provision for operating at the zero lower bound. if such a commitment can be made credible, it can yield better economic outcomes. but managing the public ’ s beliefs about the future policy path is challenging if policymakers must convince the public that they will not behave as they have in the past. and i would argue that that is the circumstance that the fomc faces. 5 managing expectations is even more challenging when policymakers have not been clear about the reaction function they use in normal times. how can policymakers credibly commit to deviate from something they have never committed to in the first place? how can policymakers convey that they will be implementing policy that is more accommodative than normal when they have not been clear about what would constitute the normal degree of accommodation? managing the public ’ s expectations may be not only difficult but also counterproductive. without the public ’ s understanding of policymaking in normal times, trying to pursue a commitment to looser - than - normal policy may send the wrong signal. for example, if the public hears that the policy rate will be lower for longer, it may interpret the message as policymakers saying that they expect the economy to be weaker for longer. if this is the interpretation, then the forward guidance will weaken rather than strengthen current spending. where do we go from here? my preference for dealing with forward guidance is for the fomc to articulate a reaction function as best it can. this entails describing a systematic approach to policymaking where policy decisions are based on available information in a consistent and predictable way. i believe the most recent fomc statement took a step in this direction when we moved to a qualitative form of forward guidance by stating that we will be assessing progress – both realized and expected – toward our policy objectives. the idea that policy will change as we approach our objectives has the flavor of a reaction function. but, of course, there is more work to do. because we do not know the true model of the economy, i would suggest the committee begin by considering a set of robust policy rules designed to have good results in a variety of models and across various stages of the business cycle. such robust rules recognize that data are measured imprecisely and are subject to revision. these robust rules typically indicate that policy should respond to changes in the gap between inflation and the inflation goal, and to changes in the deviation of output from a measure of potential output, or to changes in unemployment from

lorenzo bini smaghi : intervention at sveriges riksbank conference “ monetary policy in an era of fiscal stress ” intervention by mr lorenzo bini smaghi, member of the executive board of the european central bank, in the panel “ challenges for monetary and fiscal policy ”, at the sveriges riksbank conference “ monetary policy in an era of fiscal stress ”, stockholm, 17 june 2011. * * * it is a pleasure for me to contribute to this sveriges riksbank conference entitled “ monetary policy in an era of fiscal stress ”. the subject is indeed a very topical – and global – one. not just in europe but around the world, the crisis has progressively acquired a fiscal dimension that may be with us for a number of years to come. against this background, it may be useful for me to briefly look back over the relationship between monetary policy and fiscal policies, stressing in particular the challenges that monetary policy may face in an environment of sharply rising fiscal deficits and debt. coming from the ecb, i will of course primarily focus on the euro area experience and lessons. if, in a simple one - country setting, sovereign debt becomes unsustainable, the central bank always retains the option – in theory and partly in practice – to monetise the debt. the shortterm implication of such monetisation is that sovereign credit risk will be replaced by both an inflation and exchange rate risk. in other words, the currency of that country will no longer be considered as a good store of value, either domestically or externally. none of the above constitutes a feasible scenario for the euro area, which is characterised by a unique combination of centralised monetary policy - making and largely decentralised, albeit closely coordinated, fiscal policy - making. this one - monetary - policy - and - many - fiscalpolicies approach is at the heart of the institutional arrangement which governs the interactions between monetary and fiscal policies in the euro area. importantly, the treaty specifically excludes any “ fiscal dominance of last resort ”, due to the prohibition of monetary financing. so what are the implications of all this? ruling out the possibility of monetising sovereign debt in turn rules out inflation and exchange rate risks. however, if we exclude the possibility of monetising the debt and of bailouts between countries, the risk of sovereign default could arise. furthermore, this type of risk may emerge in financial markets in a rather disruptive way,