EP 205 . tex A Reform of the Eurosystem ’ s Monetary - Policy Strategy Is Increasingly Urgent ∗

A reform of the Eurosystem's inferior monetary-policy strategy is increasingly urgent, as noted by a number of observers. For instance, a recent extensive CEPR report finds the that the prominent first pillar of the Eurosystem's strategy, the money-growth indicator, " looks increasingly ridiculous, giving perverse signals that the ECB probably ignores " , and that it is " flawed beyond repair–both as a matter of theory and empirically. " The Eurosystem's definition of price stability is ambiguous and asymmetric, and less effective as an anchor for inflation expectations than a point inflation target. The Eurosystem should simply adopt the superior monetary-policy strategy of flexible inflation targeting that Bank of England, the Reserve Bank of New Zealand and Sveriges Riksbank follow. That is, it should announce a symmetric inflation target, demolish the first pillar, use all relevant information (including any useful information in monetary aggregates) in the construction of published inflation and output-gap forecasts, set interest rates so these forecasts are consistent with the inflation target and modest output-gap variability, and motivate its interest decisions with reference to these forecasts. A reform of the Eurosystem's monetary-policy strategy is increasingly urgent, as noted by many observers. The strategy has a " definition of price stability " and two " pillars ". The first pillar is " a prominent role for money with a reference value for the growth of a monetary aggregate, " more precisely, a money-growth indicator consisting of the difference between current M3 growth and a reference value. The second pillar is " a broadly based assessment of the outlook for future price developments, " essentially an inflation forecast. The definition of price stability and, in particular, the first pillar are problematic. As discussed in some detail in Svensson [16], the definition of price stability is problematic because it is ambiguous and asymmetric, and less effective as an anchor for inflation expectations. * Briefing paper for the Committee on Economic and Monetary Affairs (ECON) of the European Parliament for the quarterly dialogue with the President of the European Central Bank. I thank Kathleen DeGennaro for editorial and secretarial assistance. Expressed views and any errors are solely my own responsibility.