Willem F Duisenberg: Testimony before the Committee on Economic and
Monetary Affairs of the European Parliament
Introductory statement by Dr Willem F Duisenberg, President of the European Central Bank, Brussels,
8 October 2002.
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It is my pleasure to appear before your Committee today in order to explain the European Central
Bank's assessment of economic and monetary developments and to report on the decisions taken by
the Governing Council.
At the time of our last meeting, in May, we were expecting economic growth in the euro area to be in
line with trend potential again by the end of this year, and we noted that some upward risks to price
stability existed in the euro area. At the same time, we also noted that there were still uncertainties
with regard to the strength of the economic recovery, which implied the existence of uncertainties with
regard to the inflation outlook. Since then, some of the downward risks to our main growth scenario
have in fact materialised. The recovery, both in the euro area and the world economy, has progressed
more slowly than expected, and it has been necessary to scale down our expectations for economic
growth in 2002. At the same time, the exchange rate of the euro has strengthened and we have seen
some rather turbulent periods in financial markets. All these factors have contributed to balancing the
risks to price stability over recent months.
Looking at recent information in more detail, and starting with the most recent data available for the
first pillar of the ECB's monetary policy strategy, the figures up to August 2002 continue to suggest
that monetary growth is strong in the euro area and that liquidity is ample. However, we need to be
cautious in our assessment of recent monetary developments. On the one hand, in an environment
marked by considerable uncertainty, especially in the financial markets, the current high rate of
monetary growth reflects a preference for holding relatively safe assets included in M3. On the other
hand, the strong monetary growth may also reflect stimulus from the low level of short-term interest
rates. This can be seen from the fact that the most liquid components of M3, i.e. those included in the
narrow aggregate M1, have continued to rise at a rapid pace recently.
The growth of loans to the private sector appears to be stabilising at levels above 5%. While the
decline in loan growth which has occurred over the past 18 months is significant, the current rate of
growth is not low by historical standards. This indicates that bank financing conditions are overall
favourable.
The assessment of monetary developments remains complex at this stage. The existing excess
liquidity, if sustained, might signal risks to price stability in the medium term. However, it is unlikely that
excess liquidity will translate into inflationary pressures in the near future, given the environment of
subdued economic growth.
Turning to the second pillar of the ECB's monetary policy strategy, at this juncture the most likely
scenario is modest real GDP growth in the second half of 2002 and an acceleration towards growth
rates more in line with potential in the course of 2003. The recent scaling down of expectations for
economic growth stems partly from a weaker outlook for the global economy, which in turn is closely
related to the significant fall in stock prices which has occurred over recent months in all major
economies.
As regards domestic demand, higher growth of private consumption should be a key factor in
supporting economic activity in the euro area. There are indications that such a recovery took place in
the second quarter, but at a moderate pace. In the period ahead, if oil prices do not rise further,
consumption should be supported by an increase in real disposable income resulting from the decline
in inflation from the higher levels recorded at the start of this year. The impact of the introduction of the
euro banknotes and coins on consumer prices has been very limited and we are convinced that
divergences between factual and perceived inflation are a temporary phenomenon. Furthermore, the
low levels of interest rates across all maturities should help to support investment and economic
growth in the period ahead.
In spite of these positive factors, however, the uncertainty surrounding the economic outlook remains
high in the short term. In principle, the increase in direct and indirect holdings of equities by euro area
households over recent years has raised the potential for recent financial market developments to
have an adverse influence through wealth effects. Moreover, recent financial market developments
may make it more expensive to raise equity capital to finance corporate investment in the euro area.
While all available evidence suggests that these effects will continue to be relatively limited and indeed
much smaller than in other major economies, the sharp decline in equity prices is an element which
has increased the uncertainty surrounding the recovery. In addition, imbalances in the global economy
and their potential spillover to the euro area economy remain a significant source of risk for growth.
Finally, uncertainty is also high because it is difficult to foresee developments in the oil markets
against the background of current political developments.
Moving to the outlook for prices in the euro area, we have seen HICP inflation rates hovering around
2% over the past couple of months. These developments are broadly in line with previous
expectations of inflation rates for the remainder of the year, but recent upward tendencies indicate that
the short-term trend has been affected by oil price developments. However, subdued economic activity
and the stronger euro should help to dampen inflationary pressures over time.
At the same time, however, we need to assess other factors which may involve upward risks to price
stability. Among those, wage developments play a particular role. Wage growth remained on an
upward trend until early this year. Although we have indications that this trend may have come to a
halt in the second quarter of 2002, close monitoring is necessary.
To sum up, inflationary pressures have declined. Looking forward, recent trends in economic activity
and the exchange rate of the euro imply downward pressure on inflation rates, but other factors, in
particular monetary developments, wage trends and oil prices, need to be monitored for their possible
upward impact on inflation. Overall, therefore, we are of the opinion that the risks to price stability over
the medium term are at present balanced. We thus consider the current level of the key ECB interest
rates to be appropriate.
At this juncture it is of utmost importance that all macroeconomic policies remain oriented to the
medium term, with all players fulfilling their responsibilities. Monetary policy will continue to provide a
reliable anchor for the economy, especially in an environment characterised by high uncertainty and
fragile confidence. This implies focusing on the maintenance of price stability over the medium term.
Let me make a remark in this context, linked to comments which arise with a certain regularity in public
debate and which argue that monetary policy should follow a different orientation, an orientation in
which price stability is not the overriding objective.
I should like to recall in this connection the fundamental and yet simple principle that monetary policy
should not be overburdened with objectives that it cannot fulfil. It is well established that monetary
policy can only control price developments over the medium term and cannot have an impact on
output beyond the short term. Monetary policy can certainly not heal structural problems in the
economy, such as those underlying the high level of unemployment.
In line with these principles, the Treaty establishing the European Community has assigned the ECB
the primary objective of maintaining price stability. In the end, strictly following this mandate, with the
appropriate medium-term orientation, is the best contribution the ECB can make to supporting
sustainable non-inflationary growth and a high level of employment in the euro area.
Taking a broader perspective, I should like to take this opportunity to further emphasise the overall
soundness of the institutional framework for monetary and economic policy laid down by the Treaty. In
fact, the Treaty provides, in all fields, a clear and consistent allocation of policy objectives and
responsibilities among the various policy-makers.
In this respect, it is the task of fiscal policy to make its contribution to enhancing the growth potential of
the euro area by maintaining sound fiscal positions and helping to reinforce the proper framework for
the functioning of a market economy. It is also important that fiscal policy maintains a medium-term
orientation throughout the economic cycle.
The results of fiscal policy in several countries have been very disappointing in the last few years. The
pace of reform has significantly fallen and there have even been setbacks in the efforts to consolidate
in some cases. In fact, the main reason why several countries at present are in budgetary difficulties is
because they have not used the past phase of higher growth to substantially improve their fiscal
position, i.e. they have shown precisely a lack of medium-term orientation.
It is crucial that fiscal policy fully respects the basic principles of the Treaty and of the Stability and
Growth Pact, namely to avoid excessive deficits and to attain budgetary positions close to balance or
in surplus in the medium term. If the Pact is to work efficiently, all countries with remaining imbalances
must commit themselves to implementing a clear consolidation strategy. Such a strategy should
specify a credible adjustment path with significant improvements in the cyclically-adjusted budget
balance every year. This path should be followed strictly and completed within the shortest possible
time frame. It must be based on realistic assumptions for the economic environment and include
clearly specified measures. Furthermore, accounting rules must be rigorously applied and strict
procedures established to monitor the implementation of the consolidation strategies. In the end, the
full adherence of all governments to the Stability and Growth Pact can only be beneficial for the euro
area.
Finally, it is important to stress, especially in a phase of uncertainty regarding economic activity, that
decisive structural reforms will contribute to increasing the euro area's resilience to economic shocks,
enhance price and wage flexibility, and thereby reduce the costs associated with an economic
downturn and increase the euro area's growth potential. Structural reforms in product, labour and
financial markets are essential in order to foster non-inflationary growth in the euro area and create a
climate of economic stability and dynamism. Countries should therefore speed up their efforts to
implement such structural reforms, without which the benefits of the introduction of the euro can hardly
be reaped.
I will be pleased to answer your questions now.