november 1998, before the single currency came into existence on 1 january 1999, the ecb defined the following four fundamental characteristics of this strategy. quantitative definition of price stability first, the ecb provided a quantitative definition of price stability - a year - on - year increase in the harmonised index of consumer prices of below 2 % over the medium term. we further clarified that in the pursuit of price stability the ecb aims at inflation rates below but close to 2 %. this provides a sufficient safety margin against the risk of deflation. these announcements had not only the advantage of anchoring inflation expectations and enhancing the ecb ’ s transparency and accountability, but were also instrumental in preserving continuity at the time of transition from the previous national currencies to the euro : the euro area was given the very same definition of price stability adopted implicitly or explicitly by the most credible national currencies. a different definition of price stability would have immediately led to higher inflationary expectations, therefore higher market interest rates all along the yield curve, and to additional substantial risk premia to protect against higher uncertainty over future inflation. medium - term orientation second, the ecb has adopted a medium - term orientation, thereby preserving monetary policy from short - termism. constantly faced with economic news, a central bank risks being swamped by the latest indicator and by its conjectures concerning markets ’ likely reaction to the latest indicator. this can gradually steer monetary policy away from its foremost role of providing a firm medium - term anchor for the economy. instrumental in this steady - hand framework is our notion that the appropriate horizon for monetary policy is the “ medium term ”. in this respect, the time horizon over which price stability has to be re - established needs to be tailored to the circumstances prevailing in the economy. sometimes, notably if there is a suspicion that asset prices are moving up or down substantially, it pays to look very far ahead, beyond the average lag of monetary transmission. in other cases, the economy may need to return to price stability within a shorter horizon. in general, the horizon should depend on whether the shocks are temporary or permanent, whether they emerged on the supply or demand side, whether they are domestic or external, on their potential for becoming entrenched in pricing decisions and on their implications for the fragility of the financial system. in all events, the central bank has to preserve its credibility, thus ensuring that expectations remain consistent with the declared policy objective. comprehensiveness of the analytical framework third

the short to medium - term “ economic analysis ” - with its focus on real activity and financial conditions is well - equipped to study shorter - term deviations of inflation from its long - term trend. however, it often fails to track the mechanisms by which monetary factors are responsible for such trends over extended horizons. as a consequence, a monetary policy framework exclusively centred on such an analysis would leave a ‘ loose end ’ in the formation of expectations, to the extent that it would offer no anchor to anticipations of price developments as the horizon lengthens. despite the fact that the ecb had a specific arithmetic definition of price stability, it deliberately chose not to mould its own monetary policy strategy as one of “ inflation targeting. ” to be sure, the concept of “ inflation targeting ” is not always a clearly defined concept. however, if it is understood as a framework that makes macroeconomic forecasts the statistical input feeding the policy - making process, then we would consider it too narrow a description of what monetary policy should look at. a central bank needs to maintain appropriate flexibility in the way it responds to shocks, taking decisions which are robust across a set of different plausible scenarios for the future. in this respect, it has been increasingly recognised that a central bank that focuses on inflation forecasts at around two - year horizons would not be able to appropriately take into account the formation of financial imbalances, as they generally exert effects on price developments at longer horizons. given the substantial uncertainty over the sustainability of asset - price developments in particular, it may be advisable to set interest rates with a time - frame extending well beyond conventional forecast horizons. however, the mere extension of the time horizon for inflation targeting may still fail to adequately guard against the detrimental effect that large asset - price swings could exert on price stability. the japanese experience of the 1980s shows that it may take many years before asset - price movements can affect consumer - price inflation to any great extent. our monetary analysis, with its focus on money and credit developments, can be valuable in such situations. as it has been extensively documented in several recent economic studies, asset - price booms and busts - especially the ones that have led to the worst macroeconomic and financial imbalances - have generally been accompanied by excessive money and credit growth. thus, a monetary policy that ensures that money and credit do not grow unchecked may also help, as a side - effect, to reduce the likelihood of those abnormally large