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The following OECD assessment and recommendations summarise Chapter 2 of the Economic survey of the Euro Area published on 4 January 2007.
See also the extract "The Role of Monetary Aggregates in Monetary Policy".
Monetary policy is responding to inflation pressures
The European Central Bank’s (ECB) monetary policy has succeeded in anchoring inflation expectations around the price stability objective. While inflation picked up slightly over the past year, peaking at 2.5% around mid 2006, it has eased back since then. Most of the increase is explained by the direct impact of energy prices, which have contributed around 1 percentage point to inflation in 2005 and 2006. Higher energy costs are beginning to push up other prices as they work their way through the production chain. Although there are few signs yet of second-round effects on wages, various measures of core inflation and industrial producer prices are signalling potential inflationary pressures over the next year or two. Against this background, the ECB has been withdrawing monetary stimulus since December 2005. The level of interest rates remains below most estimates of the neutral rate, so monetary policy is still supporting activity.
Contributions to inflation
Year-on-year percentage change
The ECB should continue to enhance its economic and monetary analyses and their communication
In this tightening cycle ECB statements have put emphasis on money and credit aggregates. The ECB argues that monetary growth, which has outpaced nominal GDP growth by 10 percentage points since 2003, is signalling risks to price stability over the medium term. The ECB is not alone in paying attention to money and credit developments but it is unique in elevating them to the status of one of the two pillars of its monetary policy strategy. The ECB clarified the role of the monetary pillar in 2003 and now describes it as a “cross check” on the economic analysis (the other pillar), providing information on the outlook for price developments at medium to longer horizons. There is no question that central banks should monitor monetary developments and assess their implications for price stability. The relevant question is the appropriate weight to put on money relative to other indicators of future inflation. Some commentators believe that the ECB puts too much weight on monetary indicators, partly because of recent tentative evidence that money and credit aggregates may have become less reliable as guides for policy. At the same time, a few other recent and, in part, preliminary studies find evidence in favour of the information content of money for inflation, especially over longer horizons.
The velocity of circulation has become less stable
The monetary and economic analyses are intended to complement each other and thereby aim to develop a deeper insight into the risks to price stability at various horizons in order to ensure that the most appropriate policy decisions are made. The ECB’s two pillar strategy is one response to the difficulty of finding a single model or analytical framework which encompasses both the economic and monetary analyses in a meaningful way. However, presenting monetary policy decisions to the public within this framework, which reflects the complexity of the decision-making process, poses communication challenges. In responding to these challenges, the ECB has now achieved a high degree of predictability for its monetary policy decisions over shorter horizons. Yet other challenges remain. Against this background, the ECB should continue to refine its communication strategy in order to enhance clarity. For example, concerning the economic analysis, the ECB could consider publishing more detailed staff projections and lengthening their horizon. Regarding the monetary analysis, it should describe more precisely and in more quantitative terms what today’s money growth implies for future inflation. More generally, the ECB should strive to deepen the cross-checking between the economic and monetary analyses and enhance their integration.
How to obtain this publication
The Policy Brief (pdf format) can be downloaded. It contains the OECD assessment and recommendations but not all of the charts included on the above pages.
The complete edition of the Economic survey of the Euro Area 2007 is available from:
For further information please contact the EU Desk at the OECD Economics Department at firstname.lastname@example.org. The OECD Secretariat's report was prepared by David Rae and Boris Cournède under the supervision of Peter Hoeller.