After three decades of careful planning the single monetary policy was implemented from the start of 1999. Since then, the process of economic integration has accelerated considerably and it has now gained a level of momentum whereby it is no longer crucially dependent on - or led by - political decisions. It is an automatic, dynamic and self-sustaining process, which affects all sectors of the economy.
In many respects, the European integration process is only a reflection of - or a specific way of responding to - the growing trend towards globalisation. Globalisation means increased competition in all areas, also affecting areas which were traditionally under the direct control of government policy, such as the level of taxes and public expenditures. European integration is a serious effort to counterbalance this strengthening pressure from the market forces in a healthy co-ordinated way. On an individual basis, small countries - and all European countries are small in a global sense - are vulnerable and even powerless in the globalised world but as a group they have much more strength and power.
Globalisation has enormous implications for policy-making - not least for central banks. Policy-makers need to take due account of how their actions are judged by the international markets. Short-term-oriented, pro-cyclical or undisciplined economic policies are immediately “punished” by the markets. Thus, the actual degree of freedom available for a national economic policy - including monetary policy - is in practice more and more limited.
There is a broad consensus among politicians as well as among central bankers around the world that the best contribution that monetary policy can make to growth, employment and worldwide financial stability is to keep inflation and inflation expectations at a low and stable level.
It is more than 20 months since the euro was introduced in 11 European countries and, at the beginning of next year, Greece will become the twelfth country to adopt it. The introduction of a single currency is a long-term project and most of its benefits are likely to be of a structural nature. It is therefore too early to make any serious assessment of the overall effects; euro banknotes and coins will be introduced in 2002 and only then will the full microeconomic effects of the euro be seen.
In the public discussion, particularly in the English-speaking world, it is often argued that the euro has not been successful. Here, it is mostly the currency's external value which is used as the main yardstick for measuring its degree of success. We readily admit that we are not happy with the development of the exchange rate of the euro, and we firmly believe that the present exchange rate does not reflect the fundamental strength of the euro area economy. But the focus on the exchange rate of the euro neglects two important elements. First, most of the factors commonly referred to as the cause for the weakness of the euro would have influenced currency developments in Europe in any case. Second, it neglects the fact that the introduction of the single currency has already set in motion positive long-term structural processes in all areas - and especially in the financial markets. These will have important implications for the competitiveness and growth prospects of the euro area.
The single monetary policy has, in fact, worked very well - in terms of both the decision-making process and the practical implementation. The Eurosystem consists of the European Central Bank (ECB) in Frankfurt and the national central banks of the 11 (soon 12) countries which have adopted the euro. The monetary policy decisions are taken by the highest decision-making body, the governing council of the ECB, comprising the six members of the ECB's executive board and the 11 governors of the national central banks of the participating countries.
The decisions on monetary policy issues - and monetary policy infrastructure issues - are taken on a one person, one vote basis. The discussion in the meetings of the governing council is very active, analytical and well-balanced, with decision-making clearly focused on the economic developments in the euro area as a whole. Each member is therefore expected to focus on what is best for the euro area, rather than acting as a representative of its own country.
When the Eurosystem was set up, there was broad political consensus that its credibility should be firmly anchored in the Maastricht Treaty. The treaty specifies that the Eurosystem's unambiguous primary objective is to maintain price stability and it ensures that the Eurosystem can carry out its tasks without political interference.
Sometimes it is stated in the debate that the political independence of the Eurosystem is “undemocratic”. I strongly disagree with this view. All industrialised countries have chosen a model whereby the clear and “narrow” mandate to formulate and implement monetary policy has been assigned to the central bank by way of a democratically taken decision. The central bank is then accountable to the relevant democratic institutions with regard to the fulfilment of its mandate. This is also the case for the Eurosystem. The tasks and objectives of the Eurosystem have been established in the most democratic manner possible: the national parliaments of each of the EU member states have approved the principles, tasks, objectives and institutional structure of the Eurosystem.
Of course, it is important for central bankers to be accountable for their policy actions. Any monetary policy actions must be well-founded. The treaty itself guarantees an adequate degree of accountability on the part of the Eurosystem, for example through regular reporting to the European Parliament. The governing council has taken further measures to make it easier for the public to assess how well the Eurosystem is performing its tasks. A precise quantitative definition of price stability has been adopted, with price stability defined as a year-on-year increase of below two percent in the Harmonised Index of Consumer Prices for the euro area over the medium term. Short-term developments outside the direct influence of monetary policy, such as the recent increase in oil prices, may of course temporarily affect price movements.
Most economists would probably agree that the Eurosystem's monetary policy decisions have been appropriate to the prevailing economic situation. The single monetary policy has guaranteed price stability and has, at the same time, contributed to the recovery of the euro area economy. In parallel with the upswing in the euro area economy and the increasing upward risks to price stability over the last year or so, monetary policy has been carefully tightened without excessive reactions. The Eurosystem does not react mechanistically to short-term inflationary developments or to temporary developments in monetary aggregates or key indicators. The decision-making process is indeed focused on the overall assessment of price developments in the medium term.
The success of the introduction of the euro is beyond question also with regard to its impact on the development of the financial markets in the euro area. Right from the outset, the euro established itself as one of the world's leading trade and investment currencies. Given the size of the euro area economy - comparable to that of the United States - it was only natural that the euro should enjoy a leading role in global financial markets. In particular, the euro's popularity as a currency for international bond issuance has been remarkable, matching the popularity of the US dollar on a global scale. The rapid process of restructuring currently under way in the corporate sector in Europe - evidenced by unprecedented merger and acquisition activity as well as improved efficiency and competitiveness - has been underpinned by the introduction of the euro and the development of the corporate bond market.
We cannot shy away, however, from the fact that the exchange rate of the euro is at times affected by doubts about the prospects for the euro area economy. First, the persisting growth differential between the US economy and the euro area economy has been a source of concern. Second, the euro area economy is still suffering from structural problems and rigidities, for example insufficient labour market flexibility, by comparison with the US. These problems need to be addressed through appropriate structural measures by the national governments.
I see no reason to assume that the euro area economy will develop at a slower pace than the US economy in the medium term. The euro area economy is now in better shape than it has been for several decades. Growth is picking up, the employment situation is becoming brighter, public finances are improving and there are signs that governments are increasingly committed to undertake the necessary structural reforms in the areas of labour markets, pension systems, social security and taxation.
Rising oil prices, which constitute an external factor common to all countries have, in combination with the weakening of the exchange rate of the euro, contributed to some increase in the inflation rate in the euro area over the last year. The price pressures have prompted the Eurosystem to gradually tighten monetary policy in order to prevent them from being reinforced by internal second-round effects in an environment of strong growth prospects. Owing to the time-lags between changes in the monetary policy stance and their impact on price developments, we will see the full effects of the recent interest rate hikes only gradually. We shall continue to monitor the situation closely in order to be able to react promptly should new information change our assessment of the risks to price stability in the medium term.
Sirkka Hämäläinen is a member of the executive board of the European Central Bank. This article is based on a speech she delivered to the Euro-conference at the Danish Parliament in September.