Christian Noyer: The stability-oriented monetary policy of the ECB
Luncheon speech by Mr Christian Noyer, Vice-President of the European Central Bank, at the
conference organised by HSBC CCF Securities, Paris, 6 September 2001.
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Ladies and Gentlemen,
I am very grateful for your invitation to speak today in Paris on the occasion of the forum organised by
HSBC. As a contribution to today's discussion of strategies, I should like to explain the design of the
monetary policy strategy of the ECB and how it helps the Governing Council of the ECB in its
monetary policy deliberations and the communication with the public. Then, I should like to discuss the
current monetary and economic situation and its implications for monetary policy. Finally, I would like
to give you some information on the introduction of the new banknotes and coins.
Let me turn to the monetary policy strategy of the ECB. The primary objective of the ECB is to
maintain price stability in the euro area. This objective has been chosen because price stability
supports higher living standards through a number of channels. It enhances the transparency of
relative prices and thereby fosters competition. Inflation risk premia that would be asked for by
investors in the presence of uncertainty about inflation are minimised. Firms and individuals do not
need to heavily invest in hedging against inflation and deflation, and thus can allocate their resources
to productive uses. In an environment of price stability possible distortions of tax systems are reduced.
The related improvement in the efficient allocation of production factors may help to enhance the
production potential of the economy. Also from a social point of view, inflation is not welcome. It leads
to a 'random' redistribution of wealth between economic actors, to the detriment of the most
vulnerable.
Since the start of 1999, the ECB applies its monetary policy strategy, which is centred around a
quantitative definition of price stability and the analysis of risks to price stability. This monetary policy
strategy has helped the Governing Council to derive and explain monetary policy decisions. It has
contributed a lot to the successful mastering of this task and has triggered academic debates whether
elements of this strategy should be introduced by other monetary authorities.
The key element of the ECB's policy framework is the precise quantitative definition of price stability. It
clarifies that the Governing Council aims to keep annual increases in the Harmonised Index of
Consumer Prices (HICP) for the euro area below 2%. Moreover, the Governing Council announced
that price stability according to this definition shall be maintained over the medium term. Thereby, it
provides the public with clear guidance for inflation expectations. In addition, the ECB's transparent
framework facilitates the process of accountability of the ECB by providing a yardstick against which
its performance can be assessed.
The statement that "price stability is to be maintained over the medium term" acknowledges the
existence of short-term volatility in prices, resulting from non-monetary shocks to the price level such
as the effects of indirect tax changes or variations in international commodity prices. There are good
economic reasons why monetary policy should be oriented towards the medium term. Monetary policy
affects prices with "long and variable lags", so that a policy of fine-tuning the economy is, in practice,
neither a viable nor a desirable option. It is evident that the ECB cannot be held responsible for
short-term shocks to the price level, since it has little control over them. Rather, assessing the
outcome of the monetary policy of the ECB over the medium term ensures a meaningful and genuine
accountability.
Having a well-defined goal is vital. In addition, the ECB, like any other central bank, also requires an
analytical framework which facilitates the achievement of this goal. The ECB's strategy recognises
that, in an environment of change and uncertainty, no single model or view of the world is likely to be
fully adequate to capture the ongoing economic processes and the implications for price stability.
The need to adopt a diversified approach to analysing and assessing information in an uncertain world
was a main reasoning behind the adoption of the ECB's two-pillar strategy. The distinct, yet
mutually-reinforcing perspectives of a complex and changing environment provided by the two pillars
are the best tools with which the ECB can distil and master the information relevant for monetary
policy-making.
Under the first pillar, the ECB assigns a prominent role to money. A broad array of aggregates,
ranging from M3 to its components and counterparts, notably credit, are analysed in order to assess
threats to price stability. Assigning a prominent role to money guarantees that the fundamentally
monetary origins of inflation will not be neglected in the analysis driving monetary policy decisions.
The prominent role of money is signalled by the announcement of a reference value of 41⁄2% for the
annual growth of the broad aggregate M3. This reference value defines the rate of growth of M3 which
is consistent with price stability over the medium term. The ECB has from the start explained that it will
not react mechanistically to deviations of M3 growth from the reference value. Rather monetary
developments always have to be analysed carefully in order to assess the information content they
have for future inflation. This is because the money - price link is in essence a medium-term
relationship, whereas short-term movements in monetary aggregates always have to be interpreted
carefully.
In parallel, a wide range of other economic and financial indicators is assessed under the second
pillar, in order to extract additional information which is not contained in monetary data, and to
cross-check the evidence obtained from assessing monetary developments. Analysis within this
second framework is intended to reveal the impact of a host of factors on price developments in the
short to medium term, such as wage developments, fluctuations in commodity prices and exchange
rates, confidence among consumers and producers, etc.
Under the second pillar, macroeconomic projections based on conventional models also play a role as
a tool for organising and summarising existing information. In the light of the ECB's commitment to
being a transparent institution, the ECB has published the Eurosystem staff macroeconomic
projections since last December. However, the analysis carried out under the second pillar does not
only involve the production of projections. The staff projections cannot, in practice, include the latest
developments in all economic indicators. It is therefore useful to monitor individual indicators in parallel
with producing the projections, not least because such analysis also provides an insight into the forces
driving the projections. Moreover, under the second pillar of the ECB's strategy, the Governing Council
also evaluates indicators of financial market expectations derived from financial yields and prices. The
Governing Council also looks at forecasts for the euro area produced by international organisations
and the private sector. All this information is assessed simultaneously by the Governing Council under
the second pillar, and is complemented by the monetary analysis under the first pillar.
In the discussions leading to its policy decisions the Governing Council systematically incorporates the
analyses conducted under both of the complementary pillars underlying the ECB's monetary policy
strategy. It should be regarded as a strength of the strategy that multiple frameworks are embodied
and the resulting need for decisions which are robust across different models of the economy
becomes obvious.
A good understanding of the ECB's monetary policy in public enhances the effectiveness and fosters
the credibility of the ECB's monetary policy. Experience collected over the time since the start of Stage
Three of EMU suggests that the anti-inflationary credibility of the ECB is high. Indeed, long term
inflation expectations have remained in line with price stability since early 1999.
Finally, let me briefly explain the Governing Council's assessment provided under the two pillars of the
ECB's monetary policy strategy.
As regards the first pillar, growth in monetary aggregates has somewhat picked up in recent months.
In the period May to July, the three-month moving average of M3 growth was 5.9%. However, this
figure needs to be corrected for the upward distortion related to non-euro area residents' holdings of
money market paper and short-term debt securities by non-residents of the euro area. According to
preliminary estimates, these factors explain around three-quarters of a percentage point of annual M3
growth. Furthermore, the recent move in this figure is driven very much by the effects on money
demand of some factors which are likely to remain temporary. First, the increase in the rate of growth
of M3 over the past few months reflects a relatively flat yield curve and the recent weakness in stock
markets, both of which made the holding of short-term deposits and marketable paper included in M3
attractive. Second, as it also reflects the fact that consumers needed a higher level of transaction
balances to finance the past rise in energy and food prices, recent increases in M3 growth may be
transitory and, hence, do not necessarily have implications for price stability in the medium term.
Lastly, the annual rate of growth of loans to the private sector, although still high, has continued to
decline over recent months.
As regards the second pillar, there are clear signals of lower inflationary pressure from the demand
side. Recent data on economic activity indicate that real GDP growth in 2001 will most likely be lower
than was expected a few months ago. The deceleration reflects both the global slowdown, which has
affected euro area exports, and weaker than expected consumption growth owing to losses in real
disposable income related to past increases in consumer prices. All these factors also had a negative
impact on investment. This notwithstanding, over time, the expected decline in consumer price
inflation, to which the strengthening of the exchange rate has contributed, should support the growth
of domestic demand. Further positive effects on euro area economic growth are expected from the full
impact of tax reductions in several euro area countries and the favourable financing conditions.
Turning to price developments, annual consumer price inflation in the euro area, as measured by the
Harmonised Index of Consumer Prices (HICP), declined to 2.8% in July, from a peak of 3.4 % in May.
A concern with regard to the outlook for price stability in the coming years has been the possible
emergence of second-round effects, via wages, on the current level of consumer price inflation. The
information available shows that wage moderation prevailed in the first quarter of 2001. At the current
juncture, two factors support the view that this downward trend will continue in future. First, the
slowdown in economic activity may contribute to containing inflationary pressure stemming from the
labour market. Second, there are encouraging signs, such as those coming from data on consumer
and producer prices, which confirm that the increase in consumer price inflation was temporary. In the
absence of further unfavourable price shocks, it is likely that price stability will be restored in the not
too distant future.
Against the background of lower inflationary pressure, the Governing Council decided on
30 August 2001 to lower the minimum bid rate on the main refinancing operations and the interest
rates on the marginal lending facility and the deposit facility by 25 basis points respectively. It
emphasised that it considers the new level of interest rates as compatible with the maintenance of
price stability over the medium term, which at the same time, is an essential contribution to creating a
favourable environment for sustainable economic growth.
At this juncture, let me also make some remarks about recent discussions on fiscal policy. For the
euro to be successful, governments need to adhere strictly to the Stability and Growth Pact and
achieve a budget position in balance or surplus. Under the present circumstances, the automatic
stabilisers should only be allowed to work fully in those countries whose budget positions have
achieved this sustainable level. Let me emphasise that a medium-term perspective is essential for the
conduct of fiscal policies in all euro area countries. Short-term discretionary measures aimed at
strengthening domestic demand risk having an unwelcome impact on the economy, not least on
account of time lags. In addition, if such measures are not consistent with the Pact, they may
undermine the credibility of the consolidation process.
Let me turn to the introduction of the euro. With the forthcoming introduction of euro banknotes and
coins, it is sometimes forgotten that Europe has had a single currency since 1 January 1999.
Therefore, let me recall that today most cash-less transactions in the euro area involve the euro as a
currency (with the exception of retail payments). The euro is present on all major financial markets
around the globe. Currency trading in euro has been going on for two and a half years. Shares are
denominated in euro on most European stock exchanges. The next and final step will be the
introduction of euro-denominated banknotes and coins on 1 January 2002.
The introduction of the new euro banknotes and coins is the final step which completes the creation of
the single currency. With this changeover, the considerable benefits of the single currency will become
apparent to European citizens. A natural advantage of the single currency is that it reduces transaction
and information costs in the euro area. It enhances the function of money as a medium of exchange
by lowering the costs typically associated with market transactions. Generally speaking, money is an
important component of any market economy. In a complex exchange economy, money is an
important means of achieving decentralised co-ordination between the plans and actions of economic
agents across time and space. The function of money as a medium of exchange is significantly
enhanced by enlarging the area in which a single currency is used as legal tender not least since this
eliminates exchange rate uncertainty within the currency area.
The introduction of the new euro banknotes and coins in the euro area, which comprises around
300 million citizens, is in many respects a huge challenge. First, the launch of the euro banknotes
requires an initial supply of about 14.25 billion banknotes - representing a value of around €641 billion
- to be available by a fixed deadline. Second, the banking sector, security carriers, retailers and the
cash-operated machine industry are closely involved in the preparations at an early stage, as a
smooth cash changeover can only be achieved in a short period of time by systematic and
co-ordinated interaction on the part of all the main participants. Third, the successful introduction of
euro cash is preceded by a goal-oriented information campaign to prepare the general public and
professional cash handlers in Europe for the new currency. The President of the ECB launched this
campaign on 30 August and at the same time presented the details of the new banknotes to the
public. This new currency which will be in some 100 days' time in our pockets, is our money, a tangible
reality and a symbol of European integration in every sense of the word. The euro banknotes are
produced with state-of-the-art security standards and combine many of the highly effective security
features already used in the national banknotes of the euro area Member States together with some
additional features. Finally, a series of legal and organisational measures is being taken to ensure
both a successful currency changeover and unimpeded circulation in the future. Production of the euro
banknotes started in July 1999. The euro banknotes are currently being produced by 15 different
printing works throughout Europe, including the printing works of a number of national central banks
(NCBs).
The role of the ECB can be described as that of a central co-ordinating, controlling and monitoring
body, focusing in particular on the timely production of the euro banknotes and on the organisation of
the changeover. Let me emphasise that both production and delivery of euro banknotes are on
schedule. In most countries frontloading and sub-frontloading of euro banknotes and coins has
already started and is well under way. Frontloading is the advance distribution of euro banknotes and
coins to those credit institutions that are counterparties for monetary policy operations within the
Eurosystem. Credit institutions can then sub-frontload euro banknotes and coins to professional
groups (retailers, cash-in-transit companies, the cash-operated machine industry) provided that certain
conditions are fulfilled. The most important condition is to guarantee that the euro banknotes will not
be put into circulation before 1 January 2002.
Thank you for your attention.