Christian Noyer: From Maastricht to the present and beyond
Speech by Mr Christian Noyer, Governor of the Bank of France, at the GIC / Drexel Spring 2007
Conference, Philadelphia, 16 April 2007.
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We have just passed the European Union 50th anniversary. It is a good time to reflect upon the
essence and future of this extraordinary endeavor. Never before, in the whole history of mankind, have
democratic nations pursued and reached, through peaceful cooperation, such a close degree of
interdependence, involving, in many crucial areas, deliberate pooling of sovereignty. Of course, the
process has not been without difficulties and tensions, many of which are still apparent and acute. Of
course, numerous challenges remain and the future is paved with roadblocks which could still derail
the whole project. But, for the first time in more than a thousand years, Europe is at peace and
prosperous, with democratic regimes everywhere. This is, by historical standards, an exceptional
achievement.
At the start, EU was built on a strong intuition: by sharing the instruments and policies underpinning
economic prosperity, European nations would create an irreversible situation of interdependence and
solidarity where conflicts and wars of the past would become impossible. This intuition led to the
creation of the European Coal and Steel Community in 1951, then, a few years later, to the European
Community. Thus in 1957 the signature of Treaty of Rome was the starting point of this unique
experience of regional integration in modern History. This was more than a simple customs union
since, from the beginning, external trade policy was a full Community competence. Even the CAP,
whose image to day is not universally positive, was seen, at the time, as the archetype of a common
policy, bringing together the shared interests and joint actions of member states.
The project was further developed and enriched in two directions. A further impetus was provided by
the adoption of the Single European Act in 1986. This Act set a timeframe for launching the Single
Market and reaffirmed the need for achieving Economic and Monetary Union (EMU). The Single Act
created the framework for full economic integration, with total freedom in the flows of goods, services
and capital between member states. Even today, in some service sectors, the EU is a more integrated
area, from a legal and prudential viewpoint, than the United States. And second, the intrinsic solidarity
between European nations was embedded into a policy of "cohesion" through which very important
financial transfers took place, over a long period of time, between the richest and the poorest
members. At some stage, some members have benefited for several years from such cohesion flows
to an order of 5% of their GDP, significantly more than what most poor countries get from the IMF and
the World Bank.
Many other developments - both on institutions and policies - took place over the years. And it is clear
that, to day, the EU is much more than an economic project. But it is my strong opinion that the
original intuition is still valid: it is by pooling and sharing the instruments of economic welfare and
prosperity that European nations have reached and will develop a strong sense of their common
destiny and a joint vision of their future.
Today, the EU has reached a diversified but, broadly speaking, very ambitious level of integration: it is
complex because the degree of integration is largely dependent on which areas are at stake, it is
ambitious since, in some areas precisely, the system is completely integrated and relies on one single
policy.
The creation of the euro seems to me the natural consequence of the original intuition. It results both
from a political vision and an economic and financial necessity. The process of monetary cooperation
was launched as early as 1975, as a response to the potential financial and economic instability
stemming from the collapse the Bretton Woods system. It met with many obstacles and went through
several crises. At some point, it came close to being abandoned altogether. But today, the euro is alive
and well: since 2002, it has been the sole currency with legal tender in all countries of the euro area,
providing more than 300 million of European citizens with a new, practical unifying symbol as well as
many direct economic benefits.
What are those benefits?
The first, and most obvious, is price stability. Over the last five years, inflation has stayed broadly in
line with the price stability objective set by the European Central Bank, i.e. inflation below but close to
2% over the medium-term. Gone are the days when European citizens had to worry about the
purchasing power of their savings. This stability goes beyond the behaviour of prices. Inflation
expectations themselves have been remarkably stable, including during the recent period when oil
prices jumped to levels no one could have expected only a year ago. This, by itself, illustrates the
credibility achieved by the Eurosystem of Central Banks, after only six years of existence.
Second, European households and companies are reaping the benefits of that credibility. Long term
interest rates stand at a historically low level, around 100 basis points below the level in the United
States. So, even after the recent increases in short term rates, monetary and financial conditions
remain extremely favourable for investment and growth. And indeed, we might be witnessing in
Europe the start of period of sustained and stable growth, at least if current projections and surveys
are proven to be right in the coming months.
A third benefit of the Euro is the boost it gives to financial integration in Europe. In many segments,
European financial markets have reached the depth and liquidity which, up to now, were the preserve
of dollar markets. This stimulates productive investment, helps in restructuring (as witnessed by the
current wave of M&As) and, more generally, allows a better allocation of savings and sharing of risks.
As a consequence, the euro is becoming extremely attractive, as a vehicle, a transaction, an
investment and a reserve currency. As you may know, as central bankers, we remain neutral as far as
the internationalisation of the euro is concerned. We are neither encouraging, nor discouraging the
process. But, as a citizen, I cannot help and feel proud of having one the two main currencies in the
world.
Long term prospects
Looking into the future, I would like to try and answer four questions: is monetary integration
sustainable in the long run? What are the prospects for the enlargement of the euro area? Can the
euro serve as a model for other regions in the world? And finally, is monetary union going to lead to
further political integration in Europe?
Solidity of the euro area
I am aware that there still is, on this side of the Atlantic, a lot of skepticism about the future for the
euro. Four years ago, one of your leading academics, (Martin Feldstein) wrote a piece in Foreign
Affairs arguing that monetary union would reignite conflicts and war in Europe.
This is, of course, the extreme form of a basic argument: that there are too many divergences between
European states for them to withstand the pressures of monetary unification. Put in simple economic
terms, it boils down to the argument that the euro is not an optimum currency area.
In my view, this is less and less true. While European labor markets are not - and will never be - as
integrated as in the United States, goods, services, and capital markets are now fully unified, in many
regards to a greater extent than in any other countries. Our studies show that business cycles tend to
be more and more synchronized with time, an evolution which allows for greater efficiency and
sustainability for a common monetary policy. This shows that monetary union is a self sustaining
process: convergence can be a result, as much as a condition of economic integration. This has been
termed the "endogeneity of optimum currency area" effects.
Enlargement of the euro area
As I said before, in contrast with some gloomy predictions made ten years ago, the euro is a success
story. Far from being a closed Club, the Euro area is open and has a true calling for covering all the
EU members, in so far as they fulfil the convergence criteria. Indeed, adopting the Euro can be seen
as a legal obligation for all EU members once they have fulfilled the Maastricht convergence criteria.
Monetary union is an on-going process.
Starting in 1999 with 11 members, the Euro area has regularly expended. On 1 January 2001, Greece
joined the Euro area. More recently, on 1 January 2007, Slovenia was the first of the 10 New Members
States entered into the EU in 2004 to adopt the Euro; this brought the current number of members of
the Euro area to 13.
At this stage, the relevant question for the new EU member states (NMS) is thus not whether but when
to join the euro area. Entry is subordinated to the so called Maastricht criteria whose economic
rationale is very strong. These criteria encompass: limited inflation differential vis-à-vis the best
performing EU member; stability of the nominal exchange rate with the euro; sound fiscal accounts;
and low long term interest rate spread vis-à-vis the best performing EU member states in terms of
price stability. They must be satisfied simultaneously for the country to be able to join the EMU.
The economic rationale is clear: membership of a monetary union entails the absence of monetary
policy as a domestic adjustment tool. Diverging inflation rates become quickly unsustainable both
because they create strong real exchange rates movements and within the area and different real
interest rates at the national level. In this context more inflation-prone countries would have too low
real interest rates leading eventually to credit booms, domestic demand overheating, and loss in
competitiveness and current account deficits. Furthermore, in the absence of an independent
monetary policy at the national level, fiscal policy becomes the main adjustment tool. In this context,
fiscal criteria were designed in order to assess the ability of the government to conduct sound fiscal
policies.
Is the euro a model of monetary cooperation for other regions in the world?
What is happening in Europe is triggering a lot of interest in other parts of the world. Many countries to
day, especially in Asia, are confronted with the same challenges we faced, in Europe, fifteen years
ago: first, is it possible to reconcile greater economic integration with exchange rate volatility? And, if
not, can fixed or pegged exchange rates regimes be sustained in an environment of full capital
mobility? Taken together, these two questions led European countries to forgo monetary autonomy. Is
this always advisable?
This is a very difficult question. My own answer would be to progress towards closer monetary
cooperation with determination and caution. A strong degree of political determination is necessary
because, clearly, full monetary autonomy becomes more and more problematic when economic
integration has reached a certain stage. With greater economic openness, it is no longer an option, for
small and medium size economies, to be indifferent to their exchange rates. On the other hand,
independent management of their exchange rates by countries with close trade and investment links
can lead to undesirable outcomes. Thus, cooperation is warranted.
Monetary union, however, is a demanding endeavor. I have alluded earlier to the theory of optimum
currency areas. While it is debatable in some of its details and developments, the main message is
clear: the exchange rate remains an essential adjustment tool whenever economies are faced with
asymmetric shocks and markets are insufficiently flexible to absorb them internally. This is still the
case in many regions of the world where regional economic integration moves at a rapid pace, but
between countries whose economic structures and specialization are very different. In such
circumstances, it would be extremely penalizing to give up the possibility of real exchange rate
adjustments.
This shows that there is no single model of monetary cooperation which could be duplicated around
the world. It is up to each group of countries to find their own sustainable path to economic integration.
Will monetary union evolve towards closer political union?
As you well know, these are difficult times for European political integration. The Treaty creating a
Constitution for Europe was not ratified by two founding members of the European Community. As a
consequence, the future of political integration is fraught with uncertainties. These raise several
important questions for the future. Has the process of political integration stalled or just paused? What
is the appropriate institutional framework for an enlarged Europe? These are questions best left for the
historians and political scientists to answer.
But one question is essential: can monetary union progress and survive without a full fledged political
union? Can we - to quote, Otmar Issing, my former colleague in the ECB's Executive Board - have "a
currency without a state"? For me, like for Otmar Issing, the answer is clear: yes, we can. From the
start, the European project has ventured into unchartered territory. We have created an institutional
framework without any historical precedent and model. This is especially true for monetary policy,
where we have transferred the decision making powers to a supra national entity. In that sense,
monetary union in itself has a clear political dimension. This was only possible because euro area
members had achieved a high degree of convergence in attitudes and preferences.
It also happens that, in all countries in the world, Central Banks have been made independent in the
last decades, and monetary policy has been, as a consequence, depoliticised. This was seen as a
necessity to ensure price stability. From that point of view, the euro is no exception and the ECB's
mandate is similar to those of other Central Banks.
So, monetary union in Europe is well grounded, both on its technical and political pillars. Actually, the
euro to day seems to me the main driver for European integration. It exists. It is a success. The
institutional process is working smoothly. Sharing the same banknotes and currency has given
European citizens a strong sense of common identity and joint destiny. And those who worried that
monetary union would impede growth in Europe should be comforted by our recent record. Europe's
growth rate to day is equal - or higher - to the US. In the six years since the creation of the euro, twice
as many jobs have been created in Europe as compared to the US economy. Admittedly, we are
lagging behind in terms of productivity growth, innovation capacity and market flexibility. But there is
nothing which cannot be corrected provided the necessary policies are implemented with
determination and continuity.
This is why, looking beyond the current difficulties, I feel very optimistic. And the reason for this
optimism is the euro. The single currency has the potential to bring enormous benefits to European
nations, which they can use to achieve a high degree of stability and prosperity, in the interest of all
countries in the world.