In order to achieve the price stability objective, the Eurosystem uses a set of monetary policy instruments and procedures. These form the operational framework for the implementation of monetary policy decisions. Basic operational principles and policy strategy have a special role in monetary policy implementation. The strategy targets the level of money market interest rates required to maintain price stability in the medium term, while the operational principles outline the means of achieving the particular interest rate level by applying the available monetary policy instruments and procedures. The ECB steers the short-term money market rates by its decisions regarding the key ECB interest rates which reflect the monetary policy stance of the ECB and affect the free liquidity on the money market.
In order to fulfil those tasks, it is important to understand how an economy works. Based on the available information about the latest economic developments, the ECB has to evaluate their implications for future risks to price stability. The monetary policy strategy pursued by the ECB in analysis of the macroeconomic developments is based on two pillars: a broad-based economic analysis of both the euro area and global financial markets and monetary analysis. In practice this means that the ECB's monetary policy decisions are taken based on a detailed analysis of factors that may influence inflation and of money supply developments.
First pillar
The first pillar includes an analysis of many economic and financial variables with potential short-term or medium-term price stability implications. The ECB constantly analyses the real sector activities and the developments of prices and costs, wages, the fiscal sector, government bond yields, exchange rates, business and consumer confidence and essential global financial market indicators.
Second pillar
The second pillar includes an analysis of monetary aggregates pointing to the leading role of money supply in maintaining price stability and focussed on a longer-term perspective. The analysis involves a detailed analysis of the monetary and lending developments, in order to evaluate their future implications for inflation and economic growth in the euro area. Analysis of the annual growth of monetary aggregates (currency in circulation, MFI loans, liquidity surplus and particularly M3 (currency in circulation + overnight deposits + deposits with an agreed maturity of up to 2 years + deposits redeemable at a period of notice of up to 3 months)) is used as a monetary policy strategy implementation instrument.
Both Eurosystem's strategy pillars are designated to ensure a deep analysis of the monetary, economic and financial developments in all euro area. This detailed analysis enables the ECB to set the key ECB rates at a level best suited to promote the overall euro area price stability. Thus the quantitative definition of price stability and both the above-mentioned two-pillar approach form the key monetary policy strategy elements of the ECB.