Jean-Claude Trichet: EMU after seven years - successes and challenges
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, at the Frankfurt
Chamber of Industry and Commerce, Frankfurt am Main, 5 May 2006.
* * *
Ladies and gentlemen,
Es ist eine große Freude für mich, heute auf Ihrer Konferenz über meine Ansichten und Erfahrungen
zur Europäischen Wirtschafts- und Währungsunion und zum Euro sprechen zu dürfen.
Selbstverständlich ist mir bewusst, dass der Deutsche Industrie- und Handelskammertag (DIHK)
immer ein starker Befürworter der Währungsunion und allgemein des europäischen
Integrationsprozesses war. Lassen Sie mich den weiteren Vortrag nun in Englisch halten.[It is a great
pleasure for me to speak today at this conference about my views on and experience of Economic and
Monetary Union in Europe and the euro. I am fully aware that the Deutscher Industrie und
Handelskammertag (DIHK) has always been a strong supporter of the EMU and, more generally, of
the European unification process. Before continuing, please let me switch into English.]
In the first part of my talk today I shall elaborate on the reasons why I think that the single currency
and the single monetary policy introduced more than seven years ago have worked very well.
Nevertheless, past success is not an excuse to overlook the challenges that lie ahead of us all,
policymakers and social partners. In the second part of my speech I shall thus try to make clear how,
in my view, these future challenges imply an urgent need for action and reform going forward. And
finally, I will discuss how such reforms support the ECB's monetary policy and the adjustment
mechanism in the euro area.
But let me start with the first years of EMU.
A credible and transparent new monetary policy framework
At the time of the introduction of the euro, a completely new monetary policy framework was
introduced in Europe, with the European Central Bank (ECB) conducting a single monetary policy for
the entire euro area, consisting of eleven and soon twelve countries and more than 300 million
citizens. The most remarkable aspect of this new endeavour is that since the very beginning the ECB
and the euro managed to inherit the high level of credibility already achieved by the most stable
national currencies, which had been earned during many years of successful, stability-oriented
monetary policy. It should not be underestimated that at the time of the introduction of the euro, all
along the yield curve, market interest rates on instruments denominated in euro became aligned with
the lowest - and not with the average - rates prevailing prior to the euro; the historically low level of
short, medium and long-term market interest rates was unthinkable in some countries which had
experienced much higher interest rates in the past. At the same time, the creation of a single currency
put an end to the high volatility and realignments of exchange rates among euro area countries which
used to significantly distort their relative competitiveness.
The successful implementation of the single monetary policy in the euro area is rooted in the
institutional framework enshrined in the Treaty establishing the European Community as well as in the
effectiveness of the ECB's monetary policy strategy.
With regard to the key institutional provisions, the ECB has been given a clear mandate, namely to
pursue the primary objective of maintaining price stability, and its independence is fully guaranteed by
the Treaty. Furthermore, principles for pursuing sound fiscal policies are enshrined in the Treaty; the
Stability and Growth Pact implements these principles via regulations.
Turning to the monetary policy strategy, it is based on the definition of price stability and on a
comprehensive two-pillar approach involving both an economic and a monetary analysis. The precise
definition of price stability for the euro area showed full continuity with the national central banks'
previous definitions of price stability and thus ensured that inflation expectations for the new currency
would be the same as for the most credible national currencies immediately before the setting up of
the euro. Our commitment to monitoring monetary developments and cross-checking the results of this
analysis with the results of the economic analysis helps to frame the ECB's daily assessment and
monetary policy conduct in a medium-term perspective that provides strong support to the anchoring
of long-term inflation expectations. Over time we have deepened our monetary and economic analysis
and we publicly explained in considerable detail the principles which govern our monetary policy. This
includes issues such as the relationship between asset prices, fiscal policy or cross-country diversity,
on the one hand, and monetary policy, on the other.
It is my conviction that the public and in particular financial markets have over time understood very
well how the ECB conducts its monetary policy. This has helped us to achieve a high level of
predictability of policy, which signals a high degree of transparency. This is particularly rewarding,
considering that part of our job is devoted to explaining and discussing our actions and our concept to
the public. Transparency is not only a precondition for accountability, but also a crucial aspect of a
successful monetary policy, as it makes policy more effective. In this regard, allow me to stress that
the ECB was the first major central bank to introduce on a monthly basis a press conference
displaying in detail the diagnosis and the monetary policy decisions of the Governing Council to the
public only a few hours after the end of the relevant meeting.
All of these factors have contributed to the high degree of credibility enjoyed by the ECB's monetary
policy and thus to price stability and the successful anchoring of inflation expectations. But credibility is
never gained once and for all. It has to be permanently preserved and enhanced. That is why the ECB
pays the utmost attention to monitoring inflation expectations.
Price stability contributes to low macroeconomic volatility in the euro area
In our short history, we have had to face substantial challenges and economic shocks. Just think of the
economic consequences of the terrorist attacks in September 2001, the sharp decline of equity prices
at the beginning of this decade and the substantial increases in oil prices.
Against this background, our track record since 1999 in terms of price developments and inflation
expectations bears testimony to the ECB's ability to deliver a monetary policy that is in continuity with
the best practices inherited from the national central banks of the euro area. As you know, the ECB
aims to maintain price stability by keeping inflation rates below, but close to 2% over the medium term.
Since the launch of the euro back in 1999, the inflation rate in the euro area has been on average
slightly above 2%. We are of course not satisfied with inflation above 2%. In this context it is important
that, since 1999, average long-term inflation expectations - as measured, for example, by Consensus
Economics forecasts or the Survey of Professional Forecasters - have been at a level consistent with
price stability, i.e. below, but close to, 2%. The steadiness of inflation expectations over such a long
period of time, during which, as mentioned, many unforeseen events impacted on the euro area
inflation rate, demonstrates that markets and private agents perceive the ECB as being fully
committed to maintaining price stability in the euro area.
The process towards Monetary Union and the stability-oriented monetary policy of the ECB have
improved the welfare of euro area citizens, both directly by maintaining price stability and indirectly by
contributing to lower volatility and uncertainty of macroeconomic developments. First, in concomitance
with the intra-euro area convergence process in the 1990s, inflation volatility almost halved. The
volatility of quarterly changes of HICP inflation in the euro area (measured as the standard deviation)
fell from around 0.6 percentage point during the 1980s to around 0.3 percentage point in the 1990s.
Over the last seven years, inflation volatility has only been 0.2 percentage point, in spite of major
inflationary shocks during this period. And the average volatility of long-term consensus inflation
expectations has also declined substantially, by four-fifths, from almost 0.5 percentage point in the
1990s to less than 0.1 percentage point in recent years.
Lower volatility of actual and expected inflation reduces consumer and investor uncertainty and
thereby benefits all citizens. Stable inflation expectations and a high degree of confidence on the part
of financial market participants in monetary policy should, over time, also lead to a reduction in the
volatility of longer-term interest rates, and thus also to lower risk premia. Indeed, we have seen a
substantial decline in the volatility of long-term interest rates. In the 1990s, for example, the standard
deviation of long-term interest rates (on the basis of monthly data) was around 2 percentage points; in
the past seven years, this measure has fallen to around 0.7 percentage point.
Anchoring inflation expectations is not only important for maintaining low medium and long-term
market interest rates, it is also crucial for reducing macroeconomic fluctuations in response to
economic shocks. It is welcome if wage and price-setters in the euro area incorporate an inflation rate
which is in line with our definition of price stability. Indeed, less indexation of wages and prices to
current and past inflation would tend to contribute to lower volatility of employment and output in
response to macroeconomic shocks. Under current circumstances, this implies that higher inflation
due to oil price shocks and higher indirect taxes should not be included in wage contracts. Otherwise
unemployment and inflationary pressures would increase.
It is sometimes argued that a policy aimed at price stability could lead to higher unemployment and
increased macroeconomic volatility. It will not surprise you that I do not agree with this view. To the
contrary, not only reforms that enhance the flexibility of markets, but also credible monetary policy and
well-anchored inflation expectations, over time, contribute to job creation and to dampening
macroeconomic fluctuations. And indeed, the achievements in the area of monetary stability have not
come at the cost of higher unemployment. Despite remaining at still unacceptably high levels,
especially in some euro area countries, the unemployment rate in the whole euro area has averaged
around 81⁄2% over the past seven years, which is more than one percentage point lower, on average,
than in the 1990s. Furthermore, annual employment growth (in terms of persons employed) has
doubled from an average of around 0.5% in the 1980s and 1990s to around 1.2% since the start of the
single monetary policy. Moreover, in recent years the volatility of some real variables has also declined
relative to the averages observed during the 1980s and 1990s. For example, the volatility (in terms of
standard deviation) of quarter-on-quarter percentage changes of real GDP growth has fallen from
around 0.5 percentage point in the 1990s to around 0.4 percentage point in the last seven years. The
volatility of employment growth has also fallen from over 0.3 percentage point in the 1990s to 0.2
percentage point since 1999.
The challenges ahead: reforming the structure of the euro area economy
A fair assessment of the last seven-and-a-half years of economic developments in Europe cannot
avoid taking into account the fact that despite the success of EMU, output growth has been
disappointing. A major reason has been that labour productivity growth has been weak since the
mid1990s. In my view, this is, together with too high unemployment and the implications of population
ageing, the main economic problem that policy-makers are currently facing in the euro area. I will now
illustrate this issue in more detail and thereafter argue that the solution requires a stepping-up of
structural reforms aimed at increasing the as yet insufficient flexibility and dynamism of some euro
area economies.
Since the launch of the Lisbon strategy in 2000, the average annual real GDP growth rate for the euro
area has averaged 1.8%, thus remaining below its main competitors. In the last fifteen years per capita
income growth in the euro area has been relatively subdued and systematically lower than in other
developed economies like the US. Furthermore, the employment rate in 2005, at 64%, remains
considerably lower than the employment rate in the US, where it stood at 71% in 2005.
The main factor behind these developments is the disappointingly low trend in hourly labour
productivity growth in the euro area, which declined to an average 1.2% over the period 2000-2004,
down from 1.8% during the 1990s and 2.4% during the 1980s. By contrast, in the US hourly labour
productivity growth accelerated to an average of 2.8% over the period 2000-2004, which is more than
double as high as in the euro area.
The lack of sufficient flexibility in labour and product markets in Europe is, in my view, a major
determinant of the sluggish economic growth and of the still high unemployment in the euro area.
I will therefore now turn to structural reforms that have the potential to increase both euro area labour
productivity growth and labour utilisation, and therefore also the long-run growth potential of the
economy.
Without aiming to be exhaustive, I should like to highlight some of the key priorities for reform in three
main areas, namely getting people into work by enhancing the functioning and the flexibility of the
labour market, increasing competition in product markets and unlocking business potential by creating
an entrepreneurial-friendly economic environment.
Finally, I shall address the main fiscal policy challenges and in particular the implications of population
ageing in the euro area for the sustainability of pension and healthcare systems.
First of all, well-functioning labour markets set the right incentives for households which take decisions
concerning their participation in the production process by entering the labour market and actively
searching for a job. Some observers have argued that European households prefer to work less in
comparison with, for example, US households, thus attributing the relatively low participation in the
labour market to some deep behavioural motivation or preferences. In my view, this argument is not
satisfactory. The low labour participation rates in the euro area are significantly influenced by structural
distortions like the legal and regulatory environment, the tax systems and social institutions. For
example, marginal tax rates that are too high discourage labour market entry and have a downward
effect on average hours worked. Moreover, restrictions on the maximum number of hours worked,
imposed either by social partners' agreements or by law, are also often not in line with preferences of
a number of individual employees. Furthermore, benefit systems that are too generous discourage job
search and early retirement schemes encourage early withdrawal from the labour market. Rigidities
caused by regulations, in particular wage rigidity and a high degree of job protection for older workers,
reduce the incentives for firms to hire people in this age group. Indeed, in 2005 the employment rate
for workers aged 55-64 in the euro area was just two-thirds of the corresponding figure in the US. In
addition, female labour force participation rates in the euro area could also be supported by specific
measures, like the adequate provision of childcare facilities, aiming at reconciling motherhood with
professional life. Finally, a more extensive use of flexible forms of work such as part-time and
temporary work may also provide further working incentives for those categories of workers that would
not find it feasible to become full-time employed.1
I do not deny that much has been done in the last ten years in those European countries that have
joined the euro area. In many countries labour market institutions, for example, have become less
rigid. This has helped to maintain wage moderation across the euro area and has helped monetary
policy to maintain price stability. Furthermore, the liberalisation and the increase in competition in
some sectors have already brought significant benefits in terms of lower prices for some goods and
services.
However, it is my firm opinion that much remains to be done in order to address the structural difficulty
of the euro area economies to achieve a satisfactory level of productivity.
Beyond the reform of tax system and labour market regulations, it is crucial to improve the labour
force's level of education and expertise. This will allow for an efficient allocation of workers between
sectors and firms as well as facilitate product innovation and the adoption of new technologies.2 The
last decades have seen an enormous increase in the level of educational attainment of new
generations in the euro area. Nevertheless, meeting the challenges of technological progress and
preserving the labour force's employability and flexibility require that human capital continuously
adjusts to labour market needs through improved education and training as well as lifelong learning.
We need to think of market-oriented measures which enhance the incentives of firms, employees and
unemployed people to invest in education and knowledge.
Structural measures aiming at increasing labour supply, however, would not solve the serious
unemployment problem in the euro area, which requires the fostering of labour demand through higher
wage flexibility and adjustments to the level of employment protection legislation, in particular where
this legislation impedes the hiring of younger and older workers.
Second, increasing competition in an effort to establish efficient and well-functioning product and
service markets is another prerequisite for higher medium to long-term growth. A lack of competition
harms productivity trends by limiting production efficiency and by reducing the incentive to innovate.
Restrictions on competition also hinder job creation. In the EU, it is crucial to build on the experience
of several network industries that are now fully or largely open to competition. For example, the
extensive liberalisation of the telecommunication sector in the course of the 1990s led hourly labour
productivity in that sector to grow on average by 8.5% in the euro area over the period 1996-2003
compared with 6.9% in the US.3 If liberalisation and higher competition are pursued in other services
sectors, it is very likely that such excellent productivity growth performances can be repeated. And to
the extent that nominal wage moderation is ensured conditions for job creation are enhanced.
In this respect, it is crucial that policies aimed at increasing the level of competition and at liberalising
the product markets include the extension and deepening of the EU internal market. The internal
market policies have already contributed to an increase in employment and real income in the EU.
However, there is much more potential that could be exploited, especially in the services-related
activities, which represent around 70% of nominal value added and employment in the euro area and
where labour productivity is particularly disappointing in comparison with the US. The directive aimed
at a free market for services in the European Union which is currently being prepared is thus very
important.4 However, it would be desirable that Member States improve their record of existing internal
market legislation and proactively ensure that the number of internal market infringements is kept to a
minimum.
The third prerequisite for higher growth in the euro area is the unlocking of business potential by
creating an entrepreneur-friendly economic environment. This includes lowering costs and constraints
imposed by public sector administrations on existing firms and business start-ups. According to the
World Bank, in 2004 the average cost of starting a business with up to 50 employees in the euro area
(excluding Luxembourg) is estimated to have been around ten times higher than in the US.
Furthermore, today it takes on average 27 days to set up a new business in the euro area5 compared
with 5 days in the US.6 In this respect, it is important that European governments and EU institutions
follow up on the recent call of the European Council for the establishment of "one-stop" arrangements
in each Member State which would allow the setting-up of a company in one week by end-2007.
Furthermore, to fully exploit productivity potential, the labour and product market reforms just
mentioned need to be accompanied by policies that help to diffuse innovation and technological
change. This includes, inter alia, measures to support innovation through higher investment in
research and development in order to reach the target of 3% of GDP by 2010 that Europe has set
itself.
Turning to the challenges pertaining to fiscal aspects of EMU, I would start by stressing why
maintaining sound fiscal positions is important. The sustainability of fiscal policies reduces the
uncertainty surrounding long-term economic decisions, thus reducing risk premia on borrowing and
lending rates, and fostering higher investment and consumption. Hence, it is of the utmost importance
that national governments continue to proceed along the virtuous fiscal policy path that they took in
the 1990s, when the convergence process led the average deficit ratio in the euro area to decline to
2.6% in 1997 from about 5% in 1990. More recently, the euro area average deficit ratio has remained
below the values recorded in the 1980s and 1990s. As a consequence, the long-run increasing trend
in the debt ratio, which more than doubled from 34.2% in 1980 to 74.7% in 1997, has been halted.
Overall, the fiscal policy framework was successful in reducing average fiscal deficits in the euro area
and halting the trend increase in the debt ratio. This framework, as laid down in the Maastricht Treaty
and the Stability and Growth Pact, ensures that fiscal discipline is maintained in EMU. In this respect,
it must be admitted that a number of governments still need to correct large fiscal imbalances and
improve the structure of public finances. Moreover, national institutions for fiscal policy-making should
support the fiscal commitments under the EU framework. Finally, governments must prepare now for
the fiscal burden arising from demographic ageing that in the long run will put a substantial burden on
public finances. In a recent report by the Economic Policy Committee, it has been projected that if the
implications of ageing are not addressed by structural changes, public expenditure could increase by
up to 10% of GDP in the euro area by 2050.
This will occur directly through the impact on public pension and healthcare expenditure as well as via
the growth-dampening effects of a gradually shrinking share of the labour force in the population.
Hence, governments need to take pre-emptive action today before expenditure pressures start to
increase rapidly after 2010. In many countries, this requires reducing current debt ratios and reforming
public pension and healthcare systems. This, in conjunction with reforms that aim at increasing labour
market participation and lowering unemployment, will allow the euro area to cope with population
ageing and to maintain a sustainable fiscal position whereby the tax burden is reasonable and does
not impede sustained growth.
Structural reforms support the ECB's monetary policy and also enhance the intra-euro area
adjustment mechanism
As a welcome side-effect, the structural reforms that I just discussed also have a positive impact on
the conduct of monetary policy in the euro area.
From the euro area point of view, structural changes which enhance flexibility, job creation and
potential growth tend to facilitate monetary policy and increase its effectiveness. A more flexible
economic environment helps the labour and product markets to better adjust to economic shocks and
to respond to policy actions more quickly. For example, more flexible labour markets may imply that
negative supply shocks are absorbed with a less pronounced increase in inflationary pressures. This,
in turn, allows monetary policy to react less strongly. Furthermore, in the case of a cyclical downturn
caused by a temporary lack of demand, flexible markets and, in particular, wages normally allow
monetary policy to lower policy rates more or faster as inflationary pressures decline more quickly in
an economic downturn.
Furthermore, enhancing the single market as well as the structural flexibility of the euro area national
economies will also facilitate the ECB's single monetary policy by improving the functioning of the
intra-euro area adjustment mechanism.
If there are situations of excess demand, or overheating, in one region of the euro area and, at the
same time, there is a lack of demand, or under-utilisation of capacity, in another region of the euro
area, a well functioning adjustment mechanism ensures that such divergences do not become too
persistent and do not lead to an unwelcome dispersion of countries' business cycle positions.
To be sure, the available empirical evidence on output growth and inflation differentials within the euro
area shows that the magnitude of inflation and output growth differentials across the euro area
countries is not exceptional and is comparable to that in the United States.
In addition, it appears that cyclical synchronisation in the euro area is relatively high.
However, contrary to the experience of the US regions, output growth and inflation differentials in the
euro area have been rather persistent and seem to be largely driven by persistent positive or negative
deviations from the euro area averages. Over the last ten years, the performance of euro area national
economies in terms of real GDP growth rates has been polarised, with a group of countries growing
persistently at lower rates than the euro area average and another group growing persistently at
higher rates. These trend deviations reflect in particular differences in the potential growth. In turn,
these differences can be very much related to the different degree of market flexibility in each single
country and to the structural reforms that have been implemented in the past.
Hence, structural reforms are needed that help to reduce output growth differentials in two ways: first,
by increasing potential growth, especially in those euro area countries that have shown a persistently
low growth performance; and second, by enhancing the functioning of the key channels or
mechanisms of adjustment within the euro area, namely the trade channel and the risk sharing
channel.
I have discussed the impact of reforms on productivity and potential output growth one minute ago. Let
me now elaborate on the second issue by giving you some examples of how structural reforms could
improve the adjustment mechanism within the euro area.
First and foremost, it is important to increase price and wage flexibility within the euro area in order to
allow firms to quickly adjust their cost and price structure to the changing demand conditions for their
products. For example, following a negative demand shock in one country, a lack of competition and
the related rigidities of wages and prices - including stickiness of nominal wages and excessive
protection - would hinder the market adjustment that entails lower prices and costs for domestically
produced services and goods. In this case, the real exchange rate (or the trade) channel cannot work
effectively and higher unemployment and other regional disparities could be persistent. However,
increasing the flexibility of the national economies, while necessary, may not be fully sufficient to
ensure that the adjustment to asymmetric shocks does not generate unwelcome inflation and output
growth differentials. To reduce the persistence of low capacity utilisation and higher unemployment in
the regions hit by a negative shock, it is important to foster competition and trade across national
borders. Firms and workers in the slow-growing regions with under-utilised capacity would then find it
easier to supply their goods and services in fast-growing, overheating regions. Enhancing
crossborder trade and competition would thus contribute over time to a smoother and quicker "reallocation
of excess demand" across the euro area countries and in this way allow the euro area to adjust to
asymmetric shocks and different national policies with less pronounced and less persistent swings in
relative wages and in relative unemployment.
Another important area for reform relates to the progress in creating conditions which allow a market
and competition-based process of enhanced integration and efficiency of financial markets across the
euro area. To be sure, the money market is already very well integrated. This is crucial for a swift
implementation of the single monetary policy, since only an integrated interbank market can ensure
that central bank liquidity is evenly distributed and the level of short-term interest rates across the euro
area is homogeneous. Furthermore, the level of integration of the euro area government bond markets
is also very high, mainly due to the disappearance of intra-euro area exchange rate risk and the
convergence of inflation expectations across countries by the time the euro was introduced. Finally,
the corporate bond market in the euro area is fairly well integrated in the sense that the country of
issuance is only of marginal importance in explaining yield differentials.
Leaving aside stock markets where the integration across the euro area, measured by the reaction of
individual markets to euro area-wide factors and news, is an ongoing process, one major area where
further integration is warranted is the retail banking industry. The Eurosystem, together with the
European Commission, supports the initiative by the European Payments Council to create a Single
Euro Payments Area (SEPA), in which European citizens should be able to make payments
throughout the euro area from a single bank account using a single set of payment instruments as
easily and safely as in the national context today.
Enhanced financial integration and portfolio diversification should tend to make financial structures
more similar and reduce firms' and households' exposure to regional shocks. In particular, it would
help to mitigate the adverse consequences of a downturn in the economic activity of a particular
country or region within the euro area. In this way, enhancing conditions for cross-border investment
and financial integration and the related increased portfolio diversification would imply that original
asymmetric shocks and trends have more homogeneous effects on real income across the euro area.
This would limit one possible source of unwelcome inflation and income differentials.
Conclusion
Let me now conclude. I have explained today that EMU and a credible monetary policy benefit euro
area citizens and create great opportunities for job creation. A good monetary policy is a prerequisite
for sustainable growth and job creation but cannot, alone, guarantee full success. Other conditions
have to be met. It cannot be stressed enough that a high degree of flexibility in all markets, as well as
further progress in terms of financial and economic integration, are also preconditions for job creation,
prosperity and growth.
Regulations or laws that hinder competition between existing firms and the entry of new competitors
tend to support excess prices, incomes and profits in those sectors that are protected. Of course, the
costs of such protection have to be borne by consumers in the form of overly high prices, by the
unemployed in the form of fewer opportunities for new jobs and by most workers as reduced
productivity growth undermines prospects for real wage increases.
Indeed, the more successful the structural measures aiming at increasing productivity growth are, the
more jobs will be created at current wage levels.
I am fully aware that it is often not easy to implement structural reforms and consolidate government
budgets because public opinion is sometimes not fully convinced or aware that everybody would
benefit from these reforms. The ECB considers itself part of the necessary p