policies can no longer cause disturbances at the national level. what is more, the integration process has created a highly integrated economic area without a tendency for protectionist measures. what was expected of monetary union? what has been achieved five years after the establishment of the ecb and four and a half years into the euro era? initial expectations varied. some were positive and others negative. in creating a single currency, the politicians fundamentally set out to make the process of european integration irreversible. economic and monetary union was expected : • to complete the single market and to create an european area of monetary and financial stability ( stability union ) ; • to act as a catalyst for further political integration and economic structural reforms ; and • at least for some ( non - german ) politicians : to counterbalance the currency dominance of the us dollar by means of the euro. the expectations of the sceptics can be summed up as follows : • the euro area is not an optimal currency area ; a “ one - size - fits - all ” monetary policy is not appropriate ; • emu is premature as there is insufficient convergence ; • without political union, emu will fail. i am not going to comment on all these arguments. to be frank : we all know that the benefits of emu will materialize over time. in historical terms 4 years is an extremely short period of time. but allow me to assess what has actually taken place since june 1998. the ecb and the third stage of economic and monetary union were launched during difficult times. even after having achieved a sufficiently high degree of convergence by the start of the third stage, the creation of the new and still diverse euro area in 1999 generated uncertainties about possible structural changes to existing economic relationships, including changes in the transmission mechanisms of monetary policy decisions. the eurosystem ’ s monetary policy has thus been faced with challenges which differ from those confronting other central banks. in the first five years of its existence, the ecb ’ s main challenges have been • to gain credibility and • to build up confidence in a new environment and under a totally new policy regime • with a centralised monetary policy and • decentralised but closely coordinated economic and budgetary policies carried out by states which retain to a large extent their sovereignty. another challenge was to determine, adopt and implement an appropriate monetary policy strategy and to define the term “ to maintain price stability in the medium term ”. this was to be achieved by a two - pillar approach which •

additional debts of one country would have the effect of increasing the overall demand for loans, and with it the level of capital market interest rates in the euro area, only slightly. nevertheless, the increase would affect all the countries because part of the cost of debt would be passed on to others, producing a greater incentive to take on more debt. to keep monetary union on track in spite of these dangers, the founders of european monetary union drew up the fiscal rules enshrined in the stability and growth pact, which cap deficits at 3 % and total debt at 60 % of gdp. however, these rules had only a limited effect. if one country breached the rules, it was down to the finance ministers of the other euro - area countries to decide on possible sanctions. game theory leaves us in little doubt as to the outcome of such an arrangement. or to be more blunt, we might use the words of otmar issing, former chief economist of the ecb, who described the situation as one in which potential sinners pass judgement on actual sinners. the stability and growth pact was not the only safeguard against excessive government debt, however. national responsibility also means that member states be held responsible for the consequences of their own decisions. that is why the maastricht treaty explicitly rules out the assumption of debt by the european unionor by other member states. this liability principle was intended to have a disciplining effect in that member states running unsound fiscal policies or dubious economic policies would only be able to borrow at worse terms, since investors would demand compensation for the risk they were taking. however, the disciplining by the markets which, it was hoped, would result from the no bailout clause failed to materialise. for many years, greece was highly indebted, but paid little more for its debt than germany or france. why that should be is quite easy to explain. and this is where basel again enters the scene to play an important role. at around the same time as the delors committee, another committee was meeting in basel – the basel committee on banking supervision – and made what proved to be a momentous decision for the euro area. the new common set of international capital rules stipulated that government bonds issued by developed countries in their own currency be valued as riskfree assets. this meant that banks did not have to back them with capital. the european union, too, translated these rules into european law, despite the no bail - out clause anchored