Opinion on Monetary Policy (94/C 393/32)

On 24 February 1994, the Economic and Social Committee decided, in accordance with Article 23, 3rd paragraph of the Rules of Procedure, to issue an Opinion on Monetary Policy.

The Section for Economic, Financial and Monetary Questions, which had been instructed to carry out the preparatory work, adopted its Opinion on 6 September 1994. The Rapporteur was Mr Meyer-Horn.

The Committee unanimously adopted the following Opinion at its 318th Plenary Session (meeting of 15 September).

SUMMARY

1. If economic policies are not now harnessed to launch an energetic, urgent assault on unemployment, the result may be a situation which leaves Economic and Monetary Union looking utopian. If the economic policy required by the recession is properly coordinated, it need not automatically run counter to convergence policies required for the preparation of EMU (point 1.5.1).

2. The convergence programmes must be adjusted to reflect the recession and be developed into convergence-and-recovery programmes. With mass unemployment and recession, greater efforts must be made to coordinate economic and monetary policy in the Community, to observe the common guidelines and to strengthen multilateral surveillance (point 1.5.2).

3. Initial joint monetary policy measures through the EMI would require it to carry out the tasks allocated to it successfully, i.e. strengthening cooperation between the national central banks and coordinating their monetary policies with the aim of promoting price stability (point 2.1.4).

4. The ESC refers to its suggestion that when the time is ripe, the national media should be enlisted in order to provide a comprehensive explanation of EMU, and in particular the replacement of national currencies by a single currency, the ecu, and to boost confidence in the new system (point 2.1.7.1).

5. Reports should be published by the EMI and its relevant working party to keep the public informed on the progress of the discussions on the design of the new ecu banknotes. Unlike format and paper quality, design is not something which can be decided behind closed doors (point 2.1.7.2).

6. The ESC believes that ecu banknotes should be identical in all the Member States. Each denomination could feature front and back a different national, but universally familiar, figure from science or the arts, or a national monument; in this way each Member State would be represented on at least one of the eight banknotes (e.g. 1, 2, 5, 10, 20, 50, 100 and 200 ECU (point 2.1.7.3).

7. The EMI should use its, albeit non-binding, opinions and recommendations frequently and at an early stage to contribute to closer cooperation between the central banks and the coordination of their monetary policies. The EMI will secure the credibility and public confidence it needs in its activities as a precursor of the European Central Bank by issuing well founded opinions and recommendations based on thorough analysis (point 2.2.3).

8. In parallel with closer cooperation between the central banks and coordination of monetary policy, the Member States' economic policies must also be more closely coordinated. The success of monetary policy will depend on the successful coordination of economic policies (point 3.1.1).

9. The ESC feels that the Monetary Committee can play an important role in coordinating economic and monetary policy by thrashing out differences of opinion between the ECOFIN Council and the EMI.

10. It is particularly important that the economic and social groups represented on the ESC be consulted on the issues of monetary stability, employment, investment and production costs, which are dealt with in the Annual Economic Report and the broad economic policy guidelines (point 3.2.2).

11. Regardless of the prevailing average inflation rate, the ESC would like to see the Council of the EMI specifically recommend an ambitious monetary policy stability target before the third stage, offering the prospect of a stable common currency within a monetary union (point 4.2.4).

12. The ESC considers the 'normal fluctuation margins' referred to in Article 109j(1) as a legal concept which does not yet need to be quantified. Retention of the 'temporarily' widened fluctuation margins eases speculative pressure on the ERM grid and makes it possible for exchange rate adjustments necessitated by different levels of convergence to be carried out without drama (points 4.3.5, 4.3.5.1).

13. In the context of exchange rate policy, a coordinated EMI initiative should be considered to bring derivatives within the scope of banking supervision. Bringing derivatives into the ambit of the Member States' banking supervision - if possible in concert with the OECD countries - would reduce the scale of speculative monetary movements on the foreign exchanges, or at least curb their growth (point 4.3.7).

14. The degree of integration achieved with the completion of the internal market also requires a certain approximation of monetary policy instruments, in particular with regard to financial and capital movements and the growing cross-border activities of credit institutions and insurance companies (point 4.5.2).

15. In the field of open market policy, the choice of money market paper, treasury bills, treasury bonds and other securities issued and purchased by the central banks in order to influence the liquidity of the banking system and to some extent that of the entire economy, needs to be brought into line rapidly (point 4.5.3).

16. The EMI should make proposals for a common definition of money supply (M1 or M2) and for its uniform statistical calculation. As the next step, the EMI could consider ways of achieving agreement between the central banks on attaching comparable weight to money supply targets in the second stage, and finally on a certain approximation of money supply targets or margins (point 4.5.5).

17. Approximation of monetary policy instruments and procedures presupposes preparation for a common monetary policy. Drawing up a plan acceptable by consensus during the second stage is an important task for the EMI (point 4.5.6).

MANDATE

The Economic and Social Committee decided to draw up an Initiative Opinion on Monetary Policy, as the ESC wished to express its views on the realization of Economic and Monetary Union, even though consultation of the Committee is not mandatory. Monetary policy is of great importance for the recovery and convergence of the Member States' economies, and thus for the transition to Economic and Monetary Union (EMU) scheduled for 1999 at the latest. Experience of institutionalized cooperation between central banks in the European Monetary Institute since early 1994, and progress on the preparations for a common monetary policy will be taken into account at the intergovernmental conference scheduled for 1996 and in any revision of the Maastricht Treaty on European Union.

1. Monetary policy during the second stage of EMU against the background of the recession

1.1. Monetary policy, whether during the second stage of EMU or thereafter, cannot be seen in isolation. It is not an objective in itself, but rather a component of economic policy - designed where possible to promote steady growth of national output, to create and safeguard jobs, and at the same time to prevent inflation. In the EU, economic policy is also geared to economic convergence [Art. 103(3) Treaty on European Union], eventually leading to economic and monetary union, without which the advantages of the internal market cannot be fully exploited.

1.2. Under Article 109j(4) of the version of the EEC Treaty adopted at Maastricht, the third stage of EMU is to begin on 1 January 1999, if no earlier deadline is set. At the starting date of the third stage, the Council will adopt the conversion rates at which the currencies will be fixed and at which rates they will shortly afterwards be replaced by the ECU [Article 109l(4)]. A mere four years before the 1999 deadline, however, public interest is focused on mass unemployment and the persistent recession, rather than on feverish preparations for monetary union. A Eurobarometer (40 - 12/93) opinion poll showed that for 67 % of respondents, unemployment was the major problem; inflation and exchange rate instability were considered the main problems by only 9 and 10 % respectively.

1.3. Even in 1991 during negotiations on the inter-governmental conference considerable doubt was expressed as to the feasibility of EMU. Would it be possible:

- on the one hand to transfer a future common monetary policy to an independent European central bank;

- and on the other, to leave economic and financial policy with the national governments, subject only to coordination in the ECOFIN Council in accordance with common guidelines and without a joint economic and financial policy adopted by some form of 'European government'?

1.4. The most severe recession of the second half of this century and (partly structural) mass unemployment have given rise to new doubts about the EMU decided at Maastricht:

1.4.1. Is there not a contradiction between a) the economic and financial policy needed to cope with 17 million unemployed and b) that dictated by convergence in preparation for EMU?

1.4.2. Does the reaction () to the Commission's White Paper () on Growth, Competitiveness and Employment not show how differently these challenges are assessed, e.g. in relation to the investment of ca. ECU 400 bn. in trans-European transport, telecommunications and energy networks in the period to 1999?

1.4.3. Can twelve, and perhaps soon sixteen, Member States regularly reach consensus on the coordination of their economic policies? Can such a consensus be expected after the experience with the first broad economic policy guidelines recommendation of December 1993 (), and in particular the Commission's recommendation that the Community should aim to create 15 million jobs by 2000 and thus to halve the present rate of unemployment (1994: 12 %)?

1.4.4. Does the prospect of a European Council Decision (under Articles 109g and h of the EEC Treaty) to establish EMU with only half the Member States not threaten to split the Community? Do the convergence requirements of the second stage not already expect too much of Member States with relatively low incomes? Are the resources to be made available from the Structural and Cohesion Funds a suitable way of bolstering efforts by these countries to make progress on real as well as nominal convergence?

1.4.5. In view of these doubts should the deadline for EMU not be postponed and the convergence criteria relaxed to reflect the deterioration in economic circumstances?

1.5. The doubts expressed in point 1.4. have prompted the ESC to supplement its October 1993 Opinion () on policies to be pursued in the Community during the transitional stage of EMU with this Opinion on monetary policy. The ESC asked how, against the background of the recession, monetary policy could be coordinated and an EMU with a single currency be prepared; it came to the following conclusion.

1.5.1. If economic policies are not now harnessed to launch an energetic and urgent assault on unemployment, the result may be a situation which leaves Economic and Monetary Union looking utopian. If the economic policy required by the recession is properly coordinated, it need not automatically run counter to convergence policies required for the preparation of EMU.

1.5.2. The convergence programmes must be adjusted to reflect the recession and be developed into convergence-and-recovery programmes. With mass unemployment and recession, greater efforts must be made to coordinate economic and monetary policy in the Community, to observe the common guidelines and to strengthen multilateral surveillance. A new recommendation on broad economic policy guidelines (see point 1.4.3) could place more emphasis on active support of economic growth, without however neglecting the medium-term objectives of convergence policy (). With the Internal Market and freedom of capital movements largely in place, economic interdependence and interpenetration is so great that any Member State which goes it alone on economic and monetary policy hurts both itself and its neighbours.

1.5.3. For the ESC, merely softening the convergence criteria is no solution. An adjustment of this kind is not even necessary as the convergence criteria are to some extent relative, i.e. related to the Member States with the best relative performance [Article 109j(1)] or open to interpretation [Article 104c(2)]. Moreover, GDP must also be calculated in a uniform and reliable manner; taking account of the black economy poses problems. It has been demonstrated that the recalculation of GDP, Portugal's for instance, would enable the government debt/GDP criterion to be met. Closer cooperation on statistics is therefore particularly important ().

1.5.4. Adjustment of the convergence criteria would also have the twofold disadvantage that:

- confidence in the feasibility of EMU, already diminished, would be further undermined, and

- efforts to achieve convergence would be relaxed.

1.5.5. In some countries, the budget convergence criteria can in the present recession only be given medium-term priority. In a recession, the budgetary criteria should not trigger or even be used as a pretext for, economic measures which are likely to exacerbate the crisis even further. An excessively tight interpretation of the budget policy criteria could reduce the scope for cyclical fine tuning and would reinforce the cyclical downturn rather than counter it. On the other hand, the unavoidable new borrowing required to finance extraordinary expenditure should be limited because of the already considerable burden imposed by debt servicing on the budgets of some Member States. It should be borne in mind, however, that gradual reduction of budget deficits and government debt would place a heavy burden on these Member States in the run-up to EMU (see point 3.1.4).

1.5.6. The convergence criteria are important mainly because they have been, and are, interpreted as a quality standard for the future monetary union, a guarantee of monetary stability, which the Maastricht Treaty makes the main plank of the European Central Bank's monetary policy. Most Member States endorsed the Maastricht Treaty because of this confidence in the stability of a European currency (see point 4.2.4). The ESC shares the view () that the Member States' policy and behaviour up to 1996 should be consistent with the objective of an inflation rate of no more than 2 to 3 %. Lack of such coherence would constitute a major macroeconomic obstacle to growth, overload monetary policy and make it necessary to pursue the stability objective by means of high interest rates.

2. The institutional framework of monetary policy

2.1.

Role and responsibilities of the EMI

2.1.1. The EU Treaty does not give the EMI any monetary policy responsibilities of its own, correctly the ESC feels, as there would otherwise be conflicts of interest in view of the fact that, during the second stage, responsibility for monetary policy will continue to rest exclusively with the central banks. The possibility of the central banks coordinating their monetary policy to a limited extent via the EMI towards the end of the second stage should be considered however. Intervention on foreign exchange markets and common money supply targets would be possible areas for joint action.

2.1.2. Foreign exchange market intervention by the EMI would however require the national central banks to transfer some of their foreign exchange reserves to the EMI and the Central Banks to agree in the EMI Council on a common exchange rate policy. This would, however, be difficult because of the possible need for further parity adjustments in the event of different rates of progress on convergence and in view of the varying extent to which Member States have used the wider (ERM) fluctuation band of 15 % either side of the parity, introduced on 2 August 1993.

2.1.3. The establishment of common money supply targets by the EMI could be considered by the central banks as an additional, non-binding guideline. But the money supply is defined and calculated differently from one Member State to another. The central banks of the Member States do not all attach the same importance to the money supply as a component of monetary policy. The monetary policy of some central banks is aimed, rather, primarily at the exchange rate and/or interest rates. In some countries, money supply targets are even regarded as an obsolete criterion. In others control of government debt is considered to be of particular importance for monetary policy.

2.1.4. The initial joint monetary policy measures through the EMI would require it to carry out the tasks allocated to it () successfully, i.e. strengthening cooperation between the national central banks and coordinating their monetary policies with the aim of promoting price stability and taking over the tasks of the European Monetary Cooperation Fund (EMCF) and monitoring the functioning of the EMS.

2.1.5. The EMI also has statutory responsibility for preparing the third stage of EMU, in particular: promoting the efficiency of cross-border payments (), drafting the rules for operations to be undertaken by the national central banks in the framework of the future European system of central banks (ESCB) and promoting cooperation on statistics () in areas within its field of competence. The ESC feels that the EMI should also promote cooperation on banking supervision, which is partly the responsibility of the central banks themselves and partly that of independent supervisory authorities, to some extent separately from credit insurance and the securities markets. With regard to cooperation on banking supervision, common initiatives should in particular be looked at to bring derivatives transactions within the scope of supervision (see point 4.2.7).

2.1.6. The ESC sees the EMI's two most important tasks as the coordination of the monetary policies of the participating central banks (see point 2.2) and the preparation of the instruments and procedures needed for carrying out a single monetary policy (see point 4.5).

2.1.7. The ESC feels that the EMI should provide the public with timely, comprehensive and comprehensible information on two of its other statutory responsibilities:

- supervising the technical preparation (design, denominations) for the issue of approx. ECU 15 billion banknotes and 100 billion coins, and

- facilitating the use of the ECU.

2.1.7.1. The ESC refers to its suggestion () that when the time is ripe, the national media should be enlisted in order to provide a comprehensive explanation of EMU, and in particular the replacement of national currencies by a single currency, the ecu, and to boost confidence in the new system. The introduction of the ecu as a currency will mean an unprecedented adjustment to a completely new structure of prices and incomes in all the participating Member States; expressed in national currencies one ecu will be equivalent to an amount ranging from four places before the decimal point to four places after the point; in no case will the conversion rate be a round figure.

2.1.7.2. Reports should be published by the EMI and its competent working party to keep the public informed on the progress of the discussions on the design of the new ecu banknotes. Unlike format and paper quality, design is not something which can be decided behind closed doors.

2.1.7.3. The ESC believes that ecu banknotes should be identical in all the Member States. Each denomination could feature front and back a different national, but universally familiar, figure from science or the arts, or a national monument; in this way each Member State would be represented on at least one of the eight banknotes (e.g. 1, 2, 5, 10, 20, 50, 100 and 200 ECU). This approach would reflect Europe's common cultural heritage. The appearance of the ecu banknotes must not remain a secret until 1999, however.

2.2.

Coordination

2.2.1. The ESC expects monetary policy cooperation to be stepped up between the national central banks within the institutional framework of the EMI, i.e. over and beyond the cooperation which already took place in the EC Committee of Central Bank Governors. Without step-by-step closer cooperation in the second stage, it is difficult to imagine that a European Central Bank would be able to operate a single monetary policy from the beginning of the third stage.

2.2.2. The practical coordination of monetary policy is even more important than its legal framework. Coordination will of course be made more difficult by the fact that:

- the central banks will guard their monetary policy responsibility and independence jealously until the end of the second stage;

- it is impossible to imagine an overnight transition to a common monetary policy under the aegis ECB.

The central banks ought therefore to confer as frequently as possible, and certainly before all major decisions. The EMI is the appropriate forum for this. In addition to these, generally informal, coordination meetings, the central bank governors should meet regularly, perhaps every two weeks, for a session of the EMI Council. This is essential if the central bank governors are to be able to assume responsibility for a common European monetary policy at the beginning of the third stage, in their capacity as members of the ECB Council. Successful coordination of monetary policy, which in the second stage will still be nationally based, will depend on the willingness of the central banks to be guided increasingly by Community objectives, in particular with regard to price stability.

2.2.3. The EMI should use its, albeit non-binding, opinions and recommendations frequently and at an early stage to contribute to closer cooperation between the central banks and the coordination of their monetary policies. Opinions and recommendations are adopted by the EMI Council by a two-thirds majority. Unanimity is required for the publication of opinions and recommendations. The ESC feels that such opinions and recommendations, if not published, should at least be commented on by the EMI Chairman. The EMI will secure the credibility and public confidence it needs in its activities as a precursor of the European Central Bank by issuing well founded opinions and recommendations () based on thorough analysis.

2.2.4. The ESC welcomes the arrangement whereby the President of the ECOFIN Council and a member of the Commission may attend the meetings of the EMI Council, and under which the Chairman of the EMI will be invited to meetings of the ECOFIN Council when it discusses matters falling within the EMI's area of responsibility. This reciprocal participation, provided for in Article 11 of the EMI statute, would appear appropriate.

3. The relationship between monetary policy and economic policy coordination

3.1.

Recommended economic policy guidelines

3.1.1. In parallel with closer cooperation between the central banks and coordination of monetary policy, the Member States's economic policies must also be more closely coordinated. The success of monetary policy will depend on the successful coordination of economic policies. The central banks' monetary policy will be overloaded and coordination of policy in the EMI hampered if monetary policy is expected to remedy the mistakes and shortcomings of economic policy in general and budgetary policy in particular. On the other hand, reducing budget deficits and government debt in line with the budgetary policy convergence criteria will facilitate monetary policy, as it will lay the foundations for a further reduction of the inflation rate and for lower interest rates, thus fulfilling two other convergence criteria.

3.1.2. On 22 December 1993 the ECOFIN Council adopted, in the form of a recommendation, the broad guidelines of economic policies as defined in Article 103(2) of the EU Treaty. These broad guidelines will serve to gear national economic policies towards Community objectives. One of these is achieving sufficient convergence between the economies for the transition to the third stage.

3.1.3. The ESC welcomes the fact that the guidelines are from now on to be reviewed and adjusted in mid-year, before the budget for the following year is adopted. The guidelines of 22 December 1993 include important measures from the White Paper (growth, competitiveness and employment) submitted by the Commission to the European Council on 10 December 1993 ().

3.1.4. The economic policy guidelines of 22 December 1993 (), which were reaffirmed by the ECOFIN Council on 11 July 1994, include efforts held by the Member States to prevent any further deterioration in their budgetary situations in 1994 and to achieve budget consolidation. In 1995 they are required to pursue action to make their public finance positions sustainable again. The ESC welcomes these recommendations. It points out however that some Member States will need more time than others to consolidate their budgets. They may not be able to fulfil the 22 December 1993 conditions until after 1996.

3.2.

Multilateral surveillance and the convergence programmes

3.2.1. The coordination of economic policy, compliance with the guidelines referred to in point 3.1.2 by the various Member States and the implementation of their convergence programmes are all to be the subject of multilateral surveillance (). Apart from the initial economic policy guidelines, the ESC feels that two innovations in the second stage will improve multilateral surveillance:

3.2.1.1. The ECOFIN Council, acting by qualified majority, may decide to make public its recommendations to individual Member States in connection with multilateral surveillance [Art. 103(4) EU Treaty].

3.2.1.2. On a proposal from the Commission, the ECOFIN Council may adapt the multilateral surveillance procedures to the requirements of economic policy coordination [Art. 103(5)].

3.2.2. The ESC has already commented on the new procedure provided for in Article 103 of the EEC Treaty in its Opinion on the 1994 Annual Economic Report (). The ESC regrets that the old consultation requirement has been dropped. It is particularly important that the economic and social groups represented in the ESC be consulted on the issues of monetary stability, employment, investment and production costs, which are dealt with in the Annual Economic Report, the country reports it produces and the broad economic policy guidelines.

3.2.3. In accordance with the decision of the ECOFIN Council of 8 July 1991, most governments drew up convergence programmes at the beginning of the second stage. The convergence programmes list the measures whereby the Member States hope eventually to be able to meet the convergence criteria for transition to the third stage. The ESC considers that the convergence programme must be adjusted to reflect economic conditions and be developed into convergence and recovery programmes (). The ECOFIN Council assesses the convergence programmes submitted to it in restricted session. Only a summary of the results of the discussions is made public. The ESC regrets this.

3.2.4. The ESC considers that national convergence and recovery programmes should not be drawn up in isolation, but rather on a coordinated basis. Cooperation between Germany and France on drawing up their respective programmes is an initiative to be welcomed. In this way the possible repercussions of national measures on other Member States can be better assessed and taken into account in the convergence programmes, whose timescales should as far as possible be coordinated.

3.2.5. All the convergence programmes () require deficits to be reduced in the medium term and the reference value of 3 % of GDP to be achieved by 1996. Government debt, which rose from an EC average of 58 % in 1991 to 66.4 % in 1993, is first to be stabilized, and then reduced. The ESC welcomes these ambitious objectives, but wonders whether the political will exists everywhere actually to put the convergence programmes into effect; this would certainly be desirable.

3.2.6. The ESC feels that the procedure for pursuing convergence programmes after the beginning of the third stage should be decided now. In so doing, thought should be given a) to the continuation of the convergence programmes for those Member States not participating in the currency union from the beginning and b) their coordination with the countries forming the ecu zone. This would make it easier for the first group of Member States to join the ecu zone at an early stage.

3.2.7. Under Article 104c(6) the ECOFIN Council decides whether an excessive deficit exists and makes recommendations to the Member State concerned with a view to bringing that situation to an end within a given period. If no effective action is taken, the recommendations may be made public. The ESC expects that the excessive deficit procedure will be invoked only where an overshoot of the reference value is not purely a result of the recession and mass unemployment. On the other hand, compliance with the prohibition on deficit financing by central banks and on privileged access for the public sector to financial institutions should be enforced.

3.2.8. Because of the scale of the recession most Member States will not be immediately able to meet both budgetary convergence criteria (). In 1993 eleven Member States exceeded the deficit criterion and seven the debt criterion; only Luxembourg fulfilled both criteria.

3.2.9. The budgetary problems of most Member States make it more difficult to pursue a monetary policy aimed at price stability. This in turn adversely affects the relationship between the central banks working together in the EMI, and in particular between the central banks which are already independent on the one hand, and the economics and finance ministers meeting in the ECOFIN Council on the other.

3.2.10. The ESC feels that the EU's Monetary Committee (established under Article 109c) could play an important role here, as its membership includes senior representatives of the central banks, the finance ministries and the Commission. Differences between the ECOFIN Council and the EMI on economic and monetary policy and their coordination could be thrashed out and eliminated at the Monetary Committee stage. The ESC feels that the Monetary Committee holds the key to the desired progress on coordination, both of economic policy and monetary policy. If no consensus is achieved in the Monetary Committee neither the ECOFIN Council nor the EMI Council will be able to work for coordination where obstacles exist.

3.2.11. In its Maastricht Declaration () the Community affirms its intention of contributing to stable international monetary relations. To this end the Community is prepared to cooperate with countries with which it has close economic ties. Under the Agreement (Article 46) on the European Economic Area (EEA), the EU intends to discuss common problems of economic and monetary policy with its EEA partners. The ESC is pleased to note that the meetings initiated in April 1993 are in future to be held twice a year.

4. Major areas of monetary policy cooperation

4.1.

The EU, the G7 and the OECD

4.1.1. The major areas of cooperation between the central banks in the EMI include securing price stability, EMS exchange rate policy, interest rate policy and the approximation of monetary policy instruments and procedures.

4.1.2. Monetary policy cooperation in the EMI must also take account of economic trends in the main industrialized countries, the Group of Seven and the OECD, with which most EU countries have close trading relations. In particular, the reaction to trends in the exchange rates of the US dollar and the yen must be as far as possible coordinated.

4.1.3. It would facilitate the EU's monetary policy if the USA were, in the framework of its otherwise highly successful economic policy, to make efforts to cut its budget deficit and if the Federal Reserve Bank were not to raise its discount rate any further. The Congressional Budget Office (CBO) has estimated that US government debt is rising faster than national income. Government debt is forecast to more than double as a proportion of GDP within a generation. This far-reaching projection is based on the fact that over half of government spending is currently required by law, i.e. social security, and in particular pensions and medical cover, and that demographic trends will cause this spending to continue to rise. The USA faces similar problems to some EU Member States; i.e. it must attempt to curb its budget deficit rather than simply raising interest rates. Because of the dollar's importance for payments in international trade, for the currency markets and for central banks' reserves, the US budget deficit and interest rate adjustments have a direct impact on the monetary policy environment for the EU and its Member States. A successful US budget policy would thus benefit the monetary policy of the EU and its Member States.

4.2.

Price stability

4.2.1. The primary objective of monetary policy [under Art. 105(1)] is the maintenance of price stability. Monetary policy will also support general economic policies in the EU, without prejudice to the objective of price stability.

4.2.2. In 1993 the average inflation rate in the EU was 3.8 %. The four countries with the lowest inflation rates were Denmark with 1.4 %, the Netherlands with 2.1 %, and France and Ireland each with 2.3 %. Under the convergence criterion, the inflation rate in the other Member States should not have been more than 1.5 % higher. In fact, five Member States had an inflation rate above 3.8 % (), including Germany with 4.3 %, Italy with 4.4 % and Spain with 4.7 %.

4.2.3. In its broad economic policy guidelines the Community sets itself the objective () of achieving an annual inflation rate not higher than 2-3 % in most of the Member States by 1996. All economic policy and behaviour should be consistent with this objective.

4.2.4. The Commission believes () that an inflation rate not higher than 2-3 % is in keeping with a monetary policy stability target which is not usually spelt out explicitly. This seems realistic as an initial objective. The ESC believes that an average Community inflation rate of 2-3 % can be achieved as early as 1995, although admittedly more as a result of the recession than of the central banks' monetary policies. This is not entirely satisfactory from the saver's point of view. The ESC would like to see the Council of the EMI, regardless of the then prevailing average inflation rate, specifically recommend an ambitious monetary policy stability target for the ECU before the third stage, offering the prospect of a stable common currency within a monetary union.

4.3.

Exchange rate policy

4.3.1. The Council Recommendation of 22 December 1993 stated that the high degree of integration and the reaping of the benefits of the internal market demanded that the Community continue to aim for exchange rate stability built on common efforts to make progress on convergence ().

4.3.2. The Commission has established () that the Member States have not made use of the greater potential to differentiate their monetary stance offered by the temporary widening since 2 August 1993 of the EMS exchange rate mechanism's fluctuation bands to 15 % either side of the parity. Instead, after some major rate adjustments in the wake of the foreign exchange market turbulence of July 1993, they have maintained their commitment to monetary policy cooperation based on stable exchange rates and have pursued a 'cautious' interest rate policy. As a result, since the beginning of 1994, exchange rate movements have in effect been limited () to a fluctuation margin of less than 4.5 %.

4.3.3. In its Opinion of 24 November 1993 (), the ESC argued that the central banks should, through the EMI, continuously monitor the extent to which the wider fluctuation bands are actually being used. On this basis the ESC felt that a timescale for gradual coordinated narrowing could be considered.

4.3.4. The ESC welcomes the Commission's assessment contained in its convergence report, submitted in accordance with Article 109(1)(2)b (). The text reads as follows: 'Any effort to re-establish narrow bands without improved economic convergence among Member States would almost certainly not be accepted by the financial markets and would incite renewed speculative attacks on the ERM grid. The experience of the recent crises has demonstrated that a necessary condition for exchange-rate stability is achieved by the pursuit of credible and consistent economic policies designed to foster economic convergence in conditions of economic growth, while focusing on the fundamentals of price stability and sound public finances.'

4.3.5. Art. 109j(1) of the EU Treaty states as a third convergence criterion: 'the observance of the normal fluctuation margins provided for by the Exchange Rate Mechanism of the European Monetary System, for at least two years, without devaluing against the currency of any other Member State.' The EMI should perhaps decide what is to be considered as 'normal' with a view to the third stage of EMU following the 'temporary' widening of the fluctuation margins on 2 August 1993. In this connection, the view () that the reintroduction of a general, narrow fluctuation band is no longer an absolute precondition for transition to the third stage of EMU, is particularly striking. The ESC considers the 'normal fluctuation margins' referred to in Article 109j(1) as a concept which need not yet be quantified.

4.3.5.1. Retention of the 'temporarily' widened fluctuation margins reduces speculative pressure on the ERM grid and makes it possible for exchange rate adjustments necessitated by divergent progress on convergence to be carried out without drama (). The general retention of the 'temporarily' widened margins does not prevent individual central banks agreeing among themselves on narrower fluctuation margins for their currencies, as has already been done in the case of the German mark and the Dutch guilder.

4.3.5.2. The retention of the wider margins would also make it easier for the Italian lira and pound sterling to rejoin the ERM, and for the Greek drachma finally to join, the ERM. The EMI can play a constructive role here through its recommendations and opinions, and through proposals for improved application of the EMS rules capable of commanding consensus support. In the framework of the EMI a general lesson can be learnt from the EMS crises, namely that the EMS should again be regarded as a system of fixed, but adjustable exchange rates.

4.3.6. A once again fully operational EMS exchange rate mechanism would not only facilitate transition to the third stage of EMU, but would also prevent the damaging effects of parity changes on common farm prices.

4.3.7. In the context of exchange rate policy, a coordinated EMI initiative should be considered to bring derivatives within the scope of banking supervision. The banks' off-balance-sheet transactions in futures, options and swaps often exceed their balance sheet totals. And yet prudential controls such as solvency or liquidity ratios do not as yet extend to derivatives transactions. Bringing derivatives under the Member States' banking supervision - if possible in concert with the OECD countries - would reduce the volume of speculative monetary movements on the foreign exchanges, or at least curb their growth.

4.3.8. For the reasons set out above, the coordination of exchange-rate policy in the EMI is one of the main tasks for monetary policy. This task will be facilitated if:

- the signs of recovery of economic growth are confirmed,

- in particular, unemployment can be reduced; (here the Commission's White Paper has proposed important measures for the creation of fifteen million new jobs), and

- in general, further progress is made on price stability, as is already suggested by the fall in the average Community inflation rate from 5.3 % in 1991 to 3.8 % in 1993.

4.3.9. Under these conditions the EMI can afford to be less concerned about possible unilateral national monetary policy action and look forward with greater confidence to generally more stable exchange rate relationships.

4.4.

Interest rate policy

4.4.1. The Commission () rightly notes progress on convergence of long-term interest rates. Between 1990 and 1993 average long-term interest rates in the Community fell from 11.0 % to 8.1 % and the reference band from 11-13 % to 8.7-10.9 %. The fall in interest rates was accompanied by an improvement in convergence: in 1993 only two countries were above the reference band, as against four in 1990; seven countries were below the reference band, compared with five in 1990. The interest rate spread has thus narrowed.

4.4.2. Measuring convergence on interest rate policy is made more difficult by the fact that reported interest rates are determined differently. The Commission's draft Regulation on Community action in the field of statistics will improve matters. The ESC welcomes this in its Opinion ().

4.4.3. These cautious interest rate cuts demonstrate two things:

- that progress towards lower inflation has created a sounder basis for cuts in short- and long-term interest rates;

- that the scope for differentiated monetary policy created by the widening of the EMS fluctuation margins has not led to precipitous interest rate cuts.

One may therefore hope and expect that closer monetary policy cooperation in the EMI will lead to further interest rate convergence.

4.4.4. The respective importance of short and long-term interest rates varies from one economy to another. This is explained by the varying approaches to financing the banking system, the use of debt finance by the public sector and the open market policies of the central banks. One much quoted example is the different approach to financing home ownership/building in Great Britain and Germany. The predominance of short-term finance in Britain has a greater impact on short-term interest rates there than in Germany, where housing loans are made at long-term interest rates, financed mainly by the issue of special long-term debt instruments ('Pfandbriefe'). Closer cooperation between central banks on interest rate policy is hampered by differences of this kind (See point 4.5.3).

4.5.

Monetary policy instruments

4.5.1. The EMI must as a matter of priority work for approximation of monetary policy instruments and procedures. The monetary policy of the central banks places differing emphasis on the classical instruments of discount, open market and minimum reserve policy. Moreover, these instruments and procedures differ from one country to another.

4.5.2. Step-by-step approximation is necessary not only in preparation for the single monetary policy to be adopted with the beginning of the third stage of EMU. The degree of integration achieved with the completion of the internal market also makes a certain approximation of monetary policy instruments necessary, in particular with regard to financial and capital movements and the growing cross-border activities of credit institutions and insurance companies.

4.5.3. In the field of open market policy, the range of money market paper, treasury bills, treasury bonds and other securities issued and purchased by the central banks in order to influence the liquidity of the banking system, and to some extent that of the whole economy, needs to be brought into line rapidly. A gradual approximation of the maturities of central bank open market liabilities and of securities taken on deposit and lent on by the central banks is of great importance. This would lessen the remaining differences in the impact of interest rate policy based on the discount rate from one country to another. This disparity is clearly illustrated by the different impact of discount rate adjustments in Great Britain and in Germany (see point 4.4.4):

- in Great Britain the short-term interest rate has an immediate impact on credit which is mostly financed short term;

- in Germany a higher proportion of loans are refinanced longer term by the issue of mortgage bonds (Pfandbriefe), municipal or bank bonds and other securities with maturities of ten years or more. The short-term interest rate, and discount rate adjustments by the Bundesbank, thus do not have the same impact as in Great Britain.

4.5.4. For the purposes of the interest-rate and open-market policy of a European central bank, intended to apply evenly throughout the Community, it would be a good thing to have convergence in the use of these monetary policy instruments during the second stage. This is also true of the central banks' minimum reserve policies. In its Opinion of 24 March 1993 () the ESC compared the different extent to which credit institutions are affected by the requirement to maintain (generally interest-free) minimum reserves with the central bank and by compulsory investment in securities. These differences, now less pronounced, lead to distortions of competition in the financial sector and to transfers of banking activity to countries with lower minimum reserve requirements, or none at all. The requirement still imposed by central banks on credit institutions in some Member States to buy government securities continues to affect competition in cross-border banking. Such a requirement is also in contravention of the ban on the financing of public-sector deficits via the central banks.

4.5.5. In addition to the monetary policy instruments and procedures, the parameters also need to be approximated. The main benchmark in most Member States is money supply trends. But this is differently calculated and defined, e.g. with regard to the inclusion of savings accounts and term deposits. The EMI should therefore make proposals for a common definition of money supply (M1 or M2) and for its uniform statistical calculation ()(). As the next step, the EMI could consider ways of achieving agreement between the central banks on attaching comparable weight to money supply targets in the second stage, and finally on a certain approximation of money supply targets or margins (see point 2.1.3).

4.5.6. Approximation of monetary policy instruments and procedures presupposes preparation for a single monetary policy. Drawing up a plan acceptable by consensus during the second stage is an important task for the EMI.

Done at Brussels, 14 September 1994.

The President

of the Economic and Social Committee

Susanne TIEMANN

() Cf. the ESC's Opinion on the economic, social and industrial aspects of the White Paper: OJ No C 295, 22. 10. 1994.

() Cf. COM(93) 700 final, 5. 12. 1993.

() See Commission Framework of 10. 11. 1993, Commission Recommendation of 24. 11. 1993, Council Recommendation of 22. 12. 1993, based on the Conclusions of the European Council of 10/11. 12. 1993, in European Economy 55/94.

() ESC Opinion, OJ No C 352, 31. 12. 1993, pp. 3-8.

() OJ No C 295, 22. 10. 1994.

() See ESC Opinion of 27. 4. 1994, OJ No C 195, 18. 7. 1994, p. 1.

() European Economy 55/93, foreword, paragraph 6.

() See Protocol 4 annexed to the EU Treaty, Articles 4, 5 and 7.

() See ESC Opinion of 6. 7. 1994 (CES 854/94).

() See ESC Opinion of 27. 4. 1994, OJ No C 195, 18. 7. 1994, p. 1.

() See ESC Opinion, O.J. No C 34, 2. 2. 1994, pp. 25-35.

() See Hearing of EMI Chairman Lamfalussy by the European Parliament on 10. 11. 1993.

() The ESC has adopted Opinions on the subject - see footnote 1.

() European Economy 55/1993, Part A, I, Point 2.2 and No 58/1994.

() Decision 90/141 EEC, OJ No L 78, 24. 3. 1990.

() ESC Opinion of 27. 4. 1994, OJ No C 195, 18. 7. 1994, pp. 44-52, point 6.

() See Opinion on policy during the transitional stage of EMU (OJ No C 352, 30. 12. 1994, pp. 3-8, points 1.1.2 and 2.2.2.1).

() European Economy 55/1993, Part B, I, Point 2.2.2 and tables 3 and 7.

() Under Article 104(c)(2)(a) budget deficits may not exceed 3 % of GDP. Under Article 104(c)(2)(b) government debt may not exceed 60 % of GDP.

() Fifth Declaration appended to the Final Act of the EU Treaty.

() European Economy, No 55/1993: Broad economic policy guidelines and convergence report, Part B, table 1.

() European Economy, No 55/1993, part A, I and II, point 2.1 and No 58/94.

() European Economy, No 55/1993, part A, III, point 2.1.

() European Economy, part A, I, point 2.1.

() European Economy No 55/1993, part A, III, point 2.1.

() European Economy No 55/1993, part B, I, point 2.2.5 and table 53.

() OJ No C 34, 2. 2. 1994, pp. 23-25, point 1.4.10.

() European Economy No 55/1993, part B, I, point 2.2.5, p. 7.

() Financial Times, 27. 10. 1993.

() See ESC Opinion of 24. 11. 1993, OJ No C 34, 2. 2. 1994, pp. 25-35, point 1.3.2.2.

() European Economy No 55/1993, part B, I, point 2.2.4 and table 9.

() See ESC Opinion of 27. 4. 1994 on COM(94) 78 final of 10. 3. 1994, OJ No C 195, 18. 7. 1994, p. 1.

() See OJ No C 129, 10. 5. 1994, pp. 10-17.

() See ESC Opinion on COM(94) 78 final of 10. 3. 1994, OJ No C 195, 18. 7. 1994, p. 1.