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.
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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 rise 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.