Some thoughts on the performance of the ECB
Speech by Eugenio Domingo Solans, Member of the Governing Council and of the Executive Board of the European Central Bank, delivered at the Deutsch-Spanische Gesellschaft, Stuttgart, 22 November 2002
It is a great pleasure for me to have been invited to take part in this event organised by the Deutsch-Spanische Gesellschaft and to have the opportunity to address such a highly distinguished audience comprising members of the economic and political arena here in Stuttgart. Thank you for your invitation.
The main topics that I intend to address, namely the compliance with the Eurosystem's monetary policy objectives, the need for finance ministries to honour the Stability and Growth Pact (SGP) and the Excessive Deficit Procedure (EDP), statistical issues related to the SGP and the EDP and the important role played by the European Central Bank (ECB) in integrating the euro's financial markets.
Let me first mention that the ECB and the national central banks of the 12 countries which have adopted the euro form what we call the "Eurosystem". Second, you will also know that the Eurosystem is governed by the decision-making bodies of the ECB. In particular, the Governing Council of the ECB is responsible, among other competencies, for formulating monetary policy decisions for the euro area as a whole with the aim of maintaining price stability. Therefore, the Eurosystem can be considered as the euro area's fully-fledged central bank.
The fulfilment of monetary policy objectives
The main benchmark or point of reference to evaluate the ECB's performance is, of course, the degree of compliance with its primary objective, which is to maintain price stability, as stated in Article 105 of the Maastricht Treaty.
Price stability is a concept rather than a single figure. Any price increase which is low or short-lived enough so as not to cause distortions in price setting, and low or short-lived enough so as not to trigger the implementation of an indexation procedure, is compatible with the concept of stability. The ECB agrees that this is the case when the year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area as a whole stays below 2% over the medium term.
Why below 2%? This limit is, of course, a convention. It could be 2.5% instead, just as one could set the speed limit at 40 km/h instead of 30 km/h in residential areas. But, on the other hand, stability must not be defined as an increase in prices of, say, up to 4%, just as 60 km/h would not be an appropriate speed limit in residential areas.
The annual inflation rate in the euro area is 2.3%, according to figures from October 2002. Strictly speaking, this does not meet the figure stated in the definition of price stability, although there are good reasons to expect that "over the medium term" – to use the same wording which accompanies the definition –, i.e. in 2003, the inflation rate of the euro area will break through the 2% level and remain below it, unless certain factors such as oil prices and wages have unforeseen adverse developments. From the experience gained since 1999, we can conclude that the ECB's monetary policy is providing a high degree of price stability to the European consumers, savers and investors. Therefore, the performance of the ECB in respect of its main objective is encouraging.
Article 105 of the Maastricht Treaty, after stating that "the primary objective of the European Systems of Central Banks (ESCB) shall be to maintain price stability" adds that "without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community with a view to contributing to the achievement of the objectives of the Community as laid down in Article 2".
These Community objectives include "sustainable and non-inflationary growth respecting the environment" and "a high level of employment and of social protection".
It is, therefore, clear that, as a matter of priority, the ECB must focus its decisions on the objective of stability, which is its real "raison d'être"; in addition, and without prejudice to this aim of stability, the ECB also has responsibilities relating to economic growth, employment and social protection. These responsibilities are general, conditional and secondary, if you like, but responsibilities nevertheless.
Hence, beyond the primary objective of price stability, the ECB also has an implicit secondary objective: to support the other economic policies and, in so doing, to contribute to sustainable and non-inflationary economic growth, as well as to achieve a high level of employment and social protection.
If we are to accept that there is more than one general objective for monetary policy, it seems important to stress the need to prioritise these objectives and, in the case of the Eurosystem, to give top priority to the objective of stability. Any doubts about this could undermine the confidence of the public and the markets in the Eurosystem's commitment to stability, trigger inflationary expectations, and eventually – and paradoxically – hinder or jeopardise economic growth and job creation.
In the medium term, the best contribution that the ECB can make in favour of sustained economic growth is, precisely, to create an environment or atmosphere of stability. Stability implies an efficient allocation of resources, competitiveness, lower interest rate risk premia, appropriate conditions for investment, and so on. All these factors are preconditions for economic growth or, in other words, preconditions for the fulfilment of the secondary objective of the ESCB. In securing its objective of stability, the Eurosystem creates the necessary conditions to comply with the European Union's objective of economic growth. There is clearly no greater fertiliser for economic growth than price stability, and nothing is more damaging to economic growth than inflation.
I said that stability is "the best contribution" to growth, but I believe that it is not the only possible contribution. In other words, I understand that we cannot comply with the ECB's implicit secondary objective stemming from the Treaty by means of simple adherence to its primary objective. Moreover, the ECB creates the best monetary conditions to support economic growth and job creation: ample liquidity, low nominal interest rates and historically low real interest rates. I believe that I can conclude that the contribution of the Eurosystem to a sustainable economic growth and job creation in the euro area is as encouraging and reassuring as it is in the case of its primary objective, price stability.
Establishing the appropriate monetary conditions for price stability should be seen as a necessary condition to achieve economic growth and job creation but, unfortunately, it is not a sufficient condition. Other aspects should be considered, such as budgetary discipline, moderation of wage developments, economic dynamism and flexibility and, last but not least, luck in the oil market (although when it comes to energy, apart from relying on luck, it is also well worth taking action to reduce Europe's dependence on external sources). As we say in Spanish, "a Dios rogando y con el mazo dando" (God helps those who help themselves).
Allow me now to briefly stress the importance of economic dynamism and flexibility to enable production to be adapted to the changing conditions of the environment and to enable external shocks to be absorbed. Economic dynamism and flexibility, which imply the existence of market-oriented supply side policies, is a condition for efficiency and competitiveness, two aspects which, as was agreed at the Lisbon and Barcelona European Council summits, need to be enhanced in the European economic system.
Need for budgetary discipline
I will certainly not skip the issue of budgetary discipline, a cornerstone of the European economic model and an issue which is being much discussed at present. Given the existence of national fiscal policies, the principle of budgetary discipline enshrined in the Treaty and the SGP is indispensable for Economic and Monetary Union. The main commitment of Member States under the SGP is that fiscal policies should result in medium-term budgetary positions which are "close to balance or in surplus". This, in conjunction with the Maastricht Treaty obligation to avoid excessive deficits and to apply appropriate implementation procedures, such as the Excessive Deficit Procedure (EDP), secures the sustainability of public finances and provides scope for dealing with the expected fiscal challenges caused by population ageing. Full compliance with the fiscal framework will also send an important message to accession countries.
It is extremely important to understand why compliance with the SGP is of the utmost importance for macroeconomic equilibrium and dynamism. Beyond certain levels, public deficits and debt would have a negative impact on market interest rates because of the existence of an excessive additional demand for funds and the development of inflation expectations. Public deficits could crowd out private investment and consumption and hamper economic growth. The idea that who is spending and how expenditure is financed is irrelevant ("ultrarationality hypothesis") and that what really matters is having some kind of expenditure and some way of financing it in order to have economic growth is simply not true, because the economic effects of both hypotheses are very different. Furthermore, our socioeconomic model enshrined in the Maastricht Treaty would prevent an economic policy not conducted in accordance with the principle of an open market economy with free competition (Article 3a) and a situation of excessive government deficits (Article 104c).
If public deficits affect market rates, the link between the key or official ECB interest rates and the market interest rates would become less robust and the monetary policy transmission mechanism less effective. The deficit in certain countries, as opposed to the common monetary policy stance, would, in an extreme case, be the main factor affecting the market interest rate for the whole area. In this perspective, it is crystal clear that the SGP is really a "public good" for the whole euro area and that those who breach it should be considered "free riders". Normally, behind the non-fulfilment of the SGP, let us be frank about this, is a case of bad public administration, whether past or present.
Let me now consider the issue of compliance with the SGP and the EDP from quite a different angle: one involving statistics.
There is nothing more important for the EDP and the SGP than reliable statistics. This is recognised by the Maastricht Treaty and related primary and secondary legislation, which together provide at the European level a sound statistical methodology for the provision of government accounts, and in particular for the provision of data on government deficit and debt.
Government accounts are today much more detailed, timely and comparable between Member States than when the Maastricht Treaty was ratified in 1992. Despite the good progress made in the previous ten years, there are still problems on a national level in terms of compiling government accounts, reporting government deficit and debt data to the European authorities, and publishing government revenue and expenditure in due course and on a quarterly basis. The reporting delays in and revisions of the deficit and debt data for some countries are clear evidence in this respect.
While the importance of the EDP is undisputed, there is a pressing need to safeguard and strengthen best practices in compiling, reporting and publishing government accounts by Member States. In order to be effective, these best practices must also be transparent to the public at large. The citizens of the European Union are obviously entitled to know the precise actual revenue and expenditure of their general government at central, regional and local level, as well as the social security funds.
In my view, best practices should relate to the following:
First, national compilation procedures. According to primary and secondary legislation at European level, government accounts must comply with national accounting rules as laid down in the European System of Accounts. The compilation of the GDP follows the same set of rules. It is therefore evident that the national statistical institutes are in the best position to provide details of government accounts for the purposes of European Union information. The national statistical institutes close co-operation with Eurostat – the statistical office of the European Communities – in the European Statistical System guarantees the comparability of results between the Member States. The national central banks have also been involved in this process in many countries, given their expertise in financial accounts, including statistics on government debt.
When compiling and reporting the government accounts, the national statistical institutes must carry out this task independently, in the same way as the ECB and the national central banks carry out the tasks and duties conferred upon them under the Treaty. Governments should commit themselves to respect this principle and not to seek to influence the accounting rules. The role of governments is to take real measures to achieve the objectives of the SGP in a forward-looking manner. The experience gained in the previous ten years shows that the citizens of the European Union can rely on the national statistical institutes, and where applicable on the national central banks, when compiling harmonised government accounts for the Member States.
Second, reporting and publishing government accounts. The data to be reported by Member States for the purposes of the EDP were decided on about ten years ago. Much has changed since then, in particular after the Action Plan on EMU Statistical Requirements, which was developed in close co-operation between the European Commission and the ECB. The Action Plan, which was published by the Council of the European Union in September 2000, requires data for government revenue, expenditure and financial assets and liabilities on a quarterly basis. Many Member States compile these data already, but only some publish them. While the citizens of the European Union are, for example, aware of the development of GDP and private consumption on a quarterly basis, the available quarterly data on government revenue and expenditure are not yet published in many Member States. This is not good practice and must change soon. How can macroeconomic performance be assessed at European level, when there is monthly information on monetary developments provided by the ECB yet only annual information on fiscal developments?
Third, preventing accounting issues from arising. From time to time the press reports on Eurostat decisions changing ex post the government accounts, including government deficit and Member States' debt. The decisions are taken by Eurostat in full compliance with the Treaty and following a sound procedure involving the Committee on Monetary, Financial and Balance of Payment Statistics (CMFB), a committee comprising senior statisticians from national statistical institutes, Eurostat, the national central banks and the ECB Directorate General Statistics. While these decisions were necessary in the past, ex post changes in statistics and forecasts due to amendments and clarifications in the accounting rules undermine the EDP and the SGP.
The procedures in place are useful to resolve issues, but the best practice is to prevent issues. This requires not only the independence of the national statistical institutes, but also the willingness of governments to consult them, and where applicable, to consult the national central banks, and this at an early stage in the planning of specific measures to attain the objectives of the SGP. The same efficient procedure which currently helps to resolve accounting issues is best applied to prevent them.
Best practices may be detailed further, but I will leave it to those responsible to develop operational solutions. Reliable statistics are indispensable for the EDP and the SGP and the citizens of the European Union have a right to be informed of the complete government accounts in due course and on a quarterly basis. The ECB will continue to insist on rigorous accounting rules and their application at European level. As in the past, the ECB's Directorate General Statistics stands ready to contribute to this task when requested.
Integration and functioning of the euro financial markets
In the final part of my speech I will refer to the Eurosystem's responsibilities in terms of the integration and functioning of the euro financial markets. The basic strategy of the Eurosystem in this respect has to do with the removal of obstacles in the formerly segmented national financial markets.
Indeed, in a number of cases, the removal of the former obstacles created by the existence of different currencies has revealed co-ordination problems that cannot be solved by competition alone. I should like to underline that this, I believe, is where the role of the Eurosystem is crucial to ensure that the full benefits of economic and monetary union are obtained. By definition, public policy consists in the resolution of co-ordination problems between private agents, leading to the production of a public good or the protection of a public interest.
Let me immediately provide two examples of how the Eurosystem has contributed to solving co-ordination problems, where market forces alone could not be effective. Here I would like to emphasise that, for the sake of simplicity, I have chosen two very practical and very down-to-earth examples. But the same concepts apply to significantly more complex issues.
My first example refers to the calculation of the EONIA reference rate, which, as you know, is a weighted average of the interest rate at which major banks active in the euro market conduct their overnight transactions in the unsecured money market. The existence of such a reference rate has some of the properties of a public good, insofar as it has provided the basis for the development of an extremely liquid overnight interest rate swap market, of which no equivalent exists anywhere in the world.
The EONIA reference rate was not designed by the ECB, nor did the ECB play any leading role in its creation. Whereas the creation of the EONIA was a typical example of a co-ordination problem being resolved by market participants themselves, the ECB was involved as a facilitator of this resolution. It was seen as desirable by market participants that the calculation of the daily EONIA rate be done by a third party, which would receive the contributions of each bank on the panel on a confidential basis. It is the ECB that was asked to play this role.
A different example of a co-ordination problem, of a considerably more serious nature, relates to the existence of a payment mechanism across the euro area. In the absence of a satisfactory solution, the Eurosystem took it upon itself to design and operate such a payment mechanism. This, of course, is TARGET, which needs no introduction.
The role of TARGET at the time of the introduction of the euro cannot be overestimated. In allowing the immediate integration of the whole euro area unsecured money market in the first days of existence of our single currency, it effectively ensured the singleness of monetary policy. The reason why I mention this example is because this is one where public authorities could not act simply as facilitators of the resolution of a co-ordination problem, but had to act as principals in the resolution itself.
The other merit of this example, in my view, is to highlight the following: the Eurosystem did not integrate the money market. It is the banks themselves, through their activity of arbitrating any remaining differences between interest rates across the euro area, which integrated the money market. What the Eurosystem did was to ensure that there existed an environment where these market forces could be unleashed. The strict implementation of the single monetary policy with a pan-euro area approach and no consideration for the liquidity situation in each country taken individually of course helped to foster this environment.
This, I believe, underlines the role of the Eurosystem in the integration of euro area financial markets. The examples I have used are very limited and down-to-earth. When one thinks of public intervention in the field of financial markets, one thinks about legislation, such as the work being undertaken in the area of European Directives on banking, taxation of savings, or collateral. One also thinks about regulation and, for instance, the work recently carried out by the Committee of Wise Men on the regulation of the European securities market. But the underlying principle is the same. The role of the authorities, in each case, is to create, by the resolution of what are essentially co-ordination problems, a safe and competitive environment, where market forces can effectively express themselves, leading to an efficient allocation of resources.
Ladies and gentlemen, I shall come to a conclusion.
Next year, in six months' time, the ECB and the Eurosystem will be five years old. Five years is less than one tenth of the age of the Deutsche Bundesbank, which is over 50 years old, and it is almost nothing compared with the age of Banco de España, set up in the 18th century, in 1782 to be exact, under the name Banco de San Carlos.
In only five years the Eurosystem has become a fully-fledged central bank which formulates and implements a stability-oriented monetary policy, supports the general economic policies in the European Union with a view to contributing to the achievement of the objectives of the Community, conducts foreign exchange operations, holds and manages the official foreign reserves of the Member States, promotes the smooth operation of payment systems, contributes to the smooth conduct of policies pursued by the competent authorities relating to the prudential supervision of credit institutions and the stability of the financial system, collects, compiles and disseminates monetary and financial statistics, has created and developed the second most important currency of the world economy and has successfully introduced the euro banknotes and coins in the 12 countries of the system. In doing so successfully – i.e. in an efficient, transparent and accountable way –, the Eurosystem acts as a catalyst of European integration and honours the mandate it was given by the European public.