Examination of Witnesses (Questions 1
- 19)
TUESDAY 13 JUNE 2000
MR JAMES
BARTY, PROFESSOR
IAIN BEGG,
MR ROGER
BOOTLE, PROFESSOR
WILLEM BUITER
AND DR
DANIEL GROS
Chairman
1. Welcome. I am sorry to keep you waiting.
As you know, this is not an inquiry into whether we should go
in and join the euro or whether we should not. It is an inquiry
into the progress of the euro and future prospects of Euro-land,
about convergence between the UK and continental economies and
so on. We accept that our questions have political implications,
of course, but we are trying to make this a technical exercise,
given the fact that the Committee reflects the House of Commons
and is split and we have a majority broadly in favour of entry
in the right conditions and a minority which is against. So thank
you very much. I think I am just going to ask an opening question
which I may ask you all to give a short answer to which is how
would you assess the first eighteen months of the euro, of the
economic and monetary union. Dr Gros?
(Dr Gros) Thank you. I would say so far
so good. On the technical side I would say very good; the Target
system works very well; the inter banking market is also showing
signs of functioning well—
2. Can I just interrupt you a second to say
that we have very bad acoustics in this room, so would you mind
speaking up?
(Dr Gros) I will try to, yes. I would say so far so
good; better on the technical side in terms of the infrastructure
on the banking market and the monetary policy operations. The
one thing that was not satisfactory—namely, the fixed rate
tenders—have now been re-amended, so I would say on the
operational side it is a full success. The euro has also functioned
very well on the international monetary and financial markets.
The economic performance has also been good, I would say, but
not excellent; price stability is guaranteed for the foreseeable
future and unemployment has been going down, as you know, and
the growth prospects are, I would say, pretty good—perhaps
not as excellent as they are in the United States. So compared
with the past performance of the EU I would say it is distinctly
above average and certainly above the experience of the last years,
but perhaps not as excellent as in the United States.
(Mr Bootle) I largely concur with that. I think the
performance has in many ways been remarkably good in the sense
that this was an extraordinary thing to have achieved, to set
up a new currency, and all the more so given the international
conditions that existed at the time. I think it should not be
forgotten that when the euro was begun this was a period of considerable
instability in the world economy and world financial markets.
I think a lot of people when they consider this question automatically
associate it with the performance of the currency on the exchanges—that
is to say, how weak the currency has been—and that has been
a considerable surprise to many people and a disappointment to
some. I do not think myself it says anything about the performance
of the currency system or the institutions that have been set
up around it. It is simply another example of exchange markets
moving currencies to a considerable degree which they have done
over many years with regard to the yen, the pound and the dollar,
and I do not myself think it has particular implications. One
area where I think the arrangements have been quite weak is with
regard to presentational features of the ECB procedure. There
has been a sense in which I think that could have been improved.
The markets have been confused and, in some cases, misled but
it is early days and there is scope for that to improve.
(Professor Buiter) Again, I would second most of these
sentiments. From a technical point of view, things have worked
even better than the most enthusiastic proponents could have hoped,
with Target operating well, an active interbank bank market and
corporate issuance which has taken off at a rate which I think
is quite remarkable. The influence of the euro on the wave of
cross-border mergers and takeovers that now takes place in the
euro zone is also something to point at. It seems to definitely
have been a plus for the serious restructuring that the continent
requires. The monetary policy conducted by the ECB has, I think,
been conjunctionally appropriate; they have done the right thing
at the right time. As Mr Bootle pointed out, the euro was born
immediately following a period of global financial turmoil, so
they have come through that pretty well. I think there are some
problems not just with presentation of the monetary policy but
also as regards the clarity of the target, the twin pillars, the
meaning/significance of the monetary reference numbers that have
been tossed around—and there continue to be some accountability,
openness and transparency issues. The real economic performance
in Euro-land has been good and is likely to continue to be quite
robust. We have growth now at a rate that finally puts a dent
in continental unemployment even in the core areas where it has
been high for quite a while now, and that is good news, and also
I think that the growth that we see here now is more balanced
and less driven by irrational exuberance than the growth which
is still proceeding in the United States today, so I am more impressed
with the quality of growth that we are getting there at the moment
as opposed to what we are seeing in the US.
(Professor Begg) Chairman, I think we are seeing remarkable
agreement amongst economists! I would draw a distinction, though,
between the internal and external perceptions of what has gone
on with the euro. Internally I think things have worked well within
Euro-land; externally we are dominated, especially in this country,
by what we see on the foreign exchange markets which is that the
euro is a complete disaster. I think that is a false perception
but one that has nevertheless become very popular. I would concur
with Willem Buiter in saying that the decisions on monetary policy
have been by and large correct; they have sustained a growth that
was probably going to happen anyway. They have not damaged it
which is giving it faint praise. Plainly the fall of the euro
is unfortunate from the point of view of the way the currency
has developed. I think it has been exacerbated by bad presentation
and a lack of clarity on the ambitions of both the ECB members
and the finance ministers of Euro-land for what they want and
that has been perhaps the weakest point in the way it has developed
so far.
(Mr Barty) I am not really diverging from the agreement
we have had so far. I do think that the 18 months or so we have
had since the start of the single currency area have proved to
be reasonably successful and the ECB has conducted monetary policy
quite appropriately. I do agree there have been teething problems
and certainly their presentation at times has been lacking. I
think that you could even argue they have misled markets from
time to time. Whether that is a function of inexperience or a
function of the structure of the ECB is something which I am not
quite sure about. You have seventeen members on the Council; that
is a lot of members to get a degree of consensus. But in terms
of the monetary policy stance, I think it has been very appropriate;
it has been very loose which, given the very low inflation rate,
high unemployment and weak growth at the start of monetary union
was appropriate. On economic performance, low inflation has been
sustained on a core basis; growth has improved; it looks like
growth is going to be 3.5 per cent or plus this year and probably
carrying that on into next year—that is a good performance.
On the euro, I would say that perhaps the timing is unfortunate
but it is more a reflection of dollar strength necessarily than
euro weakness. Every currency has struggled against the dollar
over the last 18 months which is not surprising given the strength
of the US economy. Maybe it has been exacerbated by, again, a
lack of clarity in the ECB at times. The only other thing I would
add is that, as I put in my written evidence to the Committee,
I think it is too early really to pull any conclusions from any
signs of strains in some economies in the euro area. On the whole
they have been reasonably well behaved but I think in some of
the faster growing economies there are beginning to emerge potentially
some signs of divergence. Ireland is an obvious example but also
the likes, potentially, of Spain and Finland. That is something
which will be worth watching very closely in the years to come.
Chairman: Thank you very much. Commendably
brief.
Sir Teddy Taylor
3. While the enthusiasm is quite clear, I see
that Mr Bootle in his paper to us said that the euro's weakness
has been something of a puzzle. I would like to know what reasons
the team think that we have had such a poor performance. We have
suggestions put forward in papers to us. One of them was, in fact,
the outflow of capital since the euro started. For example, I
am told there has been a direct investment outflow of 140 billion
euro. I wonder if Mr Bootle thinks one of the main reasons for
poor performance has been the fact that capital has simply flowed
out of Europe since they established the euro?
(Mr Bootle) This is one of these questions where I
think one has to be very careful because one can confuse accounting
facts with economic explanations and, if you look at the breakdown
of the balance of payments, it is true to say that for a substantial
part of the period in question there was a significant outflow
of direct investment. Whether that actually economically explains
the weakness of the euro is I think a further stage and in particular
what one has to ask, I think, is why, given the fundamentals,
there was not a countervailing supply of different sorts of capital
buying the euro at levels of the exchange rate which seemed far
too low given the fundamentals. So I think that is part of the
story but it seems to me to beg quite a lot of other questions.
4. Mr Barty talked about Ireland. A second suggestion
made for the weaknesses by the IOD who sent us a splendid paper
and they said one of the worries they saw was that, instead of
becoming economically convergent, in fact, the nation states within
Euro-land are diverging and they have given us a pile of figures.
Do you think the divergence of the European countries, some like
Spain and Ireland doing very well and some like Italy doing badly,
is a worry and could affect the currency markets?
(Mr Barty) I am not sure it dramatically affects the
currency market. I think it is a potential worry going forward.
What I would argue is that you need to see these economies over
the full course of a cycle to decide whether there is real divergence
or not. Some countries may well be more sensitive to short-term
interest rates particularly, for example, Ireland than others
and it may well be that they slow more rapidly once the ECB moves
rates to a higher level. The Irish situation is a peculiar one
and you cannot attribute all of the problems in Ireland just to
monetary union. The Irish economy was growing very rapidly and
credit growth was very fast even in advance of monetary union.
I flagged it up in my paper because I think it is something we
need to keep an eye on; there are some signs that some economies
are growing faster than others. I certainly think the Spanish
economy, the Finnish economy and the Irish economy are going to
run into capacity constraints ahead of, for example, the German
and Italian economies. I am not sure that itself underlies the
weakness of the euro. As I said, the weakness of the euro is as
much a problem of dollar strength as it is euro weakness and,
if you look at what happened last year, most economists started
last year forecasting that the euro-zone would grow at about 2
per cent; that is broadly what it grew at last year. If you look
at most economists' forecasts for the United States, they started
again at about 2 per cent but US economy grew at over 4 per cent.
Even more recently, at the end of last year, the consensus forecast
for the US economy was a bit over 3.5 per cent; now it is about
5 per cent. I think those upward revisions to US growth rate have
as much to do with the weakness of the euro against the dollar
as any intrinsic problems with the euro as a whole.
(Dr Gros) I would just like to mention a fact which
is that, if you look at divergence within the euro area, of course
if you take cases like Ireland and give them the same weight as
Germany, then you find the euro area is diverging. If you weigh
countries by their proper weight, namely GDP and population, then
you actually find that divergence within the euro area has decreased
over the last years, divergence both in terms of inflation and
growth rates.
5. I am sure that would be very reassuring to
Ireland but my final point is this: perhaps Professor Buiter could
give me some information because of his long knowledge and experience
on the Business for Sterling Group who put forward a suggestion.
They said one of the reasons is because the Euro-land is over-regulated,
over-taxed and not conducive to the development of the new economy
and that, for example, their bankrupt pension system will cause
political problems and impose either massive tax rises or massive
spending cuts. Do you think that kind of basic problem might have
infected the international money markets and the international
people saying "Do not touch it because the economy has foretold
these terrible problems", and we do know there is a massive
difference between taxation and bureaucracy.
(Professor Buiter) The particular quote sounded to
me like a rather cavalier distortion of the true state of affairs.
It is a piece of propaganda rather than an economic analysis.
There are parts of the European economic area, indeed, that need
structural reform. Some countries have made remarkable progress—the
Netherlands is one of them; in fact Spain has done rather well,
and also some of the Scandinavian countries. The notion that the
European continental economies are not well set up to deal with
the internet revolution and the e-everything revolution is also
an assertion rather than a fact. I think that in some dimensions,
the Nordic members, for instance, are well ahead of really anybody
in the world so again you have a very uneven picture. There is
no Euro-land answer even to the problems of distortions or to
the problems of being ahead or behind of the game in terms of
the e-commerce revolution. As regards the defunct state pension
schemes that, again, is a simplistic misrepresentation. The pension
schemes people refer to are the unfunded pension schemes and,
by definition, an unfunded, pay-as-you-go, scheme cannot be bankrupt
because it is not funded, so you pay basically current benefits
out of current contributions. If the political promises implicitly
made as regards the benefit are, because of demographic developments
or technological growth whatever, no longer commensurate with
the political promises to the contributors, then something will
have to give and something will give, just as, in this country,
it gave. When the promises to the beneficiaries, to the pensioners
and the contributors were no longer reconcilable in this country,
the pension entitlements were written down by moving from linking
to earnings to linking to prices. In Euro-land some sort of reconciliation
will also take place. It will take the form partly of a cut in
benefits; partly, I think, the form of longer working lives—
6. Longer working lives?
(Professor Buiter) Oh, yes. We are moving into an
era, at least in the demographic deficit countries, in the absence
of massive migration, of an increased scarcity of labour of all
kinds, and I expect to see in decades to come that the age in
which one can retire with the full benefit of pension will be
raised rather than lowered, yes.
7. So you do not think it is relevant at all
that, for example, we are told that in Euro-land the average tax
as a proportion of GDP is 44 per cent and in Britain it is 37
per cent and elsewhere it is 30. Something must be influencing
the people who buy and sell currency. If you are saying that is
all rubbish, what is the reason?
(Professor Buiter) Different countries have very different
sizes of their public sectors. The average in Euro-land is higher
than the average in the UK. Of course, not every Euro-land country
is higher than the UK. Ireland, for instance, is below the UK.
8. They are doing very well?
(Professor Buiter) You cannot disentangle the high
taxes from the high spending. There are real benefits associated
with the higher public expenditures and different countries will
be able to sustain indefinitely quite different sizes of the public
sector according to their national preferences as long as there
is an effective way of linking the entitlement to the benefit
of the public spending somehow to contributions made through taxes
and in other ways. As long as that can be done, very different
views of the state can be expressed effectively within the European
Community.
(Professor Begg) There is a short term trend in the
exchange rate which is what your question seemed to be about,
whereas the structural things you are referring to are very long
term processes. Nothing structural changed at the beginning of
January 1999 to explain why the euro should suddenly fall. That
is the short term. If there are long term problems they would
manifest themselves over a period of years—not as quickly
and as reversibly as the change in euro has been.
Mr Beard
9. Why would you say that the external value
of the euro matters at all? If you were a German small businessman,
you would be trading within the euro area; you may go on holiday
to Spain; you would not experience a drop in the value of the
euro; so why is it achieving so much publicity and concern?
(Professor Buiter) I think there are two reasons for
that. One is a good reason: that depending, of course, on what
the cause of the weakness is, a weaker currency has an impact
on the price level and, through that, on the rate of inflation
that the ECB implicitly targets. So as a contributor to price
stability or a detractor from it, the external value of the currency
matters. That is the good reason. It also matters, of course,
for real economic performance. We know in the UK the consequences
of a seriously out-of-equilibrium external value of currency which
causes an imbalance between the externally exposed and externally
sheltered sectors. It is, of course, less of a problem for Euro-land
as a whole because it is a much more closed area, rather like
the United States. Part of the excessive concern about it is due
to the fact that people still look at Euro-land the way people
looked at the external value of the currency for its individual
components before. Clearly, for Germany even, the external value
of the currency was a greater concern before 1999 than it is now
because they are locked into this large common currency area.
So partly it is justified; it is connected with inflation; it
causes imbalances in the composition of the external demand and
domestic demand but also part of it is failure to adjust to the
fact that Euro-land is more like the United States which can,
in some sense, afford to treat the external currency with benign
or malign neglect, rather than like the old system where this
was much more directly relevant.
10. But would you agree that none of these adverse
consequences have been experienced so far and at what point, if
it kept on falling, would you think it would be experienced?
(Professor Buiter) Of course the euro has now reversed.
The ECB has always made it very clear that they were concerned
about the external value of the euro if and to the extent that
it undermined price stability—not in and of itself. At some
point, certainly when it started going way below 0.90 against
the dollar, there were serious threats. But there has been a recovery
now and I think as long as the ECB makes it clear that they will
respond to the consequences for price stability of moves in the
exchange rate, either way, that commitment itself will in due
course, once familiarity grows with the operating proceedings
of the ECB, limit exchange rate movements.
Sir Michael Spicer
11. Dr Gros, in your list of the virtues of
the euro, you mentioned that unemployment was coming down and
it is quite true that it has come down to just over an average
of 10 per cent to just around 10 per cent and this compares with
the US around 5 per cent and the UK of 5 per cent. What is the
reason behind this abysmal performance in Euro-land, and would
it possibly be the case that it has suffered from fixed and managed
exchange rates now for at least ten years and the euro and the
present regime is part of that? To what extent is fixed exchange
rate the reason behind this unemployment rate?
(Dr Gros) I would see it the opposite way. I would
argue that the fixing of the exchange rates and the framework
of the EMU has already led to a slight fall of unemployment and,
moreover, I would say it would lead to a continuous pressure on
national governments to continue further in the right direction—namely
of de-regulating the labour markets and adapting their structural
reforms. The starting point, however, was very bad. One has to
distinguish between the starting point and the effect of the EMU.
The starting point was very bad partially because of the very
tight monetary and fiscal policy that had to be conducted because
some countries were starting with too high inflation and too large
deficits, and bringing these down had some costs in terms of unemployment.
So that was a very bad starting point. From there on, however,
I think we are going downhill—I would say all the way—in
the sense that, from now on, national governments can no longer
use active monetary policies or fiscal policies. Basically all
they have left is competing on structural reforms. They are doing
that—slowly, I admit, but usually they are going in small
steps in the right direction and they are basically set for a
rather long-term period of above average growth which will slowly
bring down Europeans' unemployment level.
12. But that argument would be much more plausible
were the euro something that had just come out of the blue and
were it not resulting from or being part of continuing fixed exchange
rates which go deeply back into the ERM. Would you not accept,
at least, that, during the period of the ERM for which the euro
is merely a development, fixed exchange rates did play their part
in creating unemployment levels?
(Dr Gros) Yes. There were some countries for which
that was the case.
Mr Beard
13. Mr Barty, what has been the reaction of
the financial institutions to the launch of the euro in terms
of borrowing and investment, in your assessment?
(Mr Barty) If you want to talk about the reaction
of financial institutions I would re-angle your question which
is, if you look at the development of the euro capital markets
since the single currency came into force, what you basically
see is a much deeper and broader capital market. In my note I
made the point that, if you look at corporate bond issuance in
the euro-zone, or denominated in euros, it is now running much
faster than dollar bond issuance and the dollar was the main corporate
bond issuance prior to monetary union. So that has happened. I
think you can also see it in the euro zone equity markets as well.
There are a lot more investors these days who invest across the
whole euro-zone market; it is much less country-focused; there
is more depth to the market; there is a higher issuance in the
euro-area as well as a result of single currency, and that is
just a natural function of the fact that you have taken eleven
different financial markets and created one financial market and
it is much deeper and broader. I think you can see that in a number
of areas. Companies have been able to go and tap the euro area,
both the equity and bond markets, for much larger amounts of capital
than they could have before.
14. So has borrowing, in other words, exceeded
investment?
(Mr Barty) I was not really addressing it in that
way; I do not think that is really the answer I would give.
15. Is there any evidence of that?
(Mr Barty) No. If investment tends to exceed savings
then you would end up with a current account deficit. Europe still
runs a current account surplus and that is primarily because we
run a slight surplus of savings over investment. If you are looking
at the effects of the euro area on financial markets, you have
to look at how it has actually facilitated borrowing and equities.
16. To what extent do you think the euro itself
has facilitated investment?
(Mr Barty) I think it is far too early to try and
get a feel for that. Investment is something which is driven much
more by cyclical factors. The low interest rates that the ECB
has introduced has undoubtedly stimulated investment and that
has started to rise. The information technology revolution as
well is going to stimulate investment and disentangling those
effects from just the impact on single currency is impossible
at the moment.
17. Although it has been weak during this last
twelve months or so, do you believe it has already assumed the
status of a reserve currency?
(Mr Barty) I think it has taken over the role of the
other European currencies that were there as reserve currencies
before that. The evidence of a significant shift into the euro
out of the dollar, for example, as a reserve currency is pretty
thin. There is no really good hard data on it. I was asking our
foreign exchange department last week about this and they said
we do not have any new data that would show a shift one way or
the other but our feeling is that, as we currently stand, there
has not been a big shift into the euro as a reserve currency.
18. Does it matter whether it becomes a reserve
currency or not?
(Mr Barty) I think from a credibility perspective
certainly the ECB would like the euro to become a reserve currency.
To be honest, over time, it would. You have to remember the euro
area economy is second only to the US in size and therefore, as
the euro becomes a more mature currency, it would be natural for
other central banks to hold it in their portfolios and, therefore,
I think it will develop over time into an international reserve
currency. But you have already seen some of the developments of
the euro and I made the point in my note that the development
of the advent of the euro has allowed capital markets to function
much more effectively in the single currency area and that in
itself will actually increase the demand for the euro.
Sir Teddy Taylor
19. Could I ask Dr Gros a question about the
paper which he very kindly sent to us about the future. You say
here in the press report, "That suggests the euro is likely
to stay weak for some time", and then you argue for intervention
and suggests that you want to get the US states involved in helping
to prop up the euro. What I am wondering is why do you think the
euro is likely to stay weak for some time because obviously that
is something which would cause concern to the optimists?
(Dr Gros) Let me just rectify that we do not argue
for interventions. I said, "If ever interventions were to
be undertaken, they should be undertaken only in concert with
the US authorities". So there should never be any unilateral
intervention by the ECB.
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