The ECB's monetary policy since 1999

1
The ECBs monetary policy and
macroeconomic stability since 1999
12th Dubrovnik Economic Conference Dubrovnik, 30
June 2006 Klaus Masuch European Central Bank
The contents of this presentation do not
necessarily reflect the views of the ECB.
2
Contents
The ECBs monetary policy strategy key
features Definition of price stability The medium
term orientation The two-pillar approach Monetary
policy in a heterogeneous currency area The
first years of the euro Macroeconomic
developments Annex tables and charts
3
Monetary Policy Strategy key features
Definition of price stability Medium-term
orientation Two-pillar approach Monetary policy
in a heterogeneous currency area
4
Definition of price stability
Year-on-year increase in the Harmonised Index of
Consumer Prices (HICP) for the euro area of below
2 to be maintained over the medium term The
Governing Council aims to maintain inflation
rates at levels below, but close to 2 over the
medium term
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The medium-term orientation

• Price stability is to be maintained over the
  medium term
• Transmission lags and uncertainty imply
• Impossible to avoid short-run volatility
• of inflation
• (important for accountability)
• No fine-tuning
• Need to be forward-looking
• No fixed horizon

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The two-pillar approach

• Complementary analytical perspectives
• Economic analysis
• Focus on shorter-term price movements (largely
  influenced by interplay of supply and demand in
  goods, services and factor markets)
• Monetary Analysis
• Focus on longer-term price trends (closely
  linked to underlying trends in the money stock)

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The primary objective of price stability
Governing Council takes monetary policy decisions
based on a unified overall assessment of the
risks to price stability
Monetary analysis
Economic analysis
Analysis of economic dynamics and shocks
Analysis of monetary trends
cross- checking
Full set of information
8
Monetary policy in a heterogeneous currency area

• Inflation and growth differentials within a
  currency area
• . often reflect welcome adjustment processes
• Asymmetric shocks
• Catching-up processes
• but may also signal the need for changes in
  national economic policies
• Labour market
• Fiscal policies
• Structural policies (potential growth)

9
Real GDP growth divergence in the euro area and
the US is comparable (percentage points)
Sources Eurostat, Bureau of Labor Statistics and
ECB calculations. Note Divergence is calculated
as unweighted standard deviation annual averages.
10
The dispersion of inflation across euro area
countries is comparable to the one of the US
MSAs (unweighted standard deviation in
percentages)
MSA Metropolitan Statistical Area Sources
EUROSTAT, US Bureau of Labor Statistics and ECB
calculations
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Monetary policy in a heterogeneous currency area

• Monetary policy cannot address inflation or
  growth differentials the objective is defined in
  terms of area-wide price developments
• As monetary policy ensures price stability in the
  currency area, a local deflation/inflation spiral
  is excluded
• Monetary policy needs to analyse regional
  developments
• Importance of adjustment mechanism within the
  currency area

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The first years of the euro Macroeconomic
developments
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The first years of the euro inflation and
inflation expectations
The level and the volatility of key inflation
measures have been substantially lower since 1999
compared to the eighties and early nineties.
The volatility of consumer price inflation
since 1999 is lower in the euro than in the US
(the volatility of the GDP deflator is similar in
both currency areas). Long-term inflation
expectations could be stabilised at low levels in
the period since 1999. The level and volatility
of interest rates declined.
14
Inflation and inflation expectations in the euro
area
(monthly data non-seasonally adjusted)
Sources ECB, Eurostat and Consensus Economics
Forecast. Note Last observation refers to May
2006 for the HICP headline and core HICP. The
latest Consensus Economics Forecast refers to
April 2006 and the latest SPF survey to March
2006. Longer-term inflation expectations from
Consensus Economics Forecasts refer to a horizon
of six to ten years, while those from the Survey
of Professional Forecasters refer to five years
ahead. Consensus inflation expectations until
December 2002 are constructed as a weighted
average of the five largest euro area countries
which together account for more than 80 of euro
area GDP.
15
Volatility in consumer price inflation in the
euro area and the US
Rolling standard deviation of quarterly changes
in consumer inflation in the euro area and the US
Sources Eurostat, BIS and ECB calculations.
Note Last observation refers to March 2006.
Rolling standard deviation with window of 20
quarters.
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Inflation and interest rates
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The first years of the euro employment and real
activity

• Average real GDP growth was around 2 since 1999,
  close to the average in the eighties and the
  nineties.
• Employment growth since the introduction of the
  euro was on average above 1 per annum,
  substantially higher than during the last two
  decades.
• Volatility of unemployment has declined
  substantially.
• Trend unemployment is falling since price
  stability was re-established in the second half
  of the 1990s.
• However, productivity growth was weak, both
  compared to the past and the US.

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Real economic variables
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Volatility in real GDP in the euro area and the
US
Rolling standard deviation of quarterly changes
in real GDP in the euro area and the US
Sources Eurostat, BIS and ECB calculations.
Note Last observation refers to March 2006.
Rolling standard deviation with window of 20
quarters.
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Inflation and unemployment
Example Inflation and unemployment trends in the
euro area
Source ECB. Note Trends are calculated based
on a Hodrick-Prescott filter with a smoothing
parameter of 10,000. Last observation refers to
2006Q1.
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Inflation and unemployment
Example Inflation and unemployment trends in the
euro area
Source ECB. Note Trends are calculated based
on a Hodrick-Prescott filter with a smoothing
parameter of 10,000. Last observation refers to
2006Q1.
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Annex I Background Charts Tables Euro Area
23
Inflation expectations in the euro area (annual
percentages)
Sources Reuters, Consensus Economics and ECB
Latest observation May 2006
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Euro area economic activity
Sources Eurostat Latest observation 2006 Q1.
25
Euro area unemployment (change in millions
percentage of the labour force)
Source Eurostat Latest observation April 2006.
26
Interest rates (annual percentages)
Sources NCBs, Global Financial data, BIS and
Reuters. Last observation May 2006
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External value of the euro (current account
balances as percentages of GDP)
Sources BIS and ECB Latest observation May
2006
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Euro area HICP inflation (annual percentage
changes)
Source Eurostat Latest observation May 2006
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M3 growth (annual percentage changes)
Source ECB Latest observation April 2006.
30
Loans to the private sector (annual percentage
changes)
Source ECB Latest observation March 2006
31
House price developments are strong in most euro
area countries (annual percentage changes)
Sources National sources and ECB calculations.
Note Weights based on 2004 nominal
GDP. Definitions 1) New and existing
houses whole country. 2) All dwellings (new
and existing houses and flats) whole country.
3) Existing dwellings (houses and flats) whole
country. 4) Up to 2000 data for Vienna
only.
32
ECB increased interest rates by 50 basis points
since December 2005 (annual percentage changes)
Source ECB Latest observation 19 June 2006.
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Annex II Background Charts Tables Euro Area
versus US
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Interest rates in the euro area and the US
Policy rates
3 months nominal
interest rates
3 months real interest rates
5-year real government bond
yields
Source ECB, BIS, Eurostat and Consensus
Economics Forecast. Note Monthly data 3 months
moving averages, except for policy rates which
are shown as daily data. Real yields have been
calculated as nominal yield minus HICP/CPI
inflation for the short-term rates and as nominal
yield minus Consensus long-term inflation
expectations for the long-term yields.
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Inflation and cost measures in the euro area and
the US
Consumer price inflation
CPI excl. energy and unprocessed
food
Change in unit labour costs
Source Eurostat, BIS and Bureau of labour
statistics Note For CPI and core CPI 3 months
moving averages are shown and the last
observations refers to May 2006. For ULC annual
percentage changes for quarterly data are shown.
For the US ULC refers to non-farm business sector
and to total economy for the euro area. Last
observation here refers to 2005-Q4.
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Real activity measures in the euro area and the
US
Capacity utilisation
Output gap (OECD)
Change in unemployment rate
Change in employment
Source OECD, Eurostat, European Commission and
BIS. Note Capacity utilisation, output gap and
employment are quarterly data. Capacity
utilisation refers to the manufacturing sector.
Change in employment refers to the annual
percentage change. Unemployment rate is monthly
data and refers to the three-month moving average
of the annual percentage change.
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Inflation and unemployment
Example Inflation and unemployment trends in the
US
Source St. Louis FRED database. Note Trends
are calculated based on a Hodrick-Prescott filter
with a smoothing parameter of 10,000. Last
observation refers to 2006Q1.
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Stock market price/earnings ratio
in the euro area and the US
Stock market price/earnings ratio in the euro
area and the US
Sources Thomson Financial Datastream (euro area)
and Global Financial Data (US). Notes Last
observation refers to 26 June 2006. For the euro
area the ratio between the EMU Datastream index
and Datastream earnings is used and for the US
the ratio between the SP 500 index and reported
earnings respectively.
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Stock prices, effective exchange rate and oil