## Mr Noyer reviews first experiences with the euro
Speech delivered by the Vice-President of the European Central Bank, Mr Christian No the conference organised by Swedback in Stockholm on 26 May 1999.
I should like to start by thanking you for your kind invitation to speak here on the this conference organised by Swedbank. It is some five months now since the eur launched. The introduction of the euro has been accomplished successfully and the en technical and logistical challenges arising during the early days of monetary union overcome. The first months of the euro have been successful in both political and op terms. With the introduction of the euro, European integration has taken a large st as the new millennium approaches.
The euro plays an important role in the euro area and beyond. Just after its launch the euro already featured on all major financial markets around the globe. Currency regularly carried out in euro and shares are denominated in euro on most Europea exchanges. Moreover, the euro has attracted new international bond issues as the cu denomination. In some ways, the introduction of the euro may justify expectations overall efficiency gains. For citizens living in the euro area, two obvious gains reduction of transaction costs and increased transparency across countries, comparisons between goods sold in different countries are made easier.
The Governing Council of the ECB is the central decision-making body in charge of mon policy for the euro area. The Treaty on European Union - the Maastricht Treaty - ass ESCB the primary objective of maintaining price stability in the euro are implementation of monetary policy decisions taken centrally by the Governing Counci with the Eurosystem, comprising the ECB and the national central banks (NCBs) o member states which have adopted the euro in stage three of economic and monetary u The respective operational tasks are to a large extent carried out in a decentralise the NCBs.
For the euro to become a success story as the single currency for around 300 millio the confidence of European citizens in the stability of the new currency and in the is crucial. You would probably agree that the Eurosystem has already achieved a lot of building up credibility and gaining a sound reputation in financial markets for i policy in its early days. This will certainly facilitate the establishment of a s throughout Europe. The foundation of this stability culture is a broad consensu Europeans that the maintenance of price stability is of the utmost importance and is to the achievement of other objectives such as high employment.
## Monetary policy and other policy areas
By maintaining price stability in the euro area, we will ensure that the single mone contributes as much as possible to economic growth and high employment. At the same national fiscal authorities and general economic policies also have to demonstr commitment to the maintenance of price stability in the euro area. In this context, and Growth Pact adopted in 1997 is a crucial element. Its aim is to encourage the disciplined and sustainable fiscal policies for the participating member states and members. In so doing, it can make a significant contribution to the establis favourable conditions for sustained economic growth and high employment in the med
term. Moreover, sound fiscal policies facilitate the task of monetary policy to maintain stability. It would be counterproductive if national fiscal policymakers were not to cont work towards a budgetary situation which is close to balance or in surplus in the light achievement of monetary union and the positive price outlook for the euro area.
In this connection please allow me to briefly address the matter of calls for closer coor between monetary policy and fiscal policies. Any form of ex ante coordination that, example, would commit the monetary policy of the ECB to move its interest rates in a cer way in response to specific action or plans of other policymakers would provide the wr impetus for the conduct of sound macroeconomic policies and would not be efficient. Th does not, however, exclude a constructive dialogue between the Eurosystem and government authorities which clearly respects the independence of the ECB.
In line with its clear mandate, enshrined in the Treaty establishing the European Communi and for sound economic reasons, the ECB has to decide which monetary policy best serves t maintenance of price stability over the medium term and then act accordingly. At the s time, the Treaty also emphasises the need for sound fiscal policies. This clear separat responsibilities is both efficient and transparent. Obviously, monetary policy alone c solve Europe's economic problems such as the present intolerably high level o unemployment. Appropriate structural reforms implemented by national governments are of the utmost importance and much progress is required in this broad area. Moderate wag settlements in both the public and private sectors would, of course, contribute to reduc high level of unemployment in many parts of the euro area. In this context, let me remark recent wage agreements in some parts of the euro area do not appear to be in line with need to encourage higher employment.
## The Eurosystem's monetary policy strategy
With regard to the Eurosystem's monetary policy strategy, I should like to emphasise tha euro area monetary policy is a single one and therefore indivisible - by definition. Mon policy decisions must be based on area-wide rather than national considerations and hence area-wide indicators. Monetary policy has to be transparent so as to stabilise p expectations of future price developments. In order to clarify how we interpret the man conferred on the ECB by the Treaty, the Governing Council has announced a quantitativ definition of its primary objective.
Price stability has been defined as a year-on-year increase in the harmonised index consumer prices (HICP) for the euro area of below 2%. This has to be maintained over t medium term. As the wording 'increase' makes clear, deflation - that is, a persistent fal price level - would not be consistent with price stability. It would not be possible f announce where exactly we would draw the dividing line between price stability an deflation. This is partly for reasons that have been described as the measurement bi consumer price indices. For the United States it was estimated that measured consumer pri tend to slightly overestimate actual inflation. A bias may also exist for the euro are although its exact magnitude is as yet unknown and needs to be explored further.
To maintain price stability, the Governing Council has chosen a stability-oriented mone policy strategy. The chosen strategy is forward-looking in nature and also ensures as continuity as possible with the former strategies of the NCBs. In this respect and with to the overriding objective to maintain price stability in an environment of flexible ex
rates, our strategy is broadly similar to that of Sveriges Riksbank, although there a differences. In particular, the Riksbank follows a direct inflation targeting strat monetary policy is almost exclusively guided by inflation forecasts of about two yea In contrast, the Eurosystem relies on two pillars, thereby focusing on the medium does not give such a predominant role to inflation forecasts as the Riksbank.
In our view, the Riksbank has achieved high standards with regard to transparen accountability, as is for example evidenced by its comprehensive quarterly inflation more recent years, the Riksbank has enjoyed a fair measure of success in gaining con domestic price developments, as supported by its strong performance in fighting infl in overcoming a deep recession in the early 1990s. Its track record also demonstr price stability in Sweden was given a high priority long before this was formally by an amendment to the Riksbank Act at the start of 1999.
The Eurosystem's stability-oriented monetary policy strategy rests on two pillars, both important when the Governing Council discusses monetary, financial and econ developments at its biweekly meetings. The first pillar, which is a prominent role takes into account the essentially monetary origins of inflation over the medium to It recognises that empirical studies show a stable long-term relationship between m prices in the euro area. Therefore, in the euro area, monetary developments cons important guide for the conduct of monetary policy and it is essential to analyse a the development of monetary aggregates closely. The ECB has announced a quantita reference value for broad monetary growth as measured by M3, the first reference v M3 growth being set at an annual rate of 4.5%. This reference value is consistent maintenance of price stability over the medium term, while allowing for sustainabl growth and assuming a trend decline in the velocity of circulation of M3. In se reference value for monetary growth, the Governing Council emphasised its mediumorientation. Substantial or prolonged deviations of current monetary growth fr reference value will normally signal risks to price stability in the medium term.
The ECB does not intend to react to deviations of monetary growth from the referenc in a mechanistic way. In the first instance, such deviations are analysed thorough any signals which they may give about the prospects for price developments. If the points to a threat to price stability, monetary policy has to react in a manner a counter this threat.
Although monetary data contain information which is important for monetary policy de making, monetary developments alone clearly do not constitute a complete summary of economic information necessary for appropriate policy decisions to be taken. Th Governing Council emphasises that it is important, in parallel with the asses monetary growth, to look at a wide range of financial and other economic indi including economic forecasts. The second pillar of the Eurosystem's strategy t consists of a broadly based assessment of the outlook for price developments and th price stability in the euro area as a whole. This broadly based assessment takes in inter alia, the information provided by wage developments, exchange rates, fiscal i real economic activity, and asset and commodity prices. Forecasts of economic acti prices in the euro area can certainly also contribute to the success of an appropria looking monetary policy. Thus we take into account forecasts available from inter organisations such as the IMF and the OECD as well as internal forecasts.
We are aware that forecasts have to be interpreted with great caution. Given behaviou institutional and structural uncertainties, forecasting price and other developments in t area is inevitably difficult. Moreover, a forecast cannot encompass all the indicator va that are important for monetary policy. Nor can it always incorporate indicators in a manner. Furthermore, by the time the forecast has been finalised, the original assumpt may have become less realistic, requiring a careful interpretation of the results. Ther thorough analysis of individual indicator variables plays an important role in our mon policy strategy, in addition to any role that these variables may have in the forecast.
Within the stability-oriented monetary policy strategy, the Eurosystem also takes into ac the external value of the euro as an important determinant of the outlook for price stab exchange rate developments pose a significant threat to price stability in the euro a other things being equal, monetary policy will have to respond. Of course, all other f that impart information on price developments will also be taken into account before interest rate decision is taken.
## Monetary policy decisions and the outlook for price stability
In December 1998 the Governing Council announced that the interest rate on the main refinancing operation would be 3%. In the first quarter of 1999 the Governing Council k this rate unchanged. After an in-depth review of recent monetary, financial and econo developments, the Governing Council decided at its meeting on 8 April to set the interes for the ECB's main refinancing operations at 2.5%. In addition, the interest rate o marginal lending facility was lowered to 3.5% and the interest rate on the deposit faci 1.5%. These rates were left unchanged at the meeting of the Governing Council last wee The decision to lower interest rates taken at the first meeting in April has to be see context of the stability-oriented strategy. The decision has thus been taken from a fo looking perspective, focusing on the medium-term trends in inflation and the compatibili these trends with the Eurosystem's definition of price stability. By adhering to this s the Eurosystem's monetary policy contributes to creating the economic conditions which a essential to exploiting the considerable growth potential of the euro area and to re uncertainty about future economic developments.
I should like to take this opportunity to explain the current assessment, which is in l the Governing Council's expectations at the beginning of April. With regard to the first of the Eurosystem's monetary policy strategy, monetary growth cannot be seen as signalli upcoming inflationary pressures at this stage. Since the beginning of this year, the three moving average of M3 growth has been close to the reference value of 4.5%. For the peri from January to March 1999 the average growth rate increased somewhat to 5.2%. This observation may, however, have been affected by special factors prevailing at the start o three. Therefore, in its current assessment the Governing Council does not regard cur monetary trends as constituting a signal of future inflationary pressures.
With regard to the second pillar of the Eurosystem's monetary policy strategy, the bro based outlook for price developments and risks to price stability and various indicato future price developments and economic activity in the euro area indicate a favoura outlook for price stability. Financial indicators such as the very low level of long-term rates point to low inflation expectations and the credibility of monetary policy. Follow cut in short-term interest rates, long-term rates decreased somewhat initially, which co that the market considered the cut in interest rates by the ECB to be appropriate.
recently these rates have risen somewhat, mainly as a reflex to the strong increas term interest rates in the United States.
Regarding economic activity in the euro area, data available for the first two mont do not yet reveal evidence of a rebound in economic growth. Labour market indicator signs of a somewhat decelerating level of employment growth towards the end of 1998. Meanwhile, preliminary April figures from the European Commission on confiden indicators point towards some first signs of an improvement in industrial confidence
Recent price trends have been consistent with price stability. Inflation for the measured by the harmonised index of consumer prices (HICP) has been close to 1% sinc fourth quarter of 1998. As has been emphasised on previous occasions, the curre inflation rates are to some extent the reflection of the large fall in energy price HICP data for March 1999 show an annual increase of 1%. The slight increase relat January and February reflects the fact that goods prices are subject to some upward in the short term owing to the reversal in energy price trends expected by the Council at the beginning of April. However, the effects of changes in energy prices HICP increase may only be of a temporary nature. More lasting effects on future co prices normally come from changes in the overall monetary and economic situation.
To sum up, weighing all the relevant indicators and adopting a forward-looking and m term perspective, the Governing Council regards the current level of ECB interest appropriate with a view to maintaining the outlook for continued price stability.
## Aspects of the Eurosystem's communication policy
The Treaty acknowledges that it is important in a democratic constitution for an in central bank to be open, transparent and clear about the reasoning underlying it Therefore, a number of reporting obligations exist for the ECB which aim at making t accountable for its performance. Moreover, by communicating clearly with the publ Eurosystem reinforces its credibility. In this regard, the Eurosystem's approa comparison with the best practices of any other central bank.
In practice the ECB has committed itself to exceeding the stringent requirements of concerning transparency and accountability. For example, the ECB releases each mo bulletin providing detailed background information regarding the current assessmen economic outlook. At the same time, with the more extended editions of the bull March, June, September and December, we fulfil the Treaty requirement to publish a qu report. For the benefit of the general public, the ECB issues regular press relea introductory statement by the President, which is released immediately after Governing Council meeting each month. Furthermore, the ECB submits an annual report its activities to the European Community institutions (the Council of the European U European Commission and the European Parliament).
With regard to the Eurosystem's relationship with European Community institution Treaty states that the President of the ECOFIN Council and a member of the Eur Commission may participate in the meetings of the Governing Council of the ECB, wit right to express their views but without voting power. The President of the ECB hearings at the European Parliament at least four times a year to discuss the acti Eurosystem and is also invited to attend the informal euro-11 Council meetings. I s
to stress that the participation of the President in these meetings serves the purp exchanging information and views, while fully respecting the independence of th Eurosystem.
In the field of the international representation of the ECB, formal and informal agree have been reached with the IMF and the OECD and in the context of the G7 and the G10. At the end of last year the IMF granted the ECB observer status, full membership being restr to individual nations. Nevertheless, this observer status will allow the ECB to partici the relevant work and assessments by the IMF of economic policies in the euro area a beyond.
## The international role of the euro
Clearly, the introduction of the euro has had important implications for international markets. This has been the case not just because a number of currencies replaced by the played an important international role in the past but also because the euro has becom currency of an economic area which roughly equals the United States in terms of economi size and external trade, and which has the world's second largest capital markets.
Let me emphasise at this juncture that the Eurosystem has no exchange rate target vis-à other major currencies. We are also not participating in a formal exchange rate arrange with third countries outside the EU, for instance with the United States, and we believ this situation will continue in the future. It is important to mention that according to the single exchange rate policy has to respect the primary objective of price stability.
As the representative of a large economic area, the Eurosystem can best meet its overri objective to maintain price stability in the euro area if it is not constrained by an exc target. However, for smaller, very open economies, setting an exchange rate target may very reasonable decision. Against this background the ERM II exchange rate mechanism was created for those member states which have not yet joined monetary union but are willing do so in the near future. Experience with the European Monetary System (EMS), the predecessor of ERM II, has shown that participation in a system of this kind may facilita fulfilment of other convergence criteria. The new exchange rate mechanism may play a similar role. In this context, we should certainly wish to acknowledge the efforts Sweden is making to achieve sustainable convergence with the euro area. We hope that t success of the euro in its early months will help to convince the Swedish population o benefits of early participation in monetary union. Clearly, a decision to join ERM II wou important for fulfilling the convergence criterion of exchange rate stability and would smooth the transition to participation in the euro area.
In recent months the external value of the euro has been influenced by the market view o economic developments in the euro area relative to the United States. More recently o factors had an impact on the exchange rate of the euro vis-à-vis the dollar, in partic conflict in Kosovo. From the beginning of the year to mid-May, the euro weakened against dollar by about 10%. In nominal terms, measured against a trade-weighted basket of t currencies of the 15 most important trading partners of the euro area, the euro has wea significantly less, i.e. by about 6% since its launch. However, rather than focusing o short-term developments, one should look at long-term evolution. In that respect, it has observed that the current exchange rate of the euro against the dollar is not so very d from the levels observed in the first three quarters of 1998.
Clearly, some variability is typical for the bilateral exchange rate vis-à-vis th Market expectations about future cyclical developments and the course of monetary an policy in the United States and Europe play a role in explaining exchange rate vola widely recognised that in the medium to long term exchange rates follow a path determ fundamental factors such as price and economic developments. In this context, it s pointed out that recent exchange rate developments have as yet not indicated any future price stability. Moreover, internal price stability should serve as an an development of the euro's external value in the medium term. Indeed, a stability monetary policy strategy protecting the purchasing power of the euro is the basis and stable currency over the medium term.
Maintaining price stability in the euro area also promotes credibility and thereby e international role of the euro. The Eurosystem neither promotes nor hinders the dev of the euro as an international currency. We consider that the international role should develop through the interaction of market forces. As yet it is too early to long it will take for the euro to be considered as a truly international currency US dollar.
Clearly, the disappearance of 11 national currencies and the introduction of the major international currency had an immediate impact on the turnover and focus of a in the global foreign exchange markets. This has been reflected, for example, in ra and liquid euro/dollar trading in the foreign exchange market since the launch of currency. However, there are also indications that the euro has further potential other markets as the surprisingly slow development of euro/yen trading suggests.
The euro can also be expected to become an attractive currency for the investment o reserves.
One of the key elements to further international portfolio diversification in favour is the creation of a large, liquid and integrated capital market in Europe that be launch of the euro. For short-term instruments, we are now dealing with a broad an European money market that ensures very similar short-term interest rates for com instruments and credit risks. The development of this market has been strengthened Eurosystem's operational framework of open market operations, which is mainly base reverse transactions, and the implementation of the new TARGET real-time gross sett system in participating countries. At the longer end of the maturity spectrum integration was jumpstarted by the redenomination of outstanding government debt i and by the convergence of interest rates to narrower spreads following the eliminat exchange rate risk. The elimination of this main risk will also foster the deve uniform market standards so that government bonds in the euro area will become rathe substitutes, creating a large and liquid bond market. Obviously, this requires sustainable budgetary policies that ensure that credit risk spreads remain small.
## Concluding remarks
Following a remarkable period of disinflation in most member states, the Eurosystem the good fortune to commence its operations in an environment of price stability. Th enjoyed by the euro in its first five months can be certainly attributed to a numbe Above all, the successful efforts of member states made possible a smooth changeove euro. The independence of the ECB and the clear mandate to maintain price stabili
crucial for ensuring a high degree of credibility of the Eurosystem's monetary policy. final observation, I should simply like to mention that without the positive echo of fi markets and the permanent support of banks and financial institutions, a single curren Europe could not have become a reality.