Select Committee on European Union Eighteenth Report


7. When we embarked upon this inquiry, we were well aware that at this stage we could make no more than an interim progress report on how the euro is working. Less than two years have passed since it was introduced, on 1 January 1999. Euro notes and coins will not start to circulate until 1 January 2002, and most of the general public will have little opportunity to judge how the euro affects their lives and to reach conclusions about the success of the euro until some time after that. Even where deep-seated structural and macro-economic changes have begun, it is too soon for their full effects to be felt. Nor is it possible as yet—if indeed it ever will be—to disentangle the effects of the single currency from the other forces at work: the general economic upturn in the countries of the euro-zone, the information technology revolution, the development of the Single European Market, and the discipline imposed by the Stability and Growth Pact (SGP). What our inquiry has shown, however, is that it is not too soon to take a considered, if interim, view on how the euro is working so far. In this regard, we have obviously concentrated on the experience of those countries which are already members of the euro-zone, but we have also taken a broader look at the role of the European Central Bank (ECB), and at the development of the euro itself.

8. Since the Government has expressed its belief that the United Kingdom should be part of a single currency if it is "successful" (provided the economic case is clear and unambiguous), we thought that we could usefully explore with our witnesses, particularly witnesses from Member States participating in the euro-zone, the criteria by which they would measure success, and the extent to which what had happened so far in their view met those criteria. They thought that one would need to examine whether:

  • monetary policy was achieving the desired objective of price stability;

  • the ECB was able to formulate its monetary policy with complete independence, free from political interference or influence either from national governments or from other European institutions, while being transparent and accountable;

  • participating Member States were adopting appropriate fiscal policies, and maintaining budget discipline;

  • looking to the longer term, participating Member States were making or preparing to make appropriate structural changes (both in labour and in product and service markets), there was sustainable economic growth and employment rates and productivity improved;

  • the integration of financial markets proceeded smoothly, and brought the expected benefits of lower levels of interest rates, greater liquidity of markets, the removal of exchange rate risks within the euro-zone and savings on transaction costs;

  • the change-over to the euro proceeded smoothly, in the sense that the mechanics for the introduction of euro notes and coins were well in hand, and the euro was being adopted for accounts and for pricing;

  • the single currency facilitated the completion of the Single Market, with resulting benefits for industries and for consumers from increased competition and from greater price transparency;

  • the single currency enhanced the ability of the euro-zone to respond to economic crises, and did not unacceptably diminish the ability of individual Member States to respond to asymmetric shocks;

  • a "euro-zone mentality" was developing, so that monetary policy, and perhaps other policies, were based on the needs of the euro-zone as a whole, not of individual participating Member States;

  • confidence in the euro-zone and its individual Member States was growing, both within the zone and in other EU countries and in non-EU countries, which would be reflected in the markets.

9. As these criteria emerged, we found them a comprehensive and useful basis for our questioning. Clearly there has been considerable progress in relation to some of the criteria, but less in relation to others.

10. The Member States participating in the euro had sought to join because they saw a likely positive balance of gains. A favourable balance of economic advantage and disadvantage of course brings with it political benefits; but there was more to it than that. The creation and institution of the euro was seen as a major step in the process of greater European integration, and some of the smaller Member States also saw participation in the euro and its institutions as a way of increasing their own political influence on the development of the European Union.

11. All the euro-zone governments from whom we received evidence assured us that so far their expectations were being fulfilled, and even exceeded, and that the euro was a success. Perhaps that was to be expected: the governments concerned could hardly say otherwise. Nonetheless, the sincerity with which their views were expressed left no room for doubt as to the strength with which they were held. These governments, while recognising that it was too soon for definitive judgments, all thought that the combination of the introduction of the euro (together with the other factors mentioned above) had helped to boost the growth of the euro-zone economies and to bring about a substantial fall in unemployment (even though the rate remained too high), and that this had generally speaking been accomplished without excessive inflation or undue demand-side pressures. The Governor of the Bank of England (who described himself to us as being neither a euro-sceptic nor a euro-phile but a euro-pragmatist, and emphasised that he was taking no position on whether the United Kingdom should sooner or later join the euro) judged that so far the euro was working well, and was a success for those who were participating in it.

12. Our evidence suggested many economic advantages. The single currency has reinforced the development of the Single Market by making markets increasingly transparent, and the resulting increase in competition must benefit industry and consumers. Those engaged in trade within the euro-zone no longer have to reckon with foreign exchange risks and transaction costs. Both trade and investment seem to be drawing some benefit from the introduction of the single currency. The evidence suggests that the introduction of the euro has strengthened the disciplines of the Stability and Growth Pact and the determination of participating Member States to comply with them; we have no doubt that compliance with the disciplines of the SGP throughout the euro-zone has contributed to the success of the euro so far, and that continued compliance will continue to contribute to its strength and success.

13. Financial institutions and markets—and not only those within the euro-zone—have undoubtedly benefited, in a way which more than compensates them for the loss of earnings from foreign exchange transactions. The euro is being increasingly widely used for bond and stock issues, with benefit to consumers from the liquidity of the instruments created and to the issuers in reducing the costs of raising money. We were told that the euro now ranks second to the dollar as an international investment, reserve and "anchor" currency, and has the potential to challenge the dollar's leading role. This is an impressive achievement in such a short time, and there is no doubt that there are advantages from the certainty of the nominal exchange rate within the euro-zone and the integration of European money and capital markets.

14. But we have noted the potential downside of the "one size fits all" monetary policy. It has deprived the national governments and central banks in participating Member States of the possibility of adjusting their economies either by alterations in their exchange rates or by differential interest rates. The fact that during the period since the euro was introduced the euro-zone economies have been growing has meant that there have not been any great pressures on individual Member States to break ranks; so there is no empirical evidence on how serious this potential downside might prove to be in practice. But the inability to use exchange rates or interest rates to serve individual national purposes must throw the burden on the two remaining tools: fiscal adjustments and structural changes. The scope for fiscal adjustments is constrained by the SGP. Even if that proves in practice not to be a real constraint, fiscal adjustments tend to be generally slow in producing their economic effects, and are not therefore always an ideal tool of policy. As to structural change, although it is under way, in some participating Member States it may be moving too slowly, leading to sluggish growth and lower profitability, and hence contributing to the fall in the value of the euro. The evidence we received referred particularly to the need for increasing flexibility in labour markets.

15. We looked in some detail at the position in Ireland. Ireland may be a special case: its economy has been growing and developing very fast as it catches up with hitherto more advanced economies; it traditionally has high labour mobility (now in the form of net inflows rather than net outflows); and a high proportion of its trade is with the United Kingdom, which of course remains outside the euro-zone. We understand the political reasons why Ireland was determined to be in the euro-zone from the outset. But the rate of inflation there has recently been increasing rapidly, and the Central Bank of Ireland cannot respond by increasing interest rates. There must be difficulties about using fiscal policies to stem inflation in Ireland, particularly when there is already a comfortable public sector surplus. In these circumstances the SGP plays no part: Ireland is not transgressing its rules and guidelines. High labour mobility cannot be expected to provide a full solution to the problem. We noted, however, that our Irish witnesses—and not only those from the Irish government—thought that Ireland would experience a soft landing. We hope that they are proved right.

16. We gave careful consideration to the functioning of the ECB, noting the need for strong management, for transparency, and for accountability, in a form which does not put independence at risk.

  • On management, we noted that, despite sometimes unfavourable media comment, our witnesses had no fault to find either with the strength and competence of the management of the ECB or with their judgment as evidenced by the nature and timing of their decisions on interest rates. The consensus in the evidence was that the ECB had done pretty well so far. We see no reason to take a different view.

  • On transparency, we welcome the fact that the ECB has been more transparent than had been expected, and is becoming more so. It publishes much of the data on which it bases its decisions. We are glad to learn that it has now decided to publish its economic forecasts. It does not however publish the minutes or voting records of meetings of its Governing Council. We recognise that transparency is particularly crucial for the credibility of a new institution, and that perceived deficiencies of transparency may affect market confidence in the institution and its decisions. But we are clear that the ECB is right to proceed with care in this area: it would be almost impossible, without serious damage to confidence, to pull back. In particular we accept that it would not be appropriate for the ECB to publish minutes or voting records, at any rate at this early stage: as a number of our witnesses pointed out, to do so would run the risk of exposing individual members of the Governing Council to criticisms or pressures from their own countries, and thus of impairing, or at any rate appearing to impair, the independence of the ECB itself.

  • On accountability, we searched first for a definition. Because no-one would expect central bankers to be directly elected, it is arguable that they should not be trusted with decisions which are essentially political: we do not accept that view. But we do believe that they should be subject to the scrutiny of some democratically elected body. While we note the problems that are liable to affect "a currency without a country", we recognise the role of the European Parliament as the European body to which the ECB is formally accountable, and we welcome what we were told of the Parliament's intentions of strengthening that accountability. We do not believe that it would be practicable, or even desirable, to make the ECB also directly accountable to national parliaments. Nor should it be made formally accountable to national governments within the euro-zone. But we think that there may be a case for strengthening the arrangements for the ECB's reporting to the Council of Ministers (ECOFIN) and to the euro-group of Finance Ministers of participating Member States, so long as the independence of the ECB is rigorously observed and maintained.

  • We can see a case for stronger economic co-ordination among participating Member States, under the political control of euro-group Ministers. We do not think that this need jeopardise the ECB's independence. But the position of ECOFIN and of those EU countries who are not participating in the euro will need to be safeguarded. If developments on these lines led to a reduction in casual, and often unhelpful, remarks by politicians, that would be no bad thing.

17. The persistent fall in the external value of the euro since it was introduced is a matter of concern, and was recognised by our witnesses to be so. But we believe that that concern can be and is exaggerated, not least by the media. It may be that (as some witnesses suggested) initial expectations of the euro's attractiveness to the markets were too great. It may be that the rate against the dollar at which it was introduced was too high (although it corresponded to market conditions at the time). There was general agreement among our witnesses, and we are inclined to agree, that at current levels the dollar-euro rate does not correctly reflect economic fundamentals. We noted with particular interest the persuasive argument of the Governor of the Bank of England that it reflects a continuing net outflow of long-term capital from Europe to the United States, and that, once that flow ceases or is reversed—perhaps when relative asset prices have changed sufficiently—the influence of economic fundamentals will reassert itself and the rate of the euro against the dollar will rise again. For the sake of the acceptability of the euro as a world currency, that is a consummation devoutly to be wished. But all this is for the unknowable future; and it has to be said that the fall in the external value of the euro during this period has benefited the economies of participating Member States.

18. We decided to adhere strictly to our subject of how the euro has been and is now working, and not to allow ourselves to look into the future. We have not therefore sought to speculate on how the euro might work in the future in less favourable economic circumstances: if, for example, the macro-economic growth of the euro-zone seriously faltered, or if one or more countries in the euro-zone were seriously affected by economic difficulties which they did not share with other countries (that is, if they experienced what have been described in our evidence as asymmetric shocks). It is to be hoped that the increasing convergence of the euro-zone economies, a growing willingness within the euro-zone and indeed in the EU generally to practise greater co-ordination of economic and fiscal policies, and the gradual development of more flexible policies of structural change, particularly in relation to labour markets, will make such problems less likely to occur and make them more readily amenable to wise management if they do occur.

19. The success of the European Monetary System, of the single currency and of the European Central Bank will be a continuing theme for this Committee. We considered this theme before the single currency was launched; we are reporting on it now in the euro's relatively early days; and we shall wish to return to it in future inquiries, to see how the system, the currency and the Bank fare, and how they rise to the opportunities and cope with the problems that lie ahead of them.

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