Review of the quantitative reference value for monetary growth

6 December 2001

Review of the reference value

At its meeting on 6 December 2001 the Governing Council reviewed the reference value for monetary growth. It decided to reconfirm the existing reference value for monetary growth, namely an annual growth rate of 4½% for the broad aggregate M3.

This decision was taken on the grounds that the evidence continues to support the assumptions underlying the first derivation of the reference value in December 1998, namely those for trend potential output growth of 2-2½% and for a trend decline in M3 income velocity of ½-1% per annum in the euro area.

With regard to the assumption of trend potential output growth, the Governing Council considers that there is still no decisive evidence of measurable and lasting increases in productivity growth in the euro area that would warrant an upward revision to this assumption. The Governing Council believes that the potential upward impact on trend output growth from structural reforms and technological innovation could be large. However, while some progress has been made in the field of structural reform, significant further steps ­ especially in the labour and goods markets ­ need to be taken in order to achieve a permanent and significant increase in potential output growth in the euro area. Against this background, the Governing Council will continue to monitor the evidence with regard to developments in productivity growth in the euro area, and the ECB's monetary policy will take such evidence into account as appropriate.

The Governing Council will undertake the next review of the reference value in December 2002.

The ECB's monetary policy strategy and the reference value

The Governing Council wishes to recall the following features of the reference value and its role in the ECB's monetary policy strategy.

  1. Under its first pillar, the monetary policy strategy of the ECB assigns a prominent role to money. To signal the prominent role of money to the public, the Governing Council decided in October 1998 to announce a quantitative reference value for the growth rate of the broad monetary aggregate M3. Several studies have provided empirical evidence in support of this role and confirm that the conditions for announcing a reference value are satisfied for the euro area. The official series of M3 (which is now adjusted for all non-euro area residents' holdings of negotiable instruments) exhibits all the desired properties, i.e. a stable money demand relationship and good leading indicator properties for future price developments at medium-term horizons. This evidence also matches the Governing Council's experience that since the start of Stage Three of Economic and Monetary Union the analysis of monetary developments has provided very useful information for monetary policy decisions.
  2. To be consistent with the medium-term relationship between money and prices, the reference value is derived using assumptions for the medium-term trends in M3 income velocity and potential output growth. At its meeting on 6 December 2001, the Governing Council reassessed and confirmed the assumptions underlying the derivation of the reference value, namely that over the medium term: a) M3 income velocity declines at a trend rate in the range from ½% to 1% per annum; and b) potential output grows at a trend rate between 2% and 2½% per annum. Taking account of the definition of price stability and these two assumptions, the Governing Council decided to reconfirm the existing reference value for monetary growth, namely an annual growth rate of 4½% for M3. Furthermore, the Governing Council will continue to monitor monetary developments in relation to the reference value on the basis of a three- month moving average of annual growth rates.
  3. The reference value for monetary growth is a medium-term concept. Short-run movements in M3 may stem from a number of temporary factors and do not necessarily have implications for future price developments. For this reason the Governing Council already made it clear in 1998 that the announcement of the reference value does not entail a commitment on the part of the ECB to correct mechanistically deviations of monetary growth from the reference value. Rather, developments in M3 are thoroughly analysed by the ECB, in conjunction with other indicators, in order to ascertain their implications for the risks to price stability over the medium term.
  4. The analysis of the deviations of annual M3 growth from the reference value represents an important element in the evaluation of monetary developments and the implications for future price stability. However, monetary analysis is not limited to this evaluation. Other monetary indicators (such as components and counterparts of M3, in particular loans) also contain significant information. Furthermore, it is important to take into account past deviations from the reference value which have dropped out of annual growth rates, in order to come to a broadly based assessment of the liquidity conditions in the euro area. Finally, developments in M3 need to be analysed in conjunction with other, non-monetary indicators (e.g. GDP, prices, interest rates and other financial market indicators) in order to understand the nature of the shocks affecting monetary developments and to extract best the indications for future price developments.
  5. The relatively high growth rate of M3 observed over the past few months should be assessed in the light of the above considerations. The recent pick-up in the rate of growth of M3 can be explained partly as an adjustment of M3 following a sharp increase in the price level resulting from the oil and food price shocks in the euro area and partly as a consequence of the effects of portfolio shifts. These shifts were initially triggered by a relatively flat yield curve and developments in stock markets, and, more recently, by a surge in financial market uncertainty in the aftermath of the events of 11 September. Taking into account also the continuing decline in the growth of credit to the private sector, the Governing Council has made it clear that it does not see any risks to price stability in the medium term arising from recent monetary developments. Owing to the current economic and financial market uncertainty, the interpretation of monetary developments in the near future is likely to be more difficult than under normal circumstances ­ as is true for other indicators ­ and these developments should therefore be assessed with caution. Should, however, the current economic and financial market uncertainties subside, any persisting excess liquidity in the economy should be carefully reassessed with respect to whether it signals risks to future price stability.
  6. The Governing Council also wishes to recall that the ECB's monetary policy strategy uses two pillars in order to assess the risks to future price stability. The monetary analysis always has to be seen in conjunction with the second pillar of the ECB's monetary policy strategy, which uses other economic and financial indicators for the evaluation of the risks to price stability. This diversified approach to the analysis stimulates the cross-checking of information and takes into account various interpretations of this information, thereby reducing the risks of policy-related mistakes in an uncertain environment.

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