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.
Analysis of data for price developments in various US cities over the past suggests not only that significant inflation differences occur within a monetary union, but also that they are at least as great as those currently prevailing between euro area countries. Thus, recent divergences in the euro area are by no means unusual. A further feature of the US data is that the observed divergences in inflation rates among these cities, although persistent, are not permanent. There is a tendency for price levels in individual cities to converge back towards their initial levels relative to the national average. It can be assumed that similar adjustment processes would also operate in the euro area. The role of other economic policies Differences in economic developments between countries within the euro area do not, therefore, always warrant an economic policy response. Action may, however, be necessary. For instance, when developments diverging from those in other countries threaten to trigger painful adjustment processes in the form of increasing unemployment. This can be avoided. If action is required it must be taken through other, national economic policies, in particular wage developments and fiscal policy. As said before, “Frankfurt” has no role to play in this area. As regards labour and product market developments, it is important, also for this reason, to reduce as far as possible existing rigidities, so as to allow wages and prices to adjust.