The second element of the strategy is a comprehensive analysis of the risks to the outlook for price stability, according to two perspectives: economic analysis and monetary analysis. These two perspectives offer complementary analytical frameworks to support the Governing Council’s overall assessment of risks to price stability. The economic analysis aims at identifying those factors that have a bearing on risks at short- to medium-term horizons. It includes, inter alia, projections of key macroeconomic variables and an analysis of shocks hitting the euro area economy. In turn, the monetary analysis – which has been broadened and deepened over time – draws on a wide range of tools, techniques, models and frameworks, complemented by the use of informed judgment, in order to identify risks at longer horizons. After the evaluation of the strategy in 2003, the Governing Council of the ECB explained that the monetary analysis mainly serves as a means of cross-checking the short to medium-term indications coming from the economic analysis. When compared to the strategy of inflation targeting, the Eurosystem’s Monetary Policy Strategy shares the essentials: that is, the importance of price stability and the need for monetary policy to act pre-emptively and make comprehensive use of all available information. The strong belief that institutional independence must necessarily be supplemented by high standards of accountability and transparency is also shared by both camps. This is reflected in the growing weight that central banks, in industrial countries and beyond, place on the importance of communication.

They are particularly useful because they are able to summarise a vast amount of information and analyses within a coherent and internally consistent accounting and economic framework. However, unlike in the case of inflation targeting strategies, they do not constitute the main vehicle around which the policy process and communication are organised. The Governing Council of the ECB bases its policy judgment on these and many other inputs, which include inter alia competing forecasts from other private and public organisations as well as other pieces of information that, for a number of reasons, are difficult to integrate within the framework of the projections. By way of example, information (i.e. data, indicators, analyses, etc.) that becomes available after the cut-off date for the projections cannot, by definition, be incorporated in the exercise. At a more fundamental level, we should acknowledge that even the state-of-the-art macroeconometric models of the kind used nowadays by leading central banks are, as yet, unable to fully incorporate a richer description of the economy’s financial structure. Wealth effects, swings in asset prices, credit and liquidity constraints and other financial frictions are not sufficiently taken into account. That results in an over-simplified view about the channels through which monetary policy can affect economic activity and inflation. It also affects the ability of such models to identify, and hence estimate with any degree of precision, the potentially significant role of financial variables and financial intermediation in the monetary transmission process.