Accession Countries on the Way to the Euro: A Central Banker's View,
Speech by Tommaso Padoa-Schioppa Member of the Executive Board of the European Central Bank, Conference on "Economic Policy Directions in the OECD Countries and Emerging Markets: Analysing the Experiences", Warsaw, 21 March 2002.
"We must build the united Europe not only in the interest of the free nations, but also in order to admit the peoples of Eastern Europe into this community if, freed from the constraints under which they live, they want to join and seek our moral support. We owe them the example of a unified, fraternal Europe. Every step we take along this road will mean a new opportunity for them. They need our help with the transformation they have to achieve. It is our duty to be prepared."
Ladies and Gentlemen, these words were not pronounced a few years ago as part of the rhetoric of so-called EU enlargement. They were pronounced back in 1963 by Robert Schuman, when the Soviet block was still seen as a potential winner of the cold war and the reunification of Europe in a regime of democracy and economic freedom looked like a dream. The vision of Robert Schuman should in my view still guide decision-makers in today's enlargement process. It will in any case very much inspire the reflections on the process of EU accession and euro adoption, which I would like to share with you today.
European integration and EU enlargement
EU enlargement rests on the proven success of European unification. As we all know, economic and political integration has helped ensure peace and prosperity in Europe and develop stable democracies across the continent. The process has yielded achievements that are tangible for all European citizens. Several countries east and south of the EU are now about to join this process in order to benefit from it and contribute to it.
The accession of up to twelve new members poses huge challenges to the EU. Due to its sheer dimensions, it will have profound implications for the institutional design of the Union. Indeed, more and more European citizens, both in the EU and in the candidate countries, want to know to what kind of Union they are going to adhere. They are inquiring about the domestic and global role of the future EU, about the shape of its civic society and about its economic governance system. Some observers are sceptical with regard to the ability of the EU to reform itself. Similarly, observers had been sceptical all along the creation of monetary union, and they proved to be wrong. I am confident that today's scepticism will also prove to be unfounded.
Some months ago, the last remaining challenge in the setting up of monetary union has been overcome, when citizens throughout Europe have welcomed the euro banknotes and coins with enthusiasm. This enthusiasm is a clear indication that, when Europe undertakes a serious and ambitious project, people understand and support it. However, the successful introduction of the euro should not distract us from the need for further reforms. Indeed, many aspects of the EU process are not yet fully developed, and the European house is unfinished. Not only geographically, but also politically, we have not achieved the "united Europe" Robert Schuman was advocating in 1963.
Four key issues from an ECB perspective
From an ECB perspective, four issues in the enlargement process deserve special attention: first, real and nominal convergence; second, monetary policies and exchange rate strategies on the road towards the euro; third, the functioning and stability of the financial sector; and, last but not least, central bank independence. Let me offer a brief comment on each of them.
1. Real and nominal convergence. Several observers argue that real and nominal convergence are conflicting objectives and therefore cannot be pursued together. Some argue that real convergence – i.e. structural adjustment and real income catching up – should come first, as it is directly linked to welfare and living standards, and that nominal convergence – i.e. meeting the nominal Maastricht criteria – should come later. Other observers argue that it is crucial to focus first on nominal convergence in order to adopt the euro as quickly as possible and to be concerned with real convergence only at a later stage, when being already part of monetary union.
I would like to take issue with both these views and stress that real and nominal convergence should be pursued in parallel. Let me explain what I mean. Real convergence is more than the catching up in income levels; it is the adjustment of the real economies towards structures that allow the countries to participate in a monetary union without contributing to, or suffering from, significant asymmetric shocks. The level of per capita income is a useful, but by no means always close, approximation of the relevant concept of real convergence. As you know, income levels in accession countries are still far below those of the EU, to an extent never observed in previous EU enlargements. However, for countries that are highly integrated with the EU and advanced in the process of transition, privatisation and structural adjustment, the convergence indicators based purely on income levels may understate the true degree of real convergence.
How does nominal convergence relate to real convergence? Nominal convergence is the gradual fulfilment of the Maastricht criteria. Saying that nominal convergence should be pursued already at this stage means that, although the Maastricht criteria themselves will only be relevant at the moment of joining the euro, i.e. in some years from now, countries should already at present strive to achieve as much price stability as possible, hence work towards lowering inflation rates continuously. If the time horizon for full compliance with the Maastricht criteria is chosen in line with the starting conditions and the economic environment, nominal convergence will not be disruptive to real convergence. On the contrary, by anchoring inflation expectations both in accession countries and in international financial markets, it will facilitate the achievement of sustainable non-inflationary growth.
Undoubtedly, nominal convergence remains a difficult task in accession countries. Despite the progress made in recent years, several factors, including transition-related factors and productivity developments, continue to influence price developments in many countries. The pace of disinflation needs to take these factors into account, and the appropriate measure of price stability (which is that of unavoidable price dynamics) may not coincide, for some time, with the one applied in the euro area.
2. Monetary policy and exchange rate strategies. On the road towards the euro the difficult task of monetary policy and exchange rate strategies is to support the parallel pursuit of real and nominal convergence. As you know, the ECB is not recommending a particular monetary policy strategy, which should uniformly apply to all accession countries, but only recommends that the aim to maintain price stability be the ultimate compass of monetary policy. The monetary strategies of accession countries are generally in line with this principle. In particular, strategies of direct inflation targeting recently implemented in some countries have helped the central banks to build up credibility and further advance disinflation. In the case of Hungary inflation targeting has also been combined with a relatively flexible peg to the euro that has provided an effective external anchor.
In all cases, however, accession countries cannot disregard exchange rate developments, given that they are small open economies. Exchange rate developments are indeed crucial to the pass-through of external shocks into domestic inflation and often constitute a more powerful transmission channel of monetary policy than domestic interest rates. For this reason, a number of accession countries have pursued hard peg regimes or even currency board arrangements, which have served them well in their pursuit of price stability. In practice, a growing number of accession countries already follow exchange rate strategies that are in line with the ERM II requirements and only a few will have to modify their policies to make them compatible with ERM II membership. Overall, we believe that accession countries have made good choices with regard to their monetary and exchange rate strategies.
3. The functioning and stability of the financial sector. A sound and well-functioning financial market is key for two reasons. First, it is crucial for nominal convergence because it fortifies an interest-rate based monetary policy transmission and helps providing a stable macroeconomic environment. Second, it promotes real convergence by fostering investment and saving possibilities. Partly for historical reasons, in accession countries banks dominate the financial sectors even to a greater extent than in the current EU countries.
Over the past few years, progress in restructuring and consolidating the banking industry in accession countries has contributed to greater stability, efficiency and also integration with the EU's financial sector. Large-scale privatisations of state-owned banks and the extensive opening-up of the banking sector to foreign ownership have, undoubtedly, supported the strengthening of the financial system as a whole. This is one of the reasons why accession countries have weathered the global emerging market crisis of the past few years so well and suffered from little contagion. However, the reform agenda is not yet complete, as in some countries the financial sector still suffers from inadequate size and instruments, is burdened by a high share of non-performing loans and suffers from inefficiencies.
4. Central bank independence. Central bank independence was almost unthinkable twenty years ago in many European countries, at a time when monetary policy was still seen as an indispensable tool of government policies. Experience and economic thinking have gradually given rise to the conviction that monetary policy is best left to an independent but accountable institution whose mandate is clearly specified. Central bank independence is now accepted as a practically universal consensus throughout the world. It has been implemented everywhere in the EU as a fundamental aspect of the monetary unification process. It is therefore only natural that it is also a fundamental element in the accession process. As you know, central bank independence is indeed an absolute requirement for entry into the European Union. It is not only a formal requirement, it is also a substantial requirement and an essential component of a sound economic policy framework.
Unfortunately, accession countries provide us with mixed signals in this respect. On the one hand, most of them have amended their legislation broadly in line with the Treaty, and where gaps remain, they are mostly small. On the other hand, there are some countries where attempts are made – either de jure or de facto – to step back on progress already achieved. These cases are for us a reason for serious concern, as they imply that in the countries concerned the institutional framework to join the EU is undermined rather than respected.
Let me repeat: we, at the ECB, are seriously concerned that political pressure may put central bank independence at risk in some accession countries. This has once been the case with the Czech National Bank, although pressures were finally blocked by the Constitutional Court. And it is now the case in Poland, where again severe political pressure is put on the central bank. Last year, it was threatened to amend the central bank statute and change the size and composition of the Monetary Policy Council in a way that would make it more exposed to political influence. Some days ago, the Parliament passed a resolution that makes the central bank responsible for unemployment and low growth, and aims at refocusing monetary policy towards growth and employment creation. In all EU countries, a parliamentary resolution refocusing the objective of the central bank would be unthinkable today, since price stability is generally accepted as the key mission for the central bank. The present statute of the Polish central bank, which foresees price stability as the objective for monetary policy, is in line with this notion. Changing the statute away from this objective would deviate from the generally accepted consensus and may also make Poland's path towards the EU and the euro more difficult. Our concerns with the situation in Poland do not stem from any lack of sensitivity to the importance of economic growth, but from the well-established experience that monetary policy can contribute to sustainable growth by focusing on price stability, rather than by artificially inflating the economy.
What path towards the euro?
Let me now turn to the path ahead. The euro is a public good that will bring many benefits to accession countries. It will eliminate exchange rate risk, lead to lower interest rates and contribute to low inflation and monetary stability. From this perspective, it is understandable that the accession countries are keen to adopt the euro as soon as possible. I can only share this aim.
Of course, to participate in monetary union and to fully exploit the beneficial effects, a country must be ready for the euro. And readiness is to be assessed on the basis of the Maastricht Treaty. As you know, the convergence criteria set by the Treaty have been the centre of much academic discussion, both when they were adopted and when they were first applied in 1998. In the context of enlargement, criticism has centred on the question whether a catching-up component should be included in the measurement of inflation or whether the criteria should be applied in the same way as they have been applied in the past. Without going into the details of this issue, I would like to stress the principle here. The principle is that no extra criteria whatsoever are required from accession countries different from, or additional to, those that were applied to all countries that have adopted the euro so far. Of course, like for any other country, an assessment will be made about sustainable convergence. The Maastricht criteria are there also to contribute to making this assessment. They need to be, and will be, applied in a rigorous way, but they cannot, and will not, be applied in a simplistic or mechanistic fashion. They are guideposts to help assess sustainable convergence and ultimately a judgement will have to be passed as to whether a given applicant country is ready to adopt the euro.
Many policy-makers in accession countries are already now advocating for joining the euro sooner rather than later and this is indeed a desirable perspective in principle, as it helps to keep the reform prospect focused. Some have expressed their wish to adopt the euro immediately after the two-year participation in ERM II; others advocate for setting even before EU accession a pre-determined timeframe to join the euro area. Setting such a timeframe is said to anchor policies towards the fulfilment of the Maastricht criteria, thus providing the necessary incentive for virtuous economic policies. It is also seen as an anchor in a potential turbulent phase in financial markets, avoiding adverse shocks and shifts in market sentiment in an environment of free capital movement. In accession countries, however, there are also policy makers that are arguing in the opposite direction, for a possibly longer stay in the EU before the adoption of the euro. Their arguments are based on the fact that, as new EU members, countries will become exposed to the full competition of the single market and to the global capital market. Therefore, it remains to be seen in their view at what point in time the economies can forego the exchange rate as an adjustment tool in this new and highly competitive environment.
I believe that it is wrong to take sides in this debate in a generalised way. I also believe that it is too early to give an answer to this question on a case-by-case basis at the current juncture. The ECB will have to take a view in due time, conducting its assessment by looking at all the relevant factors, country by country. It is, however, first and foremost for the individual countries concerned to review this question and prepare in the best possible way their economies for the challenges ahead.
In closing my remarks, I would like to stress my conviction that both the EU and the accession countries will live up to their challenges and both fulfil their duty "to be prepared". Moreover, I believe that this will turn the upcoming enlargement of the European Union into a success for the direct benefit of all citizens concerned. About forty years later, we will then have the chance to turn Robert Schuman's vision into reality and build a union that will mean a new opportunity for all of us.
Thank you for your attention.