Willem F Duisenberg: The ECB's assessment of current economic and
monetary developments and prospects for the euro area
Introductory statement delivered by Dr Willem F Duisenberg, President of the European Central Bank,
at the Testimony before the Committee on Economic and Monetary Affairs of the European
Parliament, Brussels, on 28 May 2001.
* * *
It is a pleasure for me again to appear before your Committee to report to you on recent decisions by
the Governing Council in the area of monetary policy as well as within its other fields of competence. I
shall start with the ECB's assessment of current economic and monetary developments, as well as the
prospects for the euro area, and explain our recent monetary policy decisions. I shall then turn to the
preparations for the introduction of the euro banknotes and coins. Finally, I should like to address the
role of central banks in the field of banking supervision. I should like to indicate already at this stage
that my opening remarks may slightly exceed the usual time frame.
1. Economic and monetary developments
Since my last appearance before this Committee on 5 March 2001, the Governing Council of the ECB
decided to reduce its key interest rates by 25 basis points on 10 May. I would like to explain the
reasons for the decision.
Over the last few months, the Governing Council has gradually changed its view on the balance of
risks to price stability in the euro area, moving from a situation where the risks basically remained on
the upside towards a far more balanced situation.
Starting with the first pillar, we have been witnessing a downward trend in the dynamics of both money
and credit growth in the second half of 2000 and early 2001, partly reflecting the increase of 225 basis
points in key ECB interest rates, which occurred between November 1999 and October 2000. The
three-month average of the annual growth rates of M3 was 4.8% in the period from January to March
2001. In addition, some slowdown in credit aggregates had also been visible over the past few
months, and M1 continued to grow at a very low pace.
Moreover, there is now evidence that the monetary growth figures are distorted upwards by non-euro
area residents' purchases of negotiable paper included in M3. The Vice-President of the ECB already
informed this Committee on 2 May, in his presentation of the ECB's Annual Report, that the ECB was
working on identifying these distortions precisely and on making the necessary corrections to the data.
Some of these distortions have recently been confirmed by more specific evidence, and there are now
indications that, over recent months, the inclusion of non-euro area residents' holdings of negotiable
instruments has increasingly led to an upward distortion of M3 growth. The magnitudes involved are
significant and higher than previously expected.
As regards holdings of money market fund units/shares by non-euro area residents, on which reliable
statistical data are now available, the distortion has become more sizeable over recent months and
currently amounts to around half a percentage point of the annual rate of growth of M3. As for
non-euro area residents' holdings of other marketable paper included in M3, precise statistical
information is currently being developed. Preliminary evidence indicates that the size of this upward
distortion to M3 growth might have been similar in early 2001 to that related to non-resident holdings
of money market funds units/shares. Consequently, the upward distortion to M3 growth figures in early
2001 may be in the order of one percentage point.
A detailed analysis of these distortions to M3 growth was published in the Monthly Bulletin of May. The
ECB intends to publish a revised M3 series towards the end of this year. In the meantime, the ECB will
continue to inform the public about these developments and explain how these distortions are taken
into account in the regular assessment of monetary developments.
Taking into account all these factors, it was clear that the slowdown in M3 over the past few months
was more pronounced than expected, with estimates of corrected M3 growth at or even below the
reference value of 41⁄2% for some months now. Overall, the Governing Council therefore concluded on
10 May that current analysis under the first pillar no longer signalled risks to price stability over the
medium term.
In the analysis from the second pillar of the monetary policy strategy, several developments pointed to
moderating inflationary pressures in the medium term. The global outlook for growth in 2001 has
deteriorated over the last few months, and has continued to be characterised by substantial
uncertainty, especially with respect to the outlook for the US and Japanese economies. Owing to a
less favourable external environment, a moderation in real GDP growth in the euro area from the high
levels reached in 2000 is expected in 2001, and this should dampen upward pressure on consumer
prices. Data on economic activity recently released in the euro area, like industrial production in
March, and business confidence indicators confirm this picture of a moderation in growth. This
notwithstanding, currently available forecasts, both by international organisations and private
institutions, expect that economic growth in the euro area will, supported by domestic demand, be
broadly in line with trend potential growth in 2001. This outlook for a continuation of solid growth in the
euro area is accompanied by expectations for inflation to remain in line with the ECB's definition of
price stability in the medium term. Bond yields in the euro area further underpin this expectation.
The improvement in the medium-term outlook for price stability will, however, be overshadowed for
some more months by short-term developments in inflation. As expected, the annual rate of increase
in the Harmonised Index of Consumer Prices (HICP) rose to 2.9% in April 2001. Recent increases in
HICP inflation have mainly resulted from developments in unprocessed food prices due to the BSE
related health concerns and the measures taken to contain the outbreak of the foot-and-mouth
disease. Furthermore, energy prices continue to have an impact, after the strong increases seen in
2000. In addition, other non-energy components of the HICP, namely prices of services and industrial
goods, have been on an upward trend since summer 1999. However, this upward movement was
partly due to temporary factors (such as rises in administrative prices or indirect taxes) and is also a
consequence of indirect effects of past oil price increases and the feeding-through of the depreciation
of the euro.
The effects of all these factors, which have caused HICP inflation to remain above 2% since mid-2000,
should, however, gradually diminish, making it likely that annual HICP inflation will start to fall in the
course of this year and be below 2% in 2002. The protracted period of time in which inflation has
remained above 2% should not have medium-term consequences. This assessment is also supported
by the continuation of wage moderation in the euro area, as we have seen so far.
Overall, the recent reduction in key ECB interest rates is to be seen as an adjustment of the levels of
interest rates to somewhat lower inflationary pressures in the medium term. The Governing Council of
the ECB has to focus on the maintenance of price stability in the medium term, as only this
perspective takes account of the time lags for monetary policy to work its way through the economy.
On the basis of the information available, the current stance of monetary policy is appropriate to
ensure that the euro area will be able to maintain price stability over the medium term. Nonetheless,
while recent wage developments have been encouraging, we will monitor very closely the upward
risks to price stability related to the risk of possible second-round effects of past oil price increases on
consumer prices via wages.
The maintenance of robust non-inflationary growth is a challenge to be met by many policy areas.
Fiscal policy will have to continue the consolidation process, and governments should abide by the
commitments of the Stability and Growth Pact and by those made in the context of their stability
programmes, pursuing further improvements on the expenditure and revenue sides of the budget.
Progress along the way to the medium-term objective of budgetary positions "close to balance or in
surplus" cannot be delayed. In fact, economic growth lower than previously expected should not be a
reason to miss budgetary targets in countries with remaining fiscal imbalances.
Finally, the objective of expanding the growth potential of the euro area economy must remain a
priority in the agenda of the euro area. While progress is being made in a number of areas, more
ambitious market-oriented structural reforms remain a challenge. The still high level of unemployment
calls for ongoing policy efforts to remove structural rigidities from the product and labour markets, and
to diminish adverse incentives provided by tax, benefit and pension systems. Moreover, it is crucial to
increase investment incentives through structural policy measures such as deregulation, privatisation,
and tax reforms.
2. Issues relating to the introduction of the euro banknotes and coins
I should now like to turn to the preparations for the introduction of the euro banknotes and coins. As
far as the Eurosystem is concerned, preparations are well on track. At the end of April 2001, more
than half of the euro banknotes to be put into circulation from 1 January 2002 onwards, or needed as
logistical stocks, had already been produced. If measured only against the initial launch requirements,
the produced banknotes amount to as much as 70% of those needs.
At the same time, the logistical arrangements within the Eurosystem related to the circulation of the
euro banknotes and coins are being implemented in line with the plans that have been agreed over
the last few years after careful consultation with all parties involved. This includes the storage of
substantial amounts of banknotes and coins, for which adequate provisions have been established,
even though it posed unprecedented logistical and organisational challenges, not least with regard to
security and spatial requirements. The preparations for the transportation and frontloading of
banknotes to banks also form part of these activities.
As concerns the latter, on which I have already reported on previous occasions, there are still
discussions in some quarters, even at this late stage of the preparations, on whether it might not be
preferable to go back on our decision not to frontload euro banknotes to the general public. As I have
seen, your Committee, too, is preparing a Resolution calling for a review of this decision.
In this context, I should like to stress that the Governing Council of the ECB does not intend to change
its decisions with regard to the front-loading of euro banknotes to the general public. The reasons for
this decision, which I have already spelled out in detail on other occasions and which I am willing, if
necessary, to elaborate further, are still valid and there are, according to our assessment, no new
elements which would justify a renewed reflection on this issue at this late stage of preparations. We
are certainly aware that retailers, albeit not all of them, are very vocal in their demands for a
frontloading of euro banknotes to the general public. It is also indisputable that there might be specific
situations in support of this request. However, the ECB has to take a global perspective covering all
aspects and, especially, the general interest.
Having said this, I should like to stress that, in any case, the smooth conduct of the cash changeover
will require particular efforts by all parties concerned, be they banks, businesses or citizens. However,
quite a number of measures have been prepared or are under consideration which should help to
smooth the introduction of the euro banknotes and coins, in particular during the very first days of the
cash changeover. In this respect, I should like to mention the conversion of ATMs already in the early
hours of 1 January as well as their provision with lower-denomination banknotes. Moreover, the
opening of banks on 1 January 2002, as has so far been foreseen in some countries and might be
considered by others, should help smooth the specific challenges during the early stages of the
changeover. Finally, I should like to stress that the various extensive and well-prepared information
campaigns should familiarise the general public with the organisation of the cash changeover.
All in all, the challenges with regard to the cash changeover should, of course, not be underestimated.
At the same time, however, I am not aware of any indications that could place the effectiveness of the
careful and comprehensive preparations for a smooth and successful cash changeover in doubt.
3. Issues related to banking supervision
To conclude my opening remarks, I should like briefly to address some issues related to banking
supervision. As you are aware, the financial systems are undergoing an impressive transformation,
which - in the euro area - is further reinforced by the changes triggered by the introduction of the
euro. In many euro area countries, this has led to a debate on the institutional structure for prudential
supervision. The ECB is strongly convinced that there are good arguments for maintaining, or even
reinforcing, one of the basic features of the institutional arrangements in the euro area, that is the
strong involvement of central banks in the conduct of supervisory tasks.
Within the institutional framework brought about by the introduction of the euro, many of the
arguments frequently raised for attributing supervisory and monetary policy responsibilities to separate
authorities do not apply, since the two functions are now performed with distinct decision-making
processes and with reference to different geographic jurisdictions. At the same time, Economic and
Monetary Union (EMU) is changing the nature and scope of systemic risk. This calls for extensive
monitoring within the euro area, attentive to the cross-border dimension and to the channels for
contagion through increasingly integrated payment, clearing and settlement infrastructures and capital
markets. Central banks, due to their traditional focus on systemic issues and to their twofold nature of
national institutions and members of the Eurosystem, are well placed to carry out this monitoring
activity. In this way, they also provide a substantial contribution to the operation of prudential
supervision.
The Governing Council of the ECB has discussed these issues extensively and has decided to convey
its position to the Ministers of Finance, anticipating the main elements of the opinions it intended to
deliver on national legislative projects for reform, according to Article 105 (4) of the Treaty. In the
analysis of concrete draft laws reforming national arrangements for prudential supervision, the ECB
will reiterate its views. In cases where supervisory responsibilities are not allocated to national central
banks, in particular, we will argue in favour of a strong operational involvement of the central bank in
prudential supervision, calling also for an open exchange of information and effective mechanisms for
close co-operation between all authorities with responsibilities for financial stability.