The ECB has only one instrument at its disposal – short-term official interest rates - and can therefore only aim at one objective. This has been defined by the Governing Council as “a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%”. The objective of price stability “is to be maintained over the medium term”, emphasising that monetary policy needs to be forward-looking. But this definition also stresses the fact that the focus of the ECB is on price developments “in the euro area”. In reaching its decisions on monetary policy, the Governing Council is concerned with economic conditions in the euro area as a whole, rather than specific regional or national developments. It is sometimes said that while the single monetary policy may be “right” for the euro area as a whole, it is “wrong” for many individual countries within the area. I disagree with this view. First, it overlooks the fact that within a single currency area adjustment can occur via prices and wages. Second, it infers a very narrow perspective on the costs and benefits of a single monetary policy, in isolation from the broader arguments. These broader considerations can be assessed in my view, as being very clearly positive in the medium to long term for growth as well as employment. Nevertheless, an analysis of the causes of and policy responses to the differences across countries is useful.
There are, of course, still plenty of rules-based aspects to the new capital framework: it's difficult otherwise to understand what the many hundreds of pages of the Basel II document are needed for. However, the point I want to stress is that the advanced approaches, and especially IRB, introduce a new element into banking supervision. For want of a better term, I'll call this process-regulation. Whereas the old Accord focused on rules, the IRB approaches focus instead on the processes by which risks are managed. Rather than prescribing detailed rules for assessing capital adequacy, supervisors will in future need to assess the adequacy of the internal processes used by firms to manage their risks. This is reflected, for example, in the approach that we propose to take to the validation of IRB systems: we will not be prescribing specific numerical standards that we expect internal risk measurement systems to achieve. Rather, we will discuss with each individual IRB bank how its system performs in relation to the bank's own internal objectives and appetite for risk. IRB will require us to engage in a dialogue with AIs to understand how they go about developing and approving their IRB models. As a result, the future for banking supervision is likely to take the form of an active discussion with our counterparts in the risk management and credit control functions. It will be less a matter of us setting hard and fast rules, and more a matter of us holding a dialogue with risk managers.