Mr. Lamfalussy reflects on the possibilities and constraints of monetary
policy against the background of price stability in Europe Address by the President of the
European Monetary Institute, Baron Alexandre Lamfalussy, on the occasion of the change of the
presidency of the European Monetary Institute in Frankfurt am Main on 30/6/97.
The moment has come for me to say a heartfelt "thank you" to you all!
I should like to express my gratitude, first of all, to the governors of the central
banks of the European Union, who, in the autumn of 1993, chose me as their candidate for the
presidency of the European Monetary Institute, thereby setting in train a process which has
allowed me to play a part in a ground-breaking enterprise of exceptional scope and
responsibility. I should like to thank them, secondly, in their capacity as members of the EMI
Council, for their cooperation in this undertaking and for their wisdom, prudence, willingness to
compromise but also their will to achieve results. They have invariably acted with the utmost
professionalism. I should like to add that we should not have been able to achieve what has been
done without the conviction - which each of us shares - that the first duty of a central bank is to
maintain price stability. This fundamental principle has never been a matter of dispute.
My thanks go next to the political authorities. First, to the Heads of State or of
Government, who did me the honour of putting their faith in me in appointing me President of
the EMI. Second, to the Finance Ministers, who resigned themselves gracefully to the existence
of an institution which would be independent of the executive and who played their part, with
consummate political skill, in establishing the good working atmosphere between the ECOFIN
and the EMI, in the mutual respect of our respective competencies. I hope that this will be an
enduring legacy.
Thanks go, too, to the European Commission, with which we have been able
after a little trial and error, and with both sides demonstrating good will and a certain ability to
listen - to draw up the rules of the game for the indispensable cooperation which is needed to
enable the project of Economic and Monetary Union to go ahead.
The European Parliament - and several national parliaments - have given me the
opportunity to report on the work of the EMI, in an atmosphere of constructive dialogue. Their
questions and concerns, as well as those of the media and of the large number of associations
from both the banking and financial sphere as well as society at large, have given me valuable
insights into the expectations and concerns of our fellow citizens.
These thanks would not be complete without expressing publicly what I have
already had the opportunity to say in private to the members of the management and staff of the
European Monetary Institute: without their personal commitment, their spirit of innovation, their
boundless ability to find the happy medium - and not just a practical compromise between the
concerns of our central banks - nothing would have been accomplished.
What can I say to you know by way of farewell? There is little point in giving
you the "final score" at this stage - the match is not over yet ... Recommendations on how to
cope with the challenges which are looming on the horizon? You will deal with them effectively,
I am convinced, without my advice. But perhaps you will accept some reflections on the ability
and the limits - of monetary policy to meet the expectations of our fellow citizens who, while
appreciating the confirmation (or renewal) of price stability, are looking for stronger growth
and, above all, more jobs. I share their concern unreservedly. The current level of
unemployment in the majority of our countries is ethically unacceptable; it is leading to the
erosion of the social fabric and, because of the waste it represents, it is a clear signal that the
economy is not functioning properly. Reducing unemployment must be the prime objective of
action by the authorities. But what should be the role of monetary policy? In view of the short
time available to me - plus the fact that you cannot contradict me - I shall be brief. You may
perhaps feel that I am being dogmatic: if so, please bear with me. I should like to make four
observations.
1. There is not doubt whatsoever that monetary policy can bring inflation under
control. When monetary policy is not flanked by the appropriate budgetary policy, and when
labour markets - but also goods and services markets - are not flexible, bringing inflation under
control will take time. It will take time, and it can also entail costs - which could otherwise have
been avoided. But even so, these costs would still be less than the (very high long-term) cost of
not dealing with inflation. Let us not forget that while the rich and the powerful can protect
themselves from any loss of purchasing power of their money - and in many cases can even
benefit from such a loss - the weak and the not-so-rich will always be the losers. Inflation has
always been a major source of social iniquity. In addition, it prevents the economy from
functioning properly, by falsifying the signals which are given by prices. The speculative boom
in the real estate markets in some of our countries at the end of the 1980s caused serious damage
- and we are still paying the price.
2. Once inflation has been brought under control, and once this control has been
confirmed, monetary policy can guide short-term interest rates to a level which contributes to
balanced growth. Quite a number of EU countries are in such a situation already, with short-term
interest rates at around 3%. In others, where inflation has been brought under control more
recently, rates have not yet reached this level but are approaching it gradually. The confirmation
that inflation has been brought under control does, unfortunately, take time. Finally, in one
major country which has seen rapid growth for several years now and in which unemployment
has fallen remarkably, short-term interest rates have been raised - applying the principle of
preventive medicine.
3. Now, what can we say about long-term interest rates, which also have an
important role to play in stimulating growth - perhaps an even more important one than
short-term rates?
Monetary policy does have an influence on the level of these rates, but its
influence is not exclusive and we cannot even predict the direction of its influence with
certainty. At this particular point in time, in the first group of countries to which I referred a
moment ago, nominal long-term interest rates are at a historically low level - they are well below
6% - but real long-term interest rates can be regarded, perhaps, as still being too high to put
continental Europe on the road to more vigorous growth.
I am doubtful whether a further easing of monetary policy in this group of
countries would be able to help move the yield curve in the desired direction. It could actually
have the opposite effect - if investors perceived it as heralding a weak euro. In any event, given
the current level of short-term interest rates, monetary policy's margin for manoeuvre is
extremely limited.
It is possible that the level of real long-term interest rates in Europe reflects,
partially at least, that of real interest rates worldwide. Europe has no influence over that effect.
Europe can, however, have an influence on the effect which comes from the
constant increase in public sector indebtedness in our countries. As a reminder, between the end
of 1991 and the end of 1996 the general government debt rose from around 56 to above 73% of
GDP for the European Union as a whole. This development, together with the worry that it
might not yet have run its course, are not likely - to say the least - to lead to a fall in real interest
rates. Nor do they create the climate of confidence necessary for consumers and investors to
modify their current prudent behaviour. On the other hand, the certainty that governments are
tackling the underlying causes of the public deficits which are responsible for the constant
increase in the debt burden could well bring about such a change in behaviour. "Faceless"
markets are not the only ones looking beyond the immediate present to the future - our fellow
citizens are, too. The prospect of self-perpetuating, ever-increasing deficits will not encourage
them to spend more.
4. Stronger growth would certainly have a beneficial effect on employment. But
it would not eliminate the largest component of unemployment - the structural component. This
can be done by means of measures which remedy labour market rigidities and reduce the burden
of non-wage labour costs. It is this latter channel that links efforts to create jobs with the task of
bringing public expenditure under control. I observe, too, that in those countries where
unemployment has fallen substantially, jobs have been created not by existing enterprises - and
especially not by large enterprises - but by the setting-up of a large number of new enterprises,
which have necessarily been small to begin with.
To conclude - allow me, if you will, to be quite blunt. Yes, once inflation has
been brought properly under control, monetary policy can and must contribute to supporting
balanced growth, but balanced growth will not depend on monetary policy alone. Both the
acceleration and the viability of growth will rely on the contribution to be made by other
policies. First, on that of a fiscal policy which does not crowd out private investment but, rather,
fosters a climate of confidence by implementing a credible process of reforms. Second, on that
of a policy which creates a favourable fiscal, financial and regulatory environment for the
proliferation of new enterprises. And, so that the growth fostered in this way can create many
jobs, structural policies will have to assume the principal role, while the role of monetary policy
will then dwindle and fade away - alas - to nothing.