European Monetary System

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

bonds. This will contribute to reducing the financing costs for private

companies, and it will provide improved opportunities for investors.

Monetary Union provides much needed assurance of exchange rate

stability for exporters, importers and investors. This is particularly

important for small and open economies. In fact, most countries in Europe

are to be considered small in the current global perspective. The active

use of the exchange rate as a tool of economic policy could be an

alternative for a large reserve-currency country. For a small country,

experience has shown that large changes in the exchange rate tend to give

rise to higher costs rather than benefits, due to the harmful effects on

expectations and higher interest rates.

Some of the economic effects of the Monetary Union may partially

benefit also the countries remaining outside Monetary Union. Nevertheless,

it is important for the "out" countries, to assess whether they find that

the benefits of maintaining a national monetary policy "autonomy" - if

there is any such autonomy in an integrated and globalised market situation

- outweigh the possible drawbacks of not being able to fully draw on the

credibility of the euro area, the integration of the euro area financial

markets, lower transaction costs, improved price transparency and increased

competition.

The euro and the Nordic countries

The Nordic countries have chosen to organise their monetary policy

ties to the euro area in very different ways: Finland is the only Nordic

country taking part in Monetary Union as from the start of Stage Three;

Denmark negotiated an opt-out from Monetary Union but follows a fixed

exchange rate policy vis-а-vis the euro within the new Exchange Rate

Mechanism (ERM II); Sweden decided not to participate in Monetary Union

from the start of Stage Three, without having a formal opt-out and the

Swedish krona still floats freely against the euro; and Norway and Iceland

remain outside the EU altogether.

The divergent approaches taken by the Nordic countries as regards one

of the most important economic and political projects in Europe in modern

times are somewhat strange in view of their traditionally close cultural,

historical, political and economic ties. Nordic co-operation has always

been very important and close. I note with satisfaction that the public

opinions in Denmark and Sweden now seem to be swinging in a more favourable

direction with regard to future membership. Maybe the successful

implementation of the euro has made the public understand that Monetary

Union is aimed at ensuring long-term stability in Europe. In this context,

the recent signals from the Government of the United Kingdom in favour of

membership in the Monetary Union are also very encouraging.

Personally, I think that it would be beneficial to all Nordic

countries - and the United Kingdom - to join Monetary Union within the not

too distant future. I hope that Sweden and Denmark can become members

already before the introduction of the euro banknotes and coins in 2002.

It is important for these countries to also assess the political

aspects of remaining outside Monetary Union. Experience has shown that EU

Member States which have taken initiatives and worked constructively

towards European integration have been generally more successful in gaining

influence than those less committed to the project. In this respect, it

should be noted that the aim of the Maastricht Treaty is clearly to

establish a Monetary Union comprising all EU Member States.

Personally, I also think that the Nordic countries could provide a

fruitful joint contribution to the long-term success of Monetary Union.

There is no need to overemphasise the role of small countries in this

process, but it is clear that co-ordinated views by a group of small

countries would have a larger influence than the views of individual

countries. One of the benefits of the Nordic countries - and small

countries in general - is that they are seldom bound to their old

traditional system. In contrast, they typically fight for efficient

solutions which would be in the interest of the whole of the euro area.

Concluding remarks

The project to establish European Economic and Monetary Union was

carefully prepared and based on very strong political commitment. It has

contributed to the co-ordination of economic policies - even in a wider

sense - in an environment of deregulated financial markets and the free

flow of capital. The stability arguments behind the introduction of the

euro have been so well accepted that we are already seeing serious and

visible efforts aimed at the next step towards a global "single currency"

through the establishment of exchange rate co-ordination between the euro,

the US dollar and the Japanese yen. In order for any such world-wide

currency co-ordination to become successful, there would be a need for

political commitment to globally harmonising fiscal, monetary and

structural policies. In this context, I would advise realism, caution and a

gradual approach in spite of the longer-term ideal goal of global

stability. There are still many challenges and adjustments ahead within the

euro area before any world-wide steps should be considered. Our first

priority is to ensure long-term stability in the euro area economies under

the single monetary policy and on the hope that the euro area will soon

cover all EU countries.

***

Eurosystem: new challenges for old missions

Inaugural Lecture by Tommaso Padoa-Schioppa,

Member of the Executive Board of the European Central Bank,

on the occasion of his appointment as

1999\GERMAN COFFEE COMPANY ORGANIZES THE PROMOTION CAMPAIGN IN

ST.DOCЦюй±%€ѕ[pic]

А- -#"+ !-+ 1999\GERMhonorary Professor of Johann Wolfgang Goethe-

Universitдt,

Frankfurt am Main, 15 April 1999

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