EP 011 . tex What Is Wrong with the Eurosystem ’ s Money - Growth Indicator , and What Should the Eurosystem Do about It ? ¤ Lars

The primary objective of Eurosystem monetary policy is to maintain price stability, de…ned as an annual increase in the HICP below two percent. 1 Because of the lags in the e¤ects of monetary-policy actions on aggregate demand and in ‡ation, monetary-policy actions cannot a¤ect current in ‡ation and output, nor in ‡ation or output in the near future. A rough benchmark is that monetary policy a¤ects output in about a year and in ‡ation in about two years. Therefore, Eurosystem monetary policy has to be guided by in ‡ation forecasts about two years ahead. As discussed further in Svensson [11], for successful policy, the Eurosystem must construct conditional in ‡ation forecasts. These forecasts should depend on all relevant information, including the Eurosystem's view of the transmission mechanism for monetary policy, its view of the current economic and monetary situation within and outside the Euro area, information about current and future …scal policy, private-sector in ‡ation expectations, etc. In particular, the forecasts should be contingent on alternative paths for the monetary-policy instrument rate, that is, the interest rate on the main re…nancing operations. This way, the Eurosystem can select an instrument-rate path, for which the conditional in ‡ation forecast about two years ahead is in line with the de…nition of price stability, and then set the instrument rate accordingly. ¤ Brie…ng paper for the Committee on Economic and Monetary A¤airs (ECON) of the European Parliament for the quarterly dialogue with the President of the European Central Bank. I thank Stefan Gerlach for comments and Annika Andreasson for secretarial and editorial assistance. Expressed views and any errors are solely my own responsibility. 1 As many commentators have suggested, it would be better to formulate this de…nition in an unambiguous and symmetric way as a point in ‡ation target, say 1.5%, possibly with a tolerance interval, §1%.