According to the Treaty establishing the European Community, the primary objective of the Eurosystem is to maintain price stability in the euro area and hence safeguard the purchasing power of the euro.
According to a decision of the Governing Council of the European Central Bank (ECB) of 13 October 1998, price stability was defined as keeping year-on-year increases in the Harmonised Index of Consumer Prices (HICP) for the euro area below 2%. Price stability is to be maintained over the medium term. On 8 May 2003, the Governing council defined its monetary policy strategy more closely in deciding that the Council, in the pursuit of price stability, will aim to maintain inflation rates close to 2% over the medium term. This revision emphasised the Governing Council's endeavours' to maintain an adequate safety margin against deflation risk.
The Eurosystem’s monetary policy strategy is a structured description of the monetary policy decision process.
The strategy has two key functions:
- It provides a framework for the policy decision process. The strategy must ensure that the Governing Council of the ECB has access to all the information and analyses required for the making of efficient monetary policy decisions that maintain price stability.
- The strategy is a tool for communication with the public. Monetary policy is most efficient when it is credible, ie when the public is fully convinced that monetary policy is entirely committed to the price stability objective and implemented so that the goal is efficiently achieved.
To perform these two tasks, complementing each other, it is essential to know how the economy works. It is especially important to be able to assess, on the basis of available information, any future threats to price stability by studying current economic developments. The monetary policy strategy for assessing macroeconomic developments is based on two pillars: a broad economic analysis and a monetary analysis.
- The broad economic analysis uses a large number of macroeconomic indicators of macroeconomic developments that serve as a basis for the assessment of the potential risks to price stability. Such indicators are, for example, salaries and wages, foreign exchange rates, long-term rates, different indicators of economic activity and fiscal policies, price and cost indices, and business and consumer barometers.
- The monetary analysis uses monetary indicators to assess potential risks to price stability. Monetary indicators are, for example, the amount of notes and coins held by the public and the stock of lending of monetary financial institutions (MFIs). Attention is paid to expansion of monetary aggregate M3, increase in private sector lending and liquidity surplus indicators.
The two strategy pillars of the Eurosystem are designed to ensure that monetary, economic and financial developments across the euro are monitored and analysed carefully. This in-depth analysis enables the ECB to set its key interests at a level that is best suited to promote price stability. In this way, the Eurosystem safeguards the purchasing power of the euro while supporting the external value of the currency, as measured by the exchange rate against other currencies. However, the exchange rate in itself is not part of monetary policy strategy.