Klaus Liebscher: The euro - a contribution to international stability
Luncheon speech by Dr Klaus Liebscher, Governor of the Austrian National Bank, at the
Metropolitan Club, New York, 16 April 2007.
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Ladies and Gentlemen!
It is a great pleasure and honor to have the opportunity today to talk in front of such a
distinguished audience, in one of the most fascinating cities of the world. Financial markets
have become global, yet I think New York and Wall Street will always remain synonyms for
investors seeking returns, prosperity and new horizons.
Today, I would like to share with you one of Europe's most recent success stories, notably
the story of our common currency, the euro. Recently, we celebrated the 50th anniversary of
the Treaty of Rome, which established the European Economic Community (EEC). The day
the Treaty was signed, March 25, 1957, was the birthday of the European Union, which
today unites 490 million inhabitants and 27 countries.
The euro was introduced on January 1, 1999, and meanwhile, the euro and the Economic
and Monetary Union (EMU) have entered their ninth year.
In today's euro area 317 million people in 13 countries (including Slovenia as the first of the
new Member States to introduce the euro on January 1, 2007) benefit from a low inflation
environment and stable inflation expectations, a high degree of confidence in their currency
as well as a moderate level of interest rates - all elements of a favorable economic
environment conducive to investment and business making.
Skeptics but also some advocates of Economic and Monetary Union once regarded the euro
as "the world's largest economic policy experiment".1 Well, although the introduction of the
euro was an unparalleled project in European history, I certainly would not want to consider
the euro a mere experiment. Launching the euro was, after all, a solidly founded and well
prepared project, based on policymakers' firm conviction that the introduction of a single
currency would entail ample benefits. Hence, I do not regard the euro as an experiment, but
as a very wise and successful strategy.
Economic and Monetary Union has to be seen as one of our most important strategic
responses to the chances and challenges in a globalized world.
The euro has fostered the European integration process; the euro has enhanced Europe's
role in international economic policy circles; and the euro provides a sound basis for our
businesses in a very competitive world.
The stability created by the euro already extends beyond the euro area: The non-euro area
EU Member States, many Eastern European, Middle Eastern and African countries are
positively affected by the euro as well. The euro is a key currency for monetary policy in
many countries. In 2006, 25% of all official foreign exchange reserves worldwide were held in
euro.
Since its introduction, the euro has become the second most widely used currency in the
world. And in terms of banknotes and coins in circulation, the euro with 646 billion has
already overtaken the US-Dollar.2
Moreover, the euro has proved to be a stabilizing influence not only for the European capital
markets, but also for the international financial system, as was demonstrated after the
shocking and very tragic events of September 11.
How did the euro establish itself that swiftly as an anchor of stability? To answer this
question, monetary, fiscal and structural policies in the euro area have to be considered. Let
me start with monetary policy.
The monetary policy framework of the European Central Bank (ECB) and the Eurosystem
respectively, which includes the national central banks of the euro area, is based on central
bank independence, transparency, accountability and an explicit mandate to maintain price
stability.
The Eurosystem goes to great lengths to communicate the ECB's monetary policy strategy,
the rationale for monetary policy decisions and our assessment of economic developments.
These communication efforts not only take the form of regular testimonies in the European
and national Parliaments, periodic bulletins and speeches, but also take place in "real time":
ECB President Jean-Claude Trichet explains the monetary policy decisions and the
underlying reasoning in press conferences which take place immediately after Governing
Council meetings and which provide "question and answer sessions" for journalists.
The ECB's monetary policy is based on a clearly defined monetary policy strategy aimed at
fulfilling our primary mandate of price stability. This is defined as an inflation rate of below,
but close to 2% over the medium term.
By and large we have maintained price stability since the introduction of the euro despite a
difficult macroeconomic environment characterized by a high level of uncertainty and a series
of adverse external and internal shocks:
Oil price developments accelerated inflation; at the same time events such as the burst of the
equity bubble, geopolitical tensions and a decline in productivity dampened growth in the
euro area.
These divergent developments in inflation and growth, as well as asymmetric effects of these
shocks across countries posed challenges, especially for a new central bank.
Given such an environment of constant economic uncertainties and challenges, the
European Central Bank has put a monetary policy strategy in place that is based on a
comprehensive analysis of economic and monetary developments. That means that the
Governing Council cross-checks the information gained from economic analysis with all
available evidence from a wide range of monetary, credit and asset market indicators.
Looking back, this monetary strategy has served us very well, despite some inherent volatility
between money demand and inflation: Since 2004, private lending and money aggregates
have grown in parallel and at accelerated speed. This was an early indication of the current
economic upswing, which most other data did not signal until much later.
Indeed, the ECB's monetary policy strategy contributed to the timely and highly warranted
adjustment of the ECB's monetary policy stance, with the first interest rate increase in
December 2005, which was to ensure that risks to price stability over the medium term do
not materialize. Having said this, we are aware that strong money and credit growth may also
signal the build-up of financial imbalances and potential price bubbles in asset markets, as
could be indicated, for instance, by significant housing price increases in some regions in the
euro area.
Despite the negative factors mentioned before inflation stood at only 2.2% in 2006. On
average, inflation has come to 2.1% since the start of EMU, which shows that inflation
expectations have been firmly anchored. Hence, price stability has created a favorable
environment for investments and the euro area's growth performance.
Indeed, economic activity accelerated to 2.8% last year, and since the start of Monetary
Union real GDP growth has amounted to 2.1% on average. Unemployment has declined
significantly, dropping from 9% in 1999 to 7.3% recently, a development which is particularly
welcome. 12 million new jobs were created since 1999.
The ECB staff projections foresee growth in a range between 2.1% and 2.9% in 2007 and
between 1.9% and 2.9% in 2008. In the opinion of the ECB's Governing Council, the risks
surrounding this favorable outlook for economic growth are broadly balanced over the short
term. However, looking at longer time horizons, risks may lie mainly on the downside. The
main risks relate to the possibility of a renewed increase in oil prices, fears of a rise in
protectionist pressures and concerns about possible disorderly developments owing to global
imbalances.
Concerning the outlook for prices, last year's volatility in energy prices will lead to significant
base effects, affecting the profile of annual inflation rates in a slightly U-shaped way. The
ECB staff projections from March 2007 foresee annual inflation averaging between 1.5% and
2.1% this year and between 1.4% and 2.6% in 2008.
Given these projections and the credible price stability commitment of the ECB, long-term
inflation expectations according to professional forecasters continue to be firmly anchored at
just below 2%.
Having said this, upside risks to price stability remain and relate foremost to higher wage
claims, and of course the oil price. Given the favourable economic environment, our
monetary policy continues to be on the accommodative side, with the key ECB interest rates
moderate, money and credit growth vigorous, and liquidity in the euro area ample by all
plausible measures.
Therefore, looking ahead, acting in a firm and timely manner to ensure price stability in the
medium term is warranted. Indeed, it is essential to ensure that risks to price stability over
the medium term do not materialise.
A price stability-orientated monetary policy is a necessary precondition for sustainable
dynamic growth and employment, but it is by no means the only precondition.
Monetary policy needs to be supported by sound public finances, ambitious structural
reforms and a competitive economic framework. While monetary policy in the euro area is
firmly vested in a supranational body - the ECB - fiscal and structural policies remain the
responsibility of national governments.
It is important to understand that unsustainable fiscal policies may put the entire euro area at
risk. For instance, higher risk premiums in response to unsustainable policies in one Member
State could spill over to other euro area countries. Hence, membership in the euro area also
means compliance with a stringent regulatory framework, the Stability and Growth Pact.
We are aware that the present improvement of fiscal balances in the euro area, from -2.4%
in 2005 to an expected -1.6% in 20063, is only partly driven by structural improvements.
Thus, it is essential that any budgetary leeway emerging from the currently very favorable
economic environment is used for lasting budgetary consolidation in order to prepare for
challenges such as population ageing and to create room to maneuver for future economic
weaknesses.
Monetary policy needs to be supported by sound public finances and, apart from that, by
ambitious structural reforms and a competitive economic framework, to enable the euro area
to fully reap the benefits of the common currency. Structural polices need to ensure that
countries can flexibly react to asymmetric shocks, as the common monetary regime makes
adjustments to asymmetric shocks a painful and tedious process.
Even though a number of Member States have achieved significant progress in several
areas, much remains to be done. Necessary measures include more effective and efficient
investment in knowledge and innovation, as well as promoting the flexibility of labor and
product markets in order to unlock business potential. At the end of the day, only dynamic
economies can sustain modernized, but still generous welfare systems in Europe.
This brings me to another part of Europe, the new Member States of Central and Eastern
Europe. They have succeeded in transforming their economies from centrally planned
systems to market economies. Substantial progress has been achieved in the areas of
property rights, privatization, as well as capital and trade liberalization.
As these countries have anchored their institutional structures to the EU, they are viewed as
increasingly secure places for investing and doing business in general. Moreover, the euro
serves as an anchor of monetary stability in the region, often directly, for instance in the
framework of the European Exchange Rate Mechanism ERM II. Currently, six countries of
the 12 new Member States participate in the exchange rate mechanism ERM II: Estonia,
Cyprus, Latvia, Lithuania, Malta, and Slovakia.
All Member States of the EU, with the exception of Denmark and the United Kingdom, are to
adopt the euro, once they fulfill the Maastricht convergence criteria in a sustainable way, as
laid down in the EU Treaty.
In line with this procedure, Slovenia joined the euro area as its 13th member at the beginning
of this year. In February 2007, Malta and Cyprus submitted their requests for convergence
assessment by the ECB and the European Commission. Both institutions will publish their
convergence reports in May. Based on these reports, the ECOFIN Council (i.e. the EU
Ministers of Finance) will take a final decision in July, after having consulted with the
European Parliament and after a discussion of the matter by the European Council (i.e. the
Heads of State and Government) in June. In case of a positive decision, both countries
would adopt the single currency by the beginning of 2008.
Even though the new EU Member States of Central and Eastern Europe account for only
some 6% of GDP within the EU, one cannot neglect their positive effects on the rest of the
European Union. Central and Eastern Europe is the most dynamic region in the EU - both in
terms of economic growth and in terms of reform speed. During their catching-up-process,
the new Member States will further gain in importance and may turn into a driving force of the
European economy.
As a result of the dismantling of trade barriers, trade links with the new EU Member States
have gradually intensified. The former EU-15 countries are not only the most important
trading partners for the new Members States but also account for three quarters of their total
FDI stock. This is particularly true for the banking sector, in which foreign-owned banks have
gained an average market share of around 70%.
I expect the very positive dynamics in Central and Eastern Europe to continue. For the three
EU members Czech Republic, Hungary and Poland, and also for Russia, the staff of our
Bank forecasts annual real GDP growth to range between 5% in the Czech Republic, 6% in
Poland and 6 1⁄2% in Russia, while economic activity in Hungary is expected to slow down to
less than 3% this year, as necessary austerity measures take effect.
For 2008, our staff expects some growth acceleration for Hungary, and some moderation in
the other countries mentioned. In the long run, the leveling off of EU accession-related and
catching-up effects may dampen growth, but the general growth prospects remain favorable.
Austrian companies in general, and Austrian banks in particular, identified market
opportunities in Central and Eastern Europe at a relatively early stage and have established
a considerable presence in the region by now. With an average market share in banking
sector assets of almost 25%, Austria's banks are market leaders in Central and Eastern
Europe.4 More than one-third of the profits of the six largest Austrian banks already come
from this region.
As Austrian banks continue to move into the southeast and east, their exposure is broadly
diversified, which is intended to contain risks. At the same time, the Austrian authorities
closely monitor potential challenges involved. Stress tests indicate that the banks' exposure
is manageable and potential contagion effects on Austrian banks should be very limited.
Let me conclude by getting back from Austria's focal point of interest, Central and Eastern
Europe, to New York's focal point of interest: the world economy.
The increasing globalization of the world economy, with new players emerging on the world
stage, has contributed to the very impressive expansion of the world economy in the recent
past. Yet, this dynamic growth has also spurred economic challenges, such as strongly rising
commodity prices and significant current account imbalances. Recently, global growth
appears to be somewhat more even-footed, as growth in Japan and the euro area has been
picking up.
The economic upswing recorded in the euro area can be attributed, at least partly, to
improved economic structures and is based on the stability-orientated framework of EMU.
The ECB and the Eurosystem respectively, will continue to support economic growth in the
euro area by vigorously pursuing price stability. Following this approach also guarantees that
the euro can contribute most effectively to international stability.