. a genuine understanding of monetary policy and its goal – price stability, and therefore the preservation of the purchasing power of the euro – also creates the best conditions for correct price and wage formation in markets, whereby all parties concerned meet their obligations and second - round effects on wage and price setting stemming from transitory price increases ( e. g. oil, commodities, food ) are thus avoided. second, effective communication also enhances short - term predictability. 3 through their actions, central banks can directly control very short - term interest rates. however, given that for consumption and investment decisions the longer - term interest rates are more relevant, the whole yield curve is relevant for the effectiveness of monetary policy. medium - and longterm interest rates largely depend on private expectations regarding future central bank decisions. lack of effective central bank communication would eventually lead to higher, more volatile, levels of long - term interest rates, which could be detrimental to economic activity. by contrast, an environment in which the predictability of interest rate movements and their relation to key macroeconomic developments is well understood supports correct price formation in financial markets, contributes to the efficient allocation of funds, and reduces uncertainty concerning future interest rates. in such an environment, firms can improve their risk management and achieve better incentives to invest. how the ecb addresses its audience let me turn to how the governing council of the ecb explains its monetary policy decisions to the public. our communications aim to enhance the effectiveness of monetary policy. in this respect, the governing council fully subscribes to the basic principles of modern central bank communication described earlier. a high degree of transparency vis - a - vis our monetary policy has helped the public to hold the governing council accountable for its policy see kahnemann, d. ( 2003 ), “ maps of bounded rationality : psychology for behavioural economics ”, american economic review, vol. 93 ( 5 ), pp. 1449 - 1475, and lohmann, s. ( 2003 ), “ why do institutions matter? an audience - cost theory of institutional commitment ”, governance, vol. 16 ( 1 ), pp. 95 - 110. see ehrmann, m. and m. fratzscher ( 2007 ), ” social value of public information : testing the limits to transparency ”, ecb working paper no. 821, and the literature quoted therein. decisions. communication on monetary policy with a single voice is desirable and has been efficiently applied from the start of monetary

take action, and work co - operatively, to contribute to that common goal - hence my repeated emphasis today on words like “ shared ” and “ agreement ”. based on the canadian experience, i can tell you that the combination of a monetary policy aimed at low, stable, and predictable inflation and a fiscal policy aimed at bringing about a significant decline in the debt - to - gdp ratio works to reinforce the credibility of both policies. low and predictable inflation provides a credible monetary policy anchor when the bank of canada and the government of canada jointly announced explicit inflation targets in 1991, the purpose was to provide a clear path for inflation over the medium term to help canadians make better economic decisions. to make those better decisions, canadians had to understand what their central bank was trying to do. at the bank, we were expecting that the targets would help us communicate clearly the specific policy objectives down the road and, in that way, make our actions more understandable to everyone. the targets would also provide a better basis for judging the effectiveness of monetary policy. the importance of communication in monetary policy is also something i would like to return to later. right now, let me tell you what we have learned from our experience with inflation targeting. one lesson we draw is that a credible monetary policy requires a credible anchor. inflation targets fulfill that role successfully. they do so because they make inflation more predictable and firmly anchor inflation expectations well into the future. with inflation expectations solidly anchored, investors can better assess the future value of their investments. savers can be more confident that the purchasing power of their money will not be unexpectedly eroded by inflation. wage bargaining can become less contentious and labour disruptions decrease. the duration of wage and financial contracts can lengthen considerably because people are confident that inflation will not greatly exceed 2 per cent over the medium term. nor are they unduly concerned about the risk of deflation. altogether, the real economy works better and is more stable. moreover, the significance of the increased credibility of the targets is that it changes the whole dynamic of the inflation process. for example, sudden temporary changes in energy prices, or movements in the exchange rate, do not feed into other prices in the economy and into wages the way they did in the 1970s and 1980s. again, this is because inflation expectations are well anchored. a main benefit of a credible monetary policy based on inflation targets is that it has helped the canadian economy avoid the boom and bust cycles of the past. this is because the forward