First, among economists and central bankers, there is overwhelming agreement that there is no long-run trade-off between real activity and inflation. Attempting to use monetary policy to raise real economic activity above its sustainable level will, in the end, simply lead to ever higher inflation, but not to faster economic growth. I am convinced that the best contribution monetary policy can make to sustainable growth and employment in the euro area is to maintain price stability in a credible and lasting manner, allowing the considerable benefits of price stability to be reaped over the medium term. This is the economic rationale underlying the EC Treaty and the Eurosystem's monetary policy strategy.
Second, it is generally acknowledged that monetary policy does affect
real activity in the short run. Although the focus must always be on price
stability, in many cases the policy action required to maintain price
stability will also help sustain short-run economic and employment
prospects. The reduction of the Eurosystem's main refinancing rate on 8
April was a case in point. Following the Asian and Russian financial crises
last year, global demand weakened. Weaker external demand led to a shift in
the balance of risks to price stability in the euro area towards the
downside, as demand pressures abated. As monetary indicators did not signal
inflationary risks at that time, the Governing Council of the ECB concluded
that a cut of 50 basis points in the main refinancing rate best served the
maintenance of price stability. This lower level of interest rates may also
be supportive of real activity and employment in the short-run. Our eyes
must always be firmly focused on the goal, on our goal, to maintain price
stability in the medium term. Our monetary policy does not explicitly aim
at influencing the business cycle. However, as said in many cases, the
necessary monetary policy measures to achieve our goal also tend, almost
automatically, to work in the right direction from a cyclical point of
view.
This leads me to my third point. In situations where monetary policy
might face a short-term trade-off between adverse developments in real
activity and deviations from price stability, the over-riding priority
accorded to countering the latter must be made absolutely clear. Any
ambiguity on this point will simply endanger the credibility, and therefore
the effectiveness, of the monetary policy response. This does not mean that
the policy action must be draconian. The medium-term orientation of the
Eurosystem's monetary policy strategy permits a gradualist and measured
response to previously unforeseen threats to price stability, should this
be regarded as appropriate, depending on the nature of the threat. Such
gradualism may help to avoid the introduction of unnecessary uncertainty
into the real economy.
Recognition and an understanding of these three central points are
essential for the implementation of a successful monetary policy.
Communicating both the objective and the limitations of monetary policy to
the public is a vital issue to which I will return later in my remarks. But
it would be remiss at this point if I did not address what is surely the
greatest economic challenge facing the euro area at present, namely the
unacceptably high level of unemployment. There is a broad consensus that
unemployment in the euro area is overwhelmingly structural in nature.
Monetary policy cannot solve this problem. National governments bear the
main responsibility for structural economic reforms. In particular, further
reforms of the tax and welfare systems are required in many EU countries in
order to increase the incentives to create new jobs and to accept them.
Wage moderation can also have a significant beneficial impact. Monetary
policy makes its best supportive contribution by providing the environment
of price stability in which structural reforms can work most effectively.
It should be recognised that the implementation of EMU has made it even more urgent to improve the flexibility of labour and goods markets. In this context, it would very likely be the wrong answer if governments were to try to create a "social union", harmonising social security systems and standards at a very high level. The ECB will continue to cajole governments into implementing necessary and long overdue reforms, but the final hard decisions - and I acknowledge that they are hard decisions, since the considerable benefits of structural reform often only become apparent with time - lie with the national authorities. In those countries where appropriate structural reforms have been implemented and wage growth has been moderate, unemployment is either low by euro area standards or is falling more rapidly. These experiences offer important lessons for other countries in the euro area. Fortunately, a broader awareness of the necessity of structural reforms recently seems to be emerging in Europe. Of course, ultimately only sustained action will count. The cyclical recovery that is underway is no substitute for such action.
Thus far, I have largely discussed the goal of the single monetary policy. How is this goal to be achieved? At the heart of the answer to this question is the Eurosystem's monetary policy strategy. The strategy has two closely related aspects. First, the strategy must structure the monetary policy-making process in such a way that the Governing Council of the ECB is presented with the information and analysis required to take appropriate monetary policy decisions. Second, the strategy must ensure that policy decisions, including the economic rationale on which they are based, can be presented in a clear and coherent way to the public. The communication policy as part of the strategy obviously has to be consistent with the structure of the internal decision-making process.
In designing the Eurosystem's strategy, the Governing Council of the
ECB recognised the new circumstances faced by monetary policy in the euro
area. Where there were previously eleven open, generally small economies,
there is now one large, relatively closed single currency area. The
challenges implied by this transformation in the landscape of monetary
policy are profound.
Relatively little is known as yet about the transmission mechanism of
monetary policy in the euro area after the transition to Monetary Union.
One important challenge for the Eurosystem is to obtain a better knowledge
of the structure and functioning of the euro area economy and the
transmission mechanism of monetary policy within it, so that policy actions
can be implemented accordingly. Together with experts in the national
central banks, the ECB has embarked on an intensive programme of analysis
and research into these issues.
One obvious problem related to the fact that the euro area did not
exist as a single currency area in the past regards the availability of
statistical data. Compared with national central banks, we do not have the
same amount of long historical time series of monetary and economic
indicators, based on harmonised statistical concepts, at our disposal.
However, we have already developed quite reliable estimates for a number of
these historical series, and the quality and availability of current
statistics on the euro area has increased significantly over the last few
quarters, for example in the areas of money and banking and balance of
payments statistics, but also across a wide range of economic statistics.
This process of improving the quality and the availability of statistical
data covering the euro area will continue.
It would have clearly been unwise for the ECB to develop a strategy
which relies mechanically on the signals offered by a single indicator or
forecast in order to take monetary policy decisions. Indeed, such a
simplistic approach to monetary policy-making is unwise in all
circumstances. Our knowledge of the structure of the euro area economy and
the indicator properties of specific variables - although improving rapidly
- is simply too limited.
The primary objective of monetary policy has been quantified with the
publication of a definition of price stability, against which the
Eurosystem can be held accountable. This definition illustrates our
aversion to both inflation and deflation, since it defines price stability
as annual increases of below 2% in the Harmonised Index of Consumer Prices
(HICP) for the euro area. To maintain price stability according to this
definition, monetary developments are closely monitored against a
quantitative reference value for the broad benchmark aggregate, M3. In
parallel, a broadly based assessment of the outlook for price developments
in the euro area is undertaken. This assessment encompasses a wide range of
indicator variables, including inflation projections produced both inside
and outside the Eurosystem. Using all this information, the Governing
Council comes to a decision on the level of short-term interest rates that
best serves the maintenance of price stability over the medium term.
On the basis of this strategy, I am confident that the Governing
Council has taken - and will continue to take - appropriate monetary policy
decisions. The effectiveness of these policy decisions will depend, in
large part, on the credibility of the single monetary policy. Transparent
and accountable policy-making can help to build up a reputation and, hence
credibility. Transparency and accountability, in turn, rely on clear and
effective communications between the Eurosystem and the public.
In this regard, the Eurosystem faces an especially formidable task.
As mentioned earlier, the euro area currently consists of eleven different
sovereign nations, each with its own distinct monetary history and
heritage. With each policy announcement or Monthly Bulletin, the Eurosystem
must thus communicate with the public of eleven different countries and
must speak in all eleven different official languages of the European
Union. Such a situation is unprecedented. This diversity of language,
history and culture across the euro area raises further challenges for the
ECB.
Over the years, each national central bank had developed its own strategy and, linked to this, its own "monetary policy language" for communicating with the public in the nation it served. This language reflected the unique circumstances of the country in question. The process by which the public learnt this monetary language from the statements and behaviour of the national central bank was largely subconscious. Over time, the strategies and the related language and conventions of monetary policy came to be so well understood as to be almost second nature. In these circumstances, private economic behaviour was shaped by the monetary policy environment.
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