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The future of the Treaty: implications for economic governance in Europe

Speech by Lorenzo Bini Smaghi, Member of the Executive Board of the ECB50 Jahre “Römische Verträge”, Johann-Wolfgang Goethe Universität,Frankfurt am Main, 5 July 2007


Ladies and gentlemen, [1]

It is a pleasure for me to be here today. I would like to share with you some thoughts about Economic and Monetary Union in Europe.

In exactly one year from now, the ECB will celebrate its tenth anniversary. As you all know, anniversaries are a good occasion to take stock; to look back at the past and look forward into the future. Today, I would like to take stock of EMU.

My basic message is twofold. Looking at the last 8 years, I believe we can conclude that EMU has functioned well, maybe even better than many had expected, and its basic architecture has proven its worth. Looking forward, challenges arise which will require forceful measures to modernise our economies, to put our fiscal houses in order and to strengthen Europe’s voice in the world. The re-launched process of Treaty reform should help to address these challenges. Yet institutional reforms are not sufficient: there is also a need for political will to honour the commitments made.

Looking back at the first nine years of EMU

Let me start by briefly recalling the basic architecture of EMU.

EMU is based on two pillars. The first pillar is a monetary policy, which has a clear objective, i.e. price stability. Responsibility for monetary policy has been transferred to the European level and has been put in the hands of an independent central bank, the ECB. The second pillar is economic policies. The responsibility for most of these economic policies has remained at the national level. At the same time, Member States should treat their economic policies as a matter of common concern and thus coordinate their policies where appropriate. Only some economic policies have been moved to the European level, such as competition policy and in particular internal market regulation.

This architecture has functioned well over the last nine years.

It has been generally acknowledged that monetary policy has been a success. I see three basic reasons for this success: a clear institutional status, a clear mandate and a clear strategy. First, a clear institutional status. The ECB has been granted a high degree of independence, which was written in stone by the Maastricht Treaty. This independence has been a crucial asset for a newly created central bank to build up its credibility. Second, a clear mandate. The primary objective – as enshrined in the Maastricht Treaty – is to ensure price stability. Without prejudice to this primary objective, monetary policy supports the general economic policies of the Community. Opinion polls show an overwhelming support for this mandate and for entrusting this task to an independent central bank. Clearly, people care about stable prices. The third and final reason for success: a clear strategy. The ECB has clearly set out what it wants to achieve and how it intends to achieve it. By being transparent on its strategy, the ECB has managed to guide and anchor the expectations of the markets and the public at large.

More specifically, the ECB has given a precise definition of price stability: below, but close to 2 %. Inflation has indeed been kept at this level for the past nine years. This is no small achievement, if one takes into account the considerable international shocks which have arisen in this period. Most notably, oil prices have tripled in the period from 1999 to 2007. In spite of these pressures, the 13 Member States which adopted the euro have enjoyed a level of price stability which previously had been achieved in only a subset of these countries and was unheard of in others. Price stability is a direct economic benefit, as it fosters economic efficiency by enabling markets to allocate resources efficiently. It is also a direct social benefit to consumers and savers alike, as it protects the value of their purchasing power.

I should like to stress that the monetary policy for the euro area is the result of teamwork within the Eurosystem, i.e. the system comprising both the ECB and the national central banks of the euro area. A core construction feature of the Eurosystem is to combine centralised decision-making with de-centralised implementation. Every month, the governors of the central banks and the ECB Executive Board meet in Frankfurt’s Eurotower to formulate the monetary policy for the euro area. This allows the ECB to draw upon the vast knowledge and wisdom of each of these central banks. The implementation of monetary policy is decentralised, i.e. it is performed by the national central banks which, for reasons of proximity, logistics and experience are better equipped to deal with these tasks.

Let me now turn to the second pillar, economic policies. As I already indicated, the responsibility for economic policy has mainly remained with the Member States. The EU is directly responsible for only some aspects of economic policy, such as the Internal Market. The economic policies which remained at the national level are subject to coordination at the European level. In the field of fiscal policy, the Stability and Growth Pact has been created to ensure that Member States keep their budgets in good shape. In the field of structural reforms, the Lisbon Strategy has been put in place, so as to promote the reform agenda and speed up the delivery of reforms.

How did the economic pillar perform? Looking at the recent budgetary developments, it looks like most Member States have now moved out of excessive deficits. Still, there is no room for complacency. In particular, most of the euro area countries are still far away from reaching balanced budgets over the cycle. Furthermore, the real test for the new Stability and Growth Pact is taking place now, in a favourable phase of the business cycle, when excessive deficit countries, especially those with high debt, promised to undertake a structural correction of the budget deficit of at least 0,5 per cent of the GDP per year. Unfortunately some of those countries are not keeping their promises. The risk is that when the recovery phase ends, deficits will continue to grow, exceeding 3 per cent of GDP.

The fact that all Member States have embarked upon the path of structural reforms is very promising. Labour markets have been reformed, certain sectors have been liberalised, research and development have been promoted. Still, also here, there is no room for complacency. Most Member States do still not meet the Lisbon targets.

Finally, looking at the internal market, further progress has been made over the last years, in particular in the field of financial markets. Yet, here as well, there is no room for complacency. It is worrying that the integrating impact of the internal market seems to be waning. One of the principal reasons for this is that the internal market for services is still not fully implemented. In today’s service-oriented economies, this is clearly a liability.

All in all, in spite of these shortcomings, the basic architecture of EMU seems to be working. And the economic figures are validating this. In the eight years since the introduction of the euro, more than 12 million jobs have been created in the euro area, compared to 2 million in the preceding eight years. Moreover, unemployment in the euro area has fallen to 7.2 %, its lowest level since 1993. GDP growth has been somewhat higher during the last eight years than during the period 1991-1998.

The euro has been an undeniable asset for the euro area economy. Indeed, the single currency has bolstered Europe’s resilience to external shocks. Living under the same roof gives us more solid shelter against turbulence outside. One can only wonder what would have happened to European currency markets in the aftermath of, say, 11 September 2001, had the euro not been there. Under the roof of the euro we have been safe, at least from a financial and monetary point of view.

Yet the euro not only protects against outside pressures. It is also a dynamic factor for the domestic economy. I see three main reasons for this. The monetary policy credibility has allowed the solid anchoring of inflationary expectations, which in turn has brought about a dramatic decrease in the cost of borrowing and thereby facilitated the investment needed for job creation. The single currency has fostered the completion of the single market. It has increased price transparency and competition and reduced transaction costs related to the management of different currencies. The euro has brought an end to exchange rate fluctuations, thus providing a more stable environment for trade within the euro area. It is estimated that the euro has already boosted intra-euro area trade by 5% to 10%. The single currency has also been a catalyst for the internal market for capital, promoting the integration of Europe’s financial markets. Combined, these elements have greatly boosted investment, economic growth and employment in the euro area.

Nevertheless, in the public opinion the signs of this success are not visible. There is still disappointment towards Europe and in some cases towards the euro. Why?

Looking at the differing performances across countries, it is clear that the euro cannot be blamed for the economic problems encountered in some of them. How can the euro be blamed for holding back job creation, if a country like Spain can create almost 5 million jobs since 1999? How can the euro be blamed for holding back economic growth, if a country like Ireland records an average economic growth of over 6% since 1999? How can the euro be blamed for undermining innovation and competitiveness, if a country like Finland is the world leader in innovation and ranks on top of all competitiveness indicators? How can the euro be blamed for hindering exports, if a country like Germany is the world’s first exporting nation? The message is clear: if some countries have not thrived under the euro like others, maybe they should first look in their own back-garden.

Looking forward to the future

I have given you my personal assessment of the track record of EMU so far. Let’s now take a look at the future of EMU. The EU will be confronted with three major challenges: rapid technological change, globalisation and an ageing population.

The question is whether the EU is well equipped to deal with these challenges. And can the re-launch of the Treaty reform process be of any help? My answer is yes. An institutional reform is necessary and useful, but it cannot really be a substitute for political will.

Let me explain my reasoning in further detail. As some of you might know, the EU Heads of State or Government agreed two weeks ago on the outlines of a Reform Treaty that will replace the Constitutional Treaty. This Reform Treaty will incorporate the innovations agreed at the last IGC – together with some modifications – into the current Treaties. The Reform Treaty will be drafted by an intergovernmental conference to be opened in a few days, which should deliver its product in the fall.

The ECB has just finalised its opinion on the opening of the IGC, which will work on the basis of a very specific mandate laid down by the EU leaders. I should like to elaborate on a few elements in the opinion that are of particular relevance to the ECB.

First, the monetary pillar of EMU will be left basically unchanged. The last IGC did not relevantly change the substance of the current provisions on monetary policy. In line with the mandate, the current IGC should therefore also leave the basic provisions of the monetary pillar intact. This validates the view of the ECB that the current provisions already provide for a suitable framework for the conduct of monetary policy. If it ain’t broken, don’t fix it.

One point should be highlighted in this regard. The new Treaty will be divided in two sections, one on the Union and one on its functioning. It seems that the provisions regarding the ECB will be entailed in the second section. However, the IGC mandate makes it crystal clear that both treaties will have the same legal value. On this basis, the ECB understands that it will benefit from the same legal standing as the EU institutions. This is a fundamental requirement to maintain the central bank independence.

Confirming the current provisions is anyway not sufficient. They also need to be respected and upheld ‘on the ground’. It seems quite surprising that after more than 15 years since the Maastricht Treaty, there are members of the political sphere who announce the intention to review some propositions in order to “rebalance” economic powers.

If the mandate of the IGC is fully respected, the functioning of the economic pillar of EMU cannot but improve. Over the last years, the Treaty rules governing the procedures for coordinating economic policies and correcting excessive deficits have exhibited some shortcomings. For example, when the Council takes a decision on the non-compliance of a member state with the Broad Economic Policy Guidelines or the Excessive Deficit rules, the country in question is also allowed to vote, making it judge and defendant at the same time. The innovations agreed at the last IGC should somewhat remedy these inconsistencies.

Strengthening the provisions of the economic pillar in the Treaty – whilst important – is however not sufficient. In the end, what is needed is the political will of governments to honour their commitments and implement the necessary policies. Having the right institutions is important, but it cannot fully compensate for a decisional inability, especially to implement structural reforms.

Finally, if the mandate of the IGC is fully respected, the Union’s external representation will be improved. In a globalising world, improving the Union’s external representation is essential. In an increasingly integrated world, it is important to be able to shape the rules of the game and participate actively in the governance of globalisation. This can only be done at the European level. However, in most policy areas, Europe does not speak to the outside world through one strong voice. The Romans knew very well that one way to beat your opponents is to divide them: divide et impera; divide and rule. The Europeans do not seem to have learned from this.

The Reform Treaty foresees certain improvements in this respect. Most notably, the Reform Treaty will create a High Representative for external affairs, which will be buttressed by a newly created external action service. This should help to ensure that the Union speaks with one voice to the outside world. In the field of economic and monetary union, it is required that the Council takes measures to ensure a more unified representation within the international economic fora.

In the end, what is needed is the political will of governments to strengthen the external dimension of the Union.

Indeed, creating a High Representative for external affairs will not matter much, if the Member States cannot agree on a common policy or do not allow him to represent them in the appropriate fora. In the economic field, a provision allowing the Council to take the necessary steps to improve the international representation of the euro already exists in the current Treaties. However, the Member States have not yet activated this clause. As a result, although the euro is the second biggest currency in the world, the euro area is still a political dwarf on the world stage. This reminds me of the famous words of Paul-Henri Spaak. Half a century ago, the former Belgian Foreign Minister said the following: "Today, Europe consists solely of small countries. The only relevant distinction that remains is that some countries understand this, while others still refuse to acknowledge it." It seems that some countries still refuse to accept this. Let’s hope not for long.

Thank you very much for your attention.

  1. [1] I would like to thank W. Coussens for his input in the preparation of these remarks. The opinions expressed belong only to the author.


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