical standards.