Stage Three of EMU draws near - some Finnish comments from the viewpoint oif a central bank
Kjell Peter Söderlund
We are less than two years away from the introduction of the new single currency - the euro. Progress toward Economic and Monetary Union (EMU) gained momentum in December 1995 with the adoption in Madrid of the Ďchangeover scenarioí for the single currency. The scenario, which is based on the Maastricht Treaty, states specifically that Stage Three of EMU is to start on 1 January 1999. The euro is to be created at the same time, although banknotes and coins will not be introduced until up to three years later.
The Dublin Summit last December reconfirmed the intention to go ahead with the project according to the original schedule as several substantial issues were resolved there on the political level. This article discusses some aspects of the EMU process as well as EMU preparations from a Finnish perspective. The focus will be on central bank and monetary stability issues.
Stage One of EMU began in 1990 and Stage Two on 1 January 1994. Five years from that date, EU Member States that meet specified convergence criteria are to move on to Stage Three with its single currency, the euro, and hence to the single monetary policy. Responsibility for the single monetary policy will belong to the European System of Central Banks (ESCB). The ESCB comprises the European Central Bank (ECB), which is yet to be established, and the existing national central banks, which will function in cooperation with the ECB. According to the Maastricht Treaty, the ESCBís primary objective will be to maintain price stability. - And the agreed stability and growth pact will ensure fiscal prudence in the euro countries.
Finland and the EMU
The facts mentioned above are all well known. However, contrary to a fairly commonly held view, Finland is already in the EMU, as are all the other EU Member States. In joining the European Union on 1 January 1995, Finland thereby, according to the Maastricht Treaty, agreed to join EMU in its current Stage Two. This was in accord with the goals of the Finnish Government at the start of negotiations on Finlandís accession to the EU in February 1993.
In ratifying Finlandís treaty of accession to the EU late in 1994, the Finnish Parliament announced that it will decide separately on Finlandís entry into Stage Three. The present Governmentís programme of spring 1995 includes a declaration that it will submit a separate proposal to Parliament on participation in Stage Three of EMU. In addition, the Cabinet Economic Policy Committee stated in June 1995 that Finlandís aim is to fulfil the convergence criteria in order to qualify for inclusion among the first countries to join Stage Three. The most recent manifestation of this aim was Finlandís entry into the ERM. This took place on 12 October 1996 on the basis of a proposal of the Bank of Finland and a decision of the Government within the required multilateral framework of the EU.
Parliamentís participation in decisionmaking regarding EMU is a political reality in Finland, as in some other countries. Under EU law, formal national decisions are no longer needed; according to the Treaty the decision as to which countries will enter Stage Three is to be made by the Council meeting in the composition of Heads of State or Government.
It is Finlandís intent to fulfil the convergence criteria in 1997, thereby enabling its entry into Stage Three from the start. This is clearly the point of departure in the Finnish convergence programme. In light of data on the performance of the Finnish economy in 1996 and updated forecasts for 1997, Finland is well placed to meet the well-known criteria concerning inflation, interest rates, exchange rate stability, and public sector deficit and debt. Meeting the Maastricht criteria is fully in conformity with what would have been set as economic policy goals irrespective of the Treaty requirements. As a matter of fact the criteria cannot be regarded as too restrictive from the viewpoint of Finlandīs internal public sector adjustment needs. In mid-January the Government presented a bill to Parliament on a new Act on the Bank of Finland. This act when passed by Parliament would ensure that the criterion on central bank independence would be met - as required - before the Summit in spring 1998.
As pointed out earlier, the Government has expressed its clear intention with respect to participation in Stage Three. On the other hand, opinion polls in Finland - as in many other EU countries - indicate a clear lack of majority support for the single currency. This is true even though a clear majority of Finns are positively disposed toward EU membership.
In the discussion in Finland many traditional arguments for and against participation in the euro area have been forwarded. The Government has appointed a Committee of Professors with the mandate to produce additional studies on various aspects of the theme ĎEMU and Finlandí before the final political decisions are made.
Instead of analysing the factors behind Finnish attitudes, we will briefly dwell on the grounds on which Finnish participation could or should be evaluated. The EMU project can be seen as a logical continuation of the deepening of European cooperation. EMU can also be regarded as a necessary and/or desirable follow-up to the establishment of the internal market, which will help to maximize the fruits of the internal market. There are also those who stress the political aspects of the EMU project.
The monetary stability argument
There is, however, an additional dimension - albeit one that is intimately related to some of the above-mentioned factors - which is well worth mentioning as we consider the evaluation of fundamental aspects of EMU from the Finnish viewpoint. It has to do explicitly with monetary integration and cooperation. Why would a small country - or indeed any country - want to join a monetary union? What is the logic behind Finland`s interest in participating in deepened monetary cooperation within the EU?
Finland has been fairly successful in restoring macroeconomic balance and improving monetary stability during the last few years. If the monetary part of Economic and Monetary Union, ie the monetary union, is constructed and implemented according to the intentions of the Maastricht Treaty, then EMU will help to sustain monetary stability, the most important element of which is permanently low inflation. This, if anything, is what is sought in a monetary union. Even if monetary stability cannot solve all problems on the real side of the economy, it is a precondition for sustainable achievements in the real economy.
In the last few years Finland has achieved remarkable economic stabilization: low inflation, public sector consolidation and relatively strong economic growth, all at the same time. As our history regarding monetary stability is not very impressive, participation in deepened monetary integration would help to consolidate our credibility gains of the last few years. The other side of the coin is of course the often cited loss of national independence and flexibility in monetary policy. One can however certainly argue that the positive credibility, monetary stability and efficiency aspects of participation in the euro area could outweigh the loss of policy independence.
But there is another aspect of monetary stability besides the domestic one referred to above. The fact that there exists a large number of separate currencies and monetary policies in Europe invites the markets to form views on interest and exchange rates and to mobilize themselves for speculation. In that sense the current monetary fragmentation of Europe is perhaps not optimal, especially not from the viewpoint of a small, marginal currency like the Finnish markka.
The favourable monetary effects envisaged in the context of a monetary union are conditional upon the EMU being based on a solid foundation with participant countries already on a clear path of sustainable convergence. But monetary stability in the euro area also requires sound fiscal policy in addition to the stability-oriented monetary policy that the ESCB is obliged to guarantee under the Treaty. The stability and growth pact - if it functions as expected - will clearly support the stability efforts of the EMU.
Finnish EMU preparations can be seen against the background of the Treaty obligations as well as the political processes of the EMU. Preparations are proceeding in accord with the politically decided timetable; there are no other timetables in existence and there could not be any other such timetables. This applies to the preparatory work of the Bank of Finland and of all the other authorities and economic agents in the entire EU area.
The nature of the decision taken at the Madrid meeting is reflected in the fact that, strictly speaking, no decision on changeover need be taken at the EU level other than that at the summit meeting in spring 1998, concerning which countries are to move into Stage Three.
Political decisions on EMU will of course be made by the countryís relevant political decisionmaking bodies, not by the Bank of Finland. The central bank must be prepared to operate within EMU but equally well to live on the outside if such is the decision.
National central banks have an important role in the preparatory work, within the European Monetary Institute (EMI) framework, as a member of EMI, elsewhere in the EU and in national preparations. The performance of this preparatory work is a technical task based on the Maastricht Treaty, which has been adopted jointly by all EU Member States.
The central bankís technical preparations must proceed so that the euro changeover can be effected as scheduled without any obstacles.
The preparatory work that is Ďsubcontractedí to the central bank must be completed at both EU and national levels during Stage Two of EMU. All operations of the ECB and the ESCB, which are to be executed in euro as from 1 January 1999, must be functioning smoothly. The EMI plays a key role in EMU preparations, particularly those concerning the operations of central banks and other banks. Nevertheless, a large part of EU-level preparations for EMU is done outside of Frankfurt, in Brussels. The EU`s Monetary Committee has an important role since it is basically responsible for preparing EMU issues which are to be dealt with by the ECOFIN and subsequently by the European Council.
The Bank of Finland has specific jobs to tackle
The Bank of Finlandís EMU preparatory work is to a large extent guided by the EMIís currently valid internal plan, the Extended Master Plan (EMP). The EMP covers all anticipated projects, along with requisite definitions and timetables, that are to be completed during Stage Three. The projects relate to the entire scope of central banking as they involve the establishment of a new central banking system (ESCB) with a brand new central bank (ECB) as its core.
The work is carried out on the basis of the preparatory work done by officials in the various EMI bodies. The highest body of the EMI is the Governors' Council; preparatory bodies include the Committee of Alternates and a number of subcommittees and working groups. Some 30 persons from the Bank of Finland participate regularly in the meetings of these subcommittees and working groups. Through these people, the preparatory work is reflected throughout the Bank of Finland.
The Bank of Finlandís own EMU programme is based largely on the EMP projects. In addition to these, the Bank of Finland is involved in several projects that apply only to Finland. These concern, for example, the EMU-induced change in the role of the Bank of Finland. The further central banksí preparatory work advances, the more concrete it becomes and the more extensively central bank staffs become involved.
As far as the Bank of Finland itself is concerned, entry into Stage Three involves a new institutional environment: the Bank of Finland will become part of the ESCB and will continue as a national institution at the same time. Thus, in preparing for EMU, the Bank of Finland must also plan its own future as part of the ESCB.
As for its role in the preparations, the Bank of Finland must ensure that all preparations carried out at the EMI are implemented in Finland, both at the Bank of Finland and elsewhere. In this work the Bank of Finland cooperates not only with other authorities but also very closely with banks, which are immediately affected by the central bankís monetary policy decisions and which act as monetary policy intermediaries vis-à-vis other economic agents.
At the national level, the Bank of Finland participates in the preparatory work within the context of the EMU project under the Ministry of Finance. The projectís primary task is to ensure that all necessary legislative and other measures are taken by 1 January 1999, not only in the public sector but also elsewhere in the Finnish society.