Ladies and gentlemen, it is no exaggeration to state that the establishment of the European System of Central Banks - or ESCB - at the latest in about eight months' time, and of the euro fourteen months from now, ranks among the most significant developments in the international monetary system during the post-war period.
My task today is to describe the profile of the new institution which will be in charge of managing the euro. It is not an easy task, you will concur, because this institution does not yet exist. It is being built. What I intend to do is to examine the main pillars on which the institution is being built. I will distinguish three main pillars: first, the ESCB blueprint as contained in the EC Treaty; second, the substance given to that blueprint by the EMI's preparatory work; and third, the continuity with the European central bank experience.
2. The ESCB blueprint: key elements
The key elements of the blueprint for the ESCB were spelt out in 1989, when the so-called Committee for the Study of EMU - better known as the Delors Committee - submitted its report to the European Council meeting in Madrid. The sixteen members of this Committee comprised all twelve EU central bank Governors at that time, acting in their personal capacity. (Incidentally, both the previous as well as the current EMI President sat on that Committee.)
The Committee advocated the establishment of an independent central banking authority to conduct the single monetary policy geared towards achieving price stability. Its key characteristics, including its federal structure, the role of the national central banks within that structure and the relationship between independence and accountability, are contained in one single paragraph (paragraph 32) of the Committee's 1989 report, the thrust of which has remained unchallenged ever since.
The draft Statute of the ESCB and the ECB, which the Committee of Governors subsequently prepared, was by and large adopted at the Intergovernmental Conference. Its core elements are reflected in the Treaty:
Article 105 states that the primary objective of the ESCB shall be to maintain price stability;
Articles 107, 108 and 109a deal with various aspects of the independence of the ESCB;
Article 109b (3) refers to the accountability of the ESCB.
I would like to say a few words to clarify these three key features of the ESCB Statute.
First, let me start with the primary objective of price stability. I do not need to justify the importance of this objective for monetary policy. It is now widely agreed - not only in the central banking community but also in the academic world and among financial market practitioners - that only a monetary policy geared towards price stability can create the conditions for sustainable economic growth. An important element that may be worth mentioning, nevertheless, is that for the ESCB the objective of price stability concerns the whole euro area. It is the price level of the whole euro area that the single monetary policy will aim at stabilising. There will not be, and there could not be, differentiated policies for each region or country in the euro area, depending on the inflationary conditions prevailing there.
The second important feature of the ESCB Statute is its independence. Independence is established in four main areas: institutional independence, personal independence, functional independence and financial independence.
To summarise, institutional independence protects the ESCB from interference by other bodies in the pursuit of its statutory objectives. Personal independence provides the members of the ESCB decision-making bodies with the necessary security of tenure and avoids conflicts of interest with a view to ensuring that they can be in a position to fulfil their duties. Functional independence aims at providing the ESCB with all the necessary instruments to perform its functions. Finally, financial independence is established with a view to ensuring that the ESCB can avail itself autonomously of the appropriate economic means to fulfil its mandate.
In all these areas, it is recognised that the ESCB has been granted a high degree of independence, consistent with the desire of the political authorities that signed the Maastricht Treaty to put the ESCB in the best possible position to achieve its primary objective. The Treaty also requires that the Statutes of the national central banks are adapted to conform with that of the ESCB. This process is under way and the Statutes of the NCBs, even those that were recognised as being among the most independent, are being upgraded to satisfy the ESCB's requirements.
The ESCB will also have clear reporting commitments. The Treaty describes all the requirements, in particular with respect to the European Parliament, the Council and the European Council. These define the context in which the ESCB will give an account of its own activities and performance with respect to the achievement of its primary objective. Beyond these very precise reporting procedures one should not overlook the fact that, ultimately, the ESCB will be accountable to the European citizens on its ability to defend the purchasing power of their money holdings. If the ESCB does not perform a good job with respect to its primary objective, it will be penalised by the citizens, as savers, who will reduce their holdings of money balances and ask for higher returns to compensate for the depreciation of their currency. The strength of the currency is the ultimate judgement of savers on the performance of the central bank.
A final point that I would like to underline concerns the institutional relationship between the ESCB and the authorities in charge of economic policy in the Community.
The Treaty has provided for a number of communication channels between what one could call the political (or budgetary) and the monetary arms of the single currency area, meaning the Council and the ECB. This is perfectly compatible with the requirement of an independent central bank and I see no reason why the ESCB should try to avoid contact with those responsible for the general economic policies in the Community, which the ESCB will support, without prejudice to its primary objective of maintaining price stability. As a matter of fact, it is very important that an exchange of information and views takes place between the ECB and the ECOFIN Council. There already exist formal and informal communication channels for both sides to explain to one another the policy actions for which they are responsible.
3. The EMI's preparatory work in shaping the ESCB
Let me turn now to the technical side of the EMI's preparatory work in shaping the ESCB. In essence, this work revolves around two questions:
How will the ESCB achieve its final objective of price stability - in other words, which monetary policy strategy should it pursue?
How will it effectively implement the single monetary policy - in other words, to be efficient, which instruments and procedures should it employ?
With regard to the monetary policy strategy or, if you wish, the set of procedures according to which the ESCB will decide how to achieve its final objective of price stability, the decision will be taken once the ESCB has been established.
The EMI Council has considered several possible candidate strategies and ultimately narrowed down the number of options to two, namely monetary targeting and direct inflation targeting. Any further narrowing down was considered neither necessary nor possible at this stage. The EMI is now preparing the common key building blocks of both strategies so that a final choice by the ECB Governing Council - which does not necessarily have to be an "either/or" choice - can be made fully operational in the latter part of 1998. Having at its disposal a monetary policy strategy fully capable of being implemented by the end of next year is a key element for the credibility of the ESCB.
Communication with the general public will also be essential. It will involve the public announcement of a quantified definition of what the ESCB understands to be price stability; publication of specific targets and details of their derivation - against which its policy performance can be assessed; and the explanation of deviations from the target and concomitant policy responses by the ESCB. This will increase the transparency of the ESCB's actions and thereby enhance its accountability.
The second aspect concerns the practical implementation of the single monetary policy. The EMI has devised a set of instruments and procedures and a supporting framework which can be used in a decentralised way by the national central banks, whenever possible and appropriate, so that they can act as the operational arms of the System. Reliance on the infrastructure and operational experience built up by the national central banks will prove a valuable asset. Given that the ESCB needs to be cognisant of differences between financial market participants and structures in the EU, operating through the national central banks will ensure that it has the best possible knowledge of market conditions throughout the euro area.
It would not be useful for me to repeat here what has been described at length in various EMI publications on how the ESCB will conduct its business. You are certainly aware of the existence of the EMI's specification of the operational framework for the single monetary policy which was made public in January of this year. Following up on this work, the EMI last month published two documents which provide further details of how the decentralised operational framework will function in the areas of monetary policy and payment systems respectively. I am referring here to the General Documentation on ESCB monetary policy instruments and procedures and to the Second Progress Report on the TARGET Project.
To summarise, it is envisaged that the ESCB will mainly use open market operations to manage the liquidity situation of the market and steer interest rates; it will also offer two standing facilities, so as to enable banks to borrow or deposit reserves at the end of the day. The two facilities will bound overnight market interest rates and the interest rates applied to them will help signal the general stance of monetary policy. In addition, preparations are being made for an infrastructure that will allow the ESCB to impose minimum reserve requirements if the Council were to decide accordingly. It may serve the purpose of stabilising money market interest rates, creating or enlarging a structural liquidity shortage in the money market and possibly contributing to the control of monetary expansion.
What is crucial is that the system of monetary policy instruments will ensure that the Governing Council of the ECB is in a position to control the overall stance of monetary policy at all times, in conformity with the decision-making framework of the ESCB. Decisions will thus always be taken at the ECB, whereas implementation will, to the extent deemed possible and appropriate, be executed in a decentralised manner by NCBs.
To give you an example of this allocation of responsibilities within the ESCB, let us consider the conduct of the main refinancing operations of the ESCB, which will provide the bulk of refinancing to the financial sector and which will be executed through standard tenders. The tender announcement will be made by the ECB, via public wire services, and supplemented by announcements by NCBs via national wire services and directly to individual counterparties. Submission of bids will be organised at the level of the NCBs. Tender allotment, involving the addition of all bids received, will be decided at the level of the ECB. The tender results will be announced by the ECB, and the NCBs will directly certify the individual allotment result to all counterparties that have submitted bids. Settlement will be effected in the books of the NCBs. These procedures make maximum use of the operational experience of the NCBs, they rely as much as possible on the existing infrastructure at the national level and they allow for the participation of a broad range of counterparties under conditions of equal treatment. In sum, these procedures will permit a solid operational involvement by the ESCB, as it continues to use elements of well-tested national practices in combination with harmonised elements conforming to decisions taken at the level of the ECB's decision-making bodies.
4. Continuity with European central banking experience
The key question that is often put is: how will the ESCB take its decisions? How will it operate in the new environment in practice? It is often stated that the ESCB has no track record of its own and that it will have to establish its own credibility at the start. The impression is sometimes given that the ECB is created out of nothing. This is not correct. The creation of the ECB follows an evolutionary process that conditions not only its structure but also the way it will operate in practice.
Concerning its structure, there is clear continuity with the past. This pertains to both the status of the NCBs and to the monetary policy instruments and procedures that will be used by the ESCB, as I have already explained.
Concerning the way it will operate, there is no quantum jump here either. Let me just take as an example the recent official interest rate increases by a number of EU central banks. Given the lags with which monetary policy affects the price level, this move will produce its effect on the real economy after May of next year, when the list of initial participants in EMU is known and their bilateral conversion rates have been pre-announced. For this reason, it is essential that a high degree of monetary policy co-ordination is established so that the monetary policy conditions of the euro area in its initial phase are influenced by co-ordinated national central bank policies. The recent move is an example of such co-ordination. The same Governors who are conducting this co-ordinated monetary policy today will be members of the ECB Governing Council determining the single monetary policy in Stage Three. There is thus full continuity, although in a different institutional context, between the decision-making of today and that of the ESCB.
This seems to be confirmed by the behaviour of financial markets. Judging from long-term interest rates, market participants seem to be convinced that inflation will remain low in the euro area. Moreover, convergence of long-term interest rates towards the lowest level rather than the average indicates that expectations are of a strong euro, built on the credibility of the ESCB's single monetary policy.
Of course, such expectations are not only influenced by the prospect of a strong ESCB. There are other factors at work, such as:
- the continuing reduction of budget deficits;
- the prospective current account surplus of the euro area; and
- the potential role of the euro as a reserve currency.
In general, economic performance in the Community over the last few years has made very big strides towards convergence and this convergence has gone in the direction of the best possible performance, not the average. Inflation has been brought down to levels not seen since the 1960s; long-term interest rates have been converging to the German level, which itself is near the lower end of its observed historical range. Budget deficits have been declining at a slower pace, but, as the recent forecasts of the European Commission show, retrenchment is set to continue over the coming years, taking advantage of faster economic growth rates in Europe. The markets have fully understood these developments, which are reflected in European long-term yields.
Once Monetary Union is there, budgetary policy will be subject to the rules of the Stability and Growth Pact with its accompanying Council Regulations on speeding up and clarifying the implementation of the excessive deficit procedure and on the strengthening of surveillance in the Community. Further enhancements to economic policy co-ordination in Stage Three may still be forthcoming. I will not dwell on these matters any further as they are evidently outside the EMI's sphere of competence. Nevertheless, it is important to note that the contribution that a monetary policy geared to price stability can make towards balanced growth and employment will be significantly boosted when underpinned by other conditioning fiscal and structural policies. This will, in turn, enhance the standing of the ESCB.
5. Conclusion: a strong ESCB as a credible guardian of a stable euro
In conclusion, the Treaty already provided the blueprint of a solid ESCB able to achieve independently its primary objective. The EMI's preparatory work is seeing to it that this ESCB, acting as a credible guardian of a stable euro, is in the making, in conjunction with the other elements of a stability-oriented policy framework, outside the realm of monetary policy. I am therefore confident that this newly created central banking system, which has an ECB equipped with all the necessary euro area-wide expertise and which builds on the credibility of equally strong NCBs for the execution of its policy, will be able to achieve its objective. I am also convinced that the ESCB will enjoy the area-wide public support for the benefits to be derived from a low-inflation environment and it will go to great length to continuously "earning" that support by being transparant. The single monetary policy will thus be seen as making a valuable contribution to the achievement of the objectives of the Community./.
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