European Monetary System

governors of the national central banks (NCBs) of the Member States which

have introduced the euro. These 17 people meet every fortnight at the ECB,

in Frankfurt am Main. Decision-making on monetary policy is fully

centralised. All members of the Governing Council have one vote, whether

they come from Germany or Luxembourg. This is because of an important

principle. They are not representing their country, but are obliged to take

decisions on the basis of euro area-wide considerations. Regional or

national monetary policy does not and cannot exist in the euro area. There

is only one, single monetary policy for the euro area as a whole.

Therefore, the ECB should develop into a truly European institution. This

is a process that will inevitably take some time, but my feeling is that we

are already making good progress.

The execution of monetary policy is to a great extent decentralised.

It is in large part carried out by the NCBs. The ECB and the 11 NCBs

together are referred to as the Eurosystem. If we refer to the ECB and the

15 NCBs of all EU Member States, we speak of the European System of Central

Banks (ESCB). The General Council of the ECB meets quarterly and comprises

the President and Vice-President of the ECB and the 15 governors of the

NCBs of all the EU Member States. This body does not make decisions on

monetary policy, but discusses issues concerning the relationship between

the "ins" and the countries I prefer to call "pre-ins", such as exchange

rate issues. The third decision-making body of the ECB is the Executive

Board of the ECB, comprising the six executive directors of the ECB. The

Executive Board is responsible for current business and the implementation

of monetary policy as decided by the Governing Council. The staff of the

ECB will, in the course of this year, reach a level of between 750 and 800

and is likely to grow further in the years ahead.

The ECB is one of the most, if not the most, independent central bank

in the world. Its independence and that of the participating national

central banks are firmly enshrined in the Maastricht Treaty. Members of the

Governing Council are not allowed to take or seek instructions from

anybody, politicians included. Politicians are not allowed to give such

instructions. Members of the Governing Council have a term of office of at

least five years. The ECB is financially independent.

The independent status of the ECB fits into the recent world-wide

trend of granting independence to central banks. This tendency is evidenced

by both practical experience and academic research. By shielding monetary

policy decisions from political interference, price stability can be

maintained without having to give up economic growth. Indeed, in that sense

having an independent central bank is a good thing for all concerned. The

reason for central bank independence is that monetary policy-making under

the influence of politicians tends to focus too much on short-term

considerations. This can easily lead to temporary, non-sustainable

increases in growth, but inevitably results in lasting increases in

inflation with no lasting gains in growth and employment at all.

Politicians all over the world have come to realise this and have decided

to remove the temptation to pursue short-term gains and to make their

central bank independent. It should be underlined that granting this

independence is, as it should be, a political decision. An independent

central bank needs a clear legal mandate.

4. The monetary policy strategy

The ECB has, as I mentioned earlier, such a mandate. However, the

Treaty does not specify how the ECB should pursue its primary objective of

maintaining price stability; in other words: it is silent on what is called

the monetary policy strategy. The ECB therefore formulated its strategy in

the second half of last year. That was no easy task. The introduction of

the euro constitutes a structural break, which may change the behaviour of

firms and individuals and make it less predictable. To a certain extent it

is comparable to what Poland experienced when it embarked on its reform

process. The rules of the game change and this makes policy-making more

complicated. Our monetary policy strategy has taken these specific

circumstances into account. It is tailored to this unique period of the

introduction of the euro, although it has elements of both monetary

targeting and inflation targeting.

In the context of this strategy the ECB has provided a quantitative

definition of price stability. Price stability is defined as a year-on-year

increase in the harmonised index of consumer prices (HICP) of below 2% for

the euro area as a whole. Price stability is to be maintained in the medium

term.

The strategy consists of two pillars. The first pillar is a prominent

role for money. Ultimately, inflation is a monetary phenomenon. It is in

the end result of too much money chasing too few goods. Therefore, we have

formulated a reference value for the growth of a broad monetary aggregate,

M3, of 4 Ѕ% on an annual basis. Growth of the money stock at this pace

would provide the economy with sufficient liquidity for growth in activity

in line with trend growth, without inflation. At the end of this year this

figure will be reviewed. It should be emphasised that we did not define a

target for money growth. The reason for this is the structural break that

the introduction of the euro creates. By calling this a reference value, it

is made clear that money is one variable which we look at very carefully in

order to examine whether inflationary or deflationary pressures are tending

to emerge. We do not, however, react mechanistically to changes in money

growth.

The formulation of the second pillar is also prompted by the

potential changes in economic behaviour on account of the introduction of

the euro. It is a broadly based assessment of the outlook for price

developments on the basis of an analysis of monetary, financial and

economic developments. In this context interest rates, the yield curve,

wage developments, public finance, the output gap, surveys of economic

sentiment and many other indicators are analysed. Use is also made of

forecasts produced by other bodies and internally for inflation and other

economic variables.

This brings me to the role of the exchange rate of the euro in our

strategy. Since our primary objective is price stability and since the euro

area as a whole is a relatively closed economy with an export share of 14%

of gross domestic product, we do not have a target for the exchange rate of

the euro, for example, against the US dollar. This does not mean, and it is

good to underline this once more, that the ECB is indifferent to the

external value of the euro or even neglects it. The external value of the

euro is one of the indicators we look at in the broadly based assessment of

the outlook for price developments. Within that framework, we constantly

monitor exchange rate developments, analyse them and shall act on them, if

and when this becomes necessary. However, such action will never be

mechanistic, nor will it be isolated. The external value of the euro and

its development are analysed and considered in the context of other

indicators of future price developments. The ECB also tries to assess

international confidence in the still very young euro. Of course, the level

of international confidence in the euro is not the only factor determining

its external value, nor is the exchange rate the only indicator of

confidence in the euro. It is, for instance, encouraging to see how the

euro has been received on the international money and capital markets. I am

sure that an internally stable euro will also strongly underpin

international confidence in this currency, as it has for other currencies

in the past.

As the currency of a very large area, the issue of the international

role of the euro naturally arises. The ECB takes a neutral stance regarding

this role. It will neither be stimulated, nor hindered. On the one hand, an

international currency has advantages for citizens in the euro area, on the

other, it may sometimes complicate the conduct of monetary policy when a

large amount of euro is circulating outside the euro area. We shall leave

the development of the international role of the euro to market

participants and market forces. If history is a guide as to what will

happen, there will be a gradual process whereby the euro will have an

increasingly international role. Such a gradual development would also be a

welcome development, if only to prevent the euro from becoming too strong

externally at some point in time. It is likely and understandable that

interest in the euro is already considerable in those countries aspiring to

join the EU, including Poland. I shall elaborate on this issue at the end

of my speech.

Coming back to our monetary policy strategy, I should like to point

out that it is important to make clear what monetary policy can and cannot

do. Monetary policy can maintain price stability, but only in the medium

term. In the short term prices are also influenced by non-monetary

developments. Moreover, monetary policy measures only have an impact on

prices with long, variable and not entirely predictable time-lags of

between 1.5 and 2 years. Therefore, monetary policy-making should have a

forward-looking character. Today's inflation is the result of past policy

measures, and current policy measures only affect future inflation. The

uncertainty of the economic process in a market economy is another reason

for policy-makers to be modest. The ECB does not pursue an activist policy.

Precise steering of the business cycle or a cyclically-oriented monetary

policy are not feasible and are likely to destabilise rather than stabilise

the economy. Some commentators have interpreted our recent interest rate

reduction as a change to a more cyclically-oriented monetary policy

strategy. This is not true. Our strategy was, is and shall remain medium

term-oriented and firmly focused on maintaining the price stability which

currently prevails in the euro area.

Monetary policy should be supported by sound budgetary policies and

wage developments in line with productivity growth and taking into account

the objective of price stability. Otherwise, price stability can only be

maintained at a high cost in terms of lost output and employment. This also

explains why independence should not mean isolation. It is important to

have a regular exchange of information and views with other policy-makers.

The Maastricht Treaty stipulates that the President of the ECB is invited

to meetings of the EU Council meeting in the composition of the Ministers

of Economy and Finance whenever there are issues on the agenda which are

relevant to the ECB's tasks. The President of the Council of Ministers and

a member of the European Commission may attend meetings of the Governing

Council, although they do not have the right to vote. The President of the

Council of Ministers may submit motions for deliberation. Apart from these

formal contacts, there are many informal contacts, for example in the

context of the so-called Euro-11 group of finance ministers from the euro

area countries. I regularly attend meetings of this group.

Monetary policy cannot be used to solve structural problems, such as

the unacceptably high level of unemployment in the euro area. Structural

problems call for structural solutions, in this case measures targeted at

making labour and product markets work more flexibly. The best contribution

the ECB's monetary policy can make in this context is to maintain price

stability. In this way one of the conditions for sustainable growth in

incomes and employment is created. As important as this is, it should be

realised that jobs are created by firms which are confident about the

future and not by central banks.

5. Accountability and transparency

Accountability for policies is the logical complement to independence

in a democratic society. The Maastricht Treaty includes a number of

provisions in this respect. First, there is the mandate to pursue price

stability. This provides a qualitative measure against which the ECB's

performance can be measured. As I have already mentioned, we have decided

to enhance this by providing a quantitative definition of price stability.

One of the aims of publishing our monetary policy strategy is to make our

policy decisions transparent.

The ECB has to publish an annual report in which, inter alia, the

monetary policy of the previous and current year are discussed. I present

this Annual Report to the EU Council and to the European Parliament, which

may hold a general debate on the basis of it. The President and other

members of the Executive Board of the ECB may be heard by the competent

committees of the European Parliament. I have agreed to appear before the

European Parliament at least four times a year. The ECB has to report on

its activities at least quarterly. It has been decided to go beyond this

requirement and to publish a monthly bulletin.

It is my view that the main way to achieve accountability is through

being transparent and open. In passing, I should like to note that

transparency also enhances the effectiveness of a central bank. The better

it is understood, the more successful a central bank is. Apart from the

activities I have already mentioned, transparency is achieved in several

ways. Every month, after the first meeting of the Governing Council, the

Vice-President and I give a press conference. I start the conference with a

comprehensive introductory statement, in which I explain the decisions

taken by the Governing Council and the underlying analysis and arguments

for and against. This introductory statement is published immediately on

the ECB's Internet Web site. This is followed by a question and answer

session attended by several hundred journalists. The questions and answers

are also published on the Internet shortly afterwards. All the members of

the Governing Council frequently make speeches, give interviews and

contribute to journals and books. Thousands of people visit the ECB and the

national central banks each year and, for our part, we and our staff attend

many conferences and other public events.

6. EU enlargement

The European integration process continues. The euro should be made a

success. I have already explained how we have started the process of doing

that. Some observers have criticised the EU for its "obsession with its own

internal dynamics", in particular in the context of European Economic and

Monetary Union (EMU). With all energies focused on meeting the convergence

criteria and the preparation for the launch of the euro, Europeans outside

the EU have wondered whether EMU and enlargement are not mutually exclusive

objectives.

Let me briefly comment on this issue. After the historic decision to

complete the European Single Market in the 1980s, it was felt that economic

integration should not stop at that point. To fully reap the rewards of

economic integration within the Community, a single currency was felt

necessary; a logic pointedly encapsulated in the title of one report: "One

market, one money".

Hence, the underlying idea of EMU was to advance European integration

and to ensure that full use would be made of the economic potential of the

Single Market. This idea continues to be the focus of European policy-

makers, as evidenced by the association agreements and the ongoing

accession negotiations with a number of European countries, Poland among

them. Good and mutually beneficial economic relations with third countries

in Europe and further afield are a pillar of EU policy orientation.

Recognising this, the principles of an open market economy with free

competition are enshrined in the Treaty on European Union. EMU will not

weaken this commitment, but rather reinforce it. Closer co-operation in

Europe and the respect of common principles in the political, economic and

social fields are likely to form the basis for further integration. The ECB

shall contribute to this process within the scope of its responsibility.

Countries wishing to deepen their monetary co-operation to the

ultimate extent possible by forming a monetary union will have to adapt

their economic and legal systems to the standards required by the Treaty

and aim at a sufficient degree of economic convergence. In the absence of

these conditions, adjustment costs for both current and new participants

could be high. Any premature decision on the adoption of the euro could

have severe repercussions on a country's competitiveness and trigger

painful economic adjustments. Therefore, implementation of the necessary

institutional reforms and of a sufficient degree of convergence should not

be considered as an obstacle preventing further integration in Europe, but

rather as an essential means of ensuring the lasting success of EMU, for

existing and new participants alike. Looking at the impressive progress

made in a relatively short time in this country, there is no reason to be

pessimistic about Poland's chances of meeting these standards and

convergence criteria. I shall not venture, however, to predict when this

will be the case.

Even at the current juncture, though, EMU in one part of Europe is

already having an impact on the whole region. Let me briefly mention two

aspects:

* If the euro emerges, as I believe it will, as a strong and

stable currency, it will provide the countries in the region

with an important reference currency, an anchor towards

which, should the intention arise, monetary policy could

credibly be oriented.

* Furthermore, EMU is set to bring about the development of a

truly unified European financial market, close to that of

the United States in depth and sophistication. The

competitive pressures of this euro area financial market

will create more favourable financing conditions for

borrowers. A number of central and eastern European

countries have already successfully tapped this market.

In view of these effects, it is altogether natural that the ECB has

started to follow with great interest economic and financial developments

in the wider Europe, particularly in those countries which have applied for

EU membership. Moreover, the ECB monitors closely the exchange rate

developments with those countries which have established some form of

exchange rate link to the euro.

The euro has the potential to become more than just a new currency

for almost 300 million people in 11 countries. It may also become a

unifying symbol, standing for all that the peoples of Europe have in

common. Consequently, the public perception of the euro could endow the

single currency with a role in the European integration process reaching

beyond monetary policy in the strict sense. May the euro contribute to the

establishment of what the preamble to the Treaty Establishing the European

Community calls: "an ever closer union among the peoples of Europe".

***

The single European monetary policy

Speech by Willem F. Duisenberg

President of the European Central Bank

at the University of Hohenheim

on 9 February 1999, in Hohenheim, Germany

Ladies and gentlemen, The single European monetary policy has been a

reality for a little more than five weeks. After years of intensive

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