Willem F Duisenberg: Testimony before the Committee on Economic and
Monetary Affairs of the European Parliament
Introductory statement by Dr Willem F Duisenberg, President of the European Central Bank, Brussels,
3 December 2002.
* * *
It is my pleasure to continue today our regular dialogue. I will start my opening remarks with an
explanation of the European Central Bank's assessment of economic and monetary developments.
Subsequently, I will address some issues related to the EU arrangements for financial regulation,
supervision and stability.
Economic and monetary developments
Already at the time of our last meeting in October, the expectation had faded that economic activity in
the euro area would reach growth rates in line with trend potential by the end of 2002. In the course of
the summer, the downside risks to economic growth had become evident, reducing the likelihood that
upward risks to price stability would materialise. This development was mainly related to the episodes
of turbulence in financial markets and to the persistence of geopolitical tensions, which created
uncertainty and affected the outlook for economic activity in the euro area and at the global level.
Starting with the first pillar of our monetary policy strategy, since our last meeting monetary growth has
remained rather strong in the euro area. However, recent monetary data need to be interpreted with
caution, as the dynamics in M3 over recent months have been considerably boosted by high
uncertainty in financial markets, which has favoured portfolio shifts to the more liquid instruments
included in M3. At the same time, the persisting strong monetary growth and the resulting ample
liquidity have also been driven by the low level of short-term interest rates, which stimulates demand
for the most liquid assets which are included in the narrow aggregate M1. Loans to the private sector
have stabilised at growth rates between 5 and 5 1⁄2% in the most recent past. These are levels which,
in real terms, are not low given the cyclical situation.
Overall, more liquidity is available than would be needed to finance sustainable, non-inflationary
growth. At the same time, in the current economic environment, we do not see the risks of this excess
liquidity translating into inflationary pressures in the near future.
Turning to the second pillar of the ECB's monetary policy strategy, and starting with economic activity,
the available evidence indicates that economic activity has most likely continued to grow only
moderately in the third quarter of this year. As already noted, the hesitant pace of economic activity, as
compared with our expectations in early 2002, together with lacklustre confidence, reflects the
significant degree of uncertainty that has been building up over recent months. Early indications for
the fourth quarter of 2002 suggest that the pace of economic growth has remained broadly
unchanged.
For the time being, the main scenario for the euro area remains that economic growth should return to
rates close to potential in the course of 2003. This expectation is consistent with forecasts published
by international organisations and private institutions. In addition, financial markets have shown signs
of stabilisation in recent weeks, although volatility in the stock markets has remained high by historical
standards. The expectation of an improvement in economic activity in the euro area is contingent on
the unwinding of the current high level of uncertainty and on a recovery of growth in private
consumption, which has shown signs of resilience in the recent past. In addition, this expectation is
also based on a gradual recovery of world demand which, together with the low levels of interest rates,
should help to strengthen investment.
However, there are several downside risks to this scenario. They relate to the persistence of
macroeconomic imbalances in the global economy, geopolitical tensions and the uncertainty about the
size of the adverse effects of the past sharp declines in stock prices on aggregate demand in the euro
area and in the other major regions of the world. Moreover, risks also stem from the fact that structural
rigidities in the euro area economy do not facilitate the process of price and wage adjustments to
external shocks. Thus, overall, it remains difficult to predict at this juncture the timing and strength of
the acceleration of economic activity.
Regarding price developments, annual HICP inflation rates have been slightly above 2% in recent
months. These annual HICP inflation rates are likely to increase in the remainder of 2002 and stay
above 2% in the early months of next year, mainly on account of base effects and increases in indirect
taxes and administered prices in a number of countries. Subsequently, however, HICP inflation rates
should fall again, and provided that oil prices do not increase significantly and wage moderation
prevails, reach levels in line with our definition of price stability in the course of 2003. Looking further
ahead, both the strengthening of the euro exchange rate this year and the subdued economic activity
continue to contribute towards reducing inflationary pressures. Furthermore, for price pressures to be
contained, it is crucial that the upward trend in labour cost indicators observed in recent years does
not continue. The notable inertia in wages despite the subdued economic expansion has been of
some concern, although recent developments may suggest that wage costs have not accelerated
further in the course of this year.
At our last monetary policy meeting on 7 November we discussed extensively whether or not to reduce
the key ECB interest rates, in view of the high uncertainty surrounding future economic growth and its
implications for medium-term inflationary pressures. Summing up, there were elements in favour and
against both alternatives. On the one hand, the subdued trends in economic activity and the stronger
exchange rate of the euro supported the view that inflationary pressures should decline. On the other
hand, the stubbornly persistent rate of inflation excluding the volatile components of energy and food
prices as well as monetary and wage trends, argued for caution. Overall, on that occasion the view to
keep the key ECB interest rates unchanged prevailed. However, we also indicated that we needed to
monitor the downside risks to economic growth for their impact on medium term inflationary pressures.
Since our last meeting, the evidence has strengthened that inflationary pressures are easing
somewhat and downside risks to economic growth have not vanished.
Regarding fiscal policy in the euro area, I would like to reiterate that budgetary discipline is
indispensable for the success of EMU. Fiscal discipline strengthens the conditions for strong
sustainable growth conducive to employment. Sound fiscal positions also provide scope for dealing
with the expected fiscal challenges caused by population ageing. Clearly, therefore, sound public
finances, as enshrined in the Treaty and further developed in the Stability and Growth Pact, are in the
interest of all Member States.
I want to stress that the current fiscal framework strikes the right balance between discipline and
flexibility. By prescribing a medium-term objective of budgetary positions close to balance or in
surplus, the Stability and Growth Pact guarantees that fiscal policies will preserve the sustainability of
public finances while providing sufficient flexibility for automatic fiscal stabilisers to operate.
While it is clear that, for many - partly formal - reasons, annual budgetary targets always need to be
set in nominal terms, the assessment of fiscal policies naturally must take into account cyclical
developments. Though the discussion surrounding this issue may, at times, appear confusing, it does
not reflect a flaw in the Pact as some critics claim.
In this context, it is worth recalling that most Member States have reached budget positions which are
"close to balance or in surplus". Current fiscal problems in other countries have arisen not because the
rules are inflexible, but because countries have not honoured their commitments to make progress in
fiscal consolidation, particularly during good times. It is now high time for the countries with deficits
approaching or even exceeding 3% of GDP to honour their commitment to respect the rules. We very
much support the Eurogroup agreement that all countries with remaining imbalances should undertake
to fulfil their commitments by implementing a clear consolidation strategy. And we very much believe
that a growth-oriented consolidation policy - which aims at strengthening the productive forces of the
economy - will be an important means to strengthen the economic prospects for the euro area at this
juncture.
Additional efforts regarding transparency and timeliness in the implementation of the procedures of the
Pact are also necessary. They will help convince the public that the current framework is fully
successful in preserving discipline and providing flexibility. In this context, the Commission recently
issued a communication which aims to clarify certain aspects of the fiscal framework while
strengthening its main principles and objectives. The ECB considers this a good starting-point for
rebuilding confidence in the budgetary policy framework.
Finally, neither the discussion on monetary or fiscal policy, nor the current economic outlook should
divert attention from the need to implement decisively the structural reform agenda. We note with
some concern that progress is slow in many countries of the euro area. I should like to emphasise that
the benefits of these reforms for the economic growth potential of the euro area are likely to be
substantial. While these benefits will only be fully reaped over the medium term, I believe that reforms
would be particularly important at the current juncture. Indeed, determined structural reforms in labour,
product and financial markets should make a significant contribution to strengthening confidence,
making the euro area more attractive for investors. In the end, this will also support economic growth
in the short term.
Issues related to the EU arrangements for financial regulation, supervision and stability
Today, the ECOFIN Council is considering adapting the EU structures for financial regulation,
supervision and stability. The ECB keenly supports the basic thrust of such proposals, namely to
reduce barriers to further financial integration and to maintain systemic stability in financial markets,
which have become increasingly interconnected in a single currency area. Against this background,
the respect of the subsidiarity principle in supervisory matters necessitates enhanced co-operation
between national authorities.
The ECB has repeatedly stressed that in the banking sector close and effective co-operation between
central banks and supervisory authorities is crucial for the promotion of financial stability, a point that I
am glad to see strongly backed also in recent resolutions of the European Parliament. The ECB has
also emphasised that technical authorities need to be represented in regulatory committees and that
any new arrangements for financial stability should draw on the technical expertise at central banks
and supervisory agencies. All these points are reflected in the proposals endorsed by the ECOFIN
Council in October.
Now the crucial phase is beginning when the ability of the new arrangements to meet the high
expectations they are raising will be tested in practice. The measure of success will be whether the
overall rulebook, with which financial institutions operating throughout the EU have to comply,
becomes more homogeneous across countries. This will require a fine re-balancing of primary and
secondary Community legislation and national rulebooks, which should be conducted in a transparent
manner by the committees to be set up under the new supervisory regime, paying careful attention to
the costs of compliance. The review of the new arrangements that was requested by the European
Parliament will offer an appropriate tool for checking the progress made. Let me conclude by
highlighting that supervisory authorities and central banks should step up information sharing and
develop joint assessments. This will also allow the effectiveness of the new arrangements in
supporting financial stability in the Single Market to be tested.