1

The Eurosystem, Monetary Policy and European

Integration

Philippe Moutot(Copyright rests with the author)

Presentation at a conference on

“EMU Governance and Euro Area Changeover: Cyprus on the Path to the Adoption of the Euro”, Nicosia, 30 November 2006

The achievements over the last one and a half decade by

each and every NMS were impressive under any accountand score.

• For a number of NMS following the demise of the USSR there has been a complete overhaul and liberalisation of their economic system. Even now market-oriented reforms are advancing hand-in-hand with economic and monetary integration in the EU.

• For some NMS instead the need for adjustment was less ample.

Today I will take a more forward looking approach and present some reflections on three aspects of the monetary integration of the NMS in the euro area.

• First, I will discuss the institutional integration of NMS in the Eurosystem. • Second, I will look at aspects that help understand the functioning and the success of the single monetary

policy of the euro area. • Third, I will consider some facets of economic and

financial integration of the NMS with the EU 15.

I will address some of the themes that may prevail in theagenda of discussion of membership in the euro area.

First, the working of the Eurosystem

The ESCB comprises the European Central Bank and the national central banks (NCBs) of the 25 Member States of the European Union (EU).

The term ‘Eurosystem’ denotes a sub-set of the ESCB: it comprises the ECB and the NCBs of EU Member States that have adopted the euro. Slovenia will join in January.

An important characteristic of the Eurosystem is its relatively decentralised structure. • Monetary policy is defined by the ECB and its

Governing Council, • MP implementation and many others tasks are jointly undertaken by the ECB and NCBs.

The euro area

Main institutional features of the EurosystemOrganisational Framework of the Eurosystem

N o t e s : N C B r e f e r s t o t h e n a t i o n a l c e n t r a l b a n k s o f t h e 1 2 e u r o a r e a c o u n t r i e s .

I m p l e m e n t a t i o n S t a g e

D e c i s i o n S t a g e

E C B ( C o - o r d i n a t i n g r o l e )

N C B 1 N C B 2 N C B 3 N C B 1 2

G o v e r n i n g C o u n c i l( 1 8 M e m b e r s )

G o v e r n o r s o f N C B s ( 1 2 M e m b e r s )

E x e c u t i v e B o a r d o f E C B( 6 M e m b e r s )

E u r o s y s t e m

E C B N C B 1 * N C B 2 N C B 3 N C B 1 2

. . .

. . .

• Roles of Executive Board, Governing Council, and General Council.

• New voting scheme once the number of euro area countries exceeds 15: Executive Board members will maintain a permanent voting right, but the voting rights of NCB Governors will be

Working by Committees and Working GroupsOne aspect that is less know to outsiders is the advisory role of ESCB/Eurosystem Committees and Working Groups in supporting the policy-decision making process.

The Rules and Procedures of the ECB state that the role of committees is to “assist in the work of the decision-making bodies of the ECB” by providing expert and/or technical advice to the [Executive Board and the] Governing Council and the General Council.

There are committees active in most technical and analytical areas of the work of the Eurosystem and ESCB including the following: Monetary Policy Committee (MPC), the International Relation Committee, the Market Operation Committee (MOC), the Statistics Committee (STC), the Payment System Committee (PSSC), the Banking Supervision Committee (BSC) and others

Some rationales…..

• Committees facilitate the coordination of work of the ECB and the NCBs: important as the ECB is a relatively small structure vis-à-vis the ESCB/Eurosystem as a whole.

• Most NCBs have longer histories and traditions than the ECB itself: Committees ensure consistency at the EU/euro area level.

• Furthermore, committees are also a fora to share best practices and technical expertise, and foster co-operations across the broader staff of the ESCB.

……and some intangible effects:

• Over time they also gradually contribute to the realisation of a “system identity” and culture;

• Committee chairmen act to secure trust among members and to foster a participative team spirit; and

• Human capital side: transfer of knowledge, learning by doing, and consensus building.

Also Committees need support

• Several committees have established some substructures to assist them in their advisory role.

For example the MPC is supported by:

• the Working Group for Forecasting, • the Working Group for Econometric Modelling and • the Working Group for Public Finance.

Furthermore, some committees are making use also of task forces, i.e. groups of central banking experts with a clear mandate limited in time to address specific issues and fulfil specific tasks.

The ECB has also promoted over the years several networks for the academic analysis of specific topical subjects like:

• the Monetary Transmission Network, • the Inflation Persistence Network, and • the still ongoing Wage Dynamics Network.

Decision-making by Governing Council

• The sheer size and composition of the GovC and the various ESCB Committees can be quite intimidating.

• How are decisions actually taken?

• Monetary policy decisions are a collective decision-making process by the Governing Council: what Blinder (2004) calls “monetary policy by committees”: a practice that characterizes also the Fed and BOJ.

• Monetary policy set by a committee is likely to be better informed than monetary policy set by a single governor: committee members bring different decision heuristics and preferences to the discussion. Views are then pooled.

Decision-making by Governing Council (cont’d)

• There is also growing empirical evidence that group decisions – such as those by a monetary policy committee – outperform individual ones.

• It is essential for the Governing Council’s collegial decision making process to be supported by an array of Committees (and other bodies) facilitating and accelerating consensus building.

The two-pillar approach

Economic analysis entails• A broad based assessment of hard data, survey

information and anecdotal information• Focusing on current economic and financial

developments with a view to assessing the short-to medium-term risks to price stability

• Look at– real activity, price and cost indicators– fiscal policy– capital and labour markets– exchange rates and the external economy

• Projections play a key but not all-encompassing role

The two-pillar approach

Monetary analysis• Inflation is ultimately a monetary phenomenon.

• Leading indicator properties of money for inflation especially at longer horizons.

• Challenge of monetary analysis: extracting the „signal“ about underlying price trends contained in monetary developments in „real time“.

• Money/credit can help identify financial imbalances and/or asset price bubbles.

The two-pillar approach

Primary objective: price stability

Economic analysis

Monetary

analysisAnalysis of economic

dynamics and shocks

Analysis of monetary

trendsCross-

checking

Governing Council takes monetary policy decisions based on a unified overall assessment of the risks to

price stability

Full set of information

Source: ECB.Note: Before 28 June 2000 the main refinancing operations were conducted as fixed rate tenders. Starting from the operation settled on 28 June 2000 the main refinancing operations were conducted as variable rate tenders with a pre-announced minimum bid rate.

Key ECB interest rate and tender rates

(annual percentage changes)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

1999 2000 2001 2002 2003 2004 2005 20060.0

1.0

2.0

3.0

4.0

5.0

6.0

minimum bid rate

marginal rate on MRO

main refinancing rate

Source: ECB.

ECB interest rates and the EONIA

(annual percentage changes)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

1999 2000 2001 2002 2003 2004 2005 20060.0

1.0

2.0

3.0

4.0

5.0

6.0

overnight interest rate (EONIA)

main refinancing/minimum bid rate

marginal lending rate

deposit rate

Economic and financial integration The economic and financial integration of the NMS with the EU 15 is an extremely broad and somewhat complex issue….. ….and I probably already run out of time. Just to say that there are various aspects to it:• One aspect is the current degree of economic and financial

integration of NMS with the EU15/euro area; • Another is the changing degree of integration among euro area countries following the adoption of the euro (i.e., the

debate on the “endogeneity of Optimal Currency Union (OCA)”). • Yet another aspect is the readiness of NMS in joining at some point an euro area that is overall becoming more integrated. The ESCB/Eurosystem Committees, Working Groups, and

Some concluding reflections

• First, NMS are likely to obtain several benefits from joining the Eurosystem and its diverse decision making bodies and advisory committees and subgroups. There are also some administrative costs and investments to make.

• Second, concerning the convergence to a single monetary policy, institutional convergence is largely completed.

• Third, the current degree of economic and financial integration of NMS with the EU15/euro area is quite high. Yet an important aspect is their readiness in joining at some point an euro area that is overall becoming more integrated both economically and fi i ll

Some concluding reflections (cont’d)

The experience of the euro area thus far is that much more work is required to raise the degree of flexibility and adaptability of member countries: an aspect relevant also for several NMS.

The Eurosystem and its diverse bodies and fora, foster a careful discussion on all the pros-and-cons: after all we are all stakeholders in each others well-being.