If the volume of money and credit that is created by financial intermediaries exceeds a trend that is consistent with price stability in the long run, the central bank is also expected to increase its policy rate, because excess money and credit creation can herald risks to price stability. In this simple policy rule, excess money and credit growth is denoted by mt.
The coefficients α and λ capture the strength of the central bank’s reaction. This is of course a simplified model and a full representation of the ECB decision-making should include a broad set of variables which are leading indicators of future inflation.