Statement by Jean-Claude Milleron on Monetary and Exchange Rate Policies of the Euro Area

For the time being—and possibly for a considerable time to come—developments and prospects for the euro area are quite favorable. This upbeat outlook is underpinned by buoyant activity indicators and a supportive policy mix. High household and business confidence, rising capacity utilization and industrial production, strong job creation, and—so far—employment-friendly wage settlements point to sustained activity in the near term. Moreover, the macroeconomic fundamentals in the euro area appear much sounder than in previous recoveries.


For the time being—and possibly for a considerable time to come—developments and prospects for the euro area are quite favorable. This upbeat outlook is underpinned by buoyant activity indicators and a supportive policy mix. High household and business confidence, rising capacity utilization and industrial production, strong job creation, and—so far—employment-friendly wage settlements point to sustained activity in the near term. Moreover, the macroeconomic fundamentals in the euro area appear much sounder than in previous recoveries.

As you may know, France presently holds the Presidency of the European Council. My statement expresses the common views of the Euro-area Member States and of the European Community/EMU in their respective fields of competence.

The Euro-area Executive Directors welcome the overall well-balanced assessment of economic developments and prospects in the euro area. They agree with the main conclusions.

While the staff suggests caution regarding the longer-term prospects of sustaining economic growth, it is important to recall that the level of integration as well as the inception of monetary union have substantially changed the landscape of policy making in today’s Europe. Contrary to the 1980s, there is now a broad and uncontested consensus in Europe about the virtues of budgetary consolidation, low inflation, and continued wage moderation.

In addition, structural policies are now at the heart of Europe’s reform agenda. The achievements in the field of deregulation and privatisation are substantial. Although their economic impact in terms of productivity improvement and expansion of productive potential is still difficult to measure, competition has intensified, prices have come down, and the functioning of products, services and factor markets has improved.

Assessment of short term economic prospects

The IMF paper draws a very positive picture for short-term growth prospects. The growth rate of around 3½% per annum this year corresponds to that of the European Commission. The maintenance of that growth rate for 2001 strongly depends on the underlying assumptions. A continuously high oil price could work as a brake for domestic demand, as growth in real disposable income would be dampened by a deterioration of the terms of trade.

Directors agree that economic fundamentals in the euro area basically remain conducive to growth. The clear commitment to macro-economic stability and continued structural reform should enable the euro-area economy to weather the adverse impact of the surge in oil prices whilst ensuring sustained economic growth and a steady decline in unemployment over the medium term. This will also be important in view of the needed adjustment in world current account imbalances.

Exchange rate developments

Directors share the view that the euro exchange rate is significantly undervalued at current levels. This is a matter of concern. Estimating the magnitude of this undervaluation is an intrinsically difficult exercise. The unexpectedly robust performance of the US economy relative to that of the euro area can explain part of the depreciating trend of the euro since its launch. Amongst other factors is the need by institutional investors to diversify the currency composition of their portfolios. Moreover, the remarkable progress in broadening and deepening the euro capital market brought about by the introduction of the single currency has greatly enhanced the borrowing capacity of the corporate sector and has consequently enhanced its capacity to buy foreign companies, particularly in those areas where Europe is technologically leading such as automobiles or mobile phones. In the long run, these investments should increase the competitiveness of the euro area and support the euro. While Directors consider the current exchange rate of the euro as being out of line with economic fundamentals, they agree that this should be a temporary phenomenon, as cyclical factors should also work in favour of the euro, in addition to ongoing structural reform having an enhancing impact on economic efficiency of the euro area.

Directors believe that a strong euro is in the interest of Europe. Therefore, they welcome the statements by the Eurogroup Ministers and the ECB President of 8 May and 8 September 2000, which indicated that the level of the euro did not reflect economic fundamentals. They welcome the success of the 22 September 2000 intervention by the ECB, jointly with the FED, the central banks of the United Kingdom, Japan and Canada, in the foreign exchange markets.

Monetary policy and outlook for price stability

The ECB broadly agrees with the Fund’s staff appraisal of the euro area monetary policy. During the year 2000, inflationary risks gradually increased in the euro area and this has led monetary policy to react appropriately, by raising interest rates in a pre-emptive manner.

First, the rising inflationary risks were signaled by the protracted deviation of M3 growth from the reference value set by the ECB. This and the high credit growth in the euro area indicated a situation of ample liquidity. Second, developments in oil prices and the depreciation of the euro exchange rate also contributed to shift the risks to price stability upwards. As emphasized by the Fund’s staff, particularly in a phase of strong growth, the risk had to be taken seriously that increases in import prices gradually translate into consumer price inflation.

As regards the near-term inflation outlook, the ECB considers that, unless energy prices were to fall significantly in the coming months, HICP inflation rates may remain above 2% for a more protracted period than earlier expected. The ECB shares the concerns of the IMF on the potential development of second round effects of the rise in oil prices and the weakening of the exchange rate. Against this background, it is crucial for monetary policy to ensure that longer-term expectations of economic agents remain confident in the maintenance of price stability. In this respect, the latest increases in ECB interest rates should contribute to guide the wage and cost formation process in the euro area. However, if inflationary pressures in the context of the current upswing were to be aggravated further by too lax fiscal policies or excessive wage developments, monetary policy would have to react accordingly.

The ECB agrees with the view of the IMF that monetary policy has to follow a symmetric approach with respect to upside and downside risks to price stability. The ECB’s monetary policy will always be based on the objective to maintain price stability in line with the definition published by the ECB. The focus on maintaining price stability is also crucial to sustain the expansion under way, creating a favorable environment for GDP and employment growth.

The weakening of the euro also raised concerns for the world economy. On 22 September, at the ECB’s initiative, the monetary authorities of the United States, Japan, the United Kingdom and Canada joined the ECB in a concerted intervention in the foreign exchange markets. While it is still too early to assess the lasting effects of this intervention, so far the euro exchange rate has shown greater resilience. Nevertheless, the ECB considers that the euro continues to be out of line with euro area fundamentals.

Fiscal policy

Directors share the Staffs view that there is a risk of overall fiscal stance becoming pro-cyclical in the euro area. Therefore, Member States should avoid pro-cyclical fiscal policies. In this context, the three fiscal policy requirements identified by the Staff are relevant: using the recovery to achieve lasting consolidation, reinvigorating supply by reducing the tax burden and consolidating expenditure.

According to recent budgetary developments, the targets contained in Member States’ budgetary plans for 2000 - the stability programmes - are likely to be overachieved, partly due to more favorable developments. The strong commitment of Member States to fiscal consolidation was stressed in the Broad Economic Policy Guidelines which called on Member States to introduce expenditure restructuring and reduce the tax burden while enhancing budgetary consolidation. In particular, a number of criteria have been put forward with respect to carrying out tax reforms : Member States should abide by the close-tobalance or surplus principle; tax cuts must not be pro-cyclical; account must be taken of the level of public debt and long term sustainability of public finances; and tax reductions should form a part of a comprehensive reform package.

Directors agree that the stability programmes of euro area countries could be further improved along the lines indicated by the IMF. First, in order to avoid a pro-cyclical bias in the implementation of the Stability and Growth Pact, the assessment of the medium term budgetary targets should focus on cyclically-adjusted budget balances, in spite of the uncertainties surrounding their calculation. Second, Directors are aware that budgetary strategies should be based on realistic assumptions on economic and budgetary developments.

Structural Policies

Directors underline the crucial importance of appropriate structural policies and reforms hi improving the conditions for sustained economic recovery and growth. They welcome the recognition by the IMF that much has been achieved over the past decade, and generally subscribe to the IMF recommendations. EU Heads of State or Government decided at their Summit meeting in Lisbon in March 2000 to put structural reforms at the very top of the EU policy agenda. They detailed concrete initiatives in product markets, including the legal framework for electronic commerce, the review of telecom regulation and economic reforms for a complete and fully operational internal market. They decided to give further impetus to the deepening of financial market integration and development of risk capital and to the improvement of the quality and sustainability of public finances.

Directors fully agree with the emphasis that the IMF puts on labour market reforms and, in particular, on the need to strengthen effective labour supply. Policies in the areas of equal opportunities and active measures to improve “employability” have already contributed to meeting labour demand during a period of rapid employment growth. More progress could be made in certain areas, including through measures for older workers and comprehensive reforms of tax and benefit systems, as highlighted in the 2000 Broad Economic Policy Guidelines. The modernization of social protection systems, partly with a view to increasing labour market participation, has been put forward by the Heads of State or Government and has been recognized as a priority in a number of Member States’ National Action Plans for employment.

Internal surveillance processes and policy co-ordination

Whilst acknowledging that the modalities of EU surveillance and policy co-ordination have strengthened, the staff assessment suggests that the process is still lacking the clout needed to promote timely implementation of agreed guidelines. Directors agree that the effectiveness of the processes could be further improved by a more timely and full follow-up of guidelines. Moreover, it is important to involve national parliaments in order to enhance public acceptance and to foster political support for the implementation of these guidelines at the national level. With a view to increase peer pressure and to gain public support for the needed reforms, the Commission has been invited to give its Implementation Report on the Broad Economic Policy Guidelines “more bite”, and to increase the weight of countryspecific analyses. As regards the Eurogroup, the Directors point out that efforts to strengthen its functioning have been made recently. Finally, Directors agree that to improve the understanding of economic developments in the euro area, urgent progress is needed in fulfilling EMU statistical requirements. They believe that the recently adopted Actions Plans set the right priorities and underlines the importance of a rapid and full implementation of these plans.

Euro Area: Staff Report on the Monetary and Exchange Rate Policies of the Euro Area; Supplement Updating Information on Recent Economic Developments and Policies in the Euro Area; Supplement on EU Trade Policies; Public Information Notice Following Consultation; Two Statements by Representative on the IMF Executive Board for France, on Behalf of Euro-Area and EU Members
Author: International Monetary Fund