Jürgen Stark: EMU - recent developments
Opening address by Dr Jürgen Stark, Vice President of the Deutsche Bundesbank, at CEPR/ESI
Conference on "The Euro Area as an Economic Entity", hosted by the Deutsche Bundesbank in
Eltville, 12 September 2003.
* * *
I am very pleased to welcome you here at the Bundesbank's Training Centre on the occasion of the
seventh CEPR/ESI Conference.
It is important that academics meet with central bank staff. On the one hand, these meetings can help
to convey new ideas to monetary policymakers. On the other hand, these ideas should also be
scrutinised by more practice-oriented economists. Such meetings also serve the mutual understanding
of one another and help to clear up misunderstandings.
I consider these meetings especially valuable because academics should increasingly confront
themselves with practical questions and day-to-day policy making. In turn, central bankers are too
closely watched to allow themselves to fall behind the curve of academic thinking.
Only a few years ago, the title of this conference would have had a question mark at the end. This is
no longer necessary. The euro area, with the highest possible degree of monetary policy integration, is
indeed an economic entity, but obviously not a political entity. The political regime consists of a
centralised monetary policy and decentralised, but coordinated, economic and budgetary policies. This
institutional setting is challenging. It is a unique but appropriate concept tailored to European needs.
We all know, the euro area did not become an economic entity overnight. This fascinating
development has its roots in a much broader process initiated in Europe almost half a century ago.
The convergence which has taken place in the run-up to monetary union and beyond is impressive.
However, this process of European integration is far from complete and is still evolving.
Let me now turn to more recent developments. Naturally, the conference will touch upon crucial issues
arising after the first five years of the third stage of European Monetary Union (EMU).
In order to stimulate the discussion, allow me to make a few comments from the vantage point of
someone involved in the practical sphere of monetary union: I will comment:
firstly on the ways the perception of monetary policy within the euro area has evolved;

secondly on converging or diverging growth and inflation rates; and

finally on what we have learned up to now with regard to policy coordination and the Stability

and Growth Pact.
1. Monetary policy
In the past some rather critical statements have been made by academics belonging to the Centre for
Economic Policy Research with regard to monitoring the ECB. At times one actually had the
impression that the ECB came off much worse than other central banks. These criticisms ranged from
those on individual measures taken by the ECB - or it refrained to take - to questions of
communication and strategy. Concerns, for example, were voiced about the role of monetary growth in
the ECB's strategy. There were also many calls for a more precise definition of the term price stability.
Another favourite pastime seems to have been the hunt to dismantle at last the unpopular Stability and
Growth Pact.
Since reviewing its strategy this year, the ECB has been making efforts to clarify some
misunderstandings which have emerged in its communication with the public. It was made clear that
with regard to price stability, the ECB was striving to maintain a medium-term inflation rate of below
but close to 2%. Furthermore, it was stressed that money has to be evaluated with respect to the
long-term relationship between monetary growth and price dynamics. The "monetary analysis" will
complement the "economic analysis", which is more relevant in the short to medium term.
I have the impression that, in general, these clarifications were well received. I hope that the
conference today and tomorrow will help to shed some light on other important issues within the euro
area as well.
2. Business cycles and inflation differentials
The introduction of the euro was linked to the expectation that the business cycles of the member
states would converge more closely. Furthermore, a decoupling from the US business cycle was
expected since the euro area has only a marginally higher degree of openness than the United States.
The diversion of growth rates among member states has declined recently. Unfortunately this
represents a convergence towards Germany's stagnating growth figures - and not towards the faster
expanding euro area countries, as would actually have been desirable.
Contrary to expectations at the outset of monetary union, the business cycles of the euro area and the
US seem to be still closely correlated. Economic globalisation has increased international linkages
through various channels such as trade, foreign direct investment flows, globalised financial markets
and interlinked business expectations. But the most significant point is that shocks to confidence such
as the bursting of the high-tech equity bubble and the terrorist attacks have hit capital markets to a
similar extent all over the world.
A lack of convergence is revealed by the sustained differentials in inflation among the euro area's
member states. It is true that these differentials are fairly small in comparison to the first half of the
1990s. However, following a substantial convergence in the run-up to EMU, inflation differentials
widened again.
Divergent economic developments are apparent in other currency areas, too, such as in the USA,
without monetary policymakers being able to address this issue. Monetary policy has to be geared
towards the data for the currency area as a whole. It cannot address regional policy problems.
Otmar Issing once coined that quite succinctly - "one size must fit all!" The member states had to
accept that fact when they joined the third stage of European economic and monetary union. If
persistent diverging trends emerge, either they have to be accepted, or, if detrimental economic
consequences result, measures need to be taken at the national level. However, interest rate
differentials also reflect the adjustment of the real exchange rate.
But I do not want to elaborate much on inflation differentials. This issue will be covered in depth in
tomorrow's policy lecture by my colleague, Hermann Remsperger.
3. Policy coordination and Stability and Growth Pact
The asymmetry of political responsibilities in EMU makes a comprehensive system of coordination
procedures indispensable. I believe this is undisputed. The rationale arises from the need to take
account of the spill-over effects from national economic policies. Consequently, the EC-Treaty obliges
member states to consider national economic policies "as a matter of common concern" and subject
them to multilateral procedures.
Of all the coordination mechanisms, name recognition is highest for the Stability and Growth Pact. The
Pact may not be popular in all places, but at least it is well known, albeit not well understood
everywhere. I will later on try to illustrate why I remain an ardent advocate of the Pact.
However, the core coordination instrument are the broad economic policy guidelines (BEPG). They
contain the principal policy objectives and measures. They build the overarching structure for the more
specialised coordination and consultation procedures. The guidelines make specific recommendations
to each member state and to the Community and are endorsed by the Heads of State or Government.
However, they are politically but not legally binding and there are no really effective instruments for
enforcing their implementation. Due to the medium and long-term nature of many recommendations,
measuring progress concerning implementation has become the main focus of the Commission's
work.
The specific coordination processes are:
 The Luxembourg process (1997), which aims to create more employment. It consists of
employment guidelines which have to be implemented by "national action plans" on
employment and are monitored by the Commission.
The Cardiff process (1998), which is intended to enhance structural reforms in the member

states and their multilateral monitoring to create "peer pressure" among them.
The Cologne process (1999), which established a "macroeconomic dialogue" at Community

level with representatives of governments, ECB and trade unions involved. This dialogue
aims not to achieve an ex-ante coordination of economic policies, but the exchange of
information and views on economic developments.
These processes were enhanced in 2000 by the "Lisbon-strategy" with its "new strategic goal" for the
next decade, that is "to become the most competitive and dynamic knowledge-based economy in the
world, capable of sustainable economic growth with more and better jobs and greater social cohesion".
A very important conclusion in Lisbon was that no more coordination processes are needed and that
the existing processes should be simplified. It is also very reasonable that the BEPGs now focus
increasingly on structural policies. That can be a vantage point for the coordination processes to
accomplish better-then-expected results in future. Up to now, it has been difficult to detect a noticeable
impact from these various coordination processes on the convergence among member states.
Within the framework of the Luxembourg process, governments did not meet their commitments to
enhance employment. Unemployment is increasing again and is not significantly lower than in 1997. In
keeping with wage autonomy, governments simply cannot impose any guidelines that regulate
negotiations between management and trade unions. Up to now, the Cardiff process has led to only
limited progress, if at all, on structural reforms in larger economies. The Cologne process seems
unnecessary to me. In my judgement, all these processes have been little more than bureaucratic
exercises.
What are the reasons?
after convergence efforts in the run up to the third stage of EMU: adjustment fatigue;

the willingness for further progress on integration has lost steam;

political behaviour has not adapted to the new environment.

The integration of Europe is linked to the readiness to curb national sovereignty. The lasting success
of the euro cannot be achieved solely through monetary policy. The success relies as well on the
support of the fiscal, labour and structural policies of member states. However, coordination should not
be understood as a substitute for the responsibility of policymakers at the national level. The
decentralised approach offers scope for healthy policy competition. "Best practice" should prevail.
Furthermore, from a political-economy viewpoint, coordination is an extremely helpful instrument to
implement unpopular but necessary policy measures at the national level.
The Stability and Growth Pact is part of the foundation of economic and monetary union. But some
governments act as if they bore no overall responsibility for this political project of European
integration. The ongoing debate on so called "reform" or on relaxing the terms of the pact has already
damaged the foundation and will jeopardise the functioning of monetary union in the medium term.
However, it was in fact, a great achievement to adopt self-imposed budgetary rules in order to support
monetary policy and to prevent a repetition of the problems of the 1970s. Furthermore, the Stability
and Growth Pact is dealing with the challenges of ageing populations.
A critical assessment has to be made, I feel, concerning those initiatives - some of which have already
been implemented - that aim to refine the rules of the pact. As a result, these rules, which were
originally straightforward and transparent, are becoming increasingly complex and opaque. Even so,
the debate is continuing down the same road. The proposals contained in the Sapir Report of June
2003, which would allow an overshooting of the 3% criterion not only in "severe recessions", but also
given almost any decline in economic performance, would dilute the Stability and Growth Pact to the
point where the fiscal policy rules are no longer recognisable.
I agree with Otmar Issing: the real problem is not any supposed lack of flexibility in the pact, but the
failure of some large economies in the euro area to make use of growth phases towards sound and
sustainable fiscal positions, like others did. The current difficulties should therefore not tempt
politicians to relax the rules of the Stability and Growth Pact but to apply the rules strictly. The pact is,
after all, not an end in itself. It is in the very interest of member states and their people. The
consolidation of public finances is indispensable, not least in view of the to be expected strains and
burdens on future generations from demographic changes.
The Stability and Growth Pact should be seen as part of a comprehensive strategy to avoid
pro-cyclical behaviour, to create sufficient budgetary safety margins and to attain sustainable public
finance. I know it will be difficult to achieve, but I would very much welcome your support in convincing
both the public and politicians that the principles and procedures for budgetary policy in the Treaty and
in the Stability and Growth Pact are vital for the success of Economic and Monetary Union.
I believe I am on common ground in stating that from a theoretical perspective, the impact of fiscal
policy on the economy is rather uncertain. Empirical evidence generally points to a positive but low
impact of an expansionary policy on output. Therefore, the power of fiscal policy to reduce cyclical
volatility or to stimulate the economy should not be overestimated.
Discretionary fiscal measures have proved to be ill-suited for fine-tuning the economy in the past. Due
to time-lags it has often lead to a pro-cyclical impact on the economy. Moreover, asymmetric
behaviour in recessions and booms has contributed to deteriorating public finances in the last
decades.
Instead, structural reforms directed at improving price and wage flexibility and the mobility of labour
could strengthen other channels of stabilisation.
To sum up, by ensuring sound fiscal positions and emphasising the role of automatic fiscal stabilisers
in dampening cyclical fluctuations, the EC-Treaty and the Stability and Growth Pact form an adequate
framework for fiscal policy in monetary union. The pact is not a curse but a blessing.
And on a personal note, I would like to add that the very constituting principle of all democracies is the
rule of law. It means that government in all its actions is bound by rules fixed and announced
beforehand. The rule of law lays down the primacy of law over policy. Governments which do not
uphold this principle offend against the fundamentals of modern societies and risk a substantial loss of
confidence. This holds true for Argentina's arrears to the IMF and for attempts of EU-Countries to not
comply with the spirit and letter of the EC-Treaty and the Stability and Growth Pact.
The latter is especially disturbing, because the rule of law in modern societies seems to be a French
invention. It is based on the principle of separation of powers which was formulated as early as 1748
by the great French political philosopher, Montesquieu. Moreover, it was the French people who first
realised this concept in continental Europe. A government breaching the law leads down the slippery
slope from which escape is extremely difficult to find.
I would also like to draw your attention to a paper Hermann Remsperger and I have written on the
importance of budgetary rules and on the criticism of the Stability and Growth Pact. Up to now there is
only a German version but the English translation is already in preparation and will be available in a
few days on our website.
My experience tells me that central bankers and academics alike are willing to listen and to learn. The
ability and willingness to comprehend is decisive for the success of this conference.
My most important task today is to award the CEPR/ESI prize for the best central bank research
paper. Of the numerous papers submitted, Gert Peersman's paper entitled "What caused the early
millennium slowdown? Evidence based on vector autoregressions" was deemed to be the best. The
paper attempts to answer this difficult question by academic means. At the same time, the paper
demonstrates to what extent our answers are determined by the respective method of analysis used.
Mr Peersman, I congratulate you on receiving this award.