Review of the quantitative reference value for monetary growth
At its meeting on 2 December 1999 the Governing Council decided to confirm the 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 components underlying the derivation of the first reference value in December 1998, namely the Eurosystem's definition of price stability and the assumptions for trend real GDP growth and the trend decline in M3 income velocity, have remained unchanged.
As before, the Governing Council will assess monetary developments in relation to the reference value on the basis of a three-month moving average of annual growth rates. The Governing Council has decided henceforth to review the reference value on a regular annual basis, with the next review to take place in December 2000.
Against this background, the Governing Council wishes to emphasise that the trend growth potential of the euro area could be considerably enhanced by structural reform in the labour and goods markets. The Eurosystem's monetary policy strategy would take such changes into account, as appropriate.
The derivation of the reference value of 4½% is an expression of a medium-term-oriented approach. The generous liquidity situation in 1999 will have to be borne in mind.
In the context of the review of the reference value, the Governing Council wishes to recall the following features of the reference value and its role in the monetary policy strategy of the Eurosystem:
- Given the monetary origins of inflation over the longer term, the Governing Council assigns a prominent role to money. This is the "first pillar" of the Eurosystem's stability-oriented monetary policy strategy. To signal the prominent role of money to the public, in October 1998 the Governing Council decided to announce a quantitative reference value for the growth rate of a broad monetary aggregate. In December 1998 the Governing Council announced the first reference value of 4½% annual growth for the monetary aggregate M3.
- The first reference value was derived using the well-known relationship between monetary growth, on the one hand, and developments in prices, real GDP and the income velocity of circulation, on the other. The reference value was derived so as to be consistent with - and serve the achievement of - price stability. It was therefore based on the Eurosystem's definition of price stability. The Eurosystem defines price stability as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. Price stability is to be maintained over the medium term. To be consistent with the medium-term orientation of the Eurosystem's monetary policy strategy, the reference value was derived using assumptions for the medium-term trend in real GDP and the evolution of M3 income velocity over the medium term. The assumptions were:
- real GDP grows at a trend rate of between 2% and 2½% per annum over the medium term and
- M3 income velocity declines at a trend rate in the range from ½% to 1% per annum over the medium term.
At its meeting on 2 December 1999 the Governing Council reviewed these assumptions and confirmed that both of them remain valid. The Governing Council therefore saw no reason to change the reference value.
The Governing Council also took the opportunity of this review to re-emphasise that the concept of a reference value is embedded in a monetary policy strategy which is aimed at the maintenance of price stability. The strategy uses two pillars in order to assess the risks to future price stability. The reference value for monetary growth is an important part of the first pillar of the strategy, which assigns a prominent role to the analysis of monetary developments. The information revealed by this analysis has always to be seen in conjunction with the second pillar of the Eurosystem's monetary policy strategy, which includes a broadly based assessment of the outlook for price developments and the risks to price stability, using other available indicators. The reference value therefore does not entail a commitment on the part of the Eurosystem to correct mechanistically deviations of monetary growth from the reference value. Rather, monetary developments are thoroughly analysed in relation to the reference value in order to ascertain their implications for the outlook for price stability over the medium term.
If threats to price stability are identified by this analysis, monetary policy reacts in a manner appropriate to address these threats. Therefore, while substantial or prolonged deviations of monetary growth from the reference value would, under normal circumstances, signal risks to price stability, there is no automatic relationship between short-run deviations of M3 growth from the reference value and monetary policy decisions.
The Governing Council will continue regularly and thoroughly to analyse monetary developments in relation to this reference value and will explain the implications of this analysis for monetary policy decisions to the public. Against this background, the confirmation of the reference value implies the continuation of the pursuit of the monetary policy strategy conducted in the past and does not imply any change to the Governing Council's assessment of the current monetary policy stance.