A central bank is assigned an objective, or objectives, to achieve and maintain. To achieve the objective, or objectives, the central bank’s decision-making body usually defines a set of procedures to guide its actions. This set of procedures is called the monetary policy strategy. The pre-euro Bundesbank used a monetary policy strategy that is called ‘monetary targeting’. Under such a strategy, the central bank chooses a monetary aggregate and determines its monetary policy actions on the basis of comparisons between the target value of the monetary aggregate and the actual value of the monetary aggregate. The target value of the monetary aggregate must be defined so as to be consistent with the central bank’s definition of the ‘price stability’ objective. Another well-known and widely used (Bank of Canada, Bank of England) monetary policy strategy is the ‘inflation targeting’ strategy. Under such a strategy, the central bank’s decision-making body takes monetary policy actions on the basis of a comparison between the target for inflation and the forecast inflation rate. The monetary authority steers the final target variable (the policy objective of ‘price stability’) directly without the use of a separate intermediate target variable, such as the ‘monetary target’. The inflation targeting strategy requires an inflation forecast since monetary policy actions (i.e. changing short-term interest rates) affect the final objective with a lag. The inflation forecast is usually based on a wide range of economic and financial variables to estimate, for example, the future ‘output gap’, which has an impact on price developments. The current value of a monetary aggregate may even be considered as one of the many informational variables used to forecast inflation.
As described below, the ECB Governing Council decided to use neither a pure ‘monetary targeting’ nor a pure ‘inflation-targeting’ strategy to achieve and maintain its primary objective of price stability. It decided to use a combination of both strategies, which it called a monetary policy strategy based on ‘two pillars’. In that sense, the ECB is more like the Fed. The FOMC’s monetary policy strategy, which has evolved over time, uses a combination of both of these strategies to achieve not one, but two objectives, namely price stability, which has never been numerically defined, and a sustainable growth rate of output, which presumably means