Monetary Policy in Pre-ECB Italy In 1979, Italy entered into the Exchange Rate Mechanism (ERM) as a founding member

of the European Monetary System. After that date, the countrys monetary policy was geared toward the maintenance of exchange rate stability against its ERM partners, despite a number of exchange parity realignments and with the exception of the period from September 1992 to November 1996. The strength of the ERM commitment was not uniform over time, either in terms of amplitude of the fluctuation band or in terms of frequency of realignment of bilateral parities. Despite this variability, however, changes in official ratesthe discount rate and the rate on fixed term advanceswere overwhelmingly linked throughout the ERM period to developments in foreign exchange markets. The broad exchange-rate stability objective was made operational as a target range for the overnight interbank deposit rate. This target was articulated as a corridor (in the 1990s, of typical width between 1 and 1.5 percent) effectively determined by the rates applied on Bank of Italy lender-of-last-resort operations: the discount rate (at the lower edge) and the rate on fixed-term advances (at the upper edge); and by the market determined tender rate on repos, thse main tool used by the Bank to conduct its open market intervention, which steered the interbank rate within the corridor. Monetary Policy after the formation of ECB The Eurosystem is responsible for the single monetary policy of the euro area. The primary objective of the Eurosystems monetary policy is to maintain price stability in the euro area. Without prejudice to this objective, the Eurosystem supports the economic policies in the European Community with a view to contributing, among other things, to the achievement of a high level of employment and sustainable and non-inflationary growth. Among its other tasks, it also contributes to the maintenance of financial stability in the euro area. Monetary policy decisions are taken by the Governing Council of the European Central Bank (ECB) and mainly consist of setting the key interest rates. The ECB has quantified the definition of price stability as a year-on-year increase in the Harmonized Index of Consumer Prices (HICP) for the euro area of below but close to 2% in the medium term. The reference to the medium term above all takes account of the lag in the monetary policy transmission mechanism: shorter-term measures to combat, for example, a short-term shock to international raw materials prices, would run the risk of creating additional volatility in the economy. A forward-looking orientation is also necessary in view of the impact of inflation expectations on actual inflation; the single monetary policy aims to solidly anchor inflation expectations at levels consistent with price stability. Quantifying the definition of price stability also contributes to a further aspect of the ECBs monetary policy strategy: by increasing the transparency of monetary policy and providing a reference framework which is easy to understand, it provides a clear and measurable yardstick against which the public can hold the ECB accountable. This renders the ECBs policies credible, which is a precondition for forming market expectations.

The ECB bases its monetary policy decisions on two complementary analytical perspectives (referred to as the two pillars): economic analysis and monetary analysis. The economic analysis assesses the short to medium-term determinants of inflation, focusing on real activity and taking account of the fact that price developments over these horizons are influenced by the interplay between the supply and demand of goods, services and production factors. Account is also taken of the macroeconomic projections produced every three months alternately by Eurosystem and ECB experts. In view of the long-term connection between money and prices, the monetary analysis mainly serves as a means of cross-checking, from a medium to long-term perspective, the short to medium-term indicators stemming from the economic analysis. The ECB pays considerable attention to communicating its assessments by means of official statements or regular publications, such as the Monthly Bulletin and the Annual Report. Operational Information MONETARY POLICY OPERATIONS There are four types of open market operations in the Eurosystem: - main refinancing operations, regular liquidity-providing operations with a weekly frequency and a maturity of one week; - longer-term refinancing operations, monthly liquidity-providing reverse transactions at with a three-month maturity; - fine-tuning operations, which are executed on an ad hoc basis to manage unexpected fluctuations in liquidity or interest rates; they can be liquidity-providing or liquidityabsorbing; - structural operations. KEY EUROSYSTEM INTEREST RATES The ECBs Governing Council sets the key interest rates for the Euro area. These are - the interest rate on the main refinancing operations; - the interest rate on the deposit facility; - the interest rate on the marginal lending facility. The interest rate on the main refinancing operations, which provide the bulk of the liquidity required by the system, signals the ECBs monetary policy stance to the market by indicating the conditions at which the ECB is willing to enter into transactions with the market. The other two interest rates are on operations that can be conducted at the request of the counterparties and they represent, as a rule, the upper and lower limits of the overnight interest rate. INTEREST RATES ON MINIMUM RESERVES

The minimum reserve earns interest at the average of the marginal allotment rate in the main refinancing operations during the maintenance period, weighted according to the number of calendar days. A penalty is applied for non-compliance with minimum reserve requirements. Its amount is calculated as the average value of the rates on the marginal lending facility during the maintenance period, weighted according to the number of calendar days and increased by 2.5 points. OFFICIAL REFERENCE RATE Until 2003, the Bank of Italy calculated, in accordance with Legislative Decree 213 of 24 June 1998, an official reference rate that was used for the indexation of legal instruments. The official reference rate was based on the rate fixed periodically by the ECBs Governing Council and used in the main refinancing operations conducted by the Eurosystem: fixed rate or minimum bid rate for variable-rate tenders. As of 1 January 2004, when the deadline of five years from 1 January 1999 fixed in the Decree elapsed, the Bank of Italy no longer calculates the official reference rate. Instruments The Eurosystem uses a set of instruments to implement monetary policy, namely: - open market operations; - standing facilities; - minimum reserves. Open market operations create or absorb liquidity; all banks in the euroarea that fulfil certain eligibility criteria are allowed to take part. The Bank of Italy carries out open market operations with banks in Italy, following instructions issued by the ECB and the rules and procedures agreed within the Eurosystem. The Bank is also responsible for managing assets posted as collateral in credit operations and indicates which financial assets issued in Italy may be used for that purpose. The Eurosystem offers two standing facilities, the marginal lending facility and the deposit facility at the central bank; both instruments have overnight maturity and are available to counterparties on request. The Bank of Italy manages these operations with banks in Italy. The ECB requires banks to hold deposits in accounts with the NCB as minimum reserves, which earn the same rate of interest as the main refinancing operations with the Eurosystem. The Bank of Italy assesses the amount of the reserve due from each bank in Italy and applies the penalties laid down by the ECB for non-compliance. Implementation of monetary policy The implementation of monetary policy is entrusted to the Executive Board of the ECB in accordance with the decisions and guidelines adopted by the Governing Council.

The Eurosystem has a number of monetary policy instruments at its disposal in order to achieve its objectives. It conducts open market operations, offers standing facilities and requires credit institutions to hold minimum reserves on accounts with the Eurosystem. In accordance with the principles of operational decentralization and subsidiarity established at the European level, the monetary policy operations are carried out by the Eurosystem NCBs on the basis of the necessary instructions given by the Executive Board and under uniform terms and conditions.