## Mr. Duisenberg elucidates the European System of Central Banks' stability-oriented monetary policy strategy
Speech by the President of the European Central Bank, Dr. W.F. Duisenberg, at the Inst European Affairs in Dublin on 10/11/98.
## 1. Introduction
On January 1 - in only fifty-two days - Stage Three of Economic and Monetary Union (EMU) commence. A single monetary policy will be adopted for the entire euro area - a continent-w of eleven sovereign states and almost 300 million people.
The advent of the euro offers great opportunities for Europe and Europeans. Transaction c be reduced. Pricing will become more transparent between European countries, encouraging g competition and innovation in goods and financial markets. A truly single market will be cr
Above all, though, Monetary Union offers a unique opportunity to establish and maintai stability throughout the eleven countries that will comprise the euro area from 1 January convinced that by meeting the Treaty mandate and fulfilling the unambiguous commitment o Governing Council of the European Central Bank (ECB) to maintaining price stability we ensure that the single monetary policy makes the greatest possible contribution towards r standard of living of Europe's citizens and improving growth and employment prospects. stability, consequently, is at the core of the 'stability culture' that we are creating in
Today, I should like to describe how we intend to meet our primary objective in the uniq potentially difficult - circumstances attending the birth of the euro. At the heart of o the 'stability-oriented monetary policy strategy' recently adopted by the Governing Cou announced to the public last month.
First and foremost, this monetary policy strategy is designed to ensure that the Governing presented with the information it requires to make effective monetary policy decisions. Th must act in a forward-looking and pre-emptive manner, changing interest rates to inflationary or deflationary pressures before such trends become entrenched.
Monetary policy is most effective when it is credible, that is, when the public is con monetary policy will successfully maintain price stability over the medium term. Indeed, a enjoying your Irish hospitality, bolstering this conviction is the main purpose of m Reassuring you and the wider public of the Governing Council's commitment to price stabili thereby building up the credibility of our new 'stability-oriented monetary policy strategy only make my own job easier over the coming years. It will also increase the overall be maintaining price stability in the euro area as a whole.
Speeches such as this are important. They illustrate the commitment of the European Sys Central Banks (ESCB) to openness and accountability in its decision-making. Openness accountability are necessary complements to the independence of the ESCB, on which the cred of the single monetary policy rests. Moreover, the monetary policy strategy must be c transparent so that there is no confusion or ambiguity about the objective of monetary how this objective will be achieved.
To this end, the ESCB's stability-oriented strategy has been designed and presented i straightforward, realistic and, if I may say so, honest way. These features are central t transparency. They complement the many other efforts we have made - and will continue to
to ensure that our communication with the public is open and transparent. Statements released and press conferences, including question and answer sessions, will be held imm following Governing Council meetings. Regular monthly publications will be produced by the Discussion papers and technical analysis by the ECB staff will be published for profession and scientific assessment. In all these regards, the ESCB is exceeding the reporting requir down in the Maastricht Treaty, which are already among the most stringent applicable to an bank.
Furthermore, in these articles and other presentations, we shall address various econom facing Europe, not least the issue of the high level of unemployment. In doing so, we shal best possible use of the knowledge of experts throughout the ESCB and ensure that this ex available to the wider public and the policy-making community.
In this context, let me emphasise that the Governing Council of the ECB is very concerned a unacceptably high rate of unemployment in the euro area. However, an inflationary monetary would not solve Europe's serious unemployment problem. On the contrary, an inflationary would not only unacceptably flout the Maastricht Treaty; a Treaty, let me remind you, that ratified by all the Member States of the European Union and endorsed by the public in ref several countries, including Ireland. An inflationary monetary policy would almost certain higher unemployment in the medium run, as long-term interest rates would rise and the ben price stability would be lost. Such a policy would therefore be entirely counterproductive very clear: in the interest of all European citizens, the Governing Council is determine price stability. The ESCB's independence is a means to facilitate the achievement of this by preserving price stability and thereby creating the stable environment required for higher employment and growth, can the European System of Central Banks (ESCB) serve the pu and address the public's understandable concerns.
In describing the ESCB's stability-oriented monetary policy strategy today, I shall emph twin principles of clarity and transparency that are vital in order to establish the cr therefore ensure the success - of the single monetary policy.
Monetary Union is a unique event. It is likely to prompt considerable changes in ec behaviour and the institutional structure. These changes will be to the benefit of Europe not least as the benefits of price stability are reaped. Nonetheless the inevitable an unpredictable changes in behaviour prompted by the introduction of the euro create uncertai uncertainty will complicate the task of implementing the single monetary policy.
Against this background, the ECB Governing Council has chosen a distinct monetary policy st one that reflects the special circumstances that it faces at present. Given a natural desi the success of national central banks in bringing inflation down to its current low leve convergence process, the strategy ensures as much continuity as possible with the existing of the national central banks (NCBs) of the participating Member States. Nevertheless, th strategy takes into account to the extent necessary the unique situation created by the Monetary Union.
I shall proceed by describing the three main elements of the stability-oriented strategy. discuss the quantitative definition of the ESCB's primary objective, namely price stabilit shall outline the prominent role played by money in the overall strategy. Third, I shall analysis of a wide range of other financial and economic indicators that will enter discussion. Finally, I shall conclude by arguing that the stability-oriented strategy ad
ESCB is, in the present circumstances, both clearer and more transparent than any alternatives. In consequence, I am confident of its future success.
## 2. The quantitative definition of price stability
The Maastricht Treaty assigns the ESCB the primary objective of maintaining price stabilit interest of accountability, the Governing Council of the ECB has decided to publish a qu definition of price stability, against which its success in fulfilling the Treaty's ma sensibly judged by the public.
In this context, at its October meeting the Governing Council of the ECB agreed that 'pric shall be defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HI the euro area of below 2%'.
In this way, the Governing Council has clearly and unambiguously defined its objective. If we do not meet this objective, we are obliged to explain why this is the case and what we to do about it. Let me emphasise the over-riding priority we attach to this objective. Th not only a consequence of our legal obligations under the Treaty. It is also rooted in supported by both decades of experience and a substantial body of theoretical and e research - that maintaining price stability in the euro area is a pre-requisite for a s lasting improvement in the standard of living of Europe's citizens and can lay the foun improving growth and employment prospects in the future.
The definition we have published is clear. In particular, a specific price index is id which to assess the maintenance of price stability. The HICP for the euro area was chosen is both sufficiently harmonised across the different countries of the euro area at the s Three and consistent with the public's usual focus on consumer prices.
Using the index 'for the euro area' highlights that euro area-wide developments, instead o national or regional factors, will be the only determinants of decisions regarding the sin policy.
As I have emphasised in the past, this definition signals the aversion of the Governing both inflation and deflation. The phrase 'below 2%' clearly delineates the rate of infla HICP deemed consistent with price stability. The wording 'year-on-year increases' impli decreases in the HICP - that is to say deflation in the measured price index - would not be consistent with price stability.
The Governing Council also announced that 'price stability is to be maintained over the term'. In doing so, it realistically acknowledged that disturbances to the price level can short run - for example, those caused by changes in indirect taxes or commodity prices - t be controlled by monetary policy of the ESCB. Such factors may lead to occasional fall HICP, or occasional increases above 2%. These are quite normal and consistent with a mean definition of price stability. By focusing on the medium term, the ESCB's monetary pol ensure that these transitory deviations from the definition do not become sustained over t term.
By maintaining price stability over the medium term, the appropriate forward-looking and term orientation is imparted to monetary policy. This will ensure that policy reactions t price stability are measured and deliberate. Such actions will not introduce unnecessary i uncertainty into the economy, while nevertheless ensuring that price stability - and th benefits - are maintained.
The prominent role of money in the ESCB's monetary policy strategy
Let me now turn to the role money will play in the ESCB's stability-oriented monetary strategy.
Ultimately, inflation is a monetary phenomenon. Assigning a prominent role to money with overall stability-oriented strategy therefore guarantees that the monetary origins of infl be neglected in the regular economic and financial analysis driving monetary policy d Moreover, money is a visible 'nominal anchor' for monetary policy that will help to stab public's medium-term inflation expectations, enhancing the credibility and effectiveness of policy.
To signal the prominent role attached to money, the Governing Council of the ECB will anno quantitative reference value for monetary growth. In this regard, some commentators have that the ESCB has adopted a conventional monetary target, but simply called it by a differ However, before announcing a formal intermediate monetary target, certain conditions hav met. These requirements have been met in the past in several euro area countries, and s monetary targeting strategies have been pursued. However, one must recognise that, at pre evidence as to whether these technical preconditions will be satisfied for the euro area a Stage Three is inevitably sparse. Monetary Union will cause changes in the financial sy economic behaviour, as ten different currency zones are merged into the single euro ar mentioned in my introduction, most of these changes will be of great benefit to individuals in Europe. However, these behavioural and institutional changes are likely to change the re between money, interest rates and prices that has been observed in the past.
Consequently, a realistic alternative to a monetary target - that is, the reference value growth - will be announced. As I mentioned earlier, this reference value ensures as far continuity with successful monetary strategies pursued in the euro area in the past. Nevert a different approach that reflects the special circumstances facing the ESCB at the sta Three.
This reference value will have two key features:
- first, it will be derived in a manner that is clearly consistent with - and serves th price stability;
- second, it will be constructed such that, in the absence of special factors or othe deviations of monetary growth from the reference value will signal risks to price stab
The relationship between actual monetary growth and the pre-announced reference value therefore be regularly and thoroughly analysed by the Governing Council. Where deviations an explanation will be sought. If this explanation points towards a threat to price stabil policy will react appropriately in order to address this threat. However, in contrast to that would normally follow under a conventional monetary targeting regime, interest rates be changed in an attempt to correct deviations of money growth from the reference value short term.
The Governing Council would not wish to react in a mechanistic fashion to monetary develop precisely because the signals implied by the money data could be scrambled by the te uncertainties I have mentioned. By announcing a reference value and openly explaining how be used, the Governing Council is presenting its monetary policy strategy to the public in reflects the manner in which it discusses policy itself. This is the essence of transparenc
A number of issues remain to be finalised with regard to the quantitative reference monetary growth. First, the broad monetary aggregate for which the reference value w announced has to be defined. Second, the reference value for monetary growth for 1999 will be derived and published. Progress on these two important issues is well under way and I an final announcement by the Governing Council in December.
## 1. A broadly-based assessment of the outlook for price developments in the euro area
Although the monetary data contain information vital to monetary policy-making, mon developments alone will not, of course, constitute a complete summary of all the ec information necessary to enable appropriate policy decisions to be taken. In the ESCB's oriented monetary policy strategy, money is accorded a prominent - but not an exclusive - r
There is a clear need for the Governing Council to look at a wide range of other econo financial indicators. Consequently, in parallel with the analysis of monetary growth in re reference value, a broadly-based assessment of the outlook for price developments and the price stability in the euro area will also be undertaken. This assessment will systematic all the other information about the economic and financial situation, ensuring that the Council is as well-informed as possible when making its monetary policy decisions.
Outside the ESCB, some commentators have labelled this broadly-based assessment an 'infl forecast'. Failure to publish 'the' inflation forecast is seen by some as contrary to the transparency. I am afraid that both views are flawed. Allow me to explain why.
While it is true that accurate forecasts can contribute to the success of an appropriat looking monetary policy, the ESCB should not be judged on, or held accountable for, the acc its internal forecasts. Rather, its performance in maintaining price stability in the should be used by the public to judge the success of the ESCB's policies. Consequent publication of a forecast is only important in so far as it helps to achieve price sta increasing the clarity and transparency of the policy-making process. In this regard, the important problems with publishing a single 'official inflation forecast'.
Relying on a single forecast that attempts to summarise all the information available fr range of indicators would be misguided. The Governing Council will not wish to be presented single number to which it will have to react mechanistically, if at all. In contrast, t Council will want to know the economic reasons behind the projected risks to price stabi 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 presente set of data. From these data, it can attempt - with the help of various staff analyses nature of the disturbance to price stability. Having identified the threat, an approp response can be selected and implemented.
Even with the best intentions, making an inflation forecast requires numerous subjective j about developments in the economy. Adjustments will need to be made to forecasts to allow behavioural and institutional changes caused by the transition to Stage Three. Even 'model-based' forecasts reflect the preferences of those who constructed the models. Aga background, publishing an inflation forecast would obscure rather than clarify what the G Council is actually doing. The public would be presented with a single number inten summarise a thorough and comprehensive analysis of a wide range of indicator variables. Ho such a summary would inevitably be simplistic. Moreover, because publishing a single in
forecast would be likely to suggest that monetary policy reacts mechanistically to thi publication might mislead the public and therefore run counter to the principle of clarity.
The publication of an inflation forecast might be problematic in other ways. If the ESCB publish a projection based on the assumption of unchanged interest rates, then, when infla deflationary pressures arose, the projection might be interpreted as suggesting that pric actually in jeopardy. However, this would be very misleading. The Governing Council of the fully committed to the maintenance of price stability according to its published definitio change monetary policy in order to address and contain the threat to price stability. Ho publication of the forecast itself might introduce an independent destabilising effect inflation expectations, inadvertently undermining the credibility of the single moneta making price stability harder to maintain and reducing the overall benefits of doing so. said in the past, under certain circumstances the publication of the inflation forecast i to some form of implicit indexation of wages, imparting a costly self-sustaining momentum forecasts.
If the ESCB were to publish an inflation forecast that incorporated the effects of its po rather than assuming that monetary policy was unchanged, then it would inevitably foreca stability over the medium term. This follows from the unambiguous commitment of the Gover Council to meeting its primary objective of maintaining price stability. Publishing such might be reassuring, but it would not be very informative.
Clearly, the Governing Council could have decided to announce some form of inflation forec justify policy decisions by reference to it. Interest rate increases or decreases could the on the basis that the inflation forecast pointed to threats to price stability. However, t of monetary strategy to the public is likely to involve a circular argument. For example, increases would be justified on the basis that the inflation forecast pointed to an inflat than that consistent with price stability. However, critical observers might soon argu inflation forecast was above the target precisely because there was a perceived need to ra rates. Simply publishing a forecast does not explain why interest rates need to be Moreover, as I have said, simply presenting a forecast to the public does not explain conclusion that a rate rise is required has been reached. On both grounds, publishing t does not enhance the transparency and clarity of the strategy.
The strategy we have chosen at the ESCB avoids this danger. Based on this strategy, the G Council will inform the public regularly of its assessment of the monetary, economic and situation in the euro area. Moreover, when policy decisions are made, the reasoning behind decisions - including the economic rationale according to which judgements have been made be communicated to the public. By presenting the analysis that is actually driving t decisions, the ESCB is being both clear - since this analysis is informative about polic and transparent - since the presentation to the public will reflect the type of discussi occur in the Governing Council itself.
## 2. Conclusion
In the present circumstances, the Governing Council has decided that following any mech policy rule to determine monetary policy in the euro area would be inappropriate. Puttin eggs in one basket' would be especially dangerous at the start of Stage Three, given the un that we face. Indeed, a mechanistic approach is unlikely to produce good policy decisions circumstances. To pretend otherwise to the public would be misleading and dangerous.
Nevertheless, the ESCB's monetary policy strategy must be clear and transparent if we convince the public of our commitment to maintaining price stability and our ability to must be seen to be operating in a solid and coherent framework that leads to consistent an monetary policy decisions.
The stability-oriented monetary policy strategy adopted by the Governing Council of the EC just such a framework. Having been designed to respect the principles of clarity and trans am confident that this strategy will be successful. By maintaining price stability in the ESCB will thus lay part of the necessary foundation for Europe's future economic stabi prosperity.