The international implications of the introduction of the euro
Speech by the Vice-President of the European Central Bank, Mr. Christian Noyer Contribution to panel organised by the Japan Center for International Finance and Sumitomo Life Research Institute Tokyo/Osaka, 25 and 26 February 1999
The euro - the new European currency - has made its debut on the international financial markets this year. Its successful launch in the 11 countries which form the so-called euro area constitutes a milestone in the process of European integration. It is bound to have a profound impact upon both the euro area and the world economy in the years to come. Following almost a decade of meticulous preparation and economic convergence, a single monetary policy for the entire euro area is now determined by the Governing Council of the European Central Bank (ECB). This Council consists of the 11 governors of the national central banks of the participating Member States and the six members of the Executive Board of the ECB. Each of the 17 members of this Governing Council has one vote. Monetary policy is conducted by the Eurosystem, which comprises the ECB and the 11 national central banks of the participating Member States. The Executive Board of the ECB 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 currently has some 600 members of staff, and this number will grow to around 750 in the course of this year.
Turning from the institutional to the broader economic aspects, I should like to consider the overall international implications of the introduction of the euro. This issue is rather complex and, for the sake of clarity, I would propose to break it down into three aspects: the role of the euro as an international reserve and investment currency, the role of the euro exchange rate in the monetary policy strategy of the Eurosystem, and the role of the ECB in international monetary co-operation and international organisations.
The use of the euro as an international currency
Starting with the use of the euro as an international currency, it must be noted that the euro is the currency of an economic area which roughly equals that of the United States in terms of both its economic strength and its degree of macroeconomic openness. The euro area has a population of 292 million, which is slightly larger than the 270 million of the United States, and a GDP of E5,800 billion - somewhat smaller than the E7,600 billion of the United States. At the same time, the euro area is an open economy to more or less the same degree as the United States. Trade in goods, that is, the exports and imports of goods combined, amounts to 26% of GDP, while, in the United States, the corresponding figure is around 20%.
However, the size of an economy and external trade volume alone are not always perfect indicators of the international importance of a currency. According to most measures, for example, the US dollar is of greater international importance than the relative size of the US economy would suggest. In general, the international role of a currency has several dimensions. On the official side, these include its use as an anchor for exchange rate pegs, for holding foreign exchange reserves and as a vehicle currency for foreign exchange interventions. On the private side, these include its use as a quotation and vehicle currency for international trade, as an international investment currency and as a substitute currency in circulation abroad. Let me focus in particular on the role of the euro as a reserve currency and as an international investment currency.
As far as the reserve function of currencies is concerned, at present, the US dollar remains by far the most important reserve currency world-wide. According to IMF data for the end of 1997, the share of dollar-denominated official reserves amounted to 57%, while the Deutsche Mark accounted for 13%, the Japanese yen for 5% and the French franc for 1%. The euro area currencies' share of world-wide official reserves is likely to have fallen at the start of Stage Three of Economic and Monetary Union on 1 January 1999. The Deutsche Mark reserves and reserves in other euro area currencies previously held by euro area national central banks have become domestic euro area assets. However, the euro's share of global official reserves has the potential to increase First, it may be expected that the central banks of non-euro area countries will reassess their reserve management strategy in the light of the improved global diversification opportunities offered by the new currency. For example, the euro may in future come to represent a more important part of the foreign currency reserves held also by Asian central banks. Second, the euro might also assume a greater role as an anchor currency for other European countries which, formally or informally, intend to peg their exchange rate to the euro or to a (trade-weighted) basket of currencies which includes the euro as a large component. Thus, the euro may over time become part of the foreign currency reserves held by central banks for diversification or pegging purposes. However, whether and to what extent this will happen will depend crucially on the confidence in the economic policies across the euro area in general, and the monetary policy of the Eurosystem as well as the stability of the euro in particular. Reliable forecasts regarding the timing and quantitative dimension of such a process are hard to make at this stage.
I should like to reflect now on the use of the euro as an international investment currency. At present, this role is predominantly performed by the US dollar. In 1997 the share of dollar-denominated instruments of the bonds outstanding in the international bond markets amounted to 46%, followed by Japanese yen-denominated debt (11%). All the euro area currencies together accounted for approximately 24% of the international bond market.
There are further arguments to suggest that private investors will hold over time a greater proportion of their portfolios in euro assets than they have done in the constituent currencies. That is to say, international investors will see the euro as more than the sum of its parts. A key element in the potential attractiveness of the euro as an investment currency is the emergence of large and integrated financial markets in the euro area, as the euro has removed currency-related fragmentation in the euro area, promoting the establishment of uniform market standards. Market liquidity should benefit from this integration, thus triggering a virtuous cycle of increasing issuance and investment in euro instruments by domestic and foreign institutions. Furthermore, the introduction of the euro will most likely result in the emergence of new financial products and an increase in the maturity range on the euro bond market.
Moreover, increasingly integrated money and government bond markets may stimulate the emergence of commercial paper and corporate bond markets in the euro area. A benchmark for government bonds or swap rates, increasing economies of scale, narrower bid-ask spreads, lower hedging costs for debt securities issued by private firms and more competitive underwriting are likely to provide incentives for corporations to issue their own securities instead of borrowing from banks, while investors in search of a yield pick-up will find such securities attractive. Equity issuance and trading may also, in due course, become euro area-wide. Likewise, on the deposit side, a rapidly developing private repo or investment fund market in euro could become a serious alternative to traditional bank deposits for large investors, such as pension funds and insurance companies. The development of such new market segments is likely to attract both international investors and borrowers.
In any case, whatever the future development of the euro area financial markets will be, the euro has made a promising start on the international bond market. In January 1999 the euro was used in 50% of all new international bond issues, with a value equivalent to USD 69.3 billion. The respective share of the US dollar was 40%. However, it has to be said that the high figures for euro-denominated bond issues in January 1999 may, to a certain extent, reflect a particularly high level of initial interest in euro-denominated instruments during the new currency's first month of existence. We may therefore experience a drop in the euro's market share of new bond issues from the high level experienced last month. Nevertheless, the promising start of the euro on the international bond market clearly shows the confidence of international investors in the stability and strength of the euro and the monetary policy of the Eurosystem.
For the benefit of this audience, I should like to note that Japanese financial institutions as well are showing great interest in investing in euro-denominated assets and offering euro-related financial products. According to media reports, the seven largest life insurers in Japan are planning to invest more than JPY 1.5 trillion in euro-denominated bonds in the current fiscal year up to March, which would account for nearly half their planned new foreign bond investments. Furthermore, Japanese banks, securities firms and insurance firms are introducing a wide range of euro-related products, such as deposits, loans and cash management services. Thus, the euro seems to have gained a strong foothold in Japanese financial institutions, corporations and households as well.
Finally, as regards the use of the euro as an international currency, the above-mentioned considerations are not at the forefront of our policy-making. Rather, the primary objective of the Eurosystem is to maintain price stability as stipulated by the Maastricht Treaty. Having an international currency will be advantageous for both businesses and consumers. At the same time, however, 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 that role to be determined by market forces. There is no policy of challenging the US dollar or the Japanese yen. Naturally, to the extent that the Eurosystem is successful in maintaining price stability, the use of the euro as an international currency will be fostered. The only way to gain the confidence of international investors in one's currency is by implementing a sound monetary policy.
Exchange rates and monetary policy strategy
Let me now turn to the role of the exchange rate in the monetary strategy of the Eurosystem and the renewed interest in the concept of target zones for exchange rates among the main currency blocs, namely the United States, the euro area and Japan. In a world characterised by highly integrated and sophisticated international financial markets, there is serious doubt as to whether target zones for exchange rates are feasible or even desirable. Apart from the obvious risks of undermining price stability, which is the primary objective of the Eurosystem's monetary policy, such exchange rate targets would, in essence, imply that domestic policy objectives would have to be subordinated to external requirements.
This is the reason why, and I should like to state this clearly, the Eurosystem does not employ an exchange rate target in its monetary policy strategy. I have to say that, in making this choice, the Eurosystem is in good company: neither the United States nor Japan uses explicit targets for its exchange rate in the assessment of its monetary policy stance. The Eurosystem's choice not to use exchange rate targets is based on the conviction that the exchange rate of the euro is the outcome, rather than an objective in itself, both of the monetary, fiscal and structural policies pursued, and of cyclical developments in the euro area and abroad. Moreover, the exchange rate plays a far smaller role in the euro area than it played in the individual Member States before the start of Stage Three of Economic and Monetary Union on 1 January 1999. This is also a consequence of the fact that the euro area is larger in size and is therefore less dependent on external trade than each individual Member State was before.
According to the Maastricht Treaty, the ECOFIN Council may formulate so-called general orientations for exchange rate policy, which shall be without prejudice to the primary objective of the Eurosystem of maintaining price stability. The EU Ministers of Finance, who are ultimately responsible for the exchange rate policy of the euro, agreed in December 1997 that they would only issue these general orientations for the euro exchange rate in exceptional circumstances, such as in the case of clear and persistent misalignments of the euro. Furthermore, the Eurosystem is not currently participating in formal exchange rate arrangements with third countries outside the European Union, for instance with the United States or Japan, and it appears very likely that this situation will not alter in the foreseeable future.
However, the absence of an explicit target for the exchange rate of the euro against the major international currencies does not imply that the Eurosystem ignores or is indifferent to the exchange rate of the euro vis-à-vis the US dollar or the Japanese yen. The exchange rate will be monitored as one of the indicators of monetary policy, within the broadly based assessment of the outlook for price developments that is part of the Eurosystem's monetary policy strategy. As you may be aware, this monetary strategy consists of two pillars. The first is a prominent role for money, as signalled by the announcement of a quantitative reference value of 4½% for the growth rate of the broad monetary aggregate M3, which is regarded as being compatible with price stability. The second comprises a broadly based assessment of the outlook for price developments and the risks to price stability using financial and other economic indicators. Through the second pillar, the movement of the euro exchange rate is included in the overall monetary policy strategy of the Eurosystem. 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.
Furthermore, the absence of exchange rate targets does not suggest that these rates will necessarily be unstable or volatile. On the contrary, the pursuit of stability-oriented monetary and fiscal policies constitutes one of the major prerequisites for stable euro exchange rates. The Eurosystem's stability-oriented monetary policy strategy is a significant contribution in this regard. Furthermore, the Stability and Growth Pact, which aims in the medium term to reduce government deficits to close to balance or even to create surpluses, will help to ensure sound budgetary policies throughout the euro area. Absolute stability of the exchange rate is, of course, impossible to guarantee.
International co-operation and representation of the ECB
Finally, I should like to discuss briefly the role of the ECB with regard to international co-operation. As the representative of a monetary union comparable in size and importance with the United States, and as the central bank managing a currency that is likely to play a large and increasingly international role, the ECB will inevitably serve an important function in the international financial system. The ECB will embrace the implied responsibility, but, at the same time, it will have to be modest and realistic in its actions in the international arena. The ECB may be expected to contribute to international co-operation by adopting a positive attitude. The introduction of the euro could potentially simplify the process of international policy co-operation between the major economies, since the number of key players has been reduced. In particular, it should make this process more efficient by facilitating the exchange of views and formulation of common understandings on economic and financial issues at the global level.
Let me also make a few remarks on the international representation of the ECB. Although some decisions are still under consideration, formal and informal agreements have already been reached with the International Monetary Fund (IMF), the Organisation for Economic Co-operation and Development (OECD) and in the G7 and G10 context. At the end of last year the IMF granted the status of observer to the ECB. As you will be aware, full membership of the IMF is restricted to individual nations. Nevertheless, this observer status will allow the ECB to participate fully in the relevant work and assessments by the Fund of economic policies in the euro area and beyond.
The ECB stands ready to participate fully in, and contribute to, international policy discussions. It will, of course, offer expertise and exchange views when and where appropriate. However, in general, the best contribution which the ECB can make to a stable international monetary system, including stable exchange rates and smoothly functioning international capital markets, is to maintain price stability within the euro area. Fulfilling the mandate assigned to the Eurosystem by the Maastricht Treaty will help the ECB to shoulder its international responsibilities.
In my view, there is little doubt that the euro has the potential to achieve over time a more important position in the international monetary system than would be suggested by the sum of the positions of its constituent currencies. With regard to the euro as both an international reserve and investment currency, confidence in the stability and strength of the euro will be crucial. I am convinced that the combination of the ECB's independence and the primary objective of maintaining price stability offers the best guarantee that the ECB will achieve this confidence. As regards international monetary and economic co-operation, monetary stability, supported by fiscal stability and structural policies, will be the most effective means of securing stable exchange rates. Japan, Asia and Europe will undoubtedly intensify their relations on economic matters. A good example of this process was the Second Asia-Europe Finance Ministers' meeting on 15 January of this year, part of which was held on the premises of the ECB in Frankfurt am Main, Germany. Economic and Monetary Union and the single currency offer significant opportunities for financial and non-financial Japanese companies, as economic and monetary borders within Europe have disappeared to a large extent. The resulting closer integration of the Japanese and European economies and financial systems will establish a sound foundation for further economic prosperity in both regions, and, in so doing, contribute to the achievement of stable international economic developments in the years to come