Mr Noyer reviews first experiences with the euro
Speech delivered by the Vice-President of the European Central Bank, Mr Christian Noyer, at
the conference organised by Swedback in Stockholm on 26 May 1999.
I should like to start by thanking you for your kind invitation to speak here on the occasion of
this conference organised by Swedbank. It is some five months now since the euro was
launched. The introduction of the euro has been accomplished successfully and the enormous
technical and logistical challenges arising during the early days of monetary union have been
overcome. The first months of the euro have been successful in both political and operational
terms. With the introduction of the euro, European integration has taken a large step forward
as the new millennium approaches.
The euro plays an important role in the euro area and beyond. Just after its launch in January,
the euro already featured on all major financial markets around the globe. Currency trading is
regularly carried out in euro and shares are denominated in euro on most European stock
exchanges. Moreover, the euro has attracted new international bond issues as the currency of
denomination. In some ways, the introduction of the euro may justify expectations of large
overall efficiency gains. For citizens living in the euro area, two obvious gains will be the
reduction of transaction costs and increased transparency across countries, as price
comparisons between goods sold in different countries are made easier.
The Governing Council of the ECB is the central decision-making body in charge of monetary
policy for the euro area. The Treaty on European Union - the Maastricht Treaty - assigns the
ESCB the primary objective of maintaining price stability in the euro area. The
implementation of monetary policy decisions taken centrally by the Governing Council rests
with the Eurosystem, comprising the ECB and the national central banks (NCBs) of the
member states which have adopted the euro in stage three of economic and monetary union.
The respective operational tasks are to a large extent carried out in a decentralised manner by
the NCBs.
For the euro to become a success story as the single currency for around 300 million people,
the confidence of European citizens in the stability of the new currency and in the Eurosystem
is crucial. You would probably agree that the Eurosystem has already achieved a lot in terms
of building up credibility and gaining a sound reputation in financial markets for its monetary
policy in its early days. This will certainly facilitate the establishment of a stability culture
throughout Europe. The foundation of this stability culture is a broad consensus among
Europeans that the maintenance of price stability is of the utmost importance and is conducive
to the achievement of other objectives such as high employment.
Monetary policy and other policy areas
By maintaining price stability in the euro area, we will ensure that the single monetary policy
contributes as much as possible to economic growth and high employment. At the same time,
national fiscal authorities and general economic policies also have to demonstrate their
commitment to the maintenance of price stability in the euro area. In this context, the Stability
and Growth Pact adopted in 1997 is a crucial element. Its aim is to encourage the pursuit of
disciplined and sustainable fiscal policies for the participating member states and prospective
members. In so doing, it can make a significant contribution to the establishment of
favourable conditions for sustained economic growth and high employment in the medium
term. Moreover, sound fiscal policies facilitate the task of monetary policy to maintain price
stability. It would be counterproductive if national fiscal policymakers were not to continue to
work towards a budgetary situation which is close to balance or in surplus in the light of the
achievement of monetary union and the positive price outlook for the euro area.
In this connection please allow me to briefly address the matter of calls for closer coordination
between monetary policy and fiscal policies. Any form of ex ante coordination that, for
example, would commit the monetary policy of the ECB to move its interest rates in a certain
way in response to specific action or plans of other policymakers would provide the wrong
impetus for the conduct of sound macroeconomic policies and would not be efficient. This
does not, however, exclude a constructive dialogue between the Eurosystem and government
authorities which clearly respects the independence of the ECB.
In line with its clear mandate, enshrined in the Treaty establishing the European Communities,
and for sound economic reasons, the ECB has to decide which monetary policy best serves the
maintenance of price stability over the medium term and then act accordingly. At the same
time, the Treaty also emphasises the need for sound fiscal policies. This clear separation of
responsibilities is both efficient and transparent. Obviously, monetary policy alone cannot
solve Europe's economic problems such as the present intolerably high level of
unemployment. Appropriate structural reforms implemented by national governments are of
the utmost importance and much progress is required in this broad area. Moderate wage
settlements in both the public and private sectors would, of course, contribute to reducing the
high level of unemployment in many parts of the euro area. In this context, let me remark that
recent wage agreements in some parts of the euro area do not appear to be in line with the
need to encourage higher employment.
The Eurosystem's monetary policy strategy
With regard to the Eurosystem's monetary policy strategy, I should like to emphasise that the
euro area monetary policy is a single one and therefore indivisible - by definition. Monetary
policy decisions must be based on area-wide rather than national considerations and hence on
area-wide indicators. Monetary policy has to be transparent so as to stabilise public
expectations of future price developments. In order to clarify how we interpret the mandate
conferred on the ECB by the Treaty, the Governing Council has announced a quantitative
definition of its primary objective.
Price stability has been defined as a year-on-year increase in the harmonised index of
consumer prices (HICP) for the euro area of below 2%. This has to be maintained over the
medium term. As the wording 'increase' makes clear, deflation - that is, a persistent fall in the
price level - would not be consistent with price stability. It would not be possible for us to
announce where exactly we would draw the dividing line between price stability and
deflation. This is partly for reasons that have been described as the measurement bias in
consumer price indices. For the United States it was estimated that measured consumer prices
tend to slightly overestimate actual inflation. A bias may also exist for the euro area HICP,
although its exact magnitude is as yet unknown and needs to be explored further.
To maintain price stability, the Governing Council has chosen a stability-oriented monetary
policy strategy. The chosen strategy is forward-looking in nature and also ensures as much
continuity as possible with the former strategies of the NCBs. In this respect and with regard
to the overriding objective to maintain price stability in an environment of flexible exchange
rates, our strategy is broadly similar to that of Sveriges Riksbank, although there are important
differences. In particular, the Riksbank follows a direct inflation targeting strategy in which
monetary policy is almost exclusively guided by inflation forecasts of about two years ahead.
In contrast, the Eurosystem relies on two pillars, thereby focusing on the medium term, and
does not give such a predominant role to inflation forecasts as the Riksbank.
In our view, the Riksbank has achieved high standards with regard to transparency and
accountability, as is for example evidenced by its comprehensive quarterly inflation report. In
more recent years, the Riksbank has enjoyed a fair measure of success in gaining control over
domestic price developments, as supported by its strong performance in fighting inflation, and
in overcoming a deep recession in the early 1990s. Its track record also demonstrates that
price stability in Sweden was given a high priority long before this was formally recognised
by an amendment to the Riksbank Act at the start of 1999.
The Eurosystem's stability-oriented monetary policy strategy rests on two pillars, which are
both important when the Governing Council discusses monetary, financial and economic
developments at its biweekly meetings. The first pillar, which is a prominent role for money,
takes into account the essentially monetary origins of inflation over the medium to long term.
It recognises that empirical studies show a stable long-term relationship between money and
prices in the euro area. Therefore, in the euro area, monetary developments constitute an
important guide for the conduct of monetary policy and it is essential to analyse and monitor
the development of monetary aggregates closely. The ECB has announced a quantitative
reference value for broad monetary growth as measured by M3, the first reference value for
M3 growth being set at an annual rate of 4.5%. This reference value is consistent with the
maintenance of price stability over the medium term, while allowing for sustainable output
growth and assuming a trend decline in the velocity of circulation of M3. In setting the
reference value for monetary growth, the Governing Council emphasised its medium-term
orientation. Substantial or prolonged deviations of current monetary growth from the
reference value will normally signal risks to price stability in the medium term.
The ECB does not intend to react to deviations of monetary growth from the reference value
in a mechanistic way. In the first instance, such deviations are analysed thoroughly to infer
any signals which they may give about the prospects for price developments. If the deviation
points to a threat to price stability, monetary policy has to react in a manner appropriate to
counter this threat.
Although monetary data contain information which is important for monetary policy
decisionmaking, monetary developments alone clearly do not constitute a complete summary of all the
economic information necessary for appropriate policy decisions to be taken. Thus the
Governing Council emphasises that it is important, in parallel with the assessment of
monetary growth, to look at a wide range of financial and other economic indicators,
including economic forecasts. The second pillar of the Eurosystem's strategy therefore
consists of a broadly based assessment of the outlook for price developments and the risks to
price stability in the euro area as a whole. This broadly based assessment takes into account,
inter alia, the information provided by wage developments, exchange rates, fiscal indicators,
real economic activity, and asset and commodity prices. Forecasts of economic activity and
prices in the euro area can certainly also contribute to the success of an appropriately
forwardlooking monetary policy. Thus we take into account forecasts available from international
organisations such as the IMF and the OECD as well as internal forecasts.
We are aware that forecasts have to be interpreted with great caution. Given behavioural,
institutional and structural uncertainties, forecasting price and other developments in the euro
area is inevitably difficult. Moreover, a forecast cannot encompass all the indicator variables
that are important for monetary policy. Nor can it always incorporate indicators in a timely
manner. Furthermore, by the time the forecast has been finalised, the original assumptions
may have become less realistic, requiring a careful interpretation of the results. Therefore, a
thorough analysis of individual indicator variables plays an important role in our monetary
policy strategy, in addition to any role that these variables may have in the forecast.
Within the stability-oriented monetary policy strategy, the Eurosystem also takes into account
the external value of the euro as an important determinant of the outlook for price stability. If
exchange rate developments pose a significant threat to price stability in the euro area, all
other things being equal, monetary policy will have to respond. Of course, all other factors
that impart information on price developments will also be taken into account before an
interest rate decision is taken.
Monetary policy decisions and the outlook for price stability
In December 1998 the Governing Council announced that the interest rate on the main
refinancing operation would be 3%. In the first quarter of 1999 the Governing Council kept
this rate unchanged. After an in-depth review of recent monetary, financial and economic
developments, the Governing Council decided at its meeting on 8 April to set the interest rate
for the ECB's main refinancing operations at 2.5%. In addition, the interest rate on the
marginal lending facility was lowered to 3.5% and the interest rate on the deposit facility to
1.5%. These rates were left unchanged at the meeting of the Governing Council last week.
The decision to lower interest rates taken at the first meeting in April has to be seen in the
context of the stability-oriented strategy. The decision has thus been taken from a
forwardlooking perspective, focusing on the medium-term trends in inflation and the compatibility of
these trends with the Eurosystem's definition of price stability. By adhering to this strategy,
the Eurosystem's monetary policy contributes to creating the economic conditions which are
essential to exploiting the considerable growth potential of the euro area and to reducing
uncertainty about future economic developments.
I should like to take this opportunity to explain the current assessment, which is in line with
the Governing Council's expectations at the beginning of April. With regard to the first pillar
of the Eurosystem's monetary policy strategy, monetary growth cannot be seen as signalling
upcoming inflationary pressures at this stage. Since the beginning of this year, the three-month
moving average of M3 growth has been close to the reference value of 4.5%. For the period
from January to March 1999 the average growth rate increased somewhat to 5.2%. This
observation may, however, have been affected by special factors prevailing at the start of stage
three. Therefore, in its current assessment the Governing Council does not regard current
monetary trends as constituting a signal of future inflationary pressures.
With regard to the second pillar of the Eurosystem's monetary policy strategy, the broadly
based outlook for price developments and risks to price stability and various indicators of
future price developments and economic activity in the euro area indicate a favourable
outlook for price stability. Financial indicators such as the very low level of long-term interest
rates point to low inflation expectations and the credibility of monetary policy. Following the
cut in short-term interest rates, long-term rates decreased somewhat initially, which confirms
that the market considered the cut in interest rates by the ECB to be appropriate. More
recently these rates have risen somewhat, mainly as a reflex to the strong increase in
longterm interest rates in the United States.
Regarding economic activity in the euro area, data available for the first two months of 1999
do not yet reveal evidence of a rebound in economic growth. Labour market indicators show
signs of a somewhat decelerating level of employment growth towards the end of 1998.
Meanwhile, preliminary April figures from the European Commission on confidence
indicators point towards some first signs of an improvement in industrial confidence.
Recent price trends have been consistent with price stability. Inflation for the euro area as
measured by the harmonised index of consumer prices (HICP) has been close to 1% since the
fourth quarter of 1998. As has been emphasised on previous occasions, the current low
inflation rates are to some extent the reflection of the large fall in energy prices during 1998.
HICP data for March 1999 show an annual increase of 1%. The slight increase relative to
January and February reflects the fact that goods prices are subject to some upward movement
in the short term owing to the reversal in energy price trends expected by the Governing
Council at the beginning of April. However, the effects of changes in energy prices on rates of
HICP increase may only be of a temporary nature. More lasting effects on future consumer
prices normally come from changes in the overall monetary and economic situation.
To sum up, weighing all the relevant indicators and adopting a forward-looking and
mediumterm perspective, the Governing Council regards the current level of ECB interest rates as
appropriate with a view to maintaining the outlook for continued price stability.
Aspects of the Eurosystem's communication policy
The Treaty acknowledges that it is important in a democratic constitution for an independent
central bank to be open, transparent and clear about the reasoning underlying its actions.
Therefore, a number of reporting obligations exist for the ECB which aim at making the ECB
accountable for its performance. Moreover, by communicating clearly with the public, the
Eurosystem reinforces its credibility. In this regard, the Eurosystem's approach bears
comparison with the best practices of any other central bank.
In practice the ECB has committed itself to exceeding the stringent requirements of the Treaty
concerning transparency and accountability. For example, the ECB releases each month a
bulletin providing detailed background information regarding the current assessment of the
economic outlook. At the same time, with the more extended editions of the bulletin in
March, June, September and December, we fulfil the Treaty requirement to publish a quarterly
report. For the benefit of the general public, the ECB issues regular press releases and an
introductory statement by the President, which is released immediately after the first
Governing Council meeting each month. Furthermore, the ECB submits an annual report on
its activities to the European Community institutions (the Council of the European Union, the
European Commission and the European Parliament).
With regard to the Eurosystem's relationship with European Community institutions, the
Treaty states that the President of the ECOFIN Council and a member of the European
Commission may participate in the meetings of the Governing Council of the ECB, with the
right to express their views but without voting power. The President of the ECB attends
hearings at the European Parliament at least four times a year to discuss the activities of the
Eurosystem and is also invited to attend the informal euro-11 Council meetings. I should like
to stress that the participation of the President in these meetings serves the purpose of
exchanging information and views, while fully respecting the independence of the
Eurosystem.
In the field of the international representation of the ECB, formal and informal agreements
have been reached with the IMF and the OECD and in the context of the G7 and the G10. At
the end of last year the IMF granted the ECB observer status, full membership being restricted
to individual nations. Nevertheless, this observer status will allow the ECB to participate in
the relevant work and assessments by the IMF of economic policies in the euro area and
beyond.
The international role of the euro
Clearly, the introduction of the euro has had important implications for international capital
markets. This has been the case not just because a number of currencies replaced by the euro
played an important international role in the past but also because the euro has become the
currency of an economic area which roughly equals the United States in terms of economic
size and external trade, and which has the world's second largest capital markets.
Let me emphasise at this juncture that the Eurosystem has no exchange rate target vis-à-vis
other major currencies. We are also not participating in a formal exchange rate arrangement
with third countries outside the EU, for instance with the United States, and we believe that
this situation will continue in the future. It is important to mention that according to the Treaty
the single exchange rate policy has to respect the primary objective of price stability.
As the representative of a large economic area, the Eurosystem can best meet its overriding
objective to maintain price stability in the euro area if it is not constrained by an exchange rate
target. However, for smaller, very open economies, setting an exchange rate target may be a
very reasonable decision. Against this background the ERM II exchange rate mechanism was
created for those member states which have not yet joined monetary union but are willing to
do so in the near future. Experience with the European Monetary System (EMS), the
predecessor of ERM II, has shown that participation in a system of this kind may facilitate the
fulfilment of other convergence criteria. The new exchange rate mechanism may play a
similar role. In this context, we should certainly wish to acknowledge the efforts which
Sweden is making to achieve sustainable convergence with the euro area. We hope that the
success of the euro in its early months will help to convince the Swedish population of the
benefits of early participation in monetary union. Clearly, a decision to join ERM II would be
important for fulfilling the convergence criterion of exchange rate stability and would help to
smooth the transition to participation in the euro area.
In recent months the external value of the euro has been influenced by the market view of the
economic developments in the euro area relative to the United States. More recently other
factors had an impact on the exchange rate of the euro vis-à-vis the dollar, in particular the
conflict in Kosovo. From the beginning of the year to mid-May, the euro weakened against the
dollar by about 10%. In nominal terms, measured against a trade-weighted basket of the
currencies of the 15 most important trading partners of the euro area, the euro has weakened
significantly less, i.e. by about 6% since its launch. However, rather than focusing on very
short-term developments, one should look at long-term evolution. In that respect, it has to be
observed that the current exchange rate of the euro against the dollar is not so very different
from the levels observed in the first three quarters of 1998.
Clearly, some variability is typical for the bilateral exchange rate vis-à-vis the US dollar.
Market expectations about future cyclical developments and the course of monetary and fiscal
policy in the United States and Europe play a role in explaining exchange rate volatility. It is
widely recognised that in the medium to long term exchange rates follow a path determined by
fundamental factors such as price and economic developments. In this context, it should be
pointed out that recent exchange rate developments have as yet not indicated any risk for
future price stability. Moreover, internal price stability should serve as an anchor for the
development of the euro's external value in the medium term. Indeed, a stability-oriented
monetary policy strategy protecting the purchasing power of the euro is the basis of a solid
and stable currency over the medium term.
Maintaining price stability in the euro area also promotes credibility and thereby enhances the
international role of the euro. The Eurosystem neither promotes nor hinders the development
of the euro as an international currency. We consider that the international role of the euro
should develop through the interaction of market forces. As yet it is too early to predict how
long it will take for the euro to be considered as a truly international currency similar to the
US dollar.
Clearly, the disappearance of 11 national currencies and the introduction of the euro as a
major international currency had an immediate impact on the turnover and focus of attention
in the global foreign exchange markets. This has been reflected, for example, in rather active
and liquid euro/dollar trading in the foreign exchange market since the launch of the new
currency. However, there are also indications that the euro has further potential to grow in
other markets as the surprisingly slow development of euro/yen trading suggests.
The euro can also be expected to become an attractive currency for the investment of official
reserves.
One of the key elements to further international portfolio diversification in favour of the euro
is the creation of a large, liquid and integrated capital market in Europe that began with the
launch of the euro. For short-term instruments, we are now dealing with a broad and liquid
European money market that ensures very similar short-term interest rates for comparable
instruments and credit risks. The development of this market has been strengthened by the
Eurosystem's operational framework of open market operations, which is mainly based on
reverse transactions, and the implementation of the new TARGET real-time gross settlement
system in participating countries. At the longer end of the maturity spectrum, market
integration was jumpstarted by the redenomination of outstanding government debt in euro
and by the convergence of interest rates to narrower spreads following the elimination of the
exchange rate risk. The elimination of this main risk will also foster the development of
uniform market standards so that government bonds in the euro area will become rather close
substitutes, creating a large and liquid bond market. Obviously, this requires sound and
sustainable budgetary policies that ensure that credit risk spreads remain small.
Concluding remarks
Following a remarkable period of disinflation in most member states, the Eurosystem has had
the good fortune to commence its operations in an environment of price stability. The success
enjoyed by the euro in its first five months can be certainly attributed to a number of factors.
Above all, the successful efforts of member states made possible a smooth changeover to the
euro. The independence of the ECB and the clear mandate to maintain price stability were
crucial for ensuring a high degree of credibility of the Eurosystem's monetary policy. As a
final observation, I should simply like to mention that without the positive echo of financial
markets and the permanent support of banks and financial institutions, a single currency in
Europe could not have become a reality.