European monetary system and european currency

In most European countries, the financial markets have, traditionally, been rather shallow, with few participants and a narrow range 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. This segmentation has been a function of exchange rate borders, tradition, differing practices and, of course, national regulations and tax regimes.

Following the elimination of the barriers implied by different currencies, it is now up to the European Commission and the relevant national authorities to further the integration process in the areas of regulation and taxation. Meanwhile, it is up to market participants to take advantage of the business opportunities implied by the increased scope for market integration.

The introduction of the euro brought about an almost immediate integration of the national money markets into a euro area-wide money market. This was made possible thanks to the establishment of pan-European payment systems, such as the TARGET system set up by the Eurosystem, which enables banks to access liquidity throughout the euro area in real time.

The cross-border integration of bond markets in the euro area is progressing at a slower pace, as is also true of equities and derivatives markets. This notwithstanding, we are also experiencing important developments in these segments of the financial markets. These developments are partly due to the general trends towards globalisation and technological refinement and partly related to the introduction of the euro. As a result of the introduction of the euro, market participants increasingly perceive similar instruments traded in the different national markets to be close substitutes. This holds true, in particular, for bonds issued by the euro area governments, where the establishment of common benchmarks, the narrowing of yield spreads and increased market liquidity seem to indicate that a high degree of cross-border substitutability has already been achieved.

The fact that euro area financial instruments are increasingly considered to be close substitutes increases the competitive pressures on national markets to attract issuers and investors wishing to benefit from increased cross-border competition and lower transaction costs. In this context, we have recently experienced several initiatives aimed at creating capital markets across national borders, such as the plans to establish common trading platforms linking the European stock exchanges. Similar initiatives have also been taken to establish links between national securities settlement systems, which would facilitate the cross-border mobilisation of securities. In the longer run, such developments will make it possible for investors to manage their investment portfolios more efficiently.

The Eurosystem welcomes such initiatives aimed at improving the cross-border integration of financial markets in the euro area, and globally, since they may result in a wider range of financial instruments on offer, and at a lower cost, than is currently the case in the national markets. This could lead to a virtuous circle in which the increased issuance of instruments denominated in euro will draw the attention of international investors to the euro area capital markets, in turn making the euro an increasingly attractive currency for private as well as public issuers.

In fact, the experience of the first few months of the life of the euro seems to indicate that such a positive development may already be under way. In the first quarter of 1999, bonds denominated in euro accounted for around 50% of the bonds issued internationally. This share is considerably higher than the traditional aggregate share for bonds denominated in the constituent currencies, which had been in the range of 20% to 30% in recent years. We have also seen a considerable increase in the average size of bond issues denominated in euro, as compared with those of bonds denominated in the former currencies, which may indicate that the trade in euro-denominated issues is likely to become increasingly liquid.

Despite the recent developments in the euro area capital markets, euro area companies are still mainly dependent on financing through the banking system. Hence, there is still plenty of scope for further development in the area of corporate financing. For example, the amount of private bonds traded in the euro area is still very low compared with the United States. The market capitalisation of equities is considerably lower in most euro area countries as compared with the United States and the United Kingdom. Likewise, the venture capital business in the euro area is still in its infancy compared with the relatively mature venture capital markets in the United States and the United Kingdom. Personally, I am convinced that the introduction of the euro will also be helpful to the development of these segments of the financial markets.

In this context, I should like to say a few words on how the introduction of the euro may underpin the reshaping of the European banking sector. The increased scope for securitisation will put pressure on the European banking sector to move away from traditional retail banking activities in favour of more advanced financial services. The European banking industry is still segmented into relatively small national markets. The introduction of the euro is likely to add momentum to cross-border integration in the European banking sector. Although a considerable consolidation of the European banking sector has taken place over the last decade, this consolidation has so far been almost exclusively based on mergers and acquisitions within national borders. It is only recently that we have also started to see such deals taking place across national borders.

I welcome this trend towards an expansion beyond national borders with open arms, since the establishment of truly pan-European - and global - banking groups will be instrumental in efforts to enhance competition in the provision of financial services.

5. The Eurosystem and the equity markets

I should like to conclude my presentation today by briefly discussing about the euro area equity markets as seen from the perspective of the Eurosystem. It is clear that the Eurosystem has no direct control or influence over the development of equity markets. However, the Eurosystem acknowledges the importance of well-functioning and efficient equity markets for the economy as a means of mobilising savings into productive investment. Hence, efficient equity markets with transparent price formation, high market liquidity and low transaction costs are of great value in the capital formation process.

The existence of efficient equity markets should also reduce the risk of the emergence of asset price bubbles, which is desirable from a monetary policy perspective. Prior to the emergence of asset price bubbles in some industrialised countries in the early 1990s, few central banks paid much attention to the development of prices of equities or other assets in their monetary policy formulation.

However, the effects of the bubble economies in the early 1990s, notably in Japan, the United Kingdom and Scandinavia, led to an intense debate among economists on how monetary policy could have responded better to the situation. Some research was carried out in order to establish price indexes that would incorporate asset prices and which could be used as target variables or indicators within the monetary policy framework. However, no central bank is explicitly making use of such asset price-weighted indexes in monetary policy formulation. Nevertheless, this development in the early 1990s made most central banks aware of the fact that large swings in asset prices can have important effects the price formation in the economy through its implications on real economic developments and, in particular, financial market stability.

However, in practice it is not easy to let monetary policy actions respond to asset price developments. Central banks have only one tool for the implementation of monetary policy - the short-term interest rate. They can therefore not effectively try to achieve several objectives at the same time. It is also difficult to judge how developments in asset prices actually feed into consumer prices, thereby making it tricky to assess the need for the appropriate monetary policy response to their changes. This difficulty is exacerbated by the rather high volatility of certain asset prices, such as equities, which could result in frequent changes in policy interest rates if the central bank were to incorporate them mechanistically into its reaction function.

In this respect, the present situation in the United States, as well as in several European countries, is interesting: equity prices have risen rapidly for an extended period but consumer prices remain very subdued and there are, so far, no signs that there is going to be a spill-over from asset price developments into consumer price inflation.

Against the background of the rather unclear relationship between asset price developments and consumer price inflation, the development of equity prices does not have a prominent role in the formulation of the Eurosystem's monetary policy. This notwithstanding, the Eurosystem closely monitors the prices of equities and other assets within its broadly based assessment of economic developments in the euro area, which forms the second pillar of its monetary policy strategy. The Eurosystem will therefore remain vigilant in order to detect any influence from asset prices, through their impact on real economic developments and financial market stability, on the formation of consumer prices.

The monetary policy of the European central bank

Speech by Eugenio Domingo Solans Member of the Executive Board of the European Central Bank during the "Working Breakfast" at the Permanent Seminar on 4 December 1998 in Madrid

Introduction

It was with immense pleasure that I accepted the invitation to take part in this event, organised by Euroforum. In view of the prestigious nature of Euroforum, the professional standing of its President, Eduardo Bueno, Professor at the Universidad Autуnoma de Madrid and consultant to the Banco de Espaсa (there is a great deal of similarity between our respective professional histories) and, above all, the value I have attached to his friendship over the past thirty years, there was no question as to whether to agree to join you for this working breakfast.

I have been asked to keep my presentation brief in order to allow as much time as possible for discussion. Therefore I will try to put forward a few ideas on the monetary policy of the European Central Bank (ECB) which I can develop during subsequent discussions. During the discussion period please feel free to raise any questions on other aspects of the ECB's operations.

The three fundamental principles underlying the monetary policy

As in the case of any other central bank, the ECB's monetary policy is based on three fundamental principles: setting the objectives to be achieved, establishing the most appropriate strategy for accomplishing these objectives and, finally, selecting the best instruments for implementing its chosen strategy.

While the Governing Council of the ECB is responsible for formulating its monetary policy, both the Executive Board of the ECB and the national central banks are involved in its application and therefore this constitutes one of the tasks allotted to the European System of Central Banks (ESCB) as a whole.

Objectives, strategies and instruments therefore form the three main elements which enable us to establish the precise point within the range of monetary policy possibilities which should constitute the ECB's policy: its precise altitude, longitude and depth.

The ECB's monetary policy objectives

We did not have to think long and hard to define the ECB's monetary policy objectives and, generally speaking, those of the ESCB. This had been done for us by the Treaty on European Union in which, under Article 105, it is stated that "the primary objective of the ESCB shall be to maintain price stability" which, on a more practical level, the ECB has defined as a year-on-year increase in the harmonised index of consumer prices (HICP) for the euro area of below 2%, which it seeks to maintain in the medium term. "Without prejudice to the objective of price stability", continues the aforementioned Article 105 of the Treaty, "the ESCB shall support the general economic policies in the Community with a view to contributing to the achievement of the objectives of the Community as laid down in Article 2".

If you refer to the aforementioned Article 2 of the so-called Treaty of Maastricht, you will find that sustainable and non-inflationary growth, together with a high level of employment and social protection, are among its aims.

The ECB, then, must prioritise those of its activities which promote the objective of stability and, without prejudice to this approach, it will contribute, indirectly and to the extent possible, to economic growth and increased employment.

Is this approach in any way contradictory? Absolutely not. The best contribution the ECB can make to promoting investment and thus to generating economic growth and increased employment is precisely by providing a framework for price stabilisation. The worst path that the ECB could follow would be to implement a lax economic policy which claimed to be directly creating jobs.

In fact, in the medium term price stability will encourage efficient investment, sustainable growth and employment. This is because stability prevents price distortions, that is to say any distortion of the mechanism which guides decision-makers in the markets, and thus favours an improved allocation of resources. When stability is achieved, prices are more transparent, which promotes competition and therefore efficiency.

Moreover, if economic agents have positive expectations with regard to stability, the risk premium element of long-term of interest rates will fall, promoting investment and lasting consumption. In this respect, it should be remembered that one of the clearest inflation forecast indicators is an increasingly steep maturity-related asset yield curve.

Finally, stability promotes growth and employment insofar as it allows resources to be channelled into productive activity. Inflation, on the other hand, merely encourages speculative investment with the aim of safeguarding funds against monetary deterioration.

As we saw earlier, the aims set out in Article 2 of the Maastricht Treaty also include social safeguards. In this context, therefore, it can be said that inflation is the most unjust of all taxes, because it attacks personal income and assets while distorting certain public redistribution mechanisms such as, for instance, progressive taxation scales.

In other words, stability is not just important for economic efficiency but also for social justice, since it provides economic conditions which benefit the weakest and most vulnerable members of society.

An appropriate ECB monetary policy is a necessary condition but will not, in itself, enable us to achieve stability. National taxation policies geared to satisfying the objectives of the Stability and Growth Pact, together with several supply-side policies leaning towards liberalisation and flexibility, are also necessary to enable us to avoid the persistent need for measures to combat inflation.

We must avoid the temptation to reinterpret the Stability and Growth Pact by introducing "golden rules" of dubious legality, based on the false theoretical foundations of the so-called "ultra-rationality hypothesis" which, in the past, claimed to justify increased taxation pressure and which now calls for increased public spending in terms of investment. Let's not beat about the bush: taxation policy has only one golden rule, which consists in maintaining a long-term budgetary balance on the economic horizon.

In connection with the ECB's objectives, it should also be noted that it is difficult or even impossible to meet two separate targets simultaneously using only a single monetary policy. This applies when dealing with the concept of fixing fluctuation bands for the rate of exchange between the euro and the US dollar. In this case, the exchange rate objective could conflict with the price stability concept and the ECB would then fail in its primary objective. We must not forget, with regard to this issue, that combining linked exchange rates, the free circulation of capital and monetary autonomy is not, to be quite blunt, sustainable. It is precisely this which is the raison d'кtre of the ECB as the single monetary authority in an economic area which has irrevocably fixed exchange rates (a single currency) and freely circulating capital (a single market).

To conclude this section, let me stress that it is essential for the ECB to make it absolutely clear that its main objective is stability. If, as some would suggest (for instance in the Modigliani manifesto), the ECB were to directly target employment, this would adversely affect the credibility of its monetary policy and thus have an impact not only on inflation but also, paradoxically, on employment. The direct targeting of employment objectives by a central bank is counterproductive.

The ECB's monetary policy strategy

A strategy is a combination of criteria and procedures which allow decisions to be taken in order to achieve a monetary policy objective. This decision-making process can be based on inflation forecasts which depend on the behaviour of a relevant monetary variable or, more simply, on the "pegging" of exchange rates to a stable currency. This last strategy is ideal for more open economies, encompassed by a specific monetary zone, such as, for instance, the Netherlands and Germany. However, this would not be suitable for a much larger but relatively closed economic space such as the euro area.

I believe that it is a mistake to try to exaggerate the polarity of the inflation strategy and the monetary strategy. These are quite clearly separate strategies but they are not in any way opposed, incompatible or irreconcilable. Certainly, some aspects of each of these strategies should be combined, resulting in another, completely separate and valid strategy. This is what the ECB has done and it now needs to give the end product a name which does not merely describe the desired objective ("the stability-orientated monetary policy strategy").

There are two components to the ECB's monetary policy strategy. The first, more practical and visible component consists in a quantitative reference to the growth of the money supply as defined by the broad M3 aggregate. Taking into account the quantitative definition of stability, economic growth and realistic hypotheses on money circulation rates, this monetary reference has initially been set at 4 1/2%.

The second component of the ECB's monetary strategy, a more general and enveloping one, is the estimation of inflation forecasts and risks for price stability in view of changes in a group of significant variables, all of which are related to the euro area as a whole. Some examples of these significant variables are credit, long-term interest rates, prices of raw materials, import prices, wages and public spending deficits.

Inflation is a monetary phenomenon. When the rate at which the money supply grows is greater than the nominal potential rate of growth of an economy, in the medium term this will generate inflation. In other words, the medium-term inflation rate is indicative of excessive monetary expansion in relation to economic growth. Growth in the money supply therefore provides the best early warning of inflation and monetary control is the best monetary policy strategy. The virtues of the first component of the ECB monetary strategy are, when all is said and done, well known. If it worked, this alone would be sufficient.

In practice, however, things are never so simple. Inflation forecasting and control cannot rely solely on a monetary aggregate because of doubts as to whether or not this monetary aggregate can be controlled and is stable and meaningful. If a narrow definition of money, such as M1, is adopted, controllability can be achieved in that, through the monetary policy instrument, it is possible to have a greater impact on its evolution, but this is offset by the loss of stability and significance. If it is decided to opt for a broad monetary aggregate, such as M3 or M4, the money demand function becomes more stable and clearly more significant, in that a greater correlation can be achieved between exchange rates, providing a better explanation of changes in nominal costs and inflation, in return for some loss of control. Despite this, doubts persist. In practice, these will, of course, increase when national currencies are replaced with the euro; then the need for the second part of the monetary policy strategy will become obvious.

The ESCB monetary policy tool

The wide range of instruments available to the ESCB for the implementation of the euro area monetary policy has been established with reference to two fundamental criteria: efficiency and neutrality. These instruments can be separated into three categories, related to open market operations, standing facilities and minimum reserves.

The ESCB's instruments and procedures do not differ significantly from those traditionally used by the Banco de Espaсa and with which you are all familiar. This means that I only need to highlight a few differences. In addition, I should add that over recent weeks the Banco de Espaсa has introduced changes aimed at facilitating a smooth transition.

With regard to open market operations, the frequency and maturity of the main re-financing operation has become that of a weekly auction of loans with a maturity of two weeks, and an interest rate which is either announced in advance (fixed rate auction) or announced later as the result of offers received (variable rate auction). There will also be monthly auctions for three-month loans which will always be of the variable rate type in order to avoid sending signals to the market. Fine-tuning will be carried out in exceptional circumstances between two regular auctions and, finally, the structural liquidity demand can be influenced by means of open market transactions which consist in the direct purchase and sale of securities or the issuance of debt certificates.

Standing credit and deposit facilities will supply or absorb overnight liquidity, without the imposition of any other restrictions on their use by institutions other than the provision of guarantees or collateral. Both types of interest on standing facilities constitute a strip or corridor which will contain short-term market interest rate swings and provide a structure for monetary policy trends. This means that they will play an important role in terms of providing signals, a role also fulfilled by the Banco de Espaсa but in a less predetermined and formalised manner.

As far as guarantees for all these transactions are concerned, it should be stated that acceptable collateral may take the form of either a public instrument or a private instrument, provided that these are of a suitable nature, according to the neutrality principle applied to the public sector and to the private sector.

The minimum reserves will be equal to 2% of book liabilities calculated on the basis of a monthly average, will be subject to a minimum exempt level of EUR 100,000 and - this being the most important point underlining the main difference compared with the current position in Spain - will be remunerated in line with market rates. The averaging provision will allow us to absorb liquidity shocks without recourse to standing facilities. Such a minimum reserves will constitute a useful tool for restricting the volatile nature of monetary market interests rates, for reducing the need for fine-tuning and for tightening up the system's liquidity, thereby enhancing the effectiveness of the monetary policy. Its remuneration in line with the market will not only reduce money demand elasticity with regard to interest rates but also offer neutrality to euro area banks as compared with those in other countries which do not use such a tool.

Conclusion

Although inevitably in a simplified form, I hope that this statement on the aims, strategy and instruments of the euro area monetary policy has provided some basic information on the central core of the ECB's operations and that it can be used as a starting-point for our discussions.

Thank you for listening; during the discussion period, I shall be pleased to elaborate on the issues raised or examine any others which you think may be of interest.

The monetary policy of the Eurosystem

Main remarks of the speech delivered by Eugenio Domingo Solans Member of the Governing Council and the Executive Board of the European Central Bank at the SOCIETAT CATALANA D'ECONOMIA (Institut d'Estudis Catalans)

Barcelona, 2 July 1999

The text will be available in Catalan at a later stage

The primary objective of the Eurosystem and, therefore, the touchstone to measure its success is the achievement of price stability. In the medium term the best contribution that the Eurosystem can make in favour of sustained growth is, precisely, to create an environment of stability. There is clearly no greater fertiliser for economic growth than price stability, and nothing is more refractory to economic growth than inflation. Provided that stability is achieved and that there is no risk for stability in the future, the Eurosystem has to create the best monetary conditions for exploiting the considerable growth potential of the euro area. This should be done in a passive way, without any activism: like the air we breathe, not like the air from an oxygen tank.

The 5.2% increase in the three-month moving average of the 12-month growth rates of M3 covering the period from March to May 1999 is in line with the 4 Ѕ reference value for money growth, which is the basis of the first pillar of the ECB's monetary policy. Neither the slight increase in the moving average compared to its value last month (5.1%) nor the non-substantial and almost constant difference from the reference value signal a risk for price stability.

The results of the broadly based assessment of the outlook for price developments, which constitutes the second pillar of the ECB's strategy, confirm that there is no risk to price stability in the euro area.

The second pillar of the ECB's monetary policy strategy includes, among other indicators, the exchange rate developments of the euro. The ECB's assessment on the evolution of the exchange rate of the euro should, therefore, be linked to the risk for price stability of a depreciation of the euro. Taking into account that the euro area economy is a rather closed one, no significant inflationary impact should be expected from the recent exchange rate developments of the euro.

One main feature of the instruments and procedures of the Eurosystem's monetary policy is their high level of flexibility, in the sense that without discretionary changes the instruments can accommodate a wide range of different market situations. On the other hand, there is flexibility in the sense that the Eurosystem has at its disposal a wide set of monetary policy instruments and has, therefore, the possibility to move from one to the other if and when it is deemed appropriate, taking into account their advantages and disadvantages. In the first stage of the ECB's monetary policy, the fixed rate tender with a discretionary allotment is the best choice for the main refinancing operation owing to its advantages in terms of signalling effects and controlling both the liquidity allotted and the volatility of overnight rates. On the contrary, in the case of longer-term refinancing operations, the Eurosystem as a rule does not intend to send signals to the market and the effects on the liquidity and on the overnight rates are weaker. Therefore, for longer-term refinancing operations, the market-oriented variable rate tender has a clear advantage.

The activities and the monetary policy decisions of the ECB should be interpreted from a euro area perspective as a whole. To interpret them from a national standpoint would be a mistake.

The role of the central bank in the united Europe

Speech by Dr. Willem F. Duisenberg, President of the European Central Bank, National Bank of Poland, Warsaw, Poland on 4 May 1999

Introduction

First and foremost, I should like to congratulate the National Bank of Poland (the NBP) on its 75th anniversary. The age of the NBP already suggests that as the President of the European Central Bank (ECB), an institution that is even less than one year old and has only been conducting monetary policy since January this year, I should be modest. I am aware that the role of the NBP has not been constant over these 75 years and that in the past decade, in particular, the NBP has gone through a remarkable restructuring process. My previous central bank, de Nederlandsche Bank, has, together with the International Monetary Fund and many national central banks, been involved in assisting the NBP in its efforts to adapt to the role of a central bank in a market economy. Of course, the real work had to be done by you yourselves and I believe you can be proud of what has been achieved over the past decade.

Today in my speech I should like to focus on the role of the ECB, as a truly European institution. First of all, I shall explain the background against which the introduction of the euro and the establishment of the ECB should be considered. Thereafter, I shall discuss the main features of the institutional structure that determines monetary policy-making. I shall then turn to our monetary policy strategy and the role of accountability and transparency in this strategy. I shall conclude by briefly addressing the issue of EU enlargement.

1. The process of European integration

On 1 January of this year the euro was introduced in 11 countries with a combined population of almost 300 million. The ECB started to conduct a single monetary policy for the so-called euro area. Former national currencies, such as the French franc and the German Mark are no longer autonomous currencies, but subdivisions of the euro. Euro banknotes and coins will only be introduced in 2002.

The voluntary transfer of monetary sovereignty from the national to the European level is unique in history. However, it should not be seen as a single, isolated event. The introduction of the euro is part of the process of European integration. This process started shortly after the second World War and has now been under way for more than half a century. The aims of European integration are not only, or even primarily, economic. Indeed, this process has been driven and continues to be driven by the political conviction that an integrated Europe will be safer, more stable and more prosperous than a fragmented Europe. It is true that economic integration has been the main engine of this process and that, although it has had its ups and downs, integration has delivered important economic benefits. On balance it has been successful.

The introduction of the euro and the establishment of the ECB are important new steps in this process of European integration. They are not the completion of this process, for at least two reasons. First, the launch of the euro can be compared to the launch of a rocket. A good launch is crucial, but only the beginning of the mission. The euro has been launched successfully. The challenge now is to make it a success. This will not happen automatically, but will require effort on the part of many authorities, institutions and people. Second, four EU Member States have not (yet) introduced the euro. I hope that this will happen in the future. Moreover, as you are aware, the EU itself is likely to increase its membership over time, also to include Poland. Ultimately, this is bound to extend the euro area. This process, too, is already requiring and will continue to require great efforts: no pain, no gain, as is often the case.

2. The institutional framework of the single monetary policy

Let me now turn to the institutional framework for the conduct of the single monetary policy. This was laid down in the Treaty establishing the European Community, the so-called Maastricht Treaty, and the Statute of the ESCB, which is an integral part of this Treaty. According to the Treaty the ECB has the primary objective of maintaining price stability. Without prejudice to this objective, it is to support the general economic policies in the Community, with objectives such as economic growth and high employment.

Decisions on monetary policy are made by the Governing Council of the ECB. This body comprises the six executive directors of the ECB and the 11 governors of the national central banks (NCBs) of the Member States which have introduced the euro. These 17 people meet every fortnight at the ECB, in Frankfurt am Main. Decision-making on monetary policy is fully centralised. All members of the Governing Council have one vote, whether they come from Germany or Luxembourg. This is because of an important principle. They are not representing their country, but are obliged to take decisions on the basis of euro area-wide considerations. Regional or national monetary policy does not and cannot exist in the euro area. There is only one, single monetary policy for the euro area as a whole. Therefore, the ECB should develop into a truly European institution. This is a process that will inevitably take some time, but my feeling is that we are already making good progress.

The execution of monetary policy is to a great extent decentralised. It is in large part carried out by the NCBs. The ECB and the 11 NCBs together are referred to as the Eurosystem. If we refer to the ECB and the 15 NCBs of all EU Member States, we speak of the European System of Central Banks (ESCB). The General Council of the ECB meets quarterly and comprises the President and Vice-President of the ECB and the 15 governors of the NCBs of all the EU Member States. This body does not make decisions on monetary policy, but discusses issues concerning the relationship between the "ins" and the countries I prefer to call "pre-ins", such as exchange rate issues. The third decision-making body of the ECB is the Executive Board of the ECB, comprising the six executive directors of the ECB. The Executive Board is responsible for current business and the implementation of monetary policy as decided by the Governing Council. The staff of the ECB will, in the course of this year, reach a level of between 750 and 800 and is likely to grow further in the years ahead.

The ECB is one of the most, if not the most, independent central bank in the world. Its independence and that of the participating national central banks are firmly enshrined in the Maastricht Treaty. Members of the Governing Council are not allowed to take or seek instructions from anybody, politicians included. Politicians are not allowed to give such instructions. Members of the Governing Council have a term of office of at least five years. The ECB is financially independent.

The independent status of the ECB fits into the recent world-wide trend of granting independence to central banks. This tendency is evidenced by both practical experience and academic research. By shielding monetary policy decisions from political interference, price stability can be maintained without having to give up economic growth. Indeed, in that sense having an independent central bank is a good thing for all concerned. The reason for central bank independence is that monetary policy-making under the influence of politicians tends to focus too much on short-term considerations. This can easily lead to temporary, non-sustainable increases in growth, but inevitably results in lasting increases in inflation with no lasting gains in growth and employment at all. Politicians all over the world have come to realise this and have decided to remove the temptation to pursue short-term gains and to make their central bank independent. It should be underlined that granting this independence is, as it should be, a political decision. An independent central bank needs a clear legal mandate.

3. The monetary policy strategy

The ECB has, as I mentioned earlier, such a mandate. However, the Treaty does not specify how the ECB should pursue its primary objective of maintaining price stability; in other words: it is silent on what is called the monetary policy strategy. The ECB therefore formulated its strategy in the second half of last year. That was no easy task. The introduction of the euro constitutes a structural break, which may change the behaviour of firms and individuals and make it less predictable. To a certain extent it is comparable to what Poland experienced when it embarked on its reform process. The rules of the game change and this makes policy-making more complicated. Our monetary policy strategy has taken these specific circumstances into account. It is tailored to this unique period of the introduction of the euro, although it has elements of both monetary targeting and inflation targeting.

In the context of this strategy the ECB has provided a quantitative definition of price stability. Price stability is defined as a year-on-year increase in the harmonised index of consumer prices (HICP) of below 2% for the euro area as a whole. Price stability is to be maintained in the medium term.

The strategy consists of two pillars. The first pillar is a prominent role for money. Ultimately, inflation is a monetary phenomenon. It is in the end result of too much money chasing too few goods. Therefore, we have formulated a reference value for the growth of a broad monetary aggregate, M3, of 4 Ѕ% on an annual basis. Growth of the money stock at this pace would provide the economy with sufficient liquidity for growth in activity in line with trend growth, without inflation. At the end of this year this figure will be reviewed. It should be emphasised that we did not define a target for money growth. The reason for this is the structural break that the introduction of the euro creates. By calling this a reference value, it is made clear that money is one variable which we look at very carefully in order to examine whether inflationary or deflationary pressures are tending to emerge. We do not, however, react mechanistically to changes in money growth.

The formulation of the second pillar is also prompted by the potential changes in economic behaviour on account of the introduction of the euro. It is a broadly based assessment of the outlook for price developments on the basis of an analysis of monetary, financial and economic developments. In this context interest rates, the yield curve, wage developments, public finance, the output gap, surveys of economic sentiment and many other indicators are analysed. Use is also made of forecasts produced by other bodies and internally for inflation and other economic variables.

This brings me to the role of the exchange rate of the euro in our strategy. Since our primary objective is price stability and since the euro area as a whole is a relatively closed economy with an export share of 14% of gross domestic product, we do not have a target for the exchange rate of the euro, for example, against the US dollar. This does not mean, and it is good to underline this once more, that the ECB is indifferent to the external value of the euro or even neglects it. The external value of the euro is one of the indicators we look at in the broadly based assessment of the outlook for price developments. Within that framework, we constantly monitor exchange rate developments, analyse them and shall act on them, if and when this becomes necessary. However, such action will never be mechanistic, nor will it be isolated. The external value of the euro and its development are analysed and considered in the context of other indicators of future price developments. The ECB also tries to assess international confidence in the still very young euro. Of course, the level of international confidence in the euro is not the only factor determining its external value, nor is the exchange rate the only indicator of confidence in the euro. It is, for instance, encouraging to see how the euro has been received on the international money and capital markets. I am sure that an internally stable euro will also strongly underpin international confidence in this currency, as it has for other currencies in the past.

As the currency of a very large area, the issue of the international role of the euro naturally arises. The ECB takes a neutral stance regarding this role. It will neither be stimulated, nor hindered. On the one hand, an international currency has advantages for citizens in the euro area, on the other, it may sometimes complicate the conduct of monetary policy when a large amount of euro is circulating outside the euro area. We shall leave the development of the international role of the euro to market participants and market forces. If history is a guide as to what will happen, there will be a gradual process whereby the euro will have an increasingly international role. Such a gradual development would also be a welcome development, if only to prevent the euro from becoming too strong externally at some point in time. It is likely and understandable that interest in the euro is already considerable in those countries aspiring to join the EU, including Poland. I shall elaborate on this issue at the end of my speech.

Coming back to our monetary policy strategy, I should like to point out that it is important to make clear what monetary policy can and cannot do. Monetary policy can maintain price stability, but only in the medium term. In the short term prices are also influenced by non-monetary developments. Moreover, monetary policy measures only have an impact on prices with long, variable and not entirely predictable time-lags of between 1.5 and 2 years. Therefore, monetary policy-making should have a forward-looking character. Today's inflation is the result of past policy measures, and current policy measures only affect future inflation. The uncertainty of the economic process in a market economy is another reason for policy-makers to be modest. The ECB does not pursue an activist policy. Precise steering of the business cycle or a cyclically-oriented monetary policy are not feasible and are likely to destabilise rather than stabilise the economy. Some commentators have interpreted our recent interest rate reduction as a change to a more cyclically-oriented monetary policy strategy. This is not true. Our strategy was, is and shall remain medium term-oriented and firmly focused on maintaining the price stability which currently prevails in the euro area.

Monetary policy should be supported by sound budgetary policies and wage developments in line with productivity growth and taking into account the objective of price stability. Otherwise, price stability can only be maintained at a high cost in terms of lost output and employment. This also explains why independence should not mean isolation. It is important to have a regular exchange of information and views with other policy-makers. The Maastricht Treaty stipulates that the President of the ECB is invited to meetings of the EU Council meeting in the composition of the Ministers of Economy and Finance whenever there are issues on the agenda which are relevant to the ECB's tasks. The President of the Council of Ministers and a member of the European Commission may attend meetings of the Governing Council, although they do not have the right to vote. The President of the Council of Ministers may submit motions for deliberation. Apart from these formal contacts, there are many informal contacts, for example in the context of the so-called Euro-11 group of finance ministers from the euro area countries. I regularly attend meetings of this group.

Monetary policy cannot be used to solve structural problems, such as the unacceptably high level of unemployment in the euro area. Structural problems call for structural solutions, in this case measures targeted at making labour and product markets work more flexibly. The best contribution the ECB's monetary policy can make in this context is to maintain price stability. In this way one of the conditions for sustainable growth in incomes and employment is created. As important as this is, it should be realised that jobs are created by firms which are confident about the future and not by central banks.

4. Accountability and transparency

Accountability for policies is the logical complement to independence in a democratic society. The Maastricht Treaty includes a number of provisions in this respect. First, there is the mandate to pursue price stability. This provides a qualitative measure against which the ECB's performance can be measured. As I have already mentioned, we have decided to enhance this by providing a quantitative definition of price stability. One of the aims of publishing our monetary policy strategy is to make our policy decisions transparent.

The ECB has to publish an annual report in which, inter alia, the monetary policy of the previous and current year are discussed. I present this Annual Report to the EU Council and to the European Parliament, which may hold a general debate on the basis of it. The President and other members of the Executive Board of the ECB may be heard by the competent committees of the European Parliament. I have agreed to appear before the European Parliament at least four times a year. The ECB has to report on its activities at least quarterly. It has been decided to go beyond this requirement and to publish a monthly bulletin.

It is my view that the main way to achieve accountability is through being transparent and open. In passing, I should like to note that transparency also enhances the effectiveness of a central bank. The better it is understood, the more successful a central bank is. Apart from the activities I have already mentioned, transparency is achieved in several ways. Every month, after the first meeting of the Governing Council, the Vice-President and I give a press conference. I start the conference with a comprehensive introductory statement, in which I explain the decisions taken by the Governing Council and the underlying analysis and arguments for and against. This introductory statement is published immediately on the ECB's Internet Web site. This is followed by a question and answer session attended by several hundred journalists. The questions and answers are also published on the Internet shortly afterwards. All the members of the Governing Council frequently make speeches, give interviews and contribute to journals and books. Thousands of people visit the ECB and the national central banks each year and, for our part, we and our staff attend many conferences and other public events.

5. EU enlargement

The European integration process continues. The euro should be made a success. I have already explained how we have started the process of doing that. Some observers have criticised the EU for its "obsession with its own internal dynamics", in particular in the context of European Economic and Monetary Union (EMU). With all energies focused on meeting the convergence criteria and the preparation for the launch of the euro, Europeans outside the EU have wondered whether EMU and enlargement are not mutually exclusive objectives.

Let me briefly comment on this issue. After the historic decision to complete the European Single Market in the 1980s, it was felt that economic integration should not stop at that point. To fully reap the rewards of economic integration within the Community, a single currency was felt necessary; a logic pointedly encapsulated in the title of one report: "One market, one money".

Hence, the underlying idea of EMU was to advance European integration and to ensure that full use would be made of the economic potential of the Single Market. This idea continues to be the focus of European policy-makers, as evidenced by the association agreements and the ongoing accession negotiations with a number of European countries, Poland among them. Good and mutually beneficial economic relations with third countries in Europe and further afield are a pillar of EU policy orientation. Recognising this, the principles of an open market economy with free competition are enshrined in the Treaty on European Union. EMU will not weaken this commitment, but rather reinforce it. Closer co-operation in Europe and the respect of common principles in the political, economic and social fields are likely to form the basis for further integration. The ECB shall contribute to this process within the scope of its responsibility.

Countries wishing to deepen their monetary co-operation to the ultimate extent possible by forming a monetary union will have to adapt their economic and legal systems to the standards required by the Treaty and aim at a sufficient degree of economic convergence. In the absence of these conditions, adjustment costs for both current and new participants could be high. Any premature decision on the adoption of the euro could have severe repercussions on a country's competitiveness and trigger painful economic adjustments. Therefore, implementation of the necessary institutional reforms and of a sufficient degree of convergence should not be considered as an obstacle preventing further integration in Europe, but rather as an essential means of ensuring the lasting success of EMU, for existing and new participants alike. Looking at the impressive progress made in a relatively short time in this country, there is no reason to be pessimistic about Poland's chances of meeting these standards and convergence criteria. I shall not venture, however, to predict when this will be the case.