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The First Year of the Eurosystem

Categoria: Referat Economie


Third, communication is very explicit and to the point; policy decisions are consistently motivated with reference to published in/ation and output(-gap) forecasts. Indeed, in/ation targeting has introduced unprecedented transparency and accountability in monetary policy. Three central banksŠthe.Reserve Bank of New Zealand, the Bank of England, and Sweden™s Sveriges RiksbankŠ stand out as particularly consistent and transparent in their implementation of in/ation targeting...

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The First Year of the Eurosystem: Inflation Targeting or Not?


On January 1, 1999, the Euro was launched and the Eurosystem (the ECB and 11 na-

tional central banks in Europe) took responsibility for monetary policy in the Euro area.

This paper is a brief evaluation of the Eurosystem™s monetary-policy regime after its –rst

year, in particular of the extent to which it is similar to in/ation targeting as practiced

by an increasing number of central banks. 1 I examine three elements of the Eurosystem,

namely the goals, theframework for monetary-policy decisions and the communication

with outsiders. Criteria for evaluation are whether the goals are unambiguous and appro-

priate; whether the decision framework is e¢cient in collecting and processing information

and reaching decisions that are appropriate relative to the goals; and whether the commu-

nication is e¤ective in motivating decisions, simplifying external evaluation and thereby

improving transparency and accountability. I also consider whether the actual instrument

setting has been appropriate, given the information available at the times of decision.

During the 1990s an increasing number of central banks have adopted in/ation tar-

geting, which due to its logical and transparent design and apparent success so far has

become a focus of interest and a natural frame of reference. In/ation targeting is char-

acterized by, –rst, an explicit numerical in/ation target. The in/ation target is pursued

in the medium run, with due concern for avoiding real instability, for instance, in the

output-gap; that is, in/ation targeting is is/exiblel; rather than ihstrict.l; Second, due to

the unavoidable lags in the e¤ects of instruments on in/ation, the decision framework is in

practice irin/ation-forecast targetingl- (see below). Third, communication is very explicit

and to the point; policy decisions are consistently motivated with reference to published

in/ation and output(-gap) forecasts. Indeed, in/ation targeting has introduced unprece-

dented transparency and accountability in monetary policy. Three central banksŠthe.Reserve Bank of New Zealand, the Bank of England, and Sweden™s Sveriges RiksbankŠ

stand out as particularly consistent and transparent in their implementation of in/ation


I. Goals

The Maastricht Treaty assigns price stability as the primary objective for the Eu-

rosystem but leaves to the Eurosystem the formulation of an operational de–nition. In

October 1998 the Eurosystem de–ned price stability as isas a year-on-year increase in the

Harmonised Index of Consumer Prices for the euro area of below 2%lo (ECB 1998a). It has

several times emphasized the medium-term orientation of its policy and that a gradualist

and measured response to threats to price stability will not introduce inunnecessary and

possibly self-sustaining uncertainty into short-term interest rates or the real economy...le

(ECB 1999). This emphasis on the medium term, gradualism, and stability of the real

economy is consistent with ii/exiblel, rather than ihstrictll in/ation targeting.

However, as commentators quickly pointed out, the Eurosystem™s de–nition of price

stability was ambiguous, since it did not specify a lower bound for in/ation. In November

1998 the ECB president, Willem Duisenberg (1998a), clari–ed that the word i‚Xincreasel¨C

should be interpreted as excluding de/ation. It would seem to follow that the lower bound

was zero and that the de–nition refers to an in/ation rate between 0 and 2%. However,

two days later, Duisenberg (1998b) stated that ih[w]e did not announce a /oor for in/ation,

because we know that the price index may include a measurement bias, but we do not

know its magnitudel,.

If the lower bound is zero, it would seem logical to use the midpoint, 1%, as the point

in/ation target in the calculation of the M3 reference value. However, when the reference

value was announced in December 1998 (ECB 1998b), it appeared that a point in/ation

target of 1.5% had been used instead.

To this date (January 2000), so far as I know, the Eurosystem has not yet been

explicit about the lower bound. If this omission were due to uncertainty about possible

measurement bias, it would seem that this would a¤ect both the lower and upper bound to

the same extent; otherwise, the width of the range becomes dependent on the measurement

2.bias. It is di¢cult to see any bene–t from such ambiguity. An unambiguous symmetric

de–nition (for instance, inabove 0 and below 2%lo) would seem preferable, especially since

de/ation may be as serious a threat these days as in/ation. 2

II. Decision Framework

Although in/ation targeting is technically di¢cult in practice, the principles of in/a-

tion targeting are relatively straightforward. Given that monetary policy actions a¤ect in-

/ation with a lag, e¢cient in/ation targeting requires in/ation-forecast targeting (see, for

instance, Lars Svensson (1997) and (1999a) and Svensson and Michael Woodford (1999)).

That is, the central bank needs to make conditional in/ation forecasts (conditional on

its view of the transmission mechanism, the current state of the economy, and a given

planned path for its instrument rate). The bank then selects the instrument plan that

results in an inoptimallo in/ation forecast, that is, an in/ation forecast that approaches the

in/ation target at an appropriate pace without causing too much variability in the real

economy or interest rates. The bank then starts implementing the instrument plan, by

setting the interest rate accordingly. At regular intervals, if new signi–cant information

has been collected, the procedure is repeated and a new interest rate plan adopted and

implemented. From this perspective, in/ation-forecast targeting is just an algorithm to

solve an intertemporal optimization problem. With minor di¤erences, this is the decision

framework used by all in/ation-targeting central banks. 3 Thus, if the Eurosystem wants to

meet its de–nition of price stability in the medium term, it must decide on an instrument

plan such that the corresponding in/ation forecast in the medium term, conditional on all

relevant information and its instrument plan, falls between the undisclosed lower bound

and the upper bound of 2%.

In October 1998, the Eurosystem (ECB 1998a, see also ECB 1999) announced that

the monetary policy strategy would consist of iftwo key elements,ld later called iathe two

pillars:ll The –rst pillar is isa prominent role for moneyle with a reference value for M3

growth, set at 4.5% in December 1998 (ECB 1998b). Monetary targeting per se was

rejected, however. Instead money™s role as an indicator of future in/ation was emphasized:

i_Deviations of current monetary growth from the reference value would, under normal

3.circumstances, signal risks to price stability.le The reference value was reconsidered in

December 1999 and maintained at 4.5%. The second pillar is a isbroadly-based assessment

of the outlook for price developments and the risks to price stability,ls where the assessment

is made iausing a wide range of economic and –nancial variables as indicators for future


From the above discussion, it is clear that the –rst pillar is redundant. Only the second

pillar is needed, if interpreted as a conditional forecast, taking into account all relevant

information, including that in monetary aggregates. There seem to be no rational reason

for giving a certain set of indicators of future in/ation the status of a separate i—ápillarla

(rather than one of the bricks in one main pillar). This instead makes the framework

inconsistent and ambiguous, as several observers have noted. In contrast, when the Swiss

National Bank (1999) in December 1999 announced that it would abandon monetary

targeting, it simply made clear that ih[m]onetary policy decisions will be based mainly on

an in/ation forecast, which will take all relevant indicators into account.lo

III. Communication

In/ation-targeting central banks make considerable e¤ort to explaining past outcomes

and motivate current policy decisions, typically with reference to published conditional in-

/ation forecasts. For instance, Sveriges Riksbank organizes its quarterly In/ation Report

(see, e.g., Sveriges Riksbank, 1999) according to its view of the transmission mechanism

and the determination of in/ation; it also systematically updates its estimates of the main

determinants of in/ation and summarizes the resulting adjustments in its conditional in-

/ation forecast relative to that reported in the previous In/ation Report. The degree of

uncertainty in the forecast is also updated and assessed in each Report.

These practices of in/ation-targeting central banks allow outside observers to scruti-

nize the central banks™ analysis and forecasts and then judge whether the policy decisions

taken are appropriate, given the goals and available information. Several central banks

also publish minutes from the monetary policy meetings, which allows outsiders further


to assess whether the discussion and analysis are competent, whether the various argu-

ments presented are appropriate, and whether –nal decisions are consistent with the goals.

4.Altogether, this commitment to communicate simpli–es outside monitoring and evalua-

tion of monetary policy, strengthens the accountability of the central banks, and provides

stronger incentives for the banks to ful–ll their announced goals. Compared to previous

monetary-policy regimes, the in/ation targeting has introduced an unprecedentedly high

degree of transparency into monetary policy.

How does the Eurosystem compare? So far the Eurosystem has not published its most

crucial information, the internal forecasts. Indeed, initially keeping the forecasts secret

was considered a virtue (Duisenberg 1998a): i9... publishing an in/ation forecast would

obscure rather than clarify what the Governing Council is actually doing. ... [B]ecause

publishing a single in/ation forecast would be likely to suggest that monetary policy re-

acts mechanistically to this forecast, publication might mislead the public and therefore

run counter to the principle of clarity.lo However, since September 1999 several public

statements have indicated that forecasts will be published, and in December Duisenberg

(1999) stated: itWe, of course also compare those [external] forecasts with our internal

preliminary forecasts, which will ultimately be published in the course of next year...lx.

The extended quarterly versions of the Monthly Bulletin of June, September and Decem-

ber 1999 have started to report external forecasts. Duisenberg (1999) actually seems to

reveal ECB™s internal forecast: io...the European Commission also forecasts average in/a-tion in 2000 and 2001 to be 1.5%, and we see no reason to deviate from that forecastl (emphasis added). Duisenberg did not reveal whether this number should be interpreted as an unconditional forecast (conditional on optimal policy by the Eurosystem) or a conditional forecast (for instance, conditional on an unchanged interest rate). In the formercase, it seems that 1.5% for 2001 should probably be interpreted as the Eurosystem™s point in/ation target (consistent with the in/ation target used in the calculation of the M3 reference value).

The Eurosystem does not publish minutes and voting records of the General Council meetings. Instead, it has argued that the introductory statement at the press conference held immediately after the meetings are similar to iosummary minutes.ll If that is the case, a comparison of the statements with the minutes of Bank of England and Sveriges Riks- bank gives the unfortunate impression that the Eurosystem is considerably less advanced,

5.systematic, and forward-looking than those banks. The 2-week delay in publishing the minutes from Bank of England is probably close to the minimal time necessary to summarize and edit sophisticated and detailed discussions and arguments. In any case, a press conference is certainly not a commitment to give an adequate report of the discussions at a meeting and rather an invitation to a somewhat selective presentation.

The Eurosystem™s reluctance to be more open and transparent, in particular in publishing internal forecasts and minutes, has probably been quite costly from a public-relations perspective. The Eurosystem™s repeated pronouncements about its high degree of transparency (for instance, Ignazio Angeloni and Otmar Issing, 1999) have not carried far, since critics have the easy task of pointing to other central banks that are clearly more transparent.

IV. Actual Instrument Decisions

The Eurosystem™s main instrument is its itmain re–nancing rate,lc a short repurchase rate. On December 22, 1998, the Eurosystem announced that it would set an initial rate

of 3%. On April 8, 1999, the rate was lowered to 2.5%. On November 4, the rate was

increased to 3%. Were these decisions appropriate, given the goals of the Eurosystem and

the information available at the times of decision?

Did the Eurosystem take its controversial –rst pillar into account? Between October

1998 and October 1999, the 3-month moving average of 12-month M3 growth rates /uc-

tuated between 4.7% and 6.0%. At the time of the decision in April, the 3-month moving

average of the 12-month M3 growth through February was 5.1%, well above the reference

value of 4.5% (the money-growth rate is published with about 4 weeks lag). Presumably,

this should have motivated an increase rather than a decrease of the interest rate. During

March-September, the moving average rose steadily to 5.9%, motivating an increase, but

not necessarily as late as November. Obviously, the –rst pillar has been disregarded at

the Eurosystem™s discretionŠhardly surprising, given its redundancy.

Instrument decisions should ideally be evaluated ex ante, given the information avail-able to the Eurosystem at the time of the decisions. The crucial information would include the Eurosystem™s internal conditional in/ation forecasts during the period, for instance, 6.the conditional in/ation forecasts for 3% and 2.5% interest rates in April and November, respectively. Since the Eurosystem has declined to make this information available and to allow outside scrutiny of its forecasts, it is not possible to decide with any precision whether the decisions were appropriate. Using external forecasts is problematic, since the

assumptions of external forecasters about Eurosystem monetary policy need to be sorted out. Nevertheless, it is reassuring that external forecasts, as reported in the December 1999 Monthly Bulletin (and apparently also internal forecasts, see above) point to average in/ation of 1.5% in 2000 and 2001.

Because of the transmission lags in monetary policy, it is too early for any ex post evaluation of Eurosystem decisions. Another year or two will be needed for that. Since actual outcomes are contaminated by shocks occurring after instrument decisions, or

unknown at the time of decisions, ex post evaluation is far from straightforward. Missing the target range is not necessarily evidence of a mistake, and meeting it is not necessarily

evidence of good decisions.

V. Conclusions

The –rst year of the Eurosystem has seen a successful launch of the Euro and an apparently successful introduction of the common monetary policy. The Eurosystem monetary strategy is quite similar to /exible in/ation targeting, for instance, in having a

quantitative de–nition of price stability, in the emphasis on the medium term, and in the concern to avoid real instability. Eventual publication of internal forecasts would increase

this similarity. There seem to be no fatal mistakes in either design or instrument setting.

Still, there is considerable room for improvement with regard to internal consistency and transparency of the regime.

The remaining asymmetry and ambiguity in the de–nition of price stability, although minor, does not seem to serve any useful purpose. The insistence on the separate –rst pillar is an important source of ambiguity and inconsistency. The –rst pillar is redun-

dant (as also indicated by the –rst year™s experience), if the second pillar is interpreted as a conditional in/ation forecast incorporating all relevant information, including monetary aggregates. A rational role for monetary aggregates is to contribute to conditional 7.forecasts, among other indicators and according to their predictive power, as for the in/ation-targeting central banks (and now apparently also the Swiss National Bank).

There is considerable room for increased transparency about General Council meetings.

The introductory statements at the press conference after the meetings are hardly substitutes for the minutes published by the in/ation-targeting central banks, certainly not if the meetings become more sophisticated and are the genuine locus for decisions. It is di¢cult to see that the Eurosystem could lose from further increases in consistency and transparency.

It is worth emphasizing that since the ECB was created in 1998, it has made sin cere e¤orts to maintain an open dialogue with academic researchers and external experts, including critics, as witnessed by an active visitors program and participation in and organization of a number of academic conferences. Visitors to the ECB have also experienced open-minded, sophisticated and informative discussions with a very competent and insightful sta¤. Overall, I believe there are good reasons to be optimistic about the future of Eurosystem monetary policy.
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