jean - claude trichet : issues in monetary policy - views from the ecb speech by mr jean - claude trichet, president of the european central bank, at the luncheon organised by the economic club of new york, new york, 26 april 2004. * * * mrs president, ladies and gentlemen, dear friends, it is a great honour and a pleasure to be invited to speak to the economic club of new york on the eve of a defining moment in europe ’ s history. only five years ago we engaged in a grand enterprise of institutional design that irreversibly tied together the economic and monetary destiny of eleven, then twelve, nations. in five days from now, the european union will complete its largest ever expansion. what was originally a community of six countries in western europe will become a union of 25, spanning a geographic area that used to be divided by an iron curtain. today we can watch some 450 million europeans dismantling the barbed wire of political hatred and economic seclusion that had split the continent for more than half a century. we can watch europe, once again, engaging in a concerted effort to overcome differences and manage diversity. taking issue with this historical transition, i intend to focus my remarks on the challenges of executing monetary policy in such a rapidly changing world. a world in which high - speed structural change - whether spurred by spontaneous economic forces or institutional evolution - may put time - tested economic models at risk, and defy policy - makers ’ search for easy policy recipes. i will describe the mechanisms that the ecb has set in place to protect itself against the risk of serious misperceptions and policy mistakes. my conjecture is that these mechanisms can explain a great deal of the reasons why the institutional transition in europe has so far been accomplished in the smooth manner in which it proceeded. and i will argue that the same mechanisms are also appropriate to prepare europe for the new challenges that lie ahead. central banks and uncertainty the ecb, like all central banks, is faced with several dimensions of acute uncertainty. the economy is continuously hit by disturbances that are often difficult to identify in real time. even when policy - makers are able to correctly assess the source and the nature of a disturbance affecting the economy, tracking its propagation profile and assessing its final impact on the key variables of interest to policymakers is a daunting task. econometric theory has spent decades devising sophisticated tools to isolate different types of shocks from the tangle that appears in the data.

horizon helps to trace out the likely macroeconomic impact of a putative financial misalignment. although asset prices cannot be a target for monetary policy, they no doubt reveal very useful information about future risks to price stability that a central bank should take in due consideration. it is important to recognise, however, that a rise in asset prices does not always signal increased inflationary pressure. whether or not this is the case very much depends on the underlying shock to the economy. there is thus no easy way to shortcut the signal extraction problem faced by a central bank in the financial markets and the design of an appropriate monetary policy reaction to a given movement in asset prices. instead, a careful identification of the shocks driving the markets to best evaluate their implications for the risks to future price stability is needed. movements in asset prices that astray from their fundamental value, so - called asset - price bubbles, pose specific and additional challenges for monetary policy. the first - and already very big - challenge is to detect in real time whether a bubble is developing. asset prices are inherently forward looking and it is very difficult to assess ex ante whether the expectations underlying an ascending or descending trend are realistic or are just validating themselves. in this respect, the central bank typically has no better knowledge about future fundamentals than the market itself. this does not mean that a central bank is left all by itself in the face of major asset price movements. for example, some simple measures for identifying overly optimistic expectations in the valuation of stocks seem to have been reliable indicators on quite a few occasions in the past. moreover, apart from significant deviations of asset prices from past trends or from model - based predictions, it appears that it is also useful to look at developments in credit and monetary variables in order to identify bubble phenomena in real time. in this respect, we have gathered some evidence that growth rates of money and credit which are persistently in excess of those needed to sustain economic growth at non - inflationary levels may, under certain circumstances, provide early information on emerging financial imbalances. incidentally, this is another important argument for devoting systematic attention in our analysis to the monitoring of money and credit developments in our monetary policy strategy. finally, careful analysis of the balance sheets of the different sectors of the economy may also be able to provide early signals regarding the formation of bubble phenomena and financial imbalances in real time. but despite all this, it is clear that the difficulties involved in identifying asset - price