Once the appropriate level of the key interest rates has been set, the Executive Board of the ECB implements its monetary policy stance so that the effects of its interest rate decisions are transmitted to the financial markets and the real economy effectively. In this sense, the ECB had to act swiftly and decisively to avoid that tensions in the money market would spill-over to other markets and adversely affect the real economy. So we had to clearly convey two complementary messages. One was that the ECB was determined – from the onset of the financial crises in August 2007 – to ensure the orderly functioning of the euro area inter-bank money market by offering supplementary liquidityproviding refinancing operations or – more recently – by widening the collateral framework to facilitate the provision of liquidity to merchant banks and to engage in unlimited provision of liquidity for all our refinancing operations at a fixed rate. The other message which is fundamental was to raise the public’s awareness that the exceptional interventions aimed to alleviate the tensions in the money market would not compromise the longer-term achievement of price stability in line with our definition less than 2%, but close to 2%. Conclusions Let me conclude. The fundamental changes in central bank communication have helped to enhance the effectiveness, predictability and credibility of monetary policy and have notably contributed to lowering both inflation rates and volatility in the real economy.
The old belief was based on the notion that a central bank would measure the success of its actions by the extent to which economic activity could be raised and maintained above potential. If rational individuals already expect a certain change, they adjust their behaviour to that expectation. And that means that a monetary policy change would have no effect. In the past fifteen years, however, two important developments changed the theory and practice of central banking. First, the assumption that successful monetary policy acts by surprises and is made by a sequence of isolated steps has been the subject of thorough theoretical scrutiny and is now close to oblivion. It became clear that policy-making by surprises and isolated steps will bear no lasting effect on the economy once the public recognises the intentions that motivate the monetary authority. A monetary policy strategy made of isolated actions with the intention of boosting output above potential is bound to lose effectiveness because the short-term inflationary impact of that policy soon becomes embedded in price and wage expectations. Output and employment react in the very short-run, but in the medium term the economy suffers from a permanently higher inflation. The drive toward central bank independence provided an additional encouragement for transparency. Today an overwhelming majority of central banks across the globe is independent. The political and functional independence of central banks has been an important milestone in the way towards separating the authority to tax and spend from the power to control credit conditions.