SPEECH/00/23
Pedro Solbes Mira
Member of the European Commission
Economic and Monetary Affairs
Beginning the second year of the euro
International Bankers Forum
Berlin, 27 January 2000
Ladies and Gentlemen,
I welcome the opportunity to speak to you today about the experience of the first
year of EMU and the challenges that lie ahead. To create the European Monetary
Union was a historical decision in which Germany played a leading role.
I know that economic and financial developments in the euro area have been
monitored with great interest by the international banking community - and not least
here in Germany. Especially in the German debate about EMU, leading academic
experts had warned against the risk of inflation and irresponsible fiscal policy.
I would like to begin my remarks by offering you my interpretation of events since
the launch of the euro. I will then look to the future and highlight two of the major
challenges in EMU: the need for enhanced policy co-ordination among euro-area
Member States and the enlargement of the Union.
Achievements in the first year of EMU
Changeover to the euro a total success
The introduction of the euro on 1 January 1999 was a total success. Meticulous
preparation - with which the European Commission was heavily involved - ensured
a very smooth changeover to the new single currency. Earlier predictions of
financial meltdown proved to be without substance.
In particular, market
speculation linked to a possible “last realignment” of national currency exchange
rates did not materialise.
A predictable depreciation of the euro
The almost seamless transition to the euro was a major confidence boost for
European financial markets and the euro began its existence at a relatively high
exchange rate against the other major currencies. With hindsight, it is not
surprising that the euro experienced an orderly depreciation in the course of 1999.
The evolution of the euro exchange rate in 1999 can be explained by two main
factors.
 First, the euro was affected by the international crisis of 1997 and 1998. Initially,
the uncertainty in international financial markets favoured the euro because the
US economy and financial system appeared to be more exposed to the crisis
than those of Europe. However, as international financial conditions stabilised
early in 1999, many investors decided to return to US dollar assets.
 Second, the depreciation in the euro was a response to the relative cyclical
prospects for the euro-area economy. While growth prospects were seen to
improve in the United States early in 1999, there was a downward revision in
growth prospects for the euro-area economy - mainly due to difficulties in
Germany and Italy. Cyclical factors also mainly explain the movement in the
euro/yen exchange rate. The release of strong Japanese GDP data in early
June triggered a sharp appreciation in the yen, as investors moved back into
Japanese assets.
Despite an improvement in the outlook for the euro-area economy since mid 1999,
the euro has remained under pressure because of the remarkably robust
performance of the US economy. However, as the acceleration in the euro-area
economy materialises in the coming months, there is potential for appreciation in
the EURO.
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Brightening prospects for the euro-area economy
The prospects for the euro-area economy are clearly favorable. Economic growth
has strengthened during the year and in the last quarter it reached 2¾ per cent. As
the EU enjoys sound economic fundamentals, an appropriate and credible policy
mix and a brightening external environment, real GDP growth in the euro area - and
the wider EU - should accelerate to 3% this year and next. The unemployment rate
should fall from its unacceptably high level of above 9% in 1999 to around 8% in
2001. The inflation rate is expected to be around 1.5% this year and next, while the
external surplus of the EU should remain at around 1% of GDP. All in all, we expect
a steady recovery in the euro-area economy, with equally steady gains in
employment.
Price stability to be maintained.
It is unfortunate that so much attention has been paid to short-term developments in
the euro exchange rate. The stability of a currency has to be assessed in terms of
both its internal and external performance. In Germany too, internal stability - as
measured by a durably low inflation rate - has always been given priority over
external stability, i.e. the exchange rate. For example, the dramatic rise in the dollar
against the DEM in the 1980s was not seen as calling into question the
Bundesbank’s anti-inflationary credibility. Therefore, what really matters for the
strength of the euro in the long term is the underlying inflation performance of the
euro area. In this respect, the record of the euro in its first year is highly
encouraging.
The EURO-area is enjoying very low inflation by historical standards. For much of
1999, the euro-area inflation rate remained close to 1% - a performance not
achieved in the previous thirty years. This favourable inflation performance and the
ECB’s anti-inflationary credibility have allowed monetary policy to react flexibly to
economic developments. The ECB loosened monetary policy in the early months of
1999, when the balance of inflation risk was clearly on the downside. As the risk of
inflation pressure increased later in the year, the ECB tightened pre-emptively.
However, the Commission's autumn 1999 forecast does not indicate any
acceleration of inflation the rate over the next two years. Inflation is expected to
remain around 1½%, i.e. comfortably within the target range of the ECB.
Sound economic framework based on policy co-ordination
EMU establishes a framework for sound economic policies. This framework
comprises an independent monetary policy devoted primarily to price stability,
disciplined fiscal policies governed by mutually-agreed rules and a set of
procedures to enhance structural reform. In addition, a smoothly functioning EMU
presupposes a significant degree of economic policy co-ordination among the euroarea Member States. The recent Helsinki Council confirmed the need of coordination in fiscal policy and structural reform. At centre of these co-ordination
efforts are the Broad Economic Policy Guidelines, which provide guidance on the
role of fiscal policy and structural policies in the Member States.
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Disciplined fiscal policies
With respect to fiscal policy, the EMU framework requires that fiscal policy should
be conducted so as to be consistent with monetary policy in pursuit of its pricestability objective. This is the motivation behind the Stability and Growth Pact. The
Pact requires Member States to adhere to strict fiscal discipline, while allowing them
to respond – without inflationary risk – to cyclical developments in their national
economies. All of the Member States have made significant progress in reducing
their public sector deficits.
For the euro zone area as a whole, the public sector deficit was about 1½% of GDP
last year and we are confident that the deficit will fall below 1% of GDP this year. A
number of countries have achieved the medium-term objective of a budget surplus
or near-balance. Most of the other countries need to pursue fiscal consolidation
efforts but should be in a position to reach this objective at the latest in 2002. Given
the historical experience of divergence in terms of budgetary performances, the
consensus about the role of fiscal policy and the optimal policy mix in EMU is a
major achievement.
This consensus, together with continuous budgetary
surveillance should avoid any risk of irresponsible fiscal policy, a risk which played
an important role in German public opinion.
Structural reform to improve employment creation
With the entry into force of the Amsterdam Treaty, the Commission now has a
pivotal role in developing a co-ordinated strategy for employment. Although,
ultimate responsibility for employment policies will remain with Member States, a
process of fruitful dialogue about employment issues has resulted in a set of
employment guidelines for the Member States. Moreover, given the important role
of wages for economic prospects, a “Macro-Economic-dialogue” was set up under
German presidency. It brings together all macro-economic policy actors, including
social partners for biannual discussion aiming at improving mutual understanding
and trust
The integration of financial markets
The integration of EU financial markets will be one of the major factors fostering the
efficiency of our economies. The introduction of the euro has quickly had profound
effects across the spectrum of European financial markets. It is promoting the
creation of deep, broad and liquid markets from the money markets, through to
fixed income and equity markets. Indeed EMU has come about at a time of
dramatic changes in the financial field as a result of globalisation, deregulation, and
technological progress.
The European banking sector is going through a significant restructuring and
consolidation process. The introduction of the euro has created an increasingly
competitive environment for the EU banks. It has eliminated the competitive
advantage for domestic players associated with the existence of national currencies
and it is fostering securitisation and disintermediation through the development of
much broader and liquid security markets. One of the most visible responses to
such pressures is the recent acceleration in the pace of consolidation of the
European banking sector with an increasing involvement of large national players.
Although at this stage the consolidation process remains largely a national
phenomenon, the general view is that cross-border consolidation is likely to
accelerate in the coming years.
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The Commission has for a long time stressed that a truly efficient, well integrated
cross-border market will greatly boost the prospects for growth and development
across the EU. Some beneficial effects are already visible. National financial
markets are being forced to become more efficient. New business opportunities are
appearing for the financial services industry. A broader range of innovative and
competitive financial products and services is being offered to consumers. Over
time, access to capital should become easier and the cost of capital lower, in
particular for SMEs.
The competition among financial intermediaries - brought about by the new
currency - is certainly significant in promoting the integration and efficiency of our
capital markets, but it is also not enough. There are many areas where the
introduction of the single currency needs to be supplemented by further action. I
would like to mention the elimination of remaining obstacles to integration of EU
financial markets, the need to ensure full application of competition rules and the
creation of an appropriate framework for ensuring financial stability.
The Action Plan for Implementing the Framework for Financial Markets
launched in May 1999 by the Commission sets out priorities and proposes a
timetable for legislative and other measures to tackle three strategic objectives: first,
ensuring the completion of the single market for wholesale financial services and
hence the removal of remaining barriers to raising capital on an EU-wide basis;
second, creating open and secure retail markets to promote enhanced information,
transparency and security for the cross-border provision of retail financial services;
and thirdly, ensuring fully adequate prudential rules and supervision for integrated
financial markets. Work is well underway in implementing this action plan.
Finally the creation of an appropriate framework for financial stability must be a
priority. The emergence of deeper and more liquid securities markets should lead to
a fall in market risk and liquidity risk. This, coupled with the improved efficiency of
financial markets and of financial institutions, should in general be beneficial for
financial stability.
We must recognise, however, that the ongoing restructuring and consolidation
processes affecting the financial sector, together with technological developments
and the globalisation of the markets, present new challenges for financial stability
and for regulation and supervision of financial markets. The development of panEuropean institutions and the blurring of boundaries between financial
intermediaries and markets poses new challenges to regulation and supervision.
Increasing attention will have to be paid to co-operation and co-ordination between
authorities responsible for supervision, regulation and the stability of the financial
system, cross-border and across sectors.
International repercussions of EMU
It is evident that the single currency will have international repercussions which go
beyond globalized financial markets, e.g.:
 EMU will contribute to a more symmetric and a more stable International
Monetary System (IMS).
Some countries, in particular our closest neighbors of Central and Eastern Europe
which applied for membership in the EU, are most directly affected.
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The state of play on enlargement
As you know, the EU has already started negotiations with Cyprus, the Czech
Republic, Estonia, Hungary, Poland and Slovenia. In the Helsinki European Council
in December 1999, further decisions have been taken. They are:
 The acceptance of Turkey’s application to the EU. Turkey is now a candidate
State;
 The political issue concerning Cyprus’ condition for future accession has been
clarified;
 The start of negotiations with the five candidates countries with which
negotiations had not yet started: Bulgaria, Latvia, Lithuania, Romania, Slovakia
and with Malta;
 In addition, the Council has declared that the Union should be in a position to
accept new Member States from the end of 2002.
As you know, European Copenhagen Council in June 1993 formulated the 3 criteria
for membership, that normally referred to as Copenhagen Criteria:
 Political – stability of institutions guaranteeing democracy, the rule of law;
human rights and respect for and protection of minorities
 Economic – the existence of a functioning market economy, as well as the
ability to cope with competitive pressures and market forces within the Union
 Institutional – the ability to take on the obligations of membership (acquis
communautaire), inc. Adherence to the aims of political, economic and monetary
union.
In Helsinki, the Council has decided to open accession negotiations with all
countries which satisfy the political criteria, even if it is unclear in what time-span
they will be able to fulfil the economic criteria. This does not mean that the
relevance of the economic criteria in the medium term perspective of accession has
diminished. Candidate countries will still have to meet these criteria before
Accession. However, they can gradually start negotiations to apply the community
law. By itself, this could improve the perception that investors and markets have of
candidate countries as they move closer to implementing the community rules.
Candidate countries are not expected to join the euro area directly upon accession.
Therefore, the convergence criteria for the monetary union are not accession
criteria. In the run-up to accession, the candidates should concentrate primarily on
the process of structural, administrative and economic reform. The adoption of the
single currency can only be the final step in what has been, and will remain, a
lengthy process of economic integration with the EU.
In the more specific domain of the exchange rate stability, some of these countries
may well need, a degree of exchange rate flexibility to accompany a successful
catching up process. For some time to come, candidate countries will exhibit
differences in the average price level and price structure with the EU implying
transition-related relative price adjustments.
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Candidate countries will undergo some real exchange rate variability in the years
ahead and could experience real exchange rate appreciation, as they continue to go
through transition reforms. This brings out a possible policy trade-off-between
exchange rate flexibility and inflation in the run-up to accession.
The process of adoption of the euro for these countries will be a three stage
process: a pre-accession phase between now and accession during which progress
in the transition to well functioning market economies is reinforced, made
irreversible, and in which macroeconomic stability sustained; an intermediary phase
between accession and the adoption of the euro, where full participation in the
Single Market is taking place together with progressive monetary integration
towards the euro zone and through participation in the exchange rate mechanism
(ERM 2); the final euro phase. When that moment arrives, the decision will be
taken on the same basis as for the euro-eleven. Participation of new Member
States in the euro area will be decided following the examination of the achievement
of a high degree of sustainable convergence.
In my view, the approach we have followed to the introduction of the euro in 11
Member States and the approach to the enlargement of the European Union have
much in common. They are both progressive and realistic, with well-defined stages,
intermediate steps and goals to be met, towards an irrevocable objective. In the
case of candidate countries there is a dual objective: first the transformation of their
economies and completion of transition in order to join the EU and then the
adoption of the euro once they are fully integrated into the Internal market and
operating according to the EU rules.
Final remarks : Improving public awareness
Let me conclude.
The euro has become reality in international financial markets and it has a major
impact on economic policy making among participating countries. It also plays a
strategic role in the policy design of our neighbouring countries. However, the
average citizen, but also small business are not yet using the EURO significantly.
Preparation and information has to be completed until the end of next year when
national coins and notes are loosing their function as legal tenders.
The Commission, together with the Member States, has been working on this since
1996 but we still have a long way to go before all our citizens are adequately
informed. Therefore, in the coming weeks, I will be announcing a communications
campaign to cover the next two years.
In 2000 we will target enterprises most intensely so that they can all take the
necessary action in time. The following year we will intensify the campaign in favour
of the general public and its more vulnerable sections. While the Commission
expects to commit significant resources to the campaign, the information campaign
has to be supported by the Member States. The effort will be helped by the
European Central Bank which will itself be carrying out an intensive campaign in
relation to the notes and coins.
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The banking sector has a crucial role in this. Banks are a vital channel of
information, both to smaller firms and to the private citizen. The relationship of trust
between banker and client and the personal contacts enable banks to contribute
considerably, to the feeling of confidence into the euro.
I hope that my comments could convince you that, based on the experiences of the
first year, we have all the reasons to remain confident about the successful future of
the EURO.
Thank you for your attention.
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