At the end of 1998, the ESCB defined a monetary policy strategy, i.e. the different procedures on the basis of which it decides how to achieve its primary objective in the medium term. The announcement of this framework, intended to guide the use of monetary policy instruments, provides an anchoring point for the expectations of economic agents, guarantees the long-term consistency of the decision-making process and renders the ESCB accountable to the general public for its decisions.
A monetary policy strategy serving the final objective of price stability
The ESCB's final objective was determined by Article 3a of the Maastricht Treaty. It is a single objective, price stability, chosen in accordance with those set by German law for the Bundesbank and French law for the Banque de France (Article 1 of the Act of 4 August 1993). Price stability was not defined by the Treaty. Its definition was formulated by the Governing Council and is in line with national central bank practices.
On 13 October 1998, the ECB Governing Council presented the main elements of its price stability-oriented monetary policy strategy. The Governing Council announced its quantitative definition of the ESCB's primary objective, namely the maintenance of price stability. This was defined as a year-on-year increase in the Harmonized Index of Consumer Prices (HICP) for the euro area of below 2%. Furthermore, the Governing Council outlined the two main pillars of the strategy that it will use to achieve the objective of price stability. First, a prominent role was assigned to money. This role is signalled by the announcement of a quantitative reference value for the growth of a broad monetary aggregate. The Governing Council has decided to publish a reference rate for monetary growth rather than a range. In effect, the fact of publishing a growth range would have risked causing incorrect interpretations by the general public by giving the impression that interest rates would be automatically modified should monetary growth exceed the limits of this range. Second, in parallel with the analysis of monetary developments in relation to the reference value, there is an assessment of the outlook for price developments and the risks to price stability in the euro area. This evaluation is based on a broad range of economic and financial indicators.
At its meeting on 1 December 1998, the ECB Governing Council specified the details of the quantitative reference value for monetary growth.
The reference value refers to the broad monetary aggregate M3. M3 consists 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). The 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, repurchase agreements, debt securities with an initial maturity of up to two years, units/shares of money market funds and money market paper.
The reference value for monetary growth must be consistent with—and serve—the achievement of price stability. Furthermore, the reference value for monetary growth must take into account real GDP growth and changes in the velocity of circulation of money. The derivation of the reference value is based on the contributions to monetary growth resulting from the achievement of the ultimate objective of price stability (year-on-year increases of below 2%), and from the assumptions made for potential GDP growth (2-2.5% per annum) and the velocity of circulation (a trend decline of about 0.5-1% each year).
Taking account of these two factors, the Governing Council decided to set the first reference value at 4.5%.
The ESCB monitors monetary developments against the reference value on the basis of three-month moving averages of the twelve-month growth rates for M3. This prevents erratic monthly outturns from distorting the information contained in the aggregate, thereby reinforcing the medium-term orientation of the reference value.
In December 1999, the ECB Governing Council will review the reference value for monetary growth.
