European Monetary System
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?
______________________
(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.
***
European Economic and Monetary Union - principles and
perspectives
-#"+ !-+ 1999\DRAFT SYLLABUS FOR THE CLASummary 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.
The adoption of the Eurosystem's monetary policy strategy also aimed
at enhancing transparency in the implementation of monetary policy. The
strategy is based on two key elements: First, money has been assigned a
prominent role in the form of a reference value for the growth of the euro
area wide monetary aggregate M3. Second, the Eurosystem carries out a
broadly based assessment of the outlook for price developments and the
risks to price stability in the euro area on the basis of a wide range of
economic and financial indicators.
In order to explain to the public the Eurosystem's policy actions
against the background of the adopted monetary policy strategy, the
Eurosystem uses several channels: the ECB's Monthly Bulletin; the issuance
of a detailed press release after each Governing Council meeting, in which
the decisions are explained; the organisation of a monthly press conference
at the ECB; the appearances of the President at the European Parliament;
and, finally, the numerous speeches and articles by the members of the
Governing Council. Taken as a whole, the Eurosystem is probably among the
more active central banks when it comes to explaining its policies to the
public.
A further important building block in order to establish credibility
is the promotion of an efficient implementation of the monetary policy
decisions. The Eurosystem has aimed to set up an operational framework
which is consistent with market principles and which ensures equal
treatment of counterparties and financial systems across the euro area. The
Eurosystem's operational framework is based on the principle of
decentralisation in order to take advantage of the established links
between the national central banks and their counterparties. The monetary
policy operations will therefore be conducted by the national central
banks, while decisions are taken centrally in the ECB's decision-making
bodies.
The consequences of a single currency: perspectives for the future
The most important effects of the single currency relate to the
possibility of improving macroeconomic stability and credibility for the
policies pursued; these effects are particularly important for the smaller
European economies. Moreover, important benefits can be derived from
microeconomic factors, such as lower transaction costs, wider and deeper
financial markets, improved price transparency and increased competition.
Starting with the macroeconomic factors, Monetary Union makes it
possible for the participating countries to combine their credibility. In
this way, small countries can, to a certain extent, "borrow" credibility
from some of the large countries which have pursued stability-oriented
policies for a long time. Under credible conditions, the financial markets
are no longer under pressure from speculative attacks by large
institutional investors. Price and interest rate developments are
stabilised, and the investment climate for companies is secured. In the
microeconomic field, the most obvious consequences relate to lower
transaction costs and increased price transparency across national borders.
These factors are likely to contribute to increased competition and
downward price pressure on many products.
One very important consequence is that the use of a single currency
will give rise to larger and more competitive financial markets in the euro
area. In most European countries, the financial markets have, by tradition,
been rather shallow, with few participants and a rather narrow set of
financial instruments on offer. A high degree of segmentation and a lack of
cross-border competition have implied relatively low trading volumes, high
transaction costs and a reluctance to implement innovative financial
instruments.
On the introduction of the euro, the foreign exchange risk of trading
in the different national markets in the euro area fully disappeared. This
has triggered increasing cross-border competition and has provided an
incentive for the harmonisation of market practices. In fact, the trading
of money market paper and euro area government bonds can already be
considered to be largely integrated. The markets for private bonds are
still segmented owing to the differing institutional and regulatory
conditions across Member States, but they, too, will gradually integrate
and provide an incentive for increasing the issuance volumes of private
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