Issing's swan song: TIE asked this distinguished policymaker for his final defense of the European Central Bank's two-pillar strategy.

• Author: Issing, Otmar

The European Central Bank was established to take responsibility for a new currency, the euro, as of January 1999. To overcome some of the inevitable uncertainties and even skepticism surrounding this enterprise, in the autumn of 1998 the Governing Council of the ECB described to the public how it would organize its assessment of the economic situation and prospects in order to arrive at its monetary policy decisions. This monetary policy strategy soon became famous for its "two pillar" structure. But why two pillars?

The Maastricht Treaty assigns the European Central Bank a clear mandate, namely to maintain price stability. Because of the long and variable lags in the transmission of monetary policy to price developments, a central bank can only control inflation over the medium term. In order to do so, its decisions have to be taken in a forward-looking manner, so that monetary policy actions have an appropriate impact on price developments when the lags in transmission unwind. Against this background, the permanent challenge facing monetary policymakers is to assess future risks to price stability on the basis of the data available now.

These risks derive from many sources. One set of sources--such as developments in import prices (e.g., energy), changes in administered prices and indirect taxes, wage dynamics, etc.--have an impact on the prices of goods and services in the shorter-term, say within a year or two. A comprehensive assessment of these risks is made by the ECB in the context of its "economic analysis"--one pillar of its monetary policy strategy.

At the same time, other sources--notably monetary developments--pose risks to price stability at medium to longer horizons. Extracting the policy-relevant information about longer-term trends in inflation contained in monetary data is the core task of the ECB's monetary analysis--the other pillar of its strategy.

Playing down the importance of "money" in macroeconomic developments has become a fashion, an attitude which seems to be endorsed by mainstream academic macroeconomics. In my view, this fashion has gone too far. We should rather ask the question: Can a central bank afford to ignore the information in monetary developments in formulating monetary policy? To me, the answer is straightforward: No.

On the contrary, there are many reasons why a central bank should monitor the development of money carefully. Not least, the theoretical and empirical evidence accumulated over...