High-level seminar with the EU-candidate countries
Remarks delivered by Tommaso Padoa-Schioppa, Member of the Executive Board of the European Central Bank, Paris, 21 December 2000
My remarks will concern exchange rate policies in the accession countries and related economic policy issues. They will aim to explain the position of the Eurosystem on these issues, and will focus on nine specific points.
1. First, the Eurosystem's attitude towards the accession process. The accession process should not be seen as an enlargement, but rather as the reunification of a continent that was divided by the circumstances of history. Having said that, one should underline that while it is extremely important to keep the motivation and the hopes attached to this process very much alive, it is equally important to avoid any illusions about the difficulties it presents. It is crucial not to eliminate the hopes and expectations because these are, both in accession countries and in many current member countries, the main driving force behind the achievement of reasonable and rational policies. This is why the Eurosystem takes a positive attitude to the prospect of new EU Member States, as well as to their subsequent participation in ERM II and ultimate adoption of the euro.
2. Second, the Eurosystem's positions on the accession process. You may know that the Eurosystem's dialogue with the accession countries was launched in December 1999 at the "Helsinki Seminar". Since then, the Eurosystem has continuously pursued and further intensified this dialogue, in accordance with its positions on the accession process. Some of these, in addition to the positive attitude I have just mentioned, are relevant to today's discussion. The first is related to the plurality of approaches to monetary integration pursued by accession countries. The Eurosystem believes that a variety of approaches should be feasible without compromising equality of treatment. A second position, which is also very important, regards nominal and real convergence. Nominal convergence, understood as progress towards the nominal Maastricht criteria over the medium term, and real convergence, understood as the process of real income catching up with levels in the EU and the euro area, do not conflict and should be pursued in parallel. I will explain this point further. A third important position is related to monetary policy. Monetary policy should be conducted in a way which, in the medium term, ensures the achievement and the maintenance of price stability. Finally, the Eurosystem takes the position that exchange rate strategies should underpin an orderly integration into the EU, membership of ERM II and the eventual adoption of the euro.
3. Third, the time horizon of the accession process. It is very important to keep the time horizon clearly in mind. The conclusions of the Nice Summit imply, it is fair to say, that the earliest date for new accessions to the EU is probably the beginning of 2005. Participation in the euro area requires at least two years' membership of ERM II. Thus, to talk about the adoption of the euro is to talk about an event that cannot occur for at least six or seven years. I derive these dates from a reasonable "technical" reading of Nice and the Treaty. As such, they do not reflect any policy choice on the part of the ECB. The dates being as they are, it would be a big mistake to concentrate the discussion of accession on the final step of the process, namely the adoption of the euro, which is a rather distant event. Much more important, for the moment, is what comes before. The process as a whole will have three stages: EU membership, ERM II membership and adoption of the euro; four, if we include the pre-accession period. These stages reflect the history of the European Union, which moved from the establishment of the European Community to the creation of the EMS and finally to the introduction of the euro. This will be the path for new EU members, just as it has been and will remain the path for the present members.
4. Fourth, "catching-up" is the central economic issue of the accession process. If we look at the accession process from an economic viewpoint, the central issue is the need for accession countries to catch up with EU income levels. It is clear that a country where living standards are below those in the EU will have to catch up, in terms of both per capita income and the price level, to promote full EU integration and eventually EMU participation. This phenomenon is not new. We have seen several historical catching-up processes: it happened in the United States about a hundred years ago, in Japan and in Italy in the second half of the 20th century, and in many Asian countries in the past two decades or so. One can say that the catching-up process is a classic process of convergence; it is not specific to the accession countries. It also exists within the euro area, where some regions and countries are also "catching up". The crucial question is how to handle this process.
5. Fifth, the catching-up "trajectory". A "virtuous trajectory" of catching-up is where both per capita income and the price level gradually - but as fast as possible - and in an orderly fashion approach the level of the country or region that is ahead. This is clear as far as per capita income is concerned, but it becomes more complex when one considers the adjustment of price levels. We all know, of course, that an increase in the general price level is usually called inflation. However, this process of convergence of price levels should be distinguished from "classic" inflation. One should accept that in a country or region which is "catching up" the level of prices gradually rises, and that therefore, for some time, inflation is at rates which would be considered too high to meet the price stability requirements of a mature economy. One may ask how long this catching-up process will take. There are many calculations, whose outcome depends on the annual growth rates in the accession countries, as well as in the EU countries. Taking as a benchmark for the process Greece's per capita income relative to the EU average at the time of its accession in 1981, we see that, for plausible growth rates, it would take the accession countries on average around 15 years from now. To reach the actual lower bound of the distribution of per capita income in the EU, it will take even longer. One should acknowledge, however, that some countries could succeed in reaching this threshold much faster than indicated above, while for others it may take even longer.
6. Sixth, parallel convergence. By parallel convergence, an expression that may appear paradoxical, I mean the parallel pursuit of real and nominal convergence. I would like to explain this notion. In what I have called the catching-up trajectory, the convergence of per capita income and the convergence of the price level to the EU average (or to the lower bound of EU levels) proceed in parallel. It is important to bear in mind that inflation rates in accession countries contain a significant component of price adjustments related to the process of catching-up to EU real income levels; in the inflation rates of the mature economies of the euro area, this is negligible or non-existent. It is a well-observed empirical phenomenon, referred to as the Balassa-Samuelson effect, that this catching-up in real incomes goes hand in hand with a rise in price levels, which in accession countries are also still far below euro area averages. This price-level adjustment is an equilibrium phenomenon which - when matched by productivity increases - is sustainable. It also implies an appreciation of the real exchange rate, which has been observed in many "catching-up" economies over the past decades all around the world. For monetary policy, this means that the notion of "price stability" (or inflation targets) needs to take this component into account, so the monetary policy objectives in these countries will for some time be different from those in high-income countries or in the euro area. The magnitude of this effect and thus the component of inflation due to price adjustments is, however, difficult to quantify. Most empirical studies for the accession countries have yielded estimates in the order of around 1-3 percentage points over and above a "normal" inflation bias, with significant margins of error. Progress towards the achievement of the nominal Maastricht criteria over the medium term is not in contradiction to the catching-up process described earlier. Rather, by keeping the ultimate goal of meeting the Maastricht criteria in mind, monetary policy sets the appropriate framework for a gradual lowering of inflation rates and expectations and thereby contributes to macroeconomic stability and an environment of sustained growth. Therefore, if we are to define the ideal trajectory, it should parallel convergence.
7. Seventh, exchange rate policy. Exchange rate policy will have to be optimal for this catching-up process. Exchange rate policy should help the process, but it should not unduly constrain it or be constrained by it. What is interesting, is that neither the ECB/Eurosystem nor the ECOFIN Council has stated a single type of exchange rate policy as the only appropriate one. I would like to note that the ideal trajectory I have mentioned started some years ago, and it goes up to the final step, which is the adoption of the euro. In a way, it cuts through the four stages I mentioned in my initial remarks. The crucial point is to identify the optimal timing to move from one of these various institutional steps to the next in the monetary integration process. I would say that the best evolution of the exchange rate regime is probably one in which the exchange rate can adjust to this process. The fashion today is to say that the "corner solutions" are the only two appropriate regimes in a world of capital mobility. This would mean that either a hard peg (a currency board or even euroisation/dollarisation) or a floating regime should be chosen. We in the Eurosystem, however, have taken a strong view that "intermediate" regimes have their justification. They may be difficult to handle. However, the difficulties in handling them are, in a way, a sign that they are indeed useful, not that they should be foregone. In this trajectory, if we want the exchange rate to be adjustable when required and, at the same time, to play an anchoring role, probably neither of the two corner solutions is optimal as a general rule. In fact, it may be preferable to have an exchange rate regime which plays a disciplinary role but is adjustable enough to accommodate the catching-up process. ERM II is precisely that. ERM II requires discipline - no devaluation on a country's own initiative for two years - but provides for some flexibility through orderly adjustments. In fact, for most of the countries that are now in the euro area, the 1980s were the years in which the ERM played its greatest disciplinary role, acting as an adjustable peg. The mechanism started to pose problems when its adjustability was reduced too much.
8. Eight, currency boards and euroisation. The Eurosystem has taken a position on currency boards and euroisation, as has the ECOFIN Council. Basically, the position is "no" to euroisation and "perhaps" to currency boards. What does this mean? Euroisation as such is considered inconsistent with the Treaty, and not feasible. Currency boards, however, may be feasible under some circumstances. As I have already indicated, currency boards may introduce a degree of rigidity that could, under some circumstances, be inconsistent with the characteristics of the catching-up process. However, it would be a mistake to say that under no circumstances can currency boards be useful. In particular, they may prove to be an appropriate means to combat the classic inflationary risk, as the need for an anchor may be very strong in these cases. At the same time, the Eurosystem is of the view - which is also the position of the EU - that under no circumstances could a currency board substitute for the required ERM II membership as an "antechamber" to the euro. However, it could constitute an additional and unilateral commitment within ERM II. In any case, the appropriateness of currency boards would have to be determined on a case-by-case basis and, of course, the central rate chosen for the exchange rate system must be acceptable to all sides.
9. Ninth, central bank independence. On central banks, I just would like to take the opportunity offered by the composition of this meeting to say that another very important aspect, which is different from but, in fact, closely linked to what we are discussing, is the process of defining the statutes of the national central banks in the accession countries. This is clearly a pre-accession issue, and it is clear that statutes ensuring full independence are absolutely crucial. We know that independence is not only a question of legal arrangements. It is a question of practices, of attitudes in the state administration and in public opinion. But let me just say that none of the kind of policies we are describing now is likely to be effective if the fundamental precondition of independent national central banks is not fulfilled at a very early stage.
Thank you very much.