The primary objective and unambiguous mandate of the European
Central Bank (ECB) is price stability in the euro area. The ECB's
objective is to provide a stable environment that is supportive of
long-term growth rather than short-term fine tuning. Policy is made by
its Governing Council and implemented by its Executive Board, which
instructs national banks on actions to be taken. Given the uncertainty
of the future economic environment, especially with the introduction of
the euro as a common currency, it is important to rely a variety of
models and approaches and on judgemental appraisal. One pillar of this
approach is a focus on the relationship of inflation to monetary
aggregates. The second is more general analysis of macroeconomic
conditions. Combining these two pillars of monetary policy has been
successful in maintaining long-term interest rates consistent with price
stability.
The theme of this conference, "Monetary Policy and the
Markets" is of great interest to market participants endeavouring
to discern and assess central banks' policy directions and to U the
European Central Bank (ECB), which- since its creation almost three
years ago-has assigned a prominent role to transparency and openness in
its policymaking.
I will first elaborate on the institutional setup of the ECB and
its objectives. Against this background, I will then attempt to explain
the ECB's decision-making process as it is structured by our
monetary policy strategy.
The Institutional Setup and the Objective of the ECB
The body collectively responsible for monetary policy decisions in
the euro area is the Governing Council of the ECB, which consists of the
ECB's President and Vice-President, the remaining four members of
the Executive Board of the ECB, and the Governors of the national
central banks of those Member States that have adopted the euro as their
currency.
The Executive Board is responsible for the preparation of the
meetings of the Governing Council and for implementing the decisions the
Governing Council takes. In particular, the Executive Board instructs
the national central banks on the operations to be completed in
accordance with the Governing Council's directions, making sure
that the entire process develops in a consistent and fully harmonised
manner.
The treaty establishing the European Community assigned to the ECB
the maintenance of price stability in the euro area as the primary
objective and unambiguous mandate. Rooted in the long-standing
experience of the participating national central banks, there rests the
conviction that it is with the credible and lasting maintenance of price
stability that the ECB could best enhance the welfare of European Union
citizens. Given the uncertainties surrounding the monetary policy
transmission mechanism that arise from the complexity and the continuous
evolution of economic behaviour and institutional structures, the ECB is
ill-suited to fine-tune economic developments. Attempts to support
growth and employment by deviating from a monetary policy needed to
maintain price stability would prove detrimental over longer horizons,
thereby decreasing welfare and undermining the credibility of the single
monetary policy. On the contrary, by focusing on its mandate and
therefore avoiding either prolonged inflation or prolo nged deflation,
the ECB creates the stable environment in which appropriate structural
and fiscal polices may promote output potential effectively.
To support and safeguard the pursuit of price stability, the Treaty
endowed the ECB with a high degree of institutional independence, and in
order to ensure transparency and accountability, it imposed on the ECB
extensive reporting requirements.
The Definition of Price Stability
The complexity of the monetary policy transmission mechanism
requires that the preparation, discussion, and presentation of policy
decisions be placed in a coherent clarifying framework. This is the task
of the monetary policy strategy that is designed both to grant the
policy-making of the Governing Council a clear and consistent structure
and to provide the most suitable vehicle for communication with the
public.
The monetary policy strategy chosen by the Governing Council
ensures a comprehensive assessment of the economic situation, of the
size and nature of the shocks hitting the euro area, and of the related
risks to price stability.
The quantitative definition of price stability constitutes the
first feature of this strategy. The announcement of a numerical
definition has been devised to enhance clarity, anchor expectations, and
offer a yardstick against which the ECB can be held accountable. The
Governing Council defined price stability as "a year-on-year
increase in the Harmonised Index of Consumer Prices (HICP) for the euro
area of below two percent". The upper bound of two percent is in
line with the practice of participating national central banks before
the start of Stage Three of Economic and Monetary Union. It enables the
existence of a possible positive measurement bias in the HICP to be
taken into account and creates a "safety margin," which helps
ensure that negative rates of "true" inflation are avoided.
The headline HICP is the indicator chosen as the preferred measure
to quantify our primary objective because it is the homogeneous
statistic that most closely approximates the "true" basket of
private households' consumption in the euro area. While core
measures of inflation that exclude the most volatile items are also
regularly monitored for the purpose of a comprehensive analysis, the
headline HICP is the variable on which we focus as our objective. The
Governing Council also emphasised that price stability has to be
maintained over the medium term. This reflects the need for our monetary
policy to have a forward-looking, medium-term orientation. It also
acknowledges that short-term volatility in prices owing to non-monetary
shocks cannot be controlled by monetary policy and that monetary policy
should therefore only be held accountable for price developments over a
longer horizon.
It is important to recognise the role of the definition of price
stability in the conduct of monetary policy. The Governing Council
attempts to set the ECB's interest rates in a way that--conditional
on the available information -- maximizes the likelihood of maintaining
price stability in the euro area over the medium term.
The Two Pillars of the ECB's Strategy
It is widely acknowledged that central banks are called on to
operate in an environment characterised by substantial uncertainty, not
only with regard to current and future developments, but also concerning
the actual functioning of the economy. This is particularly true in the
context of the euro area where the regime shift entailed by the
introduction of a single currency may affect economic behaviour and
institutional structures. Under these conditions, it is crucial to
ensure that policy decisions be robust and all-encompassing. Therefore,
the ECB not only acts with a forward-looking orientation, but also
relies on a number of models and approaches as well as on a judgemental
appraisal.
The ECB designed a two-pillar structure for its strategy with the
objective of capturing and providing all of the relevant pieces of
information on the euro area economy for the assessment of the Governing
Council, thus enabling it to take its monetary policy decisions on the
basis of full information. The first pillar foresees a prominent role
for money, while the second envisages the analysis of a wide range of
other economic and financial indicators.
The ECB devoted the first pillar of its monetary policy strategy to
the appraisal of monetary developments and models that accord an
important role to monetary and credit developments. This recognises the
fact that inflation is ultimately a monetary phenomenon and allows
taking advantage of the stability that characterises the relationship
between broad monetary aggregates and the price level in the euro area.
As a form of visible public commitment, the ECB also announced a
reference value for the rate of growth of the monetary aggregate M3 that
is consistent with its definition of price stability.
The Governing Council regularly receives a comprehensive analysis
of current developments in monetary and credit aggregates. The
information revealed by the analysis of monetary developments has proved
until now to be an important and reliable guide for monetary policy
decisions.
Under the second pillar of its monetary policy strategy, the ECB
regularly monitors a broad set of non-monetary economic and financial
variables, such as wages, unit labour costs, fiscal policy statistics,
and financial market indicators like stock prices and exchange rates.
Most of this analysis focuses on cost pressures and on the interplay
between supply and demand in the goods and labour markets. It also helps
to ascertain whether shocks to the euro area economy and the resulting
risks to price stability have an external or domestic origin, are of a
temporary or permanent nature, and arise from the supply or demand side.
Within the framework of the second pillar, the Eurosystem staff also
produces macroeconomic projections that are published in the ECB Monthly
Bulletin twice a year.
The macroeconomic projections elaborated by the Eurosystem staff do
not represent the ECB's predictions of the most likely
macroeconomic outcomes. Rather, they are built on the assumption of
unchanged short-term interest rates and exchange rates of the euro. It
is important to recognise that the Eurosystem's projections are
produced on the basis of models that do not assign a relevant role to
money and that there is also a host of other economic and financial
indicators whose information could not be adequately conveyed by a
simple figure or a statistical range.
In its decision-making the Governing Council therefore assesses the
staff's projections together with all the other information under
the second pillar, in conjunction with the monetary analysis developed
within the first pillar. It is important to understand that the process
of monetary policy formulation of the ECB is not centred on any single
forecast or projection and thereby departs from the practice followed by
inflation-targeting central banks. The monetary policy decisions of the
ECB have not responded mechanistically in the past, and will not do so
in the future, to deviations of staff's inflation projections from
any numerical target. The Governing Council, moreover, does not take any
responsibility for the staffs projections which--as with forecasts
produced by other institutions--are regarded as just one of the inputs
into its deliberations. Given the uncertainty and different views about
the appropriate model of the economy, it would not be productive for the
Governing Council to produce its own single projection. The Governing
Council instead focuses directly on setting policy rates, taking into
account all information, and the uncertainty surrounding this
information, in such a way that price stability can best be maintained
over the medium term.
The robust and cross-checking assessment of information that
characterises our two-pillar strategy has provided the Governing Council
with the analytical support most suitable for the conduct of monetary
policy in the complex and dynamic euro area environment. It is in fact
with the pursuit of price stability under a forward-looking orientation
that the Governing Council can best safeguard and guarantee the
conditions for favourable economic development in the euro area.
The financial markets, well-known for their pitiless judgement,
have been confirming the credibility of our monetary policy. The
developments of long-term interest rates have in fact been in line with
our objective of maintaining price stability. This is not an
insignificant achievement, and we are committed to not putting it at
risk.
Presentation at the NABE Seminar on Monetary Policy and the
Markets, May 21, 2001.
Christian Noyer was appointed as Wee-President of the European
Central Bank (ECB) in 1998. After service in the French Navy; he has
held a number of positions relating to finance in the French government,
the most recent being Director at the Ministry for Economic Affairs,
Finance and Industry. He has also represented France in the European
Monetary Committee, International Monetary Fund, World Bank and other
organizations. He holds degrees in law from the University of Rennes and
the University of Paris, a diploma from the Institute of Political
Science, and has studied at the Ecole Nationale d'Administration.