The stability of the currency and the credibility of the ECB
The first factor concerns low risk, credibility and stability. The stability of the euro is a priority for the ECB. Compared with the idea of stability, the strength of the euro is of lesser importance. This does not mean that the exchange rate of the euro does not constitute an element to be considered in the monetary policy strategy of the ECB. However, the basic factor that will determine the importance of the euro as a widely used currency in the world economy, in addition to the demographic, economic and financial dimensions of the euro area, is, without a doubt, the stability of the new currency, understood as a means to maintain the purchasing power of savings.
In the global economy the transmission of financial crises by means of different mechanisms (devaluations of weak currencies, subsequent increases in interest rates, etc.) is frequently mentioned. Less is said about the spillover or transmission of positive economic circumstances, such as stability. The Eurosystem will "export" stability to the rest of the world economy, and not only in the case of those countries which decide to tie their currencies, formally or otherwise, to the euro (through the ERM II or other arrangements). In a global economy the euro area cannot be an island of stability, but it can transmit its stability to the rest of the world economy as the links between regions increase.
Stability is the basic requirement for a good currency. It is what we at the ECB want for the euro. We want a stable euro, not necessarily a strong euro. In the long term the euro will derive strength from its stability.
The stability of the euro is the basis for the confidence in and the credibility of the ECB, without which a large international role for the euro would be unthinkable. Stability is the proof of the effectiveness of the institution. Yet in order to be credible it is not sufficient for the ECB to maintain stability. Other parameters of its action must be considered: accountability, transparency and communication, a Europe-wide perspective.
The conditions for the credibility of the euro are certainly demanding. However, the achievement of these conditions is the aim of all those of us who have responsibilities in relation to the operation of the Eurosystem.
The "habitat" of the euro
The second factor, which we have called the large size factor or the habitat of the euro, is important because without a certain critical mass, a currency cannot have international relevance, however high its degree of stability. In addition to quality, quantity is required, as suggested by the example of the reduced degree of international use of the Swiss franc in relation to other stable currencies, such as the US dollar or the Deutsche
Mark until 1998.
The figures relating to the population and the GDP of the euro area illustrate this. With 292 million inhabitants, its population exceeds that of the United States (270 million) and that of Japan (127 million). The GDP of the euro area is, on the other hand, equal to 76% of the GDP of the United States (EUR 5,774 billion compared with EUR 7,592 billion), though it is higher than that of Japan (EUR 3,327 billion). The source of this information, which refers to 1998, is Eurostat.
However, even more important than the current figures is the potential for the future development of the euro area, in terms of population and GDP, if and when the so-called "pre-ins" (Denmark, Greece, Sweden and the United Kingdom) join the Eurosystem.
The entry of these countries would result in a monetary area of 376 million inhabitants, 39% larger than the United States and almost triple the size of Japan, with a GDP of EUR 7,495 billion, only slightly less than that of the United States and 125% higher than that of Japan.
All these facts and figures which demonstrate the demographic and economic importance of the European Union would be further strengthened by enlargement to Eastern Europe. Our continent has a historical, cultural and geographical identity - from the Iberian Peninsula to the Urals, with certain additional external territories - which, in the future, may also come to form an economic unit. However that is, for the moment, a distant prospect.
The degree of openness of an economic area is also a relevant factor as regards the international role of its currency. In this respect the euro area is more open than the United States or Japan, with a percentage of external trade of around 25.8% of GDP, compared with 19.6% for the United States and 17.9% in the case of Japan (data from Eurostat for 1997). However, a euro area consisting of the 15 countries of the European Union would be more closed, by the mere arithmetic fact that the transactions with the present pre-ins would become domestic transactions, resulting in a coefficient of openness of 19.4%, similar to that of the United States. Clearly, the size and the degree of openness are parameters that move in opposite directions: the larger the euro area, the smaller its degree of openness to other countries.
The financial dimension of the euro
The size or habitat of an economy does not only depend on demographic or economic factors; it also has to do with the financial base or dimension of the area. In considering the financial dimension of the euro area, the first relevant feature to observe is the low level of capitalisation of the stock markets in comparison with the United States and Japan. Compared with a stock market capitalisation of EUR 3,655 billion in the euro area in 1998, the United States presents a figure almost four times this amount (EUR 13,025 billion). Japan ranks third, with EUR 2,091 billion. There would be a marked difference if one were to include all 15 countries of the European Union, since the stock exchange capitalisation would increase to EUR 6,081 billion.
Although these figures could give the impression that the euro area has a relatively small financial dimension relative to its economic dimension, this is not the case. The lower degree of development of the capital markets is offset by a higher degree of banking assets. This means that the financial base of real economic activity in Europe is founded on bank intermediation, which is also a feature of the Japanese economy. For example, private domestic credit in the euro area amounts to 92.4% of GDP, while in the United States it is only 68.9%. Conversely, fixed domestic income represents 34.2% of GDP in the euro area compared with 66.1% of GDP in the United States (statistics from the International Monetary Fund and the Bank for International Settlements as at the end of 1997, taken from the Monthly Bulletin of the European Central Bank). We therefore have two distinct models of private financing which clearly have to be taken into account when assessing Europe's financial dimension compared with the United States or Japan.
THE ROLE OF THE EURO AND THE EUROSYSTEM IN THE PROCESS OF
EUROPEAN INTEGRATION
The euro as a catalyst for European integration
The euro, the Eurosystem's monetary policy and, in general, the activity of the ECB and the Eurosystem will play a key role in the integration of European financial markets and all markets in general. We can say that the euro will act as a catalyst for European economic integration.
Monetary and financial integration
The integration of the European money markets relies, of course, on the existence of a single system for refinancing the banks in the euro area, that is to say on the common monetary policy. However, it also relies technically on a system of instantaneous data transfer and on the new common payment system, TARGET, enabling real-time gross settlement. Thanks to the smooth operation of the information, communication and payment systems, a common monetary policy is realistic and the integration of the markets can take place. Such integration will, in turn, involve greater liquidity and further development of the financial markets.
A specific channel through which the monetary policy of the ECB and the TARGET system can have a direct impact on the development of the financial markets of the euro area is the requirement to have guarantees or collateral for operations with the ECB. This requirement for adequate collateral can stimulate the process of loan securitisation, especially in the case of the banking institutions of certain financial systems. The underlying assets can be used across borders, which means that a banking institution in a country belonging to the European System of Central Banks (ESCB) can receive funds from its national central bank by pledging assets located in other countries, which is also relevant from the perspective of the integration of the financial markets of the area.
The trend towards further integration of the European financial markets, accompanied by increased use of the euro as a vehicle for international investment, should logically follow a process which would start in the short-term money market, subsequently be expanded into the longer-term money market and finally extend to the public and private bond and equity markets. In the short term there must be a tendency for the differentials in money market interest rates to be eliminated, as the functioning of the market improves, while in the long-term securities markets - both public and private, of course - interest rates will always include a risk premium linked to the degree of solvency of the country (deficit and public debt, commitments on pensions), or to the credit risk of the private issuer, and to the liquidity of the securities.
Economic integration Monetary and financial integration stemming from the euro and the activity of the Eurosystem will affect the operation of the European single market in a positive way. The European market, with a single currency, will tend to be more transparent, more competitive, more efficient and will function more smoothly. This is the reason why joining the European Union, as a general rule, leads to joining the euro area, once certain economic conditions (the so-called convergence criteria) are fulfilled.
The case of Denmark, as you will know better than I, constitutes an accepted exception to the general rule, formalised in Protocol No. 8 on Denmark of the Treaty on European Union signed in Maastricht on 7 February 1992, and in the so-called "Decision concerning certain problems raised by Denmark on the Treaty on European Union" of 11 and 12 December 1992, which contains the notification from Denmark that it would not participate in the third stage of the European Economic and Monetary Union.
However, the Danish krone was in fact pegged to the Deutsche Mark from 1982 until the end of 1998. Furthermore, since 1 January 1999 it has been participating in ERM II with a rather narrow fluctuation band of ±2.25%, and effectively has had an almost fixed exchange rate vis-а-vis the euro. Therefore, the Danish monetary policy, through this exchange rate strategy, is the monetary policy of the Eurosystem. In other words, Denmark follows "the rules of the game" almost entirely, or as the Governor of Danmarks Nationalbank, Ms Bodil Nyboe Andersen, often says, "The Danish krone shadows the euro".
In this connection, and before the question and answer session begins, let me conclude by addressing the following key questions to you, on the understanding that this is a rhetorical way to express my ideas and that I do not necessarily expect any of you to answer them.
If Denmark already is following "the rules of the game", why, then, should you not make use of the advantages of belonging to the Eurosystem? Why, then, should you not participate in the decisions concerning the monetary policy which, in actual fact, applies to Denmark?
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(1) For a more detailed analysis, see the article entitled "The international role of the euro", in the August 1999 edition of the ECB's Monthly Bulletin, pp. 31-35.
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European Economic and Monetary Union - principles and
perspectives
Summary of a presentation by Ms Sirkka Hдmдlдinen,
Member of the Executive Board of the European Central Bank,
The Tore Browaldh lecture 1999,
School of Economics and Commercial Law, Gцteborg University,
Gothenburg, 25 February 1999
The European integration process started shortly after the Second World War and was, at the time, strongly motivated by political factors. The aim was to eliminate the risk that wars and crises would once more plague the continent. The first concrete result was the establishment, in 1952, of the European Coal and Steel Community between six countries (Belgium, France, Germany, Italy, Luxembourg and the Netherlands). This was followed by the adoption of the Treaty of Rome in 1957, laying the foundations for the European Economic Community.
The first concrete proposal for a Monetary Union was presented in the so-called Werner Report in 1970. The Report was intended to pave the way for the establishment of a Monetary Union in the early 1980s. However, the proposals of the Werner Report were never implemented - being overtaken by world events. After the break-up of the Bretton Woods system and the shock of the first oil crisis in 1973, most western European economies were contaminated by the economic sickness popularly labelled "Eurosclerosis", characterised by high inflation and persisting unemployment. At that time, the European economies were protected by regulations and financial markets were still poorly developed. In this environment, it was concluded that a Monetary Union would not be possible and the project was postponed.
The idea of establishing Monetary Union was revived only in 1988 and a detailed proposal was presented the following year in the Delors Report, after the launch (in 1985) of the Single Market programme on the free movement of goods, services, capital and labour. Because of the single market, the Report could be more explicit and credible with regard to how best to achieve closer economic ties between the EU economies before the introduction of a single currency. Moreover, the Report was supported by a detailed description of an institutional set-up geared towards ensuring stability-oriented economic policies.
Notwithstanding the thorough work invested in the Delors Report, almost 10 years of convergence and technical preparations were required in order to ensure the successful implementation of the euro on 1 January 1999. And the project is still not over: the euro coins and banknotes will be introduced only in 2002 - 13 years after the presentation of the Delors Report and 32 years after the presentation of the Werner Report.
Achieving a credible currency
Today, almost two months after the introduction of the euro, we can say that the technical changeover to the euro was successful. Now, the Eurosystem (i.e. the ECB and the 11 national central banks of the participating Member States) must focus on ensuring the long-term success of the new currency. The credibility of a currency is built up by several factors, the basis of which is the central bank's commitment to price stability. Here, the Eurosystem is in the fortunate position of being assigned, through the Maastricht Treaty, the unambiguous primary objective of maintaining price stability in the euro area. Another fundamental building block of credibility is ensuring that monetary policy decisions are independent of political pressures. This building block was also laid down in the Maastricht Treaty, which ensures that the ECB and the participating national central banks enjoy a very high degree of independence, possibly more than any other central bank in the world.
The credibility of a currency also relies on the preparedness of governments to pursue stability-oriented policies of fiscal discipline and to undertake necessary structural reforms. On this point, the Stability and Growth Pact adopted by the EU countries provides a basic framework for fiscal discipline and should enhance the governments' incentive to proceed with structural reforms.
In order to enhance credibility, it is also important that the central bank's strategy for achieving the primary objective is clear and that the link between the strategy and the central bank's policy actions is easily understood by the public. By following a transparent approach, the central bank can directly improve the efficiency of monetary policy. This contributes to achieving stable prices with the lowest possible interest rates.
Striving towards increased transparency led the Governing Council of the ECB (composed of the Governors of the 11 national central banks and the six members of the ECB's Executive Board) to establish a precise definition of price stability in order to bring about absolute clarity as regards the primary objective; price stability was defined as a year-on-year increase of the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. This is a medium-term objective. In the short run, many factors beyond the scope of monetary policy also affect the price movements.