Parameters of the eurosystem's monetary policy
Keynote address delivered by Eugenio Domingo Solans, Member of the Governing Council and the Executive Board of the European Central Bank at the British Businessmen's Club, Düsseldorf, 12 September 2000
Thank you for inviting me to attend this dinner at the British Businessmen's Club in Düsseldorf and for giving me the opportunity to address you as guest keynote speaker this evening.
Quantitative definition of price stability
I shall start by considering the main steps taken by the ECB in order to facilitate a better interpretation of its policy decisions.
First, the ECB approved a clear, specific and quantitative definition of its primary objective as set out in the Maastricht Treaty: price stability. Price stability as the primary objective of monetary policy has to be borne in mind in order to interpret the ECB's decisions in the correct way. What the ECB does has to be interpreted in terms of price stability. If you do that, it will be much easier to understand the ECB's course of action. If you introduce other elements to interpret our decisions, you could be making a mistake.
I am now thinking, namely, of the possibility of interpreting our decisions in terms of exchange rate developments or economic growth. There is no central bank in the world which does not care about the exchange rate of its currency and the ECB certainly does. There is no neglect whatsoever regarding the euro exchange rate. The same applies to economic growth, which is supported by our monetary policy in accordance with the Maastricht Treaty, which states that "without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community with a view to contributing to the achievement of the objectives of the Community". Both exchange rate and economic growth matter and are taken into account in our monetary policy decisions, although not independently, that is to say, not as policy objectives, but as factors closely related to our primary objective of price stability.
A two-pillar strategy
The second main step taken by the ECB to facilitate a better interpretation of its policy decisions was to establish a clear strategy based on two pillars. I shall not describe it because I am sure you know our strategy. Let me just remind you that precisely the two variables to which I referred before - the euro exchange rate and the economic growth of the euro area - are two important elements in the second pillar of our strategy since their developments are used to assess the risks for price stability.
I am prepared to agree with you that our monetary policy strategy is not simple, but rather quite sophisticated. The simplicity or complexity of a monetary policy strategy is linked to the simplicity or complexity of the area in which the strategy is applied. And certainly the euro area is a large, diverse, and in some aspects even heterogeneous economic area. Above all, the euro area is a new economic area. For all these reasons, we could not afford not to have or, at least, not to develop an explicit monetary policy strategy, as others do, nor, could we afford not to comply with the strategy, as others have done. This explains why we have two pillars instead of one, why we have a "reference value" instead of an "intermediate target" for M3 in the first pillar and why many indicators are introduced in the second pillar without boiling down the information they provide to a single figure, and so on and so forth.
Lack of activism
In order to interpret the Eurosystem's monetary decisions, it is also important to consider a more subtle element which I call the monetary policy approach, that is to say, the way we conduct our monetary policy, the basic philosophy which characterises it.
The main feature of the ECB's monetary policy approach is its lack of activism. This lack of activism implies that the ECB's monetary policy does not intend to be counter-cyclical, nor does it intend to react to short-term changes in its economic stance nor to fine-tune economic developments. On the contrary, the ECB's monetary policy intends to provide general monetary conditions with a medium-term perspective, valid for the whole geographical euro area and oriented towards the achievement of our primary objective of price stability. By doing so, we create the best monetary framework for a strong currency and also for economic growth and job creation. Not being counter-cyclical does not imply that the ECB's monetary policy cannot help to smooth out economic cycles: indeedit can extend the wavelength of the economic waves. The ECB's monetary policy cannot actively fine-tune: neither in terms of time nor space. Not being active in terms of space permits the ECB's monetary policy to meet the monetary requirements of the whole area. Furthermore, no monetary policy can discriminate its effects on a regional basis. It would, therefore, be incorrect to interpret the ECB's monetary policy decisions in terms of the needs of a single country, or a few of them, instead of adopting a euro area-wide perspective. Not being active also permits an appropriate degree of interaction with other Community or national economic policies, as I shall explain later. Frame rather than action, chassis and shock absorber rather than an engine, fresh open air rather than an oxygen tank, traditional cooking rather than a microwave oven: these are the few metaphors I use to explain the lack of activism of the ECB's monetary policy compared with an active one.
Lack of activism does not imply absence of gradualism. In order to achieve the proper monetary conditions it is not only possible, but sometimes it is even advisable, to move in gradual consistent steps, each of them taken in accordance with the new available information and following the renewed judgement of the Governing Council of the ECB.
Lack of activism does not imply automatism. The ECB's monetary policy decisions do not follow a specific "rule", such as the Friedman or the Taylor rules. Instead, we follow a strategy. Both rules and strategies rely on a basic economic model, which links the monetary policy objective with the development of some specific variables ultimately under the control of the central bank. But besides the mechanical economic relationships enshrined in the model, a strategy requires an additional important ingredient: judgement, that is to say, discretion, lack of automatism. In a new, complex and uncertain environment such as the euro area, who would prefer an automatic pilot to an experienced human pilot? I, certainly, would not.
Instead of automatism as a way to avoid the inflationary bias of the policy-makers, the Eurosystem's solution is central banking independence, which, therefore, should be seen as a necessary condition to achieve its main goal: price stability.
Through its inclusion in the Maastricht Treaty, the Eurosystem's independence has a solid constitutional basis reflecting the will of the European people. Independence implies a variety of aspects ranging from personal issues to functional ones. Among the personal aspects of independence, one thing which is important is the need to appoint as members of the decision-making bodies of the Eurosystem persons who are independent not only of political or economic influences, but also of national interests. Their mandates are extensive and they cannot be removed before the end of their terms. The fact that the Governing Council takes decisions collegially under the rule "one member, one vote" (except for issues concerning capital, income, etc.) also strengthens the Eurosystem's independence. Functional independence implies, among other aspects, the prohibition for the ECB and the national central banks to take or seek instructions from any external body and the prohibition to give credit facilities to public authorities.
Independence does not mean opacity, lack of accountability, isolation or technocracy. The more independent a central bank is - and the Eurosystem is, probably, the most independent central bank in the world - the larger the need to counterbalance independence with transparency and accountability. It also becomes more important to have a clear idea of the interaction of monetary policy with other economic policies and to avoid the risk of technocracy. Allow me to elaborate on these issues.
Transparency has to do with appropriate communication with market players, with economic agents - among them, of course, businessmen - and the public in general. Today's dinner can be seen as an example of the ECB's transparency.
When I say "appropriate" communication I mean, first of all, communication which explains, which clarifies, the ECB's monetary policy decisions. Explaining does not mean justifying. Justification is also needed, but it refers more to another central bank principle, namely accountability.
Explaining decisions is mainly related to the general goal of effectiveness. The effect of monetary policy decisions depends not only on their mechanical effects, but also on how they are perceived by the markets against the background of existing expectations. "Preparing the markets" and explaining the relevant points of the decisions - why, why now, why so much - are the key aspects of good communication.
In connection with the "preparation of the markets" some experts understand that surprise is an ingredient for efficiency. I do not share this view. The roots of that belief are deeper than they seem: it has to do with a monetary policy concept which asserts that it can directly, positively and lastingly affect economic growth through the practice of so-called "surprise inflation". It also has to do with a monetary policy concept which does not take into account the relevance of time consistency in order to be credible and, therefore, effective.
"Preparation of the markets" is an important aspect of communication, although, quite frankly, I think that the markets are wise enough to prepare themselves alone and do not need a great deal of ad hoc preparations. Central bankers, in general terms, should avoid thinking that they have better information, or that they are wiser than market players. Both markets and central banks share common information which results, through a process of interaction, in better monetary policy results.
One specific point in connection with this shared information concerns the publication of the ECB's macroeconomic forecasts. In this respect, as President Duisenberg already informed the European Parliament, preparations for publication continue and it is envisaged that the publication of forecasts will commence towards the end of 2000.
Having said this, the same note of caution that President Duisenberg conveyed to the European Parliament should be added here. Forecasts are only one input into the decisions of the Governing Council. The publication of forecasts by the ECB should not be viewed as a panacea for all the communication challenges faced by the ECB as a new institution in a multinational environment. Forecasts themselves have significant shortcomings - for example, they are surrounded by considerable uncertainty and may quickly become outdated if the external environment changes.
Because of these shortcomings, monetary policy decisions cannot be made only on the basis of a central inflation forecast, as is made clear in the ECB's monetary policy strategy. Indeed, the relevant input for policy decisions is the comprehensive analysis of the monetary and macroeconomic situation, including the forecast, and of the economic disturbances affecting the euro area economy.
We must publish forecasts in a manner which accurately reflects their real role in policy decisions and the uncertainties inherent in them. Any other approach could be potentially misleading.
Transparency deals with the amount and the kind of information given and the timing of the communication. With regard to the amount and the type of information, the golden rule is not "the more, the better". Giving too much information in a disorderly way, diverting attention from the substance to irrelevant details or procedural issues, paying attention to the persons instead of the facts, are ways of being opaque.
With regard to the timing, the golden rule is "the sooner, the better", because the reactions of the markets start immediately after the decision is taken and announced. In this respect, I should like to underline that, in the case of the ECB's monetary policy decisions, detailed information about the Governing Council's reasoning is made available very shortly after the meetings, therefore avoiding delays which are inherent in the publication of all forms of official minutes. Additionally, once a month, i.e. every other Governing Council meeting, the President and the Vice-President hold a press conference right after the meeting, followed by the rapid publication of the transcripts of the questions and answers on the ECB's website. Furthermore, the ECB Monthly Bulletin contains an in-depth analysis of the ECB's monetary policy decisions.
Transparency, as any other principle, reaches its limits when interfering with other principles like, for example, efficiency. In this specific case, the "no comment" formula must be applied and accepted as the exception which confirms the rule.
Although related, accountability is somewhat different from transparency. It certainly implies the idea of "explaining", as transparency does, but accountability implies additionally and especially the idea of "justifying" and it also conveys the idea of being responsible for one's actions, in the ECB's case, before the European Parliament. Transparency is more related to an ex ante or real-time explanation and has to be seen as an economic requirement. Accountability refers to an ex post justification and has to do with a political duty, namely central bank democratic control.
Monetary policy interacts with the rest of the economic policies adopted by the European Union or the national authorities of the euro area. If the ECB's monetary policy were active and short-term and fine-tune oriented, there would be a need for co-ordination between monetary policy and other economic policies. This need for co-ordination would pose a risk to the ECB's independence and, therefore, also a risk to the efficiency of its monetary policy.
The lack of activism of the ECB's monetary policy, therefore, becomes an approach which favours independence. We do not need to sit around a table with other policy-makers to decide in a co-ordinated manner which monetary policy we have to formulate. We already know what to do ex ante, in a statutory manner, without any genuine need for co-ordinating our monetary policy decisions with others: we already know that we must provide the appropriate monetary conditions in order to comply with the primary objective of maintaining price stability and, provided that this primary objective is achieved, also to support the general economic policies of the area. In order to do so we certainly need exchange of information and co-operation, but not a co-ordination of every action which would put our independence at risk. The Maastricht Treaty and the decision-making process at the euro area level mention specific issues which require co-ordination between monetary and political authorities. The exchange of information and the co-ordination in certain areas other than monetary policy between political authorities and those of the Eurosystem takes place in several fora: the ECB's Governing Council meetings, which can be attended by the President of the Council and a member of the Commission without the right to vote, and also the ECOFIN, the Euro Group and the Economic and Financial Committee meetings, which are attended by Eurosystem representatives at different levels.
The members of the Governing Council of the ECB certainly have technical abilities, but they are not technocrats. This means that the objectives to be pursued by the Eurosystem have not been established and prioritised by the Governing Council of the ECB, but externally by the Maastricht Treaty. In other words, the Governing Council of the ECB does not make political choices, does not take political decisions, but technical ones. If monetary policy decisions were to imply political choices - e.g. less stability and more employment, which is only an erroneous interpretation of the Phillips Curve - then monetary policy and monetary policy-makers should be subject to the normal political process of democratic societies and certainly not be put into the hands of independent central bankers.
Allow me to conclude by referring to the possible future integration of Britain in the euro area, a subject which inevitably must be treated in a speech addressed to the members of the British Businessmen's Club.
First and foremost, it is important to stress that the Governing Council of the ECB has no official position concerning this issue. This is, of course, something to be decided by the British people when and in the form that they deem appropriate.
Having stated the official position, I should like to add that my personal preferences are in favour of the United Kingdom joining the euro area. I believe that both Britain and the euro area would benefit from it. The British economy and especially London's financial market would benefit from having the euro as their own currency because, unlike the pound sterling, the euro fulfils one condition necessary for a currency to be international, namely the size factor, i.e. the larger demographic, economic and financial importance of the area which supports the currency, what I like to call the "habitat" of the currency. The size of the "habitat" matters in the sense that, without a certain critical mass, a currency cannot have real international relevance, however stable the currency may be.
On the other hand, the euro area and the euro would also benefit from British integration because, among other reasons, it would increase its "habitat" and, especially, without a doubt, the presence of London's financial centre in the euro area would reduce the present relative imbalance - compared with the United States - between its economic basis and the degree of development of its capital markets.
Allow me to finish by stressing that these are my personal views on an issue which must, of course, be mentioned at a dinner organised by the British Businessmen's Club.