But this carries risks to central bank credibility if circumstances change and no longer warrant sticking to the commitment. 2  BIS central bankers’ speeches  On the other hand, if guidance is conditional, it will have less impact and introduce volatility as markets permanently reassess the economic situation and assess the probability that the central bank will change its policy. Second, if central banks opt for conditional forward guidance, should it be “time contingent” – with time or dates references for future actions – or “state contingent” – dependent on the situation of the economy? Time contingent forward guidance runs the risk of being undermined by changes in the economic situation. “State contingent” forward guidance may appear better. Experience shows, however, that it is also more complex to manage especially when choosing the “triggers” or “thresholds” attached to commitments for the future. Partly as a result of the crisis, major structural changes are taking place in most advanced economies. Overall, the relationship between major macroeconomic variables are becoming unstable which makes it difficult to calibrate monetary policy on a limited number of parameters, such as, for instance, the unemployment rate. Nowhere are these changes more profound than in the euro area, where structural change is taking place at an accelerated pace as a result of the crisis and adjustment policies undertaken in Member States. We have taken stock of all these experiences and lessons in devising our approach to forward guidance in the euro area.
We have achieved a lot by creating the banking union and the SSM in less than two years – which is unprecedented in European history. Also, the process of balance sheet repair for banks is well underway in the euro area And we will make sure that the forthcoming asset quality review removes any doubt as to the sustainability of the euro banking sector. Furthermore, for the euro area, there is the exchange rate question. As you all know, from a monetary policy perspective, the exchange rate is not a policy variable, let alone a target. But  BIS central bankers’ speeches  1  it is obviously a very important input when considering overall monetary and financial conditions. The recent appreciation of the euro has had a strong disinflationary impact. We could discuss further the different causes of low inflation in the debate, but let me make some remarks on this crucial matter for us central bankers. First, low inflation is not deflation. As many analysts and observers are today alarmed about deflation in the euro area, it is useful to understand the difference. Deflation is a permanent and cumulative process of decrease in the overall price index, fuelled by negative expectations. Deflation is a pernicious spiral. Because consumers expect prices to decrease continuously, they tend to defer purchases, thereby further fuelling the deflation process. Deflation increases the real burden of debt and creates an incentive to defer investment.