Opinion of the Economic and Social Committee on the 'Commission staff working paper entitled "External Aspects of Economic and Monetary Union"'
Date: 1998-03-26
Institutions: European Economic and Social Committee
Subjects: Economic and Monetary Union, euro, exchange rate, financial policy

25.5.98

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Official Journal of the European Communities

C 157/65

Opinion of the Economic and Social Committee on the ‘Commission staff working paper
entitled “External Aspects of Economic and Monetary Union”’

(98/C 157/16)

On 13 May 1997 the Commission decided to consult the Economic and Social Committee,
under Article 198 of the Treaty establishing the European Community, on the ‘Commission
staff working paper entitled “External Aspects of Economic and Monetary Union”’.

The Section for Economic, Financial and Monetary Questions, which was responsible for
preparing the Committee’s work on the subject, adopted its opinion on 10 March 1998. The
rapporteur was Mr Robert Pelletier.

At its 353rd plenary session of 25 and 26 March 1998 (meeting of 26 March) the Economic
and Social Committee adopted the following opinion by 63 votes to 19 with 19 abstentions.

1.

Introduction

1.1.
The Commission working paper published
in April 1997, which is the result of a long process of
analysis and consultation, sets out the Commission’s
first thoughts on the future role and position of the euro
in the international monetary system.

1.2.
The Commission is to be congratulated on its
synthesis of highly complex problems concerning the
relationship between the economic and monetary union
and the rest of the world.

1.3.
The Commission analyses the international
consequences of the transition to the euro. It looks in
succession at the economic weight of the euro area in
the world economy, transitional issues, economic policy
and the exchange rate of the euro, and finally Europe’s
place as an international partner.

1.4. On a number of points the Commission does
not put forward proposals, but outlines the problems
without expressing a view. Thus it has opened a debate
which will be fundamental to monetary equilibrium in
the world, as the euro is destined to play a decisive
international role alongside the dollar.

1.5.
The efforts made by the Commission to promote
the euro, should probably be backed up by more detailed
technical analysis in order to respond to the problems
identified by the United Nations Economic Com-
mission (1), the International Monetary Fund (2), the
OECD and various well known EU economic research
and forecasting institutes (3); these the Commission

(1) Economic Survey of Europe in 1996-1997 — United Nations

— New York and Geneva — 1997.

(2) World Economic Outlook — May 1997 — IMF (a survey

by the staff of the IMF).

(3) In order to avoid polemics, observations made by national
institutions have not been mentioned in this document. It
should be pointed out however that as a rule these
comments coincide to a great extent with those of the
international institutions.

omits to mention, or refers to only in passing as
participants in an increasingly lively debate in inter-
national bodies.

2. Preamble

The Committee has already commented on the
2.1.
economic and monetary problems associated with the
single currency, for example in its October 1995 Opinion
on the Green Paper on the practical arrangements for
the introduction of the single currency (4). At the time
the Committee pointed out that there was a specific duty
— both for the ESC and the Community authorities — to
look at the situation realistically. This draft opinion is
based on the same principle, and its purpose is essentially
to bring the Economic and Social Committee into the
debate, without calling into question its support for the
introduction of the single currency. At this stage the
intention is to raise questions and pinpoint problems
rather than to propose solutions.

3. General Comments

3.1.
Section A of the Commission document, which
sets out the main economic indicators for assessing
the weight of the euro area in the world economy,
particularly relative to that of the United States and
Japan, clearly shows that this new area will, if it extends
to all the Member States, have an economic and
commercial weight comparable to that of the United
States. Moreover, economic and monetary union will
very quickly create one of the largest government bond
markets in the world.

3.2. However, at this stage of monetary union it is
necessary to place in its proper perspective the compari-
son between 1) the European Union, with its marked
differences from one Member State to another in

(4) OJ C 18, 22.1.1996.

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economic structure (GDP varies on a scale of 1 to 4) and
in the fundamental rules governing the operation of
the Member States’ economies (state intervention, tax
system etc.) and social relationships, and 2) the United
States or Japan, which benefit from a higher degree of
homogeneity throughout their territory despite signifi-
cant regional differences.

3.3.
Assessments of the place of the euro area in the
world economy relative to that of the United States or
Japan provide a frame of reference for public opinion.
They are however, technically speaking, built on flimsy
foundations, as they simplify complex international
relationships and the relative weight of competing
economies.

3.4.
Although the Commission’s approach to defining
the euro area is understandable (the Economic and
Social Committee fully subscribes to its desire to see the
current fifteen Member States participate in economic
and monetary union), assuming that the euro area
comprises the entire European Union ‘so as to avoid any
presumptions concerning the size of initial participation
does not make forecasting any easier’ (1). An analysis in
the form of a variable scenario would have been more
appropriate.

3.5.
And yet we already know that four EU Member
States will not be joining monetary union in 1999, either
because they do not wish to join at present or because
they cannot fulfil the economic and monetary criteria
laid down in the Maastricht Treaty. This uncertainty
as to the number of ‘ins’ limits the impact of the
Commission’s working paper. Even if we accept that
the Member States outside the euro area will be highly
dependent on the single currency area by virtue of the
rules to which they will be subject and the area’s
influence, it is not true that all fifteen Member States
will be conducting a single policy in these areas.

3.6.
It is difficult to be sure even if the possibility
exists, that tensions between the European currencies
will disappear. However, if there is complete conver-
gence, as in the case of Denmark, or if convergence
efforts are made in a credible manner, as in the case of
Greece, or if there is the political will to join the euro
bloc at an early opportunity, for which there are ever
clearer indications, for example in the United Kingdom,
there will be little room for tensions and arbitrage. The
existence of ‘in’ and ‘out’ currencies will leave the
foreign exchange markets almost daily opportunities for
arbitrage (2).

3.7. Euro financial market

The Commission rightly stresses the new
3.7.1.
dimensions of the financial market, for example with
the creation of one of the largest government bond
markets in the world, even if national bonds retain their
individual characteristics.

3.7.2.
The Economic and Social Committee would
have liked the Commission to be more explicit on a
number of points which the Committee considers
essential. Greater precision is needed with regard to:

— the obstacles to real integration of the market arising
from differences in tax systems and the danger of a
massive outflow of savings to the euro area countries
with the most favourable tax systems;

— the danger that application of reserve requirements
by the ‘ins’ will place at an advantage ‘outs’, which
might subsequently join economic and monetary
union, having secured a dominant market share for
themselves;

— the effects of a unified monetary and financial market
on the relative situations of existing financial centres.
The reduction, which is considered inevitable, of the
number of stock markets and centres for financial
transactions places the future of some national
financial centres in doubt (3). The EU currently has
32 stock markets, compared with eight in the USA.

Although the Commission document submit-
3.7.3.
ted for the Committee’s opinion looks at the external
aspects of the euro, it would be worthwhile devoting a
specific communication to the impact of monetary union
on the financial markets.

3.8.

Internationalization of the euro

3.8.1.
The Commission believes that the international
use of the euro, for example by non-EU firms trading
with the euro area, will increase, as will its use in
transactions outside the euro area.

3.8.2. On the other hand, the Commission considers
that, for reasons of stability-orientated fiscal and mone-
tary policy, use of the euro as a reserve currency should
be encouraged by economic operators and central banks.

3.8.3.
The idea, not specifically stated but nonetheless
possible, is that the euro could in effect at least partly

(1) See point 3 of Introduction to Commission document.
(2) See also the Bank of England publication entitled ‘Practical

issues arising from the introduction of the euro’.

(3) See interview with David Clementi, deputy governor of
the Bank of England, in which he argues that London,
although outside the euro area, will become the leading
euro financial centre (Financial Times, 20 January 1998).

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replace the dollar as an internationally held investment
asset.

3.8.4.
This view, which figures prominently in all the
literature aimed at promoting the euro, deserves further
analysis:

3.8.4.1.
The role of the dollar as a reserve currency
held by central banks has been less the result of a choice
than of an obligation imposed partly by the United
States’ trade deficit and inadequate domestic savings,
and partly by the inability of the central banks to sell
their dollars on the foreign exchange markets without
causing the exchange rate to collapse. The example of
Japan, with its ‘glut’ of US Treasury bonds — a quid
pro quo for its trade surplus with the United States —
is a perfect illustration of this phenomenon.

3.8.4.2.
The idea that the status of reserve currency
brings only advantages also needs to be qualified. If the
euro comes to be regarded as desirable for its intrinsic
qualities, it will be highly valued by the foreign exchange
markets in relation to its major competitors, the dollar
and the yen.

3.8.4.3.
The handicap which a euro overvalued on
the foreign exchanges could represent for all the euro
area’s firms is rarely mentioned. The Economic and
Social Committee would like to see this question
made the subject of a detailed study (1). Moreover,
undervaluation would be quite as damaging as overvalu-
ation. It is perhaps the international monetary system
which needs a radical overhaul. The dollar and the yen
have experienced extreme exchange-rate fluctuations
and it is possible that the same thing might happen to
the euro. One positive aspect of monetary union however
is that is that the external dependence of the Member
States will diminish greatly as the bulk of trade will be
transacted in euros between the participating countries.
The external value of the euro will therefore be much
less significant than hitherto, for example, the external
value of the French franc for France or the Belgian franc
for Belgium.

3.8.4.4.
In point 10 the Commission looks, unfortu-
nately too briefly, at the fundamental problem of
monetary policy, namely control of the monetary aggre-
gates, trends in which will be influenced by the decisions
of foreign operators.

Logically,

the development of

3.8.4.5.
the inter-
national role of the euro should also lead to the
accumulation outside the euro area — as has happened
with eurodollars — of euro deposits serving as a basis
for the granting of loans, the amount of which will be
beyond the control of the European Central Bank or
any other supervisory authority.

3.8.4.6.
The Commission and the European Mone-
tary Institute ought to carry out a detailed study of the
dangers inherent in weakened control of the monetary
aggregates, which would mean loss of control of the
euro money supply (2).

4. Transitional Issues — Section B

The Commission says that, while the longer-term
4.1.
outlook for an international monetary scene with the
euro is favourable, there are however a number of
transitional issues associated with the introduction of
the single currency. They refer to a potential risk either
of exchange-rate instability between the euro and other
major currencies, or of a deviation of the value of the
euro from what is considered appropriate. This is clearly
a real danger in the current international monetary
system, unconnected with the transition to the single
currency in Europe. However, the external value of the
euro will be much less important for the European
economies than was the external value of their respective
national currencies. This is a major step forward.

4.2.
The document states that instability could arise
before 1 January 1999 or during the transitional period
for four main reasons:

— a perception by economic operators that the Euro-
pean Central Bank would in future have to adopt a
tight monetary-policy stance;

— looser fiscal policy on the part of the Member States;

— a dollar overhang at the central banks;

— the unpredictability of market transactions resulting
from the introduction of the euro into investors’
portfolios.

4.3.
Although the Commission offers reassurances
on the first three points, it admits to uncertainty as to
the behaviour of investors during the transitional period.

4.3.1.
In the light of the Commission’s analysis, a
scenario could be imagined in which the euro exchange
rate is initially fixed at a level quite different from that
suggested by the fundamentals of the European economy
in all its diversity.

(1) The European Parliament warns against the deflationary
effects of over-valuation of the euro (see Resolution of
13 January 1998).

(2) Mr Duisenberg acknowledged the problem in a meeting
with the Section for Economic, Financial and Monetary
Questions of the Economic and Social Committee but said
that it was up to the monetary authorities of the countries
outside the euro area to control any movements of euro
deposits.

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4.3.2.
The European Central Bank could in effect be
obliged to impose an excessively tight monetary policy
and to raise interest rates in response to financial market
scepticism as to the objective of price stability arising as
a result of the policies pursued by certain countries.
During the transitional period therefore all actions must
be avoided which might damage the credibility of the
European Central Bank.

The dollar reserves held by the European central
4.4.
banks, already overweight, could prove excessive if the
fixed parities of currencies participating in the euro and
a sharp fall
in trade and financial transactions in
currencies other than the euro, with two thirds of trade
being intra-Community, were to reduce the need for
foreign currency reserves.

at $350 bn (1). Foreign exchange market transaction
volumes will diminish as a result of the disappearance
of national currencies in the euro area, but the foreign
exchanges are, and will continue to be, dominated by
dollar transactions.

4.8.
Despite the convergence of the fundamental
indicators, the euro area could be temporarily exposed
to turbulence on the foreign exchanges. The tensions
experienced by the European Monetary System as a
result of fluctuations in the value of the dollar will be
transferred to the euro. Whilst it is likely that the
European Central Bank will be in stronger position to
resist such pressures than under the present system of
consultation and mutual support between central banks,
the dislocating effects of the floating exchange rate
regime will not however really be totally eliminated (2).

4.4.1.
In view of the favourable risk/reward ratio for
the euro, reinforced by greater market liquidity, investors
will increase their euro holdings.

It would be unwise to exclude the possibility of
4.9.
a divergence between the value of the euro and that of
the currencies of the Member States remaining outside
the euro area. It is unhelpful to conjure up the notion of
competitive devaluation to illustrate this risk.

4.5.
The role of the European Central Bank will thus
be decisive and the risks inherent in an overvalued euro
or a desire on the part of the European Central Bank to
impose a strong euro by means of high interest rates
cannot be underestimated.

4.6. Other uncertainties which could give rise to
speculation concern the future external value of the
single currency against other currencies. This value
will be a function of the economic capacity of the
participating countries and investors’ confidence in the
European Central Bank. Any monetary grouping carries
with it uncertainties which on the financial markets will
be translated into higher risk premiums.

Turbulence caused by massive speculation is a
4.7.
real danger, despite the reassurances of the monetary
authorities and the views expressed in certain authorita-
tive financial circles. Although conditions now are
different from those prevailing at the time of the events
of September 1992, the monetary authorities might have
great difficulty in containing abnormal pressures on one
or more currencies. Although it is dangerous to compare
flows and stocks, it should be borne in mind that the
volume of daily transactions on the foreign exchanges
is estimated at approximately $1 300 bn. This figure
varies significantly from day to day however and
needs to be scaled down to take account of intra-day
transactions. Even a much scaled down figure however
still by far exceeds the total foreign currency reserves of
the European central banks, which the IMF estimates

4.10.
Although over the last few years the central rates
have shown growing convergence and great stability, one
scenario which has to be considered is strong market
pressure, which the European Central Bank and the
associated national central banks would be powerless
to control by intervention. The European Monetary
Institute acknowledges the existence of this risk, but
believes that it would be able to deal with it via interest
rates and open market intervention.

The resulting threat to the cohesion of the
4.11.
economic and monetary union must not however, be
underestimated. It could not withstand a wide disparity
in competitive conditions resulting from disordered
exchange rate adjustments. The Economic and Social
Committee feels that the matter needs further study.

The impact of a euro area on the prospects for
4.12.
enlargement of the European Union to the Central and
Eastern European Countries also needs to be studied. It
is difficult to imagine these countries joining the euro
area within the timescale envisaged for enlargement.

(1) See annex 1 to Commission document.
(2) In its resolution of 13 January 1998 on the Commission
document which is the subject of this opinion, the European
Parliament stated that during the period immediately
following its introduction the euro was likely to experience
exchange rate instability ... and that this period of instability
could last some time, as the disappearance of intra-
European exchange rate volatility would probably be
counter-balanced by greater euro exchange rate volatility.

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4.12.1. On the other hand, the benefits in terms of
competitiveness which these countries are likely to
derive from the weakness of their currencies against the
euro need further study.

4.13.
The Committee is acting as spokesman for the
views of the social partners and the European Union’s
citizens and firms. It is essential that the monetary
authorities adopt concrete measures to ensure that the
pessimistic scenarios mentioned above are not realized.
Clearly, it is not necessary for these measures to be spelt
out in detail, as speculators would be quick to take the
necessary counter-measures; it would be sufficient for
the market to know that measures were in place and
that, in the regrettable event that they became necessary,
they would be effective.

4.14.
Adopting effective measures which do not
restrict the free movement of capital or the freedom
to provide (financial) services is certainly a difficult
undertaking. Nor would it be possible to impose
restrictions on European markets alone, which would
place them at a disadvantage vis-à-vis competing,
non-European markets. The only concrete measures
which could be taken are the continued application
in Europe of orthodox monetary and fiscal policies.
Speculation is generally triggered only when there are
imbalances, inconsistencies and contradictions in the
monetary and fiscal policies of certain states. The aim
should therefore be to promote specific surveillance
and cooperation commitments by the Member States’
supervisory authorities and the international central
banks, with a view to applying the necessary measures.

5.2.
The Commission states that ‘Among the long-
term considerations, the euro exchange rate will reflect
the functioning of EMU. In particular, the challenges
of greater competition must be met by appropriate
structural policies. Greater labour market flexibility,
tax and social security reform in the direction of the
most efficient systems will help the European economy
to adapt to global challenges. If these reforms were to
continue, EMU would contribute to a structural reform
which would ultimately have a positive impact on
employment’ (1).

5.2.1.
The Economic and Social Committee would
prefer that measures with such important implications
were made the subject of detailed further analysis (2).

6. Section D defines Europe’s role as a partner at

international level

6.1.
A single exchange rate and monetary policy are
direct consequences of economic and monetary union.

6.2.
The question arises of the Community’s represen-
tation at international level, for example at the IMF.
The conclusions of the December 1997 Luxembourg
European Council are rather vague, merely stating
that ‘the Commission will be associated with external
representation insofar as necessary to enable it to fulfil
the role assigned to it by the Treaty’. Clarification is
needed in this area.

4.15.
In the light of this the Committee considers the
Council’s decision to set irrevocable parities between
the participating currencies as early as May 1998 to be
a positive step, and notes that at the end of 1997 the
parities are not far from the probable conversion rates.

7. Conclusion

4.15.1.
The announcement of exchange rates will
help reduce uncertainty. It will provide market and
economic operators with important information regard-
ing the economic operation of the union.

The announcement will spell out the frame-
4.15.2.
work for the conduct of monetary and exchange rate
policy during the interim period (May to December
1998).

5.

Impact of economic policies on the euro exchange
rate — Section C

The Economic and Social Committee would like
7.1.
to participate fully in the debate on the conditions and
effects of introduction of a single currency in the
economic union.

7.2.
The comments and scenarios set out in this draft
opinion are in no way intended to call into question the
Committee’s approval of the principle of monetary
union, but rather to contribute to the detailed study of
the practical conditions of its realization.

In view of the objectives of fiscal consolidation
5.1.
and full employment,
it would seem desirable for
monetary policy in the euro area to be relatively
non-restrictive, without however endangering the objec-
tive of price stability.

(1) See point 22 of Commission document.
(2) See the detailed analyses carried out by Horst Siebert,
President of the World Economic Institute, Kiel, and one
of the German government’s five ‘wise men’, or that of
Heiner Flassbeck, Chief Economist of the Institute for
Economic Research (DIW).

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7.3.
The evaluation and discussion contained in the
Commission staff working paper on the external aspects
of economic and monetary union and the Communi-
cation on the practical aspects of the introduction of the
euro are an essential contribution to the debate on
economic and monetary union, without however exhaus-
tively exploring a problem which is crucial to the
harmonious completion of an experiment without his-
torical precedent.

7.4.
There is a disparity between the detailed studies
of the technical conditions for the realization of econ-
omic and monetary union carried out by the Com-
mission, the EMI and professional bodies and the
still
inadequate analysis of its economic and social
repercussions.

7.5.
Paradoxically, the most voluminous studies on
the subject are to be found in the reports of international
institutions unrelated to the European Union (IMF,
United Nations, BIS, OECD etc.) or in work carried out
by national economic research institutions which have
still to be summarized. It is therefore essential that the
Commission make its views known on the subject.

7.6.
The majority of these reports and studies voice
concern as to the effect of monetary union on economic
expansion and thus on the improvement of the employ-
ment situation in Europe.

Brussels, 26 March 1998.

7.7.
The convergence of all economic, monetary and
fiscal policies on a more rigorous approach, the weight
of the Maastricht criteria and the adoption of a stability
and growth pact are aimed at placing Europe on a
growth path, but also give rise to concerns.

7.8.
The Economic and Social Committee does not
at present feel that it is in a position to judge how far
these fears are justified. It would merely like to see the
Commission’s analyses addressing these concerns. This
approach, far from calling economic and monetary
union into question, is intended to allay fears as to the
ability of economic and monetary union to adapt to the
resumption of growth which is needed to bring down
unemployment, and in the longer term for the success
of the single currency itself.

7.9.
The Economic and Social Committee hopes to
reinforce and enhance its participation in the fundamen-
tal debate on the efforts made in connection with EMU
by involving internationally renowned economists in its
discussions.

7.10.
The Economic and Social Committee is interest-
ed and pleased to note that many of the concerns
expressed in its opinion are echoed in the European
Parliament’s resolution of 13 January 1998 on the
Commission’s working paper.

The President

of the Economic and Social Committee

Tom JENKINS