Conditions for the success of EMU
Speech delivered by Dr. Willem F. Duisenberg, President of the European Monetary Institute, Pamplona, 14 November 1997
I would like to address the issue of the conditions necessary for EMU to be a success. I should like to focus on three topics: first, the technical and institutional requirements related to the establishment of the ESCB and the single monetary policy; second, the need for sustainable convergence among the countries which will form the euro area and, finally, the need for a balanced policy mix between monetary and other economic policies in Stage Three of Monetary Union.
2 Technical requirements
The first topic - the technical and institutional requirements - will also enable me to give you a brief outline of what we are doing at the EMI. The EMI is responsible for preparing the operational framework that will enable the ESCB to conduct the single monetary policy in Stage Three of EMU. In this context, we are nearing the conclusion of several years of tough but ultimately successful preparatory work. I should like to summarise very briefly the achievements in some of the most important fields of this work.
With regard to the monetary strategy to be adopted by the ESCB, the EMI has retained two potential strategies as candidates for approval, namely monetary targeting and direct inflation targeting, both of which are used by the national central banks. At this stage, it appears neither desirable nor necessary to choose between them. The final decision on which strategy to adopt will be the responsibility of the ECB.
By contrast, the framework for the instruments and procedures of monetary policy - which will be used to guide short-term interest rates - has already been broadly defined. The ESCB will mainly use open market operations, in most cases employing reverse transactions, but it will also offer two standing facilities: a marginal lending facility and a deposit facility. The interest rates on these facilities will set the upper and lower limits for short-term money market interest rates. A broad range of counterparties will have access to the ESCB operations, and it has been agreed that the bulk of monetary policy operations will be carried out, in a decentralised manner, by the national central banks. Preparations have also been made for an infrastructure that will allow the ECB to impose minimum reserve requirements, if it so chooses. Our recent report entitled "The single monetary policy in Stage Three, General documentation on ESCB monetary policy instruments and procedures", which was released in September of this year, updates the operational framework, taking account of the most recent progress made in its specification. The main aim of this report is to provide financial institutions with the information they will need to prepare for participation in ESCB monetary policy operations in Stage Three.
To ensure that a single money market interest rate holds across the euro area, the integration of payment systems is an essential element of the technical preparations for Stage Three. The EMI and the NCBs are developing an interbank funds transfer system, called TARGET, which will be able to process cross-border payments denominated in euro as smoothly as if they were domestic payments. It will interlink the domestic real-time gross settlement (RTGS) systems which the NCBs have agreed to implement in their respective countries. Furthermore, this year the EMI Council endorsed the decision to choose S.W.I.F.T. as the Interlinking network provider and a contract was finalised. The testing of NCBs' links with the EMI's test centre has begun. The EMI has just published a further progress report, covering detailed issues such as the harmonisation of the operating time of domestic RTGS systems linked to TARGET and pricing policy.
In the field of foreign exchange policy, the ESCB will have the capacity to conduct foreign exchange intervention by means of transactions in foreign reserves valued at up to EUR 50 billion, which will be transferred from the NCBs to the ECB. All decisions related to intervention will be taken by the ECB, while the implementation of such decisions will be either centralised or decentralised within the ESCB. Furthermore, following preparatory work by the EMI, the European Council adopted a resolution on the new exchange rate relationship between the euro area and the non-euro area EU countries - the so-called ERM II - in Amsterdam in June of this year.
The recent political decision by the ECOFIN Council, to pre-announce the bilateral exchange rates which will be used for determining the euro conversion rates of the currencies of the participants in Monetary Union at the time of their selection, was well received by market participants, as it was seen as a strong sign of commitment to the EMU process. The pre-announcement is expected to reduce the risk of exchange rate instability in the so-called interim period prior to the irrevocable fixing of the euro exchange rates against the euro area currencies on 1 January 1999. In the interim period the co-operation in the conduct of monetary policies has to be intensified further. It is too early to tell what the common short term interest rate of the euro-area members at the end of 1998 will be. What is clear, however, is that there is a widespread misconception that this rate has to be an average of the actual short term rates in some group of EU-countries. The only thing that can be said now is that the rate should be at the level required for the maintenance of price stability in the euro area.
Following the agreement at the December 1995 Madrid summit on the EMI's plan for the changeover to the euro, the authorities pre-announced a chronological sequence of events, which was formulated on the basis of a small number of critical benchmark dates. The preparations for the changeover to the euro have gained momentum over the past twelve months. National changeover scenarios have been defined in most EU countries. Meanwhile the legal framework for the changeover process has been substantiated in two Council Regulations which will form the lex monetae of the Community. One element still to be agreed is the common date for the introduction of the euro banknotes and coins. In line with subsidiarity, the practical arrangements for the changeover will have to be made by the EU Member States. In parallel, there has been an increasing amount of investment by the private sector in the adaption of systems and procedures across the entire European Union.
Finally, I would just like to mention that the EMI and the NCBs have started to reflect on the functions of the ECB, as well as the nature of relationships between the ECB and the national central banks within the ESCB. A great deal of thought has been given to these issues within the EMI, and the EMI Council has given serious consideration to staffing requirements. I consider it likely that around 500 staff members will be required; the EMI currently employs around 350 members of staff.
3 Sustainable convergence
Besides bringing the preparatory work to a successful conclusion, it is of utmost importance for the success of Monetary Union that a high degree of sustainable convergence be obtained with regard to price stability, sound fiscal positions, exchange rate stability and the convergence of long-term interest rates for those countries which participate in Monetary Union. These criteria are intended to "level the playing-field" in order to ensure a smooth start for the single monetary policy. Moreover, the fiscal criteria will continue to apply in the monetary union. The provisions of the Stability and Growth Pact will contribute towards making Monetary Union sustainable in the longer term.
The dangers of there being a lack of convergence at the start of EMU are obvious. In particular, if national fiscal positions are not under control from the outset, there may be repercussions on the single monetary policy and adverse spillover effects across borders affecting Monetary Union as a whole. Similarly, significant inflation differences across countries might lead to unsustainable divergences in prices and costs within the euro area or to an unnecessarily tight monetary policy for countries that have achieved price stability.
Under the Maastricht Treaty, the EMI and the Commission have been given the task of examining the progress towards convergence and of assisting the European Council in establishing which EU countries fulfil their obligations in respect of the achievement of the convergence criteria. The results of these examinations will be presented in the spring of 1998.
Current performances indicate that a significant downward convergence towards price stability has taken place in recent years. This reflects the determination of the national central banks across the entire European Union to pursue price stability as the primary objective of monetary policy. In no less than fourteen countries, inflation observed over the past twelve months was below the reference value calculated according to the Treaty. The inflation rate for the EU as a whole is currently below 2%. There has also been considerable progress in bond yield convergence, and - with some exceptions - exchange rate stability has been broadly maintained throughout the EU over the past couple of years.
On the fiscal side, despite significant progress over the past few years, the sustainability of public finances in EU countries remains an issue. The latest official data show that in 1996 many EU countries had exceeded the reference values for public deficits and debt ratios laid down in theTreaty. For 1997, forecasts from the European Commission and the IMF suggest that most countries are expected to meet the reference values for public deficits, although the projections have yet to be confirmed by outcomes. When assessing the soundness and durability of the correction of public finances in early 1998 on the basis of the 1997 figures, the EMI will, inter alia, take careful note of the potential impact of temporary or "one-off" measures. If the impact of temporary effects on the budget deficit figures proves to be significant, this will signal the necessity to implement in 1998 additional measures with permanent effects in order to guarantee the sustainability of public finances. It is, however, rather difficult to distinguish permanent influences on the budgetary position, even when one-off or temporary measures are excluded, which renders the assessment of sustainability more difficult. In analysing the issue of sustainability the EMI will follow both a backward and forward looking approach. Our final view will be expressed in the Convergence Report which will be published in the spring of 1998.
Convergence is required not only in macroeconomic terms, but also in legal terms. The achievement of central bank independence is an important precondition in order to qualify for participation in EMU. Considerable progress has been made by Member States in adapting the statutes of their respective central banks in order to comply with the requirements arising from the Treaty and the Statute of the ESCB/ECB. The statutes of some central banks require further adaptation, in particular with a view to their integration into the ESCB. Where this is the case, legislative action is under way.
4 A balanced policy-mix
The ECB will be established shortly after the decision is made on the list of countries that will participate in EMU. On 1 January 1999 the ESCB will start conducting the single monetary policy with a view to maintaining price stability in the euro area. The pursuit of this objective, in full independence, will serve to safeguard the foundations for balanced growth and employment in the longer run. It would, however, be incorrect to say that the ESCB will have the sole responsibility for maintaining price stability in the euro area. Monetary policy needs to be supported by other economic policies; in particular, fiscal policies need to be sound and wage developments need to be in line with productivity growth. Without adequate support from other policy areas, the ESCB may be forced to take measures to dampen inflationary pressures, which may entail a short-term loss in output and employment. This might have negative consequences for public acceptance of the single monetary policy.
It has been argued that it will be more difficult in Monetary Union to cope with real asymmetric shocks, such as German unification. I do not, however, believe that shocks of the nature and magnitude of German unification are likely to be repeated in the future. Moreover, the past ten to fifteen years have witnessed a considerable convergence of the economic and social structures of the EU countries. Accordingly, our national problems - those relating to unemployment, social security and pension systems - have also become quite similar, and their solution will therefore require a similar approach. Furthermore, most of the real shocks in the past created problems not so much because they were asymmetric, but because the policy responses were different. The oil shocks in the 1970s serve as good examples. Our policy philosophies - both in monetary and fiscal terms - have undergone a thorough and welcome convergence process since then. However, one cannot exclude entirely the possibility that it will be necessary to accommodate asymmetric shocks hitting individual countries participating in Monetary Union. Sustainability in fiscal positions would give enough room to cope with asymmetric shocks and adverse cyclical developments by letting the automatic stabilizers work. This provides a supplementary incentive for sound fiscal positions and is an element of the Stability and Growth pact. Europe does not need a centralised budget to cope with asymmetric shocks. This is taken care of at the national level.
Turning to structural issues affecting fiscal sustainability, it is also important that governments should implement measures for coping with new budgetary challenges, such as ageing populations, where governments face massive future liabilities of social security systems. In the absence of appropriate reforms, sizable increases in contributions or even substantial increases in government indebtedness would appear to be forthcoming which may also be a threat to maintaining price stability.
There are also a number of other significant challenges in the economic environment; notably, there is a clear and insistent need for structural adjustment, in particular in labour and product markets. Unemployment in most EU countries, though showing signs of stabilising, remains unacceptably high, and the forecast for the situation in labour markets is not one of significant improvement in the absence of structural reforms. The weak employment performance in Europe seems to a large extent to be due to a wide range of institutional rigidities, and how to tackle them decisively enough to reduce unemployment will be a major challenge. Removing these rigidities is also important to make EMU a success, since flexible wages and prices are necessary adjustment mechanisms in a monetary union. Therefore, in this area what is required for solving the unemployment problem is also necessary for making monetary union work.
The task is thus to ensure that in Stage Three of EMU an appropriate overall policy mix is achieved. For the monetary policy decisions of the ESCB to be well-informed and optimal with respect to its objectives, there is evidently a need for regular dialogue and an exchange of information with third parties on issues of common interest. This will apply in particular to national economic policies, wage developments and the overall fiscal policy stance in the Monetary Union. If all policy areas contribute to creating the right conditions, price stability will, over the longer term, be consistent with balanced economic development.
To conclude, a high degree of sustainable convergence and a balanced policy mix are necessary conditions for EMU to be a success. EU Member States have made considerable progress in terms of economic convergence, although challenges remain in terms of structural reforms, notably in the area of fiscal policy and labour markets. Considerable progress has also been made by the EMI in terms of the necessary technical preparations for the single currency to be introduced, on schedule on 1 January 1999. The greatest challenge that lies ahead is to maintain price stability within the euro area after the start of Stage Three, in fulfilment of the mandate given to the ESCB under the Maastricht Treaty. Personally, I am convinced that the application of the convergence criteria, the institutional arrangements for the ESCB and the preparations made to date will ensure that the euro will be a stable currency and that the ESCB will be a powerful institution which will safeguard the value of the new currency./.