European monetary system and european currency

3.2 Standing facilities

The ECB will operate two overnight standing facilities, which will be available to all credit institutions at national central banks of the euro area, provided that, when using the marginal lending facility, they have sufficient collateral. The rate of the marginal lending facility will constitute the upper bound of collateralised overnight money market rates. The deposit facility will be remunerated at a rate that will constitute the lower bound of overnight money market rates.

When using the marginal lending facility, or, for that matter, when entering in liquidity-providing open market operations in the form of reverse transactions, counterparties have to post assets with their national central bank (or the ECB in the exceptional case when the ECB conducts fine tuning operations on its own account). These assets are meant to act as guarantees for credits received from the European System of Central Banks. A list of eligible assets has been drawn up for this purpose. The list comprises a wide variety of assets and has two sub-sets. First, the so-called tier one assets, which are selected by the ECB according to uniform criteria relating to their credit standing in the whole euro area. Second, the so-called tier two assets, which have been selected by the ECB because they are of particular importance for certain national banking systems of the euro area, in order to promote a certain degree of continuity at the start of the Stage Three of EMU. Two principles of equal treatment are applied, however. First, the credit standing of tier two assets is as high as that of tier one assets. Second, both tier one and tier two assets may be used by any credit institution in the euro area, irrespective of its location.

In addition, a set of risk control measures has been elaborated to ensure that, for any counterparty, the amount of assets provided is always sufficient. Risk control measures cover the assets' price and credit risks, taking account of the asset type, its characteristics and the maturity of the transaction. The ECB's risk control measures have been elaborated with careful attention to the best market practices in this area. They include the deduction of haircuts from the assets and the imposition of initial margins to the credit amount. Another feature of the risk control framework is the regular revaluations of the assets, which will, in most cases, take place daily and may trigger margin calls, most often to be settled through delivery of additional assets.

3.3 Minimum reserve system

The ECB will also apply a minimum reserve system to credit institutions of the euro area. Two main monetary policy objectives have been assigned to the minimum reserve system. The first objective is to stabilise money market interest rates through the averaging mechanism, whereby the fulfilment of minimum reserve requirements is based on average reserve holdings over monthly periods of time. During the maintenance period, this allows the banking system to absorb liquidity shocks. The reduced volatility of money market rates will reduce the need for frequent fine tuning operations, which will mean that markets are less distorted by central bank interventions than they would otherwise be. The second objective of the minimum reserve system is to enlarge the demand for central bank money, so as to enlarge the liquidity deficit of the banking system vis-а-vis the ESCB. This will safeguard the role of the European System of Central Banks as a provider of liquidity to the banking system.

Reserve requirements will be calculated by applying a reserve ratio of 1.5% to 2.5% to the deposits, debt securities and money market paper issued by credit institutions, except for residual maturities above two years. Although repurchase agreements are included in the reserve base, they will be subject to a zero reserve ratio. Inter-bank liabilities and liabilities vis-а-vis the ESCB will not be subject to reserve requirements. An allowance of the order of E 100,000 will be deducted from reserve requirements, so that credit institutions with a small reserve base will not have to hold minimum reserves.

Reserve holdings will be remunerated up to the required reserve level, at the rate of the main refinancing operation (as averaged over a month). It may be argued that a less than full remuneration of minimum reserves would increase the interest rate elasticity of central bank money demand. This notwithstanding, the ECB has decided in favour of a full remuneration of minimum reserves in view of the distortion to efficient markets that a less than full remuneration would have implied. As a result of the full remuneration of minimum reserves, the European Central Bank has also decided not to exempt any credit institution from the minimum reserve system.

3.4 Procedures

The ECB will have many counterparties and be subject to close public scrutiny. It has therefore set up procedures for informing its counterparties and the public about its monetary policy instruments in a robust and transparent manner.

The ECB will inform its counterparties and the public through a document detailing its monetary policy instruments and procedures and through the regular publication of various materials on its Internet site.

3.5 General Documentation

The ECB has produced a document describing its monetary policy instruments and procedures in detail. This is called "General Documentation on ESCB Monetary Policy Instruments and Procedures". A revised version of this document was published recently. This revised version includes all the newly specified elements of the monetary policy framework of the ECB, including for instance the minimum reserve system. This document also includes a calendar for the standard tender operations in 1999 (both main refinancing and longer term refinancing operations). Calendars of standard tender operations will be published by the ECB every year.

3.6 Publications on the ECB's Internet site

The list of assets that are eligible as guarantees for liquidity providing operations will be made public on the Internet site of the ECB. The list will be updated on a weekly basis and users will be able to subscribe to an e-mailing facility for receiving certain designated parts of the list on a regular basis. Users will also be able to query the list, which will contain a large number of assets.

The list of institutions subject to minimum reserves, that is, credit institutions established in the euro area, will also be available on the Internet site of the ECB, together with the list of all monetary and financial institutions in the European Union.

3.7 Concluding remarks

We are less than three months away from the moment when monetary policy sovereignty is transferred from the NCBs to the ESCB. The bulk of the preparatory work has already been completed, but major decisions - above all, the choice of a monetary policy strategy - still have to be made. The public can be certain that we will always inform them, regularly and comprehensively, about our considerations and deliberations. We will make all our decisions transparent. I have no doubt that we will be well prepared for the moment at which we take over responsibility for monetary policy in the euro area.

The euro as an international currency

Speech delivered by Eugenio Domingo Solans, Member of the Governing Council and the Executive Board of the European Central Bank, at The Athens Summit 99, in Athens on 18 September 1999

Thank you for inviting me to the Athens Summit '99 and for giving me the opportunity to speak to you at this important event.

I should like to share with you my views, and the ECB's views, on the importance of the euro as an international currency. I understand that this issue may be of interest to experts from Greece, a "pre-in" country which intends to join the euro area, and too many participants from countries outside the euro area and the European Union, some of which currently have exchange rate regimes related to the euro.

Nowadays the euro is the second most widely used currency in the world economy, behind the US dollar and ahead of the Japanese yen. As we all know, any currency fulfils three basic functions: it is a store of value, a medium of exchange and a unit of account. As a store of value the use of the euro as an investment and financing currency is rapidly increasing, as investors understand the advisability of diversifying their portfolio currencies among those which are more stable and more internationally used. The euro is developing at a slower pace as a medium of exchange or payment currency in the international exchange of goods and services. This fact can easily be explained by the combined and reinforcing effects of network externalities and economies of scale in the use of a predominant international currency as a medium of exchange, as is the case with the US dollar. The use of the euro as a unit of account is linked to its use as a store of value and a medium of exchange. The value stored in euro or the payments made in euro will tend to be counted in euro.

There are good reasons to expect an increase in international public use of the euro as a reserve, intervention and pegging currency, inasmuch as the public authorities understand that it is worthwhile to allocate their foreign reserves among the main international currencies and to give the euro a relevant share in accordance with its internal and external stability and the economic and financial importance of the euro area.

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, 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, especially after the year 2002 when the euro banknotes and coins will begin to circulate.

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.

The euro fulfils the necessary conditions to be 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, which concerns the demographic, economic and financial dimension, generally tends to lead to centralisation around one or a few 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 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 second pillar of the monetary policy strategy of the ECB, which consists of a broadly based assessment of the outlook for price developments and risks to stability obtained from a wide range of economic indicators, the euro exchange rate being one of them. 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.

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 and we are convinced that, 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, etc.

These parameters or 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 with regard to the functioning of the Eurosystem.

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.

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 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.

Although this feature 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 euro, the Eurosystem's monetary policy and, in general, the activity of the ECB and the Eurosystem play a key role in the integration of European financial markets and all markets in general. The euro is acting as a catalyst for European economic integration. And more integration will lead to a greater economic and financial dimension.

Monetary and financial integration stemming from the euro and the activity of the Eurosystem will affect the operation of the single European 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, will lead to joining the euro area, once certain economic conditions (the so-called convergence criteria) have been fulfilled.

Monetary union is always a political operation, irrespective of its technical and economic implications. Currency is one of the most genuine expressions of sovereignty, because the power to issue money is one of the greatest powers in existence. The Treaty on European Union led, first, to the depoliticisation of monetary power in Europe, by means of granting independence to the central banks and prohibiting the monetising of public deficits, and afterwards to denationalisation or supranationalisation (via the creation of the Eurosystem). The Eurosystem was not only created for the purpose of improving the operation of the Single Market, but also in order to make progress on the building of the European political structure.

The euro should not only be seen as a catalyst for European economic integration, it should also be seen as a main beam necessary to construct the European political structure. The relationship between political power and monetary power is an interesting subject which is open to investigation and discussion, but that would certainly go beyond the scope of this speech. I merely wish to point out that, in the case of Europe, it is clear that following the achievement of a single currency, the door remains open to political union, which would represent a crucial step in the process of integration. In conclusion, it would seem clear that the implications of the euro go "beyond supply and demand" (to use the title of the work of Wilhelm Rцpke). We are now fully immersed in "meta-economy", which means it is time to end my speech.

Keynote address to be delivered by Dr. Willem F. Duisenberg President of the European Central Bank on The European System of Central Banks Current position and future prospects

At a Conference organised by the Royal Institute of International Affairs on European economic and Monetary Union Markets and Politics under the Euro London 27 november 1998

Introduction

Ladies and Gentlemen, I should like to express my appreciation at being invited to deliver a speech at this conference organised by the Royal Institute of International Affairs. It is a great pleasure for me to be here, in London, today.

The topic I am going to address relates to the current position and the future prospects of the European System of Central Banks. I feel that this topic provides me with an opportunity to deal with the objective of the ESCB and its contribution to the other policies in the Community. I will also briefly touch upon the decision-making in the ESCB, recall the main features of our monetary policy strategy and talk about our regard for openness and transparency. The final part of my talk will cover the views of the ESCB on recent economic developments and the future outlook for price stability in the euro area.

1. Independence, transparency and accountability

In the Maastricht Treaty the ESCB has been given an independent status. The reason is that politicians all over the world have come round to the view that monetary policy decisions taken with too close a political involvement tend to take too short a time horizon into consideration. The consequence is that in the longer term such decisions do not support sustainable gains in employment and income, but only lead to higher inflation. This view is confirmed by a host of economic research.

Independence, however, requires a clear mandate. The ESCB has such a mandate. Its primary objective is to maintain price stability. Without prejudice to the objective of price stability the ESCB shall support the general economic policies in the Community. Price stability is not an end in itself: it creates the conditions in which other, higher-order, objectives can be reached. In particular, I share the deep concerns about the unacceptably high level of unemployment in Europe. The ESCB will do what it can to contribute to the solution of this problem. By maintaining price stability inflation expectations and interest rates can be kept at a low level. This creates a stability-oriented environment which fosters sustainable growth, a high level of employment, a fair society and better living standards. Moreover, in specific circumstances, if production, inflation and employment all move in the same direction, monetary policy can play some role in stabilising output and employment growth without endangering price stability. However, the contribution from monetary policy can generally be only limited. Given the structural nature of the unemployment problems the solution is to be found, above all, in structural reforms aimed at well-functioning labour and product markets.

An independent central bank does not only need a clear mandate. It has also to be an open and transparent institution, for at least three reasons. First, transparency enhances the effectiveness of monetary policy by creating the correct expectations on the part of economic agents. A predictable monetary policy contributes to achieving stable prices without significant adjustment costs and with the lowest interest rate possible. The second reason is that in a democratic society the central bank has to account for its policies. Finally, transparency towards the outside world can also structure and discipline the internal debate inside the central bank.

Let me now turn to the ways and means of achieving transparency. As a first element the ESCB has defined a quantitative objective for price stability. It reads as follows: price stability is a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. Although I do not consider deflation to be likely in the current environment, I may add that a situation of falling prices would not be consistent with price stability.

The Governing Council has made it clear that "Price stability is to be maintained over the medium term". The ESCB cannot be held accountable for short-run deviations from price stability, for example due to shocks in import prices or specific fiscal measures. A monetary policy reaction to short-run fluctuations in the price level would provide the wrong signals to the market and cause unnecessary interest rate volatility. In summary, the ESCB will react in an appropriate, measured and, when necessary, gradualist manner to economic disturbances that threaten price stability in the medium term, rather than in an abrupt way, in order to avoid unnecessary disruptions of the process of economic growth. That said, the ESCB will, whenever necessary, openly discuss and explain the sources of possible deviations from the quantitative definition of price stability.

In addition, let me remind you that by focusing on the HICP for the euro area, the ESCB makes it clear that it will base its decisions on monetary, economic and financial developments in the euro area as a whole. The single monetary policy has to take a euro area-wide perspective: it will not react to specific regional or national developments.

The institutional implication is that the ESCB should develop into a strong unity, with a strong centre and strong national central banks. It should become a truly European institution, with a truly European outlook. Of course, it may take some time to arrive where we ultimately want to be. We have to get used to thinking in euro area-wide terms. In the ECB Governing Council we are already "practising" that approach and are making progress. I am confident that the ESCB will indeed act as a unity.

Transparency and openness will be apparent from the way in which the ESCB communicates with the public. The ESCB will regularly present its assessment of the monetary, economic and financial situation in the euro area and provide information about each specific monetary policy decision, be it a move in interest rates or an absence of change. This will notably be done by way of press releases, press conferences, publications and speeches. Press releases are made available immediately after the fortnightly meetings of the Governing Council and, as you may know, they always include a precise list of the decisions taken together with background information.

There will be a monthly press conference. Such a press conference will start with a detailed introductory statement, as has been the case so far, and these introductory statements will also be published immediately, without delay. In this statement the Vice-President and I will present the Governing Council's view of the economic situation and the underlying arguments for its monetary policy decisions, followed by a question and answer session.

The publications of the ESCB will include, in particular, an ECB Bulletin each month as well as an Annual Report. As from 1999, a detailed analysis of the economic situation in the euro area will be presented in the monthly Bulletin. Thematic articles in this Bulletin will include in-depth analyses by the ECB on matters regarding the monetary policy of the ESCB and the economy of the euro area. Further, you may also recall that, as required by its Statute, the ESCB will publish its consolidated balance sheet on a weekly basis.

My colleagues on the Executive Board of the ECB and I intend to be very active in giving speeches dealing with all issues of relevance for the conduct of monetary policy. I am convinced that the Governors of the national central banks will also play their role in this respect.

Since I am talking about the communication and external relations of the ESCB, I would like to underline that I am prepared to accept invitations to appear before the European Parliament at least four times a year to present the activities of the ESCB and the ECB's Annual Report. Finally, it should be noted that the ESCB will have a regular exchange of information and views with the ECOFIN. Representatives of the ECB will be invited to ECOFIN meetings whenever issues of concern to monetary policy are discussed. A similar relationship will naturally also exist with the EURO-11, whose meetings will generally be attended by the President of the ECB, whenever matters relevant to the ESCB are on the agenda.

2. Monetary policy strategy of the ESCB

We are now approaching the start of the Third Stage of EMU. The decision-making bodies of the ECB have made a certain number of important decisions since the ESCB was established. As part of these decisions, the monetary policy strategy of the ESCB was recently announced and explained to the public. The selected stability-oriented strategy promotes as much continuity as possible with the existing strategies of national central banks in the EU. At the same time, its design is adapted to the unique situation of introducing a single currency in eleven countries, which may to a certain extent change economic behaviour. Therefore as much continuity as possible and as much change as required is the thrust of our strategy.

Our strategy consists of two pillars. The first is an important role for money and the second is a broad-based assessment of the outlook for price developments in the euro area. The main reason for assigning a prominent role to money is the empirically well-founded view that inflation, at least in the long run, is a monetary phenomenon. This simple and obvious observation led the Governing Council to announce a quantitative reference value for the growth of a broad measure of money. This choice will create a "nominal anchor" for monetary policy and therefore help stabilise private inflation expectations at longer horizons. The reference value will be derived in a manner that is clearly consistent with - and serves the achievement of - price stability. It will be constructed such that, in the absence of special factors or other distortions, deviations of monetary growth from the reference value will signal risks to price stability.

However, it has to be clear that the reference value is different from an intermediate monetary target, as the ESCB has not made any commitment to correct deviations of actual monetary growth from the reference value over the short term. In particular, it has been realistically recognised that the move to a single currency and ongoing financial innovations may generate fluctuations in the selected monetary aggregate which are not necessarily associated with inflationary or deflationary pressures. For this reason, it is important to continuously monitor the relevance of temporary factors or even structural changes in order to avoid a mechanistic policy reaction to deviations of the chosen monetary aggregate from the reference value. The results of this analysis and its impact on the ESCB's monetary policy decisions will be explained to the public.

Let me turn now to the second key element of the monetary policy strategy, the broad-based assessment of the risks to price stability. The information contained in monetary aggregates, while of the utmost importance, will by no means constitute the whole of the "information set" in the hands of the ESCB. In parallel with the analysis of money growth, a wide range of economic and financial variables will be used to formulate an assessment of the outlook for price developments. The envisaged strategy will enable the ESCB to perform a cross-check between the information coming from the evolution of monetary aggregates and those from other economic and financial indicators.

3. Recent economic developments and prospects

Let me turn to the current economic situation. The euro area experienced a strengthening of economic growth in 1997, to 2.5%, and a further acceleration has been anticipated for this year. The global environment has, of course, deteriorated in the meantime, but this has not so far had an observable impact on growth which has, in any event, been increasingly led by domestic demand. Inflation has remained subdued and even fallen somewhat over the past year, partly as a result of the impact of weaker global demand on oil and commodity prices. However, the favourable pattern of inflation has also been supported by domestic factors, such as a very moderate development in unit labour costs and industrial producer prices.

Concerning recent price developments, HICP inflation for the euro area fell to 1.0% in September, due to a strong impact from food prices, but I would not want to read too much into this latest decline as some price components can be relatively volatile over short periods. More significantly, preliminary data suggest that various broad monetary aggregates for the euro area are increasing at between 3 and 5%, and thus do not appear to signal any strong incipient inflationary or deflationary pressures. We are in line with the consensus view that inflation in the euro area will rise moderately in 1999, but remain below 2%. I do not consider deflation to be a serious risk for price stability at present.

So far, despite the worsening of the global environment, euro area-wide activity has continued to expand at a fairly stable rate. At around 3%, annual real GDP growth was broadly unchanged in the first half of 1998 from the solid growth seen in the second half of 1997. Industrial production growth has slowed somewhat since the spring. More recent evidence, particularly that of the area-wide survey data, may also suggest a moderation in the pace of growth and further developments in these indicators will continue to be monitored closely. Area-wide growth should, however, be supported by a number of domestic factors. One factor supporting continued growth, particularly in private consumption, is the gradual improvement in labour market conditions. Moreover, the lowest short-term interest rates in the euro area currently stand at 3.3%, and several countries have cut interest rates towards this level recently as part of the process towards interest rate convergence. The process of convergence towards this level has been gradual, but should imply a reduction in the average short-term interest rate in the euro area of about 0.5 percentage point since July. Long-term rates also stand at low levels. And, there has been a marked degree of exchange rate stability among countries participating in the euro. This is undoubtedly a welcome development from the standpoint of encouraging trade and investment. Thus, our assessment is similar to that of other international organisations, that - unless the international environment deteriorates further, which is not currently expected - growth will be somewhat weaker in 1999. Growth should, however, remain high enough to support continued employment creation and, assuming a recovery in the international environment, there should be a pick-up in growth in the year 2000. At the meetings in December the ECB Governing Council will again assess the outlook for economic and price developments.

Although the economic outlook may be less favourable than expected - let us say - half a year ago, I believe that the conditions for a successful launch of the euro are in place. You can be sure that the ESCB will do its utmost to make the euro a stable currency.

The euro: pushing the boundaries

Presentation by Ms Sirkka Hдmдlдinen, Member of the Executive Board of the European Central Bank, at the symposium arranged by the European Private Equity and Venture Capital Association on 11 June 1999 in Prague

It is a great honour for me to be invited here today to this symposium arranged by the European Private Equity and Venture Capital Association to speak about the new European currency - the euro. Indeed, the theme of this symposium - "Pushing the boundaries" - is very appropriate when speaking about the euro. To my mind, the establishment of Economic and Monetary Union can be characterised as pushing the boundaries in several ways, such as:

pushing the boundaries in the process of European integration;

pushing the boundaries of stability-oriented policies in Europe; and

pushing the boundaries of market integration in Europe.

In today's presentation, I shall give an overview of these three aspects of Economic and Monetary Union. Thereafter, I shall discuss more thoroughly the implications of the single currency for the development of the European financial markets, focusing on the capital markets. Finally, I shall reflect briefly on the importance of equity prices, and other asset prices, in the formulation of monetary policy.

1. Pushing the boundaries of the process of European integration

I shall start with a few comments on the role of the euro in the overall European integration process: I think there is little doubt that in future books on European history the start of the third stage of European Economic and Monetary Union on 1 January 1999 will be marked as a significant and unique event in the long process of European integration. On that day, the national currencies of 11 EU countries became denominations of the euro. At the same time, the "Eurosystem" (which is composed of the European Central Bank (ECB) and the 11 national central banks (NCBs) of the participating Member States) assumed responsibility for the monetary policy of the euro area.

In order to put this event into a historical context, I should like to note that the establishment of an Economic and Monetary Union in Europe was, in fact, originally motivated more by general political arguments than by economic arguments. In the current debate, these overall political arguments have almost disappeared. Instead, the media and economic analysts are increasingly focusing their assessment of the new currency on the recent short-term economic and financial developments in the euro area.

The process of European integration started shortly after the end of the Second World War and gained momentum in the 1950s. At the time, the striving for integration was mainly driven by the aim of eliminating the risk that wars and crises would once more plague the continent. Through the establishment of common institutions, political conflicts could be avoided or at least resolved through discussion and compromise.

The idea of establishing a monetary union and a common monetary policy was raised at an early stage of this process. It was argued that the full economic effects from integration in Europe could only be gained if the transaction costs of exchanging different currencies were eliminated. Other benefits of a monetary union in Europe were emphasised less in the early stages of the discussion, partly due to the fact that at that time the Bretton Woods system was already providing a high degree of exchange rate stability.

The first concrete proposal for an economic and monetary union in Europe was presented in 1970 in the so-called Werner Report, named after the then Prime Minister of Luxembourg, Pierre Werner. However, this proposal was never implemented. In the aftermath of the break-up of the Bretton Woods system and the shock of the first oil crisis in 1973, the European economies entered a period of stagnation with high inflation, persisting unemployment and instability in exchange rates and interest rates. The European countries applied very different policy responses to the unfavourable economic developments, and policy co-ordination deteriorated. In this environment, it was not realistic to establish a monetary union.

The experience of this volatile period showed that large exchange rate fluctuations between the European currencies led to a disruption of trade flows and an unfavourable investment climate, thereby hampering the aims of achieving growth, employment, economic stability and enhanced integration. Therefore, the benefits of eliminating intra-EU exchange rate volatility became an increasingly powerful argument when the issue of establishing an economic and monetary union was revisited in the so-called Delors Report in 1989.

The Delors Report contained a detailed plan for the establishment of Economic and Monetary Union and eventually became the basis for the drafting of the Maastricht Treaty. This time, the time schedule for establishing the Economic and Monetary Union took into account the need to first achieve a high degree of nominal convergence for the participating countries.

The fact that the plan for the introduction of the single currency was then pursued and implemented in such a determined and consistent manner implied, in itself, a boost for the overall process of integration. The momentum of the process of integration is no longer crucially dependent on political decisions. By contrast, the integration of the European economies has become an irreversible and self-sustained process, which is proceeding automatically in all areas of political, economic, social and cultural life. The euro can thus be seen as a catalyst for further co-ordination and integration in other policy areas. This is one way in which the introduction of the euro has definitely helped to push the boundaries in the process of European integration.

Another way to push the boundaries in the European integration process relates to the geographical extent of the euro area and the European Union. Here, I sincerely hope that the four EU countries which have not yet adopted the euro will soon be able to join the Monetary Union. At the same time, I hope the process to enlarge the European Union with the applicant countries will progress successfully. An enlargement of the euro area and of the European Union would further strengthen the role of Europe in a global perspective and should be for the benefit of all participating countries. However, it is clear that countries aiming to join the Economic Monetary Union would have to fulfil the same degree of nominal convergence as was required from the participating countries when the Economic and Monetary Union was established. This is essential in order to avoid tensions to emerge in the euro area, which could eventually compromise macro-economic stability.

2. Pushing the boundaries of stability-oriented economic policies

Economic and Monetary Union in Europe also provides an opportunity to push the boundaries in areas of economic policy. The convergence process prior to the establishment of Economic and Monetary Union was helpful in order to achieve a broad consensus among policy makers on the virtues of stability-oriented policies, i.e. policies directed towards price stability, fiscal discipline and structural reform geared at promoting growth and employment. The convergence process also helped policy makers to focus their efforts on the formulation of stability-oriented economic policies in the participating countries and it also facilitated the acceptance of these policies among the general public.

In the new environment of Economic and Monetary Union, monetary policy can no longer be applied as a means of accommodating economic developments in an individual Member State. Such nation-specific developments would have to be countered by fiscal and structural policies, while the best way in which the single monetary policy can contribute to improved conditions for growth and employment is by ensuring price stability in the euro area as a whole. In this respect, the formulation of the Maastricht Treaty is instrumental, since it guarantees the Eurosystem's firm commitment to price stability; it clearly specifies that price stability is the primary objective of the single monetary policy.

The Eurosystem has put a lot of effort into establishing a monetary policy framework that will ensure that it can fulfil its primary objective of price stability as efficiently as possible. There are several aspects to this framework.

First, the Eurosystem has adopted a quantitative definition of the primary objective - the Governing Council of the ECB has defined price stability 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 price movements.

Second, the Eurosystem has made public the strategy to be used for the implementation of the single monetary policy. This strategy is based on two key elements, whereby money has been assigned a prominent role, as signalled by the announcement of a reference rate of 4Ѕ% for the 12-month growth of the euro area monetary aggregate M3. The other element consists of 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.

Third, the Eurosystem puts significant emphasis on the need to carefully explain its policy actions in terms of its monetary policy strategy. Therefore, the Eurosystem has established various channels for the communication with market participants and the general public. The most important communication channels are the ECB's Monthly Bulletin, its press releases and the press conferences following the meetings of the Governing Council, the President's appearances in the European Parliament and the speeches given by the members of the Governing Council.

Fourth, the Eurosystem's monetary policy is implemented in a marketed-oriented manner. The Eurosystem's key policy instrument is its weekly tender for two-week repo operations, the so-called main refinancing operations. The features of the monetary policy operations are decided by the decision-making bodies of the ECB, but the operations are conducted in a decentralised manner by the NCBs.

The experience gained from the first five months of operations has shown that the Eurosystem's procedures for decision-making and operational implementation works very well. There are therefore no operational reasons to call into question the ability of the Eurosystem to fulfil its mandate to ensure price stability in the euro area. However, stable macroeconomic policies cannot be achieved by monetary policy alone. It is also necessary for governments to pursue fiscal and structural policies consistent with such macroeconomic stability.

In order to ensure fiscal discipline in the participating countries, the EU Council agreed in June 1997 to establish the so-called Stability and Growth Pact. This Pact sets an upper limit of 3% of GDP for the fiscal deficits of the countries participating in the euro area. Furthermore, the Pact specifies as an objective that Member States are to bring government budgets close to balance or even into surplus in the medium term. Only if this objective is met will sufficient room for manoeuvre be created to enable fiscal policy to react to cyclical developments without risking a loss of credibility.

As regards structural policies, the policy framework is, so far, less well developed. This is worrying given that the need for structural reform is urgent in many areas in order to be able to effectively promote greater growth potential and higher employment. I appreciate that these problems are generally acknowledged, and some action has been taken in recent years. For example, it is encouraging that the European Employment Pact adopted at the EU Summit in Cologne last weekend explicitly recognises the need to pursue comprehensive structural labour market reform.

Nevertheless, experience from several countries shows that it usually takes a long time for the full effects of structural reforms to be seen. Therefore, it is worrisome that structural reforms, in particular as regards labour markets as well as those to limit expenditure on social security and pension systems, are long overdue in several Member States.

Clearly, the establishment of Economic and Monetary Union does not mean that the efforts undertaken during the convergence process can be relaxed. On the contrary, the need for policy co-ordination among the participating countries is now even more pressing. We have already seen examples of negative market reactions to any perceived slippage in fiscal discipline or postponement of structural reform. Personally, I think that these swift market reactions, although sometimes exaggerated, may be helpful in promoting a continued stability-oriented policy thinking in Europe. Any move towards less responsible policies would come up against intense peer pressure from other countries.

In this context, I would once more like to underline how important it is that a consensus has emerged among European policy-makers on the virtues of price stability, fiscal discipline and market-oriented structural reform. In this way, we have already pushed the boundary significantly towards a macroeconomic environment conducive to growth and employment, although much still needs to be done in the years to come.

4. Pushing the boundaries in the development of financial markets

However, the success of the euro is not only in the hands of central bankers and policy-makers. An important area in which the private sector has an instrumental role in meeting the challenge of pushing the boundaries is in the development of the European financial markets. In order for the euro to be a success, it is important for the euro area financial markets to become wider, deeper and more diversified. The introduction of the euro has provided further input into this process; the elimination of exchange rate risks has removed one of the main barriers to financial market integration in Europe.