Euro Business Seminars in Australia and New Zealand
"The EURO -Success or Failure"
ANA
HARBOUR GRAND HOTEL, SYDNEY
Dr.
JUERGEN KROEGER, EUROPEAN COMMISSION
THURSDAY 15 AUGUST 2002
Dr Kroeger's powerpoint
presentation
HE Mr
MAZZOCCHI: I will now introduce Dr
Juergen Kroeger from the European Commission. The institutions
of the European Union are structured in a way that the European
Commission, to which I belong, and Dr Kroeger belongs, is
the body which makes proposals to ministers. Ministers in
the Council decide and then the European Commission implements
them somehow. It is also the executive body. Then you have
on the side somehow, the European Central Bank, which is the
independent body charged with the development of monetary
policy and the management of the exchange rate. Without any
further delay, here is Dr Kroeger.
DR KROEGER:
Good morning, gentlemen. My topic this morning is "Has
EMU worked?". That does not mean, as it may be, European Monetary
Union, the interpretation which I hear more and more. Europe
consists of more than 30 countries and the EMU, for the time
being, comprises 12 countries. In the new era of the economy
and monetary policy, why put so much emphasis on this? Well,
EMU, to my mind, cannot be understood before knowing what
the economic union is about. They are interrelated. The economic
union reflects more than 40 years of economic integration
of the EU countries. The main element of the economic union
is free trade in goods and services. In the 1980s, the EU
engaged in the organization of capital movement. Afterwards,
the Single Market project brought about harmonisation of standards,
for example, in environment and health. There is a large degree
of harmonization in the area of state aids.
The same
competition rules prevail in all countries, but there is no
discrimination of corporations between countries. Also public
procurements have to be tendered Union-wide. More recently,
the Union engaged in cross-border consolidation, for example,
in telecommunication traffic and IT provisions. From a forward-looking
perspective, we are now trying to achieve a truly integrated
financial market.
After these achievements it was felt that
that the Single Market would not work without a monetary union.
The slogan was, after all, "one market - one money". Why?
Because in the 1990s we still had drastic devaluations, for
example in 1995 and 1996. The Italian depreciation of 20%
distorted cross-border trade in particular in neighbouring
countries. So, the EMU countries engaged in the Maastricht
process. This meant the EMU could not be achieved without
conditions, as manifested in the so-called Maastricht criteria.
The country wanting to participate in EMU had to deliver in
terms of low inflation, low budget deficits, low long-term
interest rates, which meant markets did not attach a risk
premium to the country concerned, and a certain stability
in the exchange rate.
EMU started
in 1999 with eleven Member States. Greece joined later. Although
notes and coins were distributed only at the beginning of
this year, monetary union itself started three and a half
years ago. At that time, in the 1990s, many critical voices
were raised as to the ability and success of the project by
'serious' economists. Let me quote some which could provide
the benchmark for assessing the success afterwards.
First,
doubts were raised about the functioning of the economic policy
coordination. How could it work that an area had a single
monetary policy, implemented by an independent central bank
while other policies, in particular budgetary and structural
policies, remained the responsibility of the individual Member
States? What about monetary policy itself? Would it not be
subject to pressure from national interests? Would the big
countries dominate the monetary policy stance?
Second, would sound budgetary policies
continue to prevail in the EMU or would Member States seize
the opportunity to expand deficits since the risks of being
punished by financial markets would be lower than if they
acted alone? This, of course, would have meant negative externalities
for the other countries and that could have created political
tensions.
Third, what about the consensus on low
inflation? Many countries did not have a tradition of low
inflation. Maybe there could have been a demonstration effect
of wages. Low-wage countries catching up with the high wage
countries, creating inflationary pressures for the area as
a whole?
Fourth,
what about the ECB? It would have been a new institution and
in order to establish credibility, the young ECB could have
pursued a too-tight monetary policy in order to create this
credibility. Last, EMU's do not fly in Australia, why should
it fly in Europe?
Let us
look at the achievements. This graph shows the achievement
in terms of economic growth. The US/Euro comparison shows
that the widely held- perception that European growth was
very low does not hold. It holds mainly for Germany, but not
for the EU area as a whole.
In the
first two years, growth in the EU area was above potential.
In 2001, of course, Europe was hit by the worldwide economic
slowdown. Nevertheless, the growth performance in Europe was
not bad. In terms of job creation, six million jobs were created
in the first three years of the EMU and the unemployment rate,
though still very high, climbed three percentage points to
8.%3. However, as employment creation was positive, productivity
growth was much lower than in the US. Of course, in the long-term,
this is not a very good feature.
What about the creation of inflation?
At first sight it looks as though the target of the ECB,
to remain below the 2% ceiling, has not been achieved. It
was missed for half of the period. Was this a failure of monetary
policy? I would say no. Why? Because there was no domestically-produced
inflation pressure for the EU area as a whole. Wages behaved
in a stability-oriented way, orientated towards domestic productivity
developments. Inflationary pressures were due to a series
of temporary shocks, oil price increases, seasonal food prices
in Europe rose dramatically and of course there was also the
impact of the depreciation of the Euro.
In perspective,
the performance was extraordinarily good. You have to go back
to the 1960s in order to get such a low inflation rate for
a five-year period. The BundesBank in Germany over a long
period never had an inflation record of 2% for 25 or 30 years
average; the inflation rate was nearer to 4% than 2%.
What about
the exchange rate? Yes, there has been quite a dramatic depreciation
from the beginning - 25% or more. However, exchange rate developments
are always difficult to explain. Nevertheless, you can find
some reasons why this depreciation took place. Maybe the starting
level was too high because the technical cooperation of the
EMU impressed financial markets.
In 2000
and 20001 there was a sequence of upward revisions in growth
prospects for the United States. The new economy was favouring
the US. With a higher share of ICT production and faster implementation
of new technology, the rate of return was expected to be very
high in the US. There were substantive capital flows because
of mergers and acquisitions and there was also some need for
portfolio redistribution, because after EMU, the domestic
portfolios were biased towards Euros.
If you
had a portfolio which was distributed between Franc, Deutschmark,
and Italian lira, and it suddenly became only Euros, you might
have thought that some foreign currencies in your portfolio
would be advantageous.
Finally,
euro notes and coins were not yet in circulation and of course
monetary union is difficult to understand for many without
having cash in the pockets. Since then, economic fundamentals
in the US have weakened and the Euro has appreciated by 20%.
What about
policies? The fear that the EMU Member States would use the
opportunity to expand without the risk of punishment, did
not eventuate. In 1995, there was quite an unbalanced situation
as regard to fiscal policies. The deficit was 5.1% of GDP.
There was an improvement of 2.2% in the wake of the convergence
process towards 1998.
Since then, the Euro area as a whole has
showed very positive performance. I admit that the graph is
a little too rosy. It is based on our spring forecast. In
2002, the estimated growth rate of 1.4% will not be achieved
because of the global economic slowdown. Of course, in individual
countries we see some slippages in terms of budgetary rigour
because some countries are planning cuts. Portugal now has
an excessive deficit in 2001.
What about
monetary policy? The ECB altered interest rates 12 times in
three years. Not many central banks react so proactively.
In 1999,
there was productive news on the inflation front and uncertain
prospects in the wake of the south-east Asian crisis, and
the Russian and Brazilian developments. The ECCB reacted promptly
by reducing interest rates.
In 2000,
price expectations went up. The EBC reversed the trend. However,
in 2001 - I think this is a most remarkable development -
the ECB reduced interest rates, despite inflation being above
the target level of 2%, and monetary growth was rapid. All
in all, summary indicators show that the monetary stance in
the first three years was quite accommodating.
Let me
dwell finally on an issue where the European Commission has
particular responsibility. This is country-specific surveillance.
The question
here is, Has a policy mix which was appropriate for the Euro
area as a whole also been appropriate at an individual country
level? At the outset of EMU, there were quite important cyclical
differences as countries which formerly had high interest
rates experienced very easy monetary conditions as interest
rates were reduced to the German level.
As a consequence, there was some overheating
in some peripheral countries. Meanwhile, the cyclical conditions
converged. However, there are still some differences in the
inflationary performance. To some extent such inflation differences
will be with us in the future and they may be justified,
because they may reflect catching-up dynamics. They may reflect
price level adjustments in the more competitive environment
of the euro area. The price transparency is very obvious.
Or the function cyclical stabilisers or shock absorbers in
case individual countries are hit by asymmetric shocks.
However,
the striking fact in the EMU is that high inflation rates
render monetary conditions more expansionary. Higher inflation
rates mean lower real interest rates. This is known as the
Sir Alan Walters critique. I think it this is a very serious
phenomenon. The threat is that overheating can to too far
for the country causing it to lose competitiveness. So far
we cannot detect any serious threat of loss of competitiveness
in the Euro area except perhaps in the case of Portugal. However,
if adjustments do become necessary in the EMU, in the Euro
area, they can only come about by weight adjustments or by
higher productivity growth. This is why more flexible labour
markets and more structural reform are vital elements for
the successful working of EMU.
In conclusion,
in macroeconomic terms, the first three years of the EMU were
successful, with low inflation, stable fiscal performances
and appropriate monetary policy. Policies put emphasis on
structural reform.
Second,
none of the previous expected fears has actually been realised.
Third,
the policy coordination framework has been on an upward learning
curve and we expect this to continue. The economic and monetary
union I think is the first EMU that flies, at least in Europe.
Thank you
very much.
ENDS
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