Jean-Claude Trichet: The current state of the European economy and the
ECB's monetary policy concept
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, at the International
Financial Forum, Paris, 9 July 2004.
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Mesdames et Messieurs, ladies and gentlemen,
Présent aujourd'hui à Paris, je souhaiterais remercier le Président Mestrallet et les équipes
d'Europlace pour la tenue de ce Forum Financier, témoignant une nouvelle fois du dynamisme de la
place de Paris tant en France qu'à l'étranger. J'ai pu moi-même le constater à plusieurs reprises,
notamment lors des Journés d'Europlace à New York.
I am very honoured to have been invited here on the occasion of the International Financial Forum. I
would like today to talk about two topics of obvious importance for the ECB. First, I will make some
remarks on the current state of the euro area economy. Second, I will make some more general
remarks on the monetary policy concept of the ECB.
The current state of the euro area economy
Overall, the latest data releases confirm that the economic recovery in the euro area is continuing.
Quarterly real GDP growth in the first quarter of this year was 0.6%, slightly higher than what had been
expected earlier this year. For the second quarter of this year, the latest indicators of output and
expenditure, as well as the most recent survey data, remain consistent with ongoing growth in real
activity, with the working assumption of a gradual recovery.
Looking ahead, we remain confident that the recovery of economic activity will continue. Indeed, the
conditions for a broadening and strengthening of the recovery are in place. Starting with external
developments, economic growth outside the euro area remains strong and this should promote euro
area exports. As regards domestic developments, investment should benefit from the positive external
environment and the favourable financing conditions within the euro area. As corporate restructuring
gathers pace and business efficiency advances, improved profitability should underpin business
investment. As regards private consumption, its recovery should proceed in parallel with increases in
real disposable income and the gradual strengthening of employment growth.
This picture of the euro area economy is broadly in line with all available forecasts from international
and private organisations. In addition, it is worth stressing that financing conditions in the euro area
are very favourable, supporting the ongoing gradual economic recovery in the euro area.
I should note that this scenario of an ongoing and further progressing economic recovery is subject to
some risks - in both directions. On the upside, euro area economic growth in the first quarter of this
year was stronger than anticipated and this momentum may strengthen shorter-term dynamics.
Ongoing robust growth in the global economy could also lead to stronger than expected activity in the
euro area. On the downside, although oil prices have declined somewhat recently, they remain at high
levels and may dampen growth, mainly through their impact on the euro area's terms of trade.
Considering longer horizons, concerns also remain with regard to the persistence of global
imbalances.
Turning to price developments, when assessing risks to price stability at the current juncture it is
essential to distinguish between short-term developments and the medium-term trend. Over the short
term, oil prices continue to exert upward pressure on the general price level. According to Eurostat's
flash estimate, annual HICP inflation was 2.4% in June, following 2.5% in May. Although oil prices
have fallen over the last few weeks, markets expect them to remain high for some time to come. If this
were to occur, inflation rates would most likely remain above 2% for longer than was expected this
year and, possibly, in the first half of next year.
Looking beyond the short term, however, the main scenario for medium-term inflation remains
consistent with price stability. This scenario is based on the assumption that wages will continue to
develop moderately at a time when unemployment is still high. However, there are some upside risks
to this scenario. The strength of global economic growth may continue to exert upward pressure on
commodity prices, including oil prices. Moreover, on the domestic side, indirect taxes and
administered prices have been subject to rather strong increases in the recent past and their future
evolution is uncertain at this point in time, since such information usually becomes available only later
in the year. In addition, measures of long-term inflation expectations derived from financial market
indicators remain relatively high. While such measures always need to be interpreted with caution,
their development calls for particular vigilance.
Against this background, the potential risk of second-round effects via wage and pricing behaviour
needs to be monitored closely. In this respect, I should stress again the important contribution that
social partners can make to facilitating the maintenance of price stability by focusing on the
mediumterm outlook for price developments. Certain upside risks to price stability are also indicated by the
monetary analysis. Although annual M3 growth rates have fallen over recent months, there remains
substantially more liquidity in the euro area than is needed to finance non-inflationary growth. While a
significant part of the excess liquidity has accumulated as a result of past portfolio shifts, low interest
rates have also fuelled the build-up of liquid assets. The low level of interest rates also supports credit
growth. The stock of excess liquidity, if it persists, may pose an upside risk to price stability over the
medium term. The monetary analysis therefore supports the case for continued vigilance with regard
to the materialisation of upside risks to price stability.
All in all, we are confident that the outlook remains in line with price stability over the medium term. We
therefore left the ECB interest rates unchanged at our last Governing Council meeting. We remain
vigilant as regards all developments which could affect risks to price stability. Confidence and vigilance
is the best summary I can offer of our present attitude.
Let me also mention that we all have our own, important responsibilities - on both sides of the Atlantic.
Here in the euro area we of course take our decisions on the basis of our responsibilities and
depending on our own analysis of the situation. Europe is Europe and the United States is the United
States. They had good reasons to increase rates and we had good reasons to keep rates unchanged.
Let me also make a few remarks on fiscal policies in the euro area. At present the institutional
framework of public finances in Europe is at a critical juncture. If we are to safeguard the soundness of
public finances over the long run we cannot afford to weaken the existing institutional framework. In
this respect, we observe current discussions on reforms of the Stability and Growth Pact very closely.
In our view, there are no reasons to change the letter of the Pact, although we do not deny that its
implementation could be improved further, in particular as regards the analysis of structural fiscal
balances.
The current economic recovery offers the opportunity to put public finances on a sounder track.
Credible and resolute fiscal consolidation efforts are essential for strengthening confidence in the short
term and therefore economic growth prospects in the medium term. I refer here to the neo-Ricardian
effects of fiscal consolidation, as opposed to the well-known Keynesian effects.
The ECB's monetary policy concept
I would now like to turn to the second part of my remarks, the monetary policy concept of the ECB.
Devising a monetary policy for the Eurosystem at the outset of Stage Three of EMU was one of the
challenges we were confronted with in the process of creating a new and common currency for the
people of Europe. The monetary policy strategy of the ECB was announced in October 1998. We
aimed to build on the wisdom and the wealth of experience with the conduct of monetary policy that
had been accumulated in the preceding decades by central banks and academic institutions in
industrialised countries, in particular those forming the euro area, to devise the best possible monetary
policy for the new currency.
Transparency of the ECB's monetary policy
One of the principles that has transformed the practice of central banking in recent decades is its
pursuit of a high level of transparency in all aspects of monetary policy. This includes the setting of
clear benchmarks for accountability, the announcement of unambiguous objectives to the public, and
the timely release of relevant information and the contents of monetary policy deliberations.
The ECB has played a leading role in this general trend. It has in fact set standards of transparency in
the practice of monetary policy. We were the first large central bank, and remain the only one, to hold
press conferences in which we give the public a detailed account of the Governing Council's monetary
policy diagnosis immediately after our monthly monetary policy meetings, in real time. The introductory
statement opening our press conference consists of an extended summary of the deliberations of the
Governing Council in which the situation is assessed and our diagnosis expressed. Moreover, the
press conference allows a transparent interaction with participants and, through them, with the full
body of observers, savers and investors. In addition, the ECB's Monthly Bulletin provides the public
with the full set of assessments and data underlying policy decisions only a few days after they are
taken.
The ECB is one of most transparent central banks in the world and has helped to define "the state of
the art" of central banking in this domain. The only area in which we prefer to remain cautious is in
revealing the voting behaviour of individual members of the Governing Council. We have reasons for
that.
First, we want to communicate clearly to the public that the entity which decides is not a personality or
a group of personalities but a college, a united team which benefits fully from the collegial wisdom.
Second, we do not want in any respect to take the risk of giving credit to the idea that the ECB is a
place of confrontation between various national interests, represented by various nationalities and
various national central bank governors. The Maastricht Treaty asks all of us to decide in the interest
of the euro area as a whole and to forget about reasoning on the basis of a national vision. Our
present concept is fully in line with this very important Treaty instruction. Let us not forget that, from
this standpoint, we are in a very different situation to that of the United States or the United Kingdom.
There is no central bank governor in the United States or the United Kingdom equivalent to the
Governing Council. The United States is not made up of twelve sovereign states sharing the same
currency.
Third, we publish our diagnosis in real time and we provide a press conference so that all the
arguments that have led us to our decision are known in full by the public.
Finally, empirical works - in particular by Artus and Wyplosz - have shown that we have been highly
predictable in our decisions - even more than some other very influential central banks. This
demonstrates that our present concept does not in any respect undermine predictability, which is one
of the major ultimate goals of transparency.
Let me now focus on some elements of our monetary policy concept. To start with, I would like to
stress something which is essential in order to understand all that we have done over the past five
years: we were asked to deliver a new single currency that would be at least as good as each and
every national currency. It was a solemn promise made to 306 million fellow citizens of Europe. It was
the necessary fundamental feature of a smooth transition to the euro. Had this promise not been met,
quite a number of people in Europe would have seen their market interest rates rise at the moment of
transition, and they would have rejected it. So it was undoubtedly necessary. But, at the same time, it
was also extraordinarily demanding. It was extraordinarily demanding because it called for the euro,
from day one, to be as credible, as confidence-inspiring and as good a store of value as the best
national currencies were before the introduction of the euro. And this had to be attained, not only on a
short-term basis, but also on a five-year, ten-year, thirty-year basis...
We succeeded in delivering, to the benefit both of the euro and of 306 million fellow citizens, the best
yield curve available in the euro area before the euro was introduced. This extraordinary success,
which most observers, economists and market participants were not predicting a few months before
the transition, can be attributed to the credibility of the ECB and the Eurosystem, and their
decisionmaking processes, as well as to the pertinence of the monetary policy concept devised by the ECB
before the introduction of the euro.
When judging our monetary policy concept one should never forget that it has passed the most
extraordinary test that one could imagine: that of the introduction of a new currency without any past
record, from day one, at the highest level of medium and long-term credibility and at the lowest level of
medium and long-term market interest rates.
It is my belief that each particular feature of our monetary policy concept was a necessary condition for
the success of the transition and that, all together, they created the necessary conditions for that
remarkable success. This is true, in particular, of two crucial elements of our monetary policy concept:
the focus on price stability as the primary objective of monetary policy and the need to provide the
public with a clear framework for the assessment and communication of the risks to price stability.
The objective of price stability
The basis for our strategy is the ECB's mandate that the primary objective of monetary policy should
be to maintain price stability. This mandate, which mirrors the mandates of a very large majority of the
EU national central banks before 1999, is enshrined in the Maastricht Treaty, which was signed by all
governments of the European Union and ratified by all the parliaments. It has been mentioned in the
appropriate place in the Constitution just approved at the end of the term of the Irish Presidency.
Price stability enhances the efficiency of the market system in allocating resources. It is associated, in
particular, with lower uncertainty and risk premia in financial markets. This facilitates financial
transactions and ultimately implies lower medium and long-term interest rates, fostering investment.
Maintaining price stability is the contribution of monetary policy to sustainable growth and job creation.
Price stability also makes an important contribution to attaining social cohesion.
The ECB's definition of price stability
In order to make the Treaty mandate operational, and to enhance the transparency of the policy
framework and thereby the accountability of its monetary policy, the Governing Council of the ECB has
provided a quantitative definition of price stability. Price stability has been defined as a year-on-year
increase of below 2% in the Harmonised Index of Consumer Prices (HICP) for the euro area as a
whole. By referring to increases in the HICP it was made clear that deflation is excluded from the
definition of price stability.
The May 2003 clarification: "HICP inflation below but close to 2%"
At the same time, we felt the need to convey even more clearly to the public that the Governing
Council does not view all positive inflation rates of below 2% as equally desirable. On 8 May 2003 we
made it clear that, in order to fulfil its price stability objective, the Governing Council aims to maintain
HICP inflation below but close to 2% over the medium term. This was fully in line with our past practice
and with medium-term market expectations. Thus, the announcement did not change inflation
expectations.
The main argument for maintaining a low positive rate of inflation is that it helps to reduce to very low
levels the probability that nominal interest rates will approach their lower bound of zero. Obviously, the
likelihood of nominal interest rates hitting the zero lower bound in the euro area is rather remote. This
notwithstanding, introducing a preventive margin for inflation rates is advisable, not least since
available evidence indicates that even a relatively small safety margin for inflation rates above zero is
sufficient to largely eliminate concerns that the zero lower bound for nominal interest rates will become
binding.
There are other arguments for aiming at positive rates of inflation, such as the possibility of
measurement bias in the price index and the inflation differentials in the euro area. Overall, our
assessment is that aiming at inflation below but close to 2% over the medium term strengthens the
public's confidence that deflation need not be a concern.
The anchoring of long-term inflation expectations
In the light of past experience, it is clear that the announcement of the quantitative definition of price
stability, in combination with the medium-term orientation of policy, has been an extremely valuable
element of the ECB's strategy. With its quantitative definition, the ECB has made a very significant
contribution to the firm anchoring of inflation expectations. Notably, it has provided a benchmark for
inflation expectations, which in turn has considerably facilitated the conduct of monetary policy.
Indeed, as long as longer-term inflation expectations are firmly anchored, chances are high that the
setting of wages and prices will be guided primarily by the ECB's objective rather than by past
developments. This significantly reduces the likelihood of temporary increases in inflation triggering
harmful second-round increases in wages and prices, events which were fairly frequent in previous
decades.
For these reasons, the ECB has from the start carefully monitored and continuously communicated the
developments in euro area inflation expectations. Experience indicates that the volatility of indicators
of long-term inflation expectations, especially those based on survey data, has always remained
relatively limited, at levels comparable to those in the best performing industrialised countries in this
respect. Notably, survey-based indicators of inflation expectations have always remained fairly close
to 1.8% and, most of the time, within the range of 1.7 to 1.9%, thus at levels fully in line with the ECB's
definition of price stability. However, as I have already mentioned, indicators of long-term inflation
expectations based on financial market data have edged up slightly in the course of this year. This is a
source of concern for the ECB. I assure you that the Governing Council is particularly vigilant about
the development of these indicators.
The framework for assessing and communicating the risks to price stability
Another important aspect related to the recent transformation in monetary policy concerns the ability of
the central bank to present and explain to the public at large the analytical framework used by
policymakers to continuously assess the flow of data, reach policy decisions and communicate them to the
public. In this respect, the ECB's framework emphasises two important principles: the medium-term
orientation of monetary policy for achieving price stability and the principle of robustness of the
analysis, which underlie its assessment of the risks to price stability.
The medium-term orientation of monetary policy
Ever since the announcement of its strategy in 1998 the ECB has made it clear that price stability is to
be maintained over the medium term. I emphasised before that it is crucial in monetary policy to look
through" short-term volatility in prices, which is typically outside the control of central banks. The
medium-term orientation of the ECB's monetary policy strategy clarifies that the time horizon over
which price stability has to be re-established needs to be tailored to the prevailing circumstances in the
economy. This horizon would depend on factors such as whether the shocks are temporary or
permanent, on whether they emerged on the supply or the demand side, on whether the origin of the
shocks is domestic or external or on whether they have a bearing on the performance or even the
fragility of the financial system. By adapting the appropriate monetary policy horizon to the nature of
the shock, the ECB makes an important contribution to avoiding unnecessary volatility in output
growth.
The focus on the medium term in the ECB's monetary policy strategy embodies a commitment to
avoid overly activist and ambitious attempts to fine-tune inflation outcomes. It also helps to reinforce
the credible anchoring of our definition of price stability in the medium and long-term expectations of
economic agents and markets.
Robustness of the framework
The appropriateness of a monetary policy strategy cannot be evaluated by means of just one
particular model or class of models. Rather, a good candidate strategy needs to perform well across a
variety of empirically plausible models, and it has to allow for the judgement of policy-making bodies.
The ECB's analyses and economic perspectives of the risks to price stability are founded on a
two-pillar framework. The two-pillar approach permits us to convey to the public the notion of a
diversified analysis and it ensures robust decision-making based on different analytical perspectives.
These two perspectives are referred to as "economic analysis" and "monetary analysis".
The economic analysis focuses mainly on the assessment of current economic and financial
developments, their likely future dynamics, and any implied short to medium-term risks to price
stability.
To fully assess the economic situation and the outlook for price stability, the Governing Council must
be able to call on a variety of tools and models. However, judgement is also needed, particularly in
assessing the likelihood of certain hypothetical scenarios eventually materialising. The ECB cannot
and does not rely on a single model or a single set of equations. The Eurosystem staff macroeconomic
projections constitute one important input into the monetary policy decision as a way of organising a
large amount of information and helping to create a consistent picture of possible future
developments. However, the numbers which come out of economic forecasts cannot by themselves
encompass or even reflect all the complexities, conditioning factors, nuances and the multidimensional
nature of a comprehensive assessment of the risks to price stability on which monetary policy
decisions need to be based.
In this respect, attempts to base monetary policy decisions solely on inflation forecast numbers would
involve significant limitations. Notably, they would entail the inefficient use of information, since every
forecast, or any other index of indicators, is based on one possible scenario and one combination of
assumptions. In the end, monetary policy requires judgement on the part of the policy-maker to assess
not only the plausibility of all possible scenarios, but also the nature of the shocks and the best policy
reaction in order to deal with this uncertain environment. Just focusing on one or a few forecast
numbers would make it difficult for policy-makers to transmit the complexity of monetary policy
deliberations to the public in a precise and transparent manner.
To this end, the ECB decided from the outset to single out money from the set of selected key
indicators that it would monitor and study closely. To mark the fact that, in the medium and long run,
inflation is indeed a monetary phenomenon, the Governing Council announced a reference value for
the growth of a broad monetary aggregate which is compatible with sustainable, non-inflationary
economic growth.
These decisions were made in recognition of the fact that monetary growth and inflation are closely
related in the medium to long run. Indeed, assigning money an important role underpins the medium
and long-term orientation of the strategy. It helps policy-makers to see beyond the transient impact of
the various shocks affecting the economy and to implement an adequate gradual course for the
conduct of monetary policy. A central bank simply cannot ignore the fact that, ultimately, inflation is
always a monetary phenomenon.
To sum up, the ECB's framework strives to convey to the public the full complexity surrounding the
monetary policy process. It aims to provide an honest account of all the relevant factors considered in
monetary policy deliberations, forestalling any mechanistic description of monetary policy.
Using a single framework for both external communication and internal analysis guarantees
consistency. As already mentioned, empirical studies show that the ECB has been, in the eyes of the
market, at least as predictable in its monetary policy decisions as most other central banks in the
industrialised world, if not even more so.
The emphasis on the robustness of the framework favours its stability over time. All this facilitates the
public's understanding of how monetary policy is conducted, fostering the process of transmission of
monetary policy decisions to the economy and ultimately facilitating the achievement of price stability.
Let me conclude. It may be useful to describe EMU as a long-distance race, with several rounds. So
far, a number of rounds have already been completed, always successfully, leaving us with valuable
assets, notably the high level of credibility of the ECB for attaining price stability, and highly and
increasingly integrated financial markets in which long term rates of bonds have converged not to the
average of the pre-Stage Three figures but to the best previous benchmarks. Yet we are not
complacent. Ahead lie further rounds: major challenges in restructuring markets and industries,
enhancing fiscal sustainability, and fostering technological advancement and the enlargement of the
euro area. Speaking of enlargement, which will be the topic of the following session, I would like to
stress the great opportunity it offers for the European economy as a whole. Fears and doubts have
been expressed. I recall that the same fears and doubts were expressed back in 1986, at the time
when Spain and Portugal joined the European Union. Today, nobody would dispute the positive
impact their accession had on the European economy.
Beyond the enlargement of the European Union will come the enlargement of the euro area. Joining
the euro area is a very important step, as it is an irreversible decision. This requires careful
preparation. Every country will be assessed on its own merits and its own particular situation, on the
basis of a strict analysis of the convergence criteria. Moreover, economic and monetary convergence
will need to be sustainable, which means that it can be maintained over the long term. On this basis,
the new Member States and Europe as a whole will fully reap all the economic benefits we can expect
from the enlargement.
I thank you for your attention. Je vous remercie de votre attention.