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The quantitative reference value for monetary growth

1 December 1998

On 13 October 1998 the Governing Council of the ECB announced the main elements of its stability-oriented monetary policy strategy. The Governing Council announced its quantitative definition of the ESCB's primary objective, namely price stability. Price stability was defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. Furthermore, the Governing Council outlined the two main elements of the strategy that it will use to achieve the objective of maintaining price stability. First, a prominent role will be assigned to money. This role will be signalled by the announcement of a quantitative reference value for the growth of a broad monetary aggregate. Second, in parallel with the analysis of developments in the monetary data in relation to the reference value, a broadly based assessment of the outlook for price developments and risks to price stability in the euro area will be undertaken. This assessment will encompass a wide range of economic and financial indicator variables. The announcement on 13 October left two issues unresolved, namely the derivation of the reference value for monetary growth and the definition of the specific broad monetary aggregate for which the reference value will be announced. At its meeting on 1 December 1998 the Governing Council of the ECB agreed on these remaining issues regarding the ESCB's monetary policy strategy by specifying the details of the quantitative reference value for monetary growth.

  1. The reference value will refer to the broad monetary aggregate M3. M3 will consist of currency in circulation plus certain liabilities of Monetary Financial Institutions (MFIs) resident in the euro area and, in the case of deposits, the liabilities of some institutions that are part of central government (such as Post Offices and Treasuries). These liabilities included in M3 are: overnight deposits; deposits with an agreed maturity of up to two years; deposits redeemable at notice up to three months; repos; debt securities with maturity of up to two years; unit/shares of money market funds and money market paper (net).
  2. The reference value for monetary growth must be consistent with - and serve the achievement of - price stability. Deviations of current monetary growth from the reference value would, under normal circumstances, signal risks to price stability. To this end, the reference value must be derived in a manner consistent with the ESCB's quantitative definition of price stability, i.e. that the HICP for the euro area increases at a year-on-year rate of below 2%. Price stability according to this definition is to be maintained over the medium term.
  3. Furthermore, the reference value for monetary growth must take into account real GDP growth and changes in the velocity of circulation. In view of the medium-term orientation of monetary policy, it appears appropriate to base the derivation of the reference value on assumptions about the medium-term trend in both real GDP growth and velocity growth.
    1. Regarding the trend growth of real GDP in the euro area, a figure is estimated to be in the range of 2% to 2 1/2% per annum. However, non-inflationary growth in the euro area could, in the future, be higher if necessary structural reforms in labour and product markets were realised.
    2. Concerning velocity, medium-term trends have to be assessed in the light of the regime shifts and behavioural and institutional changes associated with the convergence towards and transition to Monetary Union. The resulting uncertainties concerning broad money velocity have led to the view that a plausible assumption for the medium-term trend in velocity is a decline in the approximate range between 0.5% and 1% per annum. This assumption is consistent with the historical experience of the last twenty years.
  4. The derivation of the reference value is based on the contributions to monetary growth resulting from assumptions made for prices ("year-on-year increases of below 2%"), real GDP growth (trend growth of 2% to 2 1/2% per annum) and velocity (a trend decline in the approximate range between 1/2% and 1% each year).
  5. The Governing Council has decided to announce a reference rate for monetary growth, rather than a range. The Council believes that announcing a reference range might be falsely interpreted by the public as implying that interest rates would be changed automatically if monetary growth were to move outside the boundaries of the range.
  6. In setting the reference value for monetary growth, the Governing Council emphasised that the ESCB's published definition of price stability limits increases in the HICP for the euro area to "below 2%". Furthermore, the actual trend decline in velocity is likely to lie somewhat below the extreme of the range mentioned above. Taking account of these two factors, the Governing Council decided to set the first reference value at 4 1/2%.
  7. The ESCB will monitor monetary developments against this reference value on the basis of three-month moving averages of the monthly twelve-month growth rates for M3. This will ensure that erratic monthly outturns in the data do not unduly distort the information contained in the aggregate, thereby reinforcing the medium-term orientation of the reference value.
  8. In December 1999, the Governing Council of the ECB will review the reference value for monetary growth.

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