Jean-Claude Trichet: EMU and the euro - successes and challenges
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, at the Institute of
International Finance Spring 2006 Membership Meeting, Zurich, 30 March 2006.
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Ladies and gentlemen,
I am grateful to the organisers of this event (Institute of International Finance) for inviting me here
today and allowing me to share with you my views on EMU and the euro. This year, the euro is in its
eighth year, with a single currency and a single monetary policy for more than 300 million citizens. All
in all, EMU has worked very well since its inception. Naturally, there are also significant challenges,
pointing to the need for change and reform going forward. But allow me to start with the successes to
date.
Successes of EMU and the euro
I would like, first, to refer to the introduction of the euro on 1 January 1999, an event of the greatest
significance that has turned Western Europe into an even more economically integrated area. I will not
dwell long on this, but the logistics of the cash changeover on 1 January 2002 for over 300 million
European citizens represented a tremendous organisational and technical challenge. The changeover
however took place in a very smooth fashion, and the euro in its physical embodiment was
immediately accepted by the citizens of Europe. The transition to the new banknotes and coins was
facilitated by the fact that the financial markets were already fully accustomed to the euro since
January 1999. At that point in time, the introduction of the euro in book-entry form had represented
another complex task that was carried out successfully and in a perfectly coordinated manner.
At the time of the introduction of the euro, a completely new monetary policy framework was
introduced with the European Central Bank conducting a single, stability-oriented monetary policy for
the entire euro area. However, the European Central Bank and the euro could inherit the high level of
credibility achieved by the most stable national currencies and the monetary policy framework of these
national central banks. The new framework, together with the convergence of general economic
policies that was implemented during the run-up to the introduction of the euro, generated an
environment supporting enhanced macroeconomic stability. As you know, the European Central Bank
aims to maintain price stability by keeping inflation rates below, but close to, 2% over the medium
term. Looking back at the period since the euro was launched, the inflation rate in the euro area was
on average very close to 2%. It has occasionally risen above the 2% ceiling as a result of temporary
disturbances, such as the recent hike in oil prices. However, when such shocks occur, it is important
for us to ensure that price stability is maintained over the medium term. In this regard, it is worth
mentioning that inflation expectations over the next 10 years (as measured in particular by Consensus
Economics) have never exceeded 2% since the introduction of the euro, i.e. exactly at the level
consistent with a definition of price stability - "below but close to 2%". During the last seven years,
monetary policy in the euro area has been successful in maintaining stable prices, thereby making the
best possible contribution it can make to sustained output growth. Along the way, stability-oriented
policies have also directly improved the well-being of households, inter alia, by supporting the
purchasing power of their income and savings.
Nominal and real interest rates have remained at low levels ever since the euro was introduced and
are expected to stay at historically low levels over a long period of time. Looking back in time, it is
interesting to note that, all along the yield curve, market interest rates in euro area countries became
aligned with the lowest - instead of the average - rates prevailing prior to the euro. This low level of
interest rates is of course supportive of the economic recovery in the euro area, while at the same time
being consistent with price stability over the medium term. Moreover, interest rates have over time
reflected a high degree of "consonance" between the European Central Bank's policy intentions and
the market views concerning the course of policy. Such a level of predictability of policy, which signals
a high degree of transparency, is particularly rewarding, considering that a significant part of our job is
devoted to explaining and discussing our actions and our goals to the public. Transparency is a
precondition for accountability and improves communication with the public regarding how the
European Central Bank conducts monetary policy, thereby fostering predictability and making policy
much more effective. In this regard, allow me to stress that the European Central Bank was the first
major central bank to introduce a real-time press conference displaying in detail the diagnosis and the
monetary policy decisions of the Governing Council.
Another important result of monetary unification is the increase in European financial integration. A
large, liquid and integrated money market was created after 1 January 1999. The euro bond market
quickly turned into the second largest bond market in the world. Within the euro area, the elimination
of exchange rate risks and the lower transaction costs which followed have created new opportunities
for businesses, thereby being conducive to a more efficient allocation of capital. As a result, European
firms have attained higher levels of efficiency and competitiveness, which is by itself supportive of
greater potential growth in the long term. EMU itself has contributed to further reducing financing costs
owing to the lower premia associated with the increased focus on stability-oriented economic policies.
The available data indicate an overall high degree of integration in the euro area money market
following the introduction of the euro, as illustrated in particular by the drop to close to zero in the
cross-country standard deviations of unsecured money market rates. Government bond yields have
converged in all euro area countries and increasingly tend to be driven by common news. Ten-year
euro area government bond yields are currently at levels significantly below 4%. Furthermore, financial
deepening is evident in the rapid growth of new market segments, such as the corporate bond market,
reinforcing the access of investors to funds and thereby contributing greatly to economic growth.
Finally, measures of cross-country equity flows point to a rising degree of integration, with the
advantages of sectoral diversification gaining ground over those of geographical diversification.
Productivity and growth
Let me now turn to the major challenges facing us. First of all, I will refer to the medium- to long-term
trends for growth and productivity. If we compare growth in the US and the euro area since the
mid1990s, we find that it has been significantly higher in the former. Between 1996 and 2005, average
real GDP growth per year was 3.3% in the US and 2.1% in the euro area. The difference between the
growth performance in these two economies is partly related to demographic trends. However, it also
stems from higher productivity growth in the US. Labour productivity growth (per hour worked) was
1.3% in the euro area during the period 1996 to 2005 compared to 2.3% in the US. Over the same
period, the annual rate of increase in employment (in terms of hours worked) was around 0.8% in the
euro area, which was only moderately below that in the US, at 0.9%. It is worth mentioning the euro
area experienced a slowdown in labour productivity growth (per hour worked) at around year 2000,
with productivity growth declining from 2.0% in 1996-2000 to 0.8% in 2000-2005 (compared with rates
of 2.0% and 2.6%, respectively, in the US).
One important factor constraining euro area productivity growth has been the slowdown in capital
deepening. As you know, capital deepening is the increase in the volume of capital per unit of labour
input. During the last decade the contribution to growth from capital deepening in the euro area was
below that observed in the early 1990s, and significantly below that in the US. At a more
disaggregated level, recent studies have highlighted the role of the information and communication
technology (ICT) in explaining the acceleration of productivity growth in the US in the mid-1990s. We
have all witnessed the profound change of the economy in the domain of the production of goods and
services that has been brought about by lower costs of computing and communicating information.
Overall, the different incorporation in the economy of the ICT revolution helps explain the diverging
trends in labour productivity growth between the euro area and the US in recent years in two ways.
First, we observe lower productivity growth in the ICT-using sectors in the euro area compared with
the US. In particular, key ICT-using services, such as retail, wholesale and financial services, missed
out to raise productivity growth in recent years in the euro area. The deceleration in labour productivity
in these sectors seems primarily related to strong employment growth, which reduced the pace of
capital deepening.
Second, ICT-producing sectors have made a smaller contribution to overall labour productivity growth
in the euro area compared to the US (approximately 0.5 percentage points between 1996 and 2002 in
the euro area, compared with 0.8 percentage points in the US during the same period). This can be in
part attributed to a relatively small output share of the ICT-producing sector of 5.3% in the euro area,
compared with 7.0% in the US.
The latest empirical studies have found evidence that economic growth is associated with the degree
of development and structure of the financial system. Well-developed financial systems help to
channel resources towards the most rewarding activities and therefore encourage the most efficient
allocation of capital. A further development of the euro area financial system can be achieved via
deeper financial integration. In this regard, one requirement for increased cross-border financial flows
is the establishment of pan-European payment systems. The banking payment system put in
operation at the same time the euro was introduced - TARGET - has successfully linked up all
national payment systems and allowed settlements between financial institutions to be made gross at
any time during the day. At the retail level, one prerequisite for enhanced financial integration that is
still needed is the fulfilment of the single euro payments area - SEPA. The SEPA project, in which the
European Central Bank acts as a helping hand, will create, out of the many different national payment
schemes, an integrated scheme for each of the three main payment instruments (credit transfers,
direct debits and cards). This process would also enable the consolidation of national retail
infrastructures into more efficient pan-European infrastructures with competing operators.
Sound macroeconomic policies are also key to sustainable long-term growth. In particular, recent
studies have emphasised the benefits of maintaining low and stable inflation and preventing
unsustainable fiscal deficits and levels of debts. In this regard, a sound monetary policy is a necessary
condition for sustainable economic growth and job creation. Price stability ensures the transparency of
the relative price mechanism, thus enhancing the efficiency of resource allocation. High and uncertain
inflation gives rise to inflation risk premia, implying that fewer investment projects will be profitable and
the potential output growth rate is consequently reduced.
The need for structural reforms
Let me turn to another key challenge for the euro area, namely, to cope with accelerated globalisation.
European economies and workers in particular need to be increasingly flexible to adjust to rapidly
changing supply and demand conditions. The still high euro area unemployment rate of 8.6% in 2005
is the most obvious evidence for the euro area's insufficient ability to flexibly adjust to changes in the
economic environment. Against this background, urgently required are structural reforms that ease
adjustment processes and that have the potential to increase both labour productivity growth as well
as labour utilisation. These structural reforms must aim at what Wim Kok once summarised as
"Europe needs more people in work, working more productively". Let me briefly highlight four main
areas for structural reform.
First, the euro area needs labour market reforms that increase labour utilisation by raising employment
as well as working hours on a life-time basis. Looking back, progress with labour market reforms in the
euro area over the last years seems to bear fruit, as indicated by the overall decline in the aggregate
euro area unemployment rate from 10.5% in 1995 to 8.6% in 2005. However, particularly worrying are
the still high level of the unemployment rate of young persons aged 15-24, amounting to 17.8%, and
the still low rate of employment of older workers aged 55-64, standing at just 40.2% in 2005.
According to the European Commission, population ageing will lead to a fall in the euro area working
age population, i.e. the population aged 15-64, by 13 million between 2005 and 2030. In this context, a
general improvement in the labour market position of young and older persons is of the utmost
importance. To increase labour utilisation, necessary labour supply side measures include reforms of
tax and benefit systems that increase incentives to work. On the labour demand side, there is a need
to promote wage flexibility and to address labour market rigidities.
Second, also reforms on euro area goods and services markets have a substantial role to play in
increasing employment and productivity growth. Policies improving the functioning of product markets
include the extension and deepening of the EU internal market. With service-related activities
representing around 70% of value added and employment in the euro area (against almost 80% in the
US), more competition in EU service markets would be required. Overall, a higher competition in
services markets would promote a more dynamic economy and create more jobs. Moreover, also a
further opening up of network industries, representing around 9% of euro area production and 7% of
euro area employment, should be beneficial for consumers as some substantial price reductions in the
telecommunication sector over the last years have shown.
Third, creating an entrepreneurial-friendly economic environment with low administrative and
bureaucratic costs for firms and business start-ups should help to create new jobs. To the extent that
these measures increase product market competition, they should simultaneously contribute to
fostering labour productivity growth. The immense importance of this issue is increasingly appreciated
by European governments and several initiatives at national or EU-wide level have started to
implement actions for a "better regulation". Let me illustrate this with reference to some figures
comparing the US and the euro area. Following studies by 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 10 times larger than in the US, amounting to roughly USD 2,700 (EUR 2,250). In
2005, it took on average 27 days to set up a business in the euro area, compared to 5 days in the US.
Fourth, further policies are required that aim more directly at raising long-term productivity growth.
According to the latest available information, roughly 1.9% of euro area GDP was spent on R&D, while
the corresponding fraction was around 2.6% in the US. R&D needs to be accompanied by additional
efforts that aim at improving the labour force's level of education and expertise. The last decades have
already brought about an enormous increase in the level of educational attainment, the so-called
"catch-up effect in education". In the euro area, according to OECD data for 2003, an average of 73%
of those aged 25-34 had attained at least upper secondary education, compared to only 46% of
persons aged 55-64. Nevertheless, meeting the challenges of technological progress and ensuring the
labour force's employability and flexibility, requires that human capital is continuously adjusted to
labour market needs through improved education and training as well as lifelong learning.
Implementing this non-exhaustive list of structural policy priorities should help the euro area to
increase labour productivity and labour utilisation as well as increase its overall flexibility in response
to economic shocks. To properly address national reform priorities, the euro area countries will benefit
from ambitiously implementing the National Reform Programmes they have set up in 2005. For the
euro area countries with a single currency, open, competitive and flexible labour, product and financial
markets are especially important. For firms in the euro area, structural reforms should generally lead to
a greater choice between suitable investment options and open up possibilities of cost reductions,
thus helping them to raise competitiveness. Within a monetary union with increased price and cost
comparability it is of paramount importance that firms remain competitive by controlling domestic cost
developments as captured by, for example, unit labour costs. This is exemplarily illustrated in the case
of Germany which had lost competitiveness due to reunification, and which embarked on a catching
up exercise between 1999 and 2005, witnessing only limited cumulated unit labour cost increases of
2.6% compared to a euro area average of 11.2%. This significant improvement of the German
economy's cost competitiveness is one of the explanations for its strong export performance.
Fiscal policy
Turning to the fiscal aspects of EMU, there is no need to discuss at great length the merits of
maintaining sound fiscal positions. Sound fiscal positions inspire confidence in the sustainability of
fiscal policies. This reduces the uncertainty surrounding long-term economic decisions and is thus
conducive to stable and sustainable growth and employment. The importance of maintaining sound
fiscal positions becomes even greater in a monetary union. In such an environment, the costs of fiscal
profligacy to the individual government are reduced as negative implications for the interest rate are
distributed across the entire union. In addition, exchange rate variations do not provide signals
regarding investor confidence in the domestic economy any more.
The EU fiscal framework, as laid down in the Maastricht Treaty and the Stability and Growth Pact,
ensures that fiscal discipline is maintained in EMU. The Pact provides a system for the monitoring of
fiscal policies and, if necessary, the timely correction of excessive deficits.
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. At the beginning of the 1990s, most euro area
countries showed sizeable imbalances in their public finances, with the average deficit reaching 5% of
GDP and more. In the run-up to monetary union, fiscal balances improved substantially: the euro area
average deficit ratio declined to 2.6% in 1997, the reference year for the decision on which countries
were to join the common currency from its start in 1999. Since then, fiscal deficits have first improved
before consolidation fatigue set in. Some countries incurred deficits in excess of the 3% of GDP
reference value, in some instances even substantially above the threshold. Nevertheless, 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 between 1980
(34.2%) and 1997 (74.7%) has been halted.
Nonetheless, further reforms in the fiscal area are needed. Let me mention three major challenges: i) a
number of governments still need to correct large fiscal imbalances and improve the structure of public
finances; ii) national institutions for fiscal policy making should support the fiscal commitments under
the EU framework and iii) governments must prepare for the fiscal burden arising from demographic
ageing.
Regarding the first challenge, countries with large imbalances must correct them in line with
commitments under the Pact and country-specific ECOFIN Council recommendations. This will ensure
the soundness of national fiscal positions and strengthen the confidence of households and investors
in the sustainability of economic policies. Beyond this immediate requirement, most euro area
countries are in need of a comprehensive and growth-friendly reform strategy, which must include the
pursuit of fiscal consolidation. Structural expenditure reforms are essential for healthy and
growthpromoting public finances. To help promote investment, innovation and employment, expenditure
needs to be directed towards productive goals. But, in many cases, it will also be essential to review
government commitments, especially their less productive elements.
Turning to the second challenge, the current very high expenditure shares may also be a reflection of
the way in which fiscal policy frameworks operate at the national level. The experience shows that
some euro area countries have managed to translate the constraints under the EU fiscal framework
effectively into their domestic fiscal policy institutions. As a consequence, these countries find it much
easier to comply with the requirements while maintaining sole responsibility for their policies. To
ensure fiscal soundness over the medium and long term, euro area countries should have fiscal policy
arrangements that ensure consistency with the requirements of the EU framework.
Finally, in the long run, population ageing will put a substantial burden on public finances. This will
occur directly through the impact on public pension and health care expenditure as well as via the
growth-dampening effects of a gradually shrinking share of the labour force in the population. Public
expenditure increases of up to 10% of GDP have been projected if no action is taken. Governments
need to prepare for this burden before expenditure pressures start to increase rapidly after 2010. In
many countries, this requires reducing current debt ratios and reforming public pension and health
care systems. In addition, reforms are needed that lead to higher labour market participation and lower
unemployment. Only if these reforms are implemented swiftly can we cope with population ageing,
maintaining sustainable fiscal positions, a reasonable tax burden and sustained growth.
Conclusions
Let me conclude by stressing that the euro has been firmly and credibly established as a stable
currency. The euro has brought a period of currency stability, low rates of inflation, low levels of
medium- and long-term market interest rates, and higher economic integration via enhanced trade and
financial interdependence. I hope, however, that I have not communicated a sense of complacency
over past achievements. At the European Central Bank we must continue to comply with our mandate
of maintaining price stability and, through this, contribute to a macroeconomic environment supportive
of economic growth. The challenges ahead of us are a reminder that European integration is a
dynamic process and that it will bring about deeper structural transformations. As a matter of fact, the
historical process of European integration is moving steadily forward and will require our utmost effort
and commitment for years to come.
Thank you very much for your attention.