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Speech by Professor Otmar Issing

to the European-Atlantic Group, London 28 January 1999


The text is attached of a speech on 'The Euro - Four Weeks After the Start' given by Professor Otmar Issing, a member of the Executive Board of the European Central Bank, to the European-Atlantic Group at the House of Commons on 28 January 1999.

Among the points Professor Issing made were:

* 'With all the attention and apprehension surrounding the introduction of the euro on 1 January, it is easy to forget that this was just one, albeit very important, step on the long road of European integration.'

* In order to understand European Economic and Monetary Union, which has now become a reality, and in order to gauge its prospects, promises and risks, it is necessary to take a longer-term view and to look back in history.

* The most fundamental precondition for European Economic and Monetary Union, however, was that monetary policy must be unambiguously focused on the objective of price stability and that this is best entrusted to a central bank that is independent from political interference.

* The Maastricht Treaty has assigned the ECB the single, overriding, primary goal of price stability as the basis for accountability.

* This brings me to the possible risks inside Monetary Union. The ECB will do its job, but can we be equally confident that everybody else will do theirs?

* Europe suffers intolerably high rates of unemployment. For the most part, this unemployment is structural in nature and needs to be addressed urgently through labour market reforms and increased flexibility in the wage-setting process.

* Precisely because monetary policy can no longer respond to national conditions, the exact opposite of greater centralisation and harmonisation may be required in other areas. Talk of uniform European wage-setting or an ambitious social union is going in the wrong direction; different productivity and real economic conditions across the euro area must be taken into account more than ever. Following similar reasoning, there is a strong case for retaining and even strengthening national (and in some cases "sub-national") responsibilities for fiscal policies.

* Historically, currency jurisdictions and national borders have tended to coincide. This reflects the simple fact that the right to issue money has always been a key attribute of national sovereignty and therefore monetary union would not appear to be just a small and innocuous step of a primarily technical nature.

* One is indeed hard pressed to find any precedent in history, where sovereign nation states voluntarily ceded sovereignty in the monetary field to a genuinely supranational body. It is therefore clear that European Economic and Monetary Union has been and will continue to be not just an economic, but also a political project.

* The birth of the euro four weeks ago, on 1 January 1999, is certainly not the end of history, nor is it the sudden dawn of an entirely new age. It is, however, an important milestone on the road of European integration.

In answering questions Professor Issing underlined that, contrary to the proposals of the European Commission and of the French and German Finance Ministers for 'greater tax co-ordination' and for 'harmful tax competition to be removed', his own belief was that while economic conditions across the euro area differed undue harmonisation should be avoided.

He emphasised that harmonisation would tend to raise taxes whereas competition would tend to lower them.

* * *


Prof. Otmar Issing

Member of the Executive Board of the European Central Bank
Speech to the European-Atlantic Group
House of Commons, London - 28 Jan 1999

1. Introduction

The birth of the euro on 1 January 1999 was an event of historic proportions. After months and years of practical preparations and testing, the new currency was delivered smoothly, if not entirely painlessly. The irrevocable euro conversion rates for the participating currencies had been adopted by the EU Council in the early afternoon of 31 December 1998. This was the starting shot for the "changeover weekend". During this time, billions of electronic records had to be converted from national currencies to the euro and final tests for the new payments and securities settlement infrastructure were conducted. Several thousand staff members were at work or on call within the Euro-system, which comprises the European Central Bank and the national central banks of the euro area. Tens of thousands more - not least in the City of London - laboured intensively in financial institutions across the globe.

When the markets opened on the morning of 4 January 1999, the baptism of the new currency followed swiftly. In fact, trading in euro had already started in the Sydney market at 6 p.m. (Central European Time) on 3 January. A total of 944 banks participated in the first main refinancing operation of the Euro-system at a fixed interest rate of 3%, which was successfully completed on 5 January and settled on 7 January. In order to assist the adaptation of financial institutions to the new environment of the euro area money market, a relatively narrow corridor for the ECB's standing facilities was set, as a transitional measure, for the period between 4 January and 21 January.

The launch of the euro occurred in an environment of price stability that few observers would have imagined only a few years back. The year-on-year increase in the Harmonised Index of Consumer Prices stood at just below 1% (the last available figure for November 1998), which is consistent with our definition of price stability. Long-term interest rates have hit record lows, which points to a high level of confidence in the ability of the Euro-system to maintain price stability in the future. At the same time - according to current data - real activity in the euro area has, overall, held up reasonably well in the face of considerable turbulence in the global economy.

The euro, which represents an economic area of 290 million people - in terms of the share of world GDP second only to the United States - will, from the very beginning, play an important international role. The health of the new-born currency will be under constant observation and critical scrutiny, both by global financial markets and by the public at large. Let me assure you that the euro's immediate parents and guardians will do their utmost to see to it that the new currency will prosper and flourish and will not stray from the path of stability.

With all the attention and apprehension surrounding the introduction of the euro on 1 January, it is easy to forget that this was just one, albeit very important, step on the long road of European integration. The first four weeks since the launch of the euro have made for a promising start, but this is evidently a far too short time span to assess its prospects for the future. In order to understand European Economic and Monetary Union, which has now become a reality, and in order to gauge its prospects, promises and risks, it is necessary to take a longer-term view and to look back in history. This perspective comes naturally in premises as illustrious as those in which we find ourselves this evening. Only future generations will be able to judge whether the newly born European Central Bank can pass the test of time even remotely as convincingly as the institutions of British democracy have done over the centuries.

2. A look back in history

The long process of European integration started in the immediate aftermath of World War II. It has been characterised by a combination of grand political vision and a succession of small pragmatic steps to reap the concrete benefits of bringing the economies and the people in Europe closer together. The balance between vision and realism has not always remained constant and progress has not always been steady. British leaders over the decades have made substantial contributions to the process of European integration, frequently injecting healthy doses of realism, but also, at various times, providing new ideas and leadership for Europe.

Indeed, it was none other than Sir Winston Churchill who first expressed the vision of a "United States of Europe" in his famous speech in Z|rich on 19 September 1946. As you know, however, he did not envisage that the United Kingdom, whose place would remain in the Commonwealth, would take part.

As you will be equally aware, the process of integration unfolding on the continent later proved to develop a seemingly irresistible force of attraction for many countries not involved initially. This appears to confirm a general principle already noted by Aristotle. In his Politics (Book V, Chapter 6) he writes, if you allow me to quote, "and constitutions of all forms are broken up sometimes from movements initiating from within themselves, but sometimes from outside, when there is an opposite form of constitution either nearby or a long way off yet possessed of power." [Aristotle's Politics, Book V, Chapter 6, translated by H. Rackam MA (Heinemann, 1932).]

To avoid any misunderstandings: The mechanism described by Aristotle in general terms need not work only in one direction. Indeed, in the case of Europe, integration has been a process of mutual adaptation and reciprocal influences. The continuous process of integration has, moreover, been compatible to date with a considerable degree of variation in constitutional arrangements. It is not clear to me why this should not continue to be possible in the future, as long as sufficient common ground is guaranteed.

At the time of Churchill's speech, most of Europe still lay in ruins. Memories of the ferocious wars and destruction that have savaged our continent this century provided powerful political inspiration for closer European integration. This was particularly true for the immediate post-war years, but it appears to hold to this day. The long shadow of the past has, in fact, also been prominent on both sides of the debate over European Economic and Monetary Union. No doubt most of you will recall the arguments raised in some quarters about monetary union as a "question of war and peace", on which opinions differ. The existence of such debates supports the view that monetary union cannot be understood in isolation. It must be seen in the context of the wider economic and political process of European integration.

Having learned their lesson from history, Europeans - starting with the formation of the European Coal and Steel Community in 1952 - turned early to the creation of common, supranational institutions as an engine of integration. This was regarded as the best way to overcome national divisions in a lasting manner and to ensure that integration would be robust in the face of crises. Thus, from the inception of the ECSC to the present day, Europe has embraced a unique mixture of supranational characteristics and insistence on national sovereignty, which is perhaps quite adequately captured by the term "European Community".

Rather than pursuing grandiose political designs, European leaders quickly focused on concrete economic issues, especially after the agreement on a European Defence Community had to be abandoned when it was not ratified in the French National Assembly in 1954. The ideal of European integration as an "ever closer union" was nevertheless enshrined in the preamble to the Treaty of Rome in 1957, which created the European Economic Community (and also Euratom), with the objective of creating a customs union and a common market among Member States. After this had largely been achieved in the late 1960s, the first attempt at monetary union was launched, culminating in the "Werner Report" of 1970, which envisaged that monetary union would be in place by 1980. This first attempt at monetary union in Europe came to nothing in the face of the world wide currency turmoil of the 1970s.

As we now know, the next attempt met with success. It started with the foundation of the European Monetary System in 1979. The Single European Act and the single market programme then prompted increasing calls for further monetary integration in the late 1980s following the logic of "one market - one money". To a non-negligible number of observers, at the time, this logic appeared anything but compelling and a single currency anything but inevitable. Strong commitment on the part of leading European politicians brought this process, once set in place, finally to a successful conclusion. With the benefit of hindsight, the exchange rate crises of 1992-93, which for a moment had seemed set to derail the whole project, actually served to contribute to its success. In the aftermath of this experience, efforts to achieve greater economic convergence intensified and, in the end, allowed a timely launch of the single currency.

The most fundamental precondition for European Economic and Monetary Union, however, was a broad consensus that monetary policy must be unambiguously focused on the objective of price stability and that this is best entrusted to a central bank that is independent from political interference.

3. Price stability and central bank independence

Central bank independence and an unequivocal commitment to price stability are the common tenets of both the monetary policy framework enshrined in the Maastricht Treaty and that currently in place in the United Kingdom. It is now widely accepted - in this country and around the world - that price stability is a common good that is best safeguarded by independent central banks, which are not subject to the usual short-term pressures that characterise the political process. The Chancellor of the Exchequer, Gordon Brown, expressed this very eloquently in his statement on 6 May 1997 when he announced that the Bank of England was to be granted independence. "A fully credible framework for monetary policy can only be built", he said, "if the long-term needs of the economy, not short-term political considerations, guide monetary decision-making. We must remove the suspicion that short-term political considerations are influencing the setting of interest rates". In the words of the Chancellor, "price stabil ity is an essential precondition for the Government's objectives of high and sustainable levels of growth and employment".

These two fundamental lessons reflect the experience in Britain and elsewhere over recent decades. In the case of Britain, like in many other countries, there had been growing disillusionment with the perpetuation of stop-and-go policies. A great number of British Chancellors have been associated with short-lived booms that later turned out to be unsustainable. As a consequence, Britain has now moved a long way towards the philosophy and institutional set-up underlying the Maastricht Treaty. In particular, it is now accepted that the appropriate objective for monetary policy is to maintain price stability over the medium term, rather than to attempt short-run macroeconomic fine-tuning.

Both theoretical considerations and the empirical evidence accumulated over the years suggest that high rates of inflation are, on average, detrimental to growth and employment in the longer run. At the very least, nobody seems to be arguing that inflation is good for growth at any level. An environment of stable prices is a principal precondition for the efficient functioning of a free market economy and sustainable increases in both the standard of living and productive employment. The proposition that monetary policy should have price stability as its primary objective is not only enshrined in the Maastricht Treaty, but has become increasingly consensual across the industrial world and beyond.

A substantial body of research also confirms that independent central banks tend to be more successful in the pursuit of price stability than dependent central banks, without any identifiable costs in terms of output growth or volatility. In the words of Nobel laureate Robert Lucas, "long-run price stability is one of the few legitimate 'free lunches' economics has discovered in 200 years of trying. It (...) can be had for the asking." The principle of central bank independence is firmly entrenched in the Statute of the European System of Central Banks and of the European Central Bank. It is an important precondition for the successful pursuit of price stability in the euro area, but the task of the ECB will no doubt be greatly facilitated if other policy areas follow a stability-oriented course as well.

The Maastricht Treaty provides for a clear division of responsibilities among policy-makers in Europe. In this context, the ECB has been created as an independent supranational institution and given the unambiguous primary objective of maintaining price stability. This set-up reflects the well-founded view that, in this way, the ECB can best contribute to the shared broader objectives of the Community, including growth, employment and social cohesion.

* * *

For the remainder of the speech please see Part 2 and Part 3

Last update: 25 March 1999

© Copyright Anthony Cowgill and Andrew Cowgill, 1999

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