The euro: the new European currency
Speech by Dr. Willem F. Duisenberg, President of the European Central Bank, at the Council of Foreign Relations on 1 February 1999 in Chicago
The euro - the new European currency - has made its debut this year. Its successful launch constitutes a milestone in the process of European integration and, in consequence, is bound to have a profound impact upon the euro area as well as the world economy in the years to come. In fact, the process of European integration started immediately after the Second World War. Its objectives were not and are not only economic, nor even primarily economic, but also political. European integration aims at the creation of a stable, prosperous and peaceful Europe. For a large part, economic integration has been the engine of this process. Economic integration has its own merits, but it is also likely to contribute to better relations among the countries concerned. And, on balance, although this process has had its ups and downs, it has been successful. However, there is no room for complacency. The introduction of the euro is an important step in this process, but it is not the end of it. New challenges lie ahead. The euro has been launched successfully but, as you know, the launch is only the start of a mission.
Following almost a decade of meticulous preparation and economic convergence, a single monetary policy for the entire euro area, encompassing almost 300 million people in eleven countries, is now determined by the Governing Council of the European Central Bank (ECB). This Council consists of the eleven governors of the national central banks (NCBs) of the participating Member States and the six members of the Executive Board of the ECB. Each member of this 17-member Governing Council has one vote. Monetary policy is conducted by the Eurosystem, which is comprised of the ECB and the eleven national central banks of the participating Member States. Like the FED, the Eurosystem is a federal system. Our "Washington" is "Frankfurt" in Germany, where the ECB is located. The Executive Board of the ECB which, as I have mentioned, consists of six members, is a separate decision-making body. It has to ensure that the tasks conferred upon the European System of Central Banks (ESCB) are implemented, either by its own activities or through the national central banks. The ECB has currently a staff of some 600. This number will grow to around 750 in the course of this year and is likely to increase further in the years to come.
The ECB's monetary policy
Let me elaborate on Europe's single monetary policy framework. In accordance with the Treaty on European Union, the primary objective of the single monetary policy is to maintain price stability. Price stability is a necessary condition for promoting sustainable economic growth and better employment prospects for the citizens of the euro area. The stability-oriented monetary policy strategy announced by the Governing Council last year, and currently shaping monetary policy decisions, was conceived with the intention of making the best possible contribution to the achievement of this objective.
At the centre of the stability-oriented monetary policy strategy lies the quantification of the primary objective of price stability. By announcing a quantitative definition of price stability, the Governing Council has provided a clear guide for the formulation of expectations of future price movements. At the same time such a quantitative definition has the distinct advantage of complying with the principles of transparency and accountability. This is so because, on the one hand, it clarifies how the Treaty's mandate is interpreted by the Governing Council while, on the other, it gives the public a yardstick against which the success of the single monetary policy can be evaluated.
Price stability has been defined and publicly announced as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. This definition mirrors our aversion to both inflation and deflation. Hence neither price increases in excess of 2% nor deflation - that is, a persistent fall in the price level - would be deemed to be consistent with price stability. Based on the latest data available, the current annual rate of inflation, measured on a harmonised basis at around 1%, is consistent with the definition of price stability.
Price stability is to be maintained over the medium term. This emanates from the need for monetary policy to be forward-looking. It also recognises the reality that monetary policy cannot compensate for factors such as changes in indirect taxes or commodity prices that could distort price level movements in the short run.
The Governing Council of the ECB has founded its stability-oriented strategy upon two pillars. The first pillar relates to the prominent role assigned to money, given that the origins of inflation over the longer term are monetary in nature. Thus a quantitative reference value for the growth of a broad monetary aggregate, namely M3, has been announced. An annual rate of 4½% has been set as the first reference value. The reference value for M3 is consistent with maintaining price stability over the medium term, while allowing for sustainable output growth and taking account of the trend decline in the velocity of circulation of M3. I wish to emphasise, however, that interest rates will not be changed in a "mechanistic" way in order to react to deviations of monetary growth from the reference value in the short term. Rather, such deviations will be regularly and thoroughly analysed for the signals that they convey about future price developments. If a deviation is considered to be posing a threat to price stability, monetary policy will then react accordingly to counter this threat.
In parallel with the evaluation of monetary growth, it is imperative to monitor a broad range of other economic and financial indicators, including economic forecasts. Thus our monetary policy strategy rests also upon a second pillar. This pillar comprises a broadly-based assessment of the outlook for price developments and the risks to price stability in the euro area as a whole. This systematic analysis of all other relevant information about economic and financial conditions will ensure that the Governing Council is as well informed as possible when formulating its monetary policy decisions.
In view of the strategy I have just described, we intend to continue with our policy of regularly informing the public of our assessment of the prevailing economic, monetary, and financial conditions as well as of specific monetary policy decisions. This will take place through a wide range of publications, press conferences and speeches intended for both the general public and a professional audience. Furthermore, the European Parliament receives the annual and monthly reports from the ECB and holds a general debate on each annual report. In addition, I appear before the relevant sub-committee of the European Parliament four times a year.
As President of the ECB, I am invited to attend the meetings of the Council of the European Ministers of Finance whenever issues of relevance to our tasks come up for discussion. The President of this Council of Ministers and a member of the European Commission may participate, without having the right to vote, in the meetings of the Governing Council of the ECB. Finally, I should like to mention that I am also invited to the meetings of the informal so-called Euro-11 Council. This is a forum composed of the eleven finance ministers of the Member States which have introduced the euro.
What the monetary policy of the ESCB can do
The Treaty states that the ESCB, while having price stability as a primary objective, shall support the general economic policies in the European Community; moreover, it will operate in such a way as to be consistent with the establishment of free and competitive markets. The Treaty therefore provides an explicit order of priority for the objectives: price stability is the first reference point for the monetary policy of the Eurosystem, and only within the limits of price stability can there be scope to contribute to the achievement of the other objectives of the European Community. As a consequence, the role of other Community objectives in the monetary policy of the Eurosystem is conditional upon the achievement of the overriding target of price stability.
The high unemployment rate in Europe represents the main concern of economic policy-makers. I should like to stress that the Eurosystem shares these concerns and will do its utmost to help find a solution to this problem. That said, however, we should realise that what monetary policy is able to contribute to economic policy and the reduction of unemployment, is the achievement of price stability. By creating optimal conditions for a sustainable and strong pace of economic activity, price stability will ultimately spur employment growth and foster higher living standards. The high unemployment rate in Europe is far more the consequence of structural rigidities within the European labour and product markets than a result of adverse cyclical developments. The solution is thus to be found, above all, in structural reforms. The European unemployment rate has, indeed, been high and stable over the business cycles in the past decade. However, over the same period, unemployment was significantly reduced in those EU countries which succeeded in creating better-functioning labour and product markets, which allowed wages and prices to adjust when economic conditions changed. A clear example can be found in the Netherlands, where a substantial reduction in unemployment has been effected in recent years by reforming the labour market, while following the same monetary policy as Germany, where the unemployment rate is still close to 10%.
The medium-term orientation of the monetary policy of the Eurosystem should help to avoid excessive fluctuations in real economic activity. Given the fact that the Eurosystem does not aim to stabilise every short-term deviation of price developments from the predetermined path of price stability, it contributes to the stabilisation of economic activity around its long-run potential growth path. I should like to add, however, that the room for manoeuvre of monetary policy and the degree of success in terms of maintaining price stability crucially depend on the support of sound fiscal policies and responsible wage settlements in the euro area.
The links with other economic policies
I should now like to address the way in which the economic environment and the economic policies of both the Community and the governments of Member States will affect the functioning of monetary policy. A monetary policy reaction to inflationary or deflationary pressures may cause short-run fluctuations in real output. Flexible and competitive goods and labour markets, however, would soften this trade-off, thereby allowing central banks to attain the goal of price stability with less serious adverse consequences for real output. The establishment of free and competitive markets for labour, goods and services would facilitate to a large extent the functioning of monetary policy in the euro area.
Market flexibility may also help to reduce regional asymmetries in the effects of the single monetary policy. The monetary policy of the ESCB will be geared towards the euro area as a whole and will not be able to take into account purely national or regional developments. Moreover, the cyclical positions of participating countries will not completely converge at the start of Stage Three, although, with the single currency in place, some national differences may disappear over time. In the past, asymmetric shocks across European countries were sometimes dealt with via movements in the exchange rates. In the EMU environment, which is characterised by a single and uniform monetary policy aimed at maintaining price stability in the euro area as a whole, the required adjustments will have to stem from fiscal policies and national prices and wages, in addition to mobility of labour and capital.
Budgetary policies also play a major role in conditioning monetary policy. Sound budgetary policies enhance the credibility of monetary policy by preventing inflationary pressures. Furthermore, fiscal discipline exerts a downward influence on the risk premia embedded in nominal long-term interest rates. Moreover, given the requirements of the so-called Stability and Growth Pact, a budgetary position which is close to balance or in surplus in normal conditions may allow scope for reaction to unforeseen regional or local shocks that could bring about heavy real output losses. This would also contribute to alleviating the possible asymmetric impact of monetary policy actions on single countries.
Where do we stand at present?
Let me now turn to the operational aspects of the changeover to the new currency and the first experiences in financial markets. The start of Stage Three of EMU proved to be a formidable operation, yet it was clearly a success. In spite of the extraordinary operational risks involved, the changeover passed without any serious incident affecting the orderly conditions of the monetary system. The monitoring of the Eurosystem's activities to convert the former national currencies into the euro progressed smoothly. There was no need to invoke any contingency measure, whether "ordinary" or "extraordinary". This smooth introduction of the euro was the result of years of thorough preparatory work involving the ECB, the NCBs and a large number of public and private institutions which represent the core of the financial infrastructure in the euro area. This has been reflected clearly in the way in which financial markets have received the euro.
To ensure the integration of the various money markets and the emergence of a single interbank interest rate, we have established a European payments system. This system is called TARGET and links all the large-value national payment systems in the EU. Overall, TARGET has functioned well and contributed substantially to the integration of the euro money market. Some technical problems, however, could not be avoided during this start-up phase. These problems, however, were teething troubles related to participants - in both commercial banks and central banks - trying to adapt to the new system and environment. Nevertheless, during these early days of Monetary Union, TARGET has already demonstrated its capabilities in that it was able to handle more cross-border payments than were initially anticipated. The daily volumes concerned were of the order of around EUR 1,000 billion in these early days; this is equivalent to around USD 1,150 billion, depending, of course, on the exchange rate.
Our first decisions on the levels of the ECB's interest rates were of course taken in accordance with the announced stability-oriented monetary policy, which I outlined earlier, and were based on the current assessment of the economic situation. With regard to monetary growth, the first pillar of the strategy, careful analysis of the most recent monetary data points to the conclusion that monetary developments are in line with the primary objective of maintaining price stability in the medium term. The three-month moving average of the annual growth rates of M3 to December 1998 stood at 4.7%, which is very close to the reference value of 4½%.
As regards the broadly based assessment of the outlook for price developments, the second pillar - financial indicators - suggests that markets expect the current environment of price stability to be maintained over the medium to longer term. This outlook is supported by the significant fall observed in nominal short and long-term interest rates following the co-ordinated interest rate cut at the beginning of December. With regard to the real-side indicators for the euro area, the signals are mixed. On the one hand, euro area real GDP growth is generally expected to slow down somewhat in 1999 and business confidence, orders and capacity utilisation have been less favourable in recent months. On the other hand, the latest increase in employment figures, the acceleration in retail sales and the recent boost in consumer confidence point towards a more favourable outlook. Finally, subdued wage growth, moderate food price increases and declining energy prices have contributed to a lower rate of inflation for the euro area of just below 1%. On balance, therefore, the evidence suggests that there are no significant upward or downward pressures on the price level, at least at this juncture. Therefore, we have announced our decision to set and maintain the interest rate on our main refinancing operations at 3% for the foreseeable future.
Of course, I recognise that potential risks to price stability do exist. First, the floating and subsequent depreciation of Brazil's currency has given rise to renewed fears of a disruption in world financial markets and, potentially, of a further decline in world output growth in 1999. Second, wage demands in excess of labour productivity growth and a relaxation of the fiscal stance by national governments in the euro area constitute upward risks. The Governing Council will continue to monitor all these developments very closely, and will act, should the need arise, in order to prevent either inflationary or deflationary pressures becoming entrenched.
The international role of the euro
The introduction of the euro has created a single currency area which approximately matches the United States in terms of economic size, is larger with respect to its share in total world exports and ranks only second in terms of the size of its capital market. Such an event will have important implications for the economies outside the euro area and the international capital markets. In this context, a few words seem to be in order to clarify our view on the international role of the euro and, particularly, the policy stance of the Eurosystem with regard to such a role.
With reference to the use of the euro as an international currency, I should like to remind you that the primary objective of the Eurosystem is the maintenance of price stability. Having an international currency will be advantageous for both businesses and consumers. At the same time, though, the conduct of monetary policy could become complicated should the fraction of the money stock circulating outside the euro area increase significantly. The Eurosystem does not intend either to foster or to hinder the development of the euro as an international currency. It will take a neutral stance and leave it to market forces to determine that role. There is no conscious policy of challenging the dollar. Naturally, to the extent that the Eurosystem is successful in maintaining price stability, this will in itself foster the use of the euro as an international currency. It is hard to make a prediction with regard to the pace at which the euro will emerge as an international currency. An educated guess is that the process will be a gradual one. Nevertheless, the possibility of the euro assuming a prominent role more rapidly than is perhaps suggested by past experience cannot be ruled out.
A second aspect of the international role of the euro relates to the exchange rate of the euro against the US dollar or the Japanese yen. The Eurosystem in its monetary strategy deliberately does not specify a target for the exchange rate of the euro. The euro area is a large, relatively closed economy, similar in this respect to the United States. The maintenance of price stability could easily be undermined if a target for the euro exchange rate were to be vigorously pursued. Rather, in accordance with the Eurosystem's monetary policy strategy, the euro exchange rate will depend upon current and expected economic policies and developments and upon the interpretation markets attach to these policies and developments. The absence of an exchange rate objective against major currencies does not mean that the Eurosystem will be indifferent toward the euro exchange rate. The exchange rate is one of the indicators of monetary policy that are monitored under the second pillar of our strategy, that is the broadly based assessment of the outlook for price developments. If its development poses a threat to price stability in the euro area, this threat will be assessed and a response will be given, if considered necessary.
Moreover, the lack of a target for the euro exchange rate against the major international currencies does not necessarily mean that these rates should become more volatile. I am in favour of reasonably stable exchange rates. Who is not? However, just as a fever cannot be prevented by restricting the movement of the thermometer, we cannot ensure the absence of exchange rate pressures simply by announcing targets for exchange rates. The pursuit of stability-oriented monetary and fiscal policies at home constitutes a fundamental prerequisite for fostering a stable exchange rate environment. The Eurosystem's stability-oriented monetary policy strategy provides a significant contribution in this regard. Nonetheless, absolute stability of the exchange rate is impossible to guarantee. Such an outcome may not even be desirable if, for example, the United States and the euro area were to go through business cycles that were not fully synchronised. Such a prospect cannot be ruled out, as even recent history has shown.
Finally, I should like briefly to touch upon the issue of the role of the ECB in international co-operation. It is clear that a central bank that acts on behalf of a monetary union comparable in economic size to the United States and which is responsible for managing a major currency is bound to play an important international role. The ECB will meet this challenge by assuming the responsibility that comes with this role. Its role will develop gradually, since it is a young institution. We will also build on the experience of those central banks which have played an important international role in the past. You may guess which central bank outside the euro area I have in mind in particular.
The ECB already participates in the work of the G-7, the G-10, the Bank for International Settlements and the OECD. Last year it was also granted observer status at the International Monetary Fund (IMF). As an observer, the ECB will participate actively in the relevant work and assessment by the Fund of economic policies in the euro area and of issues, such as the world economic outlook and international capital markets, that are of interest to the euro area. At the same time the ECB enjoys good bilateral relations with other central banks throughout the world. Furthermore, the ECB stands ready to take part in, and contribute to, international policy discussions, offering its expertise and exchanging views when and where appropriate. Generally speaking, the commitment of the ECB to successfully fulfilling the mandate of the Treaty, that is to maintain price stability in the euro area, will also shape the ECB's international role. This is, without doubt, the best contribution the ECB can make to a stable international monetary system.
The euro - the new European currency - is a reality. The single monetary policy is in place and the Governing Council of the ECB has assumed responsibility for steering it. There is no doubt in my mind that the real challenges for the Eurosystem still lie ahead. I am confident that the Eurosystem, through its stability-oriented monetary policy strategy, will stand up to these challenges and be successful in maintaining price stability in the euro area. In doing so, it will not only provide for a better future for all the citizens of the euro area but will also contribute to a stable international financial system.