1. 1 The ECBs monetary policy and macroeconomic stability since 1999 12 th 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. 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. 3 Monetary Policy Strategy – key features Definition of price stability Medium-term orientation Two-pillar approach Monetary policy in a heterogeneous currency area

4. 4 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 Definition of price stability

5. 5 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 The medium-term orientation

6. 6 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) The two-pillar approach

7. 7 Full set of information Analysis of economic dynamics and shocks Analysis of monetary trends Governing Council takes monetary policy decisions based on a unified overall assessment of the risks to price stability cross- checking Economic analysis Monetar y analysis The primary objective of price stability

8. 8 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) Monetary policy in a heterogeneous currency area

9. 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. 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

11. 11 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 Monetary policy in a heterogeneous currency area

12. 12 The first years of the euro: Macroeconomic developments

13. 13 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. The first years of the euro: inflation and inflation expectations

14. 14 (monthly data; non-seasonally adjusted) Inflation and inflation expectations in the euro area 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. 15 Rolling standard deviation of quarterly changes in consumer inflation in the euro area and the US Volatility in consumer price 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.

16. 16 Inflation and interest rates

17. 17 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. The first years of the euro: employment and real activity

18. 18 Real economic variables

19. 19 Rolling standard deviation of quarterly changes in real GDP in the euro area and the US Volatility 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.

20. 20 Example: Inflation and unemployment trends in the euro area Inflation and unemployment Source: ECB. Note: Trends are calculated based on a Hodrick-Prescott filter with a smoothing parameter of 10,000. Last observation refers to 2006Q1.

21. 21 Example: Inflation and unemployment trends in the euro area Inflation and unemployment Source: ECB. Note: Trends are calculated based on a Hodrick-Prescott filter with a smoothing parameter of 10,000. Last observation refers to 2006Q1.

22. 22 Annex I Background Charts & Tables Euro Area

23. 23 Inflation expectations in the euro area (annual percentages) Sources: Reuters, Consensus Economics and ECB; Latest observation: May 2006

24. 24 Euro area economic activity Sources: Eurostat; Latest observation: 2006 Q1.

25. 25 Source: Eurostat; Latest observation: April 2006. Euro area unemployment (change in millions; percentage of the labour force)

26. 26 Interest rates (annual percentages) Sources: NCBs, Global Financial data, BIS and Reuters. Last observation: May 2006

27. 27 Sources: BIS and ECB; Latest observation: May 2006 External value of the euro (current account balances as percentages of GDP)

28. 28 Source: Eurostat; Latest observation: May 2006 Euro area HICP inflation ( annual percentage changes)

29. 29 M3 growth (annual percentage changes) Source: ECB; Latest observation: April 2006.

30. 30 Source: ECB; Latest observation: March 2006 Loans to the private sector ( annual percentage changes)

31. 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. 32 Source: ECB; Latest observation: 19 June 2006. ECB increased interest rates by 50 basis points since December 2005 (annual percentage changes)

33. 33 Annex II Background Charts & Tables Euro Area versus US

34. 34 Interest rates in the euro area and the US Policy rates 3 months nominal interest rates 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. 3 months real interest rates 5-year real government bond yields

35. 35 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.

36. 36 Real activity measures in the euro area and the US Capacity utilisationOutput gap (OECD) Change in unemployment rateChange 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.

37. 37 Example: Inflation and unemployment trends in the US Inflation and unemployment 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.

38. 38 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 S&P 500 index and reported earnings respectively.

39. 39 Stock prices, effective exchange rate and oil