Monetary and Financial Policies in the New Integrated Union
SUERF/UNICREDIT conference”Governance and structure of European finance after EU enlargement”, speech by Gertrude Tumpel-Gugerell, Member of the Executive Board of the ECB
Ladies and gentlemen,
It is a great pleasure for me to chair the second round table meeting of this conference on monetary and financial policies in the new integrated union. Today, the EU consists of 25 countries, representing around 455 million people. A significant number of other countries have indicated their intention to join the union in the near future.
Our panel session will address the challenges for monetary and financial policies in the new integrated European Union. This involves a rather large number of issues, but in my view the main challenges can be summarised as follows.
Challenges for monetary policy
In the first place, the continuing process of enlargement of the European Union implies important challenges for monetary policy. In general, the major challenge for central banks in an enlarged EU is to converge to macroeconomic stability and to prepare the introduction of the euro which implies a major step for the monetary authorities, but also relates to the functioning of the fiscal policies to some extent.
The current monetary policy strategies, including exchange rate policies, differ considerably among the new Member States. The overall success of these different strategies in anchoring expectations and in reducing inflation confirms that different ways can lead to the same goal.
It is important to ensure that the current strategies are capable of maintaining price stability and, more generally, are compatible with sustainable real and nominal convergence. Consequently, when examining and evaluating alternative strategies, we have to consider two important characteristics of the convergence process in the acceding countries, which are
the exposure to large capital flows and
the trend appreciation of the real exchange rate.
Another consideration may be that the monetary policy strategy has to take into account that a minimum participation of two years in the Exchange Rate Mechanism II (ERM II) is a precondition for the adoption of the euro.
The central banks of the new EU Member States face important institutional challenges as well, as they have become members of the European System of Central Banks. Once adopting the euro they will participate in the decision making on monetary policy and all the other decisions in the Eurosystem.
As concerns the economic conditions in the new member states the ECB’s Convergence Report published last year, highlights that improvements in various areas need to be achieved, and economic and financial reforms are needed in order to promote further integration. This reform process will lead to economic convergence and finally to the adoption of the euro, although the precise approach and timing will differ country by country.
Challenges for fiscal policy
Significant challenges lie in the area of fiscal policies. Let me quickly give an overview where the new member and pre-accession countries stand.
The budget balances worsened in many new Member States since 2000. In six of the new Member States the deficit-to-GDP ratio exceeded the 3% of GDP fiscal deficit criterion in 2004. The worsening budget balances also contributed to rising debt ratios in many new Member States, although their debt ratios are generally lower than those of the old Member States.
Also looking at candidate countries one can see, that fiscal problems need to be tackled. However, it is necessary to stress that already the outlook of a possible entry into the European Union released dynamics that lead to economic reforms and in further consequence to convergence with the euro area.
As regards the 60% of GDP debt criterion only two new member states – Cyprus and Malta – do not comply. However, in some cases the increase in the debt ratios since 2000 together with the costs of ageing populations raises concerns over sustainability.
Against this background, the major fiscal policy challenge is fiscal consolidation, particularly for those Member States with excessive deficits. There is a clear need for fiscal retrenchment not only to meet the 3% deficit criterion, but also to progress towards close-to-balance positions and to maintain a sustainable public finance position over the medium to long term.
This raises the question: How should these countries tackle fiscal consolidation?
We know from past experience that expenditure-based adjustments tend to be more durable and friendly to growth. For an expenditure-based adjustment also speaks that expenditure ratios in the new Member States are already high when compared to countries with a similar level of development.
In addition, there is the risk of further fiscal liabilities arising from population ageing and unreformed pay-as-you-go pension systems in a number of countries. This calls for reforms of the pension and health care systems. Hence, fiscal reforms that improve the targeting of social assistance and increase employment incentives are vital.
Finally, let me point out that the success of fiscal adjustment and reform crucially hinges on political and public support. We know that in some countries minority or coalition governments have had difficulties to undertake fundamental reform efforts and reform programs have often been shelved by new governments. Convincing the public is an important element of also building political majorities for essential reform.
Other indicators of economic convergence
Apart from fiscal policy one has to stress the successes in economic convergence already achieved in the new member states until now.
Looking at price developments one can see a clear convergence movement of the new member states in the direction of sustainable lower inflation. This convergence process already set in before the accession to the European Union.
Also, when looking beyond the frontiers of today’s union, one can see good examples of a successful reduction in inflation rates in countries which have a chance to become EU member states in the future. I am convinced that the perspective of an accession to the EU has helped these countries to make progress in this area.
The assessment of financial market participants of the improving economic conditions in the new member states can be retrieved from the development of long term interest rates. Since 2001 we observe a decline in long term interest rates in these countries, which was only shortly interrupted in the beginning of 2004 and continued at the end of last year.
A substantial lowering of the level of long term interest rates can also be observed in candidate countries such as Romania, Croatia, Bulgaria and Turkey.
Financial markets have already shown progress in their development. If you look at the development of credit to the private sector, you see a gradual increase in relation to GDP.
Current account balances have seen a deterioration in several new member states since the beginning of 2000.
Countries that are in a catching up process often face the phenomenon of a currency appreciation. This development was seen in most of the new member states. An exception is Latvia, which has seen a nominal effective depreciation of its currency.
If you look at exchange rate developments in real terms, Poland has seen a real depreciation of the Zloty since the year 2000.
Let me now go straight to the discussion of our panel. Before asking for the first contributions I would like to shortly introduce the panel members:
I do not think that President Axel Weber needs any further introduction in this conference. He acts as President of the Deutsche Bundesbank since April last year and is also a member of the Governing Council of the ECB. Before this he was known as an excellent economist with interest in the issues we are discussing today.
Ms Elena Kohutikova, who is also familiar to many in this room, is Deputy Governor of the National Bank of Slovakia since March 2000 and holds a PhD in Economics. Ms Kohutikova is also Alternate Governor of the World Bank Group and member of the President of Slovakia’s External Advisory and Consultancy Council.
Mr. Luděk Niedermayer is Vice-Governor of the Czech National Bank since December 2000 and graduated in operational research and systems theory from UJEP Brno. In 1991 he joined the State Bank of Czechoslovakia and became Executive Director of the CNB in 1996, being responsible for foreign exchange reserves administration and money market operations.
May I now ask Mr Weber to give his statement.