3-minute guide to monetary strategy

The Banque de France’s monetary strategy role

As a member of the Eurosystem, the Banque de France’s monetary strategy consists in maintaining price stability. It participates in ECB Governing Council meetings every six weeks to formulate and decide on monetary policy, and ensures that this policy is deployed in France.

To provide input for Governing Council decisions and inform the general public, the Banque de France produces monetary and credit statistics as well as three-year projections for French GDP and inflation. It conducts analyses and research to adapt and improve its monetary diagnostic tools, and presents the results in various publications, including the Banque de France Bulletin.

The Banque de France also safeguards confidence in the euro and strives to ensure that physical money (banknotes and coins) remains a secure and easily accessible means of payment for those wishing to use it. As part of this task, it designs and manufactures secure and innovative euro banknotes (Europa series). It also holds and manages France’s foreign exchange reserves within the framework of the Eurosystem.

The Eurosystem: a price stability target

The Banque de France forms part of the Eurosystem which was established under the Treaty of Maastricht and given a primary objective of maintaining price stability. In line with numerous global central banks, this objective is defined as an annual increase of 2% in the Harmonised Index of Consumer Prices (HICP) for the euro area as a whole. The target is symmetrical, meaning that rates both below and above 2% are equally undesirable. It is a medium-term target, which means over a horizon of two to three years.

A monetary policy designed to maintain price stability

To maintain price stability, the ECB Governing Council has a number of tools at its disposal which operate via two channels.

The first channel is financial conditions and demand, which are influenced by the steering of key short-term interest rates. The ECB sets three interest rates:

• the deposit facility rate (the rate commercial banks earn on their overnight deposits with Eurosystem central banks)
• the rate on main refinancing operations (the rate at which banks can borrow from Eurosystem central banks)
• the rate on the marginal lending facility (the rate at which Eurosystem central banks provide overnight credit to commercial banks)

The Governing Council determines the desired level of rates based on economic conditions in the euro area.

By setting the interest rates at which commercial banks can borrow, ECB monetary policy influences the rates applied throughout the euro area economy, especially those charged on loans granted by commercial banks and those earned on customer savings deposits, as well as short-term market rates.

The second channel is the inflation expectations of economic agents, or households and businesses. To influence expectations, the Governing Council explains the reasons for its monetary policy decisions in a statement published every six weeks on Eurosystem central bank websites. This statement includes a presentation of present and future economic and monetary conditions, as well as indications of the future direction of monetary policy. It also explains how monetary policy tools will help to achieve the inflation target. In addition to the statement, the ECB President holds a press conference which is streamed live on the ECB website.

If inflation remains below the 2% price stability target for too long, the Eurosystem can use non-standard monetary policy tools such as asset repurchase programmes and targeted longer-term refinancing operations that are conditional on banks achieving certain objectives.

A policy that is being adapted to tackle the resurgence of inflation

The ECB adapts its monetary policy to meet the target of 2% inflation over the medium term. After more than a decade of deflationary risks, marked by the 2007-08 Global Financial Crisis and then the Covid-19 pandemic, the resurgence of inflation in the euro area between 2022 and 2023 has prompted a sharp change of direction.

Interest rates were raised by an initial 50 basis points (0.5%) on 27 July 2022. Since then, key rates, and hence bank interest rates, have been increased regularly. The aim is to reach a sufficiently restrictive level to lower inflation by curbing demand, and to avoid the risk of inflation expectations becoming too high for too long.

This monetary policy is underpinned by an in-depth assessment of the risks to price stability, based on an integrated analytical framework consisting of two types of analysis.

An economic analysis

ECB experts use a broad range of economic and financial indicators to forecast the future path of prices in the euro area. These include unit labour costs, measures of actual activity, price and cost indicators, surveys of businesses and households, and indicators of financial conditions (effective euro exchange rate, slope of the yield curve, bond yields, etc.). The Governing Council also bases its assessment on the macroeconomic projections published by the ECB each quarter, which are prepared in conjunction with Eurosystem economists, including teams at the Banque de France.

A monetary and financial analysis

This analysis focuses on medium and long-term trends in inflation. It is based on a range of indicators, notably the change in the M3 monetary aggregate, which is the overall supply of money in circulation in the euro area economy. M3 needs to be kept to a growth rate that is compatible with 2% inflation over the medium term.

Incorporation of climate considerations

The 2021 monetary policy strategy review acknowledged that climate change has implications for price stability. As a result, the ECB Governing Council has adopted an action plan aimed at incorporating climate considerations into monetary policy assessments; expanding its analytical capacity in this field; adapting the operational framework for monetary policy; and implementing actions in line with policies on environmental sustainability disclosure and reporting.

Regular reviews of the monetary strategy framework

The Governing Council regularly reviews the effectiveness of its monetary policy strategy. The last review, which was completed in July 2021, was published by the ECB on its website. To tackle inflationary and deflationary risks more effectively, it adopted a price stability target of 2% inflation over the medium term. It also acknowledged that climate change has profound implications for price stability. The next strategy review should take place in 2025.