3. We consider that the
following raises questions of legal and political importance,
but make no recommendation for its further consideration at this
stage:-
H M TREASURY
(17793)
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Report by the European Monetary Institute (EMI): The single monetary policy in stage three; specification of the operational framework.
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Legal base:
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Article 109f(3) and Article 7 of the Statute of the EMI.
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Background
3.1 This document has
been prepared in fulfilment of two obligations. The first stems
from Article 109f(3) of the Treaty, which required the European
Monetary Institute to specify, by 31 December 1996, the "regulatory,
organisational and logistical framework necessary for the European
System of Central Banks (ESCB) to perform its tasks in the third
stage [of EMU]". The second is the requirement in Article
7 of its Statute for the EMI to report annually on the adaptation
of monetary policy instruments and the preparation of the procedures
necessary for conducting a single monetary policy in stage three.
3.2 In an Explanatory
Memorandum dated 14 January, the Chancellor of the Exchequer (Mr
Clarke) told us that the report is for information purposes. Legislation
will be necessary in due course, for which the legal base will
be Article 106(6) of the Treaty. Although the EMI has proposed
a number of draft Regulations in the Annexes to its report, they
can be formally proposed only by the Commission or recommended
by the European Central Bank (ECB) after its establishment in
July 1998.
The contents of the
report
3.3 The report is divided
into three chapters:
-- strategic
aspects of the single monetary policy;
-- implementation
of the single monetary policy;
-- supporting
framework for the single monetary policy.
In his Explanatory Memorandum,
the Chancellor summarises the principal elements of the report:
Strategic aspects
of the single monetary policy
3.4 "The framework
concerns the monetary policy of the single currency area, which
will be the responsibility of the Governing Council of the ECB.
The Treaty states that the primary objective of the ESCB will
be to maintain price stability. Two possible strategies
are described - monetary targeting (targeting measures of money
supply) and direct inflation targeting (directly targeting measures
of price inflation). The report recognises that while these two
strategies can be distinguished theoretically, all NCBs[5]
which pursue either strategy today monitor a wide and similar
set of variables. The EMI does not consider it possible to determine
more specifically now which strategy should be chosen by the Governing
Council. The EMI and NCBs are therefore carrying out preparatory
work to ensure that the ESCB will have the statistical and analytical
infrastructure to pursue either strategy."
Implementation of the single
monetary policy
3.5 "For the
implementation of the monetary policy of the single currency area,
the ESCB will rely on a set of monetary policy instruments and
procedures constituting its operational framework. The normal
operational target of the ESCB will be short-term interest rate
and this will be set to achieve the strategic objective above.
3.6 "For this purpose,
the EMI has defined the set of monetary policy instruments
which will need to be made available to the ESCB. It envisages
that the ESCB will mainly use open market operations:
-- main
refinancing operations - weekly repo[6]
transactions with a maturity of two weeks, providing liquidity
to the banking sector;
-- longer
term refinancing operations - monthly repo transactions with a
three-month maturity;
-- ad
hoc fine-tuning operations - to manage the liquidity situation
or steer interest rates in the very short term;
-- structural
operations - to affect the structural liquidity position of the
banking system relative to the ESCB.
3.7 "In addition,
two standing facilities (a marginal lending facility and a deposit
facility) which will provide or absorb overnight liquidity, will
set a corridor of upper and lower bounds to short-term interest
rates. These facilities will help the general stance of monetary
policy in the single currency area.
"The Treaty provides
for the possibility of the ECB using minimum reserve requirements
as a monetary policy tool. As the report states, the EMI is engaged
in work to keep open this option, although the decision will be
for the Governing Council of the ECB. Legislation will be required
in this area.
"The EMI has worked
out common eligibility criteria for counterparties[7]
and for the assets to be used in operations. A broad range
of eligible counterparties is proposed, consistent with the decentralisation
of the ESCB's functions. All ESCB credit operations will need
to be based on adequate collateral. Eligible collateral will
be listed in two categories ('tiers'), both including public and
private assets:
-- tier
one will be marketable assets which fulfil uniform single currency
area-wide criteria specified by the ECB;
-- tier
two will be additional assets, marketable and non-marketable,
which NCBs consider particularly important for their national
financial markets and banking systems.
"The lists will
allow for a wide range of assets, desirable for a smooth settlement
of monetary policy operations, and will be available to the public.
3.8 "The ESCB will
also have the capacity to conduct foreign exchange intervention,
either in relation to non-EU currencies, or other EU currencies
in the context of a revised exchange rate mechanism (ERM). Further
information about exchange rate co-operation between the single
currency area and other EU Member States is contained in an annex[8].
The EMI believes that intervention in a revised ERM should not
be used alone but only as a supportive instrument in conjunction
with other policy measures. Preparatory work is being undertaken
to allow the ESCB to use either a centralised or decentralised
set-up for foreign exchange policy. The choice of counterparties
will follow a uniform approach, based on prudence and efficiency."
Supporting framework
for the single monetary policy
3.9 "The ECB will
need to collect statistics with the assistance of the NCBs
to operate the monetary policy of the single currency area. The
report states that the statistical requirements will resemble
the national statistics currently available, although there will
be a need for some harmonisation and for consolidation of cross-border
flows. Legislation will be required in the field of the collection
of statistics."
3.10 "The EMI and
NCBs are developing an interbank funds transfer system (TARGET
- trans-European real-time automated gross settlement express
transfer). It is intended to process cross-border payments in
euro. TARGET will be composed of one real-time gross settlement
(RTGS) system in every EU Member State, plus an interlinking mechanism.
All Member States will be able to access TARGET. Only NCBs (as
settlement agents of the RTGS) will access the interlinking mechanism.
Additional information on TARGET is contained in an annex to
the main report. The report notes three outstanding points relating
to TARGET:
-- the
provision of intra-day liquidity (in case a commercial bank's
cumulative payments may exceed its receipts at any particular
point during the day), including the terms of access to intra-day
liquidity for NCBs in member states not participating in the single
currency area;
-- pricing,
with efforts being made to ensure that costs are properly allocated
and to respect principles of free competition;
3.11 "NCBs will
be able to choose the most appropriate securities settlement
systems to be used for monetary policy operations on the basis
of existing infrastructures. Linkages to allow cross-border use
of eligible assets are being developed."
The Government's
views
3.12 The Chancellor reminds
us that the United Kingdom is not required to participate in the
third stage of EMU. He says that nothing in the operations framework
for monetary policy within the single currency area affects this
and that participation in discussions on EMU has no implications
for future UK participation. He continues:
3.13 "The Government
is committed to full involvement in practical negotiations on
the detailed arrangements for EMU, given the implications for
the United Kingdom whether or not it participates in the single
currency, particularly for the financial sector. The Governor
of the Bank of England is a member of the Council of the EMI.
3.14 "The Government
is committed to low inflation and welcomes the consideration given
in the EMI to how this may best be achieved. It notes that the
report recognises that, in practice, NCBs within the EU (including
the Bank of England) monitor a range of monetary and financial
indicators to assist the operation of monetary policy, and that
the ESCB is likely to continue this practice. The Government
believes that the present arrangements in operation in the United
Kingdom would continue to be suitable to deliver low inflation
in line with the Government's target if the United Kingdom were
to decide not to participate in the single currency.
3.15 "The proposed
use of short-term interest rates as the general operational target
for the ESCB matches the use of short-term interest rates in the
United Kingdom today. The proposed reliance on open market operations
by the ESCB also mirrors current practices in the United Kingdom.
The Government welcomes the recognition within the EMI of the
benefits of having a wide range of eligible counterparties and
assets. The Government believes that reserve requirements have
significant disadvantages. In particular, they effectively impose
a tax on business through institutions subject to their requirements.
The Bank of England has consistently argued in the EMI against
the future actual use of reserve requirements, and would do so
in the ECB if the United Kingdom were to participate in the single
currency.
3.16 "The Government
has stated that it has no intention to participate in the proposed
revised ERM for countries not adopting the single currency. Like
the existing ERM, the revised mechanism will be voluntary and
based on intergovernmental agreement (also involving the ESCB).
These characteristics of the revised ERM have been recognised
in successive European Council conclusions.
3.17 "The Government
recognises the need for the ESCB to have statistics to enable
it to conduct monetary policy within the single currency area.
However, the Government and the Bank of England will seek to
ensure that the statistical burdens on businesses will be minimised.
In this context, the Government welcomes the statement in the
report that the statistical requirements for the single currency
area resemble the national statistics currently available.
3.18 "On TARGET,
the Government welcomes the repeated recognition by the EMI that
all Member States' NCBs will have access to TARGET. The Government
notes that decisions on the terms of access by non-participating
Member States' NCBs to intra-day liquidity in TARGET remain to
be taken. It believes that equal terms of access for all EU Member
States' NCBs would make TARGET more attractive and reduce systemic
risk within the financial system of the EU as a whole. The Government
also notes that other alternative euro settlement and payment
systems will operate alongside TARGET and that such arrangements
are used for cross-border payments today.
3.19 "The report
of the EMI is for information purposes. No compliance cost assessment
has therefore been undertaken. Assessments of the compliance
cost of future Community legislation which will be needed to establish
the framework for the operation of the single monetary policy
will be conducted if required at the appropriate time. The bulk
of the transitional costs involved in the introduction of the
single currency will fall on businesses, public authorities and
individuals in participating Member States only. The Government
will therefore take an assessment of these costs into account
when it decides whether or not the United Kingdom should participate."
3.20 In a letter dated
14 January, the Chancellor informed us that copies of the EMI
report are being circulated by the Bank of England to organisations
in the UK financial sector for information, to assist preparations
for EMU which will be required whether the UK adopts the single
currency or not. We note that the Bank says in its covering memorandum:
"We welcome
the substance of the report which in our view provides a practical
framework for the ECB's future monetary policy operations."
Conclusions
3.21 The creation
of the operating framework for the European Central Bank is, we
understand, considered by the President of the European Monetary
Institute (Mr Lamfalussy) as one of the most important tasks falling
to the EMI under the Treaty[9].
Since the ECB will need to make decisions on some issues where
this report leaves options, and the Bank itself will not be set
up until after 1 July 1998, the report does not provide a definitive
framework for future monetary policy, but it is a major step in
that direction. It clearly raises matters of political importance,
whether or not the United Kingdom opts to participate in the single
currency.
3.22 The report also
contains draft legislative proposals which, if the United Kingdom
joins the single currency area, will have unprecedented implications.
These proposals clearly raise matters of legal importance.
3.23 Our initial reaction
to this report was that it would be an appropriate subject for
a short investigation by a Departmental Select Committee. However,
our colleagues on the Treasury Select Committee have told us that
they have concluded that they will not have an opportunity to
consider the report properly in this Parliament. This we understand.
3.24 Despite the importance
of the proposals contained in this report, we are reluctant to
recommend a debate before the various financial institutions in
the United Kingdom have had opportunity to consider the report
and to react to it. At this stage, there are also no legislative
proposals on which Ministers may be required to make decisions.
3.25 Our conclusion
is that we should not recommend a debate at this stage. We shall
ask the Bank of England to let us know the reaction to the paper
from the organisations which it has consulted, and we shall report
again when we have the Bank's reply.
5 National Central Banks.
Back
6 A sale and repurchase agreement for securities. Back
7 A counterparty here means the opposite party in a transaction with the Central Bank. Back
8 The views of the EMI regarding exchange rate co-operation between the single currency area and other Member States were set out in letters of 31 October 1996 from the Chancellor of the Exchequer to the Chairman of the House of Commons Select Committee on European Legislation and the Chairman of the House of Lords Select Committee in the European Communities. We reported on them in our Third Report of the current Session under reference (17540) 10893/96; see HC 36-iii (1996-97), paragraph 1 (13 November 1996). Back
9 Reported in an article in the Financial Times: 13 January 1997. Back
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