Willem F Duisenberg: The euro area - recent developments and the economic
outlook
Opening remarks by Dr Willem F Duisenberg, President of the European Central Bank, of the panel on
"Recent developments in the world economy"at the 2nd international conference organised by the
Banco de Mexico, Mexico City , 12 November 2002.
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Ladies and gentlemen,
It gives me great pleasure to chair this panel today and to speak before such a distinguished
audience. In my opening remarks, I will briefly touch on recent economic developments in the euro
area and on our assessment of current developments in the economic outlook.
Although, earlier this year, we were expecting a relatively pronounced economic recovery in the euro
area, since the summer it has become increasingly clear that this scenario of rapid acceleration will
not materialise. Over recent months, a high degree of uncertainty - stemming mainly from
developments in stock markets and geopolitical tensions - has taken its toll on confidence worldwide.
These developments have weakened the pace of growth in the euro area. Recent data and
information suggest that activity in the euro area has continued to grow only moderately in the third
quarter of 2002 and available evidence also points to only moderate rates of growth of real GDP at the
turn of the year.
Still, for the time being, the main scenario for the euro area remains that economic growth is expected
to return to rates close to potential in the course of 2003. This expectation is consistent with all
available forecasts by international organisations and by leading private forecasters. Moreover,
financial markets have shown signs of stabilisation in recent weeks following a period of considerable
turbulence.
The expectation of an improvement in economic activity in the euro area is contingent on a recovery of
growth in private consumption, which should be supported by growth in real disposable income and a
correction of high perceived inflation rates towards those of actual rates, which are lower. This
expectation is also conditional on a projected gradual recovery in foreign demand in line with expected
stronger growth in the world economy which, together with low interest rates, should lead to a
resumption of stock building and stronger investment. However, this main scenario is still surrounded
by considerable uncertainty, and it is difficult to determine precisely both the strength and the timing of
the economic upswing in the euro area and globally.
Turning to price developments, euro area inflation is currently slightly above 2%, the upper limit of our
definition of price stability. Annual headline inflation rates in the euro area are likely to remain above
2% for the remainder of 2002 and even increase slightly around the turn of the year. Despite the
recent decline in oil prices, changes in administered prices and some adverse base effects on the
most volatile components could have some upward impact and delay the return to inflation rates below
2%. However, these developments should be temporary.
Looking further ahead to the prospects for inflation, let me start by reviewing the liquidity situation, as
evidenced in monetary developments, which is an important part of our analysis of risks to price
stability over the medium term. At present, there is more liquidity in the euro area than would be
needed to finance sustainable, non-inflationary growth. This is due in part to the low level of interest
rates in the euro area, which is fuelling the demand for liquid assets. However, the continued strength
of monetary growth is also due, to a large extent, to portfolio shifts into M3. These shifts occur for
precautionary reasons in an environment of high financial market uncertainty. In view of this, and given
the current environment of subdued economic activity, we do not see a high risk of this translating into
inflationary pressure in the near future.
The continuing strengthening of the euro since early this year together with the weak pace of
economic growth in the euro area are in fact dampening inflationary pressure. However, for annual
inflation rates to fall below 2% in the course of 2003 and for them to remain in line with our definition of
price stability thereafter, it is crucial that oil prices do not significantly increase again and that the
upward movement in labour cost indicators in the euro area, which has been taking place over recent
years, does not continue. These indicators have shown a notable inertia despite the subdued
economic expansion.
At the last meeting of the Governing Council of the ECB on 7 November, in view of the high
uncertainty on future economic growth and its implications for medium-term inflationary developments,
we discussed extensively the arguments for and against a cut in the key ECB interest rates. The
overall view was to keep interest rates unchanged. In the same statement, however, we also said that
we will monitor closely the downside risks to economic growth in the euro area, in view of their
potential dampening effect on inflationary pressures.
Let me now briefly turn to fiscal policies, an issue that is currently receiving particular attention in
Europe. Let me remind you that that the principle of budgetary discipline enshrined in the Treaty and
the Stability and Growth Pact establishes that Member States should maintain over the medium term
fiscal positions close to balance or in surplus and ensure that they do not breach at any time the
ceiling on the fiscal deficit of 3% of GDP. It is the Governing Council's view that these rules are
indispensable for Economic and Monetary Union and are also in the interest of the Member States.
The Stability and Growth Pact has been successful in promoting sound public finances in the euro
area. As a result, 8 of the 12 euro area countries have reached budget positions which are "close to
balance or in surplus", a development which has helped to support the maintenance of price stability
and growth in employment and real GDP. These 8 countries are now in a position to let the automatic
stabilisers work in full, as envisaged by the Pact.
The other 4 countries still have to make progress to achieve the medium-term requirements of the
Pact. These countries now need a credible consolidation policy that will be supportive to the outlook
for economic growth, as direct short-term effects on demand should be counteracted by a higher
credibility for the conduct of fiscal policy, boosting confidence and thus private spending. In this
regard, the full implementation of the Stability and Growth Pact is particularly important at the current
juncture.
In this same vein, the euro area should implement the reforms needed to reduce the structural
rigidities in its labour and goods markets. This would not only increase trend potential growth over the
medium term, but also make the euro area economy more resilient to economic shocks. Under the
current circumstances, rapid and decisive action would be a very important contribution to support
confidence in the euro area.
Thank you.