European Monetary System

typically European welfare state system should be profoundly corrected, but

not suppressed. Many also think that rather than following a "Thatcherian"

policy of cracking down on the trade unions, it would be preferable to work

with, rather than against, the labour organisations, although reform

entails occasional confrontations.

As with inflation in the 1970s and 1980s, so unemployment in the

1990s - while being a European disease - is quite diversified across

European countries and regions, due to differences in both policies and

economic situations. It is over or around 20 per cent in the Mezzogiorno

and Sachsen-Anhalt, but below 7 per cent in Lombardy and Baden-Wьrttemberg;

over 18 per cent in Spain, but less than 4 in the Netherlands.

Notwithstanding the intergovernmental debates at a European level and

the stated intention to undertake common initiatives, the instruments of

employment policy remain in national hands, although only partly in the

hands of governments. I regard this as appropriate because competition

should not be suppressed from the labour market.

Adopting the appropriate policies of structural reform has proved

extremely difficult in many key European countries, including my own and

this one. Other countries, such as the Netherlands and the United Kingdom,

have been more successful. Even the most successful experiences, however,

have shown that reducing unemployment is a long and gradual process.

Although some countries started labour market reforms in the early 1980s,

they only reaped the benefits in the 1990s.

Unemployment will thus remain with us in the years to come and I am

convinced that it should be regarded as the greatest policy challenge not

only by governments and labour organisations, but by the Eurosystem as

well. Let me explain why.

An economy in which unemployment drags above 10 per cent for years is

a sick economy, just like one in which public finances or inflation are

chronically destroying savings. To operate in a sick economy is always a

risk for the central bank and for the successful fulfilment of its primary

mission. In the case of prolonged unemployment, the risk arises both on a

functional and an institutional ground.

On a functional ground, i.e. from the point of view of the

relationship between economic variables that models usually consider, a

chronically weak economy is one in which expectations deteriorate,

investments stagnate, consumption declines. Structural unemployment may

increase the risk of a deflationary spiral because a longer expected

duration of unemployment may imply that households respond more

conservatively (in terms of increasing savings) in the face of a

deflationary shock. Today, we see no signs of deflation. Markets and

observers who pay attention to communications by the Eurosystem know that

the monetary policy strategy of the euro area is symmetrical, equally

attentive to inflation and deflation. Thus, they know that if that risk

became reality, the Eurosystem would have to act, and would act. But we

know that monetary policy is much less effective in countering deflation

than it is in countering inflation.

A more insidious threat, however, may arise on the institutional

ground. It comes from a chain of causation involving social attitudes,

economic theory and policy, actual economic developments and institutional

arrangements. Attitudes of society respond to economic situations and

policies, which in turn depend on the state of development of economics.

Institutions, on their part, are influenced by attitudes of society. Both

the course of economic thought and the practice of policy were lastingly

altered by the Great Depression. The epitome of this historical event was

the Keynesian revolution. In many countries the strong consensus about the

primacy of price stability and the independence of the central bank was the

outcome of the prolonged inflation suffered in the 1970s and 1980s. Here in

Germany, it is rooted in the experience of hyperinflation. Would such a

consensus survive if high unemployment remained a chronic feature of key

European economies for many more years? And how would the position of the

central bank change if that consensus faltered?

As central bankers primarily concerned with price stability, what can

we do to cope with this challenge and to reduce the risks? My answer may

seem disappointingly partial, as I do not think there is a miraculous

medicine that monetary policy can provide. I would phrase it as follows.

Firstly, the central banker should be aware of the danger. He should

know that in the future his principal objective may not receive, from the

public, governments and parliaments the same strong support which has been

the outcome of the two decades of high inflation. Since unemployment is

what concerns the voters and the youngsters most, it may be increasingly

necessary for him to play an educational role in explaining the benefits of

a stable currency to those who have not directly experienced the costs of

inflation. This is very much like the case of the post-war generations in

Europe which, being fortunate enough not to experience the horror of World

War II, need now to be reminded about the human costs of that terrible

conflict.

Secondly, the central banker should avoid mistakes. It may seem

obvious, but he should never forget that independence does not mean

infallibility and that the likely new environment will offer no forgiveness

for mistakes. A mistake would be the attempt to provide a substitute for

the lack of structural policies by providing unnecessary monetary stimulus:

it is not because the right medicine is neither supplied by the pharmacist

nor demanded by the patient that the wrong medicine becomes effective.

Another mistake would be to give the impression that the central bank has a

ceiling in mind for growth, rather than for inflation. On the contrary, the

central bank should make it clear that any rate of non-inflationary growth

is welcomed and would be accommodated, the higher the better.

Technically, this will not be an easy task. The analytical

uncertainty surrounding estimates of potential output and its growth rate

might lead the central banker to respond quite cautiously to evidence of

shifts in the rate of non-inflationary growth. While such caution is

certainly optimal from an inflation stabilisation point of view, it might

be wrongly interpreted as a systematic deflationary bias by the public and

the politicians. This is a clear case in which any progress made by

scholars in refining the analytical tools of the economic profession will

greatly help the central banker to achieve his goals without imposing

unnecessary costs on society at large.

On the whole, however, it is part of the central banker's role to

make the day-by-day decisions that, in the end, constitute monetary policy.

This responsibility can be neither transferred to, nor challenged by,

policy makers responsible for other areas. Last week, the Eurosystem has

made, for the first time in its life, an affirmative monetary policy

decision by lowering its official rates. In this way, the Eurosystem has

acted in line with its monetary policy strategy and made a significant

contribution towards an economic environment in which the considerable

growth potential of the euro area can be exploited in full. It is now the

responsibility of other sectors of economic policy making to do their part

by strictly adhering to the Stability and Growth Pact and implementing

decisive structural reforms.

6. MANAGING FINANCIAL TRANSFORMATIONS

The third challenge consists in accompanying and surveying the rapid

changes the European financial institutions and markets are undergoing, and

will continue to undergo over the coming years, partly - but not

exclusively - as a consequence of the euro.

It is sufficient to observe the US Federal Reserve System to

understand the role the Eurosystem should play in the coming years:

attention in monitoring changes in the financial system, active

participation in the policy debate caused by such change, intense dialogue

with both the Administration and Congress, influence exerted on opinions

and decisions.

To a large extent the factors of change are technology determined,

hence independent of the euro and even not specifically European.

Technology is the driving force of the transformation in banking and

finance that modifies the traditional deposit loan structure of banks.

Technology also reshapes dramatically the back office and the communication

with customers, thus producing massive over-branching and over-staffing in

traditional banks. Also the globalisation of finance comes primarily from

the combination of data processing and telecommunications.

Other changes are specifically European. Since universal banking has

historically prevailed in continental Europe, the change from an

institution-based to a market-based financial system is particularly

significant in this part of the world. Similarly, the development of

financial conglomerates is more pronounced in Europe than in the United

States or Japan. Typical of continental Europe are also the labour market

rigidities that make the restructuring of banks so difficult and slow.

Finally, there are changes induced by the euro. The removal of

currency specificity as a cause of national segmentation of the financial

industry is causing a convulsive shake-up of both institutions and markets.

Since the beginning of this year, about ten banks ranking near the top of

their respective national lists have concluded or started merger operations

in France, Spain, Italy, the Netherlands, Belgium and Norway. In most

European countries stock exchanges and other organised markets, which were

legally and structurally organised as providers of a public service, have

been transformed into profit-driven private institutions and are now in a

process of rapid concentration. In the coming two or three years the number

of banks will shrink, the largest banks will become much larger, few

financial centres and market networks will replace the present one-country

one-centre configuration.

In any national system the central bank would actively monitor and

even guide the course of such a transformation. It would do so along with

the various agencies responsible for financial supervision and competition

policy, and with an involvement of the executive power itself. Although

largely determined by business decisions, these developments indeed involve

the public interest in various ways.

Surveying and accompanying a profound transformation of the financial

industry would be a difficult task for any central bank. For the Eurosystem

it will represent a daunting challenge because it will put to the test an

unprecedented articulation of the policy functions that are called for. Let

me briefly explain this assertion.

The institutional setting of the euro area establishes a double

separation between central banking and other public functions. Firstly, a

functional separation, whereby banking supervision is now assigned to

institutions that - even when they are national central banks - no longer

exert independent monetary policy functions. Of this separation we have

many previous examples (Germany, Japan, Sweden, now the UK, etc.). Much

newer is a second, geographical, separation, whereby - with only the

partial exception of competition policy - the area of jurisdiction of

central banking does not coincide with the area of jurisdiction of the

other public functions involved (banking supervision, regulation of the

securities market, etc.).

Experts, including academic people, have so far focused attention on

lender-of-last-resort functions and suggested that the new setting would

not be able to act effectively in a crisis. I have argued elsewhere why

this criticism seems unjustified. Here, I would like to suggest that the

real challenge could come, in my opinion, from tensions between the

national and the euro area interest in the process of financial

transformation.

The process of industry transformation will inevitably involve

aspects that have traditionally been considered as sensitive by public

authorities: suppression of jobs, location of facilities and headquarters.

Financial transformation will also produce a hardening of competition and

competition will be, to a considerable extent, one between national

financial centers and industries, not only between individual banks or

institutions. The propensity to defend national champions may prevail over

the pursuit of efficiency. The risk for the Eurosystem to fall in the trap

of an improper interplay between the EU and the national dimension of the

public interest may become high. Like any central bank, the Eurosystem

should be both active and neutral in the great transformation of "its"

financial industry. The word "system" that is part of its own name refers,

and should apply in practice, to the whole euro area.

7. COPING WITH A LACK OF POLITICAL UNION

The fourth challenge consists in coping with the lack of a political

union. The relationship between monetary and political union and whether

the latter should be a precondition for the former has been a central issue

in the European debate well before the establishment of the Delors

Committee in 1988. While I do think that there is a lack of political union

and that this lack constitutes a serious challenge for the Eurosystem, I

also think that the expression "lack of political union" is often used in

an unclear way that blurs the issue. Let me thus first consider two

meanings of this expression with which I do not concur.

First, I do not concur with the idea that there is no political union

in Europe today. It is not because the content and the competence of the

European Union are mainly economic, that its nature and historical role are

not political. Even before the single currency, EU competence extended over

virtually the whole Corpus Iuris of economic activity, from the

establishment of "the free movement of goods, persons, services and

capital" (the four freedoms proclaimed by Article 3 of the Treaty) to

external economic relationships. To understand how very political these

issues are, it should suffice to think about the place they take in the US

political debate today, or have taken in the politics of our countries

before the creation of the European Community. Moreover, the institutional

architecture of the European Union is entirely that of a political system,

not that of an international organisation based on intergovernmental co-

operation: a legislative capacity that prevails over that of Member States,

a judicial power, a directly elected Parliament.

Second, I do not concur with the idea that Monetary Union has

developed outside the political process. Quite the contrary is true. The

establishment of a single currency in the European Union has been achieved

because of the strong political determination of elected governments over a

full decade, from June 1988 to May 1998. It is significant that during that

long period continuity has not been broken by repeated changes of political

majority in virtually all countries except Germany. Technocrats, i.e.

central bankers, have "only" played their role, crucial as it may be. They

have provided expertise, from the drafting of the blueprint to the

preparatory work for the actual start of the system. And, no less

important, they have loyally accepted the limits of their role and

recognised that the ultimate decisions have belonged to elected

politicians. This is the meaning of the two statements of July 1988 and

March 1998 with which the Bundesbank has defined its position at the

beginning and the end of the crucial decade. "In der Beschrдnkung zeigt

sich der Meister".

The establishment of a single currency is a strongly political event

in its genesis and a profound social and cultural change in its nature. As

economists and central bankers we pay limited attention to notes and coins

because they are a minor and endogenous component of the money stock. For

many politicians, however, Monetary Union meant little else than a common

banknote. They saw, better than us, that for the people money has to do

with the perception of the society to which they belong and, ultimately,

with their culture. As such, money goes well beyond the economic sphere of

human action. Indeed, the act whereby we accept to provide goods or

services to an unknown person in exchange for pieces of paper that have no

intrinsic value is perhaps the most significant and widespread testimony of

the social contract that binds people. This is why coinage and money

printing have always been a prerogative of the State.

Yet, for two main reasons it remains true that Europe has a lack of

political union. First, the European Union is still not the ultimate

provider of internal and external security, the two key functions that

constitute the raison d'кtre of the modern State. Second, EU institutions

still fail to comply with the key constitutional principles that constitute

the heritage of western democracies: foundation of the legislative and

executive functions on the popular vote, majority principle, equilibrium of

powers.

Why does the lack of political union constitute a challenge for the

Eurosystem? I would answer as follows.

In a period of less than thirty years money has abandoned both the

anchors it has had since the earliest times: metal and the sovereign. It is

true that central banks have struggled for years to free the printing press

from the influence of the modern sovereign, as they struggled in the past

to free it from the influence of private interests. It is equally true that

the present status of the Eurosystem in the constellation of public powers

is exceptionally favourable. However, only a superficial thinker could

confuse independence with solitude and take the view that the lack of

political union strengthens the position of the central bank and makes it

freer to fulfil its mission.

The security on which a sound currency assesses its role cannot be

provided exclusively by the central bank. It derives from a number of

elements that only the State or, more broadly, a political union as

previously defined, can provide. When we say that a currency is a "safe

haven" we refer not only to the quality and credibility of its central

bank, but to the solidity of the whole social, political and economic

structure to which it belongs. And historical experience shows that when

that structure appears to weaken, the currency weakens, irrespective of the

actions of the central bank. A strong currency requires a strong economy

and a strong polity, not only a competent central bank. The central bank

is, and should remain, an institution with too limited a mission to replace

the lack of a political union.

The problems posed by the coexistence of a single currency with a

still unachieved political union will influence both practical and

intellectual activity in the coming years. They will have implications for

the central banker, the politician and, more generally, the citizen. For

the politician the implication is that his political decision to move ahead

with Monetary Union in advance of political union contains an implicit

commitment to work for the completion of political union. The central

banker should be aware of the special difficulties and responsibilities

deriving from this anomalous condition. On the one hand he will have to

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