- c. trichet, “ lecture on activism and alertness in monetary policy ”, at the conference on central banks in the 21 century, organised by the banco de espana, madrid, 8 june 2006. f. smets and r. wouters, “ comparing shocks and frictions in us and euro area business cycles : a bayesian dsge approach ”, journal of applied econometrics, 20 ( 1 ), january 2005. st - in addition, important structural elements of an economy, that influence the relation between inflation and the shocks to which an economy is subject are price flexibility and the anchoring of price setting. in the euro area prices are less flexible than in the us 3. retailers reprice their products every 13 months, compared to 6. 7 months in the us. stickier prices imply that adjustments to external shocks operate more through changes in output, income and employment than would be the case in a situation where prices are more flexible. they also imply an increased persistence of inflation. nevertheless, despite these rigidities, inflationary shocks dissipate quickly in the euro area. an ecb study 4 shows that this paradox is explained by the fact that the impact of the ecb ’ s inflation objective on the evolution of inflation outweighs the influence of past shocks and thus at least partly compensates for the added inertia resulting from a more rigid economic structure. in other words, when the economy adopts the central bank ’ s objective, the inflation process becomes less persistent and more forward - looking. all economic agents anticipate that the central bank will eventually bring inflation back to its pre - shock level and treat past inflationary shocks as transitory and inconsequential for the future. in an economy like the one of the euro area, where expectations are well - anchored, monetary policy can be more patient and focused on the medium - term when confronting a cost - push shock. the reverse side of the coin is that deviations of expectations from the inflation objective could prove more costly to correct at a later stage and therefore require a stronger policy response in terms of timing and or size. expectations that inflation will not diverge from its anchor afford some short - term flexibility to respond to economic disturbances. establishing and maintaining its credibility is therefore of paramount importance for the central bank and requires commitment to a systematic strategy. the fact that the eurosystem is particularly transparent by having a clearly defined primary objective, a quantified inflation target, a

to price stability, as it reflected a portfolio shift to less risky assets during a period of uncertainty. consequently, it was possible to lower interest rates during this period. • by contrast, in december 2005, after a lengthy period of unchanged interest rates, the governing council of the ecb decided to raise the rate on the main refinancing operation. the re - acceleration of real gdp growth in the first months of 2006 materialised, confirming the eurosystem ’ s views that economic growth is broadening and becoming more sustained. the june 2006 eurosystem staff projections foresee growth in the 1. 8 - 2. 4 % range in 2006 and between 1. 3 and 2. 3 % in 2007. risks to price stability are signalled by the 2 pillars of the monetary policy strategy. the first pillar, which indicates short - term to medium - term risks to price stability, shows inflation above 2 % for that period. the monetary pillar, which signals medium - term to long - term risks to price stability, also indicates heightened risks to price stability as reported in the latest monthly bulletin. this is the case even if one would filter out a certain amount of noise in the statistics such as e. g. portfolio shifts. in this vein one could also discuss whether there is a structural break in trend velocity developments in the euro zone or whether the statistics are influenced by institutional product or regulatory developments. however, even if these elements are discarded, we would still find a large monetary overhang in the euro zone with heightened risks for unloading into transactions balances and therefore into inflationary pressures. as president trichet 1 remarked during a lecture at the banco de espana in early june, other central banks, such as the us federal reserve system, changed interest rates more frequently and by larger amounts during the 1999 - 2006 period than the ecb. this is very clear on this slide, which shows the mro rates in blue and the target federal funds rate in red. while phases of interest rate hikes and decreases broadly coincide on both sides of the atlantic, the eurosystem modified interest rates 18 times from 1999 until today, while federal reserve changes were about twice as frequent ( 35 ). mro and federal funds target - january 1999 - june 2006 7, 00 % 6, 00 % 5, 00 % 4, 00 % 3, 00 % 2, 00 % 1, 00 % 0, 00 % 99 199 199 199 200 200 200 200 200 200 200 200 200 200 200