Lucas Papademos: What effects is EMU having on the euro area and its member
countries (opening remarks)
Opening remarks by Mr Lucas Papademos, Vice-President of the European Central Bank, at the ECB
Workshop "What effects is EMU having on the euro area and its member countries?", Frankfurt,
16 June 2005.
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Introduction
When the ECB started organising this workshop a year ago, we thought that addressing the question
of the workshop's title would provide a necessary stocktaking and useful analysis of the effects of
EMU on the euro area and its member countries, 61⁄2 years after the introduction of the single
currency. Recent developments and debates have shown that the impact of EMU on the euro area
countries is a very topical issue indeed. Officials, economists and commentators have sought to
analyse the pertinent issues and tried to answer the question of this conference. And some of them
have come to conclusions which my colleagues in the Governing Council have called "absurd",
"nonsensical" or implying "economic suicide" - and rightly so. This debate has sometimes risked being
fairly long on polemics and rather short on arguments. With this workshop, to which I would like to
welcome you all, we can bring to this discussion some solid facts, sound arguments and a better
understanding of the manifold issues involved.
The debate on these issues has often been couched in terms of two key concepts, "convergence" and
"heterogeneity" (which do, however, need clearer definitions), and the relationship between the two.
On the one hand, further integration of labour, product and capital markets can be expected to reduce
economic heterogeneity within the euro area. On the other hand, some degree of heterogeneity can
be expected to remain and, indeed, it can be considered a natural feature of any monetary union.
These propositions raise several important questions, for example:
• What kind of convergence processes has EMU set in motion?
•
To what extent has EMU-induced convergence moderated economic heterogeneity within
the euro area?
•
What are the causes and consequences of sometimes sizeable and in some cases
persistent inflation and output growth divergences across different euro area countries, in a
macroeconomic environment shaped by the ECB's monetary policy, which aims to preserve
price stability for the euro area as a whole?
These questions, which will be addressed in this workshop, relate to diverse but interrelated issues,
such as trade integration, business cycle synchronisation, financial integration, structural reforms in
product and labour markets, as well as inflation persistence and inflation differentials. I believe that the
quality of the papers to be presented and the impressive group of discussants, chairpersons and
panellists will contribute to fruitful debates.
Looking at the titles of the various sessions of the workshop, I would like to share some thoughts with
you on three specific topics. The first relates to the consequences of market integration for trade. The
second, "closer to home" for a central banker, concerns inflation and output divergences across euro
area countries and their implications for policy. The third pertains to the role of the euro in fostering
reforms in product, labour and financial markets.
The implications of the integration of goods, services and financial markets for trade
The first topic - the effects of market integration on trade - is particularly interesting, as it raises a
number of issues which sometimes seem to lead to puzzling results. First, the conclusions about what
we should expect as the trade effects of deeper integration are, in part, ambiguous - think, for
example, of the effects of specialisation. Increased competition achieved by deregulation and the
completion of the single market, as well as cross-border price transparency due to the single currency,
may foster higher sectoral or industry-specific specialisation. Greater sectoral specialisation, as well as
increased financial integration, should lead to increases in trade flows within the euro area. At the
same time, however, if increased integration were to lead to more similar economic structures and
business cycles, this could weaken trade flows within the euro area.
But even if the expected effects of integration are not as ambiguous, appearing instead to be rather
straightforward, the evidence available thus far seems not to fully conform with the expectations. Take,
for example, the significant progress that has been made in the 1990s regarding product market
reforms, which had positive effects on the integration and the degree of competition in goods and
services markets in the euro area. One could expect that easing regulations and fostering competition
would lead to higher labour productivity growth in the industries concerned, as has happened, for
example, in the telecommunications sector. Yet, over the past decade the euro area as a whole has
experienced a decline in trend labour productivity growth.
A number of other effects of integration on trade should also be looked at: for instance, whether labour
regulations and taxation that hamper technological innovation could lead to a decline in exports within
the euro area, as well as resulting in lower exports from the euro area to the rest of the world. As
regards the latter effect, it appears that the product composition of euro area exports might involve
risks for the future export performance of the euro area, if the under-specialisation in fast-growing
high-tech sectors is not adequately addressed. Richard Baldwin's paper offers a very useful and
comprehensive treatment of the issues related to the euro's trade effects. And what he found - or did
not find - should certainly provide fertile ground for a fruitful discussion in the first session.
Inflation and growth divergences in the euro area and policy implications
The existence of divergences in growth rates and inflation in the euro area, and the associated
challenges posed for economic policy in general, and the single monetary policy in particular, are
issues that have been debated extensively and intensively since the creation of the euro. They have
again been at the centre of public debate in recent months, partly as a result of the performance of the
euro area economies over the past few quarters, and partly as a result of uncertainties and concerns
deriving from the ratification process for the Constitutional Treaty. In this context, doubts have even
been raised about the sustainability of the single currency. There are four key questions that should be
addressed regarding this matter:
•
Are growth and inflation divergences a real problem in a monetary union?
• And, if so, how serious is the problem for the euro area?
•
Are these divergences likely to get worse or likely to be self-correcting?
•
What can be done to reduce these divergences and at the same time foster higher growth
for the euro area as a whole?
It is worth recalling that growth and inflation divergences between member countries are a natural,
inevitable phenomenon in any large monetary union, as evidenced by the experience of a
long-established one, the United States. And, in general, they may reflect both structural and
conjunctural factors that affect differently the monetary union's countries or regions. Differences in
economic structures and/or in market adjustment mechanisms across member countries imply that
common or global shocks and common policies will have different effects on their economies.
Moreover, growth and inflation differentials may also reflect the impact of asymmetric shocks, fiscal
policies and diverging productivity and wage developments. Whether such divergences create
problems for the performance and functioning of a monetary union depends on their causes, size and
persistence.
What are the facts about the relative macroeconomic performances of euro area member countries?
And what is the diagnosis about the causal factors and the underlying processes that explain them? I
would like to point out two interesting facts that are contrary to popular perceptions. The first is that
during the first six years since the creation of the euro, the growth and inflation differentials observed
between member countries have not been greater than those recorded in the 25 years before the
establishment of EMU. On the contrary, according to some measures, the dispersion in growth rates
has recently reached a historically low level. The second fact is that both growth and inflation
differentials in the euro area since the introduction of the euro have been broadly of the same order of
magnitude as the corresponding differentials observed across regions and metropolitan areas in the
United States. These facts would seem to suggest that, at least on the basis of size, the heterogeneity
observed in the macroeconomic performance of euro area member countries is not exceptional and
thus need not be a cause of alarm.
Nevertheless, there are certain other developments that suggest caution and point to the need for a
deeper and more comprehensive analysis. One such development relates to the significant and
persistent divergences in measures of competitiveness between member countries. The diverging
competitiveness is a consequence of various factors and policies as well as of market adjustment
mechanisms, which in some cases reflect rigidities in labour markets and the low degree of integration
and competition in certain product markets, particularly for services. The persistence of these
developments suggests that adjustment mechanisms are functioning slowly and that self-equilibrating
forces are not sufficiently strong. The extent and the cumulative effects of differences in
competitiveness between some euro area countries raise concerns about their impact on growth. In
addition, other factors - some exogenous, such as competitive pressures resulting from globalisation,
and some internal, influencing consumer sentiment - affect economic activity and tend to compound
the adverse effects of the erosion of competitiveness in some countries or partly offset the benefits
from the increased competitiveness attained in other countries.
A better understanding of the factors and processes that determine economic fluctuations, inflation
persistence and competitiveness developments across the euro area countries will contribute to the
diagnosis of the present situation and the assessment of future trends. Two papers in this workshop
provide insights and useful results to this end. The extent of synchronisation of economic activity in
Europe is examined in the paper by Domenico Giannone and Lucrezia Reichlin, which evaluates
long-run tendencies and cyclical fluctuations. Different growth trends may be due to different patterns
of specialisation, which can be desirable within the monetary union provided that countries can share
risk through capital market integration. This study and other recent research show that European
financial integration has resulted in increasing opportunities to share risk. The paper by Ignazio
Angeloni, Luc Aucremanne and Matteo Ciccarelli concentrates on determinants of inflation dynamics
in different euro area countries, notably the evidence on the price-setting behaviour of firms and on
factors explaining inflation persistence. A thorough analysis of aggregate inflation dynamics and of the
inertia characterising core inflation is of direct relevance to the formulation of monetary policy and also
contributes to the diagnosis of the causes of growth fluctuations and of the high unemployment in
Europe.
One general conclusion that emerges from the papers prepared for this workshop is that the
divergences observed in the euro area are fundamentally the consequence of structural and not of
conjunctural factors - even if current divergences may also have been influenced to a certain extent
by conjunctural events. The policy implication of this general diagnosis is that more economic reforms
are needed to address the structural impediments to growth and the causes of growth and inflation
divergences. Of course, structural reforms are not always easy to implement, they may be politically
costly, and their positive effects may not be immediately visible - which makes it difficult to
communicate them and convince the public at large about their benefits. Nevertheless, only the
implementation of appropriate economic reforms can address effectively and permanently the root
causes of the euro area's economic problems. Consequently, the focus of the public debate should be
how to speed up the reform process and its beneficial effects and thus strengthen consumer and
business confidence.
The role of the euro in fostering reforms in product, labour and financial markets
Has the euro been of help in pushing the reform agenda? At the time of the launch of the single
currency, some observers had seen the euro as a "reform whip" that, together with the completion of
the single market, would push in the direction of increased competition, higher productivity growth and
greater market flexibility, which are essential for the smooth functioning of monetary union. After all, in
a single currency area, the adjustment of domestic imbalances cannot be corrected by exchange rate
policy any longer, but rather has to take place via prices and costs. The paper by Romain Duval and
Jørgen Elmeskov, which will be discussed tomorrow, will provide empirical evidence about the
determinants of the pace of the reform process. Our own ECB research, presented in the paper by
Lorenzo Cappiello, Philipp Hartmann, Peter Hördahl, Arjan Kadareja and Simone Manganelli, will
dwell on the impact of the euro on the integration of European financial markets, notably the equity
and bond markets. This stock-taking exercise and associated analysis should also assist in identifying
where, precisely, structural changes are most urgently needed and how to make the necessary
reforms a success.
Concluding remarks
The introduction of the euro and the conduct of the single monetary policy have established an
environment of price stability in the euro area. The ECB's monetary policy has acquired credibility and
has succeeded in anchoring long-term inflation expectations to price stability, thereby exerting a
moderating influence on price and wage-setting behaviour. Both short-term interest rates and
long-term bond yields are at historically low levels in nominal and real terms. But, as we know, price
stability and favourable financing conditions establish necessary but not sufficient conditions for
sustainable growth. There is still some way to go in terms of the implementation of the necessary
structural reforms that will result in faster and durable growth in the euro area, through higher
productivity growth, increased labour utilisation, and improved competitiveness in the global economy.
Which brings me to a final reflection, opening up a broader perspective.
The issues to be discussed in this workshop should also be seen against the background of
globalisation. The forces and dynamics of globalisation influence economic developments in the euro
area (for instance through pressures on firms' cost structures) and also have an impact on the
integration process that has been triggered by the euro. Of course, it is not easy to disentangle the
effects of globalisation on the European integration process from those which stem from the creation
of the single currency. However, both processes call for mechanisms that facilitate the economy's
efficient adjustment so as to cope with the challenges of a constantly changing environment for firms,
consumers and policy-makers. All of which reinforces the urgency to pursue the structural reform
agenda in the euro area in a determined and systematic manner. With this wider-ranging reflection, I
conclude. Once again, welcome to this ECB workshop. I can rationally predict that it will be a very
productive and enriching one.