Курсовая: European Monetary System

Курсовая: European Monetary System

of Monetary Union; and

Finally, I will describe some features of the operational framework of the

ESCB that have recently been finalised.

Let me begin by discussing the over-riding priority we attach to the

maintenance of price stability.

2. The priority of price stability

The Treaty on European Union - the Maastricht Treaty - stipulates that the

"primary objective of the ESCB shall be to maintain price stability". It was

left to the ESCB to provide a quantitative definition of this primary

objective. At the ECB's precursor, the European Monetary Institute (EMI), it

was agreed that, in the interests of transparency and accountability, the

ESCB's chosen operational definition of price stability should be announced

publicly. This announcement would form an important element of the overall

monetary policy strategy. Simply defining price stability leaves open the

question of why price stability is desirable. As a central banker, the

benefits of price stability appear self-evident. Any single argument in

favour of price stability cannot comprehensively describe the benefits that

it brings.

For instance, concerning the United States, Martin Feldstein has recently

shown that, in combination with taxes and social contributions, even quite

modest rates of inflation can cause considerable real economic losses.

Research at the Bundesbank has produced similar results for Germany.

But elimination of the losses caused by this channel is only one illustrative

example among the many benefits of price stability. The greatest contribution

that the ESCB can make to the euro area's output and employment performance

is to achieve and maintain the stability of prices. Stable prices are at the

core of the 'stability culture' we are trying to create in Europe, a culture

that is the foundation of sustainable and strong growth in the standard of

living for Europe's citizens.

At the same time, the ESCB does not operate in a vacuum. Monetary policy

needs to be supported by an appropriate fiscal policy and necessary

structural reforms implemented at the national level if this 'stability

culture' is to be built on solid and sustainable foundations. The private

sector also has its part to play, notably by exercising wage moderation,

given the high levels of structural unemployment in the euro area. Progress

on all these dimensions is not only desirable, but also absolutely necessary.

Monetary policy alone cannot ensure strong, non-inflationary growth and

improved employment prospects throughout the euro area. However, only a

monetary policy focussed closely on the achievement of price stability can

lay the basis for these conditions.

Of course, that is not to say that the ESCB can, or should, ignore broader

macroeconomic considerations. For instance, the threats posed by deflation in

combination with nominal rigidities to the real economy have to be taken into

account. In order to prevent any misunderstanding, let me be very clear: my

discussion of deflation has to be seen in the context of the formulation of

an optimal definition of price stability for the ESCB that takes into account

deflationary dangers. These dangers certainly cannot be ruled out and our

definition of price stability should reflect them. However, simply recalling

the current rate of inflation in the euro area - 1.2% - shows that deflation

is not an immediate concern for policy-makers.

While periodic and transitory falls in the price level may be normal, and

should not give rise to major concerns, a prolonged deflation is clearly

inconsistent with any meaningful definition of price stability. Moreover,

since nominal interest rates cannot fall below zero, a prolonged deflation

may render the interest rate policy of the central bank rather ineffective.

What remains is out-right purchases of assets - both foreign and domestic.

Similarly, the ESCB cannot ignore the implications of nominal rigidities in

wages and prices for the transmission mechanism of monetary policy. If we

were to live long enough under a regime of stable prices, I would not exclude

the possibility that wage and price setting behaviour would adapt, and

nominal rigidities would finally disappear. This would reduce some of the

potential output costs of fighting inflation, and thus increase the net long-

run benefits of price stability. However, for the time being we may have to

live with these rigidities and take their effects into account when deciding

on our monetary policy strategy.

In this respect, the present situation is not easy for the ESCB. Unemployment

in the euro area is currently very high.

However, in contrast to these persistently high levels of unemployment -

which are largely structural in origin - the prospects for maintaining price

stability are currently very encouraging. Inflation expectations and long-

term interest rates in the euro area are at close to historical lows. Actual

area-wide inflation is also very subdued.

The current low 'headline' rate of inflation has been moderated somewhat by

recent falls in oil and commodity prices, themselves stemming, in part, from

the economic and financial crises in Asia and, more recently, in Russia.

However, this effect on inflation has been largely off-set by the impact of

indirect tax rises in a number of participating countries, which have raised

consumer prices for certain goods. All in all, the changed external

environment contributes to an overall outlook of very subdued inflationary

pressures.

In defining price stability, one might ideally refer to a conceptual measure

of 'core' inflation that tries to isolate monetary effects on the price level

- for which the ESCB is properly responsible - from such terms of trade or

indirect tax shocks, over which it has little immediate control.

In our month-to-month communication with the public, 'core' measures of

inflation may prove useful. But, in its preparatory work for Monetary Union,

the EMI recognised that any sensible definition of price stability for the

euro area would have to be based on a comprehensive and harmonised price

measure. 'Core' measures of inflation typically exclude some items. They are

unlikely to be comprehensive enough to satisfy the requirements of an index

suitable for a sensible public definition. These considerations point to

using the 'headline' measure of the harmonised index of consumer prices (or

HICP) for the euro area in the definition of price stability.

Finally, the ESCB needs to build on the success of its constituent national

central banks (NCBs) in reducing inflation and achieving price stability

during the convergence process in Stage Two of EMU. Given the current

generally benign inflation outlook in the euro area that is the product of

these accomplishments, there is an understandable desire to 'lock-in' the

current success in achieving price stability as well as the apparent

credibility of monetary policy, and ensure continuity with existing central

bank practice.

3. The importance of the monetary strategy for a successful start of European

monetary policy

When price stability is defined using the principles just outlined, how

should the ESCB proceed to maintain it? In achieving and maintaining price

stability - the primary objective of the Treaty - the choice of monetary

policy strategy is vital.

Within the ECB, a considerable amount of work on the monetary policy strategy

has already been completed, building to a large extent on the substantial

earlier preparatory work of the EMI. A high degree of consensus has been

reached among the NCBs and within the ECB about the main outlines of the

strategy - I will address some of these areas of agreement in a moment. The

final decision has not yet been made. But you should be reassured that

progress is being made at a good pace. I have no doubt that we will be in a

position to announce the details of the ESCB's monetary policy strategy in

good time, prior to the start of Stage Three.

Being a new institution, the European Central bank must be prepared to come

under intense scrutiny right from the start. In particular, the international

financial markets will monitor its every decision like hawks. Facing this

environment in the run-up to Monetary Union, the ESCB must ensure that

everything possible is done to make the launch of Stage Three as tension-free

as is possible. Choosing and announcing an appropriate monetary strategy is

crucial.

The monetary policy strategy is, in the first place, important for the

internal decision-making process of the ESCB - how the Governing Council will

decide on the appropriate monetary policy stance, given the economic

environment. Above all, the ESCB strategy must lead to good - that is to say,

timely and forward-looking - monetary policy decisions.

But the strategy is also of the utmost significance in communicating with

audiences outside the ESCB. It should stabilise inflation expectations. The

more the strategy helps to promote credibility and confidence in the ESCB's

monetary policy at the outset of EMU, the more effective that policy will be

- and the easier the ESCB's task of maintaining price stability will become.

In deciding upon the appropriate monetary policy strategy, the following

aspects must be seen as essential requirements. The strategy must:

* reinforce the ESCB's commitment to price stability, the

primary and over-riding task stipulated by the Treaty;

* it must clearly signal the anti-inflationary objectives of

the ESCB, and serve as a consistent benchmark for the

monetary policy stance; and,

* it must be transparent and explained clearly to the general

public - only then can the strategy serve as a basis for the

ESCB's accountability to the public at large.

The realisation that achievement of an optimal, non-inflationary

macroeconomic outcome may founder on the private sector's distrust has been

central to the monetary policy debate of the nineteen-eighties and 'nineties.

The search for answers to the questions raised by this debate has spawned an

enormous economic literature. The keywords "time inconsistency" and

"credibility" draw forth an almost unmanageable flood of publications that

have appeared in the wake of the pioneering contributions of Kydland /

Prescott and Barro / Gordon.

The need to establish a credible and consistent monetary strategy in the face

of the well-known time inconsistency problem faced by policy makers - the

dilemma highlighted by this economic literature - is especially important for

the ESCB at the outset of Monetary Union. As a brand new institution, the

ESCB will have no track record of its own.

Building its reputation, and the associated credibility of monetary policy,

is vital. But the process of doing so is complicated by the relatively high

level of uncertainty surrounding the transition to Monetary Union itself. The

transition to Stage Three is a unique event, and will create unique

opportunities for many - but it will also create some unique problems for

monetary policy makers. At the ECB, we are addressing these problems and are

confident that the risks can be managed successfully. Many of the

difficulties we face will be overcome through our own efforts over the coming

months.

Among these problems are the difficulties involved in creating a

comprehensive and accurate database of euro area-wide statistics. Running a

single monetary policy for the euro area requires timely, reliable and

accurate euro area data. In some cases, the euro area statistics simply did

not exist until quite recently. In others, the statistics are based on new

concepts, and the properties of the data series are not yet well known. The

long runs of high quality back-data required for empirical economic analysis

may be unavailable. Those that do exist are likely to have been constructed

using some degree of estimation and judgement, possibly rendering the

econometric results produced with them questionable.

Furthermore, the regime shift associated with the adoption of the single

monetary policy may change the way expectations are formed in the euro area,

and thereby alter forward-looking economic behaviour. Monetary policy's

effects on consumption, investment, and wage bargaining - and therefore the

whole transmission mechanism of monetary policy to developments in the price

level - would be among the important economic relationships to be affected in

this way.

This may be no bad thing. Indeed, using the regime shift implied by the

transition to Stage Three to change both public and private sector behaviour

in favourable directions may be one of the largest gains that the euro area

can extract from Monetary Union. Nevertheless, these changes are likely to

complicate the implementation of certain important elements of a monetary

strategy, at least in the short term, as past relationships between

macroeconomic variables may break down. What is good for the euro area

economy as a whole may create some practical problems for the ESCB.

One example of this so-called 'Lucas critique' phenomenon is the impact of

current, very low rates of inflation on private behaviour. For many countries

participating in Monetary Union, there is simply no - or only very recent -

experience of how the private sector will behave in an environment of

sustained and credible low inflation. Instability in past relationships may

result, should behaviour change in this new, low inflation environment. I

have already argued that these structural changes will benefit Europe's

citizens - price stability will allow markets to work more efficiently,

thereby raising growth, and improving employment prospects. But these changes

may also complicate the ESCB's assessment of economic and financial

conditions.

These uncertainties - arising directly from the transition to Stage Three

itself - are both compounded by, and inter-related with, the broader economic

context in which Monetary Union will be established. The increasing

internationalisation of the global economy, and the current rapid pace of

technological change, have affected all sectors of the economy, and the

banking and financial systems in particular. For example, at present there

are many, inter-related innovations in the payments system, such as:

* the introduction of TARGET (directly related to EMU itself);

* greater technological sophistication of payments mechanisms,

as use of computers and information technology becomes more

widespread and advanced;

* the additional incentive for cash-less payments that may

arise from the fact that for some time to come -

approximately three years - the new euro-denominated notes

and coin will not come into circulation. In particular,

narrow monetary aggregates might be affected by this

development; and,

* increased competition among banks and settlements systems,

arising from globalisation and the breakdown of barriers

between previously segmented national markets, which may

drive down the margins and fees charged to customers.

At the ESCB we will need to keep abreast of these developments, both for

their immediate impact on one of our "basic tasks" - promoting the smooth

operation of the payments system - and because of their broader implications

for the euro area economy. Reducing transactions costs in the way I just

described will benefit European consumers and producers - but it may also

change the indicator properties of monetary, financial and economic variables

that national central banks have looked to as guides for monetary policy in

the past.

Finally, in Monetary Union there will be some heterogeneity across countries

within the euro area. Europe's diversity is one of its greatest assets. But

this diversity is greater than is typically the case between different

regions in the same country using a single currency. Nevertheless, the ECB

Governing Council will have to concentrate on monetary and economic

developments in the euro area as a whole when discussing and taking monetary

policy decisions.

How should a monetary policy strategy be selected in this - for monetary

policy makers, at least - potentially difficult environment? The EMI outlined

a number of 'guiding principles' for the selection of a monetary strategy by

the ESCB. Foremost amongst these was the principle of 'effectiveness'. The

best monetary policy strategy for the ESCB is the one which best signals a

credible and realistic commitment to, and ensures achievement of, the primary

objective of price stability.

For many commentators, this criterion points unambiguously in the direction

of so-called 'direct inflation targeting'. If monetary strategies are to be

judged according to how well they achieve price stability, defined as a low

rate of measured inflation, then advocates of inflation targets argue an

optimal strategy would surely target this low inflation rate directly. These

commentators would place explicit quantitative targets for inflation itself

at the centre of the ESCB's monetary policy strategy. Their approach has been

strongly endorsed in some academic and central banking circles.

But, in the current circumstances, a pure 'direct inflation targeting'

strategy is too simplistic for the ESCB, and possibly even mis-conceived. The

ESCB well understands the primacy of price developments and price stability

for monetary policy making. Indeed, the Treaty's mandate is unambiguous in

this respect. We will signal our intentions on this dimension very clearly by

making a transparent public announcement of our definition of price

stability. The current low level of long-term nominal interest rates in the

euro area suggests that the financial markets, at least, understand and

believe the over-riding priority that we attach to achieving price stability.

Regarding strategy, our choice therefore need not be governed solely by a

desire to signal our intent to maintain price stability. This has already

been well-established - by the Treaty, and by the success of the convergence

process in reducing inflation in Europe to its current low level. Rather than

signalling our intent, the strategy must constitute a practical guide that

ensures monetary policy is effective in achieving the goal we have been set.

In this respect, there are considerable problems with using inflation itself

as the direct target within the ESCB's overall strategy. Because of the well-

known lags in the transmission mechanism of monetary policy to the economy in

general, and the price level in particular, it is impossible for a central

bank to control inflation directly. Therefore, 'inflation targeting' in

practice means 'inflation forecast targeting' where central banks set

monetary policy to keep their best forecast of inflation at the target level

deemed consistent with price stability.

But recognition of this need for forecasts in an inflation targeting strategy

immediately raises practical difficulties. In the uncertain environment

likely to exist at the outset of Monetary Union, forecasting inflation will

be very difficult, not least for the conceptual, empirical and practical

reasons I outlined a moment ago. Forecasting models estimated using historic

data may not offer a reliable guide to the behaviour of the euro area economy

under Monetary Union. Forecast uncertainty is likely to be relatively large,

possibly rendering the whole inflation targeting strategy ineffective.

To address these uncertainties, a large element of judgement would have to be

introduced into the forecasting process, in order to allow for the regime

shifts and structural and institutional changes that are a seemingly

inevitable consequence of EMU. Simply relying on historic relationships to

forecast future developments is unlikely to prove accurate or effective.

While introducing judgmental adjustments into forecasts in these

circumstances would be both appropriate and necessary, such adjustments are

likely to compromise the transparency of the inflation forecasts and, thus,

of any inflation targeting strategy. Using judgement may prevent outside

observers from readily assessing the reliability and robustness of the

inflation forecasting procedures used by the ESCB.

I see a distinct bias in the academic discussion of the comparative

advantages of inflation targeting and monetary targeting. With good reason,

many arguments are presented against the ESCB adopting a monetary target. But

proponents of inflation targeting seem to forget that, in the current

context, most of these arguments could also be used against inflation

targeting. Above all, I have not seen any attempt thus far - even if only a

tentative one - to explain how the ESCB should deal with the specific

difficulties involved in making an inflation forecast at the outset of

Monetary Union that could be used as the centrepiece of an inflation

targeting strategy.

In many respects, a strategy giving a prominent role to monetary aggregates

has considerable advantages over direct inflation targeting. Monetary

aggregates are published. They are clearly not subject to various kinds of

'judgmental manipulation' by policy makers or central bank staff that might

be possible with inflation forecasts. To the extent that policy makers wish

to depart from the signals offered by monetary growth because of 'special

factors' or 'distortions' to the data - including those distortions arising

from the transition to Monetary Union itself - they will have to do so in a

public, clear and transparent manner.

Moreover, a strategy that assigns a prominent role to the monetary aggregates

emphasises the responsibility of the ESCB for the monetary impulses to

inflation, which a central bank can control more readily than inflation

itself. These monetary impulses are the most important determinants of

inflation in the medium term, while various other factors, such as terms of

trade or indirect tax shocks, may influence the price level over shorter

horizons.

In the light of these considerations, it was agreed at the EMI that,

regardless of the final choice of the monetary policy strategy, monetary

aggregates would be accorded a prominent role in the overall monetary

framework adopted by the ESCB.

However, the EMI also noted that certain technical pre-conditions would have

to be met before this 'prominent role' could be translated into an explicit,

publicly announced monetary target, guideline, benchmark or monitoring range.

Specifically, such targets or ranges would only be meaningful guides to

monetary policy if the relationship between money and prices - as

encapsulated in a 'demand for money' equation - was expected to remain

sufficiently stable.

In this regard, several existing empirical studies point towards the

stability of the demand for euro area-wide monetary aggregates. However,

these studies are necessarily only preliminary. The reliability of these

results in the face of the uncertainties raised by the transition to Stage

Three is unknown. Future shifts in the velocity of money are certainly

possible - perhaps even likely. They cannot be predicted with certainty.

Moreover, it is not clear whether those aggregates that have the best results

in terms of stability are sufficiently controllable in the short-term with

the policy instruments available to the ESCB. In these circumstances, relying

on a pure strategy of strict monetary targeting is simply too risky.

Against this background, the ESCB will have to design a monetary policy

strategy of its own. The chosen strategy will show as much as possible

continuity with the successful strategies that participating NCBs conducted

in the Stage Two. At the same time the ESCB's strategy will take into account

to the extent needed the unique situation created by the introduction of the

euro.

4. The new monetary policy instruments and procedures for the euro area

Having a well-designed monetary strategy is vital. But we must also be able

to implement it successfully at an operational level. What instruments are

available to implement this strategy?

The ECB will have a complete set of monetary policy instruments at its

disposal. These instruments have been selected on the basis of their

efficiency for transmitting monetary policy and their neutrality across

market participants.

Three types of instruments are available to the ESCB: open market operations,

standing facilities and a minimum reserve system. I will briefly present

these instruments in the remainder of my speech.

4.1 Open market operations

Open market operations include, first, a weekly main refinancing operation,

which will take the form of a reverse repurchase transaction with a maturity

of two weeks. The main refinancing operation will be based on a tender

procedure. The tender may be a fixed rate tender, with counterparties bidding

amounts, or a floating rate tender, where counterparties propose bids

including both amounts and interest rates.

Second, there is the monthly longer term refinancing operation, which has a

maturity of three months and will always take the form of an interest rate

tender. This is because the ECB will avoid signalling its monetary policy

stance through these particular operations.

The ECB will also conduct fine-tuning operations, through the national

central banks of the euro area or, in exceptional circumstances, on its own

account. Fine tuning operations will be conducted whenever liquidity or money

market conditions warrant. Fine tuning operations may take the form of

reverse repurchase transactions (that is, the same type of transaction as

that used in the main refinancing and the longer term refinancing operations,

but with no pre-set start date nor a pre-set maturity), foreign exchange

swaps or the taking of fixed-term deposits. Fine tuning operations in the

form of reverse repurchase operations may be executed either through quick

tenders or bilaterally. In both cases, these operations will involve a

limited set of eligible counterparties that have an appropriate track record

of activity in the money market. The other types of fine tuning operations

will also be executed with a limited number of eligible counterparties, which

will be selected ex ante by the ECB. In some countries, there will be a

rotation scheme, which will aim at giving the opportunity to all eligible

fine tuning counterparties to participate in fine tuning operations.

Finally, open market operations may also be conducted whenever structural

reasons, such as the longer-term evolution of liquidity profiles, warrant it.

These so-called structural operations may take the form of outright purchases

or sales of securities or the issuance of debt certificates by the ECB.

4.2 Standing facilities

The ECB will operate two overnight standing facilities, which will be

available to all credit institutions at national central banks of the euro

area, provided that, when using the marginal lending facility, they have

sufficient collateral. The rate of the marginal lending facility will

constitute the upper bound of collateralised overnight money market rates.

The deposit facility will be remunerated at a rate that will constitute the

lower bound of overnight money market rates.

When using the marginal lending facility, or, for that matter, when entering

in liquidity-providing open market operations in the form of reverse

transactions, counterparties have to post assets with their national central

bank (or the ECB in the exceptional case when the ECB conducts fine tuning

operations on its own account). These assets are meant to act as guarantees

for credits received from the European System of Central Banks. A list of

eligible assets has been drawn up for this purpose. The list comprises a wide

variety of assets and has two sub-sets. First, the so-called tier one assets,

which are selected by the ECB according to uniform criteria relating to their

credit standing in the whole euro area. Second, the so-called tier two

assets, which have been selected by the ECB because they are of particular

importance for certain national banking systems of the euro area, in order to

promote a certain degree of continuity at the start of the Stage Three of

EMU. Two principles of equal treatment are applied, however. First, the

credit standing of tier two assets is as high as that of tier one assets.

Second, both tier one and tier two assets may be used by any credit

institution in the euro area, irrespective of its location.

In addition, a set of risk control measures has been elaborated to ensure

that, for any counterparty, the amount of assets provided is always

sufficient. Risk control measures cover the assets' price and credit risks,

taking account of the asset type, its characteristics and the maturity of the

transaction. The ECB's risk control measures have been elaborated with

careful attention to the best market practices in this area. They include the

deduction of haircuts from the assets and the imposition of initial margins

to the credit amount. Another feature of the risk control framework is the

regular revaluations of the assets, which will, in most cases, take place

daily and may trigger margin calls, most often to be settled through delivery

of additional assets.

4.3 Minimum reserve system

The ECB will also apply a minimum reserve system to credit institutions of

the euro area. Two main monetary policy objectives have been assigned to the

minimum reserve system. The first objective is to stabilise money market

interest rates through the averaging mechanism, whereby the fulfilment of

minimum reserve requirements is based on average reserve holdings over

monthly periods of time. During the maintenance period, this allows the

banking system to absorb liquidity shocks. The reduced volatility of money

market rates will reduce the need for frequent fine tuning operations, which

will mean that markets are less distorted by central bank interventions than

they would otherwise be. The second objective of the minimum reserve system

is to enlarge the demand for central bank money, so as to enlarge the

liquidity deficit of the banking system vis-а-vis the ESCB. This will

safeguard the role of the European System of Central Banks as a provider of

liquidity to the banking system.

Reserve requirements will be calculated by applying a reserve ratio of 1.5%

to 2.5% to the deposits, debt securities and money market paper issued by

credit institutions, except for residual maturities above two years. Although

repurchase agreements are included in the reserve base, they will be subject

to a zero reserve ratio. Inter-bank liabilities and liabilities vis-а-vis the

ESCB will not be subject to reserve requirements. An allowance of the order

of E 100,000 will be deducted from reserve requirements, so that credit

institutions with a small reserve base will not have to hold minimum

reserves.

Reserve holdings will be remunerated up to the required reserve level, at the

rate of the main refinancing operation (as averaged over a month). It may be

argued that a less than full remuneration of minimum reserves would increase

the interest rate elasticity of central bank money demand. This

notwithstanding, the ECB has decided in favour of a full remuneration of

minimum reserves in view of the distortion to efficient markets that a less

than full remuneration would have implied. As a result of the full

remuneration of minimum reserves, the European Central Bank has also decided

not to exempt any credit institution from the minimum reserve system.

4.4 Procedures

The ECB will have many counterparties and be subject to close public

scrutiny. It has therefore set up procedures for informing its counterparties

and the public about its monetary policy instruments in a robust and

transparent manner.

The ECB will inform its counterparties and the public through a document

detailing its monetary policy instruments and procedures and through the

regular publication of various materials on its Internet site.

General Documentation

The ECB has produced a document describing its monetary policy instruments

and procedures in detail. This is called "General Documentation on ESCB

Monetary Policy Instruments and Procedures". A revised version of this

document was published recently. This revised version includes all the newly

specified elements of the monetary policy framework of the ECB, including for

instance the minimum reserve system. This document also includes a calendar

for the standard tender operations in 1999 (both main refinancing and longer

term refinancing operations). Calendars of standard tender operations will be

published by the ECB every year.

Publications on the ECB's Internet site

The list of assets that are eligible as guarantees for liquidity providing

operations will be made public on the Internet site of the ECB. The list will

be updated on a weekly basis and users will be able to subscribe to an e-

mailing facility for receiving certain designated parts of the list on a

regular basis. Users will also be able to query the list, which will contain

a large number of assets.

The list of institutions subject to minimum reserves, that is, credit

institutions established in the euro area, will also be available on the

Internet site of the ECB, together with the list of all monetary and

financial institutions in the European Union.

5. Concluding remarks

We are less than three months away from the moment when monetary policy

sovereignty is transferred from the NCBs to the ESCB. The bulk of the

preparatory work has already been completed, but major decisions - above all,

the choice of a monetary policy strategy - still have to be made. The public

can be certain that we will always inform them, regularly and

comprehensively, about our considerations and deliberations. We will make all

our decisions transparent. I have no doubt that we will be well prepared for

the moment at which we take over responsibility for monetary policy in the

euro area.

The euro as an international currency

Speech delivered by Eugenio Domingo Solans,

Member of the Governing Council and the Executive Board of the

European Central Bank,

at The Athens Summit '99,

in Athens on 18 September 1999

Thank you for inviting me to the Athens Summit '99 and for giving me the

opportunity to speak to you at this important event.

I should like to share with you my views, and the ECB's views, on the

importance of the euro as an international currency. I understand that

this issue may be of interest to experts from Greece, a "pre-in" country

which intends to join the euro area, and to many participants from

countries outside the euro area and the European Union, some of which

currently have exchange rate regimes related to the euro.

Nowadays the euro is the second most widely used currency in the world

economy, behind the US dollar and ahead of the Japanese yen. As we all

know, any currency fulfils three basic functions: it is a store of

value, a medium of exchange and a unit of account. As a store of value

the use of the euro as an investment and financing currency is rapidly

increasing, as investors understand the advisability of diversifying

their portfolio currencies among those which are more stable and more

internationally used. The euro is developing at a slower pace as a

medium of exchange or payment currency in the international exchange of

goods and services. This fact can easily be explained by the combined

and reinforcing effects of network externalities and economies of scale

in the use of a predominant international currency as a medium of

exchange, as is the case with the US dollar. The use of the euro as a

unit of account is linked to its use as a store of value and a medium of

exchange. The value stored in euro or the payments made in euro will

tend to be counted in euro.

There are good reasons to expect an increase in international public use

of the euro as a reserve, intervention and pegging currency, inasmuch as

the public authorities understand that it is worthwhile to allocate

their foreign reserves among the main international currencies and to

give the euro a relevant share in accordance with its internal and

external stability and the economic and financial importance of the euro

area.

In connection with the use of the euro as a pegging currency,

approximately 30 countries outside the euro area currently have exchange

rate regimes involving the euro to a greater or lesser extent. These

exchange rate regimes are currency boards (Bosnia-Herzegovina, Bulgaria,

Estonia); currencies pegged to the euro (Cyprus, the Former Yugoslav

Republic of Macedonia and 14 African countries in which the CFA franc is

the legal tender); currencies pegged to a basket of currencies including

the euro, in some cases with a fluctuation band (Hungary, Iceland,

Poland, Turkey, etc.); systems of managed floating in which the euro is

used informally as the reference currency (Czech Republic, Slovak

Republic and Slovenia); and, last but not least, European Union

currencies pegged to the euro through a co-operative arrangement, namely

ERM II. As you well know, Denmark and Greece joined ERM II on 1 January

1999 with a ±2.25% fluctuation band for the Danish krone and a ±15%

fluctuation band for the Greek drachma. Although the euro remains in

second position after the US dollar in terms of its official use, the

role of the euro will increase in the future, without a doubt,

especially after the year 2002 when the euro banknotes and coins will

begin to circulate.

Taking the current situation as a starting point, the Eurosystem's

position concerning the future international role of the euro is crystal

clear: we shall not adopt a belligerent stance in order to force the use

of the euro upon the world economy. We are convinced that the use of the

euro as an international currency will come about anyway. It will happen

spontaneously, slowly but inexorably, without any impulses other than

those based on free will and the decisions of market participants,

without any logic other than that of the market. In other words, the

internationalisation of the euro is not a policy objective of the

Eurosystem; it will neither be fostered nor hindered by us. The

development of the euro as an international currency will be a market-

driven process, a free process.

The euro fulfils the necessary conditions to be a leading international

currency with the US dollar and not against it. There is enough room for

both currencies in the world economy. The necessary conditions for a

currency to become an international currency are based on two broad

factors: low risk and large size. The low risk factor is related to the

confidence inspired by the currency and its central bank, which in turn

mainly depends on the internal and external stability of the currency.

The low risk factor tends to lead to diversification among international

currencies, since diversification is a means to reduce the overall risk;

it acts, so to speak, as a centrifugal force. By contrast, the large

size factor relates to the relative demographic economic and financial

importance of the area which supports the currency; in other words, the

"habitat" of the currency. The large size factor, which concerns the

demographic, economic and financial dimension, generally tends to lead

to centralisation around one or a few key international currencies. It

can be seen as a centripetal force, as a virtuous circle, which will

tend to lead to an increasing use of the euro as an international

currency. Let us consider these two factors in more detail.

The first factor concerns low risk, credibility and stability. The

stability of the euro is a priority for the ECB. Compared with the idea

of stability, the strength of the euro is of lesser importance. This

does not mean that the exchange rate of the euro does not constitute an

element to be considered in the second pillar of the monetary policy

strategy of the ECB, which consists of a broadly based assessment of the

outlook for price developments and risks to stability obtained from a

wide range of economic indicators, the euro exchange rate being one of

them. However, the basic factor that will determine the importance of

the euro as a widely used currency in the world economy, in addition to

the demographic, economic and financial dimensions of the euro area, is,

without a doubt, the stability of the new currency, understood as a

means to maintain the purchasing power of savings.

Stability is the basic requirement for a good currency. It is what we at

the ECB want for the euro. We want a stable euro and we are convinced

that, in the long term, the euro will derive strength from its

stability.

The stability of the euro is the basis for the confidence in and the

credibility of the ECB, without which a large international role for the

euro would be unthinkable. Stability is the proof of the effectiveness

of the institution. Yet in order to be credible it is not sufficient for

the ECB to maintain stability. Other parameters of its action must be

considered: accountability, transparency and communication, a Europe-

wide perspective, etc.

These parameters or conditions for the credibility of the euro are

certainly demanding. However, the achievement of these conditions is the

aim of all those of us who have responsibilities with regard to the

functioning of the Eurosystem.

The second factor, which we have called the large size factor or the

habitat of the euro, is important because without a certain critical

mass, a currency cannot have international relevance, however high its

degree of stability.

The figures relating to the population and the GDP of the euro area

illustrate this. With 292 million inhabitants, its population exceeds

that of the United States (270 million) and that of Japan (127 million).

The GDP of the euro area is, on the other hand, equal to 76% of the GDP

of the United States (EUR 5,774 billion compared with EUR 7,592

billion), though it is higher than that of Japan (EUR 3,327 billion).

The source of this information, which refers to 1998, is Eurostat.

However, even more important than the current figures is the potential

for the future development of the euro area, in terms of population and

GDP, if and when the so-called "pre-ins" (Denmark, Greece, Sweden and

the United Kingdom) join the Eurosystem.

The entry of these countries would result in a monetary area of 376

million inhabitants, 39% larger than the United States and almost triple

the size of Japan, with a GDP of EUR 7,495 billion, only slightly less

than that of the United States and 125% higher than that of Japan.

All these facts and figures which demonstrate the demographic and

economic importance of the European Union would be further strengthened

by enlargement to eastern Europe. Our continent has a historical,

cultural and geographical identity - from the Iberian peninsula to the

Urals, with certain additional external territories - which, in the

future, may also come to form an economic unit. However that is, for the

moment, a distant prospect.

The size or habitat of an economy does not only depend on demographic or

economic factors; it also has to do with the financial base or dimension

of the area. In considering the financial dimension of the euro area,

the first relevant feature to observe is the low level of capitalisation

of the stock markets in comparison with the United States and Japan.

Although this feature could give the impression that the euro area has a

relatively small financial dimension relative to its economic dimension,

this is not the case. The lower degree of development of the capital

markets is offset by a higher degree of banking assets. This means that

the financial base of real economic activity in Europe is founded on

bank intermediation, which is also a feature of the Japanese economy.

For example, private domestic credit in the euro area amounts to 92.4%

of GDP, while in the United States it is only 68.9%. Conversely, fixed

domestic income represents 34.2% of GDP in the euro area compared with

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