European Monetary System

and was published on 1 December. This value is based on the above-mentioned

definition of price stability and assumes a trend growth in real gross

domestic product of 2-2.5% per annum, as well as a medium-term reduction in

the velocity of circulation of M3 of around 0.5-1% per annum.

We shall not, however, respond mechanistically to deviations from the

reference value for money supply growth, but shall first analyse them

carefully for signals relating to future price developments. Larger or

sustained deviations normally signal risks to price stability.

The second pillar of the monetary policy strategy consists in a

broadly based assessment of the outlook for price developments in the

entire euro area. This assessment will be based on a broad range of

monetary policy indicators. In particular, those variables which could

contain information on future price developments will be analysed in depth.

This analysis should not only provide information on the risks for price

development, but should also help to identify the causes of unexpected

changes in important economic variables.

Some commentators reduced this comprehensive analysis to an inflation

forecast. At the same time, there were demands for the ECB to have to

publish these forecasts in order to satisfy the need for transparency and

accountability. Therefore allow me to make this clear: our strategy

includes a comprehensive analysis of numerous indicators and several

forecasts. To focus on a single official inflation forecast of the

Eurosystem for a specific point in time would in no way accurately reflect

our internal analytical and decision-making process. It would impinge upon

the transparency and clarity of the explanation of our policy. The

publication of an official inflation forecast would also be inappropriate

with regard to the accountability of the ECB, all the more so if this

forecast were based on the assumption of no change in the monetary policy.

The success of the monetary policy of the ECB should primarily be measured

in terms of the maintenance of price stability, not the accuracy of its

conditional forecasts.

The stability-oriented monetary policy strategy of the Eurosystem,

which I have just outlined, constitutes a new and clear strategy. It

emphasises the primacy of the goal of price stability. It takes into

account the inevitable uncertainties concerning economic relationships

inherent in the transition to Monetary Union and the associated systemic

changes and guarantees a high degree of transparency.

Ladies and gentlemen, allow me to comment on certain suggestions on

the orientation of monetary policy which have recently appeared in the

press. Some of these ideas give the impression that monetary policy should

concentrate upon objectives other than price stability, since stable prices

have already been achieved. Inter alia, it has been suggested that the ECB

should react more or less mechanistically to exchange rate developments or

other variables such as, for instance, unit labour costs. Furthermore,

there were calls for monetary policy, by means of reductions in interest

rates, to be used to combat unemployment. Against this background there is

a need to set out clearly the possibilities and limitations of monetary

policy.

Both the reasoning in the Maastricht Treaty and many economic

analyses show that the best contribution the single monetary policy can

make to employment growth is to concentrate on price stability. Without

such a clear approach there is a danger that the public may question the

commitment of the Eurosystem to the goal of maintaining price stability.

Inflation expectations, risk premia and thus long-term rates would rise.

This would increase the cost of the investment which is necessary for a

sustained and lasting rise in the standard of living.

Even under the best possible circumstances, though - i.e. if it

proves to be possible to assure lasting price stability - monetary policy

alone cannot solve the major economic problems of unemployment and future

problems in social security systems.

The Governing Council regards the current high level of unemployment

in the euro area as a matter of great concern. This problem is, however,

predominantly a structural one. It is mainly the result of the rigidities

in the labour and goods markets in the euro area which have arisen partly

through an excessive and disproportionate degree of regulation. Structural

economic reforms, which target the reduction of rigidities, are the

appropriate solution. In those euro area countries in which such reforms

have been implemented unemployment figures have declined markedly. In

addition, I should like to emphasise that moderate wage developments and a

reduction in the burden of tax and social security contributions would

generally help to reduce unemployment. This would be the case even if the

country concerned did not trade heavily with its neighbouring countries.

The positive influence of low taxes and wages on employment clearly has

overall benefits from an international perspective. Such a policy should

not be denounced as "wage dumping".

Turning to the role of exchange rates between the euro and other

important currencies outside the EU, in particular the US dollar, the

Eurosystem has, in formulating its monetary policy strategy, made an

unambiguous choice. This strategy clearly rules out explicit or implicit

objectives or target zones for the euro exchange rate. The pursuit of an

exchange rate objective could easily jeopardise the maintenance of the

objective of price stability and could thereby also be detrimental to real

economic development. Target zones for exchange rates could, for example,

lead to the ECB having to raise interest rates in a recession, despite

increasing downward pressure on prices. I am sure you will agree that such

a mechanistic response to a change in the euro exchange rate would not be

optimal. Furthermore, it is important to remember that we are living in a

world with high capital mobility. Exchange rate agreements, which might

have been possible to implement until recently, are no longer feasible.

The lack of an exchange rate target does not mean that the ECB is

totally indifferent to or takes no account of the euro exchange rate. On

the contrary, the exchange rate will be observed and analysed as a

potentially important monetary policy indicator in the context of the

broadly based assessment of the outlook for price developments. A stability-

oriented monetary and fiscal policy, as stipulated by the Maastricht Treaty

and the Stability and Growth Pact, is an essential pre-condition for a

stable euro exchange rate. Of course, there is no guarantee of lasting

exchange rate stability, not even in a fixed exchange rate regime. Exchange

rate fluctuations are often caused by structural or fiscal policy,

asymmetric real shocks or conjunctural differences. Monetary policy would

clearly be overburdened if it had to prevent such movements in the exchange

rate.

We cannot and shall not gear our monetary policy towards a single

variable, whether a money supply aggregate, an index, the exchange rate or

an inflation forecast for a particular point in time. Nor can we be

involved in any ex ante co-ordination which would entail an obligation to

react to particular commitments or plans. The ECB will always carefully

analyse all relevant indicators. In this context, it is particularly

important that the economic causes of potential risks to price stability in

the euro area are understood as fully as possible. Appropriate monetary

policy decisions also depend upon the causes of unexpected changes in

important economic variables. The Governing Council must, for example, take

a view on whether changes in important indicators are of a temporary or

permanent nature, and whether a demand or supply shock is involved. In our

deliberations we also attempt to take into account how the financial

markets, consumers and firms are expected to react to monetary policy

decisions. I believe few would contest that such a complex analysis cannot

meaningfully be reduced to a more or less mechanistic reaction to a few

variables or a single official forecast.

In addition, concern was often expressed that the Eurosystem would

not act transparently enough. In this context, it was said that a

transparent monetary policy also necessitated the publication of the

minutes of the meetings of the Governing Council and disclosure of the

voting behaviour of the individual members of the Council.

For sound reasons the Governing Council decided not to adopt this

approach. The publication of individual positions could easily lead to

national influence being exerted over the individual Council members. The

members of the Governing Council must not, however, be seen as national

representatives. They decide together on the monetary policy for the euro

area as a whole. The Governing Council has committed itself to go beyond

the reporting and explanatory requirements laid down in the Treaty, which

are among the most comprehensive requirements by international standards.

On the basis of our strategy, after every first meeting in the month

I deliver to the press a detailed explanation of our assessment of the

overall economic situation and, in particular, the outlook for price

stability. The content of this so-called "introductory statement" is very

close to what other central banks refer to as minutes. In this way, the

public receives comprehensive information immediately following the

meetings of the Governing Council. In addition, each month we shall publish

a detailed report on the economic situation and monetary policy throughout

the euro area in our Bulletin. Such rapid information on the results of the

meetings of the Governing Council and the current economic analysis of the

ECB without doubt demonstrates a high degree of openness and transparency.

The most recent monetary policy decisions and operations

Co-operation between the European central banks was always very

close. In the last few months of 1998 the countries participating in the

third stage of Monetary Union co-operated more and more closely. The co-

ordinated reduction in leading rates at the beginning of December 1998

clearly showed that the currency union had begun de facto before the start

of Stage Three. This co-ordinated measure contributed substantially - as we

now know - to the stabilisation of market expectations.

For more than five weeks the ECB has been conducting monetary policy

operations, mainly in the form of reverse open market operations. The main

operation will be carried out at a weekly frequency with a maturity of two

weeks. So far, five such operations have been conducted successfully, at a

fixed interest rate of 3%.

Besides the reverse transactions which constitute the main instrument

for liquidity control and targeting interest rates, the Eurosystem offers

two "standing" facilities: the marginal lending facility and the deposit

facility. These can be accessed by credit institutions via the national

central banks. The marginal lending facility is primarily a safety valve

for short-term liquidity shortages in the banking system and thereby limits

upward movements in money market rates. To some extent, its counterpart is

the short-term deposit facility, which is used to absorb short-term

liquidity surpluses. This forms the lower limit for money market rates. For

the start of Monetary Union the interest rate on the deposit facility was

set at 2% and the rate on the marginal lending facility was set at 4.5%.

As a transitional measure, the Governing Council decided to establish

a narrow corridor of 2.75-3.25% between the rates on the marginal lending

facility and the deposit facility from 4 to 21 January 1999. The intention

was to facilitate the necessary adjustment to the new institutional

environment brought about by the transition to Stage Three. As already

announced, on 21 January 1999 it was decided to return to the rates on the

two "standing" facilities that were set for the start of the single

monetary policy. Since 22 January 1999, therefore, the rate on the deposit

facility has been 2% and the rate on the marginal lending facility has been

4.5%.

A critical factor in this decision was the behaviour of the money

market for the euro area as a whole since the beginning of the year. The

Governing Council established that over time there had been a marked

reduction in the difficulties experienced by some market participants with

the introduction of the integrated money market and, in particular, with

cross-border liquidity flows. All in all, the integration of the money

market in the euro area reached a satisfactory stage only three weeks after

its implementation. In analysing the money market it should be noted that,

inter alia, there can be a marked difference between ECB interest rates and

short-term market rates. On the one hand, market rates may include credit

risk premia, and on the other, expectations may lead to differences between

the two rates.

At its meeting last Thursday the Governing Council confirmed its

earlier assessment of the outlook for price stability. Therefore it was

decided to leave the conditions for the next main refinancing operations,

on 10 and 17 February 1999, unchanged. They will be carried out as volume

tenders at a fixed rate of 3%, the same conditions as the last such

monetary policy operations.

In addition, in recent weeks the first longer-term open market

operations were also conducted, in the form of reverse transactions. These

were carried out on 14 January 1999 in three parallel tender procedures

with maturities of one, two and three months. The fixed rate tender

procedure was used. By contrast with the regular main refinancing

operations, the Eurosystem does not use these longer-term operations to

send signals to the market and therefore usually acts as a price-taker. The

ECB thus gives advance indication of the planned allocation. The interest

rates which arise from these monetary policy operations should therefore be

seen as indicators of prevailing market conditions.

Regular assessment of the monetary, financial and economic situation

To conclude, I should like briefly to report on the Governing

Council’s current assessment of the monetary, financial and economic

situation. On the basis of these assessments the Governing Council decided

last Tuesday to leave interest rates unchanged.

Taking into account the latest monetary data for December 1998, the

three-month moving average of the 12-month growth rate of the monetary

aggregate M3 (for the period from October to December 1998) remained more

or less stable at 4.7%. This value is very close to the reference value set

by the Governing Council. According to our analysis, the evolution of the

money supply shows no risks to price stability. Credit to the private

sector also grew strongly in December last year. Although at present we do

not perceive any inflationary signals, further developments will be very

carefully monitored.

With regard to the broadly based assessment of the outlook for price

developments and the risks to price stability in the euro area, monetary

and financial developments can be seen to indicate a favourable assessment

of the latest monetary policy decisions of the Eurosystem. They indicate

that market participants expect a continuation of the environment of price

stability. Long-term rates fell to new historical lows at the beginning of

1999 and there was an overall downward shift in the yield curve. Therefore,

financing conditions for investment are currently exceptionally favourable.

At present the growth prospects for the euro area are, however, still

marked by the uncertainties relating to the development of the world

economy in 1999. These uncertainties have had a negative impact on

indicators of the economic climate in the euro area. There are widespread

expectations of an economic slowdown in the near future. This deterioration

in the external economic environment can be linked, above all, to the

financial crises in Asia, Russia and Latin America. However, there is a

mixed picture. While the growth rate for industrial production fell up to

November 1998, retail sales figures and consumer confidence have recently

shown positive trends. Furthermore, growth in real gross domestic product

in the euro area was relatively robust in the third quarter of 1998. In the

United States real growth in the fourth quarter actually turned out higher

than expected. Measured against the Harmonised Index of Consumer Prices,

the HICP, consumer prices in the euro area rose by 0.8% in December 1998.

This is a tenth of a percentage point lower than in November. This

development is in line with earlier trends. It can be linked, in

particular, to a further decline in energy prices and a weakening in price

increases in industrial goods.

All in all, the above-mentioned economic development and the

available forecasts for 1999 do not indicate any noticeable upward or

downward pressure on prices. Potential upward risks could arise from a

change in the external global economic situation and any associated effects

on the euro area, via import and producer prices. These developments must

be carefully monitored. There is concern that inflationary pressure might

develop in the event of a strong increase in wage prices and an easing of

fiscal policy. Developments in the exchange rate will also be closely

monitored in view of their significance for price developments.

Finally, let me emphasise that the current level of real interest

rates is exceptionally low. If real interest rates are taken simply as the

difference between nominal rates and the current increase in consumer

prices (HICP), short-term real interest rates in January 1999 stood at

2.3%, i.e. around 80 basis points lower than one year ago. Long-term real

rates have fallen even more, by 110 basis points, and stood at 3% in

January. These levels are very low, both compared with other countries and

with historical data. In line with the safe-guarding of price stability,

the current monetary and financial conditions thus clearly support future

economic growth. Monetary policy can do no more than this without

jeopardising the great overall economic advantages of price stability and

its own credibility.

Real structural reforms which increase the flexibility of the labour

markets, as well as a continuation of the moderate increase in wage prices,

would not only ease the burden on monetary policy but would also support

employment growth. This will be all the more true if the deterioration in

the economic situation this year is worse than expected owing to the

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