jurgen stark : monetary policy during the financial turmoil – what have we learned? speech by mr jurgen stark, member of the executive board of the european central bank, at the conference “ the ecb and its watchers x ”, frankfurt am main, 5 september 2008. * 1. * * introduction ladies and gentlemen, let me begin my remarks this morning by recognising the contribution made by this conference over the past ten years to the ecb ’ s communication with market participants, journalists and academics. while the issues have evolved over time, these conferences have invariably served to improve the transparency and understanding of the monetary policy process. i trust that this tradition will be continued today. the past thirteen months have been the most challenging of the ecb ’ s ten - year history, both for the ecb itself and for other central banks across the globe. we have experienced significant, multiple and coincident shocks, notably the emergence of financial tensions and sustained significant increases in commodity prices. the latter has led to worryingly high rates of inflation. these shocks have created an extremely complex and challenging environment for central banks. many observers and commentators have characterised us and our monetary policy as facing a dilemma – or even a trilemma – as we simultaneously confront • inflation rates rising to levels not consistent with price stability • a slowdown of economic activity • and threats to financial stability. how have we addressed these challenges at the ecb? have we ever been in a dilemma – or trilemma – situation. i will demonstrate how certain longstanding principles of sound central banking – which were embedded in our monetary policy framework from the outset – have guided our deliberations and actions through the recent turbulent times. on the basis of our experience during this challenging period, i will then distil a few key lessons for central banks, in particular regarding the conduct of monetary policy. 2. the principles of sound monetary policy making the cumulated experiences of central banks over a long period of time, together with developments in modern economic theory, have forged a set of widely - accepted general principles for the conduct of sound monetary policy. as a starting point, allow me to list the most important ones : first, monetary policy must be given a clear and unambiguous mandate to maintain price stability. ever since the classic contributions of tinbergen and theil, 1 it has been recognised that a central bank endowed with one policy instrument can only pursue one goal. given the “ long - run neutrality ” of money

interest expenditure on government debt has been reduced as a consequence of lower interest rates and debt repayment. this has been accompanied by comparatively high tax payments from households as well as the corporate sector. for 1998 the financial surplus – measured as public sector revenue less expenditure – was almost sek 40 billion, which is equivalent to over 2 % of gdp. in recent years the central government budget process has been changed with a view to tightening the control of government spending. the new budget process includes a spending ceiling that sets the maximum level for central government expenditures. in addition to the new budget process, the goal has been established of achieving a general government financial surplus equivalent to 2 % of gdp over the business cycle. thus, the goal is formulated in terms of the average over the business cycle, not as an annual target. these rules do not owe their existence to happenstance. both the expenditure ceiling and the goal of a government financial surplus over the business cycle serve to promote greater confidence in economic policy. the direction of budget policy, like the monetary stance, is highly important for economic developments. the observance of these rules is important. stable fundamental rules encourage economic agents to make long - term decisions. the international situation favourable conditions in the rest of the world are of course of major importance for economic growth in sweden. in the euro area there are now also increasing signs that activity is picking up. incoming statistics on confidence indicators, for instance from italy, france and germany, show that households as well as firms foresee a brighter future than before. moreover, the japanese economy seems to be recovering from its poor performance in recent years. still, the latest statistics suggest that the trend for manufacturing output remains weak, making it advisable to wait for further statistics before taking a japanese upswing as given. the us economy remains strong. gdp growth in the first quarter this year was over 4 % and over 2 % in the second quarter. household expenditure on consumption has gone on rising more rapidly than current income, so saving has fallen and is now at a record low. this has been accompanied by a weak price trend for a majority of goods. nevertheless, the us federal reserve now considers that inflationary pressure is building up. at the two most recent meetings the federal reserve has raised interest rates in order to forestall an unduly rapid increase in consumer prices. new economic relationships? the prolonged strength displayed by the us economy has been unexpected. in the past five years us economic growth has averaged an annual rate