Jean-Claude Trichet: The current state of the euro area and its future
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, at the
conference "The euro's 10th anniversary: history and presence of the euro", Munich,
10 July 2008.
* * *
Meine Damen und Herren,
es ist mir eine große Ehre und Freude, hier am heutigen Tag über den Euroraum in seiner
derzeitigen Form und in der Zukunft sprechen zu dürfen. Noch vor wenigen Jahrzehnten
wäre eine einheitliche Währung in Europa für viele Beobachter undenkbar gewesen. Und
doch feierten wir, wie Sie wissen, vor Kurzem das zehnjährige Bestehen der EZB und somit
auch des ESZB, des Europäischen Systems der Zentralbanken. Seit der Einführung des
Euro im Januar 1999 konzentriert sich die EZB auf die Gewährleistung der Preisstabilität im
Euroraum, ihr vorrangiges Ziel.
Ladies and gentlemen,
It is a great honour and a pleasure to be invited here today to speak about the current state
of the euro area and its future. Not many decades ago, a single currency in Europe would
have been unthinkable for many observers. And yet, as you know, we have just celebrated
the tenth anniversary of the creation of the ECB and, for that matter, the ESCB - the
European System of Central Banks. Since the launch of the euro in January 1999, the ECB
has focused on preserving price stability in the euro area, its primary objective.
You all know very well that inflation rates have continued to rise since the autumn of last
year. Inflation is expected to remain above the level consistent with price stability for longer
than we previously thought. Last week we had to act to discourage second-round effects and
to counteract the increasing upside risks to price stability over the medium term. Our decision
will contribute to delivering price stability over the medium term. As I will argue in my talk
today, a lot depends on the solidly anchoring of inflation expectations.
Over the last ten years, the ECB has gained a great deal of respect and credibility. Since the
launch of the euro, the average inflation rate has been just slightly above 2%. And this has
been achieved, despite various shocks that have hit the euro area over these years,
including the ongoing strong global increase in commodity prices that is affecting Europe and
the rest of the world. In the decades before the launch of the euro, average annual inflation
rates in many EU Member States were very significantly higher. This is a remarkable result.
It shows that we have inherited the credibility that was the privilege of the most successful
currencies before the euro.
Today, I would like to share with you some of our achievements over these past ten
momentous years. They call for celebration. But over and beyond our performance in terms
of price stability, I would also like to share with you reflections on the economic performance
of the euro area and some of the remaining challenges that the ECB and the euro area as a
whole face as they enter their second decade. I will then make a few remarks on the sound
economic management of our Monetary Union.
1. On the achievements of the euro area
The new monetary policy framework - with the ECB setting the monetary policy for the entire
euro area - was quickly understood and trusted from the very first days. The ECB has a
clear mandate - to safeguard price stability in the euro area - and is independent. In 2003,
the ECB clarified that price stability meant maintaining inflation rates close to and below 2%
over the medium term. This is a clear yardstick against which the public can judge us. While
being custodian of the trust of the citizens of the euro area, we are also fully accountable to
them, and endeavour to explain our actions. Over these ten years, this framework has
contributed to anchoring longer-term inflation expectations.
We all know that price stability is essential for the success of a large economic and monetary
union. It protects the incomes of all of us, and particularly those of the most vulnerable and
poorest of our fellow citizens. An aspect that is often neglected is that, thanks to price
stability, diverse other benefits follow. Price stability is a precondition for sustainable growth
and job creation and, ultimately, social cohesion.1 It is also a major contribution for financial
stability.
The euro also promotes the functioning of our vast continental market and, therefore, helps
bring about a true single market for goods, services, capital and labour. During the first nine
years of the euro, 15.7 million new jobs were created in the euro area, and the
unemployment rate is now at the lowest level since the early 1980s. Our common currency
has also helped to protect the euro area economy from diverse global shocks, as well as
from the considerable turbulence of the last few years. Let me offer you two examples of the
credibility of the ECB and the benefits that this brings.
• Over recent months, we have seen that actual inflation may temporarily diverge from
our medium-term objective. The first example of the credibility of the ECB is that
long-term inflation expectations have remained solidly anchored. In fact, they have
remained well anchored over the entire ten years. This is remarkable considering
the series of adverse economic disturbances that have hit the euro area since its
inception.
• The second example of the credibility of the ECB is that medium and long-term
market rates of the euro are at the same low levels in terms of embedded inflation
expectations and risk premia as those experienced by the most stable national
currencies prior to it. In other words, we have been instrumental in securing the
lowest market interest rates on a 5, 10 up to 50-year basis. Most euro area countries
have benefited from significantly better financing conditions than in the 1990s, a
situation which has also supported fiscal consolidation.2
The euro has also helped strengthen trade and financial linkages across euro area countries.
There is clear evidence that the introduction of the single currency and the associated
increase in price and cost transparency have fostered both intra and extra-euro area trade in
goods and services. In fact, the sum of intra-euro area exports and imports increased from
about 31% of GDP in 1998 to around 40% in 2007 - approximately 9 percentage points.
During the same period, extra-euro area trade growth even exceeded that in intra-euro area
trade, rising 13 percentage points from 31% to 44% of GDP in 2007. Hence, there is no
"fortress Europe".
Let me also mention that, when I travel around Europe, I feel that a shift in mindset is
gradually taking place. In fact, firms are becoming more conscious of the euro area
dimension of their actions and decisions. Households are increasingly conscious of the
opportunities offered by an expanded economic and financial area.
The launch of the euro has also coincided with a remarkable deepening of financial
integration. The financial landscape has already changed a great deal in most market
segments, and is continuing to change. The euro is acting as a catalyst for a gradual portfolio
reallocation away from holdings of domestic financial instruments towards holdings of
financial instruments issued elsewhere within the euro area. For instance, euro area
crossborder holdings of long-term debt securities have increased strongly - from about 10% of
total stocks at the end of the 1990s to nearly 60% in 2006. Furthermore, euro area residents
almost doubled the amount of cross-border holdings of equity issued by euro area residents,
from 15% to 29%, between 1997 and 2006, in particular on account of institutional investors.
As for capital flows, the euro has boosted foreign direct investment - particularly
crossborder mergers and acquisitions in manufacturing - and portfolio flows across euro area
countries.
Well-integrated financial markets and diversified portfolios reduce the extent to which the
saving and spending decisions of firms and households are dependent on economic and
financial developments in a specific country, region or sector. As a result, credit and
risksharing channels are increasingly helping to attenuate the impact of shocks in a specific euro
area country or sector.
Let me mention also one important aspect. We live in an era of rapid technological progress.
Competitive forces are reshaping global manufacturing, the financial landscape and the
sharing of wealth. Large demographic changes are also under way. The impact of these
"mega-trends" is very substantial, although it is difficult to quantify them precisely.
In my view, the euro area as a whole has exhibited resilience to such external developments.
It is, as a whole, significantly more resilient than many of its individual member countries
were before the launch of the euro.3 The euro area has been a source of stability.
In short, the current state of the euro area is one of increasing interdependence and ongoing
integration. Over these ten years, we have observed greater price stability, greater
macroeconomic stability, as well as increasing economic and financial integration. However,
despite these achievements, there is no room for complacency, and a great deal still needs
to be accomplished.
I now want to put forward the argument that several changes in this second decade and
beyond will have to come from the "E" in EMU: namely that there is a need for further
substantial efforts and reforms on the economic side. In other words, I argue that there is a
need for a sound economic management. This has two facets. The first is that the overall
level of economic performance in the euro area needs to improve. Think, for example, of the
question as to how the euro area as a whole might raise its potential growth...and actually
grow at such a higher level. The second facet is that we need to understand and address
diversity of economic performance across the euro area. Think, for example, of the question
as to the extent to which euro area countries differ in terms of economic performance. I will
deal with these aspects in turn.
2. On the economic performance of the euro area
The achievements I have just described have accompanied an impressive performance in
terms of job creation. From the start of EMU to the end of last year, as I have already
mentioned, the number of people in employment in the euro area has increased by 15.7
million, compared with an increase of only some 5 million in the previous nine years, and the
euro area unemployment rate has fallen to its lowest level since the early 1980s. Of course,
the surge in employment cannot be attributed solely to the euro. It also reflects corporate
restructuring, the progress made on structural reforms and overall wage moderation in most
countries.
However, Europe is far from having exhausted its potential for further increases in labour
participation rates and employment. Let me flag just a few facts. The overall employment rate
in the euro area remains modest by international standards - 65.7% in the euro area,
compared with 72% in the United States - and the unemployment rate is still clearly too high
- over 7% in the euro area. More specifically, while the employment rate of prime-age men in
the euro area is comparable with that in the United States, considerable disparities remain
when we look at employment rates among the young, among women and among older
workers.4
Labour market reforms appear to be even more appropriate if we consider that growth
performance will increasingly be constrained by relatively low population growth rates and
population ageing. Since the early 1990s, the population of the euro area has been growing
at a yearly rate of only 0.4%, compared with 1.1% in the United States.
Europe has room to develop its growth potential. Since the early 1990s, real GDP has
grown, on average, by 2.1% in the euro area, compared with 2.8% in the United States.
Since the start of EMU, the annual growth rate for the euro area has averaged 2.2% per
year, compared with 2.7% in the United States. Even if one has to recognise that the euro
area did slightly better than the US in terms of GDP growth per capita, it remains that the
euro area's potential output growth has moved to the lower bound of its previously estimated
range of 2-2.5%. A low trend growth in labour productivity explains, in large part, the modest
growth performance. During the 1980s, hourly labour productivity in the euro area grew, on
average, by 2.3%, while it declined to 1.8% in the 1990s and decreased further to 1.2%
between 1999 and 2007. By contrast, hourly labour productivity growth in the United States
accelerated from 1.2% to 1.6% and then to 2.1% over the same periods.5
What can be done to enhance labour productivity? In recent years, we have seen rising
levels of employment, particularly in the unskilled segment of the labour market. This has
certainly contributed to the slowdown in labour productivity growth. However, to a large
extent, there has also been a significant slowdown in total factor productivity (TFP) growth.
TFP growth is generally taken as a measure of technological progress and improvement in
the organisation and overall efficiency of production.6 There are many factors behind the low
4
In 2007, for instance, the female employment rate was 58% in the euro area, compared with 66% in the
United States in 2006; among older workers, it was 43.3%, compared with 61.7% in the United States in 2006,
while the youth employment rate was 38%, compared with 54.2% in the United States in 2006. In the case of
the euro area, these features appear to be consistent with an "insider-outsider" characterisation of the
European labour market, where structural impediments resulting from the legal and regulatory environment,
high taxes on labour and rigidities associated with wage regulations may prevent those groups "at the margin"
from actively participating in the labour market.
5
Euro area data on hours worked per worker in 2007 are assumed to be constant. US data on hours worked
per worker are estimated using OECD data for 2006 and 2007. The source of the data is the AMECO
database.
6
According to the European Commission, total factor productivity grew, on average, by 1.6% in the 1980s,
before falling to 1.1% in the 1990s and to 0.7% between 1999 and 2007. The countries that have managed to
exploit the efficiency gains resulting, in particular, from new technology have enjoyed stronger labour
productivity growth. For instance, in the last ten years, investment in information and communication
4 BIS Review 89/2008
growth in TFP. Unfortunately, most European economies do not incorporate appropriate
incentives to invest in real and human capital, to innovate and raise the flexibility and
adaptability of firms when their environment changes.7
To sum up, the remarkable labour market performance observed in the euro area since its
creation could even be improved upon. Rising productivity must also contribute to enhancing
the overall economic performance of the euro area as a whole. While the ECB sets monetary
policy by looking at the performance of the euro area as a whole, the ECB also follows
closely what happens in all euro area countries. In other words, we also look at diversity of
economic performance across the euro area.
3. Diversity in EMU
Some diversity - in economic and financial developments - is a natural phenomenon in any
vast currency area.8 Rates of economic growth, inflation and changes in labour costs can
differ across countries for various reasons. Some of these reasons may have no link
whatsoever with monetary policy or a single currency. For instance, diversity might originate
from country-specific demographic trends or from their catching-up in terms of living
standards. There could also be national differences in areas such as industry characteristics,
investment in research and development (R&D), and innovation. Differences in the timing
and extent of past structural reforms in euro area countries are also a source of diversity.9
Differences in fiscal policies and other national policies can also give rise to diverse
economic situations. There is an additional source of diversity due to the one-off shock
constituted by the launch of the euro that may currently be working its way through the
system. Some countries suddenly benefited from lower short and long-term interest rates, as
well as from easier access to more competitive credit markets. This encouraged the
purchase of durable and non-durable goods, as well as housing, albeit to differing extents, in
the various euro area countries.
But let's put diversity in perspective. Over these ten years, the degree of diversity
observed in the euro area at each point in time did not appear to be substantially different
from that seen in the United States. Nor is it substantially different from that seen within the
national borders of some large economies (such as Germany, Italy and Spain). However, a
distinct feature of diversity in the euro area is its persistence over long periods of time. In
other words, diversity in most euro area countries displays significant inertia. Let me briefly
look at three types of diversity.
a) Inflation dispersion in the euro area declined considerably in the 1980s and
1990s and is now on a par with inflation dispersion in the United States. To give you
an example, the unweighted standard deviation of annual HICP inflation rates still
stood at around 6 percentage points in late 1990, but - since the launch of the euro
technology in the United States was double that of the euro area. According to the EUKLEMS database, the
average contribution from ICT capital to total economic growth in the euro area was 0.4 percentage point over
the period 1995-2005, while in the United States it averaged 0.8 percentage point over this same period.
7
It appears that the structural characteristics of the best-performing industrialised economies, namely more
flexible labour markets, greater competition in product markets and lower barriers to entry for new firms have
been more receptive to the opportunities provided by new technologies.
8
Diversity is sometimes referred to as heterogeneity or divergences: in my view, diversity might be more
appropriate in most cases because a significant degree of dispersion looks like not a defect but a fundamental
feature of any vast continental economy like the US or the euro area.
9
An example of this is the Netherlands, which undertook labour market reforms far earlier than the largest euro
area countries. This enhanced the country's flexibility and increased its ability to adjust to a wide range of
shocks. In other countries, short-term shocks may have had more persistent effects on growth differentials
owing to slow adjustment processes caused by the presence of structural rigidities.
BIS Review 89/2008 5
- this rate has broadly stabilised at around 1 percentage point. This dispersion level
is similar to that of the 14 US metropolitan statistical areas, but is somewhat higher
than that of the four US census regions. Hence, impressive progress has been
made, and I would argue that, prima facie, inflation dispersion in the euro area is not
high by international standards.
However, inflation differentials in the euro area are very persistent; in this respect,
the euro area does indeed differ from the United States. Most euro area countries
that have exhibited higher than average inflation rates in recent years have been in
this position for at least a decade. These include Spain and Greece. Similar
persistence - but on the opposite side - is observed in low-inflation countries such
as Germany. Only in some euro area countries, such as Portugal and the
Netherlands, have differentials moved from being relatively high to being in line with
- or even below - the euro area average. Such corrections are welcome, but the
point is that they are slow to materialise.
If we look at the cost side, the factors generating inflation differentials are, in most
countries, primarily domestic rather than external. In particular, we have witnessed
sustained divergence in wage developments across the euro area and smaller
differences in labour productivity growth. These differences in the growth of labour
costs have been the main sources of persistence in inflation differentials. Various
reasons can be suggested for this. Varying levels of wage rigidity across the euro
area, changes in profit margins, imperfect competition and associated price rigidities
across countries all affect labour costs and contribute to inflation differentials.
If we look at product groups, price dispersion has been greater in the field of
services, mostly owing to the dispersion observed in wage developments across
countries. By contrast, inflation dispersion has been relatively low for tradable
nonenergy industrial goods, with greater competition in tradable goods being the main
reason for this. Products with relatively volatile prices (such as energy and food)
have, on the other hand, shown high levels of dispersion across countries in terms
of price changes.
b) Output growth differentials in the euro area have remained broadly stable since
the early 1970s. No signs of increased annual divergence were observed between
1999 and 2007. The average dispersion of annual real GDP growth over this period
(measured as the unweighted standard deviation) was around 2 percentage points.
This figure is very close to the average dispersion of real growth rates since the
1980s. By comparison, if we look across all 50 US States, the dispersion of real
growth has averaged approximately 2.5 percentage points over the last 15 years.
When the United States is divided into the eight statistical regions, the average
dispersion shrinks to around 1.5 percentage points.
One issue of concern, however, is the fact that within the euro area there is also a
relatively high degree of persistence regarding output growth differentials. This is
less the case in the United States. However, taking the United States as a
benchmark only helps up to a point. On the one hand, the US economy is known to
be more flexible than the euro area, which means that the effects of asymmetric
shocks can be absorbed more easily and more quickly. On the other hand, the
United States exhibits stronger regional specialisation than the euro area, making its
regions more susceptible to specific asymmetric shocks.
Let me now turn to the two main drivers of growth differentials in the euro area:
differentials in cycles and differentials in trends. Differentials in cycles have
declined steadily since the early 1990s. There is also evidence of a stronger
common euro area cycle accounting for a large part of the business cycle
fluctuations across euro area countries. Since 1999, several shocks have spread in
similar ways across euro area countries. For example, the euro area has
successfully weathered several shocks, including the bursting of the dotcom bubble,
the ripple effects of the terrorist attacks of September 11, the surge in global
commodity prices - particularly energy prices - and the persistence of sizeable
global imbalances. The high degree of synchronisation in the business cycles of
euro area countries is a feature unique to the euro area. This suggests that EU
integration and, more recently, the launch of the euro - rather than global forces -
have led to smaller differences in output gaps among euro area countries.
The picture for the second driver of dispersion - namely differentials in trends -
shows more lasting differences since the beginning of the 1990s, with a gradual
increase in trend growth dispersion. This picture also differs across euro area
countries, some of which persistently exhibit trend output growth either above or
below the euro area average. It is here that the various sources of diversity that I
have mentioned play a role.
c) Changes in cost and price competitiveness mainly reflect changes in relative unit
labour costs and persistent inflation differentials. These demonstrate that there is
significant leeway for influencing competitiveness, even in the absence of nominal
exchange rate adjustments. To give you an idea of the magnitude of this leeway, if
we consider the cumulative growth of unit labour costs for the economy as a whole
between 1999 and 2007, the difference between the countries with the largest
increases and those with the smallest increases was around 20 to 30%. This is an
important phenomenon, and a close examination of the driving factors is therefore
required.
Germany, for example, has seen moderate growth in unit labour costs over an
extended period, leading to a correction of the losses in competitiveness that arose
in the aftermath of German reunification. This correction - and the corresponding
sustained period of relatively low inflation - is, of course, fully justified and most
welcome. It also shows that adjustment mechanisms in the euro area work. A higher
degree of wage flexibility would help to accelerate such desirable adjustment
processes.
At the other extreme, some countries may, to some extent, be catching up with
others' higher living standards. These countries are, therefore, possibly experiencing
some temporary differences in competitiveness, reflecting movement towards a new
equilibrium. Some other sources of persistent inflation differentials, however, might
not be justifiable - for example, differentials attributable to insufficient flexibility. In
some economies, weak labour productivity growth and strong increases in nominal
wages and salaries over a sustained period inevitably result in a loss of
competitiveness.
To sum up, diversity in terms of inflation and cost developments is undesirable when
it reflects structural rigidities or a lack of competition. While we see evidence of a
stronger common euro area cycle, we also see diversity in national trend growth.
Monetary policy has a limited role in addressing such diversity. Changes in
competitiveness are unfolding faster than was foreseen prior to the launch of the
euro, which is good in some respect because it means that necessary adjustments
in relative competitiveness can be more rapid. But it also suggests that a lucid
monitoring of competitive indicators is of the essence to avoid possible rapid losses
of relative competitiveness inside the euro area.
4. There is thus a clear need for sound economic management in EMU
The future of the euro area will rely as much on consolidating its achievement as in meeting
some future challenges. I will argue now that the increasing interdependence among euro
area economies, combined with the need to raise the level of economic performance while
addressing excessive differentials in inflation, growth and competitiveness, requires sound
economic management. Let me now stress the importance of four guiding principles in this
respect.
a) The first principle is the rigorous implementation of the Stability and Growth
Pact as a prerequisite for sound fiscal policies . There are several reasons for
supporting sound fiscal policies. They are needed, for instance, to reduce the risk of
fiscal policy spillover, both into monetary policy and, more generally, across
countries. They are also needed to enhance flexibility and adaptability. Sound fiscal
policies create the necessary conditions for flexibility, which cushions the effects of
the economic cycle through the functioning of automatic stabilisers. Sound fiscal
policies also ensure proper incentives. The tax and benefit system should avoid
major distortions that affect incentives to work, save, invest and innovate, thereby
making fiscal policy more efficient and growth-friendly. Moreover, the public sector
also functions as a role model as regards, for example, wages or administrative
prices.10
Importantly, sound fiscal policies must also make provisions for the effects
of population ageing.
b) The second principle for a sound economic management pertains to the full
completion of the Single Market. This will enhance not only competition and
efficiency, but also adjustment mechanisms in the event of adverse shocks. We still
have significant progress to make in this domain, despite the fact that the Single
Market was the goal of the founding fathers of the European Union, as set out in the
Treaty of Rome, and despite the fact that this 50-year endeavour was very strongly
reaffirmed with the Single European Act 20 years ago.
According to the OECD, product market regulation remains high in several euro
area countries, and the level of such regulation in the euro area as a whole is
considered significantly higher than in the United States. Let me also mention the
fact that the services sector, which represents 70% of euro area GDP, is far from
being fully integrated as an effective single market. We attach enormous importance
to the full integration of financial markets, particularly because these play a decisive
role in shock absorption and adjustment dynamics in a large single currency area.
As far as cross-border labour mobility is concerned, empirical evidence suggests
that it is still low in the euro area - both across countries and within countries - on
account of several formal barriers across the euro area. This is in clear contrast to
the situation in the United States, where labour mobility is considerable and greatly
contributes to the adjustment process. Hence, more needs to be done to enhance
labour mobility in Europe.
c) The third principle for a sound economic management is the need to closely
monitor the implementation of structural reforms. Earlier I referred to some
structural factors commonly contributing to inflation and growth differentials, as well
as to disappointing growth in productivity. These detrimental factors include
pervasive price and wage rigidities, excessive labour market regulation and the
imperfect competition observed in several important sectors.
This has been recognised for quite some time. It is widely acknowledged that
reforms are essential in order to raise factor productivity and potential output, to
create new jobs, to achieve lower prices and higher real incomes, and to increase
the resilience and flexibility of the economy. Yet, experience to date has clearly
shown how difficult it is to undertake reforms in practice.11 We have to persist and I
shall flag some specific initiatives for reform in three main areas, namely:12
(1) Getting more people into work: Despite impressive achievements in job
creation thus far, the still relatively high unemployment rates in the euro
area (as well as the low participation rates in some countries) clearly
suggest there is a need to stimulate not only labour supply but also labour
demand. As regards labour demand, there is a need to reduce labour
market rigidities as they restrict wage differentiation and flexibility, and thus
tend to discourage the hiring of younger and older workers, in particular.
Progress towards greater contractual flexibility must continue to improve in
several euro area countries. Moreover, in those European countries where
competitiveness has declined, or where the unemployment rate remains
high, it is important that wage increases do not fully exhaust productivity
gains. This in order to provide incentives for firms to create additional
jobs.13 Finally, as regards labour supply, further reforms in income tax and
benefit systems would help to increase people's incentives to work.
(2) Increasing competition: Establishing efficient and well-functioning product
and service markets can boost productivity trends by enhancing the
incentive to invest and innovate, supports further employment creation,
reduces inflation persistence and keeps upward price pressures contained,
thereby improving the adjustment capacity of countries. "Little else than
productivity growth matters in the long-run" - as Bob Solow14 once put it. It
is undeniable that, over the past two decades, significant progress has
already been made in the context of the Single Market Programme. This
has already yielded major benefits for European economies.15 However,
the extension and deepening of the Single Market still remains a high
priority as regards further financial market integration, the pursuit of
11
The need for structural reforms was highlighted by the Lisbon agenda of 2000, which represents a
fundamental and ambitious programme to draw Europe's attention to the major areas where changes are
required. More recently, the Lisbon agenda has been refocused in the direction of growth and employment.
Various attainable objectives have been set in order to enhance the flexibility and adaptability of labour
markets, to r