Jean-Claude Trichet: The role of central banks in a globalised economy
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, on the occasion of the
13th Conférence de Montréal, Montreal, 18 June 2007.
* * *
Ladies and Gentlemen,
Thank you for inviting me to the 13th Conference of Montreal hosted by the International Economic
Forum of the Americas. I am delighted to speak today before such a distinguished audience. I greatly
appreciate your objective to organise wide-ranging and open discussions on major international
economic issues. The theme of this year's conference - Succeeding through uncertainty: from risk
evaluation to strategic decisions - is a very timely and challenging one. We at the European Central
Bank often have to navigate uncertainties and find that our monetary policy strategy is of great help in
setting the course.
One of the themes most discussed in the conference programme is globalisation, and rightly so given
its huge importance. I would like to investigate with you the role of central banks in a globalised
economy. First, I will outline some of the features of the debate. Second, I will reflect on the integration
of the euro area within the globalised economy. Third, I will reflect on some of the implications of
globalisation for central banks.
1. Globalisation and some of its underlying trends
Globalisation encompasses several phenomena and trends which have led to a growing
interdependence of most economies throughout the world. It displays its effects through a strong
increase in cross-border transactions in goods and services, capital, labour and natural resources. I
would add that, at the same time, we are witnessing a substantial increase in the cross-border
exchanges of ideas and concepts between the various institutions, organisations and non-trading
companies. The concept of globalisation has been of vital importance over the last 20 years - and has
been even more so in the last ten years - thanks to a combination of factors, including the diffusion of
ever more sophisticated and affordable information and communication technologies. The cost of
shipping goods has fallen. Economies have continued to open up and many trade and financial
barriers have been lifted. National barriers to the circulation of goods, services and production factors
are diminishing everywhere. Foreign direct investment (FDI) flows have also surged, leading to an
internationalisation of production processes and new ways of doing business as companies have
established affiliates abroad both to gain access to foreign markets and to reduce input costs.
Globalisation has allowed many emerging countries to enter and compete in world markets. In order to
measure the phenomenon on a global scale, it should be noted that the labour force available for
participating in globalised markets has probably doubled from 1.5 billion to 3 billion with the
openingup of China, India, many formerly centrally planned economies and several other emerging countries.
Although labour mobility is still limited worldwide, the increased flexibility of capital flows implies that
firms now have much easier access to global labour supply than before. As a result, many industries
have set up supply chains on a global scale.
Let me now provide you with some figures to document the magnitude and scope of
globalisation. Global trade openness - measured as world exports and imports of goods and
services as a share of world GDP - has practically doubled over the last 20 years, from 33.9% of
world GDP in 1986 to 60% of world GDP in 2006. An increasingly decisive factor has been the
increase in trade in intermediate goods and services as a result of the rising internationalisation of
production processes.
Financial systems have also been deeply affected. As investors' incentives to hold foreign assets in
their portfolios and the possibilities to diversify and spread financial risks globally have grown, this has
affected all facets of financial systems, be it markets, infrastructures or institutions.
Let me briefly illustrate some impressive developments. The share of gross international asset
holdings in world GDP - which provides a measure of financial openness - has shown an eightfold
increase over the last 25 years and now stands at more than 130% of world GDP. As far as global
capital flows are concerned, it is noteworthy that their composition has changed significantly over
recent years. While FDI and international equity flows were dominant in the late 1990s, international
transactions in mainly liquid assets have risen in recent years, making up most of the increase in
global capital movements. International risk-sharing and the transfer of net savings across countries
are important features of this process.
Emerging market economies are gaining a larger share of global GDP. Aggregated data show that
they posted net private capital flows of USD 650 billion in 2006 compared with USD 458 billion in
2005. Net direct investments remained globally unchanged over this period, with net inflows of USD
267 billion in 2006. Portfolio investments, on the other hand, which include the public sector, recorded
higher outflows in 2006 of USD 379 billion, compared with USD 258 billion in 2005, while portfolio
investments to emerging market economies decreased slightly. On the whole, emerging market
economies have most recently been providing the rest of the world with net resources corresponding
to their current account surpluses. The main drivers are limited domestic absorptive capacities and
underdeveloped domestic financial systems.
Globalisation is fostering economic prosperity and raising living standards through various channels.
There is stronger international competition and a greater transfer of technology and knowledge. This is
promoting productivity gains and global economic growth. Higher efficiencies are helping to lower both
costs for firms and prices of tradables. The availability of new product varieties is increasing.
Resources are allocated to the most profitable activities across the world, and there are new
possibilities to diversify and share risks globally. Also, scrutiny by international investors serves as a
disciplining device, which enhances the quality of domestic economic policies and thus contributes to
improved economic fundamentals.
However, globalisation also presents some challenges and poses some risks. The ever closer global
integration and the surge in capital mobility have rendered the international financial system more
exposed to changes in investor sentiment. Furthermore, international trade and financial links might
intensify the transmission of shocks from one country to another and amplify cross-border spillover.
We should not forget that, a few years ago, a number of financial crises posed a major threat to the
international financial system, including the Asian crisis starting in 1997 and the Russian crisis in 1998.
Each of these crises was different and the international community managed to resolve them
successfully. Each crisis illustrated the need for adequate investment in institutions and human capital
to strengthen economic governance. I will come back to the impact of major financial crises for central
banks in my third reflection. Past crises illustrate the vulnerability of the global economic and financial
system and remind us of the importance of always being alert and never being complacent.
2. The integration of the euro area within a globalised economy
My second reflection is about the economic and financial links between the euro area and the rest of
the world. I will argue that integration within Europe has gone hand-in-hand with the integration of
Europe within the global economy. In trade terms, for example, the euro area is very open vis-à-vis the
rest of the world; more open than the United States and Japan. Extra-euro area exports of goods and
services account for around 20% of euro area GDP, roughly the same share as extra-euro area
imports. This is substantially higher than in the United States, where exports of goods and services
represent about 10% of GDP and imports 16%, as well as in Japan, where total exports amount to
15% of GDP and imports 13.4%. Moreover, particularly noteworthy for the euro area is that the
increase in trade with the rest of the world has been even greater than the increase in exchanges
within the euro area.
What is even more remarkable, perhaps, is that the euro area is more financially open than the United
States and Japan. Let me present four observations. The first observation is that the external assets
and liabilities of the euro area, as a percentage of GDP, are very large and account for around 124%
and 137%, respectively. By comparison, in the United States, the corresponding figures are
substantially lower: 90% of GDP for assets and 110% for liabilities. In Japan, foreign financial assets
are likewise significantly lower than in the euro area (94% of GDP in 2005), and the difference is even
greater for liabilities, which represent only 60% of GDP, i.e. less than half of the corresponding figure
for the euro area. This highlights how the euro area is very outward-looking.
My second observation is that the euro has very probably contributed to the financial opening of the
euro area. On the assets side, stocks of euro area assets held abroad increased from less than 87%
of GDP in 1999 to, as mentioned, over 124% in 2005. On the liabilities side, the increase was also
very substantial, from around 92% to 137%. The rise has actually been much less pronounced for the
United States: US assets have grown from 80% of GDP in 1999 to 90% today, and US liabilities have
increased from 91% to 110% of GDP. In other words, the euro area has witnessed a more substantial
increase since the start of Economic and Monetary Union.
My third observation is that the euro area is an attractive place for FDI. A breakdown reveals that
inward FDI amounts to more than 27% of euro area GDP, against 22.5% for the United States. The
euro area seems to have received, proportionally to GDP, a similar amount of FDI as China - 27.3%
for both economies - according to IMF statistics. In net terms, the stock of direct investment abroad is
only slightly higher than that of FDI within the euro area (30.4% against 27.3%, respectively).
My fourth observation concerns bilateral FDI linkages of the euro area. Based on available data, it is
worth noting that the stock of euro area FDI abroad is mostly held with mature economies: nearly 21%
in the United States, 24% in the United Kingdom, 9% in Switzerland, and between 2.5% and 3% in
Sweden, Canada and Japan. Likewise, on the liabilities side, the United Kingdom and the United
States account for a larger share than on the assets side (nearly 40% and 23.5%, respectively).
I should also stress that the amount of euro area FDI in emerging market economies rose quickly.
Between 1999 and 2005, outward FDI from the euro area to the so-called BRIC group - which
includes Brazil, Russia, India and China - increased markedly. Over this period, the stock of outward
FDI in the BRIC group rose from €63 billion to €133 billion (or by 111%). In comparison, the stock of
euro area FDI in the United States increased by 55%, from €360 billion to €558 billion, during the
same period.
The euro area itself has also become more attractive as a destination for FDI from the BRIC countries:
between 1999 and 2005, FDI stocks from the BRIC group in the euro area tripled, from €4 billion to
€12 billion. This is still low in comparative terms but is not insignificant. In terms of comparison, the
figures for US FDI stocks in the euro area rose from €322 billion to €560 billion over the same period.
Brazilian and Russian firms account for the bulk of the BRIC countries' FDI surge in the euro area, but
Chinese and Indian FDI has picked up in recent years.
On the whole, this evidence suggests that there is no "fortress Europe" or "fortress euro area"
3. The implications of globalisation for central banks
My third reflection is about the implications of globalisation for central banks in their two principal
functions, i.e. setting monetary policy and helping to secure financial stability.
Globalisation and monetary policy.
The issue of the impact that we have observed for some months of the historic episode of accelerated
globalisation on inflation is both important and much debated. Economic theory has numerous
channels through which globalisation can influence the level of prices, but these influences are not
one-directional.
I have already mentioned the basic phenomenon of the increase in the pool of labour available to the
world economy with the widespread opening-up of emerging economies and the former centrally
planned economies. The phenomenon exerts pressure, in particular, at the slightest rise in the cost of
labour, especially unskilled labour. In a more general manner, it tends to modify significantly the
previous balance between capital and labour at the global level. Globalisation also exerts pressure
conducive to price stability by strengthening global competition, by reducing the ability of firms to fix
prices and by exerting pressure on unit production costs in the industrialised countries.
A third influence, which is in keeping with my previous two points, is that globalisation has also exerted
a positive effect on the productivity of the global productive sector by facilitating, and accelerating, the
phenomenon of restructuring and optimisation of the division of labour in a wider cross-border context.
But it would be naive to think that the effects of globalisation on inflation go in one direction only.
Indeed, the sudden emergence of fast-growing economies in the global economy is exerting upward
pressure on prices for mining products and fossil fuels. This phenomenon has been particularly visible
since 2003.
The same phenomenon of rising prices is observable in certain areas of agricultural production. The
attainment of considerably higher living standards by a new and numerous middle class translates into
major changes in eating habits and, as a result, in the meat, cereal and fresh produce sectors of the
world economy.
Since the theoretical influences that globalisation can be said to have on prices are numerous and
work in different directions, it might perhaps be natural to suppose that globalisation, as a continuous
phenomenon with medium-term effects, will translate into substantial changes in relative prices - the
prices of manufactures falling and those of oil, gas and certain commodities rising - without the
general level of prices being significantly affected.
Empirical research does not allow this conjecture to be either irrefutably confirmed or disproved in the
recent period. All in all, the available data indeed confirm that the prices of manufacturing imports in
the euro area were at end-2006 still below their 2001 level. Although import prices for raw materials
have risen strongly since 2003, it can be said that, over the same period, the acceleration in import
prices overall, all products taken together, has been moderated by the growing proportion of euro area
imports coming from countries with low production costs (countries in eastern Europe and Asia,
particularly China).
It remains that the phenomenon of globalisation and of its acceleration since the mid-1990s has
coincided with a decline in global inflation and in its volatility. Concomitantly and as a consequence of
this stabilisation of inflation at a low level, we have also seen lower volatility in macroeconomic
variables.
But it would be wrong to conclude that this correlation between globalisation and low inflation
demonstrates a causal relationship. Indeed several other factors - independent of globalisation - can
be identified as helping to explain these good results. I see at least four.
In the first place, the very rapid progress in science and technology, in particular information and
communication technologies - leading to significant productivity gains which coincide with
globalisation and, moreover, are one of its underlying causes. In the second place, structural reforms
which have been introduced in the industrialised world from the beginning of the 1980s and which
have gradually increased throughout these economies. These structural reforms, like the spread of
technological progress, have helped to increase the growth potential of the economies and thus to
facilitate price stability. In the third place, the greater budgetary discipline which has recently
characterised most economies following the previous period of poor fiscal management. And finally,
the monetary policy pursued by the central banks and their enhanced credibility.
I would particularly like to stress the last point. Whatever the influences being exerted in the context of
globalisation, the basic principle which allows the anchoring of monetary policy remains: in the long
run, inflation is a monetary phenomenon. As a consequence, globalisation does not affect the central
role and overriding responsibility of central banks to preserve price stability.
In the short term, the central bank must continue anchoring inflation expectations at a level that is
consistent with the central bank's definition of price stability. Let me illustrate this by means of an
example. Let's take the significant increase in energy prices over the last few years. I will assume that
a central bank credibly commits to maintain stable prices and is fully and unequivocally trusted by the
public and by other policy-makers. The corporate sector, which uses energy as an input for its
production processes, observes a significant and sharp rise in the price of oil. Since there is a credible
commitment to price stability over the medium term and inflation expectations are well anchored at low
levels, entrepreneurs easily understand that it is the relative price of energy that is rising, while the
aggregate price level may not increase as much. Therefore, their incentives to fully pass the increase
in input prices to consumers are reduced because, if they did, their competitiveness could be
significantly eroded, especially in an increasingly competitive global environment. Hence, in this
example, the credibility of the central bank clearly reduces second-round inflationary effects and
minimises macroeconomic fluctuations in output and inflation.
Now let me turn to the role of central banks in mitigating risks to financial stability stemming
from globalisation.
Widespread interlinking of the financial systems has created a global financial system that it becoming
a real, significant entity at the global level. This affects the financial stability assessment performed
by central banks in two ways.
•
The first way is that it calls for a growing global focus on their financial stability analysis. For
instance, for the euro area, a complete and comprehensive view on the key sources of risk
and vulnerabilities facing the financial system cannot be formed without taking due account
of wide global imbalances or concerns about excess global liquidity.
•
The second way is that it calls for enhanced cross-border cooperation and exchange of
information among central banks (and between them and other authorities contributing to
financial stability). This should produce a comprehensive picture of risks and vulnerabilities
and identify appropriate and effective mitigating policy actions. In the European Union this
goal is pursued mainly through the activity of the Economic and Financial Committee in its
Financial Stability Table set-up, comprising representatives from ministries of finance, central
banks and the supervisory committees in banking, securities and insurance, as well as the
ESCB/Eurosystem. At the level of the G-10, this goal is pursued by the Financial Stability
Forum and other sectoral committees.
The globalisation of financial systems also affects the role of central banks in the design of financial
regulation and supervision. This role is played by central banks because they either have a direct
supervisory responsibility or act in an advisory capacity to governments. In general, financial
globalisation calls for an intensification of efforts among regulators on a cross-border basis to produce
consistent regulatory and supervisory standards. The aim is to promote a level playing-field and
reduce regulatory arbitrage. This is clearly illustrated by the experience of the European Union where
the establishment of a single financial market is a main strategic objective and presupposes the
removal of potential regulatory and supervisory barriers. The EU experience also shows the
usefulness of proceeding in steps in the process of convergence by focusing first on regulatory
requirements and subsequently on supervisory standards and practices. In this context, I would like to
offer three considerations:
• First, in the areas clearly identified previously it is important that the regulators of the major
financial systems deepen and strengthen their dialogue at the global level. Therefore, the
initiative of the European Commission to extend its traditional regulatory dialogue with the
United States to other major countries, including China and Japan, is supported in particular.
•
Second, we see an increase in the number of new areas in which the need for a consistent
approach at the global level is becoming apparent. Financial institutions with high leverage
are a good example here. On the basis of the mandate given informally by the G8, the
Financial Stability Forum has played and continues to play a crucial role in developing
recommendations at the global level targeted at regulators, counterparties of the leverage
funds and investors in these funds. The institutions themselves have been encouraged to
develop, voluntarily and under their own responsibility, their principles of best practice
("benchmarks"), both in terms of transparency towards their counterparties and their own
investors, and in terms of their optimal management of risks. Credit derivatives markets
could also be mentioned as another area that requires a consistent approach at the global
level.
•
Third, in general terms, there is a still a great deal of progress to be made in harmonising
effective supervisory practices at the international level. This is particularly paradoxical
regarding the banks, since the Basel Committee is the oldest and most advanced in terms of
ensuring that uniform principles and concepts of prudential supervision are defined at the
global level. However, given the diversity of practices, a significant harmonisation effort is
still necessary and is currently being made by the Basel Committee's Accord Implementation
Group (AIG), which is mandated to work on practical implementation issues for achieving
convergence of banking supervision practices at the international level.
4. Conclusion
I would like to conclude by drawing your particular attention to the following five points:
First, let us never forget that scientific and technological progress is very much at the root of
globalisation. There would be no low-cost, instantaneous transmission of information, concepts and
services at the global level without new information and communication technologies. There would be
no extremely rapid expansion of international trade in goods without technological progress in sea and
air transport.
Second, if science and technology are at the root of the current globalisation, this could be a trend that
not only lasts, but also strengthens. There is no indication that scientific and technological progress is
tending to slow down. In fact, the opposite is the case.
Third, the rapid growth that we are seeing at the global level, and highly significant transformations
which are both the cause and effect of this growth at the level of each of the economies, rapid
changes of the respective economic weightings of the various continents and of the structure of the
global economy all combine as a consequence to make predictions based on past regularities less
reliable. Consequently, uncertainty tends to increase and economic and financial risks with a weak or
very weak probability, but a strong destabilising potential, appear as the inevitable, and in fact,
"normal" counterpart to an unprecedented period of economic prosperity. Now is not a time to be
complacent.
Fourth, more than ever during a period of accelerated globalisation, central bank credibility is essential
for anchoring solidly inflation expectations and for forming a solid base for monetary and financial
stability in a brilliant, mobile international economy in which uncertainty and risks cannot be ignored.
Fifth and finally, it is crucial to deepen and strengthen global governance by exploiting to the full all
possibilities offered by all formal and informal institutions that exist and by consolidating global
financial stability, not only by unifying the principles and concepts of prudential supervision and
regulation, but also by achieving real unification, resulting at the global level from the practical
implementation of regulation and supervision.
Ladies and gentlemen, thank you for your attention.
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