same tight structure as “ theory models ”. [ 25 ] a semi - structural approach along the lines of the federal reserve ’ s frb / us model has been adopted. [ 26 ] we can therefore put more emphasis on the model ’ s ability to provide sound quantitative predictions. when introducing financial frictions, we have relied on a reduced form representation that is consistent with different theoretical micro - foundations. this more flexible, semi - structural approach allows us to model a wide range of banking and financial variables, going from bank lending spreads to term premia, without taking a stance on the theoretical fundamental debate about how they are linked to the macroeconomy. a crucial theoretical aspect which requires improvement is related to the phillips curve, the most commonly used empirical model of inflation that faces several estimation problems as it uses several unobservable variables. [ 28 ] it started as a relationship between wage growth and unemployment and later, prices or inflation substituted wages. in 1967 - 8, phelps and friedman introduced expectations as a variable that shifted the previously considered stable relationship. jointly with this change, friedman added the concept of a fixed natural rate of unemployment ( naru ), determined only by supply factors, to which the economy would tend in the long - term. the difference between actual unemployment and this long - term unemployment rate became the variable used as proxy for demand pressure in the market of goods and services, seen as the main theoretical cause of inflation. inflation was an excess demand phenomenon and demand could be controlled by monetary policy — via monetary aggregates for friedman or with interest rates, as believed today. in practice, estimates of a non - accelerating inflation rate ( nairu ) are what is obtained instead of the unobservable long - term naru, which are doubtfully deemed to be the same. in the late 1970s, two different research approaches emerged, thus characterised by robert gordon [ 29 ] : “ the left fork in the road, … is the resurrection of keynesian economics in the form of a …. phillips curve ( pc ) model that incorporates long - run neutrality and an explicit role of supply shocks in shifting the phillips curve up or down, together with an interpretation of the influence of past inflation as reflecting generalized inertia rather than expected inflation. the bis central bankers ’ speeches right fork in the road of the post - 1975 evolution, features an approach developed by kydland, prescott and sargent, and more recently by gali and gertler and others. inflation depends on

sparked a lively debate in the academic community, regarding the differences between the ecb approach and the inflation targeting regime. [ 4 ] there were criticisms about the ambiguity of having two seemingly different approaches, one close to monetary targeting ( the reference value ) and another related to a public commitment of a quantified inflation target ( less than 2 % ), an element of utmost importance in an inflation targeting regime. the sobering experience of the following few years with the framework, determined the need for clarifications and ultimately for a revision of the strategy. since 2001 the growth of m3 started to accelerate to values well above the 4. 5 %, registering 10. 9 % in december 2001 and in december 6. 6 % in 2002 [ 5 ]. it thus suggested significant risks for inflation that the behavior of prices did not show, even when considering meaningful lags. in fact, the money demand function became clearly unstable since 2001 and did not justify the use of a concept like the reference value referring to the medium - term of up to two years which is the operational horizon for monetary policy decisions. [ 6 ] the continuous need to try to explain away the growing monetary overhang without corresponding inflation in the horizon, was turning into an embarrassing exercise. consequently, in may 2003, the ecb published a review of the monetary policy framework including the following elements. first, the medium - term target for inflation was redefined to a value “ below but close to 2 % ” ; second, the presentation of the monetary policy decisions would start with the “ economic analysis to identify short - to medium - term risks to price stability ” ; third, the monetary analysis would “ mainly serve as a means of cross - checking, from a medium - to long - term perspective, the indications coming from the economic analysis ; fourth, the review of the reference value on an annual basis was dropped. while still at 4. 5 %, the reference value has, in fact, not been mentioned or used since then. the monetary pillar became thinner. finally, in june 2004 the ecb started publishing its staff macroeconomic projections for the euro area. in my assessment, the decisions taken in 2003 and 2004 were important steps towards a higher degree of transparency and accountability and made the ecb strategy even more aligned with inflation targeting. i therefore believe that the ecb ’ s monetary policy strategy can be seen as consistent with the broad features of flexible inflation targeting as described in svensson ( 2008 ). it includes : first,