In contrast to developments in M3, the growth rate of the narrow monetary aggregate M1 has – after a trough in the third quarter of 2008 – started to rise again, and reached 5.3% in the first quarter of 2009. While M1 developments usually prove inferior to M3 developments in terms of their information content about future inflation, in the case of the euro area they have traditionally exhibited good leading indicator properties for future real GDP growth. Taken per se, such a development would also speak against a deflationary scenario and might offer valuable insights into the timing of the recovery. To conclude, monetary indicators provide important information to try understanding the likelihood of different scenarios ahead. In this respect, the real-time problem which is always prevalent in monetary analysis – but also in other types of analysis – becomes more serious in a financial crisis. 4. Short and long term policy responses to the crisis  There are inevitable challenges associated with policy actions in times of crisis. Central banks around the world have embarked on untested areas of monetary policy-making. Expansionary fiscal policies and government interventions to stabilise the financial sector are expected to dramatically increase public debt. This could pose a severe threat to the sustainability of public finances and eventually to macroeconomic stability. To preserve macroeconomic stability over the medium term, there is a need for careful monitoring of the policy stimulus over the policy-relevant horizon, combined with well-designed exit strategies from non-standard policy-making.

For the central bank to maintain price stability over the medium term, we know that monetary policy must not be overburdened with other objectives: it needs to be conducted within an institutional framework which rules out any type of fiscal dominance. I do not need to elaborate further on how profligate fiscal policy can eventually produce inflationary pressures. A ‘lax’ fiscal authority which seeks to avoid the short-term political costs associated with enforcing fiscal discipline could be tempted to finance its budget through money creation. Indeed, inflation erodes the real value of public debt. However, such an outcome can be ruled out in the euro area because of the existing institutional arrangements. The Treaty establishing the European Community assigns responsibility for monetary policy to the ECB and unambiguously entrusts it with the primary objective of maintaining price stability. To fulfil this responsibility effectively, the ECB and the national central banks have been granted a high degree of independence. Under Article 101(1) of the Treaty, central banks are also prohibited from extending credit to, or purchasing public debt instruments directly from, the primary market. By preserving the financial independence of the ECB and the Eurosystem and the integrity of their balance sheet, this prohibition makes monetary policy more credible. In the same vein, the prohibition also helps to strengthen fiscal discipline and thereby to promote the smooth functioning of Monetary Union. The Stability and Growth Pact (SGP) is an additional measure to ensure fiscal discipline and the long-term sustainability of public finances.