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Европейская денежная системаКраткое описание документа Европейская денежная системаThe 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 смотреть на рефераты похожие на "Европейская денежная система" European Monetary System and European Currency Based on selected papers kindly provided by the European Central Bank Compiled by Dm. Evstafiev for the students of the School of Political Science at St. Petersburg State University St. Petersburg 1999 Developments in the Financial Sector in Europe following the Introduction of the Euro Speech by Dr. Willem F. Duisenberg, President of the European Central Bank, to be delivered at the Third European Financial Markets Convention Milan, 3 June 1999 1. Introduction 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 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. 2. Money markets 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 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 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 3. Bond markets 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 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. 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. Market participants have responded to these developments in the bond
markets with a range of concurring or competing initiatives and alliances. 4. Equity markets 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. 5. Banking 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. 6. Conclusion 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 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" [(Article 105 (5))]. Analysis of the common developments in the European financial system represents such a contribution. *** Economic and Monetary Union in Europe - the challenges ahead Speech by Professor Dr. L.H. Hoogduin, on behalf of Dr. Willem F. Duisenberg, President of the European Central Bank, at the symposium sponsored by the Federal Reserve Bank of Kansas City on "New challenges for monetary policy" on 27 August 1999 in Jackson Hole, Wyoming From the European perspective, the title of this year"s Jackson Hole
symposium - "new challenges for monetary policy" - is particularly
appropriate. Economic and Monetary Union (EMU) in Europe is a unique
project and its consummation with the introduction of the single monetary
policy on 1 January 1999 took place less than eight months ago. Today,
given the time available, I will not endeavour to review all the challenges
which are raised by EMU comprehensively. I shall have to be selective,
largely focusing on the primary objective of the Eurosystem, which is to
maintain price stability in the euro area. In this context, let me briefly
explain our terminology, which may perhaps not be known to everybody as
yet. The "Eurosystem" is the name we gave to the European Central Bank I should like to start with some observations on the objective and
limitations of monetary policy in the euro area. Owing to the successful
process of disinflation and convergence within Europe over the past decade,
the launch of the euro last January took place in an environment of price
stability that few observers would have predicted only a few years ago. This contribution is substantial. Unfortunately, it is all too easily
taken for granted. Memories of the still recent past relating to the
consequences of high and unstable inflation tend to fade rapidly. We are
sometimes already hearing the argument that, given that price stability has
been achieved, monetary policy should now be re-oriented away from its
primary objective of price stability towards other goals. One of the
challenges facing the Eurosystem is to maintain the support of the broad
public constituency necessary to resist these calls, which - as I hardly
need to point out to such a distinguished audience of central bankers and
monetary economists - are misguided and ultimately counter-productive. The institutional framework for European monetary policy, as created
by the Maastricht Treaty (i.e. the Treaty on European Union, which has
become part of the Treaty establishing the European Community, or the EC The Treaty imposes several duties and tasks on the ECB. However,
there is no doubt that the objective of price stability is over-riding. For
example, the Treaty stipulates - if I may quote - that the Eurosystem Given the clear priority attached to the primary objective of price stability, how does the ECB address these other Treaty obligations? Let me make three points in this regard. First, among economists and central bankers, there is overwhelming agreement that there is no long-run trade-off between real activity and inflation. Attempting to use monetary policy to raise real economic activity above its sustainable level will, in the end, simply lead to ever higher inflation, but not to faster economic growth. I am convinced that the best contribution monetary policy can make to sustainable growth and employment in the euro area is to maintain price stability in a credible and lasting manner, allowing the considerable benefits of price stability to be reaped over the medium term. This is the economic rationale underlying the EC Treaty and the Eurosystem"s monetary policy strategy. Second, it is generally acknowledged that monetary policy does affect
real activity in the short run. Although the focus must always be on price
stability, in many cases the policy action required to maintain price
stability will also help sustain short-run economic and employment
prospects. The reduction of the Eurosystem"s main refinancing rate on 8 This leads me to my third point. In situations where monetary policy
might face a short-term trade-off between adverse developments in real
activity and deviations from price stability, the over-riding priority
accorded to countering the latter must be made absolutely clear. Any
ambiguity on this point will simply endanger the credibility, and therefore
the effectiveness, of the monetary policy response. This does not mean that
the policy action must be draconian. The medium-term orientation of the Recognition and an understanding of these three central points are
essential for the implementation of a successful monetary policy. It should be recognised that the implementation of EMU has made it even more urgent to improve the flexibility of labour and goods markets. In this context, it would very likely be the wrong answer if governments were to try to create a "social union", harmonising social security systems and standards at a very high level. The ECB will continue to cajole governments into implementing necessary and long overdue reforms, but the final hard decisions - and I acknowledge that they are hard decisions, since the considerable benefits of structural reform often only become apparent with time - lie with the national authorities. In those countries where appropriate structural reforms have been implemented and wage growth has been moderate, unemployment is either low by euro area standards or is falling more rapidly. These experiences offer important lessons for other countries in the euro area. Fortunately, a broader awareness of the necessity of structural reforms recently seems to be emerging in Europe. Of course, ultimately only sustained action will count. The cyclical recovery that is underway is no substitute for such action. Thus far, I have largely discussed the goal of the single monetary policy. How is this goal to be achieved? At the heart of the answer to this question is the Eurosystem"s monetary policy strategy. The strategy has two closely related aspects. First, the strategy must structure the monetary policy-making process in such a way that the Governing Council of the ECB is presented with the information and analysis required to take appropriate monetary policy decisions. Second, the strategy must ensure that policy decisions, including the economic rationale on which they are based, can be presented in a clear and coherent way to the public. The communication policy as part of the strategy obviously has to be consistent with the structure of the internal decision-making process. In designing the Eurosystem"s strategy, the Governing Council of the Relatively little is known as yet about the transmission mechanism of
monetary policy in the euro area after the transition to Monetary Union. One obvious problem related to the fact that the euro area did not
exist as a single currency area in the past regards the availability of
statistical data. Compared with national central banks, we do not have the
same amount of long historical time series of monetary and economic
indicators, based on harmonised statistical concepts, at our disposal. It would have clearly been unwise for the ECB to develop a strategy
which relies mechanically on the signals offered by a single indicator or
forecast in order to take monetary policy decisions. Indeed, such a
simplistic approach to monetary policy-making is unwise in all
circumstances. Our knowledge of the structure of the euro area economy and
the indicator properties of specific variables - although improving rapidly The primary objective of monetary policy has been quantified with the
publication of a definition of price stability, against which the On the basis of this strategy, I am confident that the Governing In this regard, the Eurosystem faces an especially formidable task. Over the years, each national central bank had developed its own strategy and, linked to this, its own "monetary policy language" for communicating with the public in the nation it served. This language reflected the unique circumstances of the country in question. The process by which the public learnt this monetary language from the statements and behaviour of the national central bank was largely subconscious. Over time, the strategies and the related language and conventions of monetary policy came to be so well understood as to be almost second nature. In these circumstances, private economic behaviour was shaped by the monetary policy environment. Many of us have experienced the problem of trying to learn a second
language in adult life. This rarely comes as easily as learning your native
tongue as a child. It is certainly not a subconscious process, but rather
one that requires effort and perseverance. It is often difficult to
overcome the habits and conventions of one"s first language, which are
inevitably somewhat at odds with those of a foreign tongue. Of course, it
is easier to learn a language that shares common roots with one"s own. With the adoption of the euro last January, the public, financial
markets and policy-makers in the euro area have all had to get used to a
new monetary policy environment and have, thus, had to learn a new Some commentators have suggested that the Eurosystem simply adopt the
strategy used by another central bank or by a national central bank in the
past. Tellingly, such observers often suggest the strategy they know best: A key feature of the ECB"s communication policy is the monthly press
conference given by the ECB"s Vice-President and myself, usually
immediately following the first Governing Council meeting of each month. These press conferences are a tangible expression of the Eurosystem"s commitment to be open, transparent and accountable in its conduct of monetary policy. In my view, our commitment to openness should not be in doubt. However, ensuring that this openness translates into effective communications continues to be a challenge. Journalists, financial markets and the public are still learning the new strategy and language of monetary policy in the euro area. By its nature, the challenge of improving communications between the Before concluding, I should like to add a brief comment on the likely
future enlargement of the European Union (EU) and, prospectively, the euro
area. Currently, the EU negotiates the accession of six countries to the Let me conclude. Monetary policy cannot solve all of the economic challenges facing the euro area, in particular those concerning the urgent need to reduce the high level of structural unemployment. National governments are responsible for carrying out the required structural reforms. The Eurosystem makes its best contribution to area-wide growth and employment prospects by credibly focusing on the maintenance of price stability in the euro area. I am confident that the monetary policy strategy adopted by the Monetary policy is most effective when it is credible. Transparent and accountable policy-making can help to build up a reputation and credibility. Effective direct communications with the public, including the financial markets, other policy makers and the media requires that we speak with one voice in an even-handed way with our diverse counterparties and audience. Successfully refining our area-wide communications, aimed at making our strategy, and the monetary policy based on it, transparent so that it can be well understood by the large and varied population we serve, is one of the challenges faced by the Eurosystem and, by implication, one of our priorities. *** EMU AND BANKING SUPERVISION Lecture by Tommaso Padoa-Schioppa Member of the Executive Board of the European Central Bank at the London School of Economics, Financial Markets Group on 24 February 1999 TABLE OF CONTENTS I. Introduction II. Institutional framework III. Industry scenario IV. Current supervision V. Crisis management VI. Conclusion Tables I. INTRODUCTION 1. 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 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. II. INSTITUTIONAL FRAMEWORK 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. 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 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. 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 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 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 III. INDUSTRY SCENARIO 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. 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 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 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 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 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 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 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. IV. CURRENT SUPERVISION 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 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 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. 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 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 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. Finally, the multilateral mode is the one in which a group of
supervisors works collectively as, say, a single consolidated supervisor. 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 19. So far, the need to develop the multilateral mode has been
relatively limited, as the emergence of a single banking market in the 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. 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: The Banking Supervision Committee is in a good position to co-operate
with the Eurosystem in the collection of information. Indeed, the so-called V. CRISIS MANAGEMENT 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 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 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. Crйdit 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 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 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 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 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. VI. CONCLUSION 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. 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 TABLES Table 1. Market share of branches and subsidiaries of foreign credit institutions as % of total domestic assets, 1997 From EEA countries From third countries TOTAL Branches Subsidiaries Branches AT 0.7 1.6 0.1 1.0 3.4 BE 9.0 19.2 6.9 1.2 36.3 DE 0.9 1.4 0.7 1.2 4.2 ES 4.8 3.4 1.6 1.9 11.7 FI 7.1 0 0 0 7.1 FR 2.5 NA 2.7 NA 9.8 IR 17.7 27.8 1.2 6.9 53.6 IT 3.6 1.7 1.4 0.1 6.8 NL 2.3 3.0 0.5 1.9 7.7 SE 1.3 0.1 0.1 0.2 1.7 UK 22.5 1.0 23.0 5.6 52.1 Source: ECB report "Possible effects of EMU on the EU banking systems in the medium to long term" (February 1999). Table 2. Assets of branches and subsidiaries of domestic credit institutions in foreign countries as % of total domestic assets, 1997 In EEA countries In third countries TOTAL Branches Subsidiaries Branches AT 2.6 NA 3.7 NA NA DE 12.0 7.3 7.8 0.9 27.9 ES 5.5 1.4 2.1 5.9 14.9 FI 5.9 0.3 6.6 0.3 13.1 FR 9.1 6.9 9.4 3.8 29.2 IR 8.3 14.9 1.3 10.1 34.6 IT 7.2 2.7 3.8 1.5 15.2 SE 7.2 NA 5.4 NA NA Source: ECB report "Possible effects of EMU on the EU banking systems in the medium to long term" (February 1999). Table 3. Concentration: Assets of the five biggest credit institutions as % of total assets 1985 1990 1997 AT 35.8 34.6 48.3 BE 48.0 48.0 57.0 DE NA 13.9 16.7 ES 38.1 34.9 43.6 FI 51.7 53.5 77.8 FR 46.0 42.5 40.3 IE 47.5 44.2 40.7 IT 20.9 19.1 24.6 NL 69.3 73.4 79.4 SE 60.2 70.02 89.7 UK NA NA 28.0 Source: ECB report "Possible effects of EMU on the EU banking systems in the medium to long term" (February 1999). Table 4. Number of branches and subsidiaries of foreign credit institutions, 1997 From EEA countries From third countries TOTAL Branches Subsidiaries Branches AT 6 20 2 11 39 BE 25 16 15 15 71 DE 46 31 31 45 153 ES 33 21 20 6 80 FI 9 0 0 0 9 FR 46 118 43 98 305 IR 18 21 3 7 49 IT 36 4 17 4 61 NL 11 8 11 19 49 SE 14 0 3 1 18 UK 106 18 149 114 387 Source: ECB report "Possible effects of EMU on the EU banking systems in the medium to long term" (February 1999). Table 5. Private non-financial enterprises" bonds, credit institutions" bonds and government bonds outstanding as % of GDP, 1997 Private Credit Government non-financial institutions" bonds bonds bonds AT 2.7 31.1 30.6 BE 10.0 38.3 111.0 DE 0.1 54.6 37.6 ES 2.6 4.5 52.9 FI 3.7 7.1 35.5 IE 0.01 1.6 32.2 IT 1.6 19.4 100.4 NL NA 43.1 53.4 SE 3.6 38.6 46.5 Source: ECB report "Possible effects of EMU on the EU banking systems in the medium to long term" (February 1999). Euro and European integration Speech delivered by Eugenio Domingo Solans, Member of the Governing Council and the Executive Board of the European Central Bank, at the "Euro and Denmark" exhibition in Aalborg, Denmark, on 10 September 1999 INTRODUCTION It is a real pleasure for me to participate in the "Euro and Denmark"
exhibition in Aalborg. It is the first time since my appointment as a
member of the Executive Board of the European Central Bank (ECB) in May I should like to refer to two main topics. First, and more extensively, allow me to explain the ECB"s view and my own view on the role of the euro as an international currency. After this I intend to make some brief comments on the key role that the euro and the Eurosystem are playing in the process of European economic integration. Before I begin, I should like to add that it goes without saying that the institutional position of the ECB - and therefore my own official position - concerning Denmark"s entry to the euro area is one of strict neutrality. This is an issue which has to be decided by the Danish people, whenever and in whatever way they deem appropriate. THE EURO AS AN INTERNATIONAL CURRENCY The three basic functions of the euro Every currency fulfils three functions: store of value, medium of
exchange and unit of account. Concerning the first function (store of
value), the euro is used and will increasingly be used as an investment and
financing currency by market players, and as a reserve currency by public
authorities. Regarding the second function of money (medium of exchange),
the euro is used and will increasingly be used as a payment or vehicle
currency for the exchange of goods and services and for currency exchange
itself. It will also have an official use as an intervention currency. Let me give you some information about the present use of the euro in each of these areas. I shall first refer to the private use of the euro, after which I shall consider its official public usage. The euro as a store of value The available information seems to confirm that the euro already
plays a significant role as an investment and financing currency in
international financial markets. Without going into precise details (1),
regarding the international debt securities market (money market
instruments, bills and bonds), it can be said that in the first two
quarters of 1999 net international issues denominated in euro amounted to With regard to equity markets, the weight of euro area stock
exchanges in terms of capitalisation ranks a clear second, far behind the As to the banking sector, the latest data show that, at the end DX The euro as a medium of exchange As for the second function of money (medium of exchange), the euro
needs more time to develop as a payment currency for goods and services in
international trade and as a vehicle currency in the foreign exchange
markets. Although no precise data are available at this stage, the value of
world exports denominated in euro is not likely to differ significantly
from that of euro area exports. By contrast, the value of world exports
settled in US dollars is nearly four times as high as that of US exports. The euro as a unit of account The use of the euro as a unit of account (its third general function) is closely linked to its use for the other two main functions. The use of a currency as a unit of account is, in a way, the basis for its use as a store of value or as a medium of exchange. The value stored in euro, or the payments made in euro, will tend to be recorded in euro. Therefore, we can conclude that the euro is playing an ever larger role as a unit of account for all the financial assets linked to the use of the euro as an investment and financing currency, and has a much less relevant role as a standard for pricing goods and services, owing to the widespread use of the US dollar as a payment and vehicle currency in international trade. The convenience of using a single standard for pricing commodities in the international markets, allowing traders to make direct comparisons between prices, makes it difficult for the euro to acquire a significant role in this respect. We can conclude that the development of the euro as a unit of account will follow the pace at which the issuers or suppliers of assets, goods or services priced or quoted in euro obtain a predominant position in the international markets. The official use of the euro The euro also has official uses as reserve, intervention and pegging currency, all three functions being strongly interrelated in most cases. With regard to its official use, the euro is currently the second most international currency after the US dollar, this being a legacy of the former euro area national currencies. Compared with the former euro area national currencies, there has
been a technical decline in the share of the euro as a reserve (and,
therefore, as an intervention) currency, mainly owing to the fact that such
former national currencies became domestic assets within the euro area. In connection with the use of the euro as a pegging currency,
approximately 30 countries outside the euro area currently have exchange
rate regimes involving the euro to a greater or lesser extent. These
exchange rate regimes are: currency boards (Bosnia-Herzegovina, Bulgaria, The position of the Eurosystem concerning the international role of the euro As a general conclusion stemming from the previous analysis of the
use of the euro in the world economy, we can affirm that the euro is the
second most widely used currency, behind the US dollar and ahead of the Taking the current situation as a starting point, the Eurosystem"s
position concerning the future international role of the euro is crystal
clear: we shall not adopt a belligerent stance in order to force the use of
the euro upon the world economy. We are convinced that the use of the euro
as an international currency will come about anyway. It will happen
spontaneously, slowly but inexorably, without any impulses other than those
based on free will and the decisions of market participants, without any
logic other than that of the market. In other words, the
internationalisation of the euro is not a policy objective of the Factors determining the importance of the euro in the world economy We understand that the euro fulfils the necessary conditions to become a leading international currency with the US dollar and not against it. There is enough room for both currencies in the world economy. The necessary conditions for a currency to become an international currency are based on two broad factors: low risk and large size. The low risk factor is related to the confidence inspired by the currency and its central bank, which in turn mainly depends on the internal and external stability of the currency. The low risk factor tends to lead to diversification among international currencies, since diversification is a means to reduce the overall risk; it acts, so to speak, as a centrifugal force. By contrast, the large size factor relates to the relative demographic economic and financial importance of the area which supports the currency; in other words, the "habitat" of the currency. The large size factor generally tends to lead to centralisation around one or several key international currencies. It can be seen as a centripetal force, as a virtuous circle, which will tend to lead to an increasing use of the euro as an international currency. Let us consider these two factors in more detail. The stability of the currency and the credibility of the ECB The first factor concerns low risk, credibility and stability. The stability of the euro is a priority for the ECB. Compared with the idea of stability, the strength of the euro is of lesser importance. This 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 the demographic, economic and financial dimensions of the euro area, is, without a doubt, the stability of the new currency, understood as a means to maintain the purchasing power of savings. In the global economy the transmission of financial crises by means
of different mechanisms (devaluations of weak currencies, subsequent
increases in interest rates, etc.) is frequently mentioned. 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 (through the Stability is the basic requirement for 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 for the confidence in and the
credibility of the ECB, without which a large international role for the
euro would be unthinkable. Stability is the proof of the effectiveness of
the institution. Yet in order to be credible it is not sufficient for the The conditions for the credibility of the euro are certainly
demanding. However, the achievement of these conditions is the aim of all
those of us who have responsibilities in relation to the operation of the The "habitat" of the euro The second factor, which we have called the large size factor or the
habitat of the euro, is important because without a certain critical mass,
a currency cannot have international relevance, however high its degree of
stability. In addition to quality, quantity is required, as 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 Mark until 1998. The figures relating to the population and the GDP of the euro area
illustrate this. With 292 million inhabitants, its population exceeds that
of the United States (270 million) and that of Japan (127 million). The GDP
of the euro area is, on the other hand, equal to 76% of the GDP of the However, even more important than the current figures is the
potential for the future development of the euro area, in terms of
population and GDP, if and when the so-called "pre-ins" (Denmark, Greece, The entry of these countries would 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. All these facts and figures which demonstrate the demographic and economic importance of the European Union would be further strengthened by enlargement to 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. However 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 role 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, compared with 19.6% for the United The financial dimension of the euro The size or habitat of an economy does not only depend on demographic
or economic factors; it also has to do with the financial base or dimension
of the area. 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 3,655 billion in the euro area in Although these figures could give the impression that the euro area
has a relatively small financial dimension relative to its economic
dimension, this is not the case. The lower degree of development of the
capital markets is offset by a higher degree of banking assets. This means
that the financial base of real economic activity in Europe is founded on
bank intermediation, which is also a feature of the Japanese economy. For
example, private domestic credit in the euro area amounts to 92.4% of GDP,
while in the United States it is only 68.9%. Conversely, fixed domestic
income represents 34.2% of GDP in the euro area 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). We therefore have two
distinct models of private financing which clearly have to be taken into
account when assessing Europe"s financial dimension compared with the THE ROLE OF THE EURO AND THE EUROSYSTEM IN THE PROCESS OF EUROPEAN INTEGRATION The euro as a catalyst for European integration The euro, the Eurosystem"s monetary policy and, in general, the activity of the ECB and the Eurosystem will play a key role in the integration of European financial markets and all markets in general. We can say that the euro will act as a catalyst for European economic integration. Monetary and financial integration The integration of the European money markets relies, of course, on the existence of a single system for refinancing the banks in the euro area, that is to say on the common monetary policy. However, it also relies technically on a system of instantaneous data transfer and on the new common payment system, TARGET, enabling real-time gross settlement. Thanks to the smooth operation of the information, communication and payment systems, 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 the requirement to have guarantees or
collateral for operations with the ECB. This requirement for adequate
collateral can stimulate the process of loan securitisation, especially in
the case of the banking institutions of certain financial systems. 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 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 into 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
functioning of the market improves, while in the long-term securities
markets - both public and private, of course - interest rates will always
include a risk premium linked to the degree of solvency of the country Economic integration Monetary and financial integration stemming from the euro and the activity of the Eurosystem will affect the operation of the European single market in a positive way. The European market, with a single currency, will tend to be more transparent, more competitive, more efficient and will function more smoothly. This is the reason why joining the European Union, as a general rule, leads to joining the euro area, once certain economic conditions (the so-called convergence criteria) are fulfilled. The case of Denmark, as you will know better than I, constitutes an
accepted exception to the general rule, formalised in Protocol No. 8 on However, the Danish krone was in fact pegged to the Deutsche Mark
from 1982 until the end of 1998. Furthermore, since 1 January 1999 it has
been participating in ERM II with a rather narrow fluctuation band of In this connection, and before the question and answer session begins, let me conclude by addressing the following key questions to you, on the understanding that this is a rhetorical way to express my ideas and that I do not necessarily expect any of you to answer them. If Denmark already is following "the rules of the game", why, then,
should you not make use of the advantages of belonging to the Eurosystem? ______________________ (1) For a more detailed analysis, see the article entitled "The
international role of the euro", in the August 1999 edition of the ECB"s *** European Economic and Monetary Union - principles and perspectives -#"+ !-+ 1999DRAFT SYLLABUS FOR THE CLASummary of a presentation by Ms Sirkka Hдmдlдinen, Member of the Executive Board of the European Central Bank, The Tore Browaldh lecture 1999, School of Economics and Commercial Law, Gцteborg University, Gothenburg, 25 February 1999 The European integration process started shortly after the Second 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 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 Achieving a credible currency Today, almost two months after the introduction of the euro, we can
say that the technical changeover to the euro was successful. Now, the The credibility of a currency also relies on the preparedness of
governments to pursue stability-oriented policies of fiscal discipline and
to undertake necessary structural reforms. On this point, the Stability and 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 transparent approach, 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 absolute clarity as regards the primary objective; 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 A further important building block in order to establish credibility
is the promotion of an efficient implementation of the monetary policy
decisions. 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 The consequences of a single currency: perspectives for the future 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 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. 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 The euro and the Nordic countries The Nordic countries have chosen to organise their monetary policy
ties to the euro area in very different ways: Finland is the only Nordic
country taking part in Monetary Union as from the start of Stage Three; 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 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 Personally, I also think that the Nordic countries could provide a
fruitful joint contribution to the long-term success of Monetary Union. Concluding remarks 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. *** Eurosystem: new challenges for old missions Inaugural Lecture by Tommaso Padoa-Schioppa, Member of the Executive Board of the European Central Bank, on the occasion of his appointment as 1999GERMAN COFFEE COMPANY ORGANIZES THE PROMOTION CAMPAIGN IN ST.DOCЦюй±%?ѕ[pic] А- -#"+ !-+ 1999GERMhonorary Professor of Johann Wolfgang Goethe- Universitдt, Frankfurt am Main, 15 April 1999 Table of contents 1. Introduction 2. Policy missions 3. New challenges 4. Making the eurosystem a central bank 5. Dealing with the European unemployment 6. Managing financial transformations 7. Coping with a lack of political union 8. Conclusion 1. INTRODUCTION 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 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". The mode of the following remarks will be the interrogative, rather
than the assertive one. Not only because presumption is certainly not my 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. 2. POLICY MISSIONS 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 central banking the public interest is to provide
economic activity with a medium of exchange that preserves its value over
time. In the broader field of economic policy - 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" 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 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 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. 3. NEW CHALLENGES 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 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, 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? 4. MAKING THE EUROSYSTEM A CENTRAL BANK The first challenge consists in making the Eurosystem a central bank. Eurosystem is the word chosen by the ECB to indicate the "ECB+11
participating national central banks", i.e. the central bank of the euro. Central bank is the institution in charge of the public interests associated with the currency. It originates from fundamental 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 payment system function: monetary policy and banking supervision. 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 triadic function 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 its 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 all these activities it pursues and represents the
public interest of a sound currency; all are instrumental to that interest. For the Eurosystem the challenge is to rise to a full central banking role as just defined. It is necessary 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, "die Wдhrung zu sichern" - 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 difficult, 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 Although a federal and 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 public
interest they were referring to was the notion of a national interest. 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 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 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 5. DEALING WITH EUROPEAN UNEMPLOYMENT The second challenge comes from the high level of unemployment in 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 structural factors and flexibility. 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 with, rather than against, the labour organisations, although reform entails occasional confrontations. As with inflation in the 1970s and 1980s, so unemployment in the Notwithstanding the intergovernmental debates at a European level and the stated intention to undertake common initiatives, the instruments of employment policy remain in national 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. 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 functional 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 institutional
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. 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 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. 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. 6. MANAGING FINANCIAL TRANSFORMATIONS 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 technology determined,
hence independent of the euro and even not specifically European. Other changes are specifically European. 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 Finally, there are changes induced by the euro. 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. 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 functional 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, geographical, 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. 7. COPING WITH A LACK OF POLITICAL UNION 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 First, I do not concur with the idea that there is no political union
in Europe today. It is not because the content and the competence of the 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 The establishment of a single currency is a strongly political event in its genesis and a profound social and cultural 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 raison d"кtre 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 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 his 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. 8. CONCLUSION 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 by the 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 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. *** Monetary policy in EMU Prof. Otmar Issing Member of the executive board of the European Central Bank Washington, D.C. 6 October 1998 1. Introduction On 1 January 1999, the curtain will ri"+ !-+ 1999MAYOR99.DOC†[?]р?p- The decision has been taken. The Euro will start on time. It must not The French president recently called this unique project a "great
collective adventure". As a central banker I am generally not in favour of 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 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. 2. The priority 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 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 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. 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. 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. 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 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 3. The importance of the monetary strategy for a successful start of 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. The monetary policy strategy is, in the first place, important for
the internal decision-making process of the ESCB - how the Governing 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: * reinforce the ESCB"s commitment to price stability, the primary and over-riding task stipulated by the Treaty; * it must clearly signal the anti-inflationary objectives of the ESCB, and serve as a consistent benchmark for the monetary policy stance; and, * it must be transparent and explained clearly to the general public - only then can the strategy serve as a basis for the ESCB"s accountability to the public at large. 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 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 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 * the introduction of TARGET (directly related to EMU itself); * greater technological sophistication of payments mechanisms, as use of computers and information technology becomes more widespread and advanced; * the additional incentive for cash-less payments that may arise from the fact that for some time to come - approximately three years - the new euro-denominated notes and coin will not come into circulation. In particular, narrow monetary aggregates might be affected by this development; and, * increased competition among banks and settlements systems, arising from globalisation and the breakdown of barriers between previously segmented national markets, which may drive down the margins and fees charged to customers. 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. How should a monetary policy strategy be selected in this - for
monetary policy makers, at least - potentially difficult environment? The 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. 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. In many respects, a strategy giving a prominent role to monetary
aggregates has considerable advantages over direct inflation targeting. 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 Against this background, the ESCB will have to design a monetary policy strategy of its own. The chosen strategy will show as much as possible 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 to the extent needed the unique situation created by the introduction of the euro. 4. The new monetary policy instruments and procedures for the euro area 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. 4.1 Open market operations 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. 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. 4.2 Standing facilities 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. 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 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. 4.3 Minimum reserve system 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-а-vis the ESCB. This will safeguard the role of the European 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. In 1999SCHD-MAY.DOCf[pic]1 T- 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. 4.4 Procedures 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. General Documentation The ECB has produced a document describing its monetary policy instruments and procedures in detail. This is called "General Documentation on ESCB Monetary Policy Instruments and Procedures". 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. Publications on the ECB"s Internet site 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 of institutions subject to minimum reserves, that is, credit
institutions established in the euro area, will also be available on the 5. Concluding remarks 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. The euro as an international currency Speech delivered by Eugenio Domingo Solans, Member of the Governing Council and the Executive Board of the European Central Bank, at The Athens Summit "99, in Athens on 18 September 1999 Thank you for inviting me to the Athens Summit "99 and for giving me the opportunity to speak to you at this important event. I should like to share with you my views, and the ECB"s views, on the importance of the euro as an international currency. I understand that this issue may be of interest to experts from Greece, a "pre-in" country which intends to join the euro area, and to many participants from countries outside the euro area and the European Union, some of which currently have exchange rate regimes related to the euro. Nowadays the euro is the second most widely used currency in the world economy, behind the US dollar and ahead of the Japanese yen. As we all know, any currency fulfils three basic functions: it is a store of value, a medium of exchange and a unit of account. As a store of value the use of the euro as an investment and financing currency is rapidly increasing, as investors understand the advisability of diversifying their portfolio currencies among those which are more stable and more internationally used. The euro is developing at a slower pace as a medium of exchange or payment currency in the international exchange of goods and services. This fact can easily be explained by the combined and reinforcing effects of network externalities and economies of scale in the use of a predominant international currency as a medium of exchange, as is the case with the US dollar. The use of the euro as a unit of account is linked to its use as a store of value and a medium of exchange. The value stored in euro or the payments made in euro will tend to be counted in euro. There are good reasons to expect an increase in international public use of the euro as a reserve, intervention and pegging currency, inasmuch as the public authorities understand that it is worthwhile to allocate their foreign reserves among the main international currencies and to give the euro a relevant share in accordance with its internal and external stability and the economic and financial importance of the euro area. In connection with the use of the euro as a pegging currency,
approximately 30 countries outside the euro area currently have
exchange rate regimes involving the euro to a greater or lesser
extent. These exchange rate regimes are currency boards (Bosnia- Taking the current situation as a starting point, the The euro fulfils the necessary conditions to be a leading international currency with the US dollar and not against it. There is enough room for both currencies in the world economy. The necessary conditions for a currency to become an international currency are based on two broad factors: low risk and large size. The low risk factor is related to the confidence inspired by the currency and its central bank, which in turn mainly depends on the internal and external stability of the currency. The low risk factor tends to lead to diversification among international currencies, since diversification is a means to reduce the overall risk; it acts, so to speak, as a centrifugal force. By contrast, the large size factor relates to the relative demographic economic and financial importance of the area which supports the currency; in other words, the "habitat" of the currency. The large size factor, which concerns the demographic, economic and financial dimension, generally tends to lead to centralisation around one or a few key international currencies. It can be seen as a centripetal force, as a virtuous circle, which will tend to lead to an increasing use of the euro as an international currency. Let us consider these two factors in more detail. The first factor concerns low risk, credibility and stability. Stability is the basic requirement for a good currency. It is what we at the ECB want for the euro. We want a stable euro and we are convinced that, in the long term, the euro will derive strength from its stability. The stability of the euro is the basis for the confidence in and the credibility of the ECB, without which a large international role for the euro would be unthinkable. Stability is the proof of the effectiveness of the institution. Yet in order to be credible it is not sufficient for the ECB to maintain stability. Other parameters of its action must be considered: accountability, transparency and communication, a Europe-wide perspective, etc. These parameters or conditions for the credibility of the euro are certainly demanding. However, the achievement of these conditions is the aim of all those of us who have responsibilities with regard to the functioning of the Eurosystem. The second factor, which we have called the large size factor or the habitat of the euro, is important because without a certain critical mass, a currency cannot have international relevance, however high its degree of stability. The figures relating to the population and the GDP of the euro
area illustrate this. With 292 million inhabitants, its population
exceeds that of the United States (270 million) and that of 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 compared with EUR However, even more important than the current figures is the
potential for the future development of the euro area, in terms of
population and GDP, if and when the so-called "pre-ins" (Denmark, The entry of these countries would result in a monetary area of All these facts and figures which demonstrate the demographic and economic importance of the European Union would be further strengthened by enlargement to 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. However that is, for the moment, a distant prospect. The size or habitat of an economy does not only depend on
demographic or economic factors; it also has to do with the financial
base or dimension of the area. 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 Although this feature could give the impression that the euro
area has a relatively small financial dimension relative to its
economic dimension, this is not the case. The lower degree of
development of the capital markets is offset by a higher degree of
banking assets. This means that the financial base of real economic
activity in Europe is founded on bank intermediation, which is also a
feature of the Japanese economy. For example, private domestic credit
in the euro area amounts to 92.4% of GDP, while in the United States
it is only 68.9%. Conversely, fixed domestic income represents 34.2%
of GDP in the euro area compared with 66.1% of GDP in the United The euro, the Eurosystem"s monetary policy and, in general, the
activity of the ECB and the Eurosystem play a key role in the
integration of European financial markets and all markets in general. Monetary and financial integration stemming from the euro and the
activity of the Eurosystem will affect the operation of the single 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 Treaty on European Keynote address to be delivered by Dr. Willem F. Duisenberg President of the European Central Bank on The European System of Central Banks Current position and future prospects At a Conference organised by the Royal Institute of International Affairs on European economic and Monetary Union Markets and Politics under the Euro London 27 november 1998 1. Introduction Ladies and Gentlemen, I should like to express my appreciation at
being invited to deliver a speech at this conference organised by the Royal 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. 2. Independence, transparency and accountability 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. 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 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 institutional implication is that the ESCB should develop into a
strong unity, with a strong centre and strong national central banks. It
should become a truly European institution, with a truly European outlook. Transparency and openness will be apparent from the way in which the 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 The publications of the ESCB will include, in particular, an ECB 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. 3. Monetary policy strategy of the ESCB 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. 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. 4. Recent economic developments and prospects 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 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. The euro: pushing the boundaries Presentation by Ms Sirkka Hдmдlдinen, Member of the Executive Board of the European Central Bank, at the symposium arranged by the European Private Equity and Venture Capital Association on 11 June 1999 in Prague It is a great honour for me to be invited here today to this
symposium arranged by the European Private Equity and Venture Capital * pushing the boundaries in the process of European integration; * pushing the boundaries of stability-oriented policies in Europe; and * pushing the boundaries of market integration in Europe. In today"s presentation, I shall give an overview of these three aspects of Economic and Monetary Union. Thereafter, I shall discuss more thoroughly the implications of the single currency for the development of the European financial markets, focusing on the capital markets. Finally, I shall reflect briefly on the importance of equity prices, and other asset prices, in the formulation of monetary policy. 1. Pushing the boundaries of the process of European integration I shall start with a few comments on the role of the euro in the
overall European integration process: I think there is little doubt that in
future books on European history the start of the third stage of European In order to put this event into a historical context, I should like to note that the establishment of an Economic and Monetary Union in Europe was, in fact, originally motivated more by general political arguments than by economic arguments. In the current debate, these overall political arguments have almost disappeared. Instead, the media and economic analysts are increasingly focusing their assessment of the new currency on the recent short-term economic and financial developments in the euro area. The process of European integration started shortly after the end of the Second World War and gained momentum in the 1950s. At the time, the striving for integration was mainly driven by the aim of eliminating the risk that wars and crises would once more plague the continent. Through the establishment of common institutions, political conflicts could be avoided or at least resolved through discussion and compromise. The idea of establishing a monetary union and a common monetary
policy was raised at an early stage of this process. It was argued that the
full economic effects from integration in Europe could only be gained if
the transaction costs of exchanging different currencies were eliminated. The first concrete proposal for an economic and monetary union in The experience of this volatile period showed that large exchange
rate fluctuations between the European currencies led to a disruption of
trade flows and an unfavourable investment climate, thereby hampering the
aims of achieving growth, employment, economic stability and enhanced
integration. Therefore, the benefits of eliminating intra-EU exchange rate
volatility became an increasingly powerful argument when the issue of
establishing an economic and monetary union was revisited in the so-called The Delors Report contained a detailed plan for the establishment of The fact that the plan for the introduction of the single currency was then pursued and implemented in such a determined and consistent manner implied, in itself, a boost for the overall process of integration. The momentum of the process of integration is no longer crucially dependent on political decisions. By contrast, the integration of the European economies has become an irreversible and self-sustained process, which is proceeding automatically in all areas of political, economic, social and cultural life. The euro can thus be seen as a catalyst for further co-ordination and integration in other policy areas. This is one way in which the introduction of the euro has definitely helped to push the boundaries in the process of European integration. Another way to push the boundaries in the European integration
process relates to the geographical extent of the euro area and the 2. Pushing the boundaries of stability-oriented economic policies Economic and Monetary Union in Europe also provides an opportunity to push the boundaries in areas of economic policy. The convergence process prior to the establishment of Economic and Monetary Union was helpful in order to achieve a broad consensus among policy makers on the virtues of stability-oriented policies, i.e. policies directed towards price stability, fiscal discipline and structural reform geared at promoting growth and employment. The convergence process also helped policy makers to focus their efforts on the formulation of stability-oriented economic policies in the participating countries and it also facilitated the acceptance of these policies among the general public. In the new environment of Economic and Monetary Union, monetary policy can no longer be applied as a means of accommodating economic developments in an individual Member State. Such nation-specific developments would have to be countered by fiscal and structural policies, while the best way in which the single monetary policy can contribute to improved conditions for growth and employment is by ensuring price stability in the euro area as a whole. In this respect, the formulation of the Maastricht Treaty is instrumental, since it guarantees the Eurosystem"s firm commitment to price stability; it clearly specifies that price stability is the primary objective of the single monetary policy. The Eurosystem has put a lot of effort into establishing a monetary policy framework that will ensure that it can fulfil its primary objective of price stability as efficiently as possible. There are several aspects to this framework. First, the Eurosystem has adopted a quantitative definition of the
primary objective - the Governing Council of the ECB has defined price
stability as a year-on-year increase of the Harmonised Index of Consumer Second, the Eurosystem has made public the strategy to be used for
the implementation of the single monetary policy. This strategy is based on
two key elements, whereby money has been assigned a prominent role, as
signalled by the announcement of a Z- -#"+ !-+ Third, the Eurosystem puts significant emphasis on the need to
carefully explain its policy actions in terms of its monetary policy
strategy. Therefore, the Eurosystem has established various channels for
the communication with market participants and the general public. The most
important communication channels are the ECB"s Monthly Bulletin, its press
releases and the press conferences following the meetings of the Governing Fourth, the Eurosystem"s monetary policy is implemented in a marketed- oriented manner. The Eurosystem"s key policy instrument is its weekly tender for two-week repo operations, the so-called main refinancing operations. The features of the monetary policy operations are decided by the decision-making bodies of the ECB, but the operations are conducted in a decentralised manner by the NCBs. The experience gained from the first five months of operations has shown that the Eurosystem"s procedures for decision-making and operational implementation works very well. There are therefore no operational reasons to call into question the ability of the Eurosystem to fulfil its mandate to ensure price stability in the euro area. However, stable macroeconomic policies cannot be achieved by monetary policy alone. It is also necessary for governments to pursue fiscal and structural policies consistent with such macroeconomic stability. In order to ensure fiscal discipline in the participating countries,
the EU Council agreed in June 1997 to establish the so-called Stability and As regards structural policies, the policy framework is, so far, less
well developed. This is worrying given that the need for structural reform
is urgent in many areas in order to be able to effectively promote greater
growth potential and higher employment. I appreciate that these problems
are generally acknowledged, and some action has been taken in recent years. Nevertheless, experience from several countries shows that it usually
takes a long time for the full effects of structural reforms to be seen. Clearly, the establishment of Economic and Monetary Union does not
mean that the efforts undertaken during the convergence process can be
relaxed. On the contrary, the need for policy co-ordination among the
participating countries is now even more pressing. We have already seen
examples of negative market reactions to any perceived slippage in fiscal
discipline or postponement of structural reform. Personally, I think that
these swift market reactions, although sometimes exaggerated, may be
helpful in promoting a continued stability-oriented policy thinking in In this context, I would once more like to underline how important it is that a consensus has emerged among European policy-makers on the virtues of price stability, fiscal discipline and market-oriented structural reform. In this way, we have already pushed the boundary significantly towards a macroeconomic environment conducive to growth and employment, although much still needs to be done in the years to come. 4. Pushing the boundaries in the development of financial markets However, the success of the euro is not only in the hands of central bankers and policy-makers. An important area in which the private sector has an instrumental role in meeting the challenge of pushing the boundaries is in the development of the European financial markets. In order for the euro to be a success, it is important for the euro area financial markets to become wider, deeper and more diversified. The introduction of the euro has provided further input into this process; the elimination of exchange rate risks has removed one of the main barriers to financial market integration in Europe. In most European countries, the financial markets have, traditionally, been rather shallow, with few participants and a narrow range 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. This segmentation has been a function of exchange rate borders, tradition, differing practices and, of course, national regulations and tax regimes. Following the elimination of the barriers implied by different currencies, it is now up to the European Commission and the relevant national authorities to further the integration process in the areas of regulation and taxation. Meanwhile, it is up to market participants to take advantage of the business opportunities implied by the increased scope for market integration. The introduction of the euro brought about an almost immediate integration of the national money markets into a euro area-wide money market. This was made possible thanks to the establishment of pan-European payment systems, such as the TARGET system set up by the Eurosystem, which enables banks to access liquidity throughout the euro area in real time. 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 also experiencing important developments in these segments of the financial markets. These developments are partly due to the general trends towards globalisation and technological refinement and partly related to the introduction of the euro. As a result of the introduction of the euro, market participants increasingly perceive similar instruments traded in the different national markets to be close substitutes. This holds true, in particular, for 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 on 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 common trading platforms linking the European stock exchanges. Similar initiatives have also been taken to establish links between national securities settlement systems, which would facilitate the cross-border mobilisation of securities. In the longer run, such developments will make it possible for investors to manage their investment portfolios more efficiently. The Eurosystem welcomes such initiatives aimed at improving the cross-
border integration of financial markets in the euro area, and globally,
since they may result in a wider range of financial instruments on offer,
and at a lower cost, than is currently the case in the national markets. In fact, the experience of the first few months of the life of the
euro seems to indicate that such a positive development may already be
under way. 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 bonds
denominated in the constituent currencies, which had been in the range of Despite the recent developments in the euro area capital markets,
euro area companies are still mainly dependent on financing through the
banking system. Hence, there is still plenty of scope for further
development in the area of corporate financing. For example, the amount of
private bonds traded in the euro area is still very low compared with the In this context, I should like to say a few words on how the
introduction of the euro may underpin the reshaping of the European banking
sector. The increased scope for securitisation will put pressure on the I welcome this trend towards an expansion beyond national borders
with open arms, since the establishment of truly pan-European - and global 5. The Eurosystem and the equity markets I should like to conclude my presentation today by briefly discussing
about the euro area equity markets as seen from the perspective of the The existence of efficient equity markets should also reduce the risk of the emergence of asset price bubbles, which is desirable from a monetary policy perspective. Prior to the emergence of asset price bubbles in some industrialised countries in the early 1990s, few central banks paid much attention to the development of prices of equities or other assets in their monetary policy formulation. However, the effects of the bubble economies in the early 1990s,
notably in Japan, the United Kingdom and Scandinavia, led to an intense
debate among economists on how monetary policy could have responded better
to the situation. Some research was carried out in order to establish price
indexes that would incorporate asset prices and which could be used as
target variables or indicators within the monetary policy framework. However, in practice it is not easy to let monetary policy actions respond to asset price developments. Central banks have only one tool for the implementation of monetary policy - the short-term interest rate. They can therefore not effectively try to achieve several objectives at the same time. It is also difficult to judge how developments in asset prices actually feed into consumer prices, thereby making it tricky to assess the need for the appropriate monetary policy response to their changes. This difficulty is exacerbated by the rather high volatility of certain asset prices, such as equities, which could result in frequent changes in policy interest rates if the central bank were to incorporate them mechanistically into its reaction function. In this respect, the present situation in the United States, as well as in several European countries, is interesting: equity prices have risen rapidly for an extended period but consumer prices remain very subdued and there are, so far, no signs that there is going to be a spill-over from asset price developments into consumer price inflation. Against the background of the rather unclear relationship between
asset price developments and consumer price inflation, the development of
equity prices does not have a prominent role in the formulation of the *** THE MONETARY POLICY OF THE EUROPEAN CENTRAL BANK Speech by Eugenio Domingo Solans Member of the Executive Board of the European Central Bank during the "Working Breakfast" at the Permanent Seminar on 4 December 1998 in Madrid Introduction 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 MESTER PROGRAM OF 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. The three fundamental principles underlying the monetary policy 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 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. The ECB"s monetary policy objectives 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. 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 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 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"кtre 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 The ECB"s monetary policy strategy 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 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. 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 ESCB monetary policy tool 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 Espaсa and with which you are
all familiar. This means that I only need to highlight a few differences. 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 Espaсa 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 Conclusion 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. The monetary policy of the Eurosystem Main remarks of the speech delivered by Eugenio Domingo Solans Member of the Governing Council and the Executive Board of the European Central Bank at the SOCIETAT CATALANA D"ECONOMIA (Institut d"Estudis Catalans) Barcelona, 2 July 1999
* The primary objective of the Eurosystem and, therefore, the touchstone to
measure its success is the achievement of price stability. In the medium
term the best contribution that the Eurosystem can make in favour of
sustained growth is, precisely, to create an environment of stability. * The 5.2% increase in the three-month moving average of the 12-month
growth rates of M3 covering the period from March PROGRAM аto May 1999 is in line with the 4 Ѕ reference value for money growth,
which is the basis of the first pillar of the ECB"s monetary policy. * The results of the broadly based assessment of the outlook for price developments, which constitutes the second pillar of the ECB"s strategy, confirm that there is no risk to price stability in the euro area. * The second pillar of the ECB"s monetary policy strategy includes, among other indicators, the exchange rate developments of the euro. The ECB"s assessment on the evolution of the exchange rate of the euro should, therefore, be linked to the risk for price stability of a depreciation of the euro. Taking into account that the euro area economy is a rather closed one, no significant inflationary impact should be expected from the recent exchange rate developments of the euro. * One main feature of the instruments and procedures of the Eurosystem"s monetary policy is their high level of flexibility, in the sense that without discretionary changes the instruments can accommodate a wide range of different market situations. On the other hand, there is flexibility in the sense that the Eurosystem has at its disposal a wide set of monetary policy instruments and has, therefore, the possibility to move from one to the other if and when it is deemed appropriate, taking into account their advantages and disadvantages. In the first stage of the ECB"s monetary policy, the fixed rate tender with a discretionary allotment is the best choice for the main refinancing operation owing to its advantages in terms of signalling effects and controlling both the liquidity allotted and the volatility of overnight rates. On the contrary, in the case of longer-term refinancing operations, the Eurosystem as a rule does not intend to send signals to the market and the effects on the liquidity and on the overnight rates are weaker. Therefore, for longer-term refinancing operations, the market-oriented variable rate tender has a clear advantage. * The activities and the monetary policy decisions of the ECB should be interpreted from a euro area perspective as a whole. To interpret them from a national standpoint would be a mistake. *** THE ROLE OF THE CENTRAL BANK IN THE UNITED EUROPE Speech by Dr. Willem F. Duisenberg, President of the European Central Bank, National Bank of Poland, Warsaw, Poland on 4 May 1999 1. Introduction 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 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. 2. The process of European integration 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 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. 3. The institutional framework of the single monetary policy 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 Decisions on monetary policy are made by the Governing Council of the The execution of monetary policy is to a great extent decentralised. 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 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. 4. The monetary policy strategy The ECB has, as I mentioned earlier, such a mandate. However, the 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, 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. 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. 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. 5. 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. As I have already mentioned, we have decided
to enhance this by providing a quantitative definition of price stability. 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 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 6. EU enlargement 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 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 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 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 *** The single European monetary policy Speech by Willem F. Duisenberg President of the European Central Bank at the University of Hohenheim on 9 February 1999, in Hohenheim, Germany 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 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. 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 stability-oriented monetary policy strategy of the Eurosystem The Treaty establishing the European Community assigns the European 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 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 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. 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 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. 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. Turning to the role of exchange rates between the euro and other
important currencies outside the EU, in particular the US dollar, the 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 The most recent monetary policy decisions and operations 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 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 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 Regular assessment of the monetary, financial and economic situation To conclude, I should like briefly to report on the Governing 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 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 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 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. The statistical requirements of the ESCB Speech delivered by Eugenio Domingo Solans, Member of the Executive Board of the European Central Bank on the occasion of a visit to the Banque Centrale du Luxembourg Luxembourg, 25 March 1999 The booklet introducing statistical requirements for Stage Three,
which the EMI published in July 1996, began with the bold statement: The statement of requirements 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. 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 The focus on the euro area as a whole 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. How far the provision meets the current need 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. 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. Priorities for further improvement of statistics 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 The organisational, legal and technical infrastructure I have talked mainly about statistical requirements and their
provision, but this is only part of the story. The Treaty (specifically in Information Technology is another of my responsibilities at the ECB. Conclusion "Nothing is more important for monetary policy than good statistics." *** The tasks and limitations of monetary policy Speech delivered by Christian Noyer Vice-President of the European Central Bank, at the Volkswirtschaftliche Tagung of the Oesterreichische Nationalbank, on 10 June 1999 in Vienna Ladies and Gentlemen, 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 tasks and limitations of monetary policy. 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. 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. The absence of exchange rate targets for the euro vis-а-vis other
major currencies should not be misunderstood. For smaller, very open
economies, fixed exchange rates may be a very reasonable choice. The 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 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. *** European Central Bank Press Division Kaiserstrasse 29, D-60311 Frankfurt am Main Tel.: 0049 69 1344 7455, Fax: 0049 69 1344 7404 Internet: http://www.ecb.int Reproduction is permitted provided that the source is acknowledged |
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