Role for the Euro in the Global Economy
Prepared remarks delivered at the Fifth Whitman Lecture
It is a great pleasure to join you today at the Peterson Institute, an organization that has always stood out among Washington think tanks for the depth of its analysis of European economic issues.
I am particularly honored to be presenting the 2008 Whitman Lecture, as we prepare to celebrate 10 years since the decision to launch the European single currency. This historic move signaled a watershed in European integration. The foundations of the single currency lay in 50 years of European economic integration: from the Treaty of Rome of 1957, to the development of our economic community and the creation of the single market in the early 1990s.
In recognition of the tenth anniversary, I will present a special report in May of this year to mark the achievements of the first decade of the Economic and Monetary Union (EMU) and to provide a detailed analysis of the challenges that we will face in the coming decade.
The report aims to stimulate further debate on euro area policymaking. Therefore, where better than the Peterson Institute to give an early preview of our findings? I will review the performance of the euro over its first decade and set out how new global trends are reshaping our future policy agenda for EMU.
Performance of the Euro in the First Decade
The introduction of the euro implied the beginning of a new era for economic policymaking in Europe, with a new environment calling for new arrangements for economic policy coordination.
And the significance of the euro's launch goes far beyond its economic dimension. Its introduction in 1999 was the crowning achievement of a hugely complex political, legal, and technical process. It also sent a political signal to the rest of the world that Europe was capable of taking far-reaching decisions to define a common future for a continent that had all too often suffered from wars and political instability.
Of course, there were dissenting voices. I recall one economist describing the creation of the euro as "at best, an act of uncertain merit" and another denouncing it as a "great mistake." A decade on, we have been able to assess the performance of EMU through a complete business cycle. And I am pleased to say that the euro has proved an economic success.
The defining achievement of EMU has been to anchor macroeconomic stability in Europe. EMU has put an end to periods of internal currency turbulence within the euro area and made us more resilient to negative external developments, as the euro area's economic strength in the face of continuing financial turmoil testifies. The result has been a decade of low and stable inflation.
Indeed, over the last decade EMU's impressive record of price stability has anchored inflation expectations around the European Central Bank's (ECB) goal of close to 2 percent, with the result that interest rates have been sharply reduced for many participating member states. I believe that even in today's environment of rising oil and commodity prices, EMU will shield our economies better than has been the case at any moment in the past.
Budget balances have improved significantly in less than a decade of economic and monetary union. Government deficits have declined considerably in comparison with previous cycles-and in the euro area more so than elsewhere. In the majority of euro area countries, government debt has also been reduced.
Clearly the reform in 2005 of our framework of fiscal rules-the Stability and Growth Pact-has helped drive a renewed commitment to sound public finances, which is paying off. We have now achieved the best structural balances since 1973 and have started dealing with the quality and efficiency of our public spending. However, long-term fiscal sustainability constitutes a major challenge in view of demographic trends in Europe and is an issue we will continue to address.
A major success story of the first ten years of EMU has been the significant growth in employment, boosted by measures taken under the Lisbon Strategy to reform labor markets. With almost 16 million new jobs created in the euro area during the last decade, job creation has by far outpaced that of other mature economies, including the United States. In parallel, the unemployment rate has fallen to 7 percent in 2008.
The euro has delivered new opportunities for the development of financial markets and has spurred their integration, fostering deeper and more liquid bond and money markets in Europe. The movement of cross-border capital towards its best use has been encouraged, as well as risk diversification and associated cyclical smoothing.
Finally, EMU's success is marked by the rising number of member states joining the euro area. Three new countries have joined the original 12 members in the last two years, and the euro area is set to enlarge further in the future.
Some Expectations Not Met
But we acknowledge that in some respects, our initial expectations have not been fully met.
From the outset, we hoped that increased exposure to competition implied by EMU and the removal of the exchange rate and monetary policy instrument would stimulate structural reforms much more forcefully. We anticipated faster integration of product and labor markets that would boost higher growth and productivity.
Progress has been made. Take the wide ranging reforms implemented in the European telecoms sector that have increased productivity significantly. But overall progress has fallen short of expectations. GDP growth and productivity performance have underperformed compared to other economies in an environment of global growth. Progress towards structural reforms has been slow and has prevented us from fully benefiting from the productivity enhancements that new technologies and more competition could bring.
As a result, the capacity of euro area countries to adjust to economic shocks has not been as efficient as it could be, leading to persistent divergences in growth and inflation figures across euro area countries.
We clearly have to tackle the causes at the root of this insufficient progress in order to further strengthen the euro area economy.
But our policy agenda will also be shaped by the major shifts that are taking place in our economies and societies due to changes in the global landscape.
Challenges for the Second Decade of EMU
When the founding fathers were preparing the framework for the EMU, they could not foresee the shifts in world economic power that would characterize the 21st century.
Globalization is reshaping the architecture of the global economy. World trade has expanded at an unprecedented pace, and global financial markets have become increasingly integrated.
Emerging economies are today the main engine of growth in the world economy. Their share in the total imports of advanced economies has risen from below 10 percent in the 1970s to 45 percent today. China is already one of the largest economies in the world, and as the growth boom of Asia and Latin America continues, Western countries' share in world GDP will shrink accordingly.
For emerging and advanced economies alike, globalization is an overwhelmingly positive process. It has drawn developing countries into the world economy and is acting as an unprecedented ladder out of poverty. Economic integration is opening new markets and bringing substantial opportunities for increased trade, growth, and efficiency gains.
However, globalization also raises a number of urgent questions, such as how to balance deepening economic integration with concerns for growing inequality between countries and especially within countries, or how to tackle the rapid accumulation of global imbalances and the risk of their disorderly unwinding.
Additionally, the rapid growth of the global economy means scarcity of primary resources is becoming acute and is pushing up prices for goods such as oil and food. And these global price increases may contribute to inflationary pressures and pose challenges for the conduct of monetary policy in the euro area.
Globalization is also putting pressure on the competitiveness of advanced economies. Companies must become better able to move production from sectors in which they are not globally competitive and invest in those where they can compete at the technology frontier.
At the same time, the need to increase productivity and growth will become more urgent as our populations progressively age and we have fewer workers to support the growing number of people in retirement.
Finally, the effects of climate change will entail social and economic costs worldwide. And while the European Union is-commendably-spearheading the global fight to reduce carbon emissions, our environmental reforms will impact economic policy.
This new context is forcing all advanced economies to reconsider the way they develop economic policies. But the major trends I have just outlined-globalization, aging, pressures on commodity prices and climate change-pose particularly compelling policy challenges for the euro area.
As a result, we are taking a fresh look at the euro area's policy agenda for the coming years. Let me set out the main areas for attention, starting with the domestic agenda.
The Domestic Policy Agenda
There are two key elements to our domestic policy agenda: to strengthen EMU's surveillance capacity and to allow greater coordination of economic policies in the euro area.
Despite the good results in terms of low budgetary deficits, fiscal discipline cannot alone defuse risks that stem from the macroeconomic side. We need to maintain overall macroeconomic and financial stability. Some member states with sound public finances can still face large current account deficits or experience inflationary problems.
Maintaining price stability is the primary task of the European Central Bank, and its track record is very good in this respect. But governments should also take steps to counter inflation by avoiding procyclical fiscal policies, avoiding tampering with administrative prices and excise duties, improving competition-particularly in the nontradables sectors-and promoting policies that link wage developments to productivity. In the future, such considerations should be factored into the broader coordination of euro area economic policies.
Similarly, while the synchronization of euro area economies has improved since EMU compared to previous periods, the newly emerging external shocks will impact our economies differently. We therefore have to broaden the scope of our surveillance beyond the fiscal sphere in order to better anticipate and manage the risks of macroeconomic imbalances developing within euro area countries. In this environment, financial stability considerations should climb higher in our surveillance priorities.
The new Lisbon Treaty, which will come into force next year, will increase the instruments for surveillance.
Another element of our domestic strategy is to increase potential growth and smooth economic adjustment. For this, structural reforms are essential and pay a double dividend. First, they increase productivity. Thus the positive experience of reforms in some sectors must now be replicated in the services sector, which despite representing 70 percent of the EU economy, is still hindered by insufficient productivity, lack of competition, and inadequate regulation.
Second, structural reforms are vital in the euro area to enhance the capacity to adjust to economic shocks and changes in competitiveness as this is no longer possible via the exchange rate instrument. Well functioning financial markets can play a very beneficial role in smoothing adjustment to shocks, which is why EMU countries should be driving the process for deeper and more integrated financial markets in Europe.
In general, there is scope to build on the euro area recommendations in the Lisbon Strategy, both to advance reforms at national level and to reap the benefits that can be derived from coordinating structural reforms in EMU.
The economic governance of the euro area is central to delivering on this objective. The Eurogroup, which benefits from a stable presidency, can become an even more important motor for reaching consensus and agreeing common action on economic policy issues.
Enhanced governance structures will also be crucial for moving forward on the external pillar of our policy agenda. Increasingly, the euro is having an impact beyond the 320 million Europeans who use it everyday, and we need to address the global role of EMU more vigorously.
The External Dimension of EMU
Therefore let me now turn to the international dimension of EMU. This should be a familiar topic to some of you here today. Indeed, Fred Bergsten and his colleagues are leading voices on the global importance of the Economic and Monetary Union.
The International Role of the Euro
The euro was launched amid a vigorous debate over its potential to challenge the US dollar as a global currency. While opinions differed, I recall that in 1997 Fred Bergsten was already arguing that with the creation of a single European currency, the dollar would have its first real competitor since it took over from the pound sterling as the globe's dominant currency.
He also argued that the political impact of the euro would be at least as great, predicting that a bipolar currency regime dominated by Europe and the United States, with Japan as a junior partner, would replace the dollar-centered system that had prevailed for most of the 20th century.
Today, we know that the euro has indeed become the second most important international currency after the US dollar. The euro's international prominence clearly surpasses that of the Japanese yen and the pound sterling. In fact, with the present exchange rates, the euro area GDP is higher than that of the United States.
In financial markets, the euro has seen remarkable growth as a currency of issue for international bonds and notes. Euro-denominated international debt accounts for almost 49 percent of the outstanding stock of international bonds and notes.
In global foreign exchange markets, the euro is the second most actively traded currency after the US dollar. The euro-dollar currency pair is the most actively traded pair in global foreign exchange markets, and it accounts for more than one-quarter of global turnover.
Data on the currency composition of global foreign exchange reserves show that the euro now accounts for more than 26 percent of foreign exchange reserves.
And if we look at the main variables determining the international use of a currency-like the economic size and the significance of foreign trade flows, financial market size, liquidity and development, and the degree of price and exchange rate stability-the euro has further potential to rise in international prominence. So in spite of inertia and the dollar's incumbency advantages, chances are that the euro will continue to advance its international role.
New Risks and Challenges Facing an International Euro
But beyond its relationship with the US dollar, the past decade has seen the emergence of new players in the global economy, and the international financial system has become increasingly multipolar in nature. Within this new landscape, the euro has become a valuable public good.
The case for the euro area as a major actor in international monetary and financial relations is-in my view-clear. Our policy decisions have a global impact. This is a fact and one that becomes more relevant with the growing international role of the euro.
The euro area and the euro are playing an increasingly important role in supporting the stability of the world economy and the global financial system. EMU has contributed to the stabilization of a number of financial and macroeconomic variables within the euro area. To some extent, this intra-euro area stabilization has also reduced volatility in the world economy.
Moreover, non-EU countries increasingly perceive the euro area (and the European Union as a whole) as a pole of stability, a source of new capital, and also a source of advice and expertise on regulatory approaches.
But beyond the benefits it provides, the rising international status of the euro also carries new risks and responsibilities for the euro area. It raises the exposure of the euro area-including its financial system-to shocks originating in other parts of the world and to disruptive portfolio shifts between key international currencies. And it is precisely such shocks that are likely to occur more frequently in a world characterized by financial and economic globalization.
Today's environment of economic uncertainty is a case in point. The repricing of risk and the deleveraging of the financial system continue to disrupt financial markets. As a result, conditions in the international financial system remain fragile.
The current financial turmoil provides a compelling argument for a better monitoring of risk and a better enforcement of global responsibility. The euro area, on account of its sheer size in the world economy and the stabilizing role it is required to play, as well as its weight in financial markets and leading role in financial regulation, must assume its rightful place in such a process.
Whether it concerns financial sector stability, exchange rate policies, or fiscal surveillance, the euro area should make its voice heard in global debates that directly impact the euro area economy.
For instance, today the most prominent issues to be tackled on the international front are the large current account imbalances in the global economy and the risk of their disorderly winding.
Despite the fact that the euro area's current account is broadly balanced, a disorderly unwinding could disproportionately impact our economy, with the exchange rate appreciating further against the US dollar. The euro has already contributed significantly more than its fair share to the ongoing global adjustment process.
This is one clear example where euro area countries should naturally present a well defined common position, a strong single voice and improve their external representation.
Improving External Representation: Euro Economic Diplomacy
Practically speaking, how should we achieve this objective?
To begin with, the euro area should expand and make more use of its bilateral macroeconomic dialogues with strategic partners, such as the United States, Japan, China, and other emerging economies.
But for external action to be truly effective, euro area representation needs to move from fragmentation to consolidation in the IMF and G groups. This would strengthen the euro area's negotiating power and reduce the costs of international coordination.
Ultimately, a single euro area chair in international fora remains the best solution. It is a natural consequence of the process of economic and monetary integration and would help the euro area play its full role in the resolution of global economic challenges. However, it is only one half of the answer. The other is an enhanced governance system within EMU that would allow euro area countries to streamline policy positions and speak with a common voice on global issues.
The creation of the European single currency was a bold move, without precedent in economic and political history. Ten years into its existence, it is evident that the euro is a major success and is underpinning the prosperity of Europe's economies.
For European citizens, the euro is a tangible symbol of European integration, of our common values, and our shared future. Our citizens consider the euro to be among the most positive results of European integration, surpassed only by the achievement of peace and free movement within Europe.
EMU is hence an achievement of strategic importance for the European Union, and indeed for the world at large, in which Europe has become a welcome pole of stability.
But with new challenges facing us, including a global landscape in transformation, the time has come to push forward our domestic and external economic policy agenda in order to deal with the challenges of the next decade and build on our achievements of the last. EMU has accomplished a lot for Europe in a very short period of time, and we Europeans are confident that it will continue to do so in the future.