Mr Noyer gives a review of the economic situation in the euro area
Speech by Mr Christian Noyer, Vice-President of the European Central Bank, at the conference of the
International Finance Futures snc (IFF), Paris, on 8 March 2000.
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Introduction
Ladies and gentlemen, it is a pleasure for me to speak here at this conference. The topic of my speech
is "la conjoncture dans la zone euro" and this may warrant some explanation, given that this
conference traditionally focuses on the cyclical outlook for the French economy. Some, but hopefully
not too many of you may simply see this as confirming their suspicion that central bankers like to
surprise financial market participants. Let me assure you that this is not our intention, and there are
good reasons indeed why, as a European central banker, my focus should naturally be on
developments in the euro area as a whole, rather than on those in individual Member States. And,
while I will also briefly go into the cyclical outlook for France, this will be largely with the outlook for
the euro area as a whole in mind. Before I turn to this discussion and the policy challenges associated
with it, please allow me to review the case for this area-wide perspective.
The primary objective of the Eurosystem is to maintain price stability in the euro area. This implies
that the single monetary policy can only be based on developments in the euro area as a whole. Given
this view, decisions are made with due consideration of all information that is available and relevant
with a view to maintaining price stability in the medium term. This requirement is reflected in the
two-pillar strategy of the Eurosystem, which comprises an assessment of monetary developments
against a reference value for growth of M3 and a broadly based assessment of the outlook for price
developments.
Economic analysis for the euro area as a whole critically hinges on the availability of appropriate data.
In addition to requirements in terms of sufficiency, quality and timeliness, area-wide data also need to
be harmonised to the highest degree possible. The latter requirement is clearly met regarding the data
on, for instance, monetary aggregates and consumer prices, as measured by the HICP. Moreover, the
changeover to the new European System of Accounts (ESA 95), which began in the course of last
year, meant a further improvement in this respect and should be seen as representative of the ongoing
efforts to develop a wholly satisfactory basis for the single monetary policy. It is true that in some
areas further progress is still needed and, overall, it still holds that there is relative dearth of area-wide
data compared with the availability of data in individual Member States. In addition, when assessing
developments in the euro area as a whole, the possibility has to be considered that economic
relationships which are taken to prevail at the level of the individual countries may look different at
the area-wide level. But this cannot be taken as implying that a single monetary policy is not feasible
or that there is an alternative to its focus on developments in the area as a whole. Rather, these
intricacies should be seen as re-emphasising the case for the strategy which has been chosen by the
Eurosystem and which reflects these particular circumstances.
Cyclical outlook for the euro area ...
With this in mind, let me now turn to the economic outlook for the euro area. There is by now
sufficient evidence to say that the euro area is enjoying a strong upturn in growth, as had indeed also
been predicted by the vast majority of international organisations and private institutions in the autumn
of last year. The headline figure for this upturn is clearly the rate of growth of real GDP in the third
quarter of 1999, which was well up from what had been recorded for the first two quarters of the year.
No estimate for real GDP is yet available for the final quarter of last year, but on the basis of available
indicators growth should have continued to be strong.
Taken together, the year 1999 has been characterised by a rather swift and strong rebound from the
slowdown in growth in the course of 1998 and early 1999 following the crises in Asia and Russia.
Indeed, when reviewing the magnitude of the disturbances in the external environment as they
appeared at the time, the likely outcome of 2% for euro area growth in 1999 as a whole is not bad at
all. Judging from the currently available evidence, there seems to be a broad consensus in the
forecasting community that the prospects for a strengthening of growth in the years 2000 and 2001 are
favourable. On average, the latest forecasts point to real GDP growth of about 3% in the euro area in
each of these years. It should be noted, however, that most of the currently available forecasts were
made in the autumn of last year and that some of their underlying assumptions and initial conditions
may thus no longer fully reflect current perceptions. For example, the IMF has since revised its
projections for world growth upwards and such a scenario could well provide for somewhat larger
impulses on euro area export growth than have been incorporated so far. Similarly, the quasi-technical
assumptions for variables such as exchange rates, interest rates and certain commodity prices, which
forecasts tend to be built on, might need to be revised in order to bring them into line with the latest
developments. Rather than precisely forecasting numbers, my explanations should therefore be seen as
relating to the general picture of the outlook which is likely to be much more stable.
The favourable outlook for euro area growth is essentially based on the prospect that the initial
impulses from external demand and the sustained domestic demand within the euro area reinforce each
other in a beneficial way in the current upturn. This is exemplified by the fact that, together with the
brightening picture on the external side of the economy, there has been a strong rebound in industrial
confidence. Following steady increases up to the first months of this year, most of the previous decline
in industrial confidence has now largely been reversed. The cyclical pattern of consumer confidence
was fairly subdued and confidence remained at a level close to its all-time high throughout 1999.
Continued employment growth and further reductions in unemployment should help to sustain it at
this high level. Taken together, the prospects for a strengthening of domestic demand growth appear to
be good. In this context, it is worth pointing to a key feature of the euro area economy, namely that its
degree of openness, and thus its dependency on foreign demand, is much lower than that of individual
Member States. Developments in the world economy will nevertheless remain important, in particular
through their repercussions via financial markets, and need to be monitored carefully. But if conditions
for growth are right from the domestic side, the euro area economy should, in principle, be fairly
resistant to potential shocks to foreign demand.
Let me now turn to developments in prices. Looking back, the average rate of increase in consumer
prices in 1999 was just over 1%, the same as it had been in 1998. And most of the forecasts currently
available from private and international institutions, while projecting a somewhat faster rise in 2000
and 2001, expect inflation to remain below 2% on average. So, is there any reason to worry? The bulk
of these forecasts was made in the autumn of last year and is subject to the caveat of the potentially
outdated forecasting assumptions already mentioned earlier. In a number of cases, these forecasts also
incorporate the assumption of rising short-term interest rates in 2000. Prices are now rising faster and
further than was expected earlier. In the course of the second half of last year, inflation moved up by
almost one percentage point to reach 1.7% in December. And expectations of higher inflation rates in
the first months of this year have just been confirmed by a rise to 2.0% in January. This continued
upward movement essentially reflects the increase in oil prices, but - increasingly - also the impact that
the lower exchange rate of the euro has on import prices in general. While these effects can be
expected to unwind sooner or later, they have been more protracted and more fervent than expected
earlier and, through their very duration and magnitude, they clearly heighten the risk for second round
effects.
At this point, let me say something about interest rates. About one month ago, the Governing Council
of the ECB decided to raise the interest rate on the main refinancing operations by 25 basis points. I
would like to stress that this was not a direct consequence of the favourable prospects for euro area
activity growth which I just described. As has been emphasised repeatedly, the ECB is not concerned
about higher growth as such, but that this higher growth be non-inflationary. In this respect, the
interest rate decision of 3 February should have been a reassuring one. On the one hand, the rate
increase did not mean that the ECB had put the brakes on. Rather, when looking at the high rates of
monetary and credit growth and the fact that the levels of both nominal and real interest rates remained
relatively low in a longer-term perspective, the appropriate picture would have been that of throttling
back. The economic upturn in the euro area is now well under way and its momentum should not be
hurt by an adjustment of the monetary policy stance. On the other hand, the interest rate move
provided a clear signal to market participants, social partners and policymakers that the ECB was
determined to counter inflationary dangers in a timely fashion and that the prospects for price stability
in the euro area remained good.
In the run-up to this interest rate decision, a number of risks to price stability in the medium term came
more clearly to the fore, indicated by both of the two pillars of the monetary policy strategy. First,
monetary growth has remained consistently above the reference value and the uneven growth pattern
at the turn of the year 1999/2000, with lower growth in January, should be seen against the
background of a base effect. It is worth re-emphasising that there are no mechanistic reactions to
deviations of monetary growth from its reference value, but, together with the continuing strong
expansion of credit to the private sector, liquidity conditions in the euro area remained generous. As
regards the second pillar, the outlook for future price developments has become less favourable. In
particular, the danger has increased that the temporary upward pressures on consumer prices from the
external side of the economy, from higher oil prices and a lower exchange rate, may feed into more
lasting price pressures from the domestic side. In this respect, the interest rate increase has not, for
instance, eliminated the need in the upcoming wage bargaining rounds to ensure that wage settlements
do not give rise to second round effects. It should instead have given additional assurance to wage
negotiators to keep wage increases in line with price stability.
... and the policy challenges lying ahead
What we currently observe in the euro area is a noticeable upturn in growth accompanied by price
stability, and the challenge is to set the scene for this to turn into a prolonged period of
non-inflationary growth. Monetary policy can best contribute to long-term growth of output and
employment by pursuing its primary objective of safeguarding price stability and by counteracting
risks in a forward-looking manner. This has been confirmed by several studies - within and outside the
ECB. However, it would mean an overburdening of monetary policy if the responsibility for
non-inflationary growth and for the single currency were left to that policy field alone.
So what can other policy areas do in support of these joint responsibilities? Ongoing efforts are
required from macroeconomic and general economic policies as well as from wage negotiators to raise
the productive potential of the euro area. In particular, further progress in structural reforms of labour
and product markets is needed to eliminate or at least significantly reduce existing rigidities. There is
now a broad consensus that the larger part of the still very high unemployment is of a structural nature.
It is true that estimates of structural unemployment are subject to considerable uncertainty, but the
dimension of the problem is certainly large enough to warrant decisive action. And there is no time to
lose. The change to a post-industrial economy with different work profiles and job requirements is
already under way. There is also the prospect of rising participation rates as demand for part-time
employment increases. In order to ensure employability of the work force at all levels of productivity,
structural reforms of labour markets are urgently needed. However, the full benefits of such reforms
can only be reaped if supported by appropriate wage policies. The participants in the wage negotiation
process thus have the dual responsibility of keeping wage increases consistent with both price stability
and continued employment growth.
Some deregulation and liberalisation of previously sheltered sectors has already taken place in recent
years, but there remains significant scope for further action along these lines. The favourable impact of
such measures in terms of lower price increases have, for instance, become clear in the
telecommunications and energy sectors and should be encouragement enough to step up efforts in
other sectors as well.
As regards fiscal policies, the current cyclical upturn provides a good opportunity to intensify the
necessary consolidation of public finances. It has to be acknowledged that public deficits have come
down in recent years and that budgetary objectives for 1999 seem to have been met by all euro area
countries. However, it has also to be borne in mind that the recent reduction of deficits has been
greatly helped by the relatively low levels of interest rates achieved in the run-up to Monetary Union.
And in a number of Member States the budgetary situation is still far from reaching the targets
specified in the Stability and Growth Pact, which are for budgets close to balance or in surplus. The
additional room for manoeuvre offered by such positions is urgently needed. First, sufficient safety
margins are necessary to cope with the adverse shocks which will not cease to occur in a Monetary
Union. Second, they are necessary to increase the scope for reforms of tax and expenditure systems
which are conducive to long-term growth, and to start on the necessary reforms of social security
systems. It appears that a number of updated stability programs, which have recently been sent to the
European Commission for examination, do not yet sufficiently incorporate such objectives.
With all the appropriate policies in place, the momentum of non-inflationary growth could eventually
be stronger than is currently expected. Such a prospect would have made a nice ending to a discussion
on the outlook for the euro area. However, the question which currently appears to occupy European
policymakers is whether Europe is about to convert into a so-called "New Economy" and whether it
could be expected to mirror the strong performance of the US economy in terms of high growth and
subdued inflation. At this juncture, the concept of the New Economy is still somewhat unclear,
essentially combining a range of rather diverse factors which have in common that they potentially
raise the speed at which the economy can grow before inflation starts to accelerate. In this respect,
while certainly not "new" as a prescription, decisive action on the part of policymakers to pursue
structural reforms and sound economic policies would certainly be part of this concept. The extent to
which the potential gains of factors such as information technology can be reaped, is likely to depend
on whether appropriate market structures and sound economic policies are in place.
To date, there has been a difference between the US economy and the euro area. This is most apparent
with respect to the different growth performance, which is also reflected in recent developments of the
euro. To the extent that exchange rates are a reflection of cyclical divergence between countries or
economic regions, it is worth pointing out that the current external value of the euro vis-à-vis the US
dollar is not so much an expression of bad performance or unfavourable prospects of the euro area.
Rather, it reflects the exceptionally good performance achieved by the US economy. However, the
growth differential vis-à-vis the United States is likely to narrow rapidly as the upturn in the euro area
continues [and some re-balancing of the exchange rate can hence be expected. At the same time, in the
longer-term, the exchange rate reflects more than just cyclical differences. Of greater importance for
the upward potential of the euro will therefore be that monetary policy is committed to securing price
stability. In addition, and this also ties up with the requirements for something like a New Economy to
emerge, it is necessary that convincing further progress be made in the individual Member States
regarding the structural reform of labour and product markets.]
Differences in economic performance across Member States ...
The single currency reflects a large number of factors, both at the area-wide and at the national level,
and is therefore a joint responsibility of all Member States and of all policy areas. In this respect,
differences in growth and inflation between Member States will continue to occur also with a single
monetary policy, just as they have been normal between regions in the individual countries. Monetary
Union is no universal shield against shocks and does not prevent these shocks from affecting countries
differently, depending on their economic structures and policy responses. At the same time, monetary
policy can no longer be geared towards the divergent developments in individual countries and it is
clear that, if this divergence is considered to reflect unwarranted cyclical or structural conditions, this
is primarily a question of the country in question and of national economic policies. But we should not
forget that some divergence is quite normal. For instance, with countries still in a process of
catching-up in terms of productivity and living standards, there will be some natural and even
warranted divergence in growth and inflation in the course of this process.
While the single monetary policy is determined by developments in the euro area as a whole, looking
also at the performance in the individual Member States is necessary to gain a better understanding of
area-wide developments.
... and the outlook for the French economy
With this in mind, let me now say something about the outlook for the French economy - and to point
out that it is indeed favourable. The cyclical developments in France combine moderate inflation,
below the euro area average, and strong economic growth, above the euro area average. Towards the
end of the decade, France has thus contributed to a great extent to stabilising the prospects of the euro
area economy. In particular last year, and in contrast with other large economies of the area, the
French economy has proved resilient in terms of activity and stable in terms of prices. Looking at the
headline figures for 1999, an estimated 3.2% real GDP growth for the fourth quarter and a 0.6%
annual average increase in consumer prices, the conclusion can be drawn that economic agents in
France have so far successfully adapted to the new euro-wide macroeconomic context associated with
the single monetary policy.
With a view to the near future, available indicators and forecasts suggest similarly favourable
prospects for France as for the euro area as a whole. According to recent results from industrial and
consumer surveys, both entrepreneurs and households remain confident about their short-term
prospects. The optimism of the latter is best reflected in the historically high level of consumer
confidence and stems partly from the on-going improvement of the situation on the labour market.
Household consumption, which has been resilient in 1999 despite the temporary economic slowdown,
is therefore expected to continue to grow rapidly this year. As far as enterprises are concerned,
business confidence is in line with the historically high levels reached in 1998 and entrepreneurs have
kept on signalling well-filled order books. With capacity utilisation rates some 2 percentage points
above their long-term average, the overall positive environment can be expected to contribute to
dynamic investment expenditure. This would be reinforced by other major determinants for
investment. Irrespective of the positive influence of monetary policy on financing conditions,
companies' financial positions can indeed be expected to remain healthy, while re-payment difficulties
would continue to ease.
Not surprisingly in this context, there is a broad consensus among forecasters on a scenario of rapid
economic growth in France, with inflation remaining within the definition of price stability for the two
years ahead. So far, the consensus forecast predicts that real GDP could increase by some 3.4% in
2000 and by 3.0% in 2001, while consumer prices will grow by 1.2% in both years, although more
recent forecasts indicate that prices could rise more rapidly. It is also widely expected that growth will
be sustained by both domestic and external demand and will result in continued employment growth
and further reductions in unemployment.
This is a bright picture and we should wish that it all comes true, not only in 2000 and 2001, but also
beyond. But, although this scenario for the coming years is a likely one, it is important to bear in mind
that it is subject to uncertainties. Some of them, like the event of an unexpected external shock, cannot
be eliminated. But others fall within national responsibility. Proper economic policies and/or an
adequate consensus among economic agents can in some cases be key factors in ensuring that crucial
pending issues are faced in a way compatible with sustained and non-inflationary growth.
Among the pending issues for the future of the French economy, the implementation and financing of
the 35-hour working week is certainly an important one. But other uncertainties also call for attention.
I would like to stress the importance of maintaining the credibility of fiscal consolidation. In this
regard, avoiding any relaxation of the fiscal stance, as well as reducing the risk of any deficit slippage
in the event of an unexpected growth slowdown are certainly key elements. Moreover, with a view to
external competitiveness, an explicit commitment on the part of the social partners to maintain wage
developments in line with productivity increases is an important factor.
More generally, France faces the same fundamental challenge as the other European economies. It can
be summarised in the following short question: "How can one develop an internal dynamic for
sustainable long-term growth?" This is a crucial challenge if one wants to significantly reduce
unemployment. And, at the same time, in an increasingly integrated world economy, one wishes the
euro area economy not to be too vulnerable to every external slowdown. By committing themselves to
fostering low inflation and sounder public finances, public authorities, both French and European,
have been working for years to develop the necessary background environment for such a domestic
dynamic. The relative resilience of the French economy, despite the recent temporary slowdown,
could be a sign of a successful policy mix in this regard.
Earlier in my speech I spoke about the "New Economy", an appealing expression which is also being
used more and more when referring to the good performance of the French economy in the recent past.
However, for its true emergence, two important elements are required. First is the commitment to
maintain an environment with moderate developments in production costs and to pursue sound public
finances. Second is the need to continue and step-up the process of structural reforms. That is the only
way to foster employability of the labour force and to encourage entrepreneurship, leading to
appropriate choices in terms of product specialisation and ultimately, high economic growth coupled
with macroeconomic stability.