European monetary system and european currency

In connection with the use of the euro as a pegging currency, approximately 30 countries outside the euro area currently have exchange rate regimes involving the euro to a greater or lesser extent. These exchange rate regimes are: currency boards (Bosnia-Herzegovina, Bulgaria, Estonia); currencies pegged to the euro (Cyprus, FYROM [the Former Yugoslav Republic of Macedonia] and 14 African countries in which the CFA franc is the legal tender); currencies pegged to a basket of currencies including the euro, in some cases with a fluctuation band (Hungary, Iceland, Poland, Turkey, etc.); systems of managed floating in which the euro is used informally as the reference currency (Czech Republic, Slovak Republic and Slovenia); and, last but not least, European Union currencies pegged to the euro through a co-operative arrangement, namely ERM II. As you well know, Denmark and Greece joined ERM II on 1 January 1999 with a ±2.25% fluctuation band for the Danish krone and a ±15% fluctuation band for the Greek drachma. Although the euro remains in second position after the US dollar in terms of its official use, the role of the euro will increase in the future, without a doubt.

The position of the Eurosystem concerning the international role of the euro

As a general conclusion stemming from the previous analysis of the use of the euro in the world economy, we can affirm that the euro is the second most widely used currency, behind the US dollar and ahead of the Japanese yen. The private use of the euro as an investment and financing currency and its official use as a reserve, intervention and pegging currency are increasing rapidly, while it is developing at a slower pace as a payment currency in the exchange of goods and services. The use of the euro as a unit of account is linked to its use as store of value and a medium of exchange.

Taking the current situation as a starting point, the Eurosystem's position concerning the future international role of the euro is crystal clear: we shall not adopt a belligerent stance in order to force the use of the euro upon the world economy. We are convinced that the use of the euro as an international currency will come about anyway. It will happen spontaneously, slowly but inexorably, without any impulses other than those based on free will and the decisions of market participants, without any logic other than that of the market. In other words, the internationalisation of the euro is not a policy objective of the Eurosystem; it will neither be fostered nor hindered by us. The development of the euro as an international currency will be a market-driven process, a free process, which will take place, without a doubt.

Factors determining the importance of the euro in the world economy

We understand that the euro fulfils the necessary conditions to become a leading international currency with the US dollar and not against it. There is enough room for both currencies in the world economy.

The necessary conditions for a currency to become an international currency are based on two broad factors: low risk and large size. The low risk factor is related to the confidence inspired by the currency and its central bank, which in turn mainly depends on the internal and external stability of the currency. The low risk factor tends to lead to diversification among international currencies, since diversification is a means to reduce the overall risk; it acts, so to speak, as a centrifugal force. By contrast, the large size factor relates to the relative demographic economic and financial importance of the area which supports the currency; in other words, the "habitat" of the currency. The large size factor generally tends to lead to centralisation around one or several key international currencies. It can be seen as a centripetal force, as a virtuous circle, which will tend to lead to an increasing use of the euro as an international currency. Let us consider these two factors in more detail.

The stability of the currency and the credibility of the ECB

The first factor concerns low risk, credibility and stability. The stability of the euro is a priority for the ECB. Compared with the idea of stability, the strength of the euro is of lesser importance. This does not mean that the exchange rate of the euro does not constitute an element to be considered in the monetary policy strategy of the ECB. However, the basic factor that will determine the importance of the euro as a widely used currency in the world economy, in addition to the demographic, economic and financial dimensions of the euro area, is, without a doubt, the stability of the new currency, understood as a means to maintain the purchasing power of savings.

In the global economy the transmission of financial crises by means of different mechanisms (devaluations of weak currencies, subsequent increases in interest rates, etc.) is frequently mentioned. Less is said about the spillover or transmission of positive economic circumstances, such as stability. The Eurosystem will "export" stability to the rest of the world economy, and not only in the case of those countries which decide to tie their currencies, formally or otherwise, to the euro (through the ERM II or other arrangements). In a global economy the euro area cannot be an island of stability, but it can transmit its stability to the rest of the world economy as the links between regions increase.

Stability is the basic requirement for a good currency. It is what we at the ECB want for the euro. We want a stable euro, not necessarily a strong euro. In the long term the euro will derive strength from its stability.

The stability of the euro is the basis for the confidence in and the credibility of the ECB, without which a large international role for the euro would be unthinkable. Stability is the proof of the effectiveness of the institution. Yet in order to be credible it is not sufficient for the ECB to maintain stability. Other parameters of its action must be considered: accountability, transparency and communication, a Europe-wide perspective.

The conditions for the credibility of the euro are certainly demanding. However, the achievement of these conditions is the aim of all those of us who have responsibilities in relation to the operation of the Eurosystem.

The "habitat" of the euro

The second factor, which we have called the large size factor or the habitat of the euro, is important because without a certain critical mass, a currency cannot have international relevance, however high its degree of stability. In addition to quality, quantity is required, as suggested by the example of the reduced degree of international use of the Swiss franc in relation to other stable currencies, such as the US dollar or the Deutsche Mark until 1998.

The figures relating to the population and the GDP of the euro area illustrate this. With 292 million inhabitants, its population exceeds that of the United States (270 million) and that of Japan (127 million). The GDP of the euro area is, on the other hand, equal to 76% of the GDP of the United States (EUR 5,774 billion compared with EUR 7,592 billion), though it is higher than that of Japan (EUR 3,327 billion). The source of this information, which refers to 1998, is Eurostat.

However, even more important than the current figures is the potential for the future development of the euro area, in terms of population and GDP, if and when the so-called "pre-ins" (Denmark, Greece, Sweden and the United Kingdom) join the Eurosystem.

The entry of these countries would result in a monetary area of 376 million inhabitants, 39% larger than the United States and almost triple the size of Japan, with a GDP of EUR 7,495 billion, only slightly less than that of the United States and 125% higher than that of Japan.

All these facts and figures which demonstrate the demographic and economic importance of the European Union would be further strengthened by enlargement to Eastern Europe. Our continent has a historical, cultural and geographical identity - from the Iberian Peninsula to the Urals, with certain additional external territories - which, in the future, may also come to form an economic unit. However that is, for the moment, a distant prospect.

The degree of openness of an economic area is also a relevant factor as regards the international role of its currency. In this respect the euro area is more open than the United States or Japan, with a percentage of external trade of around 25.8% of GDP, compared with 19.6% for the United States and 17.9% in the case of Japan (data from Eurostat for 1997). However, a euro area consisting of the 15 countries of the European Union would be more closed, by the mere arithmetic fact that the transactions with the present pre-ins would become domestic transactions, resulting in a coefficient of openness of 19.4%, similar to that of the United States. Clearly, the size and the degree of openness are parameters that move in opposite directions: the larger the euro area, the smaller its degree of openness to other countries.

The financial dimension of the euro

The size or habitat of an economy does not only depend on demographic or economic factors; it also has to do with the financial base or dimension of the area. In considering the financial dimension of the euro area, the first relevant feature to observe is the low level of capitalisation of the stock markets in comparison with the United States and Japan. Compared with a stock market capitalisation of EUR 3,655 billion in the euro area in 1998, the United States presents a figure almost four times this amount (EUR 13,025 billion). Japan ranks third, with EUR 2,091 billion. There would be a marked difference if one were to include all 15 countries of the European Union, since the stock exchange capitalisation would increase to EUR 6,081 billion.

Although these figures could give the impression that the euro area has a relatively small financial dimension relative to its economic dimension, this is not the case. The lower degree of development of the capital markets is offset by a higher degree of banking assets. This means that the financial base of real economic activity in Europe is founded on bank intermediation, which is also a feature of the Japanese economy. For example, private domestic credit in the euro area amounts to 92.4% of GDP, while in the United States it is only 68.9%. Conversely, fixed domestic income represents 34.2% of GDP in the euro area compared with 66.1% of GDP in the United States (statistics from the International Monetary Fund and the Bank for International Settlements as at the end of 1997, taken from the Monthly Bulletin of the European Central Bank). We therefore have two distinct models of private financing which clearly have to be taken into account when assessing Europe's financial dimension compared with the United States or Japan.

The role of the euro and the eurosystem in the process of european integration

The euro as a catalyst for European integration

The euro, the Eurosystem's monetary policy and, in general, the activity of the ECB and the Eurosystem will play a key role in the integration of European financial markets and all markets in general. We can say that the euro will act as a catalyst for European economic integration.

Monetary and financial integration

The integration of the European money markets relies, of course, on the existence of a single system for refinancing the banks in the euro area, that is to say on the common monetary policy. However, it also relies technically on a system of instantaneous data transfer and on the new common payment system, TARGET, enabling real-time gross settlement. Thanks to the smooth operation of the information, communication and payment systems, a common monetary policy is realistic and the integration of the markets can take place. Such integration will, in turn, involve greater liquidity and further development of the financial markets.

A specific channel through which the monetary policy of the ECB and the TARGET system can have a direct impact on the development of the financial markets of the euro area is the requirement to have guarantees or collateral for operations with the ECB. This requirement for adequate 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?

European Economic and Monetary Union - principles and perspectives

Summary 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 Breton 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 Delores 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 honorary Professor of Johann Wolfgang Goethe-Universitдt, Frankfurt am Main, 15 April 1999

Table of contents

Introduction

1. Policy missions

2. New challenges

3. Making the eurosystem a central bank

4. Dealing with the European unemployment

5. Managing financial transformations

6. Coping with a lack of political union

Conclusion

Introduction

I participate in this Dies Academicus, at the University that carries the name of Goethe, in the town of Frankfurt, in the first year of the euro, with thoughts and emotions that are hard to conceal.

In my early youth, at the time of the decisions that determine one's life, the dearest of my Gymnasium teachers told me: "You have to resolve, in order to decide your future, the dilemma of what interests you most: whether to understand or to change the world." My choice has been Economics. And, the subject of economics being human action, I early discounted that the call for action would prevail, in my motivations, over the enquiring spirit. I did not expect how strongly that dilemma would continue to accompany my life. More importantly, I did not understand, at the time, how much acting and enquiring are complementary ways of being in the world and searching for truth, as Goethe's work and life so profoundly witness. Science changes reality; practical activity not supported by reflection and analysis is ineffective and even harmful.

If I now live in Frankfurt and am here today it is because most of my professional life was spent in an institution - the Banca d'Italia - where eminent persons like Guido Carli, Paolo Baffi and Carlo Azeglio Ciampi allowed the dilemma of my early years being kept somewhat unresolved and favoured independent analysis as a complement of practical activity. They also shared and encouraged the combination of enquiry and action that helped the euro to become a reality. To them I therefore dedicate this lecture.

Academia is the place where teaching and enquiring reinforce each other by going hand in hand. It originates from Socrates' precept that "the wisest recognises that he is in truth of no account in respect to wisdom". Teaching is assertive, enquiring interrogative. One is based on the presumption that we have answers to transmit; the other is based on the modesty imposed by unresolved questions.

The mode of the following remarks will be the interrogative, rather than the assertive one. Not only because presumption is certainly not my йtat d'esprit today, but, more importantly, because the theme of this lecture - the new challenges posed by the advent of the euro - has a distinctly intellectual dimension, not only a practical one. The success of EMU will largely depend on the ability to identify new problems at an early stage and to analyse them without prejudice. While the mission entrusted to central bankers is not new, the challenges in the years to come may indeed differ from those of the last few decades. They may be "new" either because they have not been experienced before, or because they have acquired a new dimension.

In reviewing what I consider to be, for the Eurosystem, the most important of such challenges, I shall use the academic privilege of taking a free and forward-looking perspective. My point of view will, therefore, not necessarily coincide with that of my institution. Moreover, I shall not be objective, because I shall mainly draw on the intellectual and practical experiences that have constituted my professional life.

1. Policy missions

Policy missions have not been altered by the start of the euro. They correspond to aspects of the public interest that were not redefined, and did not need a redefinition, because of the euro.

In the field of central banking the public interest is to provide economic activity with a medium of exchange that preserves its value over time. In the broader field of economic policy - of which monetary policy is part - the public interest is, to use words from the Maastricht Treaty that can be similarly found in most national constitutions and legislation, "to promote economic and social progress which is balanced and sustainable" (Article B). In the field of European integration, the mission is that of "creating an ever closer union among the people of Europe, in which decisions are taken as closely as possible to the citizen" (Article A). Finally, in the field of international relations the public interest is to "maintain international peace and security" (UN Charter Article 1.1) as well as to "contribute to the promotion and maintenance of high level of employment and real income" (Articles of Agreement of the IMF, Article 1.ii).

The formulation of these policy missions has taken shape over the course of this century, or even earlier, on the basis of experience, scholarly investigation, political debate and action. There would be no consensus about the primary mission of the central bank if countries had not experienced first hyperinflation and then successful monetary management by a stability-oriented and independent central bank. Social progress and economic growth would not be on the agenda of governments without the labour movement and the Great Depression. We would not have the EU Treaties and the Charter of the UN without the tragedy of two World Wars.

Economists have explored the scope for economic policy action, and the limits thereof, in the monetary, fiscal and regulatory fields. Without thirty years of academic debate about the role of monetary policy, the EMU Treaty and the Statute of the ESCB/ECB would not have been written the way they were. The subordination of economic policies to the principle of "an open market economy with free competition" would not have been explicitly inserted in the Maastricht Treaty (Article 3A) had those principles not gained recognition in the community of scholars.

Central bankers (most notably in the Delors Committee) have prepared the blueprint for the single currency. International and constitutional lawyers have elaborated the legal concepts and studied the procedures to carry out the policy missions. They have built that legal monument that is the Rome/Maastricht Treaty. Citizens and politicians have discussed, promoted and implemented the whole process.

Different policies carry different degrees of compulsion and effectiveness. In general, instruments are more strongly framed when they are entrusted to institutions whose area of jurisdiction coincides with that of the nation state. Strongly framed instruments, however, do not necessarily produce strong results. Tough regulation against air pollution adopted only by a small country is less effective, for that same country, than softer regulation adopted by a larger group of countries. The economic literature about externalities, or that about optimal currency areas, are seminal examples of the contribution economic research can make in this respect.

In the following I shall focus on the mission of the central banker, because this is the function assigned to me. I am convinced, however, that the missions I mentioned are fundamentally complementary. Different assignments are part of an orderly division of labour. In a democratic and market-oriented environment not only citizens, but also officials, can consider the aims of the various policy bodies and charters - national and international - to which they refer as forming a consistent configuration. I regard this as a special privilege of the time and space in which I have lived so far.

2. New challenges

In the last thirty years central bankers have fought for two objectives: the recognition of the primacy of price stability for monetary policy, and the independence of the central bank. This has been the period in which the combination of political democracy and fiduciary currency made the governance of money particularly difficult in many countries.

The intellectual recognition, then the political acceptance and finally the actual implementation of a monetary constitution based on price stability and central bank independence have required a long process. The academic profession has contributed to it in a powerful way, from Irving Fisher to Don Patinkin to Robert Lucas. Even those who have denied the need of having a central bank, like Milton Friedman and Friedrich A. von Hayek, have in the end contributed to clarify its role and function. No less persuasive have been the arguments of experience. In a positive sense, the economic success of the country - Germany - where the two elements had been introduced at an early stage. In a negative sense, the social evil of high and prolonged inflation suffered by many other countries, including my own.

In legal and institutional terms, the result of this long fight has been engraved in the Treaty of Maastricht. The Treaty represents the strongest monetary constitution ever written, not only because of its substance, but also because the procedure to amend it is more difficult than that required for the charter of any existing central bank. Largely induced by Maastricht and EMU is also the independent status of national central banks in the European Union. We should indeed not forget that, until recently, key decisions in the field of monetary policy were still in the hands of the Treasury in such countries as the United Kingdom, France, Italy and Spain. The Maastricht process has been the catalyst for monetary reforms central bankers had advocated for years.

Partly, but not exclusively, because of this process, the conditions under which the single currency has come to life differ from those prevailing in the past years.

Prices have for some time now shown the highest degree of stability seen for more than thirty years. Most countries have made significant progress towards fiscal consolidation. The consensus on sound principles of budgetary and monetary management is broader and stronger, among both politicians and ordinary people, than in any other period the present generation can remember. Few dispute in an open way the now widely used expression "culture of stability".

However, when in 1981 it was decided to save the last specimen of the smallpox virus in a laboratory for the sake of documentation, health had not ceased to be in danger. Similarly, none of these achievements can be considered as permanent and central bankers should primarily strive to preserve them. To this end, detecting new challenges at an early stage is essential. The question is: where do the problems come from? What are the circumstances under which the "old mission" will have to be accomplished in the coming years? What threatens our health besides smallpox?

3. Making the eurosystem a central bank

The first challenge consists in making the Eurosystem a central bank. It may seem simple, but is not. Let me start my explanation from the two key words of this proposition.

Eurosystem is the word chosen by the ECB to indicate the "ECB+11 participating national central banks", i.e. the central bank of the euro. The Treaty has no name for this key entity, while it refers extensively to the ESCB (European System of Central Banks) formed by the ECB and the 15 European national central banks). However, as long as there are "out" countries, the ESCB in its full composition will remain a scarcely relevant entity because it neither refers to a single currency area nor has any policy competence. Instead, the word Eurosystem indicates clearly the articulated entity which is for the euro what the Federal Reserve System is for the dollar.

Central bank is the institution in charge of the public interests associated with the currency. It originates from fundamental changes in the technology of payments: the adoption of banknotes, cheques and giros, and their final disconnection from gold. These changes have shaped the two other functions that most central banks have derived from the original payment system function: monetary policy and banking supervision. Man-made money made monetary policy possible. Commercial bank money made banking supervision necessary.

These three functions have most often been entrusted to the same institution because they are inextricably linked. Just as money has the interrelated roles of means of payment, unit of account and store of value, so central banking has a triadic function that refers to the three roles of money. Operating and supervising the payment system refers to money as a means of payment; ensuring price stability refers to money as a unit of account and a store of value; pursuing the stability of banks refers to money as a means of payment and a store of value. The function remains triadic (albeit, in my view, in a less satisfactory way) even where prudential control is entrusted to a separate agency. I am referring to the special "supervision" any central bank has over its banking community, necessitated by the fact that banks are the primary creators of money, providers of payment services, managers of the stock of savings and counterparties of central bank operations.

In performing its triadic function the central bank exerts operational and regulatory powers, interacts with other public authorities and the financial community, entertains relations with other central banks, participates in international debates and negotiations about monetary and financial matters. In all these activities it pursues and represents the public interest of a sound currency; all are instrumental to that interest. From the point of view of the perceptions of people and markets all such activities refer to that same public good that we call confidence.

For the Eurosystem the challenge is to rise to a full central banking role as just defined. It is necessary because of the links that bind the various functions of money. The Eurosystem would find it hard to play effectively its most delicate role - the pursuit of a stable currency or, as the German Constitution puts it, "die Wдhrung zu sichern" - if it appeared as an inexplicable exception to the classic paradigm of a central bank. The public, the markets, the international institutions and fora would not understand.

But it is also difficult, because the steps to take are multiple and complex from both a conceptual and a practical point of view. Moreover, they cannot all be taken at once. Let me briefly explain.

In the articulation of any federal constitution (Bund, Land and local, to use the German terminology) the central bank undoubtedly belongs to the level of the "federation", or Bund. The fact that important activities are conducted by "local" components of the system (Landeszentralbanken, or Federal Reserve District Banks) is an organisational feature that does not impinge upon the constitutional position of the central bank. The same happens within Monetary Union. The Eurosystem is the central bank of the euro area, even though operations are carried out - to the extent possible and appropriate - through its component parts, the NCBs. Indeed, the constitutional and the organisational profile of the institution are not in contradiction.

Although a federal and decentralised central bank is not a novelty, the Eurosystem is a special case. It is the central bank of an economy that has a much deeper national segmentation than any other currency area. Its components have for many generations (and until few weeks ago) performed the full range of central banking functions under their own responsibility and in a national context. They have been accountable to, and sometimes dependent on, national institutions. Public opinion has perceived, and still perceives, them as national entities. The notion of the public interest they were referring to was the notion of a national interest. Significant differences existed, and partly remain, in their tasks, organisations, statutes and cultures.

In this situation, making the Eurosystem a central bank requires drawing the appropriate distinction between being national in the organisational sense and being euro area-wide in the definition of the public interest pursued. This is a difficult distinction to draw in conceptual terms, not only in practical terms or from the point of view of personal attitudes.

In the preparatory discussions and negotiations that led to the Maastricht Treaty, central banks took the view that monetary functions are indivisible and that, contrary to the fiscal field, subsidiarity cannot apply to the monetary field. Their traditional and strongly held position has been that the public interest assigned to central bank is a whole which cannot easily be decomposed. Indeed, while there is a fairly well developed theory of fiscal federalism, there is no equivalent for the monetary field.

As I said, I do think that the functions of a central bank constitute a whole that cannot be split. This does not exclude that the Eurosystem should avoid seeking more uniformity than necessary and that some diversity is a positive factor and has always been valued as an aspect of the richness of Europe. Perhaps even a limited degree of internal competition may be used as an incentive to good performance. But can the Eurosystem depart from the two historical models of the Federal Reserve System and the Bundesbank? What are, in conceptual terms, the criteria of what I just called the "appropriate distinction"? What should be the touchstone?

It would be an illusion, I think, to expect or pretend to have a full and satisfactory answer solely from legal interpretation. And it would be unfortunate if the Eurosystem were to fall into the trap of the narrowly legalistic approach that paralyses international organisations. The Eurosystem is not an international organisation, its model is not the Articles of Agreement of the IMF. Of course, the answer will have to comply with the Treaty, which provides useful guidance. However, the system is entrusted to decision-making bodies that are composed not of lawyers, but of central bankers. They carry the primary responsibility to manage the euro and are accountable for that responsibility. They have known for years what a central bank is and how vague the wordings of central bank statutes have historically been. Their touchstone can only be, in the end, the effectiveness in the accomplishment of the basic mission embodied in the triadic paradigm of central banking functions.

4. Dealing with european unemployment

The second challenge comes from the high level of unemployment in Europe.

Every economist, observer or policy-maker would probably agree that the most serious problem for the European economy, today and in the years to come, is high unemployment. In large parts of continental Europe the economic system just seems to have lost the ability to create new jobs.

Also on the nature and causes of European unemployment there is a large degree of agreement, as there was agreement on the nature and causes of European inflation well before price stability was finally restored in the 1990s. The key words describing such agreement are structural factors and flexibility. There is agreement that perverse incentives, direct and indirect taxation of labour, unsustainable pension schemes, overly tight employment rules and rigidities throughout the economy are the main obstacles to the creation of new jobs. There is agreement that the 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.