EMU - How to grasp the opportunities and avoid the risks

Speech delivered by Dr. W. F. Duisenberg, President of the European Monetary Institute, at the Forum de l'Expansion Paris, 22 January 1998


It is a great pleasure for me to speak to you about Economic and Monetary Union (EMU) which is a unique enterprise that provides a broad range of promising opportunities. The benefits of a single currency are by now well known,

On the other hand, as with any such undertaking, Monetary Union also involves some risks. However, I am convinced that the risks can be contained, if not fully avoided, by a high degree of sustainable convergence of those countries which participate in Monetary Union, by a single monetary policy which strictly aims at price stability in the euro area as a whole, by stability-oriented economic and fiscal policies and by sound wage developments in Stage Three.. If all policy areas contribute to creating the right conditions, the chances far outweigh the risks - or, in other words, the net benefits to be expected from EMU are clearly positive.

It is of utmost importance for the success of Monetary Union that a high degree of convergence be achieved for the participating countries. The dangers of there being a lack of convergence at the start of EMU are obvious. In particular, if national fiscal positions are not under control from the outset, the single monetary policy may be overburdened and adverse spillover effects may arise within the Monetary Union as a whole, and thus also for those countries whose fiscal policies are under control.

I should like to address the issue of what monetary policy, but also other areas of economic policy, in particular those responsible for fiscal and labour market developments, can contribute to grasping the opportunities and avoiding the risks of EMU.

The contribution of monetary policy: maintaining price stability

First, the most important contribution that the ESCB can make towards exploiting to the maximum the opportunities and avoiding the risks of EMU is to fulfil its primary objective to maintain price stability. Given the considerable lags between monetary policy measures and price developments, policy decisions directed at price stability must inevitably be both forward-looking in their formulation and pre-emptive in their implementation. This implies that the ESCB will have to take appropriate and timely action to ensure that the final objective is achieved. Therefore, it will have to carry out a thorough and broad analysis of all economic developments - in the euro area and beyond - which could potentially endanger current or future price stability.

To achieve this goal, the ESCB will also express its views on other policy areas which can potentially have an impact on its primary objective of price stability. Consequently, the ESCB will try to convince both policy-makers and the general public of the advantages of stability-oriented budgetary policies, of moderate wage developments and of structural reforms which make labour and product markets more responsive to economic signals.

Second, a high degree of credibility of the single monetary policy will certainly further heighten the advantages associated with an environment of stable prices. Credibility can be enhanced by the transparency of the monetary policy strategy - whichever strategy the ESCB will finally adopt - and by a policy which leaves no doubt regarding its determination to keep prices stable. In this context, it should be taken into account that given the long lags of monetary policy measures, the monetary stance in the current year will already have a significant impact on price developments in 1999 and beyond. Thus, current national monetary policies, in particular in the second half of this year, will de facto be responsible for ensuring price stability in the euro area in the initial phase of Stage Three, which is of crucial importance for the credibility and reputation of the ESCB. To achieve this aim in a consistent and effective way, co-ordination in the conduct of national monetary policies will have to be intensified further once the selection of the participants in Monetary Union has been carried out.

The independence of the ESCB, as laid down in the Maastricht Treaty, is a key factor in ensuring a high level of credibility of monetary policy geared to price stability. Therefore, it is of great importance that there is no doubt that the European Council clearly supports the independence of the ESCB. In its Resolution of last December the European Council states that only in exceptional circumstances may the Council formulate general orientations for exchange rate policy in relation to non-EU currencies. Moreover, the European Council points out that "these general orientations should always respect the independence of the ESCB and be consistent with the primary objective of price stability" and also that the dialogue between the Council and the ECB should respect all aspects of the independence of the ESCB.

Third, it should be emphasised that the single monetary policy has to focus on the euro area as a whole. This implies that product and labour markets should be more flexible in Stage Three than was needed before to absorb the impact of regional shocks. I will come back to this issue later in my presentation.

Fourth, accountability and transparency are important principles for the ESCB. Accordingly, the Governing Council of the ECB should be in a position to inform the general public in detail about its strategy and the rationale for its decisions.. This should stabilise inflationary expectations at a low level and, thus, enhance the advantages of EMU. Therefore, the ESCB will publish a quantified definition of the final objective of price stability and the specific targets against which the public can assess the ESCB's performance. Regarding the former, it would be fair to say that a rate of consumer price inflation not exceeding 2% is probably close to a level with which central banks would normally be quite satisfied.

Moreover, when explaining the general monetary policy strategy to the public, the ESCB will make clear what the single monetary policy can and cannot achieve, and how other areas of economic policies can support monetary policy and thereby enhance the benefits associated with price stability. This should also contribute to avoiding illusions and overly optimistic expectations regarding the direct contribution of EMU to resolving the problems of high unemployment and overburdened social security systems.

Furthermore, one may argue that Article 105.1 of the Treaty gives the ESCB the opportunity, if not the obligation, to support the general economic policies in the Community also by giving appropriate advice to those responsible for these policies and that this advice should be given with a view to supporting price stability and an open market economy with free competition, favouring an efficient allocation of resources. Moreover, to the extent that price stability has been firmly established, the ESCB will implement its monetary policy with a view to supporting the realisation of other economic policy goals, to the extent that this does not endanger future price stability.

The contributions of fiscal and labour market policies: achieving a balanced policy mix

For the monetary policy decisions of the ESCB to be well-informed and, thus, optimal with respect to its objectives, there is evidently a need for regular dialogue and an exchange of information with third parties on issues of common interest. This will apply in particular to national economic policies, wage developments and the overall fiscal policy stance in the Monetary Union.

This dialogue may also contribute to improving the economic environment of the single monetary policy and, thereby, the chances of achieving a balanced policy mix, i.e. of maintaining price stability without the need to adopt restrictive monetary policy measures.. Clearly, the dialogue will have to be conducted in such a way as to avoid any interference with the independence of the ESCB and the primary objective of price stability.

I have already mentioned that the full benefits of the single currency will not come quasi-automatically with a monetary policy geared towards price stability, but only if there is appropriate support from other economic policies, especially fiscal and wage policies, and if structural reforms are carried out in these areas. Thus, price stability is a necessary, but not a sufficient condition for grasping all the opportunities of EMU. Therefore, I would now invite you to have a brief look at the possible contribution of these policy areas towards ensuring that the potential benefits of EMU are fully realised and that the risks are minimised.

The ESCB may be forced to tighten its policy stance in order to keep prices stable, if it is confronted with inflationary budgetary policies and wage developments. In this case, there may be transitory losses in terms of economic activity and employment in the whole euro area and, thus, the overall benefits of EMU may be diminished. However, given that the ESCB, according to the Treaty, has the obligation to maintain price stability, those economic policies which threaten price stability should ultimately be regarded as responsible for this undesirable result.

How can this risk be avoided? It should be emphasised that a monetary policy which tolerated the inflationary impulse would not improve the situation - on the contrary, it would very likely lead to higher interest rates, increasing further the long-term risks to growth and employment creation. Thus, the only solution seems to be for all areas of economic policy to try to contribute to stable prices and, especially, to avoid measures which worsen inflation prospects.

In this context, I appreciate that the European Council obviously takes this issue very seriously. The Luxembourg European Council based its agreement on economic policy co-ordination in Stage Three of EMU on the fact that national economic developments can have an impact on inflation prospects in the euro area as a whole and, thereby, will influence monetary conditions in this area [1]. Thus, inflationary pressures stemming from national policies in some countries could have negative consequences for other parts of the euro area. Economic policy co-ordination should help to avoid such negative spill-over effects.

As already indicated, in Stage Three national authorities will face a new environment, characterised by the Stability and Growth Pact, by the permanent prohibition of monetary financing of the government deficit, by the inability of monetary and exchange rate policy to react to purely country-specific shocks, and by the likely - but difficult to predict - changes in the shape of financial markets following the introduction of the single currency. Moreover, there will be a strengthened economic co-ordination among Member States in Stage Three [2]. The significance of these changes, of course, may vary across countries, depending on the institutional environments and fiscal conditions as well as on the monetary and fiscal policy strategies prevailing in Stage Two.

This new environment, in particular the Stability and Growth Pact, will provide a good basis for sound public finances and should help to further reduce government deficits. However, there are still some problems and risks, in particular as some countries may start with a deficit of close to 3%. In the case of an economic downturn in one or more of these countries, this would imply either a substantial constraint on automatic stabilisers or the risk of breaching the reference value. Thus, it is important to reduce deficits further to levels close to balance or in surplus. This is not only required by the Stability and Growth Pact, but also by economic rationality and by the need to avoid an overburdening of younger and future generations.

Moreover, in Stage Three of EMU the option of using monetary and exchange rate policy in the event of country-specific problems in the real or the financial sector, including overly high labour costs, or with the aim of reducing the burden of financing a high level of government debt will no longer be available. To be sure, such monetary policy strategies did not and do not solve the underlying economic problems. However, by producing transitory improvements in economic conditions or by giving some relief to certain sectors which are in trouble, they sometimes allowed authorities to postpone the necessary and urgent reforms and policy measures. This will no longer be possible in Stage Three. The absence of a monetary policy oriented to the economic situation in individual member countries puts even greater premium on removing rigidities, particularly in product and labour markets. These markets should be flexible enough to allow wages and prices to be adjusted quickly. Such flexibility would be needed to avoid increased unemployment should local economic conditions worsen - due, for example, to an asymmetric shock or a relatively weak local productivity increase. Sufficient flexibility of national wages and prices could also be required if increases in indirect taxes and regulated prices were to contribute to rising area-wide inflationary pressures. In addition, national budgets should allow for sufficient room for manoeuvre to enable automatic stabilisers to work, while respecting the deficit limits of the Stability and Growth Pact.

Unemployment in most EU countries, though showing signs of stabilising, remains unacceptably high. As the bulk of EU unemployment is of a structural rather than of a cyclical nature, the key factors for securing existing jobs and creating productive new employment opportunities are continued moderation in wages, lower overall taxes and social security contributions and a reduction in structural rigidities in labour and product markets.

The prevailing structure of social security contributions, taxes and transfer payments in a number of EU Member States sometimes cause disincentives for employers to create new jobs. Labour market and fiscal reforms can contribute to increasing the incentives and the scope to create and offer new productive jobs. While such policies and structural reforms would support price stability and increase the benefits of EMU, they normally do not deliver employment miracles in the short-run. Their positive impact on employment will be stronger and quicker, if they are decisive and credible and if the private sector can be convinced that they will be sustained in the long-run. Under certain conditions as for example cost neutrality a policy of shortening working hours may also be an element in employment policies.

I know and understand that it is sometimes rather difficult to implement structural reforms. Nevertheless, they are needed to reduce unemployment, independently of EMU. However, EMU makes them even more urgent and indispensable.


To conclude, Monetary Union provides the great opportunity to create and maintain a large zone of price stability in Europe. However, while price stability is a necessary conditions for fully grasping the opportunities of EMU, it is not in itself sufficient.

I am confident that policy-makers in all areas are determined to take the new environment of Stage Three and its consequences appropriately into account when forming their policies.

Monetary Union, in this sense, offers the great opportunity to substantially improve living conditions in the medium-run. However, as I have explained, these gains will not come as a quasi automatic benefit of EMU.

As regards the mandate of the ESCB to maintain price stability, I am convinced that the application of the convergence criteria and the institutional arrangements laid down in the Maastricht Treaty and the Stability and Growth Pact will guarantee that the ESCB will be a powerful institution which will ensure that the euro will be a stable currency.

[1] See "Resolution of the European Council on economic policy co-ordination in Stage 3 of EMU and on Treaty Articles 109 and 109b" adopted last December in Luxembourg. The Resolution emphasises in its first Article that "to the extent that national economic developments have an impact on inflation prospects in the euro area, ... they will influence monetary conditions in this area". The European Council regards this as the "basic reason that the move to a single currency will require closer Community surveillance and co-ordination of economic policies among euro-area Member States."

[2] "This was agreed by the European Council in Luxembourg : "..strengthened economic co-ordination among States which will be sharing a single currency and between those States and States which will not yet be in a position to participate in the euro".

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