EMU: many countries - one monetary system
Speech by Dr. Willem F. Duisenberg (Hong Kong, 19 January 1998)
Ladies and gentlemen, distinguished guests, etc.
I have great pleasure in being in Hong Kong once again to address issues concerning European Economic and Monetary Union.
Since the last time I was here - on the occasion of the International Monetary Fund (IMF) and World Bank's annual meeting - two developments have taken place.
In Europe preparations for EMU have continued unabated: at the latest European Councils - held on 22 November and on 12 and 13 December - the Heads of State or Government approved common lines for coherent employment creation policies and finalised an agreement on the co-ordination of economic policies in the European Union after the start of EMU and on the dialogue between the Council of Ministers and the European Central Bank.
In parallel a severe financial crisis has shaken the economies of some countries in Asia - requiring the mobilisation of international multilateral support under the aegis of the IMF for Thailand, Indonesia and Korea. In other countries of the region the authorities have intervened repeatedly in order to re-establish confidence in the stability of their banking and financial systems.
Although the main impact of the financial turbulence in Asia will be felt in Asian countries, the rest of the world will also be affected. This underscores the importance of the Asian economies and their share in the globalisation process. However, the prospect that EMU will start in January 1999 remains unaltered. This prospect is underpinned by a low level of inflation and by renewed progress towards convergence - also in the domain of public finances, where further consolidation is nevertheless required.
While not disregarding international developments, in particular those in this part of the globe, I shall concentrate my address today on illustrating how the EU countries are building a common monetary system which is almost the opposite of your situation, where two monetary systems exist in one country. I should like to address the process by which EMU is being established, focusing specifically on three aspects: first, the technical preparations for the introduction of the single currency - the euro; second, the management and the conduct of the single monetary policy by a European System of Central Banks (the ESCB, which will consist of the European Central Bank (the ECB) and the national central banks of the EU Member States); and, third, the elaboration of economic policies in the EU after 1999.
2. Organising the transition to the single currency
2.1 The procedure in 1998
In a report to be published on 25 March, the EMI will make public its analysis of the progress made by individual Member States in terms of sustainable convergence by reference to the fulfilment by each Member State of a number of criteria. In parallel the European Commission will publish its own report and formulate a recommendation based on the outcome of the report. The EMI's and the European Commission's reports, which will be released simultaneously, will guide the Council of Ministers - composed of the Finance Ministers of the EU Member States - in drawing up its recommendation to the European Council - composed of the Heads of State or Government - on which Member States are ready to adopt the single currency from the beginning of 1999. The European Parliament will be consulted on the matter and will forward its opinion to the European Council. I do not want to dwell on this topic today. I can only observe that many countries have already reaped some of the benefits they were expecting from participation in EMU: low inflation, lower interest rates and reduced exchange rate volatility.
The Heads of State or Government will select the Member States eligible to participate in the first round of EMU during the first weekend of May of this year. Thereafter, the Executive Board of the ECB will be appointed and the ESCB will be established. The Executive Board will consist of the President and Vice-President, plus up to four executive directors. The ESCB will carry out, in the period lasting until 1 January 1999 (the so-called interim period), the adoption and testing of the monetary policy framework prepared over the past few years. Economic and Monetary Union will start on 1 January 1999. In the interim period, monetary policy will remain a national responsibility, but the monetary policies of the individual Member States will become increasingly co-ordinated. The bilateral exchange rates between the participating currencies - which will be used for determining the euro conversion rates - will be pre-announced on the date of the selection of the first countries to participate. On the eve of EMU, the rates at which the participating currencies will be irrevocably converted into euro will be fixed. One euro will then be equal to one ECU at that point in time. Euro conversion rates cannot be pre-announced owing to the Treaty requirement that one ECU will be equal to one euro at the start of EMU. The ECU is a basket currency, also comprising currencies which will not be converted into euro, such as the pound sterling. The euro will not be a basket currency, but a normal currency just as the Deutsche Mark and the US dollar are today.
2.2 The changeover in 1999-2001
The organisation of the transition to the single currency has been a complex and demanding exercise, as the authorities have had to strike a balance between two different and sometimes conflicting demands: a common framework for the single currency area as a whole, as defined in Madrid in December 1995, and the need to provide scope for adaptation to differing national environments. A three-year transitional period is envisaged.
From the start of the three-year transitional period, the lawful currency of the European Union will be the euro, issued by the ESCB. The national currencies of the participating Member States will legally be equivalent to non-decimal subdivisions of the euro. The ESCB will operate exclusively in euro from the very start of EMU. New marketable public debt will also be issued exclusively in euro. For the rest, public and private agents will be able to decide for themselves whether or not they wish to use the new or the old currency denominations, which will in any case be irrevocably linked together. The euro will assume the appearance of the national monetary tokens. This means that fiduciary retail payments will continue to be mainly in banknotes denominated in national currencies.
Legal certainty will be guaranteed by a common legal framework which has been agreed at the European level. This framework establishes the principle of the continuity of contracts, thereby preventing any contractual party from refusing to perform outstanding obligations for the simple reason that EMU has entered into force.
Similar legal amendments in relation to the continuity of contracts and the euro have already been enacted in the United States, e.g. in the State of New York, the State of Illinois and in the State of California.
This common framework has been supplemented by a host of preparations at the national level, which encompass all economic sectors. I shall refer only to some of the most significant developments:
- the governments of most Member States have published national changeover schemes which have been validated by committees and other planning bodies consisting of representatives of all sectors of the economy. In some cases, draft laws have been presented to or already approved by parliaments;
- all Member States intend to redenominate outstanding public debt in euro at the start of Stage Three, that is to say three years before the date by which secondary markets for bonds are to change over to the euro;
- industry associations and institutions linked to the financial markets have been preparing for the complete integration of financial markets.
In summary, Member States have been given considerable leeway in the area of changeover preparations to implement different strategies for the introduction of the single currency. However, a competition-led process of mutual emulation has brought most public and private entities to similar conclusions. The developments I have just described highlight the intention of the great majority of public authorities and market participants throughout the EU to accelerate the pace of the changeover to the euro. The preparatory work for the euro is seen as a golden opportunity to upgrade the services provided by the public sector and to increase the efficiency of the financial system.
2.3 Developments after 1 January 2002
As from 1 January 2002, euro banknotes and coins will be introduced in all the Member States participating in Economic and Monetary Union at the same time. However, each Member State has the right to determine the pace of the cash changeover in its economy, provided it is completed by the middle of that year, i.e. end-June 2002. From that point onwards, only the euro will be in use as the national unit of account and means of payment in the participating countries of the Economic and Monetary Union and national currencies will no longer have legal tender status.
3. The single currency of Europe as a symbol of unity
I should now like to turn to the management and conduct of monetary policy once Economic and Monetary Union has been launched in January 1999.
3.1 Decision-making bodies and the decision-making process in the euro area
The monetary policy decisions will be taken by the Governing Council of the ECB by simple majority. The Governing Council will be composed of the President and Vice-President, the other members of the Executive Board and the governors of the national central banks of the participating countries. Each member of the Governing Council will have a single vote. The execution of policy decisions will to a large extent be decentralised and rely on the infrastructure of the national central banks.
3.2 The ECB as guarantor of a stable euro
From the first day of Economic and Monetary Union, national central banks will transfer their monetary policy competencies to the ESCB, which will have the primary objective of maintaining price stability, and thus be the guarantor of a stable euro.
3.3 Strategy and instruments for the conduct of the single monetary policy
The EMI has published material in which it recommends two possible monetary policy strategies for the ECB to consider: monetary targeting and direct inflation targeting. The final decision on which one - or on which combination - of the two strategies to adopt will need to be taken by the Governing Council of the ECB in 1998.
In its theoretical description, monetary targeting involves the central bank choosing a monetary aggregate as its intermediate target and deciding its monetary policy actions solely on the basis of comparisons between the target and actual monetary developments. By contrast, an inflation targeting strategy aims at directly steering the final target variable, the inflation rate, without the use of a separate intermediate target variable. Monetary policy actions are based on a comparison between the target for inflation and the forecast inflation rate.
The practical differences between these two theoretically distinct strategies are not so great and their application in different countries has shown that several variants integrating elements of both strategies may exist. Both strategies are based on the same final objective, price stability; they are forward-looking, and they employ a wide range of indicators to assess the appropriateness of the stance of monetary policy.
To achieve price stability, the ESCB will use a number of monetary policy instruments within the context of the chosen monetary policy strategy.
The EMI has already published a blueprint for the monetary policy instruments of the ECB. These will mainly comprise open market operations, supplemented by two standing facilities which will provide a ceiling and a floor to the corridor of official interest rates. Whether or not, in addition, use will be made of minimum reserve requirements remains to be decided by the Governing Council of the ECB.
The EMI has not recommended an exchange rate objective as an appropriate monetary policy strategy for the ECB, given that for an area potentially as large as the euro area, such an approach might be inconsistent with the internal goal of price stability. The external value of the euro will thus mainly be an outcome of the ECB's monetary policy.
This is not to say, however, that the euro area will totally disregard exchange rates. The Treaty on European Union provides for the possible conclusion of formal exchange rate arrangements with non-EU countries. It is unlikely that such arrangements will be made in the foreseeable future. The Treaty also provides for the formulation of general exchange rate orientations vis-à-vis non-EU currencies. But it has already been agreed that these will be resorted to in exceptional circumstances only and in any event without prejudice to the ESCB's primary objective of maintaining price stability. The ESCB will also have the technical capacity to conduct intervention operations in order to counteract excessive or erratic fluctuations of the euro against the major non-EU currencies. In addition, the ESCB will be a party to the so-called ERM II arrangement, the successor to the current EMS, under which EU Member States which have not yet adopted the euro will manage their exchange rate against the euro.
3.4 The international role of the euro
There is no doubt that the creation of a single currency area will transform the international monetary landscape. Academics seem to be divided between those who expect the birth of a European monetary pole to contribute to more stable international exchange rate relations and those who anticipate increased volatility in the medium term in the foreign exchange markets. As the European economy will be characterised by stable low inflation and sustainable fiscal policies in the Member States, there is no a priori reason to expect increased exchange rate volatility; indeed, one could even expect the contrary. By conducting similar policies in all major industrial countries, one of the pre-conditions for a stable international monetary system will be in place.
The euro can be expected to become a major international currency, not only because it will be the currency of a large area but also because it is based on monetary and fiscal policy driven by the objective of stability. However, the international role of the euro will probably develop gradually.
4. Economic policy in EMU and some challenges
I should now like to address the question of how economic policy will be conducted in the European Union as from the start of Economic and Monetary Union.
4.1 The other components of a stability-oriented economic framework
Since EMU is not only about monetary union but also about economic union, it is evident that national economic policies cannot be conducted with total disregard to their potential spillover effects on neighbouring countries. On the other hand, economic union does not require a supranational decision-making on economic policies, and the Treaty clearly reflects this distinction between the monetary and the economic arrangements in Stage Three. This being said, there must be common institutional procedures to enable crucial issues of economic policy, almost - by definition - of common concern in the EU, to be raised and resolved at the Community level. Such procedures were already provided for in the Treaty and put into practice, but with the advent of Monetary Union they will need to be strengthened. I should like to highlight three such procedures.
The first mechanism is the formulation of broad guidelines for the economic policies of the Member States and of the Community, as stipulated in Article 103 of the Treaty. Monetary Union will inevitably create greater interdependence between the participating countries as well as the other EU countries bordering on the euro area. It is thus reasonable to assume that governments will feel the need to hold joint discussions and formulate economic orientations. The recent conclusions drawn by the European Council in Luxembourg (on 12 and 13 December 1997) confirm that the ECOFIN Council, which is the Council of all fifteen EU Finance Ministers, will be the centre of co-ordination for Member States' economic policies.
A second instrument is the so-called "Stability and Growth Pact", the terms of which were agreed at the Amsterdam Council of 16 and 17 June 1997. The Pact, which builds on and refines rules already laid down in the Treaty on the joint surveillance of economic developments (Article 102, paragraph 3) and joint EU procedures in the event of an excessive deficit in one or more Member States (Article 103), contains a shared goal for Member States - namely that of bringing government budgets in the medium term close to balance or even into surplus and to take corrective action to avoid excessive budgetary deficits. In this way, it will be possible to let the automatic stabilisers work, without causing public deficits and debt levels to increase and reach unsustainable levels.
A third element is what has been coined the "Euro-x" Council, which will informally gather the Finance Ministers of the Member States of the euro area for discussions on issues connected with their shared specific responsibilities for the single currency. The Commission, and the ECB when appropriate, will be invited to take part in these meetings. Whenever matters of common EU-wide interest emerge, they will normally be discussed within the ECOFIN Council.
Other policy rules firmly enshrined in the Treaty with a disciplining effect on the behaviour of groups and institutions in the governmental area should not be overlooked: the prohibition on extending central bank credit to governmental institutions; the ban on any form of preferential access to credit by the public sector; and the "no bail-out clause", which prevents the transfer of one government's liabilities to the Community or to other Member States.
4.2 The most frequent objections from economists overseas: the lack of a federal budget of the EU and insufficient labour mobility across national borders
Insufficient mobility of the labour force across the euro area is seen by some academics as a serious cause for concern for the longer-term viability of Economic and Monetary Union. Other compensatory mechanisms - such as large-scale financial transfers to the affected country or countries - will also be ruled out in Europe given that the budget of the Community will be very small.
But the existence of the Stability and Growth Pact leads to the conclusion that EMU does not need a centralised budget. With national budget positions close to balance or in surplus, countries have ample room for manoeuvre to cope with adverse economic developments.
Certainly, Europe requires more market flexibility to better ensure adjustments in EMU. However, labour market flexibility is required independently of EMU. The current excessive level of unemployment cannot be solved unless major structural reforms, especially in the labour markets, are implemented. That which is needed to make EMU work is also required in order to reduce unemployment in Europe. It is important to underline that the introduction of the euro, although in itself an important step in the further economic integration of Europe, will not - and cannot - solve all the problems and needs to be accompanied by other policies.
European integration has always been an evolutionary process.
Economic and Monetary Union in Europe is a further step in this process.
The euro will be a stable currency and, as such, it may become a symbol of unity and shared values among Europeans. As the destinies of the peoples of the world become increasingly interdependent, the experience gained from European integration may be useful to all.