1

The ECB’s monetary policy and macroeconomic stability since 1999

12th Dubrovnik Economic ConferenceDubrovnik, 30 June 2006

Klaus MasuchEuropean Central Bank

The contents of this presentation do not necessarily reflect the views of the ECB.

2

Contents

The ECB’s monetary policy strategy: key featuresDefinition of price stabilityThe medium term orientationThe two-pillar approachMonetary policy in a heterogeneous currency area

The first years of the euro: Macroeconomic developments

Annex: tables and charts

3

Monetary Policy Strategy – key

featuresDefinition of price stabilityMedium-term orientation

Two-pillar approachMonetary policy in a heterogeneous currency

area

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

‘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

Complementary analytical perspectives

• Economic analysisFocus on shorter-term price movements (largely influenced by interplay of supply and demand in goods, services and factor markets)

• Monetary AnalysisFocus on longer-term price trends (closely linked to underlying trends in the money stock)

The two-pillar approach

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

Economicanalysis

Moneta

ry analysi

s

The primary objective of price stability

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

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.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

1990 1995 2000 2005

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Euro area US (8 regions) US (51 States)

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 AreaSources: EUROSTAT, US Bureau of Labor Statistics and ECB calculations

0

1

2

3

4

5

6

7

1990 1992 1994 1996 1998 2000 2002 2004

0

1

2

3

4

5

6

7

Euro area US (14 MSAs)

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

The first years of the euro: Macroeconomic developments

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

(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.

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

Jan-

90

Jan-

91

Jan-

92

Jan-

93

Jan-

94

Jan-

95

Jan-

96

Jan-

97

Jan-

98

Jan-

99

Jan-

00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

HICP inflation

HICP excluding unprocessed food and energy inflation

HICP inflation expectations (SPF) for the five-year period ahead

Upper bound of definition of price stability

Longer-term inflation expectations (Consensus Economics Forecasts)

Stage Three of EMU

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.

0.0

0.2

0.4

0.6

0.8

1.0

1.2

Jan-

80

Jan-

82

Jan-

84

Jan-

86

Jan-

88

Jan-

90

Jan-

92

Jan-

94

Jan-

96

Jan-

98

Jan-

00

Jan-

02

Jan-

04

Jan-

06

euro area

United States

Stage three of EMU

16

Inflation and interest rates

Euro area US Euro area US

1970-1979 9.7 7.1 2.6 2.71980-1989 6.0 5.6 3.2 3.51990-1998 2.9 3.1 1.1 1.11999-2005 2.0 2.6 0.5 0.8

1970-1979 #DIV/0! #DIV/0! #DIV/0! #DIV/0!1980-1989 #DIV/0! #DIV/0! #DIV/0! #DIV/0!1990-1998 2.8 3.5 0.5 0.51999-2005 1.9 2.5 0.1 0.1

1970-1979 8.4 7.5 1.2 1.01980-1989 11.4 10.6 2.2 2.21990-1998 8.2 6.8 2.0 1.01999-2005 4.5 4.8 0.7 0.8

1970-1979 8.3 6.3 2.0 1.91980-1989 10.9 8.8 2.4 2.81990-1998 7.6 4.9 2.8 1.31999-2005 3.1 3.0 1.0 1.7

1)

2)3)4)

Long-term inflation expectations 2)(percentage per annum)

Average Standard deviation

Consumer inflation 1)

Sources: Eurostat, BIS, AWM database (see G. Fagan, J. Henry and R. Mestre (2001), "An Area-Wide Model for the euro area", ECB Working Paper No. 42), Consensus Economics Forecast, Reuters and ECB calculations.

(year-on-year percentage change)

Short-term interest rates 4)(percentage per annum)

Long-term interest rates 3)(percentage per annum)

Based on non-seasonally adjusted monthly data. For the euro area data refer to the quarterly private consumption deflator, which has been interpolated by a cubic spline, taken from the AWM database up to 1980 and to the HICP headline index calculated by the ECB from Eurostat and national sources thereafter. Data are collected on a semi-annual basis and refer to a horizon of six to ten years. Data refer to the 10-year government bond yields or the closest available bond maturity.For the euro area data refer to the 3-month money market interest rate up to 1999 and to the Euribor thereafter. Prior to 1980, data are taken from the AWM database up to 1995 (see G. Fagan, J. Henry and R. Mestre (2001),

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

Real economic variables

Euro area US Euro area US

1970-1979 3.5 3.3 2.0 2.71980-1989 2.2 3.1 1.4 2.71990-1998 2.0 3.0 1.3 1.51999-2005 2.0 3.0 1.2 1.4

1970-1979 0.3 2.4 0.7 1.71980-1989 0.6 1.7 0.9 1.51990-1998 0.5 1.3 1.2 1.01999-2005 1.2 1.1 0.8 1.0

1970-1979 3.2 0.8 1.4 1.81980-1989 1.8 1.3 0.9 1.51990-1998 1.6 1.7 0.8 0.91999-2005 0.8 1.9 0.7 1.0

1970-1979 3.2 6.2 1.2 1.21980-1989 8.4 7.3 1.4 1.51990-1998 9.8 5.9 1.0 1.01999-2005 8.5 5.0 0.5 0.8

1)2)3)

4)

Data are taken from the AWM database up to 1995 and from Eurostat (ESA95) thereafter. Data are taken from the AWM database up to 1980 and from Eurostat (ESA95) thereafter. Data are taken from the AWM database up to 1991 and from Eurostat (ESA95) thereafter. Measured as output per employee.Data are taken from the AWM database up to 1993 and from Eurostat (ESA95) thereafter.

Sources: Eurostat, BIS, AWM database (see G. Fagan, J. Henry and R. Mestre (2001), "An Area-Wide Model for the euro area", ECB Working Paper No. 42) and ECB calculations.

(year-on-year percentage change)

Unemployment rate 4)(as % of total labour force)

Labour productivity 3)(year-on-year percentage change)

Average Standard deviation

Real GDP 1)

Total employment 2)(year-on-year percentage change)

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.

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

Jan-

80

Jan-

82

Jan-

84

Jan-

86

Jan-

88

Jan-

90

Jan-

92

Jan-

94

Jan-

96

Jan-

98

Jan-

00

Jan-

02

Jan-

04

Jan-

06

euro area

United States

Stage three of EMU

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.

1.0

3.0

5.0

7.0

9.0

11.0

1970Q1 1976Q1 1982Q1 1988Q1 1994Q1 2000Q1 2006Q1

1.0

3.0

5.0

7.0

9.0

11.0

Trend HICP inflation (%) Trend unemployment rate (%)

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.

1.0

3.0

5.0

7.0

9.0

11.0

1970Q1 1976Q1 1982Q1 1988Q1 1994Q1 2000Q1 2006Q1

-0.2

-0.1

0.0

0.1

0.2

0.3

Trend HICP inflation (%, left scale)

Change in trend unemployment rate (percentage points, right scale)

22

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

1.0

1.5

2.0

2.5

3.0

1999 2000 2001 2002 2003 2004 2005 2006

1.0

1.5

2.0

2.5

3.0

ten-year break-even inflation rate (monthly average)

upper bound of definition of price stability (below 2%)

inflation expectations 5 to 10 years ahead (Consensus Economics Forecasts)

HICP inflation expectations (SPF) for the five-year period ahead

24

Euro area economic activity

Sources: Eurostat; Latest observation: 2006 Q1.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

annual percentage changes (LHS)

quarter-on-quarter percentage changes (RHS)

25

Source: Eurostat; Latest observation: April 2006.

Euro area unemployment

(change in millions; percentage of the labour force)

7.0

7.5

8.0

8.5

9.0

9.5

10.0

1999 2000 2001 2002 2003 2004 2005 2006

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

unemployment (r.h.s.)

annual change in millions (l.h.s.)

26

Interest rates

(annual percentages)

Sources: NCBs, Global Financial data, BIS and Reuters. Last observation: May 2006

1

3

5

7

9

11

13

15

17

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

1

3

5

7

9

11

13

15

17

short-term interest rate

long-term interest rate

27

Sources: BIS and ECB; Latest observation: May

2006

External value of the euro

(current account balances as percentages of GDP)

60

70

80

90

100

110

120

130

140

150

160

1980 1985 1990 1995 2000 2005

0.6

0.8

1.0

1.2

1.4

1.6

usd/eur (right-hand scale)

real effective euro exchange rate (left-hand scale)

28

Source: Eurostat; Latest observation: May 2006

Euro area HICP inflation

(annual percentage changes)

0.5

1.0

1.5

2.0

2.5

3.0

3.5

1999 2000 2001 2002 2003 2004 2005 2006

0.5

1.0

1.5

2.0

2.5

3.0

3.5

excluding unprocessed food and energy

overall index

29

M3 growth(annual percentage changes)

Source: ECB; Latest observation: April 2006.

0

3

6

9

12

15

1999 2000 2001 2002 2003 2004 2005 2006

0

3

6

9

12

15

M3

M1

30

Source: ECB; Latest observation: March 2006

Loans to the private sector(annual percentage changes)

3.0

5.0

7.0

9.0

11.0

13.0

1999 2000 2001 2002 2003 2004 2005 2006

3.0

5.0

7.0

9.0

11.0

13.0

non-financial corporations

households

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.

Weight 2001 2002 2003 2004 2005 2006

H1 H2 Q1 Q2 Q3 Q4 Q1

Belgium 1) 3.7% 6.8 6.7 7.6 6.2 10.7 17.1 18.3 16.1 17.7 18.8 16.1 16.0 -

Germany 2) 28.6% -0.5 0.2 -1.2 -1.3 -1.5 -1.6 - - - - - - -

Greece 2) 2.2% 10.5 14.5 13.0 5.7 2.6 - 8.9 - 7.3 10.4 - - -

Spain 2) 10.8% 7.7 15.6 16.7 17.6 17.3 13.9 14.8 13.1 15.7 13.9 13.4 12.8 12.0

France 3) 21.3% 4.4 7.9 8.3 11.7 15.2 15.2 15.5 14.9 15.7 15.3 15.5 14.2 -

Ireland 2) 1.9% 21.0 8.1 10.1 15.2 11.4 - - - 11.1 10.5 11.5 - -

Italy 2) 17.9% 2.0 8.0 13.0 9.9 9.1 9.9 11.6 8.4 - - - - -

Luxembourg 1) 0.3% 3.7 13.8 11.9 13.3 - - - - - - - - -

Netherlands 3) 6.3% 14.2 11.2 8.5 5.0 4.3 4.8 5.0 4.6 5.1 4.9 4.7 4.4 4.4

Austria 2) 4) 3.1% -1.8 2.1 0.2 0.3 -2.1 5.2 6.9 3.6 9.5 4.3 4.1 3.1 -

Portugal 2) 1.8% 5.8 3.6 1.1 1.6 0.4 - 1.9 - 0.5 3.2 - - -

Finland 2) 2.0% 10.6 -0.5 7.4 6.2 7.1 6.1 4.4 7.9 4.0 4.7 6.7 9.0 11.5

Euro area 2)100% 3.8 5.6 6.8 6.8 7.2 7.5 7.8 7.2 - - - - -

1997-

2000

2005 2005

32

Source: ECB; Latest observation: 19 June 2006.

ECB increased interest rates by 50 basis points since December 2005

(annual percentage changes)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

1999 2000 2001 2002 2003 2004 2005 2006

0.0

1.0

2.0

3.0

4.0

5.0

6.0

overnight interest rate

main refinancing/minimum bid rate

marginal rate on MRO

marginal lending rate

deposit rate

33

Annex II

Background Charts & Tables

Euro Area versus US

34

Interest rates in the euro area and the US

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

euro area

United States

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

euro area

United States

0.0

1.0

2.0

3.0

4.0

5.0

0.0

1.0

2.0

3.0

4.0

5.0

euro area

United States

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

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

euro area

United States

35

Inflation and cost measures in the euro area and the US

0.5

1.0

1.5

2.0

2.5

3.0

0.5

1.0

1.5

2.0

2.5

3.0

euro area

United States

0.0

1.0

2.0

3.0

4.0

5.0

0.0

1.0

2.0

3.0

4.0

5.0

euro area

United States

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.

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

euro area

United States

36

Real activity measures in the euro area and the US

-2.0

-1.0

0.0

1.0

2.0

3.0

Jan-

99

Jul-9

9

Jan-

00

Jul-0

0

Jan-

01

Jul-0

1

Jan-

02

Jul-0

2

Jan-

03

Jul-0

3

Jan-

04

Jul-0

4

Jan-

05

Jul-0

5

Jan-

06

-2.0

-1.0

0.0

1.0

2.0

3.0

euro area

United States

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

euro area

United States

70

72

74

76

78

80

82

84

86

70

72

74

76

78

80

82

84

86

euro area

United States

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.

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

Jan-

99

Jul-9

9

Jan-

00

Jul-0

0

Jan-

01

Jul-0

1

Jan-

02

Jul-0

2

Jan-

03

Jul-0

3

Jan-

04

Jul-0

4

Jan-

05

Jul-0

5

Jan-

06

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

euro area

United States

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.

1.0

3.0

5.0

7.0

9.0

1970Q1 1976Q1 1982Q1 1988Q1 1994Q1 2000Q1 2006Q1

1.0

3.0

5.0

7.0

9.0

Trend CPI inf lation (%) Trend unemployment rate (%)

38

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 S&P 500 index and reported earnings respectively.

0

5

10

15

20

25

30

35

40

45

50

1871 1881 1891 1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001

United States euro area US average euro area average

39

Stock prices, effective exchange rate and oil

Euro area US Euro area US

1970-1979 28.0 33.1 13.4 19.91980-1989 42.8 45.0 18.6 19.71990-1998 16.8 21.7 3.8 5.81999-2005 27.5 29.3 7.5 9.8

1970-1979 0.1 -0.4 6.0 4.01980-1989 0.5 0.6 7.3 3.81990-1998 0.7 0.9 4.2 3.11999-2005 0.1 -0.1 4.6 3.6

1970-1979 0.2 -0.3 1.1 1.21980-1989 -0.1 0.0 1.6 1.81990-1998 -0.1 0.1 1.3 1.41999-2005 0.0 0.0 1.6 1.3

1)2)

Sources: IMF, BIS, Global Financial Data and ECB calculations.For the euro area data refer to the EuroStoxx index and for the US to the S&P 500.Against the currencies of 27 trading partners.

Real CPI-deflated effective exchange rate 2)(month-on-month percentage change)

Average

(per barrel; base year: 2000)

Real Stock market returns 1)(month-on-month percentage change)

Standard deviation

Real CPI-deflated oil price in national currency