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... А Б В Г Д Е Ж З И К Л М Н О П Р С Т У Ф Х Ц Ч Ш Щ Э Ю Я

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Европейская денежная система

brand new institution, the ESCB will have no track record of its own.

Building its reputation, and the associated credibility of monetary

policy, is vital. But the process of doing so is complicated by the

relatively high level of uncertainty surrounding the transition to Monetary

Union itself. The transition to Stage Three is a unique event, and will

create unique opportunities for many - but it will also create some unique

problems for monetary policy makers. At the ECB, we are addressing these

problems and are confident that the risks can be managed successfully. Many

of the difficulties we face will be overcome through our own efforts over

the coming months.

Among these problems are the difficulties involved in creating a

comprehensive and accurate database of euro area-wide statistics. Running a

single monetary policy for the euro area requires timely, reliable and

accurate euro area data. In some cases, the euro area statistics simply did

not exist until quite recently. In others, the statistics are based on new

concepts, and the properties of the data series are not yet well known. The

long runs of high quality back-data required for empirical economic

analysis may be unavailable. Those that do exist are likely to have been

constructed using some degree of estimation and judgement, possibly

rendering the econometric results produced with them questionable.

Furthermore, the regime shift associated with the adoption of the

single monetary policy may change the way expectations are formed in the

euro area, and thereby alter forward-looking economic behaviour. Monetary

policy's effects on consumption, investment, and wage bargaining - and

therefore the whole transmission mechanism of monetary policy to

developments in the price level - would be among the important economic

relationships to be affected in this way.

This may be no bad thing. Indeed, using the regime shift implied by

the transition to Stage Three to change both public and private sector

behaviour in favourable directions may be one of the largest gains that the

euro area can extract from Monetary Union. Nevertheless, these changes are

likely to complicate the implementation of certain important elements of a

monetary strategy, at least in the short term, as past relationships

between macroeconomic variables may break down. What is good for the euro

area economy as a whole may create some practical problems for the ESCB.

One example of this so-called 'Lucas critique' phenomenon is the

impact of current, very low rates of inflation on private behaviour. For

many countries participating in Monetary Union, there is simply no - or

only very recent - experience of how the private sector will behave in an

environment of sustained and credible low inflation. Instability in past

relationships may result, should behaviour change in this new, low

inflation environment. I have already argued that these structural changes

will benefit Europe's citizens - price stability will allow markets to work

more efficiently, thereby raising growth, and improving employment

prospects. But these changes may also complicate the ESCB's assessment of

economic and financial conditions.

These uncertainties - arising directly from the transition to Stage

Three itself - are both compounded by, and inter-related with, the broader

economic context in which Monetary Union will be established. The

increasing internationalisation of the global economy, and the current

rapid pace of technological change, have affected all sectors of the

economy, and the banking and financial systems in particular. For example,

at present there are many, inter-related innovations in the payments

system, such as:

* the introduction of TARGET (directly related to EMU itself);

* greater technological sophistication of payments mechanisms,

as use of computers and information technology becomes more

widespread and advanced;

* the additional incentive for cash-less payments that may

arise from the fact that for some time to come -

approximately three years - the new euro-denominated notes

and coin will not come into circulation. In particular,

narrow monetary aggregates might be affected by this

development; and,

* increased competition among banks and settlements systems,

arising from globalisation and the breakdown of barriers

between previously segmented national markets, which may

drive down the margins and fees charged to customers.

At the ESCB we will need to keep abreast of these developments, both

for their immediate impact on one of our "basic tasks" - promoting the

smooth operation of the payments system - and because of their broader

implications for the euro area economy. Reducing transactions costs in the

way I just described will benefit European consumers and producers - but it

may also change the indicator properties of monetary, financial and

economic variables that national central banks have looked to as guides for

monetary policy in the past.

Finally, in Monetary Union there will be some heterogeneity across

countries within the euro area. Europe's diversity is one of its greatest

assets. But this diversity is greater than is typically the case between

different regions in the same country using a single currency.

Nevertheless, the ECB Governing Council will have to concentrate on

monetary and economic developments in the euro area as a whole when

discussing and taking monetary policy decisions.

How should a monetary policy strategy be selected in this - for

monetary policy makers, at least - potentially difficult environment? The

EMI outlined a number of 'guiding principles' for the selection of a

monetary strategy by the ESCB. Foremost amongst these was the principle of

'effectiveness'. The best monetary policy strategy for the ESCB is the one

which best signals a credible and realistic commitment to, and ensures

achievement of, the primary objective of price stability.

For many commentators, this criterion points unambiguously in the

direction of so-called 'direct inflation targeting'. If monetary strategies

are to be judged according to how well they achieve price stability,

defined as a low rate of measured inflation, then advocates of inflation

targets argue an optimal strategy would surely target this low inflation

rate directly. These commentators would place explicit quantitative targets

for inflation itself at the centre of the ESCB's monetary policy strategy.

Their approach has been strongly endorsed in some academic and central

banking circles.

But, in the current circumstances, a pure 'direct inflation

targeting' strategy is too simplistic for the ESCB, and possibly even mis-

conceived. The ESCB well understands the primacy of price developments and

price stability for monetary policy making. Indeed, the Treaty's mandate is

unambiguous in this respect. We will signal our intentions on this

dimension very clearly by making a transparent public announcement of our

definition of price stability. The current low level of long-term nominal

interest rates in the euro area suggests that the financial markets, at

least, understand and believe the over-riding priority that we attach to

achieving price stability.

Regarding strategy, our choice therefore need not be governed solely

by a desire to signal our intent to maintain price stability. This has

already been well-established - by the Treaty, and by the success of the

convergence process in reducing inflation in Europe to its current low

level. Rather than signalling our intent, the strategy must constitute a

practical guide that ensures monetary policy is effective in achieving the

goal we have been set.

In this respect, there are considerable problems with using inflation

itself as the direct target within the ESCB's overall strategy. Because of

the well-known lags in the transmission mechanism of monetary policy to the

economy in general, and the price level in particular, it is impossible for

a central bank to control inflation directly. Therefore, 'inflation

targeting' in practice means 'inflation forecast targeting' where central

banks set monetary policy to keep their best forecast of inflation at the

target level deemed consistent with price stability.

But recognition of this need for forecasts in an inflation targeting

strategy immediately raises practical difficulties. In the uncertain

environment likely to exist at the outset of Monetary Union, forecasting

inflation will be very difficult, not least for the conceptual, empirical

and practical reasons I outlined a moment ago. Forecasting models estimated

using historic data may not offer a reliable guide to the behaviour of the

euro area economy under Monetary Union. Forecast uncertainty is likely to

be relatively large, possibly rendering the whole inflation targeting

strategy ineffective.

To address these uncertainties, a large element of judgement would

have to be introduced into the forecasting process, in order to allow for

the regime shifts and structural and institutional changes that are a

seemingly inevitable consequence of EMU. Simply relying on historic

relationships to forecast future developments is unlikely to prove accurate

or effective. While introducing judgmental adjustments into forecasts in

these circumstances would be both appropriate and necessary, such

adjustments are likely to compromise the transparency of the inflation

forecasts and, thus, of any inflation targeting strategy. Using judgement

may prevent outside observers from readily assessing the reliability and

robustness of the inflation forecasting procedures used by the ESCB.

I see a distinct bias in the academic discussion of the comparative

advantages of inflation targeting and monetary targeting. With good reason,

many arguments are presented against the ESCB adopting a monetary target.

But proponents of inflation targeting seem to forget that, in the current

context, most of these arguments could also be used against inflation

targeting. Above all, I have not seen any attempt thus far - even if only a

tentative one - to explain how the ESCB should deal with the specific

difficulties involved in making an inflation forecast at the outset of

Monetary Union that could be used as the centrepiece of an inflation

targeting strategy.

In many respects, a strategy giving a prominent role to monetary

aggregates has considerable advantages over direct inflation targeting.

Monetary aggregates are published. They are clearly not subject to various

kinds of 'judgmental manipulation' by policy makers or central bank staff

that might be possible with inflation forecasts. To the extent that policy

makers wish to depart from the signals offered by monetary growth because

of 'special factors' or 'distortions' to the data - including those

distortions arising from the transition to Monetary Union itself - they

will have to do so in a public, clear and transparent manner.

Moreover, a strategy that assigns a prominent role to the monetary

aggregates emphasises the responsibility of the ESCB for the monetary

impulses to inflation, which a central bank can control more readily than

inflation itself. These monetary impulses are the most important

determinants of inflation in the medium term, while various other factors,

such as terms of trade or indirect tax shocks, may influence the price

level over shorter horizons.

In the light of these considerations, it was agreed at the EMI that,

regardless of the final choice of the monetary policy strategy, monetary

aggregates would be accorded a prominent role in the overall monetary

framework adopted by the ESCB.

However, the EMI also noted that certain technical pre-conditions

would have to be met before this 'prominent role' could be translated into

an explicit, publicly announced monetary target, guideline, benchmark or

monitoring range. Specifically, such targets or ranges would only be

meaningful guides to monetary policy if the relationship between money and

prices - as encapsulated in a 'demand for money' equation - was expected to

remain sufficiently stable.

In this regard, several existing empirical studies point towards the

stability of the demand for euro area-wide monetary aggregates. However,

these studies are necessarily only preliminary. The reliability of these

results in the face of the uncertainties raised by the transition to Stage

Three is unknown. Future shifts in the velocity of money are certainly

possible - perhaps even likely. They cannot be predicted with certainty.

Moreover, it is not clear whether those aggregates that have the best

results in terms of stability are sufficiently controllable in the short-

term with the policy instruments available to the ESCB. In these

circumstances, relying on a pure strategy of strict monetary targeting is

simply too risky.

Against this background, the ESCB will have to design a monetary

policy strategy of its own. The chosen strategy will show as much as

possible continuity with the successful strategies that participating NCBs

conducted in the Stage Two. At the same time the ESCB's strategy will take

into account to the extent needed the unique situation created by the

introduction of the euro.

4. The new monetary policy instruments and procedures for the euro


Having a well-designed monetary strategy is vital. But we must also

be able to implement it successfully at an operational level. What

instruments are available to implement this strategy?

The ECB will have a complete set of monetary policy instruments at

its disposal. These instruments have been selected on the basis of their

efficiency for transmitting monetary policy and their neutrality across

market participants.

Three types of instruments are available to the ESCB: open market

operations, standing facilities and a minimum reserve system. I will

briefly present these instruments in the remainder of my speech.

4.1 Open market operations

Open market operations include, first, a weekly main refinancing

operation, which will take the form of a reverse repurchase transaction

with a maturity of two weeks. The main refinancing operation will be based

on a tender procedure. The tender may be a fixed rate tender, with

counterparties bidding amounts, or a floating rate tender, where

counterparties propose bids including both amounts and interest rates.

Second, there is the monthly longer term refinancing operation, which

has a maturity of three months and will always take the form of an interest

rate tender. This is because the ECB will avoid signalling its monetary

policy stance through these particular operations.

The ECB will also conduct fine-tuning operations, through the

national central banks of the euro area or, in exceptional circumstances,

on its own account. Fine tuning operations will be conducted whenever

liquidity or money market conditions warrant. Fine tuning operations may

take the form of reverse repurchase transactions (that is, the same type of

transaction as that used in the main refinancing and the longer term

refinancing operations, but with no pre-set start date nor a pre-set

maturity), foreign exchange swaps or the taking of fixed-term deposits.

Fine tuning operations in the form of reverse repurchase operations may be

executed either through quick tenders or bilaterally. In both cases, these

operations will involve a limited set of eligible counterparties that have

an appropriate track record of activity in the money market. The other

types of fine tuning operations will also be executed with a limited number

of eligible counterparties, which will be selected ex ante by the ECB. In

some countries, there will be a rotation scheme, which will aim at giving

the opportunity to all eligible fine tuning counterparties to participate

in fine tuning operations.

Finally, open market operations may also be conducted whenever

structural reasons, such as the longer-term evolution of liquidity

profiles, warrant it. These so-called structural operations may take the

form of outright purchases or sales of securities or the issuance of debt

certificates by the ECB.

4.2 Standing facilities

The ECB will operate two overnight standing facilities, which will be

available to all credit institutions at national central banks of the euro

area, provided that, when using the marginal lending facility, they have

sufficient collateral. The rate of the marginal lending facility will

constitute the upper bound of collateralised overnight money market rates.

The deposit facility will be remunerated at a rate that will constitute the

lower bound of overnight money market rates.

When using the marginal lending facility, or, for that matter, when

entering in liquidity-providing open market operations in the form of

reverse transactions, counterparties have to post assets with their

national central bank (or the ECB in the exceptional case when the ECB

conducts fine tuning operations on its own account). These assets are meant

to act as guarantees for credits received from the European System of

Central Banks. A list of eligible assets has been drawn up for this

purpose. The list comprises a wide variety of assets and has two sub-sets.

First, the so-called tier one assets, which are selected by the ECB

according to uniform criteria relating to their credit standing in the

whole euro area. Second, the so-called tier two assets, which have been

selected by the ECB because they are of particular importance for certain

national banking systems of the euro area, in order to promote a certain

degree of continuity at the start of the Stage Three of EMU. Two principles

of equal treatment are applied, however. First, the credit standing of tier

two assets is as high as that of tier one assets. Second, both tier one and

tier two assets may be used by any credit institution in the euro area,

irrespective of its location.

In addition, a set of risk control measures has been elaborated to

ensure that, for any counterparty, the amount of assets provided is always

sufficient. Risk control measures cover the assets' price and credit risks,

taking account of the asset type, its characteristics and the maturity of

the transaction. The ECB's risk control measures have been elaborated with

careful attention to the best market practices in this area. They include

the deduction of haircuts from the assets and the imposition of initial

margins to the credit amount. Another feature of the risk control framework

is the regular revaluations of the assets, which will, in most cases, take

place daily and may trigger margin calls, most often to be settled through

delivery of additional assets.

4.3 Minimum reserve system

The ECB will also apply a minimum reserve system to credit

institutions of the euro area. Two main monetary policy objectives have

been assigned to the minimum reserve system. The first objective is to

stabilise money market interest rates through the averaging mechanism,

whereby the fulfilment of minimum reserve requirements is based on average

reserve holdings over monthly periods of time. During the maintenance

period, this allows the banking system to absorb liquidity shocks. The

reduced volatility of money market rates will reduce the need for frequent

fine tuning operations, which will mean that markets are less distorted by

central bank interventions than they would otherwise be. The second

objective of the minimum reserve system is to enlarge the demand for

central bank money, so as to enlarge the liquidity deficit of the banking

system vis-а-vis the ESCB. This will safeguard the role of the European

System of Central Banks as a provider of liquidity to the banking system.

Reserve requirements will be calculated by applying a reserve ratio

of 1.5% to 2.5% to the deposits, debt securities and money market paper

issued by credit institutions, except for residual maturities above two

years. Although repurchase agreements are included in the reserve base,

they will be subject to a zero reserve ratio. In 1999\SCHD-MAY.DOCf[pic]1 T-

-#"+ !-+ 1999\PROT10.DOCfter-bank liabilities and liabilities vis-а-vis

the ESCB will not be subject to reserve requirements. An allowance of the

order of E 100,000 will be deducted from reserve requirements, so that

credit institutions with a small reserve base will not have to hold minimum


Reserve holdings will be remunerated up to the required reserve

level, at the rate of the main refinancing operation (as averaged over a

month). It may be argued that a less than full remuneration of minimum

reserves would increase the interest rate elasticity of central bank money

demand. This notwithstanding, the ECB has decided in favour of a full

remuneration of minimum reserves in view of the distortion to efficient

markets that a less than full remuneration would have implied. As a result

of the full remuneration of minimum reserves, the European Central Bank has

also decided not to exempt any credit institution from the minimum reserve


4.4 Procedures

The ECB will have many counterparties and be subject to close public

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