On the eve of the euro
Lecture by Tommaso Padoa-Schioppa, Member of the Executive Board of the European Central Bank, Brixen Summer School, European Academy, Brixen, 3 September 1998
Introduction (Bertram Schefold):
Signore e Signori, sono molto lieto di accogliere il Dott. Padoa-Schioppa, membro del Comitato direttivo della Banca Centrale Europea a Francoforte: è un onore per noi e per la nostra scuola estiva. Mi permetto anche di parlare di un sollievo, visto che le turbolenze di Borsa non gli hanno impedito di venire qui da noi a Bressanone.
Meine Damen und Herren, ich gestatte mir persönlich hinzuzufügen, wie sehr es mich freut, daß damit ein Mitbürger Frankfurts (für die nächsten 7 Jahre) den Weg zu uns nach Brixen gefunden hat. Für uns in der Sommerschule ist dies das Hauptereignis, nämlich die einzige öffentliche Sitzung. Also gestatte ich mir auch, bei dieser Gelegenheit unsere Gäste ganz besonders herzlich zu begrüßen.
Ladies and gentlemen, on behalf of the Brixen summer school's organisation committee and of the European Academy, and bearing in mind that the European Commission is the main sponsor of this event, I should like to welcome Mr. Padoa-Schioppa here as a member of the Executive Board of the European Central Bank (ECB) in Frankfurt - moreover, the member elected with the highest number of votes by the European Parliament! (Applause) The circumstances of that election prove that you are so well known that I do not have to say much more by way of introduction, but I should nonetheless like to recall your distinguished career in the Banca d'Italia, at the European Commission in Brussels and as the Surveyor of the Italian Stock Exchanges. Your work for the Delors Committee on European Economic and Monetary Union (EMU) has made you one of its founding fathers. You are the author of an amazingly large number of books and articles on monetary matters. We had agreed that you should speak here about the functioning of European Economic and Monetary Union and the role of the European Central Bank in particular. We are grateful that you will be available afterwards for a discussion which may also touch on current policy problems. The floor is yours. Thank you. (Applause)
Thank you very much. I am happy and honoured to be here tonight. The assumption underlying your applause is that to be liked by the European Parliament is a good sign for a central banker. I am not sure that this is always the way central bankers feel, and so I may, in fact, have to recover from that vote, rather than build upon it! I am particularly happy, Duncan, to see you again after so many years. If I may, I should like to make a personal reference. Duncan Foley was my teacher at MIT 30 years ago. He was then teaching a very different kind of economics from that which he has taught subsequently, if my information is correct, but he was an extraordinary teacher for me. When I came back to Italy, I remember giving some seminars on Foley's Sidrauski model. These gave me the reputation of being almost a reactionary in an Italian intellectual environment that was thinking along very different lines from that model. Well, many things have now changed. 30 years have seen many, many changes, and I am very happy to see you here.
The title of this lecture - although I think of this talk more as of a kind of conversation - that Professor Schefold and myself have chosen is "On the eve of the euro". First, I shall elaborate upon this title by recapitulating the steps involved in reaching this eve. I shall then go on to say something about what, in my view, is special about EMU. Third, I shall describe what is happening during this eve.
How did we get here?
"Eve" refers to the period in which the European Central Bank is already in existence, but has not fully assumed its monetary policy functions. It will do so on 1 January 1999. It is a period of several months, of which we have just about reached the middle.
Thus, how did we arrive at the inception of the European Central Bank? It has been a long process. Indeed, I could say that it started with the Treaty of Rome in 1957. I do not know how many of you are familiar with this extraordinary book that every economist should read, because it contains, in legal language, many implicit and some explicit propositions about the way in which the economy should function and economic policy should operate. The Treaty has proved, over a period of 40 years, to be extremely powerful and flexible in many ways.
One of the implicit propositions is that, in order to have a Common Market (as it was called at the time), it is necessary to have a corresponding monetary order, in other words, I would suggest, some kind of monetary union. This proposition is only implicit because, in the mid-1950s, this kind of system existed in reality. At the time, the system of fixed exchange rates created at Bretton Woods was such a key component of the world economic order that it was taken for granted that it would last. In fact, it was not even the subject of much discussion, except for a few references to exchange rates. Most of the efforts in the early years following the birth of the European Community in 1958 were devoted to scaling down tariffs, which were of a much smaller order of magnitude than the fluctuations on foreign exchange markets in the present floating situation. If it was considered such a difficult task to abolish tariffs while nothing was said about exchange rates, this is because exchange rates were taken as being fixed.
Thus, we could say that there was a monetary union in the beginning, and this was the Bretton Woods system. When, about 10 years later, that system started to show signs of weakness, discussions began in the European Community on replacing it with an arrangement that would grant stable exchange rates at least for intra-European relationships. The notion of economic and monetary union, this very expression, is used for the first time in 1969 and 1970.
The second decade of the approximately 40-year period since the signing of the Treaty of Rome, say from 1969 to 1979, saw the collapse of the Bretton Woods system, repeated devaluations and all types of inflation; it also coincides with a period in which the process of European integration virtually came to a halt.
The third decade begins in 1979 with the launch of the European Monetary System, the first successful attempt to organise a European exchange rate system designed to provide, at least within Europe, fixed but adjustable exchange rates.
The forth decade begins in 1988 when - and again I am focusing solely on the monetary line of development, disregarding the many other things that happened on the European scene - the Delors Committee was created in June 1988 in order to study economic and monetary union and its implementation in various stages. The history of EMU - all I have said so far has concerned the "prehistory" - started then.
As stated above, the "prehistoric" phase ends with the creation of the Delors Committee, and the "historical" phase, of which we are now nearing the conclusion, began just 10 years ago when the Heads of State or of Government decided (and there had been much preparatory work behind that decision) to create a committee to develop the project of Monetary Union. The said Committee was chaired by Jacques Delors; it was composed of all the twelve governors of the national central banks of the European Community and a small number of "lay" members.
Since then, between June 1988 and, say, June 1998, when the ECB came into existence, a rather extraordinary sequence of events has occurred: a very ambitious project has been launched and implemented, because the creation of a single currency and a single central bank for a number of sovereign countries which have not yet merged into a federation is something that has never previously been attempted.
This project, owing to a series of special circumstances, never fell from the top of the agenda of the European leaders, showing a degree of continuity that is rare in international negotiations. In many countries the political parties holding the balance of power changed, mainly because of economic events, cyclical changes in the economy, etc. Yet, the project was never cancelled. The Bretton Woods conference had lasted two and half weeks. The negotiations leading to the Treaty of Rome, which created the European Economic Community, from the moment when the original idea was conceived in Messina (1956) to the moment when the institutions came into existence (1958), lasted little more than two years. Normally, in international affairs, favourable constellations are short-lived and things have to be done fast. It is remarkable that the favourable constellation present in the run-up to EMU has lasted for so long.
The 10 years from June 1988 to June 1998 can be divided into two distinct periods of about five years: a period of negotiations on, and design of, the project, which began with the creation of the Delors Committee and ended with the ratification of the Maastricht Treaty; and a period of preparation, mainly of the macroeconomic conditions, which has come to be known as economic convergence.
You will always notice the involvement of Germany and, most often, Chancellor Kohl at the watersheds of both these periods. Kohl was in Hannover in June 1988 and he was in Brussels in May 1998. Germany was the last country to ratify the Maastricht Treaty when the Federal Constitutional Court in Karlsruhe issued its statement. Kohl relaunched the project in March 1990, immediately after the elections in East Germany that restored democracy and unified Germany. One of the explanations for this continuous involvement is the continuity of leadership in Germany, and, because of that, in Europe.
During the first of the two five-year periods the idea of monetary union was conceived and the project formed; then it was endorsed politically and translated into a Treaty; and, finally, that Treaty was ratified. All that occurred in the years 1988 to 1993.
The Maastricht Treaty largely follows the German model in terms of the role of the central bank and the aims of economic policy, as well as the idea, strongly advocated by the Germans, that monetary union could only start if a high degree of economic convergence, low inflation, sound public financial conditions, etc. had previously been achieved. People who were in favour of monetary union on the basis of both their economic convictions and their political faith, like myself, tried to explain that it was not indispensable from a conceptual point of view to have so much prior convergence, although convergence was highly desirable per se. In fact, Monetary Union is being launched after five years of preparation during which the most fundamental event was the adjustment of macroeconomic conditions in all countries, and, in particular, in the most divergent countries, including my own.
In reference to this preparatory period, I should like to mention only a couple of things. In all European countries, and to some extent even outside Europe, the Maastricht criteria - the pros and cons of which we shall discuss presently -became a benchmark that policy-makers could not ignore, whether or not they favoured Monetary Union and whether or not they intended to join. In many international meetings I have heard the British representative say: "We comply with Maastricht; the fact that we are not joining Monetary Union does not mean that we are 'behaving badly' in terms of the criteria". Even the American representative, as I recall on certain occasions, when wishing to convey the message that "our macroeconomic situation is in order", would maintain: "You want to achieve Monetary Union and you don't comply with the criteria, but you should know that we do comply with the criteria". Thus, these criteria have become an inescapable benchmark.
The second remark which I should like to make in this context is that in these five years a fundamental role was played by financial markets. It must be borne in mind that 10 or 15 years ago the condition of the markets was such that they could not function with the strength and the compelling force which they have enjoyed over the past five years. The Maastricht criteria are laid down in the Maastricht Treaty and would perhaps have been forgotten there, like many previous words of wisdom that can be found in international agreements. What made them compelling was, I think, a combination of two factors. One of these is the fact that the Maastricht Treaty sets a fixed date for the start of Monetary Union, i.e. 1 January 1999. The Treaty states that Monetary Union will start from that date whatever the circumstances, even with only three countries if only three countries were ready. The second factor is the adoption of the convergence criteria by the markets. These two factors together had produced a situation in which every government was constantly being judged by the markets with regard to the probability of its being ready on time for an event that was certain to occur, not subject to further decision.
It is fair to say that there have been a few moments in this five-year period in which the possibility of a postponement was discussed. However, this was never agreed, and I should mention that, although people speak very often about EMU being a project of technocrats and bankers, it was the politicians who refused to give serious consideration to postponement. Particularly in Germany, there were moments when Chancellor Kohl was almost the only person to refuse the prospect of postponement. Thus, we have got where we are now after a period of 10 years of continuous work. The basis, however, was a construction, the European Community, that from the very start included and required a form of monetary union, the one that was present in the 1950s.
What is special about EMU?
The second topic on which I should like to touch is what is special about EMU? In a sense, I should answer that nothing is special; it is simply a central bank with a currency, like many others with which we are familiar. However, seen from another angle, EMU brings a number of new elements that I shall briefly recapitulate. New elements in the area of central banking, new elements in the way in which the constitution of economic policy is designed, and also new elements outside the economic sphere, in terms of the way in which Europe functions at the political level.
What is new in the field of central banking? The European System of Central Banks, which I shall describe presently, is inspired by the Bundesbank model. Germany has a central bank with a federal structure, like the rest of the German constitution. It is, moreover, somewhat analogous with the Federal Reserve System, which also has a federal structure and is part of a federal political system. The European System of Central Banks is composed of the 15 national central banks of the European Union (the Deutsche Bundesbank, the Banca d'Italia, the Banque de France, etc.) and, in addition, the European Central Bank. The European Central Bank, which is located in Frankfurt and is the place where I am now working, is similar to the Bundesbank, which is also based in Frankfurt. The national central banks are comparable with the Landeszentralbanken in various Länder or groups of Länder in Germany, or with the Federal Reserve Board of Governors in Washington, D.C., the national central banks being equivalent to the district Federal Reserve Banks (in Boston, New York, Chicago, etc.).
There are important differences, however. The national central banks have been - and will remain, for a few weeks or months - fully fledged central banks with the complete range of functions that a central bank usually fulfils. This was not the case with the components of the German or the American system. For this reason, inter alia, they are much stronger institutions; they are located in countries that have their own financial centre and their own national banking system. Therefore, it is much less natural for them to become simply parts of the system than it was for the components of the US or German system, which were designed from the outset as parts of a system. The resources are also very different. The staff of the Federal Reserve Board of Governors in Washington, D.C. comprises around 2,000 to 3,000 persons. We in Frankfurt are less than 500.
The European System of Central Banks has unique features in the world of central banking. Compared with other similar central banking systems, the reasons for its coming into being are different, the financial centres through which it will operate are different and the financial techniques which it will employ are different. The Federal Reserve System has one financial centre, which is New York; the European System of Central Banks will operate through Paris, Madrid, Amsterdam, Milan, Frankfurt, etc. The multiplicity of languages in the euro area is another special feature, because communication has become a key component of the world of central banks.
If we go beyond central banking and consider what I previously referred to as the constitution of economic policy, the main novelty is that Monetary Union does not have an ex ante established single fiscal policy (there are some provisos to this which I shall make in a moment). One of the usual two components of the fiscal-cum-monetary policy mix is absent, and monetary policy is operating alone. It is operating, however, in an environment in which most of the legislation and regulation concerning economic activity is also "federal" in the sense that it is issued at the Community level. Indeed, there is no significant component of the economic legislation in any of the Member States that is not derived from a Community directive which sets the basic guidelines and principles. Moreover, this Community competence has expanded in recent years to the point of virtually imposing a process of privatisation and deregulation in key sectors of the public utility network that used to be considered to be national monopolies. Indeed the policy competence of the European Union, albeit of a micro nature, is very pervasive.
In two other fields of economic policy, the budgetary and the employment fields, the situation is different. In the budgetary field, the Maastricht Treaty and the Stability and Growth Pact imply that countries are now committed to achieving budgets which are in balance or close to balance, and either to keeping the public debt ratio below 60% or to decreasing the ratio at a satisfactory speed, if it exceeds the 60% reference level. Thus, Member States no longer have complete freedom in the fiscal field. In American terms, this would be called "a balanced budget condition in the constitution"; we adopted such a policy in Europe with the ratification of the Maastricht Treaty. If a country complies with the Stability and Growth Pact, then it is free to choose the composition and scale of expenditure and taxes it wishes. Thus, the fiscal field is one in which national competence is largely preserved, under a macro constraint stemming from the European Union.
As regards employment policy (labour contracts, labour legislation, wage negotiations, etc.), I would say that this is almost entirely national. Moreover, as you will be aware, labour policy in Europe is subject to a high degree of compulsion, owing to the legally binding nature of wage and labour agreements. The social partners have been given the legislative power, regardless of how representative they may be.
To sum up, Monetary Union is bringing into existence a European economic constitution in which money is federal, microeconomic legislation is largely federal, labour arrangements are highly regulated but national, and fiscal policy is national with a federal macro constraint. Such a constitution of economic policy is a novelty: I do not think that such a system has ever existed before.
The third area in which new elements have emerged concerns European institutions and the way in which they function. The first novelty here is that the process of European unification has reached its culmination in one field, the monetary field. Indeed the "end of the journey" had never been reached before in any significant field of competence. The fact that, in a field of prime importance such as the monetary field, the unification process has now been completed, is extremely important, because the outcome of this experience, its success or lack of success, will decisively influence the inclination to take integration to its ultimate conclusion in other fields.
Another institutional novelty concerns the way in which participation has been decided. It is indeed the first time that a project of such great importance has been designed in such a way as not to require the participation of all the members of the European Union. The "ins" and the "outs" are those who, being members of the European Union, respectively do and do not participate in Monetary Union. Arrangements that provide for variable geometry have occasionally been tried in the past, but never in a constitutionally well constructed way. Of course, there are two sides to every coin: in this case, the "negative" side is that it admits the possibility of a Member State not participating in a common project, while remaining a member of the European Union; the positive one is that it creates the possibility of pursuing a major new project without being hampered by those members who do not participate. Those who want to advance more quickly have gained the right to do so, even if some other members do not share this intention, and those who lag behind or are unwilling to advance more swiftly have the right not to do so. The constitutionalisation of variably geometry may become a very important factor in the future development of a European Union that will grow from 15 members to 20, 25 or 30, because then the possibility of reaching unanimous agreements involving all the Member States will be much smaller than with a Union of fewer members. An important precedent has thus been set.
Another very important institutional novelty is that the key decision-making body of the European Central Bank, which is the Governing Council of the ECB, comprising 17 members (the 11 governors of the participating national central banks and the 6 members of the Executive Board, which is based in Frankfurt), will decide by a majority vote, based on one vote per person, and not use a system of weighted voting. The decision to opt for a "one person one vote" rule was, in my view, an extremely important one. Such a rule represents the only way to make sure that the members of the Governing Council will be independent. Moreover, you cannot weight wisdom. It would be just as absurd for a council to decide on the basis of weighted voting in the field of monetary policy, as it would to have weighted voting in a court of justice. A judge is a judge; he or she is not a better judge by virtue of being British rather than Portuguese. From a conceptual point of view this was an obvious choice, but politically it was not. And it is very significant that this choice was accepted rather easily at the time when the Maastricht Treaty was negotiated.
What happens on the eve of Monetary Union?
The third and final part of my remarks concerns what happens on the eve of Monetary Union, that is, what is happening now? Generally speaking, we (by "we" I mean all the EU national central banks, in particular the 11 participating ones, and the European Central Bank) are frantically working to be ready by 1 January 1999 for the start of Monetary Union. By 1 January there will be no more national monetary policies for the countries of the euro area, no more official national rates, no more national policy operations of various kinds such as open market operations, etc. All that will be part of a single system, in which decisions are taken by the above-mentioned Governing Council, prepared by the Executive Board, comprising the six persons who are in Frankfurt on a full-time basis, and implemented, following the instructions of this Executive Board, in a decentralised manner, whereby most of the operations will be carried out by the national central banks.
Getting ready for this total change requires an enormous amount of work. The groundwork for this change had been accomplished to some extent by the predecessor of the European Central Bank, the European Monetary Institute (EMI), which operated in Frankfurt from 1994 to 31 May this year. However, many aspects of the work had to be completed - partly because the EMI and the European Central Bank are very different entities (although they have occupied the same building, are largely composed of the same staff and are headed by the same President, Willem F. Duisenberg).
Being now at the ECB myself, and having previously been closely associated with the work of the EMI (I travelled to Frankfurt on at least a monthly basis), I have witnessed this change and realised how important it was to bring it about.
During the preparatory phase from the Delors report to the Maastricht Treaty there had been discussions as to whether the European Central Bank should be created at the beginning of what was then called Phase Two, or at the beginning of Phase Three. In the end, it was decided to opt for the latter. I was among those who were strongly in favour of the former, because it seemed to me that the new institution should have been given, from the beginning, the full power to make preparations and decisions in an effective way, although not the power to conduct monetary policy, which was to be reserved for Phase Three only. The European Commission in Brussels - by way of analogy - came into existence with full powers in 1958. Although there was still nothing established, the Commission had the power to implement the Treaty of Rome. Well, for Monetary Union, it was decided otherwise, and the EMI was a weak institution. It had no powers to take legally binding decisions or to issue regulations, nor did it have the power to impose anything. Unanimous decisions are very difficult to reach. The EMI worked on the basis of seeking to achieve a de facto consensus that was close to unanimity. It was very difficult to agree on anything if one or two of the larger national central banks were in disagreement. Moreover, the EMI worked with 15 national central banks, thus disregarding any distinction between the "ins" and "outs". All that has now changed; we have majority votes; we are a group of 11 (not 15) countries; we have the legal power to impose decisions; the key decision-making body, i.e. the Governing Council, includes six members of the Executive Board.
There is now an enormous amount of work that consists in formalising the preparations that were conducted during the lifetime of the European Monetary Institute, in making choices where important issues had been left unresolved, in adapting certain tentative arrangements that had been decisively influenced by, for example, the Bank of England, which is no longer represented on the main decision-making body. On this latter point, it should be remembered that those who are represented on the decision-making body have, of course, the duty and the liberty to take the decisions that they consider optimal for the success of Monetary Union, and not necessarily for the "outs".
Accomplishing the transition from the EMI to the ECB, and learning to function within the new institutional system is the common denominator of much of the work currently being undertaken at the ECB . Of course, the work which is being accomplished concerns central bank activities. I should like to offer you a few examples, such as monetary policy design, the implementation of monetary policy decisions, international relations and the way in which communications will be organised. In each of these fields, new approaches have to be found because, as I mentioned earlier, the ESCB is in so many respects a unique construction.
As regards monetary policy design, the fundamental point is that monetary policy will have to be designed on the basis of an assessment of the economic situation of the so-called euro area (sometimes referred to as "Euroland"), i.e. of the area comprising the 11 participating Member States, and not on the basis of an exercise in comparative economics across 11 individual countries. We shall look at the price developments for the whole area. We shall consider the economic situation and the cyclical conditions in the same way. Allow me to offer you an image: it is like having, not a political map, but rather an economic map, in which there are no borders and only a "natural" description of the landscape. If you look at an economic map of Europe, based on many types of indicators, it is extremely difficult, I would even say impossible, to trace the political borders. In such a map no one would be able to separate Belgium from the Netherlands, the North of Italy from the South of Germany, etc. Well, the economic assessment on the basis of which policy will be designed has to be made on an economic map, which causes enormous problems for statistical data, forecasting instruments, etc.
No less difficult are the problems of policy implementation. Implementation will have to be conducted through 11 financial centres, of which perhaps one half could be considered major. Each of these centres is today both a policy and a financial centre which employs different techniques and practices from those which will apply in the single money market as from 1 January 1999.
As an example of the problems arising in the area of international relations, I should like to refer to participation in the International Monetary Fund. Note that it is called the International Monetary Fund, because the monetary aspect is crucial. However, the emergence of a European Central Bank does not easily fit into the IMF structure, given that the members of the IMF are countries. The assumption implicit in the Articles of Agreement is that countries are also the relevant policy-makers. With the ECB, however, we have a policy-maker, for monetary policy, which is not a country. No individual country can represent the monetary policy of Europe, i.e. the monetary policy of the second most important economic entity in the world, and of what will be a key reserve currency in international relations. As the Fund is structured at present, there is simply no provision for a reality like EMU. The founders of the Fund could not imagine that one day there would be such a thing as a European Central Bank without a European state, a European government, etc. Thus, we are now studying how best to be represented in the International Monetary Fund, notwithstanding this anomaly.
A final area which I should like to mention is communication. Communication has become a fundamental part of monetary policy in two respects: in the way central banks impart information to the markets, thereby influencing expectations, and in the way they communicate with the public, thereby cultivating support for their actions. It is no simple task to provide consistent and simultaneous communication in 11 different languages. It is not only a matter of accuracy in the translation. Very often you can accurately translate a sentence from one language into another, but the way that sentence reads is not the same because the conventions governing usage may be very different, so that what you say is understood in a different way.
Well, I think I should stop here. Five years of negotiation, five years of preparation. Monetary Union will start in four months less two days. Much preparatory work has been undertaken and many thoughts have been developed. Yet it is very difficult to predict precisely what will happen. I am convinced that powerful factors will make the euro a stable and reliable currency. However, it is hard to predict where the difficulties will lie. There is a well-known tendency of strategists to prepare for the next war on the basis of the study of the past wars, and then one discovers that each war is different from the preceding ones. The problems that have preoccupied central banks in the past 20 years may not be the same problems that will concern them most in the years to come. The system will have to cope with new situations, and this will make the implementation at least as stimulating as the two phases which are now reaching their conclusion. Thank you.
Well, thank you very much for a brilliant lecture of admirable clarity. I hope the organiser will not be held responsible for the rain. We now have a unique opportunity to ask questions.