Европейская денежная система


               European Monetary System and European Currency

    Based on selected papers kindly provided by the European Central Bank



                          Compiled by Dm. Evstafiev
             for the students of the School of Political Science
                     at St. Petersburg State University



                               St. Petersburg
                                    1999
               Developments in the Financial Sector in Europe
      following the Introduction of the Euro

      Speech by Dr. Willem F. Duisenberg,
      President of the European Central Bank,
      to be delivered at the Third European Financial Markets Convention
                             Milan, 3 June 1999

       1. Introduction

        The period of the five months following the introduction of the euro
has been very rich in  new  events,  with  significant  developments  taking
place both in the  continental  securities  markets  and  in  the  financial
system as a whole. Although experience has been gathered over  a  relatively
short  period  of  time,  I  am  tempted  to  make  two  observations  of  a
fundamental nature.
         The  first  observation  is   that   developments   following   the
introduction of the euro do not imply that the euro area is set to become  a
financial fortress whose financial markets and  institutions  would  be  cut
off from the rest of  the  world.  In  fact,  market  participants  residing
outside the euro area seem to be taking a keen  interest  in  the  financial
markets of the euro area. "Core  Europe",  so  to  speak,  has  become  more
interesting to outsiders as the  breadth  and  liquidity  of  its  financial
markets has increased.
        The second observation is that the euro can be expected  to  have  a
significant influence on the structure of the financial system  by  bringing
about more securitisation. A traditional feature of the financial system  of
continental Europe has been a marked dependency on the  funds  intermediated
by banks. This feature contrasts with the financial  system  of  the  United
States which is much more securitised. For instance,  corporate  bonds  have
not  been  very  widely  issued  in  the  euro  area,   and   stock   market
capitalisation - relative to the size of the economy - is much lower in  the
euro area than in the United States. There are good reasons to believe  that
a process of securitisation will gather pace in the euro area now  that  the
single currency is in use. This view seems to be shared  by  many  observers
and I shall, in the course of my remarks,  provide  some  arguments  in  its
favour.
        In my remarks today, I should like to discuss the structural changes
in the financial sector, in particular those that have occurred as a  result
of the launch of new product types and the changing  nature  of  public  and
private institutions. I shall address developments  in  the  money  markets,
the bond  markets  and  the  equity  markets  as  well  as  the  process  of
adaptation of banking institutions to their new environment.

       2. Money markets

       The money markets of the euro area became  rapidly  integrated  after
the introduction of the euro despite the  fact  that  their  structures  had
previously been quite different at the national level.  Transaction  volumes
and measures of bid-ask spreads on  the  various  money  market  instruments
both indicate that the markets reached a very high level of  liquidity  very
rapidly in the course of January 1999 and have subsequently retained it.
        The high degree of integration of the euro area  money  markets  is,
first of all, a result of the single monetary  policy,  which  is  conducted
through  the  harmonised  operational  framework  of  the  Eurosystem.  This
integration has also been made possible by the  significant  and  increasing
integration of payment systems. Cross-border payments  processed  by  TARGET
accounted for  more  than  37%  of  the  value  of  all  real-time  payments
(domestic and cross-border) effected by credit  institutions  in  March  and
April 1999. Moreover, the continuously high  use  which  our  counterparties
make of the correspondent central banking model (or  CCBM)  for  the  cross-
border transfer of collateral in monetary policy operations is an  important
indication of area-wide integration. This is  evidenced  by  the  fact  that
cross-border collateral currently represents around 25% of the total  amount
of collateral in custody in the context of the Eurosystem's monetary  policy
operations.
        Taking a closer look at the various instruments traded in the  money
markets, a feature that is worthy of note is  that  market  participants  in
the 11 countries of the euro area  have  shown  an  increasing  tendency  to
demonstrate a similar reliance on each instrument type.  For  example,  what
we call "overnight indexed swaps", which are swaps indexed on the  overnight
reference  interest  rate  EONIA,  have  become  an   important   derivative
instrument in the money markets of the euro area. This can be seen from  the
low level of quoted bid-ask spreads and the high turnover relative to  other
major international markets. Both indicators show a high level of  liquidity
in this instrument. Another type of instrument  of  interest  in  the  money
market (but also  at  the  fringe  of  the  bond  market)  is  that  of  the
repurchase agreement. The development of more  integrated  repo  markets  in
the  euro  area  will  obviously  accompany  the  development  of  area-wide
securities  trading,  settlement  and  custody  systems.  This  will  reduce
transaction costs and improve efficiency for the  cross-border  transfer  of
securities through repurchase operations.
        Looking ahead, other developments in the money markets are  expected
in the coming months. There are aims to establish  new  area-wide  standards
for the repo markets, with a  view  to  overcoming  the  separation  between
different  models  in  the  national  markets.  These  new  standards  could
obviously  co-exist  with  other  standards  and  broader  conventions   for
international transactions. In fact, over the last few months  the  European
Central Bank (ECB)  has  been  examining  whether  this  co-existence  could
affect the integration of money markets. We  have  come  to  the  conclusion
that, in particular owing to the efforts of the sponsors  of  the  different
standards, this should not be considered a threat.
        Finally, it should also be noted  that  national  and  international
central securities depositories are  currently  developing  links  with  one
another, which will enable participants in one country to  make  direct  use
of securities deposited  in  other  countries.  Twenty-six  of  these  links
(concerning mainly Belgium, Germany, France,  Luxembourg,  the  Netherlands,
Austria and Finland) may be used by the Eurosystem.

       3. Bond markets

        I should now like to turn to bond markets and first  to  comment  on
the position of euro area bond markets  in  the  global  market.  Some  data
sources on  international  securities  issuance  available  so  far  show  a
pattern of increased reliance on euro-denominated bonds at the beginning  of
1999, in particular as opposed to  US  dollar-denominated  bonds.  While  it
remains difficult to draw firm  conclusions  on  the  determinants  of  bond
denomination choices without considering information on the nature  of  bond
holdings and trading patterns, recent bond issuance  volumes  indicate  that
the  euro  has  the  potential  to  become   an   important   currency   for
international bond issuance.
        The importance of the euro area bond  market  is  also  apparent  in
measures of secondary market activity, i.e. turnover or trading volumes.  In
particular, trading volumes on exchange-traded bond futures  are  indicative
of  the  overall  degree  of  market  activity.  Volumes  traded  in   euro-
denominated bond futures were low  shortly  before  the  changeover  to  the
euro, when the bond markets in  the  euro  area  were  exceptionally  quiet.
Since then, volumes have increased markedly  and  they  currently  stand  at
consistently high levels, which indicates  a  continuously  high  degree  of
turnover in euro-denominated bond markets in general.
        Turning to the internal structure of the bond markets  of  the  euro
area, I should like to make an initial observation  related  to  the  recent
marked increase in  euro-denominated  corporate  bond  issuance,  which  was
accompanied by an increase in the average size of issues. This  tendency  is
likely to continue in the future, in particular to  the  extent  that  bonds
may be  used  by  firms  to  finance  increasing  mergers  and  acquisitions
activity in the  euro  area.  The  underlying  reasons  for  increased  bond
issuance by euro area firms are clear, both on the supply and on the  demand
side. On the supply side, large firms with good  credit  ratings  will  find
opportunities in the increased depth and liquidity of  the  euro  area  bond
market. On the demand side, the respect by governments of the parameters  of
the Stability and Growth Pact over the medium term should  leave  more  room
for the private sector to issue debt securities. In addition, the euro  area
must be in a position to save in order to  be  able  to  take  care  of  its
future pension payments, and a  part  of  these  savings  is  likely  to  be
invested in corporate debt securities. An  increase  in  global  demand  for
euro-denominated debt securities is also expected  as  the  euro  becomes  a
major  reserve  currency.  Moreover,  the  demand  for  higher  risk   euro-
denominated debt securities is  likely  to  increase,  particularly  as  the
current low level of sovereign yields increases  incentives  to  search  for
higher yields.
        With regard to the government bond markets, an issue  of  importance
for the euro area that I should like to stress is the fact that  governments
now find themselves in a rather new position as  issuers.  This  reflects  a
number of developments, two of which I should particularly like to  mention.
First, the major public issuers have attempted  to  position  themselves  as
providers of benchmarks for euro-denominated bond markets.  Second,  certain
issues of government  bonds  have  effectively  gained  larger  portions  of
secondary markets, in particular  in  relation  to  developments  that  have
occurred on bond futures markets.
        Market participants have responded to these developments in the bond
markets with a range of concurring or competing initiatives  and  alliances.
In the  derivatives  industry,  market  participants  have  established  new
alliances. On the trading side, electronic cross-border platforms for  bonds
have been created or are in the process of being developed. On the  clearing
side, integrated platforms for different markets have been launched  or  are
being  finalised,  while,  finally,  on  the  securities  settlement   side,
initiatives have also been launched. It is  important  to  note  that  while
some of these developments are internal to the  euro  area,  others  aim  at
creating links with  financial  markets  outside  the  euro  area.  One  may
reasonably expect that all of these new circuits, as well as others, may  in
the  future  be  enlarged  to  encompass  a   growing   number   of   market
participants.

       4. Equity markets

        Turning to equity markets, structural developments of most  interest
relate to the infrastructure of stock exchanges on the one hand  and  equity
derivative exchanges on the other.  First,  within  the  euro  area,  equity
investment and trading activities appear to be less and less  influenced  by
country-specific   factors   and   increasingly   subject    to    area-wide
considerations. Consistent with this development, area-wide  equity  indices
have been developing. Market participants are showing considerable  interest
in these area-wide indices, in particular as  they  are  also  now  adopting
investment positions on area-wide industrial sectors, using the  sub-indices
made available for that purpose. An indication of  the  degree  of  interest
raised by  area-wide  indices  is  the  relatively  fierce  competition  for
benchmark status that has developed between the various proponents of  area-
wide indices.
        Second, market developments in relation to stock index  futures  and
options will reflect the rise of area-wide indices. This may  in  turn  lead
to either consolidation  or  product  specialisation  of  equity  derivative
exchanges. For my part, I  consider  the  development  of  fair  competition
between exchanges to be a positive factor in terms  of  the  improvement  of
the range of products and services available to the financial industry.
        Third, in the equity market the euro has also  provided  a  powerful
incentive for the creation of new  -  and  possibly  competing  -  alliances
among exchanges. Before the launch of  the  single  currency,  circuits  had
been created for the launch of integrated "new markets"  within  and  beyond
the euro area, encompassing the shares of small and  medium-sized  companies
with a high potential for growth. The  development  in  the  integration  of
exchanges has also continued more recently, and, as you  know,  it  has  not
been limited to the euro area.

       5. Banking

        In the field of banking, the securitisation trend appears to  demand
strategic and organisational adjustment on the part of banks.  The  relative
importance of the more traditional types of banking activity can be seen  to
be decreasing, even though it should be mentioned that  traditional  banking
activities have nonetheless continued to grow at a rate  exceeding  that  of
growth of nominal GDP. In the euro area, growth in  recent  years  has  been
much more rapid in assets under the management of  mutual  funds  and  other
institutional investors than  in  the  assets  of  banks.  This  reflects  a
tendency towards decreasing the relative weight of  bank  deposits  compared
with securities in financial wealth.
        The euro area banking  industry  has  reacted  to  this  development
already by diversifying into the asset management area. Banking groups  have
been  able  to  "internalise"  a  significant  part  of  the  securitisation
tendency as they control a large majority of the mutual funds. As  a  result
of the securitisation trend, there has been an  increase  in  the  share  of
security holdings among bank  assets,  and  an  increase  in  the  share  of
capital gains - although those are quite cyclically sensitive - as  well  as
in fee income  stemming  from  asset  management  services.  Meanwhile,  the
relative importance of interest income has declined correspondingly. At  the
bank level, dividend income from equity participations has generally  become
much more important, indicating an increase in the importance of the  profit
generated by non-bank subsidiaries.
        Beside the establishment of non-bank subsidiaries, there  have  been
other strategic and organisational  changes  that  have  resulted  in  banks
strengthening   their   securities-related   activities.   In    particular,
significant motives behind the recent  merger  trend  seem  to  include  the
desire to increase bank size and hence to be able to operate efficiently  in
wholesale securities markets as well as to be able to cater  for  the  needs
of large international corporations for investment banking services.
        The trend towards securitisation can  be  regarded  as  one  of  the
reasons for the structural changes in the banking  system  that  appears  to
have accelerated recently. There have naturally also been other reasons  why
banks have sought to merge, predominantly the need to cut  capacity  and  to
reduce costs. These cost-driven mergers have  taken  place  primarily  among
smaller banks.

       6. Conclusion

        In my remarks today, I have referred to  a  number  of  changes  and
market initiatives in the euro area financial landscape. These  developments
point to the increasing importance of the fixed income  and  equity  markets
that many expected in Stage Three of  Economic  and  Monetary  Union  (EMU),
providing  new  opportunities  for  borrowers  and  investors  and   causing
pressure to adjust for financial institutions. In  this  respect,  I  should
like  to  mention  the  importance  of  removing  the  remaining  regulatory
barriers to the further development of the securities markets. To this  end,
the European Commission has recently published an Action Plan of  regulatory
changes to improve the single  market  for  financial  services  that  would
certainly - when implemented  -  boost  the  integration  and  market-driven
development of the European securities markets.
        Finally, I should like to conclude with some remarks about the  role
of the Eurosystem (the term that we use to mean the ECB and the 11  national
central banks of the Member States participating in Stage Three of  EMU)  in
the developments in the financial  sector  in  Europe.  First  of  all,  the
Eurosystem contributes to developments in the financial sector by  providing
it with a stable and credible monetary policy. With a  strong  and  credible
commitment to its primary objective, price  stability,  the  Eurosystem  has
created a situation in which the financial sector can concentrate  on  those
issues that are of the greatest relevance to its activities.
         The  Eurosystem  does  not  play  a  direct  role   in   structural
developments in the  financial  sector.  With  its  single  monetary  policy
framework  and  TARGET  in  particular,  the  Eurosystem  has   created   an
infrastructure that has proved to be useful  for  the  establishment  of  an
integrated money market in the euro area.
         In  addition,  the   Eurosystem   carefully   monitors   structural
developments in the financial sector to the extent that they might  have  an
impact on the conduct  of  monetary  policy.  To  make  a  final  point,  in
observing developments in the financial sector,  the  Eurosystem  constantly
takes account of the fact that one of its tasks, laid  down  in  the  Treaty
establishing the  European  Community,  is  to  "contribute  to  the  smooth
conduct of policies pursued by the competent  authorities  relating  to  (…)
the stability of the financial system" [(Article 105 (5))]. Analysis of  the
common developments in the  European  financial  system  represents  such  a
contribution.

                                     ***

      Economic and Monetary Union in Europe - the challenges ahead

      Speech by Professor Dr. L.H. Hoogduin,
                   on behalf of Dr. Willem F. Duisenberg,
                   President of the European Central Bank,
      at the symposium sponsored by the Federal Reserve Bank of Kansas
                                                City
                   on "New challenges for monetary policy"
                 on 27 August 1999 in Jackson Hole, Wyoming

       From the European perspective, the title of this year's Jackson  Hole
symposium  -  "new  challenges  for  monetary  policy"  -  is   particularly
appropriate. Economic and  Monetary  Union  (EMU)  in  Europe  is  a  unique
project and its consummation with the introduction of  the  single  monetary
policy on 1 January 1999 took place  less  than  eight  months  ago.  Today,
given the time available, I will not endeavour to review all the  challenges
which are raised by EMU comprehensively.  I  shall  have  to  be  selective,
largely focusing on the primary objective of the  Eurosystem,  which  is  to
maintain price stability in the euro area. In this context, let  me  briefly
explain our terminology, which may perhaps not  be  known  to  everybody  as
yet. The "Eurosystem" is the name we  gave  to  the  European  Central  Bank
(ECB) and the currently eleven national central  banks  of  those  countries
which have introduced the euro.  The  "euro  area"  comprises  these  eleven
countries.
       I should like to start with some observations on  the  objective  and
limitations of monetary policy in the euro area.  Owing  to  the  successful
process of disinflation and convergence within Europe over the past  decade,
the launch of the euro last January took place in an  environment  of  price
stability that few observers would have predicted  only  a  few  years  ago.
Consumers and firms are already reaping the benefits  of  this  environment.
The relative price signals on which the efficiency of the  market  mechanism
relies are not obscured by volatility in the general  level  of  prices.  By
avoiding the costs and distortions inflation would impose  on  the  economy,
price stability is contributing to the growth and  employment  potential  of
the euro area.
       This contribution is substantial. Unfortunately, it is all too easily
taken for granted. Memories  of  the  still  recent  past  relating  to  the
consequences of high and unstable inflation tend to  fade  rapidly.  We  are
sometimes already hearing the argument that, given that price stability  has
been achieved, monetary policy should  now  be  re-oriented  away  from  its
primary objective of  price  stability  towards  other  goals.  One  of  the
challenges facing the Eurosystem is to maintain the  support  of  the  broad
public constituency necessary to resist these calls, which  -  as  I  hardly
need to point out to such a distinguished audience of  central  bankers  and
monetary economists  -  are  misguided  and  ultimately  counter-productive.
However, it can be said that the situation is the same as that in the  world
of sports; winning a championship and reaching the  top  is  difficult,  but
staying there is even harder.
       The institutional framework for European monetary policy, as  created
by the Maastricht Treaty (i.e. the  Treaty  on  European  Union,  which  has
become part of the Treaty establishing the European  Community,  or  the  EC
Treaty,  in  short)  is  well  suited  to  meeting  this   challenge.   Most
importantly, the single  monetary  policy  has  been  clearly  assigned  the
primary objective of maintaining  price  stability  in  the  euro  area.  To
facilitate the achievement of this goal, the ECB and  the  national  central
banks have been accorded a high degree of institutional independence  so  as
to protect monetary policy decisions from undue external interference.
       The Treaty imposes several duties and  tasks  on  the  ECB.  However,
there is no doubt that the objective of price stability is over-riding.  For
example, the Treaty stipulates - if  I  may  quote  -  that  the  Eurosystem
"without prejudice to the objective of price stability, … shall support  the
general economic policies in the Community, with a view to  contributing  to
the  achievement  of  the  objectives  of  the  Community",  which   include
"sustainable and non-inflationary growth" and "a high level of  employment".

       Given the clear priority attached to the primary objective  of  price
stability, how does the ECB address these other Treaty obligations?  Let  me
make three points in this regard.
       First, among economists and central bankers,  there  is  overwhelming
agreement that there is no long-run  trade-off  between  real  activity  and
inflation.  Attempting  to  use  monetary  policy  to  raise  real  economic
activity above its sustainable level will, in the end, simply lead  to  ever
higher inflation, but not to faster economic growth.  I  am  convinced  that
the best contribution monetary policy can make  to  sustainable  growth  and
employment in the euro area is to maintain price  stability  in  a  credible
and lasting manner, allowing the considerable benefits  of  price  stability
to  be  reaped  over  the  medium  term.  This  is  the  economic  rationale
underlying the EC Treaty and the Eurosystem's monetary policy strategy.
       Second, it is generally acknowledged that monetary policy does affect
real activity in the short run. Although the focus must always be  on  price
stability, in many cases  the  policy  action  required  to  maintain  price
stability  will  also  help  sustain  short-run  economic   and   employment
prospects. The reduction of the Eurosystem's  main  refinancing  rate  on  8
April was a case in point. Following the Asian and Russian financial  crises
last year, global demand weakened. Weaker external demand led to a shift  in
the balance of risks to  price  stability  in  the  euro  area  towards  the
downside, as demand pressures abated. As monetary indicators did not  signal
inflationary risks at that time, the Governing Council of the ECB  concluded
that a cut of 50 basis points in the main refinancing rate best  served  the
maintenance of price stability. This lower level of interest rates may  also
be supportive of real activity and employment in  the  short-run.  Our  eyes
must always be firmly focused on the goal, on our goal,  to  maintain  price
stability in the medium term. Our monetary policy does  not  explicitly  aim
at influencing the business cycle. However,  as  said  in  many  cases,  the
necessary monetary policy measures to achieve our  goal  also  tend,  almost
automatically, to work in the right  direction  from  a  cyclical  point  of
view.
       This leads me to my third point. In situations where monetary  policy
might face a short-term  trade-off  between  adverse  developments  in  real
activity and deviations  from  price  stability,  the  over-riding  priority
accorded to countering  the  latter  must  be  made  absolutely  clear.  Any
ambiguity on this point will simply endanger the credibility, and  therefore
the effectiveness, of the monetary policy response. This does not mean  that
the policy action must be draconian.  The  medium-term  orientation  of  the
Eurosystem's monetary policy strategy  permits  a  gradualist  and  measured
response to previously unforeseen threats to price  stability,  should  this
be regarded as appropriate, depending on the  nature  of  the  threat.  Such
gradualism may help to avoid the  introduction  of  unnecessary  uncertainty
into the real economy.
       Recognition and an understanding of these three  central  points  are
essential  for  the  implementation  of  a   successful   monetary   policy.
Communicating both the objective and the limitations of monetary  policy  to
the public is a vital issue to which I will return later in my remarks.  But
it would be remiss at this point if I did not address  what  is  surely  the
greatest economic challenge facing the euro  area  at  present,  namely  the
unacceptably high level of unemployment. There is  a  broad  consensus  that
unemployment in the  euro  area  is  overwhelmingly  structural  in  nature.
Monetary policy cannot solve this problem.  National  governments  bear  the
main responsibility for structural economic reforms. In particular,  further
reforms of the tax and welfare systems are required in many EU countries  in
order to increase the incentives to create new  jobs  and  to  accept  them.
Wage moderation can also have  a  significant  beneficial  impact.  Monetary
policy makes its best supportive contribution by providing  the  environment
of price stability in which structural reforms can work most effectively.
       It should be recognised that the implementation of EMU  has  made  it
even more urgent to improve the flexibility of labour and goods markets.  In
this context, it would very likely be the wrong answer if  governments  were
to try to create a "social union", harmonising social security  systems  and
standards at a very high level. The ECB will continue to cajole  governments
into implementing necessary and long overdue reforms,  but  the  final  hard
decisions - and I acknowledge  that  they  are  hard  decisions,  since  the
considerable benefits of structural reform often only become  apparent  with
time  -  lie  with  the  national  authorities.  In  those  countries  where
appropriate structural reforms have been implemented  and  wage  growth  has
been moderate, unemployment is either low  by  euro  area  standards  or  is
falling more rapidly. These experiences offer important  lessons  for  other
countries in  the  euro  area.  Fortunately,  a  broader  awareness  of  the
necessity of structural reforms recently seems to be emerging in Europe.  Of
course, ultimately only sustained action will count. The  cyclical  recovery
that is underway is no substitute for such action.
       Thus far, I have largely discussed the goal of  the  single  monetary
policy. How is this goal to be achieved? At the heart of the answer to  this
question is the Eurosystem's monetary policy strategy. The strategy has  two
closely related aspects. First, the strategy  must  structure  the  monetary
policy-making process in such a way that the Governing Council  of  the  ECB
is presented with the information and analysis required to take  appropriate
monetary policy decisions. Second, the  strategy  must  ensure  that  policy
decisions, including the economic rationale on which they are based, can  be
presented in a clear and coherent  way  to  the  public.  The  communication
policy as part of the strategy obviously  has  to  be  consistent  with  the
structure of the internal decision-making process.
       In designing the Eurosystem's strategy, the Governing Council of  the
ECB recognised the new circumstances faced by monetary policy  in  the  euro
area. Where there were previously eleven open,  generally  small  economies,
there is  now  one  large,  relatively  closed  single  currency  area.  The
challenges implied by this  transformation  in  the  landscape  of  monetary
policy are profound.
       Relatively little is known as yet about the transmission mechanism of
monetary policy in the euro area after the  transition  to  Monetary  Union.
One important challenge for the Eurosystem is to obtain a  better  knowledge
of  the  structure  and  functioning  of  the  euro  area  economy  and  the
transmission mechanism of monetary policy within it, so that policy  actions
can be implemented  accordingly.  Together  with  experts  in  the  national
central banks, the ECB has embarked on an intensive  programme  of  analysis
and research into these issues.
       One obvious problem related to the fact that the euro  area  did  not
exist as a single currency area in the  past  regards  the  availability  of
statistical data. Compared with national central banks, we do not  have  the
same amount  of  long  historical  time  series  of  monetary  and  economic
indicators, based on  harmonised  statistical  concepts,  at  our  disposal.
However, we have already developed quite reliable estimates for a number  of
these historical  series,  and  the  quality  and  availability  of  current
statistics on the euro area has increased significantly over  the  last  few
quarters, for example in the areas of  money  and  banking  and  balance  of
payments statistics, but also across a wide range  of  economic  statistics.
This process of improving the quality and the  availability  of  statistical
data covering the euro area will continue.
       It would have clearly been unwise for the ECB to develop  a  strategy
which relies mechanically on the signals offered by a  single  indicator  or
forecast in  order  to  take  monetary  policy  decisions.  Indeed,  such  a
simplistic  approach  to   monetary   policy-making   is   unwise   in   all
circumstances. Our knowledge of the structure of the euro area  economy  and
the indicator properties of specific variables - although improving  rapidly
- is simply too limited.
       The primary objective of monetary policy has been quantified with the
publication  of  a  definition  of  price  stability,  against   which   the
Eurosystem  can  be  held  accountable.  This  definition  illustrates   our
aversion to both inflation and deflation, since it defines  price  stability
as annual increases of below 2% in the Harmonised Index of  Consumer  Prices
(HICP) for the euro area. To maintain  price  stability  according  to  this
definition,  monetary  developments  are   closely   monitored   against   a
quantitative reference value for  the  broad  benchmark  aggregate,  M3.  In
parallel, a broadly based assessment of the outlook for  price  developments
in the euro area is undertaken. This assessment encompasses a wide range  of
indicator variables, including inflation projections  produced  both  inside
and outside the  Eurosystem.  Using  all  this  information,  the  Governing
Council comes to a decision on the level of short-term interest  rates  that
best serves the maintenance of price stability over the medium term.
       On the basis of this strategy, I  am  confident  that  the  Governing
Council has taken - and will continue to take - appropriate monetary  policy
decisions. The effectiveness of  these  policy  decisions  will  depend,  in
large part, on the credibility of the single  monetary  policy.  Transparent
and accountable policy-making can help to build up a reputation  and,  hence
credibility. Transparency and accountability, in turn,  rely  on  clear  and
effective communications between the Eurosystem and the public.
       In this regard, the Eurosystem faces an especially  formidable  task.
As mentioned earlier, the euro area currently consists of  eleven  different
sovereign  nations,  each  with  its  own  distinct  monetary  history   and
heritage. With each policy announcement or Monthly Bulletin, the  Eurosystem
must thus communicate with the public  of  eleven  different  countries  and
must speak in all  eleven  different  official  languages  of  the  European
Union. Such a  situation  is  unprecedented.  This  diversity  of  language,
history and culture across the euro area raises further challenges  for  the
ECB.
       Over the years, each national central  bank  had  developed  its  own
strategy and, linked  to  this,  its  own  "monetary  policy  language"  for
communicating with the  public  in  the  nation  it  served.  This  language
reflected the unique circumstances of the country in question.  The  process
by which the public learnt this monetary language from  the  statements  and
behaviour of the national central bank was largely subconscious. Over  time,
the strategies and the related language and conventions of  monetary  policy
came to be so well understood as  to  be  almost  second  nature.  In  these
circumstances, private economic behaviour was shaped by the monetary  policy
environment.
       Many of us have experienced the problem of trying to learn  a  second
language in adult life. This rarely comes as easily as learning your  native
tongue as a child. It is certainly not a subconscious  process,  but  rather
one that  requires  effort  and  perseverance.  It  is  often  difficult  to
overcome the habits and conventions  of  one's  first  language,  which  are
inevitably somewhat at odds with those of a foreign tongue.  Of  course,  it
is easier to learn a language that  shares  common  roots  with  one's  own.
Nevertheless, to obtain any degree of fluency, there is  no  alternative  to
long  hours  practising  pronunciation,  studying   grammar   and   learning
vocabulary. Even then,  the  idioms  and  slang  of  the  new  language  are
sometimes hard to follow. There are no easy short cuts.
       With the adoption of the euro last  January,  the  public,  financial
markets and policy-makers in the euro area have all had to  get  used  to  a
new monetary  policy  environment  and  have,  thus,  had  to  learn  a  new
"monetary policy language". The Eurosystem's monetary  policy  strategy  has
been designed, in part, to make this learning process as straightforward  as
possible. Continuity with the successful strategies of the national  central
banks prior to Monetary Union was one of the  guiding  principles  governing
the selection of the  monetary  policy  strategy.  Nevertheless,  given  the
changed  environment  for  monetary  policy,  a  new  strategy  with  a  new
vocabulary  had  to  be  developed,  reflecting   the   unique   and   novel
circumstances facing the Eurosystem.
       Some commentators have suggested that the Eurosystem simply adopt the
strategy used by another central bank or by a national central bank  in  the
past. Tellingly, such observers often suggest the strategy they  know  best:
Americans suggest using the Federal Reserve as a model;  Britons,  the  Bank
of England; Germans, the Bundesbank. However, the Eurosystem  cannot  simply
adopt a strategy designed by another central bank for a  different  currency
area under different economic circumstances.  A  strategy  that  might  have
been suitable in one situation may be quite  inappropriate  for  the  unique
and novel circumstances facing the  Eurosystem,  given  the  very  different
economic structure and environment confronting it.
       A key feature of the ECB's communication policy is the monthly  press
conference  given  by  the  ECB's   Vice-President   and   myself,   usually
immediately following the first Governing Council  meeting  of  each  month.
During  these  press  conferences,  I   make   an   introductory   statement
summarising the  Council's  discussions  and  conclusions  before  answering
questions from journalists. As the statement is agreed, in  substance,  with
all the Council members  beforehand  it  is  similar  to  what  others  call
minutes. The press conference provides prompt information in an  even-handed
way, and it offers the opportunity for immediate two-way  communication.  As
far as I am aware, no other central bank communicates  with  the  public  in
such a prompt manner immediately after its monetary policy meetings.
       These press conferences are a tangible expression of the Eurosystem's
commitment to be  open,  transparent  and  accountable  in  its  conduct  of
monetary policy. In my view, our commitment to openness  should  not  be  in
doubt. However,  ensuring  that  this  openness  translates  into  effective
communications continues to be a challenge. Journalists,  financial  markets
and the public are still learning the new strategy and language of  monetary
policy in the euro area.
       By its nature, the challenge of improving communications between  the
Eurosystem and the public is two-sided. On the one hand, the ECB must use  a
clear and transparent language consistent with the strategy it has  adopted.
It  must  help  the  public  understand  the   changes   of   emphasis   and
communication  necessitated  by  the  new  monetary  policy  environment  in
Europe. We have made important progress in this regard over the  last  eight
months, but I acknowledge that we still have some way to go.  The  ECB  must
do its utmost to be understood by its counterparts in the media that act  as
important intermediaries to the  public  at  large.  By  learning  from  one
another, we can improve  the  transparency,  democratic  accountability  and
effectiveness of the single monetary policy.
       Before concluding, I should like to add a brief comment on the likely
future enlargement of the European Union (EU) and, prospectively,  the  euro
area. Currently, the EU negotiates the accession of  six  countries  to  the
EU. Once the accession of new Member  States  is  decided,  these  countries
have to fulfil the so-called convergence criteria, if they want to join  the
euro area. The euro area can  finally  only  be  enlarged  if  the  European
Council, following an assessment by the ECB  and  the  European  Commission,
decides that further Member States of the EU are ready to adopt  the  single
currency. New countries joining the euro area will be a  challenge  for  us.
For example, we will have to integrate the respective economy fully  in  our
area-wide analysis of monetary, financial and  other  economic  developments
in the euro area. Enlargement is a challenge we clearly welcome. I  have  no
doubts that we can master it, not least as the EC Treaty  outlines  a  clear
and transparent procedure for countries wishing to join the  euro  area.  In
simple terms, this can  be  viewed  as  involving  three  phases.  First,  a
candidate  country  must  join  the  European  Union,  for   which   certain
requirements must be met. Second, the candidate is expected to join the  new
exchange rate mechanism, ERM II. Third, as mentioned  earlier,  the  country
must fulfil the convergence criteria. In addition to fiscal  discipline  and
inflation control, these criteria include a relatively low  level  of  long-
term interest rates and stable exchange rates.
       Let me conclude. Monetary policy cannot solve  all  of  the  economic
challenges facing the euro area, in particular those concerning  the  urgent
need  to  reduce  the  high  level  of  structural  unemployment.   National
governments  are  responsible  for  carrying  out  the  required  structural
reforms. The Eurosystem makes its best contribution to area-wide growth  and
employment prospects by  credibly  focusing  on  the  maintenance  of  price
stability in the euro area.
       I am confident that the  monetary  policy  strategy  adopted  by  the
Governing Council of the ECB last October has  been  successful  -  and  the
monetary policy decisions that have been based on it  over  the  last  eight
months - serve the fulfilment of this objective. Nevertheless, we  will  not
become complacent; on the contrary, we  will  have  to  continue  to  invest
substantially in analysing the structure of the euro area  economy,  and  in
understanding  the  monetary   policy   transmission   mechanism   and   the
information content of the various monetary and economic indicators.
       Monetary policy is most effective when it  is  credible.  Transparent
and accountable  policy-making  can  help  to  build  up  a  reputation  and
credibility. Effective direct communications with the public, including  the
financial markets, other policy makers and the media requires that we  speak
with one voice in an even-handed way with  our  diverse  counterparties  and
audience. Successfully  refining  our  area-wide  communications,  aimed  at
making our strategy, and the monetary policy based  on  it,  transparent  so
that it can be well understood by the large and varied population we  serve,
is one of the challenges faced by the Eurosystem and,  by  implication,  one
of our priorities.

                                     ***

      EMU AND BANKING SUPERVISION
      Lecture by Tommaso Padoa-Schioppa
      Member of the Executive Board of the European Central Bank
      at the London School of Economics, Financial Markets Group
      on 24 February 1999



     TABLE OF CONTENTS

            I. Introduction
           II. Institutional framework
          III. Industry scenario
           IV. Current supervision
            V. Crisis management
           VI. Conclusion
               Tables



       I. INTRODUCTION

       1. I am speaking here, at the London School of Economics, only a  few
weeks after one of the most remarkable events in  the  history  of  monetary
systems: the establishment  of  a  single  currency  and  a  single  central
banking competence for a group of countries which retain  their  sovereignty
in many of the key fields where the State  exerts  its  power.  To  mint  or
print the currency, to manage it and to provide the ultimate  foundation  of
the public's confidence in it has been,  from  the  earliest  times,  a  key
prerogative of the sovereign. "Sovereign" is indeed the name that was  given
in the past to one currency. And a British Prime Minister not  so  long  ago
explained her opposition to the idea of the single currency with the  desire
to preserve the image of the Queen on the banknotes.
       2. For centuries money has had  two  anchors:  a  commodity,  usually
gold; and the sovereign, i.e. the political power. Less than 30 years  after
the last bond to gold was severed (August 1971), the second anchor has  also
now been abandoned. Although I personally  think  that  political  union  in
Europe is desirable, I am aware that the present  situation,  in  which  the
area of the single currency is not a politically united one,  is  likely  to
persist for a number of years. This means that we  have  given  rise  to  an
entirely new type of monetary order. For the people,  the  success  of  this
move will ultimately depend on the  ability  of  governments  and  political
forces to build a political union. For the central banker and for the  users
of the new currency, the success will be measured  by  the  quality  of  the
currency itself, and such quality will be measured in  the  first  place  in
terms of price stability. This is not only a requirement explicitly  set  by
the Treaty of Maastricht, it is also, in  the  opinion  of  most,  the  "new
anchor" that purely fiduciary currencies  need  after  the  gold  anchor  is
abandoned.
       3. My remarks, however, will focus on another, less  fundamental  but
still important novelty of the monetary  constitution  that  has  just  come
into existence. It is the novelty of  the  abandonment  of  the  coincidence
between the area  of  jurisdiction  of  monetary  policy  and  the  area  of
jurisdiction of banking supervision. The former embraces  the  11  countries
that have adopted the euro, while the latter remains national.  Just  as  we
have no precedent of any comparable size of money disconnected from  states,
we have no precedent for a  lack  of  coincidence  between  the  two  public
functions of managing the currency and controlling the banks.
       In the run-up to the euro this feature of the  system  was  explored,
and some expressed doubts about its effectiveness. I  will  tonight  examine
the problems of banking supervision  in  the  euro  area.  The  plan  of  my
remarks is the following. I will first  review  the  existing  institutional
framework for the prudential control of banks in EMU. I  will  then  examine
the likely scenario for the European banking industry in the  coming  years.
Against this institutional and industry background,  I  shall  then  discuss
the functioning of, and the challenges for, banking supervision and  central
banking in the euro area, both in normal circumstances  and  when  a  crisis
occurs.

      II. INSTITUTIONAL FRAMEWORK

       4. The origin and developments of modern central  banks  are  closely
linked to key changes undergone  by  monetary  systems  over  the  past  two
centuries. Such changes could, very sketchily,  be  summarised  as  follows.
First, paper currency established itself  as  a  more  convenient  means  of
payment than commodity  currencies.  Second,  commercial  bank  money  (bank
deposits) spread as a convenient substitute for banknotes and coins.  Third,
the quantity of money was disconnected from the quantity of  gold.  Thus,  a
double revolution in the technology of the payment  system,  the  advent  of
banknotes and that of cheques or giros, has shaped the functions  that  most
central banks performed over this century: monetary  policy  and  prudential
supervision. Man-made money made monetary policy possible. The fact  that  a
large, now a predominant, component of the money stock was in  the  form  of
commercial bank money made banking supervision necessary.
       Ensuring  confidence  in  the  paper  currency  and,  later,  in  the
stability of the relationship, one could  say  the  exchange  rate,  between
central bank and commercial bank money, were twin public functions, and,  in
general, they were entrusted to the same  institution.  Just  as  money  has
three well-known economic functions - means of payment, unit of account  and
store of value - so there are three public  functions  related  to  each  of
them. Operating and supervising the payment system  refers  to  money  as  a
means of payment; ensuring price stability relates to money  as  a  unit  of
account and a store of value; and pursuing the stability  of  banks  relates
to money as a means of payment and a store of value. In each  of  the  three
functions commercial banks have played, and still largely  play,  a  crucial
role.
       In an increasing  number  of  countries  the  original  triadic  task
entrusted to the central  bank  has  now  been  abandoned  in  favour  of  a
"separation approach", according  to  which  banking  supervision  has  been
assigned to a separate institution. Following the  recent  adoption  by  the
United Kingdom and Luxembourg of the separation approach, only  two  of  the
12 countries represented in  the  Basle  Committee  on  Banking  Supervision
(Italy and the Netherlands) have the central  bank  as  the  only  authority
responsible for banking supervision. In all  systems,  however,  whether  or
not it has the task of supervising the banks, the  central  bank  is  deeply
involved with the banking system precisely because  the  banks  are  primary
creators of money, providers of payment services, managers of the  stock  of
savings and counterparties of central bank operations. No central  bank  can
ignore the need to have a concrete and direct  knowledge  of  "its"  banking
system, i.e. the banking system that operates in the area  of  its  monetary
jurisdiction.
       Personally, I have an  intellectual  attachment  to,  as  well  as  a
professional  inclination  for,  the  central  bank  approach   to   banking
supervision, due partly to the fact that I spent  most  of  my  professional
life in a central bank which is also to this  day  the  banking  supervisor.
Yet I can see, I think, the arguments that have  led  a  growing  number  of
industrialised countries to prefer the separation approach.  Such  arguments
basically  point  to  the  potential  conflict  between  controlling   money
creation for the purpose of price stability and  for  the  purpose  of  bank
stability. On the whole, I do not think that one  model  is  right  and  the
other  wrong.  Both  can  function,  and  do   function,   effectively;   if
inappropriately managed, both may fail to satisfy the  public  interest  for
which banks are supervised.
       5. Against this background, let me  now  describe  the  institutional
framework currently adopted by the Treaty. As my description will  refer  to
the area in which both  the  single  market  and  the  single  currency  are
established, it will not specially focus on the problems  of  the  so-called
"pre-in" countries, including the United Kingdom.
       The current institutional framework of EMU (i.e.  the  single  market
plus the single currency) is a construct composed of  two  building  blocks:
national competence and co-operation. Let me first briefly review  the  main
aspects of these two  building  blocks  and  then  see  how  the  Eurosystem
relates to them.
       First,  national  competence.  In  a  market  based  on  the  minimum
harmonisation and the mutual recognition of  national  regulatory  standards
and practices, the principle of "home country  control"  applies.  According
to this principle every bank has the right to do business in the whole  area
using a single licence, under the supervision, and following the  rules,  of
the  authority  that  has  issued  the   licence.   The   full   supervisory
responsibility thus belongs to the "home country". This allows, inter  alia,
the  certain  identification  of  the  supervisor   responsible   for   each
institution acting as a counterparty to the monetary  policy  operations  of
the Eurosystem. The only exception to this principle -  the  "host  country"
competence for the supervision of liquidity of  foreign  branches  -  is  no
longer justified now that the euro is in place;  hence  it  should  soon  be
removed.
       Second, co-operation. In a highly regulated industry such as banking,
a single market that retains a plurality of "local"  (national)  supervisors
requires close co-operation among supervisors to safeguard the public  good:
namely,  openness,  competition,  safety  and  soundness  of   the   banking
industry. EU directives (the 1st and 2nd  Banking  Directives  and  the  so-
called BCCI Directive) lay the foundations for such co-operation,  but  they
do not contain specific provisions or  institutional  arrangements  to  this
end. They limit themselves to stating the principle  of  co-operation  among
national  authorities  and  to  removing  obstacles  to  the   exchange   of
information among them.
       6. How does the Eurosystem relate to this  construction?  Essentially
in two ways. First, the  Treaty  assigns  to  the  Eurosystem  the  task  to
"contribute  to  the  smooth  conduct  of  policies  pursued  by   competent
authorities relating to the prudential supervision  of  credit  institutions
and the stability of the financial system"  (Article  105  (5)).  Given  the
separation between monetary and supervisory  jurisdictions,  this  provision
is clearly intended to ensure a smooth interplay between  the  two.  Second,
the Treaty gives the Eurosystem a twofold (consultative and  advisory)  role
in the rule-making process. According to Article 105 (4), the  ECB  must  be
consulted on any draft Community and national legislation in the  fields  of
banking supervision and financial stability; and, according  to  Article  25
(1) of its Statute, the ECB can provide, on its own  initiative,  advice  on
the scope and implementation of the Community legislation in  these  fields.
It should be borne in mind that central banks are normally involved  in  the
process of drawing up  legislation  relating  to,  for  example,  regulatory
standards, safety net arrangements and supervision  since  this  legislation
contributes crucially to the attainment of financial stability.
       7. Two observations should be made about the institutional  framework
just described. First, such an arrangement establishes a  double  separation
between central banking and banking supervision: not  only  a  geographical,
but also a functional one. This is the case because for the euro area  as  a
whole banking supervision is now entrusted  to  institutions  that  have  no
independent monetary policy functions.  The  separation  approach  that  was
chosen for EMU has effectively been applied not only to the euro area  as  a
whole, but to its components as well. Indeed, even in  countries  where  the
competent  authority  for  banking  supervision  is  the  central  bank,  by
definition this authority is, functionally speaking,  no  longer  a  central
bank, as it lacks the key central banking task of  autonomously  controlling
money creation.
       The second observation is that  the  Treaty  itself  establishes  (in
Article 105 (6)) a simplified procedure  that  makes  it  possible,  without
amending the Treaty, to entrust specific supervisory tasks to  the  ECB.  If
such a provision were  to  be  activated,  both  the  geographical  and  the
functional separation  would  be  abandoned  at  once.  The  fact  that  the
Maastricht  Treaty  allows  the  present  institutional  framework   to   be
reconsidered  without  recourse  to  the  very  heavy  amendment   procedure
(remember that such  procedure  requires  an  intergovernmental  conference,
ratification by national parliaments, sometimes even a national  referendum)
is a highly significant indication that the drafters of the  Treaty  clearly
understood the anomaly of  the  double  separation  and  saw  the  potential
difficulties arising from it.  The  simplified  procedure  they  established
could  be  interpreted  as  a  "last  resort  clause",  which  might  become
necessary  if  the  interaction  between   the   Eurosystem   and   national
supervisory authorities turned out not to work effectively.

      III. INDUSTRY SCENARIO

       8. When evaluating the functioning of, and the challenges to, banking
supervision in the current institutional framework, two  aspects  should  be
borne in mind. First, the advent of the euro  increases  the  likelihood  of
the propagation of financial stability  problems  across  national  borders.
For this reason a co-ordinated  supervisory  response  is  important  at  an
early stage. Second, the sources of  banks'  risks  and  stability  problems
depend on ongoing trends that are not necessarily caused by  the  euro,  but
may be significantly accelerated by it. On the whole, we are interested  not
so much in the effects of EMU or the euro per  se,  as  in  the  foreseeable
developments due to all factors influencing banking in the years to come.
       9. It should be noted at  the  outset  that  most  banking  activity,
particularly in retail banking, remains confined  to  national  markets.  In
many Member States the number, and the market share, of banks  that  operate
in  a  truly  nationwide  fashion   is   rather   small.   Although   banks'
international  operations   have   increased,   credit   risks   are   still
predominantly related to domestic clients, and  the  repercussions  of  bank
failures would be predominantly felt by domestic borrowers and depositors.
       10. Assessing the  internationalisation  of  euro  area  banks  is  a
complex task because internationalisation can take a number  of  forms.  One
is via cross-border branches and subsidiaries.  Although  large-scale  entry
into  foreign  banking  markets  in  Europe  is  still  scarce,   reflecting
persisting legal, cultural and conduct-of-business barriers (less  than  10%
on average in terms of banking assets in the euro area; Table 1), there  are
significant exceptions. The assets of the foreign branches and  subsidiaries
of German and French banks account for roughly a  third  of  the  assets  of
their respective domestic banking  systems  (Table  2).  The  Dutch  banking
system is also strongly diversified internationally.
       Another way to spread banking activity  beyond  national  borders  is
consolidation. Cross-border mergers or acquisitions still  seem  to  be  the
exception, although things have  started  to  change.  The  recent  wave  of
"offensive" and  "defensive"  banking  consolidation  has  mainly  developed
within national industries,  thus  significantly  increasing  concentration,
particularly in the smaller countries (Table 3); it may be  related  not  so
much to the direct impact of EMU as to globally intensified competition  and
the need to increase efficiency.
       In the coming  years  internationalisation  is  likely  to  increase,
because, with the euro, foreign entrants can now  fund  lending  from  their
domestic retail deposit base or  from  euro-denominated  money  and  capital
markets. The relatively large number of foreign  branches  and  subsidiaries
already  established  could  be  a  sufficient  base  for  an  expansion  of
international banking activity (Table 4) since a single branch, or  a  small
number of branches, may be sufficient to attract customers, especially  when
they are served through direct banking techniques,  such  as  telephone  and
Internet banking. Also, the cross-border supply  of  services  on  a  remote
basis is likely to spread as direct banking techniques develop. As to cross-
border mergers and acquisitions aimed either at achieving a "critical  mass"
for wholesale financial markets, or at  rapidly  acquiring  local  expertise
and customers in the retail sector, they may remain scarce because the  cost
savings from eliminating overlaps in the retail network  are  likely  to  be
limited and the managerial costs of  integrating  different  structures  and
corporate cultures are substantial.
       11. However, banks' internationalisation does not  provide  the  full
picture of the  interconnections  of  banking  systems.  As  "multi-product"
firms, banks operate simultaneously in many  markets  which  have  different
dimensions: local, national,  continental  (or  European)  and  global.  The
advent of the euro  is  likely  to  enlarge  the  market  for  many  banking
products  and   services   to   the   continental   dimension;   this   will
"internationalise" even those banks that remain "national" in  their  branch
networks and organisation.
       The formation of the single money market in the euro area has largely
taken place already. The  dispersion  in  the  euro  overnight  rate  across
countries, as reported by 57 so-called EONIA banks,  fell  in  January  from
around  15  to  5  basis  points.  The  variation  between  banks  has  been
significantly greater than between countries. The TARGET system has  rapidly
reached the dimension of Fedwire, with a daily average value of payments  of
E1,000 billion, of which between E300 and E400 are  cross-border.  The  ever
stronger  interbank  and  payment  system   links   clearly   increase   the
possibility of financial instability spreading from one country to  another.
Through these links the failure of a major bank could  affect  the  standing
of its counterparties in the entire  euro  area.  On  the  other  hand,  the
deeper money market could absorb  any  specific  problem  more  easily  than
before.
       As regards the capital markets, the effects of  the  euro  will  take
more time to manifest themselves, but are  likely  to  be  substantial.  The
single currency offers substantial opportunities for both  debt  and  equity
issuers and investors. The increase in the  number  of  market  participants
operating in the same  currency  increases  the  liquidity  of  the  capital
markets and reduces the cost of capital. The  low  level  of  inflation  and
nominal  interest  rates  and  diminishing  public   sector   deficits   are
additional  supporting  factors  of  capital  market  activity,   especially
private bond market activity  which  has  so  far  been  relatively  limited
(Table 5). Banks  will  thus  operate  in  increasingly  integrated  capital
markets and will be exposed to  shocks  originating  beyond  their  national
borders.
       As to corporations, they may concentrate their operations  (treasury,
capital market and payment management) in a  single  or  few  "euro  banks",
while the disappearance of  national  currencies  may  break  links  between
firms and their home country "house bank". This dissociation would make  the
domestic economy indirectly sensitive  to  foreign  banks'  soundness,  thus
creating another propagation channel of banking problems across countries.
       12. When considering the industry scenario for the coming years,  the
viewpoint has to be broadened beyond the impact of  the  euro.  Rather  than
the exclusive, or even primary, force for change, the euro  is  expected  to
be a catalyst for pre-existing trends driven by  other  forces.  The  recent
ECB report prepared  by  the  Banking  Supervision  Committee  on  "Possible
effects of EMU on the EU banking systems in the medium to long  term"  gives
a comprehensive  analysis  of  such  trends,  which  can  be  summarised  as
follows. First, regulation: the industry has yet to feel the full impact  of
such  fundamental,  but  relatively  recent,  regulatory  changes  as  those
related to the single market legislation. Second,  disintermediation:  other
financial intermediaries and institutional investors will grow  relative  to
banks, pushed  by  demographic  and  social  changes,  as  well  as  by  the
increasing depth and  liquidity  of  the  emerging  euro  area-wide  capital
market. Disintermediation  is  expected  to  take  the  form  of  increasing
recourse to capital market instruments relative to bank loans by firms,  and
diminishing investment in deposits by households relative  to  mutual  funds
and  related  products.  Third,  information  technology:   bank   products,
operations and processes  are  changing  rapidly,  while  technology  offers
increasing possibilities for dissociating the supply of a  large  number  of
services from branches and face-to-face contact with customers. The  current
tendency in the EU  banking  systems  to  reduce  over-branching  and  over-
staffing will grow stronger.
        These  factors  will  increase  competition,   exert   pressure   on
profitability and oblige banks to reconsider their strategies. Such  effects
are  already  visible  throughout  the   EU.   They   produce   changes   in
organisation, new products and services, mergers, strategic  alliances,  co-
operation agreements, etc. They also involve strategic  risks,  because  the
pressure for profitability and some losses of revenue due to the  euro,  for
example from foreign exchange, may push some  banks  to  seek  more  revenue
from unfamiliar business or  highly  risky  geographical  areas.  Inadequate
implementation of new technologies or failure to reduce excess capacity  may
also affect banks' long-term viability. In the short  term,  the  structural
adaptation process could be  made  more  difficult  by  the  combination  of
factors like the protracted financial difficulties of Asia  and  Russia,  or
the preparations for the year 2000.

      IV. CURRENT SUPERVISION

       13. Against the background of the  institutional  framework  and  the
industry scenario I have outlined, let me now turn  to  the  functioning  of
banking supervision in the euro area. Two preliminary  observations.  First,
the objective of financial stability pursued by banking supervisors is  only
one in a range of public interests, which also includes  competition  policy
and depositor and investor protection policy.  Second,  current  supervision
and crisis management involve different situations and procedures  and  will
therefore be examined in sequence.
       14. Starting  with  current  supervision,  let  me  consider  banking
regulation first. As observed earlier, the regulatory platform for the  euro
area banking industry combines harmonised rules with country-specific  (non-
harmonised, but mutually recognised and hence potentially competing)  rules.

       The harmonised  part  of  the  platform  includes  most  of  the  key
prudential provisions that have been developed in national systems over  the
years. More  than  20  years  ago  (1977),  the  1st  Banking  Co-ordination
Directive adopted a  definition  of  a  credit  institution  and  prescribed
objective criteria for the granting of a banking licence. In 1983 the  first
Directive on carrying out supervision on a consolidated basis was  approved,
and in 1986 the rules relating to the preparation  of  the  annual  accounts
and the consolidated accounts of banks were  harmonised.  In  1989  the  2nd
Banking Co-ordination Directive (which became effective on 1  January  1993)
marked  the  transition  from  piecemeal   to   comprehensive   legislation,
introducing, inter alia, the principle of "home country control".  A  number
of other specific directives have subsequently addressed  the  main  aspects
of the regulatory framework - notably, own funds, solvency ratios and  large
exposures. A Directive imposing deposit guarantee schemes  supplemented  the
legislation in support of financial stability.  All  in  all,  the  European
Union, including the euro area, now  has  a  rather  comprehensive  "banking
law" consistent with the Basle Committee's rules  and  with  the  1997  Core
Principles of Banking Supervision.
       The country-specific, non-harmonised, part of the  platform  is  also
quite relevant and very diversified. It includes, among  other  things,  the
different  organisational  arrangements   for   the   conduct   of   banking
supervision (central bank, separate agency  or  a  mixed  arrangement);  the
tools used by  banking  supervisors  (e.g.  supervisory  reporting,  on-site
inspections); provisions for the liquidation  and  restructuring  of  banks;
and the  definition  and  legal  protection  of  financial  instruments  and
contracts. Even the key notion of a regulated market is harmonised  only  to
a very limited extent.
       15. Such "neutrality" and "incompleteness" on  the  part  of  the  EU
legislator with respect to key aspects that  are  normally  incorporated  in
the regulatory framework is a unique feature of EU banking  regulations  and
is likely to trigger a deregulatory process,  pushed  by  competition  among
the national systems and the different financial centres in the  euro  area,
and beyond that  in  the  EU.  Against  the  background  of  the  increasing
competition and other changes in the banking industry, one can  expect  that
the regulatory platform will evolve in the  years  to  come.  Additional  EU
legislation may prove necessary to complete and  strengthen  the  harmonised
part. One important part of common legislation, namely the  draft  Directive
on liquidation and re-organisation measures  for  credit  institutions,  has
not yet  been  adopted  and,  indeed,  has  been  stalled  for  years.  This
Directive is needed to bring legal certainty to the  framework  for  banking
crisis management. In this regard, it would be useful  for  the  Eurosystem,
if necessary, to be able to exclude counterparties from the single  monetary
policy on prudential grounds. Also, the non-harmonised part of the  platform
will come under pressure to converge, as I have just mentioned, through  the
process  of  "regulatory  competition".  Like  any  other  rapidly  changing
industry, the banking sector will require careful attention  by  regulators.
As indicated earlier, the ECB will have the possibility of  contributing  to
the rule-making process through its advisory tasks under Article 105 (4)  of
the Treaty and Article 25.1 of the Statute of the ESCB.
       16. On the whole, and taking a euro area perspective, the legislative-
cum-regulatory platform of the banking  industry,  although  rather  unusual
and  very  diversified  in  comparison   with   those   of   most   currency
jurisdictions, does not seem to present loopholes  or  inconsistencies  that
may hamper the pursuit of systemic stability. Seen from the  point  of  view
of the regulatory burden, it is a light system. It will become even more  so
if  competition  among  national  banking  systems  and  financial   centres
encourages national regulators to free their banks from  regulatory  burdens
that are not required by the EU Directives. Conversely, seen from the  point
of  view  of  its  flexibility,  i.e.  how  quickly  it  can  adapt  to  new
situations, it is, on the contrary, a heavy system. This is  the  case  both
because the EU legislative process is slow (three years or even  longer  may
be needed to pass Directives) and, perhaps more  importantly,  because  many
provisions  are  embodied  in  the  Community  primary   legislation   (i.e.
Directives)  rather  than  in  Community  secondary  legislation  (amendable
through simpler comitology procedures).
       The establishment of EMU does  not  seem  to  determine  a  need  for
revising the pillars of the  current  legal  framework.  What  seems  to  be
necessary, however, is a more flexible legislative  procedure  which  allows
for a faster and more effective revision of Community legislation,  whenever
needed in relation to market developments.
       17. Let me now turn to  the  execution  of  banking  supervision.  It
should immediately be recalled that supervision, contrary to regulation,  is
a national task, exercised by what the jargon of the  Directives  calls  the
"competent  authority".  Since  the  euro  area  has  adopted  a  separation
approach between supervisory and central banking functions,  it  is  natural
to examine first the functioning of the "euro area supervisor" (i.e. the co-
operative system of national supervisors) and then turn  to  the  tasks  and
needs of the "euro area central banker" (i.e. the Eurosystem).
       18. The euro area supervisor can be regarded  as  a  rather  peculiar
entity composed of national agencies working in  three  modes:  stand-alone,
bilateral and multilateral. Let us briefly examine each of them.
       The stand-alone mode is the one in which the  supervisor  exclusively
operates in the national (or even local) context. Today it  is  by  far  the
most predominant mode.  In  most  cases,  this  approach  is  sufficient  to
achieve the objectives of banking supervision because most banks  in  Europe
are operating in a context that does not even reach  the  nationwide  market
of the country of origin. Such a decentralised model is even more  effective
because it  allows  the  efficient  use  of  information  that  may  not  be
available far from the market in which the bank operates. That is why it  is
actually applied even within countries. In Italy, for example, over  600  of
the 900 licensed credit institutions at end-1998  were  entirely  supervised
by the Banca d'Italia branch of the town in which the bank is licensed.
       The bilateral mode  involves  co-operation  between  two  supervisory
agencies. It is used for  cross-border  supervision  of  the  same  type  of
financial institutions, such as credit institutions, or the  supervision  of
different types of financial institutions  operating  in  the  same  market,
such as credit institutions and securities firms. The  instrument  that  has
been devised to organise bilateral co-operation between banking  supervisors
is the Memorandum of Understanding (MoU). With  the  implementation  of  the
2nd Banking Co-ordination Directive, the Member States  began  to  negotiate
extensively MoUs in order to establish the  necessary  co-operation  between
"home" and "host country" authorities to supervise efficiently  institutions
that have cross-border activities or foreign country establishments.
       By the end of 1997, 78 bilateral MoUs had been signed between the EEA
banking supervisory authorities. The key aims of MoUs  are  to  establish  a
regular exchange of information between  national  supervisory  authorities.
While the "gateways" for the exchange of information have been laid down  in
Community legislation, MoUs provide a practical framework for  communication
to be carried out between supervisors. Moreover, MoUs define procedures  and
reciprocal commitments between  pairs  of  EU  supervisors  related  to  the
various parts of the supervisory process, such as  establishment  procedures
and on-site examinations.
       Finally, the multilateral mode  is  the  one  in  which  a  group  of
supervisors works collectively as, say, a  single  consolidated  supervisor.
Such a mode is required when the problems involved are area-wide.  They  may
be area-wide for a number of reasons with regard  to  the  institutions,  or
groups,  involved:  their  dimension;  their  linkages  with  a  number   of
different markets in various countries; the role they play  in  the  payment
system or in other "systemic" components of the  market,  etc.  Multilateral
co-operation can also  enhance  the  quality  of  supervision  by  examining
common macroeconomic influences on the banking system and common  trends  in
the financial system that may not be revealed from the national  perspective
only.
       Today, the  Banking  Supervision  Committee  is  the  key  forum  for
multilateral co-operation. It is composed of representatives of the  banking
supervisory authorities of the EU countries,  either  forming  part  of  the
respective NCB or separate bodies. The Banking Supervision Committee's  main
functions are the promotion of a smooth exchange of information between  the
Eurosystem and national supervisory authorities and  co-operation  among  EU
supervisory authorities. Another forum for dealing with the requirements  of
the multilateral mode is the Groupe  de  Contact,  a  group  of  EU  banking
supervisory authorities which, for  many  years,  has  discussed  individual
banking cases in a multilateral way, but at  a  lower  organisational  level
than the high-level Banking Supervision Committee.
       19. So far, the need  to  develop  the  multilateral  mode  has  been
relatively limited, as the emergence of  a  single  banking  market  in  the
European Union has been slow and the euro was not yet in  place.  Thus,  the
fact that the multilateral  mode  has  not  gone,  for  the  moment,  beyond
periodic  discussions  among  supervisors   and   occasional   industry-wide
analyses should not be a cause for concern.
       I am convinced, however, that in the future the needs will change and
the multilateral mode will have to deepen substantially. Over  time  such  a
mode will have to be structured  to  the  point  of  providing  the  banking
industry with a true and effective collective euro area supervisor. It  will
have to be enhanced to the full extent required for banking  supervision  in
the euro area to be as prompt  and  effective  as  it  is  within  a  single
nation.
       There are no legal impediments to  that.  The  existing  legislation,
whether Community or national, permits all the necessary steps to  be  made.
Information can be pooled; reporting requirements and examination  practices
can be developed and standardised; common databases can  be  created;  joint
teams can be formed; and analyses of developments across the  whole  banking
system can  be  conducted.  The  Community  legislation  providing  for  the
unconstrained exchange of confidential information between supervisors  does
not distinguish between bilateral and  multilateral  co-operation,  but  the
common interpretation is that it covers both modes. It will be the  task  of
the  Banking  Supervision  Committee,  for  its   part,   to   develop   the
multilateral mode among EU banking supervisors.
       20. If the above concerns primarily the euro  area  supervisor,  what
about the euro area central banker,  i.e.  the  Eurosystem?  The  euro  area
central banker has neither direct responsibility for supervising  banks  nor
for bank stability. It is, however, no stranger  in  this  land.  It  has  a
vital  interest  in  a  stable  and  efficient  banking  industry;  it   is,
therefore, keen to see its action complemented with an effective conduct  of
the supervisory functions by the competent authorities;  it  needs  a  clear
and precise knowledge of the state of the euro area's banking industry as  a
whole and of its major individual players; and it may have a role  to  play,
as we shall see, in the management of crises.
       For the Eurosystem, natural reference  models  are  provided  by  the
central banks of countries that apply the separation approach, for  example:
Germany before the euro; the  United  Kingdom  after  the  creation  of  the
Financial Services Authority; or Japan. In all these cases the central  bank
has a well-developed expertise in  the  micro  and  macro-prudential  field;
each distinctively plays a role in the macro-prudential field by  addressing
threats to the stability of the banking system and analysing  the  soundness
of the structural features of the system.  For  their  own  purposes,  these
central banks also have precise  and  comprehensive  information  about  the
banks in their respective country. This is obtained either  from  performing
practical supervisory duties, as in the case of the Bank  of  Japan  or  the
Bundesbank; or from the national supervisory authority;  or  through  direct
contacts with the banking industry, as in the case of the Bank of England.
       The Banking Supervision Committee is in a good position to co-operate
with the Eurosystem in the collection of information. Indeed, the  so-called
BCCI Directive has removed  the  legal  obstacles  to  the  transmission  of
confidential information from competent supervisory authorities to  "central
banks and other  bodies  with  a  similar  function  in  their  capacity  as
monetary authorities". This includes national central banks and the ECB.  Of
course, the provision  of  supervisory  information  is  voluntary  and  its
development will have to be based on an agreed view of the  central  banking
requirements the Eurosystem will have in this field.

      V. CRISIS MANAGEMENT

        21.  In  normal  circumstances  central   banking   and   prudential
supervision  have  an  arm's  length  distance  between  them.   In   crisis
situations, however, they  need  to  act  closely  together,  often  in  co-
operation  with  other  authorities  as  well.  Charles  Goodhart  and  Dirk
Schoenmaker have made here at the London  School  of  Economics  a  valuable
contribution to analysing the handling of  major  banking  problems  in  the
history of industrial countries. One of their conclusions is that,  in  most
instances, central banks have indeed been involved. Banking problems are  so
close  to  monetary  stability,  payment  system  integrity  and   liquidity
management that this finding hardly comes as a surprise. The advent  of  the
euro will not, by itself, change this state of affairs.
       22. When discussing crisis management, it  should  not  be  forgotten
that, while central banks have a direct and unique role  to  play  when  the
creation of central  bank  money  is  involved,  this  represents  just  one
category of emergency action. Another category refers to the injection -  by
politically liable Finance Ministries - of taxpayers' money into  ailing  or
insolvent  credit  institutions.  There  is  also  a  third,   market-based,
category, consisting of the injection of private money  by  banks  or  other
market participants. These three typologies of emergency action all  require
the involvement of policy-makers,  but  they  must  not  be  mixed  up  when
evaluating the existing arrangements. Therefore, before discussing the  much
debated question of the lender-of-last-resort, let  me  briefly  comment  on
the two, probably less controversial cases where  central  bankers  are  not
the providers of extra funds.
       23. First, the "private money solution". This  market-based  approach
is clearly the preferable option, not just to save public  funds  and  avoid
imbalances in public finances, but also to reduce the moral  hazard  problem
generated by public  assistance  to  ailing  institutions.  Indeed,  policy-
makers are increasingly aware that the expectations of a  helping  hand  can
increase financial institutions' risk appetite in the first place.  However,
even when a market-based solution is possible, on  the  grounds  of  private
interest, private parties may not be able to reach a solution  for  lack  of
information or co-ordination. Public authorities have  therefore  an  active
role to play for the market  solution  to  materialise.  The  recent  rescue
package co-ordinated by the Federal Reserve Bank of New York to prevent  the
LTCM hedge fund from collapsing is a good  example  of  public  intervention
being used to achieve a private solution.
       Acting as a "midwife" in brokering a private sector deal is  not  the
only example of managing crises  without  injecting  public  funds.  Banking
supervisors have at their disposal a number of tools  to  intervene  at  the
national level to limit losses and prevent  insolvency  when  a  bank  faces
difficulties. These tools include special audits, business restrictions  and
various reorganisation measures.
       In the  euro  area,  national  supervisors  and  central  banks  will
continue to be the key actors in the pursuit of  market-based  solutions  to
crises. The Eurosystem, or the Banking Supervision Committee,  would  become
naturally involved whenever the relevance of the crisis required it.
       24. Second, the "taxpayers'  money  solution".  Taxpayers  have  been
forced to shoulder banks' losses in the past, when public  authorities  felt
that otherwise the failure of a large portion of a country's banking  system
or of a  single  significant  institution  would  have  disrupted  financial
stability and caused negative macroeconomic consequences. In such  instances
banks have been taken over by the state,  or  their  bad  assets  have  been
transferred to a separate public entity to attract  new  private  investment
in the sound part of the otherwise failed banks.  The  US  savings  &  loans
crisis of the 1980s, the banking crises in Scandinavia in  the  early  1990s
and the current banking crises in Japan and some  East-Asian  countries  are
examples of system-wide insolvency problems that have  triggered  taxpayers'
support. Crйdit Lyonnais and Banco di Napoli are recent examples  of  public
support to individual insolvency problems.
       The  introduction  of  the  euro  leaves  crisis  management  actions
involving taxpayers' money practically unaffected. The option  of  injecting
equity or other funds remains available for the Member States,  since  these
operations are not forbidden  by  the  Treaty.  Nevertheless,  the  European
Commission will be directly involved in scrutinising  and  authorising  such
actions, since any  state  aid  must  be  compatible  with  the  Community's
competition legislation. This happened, for example, in the cases  of  Banco
di Napoli and ‚[pic]Crйdit Lyonnais.
       The handling of solvency crises is not within the competence  of  the
national central banks nor that of the ECB, although national central  banks
are likely to be consulted, as they have been in the past.
       25. Third, the "central bank money solution". This is the  lender-of-
last-resort issue that has brought the Eurosystem under  vigorous  criticism
by distinguished academics and the IMF's Capital  Markets  Division  of  the
Research Department. The criticism has been that the alleged  absence  of  a
clear and transparent mechanism to act in an emergency raises doubts in  the
markets about the ability of the Eurosystem to handle crisis situations.  It
is said that the uncertainty generated by  the  present  arrangements  would
entail new risks,  including  the  possibility  of  investors  requiring  an
additional risk  premium  at  times  of  financial  market  volatility  and,
ultimately, of the credibility of EMU being damaged. Two examples  of  these
concerns deserve an explicit mention. The IMF "Report on  Capital  Markets",
September 1998, stated that "it is  unclear  how  a  bank  crisis  would  be
handled under the current institutional framework …which is  not  likely  to
be sustainable". Similarly,  the  first  report  of  the  CEPR  (Centre  for
Economic Policy Research) on monitoring the ECB entitled "The ECB:  Safe  at
Any Speed?" expressly suggested that the Eurosystem lacks crisis  management
capacity and is too rigid to pass the A-Class test to keep  the  vehicle  on
the road at the first steep turn in financial market conditions in Europe.
       26. My response to this criticism  is  threefold.  To  my  mind,  the
criticism reflects a notion  of  lender-of-last-resort  operations  that  is
largely outdated; it underestimates the Eurosystem's capacity to  act;  and,
finally, it represents too mechanistic a  view  of  how  a  crisis  is,  and
should be, managed in practice.
       27. The notion of a  central  bank's  lender-of-last-resort  function
dates back more than 120 years, to the time of Bagehot. This  notion  refers
to emergency lending to institutions that, although solvent, suffer a  rapid
liquidity outflow due to a sudden collapse in depositors'  confidence,  i.e.
a classic bank run. A bank could be exposed to  depositors'  panic  even  if
solvent because of the limited amount of bank liquidity and  an  information
asymmetry between the depositors and the  bank  concerning  the  quality  of
bank's assets that do not have a secondary market value.
       Nowadays and in our industrial economies, runs may  occur  mainly  in
textbooks. They have little relevance in  reality  because,  since  Bagehot,
many antidotes have been  adopted:  deposit  insurance,  the  regulation  of
capital adequacy and large exposures,  improved  licensing  and  supervisory
standards all contribute to the preservation of depositors'  confidence  and
minimise the threat of a contagion from insolvent to solvent institutions.
       A less unlikely case  is  a  rapid  outflow  of  uninsured  interbank
liabilities.  However,  since  interbank  counterparties  are  much   better
informed than depositors, this event would typically require the  market  to
have a strong suspicion that the bank  is  actually  insolvent.  If  such  a
suspicion were to be unfounded and not generalised, the width and  depth  of
today's interbank market is such  that  other  institutions  would  probably
replace (possibly with  the  encouragement  of  the  public  authorities  as
described above) those which withdraw their funds. It should  be  noted,  in
this respect, that the emergence of the  single  euro  money  market  lowers
banks' liquidity risk, because the number of possible sources  of  funds  is
now considerably larger than in the past.
       Given all of these contingencies, the probability that a modern  bank
is solvent, but illiquid, and at the same time lacks  sufficient  collateral
to obtain regular central bank funding, is, in my  view,  quite  small.  The
textbook case for  emergency  liquidity  assistance  to  individual  solvent
institutions has, as a matter of fact, been a most rare event in  industrial
countries over the past decades.
       28. What if this rare event were nevertheless to occur  and  cause  a
systemic threat? The clear answer is that the euro  area  authorities  would
have the necessary capacity to act. This is not only my judgement, but  also
that of the Eurosystem,  whose  decision-making  bodies  have,  as  you  can
imagine, carefully discussed the matter. I am not saying  that  we  are,  or
shall be, infallible; no one can claim such a divine quality.  I  am  saying
that there are  neither  legal-cum-institutional,  nor  organisational,  nor
intellectual impediments to acting when needed. In stating this, I am  aware
that central banks may be the only source of immediate  and  adequate  funds
when a crisis requires swift action, while solvency  remains  an  issue  and
failure to act could threaten the stability of the financial system.
       In  these  circumstances  the  various  national  arrangements  would
continue to apply, including those concerning the access  of  central  banks
to  supervisors'  confidential  information.  As   is   well   known,   such
arrangements differ somewhat from country to country.
       29.  The  criticism  I  have  referred  to  also  underestimates  the
Eurosystem's capacity to act. To the extent that there would be  an  overall
liquidity effect that  is  relevant  for  monetary  policy  or  a  financial
stability implication for the euro area,  the  Eurosystem  itself  would  be
actively involved.
       The Eurosystem is, of course, well equipped for  its  two  collective
decision-making bodies  (the  Board  and  the  Council)  to  take  decisions
quickly whenever needed,  whether  for  financial  stability  or  for  other
reasons. This readiness is needed for a  variety  of  typical  central  bank
decisions, such as the execution of concerted interventions or the  handling
of payment system problems. Indeed, it has already been put to  work  during
the changeover weekend and in the first few weeks of this year.
       A clear reassurance about the capacity  to  act  when  really  needed
should be sufficient for the markets. Indeed, it may even be  advisable  not
to spell out beforehand the procedural and practical  details  of  emergency
actions.  As  Gerry  Corrigan  once  put   it,   maintaining   "constructive
ambiguity" in these matters may help to reduce the moral  hazard  associated
with a safety net. I know of no central bank law within which the lender-of-
last-resort function is explicitly defined.
       The question of  who  acts  within  the  Eurosystem  should  also  be
irrelevant for the markets, given that any  supervised  institution  has  an
unambiguously identified supervisor and national central  bank.  As  to  the
access to  supervisory  information,  the  lack  of  direct  access  by  the
Eurosystem should not be regarded as a specific  flaw  of  the  euro  area's
institutional  framework,  as  has  been  frequently  argued,   since   this
situation also exists at the national level wherever  a  central  bank  does
not carry out day-to-day supervision.
       30. Finally, the criticism reflects an overly mechanistic view of how
a crisis is, and should be, managed in practice. Arguing in favour of  fully
disclosed, rule-based policies in order to manage crises  successfully  and,
hence, maintain market confidence, is almost  self-contradictory.  Emergency
situations  always  contain  unforeseen  events  and  novel  features,   and
emergency, by its very nature, is something that allows and even requires  a
departure from the rules and procedures adopted for normal times or even  in
the previous crisis. Who cares so much about the red  light  when  there  is
two metres of snow on the road?  As  for  transparency  and  accountability,
these two sacrosanct requirements should not  be  pushed  to  the  point  of
being detrimental to the very objective for which  a  policy  instrument  is
created. Full explanations of the actions taken and procedures followed  may
be appropriate ex post, but unnecessary and undesirable ex ante.
       31. So far, I have focused on the provision of emergency liquidity to
a bank. This is not the only case, however, in which central bank money  may
have to be created to avoid a systemic crisis. A general liquidity  "dry-up"
may reflect, for example, a gridlock in the payment system or a sudden  drop
in stock market prices. The actions of the Federal Reserve  in  response  to
the stock market crash of 1987 is an often cited  example  of  a  successful
central bank operation used to prevent  a  dangerous  market-wide  liquidity
shortfall. This kind of action is close to the monetary policy function  and
has been called the "market operations approach" to lending of last  resort.
In such cases, liquidity shortfalls could be covered through  collateralised
intraday or overnight credit, or auctioning extra liquidity to  the  market.
The Eurosystem is prepared to handle this kind of market disturbance.

      VI. CONCLUSION

       32. In my remarks this evening, I have looked at the euro area as one
that has a central bank which does not carry out banking  supervision.  This
would be normal, because in many countries  banking  supervision  is  not  a
task of the central bank. What is unique is that the areas  of  jurisdiction
of monetary  policy  and  of  banking  supervision  do  not  coincide.  This
situation requires, first of all, the establishment of  smooth  co-operation
between the Eurosystem and the national banking supervisors, as is the  case
at the national level where  the  two  functions  are  separated.  The  most
prominent reason for this is, of course, the scenario  where  the  provision
of liquidity from the central bank has to be made in  a  situation  that  is
generated by problems of interest to the supervisor. But beyond that,  I  do
not know any  country  in  which  the  central  bank  is  not  very  closely
interested in the state of health of the  banking  system,  irrespective  of
its supervisory responsibilities.
       33. In my view, we should move as rapidly as possible to a  model  in
which the present division of the geographical and  functional  jurisdiction
between monetary policy and banking supervision plays no  significant  role.
I do not mean necessarily a single authority or a single set  of  prudential
rules. Rather I mean that  the  system  of  national  supervisors  needs  to
operate as effectively as a single authority when needed. While  the  causes
of banking  problems  are  often  local  or  national,  the  propagation  of
problems may be area-wide. The banking industry is much  more  of  a  system
than other financial institutions.
       34. I am  clearly  aware  that  we  are  far  from  having  a  common
supervisory system. But since the euro  has  just  been  launched  and  will
last, we have to look in prospective terms  at  what  needs  to  be  set  in
place. There is no expectation, at least to my mind, that  the  division  of
responsibility in the euro area between the central  bank  and  the  banking
supervisory functions  should  be  abandoned.  Although  the  Treaty  has  a
provision that permits the assignment of supervisory tasks  to  the  ECB,  I
personally  do  not  rely  on  the  assumption  that  this  clause  will  be
activated. What I perceive as absolutely necessary,  however,  is  that  co-
operation among banking supervisors, which is largely  voluntary  but  which
finds no obstacles in the existing Directives or in the Treaty,  will  allow
a sort of euro  area  collective  supervisor  to  emerge  that  can  act  as
effectively as if there were a single supervisor. This is desirable  in  the
first instance to render the supervisory action more effective  against  the
background of current and future  challenges  and,  second,  to  assist  the
Eurosystem in the performance of its basic tasks.

TABLES

     Table 1. Market share of branches and subsidiaries of foreign
     credit institutions as % of total domestic assets, 1997

                         From EEA countries            From third  countries
        TOTAL
                          Branches           Subsidiaries           Branches
Subsidiaries
           AT          0.7             1.6              0.1              1.0
         3.4
           BE          9.0             19.2             6.9              1.2
        36.3
           DE          0.9             1.4              0.7              1.2
         4.2
           ES          4.8             3.4              1.6              1.9
        11.7
           FI          7.1               0                0                0
         7.1
           FR          2.5               NA              2.7              NA
         9.8
           IR          17.7            27.8             1.2              6.9
        53.6
           IT          3.6             1.7              1.4              0.1
         6.8
           NL          2.3             3.0              0.5              1.9
         7.7

           SE          1.3             0.1              0.1              0.2
         1.7
           UK          22.5            1.0             23.0              5.6
        52.1

     Source: ECB report "Possible effects of EMU on the EU banking
     systems in the medium to long term" (February 1999).



     Table 2. Assets of branches and subsidiaries of domestic credit
     institutions in foreign countries
     as % of total domestic assets, 1997

                          In EEA countries              In  third  countries
        TOTAL
                          Branches           Subsidiaries           Branches
Subsidiaries
           AT          2.6               NA              3.7              NA
         NA
           DE          12.0             7.3              7.8             0.9
        27.9
           ES          5.5              1.4              2.1             5.9
        14.9
           FI          5.9              0.3              6.6             0.3
        13.1
           FR          9.1              6.9              9.4             3.8
        29.2
           IR          8.3             14.9             1.3             10.1
        34.6
           IT          7.2              2.7              3.8             1.5
        15.2

           SE          7.2               NA              5.4              NA
         NA

     Source: ECB report "Possible effects of EMU on the EU banking
     systems in the medium to long term" (February 1999).



     Table 3. Concentration: Assets of the five biggest credit
     institutions as % of total assets

                            1985            1990           1997
           AT               35.8            34.6           48.3
           BE               48.0            48.0           57.0
           DE                NA             13.9           16.7
           ES               38.1            34.9           43.6
           FI               51.7            53.5           77.8
           FR               46.0            42.5           40.3
           IE               47.5            44.2           40.7
           IT               20.9            19.1           24.6
           NL               69.3            73.4           79.4

           SE               60.2            70.02           89.7
           UK                NA              NA            28.0

     Source: ECB report "Possible effects of EMU on the EU banking
     systems in the medium to long term" (February 1999).



     Table 4. Number of branches and subsidiaries of foreign credit
     institutions, 1997

                           From   EEA   countries               From   third
countries          TOTAL
                          Branches           Subsidiaries           Branches
Subsidiaries
           AT            6              20                2               11
           39

           BE           25              16               15               15
           71

           DE           46              31               31               45
          153

           ES           33              21               20                6
           80

           FI            9               0                0                0
           9

           FR           46              118              43               98
          305

           IR           18              21                3                7
           49

           IT           36               4               17                4
           61

           NL           11               8               11               19
           49



           SE           14               0                3                1
           18

           UK           106             18              149              114
          387

     Source: ECB report "Possible effects of EMU on the EU banking
     systems in the medium to long term" (February 1999).



     Table 5. Private non-financial enterprises' bonds, credit
     institutions' bonds and government bonds outstanding as % of GDP,
     1997

                         Private            Credit          Government
                      non-financial      institutions'        bonds
                         bonds              bonds
            AT            2.7                31.1             30.6
            BE            10.0               38.3             111.0
            DE            0.1                54.6             37.6
            ES            2.6                4.5              52.9
            FI            3.7                7.1              35.5
            IE            0.01               1.6              32.2
            IT            1.6                19.4             100.4
            NL             NA                43.1             53.4

            SE            3.6                38.6             46.5

     Source: ECB report "Possible effects of EMU on the EU banking
     systems in the medium to long term" (February 1999).


                        Euro and European integration

                 Speech delivered by Eugenio Domingo Solans,
       Member of the Governing Council and the Executive Board of the
                           European Central Bank,
          at the "Euro and Denmark" exhibition in Aalborg, Denmark,
                            on 10 September 1999


      INTRODUCTION

       It is a real pleasure for me to participate in the "Euro and Denmark"
exhibition in Aalborg. It is the  first  time  since  my  appointment  as  a
member of the Executive Board of the European  Central  Bank  (ECB)  in  May
1998 that I have had the opportunity to speak  in  Denmark.  Thank  you  for
your invitation and for asking me to share my  views  on  the  euro  and  on
European integration with investors and experts of this "pre-in" country.
       I  should  like  to  refer  to  two  main  topics.  First,  and  more
extensively, allow me to explain the ECB's view and my own view on the  role
of the euro as an international currency. After this I intend to  make  some
brief comments on the key role that the euro and the Eurosystem are  playing
in the process of European economic integration.
       Before I begin, I should like to add that it goes without saying that
the institutional position of the  ECB  -  and  therefore  my  own  official
position - concerning Denmark's entry to the euro  area  is  one  of  strict
neutrality. This is an issue which has to be decided by the  Danish  people,
whenever and in whatever way they deem appropriate.

      THE EURO AS AN INTERNATIONAL CURRENCY


      The three basic functions of the euro

       Every currency fulfils three functions: store  of  value,  medium  of
exchange and unit of  account.  Concerning  the  first  function  (store  of
value), the euro is used and will increasingly be used as an investment  and
financing currency by market players, and as a reserve  currency  by  public
authorities. Regarding the second function of money  (medium  of  exchange),
the euro is used and will increasingly be  used  as  a  payment  or  vehicle
currency for the exchange of goods and services and  for  currency  exchange
itself. It will also have an  official  use  as  an  intervention  currency.
Finally, as regards the third function of any currency  (unit  of  account),
the euro is used and will increasingly be  used  by  economic  agents  as  a
pricing or quotation currency and as a pegging currency by  the  authorities
responsible for exchange rate issues.
       Let me give you some information about the present use of the euro in
each of these areas. I shall first refer to the private  use  of  the  euro,
after which I shall consider its official public usage.

      The euro as a store of value

       The available information seems to  confirm  that  the  euro  already
plays a  significant  role  as  an  investment  and  financing  currency  in
international financial markets. Without going  into  precise  details  (1),
regarding  the  international   debt   securities   market   (money   market
instruments, bills and bonds),  it  can  be  said  that  in  the  first  two
quarters of 1999 net international issues denominated in  euro  amounted  to
EUR 83.9 billion, compared with EUR 74 billion for the  US  dollar  and  EUR
50.9 billion for former euro area national currencies and  ECUs  during  the
same period of 1998. In other words, in the first two quarters of  1999  net
international issues of debt  securities  denominated  in  euro  were  13.4%
higher than those denominated in US dollars, and  64.8%  higher  than  those
denominated in former euro area national currencies and ECUs  issued  during
the same period of last year.
       With regard  to  equity  markets,  the  weight  of  euro  area  stock
exchanges in terms of capitalisation ranks a clear second,  far  behind  the
United States.
       As to the banking sector, the latest data show that, at  the  end  DX
:>48@>2:0 ?;5=:8T- -#"+ !-+   1999\DXCODE.HTof  March  1999,  above  40%  of
deposits and loans vis-а-vis non-residents were denominated  in  euro,  with
the share of the US dollar almost as high.

      The euro as a medium of exchange

       As for the second function of money (medium of  exchange),  the  euro
needs more time to develop as a payment currency for goods and  services  in
international trade and as  a  vehicle  currency  in  the  foreign  exchange
markets. Although no precise data are available at this stage, the value  of
world exports denominated in euro is  not  likely  to  differ  significantly
from that of euro area exports. By contrast,  the  value  of  world  exports
settled in US dollars is nearly four times as high as that  of  US  exports.
This difference 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 is the case with the US dollar.

      The euro as a unit of account

       The use of the euro as a unit of account (its third general function)
is closely linked to its use for the other two main functions. The use of  a
currency as a unit of account is, in a way, the  basis  for  its  use  as  a
store of value or as a medium of exchange. The value stored in euro, or  the
payments made in euro, will tend to be recorded in euro. Therefore,  we  can
conclude that the euro is playing an ever larger role as a unit  of  account
for all the financial assets linked to the use of the euro as an  investment
and financing currency, and has a much less relevant role as a standard  for
pricing goods and services, owing to the widespread use of the US dollar  as
a payment and vehicle currency in international trade.  The  convenience  of
using a  single  standard  for  pricing  commodities  in  the  international
markets, allowing traders to make direct comparisons between  prices,  makes
it difficult for the euro to acquire a significant role in this respect.  We
can conclude that the development of the euro as  a  unit  of  account  will
follow the pace at which the  issuers  or  suppliers  of  assets,  goods  or
services priced or quoted in euro  obtain  a  predominant  position  in  the
international markets.

      The official use of the euro

       The euro also has official uses as reserve, intervention and  pegging
currency, all three functions being strongly interrelated in most cases.
       With regard to its official use, the euro  is  currently  the  second
most international currency after the US dollar, this being a legacy of  the
former euro area national currencies.
       Compared with the former euro area  national  currencies,  there  has
been a technical decline in the  share  of  the  euro  as  a  reserve  (and,
therefore, as an intervention) currency, mainly owing to the fact that  such
former national currencies became domestic  assets  within  the  euro  area.
However, there are good reasons  to  expect  an  increase  in  international
public use of the euro as a reserve and intervention 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, FYROM [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.
       The position of the Eurosystem concerning the international  role  of
the euro
       As a general conclusion stemming from the previous  analysis  of  the
use of the euro in the world economy, we can affirm that  the  euro  is  the
second most widely used currency, behind the US  dollar  and  ahead  of  the
Japanese yen. The private use of the euro as  an  investment  and  financing
currency and its  official  use  as  a  reserve,  intervention  and  pegging
currency are increasing rapidly, while it is developing at a slower pace  as
a payment currency in the exchange of goods and services.  The  use  of  the
euro as a unit of account is linked to its use  as  store  of  value  and  a
medium of exchange.
       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, which will take place, without a doubt.
       Factors determining the importance of the euro in the world economy
       We understand that the  euro  fulfils  the  necessary  conditions  to
become 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 generally tends to lead to centralisation around one or  several  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 stability of the currency and the credibility of the ECB

       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 monetary policy  strategy  of  the  ECB.  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.
       In the global economy the transmission of financial crises  by  means
of  different  mechanisms  (devaluations  of  weak  currencies,   subsequent
increases in interest rates, etc.) is frequently  mentioned.  Less  is  said
about the spillover or  transmission  of  positive  economic  circumstances,
such as stability. The Eurosystem will "export" stability  to  the  rest  of
the world economy, and not only in the case of those countries which  decide
to tie their currencies, formally or otherwise, to  the  euro  (through  the
ERM II or other arrangements). In a global economy the euro area  cannot  be
an island of stability, but it can transmit its stability  to  the  rest  of
the world economy as the links between regions increase.
       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,  not  necessarily  a
strong euro. 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.
       The  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 in relation to the  operation  of  the
Eurosystem.

      The "habitat" of the euro

       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. In addition to quality, quantity is  required,  as  suggested  by
the example of the reduced degree of international use of  the  Swiss  franc
in relation to other stable  currencies,  such  as  the  US  dollar  or  the
Deutsche
      Mark until 1998.

       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 degree of openness of an economic area is also a relevant  factor
as regards the international role of its currency. In this respect the  euro
area is more open than the United States or  Japan,  with  a  percentage  of
external trade of around 25.8% of GDP, compared with 19.6%  for  the  United
States and 17.9% in the  case  of  Japan  (data  from  Eurostat  for  1997).
However, a euro area consisting of the 15 countries of  the  European  Union
would be more closed, by the mere  arithmetic  fact  that  the  transactions
with the present pre-ins would become domestic transactions, resulting in  a
coefficient of openness of 19.4%, similar to  that  of  the  United  States.
Clearly, the size and the degree of openness are  parameters  that  move  in
opposite directions: the larger the euro area, the  smaller  its  degree  of
openness to other countries.

      The financial dimension of the euro

       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. Compared  with
a stock market capitalisation of EUR 3,655  billion  in  the  euro  area  in
1998, the United States presents a figure  almost  four  times  this  amount
(EUR 13,025 billion). Japan ranks  third,  with  EUR  2,091  billion.  There
would be a marked difference if one were to include all 15 countries of  the
European Union, since the stock exchange capitalisation  would  increase  to
EUR 6,081 billion.
       Although these figures 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 66.1%  of  GDP
in the United States (statistics from the International  Monetary  Fund  and
the Bank for International Settlements as at the end  of  1997,  taken  from
the Monthly Bulletin of the European Central Bank). We  therefore  have  two
distinct models of private financing which clearly have  to  be  taken  into
account when  assessing  Europe's  financial  dimension  compared  with  the
United States or Japan.

          THE ROLE OF THE EURO AND THE EUROSYSTEM IN THE PROCESS OF
                            EUROPEAN INTEGRATION


      The euro as a catalyst for European integration

       The euro, the Eurosystem's  monetary  policy  and,  in  general,  the
activity of the ECB  and  the  Eurosystem  will  play  a  key  role  in  the
integration of European financial markets and all  markets  in  general.  We
can say that  the  euro  will  act  as  a  catalyst  for  European  economic
integration.

      Monetary and financial integration

       The integration of the European money markets relies, of  course,  on
the existence of a single system for  refinancing  the  banks  in  the  euro
area, that is to say on the common monetary policy. However, it also  relies
technically on a system of  instantaneous  data  transfer  and  on  the  new
common payment system, TARGET, enabling real-time gross  settlement.  Thanks
to the smooth  operation  of  the  information,  communication  and  payment
systems, a common monetary policy is realistic and the  integration  of  the
markets can take place. Such integration  will,  in  turn,  involve  greater
liquidity and further development of the financial markets.
       A specific channel through which the monetary policy of the  ECB  and
the TARGET system can have  a  direct  impact  on  the  development  of  the
financial markets of the euro area is the requirement to have guarantees  or
collateral for operations  with  the  ECB.  This  requirement  for  adequate
collateral can stimulate the process of loan securitisation,  especially  in
the case of the banking  institutions  of  certain  financial  systems.  The
underlying assets can be used across borders, which  means  that  a  banking
institution in a country belonging to the European System of  Central  Banks
(ESCB) can receive funds from its national central bank by  pledging  assets
located in other countries, which is also relevant from the  perspective  of
the integration of the financial markets of the area.
       The trend towards  further  integration  of  the  European  financial
markets, accompanied  by  increased  use  of  the  euro  as  a  vehicle  for
international investment, should logically  follow  a  process  which  would
start in the short-term money market,  subsequently  be  expanded  into  the
longer-term money market and finally extend to the public and  private  bond
and equity markets. In the short term there  must  be  a  tendency  for  the
differentials in money market  interest  rates  to  be  eliminated,  as  the
functioning of the  market  improves,  while  in  the  long-term  securities
markets - both public and private, of course - interest  rates  will  always
include a risk premium linked to the  degree  of  solvency  of  the  country
(deficit and public debt, commitments on pensions), or to  the  credit  risk
of the private issuer, and to the liquidity of the securities.
       Economic integration Monetary and financial integration stemming from
the euro and the activity of the Eurosystem will  affect  the  operation  of
the European single market in a positive way. The European  market,  with  a
single currency, will tend to be more transparent,  more  competitive,  more
efficient and will function more smoothly. This is the  reason  why  joining
the European Union, as a general rule, leads to joining the euro area,  once
certain  economic  conditions  (the  so-called  convergence  criteria)   are
fulfilled.
       The case of Denmark, as you will know better than I,  constitutes  an
accepted exception to the general rule, formalised  in  Protocol  No.  8  on
Denmark of the Treaty on European Union signed in Maastricht on  7  February
1992, and in the so-called "Decision concerning certain problems  raised  by
Denmark on the Treaty on European Union" of 11 and 12 December  1992,  which
contains the notification from Denmark that it would not participate in  the
third stage of the European Economic and Monetary Union.
       However, the Danish krone was in fact pegged  to  the  Deutsche  Mark
from 1982 until the end of 1998. Furthermore, since 1 January  1999  it  has
been participating in ERM II  with  a  rather  narrow  fluctuation  band  of
±2.25%, and effectively has had an almost fixed exchange rate vis-а-vis  the
euro. Therefore, the Danish monetary  policy,  through  this  exchange  rate
strategy, is the monetary policy of the Eurosystem. In other words,  Denmark
follows "the rules of the game" almost  entirely,  or  as  the  Governor  of
Danmarks Nationalbank, Ms Bodil Nyboe  Andersen,  often  says,  "The  Danish
krone shadows the euro".
       In this connection,  and  before  the  question  and  answer  session
begins, let me conclude by addressing the following key  questions  to  you,
on the understanding that this is a rhetorical way to express my  ideas  and
that I do not necessarily expect any of you to answer them.
       If Denmark already is following "the rules of the game",  why,  then,
should you not make use of the advantages of belonging  to  the  Eurosystem?
Why, then, should you  not  participate  in  the  decisions  concerning  the
monetary policy which, in actual fact, applies to Denmark?
       ______________________

       (1) For a more detailed  analysis,  see  the  article  entitled  "The
international role of the euro", in the August 1999  edition  of  the  ECB's
Monthly Bulletin, pp. 31-35.

                                     ***


            European Economic and Monetary Union - principles and
                                perspectives

  -#"+ !-+  1999\DRAFT SYLLABUS FOR THE CLASummary of a presentation by Ms
                             Sirkka Hдmдlдinen,
         Member of the Executive Board of the European Central Bank,
                       The Tore Browaldh lecture 1999,
        School of Economics and Commercial Law, Gцteborg University,
                        Gothenburg, 25 February 1999

       The European integration process started  shortly  after  the  Second
World War and was, at the time, strongly  motivated  by  political  factors.
The aim was to eliminate the risk that  wars  and  crises  would  once  more
plague the continent. The first concrete result was  the  establishment,  in
1952, of the  European  Coal  and  Steel  Community  between  six  countries
(Belgium, France, Germany, Italy, Luxembourg and the Netherlands). This  was
followed by the  adoption  of  the  Treaty  of  Rome  in  1957,  laying  the
foundations for the European Economic Community.
       The first concrete proposal for a Monetary Union was presented in the
so-called Werner Report in 1970. The Report was intended  to  pave  the  way
for the establishment of a Monetary Union in the early 1980s.  However,  the
proposals of the Werner Report were never implemented - being  overtaken  by
world events. After the break-up of the Bretton Woods system and  the  shock
of the first oil crisis  in  1973,  most  western  European  economies  were
contaminated by the economic sickness  popularly  labelled  "Eurosclerosis",
characterised by high inflation and persisting unemployment. At  that  time,
the European economies were protected by regulations and  financial  markets
were still poorly developed. In this environment, it was  concluded  that  a
Monetary Union would not be possible and the project was postponed.
       The idea of establishing Monetary Union was revived only in 1988  and
a detailed proposal was presented the following year in the  Delors  Report,
after the launch (in 1985) of  the  Single  Market  programme  on  the  free
movement of goods, services, capital  and  labour.  Because  of  the  single
market, the Report could be more explicit and credible with  regard  to  how
best to achieve closer economic ties between the  EU  economies  before  the
introduction of a single currency. Moreover, the Report was supported  by  a
detailed description of an  institutional  set-up  geared  towards  ensuring
stability-oriented economic policies.
       Notwithstanding the thorough work  invested  in  the  Delors  Report,
almost 10 years of convergence and technical preparations were  required  in
order to ensure the successful implementation  of  the  euro  on  1  January
1999. And the project is still not over: the euro coins and  banknotes  will
be introduced only in 2002 - 13 years after the presentation of  the  Delors
Report and 32 years after the presentation of the Werner Report.

      Achieving a credible currency

       Today, almost two months after the introduction of the euro,  we  can
say that the technical changeover to  the  euro  was  successful.  Now,  the
Eurosystem  (i.e.  the  ECB  and  the  11  national  central  banks  of  the
participating Member States) must focus on ensuring  the  long-term  success
of the new currency. The credibility of a currency is built  up  by  several
factors, the basis of which  is  the  central  bank's  commitment  to  price
stability. Here, the Eurosystem  is  in  the  fortunate  position  of  being
assigned, through the Maastricht Treaty, the unambiguous  primary  objective
of maintaining  price  stability  in  the  euro  area.  Another  fundamental
building block of credibility is ensuring  that  monetary  policy  decisions
are independent of political pressures. This building block  was  also  laid
down  in  the  Maastricht  Treaty,  which  ensures  that  the  ECB  and  the
participating  national  central  banks  enjoy  a  very   high   degree   of
independence, possibly more than any other central bank in the world.
       The credibility of a currency also  relies  on  the  preparedness  of
governments to pursue stability-oriented policies of fiscal  discipline  and
to undertake necessary structural reforms. On this point, the Stability  and
Growth Pact adopted by the EU  countries  provides  a  basic  framework  for
fiscal discipline and should enhance the governments' incentive  to  proceed
with structural reforms.
       In order to enhance  credibility,  it  is  also  important  that  the
central bank's strategy for achieving the primary  objective  is  clear  and
that the link between the strategy and the central bank's policy actions  is
easily understood by the public. By following a  transparent  approach,  the
central bank can directly improve the efficiency of  monetary  policy.  This
contributes to achieving stable prices with  the  lowest  possible  interest
rates.
       Striving towards increased transparency led the Governing Council  of
the ECB (composed of the Governors of the 11 national central banks and  the
six members of the ECB's Executive Board) to establish a precise  definition
of price stability in order to bring about absolute clarity as  regards  the
primary objective; price stability was defined as  a  year-on-year  increase
of the Harmonised Index of Consumer Prices  (HICP)  for  the  euro  area  of
below 2%. This is a medium-term objective. In the short  run,  many  factors
beyond the scope of monetary policy also affect the price movements.
       The adoption of the Eurosystem's monetary policy strategy also  aimed
at enhancing transparency in the  implementation  of  monetary  policy.  The
strategy is based on two key elements: First,  money  has  been  assigned  a
prominent role in the form of a reference value for the growth of  the  euro
area wide monetary aggregate  M3.  Second,  the  Eurosystem  carries  out  a
broadly based assessment of the  outlook  for  price  developments  and  the
risks to price stability in the euro area on the basis of a  wide  range  of
economic and financial indicators.
       In order to explain to the public  the  Eurosystem's  policy  actions
against  the  background  of  the  adopted  monetary  policy  strategy,  the
Eurosystem uses several channels: the ECB's Monthly Bulletin;  the  issuance
of a detailed press release after each Governing Council meeting,  in  which
the decisions are explained; the organisation of a monthly press  conference
at the ECB; the appearances of the President  at  the  European  Parliament;
and, finally, the numerous speeches and  articles  by  the  members  of  the
Governing Council. Taken as a whole, the Eurosystem is  probably  among  the
more active central banks when it comes to explaining its  policies  to  the
public.
       A further important building block in order to establish  credibility
is the promotion of an  efficient  implementation  of  the  monetary  policy
decisions. The Eurosystem has aimed  to  set  up  an  operational  framework
which  is  consistent  with  market  principles  and  which  ensures   equal
treatment of counterparties and financial systems across the euro area.  The
Eurosystem's  operational  framework  is   based   on   the   principle   of
decentralisation in  order  to  take  advantage  of  the  established  links
between the national central banks and their  counterparties.  The  monetary
policy operations will  therefore  be  conducted  by  the  national  central
banks, while decisions are taken  centrally  in  the  ECB's  decision-making
bodies.

      The consequences of a single currency: perspectives for the future

       The most important effects of  the  single  currency  relate  to  the
possibility of improving macroeconomic stability  and  credibility  for  the
policies pursued; these effects are particularly important for  the  smaller
European  economies.  Moreover,  important  benefits  can  be  derived  from
microeconomic factors, such as lower transaction  costs,  wider  and  deeper
financial markets, improved price transparency and increased competition.
       Starting with the macroeconomic  factors,  Monetary  Union  makes  it
possible for the participating countries to combine  their  credibility.  In
this way, small countries can, to a  certain  extent,  "borrow"  credibility
from some of the  large  countries  which  have  pursued  stability-oriented
policies for a long time. Under credible conditions, the  financial  markets
are  no  longer  under  pressure   from   speculative   attacks   by   large
institutional  investors.  Price  and   interest   rate   developments   are
stabilised, and the investment climate for  companies  is  secured.  In  the
microeconomic  field,  the  most  obvious  consequences  relate   to   lower
transaction costs and increased price transparency across national  borders.
These  factors  are  likely  to  contribute  to  increased  competition  and
downward price pressure on many products.
       One very important consequence is that the use of a  single  currency
will give rise to larger and more competitive financial markets in the  euro
area. In most European countries, the financial markets have, by  tradition,
been rather shallow, with few  participants  and  a  rather  narrow  set  of
financial instruments on offer. A high degree of segmentation and a lack  of
cross-border competition have implied relatively low trading  volumes,  high
transaction  costs  and  a  reluctance  to  implement  innovative  financial
instruments.
       On the introduction of the euro, the foreign exchange risk of trading
in the different national markets in the euro area fully  disappeared.  This
has triggered  increasing  cross-border  competition  and  has  provided  an
incentive for the harmonisation of market practices. In  fact,  the  trading
of money market  paper  and  euro  area  government  bonds  can  already  be
considered to be largely integrated.  The  markets  for  private  bonds  are
still  segmented  owing  to  the  differing  institutional  and   regulatory
conditions across Member States, but they,  too,  will  gradually  integrate
and provide an incentive for increasing  the  issuance  volumes  of  private
bonds. This will contribute to reducing  the  financing  costs  for  private
companies, and it will provide improved opportunities for investors.
       Monetary Union  provides  much  needed  assurance  of  exchange  rate
stability for exporters,  importers  and  investors.  This  is  particularly
important for small and open economies. In fact, most  countries  in  Europe
are to be considered small in the current  global  perspective.  The  active
use of the  exchange  rate  as  a  tool  of  economic  policy  could  be  an
alternative for a large  reserve-currency  country.  For  a  small  country,
experience has shown that large changes in the exchange rate  tend  to  give
rise to higher costs rather than benefits, due to  the  harmful  effects  on
expectations and higher interest rates.
       Some of the economic effects of  the  Monetary  Union  may  partially
benefit also the countries remaining outside Monetary  Union.  Nevertheless,
it is important for the "out" countries, to assess whether  they  find  that
the benefits of maintaining a  national  monetary  policy  "autonomy"  -  if
there is any such autonomy in an integrated and globalised market  situation
- outweigh the possible drawbacks of not being able to  fully  draw  on  the
credibility of the euro area, the integration of  the  euro  area  financial
markets, lower transaction costs, improved price transparency and  increased
competition.

      The euro and the Nordic countries

       The Nordic countries have chosen to organise  their  monetary  policy
ties to the euro area in very different ways: Finland  is  the  only  Nordic
country taking part in Monetary Union as from  the  start  of  Stage  Three;
Denmark negotiated an opt-out  from  Monetary  Union  but  follows  a  fixed
exchange rate policy  vis-а-vis  the  euro  within  the  new  Exchange  Rate
Mechanism (ERM II); Sweden decided not  to  participate  in  Monetary  Union
from the start of Stage Three, without  having  a  formal  opt-out  and  the
Swedish krona still floats freely against the euro; and Norway  and  Iceland
remain outside the EU altogether.
       The divergent approaches taken by the Nordic countries as regards one
of the most important economic and political projects in  Europe  in  modern
times are somewhat strange in view of their  traditionally  close  cultural,
historical, political and economic  ties.  Nordic  co-operation  has  always
been very important and close. I note  with  satisfaction  that  the  public
opinions in Denmark and Sweden now seem to be swinging in a more  favourable
direction  with  regard  to  future   membership.   Maybe   the   successful
implementation of the euro has made  the  public  understand  that  Monetary
Union is aimed at ensuring long-term stability in Europe. In  this  context,
the recent signals from the Government of the United Kingdom  in  favour  of
membership in the Monetary Union are also very encouraging.
       Personally, I think  that  it  would  be  beneficial  to  all  Nordic
countries - and the United Kingdom - to join Monetary Union within  the  not
too distant future. I hope  that  Sweden  and  Denmark  can  become  members
already before the introduction of the euro banknotes and coins in 2002.
       It is important for these countries  to  also  assess  the  political
aspects of remaining outside Monetary Union. Experience has  shown  that  EU
Member  States  which  have  taken  initiatives  and  worked  constructively
towards European integration have been generally more successful in  gaining
influence than those less committed to the  project.  In  this  respect,  it
should be noted that  the  aim  of  the  Maastricht  Treaty  is  clearly  to
establish a Monetary Union comprising all EU Member States.
       Personally, I also think that the Nordic countries  could  provide  a
fruitful joint contribution to the  long-term  success  of  Monetary  Union.
There is no need to overemphasise  the  role  of  small  countries  in  this
process, but it is clear  that  co-ordinated  views  by  a  group  of  small
countries would have  a  larger  influence  than  the  views  of  individual
countries. One  of  the  benefits  of  the  Nordic  countries  -  and  small
countries in  general  -  is  that  they  are  seldom  bound  to  their  old
traditional  system.  In  contrast,  they  typically  fight  for   efficient
solutions which would be in the interest of the whole of the euro area.

      Concluding remarks

       The project to establish European Economic  and  Monetary  Union  was
carefully prepared and based on very strong  political  commitment.  It  has
contributed to the co-ordination of economic policies  -  even  in  a  wider
sense - in an environment of deregulated  financial  markets  and  the  free
flow of capital. The stability arguments  behind  the  introduction  of  the
euro have been so well accepted that  we  are  already  seeing  serious  and
visible efforts aimed at the next step towards a  global  "single  currency"
through the establishment of exchange rate co-ordination between  the  euro,
the US dollar and the  Japanese  yen.  In  order  for  any  such  world-wide
currency co-ordination to become successful,  there  would  be  a  need  for
political  commitment  to  globally   harmonising   fiscal,   monetary   and
structural policies. In this context, I would advise realism, caution and  a
gradual  approach  in  spite  of  the  longer-term  ideal  goal  of   global
stability. There are still many challenges and adjustments ahead within  the
euro area before any  world-wide  steps  should  be  considered.  Our  first
priority is to ensure long-term stability in the euro area  economies  under
the single monetary policy and on the hope that  the  euro  area  will  soon
cover all EU countries.

                                     ***


                 Eurosystem: new challenges for old missions

                Inaugural Lecture by Tommaso Padoa-Schioppa,
         Member of the Executive Board of the European Central Bank,
                    on the occasion of his appointment as
       1999\GERMAN COFFEE COMPANY ORGANIZES THE PROMOTION CAMPAIGN IN
                             ST.DOCЦюй±%€ѕ[pic]
     А- -#"+ !-+  1999\GERMhonorary Professor of Johann Wolfgang Goethe-
                                Universitдt,
                      Frankfurt am Main, 15 April 1999

     Table of contents

            1. Introduction
            2. Policy missions
            3. New challenges
            4. Making the eurosystem a central bank
            5. Dealing with the European unemployment
            6. Managing financial transformations
            7. Coping with a lack of political union
            8. Conclusion


      1. INTRODUCTION

       I participate in this Dies Academicus, at the University that carries
the name of Goethe, in the town of Frankfurt,  in  the  first  year  of  the
euro, with thoughts and emotions that are hard to conceal.
       In my early youth, at the time of the decisions that determine  one's
life, the dearest of my Gymnasium teachers told me: "You  have  to  resolve,
in order to decide your future, the dilemma  of  what  interests  you  most:
whether  to  understand  or  to  change  the  world."  My  choice  has  been
Economics. And, the  subject  of  economics  being  human  action,  I  early
discounted that the call for action would prevail, in my  motivations,  over
the enquiring spirit. I did not  expect  how  strongly  that  dilemma  would
continue to accompany my life. More importantly, I did  not  understand,  at
the time, how much acting and enquiring are complementary ways of  being  in
the world and searching for truth, as Goethe's work and life  so  profoundly
witness. Science  changes  reality;  practical  activity  not  supported  by
reflection and analysis is ineffective and even harmful.
       If I now live in Frankfurt and am here today it is because most of my
professional life was spent in an institution - the Banca d'Italia  -  where
eminent persons like Guido Carli,  Paolo  Baffi  and  Carlo  Azeglio  Ciampi
allowed the dilemma of my early years being  kept  somewhat  unresolved  and
favoured independent analysis as a complement of  practical  activity.  They
also shared and encouraged  the  combination  of  enquiry  and  action  that
helped the euro to become a reality.  To  them  I  therefore  dedicate  this
lecture.
       Academia is the place where teaching  and  enquiring  reinforce  each
other by going hand in hand. It originates from Socrates' precept that  "the
wisest recognises that he is in truth of no account in respect  to  wisdom".
Teaching  is  assertive,  enquiring  interrogative.  One  is  based  on  the
presumption that we have answers to transmit; the  other  is  based  on  the
modesty imposed by unresolved questions.
       The mode of the following remarks will be the  interrogative,  rather
than the assertive one. Not only because presumption  is  certainly  not  my
#"+ !-+  1999\EVALUATION DER BEITRAEGE AUS JUNI99.DOC¤АјXї[pic][pic]?-  -#"+
!-+  1999\EVALUATION  DER  Bйtat  d'esprit  today,  but,  more  importantly,
because the theme of this lecture - the new challenges posed by  the  advent
of the euro - has a distinctly intellectual dimension, not only a  practical
one. The success of EMU will largely depend on the ability to  identify  new
problems at an early stage and to analyse them without prejudice. While  the
mission entrusted to central bankers is  not  new,  the  challenges  in  the
years to come may indeed differ from those of the  last  few  decades.  They
may be "new" either because  they  have  not  been  experienced  before,  or
because they have acquired a new dimension.
       In reviewing what I consider to be,  for  the  Eurosystem,  the  most
important of such challenges, I shall use the academic privilege  of  taking
a free and forward-looking perspective. My point of  view  will,  therefore,
not necessarily coincide with that of my institution. Moreover, I shall  not
be objective, because I shall mainly draw on the intellectual and  practical
experiences that have constituted my professional life.

      2. POLICY MISSIONS

       Policy missions have not been altered by the start of the euro.  They
correspond to aspects of the public interest that were  not  redefined,  and
did not need a redefinition, because of the euro.
       In the field of central banking the public  interest  is  to  provide
economic activity with a medium of exchange that preserves  its  value  over
time. In the broader field of economic policy - of which monetary policy  is
part - the public interest is, to use words from the Maastricht Treaty  that
can be similarly found in most national constitutions and  legislation,  "to
promote economic and social progress  which  is  balanced  and  sustainable"
(Article B). In the field of European integration, the mission  is  that  of
"creating an ever  closer  union  among  the  people  of  Europe,  in  which
decisions are taken as closely as possible  to  the  citizen"  (Article  A).
Finally, in the field of international relations the public interest  is  to
"maintain international peace and security"  (UN  Charter  Article  1.1)  as
well as to "contribute to the promotion and maintenance  of  high  level  of
employment and real income" (Articles  of  Agreement  of  the  IMF,  Article
1.ii).
       The formulation of these policy missions has  taken  shape  over  the
course of this century,  or  even  earlier,  on  the  basis  of  experience,
scholarly investigation, political debate and  action.  There  would  be  no
consensus about the primary mission of the central  bank  if  countries  had
not  experienced  first  hyperinflation   and   then   successful   monetary
management by a stability-oriented  and  independent  central  bank.  Social
progress and economic growth would not  be  on  the  agenda  of  governments
without the labour movement and the Great Depression. We would not have  the
EU Treaties and the Charter of the UN  without  the  tragedy  of  two  World
Wars.
       Economists have explored the scope for economic  policy  action,  and
the limits thereof, in the monetary, fiscal and regulatory  fields.  Without
thirty years of academic debate about the role of monetary policy,  the  EMU
Treaty and the Statute of the ESCB/ECB would not have been written  the  way
they were. The subordination of economic policies to the  principle  of  "an
open market economy with free competition" would not  have  been  explicitly
inserted in the Maastricht Treaty (Article  3A)  had  those  principles  not
gained recognition in the community of scholars.
       Central bankers (most notably in the Delors Committee) have  prepared
the blueprint for the  single  currency.  International  and  constitutional
lawyers have elaborated the legal concepts and  studied  the  procedures  to
carry out the policy missions. They have built that legal monument  that  is
the  Rome/Maastricht  Treaty.  Citizens  and  politicians  have   discussed,
promoted and implemented the whole process.
        Different  policies  carry  different  degrees  of  compulsion   and
effectiveness. In general, instruments are more strongly  framed  when  they
are entrusted to institutions whose  area  of  jurisdiction  coincides  with
that of the nation state.  Strongly  framed  instruments,  however,  do  not
necessarily produce strong results. Tough regulation against  air  pollution
adopted only by a small country is less effective, for  that  same  country,
than softer regulation adopted by a larger group of countries. The  economic
literature about externalities, or that about optimal  currency  areas,  are
seminal examples of the contribution economic  research  can  make  in  this
respect.
       In the following I shall focus on the mission of the central  banker,
because this is the function assigned to me. I am convinced,  however,  that
the  missions  I  mentioned  are  fundamentally   complementary.   Different
assignments are part of an orderly division of labour. In a  democratic  and
market-oriented environment not  only  citizens,  but  also  officials,  can
consider the aims of the various policy bodies and charters -  national  and
international - to which they refer as forming a  consistent  configuration.
I regard this as a special privilege of the time and space in which  I  have
lived so far.

      3. NEW CHALLENGES

       In the  last  thirty  years  central  bankers  have  fought  for  two
objectives: the recognition of the primacy of price stability  for  monetary
policy, and the independence of the central bank. This has been  the  period
in which the combination of political democracy and fiduciary currency  made
the governance of money particularly difficult in many countries.
       The intellectual  recognition,  then  the  political  acceptance  and
finally the actual implementation of a monetary constitution based on  price
stability and central bank independence have required a  long  process.  The
academic profession has contributed to it in a  powerful  way,  from  Irving
Fisher to Don Patinkin to Robert Lucas. Even those who have denied the  need
of having a central bank, like Milton Friedman and Friedrich A.  von  Hayek,
have in the end contributed to  clarify  its  role  and  function.  No  less
persuasive have been the arguments of experience. In a positive  sense,  the
economic success of the country - Germany - where the two elements had  been
introduced at an early stage. In a negative sense, the social evil  of  high
and prolonged inflation suffered by many other countries, including my  own.

       In legal and institutional terms, the result of this long  fight  has
been engraved in  the  Treaty  of  Maastricht.  The  Treaty  represents  the
strongest monetary constitution  ever  written,  not  only  because  of  its
substance, but also because the procedure to  amend  it  is  more  difficult
than that required for the charter of any  existing  central  bank.  Largely
induced by Maastricht and EMU is also the  independent  status  of  national
central banks in the European Union.  We  should  indeed  not  forget  that,
until recently, key decisions in the field of monetary policy were still  in
the hands of the Treasury in such countries as the United  Kingdom,  France,
Italy and Spain. The Maastricht process has been the catalyst  for  monetary
reforms central bankers had advocated for years.
       Partly, but not exclusively, because of this process, the  conditions
under which  the  single  currency  has  come  to  life  differ  from  those
prevailing in the past years.
       Prices have for some time now shown the highest degree  of  stability
seen for more than  thirty  years.  Most  countries  have  made  significant
progress towards fiscal consolidation. The consensus on sound principles  of
budgetary and monetary  management  is  broader  and  stronger,  among  both
politicians and ordinary people,  than  in  any  other  period  the  present
generation can remember. Few dispute in an open  way  the  now  widely  used
expression "culture of stability".
       However, when in 1981 it was decided to save the last specimen of the
smallpox virus in a laboratory for the sake  of  documentation,  health  had
not ceased to be in danger. Similarly, none of  these  achievements  can  be
considered as permanent and  central  bankers  should  primarily  strive  to
preserve them. To this end, detecting new challenges at an  early  stage  is
essential. The question is: where do the problems come from?  What  are  the
circumstances under which the "old mission" will have to be accomplished  in
the coming years? What threatens our health besides smallpox?

      4. MAKING THE EUROSYSTEM A CENTRAL BANK

       The first challenge consists in making the Eurosystem a central bank.
It may seem simple, but is not. Let me start my  explanation  from  the  two
key words of this proposition.
       Eurosystem is the word chosen by the  ECB  to  indicate  the  "ECB+11
participating national central banks", i.e. the central bank  of  the  euro.
The Treaty has no name for this key entity, while it refers  extensively  to
the ESCB (European System of Central Banks) formed by the  ECB  and  the  15
European national central banks).  However,  as  long  as  there  are  "out"
countries, the ESCB in its full composition will remain a scarcely  relevant
entity because it neither refers to a  single  currency  area  nor  has  any
policy competence.  Instead,  the  word  Eurosystem  indicates  clearly  the
articulated entity which is for the euro what the Federal Reserve System  is
for the dollar.
       Central bank is the institution in charge  of  the  public  interests
associated with the currency. It originates from fundamental changes in  the
technology of payments: the adoption of banknotes, cheques  and  giros,  and
their final disconnection from gold.  These  changes  have  shaped  the  two
other functions that most central  banks  have  derived  from  the  original
payment system function: monetary policy and banking  supervision.  Man-made
money made monetary policy possible.  Commercial  bank  money  made  banking
supervision necessary.
       These three functions have most often  been  entrusted  to  the  same
institution because they are inextricably linked.  Just  as  money  has  the
interrelated roles of means of payment, unit of account and store of  value,
so central banking has a triadic function that refers to the three roles  of
money. Operating and supervising the payment system refers  to  money  as  a
means of payment; ensuring price stability refers to  money  as  a  unit  of
account and a store of value; pursuing the  stability  of  banks  refers  to
money as a means of payment and a  store  of  value.  The  function  remains
triadic (albeit, in  my  view,  in  a  less  satisfactory  way)  even  where
prudential control is entrusted to a separate agency. I am referring to  the
special "supervision" any central  bank  has  over  its  banking  community,
necessitated by the fact that banks  are  the  primary  creators  of  money,
providers of  payment  services,  managers  of  the  stock  of  savings  and
counterparties of central bank operations.
        In  performing  its  triadic  function  the  central   bank   exerts
operational and regulatory powers, interacts with other  public  authorities
and the financial community, entertains relations with other central  banks,
participates in international debates and negotiations  about  monetary  and
financial matters. In all these activities it  pursues  and  represents  the
public interest of a sound currency; all are instrumental to that  interest.
From the point of view of the perceptions of people  and  markets  all  such
activities refer to that same public good that we call confidence.
       For the Eurosystem the challenge is to rise to a full central banking
role as just defined. It is necessary because of the  links  that  bind  the
various functions of money. The  Eurosystem  would  find  it  hard  to  play
effectively its most delicate role - the pursuit of a  stable  currency  or,
as the German Constitution puts  it,  "die  Wдhrung  zu  sichern"  -  if  it
appeared as an inexplicable exception to the classic paradigm of  a  central
bank. The public, the  markets,  the  international  institutions  and  fora
would not understand.
       But it is also difficult, because the steps to take are multiple  and
complex from both a conceptual and a  practical  point  of  view.  Moreover,
they cannot all be taken at once. Let me briefly explain.
       In the articulation of  any  federal  constitution  (Bund,  Land  and
local, to use the German terminology) the central bank  undoubtedly  belongs
to the  level  of  the  "federation",  or  Bund.  The  fact  that  important
activities   are   conducted   by   "local"   components   of   the   system
(Landeszentralbanken,   or   Federal   Reserve   District   Banks)   is   an
organisational  feature  that  does  not  impinge  upon  the  constitutional
position of the central bank. The same happens within  Monetary  Union.  The
Eurosystem is the central bank of the euro area, even though operations  are
carried out  -  to  the  extent  possible  and  appropriate  -  through  its
component  parts,   the   NCBs.   Indeed,   the   constitutional   and   the
organisational profile of the institution are not in contradiction.
       Although a federal and decentralised central bank is not  a  novelty,
the Eurosystem is a special case. It is the central bank of an economy  that
has a much deeper national segmentation than any other  currency  area.  Its
components have for many generations (and until  few  weeks  ago)  performed
the full range of central banking functions under their  own  responsibility
and in a national context. They have  been  accountable  to,  and  sometimes
dependent on, national  institutions.  Public  opinion  has  perceived,  and
still perceives, them  as  national  entities.  The  notion  of  the  public
interest they were referring to was  the  notion  of  a  national  interest.
Significant  differences  existed,  and  partly  remain,  in  their   tasks,
organisations, statutes and cultures.
       In this situation, making the  Eurosystem  a  central  bank  requires
drawing  the  appropriate  distinction  between  being   national   in   the
organisational sense and being euro  area-wide  in  the  definition  of  the
public interest  pursued.  This  is  a  difficult  distinction  to  draw  in
conceptual terms, not only in practical terms or from the point of  view  of
personal attitudes.
       In the preparatory discussions  and  negotiations  that  led  to  the
Maastricht Treaty, central banks took the view that monetary  functions  are
indivisible and that, contrary to  the  fiscal  field,  subsidiarity  cannot
apply to the monetary field. Their traditional and  strongly  held  position
has been that the public interest assigned to central bank is a whole  which
cannot easily be decomposed. Indeed, while there is a fairly well  developed
theory of fiscal federalism, there is no equivalent for the monetary  field.

       As I said, I do think that the functions of a central bank constitute
a whole that cannot be split. This does  not  exclude  that  the  Eurosystem
should avoid seeking more uniformity than necessary and that some  diversity
is a positive factor and  has  always  been  valued  as  an  aspect  of  the
richness of Europe. Perhaps even a limited degree  of  internal  competition
may be used as an incentive to good  performance.  But  can  the  Eurosystem
depart from the two historical models of the Federal Reserve System and  the
Bundesbank? What are, in conceptual terms,  the  criteria  of  what  I  just
called the "appropriate distinction"? What should be the touchstone?
       It would be an illusion, I think, to expect or pretend to have a full
and satisfactory answer solely from legal interpretation. And  it  would  be
unfortunate if the Eurosystem were to fall into the  trap  of  the  narrowly
legalistic  approach  that  paralyses   international   organisations.   The
Eurosystem is not an  international  organisation,  its  model  is  not  the
Articles of Agreement of the IMF. Of course, the answer will have to  comply
with the Treaty, which provides useful  guidance.  However,  the  system  is
entrusted to decision-making bodies that are composed not  of  lawyers,  but
of central bankers. They carry the  primary  responsibility  to  manage  the
euro and are accountable for that responsibility. They have known for  years
what a central bank is and how vague the wordings of central  bank  statutes
have historically been. Their touchstone  can  only  be,  in  the  end,  the
effectiveness in the accomplishment of the basic  mission  embodied  in  the
triadic paradigm of central banking functions.

      5. DEALING WITH EUROPEAN UNEMPLOYMENT

       The second challenge comes from the high  level  of  unemployment  in
Europe.
       Every economist, observer or policy-maker would probably  agree  that
the most serious problem for the European economy, today and  in  the  years
to come, is high unemployment. In large  parts  of  continental  Europe  the
economic system just seems to have lost the ability to create new jobs.
       Also on the nature and causes of European  unemployment  there  is  a
large degree of agreement, as there was agreement on the nature  and  causes
of European inflation well before price stability was  finally  restored  in
the 1990s. The key words describing such agreement  are  structural  factors
and flexibility. There is agreement that  perverse  incentives,  direct  and
indirect taxation of labour, unsustainable  pension  schemes,  overly  tight
employment  rules  and  rigidities  throughout  the  economy  are  the  main
obstacles to  the  creation  of  new  jobs.  There  is  agreement  that  the
typically European welfare state system should be profoundly corrected,  but
not suppressed. Many also think that rather than following  a  "Thatcherian"
policy of cracking down on the trade unions, it would be preferable to  work
with,  rather  than  against,  the  labour  organisations,  although  reform
entails occasional confrontations.
       As with inflation in the 1970s and  1980s,  so  unemployment  in  the
1990s - while being  a  European  disease  -  is  quite  diversified  across
European countries and regions, due to  differences  in  both  policies  and
economic situations. It is over or around 20 per  cent  in  the  Mezzogiorno
and Sachsen-Anhalt, but below 7 per cent in Lombardy and  Baden-Wьrttemberg;
over 18 per cent in Spain, but less than 4 in the Netherlands.
       Notwithstanding the intergovernmental debates at a European level and
the stated intention to undertake common  initiatives,  the  instruments  of
employment policy remain in national hands,  although  only  partly  in  the
hands of governments. I  regard  this  as  appropriate  because  competition
should not be suppressed from the labour market.
       Adopting the appropriate policies of  structural  reform  has  proved
extremely difficult in many key European countries,  including  my  own  and
this one. Other countries, such as the Netherlands and the  United  Kingdom,
have been more successful. Even the most  successful  experiences,  however,
have shown that  reducing  unemployment  is  a  long  and  gradual  process.
Although some countries started labour market reforms in  the  early  1980s,
they only reaped the benefits in the 1990s.
       Unemployment will thus remain with us in the years to come and  I  am
convinced that it should be regarded as the greatest  policy  challenge  not
only by governments and labour  organisations,  but  by  the  Eurosystem  as
well. Let me explain why.
       An economy in which unemployment drags above 10 per cent for years is
a sick economy, just like one in which  public  finances  or  inflation  are
chronically destroying savings. To operate in a sick  economy  is  always  a
risk for the central bank and for the successful fulfilment of  its  primary
mission. In the case of prolonged unemployment, the risk arises  both  on  a
functional and an institutional ground.
       On  a  functional  ground,  i.e.  from  the  point  of  view  of  the
relationship between economic variables  that  models  usually  consider,  a
chronically  weak  economy  is  one  in  which   expectations   deteriorate,
investments stagnate,  consumption  declines.  Structural  unemployment  may
increase the risk  of  a  deflationary  spiral  because  a  longer  expected
duration  of  unemployment  may   imply   that   households   respond   more
conservatively  (in  terms  of  increasing  savings)  in  the  face   of   a
deflationary shock. Today,  we  see  no  signs  of  deflation.  Markets  and
observers who pay attention to communications by the  Eurosystem  know  that
the monetary policy strategy  of  the  euro  area  is  symmetrical,  equally
attentive to inflation and deflation. Thus, they  know  that  if  that  risk
became reality, the Eurosystem would have to act,  and  would  act.  But  we
know that monetary policy is much less  effective  in  countering  deflation
than it is in countering inflation.
       A more insidious threat, however,  may  arise  on  the  institutional
ground. It comes from a  chain  of  causation  involving  social  attitudes,
economic theory and policy, actual economic developments  and  institutional
arrangements. Attitudes  of  society  respond  to  economic  situations  and
policies, which in turn depend on the state  of  development  of  economics.
Institutions, on their part, are influenced by attitudes  of  society.  Both
the course of economic thought and the practice  of  policy  were  lastingly
altered by the Great Depression. The epitome of this  historical  event  was
the Keynesian revolution. In many countries the strong consensus  about  the
primacy of price stability and the independence of the central bank was  the
outcome of the prolonged inflation suffered in the 1970s and 1980s. Here  in
Germany, it is rooted in the experience  of  hyperinflation.  Would  such  a
consensus survive if high unemployment remained a  chronic  feature  of  key
European economies for many more years? And how would the  position  of  the
central bank change if that consensus faltered?
       As central bankers primarily concerned with price stability, what can
we do to cope with this challenge and to reduce the  risks?  My  answer  may
seem disappointingly partial, as I  do  not  think  there  is  a  miraculous
medicine that monetary policy can provide. I would phrase it as follows.
       Firstly, the central banker should be aware of the danger. He  should
know that in the future his principal objective may not  receive,  from  the
public, governments and parliaments the same strong support which  has  been
the outcome of the two decades of  high  inflation.  Since  unemployment  is
what concerns the voters and the youngsters most,  it  may  be  increasingly
necessary for him to play an educational role in explaining the benefits  of
a stable currency to those who have not directly experienced  the  costs  of
inflation. This is very much like the case of the  post-war  generations  in
Europe which, being fortunate enough not to experience the horror  of  World
War II, need now to be reminded about  the  human  costs  of  that  terrible
conflict.
       Secondly, the central banker  should  avoid  mistakes.  It  may  seem
obvious, but  he  should  never  forget  that  independence  does  not  mean
infallibility and that the likely new environment will offer no  forgiveness
for mistakes. A mistake would be the attempt to  provide  a  substitute  for
the lack of structural policies by providing unnecessary monetary  stimulus:
it is not because the right medicine is neither supplied by  the  pharmacist
nor demanded by the patient  that  the  wrong  medicine  becomes  effective.
Another mistake would be to give the impression that the central bank has  a
ceiling in mind for growth, rather than for inflation. On the contrary,  the
central bank should make it clear that any rate of  non-inflationary  growth
is welcomed and would be accommodated, the higher the better.
        Technically,  this  will  not  be  an  easy  task.  The   analytical
uncertainty surrounding estimates of potential output and  its  growth  rate
might lead the central banker to respond quite  cautiously  to  evidence  of
shifts in the  rate  of  non-inflationary  growth.  While  such  caution  is
certainly optimal from an inflation stabilisation point of  view,  it  might
be wrongly interpreted as a systematic deflationary bias by the  public  and
the politicians. This is  a  clear  case  in  which  any  progress  made  by
scholars in refining the analytical tools of the  economic  profession  will
greatly help the central  banker  to  achieve  his  goals  without  imposing
unnecessary costs on society at large.
       On the whole, however, it is part of the  central  banker's  role  to
make the day-by-day decisions that, in the end, constitute monetary  policy.
This responsibility can  be  neither  transferred  to,  nor  challenged  by,
policy makers responsible for other areas. Last  week,  the  Eurosystem  has
made, for the first  time  in  its  life,  an  affirmative  monetary  policy
decision by lowering its official rates. In this  way,  the  Eurosystem  has
acted in line with its monetary  policy  strategy  and  made  a  significant
contribution towards an  economic  environment  in  which  the  considerable
growth potential of the euro area can be exploited in full. It  is  now  the
responsibility of other sectors of economic policy making to do  their  part
by strictly adhering to the  Stability  and  Growth  Pact  and  implementing
decisive structural reforms.

      6. MANAGING FINANCIAL TRANSFORMATIONS

       The third challenge consists in accompanying and surveying the  rapid
changes the European financial institutions and markets are undergoing,  and
will  continue  to  undergo  over  the  coming  years,  partly  -  but   not
exclusively - as a consequence of the euro.
       It is  sufficient  to  observe  the  US  Federal  Reserve  System  to
understand the  role  the  Eurosystem  should  play  in  the  coming  years:
attention  in  monitoring  changes   in   the   financial   system,   active
participation in the policy debate caused by such change,  intense  dialogue
with both the Administration and Congress,  influence  exerted  on  opinions
and decisions.
       To a large extent the factors of change  are  technology  determined,
hence  independent  of  the  euro  and  even  not   specifically   European.
Technology is the  driving  force  of  the  transformation  in  banking  and
finance that modifies the  traditional  deposit  loan  structure  of  banks.
Technology also reshapes dramatically the back office and the  communication
with customers, thus producing massive over-branching and  over-staffing  in
traditional banks. Also the globalisation of finance  comes  primarily  from
the combination of data processing and telecommunications.
       Other changes are specifically European. Since universal banking  has
historically  prevailed  in  continental  Europe,   the   change   from   an
institution-based  to  a  market-based  financial  system  is   particularly
significant in this  part  of  the  world.  Similarly,  the  development  of
financial conglomerates is more pronounced in  Europe  than  in  the  United
States or Japan. Typical of continental Europe are also  the  labour  market
rigidities that make the restructuring of banks so difficult and slow.
       Finally, there are changes  induced  by  the  euro.  The  removal  of
currency specificity as a cause of national segmentation  of  the  financial
industry is causing a convulsive shake-up of both institutions and  markets.
Since the beginning of this year, about ten banks ranking near  the  top  of
their respective national lists have concluded or started merger  operations
in France, Spain, Italy,  the  Netherlands,  Belgium  and  Norway.  In  most
European countries stock exchanges and other organised markets,  which  were
legally and structurally organised as providers of a  public  service,  have
been transformed into profit-driven private institutions and are  now  in  a
process of rapid concentration. In the coming two or three years the  number
of banks will shrink,  the  largest  banks  will  become  much  larger,  few
financial centres and market networks will replace the  present  one-country
one-centre configuration.
       In any national system the central bank would  actively  monitor  and
even guide the course of such a transformation. It would do  so  along  with
the various agencies responsible for financial supervision  and  competition
policy, and with an involvement of  the  executive  power  itself.  Although
largely determined by business decisions, these developments indeed  involve
the public interest in various ways.
       Surveying and accompanying a profound transformation of the financial
industry would be a difficult task for any central bank. For the  Eurosystem
it will represent a daunting challenge because it will put to  the  test  an
unprecedented articulation of the policy functions that are called for.  Let
me briefly explain this assertion.
       The institutional setting of  the  euro  area  establishes  a  double
separation between central banking and other public  functions.  Firstly,  a
functional separation,  whereby  banking  supervision  is  now  assigned  to
institutions that - even when they are national central banks  -  no  longer
exert independent monetary policy functions.  Of  this  separation  we  have
many previous examples (Germany, Japan, Sweden,  now  the  UK,  etc.).  Much
newer is a  second,  geographical,  separation,  whereby  -  with  only  the
partial exception of competition  policy  -  the  area  of  jurisdiction  of
central banking does not coincide with  the  area  of  jurisdiction  of  the
other public functions involved  (banking  supervision,  regulation  of  the
securities market, etc.).
       Experts, including academic people, have so far focused attention  on
lender-of-last-resort functions and suggested that  the  new  setting  would
not be able to act effectively in a crisis.  I  have  argued  elsewhere  why
this criticism seems unjustified. Here, I would like  to  suggest  that  the
real challenge  could  come,  in  my  opinion,  from  tensions  between  the
national  and  the  euro  area  interest  in  the   process   of   financial
transformation.
       The  process  of  industry  transformation  will  inevitably  involve
aspects that have traditionally  been  considered  as  sensitive  by  public
authorities: suppression of jobs, location of facilities  and  headquarters.
Financial transformation will also produce a hardening  of  competition  and
competition  will  be,  to  a  considerable  extent,  one  between  national
financial centers and industries,  not  only  between  individual  banks  or
institutions. The propensity to defend national champions may  prevail  over
the pursuit of efficiency. The risk for the Eurosystem to fall in  the  trap
of an improper interplay between the EU and the national  dimension  of  the
public interest may become high.  Like  any  central  bank,  the  Eurosystem
should be both active and neutral  in  the  great  transformation  of  "its"
financial industry. The word "system" that is part of its own  name  refers,
and should apply in practice, to the whole euro area.

      7. COPING WITH A LACK OF POLITICAL UNION

       The fourth challenge consists in coping with the lack of a  political
union. The relationship between monetary and  political  union  and  whether
the latter should be a precondition for the former has been a central  issue
in  the  European  debate  well  before  the  establishment  of  the  Delors
Committee in 1988. While I do think that there is a lack of political  union
and that this lack constitutes a serious challenge  for  the  Eurosystem,  I
also think that the expression "lack of political union" is  often  used  in
an unclear way that  blurs  the  issue.  Let  me  thus  first  consider  two
meanings of this expression with which I do not concur.
       First, I do not concur with the idea that there is no political union
in Europe today. It is not because the content and  the  competence  of  the
European Union are mainly economic, that its nature and historical role  are
not political. Even before the single currency, EU competence extended  over
virtually  the  whole  Corpus  Iuris  of   economic   activity,   from   the
establishment  of  "the  free  movement  of  goods,  persons,  services  and
capital" (the four freedoms proclaimed  by  Article  3  of  the  Treaty)  to
external economic relationships. To  understand  how  very  political  these
issues are, it should suffice to think about the place they take in  the  US
political debate today, or have taken  in  the  politics  of  our  countries
before the creation of the European Community. Moreover,  the  institutional
architecture of the European Union is entirely that of a  political  system,
not that of an international organisation  based  on  intergovernmental  co-
operation: a legislative capacity that prevails over that of Member  States,
a judicial power, a directly elected Parliament.
       Second, I do not  concur  with  the  idea  that  Monetary  Union  has
developed outside the political process. Quite the  contrary  is  true.  The
establishment of a single currency in the European Union has  been  achieved
because of the strong political determination of elected governments over  a
full decade, from June 1988 to May 1998. It is significant that during  that
long period continuity has not been broken by repeated changes of  political
majority in  virtually  all  countries  except  Germany.  Technocrats,  i.e.
central bankers, have "only" played their role, crucial as it may  be.  They
have  provided  expertise,  from  the  drafting  of  the  blueprint  to  the
preparatory  work  for  the  actual  start  of  the  system.  And,  no  less
important,  they  have  loyally  accepted  the  limits  of  their  role  and
recognised  that  the  ultimate   decisions   have   belonged   to   elected
politicians. This is the meaning of the two  statements  of  July  1988  and
March 1998 with which  the  Bundesbank  has  defined  its  position  at  the
beginning and the end of the crucial  decade.  "In  der  Beschrдnkung  zeigt
sich der Meister".
       The establishment of a single currency is a strongly political  event
in its genesis and a profound social and cultural change in its  nature.  As
economists and central bankers we pay limited attention to notes  and  coins
because they are a minor and endogenous component of the  money  stock.  For
many politicians, however, Monetary Union meant little else  than  a  common
banknote. They saw, better than us, that for the  people  money  has  to  do
with the perception of the society to which  they  belong  and,  ultimately,
with their culture. As such, money goes well beyond the economic  sphere  of
human action. Indeed,  the  act  whereby  we  accept  to  provide  goods  or
services to an unknown person in exchange for pieces of paper that  have  no
intrinsic value is perhaps the most significant and widespread testimony  of
the social contract that  binds  people.  This  is  why  coinage  and  money
printing have always been a prerogative of the State.
       Yet, for two main reasons it remains true that Europe has a  lack  of
political union. First,  the  European  Union  is  still  not  the  ultimate
provider of internal and external  security,  the  two  key  functions  that
constitute the raison d'кtre of the modern State.  Second,  EU  institutions
still fail to comply with the key constitutional principles that  constitute
the heritage of western  democracies:  foundation  of  the  legislative  and
executive functions on the popular vote, majority principle, equilibrium  of
powers.
       Why does the lack of political union constitute a challenge  for  the
Eurosystem? I would answer as follows.
       In a period of less than thirty years money has  abandoned  both  the
anchors it has had since the earliest times: metal and the sovereign. It  is
true that central banks have struggled for years to free the printing  press
from the influence of the modern sovereign, as they struggled  in  the  past
to free it from the influence of private interests. It is equally true  that
the present status of the Eurosystem in the constellation of  public  powers
is exceptionally favourable.  However,  only  a  superficial  thinker  could
confuse independence with solitude and  take  the  view  that  the  lack  of
political union strengthens the position of the central bank  and  makes  it
freer to fulfil its mission.
       The security on which a sound currency assesses its  role  cannot  be
provided exclusively by the central  bank.  It  derives  from  a  number  of
elements that only  the  State  or,  more  broadly,  a  political  union  as
previously defined, can provide. When we say that  a  currency  is  a  "safe
haven" we refer not only to the  quality  and  credibility  of  its  central
bank, but to the solidity  of  the  whole  social,  political  and  economic
structure to which it belongs. And historical  experience  shows  that  when
that structure appears to weaken, the currency weakens, irrespective of  the
actions of the central bank. A strong currency  requires  a  strong  economy
and a strong polity, not only a competent central  bank.  The  central  bank
is, and should remain, an institution with too limited a mission to  replace
the lack of a political union.
       The problems posed by the coexistence of a  single  currency  with  a
still  unachieved  political  union  will  influence  both   practical   and
intellectual activity in the coming years. They will have  implications  for
the central banker, the politician and, more  generally,  the  citizen.  For
the politician the implication is that his political decision to move  ahead
with Monetary Union in advance  of  political  union  contains  an  implicit
commitment to work for  the  completion  of  political  union.  The  central
banker should be aware of  the  special  difficulties  and  responsibilities
deriving from this anomalous condition. On the one  hand  he  will  have  to
cope with this situation and adapt his attitudes to a  composite  -  EU  and
national - institutional architecture, one that lacks the simplicity he  was
used to and in  which  the  Eurosystem  now  represents  the  most  advanced
supranational component. On the other he should be prepared for the  further
evolution of that same architecture. Finally, from the citizens that we  all
are, it  will  require  a  deeper  reflection  about  the  multiple  "social
contracts" he is part of, and the loyalties they entail.

      8. CONCLUSION

       I have been fortunate to  operate  in  an  environment  in  which  no
conflict has arisen between the central banking profession I have  exercised
for more than thirty years and  the  European  conviction  that,  like  many
persons of my generation, I matured in my youth.  Since  the  early  '80s  I
have also been convinced that monetary union, i.e. a confluence of  the  two
motives, was desirable and possible. At the same time,  the  challenges  for
the Eurosystem originate precisely from that confluence.
       The challenges are not solely economic in their nature, nor can their
features be captured by the functional  relationships  economists  are  most
familiar with. Although partly related to economic factors,  their  features
are in fact tied to the  special  institutional  environment  to  which  the
Eurosystem now belongs. They derive from the tension between the  completion
of the union in the monetary field and the  incompleteness  of  the  overall
construction. It is a tension because in that environment the notion of  the
public interest is no longer as simply and  statically  defined  as  it  was
when the Nation-State was an all-pervasive reality and the  jurisdiction  of
the central bank coincided with its jurisdiction. Inevitably,  this  tension
runs through the institutions of the European Union, the Eurosystem  itself,
and even our minds.
       A challenge is a call to a difficult task; it entails the two notions
of necessity and difficulty. The problems I have tried  to  describe  are  a
challenge not only for practitioners, but also for the academic  profession,
because their solutions can hardly be found in a textbook and will  only  be
invented if the creativity of practitioners will be supplemented  with  that
of scholars.

                                     ***


                           Monetary policy in EMU

                             Prof. Otmar Issing
         Member of the executive board of the European Central Bank
                              Washington, D.C.
                               6 October 1998


      1. Introduction

       On 1 January 1999, the curtain will ri"+ !-+  1999\MAYOR99.DOC†[?]р?p-
 -#"+ !-+   1999\INDUSTRIAL  MARKETING.DOC?[?]р?x-  -#"+  !-se  on  a  world
premiиre. For the first time  in  history,  sovereign  states  will  abandon
their own currencies in favour of a  common  currency,  and  transfer  their
monetary policy sovereignty to a newly  created  supranational  institution.
This process is all the more unusual from a historical  perspective  because
the national currencies involved are not being abolished  because  of  their
weakness. On the contrary, proof of a large measure  of  monetary  stability
is demanded as a precondition for participation.
       The decision has been taken. The Euro will start on time. It must not
- and it will not - fail. The European System of Central Banks  (ESCB)  will
devote its best  endeavours  to  making  European  Monetary  Union  (EMU)  a
success.
       The French president recently called this  unique  project  a  "great
collective adventure". As a central banker I am generally not in  favour  of
"adventures" - but who would deny that there are risks and uncertainties  in
this enterprise? You should be reassured that at the European  Central  Bank
(ECB), we have the necessary independence, instruments  and  tools  to  deal
with these risks and uncertainties in a successful way. I will discuss  some
of these in a moment.
        Moreover,  when  considering  the  uncertainties  implied   by   the
transition to Stage Three of EMU, we should not forget that  Monetary  Union
will also reduce, or even eliminate, a number of  risks.  This  has  already
been demonstrated, even before the actual introduction of the  euro.  Recent
turmoil in international financial markets did  not  cause  any  significant
disruption  to  exchange  rates   among   currencies   of   the   designated
participants in Stage Three. This is a clear demonstration  of  the  success
of the EMU process.
       Today, I will address the role of monetary policy in EMU.
       First, I will make reference to the final goal of monetary  policy  -
the maintenance of price stability.
       Second, I will discuss some important issues relating to  the  design
and implementation of the monetary policy strategy at the  outset  of  Stage
Three 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. In 1999\SCHD-MAY.DOCf[pic]1 T-
 -#"+ !-+  1999\PROT10.DOCfter-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  66.1%  of  GDP  in  the  United
States (statistics from the      International Monetary Fund  and  the  Bank
for International      Settlements as at the end of  1997,  taken  from  the
Monthly      Bulletin of the European Central  Bank).  We,  therefore,  have
two      distinct models of private  financing  which  clearly  have  to  be
taken   into   account   when   assessing   Europe's   financial   dimension
compared with the United States or Japan.
     The euro,  the  Eurosystem's  monetary  policy  and,  in  general,  the
activity  of  the  ECB  and  the  Eurosystem  play  a  key   role   in   the
integration of European financial markets and all markets  in       general.
The euro is acting as a catalyst  for  European  economic       integration.
And more integration will lead to  a  greater  economic       and  financial
dimension.
     Monetary and financial integration  stemming  from  the  euro  and  the
activity of the Eurosystem will affect  the  operation  of  the       single
European market in a positive way. The European market,      with  a  single
currency, will tend to be  more  transparent,  more       competitive,  more
efficient and will function more  smoothly.  This       is  the  reason  why
joining the European Union, as a general rule,       will  lead  to  joining
the  euro  area,  once  certain  economic       conditions  (the   so-called
convergence criteria) have been      fulfilled.
     Monetary  union  is  always  a  political  operation,  irrespective  of
its technical and economic implications. Currency is one  of  the       most
genuine expressions of sovereignty, because the power  to       issue  money
is one of the greatest powers in  existence.  The       Treaty  on  European
Union led, first, to the depoliticisation of      monetary power in  Europe,
by means of granting independence to      the central banks and  prohibiting
the monetising of public      deficits, and afterwards to  denationalisation
or      supranationalisation (via  the  creation  of  the  Eurosystem).  The
Eurosystem  was  not  only  created  for  the  purpose  of   improving   the
operation of the Single Market, but also in order to make       progress  on
the building of the European political structure.
  The euro should not only be seen as a catalyst for European      economic
    integration, it should also be seen as a main beam      necessary to
  construct the European political structure. The      relationship between
 political power and monetary power is an      interesting subject which is
   open to investigation and      discussion, but that would certainly go
  beyond the scope of this      speech. I merely wish to point out that, in
  the case of Europe,      it is clear that following the achievement of a
 single currency,      the door remains open to political union, which would
 represent a      crucial step in the process of integration. In conclusion,
    it      would seem clear that the implications of the euro go "beyond
 supply and demand" (to use the title of the work of Wilhelm      Rцpke). We
  are now fully immersed in "meta-economy", which means      it is time to
                               end my speech.

                     Keynote address to be delivered by
                          Dr. Willem F. Duisenberg
                   President of the European Central Bank
                                     on

                    The European System of Central Banks
                    Current position and future prospects

      At a Conference organised by the Royal Institute of International
                                 Affairs on
                    European economic and Monetary Union
                     Markets and Politics under the Euro
                           London 27 november 1998


      1. Introduction

       Ladies and Gentlemen, I should like to  express  my  appreciation  at
being invited to deliver a speech at this conference organised by the  Royal
Institute of International Affairs. It is a great  pleasure  for  me  to  be
here, in London, today.
       The topic I am going to address relates to the current  position  and
the future prospects of the European System of Central Banks.  I  feel  that
this topic provides me with an opportunity to deal  with  the  objective  of
the ESCB and its contribution to the other  policies  in  the  Community.  I
will also briefly touch upon the decision-making in  the  ESCB,  recall  the
main features of our monetary policy strategy and talk about our regard  for
openness and transparency. The final part of my talk will  cover  the  views
of the ESCB on recent economic  developments  and  the  future  outlook  for
price stability in the euro area.

      2. Independence, transparency and accountability

       In the Maastricht Treaty the  ESCB  has  been  given  an  independent
status. The reason is that politicians all over the world  have  come  round
to the view that monetary policy decisions taken with too close a  political
involvement tend to take too short a time horizon  into  consideration.  The
consequence is that in  the  longer  term  such  decisions  do  not  support
sustainable gains  in  employment  and  income,  but  only  lead  to  higher
inflation. This view is confirmed by a host of economic research.
       Independence, however, requires a clear mandate. The ESCB has such  a
mandate. Its primary objective  is  to  maintain  price  stability.  Without
prejudice to the objective of price stability the  ESCB  shall  support  the
general economic policies in the Community. Price stability is  not  an  end
in  itself:  it  creates  the  conditions  in  which  other,   higher-order,
objectives can be reached. In particular, I share the  deep  concerns  about
the unacceptably high level of unemployment in  Europe.  The  ESCB  will  do
what it can to contribute to the solution of this  problem.  By  maintaining
price stability inflation expectations and interest rates can be kept  at  a
low level. This  creates  a  stability-oriented  environment  which  fosters
sustainable growth, a high level of employment, a fair  society  and  better
living  standards.  Moreover,  in  specific  circumstances,  if  production,
inflation and employment all move in the  same  direction,  monetary  policy
can play some role in  stabilising  output  and  employment  growth  without
endangering price stability. However, the contribution from monetary  policy
can  generally  be  only  limited.  Given  the  structural  nature  of   the
unemployment problems the solution is to be found, above all, in  structural
reforms aimed at well-functioning labour and product markets.
       An independent central bank does not only need a  clear  mandate.  It
has also to be an open and  transparent  institution,  for  at  least  three
reasons. First, transparency enhances the effectiveness of  monetary  policy
by creating the correct expectations on  the  part  of  economic  agents.  A
predictable monetary policy contributes to achieving stable  prices  without
significant adjustment costs and with the  lowest  interest  rate  possible.
The second reason is that in a democratic society the central  bank  has  to
account for its policies. Finally, transparency towards  the  outside  world
can also structure and discipline the internal  debate  inside  the  central
bank.
       Let me now turn to the ways and means of achieving transparency. As a
first element the ESCB  has  defined  a  quantitative  objective  for  price
stability. It reads as follows: price stability is a  year-on-year  increase
in the Harmonised Index of Consumer Prices  (HICP)  for  the  euro  area  of
below 2%. Although I do not consider deflation to be likely in  the  current
environment, I may add that a situation  of  falling  prices  would  not  be
consistent with price stability.
       The Governing Council has made it clear that "Price stability  is  to
be maintained over the medium term". The ESCB  cannot  be  held  accountable
for short-run deviations from price stability, for example due to shocks  in
import prices or specific fiscal measures. A  monetary  policy  reaction  to
short-run fluctuations in the price level would provide  the  wrong  signals
to the market and cause unnecessary interest rate  volatility.  In  summary,
the ESCB will  react  in  an  appropriate,  measured  and,  when  necessary,
gradualist manner to economic disturbances that threaten price stability  in
the  medium  term,  rather  than  in  an  abrupt  way,  in  order  to  avoid
unnecessary disruptions of the process of economic growth.  That  said,  the
ESCB will, whenever necessary, openly discuss and  explain  the  sources  of
possible deviations from the quantitative definition of price stability.
       In addition, let me remind you that by focusing on the HICP  for  the
euro area, the ESCB makes it clear  that  it  will  base  its  decisions  on
monetary, economic and financial developments in the euro area as  a  whole.
The single monetary policy has to take  a  euro  area-wide  perspective:  it
will not react to specific regional or national developments.
       The institutional implication is that the ESCB should develop into  a
strong unity, with a strong centre and strong  national  central  banks.  It
should become a truly European institution, with a truly  European  outlook.
Of course, it may take some time to arrive where we ultimately want  to  be.
We have to get used  to  thinking  in  euro  area-wide  terms.  In  the  ECB
Governing Council we are already "practising" that approach and  are  making
progress. I am confident that the ESCB will indeed act as a unity.
       Transparency and openness will be apparent from the way in which  the
ESCB communicates with the public.  The  ESCB  will  regularly  present  its
assessment of the monetary, economic and financial  situation  in  the  euro
area and provide information about each specific monetary  policy  decision,
be it a move in interest rates or an absence of change.  This  will  notably
be done by way  of  press  releases,  press  conferences,  publications  and
speeches.  Press  releases  are  made  available   immediately   after   the
fortnightly meetings of the Governing Council and, as  you  may  know,  they
always  include  a  precise  list  of  the  decisions  taken  together  with
background information.
       There will be a monthly press conference.  Such  a  press  conference
will start with a detailed introductory statement, as has been the  case  so
far, and these introductory statements will also be  published  immediately,
without delay. In this statement the Vice-President and I will  present  the
Governing Council's view  of  the  economic  situation  and  the  underlying
arguments for its monetary policy decisions,  followed  by  a  question  and
answer session.
       The publications of the ESCB will  include,  in  particular,  an  ECB
Bulletin each month as well as an Annual Report. As from  1999,  a  detailed
analysis of the economic situation in the euro area  will  be  presented  in
the monthly Bulletin. Thematic articles in this Bulletin  will  include  in-
depth analyses by the ECB on matters regarding the monetary  policy  of  the
ESCB and the economy of the euro area. Further, you may  also  recall  that,
as required by its Statute, the ESCB will publish its  consolidated  balance
sheet on a weekly basis.
       My colleagues on the Executive Board of the ECB and I  intend  to  be
very active in giving speeches dealing with all issues of relevance for  the
conduct of monetary policy.  I  am  convinced  that  the  Governors  of  the
national central banks will also play their role in this respect.
       Since I am talking about the communication and external relations  of
the  ESCB,  I  would  like  to  underline  that  I  am  prepared  to  accept
invitations to appear before the European Parliament at least four  times  a
year to present the activities of the ESCB  and  the  ECB's  Annual  Report.
Finally, it should be noted that the ESCB will have a  regular  exchange  of
information and views with the ECOFIN. Representatives of the  ECB  will  be
invited to ECOFIN meetings whenever issues of  concern  to  monetary  policy
are discussed. A similar relationship will naturally  also  exist  with  the
EURO-11, whose meetings will generally be attended by the President  of  the
ECB, whenever matters relevant to the ESCB are on the agenda.

      3. Monetary policy strategy of the ESCB

       We are now approaching the start of  the  Third  Stage  of  EMU.  The
decision-making bodies of the ECB have made a certain  number  of  important
decisions since the ESCB was established. As part of  these  decisions,  the
monetary policy strategy of the ESCB was recently  announced  and  explained
to the public. The selected stability-oriented  strategy  promotes  as  much
continuity as possible with the  existing  strategies  of  national  central
banks in the EU. At the same time, its  design  is  adapted  to  the  unique
situation of introducing a single currency in eleven  countries,  which  may
to a certain extent change economic behaviour. Therefore as much  continuity
as possible and as much change as required is the thrust of our strategy.
       Our strategy consists of two pillars. The first is an important  role
for money and the second is a broad-based  assessment  of  the  outlook  for
price developments in the  euro  area.  The  main  reason  for  assigning  a
prominent  role  to  money  is  the  empirically  well-founded   view   that
inflation, at least in the long run, is a monetary phenomenon.  This  simple
and  obvious  observation  led  the  Governing   Council   to   announce   a
quantitative reference value for the growth of a  broad  measure  of  money.
This  choice  will  create  a  "nominal  anchor"  for  monetary  policy  and
therefore help stabilise private inflation expectations at longer  horizons.
The reference value will be derived in a manner that is  clearly  consistent
with - and  serves  the  achievement  of  -  price  stability.  It  will  be
constructed  such  that,  in  the  absence  of  special  factors  or   other
distortions, deviations of monetary growth from  the  reference  value  will
signal risks to price stability.
       However, it has to be clear that the  reference  value  is  different
from an  intermediate  monetary  target,  as  the  ESCB  has  not  made  any
commitment  to  correct  deviations  of  actual  monetary  growth  from  the
reference  value  over  the  short  term.  In  particular,   it   has   been
realistically recognised that the move to  a  single  currency  and  ongoing
financial innovations may generate fluctuations  in  the  selected  monetary
aggregate  which  are  not  necessarily  associated  with  inflationary   or
deflationary pressures. For this reason, it  is  important  to  continuously
monitor the relevance of temporary factors or  even  structural  changes  in
order to avoid a mechanistic policy reaction to  deviations  of  the  chosen
monetary aggregate from the reference value. The results  of  this  analysis
and its impact on the ESCB's monetary policy decisions will be explained  to
the public.
       Let me turn now to the second key  element  of  the  monetary  policy
strategy, the broad-based assessment of the risks to  price  stability.  The
information  contained  in  monetary  aggregates,  while   of   the   utmost
importance, will by no means constitute the whole of the  "information  set"
in the hands of the ESCB. In parallel with the analysis of money  growth,  a
wide range of economic and financial variables will be used to formulate  an
assessment of the outlook for price  developments.  The  envisaged  strategy
will enable the ESCB  to  perform  a  cross-check  between  the  information
coming from the evolution  of  monetary  aggregates  and  those  from  other
economic and financial indicators.

      4. Recent economic developments and prospects

       Let me  turn  to  the  current  economic  situation.  The  euro  area
experienced a strengthening of economic growth  in  1997,  to  2.5%,  and  a
further  acceleration  has  been  anticipated  for  this  year.  The  global
environment has, of course, deteriorated in the meantime, but this  has  not
so far had an observable impact on growth which  has,  in  any  event,  been
increasingly led by domestic demand.  Inflation  has  remained  subdued  and
even fallen somewhat over the past year, partly as a result  of  the  impact
of  weaker  global  demand  on  oil  and  commodity  prices.  However,   the
favourable  pattern  of  inflation  has  also  been  supported  by  domestic
factors, such as a very  moderate  development  in  unit  labour  costs  and
industrial producer prices.
       Concerning recent price developments, HICP  inflation  for  the  euro
area fell to 1.0% in September, due to a strong  impact  from  food  prices,
but I would not want to read too much  into  this  latest  decline  as  some
price components  can  be  relatively  volatile  over  short  periods.  More
significantly,  preliminary  data  suggest  that  various   broad   monetary
aggregates for the euro area are increasing at between 3 and  5%,  and  thus
do not appear to signal any strong incipient  inflationary  or  deflationary
pressures. We are in line with the consensus  view  that  inflation  in  the
euro area will rise moderately in 1999,  but  remain  below  2%.  I  do  not
consider deflation to be a serious risk for price stability at present.
       So far, despite the worsening of the global environment,  euro  area-
wide activity has continued to expand at a fairly  stable  rate.  At  around
3%, annual real GDP growth was broadly unchanged in the first half  of  1998
from  the  solid  growth  seen  in  the  second  half  of  1997.  Industrial
production  growth  has  slowed  somewhat  since  the  spring.  More  recent
evidence, particularly that of the area-wide survey data, may  also  suggest
a moderation in the  pace  of  growth  and  further  developments  in  these
indicators will continue to be monitored closely. Area-wide  growth  should,
however,  be  supported  by  a  number  of  domestic  factors.  One   factor
supporting continued growth, particularly in  private  consumption,  is  the
gradual improvement in labour market conditions. Moreover, the lowest short-
term interest rates in the euro area currently stand at  3.3%,  and  several
countries have cut interest rates towards this level  recently  as  part  of
the process towards interest rate convergence. The  process  of  convergence
towards this level has been gradual, but should imply  a  reduction  in  the
average short-term interest rate in the euro area of  about  0.5  percentage
point since July. Long-term rates also stand at low levels. And,  there  has
been  a  marked  degree  of  exchange   rate   stability   among   countries
participating in the euro. This is undoubtedly a  welcome  development  from
the standpoint of encouraging trade and investment. Thus, our assessment  is
similar to that of other international  organisations,  that  -  unless  the
international environment  deteriorates  further,  which  is  not  currently
expected - growth will be somewhat weaker in 1999. Growth  should,  however,
remain high enough to support continued employment creation and, assuming  a
recovery in the international environment, there  should  be  a  pick-up  in
growth in the year 2000. At the  meetings  in  December  the  ECB  Governing
Council will again assess the outlook for economic and price developments.
       Although the economic outlook may be less favourable than expected  -
let us say -  half  a  year  ago,  I  believe  that  the  conditions  for  a
successful launch of the euro are in place. You can be sure  that  the  ESCB
will do its utmost to make the euro a stable currency.

                      The euro: pushing the boundaries

                    Presentation by Ms Sirkka Hдmдlдinen,
         Member of the Executive Board of the European Central Bank,
        at the symposium arranged by the European Private Equity and
                         Venture Capital Association
                          on 11 June 1999 in Prague

       It is a great honour  for  me  to  be  invited  here  today  to  this
symposium arranged by  the  European  Private  Equity  and  Venture  Capital
Association to speak about the new European currency  -  the  euro.  Indeed,
the  theme  of  this  symposium  -  "Pushing  the  boundaries"  -  is   very
appropriate when speaking about the euro. To my mind, the  establishment  of
Economic and Monetary Union can be characterised as pushing  the  boundaries
in several ways, such as:

       * pushing the boundaries in the process of European
       integration;
       * pushing the boundaries of stability-oriented policies in
       Europe; and
       * pushing the boundaries of market integration in Europe.

       In today's presentation, I shall give  an  overview  of  these  three
aspects of Economic and Monetary Union. Thereafter,  I  shall  discuss  more
thoroughly the implications of the single currency for  the  development  of
the European financial markets, focusing on the capital markets. Finally,  I
shall reflect briefly on the importance of equity prices,  and  other  asset
prices, in the formulation of monetary policy.

      1. Pushing the boundaries of the process of European integration

       I shall start with a few comments on the role  of  the  euro  in  the
overall European integration process: I think there is little doubt that  in
future books on European history the start of the third  stage  of  European
Economic and  Monetary  Union  on  1  January  1999  will  be  marked  as  a
significant and unique event in the long process  of  European  integration.
On  that  day,  the  national  currencies  of   11   EU   countries   became
denominations of the euro. At the same  time,  the  "Eurosystem"  (which  is
composed of the European Central Bank (ECB)  and  the  11  national  central
banks (NCBs) of the participating Member States) assumed responsibility  for
the monetary policy of the euro area.
       In order to put this event into a historical context, I  should  like
to note that the establishment of an Economic and Monetary Union  in  Europe
was, in fact, originally motivated more by general political arguments  than
by economic arguments.  In  the  current  debate,  these  overall  political
arguments have almost disappeared. Instead, the media and economic  analysts
are increasingly focusing their  assessment  of  the  new  currency  on  the
recent short-term economic and financial developments in the euro area.
       The process of European integration started shortly after the end  of
the Second World War and gained momentum in the  1950s.  At  the  time,  the
striving for integration was mainly driven by the  aim  of  eliminating  the
risk that wars and crises would once more plague the continent. Through  the
establishment of common institutions, political conflicts could  be  avoided
or at least resolved through discussion and compromise.
       The idea of establishing a  monetary  union  and  a  common  monetary
policy was raised at an early stage of this process. It was argued that  the
full economic effects from integration in Europe could  only  be  gained  if
the transaction costs of exchanging different  currencies  were  eliminated.
Other benefits of a monetary union in Europe were  emphasised  less  in  the
early stages of the discussion, partly due to the fact  that  at  that  time
the Bretton Woods system was already providing a  high  degree  of  exchange
rate stability.
       The first concrete proposal for an economic  and  monetary  union  in
Europe was presented in 1970 in the so-called  Werner  Report,  named  after
the  then  Prime  Minister  of  Luxembourg,  Pierre  Werner.  However,  this
proposal was never implemented. In the aftermath  of  the  break-up  of  the
Bretton Woods system and the shock of the first  oil  crisis  in  1973,  the
European economies entered a  period  of  stagnation  with  high  inflation,
persisting unemployment and  instability  in  exchange  rates  and  interest
rates. The European countries applied very  different  policy  responses  to
the   unfavourable   economic   developments,   and   policy   co-ordination
deteriorated. In this environment, it  was  not  realistic  to  establish  a
monetary union.
       The experience of this volatile period  showed  that  large  exchange
rate fluctuations between the European currencies led  to  a  disruption  of
trade flows and an unfavourable investment climate,  thereby  hampering  the
aims of  achieving  growth,  employment,  economic  stability  and  enhanced
integration. Therefore, the benefits of eliminating intra-EU  exchange  rate
volatility became an  increasingly  powerful  argument  when  the  issue  of
establishing an economic and monetary union was revisited in  the  so-called
Delors Report in 1989.
       The Delors Report contained a detailed plan for the establishment  of
Economic and  Monetary  Union  and  eventually  became  the  basis  for  the
drafting of  the  Maastricht  Treaty.  This  time,  the  time  schedule  for
establishing the Economic and Monetary Union took into account the  need  to
first achieve a high degree of nominal  convergence  for  the  participating
countries.
       The fact that the plan for the introduction of  the  single  currency
was then pursued and implemented in such a determined and consistent  manner
implied, in itself, a boost for the  overall  process  of  integration.  The
momentum of the process of integration is no longer crucially  dependent  on
political decisions. By contrast, the integration of the European  economies
has become an irreversible and self-sustained process, which  is  proceeding
automatically in all areas  of  political,  economic,  social  and  cultural
life. The euro can thus be seen as a catalyst for further co-ordination  and
integration  in  other  policy  areas.  This  is  one  way  in   which   the
introduction of the euro has definitely helped to  push  the  boundaries  in
the process of European integration.
       Another way to  push  the  boundaries  in  the  European  integration
process relates to  the  geographical  extent  of  the  euro  area  and  the
European Union. Here, I sincerely hope that  the  four  EU  countries  which
have not yet adopted the euro will soon be able to join the Monetary  Union.
At the same time, I hope the process to enlarge the European Union with  the
applicant countries will progress successfully. An enlargement of  the  euro
area and of the European Union would further strengthen the role  of  Europe
in a global perspective and should be for the benefit of  all  participating
countries. However, it is clear that countries aiming to join  the  Economic
Monetary Union would have to fulfil the same degree of  nominal  convergence
as was required from the  participating  countries  when  the  Economic  and
Monetary Union  was  established.  This  is  essential  in  order  to  avoid
tensions to emerge in the  euro  area,  which  could  eventually  compromise
macro-economic stability.

      2. Pushing the boundaries of stability-oriented economic policies

       Economic and Monetary Union in Europe also provides an opportunity to
push the boundaries in areas of economic  policy.  The  convergence  process
prior to the establishment of Economic and Monetary  Union  was  helpful  in
order to achieve a broad consensus among policy makers  on  the  virtues  of
stability-oriented  policies,   i.e.   policies   directed   towards   price
stability, fiscal discipline  and  structural  reform  geared  at  promoting
growth and employment. The convergence process also helped policy makers  to
focus their  efforts  on  the  formulation  of  stability-oriented  economic
policies  in  the  participating  countries  and  it  also  facilitated  the
acceptance of these policies among the general public.
       In the new environment  of  Economic  and  Monetary  Union,  monetary
policy can no longer  be  applied  as  a  means  of  accommodating  economic
developments  in  an   individual   Member   State.   Such   nation-specific
developments would have to be countered by fiscal and  structural  policies,
while the best way in which the single monetary  policy  can  contribute  to
improved  conditions  for  growth  and  employment  is  by  ensuring   price
stability in the euro area as a whole. In this respect, the  formulation  of
the Maastricht Treaty is instrumental, since it guarantees the  Eurosystem's
firm  commitment  to  price  stability;  it  clearly  specifies  that  price
stability is the primary objective of the single monetary policy.
       The Eurosystem has put a lot of effort into establishing  a  monetary
policy framework that will ensure that it can fulfil its  primary  objective
of price stability as efficiently as possible. There are several aspects  to
this framework.
       First, the Eurosystem has adopted a quantitative  definition  of  the
primary objective - the Governing Council  of  the  ECB  has  defined  price
stability as a year-on-year increase of the  Harmonised  Index  of  Consumer
Prices (HICP) for  the  euro  area  of  below  2%.  This  is  a  medium-term
objective. In the short run, many  factors  beyond  the  scope  of  monetary
policy also affect price movements.
       Second, the Eurosystem has made public the strategy to  be  used  for
the implementation of the single monetary policy. This strategy is based  on
two key elements, whereby money has  been  assigned  a  prominent  role,  as
signalled    by    the     announcement     of     a     Z-     -#"+     !-+
1999\SEATSCASE.DOCh[?]€б@[?]Rreference rate of 4Ѕ% for the  12-month  growth
of the euro area monetary aggregate M3. The  other  element  consists  of  a
broadly based assessment of the  outlook  for  price  developments  and  the
risks to price stability in the euro area on the basis of a  wide  range  of
economic and financial indicators.
       Third, the Eurosystem  puts  significant  emphasis  on  the  need  to
carefully explain its  policy  actions  in  terms  of  its  monetary  policy
strategy. Therefore, the Eurosystem has  established  various  channels  for
the communication with market participants and the general public. The  most
important communication channels are the ECB's Monthly Bulletin,  its  press
releases and the press conferences following the meetings of  the  Governing
Council, the President's appearances in  the  European  Parliament  and  the
speeches given by the members of the Governing Council.
       Fourth, the Eurosystem's monetary policy is implemented in a marketed-
oriented manner. The  Eurosystem's  key  policy  instrument  is  its  weekly
tender  for  two-week  repo  operations,  the  so-called  main   refinancing
operations. The features of the monetary policy operations  are  decided  by
the decision-making bodies of the ECB, but the operations are  conducted  in
a decentralised manner by the NCBs.
       The experience gained from the first five months  of  operations  has
shown that the Eurosystem's procedures for decision-making  and  operational
implementation works very well. There are therefore no  operational  reasons
to call into question the ability of the Eurosystem to  fulfil  its  mandate
to ensure price stability in the euro area.  However,  stable  macroeconomic
policies cannot be achieved by monetary policy alone. It is  also  necessary
for governments to pursue fiscal and  structural  policies  consistent  with
such macroeconomic stability.
       In order to ensure fiscal discipline in the participating  countries,
the EU Council agreed in June 1997 to establish the so-called Stability  and
Growth Pact. This Pact sets an upper limit of  3%  of  GDP  for  the  fiscal
deficits of the countries participating in the euro area.  Furthermore,  the
Pact specifies as an objective that Member States are  to  bring  government
budgets close to balance or even into surplus in the medium  term.  Only  if
this objective is met will sufficient  room  for  manoeuvre  be  created  to
enable fiscal policy to react to cyclical  developments  without  risking  a
loss of credibility.
       As regards structural policies, the policy framework is, so far, less
well developed. This is worrying given that the need for  structural  reform
is urgent in many areas in order to be able to effectively  promote  greater
growth potential and higher employment. I  appreciate  that  these  problems
are generally acknowledged, and some action has been taken in recent  years.
For example, it is encouraging that the European Employment Pact adopted  at
the EU Summit in Cologne last weekend  explicitly  recognises  the  need  to
pursue comprehensive structural labour market reform.
       Nevertheless, experience from several countries shows that it usually
takes a long time for the full effects of structural  reforms  to  be  seen.
Therefore, it  is  worrisome  that  structural  reforms,  in  particular  as
regards labour markets as well as  those  to  limit  expenditure  on  social
security and pension systems, are long overdue in several Member States.
       Clearly, the establishment of Economic and Monetary  Union  does  not
mean that the efforts undertaken  during  the  convergence  process  can  be
relaxed. On the contrary,  the  need  for  policy  co-ordination  among  the
participating countries is now even more  pressing.  We  have  already  seen
examples of negative market reactions to any perceived  slippage  in  fiscal
discipline or postponement of structural reform. Personally,  I  think  that
these  swift  market  reactions,  although  sometimes  exaggerated,  may  be
helpful in promoting  a  continued  stability-oriented  policy  thinking  in
Europe. Any move towards less responsible policies  would  come  up  against
intense peer pressure from other countries.
       In this context, I would once more like to underline how important it
is that a consensus has emerged among European policy-makers on the  virtues
of  price  stability,  fiscal  discipline  and  market-oriented   structural
reform. In this way, we  have  already  pushed  the  boundary  significantly
towards a macroeconomic environment  conducive  to  growth  and  employment,
although much still needs to be done in the years to come.

      4. Pushing the boundaries in the development of financial markets

       However, the success of the euro is not only in the hands of  central
bankers and policy-makers. An important area in  which  the  private  sector
has an instrumental role in meeting the challenge of pushing the  boundaries
is in the development of the European financial markets. In  order  for  the
euro to be a success, it is important for the euro  area  financial  markets
to become wider, deeper and more diversified. The introduction of  the  euro
has provided further input into this process; the  elimination  of  exchange
rate risks has  removed  one  of  the  main  barriers  to  financial  market
integration in Europe.
        In  most   European   countries,   the   financial   markets   have,
traditionally, been rather shallow,  with  few  participants  and  a  narrow
range of financial instruments on offer. A high degree of  segmentation  and
a lack of cross-border  competition  have  implied  relatively  low  trading
volumes, high transaction costs and a  reluctance  to  implement  innovative
financial instruments. This segmentation has been  a  function  of  exchange
rate borders,  tradition,  differing  practices  and,  of  course,  national
regulations and tax regimes.
       Following the  elimination  of  the  barriers  implied  by  different
currencies, it is now  up  to  the  European  Commission  and  the  relevant
national authorities to further the integration  process  in  the  areas  of
regulation and taxation. Meanwhile, it is up to market participants to  take
advantage of the business opportunities implied by the increased  scope  for
market integration.
       The introduction of  the  euro  brought  about  an  almost  immediate
integration of the national  money  markets  into  a  euro  area-wide  money
market. This was made possible thanks to the establishment  of  pan-European
payment systems, such as the TARGET system set up by the  Eurosystem,  which
enables banks to access liquidity throughout the euro area in real time.
       The cross-border integration of bond markets  in  the  euro  area  is
progressing at a slower pace, as is also true of  equities  and  derivatives
markets.  This  notwithstanding,  we   are   also   experiencing   important
developments in these segments of the financial markets. These  developments
are  partly  due  to  the   general   trends   towards   globalisation   and
technological refinement and partly  related  to  the  introduction  of  the
euro. As a result of the  introduction  of  the  euro,  market  participants
increasingly perceive similar instruments traded in the  different  national
markets to be close substitutes. This holds true, in particular,  for  bonds
issued by the euro area  governments,  where  the  establishment  of  common
benchmarks, the narrowing of yield spreads and  increased  market  liquidity
seem to indicate that a high degree  of  cross-border  substitutability  has
already been achieved.
       The fact  that  euro  area  financial  instruments  are  increasingly
considered to be close substitutes increases the  competitive  pressures  on
national markets to attract issuers and investors wishing  to  benefit  from
increased cross-border competition and  lower  transaction  costs.  In  this
context, we have recently experienced several initiatives aimed at  creating
capital markets across national borders, such  as  the  plans  to  establish
common trading platforms  linking  the  European  stock  exchanges.  Similar
initiatives have  also  been  taken  to  establish  links  between  national
securities settlement  systems,  which  would  facilitate  the  cross-border
mobilisation of securities. In the longer run, such developments  will  make
it possible  for  investors  to  manage  their  investment  portfolios  more
efficiently.
       The Eurosystem welcomes such initiatives aimed at improving the cross-
border integration of financial markets in  the  euro  area,  and  globally,
since they may result in a wider range of financial  instruments  on  offer,
and at a lower cost, than is currently the case  in  the  national  markets.
This could lead to a virtuous circle in  which  the  increased  issuance  of
instruments denominated in euro will draw  the  attention  of  international
investors to the euro area capital markets,  in  turn  making  the  euro  an
increasingly attractive currency for private as well as public issuers.
       In fact, the experience of the first few months of the  life  of  the
euro seems to indicate that such  a  positive  development  may  already  be
under way.  In  the  first  quarter  of  1999,  bonds  denominated  in  euro
accounted for around 50% of the bonds issued internationally. This share  is
considerably  higher  than  the  traditional  aggregate  share   for   bonds
denominated in the constituent currencies, which had been in  the  range  of
20% to 30% in recent years. We have also seen  a  considerable  increase  in
the average size of bond issues denominated in euro, as compared with  those
of bonds denominated in the former currencies, which may indicate  that  the
trade in euro-denominated issues is likely to become increasingly liquid.
       Despite the recent developments in the  euro  area  capital  markets,
euro area companies are still mainly  dependent  on  financing  through  the
banking  system.  Hence,  there  is  still  plenty  of  scope  for   further
development in the area of corporate financing. For example, the  amount  of
private bonds traded in the euro area is still very low  compared  with  the
United States. The market capitalisation of equities is  considerably  lower
in most euro area countries as compared  with  the  United  States  and  the
United Kingdom. Likewise, the venture capital business in the euro  area  is
still in its infancy compared with the  relatively  mature  venture  capital
markets in the United States  and  the  United  Kingdom.  Personally,  I  am
convinced that the introduction of the euro will  also  be  helpful  to  the
development of these segments of the financial markets.
       In this context, I should  like  to  say  a  few  words  on  how  the
introduction of the euro may underpin the reshaping of the European  banking
sector. The increased scope for securitisation  will  put  pressure  on  the
European banking  sector  to  move  away  from  traditional  retail  banking
activities in favour of  more  advanced  financial  services.  The  European
banking industry is still segmented into relatively small national  markets.
The introduction of the euro is  likely  to  add  momentum  to  cross-border
integration  in  the  European  banking  sector.  Although  a   considerable
consolidation of the European banking sector has taken place over  the  last
decade, this consolidation has so  far  been  almost  exclusively  based  on
mergers and acquisitions within national borders. It is only  recently  that
we have also  started  to  see  such  deals  taking  place  across  national
borders.
       I welcome this trend towards an  expansion  beyond  national  borders
with open arms, since the establishment of truly pan-European -  and  global
- banking groups will be instrumental in efforts to enhance  competition  in
the provision of financial services.

      5. The Eurosystem and the equity markets

       I should like to conclude my presentation today by briefly discussing
about the euro area equity markets as  seen  from  the  perspective  of  the
Eurosystem. It is clear  that  the  Eurosystem  has  no  direct  control  or
influence over the development of equity markets.  However,  the  Eurosystem
acknowledges  the  importance  of  well-functioning  and  efficient   equity
markets for the economy as a means of  mobilising  savings  into  productive
investment.  Hence,  efficient  equity  markets   with   transparent   price
formation, high market liquidity and low  transaction  costs  are  of  great
value in the capital formation process.
       The existence of efficient equity markets should also reduce the risk
of the emergence of asset price bubbles, which is desirable from a  monetary
policy perspective. Prior to the emergence of asset price  bubbles  in  some
industrialised countries in the early 1990s, few  central  banks  paid  much
attention to the development of prices of equities or other assets in  their
monetary policy formulation.
       However, the effects of the bubble  economies  in  the  early  1990s,
notably in Japan, the United Kingdom and  Scandinavia,  led  to  an  intense
debate among economists on how monetary policy could have  responded  better
to the situation. Some research was carried out in order to establish  price
indexes that would incorporate asset prices  and  which  could  be  used  as
target  variables  or  indicators  within  the  monetary  policy  framework.
However, no central bank is explicitly  making  use  of  such  asset  price-
weighted  indexes  in  monetary  policy  formulation.   Nevertheless,   this
development in the early 1990s made most central banks  aware  of  the  fact
that large swings in asset prices  can  have  important  effects  the  price
formation  in  the  economy  through  its  implications  on  real   economic
developments and, in particular, financial market stability.
       However, in practice it is not easy to let  monetary  policy  actions
respond to asset price developments. Central banks have only  one  tool  for
the implementation of monetary policy - the short-term interest  rate.  They
can therefore not effectively try to achieve several objectives at the  same
time. It is also  difficult  to  judge  how  developments  in  asset  prices
actually feed into consumer prices, thereby making it tricky to  assess  the
need for the appropriate monetary policy response  to  their  changes.  This
difficulty is exacerbated by the rather high  volatility  of  certain  asset
prices, such as equities, which could result in frequent changes  in  policy
interest rates if the central bank were to incorporate them  mechanistically
into its reaction function.
       In this respect, the present situation in the United States, as  well
as in several European countries, is interesting: equity prices  have  risen
rapidly for an extended period but consumer prices remain very  subdued  and
there are, so far, no signs that there is going  to  be  a  spill-over  from
asset price developments into consumer price inflation.
       Against the background of the  rather  unclear  relationship  between
asset price developments and consumer price inflation,  the  development  of
equity prices does not have a prominent  role  in  the  formulation  of  the
Eurosystem's monetary policy. This notwithstanding, the  Eurosystem  closely
monitors the prices of equities and other assets within  its  broadly  based
assessment of economic developments  in  the  euro  area,  which  forms  the
second  pillar  of  its  monetary  policy  strategy.  The  Eurosystem   will
therefore remain vigilant in  order  to  detect  any  influence  from  asset
prices, through their impact on real  economic  developments  and  financial
market stability, on the formation of consumer prices.

                                     ***


              THE MONETARY POLICY OF THE EUROPEAN CENTRAL BANK

                      Speech by Eugenio Domingo Solans
         Member of the Executive Board of the European Central Bank
           during the "Working Breakfast" at the Permanent Seminar
                        on 4 December 1998 in Madrid


      Introduction

       It was with immense pleasure that I accepted the invitation  to  take
part in this event, organised by  Euroforum.  In  view  of  the  prestigious
nature of Euroforum, the professional standing  of  its  MESTER  PROGRAM  OF
MARKETING WEEK AT.DOCl[pic][?]\- -#President, Eduardo  Bueno,  Professor  at
the Universidad Autуnoma de Madrid and consultant to  the  Banco  de  Espaсa
(there is a great deal of similarity  between  our  respective  professional
histories) and, above all, the value I have attached to his friendship  over
the past thirty years, there was no question as to whether to agree to  join
you for this working breakfast.
       I have been asked to keep my presentation brief in order to allow  as
much time as possible for discussion. Therefore I will try to put forward  a
few ideas on the monetary policy of the European Central Bank (ECB) which  I
can develop during subsequent  discussions.  During  the  discussion  period
please feel free to raise any  questions  on  other  aspects  of  the  ECB's
operations.

      The three fundamental principles underlying the monetary policy

       As in the case of any other central bank, the ECB's  monetary  policy
is based on three fundamental  principles:  setting  the  objectives  to  be
achieved, establishing  the  most  appropriate  strategy  for  accomplishing
these  objectives  and,  finally,  selecting  the   best   instruments   for
implementing its chosen strategy.
       While the Governing Council of the ECB is responsible for formulating
its monetary policy, both the Executive Board of the ECB  and  the  national
central  banks  are  involved  in  its  application   and   therefore   this
constitutes one of the tasks allotted to  the  European  System  of  Central
Banks (ESCB) as a whole.
       Objectives, strategies and instruments therefore form the three  main
elements which enable us to establish the precise point within the range  of
monetary policy possibilities which should constitute the ECB's policy:  its
precise altitude, longitude and depth.

      The ECB's monetary policy objectives

       We did not have to think long and hard to define the  ECB's  monetary
policy objectives and, generally speaking, those of the ESCB. This had  been
done for us by the Treaty on European Union in which, under Article 105,  it
is stated that "the primary objective of  the  ESCB  shall  be  to  maintain
price stability" which, on a more practical level, the ECB has defined as  a
year-on-year increase in the harmonised index of consumer prices (HICP)  for
the euro area of below 2%, which it seeks to maintain in  the  medium  term.
"Without prejudice to the  objective  of  price  stability",  continues  the
aforementioned Article 105 of  the  Treaty,  "the  ESCB  shall  support  the
general economic policies in the Community with a view  to  contributing  to
the achievement of the objectives of the Community as laid down  in  Article
2".
       If you refer to the aforementioned Article 2 of the so-called  Treaty
of Maastricht, you will find that sustainable and  non-inflationary  growth,
together with a high level of employment and social  protection,  are  among
its aims.
       The ECB, then, must prioritise those of its activities which  promote
the objective of stability and, without prejudice to this approach, it  will
contribute, indirectly and to the extent possible, to  economic  growth  and
increased employment.
       Is this approach in any way contradictory? Absolutely not.  The  best
contribution  the  ECB  can  make  to  promoting  investment  and  thus   to
generating  economic  growth  and  increased  employment  is  precisely   by
providing a framework for price stabilisation. The worst path that  the  ECB
could follow would be to implement a lax economic policy  which  claimed  to
be directly creating jobs.
       In fact, in the medium term price stability will encourage  efficient
investment, sustainable growth and employment.  This  is  because  stability
prevents price distortions, that is to say any distortion of  the  mechanism
which guides decision-makers in the markets, and thus  favours  an  improved
allocation of  resources.  When  stability  is  achieved,  prices  are  more
transparent, which promotes competition and therefore efficiency.
       Moreover, if economic agents have positive expectations  with  regard
to stability, the risk premium element of long-term of interest  rates  will
fall, promoting investment and lasting  consumption.  In  this  respect,  it
should be remembered that one of the clearest inflation forecast  indicators
is an increasingly steep maturity-related asset yield curve.
       Finally, stability promotes  growth  and  employment  insofar  as  it
allows resources to be channelled into productive  activity.  Inflation,  on
the other hand, merely encourages speculative investment  with  the  aim  of
safeguarding funds against monetary deterioration.
       As we saw earlier, the aims set out in Article 2  of  the  Maastricht
Treaty also include social safeguards. In this context,  therefore,  it  can
be said that inflation is the most unjust of all taxes, because  it  attacks
personal income and assets while distorting  certain  public  redistribution
mechanisms such as, for instance, progressive taxation scales.
       In  other  words,  stability  is  not  just  important  for  economic
efficiency  but  also  for  social  justice,  since  it  provides   economic
conditions  which  benefit  the  weakest  and  most  vulnerable  members  of
society.
       An appropriate ECB monetary policy is a necessary condition but  will
not, in itself, enable us to achieve stability. National  taxation  policies
geared to satisfying the  objectives  of  the  Stability  and  Growth  Pact,
together with several supply-side policies  leaning  towards  liberalisation
and flexibility, are also necessary to enable us  to  avoid  the  persistent
need for measures to combat inflation.
       We must avoid the temptation to reinterpret the Stability and  Growth
Pact by introducing "golden rules" of dubious legality, based on  the  false
theoretical foundations  of  the  so-called  "ultra-rationality  hypothesis"
which, in the past, claimed  to  justify  increased  taxation  pressure  and
which now calls for increased public spending in terms of investment.  Let's
not beat about the bush: taxation policy has only  one  golden  rule,  which
consists in maintaining  a  long-term  budgetary  balance  on  the  economic
horizon.
       In connection with the ECB's objectives, it should also be noted that
it  is  difficult  or  even  impossible  to  meet   two   separate   targets
simultaneously using only  a  single  monetary  policy.  This  applies  when
dealing with the concept  of  fixing  fluctuation  bands  for  the  rate  of
exchange between the euro and the US dollar.  In  this  case,  the  exchange
rate objective could conflict with the price stability concept and  the  ECB
would then fail in its primary objective. We must not  forget,  with  regard
to this issue, that combining linked exchange rates,  the  free  circulation
of capital and monetary autonomy is not, to be quite blunt, sustainable.  It
is precisely this which is the raison  d'кtre  of  the  ECB  as  the  single
monetary authority in an economic area which has irrevocably fixed  exchange
rates (a single currency) and freely circulating capital (a single  market).

       To conclude this section, let me stress that it is essential for  the
ECB to make it absolutely clear that its main objective  is  stability.  If,
as some would suggest (for instance in the Modigliani  manifesto),  the  ECB
were  to  directly  target  employment,  this  would  adversely  affect  the
credibility of its monetary policy and thus  have  an  impact  not  only  on
inflation but also, paradoxically, on employment. The  direct  targeting  of
employment objectives by a central bank is counterproductive.

      The ECB's monetary policy strategy

       A strategy is a combination of criteria and  procedures  which  allow
decisions to be taken in order to achieve a monetary policy objective.  This
decision-making process can be based on inflation forecasts which depend  on
the behaviour of a relevant  monetary  variable  or,  more  simply,  on  the
"pegging" of exchange rates to a stable  currency.  This  last  strategy  is
ideal for more open economies, encompassed  by  a  specific  monetary  zone,
such as, for instance, the Netherlands and Germany. However, this would  not
be suitable for a much larger but relatively closed economic space  such  as
the euro area.
       I believe that it is a mistake to try to exaggerate the  polarity  of
the inflation strategy and the monetary strategy. These  are  quite  clearly
separate strategies but they are not in any  way  opposed,  incompatible  or
irreconcilable. Certainly, some aspects of each of these  strategies  should
be combined, resulting in another, completely separate and  valid  strategy.
This is what the ECB has done and it now needs to give  the  end  product  a
name which does not merely describe the desired objective  ("the  stability-
orientated monetary policy strategy").
       There are two components to the ECB's monetary policy  strategy.  The
first, more practical and  visible  component  consists  in  a  quantitative
reference to the growth of the money supply  as  defined  by  the  broad  M3
aggregate. Taking into account the  quantitative  definition  of  stability,
economic growth and realistic hypotheses on money  circulation  rates,  this
monetary reference has initially been set at 4 1/2%.
       The second component of the ECB's monetary strategy, a  more  general
and enveloping one, is the estimation of inflation forecasts and  risks  for
price stability in view of changes in a group of significant variables,  all
of which are related to the euro area as a whole.  Some  examples  of  these
significant variables are credit, long-term interest rates,  prices  of  raw
materials, import prices, wages and public spending deficits.
       Inflation is a monetary phenomenon. When the rate at which the  money
supply grows is greater than the nominal potential  rate  of  growth  of  an
economy, in the medium term this will generate inflation.  In  other  words,
the  medium-term  inflation  rate  is  indicative  of   excessive   monetary
expansion in relation  to  economic  growth.  Growth  in  the  money  supply
therefore provides the best early warning of inflation and monetary  control
is the best monetary policy strategy. The virtues of the first component  of
the ECB monetary strategy are, when all is said and done, well known. If  it
worked, this alone would be sufficient.
        In  practice,  however,  things  are  never  so  simple.   Inflation
forecasting and control cannot rely solely on a monetary  aggregate  because
of doubts as to whether or not this monetary  aggregate  can  be  controlled
and is stable and meaningful. If a narrow definition of money, such  as  M1,
is adopted, controllability can be achieved in that,  through  the  monetary
policy  instrument,  it  is  possible  to  have  a  greater  impact  on  its
evolution, but this is offset by the loss of stability and significance.  If
it is decided to opt for a broad monetary aggregate, such as M3 or  M4,  the
money demand function becomes more stable and clearly more  significant,  in
that  a  greater  correlation  can  be  achieved  between  exchange   rates,
providing a better explanation of changes in nominal  costs  and  inflation,
in return for some  loss  of  control.  Despite  this,  doubts  persist.  In
practice, these will, of  course,  increase  when  national  currencies  are
replaced with the euro; then the need for the second part  of  the  monetary
policy strategy will become obvious.

      The ESCB monetary policy tool

       The  wide  range  of  instruments  available  to  the  ESCB  for  the
implementation of the euro area monetary policy has  been  established  with
reference to two fundamental  criteria:  efficiency  and  neutrality.  These
instruments can be separated into three categories, related to  open  market
operations, standing facilities and minimum reserves.
       The ESCB's instruments and procedures  do  not  differ  significantly
from those traditionally used by the Banco de Espaсa and with which you  are
all familiar. This means that I only need to highlight  a  few  differences.
In addition, I should add that over recent weeks the  Banco  de  Espaсa  has
introduced changes aimed at facilitating a smooth transition.
       With regard to open market operations, the frequency and maturity  of
the main re-financing operation has become  that  of  a  weekly  auction  of
loans with a maturity of two weeks, and an interest  rate  which  is  either
announced in advance (fixed rate auction) or announced later as  the  result
of offers received (variable rate  auction).  There  will  also  be  monthly
auctions for three-month loans which will always be  of  the  variable  rate
type in order to avoid sending signals to the market.  Fine-tuning  will  be
carried out in exceptional circumstances between two regular  auctions  and,
finally, the structural liquidity demand can be influenced by means of  open
market transactions which  consist  in  the  direct  purchase  and  sale  of
securities or the issuance of debt certificates.
        Standing  credit  and  deposit  facilities  will  supply  or  absorb
overnight liquidity, without the imposition of  any  other  restrictions  on
their use  by  institutions  other  than  the  provision  of  guarantees  or
collateral. Both types of  interest  on  standing  facilities  constitute  a
strip or corridor which will contain short-term market interest rate  swings
and provide a structure for monetary policy trends.  This  means  that  they
will play an important role in terms  of  providing  signals,  a  role  also
fulfilled by the Banco de Espaсa but in a less predetermined and  formalised
manner.
       As far as guarantees for all these  transactions  are  concerned,  it
should be stated that acceptable collateral may take the form  of  either  a
public instrument or a private instrument, provided  that  these  are  of  a
suitable nature, according  to  the  neutrality  principle  applied  to  the
public sector and to the private sector.
       The minimum  reserves  will  be  equal  to  2%  of  book  liabilities
calculated on the basis of a monthly average, will be subject to  a  minimum
exempt level of EUR 100,000 and  -  this  being  the  most  important  point
underlining the main difference compared with the current position in  Spain
- will be remunerated in line with market  rates.  The  averaging  provision
will allow us to  absorb  liquidity  shocks  without  recourse  to  standing
facilities. Such a minimum  reserves  will  constitute  a  useful  tool  for
restricting the volatile nature of  monetary  market  interests  rates,  for
reducing the need  for  fine-tuning  and  for  tightening  up  the  system's
liquidity, thereby enhancing the effectiveness of the monetary  policy.  Its
remuneration in line with the market  will  not  only  reduce  money  demand
elasticity with regard to interest rates but also offer neutrality  to  euro
area banks as compared with those in other countries which do not  use  such
a tool.

      Conclusion

       Although inevitably in a simplified form, I hope that this  statement
on the aims, strategy and instruments of the euro area monetary  policy  has
provided some basic information on the central core of the ECB's  operations
and that it can be used as a starting-point for our discussions.
       Thank you for listening; during the discussion  period,  I  shall  be
pleased to elaborate on the issues raised or examine any  others  which  you
think may be of interest.

                    The monetary policy of the Eurosystem

       Main remarks of the speech delivered by Eugenio Domingo Solans
       Member of the Governing Council and the Executive Board of the
                            European Central Bank
                     at the SOCIETAT CATALANA D'ECONOMIA
                        (Institut d'Estudis Catalans)
                           Barcelona, 2 July 1999


The text will be available in Catalan at a later stage.

* The primary objective of the Eurosystem and, therefore, the touchstone  to
measure its success is the achievement of price  stability.  In  the  medium
term the best contribution  that  the  Eurosystem  can  make  in  favour  of
sustained growth is, precisely,  to  create  an  environment  of  stability.
There is clearly no  greater  fertiliser  for  economic  growth  than  price
stability,  and  nothing  is  more  refractory  to  economic   growth   than
inflation. Provided that stability is achieved and that  there  is  no  risk
for stability in the future, the Eurosystem has to create the best  monetary
conditions for exploiting the considerable  growth  potential  of  the  euro
area. This should be done in a passive way, without any activism:  like  the
air we breathe, not like the air from an oxygen tank.

* The 5.2% increase in  the  three-month  moving  average  of  the  12-month
growth   rates   of   M3   covering   the   period   from   March    PROGRAM
99.DOC[pic][pic]&Microsoft Word 8.0

аto May 1999 is in line with the 4  Ѕ  reference  value  for  money  growth,
which is the basis of  the  first  pillar  of  the  ECB's  monetary  policy.
Neither the slight increase in the moving  average  compared  to  its  value
last month (5.1%) nor the non-substantial  and  almost  constant  difference
from the reference value signal a risk for price stability.

* The results of the broadly based  assessment  of  the  outlook  for  price
developments, which constitutes the second pillar  of  the  ECB's  strategy,
confirm that there is no risk to price stability in the euro area.

* The second pillar of the ECB's monetary policy  strategy  includes,  among
other indicators, the exchange rate developments  of  the  euro.  The  ECB's
assessment on the evolution  of  the  exchange  rate  of  the  euro  should,
therefore, be linked to the risk for price stability of  a  depreciation  of
the euro. Taking into account that the euro area economy is a rather  closed
one, no significant inflationary impact should be expected from  the  recent
exchange rate developments of the euro.

* One main feature of the instruments and  procedures  of  the  Eurosystem's
monetary policy is their high  level  of  flexibility,  in  the  sense  that
without discretionary changes the instruments can accommodate a  wide  range
of different market situations. On the other hand, there is  flexibility  in
the sense that the Eurosystem has at its disposal a  wide  set  of  monetary
policy instruments and has, therefore, the possibility to move from  one  to
the other if and when it is deemed appropriate, taking  into  account  their
advantages and disadvantages. In the  first  stage  of  the  ECB's  monetary
policy, the fixed rate tender with a discretionary  allotment  is  the  best
choice for the main refinancing operation owing to its advantages  in  terms
of signalling effects and controlling both the liquidity  allotted  and  the
volatility of overnight rates. On the contrary, in the case  of  longer-term
refinancing operations, the Eurosystem as a rule does  not  intend  to  send
signals to the market and the effects on the liquidity and on the  overnight
rates are weaker. Therefore, for  longer-term  refinancing  operations,  the
market-oriented variable rate tender has a clear advantage.

* The activities and the monetary policy decisions  of  the  ECB  should  be
interpreted from a euro area perspective as a whole. To interpret them  from
a national standpoint would be a mistake.

                                     ***

              THE ROLE OF THE CENTRAL BANK IN THE UNITED EUROPE

                     Speech by Dr. Willem F. Duisenberg,
                   President of the European Central Bank,
                          National Bank of Poland,
                        Warsaw, Poland on 4 May 1999


      1. Introduction

       First and foremost, I should like to congratulate the  National  Bank
of Poland (the NBP) on its 75th anniversary. The  age  of  the  NBP  already
suggests that as the President  of  the  European  Central  Bank  (ECB),  an
institution that  is  even  less  than  one  year  old  and  has  only  been
conducting monetary policy since January this year, I should  be  modest.  I
am aware that the role of the NBP has not been constant over these 75  years
and that in the past decade, in particular,  the  NBP  has  gone  through  a
remarkable   restructuring   process.   My   previous   central   bank,   de
Nederlandsche Bank, has, together with the International Monetary  Fund  and
many national central banks, been involved  in  assisting  the  NBP  in  its
efforts to adapt to the role of a central  bank  in  a  market  economy.  Of
course, the real work had to be done by you yourselves  and  I  believe  you
can be proud of what has been achieved over the past decade.
       Today in my speech I should like to focus on the role of the ECB,  as
a truly European institution. First of all, I shall explain  the  background
against which the introduction of the euro and the establishment of the  ECB
should be considered. Thereafter, I shall discuss the main features  of  the
institutional structure that  determines  monetary  policy-making.  I  shall
then turn to our monetary policy strategy and  the  role  of  accountability
and transparency in this strategy. I shall conclude  by  briefly  addressing
the issue of EU enlargement.

      2. The process of European integration

       On 1 January of this year the euro was  introduced  in  11  countries
with a combined population  of  almost  300  million.  The  ECB  started  to
conduct a single  monetary  policy  for  the  so-called  euro  area.  Former
national currencies, such as the French franc and the  German  Mark  are  no
longer autonomous currencies, but subdivisions of the euro.  Euro  banknotes
and coins will only be introduced in 2002.
       The voluntary transfer of monetary sovereignty from the  national  to
the European level is unique in history. However, it should not be  seen  as
a single, isolated event. The introduction  of  the  euro  is  part  of  the
process of European integration. This  process  started  shortly  after  the
second World War and has now been under way for more than  half  a  century.
The aims of European integration are not only, or even primarily,  economic.
Indeed, this process has been driven and  continues  to  be  driven  by  the
political conviction that an integrated Europe will be  safer,  more  stable
and more prosperous than a fragmented  Europe.  It  is  true  that  economic
integration has been the main engine of this process and that,  although  it
has had its ups and downs,  integration  has  delivered  important  economic
benefits. On balance it has been successful.
       The introduction of the euro and the establishment  of  the  ECB  are
important new steps in this process of European integration.  They  are  not
the completion of this process, for at least two reasons. First, the  launch
of the euro can be compared to the launch of a  rocket.  A  good  launch  is
crucial, but only the beginning of the mission. The euro has  been  launched
successfully. The challenge now is to make  it  a  success.  This  will  not
happen  automatically,  but  will  require  effort  on  the  part  of   many
authorities, institutions and people. Second, four  EU  Member  States  have
not (yet) introduced the euro. I hope that this will happen in  the  future.
Moreover, as you are  aware,  the  EU  itself  is  likely  to  increase  its
membership over time, also to include Poland. Ultimately, this is  bound  to
extend the euro area. This process,  too,  is  already  requiring  and  will
continue to require great efforts: no pain, no gain, as is often the case.

      3. The institutional framework of the single monetary policy

       Let me now turn to the institutional framework for the conduct of the
single monetary policy. This was laid down in the  Treaty  establishing  the
European Community, the so-called Maastricht Treaty, and the Statute of  the
ESCB, which is an integral part of this Treaty. According to the Treaty  the
ECB has the  primary  objective  of  maintaining  price  stability.  Without
prejudice to this objective, it is to support the general economic  policies
in  the  Community,  with  objectives  such  as  economic  growth  and  high
employment.
       Decisions on monetary policy are made by the Governing Council of the
ECB. This body comprises the six executive directors of the ECB and  the  11
governors of the national central banks (NCBs) of the  Member  States  which
have introduced the euro. These 17 people meet every fortnight at  the  ECB,
in  Frankfurt  am  Main.  Decision-making  on  monetary  policy   is   fully
centralised. All members of the Governing Council  have  one  vote,  whether
they come from Germany or  Luxembourg.  This  is  because  of  an  important
principle. They are not representing their country, but are obliged to  take
decisions on  the  basis  of  euro  area-wide  considerations.  Regional  or
national monetary policy does not and cannot exist in the euro  area.  There
is only  one,  single  monetary  policy  for  the  euro  area  as  a  whole.
Therefore, the ECB should develop into a truly  European  institution.  This
is a process that will inevitably take some time, but my feeling is that  we
are already making good progress.
       The execution of monetary policy is to a great extent  decentralised.
It is in large part carried out by  the  NCBs.  The  ECB  and  the  11  NCBs
together are referred to as the Eurosystem. If we refer to the ECB  and  the
15 NCBs of all EU Member States, we speak of the European System of  Central
Banks (ESCB). The General Council of the ECB meets quarterly  and  comprises
the President and Vice-President of the ECB and  the  15  governors  of  the
NCBs of all the EU Member States. This  body  does  not  make  decisions  on
monetary policy, but discusses issues concerning  the  relationship  between
the "ins" and the countries I prefer to call  "pre-ins",  such  as  exchange
rate issues. The third decision-making body of  the  ECB  is  the  Executive
Board of the ECB, comprising the six executive directors  of  the  ECB.  The
Executive Board is responsible for current business and  the  implementation
of monetary policy as decided by the Governing Council.  The  staff  of  the
ECB will, in the course of this year, reach a level of between 750  and  800
and is likely to grow further in the years ahead.
       The ECB is one of the most, if not the most, independent central bank
in the world. Its  independence  and  that  of  the  participating  national
central banks are firmly enshrined in the Maastricht Treaty. Members of  the
Governing Council  are  not  allowed  to  take  or  seek  instructions  from
anybody, politicians included. Politicians are  not  allowed  to  give  such
instructions. Members of the Governing Council have a term of office  of  at
least five years. The ECB is financially independent.
       The independent status of the ECB fits  into  the  recent  world-wide
trend of granting independence to central banks. This tendency is  evidenced
by both practical experience and academic research.  By  shielding  monetary
policy  decisions  from  political  interference,  price  stability  can  be
maintained without having to give up economic growth. Indeed, in that  sense
having an independent central bank is a good thing for  all  concerned.  The
reason for central bank independence is that  monetary  policy-making  under
the  influence  of  politicians  tends  to  focus  too  much  on  short-term
considerations.  This  can  easily  lead   to   temporary,   non-sustainable
increases  in  growth,  but  inevitably  results  in  lasting  increases  in
inflation  with  no  lasting  gains  in  growth  and  employment   at   all.
Politicians all over the world have come to realise this  and  have  decided
to remove the temptation to  pursue  short-term  gains  and  to  make  their
central bank  independent.  It  should  be  underlined  that  granting  this
independence is, as it should  be,  a  political  decision.  An  independent
central bank needs a clear legal mandate.

      4. The monetary policy strategy

       The ECB has, as I mentioned earlier, such  a  mandate.  However,  the
Treaty does not specify how the ECB should pursue its primary  objective  of
maintaining price stability; in other words: it is silent on what is  called
the monetary policy strategy. The ECB therefore formulated its  strategy  in
the second half of last year. That was no easy  task.  The  introduction  of
the euro constitutes a structural break, which may change the  behaviour  of
firms and individuals and make it less predictable. To a certain  extent  it
is comparable to what Poland experienced when  it  embarked  on  its  reform
process. The rules of the game change  and  this  makes  policy-making  more
complicated.  Our  monetary  policy  strategy  has  taken   these   specific
circumstances into account. It is tailored to  this  unique  period  of  the
introduction of  the  euro,  although  it  has  elements  of  both  monetary
targeting and inflation targeting.
       In the context of this strategy the ECB has provided  a  quantitative
definition of price stability. Price stability is defined as a  year-on-year
increase in the harmonised index of consumer prices (HICP) of below  2%  for
the euro area as a whole. Price stability is to be maintained in the  medium
term.
       The strategy consists of two pillars. The first pillar is a prominent
role for money. Ultimately, inflation is a monetary  phenomenon.  It  is  in
the end result of too much money chasing too few goods. Therefore,  we  have
formulated a reference value for the growth of a broad  monetary  aggregate,
M3, of 4 Ѕ% on an annual basis. Growth of  the  money  stock  at  this  pace
would provide the economy with sufficient liquidity for growth  in  activity
in line with trend growth, without inflation. At the end of this  year  this
figure will be reviewed. It should be emphasised that we did  not  define  a
target for money growth. The reason for this is the  structural  break  that
the introduction of the euro creates. By calling this a reference value,  it
is made clear that money is one variable which we look at very carefully  in
order to examine whether inflationary or deflationary pressures are  tending
to emerge. We do not, however, react mechanistically  to  changes  in  money
growth.
       The formulation  of  the  second  pillar  is  also  prompted  by  the
potential changes in economic behaviour on account of  the  introduction  of
the euro. It is  a  broadly  based  assessment  of  the  outlook  for  price
developments on  the  basis  of  an  analysis  of  monetary,  financial  and
economic developments. In this context  interest  rates,  the  yield  curve,
wage developments, public finance,  the  output  gap,  surveys  of  economic
sentiment and many other indicators  are  analysed.  Use  is  also  made  of
forecasts produced by other bodies and internally for  inflation  and  other
economic variables.
       This brings me to the role of the exchange rate of the  euro  in  our
strategy. Since our primary objective is price stability and since the  euro
area as a whole is a relatively closed economy with an export share  of  14%
of gross domestic product, we do not have a target for the exchange rate  of
the euro, for example, against the US dollar. This does not mean, and it  is
good to underline this once  more,  that  the  ECB  is  indifferent  to  the
external value of the euro or even neglects it. The external  value  of  the
euro is one of the indicators we look at in the broadly based assessment  of
the outlook for price developments. Within  that  framework,  we  constantly
monitor exchange rate developments, analyse them and shall act on  them,  if
and when  this  becomes  necessary.  However,  such  action  will  never  be
mechanistic, nor will it be isolated. The external value  of  the  euro  and
its development  are  analysed  and  considered  in  the  context  of  other
indicators of future price  developments.  The  ECB  also  tries  to  assess
international confidence in the still very young euro. Of course, the  level
of international confidence in the euro is not the only  factor  determining
its external  value,  nor  is  the  exchange  rate  the  only  indicator  of
confidence in the euro. It is, for instance,  encouraging  to  see  how  the
euro has been received on the international money and capital markets. I  am
sure  that  an  internally  stable  euro   will   also   strongly   underpin
international confidence in this currency, as it has  for  other  currencies
in the past.
       As the currency of a very large area, the issue of the  international
role of the euro naturally arises. The ECB takes a neutral stance  regarding
this role. It will neither be stimulated, nor hindered. On the one hand,  an
international currency has advantages for citizens in the euro area, on  the
other, it may sometimes complicate the conduct of  monetary  policy  when  a
large amount of euro is circulating outside the euro area.  We  shall  leave
the  development  of  the  international  role  of  the   euro   to   market
participants and market forces. If history  is  a  guide  as  to  what  will
happen, there will be a gradual  process  whereby  the  euro  will  have  an
increasingly international role. Such a gradual development would also be  a
welcome development, if only to prevent the euro from  becoming  too  strong
externally at some point in time.  It  is  likely  and  understandable  that
interest in the euro is already considerable in those countries aspiring  to
join the EU, including Poland. I shall elaborate on this issue  at  the  end
of my speech.
       Coming back to our monetary policy strategy, I should like  to  point
out that it is important to make clear what monetary policy can  and  cannot
do. Monetary policy can maintain price stability, but  only  in  the  medium
term.  In  the  short  term  prices  are  also  influenced  by  non-monetary
developments. Moreover, monetary policy measures  only  have  an  impact  on
prices with  long,  variable  and  not  entirely  predictable  time-lags  of
between 1.5 and 2 years. Therefore, monetary  policy-making  should  have  a
forward-looking character. Today's inflation is the result  of  past  policy
measures, and current policy measures  only  affect  future  inflation.  The
uncertainty of the economic process in a market economy  is  another  reason
for policy-makers to be modest. The ECB does not pursue an activist  policy.
Precise steering of the business cycle  or  a  cyclically-oriented  monetary
policy are not feasible and are likely to destabilise rather than  stabilise
the economy. Some commentators have interpreted  our  recent  interest  rate
reduction  as  a  change  to  a  more  cyclically-oriented  monetary  policy
strategy. This is not true. Our strategy was, is  and  shall  remain  medium
term-oriented and firmly focused on maintaining the  price  stability  which
currently prevails in the euro area.
       Monetary policy should be supported by sound budgetary  policies  and
wage developments in line with productivity growth and taking  into  account
the objective of price stability. Otherwise, price  stability  can  only  be
maintained at a high cost in terms of lost output and employment. This  also
explains why independence should not mean  isolation.  It  is  important  to
have a regular exchange of information and views with  other  policy-makers.
The Maastricht Treaty stipulates that the President of the  ECB  is  invited
to meetings of the EU Council meeting in the composition  of  the  Ministers
of Economy and Finance whenever there are issues on  the  agenda  which  are
relevant to the ECB's tasks. The President of the Council of  Ministers  and
a member of the European Commission may attend  meetings  of  the  Governing
Council, although they do not have the right to vote. The President  of  the
Council of Ministers may submit motions for deliberation. Apart  from  these
formal contacts, there are  many  informal  contacts,  for  example  in  the
context of the so-called Euro-11 group of finance ministers  from  the  euro
area countries. I regularly attend meetings of this group.
       Monetary policy cannot be used to solve structural problems, such  as
the unacceptably high level of unemployment in  the  euro  area.  Structural
problems call for structural solutions, in this case  measures  targeted  at
making labour and product markets work more flexibly. The best  contribution
the ECB's monetary policy can make in this  context  is  to  maintain  price
stability. In this way one of  the  conditions  for  sustainable  growth  in
incomes and employment is created. As important as this  is,  it  should  be
realised that jobs are created  by  firms  which  are  confident  about  the
future and not by central banks.

      5. Accountability and transparency

       Accountability for policies is the logical complement to independence
in a  democratic  society.  The  Maastricht  Treaty  includes  a  number  of
provisions in this respect. First, there is  the  mandate  to  pursue  price
stability. This provides a  qualitative  measure  against  which  the  ECB's
performance can be measured. As I have already mentioned,  we  have  decided
to enhance this by providing a quantitative definition of  price  stability.
One of the aims of publishing our monetary policy strategy is  to  make  our
policy decisions transparent.
       The ECB has to publish an annual report in  which,  inter  alia,  the
monetary policy of the previous and current year are  discussed.  I  present
this Annual Report to the EU Council and to the European  Parliament,  which
may hold a general debate on the  basis  of  it.  The  President  and  other
members of the Executive Board of the ECB may  be  heard  by  the  competent
committees of the European Parliament. I have agreed to  appear  before  the
European Parliament at least four times a year. The ECB  has  to  report  on
its activities at least quarterly. It has been decided  to  go  beyond  this
requirement and to publish a monthly bulletin.
       It is my view that the main way to achieve accountability is  through
being transparent  and  open.  In  passing,  I  should  like  to  note  that
transparency also enhances the effectiveness of a central bank.  The  better
it is understood, the more successful a central  bank  is.  Apart  from  the
activities I have already mentioned, transparency  is  achieved  in  several
ways. Every month, after the first meeting of  the  Governing  Council,  the
Vice-President and I give a press conference. I start the conference with  a
comprehensive introductory statement,  in  which  I  explain  the  decisions
taken by the Governing Council and the  underlying  analysis  and  arguments
for and against. This introductory statement  is  published  immediately  on
the ECB's Internet Web site. This is  followed  by  a  question  and  answer
session attended by several hundred journalists. The questions  and  answers
are also published on the Internet shortly afterwards. All  the  members  of
the  Governing  Council  frequently  make  speeches,  give  interviews   and
contribute to journals and books. Thousands of people visit the ECB and  the
national central banks each year and, for our part, we and our staff  attend
many conferences and other public events.

      6. EU enlargement

       The European integration process continues. The euro should be made a
success. I have already explained how we have started the process  of  doing
that. Some observers have criticised the EU for its "obsession with its  own
internal dynamics", in particular in the context of  European  Economic  and
Monetary Union (EMU). With all energies focused on meeting  the  convergence
criteria and the preparation for the launch of the euro,  Europeans  outside
the EU have wondered whether EMU and enlargement are not mutually  exclusive
objectives.
       Let me briefly comment on this issue. After the historic decision  to
complete the European Single Market in the 1980s, it was felt that  economic
integration should not stop at that point. To  fully  reap  the  rewards  of
economic integration within  the  Community,  a  single  currency  was  felt
necessary; a logic pointedly encapsulated in the title of one  report:  "One
market, one money".
       Hence, the underlying idea of EMU was to advance European integration
and to ensure that full use would be made of the economic potential  of  the
Single Market. This idea continues to  be  the  focus  of  European  policy-
makers,  as  evidenced  by  the  association  agreements  and  the   ongoing
accession negotiations with a number of  European  countries,  Poland  among
them. Good and mutually beneficial economic relations with  third  countries
in Europe and  further  afield  are  a  pillar  of  EU  policy  orientation.
Recognising this, the  principles  of  an  open  market  economy  with  free
competition are enshrined in the Treaty on  European  Union.  EMU  will  not
weaken this commitment, but rather  reinforce  it.  Closer  co-operation  in
Europe and the respect of common principles in the political,  economic  and
social fields are likely to form the basis for further integration. The  ECB
shall contribute to this process within the scope of its responsibility.
       Countries wishing  to  deepen  their  monetary  co-operation  to  the
ultimate extent possible by forming a monetary  union  will  have  to  adapt
their economic and legal systems to the standards  required  by  the  Treaty
and aim at a sufficient degree of economic convergence. In  the  absence  of
these conditions, adjustment costs for both  current  and  new  participants
could be high. Any premature decision on the  adoption  of  the  euro  could
have  severe  repercussions  on  a  country's  competitiveness  and  trigger
painful economic adjustments. Therefore,  implementation  of  the  necessary
institutional reforms and of a sufficient degree of convergence  should  not
be considered as an obstacle preventing further integration in  Europe,  but
rather as an essential means of ensuring the lasting  success  of  EMU,  for
existing and new participants alike.  Looking  at  the  impressive  progress
made in a relatively short time in this country, there is no  reason  to  be
pessimistic  about  Poland's  chances  of  meeting   these   standards   and
convergence criteria. I shall not venture, however,  to  predict  when  this
will be the case.
       Even at the current juncture, though, EMU in one part  of  Europe  is
already having an impact on the whole region. Let  me  briefly  mention  two
aspects:
       * If the euro emerges, as I believe it will, as a strong and
       stable currency, it will provide the countries in the region
       with an important reference currency, an anchor towards
       which, should the intention arise, monetary policy could
       credibly be oriented.
       * Furthermore, EMU is set to bring about the development of a
       truly unified European financial market, close to that of
       the United States in depth and sophistication. The
       competitive pressures of this euro area financial market
       will create more favourable financing conditions for
       borrowers. A number of central and eastern European
       countries have already successfully tapped this market.

       In view of these effects, it is altogether natural that the  ECB  has
started to follow with great interest economic  and  financial  developments
in the wider Europe, particularly in those countries which have applied  for
EU  membership.  Moreover,  the  ECB  monitors  closely  the  exchange  rate
developments with those  countries  which  have  established  some  form  of
exchange rate link to the euro.
       The euro has the potential to become more than just  a  new  currency
for almost 300 million  people  in  11  countries.  It  may  also  become  a
unifying symbol, standing for  all  that  the  peoples  of  Europe  have  in
common. Consequently, the public perception of  the  euro  could  endow  the
single currency with a role in the  European  integration  process  reaching
beyond monetary policy in the strict sense. May the euro contribute  to  the
establishment of what the preamble to the Treaty Establishing  the  European
Community calls: "an ever closer union among the peoples of Europe".

                                     ***


                     The single European monetary policy

                       Speech by Willem F. Duisenberg
                   President of the European Central Bank
                       at the University of Hohenheim
                  on 9 February 1999, in Hohenheim, Germany

       Ladies and gentlemen, The single European monetary policy has been  a
reality for a  little  more  than  five  weeks.  After  years  of  intensive
preparatory work and successful economic  convergence,  monetary  policy  is
now jointly determined for a large part of Europe by the  Governing  Council
of the European Central Bank. The monetary  policy  is  implemented  by  the
Eurosystem, the name given to the ECB and the 11 central  banks  of  the  EU
Member States participating in Monetary Union.
       The single currency is quoted on the international financial  markets
and is used in non-cash payments. However, the euro will not appear  as  yet
in tangible form as banknotes and coins. Nonetheless there is no doubt  that
this currency, which was only brought into  existence  on  1  January  1999,
will play an important role both within the euro area and beyond.
       There is good reason  for  this  confidence,  ladies  and  gentlemen.
Overall the first few weeks went smoothly for the single  currency  and  the
monetary policy of the Eurosystem.  The  start  did  not  pass  by  entirely
without a hitch - which was not to  be  expected  in  any  case,  given  the
significance  and  scale  of  this  project  -  but  there  were  no   major
complications.
       Monetary Union is a unique and outstanding achievement.  It  provides
the great opportunity  to  achieve  the  goal  of  lasting  price  stability
throughout Europe. Price stability is the best  contribution  that  monetary
policy can make to lasting economic and employment  growth  in  Europe.  The
national governments and all those involved in  collective  wage  bargaining
are being called on to remove the structural causes of the excessively  high
unemployment. We can only hope that the introduction of the euro  will  spur
the implementation of structural reforms.

      The stability-oriented monetary policy strategy of the Eurosystem

       The Treaty establishing the European Community assigns  the  European
System of Central Banks (ESCB) - and thereby the Eurosystem  -  the  primary
objective of maintaining price stability. The Governing Council will do  its
utmost to fulfil this task and to explain its monetary policy so  as  to  be
comprehensible to the general public. For this reason we  have  developed  a
stability-oriented monetary policy which essentially consists of three  main
elements.
       The Governing Council has published a quantitative definition of  its
primary  objective,  price  stability.  This  gives   clear   guidance   for
expectations in relation to future price developments.  Price  stability  is
defined as an increase in the Harmonised Index of  Consumer  Prices  of  the
euro area of less than 2% compared with the previous year.  The  publication
of this definition provides the public and the European  Parliament  with  a
clear benchmark against which to measure the success of the single  monetary
policy, and thereby provides for the transparency and accountability of  the
Eurosystem and its policy.
       The wording "less than 2%" clearly defines the upper  limit  for  the
measured inflation rate which is compatible with price stability. I  do  not
think I need emphasise that deflation - or a  sustained  fall  in  prices  -
would be incompatible with price stability. The latest  available  data  for
the annual rate of inflation according to the Harmonised Index  of  Consumer
Prices for the euro area as a whole fall  within  the  definition  of  price
stability. This outcome is clearly the result, above all, of the  successful
monetary policy of the national central banks in the years before the  start
of Monetary Union.
       The ECB has only been responsible for monetary policy  for  a  little
more than one month. It will only be possible to judge the  success  of  its
current policy in one to two years'time. This reflects  the  fact  that  the
transmission of monetary policy impulses is subject to relatively  long  and
variable time lags. The Governing  Council  has  therefore  emphasised  that
price stability must be  maintained  in  the  medium  term.  This  statement
underlines not only the need for  a  forward-looking  approach  to  monetary
policy, but also takes  into  consideration  the  short-term  volatility  of
prices in response to non-monetary shocks which are beyond  the  control  of
monetary policy.
       In order to achieve the goal of price stability, our strategy  rests,
in particular, on two "pillars". Before I explain this  in  more  detail,  I
should  like  to  emphasise  that  traditional  and  previously  established
macroeconomic  relationships  could  change  as   a   consequence   of   the
introduction of the euro. This was one key reason  why  neither  a  monetary
targeting nor a direct inflation targeting strategy could  be  applied.  Our
strategy  is  also  more  than  just  a  simple  combination  of  these  two
approaches. Rather, it is precisely tailored to the needs of the ECB.
       The first pillar of the monetary policy strategy is a prominent  role
for money. Since inflation  is  ultimately  a  monetary  phenomenon  in  the
medium term, the money supply provides a  natural  "nominal  anchor"  for  a
monetary policy geared to safe-guarding price stability. To  emphasise  this
prominent  role,  the  Governing  Council  has  published   a   quantitative
reference value for growth in the money supply. The  first  reference  value
decided upon by the Governing Council for growth in M3 was  4.5%  per  annum
and was published on 1 December. This value is based on the  above-mentioned
definition of price stability and assumes  a  trend  growth  in  real  gross
domestic product of 2-2.5% per annum, as well as a medium-term reduction  in
the velocity of circulation of M3 of around 0.5-1% per annum.
       We shall not, however, respond mechanistically to deviations from the
reference value for money  supply  growth,  but  shall  first  analyse  them
carefully for signals relating  to  future  price  developments.  Larger  or
sustained deviations normally signal risks to price stability.
       The second pillar of the  monetary  policy  strategy  consists  in  a
broadly based assessment of  the  outlook  for  price  developments  in  the
entire euro area. This  assessment  will  be  based  on  a  broad  range  of
monetary policy indicators.  In  particular,  those  variables  which  could
contain information on future price developments will be analysed in  depth.
This analysis should not only provide information on  the  risks  for  price
development, but should also help  to  identify  the  causes  of  unexpected
changes in important economic variables.
       Some commentators reduced this comprehensive analysis to an inflation
forecast. At the same time, there were  demands  for  the  ECB  to  have  to
publish these forecasts in order to satisfy the need  for  transparency  and
accountability.  Therefore  allow  me  to  make  this  clear:  our  strategy
includes  a  comprehensive  analysis  of  numerous  indicators  and  several
forecasts.  To  focus  on  a  single  official  inflation  forecast  of  the
Eurosystem for a specific point in time would in no way  accurately  reflect
our internal analytical and decision-making process. It would  impinge  upon
the  transparency  and  clarity  of  the  explanation  of  our  policy.  The
publication of an official inflation forecast would  also  be  inappropriate
with regard to the accountability of the  ECB,  all  the  more  so  if  this
forecast were based on the assumption of no change in the  monetary  policy.
The success of the monetary policy of the ECB should primarily  be  measured
in terms of the maintenance of price stability,  not  the  accuracy  of  its
conditional forecasts.
       The stability-oriented monetary policy strategy  of  the  Eurosystem,
which I have just  outlined,  constitutes  a  new  and  clear  strategy.  It
emphasises the primacy of  the  goal  of  price  stability.  It  takes  into
account  the  inevitable  uncertainties  concerning  economic  relationships
inherent in the transition to Monetary Union  and  the  associated  systemic
changes and guarantees a high degree of transparency.
       Ladies and gentlemen, allow me to comment on certain  suggestions  on
the orientation of monetary policy  which  have  recently  appeared  in  the
press. Some of these ideas give the impression that monetary  policy  should
concentrate upon objectives other than price stability, since stable  prices
have already been achieved. Inter alia, it has been suggested that  the  ECB
should react more or less mechanistically to exchange rate  developments  or
other variables such as,  for  instance,  unit  labour  costs.  Furthermore,
there were calls for monetary policy, by means  of  reductions  in  interest
rates, to be used to combat unemployment. Against this background  there  is
a need to set out clearly the  possibilities  and  limitations  of  monetary
policy.
       Both the  reasoning  in  the  Maastricht  Treaty  and  many  economic
analyses show that the best contribution  the  single  monetary  policy  can
make to employment growth is to  concentrate  on  price  stability.  Without
such a clear approach there is a danger that the  public  may  question  the
commitment of the Eurosystem to the goal  of  maintaining  price  stability.
Inflation expectations, risk premia and thus  long-term  rates  would  rise.
This would increase the cost of the investment  which  is  necessary  for  a
sustained and lasting rise in the standard of living.
       Even under the best possible  circumstances,  though  -  i.e.  if  it
proves to be possible to assure lasting price stability  -  monetary  policy
alone cannot solve the major economic problems of  unemployment  and  future
problems in social security systems.
       The Governing Council regards the current high level of  unemployment
in the euro area as a matter of great concern.  This  problem  is,  however,
predominantly a structural one. It is mainly the result  of  the  rigidities
in the labour and goods markets in the euro area which  have  arisen  partly
through an excessive and disproportionate degree of  regulation.  Structural
economic  reforms,  which  target  the  reduction  of  rigidities,  are  the
appropriate solution. In those euro area countries  in  which  such  reforms
have been  implemented  unemployment  figures  have  declined  markedly.  In
addition, I should like to emphasise that moderate wage developments  and  a
reduction in the burden of  tax  and  social  security  contributions  would
generally help to reduce unemployment. This would be the case  even  if  the
country concerned did not trade heavily  with  its  neighbouring  countries.
The positive influence of low taxes and  wages  on  employment  clearly  has
overall benefits from an international perspective.  Such  a  policy  should
not be denounced as "wage dumping".
       Turning to the role of exchange rates  between  the  euro  and  other
important currencies outside the  EU,  in  particular  the  US  dollar,  the
Eurosystem has,  in  formulating  its  monetary  policy  strategy,  made  an
unambiguous choice. This strategy clearly rules  out  explicit  or  implicit
objectives or target zones for the euro exchange rate.  The  pursuit  of  an
exchange rate objective could  easily  jeopardise  the  maintenance  of  the
objective of price stability and could thereby also be detrimental  to  real
economic development. Target zones for exchange rates  could,  for  example,
lead to the ECB having to raise  interest  rates  in  a  recession,  despite
increasing downward pressure on prices. I am sure you will agree  that  such
a mechanistic response to a change in the euro exchange rate  would  not  be
optimal. Furthermore, it is important to remember that we are  living  in  a
world with high capital mobility.  Exchange  rate  agreements,  which  might
have been possible to implement until recently, are no longer feasible.
       The lack of an exchange rate target does not mean  that  the  ECB  is
totally indifferent to or takes no account of the  euro  exchange  rate.  On
the contrary,  the  exchange  rate  will  be  observed  and  analysed  as  a
potentially important monetary  policy  indicator  in  the  context  of  the
broadly based assessment of the outlook for price developments. A stability-
oriented monetary and fiscal policy, as stipulated by the Maastricht  Treaty
and the Stability and Growth Pact,  is  an  essential  pre-condition  for  a
stable euro exchange rate. Of course,  there  is  no  guarantee  of  lasting
exchange rate stability, not even in a fixed exchange rate regime.  Exchange
rate  fluctuations  are  often  caused  by  structural  or  fiscal   policy,
asymmetric real shocks or conjunctural differences.  Monetary  policy  would
clearly be overburdened if it had to prevent such movements in the  exchange
rate.
       We cannot and shall not gear our monetary  policy  towards  a  single
variable, whether a money supply aggregate, an index, the exchange  rate  or
an inflation forecast for  a  particular  point  in  time.  Nor  can  we  be
involved in any ex ante co-ordination which would entail  an  obligation  to
react to particular commitments or plans.  The  ECB  will  always  carefully
analyse all  relevant  indicators.  In  this  context,  it  is  particularly
important that the economic causes of potential risks to price stability  in
the euro area are understood as  fully  as  possible.  Appropriate  monetary
policy decisions also depend  upon  the  causes  of  unexpected  changes  in
important economic variables. The Governing Council must, for example,  take
a view on whether changes in important indicators  are  of  a  temporary  or
permanent nature, and whether a demand or supply shock is involved.  In  our
deliberations we also  attempt  to  take  into  account  how  the  financial
markets, consumers and firms  are  expected  to  react  to  monetary  policy
decisions. I believe few would contest that such a complex  analysis  cannot
meaningfully be reduced to a more or less  mechanistic  reaction  to  a  few
variables or a single official forecast.
       In addition, concern was often expressed that  the  Eurosystem  would
not  act  transparently  enough.  In  this  context,  it  was  said  that  a
transparent  monetary  policy  also  necessitated  the  publication  of  the
minutes of the meetings of the  Governing  Council  and  disclosure  of  the
voting behaviour of the individual members of the Council.
       For sound reasons the Governing Council decided  not  to  adopt  this
approach. The publication of  individual  positions  could  easily  lead  to
national influence being exerted over the individual  Council  members.  The
members of the Governing Council must not,  however,  be  seen  as  national
representatives. They decide together on the monetary policy  for  the  euro
area as a whole. The Governing Council has committed  itself  to  go  beyond
the reporting and explanatory requirements laid down in  the  Treaty,  which
are among the most comprehensive requirements by international standards.
       On the basis of our strategy, after every first meeting in the  month
I deliver to the press a detailed  explanation  of  our  assessment  of  the
overall economic  situation  and,  in  particular,  the  outlook  for  price
stability. The content of this so-called "introductory  statement"  is  very
close to what other central banks refer to as  minutes.  In  this  way,  the
public  receives  comprehensive  information   immediately   following   the
meetings of the Governing Council. In addition, each month we shall  publish
a detailed report on the economic situation and monetary  policy  throughout
the euro area in our Bulletin. Such rapid information on the results of  the
meetings of the Governing Council and the current economic analysis  of  the
ECB without doubt demonstrates a high degree of openness and transparency.

      The most recent monetary policy decisions and operations

       Co-operation between the  European  central  banks  was  always  very
close. In the last few months of 1998 the  countries  participating  in  the
third stage of Monetary Union co-operated more and  more  closely.  The  co-
ordinated reduction in leading rates  at  the  beginning  of  December  1998
clearly showed that the currency union had begun de facto before  the  start
of Stage Three. This co-ordinated measure contributed substantially - as  we
now know - to the stabilisation of market expectations.
       For more than five weeks the ECB has been conducting monetary  policy
operations, mainly in the form of reverse open market operations.  The  main
operation will be carried out at a weekly frequency with a maturity  of  two
weeks. So far, five such operations have been conducted successfully,  at  a
fixed interest rate of 3%.
       Besides the reverse transactions which constitute the main instrument
for liquidity control and targeting interest rates,  the  Eurosystem  offers
two "standing" facilities: the marginal lending  facility  and  the  deposit
facility. These can be accessed by  credit  institutions  via  the  national
central banks. The marginal lending facility is  primarily  a  safety  valve
for short-term liquidity shortages in the banking system and thereby  limits
upward movements in money market rates. To some extent, its  counterpart  is
the  short-term  deposit  facility,  which  is  used  to  absorb  short-term
liquidity surpluses. This forms the lower limit for money market rates.  For
the start of Monetary Union the interest rate on the  deposit  facility  was
set at 2% and the rate on the marginal lending facility was set at 4.5%.
       As a transitional measure, the Governing Council decided to establish
a narrow corridor of 2.75-3.25% between the rates on  the  marginal  lending
facility and the deposit facility from 4 to 21 January 1999.  The  intention
was  to  facilitate  the  necessary  adjustment  to  the  new  institutional
environment brought about by the  transition  to  Stage  Three.  As  already
announced, on 21 January 1999 it was decided to return to the rates  on  the
two "standing" facilities  that  were  set  for  the  start  of  the  single
monetary policy. Since 22 January 1999, therefore, the rate on  the  deposit
facility has been 2% and the rate on the marginal lending facility has  been
4.5%.
       A critical factor in this decision was the  behaviour  of  the  money
market for the euro area as a whole since the beginning  of  the  year.  The
Governing Council established  that  over  time  there  had  been  a  marked
reduction in the difficulties experienced by some market  participants  with
the introduction of the integrated money market  and,  in  particular,  with
cross-border liquidity flows. All in  all,  the  integration  of  the  money
market in the euro area reached a satisfactory stage only three weeks  after
its implementation. In analysing the money market it should be  noted  that,
inter alia, there can be a marked difference between ECB interest rates  and
short-term market rates. On the one hand, market rates  may  include  credit
risk premia, and on the other, expectations may lead to differences  between
the two rates.
       At its meeting last Thursday  the  Governing  Council  confirmed  its
earlier assessment of the outlook for  price  stability.  Therefore  it  was
decided to leave the conditions for the next  main  refinancing  operations,
on 10 and 17 February 1999, unchanged. They will be carried  out  as  volume
tenders at a fixed rate  of  3%,  the  same  conditions  as  the  last  such
monetary policy operations.
       In addition, in  recent  weeks  the  first  longer-term  open  market
operations were also conducted, in the form of reverse  transactions.  These
were carried out on 14 January 1999  in  three  parallel  tender  procedures
with maturities of  one,  two  and  three  months.  The  fixed  rate  tender
procedure  was  used.  By  contrast  with  the  regular   main   refinancing
operations, the Eurosystem does not  use  these  longer-term  operations  to
send signals to the market and therefore usually acts as a price-taker.  The
ECB thus gives advance indication of the planned  allocation.  The  interest
rates which arise from these monetary policy operations should therefore  be
seen as indicators of prevailing market conditions.

      Regular assessment of the monetary, financial and economic situation

       To conclude, I  should  like  briefly  to  report  on  the  Governing
Council’s  current  assessment  of  the  monetary,  financial  and  economic
situation. On the basis of these assessments the Governing  Council  decided
last Tuesday to leave interest rates unchanged.
       Taking into account the latest monetary data for December  1998,  the
three-month moving average of the  12-month  growth  rate  of  the  monetary
aggregate M3 (for the period from October to December  1998)  remained  more
or less stable at 4.7%. This value is very close to the reference value  set
by the Governing Council. According to our analysis, the  evolution  of  the
money supply shows no risks  to  price  stability.  Credit  to  the  private
sector also grew strongly in December last year. Although at present  we  do
not perceive any inflationary signals, further  developments  will  be  very
carefully monitored.
       With regard to the broadly based assessment of the outlook for  price
developments and the risks to price stability in  the  euro  area,  monetary
and financial developments can be seen to indicate a  favourable  assessment
of the latest monetary policy decisions of  the  Eurosystem.  They  indicate
that market participants expect a continuation of the environment  of  price
stability. Long-term rates fell to new historical lows at the  beginning  of
1999 and there was an overall downward shift in the yield curve.  Therefore,
financing conditions for investment are currently exceptionally  favourable.

       At present the growth prospects for the euro area are, however, still
marked by the  uncertainties  relating  to  the  development  of  the  world
economy  in  1999.  These  uncertainties  have  had  a  negative  impact  on
indicators of the economic climate in the euro area.  There  are  widespread
expectations of an economic slowdown in the near future. This  deterioration
in the external economic environment  can  be  linked,  above  all,  to  the
financial crises in Asia, Russia and Latin  America.  However,  there  is  a
mixed picture. While the growth rate for industrial production  fell  up  to
November 1998, retail sales figures and consumer  confidence  have  recently
shown positive trends. Furthermore, growth in real  gross  domestic  product
in the euro area was relatively robust in the third quarter of 1998. In  the
United States real growth in the fourth quarter actually turned  out  higher
than expected. Measured against the Harmonised  Index  of  Consumer  Prices,
the HICP, consumer prices in the euro area rose by 0.8%  in  December  1998.
This is a  tenth  of  a  percentage  point  lower  than  in  November.  This
development  is  in  line  with  earlier  trends.  It  can  be  linked,   in
particular, to a further decline in energy prices and a weakening  in  price
increases in industrial goods.
        All  in  all,  the  above-mentioned  economic  development  and  the
available forecasts for 1999  do  not  indicate  any  noticeable  upward  or
downward pressure on prices. Potential  upward  risks  could  arise  from  a
change in the external global economic situation and any associated  effects
on the euro area, via import and producer prices.  These  developments  must
be carefully monitored. There is concern that  inflationary  pressure  might
develop in the event of a strong increase in wage prices and  an  easing  of
fiscal policy. Developments in  the  exchange  rate  will  also  be  closely
monitored in view of their significance for price developments.
       Finally, let me emphasise that the current  level  of  real  interest
rates is exceptionally low. If real interest rates are taken simply  as  the
difference between nominal  rates  and  the  current  increase  in  consumer
prices (HICP), short-term real interest  rates  in  January  1999  stood  at
2.3%, i.e. around 80 basis points lower than one year  ago.  Long-term  real
rates have fallen even more, by  110  basis  points,  and  stood  at  3%  in
January. These levels are very low, both compared with other  countries  and
with historical data. In line with the  safe-guarding  of  price  stability,
the current monetary and financial conditions thus  clearly  support  future
economic  growth.  Monetary  policy  can  do  no  more  than  this   without
jeopardising the great overall economic advantages of  price  stability  and
its own credibility.
       Real structural reforms which increase the flexibility of the  labour
markets, as well as a continuation of the moderate increase in wage  prices,
would not only ease the burden on monetary policy  but  would  also  support
employment growth. This will be all the more true if  the  deterioration  in
the economic situation this  year  is  worse  than  expected  owing  to  the
negative aspects of the external economic environment.

                  The statistical requirements of the ESCB

                 Speech delivered by Eugenio Domingo Solans,
         Member of the Executive Board of the European Central Bank
       on the occasion of a visit to the Banque Centrale du Luxembourg
                          Luxembourg, 25 March 1999

       The booklet introducing statistical  requirements  for  Stage  Three,
which the EMI published  in  July  1996,  began  with  the  bold  statement:
"Nothing is more important for the conduct  of  monetary  policy  than  good
statistics." These challenging words  show  the  importance  which  the  EMI
attached to this area of preparations for Monetary Union,  and  I  must  say
this has been fully justified by our experience in the first  few  weeks  of
the life of the euro.

      The statement of requirements

       But let me start back in 1996.  Because  of  the  time  it  takes  to
implement statistical changes in reporting institutions and  central  banks,
a statement of prospective statistical  requirements  could  be  delayed  no
longer. But that statement had to be made  with  very  imperfect  knowledge.
Nobody knew at  that  stage  (for  example)  what  definitions  of  monetary
aggregates would be chosen for the single currency area, or what their  role
would be. Given the differences in financial structures  in  our  countries,
it was not clear how to  identify  the  financial  institutions  from  whose
liabilities the money stock would be compiled.  It  was  decided  to  define
them in functional terms, and in such a way that money-market funds as  well
as banks of the traditional type would be included.  It  was  not  clear  at
that stage whether minimum reserves would be applied,  and,  if  they  were,
what form they would take - although it had been decided  that  the  banking
statistics data would provide the basis for any such system.  Implementation
had to start quickly for the statistics to be ready in time for  a  Monetary
Union starting in 1999, but no one knew which Member States would adopt  the
single currency - though it was clear that the distinction between  business
inside and outside the euro  area,  would  be  of  critical  importance  for
monetary and balance of payments statistics, and would have  to  be  planned
for in statistical systems.
       In mentioning monetary and balance of payments statistics, I  do  not
want to suggest that the statistical  requirements  set  out  in  1996  were
confined to these areas. On the contrary,  they  covered  a  wide  range  of
financial and economic data, including financial accounts, prices and  costs
- relating directly to the ESCB's  main  responsibility  under  the  Treaty,
namely to maintain price  stability  -  government  finance  data,  national
accounts, labour market statistics, production  and  trade  data  and  other
conjunctural statistics, and more  besides.  These  areas  are,  or  course,
under Eurostat's responsibility.

      The focus on the euro area as a whole

       In formulating and  implementing  statistical  requirements,  it  was
important to realise that the ESCB's attention would have to  focus  on  the
euro area as a whole. Monetary policy cannot  discriminate  among  different
areas of the Monetary Union - although in practice  it  may  have  different
effects because of different national  economic  and  financial  structures.
Focus on the area as a whole has important implications. The  data  must  be
sufficiently  comparable  for  sensible  aggregation;  they  must  also   be
available to a comparable timeliness and to  the  same  frequency.  In  some
cases  (monetary  and  balance  of  payments  statistics)  they  had  to  be
available in a form permitting appropriate consolidation. In short,  with  a
few exceptions, it was realised that adding together existing national  data
would not be adequate. Important initiatives were already  under  way,  such
as the adoption of a  new  European  System  of  Accounts  [ESA95]  and  the
implementation at national level of a new IMF Balance  of  Payments  Manual.
However, wide-ranging statistical preparations would be  necessary  for  the
ECB to have the sort of statistical information that  the  national  central
banks have traditionally used in conducting monetary policy.

      How far the provision meets the current need

       I arrived at the ECB about 2 years after these requirements had  been
released and 7 months before the start of Monetary  Union.  I  must  confess
that I doubted many times in those early weeks whether statistics  could  be
ready in time to sustain  monetary  policy  decisions.  There  were  anxious
moments too in the late stages of finalising the monetary  policy  strategy:
would the requirements set out in 1996 correspond to the need  perceived  in
autumn 1998?
       I am now sure that the  decisions  made  in  1996  were  correct.  In
practice, one choice in autumn 1998 was  almost  automatic:  thanks  to  the
work of Eurostat and the national statistical offices in the context of  the
convergence criteria (with active involvement of  the  EMI),  there  was  no
plausible rival to the Harmonised Index of Consumer Prices  (HICP)  for  the
purpose of defining price stability.  I  am  aware  that  national  consumer
price indices are sometimes criticised for  overstating  inflation,  because
they take insufficient account of  quality  improvements  and  use  outdated
weights. While further development of the HICP is to come,  and  at  present
there is no satisfactory treatment of  expenditure  on  housing,  I  believe
that every effort has been made to apply the lessons  from  experience  with
national  consumer  price  measures.  The  other  choices  for   statistical
elements in the strategy were less obvious. In fact the  banking  statistics
reporting structure announced in 1996 proved able to  provide  the  monetary
aggregates and the counterpart analysis required, and - with a little  fine-
tuning - to meet the needs of a statistical basis for reserve  requirements,
details of which were also finalised in the autumn. We  were  thus  able  to
begin publishing monetary  statistics  only  a  few  days  after  the  final
decisions were taken (at the Council meeting on 1 December), and  were  able
to publish with some estimation last month back data on the  three  monetary
aggregates monthly to 1980, and a  note  urging  caution  on  users  of  the
earlier data.
       However, the monetary strategy avoids putting too much weight on  one
area or type of information. This is only partly  for  statistical  reasons.
The formation of the euro area is a  substantial  structural  change,  which
may in time affect monetary and financial relationships.  So  the  ECB  also
examines a range of economic data for the light they shed on the  assessment
of the economic situation and, in particular, prospects for  inflation.  The
editorial and economic developments sections of the Monetary  Bulletin  show
the way the ECB draws  on  this  information;  the  statistical  information
itself is set out in tables in the statistical section.  Thus,  in  addition
to money and credit and the HICP, the editorial typically  touches  on  GDP,
industrial  output,  capacity  utilisation,  orders,  the   labour   market,
business and consumer confidence, costs and  prices  other  than  the  HICP,
earnings and wage settlements, fiscal  positions  -  naturally  placing  the
emphasis on what are judged to be the most  important  developments  at  the
time. All these areas were covered by the statement of requirements made  in
1996.
       I do not need to say that, at present, an accurate assessment of  the
economic situation in the euro area is of vital  importance.  The  editorial
section of the March Bulletin concludes that the overall outlook  for  price
stability remains favourable, with no major risk that  HICP  inflation  will
exceed 2% in the near  future,  but  there  is  nevertheless  a  balance  of
conflicting influences. To reach this judgement, the Bulletin  assesses  the
latest GDP data (slower growth in the provisional Eurostat figures  for  GDP
in the 4th quarter of 1998;  declining  manufacturing  output),  the  labour
market  (unemployment  falling  slightly;   some   signs   of   rising   pay
settlements),  and  confidence  indicated  by  opinion   surveys   (business
confidence  weak;  the  consumer  mood  rather  optimistic).  The   economic
developments section supports the overall conclusion, and analyses  in  more
detail price and cost developments and of  output,  demand  and  the  labour
market. It concludes with analysis of the fiscal position in the  euro  area
in 1998, and a preview based on fiscal plans for 1999.  I  am  drawing  your
attention to this to show the  variety  of  material  supporting  the  ECB's
assessment of the economic and financial position  and  prospects.  Although
we pay particular attention to certain  items  -  the  monetary  statistics,
with an emphasis this time  on  influences  contributing  to  recent  faster
growth, and to the rather rapid growth of credit, and the HICP - we draw  on
a wide range  of  information  in  a  continuous  monitoring  exercise.  The
establishment of an institution responsible for monetary policy in the  euro
area has caused a fundamental change in the use of macroeconomic  statistics
at European level, very much as anticipated by  the  Implementation  Package
nearly 3 years ago.

      Priorities for further improvement of statistics

       I would like to take this opportunity to  thank  Eurostat  for  their
efforts to improve the quality  and  comparability  of  economic  statistics
relating to the euro area, and to deliver  them  to  the  ECB  on  a  timely
manner. They have given this high priority and much progress has  been  made
in the last year or so. Further improvement will come with the  introduction
of  the  new  European  System  of  Accounts  [ESA95]  starting  next  month
(although  we  must  expect   some   temporary   confusion   following   the
introduction  of  a  new  system).  Experience  suggests  that   substantial
statistical changes initially bring classification  problems.  Although,  of
course, provision has been made  for  back  data  to  be  available  on  the
closest possible approximation to the new basis, we must  also  expect  some
discontinuity in important series. Implementation of last year's  short-term
Statistics Regulation  will  bring  improvements  across  a  wide  range  of
conjunctural statistics not covered by ESA95. There are also initiatives  to
improve labour market statistics. With Eurostat,  who  are  responsible  for
all these areas of statistics at European level, we do our best in  the  ECB
to promote better data. Perhaps I should underline our support here for  the
priorities established  last  year  by  a  working  group  of  the  Monetary
Committee (the current Economic and  Financial  Committee),  in  which  Yves
Franchet and two of my ECB colleagues participated (Peter Bull and Gert  Jan
Hogeweg):  in  addition  to  quarterly  GDP  and   short-term   conjunctural
statistics, these were government finance statistics, data relating  to  the
labour market (including labour costs), and  the  balance  of  payments.  At
present the lack of comparable national statistics during the course of  the
year makes it difficult to monitor the  fiscal  stance  in  the  area  as  a
whole, and so to assess the balance of fiscal and  monetary  policy.  Better
labour market statistics are important, not only for  the  ECB's  assessment
of possible inflationary pressure, but also to improve understanding of  the
structure of labour markets in  our  countries,  and  the  rigidities  which
impede the achievement of fuller employment. Balance of payments  statistics
- a shared responsibility of the  ECB  and  Eurostat  at  European  level  -
require a new approach in compiling data for the euro area as  a  whole.  We
intend to publish the first monthly data for the  euro  area  following  the
new methodology next month, and to begin joint publication  of  a  quarterly
euro-area balance of payments with Eurostat in the  summer.  But  there  are
deeper questions about future needs for balance of  payments  statistics  in
the new circumstances which are currently being addressed. Principally,  the
question arises of the usefulness for policy purposes  of  national  balance
of payments statistics for Member States participating  in  Monetary  Union.
There is no question, of course, that certain data in this area  are  needed
within the ESA95 framework of national and financial accounts.

      The organisational, legal and technical infrastructure

       I  have  talked  mainly  about  statistical  requirements  and  their
provision, but this is only part of the story. The Treaty  (specifically  in
Article 5 of the Statute of the ESCB and the  ECB)  clearly  envisaged  that
the ECB  would  perform  statistical  functions,  assisted  by  and  in  co-
operation with national  central  banks,  other  national  authorities,  the
Commission  (meaning  in  this  context   in   particular   Eurostat),   and
international organisations. A large part of the  preparatory  work  carried
out by the EMI consisted of sorting out who would do what, avoiding  so  far
as possible duplication, wasted effort and  conflicting  data,  and  keeping
the   whole   development   consistent   with   international    statistical
conventions. Much of this had to  be  framed  in  legal  instruments,  which
would complete the statutory  framework  provided  by  the  Treaty  and  the
ESCB/ECB Statute. Although work on an EU Council Regulation  concerning  ECB
statistics began as early as 1996, the Regulation  could  not  be  finalised
until last  autumn  and  the  ECB  could  not  adopt  legal  instruments  on
statistics in advance of that event - much work in this area  therefore  had
to be done at the last minute.
       Information Technology is another of my responsibilities at the  ECB.
I am  glad  to  say  that  essential  elements  of  our  data  transfer  and
statistical processing systems were in place  when  I  arrived,  or  brought
into operation soon afterwards. But here, too, there  is  room  for  further
improvement - the EMI and the ECB in these early months have had so much  to
do in relation to the resources available that, broadly speaking,  only  the
essentials have been provided so far.

      Conclusion

       "Nothing is more important for monetary policy than good statistics."
The formation of Monetary Union has shifted the  focus  of  interest  on  to
data covering the euro area  as  a  whole.  This  has  required  substantial
changes to statistics, which need time to  settle  down  and  are  some  way
short of completion. At the same time, the adoption of the  single  currency
is itself a massive structural change. This will surely affect economic  and
financial relationships and make any  data  harder  to  interpret,  although
these deeper effects may occur over a period and take some  time  to  become
apparent. What  is  clear,  however,  is  that  the  ECB  must  take  policy
decisions and explain them publicly in terms of the data available  relating
to its policy responsibility. What we continue to strive to do, through  our
own efforts and with the help of Eurostat, is to improve the quality of  the
data underlying policy decisions, which are so important in  gaining  public
understanding and acceptance for them.

                                     ***


                The tasks and limitations of monetary policy

                     Speech delivered by Christian Noyer
                Vice-President of the European Central Bank,
         at the Volkswirtschaftliche Tagung of the Oesterreichische
                                Nationalbank,
                          on 10 June 1999 in Vienna


      Ladies and Gentlemen,

       It is a pleasure for me to be here in Vienna today and I should  like
to  start  by  thanking  the  conference  organisers  for  giving   me   the
opportunity to elaborate on the tasks and limitations of monetary policy.
       This topic is extremely important. Looking back over the  history  of
economic thought, it is clear that the perception of  what  monetary  policy
can do and what it cannot or should not do has  changed.  This  has  clearly
shaped the role  of  monetary  policy  in  economic  policy.  In  the  1960s
economic theories suggested  a  long-run  trade-off  between  inflation  and
output. These theories provided the intellectual basis for policy-makers  to
pursue  monetary  policies  biased  towards  higher  inflation.   The   high
inflation experience of the 1970s together with  new  theoretical  findings,
especially on the role of expectations, led policy-makers  to  move  towards
lowering and stabilising inflation.
       Theoretical considerations as well as empirical evidence over several
decades suggest that high rates of inflation are clearly unhelpful -  indeed
detrimental - to growth and employment in the long term. A large  number  of
economic arguments point to the benefits of  price  stability  for  economic
growth and employment prospects.  Stable  prices  eliminate  economic  costs
such as those arising from unnecessary  uncertainty  about  the  outcome  of
investment decisions, the distortionary effects on the  tax  system,  rising
risk  premia  in  long-term  interest  rates  and  the  reduced   allocative
effectiveness of the price and market  systems.  To  quote  Alan  Greenspan,
chairman of the United States Federal Reserve, "Price stability is  achieved
when the public no longer takes account of actual or  prospective  inflation
in its decision-making." Monetary policy must take  into  account  the  fact
that the horizon for decisions by economic agents  is  rather  long-term  in
nature. By  guaranteeing  price  stability,  monetary  policy  supports  the
efficient functioning of the price mechanism,  which  is  conducive  to  the
allocation of scarce resources. Price stability  is  a  means  of  promoting
sustainable  economic  growth  and  employment  creation  and  of  improving
productivity levels and living standards.
       Against this background, the predominant view has  emerged  that  the
best and most lasting contribution that monetary policy can  make  to  long-
term economic welfare in the broader sense is  that  of  safeguarding  price
stability. Central banks throughout  the  world  have  been  moving  towards
adopting long-term price stability as their primary goal.
       In order to achieve this goal most  successfully,  independence  from
political interference and a clear legal mandate for price stability are  of
the utmost importance. A lack of central bank independence and an  ambiguous
mandate can easily force central banks to  focus  on  the  short  term  and,
thus, fail to adopt the forward-looking,  medium-term  orientation  that  is
crucial for a successful monetary strategy.
       All these issues were taken into consideration by policy-makers  when
drafting the Treaty establishing the European Community  and  designing  the
blueprint for the European Central Bank. Both central bank independence  and
an unequivocal commitment to price stability are  therefore  tenets  of  the
monetary policy framework enshrined in the Treaty. There  can  be  no  doubt
that the European Central Bank (ECB)  is  determined  and  well-equipped  to
tackle its main task, namely, that of maintaining  price  stability  in  the
euro area  over  the  medium  term.  It  will  thereby  make  a  significant
contribution to the achievement of other Community objectives such  as  high
employment and sustainable non-inflationary growth. In this connection,  the
pursuit of sound macroeconomic  policies  by  the  EU  Member  States  would
considerably facilitate the task of the  ECB.  The  room  for  manoeuvre  in
monetary policy and the degree of success  in  terms  of  maintaining  price
stability are crucially dependent on the support of  sound  fiscal  policies
and responsible wage settlements in the euro area.
       The Treaty  establishing  the  European  Community  states  that  the
primary objective of the European System  of  Central  Banks  (ESCB)  is  to
maintain price stability. Without prejudice  to  this  objective,  the  ESCB
shall support the general economic policies in the  European  Community.  It
shall operate in a manner that is consistent with the establishment of  free
and competitive markets. The Treaty states explicitly  how  the  ESCB  shall
set its priorities. Price stability  is  the  first  goal  of  the  monetary
policy of the Eurosystem, and a  contribution  to  the  achievement  of  the
other objectives of the European Community can only be made if this  primary
objective  is   not   compromised.   However,   there   is   ultimately   no
incompatibility between  maintaining  price  stability  and  pursuing  these
other  objectives.  By  maintaining  price  stability,  the  ECB  will  also
contribute to the achievement of other Community objectives.
       Of course, the ECB is concerned about the intolerably high  level  of
unemployment in Europe, but we should realise  that  the  role  of  monetary
policy in reducing unemployment in Europe can only  be  very  limited.  Many
empirical studies show  that  the  high  unemployment  rate  is  mostly  the
consequence of structural rigidities within the European labour and  product
markets. The European unemployment rate has, indeed, been  high  and  stable
over the business cycles  in  the  past  decade.  Only  structural  reforms,
preferably of a comprehensive nature, can therefore  tackle  the  underlying
impediments to employment growth.
       The monetary policy of the Eurosystem is geared towards the euro area
as a whole and, thus, cannot take into account purely national and  regional
developments. The cyclical positions of  participating  countries  have  not
yet completely converged, although, with the single currency in place,  some
national  differences  may  disappear  over  time.  This  requires  national
policies and labour and goods markets to be increasingly flexible  in  order
to be able to  respond  effectively  to  economic  shocks.  Well-functioning
labour and product markets are therefore  needed  to  allow  adjustments  to
wages and prices to be made if local economic conditions change.
       Budgetary policies play a major role in conditioning monetary policy.
National fiscal authorities have to  demonstrate  their  commitment  to  the
maintenance of price stability in the euro area over  the  medium  term.  In
this context, the Stability and Growth Pact is a crucial  element.  Its  aim
is to encourage the pursuit of disciplined and sustainable  fiscal  policies
by the participating EU Member States and  the  prospective  members.  Sound
public finances, with lower public debt and tax  burdens,  contribute  to  a
lowering of  long-term  interest  rates,  reduce  uncertainty  and  increase
private capital formation. They not only facilitate  the  task  of  monetary
policy  with  regard  to  the  maintenance  of  price  stability,  but  also
strengthen the conditions for sustainable  growth  conducive  to  employment
creation. Conversely, unsound fiscal policies  tend  to  increase  inflation
expectations and force monetary policy to keep short-term rates higher  than
would otherwise be necessary.
       The single monetary policy has to be conducted independently  of  the
short-term  political  considerations  of  national  governments.  In   this
context, the ECB cannot commit itself  to  move  its  interest  rates  in  a
certain way in response to  specific  actions  or  plans  of  other  policy-
makers. Monetary policy has  to  take  into  account  the  overall  economic
situation to assess the  risks  to  price  stability.  Direct  ex  ante  co-
ordination with  fiscal  authorities  might  endanger  meeting  the  primary
objective and would set the  wrong  incentives  for  the  conduct  of  sound
macroeconomic policies. This does not, of  course,  exclude  a  constructive
dialogue between the Eurosystem and  government  authorities  which  clearly
respects the independence of the ECB.
       When dealing with one of the major  world  currencies  and  with  the
currency of one of the two main world economies, it  is  inconceivable  that
price stability might be maintained by setting an exchange  rate  target  as
an intermediate objective.  However,  external  developments  including  the
exchange rate are taken into account in accordance  with  our  strategy,  as
they may have an impact on domestic economic  developments  and  thereby  on
price stability. Referring to recent  exchange  rate  developments  in  this
context, it is appropriate for me to quote the President of the ECB, Dr.  W.
F. Duisenberg, who recently said that "the euro is a currency  firmly  based
on internal price stability, and therefore  has  a  clear  potential  for  a
stronger external value".
       The absence of exchange rate targets for  the  euro  vis-а-vis  other
major currencies  should  not  be  misunderstood.  For  smaller,  very  open
economies, fixed exchange  rates  may  be  a  very  reasonable  choice.  The
Austrian example is one of the most prominent in this  respect.  By  pegging
the Austrian schilling to the  Deutsche  mark  for  over  twenty  years,  it
proved possible to import credibility and price stability. The  increasingly
close pegging of the Austrian currency to the currency of its  main  trading
partner was, among other features of the Austrian policy  mix,  the  driving
force behind the economic convergence process in the run-up to  Stage  Three
of Economic and Monetary  Union  (EMU).  The  credibility  of  the  Austrian
exchange rate target was also underpinned by  an  income  policy  aiming  at
relatively high real wage flexibility and a  fiscal  policy  geared  towards
consolidation. All in all, the Austrian model, which set  out  to  guarantee
stability in nominal and real terms, has turned out to be very successful.
       The example given by past Austrian experience  is,  I  believe,  very
valuable. It shows that the achievement of sustainable convergence with  the
euro area can be assisted by means of  an  exchange  rate  target.  The  new
Exchange Rate Mechanism of the European Union, ERM II, may  play  a  similar
role for those current and prospective EU Member States which have  not  yet
joined Stage Three of EMU.
       The achievement of price stability is also of high importance for the
stability of the financial system. The financial system  of  the  euro  area
showed a high degree of stability during last  year's  period  of  financial
turbulence as well as during the rather dramatic structural shift  connected
to the changeover to the  euro.  At  the  ECB,  we  play  our  part  in  the
evolution of the euro area financial system  by  providing  it  with  stable
monetary conditions. By creating  an  environment  of  price  stability,  we
allow private sector agents to focus their attention on the  questions  that
are most relevant to their activities and to take advantage of  benefits  of
this  stable  environment,  such  as  the  lengthening  of  their   planning
horizons. There is a lot  of  empirical  evidence  that  safeguarding  price
stability is the optimal contribution that a central bank can  make  to  the
maintenance of financial stability and that those  two  goals  are  actually
complementary.
       I should like to conclude by saying that the main contribution of the
single monetary policy to the welfare of the people in the  euro  area  will
be the maintenance of price  stability  in  the  medium  term.  The  ECB  is
determined  to  tackle  this  task  and  is  well-equipped  to  do  so.  Our
conviction is that the economic performance of the euro  area  will  benefit
significantly from price stability.  This  will  ultimately  facilitate  the
achievement  of  those  objectives,  which  underlie  the  general  economic
policies of the European Community and the  individual  governments  at  the
national level. However, the economic problems in the euro  area  cannot  be
tackled by monetary policy alone. We have to be realistic  about  the  goals
which can be achieved by monetary  policy.  Neglecting  the  limitations  of
monetary policy  and  promising  too  much  could,  in  the  long  term,  be
detrimental to the establishment of  a  stability  culture  in  Europe,  and
could also lead to delays in implementing  the  economic  reforms  that  are
crucial to achieving high growth and employment.

                                     ***

                            European Central Bank
                               Press Division
                 Kaiserstrasse 29, D-60311 Frankfurt am Main
               Tel.: 0049 69 1344 7455, Fax: 0049 69 1344 7404
                        Internet: ссылка на сайт удаленаcontact://www.ecb.int
            Reproduction is permitted provided that the source is
                                acknowledged



	

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