European Monetary System

largely focusing on the primary objective of the Eurosystem, which is to

maintain price stability in the euro area. In this context, let me briefly

explain our terminology, which may perhaps not be known to everybody as

yet. The "Eurosystem" is the name we gave to the European Central Bank

(ECB) and the currently eleven national central banks of those countries

which have introduced the euro. The "euro area" comprises these eleven

countries.

I should like to start with some observations on the objective and

limitations of monetary policy in the euro area. Owing to the successful

process of disinflation and convergence within Europe over the past decade,

the launch of the euro last January took place in an environment of price

stability that few observers would have predicted only a few years ago.

Consumers and firms are already reaping the benefits of this environment.

The relative price signals on which the efficiency of the market mechanism

relies are not obscured by volatility in the general level of prices. By

avoiding the costs and distortions inflation would impose on the economy,

price stability is contributing to the growth and employment potential of

the euro area.

This contribution is substantial. Unfortunately, it is all too easily

taken for granted. Memories of the still recent past relating to the

consequences of high and unstable inflation tend to fade rapidly. We are

sometimes already hearing the argument that, given that price stability has

been achieved, monetary policy should now be re-oriented away from its

primary objective of price stability towards other goals. One of the

challenges facing the Eurosystem is to maintain the support of the broad

public constituency necessary to resist these calls, which - as I hardly

need to point out to such a distinguished audience of central bankers and

monetary economists - are misguided and ultimately counter-productive.

However, it can be said that the situation is the same as that in the world

of sports; winning a championship and reaching the top is difficult, but

staying there is even harder.

The institutional framework for European monetary policy, as created

by the Maastricht Treaty (i.e. the Treaty on European Union, which has

become part of the Treaty establishing the European Community, or the EC

Treaty, in short) is well suited to meeting this challenge. Most

importantly, the single monetary policy has been clearly assigned the

primary objective of maintaining price stability in the euro area. To

facilitate the achievement of this goal, the ECB and the national central

banks have been accorded a high degree of institutional independence so as

to protect monetary policy decisions from undue external interference.

The Treaty imposes several duties and tasks on the ECB. However,

there is no doubt that the objective of price stability is over-riding. For

example, the Treaty stipulates - if I may quote - that the Eurosystem

"without prejudice to the objective of price stability, … shall support the

general economic policies in the Community, with a view to contributing to

the achievement of the objectives of the Community", which include

"sustainable and non-inflationary growth" and "a high level of employment".

Given the clear priority attached to the primary objective of price

stability, how does the ECB address these other Treaty obligations? Let me

make three points in this regard.

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.

Many of us have experienced the problem of trying to learn a second

language in adult life. This rarely comes as easily as learning your native

tongue as a child. It is certainly not a subconscious process, but rather

one that requires effort and perseverance. It is often difficult to

overcome the habits and conventions of one's first language, which are

inevitably somewhat at odds with those of a foreign tongue. Of course, it

is easier to learn a language that shares common roots with one's own.

Nevertheless, to obtain any degree of fluency, there is no alternative to

long hours practising pronunciation, studying grammar and learning

vocabulary. Even then, the idioms and slang of the new language are

sometimes hard to follow. There are no easy short cuts.

With the adoption of the euro last January, the public, financial

markets and policy-makers in the euro area have all had to get used to a

new monetary policy environment and have, thus, had to learn a new

"monetary policy language". The Eurosystem's monetary policy strategy has

been designed, in part, to make this learning process as straightforward as

possible. Continuity with the successful strategies of the national central

banks prior to Monetary Union was one of the guiding principles governing

the selection of the monetary policy strategy. Nevertheless, given the

changed environment for monetary policy, a new strategy with a new

vocabulary had to be developed, reflecting the unique and novel

circumstances facing the Eurosystem.

Some commentators have suggested that the Eurosystem simply adopt the

strategy used by another central bank or by a national central bank in the

past. Tellingly, such observers often suggest the strategy they know best:

Americans suggest using the Federal Reserve as a model; Britons, the Bank

of England; Germans, the Bundesbank. However, the Eurosystem cannot simply

adopt a strategy designed by another central bank for a different currency

area under different economic circumstances. A strategy that might have

been suitable in one situation may be quite inappropriate for the unique

and novel circumstances facing the Eurosystem, given the very different

economic structure and environment confronting it.

A key feature of the ECB's communication policy is the monthly press

conference given by the ECB's Vice-President and myself, usually

immediately following the first Governing Council meeting of each month.

During these press conferences, I make an introductory statement

summarising the Council's discussions and conclusions before answering

questions from journalists. As the statement is agreed, in substance, with

all the Council members beforehand it is similar to what others call

minutes. The press conference provides prompt information in an even-handed

way, and it offers the opportunity for immediate two-way communication. As

far as I am aware, no other central bank communicates with the public in

such a prompt manner immediately after its monetary policy meetings.

These press conferences are a tangible expression of the Eurosystem's

commitment to be open, transparent and accountable in its conduct of

monetary policy. In my view, our commitment to openness should not be in

doubt. However, ensuring that this openness translates into effective

communications continues to be a challenge. Journalists, financial markets

and the public are still learning the new strategy and language of monetary

policy in the euro area.

By its nature, the challenge of improving communications between the

Eurosystem and the public is two-sided. On the one hand, the ECB must use a

clear and transparent language consistent with the strategy it has adopted.

It must help the public understand the changes of emphasis and

communication necessitated by the new monetary policy environment in

Europe. We have made important progress in this regard over the last eight

months, but I acknowledge that we still have some way to go. The ECB must

do its utmost to be understood by its counterparts in the media that act as

important intermediaries to the public at large. By learning from one

another, we can improve the transparency, democratic accountability and

effectiveness of the single monetary policy.

Before concluding, I should like to add a brief comment on the likely

future enlargement of the European Union (EU) and, prospectively, the euro

area. Currently, the EU negotiates the accession of six countries to the

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