The EMI and the changeover to the euro

Robert Raymond*

I.The grand design to merge the national currencies of countries fulfilling specific preconditions and thus to establish a single currency area in western Europe is now very much in the foreground. It has to be seen as being complementary to economic integration and, therefore, as a necessary feature of the Single Market.

The view that European economies should become ever more closely integrated emerged during the Second World War. This evolution started with the Marshall Plan, the implementation of which included a co-ordination of national plans for reconstruction.

The aims were both general and specific.

In general, there was the wish to find a way of avoiding any repetition of the huge policy mistakes which were made between the two world wars and which triggered hyperinflation, recession and competitive devaluation. It was felt that free trade and economic co-operation would help greatly. This philosophy inspired the statute and the mandate of international organisations such as the IMF and the terms of the GATT.

Applied to Europe in particular, this led to the Common Market, a free trade area only, supplemented by the common agricultural policy and an effort to harmonise rules and standardise procedures applied to the real economy. More recently, a further step was to prepare a Single Market, i.e. a market including several countries but functioning as if it were a domestic market, without barriers of any kind. These reforms boosted, and will continue to facilitate, intra-zone trade.

This evolution calls for the use of a single currency at some stage. There is no level playing-field if real exchange rate misalignments exist. Any sudden change in the level of the nominal exchange rate between two currencies harms competition. This has been clear from the outset. The Treaty of Rome states that exchange rates among member countries are a matter of common interest. In 1962 Robert Marjolin suggested in a memorandum that should the Common Market be successful (which it has), it would need its own currency. Well-known reports under the responsibility of Messrs Barre, Werner and Delors prepared the ground for the Maastricht Treaty.

All this is consistent with geography in Europe and with the high degree of openness of economies towards one another. However, it is not consistent with history, tradition and culture, which tend to exacerbate nationalistic reactions.

II. An additional requirement has to be met. It is only worthwhile creating a new currency if it is to be stable, and as reliable as the best European currencies today.

1. Germany was seriously marked by the hyper-inflation which prevailed after the First World War, the resurgence of which was so feared after the Second World War. Added to this distant memory are the more recent experiences of Latin America and even Europe following the oil crises.

However, it can now be claimed that the lesson has been learnt. Ten out of fifteen European Union countries fulfil the corresponding convergence criterion. In most of our countries there are plans to make the central bank more independent. The Maastricht Treaty reinforces the appropriate harmonisation efforts. This development promises interest rate cuts and, in particular, a reduction in risk premia vis-à-vis the Deutsche Mark (i.e. lower interest rate differentials vis-à-vis Germany).

Germany succeeded in exporting its culture of stability, to the advantage of both its neighbours and itself, because it could only benefit from a more sound and stable environment. This, and the realisation of a large and fully integrated market, can only help to improve growth, although it will clearly not resolve per se other structural weaknesses in Europe.

2. Member countries are also working very hard to improve convergence in other fields, especially that of public finance.

As you know, there are two fiscal policy criteria - one is related to the annual budget deficit, and the other to the ratio of government debt to the gross domestic product (GDP). The wording of the second leaves more scope for judgement in that it asks for the speed at which the ratio is approaching 60% to be taken into account if it still exceeds this value.

Indeed, public finances have deteriorated significantly over the past few years owing to the effect of previous tax cuts and structural distortions, such as the inverted pyramid representing the population by age groups. The historical trend in the public annual deficit is far below 3%. This deterioration has to be tackled now, otherwise it will be even worse in future. Those alive today cannot leave the burden of repaying these enormous debts to their children. There is now a universal awareness that waiting longer would only aggravate the problem and make fiscal consolidation more difficult at a later stage. This, independently from the wording of the Treaty, calls for the immediate improvement of the budget and the reform of social transfers.

These two fiscal criteria are the only ones which will apply to the member countries after the start of Stage Three, and there are two reasons for this.

First of all, it has to be possible to ensure that the policy mix, the combination of fiscal and monetary policies, is compatible with durable stability.

Second, it will not be acceptable for any one government to draw too heavily on the total savings accumulated in the monetary zone, because in so doing that government would oust other borrowers by provoking a rise in interest rates.

In Verona, it was clear that there is full consensus on the principle of a stability pact among participating countries in Stage Three. In particular, this will ensure that no free rider will allow its fiscal situation to deteriorate significantly after joining the euro area.

3. Finally, appropriate measures are being studied to ensure that no excessive tension will arise, in particular on the foreign exchange market, between participating and non-participating countries.

III. When the time comes, the changeover to the single currency has to be a success. A badly organised transition can ruin a project for a long period of time.

Considerable progress was made in 1995 to organise the changeover. This was started by the Commission which published a Green Paper at the beginning of the year. The European Monetary Institute then published its own report on 14th November, the conclusions of which were adopted at the Madrid Summit on 15th December.

1. At the beginning of 1999 the countries selected will have what is economically one and the same currency, which will be subject to a single monetary policy managed by an equally single central bank. This central bank will be structured along federal lines, with the yet to be established European Central Bank (ECB) at its centre. The ECB will be set up immediately after the list of member countries of the single currency area has been drawn up, although its operations will not start until 1st January 1999. The national central banks of the countries in this area will gravitate around the ECB. Together, the national central banks and the ECB will form the European System of Central Banks (ESCB).

The decisions relating to monetary and exchange rate policy will be taken by the Governing Council of the ECB, made up of members of its Executive Board and the Governors of the national central banks of the area. The latter will execute the operations which will be decided upon at the centre in accordance with the instructions of the Governing Council.

2. A "super big bang" on 1st January 1999 would be impossible. The modification of all the computer programs in banks and firms to operate in the new unit of account requires time. This work cannot be finalised in the member countries before the list of participants is known (in early 1998). Furthermore, it will take time to teach the public to use a new scale of value. The conversion will not be simple. And the conversion rates will not be definitive until the eve of Stage Three.

The conclusion to be drawn from these observations is that, after January 1999, a period of at most three years will be necessary before retail operations - those performed by credit institutions and public administrations vis-à-vis the public switch from the national units of account to the euro. It is at that point that the euro banknotes will appear, and it is estimated that approximately six months will be needed for banknotes to be exchanged.

However, a new currency will have been in existence from the start of 1999. Individuals or groups cannot be prevented from using it if they so wish. Moreover, it will be necessary for transactions in euro to be performed on the markets very soon, in order to show that this is a Monetary Union and not a system of fixed exchange rates.

3. Therefore, the changeover will inevitably be effected over a certain period of time, during which it will be necessary to organise the co-existence of the euro and the national monetary tokens.

It has been decided that, from the first day of Monetary Union in 1999, the accounts of the commercial credit institutions held at the central banks will be denominated in euro. Nevertheless, these central banks will provide their correspondents who are as yet unable to include the euro in their accounting systems with a "courtesy conversion" into their customary national currency.

The ESCB will provide the financial community with a real-time funds transfer system for the whole monetary zone, which will be capable of transferring the euro. Finally, from January 1999 onwards, at least those government debt instruments which are actively traded on the markets will be denominated in euro.

These measures should encourage the capital and exchange markets to use the euro very quickly, unlike retail operations, which will not do so until later.

4. The EMI is currently working on the preparation of instruments and procedures for the single monetary policy in Stage Three. A global framework will be finalised by the end of this year.

This project can only be brought to a successful conclusion if the efforts needed are undertaken in due time. This is why it requires the agreement and participation of all concerned.


* Director General of the European Monetary Institute