8 The concept of a balance sheet recession can be described as follows. Let us assume that we have experienced a large price rise on an important asset market, for instance, the property market, and that this rise has been largely financed through loans – that is, roughly what happened with the North Atlantic property bubble. If prices then fall drastically, many people will be stuck with assets that have declined substantially in value, while the value of the loan remains unchanged. In other words, their balance sheets look much worse than they had anticipated. This can create uncertainty regarding the outlook for the future. In this situation the participants in the economy may set a target that overshadows all others – to get rid of enough of their debts. This means that their income will for some time to come be used for amortisation rather than consumption and investment. Interest rate cuts less effective when everyone wants to pay off their debts It is then of minor importance if interest rates are cut – the participants in the economy are still only interested in consolidating their balance sheets. Even if one steps on the monetary policy accelerator pedal, the engine does not give the usual response. This is what I meant earlier when I said that monetary policy has less effect than usual in certain situations. The actual consolidation of the balance sheets may go more quickly if the interest rate is cut, as this creates scope to increase the pace of the instalment payments.
However, it was not clear, at that point in time, whether this sharp increase at the beginning of the year was a one-off effect in connection with the launch of the single currency and thus quickly fall again. In view of these uncertainties, the Governing Council of the ECB saw nothing in the development of M3 in the spring of this year to prevent it from reducing the interest rates. 3  BIS Review 99/1999  Current assessment of the monetary, financial and economic situation Please allow me to explain briefly how the Governing Council of the ECB currently views the monetary, financial and economic situation in the euro area. Since the beginning of the year, the annual inflation rate for the Harmonised Index of Consumer Prices has stood at around 1% in the euro area as a whole, i.e. within our definition of price stability. Whilst the rate of price increases in food products has been falling since the beginning of the year, energy prices have increased strongly as result of the sharp increase in oil prices over the last few months. Overall the upward pressure turned out to be moderate, and perhaps more moderate than expected, which is a reflection of the increased competition in the service sector and the success of deregulation in some markets. However, since production costs could also increase in time as a result of the increase in energy prices, the increase in oil prices contributes to certain risks to price stability.