Jean-Claude Trichet: Economic integration and adjustment processes in the
euro area
Speech by Jean-Claude Trichet, President of the European Central Bank, at the Wirtschaftstag 2007
as recipient of the "Ludwig Erhard Memorial Coin in Gold", Berlin, 13 June 2007.
I thank Malin Andersson and Juan Luis Diaz del Hoyo who prepared this paper, Hans-Joachim Klöckers and Klaus Masuch for
their helpful comments, and Arne Gieseck, Ruth Imkemeier and Philipp Rother for their additional input.
* * *
1. Introduction
Es ist mir eine große Ehre, als Ehrengast zu dieser Veranstaltung eingeladen zu sein und mit der
Ludwig Erhard Gedenkmünze in Gold ausgezeichnet zu werden. Nicht nur Deutschland, sondern ganz
Europa ist Ludwig Erhard zu Dank verpflichtet für seine mutige, auf den Prinzipien von freiem
Wettbewerb, flexiblen Preisen und offenen Märkten beruhende Politik, und insbesondere für seine
Ideen zum Konzept der Sozialen Marktwirtschaft. Er hat überdies auf die Bedeutung der Preisstabilität
hingewiesen, welche er als menschliches Grundrecht aufgefasst hat.
[English version: It is a great honour for me to be invited as guest of honour and to receive the Ludwig
Erhard Memorial Coin in Gold. Not only Germany but the whole of Europe is indebted to Ludwig
Erhard for his courageous policies based on the principles of free competition, flexible prices and open
markets, and above all for his ideas on the concept of the social market economy.1 He also stressed
the importance of price stability, which he considered to be a basic human right.]
We are today - thanks to the work of Ludwig Erhard - confronted with exciting challenges and a
unique historical development. The creation of the euro area is an exceptional endeavour, now
comprising 13 countries, with the entry of Slovenia, and 318 million people. I remember many critical
voices anticipating a failure and claiming that it would be impossible to share a single monetary policy
and a single currency.
Let me be clear from the very beginning: while there are still formidable challenges and we should not
be complacent, Economic and Monetary Union (EMU) has been a great success. Some people claim
that the euro and our focus on price stability have undermined job creation. I always put facts and
figures first: over the eight years since the creation of the euro, employment in the euro area has risen
by more than 12 million people. This can be compared with a rise of less than 3 million in the eight
years preceding the adoption of the euro. Obviously, I do not intend to give all the credit for this
impressive employment growth to the creation of the euro alone, but it is difficult to deny that the solid
anchoring of price stability for all our vast continental economy has contributed to this achievement.
It is a fact that economic integration has increased among the euro area countries. However, it is also
true that the creation of the euro area - like globalisation - highlights the need for flexible economies. I
do not see this as a negative aspect. On the contrary, it is a positive implication. In this sense, EMU
has increased the pressure on all policy-makers and also all social partners - and I stress the word
"all". They must ensure a well-functioning euro area, by good management aimed at enhanced
flexibility, integrated labour, product and financial markets and disciplined fiscal policies.
This leads me to the two main issues I would like to address this evening. First, I would like to share
with you some stylised facts on the features of the euro area's economic integration process. Second,
I will address the complex and important issue of how to ensure that economic adjustment
mechanisms function properly in the euro area. Why are these topics so decisive, you may ask?
Economic integration benefits consumers through lower prices and leads to increased employment. It
is also crucial to enhancing the adjustment mechanism. This, in turn, helps to improve the ability of
economies to cope with various events, with various "shocks" as we say in economics, so as to
prevent a country or a region from entering into a long-lasting period of recession or overheating.
These are very important issues because they are intrinsically linked to the welfare of our citizens and
the continuing success of the euro area.
2. Features of economic integration in the euro area
Allow me to briefly elaborate on five main features of the process of economic integration in the euro
area.
The first three are related to the completion of the Single Market, i.e. the integration of goods,
services, capital and labour markets across the euro area countries.
i) As to the first feature, economic integration has been reflected in a marked increase in
intraeuro area trade in goods and services. Let me provide you with some figures. Exports and
imports of goods within the euro area increased from about 26% of GDP in 1998, the year
before the adoption of the common currency, to around 32% in 2006. Intra-euro area exports
and imports of services increased from about 5% of GDP in 1998 to almost 7% in 2006. The
full achievement of a single market for services should further facilitate trade in services.2 As
this interdependence within the euro area becomes stronger, the euro area is also becoming
a more open economy. Extra-euro area exports and imports of goods rose from about 24%
of GDP in 1998 to around 33% in 2006. Over the same period, extra-euro area exports and
imports of services increased from about 8% of GDP to almost 10%. These developments
clearly show that we are not witnessing the creation of a "fortress Europe". On the contrary,
European integration complements global integration.3
ii) As a second feature, the introduction of the euro has also contributed to financial integration
which, in turn, improves the free movement of capital in the euro area. First, financial
integration raises the potential for stronger, non-inflationary growth. For example, recent
research by London Economics estimated the benefits of the integration of EU bond and
equity markets to be around 1 percentage point of additional GDP growth over a ten-year
period, or approximately €100 billion.4 Second, a well-integrated financial system is, of
course, also crucial for the conduct of the single monetary policy, as it enhances the smooth
and effective transmission of monetary policy throughout the euro area. Generally, financial
integration is more advanced in those market segments that are closer to the single
monetary policy, especially the money market.5 However, as I have stressed on several
occasions, further financial integration is particularly needed in a number of areas, including
in retail banking.
iii) Turning to labour mobility, which constitutes the third feature I would like to mention,
available evidence suggests that, overall, cross-border labour mobility is still low in the euro
area. And we still have formal barriers to labour mobility across the euro area. This is in clear
contrast to the situation in the United States.6
iv) As a fourth feature, economic integration and convergence is also reflected in the fact that
current inflation and output growth differences among euro area countries are relatively
limited by historical standards. The differences also appear to be similar to those observed
across regions or states within the United States.7
I understand that some observers may like to create headline news from the differences in
economic growth or inflation between some euro area countries in a specific quarter or year.
But let me stress that it is absolutely normal in a monetary union, such as the euro area, for
economic developments to differ across individual regions. This is also the case among
regions in the United States. Why is it normal? First, differences in growth rates and inflation
may be related to catching-up phenomena. A region which is relatively underdeveloped
would, if not hindered by bad economic policies, be expected to grow at a rate above the
currency area average and thus, over time, reach an income per capita level similar to the
currency area as a whole. This process is highly welcome. Second, there are countries that
are more advanced, in terms of structural reforms, than others and have therefore a higher
growth potential. Third, a country or region might also be exposed to country or
regionspecific shocks. This specific shock may cause a growth or inflation differential, which is also
normal in any monetary union. However, it is also true that persistent differentials which
reflect structural rigidities are a concern. I will address this issue later.8
v) Equally relevant for the conduct of the single monetary policy of the ECB is the fifth and final
feature of economic integration I would like to mention to you. The degree of synchronisation
or co-movement between the different cyclical positions across the euro area countries
seems to have increased since the beginning of the 1990s. In other words, a large number of
euro area economies now share similar business cycles.9
The increased co-movement of business cycles across the euro area economies has resulted from a
continuous process of integration. The move from several currencies to a single currency has meant
the elimination of exchange rate risk between countries in the euro area. The euro has also reduced
information costs and has enhanced price transparency. This, in turn, has fostered competition and
market integration. In this way, the adoption of the euro has acted as a catalyst for the Single Market,
within which goods, services, people and capital are to move freely. Ludwig Erhard said
" A free market can only be said to exist [...] if and as long as free performance competition and free
price formation are the motor and means of steering the economy."10
In sum, there is evidence of stronger economic integration among the euro area countries. Evidence
of the completion of the Single Market looks promising, especially the rise in intra-euro area trade and
integration in the money market. Business cycles have become more synchronised. This is an
encouragement to continue to work actively to enhance integration, notably in the provision of
services, in labour mobility and in the integration in some segments of the financial markets. A lot of
homework remains to be done in the euro area.
border labour mobility within an enlarged EU", ECB Occasional Paper No 52, 2006. See also "Action plan for skills and
mobility", European Commission, 2002.
7
The decline in inflation differentials has been impressive. At the beginning of the 1990s, the difference in inflation rates
across the euro area countries was on average around 6 percentage points (standard deviation measured in unweighted
terms). Last year, the inflation differential was only 0.7 percentage point. Moreover, the current degree of inflation dispersion
among the euro area countries is practically the same as that seen in the United States. As to real GDP growth rates across
the euro area countries, the difference has been fluctuating around a level of 2 percentage points over the past few
decades, with no apparent upward or downward trend. Since 1999, however, it has declined from 2.8 percentage points in
that year to close to 1.5 percentage points last year. Again, the growth dispersion within the euro area is virtually the same
as across the eight US regions defined by the US Bureau of Economic Analysis.
8
On output growth differentials see the article entitled "Output growth differentials in the euro area: sources and implications",
in the April 2007 issue of the ECB's Monthly Bulletin, and N. Benalal, J. L. Diaz del Hoyo, B. Pierluigi and N. Vidalis, "Output
growth differentials across the euro area countries: some stylised facts", ECB Occasional Paper No 45, 2006. On inflation
differentials, see the article entitled "Monetary policy and inflation differentials in a heterogeneous currency area", in the May
2005 issue of the ECB's Monthly Bulletin.
9
See D. Giannone and L. Reichlin (2006), "Trends and cycles in the euro area: how much heterogeneity and should we worry
about it?", ECB Working Paper No 595.
10
From: Ludwig Erhard, "Die Ziele des Gesetzes gegen Wettbewerbsbeschränkungen" (speech to the German Bundestag on
24 March 1955), in Ludwig Erhard, Deutsche Wirtschaftspolitik, Düsseldorf, 1962.
BIS Review 65/2007
3. Adjustment processes in the euro area
Economic integration is a clear prerequisite for the smooth functioning of the euro area. All the more
because the euro area is continuously confronted with adverse events or shocks, for instance in the
fields of global competition or energy price developments. In addition, individual euro area economies
or regions may be affected by specific sectoral developments, for example in real estate markets. It is
therefore important to make sure that adjustment mechanisms function efficiently.
Why is an efficient adjustment mechanism important in the euro area? As national monetary and
exchange rate policies are no longer available options, it is important to make sure that other
mechanisms of adjustment to shocks function properly within the euro area. This is needed to avoid a
situation where a country or a region, after suffering a specific or asymmetric shock, enters either into
a period of protracted low growth and high unemployment, or in a long period of overheating.
There are many factors that can improve the resilience of the euro area economies to adverse shocks.
But before addressing this issue, let me stress that the ECB's single monetary policy contributes to the
proper functioning of adjustment mechanisms within the euro area by ensuring price stability, i.e. by
anchoring price stability in economic agents' decisions. I believe that this is a very important
contribution. In other words, the social partners when agreeing on wage increases, and also national
authorities when preparing their budgets or designing policies in their fields of responsibility, should
be, and, as a matter of fact, are fully confident that we at the ECB and in the Eurosystem will deliver
price stability. On this issue, Ludwig Erhard said that
" It is a great mistake for a people, or a State, to believe that it can introduce and pursue an inflationary
policy, yet insure itself against the results. This is to try to lift oneself by one's own bootlaces. On the
contrary, it is essential to concentrate all efforts to prevent an inflation [...]".11
And let me add that the best way of anchoring price stability in economic agents' decisions is through
an independent and accountable central bank. German history provides the best possible example of
this.
Turning to other factors which are particularly relevant for the proper functioning of the euro area,
welldesigned structural reforms that enhance flexibility in product and labour markets are crucial. This is
helping to better absorb shocks and thereby improve the working of adjustment mechanisms in
individual countries, regions or sectors.
In this context, the Lisbon strategy is a fundamental and ambitious programme to draw Europe's
attention to the urgency of structural reforms. Such reforms would improve long-term growth prospects
in the euro area by, on the one hand, affecting positively labour participation and, on the other hand,
improving labour productivity growth through the promotion of innovation and technological change.
Needless to say, the responsibility for the implementation of reforms is in the hands of national
governments, of Parliaments and of social partners. We know very well that structural reforms may
face both resistance from economic agents and different sensitivities in public opinion. This is why it is
extremely important to communicate the fact that the medium to long-term benefits of structural
reforms will significantly outweigh any short-term cost. We therefore strongly support governments in
their implementation of structural reforms and we consider our duty to stress and explain their benefits.
What factors may help to increase flexibility within the euro area? Economic flexibility can be promoted
by removing the institutional barriers to flexible wage and price-setting mechanisms. If wages and
prices are flexible enough and be able to adjust to the changes in the economic conditions, then this
will help to avoid unwelcome fluctuations in unemployment.
Specifically, in a monetary union most of the adjustment has to take place through national labour
markets. Therefore, wage setting should appropriately reflect the different situations of sectors, of
firms and of overall labour market conditions.
Let me stress that governments and social partners share responsibility for ensuring that wage
determination sufficiently takes into account labour market conditions and does not jeopardise
competitiveness and employment. Governments should also be aware that wage setting in the public
sector can serve as a role model for the private sector. And social partners need to take into account
the different conditions at the firm and sectoral level, internalising the repercussions of wage
settlements on competitiveness and thus employment at their company and in their industry, sector or
region.12 Sufficient wage differentiation would improve employment opportunities for less skilled
workers and in regions or sectors with high unemployment. In this respect, excessive wage regulations
are undermining job creation, in particular for young and less qualified workers as well as for all those
who face problems entering the labour market.
Allow me to mention also that corporate governance should ensure that executive board remuneration
is properly set, in line with the performance of the board members and conditions at the respective
company.
As seen in the German case, the period of adjustment can be painful, but reforms and unit labour cost
moderation is paying off and contribute to robust growth and impressive economic records, like the
one currently observed in Germany. I remember some observers arguing that much stronger wage
increases were needed for higher growth. The recent evidence does not confirm this view. As seen in
Germany since last year, past moderation of unit labour costs has very significantly contributed to
declining unemployment and higher growth. The competitiveness gained by the German economy was
an important prerequisite for sustainable job creation and sound and long-lasting growth.
The proper functioning of adjustments through labour markets also requires the completion of the
Single Market. In particular, all existing barriers to labour mobility within the euro area - in particular as
regards Slovenians - must be removed.
As to product markets, let me stress that it is essential that the Single Market must be fully completed,
particularly in services and network industries. A deeper integration of markets would stimulate price
flexibility by fostering competition and open product markets. Greater cross-border competition and the
integration of markets across the euro area countries would contribute to lower prices. It could also
enhance the adjustment processes in the individual countries in the event of asymmetric shocks or
differing cyclical developments.13
Another important market-based mechanism in a monetary union that can help to attenuate the impact
of shocks in a country or region is well-integrated financial markets and readily available opportunities
for portfolio diversification. Well-integrated financial markets and diversified portfolios reduce the
dependence of firms' and households' saving and spending decisions on economic and financial
developments in a specific country, region or sector. This mechanism is known as the "credit and
risksharing channels". In essence, it means that consumption does not need to follow movements in
regional output, first because consumers can borrow abroad and second because their financial
wealth is less dependant on local conditions thanks to an internationally well diversified portfolio
allocation.14 Moreover, more integrated financial markets give rise to greater competition, resulting in
more favourable financing conditions for consumers and firms.
This mechanism is more important in the United States than among the euro area countries. However,
recent evidence shows that the degree of risk-sharing across euro area countries has increased since
the 1990s.15
12
See, for example, the analysis of the role of wage developments in the 1970s in explaining European unemployment in O.
Blanchard, "The medium run", Brookings Papers on Economic Activity, 2, 1997, pp. 89-141.
13
As an example, fully integrated markets across countries mean that a country which is under-utilising its capacity can more
easily absorb some of the excess demand from overheating countries. Regional differentials in capacity utilisation would
then not persist for a lengthy period and would not be associated with high and persistent unemployment in the region or
country facing a lack of demand.
14
Moving from a pay-as-you-go to a capital-based pension system would contribute to improve portfolio diversification.
15
In the United States, over the period 1963-90, capital markets smoothed out 39% of the shocks to gross state product (the
equivalent to GDP), the credit channel smoothed out 23% and the federal government, through the fiscal channel, 13%.
Around 25% of the shocks were not smoothed out. Hence financial markets and financial institutions contributed 62% to the
absorption of idiosyncratic state shocks. We therefore see from the US example that the financial channel can be much
more important than the fiscal channel. This is an additional reason to speed up financial integration in Europe. See P.
Asdrubali, B. Sorensen and O. Yosha, "Channels of interstate risk sharing: United States 1963-1990", Quarterly Journal of
Economics Vol. 111, 1996. In a more recent study, it was found that the euro area situation has begun to converge towards
the situation of the United States and that there is already modest but non-negligible insurance through inter-state capital
flows. It was found that in the euro area (excluding Luxembourg), capital markets would have smoothed out about 10% of
the country-specific shocks to GDP between 1993 and 2000. See S. Kalemli-Ozcan, B. Sorensen and O. Yosha,
BIS Review 65/2007
National authorities can make a substantial contribution to ensuring a proper functioning of adjustment
mechanisms within the euro area. Not only can they improve the flexibility and integration of labour,
product, including services, and financial markets, but they can also conduct a well-designed fiscal
policy. As I have stressed on many occasions, the best contribution fiscal policy can make to the
proper functioning of the euro area is by being sustainable and medium-term oriented, fully in line with
the orientations provided by the Stability and Growth Pact. Moreover fiscal policy can and should also
help mitigate undesirable trend growth differentials through "high quality" expenditure and tax policies.
In particular, high and inefficient public expenditure can put a brake on economic activity by imposing
a high tax burden on the economy and channelling resources into unproductive uses.
Let me take the opportunity to stress that the Governing Council of the ECB welcomes the recent
commitment by the euro area finance ministers at the Eurogroup meeting here in Berlin on 20April. All
euro area finance ministers then committed to making full use of the current economic growth and
better than expected tax revenues to pursue sound fiscal policies and to avoid procyclical policies in
line with the provisions of the Stability and Growth Pact.
In the view of the Governing Council, this requires a rigorous implementation of 2007 budgets, the
avoidance of expenditure overruns and the allocation of unexpected extra revenues to deficit and debt
reduction. For 2008, countries with remaining fiscal imbalances are expected to pursue more
ambitious than currently planned budgetary targets. This would allow euro area countries not only to
meet their commitments but also to prepare themselves for less favourable economic conditions and
the rising fiscal burden in the longer run associated with population ageing. In this context, the gradual
increase of the pension age in Germany is an important step in the right direction. It will help to reduce
the large ageing-related fiscal burden on the active and younger generations.
Let me finally mention the important issue of competitiveness. One of the most important
marketbased adjustment mechanisms in a monetary union works via changes in competitiveness.16 Simply
put, competitiveness is the ability of an economy to compete in international markets. This ability to
compete is usually assessed on the basis of various measures of cost and price competitiveness17,
complemented by accounting for some "non-price" factors, such as the quality and the technological
content of the goods produced.
Economic adjustment via the competitiveness channel works as follows. Assume, for example, that a
country or a sector in a monetary union experiences an increase in demand that drives its output
above long-term sustainable production. This will lead to inflationary pressures in this country or
sector, in particular a rise in wages and other domestic costs. As a result, competitiveness will
gradually deteriorate over time, reducing demand for goods or services produced by this country or
sector. This decline in demand will tend to restore output to its potential level and to dampen previous
inflationary pressures.
Differences in price and cost competitiveness are observed between the various regions and states of
any vast economy of the size of the euro area or of the United States. The competitiveness channel
plays a permanent role in the adjustment. It is particularly justifiable, economically, when any particular
economy has to cope with a demand shock, whether positive or negative, as in the previous example.
Such differences are also a normal phenomenon when any particular economy is in the process of
catching up, leading to a higher level of per capita income, or whenever an economy has to cope with
structural changes or past shocks of any nature that would be reflected in a new relative price
equilibrium.
That being said, developments in price competitiveness and unit labour cost competitiveness across
the euro area economies need to be closely monitored. Persistent losses in relative cost
competitiveness, for instance, can also relate to a number of structural rigidities leading to inertia in
price and wage formation. If and when such phenomena are identified, it is important for all parties
concerned - the private sector, social partners, the national public authorities - to be as lucid as
possible in their own decision-making, to avoid relative losses of competitiveness that would not be
economically justified and to minimise therefore possible unwelcome future adjustment through the
competitiveness channel.
M. Chairman, ladies and gentlemen, let me conclude. The single currency and Economic and
Monetary Union have been an impressive and remarkable success, perhaps Europe's most
remarkable success since the Treaty of Rome was signed half a century ago. It is up to all of us to
consolidate this great success and ensure that it is reinforced in the years to come. As regards
monetary policy, Europe can count on the European Central Bank and the Eurosystem to be faithful to
its primary mandate and to deliver price stability to our 318 million fellow citizens. This is a
prerequisite for sustainable growth and job creation. As regards the other elements of policy that do not
depend on the central bank, let me stress the three areas where sound policies are absolutely of the
essence: sound fiscal policies, fully in line with the Stability and Growth Pact; structural reform policies,
fully in line with the Lisbon program and the achievement of the Single Market; and appropriate
monitoring of the relative cost competitiveness indicators in the euro area.
Ludwig Erhard was a pioneer in understanding the utmost importance of price stability, of free and
flexible markets and of competition for social and economic progress and job creation. We are also
indebted to him for his thoughts and leadership that left a clear mark on the later negotiations for the
preparations for Economic and Monetary Union. I am greatly honoured to receive the Ludwig Erhard
Memorial Coin in Gold.