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r221006a_BOC	canada	2022-10-06T00:00:00	Whatâs happening to inflation and why it matters	macklem	1	Governor of the Bank of Canada Good afternoon. I am glad to be with you here in Halifax. It's been a tough couple of weeks for Atlantic Canada. I want to extend my condolences for the lives lost during the terrible storm. My sympathy goes out to all of those affected across the region, including Bank of Canada employees in our office here in Halifax. The damage and destruction bring a new wave of hardship after what has already been a difficult couple of years. Canadians have faced historic challenges since 2020. And recovering from these challenges--just like rebuilding from the aftermath of Hurricane Fiona--will take time. The global COVID-19 pandemic has sparked a challenge that is particularly pressing to the Bank of Canada--high inflation. And that's what I want to talk about today. High inflation is making life more difficult for Canadians, especially those with low or fixed incomes. Some of this inflation reflects global developments that we don't control, but inflation in Canada increasingly reflects what's happening in Canada. The demand for goods and services here at home is running ahead of the economy's ability to supply them. Businesses are having a hard time finding enough workers. And what started as higher prices and delays for many internationally produced goods has broadened to many services. Inflation in Canada peaked at 8.1% in June and has declined for two months. That's welcome news, but inflation will not fade away by itself. To get it back to more normal levels, we need to slow spending in the economy so supply can catch up with demand. This will help relieve price pressures here in Canada. In September, we raised our policy interest rate for the fifth consecutive time since March. And we indicated that interest rates will likely need to go higher still to bring inflation down to the 2% target. Later this month, we will take our next monetary policy decision, and we will update our economic outlook for growth and inflation at that time. But today I want to do three things. First, I want to unpack the run-up in inflation over the past year or so and review how the factors behind inflation in Canada are shifting from global to domestic and from goods to services. Second, I want to review the inflation indicators we are particularly focused on as we assess where inflation is headed. Finally, I want to acknowledge the hardship that high inflation is creating for many Canadians and underscore the imperative of getting inflation all the way back to the 2% target. Heading into the pandemic in 2020, Canada's total consumer price index (CPI) inflation was 2.2%--roughly on target. But when the world locked down, inflation fell steeply, dipping below zero. Prolonged deflation and economic depression were real concerns. The Bank responded with exceptional monetary support, first to put a floor under the crisis and then to help the economy regain its strength. Fortunately, combined with exceptional fiscal stimulus, it worked. We avoided deflation, and the deepest recession on record was followed by the fastest recovery ever. But repeatedly closing and reopening economies around the world brought new challenges. Households shifted their spending from in-person services to durable goods, straining global supply chains that were already disrupted by public health restrictions. Shipping bottlenecks and shortages of key intermediate inputs meant long delays for goods like cars, bicycles and appliances. So by 2021, we began experiencing higher prices for many internationally traded goods. shows, inflation in goods excluding food and energy rose to about 3.5% by July 2021, while inflation in services excluding shelter was only around 1%. Add in higher global energy prices in 2021, and goods price inflation was about 4.5% by the middle of that year. With higher goods prices, total CPI inflation was moving up in 2021 too, but it was largely a story of higher inflation for global goods spilling into Canada. Inflation was rising in most advanced economies, and Canadian households were feeling the effects of higher global inflation ( At the time, we assessed that the effect of these global forces on inflation was likely to be transitory. Historical experience has taught us that supply disturbances typically have a temporary effect on inflation, so we tend to look through them. A year ago we expected inflation in goods prices to moderate as public health restrictions were eased, production ramped up and investment in global supply chain logistics picked up. In hindsight, that turned out to be overly optimistic. Indeed, global inflationary pressures stepped up in 2022. The unprovoked Russian invasion of Ukraine in February drove up the prices of commodities-- particularly energy and agricultural goods--and created new disruptions to already impaired global supply chains. Canadians experienced these effects almost immediately with higher gas prices at the pump and big price increases for many basic food items at the grocery store. But the other thing that changed in 2022 was inflation in the prices of services. As the economy fully reopened in the spring, pent-up demand for all the services we'd missed over the pandemic started driving up their prices, especially in areas like travel and recreation. Canadians experienced these pressures first-hand when trying to book a campsite or reserve a table at their favourite restaurant. Services price inflation rose quickly through the first half of 2022, reaching about 5% this summer. With further increases in goods prices in 2022 and a rapid rise in services prices, total CPI inflation rose sharply, reaching 8.1% in June. Over the last two years, the pandemic and the war have affected lives and livelihoods. They have also had a profound impact on inflation. Our job at the Bank of Canada is to restore price stability. In the last two months, headline inflation in Canada has come down to 7%. This largely reflects lower gasoline prices. In mid-June, filling up in Halifax cost $2.15 a litre on average. By the end of August, that had fallen to $1.64. More generally, there is some evidence that global inflationary forces have begun to ease, though they remain elevated. A range of global commodity prices are starting, finally, to fall from their highs. Oil prices have come down, and the prices for key agricultural commodities have also eased back. In time, with lower input and transportation costs, we should see food inflation begin to come down. Supply bottlenecks have also begun to improve ( Global manufacturers report that delivery times are still longer than usual, but they are getting shorter, and input cost pressures are easing. Global shipping costs have also come down from exceptional highs. These signs of improving global supply chains are encouraging, but we can't count on easing pressure on global prices to lower inflation in Canada. At a minimum, improving global factors will take time to filter through to Canadian inflation. And the recent depreciation of the Canadian dollar in the face of USdollar strength will offset some of this global improvement by making US goods and vacations more expensive for Canadians. There is also considerable uncertainty about the evolution of global supply chains and commodity prices. The global economy remains highly disrupted by the effects of the pandemic and the war in Ukraine. Predicting international price movements isn't easy, and the global inflation picture could change quickly. Unfortunately, we don't have much influence over that. We can't control global developments. But we can use monetary policy to influence the balance between demand and supply in the Canadian economy and therefore ease domestic inflationary pressures over time. All the signs today point to an economy that is clearly in excess demand. Labour markets remain very tight. Job vacancies have eased a little in recent months but remain exceptionally high. Our business surveys report widespread labour shortages. And wage growth has risen and continues to broaden. With demand running ahead of supply, competition is posing less of a restraint on price increases, and businesses are passing through higher input costs more quickly. As a result, higher energy and material costs are showing up in the prices of a growing list of goods and services. So even if there is some relief at the gas pumps, price pressures remain high and continue to broaden. In August, the prices of more than three-quarters of the goods and services that make up the CPI were rising faster than 3% ( Simply put, domestic inflationary pressures have yet to ease. That doesn't mean higher interest rates are not working, but it will take time. By raising interest rates, we are making it more expensive for households and businesses to borrow and therefore to spend. In five steps since March, we have raised the overnight policy rate from 0.25% to 3.25%--one of the steepest and fastest tightening cycles we've ever conducted. And we are starting to see some effect. Some interest- rate-sensitive sectors of the economy have begun to cool. The housing market had overheated to unsustainable levels early in the pandemic due to low supply, increased demand for larger homes and low mortgage rates. With higher rates now constraining borrowing, the sector has cooled. But monetary policy takes time to work its way through the whole economy. Households or businesses making a big purchase or investment--one that requires a loan--are feeling the impact. It takes longer for monetary policy to bring down price growth in other goods and services--especially services-- because they aren't directly tied to borrowing. Instead, they adjust over time as overall spending moderates. Rogers outlined what the Bank is monitoring to guide our decisions in the months ahead. She explained that we will focus on how monetary policy is working to slow demand, how supply challenges are resolving, and, most importantly, how both inflation and inflation expectations are responding. I want to drill down on these latter two elements: measures of core, or underlying, inflation and measures of inflation expectations. These are critical guideposts for us as we seek to bring total CPI inflation all the way back to the 2% target. Core inflation As we look for a more fundamental turning point in inflation, measures of core inflation are becoming increasingly relevant. We are an inflation-targeting central bank, and we target total CPI inflation-- calculated using a basket of goods and services that represents what Canadians typically buy. But parts of the overall CPI basket are sometimes highly volatile in ways not related to broader price pressures--this can be the case for gasoline and food prices. That's why policy-makers like to look at what we call "core" inflation to gauge persistent price movements. Core inflation provides a sense of the underlying trend in total CPI inflation and relates more closely to the balance between demand and supply in our economy. In practice, there are different ways to measure core inflation. Traditionally, central banks in many countries have measured core inflation by excluding volatile components like food and energy. The drawback of these exclusionbased measures is that the components that are volatile can change over time-- something we have experienced in a big way in the last couple of years. We continue to monitor various exclusion-based measures of core inflation, but since 2016, the Bank has focused on three more-statistical measures of core inflation. CPI-median and CPI-trim strip out whatever is volatile at the time. The third measure, CPI-common, is based on a statistical technique that captures the common component in the price changes across many goods and services. This captures the idea that inflation reflects a general increase in prices. We use three measures of core inflation because no single measure is best. Depending on the circumstances, one may be a better indicator of inflationary pressure, and their diversity is their strength. With inflationary pressures as strong as they are, all three measures have risen. ). What they are telling us is that even after taking out components in the CPI that are volatile or don't reflect generalized changes in prices, inflation is running about 5%. That's too high. We can also see that our core measures have yet to decline meaningfully even though total CPI inflation has come down in the last couple of months. Going forward, we will be watching our measures of core inflation closely for clear evidence of a turning point in underlying inflation. Of our three measures, CPI-common is becoming more difficult to use in real time because it has been subject to large historical revisions. With price movements becoming much more generalized in the last year, what is included in the common component has changed considerably. CPI-trim and CPImedian, in contrast, are more robust to changes in the behaviour of prices. These measures appear to have performed well and have been subject to much smaller revisions. With this in mind, we are more focused on these two measures and we are reassessing CPI-common. The extreme events of the pandemic have stressed Canadians. They have also stressed some of our indicators and highlighted the benefits of using a variety of measures. Inflation expectations In addition to measures of inflation, we are also closely watching inflation expectations. Keeping longer-term expectations of inflation well anchored is paramount so that, as inflation pressures ease, inflation returns to the 2% target. The longer high inflation persists and the more pervasive it becomes, the greater the risk that high inflation becomes entrenched. In particular, if high inflation pushes wages up and higher labour costs then push inflation up further, inflation expectations can become unmoored and high inflation can become self-fulfilling. We can't let that happen because if it does, it will be much more costly to return inflation to target. That's why we are so focused on measures of expected inflation. We use a range of surveys and market-based measures to assess expectations of future inflation, and they show us that near-term expectations have risen. Survey results also indicate that consumers and businesses are more uncertain about future inflation and more of them expect inflation to be higher for longer. So far, longer-term inflation expectations remain reasonably well anchored, but we are acutely aware that Canadians will need to see inflation clearly coming down to sustain this confidence. This increased uncertainty heightens the risk that inflation expectations could become de-anchored. Both households and businesses view inflation pressures as mostly global, but increasingly they are identifying domestic pressures--this is similar to our own view. Results from our next consumer and business surveys, which we will release later this month, will be important for our assessment of how expectations have evolved. It's time for me to conclude. Low, stable and predictable inflation is fundamental to a well-functioning economy with sustained growth and shared prosperity. That's why price stability is the main objective of monetary policy in Canada. Without price stability, nothing works well. High and unpredictable inflation creates uncertainty and unfairness, distorting decisions and undermining confidence in our economic system. It erodes the value of money. It distorts and confuses the information and incentives that consumers, entrepreneurs, savers and investors rely on to make their economic decisions. That means workers and businesses have less to show for their work, and it's harder for everyone to plan for the future. Plain and simple, high inflation feeds frustration and creates a sense of helplessness. We want an economy where households and businesses don't have to guess where inflation is going to be. We want an economy where the money Canadians earn from their hard work keeps its value. We want an economy where businesses have the confidence to invest. And we want an economy where workers make real wage gains underpinned by rising productivity. That is why we have taken forceful action to restore price stability. We have raised our policy interest rate by three percentage points this year in five steps, and we are reinforcing these increases with quantitative tightening. Looking ahead, the Governing Council recognizes that it will take time for past interest rate increases to have their full effect on the economy and inflation. That's why we'll be carefully assessing the effects of our actions as we seek to slow spending and return inflation to the 2% target. Canadian economic data over the summer have come in largely in line with our July outlook, and forwardlooking indicators suggest the economy is slowing. However, labour markets remain tight, the economy is in excess demand, and we have yet to see clear evidence that underlying inflation has come down. When combined with stillelevated near-term inflation expectations, the clear implication is that further interest rate increases are warranted. Simply put, there is more to be done. We will need additional information before we consider moving to a more finely balanced decision-by-decision approach. We know we are still a long way from the 2% target. We know it will take some time to get there. We also know there could be setbacks along the way, and we can't afford to let high inflation become entrenched. Atlantic Canadians will rebuild after this storm as they always have. And the Bank of Canada will control inflation as it has for the last 30 years. We are resolute in our commitment to restore price stability for all Canadians. Thank you.
r221026a_BOC	canada	2022-10-26T00:00:00	Monetary Policy Report Press Conference Opening Statement	macklem	1	Governor of the Bank of Canada Press conference following the release of the Good morning. I'm pleased to be here with Senior Deputy Governor Carolyn Rogers to discuss today's policy announcement and the Bank's Today, we raised the policy interest rate by 50 basis points to 3.75%. This is the sixth consecutive increase since March. Quantitative tightening continues and is complementing increases in the policy rate. We also expect our policy rate will need to rise further. How much further will depend on how monetary policy is working to slow demand, how supply challenges are resolving and how inflation and inflation expectations are responding to this tightening cycle. Our decision today reflected several considerations. First, inflation in Canada remains high and broad-based. Inflation has come down in recent months, but we have yet to see a generalized decline in price pressures. Second, and related, the economy is still in excess demand--it's overheated. Households and businesses want to buy more goods and services than the economy can produce, and this is driving prices higher. Third, higher interest rates are beginning to weigh on growth. This is increasingly evident in interest-rate-sensitive parts of the economy, like housing and spending on big-ticket items. But the effects of higher rates will take time to spread through the economy. Fourth, there are no easy outs to restoring price stability. We need the economy to slow down to rebalance demand and supply and relieve price pressures. We expect growth will stall in the next few quarters--in other words, growth will be close to zero. But once we get through this slowdown, growth will pick up, our economy will grow solidly, and the benefits of low and predictable inflation will be restored. Finally, we are trying to balance the risks of under- and over-tightening. If we don't do enough, Canadians will continue to endure the hardship of high inflation. And they will come to expect persistently high inflation, which will require much higher interest rates and potentially a severe recession to control inflation. Nobody wants that. If we do too much, we could slow the economy more than needed. And we know that has harmful consequences for people's ability to service their debts, for their jobs and for their businesses. This tightening phase will draw to a close. We are getting closer, but we are not there yet. We are carefully assessing the effects of higher interest rates on economic activity and inflation. And we are being clear with Canadians and focusing on the job we have been assigned--to restore price stability for the benefit of all. Let me expand on these considerations and highlight the key points in the The Governing Council began by assessing international developments since the July MPR. Inflation around the world is high and increasingly broad-based. With most central banks raising their policy rates to control inflation, global financial conditions have tightened rapidly. The global economy is slowing, and we revised down our projection for global growth. We also noted the emergence of financial stresses in some markets in recent months. A number of indicators suggest that global supply disruptions are easing. Oil and other commodity prices have also come down since July. Together with slower global growth, these developments suggest global inflation should come down over time. However, uncertainty is high, particularly related to Russia's invasion of Ukraine, and there is potential for more volatility in energy markets and for renewed supply chain disruptions. Turning to Canadian developments, the Governing Council devoted considerable attention to assessing inflation, inflation expectations and the balance between demand and supply in the economy. welcome, most of that decline reflects a drop in gasoline prices. Inflation in Canada is broad-based, reflecting large increases in both goods and services prices. About two-thirds of the components of the consumer price index (CPI) have risen by more than 5% over the last year. And rising prices for essentials like groceries and rent are hitting lower income Canadians particularly hard. Because short-term movements in total CPI inflation are often dominated by swings in volatile international prices like oil prices, we are watching measures of core inflation closely for signs that price pressures in Canada are easing. Our preferred core measures have stopped rising in the last couple of months, but they have yet to show clear evidence that underlying inflation is coming down. Looking ahead, there are some early encouraging signs. Businesses have said they expect the rate of price increases for the goods and services they sell will come down. And more timely 3-month rates of core inflation have declined, although they are still averaging about 4%. We will need to see these 3-month rates come down further, and those declines be sustained. We are also looking for evidence that near-term inflation expectations are easing and that longer-term expectations are centred on our 2% target. Near-term expectations remain high and our surveys suggest that uncertainty about where inflation is headed remains unusually elevated. Looking at indicators of labour markets and economic activity, it is clear that even though the economy has started to slow, it remains in excess demand. Job vacancies have declined from their peak but remain high, and businesses continue to report widespread labour shortages. With the economy now fully reopened, households want to enjoy many of the close-contact services they have missed, but businesses can't keep up, and we have seen prices for services rise rapidly. Higher policy interest rates are beginning to slow demand. Higher mortgage rates have contributed to a sharp slowing in housing activity from unsustainable levels, and consumer and business spending on goods is moderating. This has led to declines in house prices and is exerting downward pressure on goods prices. Moving forward, we expect the effects of higher interest rates to continue to work through the economy, moderating household spending and business investment. Slowing global growth, particularly in the United States, will also weigh on Canadian exports. We project growth in gross domestic product (GDP) will stall through the end of this year and the first half of 2023 before picking up in the second half. Annual average GDP growth is therefore projected to decline from about 3 1/4 % this year to just under 1% next year and about 2% in 2024. With growth below potential for several quarters, excess demand in the economy dissipates and the economy moves into excess supply in 2023. Putting the global and Canadian outlooks together, we expect inflation will hover around 7% in the final quarter of this year, fall to around 3% by the end of next year and return to the 2% target by the end of 2024. The Bank of Canada's job is to ensure inflation is low, stable and predictable. We are still far from that goal. We view the risks around our forecast for inflation to be reasonably balanced, but with inflation so far above our target, we are particularly concerned about the upside risks. We are mindful that adjusting to higher interest rates is difficult for many Canadians. Many households have significant debt loads, and higher interest rates add to their burden. We don't want this transition to be more difficult than it has to be. But we remain focused on our mandate. Higher interest rates in the short term will bring inflation down in the long term. And getting through this difficult phase will get us back to price stability with sustained growth. As we move forward, we will be watching carefully to assess the impact of higher rates on spending and how this is feeding through to price pressures. We will also be watching to see how global supply disruptions resolve and to what extent this translates into lower inflation in Canada. Finally, we'll be watching inflation expectations closely to assess how households and businesses are responding to slowing growth and spending. With that summary, Senior Deputy Governor Rogers and I are now pleased to take your questions.
r221101a_BOC	canada	2022-11-01T00:00:00	Opening Statement before the Standing Senate Committee on Banking, Trade and the Economy	macklem	1	Governor of the Bank of Canada and the Economy Good evening. I'm pleased to be here with Senior Deputy Governor Carolyn Rogers to discuss our recent policy announcement and the Bank of Canada's Last week, we raised the policy interest rate by 50 basis points to 3.75%. This is the sixth consecutive increase since March. Quantitative tightening continues and is complementing increases in the policy rate. We also expect our policy rate will need to rise further. How much further will depend on how monetary policy is working to slow demand, how supply challenges are resolving and how inflation and inflation expectations are responding to this tightening cycle. Our decision last week reflected several considerations. First, inflation in Canada remains high and broad-based, reflecting large increases in both goods and services prices. Inflation has come down in recent months, but we have yet to see a generalized decline in price pressures. About two-thirds of the components of the consumer price index (CPI) have risen by more than 5% over the last year. And rising prices for essentials like groceries and rent are hitting lower-income Canadians particularly hard. Second, and related, the economy is still in excess demand--it's overheated. Job vacancies have declined from their peak but remain high, and businesses continue to report widespread labour shortages. With the economy now fully reopened, households want to enjoy many of the close-contact services they have missed, but businesses can't keep up, and we have seen prices for services rise rapidly. Third, higher interest rates are beginning to weigh on growth. This is increasingly evident in interest-rate-sensitive parts of the economy, like housing and spending on big-ticket items. But the effects of higher rates will take time to spread through the economy. Fourth, there are no easy outs to restoring price stability. We need the economy to slow down to rebalance demand and supply and relieve price pressures. We expect growth will stall in the next few quarters--in other words, growth will be close to zero. But once we get through this slowdown, growth will pick up, our economy will grow solidly, and the benefits of low and predictable inflation will be restored. To put this in numbers, growth in gross domestic product (GDP) is projected to decline from about 3 1/4 % this year to just under 1% next year and then rise to 2% in 2024. And inflation is expected to hover around 7% in the final quarter of this year, fall to around 3% by the end of next year and return to the 2% target by the end of Finally, we are trying to balance the risks of under- and over-tightening. If we don't do enough, Canadians will continue to endure the hardship of high inflation. And they will come to expect persistently high inflation, which will require much higher interest rates and, potentially, a severe recession to control inflation. Nobody wants that. If we do too much, we could slow the economy more than needed. And we know that has harmful consequences for people's ability to service their debts, for their jobs and for their businesses. This tightening phase will draw to a close. We are getting closer, but we are not there yet. The Bank of Canada's job is to ensure inflation is low, stable and predictable. We are still far from that goal. We view the risks around our forecast for inflation to be reasonably balanced. But with inflation so far above our target, we are particularly concerned about the upside risks. We are mindful that adjusting to higher interest rates is difficult for many Canadians. Many households have significant debt loads, and higher interest rates add to their burden. We don't want this transition to be more difficult than it has to be. But higher interest rates in the short term will bring inflation down in the long term. Canadians are looking for ways to protect themselves from rising prices, and we are working to protect them from entrenched inflation. It will take time to get back to solid growth with low inflation. But we will get there. By working through this difficult phase, we will get back to price stability with sustained economic growth, which benefits everyone. With that summary, Senior Deputy Governor Rogers and I are now pleased to take your questions.
r221102a_BOC	canada	2022-11-02T00:00:00	Preparing for payments supervision	morrow	0	Good morning, and thank you for inviting me to attend this year's Canadian Innovation Exchange Summit. This is an exciting event for entrepreneurs, investors and service providers who are on the cutting edge of technology innovation in Canada. Today I want to talk about how the Bank of Canada's evolving role in payments is keeping up with fast-paced advancements in how everyone pays for goods and services. Exchanging payment for these goods and services--like so much else in society--is moving more and more toward the digital universe. Consumers' use of cash at the point of sale decreased to about 22% in 2021--down from 54% in The COVID-19 pandemic has also led to greater use of debit and credit cards. About 85% of merchants now accept these electronic forms of payments, up from 60% in 2018. All that to say the payments ecosystem in Canada is evolving rapidly, with a sharp uptick in the use of mobile and digital payments. The fintech industry-- which includes a large number of payment service providers (PSPs)--has facilitated this evolution. And this industry is growing quickly--both in terms of the number of companies involved and the amount of capital invested. As the Notorious B.I.G. so aptly said: it's like the more money we come across, the more problems we see. There are new ways to pay and an abundance of new players in payments. When money changes hands electronically in these new and different ways, we all need to make sure that consumers and the payments ecosystem are protected. So, where does the Bank of Canada fit into all of this? Well, Canadians place their trust in these PSPs every day when they tap their card to make a purchase, send money electronically to friends or family, or click the check-out button with their favourite merchant online. And under the , which was passed last summer, the government has mandated the Bank to supervise these PSPs. This legislation will safeguard the trust that Canadians place in PSPs. The Act establishes a new supervisory framework to ensure that PSPs are managing certain risks that could affect their users. The impetus behind all of this is to build confidence in the safety and reliability of payment services. Let's dig a bit deeper into what this means when the rubber hits the road. Before we get to the how and when, let's talk about the who. I'm sure there are fintech companies in the room today that may be wondering if the new framework will apply to them. Simply put, if you're in the business of helping people and companies make dayto-day payments, or store or transfer their money through electronic means, then your organization could very well be deemed a PSP that will fall under this new framework. This includes payment processers, digital wallets, money transferers and others. Banks and credit unions are already subject to a high degree of supervision at the federal and provincial levels, so they fall outside the scope of the Act. But we currently estimate there are over 2,500 entities that will come under our regulatory supervision. This includes well-established domestic and global entities that are household names when it comes to payments. It also includes a whole suite of newly established fintech companies. Domestic and foreign PSPs will be required to register with us. And we will maintain a public list of all PSPs that have signed up as well as a list of those whose registration has been refused or revoked. This is all to help us better monitor PSPs' ongoing compliance with the Act. This framework will apply to many entities, but we're not going to use a blanket supervisory approach to the task at hand. We will establish a common baseline of supervision for all PSPs, but we recognize that companies will have different business structures and operational processes. That's why we will take a risk-based approach that will focus on end-user impacts and the efficiency of payment services. Essentially, this means that both the level of supervisory attention and the supervisory actions we take will be guided by the level of risk each PSP brings to consumers and the payments ecosystem. As a result, there is no "one size fits all" methodology. Moreover, PSPs can meet our expectations using many approaches. Our job is to make the objective very clear. And then PSPs can focus on reaching the destination, not necessarily following a prescriptive journey to get there. Of course, with this flexible risk-based approach comes a need to ensure industry participants truly understand their obligations. We will clearly lay out the requirements and expectations so that PSPs can adapt. The Act and forthcoming regulations will establish the mechanics of the new framework. But to truly make sure that industry players understand what's expected of them, we will supplement these documents with supervisory guidance. It's important that we promote understanding and compliance within the PSP community to make sure this Act does what it was designed to do. Equally important is everyone's understanding of the consequences of non-compliance. Under the Act, we have the power to take action if a PSP does not comply with the Act or its regulations. This starts with a compliance agreement that lays out the terms by which the PSP must rectify its operations. The next level of enforcement is a notice of violation. When we issue a notice of violation, we will publish on our website the company's name and the nature of its violations. The notice may also include a monetary penalty, which will be made public and could be as high as $10 million for a very serious violation. Finally, the Governor has the power to issue a compliance order if a PSP is committing--or is about to commit--an act that would have a significant adverse impact on consumers and other end users. Furthermore, if a situation of noncompliance becomes severe, we can pursue court enforcement, requiring the service provider to comply with the Act or an order. Now, I've talked about the new powers and responsibilities the legislation provides us. I think it's also important to be clear about some areas that remain outside our purview. We will not be supervising all aspects of risk. For example, we will require PSPs to ensure that end users' funds can and will be returned to them if a PSP becomes insolvent. Our supervision will not, however, prevent a PSP's failure or insolvency from happening in the first place. As well, customer complaints regarding fees charged by PSPs or other issues related to the fair treatment of customers are beyond the scope of our supervision. I want to be clear that our approach to supervision will change and evolve. We need to be forward-looking to assess emerging risks and practices in retail payment activities--and to keep up with the spirit of innovation that is driving changes in how Canadians pay for goods and services. continues to guide the path forward. The committee was established in 2020 to provide us with industry expertise. The insights we're gaining from the PSPs on this committee are shaping our advice to the Department of Finance Canada regarding the forthcoming regulations. We're also engaging with industry groups, individual PSPs and associations that represent them and raising awareness of the framework more broadly. The Bank has also started outreach efforts through trade shows that we know PSPs will attend. In due course, when the draft regulations are published online, this will open the door to a formal comment process. This will give PSPs the chance to provide feedback about the new requirements. After the subsequent publication of the final regulations, we'll begin to publish our supervisory guidance. We will continue to seek feedback; it's important that we take the time to ensure we're doing this right, from the outset. In a similar vein, the Act is expected to come into force in stages. For example, PSPs will be required to register with us before they have to comply with requirements for operational risk management and safeguarding end-user funds. With these steps in mind, we expect to require payment service providers to register with the Bank starting in 2024. The initial pilot and subsequent launch of our risk monitoring and compliance work is currently scheduled for 2025. To meet this schedule, next year we will focus on finalizing the regulations and publishing our regulatory guidance. I'd like to stress that these are our current assumptions. Ultimately, the federal government will decide how and when each provision of the Act will come into force. I'm going to wrap up now, so we have time for questions. Before I open up the floor, I want to reinforce to everyone here that our goal in all of this is to support the innovation we see in the payments ecosystem while ensuring PSPs are managing their operational risks and ensuring their consumers' funds are protected. By ensuring these key risks are well managed, we will further build and maintain Canadians' confidence that mo' ways of paying do not, in fact, create mo' problems. I'd like to thank you for your time and attention today, and I'd be happy to answer any questions you may have.
r970207a_ECB	euro area	1997-02-07T00:00:00	Conference organised by the Hungarian Banking Association	lamfalussy	0	For at least three reasons, I have accepted with pleasure the invitation to share some thoughts with you on the occasion of these tenth anniversary celebrations. First, for obvious personal reasons, I enjoy spending some time in Hungary - even if it is only for less than a day. Second, I am absolutely convinced that an efficient financial system in general, and an efficient banking system in particular, together comprise an indispensable precondition for the proper functioning of a market economy and, indeed, for economic growth. Not a sufficient condition, but a necessary one. Third, I note that Hungary has made substantial progress in this direction in four key areas. The larger part of the Hungarian banking system is now in genuinely private hands; the financial health of most banks (which, not so long ago, was - to put it mildly - precarious) has improved; the legal, accounting and regulatory framework has been consolidated, and, last but not least, there is now an interbank payment system in place which can no longer be qualified as prehistoric. Admittedly, in all these areas progress is still possible and desirable, but what has been achieved so far now enables you to address a number of institutional issues for the solution of which Western experience is fast becoming increasingly and directly relevant. But before considering some of these issues, allow me to make some remarks about the macroeconomic situation of the Hungarian economy and about the new framework within which the National Bank of Hungary will be operating. Both these areas are of key importance for the management of your banks. At the same time, both have a bearing on Hungary's declared intention to join the European Union (and within this, probably at a later stage, also EMU). Last but not least, both are important areas in themselves, irrespective of considerations relating to European integration. That there has been a significant improvement since mid-1995 in Hungary's macroeconomic situation is beyond doubt. Here are a few facts and comments on some of the features of this improvement. The current account deficit reached $3.5 billion in 1993 and almost $4 billion in 1994, i.e. more than 10% of GDP - an obviously unsustainable situation by any standards, but even more so for a country with a high debt ratio. Some of this deficit was covered by direct foreign investment, but the greater part of it was financed by borrowing, as a result of which by the end of 1994 the net external debt had reached 46% of GDP and the exceptionally high level of more than 160% of exports of goods and services and unrequited transfers. I have not yet seen the full 1996 figures, but estimates based on the first eleven months suggest a current account deficit of around (or even less than) $1.5 billion. This looks much more reasonable, not only because it was more than covered by foreign direct investment but also because of what lies behind this improvement. The $2.5 billion drop in the current account deficit between 1994 and 1996 was made possible (a) by a 35% increase in exports, accompanied by a modest increase in imports of about 14%, and (b) by the steady and rapid increase in services income, mainly (but not exclusively) derived from tourism. Since there was also a sizable inflow of foreign direct investment in 1995 and 1996, the country's net external debt dropped from $18.9 billion at end-1994 to about $13.3 billion at end-1996. Net external debt declined to 31.2 expressed as a percentage of GDP, and to 71.6 as a percentage of exports of goods, services and unrequited transfers. I have also noted that by 1996 net interest payments on the external debt had dropped to 6.7 as a percentage of exports of goods and services. The comparable figures were 12% in 1994 and as high as 17% in 1990. It is useful to point out that the sizable decline of the net external debt was made possible by the substantial decline of the public sector deficit from 8.2% of GDP in 1994 to 4% in 1996, while at the same time the share of public sector expenditure in GDP declined from 62% to a more bearable 51%. "Growing out" of the debt service burden is no longer wishful thinking. It is beginning to become a reality. The fact I find most noteworthy is that the $2.5 billion switch of resources towards external use, amounting to some 7% of GDP, took place without a recession, which is unusual for such a large switch. It was even accompanied by a small increase in GDP. This would not have been possible without the fast growth of exports. The remarkable growth of labour productivity in industry - of close to 60% between 1992 and 1996 - played a major role in this respect. This growth, together with the changing composition of exports, suggests that the structural transformation of the Hungarian economy has gone quite far. The growth of net services exports points in the same direction. So much for the bright side of the picture, which is a good thing but should not be overstated. First, these are improvements in comparison with the unsustainable imbalances which characterised both the situation prevailing in 1988-89 and that of the years 1993-94. Second, the price paid by the majority of Hungarians was very heavy indeed: a drop in net real earnings of 12% in 1995, followed by another of 4% last year. Even if this was arguably unavoidable, given the size of the imbalances which had to be corrected (and which themselves had been caused, to some extent at least, by the premature rise in real earnings in 1994), the size of the sacrifices remains a fact. Against this background, any further erosion of average living standards would be just as unsustainable as were the macroeconomic imbalances in 1993-94. Third, the rate of inflation is still far too high. Admittedly, since the post-devaluation peak reached in the late spring of 1995 - of more than 30% - the rate has been declining steadily, to stand by December last year at a shade below 20%. But I am seriously worried by the fact that the Hungarian rate of inflation, while never moving towards three digits, has remained stuck within the 18-35% range over the past seven years. The worst was avoided by maintaining positive real interest rates during the greater part of this period, but the distorting effects of such inflation rates on the economy remain substantial, not to mention their socially unacceptable impact on those people whose earnings cannot be adjusted to inflation. Looking ahead, I hope that you will bear with me if I become a little philosophical. All knowledgeable observers of Hungarian history, ancient as well as contemporary, agree that Hungarians possess the very rare ability to pull back at the last minute from the brink of disaster or at least to extricate themselves from a seemingly hopeless situation. They unfortunately also note that once the Hungarians have done so, they miss the opportunity offered by their own success to carry out policies with a long-term perspective in mind. I do hope that history will not repeat itself. Admittedly, any further decline in the average living standard would be unacceptable. The standard of living should be allowed to begin to rise - but only to the extent that this does not upset the basic balance of the economy again. At the same time, the reduction in inflation must continue at a pace which puts the attainment of single-digit inflation in sight. You must break out - downwards - of the 18 to 35% range. And, last but not least, the country will have to begin to tackle earnestly the major structural problems related to the pension, health care, education and social security systems. These are daunting challenges. Two reminders may help when tackling them. The first is that Hungary has managed major breakthroughs in the recent past which were just as difficult as these future challenges: over the past five years, real privatisation accompanied by a fundamental shift in the structure of industry and services; and, more recently, the handling of a macroeconomic crisis situation. The second is that most of these challenges are akin to those encountered by modern Western societies. For these challenges Hungary is in good company. Two recent changes have occurred regarding the institutional environment in which the National Bank of Hungary is operating. I welcome both of them. The possibility of the direct financing of the budget deficit by the NBH has been eliminated. This is in conformity with the provisions of the Maastricht Treaty, and is a measure which has already been implemented by all fifteen member countries of the European Union and which the EMI closely monitors. To remind you, this provision of the Treaty applies to the member countries at this stage, prior to effectively entering EMU. It would seem to me impossible for Hungary to join the European Union without this change in the law governing the operations of the NBH, even if Hungary's participation in the euro area were to come at a later stage. But this is only an institutional or political argument. There is more to it. Maastricht or no Maastricht, eliminating the direct monetary financing of budget deficits is simply economic common sense. In the long run, inflation is a monetary phenomenon: it cannot happen without an (at least) accommodating expansion of the money supply. And we know from historical experience that more often than not the major source of any such inflationary increase in the money supply has been the direct financing of government by the central bank. Hungary has not been an exception to this general rule - rather its confirmation. And once inflation is established, interest rates go up. Except for very short periods, it is impossible to keep market interest rates below the rate of inflation: who would be ready to undertake financial savings the remuneration of which would imply a loss in real financial wealth? To try to keep interest rates low by monetary financing of the government is a self-defeating device. It may work for a few months, but would end up producing more inflation and higher, not lower, interest rates - certainly higher nominal interest rates, but very likely also higher real rates. The simple reason for this is that people are not fools - at least not for a long time. Monetary financing of the government is therefore likely to combine two evils at the same time: inflation and high interest rates. The accumulated and potential future losses of the NBH on account of its borrowings in foreign currency have been taken over by the government. This is a salutary cleaning-up operation which ought to have been carried out long ago. It has no consequences for the "real" economy. These borrowings have been undertaken in the past on government instruction and with government approval, with the NBH acting solely as an intermediary. The NBH's only shareholder is the Hungarian State; the real burden of the State's direct or indirect external borrowing has to be borne by the present or future taxpayers. This real burden was to some extent hidden by the "seigniorage" profits of the NBH, which had two consequences: they hid the size of this burden from public view; and they distorted the NBH's accounts. As all experts know, the size of this double distortion was proportional to the rate of inflation, and was aggravated by the NBH's sterilisation policy of large capital inflows, without which, however, inflation would not have been brought down from 30 to 20% within the past eighteen months. Sterilisation was therefore a wise policy; the real culprit is the rate of inflation, which is much higher in Hungary than in the countries whose currencies were used for borrowing. In a sentence: this long overdue measure serves both public transparency and democratic accountability (of both the government and the NBH) - even if the general public, or politicians, may be excused for not fully understanding the intricate interconnection between accounting procedures in a country with high inflation and the processes of the real economy. This is a good example of the generalised mess created by inflation. As I said right at the outset, it is now time to look ahead and begin to address some major issues for the Hungarian banks - issues which, thanks to the progress made over the past few years, are no longer totally dissimilar from those facing banks in western Europe. I intend to make a few comments on these, since they are issues on which I can possibly throw some light on the basis of my own professional experience. The first is about the specificity of banking, i.e. about the possibility or desirability of clearly distinguishing banks, through rules and regulations, from other financial intermediaries. I noted that the recent changes in Hungarian banking law have implied a movement towards the de-specialisation of banks, notably in the field of securities transactions. I believe that a development towards the universal banking model is justified - on certain conditions. It is justified for two groups of reasons. First, because financial innovation in general, and securitisation in particular, are breaking down the traditionally neat distinction between banks and other financial intermediaries, indeed even between financial intermediation and financial markets, all over the world. Some time ago, banks were defined as financial intermediaries whose liabilities (mainly sight and short-term deposits) were equivalent to the money supply, and the money supply was defined as the total sum of bank liabilities. This nice circular definition kept academics, bank regulators and central bankers equally happy until the moment when financial innovation started blurring the distinction between money and other financial assets, and securitisation began blurring the distinction between financial intermediation and financial market operations. The proliferation of derivatives, financial futures and the like added to the confusion between balance sheet and off-balance sheet items. The result is that it is becoming increasingly difficult to identify banking on the basis of the old equivalence of "banking liabilities = money supply". This has now been recognised in the sweeping deregulation of banking activities affecting the whole of western Europe and, though more cautiously, also the United States. In some cases this has gone so far as to allow the emergence of consolidated banking and insurance activities. Second, in a shorter Hungarian perspective, banks in Hungary have a head start on other financial intermediaries in collecting the financial savings of households and of the enterprise sector. Admittedly, Hungary badly needs the large-scale development of life assurance companies, pension funds, mutual funds and the like, i.e. all those institutional investors which can channel savings towards equity investment. But this takes time, since experience and human resources are rare and the reform of the pension system and of health services takes time. Banks should be allowed to fill the gap for the time being, by putting at the disposal of savers a wide variety of financial instruments. Now let me come to the risks that a generalised move towards universal banking could entail, and the ways and means of containing them. The main risk, of course, is the emergence of conflicts of interest. One such potential conflict of interest may arise within any bank, between the bank's own risk-taking activity and risk-taking for its customers. The classic example of this is the potential conflict of interest between credit-granting and securities underwriting, but this is only one example. The traditional way of avoiding the misuse of such conflict-creating situations is (a) to devise an organisational structure with clearly distinguishable lines of responsibility, (b) to avoid flows of "inside" information between the various activities, (c) to attribute to each activity costs, income and profits, and (d) to entrust external auditors with the surveillance of the systems put in place. The end-result will, of course, never be entirely safe. Moreover, the building of "Chinese walls" inside a multi-polar banking organisation may weaken, or even destroy, the synergy between those poles, i.e. it may undermine the rationale of a multi-polar organisation. I would not want, however, to overstate the internal conflict of interest argument. In the long run, the kind of conflict to which I have referred is unlikely to be very strong. In a longer-term perspective, no bank can afford to favour its own risk-taking activity at the expense of its customers - especially if auditing makes it certain that any misuse of the bank's powers would come to light. Another much more dangerous conflict of interest could arise where the bank is capable of exercising a decisive shareholding power in another non-banking firm, of which it is at the same time a major creditor. This could have unacceptable consequences not only for the firm's other shareholders but, if the practice became widespread, could even lead to structural distortions for entire industries. To avoid this happening, I would favour rather strict regulations. For instance, mutual funds managed by banks should either have limits on the equity participation in individual firms or not have access to the firm's Board. The same should apply, a fortiori, to any bank's direct and permanent equity participation in a non-banking firm - unless, perhaps, the bank remains just a shareholder (as if it were, say, a pension fund), without direct banking operations with the firm in question. Under the last point, I already touched on one particular aspect of corporate governance, namely when a bank can play a decisive role in a non-banking firm's life. But you will also have to face up to the reverse problem: when a non-banking firm becomes a bank's key shareholder and could therefore potentially induce risk-taking by the bank in its favour, at the expense of the bank's other shareholders or of its depositors or customers. This is a particularly acute danger in countries where there are not many non-bank institutional shareholders, where the defence of minority shareholders has no tradition and where depositors are not properly protected. Such problems have been encountered in Western market economies. It is clearly in Hungary's interest to build up, or consolidate, the appropriate defences against the emergence of such problems. In order to avoid any misunderstandings, I am not launching any appeal in favour of overregulation. In a market economy, the best regulator is the market itself. And when spontaneous market regulation fails - which does happen - the second-best solution is to use regulatory techniques which favour the emergence of market-led self-regulation. I am simply trying to make two points. First, that banking and finance have broader and more general implications for the economy as a whole than any other kind of activity. A crisis in, say, the steel industry creates hardship, but it does not create a general crisis. A banking crisis may well do so. Second, banking and finance are evolving at a very fast pace under the combined influence of technological progress, innovation and globalisation. This needs a careful adjustment of the regulatory framework, not its general weakening. In a very different area, may I call your attention to the need to develop both retail banking in the narrow sense of the term and also banking services to the dynamic sector of small and medium-sized enterprises. In these fields, Hungarian banking is vastly underdeveloped, both in the number of consumer-friendly local offices and, even more importantly, in the range of high-quality banking services offered to these two groups of customers. This underdevelopment is particularly striking when it is compared with the sophistication of some of the wholesale banking activities being offered. This is most regrettable and goes against the long-term interests of the banks themselves, not to mention those of the country. Households are, and will remain, the major source of the country's financial savings. They deserve to be supplied with appropriate, safe and diversified vehicles which allow them to find an outlet for their financial wealth. Some small and medium-sized firms are net savers; others desperately need financing for development purposes, which financial markets will not be able to provide for a very long time indeed. I have known of a number of western European and even North American banks which derived great strength from their solid retail banking basis, which helped them considerably in situations in which some, if not many, of their cherished wholesale customers went bust. You will also need the retail banking basis for another reason. Satisfied household and small enterprise customers provide you with the greatest public support. And I can assure you that you will need this support in a democratic society. Banking has never been, and is unlikely to become, a popular activity, especially when it relies exclusively on customers recruited from among large corporations and very wealthy individuals. Beware of the danger of political backlash. In developing your retail activities, you will have to monitor western European experiences carefully. Many western European countries are overbanked in this field, and a good deal of discussion is focusing on the merits of customer proximity versus home-computer banking. My feeling is that you will be able to avoid some of the earlier western European excesses, and rely directly on the most recent communications and information systems technology. But for a long time to come, most of your customers will need close human proximity. The comparative assessment of the costs and benefits of these two approaches will be a very great challenge for the Hungarian banking system. I hope that in ten years' time, if I am still around, I shall be able to congratulate you on having been able to successfully meet this challenge. Meanwhile, I wish you good luck - and the ability to help the emergence of good luck by hard work, skilful management and good strategic choices.
r970310a_ECB	euro area	1997-03-10T00:00:00	Securing the benefits of EMU	lamfalussy	0	It is a great pleasure to be with you today here in London, at this august institution and in this distinguished company. I am acutely aware that the topic we are to discuss today is one which has been addressed in great depth and with much passion in this country; I hope the panel will advance that debate further. The main focus of my remarks is the economic benefits that members of the European Economic and Monetary Union (EMU) can expect to achieve, an assessment of costs, and how we can construct the Monetary Union so as to be sure that the net benefits are achieved. First, however, I would like to remind you briefly of the role of the European Monetary Institute (EMI), and of the progress that has been made in the preparations for EMU. , and currently has a staff of around 250. The EMI was established to contribute to the realisation of the conditions necessary for the transition to EMU; it is a temporary institution which will be dissolved when the European Central Bank (ECB) is established, i.e. some time in the second quarter of 1998. Its three main functions are: first, at this stage, i.e. before the start of EMU, further strengthening co-operation among the national central banks and the co-ordination of national monetary policies with the aim of ensuring price stability; second, providing advice to the EU Council regarding the achievement of a high degree of sustainable convergence by Member States adopting the single currency; and, third, undertaking the necessary preparations required for EMU. I shall not deal with the first function; the second will enter my remarks later. For now, I would like to focus on the highly advanced state of preparatory work. The preparations for EMU involve close collaboration between the EMI and the national central banks. Concerning preparatory work by the EMI, I would highlight, inter alia, that the scenario for the changeover to the euro after the beginning of EMU has been agreed; operational aspects of monetary policy for the ESCB, including instruments and procedures, have been specified in some detail, and the factors underlying the eventual choice of strategy by the ECB have been outlined; the foreign exchange relationship to be established between the Monetary Union and Member States which are not participants (ERM II) has been defined; and secondary Community legislation on the introduction of the euro (including the continuity of contracts after the start of Stage Three and technical rules for the conversion rates) will become effective this year. There are a large number of other areas in which preparatory work for the establishment of the ECB and the ESCB is being carried forward by the EMI, including issues relating to the interlinking of national payment systems (the TARGET project); preparation of euro banknotes; foreign exchange reserve management; statistical requirements; securities settlement systems; harmonisation of accounting rules and standards; information and communications systems; and further legal issues. A great deal of work remains to be done, notably the detailed specification of all of the technical features of the various monetary policy instruments and procedures, and more generally in respect of the implementation of the overall framework so that a single monetary policy can operate smoothly from the outset. This will undoubtedly reveal many hurdles - but I am confident that they will be overcome. All things considered, the EMI is well on track to achieve its objective of ensuring that all of the preparations will be finalised so as to allow EMU to start on 1 January 1999. I begin with the realistic expectation that EMU will ensure price stability. Price stability is laid down in the Maastricht Treaty as the primary objective of the single monetary policy, to be explicitly incorporated in the statutes of participating national central banks. The European System of Central Banks (ESCB) will enjoy full independence to determine the appropriate level of interest rates in order to satisfy this requirement of the Treaty. Moreover, the members of the ECB's Executive Board and the Governors of the participating national central banks, who will together form the ECB Governing Council, will have long terms of office and will only be dismissible for serious misconduct or inability to perform their duties. These provisions imply that the concept of monetary stability will benefit from explicit legal protection. The ECB should also reap reputational benefits, inherited from its constituent central banks. We should bear in mind that as a result of generally conservative monetary policies for a number of years, the rate of inflation in the EU is now just a little above two per cent. The benefits of price stability are increasingly appreciated. Notably, there is growing awareness that inflation, and inflation uncertainty, lead to a misallocation of resources, and hence the maintenance of price stability is associated with significant efficiency gains, and longer-term benefits to growth. In this context, EMU will be a tool to consolidate the progress towards price stability already made and to firmly anchor inflation expectations. For some countries, where inflation expectations may still be higher due to their shorter track record in terms of monetary stability, EMU will also bring lower interest rates, both nominal (due to lower inflation) and real (as inflation - and exchange rate - risk premia fall), thus providing a stimulus to investment and to growth in the euro area as a whole. There should also be benefits from EMU in terms of a reduction in the costs of disinflation following inflationary "shocks". For in the absence of EMU, maintenance of the option to alter the exchange rate may be taken as leaving open the possibility to devalue, thus giving credence to agents' expectations of higher future inflation. A further important benefit of EMU is that it will remove the risk of serious real exchange rate misalignments. These may not only hinder economic growth and give rise to a misallocation of resources; they may also trigger protectionism and, hence, pose a threat to free trade. Such misalignments are particularly devastating in Europe given the level of economic integration; you will recall that sudden sharp falls in currencies such as the lira and sterling some time ago immediately led to - rather isolated - calls for protection and compensation. Such pressures, if unchecked, could put the survival of the Single Market, and all the benefits it brings to producers and consumers, at risk. Note, in this respect, two facts. We have achieved inside Europe a spectacular downward convergence of inflation rates. At the same time, the Single Market implies generalised competition and constant pressure on profit margins. In such a world - and this is a world - even relatively small nominal exchange rate movements turn into real misalignments, with disruptive effects on trade flows and business planning. Short-term intra-EU exchange rate volatility will, of course, also be eliminated. Such volatility can again have a direct effect on trade and investment, as is shown by most empirical studies. In any event, the argument that the increased use of hedging instruments makes such volatility a matter of indifference seems exaggerated. Such instruments are not available to all economic agents, nor are they of negligible cost. It may not even be optimal to fully hedge against a single type of risk, since it may leave the firm more exposed to other types of risk, as ably demonstrated in Professor David Currie's recent paper entitled "Pros and cons of EMU". Furthermore, the benefits of economic integration afforded by the Single Market process will be enhanced once the transactions costs of exchanging different currencies are eliminated. These costs, which include commissions, the bid/offer spread and overall cash management costs, otherwise constitute a dead-weight loss for society as a whole and are far from insignificant - although I acknowledge that they are difficult to measure. Equally, they in effect form an additional layer of protection for domestic producers; a single currency will make prices across the euro area directly comparable, which should increase competition and hence efficiency and underpin progress towards a Single Market. A number of further positive effects on growth will flow from the elimination of separate currencies. I have already referred to the potential for the reduction of risk premia built into real interest rates, which in turn will stimulate productive investment. By facilitating the development of deep and integrated securities markets, the single currency should further reduce long-term rates via the elimination of an illiquidity premium. In addition, a wider and deeper capital market will improve intermediation between savers and investors. At a macroeconomic level, the savings/investment balance as reflected in the current account of the balance of payments will become much less of a constraint within the individual participating economies. An EMU country that shows valuable and attractive investment opportunities will be able to attract more capital without running into a balance of payments constraint. Moreover, foreign direct investment is sensitive both to exchange rate volatility and to the risk of lasting real exchange rate misalignments, and hence should benefit from EMU. A number of the benefits enumerated above increase with the existing degree of integration. In this context, it is important to stress that the integration of the real economies and financial markets of the Member States has already reached a high level. According to a recent estimate, around two-thirds of EU trade is intra-EU, an unparalleled degree of real integration. But equally, the single currency should stimulate further economic integration, with efficiency gains. Such further integration will be beneficial also in that it may reduce the likelihood of so-called asymmetric shocks, one of the arguments used in the debate about the dangers of EMU, to which I shall now turn. Although the case given is a sound one, the arguments put forward by the opponents of EMU cannot, and should not, be disregarded but should be considered seriously and their merits acknowledged, not least because they contain useful warnings about potential problems. The main policy or even "political" argument often put forward against EMU is that it entails the loss of monetary sovereignty, i.e. the ability to use monetary policy to achieve domestic objectives. However, this argument only retains force if countries were to disagree on the final objective of monetary policy; instead, there has been a growing consensus over the last decade or more that monetary policy cannot influence economic activity and unemployment beyond the short term. This has been the result of the experience of the 1970s, both in Europe and in the United States, which demonstrated the futility of attempts to trade inflation off against unemployment, as well as the growing awareness that inflation erodes growth potential. This has led to an intellectual and political conversion to the cause of price stability and to world-wide acceptance of it as the primary objective of monetary policy. At the EU level, since monetary policies have a common objective, and given the potential for spillovers of national policy decisions in this area, it is hard to see what is lost by sharing responsibility for the conduct of a single monetary policy - which is, in essence, what EMU means. I might add that the degree to which countries may adopt fully independent national monetary policies is itself limited by the power of the international financial markets, whose ability to punish perceived monetary laxity with rising bond yields and a falling currency has strengthened in recent years. There are, however, other arguments which to my mind carry greater weight. First, there will clearly be costs to the changeover, such as training, updating computer systems, and adjustments to cash dispensers and vending machines. These are, however, one-off costs, which should be weighed against certain permanently accruing benefits. Second, there may be differential effects of a single monetary policy on national economies, owing to differences in the monetary transmission process. However, such differences can be exaggerated. Moreover, the market forces unleashed by EMU should themselves promote convergence in this area, as, for example, sustained low inflation makes long-term fixed rate mortgage finance attractive. Perhaps the strongest argument put forward against establishing EMU is that individual countries should retain the ability to change their exchange rates as a means of responding to adverse asymmetric shocks - shocks which affect the domestic economy but not the euro area as a whole. One preliminary remark, however. I do not believe that asymmetric shocks are likely to be frequent events in western Europe. First, our economies remain rather similar in structure and are relatively diversified, certainly in comparison with the United States. To take an example, the automobile industry plays an important role in practically all our countries. It is heavily concentrated in some areas of the United States. Second, whenever we had a genuinely asymmetric shock in the past - German unification or, to a lesser extent, the oil shock - what really mattered was not so much the asymmetric nature of the shock, but the asymmetry of the policy reactions. This was evident in the case of the oil shock; and the impact of German unification on interest rates would have been significantly weaker if the Germans had not allowed their public sector borrowing requirement to rise by the equivalent of several percent of GDP. With the emergence of a genuinely converging "stability culture" in the conduct of monetary and fiscal policies the risk of asymmetric policy reactions during the coming years would appear to me to be much smaller than any time since the end of the last war. Be that as it may, I do not deny that market rigidities in most EU countries a source of concern. There is no doubt that labour and also some goods and services markets show insufficient flexibility. However, I disagree with the view that this is an argument against EMU. The source of the problem lies in structural rigidities that prevent timely adjustment in domestic prices and wages. The reduction of such rigidities, especially in labour markets, is an objective which has to be pursued irrespective of Monetary Union. Keeping the exchange rate option - which means, to put it bluntly, the devaluation option - may even foster the illusion in some circles that structural adjustments do not require immediate attention. Moreover, in an environment of real labour market rigidities, changing the nominal exchange rate may not be effective against shocks. If real wage decline is needed to prevent a negative shock from raising unemployment, it has to be the case that wage setters are prepared to allow it through a depreciation of the national currency but at the same time are not willing to accept it through nominal wage restraint. This presupposes a degree of "money illusion", which is present at most in the very short run. What role might fiscal policy play in this context? As critics of EMU note, there is no provision under current fiscal arrangements for transfers between Member States of a magnitude sufficient to offset differences in labour market rigidities. Moreover, to minimise the risk of an adverse policy mix and an excessive burden on monetary policy, the countries participating in EMU have agreed to exercise a concerted discipline in the conduct of their fiscal management, with accepted sanctions in the case of excessive deficits. But even if such discipline reduces the scope for increasing fiscal deficits and public debts, the operation of automatic stabilisers should still be available to stabilise the economy, provided the structural deficit is close to zero. This should be a worthwhile objective with or without EMU. Two years ago, I would have cited a number of challenges still to be faced in ensuring that benefits of EMU are secured, notably a mutually satisfactory exchange rate relation between countries within and outside the euro area and an adequate system of control of fiscal deficits once EMU is up and running. Since these have been addressed, I would like to focus on the key remaining elements, which I have already foreshadowed, namely those of ensuring sustainable convergence among countries before they join EMU and, in the longer term, enhanced labour market flexibility. The dangers of a lack of convergence when countries enter EMU are self-evident. If fiscal positions are not initially under control, there may be repercussions on the single monetary policy from large deficits, and adverse spillovers across borders affecting the Monetary Union as a whole from lax fiscal policies in individual Member States. These difficulties are far from theoretical. We must be aware that with such a unique enterprise as EMU, with no historical precedent, and operating in such an uncertain world environment, we will have to live with the possibility of teething troubles during the crucial "running in" period, putting considerable strain on the strategy and the technical capabilities of the ECB. Such strain could become unbearable or, to put it less dramatically, could lead to a dangerously unbalanced policy mix if it were compounded by the consequences of initially weak budgetary positions in the member countries. The authors of the Maastricht Treaty were acutely aware of these dangers and, consequently, required entrants to show a high degree of sustainable convergence by reference to compliance with various convergence criteria. The EMI is assigned an important role in the assessment of such convergence. As regards current performance, I would acknowledge that important progress has been made in respect of the downward convergence of inflation and bond yields, and exchange rate stability has to date been broadly maintained. In a welcome development, Finland and Italy are now ERM members. However, on the fiscal side, deficits in 1996 substantially overshot the benchmark laid down in the Treaty in most Member State, despite efforts aimed at consolidation. Debt ratios have continued to rise in the aggregate, despite favourable trends in some Member States. In my view, the composition of consolidation continued to rely excessively on high revenue ratios and less than is desirable on expenditure restraint. Moreover, there were measures with a one-off effect, which cannot contribute to sustainable convergence. Given the crucial importance of the issue, let me outline how I would like to see the EMI's advice on the eventual assessment of fiscal positions being given. In essence, we should stick to both the spirit and the letter of the Treaty; and the Treaty says three things, not one. Firstly, it establishes the two reference values which should not be exceeded: the 3% deficit ceiling and the 60% debt ceiling. Secondly, it accepts deviations from these reference values on certain conditions which are described carefully, but are not quantified. Thirdly, it insists on the need to have sustainable positions - in fact, it even uses this expression twice: to cover all convergence criteria and, in addition, to refer specifically to the sustainability of budgetary positions. Consideration of the risks, as I have outlined, suggests two conclusions. First, deviations from the reference values should be granted sparingly by interpreting the words used by the Treaty in a carefully restrictive way; and, second, compliance with the reference values should be regarded as sufficient for eligibility only if the deficit and debt ratios observed for 1997 are genuinely sustainable. In short, in case of doubt when applying the second and third prescriptions of the Treaty, we should lean towards caution. Beyond convergence, I consider that the greatest challenge that most EU countries face is in the labour market. I have already noted that wage and price flexibility is essential to facilitate economic adjustment to various kinds of shocks that may hit individual EU economies from time to time. With or without EMU, employment policies have to be in the forefront of attention of European policy-makers. The recent record of the Union in terms of job creation is dismal; employment has barely risen in the Union as a whole since the cyclical trough in 1993, and projections envisage little improvement. This points to the crucial need for continued labour cost moderation and enhanced labour market reforms - including attention to tax and social security systems - across the EU. For it is evident that the recovery of output growth alone will be insufficient to remedy deep-seated structural patterns of unemployment. A cause for optimism in this respect is that the enhanced competition that EMU in combination with the Single Market will unleash will be fertile ground for those arguing in favour of measures of labour market deregulation and reform of bargaining structures. The preparations for EMU are far advanced. In combination with the strong political commitment to go ahead with EMU and with the remarkable downward convergence of inflation rates, this has led to enhanced - albeit volatile - expectations in financial markets that EMU will come about. I believe that EMU will lead to major benefits for participants, although potential costs should not be disregarded. To minimise these costs and therefore to ensure large and lasting net benefits, countries entering the Monetary Union should be in a state of sustainable macroeconomic convergence and ready to improve the working of their labour markets as well as to reduce the often very substantial indirect labour costs. This is needed anyhow if they are to achieve a reduction in the unacceptable current levels of unemployment.
r970422a_ECB	euro area	1997-04-22T00:00:00	Convergence and the role of the European Central Bank	lamfalussy	0	These remarks will touch on the following topics: first, progress towards economic convergence in EU countries and related economic policies; second, the role of the European Central Bank in relation to monetary and foreign exchange policy, independence, financial supervision and management of TARGET; and, third, the possibility of the euro assuming the role of a key international currency. The dangers of a lack of convergence when countries enter EMU are self-evident. Notably, if fiscal positions are not initially under control, there may be repercussions on monetary policy from large deficits, and adverse spillovers across borders affecting the Monetary Union as a whole from lax fiscal policies in individual Member States. Similar arguments apply in respect of inflation. These difficulties are far from theoretical. With such a unique enterprise as EMU, we will have to live with the possibility of teething troubles during the crucial "running in" period, putting considerable strain on the strategy and the technical capabilities of the ECB. Such strain could become unbearable or, to put it less dramatically, could lead to a dangerously unbalanced policy mix if it were compounded by the consequences of initially weak budgetary positions in the member countries. As regards current performance, important progress has been made in respect of the downward convergence of inflation and bond yields, and exchange rate stability has to date been broadly maintained. However, on the fiscal side, deficits in 1996 substantially overshot the benchmark laid down in the Treaty in most Member States, despite efforts at consolidation. Debt ratios have continued to rise in the aggregate, despite favourable trends in some Member States. In my view, the composition of consolidation continued to rely excessively on high revenue ratios and less than is desirable on expenditure restraint. Moreover, there were measures with a temporary effect, which cannot contribute to sustainable convergence. Given its central role, I shall henceforth focus on fiscal convergence. As you know, the decision to select the countries will be made by the Heads of State or Government during the Spring of 1998. I do not know how they will interpret the convergence criteria. But I do know how I should like the advice by the EMI Council to be formulated. In assessing the fiscal criteria, we should stick to both the spirit and the letter of the Treaty; and the Treaty says three things, not one. Firstly, it establishes the two reference values, the 3% deficit ceiling and the 60% debt ceiling. Secondly, it accepts deviations from these reference values on certain conditions which are described carefully, but are not quantified. Thirdly, it insists on the need to have sustainable positions - in fact, it even uses this expression twice: to cover all convergence criteria and, specifically, sustainability of budgetary positions. Consideration of the risks suggests two conclusions. First, deviations from the reference values should be granted sparingly by interpreting the words used by the Treaty in a carefully restrictive way; and, second, compliance with the reference values should be regarded as sufficient for eligibility only if the deficit and debt ratios observed for 1997 are genuinely sustainable. In short, in case of doubt when applying the second and third prescriptions of the Treaty, we should lean towards caution. Concerning policy, the fiscal imbalances existing in the Union require the implementation of measures with lasting effects. Given distortions imposed by too high a level of fiscal levies, priority for adjustment will have to lie with the expenditure side of the budget, notably in non-productive expenditure. Fiscal consolidation can only lead to a lasting improvement in the growth potential of the Union if it is pursued with a long-term perspective, in a credible and determined manner. It is not sufficient that countries only aim to ensure that they comply with the Treaty reference values in the coming years. It is also necessary that they create sufficient room for manoeuvre to cope with adverse cyclical developments and that they implement measures for coping with new budgetary challenges such as the ageing of populations. The Treaty provides unambiguous guidance that "the primary objective of the ESCB shall be to maintain price stability". However, in its pursuit of this objective, the ESCB, like all central banks, will face a complex transmission process from policy actions to price developments with long and variable lags. Thus, policy decisions must be both pre-emptive and forward-looking, taking into account all relevant information regarding the prospective evolution of prices and taking appropriate and timely action to ensure that the final objective is achieved. In addition, the need for credibility and consistency of the decision-making process over time will require the ESCB to establish a clear framework to guide use of its monetary policy instruments with a view to achieving its final target. Final decisions on strategy will be taken by the Governing Council of the ECB. There are two potential candidate strategies, namely monetary targeting and direct inflation targeting. It can be argued that a particular strength of the monetary targeting strategy is that it clearly indicates the responsibility of the ESCB for developments which are both easily observable and under its more direct control. It also follows the strategy pursued by the central bank of the anchor country in the EMS. At the same time the long-term stability of money demand in the euro area is a crucial factor in determining the effectiveness of monetary targeting. Empirical studies provide some evidence that, for selected groups of EU countries, area-wide money demand currently has these desirable properties. On the other hand, these studies are subject to data and methodological limitations and may not be representative of the situation in Stage Three. With respect to an inflation targeting procedure, it is argued that it directly stresses the responsibility of the ESCB for achieving and maintaining price stability. Furthermore, policy actions under such a strategy can be consistently and directly linked to prospective price behaviour, which, if the strategy is credible, will affect public expectations in a favourable way. It should be noted, however, that to be successful, inflation targeting also requires stable relationships between various economic and financial indicators, on the one hand, and future inflation, on the other. Overall, the similarities in the behaviour of central banks that pursue these two strategies are greater than the differences. Regardless of their choice of strategy, they all monitor a wide and similar set of economic and financial variables as indicators in the determination of the monetary policy stance. For the implementation of its strategy, the ESCB will need to rely on a set of monetary policy instruments and procedures which will constitute its operational framework. This framework should enable the ESCB to control its operational target, normally a short-term interest rate, efficiently. It should allow signals of monetary policy intentions to be given with precision and differentiation. It should be capable of providing basic refinancing, absorbing liquidity and influencing the structural position of the banking system vis-a-vis the ESCB. It would also be desirable that the framework helps to control monetary aggregates, allows adequate information to be extracted from market developments and contributes to the smooth functioning of the payment system. It is envisaged that the ESCB will mainly use open market operations, but that it will also offer two standing facilities. In addition, preparations are being made for the ECB to impose minimum reserve requirements, if it chooses. From the start of Stage Three, the ESCB will have the capacity to conduct foreign exchange intervention. The ESCB will conduct foreign exchange intervention by means of transactions on the foreign reserves transferred from the NCBs to the ECB (up to an amount equivalent to EURO 50 billion). The management of foreign assets which are not pooled will be subject to guidelines issued by the ECB. The decisions related to intervention will be taken by the ECB; the implementation of such decisions will be either centralised or decentralised within the ESCB. The Treaty does not prescribe any specific exchange rate arrangement vis-a-vis non-EU currencies. In any event, the ESCB will have the technical capacity to conduct, if need be, intervention operations in order to counteract excessive or erratic exchange rate fluctuations of the euro against the major non-EU currencies. On the other hand, as part of the future exchange rate policy co-operation between the euro area and other EU countries, a new exchange rate mechanism has already been agreed upon. In the context of this ERM II, intervention will be used as a supportive instrument, in conjunction with other policy measures, including appropriate fiscal and monetary policies conducive to economic convergence and exchange rate stability. The new mechanism will be based on central rates, defined vis-a-vis the euro for the participating non-euro area currencies; there will be no parity grid. A standard fluctuation band, which is expected to be 15%, will be established for these currencies around their central rates. Participating non-euro area Member States could establish, on a bilateral basis, fluctuation bands between their currencies and intervention arrangements aimed at limiting excessive bilateral exchange rate oscillations. Also, the exchange rate policy co-operation between non-euro area NCBs and the ECB could - in various forms - be strengthened further. Foreign exchange intervention and financing at the standard wide margins will, in principle, be automatic and unlimited. However, the ECB and the participating non-euro area NCBs will have the possibility of suspending intervention and financing if these were to impinge on their primary objective of maintaining price stability. As noted, the Treaty states that "the primary objective of the ESCB shall be to maintain price stability". The European System of Central Banks (ESCB) will enjoy full independence to determine the appropriate level of interest rates in order to satisfy this requirement of the Treaty; "neither the ECB nor any national central bank shall seek or take instructions from Community institutions, governments of a Member State or any other body". Moreover, the members of the ECB's Executive Board and the Governors of the participating national central banks, who will together form the ECB Governing Council, will have long terms of office and will only be dismissible for serious misconduct or inability to perform their duties. These provisions imply that the concept of monetary stability will benefit from explicit legal protection. : The Maastricht Treaty assigns practically no role to the ESCB in banking supervision, though the Statute of the ESCB explicitly states that it has the obligation to "promote the smooth operation of payment systems". It is true that the Statute also stipulates that "the ESCB shall contribute to the smooth conduct of policies pursued by the competent authorities relating to the prudential supervision of credit institutions and the stability of the financial system". This, however, tends to imply that other authorities are likely to be competent for the formulation of such policies. The safeguarding of financial stability is not explicitly mentioned as an objective of the ESCB, but I would expect the ESCB to play an important role in this "macro-prudential" area. : To support the integration of the money market and thereby the singleness of the monetary policy, the EMI and the NCBs are developing an interbank funds transfer system, called TARGET, that will be able to process cross-border payments denominated in euro as smoothly as if they were domestic payments. It will interlink the domestic RTGS systems which NCBs have agreed to implement in their respective countries. Participation in the national RTGS systems will be determined by the NCBs. To avoid impediments to the efficient conduct of the single monetary policy, a certain degree of harmonisation of the features of the national RTGS systems within the euro area will be ensured in three respects: the provision of intraday liquidity, operating hours, and pricing policy. Focusing on the issue of liquidity, the value of payment orders being sent through TARGET may, for any participant at any given point in the course of the day, exceed the value of payment orders being received. To counter the ensuing liquidity shortfall which might delay settlement, intraday liquidity will be provided by NCBs, either by granting participants the right to make use of their reserve deposits with them or by providing them with intraday credit. At the end of the day, RTGS participants in the euro area that are eligible counterparties for monetary policy operations of the ESCB may draw on the marginal lending facility with their NCB in order to balance the position in their accounts. The euro area is likely to be a global player. EMU will entail the creation of a major new global currency, which will join the dollar and the yen, reinforcing a tripolar system. Although this may take decades to occur (if past history is taken as a reliable guide), it could also occur much more rapidly than in the past given the nature of today's financial markets. The impact of this on reserve holding may be considered under several headings. EMU could affect international use of the euro through, first, the creation of a large trading area with a single currency. This fact would favour greater use of the euro in the invoicing of trade, which in turn would tend to encourage use of the euro in financial transactions. Moreover, the size of the euro trading area would encourage third countries to stabilise their currencies vis-a-vis the euro, which may increase the demand for the euro as a reserve currency. However, these factors may take time to be felt and, in any case, cannot be expected to operate in a mechanical way as a critical mass would need to be reached before the established advantages of the dollar as an international currency can start to be eroded. Second, there is the creation of a large and efficient financial market operating in euro. The introduction of a single currency should, in combination with the implementation of the single market, strengthen market forces and encourage regulatory developments leading toward the full integration of national financial markets in the euro area. To the extent that this would contribute to the efficiency, liquidity and range of financial services offered in the euro area's financial market, the euro would also become a more attractive currency for international investors and issuers, including central banks. Clearly, the size and efficiency of the euro financial market would be not only a determinant but also a result of the international role of the euro. Third, EMU may alter the risk features of euro-denominated financial instruments. To the extent that the volatility of the euro's exchange rate may be lower than that of the former national currencies, euro assets and liabilities may be seen as less risky and, therefore, more attractive to international investors and borrowers, again including central banks. The same argument may apply to euro interest rates, to the extent that also these may be less influenced by country-specific shocks (although they will be more influenced by area-wide shocks). On the other hand, whether the euro would offer more or fewer opportunities for risk diversification is very difficult to predict, since it would depend on both the variances and the covariances of the returns on assets denominated in euro and in other currencies.
r970430a_ECB	euro area	1997-04-30T00:00:00	The operation of monetary policy in stage three of EMU	lamfalussy	0	I am delighted to be here today in New York, in the context of what I sense is increasing interest in the EMU project and its implications on this side of the Atlantic. My subject matter for today is an important building-block for EMU, namely, the framework for the operation of monetary policy in the euro area. I plan to show you that its preparation is well-advanced, although some key issues will only finally be resolved by the Governing Council of the European Central Bank (ECB), when it is formed in 1998. Accordingly, I shall spend most of my allotted time outlining the chosen monetary policy instruments and procedures of the ESCB and the considerations that have been raised relating to strategy. Please note that I shall not seek to cover issues of foreign exchange policy or operations, nor of payments systems. To conclude my talk, I shall also consider some practical aspects of the likely role of the European System of Central Banks (ESCB) in running monetary policy, linking these to provisions of the Treaty, the decentralisation of operations and information needed to pursue a given strategy. As is the case for all central banks, the ESCB will need to rely on a set of monetary policy instruments and procedures - its operational framework - for the implementation of its monetary policy strategy. Given the lead times involved in introducing changes in existing operational frameworks, it was necessary to take some decisions in this area at an early stage, so as to be ready in time for the start of EMU. Accordingly, the EMI Council has defined a set of monetary policy instruments that will be made available to the ESCB. Various functional criteria were borne in mind in developing the framework. Most crucially, we consider that it should enable the ESCB efficiently to control its operational target, normally a money-market short-term interest rate. It should allow precise and differentiated signals of monetary policy intentions to be given. It should be capable of providing basic refinancing, absorbing liquidity and influencing the structural position of the banking system vis-a-vis the ESCB. The framework should also possibly help to control monetary aggregates, allow information to be extracted from market developments and contribute to the smooth functioning of the payment system. The selection of the operational framework has also been guided by principles of conformity with an open market economy, equal treatment, simplicity and cost efficiency, decentralisation, continuity, harmonisation and conformity with the setting of the ESCB's decision-making. In a nutshell, we envisage that the ESCB will mainly use open market operations, in most cases employing reverse transactions, but that it will also offer two standing facilities. It is envisaged that a broad range of counterparties will have access to ESCB operations. In addition, preparations are being made for an infrastructure that will allow the ESCB to impose minimum reserve requirements, if it so chooses. There are thus some contrasts with the framework used by the Federal Reserve, which mainly uses outright transactions with a limited number of counterparties. Let me go into slightly more detail. There will be four types of open market operation. The most important will be the main refinancing operations, weekly reverse transactions with a maturity of two weeks, which will be executed on the basis of standard tenders. They will be used to steer interest rates, manage the liquidity situation in the market and signal the stance of monetary policy. In addition, there will be longer-term refinancing operations, monthly reverse transactions with a maturity of three months. They will only provide refinancing; they will not be intended to send signals to the market or guide rates. The ESCB may also carry out fine-tuning operations on an ad hoc basis. These will aim at managing market liquidity and steering interest rates, in particular in order to smooth the interest rate effects of unexpected liquidity fluctuations. They will primarily be executed as reverse transactions but may also take the form of outright transactions, foreign exchange swaps and the collection of fixed-term deposits. Fine-tuning operations will normally be executed through quick tenders or bilateral procedures with counterparties. The ESCB will also have the possibility of affecting the structural liquidity position of the banking sector vis-a-vis the ESCB by issuing debt certificates, using reverse transactions and conducting outright transactions. All of the open market operations will be decentralised, although the Governing Council of the ECB may decide that certain fine-tuning operations should be executed in a centralised manner by the ECB. Standing facilities aim at providing and absorbing overnight liquidity, thereby bounding overnight market interest rates and signalling the general stance of monetary policy. Two standing facilities will be available to the ESCB's eligible counterparties. First, the marginal lending facility will allow them to satisfy their temporary liquidity needs by obtaining overnight liquidity from the national central banks (NCBs) at a pre-specified interest rate (above market rates) against eligible assets. Under normal circumstances, there will be no credit limits or other restrictions on counterparties' access to the facility except the sufficient availability of underlying assets. The interest rate on the marginal lending facility will provide a ceiling for the overnight market interest rate under normal circumstances; the floor will be provided by the deposit facility, which will allow counterparties to make overnight deposits at a pre-specified interest rate with the NCBs. Under normal circumstances, there will be no limits on the corresponding deposit accounts or other restrictions on counterparties' access to the facility. The two standing facilities will be administered in a decentralised manner by the NCBs. According to the Statute of the ESCB, the ECB may also require credit institutions to hold minimum reserves on accounts with the NCBs. It will decide whether to do so in 1998. Reserves could be used to stabilise money market interest rates, to create or enlarge a structural liquidity shortage and, possibly, to contribute to the control of monetary expansion. For efficiency, reserve ratios might need to be imposed on a broader range of financial institutions than credit institutions alone. The amount of minimum reserves to be held by each individual institution would be determined in relation to the liability positions of its balance sheet. Reserves may be wholly or partially remunerated. In order to help stabilise money market rates, the system would include an averaging mechanism, implying that compliance would be determined on the basis of an institution's average daily reserve holdings over a one-month maintenance period. I note that an averaging provision is also present in the system of minimum reserves in the United States. In order to secure a single monetary policy stance and a level playing-field for counterparties across the whole of the euro area, common eligibility criteria, both for the counterparties and for the assets to be used by those counterparties in their operations with the ESCB, will be established. I envisage that an appropriate legal instrument will enforce the uniform conditions under which a broad range of counterparties will participate in the ESCB's open market operations and standing facilities. A broad range of eligible counterparties is consistent with the principle of decentralisation in the execution of the ESCB's monetary policy operations, it will enhance policy efficiency and equal treatment, and it will facilitate the smooth functioning of the payment system. Only in the case of fine-tuning operations may operational efficiency advocate dealing with a limited range of counterparties. As regards the final objective itself, the Treaty provides unambiguous guidance that "the primary objective of the ESCB shall be to maintain price stability". However, in its pursuit of this objective, the ESCB, like all central banks, will face a complex transmission process from policy actions to price developments with long and variable lags. Thus, policy decisions directed at price stability must be both pre-emptive and forward-looking, taking into account all relevant information regarding the prospective evolution of prices and taking appropriate and timely action to ensure that the final objective is achieved. In addition, the need for credibility and consistency of the decision-making process over time will require the ESCB to establish a clear framework to guide the use of its monetary policy instruments with a view to achieving its final objective. The assessment of alternative monetary policy strategies for the ESCB is guided by a number of general principles. The strategy has to put the ESCB in a position to pursue its final objective effectively. It needs to involve the formulation and announcement of targets so that the ESCB can be held accountable to the public for its actions. The process of setting targets and making decisions on the basis of the strategy must be clear to the public. The strategy has to enable the ESCB to meet its final objective over the medium term, thereby anchoring inflation expectations, but nevertheless providing the ESCB with some discretion in response to short-term deviations from the target. The strategy of the ESCB must build on the experience gained by participating NCBs before the start of Stage Three, and it must be consistent with the independent status granted to the ESCB by the Treaty. Final decisions on strategy will be taken by the Governing Council of the ECB in 1998. There are two potential candidate strategies, namely monetary targeting and direct inflation targeting. Common to both strategies is the fact that they are based on the same final objective - price stability; they are forward-looking; and in practice a wide range of indicators is employed under both strategies to assess the appropriateness of the monetary policy stance. The main factor distinguishing the two strategies is the role played by monetary aggregates. It can be argued that a particular strength of the monetary targeting strategy is that it clearly indicates the responsibility of the ESCB for developments which are both easily observable and under its more direct control and which, therefore, can be interpreted by the public in a transparent manner. It also follows the strategy pursued by the central bank of the anchor country in the European exchange rate mechanism before the start of Stage Three. But as you are aware from US experience, the long-term stability of money demand will be a crucial factor in determining the effectiveness and scope of monetary targeting. Existing empirical studies carried out both within the EMI and elsewhere provide some evidence that, for selected groups of EU countries, area-wide money demand currently has desirable empirical properties. On the other hand, these studies are subject to data and methodological limitations and may not be representative of the situation in Stage Three. Uncertainty concerning the empirical properties of money demand in the euro area in Stage Three is the main argument put forward against a monetary targeting strategy. The possibility of damage to the credibility of the ESCB under a monetary targeting strategy could not be excluded if aggregates were highly volatile at the start of or during Stage Three. With respect to an inflation targeting procedure, it is argued that this directly stresses the responsibility of the ESCB for achieving and maintaining price stability. Furthermore, policy actions under such a strategy can be consistently and directly linked to prospective price behaviour, which, if the strategy is credible, will affect public expectations in a favourable way. It should be noted, however, that to be successful, inflation targeting also requires stable relationships between various economic and financial indicators, on the one hand, and future inflation, on the other. Overall, however, the similarities in the behaviour of those central banks that pursue these two strategies are greater than the differences. Regardless of their choice of strategy, they all monitor a wide and similar set of economic and financial variables as indicators in the determination of the monetary policy stance. Moreover, experience suggests that the general principles set out above could be achieved in different ways. The ESCB may consequently face the choice not only of pursuing either a monetary or direct inflation targeting strategy, but also of adopting a framework which places particular emphasis on monetary targets while using supplementary elements from direct inflation targeting strategies, or vice versa. To conclude, while a few years ago I thought that the choice between these two strategies could represent a major challenge for the ECB Council, I believe now that in practice the contrast between them is far less dramatic than would appear at first sight. I have emphasised the fact that some details of the role of the ESCB will emerge closer to the date for the introduction of the euro. Others will evolve with practical experience. Nonetheless, some considerations can be adduced, since the way in which monetary policy will be implemented in Stage Three of EMU will depend inter alia on the provisions of the Treaty, the agreements reached in relation to decentralisation (particularly concerning instruments and procedures), and the specific requirements (in terms of information, data etc.) for running the monetary policy strategy efficiently in the circumstances which will prevail in Stage Three. Commencing with the Treaty, in terms of objectives it states unambiguously that the primary objective of the ESCB shall be to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community. The Treaty notes that the ESCB will pursue its objectives independently; neither the ECB nor any national central bank, nor any member of their decision making bodies, shall seek or take instructions from Community institutions, from any governments of a Member State or from any other body. This provision is supported by the fact that the members of the Executive Board of the ECB and the Governors of the participating national central banks, who will together form the Governing Council of the ECB, will have long terms of office and will only be dismissible for serious misconduct or inability to perform their duties. Meanwhile, monetary financing of government deficits is explicitly excluded by the Treaty. Besides defining and implementing the monetary policy of the Community, the Treaty states that the ESCB will have the complementary central-banking tasks of conducting foreign exchange operations, holding and managing the official foreign reserves of the Member States, and promoting the smooth operation of payments systems. The ECB Governing Council shall also have the exclusive right to authorise issue of banknotes in the euro area. In all cases, the ESCB shall act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources. The direction of monetary policy will be carried out in a way familiar from other federal central banks such as the Federal Reserve and the Deutsche Bundesbank. The Governing Council will formulate the monetary policy of the euro area and establish the necessary guidelines for its implementation during its meetings, to be held at least 10 times a year; the members of the Governing Council will have the facility to cast their votes between these times by teleconference. Meanwhile the Executive Board will implement monetary policy in accordance with the guidelines and decisions laid down by the Governing Council. In common with all independent central banks, the ESCB is to be held accountable for its actions in various ways. First there are Treaty provisions that the President or other members of the Executive Board may be required to attend hearings at the European Parliament. Second, there is a requirement to publish an Annual Report covering the single monetary policy and the other activities of the ESCB, which also has to be presented to the Council and the European Parliament, where it may trigger a general debate. Third, reports on ESCB activities will be published during the year, at least quarterly, in addition to weekly financial statements. As regards the division of operational tasks between the centre (the ECB) and the periphery (NCBs), the Treaty states that the Governing Council of the ECB shall take the decisions necessary to ensure the performance of the tasks entrusted to the ESCB. It shall formulate the single monetary policy, take key decisions and establish the necessary guidelines for their implementation. The Executive Board shall implement monetary policy and give the necessary instructions to the NCBs. The Treaty requires that to the extent deemed possible and appropriate the ECB shall have recourse to the NCBs to carry out operations which form part of the tasks of the ESCB. Operations will hence neither be concentrated on one "branch", as has evolved for the New York Fed in the US, nor will they be centralised at the ECB itself. I am sure that as a rule the implementation of the centrally defined monetary policy will be carried out by the NCBs, but I do not exclude occasional direct intervention by the ECB itself. Turning to the types of information needed for the ECB to conduct monetary policy in the euro area, the first point to make is that the main focus will be on area-wide information. In particular, the target of the ESCB in terms of price stability is defined across the euro area as a whole. Accordingly, the ESCB will wish to have its own area-wide forecasts of inflation and other key variables as a support to monetary policy. Moreover, it has already been noted that whatever strategy is adopted, there will be a number of common elements making up the desired information set. In this context, an important factor will be knowledge of the monetary policy transmission process, in particular that aspect of the transmission process which relates to the financial environment in Stage Three. EMI research has already provided an insight into the details of the average transmission process and suitable indicator variables at a Union-wide level. However, the results are still only partial and are considered as preliminary. A second aspect will be the use of a broad set of indicator variables, to help in assessing risks to future price stability. In line with prevailing practice, including that of the Federal Reserve, it would seem appropriate for these to include financial variables (in particular the money market yield curve, money and credit aggregates, credit market conditions, bond yields, exchange rates and other asset prices) and various non-financial variables (such as price and cost variables, indicators of aggregate demand and supply conditions including the output gap, the balance of payments and expectations surveys). Within the set of indicators employed by the ESCB, monetary aggregates should be assigned a prominent role, provided that money demand is sufficiently stable in the long run. A feature of the ESCB's environment - not of course present in the United States - will be the significance of structural differences across countries within the single currency area, owing to the existence of national differences in institutions, regulations, traditions and policies. The stance of the single monetary policy of the ESCB can only be set to ensure that it will be appropriate for the euro area as a whole; nevertheless it will be important for the ESCB to be fully aware of any differential impact of its policies across Member States, not least because inflation in an individual Member State may spill over into the euro area as a whole. While there will be a single monetary policy, cross-country differences are also likely to prevail in the area of other economic policies, in particular fiscal and labour market policies. The responsibility for defining and conducting these economic policies will mainly lie with the Member States. The largely decentralised set-up of economic policies will be particularly important in the field of public finance. The Treaty includes several provisions which aim at ensuring the budgetary discipline of national authorities in Stage Three; and Secondary Community legislation (the Stability and Growth Pact) to strengthen budgetary discipline in Stage Three is currently under discussion in Community bodies. But it is clear that there will not be any Union-wide decision making on fiscal policies. It will be important for all monetary strategies that the overall fiscal stance should be compatible with a stability-oriented monetary policy. Consequently, as monetary policy cannot achieve its goal of price stability without adequate support from fiscal policy, the ESCB will wish to monitor fiscal policies closely. Moreover, when implementing a monetary policy strategy for Stage Three, it should be borne in mind that the ESCB will face two particular challenges at the start of Stage Three. Firstly, the ESCB will have no track record of its own and must, therefore, attach the utmost importance to establishing and maintaining a high degree of credibility. Secondly, the transition to Stage Three will constitute a major shift in regime, which will imply a high degree of uncertainty concerning economic and financial conditions and developments in the euro area as well as the future relationships between major macroeconomic variables. It will not be easy for the ECB Council to draw firm conclusions from the observation of indicators; in particular, changes in the various Ms or shifts in the yield curves will not be easy to interpret. Given the overriding importance to establish credibility, the ECB will have to err on the side of caution. To conclude, the preparation of the framework for the monetary policy instruments and strategy to be employed in Stage Three of EMU is well-advanced, although the finalisation of some of the key aspects (notably the use and scope of minimum reserves and the choice between monetary and inflation targeting) will only be undertaken by the ECB Governing Council itself in 1998. The Treaty lays down the broad guidelines for the actual implementation of monetary policy, and progress has been made in determining the overall scope of the decentralisation of operations. As regards the types of information that the ESCB will require to fulfil its role to conduct monetary policy, area-wide developments require the sharpest focus, although developments in individual countries are also of relevance, not least in the case of fiscal policy.
r970513a_ECB	euro area	1997-05-13T00:00:00	The European Central Bank: independent and accountable	lamfalussy	0	Against a background of both historical experience and the evolution of the policy debate, central bank independence has in many countries become the preferred means of providing an institutional framework for monetary policy. Reflecting this growing consensus, the Maastricht Treaty enshrines the independent status of the European Central Bank (ECB) and the EU national central banks - which together form the European System of Central Banks (ESCB) - as a bulwark for ensuring that the future euro area benefits from price stability. However, it must be conceded that despite the fact that the legal arrangements which have been made in this regard for the ESCB are clearly spelled out in the Maastricht Treaty, clarity does not always prevail concerning the scope of such independence. It is against this background that I welcome this opportunity to clarify the basic issues of central bank independence, both as I see them and as they are incorporated in the Treaty. I would like to organise my speech in two parts. First, I shall take a backward-looking perspective by briefly describing the main arguments underlying the general move towards the establishment of independent central banks with a mandate for price stability. Since I assume that you are quite familiar with the arguments, I will not go into much detail. Second, I shall take a closer look at the Treaty arrangements relating to the independence and accountability of the future ECB. This includes the preparations which are currently under way to ensure that national central banks of Member States comply with the relevant Treaty obligations. Over the past decades, two significant changes have taken place in the approach to monetary policy-making, with important consequences for the way the institutional arrangements for the future ESCB were designed. One relates to the adoption of price stability as the primary goal of monetary policy, and the other to the mandate widely given to central banks to pursue this objective independent of political interference. The first element of this sea-change was probably triggered by the negative experience of the 1970s, when inflation and unemployment rose in parallel, despite the efforts of macroeconomic policy-makers to generate renewed growth in the traditional "Keynesian" manner. This led to growing recognition of the fact that in the long term monetary policy can only systematically control the price level and not real economic variables such as output growth or unemployment. Admittedly, over shorter horizons, monetary policy does indeed affect both real and nominal variables. However, it is by now widely accepted among policy-makers and in the academic literature, that deliberate attempts to exploit any short-run trade-offs between output and prices are likely to result in a permanently higher and more variable rate of inflation, with significant adverse consequences for resource allocation, long-run output and productivity growth. Against this background, the primary goal of monetary policy should be to achieve and maintain price stability, with any other economic objectives receiving emphasis only to the extent that price stability is not endangered. The second fundamental change which I would like to highlight is the widespread tendency to delegate the decision-making power over monetary policy to independent central banks. Modern economic theory emphasises the inflationary bias in economic policy, which relates in particular to the so-called time-inconsistency issue, i.e. the problem of convincing the public that the monetary authorities will resist the temptation to stimulate output growth in the short run by creating "surprise inflation". Against the backdrop of negative past experience, the public is unlikely to have much faith in the authorities' promises to maintain low inflation. Unless these promises are underpinned by a credible form of pre-commitment, the equilibrium inflation rate will be higher than needed, with no better performance in terms of output and possibly even a deterioration. As a solution to this problem, it has been suggested that responsibility for monetary policy be separated from political control and to enshrine this in legislation. According to this view, central banks should be given the freedom to formulate and execute monetary policy in line with their primary objective as determined by the legislator, to whom they are accountable. Accountability may involve either a legal obligation for the central bank to give reckoning for the conduct of monetary policy or a commitment to explain its actions, for example, in regular reports and to parliament. This allows central banks to take a medium-term orientation and not to be distracted by short-term political motives, an approach which benefits the credibility, transparency and efficiency of monetary policy. In line with the foregoing analysis, more and more EU central banks have over time been assigned the task of guaranteeing price stability, either explicitly by national law, or more informally as a reflection of an underlying culture of stability. In many cases, these reforms went hand-in-hand with the move towards a greater degree of central bank independence. These changes in national monetary legislation or at least the practice of central bank independence were beginning to be implemented well before the start of the Maastricht process. They were, however, further promoted by the recommendations of the Delors Committee with regard to the institutional arrangements for Stage Three of Monetary Union. The Committee's proposals culminated in the inclusion in the Maastricht Treaty and the Statute of the ESCB of the primary objective of price stability, the pursuit of which is delegated to an independent central bank system composed of the ECB and the national central banks of Member States. The Treaty (in Article 107) and the Statute of the ESCB (in Article 7) both contain very clear provisions regarding the relationship with third parties, which leave no room whatsoever for misinterpretation. To quote a key sentence: "neither the ECB, nor a national central bank, nor any member of their decision-making bodies shall seek or take instructions from Community institutions or bodies, from any government of a Member State or from any other body". Moreover, the aforementioned authorities shall also - and I quote again - "undertake to respect this principle and not to seek to influence the members of the decision-making bodies of the ECB or of the national central banks in the performance of their tasks". To put it simply: the door to the single monetary policy is locked from both sides, and neither the ESCB nor third parties can open the door for political instructions. Even attempts to do so would already be in conflict with the provisions of the Treaty and the Statute of the ESCB. For national central banks to become an integral part of the ESCB, Member States have to ensure that national legislation is compatible with the Treaty (Article 108) and the Statute of the ESCB (Article 14). This obligation of legal convergence does not require the full harmonisation of central bank statutes, but merely insists that inconsistencies with the Treaty be eliminated in respect of features such as institutional, personal, functional and financial independence. This requirement applies to all Member States, including those which may initially be unable to adopt the single currency owing to insufficient economic convergence. Exceptions are Denmark and the United Kingdom, which enjoy the right to "opt in" or "opt out" of EMU. Member States have made significant progress in recent years in amending their central bank statutes where needed in order to fulfil their Treaty obligations. For example, major reforms have taken place in Belgium, Spain, France, Luxembourg and Portugal, whilst in Germany, the Netherlands and Finland changes in legislation are pending. For those interested in further details, I would refer you to the EMI's November 1996 Report entitled "Progress towards convergence 1996", which contains a detailed account for each country of the provisions which would need to be adapted. The importance of these institutional arrangements for creating an appropriate monetary policy setting in Stage Three of EMU cannot be underestimated. I would like to illustrate this by reference to the following two arguments. First, these arrangements underline the continuity with the experience of the EU central banks with the most successful track record in terms of price stability over the past decades. In fact, in legal terms the ECB will enjoy an even higher degree of independence than the most independent national central bank at present. Moreover, these legal arrangements are firmly anchored in the Maastricht Treaty and could thus only be changed by a Treaty revision. As you know, this is a very difficult and time-consuming procedure, involving both the European Parliament and all the national parliaments, which thus ensures that such a step is not lightly taken. This brings me to the second point, namely that initially the ECB will have no track record of its own, other than the average track record that it may inherit from the participating national central banks. This implies that financial markets and the general public will assess the performance of the ECB on the basis of the effectiveness of the monetary policy framework adopted and the ability to act in accordance with its primary objective. Taken together, these two arguments make it clear that the independence of the ESCB underpins the credibility and effectiveness of the single monetary policy and is thus a key condition for the maintenance of price stability in the euro area. Given this legal framework, the Governing Council of the ECB will be able to decide on the basis of its own judgement on the scope and timing of monetary policy actions and how they should be executed. Naturally, in its assessment the Governing Council will take account of a wide range of relevant factors - including the state of the economy in the Monetary Union - but only to the extent that they affect future price developments. This does not imply, as is sometimes suggested, that the secondary objective of providing support to the general economic policies in the Community has no real meaning. Nevertheless, under its mandate the ESCB can only pursue this additional goal provided it does not prejudice the primary objective of price stability. A natural complement to the independent status of the ESCB are the Treaty provisions which make the ECB accountable for its policy actions. Accountability is reflected above all in the fact that the President and the other members of the Executive Board of the ECB, at their own initiative or on request, may be heard by the competent committees of the European Parliament (Article 109b.3). A further aspect of accountability concerns the requirement to publish an annual report covering the single monetary policy and other activities of the ESCB. The President of the ECB presents this annual report to the Council and the European Parliament, which on that basis could subsequently hold a general debate. Reports on the activities of the ESCB will also be published during the year, at least quarterly, in addition to weekly financial statements. All these provisions - to which I may add the wish to deliver speeches to the public and statements to the press - clearly promote the transparency of monetary policy objectives, intentions and actions. They thereby support the effectiveness of monetary policy. At the same time, the Treaty recognises that the ECB cannot be made responsible for outcomes in terms of inflation month-by-month, since there are lags involved between a change in the course of monetary policy and its effect on prices. Moreover, in the short term, the inflation outcome may reflect the incidence of temporary or external factors over which the ECB has no control. At this point, critical observers often confront me with the fact that the door is not completely shut against political interference, as the Treaty may seem to make an exception to the independence of the ESCB with regard to the exchange rate policy of the euro area. The ECOFIN Council may indeed conclude formal exchange rate arrangements with countries outside the EU, or formulate general orientations for exchange rate policy in relation to the currencies of these non-EU countries. This essentially reflects the current situation in most Member States, where the government determines the exchange rate rules (if any) and the central bank is responsible for the execution of this policy. On closer inspection, however, I do not fear a potential overburdening of the single monetary policy via this route. To begin with, the participation of the euro in a multinational system with non-EU currencies is, to say the least, not on the agenda. You may or may not like it, but I do not see the likely emergence of a Bretton Woods Mark II in the foreseeable future - and by this I do not refer to just a couple of years. And as regards the "general orientations for exchange rate policy", while such orientations are indeed in the hands of the ECOFIN Council, they can be issued only either on a recommendation from the ECB or on a recommendation from the Commission - but after consulting the ECB. And Article 109 of the Treaty says explicitly that "these general orientations shall be without prejudice to the primary objective of the ESCB to maintain price stability". Overall, it appears that sufficient "checks and balances" have been built into the procedure. I am confident that the view of the ECB in these exchange rate matters will carry a very high weight indeed and that the independence of the ESCB will not be affected. My confidence also finds support in the fact that the EMI has played a crucial role in helping to design the new exchange rate mechanism (ERM II) for establishing links between the euro and the non-participating EU currencies. To our satisfaction, the arrangement contains an explicit safeguard clause for the ECB (and other central banks) with regard to automatic intervention and financing at the margin, and also assigns a key role to the ECB (and other central banks) in negotiations that may culminate in realignments. So far, I have mainly concentrated on the two "monetary anchors" that should help to provide for a stable single currency: the objective of price stability and the mandate for an independent monetary policy. We all know that other economic policies have an essential supporting role to play in the effort to maintain price stability on a durable basis. In this respect, ensuring sound and sustainable budgetary positions would certainly make the ESCB's task a lot easier. Fortunately, a series of Treaty provisions support a high degree of fiscal discipline - which is of course also very much in the interests of Member States themselves. Already since the start of Stage Two, Member States have no longer been allowed to engage in monetary financing of budget deficits (Article 104). Correspondingly, for Stage Three, it is explicitly forbidden for the ESCB to supply credit facilities to government bodies, or to buy government debt instruments in the primary market. In addition, financial institutions are not allowed to grant credit to public authorities under preferential conditions (Article 104a). Furthermore, a bail-out of one Member State with financial problems by another country is strictly excluded (Article 104b). Finally, the Treaty obliges EU countries participating in the single currency to avoid excessive budget deficits (Article 104c). Compliance with this obligation will be assessed in the context of an elaborate procedure which will ultimately lead to the imposition of sanctions if no effective action is taken to correct an excessive deficit. The preventive nature and effectiveness of this procedure has recently been strengthened by the adoption of a Stability and Growth Pact, which specifies both the time limits for the consecutive steps in the procedure and the size of sanctions. Moreover, it commits each Member State to target a budgetary position that is close to balance or in surplus over the medium term. I have taken this opportunity to spell out in detail how the move to a single currency in the EU will be accompanied by the creation of a new Community institution, the European System of Central Banks, whose independent status is guaranteed by the provisions of the Maastricht Treaty. But I may perhaps conclude by saying that my confidence in the ability of the future ESCB to conduct in full independence a policy geared towards price stability is not based exclusively on my reading of the Maastricht Treaty. It is also based on our recent experience. EU central banks have been pursuing stability-oriented monetary policies for quite some time: otherwise it would have been impossible to achieve the downward convergence of inflation rates within the Community. As you know the most recent average rate of inflation is just a little above 2%. If this has become possible in Stage II, with central banks retaining their independence in conducting their own policies, why should this change when they will act jointly within the framework of the ESCB?
r970602a_ECB	euro area	1997-06-02T00:00:00	The changeover to the euro	lamfalussy	0	Prompted by the evident commitment of the political authorities to the EMU project, the successful convergence of countries' performances in some key areas and genuine efforts to reduce fiscal imbalances, financial market indicators in particular suggest a great deal of optimism that Monetary Union will indeed come about, and will commence on time - on 1 January 1999. But it is not only financial markets that are showing such confidence. Banks and companies have also begun to make the investments in information technology that will be required to handle the future single currency. My theme today is the changeover to the euro, with a particular focus on money and capital markets. , the exchange rates between the currencies of the participating countries will be replaced by irrevocably locked conversion rates and Monetary Union will become a reality. On 4 January 1999, the European System of Central Banks (ESCB) will conduct its first repo. Repos will be the main instrument of the single monetary policy. They are flexible and market-oriented and, therefore, best suited to performing the functions of steering interest rates in the money market and of signalling the ECB's policy intentions. Following the adoption of the scenario for the changeover to the single currency in Madrid in December 1995, repos will be conducted in euro as from 4 January 1999. Two standing facilities will be made available to the counterparties of the ESCB: a marginal lending facility at rates normally above market rates and a deposit facility at rates normally below market rates. The interest rates applied on these two facilities will form a corridor within which will lie the repo rate and within which money market rates will move. Like the repo transactions, operations under the two standing facilities will be conducted in euro as from 4 January 1999. It is not yet clear whether the conditions that the ECB will face at the beginning of 1999 will warrant the use of reserve requirements as a complementary instrument of the single monetary policy and what the precise features of this instrument should be. An essential feature of the operational framework for the single monetary policy is that it will operate in euro from the beginning, as agreed by the European Council in Madrid in December 1995. The European Council also decided in Madrid that governments will issue all new tradable public debt in euro as from the beginning of Monetary Union. The starting date of Monetary Union will not bring about a full introduction of the euro immediately. The timing of the physical introduction of the European banknotes and coins and of the changeover of the current operations of public administrations will depend on what is technically possible. In Madrid, the European Council agreed that the European banknotes and coins will be introduced at the latest three years after the start of Monetary Union. Agreement was also reached that the spread of the use of the euro in the current operations of public administrations (for example, payment of civil servants' salaries and social security transfers, and collection of taxes) will take place in all participating countries at roughly the moment when the European banknotes and coins are introduced. This chronological framework was adopted in order to promote the transparency and simplicity of the process of changing over to the single currency and its acceptance by the public. A key feature of the changeover scenario is that, during the period between 1 January 1999 and the moment of the introduction of the European banknotes, the authorities will not intervene, via regulatory channels, to influence the speed at which the euro is introduced in banking activity and among non-bank users of money. This will be neither desirable nor possible. During that period, economic agents will be free to develop their own mechanisms to adapt to the introduction of the euro. They will be able to use the euro, but they will not be obliged to do so (the "no prohibition, no compulsion" principle). At the latest six months after the introduction of the European banknotes, the changeover to the single currency will have been completed for all operations and all agents. There is little doubt, in my opinion, that a Monetary Union-wide money market in euro will develop very quickly. First, the integration of the national payment systems, through TARGET, will allow banks in the euro area to deal directly with each other for supplying and accessing overnight funds in euro, irrespective of their location. The implementation of TARGET, which will be operational from the first day of Monetary Union, will quickly lead to the creation of a euro area-wide interbank market in which differences in "local" interest rates would only reflect differences in credit risk and/or differences in taxation and regulation. It is a possible next step for a private repo market to develop within the euro area, with instruments ranging from overnight to longer-term contracts. The fact that repos will be the main instrument of the single monetary policy will provide a strong incentive for the development of a Monetary Union-wide interbank market for repos and, maybe, at a later stage, for a private repo market, where financial and non-financial entities may engage in short-term collateralised refinancing operations for conducting day-to-day treasury management. Second, an important consideration in our preparations for the instruments and procedures of the single monetary policy is to facilitate the development of an integrated euro money market. As I said, the single monetary policy will be conducted in euro from the beginning. Moreover, the interest rate corridor (set by the interest rates applied on the two standing facilities) is likely to be relatively wide. The larger the corridor, the more volatility is allowed and the more initiative is left to banks to manage their interest rate exposure. Compared with alternative ways of controlling volatility in the interbank market, the framework for the ECB's monetary policy assigns a central role to the market and does not require the central bank to intervene frequently in the market. This reflects a desire to gear the day-to-day conduct of monetary policy to the market and to use the interbank market as the principal means of allocating liquidity. Third, the collateral policy of the ECB will be relatively liberal. Unlike most central banks (including the Federal Reserve), it is envisaged that the ECB will accept a wide variety of instruments that range from public to private paper. This has to be seen in the context of a desire to encourage the use of private paper and in relation to the prohibition on preferential treatment of public entities. At the same time, the proposed arrangement for the cross-border use of collateral will allow banks in the euro area to obtain liquidity from their home central bank against assets held anywhere in the area, with TARGET allowing them to transfer the liquidity to any place they wish. Banks will no longer need to hold securities traded at the national level to cover their liquidity needs. Finally, the European Monetary Institute and, later, the ECB will provide assistance to market participants in the establishment of standards for market practices in the euro area-wide money market. Our recent publication on the operational framework for the single monetary policy has already provided interested market operators with elements of information that are naturally becoming a focal point for the adaptation of national standards or for the elaboration of new joint standards at the European level. The issuance of new tradable public debt in euro as from the start of Monetary Union will provide an incentive for securities markets to change over to the single currency at an early stage. However, the speed at which the euro will spread in securities markets will also depend on the speed at which public and private debt issued before 1 January 1999 will be redenominated in euro. The choices of public and private borrowers and the preferences of the banking and finance industry at large as regards the timing and modalities of redenomination will have a direct impact on the development of the euro-denominated segment of capital markets at the start of Monetary Union. Let me say a few words on this. First, the legal framework will have to clearly establish that, for non-sovereign debt, redenomination will require the consent of investors whenever it goes so far as to modify the par value of the security and to affect the legal interest of investors. This is necessary to avoid any disturbances in financial markets. The legal framework is expected to be finalised before the meeting of the EU Council in Amsterdam. Second, I see the enhancement of the liquidity and depth of capital markets as an important argument for bringing forward the redenomination of financial instruments. Financial market participants would not consider as full substitutes instruments denominated in euro and instruments denominated in the old national currencies, even where they were issued by the same entity. There is a risk that, until the end of the transition period, markets for the old national currency bonds will be de facto split from those for euro bonds and the liquidity of the one or the other segment will tend to fall. Non-redenominated securities would look like "orphan bonds" which would attract only local trading. Public borrowers will also have an interest in promoting the liquidity of their debt during the transition period, so as to benefit from the lowest possible cost of funds. A number of governments within the EU have already announced plans for the redenomination of all or part of their outstanding debt in euro at the start of Stage Three, or shortly thereafter. Such announcements are driven by competitive considerations and, above all, the search for liquidity in the new euro markets. Third, the currently envisaged modalities and techniques for redenomination are numerous. I am confident, however, that there will be a natural process of technical convergence towards similar approaches within the euro area. In my view, it is desirable that such a process be achieved via the identification by the market of the best practices of sovereign borrowers, rather than by imposing common minimum requirements. The spread of the use of the single currency in financial markets will contribute to further enhancing capital market integration in the euro area. In such an environment, credit risk is likely to become the most important component of securities pricing in the area. Increased attention, however, will also be paid to other elements of risk: bonds denominated in the same currency and with identical credit risks may still be priced differently if issuing techniques, clearing and securities settlement procedures and legal procedures differ across countries. More uniform pricing of financial assets in euro will also depend on greater uniformity and transparency in issuing techniques and financial infrastructures. Following the political agreement in Madrid that the single monetary policy of the ECB will be conducted in euro and governments will issue their new debt in euro immediately from the start of Monetary Union, one should expect that money and capital markets will largely and quickly switch over to the single currency. The announcement by a growing number of EU governments that they will redenominate their outstanding debt in euro at the start of Monetary Union, or shortly thereafter, will provide a further incentive for financial markets to quickly adopt the single currency. Meanwhile, most private individuals and most enterprises are likely to continue to operate in the old national currencies until the time when European banknotes are introduced and public administrations adopt the euro for their current transactions. One should, however, not exclude that large companies will wish to operate and open accounts in euro at an earlier stage. The challenge for banks individually will be to have completed - on time - their own technical preparations, in particular in the field of information systems, to be able to respond with flexibility to the wish of their customers to operate in euro and/or to keep their accounts in national currencies. Quite a challenge.
r970630b_ECB	euro area	1997-06-30T00:00:00	Farewell to a Central banker	duisenberg	1	Three and a half years ago, when you exchanged the premises of the Bank for International Settlements, an established international financial institution, for a couple of floors in a Frankfurter "Hochhaus", you took on a huge task. Your first mission was to set up the European Monetary Institute (EMI), more or less starting from scratch. Moreover, you were faced with the responsibility of managing the preparations for Economic and Monetary Union (EMU). It was not an easy decision to embark on a grand project like EMU, but putting the flesh on the bones of monetary union is even more difficult. To be honest, at that time I would not like to have been in your shoes. 2. On both accounts you did a great job. The EMI is currently a thriving organisation. The Institute started off with a handful of staff, more or less taken over from the Secretariat of the Committee of EC Central Bank Governors. At present the EMI employs more than 200 people. Before the EMI was established, you had to take seemingly trivial decisions, like choosing suitable furniture for the meeting room of the EMI Council. At an exhibition of furniture on the 36th floor, you immediately picked the smallest chair available, I was told. Indeed, your modesty graces you, but looking at my size, and I'm sure I also speak on behalf of some other colleagues, I'm glad you eventually picked a larger one. 3. With respect to the preparations for EMU, both the EMI as well as the central banks are on track. Indeed, as far as we are all concerned, EMU can start on 1 January 1999. Hence, you also made things easier for me. You have played the ball from the tee to the green, thus leaving me the "easy" task of putting it in. 4. Alexandre, I don't think we are able to play a birdie or an eagle, let alone a hole-in-one. But I promise you, we will play on par. And I can tell you, I've done worse. Things have not always been easy for you when chairing the meetings of the EMI Council. But being a central banker, heart and soul, you have always managed to find compromises. I vividly remember a few meetings of the EMI Council which you eventually managed to conclude successfully, although they started off as a babel of tongues. Also when ever the atmosphere around the table started to become a bit tense, you always emphasised the need for co-operation and co-ordination. Indeed, in your opening statement to the Committee on Economic and Monetary Affairs and Industrial Policy on the European Monetary Institute in November 1993, shortly before you officially took office as the first President of the EMI, you stressed the importance of enhanced monetary policy co-ordination among Member States as a means of steering as smoothly as possible towards Stage Three of EMU. You also stated that the EMI can and should play a constructive role in promoting this process of policy co-ordination. 5. With the benefit of hindsight, everybody will agree that the EMI, under your management, has indeed contributed to a co-operative spirit among the EU national central banks. Indeed, as commentators often focus on the convergence of fiscal policies, which still leaves something to be desired, it is sometimes forgotten that the monetary conditions for the start of a monetary union between the Member States have never been so favourable. In your foreword to the 1996 Annual Report of the EMI you rightly observe that EU foreign exchange markets are moderately calm and long-term interest rates are low, while differentials have narrowed appreciably. But Lamfalussy would not be Lamfalussy if he did not immediately add some reservations. The risks and challenges should not be underestimated, although you see grounds for cautious optimism. Indeed, you would not be a central banker without writing that counter-inflationary vigilance remains essential, although monetary policy has - in your eyes - justifiably been eased against the overall background of subdued inflationary pressures. 6. One of your greatest assets is that you have managed to combine this typical conservative and cautious nature of a central banker, always focused on substance, with your firm belief in European monetary integration. Having been a member of the Delors Committee for the Study of Economic and Monetary Union, you were at the cradle of European monetary union. You have never believed that a true single market is in the long run compatible with a quasi-floating exchange rate system. Over the past three and a half years, you have acted as a devoted missionary of EMU and European integration in general. In this capacity, you have managed to convert at least some incredulous European central bankers. And like any good missionary, you have also spread the message of EMU to the outside world. Over the last few years, you have held 67 official speeches and appeared in public on many other occasions, in total approximately 175 times. Indeed, you have beaten me there. A few days ago, when I took leave of the staff of De Nederlandsche Bank, I was reminded of having "only" held some 155 official speeches during my presidency of more than 15 years. 7. Dear Alexandre, good wine needs no bush, as we say in the Netherlands. But some wines have such a delicious and well-balanced taste that they cannot remain unnoticed. The "Chateau Lamfalussy", in 1929, is one of them. I am very grateful to you for leaving me a smoothly functioning and high quality institution, which the EMI currently is. And I wish you and your wife all the best.
r970630a_ECB	euro area	1997-06-30T00:00:00	Farewell address	no_info	0	The moment has come for me to say a heartfelt "thank you" to you all! I should like to express my gratitude, first of all, to the governors of the central banks of the European Union, who, in the autumn of 1993, chose me as their candidate for the presidency of the European Monetary Institute, thereby setting in train a process which has allowed me to play a part in a ground-breaking enterprise of exceptional scope and responsibility. I should like to thank them, secondly, in their capacity as members of the EMI Council, for their co-operation in this undertaking and for their wisdom, prudence, willingness to compromise but also their will to achieve results. They have invariably acted with the utmost professionalism. I should like to add that we should not have been able to achieve what has been done without the conviction - which each of us shares - that the first duty of a central bank is to maintain price stability. This fundamental principle has never been a matter of dispute. My thanks go next to the political authorities. First, to the Heads of State or of Government, who did me the honour of putting their faith in me in appointing me President of the EMI. Second, to the Finance Ministers, who resigned themselves gracefully to the existence of an institution which would be independent of the executive and who played their part, with consummate political skill, in establishing the good working atmosphere between the ECOFIN and the EMI, in the mutual respect of our respective competences. I hope that this will be an enduring legacy. Thanks go, too, to the European Commission, with which we have been able - after a little trial and error, and with both sides demonstrating good will and a certain ability to listen - to draw up the rules of the game for the indispensable co-operation which is needed to enable the project of Economic and Monetary Union to go ahead. The European Parliament - and several national parliaments - have given me the opportunity to report on the work of the EMI, in an atmosphere of constructive dialogue. Their questions and concerns, as well as those of the media and of the large number of associations from both the banking and financial sphere as well as society at large, have given me valuable insights into the expectations and concerns of our fellow citizens. These thanks would not be complete without my expressing publicly what I have already had the opportunity to say in private to the members of the management and staff of the European Monetary Institute: without their personal commitment, their spirit of innovation, their boundless ability to find the happy medium - and not just a practical compromise between the concerns of our central banks - nothing would have been accomplished. What can I say to you now by way of farewell? There is little point in giving you the "final score" at this stage - the match is not over yet... Recommendations on how to cope with the challenges which are looming on the horizon? You will deal with them effectively, I am convinced, without my advice. But perhaps you will accept some reflections on the ability - and the limits - of monetary policy to meet the expectations of our fellow citizens who, while appreciating the confirmation (or renewal) of price stability, are looking for stronger growth and, above all, more jobs. I share their concern unreservedly. The current level of unemployment in the majority of our countries is ethically unacceptable; it is leading to the erosion of the social fabric and, because of the waste it represents, it is a clear signal that the economy is not functioning properly. Reducing unemployment must be the prime objective of action by the authorities. But what should be the role of monetary policy? In view of the short time available to me - plus the fact that you cannot contradict me - I shall be brief. You may perhaps feel that I am being dogmatic: if so, please bear with me. I should like to make four observations. 1. There is no doubt whatsoever that monetary policy can bring inflation under control. When monetary policy is not flanked by the appropriate budgetary policy, and when labour markets - but also goods and services markets - are not flexible, bringing inflation under control will take time. It will take time, and it can also entail costs - which could otherwise have been avoided. But even so, these costs would still be less than the (very high long-term) cost of not dealing with inflation. Let us not forget that while the rich and the powerful can protect themselves from any loss of purchasing power of their money - and in many cases can even benefit from such a loss - the weak and the not-so-rich will always be the losers. Inflation has always been a major source of social iniquity. In addition, it prevents the economy from functioning properly, by falsifying the signals which are given by prices. The speculative boom in the real estate markets in some of our countries at the end of the 1980s caused serious damage - and we are still paying the price. 2. Once inflation has been brought under control, and once this control has been confirmed, monetary policy can guide short-term interest rates to a level which contributes to balanced growth. Quite a number of EU countries are in such a situation already, with short-term interest rates at around 3%. In others, where inflation has been brought under control more recently, rates have not yet reached this level but are approaching it gradually. The confirmation that inflation has been brought under control does, unfortunately, take time. Finally, in one major country which has seen rapid growth for several years now and in which unemployment has fallen remarkably, short-term interest rates have been raised - applying the principle of preventive medicine. 3. Now, what can we say about long-term interest rates, which also have an important role to play in stimulating growth - perhaps an even more important one than short-term rates? Monetary policy does have an influence on the level of these rates, but its influence is not exclusive and we cannot even predict the direction of its influence with certainty. At this particular point in time, in the first group of countries to which I referred a moment ago, nominal long-term interest rates are at a historically low level - they are well below 6% - but real long-term interest rates can be regarded, perhaps, as still being too high to put continental Europe on the road to more vigorous growth. I am doubtful whether a further easing of monetary policy in this group of countries would be able to help move the yield curve in the desired direction. It could actually have the opposite effect - if investors perceived it as heralding a weak euro. In any event, given the current level of short-term interest rates, monetary policy's margin for manoeuvre is extremely limited. It is possible that the level of real long-term interest rates in Europe reflects, partially at least, that of real interest rates world-wide. Europe has no influence over that effect. Europe can, however, have an influence on the effect which comes from the constant increase in public sector indebtedness in our countries. As a reminder, between the end of 1991 and the end of 1996 the general government debt rose from around 56 to above 73% of GDP for the European Union as a whole. This development, together with the worry that it might not yet have run its course, are not likely - to say the least - to lead to a fall in real interest rates. Nor do they create the climate of confidence necessary for consumers and investors to modify their current prudent behaviour. On the other hand, the certainty that governments are tackling the underlying causes of the public deficits which are responsible for the constant increase in the debt burden could well bring about such a change in behaviour. "Faceless" markets are not the only ones looking beyond the immediate present to the future - our fellow citizens are, too. The prospect of self-perpetuating, ever-increasing deficits will not encourage them to spend more. 4. Stronger growth would certainly have a beneficial effect on employment. But it would not eliminate the largest component of unemployment - the structural component. This can only be done by means of measures which remedy labour market rigidities and reduce the burden of non-wage labour costs. It is this latter channel that links efforts to create jobs with the task of bringing public expenditure under control. I observe, too, that in those countries where unemployment has fallen substantially, jobs have been created not by existing enterprises - and especially not by large enterprises - but by the setting-up of a large number of new enterprises, which have necessarily been small to begin with. To conclude - allow me, if you will, to be quite blunt. Yes, once inflation has been brought properly under control, monetary policy can and must contribute to supporting balanced growth, but balanced growth will not depend on monetary policy alone. Both the acceleration and the viability of growth will rely on the contribution to be made by other policies. First, on that of a fiscal policy which does not crowd out private investment but, rather, fosters a climate of confidence by implementing a credible process of reforms. Second, on that of a policy which creates a favourable fiscal, financial and regulatory environment for the proliferation of new enterprises. And, so that the growth fostered in this way can create many jobs, structural policies will have to assume the principal role, while the role of monetary policy will then dwindle and fade away - alas - to nothing.
r970912a_ECB	euro area	1997-09-12T00:00:00	From the EMI to the ESCB: Achievements and challenges	duisenberg	1	It is a great pleasure to be here today to speak to you about the that has been made in respect of the transition to Stage Three of European Economic and Monetary Union (EMU) and some of the that lie ahead. The European Monetary Institute (EMI), established under the Maastricht Treaty, has been assigned an important role in the transition to Monetary Union. Located in Frankfurt, it came into being on 1 January 1994, its members being the central banks of the EU Member States. The three main tasks of the EMI are to further strengthen co-operation among the national central banks and the co-ordination of national monetary policies with the aim of ensuring price stability; to provide advice to the EU Council regarding the achievement of a high degree of sustainable convergence by Member States adopting the single currency; and to undertake the necessary technical preparations required for EMU. The European Central Bank (ECB) will be established by the appointment of its President and other members of the Executive Board after the decision is taken on which countries will participate initially in Monetary Union, and will, in conjunction with the national central banks (NCBs), form the European System of Central Banks (ESCB), which will take on responsibility for monetary policy within the euro area from the beginning of 1999. By then, the EMI will have been liquidated. In considering the achievements and challenges on the way to Monetary Union I should like to focus my remarks on two issues which are at the forefront of the tasks of the EMI; first, and very briefly, the progress and challenges with respect to convergence. Second, the state of preparations for the introduction of the single currency. In the area of convergence, a key challenge facing the European Union is the selection of the countries which will be deemed eligible to participate in Monetary Union from 1 January 1999. As you are no doubt aware, the Treaty provides that no Member State can enter EMU unless the Heads of State or Government conclude that it fulfils the necessary conditions to do so in terms of attaining a high degree of sustainable convergence as indicated by price stability, the sustainability of fiscal positions, exchange rate stability and the convergence of long-term interest rates. In this context, let me say that I do not intend - and I am sure you would not expect me - to discuss the probability of individual Member States participating in EMU from the outset. The EMI will give its views on this subject in due course as, under the Maastricht Treaty, it is required to provide a report on convergence to the EU Council in the spring of next year. I am, however, happy to discuss the current situation in relation to the convergence criteria. In short, there has been a considerable measure of achievement in some areas, notably in the progress towards price stability, while some challenges still remain, particularly in the fiscal area. With regard to , Member States have made remarkable progress in recent years. As measured by both the national Consumer Price Indices (CPIs) and the recently introduced Harmonised Index of Consumer Prices (HICP), the weighted average annual rate of inflation in the EU currently stands at 1.7%. Not only has such a subdued rate of price increases not been achieved for decades, but there are also few signs of incipient price pressures. Furthermore, differences in inflation rates among Member States have declined substantially: almost all Member States currently have HICP inflation rates of around 2% or less. Reflecting the pattern of economic convergence in actual and expected inflation, and credible monetary policies, has been broadly maintained during the first half of 1997, while long-term interest rates are low and have narrowed. is less bright. Most countries exceeded the reference values of the Treaty in 1996 and had yet to ensure sustainable consolidation. In May, the ECOFIN Council sent recommendations to correct excessive deficits to all Member States with the exception of Denmark, Ireland, Luxembourg, the Netherlands and Finland. This points to the crucial need to ensure sustainable convergence in the fiscal field. Notably, it is quite evident that sustainable consolidation cannot be achieved by one-off and accounting measures. Looking ahead to the medium term, it is necessary to address the issue of the future liabilities of social security systems in the context of an ageing population. In the absence of appropriate reforms, sizable increases in contributions, or even substantial increases in government indebtedness, would appear to be in prospect. This is of particular importance as fiscal discipline is essential not only at the time of entering EMU but also thereafter. I would acknowledge that the fiscal stance has generally been tightened. The government deficit for the EU as a whole is forecast, according to the European Commission, the IMF and the OECD, to decline from 4.4% of GDP in 1996 to around 2.9-3.0% in 1997. For the EU as a whole, the debt ratio was estimated to have risen further in 1996, to 73.2%, but is generally projected to fall slightly in 1997. Needless to say, the projections have yet to be confirmed by outcomes. Besides fulfilment of the convergence criteria, there are also a number of other significant challenges in the economic environment; in particular, there is a clear and insistent need for , notably in labour markets. The Union does not have a good record in terms of job creation. Unemployment in most Member States, though showing signs of stabilising, remains high, and the situation in labour markets is forecast to remain highly unsatisfactory. A wide range of institutional rigidities account for the weak employment performance, and it will be a major challenge to tackle them in a decisive manner. Of course, continued cost moderation is also required. I welcome the importance that has been attached to the issue of labour markets by the Council, in particular the Resolution on growth and employment passed at Amsterdam in June this year and the initiative for an extraordinary meeting of the European Council this autumn under the Luxembourg Presidency. From the issue of economic convergence, let me now turn to the technical preparations for the conduct of a single monetary policy. The EMI is responsible for preparing the operational framework that will enable the ESCB to perform its tasks in Stage Three: preparatory work that is progressing according to schedule. The conceptual phase has been completed for all the main issues of relevance and the main challenge now is for the EMI (working closely with the NCBs) to ensure that the options which have been selected are designed in full detail, and that they are prepared and tested in due time. The framework, as prepared by the EMI, will be submitted to the ECB for decision after its establishment in 1998. Let me mention a number of the areas where the EMI is involved in preparations. I shall try, in particular, to provide you with a guide to the progress that has been made more recently. The EMI continues to focus on a wide range of issues, such as monetary policy strategies, the instruments and procedures necessary for conducting a single monetary policy, foreign exchange issues, the integration of national payment systems through TARGET, the issuance of euro banknotes, statistical issues relating to the conduct of a common monetary policy, the rules for operations of NCBs within the framework of the ESCB, and the structure and functions of the ECB/ESCB. First, let me remind you that the EMI published an assessment of alternative in February this year. The Treaty provides unambiguous guidance as to the ultimate objective: "the primary objective of the ESCB shall be to maintain price stability". However, in pursuing this objective, the ESCB, like all central banks, will face a complex transmission process from policy actions to price developments with long and variable lags. Thus, policy decisions directed at price stability must be both pre-emptive and forward-looking, taking into account all relevant information regarding the prospective evolution of prices, and taking appropriate and timely action to ensure that the final objective is achieved. In addition, the need for credibility and consistency of the decision-making process over time will require the ESCB to establish a clear framework to guide the use of its monetary policy instruments with a view to achieving its final objective. The document to which I am referring ("The single monetary policy in Stage Three: elements of the monetary policy strategy of the ESCB") identified two potential candidate strategies, namely monetary targeting and direct inflation targeting. Overall, it concluded that the similarities in the behaviour of those central banks that pursue these two strategies are greater than the differences. Regardless of their choice of strategy, they all monitor a wide and similar set of economic and financial variables as indicators in determining the monetary policy stance. The ESCB will face two particular challenges from the outset when implementing a monetary policy strategy for Stage Three. First, the ESCB will have no track record of its own and must, therefore, attach the utmost importance to establishing and maintaining a high degree of credibility. Second, the transition to Stage Three will constitute a major shift in regime, which will imply initial uncertainty concerning economic and financial conditions and developments in the euro area as well as the future relationships between major macroeconomic variables. It will not be easy for the Governing Council of the ECB to draw firm conclusions from the observation of indicators. Moreover, while the stance of the single monetary policy of the ESCB can only be set to ensure that it will be appropriate for the euro area as a whole, it will nevertheless be important for the ESCB to be fully aware of any differential impact of its policies across Member States due to remaining structural differences across countries, not least because inflation in an individual Member State may spill over into the euro area as a whole. In order to implement its monetary policy strategy, the ESCB will need to rely on a set of - its operational framework. The EMI Council has defined a set of monetary policy instruments that will be made available to the ESCB. In January of this year the EMI published a report entitled "The single monetary policy in Stage Three: specification of the operational framework". The aim of the report was to provide information to the public on the operational aspects of the ESCB's monetary policy, including the main features of the instruments, procedures and supporting functions which were being prepared by the EMI. Briefly, it is envisaged that the ESCB will mainly use open market operations, in most cases employing reverse transactions, but that it will also offer two standing facilities (a marginal lending facility and a deposit facility), and a broad range of counterparties will have access to ESCB operations. Preparations have also been made for an infrastructure that will allow the ESCB, if it so chooses, to impose minimum reserve requirements. The ECB will decide in 1998 whether to do so. Required reserves could be used mainly to stabilise money market interest rates and to create or enlarge a structural liquidity shortage. The EMI has seen a need to study further the extension of the relevant article of the ESCB/ECB Statute to allow the ECB to subject a broader range of financial institutions than credit institutions alone to reserve requirements. The EMI plans to publish a further report in the near future on the subject of monetary policy instruments and procedures, the so-called "General documentation", which updates the operational framework, taking account of the progress made in the specification of the ESCB's monetary policy instruments and procedures over the past few months. This new report is intended particularly to provide financial institutions with the information they need to prepare themselves to participate in ESCB monetary policy operations in Stage Three. In this respect, the report sets out the criteria to be fulfilled by financial institutions to be eligible counterparties in ESCB monetary policy operations. It then presents the features of the different types of open market operations which might be conducted by the ESCB (the main refinancing operations, the longer-term refinancing operations, fine-tuning operations and structural operations) and those of the ESCB's two standing facilities. The report will contain a detailed description of the procedures related to the various types of operations and, furthermore, it will specify the eligibility criteria and risk control measures to be applied to assets underlying the ESCB's liquidity-providing operations. It will also present the features of the ESCB's minimum reserves system as prepared by the EMI. Of course, the final decision on the operational framework will be taken by the Governing Council of the ECB after its establishment. The Governing Council, consisting of the Executive Board of the ECB together with the Governors of each of the participating Member States' central banks, may choose not to use all the options made available in the General documentation, or may decide to amend certain features. Next week the EMI also plans to publish a provisional (MFIs), primarily for the use of reporting institutions and compilers of statistics, in support of its aim to produce a homogeneous monetary sector and reporting population for the production of properly articulated money and banking statistics in Stage Three. This report will cover credit institutions but not Money Market Funds (MMFs). Work is under way to identify Money Market Funds in the EU for inclusion in an Addendum to the present provisional list, which it is planned to make available later in the year. Another important aspect of the EMI's work relates to , i.e. the adaptation of national legislation including the statutes of the NCBs, with a view to Stage Three. Member States are obliged, in accordance with the Maastricht Treaty, to eliminate incompatibilities between national legislation and the Treaty and ESCB/ECB Statute. The EMI has considered this earlier in both its 1995 and 1996 Annual Reports, distinguishing between central bank independence, the integration of NCBs in the ESCB and legislation other than the statutes of the NCBs. Recent work has built on these earlier reports. Given that not all Member States are likely to participate from the start of Stage Three, the exchange rate relationship between the euro area and the non-euro area EU countries will be of great importance. The EMI has finalised the first stage of its preparatory work on the between the euro area and other EU countries. The outline of a new mechanism (ERM II) was approved in Amsterdam in June of this year and includes the following features: it will be based on central rates, defined vis-a-vis the euro for non-euro area currencies. A standard fluctuation band will be established for these currencies around their central rates. The margins of the standard fluctuation band will be relatively wide: +/- 15%. Central rates and the standard wide band will be set by mutual agreement between the ECB, the Ministers of the euro area Member States and Ministers and Governors of the central banks of the non-euro area Member States. The ECB will have the right to initiate a realignment and the possibility of suspending intervention and financing if these were to threaten the pursuit of price stability. The ERM II does not rule out forms of closer exchange rate co-operation between non-euro area NCBs and the ECB agreed on a case-by-case basis, such as narrower fluctuation bands. The integration of is an essential element of the technical preparations for Stage Three, in order to facilitate the implementation of the ESCB's monetary policy, and to provide sound and efficient mechanisms to settle same-day cross-border payments under any circumstances. In March 1995 the EMI Council agreed to establish the TARGET system; the TARGET Report was released in May 1995 and a first progress report in August 1996, providing additional information. Further work in this field has focused on elaborating the organisational aspects of TARGET, the technical implementation of the system and legal issues. For instance, in February this year the EMI Council endorsed the decision to choose S.W.I.F.T. as the Interlinking network provider and a contract was finalised in June. Testing of NCB links with the EMI's test centre has begun. An ECB Payment Mechanism (EPM) is also being prepared. It has been decided that the ECB will have a direct link to the Interlinking, in the same way as the NCBs. The EMI will be publishing a second progress report shortly, covering detailed issues such as the harmonisation of the operating time of domestic RTGS systems linked to TARGET, pricing policy and the provision of intraday liquidity to non-euro area NCBs. It is proposed that there should only be two common days when TARGET is closed: Christmas Day and New Year's Day. On other days the TARGET system will remain open, but individual NCBs will have the flexibility to close on national or regional holidays. The Interlinking system will remain open as long as at least two national RTGS systems are open. Normal TARGET operating hours will be from 7 a.m. to 6 p.m. "ECB time" (that is, the time on the clocks at the ECB), although some flexibility could be left to NCBs to open earlier for domestic reasons. On the issue of pricing, it has been agreed by the EMI Council that a common transaction fee for cross-border TARGET transfers should be charged, based on the principle of full cost recovery (subject to confirmation from the Commission that this would not create competitive distortions). The EMI is intending to publish a price range, but the exact fees will be decided by the Governing Council of the ECB. There has also been progress with respect to options for preventing intraday credit, if provided to non-euro area NCBs, from spilling over into overnight credit. One of the options is for an earlier cut-off time for these NCBs connected to TARGET. It has been decided that if this option were to be chosen, the earlier closing time would only need to apply to the use of intraday credit in euro (which means in effect a liquidity deadline), rather than to the processing of payments. During the first half of this year, the EMI opened a dialogue with EU-wide banking and financial associations on issues concerning their preparation for the changeover to the euro. In March, the EMI and the representatives of the banking community agreed a list of priorities for preparatory work to be accomplished during the year. At the request of the banking industry, the EMI supported the private sector's preparations by defining common standards for the computation of interest rates in the money market, the method of quotation of the exchange rate of the foreign currencies against the euro and the definition of euro area-wide business days. The EMI invited the banking and financial community to take a lead in harmonizing other market conventions. This lead ten EU-wide banking associations and two International Central Securities Depositories (ICSDs) to submit to the EMI a "joint statement on market conventions for the euro". This statement is a non-binding catalogue of which are proposed by the signatory associations to issuers of financial instruments and other market participants for inclusion in new wholesale financial products after the start of EMU. The statement proposes that, after the start of Stage Three, newly issued instruments in the euro financial markets should reflect minimum standards of harmonisation. The EMI has welcomed and supported the initiative taken by the associations of the banking and financial industry, which reflects a broad consensus among market participants on common conventions for the euro financial markets, and is of the view that implementation of these conventions will enhance the integration of, and greater transparency in, the euro financial markets. In discussions with the EMI, representatives of some EU-wide banking associations have also stressed that they would favour the ESCB participating in a neutral manner in the calculation of an . Originally, the EMI Council was of the opinion that it should not interfere in what is essentially a matter for the private sector. However, the market has indicated to the EMI its difficulties in calculating this reference rate itself and, given the need to ensure the continuity of contracts, the Council has reconsidered and has agreed to assist in the calculation of this rate, although it will not take responsibility for its publication. Finally, let me come to the topic of the ESCB itself. The main issues outstanding as regards the degree of centralisation and decentralisation of operations within the ESCB have now been agreed upon. One significant challenge confronting the EMI and the NCBs in the coming months will be to determine . Significant thought has been given to these issues within the EMI, and the EMI Council has given serious consideration to staffing requirements. I regard it likely that just under 500 staff members will be required initially; the current staff at the EMI numbers less than 350. Given the lead times needed to recruit suitably qualified staff, this process will begin in the near future. Further consideration is being given to institutional issues, in particular the form of co-operation between the ECB and the NCBs. Although there are some specific responsibilities assigned to the different bodies within the ESCB, there will also need to be close co-operation between them. The experience to date with sub-committees and working groups of central bank experts meeting under the auspices of the EMI suggests that this could form a useful basis for such co-operation in Stage Three. To conclude, EU Member States have made considerable progress in terms of economic convergence, although challenges remain in terms of structural reforms, notably in the area of fiscal policy and labour and product markets. Considerable progress has also been made by the EMI in terms of the necessary preparations for the introduction of the single currency on schedule on 1 January 1999. The greatest challenge that lies ahead is to establish and maintain a zone of price stability within the euro area after the start of Stage Three, in fulfilment of the clear mandate given to the ECB in the Maastricht Treaty. Personally, I am convinced that the application of the convergence criteria, the institutional arrangements for the ESCB and the preparations that have been made to date will ensure that the euro will be a stable currency and that the ESCB will be a powerful institution, safeguarding the value of the new currency./.
r970922a_ECB	euro area	1997-09-22T00:00:00	The European Monetary Institute and progress towards monetary union	duisenberg	1	The start of Economic and Monetary Union (EMU) is only around fifteen months away. In March next year the EMI and the European Commission will present their reports on the state of convergence among EU Member States. Without prejudging this final assessment, it may be concluded that important progress has been made over recent years as regards the convergence of inflation and interest rates. In addition to that, generally speaking, exchange rates among EU currencies have been stable. Although efforts still have to be made to ensure the sustainability of sound public finances, the overall movement in this area is also in the right direction. The commitment to the EMU process was also clear in the announcement made in Luxembourg by the EU Finance Ministers just a week ago that they will pre-announce in May next year the bilateral exchange rates at which the currencies participating in the euro area will be irrevocably fixed, at the same time as the decision on which Member States will adopt the euro. This "pre-pre-announcement" was well received by financial markets and had an impact on interest rate differentials and the position of some currencies in the ERM. Since its establishment in 1994, the main task of the European Monetary Institute (EMI) has been to translate into a coherent plan, and to implement, the political commitment to establish a monetary union that the European countries made in signing the Maastricht Treaty. There was no historical precedent for achieving such an objective. What monetary theory and practice suggest, however, is that a new currency cannot be introduced only by means of an act of law. In modern economies, the role played by money is the result of the interplay between authorities' actions and the behaviour of market participants. Money cannot develop without a market in which supply and demand conditions can be expressed. Without a market for the euro, it will not be possible for it to become the European single currency. Therefore, the move to a single currency requires action by the monetary authorities and by market participants. The work conducted by the EMI over the past three and a half years has reflected this dual approach, and I should like to discuss it further. I shall first explain how the EMI has organised and conducted its preparatory work for establishing the European System of Central Banks (ESCB). I shall then explain the ways in which the EMI has been operating to ensure that a euro market will also develop from the start of Stage Three of EMU. I shall close with some personal views on the outlook for the euro. Let me start with the preparation of the ESCB for the conduct of the single monetary policy. The Maastricht Treaty specifies a clear timetable for the preparatory work to be undertaken by the EMI. Taking 1 January 1999 as the first day of Stage Three and 1 July 1998 as the deadline for the establishment of the European Central Bank (ECB), the key decisions to be taken by the EMI concerning the selection and adjustment of the key monetary policy instruments and procedures have been scheduled on the basis of the lead times estimated for the implementation of those decisions. According to this schedule, the EMI devoted its first three years to the definition, assessment and comparison of the various options available. On this basis, at the end of 1996 the EMI Council took the main decisions concerning the principal instruments and the supporting infrastructure that the EMI would have to prepare and make available to the ECB. These choices are described in detail in the EMI document entitled "The single monetary policy in Stage Three: Specification of the operational framework", published in January 1997. The second phase of the preparatory work started at the beginning of this year and will go on until mid-1998. It comprises the technical specification of the operational framework and its implementation. Two recent EMI publications ("The single monetary policy in Stage Three: General Documentation on ESCB monetary policy instruments and procedures" and the "Second Progress Report on the TARGET Project") describe the further technical specifications of the ESCB's operational framework. Implementation is under way in most areas, both at the EMI, in preparation for the ECB, and at the national central banks (NCBs). The third and final phase of the preparatory work will start in mid-1998 with the establishment of the ECB. It will comprise the final choice of certain options that have remained open and the testing of all the technical and operational procedures. The conduct of the testing work will be integrated with a view to ensuring that the ESCB will be in a position to perform its functions in full as of 1 January 1999. Although I do not wish to describe the preparatory work in greater detail, I should nevertheless like to recall the main principles and the main choices that have been made. The first main, overriding principle on which preparatory work has been based is that the ECB will conduct the single monetary policy with a view to achieving its primary objective of maintaining price stability. This principle is derived directly from the Treaty. Second, monetary policy instruments have been selected on the basis of their operational efficiency and their conformity with market principles. The third important principle that has guided the preparatory work is that monetary policy will be implemented - "to the extent deemed possible and appropriate" - in a decentralised manner, with a view to taking advantage of existing infrastructures at the NCBs. On the basis of these guiding principles, four main characteristics of the ESCB's operational framework should be underlined. First, the ESCB will operate in the money market mainly through standard market-oriented operations, such as open market operations. Two standing facilities and the possibility of imposing reserve requirements have also been prepared. Administrative instruments that may create distortions or subsidies for some categories of operators have been discarded. Second, the monetary policy operations of the ESCB will largely be executed in a decentralised manner by the NCBs. It has been agreed that the ECB will be entitled to conduct fine-tuning operations, under exceptional circumstances, and occasional foreign exchange intervention. Third, in defining eligible assets for monetary policy operations, existing differences in Member States' financial structures, which are of particular importance for national financial markets and banking systems, have been taken into account in the preparatory work with a view to ensuring some continuity for market participants in the different countries. Finally, the monetary policy framework has been designed with a view to ensuring that homogeneous conditions are applied to all counterparties, irrespective of their location in the euro area. For instance, although regular tenders for central bank money will be implemented in a decentralised manner, they will be decided and organised centrally by the ECB, thereby ensuring equal treatment for counterparties. The EMI has also conducted preparatory work in a range of other areas relevant to monetary policy, such as statistics, accounting and payment systems, with a view to ensuring that the ECB will have all the necessary instruments available to implement the single monetary policy from the start of Stage Three. I should now like to turn to the issue of how market participants have been preparing for the single currency. The EMI has taken the view that market participants should determine their own ways and means of adapting to the single currency. On the other hand, a well-functioning and efficient euro financial market is a prerequisite for a credible changeover to the single currency. The EMI has thus encouraged initiatives aimed at fostering the creation of a large, liquid and transparent euro financial market from the start of Stage Three. In particular, the EMI has been prepared to provide guidance or to take action on this matter when asked to do so by market participants. The EMI has made contributions in four main areas: Let me briefly address each of these issues in turn. I should like to start with the changeover scenario, which was approved by the European Council in Madrid in December 1995 on the basis of the contribution made by the EMI. Such a scenario was necessary for market participants to co-ordinate their actions with a view to a smooth changeover to the single currency. The adopted scenario lays down the starting dates and deadlines for the main phases of the changeover to the euro, within which market participants are free to make personal adjustments. There will be sufficient time, around three years after the irrevocable fixing of the conversion rates, to complete the final move to the new currency. Ultimately at that moment banknotes and coins of the former national currencies will be withdrawn from circulation. During this period, market participants will be neither compelled to use nor prohibited from using financial instruments denominated in euro or in national currencies, as those in different currencies will be deemed to be ex lege equivalent. What is clear is that from January 1999 onwards the single monetary policy will be conducted and implemented in euro; new sovereign debt in all participating Member States will be denominated in the single currency; and most European governments have already announced that they will also redenominate outstanding stocks in the single currency. The second area in which the EMI has contributed in order to ease the transition to the euro concerns the legal framework, which some market practitioners considered to be essential to avoid confusion and future litigation. On the basis of background work conducted by the EMI and the European Commission, the Council approved a Regulation on 17 June 1997 which reaffirms, inter alia, the principle of the continuity of contracts and gives an assurance to financial markets that "the introduction of the euro shall not have the effect of altering any term of a legal instrument or of discharging or excusing performance under any legal instrument, nor give a party the right unilaterally to alter or terminate such an instrument". It is worth recalling that a similar rule came into force in the Illinois and New York State legal systems as of July 1997, thereby ensuring respect of the principle of the continuity of contracts in the Chicago and New York markets. The third area in which the EMI has supported the process of market integration concerns payment systems. The EMI has developed a new payment infrastructure, known as TARGET, which will enable market participants to effect large-value payments across the EU in real time. TARGET is based on the national real-time gross settlement (RTGS) systems, which are connected to one another by an Interlinking mechanism. Free, unlimited and collateralised intraday credit will be made available to participants to smooth payment flows. The availability of such a payment system will enable market participants to conduct arbitrage operations and to take advantage of profit opportunities arising from any discrepancies in money market rates in the euro money market both swiftly and at low cost. This will ensure the uniformity of monetary conditions across the euro area. The ECB will have its own payment mechanism being part of TARGET. Finally, let me turn to the definition of common market standards, which will be essential for the development of a truly EMU-wide market. At present, each national financial market has its own standards concerning day-count interest rates, settlement times, operating days and fixing procedures in particular. For this reason, efforts geared to achieving harmonisation were deemed to be necessary. In March 1997 the EMI invited EU-wide banking and financial associations to take the lead in defining market conventions for the euro market. In July ten of the major banking and financial associations in the EU, including those active at the world-wide level, published a joint statement on market conventions for the euro, which should be inserted into all terms and conditions of new financial instruments after the start of EMU. The EMI publicly supported and welcomed this agreement, which sets the basis for common European standards. The work conducted by the EMI in all these areas has supported the preparations made by the banking and financial industry. In most countries, banks have made great progress in their preparatory work, and not only in the wholesale financial area. As a matter of fact, several banks are even preparing to offer their retail customers financial services in both the national currency denomination and in euro as from 1 January 1999. Very briefly, this is the state of the art in the preparatory work for the single currency, as it appears from both the authorities' and the market perspective. Stage Three of EMU will start in around fifteen months' time and the picture is becoming clearer every day. What emerges, and I should like to close with some personal views, is that the interplay between market forces and the authorities' actions are helping to create a strong euro financial market. Through the initiative demonstrated by market participants and in co-ordination with the authorities, what is currently being shaped could potentially be the largest financial market in the world if measured according to outstanding stocks of assets. The improvements in terms of the size, liquidity and transparency that this market will experience with the changeover to the euro will create the basis for strong world-wide demand for euro-denominated assets. The pace of developments cannot be forecast, but the direction is clear: the euro will be a major player in the international monetary and financial system. What role will the ESCB play in this new context? To some extent the answer is very simple, as it is given in the Treaty. The role of the ESCB will be to implement the single monetary policy with a view to achieving the overriding objective of maintaining price stability. I do not wish to enter into any of the sterile debates on a weak euro versus a strong euro which are currently taking place in some newspapers and journals. It is important to realise that the preparatory work that has been conducted to date, not only at the EMI, but also within the broader European political forums, will have enabled an ESCB to be established which will be able to operate fully and independently in order to maintain price stability in the euro area. I say that not only because, as a central banker, I am convinced of the virtues of price stability as a pre-condition for sustainable growth, but also and especially because, as a European, a stable euro will be essential for Monetary Union to create (and I quote) "an ever closer union among the people of Europe", which is the ultimate goal of EMU as laid down in the Treaties of Paris (1951) and Rome (1957), and more recently reiterated at Maastricht (1992) and Amsterdam (1997).
r971013a_ECB	euro area	1997-10-13T00:00:00	Hearing of the President of the EMI by the Monetary Sub-Committee of the European Parliament	no_info	0	It gives me particular pleasure to be able to address the members of the Monetary Sub-Committee of the European Parliament on the progress of the move to Stage Three of European Economic and Monetary Union (EMU) and on the main challenges which will affect, in the near future, the work of the European Monetary Institute (EMI). As in previous years, the EMI continued to play a pivotal role in the preparations for EMU in 1997. In accordance with the Maastricht Treaty, its efforts have focused, on the one hand, on assessing the degree of sustainable convergence achieved by Member States in indication of their readiness to adopt the single currency and, on the other hand, on undertaking the necessary technical preparations required for the establishment of the ESCB. Towards the end of March 1998 the EMI and the European Commission will be called upon to submit - to the European Parliament amongst others - their respective reports on the progress made by the Member States in the fulfilment of the necessary conditions for the achievement of EMU, the so-called "convergence reports". About one month later, having taken due account of these reports and of the opinion of the European Parliament, the Heads of State or Government will decide on the list of countries eligible to enter Monetary Union and will pre-announce the bilateral exchange rates between these countries' currencies which will be used as a basis for determining the rates at which these currencies will be converted into euro on the last day of 1998. On the recommendation of the EMI Council, the EU Finance Ministers recently reached agreement on this latter aspect. A public pre-announcement at the time of the selection of the eligible countries is expected to reduce uncertainty and thus to have a stabilising effect on the exchange rates concerned. As a matter of fact, the public statement that there will be such a pre-announcement at the time of the decision on the list of participating countries already appears to have had the effect of diminishing uncertainty in the markets. You will recall that the EMI has the statutory obligation to produce, once a year, a report on the state of preparations for Stage Three which includes an assessment of the progress made in terms of convergence in the Community. The EMI has complied with this reporting requirement by releasing - in 1995 as well as in 1996 - a special report in early November. In order not to give confusing signals on the state of convergence in the Community shortly before its assessment - due in March 1998 - of the situation for the year 1997 as a whole, the EMI Council decided against releasing a special report in November of this year. Instead, the 1996 Annual Report, published in April of this year, is considered to have fulfilled the relevant statutory reporting obligation for 1997, as was indicated in the executive summary of the Report. As regards the 1997 Annual Report, compliance with the normal schedule of publication, as laid down in the EMI's Rules of Procedure, would have meant publication in April 1998, following approval of its content by the EMI Council in early March. The one-month interim period is necessary to allow for its translation into all Community languages. One effect of this production time schedule is that economic information in the Annual Report never fully covers the whole of the previous year. The EMI's Convergence Report, scheduled for publication at the end of March 1998, will of course be based on outcomes for 1997. Again, to avoid sending confusing signals by releasing an Annual Report containing data which is unavoidably not completely up-to-date between the date of publication of its Convergence Report and that of the decision on the list of eligible countries, the EMI Council has agreed unanimously on the need to deviate from the Rules of Procedures. The 1997 Annual Report will therefore be released, and addressed to the European Parliament, in June rather than in April 1998. This timing will, in a way, symbolically close the "EMI chapter" vis-a-vis the public. Next year's Convergence Report will, in conformity with the Treaty requirement under Article 109j, paragraph 1, also deal with the achievement of so-called "legal convergence". In this connection, in August 1997 the EMI produced a report on"the adaptation of national legislation, and in particular the statutes of the national central banks, of the Member States of the European Union with a view to Stage Three". In this report, which was transmitted to the European Parliament last September, the EMI established a list of features which could serve as guidance for national legislators in their endeavours to bring legislation into line with the requirements of Article 108 of the Treaty. These adaptations aim to eliminate inconsistencies with the Treaty as regards the requirements of central bank independence and to reflect the integration of national central banks into the ESCB. Recently, in particular, considerable attention has been paid in a number of Member States to the need to adapt their national central bank's statutes to this effect and the EMI has been and is being asked for its opinion on the draft legal texts. These legislative changes will have to be finalised by the date of the establishment of the ESCB, although the amendments designed to reflect the operational integration of national central banks into the ESCB will only have to take effect at the end of 1998. As regards the technical preparations required for the establishment of the ESCB and the conduct of the single monetary policy, conceptual work was completed at the end of 1996 and the implementation phase has started. You will recall that in January of this year the EMI published a report on "The single monetary policy in Stage Three" which aimed to provide information to the public on the operational aspects of the ESCB's monetary policy, including strategic considerations and the main features of the instruments, procedures and supporting functions under preparation. Reflecting further progress on the detailed specification of the single monetary policy framework, last month the EMI published a report entitled "General documentation on ESCB monetary policy instruments and procedures". Compared with the January "Framework Report", the September "General documentation" document provides more detail on the full set of monetary policy operations in terms of their technical and operational features. It also provides a more extensive description of all the procedures which the ESCB will apply in the execution of its monetary policy operations and which evidently are of considerable interest to the central banks' counterparties for their own preparations for Stage Three. The "General documentation" does not deal with considerations of monetary policy strategy, on which subject the EMI released a special report in February 1997. This report extended the analysis provided in the January "Framework Report", explained why two potential strategies - namely monetary targeting and inflation targeting - have remained as candidates, and indicated the preparatory work needed from the EMI to enable the ECB Governing Council to choose a strategy and have it fully operational by 1 January 1999. The EMI and the national central banks are also continuing their preparatory activities to make the TARGET system operational. TARGET will link national large-value payment systems so that banks can transfer bank reserves across the euro area at same-day value and so that the ESCB will be able to ensure quick and uniform transmission of interest rate signals throughout the area. A "Second Progress Report on the TARGET Project" was released by the EMI last month, and provided updated information to market participants, in particular on the progress made in terms of the organisational aspects (e.g. operating time), pricing and the technical implementation of the system. Part of this implementation involves making operational the ECB Payment Mechanism, which will, among other things, enable the ECB to execute, under exceptional circumstances, fine-tuning monetary policy operations and to conduct occasional foreign exchange intervention. Let me also recall that other large-value payment systems will continue to operate in Stage Three in parallel with TARGET. One of these cross-border systems is the Clearing operated by the ECU Banking Association, or EBA, which will settle, on a net basis, end-of-day balances in central bank money in Stage Three. The EMI has reached an agreement on the method to be used for settlement of the EBA Clearing with the ESCB and has informed the EBA accordingly. The method provides for a single settlement account with the ECB, reflecting considerations of simplicity and safety of the settlement process. But it does not exclude decentralised settlement for clearing banks wishing to settle with their respective national central bank. Still in the area of settlement, the EMI continues to work on preparations for the cross-border use of eligible debt instruments serving as collateral for ESCB monetary policy operations. In this connection, EMU requirements for EU securities settlement systems have been spelled out and discussions with the industry professionals are ongoing. The aim is to enable eligible assets to be used for operations with the ESCB throughout the euro area. In many other areas - ranging from statistics via IT systems to accounting matters - highly technical preparatory work continues, about which I will spare you the details. The same holds for the preparation of the euro banknotes. In this connection you may recall that in July the EMI made public the draft euro banknote designs, following the presentation in December of last year of the design sketches. Work has also been undertaken on the ECB's staffing requirements, taking into account the functions which the ECB will perform and the division of labour - in terms of operational activities - between the national central banks and the ECB, on which full agreement exists within the EMI Council. The EMI is now in the process of preparing for the recruitment of the roughly 500 ECB staff members expected to be in place by the end of next year. This compares with the approximately 350 staff members expected to be employed by the EMI at the end of this year. The preparations for the changeover to the euro have gained considerable momentum over the past twelve months. The EMI has continued to monitor this activity while being of assistance, if so required, in its areas of competence. In particular, the EMI has provided a forum for the exchange of views among the EU-wide associations of the banking and financial industry, which has contributed, inter alia, to an agreement among the latter on a set of harmonised conventions for the euro-denominated money, bond and foreign exchange markets. A joint statement to this effect, released by the associations, has been explicitly welcomed by the EMI Council. The EMI has also reached an understanding with market practitioners on the role of the ESCB in the computation of an effective overnight rate in euro and in the publication of daily indicative exchange rates for the euro. As Monetary Union draws nearer, attention has started to focus more and more also on the external aspects of EMU. In this context, the Amsterdam European Council invited the EMI to co-operate with the Council and the Commission in studying effective ways of implementing all the provisions of Article 109 of the Treaty. Given the responsibility of the ESCB for the single monetary policy in the euro area and the consultation requirements of the Treaty, it is important that an exchange of information and views takes place between the ECB and the ECOFIN Council on exchange rate matters. To this end, the EMI considers the Treaty provisions for inter-institutional co-operation and the continuation of the present informal arrangements to be fully adequate. The EMI Council is of the view that the ECOFIN Council should make use only in exceptional circumstances of the possibility of formulating general orientations for exchange rate policy in relation to non-Community currencies which "shall be without prejudice to the primary objective of the ESCB to maintain price stability". Questions about the appropriateness and form of such orientations should be settled at a later stage in the light of the conditions prevailing at the time. In any case, it should be emphasised that the Treaty does not allow the ECB to make any commitment other than those indicated in the Treaty. The EMI Council also considers that it should be possible for the ESCB to be represented by the ECB at the IMF. Further work in this area is planned. In my brief introductory overview of the EMI's recent activities, I have attempted to illustrate that the institutional, legal and technical preparations for EMU are well under way from the point of view of the central banking community. Of course, much remains to be done and there is no room for complacency. The same holds true, I would say, for the preparatory work of all the other actors involved in this ambitious project of creating Monetary Union in Europe. EU Member States must continue their progress in terms of economic convergence, focusing in particular on the challenges remaining in the areas of fiscal policy and labour markets. As for the EMI, the challenge for the coming six months will be to deliver a thorough assessment of the state of convergence and to bring all the required preparatory work to a stage that will enable the ESCB to have at its disposal a well-tested, fully operational framework for the conduct of the single monetary policy.
r971014a_ECB	euro area	1997-10-14T00:00:00	Monetary stability and economic growth or: Why stable prices are good for private enterprise in France and the Netherlands	duisenberg	1	I shall today address a subject which is very familiar to central bankers: namely, the relationship between monetary stability, monetary policy and economic growth. More particularly, I would like to focus my remarks on the benefits of stable prices for private enterprise. As you know, the core task of a central bank is to safeguard the purchasing power of money or, to put it differently, to create a zone of monetary stability. The concept of monetary stability comprises in any case the requirement that money has a stable value or, to express this in more familiar terms, that there is price stability. Under specific circumstances, namely when foreign countries also adhere to price stability, this also creates favourable conditions for a stable value of the currency, in other words, exchange rate stability. Let me dwell for a moment on these two aspects of monetary stability, their interlinkages and their relative weight in formulating monetary policy in Europe. A growing number of central banks throughout the world have been given the legal mandate to ensure price stability. Such a mandate also applies in the case of the European System of Central Banks (ESCB), as the Maastricht Treaty explicitly states that "the primary objective of the ESCB shall be to maintain price stability". Following a definition which has been advocated by my colleagues Paul Volcker and Alan Greenspan, . What this definition actually means in operational terms is somewhat difficult to specify, given the various available statistical measures of inflation - that is, of the increase in the general price level. Moreover, there is a degree of upward bias in measured inflation. Taking this into account, however, one could say that a rate of consumer price inflation not exceeding 2% is probably not far off what central banks would normally be quite satisfied with. Some European central banks have indeed set themselves quantitative monetary or inflation targets that reflect this benchmark for price stability. Let me now move on to the external aspect of monetary stability, namely that of a stable exchange rate. For several EU countries it has proved highly beneficial in the past decades to aim for a stable external value of the currency against the strongest and most credible EU currencies as the key to achieving price stability. In small open economies, the existence of close trade relations is a further major justification for such an indirect approach to fighting inflation, as a stable currency removes an artificial barrier to international competition and thus promotes trade with other partners. In contrast, some central banks of other, usually larger, EU countries have preferred to focus their monetary policy directly on the achievement of price stability and thereby also to lay the foundations for a stable exchange rate. While this has allowed them to set official interest rates in line with domestic price requirements, these were nonetheless influenced by the interaction between exchange rate developments and inflation. As experience has shown, the success of either form of monetary policy orientation depends crucially on the support of economic policies directed at sound public finances, responsible wage behaviour and efficient markets. In Stage Three of EMU, the ESCB will carry out its mandate of ensuring price stability in a somewhat different economic environment, comparable to the situation of the Federal Reserve in the United States. The euro area will be a large internal market with strong trade relations among its partners stimulated by the existence of a single currency. As a natural consequence, trade flows with the rest of the world will be rather small. This allows the ESCB to focus primarily on "domestic" inflationary risks and to consider fluctuations in the euro exchange rate only to the extent that these significantly affect "domestic" prices. This also explains why it has now been agreed that any so-called orientations that might be formulated by the ECOFIN Council in the field of exchange rate policy for the euro area will be limited to exceptional circumstances. As stated in the Treaty, such general orientations shall be without prejudice to the primary objective of the ESCB to maintain price stability. Against this background, some people have asked me "Where does all this leave economic growth?" Behind this question seems to be the idea that the ESCB could - or even should - use monetary policy to promote growth and employment in EMU, especially in view of the high level of unemployment in Europe. In answer to this question, I refer to the Statutes of the ESCB which stipulate that "without prejudice to the objective of price stability, it shall support the general economic policies in the Community with a view to the achievement of the objectives of the Community", which include inter alia sustained non-inflationary growth and a high level of employment. Also relevant in this context is the sentence that the ESCB "shall act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources". Before I go on to discuss the relationship between monetary policy and economic growth in more detail, it may be useful to recall the costs of inflation - or, to put it differently, the reasons why a climate of price stability provides substantial benefits, especially for private enterprise. My remarks should make clear that I see no conflict between price stability and a balanced development of economic activity in EMU; on the contrary, a stable price environment provides excellent conditions for a flourishing market economy and thus supports a healthy creation of employment. Indeed, the best way for monetary policy to contribute to the achievement of the objectives of the Community is precisely by focusing on price stability. To arrive at a clearer understanding of the economic and social costs of inflation it is helpful to distinguish between anticipated and unanticipated inflation. Let me start with the case of inflation which is fully expected. Although the public will normally have taken account of expected price increases in their economic decision-making, this aspect of inflation nonetheless imposes non-negligible costs. They relate in particular to attempts by the public to economise on non-interest-bearing money holdings, the need to constantly revise price lists, and the misallocation of resources due to the operation of tax systems which are not fully indexed. At first sight these costs might appear somewhat trivial. The truth of the matter is, however, that the efficiency losses can be very large. This is perhaps most evident in the case of the tax argument. Taken by itself, the imposition of personal and corporate income taxes distorts the allocation of productive resources in a market-based economy because it leads to a bias towards current consumption relative to savings and investment. Recent academic studies have found that the interaction between inflation and income taxes has the unintended effect of exacerbating these distortions. Calculations for the United States suggest that the negative impact of 2 percentage points extra inflation could be as high as 1% of GDP on a permanent basis, in other words output is 1% lower each year. Although this outcome is sensitive to the underlying assumptions, similar work undertaken for some EU countries (Spain) broadly confirms the conclusion that reducing inflation and thereby the magnitude of tax distortions brings substantial benefits which, over the longer term, exceed the transitional disinflation costs. Given the adverse effects associated with inflation, it is thus worthwhile accepting the transitional sacrifices in output of moving to price stability. The costs associated with unanticipated inflation are perhaps even more evident, as they arise above all from the uncertainty that goes with it. Clearly, an environment of stable prices offers a much more reliable basis for corporate decision-making. In evaluating investment opportunities, it is crucial for firms to be able to rely on the signals conveyed by relative price changes, as these will tell them whether or not it is profitable to engage in a certain productive activity. For this mechanism to function properly, firms must be able to discriminate between relative price adjustments and general changes in the price level. However, this is a particularly difficult exercise in periods of high and variable inflation. This also explains why the prospect of a single currency produces large benefits; it allows cross-border relative price comparisons to be made without the distorting influence of exchange rate fluctuations. The more reliable the information on relative prices, both nationally and across borders, the more an efficient allocation of scarce resources and the ability of a market economy to function properly is promoted. The same positive result for resource allocation arises from the fact that in a non-inflationary environment firms are more willing to enter into long-term investment contracts. After all, when considering a long time period for evaluating costs and revenues they face a smaller risk of unanticipated inflation wiping out expected real profits. At times of high and variable inflation, however, they tend to prefer projects which promise a quick return on investment. In addition, the expected real return must be higher, because - with a higher degree of uncertainty over inflation - firms are confronted with a higher real cost of borrowing. This can be explained by the fact that financing costs tend to include an insurance premium to cover the risk of unexpected changes in the price level. A climate of stable prices thus offers companies substantial benefits in terms of lower real interest rates. This brings me to one of the main arguments against inflation, namely the unintended redistributive consequences. Inflation effectively functions as a tax which, at random and without justification, causes a redistribution of income and wealth, especially if it comes unanticipated. Who will profit and who will lose from it, depends on whether and to what extent people are able to predict and neutralise the effects of inflation. The outcome of this process is uncertain, but all too often it is the weaker in society who cannot protect themselves and bear the brunt. Accepting high inflation is thus equivalent to allowing a social injustice to endure. Ultimately, this undermines the cohesion of society. Another point to note in this context is that at times when wage increases are the driving force behind inflation, the macroeconomic income distribution tends to change to the benefit of employees and to the detriment of profits. On the one hand, wage rises in excess of labour productivity growth fuel domestic inflation, to the extent that firms succeed in passing on the increase in unit labour costs in domestic sales prices. On the other hand, firms facing international competition normally have to cut profit margins in response to higher unit labour costs, in order not to lose their share of the market. In many European economies - including France and the Netherlands - this two-way mechanism was clearly visible in the simultaneous rise of inflation and labour's share of GDP in the 1970s and early 1980s. A reverse process was set in motion in the course of the 1980s: parallel to the decline in inflation the share of profits in GDP increased, which in turn offered opportunities for investment, output growth and employment. Having arrived at a clear view of the benefits of price stability, it is time to devote a few words to the question of what may be expected from the monetary policy of the ESCB in terms of support for growth and employment. Here, it would seem that some observers still live in the "era of great expectations" which characterised the 1970s, when expansionary policies were adopted in order to stimulate domestic demand, while neglecting their adverse consequences for price stability. Society has paid a high price for this illusion in terms of stagnating economic growth combined with high and volatile inflation. The lesson which should be taken to heart is that expectations must be realistic and not overburden the monetary policy of the ESCB. Let me elaborate this point. First, the contribution that monetary policy can make towards balanced growth and employment is above all to provide for a stable price climate. However, it would be a tragic mistake to assume that the ESCB bears sole responsibility for establishing and maintaining price stability for the euro. Monetary policy needs to be supported by sound budgetary policies and wage developments in line with productivity growth. In other words, the overall policy mix must be appropriate. Without adequate support from other policy areas, the ESCB may be forced to take measures in the fight against inflation which entail a short-term loss in output and employment. This might have adverse consequences for the public's opinion of monetary policy. However, these short-term sacrifices are justified in order to safeguard the foundations for balanced growth and employment in the longer run. This also explains why it is so important that the Maastricht Treaty assigns a high degree of independence to the ESCB in carrying out its mandate. The credibility of its monetary policy is further supported by the budgetary provisions of the Treaty which oblige Member States to avoid excessive budget deficits. As clarified in the Stability and Growth Pact, excessive deficits are only allowed in clearly defined exceptional circumstances. In addition, the Stability and Growth Pact specifies a procedure for a rapid correction of excessive deficits in euro countries should they nevertheless arise. Second, one should realise that monetary policy in EMU applies to the euro area as a whole. As a consequence, it cannot be used for solving regional problems or country-specific economic shocks. These require above all well-functioning labour and product markets which allow wages and prices to adjust if local economic conditions have changed. In addition, national budgets must have sufficient room for manoeuvre to let automatic stabilisers work. As a further element of the Stability and Growth Pact, all Member States have therefore committed themselves to the achievement of a budgetary position close to balance or in surplus over the medium term. Under normal circumstances, this should allow budget deficits to fluctuate around zero, while at the same time respecting the 3% ceiling as specified in a protocol to the Treaty. Third, it is a well-known fact that the effects of monetary policy occur with long and variable lags. For this reason, it is impossible to use it for fine-tuning purposes. Monetary policy can only pursue price stability in the medium term. Once price stability is ensured, monetary policy may be used in such a way as to contribute to an automatic stabilisation of the business cycle, which means that this stabilisation does not require discretionary measures. Fourth, sustainable growth and a healthy creation of employment require more than just an appropriate monetary policy. This can be aptly illustrated by the current unemployment problem in Europe. As its underlying causes are structural, its solution requires structural remedies and not an expansionary monetary policy. As the experience of recent years shows, those Member States that have undertaken fundamental labour market reforms have achieved both a strong recovery of employment and stable prices. At the same time, they often successfully managed to reduce their budget deficits. Accordingly, if all policy areas contribute to creating the right conditions, price stability will over the longer term go hand in hand with a balanced economic development. The task is thus to ensure that in Stage Three of EMU an appropriate overall policy mix is achieved. For the monetary policy decisions of the ESCB to be well-informed and optimal with respect to its primary and secondary objectives, there is evidently a need for a regular dialogue and exchange of information on issues of common interest with third parties. This applies in particular to national economic policies, wage developments and the overall fiscal policy stance in the Monetary Union; under exceptional circumstances this could also include the exchange rate policy for the euro area. The question is how to organise such a constructive dialogue. The current situation in the Member States is that the Governor of the national central bank has a natural counterpart in the Minister of Finance, with whom frequent contacts exist, often on a weekly basis. In my previous capacity as Governor of the Nederlandsche Bank, I had, for example, regular lunch appointments with the Minister of Finance to discuss matters of common interest. In Stage Three of EMU the situation is more complicated, but the Treaty does contain some provisions in this regard (see Article 109b). On the one hand, the President of the ECOFIN Council (and also a member of the European Commission) may participate in the meetings of the Governing Council of the ECB and submit motions for deliberation, without the right to vote. On the other hand, the President of the ECB will be invited to take part in meetings of the ECOFIN Council when matters relating to the objectives and tasks of the ESCB are on the agenda. Finally, in addition to national delegations (including the independent national central banks), two representatives of the ECB will participate in the preparatory meetings of the Economic and Financial Council, the successor to the current Monetary Committee. It would thus seem to me that the Treaty contains sufficient institutional provisions for the co-ordination between economic and monetary policy in the euro area. Let me now come to a conclusion. First, I have argued that for the ESCB the concept of safeguarding monetary stability is to be interpreted as equivalent to the task of ensuring price stability. Given the large size of the euro area, the stability of the exchange rate of the euro area cannot be a direct policy focus but will have to be the outcome of the successful implementation of stability-oriented policies. Second, I have made clear that price stability is one of the pre-conditions for a flourishing market economy. Third, I have pointed out that for price stability in EMU to go hand in hand with sustainable growth and a healthy creation of employment, it is essential to have an appropriate overall policy mix. Fortunately, the Treaty contains sufficient institutional provisions to achieve a well-balanced combination of economic and monetary policy in EMU. I thank you for your attention./.
r971017a_ECB	euro area	1997-10-17T00:00:00	1999 - A new European monetary system	duisenberg	1	Stage Three of Monetary Union is little more than 14 months away. Preparations for this historic project are underway. As far as the EMI is concerned, the operational framework for the ESCB's monetary policy has been defined and specified; we have entered the stage of technical implementation. as regards economic convergence. The question thus arises of how to avoid that the euro produces divisions within the European Union, between those that are in the euro area and those that are outside, with potential foreign exchange turbulences that endanger the internal market. There are several ways to tackle this question. I would like, first, to remind that, except for the opt-out countries, the Treaty establishes a political commitment for all EU countries to join the euro area and to adopt policies consistent with this aim. This, by itself, will create a strong drive towards adopting sustainable economic policies that ensure stability and macroeconomic convergence. In this respect, the creation of the euro represents a catalyst, a force of attraction, that should foster stability also in the other EU countries. Another aspect to keep in mind is that the Treaty foresees a number of explicit mechanisms for monitoring and co-ordinating Member States' economic policies such as, for instance, the annual broad guidelines for economic policies and the multilateral surveillance process which are required for member countries, independently from whether they are in the euro area or not. Such co-ordination aims at promoting convergence of policies and economic developments, thereby contributing to exchange rate stability. In this respect, the Treaty provision that exchange rates need to be treated by the Member States as a matter of common interest aims at avoiding that exchange rate developments create distortions within the EU. To supplement these Treaty provisions, an exchange rate mechanism between the euro and the currencies of the other EU countries has been designed; it is ERM2. ERM2 has been designed in close co-operation between the European Council, the Council of Ministers and the EMI. The EMI has contributed to this process in particular through its detailed report annexed to the conclusions of the European Council of Dublin in December 1996. On the basis of this document, the European Council adopted a Resolution on the ERM2 at its meeting in Amsterdam in June 1997. In parallel, the EMI has completed the Central Bank Agreement dealing with the operational aspects, which will be submitted for signature to the ECB and the non-euro area national central banks in 1998. The EMI is currently setting up the required technical infrastructure to ensure that the arrangement will be fully operational from 1 January 1999. I would like to address with you today three main issues related to ERM2. , what are its objectives and principles? , which are the main features? , what can be expected from ERM2 in terms of contributing to monetary and exchange rate stability and thus creating a favourable business environment within Europe? Five main objectives and principles have guided the creation of ERM2. , as I already mentioned, Member States are required to treat their exchange rate policy as a matter of common interest. This is not only a Treaty requirement but a necessary condition with a view to avoiding that the single market is damaged by excessive exchange rate fluctuations. , exchange rate stability is an important element of economic convergence. As you are well aware, the Treaty's convergence criteria include the observance of the normal ERM fluctuation margins without severe tensions for at least two years. In particular, a Member State is not allowed to devalue its currency's bilateral central rate against any other Member State's currency on its own initiative. Member States joining the euro area, including those entering at a later stage, have all to fulfil this condition. , anchoring the exchange rate to a stable currency, as the euro will be, can be of help for non-euro Member States in their convergence efforts necessary to enter the euro area. It establishes a focal point for agents' expectations and may enhance the credibility of stability-oriented policies. exchange rate stability can be achieved only in the presence of continued convergence of economic fundamentals - in particular price stability - and sound fiscal and structural policies. Unless these conditions are met, there is no point - and it may even be counterproductive - to try to artificially stabilise exchange rates. ERM2 should ensure, as far as possible, continuity with the present exchange rate mechanism. At the same time, the arrangement must fully take account of the new economic and institutional environment in Stage Three. I would underline in this respect the ECB's and the non-euro area national central banks' statutory requirement to maintain price stability, which must be safeguarded. point that needs to be mentioned is that participation in ERM2 will, as in the present ERM, be voluntary. Nevertheless, the Dublin and Amsterdam European Council conclusions have stated that a Member State with a derogation can be expected to join the mechanism. The main operational features of ERM 2 may be summarised under four points. , for each participating non-euro area currency, a central rate vis-a-vis the euro will be defined. Unlike the present ERM, there will no longer be a "parity grid". The new so-called "hub-and-spokes" approach puts the euro at the centre of the system. Around the euro central rates, a standard fluctuation band of +/- 15% will be established. This rather wide band reflects the good experience with the operation of the current ERM. It avoids offering "one-way bets" in periods of speculative pressure. It also allows temporary deviations from the central rates to accommodate minor asymmetric economic disturbances. The recent experience in the ERM has shown that central rates exert a strong magnetic force for exchange rates, thus contributing to avoiding misalignments. In practice, exchange rate fluctuations have, for most currencies, proved to be even more limited than in the former 2.25% narrow band of the ERM. This effect has been reinforced after the decision taken at the Mondorf Informal ECOFIN in mid-September to announce bilateral conversion rates in May 1998. In summary, ERM2 is an asymmetric system, centred around the euro. There have been in the past many discussions concerning the asymmetric nature of the current exchange rate mechanism, and the desirability of this asymmetry. I think that there can be no doubt that ERM2 will have to be asymmetric, given the euro area's size and the stability-oriented policies that will be pursued in the euro area, in particular by the European System of Central Banks. feature is that central rates and the standard wide band will be set by mutual agreement between all parties. These parties are the euro-area Finance Ministers, the ECB, and the Finance Ministers and central bank Governors of the non-euro area Member States participating in ERM2. The European Commission will, as today, be involved in the procedure. All parties to the agreement, including the ECB, will have the right to initiate a procedure for reconsidering central rates. This will ensure that any adjustment of central rates will be conducted in a timely fashion. feature is that, as today, there will be automatic and unlimited foreign exchange intervention and financing when exchange rates reach the fluctuation margins. As a general principle, it is understood that intervention will have to be used to support - not replace - other policy measures, including appropriate fiscal and monetary policies. Furthermore, an explicit safeguard clause has been introduced, and this is new, by which both the ECB and the participating non-euro area NCBs are allowed to suspend intervention and financing if these were to impinge on their price stability objective. The central banks participating in the agreement will retain the possibility of co-ordinated intramarginal intervention, to be decided by mutual agreement in parallel with other appropriate policy responses. , there is the possibility to have closer links between non-euro area NCBs and the ECB. A non-euro area Member State that has reached an advanced degree of convergence with the euro area may request closer exchange rate co-operation. This may take various forms. It can entail participation in formal narrower bands, to be agreed upon in a procedure analogous to that for central rate decisions. Alternatively, informal arrangements can be made, for instance target ranges, which might not be made public. I believe that the new arrangement is equipped with the necessary devices to contribute to exchange rate stability in Europe. Naturally, these features and instruments will have be used in an appropriate way. The existence of a system in itself is not a guarantee for stability. The experience of the last few years is nevertheless encouraging. There is now a common understanding on the way economic policies should be conducted in the ERM framework, with a view to fostering sustainable exchange rate stability. I would like to be more specific in this respect and examine with you how, I think, ERM 2 can be expected to foster stability. I would distinguish four main aspects. , the ERM2 provides a framework to counter major competitive distortions within Europe. It will do so primarily by providing a policy co-operation mechanism through which monetary stability is fostered in countries not initially participating in the euro area. This forms an important pre-condition for stable exchange rates. On the other hand, ERM2 provides a way to initiate timely realignments of the central rates vis-a-vis the euro if prices and costs in the non-euro area countries still diverge with respect to the euro area. This ensures that major distortions do no longer build up, leading to misalignments. The experience of the so-called "hard ERM" between 1987 and 1992 by which nominal exchange rate stability was not accompanied in some cases with adequate convergence of prices and costs, is unlikely to be repeated. The brusque adjustment of exchange rates to compensate for the accumulated differences in inflation rates will be avoided as realignments will take place more promptly. Looking at ERM experience since the widening of the fluctuation bands, it is evident that the authorities have been quite successful in avoiding misalignments. Building on this positive track record, ERM2 seems to be fully equipped with all the necessary devices to avoid excessive exchange rate fluctuations within the Union. way in which ERM2 will contribute to a stable monetary environment within the EU is by limiting short-term exchange rate volatility. As I have already mentioned, the widening of the fluctuation bands has reduced the incentive for market participants to test the sustainability of the narrow margins. A two-way risk arises as exchange rates move away from central rates, thereby discouraging speculative attacks. The most recent experience is encouraging in this sense. In 1997, exchange rate volatility among ERM currencies has been the lowest since 1992. The ERM2's flexibility also allows for closer - formal or informal - exchange rate links, where this is appropriate in the light of economic convergence and the policy strategy pursued by the respective country. All in all, ERM2 can be expected to reduce short-term exchange rate uncertainty. This will be to the benefit of European exporters and importers. participation in ERM2 implies the commitment to stability-oriented fiscal and monetary policies. It also implies a commitment to structural reforms with a view to facilitating the longer-term adjustment of the economy and entry into the euro area. This commitment to sound economic policies is further enhanced by the reinforced monitoring of convergence policies which will accompany the establishment of ERM2. Let me elaborate a little on these procedures. From the start of Stage Three, all EU countries - both those participating and those not participating in the euro area - have to avoid excessive deficits. The Stability and Growth Pact will also apply to the non-euro area countries, except for a few provisions referring to sanctions. Equally, the reinforcement of the multilateral surveillance of budgetary positions and the co-ordination of economic policies fully involves both the euro area and the non-euro countries. Thus, all non-euro area countries have to submit convergence programmes. If a risk of slippage from the medium-term budgetary objective arises, an early-warning procedure is established. , by providing assistance and incentives for economic convergence, ERM2 is a way to support countries not initially participating in the euro area to join as soon as possible. Over time, the larger the euro area, the larger the area where the benefits of the single currency - such as the elimination of exchange transaction costs or the elimination of any residual exchange rate uncertainty - can be obtained. Overall, ERM2 is equipped with the necessary instruments to ensure exchange rate stability and to avoid that the move to the euro creates tensions and segregation in the European Union. I am fully aware that what I have been talking about until now may sound a bit theoretical. I do not want to shy away from the real question that you want to be tackled, which I believe is: How can it be avoided that a country not entering the euro area from the start is "left out in the cold", to use the expression of an academic, with the consequence of severe exchange rate tensions, depreciation, competitive distortions that are a detriment not only to the country itself but also to the economies of the euro area? I am fully aware that ERM2 provides only part of the answer. It represents a framework for monetary and foreign exchange policy co-operation; it does not ensure by itself that the right policies are in the end implemented, in particular in the countries outside the euro area. ERM2 is a necessary condition, it is not sufficient. But I believe that the creation of the euro will represent an additional impulse for further economic integration in Europe. In other words, I believe that the euro need not be a factor of division of Europe but rather will have the potential of becomig an instrument for accelerating its integration./.
r971022a_ECB	euro area	1997-10-22T00:00:00	The European System of Central Banks: a profile	duisenberg	1	Ladies and gentlemen, it is no exaggeration to state that the establishment of the European System of Central Banks - or ESCB - at the latest in about eight months' time, and of the euro fourteen months from now, ranks among the most significant developments in the international monetary system during the post-war period. My task today is to describe the profile of the new institution which will be in charge of managing the euro. It is not an easy task, you will concur, because this institution does not yet exist. It is being built. What I intend to do is to examine the main pillars on which the institution is being built. I will distinguish three main pillars: first, the ESCB blueprint as contained in the EC Treaty; second, the substance given to that blueprint by the EMI's preparatory work; and third, the continuity with the European central bank experience. The key elements of the blueprint for the ESCB were spelt out in 1989, when the so-called Committee for the Study of EMU - better known as the Delors Committee - submitted its report to the European Council meeting in Madrid. The sixteen members of this Committee comprised all twelve EU central bank Governors at that time, acting in their personal capacity. (Incidentally, both the previous as well as the current EMI President sat on that Committee.) The Committee advocated the establishment of an independent central banking authority to conduct the single monetary policy geared towards achieving price stability. Its key characteristics, including its federal structure, the role of the national central banks within that structure and the relationship between independence and accountability, are contained in one single paragraph (paragraph 32) of the Committee's 1989 report, the thrust of which has remained unchallenged ever since. The draft Statute of the ESCB and the ECB, which the Committee of Governors subsequently prepared, was by and large adopted at the Intergovernmental Conference. Its core elements are reflected in the Treaty: I would like to say a few words to clarify these three key features of the ESCB Statute. First, let me start with the primary objective of price stability. I do not need to justify the importance of this objective for monetary policy. It is now widely agreed - not only in the central banking community but also in the academic world and among financial market practitioners - that only a monetary policy geared towards price stability can create the conditions for sustainable economic growth. An important element that may be worth mentioning, nevertheless, is that for the ESCB the objective of price stability concerns the whole euro area. It is the price level of the whole euro area that the single monetary policy will aim at stabilising. There will not be, and there could not be, differentiated policies for each region or country in the euro area, depending on the inflationary conditions prevailing there. The second important feature of the ESCB Statute is its independence. Independence is established in four main areas: institutional independence, personal independence, functional independence and financial independence. To summarise, institutional independence protects the ESCB from interference by other bodies in the pursuit of its statutory objectives. Personal independence provides the members of the ESCB decision-making bodies with the necessary security of tenure and avoids conflicts of interest with a view to ensuring that they can be in a position to fulfil their duties. Functional independence aims at providing the ESCB with all the necessary instruments to perform its functions. Finally, financial independence is established with a view to ensuring that the ESCB can avail itself autonomously of the appropriate economic means to fulfil its mandate. In all these areas, it is recognised that the ESCB has been granted a high degree of independence, consistent with the desire of the political authorities that signed the Maastricht Treaty to put the ESCB in the best possible position to achieve its primary objective. The Treaty also requires that the Statutes of the national central banks are adapted to conform with that of the ESCB. This process is under way and the Statutes of the NCBs, even those that were recognised as being among the most independent, are being upgraded to satisfy the ESCB's requirements. The ESCB will also have clear reporting commitments. The Treaty describes all the requirements, in particular with respect to the European Parliament, the Council and the European Council. These define the context in which the ESCB will give an account of its own activities and performance with respect to the achievement of its primary objective. Beyond these very precise reporting procedures one should not overlook the fact that, ultimately, the ESCB will be accountable to the European citizens on its ability to defend the purchasing power of their money holdings. If the ESCB does not perform a good job with respect to its primary objective, it will be penalised by the citizens, as savers, who will reduce their holdings of money balances and ask for higher returns to compensate for the depreciation of their currency. The strength of the currency is the ultimate judgement of savers on the performance of the central bank. A final point that I would like to underline concerns the institutional relationship between the ESCB and the authorities in charge of economic policy in the Community. The Treaty has provided for a number of communication channels between what one could call the political (or budgetary) and the monetary arms of the single currency area, meaning the Council and the ECB. This is perfectly compatible with the requirement of an independent central bank and I see no reason why the ESCB should try to avoid contact with those responsible for the general economic policies in the Community, which the ESCB will support, without prejudice to its primary objective of maintaining price stability. As a matter of fact, it is very important that an exchange of information and views takes place between the ECB and the ECOFIN Council. There already exist formal and informal communication channels for both sides to explain to one another the policy actions for which they are responsible. Let me turn now to the technical side of the EMI's preparatory work in shaping the ESCB. In essence, this work revolves around two questions: With regard to the or, if you wish, the set of procedures according to which the ESCB will decide how to achieve its final objective of price stability, the decision will be taken once the ESCB has been established. The EMI Council has considered several possible candidate strategies and ultimately narrowed down the number of options to two, namely monetary targeting and direct inflation targeting. Any further narrowing down was considered neither necessary nor possible at this stage. The EMI is now preparing the common key building blocks of both strategies so that a final choice by the ECB Governing Council - which does not necessarily have to be an "either/or" choice - can be made fully operational in the latter part of 1998. Having at its disposal a monetary policy strategy fully capable of being implemented by the end of next year is a key element for the credibility of the ESCB. Communication with the general public will also be essential. It will involve the public announcement of a quantified definition of what the ESCB understands to be price stability; publication of specific targets and details of their derivation - against which its policy performance can be assessed; and the explanation of deviations from the target and concomitant policy responses by the ESCB. This will increase the transparency of the ESCB's actions and thereby enhance its accountability. The second aspect concerns the practical implementation of the single monetary policy. The EMI has devised a set of instruments and procedures and a supporting framework which can be used in a decentralised way by the national central banks, whenever possible and appropriate, so that they can act as the operational arms of the System. Reliance on the infrastructure and operational experience built up by the national central banks will prove a valuable asset. Given that the ESCB needs to be cognisant of differences between financial market participants and structures in the EU, operating through the national central banks will ensure that it has the best possible knowledge of market conditions throughout the euro area. It would not be useful for me to repeat here what has been described at length in various EMI publications on how the ESCB will conduct its business. You are certainly aware of the existence of the EMI's specification of the operational framework for the single monetary policy which was made public in January of this year. Following up on this work, the EMI last month published two documents which provide further details of how the decentralised operational framework will function in the areas of monetary policy and payment systems respectively. I am referring here to the General Documentation on ESCB monetary policy instruments and procedures and to the Second Progress Report on the TARGET Project. To summarise, it is envisaged that the ESCB will mainly use open market operations to manage the liquidity situation of the market and steer interest rates; it will also offer two standing facilities, so as to enable banks to borrow or deposit reserves at the end of the day. The two facilities will bound overnight market interest rates and the interest rates applied to them will help signal the general stance of monetary policy. In addition, preparations are being made for an infrastructure that will allow the ESCB to impose minimum reserve requirements if the Council were to decide accordingly. It may serve the purpose of stabilising money market interest rates, creating or enlarging a structural liquidity shortage in the money market and possibly contributing to the control of monetary expansion. What is crucial is that the system of monetary policy instruments will ensure that the Governing Council of the ECB is in a position to control the overall stance of monetary policy at all times, in conformity with the decision-making framework of the ESCB. Decisions will thus always be taken at the ECB, whereas implementation will, to the extent deemed possible and appropriate, be executed in a decentralised manner by NCBs. To give you an example of this allocation of responsibilities within the ESCB, let us consider the conduct of the main refinancing operations of the ESCB, which will provide the bulk of refinancing to the financial sector and which will be executed through standard tenders. The tender announcement will be made by the ECB, via public wire services, and supplemented by announcements by NCBs via national wire services and directly to individual counterparties. Submission of bids will be organised at the level of the NCBs. Tender allotment, involving the addition of all bids received, will be decided at the level of the ECB. The tender results will be announced by the ECB, and the NCBs will directly certify the individual allotment result to all counterparties that have submitted bids. Settlement will be effected in the books of the NCBs. These procedures make maximum use of the operational experience of the NCBs, they rely as much as possible on the existing infrastructure at the national level and they allow for the participation of a broad range of counterparties under conditions of equal treatment. In sum, these procedures will permit a solid operational involvement by the ESCB, as it continues to use elements of well-tested national practices in combination with harmonised elements conforming to decisions taken at the level of the ECB's decision-making bodies. The key question that is often put is: how will the ESCB take its decisions? How will it operate in the new environment in practice? It is often stated that the ESCB has no track record of its own and that it will have to establish its own credibility at the start. The impression is sometimes given that the ECB is created out of nothing. This is not correct. The creation of the ECB follows an evolutionary process that conditions not only its structure but also the way it will operate in practice. Concerning its structure, there is clear continuity with the past. This pertains to both the status of the NCBs and to the monetary policy instruments and procedures that will be used by the ESCB, as I have already explained. Concerning the way it will operate, there is no quantum jump here either. Let me just take as an example the recent official interest rate increases by a number of EU central banks. Given the lags with which monetary policy affects the price level, this move will produce its effect on the real economy after May of next year, when the list of initial participants in EMU is known and their bilateral conversion rates have been pre-announced. For this reason, it is essential that a high degree of monetary policy co-ordination is established so that the monetary policy conditions of the euro area in its initial phase are influenced by co-ordinated national central bank policies. The recent move is an example of such co-ordination. The same Governors who are conducting this co-ordinated monetary policy today will be members of the ECB Governing Council determining the single monetary policy in Stage Three. There is thus full continuity, although in a different institutional context, between the decision-making of today and that of the ESCB. This seems to be confirmed by the behaviour of financial markets. Judging from long-term interest rates, market participants seem to be convinced that inflation will remain low in the euro area. Moreover, convergence of long-term interest rates towards the lowest level rather than the average indicates that expectations are of a strong euro, built on the credibility of the ESCB's single monetary policy. Of course, such expectations are not only influenced by the prospect of a strong ESCB. There are other factors at work, such as: - the continuing reduction of budget deficits; - the prospective current account surplus of the euro area; and - the potential role of the euro as a reserve currency. In general, economic performance in the Community over the last few years has made very big strides towards convergence and this convergence has gone in the direction of the best possible performance, not the average. Inflation has been brought down to levels not seen since the 1960s; long-term interest rates have been converging to the German level, which itself is near the lower end of its observed historical range. Budget deficits have been declining at a slower pace, but, as the recent forecasts of the European Commission show, retrenchment is set to continue over the coming years, taking advantage of faster economic growth rates in Europe. The markets have fully understood these developments, which are reflected in European long-term yields. Once Monetary Union is there, budgetary policy will be subject to the rules of the Stability and Growth Pact with its accompanying Council Regulations on speeding up and clarifying the implementation of the excessive deficit procedure and on the strengthening of surveillance in the Community. Further enhancements to economic policy co-ordination in Stage Three may still be forthcoming. I will not dwell on these matters any further as they are evidently outside the EMI's sphere of competence. Nevertheless, it is important to note that the contribution that a monetary policy geared to price stability can make towards balanced growth and employment will be significantly boosted when underpinned by other conditioning fiscal and structural policies. This will, in turn, enhance the standing of the ESCB. In conclusion, the Treaty already provided the blueprint of a solid ESCB able to achieve independently its primary objective. The EMI's preparatory work is seeing to it that this ESCB, acting as a credible guardian of a stable euro, is in the making, in conjunction with the other elements of a stability-oriented policy framework, outside the realm of monetary policy. I am therefore confident that this newly created central banking system, which has an ECB equipped with all the necessary euro area-wide expertise and which builds on the credibility of equally strong NCBs for the execution of its policy, will be able to achieve its objective. I am also convinced that the ESCB will enjoy the area-wide public support for the benefits to be derived from a low-inflation environment and it will go to great length to continuously "earning" that support by being transparant. The single monetary policy will thus be seen as making a valuable contribution to the achievement of the objectives of the Community./.
r971110a_ECB	euro area	1997-11-10T00:00:00	Where do we stand in the EMU process?	duisenberg	1	In addressing you on the issue of where we are in the EMU process, I shall consider progress in respect of economic convergence, foreign exchange policy, the changeover to the euro and preparatory work for the single monetary policy in Stage Three. I shall conclude with observations on the conduct of monetary policy by the ESCB in Stage Three. . The EMI stresses the importance of countries achieving a high degree of sustainable convergence. One of the untercertainties in the selection of the Euro-area countries has recently been removed. The UK will not participate in EMU from the outset. On the one hand, I think it is unfortunate that such an important country as the United Kingdom will not be among the founding fathers of the euro. On the other hand, it is welcome that one of the main uncertainties surrounding the EMU-process no longer exists. It is also welcome that the UK-Government is in favour of EMU in principle. The UK debate on EMU very often focuses on psychological and political aspects such as the so-called transfer of sovereignty to the ESCB. Important as these issues may be, the statement of the Chancellor rightly makes clear that EMU needs also to be assessed on economic grounds. In this respect, it is essential that UK economic policies remain aimed at further convergence. I note with satisfaction that the Chancellor has stated that he will ensure that UK fiscal rules and the plan for deficit reduction continue to be consistent with the terms of the Stability pact and that he has underlined his commitment to avoid an excessive deficit. His intention to lower the inflation target, if international conditions permit, is important. It may foster convergence of UK-inflation on the lower inflation levels in many other EU countries. I would like to recall that the core of EMU is the irrevocable fixing of exchange rates. A single monetary policy, a single currency and a common Central Bank are impossible without it. Reflecting this, Article 109j of the Treaty requires exchange rate stability as an entry criterion for EMU; the related Protocol requires a country to respect the normal fluctuation margins of the ERM for at least two years without severe tensions and, particularly devaluations of bilateral central rates. For countries with a derogation, the Treaty emphasises that exchange rates are a matter of "common interest". As regards current performance in the EU in relation to convergence, progress has been made in respect of the downward convergence of inflation, which illustrates the determination of the national central banks across the entire Union to pursue price stability as the objective of monetary policy. In no less than fourteen countries, inflation, observed over a period of 12 months was below the reference value calculated according to the Treaty on the basis of harmonised figures recently published for July 1997. This was against the background of a historically low inflation rate for the Union as a whole of below 2%. There has also been considerable progress in bond yield convergence and - with some exceptions - exchange rate stability has, over the last couple of years, been broadly maintained throughout the EU. However, on the fiscal side, the sustainability of public finances in EU countries remains an issue. The latest official data show that in 1996 many EU countries were above the reference values for public deficits and debt ratios laid down in the convergence criteria. Reflecting this situation, the EMI's report entitled "Progress towards convergence 1996" concluded that "most countries had not yet achieved a situation which, in a broader view, might be judged as sustainable in the medium term". For 1997, the recent autumn forecasts from bodies such as the Commission and the IMF suggest that most countries are expected to meet the "headline" reference values for public finances in respect of public deficits, and to have a declining debt ratio although the projections are still to be confirmed by outcomes. To assess the soundness and durability of the correction of public finances which will be shown by the final data for 1997 available in early 1998, the EMI will, inter alia, take careful note of the potential impact of temporary or "one-off" measures adopted by various countries in order to comply with the convergence criteria on deficits and debt in 1997. Sustainability will be examined from both a backward and forward looking perspective. Our final view will be expressed in the Convergence Report to be produced under Article 109(j) and published (together with a similar report produced by the European Commission) in the spring of 1998. Convergence is not only required in macroeconomic terms, but also in legal terms. The achievement of central bank independence is an important precondition in order to qualify for participation in EMU. This obligation of legal convergence does not require the full harmonisation of central banks' statutes. It does, however, imply that national legislation and the statutes of central banks will need to be adjusted before the ESCB is established in order to eliminate incompatibilities with the Treaty in respect of features such as institutional, personal, functional and financial independence. The EMI has developed a list of the remaining incompatibilities which could serve as guidance for national legislators. Considerable progress has been made by Member States in adapting the statutes of their respective central banks in order to comply with the requirements arising from the Treaty and the Statute of the ESCB/ECB. The statutes of some central banks, require further adaptation, in particular with a view to their legal integration into the ESCB. An updated report on legal convergence has just been issued. Speaking here among industrialists, I need hardly stress the importance of exchange rate stability to trade and international investment. One of the main benefits of EMU is after all the elimination of exchange rate volatility, notably the risk of medium-term deviations of exchange rates from fundamentals which have often been observed historically - not least in this country. In discussing progress towards EMU, I should like to focus on two issues linked to foreign exchange policy which should be helpful in this regard. , I welcome the recent political decision by the ECOFIN meeting, on a recommendation by the EMI, to pre-announce the bilateral conversion rates applicable to the currencies of participants in Monetary Union at the time of their selection. This should reduce the risk of exchange rate instability in the so-called interim period prior to the irrevocable fixing of the euro exchange rates against the euro-area currencies which is set to take place on 1 January 1999. The so-called "pre pre-announcement" was well received by market participants and seen as a sign of commitment to the EMU process. It will in my view also have to be complemented by strengthened cooperation in the conduct of monetary policies. This is essential not only for a stable development in the interim period but also because monetary conditions at the beginning of Stage Three depend on the stance of monetary policy prior to its commencement. , given that not all Member States are likely to participate from the start of Stage Three, the exchange rate relationship between the euro area and the non-euro area EU countries will be of great importance. Following preparatory work by the EMI, the European Council adopted a resolution on the new mechanism (ERM II) in Amsterdam in June of this year, and a draft Central Bank Agreement to be signed by the Executive Board of the ECB and the NCBs concerned has been almost finalised. ERM II includes the following features: It will be based on central rates, defined vis-a-vis the euro for non-euro area currencies. A standard fluctuation band will be established for these currencies around their central rates. The margins of the standard fluctuation band will be relatively wide: +/-15%. Central rates and the standard wide band will be set by mutual agreement between the ECB, the Ministers of the euro area Member States and Ministers and Governors of the central banks of the non-euro area Member States. The ECB will have the right to initiate a realignment and the possibility of suspending intervention and financing if these were to threaten the pursuit of price stability. The ERM II allows for forms of closer exchange rate co-operation between non-euro area NCBs and the ECB agreed on a case-by-case basis. Following the agreement on the EMI's plan for the changeover to the euro at the 1995 Madrid summit, the ESCB will conduct its monetary policy operations in euro as of 1 January 1999 and Monetary Union Member States will issue all new debt in euro. Most Monetary Union Member States also envisage redenominating their outstanding debt in euro from the start of Stage Three. A broad timetable for the rest of the changeover has been finalised. The preparations for the changeover to the euro have gained considerable momentum over the past twelve months. National changeover scenarios have been defined in most EU countries. Meanwhile, the legal framework for the changeover process has been substantiated in two Council Regulations which will form the of the Community. Most importantly, the lex monetae will ensure the continuity of contracts denominated in euro or in the former national currencies, which will be treated as if they were in euro. One element still to be agreed is the common date of introduction of the euro banknotes and coins.In line with subsidiarity, the practical arrangements for the changeover will have to be made by the EU Member States. "Fine-tuning" at the Community level is deemed to be neither possible nor desirable. I note that a standing committee has been set up to co-ordinate preparations in the United Kingdom. As industrialists, you will certainly be aware of the need to prepare for the implications of the changeover to the euro. It is evident that in parallel with the public preparations, there has been an increasing amount of investment by the private sector in the adaptation of systems and procedures across the entire Union, notably by banks, other financial institutions and large non-financial companies. But we should not be complacent; in many area, there remains a great deal of work to be done. Banks are acting collectively. Recently, eight EU-wide banking associations and two International Central Securities Depositories (ICSDs) submitted a "joint statement on market conventions for the euro" to the EMI. Their statement - subsequently supported by several other banking associations - is a non-binding catalogue of market standards which are proposed by the signatory associations to issuers of financial instruments and other market participants for inclusion in new wholesale financial products after the start of EMU. The EMI has welcomed and supported the initiative. In discussions with the EMI, representatives of some EU-wide banking associations have also stressed that they would favour the ESCB participating in a neutral manner in the calculation of an overnight reference rate to be used in the context of derivatives contracts for the euro area. The EMI Council has agreed to assist in the calculation of this rate, although it will not take responsibility for its specification or publication. The EMI is responsible for preparing the framework that will enable the ESCB to perform its monetary policy tasks in Stage Three. Given the lead times involved, progress was essential at an early stage in the preparation of a set of monetary policy instruments and procedures - the operational framework of the ESCB, which will be necessary to control interest rates. Preparations are on track. As required by the Treaty, in January of this year the EMI published a report entitled "The single monetary policy in Stage Three: Specification of the operational framework". The report confirmed that the ESCB will mainly use open market operations, in most cases employing reverse transactions, but that it will also offer two standing facilities (a marginal lending facility and a deposit facility), and that a broad range of counterparties will have access to ESCB operations. Preparations have also been made for an infrastructure that will allow the ECB, if it so chooses, to impose minimum reserve requirements. The EMI has just published a further report on the subject of monetary policy instruments and procedures, the so-called "General documentation", which updates the operational framework, taking account of recent progress made in its specification. The main aim of this report is to provide financial institutions with the information they will need to prepare for participation in ESCB monetary policy operations in Stage Three. While the Treaty provides unambiguous guidance as to the ultimate objective of the ESCB, namely price stability, it does not specify the monetary strategy to be adopted. In this context, early decisions were less crucial, since the adoption of a strategy requires relatively less preparation and does not require action from others to implement it. Nevertheless, as a basis for the ECB Council's later decision, the EMI published an assessment of alternative monetary policy strategies in February of this year, entitled "The single monetary policy in Stage Three: Elements of the monetary policy strategy of the ESCB". It identified two potential strategies, namely monetary targeting and direct inflation targeting. Overall, it concluded that the similarities in the behaviour of those central banks that pursue these two strategies are greater than the differences; they all monitor a wide and similar set of economic and financial variables as indicators in determining the monetary policy stance. Preparation of the infrastructure needed to pursue either strategy has also advanced. For example, the estimation of econometric forecasting models is under way and research on a number of topics linked to the analysis and monitoring of the conjunctural situation in Stage Three is ongoing. Moreover, work has been under way for some time on the statistical infrastructure for EMU. In this respect, the EMI has recently issued a provisional list of Monetary Financial Institutions (MFIs) - primarily intended for use by reporting institutions and compilers of statistics -, in support of its aim to produce a homogeneous reporting population for the production of properly articulated money and banking statistics in Stage Three. A future Addendum will cover Money Market Funds. In order to ensure that a single interest rate obtains across the euro area, it is essential that payment systems be fully integrated. In early 1995 the EMI Council agreed to establish the TARGET system of linked real-time gross settlement (RTGS) systems; since then, besides specifying the system in two reports, we have focused on elaborating the organisational aspects of TARGET, the technical implementation of the system and the associated legal issues. The EMI has just published a further progress report, covering detailed issues such as the harmonisation of the operating time of domestic RTGS systems linked to TARGET and pricing policy, as well as providing further information regarding the provision of intraday liquidity to non-euro area NCBs. Technical preparations also include forging an agreement on the organisation of the ESCB itself and how it operates. The main issues outstanding as regards the degree of centralisation and decentralisation of operations within the ESCB have been resolved. However, one significant challenge in the coming months will be to determine the functions and the structure of the ECB. In this context, I consider it likely that around 500 staff members will be required initially. Further consideration is now being given to institutional issues, in particular the form which co-operation between the ECB and the NCBs will take. Finally, I should like to turn to a few more general considerations concerning the task of the ESCB in Stage Three. As you know, the core task of a central bank is to safeguard the purchasing power of money or, to put it differently, to create a zone of monetary stability. The concept of monetary stability comprises in any case the requirement that money has a stable value - that there is price stability. When foreign countries also adhere to price stability, this creates favourable conditions for the currency to have a stable value of the currency, in other words, exchange rate stability. A growing number of central banks throughout the world have been given the legal mandate to ensure price stability. As I have already observed, such a mandate also applies in the case of the European System of Central Banks (ESCB). Following a definition which has been advocated by my colleagues Paul Volcker and Alan Greenspan, . A rate of consumer price inflation not exceeding 2% is probably consistent with this definition. Some European central banks have indeed set themselves quantitative monetary or inflation targets that reflect this benchmark for price stability. How does exchange rate stability fit in? For several EU countries it has proved highly beneficial in past decades to aim for a stable external value of the currency against the strongest and most credible EU currencies as the key to achieving price stability. In contrast, some central banks of other, usually larger, EU countries have preferred to focus their monetary policy directly on the achievement of price stability and thereby also to lay the foundations for a stable exchange rate. While this has allowed them to set official interest rates in line with domestic price requirements, these were nonetheless influenced by the interaction between exchange rate developments and inflation. As experience has shown, the success of either form of monetary policy orientation depends crucially on the support of economic policies directed at sound public finances, responsible wage behaviour and efficient markets. In Stage Three of EMU, the ESCB will carry out its mandate of ensuring price stability in a somewhat different economic environment, comparable to the situation of the Federal Reserve in the United States. The euro area will be a large internal market with strong trade relations among its partners stimulated by the existence of a single currency. As a natural consequence, trade flows with the rest of the world will be relatively small. This will allow the ESCB to focus primarily on "domestic" inflationary risks and to consider fluctuations in the euro exchange rate only to the extent that these significantly affect "domestic" prices. This also explains why any so-called orientations that might be formulated by the ECOFIN Council in the field of exchange rate policy for the euro area will have to be limited to exceptional circumstances. As stated in the Treaty, such general orientations shall be without prejudice to the primary objective of the ESCB to maintain price stability. Some would argue that focusing on price stability as the primary goal of monetary policy means that the ESCB will no longer be concerned about output and employment growth. I believe this view to be wrong. Rather, stable prices are a condition for sound growth and the sustainable creation of employment. A stable price and financial environment also enhances the capacity of monetary policy to react appropriately to cyclical weakness in the economy. A central bank's long-term commitment to price stability does not mean that monetary policy will ignore the short-term impact of economic events and developments in the business cycle. When price stability is established and the credibility of the central bank in respect of its efforts to safeguard that goal is not in doubt, monetary policy can effectively play a role in stabilising the business cycle, if price pressures are least at the low point in the business cycle. To conclude, the main challenge still remaining in the EMU process is to ensure that the countries entering Stage Three of EMU are fully qualified to do so. Progress towards price and exchange rate stability as well as bond yield convergence is promising but fiscal consolidation remains a key issue; the analyses of the EMI and the Commission of the degree of convergence due early next year, will show the extent to which countries' undoubted efforts are considered to have resulted in sustainable positions. Meanwhile, foreign exchange policies vis-a-vis countries not initially participating in the euro area have been agreed in ERM II and the recent decision to pre-announce bilateral conversion rates should help to avoid instability in the interim period. Banking associations have put forward catalogues of market standards, while individual institutions are undertaking their own technical preparations. The overall preparations for the operating framework for monetary policy in Stage Three are well on track, as is the accompanying infrastructure. The monetary strategy options have been set out in detail for decision by the Governing Council of the ECB, and the accompanying infrastructure will be prepared so that we may start mimicking the procedures for the preparation of day-to-day policymaking during the second half of 1998. On balance, provided the choice of the Member States adopting the euro is credible, the institutional arrangements for the ESCB and the preparations that have been made to date will ensure that the euro will be a stable currency and that the ESCB will be a strong institution, safeguarding the value of the new currency./.
r971114a_ECB	euro area	1997-11-14T00:00:00	Conditions for the success of EMU	duisenberg	1	I would like to address the issue of the conditions necessary for EMU to be a success. I should like to focus on three topics: first, the technical and institutional requirements related to the establishment of the ESCB and the single monetary policy; second, the need for sustainable convergence among the countries which will form the euro area and, finally, the need for a balanced policy mix between monetary and other economic policies in Stage Three of Monetary Union. The first topic - the technical and institutional requirements - will also enable me to give you a brief outline of what we are doing at the EMI. The EMI is responsible for preparing the operational framework that will enable the ESCB to conduct the single monetary policy in Stage Three of EMU. In this context, we are nearing the conclusion of several years of tough but ultimately successful preparatory work. I should like to summarise very briefly the achievements in some of the most important fields of this work. With regard to the monetary strategy to be adopted by the ESCB, the EMI has retained two potential strategies as candidates for approval, namely monetary targeting and direct inflation targeting, both of which are used by the national central banks. At this stage, it appears neither desirable nor necessary to choose between them. The final decision on which strategy to adopt will be the responsibility of the ECB. By contrast, the framework for the instruments and procedures of monetary policy - which will be used to guide short-term interest rates - has already been broadly defined. The ESCB will mainly use open market operations, in most cases employing reverse transactions, but it will also offer two standing facilities: a marginal lending facility and a deposit facility. The interest rates on these facilities will set the upper and lower limits for short-term money market interest rates. A broad range of counterparties will have access to the ESCB operations, and it has been agreed that the bulk of monetary policy operations will be carried out, in a decentralised manner, by the national central banks. Preparations have also been made for an infrastructure that will allow the ECB to impose minimum reserve requirements, if it so chooses. Our recent report entitled "The single monetary policy in Stage Three, General documentation on ESCB monetary policy instruments and procedures", which was released in September of this year, updates the operational framework, taking account of the most recent progress made in its specification. The main aim of this report is to provide financial institutions with the information they will need to prepare for participation in ESCB monetary policy operations in Stage Three. To ensure that a single money market interest rate holds across the euro area, the integration of payment systems is an essential element of the technical preparations for Stage Three. The EMI and the NCBs are developing an interbank funds transfer system, called TARGET, which will be able to process cross-border payments denominated in euro as smoothly as if they were domestic payments. It will interlink the domestic real-time gross settlement (RTGS) systems which the NCBs have agreed to implement in their respective countries. Furthermore, this year the EMI Council endorsed the decision to choose S.W.I.F.T. as the Interlinking network provider and a contract was finalised. The testing of NCBs' links with the EMI's test centre has begun. The EMI has just published a further progress report, covering detailed issues such as the harmonisation of the operating time of domestic RTGS systems linked to TARGET and pricing policy. In the field of foreign exchange policy, the ESCB will have the capacity to conduct foreign exchange intervention by means of transactions in foreign reserves valued at up to EUR 50 billion, which will be transferred from the NCBs to the ECB. All decisions related to intervention will be taken by the ECB, while the implementation of such decisions will be either centralised or decentralised within the ESCB. Furthermore, following preparatory work by the EMI, the European Council adopted a resolution on the new exchange rate relationship between the euro area and the non-euro area EU countries - the so-called ERM II - in Amsterdam in June of this year. The recent political decision by the ECOFIN Council, to pre-announce the bilateral exchange rates which will be used for determining the euro conversion rates of the currencies of the participants in Monetary Union at the time of their selection, was well received by market participants, as it was seen as a strong sign of commitment to the EMU process. The pre-announcement is expected to reduce the risk of exchange rate instability in the so-called interim period prior to the irrevocable fixing of the euro exchange rates against the euro area currencies on 1 January 1999. In the interim period the co-operation in the conduct of monetary policies has to be intensified further. It is too early to tell what the common short term interest rate of the euro-area members at the end of 1998 will be. What is clear, however, is that there is a widespread misconception that this rate has to be an average of the actual short term rates in some group of EU-countries. The only thing that can be said now is that the rate should be at the level required for the maintenance of price stability in the euro area. Following the agreement at the December 1995 Madrid summit on the EMI's plan for the changeover to the euro, the authorities pre-announced a chronological sequence of events, which was formulated on the basis of a small number of critical benchmark dates. The preparations for the changeover to the euro have gained momentum over the past twelve months. National changeover scenarios have been defined in most EU countries. Meanwhile the legal framework for the changeover process has been substantiated in two Council Regulations which will form the of the Community. One element still to be agreed is the common date for the introduction of the euro banknotes and coins. In line with subsidiarity, the practical arrangements for the changeover will have to be made by the EU Member States. In parallel, there has been an increasing amount of investment by the private sector in the adaption of systems and procedures across the entire European Union. Finally, I would just like to mention that the EMI and the NCBs have started to reflect on the functions of the ECB, as well as the nature of relationships between the ECB and the national central banks within the ESCB. A great deal of thought has been given to these issues within the EMI, and the EMI Council has given serious consideration to staffing requirements. I consider it likely that around 500 staff members will be required; the EMI currently employs around 350 members of staff. Besides bringing the preparatory work to a successful conclusion, it is of utmost importance for the success of Monetary Union that a high degree of sustainable convergence be obtained with regard to price stability, sound fiscal positions, exchange rate stability and the convergence of long-term interest rates for those countries which participate in Monetary Union. These criteria are intended to "level the playing-field" in order to ensure a smooth start for the single monetary policy. Moreover, the fiscal criteria will continue to apply in the monetary union. The provisions of the Stability and Growth Pact will contribute towards making Monetary Union sustainable in the longer term. The dangers of there being a lack of convergence at the start of EMU are obvious. In particular, if national fiscal positions are not under control from the outset, there may be repercussions on the single monetary policy and adverse spillover effects across borders affecting Monetary Union as a whole. Similarly, significant inflation differences across countries might lead to unsustainable divergences in prices and costs within the euro area or to an unnecessarily tight monetary policy for countries that have achieved price stability. Under the Maastricht Treaty, the EMI and the Commission have been given the task of examining the progress towards convergence and of assisting the European Council in establishing which EU countries fulfil their obligations in respect of the achievement of the convergence criteria. The results of these examinations will be presented in the spring of 1998. Current performances indicate that a significant downward convergence towards price stability has taken place in recent years. This reflects the determination of the national central banks across the entire European Union to pursue price stability as the primary objective of monetary policy. In no less than fourteen countries, inflation observed over the past twelve months was below the reference value calculated according to the Treaty. The inflation rate for the EU as a whole is currently below 2%. There has also been considerable progress in bond yield convergence, and - with some exceptions - exchange rate stability has been broadly maintained throughout the EU over the past couple of years. On the fiscal side, despite significant progress over the past few years, the sustainability of public finances in EU countries remains an issue. The latest official data show that in 1996 many EU countries had exceeded the reference values for public deficits and debt ratios laid down in theTreaty. For 1997, forecasts from the European Commission and the IMF suggest that most countries are expected to meet the reference values for public deficits, although the projections have yet to be confirmed by outcomes. When assessing the soundness and durability of the correction of public finances in early 1998 on the basis of the 1997 figures, the EMI will, inter alia, take careful note of the potential impact of temporary or "one-off" measures. If the impact of temporary effects on the budget deficit figures proves to be significant, this will signal the necessity to implement in 1998 additional measures with permanent effects in order to guarantee the sustainability of public finances. It is, however, rather difficult to distinguish permanent influences on the budgetary position, even when one-off or temporary measures are excluded, which renders the assessment of sustainability more difficult. In analysing the issue of sustainability the EMI will follow both a backward and forward looking approach. Our final view will be expressed in the Convergence Report which will be published in the spring of 1998. Convergence is required not only in macroeconomic terms, but also in legal terms. The achievement of central bank independence is an important precondition in order to qualify for participation in EMU. Considerable progress has been made by Member States in adapting the statutes of their respective central banks in order to comply with the requirements arising from the Treaty and the Statute of the ESCB/ECB. The statutes of some central banks require further adaptation, in particular with a view to their integration into the ESCB. Where this is the case, legislative action is under way. The ECB will be established shortly after the decision is made on the list of countries that will participate in EMU. On 1 January 1999 the ESCB will start conducting the single monetary policy with a view to maintaining price stability in the euro area. The pursuit of this objective, in full independence, will serve to safeguard the foundations for balanced growth and employment in the longer run. It would, however, be incorrect to say that the ESCB will have the sole responsibility for maintaining price stability in the euro area. Monetary policy needs to be supported by other economic policies; in particular, fiscal policies need to be sound and wage developments need to be in line with productivity growth. Without adequate support from other policy areas, the ESCB may be forced to take measures to dampen inflationary pressures, which may entail a short-term loss in output and employment. This might have negative consequences for public acceptance of the single monetary policy. It has been argued that it will be more difficult in Monetary Union to cope with real asymmetric shocks, such as German unification. I do not, however, believe that shocks of the nature and magnitude of German unification are likely to be repeated in the future. Moreover, the past ten to fifteen years have witnessed a considerable convergence of the economic and social structures of the EU countries. Accordingly, our national problems - those relating to unemployment, social security and pension systems - have also become quite similar, and their solution will therefore require a similar approach. Furthermore, most of the real shocks in the past created problems not so much because they were asymmetric, but because the policy responses were different. The oil shocks in the 1970s serve as good examples. Our policy philosophies - both in monetary and fiscal terms - have undergone a thorough and welcome convergence process since then. However, one cannot exclude entirely the possibility that it will be necessary to accommodate asymmetric shocks hitting individual countries participating in Monetary Union. Sustainability in fiscal positions would give enough room to cope with asymmetric shocks and adverse cyclical developments by letting the automatic stabilizers work. This provides a supplementary incentive for sound fiscal positions and is an element of the Stability and Growth pact. Europe does not need a centralised budget to cope with asymmetric shocks. This is taken care of at the national level. Turning to structural issues affecting fiscal sustainability, it is also important that governments should implement measures for coping with new budgetary challenges, such as ageing populations, where governments face massive future liabilities of social security systems. In the absence of appropriate reforms, sizable increases in contributions or even substantial increases in government indebtedness would appear to be forthcoming which may also be a threat to maintaining price stability. There are also a number of other significant challenges in the economic environment; notably, there is a clear and insistent need for structural adjustment, in particular in labour and product markets. Unemployment in most EU countries, though showing signs of stabilising, remains unacceptably high, and the forecast for the situation in labour markets is not one of significant improvement in the absence of structural reforms. The weak employment performance in Europe seems to a large extent to be due to a wide range of institutional rigidities, and how to tackle them decisively enough to reduce unemployment will be a major challenge. Removing these rigidities is also important to make EMU a success, since flexible wages and prices are necessary adjustment mechanisms in a monetary union. Therefore, in this area what is required for solving the unemployment problem is also necessary for making monetary union work. The task is thus to ensure that in Stage Three of EMU an appropriate overall policy mix is achieved. For the monetary policy decisions of the ESCB to be well-informed and optimal with respect to its objectives, there is evidently a need for regular dialogue and an exchange of information with third parties on issues of common interest. This will apply in particular to national economic policies, wage developments and the overall fiscal policy stance in the Monetary Union. If all policy areas contribute to creating the right conditions, price stability will, over the longer term, be consistent with balanced economic development. To conclude, a high degree of sustainable convergence and a balanced policy mix are necessary conditions for EMU to be a success. EU Member States have made considerable progress in terms of economic convergence, although challenges remain in terms of structural reforms, notably in the area of fiscal policy and labour markets. Considerable progress has also been made by the EMI in terms of the necessary technical preparations for the single currency to be introduced, on schedule on 1 January 1999. The greatest challenge that lies ahead is to maintain price stability within the euro area after the start of Stage Three, in fulfilment of the mandate given to the ESCB under the Maastricht Treaty. Personally, I am convinced that the application of the convergence criteria, the institutional arrangements for the ESCB and the preparations made to date will ensure that the euro will be a stable currency and that the ESCB will be a powerful institution which will safeguard the value of the new currency./.
r971115a_ECB	euro area	1997-11-15T00:00:00	Monetary policy in EMU	duisenberg	1	It is a great pleasure to be here to speak to you about monetary policy in Stage Three. Whereas the Maastricht Treaty assigns an unambiguous primary objective to the ESCB, which is "to maintain price stability", the strategy to pursue this objective was not laid down, and hence a choice needs to be made. In fact, the monetary policy strategy for the euro area will only be chosen after the establishment of the ESCB, shortly after the initial composition of the Monetary Union is decided in May 1998. Nevertheless, the EMI has an important role to play in preparing the decision on a appropriate strategy for the ESCB. In my remarks, I shall first discuss the importance of price stability before going on to examine the two possible monetary policy strategies in Stage Three. The importance of price stability to the successful long-term performance of the economy is now widely recognised. Indeed, there seems to be a world-wide convergence of thinking among central bankers and politicians alike on the importance of price stability as the primary goal of monetary policy. Empirical research has shown that both the average rate of inflation and its variability tend to decline in line with increased central bank independence. Accordingly, a growing number of central banks have been given a legal mandate to ensure price stability in recent years. Ensuring price stability must be viewed in a long-term context as a permanent goal and not as a short-term one-off objective. Companies and households are concerned about the long-term effects of inflation and price developments on decisions related to investment and saving. Alan Greenspan, the chairman of the US Federal Reserve, has said that price stability is achieved when the public no longer takes account of actual or prospective inflation in its decision-making. To achieve that goal means that monetary policy must be oriented beyond the horizon of its short-term impact on inflation and the economy. The purpose of monetary policy actions is to set the economy on a long-term, permanent path to price stability and thereby to create the conditions for sound economic growth. Price stability is a means of promoting sustainable economic growth, employment creation and of improving productivity levels and living standards. Conversely, a rising price level - even at moderate rates - imposes substantial economic costs, such as those arising from increased uncertainty about the outcome of investment decisions and profitability, the distortionary effects on the tax system, rising risk premia in long-term interest rates and the reduced allocative effectiveness of the price and market systems. In addition, social costs arise because the weaker members of society have more difficulty in protecting themselves against the adverse effects of inflation. The Maastricht Treaty guarantees the independence of the European System of Central Banks (ESCB), which is made up of the European Central Bank and the national central banks of the EU. It assigns an unambiguous primary objective to the ESCB, namely "to maintain price stability". Some would argue that focusing on price stability as the primary goal of monetary policy means that the ECB will be no longer concerned about output and employment growth. I believe this view to be wrong. First, the most important contribution that monetary policy can make towards balanced growth and employment is to provide for a stable price environment. It would be misleading to assume that the ESCB bears sole responsibility for establishing and maintaining price stability for the euro. Monetary policy needs to be supported by sound budgetary policies and wage developments in line with productivity growth. In other words, the overall policy mix must be appropriate. Without adequate support from other policy areas, the ESCB may be forced to take measures in the fight against inflation which entail a short-term loss in output and employment. This explains why it is so important that the Maastricht Treaty assigns a high degree of independence to the ESCB in carrying out its mandate. The credibility of its monetary policy is further supported by the budgetary provisions of the Treaty which oblige Member States to avoid excessive budget deficits. The Stability and Growth Pact clearly defines the exceptional circumstances under which excessive deficits are allowed and provides for a procedure which will ensure that excessive deficits are swiftly corrected should they nevertheless arise. Second, one should realise that monetary policy in EMU applies to the euro area as a whole. As a consequence, it cannot be used for solving regional problems or country-specific economic shocks. These require above all well-functioning labour and product markets which allow wages and prices to adjust if local economic conditions have changed. In addition, national budgets must have sufficient room for manoeuvre to let automatic stabilisers work. As a key element of the Stability and Growth Pact, all Member States have therefore committed themselves to the achievement of a budgetary position close to balance or in surplus over the medium term Third, sustainable growth and creation of employment require more than just an appropriate monetary policy. This can be illustrated by the current unemployment problem in Europe. As its underlying causes are structural, its solution requires structural remedies and not an expansionary monetary policy. As the experience of recent years shows, those Member States that have undertaken fundamental labour market reforms have achieved both a strong recovery of employment and stable prices. At the same time, they often successfully managed to reduce their budget deficits. The general lesson to be learnt is that if all policy areas contribute to creating the right conditions, price stability will over the longer term go hand in hand with a balanced economic development. To summarise, it is essential to ensure that in Stage Three of EMU an appropriate overall policy mix is achieved. A stable price and financial environment enhances the capacity of monetary policy to react appropriately to cyclical weakness in the economy. A central bank's long-term commitment to price stability does not mean that monetary policy will ignore the short-term impact of economic events and developments in the business cycle. When price stability is established and the credibility of the central bank in respect of its efforts to safeguard that goal is not in doubt, monetary policy can play a role in stabilising the business cycle, provided this is not at the cost of price stability and provided so-called fine-tuning is avoided. Given lead times, the framework for monetary policy implementation, the instruments and procedures needed to be prepared well in advance of EMU. The EMI has also an important role to play in preparing for the decision on a strategy for the ESCB. On the basis of current central bank practices and taking into account theoretical considerations, two possible strategies have been considered by the EMI for Stage Three: monetary targeting and direct inflation targeting. The application of these two strategies in different countries has shown that several variants combining elements of both strategies exist, with the borderlines between them being sometimes blurred. In its extreme theoretical variant, monetary targeting would involve the central bank choosing a monetary aggregate as its intermediate target and deciding on its monetary policy actions on the sole basis of comparisons between the target and actual monetary developments. In practice, a central bank following monetary targeting adopts a more flexible approach which involves, in addition to the pursuit of the target, the monitoring of supplementary variables, including indicators of future inflation. It is notable that several central banks pursuing monetary targets also set quantitative medium-term norms for the final objective, price stability, in order to increase the transparency of their policy. Inflation targeting strategies, in contrast, aim to steer the final target variable, the inflation rate, directly without having recourse to the use of a separate intermediate target variable. Since monetary policy affects the final objective only with a lag, monetary policy actions under direct inflation targeting strategies are based on a comparison between the target for inflation and the forecast inflation rate. In several countries pursuing inflation targeting, monetary aggregates play a prominent role among the various inflation indicators that are employed, including the setting of quantitative "monitoring ranges" as reference values for these variables. This brief description already indicates that, in practice, differences between monetary and inflation targeting strategies are not overwhelming. In fact, both strategies typically have the following key features in common: they are based on the same final objective, price stability, they are forward-looking (i.e. they are not based on current inflation developments) and they employ a wide range of indicators to assess the appropriateness of the stance of monetary policy. The main factor distinguishing the two strategies is the role played by monetary aggregates. While monetary aggregates are taken into account under inflation targeting strategies, more emphasis is clearly placed on monetary developments in a strategy which publicly sets targets for monetary growth. This central role of monetary aggregates is based on the assumption that excessive money growth will generate inflation and that the chosen monetary aggregate satisfies properties which makes it a suitable intermediate target variable for monetary policy. The assessment of alternative monetary policy strategies for the ESCB should be guided by a certain number of principles, including effectiveness, accountability, medium-term orientation and continuity. Let me say a few words on these guiding principles. The effectiveness of monetary targeting depends very much on whether a stable (or at least predictable) relationship exists between the chosen monetary aggregate and the final price objective. It also depends on whether monetary aggregates possess desirable leading indicator properties for future inflation. Recent empirical studies carried out for different groups of EU countries show that area-wide money demand functions appear relatively stable and some monetary aggregates have leading indicator properties for inflationary developments. On the other hand, these studies may not be representative of the situation in Stage Three. The possibility of damage to the credibility of the ESCB under a monetary targeting strategy could not be excluded if monetary aggregates were highly volatile at the start of Stage Three. Direct inflation targeting provides a quantitative reference for future inflation which is aimed specifically at anchoring inflation expectations. Its effectiveness, however, depends on the ability of the central bank to forecast accurately and to control future inflation. With regard to accountability, any strategy will need to involve the formulation and announcement of targets so that the ESCB can be held accountable to the public for its actions. Targeting inflation directly would stress the ESCB's responsibility of maintaining price stability, although it should be noted that inflation is affected by numerous factors outside the control of the central bank. On the other hand, a monetary targeting strategy makes the central bank responsible for developments which are directly observable by the public and which are more directly under the control of the central bank. Both strategies can be seen as oriented towards the medium-term, thereby providing an anchor for inflation expectations. In this respect, both strategies provide some scope for allowing short-term deviations from the target, if these can be explained to the public. Finally, the adoption of monetary targeting would offer the advantage of ensuring continuity with the strategy of the EU central bank whose currency has performed the anchor function in the ERM. On the other hand, it might be argued that the experience of EU central banks with direct inflation targets so far has also been relatively successful. Under any monetary strategy, the ESCB will also have to define what "price stability" means. While theory does not provide a precise definition of price stability and while there are various statistical measures of inflation, one could say that a rate of consumer price inflation not exceeding 2% is probably not far off what central banks would normally be quite satisfied with. At this point, let me briefly mention the issue of the external value of the euro. The average degree of openness of the Member States of the EU (as measured by the share of exports in GDP) is currently 30%, compared with 8% for the United States and 9% for Japan. If intra-EU trade is excluded, the degree of openness of the European Community is 10%, similar to that of the United States and Japan. Its economic and commercial weight is comparable to that of the United States and larger than that of Japan. In other words, we are dealing with a large but relatively closed economy. With a low import and export ratio, the effect of exchange rate movements on internal price developments and competitiveness will be limited. This will allow the ESCB to focus primarily on "domestic" inflationary risks and to consider fluctuations in the euro exchange rate only to the extent that these significantly affect "domestic" prices. This also explains why any so-called orientations that might be formulated by the ECOFIN Council in the field of exchange rate policy for the euro area will have to be limited to exceptional circumstances. As stated in the Treaty, such general orientations shall be without prejudice to the primary objective of the ESCB to maintain price stability. This does not mean that the euro area should adopt an attitude of "benign neglect" with regard to the external value of the euro. First, exchange rate developments will continue to be monitored informally by the major global players, as is currently the case although in the context of new institutional arrangements to be devised. The introduction of the euro may indeed strengthen policy co-ordination between the US, Japan and Europe and contribute to the promotion of exchange rate stability since these three blocs are each pursuing policies aimed at internal stability. Of course, there may still be residual fluctuations in exchange rates owing to differences in cyclical positions and associated policy responses. Second, in terms of the exchange rate, the relationship between the euro area and the non-euro area EU countries will be of considerable significance. Following preparatory work by the EMI, the European Council adopted a resolution on the new mechanism (ERM II) this year. ERM II will ensure that trade and financial flows between the euro area and the non-euro area EU countries will not be distorted by large swings in exchange rates. It will also help those countries not joining EMU at the beginning of Stage Three to orient their policies towards convergence, so that they may qualify for participation as soon as possible after the start of Stage Three. To summarise, the internal value of the euro - price stability - will be the objective of the ESCB and when other countries also adhere to this objective, this will create favourable conditions for a stable external value of the euro. Before leaving the issue of monetary policy, I may add that preparation of the framework for monetary policy implementation, the instruments and procedures in EMU has advanced. The EMI has published in September a further report on monetary policy instruments and procedures, the so-called "General Documentation". That report updates the "Framework Report" and takes into account the progress made in the specification of the ESCB's monetary policy instruments and procedures in the meantime. The main aim of this report is to provide financial institutions with the information they will need in order to prepare for participation in monetary policy operations with the ESCB. Moreover, the EMI has started preparing tools for forecasting, such as a "Multi-country econometric model", that will be made available to the ESCB. Furthermore, preparation of a number of tools for the analysis and monitoring of the conjunctural situation in Stage Three is ongoing. The continuing challenge for central banks is to ensure long-term credibility for monetary policy by sustaining an environment of low inflation. Maintaining price stability will be the ESCB's primary responsibility. With regard to monetary strategy, monetary and inflation targeting are seen as the two main benchmarks on the basis of which the choice of the ESCB's strategy in Stage Three will be made. Both strategies have a number of key elements in common, such as the objective of price stability, a forward-looking nature and the employment of a wide range of indicators in the determination of the monetary policy stance. In the selection of its strategy, the ESCB will be confronted with a situation in which there will be remaining structural differences across participating countries as well as cross-country differences in economic policies. Furthermore, the transition to Stage Three will increase uncertainty about the monetary policy transmission process. In that respect, a thorough analysis of all relevant factors will be requested under all circumstances as well as a careful explanation of the ESCB's monetary policy action in the context of its monetary strategy. That will also help to cope with a new and changing environment at the start of Stage Three./.
r971120a_ECB	euro area	1997-11-20T00:00:00	Monetary policy in EMU	vienna	0	It is a great pleasure to be here to speak to you about monetary policy in Stage Three. Although the Maastricht Treaty assigns the European System of Central Banks, which will be composed of the European Central Bank and the national central banks of the EU, the unambiguous primary objective "to maintain price stability", the strategy for pursuing this objective is not laid down in the Treaty, and hence needs to be defined. In fact, the monetary policy strategy for the euro area will only be chosen after the establishment of the ESCB, shortly after the initial composition of Monetary Union is decided in May 1998. Nevertheless, the EMI has an important role to play in preparing the decision on an appropriate strategy for the ESCB. In my remarks, I shall first discuss the importance of price stability before going on to examine the two possible monetary policy strategies for Stage Three. The importance of price stability for the successful long-term performance of the economy is now widely recognised. Indeed, there seems to be a world-wide convergence of thinking among central bankers and politicians alike on the importance of price stability as the primary goal of monetary policy. Moreover, empirical research has shown that both the average rate of inflation and its variability tend to decline in line with increased central bank independence. Accordingly, a growing number of central banks have been given a legal mandate in recent years to ensure price stability. The aim of ensuring price stability must be viewed in a long-term context as a permanent goal and not as a short-term one-off objective. Enterprises and households are concerned about the long-term effects of inflation and price developments on decisions related to investment and saving. Alan Greenspan, the Chairman of the Board of Governors of the US Federal Reserve, has said that price stability is achieved when the public no longer takes account of actual or prospective inflation in its decision-making. To achieve this goal, monetary policy must be oriented beyond the horizon of its short-term impact on inflation and the economy. The purpose of monetary policy actions is to set the economy on a long-term, permanent path towards price stability and, in so doing, to create the conditions necessary for sound economic growth. Price stability is a means of promoting sustainable economic growth and job creation, and improving both productivity levels and living standards. Conversely, a rising price level - even at moderate rates of inflation - imposes substantial economic costs, such as those arising from increased uncertainty about the outcome of investment decisions and profitability, the distortionary effects on the tax system, rising risk premia in long-term interest rates and the reduced allocative effectiveness of the price and market systems. In addition, social costs arise because the weaker members of society have more difficulty in protecting themselves against the adverse effects of inflation. The Maastricht Treaty guarantees the independence of the ESCB, which will be composed of the European Central Bank (ECB) and the national central banks of the EU. As I explained a moment ago, it assigns an unambiguous primary objective to the ESCB, namely "to maintain price stability". Some would argue that focusing on price stability as the primary goal of monetary policy means that the ECB will no longer be concerned about output and employment growth. I do not agree with this view. First, the most important contribution that monetary policy can make towards balanced growth and employment is to provide a stable price environment. However, it would be misleading to assume that the ESCB will bear sole responsibility for establishing and maintaining price stability for the euro. Monetary policy needs to be supported by sound budgetary policies and wage developments in line with productivity growth. In other words, the overall policy mix must be appropriate. Without adequate support from other policy areas, the ESCB may be forced to take measures in the fight against inflation which will entail a short-term loss in output and employment. This explains the importance attached to the fact that the Maastricht Treaty assigns a high degree of independence to the ESCB in carrying out its mandate. The credibility of its monetary policy is further supported by the budgetary provisions of the Treaty which oblige Member States to avoid excessive budget deficits. The Stability and Growth Pact clearly defines the exceptional circumstances under which excessive deficits are permitted and, should any arise, provides for a procedure which will ensure their swift correction. Second, it should be clear that the single monetary policy in EMU will apply to the euro area as a whole. As a consequence, it cannot be used for solving regional problems or responding to country-specific economic shocks. These require, above all, smoothly functioning labour and product markets which allow wages and prices to be adjusted, should local economic conditions change. In addition, national budgets must allow sufficient room for manoeuvre to enable automatic stabilisers to work. As a key element of the Stability and Growth Pact, all Member States have committed themselves to achieving a budgetary position close to balance or in surplus in the medium term. Third, sustainable growth and job creation require more than just an appropriate monetary policy. This can be illustrated by the current unemployment problem in Europe. As its underlying causes are structural, its solution will require structural remedies and not an expansionary monetary policy. As the experience of recent years has shown, those Member States that have undertaken fundamental labour market reforms have achieved both a strong recovery of employment and stable prices. At the same time, they have often successfully managed to reduce their budget deficits. The general lesson to be learnt is that if all policy areas contribute to creating the right conditions, price stability will go hand in hand with a well balanced economic development in the longer term. To summarise, it will be essential to ensure that an appropriate overall policy mix is achieved in Stage Three of EMU. A stable price and financial environment enhances the capacity of monetary policy to react appropriately to cyclical weakness in the economy. Some would argue that focusing on price stability as the primary goal of monetary policy means that the ESCB will act contrary to output and employment growth. I believe this view to be wrong. Rather, stable prices are a condition for sound long-term growth and the sustainable creation of employment. Moreover, if price pressures are lowest at the trough of the business cycle, monetary policy can, in pursuing its objective of price stability, as a by-product also contribute to smoothing the business cycle. Such a result requires, however, that price stability be established and the credibility of the central bank in respect of its efforts to safeguard that goal be not in doubt. Given the lead times involved, both the framework for monetary policy implementation and the instruments and procedures required for this needed to be prepared well in advance of EMU. The EMI also has an important role to play in selecting a strategy for the ESCB. On the basis of current practice at the central banks and taking theoretical considerations into account, two potential candidate strategies have been considered by the EMI for Stage Three: monetary targeting and direct inflation targeting. The application of these two strategies in different countries has shown that several variants combining elements of both strategies exist, with the borderlines between them being sometimes blurred. In its extreme theoretical variant, monetary targeting would involve the central bank choosing a monetary aggregate as its intermediate target and deciding on its monetary policy actions on the sole basis of comparisons between the target and actual monetary developments. In practice, a central bank following monetary targeting adopts a more flexible approach which involves, in addition to the pursuit of the target, the monitoring of supplementary variables, including indicators of future inflation. It should be noted that several central banks pursuing monetary targets also set quantitative medium-term norms for the final objective, price stability, in order to increase the transparency of their policy. Inflation targeting strategies, in contrast, aim to steer the final target variable, the inflation rate, directly without having recourse to the use of a separate intermediate target variable. Since monetary policy affects the final objective with a lag, monetary policy actions under direct inflation targeting strategies are based on a comparison between the target for inflation and the forecast inflation rate. In several countries which practise inflation targeting, monetary aggregates play a prominent role among the various inflation indicators that are employed, including the setting of quantitative "monitoring ranges" as reference values for these variables. This brief description helps to indicate that, in practice, the differences between monetary and inflation targeting strategies are not overwhelming, since both strategies typically have the following key features in common: they are based on the same final objective, price stability; they are forward-looking (i.e. they are not based on current inflation developments); and they employ a wide range of indicators to assess the appropriateness of the monetary policy stance. The main distinguishing factor between the two strategies is the role played by monetary aggregates. While monetary aggregates are taken into account as part of inflation targeting strategies, a strategy which publicly sets targets for monetary growth clearly places more emphasis on monetary developments. This central role of monetary aggregates in the monetary targeting strategy is based on the assumption that excessive money growth will generate inflation and that the chosen monetary aggregate has certain properties which make it a suitable intermediate target variable for monetary policy. The assessment of alternative monetary policy strategies for the ESCB should be guided by a certain number of principles, including effectiveness, accountability, medium-term orientation and continuity. Allow me to say a few words about these guiding principles. The effectiveness of monetary targeting depends very much on whether a stable (or at least predictable) relationship exists between the chosen monetary aggregate and the final price objective. It also depends on whether monetary aggregates possess desirable leading indicator properties for future inflation. Recent empirical studies carried out for different groups of EU countries show that EU-wide money demand functions appear to be relatively stable and some monetary aggregates have leading indicator properties for inflationary developments. On the other hand, these studies may not be representative of the situation in Stage Three. The possibility of damage to the credibility of the ESCB under a monetary targeting strategy could not be excluded if monetary aggregates were highly volatile at the start of Stage Three. Direct inflation targeting provides a quantitative reference for future inflation which is aimed specifically at anchoring inflation expectations. Its effectiveness, however, depends on the ability of the central bank to forecast accurately and to control future inflation. With regard to accountability, any strategy will need to involve the formulation and announcement of targets so that the ESCB can be held accountable to the public for its actions. An inflation targeting procedure would directly stress the responsibility of the ESCB for maintaining price stability, although it should be noted that inflation is affected by numerous factors beyond the control of the central bank. On the other hand, a monetary targeting strategy would make the central bank responsible for developments which are directly observable by the public and which are more directly under control. Both strategies can be seen as being oriented towards the medium term, thereby providing an anchor for inflation expectations. In this respect, both strategies provide some scope for allowing short-term deviations from the target, if these can be explained to the public. Finally, the adoption of monetary targeting would offer the advantage of ensuring continuity with the strategy of the EU central bank whose currency has hitherto performed the anchor function in the ERM. On the other hand, it could be argued that the experience so far of those EU central banks which use direct inflation targets has also been relatively successful. Under any monetary strategy, the ESCB will also have to define "price stability". While it is difficult to provide a precise theoretical definition of price stability, it would be fair to say that a rate of consumer price inflation not exceeding 2% is probably close to a level with which central banks would normally be quite satisfied. In this context, issues of price measurement will be especially important. Progress towards a consistent measure of inflation across the EU countries has been made with the publication of harmonised consumer price indices by EUROSTAT. It is particularly important to cater for the effects of rapid technological progress, innovation and the role of consumer services. As noted by my colleague, Alan Greenspan, in a recent speech, inflation may be overestimated if such elements are not dealt with carefully and accurate measurement of inflation is especially crucial when the overall rate of inflation is low. In the same speech, Mr. Greenspan pointed out that further progress may be necessary to ensure the broadest possible coverage of consumer goods and services. The EMI also advocates as broad a coverage as possible; to meet this aim, EUROSTAT has already proposed a timetable for an expansion of the coverage of the harmonised index of consumer prices, part of which will take place in January 1999 at the outset of Monetary Union. Before moving on from the issue of monetary policy, I should like to add that preparation of the infrastructure needed for either monetary policy strategy is proceeding satisfactorily. Statistical preparation is well under way, notably for the case of monetary data. The EMI has also started to prepare tools for forecasting, such as a "multi-country econometric model", that will be made available to the ESCB. Furthermore, the preparation of a number of tools for analysing and monitoring the economic situation in Stage Three is ongoing. Work on the instruments and procedures to be used in EMU is also progressing well. In September, the EMI published a further report on monetary policy instruments and procedures, the so-called "General documentation". The report updates the "Framework Report" and takes into account the progress made in the specification of the ESCB's monetary policy instruments and procedures in the meantime. The main aim of the report is to provide financial institutions with the information they need in order to prepare for participation in monetary policy operations with the ESCB. The continuing challenge for central banks is to ensure long-term credibility for monetary policy by sustaining an environment of low inflation. Maintaining price stability will be the ESCB's primary responsibility. With regard to monetary strategy, monetary and inflation targeting are seen as the two main benchmarks in the light of which the choice of the ESCB's strategy in Stage Three will be made. Both strategies have a number of key elements in common, such as the objective of price stability, a forward-looking nature and the use of a wide range of indicators in determining the monetary policy stance. In selecting its strategy, the ESCB will be confronted with a situation in which there will still be some structural differences between participating countries, as well as cross-country differences in economic policies. Furthermore, the transition to Stage Three will increase uncertainty about the monetary policy transmission process. In this respect, a thorough analysis of all the relevant factors will be essential, whatever the circumstances, as will a careful explanation of the ESCB's monetary policy actions in the context of its monetary strategy. This will also make it easier to cope with a new and changing environment at the start of Stage Three./.
r971127a_ECB	euro area	1997-11-27T00:00:00	Monetary policy in Europe - Quo Vadis?	london	0	Ladies and Gentlemen, we are in a fortunate position in Europe. We have been able to prepare a new monetary regime for Europe at a time when a consensus about the role of monetary policy exists among central bankers and the large majority of politicians and academics. We are thus able to shape the new institutions accordingly. Let me first explain what I mean by the current consensus about the role of monetary policy among macroeconomists. Second, having established the state of the art (and it is certainly still true that central banking is more of an art than a science), I shall briefly describe my vision of how monetary policy could ideally be run in Europe, while illustrating my view that the structure of the ESCB and its operating procedures are in line with these standards, and may thus be able to transform that vision into reality. The views expressed in the following statements would nowadays be shared by a large majority of economists: Monetary policy cannot influence the growth rate of the economy by having an effect on aggregate demand in the long run. Economic growth depends on the productivity and the supply of factors of production such as labour and capital. No central bank in the world is able to increase its country's growth rate permanently by printing money or even by reducing the nominal interest rate to zero. The reason being that any excess demand over the production of goods and services will sooner or later be reflected in inflation. Persistent inflation is always a monetary phenomenon. Although monetary policy action can exert a temporary influence on the level of real economic activity - due particularly to sluggish adjustment of wages and prices. An "activist" monetary policy though aimed at boosting growth without due regard for price stability will merely cause inflation. Expectations of market participants such as trade unions and employers are of crucial importance for the effect of any policy measure, and the expected reaction pattern of the central bank affects current decisions by the private sector. Let me give you an example. If the central bank is known to react to excessive wage demands by raising interest rates, thereby stabilising prices and temporarily reducing output, instead of by lowering rates to dampen the burden on firms affected by the wage shock, excessive wage demands may not occur in the first place. Thus, if the goal of price stability is evident and credible, stable monetary policy will become much easier to implement. High inflation hampers economic growth. High and volatile inflation imposes substantial economic costs, such as those arising from increased uncertainty about the outcome of investment decisions and profitability, the distortionary effects on the tax system, rising risk premia in long-term interest rates and the reduced allocative effectiveness of the price and market system. In addition, social costs arise because the weaker members of society have more difficulty in protecting themselves against the adverse effects of inflation. There is agreement that inflation should be low, but no full consensus on what that exactly means in quantitative terms. Many of my European colleagues and myself would put the level at between 0 and 2%. Some others would envisage a somewhat wider range. On the basis of these views, the implications for a price stability oriented monetary policy in Europe are clear, and can be articulated as follows: (i) given the desirability of low inflation, and since persistent inflation is always a monetary phenomenon, it follows that a central bank's goal should be price stability; (ii) in pursuing the goal of price stability monetary policy may contribute to smoothing the level of economic activity in the short run, if inflationary pressures tend to follow a cyclical pattern. It should be noted that the success of such action depends crucially on the credibility of monetary policy; (iii) it goes without saying that monetary policy and fiscal policy should be well aligned as an adverse policy mix would imply placing an excessive burden on monetary policy; (iv) the importance of conditioning expectations and thus establishing the credibility of the central bank's anti-inflationary stance requires independent central banking. A monetary authority should be able to act free of political pressure, and according to transparent policy rules which should also be communicated to the public. A rule which aims at stabilising prices - either via a direct inflation target or a money supply target - will smoothen the business cycle and allow the economy to grow at its potential growth rate; Some of the past mistakes and deficiencies of monetary policy which have contributed over time to the emergence of the consensus I have just described have stemmed from a lack of independence. This has included attempts to use monetary policy for fiscal purposes (such as trying to reduce the real debt burden by surprise inflation) and the many unsuccessful attempts to boost growth through inflation, ignoring the effects on market expectations. A central bank which abandons its price stability target for a transitory gain in economic activity only contributes to higher average inflation. A central bank which has been susceptible to public pressure usually hits the brakes too late, too hard and, I might add, with unnecessarily heavy wear and tear on the "tyres" - aggravating the volatility of the business cycle rather than smoothing it out. I say this despite some proposals (Joseph Stiglitz, chief economist of the World Bank) claiming that "we should not follow a policy of pre-emptive strikes, but rather one of cautious expansionism" with which I disagree. This kind of strategy would mean in case of doubt letting the central bank err on the side of being too expansionary. The argument is that the costs of a minor increase in average inflation will be more than compensated by gains in employment. In my opinion, this argument again neglects the effect of market expectations. When people realise the systematic bias in the central banks monetary policy rule, there will be no output gain attached to the undoubtedly higher inflation rate. Nevertheless, there are costs involved. Even starting from low levels, higher inflation means higher volatility, which will then be reflected in higher risk premia and thus higher real interest rates - and eventually lower growth rates. If we cast an eye over the structure of the future European System of Central Banks (ESCB) the impression we get is that lessons have been learned and economic theory applied in the best possible manner. Maintaining price stability will be the ESCB's primary responsibility. Without prejudice to this primary objective of price stability, the ESCB will support the general economic policies in the European Union. The Maastricht Treaty assigns independence to the ESCB for the purpose of carrying out its mandate. With regard to monetary strategy, monetary and inflation targeting are seen as the two benchmarks on the basis of which the ESCB's strategy in Stage Three will be selected. The credibility of its monetary policy is further supported by the budgetary provisions of the Treaty, which oblige Member States to avoid excessive budget deficits. The Stability and Growth Pact clearly defines the exceptional circumstances under which excessive deficits are allowed and provides for a procedure which will ensure that excessive deficits are swiftly corrected, should they nevertheless arise, thus protecting the euro area against an unfavourable policy mix. The ESCB is prohibited from financing government debt. Thus the ESCB is relieved of any possible pressure to accommodate public debt by means of an expansionary monetary policy, which could otherwise have been interpreted as a constraint on its independence. I would like to conclude by stating that the essence of good monetary policy is good institutional design. Apparently, lessons have been learned and principles have been applied successfully. Europe has the opportunity to bring what has at times been a tumultuous chapter in its monetary history to a close. It should seize that opportunity and enjoy the benefits that sustained price stability will bring. The task ahead is to broaden and deepen the public's understanding of and support for the strategy and tactics of monetary policy and to lock in credibility for achieving low inflation, stable growth and lasting employment creation.
r980116a_ECB	euro area	1998-01-16T00:00:00	EMU: the building of one monetary system in the European Union	tokyo	0	Ladies and gentlemen, distinguished guests, etc. I have great pleasure in being in Tokyo to address issues concerning European Economic and Monetary Union. Two developments have taken place over the past few months. In Europe preparations for EMU have continued unabated: at the latest European Councils - held on 22 November and on 12 and 13 December - the Heads of State or Government approved common lines for coherent employment creation policies and finalised an agreement on the co-ordination of economic policies in the European Union after the start of EMU and on the dialogue between the Council of Ministers and the European Central Bank. In parallel a severe financial crisis has shaken the economies of some countries in Asia - requiring the mobilisation of international multilateral support under the aegis of the International Monetary Fund for Thailand, Indonesia and Korea. In other countries of the region the authorities have intervened repeatedly in order to re-establish confidence in the stability of their banking and financial systems. Although the main impact of the financial turbulence in Asia will be felt in Asian countries, the rest of the world will also be affected. This underscores the importance of the Asian economies and their share in the globalisation process. However, the prospect that EMU will start in January 1999 remains unaltered. This prospect is underpinned by a low level of inflation and by renewed progress towards convergence - also in the domain of public finances, where further consolidation is nevertheless required. While not disregarding international developments, in particular those in this part of the globe, I shall concentrate my address today on EMU and the building of a common monetary system for the whole of the EU. I should like to address the process by which EMU is being established, focusing specifically on three aspects: first, the technical preparations for the introduction of the single currency - the euro; second, the management and the conduct of the single monetary policy by a European System of Central Banks (the ESCB, which will consist of the European Central Bank (the ECB) and the national central banks of the EU Member States); and, third, the elaboration of economic policies in the EU after 1999. In a report to be published on 25 March, the EMI will make public its analysis of the progress made by individual Member States in terms of sustainable convergence by reference to the fulfilment by each Member State of a number of criteria outlined in the Treaty. In parallel, the European Commission will publish its own report and formulate a recommendation based on the outcome of the report. The EMI's and the European Commission'sreports, which will be released simultaneously, will guide the Council of Ministers - composed of the Finance Ministers of the EU Member States - in drawing up its recommendation to the European Council - composed of the Heads of State or Government - on which Member States are ready to adopt the single currency from the beginning of 1999. The European Parliament will be consulted on the matter and will forward its opinion to the European Council. I do not want to dwell on this topic today. I can only observe that many countries have already reaped some of the benefits they were expecting from participation in EMU: low inflation, lower interest rates and reduced exchange rate volatility. The Heads of State or Government will select the Member States eligible to participate in the first round of EMU during the first weekend of May of this year. Thereafter, the Executive Board of the ECB will be appointed and the ESCB will be established. The Executive Board will consist of the President and Vice-President, plus up to four executive directors. The ESCB will carry out, in the period lasting until 1 January 1999 (the so-called interim period), the adoption and testing of the monetary policy framework prepared over the past few years. Economic and Monetary Union will start on 1 January 1999. In the interim period, monetary policy will remain a national responsibility, but the monetary policies of the individual Member States will become increasingly co-ordinated. The bilateral exchange rates between the participating currencies - which will be used for determining the euro conversion rates - will be pre-announced on the date of the selection of the first countries to participate. On the eve of EMU, the rates at which the participating currencies will be irrevocably converted into euro will be fixed. One euro will then be equal to one ECU at that point in time. Euro conversion rates cannot be pre-announced owing to the Treaty requirement that one ECU will be equal to one euro at the start of EMU. The ECU is a basket currency, also comprising currencies which will not be converted into euro, such as the pound sterling. The euro will not be a basket currency, but a normal currency just as the Deutsche Mark and the US dollar are today. The organisation of the transition to the single currency has been a complex and demanding exercise, as the authorities have had to strike a balance between two different and sometimes conflicting demands: a common framework for the single currency area as a whole, as defined in Madrid in December 1995, and the need to provide scope for adaptation to differing national environments. A three-year transitional period is envisaged. From the start of the three-year transitional period, the lawful currency of the European Union will be the euro, issued by the ESCB. The national currencies of the participating Member States will legally be equivalent to non-decimal subdivisions of the euro. The ESCB will operate exclusively in euro from the very start of EMU. New marketable public debt will also be issued exclusively in euro. For the rest, public and private agents will be able to decide for themselves whether or not they wish to use the new or the old currency denominations, which will in any case be irrevocably linked together. The euro will assume the appearance of the national monetary tokens. This means that fiduciary retail payments will continue to be mainly in banknotes denominated in national currencies. Legal certainty will be guaranteed by a common legal framework which has been agreed at the European level. This framework establishes the principle of the continuity of contracts, thereby preventing any contractual party from refusing to perform outstanding obligations for the simple reason that EMU has entered into force. Similar legal amendments in relation to the continuity of contracts and the euro have already been enacted in the United States, e.g. in the State of New York, the State of Illinois and in the State of California. This common framework has been supplemented by a host of preparations at the national level, which encompass all economic sectors. I shall refer only to some of the most significant developments: the governments of most Member States have published national changeover schemes which have been validated by committees and other planning bodies consisting of representatives of all sectors of the economy. In some cases, draft laws have been presented to or already approved by parliaments; all Member States intend to redenominate outstanding public debt in euro at the start of Stage Three, that is to say three years before the date by which secondary markets for bonds are to change over to the euro; industry associations and institutions linked to the financial markets have been preparing for the complete integration of financial markets. In summary, Member States have been given considerable leeway in the area of changeover preparations to implement different strategies for the introduction of the single currency. However, a competition-led process of mutual emulation has brought most public and private entities to similar conclusions. The developments I have just described highlight the intention of the great majority of public authorities and market participants throughout the EU to accelerate the pace of the changeover to the euro. The preparatory work for the euro is seen as a golden opportunity to upgrade the services provided by the public sector and to increase the efficiency of the financial system. As from 1 January 2002, euro banknotes and coins will be introduced in all the Member States participating in Economic and Monetary Union at the same time. However, each Member State has the right to determine the pace of the cash changeover in its economy, provided it is completed by the middle of that year, i.e. end-June 2002. From that point onwards, only the euro will be in use as the national unit of account and means of payment in the participating countries of the Economic and Monetary Union and national currencies will no longer have legal tender status. I should now like to turn to the management and conduct of monetary policy once Economic and Monetary Union has been launched in January 1999. The monetary policy decisions will be taken by the Governing Council of the ECB by simple majority. The Governing Council will be composed of the President and Vice-President, the other members of the Executive Board and the governors of the national central banks of the participating countries. Each member of the Governing Council will have a single vote. A key feature of the ECB is its independence in monetary policy decision-making, which is enshrined in the Treaty. The Bank of Japan's independence - a process undertaken last year - confirms the importance of this feature. The execution of policy decisions will to a large extent be decentralised and rely on the infrastructure of the national central banks. From the first day of Economic and Monetary Union, national central banks will transfer their monetary policy competencies to the ESCB, which will have the primary objective of maintaining price stability, and thus be the guarantor of a stable euro. The EMI has published material in which it recommends two possible monetary policy strategies for the ECB to consider: monetary targeting and direct inflation targeting. The final decision on which one - or on which combination - of the two strategies to adopt will need to be taken by the Governing Council of the ECB in 1998. In its theoretical description, monetary targeting involves the central bank choosing a monetary aggregate as its intermediate target and deciding its monetary policy actions solely on the basis of comparisons between the target and actual monetary developments. By contrast, an inflation targeting strategy aims at directly steering the final target variable, the inflation rate, without the use of a separate intermediate target variable. Monetary policy actions are based on a comparison between the target for inflation and the forecast inflation rate. The practical differences between these two theoretically distinct strategies are not so great and their application in different countries has shown that several variants integrating elements of both strategies may exist. Both strategies are based on the same final objective, price stability; they are forward-looking, and they employ a wide range of indicators to assess the appropriateness of the stance of monetary policy. To achieve price stability, the ESCB will use a number of monetary policy instruments within the context of the chosen monetary policy strategy. The EMI has already published a blueprint for the monetary policy instruments of the ECB. These will mainly comprise open market operations, supplemented by two standing facilities which will provide a ceiling and a floor to the corridor of official interest rates. Whether or not, in addition, use will be made of minimum reserve requirements remains to be decided by the Governing Council of the ECB. The EMI has not recommended an exchange rate objective as an appropriate monetary policy strategy for the ECB, given that for an area potentially as large as the euro area, such an approach might be inconsistent with the internal goal of price stability. The external value of the euro will thus mainly be an outcome of the ECB's monetary policy. This is not to say, however, that the euro area will totally disregard exchange rates. The Treaty on European Union provides for the possible conclusion of formal exchange rate arrangements with non-EU countries. Its is unlikely that such arrangements will be made in the foreseeable future. The Treaty also provides for the formulation of general exchange rate orientations vis-a-vis non-EU currencies. But it has already been agreed that these will be resorted to in exceptional circumstances only and in any event without prejudice to the ESCB's primary objective of maintaining price stability. The ESCB will also have the technical capacity to conduct intervention operations in order to counteract excessive or erratic fluctuations of the euro against the major non-EU currencies. In addition, the ESCB will be a party to the so-called ERM II arrangement, the successor to the current EMS, under which EU Member States which have not yet adopted the euro will manage their exchange rate against the euro. There is no doubt that the creation of a single currency area will transform the international monetary landscape. Academics seem to be divided between those who expect the birth of a European monetary pole to contribute to more stable international exchange rate relations and those who anticipate increased volatility in the medium term in the foreign exchange markets. As the European economy will be characterised by stable low inflation and sustainable fiscal policies in the Member States, there is no a priori reason to expect increased exchange rate volatility; indeed, one could even expect the contrary. By conducting similar policies in all major industrial countries, one of the pre-conditions for a stable international monetary system will be in place. The euro can be expected to become a major international currency, not only because it will be the currency of a large area but also because it is based on monetary and fiscal policy driven by the objective of stability. However, the international role of the euro will probably develop gradually.. I should now like to address the question of how economic policy will be conducted in the European Union as from the start of Economic and Monetary Union. Since EMU is not only about monetary union but also about economic union, it is evident that national economic policies cannot be conducted with total disregard to their potential spillover effects on neighbouring countries. On the other hand, economic union does not require a supranational decision-making on economic policies, and the Treaty clearly reflects this distinction between the monetary and the economic arrangements in Stage Three. This being said, there must be common institutional procedures to enable crucial issues of economic policy, almost - by definition - of common concern in the EU, to be raised and resolved at the Community level. Such procedures were already provided for in the Treaty and put into practice, but with the advent of Monetary Union they will need to be strengthened. I should like to highlight three such procedures. The first mechanism is the formulation of broad guidelines for the economic policies of the Member States and of the Community, as stipulated in Article 103 of the Treaty. Monetary Union will inevitably create greater interdependence between the participating countries as well as the other EU countries bordering on the euro area. It is thus reasonable to assume that governments will feel the need to hold joint discussions and formulate economic orientations. The recent conclusions drawn by the European Council in Luxembourg (on 12 and 13 December 1997) confirm that the ECOFIN Council, which is the Council of all fifteen EU Finance Ministers, will be the centre of co-ordination for Member States' economic policies. A second instrument is the so-called "Stability and Growth Pact", the terms of which were agreed at the Amsterdam Council of 16 and 17 June 1997. The Pact, which builds on and refines rules already laid down in the Treaty on the joint surveillance of economic developments (Article 102, paragraph 3) and joint EU procedures in the event of an excessive deficit in one or more Member States (Article 103), contains a shared goal for Member States - namely that of bringing government budgets in the medium term close to balance or even into surplus and to take corrective action to avoid excessive budgetary deficits. In this way, it will be possible to let the automatic stabilisers work, without causing public deficits and debt levels to increase and reach unsustainable levels. A third element is what has been coined the "Euro-x" Council, which will informally gather the Finance Ministers of the Member States of the euro area for discussions on issues connected with their shared specific responsibilities for the single currency. The Commission, and the ECB when appropriate, will be invited to take part in these meetings. Whenever matters of common EU-wide interest emerge, they will normally be discussed within the ECOFIN Council. Other policy rules firmly enshrined in the Treaty with a disciplining effect on the behaviour of groups and institutions in the governmental area should not be overlooked: the prohibition on extending central bank credit to governmental institutions; the ban on any form of preferential access to credit by the public sector; and the "no bail-out clause", which prevents the transfer of one government's liabilities to the Community or to other Member States. Insufficient mobility of the labour force across the euro area is seen by some academics as a serious cause for concern for the longer-term viability of Economic and Monetary Union. Other compensatory mechanisms - such as large-scale financial transfers to the affected country or countries - will also be ruled out in Europe given that the budget of the Community will be very small. But the existence of the Stability and Growth Pact leads to the conclusion that EMU does not need a centralised budget. With national budget positions close to balance or in surplus, countries have ample room for manoeuvre to cope with adverse economic developments. Certainly, Europe requires more market flexibility to better ensure adjustments in EMU. However, labour market flexibility is required independently of EMU. The current excessive level of unemployment cannot be solved unless major structural reforms, especially in the labour markets, are implemented. That which is needed to make EMU work is also required in order to reduce unemployment in Europe. It is important to underline that the introduction of the euro, although in itself an important step in the further economic integration of Europe, will not - and cannot - solve all the problems and needs to be accompanied by other policies. European integration has always been an evolutionary process. Economic and Monetary Union in Europe is a further step in this process. The euro will be a stable currency and, as such, it may become a further symbol of unity and shared values among Europeans. As the destinies of the peoples of the world become increasingly interdependent, the experience gained from European integration may be useful to all.
r980119a_ECB	euro area	1998-01-19T00:00:00	EMU: many countries - one monetary system	kong	0	Ladies and gentlemen, distinguished guests, etc. I have great pleasure in being in Hong Kong once again to address issues concerning European Economic and Monetary Union. Since the last time I was here - on the occasion of the International Monetary Fund (IMF) and World Bank's annual meeting - two developments have taken place. In Europe preparations for EMU have continued unabated: at the latest European Councils - held on 22 November and on 12 and 13 December - the Heads of State or Government approved common lines for coherent employment creation policies and finalised an agreement on the co-ordination of economic policies in the European Union after the start of EMU and on the dialogue between the Council of Ministers and the European Central Bank. In parallel a severe financial crisis has shaken the economies of some countries in Asia - requiring the mobilisation of international multilateral support under the aegis of the IMF for Thailand, Indonesia and Korea. In other countries of the region the authorities have intervened repeatedly in order to re-establish confidence in the stability of their banking and financial systems. Although the main impact of the financial turbulence in Asia will be felt in Asian countries, the rest of the world will also be affected. This underscores the importance of the Asian economies and their share in the globalisation process. However, the prospect that EMU will start in January 1999 remains unaltered. This prospect is underpinned by a low level of inflation and by renewed progress towards convergence - also in the domain of public finances, where further consolidation is nevertheless required. While not disregarding international developments, in particular those in this part of the globe, I shall concentrate my address today on illustrating how the EU countries are building a common monetary system which is almost the opposite of your situation, where two monetary systems exist in one country. I should like to address the process by which EMU is being established, focusing specifically on three aspects: first, the technical preparations for the introduction of the single currency - the euro; second, the management and the conduct of the single monetary policy by a European System of Central Banks (the ESCB, which will consist of the European Central Bank (the ECB) and the national central banks of the EU Member States); and, third, the elaboration of economic policies in the EU after 1999. In a report to be published on 25 March, the EMI will make public its analysis of the progress made by individual Member States in terms of sustainable convergence by reference to the fulfilment by each Member State of a number of criteria. In parallel the European Commission will publish its own report and formulate a recommendation based on the outcome of the report. The EMI's and the European Commission's reports, which will be released simultaneously, will guide the Council of Ministers - composed of the Finance Ministers of the EU Member States - in drawing up its recommendation to the European Council - composed of the Heads of State or Government - on which Member States are ready to adopt the single currency from the beginning of 1999. The European Parliament will be consulted on the matter and will forward its opinion to the European Council. I do not want to dwell on this topic today. I can only observe that many countries have already reaped some of the benefits they were expecting from participation in EMU: low inflation, lower interest rates and reduced exchange rate volatility. The Heads of State or Government will select the Member States eligible to participate in the first round of EMU during the first weekend of May of this year. Thereafter, the Executive Board of the ECB will be appointed and the ESCB will be established. The Executive Board will consist of the President and Vice-President, plus up to four executive directors. The ESCB will carry out, in the period lasting until 1 January 1999 (the so-called interim period), the adoption and testing of the monetary policy framework prepared over the past few years. Economic and Monetary Union will start on 1 January 1999. In the interim period, monetary policy will remain a national responsibility, but the monetary policies of the individual Member States will become increasingly co-ordinated. The bilateral exchange rates between the participating currencies - which will be used for determining the euro conversion rates - will be pre-announced on the date of the selection of the first countries to participate. On the eve of EMU, the rates at which the participating currencies will be irrevocably converted into euro will be fixed. One euro will then be equal to one ECU at that point in time. Euro conversion rates cannot be pre-announced owing to the Treaty requirement that one ECU will be equal to one euro at the start of EMU. The ECU is a basket currency, also comprising currencies which will not be converted into euro, such as the pound sterling. The euro will not be a basket currency, but a normal currency just as the Deutsche Mark and the US dollar are today. The organisation of the transition to the single currency has been a complex and demanding exercise, as the authorities have had to strike a balance between two different and sometimes conflicting demands: a common framework for the single currency area as a whole, as defined in Madrid in December 1995, and the need to provide scope for adaptation to differing national environments. A three-year transitional period is envisaged. From the start of the three-year transitional period, the lawful currency of the European Union will be the euro, issued by the ESCB. The national currencies of the participating Member States will legally be equivalent to non-decimal subdivisions of the euro. The ESCB will operate exclusively in euro from the very start of EMU. New marketable public debt will also be issued exclusively in euro. For the rest, public and private agents will be able to decide for themselves whether or not they wish to use the new or the old currency denominations, which will in any case be irrevocably linked together. The euro will assume the appearance of the national monetary tokens. This means that fiduciary retail payments will continue to be mainly in banknotes denominated in national currencies. Legal certainty will be guaranteed by a common legal framework which has been agreed at the European level. This framework establishes the principle of the continuity of contracts, thereby preventing any contractual party from refusing to perform outstanding obligations for the simple reason that EMU has entered into force. Similar legal amendments in relation to the continuity of contracts and the euro have already been enacted in the United States, e.g. in the State of New York, the State of Illinois and in the State of California. This common framework has been supplemented by a host of preparations at the national level, which encompass all economic sectors. I shall refer only to some of the most significant developments: - the governments of most Member States have published national changeover schemes which have been validated by committees and other planning bodies consisting of representatives of all sectors of the economy. In some cases, draft laws have been presented to or already approved by parliaments; - all Member States intend to redenominate outstanding public debt in euro at the start of Stage Three, that is to say three years before the date by which secondary markets for bonds are to change over to the euro; - industry associations and institutions linked to the financial markets have been preparing for the complete integration of financial markets. In summary, Member States have been given considerable leeway in the area of changeover preparations to implement different strategies for the introduction of the single currency. However, a competition-led process of mutual emulation has brought most public and private entities to similar conclusions. The developments I have just described highlight the intention of the great majority of public authorities and market participants throughout the EU to accelerate the pace of the changeover to the euro. The preparatory work for the euro is seen as a golden opportunity to upgrade the services provided by the public sector and to increase the efficiency of the financial system. As from 1 January 2002, euro banknotes and coins will be introduced in all the Member States participating in Economic and Monetary Union at the same time. However, each Member State has the right to determine the pace of the cash changeover in its economy, provided it is completed by the middle of that year, i.e. end-June 2002. From that point onwards, only the euro will be in use as the national unit of account and means of payment in the participating countries of the Economic and Monetary Union and national currencies will no longer have legal tender status. I should now like to turn to the management and conduct of monetary policy once Economic and Monetary Union has been launched in January 1999. The monetary policy decisions will be taken by the Governing Council of the ECB by simple majority. The Governing Council will be composed of the President and Vice-President, the other members of the Executive Board and the governors of the national central banks of the participating countries. Each member of the Governing Council will have a single vote. The execution of policy decisions will to a large extent be decentralised and rely on the infrastructure of the national central banks. From the first day of Economic and Monetary Union, national central banks will transfer their monetary policy competencies to the ESCB, which will have the primary objective of maintaining price stability, and thus be the guarantor of a stable euro. The EMI has published material in which it recommends two possible monetary policy strategies for the ECB to consider: monetary targeting and direct inflation targeting. The final decision on which one - or on which combination - of the two strategies to adopt will need to be taken by the Governing Council of the ECB in 1998. In its theoretical description, monetary targeting involves the central bank choosing a monetary aggregate as its intermediate target and deciding its monetary policy actions solely on the basis of comparisons between the target and actual monetary developments. By contrast, an inflation targeting strategy aims at directly steering the final target variable, the inflation rate, without the use of a separate intermediate target variable. Monetary policy actions are based on a comparison between the target for inflation and the forecast inflation rate. The practical differences between these two theoretically distinct strategies are not so great and their application in different countries has shown that several variants integrating elements of both strategies may exist. Both strategies are based on the same final objective, price stability; they are forward-looking, and they employ a wide range of indicators to assess the appropriateness of the stance of monetary policy. To achieve price stability, the ESCB will use a number of monetary policy instruments within the context of the chosen monetary policy strategy. The EMI has already published a blueprint for the monetary policy instruments of the ECB. These will mainly comprise open market operations, supplemented by two standing facilities which will provide a ceiling and a floor to the corridor of official interest rates. Whether or not, in addition, use will be made of minimum reserve requirements remains to be decided by the Governing Council of the ECB. The EMI has not recommended an exchange rate objective as an appropriate monetary policy strategy for the ECB, given that for an area potentially as large as the euro area, such an approach might be inconsistent with the internal goal of price stability. The external value of the euro will thus mainly be an outcome of the ECB's monetary policy. This is not to say, however, that the euro area will totally disregard exchange rates. The Treaty on European Union provides for the possible conclusion of formal exchange rate arrangements with non-EU countries. It is unlikely that such arrangements will be made in the foreseeable future. The Treaty also provides for the formulation of general exchange rate orientations vis-a-vis non-EU currencies. But it has already been agreed that these will be resorted to in exceptional circumstances only and in any event without prejudice to the ESCB's primary objective of maintaining price stability. The ESCB will also have the technical capacity to conduct intervention operations in order to counteract excessive or erratic fluctuations of the euro against the major non-EU currencies. In addition, the ESCB will be a party to the so-called ERM II arrangement, the successor to the current EMS, under which EU Member States which have not yet adopted the euro will manage their exchange rate against the euro. There is no doubt that the creation of a single currency area will transform the international monetary landscape. Academics seem to be divided between those who expect the birth of a European monetary pole to contribute to more stable international exchange rate relations and those who anticipate increased volatility in the medium term in the foreign exchange markets. As the European economy will be characterised by stable low inflation and sustainable fiscal policies in the Member States, there is no a priori reason to expect increased exchange rate volatility; indeed, one could even expect the contrary. By conducting similar policies in all major industrial countries, one of the pre-conditions for a stable international monetary system will be in place. The euro can be expected to become a major international currency, not only because it will be the currency of a large area but also because it is based on monetary and fiscal policy driven by the objective of stability. However, the international role of the euro will probably develop gradually. I should now like to address the question of how economic policy will be conducted in the European Union as from the start of Economic and Monetary Union. Since EMU is not only about monetary union but also about economic union, it is evident that national economic policies cannot be conducted with total disregard to their potential spillover effects on neighbouring countries. On the other hand, economic union does not require a supranational decision-making on economic policies, and the Treaty clearly reflects this distinction between the monetary and the economic arrangements in Stage Three. This being said, there must be common institutional procedures to enable crucial issues of economic policy, almost - by definition - of common concern in the EU, to be raised and resolved at the Community level. Such procedures were already provided for in the Treaty and put into practice, but with the advent of Monetary Union they will need to be strengthened. I should like to highlight three such procedures. The first mechanism is the formulation of broad guidelines for the economic policies of the Member States and of the Community, as stipulated in Article 103 of the Treaty. Monetary Union will inevitably create greater interdependence between the participating countries as well as the other EU countries bordering on the euro area. It is thus reasonable to assume that governments will feel the need to hold joint discussions and formulate economic orientations. The recent conclusions drawn by the European Council in Luxembourg (on 12 and 13 December 1997) confirm that the ECOFIN Council, which is the Council of all fifteen EU Finance Ministers, will be the centre of co-ordination for Member States' economic policies. A second instrument is the so-called "Stability and Growth Pact", the terms of which were agreed at the Amsterdam Council of 16 and 17 June 1997. The Pact, which builds on and refines rules already laid down in the Treaty on the joint surveillance of economic developments (Article 102, paragraph 3) and joint EU procedures in the event of an excessive deficit in one or more Member States (Article 103), contains a shared goal for Member States - namely that of bringing government budgets in the medium term close to balance or even into surplus and to take corrective action to avoid excessive budgetary deficits. In this way, it will be possible to let the automatic stabilisers work, without causing public deficits and debt levels to increase and reach unsustainable levels. A third element is what has been coined the "Euro-x" Council, which will informally gather the Finance Ministers of the Member States of the euro area for discussions on issues connected with their shared specific responsibilities for the single currency. The Commission, and the ECB when appropriate, will be invited to take part in these meetings. Whenever matters of common EU-wide interest emerge, they will normally be discussed within the ECOFIN Council. Other policy rules firmly enshrined in the Treaty with a disciplining effect on the behaviour of groups and institutions in the governmental area should not be overlooked: the prohibition on extending central bank credit to governmental institutions; the ban on any form of preferential access to credit by the public sector; and the "no bail-out clause", which prevents the transfer of one government's liabilities to the Community or to other Member States. Insufficient mobility of the labour force across the euro area is seen by some academics as a serious cause for concern for the longer-term viability of Economic and Monetary Union. Other compensatory mechanisms - such as large-scale financial transfers to the affected country or countries - will also be ruled out in Europe given that the budget of the Community will be very small. But the existence of the Stability and Growth Pact leads to the conclusion that EMU does not need a centralised budget. With national budget positions close to balance or in surplus, countries have ample room for manoeuvre to cope with adverse economic developments. Certainly, Europe requires more market flexibility to better ensure adjustments in EMU. However, labour market flexibility is required independently of EMU. The current excessive level of unemployment cannot be solved unless major structural reforms, especially in the labour markets, are implemented. That which is needed to make EMU work is also required in order to reduce unemployment in Europe. It is important to underline that the introduction of the euro, although in itself an important step in the further economic integration of Europe, will not - and cannot - solve all the problems and needs to be accompanied by other policies. European integration has always been an evolutionary process. Economic and Monetary Union in Europe is a further step in this process. The euro will be a stable currency and, as such, it may become a symbol of unity and shared values among Europeans. As the destinies of the peoples of the world become increasingly interdependent, the experience gained from European integration may be useful to all.
r980122a_ECB	euro area	1998-01-22T00:00:00	EMU - How to grasp the opportunities and avoid the risks	duisenberg	1	It is a great pleasure for me to speak to you about Economic and Monetary Union (EMU) which is a unique enterprise that provides a broad range of promising opportunities. The benefits of a single currency are by now well known, On the other hand, as with any such undertaking, Monetary Union also involves some risks. However, I am convinced that the risks can be contained, if not fully avoided, by a high degree of sustainable convergence of those countries which participate in Monetary Union, by a single monetary policy which strictly aims at price stability in the euro area as a whole, by stability-oriented economic and fiscal policies and by sound wage developments in Stage Three.. If all policy areas contribute to creating the right conditions, the chances far outweigh the risks - or, in other words, the net benefits to be expected from EMU are clearly positive. It is of utmost importance for the success of Monetary Union that a high degree of convergence be achieved for the participating countries. The dangers of there being a lack of convergence at the start of EMU are obvious. In particular, if national fiscal positions are not under control from the outset, the single monetary policy may be overburdened and adverse spillover effects may arise within the Monetary Union as a whole, and thus also for those countries whose fiscal policies are under control. I should like to address the issue of what monetary policy, but also other areas of economic policy, in particular those responsible for fiscal and labour market developments, can contribute to grasping the opportunities and avoiding the risks of EMU. First, the most important contribution that the ESCB can make towards exploiting to the maximum the opportunities and avoiding the risks of EMU is to fulfil its primary objective to maintain price stability. Given the considerable lags between monetary policy measures and price developments, policy decisions directed at price stability must inevitably be both forward-looking in their formulation and pre-emptive in their implementation. This implies that the ESCB will have to take appropriate and timely action to ensure that the final objective is achieved. Therefore, it will have to carry out a thorough and broad analysis of all economic developments - in the euro area and beyond - which could potentially endanger current or future price stability. To achieve this goal, the ESCB will also express its views on other policy areas which can potentially have an impact on its primary objective of price stability. Consequently, the ESCB will try to convince both policy-makers and the general public of the advantages of stability-oriented budgetary policies, of moderate wage developments and of structural reforms which make labour and product markets more responsive to economic signals. Second, a high degree of credibility of the single monetary policy will certainly further heighten the advantages associated with an environment of stable prices. Credibility can be enhanced by the transparency of the monetary policy strategy - whichever strategy the ESCB will finally adopt - and by a policy which leaves no doubt regarding its determination to keep prices stable. In this context, it should be taken into account that given the long lags of monetary policy measures, the monetary stance in the current year will already have a significant impact on price developments in 1999 and beyond. Thus, current national monetary policies, in particular in the second half of this year, will de facto be responsible for ensuring price stability in the euro area in the initial phase of Stage Three, which is of crucial importance for the credibility and reputation of the ESCB. To achieve this aim in a consistent and effective way, co-ordination in the conduct of national monetary policies will have to be intensified further once the selection of the participants in Monetary Union has been carried out. The independence of the ESCB, as laid down in the Maastricht Treaty, is a key factor in ensuring a high level of credibility of monetary policy geared to price stability. Therefore, it is of great importance that there is no doubt that the European Council clearly supports the independence of the ESCB. In its Resolution of last December the European Council states that only in exceptional circumstances may the Council formulate general orientations for exchange rate policy in relation to non-EU currencies. Moreover, the European Council points out that "these general orientations should always respect the independence of the ESCB and be consistent with the primary objective of price stability" and also that the dialogue between the Council and the ECB should respect all aspects of the independence of the ESCB. Third, it should be emphasised that the single monetary policy has to focus on the euro area as a whole. This implies that product and labour markets should be more flexible in Stage Three than was needed before to absorb the impact of regional shocks. I will come back to this issue later in my presentation. Fourth, accountability and transparency are important principles for the ESCB. Accordingly, the Governing Council of the ECB should be in a position to inform the general public in detail about its strategy and the rationale for its decisions.. This should stabilise inflationary expectations at a low level and, thus, enhance the advantages of EMU. Therefore, the ESCB will publish a quantified definition of the final objective of price stability and the specific targets against which the public can assess the ESCB's performance. Regarding the former, it would be fair to say that a rate of consumer price inflation not exceeding 2% is probably close to a level with which central banks would normally be quite satisfied. Moreover, when explaining the general monetary policy strategy to the public, the ESCB will make clear what the single monetary policy can and cannot achieve, and how other areas of economic policies can support monetary policy and thereby enhance the benefits associated with price stability. This should also contribute to avoiding illusions and overly optimistic expectations regarding the direct contribution of EMU to resolving the problems of high unemployment and overburdened social security systems. Furthermore, one may argue that Article 105.1 of the Treaty gives the ESCB the opportunity, if not the obligation, to support the general economic policies in the Community also by giving appropriate advice to those responsible for these policies and that this advice should be given with a view to supporting price stability and an open market economy with free competition, favouring an efficient allocation of resources. Moreover, to the extent that price stability has been firmly established, the ESCB will implement its monetary policy with a view to supporting the realisation of other economic policy goals, to the extent that this does not endanger future price stability. For the monetary policy decisions of the ESCB to be well-informed and, thus, optimal with respect to its objectives, there is evidently a need for regular dialogue and an exchange of information with third parties on issues of common interest. This will apply in particular to national economic policies, wage developments and the overall fiscal policy stance in the Monetary Union. This dialogue may also contribute to improving the economic environment of the single monetary policy and, thereby, the chances of achieving a balanced policy mix, i.e. of maintaining price stability without the need to adopt restrictive monetary policy measures.. Clearly, the dialogue will have to be conducted in such a way as to avoid any interference with the independence of the ESCB and the primary objective of price stability. I have already mentioned that the full benefits of the single currency will not come quasi-automatically with a monetary policy geared towards price stability, but only if there is appropriate support from other economic policies, especially fiscal and wage policies, and if structural reforms are carried out in these areas. Thus, price stability is a necessary, but not a sufficient condition for grasping all the opportunities of EMU. Therefore, I would now invite you to have a brief look at the possible contribution of these policy areas towards ensuring that the potential benefits of EMU are fully realised and that the risks are minimised. The ESCB may be forced to tighten its policy stance in order to keep prices stable, if it is confronted with inflationary budgetary policies and wage developments. In this case, there may be transitory losses in terms of economic activity and employment in the whole euro area and, thus, the overall benefits of EMU may be diminished. However, given that the ESCB, according to the Treaty, has the obligation to maintain price stability, those economic policies which threaten price stability should ultimately be regarded as responsible for this undesirable result. How can this risk be avoided? It should be emphasised that a monetary policy which tolerated the inflationary impulse would not improve the situation - on the contrary, it would very likely lead to higher interest rates, increasing further the long-term risks to growth and employment creation. Thus, the only solution seems to be for all areas of economic policy to try to contribute to stable prices and, especially, to avoid measures which worsen inflation prospects. In this context, I appreciate that the European Council obviously takes this issue very seriously. The Luxembourg European Council based its agreement on economic policy co-ordination in Stage Three of EMU on the fact that national economic developments can have an impact on inflation prospects in the euro area as a whole and, thereby, will influence monetary conditions in this area . Thus, inflationary pressures stemming from national policies in some countries could have negative consequences for other parts of the euro area. Economic policy co-ordination should help to avoid such negative spill-over effects. As already indicated, in Stage Three national authorities will face a new environment, characterised by the Stability and Growth Pact, by the permanent prohibition of monetary financing of the government deficit, by the inability of monetary and exchange rate policy to react to purely country-specific shocks, and by the likely - but difficult to predict - changes in the shape of financial markets following the introduction of the single currency. Moreover, there will be a strengthened economic co-ordination among Member States in Stage Three . The significance of these changes, of course, may vary across countries, depending on the institutional environments and fiscal conditions as well as on the monetary and fiscal policy strategies prevailing in Stage Two. This new environment, in particular the Stability and Growth Pact, will provide a good basis for sound public finances and should help to further reduce government deficits. However, there are still some problems and risks, in particular as some countries may start with a deficit of close to 3%. In the case of an economic downturn in one or more of these countries, this would imply either a substantial constraint on automatic stabilisers or the risk of breaching the reference value. Thus, it is important to reduce deficits further to levels close to balance or in surplus. This is not only required by the Stability and Growth Pact, but also by economic rationality and by the need to avoid an overburdening of younger and future generations. Moreover, in Stage Three of EMU the option of using monetary and exchange rate policy in the event of country-specific problems in the real or the financial sector, including overly high labour costs, or with the aim of reducing the burden of financing a high level of government debt will no longer be available. To be sure, such monetary policy strategies did not and do not solve the underlying economic problems. However, by producing transitory improvements in economic conditions or by giving some relief to certain sectors which are in trouble, they sometimes allowed authorities to postpone the necessary and urgent reforms and policy measures. This will no longer be possible in Stage Three. The absence of a monetary policy oriented to the economic situation in individual member countries puts even greater premium on removing rigidities, particularly in product and labour markets. These markets should be flexible enough to allow wages and prices to be adjusted quickly. Such flexibility would be needed to avoid increased unemployment should local economic conditions worsen - due, for example, to an asymmetric shock or a relatively weak local productivity increase. Sufficient flexibility of national wages and prices could also be required if increases in indirect taxes and regulated prices were to contribute to rising area-wide inflationary pressures. In addition, national budgets should allow for sufficient room for manoeuvre to enable automatic stabilisers to work, while respecting the deficit limits of the Stability and Growth Pact. Unemployment in most EU countries, though showing signs of stabilising, remains unacceptably high. As the bulk of EU unemployment is of a structural rather than of a cyclical nature, the key factors for securing existing jobs and creating productive new employment opportunities are continued moderation in wages, lower overall taxes and social security contributions and a reduction in structural rigidities in labour and product markets. The prevailing structure of social security contributions, taxes and transfer payments in a number of EU Member States sometimes cause disincentives for employers to create new jobs. Labour market and fiscal reforms can contribute to increasing the incentives and the scope to create and offer new productive jobs. While such policies and structural reforms would support price stability and increase the benefits of EMU, they normally do not deliver employment miracles in the short-run. Their positive impact on employment will be stronger and quicker, if they are decisive and credible and if the private sector can be convinced that they will be sustained in the long-run. Under certain conditions as for example cost neutrality a policy of shortening working hours may also be an element in employment policies. I know and understand that it is sometimes rather difficult to implement structural reforms. Nevertheless, they are needed to reduce unemployment, independently of EMU. However, EMU makes them even more urgent and indispensable. To conclude, Monetary Union provides the great opportunity to create and maintain a large zone of price stability in Europe. However, while price stability is a necessary conditions for fully grasping the opportunities of EMU, it is not in itself sufficient. I am confident that policy-makers in all areas are determined to take the new environment of Stage Three and its consequences appropriately into account when forming their policies. Monetary Union, in this sense, offers the great opportunity to substantially improve living conditions in the medium-run. However, as I have explained, these gains will not come as a quasi automatic benefit of EMU. As regards the mandate of the ESCB to maintain price stability, I am convinced that the application of the convergence criteria and the institutional arrangements laid down in the Maastricht Treaty and the Stability and Growth Pact will guarantee that the ESCB will be a powerful institution which will ensure that the euro will be a stable currency.
r980130a_ECB	euro area	1998-01-30T00:00:00	The role of the future European System of Central Banks	duisenberg	1	With the single European currency moving from a distant dream to a virtual certainty, participants of this years' Davos World Economic Forum are devoting a considerable amount of time to the evaluation of the various implications of the introduction of the euro. The agenda quite rightly suggests that the start of Stage Three of European Economic and Monetary Union (EMU) is likely to trigger profound changes to the economic, political and social systems of the participating member states and inside the EU as a whole. Moreover, it is no exaggeration to state that the imminent merger of some European currencies into the euro will rank among the most important events that have influenced the international monetary system during the post-war period. The closer we come to the starting point, the more people are becoming aware that with the unprecedented simultaneous transfer of monetary sovereignty to an independent, supra-national European System of Central Banks (ESCB) we are entering unchartered waters. But that in itself does not preclude the rationality of the project. It only means that in such an environment great attention must be devoted to the preparatory work in order to avoid the ship running aground and the potential benefits of the expedition being offset. Obviously, the start of the necessary preparatory work could not await the establishment of the European System of Central Banks (ESCB) in May 1998. Therefore, a specific transitional body, the European Monetary Institute (EMI), has been set up at the future site of the ECB in Frankfurt in 1994. Its task is, inter alia, to specify the regulatory, organisational and logistical framework necessary for the ESCB to perform its tasks right from the start of Stage Three on 1 January 1999. In other words the EMI will provide the draft screenplay which, subject to the approval and amendments by the ECB, will be rehearsed during the second half of 1998. Moreover, the ECB will be able to build on the internal infrastructure of the EMI as the latter goes into liquidation immediately after the establishment of the ESCB. The preparations are well under way, facilitated by the fact that the institutional framework for the ESCB enshrined in the Treaty and spelt out in the Statute of the ESCB and the ECB contains very precise rules for the swift and smooth take over as the central bank of the euro area. As this will be the most important role to be played by the ESCB, I shall first concentrate on it. Subsequently, I would like to devote some minutes on the system's functions outside the euro area, acting as an anchor for the monetary and exchange rate policy of the EU Member States not yet participating in the euro area and progressively playing a role on the international monetary stage. But before developing these three roles of the ESCB further, it seems to be necessary to briefly introduce you to this new actor on the monetary scene. Whilst the name of the new currency, the euro, is today fairly widely known throughout the European Union, far fewer European citizens can name the central bank responsible for its management. This is certainly also due to the fact that the adopted concept of a dual layer central bank system differs substantially from the organisational structure of most national central banks. The ESCB consists of the national central banks of the Community and - at its decision-making centre - the ECB with the Governing Council as the supreme decision-making body for the euro area. The decision to opt for a federal system was taken because it corresponds best to the requirements for the new central bank and reduces the overhead to the minimum. With only some 500 staff members, the ECB can serve as a role model for a strong but efficient European administration. What is crucial is that the System will provide a monetary policy as a unified whole. The set of monetary policy instruments and procedures being prepared by the EMI will ensure that the Governing Council of the ECB and - for the day-to-day management - the ECB Executive Board are in a position to control the overall stance of monetary policy at all times, in conformity with the decision-making framework of the ESCB. Decisions will thus always be taken at the ECB level, whereas implementation will, to the extent deemed possible and appropriate, be executed in a decentralised manner by the participating national central banks. Reliance on the infrastructure and operational experience built up by the national central banks will undoubtly prove a valuable asset. The ESCB needs to be cognisant of the historically grown and substantial differences between national financial markets in the EU if it wants to successfully provide a level playing field for a broad range of counterparties throughout the euro area. This holds especially for the foreseeable period of rapid changes in market participants' behaviour also triggered by EMU itself. An additional feature of the ESCB structure is that - despite some important institutional changes - it provides the necessary continuity with European central banking experience. The creation of the ECB follows an evolutionary process which has led to convergent views on the role and functions of monetary policy among central bankers and that conditions not only the structure of the system but also the way it will operate in practice. The progressively closer co-operation of monetary policy authorities during past years will be fostered further following the pre-announcement of the bilateral conversion rates in May 1998. The same Governors who are conducting monetary policy co-operation today will be members of the ECB Governing Council determining the single monetary policy in Stage Three. The ECB as the focal point of best European central bank traditions can inherit the track record of the best performers entering the System. This statement seems to be confirmed by financial markets' expectations. Judging from long-term interest rates, market participants seem to be convinced that inflation will remain low in the euro area. Moreover, convergence of long-term interest rates towards the lowest level rather than the average indicates that a credible single monetary policy is expected. The decentralised structure of the ESCB is not inspired by the principle of subsidiarity which is often quite rightly "en vogue" elsewhere in the European integration process. The principle of subsidiarity applies only in areas which do not fall within the Communities' exclusive competencies, and is thus not applicable to the ESCB tasks. The national central banks are an integral part of the ESCB and shall act in accordance with the guidelines and instructions of the ECB. Hence, the decentralised of the system is based on the assumption that the single monetary policy is best executed locally. Moreover, the Governors of the participating central banks will not act as the representatives of their respective country or national central bank, but will act in a personal capacity with a responsibility for the entire euro area. This is, inter alia, reflected in the general voting rule -one person, one vote - which stresses the supra-national character of the ESCB's tasks the most important of which are Outside the framework of the ESCB - and acting as national agencies - national central banks may perform functions other than those specified in this Statute - for instance providing fiscal agent services to the government - unless these interfere with the objectives and tasks of the ESCB. I do not want to dwell on the crucial importance of the primary objective of maintaining price stabiliy. It is now widely accepted - not only in the central banking community but also in the academic world and among financial market practitioners - that only a monetary policy geared towards price stability can create the conditions for sustainable economic growth. An important element that may be worth mentioning, nevertheless, is that for the ESCB the objective of price stability concerns the whole euro area. It is the price level of the whole euro area that the single monetary policy will aim at stabilising. There will not be, and there could not be, differentiated policies for each region or country in the euro area depending on the prevailing inflationary conditions. It is recognised that the ESCB has been granted a high degree of institutional, personal, functional and financial independence, consistent with the desire of the political authorities that signed the Maastricht Treaty to put the ESCB in the best possible position to achieve its primary objective. The Treaty also requires that the Statutes of the national central banks be adapted to conform with that of the ECB. This process is under way and the Statutes of the NCBs, even those that were recognised as being among the most independent, are being upgraded to satisfy the Treaty's requirements. However, a high degree of independence will and should not seduce the ESCB into enclosing itself in an "ivory Eurotower", therebyalso running the risk of violating its second objective established by the Treaty which is - "without prejudice to the primary objective of price stability - to support the general economic policies of the Community." The harmonious economic development of the Community in Stage Three will call for a fruitful dialogue between the ECOFIN Council - which is at the centre of the economic decision-making process for the Union - and the ECB as the body responsible for the monetary policy of the single currency area. The Maastricht Treaty already provides for a number of formal communication channels between both, for instance the Economic and Financial Committee, bringing together senior officials from the national central banks and the ECB as well as from the finance ministries. In addition, I would like to mention the right of the President of the ECOFIN Council and a member of the European Commission to participate - without having the right to vote - in meetings of the Governing Council of the ECB. The Treaty provides in turn for the ECB President to attend ECOFIN Council meetings when it discusses matters relating to the objectives and tasks of the ESCB. Moreover, last month, in a resolution on economic policy co-ordination in Stage Three of EMU it was agreed that the finance ministers of the States participating in the euro area will meet informally - as the so-called Euro X - to discuss related issues with the participation, when appropriate, of the ECB. Formal and informal communication channels enabling both sides to explain to one another the policy actions for which they are respectively responsible are fully compatible with the independence of the ESCB. Moreover, they can prove very helpful for the participating member states to find the appropriate fiscal policy stance vis-a-vis a single monetary policy which, by definition, cannot accommodate specific national needs. I therefore very much appreciate that the European Council acknowledged the specific responsibilities of the member states of the euro area for the single currency. This will be helpful in order to avoid the ECB becoming a scapegoat for a wrong policy mix at an individual national level. The Treaty also provides for a comprehensive list of reporting commitments. The ECB shall address an annual report on the activities of the ESCB and on the monetary policy of both the previous and the current year to the European Parliament, the EU Council, the European Commission and the European Council. On the basis of that report, the European Parliament may hold a general debate. In addition, the ECB President and the other members of the ECB Executive Board may, at the request of the European Parliament or on their own initiative, be heard by the competent committees of the European Parliament. These reporting lines vis-a-vis EU institutions do not preclude the maintainance of well-established communication channels at national level. However, the respective political bodies involved should respect the fact, that in the EMU environment "their" central bank governor now has a responsibility for the whole euro area. Beyond these very precise reporting procedures one should not overlook the fact that, ultimately, the ESCB will be accountable to the European citizens on its ability to defend the purchasing power of their money holdings. If the ESCB does not perform a good job with respect to its primary objective, it will be penalised by the citizens, as savers, who will reduce their holdings of money balances in euro and ask for higher returns to compensate for the depreciation of their currency. The stability of the euro is the ultimate judgement of savers on the performance of the central bank. Communication with the general public will, therefore, involve the public announcement of a quantified definition of what the ESCB understands to be price stability; the publication of specific targets and details of their derivation - against which its policy performance can be assessed; and the explanation of deviations from the target and concomitant policy responses by the ESCB. This will increase the transparency of the ESCB's actions and thereby enhance its accountability. The ESCB should be as transparant as possible. Let me now briefly turn an eye on the external tasks of the ESCB, starting with its role as the anchor for the monetary and exchange rate policy of the Member States not yet participating in Stage Three of EMU, the so called "pre-ins". Not all EU Member States will initially participate in the euro area. Some have opted out - hopefully only for a relative short period of time; others might not yet have reached the necessary degree of economic convergence. In this context the question arises how the ESCB can help to avoid a division between those participating in the euro area and those outside giving rise to foreign exchange movements which could potentially endanger the internal market. I would like, first, to remind you that, except formally for the two opt-out countries, the Treaty establishes a political commitment for all EU countries to join the euro area and to adopt policies consistent with this aim. In particular, in stipulating that member states with a derogation shall continue to treat their exchange rate policy as a matter of common interest the Treaty provides for a further means for avoiding that exchange rate developments create distortions within the EU. This, by itself, will create a strong drive towards adopting sustainable economic policies that ensure stability and macroeconomic convergence. In this respect, the creation of the euro represents a catalyst, a force of attraction, that should foster stability also in the other EU countries. In addition, the Treaty foresees a number of explicit mechanisms for monitoring and co-ordinating Member States' economic policies in which the ESCB is involved. Such co-ordination aims at promoting economic convergence, thereby contributing to exchange rate stability. The third decision-making body of the ECB - the General Council - which includes the Governors of the central banks not initially participating in the euro area, will serve as an appropriate forum within the ESCB to discuss related issues and to monitor the functioning of the new exchange rate mechanism between the euro and the currencies of the other EU countries. This so-called ERM2 has been designed in order to supplement the aforementioned Treaty provisions and should - like a powerhouse - help current and future EU Member States to find their course to adopt the euro. As regards the main features of the system, I would only like to stress, that if they were to be in conflict with the primary objective of maintaining price stability, the ECB could suspend automatic interventions at the margins and that the ECB, too, will have the right to initiate a confidential procedure aimed at reconsidering central rates. The ESCB will play its role inside the EU, with of course extra-european repercussions. The international dimension of the euro and its potential as a major reserve and transaction currency are certainly more than a detail of EMU. I am convinced that, in the long run, a stable euro will prove to be an attractive investment opportunity. However, the valuation of a currency by the financial markets as expressed in the exchange rate cannot be administered but should be seen as the outcome of all other economic policies. Recent experience has repeatedly shown that exchange rate policies that are out of line with economic fundamentals eventually end in a major set-back with negative consequences for the ability of the country in question to attract international investors for quite some time. Article 109 of the Treaty, which deals with the external policies of EMU, provides some safety precautions against such failures which were spelt out further in the Resolution of the European Council meeting in Luxembourg one month ago. According to this Resolution, the Council may only under exceptional circumstances formulate general orientations for exchange rate policy in relation to non-EU currencies. These orientations will always have to respect the independence of the ESCB and be consistent with its primary objective of maintaining price stability. According to the Treaty, the competence to represent the Community internationally should follow the internal allocation of responsibilities for monetary, exhange rate and economic policy between the ESCB, the Council and the national Member States, respectively. However, representation in international organisations has to take account of those organisations' rules. Hence, many issues such as the ESCB's representation in the International Monetary Fund - where membership is confined to individual states and not open for the group of euro area countries as such - still have to be clarified. The ECB for its part will be well equipped to ensure that the euro area speaks consistently with one voice, which is a major asset in international fora. In conclusion, I am confident that the ESCB in conjunction with the other elements of a stability-orientated policy framework outside the realm of monetary policy - especially the strict implementation of the Stability and Growth Pact with its accompanying Council Regulations - will act as a credible guardian of a stable euro, a reliable anchor for future participating countries, and thereby will contribute to the stabilisation of the international monetary scene./.
r980205a_ECB	euro area	1998-02-05T00:00:00	EMU and the financial sector	duisenberg	1	Ladies and gentleman, I am very honoured to be asked to deliver the inaugural lecture of the Generale Bank chair. I would like to take this opportunity to discuss with you the current trends affecting the European financial sector and in particular the effects of European Economic and Monetary Union (EMU). The advent of EMU represents new opportunities and challenges for financial institutions and markets. EMU may create a new environment for the production of financial services and become a catalyst for change, providing a "critical mass" which will allow progress to be made in financial integration. Nevertheless, Monetary Union will, in many respects, only accelerate current trends. This is the reason why I should like to describe, first, where the European financial sector stands now, before considering the effects of EMU on financial markets and institutions. As I just indicated, I would like to set the stage by describing the current trends affecting the European financial sector. It is useful indeed to summarise briefly the most significant developments in the European financial system in order to give some flavour of the context in which EMU is going to take place. In my view, the European financial sector has been experiencing three major trends: (i) a general movement of deregulation and internationalisation; (ii) significant growth of financial markets, with effects on disintermediation, and (iii) rapid technological changes. Let me review them successively. First, in comparison with the very regulated financial systems in Europe inherited from the post-war period, most European countries have been liberalising their financial services industry, beginning in the mid to late 1960s, then more significantly in the 1980s and 1990s. A marked trend towards the privatisation and, in some cases, the demutualisation of financial institutions has also been observable in all countries. At the same time, European countries have progressively opened up their financial markets and institutions to foreign competition. This was partly the consequence of independent national legislation, but also resulted from the dynamics set in train by the Treaty of Rome, which received a new impetus with the Single Market programme. The most significant restrictions on capital movements in the EU were lifted by the mid-1990s. The Second Banking Co-ordination Directive, implemented by 1 January 1993, introduced the single banking licence, which allows credit institutions to establish branches or supply cross-border services to all European Economic Area countries without prior authorisation from the authorities of the particular country. One should also mention the harmonisation in the securities industry under the Investment Services Directive, implemented by 1 January 1996. Earlier, harmonised rules applying to some investment funds were introduced with the UCITS Directive, implemented by 1 October 1989. One indicator of such an evolution is the progressive internationalisation of banking networks. Effectively, the share of foreign branches in banks' total assets has increased continuously, to reach around 10% of the market for the majority of EU countries. In particular, the opening of banking markets in southern Europe was a major consequence of the Single Market programme. However, if one excludes the particular role of financial centres in countries like Ireland, Luxembourg and the United Kingdom, the level of internationalisation remains currently lower than in the United States, where foreign penetration is around 30%. The second major trend affecting the financial sector is the growth of securities markets. During the last 15 years, in Europe, intermediation between savers and investors has come to rely more on marketable instruments. The ratio of equities, bonds, certificates of deposit and commercial paper outstanding to GDP has increased significantly in most EU countries both absolutely and relative to traditional loans and deposits since the mid-1980s . Another feature of this pattern is the more active role of institutional investors in conjunction with population ageing, which increases the demand for fully funded pension schemes in many EU countries, as well as leading to increased precautionary savings for old age (e.g. via life assurance policies) even when there is a comprehensive social security pension system available. As a consequence, one can observe a trend towards disintermediation - a shift of services or functions away from the traditional loans and services offered by the banking system - even if banks still offer the most important instruments of intermediation in many countries. Third, technological innovation is leading to rapid changes in the financial sector, from the point of view of both financial "processes" and "products". I just want to mention a few examples of progress made in that area which have had effects on competition and performance. Firstly, in organised exchanges, new electronic continuous auction markets have been introduced since the early 1990s, particularly CAC in Paris, IBIS and, recently, XETRA in Frankfurt. Also, in derivatives markets, the Deutsche Termin Borse (DTB) now runs a fully electronic order-driven system with almost one-third of its members trading from workstations outside Germany. MATIF and LIFFE, traditionally specialised in open outcry systems, are currently also developing electronic trading systems. Secondly, in the banking area, the use of the Internet, as well as the development of electronic money are starting to affect the traditional distribution channels. Finally, computer-driven credit scoring systems challenge traditional bank-client relationships by reducing the information advantage of banks. Jointly with securitisation, these advances in information technology have been leading to the "unbundling" of banking activities (see Rajan, 1996), in the sense that activities formerly operated by a single bank are now processed by separate financial institutions. This paves the way for the entry into the industry of new players, in particular non-banks. One of the most recent examples is the growth of "supermarket banking" (where food retailers offer competitive deposit facilities and an increasing array of other financial services in-house) in the United Kingdom. All these trends are bringing about substantial change in the financial sector, leading to the narrowing of intermediation margins and a reduction in profitability. In such a context, EMU represents new challenges and opportunities that I want now to discuss, considering financial markets and institutions successively. The Single Currency will have significant effects on financial markets. The most immediate changes will affect the foreign exchange markets. Cross-trades between the currencies participating in Monetary Union, which currently represent about 10% of total transactions, will disappear. Demand for foreign exchange hedging transactions will also experience further reductions, although the bulk of such transactions usually involve the US dollar and should not be affected by EMU. New activities may also emerge, in particular those associated with the use of the euro as a reserve currency, but this will only develop as the euro becomes established. More predictable, though, are the likely effects of EMU on money and securities markets, on which I wish now to focus. EMU will have very significant effects on the money markets. The single monetary policy will create a new environment, to which the current money markets will have to adapt. The new framework for the implementation of the single monetary policy will create the necessary conditions for the integration of European money markets. First, the technical infrastructure to support a large European money market will be provided by the interlinking of real-time gross settlement (RTGS) systems through TARGET. Large cross-border payments denominated in euro will therefore be processed as smoothly as if they were domestic payments. Initially designed to carry out the single monetary policy, TARGET might also be available for other kinds of transfers as an alternative to private netting systems (such as the ECU Clearing), mainly at the wholesale level, and should therefore contribute substantially to reducing the kind of systemic dangers to which netting systems are exposed. Second, the ESCB will rely on monetary policy instruments designed to create a deep and liquid money market at the EU level. As indicated in the "Framework Report" published in January 1997 by the EMI, and explained in more detail in the so-called "General Documentation" published in September 1997, the ESCB will rely on open market operations as well as on standing facilities. The interest rate corridor between the latter (the deposit and the lending facilities) is expected to be relatively wide, although it may depend on the exact parameters chosen by the ESCB. Since these two rates are designed to bound overnight market rates, the likely width of the range means that significant leeway will be left to banks to manage their interest exposure, therefore encouraging market development. The ESCB will also rely on a broad range of counterparties. In addition, the ECB Governing Council might decide to make use of reserve requirements, and the averaging provisions mechanism might be viewed as contributing to increasing the volume of the interbank market. Compared with alternative ways of controlling volatility in the interbank market, reserves with averaging facilities will have the advantage of assigning a central role to market forces and of not requiring the central bank to be frequently in the market. Equal treatment of counterparties and the reliance on market-based policy instruments are consistent with the requirement, enshrined in the Maastricht Treaty, that the ESCB "shall act in accordance with the principles of an open market economy with free competition". One might anticipate that not only the harmonisation effect of the single monetary policy, but also the greater level of competition will progressively reduce arbitrage opportunities linked to liquidity differentials. However, the US case shows that it has not hindered the development of large money markets. In particular, the decision that the ECB will use reverse transactions as the main instrument for implementing monetary policy might provide a strong incentive for the development of an EMU-wide private repo market, where financial and non-financial entities may engage in short-term collateralised refinancing operations for conducting day-to-day treasury management (see Schinasi and Prati (1997)). The single monetary policy will, however, require market participants to adapt to the new environment. First, the harmonisation of Monetary Policy Instruments and Procedures (MPIPs) at the start of Stage Three will have an impact on banks' refinancing. New facilities will be introduced, requiring further adjustment of techniques towards greater use of interventions at market rates in some countries. Of course, some countries have already made some adjustment (such as the use of repos by the Bank of England, development of the short-term money market in Germany) and changes realised in the past did not prove to be too difficult to implement for many countries. For a few other countries, however, the adjustment will be more significant. Second, in order to accommodate differences in financial structures across countries, two tiers of eligible collateral are to be allowed for monetary policy operations: the first one includes instruments that are common to all countries, while the second comprises marketable and non-marketable financial obligations as well as, in some cases, equities traded on a regulated market. In the case of Tier 2, the assets and eligibility criteria are established by each NCB, under ECB guidelines and with its approval. This would, for example, allow the inclusion of a large volume of trade bills and bank loans in Germany and France. It should finally be noted that very significant progress has already been achieved in the direction of the integration of European money markets, as is evidenced by the convergence of monetary policy intervention rates, as well as the nearly identical money market and swap yield curves over the past two years for the Belgian franc, the Deutsche Mark, the Dutch guilder and the French franc regarding maturities from one week to two years. EMU will also have an impact on securities markets. First, EMU creates the potential for the emergence of deeper and more liquid financial markets. Second, it will have effects on the nature of products offered. Regarding the size of financial markets, EMU will offer EU countries the opportunity to compete in size with the United States and Japan. The capitalisation of existing (domestic and international) debt securities and equities in the EU-15 area amounted to 12,500 billions dollars at the end of 1995, as compared to 27,000 billions dollars for the US and Japanese markets taken together, on account of the large size of the EU domestic bond markets. The greater depth and liquidity of EU markets after the introduction of the Single Currency, as well as the strength and the stability of the euro, may also attract additional investors from outside the euro area. Regarding the nature of products offered on EU securities markets, EMU may have significant effects. First, one can expect that the disappearance of foreign exchange risk means that credit risk will become more important in relative terms, which may lead to the emergence of a "credit risk culture" in the management of debt instruments. While this will be favoured, in particular by the implementation of the "no bail-out" clause - which will have an impact on the rating of public debt, in the sense that domestic issues are likely to receive ratings similar to those currently attributed to foreign issues (see BIS (1996)) - fiscal discipline and the strict application of the Stability and Growth Pact should reduce credit differentials to a minimum . Of course, a "credit risk culture" would also depend on the existence of a system of rating agencies really adapted to the needs of European investors. In countries where banks hold a significant proportion of government bonds (France, Germany, Belgium and Luxembourg), banks will have to adjust their portfolios in the light of perceived variations in this credit risk. At the same time, the zero credit risk weighting for zone A government debt (which includes all EU countries' government debt) in the solvency ratio regimes will provide a strong incentive to invest in government bonds. Investors will also pay more attention to the liquidity characteristics of financial markets. Second, one could witness in the very near future the creation of a unified European capital market for prime borrowers. This would include the emergence of a single reference bond yield curve, as well as a European equity market for blue-chip stocks. Such markets would, however, not cover the whole spectrum of issuers, since securities from small and medium-sized companies would probably remain national. The latter compartment of the market will probably remain, to a large extent, separated, since investors' home bias is likely to remain important, because of asymmetric information, tax differences, or attempts by national centres to protect their market shares. Third, other markets may also develop. The Stability and Growth Pact will, by constraining fiscal policy and imposing limits on government deficits, reduce governments' recourse to the capital market, hence creating room for other issuers. In addition to population ageing, it will put additional pressures on pay-as-you-go pension systems in favour of funded ones. Non-government bond and equity markets should therefore grow, accelerating the general movement towards disintermediation. In addition, to the extent that the operational framework for monetary policy increases the demand for private paper, it will have an effect on financial market structures, by creating the "critical mass" which will allow new products to be sufficiently competitive to expand significantly. This will increase the scope for securitisation; it might even lead to the emergence of a low-grade bond market in addition to the market for prime borrowers. One qualification, however, is that, if securities markets are to expand and become more diversified to compete on an equal basis with the United States, securities settlement systems will have to further improve and develop significantly. Fourth, EMU will also have an impact on derivatives markets. Products linked with short-term interest rates will suffer falls in trading volumes, since the single monetary policy in Stage Three implies that there will be only room for one leading short-term contract. This may have consequences for the 16 European futures or options markets (including Switzerland). As far as long-term contracts are concerned, the coexistence of more than one reference bond market will not be a durable feature, so that one can anticipate either a single contract - although this may imply co-operation between financial centres, as it is currently the case between DTB and MATIF - or several identical ones with similar characteristics (margins, opening hours). Financial institutions constitute the backbone of the financial sector. In addition, given the progressive institutionalisation of financial markets, they are the ultimate participants. They will naturally be at the forefront of the changes ushered in by EMU. Following the standard (albeit sometimes criticised) paradigm in industrial economics, namely the Structure-Conduct-Performance approach, I wish to consider now how EMU will affect the nature of financial institutions' activities and their competitive environment. Then I shall deal with the effects of EMU on the performance of financial institutions. The single currency as well as the development of deeper financial markets create two challenges for financial institutions. First, it may reinforce securitisation in the "narrow sense" as well as in the "broad sense" of a growing use of instruments tradable in financial markets. Second, it will intensify competition. EMU is likely to increase the size of securities markets so that securitisation in the "narrow sense" - i.e. the transformation of banking assets into tradable securities through financial engineering - will make further progress, offering banks more flexibility in terms of asset/liability management. At the same time, with securitisation in the "broad sense," the competitive disadvantage of traditional bank intermediation vis-a-vis financial markets and non-banks is likely to increase, with differential effects on deposit collection and credit activities. On the deposit side, banks are likely to increasingly face competition from institutional investors. Following the disappearance of foreign exchange risk, limits on portfolio diversification by institutional investors, like the "currency matching rules", are likely to be applied only outside the euro area . This will boost the cross-border investment activity of institutional investors. As a consequence of the changing nature of demand, with the greater use of mutual funds, the maturity of banks' deposit-taking may become shorter and deposit collection more costly. On the asset side, greater competition in the securities business will coexist with the persistence of asymmetric information in lending activities. In the latter case, the need to have a direct link with borrowers means that traditional financial intermediation is likely to remain substantial, in particular lending to small and medium-sized enterprises, for whom access to the securities markets is more difficult. Therefore, EMU represents both challenges and new opportunities, since, in this new environment, institutions currently involved in fee-generating activities, or offering services linked to financial markets, will have a competitive advantage in the faster growing segments of the financial sector. On the other hand, EMU will increase competition among financial institutions. Note that national banking markets are today relatively concentrated, more significantly so in the smaller countries. Against this background, EMU will, by removing the last obstacle to the circulation of financial services across European countries, induce, at least in the first years, a significant increase in competition. Using data provided by IBCA, a rating agency, one can compute an upper bound for the level of concentration of assets, loans and deposits, as measured by the share of the five largest EU credit institutions. Concentration ratios might be between 10 and 11% (between 13 and 14% for universal banks), as compared to 18% in the United States in 1993 (OECD, 1995). This reveals that there may exist some scope for further consolidation in Europe, in continuation of the trend observed in the late 1980s and early 1990s. To assess the overall effect of EMU, it is however useful to distinguish between wholesale and retail markets. Wholesale markets are already significantly internationalised and competitive, but competition in these markets will nevertheless evolve over time. The single currency will imply a further redistribution of banking activities to the extent that competitive advantages, partly based on the existence of national currencies, will disappear. In particular, the "anchoring principle" imposed by some central banks and requiring domestic financial institutions to lead manage bond issues will, if maintained, be enlarged to a wider zone, or even disappear . In addition, the main currency-based competitive factor, namely the expertise in the domestic monetary environment will, according to Dermine (1996), disappear. However, other competitive factors are likely to be unaffected by the single currency in the short run. These include the existence of a distribution network of customers, as well as access to information on supply/demand flows, which help to assess the direction of price movements. Regarding mergers and acquisitions, the knowledge of the accounting, legal and fiscal environment also remains an important determinant. However, all these competitive advantages are not irreversible and may be progressively eroded by EMU. In addition, the importance of the size factor (i.e. the cumulative advantage of controlling a large market share, hence the ability to operate on a larger scale) indicates that current positions may be progressively overturned by European or even by other global players. In retail banking markets, EMU will induce further progress in payment systems, both directly and via interaction with technological innovation, the major driving force behind changes in payment systems. For instance, technological innovation may itself be fostered by the transition to the single currency. In particular, the liberalisation of telecommunications, favoured by the Single Market that EMU is due to complete, may lead to a more widespread use of phone, PC and Internet banking. Network-based e-money payments may also benefit from a global and highly competitive market. Changes in competition may therefore be expected to be more pronounced on the liabilities than on the assets side. In particular, remote access to banks in other Member States will become very easy in the context of a single currency and branches may lose their relevance as distribution centres of deposit products. Regarding the assets side, Monetary Union will enable operations in any national market to be financed through deposits obtained in the home country, hence also facilitating the remote supply of financial services. Consequently, competition in some segments of the market is likely to increase. This is the case of activities which are relatively homogeneous and closely related to the deposit function, like consumer credit and standard mortgage loans, as opposed to small-scale commercial loans and specialised consumer loans which require more direct contact with customers. On the other hand, there still exist legal, fiscal and institutional obstacles to full integration that will limit the effects of competition. However, being more visible in the single currency area, they may trigger further pressure, leading to their progressive disappearance. The move to EMU offers challenges for financial institutions. While the changeover process imposes constraints in the short run, the medium-term effects on the performance of these institutions will, in my view, certainly be positive. One should not deny that the changeover to the euro is a major undertaking which is costly for financial institutions. The changeover scenario agreed in Madrid in December 1995 is designed to minimise costs by adopting a decentralised approach. It is the principle of "no compulsion, no prohibition", which allows institutions to choose the most appropriate way and the pace at which they upgrade their operational systems. Costs vary across institutions depending on their activities. While being apparently low for firms active in securities business, costs would be higher for institutions specialised at the retail level, given their role of intermediaries, during Stage Three A (1999-2002), between agents and institutions proceeding at different paces regarding the introduction of the euro. Conversely, securities firms already operate in a multi-currency environment. It is interesting to note that various estimates tend to show that smaller and/or more specialised institutions may not always be disadvantaged, although their lower cost of organisation may in some cases be more than offset by limited expertise. Adequate planning and timing of the changeover seems to make a difference, since some changes are due to be made independently of the advent of EMU, in particular regarding preparations for the year 2000. In the medium run, however, I see the costs of the changeover as a profitable investment for financial institutions. First, in a few instances, the move to Stage Three may help reveal organisational deficiencies at the level of institutions, the solution of which will, in the end, prove decisive in improving the competitiveness of successful European institutions. Similarly, the time-consuming process of the harmonisation of market conventions and codes of practices (day counts, business days, reference rates...) will not only ensure the continuity of operations when moving to Stage Three of EMU and the smooth functioning of the area-wide money market based on the euro, it will also promote the fungibility of instruments across countries, a necessary condition for the creation of deeper financial markets (see the Giovannini Report). Second, institutions will probably gain from returns to scale associated with activities extended to the EU area level, leading to the constitution of global players able to compete with non-euro institutions. One should, however, acknowledge that the economic literature does not provide clear evidence in favour of very significant returns to scale in banking. Similarly, regarding the existence of economies of scope that may justify the existence of large universal banks, the literature is, again, inconclusive. There is, at most, evidence of small gains of joint production for liquidity management, treasury and dealing activities, risk management and payment systems. There is also only anecdotal evidence that returns to scale in money market operations may also imply the concentration of other activities. However, although it is quite speculative to predict how banks will exploit possible returns to scale and react to potential competition, one possible scenario is that EMU will lead to the coexistence of a few Europe-based global players, alongside smaller institutions specialised either in given product groups or in specific regions. It is also difficult to predict which strategy will be preferred by banks after EMU - (1) specialising in specific "niches" involving particular skills; (2) building new strategic alliances among universal banks; or (3) accelerating the movement of concentration through mergers and acquisition. Third, from a more macroeconomic point of view, the priority given to price stability in Stage Three should provide an enhanced environment for the production of financial services. Less volatile inflation and interest rates are good for banks' customers, and hence for banks. They will also benefit from higher expected economic growth via lower interest rates supported by a strong euro. Thus, EMU may increase the competitiveness of the whole European banking industry, and in particular of the international banking groups. EMU will certainly have a major impact on the European financial sector. Of course, all trends currently apparent should not be exclusively explained by the "EMU factor". However, the single monetary policy will generate new activities, in particular in connection with the emergence of larger and deeper financial markets. In addition, competition is likely to increase significantly with the single currency, as one of the major obstacles to financial integration will disappear, although retail banking markets will keep, at least at the beginning of EMU, many of their "local" features, in particular those due to tax differences. Other speakers in this Lecture Series will come back later to this issue of tax convergence. Let me finish by indicating that the objective of the EMI is to ensure that the move to Stage Three takes place as smoothly as possible. Work to establish the infrastructural support for the conduct of the single monetary policy in areas like payment systems and statistics is broadly complete. The operational framework for monetary policy has been set out in detail. The ECB Governing Council will make the last few necessary adjustments in good time. Market participants are adapting their accounting and operational systems and can now define their strategies. Provided that the supply of financial services is adequately priced (this would require that all banks do not decide to invest in the same sectors and do not lend imprudently to new customers), I am convinced that financial institutions will soon reap the benefits of EMU. , August. Davis, E. P. (1997) "The role of institutional investors in the evolution of financial structure and behaviour" LSE, . Giovannini Report (1997), "The impact of the introduction of the euro on capital markets", European Commission. .
r980216a_ECB	euro area	1998-02-16T00:00:00	The ESCB: independent, transparent and communicative	duisenberg	1	Undoubtedly, the establishment of European Economic and Monetary Union is one of the most significant developments in the international monetary system in the last fifty years. Although the United Kingdom has decided to make use of its opt-out negotiated at Maastricht, whether "in" or "out", the introduction of the euro will have a significant impact on the UK economy. I should like, therefore, to devote the first few minutes of my speech to the question of the United Kingdom's position on EMU. However, I have chosen as my main theme this evening to talk about a number of key features of the ESCB. The ESCB will be independent, and I shall try to explain the background to this and what it means. I shall also discuss the issue of how central bank independence can be combined with accountability, with transparency in decision-making, and the way in which the ESCB may conduct a fruitful dialogue - an exchange of views and information - with government ministers, European institutions (such as the European Parliament), social partners and the general public. These are, of course, issues with which you will be familiar in the United Kingdom, not least because they have recently been discussed in this country in the context of the establishment of new arrangements for the conduct of monetary policy by the Bank of England. Let me say, first of all, that of course I respect the decision as regards the opt-out made at the end of last year by the UK Chancellor of the Exchequer. On the one hand, I think it is unfortunate that such an important country as the United Kingdom will not participate from the outset. However, it was useful to end the speculation and uncertainty that surrounded the UK's position and I was pleased to hear that the government not only is in favour of joining EMU in principle, but also plans to assess this in terms of the economic benefits to the United Kingdom. The debate in the United Kingdom very often focuses on the political aspects or, if you want, the more psychological aspects of the matter. The Chancellor in my view rightly made it clear that EMU also needs to be assessed on the economic merits of the case. As to the possible entry of the UK to the euro-area, I only want to mention very briefly one particular issue. That is the issue of exchange rate stability of the pound sterling. Even allowing for the fact that the United Kingdom is not a member of the ERM, which according to the Treaty is a criterion for entry to EMU, there has not been a high degree of stability of the exchange rate. Achieving lasting exchange rate stability will be necessary for the UK to be eligible to join the euro-area. In the future, this will require an increased emphasis on the exchange rate vis-a-vis the euro in the framework of the UK's monetary policy. I make this point not just for the sake of formality, because it is required in the Treaty. Above all, I say this for economic reasons: to strengthen credibility and inspire confidence in the irrevocable fixing of an exchange rate at a certain point in time, it is necessary that for a considerable period prior to that moment that exchange rate is perceived by the markets as stable, or "quasi-fixed", already. After all, this is the fundamental reason why the so-called exchange rate criterion was included in the Treaty in the first place. But let me now turn to the main subject of my talk. Before considering the independence of the ESCB as set out in the Maastricht Treaty, it is worth looking briefly at the historical background. Significant changes have taken place in the thinking with regard to the role of monetary policy in the last two decades. There has been a growing recognition, perhaps stemming from the turbulent experience of the 1970s, that in the long term monetary policy can only systematically control the price level and not real economic variables such as output growth or unemployment. Over a shorter horizon, monetary policy does indeed affect both real and nominal variables. However, it is by now widely accepted among policy-makers and in the academic literature that any deliberate attempt to exploit the short-run trade-off between prices and output is ultimately going to result in a permanently higher and more variable rate of inflation, with significant adverse consequences for resource allocation, long-run output and employment, productivity growth, as well as the income distribution. Against this background, the primary goal of monetary policy has increasingly become the achievement and maintenance of price stability, with any other economic objectives receiving emphasis only to the extent that price stability is not endangered. This is a recognition of the adverse consequences of inflation and of the efficacy of monetary policy in this field, while at the same time being an acknowledgement that there are limits to what monetary policy can achieve. Primarily, the monetary authorities can support job creation and the attainment of higher living standards by fostering a stable macroeconomic environment in which business decisions can be made. Partly as a consequence of this widespread consensus regarding the limits of monetary policy, there has been a tendency to delegate responsibility for conducting monetary policy to independent central banks, as the most appropriate way of ensuring price stability oriented policies. Modern economic theory emphasises the inflationary bias in economic policy, which relates in particular to the so-called time-inconsistency issue, i.e. the problem of convincing financial markets and the general public that the monetary authorities will resist the temptation to stimulate output growth in the short run by creating "inflationary surprises". The public may lack faith in the authorities' promises to maintain low inflation if the authorities have succumbed to the temptation in the past. Unless these promises are underpinned by a credible form of pre-commitment, the equilibrium inflation rate will be higher than is needed, with no better performance in terms of output - and possibly even a deterioration. As a solution to this problem, it has been suggested that responsibility for monetary policy be separated from political control and that this should also be enshrined in legislation. According to this view, central banks should be given the freedom to formulate and execute monetary policy in line with their primary objective as determined by the legislator. This allows central banks to take a medium-term orientation and not to be distracted by short-term political motives, an approach which benefits the credibility, transparency, predictability and efficiency of monetary policy. In line with the foregoing analysis, more and more EU central banks - but also an increasing number of central banks outside Europe as well have over time been assigned the task of guaranteeing price stability, either explicitly by national law, or more informally as a reflection of an underlying culture of stability. In many cases, these reforms went hand-in-hand with the move towards a greater degree of central bank independence. This rather broad consensus - both with regard to the role of monetary policy and the appropriate institutional arrangements for its conduct - had been broadly reached prior to the initiation of deliberations on the design of the future ESCB. In this respect, we have been in the rather fortunate position of being able to utilise and implement this consensus in the design of the future ESCB; the fruits of this quite long monetary policy "soul searching", so to speak, are evident in the design of the ESCB. Thus, in the institutional arrangements for Stage Three of Monetary Union, as set out in the Maastricht Treaty and the ESCB Statute, the primary objective - the maintenance of price stability - is stated explicitly. The Treaty also states that, without prejudice to this objective, the ESCB shall support the general economic policies in the Community. Both the Treaty (in Article 107) and the Statute of the ESCB (in Article 7) contain very clear provisions regarding the independence of the ESCB. To quote a key sentence: "neither the ECB, nor a national central bank, nor any member of their decision-making bodies shall seek or take instructions from Community institutions or bodies, from any government of a Member State or from any other body". Moreover, the aforementioned authorities shall also - and I quote again - "undertake to respect this principle and not seek to influence the members of the decision-making bodies of the ECB or of the national central banks in the performance of their tasks". For national central banks to become an integral part of the ESCB, Member States have to ensure that national legislation is compatible with the Treaty (Article 108) and the Statute of the ESCB (Article 14). This obligation of legal convergence does not require the full harmonisation of central bank statutes, but does insist that inconsistencies with the Treaty be eliminated in respect of features such as institutional, personal, functional and financial independence. With the exceptions of Denmark and the United Kingdom, this requirement applies to all Member States, including those which may initially be unable to adopt the single currency owing to insufficient economic convergence. Member States have made significant progress in recent years in amending their central bank statutes where needed in order to fulfil their Treaty obligations. For those interested in further details, I would refer you to the EMI's report on legal convergence published last October, which contained a detailed account for each country of the provisions which would still need to be adapted. An update of this will be included in the EMI's convergence report which is currently being prepared. The importance of these institutional arrangements for creating an appropriate monetary policy setting in Stage Three of EMU cannot be underestimated. The essence of good monetary policy is a sound institutional design and I would like to illustrate this by reference to the following two arguments. First, these arrangements underline the continuity with the experience of those EU central banks with the most successful track record in terms of price stability over the past decades. In fact, in legal terms the ESCB will enjoy an even higher degree of independence than the most independent national central bank at present. Moreover, these legal arrangements are firmly anchored in the Maastricht Treaty and could thus only be changed by a Treaty revision. As you know, this is a very difficult and time-consuming procedure, involving both the European Parliament and all the national parliaments, which thus ensures that such a step is not taken lightly. This brings me to a second point, namely that initially the ECB will have no track record of its own, although it may inherit some of the credibility of the national central banks that are part of it. This implies that financial markets and the general public will assess the performance of the ESCB to a great extent on the basis of the effectiveness of the monetary policy framework adopted and the ability to act in accordance with its primary objective. Taken together, these two arguments make it clear that the independence of the ESCB underpins the credibility and effectiveness of the single monetary policy and is thus a key condition for the maintenance of price stability in the euro area. Given this legal framework, the Governing Council of the ECB will be able to decide on the basis of its own judgement on the scope and timing of monetary policy actions and how they should be executed. Naturally, in its assessment the Governing Council will take account of a wide range of relevant factors - including the state of the economy in the Monetary Union - but always with the focus on price stability. This does not imply, as is sometimes suggested, that the secondary objective of providing support to the general economic policies in the Community has no real meaning. Nevertheless, under its mandate the ESCB can only pursue this additional goal provided it does not prejudice the primary objective of price stability. Moreover, as said, the best contribution monetary policy can make to a sustainable growth of income and employment is to pursue price stability. Price stability is not inconsistent with these ultimate goals of economic policy, but rather a pre-condition for their achievement on a durable basis. The benefits of central bank independence have also been appreciated in the United Kingdom, with the recent granting of operational independence to the Bank of England. Nonetheless, there is an important difference between the "operational" independence of the Bank of England and the type of independence which the ECB will enjoy. The ECB will be free to choose the timing and the extent of adjustment of the relevant instruments, as the Bank of England is now, in order to pursue its objectives. However, the ECB will also be responsible for setting its monetary policy target; while in the United Kingdom the government formulates the objective, which the Bank of England has to pursue. Central bank independence has already proved to be a key institutional ingredient for achieving and maintaining price stability. However, I think that we would all agree that independence needs to be complemented by accountability. As a matter of principle, in a democratic society there is clearly no room for a lack of accountability in public institutions, and the ESCB, being an important public institution, must be accountable. In turn, accountability requires effective communication, since otherwise it would seem difficult, if not impossible, for any central bank to be held properly accountable. I am aware that it has sometimes been argued that there is a so-called "democratic deficit" in the current arrangements at an EU level ; that the ESCB will be a powerful, but "unaccountable", institution. I disagree with this view. The ESCB cannot afford, any more than existing European central banks, to contemplate the conduct of monetary policy "in a vacuum". The ESCB has to be accountable, and this has to be underpinned by a high degree of transparency and an active communications policy. But apart from the democratic duty of the ESCB to be accountable, coherence and being communicative also serve other practical purposes. For instance, well constructed and well explained monetary policies can influence the expectations of private agents, such as trade unions and employers. Market expectations are of importance for the effectiveness of monetary policy measures and clear as well as transparent and predictable policies may enhance and facilitate the conduct of monetary policy. Let me give you an example. If the central bank is known to react to excessive wage demands by raising interest rates, thereby stabilising prices at the cost of a temporary reduction in output and employment, the excessive wage demands may not occur in the first place. Thus, if economic agents understand how the central bank will react, the need for monetary policy measures - and the consequences in terms of foregone output and employment - may be substantially reduced. In addition, coherent and well-explained monetary policies are also needed in order to enable the national authorities to conduct compatible policies. This applies, in particular, to the overall fiscal policy stance in the Monetary Union. Monetary and fiscal co-ordination may be difficult in an environment of unpredictable and poorly understood monetary policies. Although the benefits of transparency and of being communicative are indisputable, the question is how best to organise such a process - and particularly a constructive dialogue with other policy-makers - as well as establish communication links with markets and the general public. The current situation in Member States is that the governor of the national central bank finds a natural sparring-partner in the minister of finance, with whom frequent contacts exist, often on a weekly basis. Sometimes the question is asked, "who will the governor of the ECB have breakfast or lunch with?" (referring to the arrangements in the United States and the Netherlands). In the environment of Stage Three, the situation is more complicated, but the Treaty does contain some provisions in this regard. The President of the ECOFIN Council (and also a member of the Commission) may participate in the meetings of the Governing Council of the ECB, without the right to vote (Article 109b.1). The President of the ECB will be invited to take part in meetings of the ECOFIN Council when matters relating to the objectives and tasks of the ESCB are on the agenda (Article 109b.2). Furthermore, in addition to the national central banks, the ECB will participate with two members in the meetings of the Economic and Financial Council, the successor to the current Monetary Committee. Since the ECOFIN Council also includes delegates of EU countries that do not participate in the single currency, the decision has been taken to establish a forum made up of representatives of participating countries. It is currently called euro-x, until the number of euro countries is known. In view of the fact that the institutional provisions of the Treaty do not mention the creation of a new Community body with restricted membership, such a forum can only exist in an informal capacity. It goes without saying that the statutory independence of the ESCB is not in any way affected by its deliberations. Such a forum may play a role in organising an efficient dialogue between the ECB and national governments of the euro area countries. With regard to the currently envisaged arrangements, the President and the other members of the Executive Board of the ECB, at their own initiative or on request, may also be heard by the competent committees of the European Parliament (Article 109b (3)). In October of last year, for instance, I had the pleasure of addressing the members of the Monetary Sub-Committee of the European Parliament on the progress of the move to Stage Three of EMU and the main challenges facing the EMI in the near future. I have already been invited and accepted the invitation, to present the EMI's convergence report, which will be released on 25 March 1998. In order to facilitate the exchange of views, and to achieve its statutory objectives, it will be necessary for the ESCB to be as transparent as possible in its conduct of monetary policy. In addition to the means already described, the Treaty requires the ECB to publish an annual report covering the single monetary policy and other activities of the ESCB. The President of the ECB presents this annual report to the Council and the European Parliament, which on that basis could subsequently hold a general debate. For a fruitful dialogue with the ESCB it is crucial that its mandate of achieving price stability is respected and that it is acknowledged that it cannot be made responsible for short term employment objectives. Reports on the activities of the ESCB will also be published during the year, at least quarterly, in addition to weekly financial statements. The ESCB will announce a quantified definition of what it understands "price stability" to mean in terms of its Treaty obligations. The publication of specific targets for monetary policy, and an explanation for any deviations from the target together with an explanation of the policy response, will facilitate an assessment of its policy performance. This will further add to the transparency of the ESCB and thereby enhance its accountability. All these provisions - to which I may add the expectation that in the future there will also be many speeches to the public and statements to the press - will clearly promote the understanding of monetary policy objectives, intentions and actions. They thereby support the effectiveness of monetary policy. At the same time, the Treaty recognises that the ECB cannot be made responsible for outcomes in terms of inflation month-by-month, since there are lags between a change in the course of monetary policy and its effect on prices. Moreover, in the short term, the inflation outcome may reflect the incidence of certain temporary factors over which the ECB has no control. To conclude, I have set out this evening to provide you with a description of some of the key features of the ESCB, which will be founded three months from now. The ESCB will be a powerful institution. Of that there is no doubt. It will be independent of political influence in pursuing the goal of achieving and maintaining price stability, as delegated to it under the Maastricht Treaty. The preparations and institutional arrangements are in place to enable the ESCB to fulfil its obligation to maintain price stability within the euro area. Monetary policy has, therefore, to be conducted and also be assessed in a medium term framework. In the pursuit of its statutory objectives, it has to be an open organisation, so that the policies of the ESCB are clearly understood by national and European political bodies, financial markets and by the general public. The ESCB has to engage in an exchange of views and information with these parties. Ultimately, of course, the ESCB will be held accountable to the general public through its record of achieving price stability. And this accountability has to be underpinned by both the transparency of its monetary policy actions and an effective communications policy.
r980305a_ECB	euro area	1998-03-05T00:00:00	The euro and the process of European integration	duisenberg	1	Mandeville, after whom this series of lectures is named, emphasised even before Adam Smith that individuals who strive for their own interests may unintentionally bring something about which is in the interests of all. He can thus be seen as one of the founders of the philosophy behind the market mechanism. What is required to make this market mechanism function properly is a set of institutions. A healthy currency unit and a central bank to watch over it belong to this group of necessary institutions. The question as to the extent to which institutions can be designed, or rather must be the result of a spontaneous, evolutionary process of individuals striving for their own interests, is a fundamental issue. Mandeville would tend towards the latter view. I am, as you know, no philosopher, so I will not attempt to formulate a fundamental answer to this fundamental question. Intuitively, or if you prefer, amateurishly, I am inclined to think that this is not a simple matter of 'either... or', but that both approaches can play a role. Any other response would sound strange coming from the President of an institution which has the singular task of designing new institutions - the euro and the European Central Bank - and making them work to everybody's satisfaction. These opening remarks bring me straight to the matter in hand: the huge institutional change in monetary affairs in Europe which is now at hand. 1998 is an important year for Europe. This year - in eight weeks' time to be precise - the decision will be taken as to which countries will introduce a single currency, the euro, on the first of January 1999. In just three weeks' time the decision-making process will start formally with the publication by the European Monetary Institute and the European Commission of reports assessing the progress made by the various countries with regard to economic convergence. The European Commission will attach a recommendation to its report as to which countries are ready for the introduction of the euro. The European Parliament will publish an opinion and national parliaments will also debate the selection issue. All this will culminate in the first weekend in May, first in a recommendation by the Finance Ministers, and the same weekend, in the decision by the Heads of State or Government on the participating 'euro countries'. Subsequently, bilateral exchange rates will be announced against which the currencies of the euro countries will be converted to the euro. With the appointment of the members of the Executive Board of the European Central Bank, according to the Treaty of Maastricht, this institution will be established, and 'my' institution, the European Monetary Institute, will go into liquidation. This will presumably take place around the end of May and beginning of June. Up to the end of the year, the ECB will prepare the actual introduction of the euro and the single monetary policy. I see the introduction of the euro in a broad perspective. The introduction of the euro and the associated single European monetary policy are not isolated steps, but a part - albeit a very important one - of the process of European integration which effectively started immediately after, or even perhaps during, World War II. Thus it is a process, and a process which involves more than just economics. Economists very often analyse the euro simply in economic terms. There is nothing wrong with this, because the economic aspect is important. However, what is objectionable is that people all too often draw conclusions about the euro based on purely economic arguments. Thus one loses sight of the broader context of the euro. Before I come to that, there is another mistake which is often made and has to do with taking too narrow a view. This is that people often point to the risks of the introduction of the euro on the implicit assumption that the alternative to European Economic and Monetary Union, hereafter referred to as 'EMU', is an everlasting and risk-free continuation of the world as we know it. That is not so. EMU is not without risk, but nor is the alternative. It is easier to appreciate this if we look at EMU in a broader context. The background to the process of European integration is, as I see it, above all organising Europe in such a way that the great conflicts of this century, two world wars, do not recur in the future. One way of achieving this is to incorporate Germany into a European structure. Without this policy, ultimately all problems confronting Europe directly or indirectly would end up on Germany's plate. That would force Germany into a leadership role, which we do not want, and Germany no longer wants. As Thomas Mann put it, and others have repeated: it is a choice between a European Germany or a German Europe. European integration is the choice of Europe, including Germany, as the first alternative. The great changes which took place in eastern Europe almost ten years ago reinforced the need for European integration. The almost automatically unifying element of the confrontation with Communism thereby disappeared. The position of unified Germany was potentially, and in the long term, stronger. Germany not only became larger: through the developments in the east it also came to occupy a more central position in Europe, as it were. In addition to this motif there is another motif, which is narrower and also has an economic component. This is the advance of the de facto German monetary hegemony over the last decades. The Deutsche Bundesbank in effect largely determines the levels of interest rates in other European countries. And however successful those countries may have been, partly as a result, in achieving price stability, larger countries in particular cannot in the long term accept being tied to Germany's apron strings in monetary matters. A European Central Bank places monetary policy within a European framework. In this way, it is an example of the movement from a German Europe to a Europe in which Germany is included. To this end, Germany is prepared to replace the Deutsche Mark with the euro. This should not be judged lightly. Germany is thereby, of its own volition, giving up a symbol, I would even say the symbol, of successful German policy since World War II, and relinquishing economic and administrative power. In this light it is quite understandable that Germany has continually asked for guarantees and makes repeated pleas for a stable euro. The process of integration in Europe is always, first and foremost, managed by means of the economic component. Integration may be expected to have a positive effect on prosperity: this is clearly documented in economic theory; but we can also expect that common economic interests will make conflicts less likely. European integration started with the establishment of the European Coal and Steel Community in the early fifties, intended above all to remove two of the major constituents of heavy military armament, energy and iron, from national or, if you will, nationalistic decision-making, and has proceeded step by step to the Single Market programme and now to the introduction of the euro. The euro can be seen as the final piece in the Single Market. Failure to introduce the euro could put this in jeopardy. After all, one should not underestimate the extent to which depreciation of the currency can again lead to a flare-up of protectionist 'counter-measures'. The Single Market only operates well if there is sufficient exchange rate stability. In a Europe with free movement of capital it is no longer possible to guarantee this by means of a system of stable but adjustable exchange rates. Such systems have proved vulnerable and can fall prey to speculative attacks, which may be unwarranted by the underlying economic conditions. Even the traditionally super-strong link between the Dutch guilder and the Deutsche Mark is not permanently assured without EMU. However, the process of integration will not be completed with the introduction of the euro. The process of European integration will also continue because many countries in central and eastern Europe will wish to join the EU. The accession of these countries can only take place in stages. The introduction of the euro is the last stage, which must not be forced. First, these countries must integrate their economies solidly into the EU. Then participation in the new exchange rate mechanism can follow. Ultimately, the euro can be introduced. The prospective entrants will have to meet the same requirements as the countries which will introduce the euro at the start of next year. That will take considerable time - time which must also be used to consider any changes in the working methods of the ESCB if that is to consist of between 20 and 30 national central banks. There are issues here which may be even more difficult than the decision concerning which countries will participate on the first of January 1999. It would be advisable to consider these matters in good time. This would prevent the man in the street and politicians alike later being caught off guard and feeling overtaken by events, as often seems to be the case in European debates. How must the process of European integration be judged on the basis of its own objectives, as I have just formulated them? I say: positively. Participating countries have now known peace for more than 50 years and much has been achieved in the economic field. Of course I am not deaf to all criticism, nor unaware of friction among Member States, and the failures that sometimes occur. I also recognise that the next step, the introduction of the euro, is not without risk and undoubtedly there will be problems to be overcome. Whatever else it may be, it will not be dull. However, my attitude is that taking this step offers great opportunities and that the risks are manageable, as long as one is not blind to them. To break off the process of European integration at this point - which is what failure to introduce the euro would mean - would throw Europe into great confusion. No viable political alternative exists. Why, therefore, the introduction of EMU and the euro? First of all because of the political reasons discussed. They are no less important than economic reasons, nor is there any reason for economists to sneer at them. Peace and security can also be analysed in economic terms. I would add the footnote that the introduction of the euro will not automatically have an integrating effect. Some people feel that it will actually increase the potential for conflict, not only between those who are in and those who are out, but between those who are in, among themselves. I am not that pessimistic, but I am convinced that the euro can only contribute to political integration if all EU countries have the prospect of joining EMU, and if the countries which have joined demonstrate the political will to accept that the introduction of a single currency and a single monetary policy means that interest rates must be brought to the level which is best for the entire euro region and not for individual countries. The introduction of the euro also has clear economic advantages. It removes the uncertainty over exchange rates from a large part of Europe. That is good for trade, and particularly for countries such as the Netherlands, which conduct a great deal of trade within Europe. It increases the transparency of the European market, which makes it easier to benefit from economies of scale, but - or rather, in addition - it encourages competition. The European System of Central Banks will also try to bring about price stability over a large area which, if successful, will be an important condition for a sustainable, real (i.e. actual) growth in income and employment. The economic advantages of EMU increase in proportion to the size and stability of the euro region. Perhaps it is ironic that the advantages are greater the more countries which have in the past had long periods of stability problems are included in a stable EMU. The art, of course, is to combine size and stability as well as possible. This does not detract from the fact that risks may emerge and questions may be raised and that we must be prepared to learn from experience. That is why EMU is not the end of the process of integration, but the start of a learning process. In the rest of my lecture I would like to discuss a number of frequently raised issues and fears, without of course, making any claim to completeness. . This attitude is based on a - sadly persistent - misunderstanding, which is that unemployment in Europe can be solved by lax monetary policy. However, unemployment in Europe is primarily a structural phenomenon, which requires measures to allow markets to function better. The best contribution monetary policy can make to growth and employment is to ensure price stability. Artificially stimulating employment by means of lax monetary policy does not lead to lasting low levels of unemployment, but ultimately it does lead to higher inflation. In that sense, it is a policy of shooting oneself in the foot. Making the central banks independent is a world-wide trend. This is prompted by the realisation that monetary policy can have a direct effect on growth and employment in the short term, but only directly affects inflation in the long term. There is always a temptation to use monetary policy to stimulate the economy in the short term. The growth in employment - later shown to be artificial - and the consequent improvement in election prospects come first, inflation and economic instability come later. Politicians recognise the seductive call of these sirens and they want to avoid giving in to this strong temptation. Therefore, they allow themselves, like Odysseus, to be bound to the mast by giving an independent central bank the task of ensuring price stability as its sole purpose. In practice, this construction causes tension on one point, or, to stay with Homer, has one Achilles' heel. In the short term it is true that monetary policy affects growth and employment. This makes the conduct of policy very delicate and the reading of the economic situation very precarious. The conduct of policy will also depend on the state of budgetary policy and on wage developments. This all leads to a desire in society to call the central bank to account for the choices it has made. This is understandable and, in my opinion, justifiable, but one has to be careful not to throw the baby of independence out with the bathwater of accountability. After all, the fact that monetary policy only has short-term effects on growth and employment is the very reason for placing the central bank at a distance from politics. The desire for accountability must not run over into exerting pressure on the central bank. My conclusion for the European System of Central Banks is that monetary policy must be as transparent as possible. That means that the ESCB must always make clear in word and deed how it sees the situation and that it explains its measures. To the public and to politicians; to governments and parliaments; to the European Council of Ministers and to the European Parliament. It also means that the ESCB must quantify precisely what it understands by price stability and must announce in advance what its target is. The target itself must be clearly formulated and any deviation must be explained. Transparent monetary policy is not only important, and perhaps not even primarily important, in terms of the accountability of the central bank. It can also promote the efficiency of policy by creating the right expectations in the participants in the economic process concerning what the monetary authorities hope to achieve: monetary policy must be predictable. This contributes to achieving stable prices with as little friction as possible. The ESCB is a system for the entire euro region and that must be manifest in the communication of its decisions. The remark that the ESCB is for the entire euro region also means that not all communications need pass exclusively via the centre. The national central banks can also play a useful role. They can communicate in their own language, taking into account the particular circumstances of their own country. The point is that communication should be carried out consistently throughout the euro region. It is crucial that the Eurotower in Frankfurt, the seat of the ECB, does not become an ivory tower. The ESCB must be open to contact with politicians, both sides of industry and parliaments. In these contacts it must not only provide explanations but also be a good listener. The sine qua non is that the independence of the ESCB should be respected in these contacts. The democratic legitimacy of the ECB is based on the fact that its duties are laid down in law, that the members of its Executive Board are appointed by elected politicians and that it offers explanations and is accountable in various ways for its analyses and the measures based on them. Admittedly this does not go as far as in politics, since those to whom it is accountable cannot impose any sanctions on the ECB, but that is just an inevitable consequence of opting for independent decision-making. And that is a choice which was made for good reasons. This is the key question, and it is not easy to answer. I do not agree with those who say that the creation of the right institutions is enough for the creation of a monetary union. My vision is closer to the economic theory of optimum currency areas, which says that certain conditions must be met if an area is to introduce a single currency. These conditions are not automatically met by introducing a single currency and setting up the right institutions. The latter can help, it is true, but it is not sufficient. It is therefore right that convergence criteria in the areas of inflation, long-term interest rates, exchange rate stability and government deficits and debt were formulated in the Maastricht Treaty. I do not deny that these criteria are, to a certain extent, arbitrary, almost by definition. Economic theory cannot come up with precise quantitative criteria to establish the viability of a monetary union. It will always require a certain amount of political will, and there will always be a certain amount of risk. The convergence will never be perfect. Therefore, the decision about the introduction of EMU is ultimately also a political decision. How is economic convergence going in Europe? You will appreciate that I will not talk about individual countries. In general, however, one may say that in many areas good, sometimes even remarkable, progress has been made. With regard to inflation and long-term interest rates, 14 of the 15 Member States already clearly meet the criteria. Also, over the last few years there has been a remarkable degree of exchange rate stability between the European currencies. Finally, government deficits and debt: there are still countries in a situation in which a sound analysis is required under the terms of the Treaty. This requires that a multitude of factors be taken into account, such as medium-term economic and budgetary prospects. The EMI will produce the said sound analysis in the report to be published on 25 March. The European Commission will also publish a report, as I said earlier. The decision will ultimately be taken by the Heads of State or Government. Although it is thus too early to draw conclusions, one thing is certain: among the participants in EMU there will be a large number who will have their work cut out in the next few years in the area of public finances. But that would have been equally true without EMU. Politicians are well aware of this: in the 'Stability and Growth Pact' they agreed to endeavour to achieve budgetary positions that are close to balance or even in surplus. This is a pertinent question, which arises from the idea that the official convergence criteria are not complete. There is a risk here and also a role for policy. The role of policy will be to go further towards allowing markets to operate more flexibly. Politically, this is not an easy matter, since it requires painful measures, the effects of which are not immediately perceptible. However, I would stress that this policy is necessary not only to ensure the smooth operation of EMU, but also to solve the biggest economic problem in Europe, namely high unemployment. Thus it is a double-edged sword: what is good for EMU is also necessary for the solution of the unemployment problem. This question is related to the previous one, and the answer is thus in part the same. One way of addressing this type of shock is to let wages and prices react flexibly to them. In addition I would point out that the appropriateness of the exchange rate as a mechanism for absorbing country-specific shocks must not be exaggerated. Devaluations only work if the workforce does not translate the resulting price rises into wage rises. If it does, as has often been the case historically, the result of devaluing a currency is simply higher inflation, and postponement of the inevitable adjustment to changed circumstances. This does not detract from, indeed it emphasises, the importance of adequate adjustment mechanisms. High mobility of labour is, I believe, unlikely to play any great role in Europe for the time being. The language barriers in particular are too high for that. In addition to flexibility of wages and prices, the design of EMU also provides for another important adjustment mechanism. The Stability and Growth Pact encompasses this. By keeping their budgetary positions roughly in balance in normal circumstances, governments create a margin to deal with disappointing economic trends without having to make cut-backs. Allowing the deficit to increase in such circumstances automatically counterbalances the economic problem. Of course, the ceiling for the deficit in the Maastricht Treaty must not be exceeded, except under truly exceptional circumstances. We are talking here about the familiar 3% of GDP. The margin this provides should not be underestimated. For the Netherlands it represents more than NLG 20 billion. This budgetary mechanism is not only available for country-specific shocks, it also helps to soften the blow of unfavourable trends affecting the euro area as a whole. The existence of this mechanism at national level makes loan financing at European level to offset country-specific shocks superfluous. National budgets can only fulfil their shock-absorbing role if they really are close to balance under normal circumstances. If not, then the shock is not absorbed, but hits the 3% safety rail prematurely. In view of the level (around 3%) of many government deficits at the moment, one must inevitably conclude that government deficits must continue to be reduced in the coming years. It is undoubtedly true that the establishment and functioning of a monetary union is easier if at the same time there is also a political union. There is then a single budgetary authority for the single monetary authority to deal with. It also simplifies the creation of a basis for monetary policy which by its very nature is single and indivisible in a region where developments will never quite be synchronised. However, in reality Europe is not at that stage, or has not yet reached that stage. Yet there are provisions in the Treaty, subsequently elaborated further, for example in the Stability and Growth Pact, which aim to create the conditions under which a monetary union would be workable without a political union in Europe. Think, for example, of the relationships, formal and informal, which are envisaged between the European Council of Finance Ministers, ECOFIN and the ECB. These relationships aside, the Stability and Growth Pact is an initiative to ensure that budgetary policy does not cramp the conduct of monetary policy. By reducing and practically eliminating government deficits, this can be guaranteed. The Pact is rather vaguer about assessing the budget situation in the euro region as a whole. It is conceivable that the sum of the budget balances, while individually in line with the Stability Pact, could produce an overall result which is unsatisfactory - for example, where the euro region as a whole has a balance of payments deficit. Then further co-ordination of the budgetary policies of the individual countries might be necessary. In any case, such a situation is not an immediate concern, since the euro region is expected to have a modest balance of payments surplus. All in all, there are sufficient channels for co-ordination and the exchange of information. Much will naturally depend on how these are used in practice. The agreements which have been made so far are not necessarily the last word. We will have to learn from experience. Further evolution may take place on the basis of that experience. An easy one for a change. This fear is unfounded. The ESCB must pursue whatever policy is necessary to achieve and maintain price stability. Don't forget that this is laid down in the Treaty. Taking an extra-strong line would not contribute to the realisation of this goal. The point is to strike the correct balance between inflationary and deflationary risks, and to set interest rates in such a way that price stability is the most likely outcome. Monetary policy is partly an art. Monetary policy decisions cannot be taken mechanically; they can't be calculated. That is nothing new, but certainly at the start of EMU, when the financial sector will be in transition, predicting economic trends and the effect of policy measures may be more difficult than usual. In this context, it is very important that inflation rates in many European countries currently are not only close together, but also low. Inflation in the European Union is running at less than 2%. Many European national central banks consider this level to be in keeping with price stability. Complete absence of measurable inflation is not required, because the measurement of actual inflation is beset by errors, on balance on the positive side. If this situation can be maintained until January 1999 - and that is the objective of the current policy - then the ESCB will be able to start its work under favourable conditions. Tight monetary policy from the outset of the single currency will then be unnecessary. I draw three conclusions:
r980630a_ECB	euro area	1998-06-30T00:00:00	Ceremony on the occasion of the establishment of the European System of Central Banks	duisenberg	1	The introduction of the single currency, the euro, in eleven countries of the European Union on 1 January 1999 is more than a milestone in the process of European integration which, having started soon after the Second World War, has now been continuing for almost half a century. This process is aimed at maintaining peace and stability and fostering prosperity in Europe. Although it has experienced setbacks, on balance it has been successful. The introduction of the euro is not only the result of this process. If successful, and we all are doing our utmost to make it a success, it will give further impetus to co-operation and integration in Europe. The establishment of the European System of Central Banks is the logical consequence of the decision to introduce a single currency. No single currency without a common central bank, or rather common system of central banks, comprising the European Central Bank and the national central banks since the ESCB is a federal system. This clearly reflects the fact that Europe - or the euro area for that matter - is not a single nation, but a group of nations. The ESCB was established on 1 June, i.e. well in advance of the birth of the euro, because it has to adopt a clear framework for the conduct of the common monetary policy from 1 January 1999 onwards, it has to test all systems and procedures in the context of this framework, it has to set up its own organisation and it has to ensure a smooth transition from the current national monetary policies to the future single monetary policy. There is every reason to mark today the occasion of the establishment of the ESCB. Today is the point that separates the road behind to a common European System of Central Banks and the road we have to travel in the future to make the euro a success, which means to make it a stable currency. Looking back, it is fair to say that the road has been long and sometimes winding. Thanks to the vision and determination of a number of people we have arrived where we are today. I cannot mention everybody who has been involved in the process leading to the creation of the European Central Bank over the past decades. In terms of "founding fathers" I am thinking of Raymond Barre, Valery Giscard d'Estaing and Helmut Schmidt, the three of whom regretfully could not be here today. I am further thinking, and they are here and I bid them a very warm welcome indeed, of Pierre Werner, responsible for the Werner Report in the early seventies, Jacques Delors, who chaired the committee named after him which mapped out the road to European Economic and Monetary Union and the ECB, and Alexandre Lamfalussy, President of the European Monetary Institute in years in which many people were, to say the least, somewhat sceptical about EMU. I not only thank them for what they have done in preparation for the institution of which I have the honour of being President, I also congratulate them on what has been achieved as a result of their work The establishment of the ESCB and, somewhat later in time, the introduction of the euro are, as I said, not the end of the road, but in a sense its extension into new territory. The ESCB has been given the clear mandate of maintaining price stability, and without prejudice to that of supporting the economic policies in the Community. By fulfilling its mandate it will contribute to creating the appropriate conditions for sustainable growth of incomes and employment in the Community: the ultimate goals of economic policy. This is no easy task. The road in the future will sometimes be winding again. This is true, even in view of all the preparations for EMU by all parties concerned, like the European Commission, the European Monetary Institute, the national central banks, national governments and all private companies, institutions and individuals. The ESCB faces many challenges and I should like to share with you those which I think are the most important. The first is to make clear and show in practice that monetary policy has to be based on euro area-wide considerations. The ESCB's monetary policy has to be one and indivisible. It has to be characterised by a truly European outlook. A precondition for adopting this outlook is that the ESCB acts as and is seen to act as a unity and speaks with "one voice", although sometimes in different languages. Put in modern language: this requires team-building, inevitably a process. The ESCB should be open and transparent, for at least three reasons. First, transparency enhances the effectiveness of monetary policy by creating the correct expectations on the part of economic agents. This relates not only to actual monetary policy decisions, but applies more in general. The ESCB is endowed with an independent status and it should be explained why this independence is so vital. It should also be crystal clear about what monetary policy can and what it cannot achieve. Monetary policy can only achieve price stability in the longer term, not on a year-on-year basis. It needs to be supported by sound fiscal policies and a structural development of wages in line with productivity and the objective of price stability. Otherwise, price stability can only be maintained at a high cost in terms of lost income and employment. That is why I attach great importance to the Pact for Stability and Growth. The ESCB will have to define quantitatively what it means by price stability, it will have to explain its monetary policy strategy, have to explain its monetary policy measures, the derivation of targets, etc. In the context of what monetary policy can and cannot achieve, I repeat what I have said before on several occasions: monetary policy is neither the cause of nor the solution to the still unacceptably high level of unemployment in Europe. Solving that problem mainly requires structural policies to make markets operate more flexibly. The second reason why transparency is crucial is because in a democratic society the central bank has to account for its policies. Without the broad support of the population, ultimately no central bank can fulfil its mandate over a long period of time. The third reason is that transparency towards the outside world can also structure and discipline the internal debate inside the central bank. Let me emphasise that openness not only refers to the citizens and institutions of Europe, but also to people and institutions outside Europe. The ESCB will need to have good relations with other central banks, in particular by building on the relations of the European national central banks with other central banks around the world. Perhaps the most important challenge for the ESCB is to win the confidence of the citizens of Europe. The euro is their currency, and they should be able to trust that it keeps its value. The best way for the ESCB to acquire the necessary credibility with the citizens of Europe is to demonstrate that it takes its task of maintaining price stability very seriously. Building up a track record of stable prices will be vital in achieving this. Demonstrably stable prices are more effective in this regard than a million words in speeches, interviews and official publications. Therefore, it is essential also that policies in the remainder of this year aim at maintaining the current low levels of inflation in the euro area. That would allow the start of the euro early next year to take place in a climate of favourable price developments. I have referred to the past and briefly discussed the future. Let me now turn to the present, to today. This is the right moment to thank the Federal Republic of Germany, the Land of Hessen and the City of Frankfurt for hosting this new, truly European institution, the European Central Bank. Today is also the moment to enjoy what has been achieved by the efforts of many, but we ought at the same time to be aware of the fact that from tomorrow on the challenging task of making the euro a success will again demand our dedicated efforts. This event today caps the process of living up to the obligations assumed under the Treaty on European Union, the Treaty that has become known as the Treaty of Maastricht. It seemed fitting to let the cap be put in place by the men's choir of the city of Maastricht, the Royal Maastreechter Staar. Their first performance will be to sing short excerpts from national songs of all member states of the European Union in the respective original language.
r980702a_ECB	euro area	1998-07-02T00:00:00	Crisis prevention: IMF surveillance, need for new teeth?	bank	0	For a year now, the international community has been kept in suspense by the crises in Asia. Despite very large-scale assistance measures and initial successes in achieving stability in some countries, an overall calming of the situation has not yet been accomplished. Crisis management - this morning's subject - is still what is needed most. Nevertheless, it does seem both sensible and necessary to look forward. Is there a better way of preventing financial crises in future? And if so, how? What lessons can be learned, especially with regard to IMF surveillance? Is surveillance effective? Can it - or, indeed, does it have to be intensified and improved? Not just more recent events - the collapse of Barings Bank, the peso crisis in Mexico and, now, turbulence in Asia - but also earlier ones in banking and monetary history force us to the conclusion that - in a market system - financial crises of one sort or another repeatedly occur under certain circumstances. Their specific causes are extremely varied . Nevertheless, they do have some features in common. The IMF, in an interesting analysis in the latest World Economic Outlook, points out that serious turbulence in the financial markets is frequently caused by unsustainable economic imbalances and misalignments of asset prices or exchange rates accompanied by rigidities in the financial system. According to this study, whether these undesirable developments actually lead to a financial crisis depends on the scale of the imbalances themselves, on a credible policy for a timely removal of the imbalances, and on the robustness of the country's financial system. Precautions are therefore necessary. The key to every type of crisis prevention and crisis management lies in the history leading up to financial crises. This is ultimately the crucial rationale for surveillance by the international community. The analysis of global economic developments undertaken by the IMF aims to identify potential adverse macroeconomic trends; it will then be incumbent on the national authorities of the countries concerned to tackle these imbalances as early as possible. In the bilateral talks between the IMF's representatives and national authorities (Article IV Consultations), the economic policy of the latter will be under close scrutiny. This macroeconomic approach to surveillance has to be seen in the context of the IMF's task of granting conditional financial assistance in the event of balance of payments disequilibria. This approach is important and necessary, but - in its traditional form - it will not be adequate for the future. In particular, more attention will have to be paid to international capital flows. Advances in electronic data processing and the liberalisation of financial transactions have led to an enormous swelling of cross-border capital flows. Some developing countries and emerging economies have become net importers of capital on a grand scale in the nineties - and it is not only foreign direct investment that has risen sharply; there has been a considerable increase in portfolio investment and in short-term financial credits, too. The increased financial investments in the emerging markets have to be seen against the backdrop of falling nominal interest rates in the industrial countries. The yields demanded by investors have possibly not declined to the same extent - in many minds, a complete break with the excessive (nominal) yields experienced in the past as a result of inflation does not appear to have taken place yet. By an "admixture" of high-yielding assets, professional investors are evidently attempting to approach their traditional yield level. Initially, it may indeed have made economic sense to increase investment in emerging markets; after all, such countries offered attractive earnings prospects. However, "herd behaviour" among the investors results in pressure on the spreads, which are then no longer an adequate reflection of the risk differentials between countries. Although asset management has become more professional in the nineties, it has also become more one-sided in a certain respect. An ever greater volume of financial resources is being managed according to comparatively similar criteria. Orientation towards a more or less exogenous benchmark and fierce competition among institutional investors compel the latter in many cases to behave in a similar fashion - no one wants to perform less well "than the market". As long as this short-termism prevails in the market, "conservative" portfolio managers will have little to benefit from swimming against the current and forgoing yield opportunities in order to avoid risks that are difficult to calculate. The market is interested only in today's benchmark, and anyone who fails to hold his own now will soon find himself out of business - long before a long-term strategy could pay off. Given these market conditions, reversals of opinion have a considerably wide impact. They do not just affect the operations of individual investors, but seize hold of certain categories of institutional investors simultaneously - and repeatedly have serious repercussions not only for individual countries, but also for entire regions or groups of economies on account of spillover and contagion effects. Pointing out risks of this kind in connection with international capital flows must be a key element of IMF surveillance and will be so in future. Although the IMF will not be breaking new ground in this respect, placing greater emphasis on aspects of capital flows and the financial markets in the context of surveillance will require a suitable analytical framework as well as a readiness for transparency on the part of the member countries. Above all, it will be crucial to keep adequate track of how financial market players behave under changing conditions; this is because a system of surveillance and the provision of a framework in the area of international financial transactions that do not take account of market forces will meet with little success. One should also be aware of the limitations of this kind of extended surveillance, however. Market movements are quick and sharp and spread rapidly, making forecasts of trends in cross-border capital flows and financial markets especially difficult. We can take it for granted that the IMF - despite all its expertise - will not always be right in its estimates. For that reason, the international community will, in the final analysis, not be able to relieve market players from making an independent assessment of the situation. To what extent the IMF should make specific warnings public is still being debated in depth; a tiered response in the case of countries whose policy gets completely out of hand is under discussion. Basically, the IMF is in a dilemma in this respect. Its warnings to a country would probably carry more weight if there were a threat of their being made public. At the same time, however, announcing them publicly might trigger the very crisis that surveillance was actually meant to prevent. Efficient surveillance by the IMF, just like rational decisions on the part of investors, presupposes comprehensive and reliable information on the financial circumstances not just of individual market players but also of entire economies. The IMF has now extended its proposals on this and offered its support in implementing them. It is now up to the member countries seeking access to the international capital market to implement these standards speedily and in full. Transparency is to be understood as the debt which every country owes to the international community. A matter to be considered is the extent to which the role of the IMF could or should be confined to defining the standard for supplying the data, monitoring compliance with this and pointing out any shortcomings. The evaluation itself could be left to the competition among the professional observers. The IMF would thereby be relieved of the dilemma of being at the centre of criticism, either as a "failure" if it does not give warnings in time or as a "trigger" of the crisis. When the proposals to improve transparency are being implemented, the lenders must also be called upon to exert pressure and to apply the strictest criteria to their potential partners' policy on business openness. Financial circumstances which are not very transparent must be construed as an additional risk of a credit exposure; those who still engage in transactions must not expect international assistance in the event of a crisis. Otherwise, the international community would be encouraging moral hazard. The efforts aimed at greater transparency and better surveillance by the IMF must not lead to negligence on the part of others either. In particular, the technical support provided by the IMF in the implementation of the publication standards should not be misconstrued as a seal of approval. Checking all transmitted data for accuracy would be beyond the capabilities of the IMF. The market players must use the available information, too: warnings must be heard and crisis signals taken seriously. The creditors themselves can make a major contribution to greater transparency. Would it not be feasible and practical if international lenders were to report their exposures to individual countries or borrowers to an independent credit register which, in turn, would return the aggregated data to the reporting institutions? In this way, the problem of asymmetrical information could be solved - at least partially - without the confidential transaction data having to be revealed. This would also provide an aid for comparing the statistical reports of debtor countries. In this way it would be comparatively easy to identify "black sheep". Enterprises, banks, even entire economies would be pilloried immediately if they failed to comply - or failed to comply in time - with internationally accepted publication standards; they would themselves cut off their access to the international sources of funding, as it were. The recent crises have exposed the problem of currency mismatch as a crisis-intensifying element. Short-term foreign currency loans from abroad (at favourable interest rates) were taken up for longer-term purposes (yielding higher rates of interest) in the national currency (or in third currencies). The lenders trusted explicit or implicit guarantees with regard to the exchange rate. Considerable (speculative) losses occurred when the pegging of the exchange rate could no longer be maintained. The call for a lender of last resort is fraught with problems in this situation since it is not a matter of bridging temporary liquidity difficulties but a genuine problem of profitability: at today's exchange rates, many of the investments made are no longer viable. What is called for here as a preventive measure is not a lender of last resort who is declared ex ante; rather, what is required is an efficient banking supervision and good governance geared to market economy criteria. Proposals for this are on the table. The Basle Committee on Banking Supervision has drawn up core principles for the supervision of credit institutions which provide a suitable framework. In view of the enormous economic costs of banking crises - in the worst cases, around 50 % of GDP had to be spent on rehabilitation costs; the cumulative losses in growth are estimated at almost 20 percentage points on average - it is in every country's own interests to gear its national regulatory and supervisory system to these tried-and-tested principles. Consideration ought to be given to whether the problem of banks' (short-term) foreign currency debt in emerging economies could be tackled in line with market principles by suitable capital adequacy standards for open foreign currency positions - without calling straightaway for a complete ban, as Tobin does, for example. Strengthened surveillance and better prudential supervision do not necessarily imply a reduction in capital inflows into the developing countries. Strict capital adequacy standards for banks - viewed in isolation - may limit the business volume and the borrowing opportunities of individual institutions in the international market. To the extent that investment risks are thereby reduced, however, they are also associated with positive external effects and, in that respect, make the procurement of capital easier. In dynamic terms, moreover, it is clear that the banking, exchange rate and debt crises in the developing countries have resulted in heavily fluctuating net capital flows; years of high capital imports were followed by a complete drying-up of, at least, private inflows - in some cases, even a withdrawal of private capital. A steady inflow is likely to entail much smaller adjustment costs than such extreme fluctuations. Apart from this, a warning should be given against a purely quantitative analysis in the area of external financing. Many countries do need foreign capital for their development; and large capital imports may be interpreted as an expression of optimistic expectations concerning a country's growth potential. In the event of an abrupt reversal of sentiment, however, dependence on external financing may quickly turn out to be a source of crisis, especially as large imports of capital are always accompanied by corresponding deficits on current account. What is crucial for sustained economic development, therefore, is not so much the amount, but rather the type of capital inflows and the use to which they are put; that is because, in the long term, investors expect market-related yields on their assets. It will be important to take adequate account of these factors in the reorientation of surveillance.
r980708a_ECB	euro area	1998-07-08T00:00:00	ECB Press conference: Introductory statement	no_info	0	Ladies and gentlemen, the Vice-President and I are here today to report on the outcome of the second meeting of the Governing Council of the European Central Bank held yesterday. The Governing Council first assessed current economic developments in the euro area. The general picture is one of continued economic expansion combined with broadly low inflation. Several forecasts made during spring 1998 have even suggested slightly lower rates of inflation for 1998-99 compared with expectations in autumn 1997. As far as price developments are concerned, inflation as measured by the harmonised consumer price index (HICP) is estimated to have risen slightly in April, to 1.4%, but has not increased further in May. Output growth has remained strong in recent quarters, with annual growth rates close to or even exceeding 3%. Economic growth has been driven increasingly by domestic demand rather than net exports, as might be expected at this stage of the cycle. Private consumption and stockbuilding have been the main factors underlying domestic demand to date. The favourable conjunctural situation has started to feed through into the labour market, although improvements here have in some countries been too slow to appear. It is evident, however, that economic growth alone will not reduce the urgency to proceed with structural adjustments in order to tackle unacceptably high rates of unemployment. As regards monetary and financial developments in the euro area, the annual growth rate of the broad money supply (M3H) accelerated in April to around 6% from 5.5% in March. The growth rate of M1, the narrow money supply, also picked up, to around 10%. We shall monitor these developments very carefully. In principle, the economic performance I have just described provides a favourable environment for continued fiscal consolidation. It is with some concern that we observe that in a number of member countries the prospects for this to actually develop seem to be, to put it mildly, rather subdued. In this respect, I should like to underline three aspects. First, any "growth dividend" resulting from the current cyclical upturn should be used to bring deficit and debt levels down, rather than relaxing control over expenditure. Second, most Member States need to go a step further, and indeed improve structural balances as they are not yet in compliance with the obligations under the Stability and Growth Pact. This implies that the benchmark for fiscal policy must now be a budget close to balance or in surplus - in surplus especially in countries with high ratios of debt to GDP. Third, further structural adjustments in fiscal policy would also help to improve the policy mix in some countries and in the euro area as a whole from the start of Stage Three. I would not at the present time want to try to convey too strong an impression of the implications of these various economic developments for the appropriate stance of monetary policies in euro area Member States. Although the responsibility for these policies remains with national central banks until the end of this year, the Governing Council had an extensive and thorough discussion on a euro area perspective of monetary policy. We will continue to study this issue closely before we enter the regime of a single monetary policy. For the time being, it is encouraging to see the credibility of monetary policy being reflected in the exchange rates of euro countries. There is currently no sign of exchange rate tensions among euro area currencies. Forward exchange rates are expected to be virtually identical to central rates, suggesting that the pre-announced rates are considered credible. I consider this a remarkable achievement. Following its review of economic developments, the Governing Council settled a number of organisational issues. of the European Central Bank. These will be published in the Official Journal of the European Communities; (ii) It approved, in accordance with the Rules of Procedure, the and agreed on the establishment of a Budget Committee to assist the Governing Council in ECB budget-related matters; to the European Central Bank. ECB Decisions relating to the Conditions of Employment will be published in the Official Journal of the European Communities. The Governing Council also took a number of decisions relating to various aspects of its preparatory work for Stage Three. The Governing Council decided on the introduction of a by the ESCB at the start of Stage Three. Among the three main functions that a minimum reserve system could usefully perform, the Governing Council attaches particularly high importance to its contributions to the stabilisation of money market interest rates and to the enlargement of the demand for central bank money by creating or enlarging a structural liquidity shortage in the market. In the light of the potential burden which a minimum reserve system could impose on the private sector and the effects it might have on the financial activity of credit institutions in the euro area, the Governing Council has decided on features which fulfil the two money market management purposes outlined above, while at the same time allowing an adequate remuneration of minimum reserves. A number of details of the minimum reserve system that will be applied were already specified in previous documents published by the European Monetary Institute. Additional features agreed upon yesterday include the liability base, the lump-sum allowance and the rate of remuneration. With regard to the latter, the ECB will remunerate minimum reserve holdings at a level corresponding to the rate of its main refinancing operations. The Governing Council intends to decide on the exact specification of the minimum reserve system in November 1998 at the latest. This decision, in particular as regards the reserve ratio (which is currently defined within a range of 1.5% - 2.5%), will be based on the early data from the new system for money and banking statistics. Further details are provided in the separate press release that is being issued to you this morning. It is intended that the precise features of the minimum reserve system will be published in the form of an EU Council Regulation. For this purpose, the Governing Council adopted an In accordance with the provisions of the Statute of the ESCB, the EU Council, acting by a qualified majority and after consulting the European Parliament and the Commission, is expected to adopt this Regulation. concerning the and concerning the All three ECB Recommendations will be published in the Official Journal of the European Communities for general notice. The Governing Council decided on the size and form of the from the national central banks participating in the euro area. This transfer is to take place on the first day of 1999. It has been decided that the initial transfer will be to the maximum allowed amount of EUR 50 billion, adjusted downwards by deducting the shares in the ECB's capital subscription key of the EU central banks which will not participate in the euro area at the outset. The transfer will thus be equal to 78.9153% of EUR 50 billion, i.e. approximately EUR 39.46 billion. The Governing Council furthermore agreed that this initial transfer should be in gold in an amount equivalent to 15% of the sum I have just mentioned, with the remaining 85% being transferred in foreign currency assets. I should stress that the decision on the percentage of gold to be transferred to the ECB will have no implications for the consolidated gold holdings of the ESCB. The precise modalities of the initial transfer will be finalised before the end of the year. Before the end of the current year the Governing Council will also have to adopt an pursuant to Article 31.3 of the Statute of the ESCB, which will subject all operations in foreign reserve assets remaining with the national central banks - including gold - to approval by the ECB. In connection with the the Governing Council also reached agreement on a number of issues related to the quotation and publication of reference exchange rates for the euro. Specifically, it was agreed to recommend to market participants the "certain" method for quoting the exchange rates for the euro (i.e. 1 euro = X foreign currency units) and to have daily reference exchange rates for the euro computed and published by the ECB. Further details are provided in the separate press release that is being issued to you this morning. The Governing Council decided on the conditions for the participation of the non-euro area EU central banks and credit institutions in the TARGET (Trans-European Automated Realtime Gross settlement Express Transfer) system. In TARGET the ESCB will provide central bank liquidity in the course of the day (i.e. intraday liquidity) to the extent necessary to avoid delays in the execution of payment orders. If intraday liquidity is not reimbursed at the end of the day it becomes overnight credit granted by the ESCB, which, for evident monetary policy reasons, cannot be offered to institutions outside the euro area. Nonetheless, non-euro area EU central banks and institutions in those countries will be connected to TARGET. The Governing Council considered that giving such institutions outside the euro area unlimited access to intraday credit would have created risks for the conduct of monetary policy that it was not ready to take. A facility will therefore be put in place to enable the non-euro area EU central banks to provide collateralised intraday credit in euro to their credit institutions, subject to a ceiling both at the level of the non-euro area EU central banks and at that of non-euro area credit institutions. There will also be a liquidity deadline, set at 5 p.m. , for non-euro area credit institutions so that they do not incur an overnight overdraft in euro. Further details are provided in the separate press release that is being issued to you this morning. The Governing Council also agreed that a report on recent developments in the field of and their monetary policy implications - would be published in September 1998. Finally, the Governing Council agreed on a number of legal instruments aimed at enhancing the In particular, an has been adopted, as well as an Both documents will be published for general information in the Official Journal of the European Communities. Further details are provided in the separate press release that is being issued to you this morning. We are at your disposal for further questions.
r980715a_ECB	euro area	1998-07-15T00:00:00	Presentation of the EMI annual report to the European Parliament	duisenberg	1	It gives me great pleasure to be able to present to the European Parliament the 1997 Annual Report of the European Monetary Institute (EMI). This was the fourth, and last, such publication by the EMI before it made way for the European Central Bank (ECB), which was established on 1 June 1998. I want to take this opportunity to review the preparations for European Economic and Monetary Union (EMU) leading up to the start of Stage Three on 1 January next year. Preparatory work for Stage Three proceeded as planned in 1997. Since the start of 1994 the EMI, in close collaboration with the national central banks of the European Union, has undertaken the necessary technical preparations for the establishment of the European System of Central Banks (ESCB), the conduct of the single monetary policy and the creation of the single currency. These tasks will be completed by its successor, the ECB. Increasingly, the work undertaken has been of a more technical nature as the various preparations have drawn closer to completion. As in past years, the Annual Report described the activities of the EMI in a broad range of areas. Let me highlight the following: The EMI published a report on in February 1997, identifying two potential strategies for Stage Three: intermediate monetary targeting and direct inflation targeting. However, it also highlighted that, irrespective of the final choice, there was a need for a clear definition of the objective of price stability and for specific targets against which the performance of the ESCB could be assessed; for a broad range of indicator variables to help assess risks to price stability (with a prominent role assigned to monetary aggregates); and for various tools for forecasting inflation and other key variables. Following this report, the EMI concentrated on developing the infrastructure necessary to support monetary policy decision-making, including developing a number of econometric tools for preparing policy decisions, such as an area-wide macroeconomic model and, in conjunction with national central banks (NCBs), a multi-country model. The conceptual phase of preparatory work dealing with was concluded at the end of 1996, leading to publication in January 1997 of the so-called Framework Report (the full title is "The single monetary policy in Stage Three - specification of the operational framework"). The first half of 1997 was then devoted to defining the technical specifications for the ESCB's operational framework, enabling the publication in September 1997 of a further report, entitled "The single monetary policy in Stage Three - General documentation on ESCB monetary policy instruments and procedures". Progress in terms of the technical features of monetary policy operation in 1997 related mainly to the procedures, time frame and calendar for ESCB tenders; to the settlement modalities of open market operations; and to the implications of the end-of-day procedures for the use of standing facilities. The EMI also carried out other preparatory work in this field, such as that on minimum reserve requirements, defining common eligibility criteria for monetary policy counterparties and eligible assets and setting up an effective liquidity management system. In the area of , the European Council meeting in Amsterdam in June last year approved a resolution relating to the new exchange rate mechanism to be introduced in Stage Three, ERM II. The EMI finalised a draft agreement between the ECB and future non-euro area NCBs setting out the operating procedure, to be submitted to the ECB for endorsement. It continued work on the technical infrastructure to enable the system to operate from 1 January 1999. Implementation work was conducted to enable the ECB to execute foreign exchange intervention, focusing on the operational framework and information systems support. Likewise, work has been undertaken on transferring foreign reserve assets to the ECB at the start of Stage Three. Two draft proposals for a monitoring framework were prepared by the EMI; one on operations conducted by NCBs and another on transactions made by Member States. The EMI also conducted work on procedures for the computation and publication of reference exchange rates for the euro. And, as you will recall, it was possible in May of this year, following a decision by the European Council in Luxembourg last December, to pre-announce the bilateral rates of the currencies participating in the euro area. As regards , work has focused on implementing and making more detailed the wide-ranging statistical requirements for Stage Three. For example, in 1997 the EMI published a provisional list (subsequently revised) of institutions forming the Monetary and Financial Institutions (MFI) sector; an addendum was released in December covering money market funds. It also published documents on money and banking and balance of payments statistics and work has begun with EUROSTAT on quarterly financial accounts. In the field of , in September 1997 the EMI released a "Second progress report" on TARGET, addressing issues such as the operating time, pricing policies, provision of intraday liquidity to non-euro area NCBs and the role of the ECB in TARGET. Testing and implementation of TARGET is under way to enable this to be fully operational by late December. Both static and dynamic testing, and multilateral tests, have been completed and simulation tests are now being conducted under conditions as close to the future live environment as possible. In addition, the standards and underlying analysis for the use of Securities Settlements Systems were published in early January. Preparation of has continued. In the course of 1997 final designs were developed from the draft designs which were chosen by the EMI Council in December 1996. Illustrations of the revised designs were published in July 1997. These designs have been transformed into printing plates in the first half of 1998. In order to ensure a smooth production of the euro banknotes, prototypes of the euro banknotes were manufactured in 1997 by eight different paper mills and ten different printing works. This project revealed that all the participating printing works should be in a position to produce all the euro banknote denominations to an equal standard of quality and with an identical appearance. Mass production of the euro banknotes will start in early 1999. Finally, the EMI was actively involved in 1997 with other aspects of the . To cite just a few examples, the EMI met with representatives of EU-wide banking and financial associations to discuss issues such as the replacement in contracts of price references that may lose their significance after the start of Stage Three and the replacement of existing interbank rates. Following encouragement given by the EMI to banking associations and money and foreign exchange markets to engage in the collective definition of euro area indicators, the Banking Federation of the European Union and the Financial Markets Association (the professional association of foreign exchange market dealers) announced the intention to compute and publish a euro area-wide indicator of interbank rates, to be called EURIBOR. from 1 January 1999 onwards was decided in early May. The Annual Report briefly described the main characteristics of the euro area, based on available information. There is still much work to be done in the remaining six months or so before the start of Stage Three. I began today by recalling that the took place barely six weeks ago, on 1 June 1998. Since then, we have been busy carrying forward the preparations for Stage Three. Both the General Council and the Governing Council have met, the latter twice. In its meetings so far, the ECB has been concerned with many , such as the allocation by the Executive Board of responsibilities among its members and giving us a new structure which suits the tasks of the ECB. It has, for example, agreed on the Rules of Procedure of the ECB, which will be published in the Official Journal of the European Communities. And it has approved the establishment of eleven ESCB committees to assist in the work of the ECB. In terms of the , at its first meeting the Governing Council agreed on the method to be applied for determining the NCBs' percentage shares in the key for the ECB's capital and the measures necessary for the paying up of the capital of the ECB. As a result, the ECB was endowed with an initial capital of slightly under EUR 4 billion at the start of July. The Governing Council also agreed on the framework for the organisation of the overall testing of ESCB-wide systems and procedures which will be conducted in the remaining six months before 1 January 1999. It also dealt with two specific issues relating to preparations for Stage Three: relating to TARGET and euro banknotes. On the former, a pricing policy was agreed. The main element of this is that a degressive tariff will be applied to payment transactions flowing through this system. Concerning the latter, it has been agreed that the initial supply of banknotes for the euro area should be produced largely following a decentralised approach, i.e. each of the eleven participating NCBs will be able to organise the production of euro banknotes needed to replace their national banknotes, either producing the relevant banknotes themselves or entering into bilateral pooling arrangements. The second meeting of the Governing Council took place on Tuesday last week. The Governing Council decided on the introduction of a minimum reserve system. Among the functions that such a system can usefully perform, the contribution that it can make to stabilising money market interest rates and increasing the demand for central bank money by creating or enlarging a structural liquidity shortage in the market was considered by the Council to be particularly important. However, the Council also considered very carefully the implications of such a system for the banking sector. With this in mind, it decided that the minimum reserve holdings would be remunerated at a level corresponding to the rate of its main refinancing operations. The exact specification of the minimum reserve system, including the reserve ratio (which is currently defined within a range of 1.5-2.5%), will be decided by November 1998 at the latest. A decision was also taken on the size and form of the initial transfer of foreign reserve assets to the ECB from participating NCBs. Without going into the details, the transfer amounts to around EUR 39.5 billion. The conditions for participation of non-euro area EU central banks and credit institutions in the TARGET (Trans-European Automated Real-time Gross settlement Express Transfer) system were also decided, taking into account the risks to the conduct of monetary policy that giving unlimited access to intraday credit to such institutions outside the euro area could bring. Therefore, non-euro area EU central banks will be able to provide collateralised intraday credit in euro to their credit institutions, but subject to a ceiling both at the level of the non-euro area EU central banks and at that of non-euro area credit institutions. There will also be a liquidity deadline, set at 5 p.m., for non-euro area credit institutions so that they do not incur an overnight overdraft in euro. The Council agreed on a number of legal instruments aimed at enhancing the protection of euro banknotes. Finally, the Governing Council has adopted a number of ECB Recommendations for EU Council Regulations concerning the collection of statistical information by the ECB, the application of minimum reserves, and the powers of the ECB to impose sanctions. I would like to draw your attention to the Recommendation on statistics. This is of particular importance to the ECB because it will need to base its decisions on euro area-wide statistics, particularly, in this context, monetary and balance of payments statistics, which will be provided under this framework legislation. An ECB Regulation specifying in detail the actual reporting population and the statistical information which reporting institutions will be required to provide cannot be issued until the Council Regulation is enacted. These requirements have already been discussed over a considerable period of time, but a legal instrument will provide the necessary certainty to those who must meet them. There will be an opportunity for the ECOFIN Council to adopt the relevant text at its meeting in October. This would mean that we would appreciate it if the European Parliament could deliver an Opinion in the course of September. To conclude, in my view, the thorough technical preparation carried out by the EMI during 1997, and in earlier years, enables us to look forward with confidence to the introduction of the single currency at the beginning of next year. This preparatory work is now being brought to completion by the ECB and the ESCB. However, the solid foundations which have been laid by the EMI should help the ECB and the ESCB to develop into a credible and powerful institution which will pursue its primary objective of maintaining price stability in the euro area in a determined manner. This, in turn, will provide the conditions necessary for sustained economic growth. The improvement in the economic situation in the EU seen last year, and which is expected to continue in 1998, may be considered to provide a very satisfactory starting-point for Monetary Union. However, Member States' fiscal policies now need to be geared towards achieving the medium-term requirements of the Stability and Growth Pact as soon as possible. The benchmark for fiscal policies is clearly to achieve a budget which is in balance or in surplus - a surplus is needed especially for those countries with high debt to GDP ratios.
r980903a_ECB	euro area	1998-09-03T00:00:00	On the eve of the euro	schioppa	0	Thank you very much. I am happy and honoured to be here tonight. The assumption underlying your applause is that to be liked by the European Parliament is a good sign for a central banker. I am not sure that this is always the way central bankers feel, and so I may, in fact, have to recover from that vote, rather than build upon it! I am particularly happy, Duncan, to see you again after so many years. If I may, I should like to make a personal reference. Duncan Foley was my teacher at MIT 30 years ago. He was then teaching a very different kind of economics from that which he has taught subsequently, if my information is correct, but he was an extraordinary teacher for me. When I came back to Italy, I remember giving some seminars on Foley's Sidrauski model. These gave me the reputation of being almost a reactionary in an Italian intellectual environment that was thinking along very different lines from that model. Well, many things have now changed. 30 years have seen many, many changes, and I am very happy to see you here. The title of this lecture - although I think of this talk more as of a kind of conversation - that Professor Schefold and myself have chosen is " First, I shall elaborate upon this title by recapitulating the steps involved in reaching this eve. I shall then go on to say something about what, in my view, is special about EMU. Third, I shall describe what is happening during this eve. "Eve" refers to the period in which the European Central Bank is already in existence, but has not fully assumed its monetary policy functions. It will do so on 1 January 1999. It is a period of several months, of which we have just about reached the middle. Thus, how did we arrive at the inception of the European Central Bank? It has been a long process. Indeed, I could say that it started with the Treaty of Rome in 1957. I do not know how many of you are familiar with this extraordinary book that every economist should read, because it contains, in legal language, many implicit and some explicit propositions about the way in which the economy should function and economic policy should operate. The Treaty has proved, over a period of 40 years, to be extremely powerful and flexible in many ways. One of the implicit propositions is that, in order to have a Common Market (as it was called at the time), it is necessary to have a corresponding monetary order, in other words, I would suggest, some kind of monetary union. This proposition is only implicit because, in the mid-1950s, this kind of system existed in reality. At the time, the system of fixed exchange rates created at Bretton Woods was such a key component of the world economic order that it was taken for granted that it would last. In fact, it was not even the subject of much discussion, except for a few references to exchange rates. Most of the efforts in the early years following the birth of the European Community in 1958 were devoted to scaling down tariffs, which were of a much smaller order of magnitude than the fluctuations on foreign exchange markets in the present floating situation. If it was considered such a difficult task to abolish tariffs while nothing was said about exchange rates, this is because exchange rates were taken as being fixed. Thus, we could say that there a monetary union in the beginning, and this was the Bretton Woods system. When, about 10 years later, that system started to show signs of weakness, discussions began in the European Community on replacing it with an arrangement that would grant stable exchange rates at least for intra-European relationships. The notion of economic and monetary union, this very expression, is used for the first time in 1969 and 1970. The second decade of the approximately 40-year period since the signing of the Treaty of Rome, say from 1969 to 1979, saw the collapse of the Bretton Woods system, repeated devaluations and all types of inflation; it also coincides with a period in which the process of European integration virtually came to a halt. The third decade begins in 1979 with the launch of the European Monetary System, the first successful attempt to organise a European exchange rate system designed to provide, at least within Europe, fixed but adjustable exchange rates. The forth decade begins in 1988 when - and again I am focusing solely on the monetary line of development, disregarding the many other things that happened on the European scene - the Delors Committee was created in June 1988 in order to study economic and monetary union and its implementation in various stages. The history of EMU - all I have said so far has concerned the "prehistory" - started then. As stated above, the "prehistoric" phase ends with the creation of the Delors Committee, and the "historical" phase, of which we are now nearing the conclusion, began just 10 years ago when the Heads of State or of Government decided (and there had been much preparatory work behind that decision) to create a committee to develop the project of Monetary Union. The said Committee was chaired by Jacques Delors; it was composed of all the twelve governors of the national central banks of the European Community and a small number of "lay" members. Since then, between June 1988 and, say, June 1998, when the ECB came into existence, a rather extraordinary sequence of events has occurred: a very ambitious project has been launched and implemented, because the creation of a single currency and a single central bank for a number of sovereign countries which have not yet merged into a federation is something that has never previously been attempted. This project, owing to a series of special circumstances, never fell from the top of the agenda of the European leaders, showing a degree of continuity that is rare in international negotiations. In many countries the political parties holding the balance of power changed, mainly because of economic events, cyclical changes in the economy, etc. Yet, the project was never cancelled. The Bretton Woods conference had lasted two and half weeks. The negotiations leading to the Treaty of Rome, which created the European Economic Community, from the moment when the original idea was conceived in Messina (1956) to the moment when the institutions came into existence (1958), lasted little more than two years. Normally, in international affairs, favourable constellations are short-lived and things have to be done fast. It is remarkable that the favourable constellation present in the run-up to EMU has lasted for so long. The 10 years from June 1988 to June 1998 can be divided into two distinct periods of about five years: a period of negotiations on, and design of, the project, which began with the creation of the Delors Committee and ended with the ratification of the Maastricht Treaty; and a period of preparation, mainly of the macroeconomic conditions, which has come to be known as economic convergence. You will always notice the involvement of Germany and, most often, Chancellor Kohl at the watersheds of both these periods. Kohl was in Hannover in June 1988 and he was in Brussels in May 1998. Germany was the last country to ratify the Maastricht Treaty when the Federal Constitutional Court in Karlsruhe issued its statement. Kohl relaunched the project in March 1990, immediately after the elections in East Germany that restored democracy and unified Germany. One of the explanations for this continuous involvement is the continuity of leadership in Germany, and, because of that, in Europe. During the first of the two five-year periods the idea of monetary union was conceived and the project formed; then it was endorsed politically and translated into a Treaty; and, finally, that Treaty was ratified. All that occurred in the years 1988 to 1993. The Maastricht Treaty largely follows the German model in terms of the role of the central bank and the aims of economic policy, as well as the idea, strongly advocated by the Germans, that monetary union could only start if a high degree of economic convergence, low inflation, sound public financial conditions, etc. had previously been achieved. People who were in favour of monetary union on the basis of both their economic convictions and their political faith, like myself, tried to explain that it was not indispensable from a conceptual point of view to have so much prior convergence, although convergence was highly desirable per se. In fact, Monetary Union is being launched after five years of preparation during which the most fundamental event was the adjustment of macroeconomic conditions in all countries, and, in particular, in the most divergent countries, including my own. In reference to this preparatory period, I should like to mention only a couple of things. In all European countries, and to some extent even outside Europe, the Maastricht criteria - the pros and cons of which we shall discuss presently -became a benchmark that policy-makers could not ignore, whether or not they favoured Monetary Union and whether or not they intended to join. In many international meetings I have heard the British representative say: "We comply with Maastricht; the fact that we are not joining Monetary Union does not mean that we are 'behaving badly' in terms of the criteria". Even the American representative, as I recall on certain occasions, when wishing to convey the message that "our macroeconomic situation is in order", would maintain: "You want to achieve Monetary Union and you don't comply with the criteria, but you should know that do comply with the criteria". Thus, these criteria have become an inescapable benchmark. The second remark which I should like to make in this context is that in these five years a fundamental role was played by financial markets. It must be borne in mind that 10 or 15 years ago the condition of the markets was such that they could not function with the strength and the compelling force which they have enjoyed over the past five years. The Maastricht criteria are laid down in the Maastricht Treaty and would perhaps have been forgotten there, like many previous words of wisdom that can be found in international agreements. What made them compelling was, I think, a combination of two factors. One of these is the fact that the Maastricht Treaty sets a fixed date for the start of Monetary Union, i.e. 1 January 1999. The Treaty states that Monetary Union will start from that date whatever the circumstances, even with only three countries if only three countries were ready. The second factor is the adoption of the convergence criteria by the markets. These two factors together had produced a situation in which every government was constantly being judged by the markets with regard to the probability of its being ready on time for an event that was certain to occur, not subject to further decision. It is fair to say that there have been a few moments in this five-year period in which the possibility of a postponement was discussed. However, this was never agreed, and I should mention that, although people speak very often about EMU being a project of technocrats and bankers, it was the politicians who refused to give serious consideration to postponement. Particularly in Germany, there were moments when Chancellor Kohl was almost the only person to refuse the prospect of postponement. Thus, we have got where we are now after a period of 10 years of continuous work. The basis, however, was a construction, the European Community, that from the very start included and required a form of monetary union, the one that was present in the 1950s. The second topic on which I should like to touch is what is special about EMU? In a sense, I should answer that nothing is special; it is simply a central bank with a currency, like many others with which we are familiar. However, seen from another angle, EMU brings a number of new elements that I shall briefly recapitulate. New elements in the area of central banking, new elements in the way in which the constitution of economic policy is designed, and also new elements outside the economic sphere, in terms of the way in which Europe functions at the political level. What is new in the field of central banking? The European System of Central Banks, which I shall describe presently, is inspired by the Bundesbank model. Germany has a central bank with a federal structure, like the rest of the German constitution. It is, moreover, somewhat analogous with the Federal Reserve System, which also has a federal structure and is part of a federal political system. The European System of Central Banks is composed of the 15 national central banks of the European Union (the Deutsche Bundesbank, the Banca d'Italia, the Banque de France, etc.) and, in addition, the European Central Bank. The European Central Bank, which is located in Frankfurt and is the place where I am now working, is similar to the Bundesbank, which is also based in Frankfurt. The national central banks are comparable with the in various or groups of There are important differences, however. The national central banks have been - and will remain, for a few weeks or months - fully fledged central banks with the complete range of functions that a central bank usually fulfils. This was not the case with the components of the German or the American system. For this reason, inter alia, they are much stronger institutions; they are located in countries that have their own financial centre and their own national banking system. Therefore, it is much less natural for them to become simply parts of the system than it was for the components of the US or German system, which were designed from the outset as parts of a system. The resources are also very different. The staff of the Federal Reserve Board of Governors in Washington, D.C. comprises around 2,000 to 3,000 persons. We in Frankfurt are less than 500. The European System of Central Banks has unique features in the world of central banking. Compared with other similar central banking systems, the reasons for its coming into being are different, the financial centres through which it will operate are different and the financial techniques which it will employ are different. The Federal Reserve System has one financial centre, which is New York; the European System of Central Banks will operate through Paris, Madrid, Amsterdam, Milan, Frankfurt, etc. The multiplicity of languages in the euro area is another special feature, because communication has become a key component of the world of central banks. If we go beyond central banking and consider what I previously referred to as the constitution of economic policy, the main novelty is that Monetary Union does not have an established single fiscal policy (there are some provisos to this which I shall make in a moment). One of the usual two components of the fiscal-cum-monetary policy mix is absent, and monetary policy is operating alone. It is operating, however, in an environment in which most of the legislation and regulation concerning economic activity is also "federal" in the sense that it is issued at the Community level. Indeed, there is no significant component of the economic legislation in any of the Member States that is not derived from a Community directive which sets the basic guidelines and principles. Moreover, this Community competence has expanded in recent years to the point of virtually imposing a process of privatisation and deregulation in key sectors of the public utility network that used to be considered to be national monopolies. Indeed the policy competence of the European Union, albeit of a micro nature, is very pervasive. In two other fields of economic policy, the budgetary and the employment fields, the situation is different. In the budgetary field, the Maastricht Treaty and the Stability and Growth Pact imply that countries are now committed to achieving budgets which are in balance or close to balance, and either to keeping the public debt ratio below 60% or to decreasing the ratio at a satisfactory speed, if it exceeds the 60% reference level. Thus, Member States no longer have complete freedom in the fiscal field. In American terms, this would be called "a balanced budget condition in the constitution"; we adopted such a policy in Europe with the ratification of the Maastricht Treaty. If a country complies with the Stability and Growth Pact, then it is free to choose the composition and scale of expenditure and taxes it wishes. Thus, the fiscal field is one in which national competence is largely preserved, under a macro constraint stemming from the European Union. As regards employment policy (labour contracts, labour legislation, wage negotiations, etc.), I would say that this is almost entirely national. Moreover, as you will be aware, labour policy in Europe is subject to a high degree of compulsion, owing to the legally binding nature of wage and labour agreements. The social partners have been given the legislative power, regardless of how representative they may be. To sum up, Monetary Union is bringing into existence a European economic constitution in which money is federal, microeconomic legislation is largely federal, labour arrangements are highly regulated but national, and fiscal policy is national with a federal macro constraint. Such a constitution of economic policy is a novelty: I do not think that such a system has ever existed before. The third area in which new elements have emerged concerns European institutions and the way in which they function. The first novelty here is that the process of European unification has reached its culmination in one field, the monetary field. Indeed the "end of the journey" had never been reached before in any significant field of competence. The fact that, in a field of prime importance such as the monetary field, the unification process has now been completed, is extremely important, because the outcome of this experience, its success or lack of success, will decisively influence the inclination to take integration to its ultimate conclusion in other fields. Another institutional novelty concerns the way in which participation has been decided. It is indeed the first time that a project of such great importance has been designed in such a way as not to require the participation of all the members of the European Union. The "ins" and the "outs" are those who, being members of the European Union, respectively do and do not participate in Monetary Union. Arrangements that provide for variable geometry have occasionally been tried in the past, but never in a constitutionally well constructed way. Of course, there are two sides to every coin: in this case, the "negative" side is that it admits the possibility of a Member State not participating in a common project, while remaining a member of the European Union; the positive one is that it creates the possibility of pursuing a major new project without being hampered by those members who do not participate. Those who want to advance more quickly have gained the right to do so, even if some other members do not share this intention, and those who lag behind or are unwilling to advance more swiftly have the right not to do so. The constitutionalisation of variably geometry may become a very important factor in the future development of a European Union that will grow from 15 members to 20, 25 or 30, because then the possibility of reaching unanimous agreements involving all the Member States will be much smaller than with a Union of fewer members. An important precedent has thus been set. Another very important institutional novelty is that the key decision-making body of the European Central Bank, which is the Governing Council of the ECB, comprising 17 members (the 11 governors of the participating national central banks and the 6 members of the Executive Board, which is based in Frankfurt), will decide by a majority vote, based on one vote per person, and not use a system of weighted voting. The decision to opt for a "one person one vote" rule was, in my view, an extremely important one. Such a rule represents the only way to make sure that the members of the Governing Council will be independent. Moreover, you cannot weight wisdom. It would be just as absurd for a council to decide on the basis of weighted voting in the field of monetary policy, as it would to have weighted voting in a court of justice. A judge is a judge; he or she is not a better judge by virtue of being British rather than Portuguese. From a conceptual point of view this was an obvious choice, but politically it was not. And it is very significant that this choice was accepted rather easily at the time when the Maastricht Treaty was negotiated. The third and final part of my remarks concerns what happens on the eve of Monetary Union, that is, what is happening now? Generally speaking, we (by "we" I mean all the EU national central banks, in particular the 11 participating ones, and the European Central Bank) are frantically working to be ready by 1 January 1999 for the start of Monetary Union. By 1 January there will be no more national monetary policies for the countries of the euro area, no more official national rates, no more national policy operations of various kinds such as open market operations, etc. All that will be part of a single system, in which decisions are taken by the above-mentioned Governing Council, prepared by the Executive Board, comprising the six persons who are in Frankfurt on a full-time basis, and implemented, following the instructions of this Executive Board, in a decentralised manner, whereby most of the operations will be carried out by the national central banks. Getting ready for this total change requires an enormous amount of work. The groundwork for this change had been accomplished to some extent by the predecessor of the European Central Bank, the European Monetary Institute (EMI), which operated in Frankfurt from 1994 to 31 May this year. However, many aspects of the work had to be completed - partly because the EMI and the European Central Bank are very different entities (although they have occupied the same building, are largely composed of the same staff and are headed by the same President, Willem F. Duisenberg). Being now at the ECB myself, and having previously been closely associated with the work of the EMI (I travelled to Frankfurt on at least a monthly basis), I have witnessed this change and realised how important it was to bring it about. During the preparatory phase from the Delors report to the Maastricht Treaty there had been discussions as to whether the European Central Bank should be created at the beginning of what was then called Phase Two, or at the beginning of Phase Three. In the end, it was decided to opt for the latter. I was among those who were strongly in favour of the former, because it seemed to me that the new institution should have been given, from the beginning, the full power to make preparations and decisions in an effective way, although not the power to conduct monetary policy, which was to be reserved for Phase Three only. The European Commission in Brussels - by way of analogy - came into existence with full powers in 1958. Although there was still nothing established, the Commission had the power to implement the Treaty of Rome. Well, for Monetary Union, it was decided otherwise, and the EMI was a weak institution. It had no powers to take legally binding decisions or to issue regulations, nor did it have the power to impose anything. Unanimous decisions are very difficult to reach. The EMI worked on the basis of seeking to achieve a consensus that was close to unanimity. It was very difficult to agree on anything if one or two of the larger national central banks were in disagreement. Moreover, the EMI worked with 15 national central banks, thus disregarding any distinction between the "ins" and "outs". All that has now changed; we have majority votes; we are a group of 11 (not 15) countries; we have the legal power to impose decisions; the key decision-making body, i.e. the Governing Council, includes six members of the Executive Board. There is now an enormous amount of work that consists in formalising the preparations that were conducted during the lifetime of the European Monetary Institute, in making choices where important issues had been left unresolved, in adapting certain tentative arrangements that had been decisively influenced by, for example, the Bank of England, which is no longer represented on the main decision-making body. On this latter point, it should be remembered that those who are represented on the decision-making body have, of course, the duty and the liberty to take the decisions that they consider optimal for the success of Monetary Union, and not necessarily for the "outs". Accomplishing the transition from the EMI to the ECB, and learning to function within the new institutional system is the common denominator of much of the work currently being undertaken at the ECB . Of course, the work which is being accomplished concerns central bank activities. I should like to offer you a few examples, such as monetary policy design, the implementation of monetary policy decisions, international relations and the way in which communications will be organised. In each of these fields, new approaches have to be found because, as I mentioned earlier, the ESCB is in so many respects a unique construction. As regards monetary policy design, the fundamental point is that monetary policy will have to be designed on the basis of an assessment of the economic situation of the so-called euro area (sometimes referred to as "Euroland"), i.e. of the area comprising the 11 participating Member States, and not on the basis of an exercise in comparative economics across 11 individual countries. We shall look at the price developments for the whole area. We shall consider the economic situation and the cyclical conditions in the same way. Allow me to offer you an image: it is like having, not a political map, but rather an economic map, in which there are no borders and only a "natural" description of the landscape. If you look at an economic map of Europe, based on many types of indicators, it is extremely difficult, I would even say impossible, to trace the political borders. In such a map no one would be able to separate Belgium from the Netherlands, the North of Italy from the South of Germany, etc. Well, the economic assessment on the basis of which policy will be designed has to be made on an economic map, which causes enormous problems for statistical data, forecasting instruments, etc. No less difficult are the problems of policy implementation. Implementation will have to be conducted through 11 financial centres, of which perhaps one half could be considered major. Each of these centres is today both a policy and a financial centre which employs different techniques and practices from those which will apply in the single money market as from 1 January 1999. As an example of the problems arising in the area of international relations, I should like to refer to participation in the International Monetary Fund. Note that it is called the International Fund, because the monetary aspect is crucial. However, the emergence of a European Central Bank does not easily fit into the IMF structure, given that the members of the IMF are countries. The assumption implicit in the Articles of Agreement is that countries are also the relevant policy-makers. With the ECB, however, we have a policy-maker, for policy, which is not a country. No individual country can represent the monetary policy of Europe, i.e. the monetary policy of the second most important economic entity in the world, and of what will be a key reserve currency in international relations. As the Fund is structured at present, there is simply no provision for a reality like EMU. The founders of the Fund could not imagine that one day there would be such a thing as a European Central Bank without a European state, a European government, etc. Thus, we are now studying how best to be represented in the International Monetary Fund, notwithstanding this anomaly. A final area which I should like to mention is communication. Communication has become a fundamental part of monetary policy in two respects: in the way central banks impart information to the markets, thereby influencing expectations, and in the way they communicate with the public, thereby cultivating support for their actions. It is no simple task to provide consistent and simultaneous communication in 11 different languages. It is not only a matter of accuracy in the translation. Very often you can accurately translate a sentence from one language into another, but the way that sentence reads is not the same because the conventions governing usage may be very different, so that what you say is understood in a different way. Well, I think I should stop here. Five years of negotiation, five years of preparation. Monetary Union will start in four months less two days. Much preparatory work has been undertaken and many thoughts have been developed. Yet it is very difficult to predict precisely what will happen. I am convinced that powerful factors will make the euro a stable and reliable currency. However, it is hard to predict where the difficulties will lie. There is a well-known tendency of strategists to prepare for the next war on the basis of the study of the past wars, and then one discovers that each war is different from the preceding ones. The problems that have preoccupied central banks in the past 20 years may not be the same problems that will concern them most in the years to come. The system will have to cope with new situations, and this will make the implementation at least as stimulating as the two phases which are now reaching their conclusion. Thank you. Well, thank you very much for a brilliant lecture of admirable clarity. I hope the organiser will not be held responsible for the rain. We now have a unique opportunity to ask questions.
r980918b_ECB	euro area	1998-09-18T00:00:00	Signing ceremony for the Headquarters Agreement	duisenberg	1	Damen und Herren, liebe Kollegen und Mitarbeiter, It was exactly three years ago - on 12 September 1995 - though in a different composition, that representatives of the Federal Republic of Germany and of the European Monetary Institute met in this very building to sign the Headquarters Agreement. Today representatives of the Federal Republic of Germany and of the European Central Bank have gathered here for the same purpose. Now, as then, we are to settle the details of the relations between a European institution and an EU Member State, as the host country of this institution, its staff and their families. These are two very similar events, though occurring under entirely different circumstances. At the time of the signing of the first Headquarters Agreement, in 1995, the EMI had only been established for nineteen months and had moved into its premises only a year earlier. It faced the very difficult task of preparing the framework necessary for the European System of Central Banks to perform its tasks in the third stage of EMU. There was not much time left until the end of 1996, the first deadline, which was turned down by the Member States, and subsequently until the mid-1998 deadline. President Lamfalussy, my predecessor as President of the EMI, rightly referred to this task as an unprecedented and historic one. No single past experience could guide us in the establishment of Economic and Monetary Union. Differences in culture, history, political tradition and, indeed, in approaches to central banking among the initially twelve and later fifteen national central banks, made the tasks of the EMI particularly challenging. Nonetheless, and I should emphasise this immediately, Mr. Lamfalussy clearly stated with his imperturbable confidence that, in any case, it would not be the EMI that would delay the start of EMU. My predecessor was right. The EMI did indeed do its homework and achieve its goals. The ESCB was finally established on 1 June this year, that is to say, around half a year in advance of the launch of the euro. The ECB was thus given time to set up and to staff its own organisation, to adopt the framework for the conduct of the common monetary policy from 1 January 1999 onwards, to test all the systems and procedures within this framework and to ensure a smooth transition from the current national monetary policies to the future single monetary policy. Today, I am in a position to share the same optimism expressed by Mr. Lamfalussy. The Governing Council of the ECB has, in the meantime, taken decisive steps to render the ECB fully operational by the end of the year. Allow me to raise a few points in this context. Notwithstanding the unequivocal provisions of the Treaty with regard to the independence of the ECB, concerns have been voiced that the ECB might be unaccountable and act in an untransparent way. These concerns are unfounded. The independence of the ECB, while enabling it to bring about price stability, is clearly related to accountability to the general public. The ECB will be as transparent as possible and undertake to explain its policy in full to the public. This will be accompanied by a thorough analysis of all aspects of economic and monetary developments. By pursuing its objective of price stability, the ECB will make a major contribution to supporting the economic policiesy in the Community, as it is required to do by the Treaty on European Union. The ECB will take its obligation to respect democratic accountability to other European institutions very seriously. The Governing Council has decided that it will always explain its decisions to the public, by means of a press conference or a press release, after every meeting. Moreover, there will be many other communications, such as the official publications, speeches, interviews, articles, etc. This transparency will undoubtedly contribute to fostering the credibility of monetary policy in the financial markets and to stabilising market expectations. A further point worth mentioning here is the widespread agreement reached by the Governing Council in the meantime with regard to the instruments of monetary policy. The range of instruments to be employed is more or less complete, and the testing of these instruments is well under way. Considerable progress has also been made with regard to the definition of a single monetary policy strategy. A final decision is expected in the coming months. Whilst aware of the risks we face in the run-up to EMU, I am confident that the prospects for a stable single currency are good. The ECB will have at its disposal a sophisticated infrastructure and will be operational in time to take over responsibility for monetary policy within the euro area from 1999 onwards. The Headquarters Agreement, that we have just signed, will serve as a building block to support the ECB. I should like to take this opportunity to thank again all those who have contributed to the timely completion of an agreement satisfactory to all concerned. I am grateful to Dr. Klaus Kinkel, the German Minister for Foreign Affairs, for his recent letter in which he conveyed the positive attitude of the Federal Government towards the establishment of a European School in Frankfurt. More generally, I should like to express my gratitude to all our counterparts in Bonn, Wiesbaden and Frankfurt for their co-operation in helping the ECB, its staff and their families to settle in and make themselves at home in Frankfurt.
r980918a_ECB	euro area	1998-09-18T00:00:00	Signing of the Headquarters agreement	no_info	0	Meine sehr geehrten Damen und Herren, liebe Kollegen und Mitarbeiter, It is a great honour and a pleasure to welcome you, today, to the signing of the Headquarters Agreement between the European Central Bank (the "ECB") and the Government of the Federal Republic of Germany. The signing of this Agreement represents the completion of one more step forward in the preparation of the forthcoming commencement of the third stage of Economic and Monetary Union. The Agreement that you, Dr. Kinkel and Dr. Waigel, on behalf of the Federal Government, and I, on behalf of the ECB, are about to sign, essentially includes provisions for the application of the Protocol on the privileges and immunities of the European Communities. In particular it governs technical aspects relating to the status of the ECB as an institution of the European Community and of its staff on German territory and the relationship between the ECB and the German authorities. In contrast to the ECB's predecessor, the European Monetary Institute, the ECB will conduct banking operations as from the start of Stage Three. Accordingly, legal precautions were called for, to ensure that this will be possible without limitations in the context of the fulfilment by the ECB of its duties. The Federal Government thereby fully recognises the supranational character of the ECB in its field of activity. I should like to thank the Federal Government for the speed with which it has handled the negotiations, thus enabling the Agreement to be signed today and the ratification procedure to be initiated straight afterwards. We are assuming that the legislative process will have been concluded by the end of 1998 and that it will be possible for the Agreement to come into force in time for the start of Stage Three of Economic and Monetary Union. I should now like to invite you to sign the Agreement.
r980922a_ECB	euro area	1998-09-22T00:00:00	Statement to the European Parliament subcommittee on Monetary affairs	duisenberg	1	This is the first time that I, in my capacity as President of the European Central Bank (ECB), have the privilege to appear here at the European Parliament in accordance with Article 109b(3) of the Treaty. Today I should like to inform you, first, of the decisions that have been taken by the ECB since July and, second, of our schedule for the work still to be completed during the remainder of 1998. Afterwards I shall be happy to answer your questions. . We decided to hold a second meeting in September because we felt that with regard to the long lead time, especially in those areas in which the preparatory work of our counterparties, i.e. the credit institutions, is affected by our decisions, we should move things forward faster. Today I am in a position to present to you quite a long list of important decisions taken recently by ECB bodies. I think that the list demonstrates that we have made very good progress in a number of areas. Let me please elaborate on the most important decisions relating to the preparatory work for Stage Three of EMU. The General Council endorsed the text of an Agreement between the ECB and the non-euro area national central banks, laying down the operating procedures for an exchange rate mechanism in Stage Three (the so-called ERM II). You will recall that the European Council in Amsterdam in June last year agreed to set up an exchange rate mechanism in Stage Three to replace the present European Monetary System (EMS). For this reason, the EMI prepared a draft Central Bank Agreement on the replacement of the current exchange rate mechanism with a new one in Stage Three. It is this Agreement which has now been signed by myself, as President of the ECB, and by the governors of the four non-euro area national central banks. The signing of this Agreement by the latter parties implies their acceptance of the operating procedures. It does not, however, imply their participation in ERM II. For the currency of each Member State participating in the mechanism, a central rate against the euro and a standard fluctuation band of +-15% will be defined, in principle supported by automatic unlimited intervention at the margins, with very short-term financing available. However, the ECB and the participating non-euro area national central banks could suspend automatic intervention if this were to conflict with their primary objective of maintaining price stability. In line with the Resolution of the European Council, exchange rate policy co-operation may be further strengthened, for example by allowing closer exchange rate links between the euro and other currencies in the exchange rate mechanism, where, and to the extent that, this is appropriate in the light of progress towards convergence. Last Friday, 18 September 1998, the ECB published a report entitled "The single monetary policy in Stage Three: General documentation on ESCB monetary policy instruments and procedures". This report contains a detailed description of the monetary policy instruments and procedures to be applied by the ESCB in Stage Three of EMU. Hence it provides credit institutions with the information they need in order to prepare for participation in ESCB monetary policy operations as from 1 January 1999. The report expands upon and updates the material contained in an earlier version which was published by the EMI on 23 September 1997. The report first sets out the criteria to be fulfilled by credit institutions in order to be eligible as counterparties to ESCB monetary policy operations. It then presents the features of the different types of open market operations which might be conducted by the ESCB and the ESCB's two standing facilities (the marginal lending facility and the deposit facility). The report also contains a detailed description of the procedures related to the various types of operations, and specifies the eligibility criteria and the risk control measures to be applied to assets underlying the ESCB's liquidity-providing operations. Moreover, the report includes the description of the features of the ESCB's minimum reserve system and sets out specific provisions to be applied for the ESCB's monetary policy instruments and procedures in the transition to Stage Three. In this context I should also mention that on 11 September 1998 the Governing Council of the ECB endorsed the statistical framework on the basis of a number of reports that had been prepared by the EMI - many of which had been published in the past - thereby confirming the ECB's statistical requirements for Stage Three. The reporting framework for the money and banking statistics of the ECB is included in the "General documentation". Furthermore, on 11 September 1998 the Governing Council endorsed a list of eligible securities settlement systems following an assessment of such systems against standards that had previously been laid down for their use in the credit operations of the ESCB. The list, which indicates those securities settlement systems that will be used by the ESCB and the conditions for their use, is set out in the "General documentation" as well. The technical preparations for the euro banknotes are proceeding according to schedule. The origination, i.e. the process of converting the designs into banknotes, has now been successfully completed. A zero-production run will be conducted in the autumn before mass production starts in early 1999. The Governing Council of the ECB decided on 11 September 1998 that there will be no national feature on the euro banknotes. It also confirmed, in line with previous recommendations made by the EMI, that the following seven banknote denominations will be issued: and In addition to its meetings scheduled for 13 October, 3 November and 1 December 1998, the Governing Council of the ECB has agreed to hold a further meeting on 22 December 1998. The Governing Council's final meeting before the start of Stage Three will be devoted primarily to fine-tuning its last-minute preparations. The Governing Council has also decided that during the first year of Stage Three its meetings shall, as a rule, be scheduled to take place on Thursdays every other week, starting on 7 January 1999. Furthermore, the General Council has agreed that the current practice of holding quarterly meetings on the same day as meetings of the Governing Council should continue in Stage Three. As far as the information policy of the ECB is concerned, I should like to mention that the ECB intends to hold a press conference, as a general rule, once a month. For the first three months of 1999, it envisages holding a press conference immediately after the first meeting of each month. It is my aim to pursue a policy of actively informing the public about the ECB's decisions and the rationale behind them. In addition to press conferences, the public statements of the members of the Governing Council and the ECB's regular publications will also contribute to achieving this goal. In its regular publications, for example, the ECB will report thoroughly on all aspects relevant to the conduct of the single monetary policy in the euro area. In particular, they will supply a detailed analysis of the developments upon which the respective monetary policy decisions are based. Apart from the publications foreseen in the Treaty, of which the Annual Report and the Quarterly Report are the most important ones, the ECB intends to publish a Monthly Bulletin. In order to give a well-rounded picture I should like to draw your attention to one of the most recent ECB publications, the "Report on electronic money", before I turn to our schedule for the remainder of 1998. On 31 August 1998 the ECB published a "Report on electronic money". The report deepens the analysis of the implications of prepaid cards conducted by the EMI in 1994 and extends it to new forms of electronic money, i.e. software-based electronic money products which have since started to evolve. The main findings of the study were published in the Opinion of the EMI Council on the issuance of electronic money, which is contained in Chapter III of the EMI's Annual Report 1997. Although electronic money is not a widespread phenomenon at present, it is likely to have significant implications for monetary policy in the future. In this regard, it must be ensured that, in particular, price stability and the unit-of-account function of money are not put at risk. There are a number of additional regulatory concerns regarding electronic money which also have to be taken into account, such as the efficient functioning of payment systems and confidence in payment instruments, the protection of customers and merchants, the stability of financial markets and protection against criminal abuse. With a view to ensuring monetary policy effectiveness and a level playing-field, and in order to address the regulatory concerns I have just outlined, the ECB regards it as essential that certain minimum requirements be fulfilled (see Chapter 4 of the Report). I would like to stress in this context that the ECB follows with interest and close attention the European Commission's work on a directive on electronic money and expects to be officially consulted in due time. Given the huge volume of work to be completed during the remainder of the year it seemed to us appropriate to give priority to those issues relevant to credit institutions' preparatory work for Stage Three. The above-mentioned "General documentation" is one example of this, since credit institutions' preparations for participation in ESCB monetary policy operations as from 1 January 1999 were to a large extent dependent on the decisions to be taken by the Governing Council. Given the lead time in this field I consider the approach adopted to be very helpful. The need to set priorities was also a major factor in opting to schedule our decision on euro area's monetary strategy for the autumn of this year. The determination of a strategy for the single monetary policy is a very important decision to be taken. Nonetheless, the outcome of our proceedings does not have such a direct impact on our counterparties' preparations for Stage Three as the operational framework. Moreover, another reason for not yet having taken definite decisions regarding the monetary policy strategy is that the matter requires very thorough consideration. The Governing Council has already started with this discussion which will continue for some time. I can assure you that there are no fundamentally diverging opinions within the Governing Council concerning the orientation of our future monetary policy strategy. In this context, allow me to remind you that the EMI had already achieved a broad consensus regarding the monetary policy strategy. In particular, certain strategies, such as exchange rate targeting or nominal income targeting were explicitly excluded some time ago. Moreover, it was pointed out that the implementation of the two potential candidate strategies that had been identified, namely monetary targeting and direct inflation targeting, may, in practice, be relatively similar. A combination of elements of both strategies was also considered as a possibility. Finally, there was no doubt within the EMI Council, that monetary policy decisions should be based on a broad range of indicator variables and that money would be assigned a prominent role, with either targets or monitoring ranges set for its growth, provided that money demand is sufficiently stable. The Governing Council of the ECB will continue to discuss the specification of the strategy along these lines over the months to come. The Governing Council will then specify the exact formulation of its strategy and its implementation in 1999 before the start of Stage Three. I am at your disposal for any further questions.
r980923a_ECB	euro area	1998-09-23T00:00:00	Close of the morning session of a Conference on "Monnaie unique et fiscalitÃ© de lâÃ©pargne: quelle Europe financiÃ¨re?" organised by the European Parliament	duisenberg	1	I would like to express my appreciation for the interesting exchange of views which has taken place during this round table. As was made clear during the discussion, the structure of financial systems in Europe will evolve as the single currency is created. The ECB has already contributed to this evolution in many ways and will continue to do so in the future. I would like to make a few remarks on this topic. are evolving within a global environment, which has become more liberalised, international and concentrated. Changes of particular importance in the euro area include technological innovation in payment systems, the supply and trading of new derivative products, and the improvement and diffusion of new risk management techniques. Moreover, the environment of European financial systems is characterised by the Single Market, with new harmonised pieces of regulation and practices developed on the basis of, notably, the Banking Co-ordination Directives, the Capital Adequacy Directives and, importantly in the context of this Conference, the Investment Services Directive. The scope and organisation of financial activities in the euro area will also change as a result of the creation of the euro. First, money markets are going to be unified. Second, the focus of foreign exchange activities will of course shift to currencies outside the euro area. Third, the behaviour of participants in equity and bond markets is likely to be driven less by country-specific considerations and more by precise, sector-specific or issuer-specific considerations. This latter development is what some commentators have called the development of a "credit risk culture". This development is likely to improve the effectiveness of price formation on European bond and equity markets. This, in due time, will contribute to the smooth functioning of the financing of the euro area economy, as savings are likely to be channelled more efficiently and swiftly through the economy. As such, the development of a "credit risk culture" will therefore be a welcome product of European Monetary Union. Let me now turn to the contributions that the European Central Bank has made, and will continue to make, to support the efficient working of financial markets in the euro area. The first and foremost contribution that the ECB aims to make is . The European System of Central Banks will pursue its primary objective of maintaining price stability with determination. This should facilitate the formation of price expectations by market participants and contribute to financial stability in general. This environment will be beneficial to the efficiency of savings allocation amongst the various sectors of the economy of the euro area. There are several reasons for this. First, the achievement of price stability should help to reduce the uncertainty relating to the future path of inflation. This should enhance the information content of real and financial asset prices and improve the capacity of economic agents to select investment options efficiently. Second, price stability will contribute to protecting the value of savings, thereby avoiding the undesirable wealth re-distribution effects that inflation may cause. Third, in the long run, increased financial stability may contribute to reducing the likelihood of occurrence of asset price bubbles. A second contribution of the ECB relates to the field of . The EMI, and now the ECB, have developed the TARGET system, which will be made available to market participants as from 4 January 1999. The system will ensure the unification of money markets in the euro area. It will reduce transaction costs for cross-border payments and greatly enhance security with regards to settlement risks and possible payment gridlocks. The ECB has also prepared, and is about to publish, a set of minimum standards which securities settlement systems should fulfil in order to be used in ESCB credit operations. This publication and other initiatives taken by the ECB have fostered the increased co-operation between securities settlement systems and depositories of the euro area. A third contribution of the ECB relates to . Many commentators have recognised that European Monetary Union will contribute to the furthering of the harmonisation of market rules and practices. In accordance with the mandates given by treaties and statutes, the European Monetary Institute has taken, and now the European Central Bank takes, an active role in the promotion of adequate new market conventions and rules for the euro area, bearing in mind the principles of free competition. Finally, financial markets will need to take into account the The monetary policy framework of the ECB has been built so as to be very efficient for transmitting monetary policy, while at the same time being as neutral as possible with regard to financial structure. The neutrality and, indeed, market-friendliness, of the ECB's framework is apparent in a variety of ways. First, neutrality is apparent in the way are conducted. Almost all of the ECB's open market operations will be executed through tenders, to which a broad spectrum of counterparties may submit bids. This will be a transparent and fair process. Fine tuning open market operations may also be conducted through tenders, the so-called "quick" tenders. The ECB and the national central banks will aim at giving the opportunity to participate in fine tuning operations to all counterparties having an appropriate track record of activity in the money market, if necessary on a rotating basis. Second, the consideration of neutrality has been a driving factor in the process of establishment of the . Eligible assets are the assets which counterparties have to post as guarantees for any credit received from the European System of Central Banks. The list of eligible assets comprises a wide variety of assets, which have been selected by the ECB according to area-wide uniform criteria relating to their credit standing in the whole euro area. In order to promote a certain degree of continuity at the start of the Third Stage of European Monetary Union, a sub-set (the so-called tier two eligible assets) includes assets of particular importance for certain national banking systems of the euro area. These assets have the same credit standing as the other assets. For monetary policy operations, counterparties will be able to use any eligible assets, irrespective of where they are located in the euro area. To this end, national central banks will act as correspondents for each other so as to make cross-border use possible also for assets for which this service is not yet provided by securities settlement systems. For the record, one may also mention the ECB's system of . Risk control measures will ensure that the amount of assets provided is always sufficient. When designing its system of risk control measures, the ECB has paid careful attention to the best market practices in this area. Finally, and perhaps most importantly, the of the ECB has been developed so as to be as neutral as possible. The minimum reserve system has two main objectives. The first objective is to stabilise money market interest rates. This will be achieved by requesting that average reserve holdings be above the minimum reserve requirements over monthly periods of time. This will allow the banking system to absorb liquidity shocks easily. The volatility of money market rates will, as a consequence, be reduced. Also, fine tuning operations will not have to be used frequently, which will mean that markets are less affected by central bank interventions than they would otherwise be. The second objective of the minimum reserve system is to enlarge the demand for central bank money, so as to enlarge the liquidity deficit of the banking system vis-a-vis the European System of Central Banks. This will safeguard the role of the European System of Central Banks as a key provider of liquidity to the banking system. In the minimum reserve system of the ECB, the reserve ratio will be rather small and reserve requirements will be fully remunerated. The reserve ratio will be set at between 1.5% and 2.5% and will be applied to the deposits, debt securities and money market paper issued by credit institutions, except for residual maturities above two years. Reserve holdings will be remunerated up to the required reserve level, at the rate of the ESCB's main refinancing operation (as averaged over a month). It may be argued that a less than full remuneration of minimum reserves would increase the interest rate elasticity of central bank money demand. This notwithstanding, the European Central Bank has decided in favour of a full remuneration of minimum reserves in order to avoid the potential distortions to fair and efficient markets that a less than full remuneration could have implied. As a result, the minimum reserve system is unlikely to lead to any delocation of certain parts of the reserve base, hence of savings. Finally, it may also be useful to note that the European Central Bank has also decided not to exempt any credit institution of the euro area from the minimum reserve system. I am confident that the policy of the ECB has always been, and will continue to be, guided by the principle of equal treatment, the desire to foster the development of financial markets in the euro area and the need to avoid undue shifts in economic activity. This will also contribute to providing an adequate environment for an efficient allocation of savings in the euro area.
r981006a_ECB	euro area	1998-10-06T00:00:00	Monetary policy in EMU	no_info	0	On 1 January 1999, the curtain will rise on a world premiere. For the first time in history, sovereign states will abandon their own currencies in favour of a common currency, and transfer their monetary policy sovereignty to a newly created supranational institution. This process is all the more unusual from a historical perspective because the national currencies involved are not being abolished because of their weakness. On the contrary, proof of a large measure of monetary stability is demanded as a precondition for participation. The decision has been taken. The Euro will start on time. It must not - and it will not - fail. The European System of Central Banks (ESCB) will devote its best endeavours to making European Monetary Union (EMU) a success. The French president recently called this unique project a "great collective adventure". As a central banker I am generally not in favour of "adventures" - but who would deny that there are risks and uncertainties in this enterprise? You should be reassured that at the European Central Bank (ECB), we have the necessary independence, instruments and tools to deal with these risks and uncertainties in a successful way. I will discuss some of these in a moment. Moreover, when considering the uncertainties implied by the transition to Stage Three of EMU, we should not forget that Monetary Union will also reduce, or even eliminate, a number of risks. This has already been demonstrated, even before the actual introduction of the euro. Recent turmoil in international financial markets did not cause any significant disruption to exchange rates among currencies of the designated participants in Stage Three. This is a clear demonstration of the success of the EMU process. Today, I will address the role of monetary policy in EMU. First, I will make reference to the final goal of monetary policy - the maintenance of price stability. Second, I will discuss some important issues relating to the design and implementation of the monetary policy strategy at the outset of Stage Three of Monetary Union; and Finally, I will describe some features of the operational framework of the ESCB that have recently been finalised. Let me begin by discussing the over-riding priority we attach to the maintenance of price stability. The Treaty on European Union - the Maastricht Treaty - stipulates that the "primary objective of the ESCB shall be to maintain price stability". It was left to the ESCB to provide a quantitative definition of this primary objective. At the ECB's precursor, the European Monetary Institute (EMI), it was agreed that, in the interests of transparency and accountability, the ESCB's chosen operational definition of price stability should be announced publicly. This announcement would form an important element of the overall monetary policy strategy. Simply defining price stability leaves open the question of why price stability is desirable. As a central banker, the benefits of price stability appear self-evident. Any single argument in favour of price stability cannot comprehensively describe the benefits that it brings. For instance, concerning the United States, Martin Feldstein has recently shown that, in combination with taxes and social contributions, even quite modest rates of inflation can cause considerable real economic losses. Research at the Bundesbank has produced similar results for Germany. But elimination of the losses caused by this channel is only one illustrative example among the many benefits of price stability. The greatest contribution that the ESCB can make to the euro area's output and employment performance is to achieve and maintain the stability of prices. Stable prices are at the core of the 'stability culture' we are trying to create in Europe, a culture that is the foundation of sustainable and strong growth in the standard of living for Europe's citizens. At the same time, the ESCB does not operate in a vacuum. Monetary policy needs to be supported by an appropriate fiscal policy and necessary structural reforms implemented at the national level if this 'stability culture' is to be built on solid and sustainable foundations. The private sector also has its part to play, notably by exercising wage moderation, given the high levels of structural unemployment in the euro area. Progress on all these dimensions is not only desirable, but also absolutely necessary. Monetary policy alone cannot ensure strong, non-inflationary growth and improved employment prospects throughout the euro area. However, only a monetary policy focussed closely on the achievement of price stability can lay the basis for these conditions. Of course, that is not to say that the ESCB can, or should, ignore broader macroeconomic considerations. For instance, the threats posed by deflation in combination with nominal rigidities to the real economy have to be taken into account. In order to prevent any misunderstanding, let me be very clear: my discussion of deflation has to be seen in the context of the formulation of an optimal definition of price stability for the ESCB that takes into account deflationary dangers. These dangers certainly cannot be ruled out and our definition of price stability should reflect them. However, simply recalling the current rate of inflation in the euro area - 1.2% - shows that deflation is not an immediate concern for policy-makers. While periodic and transitory falls in the price level may be normal, and should not give rise to major concerns, a prolonged deflation is clearly inconsistent with any meaningful definition of price stability. Moreover, since nominal interest rates cannot fall below zero, a prolonged deflation may render the interest rate policy of the central bank rather ineffective. What remains is out-right purchases of assets - both foreign and domestic. Similarly, the ESCB cannot ignore the implications of nominal rigidities in wages and prices for the transmission mechanism of monetary policy. If we were to live long enough under a regime of stable prices, I would not exclude the possibility that wage and price setting behaviour would adapt, and nominal rigidities would finally disappear. This would reduce some of the potential output costs of fighting inflation, and thus increase the net long-run benefits of price stability. However, for the time being we may have to live with these rigidities and take their effects into account when deciding on our monetary policy strategy. In this respect, the present situation is not easy for the ESCB. Unemployment in the euro area is currently very high. However, in contrast to these persistently high levels of unemployment - which are largely structural in origin - the prospects for maintaining price stability are currently very encouraging. Inflation expectations and long-term interest rates in the euro area are at close to historical lows. Actual area-wide inflation is also very subdued. The current low 'headline' rate of inflation has been moderated somewhat by recent falls in oil and commodity prices, themselves stemming, in part, from the economic and financial crises in Asia and, more recently, in Russia. However, this effect on inflation has been largely off-set by the impact of indirect tax rises in a number of participating countries, which have raised consumer prices for certain goods. All in all, the changed external environment contributes to an overall outlook of very subdued inflationary pressures. In defining price stability, one might ideally refer to a conceptual measure of 'core' inflation that tries to isolate monetary effects on the price level - for which the ESCB is properly responsible - from such terms of trade or indirect tax shocks, over which it has little immediate control. In our month-to-month communication with the public, 'core' measures of inflation may prove useful. But, in its preparatory work for Monetary Union, the EMI recognised that any sensible definition of price stability for the euro area would have to be based on a comprehensive and harmonised price measure. 'Core' measures of inflation typically exclude some items. They are unlikely to be comprehensive enough to satisfy the requirements of an index suitable for a sensible public definition. These considerations point to using the 'headline' measure of the harmonised index of consumer prices (or HICP) for the euro area in the definition of price stability. Finally, the ESCB needs to build on the success of its constituent national central banks (NCBs) in reducing inflation and achieving price stability during the convergence process in Stage Two of EMU. Given the current generally benign inflation outlook in the euro area that is the product of these accomplishments, there is an understandable desire to 'lock-in' the current success in achieving price stability as well as the apparent credibility of monetary policy, and ensure continuity with existing central bank practice. When price stability is defined using the principles just outlined, how should the ESCB proceed to maintain it? In achieving and maintaining price stability - the primary objective of the Treaty - the choice of monetary policy strategy is vital. Within the ECB, a considerable amount of work on the monetary policy strategy has already been completed, building to a large extent on the substantial earlier preparatory work of the EMI. A high degree of consensus has been reached among the NCBs and within the ECB about the main outlines of the strategy - I will address some of these areas of agreement in a moment. The final decision has not yet been made. But you should be reassured that progress is being made at a good pace. I have no doubt that we will be in a position to announce the details of the ESCB's monetary policy strategy in good time, prior to the start of Stage Three. Being a new institution, the European Central bank must be prepared to come under intense scrutiny right from the start. In particular, the international financial markets will monitor its every decision like hawks. Facing this environment in the run-up to Monetary Union, the ESCB must ensure that everything possible is done to make the launch of Stage Three as tension-free as is possible. Choosing and announcing an appropriate monetary strategy is crucial. The monetary policy strategy is, in the first place, important for the internal decision-making process of the ESCB - how the Governing Council will decide on the appropriate monetary policy stance, given the economic environment. Above all, the ESCB strategy must lead to good - that is to say, timely and forward-looking - monetary policy decisions. But the strategy is also of the utmost significance in communicating with audiences outside the ESCB. It should stabilise inflation expectations. The more the strategy helps to promote credibility and confidence in the ESCB's monetary policy at the outset of EMU, the more effective that policy will be - and the easier the ESCB's task of maintaining price stability will become. In deciding upon the appropriate monetary policy strategy, the following aspects must be seen as essential requirements. The strategy must: The realisation that achievement of an optimal, non-inflationary macroeconomic outcome may founder on the private sector's distrust has been central to the monetary policy debate of the nineteen-eighties and 'nineties. The search for answers to the questions raised by this debate has spawned an enormous economic literature. The keywords "time inconsistency" and "credibility" draw forth an almost unmanageable flood of publications that have appeared in the wake of the pioneering contributions of Kydland / Prescott and Barro / Gordon. The need to establish a credible and consistent monetary strategy in the face of the well-known time inconsistency problem faced by policy makers - the dilemma highlighted by this economic literature - is especially important for the ESCB at the outset of Monetary Union. As a brand new institution, the ESCB will have no track record of its own. Building its reputation, and the associated credibility of monetary policy, is vital. But the process of doing so is complicated by the relatively high level of uncertainty surrounding the transition to Monetary Union itself. The transition to Stage Three is a unique event, and will create unique opportunities for many - but it will also create some unique problems for monetary policy makers. At the ECB, we are addressing these problems and are confident that the risks can be managed successfully. Many of the difficulties we face will be overcome through our own efforts over the coming months. Among these problems are the difficulties involved in creating a comprehensive and accurate database of euro area-wide statistics. Running a single monetary policy for the euro area requires timely, reliable and accurate euro area data. In some cases, the euro area statistics simply did not exist until quite recently. In others, the statistics are based on new concepts, and the properties of the data series are not yet well known. The long runs of high quality back-data required for empirical economic analysis may be unavailable. Those that do exist are likely to have been constructed using some degree of estimation and judgement, possibly rendering the econometric results produced with them questionable. Furthermore, the regime shift associated with the adoption of the single monetary policy may change the way expectations are formed in the euro area, and thereby alter forward-looking economic behaviour. Monetary policy's effects on consumption, investment, and wage bargaining - and therefore the whole transmission mechanism of monetary policy to developments in the price level - would be among the important economic relationships to be affected in this way. This may be no bad thing. Indeed, using the regime shift implied by the transition to Stage Three to change both public and private sector behaviour in favourable directions may be one of the largest gains that the euro area can extract from Monetary Union. Nevertheless, these changes are likely to complicate the implementation of certain important elements of a monetary strategy, at least in the short term, as past relationships between macroeconomic variables may break down. What is good for the euro area economy as a whole may create some practical problems for the ESCB. One example of this so-called 'Lucas critique' phenomenon is the impact of current, very low rates of inflation on private behaviour. For many countries participating in Monetary Union, there is simply no - or only very recent - experience of how the private sector will behave in an environment of sustained and credible low inflation. Instability in past relationships may result, should behaviour change in this new, low inflation environment. I have already argued that these structural changes will benefit Europe's citizens - price stability will allow markets to work more efficiently, thereby raising growth, and improving employment prospects. But these changes may also complicate the ESCB's assessment of economic and financial conditions. These uncertainties - arising directly from the transition to Stage Three itself - are both compounded by, and inter-related with, the broader economic context in which Monetary Union will be established. The increasing internationalisation of the global economy, and the current rapid pace of technological change, have affected all sectors of the economy, and the banking and financial systems in particular. For example, at present there are many, inter-related innovations in the payments system, such as: At the ESCB we will need to keep abreast of these developments, both for their immediate impact on one of our "basic tasks" - promoting the smooth operation of the payments system - and because of their broader implications for the euro area economy. Reducing transactions costs in the way I just described will benefit European consumers and producers - but it may also change the indicator properties of monetary, financial and economic variables that national central banks have looked to as guides for monetary policy in the past. Finally, in Monetary Union there will be some heterogeneity across countries within the euro area. Europe's diversity is one of its greatest assets. But this diversity is greater than is typically the case between different regions in the same country using a single currency. Nevertheless, the ECB Governing Council will have to concentrate on monetary and economic developments in the euro area as a whole when discussing and taking monetary policy decisions. How should a monetary policy strategy be selected in this - for monetary policy makers, at least - potentially difficult environment? The EMI outlined a number of 'guiding principles' for the selection of a monetary strategy by the ESCB. Foremost amongst these was the principle of 'effectiveness'. The best monetary policy strategy for the ESCB is the one which best signals a credible and realistic commitment to, and ensures achievement of, the primary objective of price stability. For many commentators, this criterion points unambiguously in the direction of so-called 'direct inflation targeting'. If monetary strategies are to be judged according to how well they achieve price stability, defined as a low rate of measured inflation, then advocates of inflation targets argue an optimal strategy would surely target this low inflation rate directly. These commentators would place explicit quantitative targets for inflation itself at the centre of the ESCB's monetary policy strategy. Their approach has been strongly endorsed in some academic and central banking circles. But, in the current circumstances, a pure 'direct inflation targeting' strategy is too simplistic for the ESCB, and possibly even mis-conceived. The ESCB well understands the primacy of price developments and price stability for monetary policy making. Indeed, the Treaty's mandate is unambiguous in this respect. We will signal our intentions on this dimension very clearly by making a transparent public announcement of our definition of price stability. The current low level of long-term nominal interest rates in the euro area suggests that the financial markets, at least, understand and believe the over-riding priority that we attach to achieving price stability. Regarding strategy, our choice therefore need not be governed solely by a desire to signal our intent to maintain price stability. This has already been well-established - by the Treaty, and by the success of the convergence process in reducing inflation in Europe to its current low level. Rather than signalling our intent, the strategy must constitute a practical guide that ensures monetary policy is effective in achieving the goal we have been set. In this respect, there are considerable problems with using inflation itself as the direct target within the ESCB's overall strategy. Because of the well-known lags in the transmission mechanism of monetary policy to the economy in general, and the price level in particular, it is impossible for a central bank to control inflation directly. Therefore, 'inflation targeting' in practice means 'inflation forecast targeting' where central banks set monetary policy to keep their best forecast of inflation at the target level deemed consistent with price stability. But recognition of this need for forecasts in an inflation targeting strategy immediately raises practical difficulties. In the uncertain environment likely to exist at the outset of Monetary Union, forecasting inflation will be very difficult, not least for the conceptual, empirical and practical reasons I outlined a moment ago. Forecasting models estimated using historic data may not offer a reliable guide to the behaviour of the euro area economy under Monetary Union. Forecast uncertainty is likely to be relatively large, possibly rendering the whole inflation targeting strategy ineffective. To address these uncertainties, a large element of judgement would have to be introduced into the forecasting process, in order to allow for the regime shifts and structural and institutional changes that are a seemingly inevitable consequence of EMU. Simply relying on historic relationships to forecast future developments is unlikely to prove accurate or effective. While introducing judgmental adjustments into forecasts in these circumstances would be both appropriate and necessary, such adjustments are likely to compromise the transparency of the inflation forecasts and, thus, of any inflation targeting strategy. Using judgement may prevent outside observers from readily assessing the reliability and robustness of the inflation forecasting procedures used by the ESCB. I see a distinct bias in the academic discussion of the comparative advantages of inflation targeting and monetary targeting. With good reason, many arguments are presented against the ESCB adopting a monetary target. But proponents of inflation targeting seem to forget that, in the current context, most of these arguments could also be used against inflation targeting. Above all, I have not seen any attempt thus far - even if only a tentative one - to explain how the ESCB should deal with the specific difficulties involved in making an inflation forecast at the outset of Monetary Union that could be used as the centrepiece of an inflation targeting strategy. In many respects, a strategy giving a prominent role to monetary aggregates has considerable advantages over direct inflation targeting. Monetary aggregates are published. They are clearly not subject to various kinds of 'judgmental manipulation' by policy makers or central bank staff that might be possible with inflation forecasts. To the extent that policy makers wish to depart from the signals offered by monetary growth because of 'special factors' or 'distortions' to the data - including those distortions arising from the transition to Monetary Union itself - they will have to do so in a public, clear and transparent manner. Moreover, a strategy that assigns a prominent role to the monetary aggregates emphasises the responsibility of the ESCB for the monetary impulses to inflation, which a central bank can control more readily than inflation itself. These monetary impulses are the most important determinants of inflation in the medium term, while various other factors, such as terms of trade or indirect tax shocks, may influence the price level over shorter horizons. In the light of these considerations, it was agreed at the EMI that, regardless of the final choice of the monetary policy strategy, monetary aggregates would be accorded a prominent role in the overall monetary framework adopted by the ESCB. However, the EMI also noted that certain technical pre-conditions would have to be met before this 'prominent role' could be translated into an explicit, publicly announced monetary target, guideline, benchmark or monitoring range. Specifically, such targets or ranges would only be meaningful guides to monetary policy if the relationship between money and prices - as encapsulated in a 'demand for money' equation - was expected to remain sufficiently stable. In this regard, several existing empirical studies point towards the stability of the demand for euro area-wide monetary aggregates. However, these studies are necessarily only preliminary. The reliability of these results in the face of the uncertainties raised by the transition to Stage Three is unknown. Future shifts in the velocity of money are certainly possible - perhaps even likely. They cannot be predicted with certainty. Moreover, it is not clear whether those aggregates that have the best results in terms of stability are sufficiently controllable in the short-term with the policy instruments available to the ESCB. In these circumstances, relying on a pure strategy of strict monetary targeting is simply too risky. Against this background, the ESCB will have to design a monetary policy strategy of its own. The chosen strategy will show continuity with the successful strategies that participating NCBs conducted in the Stage Two. At the same time the ESCB's strategy will take into account the unique situation created by the introduction of the euro. Having a well-designed monetary strategy is vital. But we must also be able to implement it successfully at an operational level. What instruments are available to implement this strategy? The ECB will have a complete set of monetary policy instruments at its disposal. These instruments have been selected on the basis of their efficiency for transmitting monetary policy and their neutrality across market participants. Three types of instruments are available to the ESCB: open market operations, standing facilities and a minimum reserve system. I will briefly present these instruments in the remainder of my speech. Open market operations include, first, a weekly main refinancing operation, which will take the form of a reverse repurchase transaction with a maturity of two weeks. The main refinancing operation will be based on a tender procedure. The tender may be a fixed rate tender, with counterparties bidding amounts, or a floating rate tender, where counterparties propose bids including both amounts and interest rates. Second, there is the monthly longer term refinancing operation, which has a maturity of three months and will always take the form of an interest rate tender. This is because the ECB will avoid signalling its monetary policy stance through these particular operations. The ECB will also conduct fine-tuning operations, through the national central banks of the euro area or, in exceptional circumstances, on its own account. Fine tuning operations will be conducted whenever liquidity or money market conditions warrant. Fine tuning operations may take the form of reverse repurchase transactions (that is, the same type of transaction as that used in the main refinancing and the longer term refinancing operations, but with no pre-set start date nor a pre-set maturity), foreign exchange swaps or the taking of fixed-term deposits. Fine tuning operations in the form of reverse repurchase operations may be executed either through quick tenders or bilaterally. In both cases, these operations will involve a limited set of eligible counterparties that have an appropriate track record of activity in the money market. The other types of fine tuning operations will also be executed with a limited number of eligible counterparties, which will be selected ex ante by the ECB. In some countries, there will be a rotation scheme, which will aim at giving the opportunity to all eligible fine tuning counterparties to participate in fine tuning operations. Finally, open market operations may also be conducted whenever structural reasons, such as the longer-term evolution of liquidity profiles, warrant it. These so-called structural operations may take the form of outright purchases or sales of securities or the issuance of debt certificates by the ECB. The ECB will operate two overnight standing facilities, which will be available to all credit institutions at national central banks of the euro area, provided that, when using the marginal lending facility, they have sufficient collateral. The rate of the marginal lending facility will constitute the upper bound of collateralised overnight money market rates. The deposit facility will be remunerated at a rate that will constitute the lower bound of overnight money market rates. When using the marginal lending facility, or, for that matter, when entering in liquidity-providing open market operations in the form of reverse transactions, counterparties have to post assets with their national central bank (or the ECB in the exceptional case when the ECB conducts fine tuning operations on its own account). These assets are meant to act as guarantees for credits received from the European System of Central Banks. A list of eligible assets has been drawn up for this purpose. The list comprises a wide variety of assets and has two sub-sets. First, the so-called tier one assets, which are selected by the ECB according to uniform criteria relating to their credit standing in the whole euro area. Second, the so-called tier two assets, which have been selected by the ECB because they are of particular importance for certain national banking systems of the euro area, in order to promote a certain degree of continuity at the start of the Stage Three of EMU. Two principles of equal treatment are applied, however. First, the credit standing of tier two assets is as high as that of tier one assets. Second, both tier one and tier two assets may be used by any credit institution in the euro area, irrespective of its location. In addition, a set of risk control measures has been elaborated to ensure that, for any counterparty, the amount of assets provided is always sufficient. Risk control measures cover the assets' price and credit risks, taking account of the asset type, its characteristics and the maturity of the transaction. The ECB's risk control measures have been elaborated with careful attention to the best market practices in this area. They include the deduction of haircuts from the assets and the imposition of initial margins to the credit amount. Another feature of the risk control framework is the regular revaluations of the assets, which will, in most cases, take place daily and may trigger margin calls, most often to be settled through delivery of additional assets. The ECB will also apply a minimum reserve system to credit institutions of the euro area. Two main monetary policy objectives have been assigned to the minimum reserve system. The first objective is to stabilise money market interest rates through the averaging mechanism, whereby the fulfilment of minimum reserve requirements is based on average reserve holdings over monthly periods of time. During the maintenance period, this allows the banking system to absorb liquidity shocks. The reduced volatility of money market rates will reduce the need for frequent fine tuning operations, which will mean that markets are less distorted by central bank interventions than they would otherwise be. The second objective of the minimum reserve system is to enlarge the demand for central bank money, so as to enlarge the liquidity deficit of the banking system vis-a-vis the ESCB. This will safeguard the role of the European System of Central Banks as a provider of liquidity to the banking system. Reserve requirements will be calculated by applying a reserve ratio of 1.5% to 2.5% to the deposits, debt securities and money market paper issued by credit institutions, except for residual maturities above two years. Although repurchase agreements are included in the reserve base, they will be subject to a zero reserve ratio. Inter-bank liabilities and liabilities vis-a-vis the ESCB will not be subject to reserve requirements. An allowance of the order of E 100,000 will be deducted from reserve requirements, so that credit institutions with a small reserve base will not have to hold minimum reserves. Reserve holdings will be remunerated up to the required reserve level, at the rate of the main refinancing operation (as averaged over a month). It may be argued that a less than full remuneration of minimum reserves would increase the interest rate elasticity of central bank money demand. This notwithstanding, the ECB has decided in favour of a full remuneration of minimum reserves in view of the distortion to efficient markets that a less than full remuneration would have implied. As a result of the full remuneration of minimum reserves, the European Central Bank has also decided not to exempt any credit institution from the minimum reserve system. The ECB will have many counterparties and be subject to close public scrutiny. It has therefore set up procedures for informing its counterparties and the public about its monetary policy instruments in a robust and transparent manner. The ECB will inform its counterparties and the public through a document detailing its monetary policy instruments and procedures and through the regular publication of various materials on its Internet site. The ECB has produced a document describing its monetary policy instruments and procedures in detail. This is called " ". A revised version of this document was published recently. This revised version includes all the newly specified elements of the monetary policy framework of the ECB, including for instance the minimum reserve system. This document also includes a calendar for the standard tender operations in 1999 (both main refinancing and longer term refinancing operations). Calendars of standard tender operations will be published by the ECB every year. The list of assets that are eligible as guarantees for liquidity providing operations will be made public on the Internet site of the ECB. The list will be updated on a weekly basis and users will be able to subscribe to an e-mailing facility for receiving certain designated parts of the list on a regular basis. Users will also be able to query the list, which will contain a large number of assets. The list of institutions subject to minimum reserves, that is, credit institutions established in the euro area, will also be available on the Internet site of the ECB, together with the list of all monetary and financial institutions in the European Union. We are less than three months away from the moment when monetary policy sovereignty is transferred from the NCBs to the ESCB. The bulk of the preparatory work has already been completed, but major decisions - above all, the choice of a monetary policy strategy - still have to be made. The public can be certain that we will always inform them, regularly and comprehensively, about our considerations and deliberations. We will make all our decisions transparent. I have no doubt that we will be well prepared for the moment at which we take over responsibility for monetary policy in the euro area.
r981022a_ECB	euro area	1998-10-22T00:00:00	The international role of the euro	duisenberg	1	The introduction of the euro is undoubtedly the most profound change in the international monetary system since the collapse of the Bretton Woods system in 1973. It is therefore understandable that a great deal of interest is being shown in the prospective role of the euro as an international currency and its implications, not least for the monetary policy of the European System of Central Banks (ESCB) (that is, the European Central Bank (ECB) and the euro area national central banks). In my presentation this evening, I shall try to shed some light on these issues by examining the developing role of the euro as a reserve and international currency, its relation with the monetary and exchange rate policy of the ESCB, some specific policy issues and its impact on the international monetary system. My principal conclusion is that there is little doubt that Monetary Union will entail an expanded role for the euro in the global arena relative to its constituent currencies. The ESCB will not shy away from the role that this development implies; it will contribute to the international policy discussions from the perspective of price stability in the euro area being its prime objective and, at the same time, the best longer-term contribution which it can make to stable international developments. The developing role of the euro as a currency may usefully be linked to the differing functions of money, notably as a store of value and a medium of exchange. One aspect of the international role of the euro will be its evolving use as a reserve asset (a store of value) and an instrument of intervention (a medium of exchange) by central banks. At present, the US dollar remains the by far most important reserve currency world-wide. According to data for the end of 1996, the share of dollar-denominated official reserves amounts to 64%, while euro area currencies account for 25% and the Japanese yen for 6%. As far as the future share of the euro in overall official reserves is concerned, it seems plausible to expect that the national central banks of non-euro area countries will generally re-assess their reserve management strategy in light of the improved global diversification opportunities offered by holding an increased share of their portfolios in this new currency. The euro will be of particular importance as a reserve asset to those other European countries which, formally or informally, intend to peg their exchange rate to the euro or to a (trade-weighted) basket of currencies including the euro as a large component. This may hold true not only for countries participating in the new European exchange rate mechanism (ERM II), but also for transition countries in central and eastern Europe and possibly for non-EU Mediterranean countries as well as for Switzerland and Norway. Meanwhile, the euro may in future come to represent a more important part of foreign currency reserves held by Asian central banks, which include at present mainly US dollar assets. Whether and to what extent this will happen depends, however, crucially on confidence in the ESCB's monetary policy and the euro's stability. As regards official reserve holdings in the future euro area, it has been argued that the introduction of the euro would generate so-called "excess reserves" within Europe. This is distinct from the issue that there will be an automatic fall in the euro's share of world reserves since some EU countries' reserves formerly held in Deutsche Marks will become "domestic euro assets". The main argument is that the degree of external openness of the euro area will be much lower than that currently prevailing in each of the future participating economies. As a result, the need for official reserves, as assessed on the basis of future euro area exports, should significantly decline. However, while not entirely dismissing this argument, I would suggest that the appropriate level of official reserves chosen by central banks depends on many more factors than suggested by this line of reasoning - for example, financial integration and the ease with which institutional investors can mobilise huge amounts within a brief period of time have increased the level of reserves needed for effective intervention, there is a need for reserves to take part in any concerted intervention that may be agreed and there is the "reputation effect" of substantial reserve holdings. Particularly given the uncertainties prevailing at the start of Stage Three of Economic and Monetary Union (EMU), caution is likely to be the watchword in this regard. I should stress that although reserve-management aspects have tended to receive a great deal of attention in respect of the future role of the euro, I believe that private portfolio flows and the prospective adoption of the euro as a vehicle currency will be predominant factors in the euro's prospective internationalisation. It is to these topics that I now turn. As is the case for foreign exchange reserves, the US dollar is at present the dominant investment currency in the global capital market, although some decline of its position as a store of value for private investors is already apparent. The share of dollar-denominated international bonds and notes amounted to 46% at end-June 1998, followed by the yen (11%) and the Deutsche Mark (10%), whereas all euro area currencies taken together accounted for 24%. A similar pattern can also be found for the denomination structure of international bank assets and liabilities. By contrast, the falling share of the US dollar even before the start of Stage Three of EMU can be seen from the fact that between 1981 and 1995, EU currencies' share of world private portfolios rose from 13% to 37%, while the US dollar's share fell from 67% to 40%. There are strong arguments to suggest that private investors will in future hold a greater proportion of their portfolios in euro assets than they have done in the constituent currencies to date. A key element in the potential attractiveness of the euro as an investment currency will be the emergence of large and integrated financial markets in the euro area as the euro removes currency-related fragmentation in the euro area and induces the establishment of uniform market standards. Market liquidity should benefit from this integration, thus inducing a virtuous cycle of increasing issuance and investment in euro instruments by domestic and foreign institutions. In particular, at the short end of the yield curve, the necessary conditions for the creation of a broad, deep and liquid European money market are likely to be met. The operational framework for monetary policy, with the major instrument being open market operations based on reverse transactions, will foster money market integration. Integration will be supported by the implementation of the TARGET system of interlinked real-time gross settlement (RTGS) systems of the participating countries. This will ensure a common overnight interest rate throughout the euro area, a smooth settlement of cross-border payments in the euro area and a reduction of systemic risks that might arise from settlement failures. TARGET will also be available to non-euro area banks for exchanging intraday liquidity in euro, albeit only subject to strict conditions being met. The introduction of the euro should also have favourable implications for bond markets by increasing market liquidity, broadening the range of maturities and potentially offering a wider variety of financial products. Nevertheless, capital markets are likely to remain more fragmented at the long end of the yield curve than at the short end, despite the redenomination on 1 January 1999 of outstanding government debt into euro. Credit spreads between euro government bonds are likely to prevail even after the start of Stage Three of EMU, reflecting differences in credit assessments based on the respective fiscal position of governments in the euro area, including future pension obligations, and hence giving appropriate market signals. Moreover, differences in national issuing procedures, market practices and conventions as well as fiscal differences mean that the euro bond market may take time to reach the level of homogeneity of the US bond market. Meanwhile, increasingly integrated money and government bond markets may stimulate the emergence of commercial paper and corporate bond markets in the euro area. A benchmark of government bonds or of swap rates, increasing economies of scale, narrower bid-ask spreads, lower hedging costs for debt securities issued by private firms and more competitive underwriting are likely to provide incentives for corporations to issue their own securities instead of borrowing from banks, while investors in search of a yield pick-up will find such securities attractive. Equity issuance and trading may also in due course become euro area-wide. Likewise, on the deposit side, a rapidly developing private repo or investment fund market in euro could become a serious alternative to traditional bank deposits for large investors, such as pension funds and insurance companies. The development of such new market segments is likely to attract both international investors and borrowers. A further issue which will influence internationalisation is the risk, return and diversification characteristics of the euro. One such aspect is that the euro should offer international investors and borrowers from outside the EU an attractive real rate of return adjusted for risk. Such an attractive risk/return profile should be enhanced by stability-oriented monetary and fiscal policies and the ESCB's independence, thus protecting holders against losses in purchasing power. Meanwhile, whether the euro would offer more or fewer opportunities for diversification than the situation in Stage Two is very difficult to predict, since it would depend on both the variances and the co-variances of the returns on assets denominated in euro and in other currencies. On the one hand, Monetary Union may induce a greater independence of euro yields vis-a-vis those of the United States, increasing diversification benefits. On the other, a case can be made that with the elimination of exchange risk premia and the adoption of a single monetary policy, investors in bonds of euro area countries are likely to lose some diversification benefits which are currently available to them. However, for the countries that have long maintained stable exchange rates, this loss of diversification benefits may, to a large extent, have already taken place. It is difficult to predict, a priori, the net effect of these influences on the demand for euro. A further aspect of the internationalisation of the euro will be its developing role as a transaction and vehicle currency for cross-border transactions, i.e. as a medium of exchange, outside the euro area. Today, the US dollar is the most important transaction and vehicle currency. In foreign exchange markets, 71% of all spot transactions involved the dollar on one side of the deal, compared with 68% for euro area currencies, 22% for the yen and 39% for other currencies. The US dollar's share is considerably higher - over 80% - when derivatives transactions are also included. With respect to the invoicing of international trade, estimates suggest that in the early 1990s about one half of global exports were invoiced in US dollar, roughly one third was denominated in euro area currencies and only 5% in Japanese yen. Initially, following the introduction of the euro, its market share in foreign exchange transactions and foreign trade will decline "automatically, as a result of the purely mechanical effect of eliminating intra-euro area trade, which amounts to over 60% of total external trade of the future euro area countries. Its share could fall to around 20% for the invoicing of foreign trade and 56% for spot foreign exchange transactions. However, notably in respect of trade, the expected decline is likely to be a short-term development. In a medium-term perspective, the decline is likely to be offset, as international trade flows both between euro area and non-euro area countries, as well as euro-denominated trade between non-euro area residents increase. It is of interest to note in this context that according to recent press reports, some companies in non-euro area European countries such as Denmark, Sweden, the United Kingdom and Switzerland are considering switching wholly or partly to operations in euro. Nevertheless, at the global level it will clearly take time for the euro to attain a comparable stature to the dollar as a vehicle currency. Note that the value of US dollar-denominated international trade is nearly four times higher than US exports. As this ratio indicates, the use of the US dollar as an international currency on the goods and financial markets is less related to trade shares than to the convenience of using one standard currency - in other words, there are economies of scale. In this context, it is worth noting that it took several decades before the US dollar, as the currency of the largest economy in the world since the end of the last century, became the most important vehicle currency, replacing the pound. Thus, sterling was used as a standard despite the declining economic and trade weight of the United Kingdom. The arguments that I have presented so far suggest that the euro will indeed become an international currency, albeit at different rates in different domains. As regards the approach of the ESCB to these matters, I should state quite categorically that its overriding objective is price stability for the euro area as a whole; there are no plans whatsoever to stimulate the use of the euro as an international currency, to use the euro as an instrument of foreign policy, or to rival the US dollar. Nevertheless we have to acknowledge that the euro will become an important international currency merely by the operation of market forces as outlined above. This role will probably develop gradually over time, at a pace linked to the success of the ESCB in maintaining price stability. In this context, it is important to stress the role which the euro's exchange rate will play in the conduct of the ESCB's monetary policy. At its meeting in December 1997 in Luxembourg, the European Council stressed in its conclusions that the exchange rate of the euro would be heavily influenced by the economic fundamentals of the euro area relative to those of other countries. In broad terms, this implies that the exchange rate should be seen as the outcome of all relevant economic policies rather than as an objective to be set independently. Underlying this position is of course the Treaty establishing the European Community, according to which the ESCB's primary objective is to maintain price stability. For the ESCB this objective will have pre-eminence over other policy objectives, including possible exchange rate targets. Equally, the EMI's Report entitled "The Single Monetary Policy in Stage Three" concluded that an exchange rate objective for monetary policy would not be appropriate for an area as large as the euro area, because it might not be consistent with the objective of price stability. Indeed, as I announced last week, the stability-oriented monetary policy strategy that the ECB will adopt involves a prominent role for money with a reference value for the growth of a monetary aggregate and a broadly based assessment of the outlook for future price developments. In addition, I announced a quantitative definition of the primary objective of the single monetary policy, price stability, namely a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. Following the same line of reasoning, although the Treaty provides for various possible exchange rate arrangements, the European Council also concluded in December last year that so-called "general orientations" for the exchange rate policy of the euro area may only be formulated in exceptional circumstances, for example, in the case of a clear misalignment. This implies that in normal circumstances and in the absence of formal exchange rate arrangements between the euro and other major currencies, the ESCB alone will be in charge of the implementation of exchange rate policy in the euro area. The ECB will of course monitor exchange rates as part of its overall assessment of a broad range of economic and financial indicators which are relevant to the conduct of monetary policy and respond wherever necessary - in other words, there will be no "benign neglect". Having an international currency has advantages for economic agents, but may sometimes complicate monetary policy. For example, one aspect is that the currency is circulating to a much greater extent outside the own-currency area. This makes monetary aggregates harder to interpret and control. Such holdings may aggravate any distortions to the relationship between money and economic variables that could result from the "structural break" that Monetary Union may represent. Furthermore, there has been some debate as to whether the euro could initially be vulnerable to transitional problems owing to portfolio shifts. Certainly, it cannot be totally ruled out that large movements in the value of the dollar may have undesirable effects on the domestic situation of the euro area, at a time when the ESCB would be in the process of establishing its credibility. They may also have spillover effects on ERM II. The ESCB will, of course, be vigilant in respect of the potential consequences of such shifts for domestic monetary stability. However, there could be offsetting stabilising effects from capital flows at the beginning of Stage Three, not least because the attraction of the euro will be both on the assets and the liabilities side. More generally, there is the issue of managed floating and target zones. Some view exchange rate management as a desirable goal of international policy co-ordination, and also one that will become more feasible with the introduction of the euro. I take a less favourable view, as I shall now explain: Following the end of the Bretton Woods system, for almost 25 years now exchange rate relationships among the main currency blocs (the United States, Japan and the Deutsche Mark area) have been characterised by floating exchange rates and a de facto multi-polar international monetary system. This situation has reflected a number of important changes in the economic context relative to the one prevailing in the early years of the Bretton Woods system, notably a greater balance in the relative economic size of the main industrial countries and the tendency of the largest countries - and in future the euro area countries - to aim their monetary policies primarily at domestic objectives. At the same time, the liberalisation of capital movements has drastically diminished the ability of central banks and governments to control exchange rate movements. The priority assigned by large countries and currency areas to domestic objectives explains why in recent years policy co-ordination among the three main currency blocs has been essentially of a non-binding nature. Since the end of the Bretton Woods system and the move to floating rates, the three main currency areas have nevertheless occasionally taken ad hoc measures to correct exchange rate misalignments or to stabilise exchange rate levels. Examples of co-ordinated actions agreed by the main industrial countries have been the Plaza Agreement (September 1985) and the Louvre Accord (February 1987). However, these countries have always refrained from committing themselves to formal exchange rate arrangements or pre-defined rules for their management. I would acknowledge that within the limits set by its voluntary and ad hoc nature, policy co-ordination has in some cases proved effective in managing exchange rates. Joint policy action has notably been effective in specific situations, for example in the presence of speculative "bubbles" or of a high degree of uncertainty regarding the correct interpretation of fundamentals. Nevertheless, there remains deep concern, which I share, about the potential implications of such arrangements for monetary stability at the domestic level. The simple point is that they may well limit the scope for action and independence of monetary policy makers in a manner that would not be in conformity with equilibrium in the domestic economy. The current predicament of Japan may be partly traced back to its willingness to maintain an expansionary monetary policy in the late 1980s, in order to weaken the yen, which, in retrospect, fuelled credit expansion and asset price inflation, and, in due course, price inflation per se. Likewise, the boom in the United Kingdom in the same period, which eventually required severe monetary tightening, can be partly traced back to attempts to shadow the Deutsche Mark despite upward pressures on the currency. On balance, I would urge that discretionary action in this field should be entered into with considerable caution, and ill-advised or inconsistent action may have far worse consequences than largely leaving market forces to play themselves out, while strictly maintaining price stability at home. Moreover, even if all those concerned were to maintain price stability, there may well be justified shifts in exchange rates linked to cyclical differences between the major blocs. Total exchange rate stability at the global level may thus be neither attainable nor desirable. Discussion of policy co-ordination leads on to my final topic, namely the impact which Monetary Union may have on the development of the international monetary system itself. I note immediately that both the direction of these effects and the time that may be needed for them to be felt in full are difficult to predict. I shall make no comment on recent criticisms or proposals for reform of the system, but would rather prefer to highlight the underlying forces at work in promoting the weight of the euro. First, the greater cyclical synchronisation of the euro area (linked, inter alia, to a single monetary policy and common exchange rate), together with its size, will make economic developments in the euro area of considerable importance to the world. Moreover, the action of the ESCB will be made more important than those of the individual EU national central banks in the past. Second, the joining of a number of large industrial countries in a single currency area will reduce the number of major currency blocs in the global financial system. In principle, this should simplify the decision-making process on financial and economic issues at the international level. However, the net effect will also depend on the implementation of a unified internal decision-making process and external representation for the euro area. Third, the large size of the euro area will create a greater balance in the relative size of players in the global economy (the United States, the euro area and Japan). Each of the main players will be in a position to have a greater effect on the shape of the system than they had when Europe was fragmented and, at the same time, they will be more or less equally vulnerable to the possible consequences of instability. They may thus have enhanced incentives to take on a share of the responsibility for managing and preventing it. In the context of these developments, the ECB, acting on behalf of the ESCB, will clearly have an important role in international policy discussions, comparable to the current role of the US Federal Reserve. We shall not walk away from that role. Indeed, the ECB is already beginning to play a certain role at international meetings such as those at the BIS/G-10, IMF, OECD and in a G-7 context. This role will gain increased weight over time, There remain a number of unresolved issues in this area, but progress is being made on ensuring that practical and workable arrangements will be agreed - and they will evolve over time. Moreover, it has to be recognised that the ECB is not yet operational and also that the international role of the euro will develop over time. In all relevant fora, the ECB's role will be to contribute to the international policy discussions from the perspective of price stability in the euro area being its prime objective and at the same time the best longer-term contribution which it can make to stable international developments. There is little doubt that Monetary Union will entail an expanded role for the euro in the global arena relative to its constituent currencies. This will occur not least as a consequence of a profound restructuring of the euro area financial markets, which will make them more efficient and internationally competitive. However, the confidence in future internal and external stability of the euro will also play a crucial role. In this respect, although we shall take a neutral stance on this issue, I am convinced that the unambiguous mandate conferred upon the ESCB to maintain price stability and the ESCB's institutional framework, which ensures a high degree of independence, will automatically foster the future international role of the euro. Changes in the structure of the international monetary system will take time to materialise, as past experience has shown in the case of the US dollar vis-a-vis the pound sterling. However, I am rather confident that the euro will indeed play a major role in the international financial arena. Our monetary policy will be the centre of attention in this context and our basic message will remain that the best means of securing stable exchange rates is fiscal and monetary stability.
r981026a_ECB	euro area	1998-10-26T00:00:00	The European perspective on the euro	hamalainen	0	On entering the European Monetary Union, the eleven participating countries will permanently give up their own national monetary policy. Monetary policy decisions will be taken by the Governing Council of the ECB and will be based on euro area wide considerations. The primary objective of the ESCB is to maintain price stability in the euro area. Price stability has been defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. In order to achieve this objective, the ESCB will pursue a strategy comprising two elements: 1) money will be assigned a prominent role through the announcement of a quantitative reference value for the growth of a broad monetary aggregate; and 2) there will be a broadly-based assessment of the outlook for price developments on the basis of a wide range of indicators. The focus on euro area wide developments implies that if an asymmetric shock were to hit a specific Member State, or if business cycles were not to be synchronised across the euro area, the necessary adjustment at the national level would have to be performed by fiscal and structural measures. In practice, this situation was apparent already in the process towards Monetary Union. The convergence process towards Monetary Union meant that a degree of nominal convergence never before experienced in Europe was achieved. The credibility established through the convergence process became evident during the recent turmoil in the international financial markets. Exchange rates remained stable within the exchange rate mechanism ERM and long-term interest rates spreads widened only slightly. While recognising the achievements made in embarking on a path towards stability-oriented policies and a high degree of nominal convergence, we also have to admit that unemployment is still unacceptably high in the euro area. However, I would like to stress that monetary policy is neither the cause of nor the solution to the unemployment problem in Europe. The problems with European labour markets are structural. Unemployment in Europe can thus only be effectively combated through reforms addressing these underlying structural problems. On the whole, the economic fundamentals of the euro area economies look better now than they have done for many decades. Inflation is low, savings are high, public finances have improved and domestic demand seems to continue being strong. Even if it is clear that external effects will hamper the growth prospects also in the euro countries, it appears that the euro area is presently experiencing more stable and favourable economic conditions than most other regions in the world. The introduction of the euro will be the biggest change in the international financial system since the collapse of the Bretton Woods system in 1973. It is likely that the euro will play a very important role in the international financial markets, benefiting from the reputation inherited from the currencies which it will replace. Several arguments seem to indicate that the euro may become a more attractive investment currency than all the currencies which it will replace taken together. A further aspect of the internationalisation of the euro will be its developing role as a transaction and vehicle currency for cross-border transactions outside the euro area. Today, the US dollar is by far the most important international transaction currency. The euro may become an important currency for invoicing of foreign trade and for spot foreign exchange operations. On the whole, there is little doubt that the euro will have a more important role in the international financial system than any of its constituent currencies. Confidence in the future internal and external stability of the euro will be a key factor in determining the international importance of the euro. Another factor will be the efficiency and international competitiveness of the European financial markets. The European financial markets are currently undergoing a rapid development characterised by cross-border integration and provision of new financial services. I should like to highlight a few areas where the introduction of the euro is likely to directly influence the working of the financial markets in the euro area: On a more general level, cross-border integration may promote the markets for commercial paper and corporate bonds in the euro area. The market value of corporate bonds outstanding in the US is at present almost ten times larger than in the euro area. There is thus plenty of scope for further securitisation in the euro area and the introduction of the euro certainly underpins this development. These developments will have important structural implications for the banking industry in the euro area in addition to the effects of increased cross-border competition. So far, the European banking industry has remained segmented into rather small national markets; the introduction of the euro is expected to give momentum to cross-border integration in the European banking sector resulting from the disappearance of the natural "protective barriers" implied by national currencies. To conclude: The developments of the European financial sector are likely to greatly improve the efficiency in the mobilisation of savings and in the channelling of these savings into productive investments - and thus improve the growth potential of the euro area as a whole.
r981027a_ECB	euro area	1998-10-27T00:00:00	The impact of the introduction of the euro on ACP countries and particularly on the CFA franc zone	schioppa	0	I am both honoured and pleased to contribute to the proceedings of this Committee of the European Parliament. As you are aware the President of the ECB intends to appear regularly before the European Parliament in its plenary sessions or at the level of the Sub-Committee for Monetary Affairs. This is meant to be an important part of the communication policy of the ECB. Against this background, it seems also appropriate for Executive Board members to take part in the proceedings of European Parliament Committees when they deal, as it is the case today with the Development and Co-operation Committee, with matters that are relevant for the ECB. The introduction of the euro is the most momentous event in the international monetary system since the end (or perhaps since the creation) of the Bretton Woods system. The EU as a whole has developed trade and financial relations with 71 countries (the ACP -African, Caribbean and Pacific- countries) through the so-called Lome Convention. Since the fourth Lome Convention will expire in February 2000, the European Union and ACP countries started on 30 September 1998 negotiations regarding future arrangements. In addition, France has maintained a long-standing economic and monetary co-operation with 14 African countries and the Comoros (the CFA franc zone), which are members of the ACP group. Together with its African counterparts, France has expressed its intention to maintain the broad features of the existing arrangements with the CFA franc zone, by substituting the euro for the French franc from 1 January 1999. The international implications of the euro for non-EU countries having close links with the Community have recently attracted a great deal of attention. In addition to the Central and Eastern European countries and the Mediterranean countries, the potential impact on the African countries, which account for most of the ACP members (48 out of 71), has also been assessed. As regards specifically the CFA franc zone, it is also of interest to note that a Council Decision on a pegging of the CFA franc and the Comorian franc to the euro is currently under preparation. The ECB has been involved in this preparation and delivered an opinion in the context of a consultation procedure. In my remarks, I will focus, first, on the potential economic impact of the euro on ACP countries and particularly on the CFA franc zone. I will, then, turn to the preparation of a Council Decision concerning the CFA franc and the Comorian franc. As a general remark, I will first note that the ACP countries, and particularly the African countries, are less affected by the current slowdown of the world economy. This is partly because the bulk of their trade is with the EU (especially France) and also because their exports have been less affected by the overall decline in commodity prices. Specifically, the CFA franc zone is forecast to grow at least 4.5% this year, while maintaining very low (by African standards) inflation rates: less than 5% in most of the 15 countries. The introduction of the euro will benefit the world economy if it contributes to higher growth in the euroland and to the maintenance of low inflation and interest rates. This, however, will also depend on efforts being made to reduce European unemployment through structural reforms. Also, the development of integrated, liquid and efficient markets in euro will facilitate access to international bond financing by non-euro governments and private entities. Economic developments in the euro area will affect ACP countries, and particularly the CFA franc zone, through three main channels: - first, an impact on growth, through existing trade linkages; - second, price and exchange rate stability through the use of the euro as a nominal anchor; - and, third, an improved access to international capital markets. As far as downside risks are concerned, the future exchange rate of the euro vis-a-vis the US dollar seems to be the main source of concern. A potential strengthening of economic growth in the euro area is bound to benefit its trading partners, like the ACP, through increased exports. In 1996, trade with the EU accounted for 51% of total external trade of the CFA franc zone countries and for 42% for the other 33 African ACP countries. By contrast, the share of the non-African ACP countries was much lower (around 10%). According to IMF estimates, a 1% increase in euro area GDP induces an increase of the CFA franc countries' exports and GDP of 0.6% and 0.2%, respectively. The other African ACP countries are also likely to benefit from similar positive trade linkages. However, the potential impact on non-African ACP countries is bound to be more subdued in view of their limited trade link. For CFA franc zone countries, shifting the peg form the French franc to the euro will contribute to stabilizing the nominal effective exchange rate of the area. This is due to the fact that the EU accounts for 51% of the external trade of the CFA franc zone, while the share of France is only 25%. In addition, the maintainance of price stability in the euro area will also enable the CFA franc zone to keep comparatively low inflation, with a positive impact on the real exchange rate and on external competitiveness. The benefits of nominal and real exchange rate stability will be the greater, the higher the stability of the euro vis-a-vis the US dollar. Moreover, in the longer run, the CFA franc zone countries, which mostly export primary commodities priced in US dollars, would benefit from a greater use of the euro for quoting prices on commodity markets. These positive growth and price effects will be supported by improved access of CFA franc zone countries to the European financial markets. Capital movements between the CFA franc zone and the entire euro area, and not only France, are expected to be liberalized after the pegging of the CFA franc to the euro. This, together with the ongoing trade liberalization within the CFA franc zone, should help the zone to reap the benefits from globalisation. However, this will take time and will also depend on the pursuit of sound macroeconomic policies and the strengthening of domestic financial systems. In the short run, given that in 10 out of the 15 CFA franc zone countries the US dollar and the Japanese yen account for the largest share of their long-term external debt, these countries might have an interest in increasing the share of the euro. This would be advisable in view of the exchange rate risk associated with the US dollar and yen denomination. The main risk of pegging to the euro would be the loss of external competitiveness that could arise form an appreciation of the euro against the US dollar. Price stability will be the primary objective of the ECB and, thus, an active management of the euro against other major currencies is not desirable. This does not mean that the ECB will not take account of the external value of the euro. Exchange rates will continue to be monitored informally by the three main economic and currency blocs, although in the context of new institutional arrangements to be devised. The introduction of the euro may in fact strengthen policy co-ordination between the US, Japan and Europe and contribute to exchange rate stability worldwide, as domestic economic policies in the three regions aim at internal stability. Of course, in the shorter-term, there may still be fluctuations in exchange rates, owing to differences in cyclical positions and associated policy responses. But, in the medium term, confidence in the ability and willingness of the ECB to achieve monetary stability and the overall strength of the Euroland will be the basis for a stable currency. This will benefit the CFA franc zone countries too. Let me now turn to the preparation of a Council Decision concerning exchange rate matters relating to the CFA franc and the Comorian franc. France's relations with the CFA franc countries and the Comoros are not dealt with specifically in the Maastricht Treaty unlike, for instance, the relations of France with its overseas territories. However, the Treaty provides for the possibility of monetary and foreign exchange arrangements with third countries, pursuant to Article 109 (3). In the first half of 1998, the members of the Monetary Committee discussed this matter. On the basis of these discussions and in accordance with Article 109 (3), the Commission presented on 1 July 1998 a recommendation for a EU Council Decision concerning exchange rate matters relating to the CFA franc and the Comorian franc. This recommendation allows France to maintain the basic features of the present agreement with the CFA franc zone, for two main economic reasons. First, the present guarantee of convertibility of the CFA franc against the French franc is based on a budgetary commitment from the French treasury without any involvement of the Banque de France. In Stage Three, the French treasury will guarantee an unlimited convertibility of the CFA franc into euro, without any monetary policy implication for the Banque de France or the ESCB. Second, the possible impact on monetary conditions in the euro area of the guarantee of convertibility of the CFA franc vis-a-vis the euro would be extremely limited, given the relative sizes of the euro area and the CFA franc zone. Having consulted the ECB on a first draft, the ECOFIN Council will consider a new text in one of its forthcoming meetings in November or in December of this year. In its opinion expressed on 22 September 1998, which has been published in the Official Journal of the European Communities, the ECB considered in particular that: On a more general note, let me state, by way of conclusion, that the ECB regards co-operation with non-European countries as a relevant part of its international responsibilities. We are therefore closely monitoring the negotiation and conclusion of exchange rate arrangements with third countries. We are convinced that the favourable economic fundamentals prevailing in the euro area make the introduction of the euro a stabilising factor for the world economy. The pursuit by the ECB of a policy ensuring price stability is the best contribution we can make to international co-operation in general and in our relations with the ACP countries in particular.
r981103a_ECB	euro area	1998-11-03T00:00:00	ECB Press conference: Introductory statement	no_info	0	Ladies and gentlemen, as in previous months, the Vice-President and I are here today to report on the outcome of today's meeting of the Governing Council of the European Central Bank. The number of items considered by the Governing Council required a full-day meeting. Most of the items on the agenda were of a rather technical nature or were related to the legal implementation of decisions already taken at previous Governing Council meetings. Part of the meeting was attended by Mr. Edlinger, President of the EU Council, and by Commissioners de Silguy and Monti. Let me first turn to the Governing Council's in-depth discussion on Starting with the global macroeconomic environment, it was felt that the spiral of bad news has not continued over the most recent weeks. Also, when looking at market developments, we have observed a strengthening of the US dollar vis-a-vis euro area currencies since its trough in mid-October. We have seen a recovery in global stock markets and we have also witnessed some upward correction of long-term bond yields after they had fallen sharply as a result of a "flight to quality". However, markets displayed considerable volatility during the month of October, reflecting the uncertainty prevailing in the world economy. Whether or not we can now expect a process towards more normal conditions remains to be seen. Given the underlying causes of the adverse conditions in Asia , Russia and other parts of the world, a quick resolution is in any case not very likely. Moreover, it is by now quite clear that the world economy will suffer from these developments in 1999 and that the euro area will also be affected to some extent. However, the crucial and widely debated issue is the degree to which such effects on the euro area will materialise and how long they may last. As matters stand, there appears to be consensus that euro area economic growth will slow down to some extent in 1999, driven largely by a weakening in net exports. In its latest forecast, published on 21 October 1998 , the Commission has revised downwards aggregate euro area real GDP growth to 2.6% in 1999, compared with the increase of 3.2% projected earlier this year. According to the same source, the slowdown is expected to be only temporary and real GDP growth is anticipated to strengthen again in 2000, with the contribution of net trade improving. At the same time, the outlook for inflation in the near term remains generally favourable, assuming continued wage moderation and subdued developments in import prices. In today's discussion, the Governing Council agreed to examine further the broad outlook for the euro area at its two meetings in December. In this context, we shall thoroughly discuss the downside risks for output growth resulting from the evolution of world trade and from international financial tensions and the possibility of still more subdued price developments. However, one should also mention the fact that a relaxation of fiscal policies and higher wage increases could lead to a reversal of current developments in consumer prices and undermine confidence. Any uncertainties arising in these two fields would of course considerably complicate our assessment, given the high degree of uncertainty already associated with the developments in the global economy. With respect to today's review of the monetary, financial and macroeconomic situation in the euro area, the following aspects were discussed. First, with reference to monetary growth, let me recall that when looking at various definitions of broad money, our preliminary data show broadly similar and stable annual growth rates of between 3 and 5% in 1997 and the first half of 1998. According to our initial analysis these monetary trends do not appear to signal inflationary pressures at this juncture. However, a further assessment will be made in December on the basis of more up-to-date information. Second, with respect to price developments, euro area HICP inflation fell from 1.2% in August to 1.0% in September 1998. The generally low level of HICP increases mainly reflects a decline in energy prices, which were almost 4% lower in September than a year earlier, and in other commodity prices; in addition, price pressure as indicated by industrial output prices and unit labour costs has remained modest. With respect to the decline in HICP inflation in September, this is closely related to a relatively strong fall in food prices (from 1.8% in August to 1.4% in September 1998), which account for almost one-quarter of the total HICP. Such monthly changes are certainly very difficult to interpret. However, I may point out that food prices display a larger degree of volatility owing to their seasonal pattern. Third, taking into account distorting factors such as calendar effects, underlying developments in euro area-wide real GDP have remained fairly stable. Economic expansion was broadly unchanged in the first half of 1998 from the solid growth seen in the second half of 1997. Also, at this juncture, data partly available for the summer months point to the possibility that recent rates of output growth may be broadly sustained beyond the first half of this year. While the trends appear in some cases weaker, particularly when also looking at some national data, the latest euro area-wide survey data on confidence, order books and capacity utilisation generally remain well above their long-run averages. However, further developments in these data will have to be monitored closely. Concerning the assessment of the monetary policy stance in the euro area, the Governing Council - after having carefully reviewed all factors and developments - confirmed the view taken at its previous meeting. It considered further interest rate convergence towards the lower end of the current range prevailing in the euro area as being appropriate. Measured by key central bank rates, the lowest rates in the euro area currently stand at 3.3%. Market interest rates have also reached very low levels. In terms of three-month interest rates, the euro area average rate has fallen to 3.75%, following the reduction of interest rates by a number of euro area central banks. With the announcement today of further interest rate reductions by the Banco de Espana and the Banco de Portugal, both effective tomorrow, the euro area average will continue its downward trend. Nominal and real long-term interest rates for the euro area are at historically low levels. It confirms the high degree of confidence that the euro has gained in the judgement of the general public and of global investors. This confidence is a major asset in the consolidation of a financial environment conducive to growth. As has been proven in many instances in the past, monetary policy cannot solve structural problems. Indeed, monetary policies in the euro area countries have increasingly converged over the past few years and resulted in low levels of interest rates. Several countries have followed virtually a "common monetary policy stance" over a longer period, but performances - for example in labour markets - within the euro area differ considerably from country to country. The degree of success in this area seems to be closely related to structural reforms implemented in earlier years. I am confident that we can cope both with current problems and with future challenges. This requires a forward-looking, medium-term-oriented monetary policy, which keeps inflationary expectations low. This is the decisive contribution of monetary policy to the fostering of growth and employment. Dealing with structural problems is the task of policies other than monetary policy. Let me now give the floor to the Vice-President to report on various aspects of the With less than 60 days to go before the start of Stage Three, we are obviously attaching particular importance to the provision of a framework allowing for a smooth changeover to the euro. We began our preparations a long time ago and I am confident that the ESCB will be in a position to deliver its entire complex infrastructure to the markets by the morning of 4 January 1999 . I expect the banking and financial community in the euro area to be fully aware both of the logistical challenge that the changeover weekend represents and of the need for careful preparation. Given the concentration of migration operations to the euro to be conducted by a multitude of financial agents (i.e. payment systems, securities settlement systems, custodians, individual banks, exchanges and financial information providers) in the period from 31 December 1998 to 4 January 1999, the ESCB is preparing to work together with other public authorities to orchestrate the necessary policy responses to any unexpected events. To this end, the Governing Council has set up an ad hoc "Changeover Weekend Committee" which will organise the monitoring of developments vis-a-vis the final migration to the euro within the ECB and the national central banks and in the banking and financial industry, both prior to and during the changeover weekend. Additional details on the preparation of the changeover weekend are provided in a separate press release which is to be issued to you this evening. With regard to euro payment and settlement systems, I should like to draw your attention to recent developments which suggest that many market participants consider the euro as a special currency to which the traditional rules applied elsewhere in the developed world would not necessarily be applicable. Initiatives were taken, or allowed to develop, that have no precedent in the arrangements concerning other currencies. This relates in particular to the granting of payment finality and intraday credit in a currency other than a country's own. Therefore, the Governing Council considered it appropriate to issue a policy statement clearly spelling out the fact that the rules which apply to all of the other currencies in the world will also apply to the euro, and that the ECB bears the same responsibilities as all the other central banks in the world. This policy statement on euro payment and settlement systems located outside the euro area is to be issued to you this evening. The Governing Council also agreed on the main features of the legal framework within which the TARGET system will operate. These main features are set out in greater detail in the "Third progress report on the TARGET project", which the Governing Council endorsed today. In common with previous progress reports, the current one will be published in the near future and will provide further technical details of interest to market participants. In the absence of euro banknotes at the start of Stage Three, the Governing Council today agreed on arrangements according to which the participating national central banks will exchange legal tender banknotes of other participating Member States for national banknotes and coins at the official conversion rate as from 1 January 1999 . To ensure substitutability between the national currency units, the Governing Council decided that each participating national central bank will arrange for such an exchange at one location at least. The national central banks may, however, limit the number and/or the total volume of banknotes they are prepared to accept for any given transaction or on any one day. Further details on that matter are provided in a separate press release which is to be issued to you this evening. As regards the income arising from the issuance of national banknotes from the participating Member States the Governing Council today decided that such income will not be redistributed prior to the introduction of the euro banknotes. The Governing Council also confirmed with respect to the allocation of monetary income of the national central banks of the participating Member States for the financial years 1999 to 2001, that the monetary income for the said period will be calculated by employing the so-called indirect method, by multiplying a defined liability base by a specified reference rate of interest. The sum of the monetary income of each national central bank will be allocated to the participating national central banks in proportion to their paid-up share in the ECB's capital. Owing to the temporary character of the current decision, the question of monetary income allocation will need to be revisited before the introduction of euro banknotes in 2002. Today the Governing Council also adopted an ECB Guideline establishing the legal format as well as the modalities of the initial transfer of foreign reserves from the national central banks to the ECB. In this connection and as a measure for covering possible foreign exchange risks for the ECB, the Governing Council endorsed, in line with the Statute of the ESCB, an ECB Recommendation for a Council Regulation which would authorise the ECB to increase its capital from the current level of EUR5 billion to up to twice that amount. Further decisions have also been taken with regard to preparing the monetary and foreign exchange policy of the euro area. On previous occasions I have mentioned to you that legal acts are under preparation which specify general principles to be followed by the national central banks when carrying out operations in domestic assets and liabilities and in foreign exchange reserve assets remaining with the national central banks. Such instruments, which are based on provisions of the Statute of the ESCB, aim from a legal point of view at ensuring the singleness of the ECB's monetary policy and the consistency of such transactions with the Community's exchange rate and monetary policies. Against this background, the Governing Council today adopted an ECB Guideline which establishes certain reporting obligations for the national central banks' domestic asset and liability management operations and subjects such transactions to the prior approval of the ECB whenever they exceed a certain amount. A similar ECB Guideline was adopted which subjects all operations in foreign reserve assets - including gold - which exceed a certain amount to the approval of the ECB. In addition, the Governing Council adopted an ECB Guideline according to which any participating Member States' transactions with their foreign exchange working balances which exceed a certain amount have to be notified to the ECB in advance. A similar arrangement is envisaged between the ECB and the Commission of the European Communities for all foreign exchange transactions carried out in the context of implementing the Commission's budget. In the context of the statutory function of the ESCB to contribute to the smooth conduct of policies of competent authorities in the field of the Governing Council discussed the main driving forces that are likely to affect the EU banking systems in the medium and long term, including the establishment of EMU. The Council members hold the view that the establishment of EMU is expected to reinforce the structural tendencies that are already under way in the EU banking systems. These tendencies include the reduction of excess capacity, pressure on profitability, enhanced competition, increased internationalisation and geographical diversification. One important aspect is the fact that EU banks seem to have significantly increased their awareness of the strategic implications of the introduction of the euro over the past few months. They are devising specific responses accordingly, which include: (i) improvements in services and procedures; (ii) changes in the range of products supplied to customers; and (iii) mergers, strategic alliances and co-operation agreements. We intend to make the outcome of this examination public in due course. This Decision will be published in the Official Journal of the European Communities. We are now at your disposal should you have any questions. Question (translation): President Duisenberg, you said that labour market and economic problems which are structural in character cannot be solved by monetary policy. Is this an appeal to certain leading policy makers - one of whom bears a French name, even though he is German - to stop pressuring you? Second Is it really possible, in times of historically low interest rates, to promote consumption and investment through lower interest rates? I didn't understand the second question. is it really possible to promote or encourage consumption and investment through central interest rates which are lower than those currently prevailing in Germany, for instance? The answer to the first question is that it is an appeal to all politically responsible office holders, and not to a single one. Because of the fact that monetary policy cannot solve structural problems, it is an appeal to those politically responsible to bear their responsibility in the right direction, but not any single one. Whether it is possible to promote consumption and investment through lower interest rates is very doubtful. The main factor contributing to the promotion of consumption and investment is confidence, and continued confidence, as well as continuity and stability also in monetary policy, whereas one quarter more or less is not the driving force behind consumer or investment spending. The German Finance Minister has proposed closer policy co-ordination between monetary and fiscal policy. Could you tell us how far such policy can go under the euro zone, and specifically where the limits of this Cupertino would be? And I have a second question about the proposals by the Italian commissioner Mario Monti who has written a letter to the President of the European Commission urging for the Stability and Growth Pact to be re-interpreted on the lines of the "Golden Rule" of fiscal policy. The co-ordination of policies in the economic field in general, i.e. monetary policies, fiscal policies, wage policies, is foreseen in the Treaty to take place through a dialogue between the various authorities on an almost continuous basis. That means, the President of the ECOFIN has the right to attend the meetings of the Council of the European Central Bank. He even has the right to introduce motions there, but he does not have the right to vote on those motions. And, conversely, the President and/or members of the Executive Board have the right to be invited to meetings of the ECOFIN Council. There is a continuous dialogue going on on the general stance of the various policies. Only the decisions on the various aspects of policies, be it monetary, be it fiscal, be it wage policies, are being upheld by the separate authorities in their independent way. I have not seen the precise proposals that Mr. Monti has formulated, but - to the extent that they were to undermine the Stability and Growth Pact to be applied to the full, as was intended - to that extent, I can assure you that the Council is not too happy with those proposals. Question (translation): Mr. Duisenberg, have you already discussed whether your monetary policy strategy will include only one single reference rate or whether there will be an additional corridor and when can such a decision be expected? We have not discussed that particular question anew. We have - as was indicated in our previous press conference - defined what price stability is, what we understand price stability to be, and I would like to repeat that we define price stability as a rate of increase - and I underline the word increase - in prices of below 2%. Mr. President, you said that the President of the Council, Mr. Edlinger, and two commissioners Monti and de Silguy joined you in the meeting today. What were the topics that were discussed and did you join in the present discussion about publicity of the ECB and about level of interest rates, and which conclusions can be drawn from the discussions with these politicians. Now, with Mr. Edlinger we had, in particular, an exchange of views on the current stance of economic policies in general, including monetary policy, and the assessment as we and the Finance Ministers respectively saw economic development in the world and in the euro area, in particular. Mr. de Silguy was present at the entire meeting of the Council, except when Mr. Monti was present, when we discussed areas of banking supervision which were outlined by the Vice-President a moment ago and which, in the European Commission, fall into his area of competence. Could I ask you what damage if any do you think will be done to the credibility of the new European single currency if you and politicians don't seem to be speaking with the same voice on interest rates, if this current difference appears to continue? I haven't seen yet that we don't speak with the same voice, because the central bankers have not spoken yet. And I hear different through the media; I hear various wishes being expressed, which I regard as normal. And they will not damage the credibility of the euro in any way, because they will not, in any way, have an impact on the behaviour of the decision-making body of the ECB, i.e. the Governing Council. Question (translation): Mr. President, a question on economic policy and on monetary policy in 1999. Fiscal and wage policy makers in many countries hold the view that they should take an expansionary stance so as to make up for gaps in demand. What is your position in this respect and how will monetary policy makers respond? What is your assessment, against this background, of the policy mix between monetary, fiscal and wage policy in view of the statements made by economic policy makers in the EMU countries? Well, we have noted already on various occasions both here and in the European Parliament -we and the European Commission have done the same - that we are somewhat concerned about the intensity with which the policies are directed to meet the criteria - not only the Maastricht criteria - but also the criteria implied in the Stability and Growth Pact. And we have warned against that repeatedly and have, in fact, done so again today. Nevertheless, I must conclude that, given the current monetary policy stance and assuming that that monetary policy stance will be continued also during the transition to the euro and given the current fiscal policy stance, there seem to be no indications that there is a policy mix in euroland which is detrimental to either fiscal or monetary policies. I have got a rather technically question on the press release about the exchanging of national banknotes. There is this point about the National Central Banks being allowed to limit the number or the total value of banknotes they are prepared to accept for any given transaction and on a given day. Now, what is the logic behind this? Because I just thought that, if this is implemented, there is the danger - is there not - of damaged credibility if people refuse to accept one another's banknotes under the new system. It sort of evokes those old pictures of a run on the bank and the guichet being closed. And also ... That would happen if you were to set that limit very low, but that is not the intention. And then another small In this ad hoc Changeover Weekend Committee, who is going to be on that, the ad hoc committee for your changeover weekend? The committee has already been established. It will be a decentral committee and also a decentral early warning point for any developments in the event of matters getting out of line with the plans. So, who will be on the committee? There will be three people from each participating national central bank and from the ECB, and the committee will be chaired by the Director General Operations of the European Central Bank, Mr. Papadia. It seems that euro is now gaining the confidence and is being appreciated against other currencies like US$, and some concerns about the dampening effect of euro's appreciation on the European economy, and some people like the new German Finance Minister, Oskar Lafontaine, are proposing to establish the target zone for the exchange rate between euro and US$. So what is your idea about this? As I have indicated in my Introductory Statement, after a period of depreciation of the dollar vis-a-vis the euro, or of appreciation of the euro, that trend has been reversed in recent days to some extent and as I indicated already a month ago, the level that has been reached and that has, in the meantime, somewhat changed again does not imply a cause of concern for the monetary authorities in Europe. Your second question on target zones: I want to repeat that the competence on exchange rate policies is in the hands of governments and not of the monetary authorities, but I do not want to keep secret either that, at this stage, when we are introducing the euro and getting the euro settled and into a credible currency, we are not very enthusiastic of taking up the idea of target zones at this stage. Question (translation): Mr. President, I should like to revert once more to the domestic policy debate in Germany. As you know, some of those involved are of the opinion that the heated controversy about the role and tasks as well as the independence of the Deutsche Bundesbank is, in essence, actually aimed at the European Central Bank as the Bundesbank will be giving up its responsibility in two months' time. Do you share this view and, if so, are you - as has been said - feeling placed under pressure or influenced by this debate? The answer can be fairly simple. The answer to the first question is "yes", And the answer to the second question is "no". Question (translation): Mr. President, I have probably not understood this issue properly, payment issues: the point you want to make there. Is it correct if I interpret it as such that you want to clearly say that you are prepared to be lender of last resort in cases of banking troubles. On the issue of lender of last resort, I will say no more than I said at the last press conference, which was already very little. And I would like to ask Monsieur Noyer to explain precisely what we do want to say. Noyer: What the Governing Council has discussed is, how can we in the Governing Council take into account the general responsibility of the ECB to contribute to a smooth conduct of policies by national authorities, because the precise tasks are, in the end, for national authorities to check whether the transition to the euro creates its special problems or is likely to accelerate some tendencies, and how can we assess any new risks that may arise and the best way to respond. It has nothing to do with the idea of lender of last resort that was addressed precisely by the President the last time in answer to a question on this matter. Question (translation): I should like to return once more to the debate on monetary policy. Could this renewed debate - which, if I have understood you correctly, you feel also has implications for the European Central Bank - could this debate be reason for you personally to re-consider the question of your perhaps retiring early from the office of President, as you had initially indicated? I don't think I have to comment any further after what I have said already on what I think of the discussion. So far it is a discussion in one country only. The development of a dialogue between the governmental authorities and the European Central Bank has taken the form of regular meetings of the so-called Euro 11 group, which is a very useful and fitting setting for having a dialogue about policies in general. We do not shy away from such a dialogue. As far as the discussion in one particular country about the position of the central bank, be it the central bank of that country or the European Central Bank, is concerned, I think that, so far, it has been a very one-sided discussion, as I understand it, because no central bank in any country has participated in that discussion, and I assume that this will remain so in the foreseeable future. Oh, that is a very hypothetical question - if the Treaty of Maastricht were to be changed, which would be required as a result of this discussion and which, in itself, is a very unlikely event, then I would of course also reconsider my position, but I do not regard a change in the Treaty of Maastricht as very likely for the first eight years to come. I have two questions. The first one concerns convergence. The rates are coming down but some analysts here are saying they are not coming down enough. Do you think that can be dangerous for the euro changeover with the present economic situation slowing down? And the second Some articles appeared in the last weeks with strong criticisms about the central bank being too decentralised, not strong enough. How do you think you want to react to that? Do you think you are strong enough as far as budget, personnel and supervision are concerned? Do you think that you are too decentralised? Are these criticisms completely without the ground? On the first question, I do not share the judgement of the analysts you quote that convergence is not enough, because I think we have seen in October, up and to including today, a remarkable rate of convergence toward the lower level of interest rates. And I would like to point out, I mentioned the key central bank interest rates at the moment at the lower end being 3.3%. Today, the Banco de Espana lowered its rate to 3.5%, so that it is getting close. And the Banco de Portugal has done a similar thing. And, in the case of Portugal, you have to look at the lowest official rate, rather than at the repo rate, because the banking system in Portugal happens to be in a very liquid situation; there is no liquidity deficit in Portugal, but a liquidity surplus. And, therefore, you have to look at the lower rate which is the relevant one to judge by. So convergence has continued and will continue during the remaining 60 days of this year, and we are very close already. Now is the ECB strong enough? I think the ECB is a very strong institution, staffed with highly qualified staff, and we are in the process of expanding it at a rather rapid pace. We are now in the process of finalising our budget for 1999, which also implies a sizeable further increase in the staff of the ECB. Those things take time in practice. Question (translation): I should like to revert once more to the debate on interest rates. As you know, it has been argued time and again that the European Central Bank - or that the level of central rates in Europe cannot, on grounds related to convergence, fall below the mark of 3.3% recorded in the core countries. Do you believe it to be possible for concerted action to reduce interest rates in future EMU countries to be taken before the end of the year or can this only occur next year, when the ECB can determine its interest rates independently? And then I have another question on ... Let me first answer the first question. It is, of course, nonsense that interest rates could not be raised or lowered further than below the levels they have already reached. It could be done. Whether it will be done - don't ask me, I would like to say, because, if I were to give you an answer, you wouldn't necessarily have to trust me. I will not, in other words, make forecasts about what will happen to interest rates. But, for the moment, the Council gives the highest priority to the continuation of the convergence process, which you can also interpret as an act of solidarity amongst the 11 central banks involved. Question (translation): And then I have another question on the currently ongoing debate in Germany on the role of the central banks. To what extent do you believe it to be appropriate for that debate to take place in public as it is and how will the ECB participate in it and to what extent do you feel it to be justified for the ECB to gear its interest rate policy also to the employment objective? The ECB will not participate in that discussion and, second, I would like to point out that it is the explicit mandate of the ECB with its policies to achieve price stability and - to the extend that the policy would not jeopardise price stability - to contribute to achieving the general economic goals of the Community, as they are spelled out in Article 2 of the Treaty, namely promoting growth and employment. Question (translation): President Duisenberg, you have emphasised that the latest statements of German policy makers in this debate are not pressuring you, but it is another question whether you see these statements as attempts to influence you, as is prohibited under Article 107 of the Maastricht Treaty. I do not see them as such. I hold it to be quite normal that, from the political side, there may from time to time be offered opinions or suggestions of what the political authorities would like interest rates to do or to be. That, in itself, is a quite normal phenomenon and it would be very abnormal if those suggestions were to be listened to. But then, as I said earlier, it is actually the right of the political authorities, in the person of the President of the Council of the Ministers of Finance and Economics, not only to attend meetings of the Governing Council of the ECB, but also to introduce motions. So he can give suggestions there. The only thing he cannot do is vote on those motions. Question (translation): Mr. President, did Portugal and other European countries co-ordinate the latest reduction of their central or repo rates with you or not? And secondly: which countries are likely also to reduce their interest rates in the next few years, surely those with interest rates deviating most from 3.3 or 3%? Which countries, in your opinion, should make a move? Duisenberg (translation): Co-ordination is an ongoing process; it takes place all the time, and we inform one another continuously. This also holds true of Spain and Portugal, and it is not coincidental that the decisions announced today were announced today. And with regard to your question as to which countries can be expected to follow, I would say it is obvious - those countries in which the level of interest rates is not yet the lowest in Europe. Mr. President, I have a couple of questions, and one is a short kind of yes/no You mentioned that the dollar has been stronger the last week. Are you pleased with the recent movement direction of the dollar against the German mark? Well, as I have said, I was not concerned about the level that the dollar has reached, so I will not express any pleasure at the movement over the last few days. What I am most pleased about is that the situation seems to have settled somewhat. So you are comfortable with the level of the dollar right now? The other question has to do with how monetary policy is being decided in Europe right now. There seems to be some confusion. A lot of people are saying the Bundesbank needs to cut rates while at the same time others are saying that the Bundesbank would not make a move without the approval of the ECB Governing Council. It would be interesting to know how this would work out. If the Bundesbank were to cut rates could they do that unilaterally or would they first want to get a green light from you? Second part of that question is, if the ECB Governing Council would vote for a rate cut and ask the Bundesbank to cut, would you expect the Bundesbank to abide by the Governing Council? On the first question, I only can give what may seem a legalistic answer. The legal situation is that, until the 1st of January, every single central bank is autonomous in determining its policies. So the answer to your question whether the Bundesbank or De Nederlandsche Bank or the Banque de France could do something unilaterally is "yes". If the question were to be "will they", the answer would be that it is very unlikely that they will do anything without consulting all their partners. The co-ordination of monetary policy is already taking shape increasingly intensively across Europe. I was also wondering whether you could expand a bit more on the interest rate cut by Spain and Portugal today. Was that agreed or at least discussed within the ESCB framework beforehand and can we regard that as an interest rate cut by the whole of Euroland? Does that amount to an interest rate cut for the whole euro area since two countries did that today? Well, I would like to point out that decisions are not only being taken precisely on the day and hour that the Council is meeting, but we are in continuous touch with each other and there is a continuous co-ordination and discussion going on between central bankers across Europe, so that the developments of today, I can assure you, certainly did not come as a surprise to any of us.
r981106a_ECB	euro area	1998-11-06T00:00:00	The housing finance markets and EMU	schioppa	0	I should like to thank you for inviting the European Central Bank to this Conference. The Conference offers an excellent opportunity to assess the developments which could occur in the special segment of the financial market represented by housing finance as a result of the introduction of the euro. Developments in the field of housing finance are of great importance, in the first instance, for the banking systems and households, since it is a field which accounts for a major proportion of credit institutions' assets and for the bulk of private households' debt. However, the issues involved are of considerable interest also to central banks, including the European Central Bank, because the level of indebtedness and mortgage interest rates as well as other terms and conditions of housing loans are among the key factors which influence the responsiveness of the household sector to monetary policy. In general, it is widely recognised that the introduction of the euro, together with the single market legislation relating to financial services, provides an opportunity to create a more competitive and efficient banking industry, as well as more integrated and liquid capital markets in Europe. Indeed, competition has already increased considerably in several areas of the financial system as a result of a number of fundamental driving forces for change - internationalisation, technological progress, diversification of savings portfolios - to name but a few. However, the introduction of the euro is likely to act as a catalyst for these changes, speeding up the emergence of a genuine single market for financial services. There is, of course, a great deal of uncertainty involved, since only time will tell how financial institutions will respond strategically to the opportunities and challenges brought about by the euro, and how customers and investors will change their behaviour. In terms of its timing and effects, the impact of the euro will probably vary significantly across different types of financial services and markets. The segment of the financial system that is being addressed at this Conference - housing finance - is an integral part of retail banking where, at the risk of oversimplification, the impact of the euro is likely to be more gradual than in other areas of financial activity. In this respect, the basic question which I should like to address today is . So far, these have in fact remained largely segmented to the extent that activities are still conducted predominantly by domestic institutions. In addressing this issue, I intend to proceed as follows: after recalling the main trends in and features of the housing finance markets in the EU, I will attempt to highlight what I believe to be the most likely effects of the euro with respect to lowering the barriers to entry in this specific sector and to offer some conclusions. Without presuming to identify all relevant trends and features, the EU housing finance market might, in summary, be said to have been characterised by three main developments in the past. First, there has been . Over the past ten years, outstanding mortgage loans for residential property have more than doubled in most European countries. In some countries (especially in Spain, Italy and Portugal), the increase has been even more marked. The underlying factors behind these developments are the improvements in living standards which have raised the quality of the required dwellings, the stability of the macro-economic environment and, in particular over the past few years, the decline in interest rates. Mortgage lending continued to expand significantly in many European countries in 1997, namely by about 2.5% in the EU. However, many structural features of the property markets, such as the level of owner occupation, continue to influence the scope of lending. The ratio of mortgage loans to the gross domestic product (GDP) still varies across EU countries, ranging from over 50% in Denmark, the United Kingdom and the Netherlands to below 10% in Greece and Italy. Second, there has been over the last decade. However, the extent to which institutions resort to capital markets varies substantially across countries. Countries with dedicated mortgage credit institutions also tend to have relatively deep mortgage bond markets, as these institutions finance their fixed-rate lending by issuing fixed-rate bonds to match their interest rate exposure. This holds true, in particular, of Denmark and Sweden and, albeit to a lesser degree, of Germany. In other countries, retail savings tend to be the most important means of funding as banks or mutual institutions act as intermediaries for most of the mortgage loans. Third, despite common trends, , if the current situation is compared with that of, say, a decade ago. In particular, many aspects of housing finance have remained closely linked to national regulations (security and consumer protection issues, for instance), national taxation (tax deductions and stamp duties), and national subsidies as well as to administrative procedures that thwart or even discriminate against cross-border operations. These differences make it difficult or, occasionally, impossible to develop standard "pan-European" products or capital market instruments. It should be acknowledged, however, that the European Commission has been active in developing common consumer protection standards in order to enhance the single market. The lack of familiarity with the specific conditions of national markets is likely to be another major reason why the markets for housing finance have remained localised. From the borrower's perspective, caution with respect to foreign institutions may partly be explained by the sheer size of the loan required. From the lender's perspective, the inadequate familiarity with national features of the market gives local institutions a competitive edge. Segmentation in the EU housing finance market has persisted despite the fact that the Second Banking Co-ordination Directive has significantly lowered the legal barriers to cross-border entry by permitting institutions from any one country to operate freely in another. Against this background, one might ask what implications the introduction of the euro might have for the EU housing finance markets. In my view, there are a number of reasons to believe that the introduction of the euro will foster a further integration of the EU housing finance markets - perhaps not in the short term, but at least in the medium-term - by eliminating certain "non-legal" barriers to cross-border operations of credit institutions in this sector. To the extent that this objective is achieved, the euro would help significantly to complement single market legislation. In this respect, I should like to draw attention to three key aspects. First, the introduction of the euro can be expected to trigger mainly because the disappearance of foreign exchange risk will reduce risks and costs for both lenders and borrowers. On the supply side, in particular, institutions will be able to fund their lending in another euro area country from their domestic retail deposit base or euro denominated bond markets without incurring specific foreign exchange-related risks. Moreover, the expected increase in competition as a result of the introduction of the euro may compel institutions to broaden their customer base across national borders in order to spread their fixed banking costs. This will take place in an environment in which technological development will likewise affect cross-border lending activity. Direct banking facilities (such as telephone banking) may, in fact, increasingly allow customers to be extended credit "from a distance". The need to establish a branch network - which has always been considered a major barrier for mortgage institutions wishing to enter foreign markets - would consequently lose importance. On the demand side, the interest of customers in mortgage loans offered by foreign institutions should also increase as a direct consequence of the disappearance of foreign exchange risk. Such an increased interest should also stem from the enhanced comparability of prices of banking services throughout the euro area. This enhanced transparency is set, in itself, to increase competition among institutions. Some time will be needed before customers become sufficiently aware of the new state of affairs. In particular, these effects should become more pronounced when customers start to receive income in euro and become accustomed to new market conventions. Second, the introduction of the euro is expected . In general terms, the euro will make European bond markets more attractive, since the increase in the number of issuers and investors operating in the same currency would increase the liquidity of and reduce the cost of obtaining funding from these markets. The national bias is likely to diminish and funds will increasingly be managed on a wider international basis, possibly involving reallocation of existing investments. Moreover, the euro will be introduced at a time when current and prospective inflation as well as nominal interest rates in the euro area are low. In this context, the possibility of using bonds issued by credit institutions operating in the field of housing finance as collateral in ESCB monetary policy operations can enhance the liquidity of such bond issues and contribute to the development of the respective markets. These bonds may be included in the list of eligible assets if they meet the established criteria. The list of eligible assets is available on the ECB's Internet website. The eligibility criteria are specified in the document entitled "The Single Monetary Policy in Stage Three - General Documentation on ESCB Monetary Policy Instruments and Procedures", which is also available on the ECB's Internet website. It should be borne in mind that, so far, low liquidity (high liquidity premia) and prepayment risks (the possibility of a premature amortisation of the underlying mortgage loans leading to a premature repayment of the principal to the final bondholders) seem often to have been the biggest obstacles to the issuance of mortgage-related securities. If the euro-denominated market offers a possibility for larger issues, the liquidity obstacle would be reduced, possibly encouraging larger scale international activity in the mortgage lending business. The prepayment risk could likewise be reduced through a cross-border diversification of lending. Third, the introduction of the euro . The issuance of these instruments has been taking place in an increasing number of EU countries, and respective changes to legislation are underway. At the end of 1996, however, mortgage-backed securities only accounted for less than 1% of the total stock of mortgage loans in the EU. This is in sharp contrast to the United States where the securitisation has advanced very far. There are many reasons for this trend in the United States, namely the emergence of large "secondary institutions" acting as large-scale security issuers, a shortage of retail deposit funding, banks' incentives to reduce maturity mismatches and - perhaps most importantly - the existence of a deep capital market in US dollars. For European countries, the further development of mortgage-backed securities - which is rather limited so far - could expand the use of the capital market funding as well as the range of products offered to customers. To sum up, I should like to underline three aspects. First, it should be recognised that, while the integration of the EU housing finance market has been modest to date, the introduction of the euro will represent a significant opportunity to achieve further integration. From the perspective of the euro area, attempting to establish a more integrated housing finance market is a desirable objective since it would bring benefits to consumers in terms of both a wider range of products on offer and reduced costs stemming from increased competition among lenders and lending practices. . These institutions are expected, wherever and to the extent possible, to make use of the opportunity offered by the introduction of the euro to expand beyond their own home markets. Further integration will, of course, also depend on the degree to which remaining fiscal and regulatory differences across countries are eliminated. The sooner these differences can be reduced by the competent authorities, the faster will the euro have a perceptible impact. Second, it should be acknowledged that the introduction of the euro will trigger substantial changes in the European capital markets by fostering an increased width and depth of these markets. In general, . This also demands that those financial institutions which have not resorted to capital market funding so far, are invited to exploit this opportunity. Indeed, the issuance of securities as a form of funding mortgage lending might even become a necessity, if saving shifts increasingly away from bank deposits, as has often been envisaged. This stems from the consideration that, in a more competitive environment, the option to fund cheaply is likely to become a more and more decisive factor. Finally, it should be pointed out that the changes in the financial landscape triggered by the introduction of the euro will bring numerous strategic challenges and risks for credit and financial institutions. The forecast increase in competition is also likely to affect the funding side and to reduce the share of cheap retail deposits. Therefore, all institutions should be aware of and prepared to adapt to changes in market conditions, fiercer competition and increasing demand for low-cost service. This will also apply to institutions operating in the mortgage sector. Against this background, it is important that the adjustment takes place smoothly, without any adverse effects on the stability of the financial system. To that end, .
r981110a_ECB	euro area	1998-11-10T00:00:00	The ESCB's stability-oriented monetary policy strategy	bank	0	On January 1 - in only fifty-two days - Stage Three of Economic and Monetary Union (EMU) will commence. A single monetary policy will be adopted for the entire euro area - a continent-wide zone of eleven sovereign states and almost 300 million people. The advent of the euro offers great opportunities for Europe and Europeans. Transaction costs will be reduced. Pricing will become more transparent between European countries, encouraging greater competition and innovation in goods and financial markets. A truly single market will be created. Above all, though, Monetary Union offers a unique opportunity to establish and maintain price stability throughout the eleven countries that will comprise the euro area from 1 January 1999. I am convinced that by meeting the Treaty mandate and fulfilling the unambiguous commitment of the Governing Council of the European Central Bank (ECB) to maintaining price stability we shall ensure that the single monetary policy makes the greatest possible contribution towards raising the standard of living of Europe's citizens and improving growth and employment prospects. Price stability, consequently, is at the core of the "stability culture" that we are creating in Europe. Today, I should like to describe how we intend to meet our primary objective in the unique - and potentially difficult - circumstances attending the birth of the euro. At the heart of our approach is the "stability-oriented monetary policy strategy" recently adopted by the Governing Council and announced to the public last month. First and foremost, this monetary policy strategy is designed to ensure that the Governing Council is presented with the information it requires to make effective monetary policy decisions. The Council must act in a forward-looking and pre-emptive manner, changing interest rates to contain inflationary or deflationary pressures before such trends become entrenched. Monetary policy is most effective when it is credible, that is, when the public is convinced that monetary policy will successfully maintain price stability over the medium term. Indeed, aside from enjoying your Irish hospitality, bolstering this conviction is the main purpose of my speech. Reassuring you and the wider public of the Governing Council's commitment to price stability - and thereby building up the credibility of our new "stability-oriented monetary policy strategy" - will not only make my own job easier over the coming years. It will also increase the overall benefits of maintaining price stability in the euro area as a whole. Speeches such as this are important. They illustrate the commitment of the European System of Central Banks (ESCB) to openness and accountability in its decision-making. Openness and accountability are necessary complements to the independence of the ESCB, on which the credibility of the single monetary policy rests. Moreover, the monetary policy strategy must be clear and transparent so that there is no confusion or ambiguity about the objective of monetary policy and how this objective will be achieved. To this end, the ESCB's stability-oriented strategy has been designed and presented in a very straightforward, realistic and, if I may say so, honest way. These features are central to clarity and transparency. They complement the many other efforts we have made - and will continue to make - to ensure that our communication with the public is open and transparent. Statements will be released and press conferences, including question and answer sessions, will be held immediately following Governing Council meetings. Regular monthly publications will be produced by the ECB. Discussion papers and technical analysis by the ECB staff will be published for professional review and scientific assessment. In all these regards, the ESCB is exceeding the reporting requirements laid down in the Maastricht Treaty, which are already among the most stringent applicable to any central bank. Furthermore, in these articles and other presentations, we shall address various economic issues facing Europe, not least the issue of the high level of unemployment. In doing so, we shall make the best possible use of the knowledge of experts throughout the ESCB and ensure that this expertise is available to the wider public and the policy-making community. In this context, let me emphasise that the Governing Council of the ECB is very concerned about the unacceptably high rate of unemployment in the euro area. However, an inflationary monetary policy would not solve Europe's serious unemployment problem. On the contrary, an inflationary policy would not only unacceptably flout the Maastricht Treaty; a Treaty, let me remind you, that has been ratified by all the Member States of the European Union and endorsed by the public in referenda in several countries, including Ireland. An inflationary monetary policy would almost certainly lead to higher unemployment in the medium run, as long-term interest rates would rise and the benefits of price stability would be lost. Such a policy would therefore be entirely counterproductive. Let me be very clear: in the interest of all European citizens, the Governing Council is determined to protect price stability. The ESCB's independence is a means to facilitate the achievement of this goal. Only by preserving price stability and thereby creating the stable environment required for continued higher employment and growth, can the European System of Central Banks (ESCB) serve the public and address the public's understandable concerns. In describing the ESCB's stability-oriented monetary policy strategy today, I shall emphasise the twin principles of clarity and transparency that are vital in order to establish the credibility - and therefore ensure the success - of the single monetary policy. Monetary Union is a unique event. It is likely to prompt considerable changes in economic behaviour and the institutional structure. These changes will be to the benefit of Europe's citizens, not least as the benefits of price stability are reaped. Nonetheless the inevitable and not totally unpredictable changes in behaviour prompted by the introduction of the euro create uncertainty. This uncertainty will complicate the task of implementing the single monetary policy. Against this background, the ECB Governing Council has chosen a distinct monetary policy strategy, one that reflects the special circumstances that it faces at present. Given a natural desire to build on the success of national central banks in bringing inflation down to its current low level during the convergence process, the strategy ensures as much as possible with the existing strategies of the national central banks (NCBs) of the participating Member States. Nevertheless, the chosen strategy takes into account to the extent necessary the created by the transition to Monetary Union. I shall proceed by describing the three main elements of the stability-oriented strategy. First, I shall discuss the quantitative definition of the ESCB's primary objective, namely price stability. Second, I shall outline the prominent role played by money in the overall strategy. Third, I shall describe the analysis of a wide range of other financial and economic indicators that will enter the policy discussion. Finally, I shall conclude by arguing that the stability-oriented strategy adopted by the ESCB is, in the present circumstances, both clearer and more transparent than any of the alternatives. In consequence, I am confident of its future success. The Maastricht Treaty assigns the ESCB the primary objective of maintaining price stability. In the interest of accountability, the Governing Council of the ECB has decided to publish a quantitative definition of price stability, against which its success in fulfilling the Treaty's mandate can be sensibly judged by the public. In this context, at its October meeting the Governing Council of the ECB agreed that "price stability shall be defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%". In this way, the Governing Council has clearly and unambiguously defined its objective. If and when we do not meet this objective, we are obliged to explain why this is the case and what we are going to do about it. Let me emphasise the over-riding priority we attach to this objective. This priority is not only a consequence of our legal obligations under the Treaty. It is also rooted in our belief - supported by both decades of experience and a substantial body of theoretical and empirical research - that maintaining price stability in the euro area is a pre-requisite for a sustainable and lasting improvement in the standard of living of Europe's citizens and can lay the foundation for improving growth and employment prospects in the future. The definition we have published is clear. In particular, a specific price index is identified with which to assess the maintenance of price stability. The HICP for the euro area was chosen because it is both sufficiently harmonised across the different countries of the euro area at the start of Stage Three and consistent with the public's usual focus on consumer prices. Using the index "for the euro area" highlights that euro area-wide developments, instead of specific national or regional factors, will be the only determinants of decisions regarding the single monetary policy. As I have emphasised in the past, this definition signals the aversion of the Governing Council to both inflation and deflation. The phrase "below 2%" clearly delineates the rate of inflation in the HICP deemed consistent with price stability. The wording "year-on-year " implies that decreases in the HICP - that is to say deflation in the measured price index - would not be considered consistent with price stability. The Governing Council also announced that "price stability is to be maintained over the medium term". In doing so, it realistically acknowledged that disturbances to the price level can occur in the short run - for example, those caused by changes in indirect taxes or commodity prices - that cannot be controlled by monetary policy of the ESCB. Such factors may lead to falls in the HICP, or occasional increases above 2%. These are quite normal and consistent with a meaningful definition of price stability. By focusing on the medium term, the ESCB's monetary policy will ensure that these transitory deviations from the definition do not become sustained over the medium term. By maintaining price stability over the medium term, the appropriate forward-looking and medium-term orientation is imparted to monetary policy. This will ensure that policy reactions to threats to price stability are measured and deliberate. Such actions will not introduce unnecessary instability or uncertainty into the economy, while nevertheless ensuring that price stability - and the attendant benefits - are maintained. Let me now turn to the role money will play in the ESCB's stability-oriented monetary policy strategy. Ultimately, inflation is a monetary phenomenon. Assigning a prominent role to money within the overall stability-oriented strategy therefore guarantees that the monetary origins of inflation will not be neglected in the regular economic and financial analysis driving monetary policy decisions. Moreover, money is a visible "nominal anchor" for monetary policy that will help to stabilise the public's medium-term inflation expectations, enhancing the credibility and effectiveness of monetary policy. To signal the prominent role attached to money, the Governing Council of the ECB will announce a quantitative . In this regard, some commentators have assumed that the ESCB has adopted a conventional monetary target, but simply called it by a different name. However, before announcing a formal intermediate monetary target, certain conditions have to be met. These requirements have been met in the past in several euro area countries, and successful monetary targeting strategies have been pursued. However, one must recognise that, at present, the evidence as to whether these technical preconditions will be satisfied for the euro area as a whole in Stage Three is inevitably sparse. Monetary Union will cause changes in the financial system and economic behaviour, as ten different currency zones are merged into the single euro area. As I mentioned in my introduction, most of these changes will be of great benefit to individuals and firms in Europe. However, these behavioural and institutional changes are likely to change the relationship between money, interest rates and prices that has been observed in the past. Consequently, a realistic to a monetary target - that is, the reference value for monetary growth - will be announced. As I mentioned earlier, this reference value ensures as far as possible continuity with successful monetary strategies pursued in the euro area in the past. Nevertheless, it is a different approach that reflects the special circumstances facing the ESCB at the start of Stage Three. This reference value will have two key features: first, it will be derived in a manner that is clearly consistent with - and serves the purpose of - price stability; second, it will be constructed such that, in the absence of special factors or other distortions, deviations of monetary growth from the reference value will signal risks to price stability. The relationship between actual monetary growth and the pre-announced reference value will therefore be regularly and thoroughly analysed by the Governing Council. Where deviations occur, an explanation will be sought. If this explanation points towards a threat to price stability, monetary policy will react appropriately in order to address this threat. However, in contrast to the reaction that would normally follow under a conventional monetary targeting regime, interest rates will not be changed in an attempt to correct deviations of money growth from the reference value over the short term. The Governing Council would not wish to react in a mechanistic fashion to monetary developments, precisely because the signals implied by the money data could be scrambled by the technical uncertainties I have mentioned. By announcing a reference value and openly explaining how it will be used, the Governing Council is presenting its monetary policy strategy to the public in a way that reflects the manner in which it discusses policy itself. This is the essence of transparency. A number of issues remain to be finalised with regard to the quantitative reference value for monetary growth. First, the broad monetary aggregate for which the reference value will be announced has to be defined. Second, the reference value for monetary growth for 1999 will have to be derived and published. Progress on these two important issues is well under way and I anticipate a final announcement by the Governing Council in December. Although the monetary data contain information vital to monetary policy-making, monetary developments alone will not, of course, constitute a complete summary of all the economic information necessary to enable appropriate policy decisions to be taken. In the ESCB's stability-oriented monetary policy strategy, money is accorded a prominent - but not an exclusive - role. There is a clear need for the Governing Council to look at a wide range of other economic and financial indicators. Consequently, in parallel with the analysis of monetary growth in relation to the reference value, a and the risks to price stability in the euro area will also be undertaken. This assessment will systematically analyse all the other information about the economic and financial situation, ensuring that the Governing Council is as well-informed as possible when making its monetary policy decisions. Outside the ESCB, some commentators have labelled this broadly-based assessment an "inflation forecast". Failure to publish "the" inflation forecast is seen by some as contrary to the principle of transparency. I am afraid that both views are flawed. Allow me to explain why. While it is true that accurate forecasts can contribute to the success of an appropriately forward-looking monetary policy, the ESCB should not be judged on, or held accountable for, the accuracy of its internal forecasts. Rather, its performance in maintaining price stability in the medium term should be used by the public to judge the success of the ESCB's policies. Consequently, the publication of a forecast is only important in so far as it helps to achieve price stability through increasing the clarity and transparency of the policy-making process. In this regard, there are some important problems with publishing a single "official inflation forecast". Relying on a single forecast that attempts to summarise all the information available from a wide range of indicators would be misguided. The Governing Council will not wish to be presented with a single number to which it will have to react mechanistically, if at all. In contrast, the Governing Council will want to know the economic reasons behind the projected risks to price stability. The appropriate monetary policy response to a threat to price stability will depend on the nature of the threat. The Governing Council can only understand the nature of the risk if it is presented with a full set of data. From these data, it can attempt - with the help of various staff analyses - to identify the nature of the disturbance to price stability. Having identified the threat, an appropriate policy response can be selected and implemented. Even with the best intentions, making an inflation forecast requires numerous subjective judgements about developments in the economy. Adjustments will need to be made to forecasts to allow for the behavioural and institutional changes caused by the transition to Stage Three. Even purely "model-based" forecasts reflect the preferences of those who constructed the models. Against this background, publishing an inflation forecast would obscure rather than clarify what the Governing Council is actually doing. The public would be presented with a single number intended to summarise a thorough and comprehensive analysis of a wide range of indicator variables. However, such a summary would inevitably be simplistic. Moreover, because publishing a single inflation forecast would be likely to suggest that monetary policy reacts mechanistically to this forecast, publication might mislead the public and therefore run counter to the principle of clarity. The publication of an inflation forecast might be problematic in other ways. If the ESCB were to publish a projection based on the assumption of unchanged interest rates, then, when inflationary or deflationary pressures arose, the projection might be interpreted as suggesting that price stability is actually in jeopardy. However, this would be very misleading. The Governing Council of the ECB is fully committed to the maintenance of price stability according to its published definition and would change monetary policy in order to address and contain the threat to price stability. However, the publication of the forecast itself might introduce an independent destabilising effect into private inflation expectations, inadvertently undermining the credibility of the single monetary policy, making price stability harder to maintain and reducing the overall benefits of doing so. As I have said in the past, under certain circumstances the publication of the inflation forecast itself may lead to some form of implicit indexation of wages, imparting a costly self-sustaining momentum to such forecasts. If the ESCB were to publish an inflation forecast that incorporated the effects of its policy changes, rather than assuming that monetary policy was unchanged, then it would inevitably forecast price stability over the medium term. This follows from the unambiguous commitment of the Governing Council to meeting its primary objective of maintaining price stability. Publishing such a forecast might be reassuring, but it would not be very informative. Clearly, the Governing Council could have decided to announce some form of inflation forecast and justify policy decisions by reference to it. Interest rate increases or decreases could then be explained on the basis that the inflation forecast pointed to threats to price stability. However, this presentation of monetary strategy to the public is likely to involve a circular argument. For example, interest rate increases would be justified on the basis that the inflation forecast pointed to an inflation rate higher than that consistent with price stability. However, critical observers might soon argue that the inflation forecast was above the target precisely because there was a perceived need to raise interest rates. Simply publishing a forecast does not explain interest rates need to be changed. Moreover, as I have said, simply presenting a forecast to the public does not explain the conclusion that a rate rise is required has been reached. On both grounds, publishing the forecast does not enhance the transparency and clarity of the strategy. The strategy we have chosen at the ESCB avoids this danger. Based on this strategy, the Governing Council will inform the public regularly of its assessment of the monetary, economic and financial situation in the euro area. Moreover, when policy decisions are made, the reasoning behind specific decisions - including the economic rationale according to which judgements have been made - will be communicated to the public. By presenting the analysis that is actually driving the policy decisions, the ESCB is being both - since this analysis is informative about policy changes - and - since the presentation to the public will reflect the type of discussion I expect to occur in the Governing Council itself. In the present circumstances, the Governing Council has decided that following any mechanical policy rule to determine monetary policy in the euro area would be inappropriate. Putting "all our eggs in one basket" would be especially dangerous at the start of Stage Three, given the uncertainties that we face. Indeed, a mechanistic approach is unlikely to produce good policy decisions under any circumstances. To pretend otherwise to the public would be misleading and dangerous. Nevertheless, the ESCB's monetary policy strategy must be clear and transparent if we are to convince the public of our commitment to maintaining price stability and our ability to do so. We must be seen to be operating in a solid and coherent framework that leads to consistent and effective monetary policy decisions. The stability-oriented monetary policy strategy adopted by the Governing Council of the ECB offers just such a framework. Having been designed to respect the principles of clarity and transparency, I am confident that this strategy will be successful. By maintaining price stability in the euro area, the ESCB will thus lay part of the necessary foundation for Europe's future economic stability and prosperity.
r981112b_ECB	euro area	1998-11-12T00:00:00	The stability-oriented monetary policy strategy of the European System of Central Banks and the international role of the euro	duisenberg	1	On 1 January 1999 - in only fifty days' time - Stage Three of Economic and Monetary Union (EMU) will commence in Europe. The introduction of the euro will mark a tremendous achievement, the culmination of more than a decade of preparation and convergence. But, in many ways, the greatest challenges and opportunities will still lie ahead. Any momentous event - and surely EMU qualifies as such - is likely to have profound implications both for Europe itself and for the wider international economy. First and foremost, the introduction of the euro offers a unique opportunity to establish and maintain price stability throughout the eleven countries that comprise the euro area. By ensuring that prices throughout the euro area can be kept stable over time, the European System of Central Banks (ESCB) will be laying the foundations for sustainable economic growth and improved employment prospects in Europe as a whole. Today, before turning to the implications of the euro for the international economy, I should like to describe how we intend to meet our objective of maintaining price stability in the unique circumstances attending the introduction of the euro. At the heart of our approach is the "stability-oriented" monetary policy strategy which was recently adopted by the Governing Council of the European Central Bank (ECB) and presented to the general public last month. The establishment of EMU is a unique event. It may also lead to changes in economic behaviour. People inside and outside the euro area may, for example, restructure their investment portfolios. The wage formation process may be affected by the introduction of the euro in future. Entrepreneurs will face additional competitive pressures which may have an impact on their price-setting behaviour. In other words and in general: the transmission of changes in interest rates, of monetary policy measures, may change to a certain extent with the start of Stage Three of EMU. This is an inevitable consequence of the introduction of the euro which had to be taken into account in the design of the ESCB's monetary policy strategy. Against this background, the Governing Council of the ECB has chosen a distinct monetary policy strategy, one that reflects the special circumstances existing at present. Given a natural desire to build on the success of national central banks (NCBs) in the euro area prior to Stage Three, the strategy ensures as much as possible with the existing strategies of NCBs. Nevertheless, the chosen strategy gives due consideration to the created by the transition to Monetary Union. Given these specific circumstances, the Governing Council has decided that it would not be wise at the start of Stage Three to define a single intermediate target for the ESCB's monetary policy. Instead, it has chosen a strategy combining elements of monetary targeting, as practised by the Deutsche Bundesbank, and elements of direct inflation targeting, as conducted by the Bank of England, for instance. The ESCB's monetary policy strategy must be clear and transparent if we are to convince the general public both of our commitment to maintain price stability and of our ability to do so. We must be seen to be operating within a sound and coherent framework that leads to consistent and effective monetary policy decisions. The Maastricht Treaty entrusts the ESCB with the primary objective of maintaining price stability. It does not, however, quantify this objective or stipulate how it should be achieved. A clear indication in quantitative terms of the objective of monetary policy will help build up the credibility of the new, single monetary policy of the euro area and will thereby increase its effectiveness. The ESCB is an institution which is independent from political interference. In a democratic society, independence has to be accompanied by accountability. Transparency regarding the ultimate objective of monetary policy is one way of ensuring that the ESCB can be held accountable for its policies. The Governing Council of the ECB has, therefore, decided to publish a quantitative definition of price stability, with which the general public can sensibly judge its success in fulfilling the Treaty's mandate. In this context, the Governing Council agreed in October that . As I mentioned earlier, the Maastricht Treaty stipulates that the primary objective of the ESCB is to maintain price stability. In addition, but without prejudice to this objective, the ESCB is required to support the general economic policies in the European Community. The choice of price stability as the primary objective is based on the view that this is the best contribution monetary policy can make to the creation of conditions conducive to durable income and employment growth. This conviction has been confirmed both by decades of experience and by a broad range of theoretical and empirical studies. In the longer term the achievement of price stability and the creation of sustainable employment are fully compatible. Indeed, price stability is one of the longer-term conditions for the achievement of other economic policy objectives of a higher order, such as sustainable economic growth and full employment. By fulfilling its primary objective of maintaining price stability, the ESCB will automatically also support the general economic policies in the European Community which are aimed at achieving the aforementioned objectives, namely growth and employment. If production, inflation and employment all move in the same direction in the shorter term, as is the case in some business cycles, monetary policy can play some role in stabilising incomes and employment without endangering the pursuit of price stability. In such cases, ensuring price stability and, at the same time, supporting the general economic policies in the European Community does not create a policy dilemma. The various objectives all require a similar monetary policy stance. A policy dilemma only arises if prices, on the one hand, and incomes and employment, on the other, are moving in opposite directions in the shorter term, as may be the case whenever the business cycle is driven mainly by supply shocks. In that case, the Treaty clearly stipulates that monetary policy should give priority to maintaining or achieving price stability. Even then, however, monetary policy will generally still give due consideration to other objectives of economic policy by only gradually restoring price stability, especially if the deviation from price stability is substantial. In this context, it should be emphasised that the European unemployment problem is not cyclical, but rather structural. Monetary policy cannot solve this problem. It can only contribute to creating the conditions needed to solve the problem by maintaining price stability. The main solution has to be provided by structural policies aimed at making European goods, services and labour markets operate more flexibly. Although monetary policy may, in some circumstances, play some part in stabilisation policy, an activist monetary policy should be avoided. We simply do not know enough about the economic process for such a type of policy to be feasible. Monetary policy should take a medium-term perspective. Maintaining price stability in the medium -term ensures that the appropriate forward-looking and medium-term orientation is imparted to monetary policy. This will ensure that policy responses to threats to price stability are measured and deliberate. Such actions will not introduce unnecessary instability into the economy, while nevertheless ensuring that price stability is maintained. Let me now return to the quantitative definition of price stability. As I have emphasised in the past, the definition we have announced reflects the aversion of the Governing Council to both inflation and deflation. The phrase "below 2%" clearly delineates the maximum rate of inflation deemed to be consistent with price stability. The wording implies that persistent price decreases - that is to say deflation in the measured price index - would not be considered to be consistent with price stability either. We did not announce a floor for inflation, because we know that the price index may include a measurement bias, but we do not know its magnitude. ". In doing so, it also acknowledged that price levels may be distorted by short-term factors - for example, by changes in indirect taxes or commodity prices - which cannot be controlled by monetary policy or by the ESCB. In order to fulfil the Treaty mandate and maintain price stability in accordance with the published definition, the ESCB has adopted a stability-oriented monetary policy strategy which rests on two "pillars". The first pillar is a prominent role for money. This is deemed to be appropriate on account of the basically monetary origins of inflation over the longer term. In indication of the prominent role it attaches to money in the formulation of its monetary policy, the Governing Council of the ECB will announce a quantitative in December. The relationship between actual monetary growth and this pre-announced reference value will be regularly and thoroughly analysed by the Governing Council. Wherever monetary growth deviates from the reference value, an explanation will be sought. If this explanation indicates a threat to price stability, monetary policy will react accordingly in order to address this threat. However, interest rates will not be changed in an almost mechanistic fashion in an attempt to correct deviations of money growth from the reference value over the short term. That is why we do not speak of a target for monetary growth, but rather of a reference value. Although monetary data contain information which is vital for monetary policy decision-making, monetary developments alone will not constitute a complete summary of all the economic information necessary to take appropriate policy decisions. There is a clear need for the Governing Council to look at a wide range of other economic and financial indicators. Consequently, in parallel with the analysis of monetary growth in relation to the reference value, its strategy will also rest on a second "pillar". It will consist of a and of the risks to price stability in the euro area as a whole. This assessment will comprise a systematic analysis of all the other information on the economic and financial situation, ensuring that the Governing Council is as well informed as possible when making its monetary policy decisions. On the basis of the strategy I have just outlined, the Governing Council will regularly inform the public about its assessment of the monetary, economic and financial situation in the euro area and about specific monetary policy decisions. The Governing Council will meet every fortnight. The first meeting in every month will be followed by a press conference. The ECB will frequently issue press releases and intends to publish a monthly bulletin as well as an annual report. We shall also regularly explain our policies in speeches and interviews, and I have already announced my acceptance of invitations to present them to the European Parliament four times a year. Within this stability-oriented monetary policy framework, I am confident that the ESCB and the single monetary policy will succeed in maintaining price stability in the euro area, thereby laying the necessary foundations for Europe's future economic stability and prosperity. However, it should be noted that, unless it enjoys the support of sound budgetary policies and responsible wage behaviour, monetary policy can sometimes only achieve price stability at a high cost in terms of lost output and employment. That is why I attach great importance to the so-called Stability and Growth Pact, which was agreed by European governments. In the context of this Pact, it was agreed in the medium term to reduce government deficits to close to balance or even to create surpluses. This is intended to ensure sound budgetary policies and, at the same time, create room to allow automatic stabilisers to take effect. Let me now turn to the second issue I should like to address today: the international role of the euro. Clearly, the introduction of the euro will have major implications in this field. The euro will be the currency of an economic area which will roughly equal the United States in terms of both its economic strength and the volume of its external trade. It will also rank second in the world to the United States in terms of the size of its capital market. The introduction of the euro will therefore have consequences for economies abroad and for the international capital markets. This will also be the case because the Deutsche Mark, which will be replaced by the euro, has already played an important international role in the past. The size of an economy, its capital markets and external trade volume alone, however, are not perfect indicators of the international importance of a currency. By most measures, for example, the Japanese yen is of lesser international importance than the relative size of the Japanese economy and its capital market would suggest, while the opposite holds true for the US dollar. The reason for which there is no strict relationship between the size of an economy and the international importance of its currency is to be found in the fact that the international role of a currency is a complex phenomenon. There are many uses for a currency in an international context. On the official side, they include its use as an anchor for exchange rate pegs, as a storage for foreign exchange reserves and as a vehicle currency for foreign exchange interventions. On the private side, they include its use as a quotation and vehicle currency for international trade, as the currency of denomination for financial assets and as a substitution currency in circulation abroad. There are also very different groups of economic agents who decide on the international use of a currency. These include governments, central banks, institutional and private investors, corporations, and traders. In some cases, for example portfolio diversification, these agents may find it desirable to use different currencies; in others, such as commodity trading, they may prefer to use a single currency world-wide. For the euro, this means that its international role cannot be a single one, but that there are several areas in which it could play a significant part. In the near future, such a role obviously seems to be more likely in areas where global currency diversification is desired, and less likely where global standardisation on a single currency has occurred. While it is difficult and not always meaningful to try to predict the overall role which the euro will play internationally, it seems safe to assert that the role of the euro will be significant in a number of the areas outlined above. First, there are what one might call the "static" effects stemming from the changeover and the conversion of existing financial assets and liabilities to the euro. There are at least a dozen countries that have pegged their exchange rates to the Deutsche Mark or another euro area currency, and many of them will switch to pegging them to the euro. Foreign exchange reserves in euro area currencies currently account for about one-quarter of global reserves, and I could well imagine that many central banks in the world will, ultimately, hold at least an appropriate proportion in euro. It also seems likely that issuers of debt instruments and investors will hold onto any assets and liabilities which are converted to the euro. This should result from the smooth process of conversion to the euro which will ensure the continuity of the value of the ECU and will not, in itself, significantly affect the value of portfolios. These "static" effects alone are likely to give the euro an internationally recognised role. Second, and potentially of far greater interest, there will be "dynamic" effects stemming from the new assets and liabilities acquired or issued in euro. Here, the creation of a large and liquid, integrated capital market will be the most important element in fostering this development. For short-term instruments, we will see this occurring in a deep and liquid European money market which will ensure a common overnight rate and very similar short-term interest rates for comparable instruments and credit risks. The development of this market will be strengthened by the ESCB's operational framework for open market operations, which will be based primarily on reverse transactions and the implementation of the new TARGET (Trans-European Automated Real-time Gross settlement Express Transfer) system in all participating countries. At the longer end of the spectrum of maturities, market integration will be jump-started by the redenomination of outstanding government debt in euro on 1 January 1999. Here, we are likely to see a further convergence of interest rates to narrower spreads, because the risk of possible exchange rate changes, the main cause of existing differences within the euro area, will no longer exist. The significant convergence of both short and long-term interest rates in the future euro area over the past few months is a clear indication of a development of this kind. However, some differences in longer-term interest rate spreads are likely to persist as a result of differences in the markets' assessment of counterparty risk and technical implications. Nevertheless, the segmentation of bond markets, which to some extent still exists in Europe and which is due to the use of different currencies, will be eliminated, and uniform market standards will clearly develop. In this context, it is interesting to note that between 1981 and 1995 the share of EU currencies in world-wide private portfolios is estimated to have risen from 13% to 37%, while the US dollar's share fell from 67% to 40%. Although this process has slowed down somewhat in the 1990s, I would expect the introduction of the euro to lead to a continuation of this trend and, potentially, to accelerate it again. Let me now address an important policy issue that has been raised in this context: what stance will the ESCB take with regard to the international role of the euro? At least three aspects can be distinguished: the role of the euro as an international currency, the exchange rate of the euro, and the role of the ECB in international co-operation and international institutions. I shall briefly summarise each of these aspects. With regard to the role of the euro as an international currency, it must be borne in mind that the ESCB has a clear mandate, namely to maintain price stability in the euro area. Having an international currency would, of course, be of some advantage to the citizens of the euro area. At the same time, however, the conduct of monetary policy may sometimes become more complicated, if a significant proportion of the money stock is circulating outside the euro area. The ESCB will take a neutral stance. It will neither promote nor hinder the development of the euro as an international currency. The ESCB will accept the international role of the euro as it develops through market forces. There will be no deliberate policy of challenging the US dollar. To the extent that the ESCB is successful in maintaining price stability, however, it will also automatically foster the use of the euro as an international currency. The pace with which the role of the euro as an international currency will develop is hard to predict. If history were to provide a key, it will be a gradual process, but the possibility cannot be ruled out that it will happen quicker this time than is perhaps suggested by past experience. A second policy aspect of the international role of the euro concerns the exchange rate of the euro vis-a-vis so-called third currencies, such as the US dollar and the Japanese yen. In its monetary policy strategy, the ESCB does not specify a target for the exchange rate of the euro. The euro area will be a rather closed economy, in the same way as the United States. Pursuing a target for the euro exchange rate could easily compromise the maintenance of price stability. In line with the ESCB's monetary policy strategy, the exchange rate of the euro will mainly be the outcome of the economic, monetary and other policies, as well as of cyclical developments in the euro area and in other countries. This does not mean that the exchange rate of the euro will be neglected. The exchange rate will definitely be monitored as one of the indicators of monetary policy. To the extent that its development has an impact on price developments in the euro area, it will be taken into account and a response given, if need be. In line with the ESCB's approach to the euro exchange rate, the Ministers of Finance, who have ultimate responsibility for the exchange rate of the euro, have agreed only to issue so-called orientations for exchange rate policy in exceptional circumstances, such as a clear misalignment of the euro which is likely to persist. The fact that our strategy does not provide for any target for the euro exchange rate vis-a-vis the US dollar does not imply that the euro/dollar rate will be unstable or volatile. The pursuit of stability-oriented monetary and budgetary policies on both sides of the Atlantic would put in place one of the major prerequisites for a stable euro exchange rate vis-a-vis the US dollar. At the current juncture, the policy framework in both the United States and Europe seems to bode well for the adoption of such policies. Absolute stability is, of course, impossible to guarantee and would not even be desirable, if the United States and the euro area were to go through business cycles which are not fully synchronised. This possibility cannot be ruled out, as even recent history has shown. The third policy aspect of the international role of the euro which I should briefly like to discuss is the impact on international co-operation. I shall restrict my comments to the ECB. It is clear that a central bank which represents not only such a large economic area with such a large population (300 million), but also a currency which will increasingly circulate outside the euro area, will have an important international role to play. The ECB will not walk away from that role, but it will have to be modest and realistic. Its role will develop over time, and it will be required and willing to learn from experience, also from the experience of countries which have already played such a role for a far longer period of time. Even today, before it has actually started proper operations, the ECB is already participating at various levels in meetings of the G-7 and G-10 countries as well as in meetings at the Bank for International Settlements and the OECD. Its relations with the IMF are institutionally complex, because only countries are allowed to be members of the IMF, not central banks. In all likelihood, a pragmatic solution, which would give the ECB observer status, will be adopted. The ECB's international role will be guided by the fundamental view that price stability in the euro area is the best contribution it can make to a stable international monetary system. In addition, the ECB will, of course, stand ready to participate fully in and to contribute to international policy discussions, offering its expertise, when and where appropriate. The ECB aims at maintaining good relations with other central banks across the world. It goes without saying that maintaining good relations with our larger counterparts, such as the Bank of Japan and, in particular, the Federal Reserve, is essential. This is not only in our own interest, but also in the interests of a prosperous world economy at large. I should like to conclude on an optimistic note. I am confident not only that the euro will become a stable currency, but also that the ECB and the Federal Reserve will build up the spirit of good co-operation which I have just mentioned.
r981112a_ECB	euro area	1998-11-12T00:00:00	"Achieving a credible euro - the role of the ESCB's monetary policy"	hamalainen	0	The introduction of the euro marks a major milestone on the long road towards European integration, a process which was initiated with the aim of ensuring peace and stability in Europe. Apart from the political motives behind the implementation of Monetary Union, the introduction of the euro will also have significant economic implications for the participating countries. In order to ensure the success of Monetary Union in supporting growth and employment, it is essential to maintain the credibility of the long-term stability of the euro. The credibility of a currency is built up on many elements, some of which are beyond the control of the central bank. In my presentation today, I intend mainly to discuss the building blocks which the European System of Central Banks (ESCB) has on hand with respect to the establishment of a credible and successful monetary policy. A first fundamental building block for the establishment of credibility is the assurance that the central bank's monetary policy decisions are independent from political pressures. This building block has already been enshrined in the Maastricht Treaty. The institutional set-up for the ESCB, ensures that the European Central Bank (ECB) and the participating national central banks will enjoy a very high degree of independence. All monetary policy decisions will be taken by the Governing Council of the ECB, which comprises the Governors of the eleven participating national central banks and the six members of the Executive Board of the ECB, on the basis of one vote per person. Article 7 of the Statute of the ESCB explicitly forbids governments, or Community institutions, to instruct or seek to influence the ECB, the national central banks or any members of the decision-making bodies. However, a high degree of independence does not mean that the ESCB would not be accountable for its actions or that it would not be ready to discuss its analyses and monetary policy actions in public. This notwithstanding, it is important that the desire for accountability does not spill over into exerting political pressure on the central bank. Public accountability for the actions of the ESCB can best be achieved through transparency. This is, in fact, the second building block on which the ESCB's monetary policy rests. For the credibility of the monetary policy, it is important that the overall objective is unambiguous, that the strategy to achieve this objective is transparent and that the policy actions are well explained. By following such a transparent approach, the central bank can directly promote the efficiency of monetary policy by fostering the right expectations among market participants with regard to what the monetary authorities hope to achieve. Hence, a predictable monetary policy may contribute to achieving stable prices with little friction and with the lowest interest rates possible. For these reasons, the ESCB has placed particular emphasis on transparency in its monetary policy framework. The ESCB will also place a great emphasis on explaining not only its assessment of economic developments and inflation prospects, but also the impact of this assessment on its monetary policy decisions. The primary objective of the ESCB's monetary policy, as laid down in the Maastricht Treaty, is to maintain price stability. In order to bring about absolute clarity as regards the primary objective, the Governing Council decided last month to define that it understands price stability "as a year-on-year increase of the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%". This is a medium-term objective. In the short run, many factors beyond the scope of monetary policy-makers also have an impact on price movements. I should like to highlight, in particular, two important features of the definition of price stability; first, it relates to price developments "for the euro area". The single monetary policy will be guided by a euro area-wide perspective, and it can therefore not react to specific regional or national developments. Such specific regional or national developments will have to be tackled through fiscal and structural policy measures. Second, the ESCB's definition of price stability does - contrary to what is claimed by some critics - provide for a lower boundary. The use of the word "increase" implies that the ESCB will be worried about deflation as well as about inflation. The adoption of a euro area-wide viewpoint will be a demanding and immediate challenge for the ESCB. This challenge requires the Governors of the national central banks and the members of the Executive Board to base their analyses, actions and decisions on the interests of the euro area as a whole, instead of pursuing national interests. Therefore, I strongly believe that it is a good idea not to publish the minutes and the voting positions of the Governing Council, because publication would dramatise differences in national opinions, which might lead to public pressure on individual members at the national level. To my mind, publishing the views and the voting positions of individual members is not essential for transparency. The approach chosen by the Governing Council allows it to act most effectively as a single body, promoting the interests of the euro area as a whole. The monetary policy strategy to be followed by the ESCB in the pursuit of its overall objective will consist of two key elements: Critics have argued that the ESCB's monetary policy would not sufficiently enhance transparency since the weight assigned to money, as compared to other indicators, is not clear from the outset. In this context, I would like to make two remarks. First, I should like to recall the environment in which the single monetary policy will operate as from the start of Stage Three. The move to Monetary Union may in itself give rise to structural changes and uncertainties, which would make it inappropriate to rely too heavily on a specific pre-defined monetary variable. These uncertainties relate, for example, to the way in which the transition to Monetary Union will affect economic behaviour as well as the institutional and financial structures in the euro area. They also relate to purely statistical issues. Even if money demand functions in the euro area have been very stable in the past, we cannot rely on the continuity of this stability in the new structure. My second remark is linked to the first one. The encompassing strategy adopted by the ESCB assigns a very important role to the development of the chosen monetary aggregate without implying a mechanical or automatic reaction to deviations from the reference value. When monetary policy decisions are made, the general price development prospects - based on very careful analysis - will also be taken into account. In practice, the choice of a monetary policy strategy should not be seen as a choice between fundamentally different theories on how best to conduct monetary policy. Instead, it should be seen as a realistic and balanced choice on how to present monetary policy decisions in a clear and consistent way. In this respect, the Governing Council intends to inform the public regularly and in detail about its assessment of the monetary, economic and financial situation in the context of the framework set for its monetary policy strategy. To this end, a press conference will be held once a month, as soon as possible after a meeting of the Governing Council. The ECB's publications, in particular the monthly bulletin, will also play an important role in its regular communications to the general public. A third important building block for the credibility of monetary policy is the assurance that the operational framework is designed in a way that allows monetary policy decisions to be implemented efficiently. The operational framework should be consistent with market principles and ensure an equal treatment of counterparties and financial systems across the euro area. Furthermore, the ESCB has placed great emphasis on the need to ensure that the operational framework is based on the principle of decentralisation in order not to disrupt established links between the national central banks and their counterparties. Monetary policy operations will therefore be conducted by the national central banks, while decision-making will take place centrally in the ECB's decision-making bodies. In the implementation of monetary policy, all central banks make use of an operational target as a proxy for the desired monetary policy stance. The ESCB will rely on a short-term interest rate as its operational target, and it will use open market operations as its main monetary policy instrument. Open market operations are flexible and market-oriented; they have signalling functions, and they are used for managing the liquidity situation in the market. I do not wish to go into detail about the ESCB's monetary policy tools and procedures. However, I should like to mention some of the main functions of the framework, which is very similar to the framework already used in most EU countries. As I have already said, open market operations will be the basic tool used in the implementation of monetary policy. The main refinancing operations will be regular liquidity-providing reverse transactions at weekly intervals with maturities of two weeks. These reverse transactions will be executed by the ESCB on the basis of tender procedures in which, in principle, all credit institutions established in the euro area may participate. These operations will provide the bulk of refinancing in the financial sector and they will be used both to manage the money market interest rates and to signal the stance of monetary policy. In addition to these two-week repo operations, the ESCB will conduct longer-term refinancing operations, which are liquidity-providing reverse transactions at monthly intervals with maturities of three months. They, too, will be based on tender procedures. These monthly repo operations will, as a rule, not be conducted with the intention of sending signals to the market or of managing market interest rates. The ESCB will, of course, also be able to carry out fine-tuning open market operations on an ad hoc basis with the aim of managing the liquidity situation in the market and steering interest rates. For these operations, the ESCB will have a large number of instruments (collection of deposits, foreign exchange swaps, outright transactions, etc.) and procedures at its disposal, which it can use, where necessary, with only a limited set of counterparties. The ESCB will also have the possibility of conducting so-called structural operations. These operations will aim at affecting the longer-term liquidity position of the banking sector vis-a-vis the ESCB. A main instrument for these operations may be the issuance of debt certificates. Reverse and outright transactions might also be employed for this purpose. Another important structural tool is the ESCB's minimum reserve system, which was designed with a view to fulfilling two main functions: first, the enlargement of the structural deficit in the money market, thereby increasing the banks' dependence on central bank credit, and, second, the stabilisation of money market interest rates through the use of an averaging mechanism. This latter feature will help absorb liquidity shocks, without the need for the ESCB to undertake frequent fine-tuning interventions in the money market. All credit institutions in the euro area will be required to hold minimum reserves on accounts with the national central banks. In order to prevent the minimum reserve system from imposing significant financial burdens on the banking sector, which might lead to a relocation of banking business to countries outside the euro area, the ESCB will remunerate reserve holdings at its two-week repo rate. In addition to the open market instruments and the structural tools, two standing facilities will be available. The interest rates on the standing facilities establish a corridor within which the market interest rate will move. In contrast to open market operations and structural tools, the standing facilities are used at the initiative of the market counterparties. The marginal lending facility will enable the counterparties automatically to cover any possible end-of-day liquidity needs at a rate of interest above the repo rate. Under normal circumstances, there will not be any credit limits or other restrictions on counterparties' access to the facility. The higher interest rate is expected to guide the use of this financing facility. The lower boundary of the interest rate corridor will be set by the deposit facility, which will enable market counterparties to hold a possible end-of-day liquidity surplus with the ESCB at a rate of interest below the repo rate. In order to ensure a harmonised implementation of the ESCB's monetary policy throughout the euro area, it is important that a fully integrated euro area-wide money market is established as from the start of Stage Three of EMU. This is essential in order to avoid a segmentation of the money market interest rate according to the liquidity situation in national money markets. A precondition for the establishment of an integrated money market is the integration of national payment systems. For this reason, the ESCB has developed the so-called TARGET system, which will connect the national real-time gross settlement (RTGS) systems throughout the euro area with one another. The TARGET system will be operational from the first day of Stage Three. The domestic settlement systems will operate in real time. This complies with a major objective of the central banks, which is to minimise the risks for participants and for the payment system as a whole. The TARGET system will be an essential element in the organisation of payments in Monetary Union. It will not have a monopoly, however. Other settlement systems will continue to exist or be set up around it. The TARGET system will handle large-value payments. Only operations which are linked directly to the conduct of the single monetary policy and in which the future ESCB is involved - either as the issuer of a payment instruction or as the beneficiary of a payment - will necessarily have to be routed via TARGET. For the remainder, the market will decide on the distribution of payments among the systems in place in Stage Three. There is nothing to prevent certain banks from continuing to use their correspondents' accounts. Furthermore, numerous net and end-of-day settlement systems will continue to operate in EU countries. In the context of TARGET, the ECB decided in July 1998 that non-euro area central banks of EU Member States will also be able to offer limited intraday liquidity in euro to their counterparties. It is an innovative arrangement, intended to smooth the future transition of the relevant EU Member States to the Monetary Union. This arrangement, which is subject to an agreement with the central banks concerned, should be seen as a very specific exception to the general rule approved by the central banks of the Group of Ten countries, that no central bank shall grant credit in a currency other than its own. I have focused on the elements which are directly related to the ESCB. In these areas, I feel very confident that we are well prepared for the start of Monetary Union. But I should like to underline that the credibility of the single monetary policy also depends very heavily on another building block, namely the extent to which governments are prepared to pursue stability-oriented policies of fiscal discipline and to undertake essential structural reforms. Fiscal policy affects credibility in two ways. The first has to do with how well national fiscal policies cope with differences in the business cycle and in the monetary policy transmission mechanisms of the participating Member States. Under a single monetary policy, national fiscal policies need to be far more active and flexible than is necessary at present to deal successfully with country-specific growth and inflation differences. Both the room for manoeuvre needed at the national level and the Stability and Growth Pact explicitly demand that national public budgets are balanced and sound. The second aspect of fiscal policy is the overall degree of fiscal policy discipline in the euro area. The maintenance of price stability and subdued inflation expectations in a low interest rate environment will be more easily achieved if fiscal policy is disciplined in the euro area as a whole.
r981118a_ECB	euro area	1998-11-18T00:00:00	The euro in the global financial market	main	0	The countdown is running. We are only 43 days away from the beginning of Stage Three of European Economic and Monetary Union (EMU). Starting conditions for a smooth launch of the euro remain favourable, while the wave of bad news on external economic developments has faded away and global financial markets have tended to stabilise over the last few weeks. A high degree of domestic macroeconomic convergence among designated participants has led to sound economic fundamentals throughout the euro area. Inflation remains subdued (1.0% in September 1998), the outlook for inflation in the near term is generally favourable and persistent deflation is very unlikely. Economic growth is supported by domestic demand. Nominal and real long-term interest rates are close to historical lows providing a benign investment climate. Moreover, even before its birth, the euro has proven its ability to protect the euro area against tensions in international financial markets and the euro area has benefited from "safe haven" capital inflows. However, downside risks caused by external factors cannot be ignored. The slow recovery from last year's financial crisis in Asia, the strong contraction of economic activity in Russia, the protracted economic downturn in Japan and tensions in Brazil and certain other Latin American countries inevitably exert dampening effects on global economic activity. And the consensus view is that the euro area will also be affected to some extent. In this context, concerns have been raised that the European System of Central Banks (ESCB) might be too complacent towards these external events and their potential systemic risks or lack the willingness to co-operate at the international level in containing such risks. These criticisms are unfounded. You can be assured that the ESCB is fully aware of the seriousness of these developments and their possible adverse effects. However, we also know that activism has never been good counsel. With regard to the current stage of the world economy, it appears all the more important to ensure a successful implementation of EMU. This will create the basis for further sound economic growth in the euro area, thereby also providing a positive impact for the world economy as a whole. The introduction of the euro is a quantum leap forwards in European integration and the most profound change in the international monetary system since the collapse of the Bretton Woods system in 1973. As of 1 January, the ESCB will run the monetary policy for a group of eleven countries, almost 300 million people and a GDP which is roughly 80% of that of the United States. It is therefore understandable that a great deal of attention is being shown, notably among financial market participants, in the prospective role of the euro as an international currency in its various functions as an investment, transaction, vehicle and reserve currency. In the following, I will try to shed some light on the developing role of the euro in the global financial market. First of all, I should like to examine the implications of the introduction of the euro for private portfolio management. Second, I will discuss the potential use of the euro as a transaction and vehicle currency in the private sector. Third, I will focus on the possible effects on the public sector's use of the euro as a reserve and an anchor currency. Finally, since the future international role of the euro will also depend on its expected internal and external value, I will turn briefly to the role of the euro's exchange rate in the conduct of the ESCB's monetary policy . To start with, I should like to discuss the likely response of the private sector to the introduction of the euro. At present, the US dollar is the dominant investment currency in the global capital market. The share of dollar-denominated international bonds and notes amounted to 46% at the end of June 1998, followed by the Japanese yen (11%), whereas all euro area currencies taken together accounted for 24%. A similar pattern can also be found for the denomination structure of international bank assets and liabilities. A major factor in the potential attractiveness of the euro as an investment currency will be the emergence of a large and integrated financial market in the euro area. The introduction of the euro will foster the growth of broader and more integrated euro area money and securities markets by removing currency-related fragmentation and inducing the establishment of uniform market standards. However, the euro area money market is likely to be more fully integrated than the bond market, at least in the early stages of EMU. At the short end of the yield curve, the necessary conditions for the creation of a broad, deep and liquid European money market will be met from the very outset. First, the operational framework for the single monetary policy relies mainly on market-based monetary policy instruments providing a favourable environment for trading activities of financial market participants. Open market operations based on reverse transactions with a broad spectrum of counterparties, as the major policy instrument, will foster money market integration. Second, the integration will technically be supported by the implementation of the European payment system TARGET (which stands for Trans-European Automated Real-time Gross Settlement Express Transfer). This system consists of the inter-linked real-time gross settlement (RTGS) systems of participating countries and, within certain limits, the non-euro area countries. It provides a major component of the financial infrastructure of the future euro area. It is designed not only to ensure a common overnight rate throughout the euro area and a smooth settlement of cross-border payments in the euro area, but also to reduce systemic risks that might arise from settlement failures. Even today, money market rates and swap yields on maturities ranging from one week to two years are almost identical in the future euro area countries. The introduction of the euro will also have favourable implications for bond markets as the euro will increase market liquidity, broaden the range of maturities and potentially offer a greater variety of financial products. Current pricing and ratings for bonds issued by euro area governments already show a significant degree of convergence, indicating that government bonds of the future euro area are increasingly being dealt with as a common class of assets. However, in the absence of a single issuer such as the US Government for the dollar area, capital markets are likely to remain more fragmented at the long end of the yield curve than at the short end. This holds true, despite the re-denomination of outstanding government debt into euro on 1 January 1999. Some of the credit spreads between euro government bonds issued by different national euro area treasuries are likely to prevail even after the elimination of exchange risk premia. These spreads may, at least to some extent, reflect differences in credit assessments based on the respective fiscal position of governments in the euro area, including future pension obligations. They may also reflect differences in market liquidity of benchmark issues, and in market practices and conventions. Turning to private sector issuers, increasingly integrated money and government bond markets may stimulate the emergence of commercial paper and corporate bond markets in the euro area. Increasing economies of scale, narrower bid-ask spreads, lower hedging costs for debt securities issued by private firms and a more competitive underwriting activity are likely to provide incentives for corporations to issue their own securities instead of borrowing from banks. In the same vein, investors in search for higher yields will find such securities attractive. This market segment might expand to an increasing extent in the euro area. Likewise, on the deposit side, a rapidly developing private repo market in euro could become a serious alternative to bank deposits for large investors, such as pension funds and insurance companies. The development of such new market segments is likely to attract both international investors and borrowers. Finally, other factors influencing internationalisation are the risk, return and diversification characteristics of the euro. In short, the attractiveness of the euro, which will foster low market interest rates all along the yield curve, and provide for a benign investment climate, will be enhanced by the stability-oriented monetary policy guaranteed by a highly independent ECB and by sound fiscal policies throughout the euro area. Let me now turn to the role of the euro as a transaction and vehicle currency for cross-border transactions outside the euro area. That role will depend on its potential for becoming a means of payment in foreign trade and foreign exchange markets. In this context, relevant factors are the weight of the euro area in the global economy and the size of its foreign trade and financial linkages, since increasing economies of scale will play an important role in promoting the use of the euro. Today, the US dollar is the world's by far most important transaction and vehicle currency. Its share in all transactions (spot plus derivatives transactions) in foreign exchange markets is one and a half times higher than that of the euro area currencies. With respect to the invoicing of international trade, estimates suggest that in the early 1990s about one half of global exports were invoiced in US dollars, while roughly one third was denominated in euro area currencies and only 5% in yen. Initially, following the introduction of the euro, the euro market share in foreign trade and foreign exchange transactions will decline as a result of the purely mechanical effect of the elimination of intra-European trade which accounts for about 60% in 1997 of the total external trade of the future euro area countries. However, notably in respect of trade, the expected decline is likely to be a short-term development. In a medium-term perspective, this decline is likely to be offset, as far as international trade flows both between the euro area and foreign countries and between non-euro area residents are concerned. It is worth noting that according to recent press reports, some companies in non-euro area countries in Europe, such as Denmark, Sweden, the United Kingdom and Switzerland, are considering switching wholly or partly to transactions in euro. However, the use of the US dollar as an international currency in the goods and financial markets is likely to remain predominant, at least for a certain period of time, since it is less related to trade shares than to the convenience of using one standard for pricing, in particular in commodity markets with homogenous goods and a large number of market participants. In this context, it is of interest to note that it took several decades before the US dollar, as the currency of the largest economy in the world since the end of the last century, became the world's key vehicle currency, replacing the pound sterling. So far, I have mainly discussed the implications for the international use of the euro from the perspective of the private sector. Although private portfolio flows will presumably be the dominant factor in the internationalisation of the euro, central bank demand for euro in the context of their official reserve portfolio management is likely to play a significant role. At present, the US dollar remains the most important reserve currency worldwide. At the end of 1996, the share of dollar-denominated official reserves amounted to 64%, while euro area currencies accounted for one-quarter and the yen for 6%. As regards official reserve holdings in the future euro area, it is to be noted that there will be a fall in the euro's share of world reserves, since a large part of euro area countries' reserves which were previously held as foreign assets (primarily Deutsche Mark) will become domestic euro assets after the entry into Stage Three. As far as the future share of the euro in overall official reserves is concerned, it seems plausible to expect that central banks of non-euro area countries will re-assess their reserve management strategy in light of the better global diversification opportunities offered by this new currency. Moreover, the euro might also assume a greater role as an anchor currency in other European countries which, formally or informally, intend to peg their exchange rate to the euro or to a (trade-weighted) basket of currencies including the euro as a large component. This may hold true not only of the countries participating in the newly established exchange rate mechanism (ERM II) but also of transition countries in central and eastern Europe, possibly of non-EU Mediterranean countries as well as of Switzerland and Norway. Finally, the euro may increasingly become part of the total foreign currency reserves held by Asian central banks to the extent that they take the opportunity to diversify their reserves. Whether this will happen, however, depends crucially on the confidence in the ECB's monetary policy and the euro's stability. I will now turn briefly to the role that the euro's exchange rate will play in the conduct of the ECB's monetary policy. At its meeting in December 1997 in Luxembourg, the European Council underlined in its conclusions that the exchange rate of the euro will be heavily influenced by economic fundamentals of the euro area relative to those of other countries. In broad terms, this implies that the exchange rate should be seen as the outcome of all relevant economic policies rather than as an objective to be set independently. Hence, the euro exchange rate will clearly not play an instrumental role in the conduct of the euro area monetary policy, as was the case in the ERM. Underlying this position is of course Article 105 (1) of the Treaty establishing the European Community, according to which the ESCB's primary objective is to maintain price stability, irrespective of the exchange rate system agreed upon under the Treaty. For the ESCB, this objective will have pre-eminence over all other policy objectives, including the exchange rate. This is in line with the monetary policy strategy chosen for Stage Three of EMU, which was presented to the public a month ago. It assigns a prominent role to money, with a reference value for the growth of a monetary aggregate. The reference value for the growth of the monetary aggregate will be derived in a manner, which is consistent with - and will serve to maintain - price stability throughout the euro area. Moreover, a broadly based assessment of the outlook for future price developments will play a major role. Finally, the Governing Council of the ECB has defined price stability as a year-on-year increase in the Harmonised Index of Consumer Prices (HIPC) for the euro area of less than 2% which is to be maintained over the medium term. To make it quite clear: both persistent inflation and deflation are incompatible with this definition of price stability. The European Council also concluded in December last year that "general orientations" for the exchange rate policy of the euro area may be formulated only in exceptional circumstances, such as in the case of a clear misalignment of the euro which is likely to persist. This implies that, in normal circumstances and in the absence of formal exchange rate arrangements between the euro and other major currencies, the ESCB will be in charge of the day-to-day exchange rate policy in the euro area. But the ESCB will, of course, monitor exchange rate developments as part of its overall assessment of a broad range of economic and financial indicators which are relevant to the conduct of monetary policy. If the Governing Council of the ECB takes the view that the external value of the euro is out of line with fundamentals, it may take corrective action. In other words, we will not pursue a policy of "benign neglect" with respect to exchange rate developments. At the end of my speech, let me quote Mark Twain by saying that predictions should be avoided, particularly those about the future. Specifically, that holds true of assessments of the future international role of the euro. Current conditions in the global financial markets can only be seen as a rough indication of the direction and magnitude of future developments. However, there is little doubt that the introduction of the euro will lead to a far-reaching restructuring of the euro area financial markets, which will make them more efficient and internationally competitive. Nevertheless, over a medium-term horizon, confidence in the future internal and external stability of the euro will play a crucial role. In this respect, I am convinced that the unequivocal mandate conferred upon the ESCB to maintain price stability and the ESCB's institutional framework, which ensures a high degree of independence, will foster the future international use of the euro in its various functions. The ESCB takes a neutral stance towards the development of the international role of the euro. It is not our objective to stimulate, or to hinder the development of this role. However, the more successful the ECB is in achieving its primary objective of maintaining price stability, the more will the international role of the euro be "automatically" fostered. In order to be successful in ensuring a stable price environment without being overburdened, the monetary policy of the ESCB needs to be supported by sound fiscal policies, structural reforms and responsible wage behaviour at the national level. The relatively favourable domestic conditions currently prevailing in Europe should be used to further reduce structural imbalances in government budgets, also with a view to creating greater policy flexibility over the whole business cycle. In this context, the slowing down of fiscal consolidation in some euro area countries since 1997 could prove to be counterproductive. As regards unemployment, which is largely structural in nature, only measures intended to improve the working of the labour and goods markets at the national level are bound to be effective. Let me close by saying that changes in the structure of the international monetary system will take time to materialise, as past experience has shown in the case of the US dollar vis-a-vis the pound sterling. I am nevertheless rather confident that the euro will indeed play a major role in the international financial arena as a result of both the stability-oriented monetary policy conducted by the ECB and the weight of the euro area in the global economy. At any rate, we at the ECB will of course spare no efforts and pains to make sure that our new currency becomes a success story.
r981120a_ECB	euro area	1998-11-20T00:00:00	The International Role of the Euro and the ESCBÂs Monetary Policy	duisenberg	1	I very much welcome the opportunity today to share some thoughts with you on the issue of the international role of the euro and the monetary policy strategy of the European System of Central Banks (ESCB). In order to remain within the tight time frame and leave room for discussion, I shall try to be as concise as possible, and I shall therefore focus on the three questions addressed to me directly. Some observers have asserted that one of the main motives behind Economic and Monetary Union in Europe is the creation of a major international role for the euro, and that fostering such a role would be an important objective for the European Central Bank (ECB). Both assertions are incorrect. The purpose of the introduction of the euro is to promote economic integration and economic welfare in the Member States, and the objective of the ESCB and of the ECB as part of this system is to maintain price stability within the euro area. The ESCB will take a neutral stance towards an international role of the euro. It will neither hinder nor deliberately encourage the development of this role, but will rather leave this to market forces. The ESCB will, however, contribute indirectly to the international recognition of the euro by achieving its objective of maintaining price stability within the euro area. A successful monetary policy is a necessary condition, but not the only prerequisite for the international recognition and use of a currency. The reason is that the latter is a complex phenomenon. While there is no single international role for a currency, there are many uses for a currency in an international context. On the official side, they include the use of a currency as an anchor for exchange rate pegs, as a means of storing foreign exchange reserves, and as a vehicle for foreign exchange interventions. On the private side, they include the use as a quotation and vehicle currency for international trade, as a currency of denomination for financial assets, and as a substitute currency in circulation abroad. The significance of all these roles depends on the decisions of a large number of economic agents including governments, central banks, institutional and private investors, corporations, and traders which the central bank can only influence to a limited extent. While it is difficult and not always meaningful to make predictions about the overall international role of the euro, it seems safe to assert that it will be significant in a number of areas. , there are what one might call the static effects stemming from the changeover and the conversion of existing financial assets and liabilities into euro. That alone will already give the euro an internationally recognised role, since the euro area currencies, in general, and the Deutsche Mark, in particular, have played a significant role as anchor, reserve, investment and vehicle currencies in the past. , and potentially even more important, there will be dynamic effects stemming from new assets and liabilities acquired or issued in euro. Here, the creation of a large and liquid, integrated capital market will be the most important element in fostering such a development. For short-term instruments, there will be a broad and liquid European money market with a common overnight rate and very similar short-term interest rates for comparable instruments. At the longer end of the maturity spectrum, market integration will be jump-started by the re-denomination of outstanding government debt in euro on 1 January 1999. The elimination of the currency fragmentation in the European bond markets will also lead to the development of uniform market standards and the creation of a large and liquid market for portfolio investors. 2. How will the euros international role influence the ECBs monetary policy? Having an international currency has significant advantages for businesses and consumers. It may, however, sometimes complicate the conduct of monetary policy. In the ESCBs monetary policy strategy, developments in monetary aggregates play a prominent role, and these developments will be analysed very carefully. If a significant part of the money stock were to circulate outside the euro area and if its development were to deviate from that circulating inside the euro area, this could be a source of instability in money demand. But this is only one of the challenges which the ESCB will be facing in analysing developments in monetary aggregates. Other challenges are related to changes in money demand as a result of the introduction of the euro itself. Together, these changes represent a structural break, and it is obviously difficult to predict how demand for money will evolve around such a break. The ESCB has taken these difficulties into account in its monetary policy strategy in that, , it will announce only a reference value for a monetary aggregate, and not a target value. This means that, although monetary developments will be used as the main indicator of potential inflationary or disinflationary pressures, the ESCB will not react in an almost mechanical way to correct deviations from the reference value in the short term. , the ESCB will not focus solely on the analysis of monetary aggregates, but will complement this analysis with a broadly based assessment of the outlook for future price developments. On the one hand, the chosen strategy will, in my view, ensure as great a degree of continuity as possible in relation to the existing strategies of national central banks in the euro area. On the other hand, due consideration has simultaneously been given to the unique situation created by the transition to Monetary Union, in which a possibly growing international role of the euro is but one element. The ECB, acting on behalf of the ESCB, is already beginning to play a major role in international fora, such as those at the Bank for International Settlements (BIS), the OECD and in a G7 and G10 context, and I expect this role to grow considerably in significance once the ESCB is operational. In all fora, the ECB's role will be to contribute to the international policy discussions from the perspective that price stability in the euro area is its prime objective. At the same time, the ECB will seek to make the best contribution it can to stable international developments. In particular, the introduction of the euro will reduce the number of major currency blocs in the global financial system. In principle, this should simplify the exchange of views on financial issues at the global level. Each of the main partners the United States, the euro area and Japan will be in a position to speak for a comparatively large economic area and will be similarly vulnerable to possible consequences of instability. They may thus have a greater incentive to take on a share of the responsibility for helping to maintain a stable global environment. On the question of exchange rates and target zones, I would like to state clearly that, in its monetary strategy, the ESCB does not have an exchange rate target. Nor do the United States and Japan. An exchange rate target for an area as large and relatively closed as that of the euro area could easily conflict with the maintenance of price stability and could, therefore, not be sustainable. According to our monetary policy strategy, the exchange rate of the euro will thus be an outcome, rather than the objective, both of the economic, monetary and other policies pursued in the euro area, and of cyclical developments in the euro area and abroad. It will be monitored as one of the indicators of monetary policy and as a source of potential changes in the price level in the euro area. However, the exchange rate will play a far smaller role in the euro area than it has played in the Member States in the past. In line with the ESCBs approach to the euro exchange rate, the Ministers of Finance, who are ultimately responsible for the exchange rate policy of the euro, have agreed to issue so-called exchange rate orientations only in exceptional circumstances, such as in the case of clear and persistent misalignments of the euro. This is apparently not the case at this juncture. Nor is there any indication that such misalignments will be unavoidable in the future. In particular, the fact that our strategy does not include any exchange rate target vis-a-vis the US dollar does not imply that the euro/dollar rate will be unstable or volatile, or that the ESCB is against reasonably stable exchange rates. The pursuit of stability-oriented monetary and budgetary policies on both sides of the Atlantic would put in place one of the major prerequisites for a reasonably stable euro/dollar exchange rate. At the current juncture, the policy framework in both regions seems to bode well for the adoption of such policies. Absolute stability is, of course, impossible to guarantee and would not even be desirable, if the United States and the euro area were to go through business cycles which are not fully synchronised.
r981126a_ECB	euro area	1998-11-26T00:00:00	The European Central Bank on the eve of EMU	no_info	0	In only slightly more than one month's time, the curtain will rise on a world premiere. Stage Three of European Economic and Monetary Union (EMU) will commence. The eleven participating nations will transfer their monetary policy sovereignty to the European System of Central Banks (ESCB). Henceforth, the euro will become the single currency for a population of almost 300 million people. Although the new notes and coins denominated in euro will not circulate for another three years, a single monetary policy for the entire euro area will be determined by the Governing Council of the European Central Bank (ECB) in Frankfurt . Bringing Europe to the threshold of Monetary Union has been a tremendous achievement, the culmination of more than a decade of preparation and convergence. But the greatest challenges lie ahead. As with any great enterprise - and surely Monetary Union is one -these unprecedented challenges entail both opportunities and risks. Monetary Union offers the opportunity for Europe to unleash its enormous creative and productive potential. Through lowering transactions costs and making pricing more transparent, Monetary Union will create larger and more integrated markets. These, in turn, will spur greater competition and innovation. A truly continental single market will be created. But above all, Monetary Union offers a unique opportunity to establish and maintain price stability throughout the euro area. We must ensure that this great opportunity is not missed. Price stability is at the heart of the 'stability culture' that we are creating in Europe - a culture that is a necessary foundation for improving output and employment prospects. Only in an environment of stable prices can truly sustainable and lasting improvements in the standard of living of Europe 's citizens be generated. However, a transformation of the magnitude and importance of EMU is inevitably attended by some risks. They relate, in part, to the possibility of breaks in previously well established economic relationships and behaviour that may complicate our interpretation of the euro area-wide economic data, and therefore the implementation of the single monetary policy. At the ESCB, we are well aware of these risks. They are thoroughly monitored and carefully addressed. We are confident that we can manage the challenges that they pose successfully in the coming years. But the ESCB does not operate in a vacuum. It is affected by changes in its environment: both by developments in the rest of the world, and by the policies and actions of other institutions and the private sector in the euro area itself. As we approach EMU in January, in my view, it is in some of these areas - rather than directly in the field of monetary policy - where the greatest risks lie. Unfortunately, developments in the world economy have not been favourable of late. Starting with the exchange rate and financial crises in Asia last year, we have faced a lengthy period of financial market turmoil. Within this turmoil, the euro area itself has been a 'zone of stability' - a mark of the advantages offered by the process of Monetary Union itself. But both the market volatility and the real effects of the crises in Asia and, more recently, in Russia have increased the uncertainty surrounding the prospects for economic growth and price stability in the global economy as a whole, including the outlook for the euro area. There have been encouraging signs in the last few weeks that this volatility has been somewhat contained. However, these international crises have clearly increased the uncertainty faced by the ESCB at the start of Stage Three. Further uncertainties and risks are 'home-grown' within the euro area itself. Although a monetary policy that maintains price stability is a prerequisite for Europe 's future prosperity, monetary policy alone cannot ensure strong, non-inflationary growth and improved employment prospects throughout the euro area. Monetary policy can simply ensure that the fundamentals are in place. Only appropriate fiscal policies and badly needed structural reforms can directly influence growth and employment. Although the Stability and Growth Pact should impose an important discipline on fiscal policy, national governments must ensure that the dangerous fiscal profligacy of the past is not repeated. The enormous implicit liabilities implied by public pension and health care systems must also be addressed. Structural reforms to improve the flexibility of Europe 's labour markets are absolutely necessary in many countries. Indeed, reducing market rigidities in general is desirable, so that resources can be directed to their most productive uses. The private sector also has its part to play, notably by exercising wage moderation. Progress on all these dimensions is not only desirable, but also absolutely vital. In this context, let me emphasise that the ECB Governing Council naturally shares the public's understandable concerns about the current unacceptably high rate of unemployment in the euro area. But Europe 's unemployment is largely structural in origin. Implementing structural reforms is the only lasting solution. This is not an easy task. However, governments must muster the courage to make these vital reforms immediately. It is through maintaining price stability that the ESCB can best contribute to raising welfare and employment in the euro area. Only in this way can the ESCB serve the public's interests and provide the stable environment where necessary structural reforms can work effectively. The current stance of monetary policy in the euro area is focused, as it should be, on maintaining price stability - it is neither inflationary nor deflationary. Nevertheless, let me emphasise that pursuit of an inflationary monetary policy would not solve Europe 's unemployment problems. If the ESCB were to pursue an inflationary policy, it would simply lead to higher unemployment in the long run, as the important benefits of price stability for job creation are foregone. Longer-term interest rates would rise as inflation expectations and risk premia increase, thereby raising the cost companies face when making the investment necessary for sustainable future economic growth. An inflationary policy would therefore be entirely counter-productive. The ESCB is determined to protect price stability, not least from the dangers inherent in political interference in monetary policy. With these opportunities and risks in mind, today I will discuss the theme 'the European Central Bank on the eve of EMU'. First, I will address the institutional context in which the ECB operates - its structure and its objective, namely the maintenance of price stability. Second , I will describe the ESCB's recently announced stability-oriented monetary policy strategy that will achieve this objective; and finally , I will outline the monetary policy instruments available to the ESCB that will be used to implement this strategy. The European System of Central Banks was created by the Maastricht Treaty to design, decide and implement the euro area's single monetary policy. It consists of the fifteen national central banks (NCBs) of the European Union, plus a central institution - the European Central Bank - based in Frankfurt . As regards monetary policy, the key decision-making body of the ESCB is the Governing Council of the ECB. At present, this Council has seventeen members: the NCB Governors or Presidents of the eleven countries participating in EMU from the outset and the six members of the ECB's own Executive Board. It is important to realise that, although only the six members of the Executive Board are appointed on a centralised European-wide basis, all members of the Governing Council are obliged to pursue the Treaty mandate of price stability. The Governors of NCBs are not representatives of their country or delegates of their home institutions. They are appointed to the Council as individuals who share a collective obligation under the Treaty to maintain price stability in the euro area as a whole. The Governing Council is therefore determined to take an area-wide perspective in analysing the economic and monetary data. This is absolutely necessary: with a unified single monetary policy, policy decisions must be made in a manner that reflects conditions across the euro area in its entirety. This pre-requisite was clearly recognised in the announcement of the main elements of the ESCB's monetary policy strategy in October: "[the Governing Council] The Governing Council's recent decision to meet on a fortnightly basis will serve to intensify this necessary area-wide approach. A regular and frequent collegial discussion of the single monetary policy will inevitably foster an area-wide perspective, as members of the Governing Council exchange their views on the economic situation and the direction of policy focusing on the euro area as a whole. To guarantee that the single monetary policy is strictly focused on the primary objective of price stability in an effective and credible way, the Treaty has conferred considerable independence on the ESCB. In making monetary policy decisions, the Governing Council is not subject to political interference. The reasons for this independence are well understood - indeed, they were the dominant reason for giving the Bank of England its new status in May 1997, after a long period of being subordinate to the government. It is widely recognised - although perhaps not widely enough - that a lack of independence can easily lead central banks to focus on the short-term and, thus, fail to adopt the forward-looking, medium-term orientation that is crucial for a successful monetary strategy. The Maastricht Treaty is based on the belief - confirmed by a substantial body of recent empirical economic research - that delegating monetary policy decisions to an independent institution with a clearly defined and specific mandate improves the quality of policy-making, results in more stable prices and therefore facilitates both sustainable real growth and lasting improvements in living standards, as I described a moment ago. Such a delegation of the responsibility of monetary policy to an independent central bank therefore serves the interest of the public at large. Nevertheless, in a democratic context, there is no doubt that this institutional independence must be supplemented by accountability to the public. As I will describe in a moment, the ESCB's mandate is clear and limited - it must maintain price stability. The ESCB's independence is crucial in achieving this objective, but the ESCB must also be prepared to explain to the public, in an encompassing manner, how its monetary policy has been geared to this goal. Before turning to the details spelt out in the Treaty, it is crucial to place the independence and accountability of the ESCB in a wider context. The ESCB's independence and its primary objective of price stability are established in a Treaty that was subject to intense public scrutiny and debate. The Treaty was finally ratified by all fifteen Member States of the European Union. Moreover, in several of the participating countries, the Treaty was endorsed by popular referenda. This confers a maximum democratic legitimacy on the ESCB's independence guaranteed in the Treaty. The Treaty itself imposes very high standards of accountability on the ESCB. We must produce a quarterly report on the activities of the ESCB, and submit an Annual Report to the European Parliament, Council and Commission. The European Parliament will hold a general debate on the report it receives, and the ECB President and Executive Board members will have to answer questions posed by its parliamentary committees. These are among the most stringent reporting requirements for any central bank. But the ESCB intends to go further. Through regular press conferences after Governing Council meetings, speeches and a monthly report, the ECB is committed to keeping the public informed about its decisions and the economic rationale on which they are based. A press conference will be held immediately following the first Governing Council meeting of every month. An extensive statement of the Council's view of the economic situation and the outlook for price developments will be presented by the President, followed by a question and answer session. The schedule for these meetings and conferences has already been announced for 1999. Discussion papers and technical analysis by the ECB staff will be published for professional review and scientific assessment. Furthermore, in these articles and other presentations, we will address various major economic problems facing Europe , not least the problem of the high level of unemployment. In doing so, we will make the best possible use of experts knowledge throughout the whole ESCB and ensure that this expertise is available to the wider policy-making community. Of course, it not only matters that we make reports, but also what these reports contain. They must be informative, clear and meaningful. The ECB is committed to communicating with the public in a clear and transparent manner. The monetary policy strategy recently selected by the Governing Council has been designed with these commitments in mind. Against this background, the ESCB will stand any comparison on the grounds of accountability and transparency. The Maastricht Treaty stipulates that the It was left to the ESCB to provide a quantitative definition of this primary objective. In the interests of transparency and accountability the Governing Council has agreed that the ESCB's chosen operational definition of price stability should be announced publicly. This announcement forms an important element of the overall monetary policy strategy, and constitutes a clear benchmark against which the public can properly judge the performance of the single monetary policy. The Governing Council has decided that It almost goes without saying that the Governing Council is fully committed to the maintenance of price stability on this definition. The definition of price stability is intended to be a lasting quantification of the commitments made by the Governing Council in relation to its Treaty mandate. The 'headline' measure of the HICP is the appropriate index to use in the definition. It is harmonised across the countries participating in Monetary Union and is consistent with the general public's usual focus on consumer prices. The definition embodies a euro area measure of the price level, signalling the area-wide perspective that should be adopted in the conduct and assessment of monetary policy. This definition clearly signals that the Governing Council is symmetrically concerned about both inflation and deflation. The phrase clearly delineates the rate of inflation in the HICP deemed consistent with price stability. The wording implies that prolonged decreases in the HICP - that is to say deflation in the measured price index - would not be considered consistent with price stability. In this way, the definition takes into account the threats posed by ongoing deflation in combination with nominal rigidities to the real economy. While periodic and transitory falls in the price level may be quite normal, and should not give rise to major concerns, a prolonged deflation is clearly inconsistent with any meaningful definition of price stability. Moreover, since nominal interest rates cannot fall below zero, the private expectation of a sustained fall in the price level may render the interest rate policy of the central bank rather ineffective. All that remains is out-right purchases of assets - both foreign and domestic. However, to make myself absolutely clear, this discussion of deflation refers to the definition of price stability. I would not want to be seen as suggesting that a sustained deflation is an imminent threat. 'Headline' price inflation in the euro area has been reduced by the falls in international commodity prices that have stemmed, in part, from the crises in Asia and Russia . Such falls in commodity prices may not persist. Moreover, measures of 'core' inflation for the euro area - which exclude energy prices and other volatile components of the price index - are still higher than the headline rate. Among economists in academic, financial and central banking circles, it is widely recognised that a 'measurement bias' can exist in consumer price indices (CPIs). The bias arises from changing spending patterns and quality improvements in those goods and services that are included in the basket used to define a specific price index. These effects are sometimes not fully corrected in the construction of price indices. The measurement bias causes CPIs to overstate the 'true' rate of inflation. It is well- established central bank practice to allow for such measurement bias in the definition of price stability - for example, this approach was adopted by many national central banks in the euro area in recent years. However, I should emphasise that the HICP has been constructed with a view to minimising any measurement bias. It is therefore quite likely that the bias in the HICP is smaller than that observed in national CPIs. This might substantially reduce the risk of de facto deflation in euro area consumer prices while the measured price index continues to show an increase. The Governing Council has also announced that price stability will be This announcement points to the need for the single monetary policy to have a forward-looking, medium-term orientation. It acknowledges the existence of short- term volatility in the price level that cannot be controlled by monetary policy alone. The single monetary policy will react in an appropriate, measured and, when necessary, gradualist manner to economic disturbances that threaten price stability in the medium- term, rather than in a reflexive or unconscious way. The ESCB can build on the success of its constituent NCBs in reducing inflation and achieving price stability during the convergence process in Stage Two of EMU. Given the current generally benign inflation outlook in the euro area that is the product of these accomplishments, there is an understandable desire to 'lock-in' the current success by maintaining price stability as well as the apparent credibility of monetary policy, and ensure continuity with existing central bank practice. With price stability clearly defined in this manner, how should the ESCB proceed to maintain it? In achieving and maintaining price stability - the primary objective of the Treaty - the choice of monetary policy strategy is vital. The monetary policy strategy is, in the first place, important for the internal decision- making process of the ESCB - how the Governing Council will decide on the appropriate monetary policy stance, given the economic environment. Above all, the ESCB strategy must lead to good - that is to say, timely and forward-looking - monetary policy decisions. But the strategy is also of the utmost significance in communicating with audiences outside the ESCB. In particular, the strategy must convince the public that the Governing Council is unambiguously committed to maintaining price stability in the euro area and has the resources, information and instruments available to fulfil this commitment. The more the strategy helps to promote credibility and confidence in the ESCB's monetary policy, the more effective that policy will be - and the easier the ESCB's task of maintaining price stability will become. The need to establish a credible and consistent monetary strategy is especially important for the ESCB at the outset of Monetary Union. As a brand new institution, the ESCB will have no track record of its own. Building its reputation, and the associated credibility of monetary policy, is vital. But the process of doing so is complicated by the relatively high level of uncertainty surrounding the transition to Monetary Union itself. The transition to Stage Three is a unique event, and as I have mentioned, it will create unique opportunities for many. However, the transition may also create some special problems for monetary policy makers. At the ECB, we are addressing these problems and are confident that the risks can be managed successfully. Some of the difficulties we face will be overcome through our own efforts. However, there are some uncertainties that remain beyond our control, such as the external shocks coming from the Asian and Russian financial crises that I mentioned a moment ago. However, today I will focus on the uncertainties arising from the transition to Stage Three itself. The adoption of the single monetary policy marks a significant regime shift. This is likely to change the way expectations are formed in the euro area, and thereby alter forward-looking economic behaviour. The effect of monetary policy on consumption, investment, and wage bargaining - and therefore the whole transmission mechanism of monetary policy to developments in the price level - will be among the important economic relationships likely to be affected in this way. This may be no bad thing. Indeed, the contribution of the regime shift implied by the transition to Stage Three to changing both public and private sector behaviour in favourable directions may be one of the largest gains that the euro area can extract from Monetary Union. Nevertheless, these changes are likely to complicate the implementation of certain important elements of a monetary strategy, at least in the short term, as past relationships between macroeconomic variables may no longer be sufficiently reliable. One example of this so-called 'Lucas critique' phenomenon is the impact of current, very low rates of inflation on private behaviour. For many countries participating in Monetary Union, there is simply no - or only very recent - experience of how the private sector will behave in an environment of sustained and credible low inflation. Instability in past relationships may result, should behaviour change in this new environment. I have already argued that these structural changes will benefit Europe 's citizens - price stability will allow markets to work more efficiently, thereby raising growth, and improving employment prospects. But these changes may also complicate the ESCB's assessment of economic and financial conditions. Moreover, Monetary Union is creating an entirely new economic area for which, until quite recently, harmonised and comprehensive data have simply not been collected or constructed. Although area-wide statistics are now available, they are based on new concepts, and the properties of the series are sometimes not yet well known. In some cases, the long runs of high quality back-data required for empirical economic analysis are unavailable. These uncertainties - arising directly from the transition to Stage Three itself - are both compounded by, and inter-related with, the broader economic context in which Monetary Union will be established. The increasing internationalisation of the global economy, and the current rapid pace of technological change, have affected all sectors of the economy, and the banking and financial systems in particular. All these factors will alter the relationships between economic variables that NCBs have used as a guide to monetary policy decisions in the past. The ECB Governing Council has selected a monetary policy strategy of its own, to reflect the unique circumstances that it faces at the start of Monetary Union. Given a desire to inherit the good reputation of its constituent NCBs prior to Stage Three, the chosen strategy exhibits continuity with the successful strategies they have pursued in the past. At the same time the ESCB's strategy takes into account the unprecedented challenges and specific uncertainties created by the introduction of the euro. The Governing Council has selected a "stability-oriented monetary policy strategy". Neither 'pure' intermediate monetary targeting nor 'pure' direct inflation targeting - which were sometimes referred to as the two most prominent candidates prior to the decision - nor a simple combination of both strategies was deemed to fulfil in an optimal way the ESCB's unique needs. The ESCB's stability-oriented monetary policy strategy rests on two pillars. Money will be assigned a prominent role, to be signalled by the announcement of a quantitative reference value for the growth of a broad monetary aggregate. In parallel with the analysis of monetary developments relative to the announced reference value, a broadly-based assessment of the outlook for price developments and the risks to price stability in the euro area will be undertaken. In selecting its monetary policy strategy, the foremost criterion used by the Governing Council was the principle of 'effectiveness'. The best monetary policy strategy for the ESCB is the one which best signals a credible and realistic commitment to, and ensures achievement of, the primary objective of price stability. I am aware that for many external commentators, this criterion points unambiguously in the direction of 'direct inflation targeting'. If monetary strategies are to be judged according to how well they achieve price stability, defined as a low rate of measured inflation, then advocates of inflation targets argue an optimal strategy would surely target this low inflation rate directly. These commentators would place explicit quantitative targets for inflation itself at the centre of the ESCB's monetary policy strategy. Their approach has been strongly endorsed in some academic and central banking circles. Indeed, here in the United Kingdom , the Bank of England has set the standard for developing and implementing a monetary strategy based on inflation targeting. Its undoubtedly represents 'state-of-the-art'. However, the situation facing the ESCB is different in many respects, and its choice of strategy reflects these differences. The ECB Governing Council's choice of monetary policy strategy was not governed solely by a desire to signal again our intent to maintain price stability. This has already been well established - by the Treaty and by the transparent public announcement of our definition of price stability. Rather than mainly signalling our intent, the ESCB's strategy must constitute a practical guide that ensures monetary policy is effective in achieving the goal we have been set. As a practical guide, there are considerable problems with using inflation itself as the direct target for the ESCB's overall strategy. Because of the well-known lags in the transmission mechanism of monetary policy to the economy in general, and the price level in particular, it is impossible for a central bank to control inflation directly. Therefore, 'inflation targeting' in practice means 'inflation forecast targeting' where central banks set monetary policy to keep their best forecast of inflation at the target level deemed consistent with price stability. But recognition of this need for forecasts in an inflation targeting strategy immediately raises practical difficulties for the ESCB. In the uncertain environment likely to exist at the outset of Monetary Union, forecasting inflation will be difficult, not least because of the many conceptual, empirical and practical uncertainties faced by the ESCB at the start of Stage Three. Forecasting models estimated using historic data may not offer a reliable guide to the behaviour of the euro area economy under Monetary Union. Forecast uncertainty is likely to be relatively large. Forecasting inflation requires thorough knowledge of the properties of the new euro area- wide data series and experience and understanding of the transmission mechanism of monetary policy in the new euro area economy. Both are likely to be quite different from what we have been used to in the existing environment of eleven distinct national economies prior to Monetary Union. I see a distinct bias in the academic discussion of the comparative advantages of inflation targeting and monetary targeting. With good reason, many arguments are presented against the ESCB adopting a monetary target. But proponents of inflation targeting seem to forget that, in the current context, most of these arguments could also be used against inflation targeting. While there are many uncertainties about the economic properties of money in the special circumstances facing the ESCB, there are also considerable uncertainties surrounding the properties of inflation forecasts. Moreover, the ESCB should not be judged on, or held accountable for, the accuracy of its internal forecasts, including its inflation forecasts. Indeed, since the published inflation forecast would be 'conditional' - that is, it would be based on the assumption of unchanged interest rates - the forecast is unlikely to be very accurate. It will not capture the ESCB's policy responses to any incipient inflationary or deflationary pressures. The forecast would therefore be an unsuitable measure of the ESCB's professional competence or the success of its policies. Rather, its performance in maintaining price stability - the primary objective assigned by the Treaty - should be used by the public to judge the success of the ESCB's policies. Consequently, publication of a forecast is only important in so far as it helps to achieve price stability. Against this background, let me make absolutely clear that the stability-oriented strategy selected by the ESCB Governing Council is not inflation targeting. The definition of price stability I discussed at some length is not an inflation target. It is a once and for all description of the mandate that the ESCB is committed to achieve. As long as the ESCB is governed by the existing provisions of the Maastricht Treaty, it will interpret its mandate as maintaining price stability on this published definition. This is quite different from an inflation targeting strategy where the target rate of inflation is set on a year-to-year basis with a specific horizon and the centrepiece of the strategy is a published inflation forecast. For the reasons I have outlined, this approach would not be suitable for the ESCB. By the same token, the monetary policy strategy selected by the ESCB is not a variant of intermediate monetary targeting either. Certain technical pre-conditions have to be met before a monetary targeting strategy is feasible. Specifically, an intermediate monetary target would only be a meaningful guide to monetary policy if a stable relationship existed between money and prices, and money was controllable in the short run using policy determined interest rates. In this regard, several existing empirical studies point towards the stability of the demand for euro area-wide monetary aggregates. However, the reliability and robustness of these results is unknown. First, many studies are based on a selection of EU countries that differs from the nations that will participate in Monetary Union as of January 1999. Moreover, the 'area-wide' monetary data used for these investigations are estimates, having been more or less artificially constructed from national data rather than based on genuine consolidated euro area statistics. Second, the transition to Stage Three marks a significant regime shift that may prompt considerable changes in the banking sector and in private saving behaviour. How the economic properties of money will change in the face of the uncertainties raised by the transition to Stage Three is unknown. Future shifts in the velocity of money are certainly possible - perhaps even likely. They cannot be predicted with certainty. Moreover, it is not clear whether those aggregates that have the best results in terms of stability are sufficiently controllable in the short-term with the policy instruments available to the ESCB. In these circumstances, relying on a pure monetary targeting strategy would constitute an unrealistic, and therefore misguided, commitment. However, since inflation is fundamentally monetary in origin over the longer-term, giving money a prominent role in the strategy is vital. It creates a firm 'nominal anchor' for monetary policy and therefore helps to stabilise private inflation expectations at longer horizons. Assigning a prominent role to money in the overall stability-oriented monetary policy emphasises the responsibility of the ESCB for the monetary impulses to inflation, which a central bank can control more readily than inflation itself. Consequently, the Governing Council will announce a quantitative reference value for monetary growth as one pillar of the overall stability-oriented strategy. This reference value is different from an intermediate monetary target, as the ESCB has not made any commitment to correct deviations of actual monetary growth from the reference value over the short-term. Monetary policy will not react "mechanistically" to deviations in this sense. The reference value will be derived in a manner that ensures, as far as possible, that deviations of monetary growth from the value will signal risks to price stability. In the first instance, such a deviation will prompt further analysis to identify and interpret the economic disturbance that caused the deviation, and evaluate whether the disturbance requires a policy move to counter risks to price stability. To extract the important signals about inflationary or deflationary pressures contained in the monetary data, the relationship between actual monetary growth and the reference value will be regularly and thoroughly analysed by the Governing Council. The results of this analysis and its impact on monetary policy decisions will be explained to the public. Through this process, monetary policy decision-making will be made both clearer and more transparent. Although the monetary data contain information vital to informed monetary policy making, on their own they will not constitute a complete summary of all the information about the economy required to set an appropriate monetary policy and maintain price stability. There is a clear need to look at other indicators. Therefore, in parallel with the analysis of monetary developments in relation to the reference value, the Governing Council will undertake a regular, broadly-based assessment of the outlook for price developments and the risks to price stability in the euro area. This assessment will embody a wide range of economic and financial indicators. All the indicators will be thoroughly assessed for the signals that they offer about the threats to price stability over the medium-term and the information they contain regarding the appropriate monetary policy response to disturbances to the economy. This thorough analysis cannot be subsumed into a meaningful summary statistic or single number to which monetary policy will react in a mechanical way. The monetary policy response required to maintain price stability over the medium-term will depend upon both the prevailing circumstances and the source of the threat to price stability. In this respect, a single forecast is clearly insufficient to provide the detailed information required to make appropriate and informed policy decisions. All in all, the new stability-oriented monetary policy strategy of the ESCB is designed to avoid giving the impression that monetary policy responds "mechanistically" to deviations from a single target or the evolution of a specific variable. The monetary policy strategy selected by the ESCB signals that monetary policy decisions will focus on maintaining price stability over the medium-term, responding to new developments in the economy in a manner that is consistent with this over-riding objective. Having a well-designed monetary strategy is vital. I am confident that the strategy selected by the Governing Council will be successful and price stability in the euro area will be maintained. But we must also be able to implement the strategy effectively at an operational level. What instruments are available to implement this strategy? The ESCB will have a complete set of monetary policy instruments at its disposal. These instruments have been selected on the basis of their efficiency for transmitting monetary policy and their neutrality across market participants. Three types of instruments are available to the ESCB: open market operations, standing facilities and a minimum reserve system. I will briefly present these instruments in the remainder of my speech. Open market operations include, first, a weekly main refinancing operation, which will take the form of a reverse repurchase transaction with a maturity of two weeks. The main refinancing operation will be based on a tender procedure. The tender may be a fixed rate tender, with counterparties bidding amounts, or a floating rate tender, where counterparties propose bids including both amounts and interest rates. Second, there is the monthly longer term refinancing operation, which has a maturity of three months and will always take the form of an interest rate tender. This is because the ESCB will avoid signalling its monetary policy stance through these particular operations. The ESCB is also equipped to conduct fine-tuning operations, through the national central banks of the euro area or, in exceptional circumstances, centrally. Fine tuning operations will be conducted only when liquidity or money market conditions warrant. Finally, open market operations may also be conducted whenever structural reasons, such as the longer-term evolution of liquidity profiles, warrant it. These so-called structural operations may take the form of outright purchases or sales of securities or the issuance of debt certificates by the ECB. The ECB will operate two overnight standing facilities, which will be available to all credit institutions at national central banks of the euro area, provided that, when using the marginal lending facility, they have sufficient collateral. The rate of the marginal lending facility will constitute the upper bound of collateralised overnight money market rates. The deposit facility will be remunerated at a rate that will constitute the lower bound of overnight money market rates. When using the marginal lending facility, or, for that matter, when entering in liquidity- providing open market operations in the form of reverse transactions, counterparties have to post assets as collateral. These assets are meant to act as guarantees for credits received from the European System of Central Banks. A list of eligible assets has been drawn up for this purpose. The list comprises a wide variety of assets and has two sub sets. First, the so-called tier one assets, which are selected by the ECB according to uniform criteria relating to their credit standing in the whole euro area. Second, the so- called tier two assets, which have been selected by the ECB because they are of particular importance for certain national banking systems of the euro area, in order to promote a certain degree of continuity at the start of the Stage Three of EMU. Two principles of equal treatment are applied, however. First, the credit standing of tier two assets is as high as that of tier one assets. Second, both tier one and tier two assets may be used by any credit institution in the euro area, irrespective of its location. In addition, a set of risk control measures has been elaborated to ensure that, for any counterparty, the amount of assets provided is always sufficient. Risk control measures cover the assets' price and credit risks, taking account of the asset type, its characteristics and the maturity of the transaction. The ECB's risk control measures have been elaborated with careful attention to the best market practices in this area. The ECB will also apply a minimum reserve system to credit institutions of the euro area. Two main monetary policy objectives have been assigned to the minimum reserve system. The first objective is to stabilise money market interest rates through the averaging mechanism, whereby the fulfilment of minimum reserve requirements is based on average reserve holdings over monthly periods of time. During the maintenance period, this allows the banking system to absorb liquidity shocks without the need to use the standing facilities. The lower volatility of money market rates will reduce the need for frequent fine tuning operations, which will mean that markets are less distorted by central bank interventions than they would otherwise be. The second objective of the minimum reserve system is to increase the demand for central bank money, so as to enlarge the liquidity deficit of the banking system vis-a-vis the ESCB. This will safeguard the role of the European System of Central Banks as a provider of liquidity to the banking system. Reserve requirements will be calculated by applying a reserve ratio of 2% to the deposits, debt securities and money market paper issued by credit institutions, except for maturities above two years. Although repurchase agreements are included in the reserve base, they will be subject to a zero reserve ratio. Inter-bank liabilities and liabilities vis-a-vis the ESCB will not be subject to reserve requirements. An allowance of E 100,000 will be deducted from reserve requirements, so that credit institutions with a small reserve base will not have to hold minimum reserves. Reserve holdings will be remunerated up to the required reserve level, at the rate of the main refinancing operation (as averaged over the month). It may be argued that a less than full remuneration of minimum reserves would increase the interest rate elasticity of central bank money demand. This notwithstanding, the Governing Council of the ECB has decided in favour of a full remuneration of minimum reserves in view of the distortion to efficient markets that a less than full remuneration would have implied. The Governing Council has also decided not to exempt any credit institution from the minimum reserve system. We are only thirty-six days away from the moment when the responsibility for monetary policy decisions in the euro area is officially transferred to the Governing Council of the ECB. A stability-oriented monetary policy strategy has been selected and the operational framework has been tested and will be in place as of January 1999. The public can be certain that we will always remain committed to the maintenance of price stability in the euro area, thereby ensuring that the single monetary policy makes its best contribution to growth and employment prospects. Within the ESCB's stability oriented monetary policy strategy, the Governing Council has undertaken to inform the public, regularly and comprehensively, about its considerations and deliberations. We will make all our decisions transparent. Within this solid, open and convincing framework, I am confident that we are well prepared to accept responsibility for monetary policy in the euro area.
r981127a_ECB	euro area	1998-11-27T00:00:00	Keynote address on The European System of Central Banks, Current position and future prospects	duisenberg	1	Ladies and Gentlemen, I should like to express my appreciation at being invited to deliver a speech at this conference organised by the Royal Institute of International Affairs. It is a great pleasure for me to be here, in London, today. The topic I am going to address relates to the current position and the future prospects of the European System of Central Banks. I feel that this topic provides me with an opportunity to deal with the objective of the ESCB and its contribution to the other policies in the Community. I will also briefly touch upon the decision-making in the ESCB, recall the main features of our monetary policy strategy and talk about our regard for openness and transparency. The final part of my talk will cover the views of the ESCB on recent economic developments and the future outlook for price stability in the euro area. In the Maastricht Treaty the ESCB has been given an independent status. The reason is that politicians all over the world have come round to the view that monetary policy decisions taken with too close a political involvement tend to take too short a time horizon into consideration. The consequence is that in the longer term such decisions do not support sustainable gains in employment and income, but only lead to higher inflation. This view is confirmed by a host of economic research. Independence, however, requires a clear mandate. The ESCB has such a mandate. Its primary objective is to maintain price stability. Without prejudice to the objective of price stability the ESCB shall support the general economic policies in the Community. Price stability is not an end in itself: it creates the conditions in which other, higher-order, objectives can be reached. In particular, I share the deep concerns about the unacceptably high level of unemployment in Europe. The ESCB will do what it can to contribute to the solution of this problem. By maintaining price stability inflation expectations and interest rates can be kept at a low level. This creates a stability-oriented environment which fosters sustainable growth, a high level of employment, a fair society and better living standards. Moreover, in specific circumstances, if production, inflation and employment all move in the same direction, monetary policy can play some role in stabilising output and employment growth without endangering price stability. However, the contribution from monetary policy can generally be only limited. Given the structural nature of the unemployment problems the solution is to be found, above all, in structural reforms aimed at well-functioning labour and product markets. An independent central bank does not only need a clear mandate. It has also to be an open and transparent institution, for at least three reasons. First, transparency enhances the effectiveness of monetary policy by creating the correct expectations on the part of economic agents. A predictable monetary policy contributes to achieving stable prices without significant adjustment costs and with the lowest interest rate possible. The second reason is that in a democratic society the central bank has to account for its policies. Finally, transparency towards the outside world can also structure and discipline the internal debate inside the central bank. Let me now turn to the ways and means of achieving transparency. As a first element the ESCB has defined a quantitative objective for price stability. It reads as follows: price stability is a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. Although I do not consider deflation to be likely in the current environment, I may add that a situation of falling prices would not be consistent with price stability. The Governing Council has made it clear that "Price stability is to be maintained over the medium term". The ESCB cannot be held accountable for short-run deviations from price stability, for example due to shocks in import prices or specific fiscal measures. A monetary policy reaction to short-run fluctuations in the price level would provide the wrong signals to the market and cause unnecessary interest rate volatility. In summary, the ESCB will react in an appropriate, measured and, when necessary, gradualist manner to economic disturbances that threaten price stability in the medium term, rather than in an abrupt way, in order to avoid unnecessary disruptions of the process of economic growth. That said, the ESCB will, whenever necessary, openly discuss and explain the sources of possible deviations from the quantitative definition of price stability. In addition, let me remind you that by focusing on the HICP for the euro area, the ESCB makes it clear that it will base its decisions on monetary, economic and financial developments in the euro area as a whole. The single monetary policy has to take a euro area-wide perspective: it will not react to specific regional or national developments. The institutional implication is that the ESCB should develop into a strong unity, with a strong centre strong national central banks. It should become a truly European institution, with a truly European outlook. Of course, it may take some time to arrive where we ultimately want to be. We have to get used to thinking in euro area-wide terms. In the ECB Governing Council we are already "practising" that approach and are making progress. I am confident that the ESCB will indeed act as a unity. Transparency and openness will be apparent from the way in which the ESCB communicates with the public. The ESCB will regularly present its assessment of the monetary, economic and financial situation in the euro area and provide information about each specific monetary policy decision, be it a move in interest rates or an absence of change. This will notably be done by way of press releases, press conferences, publications and speeches. Press releases are made available immediately after the fortnightly meetings of the Governing Council and, as you may know, they always include a precise list of the decisions taken together with background information. There will be a monthly press conference. Such a press conference will start with a detailed introductory statement, as has been the case so far, and these introductory statements will also be published immediately, without delay. In this statement the Vice-President and I will present the Governing Council's view of the economic situation and the underlying arguments for its monetary policy decisions, followed by a question and answer session. The publications of the ESCB will include, in particular, an ECB Bulletin each month as well as an Annual Report. As from 1999, a detailed analysis of the economic situation in the euro area will be presented in the monthly Bulletin. Thematic articles in this Bulletin will include in-depth analyses by the ECB on matters regarding the monetary policy of the ESCB and the economy of the euro area. Further, you may also recall that, as required by its Statute, the ESCB will publish its consolidated balance sheet on a weekly basis. My colleagues on the Executive Board of the ECB and I intend to be very active in giving speeches dealing with all issues of relevance for the conduct of monetary policy. I am convinced that the Governors of the national central banks will also play their role in this respect. Since I am talking about the communication and external relations of the ESCB, I would like to underline that I am prepared to accept invitations to appear before the European Parliament at least four times a year to present the activities of the ESCB and the ECB's Annual Report. Finally, it should be noted that the ESCB will have a regular exchange of information and views with the ECOFIN. Representatives of the ECB will be invited to ECOFIN meetings whenever issues of concern to monetary policy are discussed. A similar relationship will naturally also exist with the EURO-11, whose meetings will generally be attended by the President of the ECB, whenever matters relevant to the ESCB are on the agenda. We are now approaching the start of the Third Stage of EMU. The decision-making bodies of the ECB have made a certain number of important decisions since the ESCB was established. As part of these decisions, the monetary policy strategy of the ESCB was recently announced and explained to the public. The selected stability-oriented strategy promotes as much continuity as possible with the existing strategies of national central banks in the EU. At the same time, its design is adapted to the unique situation of introducing a single currency in eleven countries, which may to a certain extent change economic behaviour. Therefore as much continuity as possible and as much change as required is the thrust of our strategy. Our strategy consists of two pillars. The first is an important role for money and the second is a broad-based assessment of the outlook for price developments in the euro area. The main reason for assigning a prominent role to money is the empirically well-founded view that inflation, at least in the long run, is a monetary phenomenon. This simple and obvious observation led the Governing Council to announce a quantitative reference value for the growth of a broad measure of money. This choice will create a "nominal anchor" for monetary policy and therefore help stabilise private inflation expectations at longer horizons. The reference value will be derived in a manner that is clearly consistent with - and serves the achievement of - price stability. It will be constructed such that, in the absence of special factors or other distortions, deviations of monetary growth from the reference value will signal risks to price stability. However, it has to be clear that the reference value is different from an intermediate monetary target, as the ESCB has not made any commitment to correct deviations of actual monetary growth from the reference value over the short term. In particular, it has been realistically recognised that the move to a single currency and ongoing financial innovations may generate fluctuations in the selected monetary aggregate which are not necessarily associated with inflationary or deflationary pressures. For this reason, it is important to continuously monitor the relevance of temporary factors or even structural changes in order to avoid a mechanistic policy reaction to deviations of the chosen monetary aggregate from the reference value. The results of this analysis and its impact on the ESCB's monetary policy decisions will be explained to the public. Let me turn now to the second key element of the monetary policy strategy, the broad-based assessment of the risks to price stability. The information contained in monetary aggregates, while of the utmost importance, will by no means constitute the whole of the "information set" in the hands of the ESCB. In parallel with the analysis of money growth, a wide range of economic and financial variables will be used to formulate an assessment of the outlook for price developments. The envisaged strategy will enable the ESCB to perform a cross-check between the information coming from the evolution of monetary aggregates and those from other economic and financial indicators. Let me turn to the current economic situation. The euro area experienced a strengthening of economic growth in 1997, to 2.5%, and a further acceleration has been anticipated for this year. The global environment has, of course, deteriorated in the meantime, but this has not so far had an observable impact on growth which has, in any event, been increasingly led by domestic demand. Inflation has remained subdued and even fallen somewhat over the past year, partly as a result of the impact of weaker global demand on oil and commodity prices. However, the favourable pattern of inflation has also been supported by domestic factors, such as a very moderate development in unit labour costs and industrial producer prices. Concerning recent price developments, HICP inflation for the euro area fell to 1.0% in September, due to a strong impact from food prices, but I would not want to read too much into this latest decline as some price components can be relatively volatile over short periods. More significantly, preliminary data suggest that various broad monetary aggregates for the euro area are increasing at between 3 and 5%, and thus do not appear to signal any strong incipient inflationary or deflationary pressures. We are in line with the consensus view that inflation in the euro area will rise moderately in 1999, but remain below 2%. I do not consider deflation to be a serious risk for price stability at present. So far, despite the worsening of the global environment, euro area-wide activity has continued to expand at a fairly stable rate. At around 3%, annual real GDP growth was broadly unchanged in the first half of 1998 from the solid growth seen in the second half of 1997. Industrial production growth has slowed somewhat since the spring. More recent evidence, particularly that of the area-wide survey data, may also suggest a moderation in the pace of growth and further developments in these indicators will continue to be monitored closely. Area-wide growth should, however, be supported by a number of domestic factors. One factor supporting continued growth, particularly in private consumption, is the gradual improvement in labour market conditions. Moreover, the lowest short-term interest rates in the euro area currently stand at 3.3%, and several countries have cut interest rates towards this level recently as part of the process towards interest rate convergence. The process of convergence towards this level has been gradual, but should imply a reduction in the average short-term interest rate in the euro area of about 0.5 percentage point since July. Long-term rates also stand at low levels. And, there has been a marked degree of exchange rate stability among countries participating in the euro. This is undoubtedly a welcome development from the standpoint of encouraging trade and investment. Thus, our assessment is similar to that of other international organisations, that - unless the international environment deteriorates further, which is not currently expected - growth will be somewhat weaker in 1999. Growth should, however, remain high enough to support continued employment creation and, assuming a recovery in the international environment, there should be a pick-up in growth in the year 2000. At the meetings in December the ECB Governing Council will again assess the outlook for economic and price developments. Although the economic outlook may be less favourable than expected - let us say - half a year ago, I believe that the conditions for a successful launch of the euro are in place. You can be sure that the ESCB will do its utmost to make the euro a stable currency.
r981201a_ECB	euro area	1998-12-01T00:00:00	ECB Press conference: Introductory statement	no_info	0	Ladies and gentlemen, the Vice-President and I are here today to report on the outcome of today's meetings of the Governing Council and the General Council of the European Central Bank. Similarly to last month, the Governing Council had a very heavy agenda with many of the items being of a rather technical nature or related to the legal implementation of decisions already taken at previous meetings. Let me first turn to the Governing Council's in-depth discussion on Today the Governing Council focused, inter alia, on various projections available for the world economy and the euro area. This material pointed unequivocally to some deceleration of real GDP growth in the euro area in 1999, compared with the widely expected growth rate of just below 3% in 1998. In addition, the Governing Council took note of the apparently calmer conditions in world financial markets in November this year. A key feature has been the diminished volatility in financial markets. However, the Governing Council pointed out that caution is warranted when interpreting the most recent developments and the projections available. Indeed, downward risks continue to exist. In the view of the Governing Council, apart from global developments, the most significant risk for all forecasts is that confidence within the euro area and thereby domestic demand could be negatively affected. Confidence in the corporate sector has already declined. In this respect, the Governing Council emphasised the utmost importance of maintaining a sound and sustainable policy framework within the euro area, particularly in the interest of supporting confidence. This framework is characterised by the maintenance of a stability-oriented monetary policy, a conduct of fiscal policies which is consistent with the Stability and Growth Pact, and ongoing structural reforms in the labour and product markets, accompanied by continued wage moderation. Maintaining this policy framework will help to foster competitiveness and profitability in the corporate sector, thereby promoting investment. Equally, it will help to sustain and foster the employment growth that has been seen recently, thereby supporting private consumption. Against this background, the Governing Council discussed in depth issues related to the conduct of monetary policy for the euro area. Let me elaborate on that discussion, which further prepared the ground for the setting of interest rates for the euro area. In the context of the stability-oriented monetary policy strategy, the main elements of which were announced in October this year, the Governing Council agreed on the quantitative reference value for monetary growth and the monetary aggregate to which it applies. Moreover, the Governing Council carefully analysed the data on monetary developments and made a thorough examination of the broad outlook for price stability. The first reference value for monetary growth decided by the Governing Council, which plays a prominent role in the Governing Council's monetary policy assessment, will apply to the broad monetary aggregate M3 and has been set at an annual rate of 4 1/2%; it will be reviewed in December 1999. This rate is consistent with the maintenance of price stability according to the ESCB's published definition, while allowing for sustainable output growth. It has been derived by assuming that the trend growth rate of real GDP in the euro area is in the range of 2% to 2 1/2% per annum and the velocity of circulation of M3 declines at a trend rate of between 1/2% and 1% each year. Further details related to the derivation of the reference rate and the definition of the broad aggregate M3 are described in a separate press statement to be released today. With regard to the reference value, let me stress two points very clearly. First, the reference value for M3 growth has been derived in an explicit medium-term context, in line with the ESCB's monetary policy strategy. Analysis of monetary developments relative to the reference value will provide a firm anchor for the conduct of the stability-oriented single monetary policy. Second, the ESCB's monetary policy strategy does not entail "mechanistic" policy reactions to deviations of monetary growth from the announced reference value. In the first instance, deviations of monetary growth will be analysed thoroughly, in parallel with the broadly based assessment of the outlook for price developments. Preliminary estimates for part of the euro area indicate that the average of the 12-month growth rates for the last three months (including October) was around 4.5%. Taking a medium-term perspective, the Governing Council took note of the fact that over the last two years the annual rate of M3 growth has constantly fluctuated in a range of 3.5% to 5.5%. It was concluded that this monetary trend appears to be broadly compatible with continued price stability in the euro area. In line with the ESCB's monetary policy strategy, the Governing Council will closely monitor developments in M3 in relation to the reference value. As regards other financial indicators, average long-term interest rates in the euro area declined slightly in November to 4.15%. The decline in long-term interest rates, which has been substantial since June this year, is consistent with the view that markets currently have low inflation expectations. The discussion on the appropriate interest rates for the start of Stage Three was further deepened during the deliberations of the members of the Governing Council on the broad outlook for price stability in the euro area. Prospects for price developments are generally seen as favourable as the rate of increase in the HICP, which stood at 1.0% in October, is expected to remain below 2% in the foreseeable future. However, this is conditional on import prices remaining subdued and wage developments continuing to be moderate. In the same context, the Governing Council emphasised once again that budgetary positions are still far from being close to balance or in surplus, while debt ratios are still at a very high level. All the members of the Governing Council agreed that any tendency to relax the fiscal stance or to alter the strategy enshrined in the Stability and Growth Pact would risk endangering the credibility of the euro and the objective of price stability. On balance, the outlook for price stability was judged favourably by the Governing Council. In an environment of substantial uncertainty, monetary policy will be guided by a continuous convergence of central bank interest rates towards the level considered to be appropriate for the monetary, financial and economic situation prevailing at the start of Stage Three. Let me now give the floor to the Vice-President to report on various aspects of the Revised GDP data, which are used to calculate the key for the capital of the European Central Bank, have been received from the Commission of the European Communities. When the revisions are applied to the calculation of the capital key, variations of more than 0.01% occur. Article 2 of the original Decision of the Governing Council of the ECB of 9 June 1998 (ECB/1998/1) states that should revisions received before December 1998 result in variations of this magnitude, the key for the capital of the ECB may be revised. The General Council and the Governing Council have therefore considered and agreed to an adjustment of the key and the Governing Council has adopted the related ECB Decision. Details of the adjusted shares of the national central banks (NCBs) are presented in a separate press release which is to be issued this evening. Today, also in this connection, the General Council adopted an ECB Decision on the contribution of the non-euro area national central banks to the capital of the ECB, for which the adjustment of the key has knock-on implications. The Decision states that the non-euro area NCBs will pay up 5% of their subscriptions to the capital of the ECB. However, the four NCBs concerned will not actually be asked to pay their share since the amounts due are less than they can expect to receive as their share in the proceeds of the liquidation of the European Monetary Institute. These details were already agreed by the General Council at its meeting on 1 September this year and are now contained in a legally binding text. As you are already aware, from January 1999, the single monetary policy will be defined and implemented by the decision-making bodies of the ECB, the Governing Council and the Executive Board. The operations of the monetary policy of the ESCB will be carried out in a decentralised manner by the participating NCBs. Therefore, the NCBs have prepared contractual and/or regulatory legal documentation (the national legal documentation) in order to implement the monetary policy framework of the ESCB as adopted by the Governing Council on 11 September 1998 and published in the report entitled "The single monetary policy in Stage Three: General documentation on ESCB monetary policy instruments and procedures". The national legal documentation of each NCB has been assessed by legal experts from the NCBs and the ECB in order to ensure that it properly implements and complies with the monetary policy framework of the ESCB, which aims at establishing a level playing- field across the euro area. All eligible institutions wishing to access monetary policy operations and standing facilities in Stage Three should therefore contact their local NCB in order to prepare for the execution of that national legal documentation in good time before the beginning of Stage Three. Today the Governing Council adopted the Regulation of the European Central Bank on the application of minimum reserves. The final specifications of the minimum reserve system to be used by the ESCB in Stage Three was the subject of a press release following the Governing Council meeting on 13 October this year. At that time it was announced that an ECB Regulation on minimum reserves would be published shortly thereafter. This commitment has now been fulfilled and the features of the ESCB's minimum reserve system are contained in a legally binding text. Further details of this matter are contained in a separate press release, which will be issued to you this evening. Today the Governing Council also adopted an ECB Regulation concerning the consolidated balance sheet of the Monetary Financial Institutions (MFI) sector. The purpose of this Regulation is to enable the ECB and the NCBs to collect the statistical material required for the establishment of the consolidated balance sheet of the MFI sector. The aim of this balance sheet is to provide the ECB with a comprehensive, statistical picture of monetary developments covering the aggregated financial assets and liabilities of MFIs located in the euro area. The correspondent central banking model (CCBM) is a system which will enable all collateral that is eligible for ESCB monetary policy operations to be used on a cross-border basis. It is a system that relies on bilateral relations between the NCBs involved and implies, inter alia, a regime of rights and liabilities between the NCBs. There are two pieces of legal documentation involved in this issue. First, there is the so called "CCBM Main Agreement", which concerns the participating Member States and the ECBs, and second, there is what we call the "Out CCBM Agreement", which deals with the regulations for operations concerning non-participating Member States. Today, the central bank Governors of all 15 Member States and the President of the ECB signed the "Out CCBM Agreement" and the members of the Euro system signed the "CCBM Main Agreement", "Eurosystem" being the term which we now intend to use to refer to the 11 euro area NCBs and the ECB. Further details of the CCBM and information concerning the forthcoming publication of a brochure on the subject are contained in a separate press release which will be issued to you this evening. Further to the Governing Council's agreement on the main features of the legal framework for TARGET in November this year, I am pleased to be able to inform you that today the TARGET Agreement has been signed by all 15 central bank Governors and the President of the ECB, thus allowing the non-euro area NCBs to be connected to TARGET. By entering into the TARGET Agreement today, the central banks of Denmark , Greece , Sweden and the United Kingdom have consequently agreed to adhere to the rules and procedures referred to in the TARGET Guideline, which regulates the relationship between the ECB and all euro area central banks. Finally, it gives me pleasure to announce that the central bank Governors of these four countries have committed their NCBs to adhere to the principles laid down in the policy statement on euro payment and settlement systems located outside the euro area, which was released to you on 3 November 1998 . Finally, today the Governing Council, having considered the observations of the General Council, adopted an ECB Guideline on the legal framework for accounting and reporting in the ESCB. This Guideline will not be published but will be available on request from the ECB. A number of other decisions were also taken regarding the consolidated weekly financial statement of the ESCB. The formats for the external reporting of the financial accounts of the ESCB were agreed. It was decided that Friday will be the reporting date of the ESCB and that publication of the weekly consolidated balance sheet will take place on the following Tuesday. Further information on the accounting principles and techniques involved will be made available before the end of 1998, when the first consolidated balance sheet is to be published. President Duisenberg, I have a question with respect to point 5 in your statement that says that you decided on a reference rate rather than on a range, and the reason you gave was that the Council believes that announcing a reference range might be falsely interpreted by the public as implying that interest rates would be changed automatically. On the other hand, you said that deviations from this reference rate will not be followed mechanistically by you. And I do not quite see why this should not also apply to a range? We simply felt that the announcement of a range was more likely to be interpreted by the public at large as triggering automatic reactions than the announcement of a rate, a reference rate. We may have been wrong in that feeling, but that was our - let's say - psychological estimate of public reactions. And then I should like to point out that, if you read that press statement, you will see the reference rate given as 4 1/2%, and specifically so. For the same reason, it has not been given as 4.5%, but rather as 4 1/2%. Is the harmonisation of tax rates in Europe desirable or useful or necessary for the success of Economic and Monetary Union? Whether it is desirable or useful or necessary has not been discussed by the Governing Council. If you want my personal opinion, I regard it as something that will happen over time. And over time means that it could take decades, a process of tax structures starting to look more like one another, without perhaps ever becoming totally equal. When you were in London a couple of days ago, you said you wanted the ECB to be one of the most open banks, central banks, in the world. Yet it is still not your intention to publish minutes, to publish votes or to publish inflation forecasts. How do you reconcile these two positions? I reconcile them by not defining openness as publishing everything that would be available. And that openness, by the definition of openness, is publishing, explaining every decision, every consideration, including the pros and cons. To be very open about that and to be frequent and immediate in that openness. And I think, I admit, we have been a central bank for only 5 months. I am still pretentious in thinking that, looking at our record of publications, etc., we already are the most open central bank in the world. Mr. President, I have noticed that your comments on the European economy were more cautious, significantly more cautious this time than last time and the times before. And I just wanted to get an indication of the forecast range for GDP growth that you implicitly assumed in your M3 forecast of 2-2 1/2%, whether that is still your latest forecast and whether there is in that forecast range a trend downwards or upwards. In other words, is this currently a symmetric GDP estimate? Very preliminary forecasts for GDP growth in 1999 indicate some slowdown, compared with 1998. In 1998 we already had to lower the estimate slightly from around 3%; it would be now in all likelihood be slightly, only slightly, below 3%. Our very preliminary forecasts for 1999 indicate a range of growth in the order of 2 1/2%, and they also indicate that this slowdown might be temporary, that it might pick up somewhat later next year. But, adding to that, I think the risks, as far as we can analyse and observe them, are on the down side. President Duisenberg, are there any concerns which you or your colleagues have with respect to the stock of confidence in the euro, concerns which we should know about? That is my first question. It has been reported time and again - my second question - that leading policy makers in Italy, in France and in Germany are saying in small inner circles that they want to draw on central bank reserves to finance additional programmes within the scope of the European employment pact. If that were so - the first policy maker to say so was Mr. Prodi, who is no longer in office - what position would you take? With regard to the first question as to whether is there a certain concern which we have not told you about yet, the answer is "no". The concerns we have are implicit in the forecasts or assessments of the outlook as we see it developing in 1999. Perhaps, as I have just indicated in the answer to the previous question, there is some concern that there will be some moderation in the rate of growth and that the risks are more on the downside than on the upside. With regard to the second question, I can note that you refer to small inner circles. I was part of such a small inner circle last week, when I attended the meeting of the Ministers of Finance of the Euro-11 countries together with the Vice-President, and we did not hear any utterances or comments pointing in the direction you suggested. On the contrary, we heard a re-confirmation by the Ministers of Finance of their will to adhere to the Stability and Growth Pact. How do you think the European citizens will feel and experience what will happen after the New Year? They will feel as excited as I feel around the year-end. I do not know how they will feel. What we hope to inspire is that they, approaching that day and from that day onwards, look to the future with confidence, confidence in their own future and confidence in the European Central Bank. Mr. President, this reference value of 4 1/2% - I am wondering: with the changeover to a single currency, there has been a lot of talk about a change in this system, in structural changes, and that could have an effect on the money supply. And I am wondering what sort of assumptions there are now about how the money supply will be affected. First, are you considering it would be going up or possibly down? Second, there has been a lot of talk about the policy mix in recent weeks, and I am just wondering what are you assuming in terms of wage agreements with this reference value. We have seen agreements coming through on the order of 3.5%, e.g. in the chemical industry. Is this something you are also looking at? With regard to the uncertainties surrounding the changeover, the structure, they pertain not only to the development of the money supply, but to one thing in particular, i.e. also to the velocity of the circulation of money. The reference value, as I told you in my introductory remarks, has to be seen as the summing up or the addition of the trend rate of growth of the euro economy, which we estimate at between 2 and 2.5%, and with respect to which we have emphasised that, if the process of adjustment or change in the supply factors on the labour market structural policies were to continue, one could have a higher trend rate of growth. But this trend rate is based on past experience, with all the rigidities that were there. Then we have the trend value for prices which is defined as the rate of increase in the Harmonised Index of Consumer Prices (HICP), a rate below 2%. And, finally, on the velocity of circulation, we are also not quite certain about it. We estimate that the velocity of circulation is on a slightly downward trend of between one-half and one percentage point per year. Now, it is quite uncertain how the transition to the euro will in itself affect behavioural relations. And, in particular, more than you suggested regarding the money supply, it is quite uncertain what it will do to the velocity of circulation of money. So, we cannot do anything but assume that the trends in all three areas - the money supply, prices and velocity - will broadly continue in the future. That altogether forms the basis for our reference value, but it also forms the justification for calling it a reference value, rather than a target which it specifically is not. In practice, deviations of actual figures from the reference value over the medium term will also be evaluated and judged and can lead - but will not necessarily mechanistically lead - to monetary policy decisions. Mr. President, in one month's time the European Central Bank will begin to use its powers. Some economic analysts say that you will then be the world's most powerful man in the economic field. Some European governments actually fear that happening. How will you respond? Well, I have never regarded Mr. Greenspan as the most important or powerful man in the world and neither do I regard myself - or the European Central Bank, for that matter - as, in qualitative terms, the most important man or institution in the world. We do recognise that, through our measures and through our attitude, we will have an important impact on the economic climate in the euro area. That is, I think that, if that climate were to be one of stability, continuity and growth, then we would be very satisfied and we would be all the more satisfied, the greater the extent is to which we can contribute to creating this climate. Mr. Duisenberg, what do you think of the idea of the policy mix which Oskar Lafontaine launched in discussions with his statement that employment policy always also has something to do with monetary policy? No matter which Minister brought it up, my answer, in general, is that, of course, monetary policy and fiscal policy have something to do with employment policy, but I cannot but repeat what I have always said and what is said in the Treaty, namely that the best contribution monetary policy can make to the growth of the economy and to the growth of employment is to create a stable climate. A climate of price stability is the best thing we can deliver; and to the extent that we deliver price stability, then, as the Treaty says, without prejudice to the price stability, monetary policy should and will contribute to the other economic roles as specified in Article 2 of the Treaty on European Union. You mentioned tonight, as you have in the past, the importance of euro area governments engaging in structural reform in their labour and product markets. Do you see that urging governments to take actions on national territory is an important part of your role and is there a risk you'll be seen as interfering in national affairs if you continue to make those kinds of suggestions? I do see it as an important, I should say "almost" important, part of our role. Because if we don't urge governments to act in that way, who else will? And it is also an important part of our role because it is our task to help create the climate to do just that, and we feel not inhibited to point out that role that governments have to play on the basis of our analysis. Just as little as governments feel inhibited to point out the role the European Central Bank would have to play. We listen to one another, we hear one another, and we hope to come to the correct decision. I think there is strong pressure from the politicians, especially from the German Finance Minister, and how do you keep the independence of the ECB? Could you elaborate what kind of relation will be desirable? We keep and maintain the independence by strictly adhering to our mandate which includes that we are forbidden to follow instructions or suggestions from others, just as others are forbidden even to give such instructions. Apart from that, we will never shy away from a dialogue with other responsible authorities, a dialogue concerning our and other policies. So, we do participate in Euro-11 meetings; we do invite the President of the ECOFIN Council to every meeting of the Governing Council, as the Treaty prescribes. We do answer invitations and follow up on invitations from the ECOFIN Council to attend their meetings. We do anticipate so far as it goes even that the President of the ECOFIN Council has the right not only to attend the meeting of the Governing Council, but also to submit a motion for deliberation to the Governing Council. The only right he does not have is to vote on that motion. I wanted to ask you, when you said that your discussion about the rate level from the start had deepened on the broad outlook for price developments, it sounds as though the outlook is fairly favourable. How strongly should one interpret that? This is one thing I would like to ask you to talk more about. We have not reached conclusions, but we are now only four weeks away from actually entering Stage Three. And, before we go into that, we have to set the interest rate with which we will enter Stage Three. So it is only logical that our discussion, now that the moment of truth draws nearer, is intensifying and deepening and I might say livening up. But conclusions, we are not there yet. During this autumn, during the financial turbulence in Asia and Russia, the currencies in the euro area have been relatively stable, whereas currencies outside the euro area, such as the Swedish Crown, have lowered their value. The lowered value of a currency, as in the case of the Swedish Crown, does that make it more difficult if Sweden would like to join the euro area in some years? Whenever Sweden decides to join the euro area, if it decides to do so and when it decides to do so, one thing is certain: it will have to have demonstrated beforehand, a considerable time beforehand, that its exchange rate will not have been volatile vis-a-vis the euro for a prolonged period of time. That is what will be required. Though in view of the Europe-wide reform, structural reforms that you are talking about, that are taking place and the fact that the Bank of England is, if you like, a substantial shareholder in the new ECB, would it be more helpful if the Bank was actually on the inside of your Councils, rather than being sidelined, as it is at the moment. Well, apart from the Bank of England being a shareholder, although they have to pay up only 5 % of that capital subscription, so I would delete the word substantial. This is my personal opinion. I would have preferred the U.K. participating in the euro area and that's a normative political opinion which I have. What is the chance that Eurozone rates will have fully converged by the next meeting, the December 22 meeting, and what are the chances that we will get an announcement on December 22 of what the initial refinance rate will be? I cannot answer the question. I could answer the question if the date you had mentioned was 31 December and then my answer would have been that the chances are 100%. Mr. President, what about granting us the pleasure of helping us even before Christmas and making one of these long winter evenings short by holding yet another press conference for us before Christmas. On 22 December, to my recollection, that is just before Christmas, we will have a press conference. Ladies and Gentlemen, I think this was a very good conclusion, because this will make sure that we meet each other here on 22 December for another prolonged winter evening, as Mr. Balkhausen put it. Thank you for coming and thank you for your patience.
r981203b_ECB	euro area	1998-12-03T00:00:00	The role of monetary policy in economic policy	duisenberg	1	Ladies and gentlemen, in less than one month's time Stage Three of Economic and Monetary Union (EMU) will start and the euro will be launched. This event will have wide-reaching implications for the orientation of economic policy in the euro area. Moreover, the creation of a single currency is also likely to have a significant effect on the role of Europe in the international economy. As with any fundamental change, the start of Stage Three will be characterised by considerable uncertainty and the European System of Central Banks (ESCB) will not have an established track record. Therefore, it is particularly important to explain to the public as clearly as possible both our objective of price stability and the framework or monetary policy strategy that we shall use to achieve our main goal. I shall consider the role of monetary policy in economic policy in this context. The Treaty establishing the European Community (the "Treaty") assigns to the ESCB the overriding objective of maintaining price stability in the euro area. This mandate reflects the conviction that price stability is a key condition for creating a stability-oriented environment which is beneficial to economic activity, employment and, more generally, to the welfare of society, thereby contributing to the achievement of the objectives of the Community. As you will be aware, the Treaty also stipulates that the ESCB shall be independent in the performance of its tasks and duties. The reason for including this provision in the Treaty is that an independent central bank may be more effective in the pursuit of price stability - which is, in essence, a long-run commitment - without being pressured by the political authorities to achieve short-run objectives. In a democratic society, this gives rise to special requirements in terms of accountability and transparency, which are issues to which I shall return presently. The Governing Council of the European Central Bank (ECB) has carefully considered how these requirements could be fulfilled most effectively. One of the key results of these deliberations was the recent decision to announce a quantitative definition of price stability by which the ESCB's performance can be easily assessed by the public. Price stability was therefore specified as a "year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%". The term "increase", in particular, implies that a situation of deflation - i.e. a sustained and ongoing decline in the consumer price level - is not consistent with price stability. Price stability is a medium-term concept. The ESCB will not smooth any short-term deviations in price developments from this quantitative perspective. As monetary policy measures affect the economy with long and unpredictable time lags, it is not feasible for central banks to control prices in the short run. Moreover, the benefits of price stability pertain more to the long-run development of the price index than to its short-term fluctuations. In addition to the definition of price stability, the monetary policy strategy of the ESCB consists of two key elements. As a first pillar, the Governing Council attributed a "prominent role" to money, as the empirical evidence suggests that inflation is essentially a monetary phenomenon in the long run. For this reason, the Governing Council decided to announce a reference value for money growth. The first reference value was recently determined at 4.5% and refers to the broad monetary aggregate M3. This should allow for an adequate provision of money to the economy at a rate consistent with the achievement of sustainable non-inflationary economic growth in the euro area. The choice of this reference value was also determined by reasons other than the empirical relationship between broad money growth and inflation in the euro area. Money growth will provide a reference value for assessing the monetary policy stance. Indeed, money can help the general public to understand correctly what monetary policy can and cannot do, thereby enhancing the central bank's transparency and accountability. While money will have a prominent role, it will not be the sole and automatic guide for the monetary policy of the ESCB. Especially at the start of Stage Three, when significant and mostly unpredictable changes are likely to occur in the economic, monetary and financial environment, there will be a need to monitor a wide range of indicators. For example, the changeover to Stage Three may lead members of the public to adjust their investment portfolios and this could make the behaviour of monetary aggregates more difficult to explain. Moreover, there is considerable uncertainty surrounding future price-setting behaviour in the euro area, especially in those Member States with more limited experience of price stability. This might also blur the relationship between money and prices. The evaluation of the economic and financial indicators that will be monitored will be based exclusively on their expected influence on future price developments. For instance, the ESCB will follow closely long-term interest rates, confidence indicators, output measures, the behaviour of wages, the price of commodities and also the external value of the euro insofar as it affects prices in the euro area. I should now like to elaborate a little on the benefits of price stability, before moving on to the role of monetary policy in economic policy. I have already highlighted the importance of price stability in shaping a stability-oriented macroeconomic context in the euro area. Indeed, the empirical evidence suggests that price developments are more predictable when the inflation rate is low; price stability thus enhances the predictability of the macroeconomic environment. A situation of low inflation also allows households and firms to base their economic decisions on more reliable information, as they may find it easier to distinguish movements in relative prices from movements in the general price index. Both of these aspects of price stability lead ultimately to a more efficient allocation of resources, which is of vital importance for the economic welfare of society in the long run. For instance, firms may engage in long-term investments without fearing that an unexpected surge or decline in the inflation rate could cause their commitment to be sub-optimal or even unsustainable. In the same vein, households may plan an optimal allocation of saving and consumption over their lifetime, without facing the risk of the real value of financial assets changing on account of an unexpected rise or decline in the inflation rate. This enables financial markets to function more smoothly and perform more effectively their basic function of channelling funds to their most productive use. One particular benefit to be derived from a stable price environment is that borrowers are not requested to pay extra, to cover the risk of an unexpected rise in the general price level. As a consequence, real interest rates, i.e. interest rates corrected for expected inflation, will be lower, thereby encouraging people to commit more resources to productive activities. A situation of price stability also avoids the risk of borrowers being confronted with a rising real value of financial debts, which are normally fixed in advance in nominal terms, in the event of an unexpected and persistent decline in prices. Such a rising real debt burden may have negative effects on real economic activity, as borrowers are normally more engaged in productive activities than lenders. High inflation or persistent deflation is costly for society even in the best possible scenario, i.e. when it is perfectly anticipated. The need to take price level changes into account in every kind of nominal contract is so universal that extensive resources are ultimately diverted from alternative and more productive uses. For example, at times of high inflation sellers must continuously update menus and households expend needless time and energy when they are forced to economise on liquid balances. Moreover, if the tax system is not completely indexed to changes in the price index, which is very often the case, inflation does in the end have real redistribution effects, which, in practice, entails an automatic increase in the tax burden. Finally, I should like to emphasise the fact that price stability is particularly beneficial for the political cohesion of society, because inflation (but also deflation) brings about an undemocratic redistribution of economic resources. Experience has shown that, as a rule, this hits the weakest members of society the hardest, because, for example, they maintain a higher proportion of their wealth in liquid assets. The Treaty states that the ESCB, while having price stability as a primary objective, shall support the general economic policies in the European Community; moreover, it will operate in a such a way as to be consistent with the establishment of free and competitive markets. The Treaty therefore provides an explicit order of priority for the objectives: price stability is the first reference point for the monetary policy of the ESCB, and only within the limits of price stability can there be scope to contribute to the achievement of the other objectives of the European Community. As a consequence, the role of other Community objectives in the monetary policy of the ESCB is upon the achievement of the overriding target of price stability. The high unemployment rate in Europe represents the main concern of economic policy-makers. I should like to stress that the ESCB shares these concerns and will do its utmost to help find a solution to this problem. That said, however, we should realise that what monetary policy is able to contribute to economic policy and the reduction of unemployment, is the achievement of price stability. I have already explained the benefits of price stability for society and the reasons which underlie this conviction in some detail. By creating optimal conditions for a sustainable and strong pace of economic activity, price stability will ultimately spur employment growth and foster higher living standards. Moreover, in specific circumstances, if production, inflation and employment all move in the same direction, monetary policy can play a role in stabilising output and employment growth, without endangering price stability. However, this role is very limited, because the high unemployment rate in Europe is far more the consequence of structural rigidities within the European labour and product markets than a result of adverse cyclical developments. The solution is thus to be found, above all, in structural reforms. The European unemployment rate has, indeed, been high and stable over the business cycles in the past decade. However, over the same period, unemployment was significantly reduced in those EU countries which succeeded in creating better-functioning labour and product markets, which allowed wages and prices to adjust when economic conditions changed. A clear example can be found in the Netherlands, where a substantial reduction in unemployment has been effected in recent years by reforming the labour market, while following the same monetary policy as Germany, where the unemployment rate is still close to 10%. The ESCB is also concerned with the variability of real output and the associated fluctuations in employment, which could be considered to be an undesired consequence of an excessive control of price developments. In this respect, the medium-term orientation of the monetary policy of the ESCB should help to avoid excessive fluctuations in real economic activity. Given the fact that the ESCB does not aim to stabilise every short-term deviation of price developments from the predetermined path of price stability, it contributes to the stabilisation of economic activity around its long-run potential growth path. I should like to add, however, that the room for manoeuvre of monetary policy and the degree of success in terms of maintaining price stability crucially depend on the support of sound fiscal policies and responsible wage settlements in the euro area. I should now like to address the way in which the economic environment and the economic policies of both the Community and the governments of Member States will affect the functioning of monetary policy. A monetary policy reaction to inflationary pressures and the uprooting of inflationary expectations may cause short-run fluctuations in real output. Flexible and competitive goods and labour markets, however, would soften this trade-off, thereby allowing central banks to attain the goal of price stability with less serious adverse consequences for real output. The establishment of free and competitive markets for labour, goods and services would facilitate to a large extent the functioning of monetary policy in the euro area. At the limit, it is conceivable that if markets were to operate without friction, the control of inflation by a central bank could be exercised with a negligible impact on real output. Market flexibility may also help to reduce regional asymmetries in the effects of the single monetary policy. The monetary policy of the ESCB will be geared towards the euro area as a whole and will not be able to take into account purely national or regional developments. Moreover, the cyclical positions of participating countries will not completely converge at the start of Stage Three, although, with the single currency in place, some national differences may disappear over time. In the past, asymmetric shocks across European countries were sometimes dealt with via movements in the exchange rates. In the EMU environment, which is characterised by a single and uniform monetary policy aimed at maintaining price stability in the euro area as a whole, the required adjustments will have to stem from fiscal policies and national prices and wages, in addition to mobility of labour and capital. For this reason, the ESCB will follow closely, and contribute to, the debate on the reform of European wage-setting mechanisms. Sound economic reasoning recommends that wages should reflect the differentials in productivity; otherwise inflation and unemployment could result. Budgetary policies also play a major role in conditioning monetary policy. Sound budgetary policies enhance the credibility of monetary policy by preventing inflationary pressures due to an excessive stimulation of domestic demand. Furthermore, fiscal discipline exerts a downward influence on the risk premia embedded in nominal long-term interest rates. Moreover, given the requirements of the Stability and Growth Pact, a budgetary position which is close to balance or in surplus in normal conditions may allow scope for reaction to unforeseen regional or local shocks that could bring about heavy real output losses. This would also contribute to alleviating the possible asymmetric impact of monetary policy actions on single countries. Allow me now to return to the issues of democratic accountability and transparency. The Treaty contains several provisions which ensure the accountability of the ESCB. First, it states that the ECB is required to disclose to the European Community institutions (the Council of the European Union, the European Commission and the European Parliament) an annual report on the ESCB's monetary policy. Moreover, as President of the ECB, I am required to present the report to the European Parliament and to take part in the subsequent debate. As I have announced before, I shall attend the hearings at the European Parliament at least four times per year to discuss the activities of the ESCB. The Parliament has the right to ask the members of the Executive Board to provide answers to specific questions. Finally, representatives of the European Commission and of the ECOFIN Council participate in the meetings of the Governing Council of the ECB and thus monitor the preparation of monetary policy decisions. Broadly speaking, the issue of the transparency of monetary policy is very important at the start of Stage Three, given that the ESCB is a new institution and the public is not accustomed to evaluating its behaviour. The monetary policy of the ESCB will be transparent in fulfilling its overriding objective of maintaining price stability, as stated explicitly in the mandate of the Treaty; it will also be held accountable in reaching its main goal. The ESCB has also gone beyond the Treaty requirements. Since the summer, a routine of holding a monthly press conference has been established, in which I and the Vice-President of the ECB report on the decisions taken by the Governing Council of the ECB and disclose and explain the underlying arguments. My introductory statements at these press conferences are and will continue to be published without delay. Moreover, as from January 1999 the ECB will provide the public with a Monthly Bulletin containing a detailed analysis of the economic situation that led to the monetary policy decisions. Furthermore, my colleagues on the Executive Board of the ECB and myself intend to be very active in giving speeches which deal with all issues of relevance for the conduct of monetary policy. I am convinced that the Governors of the national central banks will be glad to perform the same role for national audiences. Furthermore, the publication of working and occasional paper series will further clarify the "economic model" that underpins the ESCB's reasoning and behaviour and stimulate the debate on relevant technical and policy issues. I should also like to emphasise that the ESCB does not see communication as a one-way street. On the contrary, I think that we would greatly benefit from a frequent exchange of opinions and ideas with social partners and the public at large. The relationship between the ESCB and other European institutions is explicitly mentioned in the Treaty. There is considerable scope for collaboration and exchange of views with other European institutions. However, the ESCB is independent in its pursuit of price stability. I have already mentioned my reports to the European Parliament, which represent an example of the democratic accountability of monetary policy. Furthermore, as President of the ECB, I shall be invited to the ECOFIN Council meetings whenever issues of relevance to the ESCB come under discussion. As I mentioned earlier the President of the ECOFIN-Council and a member of the Commission may participate, without having the right to vote, in meetings of the Governing Council of the ECB. Finally, I should like to mention that I am also invited to the newly established informal Euro-11 Council meetings. The main contribution of EMU to the welfare of the people will be the maintenance of price stability. Our conviction and hope is that the economic performance of the euro area will benefit significantly from price stability. This will also ultimately facilitate the achievement of the objectives which underpin the general economic policies of the European Community and the individual governments at the national level. Moreover, both the support of the social partners and the adoption of behaviour consistent with the maintenance of price stability are of extreme importance to a successful start of EMU.
r981203a_ECB	euro area	1998-12-03T00:00:00	The external value of the euro	schioppa	0	Economic and Monetary Union will start in four weeks' time. On 31 December 1998 the Deutsche Mark and nine other national currencies will fade from the computer screens that thousands of foreign exchange traders have used for years to determine the course of the exchange rates for our economies, price and other economic developments, gains and losses for millions of households and firms. On 1 January 1999 the euro will be introduced legally. Three days later - on the first trading day of 1999 - the European Central Bank will conduct its first repo. A single monetary policy for eleven European countries will then start to be implemented. This enterprise has no precedent because the perimeter of the euro area embraces a number of countries that have retained their sovereignty in many crucial respects. 2. I said EMU will start in four weeks time. I could have said, however, that it has started today around 2 p.m. As you all certainly know, at that time all national central banks of the euro area have lowered their key central bank rates in a co-ordinated decision. The importance of this move cannot be overstated. It reflects, as the ECB press release of today indicates, "a thorough discussion in the ECB's Governing Council leading to a consensus on the basis of a common assessment of the economic, monetary and financial situation in the euro area". While, as you know, future monetary policy decisions will be taken with a majority rule, this one is equivalent to a unanimous vote of the Governing Council of the ECB. It is the result of a convergence of view of all the decision making bodies of all the national central banks. It shows, to those who may have had doubts, that the primary objective of price stability is not an obstacle to a timely downward movement in the rates when it is required. Finally, and very importantly, it sets "the level of interest rates with which the ESCB will start Stage Three of Monetary Union and which it intends to maintain for the foreseeable future." Let me say that the final phase of the transition from eleven to one monetary policy could not have occurred in a more efficient and harmonious manner. 3. The theme of my remarks tonight is the external value of the euro, i.e. its value for the rest of the world. I shall not try to deviate from the expected substance of this theme: the place of the euro in the international monetary system, its relationship with the other key currencies. But let me start with what I regard as "the" answer to the question underlying the title of my speech: the external value of the euro will be primarily determined by its internal value. The guiding principle of our monetary policy will be to maintain price stability, and we -that is the members of the two key decision-making bodies of the European Central Bank (ECB) and hence of the European System of Central Banks (ESCB) - firmly believe that our performance in this respect will be the key determinant of the international value of the euro. With this in mind, the Governing Council of the ECB has recently defined the strategic aspects of the monetary policy it will follow. It has thus completed the preparatory work on the monetary policy framework which started with the selection of the instruments and procedures. Since this was done just two days ago and is pertinent to the theme of my speech tonight, let me spend a few words on it before going to the heart of my subject. 4. In communicating our monetary policy strategy to the public, we have done our best to ensure maximum clarity and transparency. While for any central bank clarity and transparency are vital to establish credibility and ensure the success of its policy actions, this is particularly true for a new-born central bank such as the ECB. Designing a monetary policy strategy for the ECB has not been easy because Economic and Monetary Union is likely to prompt profound changes in economic and financial behaviour in the euro area. Inevitably, these changes create a special uncertainty, and our efforts to predict them cannot be expected to be entirely successful. The ECB therefore had to adopt a strategy that reflects the special features of the shift to a new monetary regime. The three main elements of the strategy should be recalled. First, we have formally defined the primary objective assigned by the Treaty, namely price stability. For the ESCB - as was decided in October - price stability means a year-on-year increase in prices for the euro area as a whole of less than 2%. Let me explain. First, this definition acknowledges the uncertainty regarding the so-called measurement bias. Second, it emphasises that the single monetary policy cannot be used to solve regional or national problems; it will apply to the entire euro area, just as the Deutsche Bundesbank's policy has so far applied to the whole Bundesrepublik. And, third, the word "increase" implies that both persistent inflation and deflation are incompatible with our definition of price stability. Price stability is to be maintained in the medium term. The second element of the strategy is the prominent role given to money. This has been reflected in the adoption by the Governing Council, the day before yesterday, of a reference value of 4 1/2% for the growth of M3. The reference value will be revised annually. It should be emphasised that the ECB did not wish to lock itself into a monetary target. Given the uncertain environment, this would have been simply too risky. Thus, while deviations from the reference value would normally signal risks to price stability, there is no commitment to mechanically correct deviations whenever they may arise. The ECB, through its President and the other members of the Governing Council, will of course regularly explain to the public how its interpretation of the actual behaviour of money relative to the reference value has affected its policy decisions. The third element is a broadly based assessment of the outlook for price developments that includes an analysis of an array of economic and financial indicators other than money. Here again, we shall regularly explain to the public the impact that this analysis has had on our decisions to change, or not to change, interest rates. We are confident that this strategy will maintain price stability in the euro area, thereby preserving the internal value of the new currency. This will also satisfy the key condition for the euro to play a positive role internationally. 5. Let now me come to the core of the subject. And I begin by noting that, given the sheer size of the future euro area, any reflection about the external value of the euro is also a reflection about exchange rate relationships at the global level. 6. The introduction of the euro, unique as it may be for Europe, will not, by itself, modify the exchange rate regime in which the world is living at present. This is a regime of floating exchange rates and is the outcome of developments that have occurred over thirty or forty years: a greater balance in the relative economic size of the leading countries, the tendency of economic policies to pursue primarily domestic objectives, the liberalisation of capital movements, the growing role of markets, the deregulation of domestic markets and, last but not least, the spectacular advances in technology. These developments have fundamentally affected the ability of the monetary authorities to control exchange rates on which the Bretton Woods system had been built. A highly integrated world financial system has taken over from official authorities the role of both exchange rate determination and the international allocation of capital. As is shown by its most recent crisis, this system has also acquired the capability to rapidly transmit the consequences of errors in private investments and public policies throughout the world. 7. The priority assigned by the large countries and currency areas to domestic objectives explains why in recent years policy co-ordination at the global level has been essentially of a non-binding nature. This has not precluded occasional active co-operation between the three main currency areas. Co-ordinated action to stabilise world exchange rates was agreed, for example, by the major industrialised countries at the Plaza meeting in September 1985 to halt the appreciation of the US dollar, and with the Louvre Accord of February 1987 to prevent its undesired depreciation. However, large countries have always refrained from committing themselves to formal exchange rate arrangements or pre-defined rules for their management. My expectation is that the introduction of the euro will not change this attitude. 8. The present international financial system is indeed a "fact of life". This does not mean that it is the best of all worlds. The Mexican financial breakdown in late 1994 and, in the last fifteen months, the crisis in East Asia and the spread of the ensuing turmoil to Russia and, to some degree, to eastern Europe and Latin America later on, have raised legitimate questions about the inherent stability of the present system. Earlier, in the 1990s, Europe had experienced a currency crisis of its own. Huge pressure was brought to bear indiscriminately on various currencies participating in the Exchange Rate Mechanism. Today, it is recognised that the main underlying cause of the near-breakdown of the arrangement in the summer of 1993 was what academics call a "co-ordination failure", including uncompromising priority given to domestic objectives on the part of national authorities. In a fully liberalised financial world, market participants exploited in full the possibility of making profits out of the co-ordination failure. 9. The European currency crisis provided a striking confirmation of the well-known proposition that free trade, complete freedom of capital movements, fixed exchange rates and autonomous national monetary policies cannot coexist for very long. The four elements constitute what I have called on other occasions an "inconsistent quartet". And I do think that the inconsistent quartet constitutes a most useful paradigm to understand international economic and monetary relationships both at the European and at the global level. Europe has now reconciled the inconsistent quartet by moving from autonomous national monetary policies to monetary union. I have long been convinced that for our countries this was the only way to preserve unrestricted trade and the freedom of capital movements. Monetary union has not only been an act of political will; it has also been the recognition that, in a region that has achieved an unprecedented degree of economic and financial integration, destabilising capital flows could destroy the single market and hence a primary source of our prosperity. At the global level, it is the third element of the inconsistent quartet -fixed exchange rates -which has been given away, and this happened 25 years ago. Like Europe, the world cannot do without free trade and high capital mobility. Unlike Europe, it has neither the possibility nor the willingness to bind monetary policies to an objective of exchange rate stability. As I have just said, when the increase in capital mobility generated the dilemma, domestic objectives took precedence over external ones. 10. The rather compelling logic of the inconsistent quartet does not mean, however, that exchange rate stability world-wide is not desirable. In my view, it is. Indeed, abrupt changes in exchange rates may generate calls for protectionism and restrictions on capital flows that would eventually erode free trade and hence economic efficiency and prosperity. Very few would claim that these outcomes are desirable. 11. While recognising that stable exchange rates are desirable not only for Europe but also elsewhere, I largely concur with those who have expressed serious doubts about the idea of setting ranges for the fluctuations of the major currencies. Even if one disregards, for a moment, the inconsistent quartet and the potential conflict with domestic price stability (something one should, of course, not do), I see three specific difficulties in establishing such ranges. First, the participants in the system would need to agree on mutually consistent values for the central rate of the target ranges, both in nominal and in real terms. This, in turn, means that they would have to agree on the resulting pattern of current account deficits or surpluses. Clearly, this is not just a technical matter, since the presence of a large US current account deficit, a legacy of the 1980s that is not likely to disappear soon, makes an agreement on exchange rates difficult to achieve. If a long-term agreement on exchange rates were negotiated, exporters both in Europe and in the United States would be likely to press their respective authorities to obtain a "favourable" rate of exchange for their currency. The current account situation of the United States would be a powerful argument for US exporters to convince their authorities that a substantial depreciation of the dollar would be desirable - and hence an appreciation of the euro and the Japanese yen. Of course, this would be resisted in Europe and Japan. An agreement could thus prove impossible, and this could even strengthen protectionist pressures on both sides of the Atlantic. Second, a major shift in the monetary regime of an area as large as Europe would make it difficult to estimate equilibrium exchange rates for the three major currencies. Estimating equilibrium rates is a very complex exercise under any circumstances. Today, such an effort would be virtually impossible, given that we simply do not have a historical record of the determinants of the external value of the new European currency. Even a qualitative assessment of how the euro will tend to move, compared with its predecessor European currencies, would be very difficult. The recent debate on the possible role of the euro as an international reserve currency shows the extent of the disagreement amongst economists on whether this role will expand or shrink compared with the role played hitherto by the Deutsche Mark, and whether the euro will depreciate or appreciate as a result. Third, and to my mind most decisively, the so-called target zones are subject to the same inherent fragility that affects all "adjustable peg" systems and that ultimately caused the end of the Bretton Woods regime and the virtual suspension of the ERM. This is the risk of being destabilised by market forces, due to the well-known difficulties in agreeing on timely changes in the reference values required by changes in economic fundamentals. Thus, while world-wide exchange rate stability is desirable, a system that tries to enforce it mechanically may just not be practicable. 12. Against the background of the inconsistent quartet theory and in the light of the difficulties entailed in a return to formal agreements on exchange rate management, one may wonder what is the key to stable international monetary relationships. As long as we live in a world of sovereign States, the core answer to this question is: sound domestic policies and sound institutions. If the two pillars of sound policies and sound institutions were firmly established, then the task left to international policy co-ordination would not be disproportionate. Let me say a few more words about these two pillars. 13. Sound economic policies. The relationship between domestic policies and the external value of a currency was vividly illustrated by the behaviour of the US dollar in the early 1980s. Between 1982 and 1985, international capital flowed into the United States in large amounts as a consequence of the opening-up of a large and chronic budget deficit. The scale of the inflows was so large that it drove up the dollar to a level which exacerbated the current account deficit. The massive overvaluation of the dollar was a spectacular example of the tendency of foreign exchange markets, with floating exchange rates and mobile capital, to generate wide and prolonged misalignments in exchange rates. This was not the result of a market imperfection, however. On the contrary, markets behaved just like any macroeconomic textbook would have predicted. The overvaluation of the dollar occurred in parallel with a massive fiscal expansion and the monetary policy tightening that responded to it: an "unbalanced policy mix", as economists call it. 14. We should not forget that episode, because also for the euro area the policy mix will be a major determinant of the external value of the new currency. Today, prices in the euro area are stable, interest rates - whether short or long, nominal or real - are at historically low levels, and economic growth is supported by the stance of monetary policy. There is a similar situation in the United States. A scenario like the one that occurred in the United States in the early 1980s does not seem likely to develop in Europe or in the United States in the current circumstances. The situation, however, would change if the currently perceived risks of fiscal relaxation in Europe were to materialise. The European policy mix might then become unbalanced, and market developments could adversely affect long-term interest rates and theexchange rate. These risks should be considered carefully when assessing the stance of fiscal policies. Reducing deficit and debt levels must therefore remain the objective of European governments, in particular where the public debt is large. This is a pre-condition for a balanced policy mix, one that will keep interest rates low and make the euro a stable currency. You may say that this is the traditional central banker's argument. Yes, it is; but that does not mean that it is not valid. 15. Sound institutions. Until recently, abundant capital had flowed into emerging countries, which were eventually unable to handle inflows of such a magnitude, partly because of a mismanagement of external liabilities, weak domestic banking systems and insufficiently sound institutional architecture. When capital left these countries, it did it so very quickly, causing a major currency (and banking) crisis, with severe damage to the economies concerned. I do not believe that globalisation per se was the cause of the crisis, although some aspects of it - such as information technology, financial innovation and the easy flow of capital across borders - may have contributed. The problem is that the development of a global financial market and the rise of the emerging economies have not been accompanied by the parallel improvement in the legal and regulatory infrastructure that is always needed, both nationally and internationally, for markets to function properly and to be reasonably stable. The current crisis is, to a large extent, the result of such an imbalance. 16. The Asian crisis has thus been just another reminder that, at the end of the day, the issue underlying the stability of currencies is the set of policies that engender (or endanger) stability. Sound policies and institutions cannot be "replaced", so to speak, by a link between the domestic currency and another currency. There is nothing wrong with such a linkage (and I even think that currency boards may be an appropriate solution for certain countries), but the currency must be tied at a competitive level and, most importantly, must be backed by sound domestic fundamentals. What has been true for the long-term participants in the international financial system also applies to those who have joined the system more recently, and will apply to future newcomers. 17. My insistence on the role of sound domestic policies and sound institutions does not imply that international arrangements and multilateral organisations have no role to play in the future. In a global economy made up of about 200 sovereign States, multilateral arrangements integrate the policy architecture by providing the incentives to improve national institutions and policies. They should be strengthened, not undermined. To this end, a number of initiatives are under way that, if implemented successfully, could significantly improve international discipline. These concern such areas as transparency, accountability, practices for supervision, payment and settlement systems, accounting standards and disclosure. International standards should be agreed and applied broadly. 18. It's time for me to conclude. The revival of a discussion about the international monetary system is in part the consequence of a series of turbulences that started - just after the celebrations to mark the 50th anniversary of the Bretton Woods institutions - with the Mexican crisis of 1994, and went on last year and this year with the Asian crisis. A serious debate, with proposals, has now started on the ways and means to promote sound macroeconomic management, sound institution building and a more efficient working of financial markets. Our aim should be to maximise the benefits to be derived from globalisation without having to suffer from its tendency to spread instability. I am persuaded that the creation of the euro, with its profound implications for political and economic life in Europe, will give impetus to this renewed thinking, and that it will provide the world with a striking example of how far sovereign nations can push their co-operative spirit. It will also bring to the international fora a new voice, strongly imbued with that same spirit. Tonight I have shared with you my conviction that sound economic policies and strong institutions are, today as in the past, the key factor in achieving stability in international economic, financial and monetary relationships. They are, therefore, the key to establishing and preserving the external value of the euro. You can be sure that our work, at the ECB, is - and will continue to be - guided by these principles.
r981204a_ECB	euro area	1998-12-04T00:00:00	The monetary policy of the European Central Bank	no_info	0	It was with immense pleasure that I accepted the invitation to take part in this event, organised by Euroforum. In view of the prestigious nature of Euroforum, the professional standing of its President, Eduardo Bueno, Professor at the Universidad Autonoma de Madrid and consultant to the Banco de Espana (there is a great deal of similarity between our respective professional histories) and, above all, the value I have attached to his friendship over the past thirty years, there was no question as to whether to agree to join you for this working breakfast. I have been asked to keep my presentation brief in order to allow as much time as possible for discussion. Therefore I will try to put forward a few ideas on the monetary policy of the European Central Bank (ECB) which I can develop during subsequent discussions. During the discussion period please feel free to raise any questions on other aspects of the ECB's operations. As in the case of any other central bank, the ECB's monetary policy is based on three fundamental principles: setting the objectives to be achieved, establishing the most appropriate strategy for accomplishing these objectives and, finally, selecting the best instruments for implementing its chosen strategy. While the Governing Council of the ECB is responsible for formulating its monetary policy, both the Executive Board of the ECB and the national central banks are involved in its application and therefore this constitutes one of the tasks allotted to the European System of Central Banks (ESCB) as a whole. Objectives, strategies and instruments therefore form the three main elements which enable us to establish the precise point within the range of monetary policy possibilities which should constitute the ECB's policy: its precise altitude, longitude and depth. We did not have to think long and hard to define the ECB's monetary policy objectives and, generally speaking, those of the ESCB. This had been done for us by the Treaty on European Union in which, under Article 105, it is stated that "the primary objective of the ESCB shall be to maintain price stability" which, on a more practical level, the ECB has defined as a year-on-year increase in the harmonised index of consumer prices (HICP) for the euro area of below 2%, which it seeks to maintain in the medium term. "Without prejudice to the objective of price stability", continues the aforementioned Article 105 of the Treaty, "the ESCB shall support the general economic policies in the Community with a view to contributing to the achievement of the objectives of the Community as laid down in Article 2". If you refer to the aforementioned Article 2 of the so-called Treaty of Maastricht, you will find that sustainable and non-inflationary growth, together with a high level of employment and social protection, are among its aims. The ECB, then, must prioritise those of its activities which promote the objective of stability and, without prejudice to this approach, it will contribute, indirectly and to the extent possible, to economic growth and increased employment. Is this approach in any way contradictory? Absolutely not. The best contribution the ECB can make to promoting investment and thus to generating economic growth and increased employment is precisely by providing a framework for price stabilisation. The worst path that the ECB could follow would be to implement a lax economic policy which claimed to be directly creating jobs. In fact, in the medium term price stability will encourage efficient investment, sustainable growth and employment. This is because stability prevents price distortions, that is to say any distortion of the mechanism which guides decision-makers in the markets, and thus favours an improved allocation of resources. When stability is achieved, prices are more transparent, which promotes competition and therefore efficiency. Moreover, if economic agents have positive expectations with regard to stability, the risk premium element of long-term of interest rates will fall, promoting investment and lasting consumption. In this respect, it should be remembered that one of the clearest inflation forecast indicators is an increasingly steep maturity-related asset yield curve. Finally, stability promotes growth and employment insofar as it allows resources to be channelled into productive activity. Inflation, on the other hand, merely encourages speculative investment with the aim of safeguarding funds against monetary deterioration. As we saw earlier, the aims set out in Article 2 of the Maastricht Treaty also include social safeguards. In this context, therefore, it can be said that inflation is the most unjust of all taxes, because it attacks personal income and assets while distorting certain public redistribution mechanisms such as, for instance, progressive taxation scales. In other words, stability is not just important for economic efficiency but also for social justice, since it provides economic conditions which benefit the weakest and most vulnerable members of society. An appropriate ECB monetary policy is a necessary condition but will not, in itself, enable us to achieve stability. National taxation policies geared to satisfying the objectives of the Stability and Growth Pact, together with several supply-side policies leaning towards liberalisation and flexibility, are also necessary to enable us to avoid the persistent need for measures to combat inflation. We must avoid the temptation to reinterpret the Stability and Growth Pact by introducing "golden rules" of dubious legality, based on the false theoretical foundations of the so-called "ultra-rationality hypothesis" which, in the past, claimed to justify increased taxation pressure and which now calls for increased public spending in terms of investment. Let's not beat about the bush: taxation policy has only one golden rule, which consists in maintaining a long-term budgetary balance on the economic horizon. In connection with the ECB's objectives, it should also be noted that it is difficult or even impossible to meet two separate targets simultaneously using only a single monetary policy. This applies when dealing with the concept of fixing fluctuation bands for the rate of exchange between the euro and the US dollar. In this case, the exchange rate objective could conflict with the price stability concept and the ECB would then fail in its primary objective. We must not forget, with regard to this issue, that combining linked exchange rates, the free circulation of capital and monetary autonomy is not, to be quite blunt, sustainable. It is precisely this which is the raison d'etre of the ECB as the single monetary authority in an economic area which has irrevocably fixed exchange rates (a single currency) and freely circulating capital (a single market). To conclude this section, let me stress that it is essential for the ECB to make it absolutely clear that its main objective is stability. If, as some would suggest (for instance in the Modigliani manifesto), the ECB were to directly target employment, this would adversely affect the credibility of its monetary policy and thus have an impact not only on inflation but also, paradoxically, on employment. The direct targeting of employment objectives by a central bank is counterproductive. A strategy is a combination of criteria and procedures which allow decisions to be taken in order to achieve a monetary policy objective. This decision-making process can be based on inflation forecasts which depend on the behaviour of a relevant monetary variable or, more simply, on the "pegging" of exchange rates to a stable currency. This last strategy is ideal for more open economies, encompassed by a specific monetary zone, such as, for instance, the Netherlands and Germany. However, this would not be suitable for a much larger but relatively closed economic space such as the euro area. I believe that it is a mistake to try to exaggerate the polarity of the inflation strategy and the monetary strategy. These are quite clearly separate strategies but they are not in any way opposed, incompatible or irreconcilable. Certainly, some aspects of each of these strategies should be combined, resulting in another, completely separate and valid strategy. This is what the ECB has done and it now needs to give the end product a name which does not merely describe the desired objective ("the stability-orientated monetary policy strategy"). There are two components to the ECB's monetary policy strategy. The first, more practical and visible component consists in a quantitative reference to the growth of the money supply as defined by the broad M3 aggregate. Taking into account the quantitative definition of stability, economic growth and realistic hypotheses on money circulation rates, this monetary reference has initially been set at 4 1/2%. The second component of the ECB's monetary strategy, a more general and enveloping one, is the estimation of inflation forecasts and risks for price stability in view of changes in a group of significant variables, all of which are related to the euro area as a whole. Some examples of these significant variables are credit, long-term interest rates, prices of raw materials, import prices, wages and public spending deficits. Inflation is a monetary phenomenon. When the rate at which the money supply grows is greater than the nominal potential rate of growth of an economy, in the medium term this will generate inflation. In other words, the medium-term inflation rate is indicative of excessive monetary expansion in relation to economic growth. Growth in the money supply therefore provides the best early warning of inflation and monetary control is the best monetary policy strategy. The virtues of the first component of the ECB monetary strategy are, when all is said and done, well known. If it worked, this alone would be sufficient. In practice, however, things are never so simple. Inflation forecasting and control cannot rely solely on a monetary aggregate because of doubts as to whether or not this monetary aggregate can be controlled and is stable and meaningful. If a narrow definition of money, such as M1, is adopted, controllability can be achieved in that, through the monetary policy instrument, it is possible to have a greater impact on its evolution, but this is offset by the loss of stability and significance. If it is decided to opt for a broad monetary aggregate, such as M3 or M4, the money demand function becomes more stable and clearly more significant, in that a greater correlation can be achieved between exchange rates, providing a better explanation of changes in nominal costs and inflation, in return for some loss of control. Despite this, doubts persist. In practice, these will, of course, increase when national currencies are replaced with the euro; then the need for the second part of the monetary policy strategy will become obvious. The wide range of instruments available to the ESCB for the implementation of the euro area monetary policy has been established with reference to two fundamental criteria: efficiency and neutrality. These instruments can be separated into three categories, related to open market operations, standing facilities and minimum reserves. The ESCB's instruments and procedures do not differ significantly from those traditionally used by the Banco de Espana and with which you are all familiar. This means that I only need to highlight a few differences. In addition, I should add that over recent weeks the Banco de Espana has introduced changes aimed at facilitating a smooth transition. With regard to open market operations, the frequency and maturity of the main re-financing operation has become that of a weekly auction of loans with a maturity of two weeks, and an interest rate which is either announced in advance (fixed rate auction) or announced later as the result of offers received (variable rate auction). There will also be monthly auctions for three-month loans which will always be of the variable rate type in order to avoid sending signals to the market. Fine-tuning will be carried out in exceptional circumstances between two regular auctions and, finally, the structural liquidity demand can be influenced by means of open market transactions which consist in the direct purchase and sale of securities or the issuance of debt certificates. Standing credit and deposit facilities will supply or absorb overnight liquidity, without the imposition of any other restrictions on their use by institutions other than the provision of guarantees or collateral. Both types of interest on standing facilities constitute a strip or corridor which will contain short-term market interest rate swings and provide a structure for monetary policy trends. This means that they will play an important role in terms of providing signals, a role also fulfilled by the Banco de Espana but in a less predetermined and formalised manner. As far as guarantees for all these transactions are concerned, it should be stated that acceptable collateral may take the form of either a public instrument or a private instrument, provided that these are of a suitable nature, according to the neutrality principle applied to the public sector and to the private sector. The minimum reserves will be equal to 2% of book liabilities calculated on the basis of a monthly average, will be subject to a minimum exempt level of EUR 100,000 and - this being the most important point underlining the main difference compared with the current position in Spain - will be remunerated in line with market rates. The averaging provision will allow us to absorb liquidity shocks without recourse to standing facilities. Such a minimum reserves will constitute a useful tool for restricting the volatile nature of monetary market interests rates, for reducing the need for fine-tuning and for tightening up the system's liquidity, thereby enhancing the effectiveness of the monetary policy. Its remuneration in line with the market will not only reduce money demand elasticity with regard to interest rates but also offer neutrality to euro area banks as compared with those in other countries which do not use such a tool. Although inevitably in a simplified form, I hope that this statement on the aims, strategy and instruments of the euro area monetary policy has provided some basic information on the central core of the ECB's operations and that it can be used as a starting-point for our discussions. Thank you for listening; during the discussion period, I shall be pleased to elaborate on the issues raised or examine any others which you think may be of interest.
r981207a_ECB	euro area	1998-12-07T00:00:00	The ESCB's stability-oriented monetary policy strategy	duisenberg	1	On 1 January 1999 - in only twenty-four days' time - Stage Three of Economic and Monetary Union (EMU) will commence in Europe. The introduction of the euro will mark a tremendous achievement, the culmination of more than a decade of preparation and convergence. But, in many ways, the greatest challenges and opportunities will still lie ahead, both for Europe and for the Europeans. The introduction of the euro offers the to establish and maintain price stability throughout the eleven countries that comprise the euro area. By ensuring that prices in the euro area can be kept stable over time, the European System of Central Banks (ESCB) will be laying the foundations for sustainable economic growth and improved employment prospects in Europe. Indeed, we are already living in a de facto Monetary Union, as has been demonstrated by the coordinated move of their key interest rates by all central banks of the euro area on 3 December 1998, reflecting a consensus reached in the Governing Council on the basis of a common assessment of the economic, monetary and financial situation in the euro area. Whereas all indicators suggest a favourable broad outlook for price stability, prospects for growth for the euro area have weakened, and the international environment is still dominated by uncertainty, so that the risks appear to be predominantly on the downside. This joint reduction in interest rates has to be seen as a de facto decision on the level of interest rates with which the Eurosystem will start Stage three of Monetary Union and which it intends to maintain for the foreseeable future. At the heart of our approach is the "stability-oriented" monetary policy strategy. The Governing Council of the European Central Bank (ECB) has adopted the broad lines two months ago and presented them to the public. Today, before explaining some further details regarding the ESCB's monetary policy strategy, I should like to describe how we interpret our mandate of maintaining price stability. The ESCB is an institution which is independent from political interference. In a democratic society, independence has to be accompanied by accountability. The ESCB's monetary policy strategy must be clear and transparent if we are to convince the general public both of our commitment to maintain price stability and of our ability to do so. Therefore, we put much effort in the design of a sound and coherent framework that leads to consistent and effective monetary policy decisions. Transparency regarding the ultimate objective of monetary policy is crucial for ensuring that the ESCB can be held accountable for its policies. The Maastricht Treaty entrusts the ESCB with the primary objective of maintaining price stability. It does not, however, quantify this objective or stipulate how it should be achieved. A clear definition in quantitative terms of price stability will help stabilise inflation expectations, build up the credibility of the single monetary policy of the ESCB and will thereby increase its effectiveness. The Governing Council of the ECB has, therefore, decided to publish a quantitative definition of price stability, with which the general public can sensibly judge its success in fulfilling the Treaty's mandate. In this context, the Governing Council agreed in October that " ". The HICP is a comprehensive measure for inflation, reflecting the focus of the general public on consumer goods. It is the only harmonised price index available in the euro area. As I have emphasised in the past, the definition we have announced reflects the aversion of the Governing Council to both inflation and deflation. The phrase " " clearly delineates the maximum rate of inflation deemed to be consistent with price stability. The wording " " implies that persistent price decreases - that is to say deflation in the measured price index - would not be considered to be consistent with price stability either. We did not explicitly announce a floor for inflation, because we know that the price index may include a measurement bias of positive order, but we currently do not know its precise magnitude. One can expect, however, that the measurement bias in the HICP is smaller than for the national consumer price indices (CPIs), given the considerable effort Statisticians in the EU put in the construction of this index. ". In doing so, it also acknowledged that price levels may be temporarily distorted by short-term factors - for example, by changes in indirect taxes or commodity prices - which cannot be controlled by monetary policy or by the ESCB. Using the index "for the euro area" highlights that area-wide developments, instead of specific national or regional factors, will be the only determinants of decisions regarding the single monetary policy. Let me emphasise the over-riding priority we attach to this objective. This priority is not only based on our legal obligations under the Treaty. It is founded in our belief - confirmed by both decades of experience and a substantial body of theoretical and empirical research - that maintaining price stability in the euro area is a pre-requisite for a sustainable and lasting improvement in the standard of living of Europe's citizens. In addition to maintaining price stability, but without prejudice to this objective, the ESCB is required to support the general economic policies in the European Community. The choice made in the Maastricht Treaty to have price stability as the primary objective of the ESCB is based on the view that this is the best contribution monetary policy can make to the creation of conditions conducive to durable income and employment growth. Indeed, price stability is one of the longer-term conditions for the achievement of other economic policy objectives, such as sustainable economic growth and full employment. By fulfilling its primary objective of maintaining price stability, the ESCB will automatically also support the general economic policies in the European Community which are aimed at achieving the aforementioned objectives, namely non-inflationary growth and high employment. Moreover, by emphasising that price stability is to be maintained in the medium term ensures that the appropriate forward-looking and medium-term orientation is imparted to monetary policy. This will ensure that policy responses to threats to price stability are measured and deliberate. Such actions will not introduce unnecessary instability into the economy, while nevertheless ensuring that price stability is maintained. However, it should be noted that, unless it enjoys the support of sound budgetary policies and responsible wage behaviour, the maintenance of price stability will be more difficult and thereby overall economic welfare will be reduced. That is why I attach great importance to the so-called Stability and Growth Pact, in which European governments agreed to reduce government deficits to close to balance or even to create a surplus in the medium term. In this context, it should be emphasised that . Monetary policy cannot solve this problem. It can only contribute to creating the conditions needed to solve the problem by maintaining price stability. The main solution to the unemployment problem has to be provided by structural reforms aimed at making European goods, services and labour markets operate more flexibly. Let me now turn to the two main elements of the ESCB's stability-oriented monetary policy strategy. The Governing Council of the ECB has chosen a distinct monetary policy strategy, one that reflects the special circumstances existing at present as well as those in the foreseeable future. Given a natural desire to build on the success of national central banks (NCBs) in the euro area prior to Stage Three, the strategy ensures as much as possible with the existing strategies of NCBs. At the same time, the chosen strategy gives due consideration to the created by the transition to Monetary Union. Given these specific circumstances, the Governing Council has decided that it would not be wise to define a single intermediate target for the ESCB's monetary policy to which it would react in an almost mechanistic manner. In accordance with the announced definition of price stability, the ESCB has adopted a stability-oriented monetary policy strategy, which rests on two "pillars". The first pillar is a . This is deemed to be important on account of the basically monetary origins of inflation over the longer term. In indication of the prominent role it attaches to money in the formulation of its monetary policy, the Governing Council of the ECB has announced a quantitative at its last meeting. In parallel with the analysis of monetary growth in relation to the reference value, its strategy will also rest on a second "pillar". This will consist of a and of the risks to price stability in the euro area as a whole. As I have just indicated, there is a wide consensus that the development of the price level is a monetary phenomenon in the medium to long term. The historical experience of central banks in- and outside Europe clearly demonstrates that it is essential, for the success of monetary policy, to carry out a thorough analysis of monetary aggregates and the information they contain. In particular, empirical evidence shows that increases in prices are relatively closely linked to rates of money growth in excess of the real growth capacity of the economy over the medium-term. Consequently, monetary developments can reveal useful information about future price developments and thereby offer an important compass for the conduct of monetary policy. Therefore, it is absolutely essential for any central bank that has the task of keeping prices stable to analyse and monitor developments of monetary aggregates closely. It is against this background that the Governing Council decided to announce a reference value for monetary growth, which is consistent with - and serves the achievement of - price stability. The Governing Council will regularly and thoroughly analyse the relationship between actual monetary growth and this pre-announced reference value. Wherever monetary growth deviates from the reference value, an explanation will be sought. If this explanation indicates a threat to price stability, monetary policy will react accordingly in order to address this threat. However, interest rates will not be changed in a mechanistic fashion in an attempt to correct deviations of money growth from the reference value over the short term. That is why we do not speak of a target for monetary growth, but rather of a reference value. In this context, the Governing Council of the ECB, a week ago, agreed on three important issues. First, the specific definition of a broad monetary aggregate for which the reference value will be announced. Second, whether a single figure or a range will be chosen for the reference value. Third, the precise level of the first reference value for monetary growth. In selecting the precise definition of the monetary aggregate that effectively serves the function of a reference value, both empirical and conceptual considerations were taken into account. Empirical economic studies have investigated the properties of various euro area-wide monetary aggregates, in particular in terms of their long-run stability and leading indicator properties. From the conceptual point of view it was considered of great importance to include also those assets in the monetary aggregate, which have a high degree of substitutability with narrower definitions of money. As most short-term money market instruments are close substitutes for more traditional bank deposits, it was decided to select the broadest of the available definitions. The reference value will, therefore, refer to M3 in a relatively broad definition, which includes in addition to currency in circulation and deposits also repos, money market paper, short-term debt securities issued and units or shares of money market funds. Announcing a specific rate of monetary growth as the reference value rather than a range supports the view that the Governing Council will not react 'mechanistically' to deviations from the reference value. Movements of monetary growth within a range might be interpreted as not requiring a monetary policy reaction, even when the information they reveal about the disturbance to the economy suggest a serious threat to price stability. Rather monetary policy will respond to the information revealed by the deviation so as to maintain price stability over the medium term. Deviations of current monetary growth from the reference value would, under normal circumstances, signal risks to price stability in the medium term. To achieve this, the reference value is derived in a manner consistent with the ESCB's announced definition of price stability. Furthermore, the reference value for monetary growth takes into account the trend of real GDP growth over the medium term, as well as the trend changes in the velocity of circulation. An approach using trend growth over some past period strengthens the medium-term orientation of the monetary policy strategy. At the same time, it adds some employment and income stabilising elements. In setting the actual reference value for monetary growth, the Governing Council has taken account of these factors. First, the Governing Council is committed to maintain price stability on its published definition. This requires increases in the HICP for the euro area of "below 2 %". Second, the Governing Council takes the view that a figure in the range of 2 % to 2 1/2 % per annum for the trend growth of real GDP in the euro area appears to be reasonable. Third, the uncertainties concerning short-term developments in velocity linked to the start of Stage Three have led the Governing Council to assume that the medium-term trend decline in velocity lies in the approximate range of 1/2 % and 1 % each year. This range encompasses the historical experience of the last twenty years. Based on these considerations, the Governing Council decided to set the first reference value for monetary growth at 4 1/2 %. The Governing Council of the ECB will monitor monetary developments against this reference value on the basis of latest three-month moving averages of the monthly year-on-year growth rates for M3. This will ensure that erratic monthly outturns in the data owing to data revisions do not unduly distort the information contained in the aggregate. Although monetary data contain information which is vital for monetary policy decision-making, monetary developments alone will not constitute a complete summary of all the economic information necessary to take appropriate policy decisions. There is a clear need for the Governing Council to look at a wide range of other economic and financial indicators. This assessment will comprise a systematic analysis of all the other information on the economic and financial situation, ensuring that the Governing Council is as well informed as possible when making its monetary policy decisions. While it is true that accurate forecasts can contribute to the success of an appropriately forward-looking monetary policy, the ESCB should not be judged on, or held accountable for, the accuracy of its internal forecasts. Rather, its performance in maintaining price stability in the medium term - should be used by the public to judge the success of the ESCB's policies. Consequently, publication of a forecast is only deemed important in so far as it helps to achieve price stability, through increasing the clarity and transparency of the policy-making process. Relying on a single forecast that attempts to summarise all the information available from a wide range of indicators would be misguided. The Governing Council will not want to be presented with a single number to which it will have to react mechanistically, if at all. In contrast, the Governing Council will want to know the economic reasons behind the projected risks to price stability. The appropriate monetary policy response to a threat to price stability will depend on the nature of the threat. The Governing Council can only understand the nature of the risk if it is presented with a full set of data. From these data, it can attempt - with the help of various staff analysis - to identify the nature of the disturbance to price stability. Having identified the threat, an appropriate policy response can be selected and implemented. The Governing Council will inform the public regularly about its assessment of the monetary, economic and financial situation in the euro area. Moreover, when policy decisions are made, the reasoning behind specific decisions - including the economic rationale on which judgements have been made - will be communicated to the public immediately after the meeting at which they have been taken. By presenting the analysis that is actually driving policy decisions, the ESCB will be transparent, since this analysis is informative about policy changes and since the presentation to the public will reflect the type of discussion I anticipate occurring in the Governing Council itself. On the basis of the strategy I have just outlined, the Governing Council will regularly inform the public about its specific monetary policy decisions. The Governing Council will meet every fortnight. The first meeting in every month will immediately be followed by a press conference. The ECB will frequently issue press releases after meetings of the Governing Council, without delay, and will regularly publish a monthly bulletin as well as an annual report. We shall also regularly explain our policies in speeches and interviews, and I have already announced my acceptance of invitations to present them to the European Parliament at least four times a year. The ESCB's monetary policy strategy must be clear and transparent if we are to convince the public of our commitment to maintain price stability and our ability to do so. We must be seen to be operating in a solid and coherent framework that leads to consistent and effective monetary policy decisions. Given the uncertainties that we face at the outset of Stage Three and taking into account the particular circumstances of the euro area, the chosen approach is more likely to produce good policy decisions than an almost automatic response based on specific rules defined in relation to an inflation or an intermediate monetary target. The stability-oriented monetary policy strategy adopted by the ECB Governing Council offers precisely this framework. Having respected the principle of transparency, I am confident that this strategy will be successful. By maintaining price stability in the euro area, the ESCB will then lay a necessary foundation for Europe's future economic stability and prosperity.
r981208a_ECB	euro area	1998-12-08T00:00:00	Hearing at the European Parliament's Committee on Economic and Monetary Affairs and Industrial Policy on 8 December 1998 in Brussels	duisenberg	1	It is a great privilege for me to meet this Committee for the first time in my capacity as President of the European Central Bank (ECB). As was the case when I previously appeared before the Sub-Committee on Monetary Affairs, I hope that we shall have a frank and fruitful exchange of views. Since September, when I reported to your Sub-Committee, the European System of Central Banks (ESCB) has continued to make further progress in finalising the preparations for the start of Monetary Union on 1 January 1999, and I am happy to say that we are practically ready. The Governing Council has continued to have a very heavy agenda, dealing in the main with the specification of the Eurosystem's monetary policy strategy, the regular monitoring of economic, monetary and financial developments as well as issues of a technical nature and legal implementation issues. Specifically, the Governing Council has met on three occasions since September. Following these meetings, the Vice-President and I have reported on the results of our deliberations at press conferences which were followed by question and answer sessions. Moreover, the statements made there were immediately made available in the form of press releases, together with various other documents explaining issues in more detail. The immediate release of this information to the press is a practice which I intend to continue in the future. From the start of next year, the Governing Council will meet every fortnight. The first meeting in each month will be followed by a press conference. We intend to publish a monthly bulletin, in the context of which we will explain in detail both our monetary and economic analysis and the assessment underlying our monetary policy decisions. Moreover, the members of the Executive Board also intend to be very active in giving speeches and interviews. The task of communicating and explaining our monetary policy is being taken very seriously. I should like to focus my remarks today on three areas, in particular. First - given its importance - I shall outline the monetary policy strategy which has been adopted by the Governing Council of the ECB for Stage Three of Economic and Monetary Union (EMU). Second, I shall discuss the view of the Governing Council on the current economic situation in the euro area and on the outlook. Third, I shall summarise our recent preparatory work for the start of the single monetary policy. After that, I shall of course be happy to answer any questions you may have regarding these and other matters. You are aware of the fact that the primary objective of the single monetary policy, as laid down in the Treaty, is to maintain price stability. In order to give clear guidance with regard to expectations of future price developments, and in the interests of accountability and transparency, it was agreed by the Governing Council to adopt a quantitative definition of this objective. Price stability has been defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. Needless to say, a persistent fall in the price level would not be consistent with the goal of price stability. The annual rate of inflation, measured on this harmonised basis, was 1.0% in October 1998. Overall, the objective of the ESCB is to maintain an environment of stable prices in the medium term. This reflects the need for monetary policy to be forward-looking, and to have a medium-term orientation. It recognises the reality that monetary policy is not able to control short-term movements in the price level. In October, the Governing Council announced that the monetary policy strategy would consist of and, just a week ago, it specified the remaining elements. , as is reflected in the announcement of a quantitative reference value for the growth of a broad monetary aggregate, namely M3. The first reference value has been set at an annual rate of 4 1/2%. It will be reviewed in December 1999. The reference value for M3 is consistent with the maintenance of price stability, while allowing for sustainable output growth. This rate was derived by assuming that the medium-term trend growth rate of real GDP in the euro area is estimated to be in the range of 2-2 1/2% per annum and the medium-term trend decline in the velocity of circulation of M3 in the range of between 1/2-1% each year. In addition, it should be pointed out that monetary policy will not react to deviations of monetary growth from the reference value in a "mechanistic" way. The second key element of the monetary policy strategy is a in the euro area as a whole. The Governing Council recognised that it would be important, in parallel to the assessment of money growth in relation to the reference value, also to look at a wide range of other economic and financial indicators. The systematic analysis of all other relevant information about economic and financial conditions is designed to ensure that the Governing Council is as well-informed as possible when taking decisions about monetary policy. Against this background, the Governing Council discussed in depth at its last meeting. The discussion included the consideration of available projections for both the world economy and the euro area in the next two years. Overall, these projections point to some deceleration of real GDP growth in the euro area in 1999, following growth in 1998 of just below 3% on the basis of current evidence. However, the general view is that this slowdown will be temporary. The Governing Council considers that the risks to economic activity continue to be on the downside. One reason for this is the continued uncertainty regarding the global environment. But there have been some positive signs lately, as world financial markets appear to have been calmer and less volatile in November. The Governing Council expressed its concern that, unless confidence is supported by appropriate economic policies, there could be a negative impact on domestic demand. In addition to the maintenance of a stability-oriented monetary policy, this requires, in particular, the conduct of fiscal policies which are consistent with the Stability and Growth Pact, wage developments which are in line with productivity gains and structural reforms in labour and product markets which will help to foster competitiveness and profitability in the corporate sector. This, in turn, will promote investment within the euro area and encourage employment growth. The main contribution that monetary policy can make to achieving sustained economic growth, higher employment levels and better living standards is to pursue the objective of maintaining price stability over the medium term. This objective was at the centre of our discussions regarding the appropriate level of the Eurosystem's key interest rate for the euro area at the start of Stage Three. When the discussion of the appropriate level of interest rates was deepened further in early December, the Governing Council considered both the monetary data and the prospects for continued low increases in the HICP. At the present juncture, preliminary estimates put the average of the twelve-month growth rates of M3 for the last three months, up to October, at around 4.5%. Over the last two years, the annual rate of M3 growth in the euro area has fluctuated in a range of 3.5-5.5%. The Governing Council has come to the conclusion that this monetary trend currently appears to be broadly compatible with continued price stability in the euro area. If import prices remain subdued and wage developments continue to be moderate, then the rate of increase in the HICP is expected to stay below 2% in the foreseeable future. This prospect of low inflation is a view which financial markets appear to share, with average long-term interest rates in the euro area falling to a level just above 4% by the end of November. The Governing Council also considered the development of budgetary positions, emphasising that they are still far from being close to balance or in surplus and that debt ratios have remained at very high levels in many Member States. Any relaxation of the fiscal policy stance in the euro area, or a tendency to alter the strategy embodied in the Stability and Growth Pact would place the credibility of the euro and price stability at risk. Overall, the Governing Council has judged that the broad outlook for maintaining price stability is favourable. Against this background, there was a co-ordinated reduction of key interest rates by all national central banks in the euro area on 3 December 1998, reflecting a consensus reached in the Governing Council on the basis of a common assessment of the economic, monetary and financial situation in the euro area. Whereas all indicators suggest a favourable broad outlook for price stability, prospects for growth in the euro area have weakened, and the international environment is still dominated by uncertainty, so that the risks appear to be predominantly on the downside. The co-ordinated move on interest rates demonstrated that, in effect, Monetary Union has already begun. Moreover, this joint reduction in interest rates has to be seen as a de facto decision about the level of interest rates with which the euro area will start Stage three of EMU and which it intends to maintain for the foreseeable future. I should now like to elaborate briefly on some decisions other than those on the monetary policy strategy which have been taken by the Governing Council since September in the context of the preparatory work for Stage Three of EMU. First, the framework for our monetary policy instruments was completed with the specification of some final elements of the minimum reserve system. The ESCB will apply a reserve ratio of 2% on a specified liability base. An ECB Regulation was published last week, with which the features of the ESCB's minimum reserve system have been set out in a legally binding text. Several major decisions were also taken with respect to TARGET, the real-time gross settlement system established by the ESCB. The ECB has published the third progress report on the TARGET project, providing further details on the legal framework and its technical implementation. The final text of the TARGET Guideline was adopted, and, last week, the TARGET Agreement was signed by the Governors of all 15 EU central banks and the President of the ECB. TARGET now stands ready to fulfil its task as the exclusive payment system to be used for all monetary policy-related operations with the Eurosystem as from the beginning of Stage Three. The Governing Council also approved the Guideline for the initial transfer of foreign reserves from the euro area national central banks to the ECB, as well as a set of legal documentation relating to the management of the ECB's foreign reserves, which specifies the roles which the ECB and the euro area national central banks respectively will play in this regard. With respect to the management of domestic assets and liabilities, a further ECB Guideline was adopted, which sets out the reporting obligations of euro area national central banks vis-a-vis the ECB. Whenever they exceed a certain amount, such transactions are subject to prior approval by the ECB. These provisions are necessary to ensure the singleness of the ECB's monetary policy. In order to strengthen the framework set up to prevent counterfeiting, the Governing Council confirmed the decision taken by the European Monetary Institute (EMI) to establish a Currency Analysis Centre and a Counterfeit Currency Database, which will store technical data relating to counterfeit euro banknotes and coins. The contents of the database will be made available to all national central banks of the EU Member States and to the respective law enforcement bodies involved in combating counterfeiting. Let me close my introductory statement with a few remarks on the preparations for the changeover weekend, the period from 31 December 1998 to the early morning of 4 January 1999. You are aware of the fact that, following the publication of the euro conversion rates, banking and financial institutions will have to finalise a broad range of migration operations to the euro under severe time constraints. Likewise, the ECB and the euro area national central banks will have to complete the final migration of their IT systems and operational procedures from the national currencies to the euro so as to ensure the availability of the entire complex infrastructure to the markets by the morning of 4 January 1999. In order to support a smooth transition to the euro, the Governing Council has set up a "Changeover Weekend Committee" which will organise the monitoring of developments regarding the final migration to the euro, both prior to and during the changeover weekend. An early-warning system has been established, consisting of central communication points at the ECB and at the euro area national central banks, which will monitor all relevant events which occur both within and outside the ESCB. In the case of unexpected events occurring in the banking and financial industry during the changeover weekend, the Governing Council will be prepared to take appropriate action. In such an event, the ECB will co-operate closely with other public authorities to orchestrate the necessary policy responses. Thank you for your attention. I am now at your disposal to answer any questions you may have.
r981208b_ECB	euro area	1998-12-08T00:00:00	A stability-oriented monetary policy strategy	noyer	0	In only twenty-three days' time, Stage Three of Economic and Monetary Union (EMU) will commence in Europe. The introduction of the euro on 1 January 1999 will mark a tremendous achievement, the culmination of more than a decade of preparation and convergence among the eleven initial participants in the euro area. In many ways, and within a medium-term perspective, the advent of the euro is creating great opportunities for Europe and the world economy. Monetary Union is a unique opportunity to establish and maintain a zone of price stability in the euro area. Price stability is at the core of the "stability culture" that we are establishing in Europe. By fulfilling the unambiguous commitment of the Governing Council of the European Central Bank (ECB) to maintaining price stability in the euro area, we will ensure that the single monetary policy contributes as much as possible to economic welfare in a broad sense. Indeed, we are already living in a de facto Monetary Union, as has been demonstrated by the coordinated move of their key interest rates by all central banks of the euro area on 3 December 1998, reflecting a consensus reached in the Governing Council on the basis of a common assessment of the economic, monetary and financial situation in the euro area. Whereas all indicators suggest a favourable broad outlook for price stability, prospects for growth for the euro area have weakened, and the international environment is still dominated by uncertainty, so that the risks appear to be predominantly on the downside. This joint reduction in interest rates has to be seen as a de facto decision on the level of interest rates with which the Eurosystem will start Stage Three of Monetary Union and which it intends to maintain for the foreseeable future. At the same time, fiscal authorities and general economic policies in Europe will also have a major contribution to make towards creating a unique stability culture. In this context the so-called Stability and Growth Pact, which was agreed by EU governments and aims at fostering the pursuit of disciplined fiscal policies, is a crucial element. The "stability-oriented monetary policy strategy" recently adopted by the Governing Council, and announced to the public two months ago, is at the heart of our approach. This monetary policy strategy, which I would like to explain first, is designed to ensure that the Governing Council can act in a forward-looking and pre-emptive manner, changing interest rates to contain inflationary or deflationary pressures before they become entrenched. In the second part of my speech, I should like to reflect on some of the possible implications of the introduction of the euro in the international field. The Treaty establishing the European Community assigns the European System of Central Banks (ESCB) the primary objective of maintaining price stability. In the interest of transparency and accountability, the Governing Council of the ECB has decided to publish a quantitative definition of price stability, against which its success in fulfilling the Treaty's mandate can sensibly be judged by the public. At its October meeting the Governing Council of the ECB agreed that "price stability shall be defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%". With the HICP, a specific price index is identified against which the maintenance of price stability will be assessed. It was chosen because it is both sufficiently harmonised across the different countries of the euro area at the start of Stage Three and is consistent with the public's usual focus on consumer prices. Using the index "for the euro area" highlights the fact that euro area-wide developments, rather than specific national or regional factors, will be the only determinants of decisions regarding the single monetary policy. This definition signals the aversion of the Governing Council to both inflation and deflation. The phrase "below 2%" clearly delineates the rate of inflation in the HICP deemed consistent with price stability. The wording "year-on-year increases" implies that decreases in the HICP - that is to say deflation in the measured price index - would not be considered consistent with price stability either. In this manner, the Governing Council has clearly defined its objective, which is to be maintained over the medium term. By adopting this approach we are being realistic, acknowledging that some disturbances in the price level can occur in the short run - such as those caused by changes in indirect taxes or commodity prices - that cannot be controlled by monetary policy or by the ESCB. Such factors may lead to occasional falls in the HICP, or occasional increases above 2%. These are quite normal and consistent with a meaningful definition of price stability. However, the ESCB's monetary policy will ensure that these transitory deviations from the definition do not become ingrained over the medium term. If and when we do not meet this primary objective, we are obliged to explain why that is the case and what we are going to do about this. Let me emphasise the overriding priority we attach to this objective. This priority is not only based on our legal obligations under the Treaty. It is also founded in our belief - confirmed by both decades of experience and a substantial body of theoretical and empirical research - that maintaining price stability in the euro area is a pre-requisite for a sustainable and lasting improvement in the standard of living of Europe's citizens, and provides the foundation for improving growth and employment prospects in the future. In order to achieve price stability, the ESCB has adopted a stability-oriented monetary policy strategy, which rests on two "pillars". The first pillar is a prominent role for money. This is deemed to be appropriate on account of the essentially monetary origins of inflation over the longer term. In parallel with the analysis of monetary growth in relation to the reference value, its strategy will also rest on a second "pillar". It will consist of a broadly-based assessment both of the outlook regarding price developments and of the risks to price stability in the euro area as a whole. This assessment will comprise a systematic analysis of all the other information on the economic and financial situation, ensuring that the Governing Council is as well informed as possible when making its monetary policy decisions. Overall, this strategy ensures the greatest possible continuity with successful monetary strategies pursued in the euro area countries in the past. Nevertheless, it is an approach that reflects the special circumstances faced by the ESCB at the start of Stage Three. This strategy underlines the strong commitment of the Governing Council of the ECB to its primary objective and should facilitate the achievement of this overriding goal. It will also ensure the transparency of the ESCB's decision-making and its accountability. Based on its strategy, the Governing Council of the ECB will inform the public regularly and in detail about its assessment of the monetary, economic and financial situation in the euro area and the reasoning behind specific policy decisions. As I have already indicated, there is a broad consensus that the development of the price level is a monetary phenomenon in the medium to long term. The historical experience of central banks in Europe and beyond clearly demonstrates that it is essential to carry out a thorough analysis of monetary aggregates and the information they contain. In particular, empirical evidence shows that increases in prices are relatively closely linked to rates of money growth in excess of the real growth capacity of the economy over the medium term. Consequently, monetary developments can provide useful information about future price developments and thereby offer an important compass for the conduct of monetary policy. Against this background, it is absolutely essential for any central bank that has the task of keeping prices stable to analyse and monitor developments in monetary aggregates closely. By way of an indication of the prominent role it attaches to money in the formulation of its monetary policy, the Governing Council of the ECB announced a quantitative reference value for monetary growth at its meeting on 1 December 1998. The reference value has two key features. First, it has been derived in a manner that is consistent with - and directed at achieving - price stability. Second, it has been constructed such that, in the absence of special factors or other distortions, deviations of monetary growth from the reference value will signal risks to price stability. In the future, the relationship between actual monetary growth and the pre-announced reference value will be regularly and thoroughly analysed by the Governing Council. Where deviations emerge, an explanation will be sought. If such an explanation points towards a threat to price stability, monetary policy will react appropriately, but not in a mechanistic manner, in order to counter this threat. In contrast to a conventional monetary targeting regime, the ESCB is not, however, committed to correcting deviations of money growth from the reference value over the short term. One week ago the Governing Council of the ECB agreed on three important issues: first, the specific definition of a broad monetary aggregate for which the reference value will be announced; second, whether a single figure or a range will be chosen for the reference value; and third, the precise level of the first reference value for monetary growth. In selecting the precise definition of the monetary aggregate that effectively serves the function of a reference value, both empirical and conceptual considerations were taken into account. Empirical economic studies have investigated the properties of various euro area-wide monetary aggregates, in particular in terms of their long-run stability and leading indicator properties. From a conceptual point of view it was considered of great importance also to include in the monetary aggregate those assets which have a high degree of substitutability with narrower definitions of money. The reference value will, therefore, refer to a relatively broad definition of M3, which, in addition to currency in circulation and deposits, also includes repos, money market paper, short-term debt securities issued and units or shares of money market funds. In setting the reference value for monetary growth, the Governing Council has taken account of various factors and emphasised its medium-term orientation. First, the Governing Council is committed to maintaining price stability according to its published definition. This requires increases in the HICP for the euro area of "below 2%". Second, the Governing Council takes the view that a figure in the range of 2% to 2 1/2 % per annum for the trend growth in real GDP in the euro area appears to be reasonable. Third, the uncertainties concerning short-term developments in velocity linked to the start of Stage Three have led the Governing Council to assume that the medium-term trend decline in velocity lies approximately within a range of 1/2% and 1% each year. This range reflects historical experience over the last twenty years. On the basis of these considerations, the Governing Council decided to set the reference value for monetary growth at 4 1/2%. The Governing Council has decided to announce a specific reference rate for monetary growth, rather than a range. The Council believes that announcing a reference range may be falsely interpreted as implying that interest rates would be changed automatically if the boundaries of the range were exceeded. This interpretation would not be consistent with the concept of a reference value, which - as emphasised in the announcement of the ESCB's stability-oriented monetary policy strategy in October 1998 - does not imply a commitment to mechanistically correct any deviation of monetary growth from the reference value over the short term. The Governing Council of the ECB will monitor monetary developments against this reference value on the basis of the latest three-month moving averages of the monthly year-on-year growth rates for M3. This will ensure that erratic monthly outturns in the data owing to data revisions do not unduly distort the information contained in the aggregate. Although the monetary data contain information vital for monetary policy-making, monetary developments alone will not, of course, constitute a complete summary of all the economic information necessary to take appropriate policy decisions. In the ESCB's stability-oriented monetary policy strategy, money is accorded a prominent - but not an exclusive - role. There is a clear need for the Governing Council to look at a wide range of other economic and financial indicators. Consequently, as I have pointed out, a broadly-based assessment of the outlook for price developments and the risks to price stability in the euro area aims at systematically analysing all the other available information about the economic and financial situation both within and beyond the euro area. However, the stability-oriented monetary strategy does not include the regular publication of inflation forecasts, for the following reasons. While it is true that accurate forecasts can contribute to the success of an appropriately forward-looking monetary policy, the ESCB should not be judged on, or held accountable for, the accuracy of its internal forecasts. Rather, its performance in maintaining price stability in the medium term should be used by the public to judge the success of the ESCB's policies. Consequently, publication of the definition of price stability is important, as it helps to anchor inflation expectations, by increasing the clarity and transparency of the ultimate objective of the ESCB. The ESCB aims at defining price stability according to its announced quantitative definition. A credible commitment to this definition should provide the main anchor for inflation expectations, rather than an uncertain inflation forecast. In fact, it is not always transparent and appropriate to publish a forecast for future inflation, which might deviate, on the one hand, from the ESCB's definition of price stability and, on the other, from the actual outturn. In certain cases the publication of forecasts may even destabilise expectations and price developments, in particular as the forecasts are normally conditional and reflect some of the risks and uncertainties prevailing at the time. Let me now turn to the international role of the euro. The euro will be the currency of an economic area, which will roughly equal the United States in terms of both its economic strength and its degree of macroeconomic openness. However, the size of an economy and external trade volume alone are not always perfect indicators of the international importance of a currency. According to most measures, for example, the US dollar is of greater international importance than the relative size of the US economy would suggest. It is clear that the European Central Bank - which represents not only an equally large economic area with an equally large population (of 300 million), but also a currency which will increasingly circulate outside the euro area - will have an important international role to play. The international role of a currency is a complex phenomenon. There are many uses for a currency in an international context. On the official side, these include its use as an anchor for exchange rate pegs, for holding foreign exchange reserves and as a vehicle currency for foreign exchange interventions. On the private side, these include its use as a quotation and vehicle currency for international trade, as the currency of denomination for financial assets and as a substitute currency in circulation abroad. The introduction of the euro will also have consequences for economies abroad and for the international capital markets. For the euro, this means that there are several areas in which it could play a significant role. In the near future, such a role obviously seems to be more likely in areas where global currency diversification is desired, and less likely where global standardisation on the use of a single currency has occurred. In this context, it should be stressed that the euro will inherit the international role of all the currencies participating in the euro area, for instance the Deutsche Mark and the French franc. For short-term instruments, we anticipate a deep and liquid European money market, which will ensure very similar short-term interest rates for comparable instruments and credit risks. Until 1 January 1999, we will see further convergence of short-term interest rates to narrow spreads among Member States of the euro area, because of the irrevocable fixing of exchange rates, which will cause such differences to disappear within the euro area. Developments in this market segment will also be strengthened by the ESCB's operational framework for open market operations, which will be based primarily on reverse transactions and the implementation of the new payment system called TARGET (the Trans-European Automated Real-time Gross settlement Express Transfer system) in all participating countries. In this context the role of the euro vis-a-vis so-called third currencies, such as the Japanese yen and the US dollar, will receive increasing public attention. The ESCB will take a neutral stance. It will neither promote nor hinder the development of the euro as an international currency. The ESCB will accept the international role of the euro as it develops through market forces. There will be no deliberate policy of challenging third currencies. However, by being successful in maintaining price stability, the ESCB will also automatically foster the role of the euro as an international currency. We are not currently participating in a formal exchange rate arrangement with third countries outside the EU, for instance with the United States, and we consider it very likely that this situation will remain the same for the foreseeable future. Moreover, the European Ministers of Finance have agreed only to issue so-called orientations for exchange rate policy in exceptional circumstances, such as a clear and sustained misalignment of the euro. Experience of fixed exchange rates supports the view that target zones are vulnerable to speculative capital movements and could become inconsistent with the primary objective of price stability. In its monetary policy strategy, the ESCB, therefore, does not specify a target or target zones for the exchange rate of the euro. This follows from our clear mandate to maintain price stability. The exchange rate will mainly be an outcome of the economic process and of economic and monetary policies. The lack of a formal exchange rate target does not imply that the exchange rate of the euro will be unstable or volatile. Let me stress that price stability in the euro area is the best contribution the ESCB can make to a stable international monetary system and an externally stable euro. The Governing Council cannot therefore conduct an exchange rate policy separate from its monetary policy strategy. Rather, the monetary policy strategy comprises a thorough analysis of exchange rate developments. The effective exchange rate of the euro area will be a key indicator within the stability-oriented monetary policy strategy of the ESCB. Based on its monetary strategy, the ESCB will be able to conduct a successful monetary policy, which takes into account the development of the exchange rate of the euro in an appropriate manner, as one of the determinants of price developments in the euro area. The success of EMU and of the single currency will clearly depend on the establishment of a stability culture in Europe. This will facilitate the conduct of the stability-oriented monetary policy over the coming years and in particular support economic policies in achieving high international standards in terms of economic growth and employment. To the extent that the ESCB is successful in maintaining price stability, it will also foster the use of the euro as an international currency and contribute to its stability. I am convinced that the euro will follow a long European tradition of stable currencies. Its success will not come overnight. But over the coming years, stable prices in the euro area are likely to guarantee that it is widely used by Europeans and international investors.
r981222a_ECB	euro area	1998-12-22T00:00:00	ECB Press conference: Introductory statement	no_info	0	Ladies and gentlemen, the Vice-President and I are here today to report on the outcome of today's meeting of the Governing Council of the European Central Bank at which we took the opportunity to finalise a number of issues of a rather technical or legal nature ahead of the forthcoming Changeover Weekend. Let me first turn to the Governing Council's discussion on On 1 January 1999 the ESCB will assume responsibility for defining and implementing the single monetary policy of the euro area. The Governing Council of the ECB deemed it appropriate to announce in advance the interest rates that will apply to the monetary policy instruments of the ESCB as from the start of Stage Three. This should eliminate any remaining uncertainties about the monetary policy stance of the ESCB and contribute to a smooth changeover to Stage Three of Economic and Monetary Union. As you have already been informed, the following were taken: With respect to the interest rates on the which are designed to form a corridor for movements in short-term money market rates, the Governing Council had to consider two aspects. First, it needed to signal clearly its monetary policy intentions. These were expressed by setting the rate for the marginal lending facility at 4.50% and the rate for the deposit facility at 2% for the start of Stage Three. Hence, the corridor for movements in short-term interest rates is asymmetric towards the upper boundary. Determining these rates was also necessary in order to provide successors to the official national central bank rates previously used as reference rates in certain legislation and contracts in some Member States. Second, however, the Governing Council also had to consider the possibility that market participants may need some time to get used to the new environment for monetary policy. In principle, cross-country deviations of short-term interest rates will not exist in Stage Three, as intra euro area arbitrage should be expected to prevent this. However, the many novelties related to the changeover make it difficult to foresee whether the euro area money market will indeed work in a fully integrated way immediately from the very first day of Stage Three. For this reason, the Governing Council has decided to use a relatively narrow corridor of interest rates on the standing facilities of the ESCB in the first three weeks of Stage Three as an automatic device to reduce the maximum range of fluctuations in the overnight interest rate. Accordingly, we have temporarily designed an exceptional corridor of only 50 basis points, with the interest rate for the marginal lending facility at 3.25% and the interest rate for the deposit facility at 2.75% which we intend to terminate on 21 January 1999 . Concerning the decision to set the level of the interest rate for the first of the ESCB at 3%, it may be recalled that on 3 December 1998, in a co-ordinated decision, all national central banks participating in the single monetary policy lowered their key interest rates to 3% (with the exception of the Banca d'Italia, which reduced the discount rate to 3.5%). As explained by the ECB at that time, this joint reduction had to be seen as a de facto decision on the level of interest rates with which the ESCB will start Stage Three and which it intended to maintain for the foreseeable future. It was based on the common assessment that these interest rate reductions are in line with maintaining price stability in the euro area over the medium term. In this connection, it is to be pointed out that a rate of 3% is very low by historical standards. This should be seen as clear indication that the ESCB does not want to give any signal for a further easing in the foreseeable future. At today's meeting, taking account of the latest monetary, financial and economic data, the Governing Council confirmed these views. At this juncture, there are no signs to suggest either that current rates of increase in the HICP of around 1% would decelerate significantly, or, conversely, accelerate to levels which are inconsistent with the definition of price stability provided by the ESCB in October 1998. Let me provide you with a more The information coming from the data on signals a relatively smooth path for M3 growth in 1998, compatible with continued price stability. In particular, the latest three-month moving average annual growth rate of M3 stood at around 4.5%. This was exactly in line with the reference value set by the Governing Council at its last meeting. With respect to the other pillar of the ESCB's monetary policy strategy, the various indicators confirm the assessment of developments in monetary data. The further reduction by almost 20 basis points since the end of November to a level of 3.9% on 21 December, as well as the downward shift in the can be regarded as a sign that markets expect the environment of price stability to continue. From the point of view of the Governing Council, it is an encouraging signal that financial market participants are apparently prepared to attribute a credibility bonus to our stability-oriented monetary policy shortly before its official start. At the current juncture, the outlook for the euro area economy is still very much influenced by the uncertainties surrounding the evolution of the in 1999. These uncertainties have affected negatively indicators of in the euro area and have fuelled expectations of a slowdown in economic activity in the short term. Very recently, a first estimate of in the euro area in the third quarter of 1998 has been released by EUROSTAT, suggesting a growth rate of 2.4% against the third quarter of 1997. This would be around one-half of a percentage point lower than the average growth rate of 3% in the first half of 1998, compared with the first half of 1997. Other indicators of real activity were mixed up to November. While point to a less optimistic assessment of growth prospects, remained high and continued to increase at a broadly stable pace up to September, i.e. the latest month for which data are available. Also, the decline in after having paused in the summer months, resumed, with the rate of unemployment decreasing from 10.9% in September to 10.8% in October. The factors underpinning the currently low increases in the HICP continued to include falling energy prices, downward movements in producer prices, subdued wage growth and slight decreases in unit labour costs. On balance, the overall environment described above does not point to significant upward or downward pressure on prices in the short term, as also reflected in all available forecasts for 1999. Nevertheless, factors contributing to on both sides need to be taken into account. On the one hand, downward risks relate to the global environment and potential repercussions on the euro area, for example via import prices and further pressure on producer prices. These developments will be monitored closely. On the other hand, unexpected upward pressure on wages and a relaxation of the fiscal stance would clearly alter the general environment. Therefore, we will also carefully monitor the outcome of ongoing wage rounds, the plans for fiscal policy in 1999 and over the medium term, as well as their implementation towards compliance with the Stability and Growth Pact. the actual situation, characterised by monetary growth compatible with continued price stability and the absence of immediate upward or downward pressure on prices, justifies maintaining the current stance of monetary policy, with an ECB interest rate of 3% for the main refinancing facility. As we indicated in the ECB press release of 3 December 1998 , the intention was also to maintain this rate "for the foreseeable future". Indeed, monetary policy in Stage Three starts with interest rates which are very low by historical standards. Let me now give the floor to the Vice-President to report on various aspects of the On 11 December 1998 the ECB issued a press release on the practical issues relating to the forthcoming Changeover Weekend as a follow-up to the information provided in the press release issued on 3 November 1998 . At its meeting today, the Governing Council took stock of the state of the preparations of the ECB and of the national central banks and took note of the very detailed planning which has been co-ordinated by the special Changeover Weekend Committee which the Governing Council set up in November. The Governing Council also took note of the outcome of the recent "dress rehearsal", which had simulated the full operational activity of the ESCB using normal systems and procedures and, if they were to fail, contingency procedures. In line with the announcement made in the Joint Communique issued on 2 May 1998 - by the Ministers of the Member States adopting the euro as their single currency, the Governors of the central banks of those Member States, the European Commission and the European Monetary Institute - the Governing Council reconfirmed today that appropriate market techniques would be used to ensure that on 31 December 1998 the market exchange rates, recorded during the teleconference held between 11 a.m. and 11.30 a.m. (C.E.T.) and used for calculating the daily exchange rates of the official ECU will be equal to the ERM bilateral central rates. These bilateral central rates were published in the Joint Communique in the form of a parity grid. The ECB has also been involved in the testing of the procedures to be applied to the fixing of the irrevocable euro conversion rates so as to minimise the likelihood that technical problems might arise on 31 December 1998 . As part of the process of fixing these rates, the Governing Council - in consultation with the General Council of the ECB - will adopt by special teleconference its formal Opinion on a proposal from the European Commission, which the ECB President will deliver personally to the specially convened session of the Council of the European Union in Brussels in the early afternoon of 31 December 1998. The ECB and the NCBs will contribute to the efforts to publicise the information on the irrevocable euro conversion rates by publishing them on their respective web sites. Contemporaneously, the ECB will send a S.W.I.F.T. broadcast message to the whole banking community in the world to confirm the rates of the eleven currencies against the euro. The Governing Council agreed that, as of 1 January 1999 , the ECB will fully change over to the euro. As a consequence, the staff of the ECB will be remunerated in euro with effect from that date. The Governing Council took stock of the final preparations being made for the calculation of the Euro OverNight Indexed Average interest rate - to be more simply known as EONIA. This will be calculated on the basis of data supplied by a panel of banks in the European Union. The EONIA will be published each day, starting on Monday, 4 January 1999 . With the start of Stage Three, banknotes and coins denominated in the national currencies of the eleven participating Member States will become sub-divisions of the euro from that date onwards. Although euro banknotes and coins will not be put into circulation until 1 January 2002, from 1 January 1999 the right to authorise the issue of national banknotes - and the right to approve the volume of national coins to be issued - will belong to the Governing Council of the ECB. With regard to the issue of national banknotes during the three years until euro banknotes are put into circulation, the Governing Council agreed today to develop a set of common procedures by the spring of 1999 to be followed by the participating national central banks when requesting authorisation to issue national banknotes. Similarly, on an annual basis, the national central banks will submit estimates to the ECB of the volume of national coins to be issued. In connection with the preparations for the 2002 cash changeover, the Governing Council addressed the issue of "front-loading", i.e. the distribution of euro banknotes and coins prior to 1 January 2002 to certain target groups. A final decision will be taken in the first week of 1999. The Governing Council agreed that the 1998 Annual Report covering the first six months of the life of the ECB and the transition from the EMI will be released to the media on Thursday, 15 April 1999 . It was also agreed to release the ECB's first Monthly Bulletin on Tuesday, 19 January 1999 . The Governing Council took the opportunity of the forthcoming introduction of the euro on 1 January 1999 to review and adjust existing swap agreements between euro area central banks, on the one hand, and the Federal Reserve System and Norges Bank, on the other hand. First, the Governing Council jointly agreed with the Federal Reserve System that the existing bilateral agreements of six euro area national central banks - namely, the central banks of Belgium , Germany , France , Italy , the Netherlands and Austria - with the Federal Reserve System will be allowed to lapse as they expire. Second, the current swap agreements between euro area national central banks and Norges Bank will be replaced by a new swap agreement between the ECB and Norges Bank amounting to EUR1,535 million as from 1 January 1999 . The Governing Council approved the ECB's budget for 1999, which gives the ECB the green light to recruit around 150 additional staff (both permanent and temporary) needed to support the new operational activities which the ECB will take on from 1 January 1999 . This will bring the ECB's permanent staff to around 700, with nearly 50 limited contract staff. We stand ready to take any questions you might have. Mr. Duisenberg, you said that the Council wanted to give a clear indication that the ESCB does not want to give any signal for further easing. The asymmetric range of interest rates around the 3%, is this an indication based on today's knowledge that the next move in interest rates at some point in the medium term may well be upwards rather than downwards. Is that the signal the asymmetric range is supposed to give? No, that is not a signal that it is supposed to give. The only signal that we do want to give is - and I cannot state it more clearly than I do now - is that markets do not expect a change in interest rates in the foreseeable future. Mr. Duisenberg, you said that as from 3 December all central banks have a key interest rate of 3% apart from the Banca d'Italia. Do you mean that on the basis of today's decision the Banca d'Italia should lower its discount rate or could it in principle continue like this until 31 December? Theoretically, yes; but in any case it is a matter that is entirely up to the Banca d'Italia to decide. It remains fully autonomous until 31 December of this year. Mr. Duisenberg, the summit in Vienna decided to adopt a European employment pact by June. What is your position on this initiative? My position is one of "wait-and-see" because I was not involved in it; and we shall wait until we see the "employment pact "- as I believe it is called - in the course of the next six months. There is a certain number of economies who are a little fearful of the start to the euro because they fear that it might make them less competitive in the short and medium term. How do you view this and what do you think the influence is going to be on the problems in Asia and those under pressure from the crisis in Asia? I assume that your question is really aimed at a potential upward pressure which the euro might suffer from at the beginning of next year. Well, I confess that we have no particular reason to think that that would happen. Consequently we have to wait and see what happens on the exchange markets. That depends mainly upon market forces; and there is absolutely no reason to believe there will be a sudden upward pressure, a sudden upward appreciation, in the value of the euro. In any case we have always said that we are looking for a sound, stable euro and of course we also hope that the other leading currencies, in particular the US dollar, will also be stable, sound currencies and remain as stable as possible. I can't really say anything more than that. A question for the President: Would you agree that deflation at present represents a greater danger to the euro area than inflation? And if that danger becomes imminent, what will you do about it? As I already stated in my introductory remarks, we see at the present time no signals either for inflation to move downwards, nor for it to move in an upward direction. So, your question precisely was: would you agree on that? The answer is: I don't agree. It was a very rapid worldwide portfolio shift into the euro. What will this do to your 4.5% reference value for the growth in M3? If there's very rapid investment worldwide in the euro, people moving their portfolios into euro, will this make your monetary target unsustainable? That would depend on the size. But we would, of course, try to counter such a very rapid movement into the euro to the extent possible. The reference value is meant for the medium term; it is not meant to be changed rather quickly. We have said we will reassess the validity of the reference value in December next year. Mr. Duisenberg, I wanted to ask about this asymmetric corridor. I didn't quite understand what you said, perhaps. Why have you opted for an asymmetric corridor if your purpose was not to say that the inclination of the ECB would be in a particular direction? The basic decision, really, is to make it a band of 250 basis points. That cannot always be placed precisely around the current repo rate. Although we intend to maintain it for the foreseeable future, at some time it will be changed, that is sure. There will come a moment in time when the repo rate may be changed and then the symmetry would have been lost anyway. So we do not give so much prominence to the idea of symmetry around a rate which is set every two weeks. And if - at any rate - you were to interpret it as a move which would signal that markets should not expect a further easing of monetary policy in the near future, then that interpretation would not be unwelcome to us. Mr. President, we are still learning, and that's why I'm asking you the question. Are there reasons - other than inflation in the conjuncture - why interest rates might rise? If, for example, too much money were to flow from Europe to the United States where interest rates are higher? Could that in given circumstances be a reason? I'm asking the question because we are still learning. The earlier question pointed in the opposite direction - i.e. that money would flow to Europe rather than the other way around. If it were to flow away, because interest rates elsewhere were more attractive and given the risks for the exchange rate that would go along with that, then it could happen that at some point there would be repercussions on the growth rate of the monetary aggregate. And if it were also to have an impact on other economic valuables, then that could lead to a reaction in monetary policy. But I cannot indicate when, where and how much. Mr. Duisenberg, we are very near in approaching this historic moment of the start of Stage Three of Monetary and Economic Union; what advice would you give to governments at this moment so that the euro is a success, and do you think that fiscal policies are now adequate to achieve this success? My advice (if I am permitted to give advice to governments, and if I am not permitted, I will give it anyway) is to stick to their policies as they have outlined them themselves in the Stability and Growth Pact: that is, to continue to exude an image of continuity and stability and the political impetus to achieve - over the medium term - balanced budgets or even a small surplus; and what I would advise governments to do is to inspire that feeling of continuity and stability sooner rather than later. : Mr. Duisenberg, could you just say a few words about expectations concerning the introduction of the euro in ten days? You know that there are still a lot of people in Germany who expect the euro to be not as strong as the Deutsche Mark. Could you just say some words about your personal expectations? Will it be a strong currency and what do you think about the competition against the yen and the dollar? How will they live together? Well, we do not think about the exchange rates of the big currencies in the world in terms of competition. What we do hope and are after is that the euro will be a stable currency, more than anything else. Stability in the first place that it will be a currency characterised by price stability in the entire euro area and, as a result, then we would hope that it would also be a stable currency in its external relations, that is vis-a-vis the dollar and the yen in particular. Mr. Duisenberg, the ECB has set a very narrow band for the first three weeks of its existence. I have two questions concerning that: First one, would it be desired from your point of view that the national central banks would take similar measures for the time of the changeover weekend, and second, the narrow band is valid only for three weeks so far. Do you foresee or is it a possibility that the period in which such a narrow band might be needed would be longer? Well, as I said, it is the strong intention of the Governing Council to terminate this narrow band on 21 January. We think at the moment that a three-week period for markets to get used to the new environment and to become full players in the new game is enough. So we do not envisage that the period will be longer. No, we strongly intend to terminate this narrow band after three weeks. To totally exclude that it might be longer of course we can not do. Would you desire similar measures by the national central banks? No, we have not discussed that, and I would also expect the national central banks, also in the last four working days of this year, the transition period, to stay calm. Mr. President, does the fact that you see neither a need for easing nor a need for tightening, indicate that you think the euro is being launched under optimal economic conditions, and if not, what would make conditions more optimal? Well, the euro is being launched as far as Europe is concerned under optimal economic conditions. We would have been pleased if the international environment had been a little bit calmer than it has been over the past three to four months, but that by itself has not at all perturbed the process of the changeover. On the contrary, as I have repeatedly said, it is remarkable - and we are grateful for that - the extent to which the international turmoil has had no impact whatsoever on exchange rate developments inside the euro area and interest rate developments inside the euro area. (translation) Mr. Duisenberg, can you tell us what will be the theme of the ECB's first Monthly Bulletin and what other publications is the ECB planning to produce? From the Bundesbank we are familiar with weekly balance sheet statements, monthly money supply figures, etc. Or are the data not yet ready, if the ECB has only the September data available? When will this be available? When shall we receive information in the form of regular documentation? The Monthly Bulletin will certainly contain the first time and every month thereafter an assessment of the current economic situation, similar to the one I have given to you in my introductory statement of today. The publication date of the Monthly Bulletin will be announced in a relatively short period from now, when we have finalised our schedule. The Monthly Bulletin will be complemented of course by the weekly publication of a consolidated balance sheet for the entire European System of Central Banks and then, in addition, we will publish new data when they become available; for the monetary aggregate, for example, this will be every month. We will publish them separately. Mr. Duisenberg, the recent reduction in interest rates to 3% has led to some observers asking questions about the transparency of the ECB. Could you say briefly once again why this reduction had to take place. Was it due to the economic cycle? Do you not see a risk that the ECB's strategy could be criticised as being a cyclically-oriented monetary policy, which is then susceptible to slight political pressure, if it has no clear and binding link to the money supply, like the Bundesbank's strategy up until now? I would deny that with all the force I have in me. As I have explained, as far as the co-ordinated reduction in key interest rates to 3% is concerned, I would rather be inclined to expect that it would be regarded as a remarkable consensus among the European national central banks, even weeks ahead of their obligatory consensus, which will start on 1 January 1999. In this connection, I almost have a counterquestion: as regards the so-called lack of transparency, don't you mean, rather, that it was so totally unexpected by the markets and the media? And that that is what is now being called a lack of transparency. We are rather pleased about the unexpectedness of the move.
r981231a_ECB	euro area	1998-12-31T00:00:00	Statement at the joint press conference following the ECOFIN meeting	no_info	0	Council adopted the irrevocable conversion rates for the euro. It did so upon a proposal from the Commission of the European Communities and after consultation of the European Central Bank (ECB). Earlier today the Governing Council of the ECB held a meeting by means of a teleconference to approve the ECB's legal Opinion. I have delivered that ECB Opinion personally to the Council. Today's decision is a historic one. In the end it turned out to be almost a formality - different from what many of us might have expected barely a year ago. First, this can be attributed to the credibility of the convergence process. Second, we also owe this to the pre-announcement early in May of this year that the ERM central rates would be used for today's process to fix the conversion rates. Today's decision was the last of many decisions to make possible the introduction of the euro, a new currency for almost 300 million people in eleven countries. This last decision was as simple as it is far-reaching. A currency is far more than just a medium of exchange, a unit of account and a store of value - important though these properties already are. A currency is also part of the identity of a people. It reflects what they have in common, now and in the future. May the euro become a unifying symbol for the people of Europe. I also feel quite touched - personally - by today's events. I have been involved in the process leading to the creation of the single currency for more than twenty years now, first as a Minister of Finance and later as a central banker. Now we have made it. From now on, monetary policy, usually an essential part of national sovereignty, will be decided by a truly European institution, the ECB. This will be a great challenge. I can assure you that we shall do our utmost to make the euro a currency in which European citizens will be able to place their trust. The euro has to become a currency which will keep its value over time and contribute to a stable, prosperous and peaceful Europe.
r990114a_ECB	euro area	1999-01-14T00:00:00	The euro has arrived	bank	0	The euro has arrived! This was a very happy occasion. Although it has yet to appear in the tangible form of new banknotes and coins, there is no doubt that the new currency is set to play an important role, both in the euro area and beyond. After years of intensive preparation and successful economic convergence, a single monetary policy for the entire euro area determined by the Governing Council of the European Central Bank (ECB) is now being implemented by the Eurosystem, which is made up of the ECB and the eleven national central banks (NCBs) of the participating Member States. The technical and logistical challenges posed by the changeover to the euro over the weekend of the New Year's Day public holiday have been successfully met. During the changeover weekend the Eurosystem monitored the conversion activities at the ECB, at the participating NCBs and at certain private institutions which - in the view of the Eurosystem - represent the core of the financial infrastructure in the euro area. Regular contacts were also maintained with other EU and non-EU central banks and the European Commission. This monitoring activity during the changeover weekend was justified by the concern that, owing to the extraordinary concentration of operational risks within all the institutions of the banking and financial industry, events could occur immediately prior to the launch of Stage Three of EMU which might either impinge on the orderly conditions in the monetary system or create risks for financial stability at the very start of Monetary Union. The decision-making bodies of the ECB stood ready to gather for extraordinary meetings via teleconference, if necessary. During the changeover weekend, no incidents that could have impaired the smooth start of Stage Three were reported to the Eurosystem. The successful navigation of the changeover weekend was the result of considerable and thorough preparation by a very large set of public and private institutions, including the ECB and the NCBs. Indeed, the introduction of the euro marks the culmination of a great deal of successful preparatory work over a period of many years. This has been reflected in the positive and confident way in which financial markets have received the euro in the first two weeks of Monetary Union. Although some minor problems of a technical nature could not be avoided, overall the TARGET payments system has functioned well and contributed substantially to the integration of the euro money market. A number of "teething troubles" have been experienced as participants - in both commercial banks and central banks - adapt to the new system and environment. Nevertheless, during these early days of Monetary Union, TARGET has handled more cross-border payments than were anticipated, thereby demonstrating its processing capacity. With regard to monetary operations, on 4 January the Eurosystem announced its first main refinancing operation, which was successfully completed on the following day. A successful monetary policy must always be forward-looking, acting to contain threats to price stability before they become entrenched. Therefore, today I should also like to look to the future. Monetary Union is a unique and significant achievement. It promises a credible and lasting environment of price stability for almost 300 million people. This stable environment is the foundation for sustainable economic growth, better employment prospects and improvements in the standard of living throughout the euro area. Price stability is a necessary condition for improved economic performance in all these areas. I am confident that the single monetary policy will make the greatest possible contribution in this regard. The stability-oriented monetary policy strategy announced by the Governing Council last year, and which is now guiding monetary policy decisions, was designed with this goal in mind. Nevertheless, monetary policy alone - however well designed and implemented - cannot solve Europe's economic problems. Appropriate fiscal policies and structural reforms implemented by national governments are vital and considerable progress is required in these areas. Moreover, continued wage moderation in both the public and private sectors would contribute to reducing the unacceptably high level of unemployment in many parts of the euro area. Unemployment in the euro area is largely structural in origin. Implementing an inflationary monetary policy will not solve this problem, but rather exacerbate it over the medium term, as inflation distorts investment and saving decisions, raises the risk premium in long-term interest rates and undermines the allocative efficiency of the price mechanism. Only effective structural policies that improve the flexibility and efficiency of labour and goods markets can reduce unemployment in a successful and lasting manner. I appreciate that these structural reforms are not always easy to implement, not least because the benefits they yield occur mainly in the medium to long term. However, they are unavoidable. In those euro area countries that have taken up the challenge of structural reform, unemployment has fallen significantly. Other euro area countries should and must take note: structural reform throughout the euro area is fundamental to the success of Monetary Union and to improving Europe's economic performance. The Treaty on European Union assigned the ESCB the primary objective of maintaining price stability in the euro area. You may rest assured that the Governing Council of the ECB is totally committed to fulfilling this mandate. In order to meet this commitment, the Governing Council has adopted a stability-oriented monetary policy strategy consisting of three main elements. First, in order to give clear guidance in relation to expectations of future price developments, the Governing Council has announced a quantitative definition of its primary objective. Defining price stability also serves the principles of transparency and accountability. It clarifies how the Treaty's mandate is interpreted by the Governing Council and gives the public clear guidance concerning its assessment of the success of the single monetary policy. Price stability has therefore been defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. Needless to say, deflation - that is, a persistent fall in the price level - would not be consistent with price stability. The annual rate of inflation in the most recent available data, measured on this harmonised basis, is consistent with the definition of price stability. The Eurosystem has therefore enjoyed the good fortune to assume monetary sovereignty in the euro area in an environment of price stability, owing to the successful process of disinflation and convergence achieved by national central banks during the last decade. Price stability is to be maintained over the medium term. This reflects the need for monetary policy to be forward-looking and to have a medium-term orientation. It recognises the fact that monetary policy is not able to control all short-term movements in the price level. To maintain price stability according to this published definition, the Governing Council's strategy relies on two pillars. First, a prominent role has been assigned to money, in recognition of the monetary origins of inflation over the longer term. This prominent role is reflected in the announcement of a quantitative reference value for the growth of a broad monetary aggregate, namely M3. The first reference value has been set at an annual rate of 4 1/2%. The reference value for M3 is consistent with the maintenance of price stability over the medium term, while allowing for sustainable output growth and taking account of the trend decline in the velocity of circulation of M3. Monetary policy will not react to deviations of monetary growth from the reference value in a "mechanistic" way. In the first instance, such deviations will be thoroughly analysed for the signals that they offer with regard to the prospects for price developments. If the deviation points to a threat to price stability, monetary policy will react in a manner appropriate to counter this threat, rather than attempting to eliminate the deviation of monetary growth from the reference value in the short term. The second pillar of the monetary policy strategy is a broadly-based assessment of the outlook for price developments and the risks to price stability in the euro area as a whole. The Governing Council of the ECB recognises that it is important, in parallel with the assessment of monetary growth in relation to the reference value, to look at a wide range of other economic and financial indicators, including economic forecasts. This systematic analysis of all other relevant information about economic and financial conditions will ensure that the Governing Council is as well informed as possible when taking monetary policy decisions. A moment ago, I emphasised the importance of the formal introduction of the euro on New Year's Day. However, co-operation among European national central banks has been close for a long time and, among the NCBs of the countries participating in Stage Three, has become increasingly so in recent years and months. The co-ordinated interest rate cut at the beginning of December last year is an illustration of this co-operation. This co-ordinated interest rate move was thoroughly discussed by the members of the Governing Council of the ECB. De jure, the decision to change interest rates had to be taken by the national central banks, but, de facto, Monetary Union existed in all but name prior to its formal implementation on 1 January 1999. At its first December meeting, the Governing Council made a thorough assessment of the latest monetary data and other economic indicators, noting in particular the decline in business confidence in the euro area arising, in part, from the deteriorating external environment. This deterioration in the international economy has its origins, to a large extent, in the Asian and Russian financial crises. Following its appraisal of both pillars of the monetary policy strategy, the Governing Council concluded that key central bank interest rates of 3% would best serve the maintenance of price stability in the euro area over the medium term. National central banks adjusted their interest rates accordingly. This co-ordinated interest rate move allowed the ECB to announce that the new level of interest rates would prevail "for the foreseeable future". In other words, in the absence of further disturbances to the economy or the emergence of new and unanticipated threats to price stability, this level of interest rates should be appropriate to fulfil the primary objective of maintaining price stability over the medium term. This announcement helped to resolve some uncertainty at a time when the practical, technical and logistical tasks necessitated by the changeover weekend were uppermost in our minds and in those of market participants. Following the second Governing Council meeting in December, I was therefore able to announce that the interest rate on the first main refinancing operation of the Eurosystem would also be 3%. Moreover, the interest rates for the deposit and marginal lending facilities - which, in normal circumstances, would constitute the upper and lower bounds for overnight market interest rates - were set at 2% and 4.5% respectively. As a transitional measure to help the financial system adjust to the new institutional environment resulting from the transition to Stage Three, from 4 January until 21 January a narrower band of 2.75% to 3.25% has been set for the rates on the deposit and marginal lending facilities. During the first few days of Stage Three we observed a relatively large recourse by credit institutions to these facilities. This was to be expected, given the relatively narrow spread between the Eurosystem's marginal lending facility and the overnight money market rate. Although the narrow corridor is intended to facilitate the transition by market participants to the new regime, over a longer period of time such a measure would hamper the development of an efficiently functioning euro area money market. We therefore intend to terminate the transitional measure of the narrow band next week, in line with our pre-announced schedule. At the meeting of the Governing Council of the ECB on 7 January it was confirmed that the 3% rate would apply to the Eurosystem's next two main refinancing operations. This level is based on the Governing Council's current assessment of the economic situation, viewed from the perspective of the stability-oriented monetary policy strategy. First, monetary growth in recent months has been broadly in line with the quantitative reference value. This, together with further analysis of the monetary data, signals that monetary developments are consistent with the maintenance of price stability over the medium term. Of course, monetary growth relative to the reference value should always be interpreted in a medium-term context. Short-run deviations from the reference value are inevitable and, while being monitored and assessed carefully, would not automatically signal an immediate threat to price stability. Nevertheless, it is reassuring that the three-month moving average of the annual growth rates of M3 up to November 1998 stood at 4.7%, very close to the reference value of 4 1/2%. Second, as regards the broadly-based assessment of the outlook for price developments, a number of indicators have recently proved noteworthy. Following the co-ordinated interest rate cut at the beginning of December, long-term interest rates have also fallen, suggesting that financial markets viewed the cut favourably and considered it to be consistent with the credible maintenance of price stability over the medium term. The indicators emerging from the real economy are mixed. Overall, real GDP growth in the euro area weakened in the third quarter of last year as compared with the first half. While business confidence, orders and capacity utilisation have developed less favourably in recent months, the latest data for employment, retail sales and consumer confidence suggest more favourable trends. Against this background, the annual rate of increase in the HICP for the euro area slowed further in November, falling to 0.9% as compared with 1.0% in the previous two months. This reduction in the rate of increase of the HICP resulted from further moderation of food price increases and continued falls in energy prices. On balance, the general environment continued to suggest that there is no significant upward or downward pressure on the price level. Of course, the Governing Council is fully aware that potential risks to price stability do exist. On the one hand, the external environment could again deteriorate if the financial crises in Asia and Russia were to spread or deepen further. On the other, fiscal indiscipline by national governments failing to respect the Stability and Growth Pact or inflationary wage settlements could threaten the 2% upper bound of the Eurosystem's published definition of price stability. The Governing Council is monitoring all these developments very closely and will react in a prompt and pre-emptive manner to ensure that neither inflationary nor deflationary pressures take hold. Changes in the external environment - that is, in the economic condition and performance of countries outside the euro area - may affect the outlook for price developments within the euro area, and thereby the conduct of the single monetary policy. The effects of financial crises on external demand and business confidence are a notable recent example. However, this relationship works in both directions. The introduction of the euro has created a single currency area of a size and importance and with a population broadly similar to the United States. An event of this magnitude is likely to have major implications for the rest of the world, especially the international financial system. In the remainder of my speech, I shall consider some of these implications. In its monetary policy strategy, the Eurosystem deliberately does not specify a target for the exchange rate of the euro against the US dollar or the Japanese yen. Although it will always stand ready to exchange views with other central banks concerning the development of exchange rates, there are no explicit or implicit target zones for the euro exchange rate against non-EU currencies. The euro area is a large, relatively closed economy, similar in this respect to the United States. Pursuing a target for the euro exchange rate could easily jeopardise the maintenance of price stability. The level of interest rates required to sustain an exchange rate target may, in some cases, not be that which best serves the maintenance of price stability over the medium term. I might add that it may also conflict with the achievement of other domestic policy objectives. It could be very painful if it were necessary to raise interest rates in a recession in order to defend the exchange rate of the euro. Finally, it should be acknowledged that today we are living in a world with high capital mobility. Exchange rate arrangements that could be implemented thirty years ago may no longer be feasible. The required amount of foreign exchange reserves could simply be too large. Within the Eurosystem's monetary policy strategy, the euro exchange rate is the outcome of current and expected economic policies and developments in both the euro area and elsewhere, and of the market participants' perception of these policies and developments. Supporting the Eurosystem's approach, the Ministers of Finance, who are assigned ultimate responsibility for the exchange rate of the euro by the Maastricht Treaty, have agreed not to issue so-called "general orientations" for the exchange rate policy to the Eurosystem other than in clearly exceptional circumstances, such as when there is a substantial and persistent misalignment of the euro against other currencies. However, the absence of a target for the exchange rate of the euro against major international currencies does not imply that the ECB ignores or is indifferent to the exchange rate of the euro vis-a-vis the US dollar or the Japanese yen. The exchange rate will be monitored as one of the indicators of monetary policy, within the broadly-based assessment of the outlook for price developments that constitutes one pillar of the overall strategy. Nor does the absence of exchange rate targets suggest that these rates will necessarily be unstable or volatile. On the contrary, the pursuit of stability-oriented monetary and fiscal policies puts in place one of the major prerequisites for stable euro exchange rates. The Eurosystem's stability-oriented monetary policy strategy is a significant contribution in this regard. Absolute stability of the exchange rate is, of course, impossible to guarantee. It would not even be desirable if, for example, the United States and the euro area were to go through business cycles that were not fully synchronised. This possibility cannot be ruled out, as even recent history has shown. We are aware that the emergence of an international role for the euro may sometimes complicate the conduct of monetary policy if a significant proportion of the money stock is circulating outside the euro area. Nevertheless, the Eurosystem will accept the international role of the euro as it develops as a result of market forces. To the extent that the Eurosystem is successful in meeting its mandate and maintaining price stability, it will also automatically foster the use of the euro as an international currency. The pace at which the euro will emerge as an international currency is hard to predict. If history is taken as a guide, it will be a gradual process, but it is possible that, in today's more dynamic and flexible financial markets, the euro could assume a prominent role more rapidly than past experience might suggest. Finally, I should like to discuss briefly the role of the ECB in international co-operation. As the representative of a monetary union comparable in size and importance to the United States and as the central bank managing a currency that is likely to play a large and increasing international role, the ECB will inevitably play an important role in the international financial system. The ECB will embrace the implied responsibility, but at the same time it will have to be modest and realistic in its actions on the international stage. Its role will develop over time, drawing on the experience of those national central banks that have played an important international role in the past. At the end of last year, the ECB was accorded observer status at the International Monetary Fund (IMF). Full membership of the IMF is restricted to individual nations. Nevertheless, this observer status will allow the ECB to participate fully in the relevant work and assessment by the Fund of economic policies in the euro area and beyond. The ECB also participates in the work of the G-7, the G-10, the Bank for International Settlements and the OECD. It enjoys good bilateral relations with other central banks throughout the world. The ECB stands ready to participate fully in, and contribute to, international policy discussions. It will, of course, offer expertise and exchange views, when and where appropriate. However, in general, the best contribution the ECB can make to a stable international monetary system, including stable exchange rates and well-functioning international capital markets, is to maintain price stability within the euro area. Fulfilling the mandate assigned to the ESCB by the Treaty on European Union will help the ECB to meet its international responsibilities. The euro has arrived. The Governing Council of the ECB has taken up the reins of monetary sovereignty in the euro area and a truly single monetary policy has been in place for two weeks. For those of us who have been involved in the long and at times arduous preparations for Monetary Union, this is an occasion which provides a sense of satisfaction. However, as I have outlined in this speech, in many ways the real work of the ECB is only just beginning. The stability-oriented monetary policy strategy is in place. I am confident that this framework will enable the Governing Council to fulfil the Treaty mandate of maintaining price stability. Meeting this mandate will ensure that the single monetary policy makes its best possible contribution to improving the standard of living in the euro area and helping to ensure the stability of the international financial system.
r990115a_ECB	euro area	1999-01-15T00:00:00	European economic and monetary union - latest developments	bank	0	It is a great pleasure for me to welcome you to the European Central Bank (ECB), at a time when the Eurosystem - that is, the ECB and the 11 national central banks (NCBs) of the Member States which have adopted the euro - has just started to assume responsibility for the conduct of monetary policy in the euro area. After their meeting in 1997 in Bangkok, this is the second time that Asian and European Finance Ministers are coming together with the aim of establishing closer political, economic and financial links between Europe and Asia. I very much appreciate this approach, since the process of rapid globalisation, with highly integrated financial markets, calls for strengthened co-operation between the two regions. Today, I should like to share some thoughts with you on recent developments surrounding the introduction of the euro. First of all, I should like to comment on the successful changeover to the euro only two weeks ago and its rapid acceptance by financial markets. Second, I shall focus on how we intend to accomplish our primary task of maintaining price stability across the euro area in an internationally challenging environment. Finally, I shall turn to the international aspect of Economic and Monetary Union (EMU). the Eurosystem has been responsible for determining monetary policy for the entire euro area, which has an overall population of almost 300 million people and a GDP which is roughly equal to that of the United States. The start of the euro has been successful. Such a smooth launch of the new currency was not widely expected until the very end of 1998. In the early afternoon of 31 December 1998, the Council of the European Union adopted the irrevocable conversion rates of the euro against the participating currencies. During the following three and a half days, over the so-called changeover weekend, all technical work required to create a single integrated euro area money market was implemented without any major incidents. Under very severe time constraints, the banking and financial community in the euro area and beyond, including the ECB and the national central banks, carried out the complex task of converting billions of electronic records and managing a variety of other logistical challenges. Large-value payment systems were adjusted to function in the new currency and the bulk of the outstanding public debt of participating countries was redenominated before the first trading day in euro started on 4 January 1999. The Eurosystem played a crucial role in this process. It was involved in a very large number of activities, including helping to compute and publish the irrevocable conversion rates. The ECB co-ordinated the orderly transition to the new currency within the Eurosystem. It conducted final tests, when required, and it launched the new infrastructure for payments and securities settlement. For this purpose, a "Changeover Weekend Committee" and a network of "central communication points" were created to gather and share information. Contacts were established with the central banks of non-participating EU Member States and of the Concertation Group - including the Bank of Japan - as well as the European Commission. The decision-making bodies of the ESCB stood ready to gather in extraordinary teleconference meetings, if necessary. As regards monetary policy operations, the Eurosytem announced its first main refinancing operation in the form of a fixed rate tender in the amount of E75 billion on 4 January, which was completed successfully on the following day. In the context of this operation, 944 Monetary Financial Institutions bid and, since a fixed rate tender procedure was applied, every institute was allotted a refinancing amount. In addition, the Eurosystem began successfully operating the euro area payment system, TARGET, which ensures the smooth settlement of cross-border payments in the euro area and, as such, has contributed substantially to the integration of the euro money market. After some "teething troubles", the financial community in the euro area is adapting to the system and the new euro environment. More than 5,000 credit institutions are currently participating directly in TARGET. The very rapid acceptance of the new currency by financial market participants in the first two trading weeks following its introduction has further contributed to the credibility of the Eurosystem. Such credibility, which already existed prior to the introduction of the euro, helps to explain why the euro area weathered the financial market turmoil relatively well in the second half of 1998. Propitious starting conditions within the euro area facilitated the task of the Eurosystem. In most of 1998 and at the beginning of 1999, the overall price climate has been very favourable, with neither risks of inflation nor signs of deflation. In addition, long-term interest rates have fallen to new historical lows and the whole yield curve has shifted downward. Of course, this favourable environment is facilitating our task of maintaining price stability across the euro area. Price stability is at the heart of the "stability culture" that has developed in Europe in the period leading to the adoption of the euro. This culture is not to be seen as an objective in itself but as a major prerequisite for sustainable growth and improved employment prospects in Europe. To meet the objective of maintaining price stability in the euro area in an effective and credible way, the Treaty establishing the European Community has endowed the Eurosystem with a high degree of independence. The counterpart of such independence is accountability and transparency vis-a-vis the European Parliament and the public at large. In terms of its institutional framework, the ESCB is based on the concept of a dual-layer central bank system consisting of the ECB and the 15 NCBs of the EU Member States. As regards the Eurosystem, its highest decision-making body is the Governing Council of the ECB, which meets every fortnight. It is composed of the six Executive Board members of the ECB and the Governors of the 11 participating NCBs. In addition, the General Council, comprising the members of the Governing Council and the Governors of all the national central banks in the European Union, including the four EU central banks not yet participating in the euro area, meets quarterly. By virtue of their involvement in the General Council, the four non-participating national central banks are associated with the relevant ESCB decisions, such as those relating to the new exchange rate mechanism ERM II. With regard to accountability and transparency, the Eurosystem goes beyond the requirements of the Treaty. In addition to my yearly appearance before the European Parliament to present the ECB's Annual Report, I shall take part in hearings at the European Parliament four times a year. Since summer 1998, a routine of holding monthly press conferences has been established, in which the Vice-President and I report on the decisions taken by the Governing Council of the ECB and explain the underlying reasoning. Our introductory statements at these press conferences are published without delay. In addition, the ECB will provide the public with a Monthly Bulletin, the first issue of which will be published next week. Let me now describe how we intend to meet our mandate to maintain price stability at the start of Stage Three of EMU. At the heart of our approach is our recently adopted and publicly announced "stability-oriented monetary policy strategy". Since the introduction of the euro implies a regime shift, the formulation of an appropriate monetary policy strategy was a complex exercise. Breaks in previously established economic relationships are bound to make our interpretation of euro area-wide data more difficult in the initial phase of Stage Three. The length of this transition period itself is difficult to ascertain. Economic agents may restructure their investment portfolios and adjust their expectations. The wage formation process may change and entrepreneurs could alter their traditional price-setting behaviour. Bearing this in mind, the Governing Council invested considerable effort in the design of a coherent framework, taking into account the specific circumstances of the shift to the new monetary regime. Let me briefly recall the main features of our monetary policy strategy. First of all, we have defined price stability as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%, which is to be maintained over the medium term. This definition constitutes a clear benchmark against which the public can properly assess the success of the Eurosystem in fulfilling the Treaty's mandate of price stability. It shows that the Eurosystem pursues a symmetric approach to deal with both inflation and deflation, and that the single monetary policy cannot, and should not, react to specific national developments. In order to maintain price stability according to this definition, the Eurosystem's monetary policy strategy is based on two pillars. First, money is assigned a prominent role, since monetary developments are the determinants of inflation in the medium to long term. Therefore, we have announced a reference value for the growth of a broad monetary aggregate, namely M3, in 1999. On the basis of our current economic forecasts, a growth rate of 4.5% has been set, which is consistent with price stability. However, the fact that it is a reference value and not a monetary policy target implies that monetary policy will not react in a mechanistic way to short-term deviations from this level. Second, a broadly based assessment of the outlook for price developments and of potential risks to price stability in the euro area also plays a major role. This is achieved by making use of a wide range of monetary, financial and economic indicators in the preparation of our monetary policy decisions. On the operational side of monetary policy, the ECB has recently set interest rates for the Eurosystem's monetary policy instruments. Consistent with the key central bank rates prevailing at the end of Stage Two of EMU, after the remarkable co-ordinated interest rate cuts carried out by euro area NCBs in early December last year, the benchmark level for the first main refinancing operation was set at 3%. We announced our intention to maintain this interest rate level for the foreseeable future. In addition, the Eurosystem uses standing facilities, namely the deposit facility and the marginal lending facility, to absorb and provide overnight liquidity respectively. The deposit rate has been set at 2% and the marginal lending rate at 4.5%. However, as a transitional measure aimed at smoothing the adaptation of market participants during the initial days of Stage Three of EMU, the corridor established by the interest rates for the Eurosystem's standing facilities has been kept narrow, with the deposit rate at 2.75% and the lending rate at 3.25%. Since such a narrow corridor hampers the development of an efficiently functioning euro area money market, we intend to terminate it next week, in accordance with our pre-announced schedule. The ESCB does not operate in a vacuum. If not adequately supported by other policy areas, namely fiscal, labour and structural policies, implemented mainly at the national level, the single monetary policy may become overburdened. Monetary policy needs to be supplemented by appropriate fiscal, labour and structural policies if it is to yield in full its welfare benefits to the euro area. This is a major prerequisite to improve the perspectives for sustainable economic growth and for tackling the unemployment problem. That is why I attach the utmost importance to the so-called Stability and Growth Pact. In this Pact, euro area Member States agreed to reduce their general government deficits to close to balance or even to create a surplus in the medium term. This is intended to enable the working of automatic stabilisers over the economic cycle while, simultaneously, respecting the limit of 3% on the public deficit/GDP ratio, as laid down in the Treaty. As regards labour and structural policies, the single monetary policy cannot solve Europe's unemployment problem by itself. Of course, a stability-oriented monetary policy can help to stabilise inflationary expectations and, thereby, hold interest rates at levels consistent with the highest possible non-inflationary growth rate. However, since Europe's unemployment problem is largely structural in origin, only structural reforms improving the flexibility of labour markets and supportive wage policies can provide the appropriate policy response. Let me now try to shed some light on the international aspect of EMU. Clearly, the newly designed monetary setting in Europe will have far-reaching implications not only for Europe and its citizens, but also for the world economy and the international community. Although, the introduction of the euro represents a major institutional change in the architecture of the international monetary system, it does not in itself imply a regime shift from the present managed floating exchange rate system. A number of observers consider that one important motivation behind EMU is the creation of a major international role for the euro. This assessment is largely incorrect. The ECB takes a neutral stance with respect to the international role of the euro. First of all, the euro represents a major contribution to the completion of a fully integrated single market, encouraging competition and innovation at the area-wide level, in an environment of prices which remain stable over time. The international role of a currency is a complex phenomenon. A currency can be used for different functions, as an anchor and reserve currency on the official side, and, on the private side, as an invoicing and vehicle currency for international trade, as well as a currency of denomination for financial assets. In addition, there are very different groups of economic agents which decide on the use of the currency, including governments, central banks, institutional and private investors, corporations and traders. At any rate, it will take time for the euro to develop its role as an international currency in its various functions. In principle, two basic factors will determine the future international dimension of the euro - risk and size. Economic agents may use the euro to hedge their risks through portfolio diversification. If international investors and borrowers consider that the euro will become a stable currency, they will hold euro assets to minimise risk in their internationally diversified portfolios. With regard to the size factor, a broad and liquid euro financial market may lead to a widespread use of the euro, which, in turn, would facilitate its development as a vehicle currency for trade and commodity pricing. The euro is likely to develop over time as an international currency used by the private sector, although the pace of internationalisation may vary depending on the function. As far as the future share of the euro in overall official reserves is concerned, it may be expected that central banks of non-euro area countries will also reassess their reserve management strategy in the light of improved global diversification opportunities offered by the new currency. Moreover, the euro might also assume a greater role as an anchor currency for other European countries which, formally or informally, intend to peg their exchange rate to the euro or to a (trade-weighted) basket of currencies which includes the euro as a large component. In this context, the euro may increasingly become part of foreign currency reserves held by central banks for diversification or pegging purposes. Let me turn to the institutional aspect. The euro area is a new counterpart in the context of international co-operation. By reducing the number of key players, the euro will simplify the international policy co-operation process between the major economies. In particular, it should make this process more efficient by facilitating the exchange of views and formulation of common understandings on economic and financial issues at the global level. Each of the main partners - the United States, the euro area and Japan - is in a position to speak for a comparatively large economic area and is similarly vulnerable to adverse shocks to the international financial system. A more balanced relationship between the major players might help to induce each of them to take on responsibility for contributing to a stable global environment. In many ways, the ECB as part of the Eurosystem is already represented in international institutions and fora. Although some decisions are still under consideration, formal and informal agreements have already been reached with the International Monetary Fund (IMF), the Organisation for Economic Co-operation and Development (OECD), the Bank for International Settlements (BIS) and in the G-7 and G-10 context. Most recently, the IMF has granted observer status to the ECB. The IMF, as the cornerstone of the international financial system, plays a key role in the process of multilateral surveillance of economic policies. Therefore, it is important for the ECB to be represented at the IMF from the outset of Stage Three of EMU, given the respective mandates of both institutions. I should also like to make a few remarks on the renewed interest in the concept of target zones for exchange rates among the main currency blocs, namely the United States, the euro area and Japan. In a world characterised by highly integrated and sophisticated international financial markets, there is serious doubt whether target zones for exchange rates are feasible. Apart from the obvious risks of undermining price stability, such exchange rate targets would, in essence, imply that domestic policy objectives would have to be subordinated to external requirements. This is the reason why the exchange rate is not an explicit aim of our monetary policy. This stance is based on the conviction that the exchange rate of the euro is the outcome, rather than an objective in itself, both of the economic, monetary and other policies pursued in the euro area, and of cyclical developments in the euro area and abroad. Of course, this does not mean that we shall neglect the exchange rate of the euro. Exchange rate developments are monitored carefully in the context of our broadly based assessment of future price developments. Moreover, the euro exchange rate plays a far smaller role in the euro area than it played in the individual Member States in the past, which is also a consequence of the fact that the euro area is larger in size and is therefore less dependent on external trade than each individual Member State was before. In line with the Eurosystem's approach to the euro exchange rate, the EU Ministers of Finance, who are ultimately responsible for the exchange rate policy of the euro, agreed in December 1997 to issue "general orientations" only in exceptional circumstances, such as in the case of clear and persistent misalignments of the euro. It seems to me we have not reached that stage.
r990118a_ECB	euro area	1999-01-18T00:00:00	Hearing at the European Parliament's Sub-Committee on Monetary Affairs on 18 January 1999	duisenberg	1	With the opening statement by the Chairperson of the Sub-Committee, Mrs. Randzio-Plath, and the transcript of the questions and answers a new chapter in European economic history was opened. After years of intense and thorough preparation, the launch of the single currency in Europe was accomplished successfully. Today, just a little more than two weeks after this historic event, it is a great privilege for me to be here at the European Parliament for another exchange of views with your committee. I should like to begin my statement by reviewing the changeover to the euro, including money market developments during the first two weeks of the single currency. I shall then go on to summarise the assessment by the Governing Council of the European Central Bank (ECB) of the economic environment in which the new currency has been launched and which has shaped our initial decisions about monetary policy. Moreover, I shall comment on some of the challenges that lie ahead. Finally, I shall touch briefly upon some issues related to the communication policy of the European Central Bank, after which I shall, as usual, stand ready to answer any questions you might have. The transition of the banking and finance community from the national currencies to the euro in only three and half days after the publication of the conversion rates, was, indeed, a success. The smooth migration of all electronic systems and procedures was a sign of the quality of the preparatory work carried out over recent months and years. In our view, the workforce that was directly involved in the changeover in the global financial markets - including all major financial centres outside the euro area - was probably higher than the 50,000 reported by the media. Within the Eurosystem, which comprises the ECB and the 11 participating national central banks (NCBs), preparations had been ongoing for some time. The first plan of action for the changeover weekend had already been approved by the EMI Council in March 1998. After the establishment of the ECB, the Governing Council examined reports on the changeover at four of its meetings. During the changeover weekend several thousand staff members were at work or on call at the ECB and the NCBs. The major concern of the Governing Council was to avoid a breakdown in the transition to the euro - at the ECB, at any NCB or within any of the systems of the "core infrastructure" of financial markets in the euro area. For this reason, the ECB made recommendations to credit institutions and securities settlement systems and set up a procedure for monitoring developments within and outside the European System of Central Banks (ESCB) during the weekend. Moreover, the decision-making bodies of the ECB stood ready to convene extraordinary meetings via teleconference and to adopt, if needed, contingency measures. The latter was not necessary. The monitoring of conversion activities conducted by the ESCB during the changeover weekend revealed no incident that might have impaired the smooth start of Monetary Union. As to the involvement of the Eurosystem in the changeover activities, I should like to mention that I had the honour of attending the meeting of the ECOFIN Council on 31 December 1998, during which the conversion rates were irrevocably fixed. I delivered personally to the ECOFIN Council the Opinion of the ECB on the proposed conversion rates. On the morning of 31 December, the Eurosystem had contributed to the computation of the conversion rates. Later on, the Governing Council had, with the participation of the national central bank governors of the countries not adopting the euro at the start of Stage Three, a meeting by means of a teleconference to approve its legal Opinion. The Eurosystem also contributed to the dissemination of the conversion rates in a prompt and secure manner to the banking and finance community, as requested by market operators in order to enable them to start their conversion activities as soon as possible in the early afternoon of 31 December. In addition, on 31 December 1998 the euro central rates for the Danish krone and the Greek drachma in ERM II were agreed by written procedure between the relevant parties. The new central rates are in line with the previous ones, after allowing for minor deviations due to rounding. Moreover, the ECB, Danmarks Nationalbank and the Bank of Greece established by common accord and announced, on the same day, the compulsory intervention rates for the Danish krone and the Greek drachma. Fluctuations of the two currencies during the first two weeks of the year remained subdued. With a view to ensuring a smooth transition to the euro, the Governing Council took two important decisions already on 22 December 1998, in order to give guidance to the markets on the monetary conditions at the outset of Monetary Union. First, it was decided to start the provision of liquidity via the first tender operation, which was carried out in the first week, at a fixed rate of 3%. The Governing Council also agreed that the interest rate for the marginal lending facility would be set at 4.50% and the interest rate for the deposit facility at 2%. Together, these two rates form the so-called "corridor" for movements in short-term rates. However, the Governing Council considered the possibility that market participants may need some time to accustom themselves to the new environment for monetary policy. To this end, it was decided to use a relatively narrow corridor of interest rates for the standing facilities of the Eurosystem in the first three weeks of Stage Three as an automatic device to reduce the maximum range of fluctuations in the overnight interest rate. Accordingly, the Governing Council temporarily introduced an exceptionally narrow corridor of only 50 basis points, with the interest rate for the marginal lending facility at 3.25% and the interest rate for the deposit facility at 2.75%. This measure will be terminated on 21 January 1999. Indeed, this guidance given to the markets proved to be justified, since market developments over the first days showed that the formation of the single European money market would not happen overnight. In the meantime, this situation has been overcome. The spread between the highest and the lowest rates reported to the ECB by banks of the EONIA (Euro Overnight Index Average) panel has narrowed from 21 basis points on 4 January to below 10 basis points. Moreover, the use of the marginal lending facility and the deposit facility has been significantly reduced to a more normal level. A further confirmation of the increasing integration of money markets in the euro area is the growing use of payment and securities settlement systems. On 5 January 1999 the value of cross-border transactions settled through TARGET had already exceeded EUR 310 billion. Including domestic real-time gross settlement (RTGS) transactions, which themselves accounted for at least another EUR 660 billion, the total value of transactions settled was therefore almost EUR 1,000 billion. This amount corresponds to about 17% of last year's GDP of the euro area. In the meantime, the total volume of transactions has increased further. Moreover, the extensive use of the so-called correspondent central banking model (CCBM) - a mechanism which permits banks to make cross-border use of eligible assets as collateral in monetary policy operations and payment systems - suggests that market integration is proceeding well. The TARGET system, the cross-border payment system of the ESCB, has contributed substantially to the integration of the euro money market and it has made possible the consolidation of the treasury management of institutions with different activity centres throughout Europe. TARGET has processed more cross-border payments than anticipated in these early days of Monetary Union and, in so doing, has amply demonstrated its processing capacities. Given the extensive use of the system, the ECB recently decided to extend the operating hours of the TARGET system by one hour to 7 p.m. for a limited period ending on 31 January 1999. This should alleviate some of the time pressure on commercial banks when familiarising themselves with the TARGET rules. Similarly, the Governing Council decided that, during this transition period, the deposit facility of the Eurosystem would be available until one hour after the closure of TARGET. I should like to also mention the results of the two first main refinancing operations of the ECB. EUR 75 allocated at a fixed rate of 3% to the banking system under the first operation, while the amount for the second operation was, under the same conditions, EUR 48 billion. In addition, on 13 January 1999 the ECB allocated EUR 45 billion in three tranches with maturities of 42, 70 and 105 days through its first longer term financing operation, at marginal single rates of respectively 3.13 %, 3.10 % and 3.08 %. We have provided sufficient liquidity to allow credit institutions, on aggregate, to neutralise their monetary reserve deficit relatively soon within the first reserve maintenance period. The Governing Council's decisions on the initial level of interest rates for the euro area, announced on 22 December 1998, have been made with a view to the objective of maintaining price stability. The decisions were taken on the basis of a thorough assessment of the monetary, financial and economic situation in the euro area and against the background of the stability-oriented monetary policy strategy. As you will be aware, the Governing Council has announced a quantitative definition of price stability, measured on the basis of a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. The monetary policy strategy further consists of two key elements; first, a reference value of 4 1/2% for annual growth in the broad monetary aggregate M3 and, second, a broadly based assessment of the outlook for price developments and the risks to price stability. The views of the Governing Council on the monetary and financial situation, the economic conjuncture and prospects for price developments in the euro area which underpinned its decisions on the appropriate monetary policy stance to be adopted were set out at a press conference at the time of the announcement. In addition, a more detailed assessment of the economic situation underlying the Governing Council's monetary policy decisions will be released in the ECB's first Monthly Bulletin, to be published tomorrow. This will include a commentary on the economic situation in the euro area. Let me briefly summarise the main features of our assessment of the current economic situation and outlook. As regards monetary developments, which are monitored on the basis of a three-month moving average of the 12-month growth rate of M3 (in order to minimise distortions from erratic monthly figures), the Governing Council set the first reference value at 4 1/2%. The latest three-month moving average of annual growth in M3 was around 4.7%, which is very close to the reference value and compatible with the maintenance of price stability. A broader assessment of economic and financial developments supported the available monetary data in signalling the absence of significant upward or downward pressures on prices. Financial indicators suggested that market participants expect the current climate of price stability to continue in the medium to longer term. In this context, it may be observed that at the start of Stage Three nominal short-term and long-term interest rates in the euro area have reached levels which are very low by historical standards and that real interest rates are also significantly below their long-term averages. The real long-term interest rate is currently at a level of about 3 %, which is approximately 1 percentage point below the level prevailing at the end of 1997. Increases in consumer prices, as measured by 12-month-changes in the HICP, have been around 1% since autumn 1998, falling to 0.9% in November. The rate of increase in service prices has remained unchanged at around 2%, but increases in goods prices are much lower, at 0.3%, reflecting downward influences on both food and industrial consumer goods prices. Energy prices have also continued to contribute to moderate price developments, falling by 4.3% in the 12 months to November. In addition, modest developments in unit labour costs are a further key factor underpinning the current low rate of consumer price increases. The preliminary data released by EUROSTAT for the third quarter of 1998 showed euro area-wide real GDP growth at 2.4%, thus reflecting some deceleration compared with the first half of the year when output growth averaged 3%. Growth has increasingly been driven by domestic demand rather than net exports in the course of 1998. Private consumption, in particular, has been robust, supported by growth in employment. However, unemployment in the euro area remains very high (at 13.8 million) and is declining only gradually. In the short term, output growth is expected to slow somewhat as a consequence of a weaker global environment. In addition to the lower real GDP growth figure in the third quarter, further evidence of an economic slowdown has been provided by survey data, most notably on order books and industrial confidence, which have weakened significantly since the spring of 1998. Industrial production growth also slowed during the course of last year. By contrast, consumer confidence was quite resilient, providing some support to domestic demand. There is considerable uncertainty about the impact of external developments on the euro area, not least because of recent events in Brasil, but the slowdown is currently expected to be temporary. The current low levels of short and long-term interest rates in the euro area should contribute to sustained confidence and domestic demand. Overall, the Governing Council felt that the risks to price stability appear to be balanced. However, there is a potential downside risk to the global situation, which could lead to lower inflation via a more pronounced growth slowdown in the euro area and weaker import and producer prices. On the other hand, higher-than-expected wage increases and/or a relaxation of the fiscal stance could lead to higher price increases. The ECB will continue to monitor these developments closely. Looking ahead, the introduction of the euro and a stability-oriented monetary policy will contribute significantly to the creation of the conditions necessary for improved growth and employment prospects. However, important challenges remain, two of which I should like to mention in particular: Coming now to the last part of my statement, I should like to touch briefly upon some decisions related to the ECB's communication policy that have been taken recently. As you might be aware, the ECB published, on 5 January 1999, a consolidated opening financial statement of the Eurosystem, and subsequently, on 12 January, the first weekly financial statement, containing the assets and liabilities held by the ECB and the national central banks of the euro area vis-a-vis third parties. With a view to providing regular information, in particular on monetary policy operations and changes in foreign reserves, the ECB will continue to publish a weekly financial statement every Tuesday, accompanied by an explanatory note, in all official EU languages. As already indicated, the ECB will release the first edition of its Monthly Bulletin tomorrow. It will contain an assessment of the current economic situation underlying the ECB's monetary policy decisions and also tables and charts covering a wide range of statistics relevant to monetary policy. In addition, the ECB will continue to release current monetary statistics on wire services. I should like to conclude by emphasising that these publications, together with the regular press conferences following the meetings of the Governing Council of the ECB and the numerous speeches given by the members of the Executive Board, demonstrate the importance which we attach to explaining the ECB's monetary policy in a clear and transparent manner. I am now at your disposal to answer your questions. Thank you very much colleagues. I would like to convene the first meeting of the Monetary Subcommittee in this very important year of 1999 when EMU has begun, and I would like to extend a very cordial welcome to the President of the ECB, Wim Duisenberg. We are having this first monetary dialogue at point in time when the ECB enjoys exclusive decision-making powers in the area of monetary policy and is able to carry out these powers and this was established at the meeting of the Council of the European System of Central Banks. We are very impressed indeed with the introduction of the euro and its very smooth introduction to replace the national currencies. We have seen that the euro has been readily accepted not just in financial markets, not just in the EU but in all regions of the world and I, myself, would wish that certain childhood diseases, that we're not going to talk about today, would in fact belong in past history in this era of the introduction of the euro. This is the first month, January, of EMU and we recognise that unfortunately fees are being charged for exchange operations, up to 4%. That's from one EMU currency to another and that is not in the interests of our citizens. I, myself, exchanged 10 Deutsche Marks and received French francs back to the equivalent of 7 Deutsche Marks. Now these are things that our citizens will fail to understand. The euro age should surely not have these effects on our fellow citizens. They will find it difficult to follow and we must push the private sector, the banks and savings banks and I hope that they are going to improve this so that the euro is going to be readily accepted without any hiccups, certainly in the EU and the euro-11 area in a more natural way than perhaps it is at the moment. So may I invite you, President, to speak. We would like to progress together in this euro era and I understand that you have provided a preliminary copy of the first monthly bulletin of the European Central Bank to the Committee which was presented this morning in Frankfurt. That has been made available to all Members of the Subcommittee and you have the floor, Sir. Thank you very much indeed, President, for those very clear words concerning monetary policy. You cover transparency, the need for work with the public and the move from the second to the third stage. Now, before I come onto questions I would like to welcome Mr van Velzen's and Mr Goedbloed's visitors groups and particularly my colleagues from National Parliaments, Mr Didden from Belgium and Mr Ahern from Ireland. First of all may I start by saying that I had hoped that the monthly bulletin from the ECB would be available today because that would mean that we would have the figures in front of us. Mr Duisenberg says it is only going to be available tomorrow but we would have been able to put specific questions if we had these figures in front of us. However I would like to restrict myself to questions and the introduction of the euro in 2002. Now in 2002 we don't want to have two legal tender currencies at the same time. Some member countries are thinking about a legal big bang. In other words there is only going to be the national legal tender up until 1st January 2002 and then there will be an overnight change. This means that we will have to teach the public how to deal with the euro without the euro actually being a method of payment. The euro will be a foreign currency that you change at a bank when you go abroad on holidays. Now on 7th January the Governing Council of the ECB said that, on the basis of Regulation 974, it would be impossible to have the euro in circulation at the same time as the national currencies before 2002. My question is the following, the text of the Regulation, which according to your text can be adjusted, is that the basis for your complaint or does it go deeper than this? The implication is that circulation of two legal tenders after 1st January 2002 should be possible if not necessary. On the issue of frontloading it is our view that frontloading to the general public is the same as issuing or putting the money into circulation and it has been agreed to start the issuance of the euro banknotes and coins only on January 1st 2002. We are of the opinion that also in order to avoid confusion amongst the public, that frontloading to the general public is to be avoided not only on grounds of the decisions of the Council (articles 10 and 11), that have been published in May 1998 but also that it is undesirable for substantive reasons ; namely to avoid as much as possible confusion on which currency is in circulation. On the other hand we have full understanding for the desire of market operators, that is banks, shops, firms, retail organisations, to have the new currency already available some time before they can be put into circulation. Therefore we had also our decision of two weeks ago, which includes the statement that frontloading to banks, to retail organisations and other interested parties except the general public is permissible and possible provided that there are legal or contractual arrangements which prevent that frontloaded currency be made available to the general public in an indirect way. I understand that the first argument is the text of the Regulation. Mr Wellink said, we can't change that. The second argument is one of confusion. Now the circulation of two legal tenders after 2002, is that not confusing? And a second point is, the status of the euro which will be frontloaded before 2002, is that not comparable with foreign currency where the consumer also knows, well I can't yet pay with it, at least I can't pay with that currency in the country where I have exchanged it but I can only use it in the country where it's a legal tender? I believe those two questions to be very similar indeed. The co-existence of two currencies during a certain period may also create confusion and so I have full understanding for every effort that is being made in many countries to let that period last as briefly as possible. We hope that the public already becomes so familiar with the euro in the meantime that we will be able to minimise that potential confusion, but totally avoid it, we cannot. Several governments have launched the idea of reducing the first phase from three to two years. Now what are the reasons why this is considered to be impossible? I don't say that it is impossible. I think that shortening that period by one full year is technically impossible. We need more time to produce the notes and in particular the coins, although as a Central Bank we have not much to do with that. We need more time than the limited time of two years which would only then be available or even less than two years. Given the fact that it is intended to put into circulation notes and coins simultaneously, one could imagine however, that for notes special measures would be taken to shorten the production period, but it would be a costly operation to do so. It would not be possible to shorten the period by more than just a few months, technically. It would, more politically, imply the requirement for many organisations to change their investment plans and their planning procedures which they now have made justifiably on the basis of the announcement that the introduction would be on 1st January 2002. In a way if we were now to shorten that period that could, although not legally, be interpreted as a breach of trust. There are organisations in various countries amongst which governments or local governments which have already announced that they need the full period up until 1st January 2002 in order to adjust all their systems, software applications etc. Yes, indeed President. In December Mr Kopper stated in Strasbourg that in technical terms it ought to be possible to reduce it by one or one and half years, down to eighteen months. What was at stake here was that the National Central Banks did not want to have the private sector producing banknotes and coins. Is that the opinion of a maverick banker? Or do you share that view? Well the answer is that I don't share that view. I have of course consulted technicians again ahead of this meeting also and asked them what would be possible and what would not be possible. One has to realise that the mass production of notes has not even begun. The production will start only in late February or early March and then orders have been placed to produce a quantity of 13 billion banknotes and it is envisaged that that process should be completed by 1st September 2001. Also the investment plans of the printing firms, of all the paper firms have been based on the fact that this process should be completed by 1st September 2001. Technically, it is my conviction, it simply is impossible to shorten that period by more than a couple of months. And then my question is what really are we talking about, if that is all that is possible. And the problem seems to be even larger where coins are concerned. There, the production and logistical efforts are far more complicated than in the case of banknotes. One also has to remember that the production of the euro coins has up until today started only in four of the eleven participating countries. Mr Duisenberg, you said that according to the May Regulation, it is not possible to distribute the Euro notes and coins four days in advance. You then say that for technical reasons the transition period cannot be reduced to one and half years but not under the Regulation. Now this implies that the Regulation can be changed if indeed that were to be the will of all those concerned in the European Union and I think that would be very useful indeed to get rid of people's fears and worries about this transition, this change-over weekend. You were also talking about confusion. I would say that I am in favour of one national tender but if on 1st January 2002, if the public is expected to keep a currency separate, what about blind people's organisations, shouldn't they get the coins and notes four days beforehand so that they can get accustomed to this? And by way of conclusion, Mr Duisenberg, I would say that in the European Union we think that the best educated consumers in the world are being insulted if they will not be entrusted with keeping money for four days before they can actually use it. Of course one can change a decision and revoke old ones but as I said is it worthwhile to do it for only four days or one week? I have serious doubts whether that would be wise. To my mind, it would also imply a not so stable and certain policy making process, as has been demonstrated by already publishing the decisions on when the currency would be introduced as early as May 1998 and by giving a clear indication to all concerned - that is Governments, the public, industry, services industries - that that would be the time that they had available to adjust all their systems. Then, to have it four days earlier than envisaged on 1st January, of course that would be technically possible, I don't deny that, but I think it would be less than desirable. I ask myself what are the gains that you achieve by doing that and then by putting into circulation money around Christmas yime, that is the time when money in circulation reaches its peak of the year in all countries ; precisely at that moment then to introduce new notes and coins seems to me to be less than desirable. What is your opinion on the irksome bank charges and excessive minimum charges that are made on exchange operations? I have not yet full information of how it is across the European Union. Second, although I have no competence in the field to do something about it, I do with you deplore it if the rates that are being charged by financial organisations to make the change were proved to be excessively high. Then I would hope that at least market competition would lead to reduce unacceptably high charges as soon as possible. The Financial Times of 5th January stated "several German Central Bankers said privately they might have cut interest rates earlier had it not been for political pressure". This suggests the central bankers knowingly conducted the wrong policy to keep up an appearance of independence. Now although this happened before the European Central Bank started to operate monetary policy it might still point to a potential problem. The implication of this is that the banks knowingly delayed the interest cut. Could I ask Mr Duisenberg's view on that. In particular as politicians cannot and should not be stopped from giving their views about monetary policy in public, will the ECB adopt a reasoned approach in this respect which means that if politicians are right at some stage to call for a cut or rise in the interest rate the ECB - provided they agreed on the need for a cut - would not delay the cut or dismiss it purely to provide the appearance of independence? Well the question starts with an hypothesis, that something would be true which I simply can say is not. The decision on 3rd December to announce already the extraordinary decision of a coordinated cut in interest rates to a level of 3% from the then prevailing level in most countries of 3.3% and in some countries of even more than that was taken under circumstances when at the same time there was big political pressure to lower interest rates. Yet of course we have felt that pressure. We have noted it but it has not influenced us to do precisely that. Neither has it led to postpone it. On the contrary the decision to already on 3rd December announce a cut of interest rates and then on 22nd December to confirm that that interest rate would also be the interest rate with which we would enter stage three of monetary union, both were decisions which were contrary to what you suggest following the Financial Times were brought forward rather than anything else with a view to provide the market with as much certainty and a sense of continuity as we could. And those were decisions which were made in full independence, independent also of any pressure which might be exerted anywhere. Of course with you I regard it, as I have said publicly, as completely normal that politics or politicians sometimes will try to give a certain advice to the monetary authorities what to do, although in my experience I have seldom, if ever, received the advice to raise interest rates. Normally it goes in the other direction and that I regard as normal. Equally I regard it as normal for an independent Central Bank to come with its own judgement and ignore any advice given on political grounds. Given recent statistical indications, i.e. constant consumer prices and declining producer prices, does Mr Duisenberg not believe that the European economy has already entered a slight deflationary phase since at least June of last year, or at least come critically close to it? And given that the European economy will continue to experience the negative effects of the international financial crisis, is there not a danger that a more serious deflation is threatening us in the months to come which might not yet be recorded in the latest statistical data? Well may I pretend or say that very careful analysis of all the available data does not suggest, as I indicated in my statement, that we have entered a deflationary phase as you call it. I did mention to you that the composition of the price increase figures that I mentioned for November contains a 2% increase in prices of services and only a 0.3% increase in the prices of goods. In addition it has to be remembered that some of the factors that have brought inflation down so much are by themselves of a temporary nature as we assume that for example the fall in energy prices which has greatly contributed to the lowering of the inflation levels is in itself of a temporary nature, at least it will not continue, it cannot continue at the rate at which it has. And then indications are, as I said, that it is not impossible that wage pressures may increase somewhat and we have taken that into account and we have seen that the impetus of the process of fiscal consolidation in the direction of the aims of the stability and growth pact clearly seems to have weakened in the course of the year 1998 and also as contained in the plans, as far as we know them, for the year 1999. So we see on balance no forces either for inflation to increase nor for inflation to diminish. Were we to see so, and I have said that we monitor developments very closely then of course we could come up with new decisions but for the future as far as we can foresee it now, the foreseeable future, we think that the level of interest rates we have chosen towards the end of 1998 is an appropriate one for the current economic situation. Mr Duisenberg you said that economic growth estimated for the third quarter was not very optimistic for this year and you said that there are challenges in the reform of structures, in the labour market and the products market. And my question to you is can you just give advice on to how this should happen, or indeed are you also accompanying this with monetary policy measures? I'm not quite sure that I understood the question precisely. We are living in a time of very great uncertainties about the global environment and the worsening economic climate globally, although in some areas of the world the economic climate already is improving again, I'm thinking of certain parts of Asia and the way it will have an impact on the euro area-wide economic developments. A few international institutions have recently revised downwards their estimates for growth in 1999. We have not, not even internally, done so yet but we are carefully monitoring the situation and, as I said, we regard, as far as monetary policy is concerned, the level at which the key rates have been set which imply markets interest rates which are lower than at any time since World War II, as appropriate for the time being, for the present economic situation. Thank you very much Mr President. I have a short question about the situation in Brazil. Can this have an impact on other areas such as Argentina and Chile? Secondly, from the internal point of view, one of the reasons which led to deciding on a central system but on a decentralised execution was to maintain a neutrality in the financial market place to avoid the dismantling of the markets and also concentration of operations in a limited number of market places. However, there is doubt over the concept and form of the national market places in the future. Has the European Central Bank decided to set up a monitoring system to assess how exchanges take place as well as the risks of geographical concentration of such operations? That is my question. On Brazil, I can be very brief. In recent discussions with the Central Bankers of the countries mentioned by you, they proved to be very confident that any contagion effects of the Brazilian crisis on their economies, Argentina, Mexico, would be very limited indeed and that the effects could well be contained. So far market developments seem to prove them right. But of course the tumultuous events are of only a very recent nature so it may be too early to give a final judgement there. Now the second question, I honestly didn't understand what the question was. The monitoring of the exchanges euro-wide is taking place both at the national level and at the central level. At the European Central Bank there is a lively exchange of information and providing of information to the European Central Bank by the National Central Banks on the monitoring of all the financial market places, which so far in the first two weeks of operation has proven to work out very satisfactorily. Well President can I also congratulate Mr Duisenberg and his colleagues for the very successful launch of the euro and I think it is a very good sign for the developments of the European Union. But I want to come back on the point that Mr Hendrick made because, with great respect to you Mr President, I think you were rather dismissive of the question. And the question is very clear that if you look at Japan you've had a movement in Japan in their economy down to zero inflation. You therefore have a liquidity trap where the citizens in Japan prefer to keep their assets in monetary reserves - in other words they collect savings - and as a result monetary policy is having no impact on the Japanese economy. Now I know that there is an argument about whether monetary policy has any role in the overall role of the management of the economy, but the fact is that if you look at the statistics, at the end of last year we are moving very close to zero in terms of inflation in France and Germany. Now I really don't accept your answer. I think it's rather dismissive of the Parliament just to say oh well if trends change then of course we'll take appropriate action. Are you saying today to us absolutely there is no threat of the Japanese scenario occurring in the European Union in the euro-area? And if not, why can you not spell it out rather more clearly because of course if you look at the domestic output price index or the producer price index this has actually been continually declining since December 1997 and there is a serious worry. And can I just ask one other point, which I think is rather important. I look at the terms of reference of the Central Bank and we have a Governing Council that is meeting every two weeks and therefore the Governing Council of course is running the European Central Bank. Is the Executive Board fulfilling any other task other than acting as a secretariat to the Governing Council of the Central Bank? I'll take the last question first. The Executive Board of the European Central Bank : all six of them are individual members - with full voting rights - of the Governing Council. So, that part of the work, they do perform. Moreover, they coordinate all activities of the European System of Central Banks, the ECB and the NCBs of the participating Member States in a very active manner and thereby not only acting as secretaries but rather more often than not as the initiative takers. That's not what you hear, but it's what I do and very much we have the feeling that that is precisely what we are doing. On the second part, what has Japan achieved by following a monetary policy which has brought interest rates down with official interest rates to 0,25%? Further than that they cannot go, but the results for the real economy so far have demonstrably been very meagre indeed to say the least. We have an interest rate level, in a time when growth admittedly shows signs of coming down somewhat, of deceleration, but still the expectation is there will be growth, still the expectation is that the deceleration will be only temporary. In that context then to have interest rates at a level which is lower than at any time over the last 50 years seems to us to be an appropriate decision. You may compare these interest rates with those in Japan, I would also like to compare them with those in the United States, which seems to go through a similar phase of the economic cycle. We have interest rates at least 150 basis points lower than in the United States. Well you see that's not really the question I put to you because as we know the Japanese started reducing their interest rates too late. They started reducing their interest rates as their economy slipped into recession and I'm asking you whether or not we run the same risk that you may take action, as you said earlier of course politicians always ask for interest rates cuts, but that we end up taking the action too late and therefore monetary policy has no impact which is what's happened in Japan? Yes, but then our analysis, and I can say it is shared by the Ministers of the Euro-11 group whose meeting, as indicated, I attended this morning, does not show or demonstrate or yield to the result that we are already moving into a recession. We are moving from a period where we had above average growth, above trend rate growth - think of the 3% during the first half of 1998 - into a period where growth will be somewhat slower. I define a recession as a continued period of more than a few quarters of no or negative growth. Then by no means are we moving in that direction according to our analysis. Before my questions I would like to come back to this point of my colleagues Hendrick and Donnelly. So you think that there is no deflation, but supposing that there is deflation, you said I took note, you would take new decisions. What kind of decisions would you take in the case there was deflation? And my main question, if I can, it's about Brazil. There is a big discussion between the former Governor of the Bank of Brazil and the new Governor because the first one tried to have stable prices and with a very strong rate of exchange. Do you think the former Governor was right, or the present one, about decisions taken last week? Well I don't want to suppose that there were deflation because I don't think there is deflation but taking the academic view point, if there were to be a further sustained deceleration of prices then a relaxation of monetary policy would be called for and we would take decisions accordingly without any doubt. On Brazil, really Mrs Chairman, I would prefer not to take sides with the previous or the current Governor of the Central Bank of Brazil. President, with regard to the Chinese and Japanese operators how do you see their view on the euro and also on the ECB to manage the exchange rate with the dollar. Are you ready to answer certain requests linked to the fact that the Chinese might switch reserves of their Central Bank into euro to make it equivalent to their dollar reserves? This question we can also take for the subject number 4 if you don't mind because we wanted now to discuss monetary polices. Monetary Policy? I should also like to raise a question about deflation which has already been put here. First of all, as far as I know with the German price index, the price development has always been overestimated by about 0.8%. Has the ECB carried out investigations or plans to investigate the extent to which the Eurostat price index overestimates prices? I think that's important, that was my first point. Secondly I would like to put a question and I think it is a question of monetary policy. Are you discussing, in the Euro-11, on matters of monetary policy and exchange rate policy? The ECB closely follows the inflation figures, of course, but we cannot yet measure or make even an effort to measure this so-called measurement bias in inflation, because the series we have for our core rate of inflation, that is the harmonised index of consumer prices, only has a very recent history. We simply don't have the data for a sufficiently long period of time to make an acceptable effort to measure the potential measurement bias. We think there is one as there is one in every inflation index all over the world, in Germany, in the United States, in the United Kingdom, everywhere but we are not sure yet what it would be in the euro area and because of that uncertainty that is also the main reason why when publishing our definition of price stability we have published an upper bound but not made very precise or explicit a lower bound. We have said we measure price stability by a rate of increase, thereby giving a bias in the positive direction, by a rate of increase over the medium term of below 2%. As I also have indicated in various public statements and in answers to questions, also here in this Parliament, you can be sure that we dislike deflation as much as we dislike inflation so implicitely there is a lower limit but we cannot yet measure or even try to measure the potential measurement bias that is contained in these figures. Now in the Euro-11 meetings, the debate in which I participate on the current economic situation covers all aspects of economic developments including monetary developments but also fiscal developments and well it is only understandable that in the dialogue which is developing in the Euro-11 I have the inclination to talk a little bit more about fiscal developments than most Ministers do and Ministers have the inclination to talk a little bit more about monetary developments than the President of the Central Bank does. First of all if it is uncertain then shouldn't we start thinking how a preventive policy could be carried out against inflation because that may come about and secondly the question on exchange rate policy in the Euro-11 was mentioned but you didn't take up that point. We are following a preventive policy by pursuing a policy which is aiming at price stability over the medium term and it is a forward looking policy so in that way it is preventive but we think that by setting the interest rates at an historically low level for the foreseeable future, and I cannot specify how long we can foresee that future, we give as much certainty and a feeling of continuity and stability to the markets as we can. We think this is most conducive to the growth of income and employment, but it is preventive in the sense of a forward looking policy formulation. Exchange rate policy has not been discussed if that answers your question. Thank you very much Mr Duisenberg. I would like to come back again to the question of deflation. There is a kind of asymmetry between the competence of acting in the ECB in questions of inflation and deflation and how do you interprete in the ECB Article 105. I still fail to understand when the time is that the ECB must act in order to support employment. If it is clear from the stability programmes that the Governments of the Member States respect at this stage the stability pact and on the other hand the trade unions are carrying out very cautious wage policy, do you already at this stage have a clearer opinion, a clearer position especially in view of the father of the euro that the euro could be too strong rather than too weak? I don't see an asymmetry in the competences of the European Central Bank to take decisions and as far as Article 105 is concerned the European Central Bank shall contribute to the general goals of the European Community in terms of promoting growth and employment as far as the primary aim of price stability is not being endangered. But then it is our strong belief that the best contribution that monetary policy can make precisely to that end, is to create and maintain a climate of price stability. As I indicated in my introductory statement to the extent that that climate then contributes to the lowest possible risk premium which is contained in the long-term interest rate and in inflationary expectations that is to our mind the best contribution that monetary policy in those circumstances can make. I would warn against the reasoning that now that we have achieved price stability with a certain level of interest rates, we should change track and focus on other things, in the interest of economic policy in general. Our aim isnot only to have price stability but also to maintain it. That is explicitly in our mandate. But if we have an inflation rate tending towards zero and if you look at the real interest rates then don't you think that for economic growth, investment it is the real interest rate in the EU which is still too high, the real interest rates? Well the real interest rates as I said are lower than they have been for a very long time and I want to point to the fact that as I also already earlier said they have come down over the past year by about 100 basis points so that development has already by itself had the beneficial effect of contributing to a resumption of growth and employment. Thank you Madame President. The introduction seems to have been relatively successful as you said. Electronics and data and technics have functioned well. But when there will come crisis, with economic, regional differences, increased unemployment, winners or losers about the euro, what readiness do you have for real life? Meaning is it the stability and growth pact which is the readiness you have or will it be the direction of changes in the meaning of more of finance and tax harmonisation in line with the proposal from the German Finance Minister? That's my question. Thank you. Well the assumption is if a crisis develops here or there in the monetary union what will the policy reaction of the ECB be? Well the answer is that we always have to take a euro area-wide perspective and that regional differences in the developments we have to more or less overlook but it is only euro area-wide considerations that will induce us to take certain policy measures which differ from the measures that already have been taken. You said that you are not going to take account of regional differences within the framework of difficulties with unemployment for example? Did I hear you right? Our policy has a euro area-wide perspective and cannot, and will not, be based on diverging developments in the region, just the same as there always used to be one monetary policy also in countries which had very diverging regional developments - in Germany, in Italy, in the Netherlands -, and everywhere, always, one monetary policy not taking into account the interests or developments in one particular region. Regional monetary policy as I have often said does not exist. I have a question concerning transition. Transition of the pre-ins, take my own country where the Social Democratic Party at long last has decided to go for the referendum and to secure a yes for Sweden to join the monetary union, this referendum if held as planned in the autumn of year 2000, how long would it practically take before a country could then join? The easiest thing is to say 2 years but that is a highly political question which requires a highly political answer and the ECB itself is not the one that will be asked to give that answer. It will be the Governments of the European Union and of the Monetary Union in particular who will answer that question but practically now as an economist I would think that a country aspiring to become a full member of monetary union would have to demonstrate that it in practice is able to meet the same convergence criteria as those which have been applied to the countries in the first wave. Mr President, in a large part of the professional press you see that in the stock exchanges throughout the world at the moment and particularly on Wall Street there is a 'bubble' situation and your colleague from the Federal Reserve in the United States is cultivating in a very reasonable way this view which could be considered legitimate in the rest of the world. But the problem is that 'bubbles' can burst at any time with the results that we're familiar with. Is this a problem which you have thought about, and as the rates influence each other, is this a consideration for the interest rate of the ECB? The question pertains to the increase in asset prices which has taken place and is taking place. We follow that carefully, we monitor it carefully and we have come to the conclusion that for the time being this is not developing into a bubble which could burst suddenly or unexpectedly. So it has been considered just as it is being considered in the United States and there they have come to the same conclusion but as I have not heard Mr Greenspan repeat the words he said in 1987 of an 'irrational exuberance' prevailing in markets. He has been very careful to avoid expressions in that direction and rightly so, I think. I wouldn't expect him to say such things in the present situation, would you? No, that's right. Yes that's clear. Well colleagues we move onto the third series of issues. Democratic accountability, transparency of the decisions taken by the ECB. As regards democratic accountability and particularly transparency, we have tried to have clear definitions in real policy terms. This means that monetary policy should not stand, and cannot stand, outside an economic and social policy and it tends to be focused on the economic policy side. Therefore what you said about foreign exchange mechanisms didn't gladden my heart. However that's part and parcel of the economic framework and I think that the ECB should use all possible margins for stability and growth and we need to have transparency, accountability of the ECB, that is quite clear. Now pursuing the goal of price stability is obviously at stake, but you are looking at the domestic market and at the issue of employment, I have a question that springs to mind. What do you see as the ECB contribution towards the European Parliament and also to European socio and economic partnership? What is the Bank's contribution to that, the partners who you need in order to translate your policies into reality? I would like to see how you envisage this fitting together practically. Thank you. I must say, I know of no central bank in the world which has such intensive contacts with the Parliament of the region it represents as the ECB, which goes to such lengths to publish immediately and explain immediately all decisions that are being taken. I must confess, I look at our own website every day and there are days that I am surprised that so many things have again been decided and published and explored widely. The ECB not only has in terms of democratic accountability and transparency to my mind extremely intensive contacts with the European Parliament, but also with the public at large, also with governments and also, and that's the second part of your question, we are actively engaging in developing a dialogue with the social partners. But it is very difficult to organize and to structure, with social partners coming from 11 participating countries, to develop a useful dialogue, but we have started that and we will continue to have that dialogue with the partners, we are open to that. Even the economic and monetary experts have noticed that the press communications of the European Central Bank are very difficult to understand. They are cryptic in nature. This has become evident when we have just in this same room discussed the inflationary targets and then compared that to the Bank's bulletin in October containing completely contradictory information. Now that you mention the monthly bulletin, or information leaflet, can you improve it so as to contain a simplified section in it as well, because there is great interest in it and there are lots of leaks to that effect as well? Could you also publish the results of the meetings of the Governing Council? Well, I don't know whether we can simplify the language. We are doing our utmost to make ourselves understood as best as we can and as quickly as we can. I do want to point out that it has already been decided and announced that there will be a press conference which is widely attended after every other meeting of the Governing Council, publishing and explaining all decisions and discussions that have taken place in the Governing Council on that day, and we do that in a very coordinated way and to make ourselves understood as best as we can. I am sorry to hear that, apparently, we still use too difficult language, but then I am reminded of a statement by Mr Greenspan who once said "if I understand that you have understood what I said, I must have chosen the wrong words", but that's not what we intend. We want to be understood and we want to explain as explicitly as we can our decisions, in the monthly bulletin which you will have a chance to read carefully as from tomorrow, and we will repeat that, of course, every month. Weekly, we publish a financial statement, let's say a balance sheet, of the consolidated central banking system of Europe, together with explanatory notes. Admittedly, these explanatory notes are normally understood, as is the case in national central banks also, mainly only by the experts. There was a criticism by my colleague Mr Donnelly that the board meets every fortnight. If I can appreciate this from the view point of my country, I think this is good for the euro because people feel that their central bank is involved in the euro. So what is seen by some as a criticism, I think is a positive element. Besides the role you have is not the one of a secretariat. If I may put my question. Do you think there will be new thinking in the ECB concerning the publication of the minutes ; may this 16 year period be subject to review in order to move closer towards the transparency as in the German Bundesbank? There has been a broad discussion about greater transparency, and perhaps that might encourage you to achieve progress in that area in terms of democratic accountability. Well, the answer I have given already many times, and that answer is no Madame Chair. Well that's a question I'm going to have to keep on putting until I have a different answer I think. I can assure you that this Parliament is optimistic that there will indeed be a positive change. So, we now move on to the international dimension of the euro. Thank you Madame Chair. Two questions. The first is, I quite understand why you don't want to talk about target zones for currencies at all, vis-a-vis the dollar or the yen. Nevertheless, the fact that there are problems over the statistics, that you have on inflation and indeed the statistics you have on money supply - we were talking about the problems of the inflation statistics before - there is a view around in international markets that because you do not have real guidance on your inflation and your money supply statistics, you are going to be de facto forced into some form of exchange rate policy. I was just wondering whether you would comment on that. My second question is, what about the future shape of international monetary cooperation? Do you feel basically that it is inevitable that we are going to be getting rid of G-7 and that there will be a block of three running the world monetary system - dollar, yen and euro? I am almost inclined to say that the statistics, both on money supply and inflation, are improving every day and by no means are we forced, through qualitative insufficiency in the statistics, forced in the direction of an exchange rate target. The Treaty is clear in giving its mandate to the ECB, that is to maintain price stability, and that means internal price stability. The exchange rate, vis-a-vis the other big blocks in the world, let's give the animal a name, the dollar and the yen, is the outcome rather than a target of monetary policy and of the economic policies of the various blocks.What we are very much in favour of, is not so much target zones, but as stable a relationship as we can achieve. But our primary goal is and remains internal price stability, so there is no forcing us in another direction. On the institutional side, the ECB, of course, still has to find its place in the various international fora. There are formal and informal fora. There is the G-7, which is an informal forum, there is the IMF which is a formal forum, where we have the complication that the IMF only has sovereign states as its members and the ECB is not such a sovereign state. Still, we have reached agreement with the IMF, and I am extremely grateful for that, that the ECB will be invited to appoint a permanent representative on the executive board of the IMF. So we will be there and we will be able to make our voice heard on matters which are of crucial interest to the ECB. In the G-7, which is an informal gathering, on the agenda of the G-7 meetings, there are of course many points other than monetary policy and it is only on monetary policy where Europe is united and speaks and has to speak with one voice. Therefore, in those parts of the G-7 meetings which deal with matters of relevance for monetary policy, the ECB is already being invited to represent the European monetary system's views, so there we have come, to my mind at least, to a highly acceptable and satisfactory arrangement. How future developments will go, once again I say the G-7 deals with many more problems than monetary policy alone, and I cannot predict how Europe will further represent itself. President, would you allow me to stress this particular point of the international dimension of the euro, particularly the possible setting-up of exchange rate target zones. We are fully aware of your position, generally the position of central bankers. We are also aware of the position of a number of prominent politicians. Some of them, and in particular Oscar Lafontaine has qualified his initial position, but at any rate public opinion perceives a difference in focus on this problem between the politicians and those responsible for the central banks, and I would like to remind you that the Treaty guarantees to the Central Bank independence of monetary policy, but it falls to the Council to deal with exchange rates, I believe. Now you said that in the Euro-11, that subject has never been discussed. I take it that it cannot be excluded that this matter might arise there in the near future in the Euro-11, or in the ECOFIN Council, they may well seek to discuss this issue of exchange rates. So, I would like to know what your reaction would be and what remarks you would care to make at the moment as to that possibility? I am also fully convinced that that matter will come up in one of the future meetings of either the ECOFIN or the Euro-11 getting together. On exchange rate targets, it has to remain clear that first of all I want to say exchange rates are the competence indeed, as you indicated, of Governments and not of the central banks, yet an exchange rate policy in practice has to be carried out mainly by the central banks. But also other areas of economic policy would have to contribute to fulfilling the "targets", if and how they were to be set, and the European System of Central Banks would be willing to contribute to such "targets" only to the extent that they would not endanger its primary aim, that is the aim of achieving internal price stability and that might very well happen. Suppose that Europe were in a recession and that in that recession the exchange rate, vis-a-vis the dollar, would drop, would depreciate. Then the exchange rate policy could require the European System of Central Banks to increase interest rates which would come at a very painful moment if it were in that phase of the conjunctural cycle. So it is not all benefits that can be expected. The general attitude towards "targets" is that the world is nowadays a little bit different from what it was 14 years ago when Louvre and Plaza agreements were put in place. Capital markets have been liberalized and developed tremendously. You can be certain that if ever you announce a certain target, which you have to do multilaterally, also with the other parties involved, of course, you can be certain that there will always come moments when markets will test the limits or the ability of the authorities to defend the exchange rate against the limits which are being reached. And it is very doubtful whether that defence at that time would be in the interest of the primary goal that the Central Bank has to achieve. So there are grave doubts. May I once again quote my colleague on the other side of the Atlantic when asked the same question in a recent public appearance he made. When asked this question, his answer was very brief and very simple and that was "target zones have to be regarded as in the modern world neither feasible nor desirable". I much appreciate the pragmatism of your answer, but taking into account your last comment, I have a more specific question to put to you. You said that the ECB will not follow a benign neglect policy, but this will be done by the people on the other side of the Atlantic, and you also said that you will not follow a policy of explicit objectives with regard to exchange rates. Could you explain a little more what the terms of this policy would be with regard to exchange rates? Which you would recommend? The monetary policy strategy, as I outlined it earlier, the second pillar I mentioned, is that it would be based on a broadly based assessment of all the main economic indicators which have an impact on price stability. Well one of these indicators, of course, and it could be a very prominent one, is the development of the exchange rate vis-a-vis other major currencies. So, it would be regarded as an indicator, although the exchange rate itself would be the result of policies rather than the target of policies. As an indicator it could also trigger certain policy actions at certain times, namely to the extent that the development of this indicator would in itself endanger the achievement of the goal of internal price stability, so there will be no neglect, neither benign nor malign. It is indeed difficult today to measure the stability of the euro vis-a-vis the dollar, although since the beginning of January we have enjoyed quite stable parities from one day to the other, but at the end of 1998 the Chinese and Japanese especially, expressed from the central bank, said that they wanted to introduce the euro in their reserves in quite large numbers, to be equivalent to their dollar reserves with a view to balancing their reserves for a currency which they believe dominates the others more. I'd like to know what your position is Mr President on this request, because it may be a massive request in months to come? The ECB takes a neutral stance on this question. It will neither encourage nor discourage foreign reserve holders of moving into the euro as their reserve currency, because we believe that if they want to do it we cannot do anything against it anyway, so we will have to accept it. We will cross that bridge when we come to it and we see it happening. I do not expect, looking at history, that it will be a sudden and unexpected process. The only thing I talked about with my Japanese and Chinese colleagues is that if ever they do it, and I don't ask them to do it, but if ever they decide they want to diversify their reserve holdings, let us be in close touch when you do it, so as to avoid any disturbance in markets which might arise if it is done in an unexpected or too quick way. And it is of course also in their own interest to do it in a very responsible way, so we'll be in touch maybe some time. I'd like to come back to the very first question which Mr Metten put. If I've correctly understood things, then Mr Duisenberg said that there are legal reasons for not having frontloading to the public at large and that in addition to the legal reasons there are really just reasons along the lines of, well it could lead to confusion. Now, if we in the European Parliament were to take a majority decision as representatives of the people, and we say that the only confusion that can arise from frontloading is less than the confusion which would arise in the dual system at the beginning of 2002, if we were to draw that conclusion, could we count on your support vis-a-vis the European Commission, or have we to leave everything as it is in the present Regulation concerning the introduction of the actual notes? I got the impression that it is a political decision rather than monetary arguments which justify that. If frontloading to the general public at a date earlier than the moment of circulation were to be the recommendation of the European Parliament, I would disagree and I think the ECB would not follow that recommendation. If it were to be to change the Council decision that has been taken, that's up to the Council to decide. It's the Council of Ministers which took and published those decisions. That would be up to the Ministers. My personal inclination would be to discourage the Ministers, I say in all frankness, to change their decision, but rather to maintain the position of certainty and predictability which has been achieved so far. But that's my personal declaration. On this aspect, I cannot yet speak for the ECB as a whole. I would have to discuss that in the ECB Governing Council before I make it an ESCB recommendation. I have a technical question. I hope you don't mind me putting it. I want to understand better how the monetary policy will be implemented and I also think it is important for the euro-zone banking system. When the ECB decides on its refinancing policy, I suppose it decides a package for the banking system, and how is this package distributed between the various national central banks? Is there a quota, does it depend on the GDP, how is it done? Specifically, how is the monetary policy specifically implemented? Well, for example, but I'm not a technical expert either, weekly there is a decision on the next short-term financing facility, the REPOS. To that end, the Executive Board which takes those decisions, and it does not act as a secretariat but it actually takes the decisions every week, meets every Tuesday at 10.55 a.m. so that the decision is taken and made public at 11.00 a.m. Then it is distributed over the countries according to the bids that have come in from all the various national banking systems, private banking systems. Only part of the bids, in one case 15% in another case below 10%, are actually granted and allotted, but how precisely the key of dividing it is determined, I must honestly say that - I'll ask Mr Hoogduin if he knows this - but I don't. Well, it's just as explained. Every bank is allowed to bid on the main refinancing facility and then we aggregate all the bids that have come in and we know the amount that we want to allot. That determines the percentage of the bid that is granted to every bank. So it's not based on the GDP share, but on the bids that are received from the banks. The banks themselves can bid, we add all the bids together, look at the amount to be allotted and determine the share that every bank receives. Every bank receives the same share of its bid. You said, President, that the euro-zone doesn't risk deflation at present, but what about the employment situation? In your presentation you said that the question of employment was to be tackled through reform of the employment market. More and more people believe that without real growth there will be no improvement in employment. So my question is, how do you think that monetary policy can and should contribute towards such growth, and to what extent can it help growth? We know that employment is built up through growth and risk capital. Let me repeat what I have said earlier, that in our view the best contribution that monetary policy can deliver to promote growth of ouput and employment, is to create a stable environment in terms of a stable price environment and also that the expectations of future price developments are as low as possible and are as credible as possible, by delivering the low price increases environment, which in turn leads to eliminating, to the maximum extent possible, the risk premia that are included in particular in long-term interest rates. I think we have delivered that promise already to a great extent. However, the simple fact that in 1997 and the first half of 1998, on a euro area-wide basis, the rate of growth of GDP was in excess of the trend rate of growth of GDP in the euro area and yet there was hardly any decline, or only a very gradual decline in the rate of unemployment in the euro area, underpins the statement that the unemployment problem as we are facing it now is not caused by cyclical factors, but that it is, to the largest extent possible, of a structural nature. Therefore, in order to cure it, it requires measures of a structural nature like making labour markets and product markets more flexible. And measures have to be taken in that context, and we don't believe, given this economic development as we have seen it over the past year, that you can spend your way out of the unemployment problem. On the external impact of the euro, what is the role Europe has taken in the recent arrangements with the IMF and the Brazilian authorities in granting a 40 billion dollar loan? I have been kept continuously informed. The package was, of course, designed at a time when the ECB itself was not yet operational. It is a complex package including the IMF, the BIS, the national governments who used the help of their national central banks in that situation. We have been continuously kept informed in our role of, already then, increasingly becoming the coordinator of all the national central banks policies, but that was about it. Well thank you very much indeed for this first dialogue in this new euro era. I think that we will have food for thought. You have quoted Mr Greenspan on five occasions. I wonder if you are going to be quoted in his speeches in the US as the equivalent authority, and certainly I would like to thank you, and I'm speaking for everyone here. I would also like to thank your team and the new staff members who are starting at the ECB this year and wish you every success. I am sure we all want to see things going as smoothly as possible this year to achieve the stabilisation of the euro and a balanced internal and external value for the euro. You are pursuing your monetary policy we realise, but all of us are supporting the aims of the Maastricht Treaty and also monetary policy is part and parcel of that. We also have to see whether this year it is going to be possible to get a greater coordination of economic policies by member governments and we will observe with very great interest the dialogue that you have with representatives of governments in the Euro-11 as well as in ECOFIN, but rest assured that we will continue to push for transparency of monetary policy decisions. We will be able to follow your press conferences but, of course, we will also count on further dialogues with you. Thank you very much indeed.
r990125b_ECB	euro area	1999-01-25T00:00:00	Monetary policy in the euro area	bank	0	Thank you for the invitation to speak at this New Year's reception. 1999 is a special year: the year in which the euro was launched, and the year in which it will have to become a stable currency. This is the challenge which lies ahead. The introduction of the euro was a very happy event for all involved. The euro is present on all major financial markets around the globe. Currency trading in euro has commenced and for three weeks now shares have been denominated in euro on most European stock exchanges. Although not yet embodied in the physical form of new banknotes and coins, there is no doubt that the new currency is set to play an important role, both in the euro area and beyond. The euro is a symbol of the achievements of Europeans in the pursuit of common goals. It is unprecedented in European history. After years of intensive preparations and successful efforts towards convergence, the single monetary policy for the entire euro area is being determined by the European Central Bank (ECB). The Governing Council of the ECB, which comprises the Governors of the 11 national central banks of the participating Member States plus the six members of the Executive Board of the ECB, has assumed this responsibility and is in charge of monetary policy decisions for the euro area. Decisions by the Governing Council will be implemented via the Eurosystem - that is, the ECB and the 11 participating national central banks (NCBs). Indeed, the introduction of the euro marks the culmination of much successful preparatory work over a period of many years. This has been reflected in the very positive and confident way in which financial markets have received the euro in the first three weeks of Monetary Union. Moreover, the enormous technical and logistical challenges posed during the changeover weekend at the start of the year have been surmounted. Monetary Union offers a unique opportunity to establish and maintain price stability within the euro area. It promises a credible and lasting environment of price stability for almost 300 million people. Price stability is at the core of the "stability culture" that we are seeking to establish throughout Europe. By fulfilling the unequivocal commitment of the Governing Council of the ECB to maintaining price stability in the euro area, we shall ensure that the single monetary policy contributes as much as possible to economic welfare in the broadest sense. At the same time, national fiscal authorities and general economic policies also have to demonstrate their commitment to the creation of this stability culture in Europe. In this context, the Stability and Growth Pact is a crucial element. Its aim is to foster the pursuit of disciplined and sustainable fiscal policies in the euro area. In so doing, it can make a significant contribution to the establishment of favourable conditions for sustained economic growth and high employment in the medium to long term. It would be counterproductive if national fiscal policies started to discontinue their efforts in the light of the achievement of Monetary Union and the currently positive price outlook. I am not fully convinced that consolidation efforts are currently being undertaken with sufficient determination in all participating Member States. Monetary policy alone - however well designed and implemented - cannot solve Europe's economic problems. Appropriate structural reforms implemented by national governments are of the utmost importance. Much progress is required in this broad area. Moreover, continued wage moderation in both the public and private sectors would contribute to the reduction of the unacceptably high level of unemployment in many parts of the euro area. Unemployment in the euro area is largely structural in origin. Implementing too lax a monetary policy will not solve this problem, but rather exacerbate it over the medium term, as inflation distorts investment and savings decisions, raises the risk premium in long-term interest rates and undermines the allocative efficiency of the price mechanism. Only effective structural policies that improve the flexibility and efficiency of labour and goods markets can reduce unemployment in a successful and lasting manner. I appreciate that such reforms are not always easy, not least because the benefits which they yield occur mainly in the medium to long term. However, they are unavoidable. In those euro area Member States that have taken up the challenge of structural reform, unemployment has fallen significantly. Other euro area Member States should and must take note: structural reform throughout the euro area is fundamental to the success of Monetary Union and to improving Europe's economic performance. In this respect, we may also be able to learn something by looking at the reasons behind strong employment growth and low unemployment in some of the Member States of the European Union and in the United States, in particular regarding the flexibility of labour markets and the incentives to create and accept new jobs. Today, I shall describe the main features of the stability-oriented monetary policy strategy of the Eurosystem, which underlie our single monetary policy. Against this background, I shall briefly explain the recent monetary policy decisions adopted by the Governing Council of the ECB. Finally, I shall summarise how we currently see the outlook for maintaining price stability in the euro area. The Treaty on European Union, commonly referred to as the "Maastricht Treaty" assigns the European System of Central Banks (ESCB) the primary objective of maintaining price stability in the euro area. In order to steer expectations of future price developments, the Governing Council has announced a quantitative definition of its primary objective. This clarifies how the Treaty's mandate is interpreted by the Governing Council and gives the public clear guidance concerning its assessment of the success of the single monetary policy. Price stability is to be maintained over the medium term. According to the published definition, price stability has been defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. Neither would deflation - that is, a persistent fall in the price level - be consistent with price stability. The annual rate of inflation in the most recent available data of around 1%, measured on this harmonised basis, is consistent with the definition of price stability. The Eurosystem has therefore enjoyed the good fortune to assume authority over monetary policy in the euro area in an environment of price stability, owing to the successful process of disinflation and convergence achieved within Europe over the past decade. Monetary policy needs a forward-looking, medium-term orientation. This takes into account the fact that monetary policy affects the price level only with variable, usually long and unpredictable time lags. It is not able to control all short-term movements in the price level. To maintain price stability, we have chosen a distinct monetary policy strategy, one that reflects the special circumstances that exist at present as well as those likely to prevail in the foreseeable future. The chosen strategy ensures as much continuity as possible with the former strategies of the NCBs. At the same time, it gives due consideration to the unique situation which will prevail in the early years of Monetary Union. The stability-oriented monetary policy strategy rests on two "pillars". The first pillar is a prominent role for money. This is deemed to be important on account of the essentially monetary origins of inflation over the longer term. The second pillar of the monetary policy strategy is a broadly based assessment of the outlook for price developments and the risks to price stability in the euro area as a whole. The Governing Council recognises that it is important, in parallel with the assessment of monetary growth, to look at a wide range of financial and other economic indicators, including economic forecasts. This systematic analysis of all other relevant information about economic and financial conditions will ensure that the Governing Council is as well-informed as possible when taking monetary policy decisions. Monetary developments can reveal useful information about future price developments and thereby offer an important compass for the conduct of monetary policy. Therefore, it is absolutely essential for any central bank entrusted with the task of keeping prices stable to analyse and monitor the developments of monetary aggregates closely. Consequently, the Governing Council of the ECB has announced a quantitative reference value for broad monetary growth as measured by M3, which should, under normal circumstances, give some indication of future inflationary pressure. The choice of M3 as an aggregate is supported by empirical evidence regarding the long-run stability and leading indicator properties of this aggregate. Moreover, conceptual arguments pointed to the considerable importance of including in the monetary aggregate those assets which have a high degree of substitutability with narrower definitions of money. Therefore, in addition to currency in circulation and deposits, repos, units or shares of money market funds and money market paper as well as short-term debt securities, all of which are close substitutes for more traditional bank deposits, have also been included in this definition. The first reference value for M3 growth has been set at an annual rate of 4 1/2 %. This reference value is consistent with the maintenance of price stability over the medium term, while allowing for sustainable output growth and the trend decline in the velocity of circulation of M3. In setting the reference value for monetary growth, the Governing Council has taken account of various factors and emphasised its medium-term orientation. First, the Governing Council is committed to maintaining price stability according to the definition enshrined in the Treaty on European Union. This requires increases in the HICP for the euro area of "below 2%". Second, the Governing Council takes the view that a figure in the range of 2% to 2 1/2 % per annum for the trend growth in real GDP in the euro area appears to be reasonable. Third, the uncertainties concerning short-term developments in velocity linked to the start of Stage Three have led the Governing Council to assume that the medium-term trend decline in velocity lies approximately within a range of 1/2 % to 1% each year. This range reflects historical experience over the past twenty years. Substantial or prolonged deviations of current monetary growth from the reference value should, under normal circumstances, signal risks to price stability in the medium term. Monetary policy does not react to deviations of monetary growth from the reference value in a "mechanistic" way. In the first instance, such deviations will be thoroughly analysed to infer any signals which they may offer about the prospects for price developments. If the deviation points to a threat to price stability, monetary policy will react in a manner appropriate to counter this threat, rather than attempt to eliminate the deviation of monetary growth from the reference value in the short term. Although monetary data contain information which is vital for monetary policy decision-making, monetary developments alone will not constitute a complete summary of all the economic information necessary to take appropriate policy decisions. There is a clear need for the Governing Council to look at a wide range of other economic and financial indicators. At the same time, relying on a single forecast that attempts to summarise all the information available from a wide range of indicators would be misguided. The Governing Council does not react mechanistically to a single variable - whether this be a forecast, the exchange rate, unit labour costs or fiscal indicators - but rather takes into account the complete picture offered by all available and meaningful leading indicators of future inflation. In this context, the Governing Council analyses the economic reasons behind the projected risks to price stability. The appropriate monetary policy response to a threat to price stability will depend on the nature of the threat. The Governing Council can only understand the nature of the risk if it is presented with a full set of data. From these, it can attempt to identify the nature of the disturbance to price stability. Having identified the threat, an appropriate policy response can be selected and implemented. Internal forecasts of economic activity and inflation in the euro area can also contribute to the success of an appropriately forward-looking monetary policy. However, the Eurosystem should not be judged on, or held accountable for, the accuracy of its internal forecasts. Thus, publication of the forecasts cannot contribute to accountability. Rather, its performance in maintaining price stability in the medium term should be used by the public to judge the success of the Eurosystem. Allow me to say a few words on certain proposals made in the recent public debate, which may be deemed to suggest that the focus of monetary policy should be shifted towards objectives other than price stability. Indeed, some recent suggestions seem to imply that the Eurosystem should react more or less automatically to exchange rate movements or other specific variables such as unit labour costs. The Eurosystem's monetary policy stance is not one of benign neglect with respect to the exchange rate. The Eurosystem's stability-oriented monetary policy strategy takes into account the external value of the euro as one, potentially important, determinant of the outlook for price stability. Obviously, if a strong and abrupt appreciation of the euro were to occur, this would lead, all other things being equal, to downward pressures on price developments. In such a situation, there would be a stronger reason for lowering the ECB's interest rates, which might then, in turn, help to counteract part of the prior exchange rate movement. However, monetary policy reactions to the exchange rate, or to any other variable, can never be mechanistic or automatic. According to its stability-oriented strategy, the Eurosystem always has to analyse carefully a wide set of indicators, the nature of any disturbances and their implications for the overall outlook for price developments in the medium term. In any case, it must be borne in mind that the Treaty on European Union also requires the single exchange rate policy to respect the primary objective of price stability. Thus, the ECB cannot commit itself in advance to any specific reaction with respect to the exchange rate. I am sure you would agree with me that it would not necessarily be appropriate to tighten the monetary policy stance simply because the euro had depreciated, if, at the same time, we were in a recession with increasing downward pressures on prices. As such mechanistic reactions to exchange rate developments could easily endanger price stability and destabilise economic developments in the euro area, we deliberately excluded any kind of exchange rate targets or target zones from our strategy. In line with its clear mandate enshrined in the Treaty, and for sound economic reasons, the ECB has to decide which monetary stance best serves the maintenance of price stability over the medium term and then act accordingly. At the same time, the Treaty also emphasises the need for sound fiscal policies. This clear separation of responsibilities is both efficient and transparent. The Eurosystem is open, transparent and, above all, accountable for its performance. As part of its communication strategy, the Governing Council of the ECB regularly informs the public about changes in its assessment of the monetary, economic and financial situation in the euro area and about specific monetary policy decisions. The Governing Council meets every fortnight. The first meeting in every month is immediately followed by a press conference and the release of the President's Introductory Statement, which is a summary of the conclusions of the Governing Council with regard to its assessment of monetary, financial and other economic developments. This is similar to what other central banks call minutes. We are convinced that this very prompt delivery of information serves the interests of the public in an optimal way. I do not think that many central banks publish their minutes only a few hours after the meeting of their governing body. I am also convinced that it is in the public interest for the view of the whole Governing Council to be presented, rather than the views of individual members. Moreover, the ECB has just published its first edition of the Monthly Bulletin, and will publish an Annual Report. We shall also explain our policies on a regular basis in speeches and interviews, also making a presentation to the European Parliament at least four times a year. Co-operation among European national central banks has always been close and, among participants in Stage Three, it has become increasingly so in recent years and months. The co-ordinated reduction of the key interest rates by all central banks of the euro area in December 1998 clearly demonstrated that Monetary Union had begun de facto before the start of Stage Three. This co-ordinated measure contributed to the stabilisation of market expectations. The Governing Council of the ECB announced that the new level of the euro area-wide key interest rate of 3% would prevail "for the foreseeable future". In other words, in the absence of further disturbances to the economy or the emergence of new and unanticipated threats to price stability, this level of interest rate is considered to be consistent with the primary objective of maintaining price stability over the medium term. Our announcement helped to resolve some uncertainty at a time when the practical, technical and logistical tasks required by the changeover weekend were uppermost in our minds and in those of market participants. The first main refinancing operations of the Eurosystem were successfully settled. While paying due attention to the uncertainties related to the phasing-in of the new system, the decisions were taken on the basis of the liquidity conditions prevailing in the euro area money market as a whole. In addition to the refinancing operations, the Eurosystem offers standing facilities, which can be accessed by credit institutions via the NCBs. The deposit and marginal lending facilities constitute, in normal circumstances, the upper and lower bound for the overnight market interest rate. As a transitional measure, the Governing Council of the ECB had narrowed the corridor established by the interest rates on the Eurosystem's standing facilities from 4 January until 21 January 1999. The intention was to facilitate the necessary adjustments to the new institutional environment resulting from the transition to Stage Three. At its last meeting, the Governing Council of the ECB confirmed its earlier assessment of the outlook for price stability. The Governing Council therefore decided that for the two next main refinancing operations the same conditions will apply as for the three main refinancing operations settled earlier this month. This means they will be fixed rate tenders conducted at an interest rate of 3.0% Furthermore, the Governing Council confirmed that it did not see a need for continuing the application of the narrow interest rate corridor beyond the date of 21 January 1999. It was thus decided to revert to the interest rates on the Eurosystem's two standing facilities, which it had set for the start of Stage Three. It set the marginal lending rate at a level of 4.5% and the deposit rate at 2.0% with effect from 22 January 1999. This decision has to be seen against the background of the experience with the functioning of the euro area-wide money market since the beginning of the year. Difficulties of some market participants with the functioning of the area-wide money market have diminished substantially over time. As a consequence, overall, the integration of the euro area money market has therefore reached a satisfactory state only three weeks after its creation. The first regular longer-term refinancing operation, which was conducted using parallel tenders with three different maturities of one, two and three months, was also settled successfully on 14 January 1999. It was conducted as a standard variable rate tender, using the single rate allotment procedure. In contrast to the main refinancing operations, these longer-term market operations are not aimed at signalling the Eurosystem's monetary policy stance. The ECB announces standard allotment volumes in advance. Therefore, interest rates from these operations are to be seen as indicators of market conditions. Finally, I should like to report on the Governing Council's regular assessment of monetary, financial and economic conditions. We consider the current monetary trend for the euro area to be compatible with continued price stability in the euro area. The 12-month growth rate of the broad monetary aggregate M3 decreased from 5.0% in October 1998 to 4.5% in November 1998. The three-month moving average of M3 (covering the months September to November 1998) stood at 4.7%, i.e. very close to the reference value of 4 1/2 % per annum. With respect to the broadly based outlook for price developments and risks to price stability, financial market developments may be seen as indicating a favourable assessment of the recent monetary policy decisions of the Eurosystem, signalling that financial market participants expect the environment of price stability to continue. In this connection, I could mention the fall in long-term interest rates at the start of 1999 to new historical lows and the fact that the yield curve has shifted downwards. Indeed, conditions for investment at the start of Monetary Union are favourable. This relates, in particular, to the currently prevailing low interest rate level, which significantly reduces the costs of financing for investors. Economic growth in the euro area has become more broadly based, as is reflected in private consumption and investment. At the present juncture, the outlook for the euro area economy is still very much influenced by the uncertainties surrounding the evolution of the world economy in 1999. These uncertainties have adversely affected indicators of industrial confidence in the euro area and have fuelled expectations of a slowdown in economic activity in the short term. In part, the deteriorating external environment, which has its origins in the Asian and Russian financial crises, places a high burden on overall growth prospects. The picture, however, is mixed. Order books and capacity utilisation point to a less optimistic outlook, while retail sales and the recent pattern in employment and unemployment suggest more favourable trends. Consumer confidence also remained high until late 1998. In general, this pattern of mixed evidence appears to characterise the economic situation in the euro area around the turn of the year, and we shall continue to monitor developments carefully. I should also like to emphasise that the Governing Council carries out a forward-looking assessment of inflationary pressures and carefully assesses risks to price stability, whatever direction these may take. With respect to the latest data on the HICP, the annual increase for November 1998 showed a further slowdown to 0.9%, compared with 1.0% in the two previous months. This development was in line with previous trends. It was mainly due to lower annual percentage changes in the prices of food and a further reduction in energy prices. A significant contribution was also made by moderate wage increases. In combination with high overall productivity gains throughout the whole economy, a reduction in unit labour costs was reported. On balance, the described overall economic environment and all available forecasts for 1999 do not point to significant upward or downward pressure on price developments in the short term. Nevertheless, factors contributing to risks to price stability on both sides need to be taken into account. On the one hand, downward risks relate to the global environment and potential repercussions on the euro area, for example via import prices and further pressure on producer prices. These developments will be monitored closely. On the other, unexpected upward pressure on wages and a relaxation of the fiscal stance would clearly alter the general environment. Therefore, we shall also carefully monitor the outcome of ongoing wage rounds, the plans for fiscal policy in 1999 and over the medium term, as well as the implementation of such plans in compliance with the Stability and Growth Pact. In summary, the current situation, which is characterised by monetary growth compatible with continued price stability and the absence of immediate upward or downward pressure on price developments, justifies maintaining the current monetary policy stance, with an ECB interest rate of 3% for the main refinancing facility. Indeed, monetary policy in Stage Three started with very low interest rates by historical standards.
r990125a_ECB	euro area	1999-01-25T00:00:00	Finnish savers and investors in the euro area	hamalainen	0	It is now just over three weeks since the launch of the single monetary policy and the euro area-wide money markets. The impact of these changes on the lives of the average Finnish savers and investors in financial operations to date has probably been marginal - apart from the wide press coverage and the extra digits in the bank statements and pay slips of many citizens, displaying the value of markka-denominated balances in euro. Nonetheless, the Finnish investors' environment has already changed significantly and will continue to change radically in the years to come. It may be useful to divide the changes in the saving and investment domains into three main categories: The single most significant new characteristic of the financial environment of Finnish and European savers and investors alike is the transition to an era of low inflation related to the emergence of money and capital market deregulation. Market predictability and positive real interest rates generated by sustained low inflation have meant that the established practice of investing in fixed assets has begun to wane and is being replaced by a greater demand for investment in liquid financial assets. The non-liquid market segment of housing and fixed asset investment now has a new contender of a much more liquid kind, namely equity investment. Shareholding, as such, is already widespread in Finland in the sense that holding shares or a stake in equity funds is quite common. However, as a proportion of overall investments, the asset volume of small investors remains very modest both in Finland and in most of Europe, compared with that of the United States. Financial market deregulation and low inflation have led to a far more diversified supply of financial assets. A much wider variety of new competitive financial investment instruments now exists together with the more traditional bank deposits, such as debt securities (issued both by the public sector and private firms), units or shares in money market funds that invest in money market paper, debt securities, and equity and derivative instruments. The changing demographic structure is another element that has a bearing on the financial savings segment. An ageing European population is leading to a position where it is no longer possible to meet all health care and pension obligations using taxpayers' money or by means of other public sector funds bearing a direct burden on labour costs. The narrowing financial latitude in public sector finances has made investment in voluntary pension and life assurance schemes, as well as in more liquid assets, an attractive alternative to the average consumer. The third change affecting investment behaviour - one that both played a part in and eventually led to financial market deregulation - was and continues to be technological development. Technological evolution has made real-time data transfer and real-time asset transfer viable, it has made it possible to intercept real-time information on a far broader scale, globally in fact, and it has opened up new opportunities in the world of financial instruments, for example in the case of numerous derivative instruments. Globalisation and advanced data transfer that becomes everyone's right in the Promised Land of the Internet will doubtless alter the behaviour of Finnish savers and investors, perhaps far more than we can at present envisage. All these changes have been instrumental in bridging the gap between the Finnish and European investment environment and that of the United States. Moreover, all these developments will continue to strengthen the changes brought about by the adoption of the euro. The birth of the euro area has already considerably broadened the opportunities for the Finnish investor, both institutional and private. In the past, because of the exchange rate risk, the bulk of investment was focused on domestic investment instruments, owing either to legal restrictions (e.g. insurance companies) or to a lack of experience in hedging against risk, but also due to the dearth of competitive hedging instruments. The disappearance of exchange rate risk between the 11 euro area Member States has broadened opportunities to invest in any instrument in all 11 participating Member States. The integrated market has given rise to financial markets that are both broad and deep, and to the emergence of new financial instruments. In practice, the present options open to investors have widened to include only euro area-wide short-term money markets. These markets can in fact be construed as wholesale markets, markets that cater best for the liquidity and cash management needs of financial institutions and business investors. Indeed, for institutional investors there has been an immediate improvement in investment opportunities. The options of private investors, however, have changed only indirectly through the greater variety of financial products offered by money market funds. Essentially, the earlier concept of "domestic" investment instruments has now expanded to refer to the whole of the euro area. The real-time integration of the money markets - on the one hand essential for the single monetary policy, and, on the other, feasible thanks to the creation of the European real-time gross settlement system TARGET - has made strong progress, and will continue to strengthen this market segment. Accordingly, new market segments, such as private repo markets, will emerge. One key element in developing euro area monetary policy has been the creation of common collateral standards and, together with this, the shift to collateralised transactions (replacing earlier fiduciary transactions based on mutual trust), and progress in the harmonisation of market practices. This, in turn, has reduced risks involved in money market investment. Fully integrated short-term liquid asset markets in the euro area, however, would fail to provide savers and investors with an opening for interest yield differentiation. The underlying principle in the single monetary policy is that markets that operate efficiently can ensure harmonised short-term interest rates across the board in the euro area. The advantage in the euro markets gained by the investor is the sheer volume and depth of the markets, making it possible to spread and minimise risk. However, the elimination of exchange rate risk between the economies of the 11 participating Member States is equally important from the viewpoint of the bond, equity and derivative markets. This provides better potential for diversifying investments from the thin Finnish markets to the broader and deeper European markets. At this stage, however, bond and equity markets still remain segmented and nationally diversified. These investment instruments are quoted, applying varying trading practices and differing market rules and regulations, for the most part on the national stock exchanges, making direct comparison difficult for individual investors. This notwithstanding, the near future also promises significant market harmonisation, integration and deepening on the side of the capital markets. Harmonised market practices can be seen as a natural market-driven sequel to the ECB-steered harmonisation process on the short-term markets. The European Commission survey commissioned by the Ministries of Finance of the respective Member States last spring, which was designed to disclose cross-country differences in legislation on financial market services, clearly serves this purpose. The aim is, for example, to harmonise the contents and to enhance the acceptance of stock exchange brochures and press releases, to scale down the number of institutional investment restrictions and to harmonise legislation on collateral throughout the euro area. It is realistic to assume and indeed to anticipate that market forces will soon drive the capital markets - bonds and equities alike - towards more centralised operations in the big financial centres of Europe. This can already be seen in the existing alliances and alliance and merger talks between major European stock exchanges, and, beyond that, in the linking of smaller stock exchanges to the satellite networks of bigger centres. This does not mean that trading on the smaller, national stock exchanges will cease altogether, as limited trading in domestic securities is bound to continue. However, markets extending across the whole of Europe that are centralised, transparent, deep and liquid nonetheless offer great potential for Finnish savers and investors. Common interest in the euro as an official reserve and investment currency will also pave the way for wider capital markets in the euro area. The capital markets of the euro area are as yet unable to compete fully with the deep, liquid and versatile markets of the United States. However, with the euro being seen as a major international currency and clearly construed as a potential vehicle for spreading investment risk in both central bank reserves outside the euro area and those of private investors, it seems probable that demand will soon drive the markets to greater efficiency and diversity. The markets are heralding greater depth and improved liquidity. New, clearer benchmark practices are on the horizon, making it easier to compare the terms and conditions and credits of different issuers. More efficient and better co-ordinated credit risk assessments can be made, not only of issuers, but also of individual securities, making it considerably easier to compare the risks involved. Above all, the variety of instruments promises to become wider, especially as regards maturities and collateral. Hand in hand with increased variety comes greater transparency and enhanced comparability across the different options. The market segments that foretell change on the European capital markets are the bond markets, where the volume of bonds issued by private firms is likely to grow, and the stock markets, where greater expansion and further integration are envisaged. In other words, European markets and instruments will begin to resemble the North American markets in this context too. Cuts in public sector deficits and reduced debt burdens lead to a smaller volume of government bonds, thus creating room for bonds issued by private enterprises and providing incentives for companies to raise funds on the wide, efficient markets. In these conditions of low inflation, the low interest rates on financial assets make equities an attractive option for lucrative investment. From the viewpoint of individual investors, these developments offer more alternatives, but, by the same token, they also highlight the saver's and investor's own responsibility for making the choice between higher yields with greater risk, on the one hand, and lower yields with lower risk, on the other. In this context, the developments occurring independently of the euro, which I discussed above, play a key role. Low inflation and low interest rates imply low nominal rates of return, but yield expectations (especially regarding returns on pension savings, both in relation to pension funds' and private individuals' investment activities) are invariably demanding. This compels investors actively to assess and monitor the risk/reward ratio on the markets, i.e. it calls for far more active and professional investment behaviour than before. A more active approach by investors can be expected to emerge as skills in exploiting computer technology and information technology improve. That is to say, the disposition of Finnish and European investors towards more "Americanised", that is, more skilled and dedicated behaviour in financial operations is bound to grow in the near future, notably when related to their own household finances. This trend, one in which I myself believe, gives rise to a number of implications and challenges in different segments of the economy: Will financial institutions in Finland be able to make the appropriate adjustments in operations and devise competitive and adequate services for customers, for example in investment services and in mutual fund activities, in order to withstand these changes? The new investment environment also challenges society to offer appropriate basic training in economics and information technology skills as equitably as possible. This should also prompt financial service operators and firms to offer services to small investors and savers that are both cost-effective and competitive. With a growing and more diverse market share of assets taking the form of longer maturities and with shareholdings on the rise, investors are becoming more dependent on market-driven expectations, as reflected in long-term interest rates and in stock quotations. In the same vein, the "Americanised" consumer behaviour of savers makes these assets more prone to fluctuations than before. The effects of both European monetary policy and of national fiscal policy are thus lessened. A long-ranging approach and effective prevention of speculative bubbles are the challenges faced by today's economic policy-makers. A key feature in current developments lies in fostering the role of the financial markets as a broker for the efficient allocation of capital, and in ensuring potential growth in productive activities and employment prospects in all of Europe. Indeed, these constitute key objectives of the whole EU and euro project. However, changes are also the harbinger of adjustment pain, and Finland is very familiar with this. Timely preparation and early adjustment would alleviate this pain. A crucial question is how swiftly Finnish savers and investors will become aware of the changes that have taken place and are able to modify their own behaviour accordingly, and how fast and efficiently the Finnish financial system can prepare for these changes in investment activities. Finnish history over the past 15 to 20 years leaves quite a lot to be desired in this respect, as behavioural changes have traditionally occurred slowly in Finland. The question which we must now ask ourselves is whether this "tradition" is likely to continue into the 21st century?
r990128a_ECB	euro area	1999-01-28T00:00:00	The euro - four weeks after the start	no_info	0	The birth of the euro on 1 January 1999 was an event of historic proportions. After months and years of practical preparations and testing, the new currency was delivered smoothly, if not entirely painlessly. The irrevocable euro conversion rates for the participating currencies had been adopted by the EU Council in the early afternoon of 31 December 1998. This was the starting shot for the "changeover weekend". During this time, billions of electronic records had to be converted from national currencies to the euro and final tests for the new payments and securities settlement infrastructure were conducted. Several thousand staff members were at work or on call within the Eurosystem, which comprises the European Central Bank and the national central banks of the euro area. Tens of thousands more - not least in the City of London - laboured intensively in financial institutions across the globe. , the baptism of the new currency followed swiftly. In fact, trading in euro had already started in the Sydney market at 6 p.m. (Central European Time) on 3 January. A total of 944 banks participated in the first main refinancing operation of the Eurosystem at a fixed interest rate of 3%, which was successfully completed on 5 January and settled on 7 January. In order to assist the adaptation of financial institutions to the new environment of the euro area money market, a relatively narrow corridor for the ECB's standing facilities was set, as a transitional measure, for the period between 4 January and 21 January. The launch of the euro occurred in an environment of price stability that few observers would have imagined only a few years back. The year-on-year increase in the Harmonised Index of Consumer Prices stood at just below 1% (the last available figure for November 1998), which is consistent with our definition of price stability. Long-term interest rates have hit record lows, which points to a high level of confidence in the ability of the Eurosystem to maintain price stability in the future. At the same time - according to current data - real activity in the euro area has, overall, held up reasonably well in the face of considerable turbulence in the global economy. The euro, which represents an economic area of 290 million people - in terms of the share of world GDP second only to the United States - will, from the very beginning, play an important international role. The health of the new-born currency will be under constant observation and critical scrutiny, both by global financial markets and by the public at large. Let me assure you that the euro's immediate parents and guardians will do their utmost to see to it that the new currency will prosper and flourish and will not stray from the path of stability. With all the attention and apprehension surrounding the introduction of the euro on 1 January, it is easy to forget that this was just one, albeit very important, step on the long road of European integration. The first four weeks since the launch of the euro have made for a promising start, but this is evidently a far too short time span to assess its prospects for the future. In order to understand European Economic and Monetary Union, which has now become a reality, and in order to gauge its prospects, promises and risks, it is necessary to take a longer-term view and to look back in history. This perspective comes naturally in premises as illustrious as those in which we find ourselves this evening. Only future generations will be able to judge whether the newly born European Central Bank can pass the test of time even remotely as convincingly as the institutions of British democracy have done over the centuries. The long process of European integration started in the immediate aftermath of World War II. It has been characterised by a combination of grand political vision and a succession of small pragmatic steps to reap the concrete benefits of bringing the economies and the people in Europe closer together. The balance between vision and realism has not always remained constant and progress has not always been steady. British leaders over the decades have made substantial contributions to the process of European integration, frequently injecting healthy doses of realism, but also, at various times, providing new ideas and leadership for Europe. Indeed, it was none other than Sir Winston Churchill who first expressed the vision of "a United States of Europe" in his famous speech in Zurich on 19 September 1946. As you know, however, he did not envisage that the United Kingdom, whose place would remain in the Commonwealth, would take part. As you will be equally aware, the process of integration unfolding on the continent later proved to develop a seemingly irresistible force of attraction for many countries not involved initially. This appears to confirm a general principle already noted by Aristotle. In his (Book V, Chapter 6) he writes, if you allow me to quote, "and constitutions of all forms are broken up sometimes from movements initiating from within themselves, but sometimes from outside, when there is an opposite form of constitution either nearby or a long way off yet possessed of power." [Aristotle's To avoid any misunderstandings: The mechanism described by Aristotle in general terms need not work only in one direction. Indeed, in the case of Europe, integration has been a process of mutual adaptation and reciprocal influences. The continuous process of integration has, moreover, been compatible to date with a considerable degree of variation in constitutional arrangements. It is not clear to me why this should not continue to be possible in the future, as long as sufficient common ground is guaranteed. At the time of Churchill's speech, most of Europe still lay in ruins. Memories of the ferocious wars and destruction that have savaged our continent this century provided powerful political inspiration for closer European integration. This was particularly true for the immediate post-war years, but it appears to hold to this day. The long shadow of the past has, in fact, also been prominent on both sides of the debate over European Economic and Monetary Union. No doubt most of you will recall the arguments raised in some quarters about monetary union as a "question of war and peace", on which opinions differ. The existence of such debates supports the view that monetary union cannot be understood in isolation. It must be seen in the context of the wider economic political process of European integration. Having learned their lesson from history, Europeans - starting with the formation of the European Coal and Steel Community in 1952 - turned early to the creation of common, supranational institutions as an engine of integration. This was regarded as the best way to overcome national divisions in a lasting manner and to ensure that integration would be robust in the face of crises. Thus, from the inception of the ECSC to the present day, Europe has embraced a unique mixture of supranational characteristics and insistence on national sovereignty, which is perhaps quite adequately captured by the term "European Community". Rather than pursuing grandiose political designs, European leaders quickly focused on concrete economic issues, especially after the agreement on a European Defence Community had to be abandoned when it was not ratified in the French National Assembly in 1954. The ideal of European integration as an "ever closer union" was nevertheless enshrined in the preamble to the Treaty of Rome in 1957, which created the European Economic Community (and also Euratom), with the objective of creating a customs union and a common market among Member States. After this had largely been achieved in the late 1960s, the first attempt at monetary union was launched, culminating in the "Werner Report" of 1970, which envisaged that monetary union would be in place by 1980. This first attempt at monetary union in Europe came to nothing in the face of the world wide currency turmoil of the 1970s. As we now know, the next attempt met with success. It started with the foundation of the European Monetary System in 1979. The Single European Act and the single market programme then prompted increasing calls for further monetary integration in the late 1980s following the logic of "one market - one money". To a non-negligible number of observers, at the time, this logic appeared anything but compelling and a single currency anything but inevitable. Strong commitment on the part of leading European politicians brought this process, once set in place, finally to a successful conclusion. With the benefit of hindsight, the exchange rate crises of 1992-93, which for a moment had seemed set to derail the whole project, actually served to contribute to its success. In the aftermath of this experience, efforts to achieve greater economic convergence intensified and, in the end, allowed a timely launch of the single currency. The most fundamental precondition for European Economic and Monetary Union, however, was a broad consensus that monetary policy must be unambiguously focused on the objective of price stability and that this is best entrusted to a central bank that is independent from political interference. Central bank independence and an unequivocal commitment to price stability are the common tenets of both the monetary policy framework enshrined in the Maastricht Treaty and that currently in place in the United Kingdom. It is now widely accepted - in this country and around the world - that price stability is a common good that is best safeguarded by independent central banks, which are not subject to the usual short-term pressures that characterise the political process. The Chancellor of the Exchequer, Gordon Brown, expressed this very eloquently in his statement on 6 May 1997 when he announced that the Bank of England was to be granted independence. "A fully credible framework for monetary policy can only be built", he said, "if the long-term needs of the economy, not short-term political considerations, guide monetary decision-making. We must remove the suspicion that short-term political considerations are influencing the setting of interest rates". In the words of the Chancellor, "price stability is an essential precondition for the Government's objectives of high and sustainable levels of growth and employment". These two fundamental lessons reflect the experience in Britain and elsewhere over recent decades. In the case of Britain, like in many other countries, there had been growing disillusionment with the perpetuation of stop-and-go policies. A great number of British Chancellors have been associated with short-lived booms that later turned out to be unsustainable. As a consequence, Britain has now moved a long way towards the philosophy and institutional set-up underlying the Maastricht Treaty. In particular, it is now accepted that the appropriate objective for monetary policy is to maintain price stability over the medium term, rather than to attempt short-run macroeconomic fine-tuning. Both theoretical considerations and the empirical evidence accumulated over the years suggest that high rates of inflation are, on average, detrimental to growth and employment in the longer run. At the very least, nobody seems to be arguing that inflation is good for growth at any level. An environment of stable prices is a principal precondition for the efficient functioning of a free market economy and sustainable increases in both the standard of living and productive employment. The proposition that monetary policy should have price stability as its primary objective is not only enshrined in the Maastricht Treaty, but has become increasingly consensual across the industrial world and beyond. A substantial body of research also confirms that independent central banks tend to be more successful in the pursuit of price stability than dependent central banks, without any identifiable costs in terms of output growth or volatility. In the words of Nobel laureate Robert Lucas, "long-run price stability is one of the few legitimate 'free lunches' economics has discovered in 200 years of trying. It (...) can be had for the asking." The principle of central bank independence is firmly entrenched in the Statute of the European System of Central Banks and of the European Central Bank. It is an important precondition for the successful pursuit of price stability in the euro area, but the task of the ECB will no doubt be greatly facilitated if other policy areas follow a stability-oriented course as well. The Maastricht Treaty provides for a clear division of responsibilities among policy-makers in Europe. In this context, the ECB has been created as an independent supranational institution and given the unambiguous primary objective of maintaining price stability. This set-up reflects the well-founded view that, in this way, the ECB can best contribute to the shared broader objectives of the Community, including growth, employment and social cohesion. While the fundamental approach to monetary policy-making is now fairly similar in the United Kingdom and in the euro area, some notable differences remain. The British public, in keeping with its long and proud parliamentary tradition, has - understandably - been particularly concerned with the issue of democratic accountability in the context of central bank independence. From this perspective, some commentators have criticised the ECB as being "too powerful", "undemocratic" and "accountable to no one". You will not be surprised to hear that I should like to take issue with that characterisation. As explained above, it makes good economic sense to take the responsibility for the common good of price stability outside the direct, day-to-day influence of partisan politics. Moreover, it is perfectly democratically legitimate for society to delegate authority for a particular policy area to an institution outside the regular political process. Such an institution can and will only be held accountable effectively if it is given a clear and limited mandate. If monetary policy were instead to be called upon to serve a multitude of - usually competing - goals, the status of independence would be much harder to justify and the related accountability difficult to achieve. The economic rationale for the democratic act of granting independence to central banks is the recognition that monetary policy can and should only be held responsible for the single overriding objective of medium-term price stability. If (and only if) it is agreed that price stability is a common good that should and must not be subject to the normal kind of trade-offs and value judgements which are the domain of the regular political process, would such delegation of authority appear to be wise and democratically legitimate. In the case of the ECB, the primary objective of maintaining price stability is enshrined in an international Treaty, which would be rather difficult to change. Its quasi-constitutional character, while offering greater protection from political interference, does not mean that the ECB's mandate carries less democratic legitimacy. On the contrary, a Treaty concluded by 15 national governments and ratified by 15 national parliaments, in some cases endorsed in addition by a popular referendum, confers a profound and robust degree of democratic legitimacy. Once it is accepted that price stability is a lasting value and not simply a short-term objective, it appears quite legitimate to afford the ECB, as the institution entrusted with maintaining price stability, a high degree of legal protection. Accountability is the reverse side of the coin of independence. Accountability in a democracy must ultimately be achieved vis-a-vis the supreme sovereign, i.e. the people whose interests the institution must be seen to serve. The accountability of an independent institution that is not subject to the regular political process, as argued before, requires, in particular, that the institution's mandate should be limited and clearly defined. Only under these circumstances can the performance of the central bank be monitored and evaluated effectively by the public. The Maastricht Treaty has assigned the ECB the single, overriding, primary goal of price stability as the basis for accountability. Moreover, the Governing Council of the ECB adopted in October 1998 a quantitative definition of price stability as "a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%". The clear definition of the ECB's final objective provides the European public with a precise benchmark against which to judge its performance, for which it can and will be held accountable. The issue of accountability for the ECB's performance with respect to its clearly defined mandate needs to be logically separated from concerns over the transparency of the policy-making itself (as opposed to the of this process). Transparency, openness and clarity about the central bank sets out to achieve its mandate are also desirable, since they reduce the degree of uncertainty in the monetary policy process and help the public to understand and assess the central bank's actions. Criticism that the ECB will not be accountable for, nor transparent about, its actions is misplaced, to my mind in most cases arising purely from a lack of information. Clearly, the ECB will not and cannot be held formally and directly accountable by . This would contradict the very notion of full institutional independence embodied in the Treaty. Besides, of course, a European government does not exist. Given that the ECB has a clear mandate, any formal accountability vis-a-vis governments and even would run counter to the logic of a single and supranational European monetary policy. The ECB is, however, committed to a high degree of accountability for its monetary policy decisions and its performance in achieving price stability vis-a-vis the European public and its elected representatives. The Treaty mandates the ESCB to submit quarterly reports as well as an annual report to the European Parliament, the Council of Ministers and the European Commission. These reports will be debated by the European Parliament. Furthermore, the ECB's President and Members of the Executive Board of the ECB can be questioned before the European Parliament's Committees. In addition to the reporting requirements foreseen in the Maastricht Treaty, which are among the most stringent for any central bank, the ECB is committed to going even further in ensuring transparency and accountability. Most importantly, the President will hold an extensive press conference immediately following the first Governing Council meeting of every month. A thorough assessment of the economic environment together with special articles on topical issues are also provided in a Monthly Bulletin. The first issue of the Bulletin appeared last week. In addition, there will be working papers and occasional papers presenting the analysis and research conducted by ECB staff for scientific review. The members of the Executive Board and other members of the Governing Council will further communicate with the public very actively through regular speeches and interviews. The decision by the Governing Council of the ECB not to publish the minutes of its meetings and not to make public the voting behaviour of its members has been criticised in some quarters as a lack of accountability and transparency. In this context, one should recall that, for the purpose of accountability, what matters most will be the ECB's of stability performance. Moreover, the Governing Council will strive for a maximum degree of accountability and transparency regarding its operation as a collegiate/collective body and not with respect to members. For that purpose it is essential to convey to the public a sense of the reasoning behind the decisions of the Governing Council and a coherent summary of the information upon which decisions are based. On the occasions of the President's press conferences, a detailed assessment of the economic situation and the outlook for price developments will be given every month followed by a question and answer session. A summary of all relevant information that would normally be expected to be contained in published minutes will therefore - for all practical purposes - be available, together with an opportunity to pose further questions. This goes far beyond what most central banks are prepared to do in terms of communicating with the public. It is not quite obvious to my mind that the legitimate and important cause of transparency would be advanced if central banks were to make available to the public the maximum amount of information at their disposal. You could perhaps imagine all data and records continuously being put on the Internet. You could, in addition, imagine live broadcasts of all Governing Council meetings, committee meetings, perhaps including the coffee breaks and all words uttered in the halls and corridors of power. George Orwell in reverse, if you will. Apart from all practical difficulties, would such complete openness really enhance the general public's (and even the specialists') understanding of monetary policy? Moreover, could the public ever be sure that some important information was not withheld, some ulterior motives hidden, some decisions not revealed? The Statute of the European System of Central Banks and of the European Central Bank stipulates that the proceedings of the meetings of the Governing Council shall be confidential, whereas the outcome of its deliberations may be made public. This is a wise decision both for reasons of internal efficiency of the decision-making process and the public's perception of it. Efficient decision-making requires a frank and open discussion (and subsequent voting) based on maximum objectivity in judging the available information and policy options with respect to fulfilling the Treaty mandate. Experience shows that if individual statements during meetings are made public with the names attributed to them, a tendency simply to exchange carefully drafted - and possibly lengthy - statements can emerge. Thereby the free flow of discussion is likely to be inhibited. Similarly, voting behaviour may become more heavily influenced by tactical considerations and peer pressure rather than be based on the best judgement of the situation at hand. Perhaps more importantly, the publication of individual votes would lead the public and financial markets to focus on individual voting patterns. The Maastricht Treaty prescribes that all members of the Governing Council serve in a personal capacity as representatives of the System as a whole and on a purely European mandate. National considerations must therefore play no role in the decision-making process. It would be unrealistic to assume, at least for the initial years, that there would not be a risk that, in the public's perception, individual central bank governors would still be associated with their country of origin. This would inevitably invite pressures on individual members generated by national or local interests. Such pressures would be detrimental, even if they were firmly resisted. In fact, distortions in voting behaviour to "prove" that one was immune from national interests and pressures could be just as damaging. Neither a "personalisation" of monetary policy in general, nor the specific risks of its "renationalisation" in the perception of the public would be helpful for establishing the reputation of the ECB as an independent and genuinely European institution which is collectively responsible and accountable for the health and stability of the single currency. I can assure you that the ECB will continuously strive for the maximum possible degree of openness and transparency in its monetary policy. This is in the interest of accountability vis-a-vis the European public. This is also in the interest of the effectiveness of monetary policy itself, which should be clearly understood by the public and the financial markets. The ECB's efforts to provide a high degree of both accountability and transparency are clearly reflected in its choice of monetary policy strategy. The importance of a precise definition of price stability as the basis for accountability with respect to the final goal of the ECB has already been discussed. I shall briefly review the other main aspects of the ECB's strategy below. Let me first point out, however, why we feel that a central bank needs a monetary policy strategy at all. This has a lot to do with accountability and transparency, but it also concerns the internal decision-making process of a central bank. Monetary policy is not a simple task. The transmission from the monetary policy instruments through short-term interest rates and a variety of channels to the price level is complex and may vary over time. A monetary policy strategy provides a conceptual framework that structures the processing of the vast amount of information in order to provide guidance and decision criteria to policy-makers. In terms of communication with the public, the monetary policy strategy should help the public to understand and assess monetary policy actions. The simple point to be made in this context is that openness will always be a matter of degree. It need not by itself necessarily lead to greater transparency, let alone be helpful for clarity and understanding. In the present information age we are all too aware of this. Anyone having "surfed the Internet" knows that the mere availability of information is not enough, the least that is required is a powerful "search engine" and then an ability to process and interpret the information properly. This is also a problem faced by central bankers when deciding on the appropriate stance of monetary policy, and this is why a monetary policy strategy is required. This is also the reason why - thankfully - we central bankers (and human beings in general) cannot entirely be replaced by computers. The key for the degree of transparency and clarity is therefore not the amount of information made available to the public, but the degree to which the monetary policy strategy followed within central banks truthfully corresponds to what can be communicated intelligibly to the public. An old-fashioned word for this degree of correspondence would be "honesty". The Governing Council of the ECB has adopted a monetary policy strategy which is neither conventional monetary targeting nor direct inflation targeting, nor a simple combination of the two. The manifold uncertainties in economic relationships accentuated by the very transition to a single currency pose substantial difficulties both for the stability of money demand as well as for the accuracy of inflation forecasts. Making a strict commitment to adjust monetary policy mechanistically in response to deviations from pre-announced monetary targets (or inflation targets at some particular horizon) in a situation of such great uncertainty would have been unwise, misleading and not credible. There would have been a great likelihood that targets would either have to be frequently missed or ignored. Despite the virtue of simplicity, it is, moreover, doubtful whether all relevant information can be usefully summarised in a single indicator like a monetary aggregate or a single inflation forecast. The "stability-oriented monetary policy strategy" decided by the Governing Council of the ECB comprises two pillars. First, a prominent role for money, in relation to which a quantitative reference value of 41/2% for the growth rate of M3 was announced in December, and, second, a broadly based assessment of the outlook for price developments. Given that inflation is ultimately a monetary phenomenon, monetary aggregates are a natural first choice as a "nominal anchor" and guidepost for monetary policy. In the early years of monetary union, however, the relationships between money, prices and interest rates are likely to be subject to an exceptional degree of uncertainty. While the basic longer-run relationship between money and prices has been shown to be robust across a wide range of policy regimes, it would be risky for monetary policy, in such a situation, to respond to short-term developments of monetary aggregates in a mechanical way. The notion of a reference value for money, as distinct from a monetary target, will provide an important benchmark against which to assess monetary developments and to judge and explain policy actions. As the second pillar and in parallel with the analysis of monetary conditions, a comprehensive "broadly based assessment of the outlook for price developments and the risks to price stability" will be conducted. Some observers have taken this to be synonymous with an inflation forecast, which is customarily at the centre of direct inflation targeting strategies, and have called upon the ECB to publish such a forecast. However, the broadly based assessment undertaken under the second pillar of the strategy will comprise an analysis of a wide range of indicator variables as well as the use of various forecasts of the outlook for price developments. Publishing any single "official inflation forecast" would, therefore, not adequately reflect the actual decision-making process in the Governing Council of the ECB and - rather than enhancing transparency and clarity - would actually be confusing and mislead the public. Besides, the underlying various inflation forecasts may not be fully understood by the public and the markets and could, under those circumstances, actually undermine the central bank's anti-inflation credibility. For all the manifold uncertainties associated with the transition to Monetary Union, it is paramount that the ECB is understood to be strongly committed to and very clear about the final objective of price stability. This is the basis for its vis-a-vis the general public. At the same time, the ECB will need to retain the necessary flexibility in interpreting and reacting appropriately to the available economic data. As described before, the ECB will go to great lengths to explain its policy decisions and the reasoning behind them to the public and thus will also aspire to the highest standards of upheld by any central bank. The Maastricht Treaty provides the necessary foundations for a successful monetary policy. It has enshrined the principle of central bank independence, endowed with a high degree of political legitimacy, and it has assigned the ESCB the clear mandate of maintaining price stability. The Governing Council of the ECB has presented its stability-oriented monetary policy strategy, which provides a coherent framework for its policy decisions and - together with the quantified definition of its overriding objective of price stability - furnishes a clear and "honest" basis for its accountability vis-a-vis the European public. At the same time, it takes account of the unique challenges and uncertainties facing the euro area. One should add that, of course, the ECB also has at its disposal the necessary policy instruments to implement its strategy and to attain its primary objective of price stability over the medium term. The Governing Council of the ECB has already demonstrated that it can act decisively with the co-ordinated interest rate move in early December even before the euro was born. This has reduced the uncertainty in the markets and cleared the way for a smooth start of the new currency. The past four weeks have made for a promising beginning. Thus, looking ahead, what will be the principal concerns regarding the longer-term health of the euro? There can be no doubt in anybody's mind that the ECB is determined and well-equipped to maintain price stability successfully in the euro area over the medium term. It will thereby do its part in contributing to the wider objectives of the Community. In particular, safeguarding the value of the currency is a crucial precondition for long-term investment, sustainable growth and employment creation. The maintenance of price stability is a task that should never be underestimated. The appropriately forward-looking assessment of future risks of inflationary or deflationary pressures in the economy will tend to be finely balanced at any point in time. Those commentators who call for monetary policy to be simultaneously directed at objectives other than price stability often forget this. We always need to be clear about what monetary policy do and equally what it do. This brings me to the possible risks inside Monetary Union. The ECB will do its job, but can we be equally confident that everybody else will do theirs? Europe suffers intolerably high rates of unemployment. For the most part, this unemployment is structural in nature and needs to be addressed urgently through labour market reforms and increased flexibility in the wage-setting process. It is a dangerous and counterproductive illusion that any of this could be helped by printing money, quite on the contrary. Monetary Union should take away that illusion once and for all. National governments and social partners must shoulder their responsibilities and one can only hope that the introduction of the euro serves as a "catalyst for change" and triggers the badly needed structural reforms at the national level. There have recently been calls for greater policy co-ordination among the euro area countries. Much has been made of the clear asymmetry in the Maastricht construction, i.e. the combination of a centralised single monetary policy alongside continued national responsibilities for most other areas of economic policy-making. While this may be a reflection of political realities and the requirements of subsidiarity, it would be premature to conclude that the Maastricht construction was devoid of economic logic. On the contrary, Monetary Union, above all, calls for a greater need for flexibility as well as discipline in wage-setting and budgetary policies and a better functioning of market adjustment mechanisms. monetary policy can no longer respond to national conditions, the exact opposite of greater centralisation and harmonisation may be required in other areas. Talk of uniform European wage-setting or an ambitious social union is going in the wrong direction; different productivity and real economic conditions across the euro area must be taken into account more than ever. Following similar reasoning, there is a strong case for retaining and even strengthening national (and in some cases "sub-national") responsibilities for fiscal policies. Indeed one reason for the Stability and Growth Pact being aimed at budgets that are close to balance or in surplus in normal times is to recover the room for manoeuvre for fiscal policy required to let automatic stabilisers operate effectively to smooth out national and regional business cycles. As long as the letter and the spirit of the Stability and Growth Pact are respected, national fiscal policies are free to use the remaining room for manoeuvre as best fits national circumstances and preferences. This should also be sufficient to prevent gross imbalances in the aggregate monetary-fiscal policy mix. Beyond that, it is not quite clear to me what any further "co-ordination", over and above the regular exchange of views and data, could possibly achieve. In particular, it would seem highly unrealistic, impractical and counterproductive if attempts were to be made at European-wide "Keynesian-style" fine-tuning and demand management among 11 Finance Ministers. Such attempts have proven a failure in the past, even at the national level, where the institutional preconditions would appear to be much more congenial. The Maastricht Treaty provides for a clear assignment of responsibilities. Monetary policy is centralised at the European level and has been given the single overriding objective of price stability. Fiscal policy and most other areas of economic policy-making remain largely rooted at the national level. Nevertheless, it is obvious - and the Treaty recognises this - that monetary policy does not operate in a vacuum. Unfavourable developments in other policy areas, in particular wages and fiscal polices, can place additional burdens on monetary policy and make the maintenance of price stability more difficult for the ECB. Therefore, it is natural that the ECB will participate in a continuous dialogue with European and national officials in a number of institutional settings, and we shall not hesitate to engage actively in the wider economic debate in Europe. However, this dialogue or any form of co-operation must not at any time blur the respective fundamental responsibilities. Without a clear assignment of responsibilities, policies are unlikely to be conducted in an effective and credible manner. Moreover, without it, there can be no meaningful accountability towards the ultimate sovereign - the people of Europe. In European Economic and Monetary Union sovereignty, which in any democracy ultimately belongs to the people, is delegated to a new supranational European institution as far as monetary policy is concerned. At the same time, the Eurosystem has been assigned a clear and limited mandate, i.e. to maintain price stability in the euro area, which it is to pursue free of political interference. This "twin transfer of sovereignty" in the monetary field - pooled at the European level and exercised through an independent central bank - is at the heart of the Maastricht Treaty. To be successful over the longer term, the ECB as the guardian of the euro, like any institution in a democracy, will have to win and maintain the trust and support of the European public. Historically, currency jurisdictions and national borders have tended to coincide. This reflects the simple fact that the right to issue money has always been a key attribute of national sovereignty and therefore monetary union would not appear to be just a small and innocuous step of a primarily technical nature. One is indeed hard pressed to find precedent in history, where sovereign nation states voluntarily ceded sovereignty in the monetary field to a genuinely supranational body. It is therefore clear that European Economic and Monetary Union has been and will continue to be not just an economic, but also a political project. Indeed, as I mentioned at the beginning of my speech, the European integration process as a whole has been characterised by an interplay of political and economic forces and motivations. Perhaps in no other Member State of the European Union is the political dimension of EMU debated as fiercely as in the United Kingdom. The perceived "loss of sovereignty" has raised fears that the single currency might open the floodgates to a centralised European "super state" run by unelected and "faceless bureaucrats". Baroness Thatcher has famously called the Maastricht Treaty a "treaty too far". Others make no secret of their view that, on the contrary, it is a treaty "not far enough". They believe that the single currency can be used as a vehicle towards the ultimate objective of greater political union and that further integration in other policy areas would be required to make European Economic and Monetary Union work. I have always found the idea that a single currency could be used as a "pace-setter", which would itself trigger further political integration, to be highly doubtful and extremely risky. The stability of the currency is too important a goal in itself and must not be overburdened with not strictly related political ambitions, however worthy these may be. Indeed, some commentators, such as the Berkeley economist Maurice Obstfeld, have warned that Europe "has taken a gamble in placing monetary unification so far ahead of political unification". However, in this whole debate the precise meaning of political union and the link to monetary union often remain unclear. It is certainly hard to draw a direct line from monetary union to, say, a common foreign policy. What is required, to my mind, for a successful monetary union is a sufficient degree of political commitment by all participating countries, the leading economic actors and the wider public to accept fundamentally and genuinely the political and economic constraints that a single and stable currency represents. The deeper underlying commitment to make European integration a success even in the most difficult of times in history gives some general grounds for hope on this count. Some degree of political unity (not necessarily union), or rather a sense of common responsibility would appear to be important for the long-run health of EMU. However, it is not a substitute for the right conditions for lasting success. The Maastricht Treaty, together with the Stability and Growth Pact adopted subsequently, provides the necessary foundations for stable money, sound economic policies and a flourishing free market economy in Europe. In particular, a single European monetary policy is compatible with responsibilities for many other policy areas, remaining firmly rooted at the national level, as long as the minimum set of common objectives, principles and rules established in the Treaty are followed in letter and in spirit. Most importantly, the delegation of monetary policy to an independent and European institution does not at all contradict the basic principles of democratic legitimacy. On the contrary, the ECB is given a precise and limited mandate, ratified by all 15 national parliaments, it can and will be held accountable effectively for its performance by the European public and its elected representatives. My conviction that the Maastricht Treaty offers a sound and convincing framework for economic policy-making in Europe, even with the presently very limited degree of political integration in other areas, does not mean that current institutions and structures in the European Union will and should be cast in stone. All durably successful institutions need to adapt as circumstances change, as has been the case for the institutions of British democracy. This has been and will continue to be true for the further evolution of European integration. The birth of the euro four weeks ago, on 1 January 1999, is certainly not the end of history, nor is it the sudden dawn of an entirely new age. It is, however, an important milestone on the road of European integration. It is a vision that has become reality. But it is now a reality that requires a constant vigil against manifold risks and, more prosaically, continued plain hard work to turn it into a lasting success. The ECB is prepared to do its part.
r990201a_ECB	euro area	1999-02-01T00:00:00	The euro: the new European currency	duisenberg	1	The euro - the new European currency - has made its debut this year. Its successful launch constitutes a milestone in the process of European integration and, in consequence, is bound to have a profound impact upon the euro area as well as the world economy in the years to come. In fact, the process of European integration started immediately after the Second World War. Its objectives were not and are not only economic, nor even primarily economic, but also political. European integration aims at the creation of a stable, prosperous and peaceful Europe. For a large part, economic integration has been the engine of this process. Economic integration has its own merits, but it is also likely to contribute to better relations among the countries concerned. And, on balance, although this process has had its ups and downs, it has been successful. However, there is no room for complacency. The introduction of the euro is an important step in this process, but it is not the end of it. New challenges lie ahead. The euro has been launched successfully but, as you know, the launch is only the start of a mission. Following almost a decade of meticulous preparation and economic convergence, a single monetary policy for the entire euro area, encompassing almost 300 million people in eleven countries, is now determined by the Governing Council of the European Central Bank (ECB). This Council consists of the eleven governors of the national central banks (NCBs) of the participating Member States and the six members of the Executive Board of the ECB. Each member of this 17-member Governing Council has one vote. Monetary policy is conducted by the Eurosystem, which is comprised of the ECB and the eleven national central banks of the participating Member States. Like the FED, the Eurosystem is a federal system. Our "Washington" is "Frankfurt" in Germany, where the ECB is located. The Executive Board of the ECB which, as I have mentioned, consists of six members, is a separate decision-making body. It has to ensure that the tasks conferred upon the European System of Central Banks (ESCB) are implemented, either by its own activities or through the national central banks. The ECB has currently a staff of some 600. This number will grow to around 750 in the course of this year and is likely to increase further in the years to come. Let me elaborate on Europe's single monetary policy framework. In accordance with the Treaty on European Union, the primary objective of the single monetary policy is to maintain price stability. Price stability is a necessary condition for promoting sustainable economic growth and better employment prospects for the citizens of the euro area. The stability-oriented monetary policy strategy announced by the Governing Council last year, and currently shaping monetary policy decisions, was conceived with the intention of making the best possible contribution to the achievement of this objective. At the centre of the stability-oriented monetary policy strategy lies the quantification of the primary objective of price stability. By announcing a quantitative definition of price stability, the Governing Council has provided a clear guide for the formulation of expectations of future price movements. At the same time such a quantitative definition has the distinct advantage of complying with the principles of transparency and accountability. This is so because, on the one hand, it clarifies how the Treaty's mandate is interpreted by the Governing Council while, on the other, it gives the public a yardstick against which the success of the single monetary policy can be evaluated. Price stability has been defined and publicly announced as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. This definition mirrors our aversion to both inflation and deflation. Hence neither price increases in excess of 2% nor deflation - that is, a persistent fall in the price level - would be deemed to be consistent with price stability. Based on the latest data available, the current annual rate of inflation, measured on a harmonised basis at around 1%, is consistent with the definition of price stability. Price stability is to be maintained over the medium term. This emanates from the need for monetary policy to be forward-looking. It also recognises the reality that monetary policy cannot compensate for factors such as changes in indirect taxes or commodity prices that could distort price level movements in the short run. The Governing Council of the ECB has founded its stability-oriented strategy upon two pillars. The first pillar relates to the prominent role assigned to money, given that the origins of inflation over the longer term are monetary in nature. Thus a quantitative reference value for the growth of a broad monetary aggregate, namely M3, has been announced. An annual rate of 4 1/2 % has been set as the first reference value. The reference value for M3 is consistent with maintaining price stability over the medium term, while allowing for sustainable output growth and taking account of the trend decline in the velocity of circulation of M3. I wish to emphasise, however, that interest rates will not be changed in a "mechanistic" way in order to react to deviations of monetary growth from the reference value in the short term. Rather, such deviations will be regularly and thoroughly analysed for the signals that they convey about future price developments. If a deviation is considered to be posing a threat to price stability, monetary policy will then react accordingly to counter this threat. In parallel with the evaluation of monetary growth, it is imperative to monitor a broad range of other economic and financial indicators, including economic forecasts. Thus our monetary policy strategy rests also upon a second pillar. This pillar comprises a broadly-based assessment of the outlook for price developments and the risks to price stability in the euro area as a whole. This systematic analysis of all other relevant information about economic and financial conditions will ensure that the Governing Council is as well informed as possible when formulating its monetary policy decisions. In view of the strategy I have just described, we intend to continue with our policy of regularly informing the public of our assessment of the prevailing economic, monetary, and financial conditions as well as of specific monetary policy decisions. This will take place through a wide range of publications, press conferences and speeches intended for both the general public and a professional audience. Furthermore, the European Parliament receives the annual and monthly reports from the ECB and holds a general debate on each annual report. In addition, I appear before the relevant sub-committee of the European Parliament four times a year. As President of the ECB, I am invited to attend the meetings of the Council of the European Ministers of Finance whenever issues of relevance to our tasks come up for discussion. The President of this Council of Ministers and a member of the European Commission may participate, without having the right to vote, in the meetings of the Governing Council of the ECB. Finally, I should like to mention that I am also invited to the meetings of the informal so-called Euro-11 Council. This is a forum composed of the eleven finance ministers of the Member States which have introduced the euro. The Treaty states that the ESCB, while having price stability as a primary objective, shall support the general economic policies in the European Community; moreover, it will operate in such a way as to be consistent with the establishment of free and competitive markets. The Treaty therefore provides an explicit order of priority for the objectives: price stability is the first reference point for the monetary policy of the Eurosystem, and only within the limits of price stability can there be scope to contribute to the achievement of the other objectives of the European Community. As a consequence, the role of other Community objectives in the monetary policy of the Eurosystem is upon the achievement of the overriding target of price stability. The high unemployment rate in Europe represents the main concern of economic policy-makers. I should like to stress that the Eurosystem shares these concerns and will do its utmost to help find a solution to this problem. That said, however, we should realise that what monetary policy is able to contribute to economic policy and the reduction of unemployment, is the achievement of price stability. By creating optimal conditions for a sustainable and strong pace of economic activity, price stability will ultimately spur employment growth and foster higher living standards. The high unemployment rate in Europe is far more the consequence of structural rigidities within the European labour and product markets than a result of adverse cyclical developments. The solution is thus to be found, above all, in structural reforms. The European unemployment rate has, indeed, been high and stable over the business cycles in the past decade. However, over the same period, unemployment was significantly reduced in those EU countries which succeeded in creating better-functioning labour and product markets, which allowed wages and prices to adjust when economic conditions changed. A clear example can be found in the Netherlands, where a substantial reduction in unemployment has been effected in recent years by reforming the labour market, while following the same monetary policy as Germany, where the unemployment rate is still close to 10%. The medium-term orientation of the monetary policy of the Eurosystem should help to avoid excessive fluctuations in real economic activity. Given the fact that the Eurosystem does not aim to stabilise every short-term deviation of price developments from the predetermined path of price stability, it contributes to the stabilisation of economic activity around its long-run potential growth path. I should like to add, however, that the room for manoeuvre of monetary policy and the degree of success in terms of maintaining price stability crucially depend on the support of sound fiscal policies and responsible wage settlements in the euro area. I should now like to address the way in which the economic environment and the economic policies of both the Community and the governments of Member States will affect the functioning of monetary policy. A monetary policy reaction to inflationary or deflationary pressures may cause short-run fluctuations in real output. Flexible and competitive goods and labour markets, however, would soften this trade-off, thereby allowing central banks to attain the goal of price stability with less serious adverse consequences for real output. The establishment of free and competitive markets for labour, goods and services would facilitate to a large extent the functioning of monetary policy in the euro area. Market flexibility may also help to reduce regional asymmetries in the effects of the single monetary policy. The monetary policy of the ESCB will be geared towards the euro area as a whole and will not be able to take into account purely national or regional developments. Moreover, the cyclical positions of participating countries will not completely converge at the start of Stage Three, although, with the single currency in place, some national differences may disappear over time. In the past, asymmetric shocks across European countries were sometimes dealt with via movements in the exchange rates. In the EMU environment, which is characterised by a single and uniform monetary policy aimed at maintaining price stability in the euro area as a whole, the required adjustments will have to stem from fiscal policies and national prices and wages, in addition to mobility of labour and capital. Budgetary policies also play a major role in conditioning monetary policy. Sound budgetary policies enhance the credibility of monetary policy by preventing inflationary pressures. Furthermore, fiscal discipline exerts a downward influence on the risk premia embedded in nominal long-term interest rates. Moreover, given the requirements of the so-called Stability and Growth Pact, a budgetary position which is close to balance or in surplus in normal conditions may allow scope for reaction to unforeseen regional or local shocks that could bring about heavy real output losses. This would also contribute to alleviating the possible asymmetric impact of monetary policy actions on single countries. Let me now turn to the operational aspects of the changeover to the new currency and the first experiences in financial markets. The start of Stage Three of EMU proved to be a formidable operation, yet it was clearly a success. In spite of the extraordinary operational risks involved, the changeover passed without any serious incident affecting the orderly conditions of the monetary system. The monitoring of the Eurosystem's activities to convert the former national currencies into the euro progressed smoothly. There was no need to invoke any contingency measure, whether "ordinary" or "extraordinary". This smooth introduction of the euro was the result of years of thorough preparatory work involving the ECB, the NCBs and a large number of public and private institutions which represent the core of the financial infrastructure in the euro area. This has been reflected clearly in the way in which financial markets have received the euro. To ensure the integration of the various money markets and the emergence of a single interbank interest rate, we have established a European payments system. This system is called TARGET and links all the large-value national payment systems in the EU. Overall, TARGET has functioned well and contributed substantially to the integration of the euro money market. Some technical problems, however, could not be avoided during this start-up phase. These problems, however, were teething troubles related to participants - in both commercial banks and central banks - trying to adapt to the new system and environment. Nevertheless, during these early days of Monetary Union, TARGET has already demonstrated its capabilities in that it was able to handle more cross-border payments than were initially anticipated. The daily volumes concerned were of the order of around EUR 1,000 billion in these early days; this is equivalent to around USD 1,150 billion, depending, of course, on the exchange rate. Our first decisions on the levels of the ECB's interest rates were of course taken in accordance with the announced stability-oriented monetary policy, which I outlined earlier, and were based on the current assessment of the economic situation. With regard to monetary growth, the first pillar of the strategy, careful analysis of the most recent monetary data points to the conclusion that monetary developments are in line with the primary objective of maintaining price stability in the medium term. The three-month moving average of the annual growth rates of M3 to December 1998 stood at 4.7%, which is very close to the reference value of 4 1/2 %. As regards the broadly based assessment of the outlook for price developments, the second pillar - financial indicators - suggests that markets expect the current environment of price stability to be maintained over the medium to longer term. This outlook is supported by the significant fall observed in nominal short and long-term interest rates following the co-ordinated interest rate cut at the beginning of December. With regard to the real-side indicators for the euro area, the signals are mixed. On the one hand, euro area real GDP growth is generally expected to slow down somewhat in 1999 and business confidence, orders and capacity utilisation have been less favourable in recent months. On the other hand, the latest increase in employment figures, the acceleration in retail sales and the recent boost in consumer confidence point towards a more favourable outlook. Finally, subdued wage growth, moderate food price increases and declining energy prices have contributed to a lower rate of inflation for the euro area of just below 1%. On balance, therefore, the evidence suggests that there are no significant upward or downward pressures on the price level, at least at this juncture. Therefore, we have announced our decision to set and maintain the interest rate on our main refinancing operations at 3% for the foreseeable future. Of course, I recognise that potential risks to price stability do exist. First, the floating and subsequent depreciation of Brazil's currency has given rise to renewed fears of a disruption in world financial markets and, potentially, of a further decline in world output growth in 1999. Second, wage demands in excess of labour productivity growth and a relaxation of the fiscal stance by national governments in the euro area constitute upward risks. The Governing Council will continue to monitor all these developments very closely, and will act, should the need arise, in order to prevent either inflationary or deflationary pressures becoming entrenched. The introduction of the euro has created a single currency area which approximately matches the United States in terms of economic size, is larger with respect to its share in total world exports and ranks only second in terms of the size of its capital market. Such an event will have important implications for the economies outside the euro area and the international capital markets. In this context, a few words seem to be in order to clarify our view on the international role of the euro and, particularly, the policy stance of the Eurosystem with regard to such a role. With reference to the use of the euro as an international currency, I should like to remind you that the primary objective of the Eurosystem is the maintenance of price stability. Having an international currency will be advantageous for both businesses and consumers. At the same time, though, the conduct of monetary policy could become complicated should the fraction of the money stock circulating outside the euro area increase significantly. The Eurosystem does not intend either to foster or to hinder the development of the euro as an international currency. It will take a neutral stance and leave it to market forces to determine that role. There is no conscious policy of challenging the dollar. Naturally, to the extent that the Eurosystem is successful in maintaining price stability, this will in itself foster the use of the euro as an international currency. It is hard to make a prediction with regard to the pace at which the euro will emerge as an international currency. An educated guess is that the process will be a gradual one. Nevertheless, the possibility of the euro assuming a prominent role more rapidly than is perhaps suggested by past experience cannot be ruled out. A second aspect of the international role of the euro relates to the exchange rate of the euro against the US dollar or the Japanese yen. The Eurosystem in its monetary strategy deliberately does not specify a target for the exchange rate of the euro. The euro area is a large, relatively closed economy, similar in this respect to the United States. The maintenance of price stability could easily be undermined if a target for the euro exchange rate were to be vigorously pursued. Rather, in accordance with the Eurosystem's monetary policy strategy, the euro exchange rate will depend upon current and expected economic policies and developments and upon the interpretation markets attach to these policies and developments. The absence of an exchange rate objective against major currencies does not mean that the Eurosystem will be indifferent toward the euro exchange rate. The exchange rate is one of the indicators of monetary policy that are monitored under the second pillar of our strategy, that is the broadly based assessment of the outlook for price developments. If its development poses a threat to price stability in the euro area, this threat will be assessed and a response will be given, if considered necessary. Moreover, the lack of a target for the euro exchange rate against the major international currencies does not necessarily mean that these rates should become more volatile. I am in favour of reasonably stable exchange rates. Who is not? However, just as a fever cannot be prevented by restricting the movement of the thermometer, we cannot ensure the absence of exchange rate pressures simply by announcing targets for exchange rates. The pursuit of stability-oriented monetary and fiscal policies at home constitutes a fundamental prerequisite for fostering a stable exchange rate environment. The Eurosystem's stability-oriented monetary policy strategy provides a significant contribution in this regard. Nonetheless, absolute stability of the exchange rate is impossible to guarantee. Such an outcome may not even be desirable if, for example, the United States and the euro area were to go through business cycles that were not fully synchronised. Such a prospect cannot be ruled out, as even recent history has shown. Finally, I should like briefly to touch upon the issue of the role of the ECB in international co-operation. It is clear that a central bank that acts on behalf of a monetary union comparable in economic size to the United States and which is responsible for managing a major currency is bound to play an important international role. The ECB will meet this challenge by assuming the responsibility that comes with this role. Its role will develop gradually, since it is a young institution. We will also build on the experience of those central banks which have played an important international role in the past. You may guess which central bank outside the euro area I have in mind in particular. The ECB already participates in the work of the G-7, the G-10, the Bank for International Settlements and the OECD. Last year it was also granted observer status at the International Monetary Fund (IMF). As an observer, the ECB will participate actively in the relevant work and assessment by the Fund of economic policies in the euro area and of issues, such as the world economic outlook and international capital markets, that are of interest to the euro area. At the same time the ECB enjoys good bilateral relations with other central banks throughout the world. Furthermore, the ECB stands ready to take part in, and contribute to, international policy discussions, offering its expertise and exchanging views when and where appropriate. Generally speaking, the commitment of the ECB to successfully fulfilling the mandate of the Treaty, that is to maintain price stability in the euro area, will also shape the ECB's international role. This is, without doubt, the best contribution the ECB can make to a stable international monetary system. The euro - the new European currency - is a reality. The single monetary policy is in place and the Governing Council of the ECB has assumed responsibility for steering it. There is no doubt in my mind that the real challenges for the Eurosystem still lie ahead. I am confident that the Eurosystem, through its stability-oriented monetary policy strategy, will stand up to these challenges and be successful in maintaining price stability in the euro area. In doing so, it will not only provide for a better future for all the citizens of the euro area but will also contribute to a stable international financial system.
r990205a_ECB	euro area	1999-02-05T00:00:00	The role of the euro in the international monetary system - reserve currency, trade currency and investment currency	hamalainen	0	I should like to thank you for inviting me to speak here at the City of Frankfurt Euro Symposium. A few weeks ago, Frankfurt, as the location of the European Central Bank (ECB), was very much a focus of international media attention. The introduction of the euro on 1 January 1999 was a historic step towards European integration, which was followed with excitement - and perhaps also some anxiety - by the media and the public at large. On that date, the national currencies of 11 European countries became denominations of a single currency; the euro. At the same time, the "Eurosystem" (which is composed of the ECB and the 11 national central banks of the participating EU Member States) assumed responsibility for the monetary policy of the euro area. I must admit that I personally was quite nervous about the changeover to the euro. Although I knew that the ECB was technically well prepared for the changeover, one can never entirely rule out unexpected problems in such a gigantic project. With hindsight, I am very relieved that the technical changeover to the euro went so smoothly. However, the technical changeover was only the first hurdle for the successful establishment of the euro. We now have to focus on ensuring its long-term success. In today's presentation, I shall discuss some of the factors affecting the role of the euro in the international monetary system in the longer term. In this regard, I shall also give an overview of the possible development of the euro as an investment currency, a reserve currency and a trade currency. Clearly, it is still too early to be able to assess accurately how important the euro will become in the international monetary system. It is only natural that it should take some time for traders, investors, analysts and other financial market agents to become accustomed to a new currency and decide on the weight which they will assign to it for various purposes. In practice, the international importance of a currency is mainly determined by three distinct factors: Turning first to the it may be of interest to make a brief comparison between the size of the euro area and that of the United States: the population of the euro area (292 million) is slightly larger than that of the United States (270 million), while the GDP of the euro area (EUR 5,800 billion) is somewhat smaller than the GDP of the United States (EUR 7,600 billion). The euro area is, however, a more open economy than the United States in the sense that foreign trade (exports and imports) amounts to 25% of GDP, while in the United States the corresponding figure is just below 20%. Altogether, the size of the euro area, regardless of which measure is applied, is comparable with that of the US economy. The large size of the euro area would suggest that the euro should, from the outset, assume the role of one of the world's leading currencies. However, the sheer size of the euro area is not sufficient to ensure the importance of the euro in the international financial scene. It is also necessary for euro area economic policies to be perceived as ensuring stability and credibility. On this point, I think that the institutional set-up of the Eurosystem ensures that the euro will be a stable and credible currency. In practice, the credibility of a currency is built on many elements, some of which are beyond the control of the central bank. A first fundamental building block is to ensure that the central bank's monetary policy decisions are of political pressures. This building block was enshrined in the Maastricht Treaty. The institutional set-up ensures that the ECB and the participating national central banks enjoy a very high degree of independence, possibly more than any other central bank in the world. For the credibility of the monetary policy, it is also important that the overall objective is unambiguous, that the strategy for achieving this objective is transparent and that policy measures are clearly explained. By following a , the central bank can directly improve the efficiency of monetary policy by promoting the right expectations among market participants concerning what the central bank hopes to achieve. Hence a predictable monetary policy may contribute to achieving stable prices with the lowest possible interest rates. For these reasons, the Eurosystem emphasises transparency in its monetary policy framework. In order to enhance transparency with regard to its policy measures, the Governing Council of the ECB intends to inform the public regularly and in detail about its assessment of the monetary, economic and financial situation in the euro area. Its policy measures will be explained in relation to the framework of the monetary policy strategy of the Eurosystem. A third important building block for a credible monetary policy is to ensure that the operational framework makes it possible for the monetary policy decisions to be . The Eurosystem has placed considerable emphasis on the establishment of an operational framework which is consistent with market principles and which ensures equal treatment of counterparties and financial systems across the euro area. Apart from these three building blocks, which are largely under the direct control of the Eurosystem, credibility also relies to a considerable extent on the preparedness of governments to pursue stability-oriented policies of and to undertake necessary . On this point, the Stability and Growth Pact provides a basic framework for fiscal discipline and should enhance the governments' incentive to proceed with structural reforms. I am also optimistic with regard to the development of in the euro area. Traditionally, financial market developments in continental Europe have lagged behind developments in the United States and the United Kingdom. A main factor behind the slower development of the financial markets in continental Europe is their strict national segmentation. This segmentation and a lack of cross-border competition have implied relatively low trading volumes, high transaction costs and a reluctance to implement innovative financial instruments. The segmentation is a function of tradition, differing practices and, of course, national regulations and tax regimes. However, the European financial markets are currently undergoing rapid development characterised by cross-border integration and the provision of new financial services. These developments are partly due to the continuous technological development in the financial sector. They have also received new impetus from the establishment of the Single Market in the European Union and were further underpinned by the introduction of the euro, which removed the foreign exchange risk of cross-border operations in the euro area. Turning to the role of the euro in different segments of the international financial markets, I should first like to say a few words about the spot and forward foreign exchange markets. In these markets, the US dollar has been the most important currency since it overtook the pound sterling in the 1930s. It is estimated that in 1997 the dollar was involved in 84% of all foreign exchange transactions. This compares with 55% for the currencies which were replaced by the euro and 24% for the Japanese yen. The introduction of the euro immediately produced major changes in the functioning of foreign exchange markets. The disappearance of 11 national currencies and the introduction of the euro as a major international currency had an impact, in itself, on the turnover and focus of attention in the global foreign exchange markets. Euro/dollar trading has, from the start, established itself as the most active and liquid segment of the foreign exchange market. By contrast, the development of euro/yen trading has so far been surprisingly slow. The role of the euro in the foreign exchange markets must be seen against the background of the exchange rate policy of the Eurosystem. By contrast with most of the currencies which it replaced, the euro is a freely floating currency. In the absence of any policy co-ordination between the three main currency blocs, the euro exchange rate will reflect the outcome of all relevant economic policies rather than being an objective in itself. Of course, the ECB will monitor exchange rate developments as part of its overall assessment of a broad range of economic and financial indicators which are relevant for inflation developments. How important will the euro become, though, as an investment currency in the global money and capital markets? At present, the US dollar is the predominant international investment currency. In 1997 the share of dollar-denominated instruments of the bonds outstanding in the international bond markets amounted to 46%, followed by Japanese yen-denominated debt (11%) and debt denominated in Deutsche Mark (10%). All the euro area currencies together accounted for approximately 24% of the international bond market. Several arguments seem to indicate that the euro may become a more attractive currency for bond issuers than all the currencies which it replaced taken together. In fact, the euro was the most popular currency for bonds issued in the international markets in the first month after its introduction, accounting for approximately 55% of the volume of new bond issues, compared with 40% for the US dollar. However, the high figures for euro-denominated bond issuance in January 1999 may, to a certain extent, reflect a particularly high level of initial interest in euro-denominated instruments during the new currency's first month of existence. We may therefore experience a drop in the euro's market share of new bond issues from the high level experienced last month. As I mentioned in my introduction, a key element in determining the longer-term attractiveness of the euro as an investment currency will be the emergence of efficient, large and integrated financial markets in the euro area. The introduction of the euro will remove currency risk, increase cross-border competition and provide an incentive for the harmonisation of market practices, thereby generally reducing transaction costs. The conditions for financial market integration in the euro area seem to be best at the short end of the yield curve. In fact, the conduct of a single monetary policy by the Eurosystem gave market agents an incentive to start large-scale cross-border trade right from the outset, thereby creating an almost fully integrated money market in the euro area. The integration of the previous national money markets was made possible thanks to the TARGET system, which connects the national real-time gross settlement systems in the euro area. It thereby facilitates banks' cross-border dealing and accessing of funds in euro. The existence of an integrated money market implies that arbitrage should eliminate any cross-border differences in interest rates. At the longer end of the yield curve, cross-border integration is likely to take more time. Before the introduction of the euro, European bond markets were highly segmented. Traditionally, this segmentation was a result partly of different currency denominations and partly of other market-specific conditions, such as differences in national regulations, tax regimes, practices and market conventions. The introduction of the euro did remove the foreign currency risks and has been accompanied by an increased harmonisation of market conventions. As a consequence, the substitutability between bonds traded in different national markets improved. In fact, the trading of euro area government bonds can already be considered to be largely integrated. However, the markets for private bonds, and in particular for mortgage bonds, are still highly segmented owing to the differing institutional and regulatory frameworks across Member States. Nevertheless, the tendency towards increased cross-border competition and lower transaction costs in the national markets may also provide an incentive for increased issuance volumes of private bonds. We may experience a virtuous circle in which the increased issuance of bonds denominated in euro will draw the attention of international investors to euro-denominated assets, thereby making the euro an increasingly attractive currency for private as well as public bond issuers. In this context, it is interesting to compare the current sizes of the bond markets in the euro area and the United States. The market value of the bonds issued in the United States (USD 10,700 billion) is currently twice as large as in the euro area (USD 5,300 billion). While the market value of government bonds is of a comparable magnitude in the United States and the euro area, there are large differences in the markets for corporate bonds. The market value of corporate bonds outstanding in the United States is, at present, almost ten times larger than in the euro area. These figures seem to indicate that there is plenty of scope for further securitisation in the euro area. The introduction of the euro certainly underpins this development. The establishment of a benchmark for government bonds, increasing economies of scale, narrower bid-ask spreads, lower hedging costs for debt securities issued by private firms and more competitive underwriting are likely to provide incentives for European corporations to issue their own securities instead of borrowing from banks. Moreover, the euro area financial markets now offer a more diversified set of financial instruments than that which was previously available in any national market in the euro area. This will give international investors greater scope for portfolio diversification for investments in euro-denominated assets without their having to incur additional foreign exchange risk. To the extent that the euro area is a large and rather closed economy, yields on bonds denominated in euro are likely to become increasingly independent of changes in US yields compared with the present situation for bonds denominated in the national currencies. If this is the case, euro area bonds will provide an attractive opportunity for investors who would like to achieve increased risk diversification in relation to US financial instruments. The euro may also become an attractive currency for the investment of official reserves. Currently the US dollar is by far the most important official reserve currency world-wide; at the end of 1996 the share of dollar-denominated instruments in official reserves amounted to approximately 64%, while the euro area currencies accounted for 25% and the Japanese yen for 6%. The euro's share of world-wide official reserves is likely to have fallen at the start of Stage Three since the Deutsche Mark reserves previously held by euro area national central banks have become domestic euro area assets. However, the euro's share of the global official reserves may soon increase again. The euro is likely to become an important anchor currency in other European countries which, formally or informally, might find it useful to peg their exchange rate to the euro or to a basket of currencies in which the euro is a large component. This is the case at present for the "pre-in countries" participating in ERM II as well as for several countries in central and eastern Europe which link their currencies to the euro, whether by a currency board, a fixed or crawling peg or a managed float. In addition, other countries will also have to reassess their reserve management strategies in the light of the improved diversification opportunities offered by the new currency. It is possible that countries in Asia and Latin America, which traditionally have predominantly held US dollar reserves, may find it useful to diversify their reserve holdings gradually by acquiring euro. A further aspect of the internationalisation of the euro is its developing role as an invoicing currency for foreign trade. Today, the US dollar is by far the most important international transaction currency. It is estimated that approximately 50% of world trade is currently priced in dollars, compared with less than one-third in the currencies which were replaced by the euro and 5% in Japanese yen. Initially, the "market share" of the euro will have fallen compared with the previous combined "market shares" of the currencies which it replaced. This was a result of the elimination of intra-euro area trade from the statistics on foreign trade and exchange transactions. However, in the longer term, the euro may become an important currency for the invoicing of foreign trade. It should be emphasised, though, that at the global level, it will clearly take time for the euro to attain a stature comparable with that of the US dollar as the leading international transaction currency. The dollar is used as a standard for pricing in several areas, in particular in commodities trading. It usually takes a long time for changes in such conventions to take place. In conclusion, I should like to underline once more that it is still too early to make any clear assessment of the possible role of the euro in the international monetary system. However, I am convinced that the mandate of the Eurosystem to maintain price stability in the euro area and its institutional framework, ensuring a high degree of independence, will be a good basis for developing the international role of the euro. In addition, I am convinced that the introduction of the euro will contribute to further development of the euro area financial markets with a view to achieving higher efficiency and international competitiveness. Against this background, I think there is little doubt that the euro will play a major role as an international currency.
r990209a_ECB	euro area	1999-02-09T00:00:00	The single European monetary policy	duisenberg	1	Ladies and gentlemen, The single European monetary policy has been a reality for a little more than five weeks. After years of intensive preparatory work and successful economic convergence, monetary policy is now jointly determined for a large part of Europe by the Governing Council of the European Central Bank. The monetary policy is implemented by the Eurosystem, the name given to the ECB and the 11 central banks of the EU Member States participating in Monetary Union. The single currency is quoted on the international financial markets and is used in non-cash payments. However, the euro will not appear as yet in tangible form as banknotes and coins. Nonetheless there is no doubt that this currency, which was only brought into existence on 1 January 1999, will play an important role both within the euro area and beyond. There is good reason for this confidence, ladies and gentlemen. Overall the first few weeks went smoothly for the single currency and the monetary policy of the Eurosystem. The start did not pass by entirely without a hitch - which was not to be expected in any case, given the significance and scale of this project - but there were no major complications. Monetary Union is a unique and outstanding achievement. It provides the great opportunity to achieve the goal of lasting price stability throughout Europe. Price stability is the best contribution that monetary policy can make to lasting economic and employment growth in Europe. The national governments and all those involved in collective wage bargaining are being called on to remove the structural causes of the excessively high unemployment. We can only hope that the introduction of the euro will spur the implementation of structural reforms. The Treaty establishing the European Community assigns the European System of Central Banks (ESCB) - and thereby the Eurosystem - the primary objective of maintaining price stability. The Governing Council will do its utmost to fulfil this task and to explain its monetary policy so as to be comprehensible to the general public. For this reason we have developed a stability-oriented monetary policy which essentially consists of three main elements. The Governing Council has published a quantitative definition of its primary objective, price stability. This gives clear guidance for expectations in relation to future price developments. Price stability is defined as an increase in the Harmonised Index of Consumer Prices of the euro area of less than 2% compared with the previous year. The publication of this definition provides the public and the European Parliament with a clear benchmark against which to measure the success of the single monetary policy, and thereby provides for the transparency and accountability of the Eurosystem and its policy. The wording "less than 2%" clearly defines the upper limit for the measured inflation rate which is compatible with price stability. I do not think I need emphasise that deflation - or a sustained fall in prices - would be incompatible with price stability. The latest available data for the annual rate of inflation according to the Harmonised Index of Consumer Prices for the euro area as a whole fall within the definition of price stability. This outcome is clearly the result, above all, of the successful monetary policy of the national central banks in the years before the start of Monetary Union. The ECB has only been responsible for monetary policy for a little more than one month. It will only be possible to judge the success of its current policy in one to two years'time. This reflects the fact that the transmission of monetary policy impulses is subject to relatively long and variable time lags. The Governing Council has therefore emphasised that price stability must be maintained in the medium term. This statement underlines not only the need for a forward-looking approach to monetary policy, but also takes into consideration the short-term volatility of prices in response to non-monetary shocks which are beyond the control of monetary policy. In order to achieve the goal of price stability, our strategy rests, in particular, on two "pillars". Before I explain this in more detail, I should like to emphasise that traditional and previously established macroeconomic relationships could change as a consequence of the introduction of the euro. This was one key reason why neither a monetary targeting nor a direct inflation targeting strategy could be applied. Our strategy is also more than just a simple combination of these two approaches. Rather, it is precisely tailored to the needs of the ECB. The first pillar of the monetary policy strategy is a prominent role for money. Since inflation is ultimately a monetary phenomenon in the medium term, the money supply provides a natural "nominal anchor" for a monetary policy geared to safe-guarding price stability. To emphasise this prominent role, the Governing Council has published a quantitative reference value for growth in the money supply. The first reference value decided upon by the Governing Council for growth in M3 was 4.5% per annum and was published on 1 December. This value is based on the above-mentioned definition of price stability and assumes a trend growth in real gross domestic product of 2-2.5% per annum, as well as a medium-term reduction in the velocity of circulation of M3 of around 0.5-1% per annum. We shall not, however, respond mechanistically to deviations from the reference value for money supply growth, but shall first analyse them carefully for signals relating to future price developments. Larger or sustained deviations normally signal risks to price stability. The second pillar of the monetary policy strategy consists in a broadly based assessment of the outlook for price developments in the entire euro area. This assessment will be based on a broad range of monetary policy indicators. In particular, those variables which could contain information on future price developments will be analysed in depth. This analysis should not only provide information on the risks for price development, but should also help to identify the causes of unexpected changes in important economic variables. Some commentators reduced this comprehensive analysis to an inflation forecast. At the same time, there were demands for the ECB to have to publish these forecasts in order to satisfy the need for transparency and accountability. Therefore allow me to make this clear: our strategy includes a comprehensive analysis of numerous indicators and several forecasts. To focus on a single official inflation forecast of the Eurosystem for a specific point in time would in no way accurately reflect our internal analytical and decision-making process. It would impinge upon the transparency and clarity of the explanation of our policy. The publication of an official inflation forecast would also be inappropriate with regard to the accountability of the ECB, all the more so if this forecast were based on the assumption of no change in the monetary policy. The success of the monetary policy of the ECB should primarily be measured in terms of the maintenance of price stability, not the accuracy of its conditional forecasts. The stability-oriented monetary policy strategy of the Eurosystem, which I have just outlined, constitutes a new and clear strategy. It emphasises the primacy of the goal of price stability. It takes into account the inevitable uncertainties concerning economic relationships inherent in the transition to Monetary Union and the associated systemic changes and guarantees a high degree of transparency. Ladies and gentlemen, allow me to comment on certain suggestions on the orientation of monetary policy which have recently appeared in the press. Some of these ideas give the impression that monetary policy should concentrate upon objectives other than price stability, since stable prices have already been achieved. Inter alia, it has been suggested that the ECB should react more or less mechanistically to exchange rate developments or other variables such as, for instance, unit labour costs. Furthermore, there were calls for monetary policy, by means of reductions in interest rates, to be used to combat unemployment. Against this background there is a need to set out clearly the possibilities and limitations of monetary policy. Both the reasoning in the Maastricht Treaty and many economic analyses show that the best contribution the single monetary policy can make to employment growth is to concentrate on price stability. Without such a clear approach there is a danger that the public may question the commitment of the Eurosystem to the goal of maintaining price stability. Inflation expectations, risk premia and thus long-term rates would rise. This would increase the cost of the investment which is necessary for a sustained and lasting rise in the standard of living. Even under the best possible circumstances, though - i.e. if it proves to be possible to assure lasting price stability - monetary policy alone cannot solve the major economic problems of unemployment and future problems in social security systems. The Governing Council regards the current high level of unemployment in the euro area as a matter of great concern. This problem is, however, predominantly a structural one. It is mainly the result of the rigidities in the labour and goods markets in the euro area which have arisen partly through an excessive and disproportionate degree of regulation. Structural economic reforms, which target the reduction of rigidities, are the appropriate solution. In those euro area countries in which such reforms have been implemented unemployment figures have declined markedly. In addition, I should like to emphasise that moderate wage developments and a reduction in the burden of tax and social security contributions would generally help to reduce unemployment. This would be the case even if the country concerned did not trade heavily with its neighbouring countries. The positive influence of low taxes and wages on employment clearly has overall benefits from an international perspective. Such a policy should not be denounced as "wage dumping". Turning to the role of exchange rates between the euro and other important currencies outside the EU, in particular the US dollar, the Eurosystem has, in formulating its monetary policy strategy, made an unambiguous choice. This strategy clearly rules out explicit or implicit objectives or target zones for the euro exchange rate. The pursuit of an exchange rate objective could easily jeopardise the maintenance of the objective of price stability and could thereby also be detrimental to real economic development. Target zones for exchange rates could, for example, lead to the ECB having to raise interest rates in a recession, despite increasing downward pressure on prices. I am sure you will agree that such a mechanistic response to a change in the euro exchange rate would not be optimal. Furthermore, it is important to remember that we are living in a world with high capital mobility. Exchange rate agreements, which might have been possible to implement until recently, are no longer feasible. The lack of an exchange rate target does not mean that the ECB is totally indifferent to or takes no account of the euro exchange rate. On the contrary, the exchange rate will be observed and analysed as a potentially important monetary policy indicator in the context of the broadly based assessment of the outlook for price developments. A stability-oriented monetary and fiscal policy, as stipulated by the Maastricht Treaty and the Stability and Growth Pact, is an essential pre-condition for a stable euro exchange rate. Of course, there is no guarantee of lasting exchange rate stability, not even in a fixed exchange rate regime. Exchange rate fluctuations are often caused by structural or fiscal policy, asymmetric real shocks or conjunctural differences. Monetary policy would clearly be overburdened if it had to prevent such movements in the exchange rate. We cannot and shall not gear our monetary policy towards a single variable, whether a money supply aggregate, an index, the exchange rate or an inflation forecast for a particular point in time. Nor can we be involved in any ex ante co-ordination which would entail an obligation to react to particular commitments or plans. The ECB will always carefully analyse all relevant indicators. In this context, it is particularly important that the economic causes of potential risks to price stability in the euro area are understood as fully as possible. Appropriate monetary policy decisions also depend upon the causes of unexpected changes in important economic variables. The Governing Council must, for example, take a view on whether changes in important indicators are of a temporary or permanent nature, and whether a demand or supply shock is involved. In our deliberations we also attempt to take into account how the financial markets, consumers and firms are expected to react to monetary policy decisions. I believe few would contest that such a complex analysis cannot meaningfully be reduced to a more or less mechanistic reaction to a few variables or a single official forecast. In addition, concern was often expressed that the Eurosystem would not act transparently enough. In this context, it was said that a transparent monetary policy also necessitated the publication of the minutes of the meetings of the Governing Council and disclosure of the voting behaviour of the individual members of the Council. For sound reasons the Governing Council decided not to adopt this approach. The publication of individual positions could easily lead to national influence being exerted over the individual Council members. The members of the Governing Council must not, however, be seen as national representatives. They decide together on the monetary policy for the euro area as a whole. The Governing Council has committed itself to go beyond the reporting and explanatory requirements laid down in the Treaty, which are among the most comprehensive requirements by international standards. On the basis of our strategy, after every first meeting in the month I deliver to the press a detailed explanation of our assessment of the overall economic situation and, in particular, the outlook for price stability. The content of this so-called "introductory statement" is very close to what other central banks refer to as minutes. In this way, the public receives comprehensive information immediately following the meetings of the Governing Council. In addition, each month we shall publish a detailed report on the economic situation and monetary policy throughout the euro area in our Bulletin. Such rapid information on the results of the meetings of the Governing Council and the current economic analysis of the ECB without doubt demonstrates a high degree of openness and transparency. Co-operation between the European central banks was always very close. In the last few months of 1998 the countries participating in the third stage of Monetary Union co-operated more and more closely. The co-ordinated reduction in leading rates at the beginning of December 1998 clearly showed that the currency union had begun de facto before the start of Stage Three. This co-ordinated measure contributed substantially - as we now know - to the stabilisation of market expectations. For more than five weeks the ECB has been conducting monetary policy operations, mainly in the form of reverse open market operations. The main operation will be carried out at a weekly frequency with a maturity of two weeks. So far, five such operations have been conducted successfully, at a fixed interest rate of 3%. Besides the reverse transactions which constitute the main instrument for liquidity control and targeting interest rates, the Eurosystem offers two "standing" facilities: the marginal lending facility and the deposit facility. These can be accessed by credit institutions via the national central banks. The marginal lending facility is primarily a safety valve for short-term liquidity shortages in the banking system and thereby limits upward movements in money market rates. To some extent, its counterpart is the short-term deposit facility, which is used to absorb short-term liquidity surpluses. This forms the lower limit for money market rates. For the start of Monetary Union the interest rate on the deposit facility was set at 2% and the rate on the marginal lending facility was set at 4.5%. As a transitional measure, the Governing Council decided to establish a narrow corridor of 2.75-3.25% between the rates on the marginal lending facility and the deposit facility from 4 to 21 January 1999. The intention was to facilitate the necessary adjustment to the new institutional environment brought about by the transition to Stage Three. As already announced, on 21 January 1999 it was decided to return to the rates on the two "standing" facilities that were set for the start of the single monetary policy. Since 22 January 1999, therefore, the rate on the deposit facility has been 2% and the rate on the marginal lending facility has been 4.5%. A critical factor in this decision was the behaviour of the money market for the euro area as a whole since the beginning of the year. The Governing Council established that over time there had been a marked reduction in the difficulties experienced by some market participants with the introduction of the integrated money market and, in particular, with cross-border liquidity flows. All in all, the integration of the money market in the euro area reached a satisfactory stage only three weeks after its implementation. In analysing the money market it should be noted that, inter alia, there can be a marked difference between ECB interest rates and short-term market rates. On the one hand, market rates may include credit risk premia, and on the other, expectations may lead to differences between the two rates. At its meeting last Thursday the Governing Council confirmed its earlier assessment of the outlook for price stability. Therefore it was decided to leave the conditions for the next main refinancing operations, on 10 and 17 February 1999, unchanged. They will be carried out as volume tenders at a fixed rate of 3%, the same conditions as the last such monetary policy operations. In addition, in recent weeks the first longer-term open market operations were also conducted, in the form of reverse transactions. These were carried out on 14 January 1999 in three parallel tender procedures with maturities of one, two and three months. The fixed rate tender procedure was used. By contrast with the regular main refinancing operations, the Eurosystem does not use these longer-term operations to send signals to the market and therefore usually acts as a price-taker. The ECB thus gives advance indication of the planned allocation. The interest rates which arise from these monetary policy operations should therefore be seen as indicators of prevailing market conditions. To conclude, I should like briefly to report on the Governing Council's current assessment of the monetary, financial and economic situation. On the basis of these assessments the Governing Council decided last Tuesday to leave interest rates unchanged. Taking into account the latest monetary data for December 1998, the three-month moving average of the 12-month growth rate of the monetary aggregate M3 (for the period from October to December 1998) remained more or less stable at 4.7%. This value is very close to the reference value set by the Governing Council. According to our analysis, the evolution of the money supply shows no risks to price stability. Credit to the private sector also grew strongly in December last year. Although at present we do not perceive any inflationary signals, further developments will be very carefully monitored. With regard to the broadly based assessment of the outlook for price developments and the risks to price stability in the euro area, monetary and financial developments can be seen to indicate a favourable assessment of the latest monetary policy decisions of the Eurosystem. They indicate that market participants expect a continuation of the environment of price stability. Long-term rates fell to new historical lows at the beginning of 1999 and there was an overall downward shift in the yield curve. Therefore, financing conditions for investment are currently exceptionally favourable. At present the growth prospects for the euro area are, however, still marked by the uncertainties relating to the development of the world economy in 1999. These uncertainties have had a negative impact on indicators of the economic climate in the euro area. There are widespread expectations of an economic slowdown in the near future. This deterioration in the external economic environment can be linked, above all, to the financial crises in Asia, Russia and Latin America. However, there is a mixed picture. While the growth rate for industrial production fell up to November 1998, retail sales figures and consumer confidence have recently shown positive trends. Furthermore, growth in real gross domestic product in the euro area was relatively robust in the third quarter of 1998. In the United States real growth in the fourth quarter actually turned out higher than expected. Measured against the Harmonised Index of Consumer Prices, the HICP, consumer prices in the euro area rose by 0.8% in December 1998. This is a tenth of a percentage point lower than in November. This development is in line with earlier trends. It can be linked, in particular, to a further decline in energy prices and a weakening in price increases in industrial goods. All in all, the above-mentioned economic development and the available forecasts for 1999 do not indicate any noticeable upward or downward pressure on prices. Potential upward risks could arise from a change in the external global economic situation and any associated effects on the euro area, via import and producer prices. These developments must be carefully monitored. There is concern that inflationary pressure might develop in the event of a strong increase in wage prices and an easing of fiscal policy. Developments in the exchange rate will also be closely monitored in view of their significance for price developments. Finally, let me emphasise that the current level of real interest rates is exceptionally low. If real interest rates are taken simply as the difference between nominal rates and the current increase in consumer prices (HICP), short-term real interest rates in January 1999 stood at 2.3%, i.e. around 80 basis points lower than one year ago. Long-term real rates have fallen even more, by 110 basis points, and stood at 3% in January. These levels are very low, both compared with other countries and with historical data. In line with the safe-guarding of price stability, the current monetary and financial conditions thus clearly support future economic growth. Monetary policy can do no more than this without jeopardising the great overall economic advantages of price stability and its own credibility. Real structural reforms which increase the flexibility of the labour markets, as well as a continuation of the moderate increase in wage prices, would not only ease the burden on monetary policy but would also support employment growth. This will be all the more true if the deterioration in the economic situation this year is worse than expected owing to the negative aspects of the external economic environment.
r990210a_ECB	euro area	1999-02-10T00:00:00	The stability-oriented monetary policy strategy	bank	0	The introduction of the euro was a very happy event for all involved. The euro is present on all major financial markets around the globe. Currency trading in euro has commenced and for five weeks now shares have been denominated in euro on most European stock exchanges. Although not yet embodied in the physical form of new banknotes and coins, there is no doubt that the new currency is set to play an important role, both in the euro area and beyond. The euro is a symbol of the achievements of Europeans in the pursuit of common goals. It is unprecedented in European history. After years of intensive preparations and successful efforts towards convergence, the single monetary policy for the entire euro area is being determined by the European Central Bank (ECB). The Governing Council of the ECB, which comprises the Governors of the 11 national central banks of the participating Member States plus the six members of the Executive Board of the ECB, has assumed this responsibility and is in charge of monetary policy decisions for the euro area. Decisions by the Governing Council will be implemented via the Eurosystem - that is, the ECB and the 11 participating national central banks (NCBs). Indeed, the introduction of the euro marks the culmination of much successful preparatory work over a period of many years. This has been reflected in the positive way in which financial markets have received the euro in the first five weeks of Monetary Union. Moreover, the enormous technical and logistical challenges posed during the changeover weekend at the start of the year have been surmounted. Today, I shall deal with the role of monetary policy in general. More in particular, I shall describe the main features of the stability-oriented monetary policy strategy of the Eurosystem, which underlie our single monetary policy. Against this background, I shall briefly explain recent monetary policy decisions adopted by the Governing Council of the ECB and its assessment of the current economic situation. Finally, I shall summarise how I view the international role of the euro and that of the ECB. A successful monetary policy must always be forward-looking, acting to contain threats to price stability before they become entrenched. Therefore, today I should also like to look to the future. Monetary Union is a unique and significant achievement. It promises a credible and lasting environment of price stability for almost 300 million people. This stable environment is the foundation for sustainable economic growth, better employment prospects and improvements in the standard of living throughout the euro area. Price stability is a necessary condition for improved economic performance in all these areas. I am confident that the single monetary policy will make the greatest possible contribution in this regard. The stability-oriented monetary policy strategy announced by the Governing Council last year, and which is now guiding monetary policy decisions, was designed with this goal in mind. Nevertheless, monetary policy alone - however well designed and implemented - cannot solve Europe's economic problems. Appropriate fiscal policies and structural reforms implemented by national governments are vital and much progress is required in these areas. Moreover, continued wage moderation in both the public and private sectors would contribute to reducing the unacceptably high level of unemployment in many parts of the euro area. Unemployment in the euro area is largely structural in origin. Implementing too lax a monetary policy will not solve this problem, but rather exacerbate it over the medium term, as inflation distorts investment and saving decisions, raises the risk premium in long-term interest rates and undermines the allocative efficiency of the price mechanism. Only effective structural policies that improve the flexibility and efficiency of labour and goods markets can reduce unemployment in a successful and lasting manner. I appreciate that these structural reforms are not always easy to implement, not least because the benefits they yield occur mainly in the medium to long term. However, they are unavoidable. In those euro area countries that have taken up the challenge of structural reform, unemployment has fallen significantly. Other euro area countries should and must take note: structural reform throughout the euro area is fundamental to the success of Monetary Union and to improving Europe's economic performance. The Treaty on European Union assigned the ESCB the primary objective of maintaining price stability in the euro area. You may rest assured that the Governing Council of the ECB is totally committed to fulfilling this mandate. In order to meet this commitment, the Governing Council has adopted a stability-oriented monetary policy strategy consisting of three main elements. First, in order to give clear guidance in relation to expectations of future price developments, the Governing Council has announced a quantitative definition of its primary objective. Defining price stability also serves the principles of transparency and accountability. It clarifies how the Treaty's mandate is interpreted by the Governing Council and gives the public clear guidance concerning its assessment of the success of the single monetary policy. Price stability has therefore been defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. Needless to say, deflation - that is, a persistent fall in the price level - would not be consistent with price stability. The annual rate of inflation in the most recent available data, measured on this harmonised basis, is consistent with the definition of price stability. The Eurosystem has therefore enjoyed the good fortune to assume monetary sovereignty in the euro area in an environment of price stability, owing to the successful process of disinflation and convergence achieved by national central banks during the last decade. Price stability is to be maintained over the medium term. This reflects the need for monetary policy to be forward-looking and to have a medium-term orientation. It recognises the fact that monetary policy is not able to control all short-term movements in the price level. To maintain price stability according to this published definition, the Governing Council's strategy relies on two pillars. First, a prominent role has been assigned to money, in recognition of the monetary origins of inflation over the longer term. This prominent role is reflected in the announcement of a quantitative reference value for the growth of a broad monetary aggregate, namely M3. The first reference value has been set at an annual rate of 4 1/2 %. The reference value for M3 is consistent with the maintenance of price stability over the medium term, while allowing for sustainable output growth and taking account of the trend decline in the velocity of circulation of M3. Monetary policy will not react to deviations of monetary growth from the reference value in a "mechanistic" way. In the first instance, such deviations will be thoroughly analysed for the signals that they offer with regard to the prospects for price developments. If the deviation points to a threat to price stability, monetary policy will react in a manner appropriate to counter this threat, rather than attempting to eliminate the deviation of monetary growth from the reference value in the short term. The second pillar of the monetary policy strategy is a broadly-based assessment of the outlook for price developments and the risks to price stability in the euro area as a whole. The Governing Council of the ECB recognises that it is important, in parallel with the assessment of monetary growth in relation to the reference value, to look at a wide range of other economic and financial indicators, including economic forecasts. This systematic analysis of all other relevant information about economic and financial conditions will ensure that the Governing Council is as well informed as possible when taking monetary policy decisions. Co-operation among European national central banks has been close for a long time and, among the NCBs of the countries participating in Stage Three, has become increasingly so in recent years and months. The co-ordinated interest rate cut at the beginning of December last year is an illustration of this co-operation. This co-ordinated interest rate move was thoroughly discussed by the members of the Governing Council of the ECB. De jure, the decision to change interest rates had to be taken by the national central banks, but, de facto, Monetary Union existed in all but name prior to its formal implementation on 1 January 1999. At its first December meeting, the Governing Council made a thorough assessment of the latest monetary data and other economic indicators, noting in particular the decline in business confidence in the euro area arising, in part, from the deteriorating external environment. This deterioration in the international economy has its origins, to a large extent, in the Asian and Russian financial crises. Following its appraisal of both pillars of the monetary policy strategy, the Governing Council concluded that key central bank interest rates of 3% would best serve the maintenance of price stability in the euro area over the medium term. National central banks adjusted their interest rates accordingly. This co-ordinated interest rate move allowed the ECB to announce that the new level of interest rates would prevail "for the foreseeable future". In other words, in the absence of further disturbances to the economy or the emergence of new and unanticipated threats to price stability, this level of interest rates should be appropriate to fulfil the primary objective of maintaining price stability over the medium term. This announcement helped to resolve some uncertainty at a time when the practical, technical and logistical tasks necessitated by the changeover weekend were uppermost in our minds and in those of market participants. Following the second Governing Council meeting in December, the President of the ECB was therefore able to announce that the interest rate on the first main refinancing operation of the Eurosystem would also be 3%. Moreover, the interest rates for the deposit and marginal lending facilities - which, in normal circumstances, would constitute the upper and lower bounds for overnight market interest rates - were set at 2% and 4.5% respectively. As a transitional measure to help the financial system adjust to the new institutional environment resulting from the transition to Stage Three, from 4 January until 21 January a narrower band of 2.75% to 3.25% has been set for the rates on the deposit and marginal lending facilities. During the first few days of Stage Three we observed a relatively large recourse by credit institutions to these facilities. This was to be expected, given the relatively narrow spread between the Eurosystem's marginal lending facility and the overnight money market rate. Although the narrow corridor is intended to facilitate the transition by market participants to the new regime, over a longer period of time such a measure would hamper the development of an efficiently functioning euro area money market. At its meeting on 21 January, the Governing Council reviewed the experience with the functioning of the euro area-wide money market since the beginning of the year. It noted that the few difficulties encountered by some market participants with the functioning of the euro area-wide money market and, in particular, with the cross-border flow of liquidity, have diminished substantially over time. As a consequence, overall, the integration of the euro area money market has therefore rapidly reached a satisfactory state. Against this background, there was no need to continue the application of the narrow interest rate corridor beyond the date of 21 January. At the meetings of the Governing Council of the ECB of this year so far, it was confirmed that the 3% rate would apply to the Eurosystem's next main refinancing operations. This level is based on the Governing Council's current assessment of the economic situation, viewed from the perspective of the stability-oriented monetary policy strategy. First, monetary growth in recent months has been broadly in line with the quantitative reference value. This, together with further analysis of the monetary data, signals that monetary developments are consistent with the maintenance of price stability over the medium term. Of course, monetary growth relative to the reference value should always be interpreted in a medium-term context. Short-run deviations from the reference value are inevitable and, while being monitored and assessed carefully, would not automatically signal an immediate threat to price stability. Nevertheless, it is reassuring that the three-month moving average of the annual growth rates of M3 up to December 1998 stood at 4.7%, very close to the reference value of 4 1/2 %. Second, as regards the broadly-based assessment of the outlook for price developments, a number of indicators have recently proved noteworthy. Following the co-ordinated interest rate cut at the beginning of December, long-term interest rates have also fallen, suggesting that financial markets viewed the cut favourably and considered it to be consistent with the credible maintenance of price stability over the medium term. According to revised Eurostat estimates, remained broadly robust in the third quarter of 1998, while in more recent months activity may have slowed down. Such a slowdown is apparent in growth up to November 1998, in particular in the intermediate goods sector, which is particularly sensitive to any deterioration in the external environment. However, at the same time, production of capital goods and consumer durables has continued to expand rather strongly. A similar pattern can be observed in the decline in that has been apparent in the second half of 1998 in the euro area, while, however, stabilising in January 1999. On the other hand, continued to increase in December and in January; it has now exceeded the peak level reached in 1990, with up to November showing continued solid growth and growing strongly during the last months of 1998. Finally, the mixed picture is confirmed by other data. , which overall declined slightly further in December, apparently increased again in January, particularly with respect to export orders. in the manufacturing sector, which started to decrease in the third quarter recovered again thereafter, while December data on appear to suggest that the decline in unemployment rates stalled around year-end. Therefore, with regard to the cyclical situation, recent data seem to confirm our earlier assessment that there are downside risks for output growth and that production may have slowed down around the turn of the year. Nonetheless, there are also no clear signals as yet of a stronger than expected weakening in output growth. Given this mixed picture, it should be emphasised that further thorough analysis and very close monitoring of underlying trends are needed before any conclusions can be drawn concerning the broad outlook for 1999 and 2000. Against this background, the annual rate of increase in the HICP for the euro area slowed further in December, falling to 0.8% as compared with 0.9% in November and 1.0% in October. This reduction in the rate of increase of the HICP resulted from further moderation of food price increases and continued falls in energy prices. On balance, the general environment continued to suggest that there is no significant upward or downward pressure on the price level. Of course, the Governing Council is fully aware that potential risks to price stability do exist. On the one hand, downward risks could materialise if import or producer prices were to fall further. On the other, fiscal indiscipline by national governments failing to respect the Stability and Growth Pact or inflationary wage settlements could threaten the 2% upper bound of the Eurosystem's published definition of price stability. In addition, exchange rate trends need to be monitored closely given their importance for domestic price developments. Changes in the external environment - that is, in the economic condition and performance of countries outside the euro area - may affect the outlook for price developments within the euro area, and thereby the conduct of the single monetary policy. The effects of financial crises on external demand and business confidence are a notable recent example. However, this relationship works in both directions. The introduction of the euro has created a single currency area of a size and importance and with a population broadly similar to the United States. An event of this magnitude is likely to have major implications for the rest of the world, especially the international financial system. In the remainder of my speech, I shall consider some of these implications. In its monetary policy strategy, the Eurosystem deliberately does not specify a target for the exchange rate of the euro against the US dollar or the Japanese yen. Although it will always stand ready to exchange views with other central banks concerning the development of exchange rates, there are no explicit or implicit target zones for the euro exchange rate against non-EU currencies. The euro area is a large, relatively closed economy, similar in this respect to the United States. Pursuing a target for the euro exchange rate could easily jeopardise the maintenance of price stability. The level of interest rates required to sustain an exchange rate target may, in some cases, not be that which best serves the maintenance of price stability over the medium term. I might add that it may also conflict with the achievement of other domestic policy objectives. It could be very painful if it were necessary to raise interest rates in a recession in order to defend the exchange rate of the euro. Finally, it should be acknowledged that today we are living in a world with high capital mobility. Exchange rate arrangements that could be implemented thirty years ago may no longer be feasible. The required amount of foreign exchange reserves could simply be too large. Within the Eurosystem's monetary policy strategy, the euro exchange rate is the outcome of current and expected economic policies and developments in both the euro area and elsewhere, and of the market participants' perception of these policies and developments. Supporting the Eurosystem's approach, the Ministers of Finance, who are assigned ultimate responsibility for the exchange rate of the euro by the Maastricht Treaty, have agreed not to issue so-called "general orientations" for the exchange rate policy to the Eurosystem other than in clearly exceptional circumstances, such as when there is a substantial and persistent misalignment of the euro against other currencies. However, the absence of a target for the exchange rate of the euro against major international currencies does not imply that the ECB ignores or is indifferent to the exchange rate of the euro vis-a-vis the US dollar or the Japanese yen. As I already said earlier, the exchange rate will be monitored as one of the indicators of monetary policy, within the broadly-based assessment of the outlook for price developments that constitutes one pillar of the overall strategy. Nor does the absence of exchange rate targets suggest that these rates will necessarily be unstable or volatile. On the contrary, the pursuit of stability-oriented monetary and fiscal policies puts in place one of the major prerequisites for stable euro exchange rates. The Eurosystem's stability-oriented monetary policy strategy is a significant contribution in this regard. Absolute stability of the exchange rate is, of course, impossible to guarantee. It would not even be desirable if, for example, the United States and the euro area were to go through business cycles that were not fully synchronised. This possibility cannot be ruled out, as even recent history has shown. We are aware that the emergence of an international role for the euro may sometimes complicate the conduct of monetary policy if a significant proportion of the money stock is circulating outside the euro area. Nevertheless, the Eurosystem will accept the international role of the euro as it develops as a result of market forces. To the extent that the Eurosystem is successful in meeting its mandate and maintaining price stability, it will also automatically foster the use of the euro as an international currency. The pace at which the euro will emerge as an international currency is hard to predict. If history is taken as a guide, it will be a gradual process, but it is possible that, in today's more dynamic and flexible financial markets, the euro could assume a prominent role more rapidly than past experience might suggest. Finally, I should like to discuss briefly the role of the ECB in international co-operation. As the representative of a monetary union comparable in size and importance to the United States and as the central bank managing a currency that is likely to play a large and increasing international role, the ECB will inevitably play an important role in the international financial system. The ECB will embrace the implied responsibility, but at the same time it will have to be modest and realistic in its actions on the international stage. Its role will develop over time, drawing on the experience of those national central banks that have played an important international role in the past. At the end of last year, the ECB was accorded observer status at the International Monetary Fund (IMF). Full membership of the IMF is restricted to individual nations. Nevertheless, this observer status will allow the ECB to participate fully in the relevant work and assessment by the Fund of economic policies in the euro area and beyond. The ECB also participates in the work of the G-7, the G-10, the Bank for International Settlements and the OECD. It enjoys good bilateral relations with other central banks throughout the world. The ECB stands ready to participate fully in, and contribute to, international policy discussions. It will, of course, offer expertise and exchange views, when and where appropriate. However, in general, the best contribution the ECB can make to a stable international monetary system, including stable exchange rates and well-functioning international capital markets, is to maintain price stability within the euro area. Fulfilling the mandate assigned to the ESCB by the Treaty on European Union will help the ECB to meet its international responsibilities. The euro has arrived. The Governing Council of the ECB has taken up the reins of monetary sovereignty in the euro area and a truly single monetary policy has been in place for five weeks. For those of us who have been involved in the long and at times arduous preparations for Monetary Union, this is an occasion which provides a sense of satisfaction. However, as I have outlined in this speech, in many ways the real work of the ECB is only just beginning. The stability-oriented monetary policy strategy is in place. I am confident that this framework will enable the Governing Council to fulfil the Treaty mandate of maintaining price stability. Meeting this mandate will ensure that the single monetary policy makes its best possible contribution to improving the standard of living in the euro area and helping to ensure the stability of the international financial system.
r990224a_ECB	euro area	1999-02-24T00:00:00	EMU and banking supervision	bank	0	I am speaking here, at the London School of Economics, only a few weeks after one of the most remarkable events in the history of monetary systems: the establishment of a single currency and a single central banking competence for a group of countries which retain their sovereignty in many of the key fields where the State exerts its power. To mint or print the currency, to manage it and to provide the ultimate foundation of the public's confidence in it has been, from the earliest times, a key prerogative of the sovereign. "Sovereign" is indeed the name that was given in the past to one currency. And a British Prime Minister not so long ago explained her opposition to the idea of the single currency with the desire to preserve the image of the Queen on the banknotes. 2. For centuries money has had two anchors: a commodity, usually gold; and the sovereign, i.e. the political power. Less than 30 years after the last bond to gold was severed (August 1971), the second anchor has also now been abandoned. Although I personally think that political union in Europe is desirable, I am aware that the present situation, in which the area of the single currency is not a politically united one, is likely to persist for a number of years. This means that we have given rise to an entirely new type of monetary order. For the people, the success of this move will ultimately depend on the ability of governments and political forces to build a political union. For the central banker and for the users of the new currency, the success will be measured by the quality of the currency itself, and such quality will be measured in the first place in terms of price stability. This is not only a requirement explicitly set by the Treaty of Maastricht, it is also, in the opinion of most, the "new anchor" that purely fiduciary currencies need after the gold anchor is abandoned. 3. My remarks, however, will focus on another, less fundamental but still important novelty of the monetary constitution that has just come into existence. It is the novelty of the abandonment of the coincidence between the area of jurisdiction of monetary policy and the area of jurisdiction of banking supervision. The former embraces the 11 countries that have adopted the euro, while the latter remains national. Just as we have no precedent of any comparable size of money disconnected from states, we have no precedent for a lack of coincidence between the two public functions of managing the currency and controlling the banks. In the run-up to the euro this feature of the system was explored, and some expressed doubts about its effectiveness. I will tonight examine the problems of banking supervision in the euro area. The plan of my remarks is the following. I will first review the existing institutional framework for the prudential control of banks in EMU. I will then examine the likely scenario for the European banking industry in the coming years. Against this institutional and industry background, I shall then discuss the functioning of, and the challenges for, banking supervision and central banking in the euro area, both in normal circumstances and when a crisis occurs. 4. The origin and developments of modern central banks are closely linked to key changes undergone by monetary systems over the past two centuries. Such changes could, very sketchily, be summarised as follows. First, paper currency established itself as a more convenient means of payment than commodity currencies. Second, commercial bank money (bank deposits) spread as a convenient substitute for banknotes and coins. Third, the quantity of money was disconnected from the quantity of gold. Thus, a double revolution in the technology of the payment system, the advent of banknotes and that of cheques or giros, has shaped the functions that most central banks performed over this century: monetary policy and prudential supervision. Man-made money made monetary policy possible. The fact that a large, now a predominant, component of the money stock was in the form of commercial bank money made banking supervision necessary. Ensuring confidence in the paper currency and, later, in the stability of the relationship, one could say the exchange rate, between central bank and commercial bank money, were twin public functions, and, in general, they were entrusted to the same institution. Just as money has three well-known economic functions - means of payment, unit of account and store of value - so there are three public functions related to each of them. Operating and supervising the payment system refers to money as a means of payment; ensuring price stability relates to money as a unit of account and a store of value; and pursuing the stability of banks relates to money as a means of payment and a store of value. In each of the three functions commercial banks have played, and still largely play, a crucial role. In an increasing number of countries the original triadic task entrusted to the central bank has now been abandoned in favour of a "separation approach", according to which banking supervision has been assigned to a separate institution. Following the recent adoption by the United Kingdom and Luxembourg of the separation approach, only two of the 12 countries represented in the Basle Committee on Banking Supervision (Italy and the Netherlands) have the central bank as the only authority responsible for banking supervision. In all systems, however, whether or not it has the task of supervising the banks, the central bank is deeply involved with the banking system precisely because the banks are primary creators of money, providers of payment services, managers of the stock of savings and counterparties of central bank operations. No central bank can ignore the need to have a concrete and direct knowledge of "its" banking system, i.e. the banking system that operates in the area of its monetary jurisdiction. Personally, I have an intellectual attachment to, as well as a professional inclination for, the central bank approach to banking supervision, due partly to the fact that I spent most of my professional life in a central bank which is also to this day the banking supervisor. Yet I can see, I think, the arguments that have led a growing number of industrialised countries to prefer the separation approach. Such arguments basically point to the potential conflict between controlling money creation for the purpose of price stability and for the purpose of bank stability. On the whole, I do not think that one model is right and the other wrong. Both can function, and do function, effectively; if inappropriately managed, both may fail to satisfy the public interest for which banks are supervised. 5. Against this background, let me now describe the institutional framework currently adopted by the Treaty. As my description will refer to the area in which both the single market and the single currency are established, it will not specially focus on the problems of the so-called "pre-in" countries, including the United Kingdom. The current institutional framework of EMU (i.e. the single market plus the single currency) is a construct composed of two building blocks: national competence and co-operation. Let me first briefly review the main aspects of these two building blocks and then see how the Eurosystem relates to them. First, national competence. In a market based on the minimum harmonisation and the mutual recognition of national regulatory standards and practices, the principle of "home country control" applies. According to this principle every bank has the right to do business in the whole area using a single licence, under the supervision, and following the rules, of the authority that has issued the licence. The full supervisory responsibility thus belongs to the "home country". This allows, inter alia, the certain identification of the supervisor responsible for each institution acting as a counterparty to the monetary policy operations of the Eurosystem. The only exception to this principle - the "host country" competence for the supervision of liquidity of foreign branches - is no longer justified now that the euro is in place; hence it should soon be removed. Second, co-operation. In a highly regulated industry such as banking, a single market that retains a plurality of "local" (national) supervisors requires close co-operation among supervisors to safeguard the public good: namely, openness, competition, safety and soundness of the banking industry. EU directives (the 1st and 2nd Banking Directives and the so-called BCCI Directive) lay the foundations for such co-operation, but they do not contain specific provisions or institutional arrangements to this end. They limit themselves to stating the principle of co-operation among national authorities and to removing obstacles to the exchange of information among them. 6. How does the Eurosystem relate to this construction? Essentially in two ways. First, the Treaty assigns to the Eurosystem the task to "contribute to the smooth conduct of policies pursued by competent authorities relating to the prudential supervision of credit institutions and the stability of the financial system" (Article 105 (5)). Given the separation between monetary and supervisory jurisdictions, this provision is clearly intended to ensure a smooth interplay between the two. Second, the Treaty gives the Eurosystem a twofold (consultative and advisory) role in the rule-making process. According to Article 105 (4), the ECB must be consulted on any draft Community and national legislation in the fields of banking supervision and financial stability; and, according to Article 25 (1) of its Statute, the ECB can provide, on its own initiative, advice on the scope and implementation of the Community legislation in these fields. It should be borne in mind that central banks are normally involved in the process of drawing up legislation relating to, for example, regulatory standards, safety net arrangements and supervision since this legislation contributes crucially to the attainment of financial stability. 7. Two observations should be made about the institutional framework just described. First, such an arrangement establishes a double separation between central banking and banking supervision: not only a geographical, but also a functional one. This is the case because for the euro area as a whole banking supervision is now entrusted to institutions that have no independent monetary policy functions. The separation approach that was chosen for EMU has effectively been applied not only to the euro area as a whole, but to its components as well. Indeed, even in countries where the competent authority for banking supervision is the central bank, by definition this authority is, functionally speaking, no longer a central bank, as it lacks the key central banking task of autonomously controlling money creation. The second observation is that the Treaty itself establishes (in Article 105 (6)) a simplified procedure that makes it possible, without amending the Treaty, to entrust specific supervisory tasks to the ECB. If such a provision were to be activated, both the geographical and the functional separation would be abandoned at once. The fact that the Maastricht Treaty allows the present institutional framework to be reconsidered without recourse to the very heavy amendment procedure (remember that such procedure requires an intergovernmental conference, ratification by national parliaments, sometimes even a national referendum) is a highly significant indication that the drafters of the Treaty clearly understood the anomaly of the double separation and saw the potential difficulties arising from it. The simplified procedure they established could be interpreted as a "last resort clause", which might become necessary if the interaction between the Eurosystem and national supervisory authorities turned out not to work effectively. 8. When evaluating the functioning of, and the challenges to, banking supervision in the current institutional framework, two aspects should be borne in mind. First, the advent of the euro increases the likelihood of the propagation of financial stability problems across national borders. For this reason a co-ordinated supervisory response is important at an early stage. Second, the sources of banks' risks and stability problems depend on ongoing trends that are not necessarily caused by the euro, but may be significantly accelerated by it. On the whole, we are interested not so much in the effects of EMU or the euro per se, as in the foreseeable developments due to all factors influencing banking in the years to come. 9. It should be noted at the outset that most banking activity, particularly in retail banking, remains confined to national markets. In many Member States the number, and the market share, of banks that operate in a truly nationwide fashion is rather small. Although banks' international operations have increased, credit risks are still predominantly related to domestic clients, and the repercussions of bank failures would be predominantly felt by domestic borrowers and depositors. 10. Assessing the internationalisation of euro area banks is a complex task because internationalisation can take a number of forms. One is via cross-border branches and subsidiaries. Although large-scale entry into foreign banking markets in Europe is still scarce, reflecting persisting legal, cultural and conduct-of-business barriers (less than 10% on average in terms of banking assets in the euro area; Table 1), there are significant exceptions. The assets of the foreign branches and subsidiaries of German and French banks account for roughly a third of the assets of their respective domestic banking systems (Table 2). The Dutch banking system is also strongly diversified internationally. Another way to spread banking activity beyond national borders is consolidation. Cross-border mergers or acquisitions still seem to be the exception, although things have started to change. The recent wave of "offensive" and "defensive" banking consolidation has mainly developed within national industries, thus significantly increasing concentration, particularly in the smaller countries (Table 3); it may be related not so much to the direct impact of EMU as to globally intensified competition and the need to increase efficiency. In the coming years internationalisation is likely to increase, because, with the euro, foreign entrants can now fund lending from their domestic retail deposit base or from euro-denominated money and capital markets. The relatively large number of foreign branches and subsidiaries already established could be a sufficient base for an expansion of international banking activity (Table 4) since a single branch, or a small number of branches, may be sufficient to attract customers, especially when they are served through direct banking techniques, such as telephone and Internet banking. Also, the cross-border supply of services on a remote basis is likely to spread as direct banking techniques develop. As to cross-border mergers and acquisitions aimed either at achieving a "critical mass" for wholesale financial markets, or at rapidly acquiring local expertise and customers in the retail sector, they may remain scarce because the cost savings from eliminating overlaps in the retail network are likely to be limited and the managerial costs of integrating different structures and corporate cultures are substantial. 11. However, banks' internationalisation does not provide the full picture of the interconnections of banking systems. As "multi-product" firms, banks operate simultaneously in many markets which have different dimensions: local, national, continental (or European) and global. The advent of the euro is likely to enlarge the market for many banking products and services to the continental dimension; this will "internationalise" even those banks that remain "national" in their branch networks and organisation. The formation of the single money market in the euro area has largely taken place already. The dispersion in the euro overnight rate across countries, as reported by 57 so-called EONIA banks, fell in January from around 15 to 5 basis points. The variation between banks has been significantly greater than between countries. The TARGET system has rapidly reached the dimension of Fedwire, with a daily average value of payments of EUR1,000 billion, of which between EUR300 and EUR400 are cross-border. The ever stronger interbank and payment system links clearly increase the possibility of financial instabilityspreadingfrom one country to another. Through these links the failure of a major bank could affect the standing of its counterparties in the entire euro area. On the other hand, the deeper money market could absorb any specific problem more easily than before. As regards the capital markets, the effects of the euro will take more time to manifest themselves, but are likely to be substantial. The single currency offers substantial opportunities for both debt and equity issuers and investors. The increase in the number of market participants operating in the same currency increases the liquidity of the capital markets and reduces the cost of capital. The low level of inflation and nominal interest rates and diminishing public sector deficits are additional supporting factors of capital market activity, especially private bond market activity which has so far been relatively limited (Table 5). Banks will thus operate in increasingly integrated capital markets and will be exposed to shocks originating beyond their national borders. As to corporations, they may concentrate their operations (treasury, capital market and payment management) in a single or few "euro banks", while the disappearance of national currencies may break links between firms and their home country "house bank". This dissociation would make the domestic economy indirectly sensitive to foreign banks' soundness, thus creating another propagation channel of banking problems across countries. 12. When considering the industry scenario for the coming years, the viewpoint has to be broadened beyond the impact of the euro. Rather than the exclusive, or even primary, force for change, the euro is expected to be a catalyst for pre-existing trends driven by other forces. The recent ECB report prepared by the Banking Supervision Committee on "Possible effects of EMU on the EU banking systems in the medium to long term" gives a comprehensive analysis of such trends, which can be summarised as follows. First, regulation: the industry has yet to feel the full impact of such fundamental, but relatively recent, regulatory changes as those related to the single market legislation. Second, disintermediation: other financial intermediaries and institutional investors will grow relative to banks, pushed by demographic and social changes, as well as by the increasing depth and liquidity of the emerging euro area-wide capital market. Disintermediation is expected to take the form of increasing recourse to capital market instruments relative to bank loans by firms, and diminishing investment in deposits by households relative to mutual funds and related products. Third, information technology: bank products, operations and processes are changing rapidly, while technology offers increasing possibilities for dissociating the supply of a large number of services from branches and face-to-face contact with customers. The current tendency in the EU banking systems to reduce over-branching and over-staffing will grow stronger. These factors will increase competition, exert pressure on profitability and oblige banks to reconsider their strategies. Such effects are already visible throughout the EU. They produce changes in organisation, new products and services, mergers, strategic alliances, co-operation agreements, etc. They also involve strategic risks, because the pressure for profitability and some losses of revenue due to the euro, for example from foreign exchange, may push some banks to seek more revenue from unfamiliar business or highly risky geographical areas. Inadequate implementation of new technologies or failure to reduce excess capacity may also affect banks' long-term viability. In the short term, the structural adaptation process could be made more difficult by the combination of factors like the protracted financial difficulties of Asia and Russia, or the preparations for the year 2000. 13. Against the background of the institutional framework and the industry scenario I have outlined, let me now turn to the functioning of banking supervision in the euro area. Two preliminary observations. First, the objective of financial stability pursued by banking supervisors is only one in a range of public interests, which also includes competition policy and depositor and investor protection policy. Second, current supervision and crisis management involve different situations and procedures and will therefore be examined in sequence. 14. Starting with current supervision, let me consider banking regulation first. As observed earlier, the regulatory platform for the euro area banking industry combines harmonised rules with country-specific (non-harmonised, but mutually recognised and hence potentially competing) rules. The harmonised part of the platform includes most of the key prudential provisions that have been developed in national systems over the years. More than 20 years ago (1977), the 1st Banking Co-ordination Directive adopted a definition of a credit institution and prescribed objective criteria for the granting of a banking licence. In 1983 the first Directive on carrying out supervision on a consolidated basis was approved, and in 1986 the rules relating to the preparation of the annual accounts and the consolidated accounts of banks were harmonised. In 1989 the 2nd Banking Co-ordination Directive (which became effective on 1 January 1993) marked the transition from piecemeal to comprehensive legislation, introducing, inter alia, the principle of "home country control". A number of other specific directives have subsequently addressed the main aspects of the regulatory framework - notably, own funds, solvency ratios and large exposures. A Directive imposing deposit guarantee schemes supplemented the legislation in support of financial stability. All in all, the European Union, including the euro area, now has a rather comprehensive "banking law" consistent with the Basle Committee's rules and with the 1997 Core Principles of Banking Supervision. The country-specific, non-harmonised, part of the platform is also quite relevant and very diversified. It includes, among other things, the different organisational arrangements for the conduct of banking supervision (central bank, separate agency or a mixed arrangement); the tools used by banking supervisors (e.g. supervisory reporting, on-site inspections); provisions for the liquidation and restructuring of banks; and the definition and legal protection of financial instruments and contracts. Even the key notion of a regulated market is harmonised only to a very limited extent. 15. Such "neutrality" and "incompleteness" on the part of the EU legislator with respect to key aspects that are normally incorporated in the regulatory framework is a unique feature of EU banking regulations and is likely to trigger a deregulatory process, pushed by competition among the national systems and the different financial centres in the euro area, and beyond that in the EU. Against the background of the increasing competition and other changes in the banking industry, one can expect that the regulatory platform will evolve in the years to come. Additional EU legislation may prove necessary to complete and strengthen the harmonised part. One important part of common legislation, namely the draft Directive on liquidation and re-organisation measures for credit institutions, has not yet been adopted and, indeed, has been stalled for years. This Directive is needed to bring legal certainty to the framework for banking crisis management. In this regard, it would be useful for the Eurosystem, if necessary, to be able to exclude counterparties from the single monetary policy on prudential grounds. Also, the non-harmonised part of the platform will come under pressure to converge, as I have just mentioned, through the process of "regulatory competition". Like any other rapidly changing industry, the banking sector will require careful attention by regulators. As indicated earlier, the ECB will have the possibility of contributing to the rule-making process through its advisory tasks under Article 105 (4) of the Treaty and Article 25.1 of the Statute of the ESCB. 16. On the whole, and taking a euro area perspective, the legislative-cum-regulatory platform of the banking industry, although rather unusual and very diversified in comparison with those of most currency jurisdictions, does not seem to present loopholes or inconsistencies that may hamper the pursuit of systemic stability. Seen from the point of view of the regulatory burden, it is a light system. It will become even more so if competition among national banking systems and financial centres encourages national regulators to free their banks from regulatory burdens that are not required by the EU Directives. Conversely, seen from the point of view of its flexibility, i.e. how quickly it can adapt to new situations, it is, on the contrary, a heavy system. This is the case both because the EU legislative process is slow (three years or even longer may be needed to pass Directives) and, perhaps more importantly, because many provisions are embodied in the Community primary legislation (i.e. Directives) rather than in Community secondary legislation (amendable through simpler comitology procedures). The establishment of EMU does not seem to determine a need for revising the pillars of the current legal framework. What seems to be necessary, however, is a more flexible legislative procedure which allows for a faster and more effective revision of Community legislation, whenever needed in relation to market developments. 17. Let me now turn to the execution of banking supervision. It should immediately be recalled that supervision, contrary to regulation, is a national task, exercised by what the jargon of the Directives calls the "competent authority". Since the euro area has adopted a separation approach between supervisory and central banking functions, it is natural to examine first the functioning of the "euro area supervisor" (i.e. the co-operative system of national supervisors) and then turn to the tasks and needs of the "euro area central banker" (i.e. the Eurosystem). 18. The euro area supervisor can be regarded as a rather peculiar entity composed of national agencies working in three modes: stand-alone, bilateral and multilateral. Let us briefly examine each of them. The stand-alone mode is the one in which the supervisor exclusively operates in the national (or even local) context. Today it is by far the most predominant mode. In most cases, this approach is sufficient to achieve the objectives of banking supervision because most banks in Europe are operating in a context that does not even reach the nationwide market of the country of origin. Such a decentralised model is even more effective because it allows the efficient use of information that may not be available far from the market in which the bank operates. That is why it is actually applied even within countries. In Italy, for example, over 600 of the 900 licensed credit institutions at end-1998 were entirely supervised by the Banca d'Italia branch of the town in which the bank is licensed. The bilateral mode involves co-operation between two supervisory agencies. It is used for cross-border supervision of the same type of financial institutions, such as credit institutions, or the supervision of different types of financial institutions operating in the same market, such as credit institutions and securities firms. The instrument that has been devised to organise bilateral co-operation between banking supervisors is the Memorandum of Understanding (MoU). With the implementation of the 2nd Banking Co-ordination Directive, the Member States began to negotiate extensively MoUs in order to establish the necessary co-operation between "home" and "host country" authorities to supervise efficiently institutions that have cross-border activities or foreign country establishments. By the end of 1997, 78 bilateral MoUs had been signed between the EEA banking supervisory authorities. The key aims of MoUs are to establish a regular exchange of information between national supervisory authorities. While the "gateways" for the exchange of information have been laid down in Community legislation, MoUs provide a practical framework for communication to be carried out between supervisors. Moreover, MoUs define procedures and reciprocal commitments between pairs of EU supervisors related to the various parts of the supervisory process, such as establishment procedures and on-site examinations. Finally, the multilateral mode is the one in which a group of supervisors works collectively as, say, a single consolidated supervisor. Such a mode is required when the problems involved are area-wide. They may be area-wide for a number of reasons with regard to the institutions, or groups, involved: their dimension; their linkages with a number of different markets in various countries; the role they play in the payment system or in other "systemic" components of the market, etc. Multilateral co-operation can also enhance the quality of supervision by examining common macroeconomic influences on the banking system and common trends in the financial system that may not be revealed from the national perspective only. Today, the Banking Supervision Committee is the key forum for multilateral co-operation. It is composed of representatives of the banking supervisory authorities of the EU countries, either forming part of the respective NCB or separate bodies. The Banking Supervision Committee's main functions are the promotion of a smooth exchange of information between the Eurosystem and national supervisory authorities and co-operation among EU supervisory authorities. Another forum for dealing with the requirements of the multilateral mode is the Groupe de Contact, a group of EU banking supervisory authorities which, for many years, has discussed individual banking cases in a multilateral way, but at a lower organisational level than the high-level Banking Supervision Committee. 19. So far, the need to develop the multilateral mode has been relatively limited, as the emergence of a single banking market in the European Union has been slow and the euro was not yet in place. Thus, the fact that the multilateral mode has not gone, for the moment, beyond periodic discussions among supervisors and occasional industry-wide analyses should not be a cause for concern. I am convinced, however, that in the future the needs will change and the multilateral mode will have to deepen substantially. Over time such a mode will have to be structured to the point of providing the banking industry with a true and effective collective euro area supervisor. It will have to be enhanced to the full extent required for banking supervision in the euro area to be as prompt and effective as it is within a single nation. There are no legal impediments to that. The existing legislation, whether Community or national, permits all the necessary steps to be made. Information can be pooled; reporting requirements and examination practices can be developed and standardised; common databases can be created; joint teams can be formed; and analyses of developments across the whole banking system can be conducted. The Community legislation providing for the unconstrained exchange of confidential information between supervisors does not distinguish between bilateral and multilateral co-operation, but the common interpretation is that it covers both modes. It will be the task of the Banking Supervision Committee, for its part, to develop the multilateral mode among EU banking supervisors. 20. If the above concerns primarily the euro area supervisor, what about the euro area central banker, i.e. the Eurosystem? The euro area central banker has neither direct responsibility for supervising banks nor for bank stability. It is, however, no stranger in this land. It has a vital interest in a stable and efficient banking industry; it is, therefore, keen to see its action complemented with an effective conduct of the supervisory functions by the competent authorities; it needs a clear and precise knowledge of the state of the euro area's banking industry as a whole and of its major individual players; and it may have a role to play, as we shall see, in the management of crises. For the Eurosystem, natural reference models are provided by the central banks of countries that apply the separation approach, for example: Germany before the euro; the United Kingdom after the creation of the Financial Services Authority; or Japan. In all these cases the central bank has a well-developed expertise in the micro and macro-prudential field; each distinctively plays a role in the macro-prudential field by addressing threats to the stability of the banking system and analysing the soundness of the structural features of the system. For their own purposes, these central banks also have precise and comprehensive information about the banks in their respective country. This is obtained either from performing practical supervisory duties, as in the case of the Bank of Japan or the Bundesbank; or from the national supervisory authority; or through direct contacts with the banking industry, as in the case of the Bank of England. The Banking Supervision Committee is in a good position to co-operate with the Eurosystem in the collection of information. Indeed, the so-called BCCI Directive has removed the legal obstacles to the transmission of confidential information from competent supervisory authorities to "central banks and other bodies with a similar function in their capacity as monetary authorities". This includes national central banks and the ECB. Of course, the provision of supervisory information is voluntary and its development will have to be based on an agreed view of the central banking requirements the Eurosystem will have in this field. 21. In normal circumstances central banking and prudential supervision have an arm's length distance between them. In crisis situations, however, they need to act closely together, often in co-operation with other authorities as well. Charles Goodhart and Dirk Schoenmaker have made here at the London School of Economics a valuable contribution to analysing the handling of major banking problems in the history of industrial countries. One of their conclusions is that, in most instances, central banks have indeed been involved. Banking problems are so close to monetary stability, payment system integrity and liquidity management that this finding hardly comes as a surprise. The advent of the euro will not, by itself, change this state of affairs. 22. When discussing crisis management, it should not be forgotten that, while central banks have a direct and unique role to play when the creation of central bank money is involved, this represents just one category of emergency action. Another category refers to the injection - by politically liable Finance Ministries - of taxpayers' money into ailing or insolvent credit institutions. There is also a third, market-based, category, consisting of the injection of private money by banks or other market participants. These three typologies of emergency action all require the involvement of policy-makers, but they must not be mixed up when evaluating the existing arrangements. Therefore, before discussing the much debated question of the lender-of-last-resort, let me briefly comment on the two, probably less controversial cases where central bankers are not the providers of extra funds. 23. First, the "private money solution". This market-based approach is clearly the preferable option, not just to save public funds and avoid imbalances in public finances, but also to reduce the moral hazard problem generated by public assistance to ailing institutions. Indeed, policy-makers are increasingly aware that the expectations of a helping hand can increase financial institutions' risk appetite in the first place. However, even when a market-based solution is possible, on the grounds of private interest, private parties may not be able to reach a solution for lack of information or co-ordination. Public authorities have therefore an active role to play for the market solution to materialise. The recent rescue package co-ordinated by the Federal Reserve Bank of New York to prevent the LTCM hedge fund from collapsing is a good example of public intervention being used to achieve a private solution. Acting as a "midwife" in brokering a private sector deal is not the only example of managing crises without injecting public funds. Banking supervisors have at their disposal a number of tools to intervene at the national level to limit losses and prevent insolvency when a bank faces difficulties. These tools include special audits, business restrictions and various reorganisation measures. In the euro area, national supervisors and central banks will continue to be the key actors in the pursuit of market-based solutions to crises. The Eurosystem, or the Banking Supervision Committee, would become naturally involved whenever the relevance of the crisis required it. 24. Second, the "taxpayers' money solution". Taxpayers have been forced to shoulder banks' losses in the past, when public authorities felt that otherwise the failure of a large portion of a country's banking system or of a single significant institution would have disrupted financial stability and caused negative macroeconomic consequences. In such instances banks have been taken over by the state, or their bad assets have been transferred to a separate public entity to attract new private investment in the sound part of the otherwise failed banks. The US savings & loans crisis of the 1980s, the banking crises in Scandinavia in the early 1990s and the current banking crises in Japan and some East-Asian countries are examples of system-wide insolvency problems that have triggered taxpayers' support. Credit Lyonnais and Banco di Napoli are recent examples of public support to individual insolvency problems. The introduction of the euro leaves crisis management actions involving taxpayers' money practically unaffected. The option of injecting equity or other funds remains available for the Member States, since these operations are not forbidden by the Treaty. Nevertheless, the European Commission will be directly involved in scrutinising and authorising such actions, since any state aid must be compatible with the Community's competition legislation. This happened, for example, in the cases of Banco di Napoli and Credit Lyonnais. The handling of solvency crises is not within the competence of the national central banks nor that of the ECB, although national central banks are likely to be consulted, as they have been in the past. 25. Third, the "central bank money solution". This is the lender-of-last-resort issue that has brought the Eurosystem under vigorous criticism by distinguished academics and the IMF's Capital Markets Division of the Research Department. The criticism has been that the alleged absence of a clear and transparent mechanism to act in an emergency raises doubts in the markets about the ability of the Eurosystem to handle crisis situations. It is said that the uncertainty generated by the present arrangements would entail new risks, including the possibility of investors requiring an additional risk premium at times of financial market volatility and, ultimately, of the credibility of EMU being damaged. Two examples of these concerns deserve an explicit mention. The IMF "Report on Capital Markets", September 1998, stated that "it is unclear how a bank crisis would be handled under the current institutional framework - which is not likely to be sustainable".Similarly, the first report of the CEPR (Centre for Economic Policy Research) on monitoring the ECB entitled "The ECB: Safe at Any Speed?" expressly suggested that the Eurosystem lacks crisis management capacity and is too rigid to pass the A-Class test to keep the vehicle on the road at the first steep turn in financial market conditions in Europe. 26. My response to this criticism is threefold. To my mind, the criticism reflects a notion of lender-of-last-resort operations that is largely outdated; it underestimates the Eurosystem's capacity to act; and, finally, it represents too mechanistic a view of how a crisis is, and should be, managed in practice. 27. The notion of a central bank's lender-of-last-resort function dates back more than 120 years, to the time of Bagehot. This notion refers to emergency lending to institutions that, although solvent, suffer a rapid liquidity outflow due to a sudden collapse in depositors' confidence, i.e. a classic bank run. A bank could be exposed to depositors' panic even if solvent because of the limited amount of bank liquidity and an information asymmetry between the depositors and the bank concerning the quality of bank's assets that do not have a secondary market value. Nowadays and in our industrial economies, runs may occur mainly in textbooks. They have little relevance in reality because, since Bagehot, many antidotes have been adopted: deposit insurance, the regulation of capital adequacy and large exposures, improved licensing and supervisory standards all contribute to the preservation of depositors' confidence and minimise the threat of a contagion from insolvent to solvent institutions. A less unlikely case is a rapid outflow of uninsured interbank liabilities. However, since interbank counterparties are much better informed than depositors, this event would typically require the market to have a strong suspicion that the bank is actually insolvent. If such a suspicion were to be unfounded and not generalised, the width and depth of today's interbank market is such that other institutions would probably replace (possibly with the encouragement of the public authorities as described above) those which withdraw their funds. It should be noted, in this respect, that the emergence of the single euro money market lowers banks' liquidity risk, because the number of possible sources of funds is now considerably larger than in the past. Given all of these contingencies, the probability that a modern bank is solvent, but illiquid, and at the same time lacks sufficient collateral to obtain regular central bank funding, is, in my view, quite small. The textbook case for emergency liquidity assistance to individual solvent institutions has, as a matter of fact, been a most rare event in industrial countries over the past decades. 28. What if this rare event were nevertheless to occur and cause a systemic threat? The clear answer is that the euro area authorities would have the necessary capacity to act. This is not only my judgement, but also that of the Eurosystem, whose decision-making bodies have, as you can imagine, carefully discussed the matter. I am not saying that we are, or shall be, infallible; no one can claim such a divine quality. I am saying that there are neither legal-cum-institutional, nor organisational, nor intellectual impediments to acting when needed. In stating this, I am aware that central banks may be the only source of immediate and adequate funds when a crisis requires swift action, while solvency remains an issue and failure to act could threaten the stability of the financial system. In these circumstances the various national arrangements would continue to apply, including those concerning the access of central banks to supervisors' confidential information. As is well known, such arrangements differ somewhat from country to country. 29. The criticism I have referred to also underestimates the Eurosystem's capacity to act. To the extent that there would be an overall liquidity effect that is relevant for monetary policy or a financial stability implication for the euro area, the Eurosystem itself would be actively involved. The Eurosystem is, of course, well equipped for its two collective decision-making bodies (the Board and the Council) to take decisions quickly whenever needed, whether for financial stability or for other reasons. This readiness is needed for a variety of typical central bank decisions, such as the execution of concerted interventions or the handling of payment system problems. Indeed, it has already been put to work during the changeover weekend and in the first few weeks of this year. A clear reassurance about the capacity to act when really needed should be sufficient for the markets. Indeed, it may even be advisable not to spell out beforehand the procedural and practical details of emergency actions. As Gerry Corrigan once put it, maintaining "constructive ambiguity" in these matters may help to reduce the moral hazard associated with a safety net. I know of no central bank law within which the lender-of-last-resort function is explicitly defined. The question of who acts within the Eurosystem should also be irrelevant for the markets, given that any supervised institution has an unambiguously identified supervisor and national central bank. As to the access to supervisory information, the lack of direct access by the Eurosystem should not be regarded as a specific flaw of the euro area's institutional framework, as has been frequently argued, since this situation also exists at the national level wherever a central bank does not carry out day-to-day supervision. 30. Finally, the criticism reflects an overly mechanistic view of how a crisis is, and should be, managed in practice. Arguing in favour of fully disclosed, rule-based policies in order to manage crises successfully and, hence, maintain market confidence, is almost self-contradictory. Emergency situations always contain unforeseen events and novel features, and emergency, by its very nature, is something that allows and even requires a departure from the rules and procedures adopted for normal times or even in the previous crisis. Who cares so much about the red light when there is two metres of snow on the road? As for transparency and accountability, these two sacrosanct requirements should not be pushed to the point of being detrimental to the very objective for which a policy instrument is created. Full explanations of the actions taken and procedures followed may be appropriate ex post, but unnecessary and undesirable ex ante. 31. So far, I have focused on the provision of emergency liquidity to a bank. This is not the only case, however, in which central bank money may have to be created to avoid a systemic crisis. A general liquidity "dry-up" may reflect, for example, a gridlock in the payment system or a sudden drop in stock market prices. The actions of the Federal Reserve in response to the stock market crash of 1987 is an often cited example of a successful central bank operation used to prevent a dangerous market-wide liquidity shortfall. This kind of action is close to the monetary policy function and has been called the "market operations approach" to lending of last resort. In such cases, liquidity shortfalls could be covered through collateralised intraday or overnight credit, or auctioning extra liquidity to the market. The Eurosystem is prepared to handle this kind of market disturbance. 32. In my remarks this evening, I have looked at the euro area as one that has a central bank which does not carry out banking supervision. This would be normal, because in many countries banking supervision is not a task of the central bank. What is unique is that the areas of jurisdiction of monetary policy and of banking supervision do not coincide. This situation requires, first of all, the establishment of smooth co-operation between the Eurosystem and the national banking supervisors, as is the case at the national level where the two functions are separated. The most prominent reason for this is, of course, the scenario where the provision of liquidity from the central bank has to be made in a situation that is generated by problems of interest to the supervisor. But beyond that, I do not know any country in which the central bank is not very closely interested in the state of health of the banking system, irrespective of its supervisory responsibilities. 33. In my view, we should move as rapidly as possible to a model in which the present division of the geographical and functional jurisdiction between monetary policy and banking supervision plays no significant role. I do not mean necessarily a single authority or a single set of prudential rules. Rather I mean that the system of national supervisors needs to operate as effectively as a single authority when needed. While the causes of banking problems are often local or national, the propagation of problems may be area-wide. The banking industry is much more of a system than other financial institutions. 34. I am clearly aware that we are far from having a common supervisory system. But since the euro has just been launched and will last, we have to look in prospective terms at what needs to be set in place. There is no expectation, at least to my mind, that the division of responsibility in the euro area between the central bank and the banking supervisory functions should be abandoned. Although the Treaty has a provision that permits the assignment of supervisory tasks to the ECB, I personally do not rely on the assumption that this clause will be activated. What I perceive as absolutely necessary, however, is that co-operation among banking supervisors, which is largely voluntary but which finds no obstacles in the existing Directives or in the Treaty, will allow a sort of euro area collective supervisor to emerge that can act as effectively as if there were a single supervisor. This is desirable in the first instance to render the supervisory action more effective against the background of current and future challenges and, second, to assist the Eurosystem in the performance of its basic tasks. Table 1. Market share of branches and subsidiaries of foreign credit institutions as % of total domestic assets, 1997 Table 2. Assets of branches and subsidiaries of domestic credit institutions in foreign countries as % of total domestic assets, 1997 Table 3. Concentration: Assets of the five biggest credit institutions as % of total assets Table 4. Number of branches and subsidiaries of foreign credit institutions, 1997 Table 5. Private non-financial enterprises' bonds, credit institutions' bonds and government bonds outstanding as % of GDP, 1997
r990225a_ECB	euro area	1999-02-25T00:00:00	European Economic and Monetary Union - principles and perspectives	hamalainen	0	The European integration process started shortly after the Second World War and was, at the time, strongly motivated by political factors. The aim was to eliminate the risk that wars and crises would once more plague the continent. The first concrete result was the establishment, in 1952, of the European Coal and Steel Community between six countries (Belgium, France, Germany, Italy, Luxembourg and the Netherlands). This was followed by the adoption of the Treaty of Rome in 1957, laying the foundations for the European Economic Community. The first concrete proposal for a Monetary Union was presented in the so-called Werner Report in 1970. The Report was intended to pave the way for the establishment of a Monetary Union in the early 1980s. However, the proposals of the Werner Report were never implemented - being overtaken by world events. After the break-up of the Bretton Woods system and the shock of the first oil crisis in 1973, most western European economies were contaminated by the economic sickness popularly labelled "Eurosclerosis", characterised by high inflation and persisting unemployment. At that time, the European economies were protected by regulations and financial markets were still poorly developed. In this environment, it was concluded that a Monetary Union would not be possible and the project was postponed. The idea of establishing Monetary Union was revived only in 1988 and a detailed proposal was presented the following year in the Delors Report, after the launch (in 1985) of the Single Market programme on the free movement of goods, services, capital and labour. Because of the single market, the Report could be more explicit and credible with regard to how best to achieve closer economic ties between the EU economies before the introduction of a single currency. Moreover, the Report was supported by a detailed description of an institutional set-up geared towards ensuring stability-oriented economic policies. Notwithstanding the thorough work invested in the Delors Report, almost 10 years of convergence and technical preparations were required in order to ensure the successful implementation of the euro on 1 January 1999. And the project is still not over: the euro coins and banknotes will be introduced only in 2002 - 13 years after the presentation of the Delors Report and 32 years after the presentation of the Werner Report. Today, almost two months after the introduction of the euro, we can say that the technical changeover to the euro was successful. Now, the Eurosystem (i.e. the ECB and the 11 national central banks of the participating Member States) must focus on ensuring the long-term success of the new currency. The credibility of a currency is built up by several factors, the basis of which is the central bank's . Here, the Eurosystem is in the fortunate position of being assigned, through the Maastricht Treaty, the unambiguous primary objective of maintaining price stability in the euro area. Another fundamental building block of credibility is ensuring that monetary policy decisions are of political pressures. This building block was also laid down in the Maastricht Treaty, which ensures that the ECB and the participating national central banks enjoy a very high degree of independence, possibly more than any other central bank in the world. The credibility of a currency also relies on the preparedness of governments to pursue stability-oriented policies of and to undertake necessary . On this point, the Stability and Growth Pact adopted by the EU countries provides a basic framework for fiscal discipline and should enhance the governments' incentive to proceed with structural reforms. In order to enhance credibility, it is also important that the central bank's strategy for achieving the primary objective is clear and that the link between the strategy and the central bank's policy actions is easily understood by the public. By following a , the central bank can directly improve the efficiency of monetary policy. This contributes to achieving stable prices with the lowest possible interest rates. Striving towards increased transparency led the Governing Council of the ECB (composed of the Governors of the 11 national central banks and the six members of the ECB's Executive Board) to establish a precise definition of price stability in order to bring about ; price stability was defined as a year-on-year increase of the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. This is a medium-term objective. In the short run, many factors beyond the scope of monetary policy also affect the price movements. The adoption of the Eurosystem's monetary policy strategy also aimed at enhancing transparency in the implementation of monetary policy. The strategy is based on two key elements: First, money has been assigned a prominent role in the form of a reference value for the growth of the euro area wide monetary aggregate M3. Second, the Eurosystem carries out a broadly based assessment of the outlook for price developments and the risks to price stability in the euro area on the basis of a wide range of economic and financial indicators. In order to explain to the public the Eurosystem's policy actions against the background of the adopted monetary policy strategy, the Eurosystem uses several channels: the ECB's Monthly Bulletin; the issuance of a detailed press release after each Governing Council meeting, in which the decisions are explained; the organisation of a monthly press conference at the ECB; the appearances of the President at the European Parliament; and, finally, the numerous speeches and articles by the members of the Governing Council. Taken as a whole, the Eurosystem is probably among the more active central banks when it comes to explaining its policies to the public. A further important building block in order to establish credibility is the promotion of an . The Eurosystem has aimed to set up an operational framework which is consistent with market principles and which ensures equal treatment of counterparties and financial systems across the euro area. The Eurosystem's operational framework is based on the principle of decentralisation in order to take advantage of the established links between the national central banks and their counterparties. The monetary policy operations will therefore be conducted by the national central banks, while decisions are taken centrally in the ECB's decision-making bodies. The most important effects of the single currency relate to the possibility of improving macroeconomic stability and credibility for the policies pursued; these effects are particularly important for the smaller European economies. Moreover, important benefits can be derived from microeconomic factors, such as lower transaction costs, wider and deeper financial markets, improved price transparency and increased competition. Starting with the macroeconomic factors, Monetary Union makes it possible for the participating countries to combine their credibility. In this way, small countries can, to a certain extent, "borrow" credibility from some of the large countries which have pursued stability-oriented policies for a long time. Under credible conditions, the financial markets are no longer under pressure from speculative attacks by large institutional investors. Price and interest rate developments are stabilised, and the investment climate for companies is secured. In the microeconomic field, the most obvious consequences relate to lower transaction costs and increased price transparency across national borders. These factors are likely to contribute to increased competition and downward price pressure on many products. One very important consequence is that the use of a single currency will give rise to larger and more competitive financial markets in the euro area. In most European countries, the financial markets have, by tradition, been rather shallow, with few participants and a rather narrow set of financial instruments on offer. A high degree of segmentation and a lack of cross-border competition have implied relatively low trading volumes, high transaction costs and a reluctance to implement innovative financial instruments. On the introduction of the euro, the foreign exchange risk of trading in the different national markets in the euro area fully disappeared. This has triggered increasing cross-border competition and has provided an incentive for the harmonisation of market practices. In fact, the trading of money market paper and euro area government bonds can already be considered to be largely integrated. The markets for private bonds are still segmented owing to the differing institutional and regulatory conditions across Member States, but they, too, will gradually integrate and provide an incentive for increasing the issuance volumes of private bonds. This will contribute to reducing the financing costs for private companies, and it will provide improved opportunities for investors. Monetary Union provides much needed assurance of exchange rate stability for exporters, importers and investors. This is particularly important for small and open economies. In fact, most countries in Europe are to be considered small in the current global perspective. The active use of the exchange rate as a tool of economic policy could be an alternative for a large reserve-currency country. For a small country, experience has shown that large changes in the exchange rate tend to give rise to higher costs rather than benefits, due to the harmful effects on expectations and higher interest rates. Some of the economic effects of the Monetary Union may partially benefit also the countries remaining outside Monetary Union. Nevertheless, it is important for the "out" countries, to assess whether they find that the benefits of maintaining a national monetary policy "autonomy" - if there is any such autonomy in an integrated and globalised market situation - outweigh the possible drawbacks of not being able to fully draw on the credibility of the euro area, the integration of the euro area financial markets, lower transaction costs, improved price transparency and increased competition. The Nordic countries have chosen to organise their monetary policy ties to the euro area in very different ways: is the only Nordic country taking part in Monetary Union as from the start of Stage Three; negotiated an opt-out from Monetary Union but follows a fixed exchange rate policy vis-a-vis the euro within the new Exchange Rate Mechanism (ERM II); decided not to participate in Monetary Union from the start of Stage Three, without having a formal opt-out and the Swedish krona still floats freely against the euro; and and remain outside the EU altogether. The divergent approaches taken by the Nordic countries as regards one of the most important economic and political projects in Europe in modern times are somewhat strange in view of their traditionally close cultural, historical, political and economic ties. Nordic co-operation has always been very important and close. I note with satisfaction that the public opinions in Denmark and Sweden now seem to be swinging in a more favourable direction with regard to future membership. Maybe the successful implementation of the euro has made the public understand that Monetary Union is aimed at ensuring long-term stability in Europe. In this context, the recent signals from the Government of the United Kingdom in favour of membership in the Monetary Union are also very encouraging. Personally, I think that it would be beneficial to all Nordic countries - and the United Kingdom - to join Monetary Union within the not too distant future. I hope that Sweden and Denmark can become members already before the introduction of the euro banknotes and coins in 2002. It is important for these countries to also assess the political aspects of remaining outside Monetary Union. Experience has shown that EU Member States which have taken initiatives and worked constructively towards European integration have been generally more successful in gaining influence than those less committed to the project. In this respect, it should be noted that the aim of the Maastricht Treaty is clearly to establish a Monetary Union comprising all EU Member States. Personally, I also think that the Nordic countries could provide a fruitful joint contribution to the long-term success of Monetary Union. There is no need to overemphasise the role of small countries in this process, but it is clear that co-ordinated views by a group of small countries would have a larger influence than the views of individual countries. One of the benefits of the Nordic countries - and small countries in general - is that they are seldom bound to their old traditional system. In contrast, they typically fight for efficient solutions which would be in the interest of the whole of the euro area. The project to establish European Economic and Monetary Union was carefully prepared and based on very strong political commitment. It has contributed to the co-ordination of economic policies - even in a wider sense - in an environment of deregulated financial markets and the free flow of capital. The stability arguments behind the introduction of the euro have been so well accepted that we are already seeing serious and visible efforts aimed at the next step towards a global "single currency" through the establishment of exchange rate co-ordination between the euro, the US dollar and the Japanese yen. In order for any such world-wide currency co-ordination to become successful, there would be a need for political commitment to globally harmonising fiscal, monetary and structural policies. In this context, I would advise realism, caution and a gradual approach in spite of the longer-term ideal goal of global stability. There are still many challenges and adjustments ahead within the euro area before any world-wide steps should be considered. Our first priority is to ensure long-term stability in the euro area economies under the single monetary policy and on the hope that the euro area will soon cover all EU countries.
r990226a_ECB	euro area	1999-02-26T00:00:00	The international implications of the introduction of the euro	bank	0	The euro - the new European currency - has made its debut on the international financial markets this year. Its successful launch in the 11 countries which form the so-called euro area constitutes a milestone in the process of European integration. It is bound to have a profound impact upon both the euro area and the world economy in the years to come. Following almost a decade of meticulous preparation and economic convergence, a single monetary policy for the entire euro area is now determined by the Governing Council of the European Central Bank (ECB). This Council consists of the 11 governors of the national central banks of the participating Member States and the six members of the Executive Board of the ECB. Each of the 17 members of this Governing Council has one vote. Monetary policy is conducted by the Eurosystem, which comprises the ECB and the 11 national central banks of the participating Member States. The Executive Board of the ECB is a separate decision-making body. It has to ensure that the tasks conferred upon the European System of Central Banks (ESCB) are implemented, either by its own activities or through the national central banks. The ECB currently has some 600 members of staff, and this number will grow to around 750 in the course of this year. Turning from the institutional to the broader economic aspects, I should like to consider the overall international implications of the introduction of the euro. This issue is rather complex and, for the sake of clarity, I would propose to break it down into three aspects: the role of the euro as an international reserve and investment currency, the role of the euro exchange rate in the monetary policy strategy of the Eurosystem, and the role of the ECB in international monetary co-operation and international organisations. Starting with the use of the euro as an international currency, it must be noted that the euro is the currency of an economic area which roughly equals that of the United States in terms of both its economic strength and its degree of macroeconomic openness. The euro area has a population of 292 million, which is slightly larger than the 270 million of the United States, and a GDP of E5,800 billion - somewhat smaller than the E7,600 billion of the United States. At the same time, the euro area is an open economy to more or less the same degree as the United States. Trade in goods, that is, the exports and imports of goods combined, amounts to 26% of GDP, while, in the United States, the corresponding figure is around 20%. However, the size of an economy and external trade volume alone are not always perfect indicators of the international importance of a currency. According to most measures, for example, the US dollar is of greater international importance than the relative size of the US economy would suggest. In general, the international role of a currency has several dimensions. On the official side, these include its use as an anchor for exchange rate pegs, for holding foreign exchange reserves and as a vehicle currency for foreign exchange interventions. On the private side, these include its use as a quotation and vehicle currency for international trade, as an international investment currency and as a substitute currency in circulation abroad. Let me focus in particular on the role of the euro as a reserve currency and as an international investment currency. As far as the reserve function of currencies is concerned, at present, the US dollar remains by far the most important reserve currency world-wide. According to IMF data for the end of 1997, the share of dollar-denominated official reserves amounted to 57%, while the Deutsche Mark accounted for 13%, the Japanese yen for 5% and the French franc for 1%. The euro area currencies' share of world-wide official reserves is likely to have fallen at the start of Stage Three of Economic and Monetary Union on 1 January 1999. The Deutsche Mark reserves and reserves in other euro area currencies previously held by euro area national central banks have become domestic euro area assets. However, the euro's share of global official reserves has the potential to increase First, it may be expected that the central banks of non-euro area countries will reassess their reserve management strategy in the light of the improved global diversification opportunities offered by the new currency. For example, the euro may in future come to represent a more important part of the foreign currency reserves held also by Asian central banks. Second, the euro might also assume a greater role as an anchor currency for other European countries which, formally or informally, intend to peg their exchange rate to the euro or to a (trade-weighted) basket of currencies which includes the euro as a large component. Thus, the euro may over time become part of the foreign currency reserves held by central banks for diversification or pegging purposes. However, whether and to what extent this will happen will depend crucially on the confidence in the economic policies across the euro area in general, and the monetary policy of the Eurosystem as well as the stability of the euro in particular. Reliable forecasts regarding the timing and quantitative dimension of such a process are hard to make at this stage. I should like to reflect now on the use of the euro as an international investment currency. At present, this role is predominantly performed by the US dollar. In 1997 the share of dollar-denominated instruments of the bonds outstanding in the international bond markets amounted to 46%, followed by Japanese yen-denominated debt (11%). All the euro area currencies together accounted for approximately 24% of the international bond market. There are further arguments to suggest that private investors will hold over time a greater proportion of their portfolios in euro assets than they have done in the constituent currencies. That is to say, international investors will see the euro as more than the sum of its parts. A key element in the potential attractiveness of the euro as an investment currency is the emergence of large and integrated financial markets in the euro area, as the euro has removed currency-related fragmentation in the euro area, promoting the establishment of uniform market standards. Market liquidity should benefit from this integration, thus triggering a virtuous cycle of increasing issuance and investment in euro instruments by domestic and foreign institutions. Furthermore, the introduction of the euro will most likely result in the emergence of new financial products and an increase in the maturity range on the euro bond market. Moreover, increasingly integrated money and government bond markets may stimulate the emergence of commercial paper and corporate bond markets in the euro area. A benchmark for government bonds or swap rates, increasing economies of scale, narrower bid-ask spreads, lower hedging costs for debt securities issued by private firms and more competitive underwriting are likely to provide incentives for corporations to issue their own securities instead of borrowing from banks, while investors in search of a yield pick-up will find such securities attractive. Equity issuance and trading may also, in due course, become euro area-wide. Likewise, on the deposit side, a rapidly developing private repo or investment fund market in euro could become a serious alternative to traditional bank deposits for large investors, such as pension funds and insurance companies. The development of such new market segments is likely to attract both international investors and borrowers. In any case, whatever the future development of the euro area financial markets will be, the euro has made a promising start on the international bond market. In January 1999 the euro was used in 50% of all new international bond issues, with a value equivalent to USD 69.3 billion. The respective share of the US dollar was 40%. However, it has to be said that the high figures for euro-denominated bond issues in January 1999 may, to a certain extent, reflect a particularly high level of initial interest in euro-denominated instruments during the new currency's first month of existence. We may therefore experience a drop in the euro's market share of new bond issues from the high level experienced last month. Nevertheless, the promising start of the euro on the international bond market clearly shows the confidence of international investors in the stability and strength of the euro and the monetary policy of the Eurosystem. For the benefit of this audience, I should like to note that Japanese financial institutions as well are showing great interest in investing in euro-denominated assets and offering euro-related financial products. According to media reports, the seven largest life insurers in Japan are planning to invest more than JPY 1.5 trillion in euro-denominated bonds in the current fiscal year up to March, which would account for nearly half their planned new foreign bond investments. Furthermore, Japanese banks, securities firms and insurance firms are introducing a wide range of euro-related products, such as deposits, loans and cash management services. Thus, the euro seems to have gained a strong foothold in Japanese financial institutions, corporations and households as well. Finally, as regards the use of the euro as an international currency, the above-mentioned considerations are not at the forefront of our policy-making. Rather, the primary objective of the Eurosystem is to maintain price stability as stipulated by the Maastricht Treaty. Having an international currency will be advantageous for both businesses and consumers. At the same time, however, the conduct of monetary policy could become complicated should the fraction of the money stock circulating outside the euro area increase significantly. The Eurosystem does not intend either to foster or to hinder the development of the euro as an international currency. It will take a neutral stance and leave that role to be determined by market forces. There is no policy of challenging the US dollar or the Japanese yen. Naturally, to the extent that the Eurosystem is successful in maintaining price stability, the use of the euro as an international currency will be fostered. The only way to gain the confidence of international investors in one's currency is by implementing a sound monetary policy. Let me now turn to the role of the exchange rate in the monetary strategy of the Eurosystem and the renewed interest in the concept of target zones for exchange rates among the main currency blocs, namely the United States, the euro area and Japan. In a world characterised by highly integrated and sophisticated international financial markets, there is serious doubt as to whether target zones for exchange rates are feasible or even desirable. Apart from the obvious risks of undermining price stability, which is the primary objective of the Eurosystem's monetary policy, such exchange rate targets would, in essence, imply that domestic policy objectives would have to be subordinated to external requirements. This is the reason why, and I should like to state this clearly, the Eurosystem does not employ an exchange rate target in its monetary policy strategy. I have to say that, in making this choice, the Eurosystem is in good company: neither the United States nor Japan uses explicit targets for its exchange rate in the assessment of its monetary policy stance. The Eurosystem's choice not to use exchange rate targets is based on the conviction that the exchange rate of the euro is the outcome, rather than an objective in itself, both of the monetary, fiscal and structural policies pursued, and of cyclical developments in the euro area and abroad. Moreover, the exchange rate plays a far smaller role in the euro area than it played in the individual Member States before the start of Stage Three of Economic and Monetary Union on 1 January 1999. This is also a consequence of the fact that the euro area is larger in size and is therefore less dependent on external trade than each individual Member State was before. According to the Maastricht Treaty, the ECOFIN Council may formulate so-called general orientations for exchange rate policy, which shall be without prejudice to the primary objective of the Eurosystem of maintaining price stability. The EU Ministers of Finance, who are ultimately responsible for the exchange rate policy of the euro, agreed in December 1997 that they would only issue these general orientations for the euro exchange rate in exceptional circumstances, such as in the case of clear and persistent misalignments of the euro. Furthermore, the Eurosystem is not currently participating in formal exchange rate arrangements with third countries outside the European Union, for instance with the United States or Japan, and it appears very likely that this situation will not alter in the foreseeable future. However, the absence of an explicit target for the exchange rate of the euro against the major international currencies does not imply that the Eurosystem ignores or is indifferent to the exchange rate of the euro vis-a-vis the US dollar or the Japanese yen. The exchange rate will be monitored as one of the indicators of monetary policy, within the broadly based assessment of the outlook for price developments that is part of the Eurosystem's monetary policy strategy. As you may be aware, this monetary strategy consists of two pillars. The first is a prominent role for money, as signalled by the announcement of a quantitative reference value of 4 1/2 % for the growth rate of the broad monetary aggregate M3, which is regarded as being compatible with price stability. The second comprises a broadly based assessment of the outlook for price developments and the risks to price stability using financial and other economic indicators. Through the second pillar, the movement of the euro exchange rate is included in the overall monetary policy strategy of the Eurosystem. If its development poses a threat to price stability in the euro area, this threat will be assessed and a response will be given, if considered necessary. Furthermore, the absence of exchange rate targets does not suggest that these rates will necessarily be unstable or volatile. On the contrary, the pursuit of stability-oriented monetary and fiscal policies constitutes one of the major prerequisites for stable euro exchange rates. The Eurosystem's stability-oriented monetary policy strategy is a significant contribution in this regard. Furthermore, the Stability and Growth Pact, which aims in the medium term to reduce government deficits to close to balance or even to create surpluses, will help to ensure sound budgetary policies throughout the euro area. Absolute stability of the exchange rate is, of course, impossible to guarantee. Finally, I should like to discuss briefly the role of the ECB with regard to international co-operation. As the representative of a monetary union comparable in size and importance with the United States, and as the central bank managing a currency that is likely to play a large and increasingly international role, the ECB will inevitably serve an important function in the international financial system. The ECB will embrace the implied responsibility, but, at the same time, it will have to be modest and realistic in its actions in the international arena. The ECB may be expected to contribute to international co-operation by adopting a positive attitude. The introduction of the euro could potentially simplify the process of international policy co-operation between the major economies, since the number of key players has been reduced. In particular, it should make this process more efficient by facilitating the exchange of views and formulation of common understandings on economic and financial issues at the global level. Let me also make a few remarks on the international representation of the ECB. Although some decisions are still under consideration, formal and informal agreements have already been reached with the International Monetary Fund (IMF), the Organisation for Economic Co-operation and Development (OECD) and in the G7 and G10 context. At the end of last year the IMF granted the status of observer to the ECB. As you will be aware, full membership of the IMF is restricted to individual nations. Nevertheless, this observer status will allow the ECB to participate fully in the relevant work and assessments by the Fund of economic policies in the euro area and beyond. The ECB stands ready to participate fully in, and contribute to, international policy discussions. It will, of course, offer expertise and exchange views when and where appropriate. However, in general, the best contribution which the ECB can make to a stable international monetary system, including stable exchange rates and smoothly functioning international capital markets, is to maintain price stability within the euro area. Fulfilling the mandate assigned to the Eurosystem by the Maastricht Treaty will help the ECB to shoulder its international responsibilities. In my view, there is little doubt that the euro has the potential to achieve over time a more important position in the international monetary system than would be suggested by the sum of the positions of its constituent currencies. With regard to the euro as both an international reserve and investment currency, confidence in the stability and strength of the euro will be crucial. I am convinced that the combination of the ECB's independence and the primary objective of maintaining price stability offers the best guarantee that the ECB will achieve this confidence. As regards international monetary and economic co-operation, monetary stability, supported by fiscal stability and structural policies, will be the most effective means of securing stable exchange rates. Japan, Asia and Europe will undoubtedly intensify their relations on economic matters. A good example of this process was the Second Asia-Europe Finance Ministers' meeting on 15 January of this year, part of which was held on the premises of the ECB in Frankfurt am Main, Germany. Economic and Monetary Union and the single currency offer significant opportunities for financial and non-financial Japanese companies, as economic and monetary borders within Europe have disappeared to a large extent. The resulting closer integration of the Japanese and European economies and financial systems will establish a sound foundation for further economic prosperity in both regions, and, in so doing, contribute to the achievement of stable international economic developments in the years to come
r990308a_ECB	euro area	1999-03-08T00:00:00	First experiences with the euro	noyer	0	Thank you for the invitation to speak here on the occasion of this conference organised by the "Gesprachskreis Nord" of the Friedrich-Ebert Foundation. It is only two months since the euro was launched. The introduction of the euro has been accomplished successfully and the enormous technical and logistical challenges arising during the early days of Monetary Union have been surmounted. The start of Monetary Union proved to be a formidable operation. In spite of the operational difficulties and risks involved, the changeover passed without any serious incidents affecting the orderly conditions in the monetary system. The operations of the Eurosystem relating to the conversion of former national currencies into the euro went smoothly. There was no need to invoke any contingency measure, whether "ordinary" or "extraordinary". The first main refinancing operations of the Eurosystem and the first regular longer-term refinancing operations were also settled successfully. The introduction of the euro is unprecedented in European history. Although not yet embodied in the physical form of new banknotes and coins, there is no doubt that the new currency is set to play an important role in the euro area and beyond. The euro is present on all major financial markets around the globe. Currency trading is regularly carried out in euro. There are now shares denominated in euro on most European stock exchanges. Moreover, the euro has attracted new international bond issues as the currency of denomination. In some ways, the introduction of the euro may justify expectations of large efficiency gains in the international financial system. For EU citizens, two obvious gains will be, on the one hand, the reduction of transaction costs and, on the other, increased transparency, which facilitates price comparisons between different goods. Monetary Union offers a unique opportunity to establish and maintain price stability within the euro area. It promises a credible and lasting environment of price stability for almost 300 million people. Price stability is at the core of the "stability culture" that we are seeking to establish throughout Europe. The Governing Council of the European Central Bank (ECB) is in charge of monetary policy decisions for the euro area. However, their implementation rests with the Eurosystem - that is the ECB and the 11 participating national central banks (NCBs). The Eurosystem has had the good fortune to assume authority over monetary policy in the euro area in an environment of price stability, owing to the successful process of disinflation and convergence within Europe over the past decade. The Treaty on European Union, commonly referred to as the "Maastricht Treaty", assigns the European System of Central Banks (ESCB) the primary objective of maintaining price stability in the euro area. In order to give clear guidance for expectations of future price developments, the Governing Council has announced a quantitative definition of its primary objective. This clarifies how the Treaty's mandate is interpreted by the Governing Council and gives the public and the European Parliament clear guidance concerning its assessment of the success of the single monetary policy. Price stability is to be maintained over the medium term. It has been defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. As the phrase "increase" makes clear, deflation - that is, a persistent fall in the price level - would not be consistent with price stability. The annual rate of inflation, according to the most recent available data, of 0.8%, measured on this harmonised basis, is consistent with the definition of price stability. It should also be underlined once again that the monetary policy is a single one and therefore indivisible - by definition. Monetary policy decisions must be based on euro area-wide considerations, rather than national considerations. As simple as it may sound, those commentating on our monetary policy do not always appear to grasp this principle. Monetary policy needs a forward-looking, medium-term orientation. Monetary policy should not and shall not react to every change in all the information that is produced on an almost daily basis. It would be over-ambitious and therefore risky to try to steer the economy in the short term. Fine-tuning would be more likely to lead to instability than stability. To maintain price stability, we have chosen a distinct monetary policy strategy, one that reflects the special circumstances that exist at present as well as those likely to prevail in the foreseeable future. The Eurosystem's stability-oriented monetary policy strategy ensures as much continuity as possible with the former strategies of the NCBs. At the same time, it gives due consideration to the unique situation which will prevail in the early years of Monetary Union. This strategy rests on two "pillars". First, broad money is assigned a prominent role in the strategy. This is deemed to be important on account of the essentially monetary origins of inflation over the longer term. Second, a broadly based assessment of the outlook for price developments and the risks to price stability in the euro area as a whole is carried out. Monetary developments can reveal useful information about future price developments and thereby offer an important compass for the conduct of monetary policy. There is broad consensus that the development of the price level is a monetary phenomenon in the medium to long term. This takes into account the fact that monetary policy affects the price level only with variable, usually long and unpredictable time lags. It is not able to control all short-term movements in the price level. Furthermore, the historical experience of central banks in Europe and beyond demonstrates that it is important for the success of monetary policy to carry out a thorough analysis of monetary aggregates and the information they contain. The Governing Council of the ECB has announced a quantitative reference value for the annual growth of the broad monetary aggregate M3. Substantial or prolonged deviations of current monetary growth from the reference value should, under normal circumstances, signal risks to price stability in the medium term. The choice of M3 as an aggregate is supported by empirical evidence regarding the long-run stability and leading indicator properties of this aggregate. Moreover, conceptual arguments pointed to the importance of including in the monetary aggregate those assets which have a high degree of substitutability with narrower definitions of money. Monitoring monetary developments also helps to identify the nature of shocks hitting the economy. It thereby contributes to the assessment of overall economic developments. Monetary policy does not react to deviations of monetary growth from the reference value in a "mechanistic" way. In the first instance, such deviations will be thoroughly analysed to infer any signals which they may offer about the prospects for price developments. If the deviation points to a threat to price stability, monetary policy will react in a manner appropriate to counter this threat, rather than attempting to eliminate the deviation of monetary growth from the reference value in the short term. The first reference value for M3 growth has been set at an annual rate of 4 1/2 %. This reference value is consistent with the maintenance of price stability over the medium term, while allowing for sustainable output growth and the trend decline in the velocity of circulation of M3. It will be reviewed in December 1999. Although monetary data contain information which is important for monetary policy decision-making, monetary developments alone will clearly not constitute a complete summary of all the economic information necessary to take appropriate policy decisions. The Governing Council recognises that it is important, in parallel with the assessment of monetary growth, to look at a wide range of financial and other economic indicators, including economic forecasts. This systematic analysis of all other relevant information about economic and financial conditions will ensure that the Governing Council is as well informed as possible when taking monetary policy decisions. By fulfilling the unequivocal commitment of the Governing Council of the ECB to maintaining price stability in the euro area, we shall ensure that the single monetary policy contributes as much as possible to economic welfare in the broadest sense. At the same time, national fiscal authorities and general economic policies also have to demonstrate their commitment to the maintenance of price stability in the euro area over the medium term. In this context, the Stability and Growth Pact is a crucial element. Its aim is to encourage the pursuit of disciplined and sustainable fiscal policies in the euro area. In so doing, it can make a significant contribution to the establishment of favourable conditions for sustained economic growth and high employment in the medium to long term. It would be counterproductive if national fiscal policy-makers did not continue their efforts in the light of the achievement of Monetary Union and the currently positive price outlook. I am not fully convinced that consolidation efforts are currently being undertaken with sufficient determination in all participating Member States. The ECB cannot commit itself to take into account, in its overall assessment, any announced, but as yet uncertain, fiscal consolidation in some of the Member States. In line with its clear mandate, enshrined in the Treaty, and for sound economic reasons, the ECB has to decide which monetary stance best serves the maintenance of price stability over the medium term and then act accordingly. At the same time, the Treaty also emphasises the need for sound fiscal policies. This clear separation of responsibilities is both efficient and transparent. Monetary policy alone - even if it is well designed and fully successful in monitoring price stability - cannot solve Europe's economic problems. Appropriate structural reforms implemented by national governments are of the utmost importance. Much progress is required in this broad area. Moreover, responsible wage settlements in both the public and private sectors are necessary to reduce the unacceptably high level of unemployment in many parts of the euro area. Recent wage agreements in some parts of the euro area do not appear to be in the interest of higher employment. Unemployment in the euro area is largely structural in origin. Implementing a monetary policy stance which is more lax than is justified by the monetary, financial and economic conditions will not solve this problem. Instead it will exacerbate it over the medium term, as inflation distorts investment and savings decisions, raises the risk premium in long-term interest rates and undermines the allocative efficiency of the price mechanism. Only effective structural policies that improve the flexibility and efficiency of labour and goods markets can reduce unemployment in a successful and lasting manner. I appreciate that such reforms are not always easy, not least because the benefits which they yield occur mainly in the medium to long term. However, they are essential. In those euro area Member States that have taken up the challenge of structural reform, unemployment has fallen significantly. Other euro area Member States are called upon to follow these examples: structural reform throughout the euro area is fundamental to the success of Monetary Union and to improving Europe's economic performance. In this respect, we may also be able to learn something by looking at the reasons behind strong employment growth and low unemployment in some of the Member States of the European Union and in the United States, in particular regarding the flexibility of labour markets and incentives to create and accept new jobs. Since the start of this year the Governing Council has taken the following main monetary policy decisions. In December 1998, the Governing Council of the ECB announced that the level of interest on the main refinancing operation would be 3%. Since then, the Governing Council has kept this rate unchanged, as it has judged that doing so was serving best the maintenance of price stability. The 12-month growth rate of the broad monetary aggregate M3 increased to 5.7% in January 1999 from 4.5% in December 1998. This increase is mainly due to rapidly growing overnight deposits, which account for around one-third of M3. The three-month moving average of M3 (for the period from November 1998 to January 1999) increased to 4.9%, that is, slightly above the announced reference value of 4 1/2 % per annum. In view of the uncertainty relating to special factors pertaining to the changeover to the Stage Three environment and the introduction of the euro, the Governing Council does not view the recent acceleration in M3 as a signal of future inflationary pressures. However, monetary developments need to be monitored closely in the coming months. With regard to the broadly based outlook for price developments and risks to price stability, new information on indicators of future price developments and economic activity in the euro area continue to provide mixed signals. Financial indicators such as the yield curve show that the spread between short-term and long-term interest rates has recently widened somewhat. This followed the decline in long-term interest rates in January to the lowest levels seen since the late 1940s. Nevertheless, conditions for investment at the start of Monetary Union are favourable. This relates in particular to the prevailing low interest rate level, which significantly reduces the costs of financing for investors. Recent developments appear to have led to a reduction in some of the uncertainties surrounding the evolution of the world economy in 1999. This mainly relates to the strong performance of the US economy. In the euro area the latest indicators confirm that those risks which were identified earlier have materialised to some extent. Real GDP growth in the euro area, which weakened in the fourth quarter of 1998 compared with the previous quarter, suggests that activity has been slowing down in recent months. This assessment is supported by other indicators, such as decreasing capacity utilisation and industrial confidence, both of which have been on a declining trend since mid-1998. By contrast, consumer confidence continues to present a favourable picture. The level of unemployment has remained more or less unchanged over the past few months. Recent price developments are consistent with price stability. The latest data on the Harmonised Index of Consumer Prices show that the downward movement of inflation has stopped. The annual increase for February 1999 was reported to be 0.8%, the same as in the previous month. The current low inflation rate is partly due to substantial reductions in energy prices over the past half year, which have diminished somewhat very recently. Decreasing unit labour costs have also made a significant contribution. In summary, the outlook for price stability remains favourable and, until now, we have not identified anysignificant upward or downward pressures on prices in the short term. On the downward side, the slowdown in the euro area economy is a cause for concern. On the upward side, increasing wage pressure and a relaxation of the fiscal stance could adversely affect the prospects for future price stability. Furthermore, recent exchange rate developments will also need to be monitored closely in view of their impact on prices. In the absence of any strong upward or downward pressure on price developments, maintaining the current stance of monetary policy appeared justified. The Governing Council therefore decided last week that for the two next main refinancing operations the same conditions will apply as for the main refinancing operations settled earlier this year. This means they will be fixed rate tenders conducted at an interest rate of 3.0%. Interest rates applicable to the deposit facility and the marginal lending facility will continue to be 2.0% and 4.5 % respectively. Of course, the Governing Council will continue to monitor all developments and reassess its monetary policy in its bi-weekly meetings. Let me now turn to the international dimension of the euro. As the representative of a monetary union which is comparable in size and importance with the United States, and as the central bank managing a currency that is likely to play a large and increasingly international role, the ECB will inevitably serve an important function in the international financial system. The ECB will embrace the implied responsibility, but, at the same time, it will have to be modest and realistic in its actions in the international arena. The ECB may be expected to contribute to international co-operation by adopting a positive attitude. The introduction of the euro could potentially simplify the process of international policy co-operation between the major economies, since the number of key players has been reduced. In particular, it should make this process more efficient by facilitating the exchange of views and the formulation of common understandings on economic and financial issues at the global level. With regard to the Eurosystem's relationship with European Community institutions, the Treaty states that the President of the ECOFIN Council and a member of the European Commission may participate in the meetings of the Governing Council of the ECB, with the right to express their views but without voting power. Moreover, the ECB is required to disclose to the European Community institutions (the Council of the European Union, the European Commission and the European Parliament) an annual report on its monetary policy. The President of the ECB shall present this report to the ECOFIN Council and the European Parliament and also take part in the subsequent debate. As announced before, the President will attend the hearings at the European Parliament at least four times a year to discuss the activities of the Eurosystem. Finally, I should like to mention that the President of the ECB is also invited to the newly established informal Euro-11 Council meetings. In the field of the international representation of the ECB, some decisions are still under consideration. Formal and informal agreements have already been reached with the International Monetary Fund (IMF), the Organisation for Economic Co-operation and Development (OECD) and in the context of the G7 and the G10. At the end of last year the IMF granted the ECB the status of observer. As you will be aware, full membership of the IMF is restricted to individual nations. Nevertheless, this observer status will allow the ECB to participate in the relevant work and assessments by the Fund of economic policies in the euro area and beyond. The ECB stands ready to participate fully in, and contribute to, international policy discussions. It will, of course, offer expertise and exchange views when and where appropriate. However, the best contribution which the ECB can make to a stable international monetary system, including stable exchange rates and smoothly functioning international capital markets, is to maintain price stability within the euro area. Fulfilling the mandate assigned to it by the Maastricht Treaty will help the ECB to shoulder its international responsibilities. The Eurosystem takes a neutral stance with regard to the international role of the euro. It neither promotes nor hinders the development of the euro as an international currency. The Eurosystem accepts the international role of the euro as it develops through market forces. There will be no deliberate policy of challenging third currencies. As yet it is too early to predict how long it will take for the euro to emerge as a truly international currency. Generally speaking, the commitment of the ECB to successfully fulfilling the mandate of the Treaty, that is to maintaining price stability in the euro area, will contribute to the international role of the euro. Allow me to say a few words on certain proposals made in the ongoing public debate, which might suggest that the focus of monetary policy should be shifted towards objectives other than price stability. Some suggestions seem to imply that the Eurosystem should react more or less automatically to exchange rate movements or other specific variables. Just as a doctor cannot stop a fever by holding the thermometer under cold water without an appropriate therapy, monetary policy cannot stabilise exchange rates if pressure occurs as a result of diverging cyclical positions, market fundamentals or structural and fiscal policies. Therefore, we deliberately excluded any kind of explicit or implicit exchange rate objectives or targets from our monetary policy strategy. Nevertheless, the Eurosystem's stability-oriented monetary policy strategy takes into account the external value of the euro as one, potentially important, determinant of the outlook for price stability. If its development poses a threat to price stability in the euro area, this threat will be assessed. However, all other factors that impart information on price developments will always be taken into account before a decision will be taken. Obviously, if a strong and abrupt appreciation of the euro were to occur, this would lead, all other things being equal, to downward pressures on price developments. In such a situation, there would be more reason to lower the ECB's interest rates, which might then, in turn, help to counteract part of the prior exchange rate movement. But setting exchange rate targets might, for example, imply that a central bank has to increase its interest rates in a situation of weak demand and downward pressures on prices, just because of a depreciation in the exchange rate. I think you will agree with me that this might not be appropriate. According to the Maastricht Treaty, the ECOFIN Council may formulate so-called general orientations for the exchange rate policy, which shall be without prejudice to the primary objective of maintaining price stability. The ECOFIN Council has agreed to issue so-called orientations for exchange rate policy only in exceptional circumstances, such as a clear and sustained misalignment of the euro. In addition, we are not currently participating in a formal exchange rate arrangement with third countries outside the EU, for instance with the United States, and we consider it very unlikely that this situation will change. Let me turn to the issues of accountability and transparency. In general, central banks should be open, transparent and accountable, reporting extensively to the public on their activities. The issue of the transparency of monetary policy is very important, given that the Eurosystem is a new institution and the public is not accustomed to evaluating its behaviour. Moreover, by communicating clearly with the public, the Eurosystem reinforces its credibility and signals that its monetary policy is appropriately geared to the maintenance of price stability. In this regard, the Eurosystem's approach bears comparison with the "best practices" of any other central bank. Accountability is the counterpart to independence. We should also be clear that the independence of the ECB does not exclude a dialogue with political authorities. The monetary policy of the Eurosystem will be held accountable for reaching its overriding objective of maintaining price stability. The Eurosystem is open, transparent and, above all, accountable for its performance. As part of its communication strategy, the Governing Council of the ECB regularly informs the public about its assessment of the monetary, economic and financial situation in the euro area and about specific monetary policy decisions. Moreover, since January 1999 the ECB has been providing the public with a Monthly Bulletin containing additional and detailed analysis of the economic situation in the euro area. In some areas the Eurosystem has gone beyond the Treaty requirements. The Governing Council meets every fortnight. The first meeting in every month is immediately followed by a press conference, in which the President of the ECB and I explain the decisions taken by the Governing Council of the ECB. On that occasion, the "Introductory Statement of the President" of the Eurosystem is released to the press. This is similar to what other central banks call minutes. We are convinced that this very prompt delivery of information serves the interests of the public in an optimal way. Few central banks follow a policy of publishing their minutes almost immediately after the meeting of their governing body. We are also convinced that it is in the public interest for the view of the Governing Council as a whole to be presented, rather than the views of individual members. Let me finally urge caution with regard to any excessively high expectations at the start. History also shows that the full benefits of changes as substantial as the introduction of the euro may come neither immediately nor automatically. It normally takes some time to adapt to a new situation. Most importantly, efficiency and welfare gains will require structural reforms of labour and goods markets to improve flexibility. One can only hope that the euro is working as a catalyst for such change.
r990309a_ECB	euro area	1999-03-09T00:00:00	The euro: significance for Europe and beyond	committee	0	Since I came to your country for the first time in 1971, I have become conscious of the primary importance of Japan for the world economy and of the outstanding qualities of its people. As I have returned here many times afterwards, my professional and personal bonds with this country have become stronger and stronger. It is therefore a very special honour for me to speak today before the Committee of Financial Affairs of the House of Councillors, which represents the people of Japan. Of course, I am quite aware of the difficulties the Japanese economic and financial systems are now facing. But knowing the skills and the dedication of your people, I am sure that such difficulties will be successfully overcome. In my remarks today I shall try to explain the significance and the functioning of Economic and Monetary Union (EMU), which reached its final stage on 1 January 1999, when the euro was launched. With this purpose in mind, I will try to answer three main questions: first, what is the euro; second, how did Europe arrive at the euro; and third, what are the implications of the advent of the euro. I shall conclude with some broader reflections inspired by my visit to Japan. What is the euro? "Euro" is the name the Europeans have given to the new currency that has replaced the national currencies existing before 1 January 1999. The long history of European national currencies - the Italian lira, the Deutsche Mark, the French franc, the Spanish peseta - goes back for many generations, in some cases for centuries. Until last December each of these currencies had its own central bank that independently printed it, or created it via the banking system; each was traded separately in the foreign exchange market and had its own exchange rate vis-a-vis all the others as well as vis-a-vis the yen and the US dollar; each was used by the government to issue bonds, by the stock exchange to price shares, by corporations to raise capital and by households to invest savings. Today we only have one currency and therefore only one central bank, called the Eurosystem; all public debts and all stock exchanges are denominated in euro; the foreign exchange market does not trade Deutsche marks, French francs or pesetas any more, but only euro; the national central banks do not take independent monetary policy decisions any more, but are parts of the Eurosystem and execute the decisions made by the Eurosystem itself. It is important to understand that EMU is a fixed exchange rate regime linking many currencies; it is an international agreement to co-ordinate monetary policies. It is the establishment, for the European Union, of the same monetary regime that normally exists for one nation: currency and central bank. What makes EMU both so interesting for you and so difficult for the public to understand, is that the euro is not the currency of a single state or nation, but rather that of a group of states that still retain their separate sovereignty in many important fields. These countries have different languages and traditions, have had many exchanges and reciprocal influences through history, but they have also waged against each other many cruel wars, the worst of which killed tens of millions of people in the generation of my father and my grandfather. In modern monetary systems based on currencies without intrinsic value (paper or electronic money), the value of the currency rests entirely on confidence, and the source of confidence has always been the sovereign, i.e. the state. "Sovereign" was actually the name of one currency in the past. This clearly indicates the deep political significance of entrusting monetary power to an EU institution. Imagine if Japan, China and Korea replaced the yen, the renmimbi and the won by a single currency - say the "asian" - issued and managed by a single central bank. This is what we have just done in Europe. Let me turn to my second question, namely how did Europe arrive at the euro. Although the final steps were taken only less than a year ago, the journey has lasted almost 50 years. To summarise it very briefly, three processes should be recalled. First, a was created, starting in the late 1950s, at the beginning among six European countries, then incorporating more and more, to make 15; today 10 more countries are applying for membership. A single market means much more than free trade. In the European Union goods, services, capital and persons circulate freely without being stopped or checked at frontiers; no passports are necessary. Most laws and regulations concerning economic activity - whether banking, industrial production, or consumer protection - are issued by the Union itself and enforced by the courts. That the proper functioning of the single market required a monetary order was clear from the start. In the 1950s, when the European Community was founded, that order was provided by the fixed exchange rate regime created in Bretton Woods. Since at the time that regime seemed to be permanent, the need for a single European currency was not made explicit. It began to be felt in the 1960s and 1970s as the Bretton Woods system first crumbled and then collapsed. The idea of "one market, one currency" gradually gained ground in the 1980s. Second, a has been adopted. This is the Treaty of Maastricht (the Dutch town where it was signed in 1992), which established the legal and institutional basis of the single currency and of the Eurosystem, i.e. the "central bank" in charge of it. The Maastricht Treaty also prescribes stability-oriented policies and lays down the principle that economic policy must be conducted according to the precept of an open economy and free competition. The Treaty also indicates that the Eurosystem should be independent from the legislative and government bodies in order to make the euro a stable currency. has been achieved. "Economic convergence" is the expression used to indicate that, in compliance with the Treaty prescriptions and prior to the start of the euro, all countries had to reduce their public deficits to below 3% and inflation to below 2%, to bring down and maintain within a narrow band their long-term interest rates, while keeping the exchange rate stable. This means that, when the euro started, Europe had reached a uniform degree of monetary and budgetary stability that had not been seen for many decades. The move to the euro was therefore not an improvised decision. It was implicit from the start in the original project of the single market, and at the same time it was the conclusion of a long process that laid both the micro and the macroeconomic foundations as well as the legal and institutional conditions for a single currency and a single central bank. In this respect the euro is crowning what has been constructed by three generations of political and economic leaders. The third and final question I should like to answer is what are the implications of the advent of the euro. I shall review the implications for the international monetary system, for the world economy and for the relations among nations in general. In each of these three fields such implications may be relevant for the East Asian region and for Japan, as I have been led to believe once again during this tour of the area. For the , the advent of the euro means in the first place that Europe as such ceases to be the area of currency instability it has been in the past: remember the currency turmoil of 1992-93 in which some European currencies, including that of my own country, lost up to a quarter of their value, thus determining huge alterations in trade flows. The Eurosystem will have the task of creating an internally stable currency by maintaining price stability. The euro will also contribute to the emergence of a genuine tripolar monetary system, based on the dollar, the euro and the yen. It is already the second currency in the world and over time it could become the anchor currency for countries in its own time zone, from central and eastern Europe to the Mediterranean and African countries. It will have a significant share in the official reserves of many countries in the world and in the portfolios of private investors. For the , the euro means that a new economic player is emerging which has about the same importance as the United States and twice that of Japan. The euro area, or "Euroland" as it is often called, is an area of almost 300 million people, producing 15% of world GDP. (The United States produces 20% and Japan 8%.) Accounting for 16% of world exports, "Euroland" is the largest trading partner in the world economy. Acting as a single entity in trade negotiations, the European Union has played a key role in the process that led to the creation of the World Trade Organisation (WTO). In the future "Euroland" will remain committed to free trade and international co-operation, supporting and promoting initiatives aimed at a better management of the world economy. the advent of the euro means much more than just a monetary regime, however innovative this may be. Let me underline two points in this respect. First, if the century-long coincidence between the geography of states and that of monies is no longer binding, this means that important components of sovereignty can be pooled and shared among nations in the pursuit of welfare and peace. This opens up new possibilities precisely at a time when growing economic interdependence and world-wide systemic risks call for an enhancement of co-operation among sovereign states and for new and more efficient ways to manage the global economy. Second, the European Union is an example of a regional construction in which different nations co-operate through a common rule of law and common institutions. While continuous support of arrangements through multilateral institutions is necessary, I firmly believe that a level of co-operation is becoming an indispensable complement. Over 180 independent countries in the world are just too many for one-tier global governance to be sufficient. Moreover, interdependence is often regional, rather than global. And at the regional level deeper forms of co-operation may be possible, because an effective pooling of sovereignty may be less difficult to achieve. Europe provides an outstanding example of all that, and the advent of the euro is only the last, albeit the most prominent, manifestation of a long process. It is not for me to judge whether Asian countries have anything to draw from the European experience. What I can say is that we in Europe, like you here in East Asia, have a recent past of harsh conflicts. It is in memory of this past that we have tried to construct a peaceful and prosperous future. Coming to this country shortly after the start of the euro, I have been struck by the strong impression this event has made upon our Japanese friends and in other East Asian countries. It is as if you had suddenly opened your eyes to what Europe has done, not only by adopting a single currency, but also before, by gradually constructing a unitary and institutionalised system of economic integration. You now realise that this construction, going well beyond the economic field, has a relevant political dimension. This may give rise to anxiety, but should also generate hope. Anxiety, because it may convey the impression that a new colossus is taking shape, and that Japan, particularly in a period of persistent internal difficulties, risks marginalisation. Hope, because European countries, notwithstanding their past conflicts, have achieved advanced forms of co-operation that may be of interest to others. Having in mind both the anxiety and the hope, I should like to conclude with three remarks. First, the Eurosystem is open and firmly committed to international co-operation. It has no ambition to become a colossus. It is inspired by the same co-operative principles that originated it. Second, the Eurosystem sees itself and the euro as forming, together with the dollar and the yen, a tripolar monetary system. While the dollar will remain the key world currency, each of the three currencies has a natural international role to play in its time zone and should be managed in such a way as to contribute to stable trade and monetary relations. An internationally oriented yen could play a relevant role in East Asia. Third, the international role of any currency is, and must be, based on the soundness and strength of the domestic economy, not on active external promotion. For Europe the challenge consists in preserving price stability while reabsorbing its mass unemployment. For Japan, it consists in achieving economic recovery and financial restructuring. I am convinced that both our regions of the world have the strength and capacity to overcome these challenges.
r990310a_ECB	euro area	1999-03-10T00:00:00	The euro as a new world currency	no_info	0	Whether the euro will become a new world currency - as expressed in the title given to my speech - depends on three major groups of factors. First, it depends on what we might call the "habitat" of the euro, that is to say the relative demographic and economic importance of the euro area, which forms the base on which the currency is supported. In this respect, not only is its present importance of relevance, but also its foreseeable future trend. Moreover, linked to the monetary habitat, the degree of openness of the economy may also be considered in that this provides us with an idea of its capacity in relation to the rest of the world economy. In the second place, the financial dimension is of fundamental importance in order to evaluate the world impact of the euro, this being understood as the rate of development and the level of activity of the European financial markets and institutions, both in terms of volume and the diversity of business, in addition to their degree of integration. As with the volume and diversity of business, the degree of integration of the financial markets constitutes a factor that magnifies the external impact, and, therefore, it is a fundamental element in reinforcing the role of the euro as an international currency. Finally, the global importance of the new European currency is also linked to the confidence inspired by the euro and the European Central Bank (ECB), which, in turn, depends on the stability of the currency as well as on the transparency and degree of accountability of the institution determining monetary policy. It can already be said that a consideration of these factors gives rise to the conclusion that the euro area has, from the outset, played a decisive role in the world economy, comparable in certain respects with that of the United States, naturally being capable of significantly affecting international economic relations and - more importantly - having great potential for future development. The first factor, which we have called the habitat of the euro, is important because without a base providing sufficient critical mass, it is not possible to expect a currency to have international relevance, however high its degree of stability. In addition to quality, quantity is required, as is suggested by the example of the reduced degree of international use of the Swiss franc in relation to other stable currencies such as the US dollar or the Deutsche Mark until 1998. The figures relating to the population and the GDP of the euro area illustrate this. With 292 million inhabitants, it exceeds the population of the United States (270 million) and Japan (127 million). The GDP of the euro area is, on the other hand, equal to 76% of the GDP of the United States (EUR 5,774 billion as against EUR 7,592 billion), though it is higher than that of Japan (EUR 3,327 billion). The source of this information, which refers to 1998, is Eurostat. But even more important than the current figures is the potential for the future development of the euro area, in terms of population and GDP, as the so-called "pre-ins" (Denmark, Greece, the United Kingdom and Sweden) join the Eurosystem. The entry of these countries will result in a monetary area of 376 million inhabitants, 39% larger than the United States and almost triple the size of Japan, with a GDP of EUR 7,495 billion, only slightly less than that of the United States and 125% higher than that of Japan. Naturally, the entry of Britain into the Eurosystem - which for me, personally, would be most desirable, although I must, of course, respect the decision of the British citizens - would make the main difference between the international present and future weight of the euro, as the pound sterling is currently the fourth world currency after the dollar, the euro and the yen. All these facts which demonstrate the demographic and economic importance of the European Union would be further strengthened by expansion into Eastern Europe. Our continent has a historical, cultural and geographical identity - from the Iberian Peninsula to the Urals, with certain additional external territories - which, in the future, may also come to form an economic unit. But that is, for the moment, a distant prospect. The degree of openness of an economic area is also a relevant factor as regards the international impact of its currency. In this respect the euro area is more open than the United States or Japan, with a percentage of external trade of around 25.8% of GDP, as compared with 19.6% for the United States and 17.9% in the case of Japan (data from Eurostat for 1997). However, a euro area consisting of the 15 countries of the European Union and, therefore, more closed by the mere arithmetic fact that the transactions with the present "pre-ins" would become domestic transactions, would result in a coefficient of openness of 19.4%, similar to that of the United States. Clearly, the size and the degree of openness are parameters that move in opposite directions, so that the larger the euro area, the smaller its degree of openness to other countries. In considering the financial dimension of the euro area, the first relevant feature to observe is the low level of capitalisation of the stock markets in comparison with the United States and Japan. Compared with a stock-market capitalisation of EUR 3190.9 billion in our markets, that in the United States presents a figure triple this amount (EUR 9679.7 billion) and even Japan exceeded the euro area (EUR 3300.9 billion) (statistics from Eurostat, October 1998). There would be a marked difference if one were to take all 15 countries of the European Union (a stock-exchange capitalisation of EUR 6055.4 billion) due to the importance of the London stock exchange. There is no doubt that, from the financial standpoint, the entry of the United Kingdom into the euro area would be a considerable boost and that - without questioning the financial importance of markets such as Frankfurt, Paris, Madrid or Milan - London, as a financial centre, would make the difference, not only quantitatively but also qualitatively from the point of view of globalisation, as it forms the bridge between Europe and the United States. Significant and prolonged maladjustments between the economic and financial spheres are such exceptional situations that they require an explanation. In the case of Europe the said exception does not in fact arise, as the lower degree of development of the capital markets is offset by a higher degree of banking, which, in short, signifies that the financial base of real economic activity is sustained in Europe by bank intermediation, which is also a feature of the Japanese economy. Thus, for example, while private domestic credit in the euro area amounts to 92.4% of GDP, in the United States it is only 68.9%. Conversely, fixed domestic income represents 34.2% of GDP in the euro area as compared with 66.1% of GDP in the United States (statistics from the International Monetary Fund and the Bank for International Settlements as at the end of 1997 taken from the Monthly Bulletin of the European Central Bank 1999). We therefore have two distinct models of private financing which cannot be separated from the different degree of integration of the American and European capital markets, a matter to which we shall return later. The basic attribute of the euro is stability. At the ECB the stability of the currency which it is responsible for regulating is considered a priority. Compared with the idea of its stability, the strength of the euro is of lesser importance, which does not mean that the exchange rate of the euro does not constitute an element to be considered in the monetary policy strategy of the ECB. However, the basic factor that will determine the importance of the euro as a widely used currency in the world economy, in addition to its habitat and the financial dimension of the euro area, is, without a doubt, the stability of the new currency, by means of which a guarantee of maintenance of the purchasing power of savings can always be provided. In the global economy frequent mention is made of the international spillovers of financial crises by means of different mechanisms (devaluations of weak currencies, subsequent increases in interest rates, etc). Less is said about the spillover or transmission of positive economic circumstances, such as stability. The Eurosystem will "export" stability to the rest of the world economy, and not only in the case of those countries which decide to tie their currencies, formally or otherwise, to the euro (ERM II, economies of the area of influence of the euro). In the global economy the euro area will not be an island of stability, but there will be a tendency for stability to be transmitted to the rest of the economic world as the volume of transactions increases. Stability is the basic requirement of a good currency. It is what we at the ECB want for the euro. We want a stable euro, not necessarily a strong euro. In the long term the euro will derive strength from its stability. The stability of the euro is the basis or foundation of the confidence in and credibility of the ECB, without which a euro with a high international profile is unthinkable. Stability is the proof of the efficacy of the institution. Yet in order to be credible it is not sufficient for the ECB to be efficient. Other parameters of its action must be considered: accountability, transparency and communication, a European-wide perspective. The conditions for the success of the euro as a new world currency are certainly demanding. And the achievement of these conditions is the aim of those of us who have responsibilities in the operation of the ECB. It is said that, of the 82 million Germans, not all of them believe in God, but they all believe in the Bundesbank. How many of the 292 million inhabitants of the euro area believe in the ECB? That is the question. The initial situation of the euro as an international currency is, having regard to the factors considered, solid. Apart from this encouraging, albeit incipient, base, how will the euro perform as an international reserve currency? Ignoring the advice of Mark Twain to avoid making predictions, above all if they relate to the future, it can be ventured that, in an initial phase, the international role of the euro will be greater as a currency for financial investment by market participants and as a reserve currency by the central banks than as a vehicle for the exchange of goods and services in the world economy. That is to say, the euro will be used internationally more as a store of value than as a medium of exchange. There is reason to believe that private investors will have a tendency to increase the proportion of their portfolios denominated in euro in comparison with their holdings in the 10 currencies which became a single currency. The solid economic base supporting the euro, the confidence in its stability and in the monetary policy of the ECB as well as the increasing development and integration of the hitherto fragmented European monetary and financial market - which, in turn, will increase its liquidity - are the principal factors confirming such a belief. The integration of the European monetary markets relies, of course, on the existence of a single system of refinancing the banks in the euro area, that is to say on the common monetary policy. But it also relies technically on a system of instantaneous data transfer and on the new common payments system, TARGET, enabling real-time gross settlement. Thanks to the smooth operation of the systems of information, communication and payments, a common monetary policy is realistic and the integration of the markets can take place. Such integration will, in turn, involve greater liquidity and further development of the financial markets. A specific channel through which the monetary policy of the ECB and the TARGET system can have a direct impact on the development of the financial markets of the euro area is via the requirement to have guarantees or collateral for operations with the ECB. This requirement of adequate collateral, especially in the case of the banking institutions of certain financial systems, can stimulate the process of loans securitisation. The underlying assets can be used across borders, which means that a banking institution in a country belonging to the European System of Central Banks (ESCB) can receive funds from its national central bank making use of assets located in other countries, which is also relevant from the perspective of integration of the financial markets of the area. The trend towards further integration of the European financial markets, accompanied by increased use of the euro as a vehicle for international investment, should logically follow a process which would start in the short-term money market, subsequently be expanded to the longer-term money market and finally extend to the public and private bond and equity markets. In the short term there must be a tendency for the differentials in money-market interest rates to be eliminated, as the market improves, while in the long-term securities markets - naturally, both public and private - interest rates will always include a risk premium, linked to the degree of solvency of the country (deficit and public debt, commitments on pensions) or to the credit risk of the private company issuing the loan, as well as the liquidity of the securities. As a medium of exchange in the trade of goods and services, the euro will possibly develop more slowly and will need time to achieve a situation comparable with that of the dollar. The American currency has a dominant position in this respect and, as economies of scale exist in this connection, there is a tendency for its use to be reinforced. Just as it took decades for the dollar to substitute the pound sterling as a vehicle for international trade, so it will take time for the euro to reach a position where it is playing a role comparable with that of the dollar. This will depend, in any case, on the different markets (the dollar is proportionately more rooted in the derivatives exchanges) and the different geographical areas (Eastern Europe and North Africa will be more "euroised" regions and Latin America more "dollarised"). In any event, it is important to emphasise that the ECB will not adopt a belligerent stance to force the use of the euro in the world economy. This will take place spontaneously, slowly yet inexorably, without any impulses other than those based on desire and the free decision of the market participants, with no logic other than that of the market. It is certainly the case that advantages are gained from the international use of a currency, such as income from seignorage, but there are also disadvantages, such as the complication of the formulation or implementation of monetary policy. Neither does the ECB have the intention to co-ordinate the movement of its interest rates with other central banks, such as the US Federal Reserve, or to peg or limit the fluctuations in the euro exchange rate with other currencies outside the ESCB, in particular the US dollar. Having regard to the desirability of reducing, as far as possible, the relative volatility of the dollar and the euro, it should nevertheless be affirmed that the establishment, officially or unofficially, implicitly or explicitly, of certain fluctuation bands between the exchange rates of the dollar and of the euro would represent an error of economic policy and this idea is therefore dismissed by the ECB. It is important to emphasise in this connection the impossibility of simultaneously achieving two independent objectives - price stability and exchange rate stability - with a single instrument of monetary policy. If there were a set fluctuation band for the euro exchange rate, the said exchange rate objective could come into conflict with price stability and the ECB would not be fulfilling its primary objective. To have simultaneously pegged exchange rates, free movement of capital and monetary autonomy is simply impossible. This is precisely the reason why the countries of the Eurosystem have transferred their monetary autonomy to the ECB, which acts as a single monetary authority within an economic area whose exchange rates are completely fixed (single currency) and with free movement of capital (single market). And exactly the same argument explains that two different monetary authorities, each with its own decision-making autonomy (the US Federal Reserve and the ECB) in an environment of free movement of capital, cannot hope successfully to peg the exchange rates of their respective currencies in the face of deep-rooted trends in the markets in divergent directions. Instead of establishing set exchange rate fluctuation bands, European experience has shown that certain good common macroeconomic fundamentals represent the best strategy for achieving a better co-ordination of exchange rates. Monetary Union is always a political operation, irrespective of its technical and economic implications. Currency is one of the most genuine expressions of sovereignty because the power to issue money is one of the greatest powers in existence. The strength it affords was perceived by rulers who did not hesitate to monopolise it and take advantage of it, not always to the benefit of the people. The Treaty on European Union led, first, to the depoliticisation of monetary power in Europe, by means of granting independence to the central banks and prohibiting the monetising of public deficits, and then to denationalisation or supranationalisation (via the ESCB), not only for the purpose of improving the operation of the single market, but also to make progress in the building of the European political structure. One of the greatest differences between the euro and the other world currencies is that the European currency is denationalised and supranationalised. The euro does not have behind it a political power as strong and as cohesive as that of the dollar. This has consequences of a technical nature which the ECB, as the body responsible for issuing euro, takes into account, for example, in the fight against money counterfeiting. But it may also have other consequences relating to its use as an international reserve currency, to the extent that the public may have more confidence in a currency which, in addition to the guarantee of an independent central bank, has the support of a strong political power. If this were the case, it would represent an assertion in favour of continuing with the decision to build the European political structure, one of whose supports is the euro. The relationship between political power and monetary power is an interesting subject open to investigation and discussion, which certainly goes beyond the scope of this speech. I merely wish to point out that, in the case of Europe, it is clearly apparent that following the achievement of a single currency, the door remains open to political union, which would represent a crucial step in the process of integration. In conclusion, it would seem clear that the implications of a world currency such as the euro go "beyond supply and demand" (to use the title of the work of Wilhelm Ropke). We are fully immersed in the "meta-economy", which means it is time to end my speech.
r990312a_ECB	euro area	1999-03-12T00:00:00	The Eurosystem's strategy for the euro	duisenberg	1	I should like to start by thanking you for the invitation to speak here on the occasion of this conference. It is only a little more than two months since the euro was launched. Today I should like to discuss the main challenges for monetary policy at the start of Monetary Union. Clearly, keeping the internal value of the euro stable is the overriding task ahead of us. With this in mind I shall begin by broadly outlining the objectives and main elements of the monetary policy strategy of the Eurosystem. I shall then turn my attention to the role that can be played by fiscal policy and structural reforms in supporting the stability of the euro and reducing unemployment. Finally, I should like to say a few words about the distribution of responsibilities at different levels of economic policy-making with a view to maintaining stability and growth in the euro area. Let me turn to the monetary policy strategy of the Eurosystem. The Treaty establishing the European Community assigns the European System of Central Banks (ESCB) the primary objective of maintaining price stability in the euro area. In order to guide expectations of future price developments and to facilitate the public's assessment of the success of the single monetary policy, the Governing Council of the European Central Bank (ECB) has announced a quantitative definition of its primary objective. This clarifies how the Treaty's mandate is interpreted by the Eurosystem, that is, by the ECB and the 11 participating national central banks (NCBs). Price stability has been defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. Price stability is to be maintained over the medium term. According to the most recent available data, the annual rate of inflation of 0.8%, measured on this harmonised basis, is consistent with this definition of price stability. The Treaty states that the ESCB shall support the general economic policies in the European Community only if it can do so without prejudice to the objective of price stability. The logic of the Treaty seems clear. It is acknowledged that the best contribution monetary policy can make to high employment and economic growth is to maintain price stability. In this context, it is difficult to see how certain proposals made in the ongoing public debate, which might suggest that the focus of monetary policy should be shifted towards short-term growth or employment objectives, can be fulfilled without violating the primary objective of maintaining price stability, thus ultimately producing an overall deterioration in prospects for economic growth and employment. Monetary policy needs a forward-looking, medium-term orientation. It would be overambitious and therefore risky to steer the economy in the short term. Fine-tuning would more likely lead to instability than stability. A medium-term orientation takes into account the fact that monetary policy affects the price level only with variable, usually long and unpredictable time lags. For example, a large proportion of the substantial reduction in interest rates during the second half of last year will still have an impact on the euro area economy. To maintain price stability, we have chosen a distinct monetary policy strategy, one that reflects the special circumstances that exist at present as well as those likely to prevail in the foreseeable future. It ensures as much continuity as possible with the strategies previously pursued by the NCBs. At the same time, it gives due consideration to the unique situation which will prevail in the early years of Monetary Union. This strategy rests on two "pillars": a prominent role for money as expressed by the announcement of a reference value for the annual growth of M3 and a broadly based assessment of the outlook for price developments, and the risks to price stability in the euro area as a whole. Monetary developments can provide useful information about future price developments and thereby act as an important compass for the conduct of monetary policy. There is broad consensus that, in the medium to long term, the development of the price level is a monetary phenomenon. Consequently, the Governing Council of the ECB has announced a quantitative reference value for M3 growth, which has been set at an annual rate of 4 1/2 %. Under normal circumstances, substantial deviations from the reference value would tend to indicate future risks to price stability. However, monetary policy does not react to deviations of monetary growth from the reference value in a "mechanistic" way. In the first instance, such deviations will be thoroughly analysed to infer any signals which they may send about the prospects for price developments. If this analysis points to a threat to price stability, monetary policy will react in a manner appropriate to counter this threat, rather than attempt to eliminate the deviation of monetary growth from the reference value in the short term. Although monetary data contain information which is vital for monetary policy decision-making, monetary developments alone will clearly not constitute a complete summary of all the economic information necessary to enable appropriate policy decisions to be taken. The Governing Council recognises that it is important, in parallel with the assessment of monetary growth, to look at a wide range of financial and other economic indicators, including economic forecasts. This systematic analysis of all other relevant information about economic and financial conditions will ensure that the Governing Council is as well-informed as possible when taking monetary policy decisions. This broadly based assessment takes into account, inter alia, the information content of wage developments, exchange rates, fiscal indicators, real activity, assets and commodity prices. Internal forecasts of economic activity and prices in the euro area can also contribute to the success of an appropriately forward-looking monetary policy. Monitoring monetary, financial and economic developments also helps to identify the nature of shocks hitting the economy. It thereby contributes to the assessment of overall economic developments. On the basis of this thorough analysis, the interest rate will be set in a way that best serves the maintenance of price stability. With regard to fiscal policies, I should like to stress the following main points of interest with regard to a stable euro: A sound conduct of fiscal policies is important for the stability of the euro. In particular, strict implementation of the Stability and Growth Pact by each Member State is vital. The targets envisaged in the current stability programmes to bring down government deficits and debt levels represent a minimum requirement for most Member States rather than a final aim. Budgetary positions in the euro area as a whole have not yet been consolidated sufficiently. Government debt as a percentage of GDP remains far too high on average and has only started declining hesitantly in the recent past. Deficit-to-GDP ratios in a number of countries are still closer to the 3% value set in the Treaty as a reference for excessive deficits than to the medium-term balanced or surplus position envisaged in the Stability and Growth Pact. In case of a prolonged growth slowdown we might therefore easily see deficits reaching excessive levels. In addition, deficits fell very slowly in 1998, this reduction in fiscal imbalances being the result of strong economic growth and falling interest payments rather than of genuine fiscal consolidation measures. Structural and primary balances have even deteriorated. In addition, the progress in structural fiscal consolidation envisaged for the medium term appears to be only moderate. Why should monetary policy-makers be bothered by such unbalanced budgetary positions? Institutional arrangements for Monetary Union and the Eurosystem have been fully and specifically developed so as to prevent any direct link between an increase in public sector deficits and a monetary expansion, and thereby inflation. This is ensured by (a) assigning to the Eurosystem the primary objective of price stability, (b) banning the direct financing of government deficits by central banks, and (c) precluding any influence by governments or other institutions on monetary policy decisions. However, even in this setting, the conduct of fiscal policies has a clear bearing on the objective of price stability. In particular, doubts about the soundness of fiscal policy can influence the effectiveness of monetary policy instruments and can undermine the credibility of monetary policy. For decades - and until very recently - fiscal policies have followed a trend of ever-growing public sector and government debt levels. In Monetary Union, without binding fiscal rules, countries might have even less incentive to pursue prudent fiscal policies. The main reasons are, first, that risk premia offsetting inflation and exchange rate expectations disappear on a country-specific basis and may not be fully outweighed by default risk premia, and, second, that in Monetary Union fiscal consolidation and its effects on financial stability partly take on the role of a public good, the benefits of which in terms of lower interest rates can be enjoyed by individual countries even if they have not contributed to its supply. Hence, the Treaty establishing the European Community contains, for good reasons, a number of provisions on the conduct of fiscal policies, which have been further clarified by the Stability and Growth Pact. However, I must admit that the current position with regard to the implementation of these provisions in the stability programmes submitted to the European Commission by a number of Member States is less than fully satisfactory. The centrepiece of the budgetary provisions to be respected by Member States is the medium-term objective of a budgetary position close to balance or in surplus. Safeguarding sound government finances is a means of reinforcing the conditions for price stability and of promoting strong sustainable growth which is conducive to employment creation. In addition, by achieving at least balanced budgets in normal periods of the cycle, governments would create a sufficient safety margin to allow full operation of automatic stabilisers in the event of a slowdown in growth without inflating deficits to excessive levels. In the euro area as a whole we are still far from reaching this target. Substantial structural imbalances continue to restrict the flexibility of public sector budgets. Any significant increase in overall deficits - for instance, as a response to a decline in real GDP growth rates - could reverse the limited progress we have seen in recent years in reducing debt ratios across the euro area. This would imply the risk of initiating detrimental debt dynamics. Hence, governments could contribute most effectively to supporting stability and growth in the euro area by regaining sufficient flexibility in their budgets as soon as possible. However, despite the desirability of achieving this room for manoeuvre swiftly, a number of stability programmes only aim to attain this flexibility at a relatively late date and on the assumption that economic growth will be sustained and interest rates low. Apart from showing slow progress in restoring budgetary flexibility for the purposes of automatic stabilisation, governments have paid insufficient attention to other considerations that are also of major importance in setting the appropriate medium-term objectives which respect the requirements of the Stability and Growth Pact. This is the case with regard to the need to ensure a rapid decline in high debt ratios and the need to cater for the costs associated with the ageing of the population. In particular, additional budgetary room for manoeuvre will soon be required in order to address the substantial financial consequences of ageing populations. According to long-term projections and estimates, current trends in birth rates and life expectancy, together with unfunded public pension and health care schemes, result in very high implicit government liabilities in most euro area countries. In many cases these implicit liabilities appear to be far in excess of official government debt levels. Preventing these financial burdens from being shifted onto future generations of taxpayers and thereby safeguarding sound government finances would require substantial surpluses to be built up over the medium term. I now turn my attention to the contribution that structural reforms, particularly of euro area labour markets, can play in reducing unemployment and in supporting the stability of the euro. The high level of European unemployment is quite rightly a source of deep concern. It is of the utmost importance to implement policies than can bring about a lasting reduction in unemployment. Clearly, the approaches that are most likely to have a lasting effect are those that address the root cause of the problem, not just the symptoms. The root causes of high unemployment in the European Union are structural rigidities in the labour market as well as tax and public transfer policies. This view is supported by a wide body of academic literature and was also a key finding of the OECD Jobs Study. It is obvious that structural problems require structural solutions. Implementing an inflationary monetary policy will not make lasting reductions in unemployment, but will actually serve to exacerbate the problem over the medium term. As we know, inflation distorts saving and investment decisions, raises the risk premium in long-term interest rates and undermines the allocative efficiency of the price mechanism. In addition, it is particularly detrimental from the perspective of social justice. The underlying structural nature of the European unemployment problem can be seen most strikingly if one compares developments in Europe with those in the United States over the last three decades. In 1970 the unemployment rate in the United States, at around 4%, was at least twice as large as that prevailing in most European economies. Since 1970 there has been significant cyclical variation in the unemployment rate in the United States but no upward trend. At 4.4% in January 1999, the unemployment rate in the United States is almost the same as it was in 1970. In contrast, average European unemployment appears to have risen with each passing economic cycle. By the early 1980s the unemployment rates in the United States and Europe had broadly converged. Since then the unemployment rate in the United States has been below the average for the European Union. Despite recording a measure of decline last year, the euro area unemployment rate remained at 10.8% in December, more than double the corresponding rate in the United States. However, some European countries, particularly those with more flexible labour markets, have managed to avoid the trend of ever-rising unemployment. For example, the Netherlands, Ireland, Portugal, Austria and Luxembourg at present have unemployment rates well below the euro area average. If one examines the duration of unemployment, it is immediately apparent that Europe's problem is principally one of long-term unemployment. According to OECD figures, around half of the unemployed of the European Union has been out of work for at least a year, while in the United States, under 10% of the unemployed have been without work for this long. This suggests that in Europe there is an urgent need to improve incentives aimed at getting the long-term unemployed back to work. It also suggests that there is little scope for a stimulus to increase demand, but rather that structural measures should be implemented. It has been suggested that the Eurosystem focuses too exclusively on supply, almost forgetting demand. This is a misunderstanding. The truth is this - and I repeat - we are convinced that a lasting cure for European unemployment can only be found by applying measures affecting supply. It is not true, however, that our monetary policy strategy neglects the demand side of the economy. On the contrary, our monetary policy takes into account all monetary and economic developments, including demand shocks, when decisions are taken on the monetary stance which best serves the maintenance of price stability. One might rightly argue that in this way we do not actively respond to short-term changes in GDP. There is a good reason for this: it would be overambitious. We cannot steer demand precisely, especially in the short-term. Therefore, we focus on creating the appropriate conditions for non-inflationary growth of demand in the medium term. With money supply growing at almost 5% and with real interest rates well below historical averages, monetary policy is delivering in practice what I have just explained in theory. It goes without saying that we will continue to monitor all developments to determine the appropriate policy stance in the meetings of the Governing Council. There are many good examples of what can be done - and is currently being done in some euro area countries - in terms of structural reforms. First, there are "active labour market measures" which provide programmes of education, training and work experience targeted at the long-term unemployed; second, reforms to the tax and benefit systems which ensure that people are significantly better off in work than out of it; and third, there are measures to ensure that low-productivity workers are not forced out of the labour market. To this end, the burden of taxes and non-wage labour costs could be reduced for low-paid workers. In addition, minimum wage schemes and wage agreements reached by collective bargaining need to take account of the need to preserve jobs for low-productivity workers by reducing labour costs. The need for structural reform of the European labour markets is widely recognised and some progress is already being made. At the meeting of the European Council held in Luxembourg in November 1997 it was decided to adopt "guidelines for employment" at the EU level every year. Each Member State has undertaken to draw up a national action plan for employment based on these EU guidelines. Although of themselves guidelines will not reduce unemployment, if one looks at the national action plans for 1998, one can find many good examples of policy measures that are aimed at increasing labour market flexibility. However, progress appears rather slow and uneven across Europe and it is important that we redouble our efforts in this area. I recognise that structural reforms are not always easy to implement. The benefits are often enjoyed in the medium term, while short-term costs for some groups may mean that reforms are vigorously opposed by interest groups. Although there is a common objective of reducing unemployment, there is no common programme of reforms that will work in all countries. While it is possible to learn from the experience of others, each Member State will wish to develop workable policies that reflect its own particular circumstances. Although the path of structural reform is not always an easy one, it is the only way in which we can achieve the lasting reductions in unemployment that are so urgently required. I should wish to add that, contrary to competitive devaluations, such reforms, as well as wage moderation, are no zero-sum game. They contribute to net increases in average employment in an international perspective. They should thus not be criticised as "wage or social dumping". In line with its clear mandate enshrined in the Treaty establishing the European Community, and for sound economic reasons, the ECB has to decide which monetary stance best serves the maintenance of price stability over the medium term and then act accordingly. At the same time, the Treaty also emphasises the need for sound fiscal policies. This clear separation of responsibilities is both efficient and transparent. It takes account of the substantial empirical evidence and practical experience, according to which monetary policy makes its best possible contribution to the achievement of other goals by focusing on the primary objective of maintaining price stability over the medium term. This clear division of responsibilities is a sound basis for the exchange of views and information about monetary, financial and economic matters between various political authorities in the euro area and the Eurosystem. The Eurosystem's monetary policy strategy does not foresee any mechanistic reaction to specific variables, indices or forecasts. This also applies to fiscal developments, regardless of whether they are actual, planned or promised. Clearly, we will always have to analyse thoroughly whether fiscal developments have any impact on the outlook for price stability. However, as already emphasised, we will also assess the information provided by the broad monetary aggregate and all other indicators relevant for price stability. The clear distribution of responsibilities between monetary and government authorities enhances the credibility of monetary and economic policies in Europe. The "policy mix" resulting from monetary and fiscal policies will be an outcome of these policies rather than our initial objective. This assignment of responsibilities increases transparency and facilitates accountability. Under normal circumstances the joint interaction of all policies would be optimal provided that the basic allocation of instruments and objectives is respected and that policy-makers focus on their main objective. The Eurosystem is always ready to engage in an open exchange of views and information with policy-makers. Moreover, the public and governments are kept well informed about the ECB's objective and strategy. Monetary policy alone - however well designed and implemented - cannot solve Europe's economic problems. National fiscal authorities can make a significant contribution to the establishment of favourable conditions for sustained economic growth and high employment in the medium to long term by conducting sound budgetary policies. Appropriate structural reforms implemented by national governments that improve the flexibility and efficiency of labour and goods markets are of utmost importance. An increase in the flexibility of labour and goods markets would certainly also help to lessen the impact of shocks, regardless of their nature. Moreover, continued wage moderation in both the public and private sectors would contribute to the reduction of the unacceptably high level of unemployment in many parts of the euro area. If policy-makers take their responsibilities seriously and respect the assignment of instruments and objectives as laid down in the Treaty establishing the European Community, this will be the best contribution that they can make to establishing a solid foundation for sustained stability and growth in the euro area.
r990317a_ECB	euro area	1999-03-17T00:00:00	The external representation of the euro area	no_info	0	I am both honoured and pleased to be contributing to the proceedings of the Sub-Committee on Monetary Affairs of the European Parliament. As the member of the Executive Board of the European Central Bank (ECB) responsible for international relations, I shall contribute to this exchange of views with the Sub-Committee by focusing on the external representation of the Eurosystem, which comprises both the ECB and the 11 euro-area national central banks (NCBs). I shall touch upon the broader issue of the external representation of the euro area as a whole only to the extent that it is relevant to the Eurosystem. As you will be aware, the European Council already addressed this issue at its meetings in Luxembourg in December 1997 and in Vienna in December 1998. Although the main principles on which the euro area's external representation should be based have been developed, a formal decision is still pending. The main reason for this delay is the reluctance of non-EU countries to support what is perceived as an over-representation of the EU in certain forums, such as the G7, as a consequence of EMU. I shall address five issues. First, I shall clarify the implications of EMU for the external representation of the euro area and the Eurosystem in particular. Second, I shall discuss the legal basis used by the Eurosystem to develop its external representation. Third, I shall review the external representation of the Eurosystem in multilateral institutions and forums, by focusing on international as opposed to European bodies. Finally, I shall deal with the issue of the Eurosystem's representation at the bilateral level. After I have delivered my introductory statement, I shall stand ready to answer questions you might have on this topic. The introduction of the euro implies a transfer of central banking competence from the national to the Community level. This refers to monetary and exchange rate policies, the conduct of foreign exchange operations, the holding and management of the official reserves of the Member States, the promotion of the smooth operation of payment systems and contributing to the smooth conduct of policies relating to prudential supervision and the stability of the financial system. With the exception of the exchange rate policy, which is a shared responsibility of the ECOFIN Council and the Eurosystem, and banking supervision, to which the Eurosystem contributes, the other tasks are an exclusive competence of the Eurosystem within the euro area. As far as other economic policies (for example, fiscal and structural policies) are concerned, these remain largely the preserve of the individual euro area Member States. However, EMU implies that these national policies are subject to enhanced co-ordination in accordance with Article 103 (on strengthened Surveillance and broad economic policy guidelines) and Article 104C (on strengthened excessive deficit procedure in the framework of the Stability and Growth Pact). Depending on whether these economic policies are formulated at the Community or the national level, the external representation of the euro area is organised differently. The singleness of monetary policy implies that the euro area is represented externally by the Eurosystem. A different, and less demanding, solution has to be developed for economic policies which are conducted at a national level, while being co-ordinated at Community level. As regards monetary policy and the related tasks, which constitute the core activity of modern central banking, a specific feature to be kept in mind is that the Eurosystem is the central bank of the euro area. This implies that, in all institutions and forums, the ECB represents the euro area on matters related to the Eurosystem's basic tasks, while the participation of the euro area NCBs may vary. Specifically, depending on the institution or forum, the format of the Eurosystem may range from a representation by the ECB only (for example in the ECOFIN Council or Euro-11 Group) to participation by all 11 NCBs (for example in the informal ECOFIN), with varying degrees of participation between the two extremes. These differences are attributable, inter alia, to the fact that membership of different forums (for example the G7 or G10) varies across euro area Member States. However, irrespective of its format, the ECB represents the Eurosystem externally whenever issues falling within its field of exclusive competence are discussed. This results from the requirement to represent consistent views in multilateral institutions. It also implies the formulation of common positions, as exemplified by the Eurosystem's contribution to the "Code of Good Practices on Transparency in Monetary and Financial Policies", which is currently under preparation on the initiative of the IMF. Another specific feature of the external representation of the euro area by the Eurosystem is the difficulty arising from the fact that intergovernmental institutions such as the IMF or the OECD are organised on the basis of a strict correspondence between one currency and one country. Specific arrangements therefore had to be designed in order to enable the ECB to represent the Eurosystem in those institutions as I shall explain in due course. With regard to other economic policies which are either conducted or only co-ordinated by the euro area Member States at the Community level, the external representation of the euro area also needs to be organised. This applies to exchange rate policy which is both formulated at the Community level and a shared competence with the Eurosystem. As a result, it has proven difficult to find a solution until now, which I shall discuss in a moment. Other economic policies, while remaining the preserve of Member States, are co-ordinated, to varying degrees, at the Community level. As for the Eurosystem, although to a lesser extent, the need to represent consistent positions at the international level implies the formulation of common understandings on relevant issues. Discussions at the IMF Executive Board provides an example, as the Executive Director holding the EU Presidency will present a common understanding on non-monetary policy matters (e.g. fiscal and structural policies) at the forthcoming meeting on the euro area monetary and exchange rate policies in the context of Article IV consultation with Member States. In preparing the external representation of the Eurosystem, the ECB took the view that Article 6 of the Statute of the ESCB, provided a proper and sufficient legal basis for developing arrangements with multilateral institutions and forums. Article 6.1 provides that "in the field of international co-operation involving the tasks entrusted to the ESCB, the ECB shall decide how the ESCB shall be represented". As I have already mentioned, the single monetary policy and the related tasks have been entrusted to the Eurosystem as an exclusive competence. Such an exclusive competence does not apply only within the euro area vis-a-vis the Member States, but extends to the international level, where only the Eurosystem may represent the euro area positions on these matters. Accordingly, when taking a formal decision pursuant to Article 109(4) of the Treaty, establishing the European Community, the ECOFIN Council has to comply with the powers allocated to the Eurosystem under the Treaty. Specifically, an ECOFIN Council decision pursuant to Article 109(4) may only confirm at the international level the allocation of powers existing within the euro area. This is reflected in the report by the ECOFIN Council to the Vienna European Council, where the representation of the Community at the central banking level, alongside the Council/ministerial level, is provided for. In addition, the Eurosystem determines also the modalities of its external representation. The term "how" used in Article 6.1 of the Statute of the ESCB means that it is the ECB's prerogative to decide how it should be represented, whether by the ECB and/or by euro area NCBs. This is in keeping with Article 6.2, which provides that the NCBs' participation in international monetary institutions is subject to the approval of the ECB. As discussed, the setting up of the Eurosystem does not easily fit into the structure of international institutions such as the IMF and the OECD, given that the members of these institutions are countries. The assumption implicit in the IMF Articles of Agreement and in the OECD Convention is that national are the relevant policy-makers. A similar approach applies to the G10 Ministers and Governors, the origin of which is linked to the creation of the General Arrangements to Borrow (GAB) back in 1965. Since GAB resources complement IMF's ordinary resources, issues discussed by the G10 Ministers and Governors are closely related to IMF policy matters and its proceedings are close to the ones of an intergovernmental institution. By contrast, the G7 Ministers and Governors and the G10 Governors, set up under the aegis of the Bank for International settlements (BIS), are less institutionalised and work rather like informal forums. Against this background, it proved more difficult to work out pragmatic solutions for ECB's representation in intergovernmental institutions than in informal forums. First, let me consider the (IMF). As the cornerstone of the international monetary system, the IMF plays a key role in the process of the multilateral and bilateral surveillance of macroeconomic policies and financial market stability. Note that it is called the International Fund, because the monetary aspect is crucial. Thus, even though the ECB cannot be a of the Fund, it was important for it to be at the IMF from the start of Stage Three, given the respective mandates of both institutions. At the IMF Executive Board meeting on 21 December 1998 a decision was made to grant observer status to the ECB. The ECB observer participates automatically in all meetings of the IMF Executive Board regarding the surveillance, under Article IV, of the monetary and exchange rate policies of the euro area, the surveillance, under Article IV, of the policies of individual euro area Member States, the role of the euro in the international monetary system, the IMF World Economic Outlook, international capital market reports and world economic and market developments. Moreover, the observer represents the ECB at IMF Executive Board meetings on agenda items recognised by the ECB and the IMF to be of mutual interest for the performance of their respective mandates. On 8 February 1999, Mr. Robert Raymond, former Director General of the European Monetary Institute, was appointed as the ECB permanent representative in Washington D.C. with observer status at the IMF. He has taken up his duties since then. As noted above, in order to express consistent views on the euro area monetary policy at the IMF, common positions are prepared within the Eurosystem. Accordingly and in the context of Article IV consultation with euro area Members States referred to above, a common position of the Eurosystem on monetary policy matters will be delivered by the ECB observer at the Fund. As far as the Interim Committee is concerned, the President of the ECB participates in its meetings as an observer. Second, the (OECD). The OECD is another intergovernmental institution that deals with issues relating to the basic tasks entrusted to the Eurosystem. Using Protocol No 1 to the OECD Convention as a legal basis, the OECD Secretary General confirmed in February 1999 that the ECB would be allowed to participate in the work of the relevant committees and working groups of the OECD. As a result, the ECB is a separate member of the European Community delegation in these meetings alongside the European Commission. As regards participation in the proceedings which are organised in connection with the IMF Interim Committee meetings, the President of the ECB attends with an observer status. Turning to informal forums, the has become a major component of international co-operation arrangements in the field of monetary and financial policies, providing political guidance not only to the major industrialised countries but also to emerging-market and transition economies. Given its role in exchange rate policy co-operation, it is also the forum where the euro area's external representation is most difficult to arrange. This is due to the fact that a trade-off has to be found between the need to accommodate the shared responsibilities at Community level between the ECOFIN and the Eurosystem, on the one hand, and concerns of non-EU members to avoid an over-representation of the euro area. As far as the Eurosystem is concerned, the President of the ECB has been participating in G7 meetings since October 1998 on issues related to monetary policy and multilateral surveillance, including exchange rate policy. Finally, with respect to , the President of the ECB participates in meetings of the G10 Governors organised in the context of the BIS. In addition, ECB representatives also take part in the Committees set up under the G10 Governors's aegis. In contrast to intergovernmental institutions like the IMF and the OECD, the BIS is a central bank institution, as its shareholders come exclusively from the central banking community. Matters dealt with by the G10 Governors and its Committees (e.g. Basle Committee on Banking Supervision, Committee on the Global Financial System) are typically related to monetary and financial developments and systems. I shall now turn, briefly, to the Eurosystem's representation in European institutions and forums. Regular hearings of the ECB President and of other Executive Board members before the European Parliament's Sub-Committee on Monetary Affairs are the main part of the inter-institutional relationship between the European Parliament and the ECB. They reflect the readiness of the ECB to be open and accountable in discharging its basic tasks. The ECB has a standing invitation to participate in ECOFIN Council and Informal ECOFIN Council meetings. The President of the ECB is invited to meetings of the Euro-11 Group whenever issues connected with their respective responsibilities for the single currency are discussed. These meetings provide an opportunity for a wide-ranging exchange of information and views between the ECB and EU ministers on issues related to both international and European developments. Furthermore, the Economic and Financial Committee (EFC) is a key forum for the involvement of the ECB in the preparation of a broad range of issues for discussion and adoption by the ECOFIN Council. The ECB is represented in the EFC by two members of the Executive Board and by two alternate members. Finally, building upon the links already established over the past few years by the EMI, the ECB maintains close working relationships with the European Commission and with other relevant European bodies. Closely related to the issue of representation is the Eurosystem's network of bilateral contacts with other central banks throughout the world, since working relationships with them are a component of its international activity. These bilateral relations include both applicant countries and other partner countries of the EU in central and eastern Europe, and non-European countries. With reference to , the current enlargement process of the EU makes it necessary for the ECB to develop working relationships with the central banks of applicant countries with a view to assessing progress towards accession and their eventual participation in the ESCB. Issues of common interest are primarily monetary and foreign exchange policy matters, financial market structures and the legal convergence of central bank statutes in applicant countries. As regards , a number of them, especially outside the G10 Group, have limited opportunities to meet ECB representatives at international meetings. Other ways of developing working relationships have to be found. In this context, I have just visited the central banks of China, Korea and Japan and in Tokyo I held a speech before the Financial Committee on Financial Affairs of the House of Councillors. The purpose of such relations is to make the host institution more familiar not only with the institutional and policy setting of the ECB, but also with the stage of development of the financial market infrastructure in the euro area, which is relevant because many foreign central banks are likely to be interested in investment opportunities in euro-denominated financial instruments. Furthermore, topics of common interest include systemic issues, such as the strengthening of the international monetary and financial system. Bilateral issues, such as operational facilities, co-operation in matters concerning prudential supervision and financial stability, and the provision of technical assistance, potentially in all areas in which the ECB has specific expertise are also of interest to these central banks. In addition to central banks, the ECB may also establish contacts with other relevant foreign institutions, such as banking supervisory authorities, local banking associations, stock exchanges and national administrations. By way of conclusion, I would like to stress that the implications of the introduction of the euro for international monetary co-operation are likely to be twofold. First, by reducing the number of major participants the euro should contribute to simplifying international co-operation and make it more efficient. Second, in this new streamlined international setting, the European Union can be expected to play a greater role and to take a higher profile. As regards the euro area's external representation, the Eurosystem will provide its contribution in line with the basic tasks entrusted to it and in a manner consistent with its statutory mandate to maintain price stability. In discharging its mandate, the Eurosystem will be conscious of the special responsibilities it has within the European Union.
r990325a_ECB	euro area	1999-03-25T00:00:00	The euro, the dollar and national economic policies: what room for manoeuvre?	duisenberg	1	The euro made its debut on the international financial markets at the start of this year. Its successful launch in the 11 countries which form the so-called euro area constitutes a milestone in the process of European integration. The introduction of the euro has created a single currency area which approximately matches the United States in terms of economic size, is the world's largest with respect to its share in total world exports and ranks second in terms of the size of its capital markets. Thus, the euro has and will continue to have in the years to come a profound impact upon both the euro area and the world economy. The launch of the euro has raised questions concerning the relationship between the exchange rate, the monetary policy of the ECB and the room for manoeuvre of national policy. For the purpose of today's discussion I would propose to break down this rather complex issue into three aspects: namely, the role of the exchange rate of the euro in the Eurosystem's monetary policy strategy, the ECB's view of recent developments of the euro exchange rate vis-a-vis the US dollar, and the relationship between the single currency in the euro area and the flexibility of macroeconomic and structural policies in euro area countries. The introduction of the euro implies a change in the role and the importance of the exchange rate in Europe. Considered individually, most euro area countries are exceptionally open economies. In 1997 the sum of their exports plus imports as a share of their combined GDP was 53%. By contrast, for the euro area as a whole, trade in goods, measured as exports and imports combined, is around 26% of GDP and thus only somewhat higher than that of the United States and Japan. Hence the importance of a certain movement in the euro exchange rate for domestic economic developments has become less compared with the same movement of the exchange rate of a national currency in the past. Nevertheless, through its effect on economic activity and prices, the exchange rate affects the outlook for price stability and thus still undoubtedly plays an important role in the monetary policy of the Eurosystem. Let me therefore elaborate on this role in some more detail. The primary objective of the single monetary policy is the maintenance of price stability. Monetary policy will always be geared to this objective. Consequently, the monetary policy strategy of the Eurosystem does not embody an implicit or explicit exchange rate target or objective, since gearing monetary policy decisions to maintaining such an exchange rate target may, at times, conflict with the goal of price stability. Consequently, the ECB subscribes to the view that the exchange rates are primarily the outcome of current and expected monetary, fiscal and structural policies as well as cyclical and other economic developments, rather than an objective or target of monetary policy. Exchange rate misalignments and excessive volatility often reflect macroeconomic imbalances and/or market uncertainties. Accordingly, stability-oriented macroeconomic policies pursued in a transparent manner are the best contribution that can be made by policy-makers to fostering exchange rate stability. In other words, misalignments and excessive volatility should be contained by addressing their underlying causes. The Eurosystem's stability-oriented monetary policy strategy ensures that the single monetary policy makes the best possible contribution in this regard. By contrast, attempts to suppress exchange rate movements through direct targeting do not address, by themselves, the underlying causes of misalignment. Monetary policy in particular cannot correct misalignments caused by structural or fiscal policies. They need to be addressed via other policy actions. Moreover, in a world characterised by integrated and highly liquid international financial markets, there is serious doubt as to whether pegging or targeting exchange rates is feasible. The sophistication, depth and liquidity of today's financial markets makes it increasingly difficult for a central bank to defend an exchange rate for a prolonged period. In addition, the experience with exchange rate co-ordination among the G7 countries shows that it has always been very difficult to agree on a common objective. Obstacles to exchange rate co-ordination were also experienced by some ERM Member States. When during the late 1980s and early 1990s economic developments in some Member States of the ERM diverged, their bilateral exchange rates came under pressure, and eventually the exchange rate bands had to be widened to ensure two-way risk for speculators. Some currencies were even forced to abandon the ERM. These experiences are now reflected in ERM II. ERM II has relatively wide standard fluctuation bands and the ECB has the possibility of suspending intervention and financing if these could impinge on its primary objective of maintaining price stability. ERM II is explicitly designed to foster convergence to the euro area of countries that have not yet adopted the euro. For all these reasons, stable exchange rates of the euro are best served by stability-oriented policies that are consistent with economic fundamentals. In particular, exchange rate targets or objectives would neither be a substitute for a credible and stability-oriented macroeconomic policy stance nor a surrogate for a flexible response on the part of domestic markets. Nevertheless, exchange rates affect the maintenance of price stability as they influence import prices and activity, and thereby consumer prices, in the euro area. Moreover, they reflect market expectations about future economic developments and policies. Furthermore, due consideration has to be given to the exchange rate of the euro against the background of the importance of the euro area in the international monetary and financial system. Therefore, the ECB monitors exchange rate movements on an ongoing basis within its broadly based assessment of the outlook for price developments. The euro exchange rate is an integral part of the broad range of variables used by the Eurosystem to take its monetary policy decisions. The exchange rate is also monitored as it may be a channel for monetary policy transmission. Clear exchange rate misalignments, although difficult to identify, would be a cause of concern for the Eurosystem. If prolonged, they might affect inflation expectations and distort economic activity as well as hamper the efficient allocation of financial resources. Although in the euro area these negative effects will be mitigated, as a result of the low degree of openness of the economy, they cannot be ignored altogether. According to the Maastricht Treaty, the ECOFIN Council may formulate so-called general orientations for exchange rate policy. These orientations - and this is consistent with the above - shall be without prejudice to the primary objective of the Eurosystem of maintaining price stability. Therefore, the EU Finance Ministers, who are ultimately responsible for the exchange rate policy of the euro, agreed in December 1997 that they would only issue these general orientations for the euro exchange rate in exceptional circumstances, such as in the case of clear and persistent misalignments of the euro. Successful and credible stability-oriented policies should help to prevent the emergence of misalignments in the future. Let me now share with you our views on the exchange rate of the euro against the dollar. The weakening of the euro vis-a-vis the dollar during January and February was mainly attributable to a series of economic data releases over this period, which were mostly relatively favourable as far as the US economy was concerned. The US economy surprised commentators with very positive data on employment and output. Over the same period data releases for the euro area were more muted. It appears, therefore, that the recent developments of the euro exchange rate primarily reflect the previously unexpected strength of the US economy. Therefore, the recent fluctuations of the euro exchange rate should not be considered overly dramatic. The exchange rate of the euro against the dollar is now comparable with the level at which the so-called synthetic euro was quoted against the dollar prior to September 1998. Moreover, long-term government bond yields of euro area Member States continue to be lower than in the United States, also suggesting that investors believe in the stability of the euro. The current euro exchange rate, therefore, does not hint at a misalignment or at a structural weakness of the euro. Moreover, there is no indication that financial markets doubt the credibility of the monetary policy of the Eurosystem. Nevertheless, we should keep in mind that the credibility of a currency is a precious but likewise fragile asset. The possibility cannot be excluded that increased uncertainty about the political support for a stability-oriented monetary and fiscal policy has contributed to the weakening of the euro. Through pursuing a stability-oriented monetary policy, the Eurosystem underscores the confidence that the world has in this young currency, the euro. So I now turn to the final part of my talk. It is clear that euro area governments will continue to need flexibility in national policies to address country-specific developments. For example, they will need to be able to respond to asymmetric shocks, that by their nature do not affect all euro area countries equally, and to more deep-seated economic problems related to the structure of their economies. Clearly, following the introduction of the euro, the instruments of monetary policy and the exchange rate are no longer available to national governments for addressing country-specific developments. Therefore the need for flexibility in other policies at the national level is even more apparent than before. Such national flexibility will be necessary both to address short-term imbalances in demand and to deepen structural reform efforts with a view to improving the supply-side conditions of the individual euro area economies. National governments retain the principal ability to address both objectives as they retain control of fiscal policy and the capacity to undertake structural reform. Let us first consider the role that national governments continue to play in responding to short-term imbalances in patterns of demand. It is sometimes argued that the requirements of the Stability and Growth Pact will prevent national governments from using fiscal policy to address these imbalances. However, if implemented correctly and without undue delay, the contrary is true, as compliance with the Stability and Growth Pact provisions will allow sufficient room for manoeuvre. The centre-piece of the budgetary provisions to be respected by Member States is the medium-term objective of a budgetary position close to balance or in surplus. Sound government finances are important to strengthen the conditions for price stability and for the strong and sustainable growth necessary to support employment growth. Moreover, if governments achieve balanced budgets in normal periods of the cycle, they create a safety margin, sufficient to allow the operation of automatic stabilisers in the event of a slowdown, or in the face of unexpected shocks, without risking excessive deficits. The problem at the moment is that in the euro area as a whole we are still far from reaching the target of balanced budgets in normal cyclical conditions. Substantial structural imbalances continue to restrict the flexibility of public sector budgets. In a number of countries, deficit-to-GDP ratios remain close to the 3% value set in the Treaty as a reference for excessive deficits, rather than the medium-term balanced or surplus position envisaged in the Stability and Growth Pact. Recent fiscal consolidation has been rather disappointing. A significant increase in overall deficits, for instance as a response to a decline in real GDP growth rates, could reverse the progress we have seen in recent years in reducing deficit-to-GDP ratios across the euro area. Moreover, in the case of a prolonged growth slowdown, it is quite possible that deficits will quickly reach excessive levels. So it is clear that it is of the utmost importance that governments make structural improvements to their fiscal positions, as this would allow them to regain sufficient flexibility in their budgets and, most importantly, could effectively contribute to supporting stability and growth in the euro area. However, despite the desirability of achieving this room for manoeuvre swiftly, only moderate fiscal consolidation is currently envisaged for the medium-term. A number of stability programmes are aimed at attaining the necessary flexibility only at a relatively late date, and this is on the assumption of sustained economic growth and low interest rates. It is important that we see a commitment from policy-makers to ensuring the swift achievement of this aim or to going beyond the aims envisaged in these programmes once economic growth has picked up. The most important area where there is national flexibility is in relation to structural policies. Indeed it is arguable that many of the important challenges which face euro area countries can only be addressed through national policies in this area. As the March 1998 Convergence Report of the European Monetary Institute already identified, there is an urgent need for lasting policy adjustments arising from: To start with the first long-term economic issue, I now turn my attention to the contribution that structural reforms to euro area labour markets can make to reducing the very high level of European unemployment. As I have done in my comparison of the euro with the dollar, let us again contrast the developments in Europe with those of the United States. In 1970 unemployment in the United States, at around 4%, was actually significantly higher than in most European economies. Since then, although there has been a marked variation in the US unemployment rate during the course of each economic cycle, there has been no apparent long-term trend, as the unemployment rate stood at 4.4% in January 1999. In contrast, average European unemployment has been on a steadily rising path. The unemployment rates in the United States and Europe appeared to have broadly converged by the early 1980s, and since that time the unemployment rate in the United States has been below the EU average. Even though the euro area unemployment rate fell last year, the January 1999 figure of 10.6% was more than double the corresponding US rate. Looking at the latest unemployment rates around the euro area, which range from 2.8% in Luxembourg (January 1999) and 3.6% in the Netherlands (December 1998) to 17.8% in Spain (January 1999), suggests that policies must be developed at the national level. What is needed appears to be national structural reforms to make sustainable reductions in unemployment rather than a boost to euro area aggregate demand. Moreover, making labour markets more flexible can also make it easier to cope with short-term imbalances in demand. However, the situation in euro area labour markets is not uniformly bad. Some countries, particularly those with more flexible labour markets, more moderate wage increases and less discouraging tax and social security policies, have managed to avoid the trend of ever-rising unemployment. For example, the Netherlands, Ireland, Portugal, Austria and Luxembourg all currently show unemployment rates well below the euro area average. There are also examples of other countries with higher unemployment rates, such as Spain, that have begun to take steps to reform their labour markets and are now beginning to see tangible results. We can also look at some of the non-participating EU Member States, such as Denmark and the United Kingdom, to see that high unemployment can be reduced through structural reforms. The need for structural reform is widely recognised, for instance in the OECD Jobs Study and at the November 1997 Luxembourg European Council meeting, and some progress with new policy measures is already being made. First, there are "active labour market measures" to provide education, training and work experience - particularly targeted at the long-term unemployed. Second, there are reforms to ensure that tax and social security systems make people significantly better off in work than out of it. Third, measures to ensure that low-productivity workers are not forced out of the labour market. These include reducing the burden of taxes and non-wage labour costs and making sure that minimum wage schemes and collectively bargained wage agreements take account of the need to preserve such jobs. I would also wish to add that, contrary to some suggestions, such policies do not amount to "competitive devaluations", and structural reforms and wage moderation are no "zero sum game". They can help to generate net increases in average employment and should not be criticised as "wage or social dumping". The second long-term economic issue I should like to address today is the need to prepare for the substantial financial consequences of the ageing of European populations. On the basis of current trends in birth rates and life expectancy, unfunded public pension and health-care schemes generate very high implicit government liabilities in most euro area countries. Indeed, in many cases these implicit liabilities appear to be of such magnitude that they dwarf even the large official government debt levels. Unless action is taken quickly, these financial burdens will fall on future generations of taxpayers and may also threaten the soundness of government finances. Therefore, to prepare for the ageing of the population, substantial savings need to be made. The third key issue is the need to make progress in reducing the high government debt-to-GDP ratios that have substantially increased over the past two decades. Whilst there was some improvement in the run-up to the start of EMU, the recent progress has been disappointing as the average debt-to-GDP ratio for the euro area fell only slightly to 73.8% in 1998, compared with 74.6% in 1997. Such imbalances are undesirable and can also have wider implications for the conduct of monetary policy. If there are any doubts about the soundness of fiscal policies, this can influence the effectiveness of monetary policy instruments, and undermine the credibility of monetary policy. In addition to the long-term economic issues mentioned so far, I should also like to emphasise that the structural reform agenda available to national governments to promote economic development extends well beyond the reform of labour markets and public finances. For example, national governments can take steps to promote entrepreneurship and make it easier for people to start and run businesses and thus create new jobs. This could involve encouraging competition through measures to promote the entry of new firms, such as reducing the administrative burdens they face, making markets more competitive and facilitating access to venture capital. Governments can also liberalise previously highly regulated sectors, such as utilities, to increase efficiency and reduce prices to the benefit of industrial and household users of these services. National governments may also wish to take steps to raise productive investment in research and development to increase growth in expanding high-tech industries. The introduction of the euro and a common monetary policy has certainly not rendered national governments impotent. With the ability to vary fiscal policy and undertake structural reforms, national governments retain the key powers to address the real needs of their economies. If the terms of the Stability and Growth Pact are adhered to, then there is sufficient flexibility to allow automatic stabilisers to work in the event of a slowdown. Structural reforms provide the only means of achieving lasting reductions in unemployment, preparing for the ageing of the population and reducing the burden of government debt. National governments would be well advised to press ahead with such reforms. Apart from having their own merits, such policies would also support the ECB in maintaining price stability in the euro area.
r990325b_ECB	euro area	1999-03-25T00:00:00	The statistical requirements of the ESCB	solans	0	The booklet introducing statistical requirements for Stage Three, which the EMI published in July 1996, began with the bold statement: "Nothing is more important for the conduct of monetary policy than good statistics." These challenging words show the importance which the EMI attached to this area of preparations for Monetary Union, and I must say this has been fully justified by our experience in the first few weeks of the life of the euro. But let me start back in 1996. Because of the time it takes to implement statistical changes in reporting institutions and central banks, a statement of prospective statistical requirements could be delayed no longer. But that statement had to be made with very imperfect knowledge. Nobody knew at that stage (for example) what definitions of monetary aggregates would be chosen for the single currency area, or what their role would be. Given the differences in financial structures in our countries, it was not clear how to identify the financial institutions from whose liabilities the money stock would be compiled. It was decided to define them in functional terms, and in such a way that money-market funds as well as banks of the traditional type would be included. It was not clear at that stage whether minimum reserves would be applied, and, if they were, what form they would take - although it had been decided that the banking statistics data would provide the basis for any such system. Implementation had to start quickly for the statistics to be ready in time for a Monetary Union starting in 1999, but no one knew which Member States would adopt the single currency - though it was clear that the distinction between business inside and outside the euro area, would be of critical importance for monetary and balance of payments statistics, and would have to be planned for in statistical systems. In mentioning monetary and balance of payments statistics, I do not want to suggest that the statistical requirements set out in 1996 were confined to these areas. On the contrary, they covered a wide range of financial and economic data, including financial accounts, prices and costs - relating directly to the ESCB's main responsibility under the Treaty, namely to maintain price stability - government finance data, national accounts, labour market statistics, production and trade data and other conjunctural statistics, and more besides. These areas are, or course, under Eurostat's responsibility. In formulating and implementing statistical requirements, it was important to realise that the ESCB's attention would have to focus on the euro area as a whole. Monetary policy cannot discriminate among different areas of the Monetary Union - although in practice it may have different effects because of different national economic and financial structures. Focus on the area as a whole has important implications. The data must be sufficiently comparable for sensible aggregation; they must also be available to a comparable timeliness and to the same frequency. In some cases (monetary and balance of payments statistics) they had to be available in a form permitting appropriate consolidation. In short, with a few exceptions, it was realised that adding together existing national data would not be adequate. Important initiatives were already under way, such as the adoption of a new European System of Accounts [ESA95] and the implementation at national level of a new IMF Balance of Payments Manual. However, wide-ranging statistical preparations would be necessary for the ECB to have the sort of statistical information that the national central banks have traditionally used in conducting monetary policy. I arrived at the ECB about 2 years after these requirements had been released and 7 months before the start of Monetary Union. I must confess that I doubted many times in those early weeks whether statistics could be ready in time to sustain monetary policy decisions. There were anxious moments too in the late stages of finalising the monetary policy strategy: would the requirements set out in 1996 correspond to the need perceived in autumn 1998? I am now sure that the decisions made in 1996 were correct. In practice, one choice in autumn 1998 was almost automatic: thanks to the work of Eurostat and the national statistical offices in the context of the convergence criteria (with active involvement of the EMI), there was no plausible rival to the Harmonised Index of Consumer Prices (HICP) for the purpose of defining price stability. I am aware that national consumer price indices are sometimes criticised for overstating inflation, because they take insufficient account of quality improvements and use outdated weights. While further development of the HICP is to come, and at present there is no satisfactory treatment of expenditure on housing, I believe that every effort has been made to apply the lessons from experience with national consumer price measures. The other choices for statistical elements in the strategy were less obvious. In fact the banking statistics reporting structure announced in 1996 proved able to provide the monetary aggregates and the counterpart analysis required, and - with a little fine-tuning - to meet the needs of a statistical basis for reserve requirements, details of which were also finalised in the autumn. We were thus able to begin publishing monetary statistics only a few days after the final decisions were taken (at the Council meeting on 1 December), and were able to publish with some estimation last month back data on the three monetary aggregates monthly to 1980, and a note urging caution on users of the earlier data. However, the monetary strategy avoids putting too much weight on one area or type of information. This is only partly for statistical reasons. The formation of the euro area is a substantial structural change, which may in time affect monetary and financial relationships. So the ECB also examines a range of economic data for the light they shed on the assessment of the economic situation and, in particular, prospects for inflation. The editorial and economic developments sections of the Monetary Bulletin show the way the ECB draws on this information; the statistical information itself is set out in tables in the statistical section. Thus, in addition to money and credit and the HICP, the editorial typically touches on GDP, industrial output, capacity utilisation, orders, the labour market, business and consumer confidence, costs and prices other than the HICP, earnings and wage settlements, fiscal positions - naturally placing the emphasis on what are judged to be the most important developments at the time. All these areas were covered by the statement of requirements made in 1996. I do not need to say that, at present, an accurate assessment of the economic situation in the euro area is of vital importance. The editorial section of the March Bulletin concludes that the overall outlook for price stability remains favourable, with no major risk that HICP inflation will exceed 2% in the near future, but there is nevertheless a balance of conflicting influences. To reach this judgement, the Bulletin assesses the latest GDP data (slower growth in the provisional Eurostat figures for GDP in the 4th quarter of 1998; declining manufacturing output), the labour market (unemployment falling slightly; some signs of rising pay settlements), and confidence indicated by opinion surveys (business confidence weak; the consumer mood rather optimistic). The economic developments section supports the overall conclusion, and analyses in more detail price and cost developments and of output, demand and the labour market. It concludes with analysis of the fiscal position in the euro area in 1998, and a preview based on fiscal plans for 1999. I am drawing your attention to this to show the variety of material supporting the ECB's assessment of the economic and financial position and prospects. Although we pay particular attention to certain items - the monetary statistics, with an emphasis this time on influences contributing to recent faster growth, and to the rather rapid growth of credit, and the HICP - we draw on a wide range of information in a continuous monitoring exercise. The establishment of an institution responsible for monetary policy in the euro area has caused a fundamental change in the use of macroeconomic statistics at European level, very much as anticipated by the Implementation Package nearly 3 years ago. I would like to take this opportunity to thank Eurostat for their efforts to improve the quality and comparability of economic statistics relating to the euro area, and to deliver them to the ECB on a timely manner. They have given this high priority and much progress has been made in the last year or so. Further improvement will come with the introduction of the new European System of Accounts [ESA95] starting next month (although we must expect some temporary confusion following the introduction of a new system). Experience suggests that substantial statistical changes initially bring classification problems. Although, of course, provision has been made for back data to be available on the closest possible approximation to the new basis, we must also expect some discontinuity in important series. Implementation of last year's short-term Statistics Regulation will bring improvements across a wide range of conjunctural statistics not covered by ESA95. There are also initiatives to improve labour market statistics. With Eurostat, who are responsible for all these areas of statistics at European level, we do our best in the ECB to promote better data. Perhaps I should underline our support here for the priorities established last year by a working group of the Monetary Committee (the current Economic and Financial Committee), in which Yves Franchet and two of my ECB colleagues participated (Peter Bull and Gert Jan Hogeweg): in addition to quarterly GDP and short-term conjunctural statistics, these were government finance statistics, data relating to the labour market (including labour costs), and the balance of payments. At present the lack of comparable national statistics during the course of the year makes it difficult to monitor the fiscal stance in the area as a whole, and so to assess the balance of fiscal and monetary policy. Better labour market statistics are important, not only for the ECB's assessment of possible inflationary pressure, but also to improve understanding of the structure of labour markets in our countries, and the rigidities which impede the achievement of fuller employment. Balance of payments statistics - a shared responsibility of the ECB and Eurostat at European level - require a new approach in compiling data for the euro area as a whole. We intend to publish the first monthly data for the euro area following the new methodology next month, and to begin joint publication of a quarterly euro-area balance of payments with Eurostat in the summer. But there are deeper questions about future needs for balance of payments statistics in the new circumstances which are currently being addressed. Principally, the question arises of the usefulness for policy purposes of national balance of payments statistics for Member States participating in Monetary Union. There is no question, of course, that certain data in this area are needed within the ESA95 framework of national and financial accounts. I have talked mainly about statistical requirements and their provision, but this is only part of the story. The Treaty (specifically in Article 5 of the Statute of the ESCB and the ECB) clearly envisaged that the ECB would perform statistical functions, assisted by and in co-operation with national central banks, other national authorities, the Commission (meaning in this context in particular Eurostat), and international organisations. A large part of the preparatory work carried out by the EMI consisted of sorting out who would do what, avoiding so far as possible duplication, wasted effort and conflicting data, and keeping the whole development consistent with international statistical conventions. Much of this had to be framed in legal instruments, which would complete the statutory framework provided by the Treaty and the ESCB/ECB Statute. Although work on an EU Council Regulation concerning ECB statistics began as early as 1996, the Regulation could not be finalised until last autumn and the ECB could not adopt legal instruments on statistics in advance of that event - much work in this area therefore had to be done at the last minute. Information Technology is another of my responsibilities at the ECB. I am glad to say that essential elements of our data transfer and statistical processing systems were in place when I arrived, or brought into operation soon afterwards. But here, too, there is room for further improvement - the EMI and the ECB in these early months have had so much to do in relation to the resources available that, broadly speaking, only the essentials have been provided so far. "Nothing is more important for monetary policy than good statistics." The formation of Monetary Union has shifted the focus of interest on to data covering the euro area as a whole. This has required substantial changes to statistics, which need time to settle down and are some way short of completion. At the same time, the adoption of the single currency is itself a massive structural change. This will surely affect economic and financial relationships and make any data harder to interpret, although these deeper effects may occur over a period and take some time to become apparent. What is clear, however, is that the ECB must take policy decisions and explain them publicly in terms of the data available relating to its policy responsibility. What we continue to strive to do, through our own efforts and with the help of Eurostat, is to improve the quality of the data underlying policy decisions, which are so important in gaining public understanding and acceptance for them.
r990414a_ECB	euro area	1999-04-14T00:00:00	100 days of EMU: First experiences and further perspectives	no_info	0	Allow me to begin by going back two and a half years, to 4 October 1996 to be exact, when I had the opportunity to address the members of the Hochschule fur Bankwirtschaft at the diploma ceremony for graduates. On that occasion, I referred to the process of European Monetary Union and to Spain's position on this issue. I should like to recall one paragraph of my speech: "Is it really a question of choosing between the number of countries joining the future European Monetary Union or its stability? Quite honestly, I do not think so. I do not mind admitting that if there were a dilemma about this, I should be in favour of stability. I think it would be better to construct the European Union more slowly and give priority to economic stability. But given the efforts the main European countries are making to converge, I am sure that a significant number of them will meet the convergence criteria and be able to join Monetary Union with full guarantees of stability. I am also sure that Spain will be one of them." I still remember the smiles of most of those attending when I pronounced these last words, clearly reflecting scepticism. I was convinced that the single currency, which was later named the euro, would be introduced. I was also convinced that Spain would be present among the countries joining this project. I could even accept back then the idea of a Spaniard as member of the Executive Board of the future European Central Bank (ECB). But what I could not predict, because my optimism has its limits, was that this Spaniard would be me. The fact is that here I am now, pleased to be a citizen of Frankfurt, and to have the opportunity of visiting the Hochschule again, this important centre of Frankfurt. Thank you very much for inviting me. Although we conventionally consider 100 days to be the minimum period of time necessary to form an opinion on something or somebody, we would all agree that this period is nothing in the lifetime of a currency. The Deutsche Mark has lasted fifty years. Several years went by before it could gain its reputation of stability. Something similar could be the case for the euro. Nevertheless, if not a sound judgement, it is always possible to convey some first impressions after the first 100 days of the life of a new currency, and after almost one year of the life of the institution responsible for its regulation: the ECB. In this first appraisal of the euro and the ECB, I shall mainly refer to the functional aspects related to monetary policy, after which I shall say a few words about other ESCB functions. I shall end my contribution with comments on some of the further perspectives of the euro and the ESCB, especially regarding institutional issues, as indicated in the second part of the title of my speech. The monetary policy of the European System of Central Banks (ESCB) formulated by the ECB and implemented by the national central banks (NCBs) is, without a doubt, a big success. Speaking of monetary policy means speaking of three different elements, which together form the basic machinery, the correct functioning of which is the main responsibility of the ESCB. These three elements are the following: the objectives, the strategy and the instruments. Let us consider them separately. The objectives of the ECB were established in the Maastricht Treaty. According to Article 105 of the Treaty, "the primary objective of the ESCB shall be to maintain price stability". Thus, stability is the main goal of the Eurosystem and it is, therefore, the main touchstone to assess its success or failure. The success of the euro and the Eurosystem should first and foremost be measured in terms of its stability. Stability is the basic requirement of a good currency. And the euro enjoys stability, as proven by the latest inflation data for the euro area, corresponding to the month of February 1999, which - measured by the Harmonised Index of Consumer Prices (HICP) - reflected an annual increase of 0.8%. The success of the euro cannot, however, be measured by the evolution of its exchange rate in relation to other currencies. The fact that since 1 January 1999 the effective nominal exchange rate of the euro has depreciated is of much less relevance than the sound inflation rates. In the long run the strength of a currency and its stability move together. We say that in order to measure the success of the euro the level of inflation is of relevance and not the exchange rate, mainly because inflation depends basically - but not exclusively - on the action of the Eurosystem, while the exchange rate of the euro depends on the macroeconomic fundamentals of the euro area, the evolution of other currencies and market expectations, against which it is preferable not to act. We would have to ask ourselves to what extent the evolution of the euro reflects the strength of the dollar rather than the weakness of the euro. And, finally, we Europeans must be conscious of the fact that, with the parities of 10 of our currencies irrevocably fixed, the external exchange rate for our respective economies is now of less importance than before. Regarding the objective of price stability, let me remind you that reaching price stability is the main responsibility of the ECB, but it cannot be achieved by the ECB alone. Stability concerns the whole society, and this is precisely why we speak of a "stability culture". Governments in particular are, of course, also involved in the achievement of stability by applying an appropriate economic policy. Complying with the Stability and Growth Pact or implementing structural reforms in the markets to foster competition are key elements in this respect. The remaining task in connection with the primary objective of the ESCB was undertaken by the ECB last autumn and consisted in providing a quantitative definition of price stability. This definition, in the exact terms approved by the Governing Council of the ECB, reads as follows: "Price stability shall be defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%". And the Governing Council added that price stability will be "maintained over the medium term". I should like to make some comments regarding this definition of stability. First of all, I should like to underline that this is a definition and, therefore, it is a lasting commitment, and not simply an objective for a limited period of time to be revised on an annual basis, for instance. Second, you should note that we use the term "increase" and not "variation", meaning that a decrease in the HICP (or deflation) is not consistent with the idea of stability. Third, we specify the index to be used to measure inflation, the HICP. Although we should always be open to future improvements, let me state that this index, prepared by Eurostat, is good enough. It takes into account very hi-tech items such as computers, and it is a "price index" and not a "cost of living index". This explains the fact that it does not fully cover owner-occupied housing costs, for example, it excludes imputed rents. Fourth, what the ECB must really consider is the euro area-wide trend of inflation and not the specific figures for each country. Fifth, we understand that it is appropriate to allow a range of stability and not a single figure, in order to give room for some possible measurement bias in the HICP (Boskin effect) and also, in my opinion, to introduce the idea of intensity of stability, which I shall explain later. Sixth, it must be stressed that stability has to be understood in a medium-term perspective, disregarding short-term volatility. And, finally, why precisely below 2%? This limit is, of course, a convention. It could be 2.5% instead, just the same as the speed limit could be 90 kmph instead of 80 kmph. But, on the other hand, stability cannot be defined as an increase in prices of, say, up to 4%, just as 160 kmph is not a real speed limit. The substance underlying the 2% limit is that the price increase should take measurement bias into account. This limit should be low enough to avoid significant distortions in price setting and to make any general indexation process unnecessary. Following our example, the limit must take into account the lack of precision of the car's speedometer and discourage reckless driving. To sum up, the ECB has completed an important task defining in very precise terms the concept of stability, which is its main responsibility. Besides stability, which is the primary objective of the ESCB, the Maastricht Treaty refers to a secondary objective in Article 105: "Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community, with a view to contributing to the achievement of objectives of the Community as laid down in Article 2". Among other things, Article 2 refers to "sustainable and non-inflationary growth respecting the environment" and to a "high level of employment and of social protection". Although, without a doubt, the outstanding objective of the ESCB, its real "raison d'etre", is to pursue stability, this secondary objective implies that the ECB, when taking decisions on monetary policy, has responsibilities in the field of economic growth and employment. General, indirect and conditional responsibilities, but responsibilities nevertheless. Let me add that denying these responsibilities does not enhance the ESCB's commitment to stability. On the contrary, fundamentalism is not the best approach when trying to convince others of an idea. In order to be convincing I rather prefer to use rational arguments, which imply, among other things, an awareness of the global picture surrounding an idea. Let me also add that we must be aware that the main risk for the present consensus on the "culture of stability" stems, precisely, from the unacceptably high level of unemployment in our countries. My personal understanding of this secondary objective of the ESCB is that, in the long run, the best contribution that the ECB can make in favour of sustainable growth and of a high level of employment is, precisely, providing an atmosphere of stability. Stability implies efficient allocation of resources, competitiveness, lower interest rate risk premiums, investment, job creation and protection of the value of incomes, savings and wealth. All these factors are preconditions for economic growth, a high level of employment and social protection or, in other words, preconditions for the fulfilment of the secondary objective of the ESCB. In securing its objective of stability, the Eurosystem creates the conditions for complying with the other objectives of the European Union. Does this mean that the motto of the ECB should be "only stability matters" or "the greater stability, the better"? Of course not. We should recognise that, in the short run, there could be a trade-off between the degree of stability and growth. Let me stress that I am speaking of a trade-off between the degree of stability and growth, and not between stability itself and growth. To put it in a more technical way, monetary policy affects both prices and quantities in the short run. Intensity of stability matters in the short run. In terms of economic growth, a degree of stability of, for example, a 0.5% increase in the HICP would not mean the same as a degree of stability of, for example, 1.5% increase of HICP, especially if a significantly tighter monetary policy is required to achieve the former. The required degree of monetary policy tightness will depend, among other factors, on the economic cycle and on exogenous variables such as commodity prices. In the short run, assuming an inflationary scenario, the pace or rhythm of movement towards stability can also have effects in terms of economic growth. The right moment to make decisions, the timing, also matters: it must be neither too early nor too late, so as not to affect growth expectations. To summarise, in the short run, "stability: the deeper, the faster, the sooner, the better" is not always the best guidance for monetary policy. Actually, hitting the mark is more than a technique, it is a real art form: the so-called "art of central banking". Another very important decision of the ECB was the choice of monetary policy strategy. Strategy is the guidance which makes good decisions possible and which is, therefore, a vital element of the internal decision-making process. Moreover, a well-defined strategy explains the reasons for taking a certain decision, and thus enables the markets and the public to understand, interpret and judge correctly the central bank's performance. You should bear in mind that the way in which a measure is interpreted is as important for monetary policy as, so to speak, the "mechanical" effect of the measure itself. A misinterpreted measure can reverse the impact it was intended to have. A correct strategy promotes credibility and confidence and therefore enhances the effectiveness of monetary policy. Last but not least, the strategy of monetary policy, as well as a precise definition of its primary objective, is closely linked to the idea of accountability. The European Monetary Institute (EMI) and later the ECB were confronted with three possible, let us say, "pure models" of monetary policy strategy: the exchange rate strategy, the intermediate monetary targeting strategy and the direct inflation targeting strategy. The first one (the exchange rate strategy) was discarded by the EMI from the very beginning. It can be useful in the case of a small open economy, which has close economic links to a major one with a high degree of stability. In that specific case, pegging the exchange rate to the stable currency is a way to "import" stability and avoid any disturbance in the economic exchanges between the two countries, but it implies giving up monetary policy autonomy. Needless to say this is not the case for the euro area given its size or for the euro vis-a-vis any other currency in the world. Regarding this point, let me make some more general comments about the possibility of co-ordinating or limiting the fluctuations of the euro exchange rate in relation to other currencies outside the ESCB, in particular the US dollar. Having regard to the desirability of reducing, as far as possible, the relative volatility of the dollar and the euro, it should nevertheless be affirmed that the establishment, officially or unofficially, implicitly or explicitly, of certain fluctuation bands between the exchange rates of the dollar and of the euro would represent an error of economic policy. This idea is therefore dismissed by the ECB. It is important to emphasise in this connection the impossibility of simultaneously achieving two independent objectives - price stability and exchange rate stability - with the single instrumentation of monetary policy. The only specific case in which this possibility occurs is, indeed, pegging the exchange rate to a stable currency as a way to secure stability in line with an exchange rate strategy for monetary policy, as I have already said. Otherwise, if there were a set fluctuation bands for the euro exchange rate, the said exchange rate objective could come into conflict with price stability and the ECB would not be fulfilling its primary objective. Simultaneously having pegged exchange rates, free movement of capital and monetary autonomy is simply impossible. This is precisely the reason why the countries of the Eurosystem have transferred their monetary autonomy to the ECB, which acts as a single monetary authority within an economic area whose exchange rates are completely fixed (the single currency) and with free movement of capital (the single market). And exactly the same argument explains why two different monetary authorities, each with its own decision-making autonomy (the US Federal Reserve and the ECB) in an environment of free movement of capital, cannot hope to peg or even to co-ordinate the exchange rates of their respective currencies successfully in the face of deep-rooted divergent trends in the markets. Instead of establishing exchange rate fluctuation bands, European experience has shown that certain good common macroeconomic fundamentals represent the best strategy for achieving a better co-ordination of exchange rates. Let us go back to the ECB's monetary policy strategy. Discarding the exchange rate strategy for the reasons explained above, the ECB selected a monetary policy strategy of its own which contains elements of pure intermediate monetary targeting and pure direct inflation targeting. By doing so, the ECB avoided any kind of polarisation between these two strategies. They are, certainly, different, but not opposite nor contradictory. They complement each other. And indeed, it is possible to take elements from one or the other and build a new and authentic strategy. As you probably know, the ECB's own strategy, which in my opinion deserves a better label than the descriptive "stability-oriented monetary policy strategy", comprises two pillars. First, a quantitative reference value for the growth rate of M3 of 4 1/2 %. This percentage derives - in the context of a medium-term framework - from Fisher's quantity equation, using the definition of stability and realistic hypothesis of the trend growth of GDP (between 2% and 2.5%) and the trend decline in velocity of money (between -0.5% and -1%). The second pillar of our monetary policy strategy consists of a broadly based assessment of the outlook for price developments and risks to stability obtained from a wide range of economic indicators (growth prospects, wage developments, fiscal variables, the euro exchange rate, raw material prices, import prices, monetary and credit aggregates, long-term market interest rates, and so on). Notice that the link between the secondary objective of the ESCB and its strategy occurs in this second pillar, where growth prospects are an important indicator of price developments. Why a new strategy with two pillars? Because we are dealing with a new currency regulated by a new institution in a new economic area. The term "new" conveys the idea of "uncertainty" to the prudent. The best way to clear up uncertainties is to rely as much as possible not on one or the other, but on all successful past experiences of the NCBs, and not to make only one strong bet. Thus, the ECB's monetary policy strategy takes or combines elements of the two strategies used by most NCBs of the euro area, which is not the same as combining the two strategies. Instead of a monetary target, the ECB prefers to have a monetary reference value, because, for the time being, the ECB cannot afford to miss a target, as the Deutsche Bundesbank did, without losing credibility. No one should expect a systematic and mechanical reaction of the ECB when deviations from the reference value occur. Moreover, the ECB does not publish inflation forecasts, nor does it set an annual inflation objective, as the Bank of England does now and the Banco de Espana did in the past, although it has a precise definition of stability. The touchstone of a good monetary policy strategy is how clear and predictable the so-called reaction function of monetary policy is. In my opinion, the ECB's monetary policy strategy makes it possible to understand decisions, whether "passive ones" (not changing anything) or "active ones" (moving interest rates). The expectations and reactions surrounding the 8 April interest rate move are a good example of this. The ECB's monetary policy strategy has been accused of opacity, of a lack of transparency. I do not think this is true. I think rather that one must not confuse opacity with discretion, transparency with automatism. I can accept that there is no automatism in the ECB's strategy, in the sense that monetary policy decisions do not feed back from a change in specific variables. In the dilemma between rules and discretion, I admit that the ECB is closer to discretion. After all, who really believes in rules robust enough to eliminate the need for discretion in monetary policy decisions? Who really thinks that the Friedman rule or the Taylor rule is more than a meritorious academic contribution to monetary policy theory, useful only as background material? Who genuinely believes that these and other similar rules can be used as a real guide to take monetary policy decisions? No central bank has compiled in its manual of procedures such a wide range of monetary policy instruments as those listed in the so-called "General Documentation" of the ESCB. (From the European Central Bank publication entitled "The single monetary policy in Stage Three: General documentation on ESCB monetary policy instruments and procedures", dated September 1998.) There is no special merit to this. Open market operations of various types, with several maturities and frequencies and for different purposes, are easy to specify, taking advantage of the rich experience of our NCBs. At the same time, establishing standing facilities or a remunerated minimum reserve is within the reach of any central bank. All these instruments with their different varieties and procedures have their pros and cons, advantages and drawbacks. The merit lies in being able to assess these pros and cons in a proper manner and in choosing the best instrument and procedure for each situation. The merit also lies in changing the instruments and procedures whenever necessary. The ECB has done so and is prepared to do so in the future. In the first days of single monetary policy, there was little doubt of the advantages of a fixed rate tender with a certain percentage of allotment for the weekly main refinancing operation. It makes it possible to control both price and quantities. It avoids giving wrong signals to the market and liquidity can be kept under control. The idea of control is fundamental at the very beginning of the life of a currency and an institution. In the meantime, the ECB has improved some specific procedures in order to avoid or, at least, to minimise problems arising from the fact that the availability of collateral varies. However, as I said before, no system is without drawbacks. In the case of a fixed rate tender with allotment, problems can arise in the case of some banking institutions (or "counterparties" as we call them) operating in financial systems with a scarcity of collateral for several reasons: a low level of public debt, less tradition of loan securitisation, etc. As examples of Eurosystem decisions to improve the procedures in order to avoid or minimise these kinds of problems, I shall mention two steps. One was clarifying to the counterparties that the correct interpretation of the General Documentation allows tender bids which are not actually covered by collateral at the time of the submission of bids, and that the only requirement is the financial capacity to have the collateral on the date of settlement of the tender. Of course, the final settlement of the tender operation is subject to the availability of sufficient collateral to cover the allotted amount. The second step, taken on 8 April 1999 when we decided to reduce the interest rates, was to establish a symmetric interest rate corridor between the repo rate on the one hand and the marginal lending facility and the marginal deposit facility on the other. The markets could - and it actually seems that they did - infer that the overnight rate will tend to move around the middle point of the marginal facilities corridor. If this is so, it is better for the time being (but not necessarily forever) to have a symmetric corridor in order to signal that there is no reason for the overnight rate to stay necessarily above the repo rate. By doing so, we avoid systematic arbitrage gains stemming from financial institutions asking for more liquidity than they actually need. This is legitimate provided that they do not ask for more liquidity than the amount of collateral they can afford, but it gives a clear advantage to institutions operating in financial systems with a large stock of collateral. Another good example of the Eurosystem choosing the appropriate instrument of monetary policy and of changing details of its application concerns the longer-term refinancing operations, which have a monthly frequency and a maturity of three months. Unlike the main refinancing operations, these consist of a variable rate tender, which is not intended to have its usual signalling effect. As you may know, the signalling effect of monetary policy is important and must be taken into account whenever choosing the appropriate instrument and using it. For the sake of efficiency, the Governing Council of the ECB decided on 4 March 1999 to modify the tender method applying to longer-term refinancing operations, switching from a variable single rate auction (the so-called Dutch method) to a variable multiple rate auction (the American method). Rather than describing to you all the Eurosystem's monetary policy tools in the part of my speech devoted to monetary policy implementation, I preferred to give you some examples of which instruments were chosen and on which grounds, and to demonstrate that an important task in these first 100 days of European Monetary Union has been to improve these instruments with a view to efficiency and fairness. Nothing is more important for the conduct of monetary policy than good statistics. In this respect, I should like to highlight the progress, which the ESCB has made in this field, thanks to the efforts of the staff of both the ECB and of the NCBs. The ESCB has direct responsibility for preparing money and banking statistics and those relating to financial accounts. It also has shared responsibility with EUROSTAT (European Commission) for balance of payments statistics. Although the work has not yet been concluded, I wish to emphasise that the progress made has been considerable and that we now have the basic statistical information required for our monetary policy strategy and for taking appropriate decisions. As I often say when I comment on this point, you do not need a scalpel to cut a slice of bread. It is my understanding that, after 100 days of running, the payment systems function of the ESCB has had a positive result on balance. Following an expected learning and adjustment period to become accustomed to the new procedures and techniques, the real-time gross settlement system (TARGET) is functioning well. And, more importantly, the ESCB has alternative methods and contingency solutions, which can always be introduced if considered necessary or opportune. As the person directly responsible for the information and communication systems of the ECB, I must say - and this is not to my credit but to the credit of the staff of the ECB - that the information systems in general, and, in particular, both the technical infrastructure allowing the instantaneous transmission of data on monetary policy, and the communication systems required to co-ordinate the activity of the NCBs and of the ECB, are functioning perfectly. Another one of my specific responsibilities at the ECB involves the production and issuance of euro banknotes. Several milestones were reached already on our road to prepare the euro banknotes, which will be issued in the year 2002. Thus, we decided in favour of a no pooling decentralised solution for the production of banknotes by the NCBs. We have finalised the so-called "zero production run", which involved the printing works of the participating countries. The main purposes of this test were, first, to check the compliance of the "test banknotes" against the technical specifications and, second, to prove that all printing works are in a position to produce the euro banknotes to the same high quality standards. The result of this test was positive, as only some minor technical specifications need to be modified slightly. The printing works will now start their final preparations for the commencement of the mass production of the euro banknotes. The Governing Council also decided to establish an Analysis Centre for Counterfeit Euro Banknotes. As is already indicated by its name, the main purpose of this Analysis Centre will be to technically analyse and classify new types of printed counterfeits, and to store the related technical data in a database. The Analysis Centre will be located at the ECB in Frankfurt. The future perspectives of the euro and the ESCB, to come to the last part of the title of my contribution, are clearly linked to the ideas of confidence and credibility. The main goals I am striving to achieve concerning the future perspectives of the euro and of the ESCB are, indeed, confidence and credibility. All the technical achievements in monetary policy, payment systems, information systems, statistics, etc. are worth nothing if the euro and the ESCB do not manage to win the confidence of the 292 million citizens of the euro area, as the Deutsche Bundesbank did with the 82 million German citizens. The key to gaining confidence in the ESCB is, first, to be efficient, to be successful, in meeting the primary objective of price stability, for which an appropriate monetary policy is a necessary but not sufficient condition. As stated before, in order to achieve stability, it is necessary to combine and co-ordinate with other economic policies, such as fiscal policy (Growth and Stability Pact) and those relating to the supply side of the economy (liberalisation, deregulation and flexibility). It is also essential for the credibility of the ESCB that there is respect for its independence, with regard to the various functional, organic and personal aspects which independence encompasses. Independence does not mean no co-ordination or no communication, or a lack of transparency, or a lack of accountability. Accountability to the European Parliament and good communication with the public and with the markets is an essential condition for the credibility of the ESCB and for the efficiency of its monetary policy. As I said before, it is important to remember that the impact of the monetary policy measures depends both on their mechanical effect and on their perception and interpretation by the public and by the markets. A further key to the success of the ESCB is that it should act as what it is, a system, that is to say a harmonious and interdependent whole. Co-ordination between the ECB and the NCBs, which up to now has been fully achieved, mainly thanks to the actions of the Governing Council and of the committees, is another factor for the euro. Last but not least, a further key to the credibility of the euro and of the ESCB is the adoption of a European-wide perspective, with no national bias. Efficiency, independence, accountability, transparency and communication, co-ordination and a European-wide perspective: these are the main ruling principles of the ESCB. They are certainly demanding conditions, but they are necessary in order to achieve credibility on the part of Europeans and those who wish to view the euro as a currency on which they can rely. Thank you very much.
r990415b_ECB	euro area	1999-04-15T00:00:00	The euro in the international capital markets	bank	0	Allow me to begin by stating that I am convinced that the euro will play a decisive role in the world economy and in the international capital markets. I will divide my speech in three sections, which I hope will serve to explain why I am convinced of the above. There are three main conditions for a currency to acquire an international role. First, it will depend on what we might call the "habitat" of the euro, that is to say the relative demographic and economic importance of the euro area, which forms the basis on which the currency is supported. In this respect, it is not only its present importance which is relevant, but also its foreseeable future trend. Moreover, linked to the monetary habitat, we should also consider the degree of openness of the economy, in the sense that this provides us with an idea of the number of commercial transactions of an area compared with the rest of the world economy. Second, the financial dimension is of fundamental importance in order to evaluate the impact of the euro in the world. By financial dimension, I am referring to the degree of development and the level of activity of the European financial markets and institutions, in terms of volume, diversity of business, and degree of integration. Like the volume and diversity of business, the degree of integration of financial markets constitutes a factor that magnifies the external impact, and is, therefore, a fundamental element in reinforcing the role of the euro as an international currency. Finally, the global importance of the new European currency is also linked to the confidence inspired by the euro and the European Central Bank (ECB), which, in turn, depends on whether stability is achieved as well as on the transparency and degree of accountability of the institution determining monetary policy. The consideration of these three factors gives rise to the conclusion that the euro area will, from the outset, play a decisive role in the world economy, comparable in certain aspects with that of the US dollar, naturally being capable of significantly affecting international economic relations and - more importantly - having great potential for future development. The initial situation of the euro as an international currency is, in conclusion, solid. Apart from this encouraging, but incipient, base, how will the euro perform as an international reserve currency? It can be ventured that, in an initial phase, the international role of the euro will be greater as a currency for financial investment by market participants and as a reserve currency for central banks, than as a vehicle for the exchange of goods and services in the world economy. That is to say, the euro will be more used internationally as a store of value than as a medium of exchange. There are reasons to believe that private investors will have a tendency to increase the proportion of their portfolios denominated in euro in comparison with their holdings in the 10 currencies which form the basis for the single currency. The solid economic base supporting the euro, the confidence in its stability and in the monetary policy of the ECB, as well as the increasing development and integration of the up to now fragmented European monetary and financial market, are the principal factors confirming such a belief. The integration of the European monetary markets relies, of course, on the existence of a single refinancing system for banks in the euro area, that is to say on the common monetary policy. But it also relies technically on a system of instantaneous data transfer and on the new common payments system, TARGET, enabling real-time gross settlements. Thanks to the smooth functioning of the information, communication and payments systems, a common monetary policy is a reality and the full integration of money markets can take place. Such integration will, in turn, imply greater liquidity and a further development of the financial markets. A specific channel through which the monetary policy of the ECB can have a direct impact on the development of the financial markets of the euro area derives from the requirement to have adequate collateral for operations with the ECB. This requirement, especially in the case of certain financial systems in Europe, can stimulate the process of loan securitisation. In addition, collateral can be used across borders, which means that a banking institution in a country belonging to the European System of Central Banks (ESCB) can receive funds from its national central bank by making use of assets located in other countries. This should clearly have a positive impact on the integration of financial markets in the euro area. The trend towards further integration of the European financial markets, together with the increased use of the euro as a vehicle for international investment, should logically follow a process which would start in the short-term money market, subsequently be expanded to the longer-term money market and then reach the public and private bond and equity markets. In the short term there must be a tendency for the differentials in money-market interest rates to be eliminated, while, in the long-term, interest rates on securities markets - both public and private - will always include a risk premium, linked to the degree of solvency of the country (deficit and public debt, commitments on pensions, etc.) or to the credit risk of the private company issuing the loan, as well as the liquidity of the securities. As a medium of exchange for the trade of goods and services, the euro will possibly develop more slowly and will need time to achieve a situation comparable with that of the dollar. The American currency has a dominant position in this respect and there is a tendency for its use to be reinforced because of economies of scale. Just as it took decades for the dollar to substitute the pound sterling as a vehicle for international trade, it will also take some time for the euro to reach a position where it is playing a role comparable with that of the dollar. This will depend, in any case, on the different markets (the dollar is proportionally more rooted in the derivatives exchanges) and the different geographical areas (Eastern Europe and North Africa will be more "euroised" regions and Latin America more "dollarised"). In any event, it is important to emphasise that the ECB will not adopt a belligerent stance to force the use of the euro in the world economy. This will take place spontaneously, slowly but inexorably, without any impulses other than those based on desire and the free decision of the market participants, with no logic other than that of the market. It is certainly the case that advantages are gained from the international use of a currency, such as income from seignorage, but there are also disadvantages, such as the complication of the formulation or implementation of monetary policy. Instead of establishing exchange rate fluctuation bands, European experience has shown that certain good common macroeconomic fundamentals represent the best strategy for achieving a better co-ordination of exchange rates. You will probably agree with me that 100 days are not enough to identify broad trends and structural developments related to the introduction of a new currency, especially if this currency is the legal tender of an economic region of the dimensions of the euro area. However, some interesting facts have already been observed and several positive signs can be identified. The one I consider most favourably surprising is what I would call "normality". During this period there has not been sharp volatility in the exchange rate of the euro against major currencies, the money markets have worked smoothly and there have not been too rapid or too large shifts in the share of financial assets denominated in euro. As regards the exchange rate, the euro has gradually depreciated from the beginning of the year, but volatility has been small compared to what was expected for a new currency. In any case, if you compare the present exchange rate of the euro vis-a-vis the dollar with the 1998 average of the so-called synthetic euro, you will realise that they are similar. On the money market, which is an area more clearly linked to the ESCB's direct responsibility, the sudden transformation of the eleven euro-area domestic markets to the new situation took place in a fast and smooth way, notwithstanding the large differences in practices that existed. An indication in this respect is the reduced dispersion of overnight interest rates among participating countries as well as the high turnover in the overnight market. The first developments in the repo market have also been quite satisfactory. The transition has been smooth in general terms, and major problems which could have disturbed the transition have been avoided. Examples of such potential problems are related to securities redenomination, methodological changes in the calculation of accrued interest, and clearing and settlement procedures. In any event substantial developments in the main factors promoting the integration of the euro-area repo market are to be expected over the medium term. These are, among others, changes in securities trading and custody systems. In any event, the repo-based implementation of the ESCB's monetary policy is already playing a major leading role in this respect. In addition to the money market, the government bond market is the one where the impact of EMU has been more visible from the very beginning. In fact, some of the changes already started before the introduction of the euro. Yield spreads prevailing between the various euro area government bonds were substantially reduced and, in several aspects, coordination among participating national treasuries developed at a fast speed. A landscape of co-operation and competition among national treasuries is developing; this will eventually be reflected in more efficient and integrated euro government bond markets. As regards the private bond market, the share of financial assets denominated in euro has steadily increased since the beginning of the year. The share of bond issuance denominated in euro is now 44.1%, practically reaching the level of dollar-denominated bond issuance (44.9%). This outcome is again more satisfactory than previously expected. It may be useful to add that the driving force behind the increased issuance is the private sector, given that government deficits are limited and trending structurally downwards. It also appears that foreign borrowers, especially US ones, are contributing substantially to the increase in euro-denominated issuance. This shows that the opportunities offered by the euro for portfolio diversification and arbitrage are being exploited by the markets. In conclusion, from the first trends since the introduction of the euro, one may state that "normality" has been the key characteristic of this transition process, and probably the most warranted one. The impact of the introduction of the euro has been stronger on the markets which are closer to monetary policy, especially the money market, but the government and private bond markets have also been positively affected. These favourable developments in the euro financial markets and the good performance of monetary policy enhance each other. Both market participants and monetary policy makers will benefit from these positive first experiences of the euro. I am convinced that they will last.
r990415c_ECB	euro area	1999-04-15T00:00:00	Rede zur Verleihung der WÃ¼rde eines Ehrendoktors des Fachbereichs Wirtschaftswissenschaften der Johann Wolfgang Goethe-UniversitÃ¤t, Frankfurt am Main, am 15. April 1999	no_info	0	Wer Entscheidungen zu verantworten hat, kann die Kluft nicht ignorieren. Hier die Wissenschaft, deren unersattliche Neugier immer neue Fragen aufwirft, ewig nach den richtigen Antworten suchend - dort der Zwang der Politik, taglich neu zu handeln, langst bevor die letzte Sicherheit - wenn es sie denn gabe - gefunden ist. Fur welche Aufgabe trafe dies mehr zu als fur die, mitzuwirken bei der Schaffung einer neuen Wahrung, zumal unter den besonderen Bedingungen der Europaischen Wahrungsunion. Ich sehe meine Rolle im Versuch, eine Brucke zu schlagen zwischen dem verwirrend reichen Spektrum der Wissenschaft und dem Gebot der Politik, laufend Entscheidungen zu treffen. Von daher mogen Sie verstehen, was es mir bedeutet, von der Universitat in dieser Form geehrt zu werden, und dies von einer derart angesehenen Institution wie dem Fachbereich Wirtschaftswissenschaften der Johann Wolfgang Goethe-Universitat. Dafur meinen tiefen Dank. Ich freue mich uber diese Auszeichnung um so mehr, als Sie bei gleicher Gelegenheit Tommaso Padoa-Schioppa, einem wahren Europaer, die Wurde eines Honorarprofessors verleihen, einem Kollegen, mit dem ich mich uber den gemeinsamen Einsatz fur den Erfolg des Euro hinaus verbunden fuhle. Dem Wunsch der Fakultat entsprechend werde ich die verbleibenden 12 Minuten in englisch sprechen, der Sprache des Euro-Towers: I must confess that it was extremely difficult for me to select a topic from the wealth of potential subject matter. Every topic runs the risk, once broached, of turning into a lecture, which takes up an entire evening. On the other hand, the ECB is not any more an unknown entity. Taxi drivers no longer take visitors to the wrong address. And I am sure that most of you will already be familiar with our activities not least with our monetary policy strategy. As the most recently established central bank, the ECB attracted the attention of the whole world from the very outset. There are obvious explanations for this. On 1 January 10 currencies, some of which were far from insignificant at the international level, became one. Thus almost instantaneously a monetary policy institution was born that - in global terms - ranks second only to the US Federal Reserve. Its currency, the euro, has given rise to high expectations from the right beginning of the Maastricht process. There are two reasons for this. On the one hand, it was necessary to make it easier for citizens to accept the end of their familiar currencies. Prior to the birth of the euro, surveys showed that its popularity stood in inverse proportion to the stability displayed by the participating currencies in the past. Accordingly, the pledge of a stable euro was emphasised time and time again and with great clarity. On the other hand, the project of a single currency has always been given a meaning which goes far beyond the purely economic. The idea of the euro acting as a pacesetter along the road to political union has long been entertained by many illustrious proponents. Historically, political borders and currency domains have indeed tended to coincide. Banknotes and coins no doubt represent a visible and tangible symbol of sovereignty, national identity, and even emotional attachment. Explanations for this phenomenon sometimes drift into the realm of the mystical or religious. Andre Glucksmann once elevated the German predilection for price stability to the status of a "currency religion" (Rheinischer Merkur, 3 September 1993). In the same vein the Portuguese Prime Minister Guterres is reported to have made the following statement at the summit in Madrid at the end of 1995: "when Jesus Christ decided to found a church, he said to Peter: thou art Peter, and upon this rock I will build my church. You are the euro, and on this new currency, the euro, we will build our new Europe" (Frankfurter Allgemeine Zeitung, 13 December 1995). You will understand that a central banker may become slightly dizzy at this ideological elevation. We do not see ourselves as the high priests of a currency religion. Fulfilling the expectation of a stable euro is difficult enough in itself and demands absolute commitment, if not devotion, to the task. However, the special constellation of one currency and one market but 11 sovereign states does invite more far-reaching reflections. On the one hand, there are hopes inspired by a European vocation that the euro will exert a unifying and catalytic effect at the political level. On the other hand, there are concerns about the robustness of this historically unprecedented undertaking. The discrepancy between a single monetary policy and the heterogeneity of the political decision-making process represents a potential for considerable tension, the influence of which, like the two faces of Janus, points in opposite directions. On the one hand, there is the opportunity for the ECB and the euro to help set Europe on a stability-oriented course and thus contribute to further advance down the road of ever-closer integration. On the other hand lies a minefield of potential conflicts with other actors in the economic policy field. Against a background of high unemployment - around 15 million unemployed in the euro area at the start of Monetary Union - the special challenge for monetary policy was clear from the outset. For politicians, there exists in this context even more than usual, the temptation to offload their responsibility onto the central bank. To this end, the obvious strategy for them, in the first instance, is to emphasise and exaggerate the ability of monetary policy to influence growth and employment at every suitable opportunity. The second - and related - strategy for politicians to "pass the buck" is offered by the seemingly very convincing concept of co-ordinating the policies of all those responsible for the economy. Do economic models not provide irrefutable proof of an outcome, which is already clear intuitively? If central banks, fiscal policy-makers and both sides of industry bring their actions into line ex ante, the result will be optimal. Acting alone or even in contradiction to the other parties, by contrast, leads to poor outcomes. The notion of policy co-ordination has, in various forms, again become popular with politicians in recent time. The idea, that separate policies, which affect each other, should take each others' objectives and actions into account appears to be an attractive and self-evident proposition. However, there is a general danger that such an approach dilutes incentives and accountability for individual policy makers. In the extreme, if everybody is regarded as responsible for everything, nobody will take responsibility for anything. Moreover, the notion of policy co-ordination has in some cases also been used - I should rather say misused - as an all too clever cover for attempts at a more fundamental shift in responsibilities. In fact, in some quarters it has been argued quite openly that wage policy should be geared to secure price stability by ensuring the constancy of unit labour costs. If fiscal policy remains "neutral", monetary policy would then be "free" to promote growth and employment. Who, then, would be to blame if growth proves to be unsatisfactory and unemployment remains at an unacceptably high level? This is the appropriate moment, in this place and in this year, to pay the inevitable tribute to Frankfurt's most famous son. In keeping with the season, the quote is taken from Faust's walk with Mephistopheles on Easter Sunday: I shall try to do so. However, given the time constraints, I shall restrict myself to a few propositions. (You will have to take the word of a doctor rerum politicarum honoris causa that he could well speak for longer - you would, indeed, not wish to imply that the faculty had made a mistake?) Discussions on the role of the ECB's monetary policy are in full flow. Against the background of the appallingly high level of unemployment in Europe, this debate was to be anticipated. Any other expectation would have been unrealistic. However, the key to combating unemployment definitively does not lie with monetary policy. The less those responsible for other policy areas are willing or able to undertake the necessary structural reforms, the greater is the incentive for them to distract attention from their own failures. And then it is only a small step towards making the ECB a convenient scapegoat. We must take this challenge very seriously. The independence of the ECB as enshrined in the Treaty acts as a shield against direct political influence. In the long run, however, not only the monetary policy of the ECB, but also its Statute must be backed by the continued support of the public at large. Achieving and maintaining this support is a far from easy task. The evident diversity created by 11 participating Member States makes this task even more difficult. We shall do everything in our power to meet this challenge: by pursuing a stability-oriented policy for the euro and by always striving to inform the public of the reasons for our decision in a clear and transparent manner.
r990415a_ECB	euro area	1999-04-15T00:00:00	Eurosystem: new challenges for old missions	schioppa	0	I participate in this Dies Academicus, at the University that carries the name of Goethe, in the town of Frankfurt, in the first year of the euro, with thoughts and emotions that are hard to conceal. In my early youth, at the time of the decisions that determine one's life, the dearest of my Gymnasium teachers told me: "You have to resolve, in order to decide your future, the dilemma of what interests you most: whether to understand or to change the world." My choice has been Economics. And, the subject of economics being human action, I early discounted that the call for action would prevail, in my motivations, over the enquiring spirit. I did not expect how strongly that dilemma would continue to accompany my life.More importantly I did not understand, at the time, how much acting and enquiring are complementary ways of being in the world and searching for truth, as Goethe's work and life so profoundly witness. Science changes reality; practical activity not supported by reflection and analysis is ineffective and even harmful. If I now live in Frankfurt and am here today it is because most of my professional life was spent in an institution - the Banca d'Italia - where eminent persons like Guido Carli, Paolo Baffi and Carlo Azeglio Ciampi allowed the dilemma of my early years being kept somewhat unresolved and favoured independent analysis as a complement of practical activity. They also shared and encouraged the combination of enquiry and action that helped the euro to become a reality. To them I therefore dedicate this lecture. Academia is the place where teaching and enquiring reinforce each other by going hand in hand. It originates from Socrates' precept that "the wisest recognises that he is in truth of no account in respect to wisdom". Teaching is assertive, enquiring interrogative. One is based on the that we have answers to transmit; the other is based on the imposed by unresolved questions The mode of the following remarks will be the interrogative, rather than the assertive one. Not only because presumption is certainly not my today, but, more importantly, because the theme of this lecture - the new challenges posed by the advent of the euro - has a distinctly intellectual dimension, not only a practical one. The success of EMU will largely depend on the ability to identify new problems at an early stage and to analyse them without prejudice. While the mission entrusted to central bankers is not new, the challenges in the years to come may indeed differ from those of the last few decades. They may be "new" either because they have not been experienced before, or because they have acquired a new dimension. In reviewing what I consider to be, for the Eurosystem, the most important of such challenges, I shall use the academic privilege of taking a free and forward-looking perspective. My point of view will, therefore, not necessarily coincide with that of my institution. Moreover, I shall not be objective, because I shall mainly draw on the intellectual and practical experiences that have constituted my professional life. Policy missions have not been altered by the start of the euro. They correspond to aspects of the public interest that were not redefined, and did not need a redefinition, because of the euro. In the field of the public interest is to provide economic activity with a medium of exchange that preserves its value over time. In the broader field of - of which monetary policy is part - the public interest is, to use words from the Maastricht Treaty that can be similarly found in most national constitutions and legislation, "to promote economic and social progress which is balanced and sustainable" (Article B). In the field of , the mission is that of "creating an ever closer union among the people of Europe, in which decisions are taken as closely as possible to the citizen" (Article A). Finally, in the field of the public interest is to "maintain international peace and security" (UN Charter Article 1.1) as well as to "contribute to the promotion and maintenance of high level of employment and real income" (Articles of Agreement of the IMF, Article 1.ii). The formulation of these policy missions has taken shape over the course of this century, or even earlier, on the basis of experience, scholarly investigation, political debate and action. There would be no consensus about the primary mission of the central bank if countries had not experienced first hyperinflation and then successful monetary management by a stability-oriented and independent central bank. Social progress and economic growth would not be on the agenda of governments without the labour movement and the Great Depression. We would not have the EU Treaties and the Charter of the UN without the tragedy of two World Wars. Economists have explored the scope for economic policy action, and the limits thereof, in the monetary, fiscal and regulatory fields. Without thirty years of academic debate about the role of monetary policy, the EMU Treaty and the Statute of the ESCB/ECB would not have been written the way they were. The subordination of economic policies to the principle of "an open market economy with free competition" would not have been explicitly inserted in the Maastricht Treaty (Article 3A) had those principles not gained recognition in the community of scholars. Central bankers (most notably in the Delors Committee) have prepared the blueprint for the single currency. International and constitutional lawyers have elaborated the legal concepts and studied the procedures to carry out the policy missions. They have built that legal monument that is the Rome/Maastricht Treaty. Citizens and politicians have discussed, promoted and implemented the whole process. Different policies carry different degrees of compulsion and effectiveness. In general, instruments are more strongly framed when they are entrusted to institutions whose area of jurisdiction coincides with that of the nation state. Strongly framed instruments, however, do not necessarily produce strong results. Tough regulation against air pollution adopted only by a small country is less effective, for that same country, than softer regulation adopted by a larger group of countries. The economic literature about externalities, or that about optimal currency areas, are seminal examples of the contribution economic research can make in this respect. In the following I shall focus on the mission of the central banker, because this is the function assigned to me. I am convinced, however, that the missions I mentioned are fundamentally complementary. Different assignments are part of an orderly division of labour. In a democratic and market-oriented environment not only citizens, but also officials, can consider the aims of the various policy bodies and charters - national and international - to which they refer as forming a consistent configuration. I regard this as a special privilege of the time and space in which I have lived so far. In the last thirty years central bankers have fought for two objectives: the recognition of the primacy of price stability for monetary policy, and the independence of the central bank. This has been the period in which the combination of political democracy and fiduciary currency made the governance of money particularly difficult in many countries. The intellectual recognition, then the political acceptance and finally the actual implementation of a monetary constitution based on price stability and central bank independence have required a long process. The academic profession has contributed to it in a powerful way, from Irving Fisher to Don Patinkin to Robert Lucas. Even those who have denied the need of having a central bank, like Milton Friedman and Friedrich A. von Hayek, have in the end contributed to clarify its role and function. No less persuasive have been the arguments of experience. In a positive sense, the economic success of the country - Germany - where the two elements had been introduced at an early stage. In a negative sense, the social evil of high and prolonged inflation suffered by many other countries, including my own. In legal and institutional terms, the result of this long fight has been engraved in the Treaty of Maastricht. The Treaty represents the strongest monetary constitution ever written, not only because of its substance, but also because the procedure to amend it is more difficult than that required for the charter of any existing central bank. Largely induced by Maastricht and EMU is also the independent status of national central banks in the European Union. We should indeed not forget that, until recently, key decisions in the field of monetary policy were still in the hands of the Treasury in such countries as the United Kingdom, France, Italy and Spain. The Maastricht process has been the catalyst for monetary reforms central bankers had advocated for years. Partly, but not exclusively, because of this process, the conditions under which the single currency has come to life differ from those prevailing in the past years. Prices have for some time now shown the highest degree of stability seen for more than thirty years. Most countries have made significant progress towards fiscal consolidation. The consensus on sound principles of budgetary and monetary management is broader and stronger, among both politicians and ordinary people, than in any other period the present generation can remember. Few dispute in an open way the now widely used expression "culture of stability". However, when in 1981 it was decided to save the last specimen of the smallpox virus in a laboratory for the sake of documentation, health had not ceased to be in danger. Similarly, none of these achievements can be considered as permanent and central bankers should primarily strive to preserve them. To this end, detecting new challenges at an early stage is essential. The question is: where do the problems come from? What are the circumstances under which the "old mission" will have to be accomplished in the coming years? What threatens our health besides smallpox? The first challenge consists in making the Eurosystem a central bank. It may seem simple, but is not. Let me start my explanation from the two key words of this proposition. is the word chosen by the ECB to indicate the "ECB+11 participating national central banks", i.e. the central bank of the euro. The Treaty has no name for this key entity, while it refers extensively to the ESCB (European System of Central Banks) formed by the ECB and the 15 European national central banks). However, as long as there are "out" countries, the ESCB in its full composition will remain a scarcely relevant entity because it neither refers to a single currency area nor has any policy competence. Instead, the word Eurosystem indicates clearly the articulated entity which is for the euro what the Federal Reserve System is for the dollar. is the institution in charge of the public interests associated with the currency. It originates fromfundamental changes in the technology of payments: the adoption of banknotes, cheques and giros, and their final disconnection from gold. These changes have shaped the two other functions that most central banks have derived from the original and . Man-made money made monetary policy possible. Commercial bank money made banking supervision necessary. These three functions have most often been entrusted to the same institution because they are inextricably linked. Just as money has the interrelated roles of means of payment, unit of account and store of value, so central banking has a that refers to the three roles of money. Operating and supervising the payment system refers to money as a means of payment; ensuring price stability refers to money as a unit of account and a store of value; pursuing the stability of banks refers to money as a means of payment and a store of value. The function remains triadic (albeit, in my view, in a less satisfactory way) even where prudential control is entrusted to a separate agency. I am referring to the special "supervision" any central bank has over banking community, necessitated by the fact that banks are the primary creators of money, providers of payment services, managers of the stock of savings and counterparties of central bank operations. In performing its triadic function the central bank exerts operational and regulatory powers, interacts with other public authorities and the financial community, entertains relations with other central banks, participates in international debates and negotiations about monetary and financial matters. In these activities it pursues and represents the public interest of a sound currency; are instrumental to that interest. From the point of view of the perceptions of people and markets such activities refer to that same public good that we call confidence. For the Eurosystem the challenge is to rise to a full central banking role as just defined. It is because of the links that bind the various functions of money. The Eurosystem would find it hard to play effectively its most delicate role - the pursuit of a stable currency or, as the German Constitution puts it, " " - if it appeared as an inexplicable exception to the classic paradigm of a central bank. The public, the markets, the international institutions and fora would not understand. But it is also , because the steps to take are multiple and complex from both a conceptual and a practical point of view. Moreover, they cannot all be taken at once. Let me briefly explain. In the articulation of any federal constitution (Bund, Land and local, to use the German terminology) the central bank undoubtedly belongs to the level of the "federation", or Bund. The fact that important activities are conducted by "local" components of the system (Landeszentralbanken, or Federal Reserve District Banks) is an feature that does not impinge upon the position of the central bank. The same happens within Monetary Union. The Eurosystem is the central bank of the euro area, even though operations are carried out - to the extent possible and appropriate - through its component parts, the NCBs. Indeed, the constitutional and the organisational profile of the institution are not in contradiction. Although a federal decentralised central bank is not a novelty, the Eurosystem is a special case. It is the central bank of an economy that has a much deeper national segmentation than any other currency area. Its components have for many generations (and until few weeks ago) performed the full range of central banking functions under their own responsibility and in a national context. They have been accountable to, and sometimes dependent on, national institutions. Public opinion has perceived, and still perceives, them as national entities. The notion of the interest they were referring to was the notion of a interest. Significant differences existed, and partly remain, in their tasks, organisations, statutes and cultures. In this situation, making the Eurosystem a central bank requires drawing the appropriate distinction between being national in the organisational sense and being euro area-wide in the definition of the public interest pursued. This is a difficult distinction to draw in conceptual terms, not only in practical terms or from the point of view of personal attitudes. In the preparatory discussions and negotiations that led to the Maastricht Treaty, central banks took the view that monetary functions are indivisible and that, contrary to the fiscal field, subsidiarity cannot apply to the monetary field. Their traditional and strongly held position has been that the public interest assigned to central bank is a whole which cannot easily be decomposed. Indeed, while there is a fairly well developed theory of fiscal federalism, there is no equivalent for the monetary field. As I said, I do think that the functions of a central bank constitute a whole that cannot be split. This does not exclude that the Eurosystem should avoid seeking more uniformity than necessary and that some diversity is a positive factor and has always been valued as an aspect of the richness of Europe. Perhaps even a limited degree of internal competition may be used as an incentive to good performance. But can the Eurosystem depart from the two historical models of the Federal Reserve System and the Bundesbank? What are, in conceptual terms, the criteria of what I just called the "appropriate distinction"? What should be the touchstone? It would be an illusion, I think, to expect or pretend to have a full and satisfactory answer solely from legal interpretation. And it would be unfortunate if the Eurosystem were to fall into the trap of the narrowly legalistic approach that paralyses international organisations. The Eurosystem is an international organisation, its model is the Articles of Agreement of the IMF. Of course, the answer will have to comply with the Treaty, which provides useful guidance. However, the system is entrusted to decision-making bodies that are composed not of lawyers, but of central bankers. They carry the primary responsibility to manage the euro and are accountable for that responsibility. They have known for years what a central bank is and how vague the wordings of central bank statutes have historically been. Their touchstone can only be, in the end, the effectiveness in the accomplishment of the basic mission embodied in the triadic paradigm of central banking functions. The second challenge comes from the high level of unemployment in Europe. Every economist, observer or policy-maker would probably agree that the most serious problem for the European economy, today and in the years to come, is high unemployment. In large parts of continental Europe the economic system just seems to have lost the ability to create new jobs. Also on the nature and causes of European unemployment there is a large degree of agreement, as there was agreement on the nature and causes of European inflation well before price stability was finally restored in the 1990s. The key words describing such agreement are factors and . There is agreement that perverse incentives, direct and indirect taxation of labour, unsustainable pension schemes, overly tight employment rules and rigidities throughout the economy are the main obstacles to the creation of new jobs. There is agreement that the typically European welfare state system should be profoundly corrected, but not suppressed. Many also think that rather than following a "Thatcherian" policy of cracking down on the trade unions, it would be preferable to work , rather than , the labour organisations, although reform entails occasional confrontations. As with inflation in the 1970s and 1980s, so unemployment in the 1990s - while being a disease - is quite diversified across European countries and regions, due to differences in both policies and economic situations. It is over or around 20 per cent in the Mezzogiorno and Sachsen-Anhalt, but below 7 per cent in Lombardy and Baden-Wurttemberg; over 18 per cent in Spain, but less than 4 in the Netherlands. Notwithstanding the intergovernmental debates at a European level and the stated intention to undertake common initiatives, the instruments of employment policy remain in hands, although only partly in the hands of governments. I regard this as appropriate because competition should not be suppressed from the labour market. Adopting the appropriate policies of structural reform has proved extremely difficult in many key European countries, including my own and this one. Other countries, such as the Netherlands and the United Kingdom have been more successful. Even the most successful experiences, however, have shown that reducing unemployment is a long and gradual process. Although some countries started labour market reforms in the early 1980s, they only reaped the benefits in the 1990s. Unemployment will thus remain with us in the years to come and I am convinced that it should be regarded as the greatest policy challenge not only by governments and labour organisations, but by the Eurosystem as well. Let me explain why. An economy in which unemployment drags above 10 per cent for years is a sick economy, just like one in which public finances or inflation are chronically destroying savings. To operate in a sick economy is always a risk for the central bank and for the successful fulfilment of its primary mission. In the case of prolonged unemployment, the risk arises both on a functional and an institutional ground. On a ground, i.e. from the point of view of the relationship between economic variables that models usually consider, a chronically weak economy is one in which expectations deteriorate, investments stagnate, consumption declines. Structural unemployment may increase the risk of a deflationary spiral because a longer expected duration of unemployment may imply that households respond more conservatively (in terms of increasing savings) in the face of a deflationary shock. Today, we see no signs of deflation. Markets and observers who pay attention to communications by the Eurosystem know that the monetary policy strategy of the euro area is symmetrical, equally attentive to inflation and deflation. Thus, they know that if that risk became reality, the Eurosystem would have to act, and would act. But we know that monetary policy is much less effective in countering deflation than it is in countering inflation. A more insidious threat, however, may arise on the ground. It comes from a chain of causation involving social attitudes, economic theory and policy, actual economic developments and institutional arrangements. Attitudes of society respond to economic situations and policies, which in turn depend on the state of development of economics. Institutions, on their part, are influenced by attitudes of society. Both the course of economic thought and the practice of policy were lastingly altered by the Great Depression. The epitome of this historical event was the Keynesian revolution. In many countries the strong consensus about the primacy of price stability and the independence of the central bank was the outcome of the prolonged inflation suffered in the 1970s and 1980s. Here in Germany, it is rooted in the experience of hyperinflation. Would such a consensus survive if high unemployment remained a chronic feature of key European economies for many more years? And how would the position of the central bank change if that consensus faltered? As central bankers primarily concerned with price stability, what can we do to cope with this challenge and to reduce the risks? My answer may seem disappointingly partial, as I do not think there is a miraculous medicine that monetary policy can provide. I would phrase it as follows. Firstly, the central banker should be aware of the danger. He should know that in the future his principal objective may not receive, from the public, governments and parliaments the same strong support which has been the outcome of the two decades of high inflation. Since unemployment is what concerns the voters and the youngsters most, it may be increasingly necessary for him to play an educational role in explaining the benefits of a stable currency to those who have not directly experienced the costs of inflation. This is very much like the case of the post-war generations in Europe which, being fortunate enough not to experience the horror of World War II, need now to be reminded about the human costs of that terrible conflict. Secondly, the central banker should avoid mistakes. It may seem obvious, but he should never forget that independence does not mean infallibility and that the likely new environment will offer no forgiveness for mistakes. A mistake would be the attempt to provide a substitute for the lack of structural policies by providing unnecessary monetary stimulus: it is not because the right medicine is neither supplied by the pharmacist nor demanded by the patient that the wrong medicine becomes effective. Another mistake would be to give the impression that the central bank has a ceiling in mind for , rather than for . On the contrary, the central bank should make it clear that rate of non-inflationary growth is welcomed and would be accommodated, the higher the better. Technically, this will not be an easy task. The analytical uncertainty surrounding estimates of potential output and its growth rate might lead the central banker to respond quite cautiously to evidence of shifts in the rate of non-inflationary growth. While such caution is certainly optimal from an inflation stabilisation point of view, it might be wrongly interpreted as a systematic deflationary bias by the public and the politicians. This is a clear case in which any progress made by scholars in refining the analytical tools of the economic profession will greatly help the central banker to achieve his goals without imposing unnecessary costs on society at large. On the whole, however, it is part of the central banker's role to make the day-by-day decisions that, in the end, constitute monetary policy. This responsibility can be neither transferred to, nor challenged by, policy makers responsible for other areas. Last week, the Eurosystem has made, for the first time in its life, an affirmative monetary policy decision by lowering its official rates. In this way, the Eurosystem has acted in line with its monetary policy strategy and made a significant contribution towards an economic environment in which the considerable growth potential of the euro area can be exploited in full. It is now the responsibility of other sectors of economic policy making to do their part by strictly adhering to the Stability and Growth Pact and implementing decisive structural reforms. The third challenge consists in accompanying and surveying the rapid changes the European financial institutions and markets are undergoing, and will continue to undergo over the coming years, partly - but not exclusively - as a consequence of the euro. It is sufficient to observe the US Federal Reserve System to understand the role the Eurosystem should play in the coming years: attention in monitoring changes in the financial system, active participation in the policy debate caused by such change, intense dialogue with both the Administration and Congress, influence exerted on opinions and decisions. To a large extent the factors of change are determined, hence independent of the euro and even not specifically European. Technology is the driving force of the transformation in banking and finance that modifies the traditional deposit loan structure of banks. Technology also reshapes dramatically the back office and the communication with customers, thus producing massive over-branching and over-staffing in traditional banks. Also the globalisation of finance comes primarily from the combination of data processing and telecommunications. Other changes are specifically . Since universal banking has historically prevailed in continental Europe, the change from an institution-based to a market-based financial system is particularly significant in this part of the world. Similarly, the development of financial conglomerates is more pronounced in Europe than in the United States or Japan. Typical of continental Europe are also the labour market rigidities that make the restructuring of banks so difficult and slow. Finally, there are changes induced by the . The removal of currency specificity as a cause of national segmentation of the financial industry is causing a convulsive shake-up of both institutions and markets. Since the beginning of this year, about ten banks ranking near the top of their respective national lists have concluded or started merger operations in France, Spain, Italy, the Netherlands, Belgium and Norway. In most European countries stock exchanges and other organised markets, which were legally and structurally organised as providers of a public service, have been transformed into profit-driven private institutions and are now in a process of rapid concentration. In the coming two or three years the number of banks will shrink, the largest banks will become much larger, few financial centres and market networks will replace the present one-country one-centre configuration. In any national system the central bank would actively monitor and even guide the course of such a transformation. It would do so along with the various agencies responsible for financial supervision and competition policy, and with an involvement of the executive power itself. Although largely determined by business decisions, these developments indeed involve the public interest in various ways. Surveying and accompanying a profound transformation of the financial industry would be a difficult task for any central bank. For the Eurosystem it will represent a daunting challenge because it will put to the test an unprecedented articulation of the policy functions that are called for. Let me briefly explain this assertion. The institutional setting of the euro area establishes a double separation between central banking and other public functions. Firstly, a separation, whereby banking supervision is now assigned to institutions that - even when they are national central banks - no longer exert independent monetary policy functions. Of this separation we have many previous examples (Germany, Japan, Sweden, now the UK, etc.). Much newer is a second, separation, whereby - with only the partial exception of competition policy - the area of jurisdiction of central banking does not coincide with the area of jurisdiction of the other public functions involved (banking supervision, regulation of the securities market, etc.). Experts, including academic people, have so far focused attention on lender-of-last-resort functions and suggested that the new setting would not be able to act effectively in a crisis. I have argued elsewhere why this criticism seems unjustified. Here, I would like to suggest that the real challenge could come, in my opinion, from tensions between the national and the euro area interest in the process of financial transformation. The process of industry transformation will inevitably involve aspects that have traditionally been considered as sensitive by public authorities: suppression of jobs, location of facilities and headquarters. Financial transformation will also produce a hardening of competition and competition will be, to a considerable extent, one between financial centers and industries, not only between banks or institutions. The propensity to defend national champions may prevail over the pursuit of efficiency. The risk for the Eurosystem to fall in the trap of an improper interplay between the EU and the national dimension of the public interest may become high. Like any central bank, the Eurosystem should be both active and neutral in the great transformation of "its" financial industry. The word "system" that is part of its own name refers, and should apply in practice, to the whole euro area. The fourth challenge consists in coping with the lack of a political union. The relationship between monetary and political union and whether the latter should be a precondition for the former has been a central issue in the European debate well before the establishment of the Delors Committee in 1988. While I do think that there is lack of political union and that this lack constitutes a serious challenge for the Eurosystem, I also think that the expression "lack of political union" is often used in an unclear way that blurs the issue. Let me thus first consider two meanings of this expression with which I do concur. First, I do not concur with the idea that there is no political union in Europe today. It is not because the and the competence of the European Union are mainly economic, that its and historical role are not political Even before the single currency, EU competence extended over virtually the whole of economic activity, from the establishment of "the free movement of goods, persons, services and capital" (the four freedoms proclaimed by Article 3 of the Treaty) to external economic relationships. To understand how very political these issues are, it should suffice to think about the place they take in the US political debate today, or have taken in the politics of our countries before the creation of the European Community. Moreover, the institutional architecture of the European Union is entirely that of a political system, not that of an international organisation based on intergovernmental co-operation: a legislative capacity that prevails over that of Member States, a judicial power, a directly elected Parliament. Second, I do not concur with the idea that Monetary Union has developed outside the political process. Quite the contrary is true. The establishment of a single currency in the European Union has been achieved because of the strong political determination of elected governments over a full decade, from June 1988 to May 1998. It is significant that during that long period continuity has not been broken by repeated changes of political majority in virtually all countries except Germany. Technocrats, i.e. central bankers, have "only" played their role, crucial as it may be. They have provided expertise, from the drafting of the blueprint to the preparatory work for the actual start of the system. And, no less important, they have loyally accepted the limits of their role and recognised that the ultimate decisions have belonged to elected politicians. This is the meaning of the two statements of July 1988 and March 1998 with which the Bundesbank has defined its position at the beginning and the end of the crucial decade. " The establishment of a single currency is a strongly event in its genesis and a profound and change in its nature. As economists and central bankers we pay limited attention to notes and coins because they are a minor and endogenous component of the money stock. For many politicians, however, Monetary Union meant little else than a common banknote. They saw, better than us, that for the people money has to do with the perception of the society to which they belong and, ultimately, with their culture. As such, money goes well beyond the economic sphere of human action. Indeed, the act whereby we accept to provide goods or services to an unknown person in exchange for pieces of paper that have no intrinsic value is perhaps the most significant and widespread testimony of the social contract that binds people. This is why coinage and money printing have always been a prerogative of the State. Yet, for two main reasons it remains true that Europe has a lack of political union. First, the European Union is still not the ultimate provider of internal and external security, the two key functions that constitute the of the modern State. Second, EU institutions still fail to comply with the key constitutional principles that constitute the heritage of western democracies: foundation of the legislative and executive functions on the popular vote, majority principle, equilibrium of powers. Why does the lack of political union constitute a challenge for the Eurosystem? I would answer as follows. In a period of less than thirty years money has abandoned both the anchors it has had since the earliest times: metal and the sovereign. It is true that central banks have struggled for years to free the printing press from the influence of the modern sovereign, as they struggled in the past to free it from the influence of private interests. It is equally true that the present status of the Eurosystem in the constellation of public powers is exceptionally favourable. However, only a superficial thinker could confuse independence with solitude and take the view that the lack of political union strengthens the position of the central bank and makes it freer to fulfil its mission. The security on which a sound currency assesses its role cannot be provided exclusively by the central bank. It derives from a number of elements that only the State or, more broadly, a political union as previously defined, can provide. When we say that a currency is a "safe haven" we refer not only to the quality and credibility of its central bank, but to the solidity of the whole social, political and economic structure to which it belongs. And historical experience shows that when that structure appears to weaken, the currency weakens, irrespective of the actions of the central bank. A strong currency requires a strong economy and a strong polity, not only a competent central bank. The central bank is, and should remain, an institution with too limited a mission to replace the lack of a political union. The problems posed by the coexistence of a single currency with a still unachieved political union will influence both practical and intellectual activity in the coming years. They will have implications for the central banker, the politician and, more generally, the citizen. For the politician the implication is that political decision to move ahead with Monetary Union in advance of political union contains an implicit commitment to work for the completion of political union. The central banker should be aware of the special difficulties and responsibilities deriving from this anomalous condition. On the one hand he will have to cope with this situation and adapt his attitudes to a composite - EU and national - institutional architecture, one that lacks the simplicity he was used to and in which the Eurosystem now represents the most advanced supranational component. On the other he should be prepared for the further evolution of that same architecture. Finally, from the citizens that we all are, it will require a deeper reflection about the multiple "social contracts" he is part of, and the loyalties they entail. I have been fortunate to operate in an environment in which no conflict has arisen between the central banking profession I have exercised for more than thirty years and the European conviction that, like many persons of my generation, I matured in my youth. Since the early '80s I have also been convinced that monetary union, i.e. a confluence of the two motives, was desirable and possible. At the same time, the challenges for the Eurosystem originate precisely from that confluence. The challenges are not solely economic in their nature, nor can their features be captured bythe functional relationships economists are most familiar with. Although partly related to economic factors, their features are in fact tied to the special institutional environment to which the Eurosystem now belongs. They derive from the tension between the completion of the union in the monetary field and the incompleteness of the overall construction. It is a tension because in that environment the notion of the public interest is no longer as simply and statically defined as it was when the Nation-State was an all-pervasive reality and the jurisdiction of the central bank coincided with its jurisdiction. Inevitably, this tension runs through the institutions of the European Union, the Eurosystem itself, and even our minds. A challenge is a call to a difficult task; it entails the two notions of necessity and difficulty. The problems I have tried to describe are a challenge not only for practitioners, but also for the academic profession, because their solutions can hardly be found in a textbook and will only be invented if the creativity of practitioners will be supplemented with that of scholars.
r990419a_ECB	euro area	1999-04-19T00:00:00	Hearing at the European Parliament's Sub-Committee on Monetary Affairs on 19 April 1999	duisenberg	1	With the opening statement by the Chairperson of the Sub-Committee, Mrs. Randzio-Plath, and the transcript of the questions and answers Once again it is my pleasure to be here at the European Parliament to have an exchange of views with your Sub-Committee. As you are aware, today is a special meeting. Three days ago the ECB released its first Annual Report, on which I shall report to you. I should like, however, to begin my statement by presenting the ECB's assessment of the current economic developments in the context of our recent monetary policy decisions. Finally, I shall summarise the most important decisions taken by the Governing Council of the ECB since our last hearing. As usual, I shall then stand ready to answer any questions that you might have. Since my last appearance before your Sub-Committee, the balance of risks of both price stability and economic activity has tilted downwards. Against the background of more subdued inflationary pressures in the euro area than expected, the Eurosystem deemed it appropriate to ease its monetary policy stance, with a view to maintaining the outlook for continued price stability. The Governing Council therefore decided at its last meeting on 8 April to reduce the interest rate for the ECB's main refinancing operations by 0.5 percentage point, setting the repo rate at 2.5%. In addition, with effect from 9 April, the interest rate on the marginal lending facility was lowered by 1 percentage point to 3.5% and the interest rate on the deposit facility by 0.5 percentage point to 1.5%. Allow me to explain in some detail the rationale of this decision. As you are aware, the ECB's monetary policy strategy focuses on the primary objective of price stability, which is defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. Furthermore, this strategy is based on a two-pillar approach, including a prominent role for money and a broadly based assessment of the outlook for price developments and the risks to price stability on the basis of financial and other economic indicators With regard to the first pillar, the acceleration in growth of monetary aggregates seen in January 1999 was partly reversed in February. In addition, there was also a moderate slowdown in the growth of credit to the private sector in February 1999. The 12-month growth rate of M3 declined from 5.6% in January to 5.2% in February. This largely reflected a moderation in the rapid growth of overnight deposits, presumably resulting from the unwinding of the influence of special factors related to the start of Stage Three of EMU and the introduction of the euro. Yet, as the February figures were somewhat higher than those observed in late 1998, the three-month moving average of annual M3 growth in the period from December 1998 to February 1999 increased to 5.1%. This was slightly higher than in the previous three-month period, but the result was still close to the reference value for M3 growth of 4 1/2 %. This fact and the consideration that the deviation may to some extent mirror the specific environment at the start of Stage Three led the Governing Council to hold the view that current monetary trends are not conveying a signal of upcoming inflationary pressures. With regard to the second pillar, let me start with financial indicators. After having risen somewhat in February 1999, in tandem with US bond yields, euro area government bond yields remained broadly unchanged during March. At the same time, the US dollar had strengthened further against the euro. In my view, the weakening of the euro against the US dollar over the past few months is mainly due to changes in the growth outlook for the euro area and the US economy. While growth forecasts for the euro area have been generally revised downwards, the US economy has shown unexpected strength and no signs of a slowdown so far. Looking at consumer prices as measured by the HICP, the rate of increase on a yearly basis remained unchanged at 0.8% between November 1998 and February 1999. However, a more detailed analysis of this stable rate of price increase reveals slightly divergent developments at the level of services and goods prices. In February, price increases for services saw a further fall, mainly due to declining prices in the telecommunications area. This development in services prices was offset by a higher increase in goods prices, which was largely accounted for by developments in two components. First, prices for unprocessed food increased more than in the preceding months and, second, the fall in energy prices decelerated further. As oil prices increased strongly from mid-February onwards, developments in energy prices in the HICP may continue to add some upward pressure on industrial goods prices in the coming months. While a higher volatility of price changes in energy or food products may be reflected in some upward movement of the overall level of price increase, these effects represent a return to earlier levels and, as such, could prove to be of a more temporary nature. More lasting effects on the outlook for future price developments came from less favourable developments in the overall economic environment. These have led to a downward revision of projections for both output growth and consumer price increases in the euro area. Looking at developments in economic activity in the euro area, the prospects for overall growth worsened towards the end of last year, mainly due to a noticeable decline in export growth. Growth of real GDP, according to figures released by Eurostat, weakened in the fourth quarter of 1998. Related to the deterioration of the external environment, weakness is particularly apparent in the manufacturing sector. Production in this sector declined in the last two months of 1998 and industrial confidence continued to deteriorate in the first months of this year, largely reflecting a worsening in the assessment of export order books. As regards the outlook for the external environment, the evolution of the world economy seems to have improved slightly, but not yet enough to expect a significant strengthening of the external performance of the euro area. The positive signs relate to the continuously strong growth of the US economy. Moreover, a mild improvement in the external environment is suggested by the gradual recovery in some Asian countries and indications of a stabilisation in Latin American countries. On the other hand, there are no definite signs as yet of a turnaround in the Japanese economy. In contrast to developments in the more export-oriented sectors of the economy, the domestic sectors witnessed broadly sustained growth up to the end of last year, most noticeably reflected in the ongoing improvement in consumer confidence. This, in turn, is likely to have been supported by improved labour market prospects for the most part of 1998. However, most recent data for the fourth quarter of last year point to a further slowdown in employment growth in the manufacturing sector and a deceleration in the pace of net job creation for the euro area economy as a whole. Likewise, the rate of decline in unemployment has continued to slow down at the beginning of this year. The unemployment rate, according to data released by Eurostat, stood at 10.5% in February. This is the same level as in January and only marginally lower than the rate prevailing during the last months of 1998. Finally, the latest data suggest that consumer confidence is no longer improving. After reaching a record high level at the beginning of this year, consumer confidence did not increase further in February and, according to preliminary results from the European Commission, it weakened slightly in March, the first time since August 1998. In sum, weighing all the relevant indicators and taking a forward-looking and medium-term perspective, the Governing Council considered it appropriate to lower the interest rates on its monetary policy instruments. A main consideration underlying this decision was that monetary growth slightly above the reference value is at the moment not seen as a risk to future price stability. At the same time, the current economic environment puts downward pressure on inflation. The risk that HICP increases could exceed 2% for an extended period of time is considered to be small at this juncture. With its recent decisions, the Eurosystem underscored its commitment to a stability-oriented monetary policy course, which is required for creating economic conditions that enable a full use of the growth potential of the euro area. In addition, the significant cut in ECB interest rates should help to reduce uncertainty about future economic developments and thereby restore confidence. Having said that, let me make clear our position on the question of how other policy areas could contribute to further reducing uncertainty and restoring confidence. In particular with a view to continued reduction in unemployment, monetary policy needs to be accompanied by structural measures to improve the functioning of labour and product markets. For example, we need to make sure that welfare and tax systems do not make work financially unattractive for low-paid workers. This needs to be supported by measures to develop the skills and experience of the long-term unemployed workers to enable them to participate fully in the labour market. It is also crucial that the social partners take account of the need to reduce unemployment when negotiating pay agreements. The efficiency of such measures could be increased if they were accompanied by further budgetary consolidation focused on reducing spending rather than increasing the tax burden. They will also be supported by product market reforms, such as making it easier for people to start and run businesses and thus create new jobs. It is important to note that the euro area countries at a more advanced stage in the structural reform process have been very successful in reducing unemployment. This points to the appropriateness of such an approach and suggests that these are examples which could be followed by other countries. Let me add at this point that I fully share the concerns about the current level of unemployment prevailing in the euro area. I also agree with the assessment that the maintenance of social stability is an important objective, which plays a fundamental role in Europe's tradition and cohesion. It is my firm belief that the best contribution the ECB can make to support employment and social stability consists in fulfilling its primary objective defined by the Treaty, the maintenance of price stability. Indeed, the pursuit of a stability-oriented monetary policy yields important social benefits. Most importantly, it contributes to fostering investment and, thereby, employment growth. Moreover, one must not neglect the fact that households at the lower end of the income spectrum are particularly vulnerable to inflation, since they are likely to suffer the most from a loss of value of their income and savings. Therefore, price stability and social stability are not conflicting, but supplementary and mutually reinforcing policy objectives. As economic policy-makers, we should keep this in mind when we formulate strategies to promote employment and social stability. I should now like to comment on the ECB's first Annual Report, which was published on 16 April 1999 and addressed to the European Parliament, the Council, the Commission and the European Council. As required by the EC Treaty, the Report gives a presentation of the activities of the ESCB and of the monetary policy of both the previous and current year. In particular, the Report describes the macroeconomic environment that prevailed in 1998 and the monetary policy decisions taken in the EU. It recalls the major decisions of the Eurosystem in the framework of the preparatory work for Stage Three that paved the way for the successful launch of the euro. The Report also gives an account of the way in which the other tasks conferred upon the ECB by the EC Treaty have been carried out. Finally, the Report presents the annual accounts of the former EMI and the ECB, which have been approved by independent external auditors. If you have any questions related to particular issues dealt with in the Annual Report, I shall be glad to reply during the question and answer session of our meeting. Let me finally highlight a few aspects concerning the technical implementation of the third stage of EMU in some detail. First, the functioning of cross-border payment systems in Europe remains one of the most important technical pillars of EMU. Therefore, the development of the large-value payment system TARGET was one of the major projects in the run-up to EMU. It is my pleasure to inform you that TARGET is functioning well and stands as Europe's most important payment system in terms of the value of transactions processed. According to the latest available statistics, more than 3.6 million payment instructions were processed through TARGET in March 1999, amounting to a total value of nearly EUR 20 trillion, of which 40% was cross-border activity. Several transitional measures related to the standing facilities and TARGET have been terminated since my last appearance before your Sub-Committee. As envisaged, the initial narrowing of the interest rate corridor set by the standing facilities was not extended beyond 21 January 1999. On 4 February, the Governing Council of the ECB agreed to harmonise further the access to the standing facilities and the closing of TARGET. These decisions reflect the rapid progress in euro area money market integration. I should now like to turn to the issue of the Year 2000. As you might be aware, the Governing Council of the ECB has decided to close TARGET on 31 December 1999. This decision, which accommodates frequently expressed requests by the European financial industry, was taken in order to facilitate a smooth transition of IT systems to the Year 2000 and to avoid possible disruptions in payment systems. This initiative was accompanied by a proposal by the ECB to the President of the ECOFIN to declare 31 December 1999 a non-business day throughout the European Union, which is also widely supported by market participants. Such a decision would be the most clear-cut and transparent way to facilitate the completion of end-of-year procedures and the full backup of all systems before midnight on that day. Let me now turn to another topic, namely the development of euro banknotes and the preparation for the cash changeover in the euro area. As you might recall, the designs and technical specifications of the euro banknotes were already agreed by the EMI Council in February 1998. In February 1999, the evaluation of the pilot series of several million banknotes printed under normal operating conditions was completed successfully. National central banks of the Eurosystem are free to decide where their national supply of euro banknotes will be printed. A zero-production run was therefore necessary to ensure that all euro banknotes will feature the same high technical standards throughout the euro area. In this context, a major concern of the ECB is the prevention of the counterfeiting of euro banknotes. To this end, the euro banknotes will be provided with the most up-to-date standard of security features. These security features should effectively impede falsification of euro banknotes, while, at the same time, being easily identifiable by the general public and banknote-accepting machines. The general public will be informed of the design and the security features of the euro banknotes in the framework of a broad information campaign that will be conducted by the ECB in co-operation with the European Commission and the Member States. The Governing Council of the ECB has also agreed on the location of the analysis centre for counterfeit euro banknotes on the ECB's premises. The centre, which will take up its operational functions by 1 January 2002, will be responsible for the technical analysis and classification of new types of printed counterfeits. The centre's database will be available to the national central banks and the respective law enforcement authorities of Member States and at the European level. Finally, I should like to address briefly another important issue related to the conversion of banknotes and coins of euro area Member States. It has been observed that some financial institutions and other operators (e.g. bureaux de change, travel agencies, etc.) do not clearly differentiate between the conversion rate and the banking fees applied to such transactions, thereby giving rise to confusion with regard to the proper use of the euro conversion rates. In addition, banking charges for the conversion of banknotes and coins of euro area Member States differ widely throughout the euro area. The members of the Governing Council of the ECB are concerned about such practices. However, it is felt that enhanced transparency and competition are the appropriate means of tackling and, ultimately, to solving these issues. I understand that the European Commission is intending to publish a report on this question around the end of this month. I am now at your disposal to answer any questions that you might have. I am very pleased to welcome Mr Duisenberg to our second monetary dialogue of the year. We in the European Parliament have followed the monthly reports from the European Central Bank with great interest. We have read them, we have studied them, and I am sure we feel that they are of very high quality, as is the annual report of the ECB. This is now also available, and was presented to the public last Friday. I think this indicates the desire of the ECB to be fully open and above board about its decisions and the background to them. We in this sub-committee have always emphasized that the transparency of monetary decision-making is the other side of the coin of the ECB's autonomy and independence. We need the highest possible degree of transparency. The European Parliament was a little astonished to find that we are only really mentioned on page 91 of the Annual Report, where you talk about cooperation with other institutions. This is the first mention there is of monetary dialogue between the European Parliament and the ECB. Now that, surely, is something of a slightly different nature to the ECB's role as observer in the International Monetary Fund or in other bodies. So, I hope we can talk about that today, but we, the European Parliament, will go on attaching great importance to the transparency of monetary decision-making; we will go on pressing for that and we shall also press for publication, not just of the reasons for decisions taken, but also to see publication of the opposing arguments. We look forward with great interest to what you have to say, and we are interested, of course, in the background to decisions taken in recent times. You won't be surprised to hear that here in the European Parliament, the cut in interest rates was something that we very much welcomed. Looking at the political situation, you pointed out that what is important is the maintenance of internal price stability; we have to keep the value of the euro stable within the euro-zone. Many people, many of our citizens who talk to us as Members, feel that at a time when there is a crisis in Kosovo, it is worrying to find that the euro is declining in value against other world currencies. The yen and the dollar seem to be stable, but the euro is not so stable against those other currencies. I hope you can comment on those aspects in your remarks, because this is a problem that is of concern to many people in society. We will certainly have many questions to put to you after your statement. Once again, welcome, and I give the floor to you for your statement. Can I welcome Mr Duisenberg on behalf of the Socialist group and thank him for a very wide-ranging and comprehensive report on monetary developments and for presenting some comments on the Annual Report. Can I start by welcoming the recent interest rate reduction, but can I ask Mr Duisenberg, given the absence of any inflationary pressure earlier in the year, I put it to Mr Duisenberg that the ECB could have pursued a more aggressive monetary policy of lower interest rates at that time in order to offset the output effect of the negative external shock. If the Governing Council feels that it is possible to take action now, why did it not feel that this was possible in February? What changes, if any, have there been in the data to justify this change of stance? Indeed from your own comments, Mr Duisenberg, you mention that M3 is above the reference value of 4 1/2 %, in fact 12 1/2 % above that reference point in terms of the total amount as a percentage of 4 1/2 . What changes in the current economic environment have taken place since February? As I said already in my introductory statement, the changes that have taken place in the last few months are, generally speaking, a weakening of the outlook for real economic developments caused by the external shock, as you mentioned. That is mainly the deteriorating demand for our export products. Indications that the inflationary pressures in line with that have come down is a change which was observed by us in many indicators, based also on forecasts and enquiries about the expected rate of inflation. That figure has come down over the last couple of months on average for the euro area. Three months ago we thought, as I believe I have reported to you, that expected inflation for 1999 as a whole would be in the order of 1 1/2 %. We now think, looking at the Commission's forecasts, that it will be in the order of I believe 1.1%. So these are changes which induced the Governing Council to take the decisions they took. These changes were not apparent much before 8 April, the day we took the decision. You said recently that you cut the interest rate to support the general economic policies of the Community. Were there any other reasons behind your decision? Do you fear deflationary pressures, or is it simply that the ECB at the moment perceives that political pressure on it has been reduced through recent political developments? The answer to both questions is no. To the last question in particular and as far as the first part of your question is concerned, we do not fear deflation. As I indicated, there are risks both on the upside and the downside. There is an increase in energy prices which will work its way through into the consumer price level, but we do expect that to be of a temporary nature. There have been increases in indirect taxation in parts of the euro area. They will work their way through in an upward direction for the price level. We also, as normal, expect those influences to be of only a temporary nature. But the major risk is that we see the down-turn in expectations regarding real economic developments. So you might also say that the weighing of all these risks with regard to both pillars of our monetary strategy means that it is possible for us to pay due attention to the secondary objective of monetary policy of the ECB, namely to support without risk to price stability, the general economic policies in the Community. President, you said that there has been a drop in consumer confidence in February and I have read very recently that at the last informal ECOFIN meeting in Dresden, Mr Strauss-Kahn raised the issue of changing the stability pact. It is not a surprise that you debate these if you consider the budgetary figures in France and Germany. However, it is surprising if you look at the average throughout Europe and this is where my question arises. You were there in Dresden, how would you assess this initiative and what were your comments on that initiative? I can be very brief Chairman in answering this question; the French Minister of Finance did not make any proposal to change the stability pact. He did not, so I do not have to react to it either. Well very often in the press we receive hints, but they are misleading hints. To enlarge a little on my answer. He did introduce certain proposals on intensifying the economic policy dialogue, including the dialogue with the ECB in the context of the Euro-11 Group. These proposals have been sent on by the Ministers to the Economic and Finance Committee to be further studied and advised upon by that Committee before being discussed by the ECOFIN Council itself. Mr Duisenberg, I am very satisfied but also puzzled by the recent interest rate cut. I am puzzled even more because of your latest answer to Mr Hendrick, because in the January monthly report there was an extensive section on your monetary policy strategy and in that you explained that the secondary goal of monetary policy, namely the supporting of economic policy of the Member States, was reduced to the mere result of the primary goal, price stability. Now you have made an interest rate cut apparently to support the economic policy, which I welcome, but now I want to know first if you plan to revise your monetary policy strategy? Apparently there is a long- standing goal to support the economic policy and second, by what transmission mechanism do you expect this interest rate cut to support the economic policy and with what delays? We by no means intend to change our strategy and this latest move is not a witness thereof. I believe that the recent decisions are fully in line with the strategy as they are based on the strategy. As I fully explained in my introductory statement, they are based on an assessment of the events with regard to the two main pillars, both the money supply developments and the broadly-based assessment of a range of indicators having to do with the outlook for price stability. As I believe I explained adequately, changes in these, as I said to Mr Hendrick, clarify and explain the decision to reduce interest rates. So there is no change in the strategy whatsoever and also it remains, I want to emphasise this because the question has also been asked, based on a forward-looking and medium-term oriented outlook. The question has been asked, not here but elsewhere, has the ECB suddenly changed into an institution which has an activist, cyclically determined monetary policy outlook? The answer is and remains no. Regarding the second part of the question on the transmission mechanism. The main thing we hope to achieve is to restore and inspire confidence, but of course that is very hard to measure in itself. Even a significant interest rate cut of the size we have undertaken, if you put that in the various models that are available across "Euroland" and try to measure the impact on real output and investment, then the impact of a change in short-term interest rates is very limited indeed. How it works its way through in the markets might also have an impact on long-term interest rates with some delay. That is a matter which could inspire somewhat more confidence in the positive influence that this interest rate move might have. But in itself, I am not able to put a figure on what precisely the impact on growth of output and employment and investment and consumption will be of this cut in interest rates, but as for the sign we are pretty sure that it will be a plus. Yes, I understand that you are perhaps as puzzled as I am. Let me explain why I am puzzled. It is because you tried to convince us before that real interest rates are so low already that it would not work to cut them and second, that if it would work it would work only in the long-term. Well now, I understand, you hope that there will be at least confidence effects in it. Is that a correct interpretation? I don't believe it will only work in the long-term. The lags between changes in monetary instruments and their effect on the real sector of the economy normally vary between 1-2 years. But our database is also still too recent to be able to determine or measure what the likely lag is to be, but that it will be a matter of between 1-2 years seems pretty plausible. In addition to that, by implication, I am saying that we are still awaiting the effects of the significant decline in interest rates which has taken place across the euro area in the course of 1998, and particularly in the second half of 1998. The positive influence of that will also still have to materialise. I have a few questions I want to put to the President, along the same lines as the previous questions. First I would like to know about the reduction in interest rates. If I have understood your arguments on the interest rate and growth, that seems to be quite clear, but I want to know if the ECB could invoke some sort of adapted or modified Taylor Rule? I don't know exactly how you would call it but it seems that monetary policy is now based on a strategy on the one hand of inflation targeting, and the gap between potential and real growth on the other. I was wondering what your reaction to that interpretation, that vision, might be. Is that really your basic strategy? I would say that is a false, a wrong, interpretation. The output gap, of course, is one of the broad range of indicators we look at, to the extent that we can measure it, but it is only one of the indicators. It would be too limited to say that our monetary strategy would be based on two indicators only as you suggest, that is inflation and the output gap. We have a much broader assessment of indicators as a basis for our decisions, but that they are important I do not deny for one minute. On the reference aggregates, I know you talked about those already, but you said that there is no problem with those aggregates being above the 4 1/2 % reference level. I was wondering if that might undermine its validity? The impact of those aggregates on economic performance is not really that clear. If you look at aggregates in M1 and M2 you see, particularly in M1, it is above 9%, so that would seem to indicate that we are already in the middle of a very expansionist monetary policy and therefore we could fear in a couple of years a renewal of inflation. Could you talk a little bit about that question, which basically counters what you just said before, saying that we didn't have to worry so much about that. I think you can look at the other side of the coin and say we have to have a long-term vision and perhaps there actually is a fear of inflation there. I would say that it precisely justifies that we decided to base part of our strategy on what we call a reference value, and explicitly not on a target for monetary growth and explicitly not on a very narrow definition of the monetary aggregate. We have chosen the broad definition of M3 encompassing a whole range of monetary assets and we have chosen the words, it has taken us months to find the words I may tell you, the words "reference value". Something we look at in the first place and then make a judgement on the actual figure for the monetary aggregate, the difference between it and the reference value chosen and to what extent we should interpret that as giving rise to fears for inflation or deflation. Now on the actual figures you mentioned, I already myself mentioned the figure for credit to the private sector which had been growing substantially over a number of months by a figure of close to 10% or even more than 10%. That figure is still very substantial but it is coming down and the same is true, as I said, for the monetary aggregate itself if you look at monthly figures. In January, as I said it was 5.6%, in February it was 5.2%. The three-month average figures which, of course, reflect the figures for December and the high figure of January, and then the slightly lower figure for February, stood at 5.1%. It is then a matter of, admittedly subjective, judgement by all members of the Governing Council whether these figures in themselves would add to the fear that inflation might be on the rise again. Well, it is our collective judgement that it does not. Could I add my question to that. I don't believe either that the ECB has actually changed its paradigms. Nonetheless there is still the interpretation of Article 105. We still think that interpretation is very vague. Do you think there are some other reasons behind the decision to reduce the interest rate, apart from weak economic growth? Could another reason be that you wanted to avoid getting into the same situation as the Bank of Japan where there would be deflationary pressures on the horizon, and this on the basis of the reasons related to your own forecast of growth rates? I would say not. On the contrary, the experience in Japan was almost more of an incentive that we should not fall into that trap, namely of lowering interest rates to a level close to zero, as has been undertaken in Japan, with no noticeable effect on the real economy, so far at least. It seems that monetary policy in the Japanese situation does no longer work, does not function, does not do the trick, of helping the economy to revive again. That would be more of an argument against further lowering interest rates rather than in favour of it. Yes, well we have at the moment an economic situation which is probably better than that in Japan. This was perhaps the right time, but also could I ask whether inside the Governing Council there might have been voices raised warning against cuts in interest rates and, if so, could you tell us what arguments were advanced by those who might have held those views? Of course, we all had arguments for and against, and they have been extensively exchanged in an assessment and coming to a judgement about what would be required in the present situation. I have already mentioned the argument which seemed to argue against a lowering of interest rates, that is the expectation that inflation may, but we think temporarily, increase somewhat. That in itself is an argument against the lowering of interest rates, but if you add to that that you expect it to be of a temporary nature only and limited in size, you come to the judgement that it is very unlikely that inflation will even approach the critical figure of 2%. But there were counter arguments also and so at the end of the exchange of views of all the arguments, pro and con, led to the consensus that the proposal which I made to the Council to lower interest rates by 50 basis points, was accepted without even taking a vote. Despite all that was said here, I think the Bank is doing pretty well as far as its brief is concerned. The stability of prices seems to be assured and in the monetary area, everything is, to my mind at least, going alright. I have a worry though about the real economy and the effects that this will have subsequently on monetary policy. If the US demand stops being as strong as it is, and one cannot expect this thing to go on forever, or if South-East Asia switches around and starts at a much lower price level producing and importing into Europe, I suspect that we shall get into a position where a bit of panic will set into the ECOFIN Council and the governments generally of "Euroland". You cannot have an isolated successful economic policy. It has to be in the context of a real economy that more or less moves well and the data you gave us do not show this. They show that we are stagnant at best and possibly going down a bit, as far as I see them at least. With unemployment figures, we say that there have been some elements that show that unemployment is being successfully fought, but we all know that if you reduce on a full time basis the 8-hour day in the Netherlands, we get to 25% unemployment really. This as a temporary measure is alright, but structurally it doesn't seem to work. Don't you think it's time to start interfering a bit - I know it's beyond your brief, but maybe you should do it - underlining the fact that the structural efforts do not seem to work in Europe, they don't seem to work at all and to avoid or to pre-empt pressure on you subsequently, to change your monetary policy in ways to counteract this in-built recession possibility? Well first of all, we all hope, of course, for the US economy. It seems to me that even in the US they are raising doubts about whether they understand their own economy and why it is doing so well. But the general expectation is that there must come a moment when it will slow down. Now when that happens we all hope, we and the authorities across the Atlantic as well, that we can achieve, or they can achieve, what they call a soft-landing and not a panic or an abrupt cessation of the growth process which could indeed lead to some panic reactions, as you said, from the public and with the Council of Ministers. I can assure you it will not lead to panic in the Governing Council of the ECB. On the second remark, we do expect growth to be somewhat slower than we had earlier expected, although we do not have a precise forecast. But if you look at the latest forecasts, the Spring forecasts of the European Commission, they have scaled down their forecast from 2.6 to 2.2%. We have no reason to disagree fundamentally with those expectations. We still think they might be somewhat on the optimistic side, even the 2.2%. But if it's something in the order of 2%, I would not call that stagnancy. Thirdly, and I hope this answers your main question - do we not see that the structural reforms do not work - I would phrase the question differently. I would rephrase the question as, is it not true that structural reforms have not yet been applied adequately? I must confess that, mainly in the larger countries, there is a great deal of absence of actually taking measures of structural reform which are badly needed. It differs from country to country and I will not comment on individual countries, but generally speaking in the larger countries not even a start has been made to adequately tackle the structural causes of structural unemployment. Given what you said - which, if you do not follow the half empty, half full glass, more or less agrees with what I am worried about - should you not prepare to pre-empt the pressure being put on you in order to switch your, successful in my mind, monetary policy into something that temporarily will alleviate things? Should you not come out a bit stronger now? I do not know whether I could come out stronger than I have come out already. Effectively in announcing our measures on 8 April, I pointed to the need over and over again to start taking measures of a structural nature and reforming the structure of our economies. I have added to that that this interest rate removes, at least may I phrase it like this, any alibi that politicians might have thought they had in not taking structural measures. Governor, I was really put at ease to hear from you that the General Council of the ECB is not subject to the panic and other weaknesses of us lesser mortals. I find that really reassuring. Now, may I return, however, to your two pillar monetary strategy because some of us have certain doubts about a two pillar stability oriented monetary strategy. You said concerning the stock of money that you look at a reference value. Presumably you don't look at the reference value just to admire the beauty of it but you look at it to do something about it and that something is that if it deviates from what should be the proper course of it, you do something to bring it back to its proper course. But one wonders what you can do? In the short run you can control the short-term interest rate, that is granted, but in the short run many demand functions are notoriously unstable, so you cannot, in fact, control them in the short run. In the medium-run they are more stable, but in the medium-run you cannot control long-term interest rates. So in the short-term you have the instrument but the beast is not controllable, in the medium-term where the beast is controllable you do not have the instrument. So in both cases it seems that there is no chance of controlling the supply of money and, indeed, the experience of the Bundesbank shows that this has not been achieved. So why have these pillars and why not limit yourself from the broadly based assessment of the outlook for future price developments which seems to me to be a lot of words for an inflation target? Well it is a lot of words, but it explicitly is not an inflation target. That we do not have and we do believe that monetary policy with its instruments if not control can at least to a large extent manipulate the movements in money supply in a broad sense. This shoud be coupled with the strong belief that ultimately, in the long-run, inflation is a monetary phenomenon and that inflation is in the longer-run determined by the developments in monetary aggregates. Therefore, it seems to us to be indicative that the development of the money supply should play an important role in the assessment of the absence or presence of inflationary pressures. Moreover, we said it can influence or manipulate the short-term interest rates to a very high extent. Really we tried to steer for example the overnight lending rate to close to the repo-rate after the last lowering of interest rates on 8 April, it took us about 4-5 days I think before we had successfully steered that overnight rate to close to the repo- rate, where it has remained ever since. How many central banks adopt the control of the supply of money as a means of handling their monetary policy? It has been put to us by academic advisers that the only ones have been the Bundesbank and the ECB. Well I don't believe that, but then I would also say that for central banks which explicitly have other targets, for example the Bank of England, which has an inflation target, this does not mean that the Bank of England or its Monetary Policy Committee would not look at developments in the monetary aggregates as well, as one of the indicators that might have some impact on their ultimate target. They do not neglect it but they don't have to have it as a target. We also do not have it as a target, we have it as a reference value, and as I already said, it took us months to find the words. I was interested in what the President of the ECB had to say in his analysis of the reasons for the weakness of the euro against the US dollar which he identified as the strength of the US economy. Could I ask him whether he can shed any light on two things which he referred to in his introductory remarks? The first is the weakness of the European Union economy, although of course I have taken due note of what he said about the need for an improved functioning of the labour market. Secondly, why does he think that consumer confidence is weaker here in the European Union than it is in the US? If you'll permit me to ask my supplementary question at this stage rather than later, he dwelt for some time on the reasons why the dollar is strong against the euro. How does he explain the fact that the pound sterling, a traditionally weak currency, is currently strong against the euro? First of all, I am not aware that consumer confidence in Europe is weaker than in the US. I don't know how you would compare it. What I have said is that consumer confidence is almost surprisingly high in Europe and it has kept increasing to historically high levels, up until the last month. Then for the first time, while still being very high, it started to be a little less high than before. That's my point. Why do you think this? I don't know. It cannot yet have to do with the unrest around the tragedy in Kosovo, because we don't have the figures mentioned since that tragedy erupted, but it had to come down some time. We had the strange phenomenon for many, many months that industrial confidence was weakening and getting weaker and weaker over a period of almost eight months, and that, nevertheless, consumer confidence kept on rising and remained very high. That was a puzzling development in itself already and we always thought something has got to give, either industrial confidence will go up or consumer confidence will go down, but they have to get in line at some point with each other again. May I make a general remark about the rate of the euro, vis-a-vis the dollar? Some of my colleagues almost cannot help laughing when already after three weeks it was reported that the euro had reached historically low levels. Yet still the comparison that one makes normally is, naturally maybe, to compare the current rate of the euro with the one on 4 January when we started and when it was 1.16. It has not stayed there very long and what it actually has done is that it has, over a rather short period of time, reverted to its previous level. If you calculate what we call the synthetic euro, the euro "before it existed", the level where it had stood over the period of July 1997 until September 1998, that was a level of 1.08-1.10. Since then it has declined somewhat further. We do believe also today that it has to do with the increased uncertainty and anxiety over the crisis in Kosovo and that this has had a depressing impact on the rate of the euro. How to explain then that sterling has remained so strong? I don't have the full explanation, but one explanation I could point to is that interest rates in "Euroland" are significantly lower than interest rates in the UK, and that's a purely economic argument. It also explains of course, in part, the relative strength of the US dollar, vis-a-vis the euro, as interest rates are also significantly higher in the US than in Europe. Can I just say that while the Bank has certainly demonstrated that it is independent, or that its fortunes are independent of politicians, it would seem that politicians' fortunes are not independent of the activities of the Bank and the Lafontaine factor that we've all been talking about has been very interesting to watch in the last couple of months. Could I ask a question following on from what Mr Christodoulou had to ask regarding structural change. You do mention in your speech at some length the need for structural reforms within the economy of the European Union, and I just wonder if you could tell us how much time the financial markets are going to give the European Union economy to bring about these sort of structural reforms. You have said this repeatedly when you have come before us that we need structural reform, it's in almost every speech that you give. At what stage will confidence in the perceptions of the financial markets reach the point where they will feel that there is not the political will in Europe to bring about these structural changes, and what impact is that going to have in terms of the way in which you view future developments in monetary policy? I don't know the answer as to how much time the financial markets will give. But financial markets are, of course, like governors of central banks, also making their judgements about the success or lack of success of policies in certain countries, and that has an impact also on the exchange rate, the outcome of the judgement that markets make. But then one has to realise that devising and executing structural reforms in a wide variety of areas in itself is a very long-term process. It has taken the few successful countries, or relatively successful countries, which I mentioned in my introduction, it has taken them more than a decade to enact the structural reforms in parts of the market, and then the measures needed are not global, equal measures for every country. In every country, the problems - even though they are mainly of a structural nature - are different. So measures also will have to differentiate, vis-a-vis the markets they address, and vis-a-vis the intensity with which measures have to be applied or executed. That by itself is, at the same time, a long drawn-out process, and it is long overdue. On this question of confidence that we have talked about this afternoon, there is enormous bullishness in the US at the moment. But it would seem in the last few days that a large part of that is based upon the information technology industry and I just wonder, again following on from Mr Christodoulou's question, how sensitive you feel the US economy is and how delicately is the US economy based upon perceptions rather than based upon the actual strength of the real economy? In other words is this a large balloon that's inflated with hot air but there's nothing inside it? What would be the effect on Europe and on your monetary policy if we see major changes or fluctuations in the US stock market? I would not want to speculate about a balloon bursting, as we don't see it yet and as the American authorities don't see it yet as a balloon. Also the fact that it is to a very large extent based on the developments in the information technology sector, I think Europe should take that as an example rather than as a warning, because I do believe, although it is not my business, but I do believe that the roots of growth in modern, ripe economies, will increasingly lie in the area of services rather than producing goods, and services including telecommunication services, including the development of information technology. Some countries in Europe are already developing more and more in that direction. That is the case in the Netherlands, it is the case also in France which is a country which is doing remarkably better than Germany for example at the moment, where the traditional emphasis is still very much on the manufacturing sector. Well as to the well-foundedness of monetary strategy, the one that you are pursuing, I am not worried about that, so I share your analysis and your diagnosis for the need for structural measures to do something about unemployment. Having said that and given the very complex and subtle nature of all the reference values that you use, would you not be better off dumping this rather summary theory, the two pillar strategy, which I think misleads people? Surely it would be better to explain quite simply that it is complex and that your strategy tries to take account of everything, rather than making people believe that having two pillars is enough, and will cover all aspects of the situation. Now if you analyse it on the basis of the two pillars, there would be no reason to lower interest rates, so I entirely agree with you, but having said that I feel you would probably be better advised to explain the complexity of the situation. I know it's nice to simplify, but perhaps in these matters it's better to go to the complexities because it is important. Furthermore, according to the press, you said that the recent cuts in interest rates would be the last for a long time. Is it really prudent to make a statement of that kind if you did so? First, we thought that defining the two pillars - and saying what precisely these pillars are, even though it's true that the second pillar includes the broadly-based assessment of a wide-range of indicators - would increase the transparency of our decision-making process if we categorised the various ranges of indicators which we look at and on which we base our judgement. But we have also always added that we will in no way act in a mechanistic way and as a sort of automatism to changes in the indicators. There will have to be judgement. If we were to act in a mechanistic way we would not need to be there even, you would not need a decision-making body. Rather, you could put everything in the computer and that would come up with the decision you would take, so we are not inclined to dump our two categories for the reasons I mentioned. I did not say that interest rates will never be lowered again. I did want to create the impression that this unexpectedly large move, in part, was as large as it was to create the impression in the markets that for the time being this would be it, and I cannot define the length of "for the time being". I expect it to be longer than "for the foreseeable future". You are preaching to the converted. I am perfectly convinced that what you say is true, but I find that amongst experts, some very reputed experts, some that we in the Parliament use too, there is some confusion. Now I have objected to the fact that your strategy is rather simplified. Our experts, highly respected experts, have somewhat negative judgements, and it seems perhaps that there is a need at least to improve communications. Well, I do not know how further to improve our communication. Admittedly any word chosen may give rise to misinterpretations and we try to avoid that as much as possible, but we also try to be as open as possible and as quickly as possible. On the day that we take the decision, I give a press conference and I give an introductory statement at that press conference which explains in detail the rationale behind the decisions that have been taken. The introductory statement is put on the Internet immediately, and after the press conference the transcript of the question and answer sessions is also added to it on the Internet. It is as open and as transparent as possible. Last week, if I might take it as an anecdote, a Member of the British Parliament said to me that he was a close follower of the monthly bulletin, of the transcripts of the press conferences and of the question and answer sessions during the press conferences, on the Internet and that he had come to the conclusion that the transparency and openness of the ECB compares rather favourably with that of the Monetary Policy Committee of the Bank of England. Governor, you said to Mr Metten earlier that you were not quite clear about the transmission mechanisms from this present cut in interest rates to the real economy partly because the database was not yet complete. Isn't this a general problem that you've got with making policy at the moment? Whether it comes to measuring money aggregates or inflation expectations or all the rest, the problem is that there isn't enough information about the way in which the euro-zone economy works as a whole and so in a sense you are flying blind. Now this might be thought to be a problem but I would suggest picking up what Mr Christodoulou has been saying that it might actually be an opportunity. Quite clearly it would very welcome if having got over the problems with Mr Lafontaine you could have a much more aggressive discussion with ECOFIN about pushing through structural reforms. It seems to me that the uncertainty that governs your measurement of monetary policy at the moment allows you to at least to argue that you could take a few risks because no-one knows exactly what is happening. All we can with certainty is that inflation risks are very low indeed. The balance of opportunity is the other way and, therefore, you should make a virtue out of what is widely perceived to be a problem and have a more aggressive discussion with ECOFIN on that basis. We have a problem. I do not deny that our database is still very young and so we have to rely very much in our judgement over past developments on national data which are not yet available in a fully harmonised form, but that does not mean we have nothing. We have quite a lot of information. If you look at our monthly bulletin I think a host of information is being made available there and the problem by definition is improving by the day as more data become available and our series become longer. As to the measure of aggressiveness of the discussion in which I address the ECOFIN, I would certainly say that last Friday and Saturday the measure of aggressiveness with which I have expressed myself vis-a-vis the euro-11 group and the ECOFIN Council was certainly not less than the aggressive tone I have used in your midst today. Those countries that have done some of the structural reforms that is widely agreed should be a feature of the whole of euro-zone economy have tended to do those changes at a time when they have had a loosening monetary policy or indeed quite a low exchange rate. That has certainly been the experience of the United Kingdom and it does seem to me that there is a trade off here that you could offer a more generous interest rate regime perhaps or a more accommodating monetary stance if you were to get very clear undertakings from member governments that they were going to address structural problems. We all agree that getting those structural reforms through does require a short term period of accommodation, or could do so. Could you comment on that? First of all when I talk about countries that have performed structural reforms successfully, I am restricting myself to the euro-area countries only. So I am not talking about the United Kingdom. Secondly, by no means can one maintain that the monetary policy stance of the ECB is not accommodating already. I mean interest rates are at historically low levels both in nominal and in real terms. Monetary aggregates are growing in excess at least of the reference value we defined - or you might say, you have not defined your reference value well enough, that's another matter - but the growth of monetary aggregates and the prevailing level of interest rates throughout this first period of the euro-area both indicate that the monetary policy stance is accommodative, and since 8 April it has become even more accommodative. But it is not up to us to take the structural measures that we are talking about. That is up to other authorities and social partners. I have explicitly mentioned them also in my introductory statement and they will differ from country to country. And the countries that have been successful in the euro-area, I have mentioned the Netherlands, I have mentioned Ireland, I can mention Portugal. In general the smaller countries have been successful, but the bigger countries still have to follow suit. Mr Duisenberg, regarding the remark of Mrs Randzio-Plath about the interest rates in Japan and the risk of weakening or even a deflationary situation, you mentioned the importance of the structural changes. Now you have lowered the interest rate dramatically you have explained that there is a need for structural changes. Is it right to say that there might be a risk that we are coming into the Japanese situation where the governments don't take the structural measures that are needed? Japan has the problem that they have to make large internal changes which are outside the Central Bank, but for example in their case in the banking system but also in the economic system. If governments don't take the measures in the direction that are needed, if governments share, which generally they do, share the judgement that the extremely high rate of unemployment in their country is, not entirely, but to a predominant extent, around 80%, of a structural nature, then they should also share the opinion that problems of a structural nature can only be solved or fought by structural measures. If governments promise to their voters before coming into power that if they are returned to power, unemployment will come down and if they are convinced that it only can come down if measures of a structural nature are being taken, then if the situation develops as your hypothesis describes that unemployment fails to come down then I'm sure that those governments will be punished the next time the people are called to the voting box. President. You've made it clear from this rate cut that now the ball is in the court of the Member States not just when it comes to employment policies but also when it comes to structural reforms and some of the questions have been touched upon already. What measures do you think are necessary in the area of the labour market, and above all I'd like to know what your assessment is? You've said something about strong economic growth in the US arguing that that was a determining factor. And I'd like to know what you think the consequences the Kosovo crisis will be in the short-term, mid-term and the long-term on budgetary consolidation in Europe especially if we're planning a sort of Marshall Plan for the South Balkans using EU money and Member States' money? What sort of consequences does the ECB see from this and how would this make it more difficult to push through structural reform? As I indicated earlier, the difficulties countries are experiencing - being of a structural nature - still differ very much from one country to another and that means that I do not have a recipe, a "cure all" for the entire euro-area. Although it is not my competence to do so, I would be able for some countries at least to suggest some measures and I will not refrain from doing so behind the scenes. But to be quite specific would not be possible, it would have to differentiate from country to country what measures one could take to promote the flexibility and the mobility of labour. I have given a few indications in my introductory statement but I think I would be going beyond the limits of my competence to start here giving recipes for every individual country that experiences the problem. So I'm afraid I cannot go further than what I said already. We are now moving onto a second round which concerns exchange rate policy. Before we get onto that round Governor I would like to repeat the request from the Committee that you give us the inflation forecast, that this be published and made available to the Parliament so that we can look into it in greater detail. In this way, we can judge whether this 0%-2% band is too narrow, whether we need a further band or whether we should redefine your concept of price stability. But I and the Committee would be grateful if you could publish these inflation forecasts so that we could receive and study them. I have quoted expectations about inflation forecasts from various institutions and in particular from the European Commission, and many international organizations give inflation forecasts. We look at all of them. We will never make isolated inflation forecasts. What we will make - and we have to - is a comprehensive set of expectations about the behaviour of various economic variables, inflation being one of them. In econometric model terms, there will be a moment when we will have adequately reliable forecasts of which the inflation rate or the expected inflation rate will be one. That is not to say that the figure which would come out of an econometric model exercise will be the inflation forecast. That requires judgement also. There will also come a moment - it is too early but I personally have no doubt that there will come a moment - when we also like many other institutions will publish our forecasts but I explicitly say forecasts, the multiple, and inflation being one of them, but in such a way that they will never become self-fulfilling prophecies. If we have them in an adequately reliable way, if relationships which we use have reached the degree of stability that Mr Katiforis was eluding to, then we will give them. What I said today is that we have seen the inflation forecasts of various institutions and international organizations being scaled down over the last few months. I mentioned explicitly the spring forecasts of European Commission, I could mention the OECD, I could mention the IMF and private institutions, and we have relationships with all these institutions. We make inquiries amongst these institutions and most institutions cooperate with us which lead us to come to a judgement that indeed the inflation forecasts that we had in the back of our mind had also to be brought down since our last meeting in this room. I wanted to ask a question about exchange rates. Now as regards exchange rates, this is something that has been in our minds and in fact since the first time that you have come to this Committee we have been thinking about this and exchange rates are one of the indicators which are considered alongside the range of indicators that are necessary in order to arrive at economic and monetary policy measures. I agree with you as regards this trend of the euro. At the moment the exchange rates are reasonable and you at a previous meeting said explicitly in this context that the ECB would never have a target when it came to exchange rates but would have a reference value as it does for interest rates. So what is your lowest reference value? A one to one euro-dollar exchange rate? Is that when we'll start to be worried, is that when the markets will start to get worried? Neither I, nor do we, have a reference value for the exchange rate. I cannot have said that. We will not have a target. I am not able to answer your question because I have no answer. There is no specific figure I have even in the back of my mind which would cause us to be concerned. I always said I am more concerned about volatility than about the precise level of an exchange rate. I am interested in stability to put it in other words. We have seen quite some volatility over the last few months, which certainly had to do as I indicated earlier with the happenings in Yugoslavia. That has caused volatility, it has caused some additional weakening of the euro but to my mind by no means to an alarming extent. Alarming it would be if the euro were to weaken to such an extent that that in itself would have an upward, significant impact on the rate of inflation. Then we would have a problem. I basically agree with everything that the President has said. I don't have anything to add to that. However I would like to point out that it's very difficult for me to imagine that you are not working with any sort of reference value in this area whatsoever. Now you might not want to make that reference value public, I can understand that, and you can decide whether that is or is not a successful communication strategy. However, it really is very difficult for me to imagine that in all of this long list of indicators and everything that you've mentioned before you don't have any reference value for exchange rates whatsoever, I'm sorry. If you take a longer term view I see more factors which would point in the direction of a strengthening of the euro than of a weakening. The factors I see are the persistent enormous balance of payments deficit of the United States, approaching now a figure in the order of $ 300 billion per year. I see the tendency of both public and private investors to diversify their risks in their portfolios. That is to be expected. I do see, as I indicated earlier, that there will come a moment when the growth rate of the United States will come down somewhat and I hope we do see a soft landing, so that one of the causes of the present weakness as I described it will also disappear. So in the longer run my expectation is that the euro will be stronger rather than weaker. I only hope it doesn't go too fast. What real link is there between the euro exchange rate and the internal inflation rate of the euro-zone, because the percentage of GDP which is internal to the euro-zone is so overwhelming. The way to look at exchange rates is on the basis of the various aspirations that there have been towards a much more stable global exchange rate regime. I was wondering whether there was anything that you could tell us about the discussions that have been going on regarding the appropriate stability of the exchange rate between the euro and the dollar and indeed involving the yen. This is the issue that was being discussed at the Davos summit a few weeks ago. Davos I would not regard as an official discussion forum. I have been told that there have been discussions in the context of the G7, but at a point in the meeting to which I was not invited. I have not been a witness to any such discussion. What I do know is that there are some in Europe who would favour more or less formalised arrangements for a relationship between the euro and the dollar. What I also know is that I can't find anyone on the other side of the Atlantic ocean who would want to be part of such an arrangement. So there is this complete unwillingness in the United States and only partial willingness on this side of the ocean to enter into a formal relationship, or even an informal relationship, between the euro and the dollar and eventually the yen. What I do want to point out is that in the current circumstances we have no exchange rate regime. The possibility is there for the Council of Ministers to issue a so-called general orientation towards the exchange rate. It can do so only after the advice of both the Commission and the European Central Bank. The European Council in Luxembourg in December 1997 decided and announced that general orientations on the exchange rates will only be issued in exceptional circumstances such as a serious misalignment of the currencies. So that is all that there could be in theory and what in my opinion is very unlikely to materialise. For the foreseeable future that is. Do you have an exchange rate policy? At the moment it sounds like benign neglect. Secondly, with respect to the dollar-euro exchange rate, you hide behind earlier references to the position of the synthetic euro exchange rate in 1997/98 against the dollar. But the truth of the matter is that as you've now just expressed in this meeting you are worried about volatility and seen within the 3 1/2 month perspective there has been extreme volatility in the sense that the euro has declined by a marked degree. I'm still not certain where you would first of all get worried, would it be a parity US dollar versus euro and even if you were worried would you intervene in any way? And my third question is in respect to the four countries in the European Union but outside euro-land. When you are making your decisions about interest rates, do you take these particular four countries into mind given that they have a special place within the European Union? Of course I'm thinking in particular about the situation of the United Kingdom. Not having an exchange rate policy, and we have no policy, does not mean that there is benign or malign neglect. For the time being there is neglect. The exchange rate is one of the main indicators we look at in order to come to our judgement for monetary policy decisions. So far the developments have not given us any cause to be worried about the development in the exchange rate. Also, as Mr Stevens said, because the impact of exchange rate changes on this huge market of the euro-area is so much less than it was in the past for the individual countries. Bluntly I am afraid, I refuse to give any indication at what rate I would get worried. If I gave such an indication - if I gave a figure - then you could be sure it would immediately be tested by the markets. The markets would steer the rate in the direction and to the point which I had indicated would cause me to worry, and I do not want to give this riskless profit indication to market participants so it is neither parity nor any other rate which I am prepared to indicate would worry me. As I said the only thing that would start me worrying would be if there were a significant impact to be expected on price developments internally. For it is the internal price level, that is our aim, that is our objective to stabilize and not the external price. Do we have the four 'out' countries in mind was your question when coming to such monetary policy decisions, the answer is of course we look at their developments and I can confess to you that before the decisions are being taken but under consideration, I am also in touch in particular with the Central Banks of the 'out' countries. I do not think that I am satisfied with your second answer in the sense that if you comment publicly, as you have done, to say that you are not dissatisfied with the fall in the euro-dollar exchange rate then clearly there comes a point where you are dissatisfied and that was what I was trying to establish. For instance if we came to parity would there be benign neglect in saying well that is the reflexion of the markets and we should not worry about it or would you be worried about a euro that did decline that far? I simply said that I am not prepared to give any precise exchange rate. If you see us operating in the exchange markets deliberately and on a large scale you may conclude that there is something that worries us. But that moment has not come and I cannot see it coming yet. On the fall of the exchange rate over the past three months, I want to reiterate - and I do want to compare it to the period before 1st January - that the rise of the euro only started in mid-September and that it took three months for the euro to go from a level of 108/109 to the level of 1.16 on 4th January. Then a few days later, the euro strengthened further. On one day it reached almost 1.20. That caused one Prime Minister in Europe to exclaim that the euro should not strengthen too fast and not at this tempo and then it started to decline. But I admit that in the last few weeks, under the influence of the Kosovo tragedy, it has had some further downward impulse but I do not know what the level is at the moment. When I left my house this morning it was 106.50, when I arrived in Brussels it was 106.28. So the movement is still going on. First of all I was reassured at the way you have answered the questions and also I think your behaviour has been extremely consistent. I imagine that one could not say that any defined exchange rate target would be helpful, that would not be the case. Now I do not know whether there should be guide values. Even if there were any it would not be wise to publish them. Any publication of your views on that matter would not be wise. It is something that would only happen in extreme situations. Can you reassure me on the following points as well. Is there any sort of number that has been fixed in your policies on exchange rate mechanisms? I presume not. I think you're working in terms of a general exchange rate policy. Am I right in thinking that? A general policy in extreme situations of course should not be forgotten. Now have I understood you correctly on those points or not? Mine is a two-fold answer. There are no numbers fixed, either in our minds or publicly or secretly, with the exception if you mention exchange rate mechanisms of course with the two countries that participate in the exchange rate mechanism 2, namely Denmark and Greece. There we have defined central parities and margins of respectively 2.25% for Denmark and 15% for Greece. Those are the only two exceptions. Thank you. Let's now go on to the third round of discussion, transparency of decision-making and democratic accountability. I think it is fair to say that the question of transparency is a central consideration in order to get a dialogue going. If that dialogue is supposed to be meaningful in that respect I think that there are a couple of questions which you did not touch on at the beginning. First of all the date of communication. What you did say, and we respect that, is that you were not going to be publishing minutes from the meetings of the ECB's Governing Council. We can accept that but we have seen things in the press concerning the decisions taken on April 8th and in that conference you said "I must say it was a very interesting discussion today concerning the pros and cons on the interest rate cut". So my question is the following. Don't you think that in order to obtain more transparency in our dialogue in general, in our communication with public opinion, do you not think it might be a good idea to publish, not the minutes and much less the votes, but some sort of summary of the arguments in favour and against the various decisions made in the Governing Council? I think that would help your public image and the credibility of your institution as well as your dialogue with our Parliament and with public opinion at large. I am under the impression that in my press conference, in the questions and answers session, in my introductory statement to you today, I actually do that. I have given an account of the upside and downside risks. They are, in effect, the arguments for and against. When you have weighed everything, the arguments for and against then the Governing Council has to come to a judgement and to a conclusion. Citing all these risks, upward and downward, as I have done today, I effectively have given you the arguments for and against and by the decision we have given you the conclusions which the Governing Council have drawn out of this complex field of pros and cons. I mean the only thing effectively which we are not doing is giving you the names of people and their vote. And you don't ask for that. I am inclined to say that except for that we almost give you everything else. I must say that in this very interesting and broad-based discussion we should have more than just an indication of general considerations, upwards or downwards, as far as inflation is concerned. You, yourself, just a couple of minutes ago made an additional argument which was not in any of the communications, any of the information that has been given to the press and that was the risk of a further slide. You said that was an argument today and you did not mention that in any of the information that has been provided to the press or to public opinion until now. That is an additional, new argument and I'm sure that there are more such arguments as well if you look through the discussions. For example I could imagine that you would talk about the discrepancy of situations in various European countries. I'm sure that you've talked about that. You can't not have talked about that and any man on the street can imagine an argument that says that there are different economic cycles or different phases of an economic cycle in different countries and that could be one argument. So my question is don't you think that it would help your own credibility and your own image of transparency to give detailed information to public opinion so that you are not just leaving it up newspapers and financial analysts to make their own interpretations of what has happened? When Mr Herman asked me, "you have said to the press that there will be no further cuts in interest rates and wasn't that rather imprudent", my answer was, I had not said that to the press so it was not imprudent either. The argument I used that I think you referred to, is to want to prevent the expectation of a further slide in interest rates, I have given that argument to the press and you can read it on the Internet, in the transcript of the questions and answers. I have given an indication that part of the reason to come to the decision of a cut in interest rates by 50 basis points, namely that we want it to quell any expectation that this cut in interest rates would only be the first in a series. I would like to welcome the fact that the ECB uses modern information technology, above all the Internet. I think it is the best thing to promote worldwide transparency and it is not the same as speaking here, it's not the same as a press conference so I rather would like to praise you very highly for promoting transparency in this way. It is better than a sort of artificial transparency which we have rejected in Parliament several times, for example your final communiques. Then of course there was a decision in the Maastricht Treaty that monetary policy would be taken away from national sovereignty and would be given to an independent Central Bank. The reverse of this is that you bear sole responsibility for your decisions. The board of the ECB bears sole responsibility so you do not have to give your reasons, your motivations. I did not ask necessarily your assessment of the Kosovo crisis again because perhaps you haven't had time to assess the impact of the Kosovo crisis. I think the sort of transparency we have at the moment is optimal and I don't think that there is a majority in Parliament that would question that, even though this is mentioned in our draft report from our colleague on the annual report. The annual report provides such interesting information, we have not had the time to read it through yet, but it contains such interesting information that all these things that would involve Parliament more, I would say yes in favour of that but I think that when it comes to sensitive issues like monetary policy, I think that you are doing fine. Well that was the question. Will there be further possibilities above and beyond this Internet? Will you improve transparency in other ways apart from using the Internet? Well I see only one possibility. Invite you to come to the press conference. We could also ask Mr Duisenberg if you could hold your press conferences in the European Parliament. That would be one possibility. But I have two more questions. My first question is once again why you mention the monetary dialogue with the European Parliament as a means of ensuring better relations with other institutions, because I think that the monetary dialogue belongs to a different category. It is part of a democratic role. It has a different quality to relations with other institutions. For example, what other institutions have observer status or are consulted, and what other institutions can bring their influence to bear? And the second point is, you in the context of this whole question of transparency have always underscored independence, and I would like to know why politicians do not consider the interest rates of the ECB when the ECB talks about budgetary deficit, talks about reform of social security systems? Why do you just criticise the Finance Ministers who do this but you do not criticise the OECD or the IMF which most recently in the last few weeks have called again very strongly for a cut in interest rates from the ECB? Why are they not criticised? And thirdly, I would like to know whether you agree with us, as regards these final communiques - and Mr Langen, I don't think what you put forward there was correct - when we as a Parliament rejected verbatim minutes but did call for final statements, final communiques from the ECB. Will this be possible without mentioning names so that we can actually know what the arguments were in favour and what arguments were against during your decisions on monetary policy? I must confess I cannot quite understand your first question but I regard the dialogue with the European Parliament as extremely important, but we also have a dialogue with other bodies which I regard also as extremely important. You do not have a legal obligation in the Treaty to report to the IMF or to other institutions. I do not report to the IMF but the IMF has the obligation to exert 'Article 4 consultations' with its Member States and these 'Article 4 consultations' amongst other things refer to monetary policy. They have to undertake these consultations, and come to a judgement about monetary policy. Now it so happens that there are 11 countries in Europe which do not have a monetary policy. So for the monetary policy of the euro-area, although the euro-area is not a sovereign state and in itself not a single member of the IMF, still it is a counterpart and it has to be a counterpart for the monetary policy of the 'Article 4 consultations' of the IMF. What we do is to report a lot to the IMF, namely statistical data etc, which we assemble. In return for which we receive a lot of information from the IMF, also statistical data which the IMF assembles. Both being monetary institutions we are developing a very close relationship with the IMF. I think this is in the interest of the euro and the world. But the question is, given that we have the process of democratic accountability, whether you can just enumerate the monetary dialogue with the Parliament in the chapter on cooperation with other institutions? It really is the question whether there is not a difference in the quality of this dialogue concerning the institution of the European Parliament in comparison to others? I'll think about that when preparing our next annual report. The second question was on the decision-making of the Council. We do not want to have minutes, as with the Federal Reserve, just to have the conclusions with the arguments against and in favour so that we can appreciate better what the decision was based on. Well as I said we have discussed this question or request in the Governing Council time and again. We have decided, and I regret that I have to stick to that decision, of not publishing the minutes but that we will publish as much as possible, we will be as transparent as responsible. We have decided which also is not in the Treaty, to publish a monthly bulletin. We have decided, which is not in Treaty, to have a regular press conference after every first meeting of the Governing Council explaining in detail the decisions of the Governing Council. We do give the considerations for and against if certain decisions of major importance are being taken without thereby creating uncertainty. We have decided that that is the maximum of openness and transparency which we think is desirable and necessary. We do not think that publishing a discussion itself even without mentioning the names - so a sort of summary proceedings in grouping things together - would add anything to what we already publish. I don't have an answer to my third question where I said you are criticising politicians discussing monetary policies, whilst at the same time you are criticising politicians that they are not behaving correctly concerning budgetary politics or structural reforms and, on the other hand, you do not criticise OECD and the IMF for pressing the ECB to reduce interest rates. I have to contradict you. You can find no quotation from me where I criticise politicians because they were criticising or commenting on monetary policy. On the contrary I have said publicly when asked what do you think of this or that Minister making certain suggestions for monetary policy, I have said that I regard it as quite normal and natural for politicians to do that. Equally normal and natural, in my opinion, is it for me not to listen to them. I would like to address the question of transparency with regard to the monetary policy strategy itself. I actually disagree with Mr Herman when he asks for you to dump the two pillar strategy. I actually believe that there is no two pillar strategy. There is a one pillar strategy. If you would take your strategy seriously you should have increased the interest rates. I think the lack of justification does not help with credibility. Would it not be more transparent to move to a one pillar strategy and to declare this officially? If we consider the inflation indicator as a speedometer in a car, looking at the money supply figures and the notice that you have taken of them, is like looking at the ashtray. With all due respect, Mr Hendrick, you have not accepted the fact that we have that pillar as a reference value. We refer to it, we look at it, we compare that value which we have set for one year which we will review, not necessarily change but at least review, this coming December. We will compare actual developments with the reference value and then come to a judgement, and only a partial judgement because we look at a lot of other things in the second pillar as well, and then come to a judgement whether or not this deviation of actual developments from the reference value gives us cause to change anything in monetary policy. But it is a matter of judgement and it will remain so. Could I just follow up that to say if it is a pillar, then your strategy rests on that pillar. It is held up by that pillar. Now clearly inflation of 0% - 2% is a pillar and you're not going to deviate from that but when you're saying 4 1/2 % isn't being treated like the inflation figure, then it's not a pillar. Then let us first define what a pillar is. It's what your strategy rests on, it's what it depends on. Yes, it does. It does rest on those two things, the monetary aggregate developments looked at in relation to a reference value and the assessment of price developments, itself based on a wide range of indicators. Those are the two things we look at and those two things determine ultimately the judgement we come to. Mr Duisenberg, do you want to be transparent as well as to be predictable by, for example, financial markets? I ask this question because I had the impression that you were rather proud about surprising the financial markets. But if you accept that transparency is necessary to be predictable we do not need to dwell on it now, but it has a lot of implications for example for publicising internal reports, publicising all the predictions that you use yourself. The answer is I want to be as predictable as I can, or as the ECB wants to be. Predictable in our behaviour. Nevertheless on this single move it was not the idea of surprising in itself which caused us to come to such a surprising decision. Nothing whatsoever, and I don't expect it to happen very often that we will be able to surprise the markets, and we do not endeavour to surprise the markets. This time we did. That is true and that I demonstrated a little bit of pride may have been childish but nevertheless it was the way I felt. Thank you Mr Duisenberg for today's monetary dialogue. Certainly from our point of view it would be very useful if we could receive the inflation forecasts and also economic data and economic forecasts, i.e., the information on which you base your decisions - because certainly you won't just have the Commission forecasts, as you rightly said, and it is all a matter of one's own judgement - this judgement that you arrive at needs to be understandable to us and the markets. We wish you the best of luck for the next few months. The quality of your work and the quality of your reports, as we have already said, is extremely good. Particularly the very good organisation at the beginning of economic and monetary union and we only hope that there can be even more progress on transparency. Now as I said this is the final meeting of our Subcommittee. Last week Parliament decided that there will not be a Monetary Subcommittee in the next Parliament. There will in fact be an Economic and Monetary Affairs Committee. So there will be a new Committee with a new composition and it will, I am sure, wish to continue this dialogue with you. We can, I think, only undertake a provisional assessment of the annual report because the final assessment will have to be left to the new Parliament when it has its plenary debate on the annual report.
r990424a_ECB	euro area	1999-04-24T00:00:00	The Euro: Europe's new currency and the role of the ECB	francisco	0	First of all I would like to thank the organisers warmly for giving me the opportunity to address this distinguished audience and share with you some thoughts on the first months of the euro - and its prospects for the future. The launch of the euro at the beginning of this year was really a very important and unique step in the long integration process in Europe - and globally. The euro and the common monetary policy have far-reaching economic and political consequences for the participating countries as well as for the international monetary system as a whole. In view of this long-term, and global, importance of the euro, it is astonishing that the public debate appears to be increasingly dominated by attempts to assess the overall benefits of the Economic and Monetary Union on the basis of very short-term economic developments. Many analysts are trying to draw conclusions on whether the euro is a success or a failure on the basis of the economic and financial developments of the first 114 days of the new currency. To my mind, more emphasis could be given to analysis of the structural implications of the euro. I think it is also very important not to forget that the idea to establish a monetary union in Europe was originally launched primarily on the basis of political arguments. The process was based on a strong vision of an integrated Europe, and on strong leadership and commitment on the part of European politicians who had themselves experienced the effects of the Second World War. Their vision was to establish close and lasting ties between European countries so as to ensure that the continent would never again suffer from conflict and crises. In addition, many of these leaders recognised that strengthening the weight of Europe and improving the international or global balance of power would also benefit global economic co-ordination. In fact, European integration should be seen as a step towards wider global integration and monetary stability. After many different phases, both of progress and of difficulty, and after much thorough work invested in the institutions and in economic convergence, the euro and the single monetary policy were successfully implemented on 1 January 1999. I would like to point out that the introduction of the euro had been meticulously planned for a long time. In fact, it took place no less than three decades after the presentation of the so-called Werner Report and one decade after the Delors Report - two of the most important vehicles and milestones in the integration process. Europe may have been perceived - especially from the outside - as excessively inward-looking throughout this long integration process. But the construction of strong institutions for a common Europe is necessary before Europe is ready to fully assume its responsibility and role in the resolution of global issues. This notwithstanding, the establishment of the Economic and Monetary Union had - and will continue to have - an immense psychological and political impact at the global level. The international strength of Europe and the credibility of the euro will, in the future, be very much affected by further deepening and widening of European integration, by the stability and efficiency of the internal political decision-making processes, and by the stability of the economic policies. The integration of European economies is now, in practice, an irreversible, self-sustained and dynamic process. It is not only a function of political decisions, but it is proceeding automatically in all areas and in particular in the financial markets and the corporate sector. For the future, the continuation of the European integration needs new long-term visions, new strong leadership and further firm political commitment. We seriously hope that we shall find and witness this leadership and commitment among the new generation of European politicians who have not themselves directly experienced the Second World War. In order to ensure that the European Economic and Monetary Union becomes successful, it is important to establish confidence in the euro as a stable and credible currency. The credibility of a currency is determined by three main factors, namely: the orientation of economic policies; the size of the economy issuing the currency; and the depth and efficiency of the financial markets where the currency is traded. Starting with the latter two factors, it should be noted that the euro is backed by an economy which is of approximately the same size as the US economy and that the financial markets in Europe are integrating and developing very fast. These factors should enhance the attractiveness of using the euro as an investment and transaction currency. As to the first factor, the prospects that the euro will be supported by stability-oriented economic policies are very promising. The institutional set up laid down in the Maastricht Treaty is a good basis for ensuring stability-oriented policies. The Maastricht Treaty guarantees that the Eurosystem (i.e. the ECB and the eleven national central banks of the participating countries) is firmly committed to price stability - clearly defined as the primary objective of the single monetary policy. It is important to underline that the primary goal of the ECB is price stability, not the management of the economy as a whole: it is a tool, a way of guaranteeing low inflation and low inflation expectations and thus of creating conditions for growth and employment. In order to ensure absolute clarity about the primary objective, price stability has been defined as a year-on-year increase of the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. This is a medium-term objective. In the short run, many factors beyond the scope of monetary policy also affect the price movements. - It is important to underline that the word 'increase' indicates that deflation - persistent fall in price level - is not consistent with price stability. The Maastricht Treaty also ensures that the Eurosystem enjoys a very high degree of independence in the pursuance of its functions, possibly more independence than any other central banking entity in the world. The Governing Council of the ECB is composed of the eleven governors of the national central banks of the participating Member States and the six members of the ECB's Executive Board. Monetary policy decisions are taken by the 17 members of the Governing Council on a "one person - one vote" basis. The Statute of the ESCB clearly specifies that no member of the decision-making bodies of the ESCB may seek or take instructions from Community institutions, national governments or any other body. Stability and credibility also require that monetary policy is implemented efficiently and that the monetary policy actions are easily understood by the market. The Eurosystem has placed considerable emphasis on both these elements. In particular, the Eurosystem does its utmost to promote transparency by explaining its policy actions in the light of its two pillar monetary policy strategy, comprising a broadly based assessment of the outlook for price stability in the euro area and the reference value of 4 1/2 % for growth of the monetary aggregate M3 for the euro area. A further important building block for establishing credibility is the promotion of an efficient implementation of the monetary policy decisions. The Eurosystem has aimed at setting up an operational framework which is consistent with market principles and which ensures equal treatment of counterparties and financial systems across the euro area. Moreover, the Eurosystem's operational framework is based on the principle of decentralisation in order to take advantage of the established links between the national central banks and their counterparties. Whatever the implementation and strategies, the singleness of the monetary policy is ensured only if the decisions are centralised. This means that decisions on key interest rates and other aspects of monetary policy are taken at the level of the Governing Council of the ECB. It is, however, very important to underline that the credibility of the euro also relies to a considerable extent on the preparedness of the governments of the participating countries to pursue policies of fiscal discipline and to undertake necessary structural reforms. To this end, the participating countries have agreed on a Stability and Growth Pact which provides a basic framework for fiscal discipline and should enhance the governments' incentive to proceed with structural reforms. I should like to emphasise that adhering to this pact is essential for the confidence in, and stability and credibility of the euro. From an American perspective, the argument is sometimes put forward that a Monetary Union would have to be matched by a federal budget policy in order to ensure that public resources can be redistributed so as to off-set the effects of an asymmetric shock. However, I do not agree with these arguments. To my mind, the differences between the federal system applied in the USA and the reliance on national fiscal policies in the euro area are, in practice, insignificant. In the US, redistribution of the federal budget serves the role as "shock-absorber", while in the euro area this function would be performed by an adjustment of the national budgetary stance. When speaking about the euro's international role, it is important to mention, that the Eurosystem does not have any active stance, as such, regarding the development of the euro as an international currency. It will take, in this respect, a neutral attitude and leave it to market forces to determine that role. The role of the euro should also be seen against the background of the exchange rate policy of the Eurosystem. By contrast with most of the currencies which it replaced, the euro is a freely floating currency. In the absence of any policy co-ordination between the three main currency blocs, the euro exchange rate will reflect the outcome of all relevant economic policies rather than being an objective in itself. Of course, the ECB will monitor exchange rate developments as part of its overall assessment of a broad range of economic and financial indicators which are relevant for inflation developments. This is not to say that in some very exceptional cases when there seems to be a clear misalignment or excessive volatility the Eurosystem could not react in order to signal that the exchange rate level is not justified. It is still too early to give a definite assessment of the role of the euro as an international currency. Nevertheless, experience gained during the first months of the euro gives an indication of the importance given to the new currency in various market segments. As to the spot and forward foreign exchange markets, the US dollar has been the most important currency since it overtook the pound sterling in the 1930s. It is estimated that in 1997 the dollar was involved in 84% of all foreign exchange transactions. This compares with 55% for the currencies which were replaced by the euro and 24% for the Japanese yen. The introduction of the euro immediately produced major changes in the functioning of foreign exchange markets. The disappearance of eleven national currencies and the introduction of the euro as a major international currency had an immediate impact on the turnover and focus of attention in the global foreign exchange markets. As from the start, the euro/dollar trading became the most active and liquid segment of the foreign exchange market. By contrast, the development of euro/yen trading as well as the trading vis-a-vis other Asian currencies have so far been surprisingly slow. How important will the euro become, though, as an investment currency in the global money and capital markets? Traditionally, the US dollar has been the predominant international investment currency. In 1997 the share of dollar-denominated instruments of the bonds outstanding in the international bond markets amounted to 46%, followed by Japanese yen-denominated debt (11%) and debt denominated in Deutsche Mark (10%). All the euro area currencies together accounted for approximately 24% of the international bond market. However, it is expected that the increased integration of the euro area financial markets will contribute to lower transaction costs and improved diversification, thus contributing to the attractiveness of the euro as an investment currency. The conditions for financial market integration in the euro area seem to be best at the short end of the yield curve. In fact, the conduct of a single monetary policy by the Eurosystem gave market agents an incentive to start large-scale cross-border trade right from the outset, thereby creating a gradually better integration of the money market in the euro area. The integration process of the previous national money markets was made possible thanks to the Eurosystem's TARGET system, which connects the national real-time gross settlement systems in the euro area. It thereby facilitates banks' cross-border dealing and accessing of funds in euro. The existence of an integrated money market implies that arbitrage is going to eliminate cross-border differences in interest rates. At the longer end of the yield curve, cross-border integration is likely to take more time. European bond markets have been highly segmented, partly due to currency risk but also due to other market-specific conditions, such as differences in national regulations, tax regimes, practices and market conventions. At the same time as the introduction of the euro removed the foreign currency risks there has been a clear trend towards an increased harmonisation of market conventions. As a consequence, the substitutability and cross-border competition between bonds traded in different national markets have improved. Some signs of increasing efficiency in the euro bond markets are already visible in terms of the bigger average size of the issues, the bigger size of the standard trades in the secondary market, and an increasing focus on the longer maturities within the euro area. The yield spreads between government bonds of all the participating countries now range within 30 basis points. For government bonds, it appears that liquidity factors and other peculiarities of specific bond issues (such as size, maturity date and coupon structure) are now becoming more important factors than any remaining difference in issuer rating. An important aspect of the cross-border competition for government bonds relates to the benchmark status. When comparing yield curves between French and German government bonds, the yield differences along the curve indicate that the benchmark status varies according to maturity. French bonds dominate in the maturity segments up to one year, between 6 and 9 years, and above 10 years, while German bonds are dominant in the 2, 5 and 10-year ranges. All in all, it is likely that investors are likely to become more interested in a basket of issues from liquid sovereign issues or an index composed of these issues. As a result, the trading of euro area government bonds can already be considered as largely integrated. The outstanding bonds were redenominated in euros at the beginning of this year and the risk premiums of different sovereign issuers have narrowed due to the single monetary policy and the fiscal policy co-ordination. In contrast to the integration of the markets for government bonds, the markets for private bonds in the euro area, and in particular for mortgage bonds, are still highly segmented owing to the differing institutional and regulatory frameworks across Member States. Nevertheless, the tendency towards increased cross-border competition and lower transaction costs in the national markets is certainly going to provide an incentive for deepening of private bond markets. We may experience a virtuous circle in which the increased issuance of bonds denominated in euro will draw the attention of international investors to euro-denominated assets, thereby making the euro an increasingly attractive currency for private as well as public bond issuers. In this context, it is interesting to compare the current sizes of the bond markets in the euro area and the United States. The market value of the bonds issued in the United States (USD 10,700 billion) is currently twice as large as in the euro area (USD 5,300 billion). While the market value of outstanding government bonds is 23% bigger in the euro area than in the United States, the market value of corporate bonds outstanding in the United States is almost ten times larger than in the euro area. These figures seem to indicate that there is plenty of scope for further securitisation in the euro area. The introduction of the euro certainly underpins this development. The establishment of a benchmark for government bonds, increasing economies of scale, narrower bid-ask spreads, lower hedging costs for debt securities issued by private firms and more competitive underwriting are likely to provide incentives for European corporations to issue their own securities instead of borrowing from banks. In fact the effect of the monetary unification has already had clear immediate impact on the volumes in capital markets. While the available data sources provide somewhat different pictures in this regard, it is clear that the amounts of euro denominated bonds issued internationally accounted for around 50% of total issuance in the first quarter of 1999. Hence, euro-denominated issuance in the first months of 1999 was above the volume of US dollar denominated issuance. In any case, this must be viewed as a very positive sign of international acceptance for the new currency. Another sign of vitality of euro capital markets is the substantially increased average issue size compared to the one prevailing formerly in the legacy European national markets: in the new euro bond market, issues of a size above 1 billion EUR accounted for 65% of the total volume issued during the first quarter of 1999. Moreover, the euro area financial markets now offer a more diversified set of financial instruments than that which was previously available in any national market in the euro area. This will give international investors greater scope for portfolio diversification for investments in euro-denominated assets without their having to incur additional foreign exchange risk. To the extent that the euro area is a large and rather closed economy, yields on bonds denominated in euro are likely to become increasingly independent of changes in US yields compared with the present situation for bonds denominated in the national currencies. If this is the case, euro area bonds will provide an attractive opportunity for investors who would like to achieve increased risk diversification in relation to US financial instruments. The euro may also become an attractive currency for the investment of official reserves. Currently the US dollar is by far the most important official reserve currency world-wide; at the end of 1996 the share of dollar-denominated instruments amounted to approximately 64%, while the euro area currencies accounted for 25% and the Japanese yen for 6%. The euro is likely to become an important anchor currency in other European countries which, formally or informally, might find it useful to peg their exchange rate to the euro or to a basket of currencies in which the euro is a large component. This is the case at present for the "pre-in countries" participating in ERM II as well as for several countries in central and eastern Europe which link their currencies to the euro, whether by a currency board, a fixed or crawling peg, or a managed float. In addition, other countries will also have to reassess their reserve management strategies in the light of the improved diversification opportunities offered by the new currency. It is possible that countries in Asia and Latin America, which traditionally have predominantly held US dollar reserves, may find it useful to diversify their reserve holdings gradually by acquiring euro. The introduction of the euro will also underpin the reshaping of the European banking sector. Traditionally, the banking sector of the euro area countries have lagged the banks of the United States and the United Kingdom banks in the provision of advanced and international financial services. So far, the European banking industry has remained segmented into rather small national markets. The introduction of the euro seems to give momentum to cross-border integration in the European banking sector, resulting from the disappearance of the natural "protective barriers" implied by national currencies. Large-scale mergers and acquisitions have taken place in Europe, but it is only very recently that we have started to see signs of such deals to take place over national borders. The increased scope for securitisation in Europe will put further pressure on the banking sector to move away from traditional bank lending towards more specialised financial services. I think we have only seen the beginning of a major structural reshaping of the European banking sector. There are almost 10,000 credit institutions in the euro area today. Large benefits from economies of scale are to be gained from a consolidation in the European banking sector, whereby the number of universal banks will be significantly reduced. Many of the small banks will either disappear or will have to specialise in niche services. I would like to underline that it is still too early to make any clear assessment of the final success and role of the euro. This notwithstanding, the weakening of the euro since the beginning of the year has led euro-sceptic economists and media to question the credibility and the long-term stability of the euro. I would like to conclude my presentation today by saying a few words about this development. The euro is at present traded at a level close to the levels prevailing for its predecessor ecu for most of 1997 and 1998. This level should be seen against the economic situation in the euro area as compared to the US. The US economy is continuing to grow rapidly, the employment situation is favourable and the fiscal situation is well under control with a healthy surplus in the government budget. In contrast, economic activity in the euro area is more subdued. Unemployment is high and the confidence of enterprises is weak, while consumer demand and consumer confidence remain rather good. At the same time, the economic slowdown and insufficient structural measures have resulted in a stagnation in the efforts to achieve fiscal discipline. To a large extent, the developments in the foreign exchange markets over the last few months can be characterised as a period of "dollar-strength" rather than "euro-weakness". The US dollar has appreciated against all other widely-traded currencies. The positive development of the US economy is a major factor behind this "dollar-strength". In addition, the US dollar appears to have gained further strength due to the Kosovo-crisis in Europe. Despite the factors supporting the strength of the US dollar one can ask, if the market participants in the euro/dollar exchange markets are assessing properly the fundamentals. On the whole, it seems that they have put significant emphasis on factors weighing against the euro in the short term and have more or less neglected that there are also several factors that would support the euro, particularly in the medium and longer term. As an example I would like to underline the strong external balance of the euro area as compared to the external deficit of the US economy. Moreover, it is likely that economic activity in the euro area rather soon start picking up again, while a slowdown can be expected in the US. The gap between the growth rates of the US economy and the euro area economy is likely to narrow. I also believe that if, as necessary, the reluctance to undertake structural reforms and to renew efforts at completing budgetary adjustment will be surpassed, the confidence in the euro and its stability will be boosted in the eyes of the market. All in all, I am confident in the long term credibility and stability of the euro. The mandate of the Eurosystem to maintain price stability in the euro area and its institutional framework, ensuring a high degree of independence, are powerful tools in this respect. I am also convinced that the euro will contribute to a further rapid development of the euro area financial markets. Against this background, I think there is little doubt that the euro will play a major role internationally and that it will contribute to improving the competitiveness and the growth potential in Europe.
r990427a_ECB	euro area	1999-04-27T00:00:00	EMU: growth through stability	duisenberg	1	Following almost a decade of meticulous preparation and economic convergence, 1 January 1999 saw the start of Stage Three of Economic and Monetary Union (EMU), with the introduction of the euro and a single monetary policy for the euro area. This area constitutes an economic region that roughly equals the United States in terms of both its economic strength and its degree of macroeconomic openness. The euro area has a population of 292 million, which is slightly larger than that of the United States, at 270 million, and a somewhat smaller GDP of EUR 5,800 billion compared with the EUR 7,600 billion of the United States. As will be clear from these figures, the euro area economy is of a formidable magnitude, and indeed is one of the largest economies in the world, with a purchasing power matched only by that of the United States. It is my conviction that EMU has the potential to stimulate further the growth of the euro area economy and to increase the prosperity of its participants. At the same time, a successful EMU is also in the interest of the United States and the world economy in general, creating opportunities for trade, direct and portfolio investment. Before I address the benefits of EMU and the stability-oriented policies that have to be implemented to ensure that these benefits are achieved, let me briefly mention the main institutional bodies involved in the formulation and implementation of the single monetary policy. Monetary policy is determined by the Governing Council of the European Central Bank (ECB), which consists of the eleven governors of the national central banks (NCBs) of the participating Member States and the six members of the Executive Board of the ECB. The implementation of the single monetary policy is the responsibility of the Eurosystem, which is comprised of the ECB and the eleven NCBs of the participating Member States. The Executive Board of the ECB is a separate decision-making body. Its role is to ensure that the tasks conferred upon the European System of Central Banks (ESCB) are implemented, either through its own activities or through the NCBs. I should now like to address the benefits of EMU and why I believe that the introduction of the euro and the single monetary policy can result in higher economic growth in the euro area and thereby contribute positively to the development of the world economy. Of course, the degree to which these benefits are achieved depends not only on the monetary policy of the Eurosystem but even more so on accompanying stability-oriented fiscal policies and appropriate labour market policies. The most important contribution that the Eurosystem's monetary policy can make to maximising the benefits of EMU is to fulfil its primary objective of maintaining price stability, as laid down in the so-called Maastricht Treaty; the Treaty on European Union. As has long been argued by central bankers and is increasingly accepted by academic economists, inflation and deflation are economically and socially costly. EMU is a tool with which to consolidate the progress made towards price stability in recent years and to firmly anchor expectations in line with price stability, thereby establishing the framework necessary to fully exploit the opportunities of Monetary Union. The Eurosystem enjoys full independence in determining the appropriate level of interest rates so as to satisfy its primary objective of price stability. Moreover, the members of the Governing Council of the ECB have long terms of office and may only be dismissed on grounds of serious misconduct or inability to perform their duties. These provisions imply that the concept of monetary stability benefits from explicit legal protection. A further important benefit of EMU is that it has removed the risk of serious real exchange rate misalignments within the euro area. This contributes to economic growth and helps to avoid any misallocation of resources. In fact, it enables the European Single Market to function smoothly and thereby makes it possible to reap all the rewards, to the benefit of producers and consumers. Furthermore, the start of Stage Three of EMU has also eliminated short-term intra-EU exchange rate volatility and exchange rate risks, and has thereby encouraged trade and investment. In addition, the benefits of economic integration afforded by the development of the Single Market are enhanced by the elimination of the transaction costs of exchanging different currencies, a direct result of the introduction of the euro. While they are difficult to measure, they effectively form an additional layer of protection for domestic producers. The single currency makes prices across the euro area directly comparable, which should increase competition and hence efficiency and economic growth in the area. A number of further positive effects on economic growth flow from the elimination of separate currencies in the euro area countries. One benefit is the potential for the reduction of risk premia built into real interest rates, which, in turn, will stimulate productive investment. Another benefit is that by facilitating the development of deep and integrated capital markets, the single currency should further reduce long-term rates via the elimination of an illiquidity premium. In addition, a wider and deeper capital market in the euro area will improve intermediation between savers and investors. It should be emphasised, however, that the true benefits of EMU derive from the fact that it is a unique opportunity to shape a macroeconomic environment conducive to stability, growth and employment, and to foster structural change which is needed to maintain or restore medium to long-term dynamism in the European economies. It will be clear that this is not an easy process and monetary policy alone cannot achieve this. The full benefits of the single currency will come only if there is appropriate support from other stability-oriented policies, especially fiscal and labour market policies, and if structural reforms are carried out in these areas. Thus, price stability is a necessary, but not a sufficient condition for grasping all the opportunities of EMU. In this regard, it is of the utmost importance that the governments of the EU Member States continue to implement sound and stability-oriented fiscal policies, by which I mean policies aiming at the medium-term objective of a budgetary position close to balance or in surplus. As you will know, this condition is stipulated by the Stability and Growth Pact, which ensures the lasting compliance of fiscal policies with the requirement of budgetary prudence. From the perspective of a central banker, a prime reason for the establishment of the Pact was that a lack of fiscal discipline would negatively affect the ability of the Eurosystem to achieve its primary objective to maintain price stability. In this sense, the Stability and Growth Pact is one of the most important safeguards that will ensure that price and fiscal stability remains the cornerstone of EMU. Therefore, it should be clear that I regard it as crucial for governments to make further structural improvements to their fiscal positions, as this would allow them to regain sufficient flexibility in their budgets and, most importantly, could effectively contribute to supporting stability and growth in the euro area. In this regard, I should like to note that only moderate fiscal consolidation is currently envisaged for the medium term. A number of national stability programmes only aim to attain the necessary flexibility at a relatively late date. It is important that we see a commitment from policy-makers either to ensuring the swift achievement of this aim or to going beyond the aims envisaged in these programmes once economic growth has picked up. Let me turn now to the contribution that stability-oriented structural reforms, particularly of euro area labour markets, can play in reducing unemployment and in supporting the stability of the euro. The high level of European unemployment is quite rightly a source of deep concern and should be addressed at a fundamental level. Clearly, the approaches that are most likely to have a lasting effect are those that address the root causes of the problem, not just the symptoms. The root causes of high unemployment in the European Union are structural rigidities in the labour market as well as tax and public transfer policies. This view is supported by a wide body of academic literature and was also a key finding of the OECD Jobs Study. It is obvious that structural problems require structural solutions. Implementing an inflationary monetary policy would not result in lasting reductions in unemployment, but would actually serve to exacerbate the problem over the medium term. I recognise that structural reforms are not always easy to implement. The benefits are often enjoyed in the medium term, while short-term costs for some groups may mean that reforms are vigorously opposed by interest groups. Although there is a common objective of reducing unemployment, there is no common programme of reforms that will work in all countries. While it is possible to learn from the experience of others, each Member State will wish to develop workable policies that reflect its own particular circumstances. Although the path of structural reform is not always an easy one, it is the only way in which we can achieve the lasting reductions in unemployment that are so urgently needed. Only structural reforms that aim to create stable labour markets in which there is flexible interaction between supply and demand will ensure that the benefits of EMU in terms of economic growth are achieved to the maximum extent possible. To conclude, Economic and Monetary Union provides a great opportunity to create and maintain a large zone of price stability and economic prosperity in Europe. However, while price stability is a necessary condition for fully grasping the opportunities of EMU, it is not, in itself, sufficient. Stability-oriented polices regarding the development of national fiscal positions and the functioning of labour markets are also of crucial importance. As I have explained, the benefits of EMU will not come in a quasi-automatic way. While monetary policy will make its contribution by following policies that maintain price stability, other economic policies must be implemented to ensure that the opportunities of the single currency are achieved. Monetary policy alone - however well designed and implemented - cannot solve Europe's economic problems. Policy-makers in all areas must be determined to take proper account of the new environment of Stage Three of EMU and its consequences when forming their policies.
r990503a_ECB	euro area	1999-05-03T00:00:00	Politics and central banks	noyer	0	It is a pleasure to be here today. First of all, I should like to congratulate the Estonian central bank on its 80th birthday. This also suggests that I should be modest, speaking as a representative of a central bank which is not even one year old. I am particularly delighted to be addressing the topic of politics and central banks, since this is one of the basic issues in central banking. I should like to explain to you why I think independence from day-to-day politics is crucial for a successful central bank and how this has been achieved in the case of the European Central Bank (ECB). However, independence should not mean isolation. A more open and transparent central bank is more effective. Moreover, in a democratic society accountability for policies is the logical complement to independence. In this context, I shall address the issue of how we pursue our aim to be as open, transparent and responsible as possible. I shall conclude with a brief discussion of the relationship between the monetary and fiscal authorities. Recently there has been a world-wide tendency to grant independence to central banks. This tendency is evidenced by both practical experience and academic research. By shielding monetary policy decisions from political interference, lower inflation can be maintained without having to give up economic growth. Indeed, in that sense, creating an independent central bank appears to be a good thing all round. The reason for this is that monetary policy-making under the influence of politicians tends to focus too much on short-term considerations. This can easily lead to temporary, non-sustainable accelerations in economic activity, at the expense of lasting increases in inflation and also ultimately a curbing of economic output and increases in unemployment. Politicians all over the world have come to realise this and have decided to remove the temptation to pursue short-term gains - like Ulysses, who asked to be roped to the mast in order to resist the temptation of the sirens' song - and to make their central bank independent. It should be underlined that granting this independence is, as it should be, a political decision. An independent central bank needs a clear legal mandate. The ECB is one of the most, if not the most, independent central bank in the world. Its independence and that of the participating national central banks is firmly enshrined in the so-called Maastricht Treaty, the Treaty on European Union. This Treaty was concluded by the governments of all the EU Member States and ratified by all their national parliaments. In some cases referenda were held. The 17 members of the main decision-making body, the Governing Council of the ECB, are not allowed to take or seek instructions from anybody, politicians included. Politicians are not allowed to give such instructions. Members of the Governing Council have a term of office of at least five years. The ECB is financially independent and has a clear mandate, laid down in the Maastricht Treaty. Its primary objective is to maintain price stability and, without prejudice to this objective, it should support the general economic policies in the Community, with objectives such as economic growth and high employment. Independence from politics should not and does not mean isolation from politics. I have already mentioned that granting the ECB independence was a political decision. More generally, the introduction of the euro and the establishment of the ECB constitute a new, important step in the process of European integration which has now been under way for more than half a century. This process is based on the political view that an integrated Europe is in the interest of stability, security and prosperity. The European integration process is primarily a political process with, of course, important economic aspects and benefits. It should also be underlined that the appointment of the members of the Executive Board of the ECB, as you may have noticed last year, is a political decision, to be taken at the highest political level, i.e. by the heads of state or government. I should add immediately that the Treaty stipulates that the persons to be appointed should be experts in financial matters. There are also some rules of the game which the politicians must follow in making these appointments. It is equally important to avoid isolation in the daily conduct of monetary policy. That brings me to the issues of accountability and transparency. Accountability for policies is the logical complement to independence in a democratic society. The Maastricht Treaty includes a number of provisions in this respect. First, there is the mandate to pursue price stability. This provides a qualitative measure against which the ECB's performance can be measured. We have decided to enhance this by providing a quantitative definition of price stability. In addition to that, we have formulated a quantitative reference value for money growth. One of the aims of publishing our monetary policy strategy is to make our policy decisions transparent. Second, the ECB has to publish an annual report in which, inter alia, the monetary policy of the previous and current year are discussed. The President of the ECB presents the ECB's Annual Report to the European Council meeting in the composition of the Ministers of Finance and Economy (the ECOFIN Council) and to the European Parliament, which may hold a general debate on the basis of the Report. The President and other members of the ECB's Executive Board may be heard by the competent committees of the European Parliament. The President has agreed to appear before the European Parliament at least four times a year. Third, the ECB has to report on its activities at least quarterly. It has been decided to go beyond this requirement and to publish a monthly bulletin. It is my view that the main way to achieve accountability is through being transparent and open. In passing, I note that transparency also enhances the effectiveness of the central bank. A central bank that is better understood is also more successful. Apart from the activities I have already mentioned, transparency is achieved in several ways. Every month, immediately after the first of the fortnightly Governing Council meetings, the President and I give a press conference. The conference starts with a comprehensive introductory statement by the President, in which he explains the decisions taken by the Governing Council and the underlying analysis and arguments. This introductory statement is published immediately on the ECB's Internet Web site ( ). This is followed by a question and answer session attended by several hundred journalists. The questions and answers are also published on the Internet shortly afterwards. All the members of the Governing Council frequently make public speeches, give interviews and contribute to journals and books. Thousands of people visit the ECB and the national central banks each year and, for our part, we and our staff attend many conferences and other public events. The ECB has been criticised, sometimes heavily, for a lack of transparency and for being unaccountable. I could not disagree more, as you might expect from listening to me. One of the most important criticisms is that we do not publish the minutes of the meetings of the Governing Council. I would maintain, however, that the introductory statements at the press conferences are similar to what other central banks call minutes, with the difference that we publish these statements almost immediately and other central banks only publish their minutes after a delay of at least a few weeks. In addition, our Monthly Bulletin contains an explanation of recent policy decisions and an extensive account of the economic developments underlying them. What we do not do is publish individual arguments and voting records, for several good reasons. The ECB conducts a single monetary policy for 11 countries and the governors of the national central banks do not represent their individual countries on the Governing Council, but are obliged to base their arguments on euro area-wide considerations. To publish voting records and arguments put forward by individuals would be to risk undermining their independence by exposing them to national pressure. I do not believe that maximum transparency is the same as maximum information. It would, for example, be rather confusing and not at all transparent to publish a full transcript of the meetings. This would also diminish the frankness and quality of the exchange of views which takes place. I should like to emphasise that our concept of accountability is a collective one. We are accountable for the decisions taken by the ECB's Governing Council as a body. Therefore, our external communication focuses on these decisions and the underlying reasons for them, including arguments for and against. We are convinced that accountability is better served by a clear understanding of the decisions which we take than by a public debate on who are the hawks and who are the doves. Independence should not rule out communication with politicians. On the contrary, it is important for the central bank to have a regular exchange of information and views with the budgetary authorities. According to the Maastricht Treaty the President of the ECB is invited to meetings of the ECOFIN Council whenever there are issues on the agenda relevant to the tasks of the central bank. The president of the ECOFIN Council and a member of the European Commission have the right to attend meetings of the Governing Council of the ECB. The President of the ECOFIN Council even has the right to submit motions for deliberation. However, neither has the right to vote. Apart from these formal channels, there are also informal ways of communicating. One of these is through the so-called Euro-11, an informal meeting of the ministers of finance of the 11 Member States which have introduced the euro. The President and I are invited to these meetings and attend whenever there is anything on the agenda which is relevant to our tasks and mandate. Thus, one side of the coin is a regular exchange of information and views. The other side of the coin is that in any such exchange of information and views the independence and mandate of the ECB should be respected. This means, for instance, that the ECB is not prepared to enter into an ex ante co-ordination of monetary and budgetary policies. We cannot promise ex ante that interest rates will be reduced if budgetary authorities promise to reduce fiscal deficits. The main problem is not even that promises and outcomes may differ, which unfortunately they sometimes do. The basic obstacle to such ex ante co-ordination is that the objective of monetary policy is to maintain price stability and that in setting interest rates to achieve that objective the stance of fiscal policy is only one of the many factors that have to be taken into account. The central bank can never make any ex ante commitment itself in relation to an announced fiscal policy. It can never react mechanistically to a given budgetary policy. Therefore, the so-called policy mix should be the result of the ECB's monetary policy aimed at maintaining price stability and fiscal policies in compliance with the Stability and Growth Pact. In the context of this Pact, EU governments have agreed to reduce their government budget deficits to close to balance or even to create surpluses in the medium term. Should ministers refrain from speaking about monetary policy in public? My own preferred answer to this question, whatever it might be, is largely irrelevant. Ministers have always tended and will always tend to have views on interest rates and, on occasion, to make their views public. I shall not criticise them for doing so. I shall only note that I am not aware of any minister ever having asked for an increase in interest rates; the request is always for a change in the other direction. I might add that, whereas it is quite usual for ministers sometimes to voice their views on monetary policy, it is more important that the central bank focuses fully on carrying out its mandate of maintaining price stability. This is what the ECB has done, and you may be sure that it will continue to do so.
r990504a_ECB	euro area	1999-05-04T00:00:00	The role of the Central Bank in the United Europe	duisenberg	1	First and foremost, I should like to congratulate the National Bank of Poland (the NBP) on its 75th anniversary. The age of the NBP already suggests that as the President of the European Central Bank (ECB), an institution that is even less than one year old and has only been conducting monetary policy since January this year, I should be modest. I am aware that the role of the NBP has not been constant over these 75 years and that in the past decade, in particular, the NBP has gone through a remarkable restructuring process. My previous central bank, de Nederlandsche Bank, has, together with the International Monetary Fund and many national central banks, been involved in assisting the NBP in its efforts to adapt to the role of a central bank in a market economy. Of course, the real work had to be done by you yourselves and I believe you can be proud of what has been achieved over the past decade. Today in my speech I should like to focus on the role of the ECB, as a truly European institution. First of all, I shall explain the background against which the introduction of the euro and the establishment of the ECB should be considered. Thereafter, I shall discuss the main features of the institutional structure that determines monetary policy-making. I shall then turn to our monetary policy strategy and the role of accountability and transparency in this strategy. I shall conclude by briefly addressing the issue of EU enlargement. On 1 January of this year the euro was introduced in 11 countries with a combined population of almost 300 million. The ECB started to conduct a single monetary policy for the so-called euro area. Former national currencies, such as the French franc and the German Mark are no longer autonomous currencies, but subdivisions of the euro. Euro banknotes and coins will only be introduced in 2002. The voluntary transfer of monetary sovereignty from the national to the European level is unique in history. However, it should not be seen as a single, isolated event. The introduction of the euro is part of the process of European integration. This process started shortly after the second World War and has now been under way for more than half a century. The aims of European integration are not only, or even primarily, economic. Indeed, this process has been driven and continues to be driven by the political conviction that an integrated Europe will be safer, more stable and more prosperous than a fragmented Europe. It is true that economic integration has been the main engine of this process and that, although it has had its ups and downs, integration has delivered important economic benefits. On balance it has been successful. The introduction of the euro and the establishment of the ECB are important new steps in this process of European integration. They are not the completion of this process, for at least two reasons. First, the launch of the euro can be compared to the launch of a rocket. A good launch is crucial, but only the beginning of the mission. The euro has been launched successfully. The challenge now is to make it a success. This will not happen automatically, but will require effort on the part of many authorities, institutions and people. Second, four EU Member States have not (yet) introduced the euro. I hope that this will happen in the future. Moreover, as you are aware, the EU itself is likely to increase its membership over time, also to include Poland. Ultimately, this is bound to extend the euro area. This process, too, is already requiring and will continue to require great efforts: no pain, no gain, as is often the case. Let me now turn to the institutional framework for the conduct of the single monetary policy. This was laid down in the Treaty establishing the European Community, the so-called Maastricht Treaty, and the Statute of the ESCB, which is an integral part of this Treaty. According to the Treaty the ECB has the primary objective of maintaining price stability. Without prejudice to this objective, it is to support the general economic policies in the Community, with objectives such as economic growth and high employment. Decisions on monetary policy are made by the Governing Council of the ECB. This body comprises the six executive directors of the ECB and the 11 governors of the national central banks (NCBs) of the Member States which have introduced the euro. These 17 people meet every fortnight at the ECB, in Frankfurt am Main. Decision-making on monetary policy is fully centralised. All members of the Governing Council have one vote, whether they come from Germany or Luxembourg. This is because of an important principle. They are not representing their country, but are obliged to take decisions on the basis of euro area-wide considerations. Regional or national monetary policy does not and cannot exist in the euro area. There is only one, single monetary policy for the euro area as a whole. Therefore, the ECB should develop into a truly European institution. This is a process that will inevitably take some time, but my feeling is that we are already making good progress. The execution of monetary policy is to a great extent decentralised. It is in large part carried out by the NCBs. The ECB and the 11 NCBs together are referred to as the Eurosystem. If we refer to the ECB and the 15 NCBs of all EU Member States, we speak of the European System of Central Banks (ESCB). The General Council of the ECB meets quarterly and comprises the President and Vice-President of the ECB and the 15 governors of the NCBs of all the EU Member States. This body does not make decisions on monetary policy, but discusses issues concerning the relationship between the "ins" and the countries I prefer to call "pre-ins", such as exchange rate issues. The third decision-making body of the ECB is the Executive Board of the ECB, comprising the six executive directors of the ECB. The Executive Board is responsible for current business and the implementation of monetary policy as decided by the Governing Council. The staff of the ECB will, in the course of this year, reach a level of between 750 and 800 and is likely to grow further in the years ahead. The ECB is one of the most, if not the most, independent central bank in the world. Its independence and that of the participating national central banks are firmly enshrined in the Maastricht Treaty. Members of the Governing Council are not allowed to take or seek instructions from anybody, politicians included. Politicians are not allowed to give such instructions. Members of the Governing Council have a term of office of at least five years. The ECB is financially independent. The independent status of the ECB fits into the recent world-wide trend of granting independence to central banks. This tendency is evidenced by both practical experience and academic research. By shielding monetary policy decisions from political interference, price stability can be maintained without having to give up economic growth. Indeed, in that sense having an independent central bank is a good thing for all concerned. The reason for central bank independence is that monetary policy-making under the influence of politicians tends to focus too much on short-term considerations. This can easily lead to temporary, non-sustainable increases in growth, but inevitably results in lasting increases in inflation with no lasting gains in growth and employment at all. Politicians all over the world have come to realise this and have decided to remove the temptation to pursue short-term gains and to make their central bank independent. It should be underlined that granting this independence is, as it should be, a political decision. An independent central bank needs a clear legal mandate. The ECB has, as I mentioned earlier, such a mandate. However, the Treaty does not specify how the ECB should pursue its primary objective of maintaining price stability; in other words: it is silent on what is called the monetary policy strategy. The ECB therefore formulated its strategy in the second half of last year. That was no easy task. The introduction of the euro constitutes a structural break, which may change the behaviour of firms and individuals and make it less predictable. To a certain extent it is comparable to what Poland experienced when it embarked on its reform process. The rules of the game change and this makes policy-making more complicated. Our monetary policy strategy has taken these specific circumstances into account. It is tailored to this unique period of the introduction of the euro, although it has elements of both monetary targeting and inflation targeting. In the context of this strategy the ECB has provided a quantitative definition of price stability. Price stability is defined as a year-on-year increase in the harmonised index of consumer prices (HICP) of below 2% for the euro area as a whole. Price stability is to be maintained in the medium term. The strategy consists of two pillars. The first pillar is a prominent role for money. Ultimately, inflation is a monetary phenomenon. It is in the end result of too much money chasing too few goods. Therefore, we have formulated a reference value for the growth of a broad monetary aggregate, M3, of 4 1/2 % on an annual basis. Growth of the money stock at this pace would provide the economy with sufficient liquidity for growth in activity in line with trend growth, without inflation. At the end of this year this figure will be reviewed. It should be emphasised that we did not define a target for money growth. The reason for this is the structural break that the introduction of the euro creates. By calling this a reference value, it is made clear that money is one variable which we look at very carefully in order to examine whether inflationary or deflationary pressures are tending to emerge. We do not, however, react mechanistically to changes in money growth. The formulation of the second pillar is also prompted by the potential changes in economic behaviour on account of the introduction of the euro. It is a broadly based assessment of the outlook for price developments on the basis of an analysis of monetary, financial and economic developments. In this context interest rates, the yield curve, wage developments, public finance, the output gap, surveys of economic sentiment and many other indicators are analysed. Use is also made of forecasts produced by other bodies and internally for inflation and other economic variables. This brings me to the role of the exchange rate of the euro in our strategy. Since our primary objective is price stability and since the euro area as a whole is a relatively closed economy with an export share of 14% of gross domestic product, we do not have a target for the exchange rate of the euro, for example, against the US dollar. This does not mean, and it is good to underline this once more, that the ECB is indifferent to the external value of the euro or even neglects it. The external value of the euro is one of the indicators we look at in the broadly based assessment of the outlook for price developments. Within that framework, we constantly monitor exchange rate developments, analyse them and shall act on them, if and when this becomes necessary. However, such action will never be mechanistic, nor will it be isolated. The external value of the euro and its development are analysed and considered in the context of other indicators of future price developments. The ECB also tries to assess international confidence in the still very young euro. Of course, the level of international confidence in the euro is not the only factor determining its external value, nor is the exchange rate the only indicator of confidence in the euro. It is, for instance, encouraging to see how the euro has been received on the international money and capital markets. I am sure that an internally stable euro will also strongly underpin international confidence in this currency, as it has for other currencies in the past. As the currency of a very large area, the issue of the international role of the euro naturally arises. The ECB takes a neutral stance regarding this role. It will neither be stimulated, nor hindered. On the one hand, an international currency has advantages for citizens in the euro area, on the other, it may sometimes complicate the conduct of monetary policy when a large amount of euro is circulating outside the euro area. We shall leave the development of the international role of the euro to market participants and market forces. If history is a guide as to what will happen, there will be a gradual process whereby the euro will have an increasingly international role. Such a gradual development would also be a welcome development, if only to prevent the euro from becoming too strong externally at some point in time. It is likely and understandable that interest in the euro is already considerable in those countries aspiring to join the EU, including Poland. I shall elaborate on this issue at the end of my speech. Coming back to our monetary policy strategy, I should like to point out that it is important to make clear what monetary policy can and cannot do. Monetary policy can maintain price stability, but only in the medium term. In the short term prices are also influenced by non-monetary developments. Moreover, monetary policy measures only have an impact on prices with long, variable and not entirely predictable time-lags of between 1.5 and 2 years. Therefore, monetary policy-making should have a forward-looking character. Today's inflation is the result of past policy measures, and current policy measures only affect future inflation. The uncertainty of the economic process in a market economy is another reason for policy-makers to be modest. The ECB does not pursue an activist policy. Precise steering of the business cycle or a cyclically-oriented monetary policy are not feasible and are likely to destabilise rather than stabilise the economy. Some commentators have interpreted our recent interest rate reduction as a change to a more cyclically-oriented monetary policy strategy. This is not true. Our strategy was, is and shall remain medium term-oriented and firmly focused on maintaining the price stability which currently prevails in the euro area. Monetary policy should be supported by sound budgetary policies and wage developments in line with productivity growth and taking into account the objective of price stability. Otherwise, price stability can only be maintained at a high cost in terms of lost output and employment. This also explains why independence should not mean isolation. It is important to have a regular exchange of information and views with other policy-makers. The Maastricht Treaty stipulates that the President of the ECB is invited to meetings of the EU Council meeting in the composition of the Ministers of Economy and Finance whenever there are issues on the agenda which are relevant to the ECB's tasks. The President of the Council of Ministers and a member of the European Commission may attend meetings of the Governing Council, although they do not have the right to vote. The President of the Council of Ministers may submit motions for deliberation. Apart from these formal contacts, there are many informal contacts, for example in the context of the so-called Euro-11 group of finance ministers from the euro area countries. I regularly attend meetings of this group. Monetary policy cannot be used to solve structural problems, such as the unacceptably high level of unemployment in the euro area. Structural problems call for structural solutions, in this case measures targeted at making labour and product markets work more flexibly. The best contribution the ECB's monetary policy can make in this context is to maintain price stability. In this way one of the conditions for sustainable growth in incomes and employment is created. As important as this is, it should be realised that jobs are created by firms which are confident about the future and not by central banks. Accountability for policies is the logical complement to independence in a democratic society. The Maastricht Treaty includes a number of provisions in this respect. First, there is the mandate to pursue price stability. This provides a qualitative measure against which the ECB's performance can be measured. As I have already mentioned, we have decided to enhance this by providing a quantitative definition of price stability. One of the aims of publishing our monetary policy strategy is to make our policy decisions transparent. The ECB has to publish an annual report in which, inter alia, the monetary policy of the previous and current year are discussed. I present this Annual Report to the EU Council and to the European Parliament, which may hold a general debate on the basis of it. The President and other members of the Executive Board of the ECB may be heard by the competent committees of the European Parliament. I have agreed to appear before the European Parliament at least four times a year. The ECB has to report on its activities at least quarterly. It has been decided to go beyond this requirement and to publish a monthly bulletin. It is my view that the main way to achieve accountability is through being transparent and open. In passing, I should like to note that transparency also enhances the effectiveness of a central bank. The better it is understood, the more successful a central bank is. Apart from the activities I have already mentioned, transparency is achieved in several ways. Every month, after the first meeting of the Governing Council, the Vice-President and I give a press conference. I start the conference with a comprehensive introductory statement, in which I explain the decisions taken by the Governing Council and the underlying analysis and arguments for and against. This introductory statement is published immediately on the ECB's Internet Web site. This is followed by a question and answer session attended by several hundred journalists. The questions and answers are also published on the Internet shortly afterwards. All the members of the Governing Council frequently make speeches, give interviews and contribute to journals and books. Thousands of people visit the ECB and the national central banks each year and, for our part, we and our staff attend many conferences and other public events. The European integration process continues. The euro should be made a success. I have already explained how we have started the process of doing that. Some observers have criticised the EU for its "obsession with its own internal dynamics", in particular in the context of European Economic and Monetary Union (EMU). With all energies focused on meeting the convergence criteria and the preparation for the launch of the euro, Europeans outside the EU have wondered whether EMU and enlargement are not mutually exclusive objectives. Let me briefly comment on this issue. After the historic decision to complete the European Single Market in the 1980s, it was felt that economic integration should not stop at that point. To fully reap the rewards of economic integration within the Community, a single currency was felt necessary; a logic pointedly encapsulated in the title of one report: "One market, one money". Hence, the underlying idea of EMU was to advance European integration and to ensure that full use would be made of the economic potential of the Single Market. This idea continues to be the focus of European policy-makers, as evidenced by the association agreements and the ongoing accession negotiations with a number of European countries, Poland among them. Good and mutually beneficial economic relations with third countries in Europe and further afield are a pillar of EU policy orientation. Recognising this, the principles of an open market economy with free competition are enshrined in the Treaty on European Union. EMU will not weaken this commitment, but rather reinforce it. Closer co-operation in Europe and the respect of common principles in the political, economic and social fields are likely to form the basis for further integration. The ECB shall contribute to this process within the scope of its responsibility. Countries wishing to deepen their monetary co-operation to the ultimate extent possible by forming a monetary union will have to adapt their economic and legal systems to the standards required by the Treaty and aim at a sufficient degree of economic convergence. In the absence of these conditions, adjustment costs for both current and new participants could be high. Any premature decision on the adoption of the euro could have severe repercussions on a country's competitiveness and trigger painful economic adjustments. Therefore, implementation of the necessary institutional reforms and of a sufficient degree of convergence should not be considered as an obstacle preventing further integration in Europe, but rather as an essential means of ensuring the lasting success of EMU, for existing and new participants alike. Looking at the impressive progress made in a relatively short time in this country, there is no reason to be pessimistic about Poland's chances of meeting these standards and convergence criteria. I shall not venture, however, to predict when this will be the case. Even at the current juncture, though, EMU in one part of Europe is already having an impact on the whole region. Let me briefly mention two aspects: If the euro emerges, as I believe it will, as a strong and stable currency, it will provide the countries in the region with an important reference currency, an anchor towards which, should the intention arise, monetary policy could credibly be oriented. Furthermore, EMU is set to bring about the development of a truly unified European financial market, close to that of the United States in depth and sophistication. The competitive pressures of this euro area financial market will create more favourable financing conditions for borrowers. A number of central and eastern European countries have already successfully tapped this market. In view of these effects, it is altogether natural that the ECB has started to follow with great interest economic and financial developments in the wider Europe, particularly in those countries which have applied for EU membership. Moreover, the ECB monitors closely the exchange rate developments with those countries which have established some form of exchange rate link to the euro. The euro has the potential to become more than just a new currency for almost 300 million people in 11 countries. It may also become a unifying symbol, standing for all that the peoples of Europe have in common. Consequently, the public perception of the euro could endow the single currency with a role in the European integration process reaching beyond monetary policy in the strict sense. May the euro contribute to the establishment of what the preamble to the Treaty Establishing the European Community calls: "an ever closer union among the peoples of Europe".
r990507b_ECB	euro area	1999-05-07T00:00:00	The euro area economy on its way to the new millennium	bank	0	The start of European Economic and Monetary Union (EMU) on 1 January 1999 marked the beginning of a new era both for the process of European economic integration and for the world economy as a whole. The introduction of the euro is an important step in preparing Europe for the new millennium. Looking at the economic side of this process, in my speech today I shall try to address four key features of the euro area economy on its way to the new millennium. I should like to start by outlining some of the main elements and characteristics of the euro area and the role of the exchange rate. Second, I shall briefly elaborate on some of the strengths of the euro area that we can build on and, third, I shall comment on what else needs to be done to maximise the potential of the euro area economy. Finally, I shall discuss some issues relating to possible extensions of the euro area, concerning future members of the EU and EMU. While many important fields of economic policy remain primarily the responsibility of the 11 participating Member States, monetary policy is now determined at the euro area level. Monetary policy will focus on economic developments and data for the euro area as a whole. Developments in specific countries will therefore be of importance only if they have an impact at the aggregate euro area level. Consequently, monetary policy can no longer be designed specifically for any one country or group of countries within the euro area. Becoming accustomed to a completely new economic entity and a whole new set of data will obviously take some time. However, despite the relatively short period that has elapsed since the start of EMU, market participants and the media seem to be adjusting well to the change of environment. For the general public the change is, however, less evident, since the new currency does not yet exist in the form of banknotes or coins. These will come into circulation only in 2002, although many individuals already make transactions in euro using cards or cheques which draw on euro accounts. In terms of economic data and statistics, on which we base our economic analysis, important work continues to be done by the European Central Bank (ECB), the national central banks and the EU's statistical office, Eurostat, in co-operation with national statistical offices, in order to harmonise and compute euro area-wide economic series. This task should not be underestimated. It is difficult to find satisfactory compromises and to switch to using harmonised data as opposed to the more familiar national definitions and series. Moreover, not only has the framework for our analysis of the European economy changed as a result of the transition to a single currency, but many important economic relationships to which we had grown accustomed may also have changed. This uncertainty poses difficulties both for the stability of money demand as well as for the accuracy of inflation forecasts. Many of the key features of the euro area as a whole, such as the size and openness of the economy, are quite different from those of the individual Member States but very similar to those of the United States and Japan. With 290 million inhabitants and a share of world GDP of 15%, the euro area is one of the largest economies in the world, with a purchasing power matched only by that of the United States. As a consequence of being a large economy with a large internal market, the degree of openness of the euro area is much smaller than that of the individual Member States. Previously, these were perceived as "small or medium-sized open economies" with an average ratio of exports (of goods) to GDP of around 35% (including intra-euro area trade). The share of exports of goods to euro area GDP is about 14% (after adjusting for intra-euro area trade), which is slightly more open than, for instance, the United States (8.5%) or Japan (10.0%). The share of the euro area in total world exports amounts to almost 16%, larger than the shares of both the United States (12.6%) and Japan (7.7%). In this respect, the euro area, taken as a whole, has become less dependent on external demand and more on the domestic euro area economy than was previously the case in individual Member States. Therefore, it is also more important that the domestic economy functions optimally, so that the full potential of this large economy is utilised. In short, we have to rely much more on our own capabilities to overcome difficulties, such as the Asian crisis, and economic policies must therefore be conducive to market flexibility, especially with regard to the labour and product markets. Labour market characteristics in the euro area differ substantially compared with the United States and Japan. Unemployment is much higher in the euro area (10.5%) and is predominantly of a structural nature. Among these structural features are wage formation, wage and non-wage labour costs and the scale and duration of unemployment benefits. In addition, employment growth has historically been lower in the euro area than in the United States for comparable levels of real GDP growth and, contrary to the experience in the United States, there has been a clear asymmetric response to fluctuations in economic activity, so that unemployment has not fallen back during economic upturns as much as it has increased during downturns. I note with some interest that, in this respect, Denmark has addressed several structural rigidities in the labour market and achieved, by European standards, a relatively low unemployment rate, although further measures may be warranted in order to maintain this favourable situation. There will be reasons to return to this important issue of well functioning labour markets later in my speech. In addition, the government sector in the euro area differs significantly in terms of size and structure from those of the United States and Japan. The government sector is substantially larger in the euro area with a share of government expenditure in GDP of 49% compared with 39% in Japan and 35% in the United States. This difference is largely explained by differences in social security systems. This is another issue I should like to return to later on in my speech. As the euro area represents a significant share of the world economy, the euro will of course play an important international role right from the start. Although the Monetary Union has removed the exchange rate risk for cross-border payments within the euro area, the exchange rate risk remains against other major currencies in the world, as most currencies float freely. The logic behind having a fixed exchange rate is to promote trade between countries by reducing uncertainties concerning relative prices. Small and medium-sized economies with a high proportion of trade in GDP have always found it useful to peg their currencies to their main trading partners while leaving them free to float against countries with which trade relations are limited. This is anything but new for you, here in Denmark. Lately, there have been suggestions that greater nominal exchange rate stability should also prevail at the international level, between countries that can be characterised as large and closed economies, focusing on measures to limit currency fluctuations between the main three currencies in the world. As much as this stability is desirable, let me state quite frankly that exchange rate stability cannot be achieved through administrative measures. For me, the most important reason for rejecting any exchange rate objective for the euro area is that it implies costs in terms of the clarity and efficiency, and possibly the credibility, of monetary policy. An exchange rate target would, in effect, limit our options in conducting monetary policy aimed at internal price stability. For example, in response to the recent development of the euro against the US dollar, the ECB would have been inclined to raise interest rates instead of reducing them if the goal of the ECB had been to stabilise the euro exchange rate. Similarly, the ECB's response to increasing inflationary pressures at a time when the euro was strong could be difficult to predict. Cases such as these illustrate the conflicts that could arise as a result of having multiple objectives but only one instrument, namely the interest rate, available. Given the primary objective of the single monetary policy exchange rate policy to maintain price stability, it would be counterproductive and confusing also to aim at a specific exchange rate, apart from the practical difficulties involved in setting the appropriate central rate, defining the width of the fluctuation bands and controlling the exchange rate in a world of integrated capital markets. Fixed exchange rates or target zones between the leading international currencies run the risk of inviting speculators to test the willingness of central banks to defend parities. An additional aspect is that sound fiscal and structural policies are at least as essential for sustainable exchange rate stability and therefore need to be co-ordinated as well. There should be no doubt about either the objective or the policy responses of the ECB. Our primary objective is price stability and we shall adjust interest rates accordingly. This does not mean that the euro area should adopt an attitude of "benign neglect" with regard to the euro exchange rate. In the context of its stability-oriented monetary policy strategy, the ECB closely monitors exchange rate developments to assess the risks to price stability. In light of this, it is a question of time until the external value of the euro fully reflects its internal stability. Turning now to some of the strengths of the euro area and the challenges ahead, it is worth noting that just to bring the euro area countries to the point where they fulfilled the convergence criteria was a tremendous achievement for European fiscal and monetary authorities. Only a couple of years ago, few still believed that as many as 11 countries would make it. However, as I will explain in a moment, launching EMU was only the first step and the greatest challenge still lies ahead if the euro area is to maximise the benefits and opportunities of EMU. Some of the strengths of EMU I have already touched upon. They relate mainly to the dimensions of the new economic area. The Monetary Union completes the Single Market by irrevocably fixing the exchange rates between the euro area countries, thereby lowering transaction costs and making pricing more transparent in an economic union where goods, services, capital and labour move freely. Gradually, this will spur greater competition and innovation in the euro area. Additional strengths are a favourable external position in terms of assets and current account, a highly trained and skilled labour force and a high level of technology and innovation in production. Taken together, and with the right economic policies, the economic opportunities to improve growth, employment and living standards in Europe in a lasting manner are enormous. From my point of view, as a central banker, a very important feature is that the Monetary Union offers a unique opportunity to establish and maintain price stability throughout the euro area. In this field, we can build on a large amount of practical experience and research in Europe and the world over the last 20 years. Price stability is essential as a foundation for strengthening output and employment prospects and thereby creating lasting improvements in living standards for Europe's citizens. Not only does price stability reinforce the relative price mechanism, thereby ensuring that markets allocate resources efficiently, it also minimises the inflation risk premium in long-term interest rates and avoids large and arbitrary redistribution of wealth and income. A monetary policy that maintains price stability in a credible way will therefore make the best overall contribution to improving economic prospects. This has been recognised by the Treaty on European Union, as well as the Eurosystem's stability-oriented monetary policy strategy. The Treaty also recognises that making the ECB and the national central banks independent of national governments and political interference enhances the credibility of monetary policy. We at the ECB intend to fully use these provisions to fulfil our mandate of maintaining an economic environment of price stability, low inflationary expectations and long-term credibility for monetary policy, which, as a result, will make the best contribution to investment, employment and economic growth. Of course, as regards economic policies, there are clear limits to what monetary policy can achieve on its own. In guaranteeing price stability, monetary policy needs to be accompanied by responsible budgetary and wage policies. Therefore, the Stability and Growth Pact is in place to ensure sound developments in the field of fiscal policy. However, in order to achieve a badly needed improvement in non-inflationary growth and employment prospects in the euro area economies, monetary and fiscal policy need to be complemented by fundamental restructuring policies, especially in the field of labour markets, but also in the public sector. As the instruments of monetary policy and exchange rate adjustments will no longer be available to national authorities, there is emphasis on policies to further correct structural deficiencies in order to find other ways to adjust to country-specific disturbances. In this respect, EMU represents an economic and political constraint, which, to my mind, will enhance the transparency of economic policy by clarifying the distinction between what each field of economic policy can achieve and thus what each field of economic policy is accountable for.The private sector and the social partners also have an important role to play, in taking account of productivity developments and the need to reduce unemployment when negotiating wage settlements. This brings me to some of the weaknesses of the euro area and the challenges ahead. I should like to elaborate in more detail on two areas: labour markets and the public sector. The reduction of unemployment is one of the major challenges facing the euro area Member States. Labour markets in most European countries differ substantially from the more flexible ones in, for example, the United States, although several European countries have made important steps towards increased flexibility. Their experience has demonstrated that implementing structural reforms is a lengthy process and that it takes considerable time for the impact on unemployment to become evident. This is why there is a pressing need for reforms. On the basis of extensive analysis by international bodies and academic research - for example the latest IMF World Economic Outlook, which contains a comprehensive overview of the causes of unemployment in Europe - a predominant view has emerged that unemployment in Europe is mostly of a structural nature and caused by factors of an institutional and regulatory character. On the part of job seekers, generous unemployment and other benefitsand the length of time for which these can be claimed, as well as high marginal tax rates and social security contributions, are perceived as acting as a disincentive to search actively for employment or to accept job offers or training and education, especially for those with low incomes. Moreover, longer periods of unemployment are associated with a loss of skills and thus a severe reduction in re-employment prospects. The proportion of long-term unemployed is generally very high in Europe. Around half of the unemployed in the EU have been out of work for at least a year, while in the United States, for example fewer than 10% of the unemployed have been without work for this long. On the part of employers, high non-wage costs, particularly statutory social security contributions, as well as strict employment protection regulations, have been identified as important employment disincentives. Moreover, the levels of minimum wages are considered to compare unfavourably to the labour productivity of, in particular, youth and the less skilled. As regards the interplay between labour demand and supply, reference is often made to industrial relations, which are not always organised in a way that allows wage formation to reflect productivity developments. In a number of countries consensus between unions, employers and government has led to substantial wage moderation that in the medium term has tended to favour employment growth. In a world of rapid technological development and increasing global competition, a smooth and timely adjustment of wages and skills to changing requirements is crucial. Combined with higher levels of education and training (and retraining), this would imply increased labour mobility, so that vacancies that coexist with high unemployment in some regions or sectors can be filled. A higher proportion of flexible employment contracts would help to accommodate firm-specific needs while enabling the labour force to move towards the most productive sectors. In addition, the attainment of higher rates of labour force participation in a number of countries is still hampered by regulations and disincentives concerning part-time employment. The participation rate is, for instance, only around 67% in the EU as a whole, while it is around 78% in the United States and 81% here in Denmark, according to OECD figures. Finally, the coexistence of a variety of structural rigidities tends to lead to a mutual reinforcement of such rigidities. A number of measures are available to governments. In order to improve the functioning of the euro area economy and economic fundamentals, especially with a view to reducing unemployment, structural measures to improve the functioning of labour and product markets are essential. Welfare and tax systems should not make work financially unattractive to low-paid workers and efforts should be made to promote training and incentives in order to keep the long-term unemployed in the labour market. The way wage settlements are conducted and the account being taken by social partners of productivity and unemployment developments also need to be addressed. Product market reforms are equally important, such as making it easier for people to start and run businesses and thus create new jobs. Libraries are full of appropriate theoretical insights and overwhelming empirical evidence. Numerous official meetings have addressed the problem. Summit after summit at the European level has ended with strong words in favour of action. Now, finally, it is time to act - the millions and millions of unemployed should not have to wait any longer. This brings me to the other weakness of the euro area that I should like to discuss, namely the public sector. When talking about weaknesses in the overall economic framework of the euro area, it is impossible not to mention the situation in the public sectors of many euro Member States. This concerns both the short-term situation in terms of deficits and debts and the more long-term issue of public pension and health care systems, which is closely linked to demographic developments, and in particular the ageing population, as well as the more theoretical issue of the optimal size of the public sector. Although in the run-up to EMU we saw considerable progress in fiscal consolidation, government deficit and debt levels remain on a level in many euro area Member States which is too high and not sustainable. In addition, the reduction in structural budgetary imbalances seems to have been at a standstill since 1998. This is worrying, in particular because in 1998 the economic and monetary environment in the euro area was per serelatively beneficial to Member States' public finances, but many governments did not take advantage of these benefits to gain additional budgetary room for manoeuvre. Since in many Member States budgetary positions are not yet sufficiently prepared to cope with the consequences of even moderate cyclical downturns, there is a risk that government deficits and debt levels might start increasing in the near future. The requirement laid down in the Stability and Growth Pact for medium-term budgetary positions close to balance or in surplus is still far from being reached in a number of Member States. Also, for the future, a number of Member States are aiming at deficit ratios in the order of magnitude of 1% of GDP, as is apparent from the stability programmes they recently submitted to the European Commission. This might be regarded as sufficient to enable automatic stabilisers to operate under normal conditions without running a high risk of breaching the limit of 3% for the deficit-to-GDP ratio. At the same time, however, it must be stressed that only a minimum requirement would be fulfilled by Member States in achieving these medium-term budgetary plans. Severe recessions or other unexpected events might deteriorate budgetary positions further, thereby bringing deficits to excessive levels and putting renewed upward pressure on debt ratios and ultimately on long-term interest rates. Moreover, in view of the foreseeable demographic developments, there are also important risks embedded in the current financing structures of public pension and health care systems. Many countries do not, at the moment, include sufficient safety margins in their medium-term plans to address such risks. Hence, the building-up of surpluses rather than just a balancing of government budgets is indeed a medium-term necessity for many European countries. Another crucial factor representing a weakness of the euro area economy is the size of the public sector and its considerable involvement in the production of private goods. Let me look at some of the points mentioned so far in more detail: One prominent reason why even almost balanced budgets might not protect budgetary positions sufficiently against future challenges lies with the organisation of most public pension systems in Europe. Declining birth rates together with a general increase in life expectancy will result in ever-increasing dependency ratios (the ratio of people over 65 in proportion to the population of working age) over the coming decades. Government transfers to households, in particular granting public pension and health care services for a growing number of recipients of such transfers, will have to be financed out of social contributions paid by a shrinking number of workers. Over the coming 10 to 20 years, these demographic trends will lead to serious financial problems in social security schemes across the euro area. Inevitably, maintaining current levels of social protection while also keeping social contribution rates at their present levels are incompatible, if drastically increasing deficits in the social security sector are to be avoided. Other subsectors of general government could only step in to finance growing social security deficits on condition that sufficient budgetary leeway was achieved in these subsectors. Alternatively, public pension and health care transfers would need to be cut or social security contributions raised to keep the budgets of social security schemes balanced. The extent to which structural adjustments in government budgets would be required in order to achieve sound fiscal positions over the longer term has been illustrated recently by various calculations. Estimated present values of future pension payments and expected social contributions may give an indication of the amount of hidden or implicit liabilities of social security schemes financed on a pay-as-you-go basis. Also, the "generational accounting" approach has attracted growing attention from international organisations as well as national economic and monetary authorities. Long-term projections of economic or demographic trends are obviously dependent on a number of assumptions and therefore not always fully reliable. However, most calculations clearly suggest from a qualitative point of view that current fiscal policies in many euro area countries cannot be maintained in the long run while at the same time retaining the financial integrity of public sectors. Instead, today's fiscal policies often imply a shifting of financial burdens onto future generations of taxpayers. In many countries these future burdens appear to exceed the level of official government debt by a clear margin. Hence, adjusting fiscal policies with a view to reaching certain deficit and debt targets largely neglects the existence of these hidden liabilities. Even a balanced budget, or the achievement of the reference value for the government debt ratio, would not in themselves guarantee that government budgets were adequately prepared to cope with future challenges. Governments would therefore need to provide for additional safety margins in their budget plans and not just protect themselves against the consequences of potential recessions of normal magnitude. Another aspect, which is related to the issue I have just mentioned, seems to be of crucial importance. The public sector in most euro area countries appears to be excessively large. Although the reasons for the size of the public sector vary among countries according to social values and traditions, the development of the "welfare states" in Europe is very similar across countries. Over much of this century government expenditure rose as a share of GDP in all industrialised countries, from around 10% of GDP at the beginning of the century to around 30% of GDP in the early 1960s. The marked growth in public spending after the 1960s to an (unweighted) average of around 44% in the OECD countries in 1997 is, however, largely explained by the growth of public expenditures in the European countries. As I mentioned before, the government expenditure of the euro area Member States is, on average, substantially larger than in the United States or Japan, with a share of government expenditure to GDP of 49% as compared with 35% and 39% in the United States and Japan, respectively. Moreover, governments have tended to give in more and more to the temptation to finance current expenditure by means of additional debt. In many countries this development was mainly accounted for by a steady extension of the level of social protection granted through public transfers. Especially in a monetary union, the incentives to increase debt rather than raise taxes in order to finance spending might even be higher than in a national framework, since governments that run excessive debts are less likely to be penalised by higher long-term interest rates in the same way as before. This has been one main rationale behind the establishment of fiscal rules as entry criteria for EMU and for further tightening these rules by implementing the Stability and Growth Pact. However, the size of public expenditure, though probably affecting a country's economic efficiency and thereby the functioning of EMU, is not an explicit part of the Treaty's fiscal rules. There is no doubt that the provision of sufficient public services is desirable and necessary from an economic as well as a social point of view. The allocation and redistribution of a substantial amount of resources through the government sector is therefore clearly justified. It is less clear, however, to what extent it is useful for a country's resources to be administered by government authorities and thereby withdrawn from the allocative mechanism of the market economy. Research provided by, inter alia, the IMF has tried to find a way of answering this question. According to this research, in the early decades of this century the building-up of the welfare state in most industrialised countries resulted in a sizable increase in living standards which could be observed from the evolution of different social and economic indicators. For instance, the development of sufficient health care services and education facilities crucially depended on the public provision of these goods. This increase in social and economic performance continued in most countries until the early 1960s. Since then, government expenditure on social protection has more than doubled its share of GDP in many industrialised countries. At the same time, however, this increase did not go hand in hand with a significant improvement in economic or social performance in these countries. On the contrary, the further expansion of social protection schemes in most industrialised countries after the beginning of the 1960s does not appear to have been unambiguously efficient or even effective in improving social conditions and living standards. Rather, the provision of relatively comprehensive income support may have entailed an increase in so-called free-riding behaviour and heavy resistance to any reform proposals aiming at a lowering of transfer entitlements. Moreover, the countries that did not increase their spending much beyond the levels reached in the 1960s seem to have performed as well or better in terms of various economic and social indicators, such as real GDP, unemployment, inflation, education, health care and equality. Hence, many governments, notably of euro area countries, may have exceeded an optimal size. As a consequence, tax burdens may be too high and tax and transfer systems are often organised in a way that discourages economic efficiency. So there may be good reasons for investigating whether there is scope for scaling back current government activities without sacrificing too much in terms of social and economic objectives, as well as rethinking the composition of government expenditure and receipts. Finally, despite the recent efforts of governments to privatise part of their public enterprises, governments are still heavily involved in the production of private goods, thereby crowding out private enterprises and losing the economic opportunities deriving from the free operation of a market economy. As an alternative, government activity might be more efficient if concentrated on the key objectives of the public sector, in particular, the provision of an efficient public capital stock supporting the economy in a lasting way. In conclusion, the euro area economy seems to have some of the building blocks, which are essential for it to be an attractive and well functioning economic area. The monetary policy framework in place is well defined and geared towards price stability. While some progress has been achieved in the fiscal field, no relaxation can be allowed in reaching the medium-term budgetary requirements of the Stability and Growth Pact. Economic policies now need to focus on the structural and microeconomic features of the economy, especially in labour markets and the size and composition of public sector expenditure and receipts. Results from countries at a more advanced stage of the reform process imply that there are good examples that could be followed by other countries. Now let me turn to the issue of whether and how the euro area could be extended. There are various possibilities for extending the euro area. First, we have the non-euro area EU Member States that might some day join the euro area. Second, there are applicant countries to the EU for which appropriate preparations for entry to EMU need to be made, including possible monetary frameworks. In addition, the use of the euro has already been extended to several countries through their fixed exchange rate arrangements. Denmark, which has chosen to exercise its opt-out at the start of EMU, is among the four countries which are members of the EU but not participating in Monetary Union. The relations between the euro area and the four non-euro area countries, as we tend to call them, will mainly be governed by the exchange rate mechanism called ERM II, in which Denmark and Greece participate, but not Sweden or the United Kingdom. Since the start of Stage Three, Denmark has participated in ERM II with a narrow fluctuation band of 2.25%, which signals and emphasises a strong policy commitment. The fixed exchange rate policy is, and has for a long time now, been a central element in the macroeconomic policy framework in Denmark. This is likely to be appropriate for a small economy which is highly integrated in Europe, such as that of Denmark. Over the years, this framework has undoubtedly helped Denmark to foster a stability-oriented economic policy, with low inflation and inflationary expectations, sound fiscal balances and a high degree of convergence with the euro area, while at the same time placing continuous and high demands on structural and budgetary policies in order to maintain low price and wage inflation, competitiveness and a sustainable external balance. In many respects, and especially on the fiscal side, Denmark serves as a good example of the virtues of ambitious and sound stability-oriented economic policies. In recent years, Denmark has outperformed many of the euro area countries in terms of growth and employment. In fact, Denmark was among the first countries to fulfil the Maastricht criteria for joining the Monetary Union. I feel confident that there are good reasons for the non-euro area countries to eventually join the euro, not only from an economic point of view but also for political reasons. To stay outside deprives the non-euro area countries of the possibility of influencing policies that will without doubt have a great impact on their domestic policies. This is the reality of living in a highly integrated region. Joining EMU will not, however, make it easier to accomplish some of the important and sometimes painful structural reforms that I discussed earlier, but these are problems which non-euro area countries will need to address even outside the euro area, and there is no evidence that this task is made any easier by having a national currency. In some cases, it could even make it more difficult, since there can be an element of moral hazard in having a currency that can be adjusted rather than addressing the underlying problems in the economy. Within EMU, countries no longer have that possibility and the incentives to reform the economy should therefore be greater. It is also highly likely that, within a few years, there will be new Member States in the EU. Formal negotiations with several applicant countries, mostly from eastern Europe (Poland, Hungary, the Czech Republic, Slovenia, Estonia and Cyprus), have started. However, I would not expect these countries to adopt the euro as their currency immediately upon accession to the EU. They might still have some way to go in terms of meeting the convergence criteria and, equally importantly, they need time to adjust fully to the internal market and the so-called . Economic reforms and the deregulation of markets, especially financial markets, are essential in this respect. In addition, a period of participation in ERM II is not only demanded by the Treaty, but will also be useful as a means of preparing to join the euro area. To some extent, the euro has already been extended to these countries, as several eastern European countries (Poland, Hungary and Bulgaria) have exchanged the share of the Deutsche Mark in their anchor currency baskets for the euro. Also, for countries that apply a managed float system (the Czech Republic, Romania, Slovakia and Slovenia), the euro has become the most important reference currency. As trade relations with these countries increase, it is likely that the euro will become even more important in this region. Let me conclude by making some final remarks on the future of the euro. One immediate challenge the euro area is facing on its way to the new millennium is indeed the transition to the new millennium , the Year 2000 problem. With a view to minimising the risks for the European financial markets, the Governing Council of the ECB has decided that the TARGET system will be closed on 31 December 1999. This will enhance the safety of the transition to the Year 2000, since it will allow the end-of-day and end-of-year activities for all systems and all backups of data to be finalised before midnight on that day. Similar measures have been discussed by ministers of finance, in order to ensure that all necessary measures are taken to guarantee a smooth transition to the new millennium. Apart from this more technical issue, what are the prospects for the euro in the years to come? May I risk making a forecast of the future challenges and opportunities for the euro area? First, on the one hand, we have, of course, the impact of structural rigidities and market distortions on product and labour markets, which for a long time now have hampered output growth and employment in Europe and which urgently need to be addressed. The high and persistent unemployment in Europe is a tremendous waste of productive assets, not to speak of the social costs it inflicts on individuals and society. In an appropriate environment and with sound, forward-looking economic policies, more people could be brought back into active work, as many countries have shown. The issue of unemployment has been discussed for a long time but these discussions have not been followed up with decisive action, which indeed is warranted now. In addition, the euro area is facing major challenges with regard to the public sector. Not only is there the question of its optimal size highlighted by continuous growth over the century, and particularly since the 1960s, but more urgently, public finances need to be strengthened in order to cope with an ageing population. With the pay-as-you-go pension systems that many countries have today, public finances will deteriorate rapidly as the share of people of working age in relation to the number of people over 65 years of age diminishes in the future. In a world of rapid change, accelerated by the impact of globalisation and new technologies, the effectiveness of new production technologies and organisational approaches depends to a large extent on how quickly the institutional and regulatory framework can adjust. Therefore, this changing environment calls into question not only the working practices of business and education, but also economic policy. In reviewing economic policies, it is clear that the relationships between structural economic policy and conventional macroeconomic stabilisation policies have to a great extent changed. The tools of fiscal and monetary policy, which we used to consider relevant for short-run stabilisation policies, have become more long term-oriented. For instance, we are all coming to accept that the most important task for monetary policy is to stabilise the economy in a medium-term perspective by preventing inflation and deflation, rather than stabilising business cycles in the short run. Technological change makes structural policies more important in relation to stabilisation policies, as a rapidly changing economy requires more freely and better functioning markets. At the same time, further economic integration implies that stabilisation policies cannot be implemented at the national level without substantial spillover effects. The example of Japan shows clearly that there comes a point at which stabilisation policy cannot be a substitute for structural reform or overcome structural impediments. In the same vein, we have come to a point in Europe where more focus needs to be put on structural obstacles to growth and employment. On the other hand, Europe continues to have a high potential for growth as a result of its rich endowment of human and physical capital and technology. With EMU, a policy framework has been put in place, with an independent central bank pursuing the clear objective of price stability alongside the Stability and Growth Pact, which should guarantee that past mistakes do not recur as regards inflation and excessive budget deficits. In order to fully benefit from Europe's growth potential, reduce structural unemployment in a sustainable way and make the whole economy more resistant to economic disturbances, there is, in addition, a need to adjust and adapt the institutional and regulatory framework in Europe to meet the requirements of a rapidly changing modern economy. Politicians in Europe have a great responsibility to address these issues in a decisive manner. Given that monetary policy is no longer determined at the national level, there is also a risk that national political authorities may be tempted to attack the ECB and try to use it as a scapegoat for various economic malfunctions. This is why discussion on the possibilities and limits of different economic policies is so important. Transparency, accountability and a degree of honesty are needed in all these deliberations. We at the ECB do not fear open and frank discussions. By discussing all aspects of economic policy, including monetary policy and its possibilities and limits, in an open and transparent way, we narrow the gap between different views of the functioning of the European economy and increase understanding. Of course, complete consensus cannot always be achieved, nor indeed should it be achieved, in a pluralistic and free society. Even so, open discussions always leave some impression, particularly if they are based on balanced reasoning and analytical skills. The more complex and fast moving the world becomes, the less room there is for easy solutions or intellectual arrogance. The exchange of views between policy-makers in a wide range of sectors is therefore only to be welcomed. At the same time, the competencies of each policy area need to be observed in order to guarantee the independence of institutions. The European Central Bank plans to take part in this discussion in a constructive way, if only for the purpose of explaining our monetary policy and showing our determination to fulfil the task allocated to the ECB by the Treaty, namely price stability. In response to the slowdown in the world economy and the resulting weak outlook for inflation since last summer, the Eurosystem has acted resolutely by reducing interest rates. Now it is up to the elected leaders to do their part by removing structural obstacles to employment and growth in the medium to long term.
r990507a_ECB	euro area	1999-05-07T00:00:00	The euro: a currency bridging peoples and cultures	istanbul	0	I should like, first of all, to thank the Central Bank of the Republic of Turkey for the invitation to attend the meeting of the Central Bank Governors' Club in Istanbul . When I received the invitation, I immediately felt obliged to accept it. Seen from Frankfurt , the 14 countries in your club are the south-eastern neighbours of the European Union (EU), with which the EU has had privileged trade relations for decades. Indeed, in the case of Turkey these date back to the signature of the "Ankara Agreement" in 1964, which marked the start of Turkey 's association with the European Community. Your Governors' Club represents an area which has naturally close ties to the EU, and the ongoing accession process for the enlargement of the EU will bring the EU even closer to you. Other joint efforts to enhance the dialogue between the EU and your countries - for instance the establishment of a Euro-Mediterranean Conference (known as the "Barcelona process"), of a European Conference and of "agreements of partnership and co-operation" with Russia and other members of the CIS States - will enhance the quality of contacts between the EU and other countries in the area. In my view, the recent tragic events in the Balkans have made it even more urgent for the EU to have a more intense dialogue with our south-eastern neighbours. I am convinced that it will be our joint responsibility to re-establish the prospect of political stability and economic growth in that area of Europe . To our neighbours I should like to say that the EU is not building "Fortress Europe", an impregnable stronghold. Even in symbolic terms, when the design of our first series of banknotes was selected, the European Central Bank (ECB) chose to convey to European citizens the message that Europe owes a particular debt to the patrimony of ideas and values of the rest of the world, and in particular to those regions which are geographically the closest to us. As you know, the features which will be printed on the new euro banknotes are a satellite picture of Europe - including some of the neighbouring regions - together with designs of bridges and windows of different styles of European architecture, representing the main periods of our common tradition. The choice by the ECB of these architectonic elements for our first series of banknotes is not accidental, as the windows symbolise the openness of the EU to the external world and the bridges stand for the circulation of people and ideas within and beyond our territory. I should also like to add that Europe is uniting itself in full awareness of its historically attested strengths and weaknesses. Europe has inherited a splendid cultural tradition from the past and, in an invaluable symbiosis with other cultures, has greatly contributed to the progress of mankind. However, over the centuries Europe has also been an area of deep conflicts and sometimes fierce rivalries, exporting instability to the neighbouring regions. The process of European unification - which this January took a major step forward with the launch of the euro - originates from the intention of the people of Europe to create a stable basis for peace on our continent. Europe wishes to be a source of stability for its neighbours, thus contributing to a broader process of peaceful understanding among the world's regions. To sum up, I should in no way wish to give the impression that the euro area is speaking from a position of "intellectual arrogance". In the monetary field, as in others, Europe has had some good and other not so good experiences. The countries of the euro area today share a culture of monetary stability; they respect common rules of market-oriented governance of the economy and fiscal soundness. For these reasons they enjoy a high degree of respect and credibility in the international financial markets. However, the path to the single currency was a long and often difficult process spanning over 30 years. The first policy statements in favour of the creation of a single currency were solemnly approved by our Heads of State or Government in 1969 and they gave rise to the Werner Plan in 1971. However, after the collapse of the Bretton Woods system in 1971 and the oil shocks in 1973 and 1978, Europe struggled to find a common way out of excessive foreign exchange rate volatility, which was ultimately due to the divergence of its Member States' economic policies, strong inflationary pressures and general conditions of disorder, in some Member States more so than in others. One important issue which I will repeatedly stress during my presentation is that the Monetary Union in Europe is not the simple evolution from looser experiences of monetary integration (the European "snake" first and the European Monetary System later) into a stronger monetary agreement. The 11 countries participating in the euro area today have one currency and therefore only one central bank system, called the Eurosystem, which comprises the ECB - based in Frankfurt - and the 11 national central banks of these countries. Monetary policy decisions are taken by the Governing Council - which is composed of the six members of the Executive Board and the 11 national central bank governors.- These decisions are taken by a simple majority vote, following the principle of "one person, one vote". The Eurosystem has a clear policy mission, which is enshrined in Article 105 of the Treaty establishing the European Community: the primary objective is to maintain price stability. To this end, the Treaty has given the Eurosystem an unprecedented high degree of independence. The ancillary mission of the Eurosystem, also stated in Article 105 of the Treaty, is to support the general economic policies in the European Union, with a view to contributing to the achievement of the main objectives of the EU . This ancillary mission shall be pursued without prejudice to the primary objective of price stability. The Eurosystem is the sole central bank of the euro area, as the national central banks no longer take independent monetary policy decisions, but are parts of the Eurosystem and execute the decisions made by the Eurosystem itself. Monetary policy decisions taken by the Eurosystem are equally applicable across the entire euro area. The Eurosystem conducts monetary policy operations (mainly through weekly repurchase transactions) with all credit institutions in the 11 participating countries, at the same rates and under the same conditions. The banks are offered the same conditions (for instance, for the use of the standing facilities) and must comply with the same regulations (for instance, the obligation to comply with reserve requirements). Liquidity is allocated to them without any system of national quotas. The monetary policy framework has been built up with the express desire to create a level playing-field for all financial centres and national banking systems. Immediately after the launch of the euro in January 1999, the euro gained a broad financial basis, not least because all public debt in the euro area was redenominated in euro during the weekend of the transition from the old monetary regime to the new currency, creating a domestic market which is of around the same dimensions as that of fixed-term securities in the United States. Fourth months after the start of EMU, the money market is already well integrated. This was one of the main sources of concern for the Eurosystem at the start of the year, as we were aware that creating an efficient single money market also depends upon the creation of a tight network of contractual agreements between market players across the euro area. The data on the money market transactions of the 57 largest commercial banks in the euro area - which we process daily for the computation of the EONIA - indicate that overnight rates across the euro area are homogeneous, with differences of only a few basis points, mainly justified by the different liquidity needs of the credit institutions. The turnover of the overnight transactions in the euro money market of the 57 EONIA banks is in the range of between EUR 30 billion and EUR 60 billion per day. Another indicator of the smooth functioning of the money market is the reduced use which is now made of the two standing facilities offered by the Eurosystem to all our counterparts (to deposit excess liquidity or finance debit positions overnight). When the euro was launched, however, banks were forced to have very extensive recourse to these facilities, as they were not able to find counterparts in the broader market. The integration of the money markets across the area is supported by TARGET, the real-time gross settlement system of the euro area, which processed, in terms of value, a daily average of EUR 913 billion in March, of which EUR 342 billion represented cross-border transactions. Other wholesale payment systems operating across the euro area processed, on average, a further total EUR 422 billion per day in March. With the removal of currency risk and its low interest rates, the euro is also a source of dynamism in Europe 's financial markets. This is particularly evident in bond markets world-wide, where 44% of all new bond securities in the world were issued in euro in the first quarter of 1999 (around the same percentage as for the US dollar) - a substantial improvement compared with the combined percentage of the former national currencies. The euro was also one - although not the only - driving force behind recent alliances between exchange or derivative markets and the intense activity of mergers and acquisitions in the banking and financial industry. I am very aware of the fact that the unique features of the transition from the former national currencies to the euro (the immediate introduction of the euro on the financial markets and a three-year transition phase for the introduction of the euro banknotes and coins) have given rise to a number of questions in our neighbouring countries. I should like to comment briefly on some of these issues. First , I should like to stress once again that, despite the circulation (at their par value) of the former national banknotes and coins for a transition period of three years, EMU is a fixed exchange rate regime linking many currencies. The continued circulation of the banknotes of the former national currencies does not mean that these currencies still exist in the form of fully-fledged, independent national currencies. By means of directly applicable European law, the euro has become the only currency of the participating countries. The former national currencies remain for three years as mere "subdivisions" of the euro. Second , bank deposits in the former national currencies are de jure equivalent to deposits in euro at the irrevocable conversion rates; if this has not yet occurred, they will be automatically converted into euro on 1 January 2002 . Third , contracts and other liabilities - including international contracts - denominated in the former national currencies of the euro area can be executed in euro or in a former national currency during the transition phase, according to the wishes of the two parties concerned. the euro is the only vehicle for foreign exchange transactions with the participating countries, as the foreign exchange markets no longer trade in the Deutsche Mark, French franc, Italian lira or Spanish peseta. Contracts denominated in the former national currencies will be deemed to be in euro from January 2002 onwards, without any need for the parties to modify their legal terms. Fourth , the new single currency of Europe is immediately available to the neighbouring countries as a vehicle to raise capital in the new, broad financial markets of the euro zone. Several neighbouring countries - including Turkey and several Central and Eastern European states - have already taken advantage of this opportunity. Fifth , in the neighbouring countries the former national banknotes traditionally circulate as a popular means of storing value. They will continue to circulate in the euro area for the first three years of Stage Three of EMU. They will continue to be the only legal tender for cash payments in the respective countries until 1 January 2002 , the deadline which will affect your citizens the most. Shortly afterwards (most probably before the end of the maximum period of six months set by the relevant EU Regulation) the national banknotes will cease to have legal tender status. When the transition phase has been completed, i.e. when the national banknotes and coins have been ultimately withdrawn from circulation, it will become even more evident that the launch of Stage Three of EMU is a most occurrence in the history of regional institutions. EMU is an international agreement to co-ordinate monetary policies. It is the establishment, for the EU, of the same monetary regime that normally exists for currency and central bank. Nevertheless, given the current state of integration in Europe , the euro is not yet the currency of a single state or nation, but rather that of a group of states whose integration is in progress. These countries retain their separate sovereignty in many important fields, while sharing it in many others: the ultimate form of this unique political construction - which combines different levels of government - has not yet been reached. The experience of the single currency is, in my opinion, the culmination of a long progress of economic integration and, at the same time, the start of a new process of a deeper communality among EU citizens. I very often refer to the fact that the circulation of a joint currency within a territory is a symbol of confidence among its citizens, as people who do not trust one another would not ultimately consent to share the same fiduciary currency. Let me underline two implications of the European experiences for the possible future development of international relations. First, if the century-long coincidence between the geography of states and that of monies is no longer binding, this means that important components of sovereignty can be pooled and shared among nations in the pursuit of welfare and peace. This opens up new possibilities precisely at a time when growing economic interdependence and world-wide systemic risks call for an enhancement of co-operation among sovereign states and for new and more efficient ways to manage the global economy. Second, the European Union is an example of a regional construction in which different nations co-operate through a common rule of law and common institutions. While continuous support of arrangements through multilateral institutions is necessary, I firmly believe that a level of co-operation is becoming an indispensable complement. Over 180 independent countries in the world are just too many for one-tier global governance to be sufficiently effective. Moreover, interdependence is often regional, rather than global. At the regional level deeper forms of co-operation may be possible, because an effective pooling of sovereignty may be less difficult to achieve. Europe provides an outstanding example of all that, and the advent of the euro is only the last, albeit the most prominent, manifestation of a long process. It is not for me to judge whether the countries represented in the Governors' Club have anything to draw from the European experience. What I can say is that we in Europe , like you in the Balkans, in the Bosphorus region, on the Black Sea and in Central Asia , have a recent past of bitter conflicts. It is our memory of this past that caused us to try to construct a peaceful and prosperous future. At this point I should like to go on to make some comments on the international role of the euro. It is not Eurosystem policy to "sell its own currency" to foreign monetary authorities, or to express views or recommendations to other monetary authorities on their foreign exchange rate orientations or their choices for the investment of reserves. In fact, we take the view that the euro will gain ground in the international financial markets on the basis of its own intrinsic merits: a high degree of anti-inflationary credibility, the effective persistence of its internal stability, the setting-up of broad and deep financial markets, the strength of its economy and the position of Europe as the world's leading trade partner. It might well be that markets are underestimating the intrinsic strength of the euro, as a reflection of the different conjunctural positions of the American and European economies, of the difficulty of estimating the real value of assets denominated in a new currency and also against the background of the current tragic events in the Balkans. This is possibly the destiny of new currencies, since - as those who know the monetary history of Europe will be aware - something similar also happened to the newly born Deutsche Mark during the Korean crisis in 1950-51. History also tells us that, in the evolution of monetary events, inertia is often a factor which should not be underestimated: the pound sterling kept its role as the reference currency of the world markets for a long while in the first half of this century, after the US economy had exceeded the dimensions of that of the United Kingdom . The euro has the potential to become a large and important reserve currency for institutions outside the euro area. This is all the more true for those regions of the world - such as your countries - which are closest to the EU, have developed important trade relations with its economies and are in the process of strengthening them with a number of agreements for enhanced co-operation. I sometimes speak of the euro as a currency whose natural use will extend beyond the euro area - and even the borders of the European Union -to a broader area which I can only describe as "the time zone of the euro". In fact, the euro means that a new economic player is emerging, which has about the same importance as the United States and twice that of Japan . The euro area, or "Euroland" as it is often called in the media, is an area of almost 300 million people, producing 15% of world GDP. (The United States produces 20% and Japan 8%.) Accounting for 16% of world exports, the euro area is the largest trading partner in the world economy. The birth of such a large economic power may give rise to anxiety, but should also generate hope. Anxiety, because it may convey the impression that a new colossus is taking shape, and that the European Union's south-eastern neighbours, in a period of persistent internal difficulties, risk marginalisation. Yet at the same time, hope, because European countries, notwithstanding their past conflicts, have achieved advanced forms of co-operation that may be of interest to others. I am well aware of these mixed feelings. This is the reason why it gave me great pleasure to accept your invitation today and take advantage of the opportunity to convey to you a sincere message of openness and co-operation.
r990520a_ECB	euro area	1999-05-20T00:00:00	Speech at the 11th Frankfurt International Banking Evening	duisenberg	1	It is indeed an honour for me to have been invited to say a few words here this evening at the Frankfurt International Banking Evening. At the same time, it is more than a challenge and a rather daunting task. Speaking after Hans Tietmeyer is almost like preaching after the pope. Moreover, I believe it is well known by now that the members of the Governing Council of the ECB speak with one voice. So, what does that leave me to say? 2. Some have taken this principle of "speaking with one voice" to mean that there would only be one spokesperson for the ECB. That is a misunderstanding. Each of the members of the Governing Council of the ECB has a voice and makes use of it. It is essential for the decisions and views of the Governing Council to be explained comprehensively throughout the euro area as well as outside it and multiple expression is one way to do it. This is particularly so in these early years following the introduction of the euro. After I had given a speech in German, Theo Waigel once observed, "The euro speaks German." He was right, of course, but the euro actually speaks the languages of all the other countries in the Eurosystem. We speak with one voice but, if need be, in eleven languages. This evening we are speaking English, although Hans quoted an advertisement in Dutch in which I appear. I shall presently also speak two sentences in German. Incidentally, Hans could also have referred to another advertisement in which a puppet - according to some people, a President of the ECB look-alike - is doing some basic arithmetic. He calculates that if 1 euro is 2 guilders and 20 cents that then 2 euro are 4 guilders and 40 cents. At the ECB our sums are rather more complicated than that, but Hans rightly argued that central bankers cannot be replaced by computers. Neither should the second advertisement be taken as an argument for replacing central bankers by puppets, especially not with their strings being pulled by Ministers of Finance. 3. We, the members of the Governing Council of the ECB, speak with one voice, but not all voices are identical. How can they be, since they belong to different individuals? We are not in the business of producing clones. Earlier this evening we once again had the privilege of listening to a convincing and clearly audible voice. There is nothing in what was said with which I disagree, and I intend to add very little to it. In fact, on some matters I can only repeat what was said in my own words. Don't worry, I shall not do this extensively. However, repetition is the mother of all genuine knowledge. I cannot therefore resist the temptation to focus briefly on two points that Hans made. The principle of conducting monetary policy within a longer-term framework and from a longer-term perspective is the first issue that I should like to address. This principle sounds simple and its logic is indeed not complicated. It is, however, as difficult to adhere to it in practice as its logic is simple. It seems to me that it has even become more difficult to apply in recent decades as a result of the rapid development in information and communication technology. Tonight is not the occasion to elaborate on this at length, but perhaps you will allow me to share the following reflections with you. Developments in these areas have brought great benefits and have the potential to lead to significant additional welfare gains in the years ahead, not least in Europe. At the same time they present challenges to economic policy-makers, since they have already fundamentally changed the character of society and its economies. These changes are ongoing and we are only beginning to come to terms with them. The word which characterises much of today's lifestyle is "zapping". The equivalent of "zapping" in monetary policy terms is adopting an activist policy, with over-eager responses to all the items of daily information in the financial markets. I sometimes have the impression that activism is experiencing a revival in some circles, although the past has demonstrated clearly how ill-advised we would be to follow such policies. Hans Tietmeyer has time and again stressed the importance of taking a longer-term view. He has also pointed out - although this is perhaps less known - that economies do not operate in isolation. Historical developments and the wider social and cultural environment should be taken into account. Short-termism is also the name of the game being played by some commentators who, barely five months after the introduction of the euro, are drawing far-reaching conclusions about the success of the euro or, more spectacular, its failure. From a longer-term perspective, one can appreciate, for example, that the current situation of price stability is a great improvement on the situation in many countries in recent decades. Making the euro a lasting success is of course an ongoing process and indeed, in line with the title of Hans' speech, "a permanent challenge and task". This task requires the input of many persons, firms and institutions. Of course, the Eurosystem is not the least important in this respect. 4. This brings me to the second point made by Hans on which I should like to focus. That is that, in the end, even the most independent central bank cannot guarantee the maintenance of price stability if no real support for this objective is given by fiscal policies, politicians, social partners, good academic analysis, the financial community as present here this evening and the public at large. Although, technically speaking, an independent central bank is able to maintain price stability in the medium term, in the longer term the actual outcome would be radically different without the existence of what Hans would call an entrenched stability culture. The importance of this cannot be overstated here in Europe, where we have just introduced a new currency in eleven countries with different histories, cultures and backgrounds. Establishing and maintaining a European culture of stability is of the utmost importance. This also explains why central bankers regularly express their views on other policies, be it fiscal policies or structural reforms. I have done so in the past and shall continue to do so in the future - as always, on a constructive basis and in recognition of the fact that the central bank does not decide on these policies, but only gives its advice. The German authorities have received a great deal of advice from Hans over the past six years. Perhaps they did not always like his advice - for instance when they wanted to revalue the stock of gold - but I am sure that they were not surprised that he gave it. They would have been really surprised, however, if the President of the Deutsche Bundesbank had expressed his views. To help to establish and maintain a culture of stability is also one of the reasons why a central bank needs to be open and communicative. We at the ECB attach great importance to this principle and are making every effort to practise it. We are prepared to learn from experience and to adjust our line of thinking wherever and whenever it proves necessary. Only the pope is infallible - central bankers are not. Communication should not be unidirectional. We are willing to listen to others and to exchange information and views with them, while at the same time bearing in mind our own spheres of responsibility and those of others. Finally, I should like to mention the importance of a serious, well-informed and constructively critical press in this communication process. For the communication process to function well we need to provide the press with sufficient information, clearly conveying our views to its representatives. It also calls for journalists who are prepared to really digest this information, not just to "zap" through it in search of an eye-catching headline; they also need to study the sometimes technical background of central banking. A particular group of journalists awards the prize of European central banker of the year. Perhaps it would be a good idea to award a prize to the best European financial journalist of the year. Let me make myself clear, I should not want to be involved in the organisation of such a competition, nor even to have a vote in selecting the winner. I have to admit, though, that I would be interested in the outcome. 5. Tonight Hans Tietmeyer has addressed the Frankfurt International Banking Evening for the last time in his capacity as President of the Deutsche Bundesbank. Hans, I know that it is not over yet. However, August is drawing closer and closer. You have now entered the phase in which you are doing things for the last time in your present capacity. Recently, you visited De Nederlandsche Bank. It was probably your last visit, but, surprisingly, it was also your first. I say surprisingly, because as President of the Deutsche Bundesbank you represented the Deutsche Mark, which, as we in the Netherlands used to say, was for fifteen years pegged so successfully to the guilder. 6. Tonight is not the occasion to say farewell to you. Nor am I the person to make the farewell speech that you deserve. In this group of financial experts there is no need to go over your impressive career with all its highlights; they are well known. Let me just simply mention some of the facts: almost six years as President of the Bundesbank, your unique role in the German unification process, your key role in the establishment of EMU from the very beginning (in fact, you were a member of the Werner group in the early days of planning economic and monetary union) and your role on the international scene, not least but certainly not only in the central banking community. Germany, Europe and the world know you as a determined, uncompromising and convincing teacher of the necessity and merits of stability-oriented policies. What you had and have to say was perhaps often predictable, but more often than not your saying it lent it weight and inspired confidence. Moreover, what you once aptly said is absolutely true: "Man kann schone Sonntagsreden halten. Die Entscheidungen fallen an Werktagen." You are known to be a hard worker - some would even say a workaholic - and you have tremendous "Ausdauer". You never get tired of putting your analysis and convictions across, as has again been demonstrated tonight. We owe you a great deal of gratitude. After August we central bankers will miss you as a colleague, although I believe we have internalised your basic principles. They will therefore still be around as if you are still present yourself. And should we tend to forget them, I am sure that Ernst Welteke will help me to remind other colleagues of them. Sometimes, I wish that we could do the same as they do in the world of sport in the United States. There, when an outstanding player retires, in order to honour him the number he wears on the back of his shirt is never again used by another player. Central bankers do not wear shirts with numbers on the back, but if we did, I am sure that we would withdraw your number. Retirement is the natural end of one's career, but it should not be overdramatised. People do matter - and you have certainly shown that - but institutions generally outlast them. In fact, that is what many people work for. Luckily, I am convinced that this is the case in central banking. So, the institutions that you have worked to build will go on. Meanwhile, as I look ahead to August, I know that while I will lose a colleague, I will still have the same friend. I know that is true for many of us here this evening. I should therefore like to close by simply expressing my thanks for your support over the years both as a colleague and a friend.
r990521a_ECB	euro area	1999-05-21T00:00:00	The euro: the birth of a new currency	hamalainen	0	It is a great pleasure and honour for me to have been invited here today to say a few words about the birth of the new European currency - the euro. , eleven European countries took a historical step forwards by entering Stage Three of Economic and Monetary Union. Thereby, the national currencies of these eleven countries became denominations of a single currency. At the same time, the "Eurosystem" (which is composed of the European Central Bank (ECB) and the eleven national central banks of the participating Member States) assumed responsibility for the monetary policy of the euro area. In hindsight, I think we can say that the technical change over to the euro was a tremendous success. Taking into account the monumental task of more or less simultaneously implementing changes in thousands of computer programs and operational procedures throughout the financial markets, it is astonishing that we experienced only minor teething problems; and these problems seem to have been corrected in the meantime. The successful technical launch of the euro was made possible thanks to the careful preparations of the project. It also showed that all participants (i.e. the ECB, the national central banks, public authorities and, above all, banks and other financial institutions) were committed to the project and that they carried out their preparations in a professional manner. However, the changeover to the euro has not yet been completed. The euro still exists only in non-tangible form, i.e. in the form of book entries in information systems. The absence of euro coins and banknotes may have implied that the introduction of the new currency was perceived by most people as a rather abstract event. The national banknotes and coins will remain in circulation until the euro banknotes and coins are introduced in 2002. This "second" changeover will likewise require substantial preparations. Apart from the one-off large-scale printing of banknotes and minting of coins, it will also require important changes for the handling of cash in the retail sector, e.g. the adaptation of teller and vending machines. I am convinced that all the parties involved will execute this "second" changeover just as professionally as the "first" changeover at the beginning of this year. Clearly, the launch of the euro was a truly historical event, not only in view of the complexity of the task and its careful preparations, but mainly in that it would have far-reaching economic and political consequences for the participating countries and for the international monetary system as a whole. Most of these consequences are of a gradual and long-term nature. The euro will have important consequences at many different levels: In view of these long-term effects, I think that it would be unfair to judge the success of the euro only on the basis of the economic and financial developments during the first five months of the new currency's life - particularly to the extent that these short-term developments reflect effects of economic trends and political events outside the euro area. Nevertheless, the experience of the first five months of the new currency's life gives some indications of the international importance of the euro and its implications for the financial markets in the euro area as well as in a global perspective. I would like to share with you some of these experiences gained in the five months since the euro was borne, seen from a banking perspective. The most obvious consequences of the introduction of the euro were to be seen in the functioning of the foreign exchange markets. The mere fact that eleven European currencies, some of which were among the most actively traded currencies world-wide, disappeared and were replaced by the euro as a major international currency had a fundamental impact on the turnover and focus of attention in the global foreign exchange markets. . This survey shows that, in the last few years, the US dollar increased its importance in the foreign exchange markets. In 1998, the US dollar was involved on one of the sides in 88% of all foreign exchange transactions, compared with 45% for the currencies that were replaced by the euro. It is interesting to note that, compared with the previous survey carried out in 1995, the share of transactions carried out in the currencies which were replaced by the euro has fallen considerably. It appears that market participants, even before the euro was launched, considered the various constituent currencies as close substitutes. So far, there are no reliable statistics available on the development of the foreign exchange markets since the introduction of the euro. However, early indications based on information from market participants seem to indicate that the euro's share in international foreign exchange transactions is currently indeed lower than the aggregate share of the constituent currencies was in 1998. Nevertheless, euro/US dollar trading established itself from the very outset as one of the most active and liquid segments of the foreign exchange market, providing a variety of instruments and large hedging possibilities. The development of euro/yen trading, by contrast, has so far been surprisingly slow. As a matter of fact, this holds true of trading in euro against Asian currencies in general. It is as yet too early to assess the reasons behind this rather slow development of euro/yen trading, although there seems to be some caution among investors and traders in the Asian region to use the euro. This caution could be related to the generally relatively weak performance of the Asian economies, and it may be underpinned by the fact that the euro is a new currency with no historic data to conduct analysis and to base investment decisions on. Here, the Eurosystem will have to continue to play an important role by informing and communicating with actors in the international financial markets in order to increase the knowledge and understanding of the objectives of the Eurosystem and to explain the functioning of the policy measures and instruments at hand. This notwithstanding, I think that it is indisputable that the euro is likely to further strengthen its position as one the most important currencies in the foreign exchange market. The sheer size of the euro area economy, which is comparable to the US economy, is an important factor which should ensure this status. The Eurosystem's firm commitment to price stability should also contribute to the long-term stability and credibility of the euro, thereby promoting its attractiveness as a trading and investment currency. In the longer run, the further development and integration of the euro area financial markets will also contribute generally to enhancing the international attractiveness of the euro. One segment of the euro area financial markets in which we have already seen rapid changes following the introduction of the euro has been the money market. Before the euro was borne, we wondered how rapidly and smoothly eleven separate money markets would integrate. Traditionally, the national money markets each had their own market participants, different dealing procedures and settlement structures, segmented credit lines, different languages; even market conventions, such as the method for calculating interest, the opening hours and public holidays, used to differ across the national money markets. From the Eurosystem's perspective, it was considered important that an integrated euro area money market was established relatively soon after the introduction of the euro since this would be a pre-condition to ensure that cross-border arbitrage eliminates interest differentials across countries. In reality, the national money markets turned into an almost fully integrated euro area-wide money market within one or two weeks - even faster than we had expected. The experience of the euro area money market shows that, since the introduction of the euro, the daily dispersion of country averages of overnight rates (as measured by the (European Overnight Index Average)) has stabilised at around 2 to 3 basis points. In addition, it shows that there is no systematic interest rate difference between the rates offered by banks established in different financial markets. We can therefore conclude that we have achieved a euro area-wide money market which is sufficiently integrated to ensure a single monetary policy stance throughout the euro area. In order to achieve an integrated money market, the establishment of new payments systems structures was instrumental. Here, the TARGET system developed by the Eurosystem plays an important role. This system links all the large-value national payment systems in the EU. It is interesting to note that this system is currently handling considerably more cross-border payments than initially anticipated. Turning to the longer end of the yield curve, the cross-border integration of bond markets in the euro area is progressing at a slower pace, as is also true of equities and derivatives markets. This notwithstanding, we are experiencing important developments also in these segments of the financial markets, part of which is related to the introduction of the euro. The capital markets in Europe have traditionally been highly segmented. This segmentation was the result of the use of different currencies as well as of differing regulations, taxes, market practices, etc. Thanks to the introduction of the euro, market participants increasingly perceive similar instruments traded in the different national markets to be close substitutes. This holds particularly true of bonds issued by the euro area governments, where the establishment of common benchmarks, the narrowing of yield spreads and increased market liquidity seem to indicate that a high degree of cross-border substitutability has already been achieved. The fact that euro area financial instruments are increasingly considered to be close substitutes increases the competitive pressures for the national markets to attract issuers and investors wishing to benefit from increased cross-border competition and lower transaction costs. In this context, we have recently experienced several initiatives aimed at creating capital markets across national borders, such as the plans to establish pan-European stock exchanges. Initiatives towards an increased integration of capital markets are welcome since they may provide for a wider range of financial instruments on offer, at a lower cost, than is currently the case in the national markets. This could lead to a positive circle in which the increased issuance of instruments denominated in euro will draw the attention of international investors to the euro area capital markets, thereby again making the euro an increasingly attractive currency for private as well as public issuers. In fact, the experience from the first months of the life of the euro seems to indicate that such a positive development may already be at hand. In the first quarter of 1999, bonds denominated in euro accounted for around 50% of the bonds issued internationally. This share is considerably higher than the traditional aggregate share for the bonds denominated in the constituent currencies, which was in the range of 20% to 30% in recent years. We have also seen a considerable increase in the average size of the bond issues denominated in euro, as compared with those of bonds denominated in the former currencies, which may indicate that the trade in euro denominated issues is likely to become increasingly liquid. Despite the recent developments in the euro area capital markets, there is still plenty of scope for further securitisation in the euro area. For example, the amount of private bonds is still minuscule, compared with the United States. Private companies established in the euro area are still heavily dependant on financing through the banking system. However, I would expect that the increased efficiency of the euro area capital market will lead to a swift increase in the number of companies preferring to raise funds directly on the market. In this context, I would like to say a few words on how the introduction of the euro may underpin the reshaping of the European banking sector - although this is a subject you know far more about than I do. Traditionally, the banking sector of the euro area countries has lagged behind the banks of the United States and the United Kingdom in the provision of advanced and international financial services. So far, the European banking industry has remained segmented into rather small national markets. The introduction of the euro seems to have given momentum to cross-border integration in the European banking sector, as a result of the disappearance of the certain barriers implied by national currencies. For several years, large-scale mergers and acquisitions have taken place in Europe, but it was only very recently that we have started to see such deals to take place across national borders. I very much welcome this trend towards an expansion beyond national borders, since the establishment of truly pan-European - and global - banking groups will be instrumental in the efforts to enhance competition in the provision of financial services. However, increased cross-border banking activities will require close co-operation on the part of the national authorities responsible for prudential supervision and for monitoring market competitiveness. Here, I should like to express some concerns about any tendencies of national authorities to try to favour the preservation of "national" banking structures at the cost of postponing the development of a competitive and efficient pan-European banking structure. The increased scope for securitisation in Europe will put further pressure on the banking sector to move away from traditional bank lending towards more specialised financial services. We have only seen the beginning of a major structural reshaping of the European banking sector. At present, there are almost 10,000 credit institutions in the euro area. Large benefits from economies of scale are to be gained from consolidation in the European banking sector, whereby the number of universal banks may be significantly reduced. When a business sector faces the need for major structural reshaping, it is important to see the challenges and opportunities ahead, rather than applying a defensive and protectionist approach. However, I am convinced that decision-makers in the banking sector are well aware of the changing environment - I just hope that they will be able also react fast enough. I should like to conclude by underlining once more that, although it is too early to make a firm assessment of the long-term success of the euro and its role in the international monetary system, it is beyond any doubt that the euro will further strengthen its role as one of the world's leading currencies. In addition to its economic impact, Economic and Monetary Union has and will continue to have an immense psychological and political impact at the global level. Europe may have been perceived - especially from outside - as excessively inward-looking throughout this period. But the construction of strong institutions for a common Europe has been and will continue to be necessary before Europe will be ready to assume its share of the responsibility for and play its role in the resolution of global problems. The sheer size of the euro area in the world economy as well as the institutional set up of the Eurosystem, ensuring a firm commitment to price stability, are important factors determining the international role of the euro. However, the long-term success of the euro also depends crucially on the determination of governments to maintain fiscal discipline and undertake necessary structural reforms. It also depends on the ability of the private sector, and not least the financial services industry, to respond to the demands of the new environment by improving competitiveness and foster innovation. In this respect, the experience gained after the first five months of the new currency is very encouraging. The successful technical implementation of the euro, the rapid establishment of a fully integrated money market in the euro area and the on-going developments in the euro area capital markets seem to indicate a high degree of preparedness by the banking system to meet the challenges of the new environment.
r990524a_ECB	euro area	1999-05-24T00:00:00	Should the ECB have broader objectives beyond price stability?	no_info	0	Thank you for inviting me to participate as a speaker at the Wilton Park Conference on Economic and Monetary Union. It is an honour and a real pleasure for me. The question in the title of my session "Should the ECB have broader objectives beyond price stability?" deserves a clear and immediate answer: yes, the ECB should have and, as a matter of fact, it does. states that "the primary objective of the ESCB shall be to maintain price stability" and adds that "without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community with a view to contributing to the achievement of the objectives of the Community as laid down in Article 2". Among others, these Community objectives are, in accordance with Article 2, "sustainable and non-inflationary growth respecting the environment" and "a high level of employment and of social protection". It is, therefore, clear that the ECB must focus its decisions, as a matter of priority, on the objective of stability which is its real "raison d'etre"; in addition, and without prejudice to this aim of stability, the ECB also has responsibilities relating to economic growth, employment and social protection. These responsibilities are general, conditional and secondary, if you like, but responsibilities nevertheless. Thus, it seems clear that beyond the primary objective of price stability, the ECB also has an implicit secondary objective: to support the other economic policies and, in doing so, to contribute to economic growth, and to reach a high level of employment and social protection. If we accept more than one general objective for monetary policy, it seems important to stress the need to prioritise these objectives and, in the case of the ESCB, to give top priority to the objective of stability. Any doubts about this could undermine the confidence of the public and the markets in the ESCB's commitment to stability, trigger inflationary expectations, and eventually - and paradoxically - hinder or jeopardise economic growth and job creation. Before getting into the impact of monetary policy on economic growth, let me say a few words concerning the close relationship which exists between stability and social protection. In the first article I published, only 30 years ago, when I was only 23 years old, I dared to qualify inflation as "immoral", for several reasons. Inflation unfairly deteriorates personal income and wealth. It distorts the proper functioning of public redistributive schemes, such as progressive taxation. It fosters speculation. It harms the weakest and the most vulnerable. My branding inflation as "immoral" caused surprise when I mentioned it after my appointment as a member of the Executive Board of the ECB. I must say I was surprised at the surprise. Without a doubt, one of the best allies of social justice is, precisely, stability. Surprising again, if you consider that, very often, those less inclined to support institutional arrangements and policies in favour of stability are precisely those who actively pretend to take a leading role in public in favour of social justice. Let us now focus on the relationship between the ECB's monetary policy, price stability and economic growth. I am convinced that, in the medium term, the best contribution that the ECB can make in favour of sustained economic growth is, precisely, to create an environment, an atmosphere of stability. Stability implies efficient allocation of resources, competitiveness, lower interest rate risk premiums, investment. All these factors are preconditions for economic growth or, in other words, preconditions for the fulfilment of the secondary objective of the ESCB. In securing its objective of stability, the Eurosystem creates the necessary conditions to comply with the European Union's objective of economic growth. There is clearly no greater fertiliser for economic growth than price stability, and nothing is more refractory to economic growth than inflation. I said that stability is "the best contribution" to growth, but I believe that it is not the only possible contribution. In other words, I understand that we cannot comply with the implicit secondary objective of the ECB stemming from the Treaty by means of simple adherence to its primary objective. The ECB's motto cannot be "only stability matters" or "the greater stability, the better". This could be true in the long run, where monetary policy only affects prices (stability) but not quantities (growth). But in the short term, monetary policy affects both prices and quantities and, therefore, we must accept the possibility of the existence of a trade-off between stability and growth, in line with the traditional Phillips curve as reformulated by Samuelson and Solow. The existence in the short term of a trade-off between stability and growth implies for the ECB the need to consider the possibility of a compromise between the degree of stability and the level of economic growth, and I emphasise that I said "degree of stability" and growth, and not a compromise between "stability" itself and growth. Stability is a concept rather than a single figure. Any price increase low or short enough so as not to cause distortions in price-setting (in connection with the Austrian approach), and low or short enough so as not to require the implementation of a general indexation procedure (in connection with the classical and neo-classical neutrality approach to money) is compatible with the concept of stability. The ECB understands that this is the case when the year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area as a whole stays below 2% over the medium term. A price increase of below 2% for the whole euro area not only does not prevent the existence of national or regional levels of HICP increases above and below the common level, it even implies the existence of such national or regional levels. Therefore, one must accept as normal that in some specific countries the inflation rate could be higher than 2% without any inconsistency with the stability of the whole area. The differences in inflation can be the result of the Balassa-Samuelson effect, or the result of a combination of a high level of nominal demand and supply rigidities. Nevertheless, if we accept that inflation is a monetary phenomenon and that the monetary policy stance determines the level of inflation in the medium term, we must conclude that these national differences in the HICP increase cannot be too large. Why below 2%? This limit is, of course, a convention. It could be 2.5% instead, just the same as one could set the speed limit at 90 kmph instead of 80 kmph. But, on the other hand, stability cannot be defined as an increase in prices of, say, up to 4%, just as 160 kmph is not a real speed limit. The substance underlying the 2% stability limit is that price increase should take measurement bias into account (the Boskin effect), it should allow variations in relative prices in economies with rather downside inflexible prices and wages, and it should be low enough so as to avoid distortions in price-setting and make any general indexation process unnecessary. Following our example, the limit must take into account the lack of precision of the car's speedometer, it must make it possible to overtake other vehicles safely and discourage reckless driving. Taking for granted that the previous conditions are fulfilled (room for measurement bias, room for variations in relative prices, no distortions, no need for general indexation) and that, therefore, stability exists, the ECB's monetary policy has room for manoeuvre to create the best monetary conditions in order to support the general economic policies of the European Union and, in particular, to create the best monetary conditions for exploiting the considerable growth potential of the euro area. Against this background the ECB decided on 8 April 1999 to lower interest rates by 0.5 percentage point, a decision which, in addition, could help reduce uncertainties and restore confidence in the economy. In this context, let me say a few words about the general orientation of the ECB's monetary policy. We understand that it should be a medium term-oriented monetary policy. Its short-term anti-cyclic effects - if any exist - are very limited and have to do with the influence on the confidence and expectations of economic agents. The medium term, lags, etc. are factors linked to the "mechanical" channels of transmission of monetary policy. The short term and "activism" are closely linked. No one can expect "activism" from the ECB's monetary policy. Our monetary policy is primarily intended to provide a general framework, a general environment, a general atmosphere of stability. In doing so, it creates the best conditions for economic growth and job creation. Provided that stability exists, in connection with the implicit secondary objective of supporting the general economic policies of the European Union, the monetary policy of the Eurosystem contributes to creating the economic conditions which are essential for exploiting the growth potential of the euro area. However, let me stress that it does so in a passive way, without any activism: like the air we breathe, rather than air from an oxygen tank. Fresh air as opposed to air from an oxygen tank: this is my metaphor to compare the passive monetary policy of the ECB with an active one. My President, Wim Duisenberg, has another, which has to do with television. In this case, activism means engaging in "zapping" instead of, I would imagine, sitting quietly watching the film and waiting to discover that - oh surprise! - the butler is the murderer. The metaphors of one's President are always better. Being passive does not necessarily prevent our monetary policy from having anti-cyclic effects. Anti-cyclic and counter-cyclic do not mean exactly the same. The ECB's monetary policy does not try to counter every cyclical fluctuation, but it helps to prevent pronounced cyclical fluctuations. It tones down the economic waves; it extends the economic wavelength and, by doing so, creates the conditions for sustainable economic growth. Another characteristic of the ECB's monetary policy is the absence of automatism, in the sense that monetary policy decisions do not follow on from changes in specific variables. In striking a balance between rules and discretion, the ECB is closer to discretion. However, please do not confuse discretion with opacity, automatism with transparency. After all, who really believes in rules robust enough to eliminate the need for discretion in monetary policy decisions? Who really thinks that monetary policy can be conducted with an automatic pilot? Who really thinks that, apart from being meritorious theoretical contributions and good references, the Friedman rule or the Taylor rule are key solutions for taking monetary policy decisions? Another principle of the ECB's monetary policy is the adoption of a global Eurosystem perspective. According to this principle, it would be erroneous to interpret the monetary policy decisions of the ECB from a national standpoint. Owing to the characteristics of monetary policy, no one should expect it to conform to all the peculiarities of the countries, regions or sectors of activity of the euro area. We must accept that implementing monetary policy in a large area implies limitations and complications. Nonetheless, these limitations are not only counterbalanced, but also surpassed by the advantages resulting from having a single currency in a single market. One of these limitations has to do with the fact that a single monetary policy implies a single nominal repo rate for the whole area and a single nominal short-term money market rate for the whole area. Starting from this point, the effects of monetary policy among different regions or countries of the area would be different, depending on several relevant factors. One factor is the different level of inflation in each country implying different levels of real repo rates for each country and different real short-term money market rates for each country, which could give rise to pro-cyclical local effects. At the same time, the transmission mechanisms of monetary policy are different in each country, reflecting differences in the structure of the financial systems and in the habits of the public; therefore, the effects of monetary policy will not be exactly the same. The specific national economic policies of the governments, in making good use of the possibilities of fiscal policy and other measures linked to the supply side of the economies, are the proper way to overcome these limitations of monetary policy. It is wise to recognise the general limitations of monetary policy and the specific ones of the Eurosystem. However, let us also recognise the advantages of a common stability- oriented monetary policy for the whole area, which clearly outweigh the drawbacks. Euro area citizens can expect a lot from the Eurosystem's monetary policy, but not too much. Rather than a technique, monetary policy is really an art form: the so-called "art of central banking". And do not forget that, unlike those made by engineers, mistakes made by artists are always forgiven.
r990525a_ECB	euro area	1999-05-25T00:00:00	Stable and efficient financial systems for the XXIst century - The euro area -	duisenberg	1	The euro area constitutes a large economy, of a size comparable to that of the United States. That fact alone places the euro and the euro area financial system firmly "centre stage" in the global economy. Consequently, it is essential for the euro area financial system to be stable and efficient, not only for the benefit of the euro area economy itself, but also for the world economy. had a profound impact on financial systems both within and outside the euro area. Part of this impact was immediately evident in the rapid integration of money markets and the replacement of national currencies by the euro in foreign exchange markets. The fact that the changeover to the euro progressed smoothly is a reassuring indication that the euro area financial system is able to remain stable during times of structural change. However, a further part of the impact on financial systems - most likely the greater part - will be experienced over a longer period of time. The euro is likely to become one of the major factors reshaping both the domestic financial system of the euro area and the global financial system. This process should lead to a more efficient allocation of finance within the global economy, but it will also call for the ability to adjust to structural changes in order for stable financial systems to be maintained. Today, I should like to outline the likely future development of the financial sector and of the financial markets in the euro area as envisaged by the European Central Bank (ECB). To this end, I shall first briefly discuss the impact of the introduction of the euro on domestic money markets. I shall then turn my attention to likely developments in the financial markets and in the banking system, before concluding with some remarks on how these likely developments might affect the stability and efficiency of the financial system in the euro area. Until the end of 1998 the various money markets of the euro area still displayed a certain number of distinctive features. However, following the changeover to the euro they were integrated swiftly and smoothly at the beginning of January 1999. A highly competitive single money market has already emerged in the euro area, as banks were well prepared for the changeover to the euro and the TARGET system has provided an efficient means of making cross-border payments. In particular, transaction volumes in money markets rapidly reached high levels while typical bid-ask spreads decreased almost immediately to very low levels. This indicates the depth and high degree of liquidity that the euro money market has already achieved. A feature of the current stage of the development of the euro money market, which is particularly worthy of note, is that differences in overnight interest rate spreads mainly reflect differences in the credit standing of banks rather than that of the country in which the transaction takes place. These structural developments are, of course, positive. For the Eurosystem (i.e. the ECB and the national central banks of the 11 countries participating in the euro area) the existence of a deep and liquid money market enhances the efficiency of monetary policy operations. In this respect, I should like to draw your attention to the "market friendliness" of the framework applied by the Eurosystem to the conduct of monetary policy operations. By this I mean that the framework is based on tenders in which markets decide who receives the liquidity. The standing facilities are open and recourse to the marginal lending facility is not subject to scrutiny. In addition, the list of eligible collateral is extensive. Looking now at the financial markets from a broader perspective, it is important to remember that the financial markets of the euro area began the process of integration before the start of Stage Three of Economic and Monetary Union. An indication of the pace of integration before January 1999 is provided in particular by the evolution of spreads between yields on the bonds issued by the various central governments of the euro area. These spreads narrowed continuously from mid-1995 onwards and their volatility was also noticeably reduced during this period. Factors contributing to this favourable pattern included increased convergence towards low rates of inflation across the euro area during Stage Two, the gradual reduction and finally the disappearance of exchange rate risks, the commitment of governments towards improving the sustainability of public finances, and the increase in the depth and liquidity of government bond markets. As I have already said on a previous occasion, I believe that the interest rate markets of the euro area will increasingly provide an accurate reflection of the differences in credit quality between various issuers as well as differences in liquidity between bonds, while divergences purely related to the location of market participants within the euro area will become less and less relevant. It seems highly likely that the capital markets of the euro area will become even deeper and more liquid over time, and hence more efficient. The number of market participants is likely to increase as the cost of financial market transactions is lowered, and the sophistication of position-taking activities is likely to increase further as market participants equip themselves with more refined methods of adjusting their portfolio exposures. One particular area of the capital market in which the markets in euro area countries have traditionally been a lot less active than in the United States is the corporate bond and commercial paper market. However, there are good reasons to expect that corporate bond and commercial paper issuance in the euro area will gather pace in the future. During the first few months of this year we have already seen a fair amount of activity in this field. For large companies in particular, it makes sense from the point of view of efficiency to have all the methods of financing at their disposal, namely bond and paper financing, bank loans and equity financing. Indeed, since the credit ratings of many large companies are better than the credit ratings of most banks, this should lead to savings on the cost of capital for the corporate sector. The introduction of the euro should provide sufficient depth and liquidity for the corporate debt market that would guarantee competitive pricing. On the demand side, the reduced borrowing of the public sector will leave more room for the private sector to issue debt securities. As you know, the amount of public debt in the euro area is still high, and we trust that governments will keep their commitment to bring it down to more sustainable levels as agreed in the Stability and Growth Pact. In addition, the euro area has to save in order to be able to take care of its future pension payments, and a part of these savings is likely to be invested in corporate debt securities. An increase in global demand for euro-denominated debt securities is also expected as the euro becomes a major reserve currency. Moreover, the demand for higher risk euro-denominated debt securities is likely to increase, particularly as the current low level of sovereign yields increases incentives to search for higher yields. Turning to equity markets, and first to the institutional set-up of stock exchanges, an evolution towards more integration and greater market efficiency is already apparent. As consolidation within the financial services sector has increased the size and geographical reach of intermediaries and fund management institutions, they seem to be pressing for market-places to become more concentrated in order both to reduce costs and to enhance liquidity. In addition, some companies have recently announced that they are reviewing their listing practices with the aim of reducing costs by cutting back on the number of exchanges in which they are listed. However, this development towards greater concentration does not necessarily mean that trading is concentrated only in a few exchanges. A possible pattern of development could also be for different stock exchanges to concentrate on specific types of companies ("blue-chips", specialised industries, small companies and new companies, for example). In any case, the physical location of stock exchanges is becoming less relevant as screen-based trading with remote access is becoming more widely used. With regard to investor behaviour, an increasing number of equity market investors already appear to be taking positions on the equity market of the euro area from a sectoral rather than a national perspective. Area-wide equity indices have been made available by various market participants, thus providing investors with opportunities to monitor area-wide equity positions as well as, in some instances, positions in area-wide industrial sectors. The fact that the euro area (and EU) equity markets are becoming more integrated, more liquid and deeper is good for market efficiency, and a more efficient allocation of capital should mean that equity financing becomes more readily available for companies. I should also like to mention that a prudent, harmonised regulatory framework, on the one hand, and harmonised market practices, on the other, are key factors guaranteeing a favourable outcome for these structural changes. In these areas a lot of work is under way, and much has still to be achieved in order to pave the way for truly integrated financial markets. Harmonisation in, for example, repurchase agreements, national company laws including bankruptcy laws, and other aspects of the legal and regulatory framework, would enhance legal clarity and certainty and thereby improve the efficiency and stability of the financial markets. Indeed, the European Commission recently published an Action Plan containing priorities and timetables for measures aimed at improving the single market for financial services. In the Action Plan, measures are proposed to advance the harmonisation of the legal framework and market information, as well as to facilitate investors' operations throughout the single market. In this respect, I should also like to pay tribute to the International Organization of Securities Commissions (IOSCO) for its efforts. Although I have focused mainly on the financial system of the euro area, we can clearly see that the euro area financial system is an integral part of the global financial system. With this in mind, I should like to express my support for the aims of IOSCO to promote high standards of regulation in order to maintain just, efficient and sound markets. Turning now to likely developments in the banking system, it is important to note that the euro area financial systems in general and the banking sector in particular have, until now, been relatively national and fragmented with little cross-border retail activity. However, it is envisaged that the euro will add weight to a number of fundamental factors that are increasing the pressure for structural change. With these structural changes I mean not only consolidation, which seems inevitable, but also increased cross-border co-operation and mergers. In short, the euro area banking sector is expected in the future to look and behave more like the banking sector of a single economy. In addition to and reinforced by the introduction of the euro, other factors that are leading to changes in the financial landscape include technological development, globalisation and changes in what consumers and firms expect from the financial system and financial service providers. These factors are reshaping the business of banking as well as the financial system as a whole. Economies of scale and scope may have been changing in different areas of banking and even taking different directions. For example, the rapid development of information technology has made the collection and processing of information considerably cheaper, but at the same time technological investments are taking a larger share of banks' resources. Therefore, economies of scale in some aspects of the collection of information may have been reduced, but at the same the time investments in more sophisticated technology have increased economies of scale and scope in some areas of banking. While I do not wish to go into detail on this matter, the general picture that emerges is that the banking industry has to be in a position to adjust to a new situation and take these factors into consideration. Indeed, in the course of the last few months, a number of bank mergers in the euro area, including mergers between relatively large institutions, have been announced or are being contemplated. Such "high-profile" mergers are likely to contribute to an acceleration of the pace of both the consolidation and integration of the banking systems of the euro area. However, it should be remembered that the recent pattern of consolidation represents part of a longer-term trend in the European banking industry, as is highlighted by the large decline in the number of credit institutions in the euro area countries over the past decade or so. In the mid-1980s there were more than 11,000 credit institutions in the euro area countries; today they number around 8,000. This sharp decline in the number of credit institutions is mainly the result of mergers among savings and co-operative banks, which epitomise what one may call "consolidating" or "defensive" mergers - mainly aimed at cutting costs and diversifying risks but also at reaching a size of own funds compatible with a regulation that has been agreed at the EU level. So far, this consolidation process has taken place mainly within national boundaries, with the possible exception of the Benelux and Nordic countries. The preference for domestic mergers (as opposed to cross-border mergers) may be explained by the fact that the relevant market for retail services remains national rather than pan-European. Furthermore, the scope for cost-cutting appears to be larger if the merging institutions have overlapping operations. The fact that cultural "proximity", notably in the corporate style of governance and management, is traditionally seen as a key factor in the success of mergers may also have played a role. However, from my own professional experience of running a truly pan-European bank, I could add that professional identity is a much stronger force for unity than national identity is a force for separation. I have outlined the likely pattern of evolution that we envisage for the euro area financial system. Summing up the various elements, we see a pattern which leads towards a financial system that should perform its functions more efficiently using the advantages available to the financial system of a large economy. A large financial system can be more readily versatile, i.e. provide investors and those in need of financing with a full range of options to choose from according to their requirements. What does all of this mean for financial stability in the euro area? First of all, I should like to remind you that the financial system of the euro area showed a high degree of stability during last year's period of financial turbulence as well as during the rather dramatic structural shift connected to the changeover to the euro. In the former case, it is true that there was a significant spillover effect for the euro area markets, but they recovered quickly and without suffering any lasting damage. There was no disruption to any of the basic functions of the financial system, and public confidence in it remained strong throughout. Second, the foreseen structural changes require, as I mentioned earlier, the need for adjustment to be taken seriously by all participants in the financial system. This adjustment appears to have intensified recently: there has been an increase in merger activity, an establishment of alliances and an introduction of new products and services, often based on modern information technology. The process of structural change contains risks, but if these risks are identified early and analysed carefully, they do not present a threat to financial stability. After all, we are talking about decision-making and planning by people who are dealing with risks every day at the highest professional level. In this regard, the smooth changeover of the financial system to the euro demonstrates the virtues of efficient and careful forward planning. Third, I do not view efficiency and stability of the financial system as being contradictory. In many ways these qualities actually support each other by laying a firm foundation for the financial system. An inefficient financial system, in addition to being costly to society, can be more vulnerable to shocks. At the ECB, we play our part in the evolution of the euro area financial system by providing it with stable monetary conditions. By creating an environment of price stability, we allow private sector agents to focus their attention on the questions that are most relevant to their activities and to take advantage of the benefits of this stable environment, such as the lengthening of their planning horizons.
r990526a_ECB	euro area	1999-05-26T00:00:00	First experience with the euro	noyer	0	I should like to start by thanking you for your kind invitation to speak here on the occasion of this conference organised by the Swedbank. It is some five months now since the euro was launched. The introduction of the euro has been accomplished successfully and the enormous technical and logistical challenges arising during the early days of Monetary Union have been overcome. The first months of the euro have been successful in both political and operational terms. With the introduction of the euro, European integration has taken a large step forward as the new millennium approaches. The euro plays an important role in the euro area and beyond. Just after its launch in January, the euro already featured on all major financial markets around the globe. Currency trading is regularly carried out in euro and shares are denominated in euro on most European stock exchanges. Moreover, the euro has attracted new international bond issues as the currency of denomination. In some ways, the introduction of the euro may justify expectations of large overall efficiency gains. For citizens living in the euro area, two obvious gains will be the reduction of transaction costs and increased transparency across countries, as price comparisons between goods sold in different countries are made easier. The Governing Council of the ECB is the central decision-making body in charge of monetary policy for the euro area. The Treaty on European Union - usually known as the "Maastricht Treaty" - assigns the ESCB the primary objective of maintaining price stability in the euro area. The implementation of monetary policy decisions taken centrally by the Governing Council rests with the Eurosystem, comprising the ECB and the national central banks (NCBs) of the Member States which have adopted the euro in Stage Three of Economic and Monetary Union. The respective operational tasks are to a large extent carried out in a decentralised manner by the NCBs. For the euro to become a "success story" as the single currency for around 300 million people, the confidence of European citizens in the stability of the new currency and in the Eurosystem is crucial. You would probably agree that the Eurosystem has already achieved a lot in terms of building up credibility and gaining a sound reputation in financial markets for its monetary policy in its early days. This will certainly facilitate the establishment of a "stability culture" throughout Europe. The foundation of this stability culture is a broad consensus among Europeans that the maintenance of price stability is of the utmost importance and is conducive to the achievement of other objectives such as high employment. By maintaining price stability in the euro area, we shall ensure that the single monetary policy contributes as much as possible to economic growth and high employment. At the same time, national fiscal authorities and general economic policies also have to demonstrate their commitment to the maintenance of price stability in the euro area. In this context, the Stability and Growth Pact adopted in 1997 is a crucial element. Its aim is to encourage the pursuit of disciplined and sustainable fiscal policies for the participating EU Member States and prospective members. In so doing, it can make a significant contribution to the establishment of favourable conditions for sustained economic growth and high employment in the medium term. Moreover, sound fiscal policies facilitate the task of monetary policy to maintain price stability. It would be counterproductive if national fiscal policy-makers were not to continue to work towards a budgetary situation which is close to balance or in surplus in the light of the achievement of Monetary Union and the positive price outlook for the euro area. In this connection please allow me to briefly address the matter of calls for closer co-ordination between monetary policy and fiscal policies. Any form of ex ante co-ordination that, for example, would commit the monetary policy of the ECB to move its interest rates in a certain way in response to specific action or plans of other policy-makers would provide the wrong impetus for the conduct of sound macroeconomic policies and would not be efficient. This does not, however, exclude a constructive dialogue between the Eurosystem and government authorities which clearly respects the independence of the ECB. In line with its clear mandate, enshrined in the Treaty establishing the European Communities (referred to as the "Treaty"), and for sound economic reasons, the ECB has to decide which monetary policy best serves the maintenance of price stability over the medium term and then act accordingly. At the same time, the Treaty also emphasises the need for sound fiscal policies. This clear separation of responsibilities is both efficient and transparent. Obviously, monetary policy alone cannot solve Europe's economic problems such as the present intolerably high level of unemployment. Appropriate structural reforms implemented by national governments are of the utmost importance and much progress is required in this broad area. Moderate wage settlements in both the public and private sectors would, of course, contribute to reducing the high level of unemployment in many parts of the euro area. In this context, let me remark that recent wage agreements in some parts of the euro area do not appear to be in line with the need to encourage higher employment. With regard to the Eurosystem's monetary policy strategy, I should like to emphasise that the euro area monetary policy is a single one and therefore indivisible - by definition. Monetary policy decisions must be based on area-wide rather than national considerations and hence on area-wide indicators. Monetary policy has to be transparent so as to stabilise public expectations of future price developments. In order to clarify how we interpret the mandate conferred on the ECB by the Treaty, the Governing Council has announced a quantitative definition of its primary objective. Price stability has been defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. This has to be maintained over the medium term. As the wording "increase" makes clear, deflation - that is, a persistent fall in the price level - would not be consistent with price stability. It would not be possible for us to announce where exactly we would draw the dividing line between price stability and deflation. This is partly for reasons that have been described as the measurement bias in consumer price indices. For the United States it was estimated that measured consumer prices tend to slightly overestimate actual inflation. A bias may also exist for the euro area HICP, although its exact magnitude is as yet unknown and needs to be explored further. To maintain price stability, the Governing Council of the ECB has chosen a stability-oriented monetary policy strategy. The chosen strategy is forward-looking in nature and also ensures as much continuity as possible with the former strategies of the NCBs. In this respect and with regard to the overriding objective to maintain price stability in an environment of flexible exchange rates, our strategy is broadly similar to that of the Riksbank, although there are important differences. In particular, the Riksbank follows a direct inflation targeting strategy in which monetary policy is almost exclusively guided by inflation forecasts of about two years ahead. In contrast, the Eurosystem relies on two pillars, thereby focusing on the medium term, and does not give such a predominant role to inflation forecasts as the Riksbank. In our view, the Riksbank has achieved high standards with regard to transparency and accountability, as is for example evidenced by its comprehensive quarterly inflation report. In more recent years, the Riksbank has enjoyed a fair measure of success in gaining control over domestic price developments, as supported by the strong performance of the Riksbank in fighting inflation, and in overcoming a deep recession in the early 1990s. Its track record also demonstrates that price stability in Sweden was given a high priority long before this was formally recognised by an amendment of the Riksbank Act at the start of 1999. The Eurosystem's stability-oriented monetary policy strategy rests on two "pillars", which are both important when the Governing Council discusses monetary, financial and economic developments at its bi-weekly meetings. The first pillar, which is a prominent role for money, takes into account the essentially monetary origins of inflation over the medium to long term. It recognises that empirical studies show a stable long-term relationship between money and prices in the euro area. Therefore, in the euro area, monetary developments constitute an important guide for the conduct of monetary policy and it is essential to analyse and monitor the development of monetary aggregates closely. The ECB has announced a quantitative reference value for broad monetary growth as measured by M3, the first reference value for M3 growth being set at an annual rate of 4 1/2 %. This reference value is consistent with the maintenance of price stability over the medium term, while allowing for sustainable output growth and assuming a trend decline in the velocity of circulation of M3. In setting the reference value for monetary growth, the Governing Council emphasised its medium-term orientation. Substantial or prolonged deviations of current monetary growth from the reference value will normally signal risks to price stability in the medium term. The ECB does not intend to react to deviations of monetary growth from the reference value in a "mechanistic" way. In the first instance, such deviations are analysed thoroughly to infer any signals which they may give about the prospects for price developments. If the deviation points to a threat to price stability, monetary policy has to react in a manner appropriate to counter this threat. Although monetary data contain information which is important for monetary policy decision-making, monetary developments alone clearly do not constitute a complete summary of all the economic information necessary for appropriate policy decisions to be taken. Thus the Governing Council emphasises that it is important, in parallel with the assessment of monetary growth, to look at a wide range of financial and other economic indicators, including economic forecasts. The second pillar of the Eurosystem's strategy therefore consists of a broadly based assessment of the outlook for price developments and the risks to price stability in the euro area as a whole. This broadly based assessment takes into account, inter alia, the information provided by wage developments, exchange rates, fiscal indicators, real economic activity, and asset and commodity prices. Forecasts of economic activity and prices in the euro area can certainly also contribute to the success of an appropriately forward-looking monetary policy. Thus we take into account forecasts available from international organisations such as the IMF or the OECD as well as internal forecasts. We are clearly aware that forecasts have to be interpreted with great caution. Given behavioural, institutional and structural uncertainties, forecasting price and other developments in the euro area is inevitably difficult. Moreover, a forecast cannot encompass all the indicator variables that are important for monetary policy. Nor can it always incorporate indicators in a timely manner. Furthermore, by the time the forecast has been finalised, the original assumptions may have become less realistic, requiring a careful interpretation of the results. Therefore, a thorough analysis of individual indicator variables plays an important role in our monetary policy strategy, in addition to any role that these variables may have in the forecast. Within the stability-oriented monetary policy strategy, the Eurosystem also takes into account the external value of the euro as an important determinant of the outlook for price stability. If exchange rate developments pose a significant threat to price stability in the euro area, all other things being equal, monetary policy will have to respond. Of course, all other factors that impart information on price developments will also be taken into account before an interest rate decision is taken. In December 1998 the Governing Council of the ECB announced that the level of interest on the main refinancing operation would be 3%. In the first quarter of 1999 the Governing Council kept this rate unchanged. After an in-depth review of recent monetary, financial and economic developments, the Governing Council decided at its meeting on 8 April to set the interest rate for the ECB's main refinancing operations at 2.50%. In addition, the interest rate on the marginal lending facility was lowered to 3.50% and the interest rate on the deposit facility to 1.50%. These rates were left unchanged at the meeting of the Governing Council last week. The decision to lower interest rates taken at the first meeting in April has to be seen in the context of the stability-oriented strategy. The decision has thus been taken from a forward-looking perspective, focusing on the medium-term trends in inflation and the compatibility of these trends with the Eurosystem's definition of price stability. By adhering to this strategy, the Eurosystem's monetary policy contributes to creating the economic conditions which are essential to exploiting the considerable growth potential of the euro area and to reducing uncertainty about future economic developments. I should like to take this opportunity to explain the current assessment, which is in line with the Governing Council's expectations at the beginning of April. With regard to the first pillar of the Eurosystem's monetary policy strategy, monetary growth cannot be seen as signalling upcoming inflationary pressures at this stage. Since the beginning of this year, the three-month moving average of M3 growth has been close to the reference value of 4 1/2 %. For the period from January to March 1999 the average growth rate increased somewhat to 5.2%. This observation may, however, have been affected by special factors prevailing at the start of Stage Three. Therefore, in its current assessment the Governing Council does not regard current monetary trends as constituting a signal of future inflationary pressures. With regard to the second pillar of the Eurosystem's monetary policy strategy, the broadly based outlook for price developments and risks to price stability and various indicators of future price developments and economic activity in the euro area indicate a favourable outlook for price stability in the euro area. Financial indicators such as the very low level of long-term interest rates point to low inflation expectations and the credibility of the monetary policy. Following the cut in short-term interest rates, long-term rates decreased somewhat initially, which confirms that the market considered the cut in interest rates by the ECB to be appropriate. More recently these rates have risen somewhat mainly as a reflex to the strong increase of long-term interest rates in the United States. Regarding economic activity in the euro area, data available for the first two months of 1999 do not yet reveal evidence of a rebound in economic growth. Labour market indicators show signs of a somewhat decelerating level of employment growthtowards the end of 1998. Meanwhile, preliminary April figures from the European Commission on confidence indicators point towards some first signs of an improvement in industrial confidence. Recent price trends have been consistent with price stability. Inflation for the euro area as measured by the Harmonised Index of Consumer Prices (HICP) has been close to 1% since the fourth quarter of 1998. As has been emphasised on previous occasions, the current low inflation rates are, to some extent, the reflection of the large fall in energy prices during 1998. HICP data for March 1999 show an annual increase of 1.0%. The slight increase relative to January and February reflects the fact that goods prices are subject to some upward movement in the short term owing to the reversal in energy price trends expected by the Governing Council at the beginning of April. However, the effects of changes in energy prices on rates of HICP increase may only be of a temporary nature. More lasting effects on future consumer prices normally come from changes in the overall monetary and economic situation in the euro area. To sum up, weighing all the relevant indicators and adopting a forward-looking and medium-term perspective, the Governing Council regards the current level of ECB interest rates as appropriate with a view to maintaining the outlook for continued price stability. The Treaty acknowledges that it is important in a democratic constitution for an independent central bank to be open, transparent and clear about the reasoning underlying its actions. Therefore, a number of reporting obligations exist for the ECB which aim at making the ECB accountable for its performance. Moreover, by communicating clearly with the public, the Eurosystem reinforces its credibility. In this regard, the Eurosystem's approach bears comparison with the "best practices" of any other central bank in the world. In practice the ECB has committed itself to exceeding the stringent requirements of the Treaty concerning transparency and accountability. For example, the ECB releases each month a bulletin providing detailed background information regarding the current assessment of the economic outlook. At the same time, with the more extended editions of the bulletin in March, June, September and December, we fulfil the Treaty requirement to publish a quarterly report. For the benefit of the general public, the ECB issues regular press releases and an introductory statement by the President, which is released immediately after the first Governing Council meeting each month. Furthermore, the ECB submits an annual report on its activities to the European Community institutions (the Council of the European Union, the European Commission and the European Parliament). With regard to the Eurosystem's relationship with European Community institutions, the Treaty states that the President of the ECOFIN Council and a member of the European Commission may participate in the meetings of the Governing Council of the ECB, with the right to express their views but without voting power. The President of the ECB attends hearings at the European Parliament (at least) four times a year to discuss the activities of the Eurosystem and is also invited to attend the informal Euro-11 Council meetings. I should like to stress that the participation of the President in these meetings serves the purpose of exchanging information and views, while fully respecting the independence of the Eurosystem. In the field of the international representation of the ECB, formal and informal agreements have been reached with the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD) and in the context of the G7 and the G10. At the end of last year the IMF granted the ECB the status of observer. As you will be aware, full membership of the IMF is restricted to individual nations. Nevertheless, this observer status will allow the ECB to participate in the relevant work and assessments by the Fund of economic policies in the euro area and beyond. Clearly, the introduction of the euro has had important implications for international capital markets. This has been the case not only because a number of currencies replaced by the euro, played an important international role in the past. This situation has also arisen because the euro has become the currency of an economic area which roughly equals the United States in terms of economic size and external trade, and which has the world's second largest capital markets. Let me emphasise at this juncture that the Eurosystem has no exchange rate target vis-a-vis other major currencies. We are also not participating in a formal exchange rate arrangement with third countries outside the EU, for instance with the United States, and we believe that this situation will continue in the future. It is important to mention that according to the Treaty the single exchange rate policy has to respect the primary objective of price stability. As the representative of a large economic area, the Eurosystem can best meet its overriding objective to maintain price stability in the euro area if it is not constrained by an exchange rate target. However, for smaller, very open economies, setting an exchange rate target may be a very reasonable decision. Against this background the ERM II exchange rate mechanism was created for those EU Member States which have not yet joined European Monetary Union, but are willing to do so in the near future. Experience with the European Monetary System (EMS), the predecessor of ERM II, has shown that the participation in a system of this kind may facilitate the fulfilment of other convergence criteria. The new exchange rate mechanism may play a similar role. In this context, we should certainly wish to acknowledge the efforts which Sweden is making to achieve sustainable convergence with the euro area. We hope that the success of the euro in the early months of its existence will help to convince the Swedish population of the benefits of early participation in Monetary Union. Clearly, a decision to join ERM II would be important for fulfilling the convergence criterion of exchange rate stability and would help to smooth the transition to participation in the euro area. In recent months the external value of the euro has been influenced by the market view of the economic developments in the euro area relative to the United States. More recently other factors had an impact on the exchange rate of the euro vis-a-vis the dollar, in particular the conflict in Kosovo. From the beginning of the year to mid-May, the euro weakened against the dollar by about 10%. In nominal terms, measured against a trade-weighted basket of the currencies of the 15 most important trading partners of the euro area, the euro has weakened significantly less, i.e. by about 6% since its launch. However, rather than focusing on very short-term developments, one should look at long-term evolution. In that respect, it has to be observed that the current exchange rate of the euro against the dollar is not so very different from the levels observed in the first three quarters of 1998. Clearly, some variability is typical for the bilateral exchange rate vis-a-vis the US dollar. Market expectations about future cyclical developments and the course of monetary and fiscal policy in the United States and Europe play a role in explaining exchange rate volatility. It is widely recognised that in the medium to long term exchange rates follow a path determined by fundamental factors such as price and economic developments. In this context, it should be pointed out that recent exchange rate developments have as yet not indicated any risk for future price stability. Moreover, internal price stability should serve as an anchor for the development of the euro's external value in the medium term. Indeed, a stability-oriented monetary policy strategy protecting the purchasing power of the euro is the basis of a solid and stable currency over the medium term. Maintaining price stability in the euro area also promotes credibility and thereby enhances the international role of the euro. The Eurosystem neither promotes nor hinders the development of the euro as an international currency. We consider that the international role of the euro should develop through the interaction of market forces. As yet it is too early to predict how long it will take for the euro to be considered as a truly international currency similar to the US dollar. Clearly, the disappearance of 11 national currencies and the introduction of the euro as a major international currency had an immediate impact on the turnover and focus of attention in the global foreign exchange markets. This has been reflected, for example, in rather active and liquid euro/dollar trading in the foreign exchange market since the launch of the new currency. However, there are also indications that the euro has further potential to grow in other markets as the surprisingly slow development of euro/yen trading suggests. The euro can also be expected to become an attractive currency for the investment of official reserves. One of the key elements to further international portfolio diversification in favour of the euro is the creation of a large, liquid and integrated capital market in Europe that began with the launch of the euro. For short-term instruments, we are now dealing with a broad and liquid European money market that ensures very similar short-term interest rates for comparable instruments and credit risks. The development of this market has been strengthened by the Eurosystem's operational framework of open market operations, which is mainly based on reverse transactions, and the implementation of the new TARGET real-time gross settlement system in participating countries. At the longer end of the maturity spectrum, market integration was jump-started by the re-denomination of outstanding government debt in euro and by the convergence of interest rates to narrower spreads following the elimination of the exchange rate risk. The elimination of this main risk will also foster the development of uniform market standards so that government bonds in the euro area will become rather close substitutes, creating a large and liquid bond market. Obviously, this requires sound and sustainable budgetary policies that ensure that credit risk spreads remain small. To conclude, following a remarkable period of disinflation in most Member States, the Eurosystem has had the good fortune to commence its operations in an environment of price stability. The success enjoyed by the euro in its first five months can be certainly attributed to a number of factors. Above all, the successful efforts of Member States made possible a smooth changeover to the euro. The independence of the ECB and the clear mandate to maintain price stability were crucial for ensuring a high degree of credibility of the Eurosystem's monetary policy. As a final observation, I should simply like to mention that without the positive echo of financial markets and the permanent support of banks and financial institutions, a single currency in Europe could not have become a reality.
r990527a_ECB	euro area	1999-05-27T00:00:00	Hayek - currency competition and European Monetary Union	issing	0	As a young student I read "The Road to Serfdom". It was the first book written by Hayek I came across, and it has left a deep and lasting influence on me. Only eleven years after the Hitler regime and the war I suddenly started to understand the interdependence between totalitarianism and economic policy. Since then I have read most of Hayek's publications. Many left their marks, only to mention the impressive "The Constitution of Liberty". But, perhaps more than anything else, it was the perception of "competition as a discovery process" which has shaped my thinking. This approach is of extreme relevance for economics but, goes far beyond this. Related to this "discovery" is "pretence of knowledge" as a permanent danger for societies. All those in public office responsible for making decisions should never forget this message. Against this background you can imagine that it is a great honour for me to be invited to give this lecture on the occasion of Hayek's 100 th birthday. Even more so as the invitation came from the Institute of Economic Affairs , an institution devoted to the study and propagation of liberal ideas - to the idea of liberty. I accepted immediately, not reflecting the obvious time constraints. It was the Institute of Economic Affairs which in 1976 published Hayek's "Choice in Currency: A Way to Stop Inflation". I chose the subject for my lecture for the following reasons. First of all because I might have some comparative advantage in a subject related to monetary economics. Having joined the Executive Board of the European Central Bank, the relations of Hayek's ideas on currency offer a special kind of interest. And, finally, it was the publication mentioned which brought me in personal contact with Hayek. Fascinated (but, to indicate already, not convinced) by the approach which was out of line with anything discussed in mainstream monetary theory at that time, I wished to include this paper in a reader on monetary policy issues I was preparing. I proposed to put in front of the text a quote by Hayek "Inflation is made by government and its agents. Nobody else can do anything about it". But, we could not agree on the translation of the word "government" into German. After an extended correspondence we finally came to the conclusion over the phone that this quote should remain, but not be translated It only comes home to us fully how long and fruitful Hayek's career was when we realise that his rightly renowned monograph on the denationalisation of money was published some 60 years after his pioneering contribution to the theory of intertemporal equilibrium in Weltwirtschaftliches Archiv in 1928. The monograph has to be seen against the background of decades of worldwide inflation. Hayek himself mentioned the great German inflation of 1923. After the second World War, prices had moved worldwide only in one direction. In the course of the 1960s "booming" US Federal Government expenditure, which was partly associated with the Vietnam War, led to a sustained period of strong growth in nominal aggregate demand. This, in turn, led to an increase in inflation in the United States . In 1969 the inflation rate was already up to almost 6%, after having been less than 2% at the start of the decade. Given the Bretton Woods system of fixed exchange rates, the inflationary pressures emanating from the United States spread out to other areas of the world, including Europe . The strain in the Bretton Woods system became apparent in the late 1960s. In 1973 the system finally collapsed. The problems created were magnified by the increase in oil and commodity prices in 1973. This led to soaring inflation. A few years later the industrial world was caught in a combination of high inflation and substantially increased unemployment. The policy that had brought the world to such an unfavourable conjuncture, and that could be characterised by a belief that "money does not matter" and a hubris of excessive reliance on demand management, had ostensibly failed. As Robert Lucas commented: "This is the legacy of stagflation: a general loss of confidence, whether warranted or not, in the formerly accepted framework guiding discretionary economic management" Hayek's view about these developments becomes clear from, for example, an excerpt of his Nobel Lecture, delivered in December 1974: "Economists are, at this moment, called upon to say how to extricate the free world from the serious threat of accelerating inflation which, it must be admitted, have been brought about by policies that the majority of economists recommended or even urged governments to pursue. We have indeed at the moment little cause for pride: as a profession we made a mess of things." He expanded upon this in 1976: "practically all governments of history have used their exclusive power to issue money in order to defraud and plunder the people." It was against this background that Hayek proposed his radical solution. It called for no less than the complete abolition of the government's monopoly over the issue of fiat money, leaving the way open for comprehensive competition in its supply by the private sector. In his Hobart Paper Special No. 70, he spelt out his philosophy with respect to free competition in the supply of money: "The purpose of this scheme is to impose upon existing monetary and financial agencies a very much needed discipline by making it impossible for any of them, or for any length of time, to issue a kind of money substantially less reliable and useful than the money of any other. As soon as the public became familiar with the new possibilities, any deviations from the straight path of providing an honest money would at once lead to the rapid displacement of the offending currency by others. And the individual countries, being deprived of the various dodges by which they are now able temporarily to conceal the effects of their actions by 'protecting' their currency, would be constrained to keep the value of their currencies tolerably stable" (p. 125). Although his proposal was not implemented, his contribution kindled a lively and far-reaching debate on the role of government in the monetary system, a debate that addressed the choice between a free-market monetary regime and government management of the monetary system via a central bank. The proposal was so profound and radical in its conception that some leading advocates of a laissez-faire approach to most aspects of economic life (Milton Friedman, for example) were put on the defensive. As it happened, Hayek also held some pretty strong views on Monetary Union in Europe, an idea which was still only in a rather embryonic stage when he commented on it in 1978: his own scheme of competing currencies seemed to him "... both preferable and more practicable than the Utopian scheme of introducing a new European currency, which would ultimately only have the effect of more deeply entrenching the source and root of all monetary evil, the government monopoly on the issue and control of money" (p. 126). The proposal put forward by Hayek, that is, full competition between private issuers of currency, is an extremely interesting concept. It relates to the debate on the viability of unregulated banking and to the literature on the historical experience with free banking. The basic idea seems to be as follows: creating the possibility of banks issuing currency would open the way to competition. Banks could issue non-interest bearing certificates and open cheque accounts on the basis of their own distinct registered trade mark. Different banks would issue different certificates, that is currencies. The currencies of different banks would trade at variable exchange rates. Competition and profit maximisation would lead to an equilibrium in which only banks paying a competitive return on liabilities could survive. Since currency corresponds here to non-interest-bearing certificates, the crucial requirement is the maintenance of the value of the currency. So, in equilibrium, only currencies guaranteeing a stable purchasing power would exist. Banks that failed to build up such a reputation for their currency would lose customers and be driven out of business. Hayek was of the opinion that his proposal would, if implemented, contribute to the overall stability of the economy. In his monograph he wrote: Let me now examine the characteristics of the equilibrium envisaged in Hayek's proposal. The marginal costs of producing and issuing a currency (in the form of notes and coin) are rather low (close to zero). In the context of the type of competition envisaged by Hayek, the nominal rate of interest would be driven (close) to zero. If the real rate of interest required by lenders to lend funds to borrowers were positive (say 3%), equilibrium in the loan market would require that lenders would have to be rewarded by a rate of deflation equal to this real rate. This would produce an outcome that has been advocated as a normative rule for inflation by Friedman in the past, that is, in a situation in which money is non-interest bearing, the optimal rate of inflation should be set equal to the negative of the real rate of interest. This is analogous, in this context, to the well-known correlation between free competition and efficiency (Pareto optimality). Hayek's privatisation proposal would, initially at least, involve a multiplicity of privately issued moneys. If these failed to trade at par, which is not unlikely given that the financial health of the different issuers is likely to be different, then it is also likely that a multiplicity of exchange rates will also emerge between these privately issued currencies. So long as there is no restriction imposed on the holding of the different currencies, those that are likely to depreciate in value would, according to Hayek's logic, be driven out of existence leading to a situation in which only currencies with stable values would remain in existence. Hayek believed that such competition between currencies was a discovery process, which would lead to a stable non-inflationary outcome. In this respect, it may be best to let Hayek speak for himself which I do by quoting from his "Indeed, if, as I am convinced, the main advantage of the market order is that prices will convey to the acting individuals the relevant information, only the constant observation of the course of current prices of particular commodities can provide information on the direction in which more or less money ought to be spent. Money is not a tool of policy that can achieve particular foreseeable results by control of its quantity. But it should be part of the self- steering mechanism by which individuals are constantly induced to adjust their activities to circumstances on which they have information only through the abstract signals of prices. It should be a serviceable link in the process that communicates the effects of events never wholly known to anybody and that is required to maintain an order in which the plans of participating persons match" (p. 192/193). Nevertheless, despite Hayek's claims for this discovery process, most economists would argue that free competition with respect to money couldn't guarantee either a stable or an efficient outcome. This is the fundamental point. In order to try to understand and assess Hayek's proposal, it is essential to take a closer look at money and its role in the economy. This is best done by, as it were, first breaking money up into its constituent functions. The classic textbook treatment of the functions of money is still valid: money fulfils three functions, namely that of (i) a unit of account, (ii) a means of payment and (iii) a store of value. The use of money as a unit of account is, arguably, the most basic monetary function. It is the that is the unit for quoting prices, for drawing funds, for negotiating contracts, and for performing economic calculations. In this regard, money is a basic convention of society, such as the language and the standards for measurement. This seems to be a very Hayek-like way of looking at money. Indeed, the fundamental problem in economics for Hayek is that of co-ordinating the plans of many independent individuals. Competition through the market system leads to such a co-ordination. Individuals, acting in their own self-interest, respond to price signals. Prices, in turn, reflect the information available in society. Price signals allow the transmission of previously unknown information in the most synthetic and relevant way for the purpose of economic calculus. Now, prices - impersonal signals that provide for an extensive social division of labour - are expressed in terms of money. Irving Fisher coined the term "money yardstick". The unit of account represented by the respective unit of money (that is the euro, the US dollar, the Japanese yen, etc.) is a metric or measuring tape. With inflation or deflation, the measuring tape keeps changing all the time. The unit of account, as represented by money, becomes elastic and of uncertain dimension at any one time and of even more uncertain dimension over extended periods of time into the future. Inflation or deflation, therefore, means that the common unit-of-account language, or, say money language, for which the unit of account provides the foundations, is changing all the time. And uncertain inflation, which tends to accompany high inflation, means that the unit of account is changing in uncertain ways. This impairs the efficiency of the common money language and, therefore, communication and co-ordination in the economy. "Its undependability impairs the meeting of minds between borrowers and lenders and other transactors; it impairs economic calculation and co-ordination" ( Greenfield and Yeager, I983) invites his readers to "consider how difficult constructing a house would be (ordering and fitting together the components, appliances, and all the rest) if the unit of length, the metre or the foot, kept changing and accordingly were perceived by different persons to have different sizes. Consider how preposterous it would be for the length of the metre to fluctuate according to supply and demand in the market for metre sticks. Yet our dollar suffers from a comparable absurdity - or a worse one, in view of the associated macroeconomic disorders". Money used as a unit of account has characteristics of a public good. Given the unit-of-account function, the medium-of-exchange and store-of-value functions have traditionally, but not exclusively, been supplied by private enterprise. Just as stable money is of crucial importance for a stable price level in a macroeconomic context, a stable price level is of equal significance for the efficient performance of money in a microeconomic context. A stable price level is, in principle, of central importance in ensuring that the three famous microeconomic functions which money provides are allowed to operate with maximum efficiency . From the point of view of the public involvement in the economy, the unit of account is of the greatest importance. Efficient co-ordination in the economy cannot occur unless the various agents involved (that is virtually everybody) speak the same money language. The institution that allows them to do so is money itself, but more specifically the unit-of-account function of money. The decentralised plans of hundreds of millions of consumers and millions of producers and distributors cannot mesh harmoniously in the aggregate if this common money language, as encapsulated in the unit-of-account function of money, is missing. The efficiency of this language in performing this vital co-ordination role depends crucially on whether the unit of account always means the same thing to different individuals both at one and the same moment and over time. A necessary condition for it to mean the same thing is that price stability prevails both at any moment in time and with a credible commitment that it will continue to prevail into the indefinite future. From this point of view, the commitment to maintaining price stability is like the standardisation of units of measurement. It is not difficult to imagine problems in the Hayek proposal arising from the inherent dynamics behind the discovery process, which would characterise competition between banks in the supply of currency. There are many questions left unanswered by Hayek about how the discovery process would work in practice. . How would the economy function during this discovery process? Since bad issuers are, according to the theory, driven out by the fact that they have recourse to inflationary issuance, this suggests that the discovery process would itself be characterised by inflation. Furthermore, if, say, a single stable currency did initially emerge from the discovery process, how could one be sure that, having established a monopoly, that the private issuer would not then, in a time-inconsistent fashion that has become all too familiar under politically-dependent central banks, start to engage in inflationary over-issue so as to maximise seigniorage? And even if a few issuers were to survive, how could one be sure that the resulting oligopoly situation would not result in collusion and/or instabilities? Another potential problem with the Hayek proposal is that the real rate of interest would tend to vary across the business cycle in response to the short-run pressures of supply and demand for loans and so too, according to his scheme, would the rate of deflation. And, of course, a steady rate of deflation would only emerge if the whole private sector discovery process is itself stable, which any reasonable person might be permitted to doubt. It would therefore appear that the outcome earnestly desired by Hayek, a money of stable value, would not be achieved in practice by his own proposal of competing currencies. In a situation in which money were to be issued by many different issuers as in Hayek's proposal and, either because of over-issuing by some agents or because of poor investment decisions, these issues failed to trade at parity, then many different numeraires could emerge. In principle, there could, in the end, be as many numeraires as there are issuers. In the presence of many numeraires or, more meaningfully, in the absence of a single numeraire, financial communication, based on the common money language which would be provided by a single numeraire, would degenerate. This would probably result in very poor co-ordination in the economy, with the efficiency of the decentralised decision-making of firms and households, which is the hallmark of capitalist economies, being jeopardised and the productive potential of the economy being gravely endangered. The purely private provision of a public good (the unit-of-account function of money) would, in this case, be sub-optimal since private issuers cannot easily underpin the single numeraire. Nor do they have an incentive to do so since they cannot capture the vast social benefits of the common monetary language provided by the unit-of-account function of money. There are further issues that any proposal in the spirit of Hayek would have to confront. First, the use of money in transactions makes it subject to network externalities. Network externalities, in turn, may inhibit free competition and may make it difficult, if not impossible, to dislodge an incumbent issuer who has resorted to inflationary issuance. In other words, networking externalities would inhibit Hayek's discovery process from working as he envisaged it. Network externalities also provide a rationale for regulation. Second, the assumption of complete, symmetric and free information implicitly assumed in the Hayek proposal does not apply to banking. The remark is equally valid in terms of banking activities (for example, a fundamental activity in banking is the evaluation of the creditworthiness of borrowers) and banks themselves (the special nature of the balance sheets of banks makes their valuation and risk assessment particularly difficult). In the absence of symmetric information, important issues of moral hazard, adverse selection and systemic stability become relevant. Networking externalities therefore mean that there is no guarantee that new entrants into the market for supplying money would be able to dislodge the incumbent issuer(s) if these resorted to inflationary issuance, given the inertia that is an inherent part of phenomena subject to networking effects such as currencies. In any case, why should people be willing to believe the claims of any potential new entrant that its currency will, unlike that of the incumbent(s), turn out to be stable? In my opinion, there are too many unanswered questions for Hayek's proposal for currency competition to be a viable candidate for society searching for a stable monetary system. Furthermore, it is very unlikely that the kind of uncertainty about future prices, which Hayek wanted to banish with his proposal ("..a money of stable value is really the best we can hope for."), would be the outcome if his proposal were to be implemented. Hayek's discovery process could, on the contrary, entail substantial costs in practice. According to his own logic of free competition in privately-issued currencies, the nominal interest rate would be driven to zero with, as already explained, deflation being the outcome. Hayek's proposal would not therefore deliver what it seems to promise, namely price stability. Under his proposal, there would still be uncertainty about the future price level. Under Hayek's scheme, market forces would determine the relative values of the different competing currencies. In other words, the exchange rates between the competing currencies would float freely. People would not want to hold on to the currency of an issuer that was expected to depreciate relative to one that was expected to hold its value in terms of purchasing power over goods and services. Therefore, good money that maintained its purchasing power would drive out the depreciation- and inflation-prone bad money. However, it is not inconceivable that competing private issuer would decide to collude by fixing the relative values of their currencies. They would do this be agreeing to intervene mutually whenever any of the currencies in question came under pressure in the market for these currencies. This would be easier to do, and would be more likely to succeed, if there were only a few issuers left after the Hayekian discovery process has reached some equilibrium state. Although this could be the outcome in a Hayek world of competing private currencies, it would clearly not be appreciated by Hayek himself. This is because, if some arrangement were to be arrived at by private issuers to counter the tendency for the values of the different moneys to fluctuate against each other, then the bad money would begin to drive out the good money, the exact opposite of what Hayek himself espoused. In other words, Gresham 's Law would, most likely, start to apply. As Hayek himself put it: "If the law makes two kinds of money perfect substitutes for the payment of debts and forces creditors to accept a coin of smaller content of gold in the place of one with a larger content, debtors will, of course, pay only in the former and find a more profitable use for the substance of the latter" . And: "( Gresham 's Law) is not false, but it applies only if a between the different forms of money is enforced" (italics in original ). The bad (i.e., over-issued and inflation-prone) money would start to drive out the good (i.e., well-managed and maintaining stable purchasing power) money. More of the bad money would be produced at the expense of the good money and inflation would accelerate. In principle, Hayek's proposal also works with national currencies produced monopolistically by central banks provided the currencies in question are convertible and can be freely exchanged against each other on foreign exchange markets. In such settings, good national currencies will tend to increase in importance relative to bad, inflation-prone, national currencies. This naturally constrains the ability of national governments to use "their exclusive power to issue money in order to defraud and plunder the people." (op. cit.). In this context, I think it is fair to say that the widespread use of the Deutschmark, for example, as an international investment currency is symptomatic of the enduring success of the Bundesbank in maintaining, in relative terms, the internal purchasing power of the Deutschmark. However, as long as national currencies remain legal tender only within their own national boundaries, the scope for good national currencies to drive out bad national currencies may not be as complete as in the Hayek world of competing private currencies where none of these currencies has the status of legal tender. In other words, Hayek's competition between currencies goes beyond the limited competition we have seen on foreign exchange markets between national currencies. If this limited competition between national currencies is not sufficient to constrain domestic monetary policy not to engage in excessive monetary creation, then a government may decide to tie its hands further by opting for a currency board arrangement. This would eliminate the possibility of any discretionary domestic monetary policy action since the domestic component of the monetary base could only change in response to a change in the foreign currency component of the base. Despite the only limited experience with the currency board arrangement to date, the experience would nevertheless allow us to declare it, provisionally, to be a success. Some governments, which have opted for this arrangement, have found, however, that during the recent financial market turbulence, their economies were not immune from contagious spillover despite having fairly healthy economic fundamentals. This is the result of the currency board arrangement not being an unequivocal one since the government in question retains the option of revoking the arrangement. Financial markets will therefore factor this possibility into their calculations and actions, ensuring that these countries suffer some contagious effects. This has stimulated a debate as to whether it would not be better for such currency board countries to go beyond the currency board arrangement and opt for full "dollarisation", and allow the domestic currency to be replaced entirely by the "dollar" for all transactions. Hayek espoused the denationalisation of currencies. He recommended that this be achieved through a comprehensive privatisation of the supply of money. It is notable that, of the two routes to denationalisation of currencies that have been taken so far, neither follows the route recommended by Hayek. One is the route taken by the governments of the EUI I through an international agreement of equals, which has resulted in the arrival of the euro. Another route is through so-called "dollarisation" whereby a country voluntarily relinquishes its own currency in favour of adopting a foreign currency, the "dollar". It appears to me, therefore, that under the Hayek proposal, we are likely to get either one or other of the following unfavourable outcomes. On the one hand, we could see the emergence of floating exchange rates between different privately-issued moneys, resulting in an uncertain discovery process without any guarantee of a stable outcome, along with a deterioration in economic communication and co-ordination in the economy overall. On the other hand, any attempt by private issuers to pre-empt these outcomes by fixing the exchange rates between their currencies would probably trigger Gresham 's Law and result in accelerating inflation. Since the birth of central banking, governments - via the central bank - have supplied financial instruments that have simultaneously fulfilled all of the three functions of money I have already mentioned. They have suppressed competition in the supply of currency and bank reserves (that is, so-called outside money). However, they have not suppressed competition in the supply of the other components of money, that is so-called inside money, which has been supplied exclusively by the private sector. Until just recently, inside money consisted exclusively of bank deposits which were supplied competitively by banks. However, governments have nevertheless restricted the supply of means of payment and stores of value by the private sector in the past. But this has been very substantially liberalised over the last twenty years or so. The result is that the availability of efficient means of payment that can also serve as good stores of value (and thus as a hedge against inflation) has improved almost beyond recognition compared with what was available during the period of financial repression. Although governments have retained a monopoly on the production of high-powered money, they have always permitted and indeed increasingly encouraged competition in the production of inside money. The upshot of this is that outside money now comprises only a rather small fraction of total money balances (taking, say, a broad definition of the money stock). After undergoing a dramatic decline, particularly in the period following the Second World War, it now ranges from about 1% in the United States and about 5% in the United Kingdom to about 6% in Germany . Governments have retained a monopoly over the production of high-powered money. There are very good reasons for this. Notes and coin issued by the central bank and, in some cases, by the government are unique in the following sense: they are the only instrument that can mediate a transaction and settle it with finality at one and the same time which it does by virtue of its legal tender status. Currency is also unique in that it supplies the unit of account for the whole economy. Although privately supplied inside money and publicly supplied outside money compete with one another as transaction media and stores of value, there is nevertheless a kind of symbiotic relationship between the two. This is, first, because inside money (predominantly bank deposits) may owe its acceptability to the fact that its issuers promise, and indeed are legally bound, to redeem it [either immediately (sight deposits), upon maturity (time deposits) or after a period of notice (savings deposits)] in outside money and, second, because outside money provides the unit of account for the whole system without which inside money might be less acceptable in the absence of a single (commodity) numeraire. Seen in this light, it appears that Hayek was correct in arguing that efficiency and (price) stability would be enhanced if money were to be supplied privately and competitively. Indeed, the fact is that most of conventionally measured money stocks are now comprised predominantly of inside money, i.e., money supplied by private enterprise, but more specifically the medium-of-exchange and store-of-value functions of this inside money. Hayek's arguments for free competition in the supply of money are therefore, in principle, applicable to these two functions of inside money. However, I believe he was mistaken in thinking that the economy would best be served if his recommendation were to apply to all aspects or functions of money. His recommendation neglected the public good aspect of money, which derives from its function as a unit of account. Money with a stable purchasing power serves agents, who do not even use it as a medium of exchange or a store of value, as the universally acceptable unit of account. It could be argued that, with Monetary Union in Europe , two things have happened which play a role in the current discussion. First, the geographical reach of the new unit of account, the euro, has been extended dramatically, relative to that of its forerunner currencies (or forerunner units of account). Second, the degree of competition between private sector agents in the provision of the other two functions of money, those of a medium of exchange and store of value, will almost certainly be enhanced, leading - over time - to considerable improvements in the quality of the latter. The introduction of the new single unit of account means that there has, as from the beginning of January this year, already been a direct and immediate welfare gain for both producers and consumers since the "moneyness" of existing money balances has been greatly enhanced. There are several sources of this welfare gain. To mention just one: the merger of the currencies of the Euro I I countries into the single currency, the euro, last January has - in one fell swoop - eliminated foreign exchange transaction costs for all cross- border transactions within the euro area. Indeed, it is because of the greatly extended reach of the new single unit of account that the scope available to the private sector to improve the quality of money has been greatly enhanced. This will operate through the new competitive opportunities for the banking and financial industries in the whole euro area. Welfare will be further enhanced over time as the single currency imparts the necessary critical mass to the single money and financial services market in Europe . Hayek's analysis and comments related to a world of what might be called analogue money, that is money that was represented as book entries (bank deposits, so-called inside money) or in the form of paper notes or metal coin (so-called outside money). Despite the fact that many earlier predictions of the demise of paper money turned out to be false, I think it is safe to say that it is at last making way to the ongoing digitalisation revolution as reflected in the dramatic progress in computer and communications technologies. These developments are now underpinning rapid advances in payment and settlement infrastructures. It has enabled new payment media to emerge that compete directly with the means of payment, that is notes and coin, issued by the central bank and backed by government. New payment media take many forms, but the most commonly known are prepaid cards and debit cards. Still more advanced forms of digital money, such as electronic network money, have now become technically feasible and may soon make their commercial appearance. These present new opportunities for a much more efficient payment system, but at the same time pose new challenges for monetary arrangements and monetary policy. An aspect worth emphasising here is the fact that central bank money in the form of notes and coin does not need a payments infrastructure in order to mediate payments. As has already been noted, central bank money can perform the payment and settlement functions (with finality) at one and the same time, by virtue of its legal tender status. However, privately issued financial instruments (bank deposits, for example) are not money in this sense unless complemented by a payments infrastructure. The analogue payments structures with which we have become so familiar in many countries are cheques and cheque clearing. The payments technologies now becoming available to the private sector are undergoing unprecedented improvements. The effects are likely to be profound. Their widespread application could eventually mean radical rethinking about what we understand under money. In particular, they will increasingly provide private enterprise with far greater scope to compete directly with central bank notes and coin as payment media. There is a very specific part of this process which deserves special attention. When there is a delay between a transaction and its settlement, as is the case in most existing privately supplied paper-based payment and settlement infrastructures (using cheques and paper- based direct debits, for example), there is an element of risk attached to most of the payments effected in this way. A number of different types of risk are involved - credit risk, interest rate risk, operational risk, etc. The risks involved in these privately based payments media imparted a comparative advantage to currency as a transaction medium, since the latter was the only instrument that could perform a payment and settlement function (with finality) at one and the same time. And it did so by virtue of its legal tender status. This meant that notes and coin facilitated transactions in anonymous market situations since the seller never had to concern himself/herself with the creditworthiness of the buyer. However, an important feature of the new electronic payment and settlement infrastructure is its ability (at least potentially) to compress the transactions-settlement time lag to what is virtually zero in economic time. This creates an essentially new situation which has the potential to obviate many, if not all, of the types of risk normally encountered in executing payments and their settlement with inside money and, in principle, allows a much wider array of assets, especially marketable assets, to be mobilised as transaction media. The new technology allows the vendor to verify that the purchaser possesses sufficient funds to cover the transaction and, in principle, permits a transfer of these funds to the vendor's bank account in real time. It further allows the vendor to verify in real time that the funds have indeed been credited to his/her account. This allows the settlement of the transaction with finality to occur at virtually the same time as the transaction itself. Privately supplied payment instruments therefore now have the potential, when complemented with the most up-to-date computer and communications technologies, to provide a more attractive alternative to notes and coin as a transaction medium. And, given that the former are also potentially much more efficient in a number of ways, it is not inconceivable that one could face the prospect of a rapid erosion of the role of notes and coin as transaction media in the not-too-distant future. The type of networking effects that support the acceptance of the euro are the same as those supporting the growth of electronic competition to notes and coin. More specifically, the price people are to pay for the use of electronic means of payment increases with the number of existing users (demand-side economies of scale), while the price they would to pay would be likely to fall as a result of declining unit costs of production as output expands (supply-side economies of scale, which tend to be large for networking products) and as competition forces lower costs to be passed on to customers. This dynamic would, of course, only start to take effect once a critical mass of usage has been attained. There may also be forces promoting the growth of electronic means of payment at work which are unique to the euro area and the changeover process to Stage Three (B) of Economic and Monetary Union. The conventional channels of access to a currency at the retail level (that is notes and coin) will not be available in the case of the euro for the first three years, that is throughout Stage Three A of Monetary Union. The only means of access to the euro for households, and possibly for many small firms, may therefore be via electronic media, both electronic money and electronic access products that allow scriptural money (bank deposits) denominated in euro to be mobilised for transaction purposes. The non-availability of the euro in the form of notes and coin could therefore impart an extra stimulus to the growth of e-money and electronic access products. The assumption from the current perspective is that all of these new payment instruments will be issued by private issuers. Despite fairly extensive discussions of the topic among central bankers, there has been no suggestion that central banks should issue e-money or be involved in the new retail electronic payments infrastructure as an active participant. Therefore, the growth of electronic means of payment will amount to an important further step in the process of privatisation in the field of the payments and monetary system, especially because the new digital payment media compete directly with the analogue-based media (notes and coin) supplied by the central bank. If this were to happen to such an extent that central bank money were driven out of the business of retail payments, then Hayek's vision would almost have been achieved . But with distinct differences because, first, it would have been achieved by a gradual evolution in financial market innovation and by improvements in payment technologies, rather than by the type of top-down legislative decree that he himself had envisaged to remove the central bank entirely from monetary management and, second, because that evolution would have occurred without jeopardising the single unit of account. This gradual process of privatisation is one which central banks might logically be expected to oppose, but this has not been the case. On the contrary, they are actively taking steps to help promote the growth of electronic substitutes for notes and coin. They are doing so by seeking agreement between the competent official bodies and potential private sector issuers on standardisation - the objective being to promote inter-operability between different privately supplied alternatives. Although this might seem like the proverbial turkeys voting for Christmas, central bankers place a very high priority on the smooth and efficient working of the payment system at both the retail and wholesale levels. Therefore the ECB considers it essential that the following minimum requirements be fulfilled: The ECB has also identified two further objectives, the pursuit of which it deems to be desirable: the inter-operability of electronic money schemes and the adoption of adequate guarantee, insurance or loss-sharing schemes to protect depositors. The third requirement mentioned is of particular significance in the context of the current discussion. This is because, from a monetary policy point of view, "the redeemability requirement is, inter alia, necessary in order to preserve the unit-of-account function of money, to maintain price stability by avoiding any unconstrained issuance of electronic money, and to safeguard the controllability of the liquidity conditions and short-term interest rates set by the ESCB" (p. 106, ECB Annual Report, 1998). If the whole process triggered by the availability of new electronic retail means of payment is finally brought to its logical conclusion, as suggested by the dynamics of technological development and free competition, central banks and governments will be confronted with a very specific problem of pivotal significance: can the unit of account be separated from the means of payment, while still remaining a viable unit of account and playing the crucial role of providing the common money language for the whole economy? If the means of payment embodying the unit of account, that is notes and coin, is - over time - eliminated by virtue of the competition of the emerging digital equivalents issued by the private sector, would the familiar existing units of account, the euro, the US dollar, the pound sterling, etc., continue to mean anything? And, if not, what should be the official response? I don't propose to address either of these issues today, but you may rest assured that they are crucial to our concerns regarding the future, albeit probably somewhat distant future. Hayek seems to have had very little doubt but that private enterprise, operating in a largely unregulated environment, would deliver a monetary system that is stable, safe and efficient. However, I remain rather sceptical whether the private sector can cope with all the externalities involved in the provision of a smoothly working monetary and financial system. It must nevertheless be conceded that the private sector is increasingly helping to evolve a monetary and financial system, supported by increasingly sophisticated payments infrastructures that promises to be significantly more efficient than the system it is gradually displacing. There is, accordingly, no strong case to be made for attempting to introduce such a system by fiat. It is preferable that it should evolve by piece-meal engineering, rather than by some abrupt legislative change as sought by proponents of competing currencies and free banking, of which Hayek could, with some justification, be regarded as the high priest. It should also be borne in mind that the central bank will continue to play, during this transitional period and afterwards, an important role as a regulator of the financial system by, inter alia, setting the rules for competition between private suppliers of inside money. Hayek referred, in 1978 (op. cit.), to the possibility of Monetary Union in clear and strong terms. He put it this way: "though I strongly sympathise with the desire to complete the economic unification of Western Europe by completely freeing the flow of money between them, I have grave doubts about doing so by creating a new European currency managed by any sort of supra-national authority. Quite apart from the extreme unlikelihood that the member countries would agree on the policy to be pursued in practice by a common monetary authority (and the practical inevitability of some countries getting a worse currency than they have now), it seems highly unlikely that it would be better administered than the present national currencies." At one level, Monetary Union encompassing the Euro I I countries could, therefore, be seen as a project diametrically opposed to the type of scheme advocated by Hayek according to the aforementioned quotes. Instead of allowing the private sector to compete in issuing their own currencies, the single currency was introduced by governments coming together and introducing the euro in a top-down fashion by legislative decree, while continuing to prohibit the private sector from issuing currency. Any attempt by the private sector to issue banknotes or coins is counterfeiting, a serious criminal offence. At another level, one can see many strands in Hayek's thinking that may have influenced the course of the events leading to Monetary Union in subtle ways. What has happened with the introduction of the euro has indeed achieved the denationalisation of money, as advocated by Hayek, at least in the Euro 11 countries. Furthermore, the euro is being managed by a central bank (the ECB) that is protected from political interference by a Treaty (the Maastricht Treaty), to which all Member States are signatories. All national central banks that comprise the Eurosystem are now independent of their respective Euro I I governments and, according to their respective statutes, cannot take instructions from these governments. Moreover, the Eurosystem is supranational and does not therefore have any natural political counterpart in the form of a supranational government with full executive powers. This further underpins the independence of the Eurosystem and enables it to pursue its mandated ultimate objective, that is price stability, without interference from government. Thus, monetary policy in the Euro I I countries has been denationalised and is being conducted by a supranational central bank, which is politically independent of the governments of the Member States. Furthermore, any monetary financing of the public sector or privileged access to financial institutions are prohibited. The separation between public finance and monetary policy is thereby ensured. This is very much in line with views expressed by Hayek: "It may still be true that, if there were full agreement as to what monetary policy ought to aim for, an independent authority fully protected against political pressure and free to decide on the means to be employed in order to achieve the ends it has been assigned might be the best arrangement. The old argument in favour of independent central banks still has great merit." He goes on to elaborate that "under present conditions we have little choice but to limit monetary policy by prescribing its goals rather than its specific actions." He then comments on employment and price stability as goals for monetary policy, concluding that "the two aims are not necessarily in conflict provided that the requirements for monetary stability are given first place and the rest of economic policy is adapted to them." Last, but not least, Hayek emphasised (again strongly) the dangers from monetary financing: "if we are to preserve a functioning market economy, long clandestine, but formally consecrated with the victory of Keynesian economics." Hayek himself has explained the objectives of his proposal: "the abolition of the government monopoly of money was conceived to prevent the bouts of acute inflation and deflation, which plagued the world for the last sixty years." Hayek was very clear about where to put the blame: "the basic tools of civilisation - language, morals, law and money - are all results of spontaneous growth and not of design, and of the last two organised power has got hold and thoroughly corrupted them." Or, as he put it later, in even stronger terms: "the history of government management of money has, except for a few happy periods, been one of incessant fraud and deception." The institutional reform which he espoused to tackle this problem was indeed radical. It involved, as we have seen, the denationalisation of money to be achieved by the complete abolition of the government's monopoly over the issue of fiat money leaving the way open for supply of money to be determined by comprehensive private sector competition. I would not be doing justice to Hayek if I neglected to mention that, at an earlier stage in his thinking, he put forward proposals for controlling inflation which have now become the conventional wisdom. In chapter 21 of his famous book entitled: and published in 1960, he wonders, as I have just flagged, whether an independent monetary authority, fully protected against political pressure and free to decide on the means to be employed in order to achieve the ends it has been assigned, might be the best arrangement. However, he seems to have viewed central bank independence as an inadequate solution since, as early as the 1960s, he concluded that, in light of the high level of government debt, that "...an effective monetary policy can be conducted only in co-ordination with the financial policy of the government. Co-ordination in this respect, however, inevitably means that whatever nominally independent monetary authorities still exist have in fact to adjust their policy to that of the government" (see Hayek 1960, page 327). I think it is now clear that it was ideas along these lines that were the inspiration behind the rules and procedures in the EU Treaty, and I refer in particular to Articles 104 and 104a. In fact, I would argue that one reason for Hayek's change of mind and his subsequent advocacy of complete privatisation of money, as revealed by the views expressed in in I960 and those put forward in in 1978, is to be found in his disappointment with the trends in the monetary institutions during his lifetime. He seems to have said as much: "... high hopes of what could be expected from political control over money have been bitterly disappointed. ... (italics in the original). The tentative answer to Hayek's concern - the now classic time inconsistency-induced inflation bias - was finally found in institutional reform. In all industrialised countries monetary policy is now being managed by (more or less) independent central banks with the key objective of maintaining price stability. Monetary financing of the public sector is excluded. Monetary stability is protected by law and social consensus. How would Hayek, if he were alive today, see EMU and the ECB? Let me hazard what is probably a somewhat biased and speculative answer. The route to monetary union taken by member governments and central banks was almost diametrically opposed to that espoused by him in his later writings. But, should he not welcome what we have achieved? Should he not be pleased that so much of his earlier (I960) blueprint is now law? I am convinced that he would welcome the fact that the ECB has not joined the new fashionable wave arguing that money does not matter. It is very easy to slip into the trap of thinking that money is unimportant when inflation is low and to ignore the overwhelming evidence that all past episodes of persistent inflation have been preceded, or been accompanied, by rapid money growth. Robert Lucas in his Nobel Lecture has only recently reminded us of the facts and I quote: "...the prediction that prices respond proportionately to changes in money in the long run, deduced by Hume in 1752 (and by many other theorists, by many different routes, since), has received ample - I would say decisive - confirmation, in data from many times and places." (p. 668) . As I have already argued, the quality of money, which has to do with how well it performs its micro-economic functions of medium of exchange, store of value and in particular unit of account, is related to the quantity of money. Too much of the latter, relative to ex ante demand for money, can substantially impair the former. Since inflation is ultimately a monetary phenomenon, money constitutes a natural, firm and reliable "nominal anchor" for a monetary policy aimed at price stability. This accounts for why money is given a prominent role in the ECB's monetary policy strategy. Therefore, although the path taken to achieve denationalisation of money has been very different than that advocated by Hayek, the ultimate objective being sought by Hayek, i.e., monetary independence from political interference and price stability, have, to all intents and purposes, already been achieved. Of course, I should add as an essential precautionary note, that price stability is never fully achieved in the sense that it is a forward-looking concept and the ECB must be eternally vigilant, and act in a pre-emptive way, so as to ensure that inflationary pressures are not given an opportunity to translate into actual inflation. Having said this, however, I am afraid Hayek might not be in favour of a new centralised authority with monopoly powers over base money. The Treaty of Maastricht is virtually the very opposite of what Hayek proposed, because, among other things, the new monetary order in the EUI I has been created not in an evolutionary process but in a "constructivist" way per statute at a fixed date, i.e., the first of January this year. I am convinced that the EU I I governments have, in principle, taken the correct route to monetary union. They could hardly afford to take what might have been an enormous risk in adopting a Hayekian discovery process as a route to monetary union, as had been advocated in the so-called hard ECU proposal . This would amount to experimenting with the monetary constitution , a very dangerous strategy. Continuity in monetary arrangements and institutions is of the essence. A premium must be placed on the tried and tested. It is therefore preferable to subscribe to a philosophy of piecemeal engineering in the reform of a proven monetary system by allowing it to evolve in response to the needs of the economy and to the opportunities provided by advances in technology in an efficient fashion. Although the hard currency proposal has not been adopted, and correctly so in my view, it could nevertheless be plausibly argued that a kind of Hayekian discovery process has indeed been triggered by the introduction of the euro. This is because, with the introduction of the euro and the dramatically extended geographical reach of the new single unit of account, the scope available to the private sector to enhance the quality of the medium-of-exchange and store-of-value functions of money, where it's comparative advantage lies, has been significantly improved. This new and more robust competitive environment should ensure a lively discovery process in the provision of these functions of money as new opportunities are presented for the banking and financial industries in the euro area as a whole. In the sequencing of events on the road to the political integration of Europe , I once had a distinct preference for political union preceding monetary union. As I have argued elsewhere , historical experience shows that national territories and monetary territories normally coincide. Now, of course, the reality is that, if political union is ever to occur, monetary union will have preceded it. However, with the establishment of the ECB and the introduction of the single currency, intentionally or not, a process towards further political integration has been triggered. Although this process is not without risks, it nevertheless provides a golden opportunity for Europe to find its proper political shape. In Hayek's terminology, "imposing" monetary union on Europe was an act of constructionism. But, to continue in his way of argumentation, this should also have started a search process for an appropriate political framework so that, finally, the economic and monetary regime, and the field of politics, together form a viable, if not optimal, institutional arrangement. There are no patterns from the past available which could easily be imitated. Further political integration might, subsequently, develop in a quite divergent direction. In some areas, more centralisation of decision making should be necessary, whereas in other fields, responsibility might remain, or even be enhanced, at the local, regional or national level. As I have said recently , and I think it bears repeating, what is essential for a successful monetary union is a sufficient degree of political commitment by all participating countries, the leading economic actors and the wider public to accept fundamentally and genuinely the political and economic constraints that a single and stable currency represents. The deeper underlying commitment to make European integration a success even in the most difficult of times in history gives some general grounds for hope on this count. Some degree of political unity (not necessarily union), or rather a sense of common responsibility would appear to be important for the long-run health of EMU. However, it is not a substitute for the right economic conditions for lasting success.
r990603b_ECB	euro area	1999-06-03T00:00:00	Developments in the Financial Sector in Europe following the Introduction of the Euro	duisenberg	1	The period of the five months following the introduction of the euro has been very rich in new events, with significant developments taking place both in the continental securities markets and in the financial system as a whole. Although experience has been gathered over a relatively short period of time, I am tempted to make two observations of a fundamental nature. The first observation is that developments following the introduction of the euro do not imply that the euro area is set to become a financial fortress whose financial markets and institutions would be cut off from the rest of the world. In fact, market participants residing outside the euro area seem to be taking a keen interest in the financial markets of the euro area. "Core Europe", so to speak, has become more interesting to outsiders as the breadth and liquidity of its financial markets has increased. The second observation is that the euro can be expected to have a significant influence on the structure of the financial system by bringing about more securitisation. A traditional feature of the financial system of continental Europe has been a marked dependency on the funds intermediated by banks. This feature contrasts with the financial system of the United States which is much more securitised. For instance, corporate bonds have not been very widely issued in the euro area, and stock market capitalisation - relative to the size of the economy - is much lower in the euro area than in the United States. There are good reasons to believe that a process of securitisation will gather pace in the euro area now that the single currency is in use. This view seems to be shared by many observers and I shall, in the course of my remarks, provide some arguments in its favour. In my remarks today, I should like to discuss the structural changes in the financial sector, in particular those that have occurred as a result of the launch of new product types and the changing nature of public and private institutions. I shall address developments in the money markets, the bond markets and the equity markets as well as the process of adaptation of banking institutions to their new environment. The money markets of the euro area became rapidly integrated after the introduction of the euro despite the fact that their structures had previously been quite different at the national level. Transaction volumes and measures of bid-ask spreads on the various money market instruments both indicate that the markets reached a very high level of liquidity very rapidly in the course of January 1999 and have subsequently retained it. The high degree of integration of the euro area money markets is, first of all, a result of the single monetary policy, which is conducted through the harmonised operational framework of the Eurosystem. This integration has also been made possible by the significant and increasing integration of payment systems. Cross-border payments processed by TARGET accounted for more than 37% of the value of all real-time payments (domestic and cross-border) effected by credit institutions in March and April 1999. Moreover, the continuously high use which our counterparties make of the correspondent central banking model (or CCBM) for the cross-border transfer of collateral in monetary policy operations is an important indication of area-wide integration. This is evidenced by the fact that cross-border collateral currently represents around 25% of the total amount of collateral in custody in the context of the Eurosystem's monetary policy operations. Taking a closer look at the various instruments traded in the money markets, a feature that is worthy of note is that market participants in the 11 countries of the euro area have shown an increasing tendency to demonstrate a similar reliance on each instrument type. For example, what we call "overnight indexed swaps", which are swaps indexed on the overnight reference interest rate EONIA, have become an important derivative instrument in the money markets of the euro area. This can be seen from the low level of quoted bid-ask spreads and the high turnover relative to other major international markets. Both indicators show a high level of liquidity in this instrument. Another type of instrument of interest in the money market (but also at the fringe of the bond market) is that of the repurchase agreement. The development of more integrated repo markets in the euro area will obviously accompany the development of area-wide securities trading, settlement and custody systems. This will reduce transaction costs and improve efficiency for the cross-border transfer of securities through repurchase operations. Looking ahead, other developments in the money markets are expected in the coming months. There are aims to establish new area-wide standards for the repo markets, with a view to overcoming the separation between different models in the national markets. These new standards could obviously co-exist with other standards and broader conventions for international transactions. In fact, over the last few months the European Central Bank (ECB) has been examining whether this co-existence could affect the integration of money markets. We have come to the conclusion that, in particular owing to the efforts of the sponsors of the different standards, this should not be considered a threat. Finally, it should also be noted that national and international central securities depositories are currently developing links with one another, which will enable participants in one country to make direct use of securities deposited in other countries. Twenty-six of these links (concerning mainly Belgium, Germany, France, Luxembourg, the Netherlands, Austria and Finland) may be used by the Eurosystem. I should now like to turn to bond markets and first to comment on the position of euro area bond markets in the global market. Some data sources on international securities issuance available so far show a pattern of increased reliance on euro-denominated bonds at the beginning of 1999, in particular as opposed to US dollar-denominated bonds. While it remains difficult to draw firm conclusions on the determinants of bond denomination choices without considering information on the nature of bond holdings and trading patterns, recent bond issuance volumes indicate that the euro has the potential to become an important currency for international bond issuance. The importance of the euro area bond market is also apparent in measures of secondary market activity, i.e. turnover or trading volumes. In particular, trading volumes on exchange-traded bond futures are indicative of the overall degree of market activity. Volumes traded in euro-denominated bond futures were low shortly before the changeover to the euro, when the bond markets in the euro area were exceptionally quiet. Since then, volumes have increased markedly and they currently stand at consistently high levels, which indicates a continuously high degree of turnover in euro-denominated bond markets in general. Turning to the internal structure of the bond markets of the euro area, I should like to make an initial observation related to the recent marked increase in euro-denominated corporate bond issuance, which was accompanied by an increase in the average size of issues. This tendency is likely to continue in the future, in particular to the extent that bonds may be used by firms to finance increasing mergers and acquisitions activity in the euro area. The underlying reasons for increased bond issuance by euro area firms are clear, both on the supply and on the demand side. On the supply side, large firms with good credit ratings will find opportunities in the increased depth and liquidity of the euro area bond market. On the demand side, the respect by governments of the parameters of the Stability and Growth Pact over the medium term should leave more room for the private sector to issue debt securities. In addition, the euro area must be in a position to save in order to be able to take care of its future pension payments, and a part of these savings is likely to be invested in corporate debt securities. An increase in global demand for euro-denominated debt securities is also expected as the euro becomes a major reserve currency. Moreover, the demand for higher risk euro-denominated debt securities is likely to increase, particularly as the current low level of sovereign yields increases incentives to search for higher yields. With regard to the government bond markets, an issue of importance for the euro area that I should like to stress is the fact that governments now find themselves in a rather new position as issuers. This reflects a number of developments, two of which I should particularly like to mention. First, the major public issuers have attempted to position themselves as providers of benchmarks for euro-denominated bond markets. Second, certain issues of government bonds have effectively gained larger portions of secondary markets, in particular in relation to developments that have occurred on bond futures markets. Market participants have responded to these developments in the bond markets with a range of concurring or competing initiatives and alliances. In the derivatives industry, market participants have established new alliances. On the trading side, electronic cross-border platforms for bonds have been created or are in the process of being developed. On the clearing side, integrated platforms for different markets have been launched or are being finalised, while, finally, on the securities settlement side, initiatives have also been launched. It is important to note that while some of these developments are internal to the euro area, others aim at creating links with financial markets outside the euro area. One may reasonably expect that all of these new circuits, as well as others, may in the future be enlarged to encompass a growing number of market participants. Turning to equity markets, structural developments of most interest relate to the infrastructure of stock exchanges on the one hand and equity derivative exchanges on the other. First, within the euro area, equity investment and trading activities appear to be less and less influenced by country-specific factors and increasingly subject to area-wide considerations. Consistent with this development, area-wide equity indices have been developing. Market participants are showing considerable interest in these area-wide indices, in particular as they are also now adopting investment positions on area-wide industrial sectors, using the sub-indices made available for that purpose. An indication of the degree of interest raised by area-wide indices is the relatively fierce competition for benchmark status that has developed between the various proponents of area-wide indices. Second, market developments in relation to stock index futures and options will reflect the rise of area-wide indices. This may in turn lead to either consolidation or product specialisation of equity derivative exchanges. For my part, I consider the development of fair competition between exchanges to be a positive factor in terms of the improvement of the range of products and services available to the financial industry. Third, in the equity market the euro has also provided a powerful incentive for the creation of new - and possibly competing - alliances among exchanges. Before the launch of the single currency, circuits had been created for the launch of integrated "new markets" within and beyond the euro area, encompassing the shares of small and medium-sized companies with a high potential for growth. The development in the integration of exchanges has also continued more recently, and, as you know, it has not been limited to the euro area. In the field of banking, the securitisation trend appears to demand strategic and organisational adjustment on the part of banks. The relative importance of the more traditional types of banking activity can be seen to be decreasing, even though it should be mentioned that traditional banking activities have nonetheless continued to grow at a rate exceeding that of growth of nominal GDP. In the euro area, growth in recent years has been much more rapid in assets under the management of mutual funds and other institutional investors than in the assets of banks. This reflects a tendency towards decreasing the relative weight of bank deposits compared with securities in financial wealth. The euro area banking industry has reacted to this development already by diversifying into the asset management area. Banking groups have been able to "internalise" a significant part of the securitisation tendency as they control a large majority of the mutual funds. As a result of the securitisation trend, there has been an increase in the share of security holdings among bank assets, and an increase in the share of capital gains - although those are quite cyclically sensitive - as well as in fee income stemming from asset management services. Meanwhile, the relative importance of interest income has declined correspondingly. At the bank level, dividend income from equity participations has generally become much more important, indicating an increase in the importance of the profit generated by non-bank subsidiaries. Beside the establishment of non-bank subsidiaries, there have been other strategic and organisational changes that have resulted in banks strengthening their securities-related activities. In particular, significant motives behind the recent merger trend seem to include the desire to increase bank size and hence to be able to operate efficiently in wholesale securities markets as well as to be able to cater for the needs of large international corporations for investment banking services. The trend towards securitisation can be regarded as one of the reasons for the structural changes in the banking system that appears to have accelerated recently. There have naturally also been other reasons why banks have sought to merge, predominantly the need to cut capacity and to reduce costs. These cost-driven mergers have taken place primarily among smaller banks. In my remarks today, I have referred to a number of changes and market initiatives in the euro area financial landscape. These developments point to the increasing importance of the fixed income and equity markets that many expected in Stage Three of Economic and Monetary Union (EMU), providing new opportunities for borrowers and investors and causing pressure to adjust for financial institutions. In this respect, I should like to mention the importance of removing the remaining regulatory barriers to the further development of the securities markets. To this end, the European Commission has recently published an Action Plan of regulatory changes to improve the single market for financial services that would certainly - when implemented - boost the integration and market-driven development of the European securities markets. Finally, I should like to conclude with some remarks about the role of the Eurosystem (the term that we use to mean the ECB and the 11 national central banks of the Member States participating in Stage Three of EMU) in the developments in the financial sector in Europe. First of all, the Eurosystem contributes to developments in the financial sector by providing it with a stable and credible monetary policy. With a strong and credible commitment to its primary objective, price stability, the Eurosystem has created a situation in which the financial sector can concentrate on those issues that are of the greatest relevance to its activities. The Eurosystem does not play a direct role in structural developments in the financial sector. With its single monetary policy framework and TARGET in particular, the Eurosystem has created an infrastructure that has proved to be useful for the establishment of an integrated money market in the euro area. In addition, the Eurosystem carefully monitors structural developments in the financial sector to the extent that they might have an impact on the conduct of monetary policy. To make a final point, in observing developments in the financial sector, the Eurosystem constantly takes account of the fact that one of its tasks, laid down in the Treaty establishing the European Community, is to "contribute to the smooth conduct of policies pursued by the competent authorities relating to the stability of the financial system" [ . Analysis of the common developments in the European financial system represents such a contribution.
r990610a_ECB	euro area	1999-06-10T00:00:00	The tasks and limitations of monetary policy	bank	0	It is a pleasure for me to be here in Vienna today and I should like to start by thanking the conference organisers for giving me the opportunity to elaborate on the . This topic is extremely important. Looking back over the history of economic thought, it is clear that the perception of what monetary policy can do and what it cannot or should not do has changed. This has clearly shaped the role of monetary policy in economic policy. In the 1960s economic theories suggested a long-run trade-off between inflation and output. These theories provided the intellectual basis for policy-makers to pursue monetary policies biased towards higher inflation. The high inflation experience of the 1970s together with new theoretical findings, especially on the role of expectations, led policy-makers to move towards lowering and stabilising inflation. Theoretical considerations as well as empirical evidence over several decades suggest that high rates of inflation are clearly unhelpful - indeed detrimental - to growth and employment in the long term. A large number of economic arguments point to the benefits of price stability for economic growth and employment prospects. Stable prices eliminate economic costs such as those arising from unnecessary uncertainty about the outcome of investment decisions, the distortionary effects on the tax system, rising risk premia in long-term interest rates and the reduced allocative effectiveness of the price and market systems. To quote Alan Greenspan, chairman of the United States Federal Reserve, "Price stability is achieved when the public no longer takes account of actual or prospective inflation in its decision-making." Monetary policy must take into account the fact that the horizon for decisions by economic agents is rather long-term in nature. By guaranteeing price stability, monetary policy supports the efficient functioning of the price mechanism, which is conducive to the allocation of scarce resources. Price stability is a means of promoting sustainable economic growth and employment creation and of improving productivity levels and living standards. Against this background, the predominant view has emerged that the best and most lasting contribution that monetary policy can make to long-term economic welfare in the broader sense is that of safeguarding price stability. Central banks throughout the world have been moving towards adopting long-term price stability as their primary goal. In order to achieve this goal most successfully, independence from political interference and a clear legal mandate for price stability are of the utmost importance. A lack of central bank independence and an ambiguous mandate can easily force central banks to focus on the short term and, thus, fail to adopt the forward-looking, medium-term orientation that is crucial for a successful monetary strategy. All these issues were taken into consideration by policy-makers when drafting the Treaty establishing the European Community and designing the blueprint for the European Central Bank. Both central bank independence and an unequivocal commitment to price stability are therefore tenets of the monetary policy framework enshrined in the Treaty. There can be no doubt that the European Central Bank (ECB) is determined and well-equipped to tackle its main task, namely, that of maintaining price stability in the euro area over the medium term. It will thereby make a significant contribution to the achievement of other Community objectives such as high employment and sustainable non-inflationary growth. In this connection, the pursuit of sound macroeconomic policies by the EU Member States would considerably facilitate the task of the ECB. The room for manoeuvre in monetary policy and the degree of success in terms of maintaining price stability are crucially dependent on the support of sound fiscal policies and responsible wage settlements in the euro area. The Treaty establishing the European Community states that the primary objective of the European System of Central Banks (ESCB) is to maintain price stability. Without prejudice to this objective, the ESCB shall support the general economic policies in the European Community. It shall operate in a manner that is consistent with the establishment of free and competitive markets. The Treaty states explicitly how the ESCB shall set its priorities. Price stability is the first goal of the monetary policy of the Eurosystem, and a contribution to the achievement of the other objectives of the European Community can only be made if this primary objective is not compromised. However, there is ultimately no incompatibility between maintaining price stability and pursuing these other objectives. By maintaining price stability, the ECB will also contribute to the achievement of other Community objectives. Of course, the ECB is concerned about the intolerably high level of unemployment in Europe, but we should realise that the role of monetary policy in reducing unemployment in Europe can only be very limited. Many empirical studies show that the high unemployment rate is mostly the consequence of structural rigidities within the European labour and product markets. The European unemployment rate has, indeed, been high and stable over the business cycles in the past decade. Only structural reforms, preferably of a comprehensive nature, can therefore tackle the underlying impediments to employment growth. The monetary policy of the Eurosystem is geared towards the euro area as a whole and, thus, cannot take into account purely national and regional developments. The cyclical positions of participating countries have not yet completely converged, although, with the single currency in place, some national differences may disappear over time. This requires national policies and labour and goods markets to be increasingly flexible in order to be able to respond effectively to economic shocks. Well-functioning labour and product markets are therefore needed to allow adjustments to wages and prices to be made if local economic conditions change. Budgetary policies play a major role in conditioning monetary policy. National fiscal authorities have to demonstrate their commitment to the maintenance of price stability in the euro area over the medium term. In this context, the Stability and Growth Pact is a crucial element. Its aim is to encourage the pursuit of disciplined and sustainable fiscal policies by the participating EU Member States and the prospective members. Sound public finances, with lower public debt and tax burdens, contribute to a lowering of long-term interest rates, reduce uncertainty and increase private capital formation. They not only facilitate the task of monetary policy with regard to the maintenance of price stability, but also strengthen the conditions for sustainable growth conducive to employment creation. Conversely, unsound fiscal policies tend to increase inflation expectations and force monetary policy to keep short-term rates higher than would otherwise be necessary. The single monetary policy has to be conducted independently of the short-term political considerations of national governments. In this context, the ECB cannot commit itself to move its interest rates in a certain way in response to specific actions or plans of other policy-makers. Monetary policy has to take into account the overall economic situation to assess the risks to price stability. Direct ex ante co-ordination with fiscal authorities might endanger meeting the primary objective and would set the wrong incentives for the conduct of sound macroeconomic policies. This does not, of course, exclude a constructive dialogue between the Eurosystem and government authorities which clearly respects the independence of the ECB. When dealing with one of the major world currencies and with the currency of one of the two main world economies, it is inconceivable that price stability might be maintained by setting an exchange rate target as an intermediate objective. However, external developments including the exchange rate are taken into account in accordance with our strategy, as they may have an impact on domestic economic developments and thereby on price stability. Referring to recent exchange rate developments in this context, it is appropriate for me to quote the President of the ECB, Dr. W. F. Duisenberg, who recently said that "the euro is a currency firmly based on internal price stability, and therefore has a clear potential for a stronger external value". The absence of exchange rate targets for the euro vis-a-vis other major currencies should not be misunderstood. For smaller, very open economies, fixed exchange rates may be a very reasonable choice. The Austrian example is one of the most prominent in this respect. By pegging the Austrian schilling to the Deutsche mark for over twenty years, it proved possible to import credibility and price stability. The increasingly close pegging of the Austrian currency to the currency of its main trading partner was, among other features of the Austrian policy mix, the driving force behind the economic convergence process in the run-up to Stage Three of Economic and Monetary Union (EMU). The credibility of the Austrian exchange rate target was also underpinned by an income policy aiming at relatively high real wage flexibility and a fiscal policy geared towards consolidation. All in all, the Austrian model, which set out to guarantee stability in nominal and real terms, has turned out to be very successful. The example given by past Austrian experience is, I believe, very valuable. It shows that the achievement of sustainable convergence with the euro area can be assisted by means of an exchange rate target. The new Exchange Rate Mechanism of the European Union, ERM II, may play a similar role for those current and prospective EU Member States which have not yet joined Stage Three of EMU. The achievement of price stability is also of high importance for the stability of the financial system. The financial system of the euro area showed a high degree of stability during last year's period of financial turbulence as well as during the rather dramatic structural shift connected to the changeover to the euro. At the ECB, we play our part in the evolution of the euro area financial system by providing it with stable monetary conditions. By creating an environment of price stability, we allow private sector agents to focus their attention on the questions that are most relevant to their activities and to take advantage of benefits of this stable environment, such as the lengthening of their planning horizons. There is a lot of empirical evidence that safeguarding price stability is the optimal contribution that a central bank can make to the maintenance of financial stability and that those two goals are actually complementary. I should like to conclude by saying that the main contribution of the single monetary policy to the welfare of the people in the euro area will be the maintenance of price stability in the medium term. The ECB is determined to tackle this task and is well-equipped to do so. Our conviction is that the economic performance of the euro area will benefit significantly from price stability. This will ultimately facilitate the achievement of those objectives, which underlie the general economic policies of the European Community and the individual governments at the national level. However, the economic problems in the euro area cannot be tackled by monetary policy alone. We have to be realistic about the goals which can be achieved by monetary policy. Neglecting the limitations of monetary policy and promising too much could, in the long term, be detrimental to the establishment of a stability culture in Europe, and could also lead to delays in implementing the economic reforms that are crucial to achieving high growth and employment.

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