The 1998 Mais Lecture
delivered at the City University Business School in London on May 18,
1998
Professor Dr Dr h.c. Hans Tietmeyer
President of the Deutsche Bundesbank
Financial and Monetary Integration: Benefits, Opportunities and
Pitfalls
The 1998 Mais Lecture delivered at the City University Business School
in London on May 18, 1998
First of all, I wish to thank you very much for your kind invitation.
I am pleased to have the
opportunity to give this year's Mais Lecture and to share with you some
of my thoughts. It is a great
honour for me to be invited to continue the sequence of outstanding
personalities who have established
and maintained the tradition and reputation of the Mais Lecture with
their talks.
At the same time, I am happy to be here in London once again. For
every visitor London is a wonderful
city full of culture and history. For a central banker, London is, in
addition, a large and efficient
financial centre. Its strong points include, not least, the academic
infrastructure in economics and
business. The City University Business School is making an important
contribution to that.
I should of course like to add: I come from a financial centre on the
continent which likewise has
some strong points. And experience shows: competition is always
stimulating for both sides. Thus, the
two financial and monetary centres, London and Frankfurt, go some way
towards symbolising tonight's
topic: Financial and Monetary Integration: Benefits, Opportunities and
Pitfalls.
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-I-
I should like to begin with the hypothetical question: What will
historians of the future regard as
the most important, forward-looking features of the close of the
twentieth century?
Perhaps they will point to the following three features:
Firstly: following the outcome of the competition between the
political systems, the competition of
the economic systems between a market economy and a centrally planned
economy likewise seems to have come
to an end. At any rate, the state socialist model as a competitor of the
free market economy has
foundered - not only because it was dissolved in and together with the
Soviet Union and its former sphere
of influence; what is more, it is no longer a serious reference model
for the development of emerging
economies; not even for China.
Secondly: economic historians may, later on, perhaps see the present
time as a period of dramatic
technical and economic upheaval - of "creative destruction" in
Schumpeter's phrase. In particular, basic
innovation in microelectronics is being reflected in lots of procedural
innovations which are now more
and more reaching application status and in many product innovations
becoming increasingly
marketable.
And thirdly: we contemporaries are speaking more and more of an era
of progressive economic
integration, at both a regional and a global level. Globalisation is the
keyword in today's
discussion.
These three features are of course interlinked. The victory of the
market economy system and the
decline in transportation and communication costs are fuelling global
integration. Global competition, in
turn, is fostering the search for new applications of the technical
possibilities. And especially in a
dynamic period with large adjustment requirements in almost all sectors
of the economy, a centrally
planned economy is especially inferior to a market economy.
All three features have a common thrust. They work in the direction
of overcoming national frontiers
and administrative barriers. The old dream of internationalism therefore
holds out the promise of coming
true. But the more this open, increasingly barrierless world becomes
reality, the more evident it grows
that this is not a perfect or simple world. On the contrary: In the wake
of the former east-west
conflict, conflicts within countries or in individual regions have not
become less common. Indeed, some
conflicts which had previously been obscured have only now come to
light. And the technological changes
and economic globalisation are not only a source of greater prosperity.
They at the same time pose huge
challenges. The developed industrial countries are particularly feeling
the need for reform in their
labour markets and social security systems. This is especially true of
countries in continental
Europe.
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Progressive economic integration is, of course, not a new phenomenon.
But there are many indications
that this process has accelerated and intensified in the last ten years,
both quantitatively and
qualitatively. Economic integration is a comprehensive process. It is
increasingly affecting the real
economy. The international interdependence of national economies is
increasing. A new quality is
emerging. For the growing interdependence is no longer based solely or
primarily on trade in finished
products or commodities. Especially, the process of developing and
producing goods is being increasingly
split up internationally. This is possible because national frontiers
have become increasingly permeable
and communications have become more intensive, because transportation
and communication costs have fallen
sharply, and because, in particular, the emerging economies have
likewise become more integrated in the
world economy; this, above all, markedly facilitates direct investment
there.
The front runners of such integration are of course the global
financial markets. They are able to
take the best advantage of the disappearance of transaction barriers and
the new technological options.
In a world of increasing real economic interdependence, and with global
financial markets, the question
of monetary integration is also becoming more urgent.
The calculability and appropriateness of monetary relationships is
becoming more important.
Globalisation therefore increases the overall pressure to pursue a
stability-oriented monetary policy
everywhere. If a country, especially a bigger one, drops out, this may
lead, in an integrated world
economy, to serious damage due to volatile financial market prices. And
this is why many countries are
switching over to monetary cooperation, or even to pegging their
exchange rates. One part of Europe is
now going a radical step further. Eleven EU countries will enter into
monetary union on a durable basis
at the end of this year. That union will then pursue a single
supranational monetary policy decided by a
supranational and politically independent central bank.
A number of countries will closely watch the outcome of this
experiment, which may change Europe
considerably. This is true in particular of those countries of the
European Union which do not wish to
join the monetary union as yet. Accession candidates in central and
eastern Europe, too, will of course
watch developments with keen interest. But countries in other parts of
the world as well will focus their
attention on the euro area. This is because some countries in South
America or Asia are beginning at
least to contemplate the option of a monetary union. Even if they still
have a long way to go.
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-III-
What is it that prompts sovereign states to follow this basic trend
towards economic integration, even
if of course it does not always lead as far as is planned for
Euroland?
Essentially, three more or less major benefits may be derived from
any form of economic integration:
Firstly, more integration leads to more competition. Competitive
pressure enhances efficiency. Secondly,
integration changes market structures. Markets become larger.
Enterprises are able to exploit economies
of scale. National economies can specialise to a greater extent.
Resources are fed into a larger pool,
from which they can be allocated more efficiently. And market breadth
increases. The consumer can choose
from a wider range of products offered. Thirdly, integration reduces
information and transaction costs.
This applies in particular to monetary integration, too.
But - what is invariably true is also true of economic integration:
there is no such thing as a free
lunch.
First of all, it is helpful to distinguish between market integration
and policy integration. Market
integration mainly implies dismantling barriers and obstacles. Then
national markets can grow together.
Policy integration goes further. It also implies that countries
coordinate or even harmonise the general
direction of movement in individual sectors of national policy, or
individual parameters.
The countries which join an integration process must clearly
appreciate three potential problem
areas:
First problem area: market integration going beyond national borders
poses increased domestic
challenges. For instance, integration in the international division of
labour accelerates structural
change and calls for more internal flexibility, especially on the labour
market. And liberalising capital
movements places demands on the domestic financial sector, which must be
able to handle international
capital flows that may rapidly change direction.
Second problem area: to be really efficient, market integration with
the elimination of barriers may
require a minimum of policy integration. This applies, for example, to
some protection provisions for
products and in the production process. Different tax systems may of
course likewise distort cross-border
goods and financial flows. And if capital markets are globalised,
different approaches to monetary policy
may contribute to volatility. Such volatility may have a strong impact
on financial and real
investment.
But, and this is the third problem area: policy integration is itself
a two-edged sword. It may make
markets more efficient. But it can also contribute to curbing policy
competition. That may involve risks:
An excessive tendency towards centralisation may arise which does not
take sufficient account of
diverging conditions. The delineation of responsibilities may become
blurred if mixed responsibilities
arise with undue bureaucracy. In the worst-case scenario, efficient
policy solutions may no longer be
implemented. Policy innovation is blocked. Countries must be able to
come to terms with these three
risks and problem areas in their efforts to coordinate or integrate
their policies, if they are to secure
the benefits of integration. Striking the right balance here is not
always easy.
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The financial markets are something like the flywheels of
globalisation. Free capital movements and
efficient financial markets greatly facilitate direct investment. They
provide the basis for transactions
and for the safety of payment flows, which are the financial equivalent
of real integration.
The global financial markets promote and strengthen market
structures. They also make it possible for
investment in emerging economies to be funded privately, rather than
officially, today on a much greater
scale than previously. Capital is allocated today, more than it used to
be, in accordance with economic,
rather than political, criteria. Conversely, the integration of the
emerging economies into the global
financial markets provides new investment outlets for savings. This must
also be seen against the
backdrop of the ageing populations in most industrialised countries.
They in particular must accumulate
and invest capital today so as to be able to maintain their relative
standard of living in the future,
too.
And the global capital markets have assumed a role which is bearing
fruit in the disciplining of
national policies. They offer opportunities, but also pose a risk, to
countries which fail to follow the
economic constraints. Nowadays they are an effective part of the checks
and balances.
These important benefits of the international capital markets are
sometimes wrongly disregarded in the
ongoing debate.
But the financial crises being encountered by some east Asian
countries have, of course, highlighted
the risks, too. A number of emerging economies have become swiftly
integrated in the global financial
markets. Not all of those countries have adjusted their internal
structures at the same pace and as
thoroughly. That makes them vulnerable. Two weaknesses, in particular,
may become their Achilles heel: a
domestic financial sector which is unable to handle large capital flows
in a sufficiently sound manner,
and an overly rigid exchange rate pegging to one or more other
currencies.
Exchange rate pegging can in some cases and for some length of time
produce positive effects. An
overly rigid exchange rate peg, however, can have problematic
consequences: It may jeopardise the
competitiveness of an economy, and especially exports. It may fetter
domestic interest rate policy. It
thereby makes it more difficult to fight inflation in periods of heavy
capital inflows. And it may tempt
residents to borrow in foreign currencies at relatively favourable
nominal interest rates. These
consequences may make a country vulnerable, as we have seen already in
the Mexican case in 1994-5.
In addition, some risk factors are inherent in the market. The
international financial markets mostly
have a tendency towards short-termism.
A major part of international lendings and borrowings is at fairly
short term. And they quite often
tend to follow a self-reinforcing herd instinct in periods both of
euphoria and of scepticism. Both
factors, any domestic weaknesses and the properties of the international
financial markets, may cause a
potential for a reversal in sentiment for a currency to build up. Mostly
triggered by some special
economic or political change or other, the exchange rate of a currency
may go down very fast, in many
cases to an overly low point. An "undershooting" of the
appropriate relationship occurs. Such a slump in
the value of a currency can hit the economy of the country concerned
with a massive force, especially if
that country is heavily indebted in a foreign currency.
What is to be done? Two points in particular are important: Firstly,
the functioning of the financial
markets must be maintained or strengthened. On the one hand, to this end
the markets need more, better
and more up-to-date information on the level, maturity and denomination
pattern of the debts of potential
risk countries. Sufficient transparency is of particular significance
for the functioning of the
financial markets. On the other hand, the IMF must not encourage
moral-hazard attitudes on the part of
investors and recipient countries by bailing out private investors.
Losses caused by misjudgements and
enforced adjustment in the event of wrong behaviour are as much an
integral part of a functioning market
as are profit opportunities. And crises should not invariably lead to a
rollback on the part of private
investors. Private funding of investment is in principle superior to
public funding. Ways must be found
to safeguard the long-term interests of private investors. Though there
is probably no panacea, various
approaches are being considered, and rightly so. The IMF above all has
to act as a catalyst maintaining
or restoring countries' access to private capital. A policy of bailing
out private investors is heading
in the wrong direction.
Secondly, it is important for countries to eliminate their domestic
weaknesses or prevent them from
arising in the first place. This includes: Being careful about overly
rigid exchange rate pegs,
Strengthening domestic supervision of the financial system, and above
all: strengthening domestic
competitive structures in the goods markets and in the financial
sector.
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-V-
Cynics might now say: Europe should make sparing use of the advice:
"Be careful with exchange rate
pegs". After all, eleven European countries are actually on the
road towards monetary union. And hitherto
they have also largely linked their mutual exchange rates, though not
always without any problems in the
past.
Monetary union does in fact represent a maximum of policy integration
in the monetary field. Monetary
policy is not merely coordinated, but unified. And that will be for
good, because in practice this step
cannot be reversed.
There were of course also some other options. With the European
Monetary System, Europe's approach has
for a long time beem that of an exchange rate arrangement with fixed but
adjustable parities; at times
there have been some considerable difficulties, but in the end the
system has proved largely successful.
That goes in particular also for the period after the widening of the
fluctuation margins. Nevertheless,
this approach falls short of full monetary integration and the strategy
of a single currency.
At the time, your country above all proposed another, less ambitious
solution than full monetary
union; I am referring to the adoption of a parallel currency, to be used
as a common currency. That would
probably have triggered a currency competition. Depending on its design,
that solution could, however,
also have adversely affected the scope for monetary action of the
central banks of the existing hard
currency countries and thus jeopardised their anti-inflation policy. A
parallel currency would presumably
have got stuck. It might perhaps have been able to crowd out weaker
currencies. But whether also a
currency of the D-Mark's standing would at least be doubtful. This is
true, at any rate, of the specific
form of monetary policy activities discussed at the time.
Be that as it may, in the Maastricht Treaty a more far-reaching
solution was adopted. A large majority
in the EU opted not merely for a common currency. It also wanted a
single currency. There are sound
economic reasons in favour of a single currency; incidentally, also
sound political reasons, at least, if
a more thorough-going political integration is being sought.
Above all, the single currency makes it possible fully to exploit the
economic benefits of
integration. Competition will be given maximum encouragement in the
single market by the complete
transparency of prices. Factor allocation will no longer be impaired by
domestic exchange rate
uncertainty. Exchange-rate-related information and transaction costs
will be minimised by a single
currency. The euro financial markets will have an optimum depth and
breadth.
But what applies to economic integration in general also applies to
monetary integration in
particular: These benefits will not come automatically and not without
corresponding challenges.
How can monetary union secure the benefits? What risks are
looming?
Monetary union is faced with three major challenges: Firstly, the
aforementioned benefits for the
goods and financial markets will materialise only if the euro remains
lastingly stable. Only then will
the euro lead to full price transparency, reduce costs and become an
attractive investment currency.
Secondly, monetary union must not trigger or exacerbate economic
tensions. Broadly speaking, an essential
requirement that must be met is: one size fits all. And, thirdly,
monetary union must not give rise to
political tensions between the participating states.
These challenges arise against the backdrop of the specific
conditions presented by monetary union.
The euro will be legal tender in an area which consists of largely
sovereign national states whose
policies - other than monetary policy - will largely remain their
responsibility. That may lead to a
dilemma between the requirements of a supranational currency, and the
political pattern in Europe, which
will continue to be determined by the national states and their
policies.
The euro needs a high degree of flexibility in the economies of the
participating countries. But there
is no European economic and structural policy which can ordain such
necessary flexibility from above.
And even if there were a responsibility at the European level for doing
so, the possibility could not be
ruled out that, ultimately, the result would be more rigidity, rather
than more flexibility. At the same
time, there is no regional revenue equalisation scheme, comparable to
the systems operated in a national
state. A social and transfer union cannot and must not make up for any
lack of flexibility and
competitiveness. For the upshot would probably be not only less
flexibility, but possibly also more
political disagreement.
At the same time, however, the euro needs discipline on the part of
national fiscal policy, at least
as far as fiscal deficits are concerned. Otherwise there is a risk of
conflicts, because large debts in
some countries will attract the savings of the euro area as a whole, and
contribute to higher interest
rates for everyone. Fiscal policy, however, will largely remain a
national responsibility. That is why it
is so important that the Growth and Stability Pact should prove to be
effective in future. How can the
euro function against this background? The "classical" answer
of the Werner Group in the early seventies
(of which I was a member at the time) was: Europe must set up a
political union parallel to the monetary
union. Thus, supranational political structures were supposed to ensure
that Europe met the requirements
of a supranational currency.
Maastricht adopted a different approach. It left the rift between
supranational money and national
policy structures. To that extent, it has sometimes been dubbed "a
construct with a limp". If, however,
there is no supranational political authority to meet the requirements
of a supranational currency, then
the participating countries must do so on their own initiative, of their
own accord or in their own
interest. The Maastricht Treaty therefore also set important rules for
the fiscal discipline of member
countries. And compliance with those rules is likewise jointly
monitored. However, what ultimately will
be crucial for the functioning of the Stability Pact will, above all, be
the countriesability and
willingness to abide by those rules on a sustained basis. A monetary
union, under the Maastricht Treaty,
therefore needs a large measure of common "stability culture"
in all participating countries. And another
point: the euro can function as a depoliticised currency only in this
specific form. The ultimate
monetary target, i.e. monetary stability, must not be subordinated on a
discretionary basis to other
goals. And monetary policy must be conducted by a politically
independent central bank.
That may be considered in some quarters to be an overly German
postulate. But in my view this is
implied not only by the requirements of a lastingly stable currency, but
also by the logic of a monetary
union comprising several countries. For if one country subordinates its
own currency to political
objectives other than stability, that may have unpleasant consequences
for other countries, given
globalised financial markets. But still, one could live with that. If,
however, eleven countries try
subordinating their common currency to their respective primary
political objectives, things will really
get pretty chaotic in the union. That way, the euro would gain the
confidence neither of the citizens
nor of the financial markets. The upshot would, rather, be all too
likely to be permanent political
conflict. The euro must not come under the influence of the domestic
interests of individual countries.
Monetary policy must be geared to the situation in the euro area as a
whole, taking responsibility for
maintaining stability of the common currency. Some of the incidents in
Brussels during the first weekend
in May may in this context have been a timely warning, and a lesson to
be learned by all.
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-VI-
There can be no doubt that monetary union implies the irreversible
loss of the sovereignty of the
participating countries in the monetary sphere. Some loss of identity
and of the symbolism of a nation
state will of course also be associated with giving up the national
currencies. In Germany, this also
means the loss of a symbol of economic reconstruction after the war.
Monetary union thus reinforces an overall trend towards global
economic integration, especially also
as a consequence of the global financial markets: the nation state
forfeits some of its freedom to shape
events. In some countries and some quarters there are also fears about
the immediate forfeiture of
sovereign rights, as in the case of the currency, and also about an
uncontrolled dynamic integration
process which will - automatically, as it were - relegate the nation
state into the background.
Here in the U.K. (but not only here) there seems to be some concern
about an uncontrolled political
integration drive in Europe: the fear of a "superstate of
Europe". Even if this fear is manifest to some
extent in continental Europe, too, there is, at the same time, rather,
more concern about an uncontrolled
economic integration drive caused by increased competition. In Germany,
there is, in addition, concern
that the stability of the euro might not match that of the D-Mark.
At all events, the common underlying question is similar: If European
integration and/or globalisation
reduces the economic and social management capacity of the nation state,
and if the citizen's democratic
"say" in events remains tied to the institutions of the nation
state, does it follow that a democracy
problem is emerging?
This question is of course much too sophisticated to be answered in a
few sentences. I only wish to
note two points:
Firstly, regarding the fear of a superstate of Europe. It is without
doubt important that monetary
union must become a success. This means that in the distant future, too,
it should not generate crisis
situations which then - of necessity - will give rise to tendencies
towards overly strong centralisation
which actually no one wants. The lasting functionality and stability of
monetary union is a prerequisite
for political subsidiarity in Europe. Just as stable money is and will
remain an essential prerequisite
for internal subsidiarity in society. Even with further political ties,
that by no means is bound to lead
to a superstate of Europe.
And secondly: the extent to which cross-border integration and
globalisation are seen as a democracy
problem depends, not least, on onereallocation more difficult. Anyone
who regards reallocating income and
wealth as the essence of democracy must indeed consider integration and
globalisation to be a threat. If,
however, democracy is seen rather as a control mechanism against
undesirable political developments, then
the international financial markets will be regarded, rather, as a
supplement and less as a threat to
democracy.
Thus, the financial markets may often penalise an undisciplined
fiscal policy quickly and massively.
The burden arising from a long-term unsound policy therefore becomes
evident much more quickly.
Democracy in the sense of control can then function better.
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-VII-
The global financial markets are certain to test the euro, the
political and economic conditions in
the euro area and the stability orientation of the European Central Bank
as well. Basically, they are
already doing so today, even though the euro and the European Central
Bank do not exist yet. It would be
an illusion to believe that the global financial markets look critically
only at the emerging
countries.
The vital asset of a central bank is credibility. The decisions taken
in Brussels to fill the
vacancies on the Executive Board of the ECB essentially enhanced that
credibility, if anything. Actual
independence from the influence of political bodies is essential for the
future credibility of the
European Central Bank. In my view, independence does not at all conflict
with the requirements of
democracy as long as the European Central Bank abides by its
mandate.
Of course, adequate transparency of its decisions in the sense of
explaining them to the general
public and stating the reasons for them, are important. Accountability
in this sense vis-`-vis the
European political bodies, and especially vis-`-vis the European
Parliament, is useful and right.
However, accountability must not undermine the largely unpolitical
character of the euro or its
supranationality. Accountability vis-`-vis the national parliaments
would not, in my view, be consistent
with the euro's supranationality.
From the very outset, it will therefore be essential for the European
Central Bank to gain and retain
the necessary confidence of the markets.
Credibility normally develops gradually, on account of one's own
track record. To that extent, it
seems to be a privilege to be able to inherit credibility from the
national central banks. In this
context, the Bundesbank, as the guardian of the D-Mark (the
long-standing anchor currency of the EMS)
naturally plays an important part. This legacy, too, is of course not
without obligation. Rudi Dornbusch,
Carlo Favero und Francesco Giavazzi recently wrote in an article:
"The capital markets will be
unforgiving if they see anything less than Bundesbank policy." In
various respects the D-Mark and the
Bundesbank have acted as the model for the euro and the ECB. Seen from a
historic perspective, however -
and in conclusion I should like to come back to that point -there are
some far more impressive models. As
far as longevity and historical consistency are concerned, I hope that
the euro and the European Central
Bank will also try to emulate the pound sterling and the Bank of
England. This is true, at least, if one
disregards some periods in the Old Lady's history which were not quite
so succesful. Viewed over the
longer term, anyway, the U.K. has had more success with its currency
than Germany, which saw two
hyperinflations and the collapse of its currency in the first half of
this century. But - if I am
rightly informed - in this country, too, the question of whether your
currency may one day disappear and
be replaced by the euro is no longer completely unthinkable. But that is
of course your decision;
specifically - if I have got it right - the decision of your government,
Parliament and the British
people.
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