Select Committee on European Union Written Evidence

Memorandum by the Bank of England


  From the outset, the ECB announced that its monetary policy decisions would rest on three main elements: a precise definition of the objective of price stability; an analysis of monetary developments; and an analysis of inflationary trends based on a wide range of economic and financial indicators. The last two elements are described as constituting a twin-pillar strategy.

  With respect to the definition of price stability, that was originally defined as an inflation rate of the Harmonised Index of Consumer Prices (HICP) of 2 per cent or less, ie a range of 0-2 per cent. In response to criticism that it was unclear whether the ECB was indifferent between different inflation rates within this range, they have recently clarified the objective as being close to, but below, 2 per cent.

  Your inquiry asks whether this objective is too low. We would note that the Bank of England's objective, given to it by the Chancellor, is for an annual rate of RPIX inflation of 2.5 per cent. The historical difference between RPIX and the measure of HICP for the UK has generally been somewhere around ½-¾ percentage points (though it is unusually large at present); see the box on HICP on pp 38-9 of the Bank's Inflation Report, May 2003. So the ECB's objective of close to 2 per cent is roughly commensurate with our own mandated inflation objective. As to the question of whether this is too low, we would draw your attention to the various studies cited in the article by A Yates, "Monetary policy and the zero bound to nominal interest rates", Bank of England Quarterly Bulletin, Spring 2003. They suggest that an inflation objective of around 2 per cent or so is likely to give sufficient room for manoeuvre for monetary policy almost all the time and make hitting the zero lower bound on nominal interest rates an unlikely event.

  Turning to the twin-pillar strategy upon which the ECB's assessment of economic conditions rests, the motivation for that strategy is the recognition that inflation is ultimately a monetary phenomenon, and that economic forecasts are necessarily uncertain and often wrong. Monetary developments (the first pillar) may therefore be used as a complement to the broad-based analysis of inflation prospects that takes place under the second pillar. Some commentators had criticised the strategy as being confusing, saying that it was unclear what weight was being placed on each of the pillars. However, the ECB has recently refined and clarified its strategy, with the regular assessment of inflation prospects over the next two years or so being described first in ECB statements, and monetary developments discussed subsequently as an explicit cross-check, and recognising that a build-up of excessive liquidity may only pose an inflationary threat more than two years down the road.

  The contrast with our own procedures can be overstated. The regular monthly briefing providing to the MPC always includes an analysis of monetary developments. And while projections of inflation (and growth) two years out are a key ingredient of our quarterly Inflation Report, the process of preparing those projections incorporates a detailed consideration of monetary developments (see A Hauser and A Brigden, "Money and credit in an inflation-targeting regime", Bank of England Quarterly Bulletin, Autumn 2002. Consideration as to the appropriate setting for interest rates also takes on board considerations about possible developments beyond the two-year forecast horizon.

  The ECB has published numerous documents relating to the development of its monetary policy strategy, many of which are available from its web-site ( There is also a substantial book by O Issing, V Gaspar, I Angeloni and O Tristani (Monetary Policy in the Euro Area, Cambridge University Press, 2001), that describes the strategy and its intellectual basis in some depth.


  It would be inappropriate for us to comment on many of the issues that you raise under this heading, relating as they do to fundamental political considerations about the delegation of responsibility and accountability. However, we do believe that transparency is an important ingredient of an effective monetary policy. We would note that the ECB has gone to considerable lengths in trying to explain its thinking through its regular statements, the press conferences attended by senior Executive Board members, its Monthly Bulletin and appearances of the President of the ECB before the European Parliament. It also publishes a considerable volume of technical background material and has engaged actively with academics and other members of the economics profession.

11 June 2003

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