Mr. George speaks on the advent of the euro, and its possible impact on Europe and the Mediterranean region Speech by the Governor of the Bank of England, Mr. E.A.J. George, at the FT Euro-Mediterranean Capital Markets Conference in London on 26/
I'm delighted to take part in this conference which has been organised by the Government during its term of Presidency of the European Union to promote and streng financial and economic ties within the partnership between the European Union an Mediterranean neighbours.
It is a very happy accident of fate - to me as a central banker at least country should hold the EU Presidency at this particular time, as Europe prepares to definitive step to monetary union. Earlier this week in Frankfurt the Council of the Monetary Institute finalised its 'convergence report', which we published yesterday, at time as the parallel report by the European Commission. The Commission also publishe recommendation to EU Finance Ministers and Heads of Government that 11 EU member state should move to monetary union, in a first - tidal - wave, from January 1st next year. Witho to anticipate the decision to be taken by the Heads of Government under Prime Minister Tony Presidency in Brussels during the first weekend of May, the odds are that monetary union ahead on that basis. It is an historic moment.
The irony, of course, is that this country itself will not be a part of tha That is a disappointment to some, but a relief to others - a point I'll come back to view one takes about that, no-one, I think, can fail to recognise the huge achievement o who have laboured, with such determination, for so long, and against formidable difficultie the venture to this point, and I take my hat off to them.
In the circumstances, Mr Chairman, I could hardly choose to speak about anyt else this morning. The advent of the euro, on this broad basis, will, of course, have prof on financial activity, and on both providers and consumers of financial services, all world - including in our Mediterranean partner countries. And I should like to take this development, in the broader context of the evolution of the European Union, as my theme.
I recognise at the outset that the EU is, fundamentally, about politics, inspi need to ensure that Europe is never again devastated by war. I am only too happy to leave about what that implies for the political organisation of Europe - including the relations European institutions and the individual member states - to the politicians. My interes economic dimension of Europe - though I realise of course that economics and politics practice be separated quite as neatly as this distinction suggests.
The 'economics' of Europe starts from familiar arguments in favour of free tra competition as the most effective means of ensuring that productive resources are ef deployed, promoting specialisation in areas of comparative advantage - and thereby sa consumer demands more effectively and increasing aggregate, macro-economic, welfare. T arguments apply, in principle quite generally - as much to international trade and compet regional trade and competition or indeed to trade and competition within individual nationa
The macro-economic benefits are less immediately obvious at the micro-econom level. Existing activity is threatened by greater competition, and there is a natural te employees, their employers and their national governments - to seek to defend their es activity through protective action in one form or another. The benefits of greater competi the removal of barriers or distortions to free trade, on the other hand, flow essentially f activity that is likely to result - so that they are much less tangible. And the benefits short-term - do not necessarily accrue evenly across the free trade area - they accrue to flexible and adaptable enough to take advantage of the new opportunities that free trade
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that although we know that in principle at the macro-economic level free trade and competi powerful positive sum game - and although we have seen it clearly enough in practice always likely to be visible - and vocal - losers. And that is bound to provoke outbursts resistance. Against that background establishing and maintaining free trade to the extent t been achieved in the EU is in itself a remarkable achievement.
But the EU has already in many areas gone well beyond just free trade, establishing the single market. That involves more than the free movement of goods and within Europe. It involves also the free movement of both labour and capital, as well as European legislation to avoid market distortions from, for example, state aids, or g procurement, or restrictive practices within the private sector. This further pooling of so essentially the same purpose - it is designed to reinforce the macro-economic benefits from and competition and act as a stimulus to growth and employment by allocating resources st effectively based on comparative advantage, enabling savings to flow to where they can productively invested and production to be located where it can be most effectively carr satisfy consumer demand.
The advent of the euro represents a massive new step in the same direction.
The crucial and unique advantage of monetary union is the exchange rate certai will bring throughout the euro area - not just the reasonable de facto stability that ca each EU member state individually pursuing disciplined macro-economic policies in parall which has in practice been achieved within much of Europe for quite long periods wit framework of the Exchange Rate Mechanism - but actual, and in principle permanent, exchang certainty. There is no doubt that this is a very real advantage. One can argue that ex certainty is not an essential complement to the European single market - any more than exch fixity is essential to achieving the benefits of free trade more generally. But there is intra-European exchange rate certainty will - through the intensified competition resul greater transparency of prices and lower transaction costs, through broader and deepe markets, and through the associated improvement in economic resource allocation - subst enhance the macro-economic benefits to be derived from the single market. Whether or no essential, therefore, exchange rate certainty is very desirable from this perspective.
The potential drawback of monetary union can also be simply stated, though more difficult to assess. Essentially there is a risk that the single monetary policy one-size-fits-all, short-term interest rate - within the euro area, which is a necessary c single currency, will not in the event prove to be appropriate to the domestic needs of euro-member countries. There is no doubt that such risks exists. They may result from divergence. They may arise from differences in fiscal positions even though these ar constrained through the Stability Pact. Or they may result from economic shocks of some s have a bigger impact on some countries than on others. The rise in oil prices in the earl German reunification are classic examples.
So the risk of divergent monetary policy needs within the euro area is real. damage it could cause if serious tensions between member countries were to emerge is subs because alternative adjustment mechanisms, such as labour migration or fiscal redistribu exist within individual countries, and which help to alleviate the similar regional tension the national level, are simply not well-developed at the pan-European level.
The Maastricht Treaty, of course, recognised this risk, and the famous conve criteria were designed precisely as a means of reducing the risk to manageable propor requiring that, before they join the euro club, countries should have achieved at least degree of macro-economic convergence - demonstrating their commitment to macro-economi
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discipline through both fiscal consolidation and monetary policy directed at effective exchange rate, stability. And there is no doubt that all European Union member states ha huge progress towards macro-economic stability over the past few years, which you wil documented in the two 'convergence reports'. Although the EMI in particular emphasises ongoing need in a number of countries to persist in determined fiscal consolidation, it is towards nominal convergence that underlies the European Commission recommendation.
The nagging doubt is whether this pursuit of macro-economic stability will in maintained - whether the convergence that has certainly been achieved will, in the ter Treaty, prove to be sustainable.
A particular worry is that macro-economic stability, on its own, has not been to prevent the emergence of very high, and very different, levels of unemployment in a numb major Continental European economies. Unemployment has been for some considerable time, an remains, much the most urgent and important economic issue confronting us in Europe. I suggest for a moment that the right answer would be to abandon macro-economic disciplin revert to old-fashioned demand management policies. In anything other than the very short would be likely to make matters worse. I share the broad consensus view that Eu unemployment problems originate essentially in rigidities on the supply-side of the econ point is that unless we are all more successful in bringing down this structural unem through micro-economic policies designed to improve structural, supply-side flexibility, countries could find it difficult to continue to live with a common macro-economic di without significant tensions.
Some people on the Continent who basically share this concern are inclined to that if the government of a euro-participating country were to find itself in this situati that it would have no macro-economic way out, for example, through exchange rate adjustme monetary relaxation, or fiscal stimulus beyond the limits of the Stability Pact - then it overwhelming incentive to take the sort of supply-side measures which have proved so diff implement hitherto. And the people in those countries would similarly have the incentive structural change. I am not wholly persuaded that you can necessarily rely upon that making much easier. But what I think this discussion leads to the broader conclusion, given that t go ahead, that structural reform - in labour markets and welfare systems and in broade deepening the single market for goods and services, but also capital markets - in order supply-side flexibility - becomes more crucially important than ever. The need for supply-side flexibility was the subject of much of the discussion at the informal meeting o Finance Ministers and Central Bank Governors in York last weekend, and I was greatly encou by the degree of consensus around the table on this point.
The United Kingdom of course will not participate in the first wave of mon union. That decision, taken last October, was - as I noted earlier - a disappointment to EU partners; but it was a considerable relief to others because UK participation from would certainly have complicated the project - not least because of the substantial divergence between ourselves and the major countries on the Continent.
But in making its announcement the British Government made it clear that it opposed to euro membership as a matter of principle. When the time comes - and that will certainly not be during the lifetime of the present Parliament - it will make its decision to Parliament, and the people in a referendum - on pragmatic, economic, grounds. In the m the United Kingdom will prepare both for the introduction of the euro on the Continent f January and for our own eventual participation.
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The fact is that monetary union will have a major effect on this country whe not we are a part of it, and it is clearly in our national interest as well as the participating countries, that it should be successful. We benefit in macro-economic term stable and prosperous Europe just as Continental Europe benefits from a stable and pro United Kingdom - and the same mutual interest, of course, applies between Europe an Mediterranean neighbours.
We can contribute to that success in at least three ways. Most immediate Government has undertaken to use its current term as President of the European Union Cou Ministers to promote an orderly decision-making process during the crucial next few mont being part of the first wave leaves us free to concentrate on that, and while there are is the vexed question of the Presidency of the European Central Bank - which only others can the UK's role is to give them every opportunity to reach timely decisions.
More fundamentally, we can contribute to the success of the euro, even from ou by continuing to pursue policies directed towards macro-economic stability and supp flexibility in parallel with those persuaded within the euro area. The Government is commit course as a matter of national economic self interest. But these same policies are calcul make us a more prosperous and active trading partner for Europe as a whole, and to ensure do not have any avoidable disruptive effect on the policies or on the economy of t participants. More than this they are calculated to foster sustainable economic converge necessary precursor to our eventual adherence to the euro club.
But thirdly - and of particular relevance to this conference - we can con directly and positively, to the strength of the euro through the City of London's financial
The potential benefits to Europe of the euro derive importantly, as I have sa the exchange rate certainty which it will provide across the euro area; they derive impor from the greater transparency and liquidity and competition of unified financial marke euro-denominated instruments rather than the fragmented markets denominated in the va national currencies that we have now. Providing transparent and liquid, competitive, innov well-regulated financial markets is one of the things which the City of London does particu Provided the City is properly prepared - as it will be - and here I commend to you the England's quarterly reports on the practical, preparations we have been making in London introduction of the euro from 1st January next year - available, amazingly, at no charge Bank - then there will be a vigorous Euro-euro market in London, from Day 1, just as t vigorous markets in Euro-DM and Euro-francs as well as Euro-DM and Euro-Yen now. If not dowry exactly - since we are not entering into the marriage at this stage - it will be present.
The wholesale financial markets in the UK derive their strength from Lond position as a uniquely international, rather than simply a national or regional Europea centre. This reflects the critical mass of markets and financial services in commercial and banking available in London including the strongest financial businesses from all around t For instance, there are more banks operating in the City which are incorporated abroad than domestic banks, and more than half the total deposit base (over £1 trillion) of the UK bank is denominated in foreign currencies. And, the fact that so many foreign-owned instit including very many from our European partner countries - continue to build their pre London, suggests that they share this perception.
The City in this capacity is, I know, seen as something of a mixed blessing b people on the Continent. There is a view that the euro should in some sense 'belong' participating countries and to them alone. If that view were to prevail it would point in
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of one form of bureaucratic regulation or another - no doubt with a nod in the direction o policy considerations as justification - which would damage the euro at least as much as harm the financial markets of the City. At the same time some of these same people argu successful, strong and widely-used euro that will take its proper place alongside the dol yen as an international trading and portfolio currency, and in that context they positiv the active participation of London. In the end I do not think there is very much choice. I increasingly integrated capital markets and liberalised capital movements it is inconceiva international use of the euro could be unnaturally constrained.
And that will be in the interest of the users of financial markets - wh borrowers or lenders - within Europe itself and across the world, including the Mediterrane It will be in the interest, too, of the providers of financial services by promoting t financial activity throughout the European Union. Like trade in goods and other services financial services is very much a positive sum game. As the major interface between Europe rest of the world, London's success is not a threat to other European financial centres. doubt that euro activity in London will mean more rather than less euro activity in othe financial centres like Frankfurt, Paris, Milan or Amsterdam. And, conversely, I have li either that what is good for those centres will be good too for the City.
Mr. Chairman, I make no apology for concentrating my remarks today on the adve of the euro. It is an historic step; and it will affect the lives of all of us - th throughout the Mediterranean region, and across the world. It can be a powerful force through its impact on free trade and competition, and on economic prosperity. But it is not dangers. What matters now is that we should all do all that we can to maximise the potenti and minimise the risks.
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