Mario Draghi: The euro - from the past to the future
Address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial
Stability Board, at the Catholic University of the Sacred Heart (Università Cattolica del Sacro
Cuore), Milan, 21 March 2011.
* * *
The euro: an idea that goes back a long way
The idea of a single currency, in place of a congeries of local or national monies, did not gain
much ground in modern Europe until the second half of the nineteenth century. Why was
that? It would be natural to think that a universal currency is a timeless aspiration: to extend
the traditional functions and therefore the advantages of money in the widest geographical
sphere.
A possible explanation is the redistributive use that money had been put to over the
centuries: in classical antiquity and then in the Middle Ages, adjusting the currency
- increasing or reducing the gold or silver content of metal coins - was often a way for the
prince to appropriate resources; striking coins was an attribute of sovereignty. It took a long
time to reach the point, in the nineteenth century, when the value of a monetary unit was
defined solely by the quantity of precious metal it contained; paper money was declared
convertible into metal; money had been "depoliticized".
Thinking up monetary unions then became a possible exercise, as long as the candidates
had the same standard: gold, silver or bimetallic; it was sufficient to agree on the fineness,
the weight and the denomination of the coins to be put into circulation. A union of this kind,
the Latin Monetary Union, inaugurated in 1865, brought together Italy, France, Switzerland,
Belgium and Greece, but it had a difficult life and broke up, as a practical matter, at the
beginning of the next century. The monetary unions realized within federal states - the Swiss
and the German ones - fared better.
But the use of the currency for redistributing wealth did not come to an end. Despite the
establishment and consolidation of technical institutions - the central banks - delegated to
manage the issuance and circulation of money, the currency reverted, at least in wartime, to
being an instrument of state financing. The transition to paper money facilitated this process.
During the First World War, the Governor of the Bank of Italy, Bonaldo Stringher, noted that
the Bank of Italy "has given a stimulus to banknote production equal to that received by the
machine shops producing bullets".1
In the 1920s and 1930s, marked by the Great Depression, the monetary instrument was
returned, with the contribution of Keynes, to the toolkit of economic policy. The potential of
this instrument prompted the central banks and the governments that controlled them to
make ample use of it to manage the economic cycle but also as a means of more or less
openly supporting the public finances. The height of this era was reached in the 1970s, a
decade of high inflation. In Europe the Bundesbank basically protected the German economy
from these excesses. There ensued a reconsideration of the role of the central banks and the
objectives and instruments of monetary policy, whose findings would be used extensively in
the period that followed right up to today.
In the 1950s the ruinous effects of the Second World War spurred a revival of interest in
integration among the European economies, which would simultaneously be a means of
promoting growth and ensuring peace. The creation of the European Common Market
accompanied the period of the fastest economic growth ever experienced on the Continent.
To buttress these results and, almost in a utopian spirit in the midst of international monetary
disorder, plans were made for the single currency.
The 1970 Werner Report was the first official plan for European monetary union and, while it
was never implemented, it paved the way twenty years later for the Delors Report, which,
basing itself on the still limited experience of monetary cooperation realized in the meantime
(the "snake" of the 1970s and the European Monetary System of the 1980s), planned the
creation of the euro. This was made possible by an altered cultural climate, which viewed the
independence of the central banks and price stability as the fundamental values upon which
to base a sound currency.
The plan was propelled by personalities from a generation that harboured the memory of the
ruins of war: Andreotti, Ciampi, Delors, Giscard d'Estaing, Kohl, Mitterrand and Schmidt, who
were flanked by figures from the next generation, like Tommaso Padoa-Schioppa.
The Maastricht Treaty of 1992 created the institutions of modern monetary Europe,
establishing the passage of monetary sovereignty to the European System of Central Banks.
The System's objective was defined clearly and with legislation having constitutional status
- taking a leaf from the German experience - as maintaining price stability, a value that
became the common heritage of all citizens of the area. From this followed the basic
principle that governments must not interfere in monetary policy; monetary financing of states
was prohibited.
The euro has been with us since 1999 and, as an actually circulating currency, since 2002.
To achieve this outcome, in many countries major political obstacles had to be surmounted.
In Italy, it was necessary to overcome society's inurement to devaluations and inflation.
There was no lack of academic scepticism, including from the other side of the Atlantic.
There were doubts about the European economies ever being able to constitute an optimal
currency area in Mundell's terms.
The European monetary construction works. The euro is not in question.
The first twelve years of the euro
Today the euro is the second most important currency in the world: it accounts for 27 per
cent of global currency reserves; before the Union, the currencies replaced by the euro
together accounted for 18 per cent.
Between 1998 and 2010 the total value of imports and exports of goods within the euro area
rose from 27 to 32 per cent of GDP. The greater volume of internal trade was not at the
expense of that with the rest of the world, which recorded an even sharper increase, from
25 to 33 per cent, driven by the expansion of the emerging economies, more and more open
to world trade.
Integrated infrastructures were created for payments in the area: for wholesale and retail
payments and, in the near future, for the settlement of securities transactions. Between 1999
and 2008 the average daily volume of cross-border payments between euro-area countries
via TARGET increased by almost 250 per cent; the average total volume of transactions,
which includes domestic payments, grew by more than 120 per cent - more than four times
greater than the growth recorded by the equivalent infrastructure in the United States.
Price stability is inscribed in the conduct of economic agents, even in countries which were
previously the most inflationary, enhancing the legacy of the best traditions of the
participating central banks. In the twelve years of the euro, annual inflation in the area has
averaged just under 2 per cent, fully in line with the definition of price stability adopted by the
Governing Council of the European Central Bank (ECB). It has fallen by more than one half
compared with the previous two decades; the reduction was greater than that seen in the
United States in the same period. In Italy, the average annual increase in consumer prices
was five percentage points lower than in the twenty-year period preceding the introduction of
the euro.
Today exogenous price shocks have modest repercussions on the euro-area economies: the
increases in oil prices between 2007 and 2008 were comparable, in real terms, to those at
the end of the 1970s, but they generated a one-off rise in consumer prices of less than two
percentage points, which did not take hold in inflation, in contrast to what happened in the
past in several countries in the area. According to our estimates, the inflationary effect in Italy
of a shock of this kind has been reduced to one tenth of what it was in the 1970s. Of course,
structural changes in production processes have played a part, but the credibility earned by
monetary policy and the resulting changes in price and wage setting have played a crucial
role.
Price stability and low risk premiums lead to low nominal and real interest rates, thereby
fostering economic growth. From the introduction of the euro to today, the real three-month
interest rate in Italy has averaged 1 per cent, four percentage points lower than in the
previous decade; the average nominal rate on bank loans for house purchases and that on
short-term loans to non-financial firms have averaged 4.5 and 5.5 per cent respectively,
compared with 11.3 and 12.6 per cent in the ten previous years. It is surely not the monetary
conditions that are responsible for the growth difficulties of the Italian economy.
Again with reference to the twelve years of the euro, annual expenditure for interest
payments on Italy's public debt averaged 5.3 per cent of GDP, against 11.5 per cent in the
first half of the 1990s and 7.5 per cent in the 1980s. It is still the case today that, despite
strong pressures on the government securities markets of some of the countries of the area,
the yields on Italian ten-year securities are in line with the averages recorded in the last
decade.
The response of euro-area monetary policy to the global crisis of the last three years was
rapid and decisive. Inflation expectations held firm even at the height of the crisis, allowing us
to take action to keep the markets working, support lending and avert the collapse of the
economy. Money market rates were reduced to close to zero; exceptional liquidity creation
measures were adopted.
Without the Union, simply coordinating national decisions would not have produced such
rapid and effective results. Some countries, including our own, could have been overcome by
the crisis.
But the credibility we have earned will not necessarily last for ever; we have to remain
vigilant in safeguarding price stability. The culture of stability must also be extended to other
fields: to fiscal policy, to structural reform where weaknesses have emerged in the European
construction, as they did clearly during the recent sovereign debt crisis.
The sovereign debt crisis of some euro-area countries
The strains spread outwards from Greece, where they had been generated by the disorder of
that country's public finances, and hit the Irish and Portuguese government securities
markets last spring. Spanish and Italian government bonds have also seen their yield
spreads widen with respect to the corresponding German securities.
The response of the European institutions and governments has followed a rough path.
The financial support plan for Greece, agreed at the beginning of May 2010 by the euro-area
countries with the European Commission and the IMF, did not eliminate the tensions, which,
on the contrary, spread to the stock, bond and interbank markets.
To contain the contagion risk posed to other countries, several days later the EU Council
instituted a financial stabilization arrangement under which the countries of the area could
get a loan at analogous conditions to those applied by the IMF in similar circumstances. It
was decided that the bulk of the resources would come from the European Financial Stability
Facility (EFSF), a new body authorized to fund itself on the market by issuing securities
guaranteed by the countries of the euro area. In the same days a number of countries
adopted or announced drastic plans for the consolidation of public finances.
In the same month of May 2010, the Governing Council of the ECB came to the conclusion
that the tensions in the markets were compromising the monetary policy transmission
mechanism. It launched the Securities Markets Programme of purchases of public securities
issued by euro-area countries with a view to supporting market segments hit especially hard
by the crisis; and it confirmed its commitment to supply abundant liquidity to the system. This
did not imply the monetary financing of sovereign states or the creation of liquidity; the
interventions were temporary and sterilized.
This set of measures stemmed the tensions, which nevertheless began to intensify again
during the summer and even more in the final part of the year, once more affecting not only
Greek bonds but those of Portugal and especially of Ireland, which had issued a government
guarantee for all bank liabilities. At the end of November the EU finance ministers approved
a plan of financial support for Ireland.
This measure too helped to allay but did not eliminate the tensions, in a context of elevated
uncertainty in the markets regarding the prospects of stabilization in the countries hit by the
crisis and the possible interconnections between sovereign risks and the vulnerability of
some banking systems.
The crisis originates from imbalances that in some countries concern the public finances, in
others the banking system. Overcoming the difficulties first requires drastic, resolute national
measures.
The stance of monetary policy has been expansionary for a long time: since May 2009 the
Eurosystem's reference interest rate has held at 1 per cent, an exceptionally low level; real
short-term rates have remained negative by a wide margin even after the start of the cyclical
recovery. The emergence of inflationary pressure calls for a careful evaluation of the
timetable and manner in which to proceed with a normalization of monetary conditions. A
deterioration of expectations must be prevented, to keep the impulse originating from
international prices from being transmitted to domestic prices and wages and thereby
influencing inflation beyond the short term. As President Trichet recalled on the occasion of
the meeting at the beginning of March, the Governing Council of the ECB remains prepared
to act in a firm and timely manner to ensure that these risks do not materialize.
We are following the tragic events in Japan with the closest and most heartfelt attention. The
exchange rate interventions agreed on 18 March by the finance ministers and central bank
governors of the G7 countries are intended to prevent excessive volatility of exchange rates
from having adverse effects on economic and financial stability.
A construction to be strengthened
The sovereign debt crisis has brought to light at least two factors of fragility in European
construction.
In the first place, the rules did not avert imprudent fiscal policies in some countries, which
were either unable or unwilling to exploit the positive phases of the economic cycle in order
to consolidate their public finances. Each country was given a specific medium-term
objective for the budget position, agreed at European level: a position in balance or surplus,
depending on its specific sensitivity to the economic cycle and to interest rates; the objective
was subject to review in the light of long-term factors such as population ageing and the debt
level. In addition, the countries whose public debt exceeded 60 per cent of GDP had to
reduce it "at a satisfactory pace". When the global crisis came, many countries were still far
from achieving those objectives.
Second, the system of multilateral surveillance did not prevent pronounced macroeconomic
imbalances: productivity differentials, current account deficits, excessive private sector
borrowing. In 2009, the deficit on the current account of the balance of payments amounted
to 10 per cent in Greece and 7.5 per cent in Portugal. In Ireland, Portugal and Spain, the
financial debt of households and firms amounted to between one and a half and two times
the euro-area average of 170 per cent of GDP (in Italy it was equal to 130 per cent). In
Ireland, the largest national banks had balance-sheet assets totalling more than five times
GDP; the collapse of property prices and the recession caused them huge losses.
Imbalances of this kind ultimately have repercussions on the public finances, even in
countries where these are initially in order. In the Irish case, the public resources spent on
supporting the banks came to more than 20 per cent of GDP.
Last autumn the European Commission and the working group led by European Council
President Herman Van Rompuy put forward proposals concerning both aspects: how to
make the Stability and Growth Pact more cogent; how to extend surveillance to
macroeconomic developments.
It was proposed that the Pact be strengthened for the prevention of fiscal imbalances, by
intensifying monitoring and introducing timely monetary sanctions, and for their adjustment,
by providing in particular for the possibility of initiating the excessive-deficit procedure not
only when the deficit exceeds 3 per cent of GDP but also when the reduction in the debt
towards the 60 per cent ceiling is deemed unsatisfactory.
In the macroeconomic field, a system of monitoring imbalances having potentially significant
implications for the euro area's financial stability was envisaged, with quantitative indicators
and critical thresholds based on which the European Council may issue recommendations to
the country concerned and, in the most serious cases, apply financial sanctions.
Lastly, it was recommended that the EFSF be replaced from 2013 onwards by a permanent
mechanism of financial support, the European Stability Mechanism (ESM). Only the
countries considered to be solvent would have access to financing, which would be
conditional in any case on their adopting serious adjustment plans; the others would be
asked to negotiate a debt restructuring plan with private creditors by which to return to a
situation of solvency.
On 15 March the EU finance ministers agreed a "general approach" that fully implements the
recommendations of the Commission and of the Van Rompuy working group. In particular,
they approved the proposal to introduce a numerical rule - one twentieth of the debt-to-GDP
ratio in excess of the 60 per cent ceiling - for the annual reduction of the debt.
Several days earlier the Heads of State and Government of the euro area had increased the
effective lending capacity of the EFSF to €440 billion and set that of the future ESM at
€500 billion; they also decided that in exceptional circumstances both the Fund and the
Mechanism could purchase euro-area countries' government securities on the primary
market.
The pact for the euro, with all these measures, widens the focus of attention to include
macroeconomic imbalances, strengthens budget discipline in the area, and improves the
mechanism of support for countries that get into financial difficulty. This was a necessary
step to avoid dangerously sapping the Community spirit that is the lifeblood of the euro.
The measures are based on correct principles. The technical and negotiating effort involved
has been substantial; the results are encouraging but not yet sufficient. Discussion of the
pact will continue in policymaking fora; deficiencies or points that are hazy can be corrected.
Fiscal policy surveillance needs to rely on more automatic procedures that limit the
politicization of public accounting as far as possible and avert possible collusive conduct
between countries. Several other aspects of this complex reform of European governance
still require attention and work. It is necessary, for example, to determine with precision all
the "relevant factors" to be considered in assessing the adequacy of the pace of public debt
reduction; to identify the set of indicators serving to signal a situation of macroeconomic
imbalance and the related critical thresholds; and to establish the criteria for evaluating a
country's solvency.
Concerning structural policies to boost potential output and competitiveness, the pact, for the
time being, relies on procedures based on peer pressure, which in the case of the Lisbon
strategy have not worked. The commitment of the national governments remains central.
We must not forget a golden rule: increasing the economy's growth potential and
consolidating the public budget are national priorities first of all. Governments should pursue
them even independently of the European rules, for the good of their peoples, and should do
so with special commitment in the countries farthest from these objectives.
Italy's situation
Between 2008 and 2009, with the global crisis in full swing, Italy's budget deficit rose from
2.7 to 5.4 per cent of GDP; discretionary policies did not contribute to the increase.2 The
deficit of the euro area as a whole more than tripled, rising to 6.3 per cent. In 2010 the deficit
declined to 4.6 per cent in Italy, while in the euro area it remained unchanged according to
European Commission estimates. The Government's management of the accounts was
facilitated by the fact that the solidity of the Italian banking system did not require significant
aid to be charged to the public budget.
Italy's public debt, already very high, rose again. Its management was prudent; the average
residual maturity was lengthened progressively, notwithstanding a context that remained
uncertain and volatile.
The financial condition of firms and households is solid on the whole. Savers' propensity to
invest in high-risk financial instruments is low; debt is limited, although it is concentrated in
variable-rate liabilities, which are inherently riskier.
The Italian economy's problem - it is well worth recalling - is the structural difficulty of
growth. The arduous task of economic policy is to change this situation while at the same
time reducing the ratio of public debt to GDP. To rebuild a solid primary surplus rapidly and
not to elude the need to take measures that structurally support growth: this is the challenge.
Raising the tax rates is out of the question: it would jeopardize the objective of growth and
penalize honest taxpayers unbearably; indeed, the rates ought to be gradually lowered as
headway is made in reducing tax evasion and avoidance. The only option is to control
spending, but with a selective approach that distinguishes between what fosters growth and
what impedes it. Wise political choices must necessarily be based on a detailed assessment
of the effects, including the macroeconomic effects, of every expenditure item.
The more attentive multilateral surveillance of the sustainability of public budgets envisaged
by the new pact is not to be feared; it can help us. The reforms already carried out, especially
the pension reform, put us among the countries that require a smaller correction of budget
balances to ensure long-run stability.
The new European rule for debt reduction would not be a much tighter constraint for us than
the one already imposed by the existing rule on structural budget balance. It is estimated that
achieving structural budget balance would also ensure, ipso facto, compliance with the rule
on debt under favourable scenarios of economic growth.3
* * *
Seventeen sovereign countries that share a single currency form a reality without precedent
in history. The euro is a bold intellectual construction, a courageous and farsighted political
project. It was, and remains, a prerequisite for economic wellbeing.
The President of the Republic, in his address to Parliament on 17 March, called European
integration "an extraordinary historical invention in which Italy has successfully played a
leading role since the 1950s."
One hundred and fifty years ago we Italians undertook an equally important construction: our
country's monetary unification, which would then consolidate the political unification just
attained.
These two historical events are joined in an ideal continuity. For us, the present and the
future of the euro are also the continuation of our own long history.