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The intention of The
Golden Chalkboard is to feature a focused selection of data
or rare commentary that I think will be useful to enhance your
insights into the gold market and the monetary system.
The appropriate conduct of monetary policy in an imperfectly known world is by definition a standing challenge for any central bank at any time. It is always difficult to draw a correct picture of the world from sometimes ambiguous and contradicting raw data. And it is hard to devise an appropriate response to new developments that is both free of prejudice, open to new developments, and at the same time coherently and systematically designed not to compromise the fundamental principles that need to guide the central bank's policy in the medium run.
The ECB has been confronted with these challenges from day one of its debut. For us, the problem of uncertainty in the day-to-day policy management was compounded, at the start of the third phase of monetary union, by the extraordinary challenge of long-term institutional design.
We were hard pressed - as any other central bank was at that time, in the aftermath of the Asian and Russian crises - by the handling of a difficult and unpredictable situation which some regarded as heading for the worse. But at the same time we had to attend to the unique task of laying the foundations for our future action, thereby completing the work that had been initiated by the European Monetary Institute. The Governing Council of the ECB had to be given a position to command the necessary economic details over a new and unique monetary area, whose economic size is only paralleled by the US. At the same time, future monetary policy decisions had to be framed within a strategic apparatus that could be both consistent and credible.
In this endeavour, we could certainly draw on a consolidated stock of knowledge pre-dating the ECB and grounded in the - sometimes centenary - experience of the participating national central banks. But we also had to create untested instruments from scratch. And the entirely new area-wide perspective that we needed over a group of sovereign states was simply unprecedented in history.
After years of dire warnings it came, I suppose, as a somewhat puzzling surprise to many that the birth of the euro proceeded as smoothly as anyone could have hoped for. We created almost overnight a unified money market, which - notwithstanding formidable transaction overload - functioned from the very start almost without frictions. Above all, long-term bond yields in the euro area reflect the confidence that informed investors place on the ECB. Surveys of inflation expectations, which account for the trust and the credit that the general public accords to a currency, are persistently in line with our medium term objective of price stability.
The ECB has, from its very foundation, taken its challenges seriously. The recognition that monetary policy always has to cope with a changing and imperfectly known world has been placed at a premium in the design of the ECB's monetary policy strategy. We could also not ignore the fact that the ECB, as a new-born institution, had with its very appearance marked a historical discontinuity, with potentially profound implications for economic behaviours and measured structural relationships.
The Treaty entrusted the mandate to maintain price stability to the ECB and to this end it built an independent, supranational institution, put in a safe position to avert outside pressures coming from any quarter. We, on our side, between autumn 1998 and January 1999, had to concentrate our forces on solving a twofold problem of trust and controllability. As already said, we had to inherit, intact, the wealth of credibility that the best monetary tradition in Europe could bequeath to the new institution. And, on the other hand, we were called upon to elaborate an entirely new perspective on a new economic reality, which was undergoing a fundamental mutation - if I may say so - under our noses.
At the outset of Monetary Union we promised to be a consistently transparent institution. We have always striven to fulfil this promise. We understand transparency to mean that the internal process by which information is produced and presented to the Governing Council for policy decisions should be consistently reflected in the external account that is given to the public.
Price stability in a modern society
Credibility for the maintenance of low inflation, the cornerstone of an effective monetary policy, is inherently exposed to various challenges. Slipping inadvertently into a high-inflation or a deflation scenario because of errors in perspective would be unforgivable on our part, and, as we know from experience, it would be very costly afterwards. The monetary union in Europe needs a currency guaranteeing a stable purchasing power to maintain trust in its economic and social institutions. It needs it because it is - and it is expected to become even more in the coming years - a dynamic and productive society. And it does need it because it is undergoing major challenges, not last those related to a difficult demographic transition, with important consequences for the demand that people will express for economic security and personal safety.
Europe is in one respect a dynamic society and we know that in a dynamic world, where competitive forces become increasingly intense and economic decisions have to be taken at shorter notice, price stability minimises the noise surrounding price signals. Hence, it lessens the risk attached to market activities and long term planning, thus boosting the economic reward to investment, production and trade. But Europe is also - let us not forget this - an ageing society. Hence, the terms of the implicit pact that links successive generations through a chain of mutual transfers have progressively shifted into the limelight of public attention and general concern. Again, a stable currency eases the anxiety of the various cohorts of economic agents looking forward to their old age, and makes this intergenerational connection, which lies at the core of our society, a harmonious exchange.
Episodes such as substantial increases in oil prices remind us that central banks, no matter how well-designed their institutional foundations, how well-intentioned and personally committed their management, do not operate in a vacuum. Technological factors and agents' attitude towards consumption, saving and work combine with governments' thrift and the workings of law and regulations to determine the real basis for economic welfare. Credibly reassuring market participants and the public at large about price stability over the medium run, and acting in a determined manner to fulfil this promise, is the best contribution that a prudent monetary authority can make to social welfare. Any attempt on our part to correct this balance of real forces in the short run at the expense of the stability of the currency would only be futile and self-defeating.
The Treaty establishing the European Community recognises this fundamental dichotomy. Consequently, it forged a thoughtful and harmonious institutional construction, in which overlaps of competence are carefully avoided. For our part, we welcome the construction designed by the Treaty and respect the separation of policy responsibility on which it rests. The ECB's mandate to maintain price stability is perfected by the independence it was assigned.
The current situation
Our economy, in spite of being relatively closed and with a rate of expansion driven mostly by domestic factors, had over the past two years benefited from very favourable external developments. The present weaker external background, via a lower demand for euro exports, may induce a stronger decline in the euro area growth rate than was expected some months ago. Despite these external influences, there is no reason for pessimism about the euro area economy. Consumer confidence has remained high, and the ongoing employment growth, the reductions in direct taxes and the lower oil prices, foster expectations for a continued strong growth in private consumption. In contrast to other economic areas, there are also no fundamental imbalances that have been built up over recent years and that may require a correction.
[Randy's note: Could he be tactfully referring to the condition the dollar finds itself in...bloated from use as a reserve currency which, unfortunately for dollar holders, is rapidly becoming obsolete in that role? I'd say, "Definitely maybe!"]
Let me conclude this overview of the current situation by reminding that a medium term oriented monetary policy has little room for fine tuning the economy and controlling the economic cycle. The ECB has neither the instruments nor the intention to do so. The mandate of the ECB implies that the monetary policy decisions of the ECB aim at maintaining price stability in the medium term, based on the assessment of the risks to price stability, conducted on the basis of its two-pillar strategy. By following this policy, the ECB will continue to provide its best contribution to economic growth and employment. The ECB cannot raise the level of the euro area's production potential. The responsibility for the structural improvement of the production potential lies with other areas.
While the struggle to preserve the value of money will remain our daily exclusive occupation, it is conceivable that the next major challenge in policy making may lie elsewhere. Perhaps the greatest battle that governments will have to fight in the coming decades will be the maintenance of a virtuous balance between long-sought fiscal prudence on the expenditure side and the challenge to further reduce taxes. Unemployment - albeit declining - remains too high.
The need for structural reform
In particular, long-term unemployment cannot be tackled through subsidies and extended money hand-outs. An effective cure against structural unemployment requires on the part of governments an uncompromising commitment to reform the structural and regulatory underpinnings of our economies. I regard this as perhaps the major challenge that national authorities will have to face at the start of the new millennium.
It is undeniable that the most dynamic industrialised economies of the past decade are those which pioneered the drive towards dismantling monopolies and converting industries traditionally dominated by one or two -in most cases state-dominated - firms into more competitive and contestable markets. The intensification of competition that has ultimately resulted from liberalisation and deregulation has made for downward pressures on prices.
In Europe, the introduction of the euro has already contributed to an intensification of competitive pressures across firms, since cross-national comparisons of prices have become more transparent. We expect that the introduction of euro banknotes and coins early in 2002 will further confine the pricing leverage of domestic producers, and restrict the capability of retailers to cultivate privileged market positions. ...Deregulation and productivity-driven wage negotiations which take into account labour supply have still to impose themselves as a common and lasting practice. However, we do see cross-border competition already placing strain on economic decisions taken within domestic borders.
Empirical results lend support to the idea that financial market deepening contributes to overall economic growth. The related argument has also been made that financial market deepening would improve especially the prospects of young, dynamic and risky firms. These are typically the enterprises that tend to bring new technologies to the market. In other words, the type of firms that create the waves of creative destruction noted by Schumpeter. But with a less developed financial market this is precisely the category of firms that, in the absence of sufficient tangible collateral, would have their credit rationed. We expect that further deregulation as well as common European standards for regulation and the progressive integration of national financial markets in a unified area transacting in the euro will increasingly grant easier access to venture capital and allow agents to efficiently pool risks both domestically and internationally. The private sector will thus be in a better position to cope with shocks to disposable income and cash flow than was the case in the past.
Conclusion
Let me conclude on a note that has steadily accompanied Europe's history since the end of the war. The last fifty years have seen an impressive progress towards closer integration among countries that had been fierce enemies for much of their past. This historical course has, to a certain degree, always required that governments maintained a balance between the advantages of increased co-ordination and consensual action, and the need to uphold the healthy forces of competition.
I believe that care should be taken that this balance is maintained in the future. Any design of further political integration will have to be founded on a stable currency and sound, successful economy. Hence, the quest for more integration will have to eschew the danger of creating "political cartels," which would be as detrimental to Europe's economy and society, as business cartels are to market activities. Healthy competition among jurisdictions - within a unified area founded upon shared principles and a single currency - is of no less importance to promote progress than competition among enterprises in a market economy. It is therefore indispensable that we allow time for the gestation of a sustainable political structure that will eventually complement the stage of integration that monetary union has already induced.
The ECB, on its side, will be vigilant on monetary union. I do not believe that a stable monetary regime must necessarily have its root at the level of the nation state. Nevertheless, as a new money that, by replacing many currencies, has severed the traditional link assigning one means of payment to one nation state, the euro does face a unique challenge in winning the trust and the hearts of the people. The ECB can already claim credit and take pride for having fulfilled its mandate so far. We will not squander in the future the asset of trust that people have already given to us.
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