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Review of the quantitative reference value for monetary growth

14 December 2000

Review of the reference value

At its meeting on 14 December 2000 the Governing Council reviewed the reference value for monetary growth. The Governing Council decided to reconfirm the existing reference value for monetary growth, namely an annual growth rate of 4 1/2% for the broad aggregate M3. This decision was taken on the grounds that the evidence continues to support the assumptions underlying the derivation of the first reference value in December 1998 (and its confirmation in December 1999), namely those for trend potential output growth and the trend decline in M3 income velocity in the euro area.

As regards the assumption for trend potential output growth, the Governing Council acknowledged that progress has been made in the euro area in the field of structural reforms. However, there is still no decisive evidence that measurable and lasting increases in productivity growth in the euro area would warrant a significant upward revision in the assumption for trend potential GDP growth. This notwithstanding, the uncertainties surrounding estimates of medium-term development of potential output growth in the euro area have become skewed to the upside. Against this background, the Governing Council will carefully monitor further evidence with regard to an acceleration of productivity growth in the euro area. The Governing Council also wishes to emphasise that potential output growth could be strengthened by further structural reforms in the labour and goods markets. Naturally, the ECB's monetary policy would take such changes appropriately into account.

The reconfirmation of the reference value implies the continuation of the pursuit of the monetary policy strategy conducted in the past. The Governing Council will undertake the next review of the reference value in December 2001.

The ECB's monetary policy strategy and the reference value

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 ECB's monetary policy strategy.

1. Under its first pillar, the monetary policy strategy of the ECB assigns a prominent role to money. 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 4 1/2% for annual growth of the monetary aggregate M3. Several studies have provided empirical evidence in support of this role and confirm that the conditions for announcing a reference value (stable money demand relationship and leading indicator properties of M3 for future inflation) are satisfied for the euro area.

2. The 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.

A reference value derived in this way is consistent with - and serves the achievement of - price stability. The derivation of the reference value 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 ECB's monetary policy strategy, the reference value was derived using assumptions for the trend of M3 income velocity over the medium-term and the medium-term trend of potential output growth. The assumptions were:

  1. Over the medium term, M3 income velocity declines at a trend rate in the range from 1/2% to 1% per annum.

  2. Potential output grows at a trend rate between 2% and 2 1/2% per annum over the medium term.

Taking account of the definition of price stability and these two assumptions, the Governing Council decided in December 1998 to set the first reference value at 4 1/2% and confirmed this value in December 1999 on the grounds of unchanged medium-term assumptions.

3. At its meeting on 14 December 2000, the Governing Council reviewed these assumptions and concluded that both of them remain valid in principle. The Governing Council therefore confirmed the reference value at 4 1/2%.

4. The Governing Council also wishes to recall that the ECB's monetary policy strategy uses two pillars in order to assess the risks to future price stability. The monetary analysis always has to be seen in conjunction with the second pillar of the ECB's monetary policy strategy, which uses other economic and financial indicators in the context of a broadly based assessment of the outlook for price developments and the risks to price stability. The reference value 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 conjunction with other indicators in order to ascertain their implications for the risks to price stability over the medium term.


European Central Bank

Directorate General Communications

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