Since 1 January 2002, euro banknotes and coins have been in the hands of the general public. The cash changeover has been an unprecedented undertaking, directly affecting people in the 12 countries that adopted the euro, as well as many others outside the euro area. Both the acceptance of the euro by consumers and the achievement of the logistical milestones have surpassed all expectations. The European Central Bank wishes to express its gratitude to all actors involved in this undertaking, including the citizens of the euro area, who made possible the smooth changeover to the new banknotes and coins. The Eurosystem is proud of its contribution to this historic event. European central banks have been working hard since 1996, when the competition for the design of the euro banknotes was launched, and especially over the past three years, to ensure the timely production of euro banknotes and successful euro cash changeover. By mid- January 2002, the vast majority of cash transactions in the euro area were being conducted in euro. Turning to monetary policy, at its meeting on 3 January 2002, the Governing Council of the ECB decided to leave the minimum bid rate on the main refinancing operations of the Eurosystem unchanged at 3.25%. The interest rates on the marginal lending facility and the deposit facility were also left unchanged at 4.25% and 2.25% respectively. At this meeting, the Governing Council concluded that economic developments were in line with the forward-looking interest rate decisions taken last year. The level of key ECB interest rates was deemed appropriate for the maintenance of price stability over the medium term. This assessment was based on the analysis of the outlook for price stability in the medium term under the twopillar monetary policy strategy of the ECB. Starting with the first pillar, the three-month average of the annual growth rates of M3 rose to 7.4% in the period from September to November 2001, from 6.7% in the period from August to October. These high levels of M3 growth over the past few months reflect a particularly strong preference for liquid holdings by euro area investors in an economic and financial environment characterised by high uncertainty worldwide. This should, in principle, remain a temporary phenomenon and, in this respect, not indicate future inflationary pressures, although at this stage it is very difficult to anticipate when a reversal of past flows into liquid assets will take place. While the analysis related to the first pillar does not point to risks to price stability at present, the recent build-up of liquidity, if not reversed, will call for a thorough analysis of monetary developments in the coming months, in particular when the euro area economy recovers. Regarding the second pillar, recent information has confirmed the earlier assessment that economic activity in the euro area was weak in the second half of 2001 and will probably remain so in early 2002. There has been some evidence supporting the prospects for a gradual recovery in the course of 2002. For example, recent survey data for the euro area suggest that the general decline in confidence may have come to an end. Some recent developments in financial markets could be seen as supporting this view. As regards external demand, there are some incipient signs of a stabilisation in the outlook for economic growth at the global level. However, uncertainty is still high concerning economic prospects in the United States and in other regions of the world. One main reason for expecting a recovery in the course of 2002 is that no fundamental economic imbalances have built up in recent years in the euro area which would require a long correction process. Furthermore, financing conditions in the euro area are favourable at present, and the expected further decline in consumer price inflation will lead to higher growth in real disposable income which, in turn, should support domestic demand. While recent data have confirmed the expectation of a gradual recovery in the euro area economy this year, the timing and strength of this upturn remain uncertain. Therefore, continued close monitoring of incoming information is warranted. In this economic environment, upward risks to price stability are not likely to materialise over the medium term. Annual consumer price inflation, as measured by the Harmonised Index of Consumer Prices, has declined steadily over the past few months to close to 2% in December 2001, as a consequence of the unwinding of past increases in energy prices and, albeit to a lesser extent, in food prices. Recent information on producer prices supports the view that the decline in consumer price inflation will continue in the course of 2002. However, in the months to come, annual inflation rates may be somewhat erratic on account of base effects relating to price developments in early 2001. In this connection, some short-lived upward movements in the annual rate of inflation cannot be ruled out, but these should not be cause for concern. Likewise, downward shifts resulting from such base effects later in the spring should not signal a change in the longer-term outlook for price stability. With regard to the cash changeover, the expectation is that this will not have significant effects on the average price level in the short term, largely owing to strong competition in the retail sector, continued vigilance by consumers and the commitment of governments not to increase the average level of administered prices. However, some uncertainty still surrounds this assessment and a clearer picture will emerge in the months to come. Over the longer term, downward price movements should dominate, as the physical introduction of the euro will strengthen price competition in the euro area. Overall, on the basis of current information, annual inflation rates should fall safely below 2% this year and remain at levels consistent with price stability over the medium term. This expectation of a favourable outlook for inflation over the medium term is conditional on the crucial assumption that wage moderation in the euro area will continue. It is therefore important to recall the indispensable role of continued wage moderation in fostering employment and maintaining a favourable outlook for price stability. In order to maintain favourable prospects for non-inflationary growth in the euro area, it is also important that fiscal policies maintain a medium-term orientation consistent with the Stability and Growth Pact. The current weakness in economic growth undoubtedly poses a particular challenge for those countries which have not yet attained budgetary positions close to balance or in surplus or which have very high public debt-to-GDP ratios. However, rather than hindering a return to sustainable economic growth, the adherence of fiscal policies to their medium-term objectives will strengthen consumer and investor confidence. Countries without fiscal imbalances can, of course, allow automatic stabilisers to operate fully. However, there is no case for fiscal activism. There is considerable evidence showing that discretionary fiscal policy can make only a small contribution, if any, to stabilising economic activity in the short run, given the lags in the decision-making process and the time needed to fully affect economic activity. Furthermore, it should be kept in mind that any possible short-term demand effect resulting from the conduct of an activist fiscal policy may be outweighed by developments in long-term interest rates, which may react negatively to the risks of a worsening in fiscal prospects. In view of the still high level of structural unemployment in the euro area, it is important to recall that the key challenge for the euro area remains the strengthening of the productive forces as a prerequisite for expanding the trend output growth of the economy in a decisive manner. This will require an acceleration and deepening of structural reform in the labour and product markets. Likewise, governments should also resolutely pursue reforms with regard to the size and structure of public expenditure and revenue, in order to create room for further tax cuts and for absorbing the fiscal costs of an ageing population. Together with continued wage moderation, these reforms will foster employment and investment on a lasting basis. With the ECB pursuing its primary objective of price stability, with governments willing to foster structural reforms and conduct stability-oriented fiscal policies, and with wage developments consistent with job creation and price stability, the euro now also in the form of banknotes and coins will represent an economic area characterised by macroeconomic stability and economic dynamism.