European Union

Author: | Published: 2 Aug 2000
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Looking back on the first year of the euro, there are grounds for experiencing a sense of satisfaction. The single monetary policy started under reasonably favourable conditions inherited as a result of sound policy measures adopted in the run-up to the introduction of the euro. In addition, the Eurosystem's monetary policy strategy proved to be a valuable tool both for making monetary policy decisions and in explaining these decisions to the general public. Throughout the year, the Eurosystem was therefore able to focus on maintaining the environment of price stability, with inflation running on average at just over 1%. The fact that prices could be kept stable in the euro area is an achievement that should not be underestimated. An examination of the not too distant past should make that clear. In the past half century price stability has been the exception rather than the rule. The Eurosystem will, therefore, continue to explain the importance of its primary objective of maintaining price stability in the euro area and its monetary policy will continue to be conducted with a view to achieving this objective. There are, however, limits to the power of monetary policy. It cannot, for instance, prevent short-term fluctuations in price developments. Instead, monetary policy must focus on the medium term and be assessed from a medium-term perspective. Moreover, monetary policy needs the support of sound fiscal policies, of structural policies that aim to ensure that markets operate efficiently, as well as of responsible behaviour on the part of wage negotiators.

The Eurosystem must act as a single unit and as a truly European body, which means that decisions always need to be taken from an area-wide perspective. Monetary policy is one and indivisible; it cannot react to situations in individual countries or regions in the euro area. In any monetary union of the size of the euro area it is inevitable that inflation and other economic developments will not be completely uniform across all the countries involved. The existence of such differences, unless they exceed certain levels, should be seen as normal, as shown by the experience in other large monetary unions, such as the United States. However, should differences threaten to become too large, the policy response can only be provided nationally, by fiscal policy, structural policies and the adaptability of the markets.

In late 1998 and during the first months of 1999 the euro area economy experienced a slowdown in growth at a time when inflation was already low. The financial downturns in Asia and Russia made themselves felt in Europe. A broadly based assessment of the outlook for price developments and the risks to price stability, the second pillar of our monetary policy strategy, on balance pointed to further downward pressure on prices. The first pillar of the strategy, a prominent role for money with an analysis of monetary growth relative to its reference value, showed a rate of growth of M3 of around 5% in early 1999. This was still relatively close to the reference value of 4.5%. It seemed likely that the changeover to the euro itself had affected monetary growth in early 1999. It did not appear, therefore, that monetary developments in early 1999 implied a risk to price stability in the medium term. Thus, taking the information of both pillars together, the Governing Council of the ECB decided on 8 April to reduce the ECB's main refinancing rate by 50 basis points, to 2.5%. Following this rate cut, nominal short-term interest rates in the euro area were at historically low levels. This contributed to an environment in which the growth potential of the euro area could be exploited without endangering price stability.

In the course of 1999 downward risks to price stability receded and upward risks came to the fore, with their magnitude gradually increasing. The difference between the growth of money and its reference value continued to widen, while credit granted to the private sector grew by an annual rate in excess of 10%. The liquidity in the euro area was ample, while ECB interest rates were relatively low. All these developments were indicative of upward risks to price stability in the medium term. At the same time, upward pressures on prices came from the continued rise in oil prices and from the depreciation of the euro exchange rate in an environment where the economic outlook started to brighten up. Therefore, both pillars of the monetary policy strategy pointed to increasing risks to price stability in the medium term. On November 4 1999 the Governing Council raised the three main ECB interest rates by 50 basis points. Subsequently, on February 3 and March 16 2000, it was decided to increase these interest rates by a further 25 basis points in each case. The timing of all these moves demonstrated the forward-looking character of the Eurosystem's monetary policy; by acting before risks become reality, later sharper increases in interest rates can be avoided. Rather than nipping economic recovery in the bud, such policy measures contribute to creating one of the conditions for lasting strong economic growth. The euro is new and the ECB and the Eurosystem are young. Little more than a year has passed since the euro was introduced. The actual introduction of the euro, including the technical aspects of the process, went smoothly. The first few weeks of January 1999 saw the integration of the money markets in the euro area. The operational framework of the Eurosystem, with its use of refinancing operations, standing facilities and a minimum reserve system with an averaging provision, functioned remarkably well. Overnight interest rates were generally very stable without the need to resort to fine-tuning operations. The ECB conducted only one fine-tuning operation in early 2000 to mop up some excess liquidity after the successful transition to the year 2000.

The Eurosystem is naturally taking a keen interest in developments related to the possible expansion of the euro area. That is why developments in EU member states which have not yet adopted the euro are analysed carefully. The Eurosystem values its work with these member states in the General Council of the ECB. The Eurosystem also closely monitors the process of accession of new member states to the European Union. Ultimately, these countries have to fulfil the convergence criteria and can then adopt the euro. In this context, the Eurosystem has established contacts with the central banks in all the accession countries and is ready to contribute to the accession process within its fields of competence.

So far, I have focused mainly on the activities of the ECB and the Eurosystem. However, immediately upon its launch the euro started to have an impact on the financial sector as a whole, the euro area economy in general and the global monetary system. The euro immediately became the second most important currency at the global level. The impact of the euro is ongoing and will increase in scope in the years to come. The euro will change the euro area economy and, indeed, has already begun to do so. Existing trends in the financial sector were boosted by the launch of the euro. Generally speaking, the role of financial markets in the allocation of financial resources is growing relative to the role of financial intermediaries. The depth and liquidity of capital markets are increasing. Some segments of the capital market which had previously been underdeveloped, such as the corporate bond market, have grown significantly. In general, turnover in the financial markets was high, showing that the euro was well received.

Greater integration of the capital markets is still possible, and would be helped by measures to level the playing field further. This also applies to the creation of a single market for financial services. The Eurosystem has, for example, emphasised the fact that retail payment systems, which reduce the costs and increase the speed of cross-border payments, have to be developed for implementation no later than the date on which the euro banknotes and coins are put into circulation.

Pressures to restructure mounted in 1999, as also evidenced by high merger and acquisition activity, and not only in the financial sector. In the financial sector all types of intermediaries and institutions, from banks to stock exchanges, are affected, as are payment and securities settlement systems. Although mergers and acquisitions are often still national in character, this may well change in the future. The euro stimulates competition by enhancing transparency, and cross-border comparisons become simpler within the euro area. This has a favourable effect on the functioning of the Single Market and thereby ultimately enhances economic welfare. This process will be given a further boost by the introduction of euro banknotes and coins. The introduction of the euro also implies that differences in the quality of economic policies of countries in the euro area are more easily exposed. This should be seen as an opportunity for governments to learn from each other and to discover and adopt best practices. Structural changes in the euro area are carefully monitored and analysed by the Eurosystem, since they may have an impact on the way in which and the speed with which monetary policy measures affect the economic process and, in particular, inflation. From a more general perspective, an efficient and sound euro area financial system is important, since this also facilitates the conduct of monetary policy.

There are also some changes not directly related to the introduction of the euro which call for the attention of the Eurosystem. The development of electronic money impinges on all important central bank functions: monetary policy, the concern to maintain financial stability, banking supervision and the oversight of payment systems. The Eurosystem attaches great importance to the adoption of a sound regulatory framework for issuers of electronic money. As this Annual Report goes to press, progress has been made in this area in the European Union, but the present proposals for regulation leave room for further improvement. This concerns, in particular, provisions to ensure that only supervised credit institutions are allowed to issue significant amounts of electronic money, that the Eurosystem can extend its monetary policy instruments to issuers of electronic money, and that electronic money should always be redeemable at par value.

The transition to the new millennium turned out to be a non-event, thanks largely to the meticulous preparations in many sectors, including the financial sector and the Eurosystem. The euro got off to a good start, but making the euro and Economic and Monetary Union a success is clearly a long-term process. The Eurosystem will play its part in endeavouring to ensure that success. Work in all the areas mentioned above, and in others, will continue this year and beyond, with a view to further establishing the euro and the Eurosystem, its infrastructure and its policy framework.

The economy of the euro area is now entering a crucial phase. A golden opportunity to achieve substantial reductions in the level of unemployment throughout the euro area and to revitalise the economy is arising, now that economic growth is accelerating in a climate of price stability. This opportunity can only be seized if policy-makers make the right choices and the private sector is confident about the future and thus dares to take initiatives. Firmly focusing on maintaining price stability in the medium term is the best contribution monetary policy can make to reducing unemployment. At the same time, this would further enhance the credibility of the Eurosystem and boost the confidence of citizens that their currency, the euro, will retain its value over time. In line with the Stability and Growth Pact, budgetary authorities should reduce their budget deficits to close to balance, or even create surpluses. Governments should translate their intentions to undertake structural reforms enabling markets to operate more flexibly into deeds and build on the measures which they have already taken. In wage negotiations social partners should take into account the importance of maintaining price stability, the growth of productivity, the need to reduce unemployment and the fact that different local circumstances require differentiated wage developments; we should all consider the future as offering opportunities to bring welfare to European citizens; we should all seize these opportunities, thereby fostering Europe's development into a dynamic force in the world economy.

This article was taken from the ECB's Annual Report, available at