Transcript Eurosystem monetary policy strategy

The Eurosystems’ monetary policy
strategy
Maarten Hendrikx
Economics & Research Division
Monetary Policy Department
Operational Monetary Policy Seminar
De Nederlandsche Bank
April 11, 2006
Outline for this presentation
1. The European System of Central Banks
2. Monetary policy strategy of the eurosystem
3. Monetary policy in practice
The European System of Central Banks
(ESCB)
• Treaty on European Community and Statute of ESCB
• ESCB: ECB + NCB’s of EU-member states
• Eurosystem: ECB + 13 NCB’s of EMU-member states
• Every first Thursday of the month: monetary meeting of
the Governing council: ECB Executive board (6) +
Governors of EMU NCB’s (13)
Goal of ESCB: price stability
(art. 105 EU-treaty)
• “The primary objective of the ESCB shall be to maintain
price stability”
• “Without prejudice to the objective of price stability, the
ESCB shall support the general economic policies in the
Community [….]”
• These include: i) a high level of employment, and ii)
sustainable and non-inflationary growth
• So: growth and employment are secondary to price
stability!!
Why is price stability
the primary objective?
• Low and stable inflation enhances prosperity and
potential economic growth
• In the long-run: monetary policy will only influence
inflation and cannot influence the real economy (growth
and employment)
• In the short-run: a trade-off exists, but too much
emphasis on economic growth led to large policy
mistakes in the past (stagflation in the 1970s)
Political independence of the ESCB
(art. 108 EC-treaty)
• “When exercising the powers and carrying out the tasks
[…], neither the ECB, nor an NCB, nor any member of
their decision making bodies shall seek or take
instructions: i) from Community institutions or bodies, ii)
from any government of a Member State, or iii) from any
other body”
• Community institutions, bodies and governments respect
this principle, and do not seek to influence the decision
making bodies of the ECB or NCBs
Policy instrument:
short term interest rate
•
•
The instrument ultimately affects the goal: a change in
interest rates influences the price level. This is
“monetary transmission”.
Various transmission channels. Some examples:
• Through bank lending rates,
• asset prices,
• exchange rates,
• (inflation) expectations,
 real economy (consumption/investment/net exports)
 price level
However: the effect of interest rate
instrument is uncertain
• Monetary transmission is uncertain: long, variable and
uncertain time lags after an interest rate change. 
monetary policy should be forward looking!
• Moreover: the economy is uncertain too! Continuously
subject to shocks.
• Inflationary  oil price or euro exchange rate
• Economic  world trade, share prices
• “Monetary policy is an art, not a science”?
• Monetary policy strategy is necessary
Eurosystem monetary policy strategy (I):
definition of price stability
• Quantitative definition
• “a year-on-year increase in the Harmonised Index of
Consumer Prices (HICP) for the euro area of below 2%”
• ECB: aim at below but close to 2%
• Pursue over the medium term
• Definition: enhances credibility and anchors inflation
expectations.
• Adds to transparency and accountability of the ECB.
Eurosystem monetary policy strategy (II):
two-pillar framework
• Analyse economic developments, in order to assess
risks to price stability. On the basis of two analytical
perspectives, or “pillars”
• Economic pillar: risks to price developments on short to
medium term. Mostly real economic indicators and
financial developments
• Monetary pillar: based on medium to long run relation
between monetary developments and inflation
• Cross check
Economic pillar
• All economic developments that are relevant for price
stability in the medium term
• For instance: inflation, economic growth, labour market,
exchange rate, etc. etc.
• Analytical framework: bring these developments together
in a macroeconomic model and make projections
(BMPE)
• Projections are important, but not all-encompassing
Monetary pillar
• In the long run, an increase in money supply leads to a
higher price level
• Reference value for the growth of money supply (M3):
4,5% a year.
• On the basis of inflation (2%), potential growth (2-2½%)
and decreasing money velocity (½-1%)
• Do not apply mechanically, but assess underlying
developments (for instance credit growth)
Conclusion parts 1 & 2:
• ESCB has price stability as primary goal
• ESCB uses the interest rate as an instrument to achieve
this goal
• This is difficult, due to uncertainty in the economy and in
monetary transmission
• Monetary policy strategy: quantitative target for price
stability, in combination with analysis in two-pillar
strategy
• Governing council decides every month on interest rates,
on the basis of this analysis
Part 3: monetary policy in practice
• How do analysis and discussions on monetary policy go
in practice?
• Short overview of recent developments regarding
inflation, business cycle and monetary developments in
the euro area
• Implications for current monetary policy
Economic pillar (I): Inflation
Economic pillar (II): Inflation
Economic pillar (III): exchange rate
EUR exchange rate
Nominal effective and vis-à-vis the USD
120
1.5
110
1.3
100
1.1
90
0.9
80
1990
0.7
1995
Nominal effective
2000
2005
USD/EUR (rh-axis)
Economic pillar (IV): GDP-growth
Economic pillar (V): business-cycle
Economic pillar (VI): Taylor-rule
Monetary pillar (I): M3 and credit growth
"Money-gap" in the euro area
Credit growth euro area
Percentage annual increase
Percentages M3 (3-mth averages)
15
25
20
10
15
5
10
0
5
-5
0
-10
-5
99
00
01
02
Government
03
04
05
06
Other residents
07
97 98 99 00 01 02 03 04 05 06 07
Nominal gap
T/m feb 2007. Baseperiod: december 1998
Real gap
Monetary pillar (II): House prices
20
15
10
5
0
-5
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Eurogebied
Duitsland
Frankrijk
Italië
Spanje
Interest rate decision
Policy interest rate
In percentages
6.0
5.0
4.0
3.0
2.0
1.0
0.0
95
96
97
98
99
00
01
02
03
04
ECB Policy interest rate (minimum bid rate)
05
06
07