Press seminar on the evaluation of the ECB's monetary policy strategy
Willem F. Duisenberg, President of the European Central Bank, Lucas Papademos, Vice-President of the European Central Bank and Otmar Issing, Member of the Executive Board of the ECB, Frankfurt, 8 May 2003
1. Part: Slide presentation by Prof. Otmar Issing
Slides: pdf 36 kB.
2. Part: Transcript of the questions and answers
Question: Professor Issing, what does "close to 2%" mean in the definition of price stability? Is it a little bit less than 2%, on average, in the medium term or is it a pure inflation target now?
Issing: Certainly not. We have confirmed our two-pillar approach. This is totally different from what is normally seen as inflation targeting. And second, this "close to 2%" is not a change, it is a clarification of what we have done so far, what we have achieved – namely inflation expectations remaining in a narrow range of between roughly 1.7% and 1.9% – and what we intend to do in our forward-looking monetary policy.
Question: I have a follow-up question. You aim to maintain inflation rates close to 2%. Mr. Issing, some time ago you said publicly that inflation rates below 1% over the medium term are a problem, or could be a problem. Does this mean that we are now dealing with an implicit lower bound of 1% as a formalisation of what you have actually been doing over the last couple of years?
Issing: I think that what has certainly not changed, and what was always in our minds, is that if we were to identify a risk of inflation approaching very low levels on a sustainable basis and threatening to fall below 1% in a persistent way, then we should of course be extremely concerned. With our clarification now, that we aim to keep inflation at close to 2%, I think it is clear enough that we are not blind in the eye which identifies deflationary problems. We have both eyes – as Paul Samuelson said in a slightly different context – watching deflationary as well as inflationary developments.
Question: Mr. Issing, I am a little slow on the uptake. I am sorry, but I simply do not understand your distinction between "...the definition of price stability is confirmed..." and the second point "...we aim to maintain inflation...". That was my first question. I have to communicate it, I have to write it, and I have not understood it.
Second question: do you still need the distinction of two pillars or will the first pillar in the future be your economic analysis and the second pillar your monetary analysis? In other words, could we actually skip the term "pillars"?
And the next question is: if I have understood you correctly, it seems to me that you are going to be less transparent about what you are analysing in your monetary analysis as you are no longer going to publish the reference value. What do you share with the public under your former first pillar?
Issing: I am glad to contribute to your article. First, we did not say that we will no longer publish a reference value. But we will discontinue the practice we have adopted so far, namely that of the Governing Council reviewing the reference value in December each year. What is behind that? It is mainly that there was a misconception that the yearly review would lead to a yearly reference value indicator, a kind of normative indicator for the development of money. This was never intended. It was a "timeless" concept right from the beginning. A yearly review in this context has perhaps led to some confusion. So what we will do is not skip the reference value; we are keeping it. But this will be monitored and if there are changes, for example in the trend of potential growth – hopefully in the upward direction – in the euro area, which is badly needed, then this will have consequences for the reference value. But this might or might not happen. And when the time comes, then we will do it in a more technical way and not in this preannounced procedure that gave rise to expectations which were never intended from our side.
On the two-pillar structure, I am a bit surprised by your question because this is the core element of today's confirmation. What we do in the changed format of the introductory statement, and perhaps you could again see this as I think it reads much better now, is that we start with more short-term developments in the economic analysis part and then move finally to monetary analysis with a focus on medium to long-term elements, before organising the cross-checking. This remains exactly the two-pillar approach which is specific to the European Central Bank, which gives weight to monetary and to economic analysis, avoiding the impression that all the assessment comes from one single approach. The final assessment is indeed a single one, but the approach is based on two pillars. And I think we make this process very transparent. This still gives money a very prominent role in the assessment of risks to price stability. Sometimes critics argue that we should combine both assessments into one single assessment or one pillar, or whatever you might want to call it. I think that anybody who can solve this problem of integrating money into the usual models deserves the Nobel Prize. So far there has been no approach which, in a satisfactory, comprehensive way, combines monetary and the usual economic forecasting analysis. And so, we are keeping this two-pillar structure unchanged. But I think we have clarified our communication.
Finally, "close to 2%" clarifies what we have done so far, what we have had in mind so far and what we will try to continue to achieve, and if the next four-and-a-half years are marked, as were the past four-and-a-half years, by inflation expectations of below 2%, in a range of 1.7% to 1.9%, I think that this would be a result that perhaps nobody would have expected before the euro was introduced.
Question: A question to the three of you: with the definition of price stability you released today, namely to maintain inflation rates close to 2% over the medium term, would you have had a different monetary policy in the last four years?
Question: So we do not expect any changes in the future?
Duisenberg: That I cannot say for the future, but for now the answer is no.
Question: My question concerns the reference value of M3. How often will it be reviewed: on an annual basis or in the medium term? How often will it be published? If you look back over the last four years, what would be the appropriate reference value?
Issing: I think that it was appropriate for the past, otherwise we would have changed it. But for the future, I do not know. What we have discovered is that this annual review apparently causes misunderstanding and confusion. We should not specify any horizon within which the reference value should be reviewed. Changes in the trend velocity of money and in potential growth are dependent on factors which are not, so to speak, connected to the calendar year.
Question: Can I then draw the conclusion that we should expect the current reference value to be maintained for rather longer than only until December?
Second question – I do not know if you have actually said this before – do you plan to conduct further strategy reviews of the whole strategy, not just M3, in future? Will this become a regular thing?
Issing: I do not know if this procedure will become regular. My term runs for another three years and I do not expect another evaluation within that period. We are somewhat exhausted and need some recreation now. These studies which support the final decision by the Governing Council cannot be done every day and it would not make sense to do so. We have looked at and assessed so many aspects, for example ranges, point targets and focal points. You will find all that information in the background papers and I don't think it makes sense to repeat the process within a very short horizon.
On the reference value, I do not know. We will, of course, assess potential growth in the euro area and will continue to study stability of money demand. In this context, one of the results in both cases will be that we have new estimates on potential growth and on trend velocity. If these developments indicate a major, sustainable change, then we will have to consider reviewing the reference value. When this will happen, I do not know.
Question: Professor Issing, you have obviously gone to a lot of trouble to produce this review, but could you explain exactly what difference it is going to make to the way you formulate monetary policy? Will it, for example, make it easier to cut interest rates? Or is it all really a question of presentation?
Issing: First, it was no trouble. It was not always pleasurable, but it was fascinating and, for somebody with my background, it was a very challenging aspect of my work, and co-operation with our experts is always very enjoyable. The word "trouble" is certainly not appropriate in this context. But as the President has already said, even if we had had the same clarification back in 1998, our policy would not have been any different. So I do not expect – and there is no reason to expect – a different monetary policy on the basis of the clarification of the strategy, which was decided on today.
Question: What was the point of it then?
Issing: If you are married and after four years of a happy married life, perhaps one evening you sit together over a glass of wine and think about why you are so happy all the time: nobody would say it does not make sense. [Laughter] But, to be a bit more serious, there was a lot of criticism and we do not ignore criticism. We only ignore unsubstantiated criticism. There were many aspects raised by many papers with interesting questions and we had to study, for example, ranges: are they more successful in guiding inflation expectations? The outcome was "no". If you compare our policy results with those of other central banks, we cannot complain – this was an important result – but we do not just rely on our conviction that we are the best. We want to see our results confirmed by studies. And you have to study stability of money demand. It is not a question or law of nature. It depends on developments in financial markets, etc. So, all the background discussions conducted were useful and necessary and, from time to time, I think it is necessary for any institution to ask itself, "are we on the right track?" This does not mean that you start from a point of uncertainty: you simply want to be more certain that you are on the right track and this, of course, can only be done at large intervals.
Duisenberg: Let me repeat that we wanted to improve communication. A central bank has to have confidence and credibility. You only get that when you are being understood by the public and by the markets. In order to be understood, you have to explain. So, to a very large extent, this is indeed a method. It is an effort on our part to be better understood than we were in the past.
Question: Forgive me, Professor Issing, if I have missed something, but what is the clarification regarding the 2% inflation reference? I thought it was 2% before and now I see this 2% figure again. What is the clarification regarding the inflation value? What is different now?
Issing: We stated that we are satisfied with the outcome of an inflation rate of below but close to 2%. At the same time, this means that we have an adequate safety margin to alleviate any concerns about falling into the trap of deflation; or about dealing with measurement bias. This is all included now. So I think again, we have clarified what we always had in mind. Perhaps we have previously not communicated it successfully enough.
Papademos: If I can elaborate a bit on this issue. I think it is useful to focus on the role of the monetary policy strategy. It serves two purposes, it has two roles: first, to help decision-making and, second, to facilitate communicating this decision. Today's clarification helps to this end. In the past there has been some uncertainty and some criticism about the exact aim of monetary policy within the quantitative definition of price stability adopted. We have confirmed the definition of price stability. At the same time we have clarified that, within that definition, the aim of our policy will be inflation close to 2% from below. Ex post, one could say that the policies pursued over the last four years have shown that this was indeed the strategy pursued. Now this is clarified and this should help us to communicate our monetary policy decisions. So I think this is the essence.
Question: Does it mean there was an informal aim of 1.5%, or was there uncertainty about a range of 1.5% to 1.7%, and now you have clarified that it was between 1.7% and 1.9%.
Papademos: No, there was no such decision.
Question: Now that the evaluation process of the strategy is over, could you elaborate a little bit more about the different points of view among the Governing Council Members about this important issue in the last few months? Could you mention a few points where it was particularly difficult to reach agreement in the Governing Council? Do you think the new strategy will allow the Governing Council to reach monetary decisions quicker in the coming months?
Duisenberg: The last point is basically the same as the question that was asked earlier: are you not behind the curve in coming late with decisions. As Professor Issing has explained, we do not explicitly have an activist, short-term-oriented policy. We do not want that. So we will not reach decisions quicker or slower, if decisions are warranted at all. As far as the first part of your question is concerned, I would like to assure you that the discussions we had did not, of course, immediately lead to a unified view. But the decision taken and confirmed today was made with a strong consensus view in the Governing Council. That does not mean that there were no differing views. There were, but they were also going in different directions. For example, on the formula of the definition itself: maintaining price stability is defined as a rate of inflation of below 2%. There were those who pleaded for an even tighter interpretation. There were others who pleaded for a looser interpretation. In the end we all agreed that we would have a big credibility problem and would even create our own credibility problem if we were to change the definition. And so we quickly reached consensus that there was no need, and that it would even be dangerous, to change the definition. It would have been remarkable if, in a discussion involving 18 participants, we had all had our noses pointing in the same direction from the outset.
Question: Professor Issing, whatever you say to the contrary, there are bound to be those in the markets who look at this new 2% formulation and say, this is opening the door to possibly looser monetary policy in the future, so I would just like you to categorically dispel that idea.
Issing: I dispel it.
Question: There was something which I did not understand. I think Professor Papademos said that close to 2% does not mean absolutely 1.9%. The definition is close to 2% from below. Given this, now that you acknowledge you want to have a safety margin to avoid going into deflation, I have the impression you have a sort of corridor in mind. Does it mean, for instance, that 1% is the deflation point at which you start being afraid? Second, many economists have had problems with this definition of below 2%. How do you solve the problem of keeping inflation close to 2% from below when some countries, such as Germany, may be sent into deflation. Also, some sectors may be sent into deflation because services usually grow at a faster pace than other sectors. So how do you solve the problem of other sectors which can go into deflation?
Issing: The concept of deflation is not question of sectors and countries, it is a question of the monetary area. In all large monetary areas in the world, you have regions with low and even sometimes negative developments in prices, and others with higher price developments. This is not specific to the euro area, but it has nothing to do with deflation. Deflation is a concept related to monetary policy for the average of the whole monetary area. Sectoral price developments are a question of relative prices and it is quite normal that, for example, in the computer sector or telecommunications, you have extreme price declines: it is part of everyday life. It is a question of relative prices of a market economy. This is totally different from the concept of deflation and, as the Vice-President has already indicated, and as I have tried to explain, we did not have a corridor before and we do not have a corridor now.
Duisenberg: In the 16 years that I was the Governor of the central bank of the Netherlands, there were two years in which we had deflation of ½%. I publicly declared then that I lived in a central banker's paradise; as long as the others have more inflation, it is not a problem.