Monetary policy-making under uncertainty

Conference organised jointly by the European Central Bank (ECB) and the Center for Financial Studies of the University of Frankfurt Introductory Statement delivered by Dr. Willem F. Duisenberg, President of the European Central Bank, on 3 December 1999 in Frankfurt am Main

Ladies and gentlemen,

It is a great pleasure to welcome you here to Frankfurt on the occasion of the conference entitled "Monetary policy-making under uncertainty", organised jointly by the European Central Bank (ECB) and the Center for Financial Studies of the University of Frankfurt.

As you can imagine, I have had the opportunity to live through many "firsts" in recent times. It all started on 9 June 1998, when the Governing Council of the ECB met for the first time. Then, on 4 January this year, the first transactions in euro were conducted in the money and foreign exchange markets and the first payments in euro were settled in the new TARGET system. Three months later, the first decision to change official interest rates was adopted by the Governing Council on 8 April. And I could continue. In the light of the unique historical journey upon which we embarked as a consequence of the establishment of a single currency in 11 sovereign countries, the smooth and successful start of Stage Three is a tribute to the dedication and relentless efforts of many of my colleagues at the ECB, at its precursor, the European Monetary Institute, and at the national central banks, and of many others involved outside the central banking community.

This event is another important "first" that is worth celebrating: the first, large, open conference organised by the ECB. I should like to use this occasion to thank Professor Weber from the Center for Financial Studies for co-organising this event with us. This conference - and I am sure there will be many more to follow - is yet another signal of our commitment to a continuous and active exchange between the ECB and the academic world. As many of you know, such conferences are not the only way in which we interact with academics. Many of you have already visited the ECB to present your views and discuss issues of policy interest with our economists. This year alone we have hosted around 50 presentations in the context of our Invited Speaker and Lunchtime Workshop programmes. In spite of the heavy workload faced by the ECB staff, such presentations are generally well attended and very much appreciated.

In addition, ECB economists present their work at academic conferences on a regular basis. The ECB has also launched a Working Paper Series via which our research is disseminated and to which the speakers at this conference will also contribute. Finally, this summer we started a new Graduate Research Programme in which students are expected to pursue part of their dissertation work here at our headquarters, on topics that are relevant from the viewpoint of ECB policies. One such student, Petra Geraats, will tomorrow present her work at this conference.

Why do we invest so much time and resources in this exchange with the academic world? After all, as an independent pan-European institution, the ECB is, in the first place, accountable to the public at large, not to the limited circle of academic economists. I should imagine that the answer is obvious to most of you. Let me nevertheless expand somewhat on the most important reason, and this relates to what Alan Blinder, who will be the speaker at tonight's dinner, called the large, and sometimes unexploited, potential gains from trade in ideas between practitioners and academics.

Central banks are among the most intensive users of economic research. It is therefore of utmost importance that the ECB should continuously update its knowledge of and expertise in the most recent theoretical and empirical research findings. We should never be, as Keynes put it, unwitting "slaves of some defunct economist", while pretending to be exempt from intellectual influences. Just as most firms need to update regularly their computer and software systems in order to remain competitive, a central bank needs to ensure that it understands and can implement recent economic research in order to achieve its primary goal of price stability in the most efficient way. Of course, just as most firms would not abandon their old time-honoured systems for new, untested ones without gathering evidence of their benefits and reliability, central banks need to be very cautious about jumping on the bandwagon of any new paradigm that academic researchers or other observers may provide.

The usefulness of economic research in monetary policy-making is very clear at all levels, from the institutional design of central banks to the details of day-to-day monitoring. We do not need reminding that it was the revolution in rational expectations and the results concerning the time inconsistency of optimal policies, together with the experience of the great inflation of the 1960s and 1970s and its associated costs, that contributed to a wave of changes in central bank charters based on the principle of independence and a clear focus on price stability. These principles also represent the foundations of the Treaty on European Union, which established the European System of Central Banks. With this in mind, it was, for example, decided right from the outset that the Eurosystem should clearly define its primary objective of price stability as an increase in the Harmonised Index of Consumer Prices of below 2%.

A similar mixture of sound theoretical and empirical research and practical experience underpins the Eurosystem's monetary policy strategy, which, as you are aware, is based on a prominent role for money (in the form of a reference value for the growth of M3 of 4½%) and a broadly based assessment of the outlook for price developments. The money indicator provides a reference point for the evaluation of the prospects for price stability. Its usefulness is based on the long-term relationship between money and prices, which characterises virtually all economic models and which has been extensively illustrated in empirical studies. This relationship reflects the fact that inflation is ultimately a monetary phenomenon.

While the reference value for monetary growth is a useful and robust policy guide in many ways and ensures that the ECB maintains a medium-term perspective, it is clear that the ECB, like any other central bank, needs to take into account all the information it has at its disposal. No central bank can afford to rely on a single indicator or a single rule. The second pillar of our stability-oriented monetary policy strategy provides a framework in which that information can be processed and presented. The most important guiding principle is that information should be used to the extent that it is relevant for the assessment of future price developments and the risks to price stability.

And this brings me to a third area in which economic research has an important role to play: the monitoring of indicators and of their implications for the outlook for price developments. Let me focus on model-based analysis. Clearly, such analysis, including model-based forecasts, can be a useful tool for interpreting the available information in a consistent and coherent framework. However, these forecasts are only as good as the underlying models that are used. Moreover, different models may be used to answer different questions. We, at the ECB, are committed to developing and maintaining a set of tools that are useful for analysing the euro area economy and examining the implications for future inflation. This is, however, not a trivial task given the large uncertainties that we are facing due to the establishment of a multi-country monetary union. Not only can we expect some of the historical relationships to change due to this shift in regime, but also, in many cases, there is a lack of comparable historical and cross-country data series that can be used to estimate such relationships. We are availing ourselves of some of you as consultants in this difficult process. However, the bottom line is that, in spite of all the progress made, it takes time to develop such tools, and that some of these uncertainties will never disappear.

I have mainly spoken to you about the important input that economic research provides in central banking. Let me briefly touch upon the other leg of this exchange. How can central bankers contribute to the academic world? Again the answer seems obvious. By bringing together researchers and central bankers in conferences like this, by inviting academics to give presentations at our central bank and engage in discussions with our economists, by bringing academics from their ivory towers into the hustle and bustle of real-world policy-making, we hope that we can inspire them to go back to their universities and research institutes and work on the issues that confront us in our daily policy-making process. Some of these issues are very practical, like devising new econometric techniques to detect structural change. Others are empirical, like understanding movements in volatile asset prices or examining the implications of much-needed structural reforms in labour and goods markets. Finally, some of the most important issues for central banks are analytical: for example, understanding the role of money and credit in the transmission mechanism of monetary policy or the issues arising in conducting monetary policy in conditions of low inflation. All these issues show that whoever thought monetary policy would become boring once price stability was achieved was clearly way off the mark.

After all, one of the few things we economists know with certainty, is that we know little without uncertainty. It is, therefore, entirely appropriate that the first academic conference organised by the ECB should deal with the topic of "Monetary policy-making under uncertainty". I wish you very interesting and stimulating discussions and I look forward to witnessing the results.

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