The ECB’s Two Pillars - A Success

In October 1998, just before the start of the European Monetary Union, the Governing Council of the European Central Bank (ECB) adopted a stability oriented monetary policy strategy. This strategy comprises three elements: First and foremost it contains a clear commitment to the primary goal of the ECB, which is to safeguard price stability. Price stability was defined as an annual increase in the price level of below two percent over the medium term.

The other two elements, which soon became famous under the headline of “two pillars”, serve as a means to assess the risks to the goal of price stability . The monetary analysis pillar comprises all information coming from various monetary and credit aggregates and serves to figure out the risks to price stability over the medium- to long-run . The economic analysis pillar is based on a wide set of domestic and international economic indicators from the real and financial sectors (wages, import prices, interest and exchange rates etc.). It provides a basis for the assessment of short- to medium-term price developments.

This two pillar approach constitutes a framework for cross-checking indications from the shorter-term economic analysis with those from the longer-term monetary analysis in order to obtain a robust view about the risks to price stability.

In the standard model of the neo-keynesian approach, which has become more and more “state-of-the-art”, the usefulness of money to monetary policy analysis is challenged; there is no need for monetary cross-checking, monetary analysis has no value-added and is superfluous. I am not convinced by these arguments. Customary inflation forecasts and economic analysis alone are not a sufficient basis for monetary policy decisions. While such decisions must not ignore longer-term developments, the time horizon for inflation forecasts is usually only one to two years, beyond it gets highly uncertain.