The ECB's monetary policy - decision-making and implementation
Speech delivered by Ms Sirkka Hämäläinen, Member of the Executive Board of the European Central Bank, at Euro-conference held at the Danish Parliament, Copenhagen, 15 September 2000
I should like to start by extending my warmest thanks to the organisers for inviting me to speak here today. It is challenging to represent the European Central Bank at this conference taking place so close to the forthcoming referendum on whether or not Denmark should adopt the euro. However, I should like to underline from the very beginning that the purpose of my speech is to present aspects of European Monetary Union and the single monetary policy from the perspective of the European Central Bank - and not to enter into the debate surrounding the referendum.
In my presentation, I should like to give a general overview of the experience gained so far with the decision-making and implementation of a single monetary policy in the euro area. I shall also briefly discuss the impact of the euro on the development of the financial markets in the euro area.
However, before addressing these topics, I should first like to recall the visions and motives behind the project to establish an economic and monetary union in Europe. The idea of fostering economic integration among independent nations through the use of a common currency is not new. In the second half of the 19th Century, which was also a period of rapidly expanding international trade and cross-border investment flows, several initiatives were taken to reduce the difficulties caused by the then very fragmented use of currencies across Europe. Already at that time, it was widely acknowledged that fluctuations in exchange rates could be very disruptive to trade and investment activities across nations and that a currency union would be beneficial to all countries.
However, the first half of the 20th century, with its two disastrous world wars, was a serious setback for international trade and investment; nations became inward-looking in their economic policies. In this environment, the domestic currency was seen as an essential variable in defending economic independence.
The negative experience of the first half of the 20th century gave new force to the visions of international economic co-operation and integration. Plans looking towards European integration started to take form in the 1950s, aiming at ensuring that war and crisis on the European continent could be avoided through the establishment of common institutions as well as through economic and social integration. We certainly have different views on how far this integration process should go and on which political areas it should cover, but I think there can be no doubt that the European integration process has been successful in bringing the people of Europe closer together and in increasing their well-being.
The first serious discussions on a single union started in the early 1960s and the first concrete plan - the Werner Plan - was presented in 1970. After three decades of careful planning the single monetary policy was implemented as from the start of 1999. Since then, the process of economic integration has accelerated considerably and it has now gained a level of momentum whereby it is no longer crucially dependent on - or led by - political decisions. It is an automatic, dynamic and self-sustaining process, which affects all sectors of the economy. We witness this process everyday through media reporting on corporate consolidation, mergers and acquisitions across national borders.
Of course, this process puts pressure on politicians to further harmonise rules and regulations for business and financial markets. The ongoing process of reshaping the European economy from a group of small segmented national markets into a Europe-wide market is improving efficiency and will bring important welfare gains for consumers and investors, i.e. for the public at large.
In many respects, the European integration process is only a reflection of - or a specific way of responding to - the growing trend towards globalisation. Globalisation means increased competition in all areas, also affecting areas which were traditionally under the direct control of government policy, such as the level of taxes and public expenditures as well as the overall design and perceived viability of pension and social security systems. European integration is a serious effort to counterbalance this strengthening pressure from the market forces in a healthy co-ordinated way. The aim is to preserve the dictates of economic policy. On an individual basis, small countries - and all European countries are small in a global sense - are vulnerable and even powerless in the globalised world but as a group they have much more strength and power.
Globalisation has indeed enormous implications for policy-making - not least for central banks. Policy-makers need to take due account of how their actions are judged by the international markets. Short-term-oriented, pro-cyclical or undisciplined economic policies are immediately "punished" by the markets. Thus, the actual degree of freedom available for a national economic policy - including monetary policy - is in practice more and more limited.
There is a broad consensus among politicians as well as among central bankers around the world that the best contribution that monetary policy can make to growth, employment and worldwide financial stability is to keep inflation and inflation expectations at a low and stable level. The strategies to achieve this may differ across countries.
In Denmark, the basic policy objective has long been clear: the fixed-exchange rate regime has been successfully pursued for almost two decades and it has gained complete credibility in the markets. The continuous strong commitment to this regime is evidenced by the successful close pegging of the Danish krone to the euro within ERM II, which means that the price stability objective in the medium-term is the same as for the euro area.
The experience of the 1970s, 1980s and early 1990s, with the negative effects of large swings in the exchange rate, convinced most EU countries that an active use of exchange rate policy can easily put credibility at risk and may lead to speculative attacks. These experiences made them prepared to give up their imagined national autonomy in monetary and foreign exchange policy and to move to a monetary union.
It is now 20 months since the euro was introduced in 11 European countries and, at the beginning of next year, Greece will become the 12th country to adopt the euro. I should like to emphasise that the introduction of a single currencyis a long-term project and most of its benefits are likely to be of a structural nature. It is therefore too early to make any serious assessment of the overall effects. In fact, the introduction of the new currency has not even been completed. The euro banknotes and coins will be introduced in 2002 and only then will the full microeconomic effects of the euro be seen, such as full price transparency across national borders, increased competition to the benefit of consumers, and the disappearance of the costs and inconvenience involved in changing money when travelling to other euro area countries.
In the public discussion, particularly in the English-speaking world, it is often argued that the euro has not been successful. Here, it is mostly the currency's external value which is used as the main yardstick for measuring its degree of success. We readily admit that we are not happy with the development of the exchange rate of the euro, and we firmly believe that the present exchange rate does not reflect the fundamental strength of the euro area economy.
But I should like to underline the fact that the focus on the exchange rate of the euro neglects two important elements: first, most of the factors commonly referred to as the cause for the weakness of the euro would have influenced currency developments in Europe in any case. We can only speculate on what kind of currency developments these factors would have triggered among the national currencies, had Monetary Union not existed. Second, it neglects the fact that the introduction of the single currency has already set in motion positive long-term structural processes in all areas - and especially in the financial markets. These will have important implications for the competitiveness and growth prospects of the euro area.
I should also like to highlight the fact that the single monetary policy has in fact worked very well - in terms of both the decision-making process and the practical implementation. The Eurosystem consists of the European Central Bank, located in Frankfurt, and the national central banks of the 11 (soon 12) countries which have adopted the euro. The monetary policy decisions are taken by the highest decision-making body, namely the Governing Council of the ECB. It consists of 17 members (the six members of the Executive Board of the ECB and the 11 Governors of the national central banks of the participating countries).
The decisions on monetary policy issues - and also on monetary policy infra-structure issues - are taken on a one person, one vote basis. The discussion in the meetings of the Governing Council is very active, analytical and well-balanced. These discussions benefit active professional members, since it is the strength of the arguments and their analytical backing that determine the influence in the decision-making process. The decision-making is clearly focused on the economic developments in the euro area as a whole. Each member is therefore expected to focus on what is best for the euro area, rather than acting as a representative of its own country. In practice, this implies that members from smaller countries generally have strengthened their influence. Previously, members from the smaller countries responsible for their national monetary policies depended de facto largely on the policy decisions taken by the larger countries, in particular Germany - but with no say on monetary policy in Germany. Now, all members have similar input into the monetary policy in the euro area.
The key element for the success of the decision-making process of any central bank is credibility - this Denmark knows perhaps better than any other nation in Europe. In concrete terms, a credible central bank can achieve price stability with smaller interest rate movements than a central bank with low credibility can.
When the Eurosystem was set up, there was broad political consensus that its credibility should be firmly anchored in the Treaty on the European Union (i.e. the "Maastricht Treaty"). Thus, the Treaty specifies that the Eurosystem's unambiguous primary objective is to maintain price stability and it ensures that the Eurosystem can carry out its tasks without political interference.
Sometimes it is stated in the debate that the political independence of the Eurosystem is "undemocratic". I strongly disagree with this view. All industrialised countries have chosen a model whereby the clear and "narrow" mandate to formulate and implement monetary policy has been assigned to the central bank by way of a democratically taken decision. The central bank is then accountable to the relevant democratic institutions with regard to the fulfilment of its mandate.
This is also the case for the Eurosystem. The tasks and objectives of the Eurosystem have been established in the most democratic manner possible: the national parliaments of each of the EU Member States have approved the principles, tasks, objectives and institutional structure of the Eurosystem.
Of course, it is important for central bankers to be accountable for their policy actions. Any monetary policy actions must be well-founded. The Treaty itself guarantees an adequate degree of accountability on the part of the Eurosystem, for example, through regular reporting to the European Parliament. The Governing Council has taken further measures to make it easier for the public to assess how well the Eurosystem is performing its tasks. A precise quantitative definition of price stability was adopted. Price stability is defined as a year-on-year increase of below 2% in the Harmonised Index of Consumer Prices (HICP) for the euro area over the medium term. Short-term developments outside the direct influence of monetary policy, such as the recent increase in oil prices, may of course temporarily affect price movements.
I am proud of what we have achieved so far. Most economists would probably agree that the Eurosystem's monetary policy decisions have been appropriate to the prevailing economic situation. The single monetary policy has guaranteed price stability and has, at the same time, contributed to the recovery of the euro area economy. In parallel with the upswing in the euro area economy and the increasing upward risks to price stability over the last year or so, monetary policy has been carefully tightened without excessive reactions. The Eurosystem does not react mechanistically to short-term inflationary developments or to temporary developments in monetary aggregates or key indicators. The decision-making process is indeed focused on the overall assessment of price developments in the medium term.
The success of the introduction of the euro is beyond question also with regard to its impact on the development of the financial markets in the euro area. Right from the outset the euro established itself as one of the world's leading trade and investment currencies. Given the size of the euro area economy - comparable to that of the United States - it was only natural that the euro should enjoy a leading role in the global financial markets - after the US dollar. In some areas, however, progress has been even faster than we dared to imagine. In particular, the euro's popularity as a currency for international bond issuance has been remarkable, matching the popularity of the US dollar on a global scale.
The development of a deep and liquid bond market in euro is very welcome, since it enhances the possibilities for companies to raise financing, even for riskier projects, in the "domestic" capital market, without incurring exchange rate risks. Experience from the United States has shown that the existence of a very active corporate bond market, including the markets for high-risk junk bonds, was crucial in financing the growth companies in the IT sector. The rapid process of restructuring currently under way in the corporate sector in Europe - evidenced by unprecedented merger and acquisition activity as well as improved efficiency and competitiveness - has been underpinned by the introduction of the euro and the development of the corporate bond market. In the same way, the integration efforts in the fields of equities markets, derivatives markets, payment systems and settlement systems, among others, have been given a boost by the introduction of a single currency. And last but not least, the retail banking sector, too, is very much affected by the introduction of the euro. The Single Market and the single currency is expected to significantly improve the efficiency of the retail banking sector, not least leading to a lowering of the very high costs for cross-border payment transfers in the euro area. We expect this process to accelerate when the euro banknotes and coins are introduced in 2002.
It is clear that all these ongoing developments in the financial markets, for which the introduction of the euro has been a catalyst, are widely contributing to a more dynamic functioning of the euro area economies and the growth potential of the euro area.
We cannot shy away, however, from the fact that the exchange rate of the euro is at times affected by doubts about the prospects for the euro area economy. First, the persisting growth differential between the US economy and the euro area economy has been a source of concern. Second, the euro area economy is still suffering from structural problems and rigidities, for example insufficient labour market flexibility, by comparison with the United States. These problems need to be addressed through appropriate structural measures by the national governments.
I see no reason to assume that the euro area economy will develop at a slower pace than the US economy in the medium term. The euro area economy is now in better shape than it has been for several decades. Growth is picking up, the employment situation is becoming brighter, public finances are improving and there are signs that governments are increasingly committed to undertake the necessary structural reforms in the areas of labour markets, pension systems, social security and taxation.
Rising oil prices, which constitute an external factor common to all countries have, in combination with the weakening of the exchange rate of the euro, contributed to some increase in the inflation rate in the euro area over the last year. The price pressures have prompted the Eurosystem to gradually tighten monetary policy in order to prevent them from being reinforced by internal second-round effects in an environment of strong growth prospects. Owing to the time-lags between changes in the monetary policy stance and their impact on price developments, we will see the full effects of the recent interest rate hikes only gradually. We shall continue to monitor the situation closely in order to be able to react promptly should new information change our assessment of the risks to price stability in the medium term.