ECB's Monetary Policy Strategy Research Articles

Is the ECB already following albeit implicitly an average inflation targeting strategy?

A fundamental aspect of the ECB's monetary policy strategy is that it aims to pursue price stability over the medium term. However, the ECB has not defined the medium term with reference to a predetermined horizon. To shed some light on how the horizon of price stability is being achieved in practice, we have estimated a regression where the ECB policy interest rate is expressed as function of a j-period centered moving average of inflation forecasts, which may capture the length of the medium-term horizon orientation of monetary policy. We have tested for different combinations of policy horizons, and forecast horizons, to achieve the best fit. Allowing j to vary from 1 year (corresponding the standard inflation targeting regime) to a normal length of an economic cycle, we keep the model sufficiently general, and we let the data speak for itself. We have found that the ECB is targeting price stability over a period in between four years and a half and five years, implying that the ECB is area1dy following, albeit implicitly, a hybrid approach to price stability in line with average inflation target. This result is robust when we control for the Central Bank desire to avoid excessive policy interest rate variability due to the presence of policy interest rate adjustment costs.

The Mandate of the ECB: Legal Considerations in the Ecb's Monetary Policy Strategy Review

The Mandate of the ECB: Legal Considerations in the Ecb's Monetary Policy Strategy Review

Inflation Measurement and its Assessment in the Ecb's Monetary Policy Strategy Review

This paper – which takes into consideration overall experience with the Harmonised Index of Consumer Prices (HICP) as well as the improvements made to this measure of inflation since 2003 – finds that the HICP continues to fulfil the prerequisites for the index underlying the ECB’s definition of price stability. Nonetheless, there is scope for enhancing the HICP, especially by including owner-occupied housing (OOH) using the net acquisitions approach. Filling this long-standing gap is of utmost importance to increase the coverage and cross-country comparability of the HICP. In addition to integrating OOH into the HICP, further improvements would be welcome in harmonisation, especially regarding the treatment of product replacement and quality adjustment. Such measures may also help reduce the measurement bias that still exists in the HICP. Overall, a knowledge gap concerning the exact size of the measurement bias of the HICP remains, which calls for further research. More generally, the paper also finds that auxiliary inflation measures can play an important role in the ECB’s economic and monetary analyses. This applies not only to analytical series including OOH, but also to measures of underlying inflation or a cost of living index. JEL Classification: C43, C52, C82, E31, E52

German Bond Yields and Debt Supply: Is There a 'Bund Premium'?

Are Bunds special? This paper estimates the 'Bund premium' as the difference in convenience yields between other sovereign safe assets and German government bonds adjusted for sovereign credit risk, liquidity and swap market frictions. A higher premium suggests less substitutability of sovereign bonds. We document a rise in the 'Bund premium' in the post-crisis period. We show that there is a negative relationship of the premium with the relative supply of German sovereign bonds, which is more pronounced for higher maturities and when risk aversion proxied by bond market volatility is high. Going forward, we expect German government debt supply to remain scarce, with important implications for the ECB's monetary policy strategy.

A monetary policy strategy in good and bad times: lessons from the recent past

We evaluate the ECB's monetary policy strategy against some of the underlying economic features of the eurozone, in normal times and during the financial crisis. We show that in the years preceding the crisis the ECB's emphasis on monetary indicators and deliberate avoidance of excessive activism were justified by the underlying macroeconomic conditions that the ECB faced in the eurozone and contributed to avoid more volatile patterns of inflation and economic activity. After the collapse of financial intermediation in late 2008, the strategy of the ECB was to adopt several non‐standard policy measures. According to our quantitative evaluation of the impact of the main non‐standard policies decided in October 2008 and in May 2009, which notably did not include entering commitments regarding the future path of the policy rate, such measures have significantly contributed to preserving price stability and forestalling a more disruptive collapse of the macroeconomy. — Stephan Fahr, Roberto Motto, Massimo Rostagno, Frank Smets and Oreste Tristani

A Monetary Policy Strategy in Good and Bad Times: Lessons from the Recent Past

We evaluate the ECB's monetary policy strategy against the underlying economic structure of the euro area economy, in normal times and in times of severe financial dislocations. We show that in the years preceding the financial crisis that started in 2007 the strategy was successful at ensuring macroeconomic stability and steady growth despite shocks to the supply side and to the transmission mechanism which complicated the policy process. Emphasis on monetary indicators in the ECB's monetary policy strategy JEL Classification: E31, E44, E51, E58

The Bundesbank and the formation of the ECB's monetary policy strategy

The ECB is almost a complete copy of the Bundesbank's organization, having adopted the Bundesbank's definition of price stability and its monetary targeting strategy. But rather than following simply from coercive power attached to the relative size of the German economy and EU budget contribution, the decision to emulate the German monetary policy model was the result of the persuasive power of the Bundesbank, the domestic success of the German model, and the hope held by European central bankers and many European politicians that success could be replicated on the European level. The primary interests of European central bankers were to appear competent and to maintain their independence; their search for the monetary policy ideas that provided the best chance of achieving these goals led to the German model.

Hat die Geldmenge ausgedient?. Plenumsvortrag zur Jahrestagung des Vereins fur Socialpolitik

Abstract: This article reconsiders the role of money in three dimensions of monetary policy: an empirical dimension concerning the link between money and macro-economic target variables, a theoretical dimension concerning the role of monetary aggregates in models of monetary policy, and a strategic dimension, concerning the use of monetary aggregate in the design and communication of monetary policy strategies. We review recent research and present empirical evidence for the euro area and other countries. We show that money growth is a reliable indicator of euro-area inflation in the medium and long run. In contrast, the usefulness of money to predict short-run inflation is small in times when inflation and money growth are both low and relatively stable. We show that, although the presentation of models of monetary macro-economics has changed, the role of money is still the same within these models. The strategic role of money changes over time: money moves to the foreground, when inflation is too high, and it stays in the background when inflation is low. Since there is little reason to believe that inflation will always be low in the euro area, we expect that money will regain importance in the ECB's monetary policy strategy sooner or later.

Forecasting euro area inflation: Does aggregating forecasts by HICP component improve forecast accuracy?

Monitoring and forecasting price developments in the euro area is essential in light of the two-pillar framework of the ECB's monetary policy strategy. This study analyses whether the accuracy of forecasts of aggregate euro area inflation can be improved by aggregating forecasts of subindices of the Harmonized Index of Consumer Prices (HICP) as opposed to forecasting the aggregate HICP directly. The analysis includes univariate and multivariate linear time series models and distinguishes between different forecast horizons, HICP components and inflation measures. Various model selection procedures are employed to select models for the aggregate and the disaggregate components. The results indicate that aggregating forecasts by component does not necessarily help forecast year-on-year inflation 12 months ahead.

Price Stability and the Ecb's Monetary Policy Strategy

This paper focuses on the price stability objective within the framework of the single monetary policy strategy. It starts by reviewing what this objective, which is common to all central banks, means. Secondly, this paper will focus exclusively on the anchoring of short- to medium-term inflation expectations (Part 2). Several measures show that this anchoring is effective. Modern New Keynesian theory is an appropriate framework for analysing the impact that this anchoring of expectations has on the determination of the short- to medium-term inflation rate. From this point of view, observed inflation in the euro area seems to be in line with the theory and the ECB's action seems to be very effective. Thirdly, we will focus on the other aspect of monetary stability: the degree of price-level uncertainty and the anchoring of inflation expectations in the medium to long term. Even though this assessment is more difficult than it is in the short to medium term, since we only have a track record covering five years, various indicators from the theoretical analysis paint a fairly reassuring picture of the effectiveness of the device used by the ECB.

Downward Nominal Wage Rigidity and the Long-Run Phillips Curve: Simulation-Based Evidence for the Euro Area?

This paper summarises the results of a quantitative study of the possible impact of downward nominal wage rigidity on the determination of inflation and output in the euro area and the existence of a non-vertical long-run Phillips curve. The study was undertaken in the context of the review of the ECB's monetary policy strategy in Spring 2003 and complements an investigation of the consequences of the zero-interest-rate bound for monetary policy-making in the euro area, the results of which are summarised in Coenen (2003).

Forecasting Euro Area Inflation: Does Aggregating Forecasts by Hicp Component Improve Forecast Accuracy?

Monitoring and forecasting price developments in the euro area is essential in the light of the second pillar of the ECB's monetary policy strategy. This study analyses whether the forecasting accuracy of forecasting aggregate euro area inflation can be improved by aggregating forecasts of subindices of the Harmonized Index of Consumer Prices (HICP) as opposed to forecasting the aggregate HICP directly. The analysis includes univariate and multivariate linear time series models and distinguishes between different forecast horizons, HICP components and inflation measures. Various model selection procedures are employed to select models for the aggregate and the disaggregate components. The results indicate that aggregating forecasts by component does not necessarily help forecast year-on-year inflation twelve months ahead.

Exchange Rates and Monetary Policy

This paper looks at the relation between exchange rates and monetary policy. It focuses in particular on the role of the exchange rate of the euro in the context of the ECB's monetary policy strategy. The objective of monetary policy is to maintain price stability. The euro area is a large and relatively closed economy. Therefore, the exchange rate of the euro is not an intermediate target nor is it an objective. Nevertheless, the ECB's stability–oriented monetary policy strategy does not neglect the exchange rate of the euro. Clearly, exchange rate developments are taken into account both when looking at the transmission mechanism of monetary policy and when assessing the current economic situation and prospects for the euro area.

The Eurosystem's Operational Framework in the Context of the ECB's Monetary Policy Strategy

The Eurosystem's Operational Framework in the Context of the ECB's Monetary Policy Strategy

The ECB monetary policy strategy and the money market

AbstractThis paper aims at contributing to the understanding of how the ECB conducts monetary policy as seen from a money market perspective. More specifically it covers two different issues. First, it looks at the ‘learning period’ for banks since the Eurosystem started implementing the single monetary policy. It shows that during the first three weeks of 1999 the narrow corridor in place during this period was effective in limiting daily volatility of the money market overnight rates. In addition, the behaviour of banks and market rates during this period provides evidence that learning was taking place. Second, it looks at how well money market participants have anticipated the monetary policy decisions taken by the ECB. To do so, the paper analyses whether the announcements of monetary policy decisions to maintain or change interest rates impact on the stochastic behaviour of interest rates. Looking at the EONIA rates within the reserve maintenance periods, we find that the announcement of monetary policy decisions does not change significantly the level or volatility of overnight rates. Copyright © 2001 John Wiley & Sons, Ltd.

The Eurosystem's Operational Framework in the Context of the ECB's Monetary Policy Strategy

This paper discusses the implications of the European Central Bank's monetary policy strategy for the Eurosystem's operational framework, in the context of the transmission mechanism of monetary policy in the euro area. The first part of the paper uses an analytical framework common to many recent analyses of monetary policy to distinguish the operational and strategic elements of monetary policy making. The second part of the paper describes and discusses the choices made by the ECB and the Eurosystem with regard to monetary policy strategy and operational framework. In this respect, the paper highlights that the design of both these aspects of the single monetary policy reflect, in large part, the need for policy makers to retain flexibility in the face of an uncertain environment.

The ECB Monetary Policy Strategy and the Money Market

This paper aims at contributing to the understanding of how the ECB conducts monetary policy as seen from a money market perspective. More specifically it covers two different issues. First, it looks at the 'learning period' for banks since the Eurosystem started implementing the single monetary policy. It shows that during the first three weeks of 1999 the narrow corridor in place during this period was effective in limiting daily volatility of the money market overnight rates. In addition, the behaviour of banks and market rates during this period provides evidence that learning was taking place. Second, it looks at how well money market participants have anticipated the monetary policy decisions taken by the ECB. To do so, the paper analyses whether the announcements of monetary policy decisions to maintain or change interest rates impact on the stochastic behaviour of interest rates. Looking at the EONIA rates within the reserve maintenance periods, we find that the announcement of monetary policy decisions does not change significantly the level or volatility of overnight rates. JEL Classification: E52, C22

The Monetary Policy of the European Central Bank and the Euro-Dollar Exchange Rate

The aim of the research is the evaluation of the exchange rate of the Euro after the first six months of its existence. The main interpretative hypotheses of the research can be summarized in the following points: (i) the evolution of the Euro external value is strictly connected with the agents? confidence on real, financial and foreign exchange markets; (ii) the ECB monetary policy strategy influenced negatively (or at least neglected) the agents? confidence and expectations already affected by the negative cyclical conditions of european economy; (iii) the resulting portfolio reallocation determined a short-term capital outflow in favour of US Dollar denominated assets and, hence, an Euro depreciation. The consistency of the whole framework is checked by variables as the Industrial Sentiment, the Interest-Rate Spread, the Implied Volatility of exchange rates, the Risk Reversal, and by the building of a Structural Autoregressive Model.