These illustrations demonstrate that when there is a sudden jump in the risk premium embedded in the 3-month LIBOR, the way in which you respond to such a risk premium has important repercussions for the effective monetary policy stance. Let me illustrate this point with the example of John Taylor's acclaimed "Taylor rule" 18 . In generic terms, the Taylor rule is a simple monetary policy rule that prescribes how a central bank should adjust its official rate in a systematic way in response to changes in inflation and macroeconomic activity (usually the output gap). 19 While no central bank is relying solely on the Taylor rule, most central banks are deriving guidance from it in their monetary policy decisions. Assuming that the current turmoil has neither affected inflation nor the output gap the Taylor rule does not suggest a change in the official rate. In other words, the observed decoupling of the LIBOR from the official rates would have to be ignored in the conduct of monetary policy. So far, this is the approach followed by the ECB and the Bank of England. If one assumes that the level of the 3-month LIBOR plays a more important role in the transmission mechanism of monetary policy than a one or two week repo rate, monetary policy makers may want to be flexible in times of turmoil. Adhering too closely to rules might not lead to an optimal monetary policy. As John Taylor has said himself, "operating the rule requires judgment and cannot be done by computer."
This indicates that significant structural rigidities have prevented an appropriate adjustment of wages. Taking all of the above into account, at its last meeting on 6 February 2003, the Governing Council concluded that following the decision to lower the ECB key rates by 50 basis points in December, the monetary policy stance remained appropriate to preserve a favourable outlook for price stability in the medium term. Consequently, the ECB kept its key interest rates unchanged. Their already low level should help to counterbalance the negative effects on economic activity that currently stem from the high degree of worldwide uncertainty and should, therefore, contribute to a sustainable economic recovery in the course of 2003. For the time being, we still assume that the high degree of uncertainty will decline in the course of this year. However, at this juncture it is not possible to assess how the ongoing geopolitical developments will affect the world economy and, in particular, the euro area economy. The Governing Council will continue to monitor closely all factors that may affect the prospects for inflation in the euro area. The euro area outlook will also very much depend on progress in other policy areas. As regards fiscal policy, full adherence to the fiscal policy framework laid down in the Treaty and the Stability and Growth Pact provides a sound basis for limiting the risk of fiscal imbalances occurring and thus contributes significantly to favourable financing conditions for the private sector. At the same time, it preserves an appropriate medium-term orientation for fiscal policy.