Mr. Tietmeyer considers the euro: a challenge to, and opportunity for, the
Speech by the President of the Deutsche Bundesbank, Prof. Hans Tietmeyer,
financial markets
on the occasion of the 21st Colloquium of SUERF and CFS, delivered in Frankfurt on 15/10/98.
I
"Educational institutions - explicitly including universities - are not philanthropic
islands of abstract debate." This maxim of the German President's is borne out by this
colloquium. For this is not merely an "abstract debate". The subject is of great practical
relevance: "The euro: a challenge to, and opportunity for, the financial markets." And there can
be no talk of an "island", either. For this is a cross-border, joint meeting of SUERF and CFS.
Incidentally, the motive is the exchange of knowledge with the financial
community (including central banks), thus avoiding all suspicion of insular ivory-tower
erudition. There can be no doubt that the financial community will likewise benefit from an
exchange of knowledge. After all, the euro was and is an intellectual challenge for all those
concerned with it. An interesting exchange of views is therefore to be expected. And a debate
based on two fundamental perceptions may be fruitful: A consistent monetary policy, committed
primarily to the target of stability, is the best contribution a central bank - no matter whether the
Bundesbank or the European Central Bank - can make to the viability of the financial markets.
Without stable money, the financial markets cannot function properly. Conversely, it must also
be said: monetary policy needs an efficient, highly competitive and stable financial system. In the
first place, a financial sector that is susceptible to disruption poses risks to the entire monetary
system, and thus also to the safety of the currency. Secondly, in a stable environment monetary
policy impinges on economic activity more smoothly. That was and is true of the Bundesbank's
monetary policy. It is bound to apply to the ESCB's monetary policy as well.
II
Clarity now obtains in some matters of significance to financial market players
concerning the euro. The future framework for economic policy action is now emerging ever
more clearly.
Since its constitutive meeting in June, the ECB Governing Council has taken a
multitude of important decisions. There is broad clarity today about the arsenal of instruments
with which the ESCB will operate. The primary buttress of refinancing will be repo transactions,
which have been so successful at the national level. The interest rate for this main source of
finance will lie within the corridor whose ceiling and floor are marked out by the interest rates
for the marginal lending and deposit facilities. These principal elements of the range of
instruments have been designed with the intention of the money market developing as steadily as
possible, so that recourse to fine-tuning instruments can be relatively rare.
The same purpose is served by minimum reserves, which are often criticised in
banking circles. At a rate of 2 %, the cost burden is kept within very narrow bounds - especially
considering that, owing to the envisaged payment of interest on minimum reserves, the banks'
working balances, which will have to be held anyway, will yield interest. In the envisaged form
(a reserve to be maintained as a monthly average) they will act as a buffer in the money market.
They can therefore largely cushion unforeseen fluctuations in the demand for liquid funds
without any major central bank intervention.
A very important step on the way to a single monetary policy is the agreement on
the main elements of the monetary policy strategy which was reached in the ECB Governing
Council two days ago. These elements comprise: the quantitative definition of price stability as
the primary objective of the single monetary policy: "Price stability shall be defined as a
year-onyear increase in the Harmonised Index of Consumer Prices for the euro area of below 2 %." And
this price stability is to be maintained over the medium term. Money will be assigned a
prominent role, with a reference value for the growth of a broad monetary aggregate. This
reference value will be derived in a manner consistent with - and will serve to achieve - price
stability. Under normal circumstances, deviations of the current monetary growth rate from the
reference value signal risks to price stability. This concept of a reference value, of course, does
not imply a commitment to mechanistically correct deviations over the short term, as it was not
the case in the Bundesbank policy. Besides this prominent reference value for the growth of
broad money, a broadly-based assessment of the outlook for price developments and the risks to
price stability will play a major role in the ESCB's strategy. However, a forecast figure will not
be published.
By this decision, the ECB Governing Council is following up to a large degree on
the Bundesbank's successful strategy while at the same time taking due account of the specific
conditions prevailing in the euro area, especially at the start of EMU. By and large, the
institutional and technical preparations are making substantial progress. On January 1, 1999 the
ESCB will certainly be fully operational. Happily, there is broad agreement in the ECB
Governing Council on the basic orientation of anti-inflation policy. And, economically speaking,
Euroland has been in a de facto monetary union anyway since the eleven participating states were
determined and the bilateral entry rates defined.
Not later than January 1, 1999, central bank interest rates must be running at a
single level. But where that common level will be, cannot, of course, be said with any certainty
today - some eleven weeks before the start of monetary union. However, given our current
knowledge of monetary trends and other economic prospects, the interest rates are likely to
converge towards the lower end of the current range in the euro area. In the past few weeks, a
number of central banks of the future Euroland whose interest rates are still relatively high have
undertaken significant interest-rate cuts. That process will continue in the course of the next two
months.
On the average, such convergence will result in a further not inconsiderable
reduction in interest rates in Europe.
With its "steady-as-she-goes" interest-rate policy, the Bundesbank has contributed
to a stable monetary and economic situation in Germany and Euroland as a whole. That is why
the IMF expressly "commended" the Bundesbank a month ago "for having led the way in
establishing price stability in Germany as well as through out much of the European Union". In
the process, it had created favourable conditions for the introduction of the euro. The
Bundesbank's monetary policy was even characterised at that time as "somewhat
accommodative". Gratifyingly, the target of price stability has virtually been reached in Germany
and Europe alike. For the immediate future, neither particular inflation risks nor particular
deflation risks are detectable at present. That must remain so. But the Bundesbank still remains
vigilant. Vigilant as to the extent to which new constraints might arise. And, of course, vigilant
as to the extent to which new room for manoeuvre might materialise.
And monetary policy must always pay heed to the specific conditions prevailing.
For instance, the conditions for monetary policy in the future euro area differ to some extent from
those in the United States and also in the United Kingdom. Besides the different levels of central
bank rates, there are differences in the position in the business cycle and in the intensity of the
trade relations with the crisis regions, not to mention the specifically European subject of the
convergence of central bank rates.
III
However, there can be no doubt that the global environment has become harsher
and more turbulent for Germany and Europe as well in the past few weeks and months. A
number of East Asian countries are beset by a deep-seated, persistent financial crisis. Happily, in
some countries that have initiated far-reaching adjustments, encouraging signs of consolidation
are meanwhile to be seen. Russia is in the grip of a profound economic crisis, which naturally
has a very worrying political dimension. In Latin America, despite considerable efforts at
adjustment in some countries, there are still latent risks of contagion, and the markets have, alas,
so far not taken sufficient account of the differences in conditions. And in Japan a severe crisis of
confidence still prevails, involving substantial potential risks to the world economy. The recent
measures to remedy the weaknesses in the banking sector might, however, constitute an
important step towards overcoming the difficulties.
On the continent of Europe, by contrast, conditions have so far been distinctly
more favourable. The economic upswing in the future euro area is now more broadly based.
Internal expansionary forces are in the ascendant. Our trade relations with the crisis regions are
not so close that the crises there are bound to trigger a recession in Europe. But besides the
comparatively reassuring perception that those crises are unlikely to spill over to us (at least in
the short run) through the channel of trade relations, there is increasing concern that the crises
might, instead, come right into our "front room" through the channel of financial relations, via
the global financial markets. That concern also owes something to the fiasco of the Hedge Fund
Long-Term Capital Management and to the response it triggered. Many people are wondering
whether the greater part of the problem is not still floating below the surface, as with an iceberg.
And many people fear that the present crises might result in a structural weakness
of the financial system with regard to appropriate risk transformation. The first aspect concerns
the emerging countries. There is a danger that, as it were, the financial markets will now
withdraw from a whole category of countries without distinguishing sufficiently carefully to what
extent individual countries have made structural progress. A second aspect - albeit very vaguely
might be seen in the fact that banks may be less willing to run risks in extending credit,
especially to enterprises. But it is not only the financial markets that should differentiate
appropriately when taking investment decisions and assuming risks. The responsible politicians
and central bankers should likewise make adequate distinctions in their analyses.
For general panic is unwarranted. And there is no reason for lapsing into an
apocalyptic mood. A dispassionate analysis shows that there are a number of factors stabilising
the world economy. They certainly include the high degree of monetary stability world-wide.
They also include the favourable overall performance in the future euro area. And they likewise
include the still favourable course of business activity, by and large, in the English-speaking area.
What is more, many analysts make far too little distinction between developments of crisis
proportions, on the one hand, and adjustments, which may even be desirable in the medium run,
of previous exaggerations, on the other hand. That applies, for instance, in part to some equity
markets. And, by the way, it is also wrong to regard the recent Annual Meetings of the IMF and
the World Bank - as has widely been claimed - as a failure. It may be true that certain incautious
statements in the wings aroused some unrealistic expectations. But the results achieved in
Washington should not necessarily be judged by that. Distinct progress was definitely made in
Washington with regard to the future work of those organisations. And I hope very much that in
the near future the US Congress will clear the hurdle and remove the obstacle to a better financial
endowment of the IMF.
IV
Unwarranted though panic in the assessment of the situation is, blind political
hyperactivity, with the aim of inordinately large financial programmes, would be equally
undesirable. For the essential prerequisite for steering a country out of a crisis of confidence is
sound domestic policies. After all, it cannot be denied that some of the emerging countries
affected by the turmoil had previously made certain serious domestic mistakes. Not infrequently,
the public and private sectors are interlinked. Foreign investors, as well as domestic financial
institutions, could therefore take it for granted that they would be bailed out by the state or by
IMF programmes in the event of a crisis. Unfortunately, moral hazards and the lack of financial
supervision have in the past often prompted overly risky behaviour. Asset prices - especially
those of real property and equities - have sky-rocketed in some cases. Investments were made
which were not duly geared to the return that could realistically be expected.
Moreover, many countries had overly rigid exchange rate links. Such links may be
dangerous. After all, they obstruct monetary policy. And, under such a system, massive current
account deficits may accumulate if a persistent inflation differential exists and one's own
currency therefore appreciates sharply in real terms. Some countries have also shown
unsustainable budget deficits. All these weaknesses of domestic policies are points calling for
action. And the therapy and conditionality of the IMF must likewise make appropriate
distinctions and take action to deal with the actual causes of the problems. In some countries,
investors' confidence can only be regained by a sustained consolidation of the national budget. In
other cases, it will be necessary to settle a domestic banking crisis. And in some places, that may
entail, not least, the creation of a stable legal system, with a clear dividing-line between the
private and public sectors. And in very many, if not in all, cases, domestic financial market
supervision must be improved. It must at least meet international standards, such as have been
laid down by the G-10 in its Core Principles. Enhanced and efficient surveillance is likewise
necessary in this context.
Not blind political hyperactivity, but action in steps, albeit target-oriented action,
is on the agenda, because there have for some time been a number of sound and promising
approaches at the level of international cooperation. Those approaches must be implemented.
That builds more confidence in the markets than all new announcements of generous financial
programmes. There are likewise reasonable approaches to making what many people regard as
over-sensitive financial markets more resilient again. It is generally agreed that the global
financial markets need greater transparency in order to improve their viability. Firstly, more
transparency at the national level: besides macro-economic data, financial market data must be
monitored more carefully than before. Above all, more, and more up-to-date, particulars on
national debts in foreign currencies, and on maturities, are required. This is a challenge to
borrowers and lenders alike. Secondly, more transparency at the level of market players. The
experience of the past few days has shown that there seems to be a particular need to take action
in the case of Hedge Funds. How this is to be done can still be discussed. An indirect solution
has been proposed: banking supervisors monitor the lending of an individual bank to a Hedge
Fund. The data are then compiled through an international credit register. Taking Hedge Funds as
the starting point has been proposed. It may well be true that they are so flexible that they can
elude direct supervision whenever they want to. But when it becomes apparent which Hedge
Fund discloses data and which does not, then the market can discipline itself. Then it is
competition that determines the degree of transparency. Be that as it may, if Hedge Funds are so
important for the overall system as those responsible in the United States judge them to be, then
they cannot remain exempt from supervision. Thirdly, more transparency about the financial
instruments posing risks. That applies, for instance, to derivatives in bank balance sheets. And
fourthly, more transparency about the activities of the international financial institutions
themselves can do no harm. On the one hand, it is true, the confidentiality of discussions must be
upheld. On the other hand, the recipients of public funds must likewise be subject to a strict
assessment of performance.
V
A cool head rather than a hot heart; that would, by the way, even be appropriate
or would be particularly appropriate - if the crises in the global financial system were to spread
further (though I sincerely hope, and believe, they will not). That goes for the IMF. There must
be no more panic-stricken rescue operations in which private creditors are not involved. It also
goes for the countries concerned. Thus, debt moratoriums announced unilaterally - i. e. without
including the creditors - are highly questionable. After all, a country beset by a crisis has to try to
regain investors' confidence as soon as possible. Utmost caution is required on the subject of
controls on capital movements, too. Trying to control, let alone to limit, the outflow of capital ex
post
in a crisis is extremely risky. Quite apart from the limited technical options, the far-reaching
effects of such controls must also be borne in mind. On this point, Rudi Dornbusch has rightly
said: " In a global setting ad hoc capital controls in one country will immediately cause
contagion not only to the "usual subjects" but even beyond. Fearful that the crisis might spread,
investors will act pre-emptively everywhere. They will pull out their money without waiting for
more bad news."
A clear target-oriented stance, rather than hyper-activity - that motto likewise
applies to monetary policy. A relaxation beyond the degree that is consistent with domestic
stability is beneficial to nobody. In the medium and long run, it actually does harm, not only to
the country itself but to the global economy as a whole. That is a lesson taught by the current
problems in Japan. They are due not least to the overly expansionary monetary policy pursued in
the late eighties. At the time, Japan regarded that policy as a contribution to international
cooperation, and it was actually called for by the United States. That does not mean that
monetary policy should bury its head in the sand. In the Communiqué of the Interim Committee,
it says: "Should there be a worsening of the crisis or a further slowdown in economic activity,
additional action on both domestic and international grounds would be required by both
emerging market countries and industrial countries." However, upheavals in the financial
markets cannot be tackled by monetary policy instruments alone. Monetary policy in the
industrial countries must preserve the high level of confidence and credibility it now enjoys in
the financial markets. Otherwise, any measures could back-fire.
VI
Without any doubt, given the crises besetting many parts of the world, the euro
has passed its first acid test. That is gratifying. The markets regard the euro as a safe haven. In
that respect, it has already become a serious rival to the dollar. And exchange rates in the EMS
between the future euro currencies have remained stable. That demonstrates two things: The
markets have accepted the transition to monetary union as being irreversible. And the euro and
the independent European Central Bank are enjoying a high degree of confidence in investors'
eyes.
The continuous and sometimes exasperating insistence on the achievement of the
necessary stability conditions has thereby borne its first fruit. However, maintaining those
conditions for success is a long-term task. The role of the euro as an international investment
currency, anchor currency and reserve currency is inseparably associated with its internal
stability. The markets will focus their attention on that. And that is the criterion whereby the
markets, and also the man in the street, will judge European monetary policy at the end of the
day. It is this anti-inflationary basic orientation by which the Governing Council of the European
Central Bank will be guided; that emerged very clearly again from the debate we held on strategy
two days ago. However, for a durably stable monetary union, European monetary policy also
needs the support of the other areas of economic policy - not only at the start of monetary union
but also in the future.
In that case the euro has a good chance of becoming a lastingly stable currency,
respected by the markets and the population alike. And domestic stability is at the same time the
best contribution the euro can make to a sound, viable and stable global financial system in
which the financial market players can act in a spirit of responsibility.