Memorandum by Professor Dr Norbert Walter,
Deutsche Bank
1. What contribution has the introduction
of the Euro made to the level of trade within the Euro zone, and
between the Euro zone and the rest of the world?
Intra-Euro zone trade has been stimulated by
the elimination of exchange rate risks and currency-related transaction
costs as well as by more price transparency and competition. It
is estimated by several studies that the Euro has boosted intra-Euro
zone trade by 5 to 15% on average since 1999. The German Council
of Economic experts estimated that there has been a Euro-induced
surge in German exports of about 18%.
Euro area trade with the rest of the world has
risen roughly in line with world trade in the past 10 years (5Ö%
pa). It is, however, dominated by buoyant growth in the US, Eastern
Europe and in Asia. Interestingly, trade invoicing between the
Euro zone and the rest of the world has notably increased in recent
years (to over 60% on average) thus reducing the exchange rate
risks for firms in the Euro area.
2. What effect has the introduction of the
Euro had on the functioning of European capital markets?
The introduction of the Euro has strongly stimulated
the integration of European capital markets. Debt markets—in
particular the government and corporate bond markets—have
reached a high level of integration both in terms of liquidity
and the availability of instruments. By contrast, equity markets
have shown a moderate speed and extent of integration mainly due
to different national legal and tax systems. But even here the
home bias has lost in importance. For instance, the euro area's
mutual fund industry has increased the share of non-domestic stock
holdings from 40% in 1995 to 70% in 2003.
With the completion of the EMU, the integration
of Europe's financial markets became even more important as a
policy objective. The EU's Financial Services Action Plan has
strongly contributed to the great progress towards more integrated
and efficient financial markets, in particular in the field of
securities. It is now imperative to implement the FSAP as agreed.
However, the EU also needs selective new legislative and regulatory
initiatives in the segments where market integration is lacking
so far: eg retail markets, mortgages and asset management. New
regulations must be set smoothly and not burden industry.
Integrated financial markets are not only to
the benefit of customers and the financial industry but also strengthen
the competitiveness and growth prospects of the economy as whole.
Several economic studies have estimated the economic benefits
of financial market integration with an estimated increase in
terms of GDP between 0.5% and 1.1%.
3. Are there any lessons to be drawn from
the changes in Euro exchange rates since 1998?
The euro exchange rate vis-a"-vis the dollar
experienced a phase of weakness until 2002 (with a lowest rate
of 0.83 USD per EUR) followed by a multi-year upward trend until
2007 (to about 1.34 USD per EUR). However, the amplitudes of the
fluctuation of the EUR/USD exchange rates since 1998 has been
much lower than the amplitudes of DEM/USD rates from the start
of the floating-exchange-rates system In 1973 to 1998. A main
reason is that euro financial markets are much larger and more
liquid than the relatively small DEM markets before 1999 and thus
able to absorb substantial capital flows out of a weak dollar
or into a strong dollar more smoothly. Thus, the euro introduction
has reduced the adjustment pressure of a weak dollar on the Euro
zone's foreign trade sector.
Moreover, the launch of the euro has also eliminated
the negative impact of a weak dollar exchange rate on the intra-European
exchange rate pattern. A weak dollar did not only put pressure
on Europe's overseas exports but also used to triggered an up-valuation
of the DEM and higher interest rates in Germany's partner countries
with negative impact on business activity in Europe as a whole
as we witnessed, for instance, in 1992-93 and again in 1995. Assumed
there would have been the pre-1999 exchange rate pattern until
today it seems to be very likely that Europe would have suffered
massive currency turbulence after events such 9/11 or the terrorist
attacks in Madrid in 2004.
4. Was the recent reform of the Stability
and Growth Pact appropriate?
The reform of the pact in 2005 was necessary
given the fading ownership of the pact rules by France and Germany
and the rising economic heterogeneity of the enlarged EU. The
reform was appropriate as it enhanced the economic rationale and
the flexibility of the budgetary rules over the cycle and took
better account of (longer) periods of weak growth.
I appreciate the strengthening of the preventive
part of the pact by calling for a minimum annual reduction of
structural deficits by 0.5% of GDP p.a. and stronger focus on
budget consolidation in good economic times.
By contrast, I criticised the changes in the
corrective part of the pact insofar as a long list of mitigating
country-specific factors can be brought forward when it comes
to the assessment whether an excessive budget deficit over 3%
of GDP exists. Indeed the pact bestows a great deal of flexibility
on governments which might be abused to dilute the pact and undermine
fiscal discipline. So far, governments with excessive budget deficits
have dealt with the reformed pact in a responsible manner. Admittedly,
the upswing since 2006 has been very helpful for Germany's fiscal
position which was characterized by an excessive budget deficit
from 2002-05.
It is positive that the new pact stresses fiscal
sustainability. However, much more emphasis should be placed on
the demographic challenge in the Euro area.
5. What effect has the introduction of the
Euro had on individual member countries' economic development?
The introduction of the Euro has provided low
interest rates and a substantial fall in the borrowing costs,
in particular in the former high-interest-rate countries. The
ECB's credible monetary policy has also contributed to this. Lower
interest rates have stimulated the economy and supported investment
and employment throughout the Euro area.
A disappointing feature of EMU was the poor
growth performance between 2001 and 2005, not only in relation
to the US but also in comparison with the non-EMU EU member states
including the UK. The reason for this long period of weak growth
in the Euro area was not, as many claim, due to macroeconomic
policies but resonates with a lack of comprehensive structural
reforms in several member countries, in particular with regard
to the overregulated product and labour markets.
6. Has the ECB's monetary policy been too
restrictive?
No. Nominal interest rates have been lower than
in pre-Euro times. Even Germany has benefited from the fact that
interest rates have been lower since 1999 than during DEM times.
This is justified insofar as the average inflation rate of the
euro area from 1999-2006 (2.1%) has been lower than the inflation
rate during DEM times from 1948-98 (about 2.8%). But even real
interest rates were lower in Euro countries after the introduction
of the single currency.
The argument brought forward in 2003-05 by some
Anglo-American economists that the German economy would have suffered
from too high real interest rates and borrowing cost is not valid.
The corporate sector did not complain about a too restrictive
monetary policy. Real interests, however, have remained even lower
than during DEM times when the German economy embarked on a brisk
upswing in 2006.
Nevertheless, the ECB has achieved, on average
since 1999, an inflation rate only slightly above its definition
of price stability ("below but close to 2%"). The policy
yardstick of the ECB is "Harmonised Index of Consumer Prices"
(HICP). Thus, the ECB has, by definition, a one-size-fits-all
problem as it cannot take into account inflationary pressures
of individual fast-growing countries such as Ireland. Special
national inflationary problems must be addressed by national policy
such as fiscal, structural and wage policies.
7. What impact will the expected enlargement
of the Euro zone have on
a. The functioning of the Euro zone economy?
The enlargement of the euro zone will further
promote trade integration as such a step will eliminate the exchange
rate risks and exchange-related transaction costs between the
euro area and the new EMU member states. This will make it easier
for the Euro zone economy to continue to benefit from the strong
growth in the new EU member states.
The impact on the functioning of the Euro zone
economy will, however, be limited for the time being given the
fact that the overall economic size of the 11 new EU member states
(Slovenia is EMU member state since 2007) is only about 7% of
the euro zone's GDP and the bigger countries such as Poland, Hungary
and the Czech Republic are only expected to join EMU after 2010.
b. The management of monetary policy in the
Euro zone?
Euro zone enlargement affects the ECB in various
ways. The ECB has established a close cooperation with new EU
member states in order to prepare them for EMU membership. The
cooperation comprises areas such as monetary policy, banking supervision
and payment systems. The ECB will also be party to the agreement
on entering the ERM II in the pending cases of the abovementioned
three bigger countries as well as Romania and Bulgaria.
The basis of ECB's monetary policy will be little
affected given the relatively small economic weight of the new
EU member states. However, the voting procedure in the Governing
Council of the ECB will have to be adapted as the governors of
new EMU member states will also become members. The Governing
Council is already rather big (six members of the Executive Board
plus 13 national central bank governors). In order to deal with
the problem of an efficient decision-making in a growing Euro
zone, a rotation system was agreed in 2003 implying that all Governing
Council members are allowed to attend all meetings but, as soon
as EMU has more than 15 members, voting rights will rotate among
national central bank governors. The rotation system has, however,
some serious disadvantages, though, as it is very complicated
and intransparent. A further weakness is that Germany and France
would no longer have a permanent voting right.
FURTHER READING
OF DEUTSCHE
BANK RESEARCH
PUBLICATIONS ON
THE EURO
— Norbert Walter, The euro—a
success story, Welt am Sonntag, Jan. 7, 2007.
— Norbert Walter, Stefan Bergheim (2006),
Productivity, growth potential and monetary policy in EMU, EU
Monitor, Reports on European integration, No. 42.
— Raimar Dieckmann (2006), EU asset
management, Towards the creation of a single market in Europe,
EU Monitor, Reports on European integration, No. 37.
— Norbert Walter, Werner Becker, Marion
Mühlberger (2006), Estonia, Lithuania, Slovenia: Poised to
adopt the euro, Views on medium and long-term convergence, EU
Monitor, Reports on European integration, No. 33.
— Werner Becker (2005), Reform of the
stability pact—a license to run up debt, EU Monitor, Reports
on European integration, No. 23.
— Werner Becker (2004), The institutional
framework for accession to EMU, EU Monitor, Reports on European
integration, No. 12.
— Norbert Walter (2000), The euro:
second to (n)one, American Institute for Contemporary German Studies,
German Issues 23.
10 April 2007
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