The European perspective on the euro

Presentation by Ms Sirkka Hämäläinen at the Euro Conference, Fordham University, New York, on 26 October 1998.

1. The implications of the euro for the economic policy framework in Europe

On entering the European Monetary Union, the eleven participating countries will permanently give up their own national monetary policy. Monetary policy decisions will be taken by the Governing Council of the ECB and will be based on euro area wide considerations. The primary objective of the ESCB is to maintain price stability in the euro area. Price stability has been defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. In order to achieve this objective, the ESCB will pursue a strategy comprising two elements: 1) money will be assigned a prominent role through the announcement of a quantitative reference value for the growth of a broad monetary aggregate; and 2) there will be a broadly-based assessment of the outlook for price developments on the basis of a wide range of indicators. The focus on euro area wide developments implies that if an asymmetric shock were to hit a specific Member State, or if business cycles were not to be synchronised across the euro area, the necessary adjustment at the national level would have to be performed by fiscal and structural measures. In practice, this situation was apparent already in the process towards Monetary Union. The convergence process towards Monetary Union meant that a degree of nominal convergence never before experienced in Europe was achieved. The credibility established through the convergence process became evident during the recent turmoil in the international financial markets. Exchange rates remained stable within the exchange rate mechanism ERM and long-term interest rates spreads widened only slightly. While recognising the achievements made in embarking on a path towards stability-oriented policies and a high degree of nominal convergence, we also have to admit that unemployment is still unacceptably high in the euro area. However, I would like to stress that monetary policy is neither the cause of nor the solution to the unemployment problem in Europe. The problems with European labour markets are structural. Unemployment in Europe can thus only be effectively combated through reforms addressing these underlying structural problems. On the whole, the economic fundamentals of the euro area economies look better now than they have done for many decades. Inflation is low, savings are high, public finances have improved and domestic demand seems to continue being strong. Even if it is clear that external effects will hamper the growth prospects also in the euro countries, it appears that the euro area is presently experiencing more stable and favourable economic conditions than most other regions in the world.

2. The role of the euro in the international financial system

The introduction of the euro will be the biggest change in the international financial system since the collapse of the Bretton Woods system in 1973. It is likely that the euro will play a very important role in the international financial markets, benefiting from the reputation inherited from the currencies which it will replace. Several arguments seem to indicate that the euro may become a more attractive investment currency than all the currencies which it will replace taken together.

A further aspect of the internationalisation of the euro will be its developing role as a transaction and vehicle currency for cross-border transactions outside the euro area. Today, the US dollar is by far the most important international transaction currency. The euro may become an important currency for invoicing of foreign trade and for spot foreign exchange operations. On the whole, there is little doubt that the euro will have a more important role in the international financial system than any of its constituent currencies. Confidence in the future internal and external stability of the euro will be a key factor in determining the international importance of the euro. Another factor will be the efficiency and international competitiveness of the European financial markets.

3. The role of the euro for the development of the European financial markets

The European financial markets are currently undergoing a rapid development characterised by cross-border integration and provision of new financial services. I should like to highlight a few areas where the introduction of the euro is likely to directly influence the working of the financial markets in the euro area:

On a more general level, cross-border integration may promote the markets for commercial paper and corporate bonds in the euro area. The market value of corporate bonds outstanding in the US is at present almost ten times larger than in the euro area. There is thus plenty of scope for further securitisation in the euro area and the introduction of the euro certainly underpins this development. These developments will have important structural implications for the banking industry in the euro area in addition to the effects of increased cross-border competition. So far, the European banking industry has remained segmented into rather small national markets; the introduction of the euro is expected to give momentum to cross-border integration in the European banking sector resulting from the disappearance of the natural "protective barriers" implied by national currencies. To conclude: The developments of the European financial sector are likely to greatly improve the efficiency in the mobilisation of savings and in the channelling of these savings into productive investments - and thus improve the growth potential of the euro area as a whole.