B e r i c h t e
The Process of European Monetary Integration
von Professor Alexandre Baron Lamfalussy, Präsident des Europäischen Währungs- instituts, Frankfurt a. M.
Vortrag, gehalten anläßlich der Jahrestagung des Instituts für Bankwirtschaft und Bankrecht an der Universität zu Köln am 31. Mai 1995
I should like to divide my remarks today on the process of European Monetary Inte- gration into three parts. The first is a brief assessment of the progress towards con- vergence. Under the Treaty, the EMI is assigned an important role in assessing whether countries entering Economic and Monetary Union have fulfilled the necessary conditions for the adoption of a single currency. In the second part, I shall say a few words on the EMI´s task of preparing the ground for the conduct of the single monetary policy in Stage Three. Finally, I would like to briefly consider timing issues related to the transition to the single monetary policy and to the changeover to a single currency.
Progress towards convergence
The Treaty provides that the EMI and the Commission shall each prepare a report to the EU Council, focusing particularly on the achievement of a high degree of sustainable convergence. Convergence will have to be assessed by reference to the four well-known criteria regarding government budgetary positions, inflation rates, as well as exchange rate and (long-term) interest rate developments. Let me, already at this point, note the importance oft a strict interpretation of the Treaty provisions re-
economic convergence of the participating countries. The first Annual Report of the EMI, which was published in April, contained a section on convergence. We plan to deepen our analysis in the coming months. The task of the EMI is, of course, much broader than the assessment of convergence. The EMI also tries to contribute acti- vely to convergence by assisting central bank co-operation and co-ordination of monetary policies which, however, remain the full responsibility of the national central banks in the present stage, Stage Two of the EMU process. In practice, the main instruments at the disposal of the EMI are analysis and persuasion.
What then is the present state of affairs regarding the convergence criteria?
Convergence towards price stability has made considerable headway in recent years. Last year, three countries had inflation rates of 2% or less. Those countries were Denmark, Finland and France. Several Member States came close to the in- flation rates of the three best-performing countries. Belgium, Ireland, Luxembourg, the Netherlands, Sweden and the United Kingdom recorded inflation rates of around 2,5%, while consumer prices rose by 3% in Austria and Germany. The remaining countries - Italy, Spain, Portugal and Greece - still habe to catch up in terms of price stability, in spite of considerable progress made towards reducing their domestic inflation in the past few years.
The relatively favourable inflation performance since 1990 is certainly due, in part, to the severity of the last recession. Demand pressure was weak and wage growth was moderate. Moreover, in the course of 1994, substantial productivity gains could be achieved. However, this is only a partial explanation. Much more significant is the fact that price stability has, for some time, been accepted in the EU countries as one of the major objectives of economic policy in general and as the primary objective of monetary policy in particular. It is now widely accepted that price stability is good for investment, growth and employment and that a trade-off between inflation and un- employment is larged illusory.
It should be noted that inflation in the Union on average is, at around 3%, still above what is regarded as being consistent with price stability. Furthermore, the relatively favourable inflation performance in most countries should not give rise to com- placency. As the economies of the EU countries have recovered, the risk of in- flationary pressures has increased, in particular in those countries which have ex- perienced a relatively sharp depreciation of their exchange rate. So, the period ahead will be a test of the ability of Member States to maintain and strengthen their commitment to price stability. This will not only require vigilance on the part of central banks, but also full support from the social partners and governments. Wage behaviour should be geared to non-inflationary settlements by limiting wage growth to productivity growth. I will turn to fiscal policy in a moment.
With respect to convergence in long-term interest rates, the picture is not much different from that inflation: using annual averages, long-term interest rates in many EU countries have moved within a relatively narrow range, reflecting the marked progress in price convergence which has been achieved. The annual average values, however, mask a considerable widening of interest rate differentials since the beginning of 1994, in particular, between the best-performing countries in terms of price stability and the others. The widening of interest rate differentials also indi- cates important concerns in the markets over fiscal positions, as well as an in- creased focus on countries`long-term records of exchange rate and price stability.
Public finances is the area where performance is least satisfactory. This year, a fiscal deficit below the reference value of 3% of GDP is forecast in only out of fifteen EU countries. Government debt levels exceed 60% of GDP in all but four countries as well. Although the average budget deficit in the Union, which was reduced form a record high of 6.2% of GDP in 1993 to 5.5% last year, is expected to come down somewhat further, progress in reducing the structural component of the deficits is in general slow.
maintained in the European exchange rate mechanism over most of 1994. Since last December, however, market tensions have resurfaced for several currencies. These tensions related partly to the weakness of the dollar, which has had destabilising effects on European currencies. Domestic political uncertainty in serval countries also contributed to the tensions. I should like to stress, however, that currencies should not be allowed to drift for prolonged periods of time from their equilibrium levels. Misalignments in real exchange rates would reduce the benefits for Europe of the single market and could ultimately put the single market itself at risk if currency developments were found to be guided by a desire to gain a short-term competitive advantage. Authorities should therefore avoid excessive exchange rate fluctuations by continuing to aim their policies at price and exchange rate stability and the re- duction of fiscal deficits.
The overall picture of the present state of convergence is by no means satisfactory.
In order to meet the criteria for participation in EMU, efforts will need to be inten- sified. This is true, in particular, in the field of public finance. However, I do not ad- vocate fiscal consolidation only becauce it is prescribed by the Maastricht Treaty. It is desirable anyway. Firstly, if we want to create some leeway for the working of au- tomatic stabilisers in economic recessions, we have to virtually eliminate fiscal defi- cits in normal times. Secondly, high and rising government debt levels represent a future tax on our children. Instead, we should increase public saving to finance the costs associated with the ageing of the population. Fiscal consolidation would also raise consumer and business confidence, reduce the risk premia incorporated in in- terest rates and increase the funds available for private investment.
Preparing the ground for the conduct of the single monetary policy
Let me now turn to the EMI´s task of preparing the ground for the conduct of the single monetary policy in Stage Three. Before the end of 1996, the EMI must pre- pare the regulatory, organisational and logistical framework that will be needed to allow the European System of Central Banks (ESCB) to operate properly. This invol-
ves preparatory work in numerous areas of central bank activity, in particular:
monetary policy, foreign exchange policy, statistics, payment systems and the is- suance of banknotes. The organisation of a smooth transition from the present mo- netary arrangements, which vary condiderably from country tho country, to the im- plementation of a single monetary policy to be carried out by the ESCB is a very complex and demanding task. This is also the case because there are many un- certainties about the environment in which the ESCB will operate. To name just a few: which countries will participate in the first move into Monetary Union? What will be the prevailing economic and financial environment on the eve of Stage Three?
What effects will the achievement of EMU have on private investment behaviour and financial structures?
At present, the EMI is focusing on defining options as regards the various instru- ments to be used by the ESCB in the conduct of the single monetary policy. The Treaty, although very specific on the final objective of monetary policy, does not offer much guidance as to the practical implementation of this objective. Some general principles are provided, such as the maintenance of open markets with free com- petition, the ban on monetary financing of the public sector and the potential in- volvement of national central banks in the operations of the ESCB „to the extent deemed possible and appropriate“.
The EMI has to present a framework which is much more precise. Key issues will have to be clarified well in advance of the start of Stage Three, given the time re- quired to implement changes in the present national arrangements. Some of the questions which need to be addressed in this respect are: should there be com- pulsory reserves or not? If so, to what extent should such reserves be remunerated and to which range of liabilities and financial institutions should they apply? What kind of standing facilities are needed and how often should the ESCB engage in open market transactions? Options are also being designed as regards the types of securities which would be eligible as collateral for standing facilities and as un- derlying assets for open market operations. Furthermore, a technical analysis of the feasibility and the features of a decentralised execution of open market operations
may be difficult to achieve, because significant differences still exist across countries regarding the importance of various instruments, the frequency of money market in- tervention and the choice of counterparties. However, close harmonisation seems to be imperative in order to allow the ESCB to signal its policy intentions effectively and in order to avoid arbitrage and delocation of financial activity for regulatory reasons.
It is clear that each central bank brings its own experience into the discussion, but it must also be recognised that the predominance of certain instruments and pro- cedures is often contingent upon specific institutional features, accidental circum- stances and established conventions. All of us must be prepared for some changes.
We shall also have to start addressing strategic issues very soon. These are related to the way in which financial market and credit conditions are to be steered by the ESCB in order to achieve its primary objective, price stability. In very rough terms, we can distinguish between two potential monetary strategies: one relying on an in- termediate target, such as money supply, and one geared directly to the final ob- jective through the assessment of a broad set of indicators which are thought to be relevant for future price developments. I acknowledge that, in theory, the differences between intermediate monetary targeting and direct inflation targeting can be presented as being very significant. But in practice, the two approaches seem to have a lot in common and the distinctions between them have sometimes become blurred.The common feature of both approaches is that they show the policy- makers´ ability to pre-commit themselves to some form of counter-inflationary mo- netary policy rule. Such a rule imposes a measure of discipline on the authorities to avoid ad hoc decision-making. The two approaches have at times become somewhat blurred not least because, in the presence of uncertainty and imperfect information, flexibility and judgement in the application and definition of targets is required. In any strategy, the various indicators which could give information on the current and future economic and financial situation will need to be monitored. In any case, what counts most in the end appears to be the degree of determination with which central banks carry out antiinflationary politicies when needed.
The preparation of a single monetary policy also has wider implications, such as those which involve the functioning of payment and settlement systems in EU countires, the collection of money and banking statistics, the business of printing and issuing banknotes, accounting practices and rules, information systems and so on. The integration of national payment systems is a particular important objective, as it is a minimum requirement to achieve the integration of national interbank mar- kets so as to ensure that interest rate arbitrage brings about a uniform monetary stance throughout the single-currency area. For this, credit institutions must be able to rapidly transfer central bank money across borders and to achieve final settlement within the same day. With this view, the EMI has begun defining the features of a Trans-European Real Time Gross Settlement System, in short TARGET, based on a minimum harmonisation of national Real Time Gross Settlement Systems and on a common interlinking mechanism. This TARGET system will be instrumental in processing the large value payments in Stage Three and will therefore allow for ef- ficient interest rate arbitrage across the Monetary Union.
The Transition to the single monetary policy and the changeover to the single currency
Finally, I should like to share with you some current ideas about the transition to the single monetary policy and the introduction of a single European currency. It should be noted that our views as regards the scenarios for the introduction of the single currency are by no means finalised. Any decisions will have to await a thorough and systematic consultation of banks and other market participants in all the EU countries. The EMI and the national central banks intend to intensify such a dialogue in the coming months.
The Treaty identifies kwo key dates for the transition to the monetary union. The first is the date on which the decision is taken by the Heads of State or of Government to move to Stage Three, and the second is the effective date of the start of Stage Three, which is characterised by the irrevocable fixing of parities and the adoption of a single monetary policy. The Treaty is not clear about the length of time between
the interim period should last at least six months. During the interim period, im- portant decisions will have to be taken. Firstly, the members of the Executive Board of the ECB will be appointed, the ECB´s rules of procedure will be adopted, and the ECB will, of course, need premises and staff. Secondly, secondary Community legis- lation for the start of Stage Three will have to be adopted in a number of areas. Fi- nally, on the basis of the preparatory work which I outlined earlier, the Governing Council of the ECB will have to adopt the organisational framework for the conduct of the single monetary policy. The implementation of the framework should be fina- lised and it should have been tested. It is, of course, absolutely essential that the ESCB is fully operational and able to conduct monetary policy operations effectively from day one of the third stage. All in all, we expect that it will be difficult to do all of this within a period of less than twelve months.
Following the interim period, we shall enter a transitional period, usually called Stage 3A, because it will not be technically possible for the physical introduction of the ECU, or whatever the name of the single currency will be, to coincide with the start of Stage Three. After the decision to go ahead with the final stage of EMU, three to four years might elapse before the appearance of ECU banknotes. Thus, in the transitional period, national currencies will continue to be used, at least for cash transactions. The question arises of when and how the ECU should be introduced for those transactions that do not involve cash. Various scenarios are being discussed. One of these envisages a delayed introduction until all transactions can be transformed at around the same time. In another scenario the use of the single currency is phased in gradually, beginning with the monetary policy and foreign exchange policy operations of the ESCB. Between these two extremes, a number of possibilities exist, depending on the number of steps envisaged for this phasing-in and the degree of flexibility left to the public for determining the dates of each of these steps.
Let me repeat that any decisions on the scenario for the changeover to the single currency will have to await a thorough and systematic consultation of banks and
other market participants in all the EU countries. I anticipate that a number of consi- derations will play an important role. First of all, it is clear that only proper pre- parations, both technical and educational, will allow an orderly changeover and the public acceptance of the single currency. In this respect, it should also be examined whether a flexible approach based on public demands as regards the switch-over date is feasible. Secondly, authorities will have to favour an approach which stresses the irreversibility of the EMU process. Thirdly, the changeover should help the ef- ficient conduct of the single monetary policy. Fourthly, cost considerations will have to be taken into account, in particular those related to dual accounting.
