yves mersch : reflections on the eurosystem ’ s monetary policy strategy after four years speech by mr yves mersch, governor of the central bank of luxembourg, at the 33rd iscsymposium, st. gallen, switzerland, 23 may 2003. introduction the primary objective of the single monetary policy is the maintenance of price stability. however, the eurosystem, like all central banks, cannot control the price level directly but faces a complex transmission process. because the latter is complex, the preparation, discussion and presentation of monetary policy decisions must be placed in a coherent clarifying framework. this is the role of the monetary policy strategy. the strategy fulfils two crucial tasks. first, the strategy imposes a clear structure on the policy - making process itself. it must ensure that the governing council has the information and analysis required by an effective monetary policy that will maintain price stability. second, the monetary policy strategy is a vehicle for communicating with the public. monetary policy is most effective when it is credible. the strategy must therefore facilitate the communication of decisions taken and convince the public that the objective will be achieved. in october 1998 the ecb governing council announced that the eurosystem would adopt a monetary policy strategy consisting of three key elements. the first element was a quantitative definition of price stability. the second and third elements were the " two pillars " of the strategy used to achieve this objective, namely the assignment of a “ prominent role to money ” and a " broadly based assessment of the outlook for price developments and risks to price stability ". the eurosystem took the position that policymaking should not become dominated by inflation - forecast - targeting type preoccupations. eurosystem monetary policy, thus, does not react mechanically to a forecast at a fixed horizon but rather tailors the policy response depending on the nature of the shock hitting the economy. this is documented by its medium - term orientation and reflects why the medium - term has not been defined quantitatively. as the single monetary policy faces uncertainty about the functioning of the economy, the robustness of information stemming from various sources is checked. furthermore, policy decisions are based on a judgment on the likelihood of certain scenarios occurring. the distinct character of the two - pillar strategy is also stressed by the announcement of a reference value for monetary growthsignalling the prominent role assigned to money. on the contrary, strong focus on a single inflation forecast would not do justice to the complexity of the decision - making process and

produce expected outcomes in a timely way and even in adverse conditions. risk transfer my second observation relates to risk transfer more specifically. alan greenspan made the observation that the successes of the banking system in diversifying risk have increased its ability to withstand significant shocks in recent years, including the asia crisis, russia, ltcm, 9 / 11 to say nothing of enron, the it boom and bust, and the telecom write offs. a lot of people agree with him. so the development of markets for the transfer of credit risk is of real value. it allows institutions that are best placed to originate a loan to do so, without necessarily requiring them to continue to bear the risk. having a market to transfer risk allows institutions to diversify their exposures across different sectors and regions. and of course it generates price information that would not otherwise be available. that means credit exposures can be marked to market in a way that had not previously been possible. but it raises other questions. the transferors may have proper insight into the nature of the risks. but to whom have the risks been transferred? are the transferees actually aware of the risks they have taken on? and are they in the best position to monitor these risks as they evolve? how do they acquire day to day knowledge about the quality of those risks? going further, what might they do when they find out? some of the concerns being expressed by private and public sector commentators in these areas are, in my view, important and worthy of further examination. those concerns i ’ m talking about include : a lack of aggregate data on derivative positions ; lack of transparency in accounting for them ; and the potential for unexpected concentrations of risk to build up. although in principle this redistribution of risk should be benign we simply do not have the information at present to judge what the actual impact has been. but why is all this relevant to insurance? it ’ s certainly true that in a lot of cases originating banks have laid risks off to other banks. there are many possible reasons for this : for diversification or to avoid concentration ; opportunities to earn fees ; regulatory arbitrage ; and different views on pricing and spreads. but it is also well known too that risks have been transferred from banks to various areas of the insurance world. that includes reinsurance, where the degree to which such risk has now been concentrated is difficult to assess. moreover, these transfers have taken place, not only through otc contracts, but also through securitised debt instruments