## Mr Duisenberg evaluates the single European monetary policy
Speech by the President of the European Central Bank, Dr Willem F Duisenberg, a University of Hohenheim, Germany, on 09/02/99.
## Ladies and gentlemen,
The single European monetary policy has been a reality for a little more than five we years of intensive preparatory work and successful economic convergence, monetary po now jointly determined for a large part of Europe by the Governing Council of the E Central Bank. The monetary policy is implemented by the Eurosystem, the name given t ECB and the 11 central banks of the EU Member States participating in Monetary Union.
The single currency is quoted on the international financial markets and is used i payments. However, the euro will not appear as yet in tangible form as banknotes an Nonetheless there is no doubt that this currency, which was only brought into exist January 1999, will play an important role both within the euro area and beyond.
There is good reason for this confidence, ladies and gentlemen. Overall the first went smoothly for the single currency and the monetary policy of the Eurosystem. Th did not pass by entirely without a hitch - which was not to be expected in any case, significance and scale of this project - but there were no major complications.
Monetary Union is a unique and outstanding achievement. It provides the great opport achieve the goal of lasting price stability throughout Europe. Price stability contribution that monetary policy can make to lasting economic and employment grow Europe. The national governments and all those involved in collective wage bargain being called on to remove the structural causes of the excessively high unemployme can only hope that the introduction of the euro will spur the implementation of reforms.
## The stability-oriented monetary policy strategy of the Eurosystem
The Treaty establishing the European Community assigns the European System of Cen Banks (ESCB) and thereby the Eurosystem the primary objective of maintaining p stability. The Governing Council will do its utmost to fulfil this task and to monetary policy so as to be comprehensible to the general public. For this reason developed a stability-oriented monetary policy which essentially consists of th elements.
The Governing Council has published a quantitative definition of its primary object stability. This gives clear guidance for expectations in relation to future price d Price stability is defined as an increase in the Harmonised Index of Consumer Price of the euro area of less than 2% compared with the previous year. The publication definition provides the public and the European Parliament with a clear benchmark which to measure the success of the single monetary policy, and thereby provides transparency and accountability of the Eurosystem and its policy.
The wording 'less than 2%' clearly defines the upper limit for the measured infla which is compatible with price stability. I do not think I need emphasise that defl
sustained fall in prices - would be incompatible with price stability. The latest availa for the annual rate of inflation according to the HICP for the euro area as a whole fall the definition of price stability. This outcome is clearly the result, above all, of the monetary policy of the national central banks in the years before the start of Monetary Un
The ECB has only been responsible for monetary policy for a little more than one month. will only be possible to judge the success of its current policy in one to two years' ti reflects the fact that the transmission of monetary policy impulses is subject to relativ and variable time lags. The Governing Council has therefore emphasised that price stabi must be maintained in the medium term. This statement underlines not only the need for forward-looking approach to monetary policy, but also takes into consideration the shortvolatility of prices in response to non-monetary shocks which are beyond the control monetary policy.
In order to achieve the goal of price stability, our strategy rests, in particular, on tw Before I explain this in more detail, I should like to emphasise that traditional and pr established macroeconomic relationships could change as a consequence of the introducti of the euro. This was one key reason why neither a monetary targeting nor a direct infl targeting strategy could be applied. Our strategy is also more than just a simple combin of these two approaches. Rather, it is precisely tailored to the needs of the ECB.
The first pillar of the monetary policy strategy is a prominent role for money. Since in is ultimately a monetary phenomenon in the medium term, the money supply provides a natural 'nominal anchor' for a monetary policy geared to safeguarding price stability. emphasise this prominent role, the Governing Council has published a quantitative refere value for growth in the money supply. The first reference value decided upon by t Governing Council for growth in M3 was 4.5% per annum and was published on 1 December. This value is based on the above-mentioned definition of price stability and assumes a growth in real gross domestic product of 2-2.5% per annum, as well as a medium-term reduction in the velocity of circulation of M3 of around 0.5-1% per annum.
We shall not, however, respond mechanistically to deviations from the reference value money supply growth, but shall first analyse them carefully for signals relating to futur developments. Larger or sustained deviations normally signal risks to price stability.
The second pillar of the monetary policy strategy consists in a broadly based assessment o outlook for price developments in the entire euro area. This assessment will be based broad range of monetary policy indicators. In particular, those variables which could co information on future price developments will be analysed in depth. This analysis should only provide information on the risks for price development, but should also help to id the causes of unexpected changes in important economic variables.
Some commentators reduced this comprehensive analysis to an inflation forecast. At the sa time, there were demands for the ECB to have to publish these forecasts in order to satis need for transparency and accountability. Therefore allow me to make this clear: our str includes a comprehensive analysis of numerous indicators and several forecasts. To focus single official inflation forecast of the Eurosystem for a specific point in time would i accurately reflect our internal analytical and decision-making process. It would impinge the transparency and clarity of the explanation of our policy. The publication of an o inflation forecast would also be inappropriate with regard to the accountability of the E
the more so if this forecast were based on the assumption of no change in the moneta The success of the monetary policy of the ECB should primarily be measured in terms maintenance of price stability, not the accuracy of its conditional forecasts.
The stability-oriented monetary policy strategy of the Eurosystem, which I have just constitutes a new and clear strategy. It emphasises the primacy of the goal of price takes into account the inevitable uncertainties concerning economic relationships i the transition to Monetary Union and the associated systemic changes and guarantees degree of transparency.
## Ladies and gentlemen,
Allow me to comment on certain suggestions on the orientation of monetary policy have recently appeared in the press. Some of these ideas give the impression that policy should concentrate upon objectives other than price stability, since stable already been achieved. Inter alia, it has been suggested that the ECB should react m mechanistically to exchange rate developments or other variables such as unit labo Furthermore, there were calls for monetary policy, by means of reductions in interes be used to combat unemployment. Against this background there is a need to set out the possibilities and limitations of monetary policy.
Both the reasoning in the Maastricht Treaty and many economic analyses show that th contribution the single monetary policy can make to employment growth is to concentr price stability. Without such a clear approach there is a danger that the public m the commitment of the Eurosystem to the goal of maintaining price stability. expectations, risk premia and thus long-term rates would rise. This would increase t the investment which is necessary for a sustained and lasting rise in the standard of
Even under the best possible circumstances, though - i.e. if it proves to be possib lasting price stability - monetary policy alone cannot solve the major economic pro unemployment and future problems in social security systems.
The Governing Council regards the current high level of unemployment in the euro ar matter of great concern. This problem is, however, predominantly a structural one. It the result of the rigidities in the labour and goods markets in the euro area which partly through an excessive and disproportionate degree of regulation. Structural reforms, which target the reduction of rigidities, are the appropriate solution. I area countries in which such reforms have been implemented unemployment figures h declined markedly. In addition, I should like to emphasise that moderate wage devel and a reduction in the burden of tax and social security contributions would genera reduce unemployment. This would be the case even if the country concerned did not heavily with its neighbouring countries. The positive influence of low taxes and employment clearly has overall benefits from an international perspective. Such should not be denounced as 'wage dumping'.
Turning to the role of exchange rates between the euro and other important currencie the EU, in particular the US dollar, the Eurosystem has, in formulating its moneta strategy, made an unambiguous choice. This strategy clearly rules out explicit o objectives or target zones for the euro exchange rate. The pursuit of an exch objective could easily jeopardise the maintenance of the objective of price stabilit
thereby also be detrimental to real economic development. Target zones for exchange ra could, for example, lead to the ECB having to raise interest rates in a recession, increasing downward pressure on prices. I am sure you will agree that such a mechanis response to a change in the euro exchange rate would not be optimal. Furthermore, it important to remember that we are living in a world with high capital mobility. Exchange agreements, which might have been possible to implement until recently, are no long feasible.
The lack of an exchange rate target does not mean that the ECB is totally indifferent takes no account of the euro exchange rate. On the contrary, the exchange rate will observed and analysed as a potentially important monetary policy indicator in the contex the broadly based assessment of the outlook for price developments. A stability-orie monetary and fiscal policy, as stipulated by the Maastricht Treaty and the Stabilit Growth Pact, is an essential pre-condition for a stable euro exchange rate. Of course, t no guarantee of lasting exchange rate stability, not even in a fixed exchange rate r Exchange rate fluctuations are often caused by structural or fiscal policy, asymmetric shocks or conjunctural differences. Monetary policy would clearly be overburdened if it ha prevent such movements in the exchange rate.
We cannot and shall not gear our monetary policy towards a single variable, whether a mon supply aggregate, an index, the exchange rate or an inflation forecast for a particular time. Nor can we be involved in any ex ante co-ordination which would entail an obligatio react to particular commitments or plans. The ECB will always carefully analyse all rele indicators. In this context, it is particularly important that the economic causes of risks to price stability in the euro area are understood as fully as possible. App monetary policy decisions also depend upon the causes of unexpected changes in importan economic variables. The Governing Council must, for example, take a view on whether changes in important indicators are of a temporary or permanent nature, and whether demand or supply shock is involved. In our deliberations we also attempt to take into ac how the financial markets, consumers and firms are expected to react to monetary poli decisions. I believe few would contest that such a complex analysis cannot meaningfully reduced to a more or less mechanistic reaction to a few variables or a single official fo
In addition, concern was often expressed that the Eurosystem would not act transparen enough. In this context, it was said that a transparent monetary policy also necessita publication of the minutes of the meetings of the Governing Council and disclosure of voting behaviour of the individual members of the Council.
For sound reasons the Governing Council decided not to adopt this approach. The publicati of individual positions could easily lead to national influence being exerted ove individual Council members. The members of the Governing Council must not, however, be seen as national representatives. They decide together on the monetary policy for the eur as a whole. The Governing Council has committed itself to go beyond the reporting an explanatory requirements laid down in the Treaty, which are among the most comprehensive requirements by international standards.
On the basis of our strategy, after every first meeting in the month I deliver to the detailed explanation of our assessment of the overall economic situation and, in particul outlook for price stability. The content of this so-called 'introductory statement' is ve to what other central banks refer to as minutes. In this way, the public receives compreh
information immediately following the meetings of the Governing Council. In additio month we shall publish a detailed report on the economic situation and monetary throughout the euro area in our Bulletin. Such rapid information on the results of t of the Governing Council and the current economic analysis of the ECB without demonstrates a high degree of openness and transparency.
## The most recent monetary policy decisions and operations
Co-operation between the European central banks was always very close. In the la months of 1998 the countries participating in the third stage of Monetary Union comore and more closely. The co-ordinated reduction in leading rates at the begin December 1998 clearly showed that the currency union had begun de facto before the s Stage Three. This co-ordinated measure contributed substantially - as we now know stabilisation of market expectations.
For more than five weeks the ECB has been conducting monetary policy operations, main the form of reverse open market operations. The main operation will be carried weekly frequency with a maturity of two weeks. So far, five such operations hav conducted successfully, at a fixed interest rate of 3%.
Besides the reverse transactions which constitute the main instrument for liquidity targeting interest rates, the Eurosystem offers two 'standing' facilities: the marg facility and the deposit facility. These can be accessed by credit institutions via central banks. The marginal lending facility is primarily a safety valve for short-t shortages in the banking system and thereby limits upward movements in money market To some extent, its counterpart is the short-term deposit facility, which is use short-term liquidity surpluses. This forms the lower limit for money market rates. F of Monetary Union the interest rate on the deposit facility was set at 2% and the marginal lending facility was set at 4.5%.
As a transitional measure, the Governing Council decided to establish a narrow cor 2.75-3.25% between the rates on the marginal lending facility and the deposit facil to 21 January 1999. The intention was to facilitate the necessary adjustment to institutional environment brought about by the transition to Stage Three. As announced, on 21 January 1999 it was decided to return to the rates on the two 's facilities that were set for the start of the single monetary policy. Since 22 J therefore, the rate on the deposit facility has been 2% and the rate on the margi facility has been 4.5%.
A critical factor in this decision was the behaviour of the money market for the eur whole since the beginning of the year. The Governing Council established that over t had been a marked reduction in the difficulties experienced by some market participa the introduction of the integrated money market and, in particular, with cross-borde flows. All in all, the integration of the money market in the euro area reached a stage only three weeks after its implementation. In analysing the money market it s noted that, inter alia, there can be a marked difference between ECB interest rates term market rates. On the one hand, market rates may include credit risk premia an other, expectations may lead to differences between the two rates.
At its meeting last Thursday the Governing Council confirmed its earlier assessment of outlook for price stability. Therefore it was decided to leave the conditions for the ne refinancing operations, on 10 and 17 February 1999, unchanged. They will be carried out volume tenders at a fixed rate of 3%, the same conditions as for the last such monetary operations.
In addition, in recent weeks the first longer-term open market operations were conducted the form of reverse transactions. These were carried out on 14 January 1999 in three pa tender procedures with maturities of one, two and three months. The fixed rate ten procedure was used. By contrast with the regular main refinancing operations, the Eurosys does not use these longer-term operations to send signals to the market and therefore us acts as a price-taker. The ECB thus gives advance indication of the planned allocation. interest rates which arise from these monetary policy operations should therefore be se indicators of prevailing market conditions.
## Regular assessment of the monetary, financial and economic situation
To conclude, I should like briefly to report on the Governing Council's current assessme the monetary, financial and economic situation. On the basis of these assessments Governing Council decided last Tuesday to leave interest rates unchanged.
Taking into account the latest monetary data for December 1998, the three-month moving average of the 12-month growth rate of the monetary aggregate M3 (for the period fro October to December 1998) remained more or less stable at 4.7%. This value is very close the reference value set by the Governing Council. According to our analysis, the evoluti the money supply shows no risks to price stability. Credit to the private sector als strongly in December last year. Although at present we do not perceive any inflation signals, further developments will be very carefully monitored.
With regard to the broadly based assessment of the outlook for price developments and risks to price stability in the euro area, monetary and financial developments can be s indicate a favourable assessment of the latest monetary policy decisions of the Eurosys They indicate that market participants expect a continuation of the environment of p stability. Long-term rates fell to new historical lows at the beginning of 1999 and there overall downward shift in the yield curve. Therefore, financing conditions for investmen currently exceptionally favourable.
At present the growth prospects for the euro area are, however, still marked by uncertainties relating to the development of the world economy in 1999. These uncertain have had a negative impact on indicators of the economic climate in the euro area. There widespread expectations of an economic slowdown in the near future. This deterioration in external economic environment can be linked, above all, to the financial crises in Asia, and Latin America. However, there is a mixed picture. While the growth rate for indust production fell up to November 1998, retail sales figures and consumer confidence ha recently shown positive trends. Furthermore, growth in real gross domestic product in the area was relatively robust in the third quarter of 1998. In the United States real growt fourth quarter actually turned out higher than expected. Measured against the HICP, consu prices in the euro area rose by 0.8% in December 1998. This is a tenth of a percentage lower than in November. This development is in line with earlier trends. It can be link
particular, to a further decline in energy prices and a weakening in price increases goods.
All in all, the above-mentioned economic development and the available forecasts for not indicate any noticeable upward or downward pressure on prices. Potential upwar could arise from a change in the external global economic situation and any associat on the euro area, via import and producer prices. These developments must be ca monitored. There is concern that inflationary pressure might develop in the event o increase in wage prices and an easing of fiscal policy. Developments in the exchange also be closely monitored in view of their significance for price developments.
Finally, let me emphasise that the current level of real interest rates is excepti real interest rates are taken simply as the difference between nominal rates and increase in consumer prices (HICP), short-term real interest rates in January 1999 2.3%, i.e. around 80 basis points lower than one year ago. Long-term real rates ha even more, by 110 basis points, and stood at 3% in January. These levels are ve compared both with other countries and with historical data. In line with the safeg price stability, the current monetary and financial conditions thus clearly sup economic growth. Monetary policy can do no more than this without jeopardising the overall economic advantages of price stability and its own credibility.
Real structural reforms which increase the flexibility of the labour markets, as continuation of the moderate increase in wage prices, would not only ease the bu monetary policy but would also support employment growth. This will be all the more the deterioration in the economic situation this year is worse than expected owi negative aspects of the external economic environment.