NLP for Economics 1.1
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Collection with models and datasets for NLP practitioners interested in economics or economists interested in NLP !
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Lecture delivered in honour of Professor Xenophon Zolotas, Honorary Governor of the Bank of Greece, by the President of the Deutsche Bundesbank, Prof. Hans Tietmeyer, in Athens on 17/10/97. | Mr. Tietmeyer considers European monetary integration and its implications for the international monetary system Lecture delivered in honour of Professor Xenophon Zolotas, Honorary Governor of the Bank of Greece, by the President of the Deutsche Bundesbank, Prof. Hans Tietmeyer, in Athens on 17/10/97. I. The twentieth century does not lack for experience or lessons derived from different international monetary arrangements. Now -- just before this century comes to a close -- Europe is about to embark on a new experiment with far-reaching implications: a monetary union of nation states with a supranational central bank. Some economists see this as things coming full circle. The century began with the gold standard. It will end with a monetary union. As at the beginning of this century, at its end there will be a “denationalised” currency. Countries cannot produce this money more as they see fit. Whereas earlier this century they tied themselves to the availability of gold, in the future European monetary union the guardian of the currency will be a European Central Bank which is independent of national decision-making and which is committed solely to the objective of internal monetary stability. Those economists who stress this historical connection generally take an optimistic view of it. They expect the single currency to bring about an economic and political commitment which is in itself strong enough permanently to compel the participating countries to abide by the rules of the game. Without the option of altering the exchange rate and without the option of an autonomous interest-rate policy, national monetary policy will not be available as an instrument for correcting a current account deficit within the Union. The only possibility will be an adjustment in the real economy. According to this view, monetary union will have a strong disciplining effect. It will exert sufficient pressure on countries to tackle their real problems and to solve them internally, too. To that extent, it will carry on those effects of the gold standard which are regarded as having been successful. This optimistic reference to experience of the gold standard is not entirely convincing, however. First of all, one might ask how far that view idealises the way in which the gold standard worked. That is something which historians may argue over. At all events, that era was by no means a golden age. Be that as it may -- above all, the conditions for the functioning of the gold standard were different then. Countries’ government ratios were in the order of scarcely more than ten per cent at that time. The adjustments that were necessary given a change in competitive conditions -- which, naturally enough, primarily concern the private sector -- were spread comparatively widely over the major part of the economy. By contrast, the government ratio in many European countries nowadays is around fifty per cent or more. Adjustment in line with market conditions is thus now concentrated -- more or less -- on half of the economy. Prices and wages were also more flexible a hundred years ago; at any rate, more flexible than they are now in the majority of countries on the European continent. And, above all, the government had a different perception of its own role. Its core tasks at that time were to frame and protect the domestic legal system and to pursue national interests abroad. Nowadays, in the eyes of citizens and the electorate, the nation state and the government have a much deeper and more general economic and social responsibility for growth, incomes and employment. It is, at any rate, very optimistic under present-day conditions to assume that monetary commitment by the monetary union and the supranational central bank would only have to be strong enough and that it would then be able to enforce any desired adjustment needs automatically. What should not be overlooked is that abiding by the rules of the game depends on countries having an adequate capacity to be correspondingly flexible, just as it presupposes the common political will to submit to those rules of monetary stability on a lasting basis. That far-reaching economic and political dimension of monetary union should not be underestimated -- precisely in the world of today and tomorrow. The abolition of the exchange rate is, at all events, an occurrence of far-reaching importance. II. The exchange rate is a price; one of the most important in an economy. Like all prices, its prime task is to manage allocation. Put in simple terms, this means that if the exchange rate is at a level which is appropriate to competitive conditions and if the fundamental determinants -- such as differences in the inflation rate and productivity or the conditions of demand -- remain largely constant, then the exchange rate can and should be as stable as possible, too. It is then that its information content is at its highest. And this also brings about a high degree of certainty in planning for economic arrangements. If, on the other hand, there is a change in the fundamental determinants, the exchange rate should realign as rapidly as possible -- unless an economy is in a position to correct disequilibria quickly and efficiently by virtue of its own adjustment measures. These two requirements which exchange rates are expected to meet appear at first glance to pose a dilemma for monetary policy. On the one hand, the exchange rate should be stable; on the other, it should react as quickly as possible to fundamental imbalances. But, given appropriate policies, this is a pseudo-problem. It is largely solved for a monetary policy which is guided by the internal objective of stability; a steady policy geared to monetary stability helps in both respects. It reduces volatility because it introduces calm into the markets. At the same time, it is the best contribution that monetary policy can make to keeping fundamentally forced exchange rate changes at a low level and to strengthening flexibility and market mechanisms domestically. This pseudo-dilemma is then essentially solved for exchange-rate policy, too. That is because a country cannot in any case freely decide between exchange-rate systems -- say, more fixed or more flexible rates -- in line with its preferences like a visitor to a restaurant between different dishes on the menu. Fixed exchange rates presuppose the ability to cope with that arrangement. It is therefore not a matter of whether one finds less flexible exchange rates, or even their final elimination in a monetary union, “appealing” or “attractive”. The crucial point is: fixed exchange rates must be feasible and, above all, sustainable under prevailing political and economic conditions. III. Post-war global and European monetary history was inseparably linked for a quarter of a century with the Bretton Woods system. In origin, it was a gold exchange standard with fixed but adjustable exchange rates against the US dollar, for which there was an obligation to exchange currency for gold. At its inception there was, above all, the desire to overcome the monetary conditions of the 1930s. Competitive devaluations, far-reaching import restrictions and exchange controls seriously hindered world trade and economic cooperation between countries at that time. Against that historical backdrop, many economists rightly celebrated the Bretton Woods system as a great success. Without doubt, it put in place important groundwork for today’s high degree of openness in the goods and financial markets. Admittedly, a comprehensive assessment must not overlook at least three problem areas. Firstly, even the Bretton Woods system displayed the “vulnerability” of almost all systems of fixed exchange rates. Current account imbalances were combated too hesitantly. Corrections of exchange rates were made too late and often brought about new misalignments. Secondly, the years in which the system flourished have to be seen against the backdrop of restricted convertibility. It was not until 1961 that most west European countries introduced full convertibility. And precisely in the United States, too, capital controls were a frequently deployed instrument into the 1960s. Incidentally, even the financial markets which -- from the present perspective -- were still not very developed at that time showed their strength in that situation. There was, on the one hand, the ability to bypass administrative regulations. The Euro-dollar market came into being as early as the late 1950s, for example. On the other, there was the ability to exert speculative pressure on a currency with an exchange rate that appeared no longer to deserve confidence. Thirdly, countries with a better domestic stability record than the anchor country at that time, the United States -- such as Germany in the 1096s and early 1970s -- imported inflation through the fixed rate system. The expression “dollar inflation machine” was in use for a time. A firm anchor and a timely realignment of parities -- those are the basic requirements of any stability-oriented system of fixed exchange rates. The European Monetary System established at the end of the 1970s has performed better than the Bretton Woods system in a number of respects. It has provided a better solution for the question of the nominal anchor -- without officially designating the D-Mark for that role. Rather, it is a role which the D-Mark has acquired on account of its long-standing stability and its early convertibility. The parity-grid system permits the currency which is most stable on a long-term basis to set the standard. The anchor in the ERM is a position which can be recalled, however. Admittedly, even in the ERM there have been times when exchange rates that had become doubtful have not been corrected in time -- as the events of 1992 and 1993, in particular, showed. At all events, it was possible to guide the ERM out of the crisis by a formal widening of the fluctuation margins and largely stabilise it in the ensuing period. IV. Despite a number of earlier reform efforts, the Bretton Woods system eventually collapsed in 1973. Since then, the exchange rates of most European countries and of Japan have floated against the US dollar. By abandoning the fixed rates against the US dollar, monetary policy gained new freedom. From that time onwards, it has, above all, been able to pursue a domestic goal. The initial phase in the era of flexible exchange rates was clearly marked by differences in the domestic stance of monetary policy in a large number of countries. That was apparent particularly in the 1970s when most countries were hit hard -- although to differing degrees -- by oil price movements. A number of countries -- including Germany -- were principally concerned with restoring domestic monetary stability or with ensuring that it was jeopardised as little as possible in the long term. Others attempted to use a relaxed monetary policy to cushion the adjustment needs of their economies caused by the oil price shocks. In line with that, there came to be wide differences between inflation rates. Those differences had the following results. Firstly, the countries which gave priority to safeguarding monetary stability adapted more quickly to the new conditions and also achieved better results in the medium term with regard to the goal of employment. Secondly, a disparity arose between individual countries in terms of the reputation and credibility of their anti-inflationary stance -- some of the effects of which are still felt today. Thirdly, the plan to realise a European monetary union which was initiated at the end of the 1960s at the Hague Summit foundered before a real political decision had been taken. The initial phase of world-wide flexible exchange rates thus up to now has two crucial messages. Firstly, the best contribution that monetary policy can make to lasting growth and employment is a clear anti-inflationary stance. In the long term, jobs cannot be “bought” by higher inflation. That was already true even in the 1970s when unemployment -- at least in many industrial countries -- was still predominantly cyclical in nature. That is all the more the case today when unemployment in Europe has largely structural causes. The permanent anti-inflationary stance of the monetary union is therefore an essential condition for Europe’s future success in creating and safeguarding jobs. Secondly, it would be disastrous for the monetary union if political differences concerning the role of monetary policy were to emerge as they did in the 1970s. That is because countries cannot pursue different monetary policies in the monetary union. That would lead to political conflicts -- with the European Central Bank, which operates supranationally, and probably also between the political opinions that prevail at the national level. V. That first phase with -- in some cases -- high rates of inflation initially brought the system of flexible exchange rates into disrepute. The 1980s taught new lessons, however -- at least following the change of course in domestic policy starting in France after 1983. Inflation rates gradually receded in many countries. This was a broad process. It took place in the European countries which belonged to the European Monetary System. It also took place in countries without fixed exchange rates, however. Obviously, many countries changed their orientation. External exchange rate pegging, such as to the D-Mark in the European Monetary System, certainly made that easier for some countries. But it also became apparent that what mattered crucially in the final analysis was the political will for monetary stability. This reorientation was undoubtedly in part a reaction to the negative experience of an inflation-accommodating monetary policy in the 1970s and early 1980s. At the same time, it was made easier by the fact that over the years, together with a clear-cut target, a number of central banks had also gained greater independence. For that reason, the system of flexible (or, at least, sufficiently, flexible) exchange rates is now regarded in a certain way as having been rehabilitated. It is precisely on the condition of free movement of capital and financial markets which nowadays largely operate internationally that it can indeed exert pressure for a monetary policy geared to stability. Another hope of the supporters of flexible exchange rates is likely to remain unfulfilled, however: the hope that speculation will always have only a stabilising impact and that, following a change in the fundamentals, the exchange rate will glide smoothly and gently to a new equilibrium level. In actual fact, the path taken by exchange rates is often quite bumpy and cannot always be explained convincingly even ex post. Overreactions are not infrequent. Obviously, expectations of future economic and political trends play a major role in the formation of exchange rates. Not only do they contribute to higher volatility because swings in mood often set in abruptly. They can apparently also superimpose themselves on current data so strongly that misalignments may occur, at least for a while. The sharp appreciation of the D-Mark against the US dollar in spring 1995 was a development of that kind. Admittedly, a fair critic has to concede two mitigating arguments to the system of flexible exchange rates. First of all, it is undoubtedly too simplistic to blame the system for every obviously excessive exchange rate movement of currencies whose rates are formed flexibly. There are some, for example, who regard the excessive trend of the US dollar in the 1980s as the nightmare of the present global monetary system. But one has to recognise, of course, what lay behind this. It was during that period that the resolute reversal in the Fed’s monetary policy under Paul Volcker coincided with the expansionary fiscal policy of the Reagan administration. In particular, US fiscal policy stood in marked contrast at that time with German fiscal policy, which was on a course of moderate consolidation. It is quite possible to ask the question: “What other exchange rate arrangement would have actually withstood those tensions?” If anything, fixed exchange rates would probably have increased those tensions or would at least have politicised them more strongly. The Plaza and Louvre cooperation initiatives were probably the most that could be achieved at that time, although it has to be said in passing that the results were by no means only positive ones -- as is shown by the example of the development of asset price inflation in Japan, which was encouraged at that time by an expansionary monetary policy, and its consequences -- from which that country is still suffering. As a second line of defence it can be pointed out that world trade is developing at a furious pace despite flexible exchange rates between the major international currencies. That may be due to the fact that incorrectly valuated exchange rates tend to correct themselves in the medium term. It may also be due to the fact that good possibilities are now available for guarding against sharp exchange rate fluctuations. This can take the form of hedging operations in the financial markets. It can also take the form of a diversification of production centres. To that extent, highly volatile exchange rates can influence not only trade but also direct investment. And that undoubtedly has longer-term effects which should not be underrated. For that reason, exchange rates which are as stable as possible are, of course, important -- but more in terms of real rather than nominal stability. However, the question remains of how the objective of real exchange rate stability can be achieved as comprehensively as possible. There is unlikely to be an answer which is valid for all countries and their relations with each other. VI. In the current debate in Europe the question is also asked repeatedly whether the future euro/dollar exchange rate will be more stable than, say, the present relationship between the D-Mark and the dollar. Ultimately, this is an empirical question, of course. It can really be answered only in the light of the monetary union. There are a number of considerations which point in differing directions. The euro will probably have a larger and deeper financial market than the D-Mark. That means, first of all, that the price effects will tend to be slighter when assets are switched by the individual investors and that the exchange rate will also be moved less as a result. The larger euro financial market might, however, also lead to investors generally regarding the euro -- more than the D-Mark now -- as a substitute for the US dollar. That might increase the desire to switch funds in certain situations. In that case, the exchange rate would tend to fluctuate more. At times, one also encounters the argument that the euro area -- as a large economic and currency area -- will be relatively less dependent on foreign trade, particularly as the structure of exports is heavily diversified. The outcome would be -- at least, according to the standard textbooks -- that the euro/dollar exchange rate is not as important for Europe. This argument is undoubtedly fundamentally correct and also of significance. The comparison with other major currency areas -- such as the dollar area -- has only limited validity, however. The high share of domestic transactions is not the only reason why the United States can, if anything, neglect the dollar’s exchange rate. It can also do that because its own currency area corresponds to its national boundaries. In the United States, not only is there a comparatively high degree of labour mobility and flexibility in labour costs, there are also compensatory and cooperative mechanisms in the area of public finance at the level of national government. These are able to cushion remaining regional and sectoral tensions which cause major exchange rate fluctuations. The supranational monetary union in Europe has neither comparable mobility and flexibility nor compensatory mechanisms in the area of public finance. This, too, reveals, the particular conditions of monetary union in Europe. In the European monetary union asymmetrical effects will probably tend to lead more quickly to a need for real adjustment in the countries or regions concerned. VII. The present world monetary system is, of course, not just characterised by the major international currencies floating against each other. At the same time, many countries have entered into arrangements to peg exchange rates of varying intensity. There are essentially two motives for this: Firstly -- particularly in the case of smaller economies -- the foreign trade motive. Countries want to strengthen their international economic integration with a fixed exchange rate. Secondly, the stability motive. By pegging the exchange rate, countries want to import credibility for an anti-inflationary stance -- particularly one which is to be newly established. The record of these arrangements is as varied as the forms of pegging themselves. A number of emerging countries and countries in transition have had mixed experiences of pegging their exchange rates to other currencies. However useful it was for them in an initial phase to gain confidence in the international markets by pegging their exchange rate, it has almost always been the case that tensions have arisen and, unfortunately, often erupted after a few years if the trend in domestic competitiveness was not able to keep up with the anchor country on a long-term basis. That has become apparent not only for some countries in Latin America and in eastern Europe but only just recently in South-East Asia, too -- especially if exchange rates have not been adjusted quickly enough to changed competitive conditions. The prospects of a pegging of exchange rates being successful have to be seen in the context of the present-day international financial markets. Their impact on the permanence of exchange rate pegging is an ambivalent one. On the one hand, the international financial markets can make arrangements of this kind obsolete more or less overnight if the conviction disappears that the pegging will hold. On the other hand, they encourage strategies of this kind since they offer the countries the option of financing quite sizeable current account deficits. Mainly two problems arise when pegging the exchange rate. Firstly, it may be that a country is currently achieving a comparatively high level of monetary stability but the markets still doubt the country’s determination to persist with that strategy. In that case, real interest rates -- at least in a transitional phase -- are relatively high. Doubts about sustainability threaten to become a kind of self-fulfilling prophecy. That was at certain periods the French problem with its franc fort policy. Secondly, it may be that a country achieves a significant fall in inflation by pegging the exchange rate. But a certain -- if only slight -- inflation differential vis-à-vis the reference currency often stubbornly remains nonetheless. That may be due to inflation expectations from the past which are not entirely eliminated. That may also be due in part to a political deficit; a fiscal policy that fails to give adequate support to the pegging of the exchange rate or an overgenerous domestic monetary policy in the light of capital inflows. Be that as it may, the outcome is that the currency gradually appreciates in real terms. The current account shows a chronic deficit. In a situation of that kind, a country must consider a strategy to find its way out. The fixed parity is not sustainable on a lasting basis, even if the financial markets go along with it for a time. This implies an important message for the envisaged monetary union in Europe since monetary union does not offer the possibility of a way out. The requisite ability to achieve lasting domestic and external stability must be established and proven before entry in all the member states. That is what the entry criteria aim for. It would be a risk to hope that a country’s necessary ability to achieve stability will gradually come about after entry into monetary union. Even if this were achieved over time, price competitiveness might already have been seriously impaired by then. And the catching-up process would be even more ambitious. There will, in fact, be certain regional differences in inflation rates within the monetary union. That is a normal process, to the extent that it will reflect differing trends in productivity or shifts in patterns of demand. Enormous economic tensions would occur, however, if it were also a reflection of varying ability to achieve stability and hence to accept the supranational monetary policy. Sufficient anti-inflationary convergence must therefore precede entry into monetary union, not the other way round. At all events, the reverse order would not be without considerable risks. VIII. It is desirable and beneficial to have as high a degree of exchange rate stability as possible against the currencies of other EU and non-EU countries, too. Stable exchange rates need convergence -- either in the sense that fundamental deviations do not occur or in the sense that existing imbalances are rapidly eliminated owing to a high level of flexibility in domestic prices and in the structure of the economy. In principle, that is a valid statement irrespective of the exchange rate system, in fact. It just happens to be the case that in the reverse situation -- if there is a lack of convergence -- the exchange rate system plays a major role. If exchange rates are flexible, divergence in anti-inflationary policy can increase volatility but it is less dramatic overall. In turn, the degree of convergence is also lower, of course. The degree of convergence tends to be higher with fixed but adjustable exchange rates. If there is, nevertheless, no adequate convergence, costs will depend on whether there is a timely realignment. If prompt action is taken, the consequences will be contained. By contrast, if the realignments take place only under pressure from the markets, high costs can easily arise -- not just for the country itself, by the way. A “case” like this can easily negate the credibility of a whole system or make the unilateral pegging of other countries -- even those in other continents -- more difficult. For that reason the fact that the alignment of the exchange rates in ERM II is to be made easier than in the present system is a positive development. It is to be hoped that this will prove its value in practice, too, in future. The choice of the exchange rate system must, at any rate, be consistent with the economic and political conditions which obtain in the participating countries. A mixed world monetary system -- with floating key currencies, on the one hand, and regional integration through monetary union and fixed exchange rates, on the other -- might not be the best of all hypothetical worlds. But that system is probably the one that corresponds most closely to conditions in the real world. It is not inherently a badly designed structure or a non-system. There can indeed be appropriate graduations of flexibility that are in line with the realities. IX. Understandably, the question is now frequently being asked: “What place will the euro take in the future world monetary system?” The answer which is often given is the notion of a future tripolar system consisting of the dollar, the yen and the euro. That vision is, at least, not very accurate. If one wants to speak of a tripolar system at all, the weights in it will differ quite considerably. Even now, it is becoming apparent that the yen’s potential relative to the other two currencies will, if anything, remain limited. At all events, in the foreseeable future it will probably lack the regional base in Asia itself which the euro is likely to have in Europe. But the euro will first have to earn its position. That is because an international currency essentially needs three properties: • • • a high level of lasting stability a strong base in the real economy and efficient financial markets. The euro has the potential to fulfil those three conditions. But that will not occur automatically. For that to happen, the preconditions have to be right. Replacing the dollar as the leading currency is, however, probably not on the agenda. Monetary history has shown that a key currency being superseded is ultimately due to an internal crisis in the country in question. The former leading country loses the confidence of the markets. The capacity for domestic stability diminishes. The economy becomes less competitive. That was also the history of the decline of the pound sterling as a global key currency following the Second World War. There are no indications whatsoever of a comparable development in the case of the US dollar. On the contrary, the dollar is a strong currency and -- despite a current account deficit and growing external debt -- the US fundamentals do not point to a change in that situation. X. The euro and the dollar can enter into fruitful competition, however. The world monetary system as a whole will be able to benefit from healthy competition between two currencies which are geared to stability. There are three particular factors which would promote productive competition of this kind: Firstly, that the current high degree of correspondence in the anti-inflationary stance of the United States and Europe continues; secondly that fiscal policy in both the Unites States and Europe remains on a similar course of consolidation and -- particularly in Europe -achieves further progress; and thirdly, that both the United States and Europe fulfil the expectations of meeting the economic challenges which they face. The United States must demonstrate that its high debtor position and hence its future financial obligations are covered by the dynamism, efficiency and innovative potential of its economy. The Europeans must show that they are making structural changes to tackle the problem of unemployment and that they are improving their competitiveness in global markets. Productive competition of this kind does not imply a rejection of greater world-wide cooperation in economic and monetary policies with the aim of contributing to higher exchange rate stability. On the contrary, it is precisely in the future, too, that cooperation of this kind will be meaningful and desirable. In saying this, what should not be overlooked is that exchange rates are not the actual operational parameters. Rather, they are the result of economic developments and economic policy in the participating countries. For that reason, there is one lesson which should conclude this lecture. It is perhaps as old as monetary history itself. A suitable monetary framework can help a country to carry out the structural reforms which are needed. Being a substitute for the adjustments which an economy has to make to changed conditions, however, is something which monetary policy -- however good it is -- cannot do. | bank of greece | 1,997 | 10 |
Speech given by Mr Nicholas C Garganas, Deputy Governor of the Bank of Greece, at the 'Athens Summit 1999' on 18 September 1999. | Mr Garganas gives a speech on integrating Greece into the euro area and the challenges ahead Speech given by Mr Nicholas C Garganas, Deputy Governor of the Bank of Greece, at the “Athens Summit 1999” on 18 September 1999. * * * The adoption of the euro as a common currency by a first group of eleven European Union Member States on 1 January 1999 was rightly described as an historic event since the move to the final stage of Economic and Monetary Union indeed marks a decisive step towards full economic and political integration between the countries participating in this endeavour. The vigorous and credible implementation by Greece of policies aimed at achieving a high degree of sustainable economic convergence and meeting the terms of the Maastricht Treaty for EMU participation have yielded concrete results, thus placing Greece directly on the road to joining the euro area by the target date of 1 January 2001. Over the past few years, convergence towards price stability has been impressive. The annual rate of inflation in August was 2%. Great progress has also been achieved regarding the general government budgetary position. In 1998, the deficit stood at 2.5% of GDP, and is expected to fall further (to just over 1.5%) this year, continuing the downward path of the debt–to–GDP ratio, which currently stands at 105%. The gradual reduction in budget deficits, together with the entry of the drachma into the Exchange Rate Mechanism, has led to an appreciation of the drachma (first against the ECU and this year against the euro), and lower long-term interest rates. In the first half of this month, the ten-year government bond spread versus Germany was around 163 basis points, compared with 196 basis points in March 1999 and 425 basis points in September 1998. The remarkable nominal convergence achieved by Greece indicates that its objective of meeting the Maastricht criteria by early 2000 is now becoming a reality. Although it is widely anticipated that Greece will be admitted into the euro area by June next year so that it can adopt the single currency on 1 January 2001, we should not allow this achievement to dim our view of what remains to be done. As I see it, Greece faces two broad sets of challenges. First, in the remainder of 1999 and in 2000, macroeconomic policy has to remain firmly focused on keeping the EMU process on track and on securing the conditions that will make for a smooth transition and positive performance upon entry. From this point of view, the main challenge is that of sustaining price stability. Second, Greece is faced with the additional challenges of completing the necessary budgetary consolidation and stepping up the structural reforms required to prepare the economy for the demanding competitive environment of monetary union. Let me discuss each of them in turn. Maintaining price stability First, there is the issue of establishing conditions that will secure price stability between now and the end of 2000. On current projections, in the remainder of 1999 and early 2000, inflation (as measured by the Harmonised Consumer Price Index) is expected to average close to – or slightly below – 2% – a rate that is consistent with the Bank of Greece’s definition of price stability. The benign outlook for inflation reflects a number of important policy choices, most notably the tight monetary policy stance adopted to date, centred on high interest rates and a strong drachma. The reduction in inflation is also supported by a moderation of wage settlements. However, the current favourable inflation prospects reflect, in part, the impact of recent indirect tax cuts and other administrative measures. Given the need to maintain price stability throughout the year 2000 and beyond, the present tight monetary conditions will have to be maintained as long as is feasible to ensure against unforeseen inflationary pressures. Should there be renewed inflationary pressures, there are evident limits to what monetary policy could do to maintain price stability in the run-up to EMU. I do not have the time to discuss these constraints in detail. I can only mention the fact that the ability of interest rate policy to curb credit growth is being eroded by the public’s widespread perception that interest rates will necessarily decline by end-2000 and by firms’ recourse to foreign borrowing. Looking further to 2001, the alignment of Greek interest rates with those in the euro area and the slide of the drachma to its central ERM parity when Greece enters the euro area will, of course, entail a substantial easing of monetary conditions. This prospect for a substantial easing of monetary conditions in early 2001 could result in a reversal of the downward trend in inflation in the course of 2000 and beyond. Against this background, the macroeconomic policy mix will need to undergo a fundamental rebalancing, with other policy instruments – notably fiscal, wage and structural policies – being called upon to offset the effect of monetary easing on inflation and thereby help to maintain price stability. Let me now turn to the matter of the challenges facing Greece with respect to the completion of the adjustments required to prepare the economy for the exigencies of monetary union. Three interrelated issues are important in this respect. First, the need to sustain efforts to achieve and maintain a sound budgetary position consistent with the Stability and Growth Pact, and a speedy reduction in the still high debt-to-GDP ratio. Second, the need to strengthen Greece’s ability to respond to “asymmetric” shocks, i.e. negative shocks affecting the entire national economy and only that economy. Third, the challenge of stepping up the structural reforms required to secure Greece’s smooth participation in the euro area and to reap fully the opportunities offered by EMU. Sound public finances As I indicated at the outset, Greece has made enormous progress in reducing the large imbalances in its public finances over recent years. However, additional progress is required in order to ensure compliance with the Stability and Growth Pact’s medium-term objective of a budgetary position close to balance or in surplus. That will allow Greece to deal with cyclical fluctuations while keeping the government deficit within the reference value of 3% of GDP. It will also allow a speedy reduction in the still high public debt ratio and help prepare for the fiscal impact of population ageing. A sound budgetary position will impart a layer of flexibility into the economy. Since, following entry into the euro area, adjustment to adverse cyclical developments and country-specific disturbances will, to an important extent, rest with budgetary policy, it will be of paramount importance to ensure that the automatic stabilisers will be able to play their role. Greece needs to step up its budgetary adjustment to put its debt ratio firmly on a declining path and to bring it down swiftly below the reference value of 60% of GDP in the near future. A further steady decline in public debt and an appropriate debt management strategy would reduce the vulnerability of Greece’s public finances. Moreover, a speedy reduction in public debt is essential because Greece, like other EU Member States, will face increased pension liabilities in the second decade of the next century as a large number of people will retire because of a marked ageing of the population. As a result, public pension spending is likely to increase sharply in relation to GDP, particularly if there is no reform of the social security system. Reducing the debt-to-GDP ratio to 60% will not be easy. While Greece can count on comparatively large privatisation proceeds, it is burdened by a currently high government debt ratio, significant contingent liabilities and a large debt accumulated by its chronically loss-making public enterprises. An exercise on the dynamics of the debt ratio carried out under certain assumptions and starting from 2000 onwards suggests that it would take 10-12 years for the debt-to-GDP ratio to be brought down to 60%. 1 Maintaining Greece’s primary budget surplus at its present level (6.7%) for 10-12 years – which is what is assumed in this exercise – would virtually remove the scope for easing the high tax burden on Greek citizens over the next 10-12 years and would imply little room for public spending increases. It would be more realistic for the government to speed up and expand its privatisation plans, using the proceeds to reduce the debt stock. The government could also press ahead as fast as possible with the reform of the social security system (for example, along the lines implied by the Spraos Committee Report). The government could also intensify its efforts to reduce tax evasion, rationalise public expenditure and reform the wider public sector. Asymmetric shocks Let me now turn to the issue of country-specific disturbances. With the date of Greece’s entry into EMU approaching, attention should now shift from issues of transition to monetary union to the challenges posed by EMU for Greece. By definition, EMU implies the loss of national monetary autonomy. One of the criticisms often levied against the EMU project is that member countries will not be able to respond to adverse economic disturbances via changes in national monetary policy or the nominal exchange rate. It is then argued that country-specific disturbances will result in a recession and a surge in unemployment. In reality, the exchange rate is potentially appropriate for coping with adverse economic developments and country-specific shocks only in a narrow set of circumstances. Mutatis mutandis, the same can be said of monetary policy. Shocks that are truly national are already relatively infrequent. And they will become even more so once Greece joins the euro area: the stability-oriented macroeconomic framework will reduce the likelihood of policy-induced shocks (such as disturbances originating from reckless fiscal behaviour), which in the past have been an important source of country-specific shocks. Moreover, the increasing openness and trade integration of EMU members will further blur the economic importance of national boundaries, thereby reducing the national specificity of economic disturbances. In the case of Greece, there will be the added benefit to be derived from the process of catching up. A single currency will greatly enhance prospects for bringing in new industries, as the elimination of exchange rate risk will encourage firms to produce closer to their markets. Large infrastructure projects already underway – and financed through the Community Support Programmes – will improve competitiveness and provide a further inducement for firms to move to Greece. It is therefore likely that the conditions after EMU entry will be favourable to growth and employment creation in the Greek economy. To argue that the incidence of country specific disturbances will diminish is not, however, to say that such shocks will disappear altogether. In those circumstances, in which a change in the exchange rate or national monetary policy would have been helpful, alternative adjustment mechanisms will have to be provided for responding to macroeconomic disturbances once national authorities have lost monetary and exchange rate independence. To achieve this it is assumed that Greece would need growth of 3.5% a year, a cost of public borrowing of 5%, and a primary budget surplus of 6.7% of GDP. It is also assumed that the general government takes on contingent liabilities and debt of public enterprises (outside the general government). At the macroeconomic level, it was argued earlier that, in the case of Greece, public finances will have to regain the necessary room for manoeuvre to cope with adverse economic developments and country-specific disturbances. Where structural adjustment, rather than mere macroeconomic stabilisation, is called for, an improvement in price competitiveness will be needed. This brings me to the crucial role of structural reform. Structural reform On the structural front, there has been much progress in several areas over recent years and it is beginning to yield substantial benefits to the economy. But, given the breadth and the magnitude of the structural problems, much still remains to be done. I focus here only on a few selected issues where I feel that significant breakthroughs would make a major contribution to preparing the economy for the exigencies of monetary union. In particular, more stress needs to be placed on enhancing competition in product markets and improving labour market flexibility. Greater market flexibility will not only allow Greece to cope with country-specific disturbances more easily, but it will also, by reinforcing Greece’s competitiveness, ensure a tension-free macroeconomic growth process and increase the employment-content of growth. Although legislation was passed in 1998 aimed at addressing some key rigidities in the labour market (the inflexibility of working time, wages, the ineffectiveness of job matching mechanisms), the performance of the Greek labour market has not yet materially improved. This year’s National Action Plan for Employment is a well-articulated approach intended to provide an overview of the government’s initiatives and plans in this area. But more stress needs to be placed on improving the quality and job-relevance of vocational training. The government’s privatisation and flotation programme has been steadily implemented. This has contributed significantly to debt reduction and enhanced competition in the banking system. But privatisation needs to expand into other areas, including key economic sectors that remain dominated by public enterprises. Tax reform is also needed to alleviate the tax burden, particularly, although not exclusively, on wage earners and to bring the tax structure into line with that in the euro area, thereby preventing the movement of capital and labour to lower-taxed areas. In concluding, I would note that the achievements to date are impressive and have paved the way for Greece’s forthcoming participation in the euro area. By meeting the challenges of completing the necessary budgetary consolidation and stepping up action across the broad spectrum of structural reforms, Greece will not only be able to join the euro area in a strong competitive position, but will also reap the full benefits from participation in EMU. | bank of greece | 1,999 | 9 |
Address by Mr Nicholas C Garganas, Deputy Governor of the Bank of Greece, at the Euromoney International Bond Congress, held in London on 15 February 2000. | null | bank of greece | 2,000 | 3 |
Speech by Mr Lucas Papademos, Governor of the Bank of Greece, at the Euro Information Conference, Athens, 17 October 2001. | Lucas Papademos: The completion of the changeover to the euro Speech by Mr Lucas Papademos, Governor of the Bank of Greece, at the Euro Information Conference, Athens, 17 October 2001. * * * I would like to welcome you to the third session of the Euro Information Conference. Your presence here attests to the importance you attach to the successful changeover to the euro, our new currency, our money. It is a particularly great pleasure for me to welcome the Minister of National Economy and Finance, Mr Yannos Papantoniou, and the President of the European Central Bank, Dr Willem Duisenberg, to whom I express my warmest thanks for their participation. I would also like to thank the other distinguished speakers and colleagues who participated in the first two sessions of the Conference. I We have now reached the last lap in what has been a long and arduous journey culminating in the introduction of the single European currency. About 75 days from today, the euro banknotes and coins will be put into circulation and the withdrawal of the national currencies of the 12 euro area countries will begin. The euro will thus become a visible and tangible reality for some 300 million European citizens and numerous other economic agents worldwide. In the current juncture of increased uncertainty about international developments and economic prospects, the interest of the public in the introduction of euro banknotes and coins may reasonably have been reduced. This does not mean, however, that the completion of the changeover to the euro does not constitute a high priority for us all. And it is of particular importance, especially in a period of uncertainty, to prepare ourselves in time and adequately, so that the changeover to the single currency is smooth and successful. Creating Monetary Union in Europe and introducing the euro has indeed been a long, complex and unprecedented process. This vision first took shape over 35 years ago. The official political decision and commitment of the EU Member States came nearly ten years ago, with the signing of the Maastricht Treaty on 7th February 1992. A long period of extensive preparations followed to ensure that the appropriate economic and monetary conditions were established and to complete the necessary institutional and technical adjustments for the establishment of Economic and Monetary Union in Europe. The euro came into being as a currency in scriptural form in eleven EU countries on 1st January 1999. After joining EMU, Greece also adopted the euro as its currency on 1st January 2001. The introduction of the euro in scriptural form was a particularly difficult venture, but it was also a significant step towards the creation of the European monetary union and the implementation of the single monetary policy. The venture was difficult as it required many and complex institutional, technical and operational adjustments of central banks, credit institutions and financial markets. It was, however, a significant step, as in this way the money market was integrated and the monetary regime in 11 EU countries was radically and irrevocably changed. Equally difficult from a technical point of view and important for the economy and the conduct of monetary policy was the adoption of the euro as Greece’s currency in January 2001. Consequently, the euro is already with us and is actually the single currency adopted by 12 EU countries. This reality, however, is not sufficiently visible to the general public, which uses national banknotes and coins in its day-to-day transactions. That is why many people consider the euro a “virtual” currency. Moreover, since the euro does not exist in physical form, many firms and organisations have not fully adjusted their accounting and IT systems to the single currency. With the circulation of euro banknotes and coins on 1 January 2002, the changeover to the single currency will be completed and it will become a visible, tangible and irreversible reality. The last stage of the transition will produce further specific benefits for consumers and firms. It will also favourably affect the international acceptance and external value of the euro. At the same time, I believe that it will enhance and speed up the overall process of European cooperation and unification. II Completion of the changeover to the euro with the entry into circulation of euro banknotes and coins and the withdrawal of national currencies is also a complex undertaking, possibly more difficult than the introduction of the euro in scriptural form. It requires a wide range of preparatory work by the monetary and economic authorities and credit institutions in general. This work involves not only the production and distribution of euro banknotes and coins but also institutional and operational adjustments in the public sector. At the same time, however, this venture calls for the preparation and adjustment of those who will actually use the single currency: citizens, firms, organisations and other economic agents. The successful completion of the changeover to the euro thus calls for concerted efforts, preparations and cooperation between all parties involved, at both the European and the national level. I would first like to briefly reflect on the role of the Bank of Greece in this process. I will then focus on some of the challenges that we will be facing, but also on the benefits that will arise from the completion of the changeover to the euro. The Bank of Greece is responsible for the production of the euro banknotes and coins to meet cash requirements on Greek territory. In cooperation with the commercial banks, the Bank of Greece will also be responsible for the withdrawal of the drachma banknotes and coins. This is an enormous task not only because of the large volume of drachma banknotes and coins that have to be exchanged, but also because in the case of Greece only one year will have elapsed between the adoption of the euro in scriptural form and the actual circulation of the new currency in physical form, compared with three years in all the other euro area countries. It is estimated that some 650 million drachma-denominated banknotes and 7,000 tonnes of drachma coins, of a total value of 3 trillion drachmas, will have to be withdrawn in Greece. Owing to the shorter time available for production, some of the needs inevitably had to be met by importing banknotes and coins from printing works abroad. Most of the production needs have nevertheless been met by the Bank of Greece Printing Works in compliance with the common standards for the production of high-quality currency incorporating a large number of security features. To ensure the sufficiency of stocks in the event of extraordinary needs, we have taken steps to have a total of 617 million euro banknotes and 1,600 million euro coins (or 8,300 tonnes of euro coins) ready for circulation. In the case of Greece, the volume of banknotes and coins in circulation is relatively large in comparison with the size of its economy and with many other euro area countries, because cash is widely used in transactions. This is reflected in the ratio of currency in circulation over GDP, which amounts to 6.4% compared with 5.4% in the euro area on average. This percentage may seem quite high, but is not very far from the respective percentages of some other euro area countries such as Germany (6.2%) or Italy (6%), and is well below that of Spain (9%). Moreover, Greece does not lack alternative savings instruments; indeed, the share of currency in circulation in the broader monetary aggregate M3 is small (6%) and smaller than the euro area average (6.9%). Against this background, it is fair to assume that established behavioural patterns, saving patterns in particular, should not pose any particular constraints on the substitution of the euro for the drachma - at least no more than elsewhere in the euro area. On the other hand, the geography of the Greek territory does make the frontloading of euro cash to banks and the public more difficult. The Bank of Greece now has the required stock of euro banknotes and coins and is presently frontloading to banks according to schedule. Sufficient amounts of euro cash have already been delivered to the 27 branches of the Bank of Greece across the country. Another part of the euro stocks will be supplied to commercial banks through 96 branches of the National Bank of Greece, with which the Bank of Greece holds cash surpluses from funds under its management. Frontloading is at present free of charge. The counterpart of frontloaded euro banknotes and coins will be debited to banks gradually in the course of January 2002, so as to help them deal with the costs of frontloading and supplying. Let me add that the Bank of Greece is in a position to meet part of the demand for euro banknotes in neighbouring Balkan countries and, in cooperation with the respective central banks, is planning the frontloading of euro banknotes in the region. It is estimated that the public in these countries are currently holding significant amounts of legacy currencies, predominantly German marks worth at least 6 billion marks, which will have to be exchanged for euro. Until the end of the year and while the central bank will be frontloading euro banknotes and coins to banks, the latter will assume the task of supplying the economy with the new currency: they will be sub-frontloading euro coins (as from 1 November 2001) and euro banknotes of lower denominations (5 and 10 euro) to retailers (as from 1 December). Starting from 17 December 2001, the public at large will be supplied with 13 million starter kits, containing euro coins of all denominations. Meanwhile, banks are completing the adjustment of their information systems and the technical preparations that will enable ATMs to dispense euro cash as from 1 January 2002. From mid-January 2002 onwards all ATMs of banks will operate in euro only. What we have heard so far during the first two sessions of this Conference confirms that the Greek banking system is in an advanced state of preparedness for the changeover. I believe that, with close cooperation between the Bank of Greece, commercial banks and the Hellenic Bank Association, the necessary preparations will have been accomplished by the end of the year and that the banking system, on its part, will have established the proper conditions for a seamless transition to the euro. III As already mentioned, however, a successful transition also hinges on the preparation of the public at large, retailers and other economic agents. These have therefore to be familiar with the euro banknotes and coins and with the overall changeover process. The 2002 Information Campaign, prepared and conducted by the European Central Bank and the national central banks of the euro area, is targeted at citizens and business firms of the euro area and beyond and its objective is to raise awareness of the euro banknotes and coins, by providing comprehensive practical information. The campaign involves various actions, as the President of the ECB Mr Duisenberg will later explain in greater detail. Still, I would like to make two points. First, that the campaign relies heavily on the participation of public and private organisations and enterprises which have become “europartners” and act as “information multipliers”. Today's Conference, which has been organised in the context of the 2002 Information Campaign, brings together more than 100 europartners. We are looking forward to having a closer cooperation with them over the next weeks. Second, as you may have already noticed, the first TV commercials and advertisements in the press are here, as part of the 2002 Information Campaign which will gradually gain momentum and will culminate around the turn of the year, with the distribution of information leaflets. Furthermore, the Bank of Greece has scheduled additional information briefings and events intended to complement the joint European campaign. Such briefings and events include: • additional TV spots concerning the introduction of the euro in physical form and the adjustment to the new monetary environment; • the production and distribution of a board game called “Euroraces” intended to familiarise children and their parents with the new currency, as well as of a comic book entitled “Eurocles” for older children; • public expositions of 100 works of art in the shape of enlarged euro coins, made of polyester and painted by children from all the euro area countries; • the production of 1 million “euro converter cards”, with information on the banknotes’ security features; • additional information conferences on the euro throughout Greece with the participation of Bank of Greece officials. I believe that the joint Eurosystem Information Campaign, the complementary information events scheduled by the Bank of Greece, as well as the programme jointly organised by the Ministry of National Economy and the European Commission will, by the end of the year, succeed in addressing the awareness gap which continues to exist with regard to the completion of the changeover to the euro. IV A general conclusion that can be drawn from the previous sessions of this Conference is that the necessary technical preparations and operational adjustments for the introduction of the euro are progressing satisfactorily in the banking and the business sector. This, combined with the anticipated improvement in public awareness, seems to indicate that the transition to the euro will be a smooth one. This encouraging conclusion does not leave room for complacency, nor does it mean that the changeover does not entail costs for the preparation and adjustment to the new monetary environment. Adjustment costs are to some extent inevitable owing to the nature and the scale of the task. However, we must strive to minimise these costs, through adequate and systematic preparation and information. At the same time, we must bear in mind that the costs and possible inconveniences associated with the completion of the changeover to the euro are only temporary, while the advantages to be reaped will be both considerable and permanent. The macroeconomic and microeconomic benefits for Europe and Greece from the introduction of the euro are numerous, and have been enumerated in detail in the past. I do not intend to go over them here, even though I have the impression that all of the parties involved may not be fully aware of them. I would, however, like to focus on two points which are directly related to the present conjuncture and to the conversion procedure to the euro in physical form, and which specifically concern Greece. Our economy has already drawn numerous benefits from Greece’s adoption of the euro, since this adoption presupposed stability and led to it. Greece has achieved a high level of monetary and exchange rate stability in the long run, which promotes economic growth. The shielding of the economies of Greece and of the other euro area countries from exogenous shocks proved adequate in the aftermath of the tragic events of 11th September. The sudden and significant rise in uncertainty caused by the terrorist attacks on the United States was not accompanied by the tensions on the foreign exchange markets that we had become accustomed to seeing in the past. Apart form the macroeconomic benefits, however, the upcoming introduction of the euro banknotes and coins will ensure full transparency of prices, enhance consumer awareness and increase competition. As a result, inflationary pressures will be contained in the medium run. And, of course, the conversion costs between various currencies, which are quite considerable for consumers, especially in sectors such as tourism, will be eliminated. In order to fully reap these benefits, consumers should try to become familiar not only with the physical appearance of the euro banknotes but also with the new scale of values. They should try to think of monetary values, not as amounts of drachmas but as amounts of euro. On the other hand, enterprises should introduce the new currency to their everyday transactions the soonest possible and refrain from any non-transparent pricing policies that could later weaken their competitive position. One type of cost that might arise from the introduction of the euro - and which should be avoided or minimised - refers to unwarranted price increases on the occasion of the redenomination of prices as from 1 January 2002. European Commission surveys reveal that euro area citizens are concerned about this possibility. These concerns are also related to the fact that familiarisation with the new scale of values - what is expensive and what is not, in euro - is a learning process that will take time and require effort, alertness and patience on the part of citizens. However, so far there is no evidence that some enterprises might try to take advantage of consumers' lack of experience and increase their prices even before the beginning of 2002. In any case, competition is expected to protect consumers from unjustified price increases, as anyone who would charge higher prices would be faced with a loss of customers. Furthermore, enterprises are obliged by law to indicate prices both in euro and in drachmas, as well as to display, in their place of business, a conversion table from the drachma to the euro and vice-versa. This should help consumers become familiar with the new scale of values. Rounding rules must be strictly observed. Consumers, however, should be vigilant, in order to avoid any speculative increase in prices. The physical introduction of the euro is an unprecedented event in European history. Its success does not hinge uniquely on concerted efforts of authorities at the European and the national level, but also on the preparation and cooperation of everyone of us. Citizens and enterprises should be prudent and calm during the physical introduction of the euro and the withdrawal of the drachma, and be understanding and patient in the face of any minor problem that may arise, since short-term adjustment costs will be more than offset by significant, long-lasting benefits. | bank of greece | 2,001 | 10 |
Address by Mr Nicholas C Garganas, Deputy Governor of the Bank of Greece, to the Hellenic American Bankers Association, New York, 23 April 2002. | Nicholas Garganas: The Greek economy within the euro area Address by Mr Nicholas C Garganas, Deputy Governor of the Bank of Greece, to the Hellenic American Bankers Association, New York, 23 April 2002. * * * It gives me great pleasure to be able to address you today about the transformation of the Greek economy over the last few years. Since the beginning of 2001, Greece has been participating in the euro area as its 12th member. Her entry to the euro area reflects the substantial progress which was made with macroeconomic stabilisation and convergence of the Greek economy to those of the other euro area member states. Disinflation, helped significantly by the monetary and exchange rate policies pursued by the Bank of Greece, alongside fiscal consolidation, ensured that the Maastricht Treaty criteria for euro area entry were all met by early 2000. Introduction of euro notes and coins From 1 January 2002, Greece, along with the other countries of the euro area, introduced euro notes and coins. The operation, conducted swiftly and smoothly, and warmly welcomed by the public, has gone remarkably well. The success is all the more remarkable as Greece effectively had two years less than the other euro area countries to prepare for the physical introduction of the euro, since it became a member of the euro area only from the beginning of 2001. While the cash changeover represented the concluding act of the move to the single currency, many of the benefits of the euro materialized even before joining EMU. The successful cash changeover, which marks a further move towards successful integration with EU partner countries, will reinforce these positive effects. Sound economic fundamentals Thanks to the successful nominal convergence process in the second half of the 1990s, which was a condition for joining EMU, Greece can now count on sound economic fundamentals and macroeconomic stability. Fiscal consolidation was rewarded last year by the general government position being in balance; public debt, although still high at just under 100 per cent of GDP at the end of 2001, has been declining continuously from its peak of just over 111 per cent in 1996. One of the most remarkable economic developments of recent years has been Greece’s success in restoring low inflation. Consumer inflation averaged 17.25 per cent in the twenty-year period to 1994. By mid-1999 it had fallen to about 2 per cent. Rising inflation after the autumn of 1999 can mainly be attributed to higher oil prices and depreciation of the drachma, which, in turn, reflected the weakness of the euro against non-European currencies as well as the drachma’s necessary convergence (from an appreciated level) to its central rate within ERM II by the end of 2000. After subsequently subsiding to below 3 per cent in the final three months of 2001, in January of this year inflation again accelerated, largely on account of an increase in domestic unprocessed food prices caused by severe winter weather. After falling by one percentage point to 3.4 per cent in February, it rose again, to 4.0 per cent this time, on account of rising oil prices, renewed pressures from unprocessed food prices, as well as upward rounding of prices (expressed exclusively in euro since March 1st). If we look at the last three years (1999-2001) as a whole, however, inflation averaged 3.1 per cent, a level not experienced since the 1960s. While inflation in Greece has been above the euro-average in recent years, this is to be expected in an economy, which is growing at a relatively fast rate compared with those of its trading partners. This result reflects the so-called productivity bias of fast growing economies. Macroeconomic stabilisation has been accompanied by healthy growth rates. Since 1996 output growth has exceeded the euro area average. Greek growth has averaged 3.5 per cent compared with 2.4 per cent in the euro area as a whole. The growth rate of real GDP was 4.1 per cent in both 2000 and 2001 (provisional data), significantly higher than the euro area average of 3.3 per cent and 1.5 per cent, respectively. The growth differential widened considerably in 2001 as economic activity in Greece, benefiting from macroeconomic stability and the euro- entry-related decline in interest rates, held up well in the face of the global slowdown which hit most other euro area countries. Trends in the labour market have also been relatively satisfactory in recent years. The unemployment rate declined to 10.4 per cent in the first three quarters of 2001, i.e. 2 percentage points than at its peak in late 1999. But unemployment still remains the second highest (after Spain) in the euro area. Growth prospects While the forecast for Greek economic growth in 2002 was revised downwards in the aftermath of the 11 September events, real growth is nevertheless projected to be within the range of 3.5 to 3.8 per cent. This strong output performance is expected to continue in the medium term. Output growth should be sustained over the medium term by relatively robust domestic demand, underpinned by improved economic fundamentals, strong private investment spending, expenditures in preparation for the Olympic Games of 2004 and economic infrastructure projects partly financed by EU Community support funds. The growing openness and export orientation of the economy, mainly towards the economies of Central and Eastern Europe and the Balkan countries should also foster growth. In particular the return to stability in the latter countries has benefited Greece significantly. The 2001 update of the Stability and Growth Programme of Greece projects an average annual real GDP growth rate close to 4 per cent in 2003 and 2004. Higher growth than the rest of the euro area is necessary over the long run if standards of living in Greece (measured by GDP per capita in PPS), which are at present around 71 per cent of the EU average, are to converge on the European average. However, further structural reforms may prove critical to enhance growth over the longer term and accelerate real convergence. Further economic benefits to be expected from EMU membership Aside from macroeconomic stabilisation and enhanced growth prospects, there are further economic benefits to be expected from the adoption of the euro. 1. As I mentioned earlier, the adoption of the single currency has further increased economic integration with the European partner countries, which will stimulate trade and investment. Transaction costs and uncertainty are reduced. The euro contributes to a stable environment that is less exposed to exchange-rate fluctuations. These factors will boost investment and trade. They will also encourage tourism, an important sector of the Greek economy . 2. The euro is contributing to greater efficiency of the European economy by acting as a catalyst for the integration of financial markets. Greek companies will have access to a wider and deeper financial market, which means a lower cost of funds. Indeed, short-term bank lending rates to enterprises fell by almost 7 percentage points in the period December 1999 to December 2001; long-term rates fell by 5.5 percentage points over the same period. 3. Membership of EMU makes low inflation prospects more credible, and thus contributes both to lower interest rates and to moderate wage demands based on lower inflationary expectations. 4. Adoption of the euro is also promoting greater efficiency of the Greek economy by stimulating reforms in product, services and labour markets. Deregulation and a reduction of state intervention, in part through privatization, are important in reforming markets for goods and services. Increased labour market flexibility is also being encouraged. 5. Against these benefits, it could be argued that with EMU membership Greece has lost its independent exchange rate and monetary policies, which could be useful instruments for improving competitiveness and employment. However, it cannot be said that this loss is very great. In small open economies, especially those with strong trade unions, nominal devaluations are quickly offset by wage increases that aim to avoid a cut in real wages. Hence, nominal devaluations do not lead to sustained real devaluations. Greece clearly comes in this category. A similar line of reasoning applies to a monetary expansion leading to temporarily low interest rates. Challenges for the future Membership of the euro area brings with it new challenges for economic policy in the years ahead. With independent monetary and exchange rate policies no longer available to target national policy goals, emphasis has shifted towards fiscal policy and to policies to promote labour [and product] market flexibility as a means of restoring strong non-inflationary growth in the face of a negative shock. Budgetary policy will continue to be geared to maintaining public finances close to balance or in surplus in the medium run, while supporting growth by acting in a counter-cyclical manner (and allowing automatic stabilizers to work fully) as envisaged in the Stability and Growth Pact. This is supplemented by the Greek authorities’ goal of reducing the General Government debt-to-GDP ratio to 60 per cent by 2010. The latter target is crucial given Greece’s presently high debt ratio and the need to make further progress on fiscal consolidation prior to the onset of expenditure pressures relating to the ageing population. Prudent fiscal policies will also be crucial to offset the progressively larger negative private savings – private investment gap which otherwise could induce unsustainable movements in the total savings – total investment gap and correspondingly in the current account deficit. In 2002, the general government surplus is expected to be 0.8 per cent of GDP. In 2003 and 2004 the projected budgetary surplus should average 1.1 per cent of GDP, according to the 2001 update of the Greek stability and growth programme. At the same time, the debt ratio is expected to decline from 99.6 per cent in 2001 to 90 per cent of GDP in 2004. EMU membership is acting as a catalyst for further progress on the structural front and for the reinforcement of macroeconomic stabilization as Greece deepens its economic and financial integration with the euro area. Continued structural reforms will tend to increase total factor productivity, which has been a significant driving force behind growth in recent years. In this respect, considerable progress has been made with the liberalisation of markets, the safeguarding of competition and institutional changes aimed at ensuring the smooth operation of product and financial markets. Among these, the most important measures taken in 2001 were: the ending of the state monopoly in the electricity sector, the opening-up of the fixed telephony market and the awarding of UMTS licenses and supplementary CGM licenses. The liberalisation of sea transport, an area of major importance, is planned for this year. There has also been an extensive programme of privatisation. Some important companies (like Olympic Airways, the Piraeus Port Authority and the Postal Services) are scheduled to go through privatisation schemes this year. Some publicly-owned companies only recently scheduled for privatisation include the Postal Savings Bank and the General Bank, the Athens Water and Sewage Company (already partially privatized) and the public gas company (DEPA). The government agenda for structural reform also includes pension reform at the centre of the current policy debate in Greece (social dialogue on this issue was launched last month and is currently underway). Some steps are also being taken to reform the health care system, where there is vast room to improve service delivery and public expenditure control. The government is also proceeding to an overall tax reform; the proposals of an experts’ Commission were made public earlier this month; after public discussion, the government will make its decisions in the summer and new provisions will take effect as of January 2003. The tax reform is expected not only to improve the efficiency of the Greek economy, but also to reduce the administrative costs of collecting taxes and the compliance costs for the taxpayers. The challenge now is to broaden and deepen the efforts undertaken to date to strengthen competition and efficiency in factor and product markets, efforts which are essential to ensure real convergence. Further progress is required on labour market reform. There remains foremost a need to facilitate labour market entry and to improve training. In product markets, the privatisation progress should be combined with broader measures to ensure competitive market outcomes across the economy. Further efforts to reduce bureaucratic inefficiencies are also required to lift impediments to new businesses - including foreign direct investment. In conclusion, despite the slowdown in the world economy, the Greek economy continues to perform very well. Real convergence is the clear priority for the coming years and the authorities still face some major challenges to facilitate the process. Nonetheless, the commitment of the authorities to both fiscal reform and policies to improve the operation of product and labour markets augurs well for their likely success in meeting these challenges over the coming years. | bank of greece | 2,002 | 5 |
Speech by Mr Nicholas C Garganas, Governor of the Bank of Greece, at The Economist Conference: Private Banking and Asset Management, Athens, 22 October 2002. | Nicholas C Garganas: The European financial marketplace Speech by Mr Nicholas C Garganas, Governor of the Bank of Greece, at The Economist Conference: Private Banking and Asset Management, Athens, 22 October 2002. * * * Ladies and gentlemen, Let me start and by thanking The Economist for inviting me to speak at this conference. In recent years, there has been a visible acceleration in the development and integration of EU financial markets. In what follows, I will discuss, first, why financial integration is desirable, second, why it has occurred, third, trends toward financial integration in the EU, and fourth, the role of public policy in supporting integration. Why is financial integration desirable? I think it fair to say that the main function of the financial system is to serve the needs of the real economy, encouraging productive investments, allowing risks to be diversified, mobilising savings, monitoring firms’ use of funds, etc. To this end, the development of both markets and sound financial institutions plays a key role. To the extent that increased financial integration allows the tasks of markets and institutions to be completed more efficiently, it will bring about greater benefits through two main channels: increased capital accumulation and higher productivity of capital. Through these two channels, the greater efficiency of an integrated EU financial system will lead to increased economic growth and a higher standard of living for EU citizens. Three main interrelated factors have underpinned the acceleration of integration of EU financial markets. The first factor is globalisation. The integration of financial markets in Europe is part of a wider global development. Globalisation has many dimensions, all of which have been stimulated by the decline in costs of communication, transportation, data processing, and transactions. The second factor is the advances in creating a common regulatory framework across the EU as part of the effort to complete the Internal Market in financial services. The adoption of a common EU policy has been accompanied by liberalisation of financial markets in the Member States. As I will discuss shortly, however, there is still some distance to travel in this respect. The third factor is the adoption of the euro. Before January 1999, the need to operate in many national currencies was a major obstacle to financial integration in the Union. The presence of a sizeable exchange risk limited the attractiveness of cross-border investment, reduced the incentive to proceed with regulatory harmonisation at the EU level, and dampened competitive pressures in Member States' home markets. The introduction of a common currency for twelve Member States has altered this situation dramatically. The euro has eliminated exchange risk as a source of fragmentation in the EU financial system. It has also increased price transparency, stimulating competition. As a result, deeper integration has led to more homogeneous markets, a wave of consolidation among intermediaries and exchanges, and the emergence of new and innovative products and techniques. The introduction of a common currency –the euro-- has perhaps had its biggest impact on the unsecured money market, that is the interbank deposit market. There is now virtually full convergence in interest rates across the euro area with little or no differences in the rates wherever the funds are exchanged. This outcome is, to a significant extent, a consequence of monetary union as all the regional money markets existing before EMU formed a large euro area money market. The ability to move funds across the euro area enabled the emergence of a deep, liquid and homogeneous money market. Despite recent progress, however, the EU financial system remains fragmented. Member-State financial structures have evolved over time under the influence of specific national preferences with regard to legal and regulatory frameworks. For example, progress in integrating the secured money market, that is, the market in which money is exchanged for collateral and repos, or repurchase transactions, and which includes the markets for T-bills and CDs, has been hampered by differences in national rules about collateral, settlement and matters concerning the handling of insolvency. Nonetheless, a large increase in gross issues in euros by monetary financing institutions, non-monetary financial corporations and nonfinancial corporations has occurred (see Figures 1-3). Whilst the levels of monthly issues differ across groups (reflecting the fairly recent recourse by nonfinancial corporations in Europe to short-term securities markets in contrast to banks’ use of the CD market to raise funds), there is no doubt that the advent of the euro has contributed to a marked change. Bond markets, both government and corporate, remain even less integrated. In the former case, yields have converged significantly, with remaining differences reflecting either credit risk or liquidity risk. In particular, smaller countries often have difficulties in generating deep markets across the whole maturity spectrum. One solution that has been proposed is greater coordination of debt issues. This proposal, however, has met with some resistance, not least because national debt issuance is affected strongly by national-specific fiscal characteristics. With regard to markets for corporate debt, the lack of integration reflects the fact that euro-area companies have traditionally relied much less on debt raised in financial markets than have their Anglo-Saxon counterparts. Financial intermediaries play a much more important role in the euro-area than in Anglo-Saxon financial systems. Finally, equity markets remain fragmented despite several mergers between exchanges, the increased use of electronic trading and higher positive correlations between share price movements across exchanges. The current, bearish climate in equity markets appears to be delaying further integration through the creation of integrated networks which can facilitate cross-border trading. The introduction of the euro is also providing new impetus to competition between financial institutions. Wholesale banking markets have been integrated for some time now, but retail markets remain fragmented. Banks have tended to concentrate on domestic consolidation and have expanded crossborder by signing agreements with banks in other countries so as to facilitate the supply of services to their largely domestic customers. Since some EU financial markets remain fragmented despite the benefits of financial integration, let me now turn to actions that can be taken to create an integrated EU financial market. In this regard, what is the role of public policy? In my view, there are two major areas where public policy action can contribute to more-effective financial integration. The first relates to the need to remove remaining legal or regulatory barriers. The second involves responding appropriately to the new challenges raised by a more financially-integrated environment. Regarding the need to remove existing barriers, the need of action in this area has been recognised at the highest political level. Successive European Councils have declared the integration of EU financial markets as a high priority of economic reform in the EU. This priority is reflected in a coherent policy strategy at the EU level and in the urgency which has been attributed to its implementation. The issue is being addressed mainly within the context of the Commission’s Risk Capital Action Plan (RCAP) and the Financial Services Action Plan (FSAP). The RCAP focuses on improving the provision of finance to new enterprises, often working in high technology, high risk areas. These firms often cite a lack of external finance as a major impediment to their expansion. Given the dynamism they provide to an economy, measures to alleviate the shortage of finance are crucial in meeting the wider goals of the EU member states, namely increasing employment, productivity and growth. At the Cardiff European Council in June 1998, financial services were given a high profile and the European Commission was asked to prepare a framework for action. The result was the Financial Services Action Plan, a package of 42 policy initiatives aimed at improving the functioning of the EU financial system by 2005. Among the objectives underlying the plan are the creation of a single wholesale financial market in the EU and open and secure retail markets. In general, the emphasis is on promoting financial markets, which are considered to be underdeveloped in Europe. Although more than half of the FSAP initiatives have been adopted or finalised, much work remains as agreement is proving difficult in some areas. One such area is that of methods of corporate governance. A wide variety of systems exists at present, varying, in part, according to the role of banks versus markets in corporate governance and the extent to which corporate governance mechanisms associated with growth of financial markets can co-exist with other methods based on institutions. The EU is sensitive to such differences. However, the greater development of markets necessitates the implementation of rules to regulate market behaviour, for example, in the areas of takeovers and takeover bids. Such differences need to be overcome quickly if the aim of implementing the FSAP by end-2005 (and the RCAP by end-2003) is to be realized. In this connection, the recent adoption by the Commission of a Directive on Prospectuses will introduce a truly single passport for issuers. Also, a Commission Regulation has recently been adopted on the application of International Accounting Standards (IAS) in the EU. It requires that all EU listed companies prepare their consolidated accounts in accordance with IAS from 2005 onwards. Aside from the stumbling blocks in specific areas, there is also the more general question of the extent to which the infrastructure required for the smooth operation of a cross-border financial system will tend to emerge naturally through the operation of market forces and the extent to which it needs to be actively promoted by the authorities. I am inclined to think that a more proactive role for the authorities is needed to encourage the development of pan-European settlement and clearing systems, securities depositories, etc. Market forces may be impeded by the existence of strong national interests (existing national organisations often have strong monopoly powers which operate to prevent change) and/or the presence of diverse regulatory and legal environments (if a pan-European institution has to observe many different national regulations, depending on the nature of the transaction, then little will be gained by such an institution’s existence). Further financial integration brings not just benefits, but also challenges in terms of the measures needed to secure financial stability and to protect consumer and investor interests. A number of the measures in the FSAP address issues such as liquidation of financial institutions, the capital adequacy of banks and the question of how to deal with financial conglomerates. The EU has long been involved in strengthening cross-border cooperation among the member states in the area of supervision. The first two Brouwer reports, published in 2000 and 2001, examined supervisory procedures in some detail. In the second report, emphasis was placed on the need to coordinate supervision across sectors (banking, insurance, securities) in the face of the creation of large financial conglomerates. A third Brouwer report was published in September of this year which, inter alia, suggested recommendations for the procedures by which Community regulation is agreed, drawn up and adopted in an attempt to speed the presently rather cumbersome process. Financial markets cannot function properly cross-border without a co-ordinated regulation and supervision for banking, insurance and securities markets as well as across these markets. The current set of committees is structured by sector and includes committees for discussion, advisory committees and committees with regulatory powers. Following the introduction of the Lamfalussy decision-making process in the securities markets, the current structure of committees came under scrutiny. In this connection, the Lamfalussy process, which was originally designed to establish a unified regulatory and supervisory framework for the securities’ sector, is to be extended to cover banks, insurance companies, and financial conglomerates. This framework will lead to closer coordination of supervisory practices. In conclusion, I think it fair to say that European financial integration has come a long way. Yet, the process is far from complete. EU financial integration is one of the cornerstones of the effort to boost the dynamism of the European economy. A more efficient and integrated EU financial system will increase the availability of capital and increase the productivity of capital, with positive knock-on effects on output growth and employment creation. | bank of greece | 2,002 | 10 |
Address by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the Conference of the European Commission ¿Europe, The Mediterranean and the euro¿, Athens, 4 February 2003. | Nicholas C Garganas: International role of the euro Address by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the Conference of the European Commission “Europe, The Mediterranean and the euro”, Athens, 4 February 2003. * * * Introduction Ladies and gentlemen it is a pleasure to participate in an event organised by the European Commission. I would like to thank the Commission for inviting me to address some of the basic considerations that confront the euro in its emergence as an international currency. Let me begin by asking the question: “How does a currency acquire the status of an international currency?” This question is being asked more and more often as the euro takes on increasing importance in the global financial system. The interwar period was dominated by two currencies - the US dollar and the pound sterling - while the postwar world has been dominated by the US dollar. Unlike the situation in national economies or monetary unions, where the currency used is determined by government decree, currencies are used internationally because of neither an Act of Parliament nor an Act of God. Rather the choice of currencies used for international transactions is mainly the result of invisible hand processes. Currencies attain international status because they meet the various needs of foreign official institutions and foreign private parties more effectively than do other financial assets. What factors contribute to the use of a specific money as an international currency? Why was the Dutch guilder the dominant international currency in the 17th and 18th centuries, the British pound in the 19th and early 20th centuries, and the dollar since the end of the second world war? Several factors are essential if a currency is to be used internationally. First and foremost, an international currency must be perceived as sound. To be acceptable, market participants must be willing to hold it as a store of value. This circumstance means that inflation in the country or monetary union issuing the currency must be low and stable relative to those of other currencies. Inflation reduces the purchasing power of a currency, discouraging its use internationally. It also leads to exchange-rate depreciation and uncertainty. A necessary condition for the international use of a currency, therefore, is that a currency’s future value in terms of goods and services has to be perceived as predictable and stable. Clearly, many currencies meet this test; yet few emerge as international currencies. Therefore, there must be - and there are - additional factors that help determine the internationalisation of a currency. One such factor has to do with size. The size factor relates to the relative economic and demographic area for which the currency serves as legal tender - in other words the “habitat” of the currency. A strong, competitive economy, open to, and active in, international trade and finance will naturally generate a large quantity of foreign exchange transactions with at least one leg in the home economy to support its wide-ranging business activity. Another factor underlying the international use of a currency is the presence of an open, welldeveloped financial system. This factor is a necessary part of a strong, competitive, and open economy. Just as relatively low levels of inflation and inflation variability contribute to the international demand for a currency, well-developed financial markets supply assets appropriate for international use, and strengthen the demand for additional assets as well. Well-developed financial markets in the currency’s issuing jurisdiction contribute to the international use of that currency. Central banks and other investors have preferences for safe, liquid financial instruments; deep and liquid financial markets that offer a full array of instruments and services will attract business from abroad that might otherwise have stayed at home. Money as a conveyer of information History has shown that the forgoing three factors - a stable currency, a strong, competitive economy, and deep, broad and liquid financial markets - are necessary for the international use of a currency. History has also shown, however, that only a single currency, or at most a few currencies, emerge as major international currencies at any one time. To understand why this is so, we need to consider a key function of money. Money conveys information about prices. When you are in Greece, for example, and you want to compare the prices of two hotel rooms, you compare them in euros. The euro, in other words, conveys essential information which allows you to make price comparisons so that you can reach a decision. Money, in its capacity as a transmitter of information, performs a function similar to that of an international language. The greater the number of people who speak a language, the more it can facilitate communication. The same is true with money. A currency would hardly do you any good if you are the only person who uses it. The utility of money depends, in part, on how many others use it. When a Saudi Arabian exporter, who does not speak Italian, sells crude oil to an Italian importer who does not speak Arabic, the transaction may well be conducted using the English language and it may will be denominated and settled in US dollars. The US dollar, in this case, is used as a “vehicle” currency, that is, it is used to denominate and execute foreign trade transactions that do not involve direct transactions with the issuing economy. This use leads, as does the use of English, to easier communication in transmitting information. As is the case with a language, the more popular is a currency the more useful it is to those who use it. Because the attractiveness of any international currency grows as its use increases, an international currency has a tendency to become a natural monopoly. This circumstance explains why only a single money, or a few moneys, are used as international currencies at a particular time. Benefits and costs An international currency provides several major benefits to the issuing economy. First, the economy derives seigniorage, because the non interest-bearing claims on it are denominated in its own currency. When Argentina, for example, imports autos from Japan, it must pay for them with foreign exchange it earned through its exports; it is highly unlikely that the Japanese importer would be willing to accept the Argentina currency, the peso. When the US, however, imports Japanese autos, it can pay for them with Federal Reserve notes, which are just a paper claim on the US government. The Board of Governors of the US Federal Reserve System estimates that seigniorage revenue for the United States amounts to between $11 billion and $15 billion per year. Second, as the international use of a currency expands, loans, investments, and purchases of goods and services - both foreign and domestic - will increasingly be executed through the financial institutions of the issuing economy. Thus, the earnings of its financial sector are likely to increase. Third, the tendency of world trade to be denominated in the international currency means that the issuing economy will be less vulnerable to changes in the value of its currency than are other economies. If the US dollar, for example, depreciates sharply against other currencies, this will have a smaller effect on US inflation than is the case in other economies. This is because most US imports are denominated in dollars. Therefore, when the dollar declines on the foreign exchange market, the price of US imports - in dollars - need not change. The main cost of having an international currency is that it can complicate the conduct of monetary policy. Because foreigners hold a substantial share of the currency, a portfolio shift away from the currency, for example, can lead to large capital outflows and/or large declines in the exchange rate. Concerns about the effects of changes in portfolio preferences caused both the German and the Japanese governments to take measures to restrict the international uses of the deutsche mark and yen, respectively, during the 1970s and early 1980s. Concerns that the imbalances in the US economy, including the large current account deficit, could lead to a massive sell-off by foreigners of their holdings of US dollar balances have underpinned concerns of a possible hard landing for the US currency. The international role of the euro Let me now turn to the specific focus of this session - the international role of the euro. It is important to note that the ECB has adopted a neutral stance concerning the internationalization of its currency, implying that it neither fosters nor hinders the process. It accepts the view that the international role of the euro is primarily determined by the decisions of market participants. How, then, does the euro stack up in terms of the conditions that determine an international currency? The first factor I mentioned that determines international currency use is a stable currency. The mandate of the ECB is to maintain the purchasing power of its currency. Since its inception, therefore, the ECB has sought, and it has attained, stability of its currency. This stability is proof that the institution is performing well. Yet, in the quest for stability, monetary policy cannot go it alone. It needs to be complimented by a consistent fiscal-policy stance. Indeed, the academic literature has coined a name for the connection between monetary and fiscal policies, calling it “fiscal dominance”. The implication of this connection for the international role of the euro is that, to ensure the future stability of the euro, member states will need to adhere to the Stability and Growth Pact. The second factor determining international currency-status is size. Measured in terms of population, the euro area is one of the largest economies in the world, with more than 300 million inhabitants. By comparison, the populations of the United States and Japan are about 270 million and 125 million, respectively. The euro area is the largest trading partner of the world economy, accounting for almost 20% of world exports, compared with about 15% for the United States and 9% for Japan. The GDP of the euro area is equivalent to some 16% of world GDP, about 6 percentage points less than the share of the United States but more than twice the share of Japan. However, even more important than the current figures is the potential for the future development of the euro area, in terms of population and GDP, if and when the so-called “pre-ins” (Denmark, Sweden and the United Kingdom) join the Eurosystem. The entry of these countries would result in a monetary union of some 376 million inhabitants, about 40% larger than the United States and almost triple the size of Japan, with a GDP only slightly less than that of the United States and 2¼ times that of Japan. All these facts and figures, which demonstrate the demographic and economic importance of the European Union, will be further strengthened by EU enlargement. Let me now turn to financial markets in the euro area. The introduction of the euro and the successful implementation of the TARGET payment system have contributed to the potential for highly integrated financial markets within the euro area. With regard to capital markets, the euro has seen a strong development in the bond market. The launch of the euro seems to have acted as a catalyst for the development of a bond market in which corporations can issue debt securities of unprecedented size. As a result, the introduction of the euro has created the second largest bond market in the world. This circumstance has led to declining transactions costs, as bid-ask spreads have narrowed, and increased diversity, as new types of issuers participated in the market. The integration of the euro area bond market, and the associated reduction of borrowing costs in euro, have meant that the euro has been playing an increasingly significant role as a financing currency. in the international debt securities market, recent data indicate that the share in outstanding amounts of euro-denominated instruments issued by non-residents totals 29%, compared with 44% for the US dollar and 13% for the Japanese yen. In contrast to borrowers, investors are interested in income prospects and they demand high efficiency and liquidity of the financial markets in which they invest. These market characteristics exist only if the financial markets are deep and wide. Such is not yet the case in euro-area equity markets. These markets tend to be smaller, on average, than their counterparts in many other industrialised countries and they account for a commensurately smaller share of trading activity. This situation is very much a result of the segmentation of national markets, which have been built around national securities depositories and settlement systems intimately connected to the national payment infrastructures The challenge is to remove institutional and economic factors that raise the cost of cross-border operations. In particular, further integration will require harmonization of accounting rules, tax regimes, and legal frameworks, and the acquisition of the necessary technical infrastructure for handling crossborder holdings and settling securities. The costs of these regulatory obstacles are identified in the Financial Services Action Plan, issued by the European Commission. The Action Plan lists priorities and time-scales for legislative and other measure to tackle three strategic objectives: (1) completing a single wholesale market; (2) developing open and secure markets for retail services; and (3) ensuring the continued stability of EU financial markets. It also addresses the importance of eliminating tax obstacles and distortions for the creation of an optimal single financial market. To date, 30 of 42 measures contained in the Action Plan have been completed. I hope the remaining obstacles identified in the Action Plan will be removed within the scheduled deadlines. As I mentioned, the relatively narrow euro-area financial markets have meant that the euro area has not approached its full potential as an international asset. As of the end of 2001, 13% of the identified official holdings foreign reserves were in euro, compared with about 68% for the US dollar and about 5% for the Japanese yen. As a medium-of-exchange and asset vehicle in the foreign exchange markets, the US dollar remains the dominant global vehicle; the euro’s share in global spot trading amounts to about 20%. Concluding remarks The other speakers on this panel will provide specific information about the current state of play of the euro as an international currency. The evidence they will present will confirm that the euro has emerged as the world’s second most important international currency. Yet, the evidence will also confirm that the dollar is still far ahead of the euro. Before I turn the lectern over, let me make a few remarks about future prospects. Two essential, inter-related elements will help the euro attain equal status with the U.S dollar. First, improved productivity and competitiveness of the euro area will raise the rate of return on euro area assets, boosting the role of the euro as in investment currency. This prediction is predicated on profound changes in areas such as product and labour market regulations, public debt and fiscal deficits, and social security systems. Second, continued financial market integration, a necessary condition for further investments in euro assets, will require changes in, and harmonisation of, legislations, regulations, market practices, and infrastructures. The euro has made an impressive debut on the global stage. To a significant extent, this situation reflects the credibility credentials earned by the ECB in its first several years of existence. It also reflects the perceptions of market participants of the euro area as an economy with strong growth potential. Determined efforts in the remaining areas I have discussed would fulfil these perce3ptions and add to the attractiveness of the euro in the international arena, allowing it to seriously challenge the hegemonic role now played by the US dollar. Ladies and gentlemen, thank you for your attention. | bank of greece | 2,003 | 2 |
Luncheon address by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the Seminar on ¿Monetary Strategies for Accession Countries¿, Hungarian Academy of Sciences, Budapest, 28 February 2003. | Nicholas C Garganas: Exchange-rate regimes on the road to EMU: lessons from Greece’s experience Luncheon address by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the Seminar on “Monetary Strategies for Accession Countries”, Hungarian Academy of Sciences, Budapest, 28 February 2003. The references for the speech can be found on the Bank of Greece’s website. * * * Ladies and Gentlemen, I would like to thank Magyar National Bank, the Institute of World Economics of the Hungarian Academy of Sciences, and the Center of European Integration Studies of the University of Bonn for inviting me to speak to you today. In contemplating the subject of this seminar, one is struck by how dramatically things have changed in the course of a decade. In 1992 and 1993, when the Exchange Rate Mechanism - or ERM underwent a series of speculative attacks, the prospects of a European monetary union were viewed, by many observers, with considerable skepticism. This skepticism was not without foundation. After all, hadn’t there been previous false starts on the road to EMU? Hadn’t the Werner Report prescribed a European monetary union by the end of 1970s? Yet, here we are today, having fulfilled the dreams of Pierre Werner and his colleagues and having celebrated the fourth birthday of EMU. Today, I would like to address some lessons from the experience of Greece, the newest member of the euro area, in its quest for EMU membership. I will confront what appears to be a dilemma. As we have heard this morning, much of the economics profession appears to have been converted to the “hypothesis of the vanishing middle”; for economies well integrated into world capital markets, there is little, if any, middle ground between floating exchange rates and monetary unification. Effectively, this hypothesis rules out intermediate regimes. Yet, a requirement for entering the euro area is participation in ERM II, which is, after all, an intermediate regime. How can this dilemma be resolved? The Retreat from Intermediate Regimes Before I discuss Greece’s experience, let me address the reasons underlying the retreat from intermediate regimes. What has caused this retreat? First, an explosive increase in capital flows during the 1990s has made the operation of intermediate regimes problematic. As has already been discussed at this seminar by Jorge Braga de Macedo and Helmut Reisen, according to the thesis of the Impossible Trinity, developed in the 1980s, under a system of pegged exchange rates and free capital mobility, it is not possible to pursue an independent monetary policy on a sustained basis. Eventually, current-account disequilibria and changes in reserves will provoke an attack on the exchange rate. The enormous increase in capital flows has been accompanied by abrupt reversals of these flows. Whereas the logic of the thesis of the Impossible Trinity suggests that exchange-rate attacks typically originate in response to current-account disequilibria and build up gradually, in fact, recent speculative attacks have often originated in the capital account, have been sudden and difficult to predict, and have included the currencies of countries without substantial current-account imbalances. Capital-flow reversals have involved a progression of speculative attacks, mostly against pegged-exchange-rate arrangements. These reversals of capital inflows and resulting exchange-rate devaluations or depreciations have often been accompanied by sharp contractions in economic activity and have, at times, entailed “twin crises” - crises in both the foreign-exchange market and the banking system. Finally, there has been a tendency of instability in foreign-exchange markets to be transmitted from one pegged-exchange-rate regime to others in a process that has come to be known as “contagion”. The victims of contagion have seemingly included innocent bystanders - economies with sound fundamentals whose currencies might not have been attacked had they adopted one of the corner solutions. This triad of factors - (1) the difficulty of conducting an independent monetary policy when the exchange rate is pegged and the capital account open, (2) sudden capital-flow reversals, and contagion - have profoundly affected the way we think about exchange-rate regimes. The Experience of Greece: Pre-ERM The foregoing factors significantly affected the Greek economy in the 1990s. Through 1994, the performance of the Greek economy was pretty dismal. Growth was almost flat, and inflation and the fiscal deficit as a percentage of GDP, were in the double-digit levels throughout the period. Other EU countries were moving forward in their quests to become members of EMU while Greece was falling farther and farther behind. Clearly, a regime change was called for. It came in 1995. The signing of the Maastricht Treaty in 1992 and the government’s publicly-stated objective of joining the euro area provided powerful incentives for mobilising broad public support for policy adjustment. Among the policy measures undertaken were the following: • Fiscal policy was progressively tightened. The fiscal deficit, as a percentage of GDP, fell from over 10 per cent in 1995 to around to 4 per cent in 1997. • Financial deregulation, which had begun in the late 1980s, was completed and in 1994 the capital account was opened. The deregulated financial system facilitated the use of indirect instruments of monetary policy so that small, frequent changes in the instruments became feasible, enabling rapid policy responses. • The Greek Parliament approved independence of the Bank of Greece and provided the Bank with a mandate to achieve price stability. For its part, beginning in 1995, the Bank of Greece adopted what became known as a “hard drachma policy”, under which the exchange rate was used as a nominal anchor. For the first time, the Bank announced a specific exchange-rate target. Underlying this policy, both in Greece and elsewhere during the 1990s, was the belief that the adoption of a visible exchange-rate anchor could enhance the credibility of the dissinflationary effort because (1) the traded-goods component of the price level could be stabilised and (2) wage-settling and price-setting behaviour were restrained. I will not go into details of the operation of the hard-drachma policy. Suffice it to say that, during the years 1995-97, real interest rates at the short-end were kept in the vicinity of 5 per cent. Fairly specific targets for the exchange rate were announced in each of the three years and were achieved. Importantly, inflation fell from about 11 per cent in 1994 to under 5 per cent at the end of 1997 while, in the first three years of the policy, real growth almost tripled compared with the rate of 1991-94. Yet, as is typically the case with all nominal-anchor exchange-rate pegs, this regime produced difficulties. As predicted under the thesis of the Impossible Trinity, the ability to conduct an independent monetary policy under an exchange-rate peg and open capital account became increasingly demanding. The wide interest-rate differentials in favour of drachma-denominated financial instruments led to a capital-inflows problem. The Bank of Greece responded by sterilising these inflows, limiting the appreciation of the nominal exchange rate, reducing the impact of the inflows on the monetary base, and buying time for other policies to adjust. Still, the sterilisation entailed quasi-fiscal costs and, by preventing domestic interest rates from falling, tended to maintain the yield differential that had given rise to the inflows. Additionally, the Greek economy experienced a fundamental problem associated with all exchange-rate nominal-anchor pegs during the move to lower inflation; the real exchange-rate appreciated significantly contributing, along with strong domestic demand, to a widening current-account deficit. This circumstance brings me to the second and third of the triad of factors - sudden capital-flow reversals and contagion. The widening current-account deficit, combined with rapid wage growth, fed market expectations that the drachma was overvalued and provided the basis for contagion from Asia, which commenced with the devaluation of the Thai baht in July 1997. The sharp rise in interest rates required to support the drachma increasingly undermined growth and fiscal targets. A further regime shift was needed. That regime shift was provided by the ERM. Effective March 16, 1998, the drachma joined the ERM at a central rate that implied a 12.3 per cent devaluation against the ECU. As I will explain, entry into the ERM allowed Greece to orient its policies to stability, fostering convergence. Because participation in the ERM, without severe tensions, plays a role in the convergence criteria for joining the euro area, it acts as testing phase for the central rate as well as for the sustainability of convergence in general. Lessons from the ERM Before I discuss the drachma’s experience in the ERM, let me posit a question: What kind of an intermediate exchange-rate regime do we have in mind when we refer to the ERM? In my view, the present ERM system is the result of an evolutionary process. Like all Darwinian evolutions, several distinct versions of the species can be distinguished. To provide analytic focus, I think it useful to distinguish among the following. ERM Mark 1. This species lasted from the inception of the EMS, in 1979, to 1987. Compared with the 2 per cent bands under the Bretton-Woods system, the ERM bands of fluctuation, at 4.5 per cent, were fairly wide and the system was supported by capital controls. For some currencies, the bands were even wider, at 12 per cent. Small realignments occurred frequently. Between March 1979, when the system started, and January 1987, realignments occurred on eleven occasions. The foregoing features of the system allowed France, for example, to devalue the franc by shifting the upper and lower limits of its band without affecting the market exchange rate, helping to forestall the possibility of the large profit opportunities that give rise to speculative attacks. ERM Mark 2. What has been dubbed the “new EMS” began to take shape in 1987. Increasingly, the deutsche mark was used as a nominal anchor, with the Bundesbank’s reputation as a stalwart inflation fighter supporting the monetary authorities of some participating countries in their efforts to attain anti-inflation credibility. Except for an implicit devaluation of the Italian lira in January 1990, when that currency moved from the wide band to the narrow band, realignments ceased to be a characteristic of the system. In 1990, the remaining capital controls were eliminated by participating countries. German reunification required a tight monetary policy to counterbalance the large fiscal deficits generated by reunification. With other ERM countries in recession and requiring a loosening of monetary policy, the ERM was confronted with a classic (n-1) problem. ERM Mark 3. Beginning in September 1992, many of the currencies participating in the ERM were subjected to attacks, eventuating in a series of devaluations and the suspension of the pound sterling and the Italian lira from the system. These attacks were sudden and massive. Thus, they were different from the currency realignments of the 1980s, which were mainly the result of pressures that had build up gradually in response to current-account disequilibria. With the lifting of capital controls, the attacks in 1992-93 arose on the capital account and sometimes infected the currencies of countries with seemingly-sound fundamentals, such as France. Several new terms made their way into the lexicon of economists: (1) capital-account-driven crises, (2) sudden-stops, and (3) contagion. ERM Mark 4. In a last-ditch effort to rescue the system, in August 1993 the ERM bands were widened to ± 15 per cent. As things turned out, this move helped salvage the system. It provided necessary breathing space for nominal convergence to occur. ERM Mark 5, or formally, ERM II. Under the present arrangement, exchange-rate stability is explicitly subordinated to the primary objective of price stability for all participating currencies and obligations under the system are deliberately more asymmetric than under the previous ERM. The notion of asymmetry is particularly important in underlining the principle that it is the country whose currency comes under pressure that has to undertake the necessary policy adjustments. Let me now return to the case of the drachma and the ERM. By the time that the drachma entered the ERM, in March 1998, the participating countries had demonstrated their determination to form a monetary union by attaining considerable nominal convergence, as specified in the Maastricht criteria. This convergence took place under a backdrop of market-based economies that could compete effectively in an open economic and financial system. In these conditions, the system built up a considerable amount of trust. As Otmar Issing has pointed out in several recent papers, the trust evoked by governments, including in their ability to deliver credible, non-inflationary policies, is a prerequisite for the existence of a stable currency, both internally and externally. When the drachma entered the ERM, it became a beneficiary of the credibility established in the system over the previous years. It also benefited from the market’s knowledge of the availability of the system’s mutual support facilities, such as the Very Short-Term Financing Facility. Yet, Greece’s participation was not a free ticket. The other participants in the system did not wish to endanger the credibility that had taken so long to achieve. They rightly asked for an entry fee. This fee included the following elements. • The new central rate - which as I have noted, involved a 12.3 per cent devaluation - had been agreed by all members. • The devaluation of the drachma was both backward looking and foreward looking. The magnitude of the devaluation took account of both past inflation differentials between Greece and other EU countries and prospective differentials in the period leading up to Greece’s expected entry into the euro area. Thus, the new central rate was meant to be sustainable. • A package of supportive fiscal and structural measure was announced. Efforts to restructure public enterprises were stepped up. The aim of the measures was to ensure the sustainability of the drachma’s new central rate. In other words, the ERM was meant to be a testing phase for EMU participation, not a free pass into the euro area. Unlike many other devaluations of the mid-1990s and late-1990s, the drachma’s devaluation was not followed by further rounds of speculative attacks, nor by a financial crisis. Unlike other devaluations, it was not followed by contraction in economic activity, but by an acceleration. Moreover, and again in contrast with the other devaluations of this period, the impact of the drachma’s devaluation on inflation was strictly contained. What accounts for the drachma’s successful exit from one central rate to another? In my view, the key ingredients of the successful devaluation were the following. • Unlike other currencies that were devalued during the mid-1990s and late 1990s, the drachma exited a unilateral peg and entered a systems’ arrangement, benefiting from the credibility of the ERM. • Fiscal tightening continued following the devaluation. The fiscal deficit, as a per cent of GDP, fell to about 1 per cent in 1999, from 4 per cent in 1997. Labour-market policy gradually adjusted to the needs for fiscal discipline and for enhancing international competitiveness. • Prudential regulation and supervision of the banking system had been strictly enforced and there was no net foreign exposure of the banking system. Thus, there was no currency-mismatching problem - i.e., large, uncovered foreign-currency positions, which, under conditions of currency devaluations, raise the debt burden of domestic foreign-currency borrowers, resulting in bankruptcies and financial crises. In addition to placing the Bank of Greece’s disinflation strategy within a new institutional framework that gave it added credibility, the ERM provided another important advantage. Entry at the standard fluctuation bands of ± 15 per cent gave the Bank ample room for manoeuvre. Thus, when capital inflows resumed following ERM entry, the Bank allowed the exchange rate to appreciate relative to its central rate, helping to maintain the tight monetary-policy stance and to contain the inflationary impact of the devaluation. The exchange rate remained appreciated relative to its central rate throughout the rest of 1998 and for all of 1999. In 1999, for example, the drachma traded (on average) 7.7 per cent above its central rate while, for most of that year, the three-month interbank rate stood about 700 basis points above the corresponding German rate. As a result of the tightened and consistent policy mix, inflation reached a low of 2 per cent during the second half of 1999. Then, in order to limit the degree of depreciation that would be required for the market rate to reach its central rate and the resulting inflationary pressures, the central rate was revalued by 3.5 per cent in January 2000. The rest, as they say, is history; having fulfilled all the Maastricht criteria, on January 1, 2001 Greece became the 12th member of the euro area. Concluding Remarks What are the key lessons that emerge from Greece’s experience? Let me highlight the following. First, an intermediate exchange rate regime can be viable in today’s world of high capital mobility provided that (1) the participants adhere to sound and sustainable policies, including those that ensure the existence of a well-functioning market economy, and, (2) the intermediate regime is used as a transitional arrangement on the road to the corner solution of a monetary union. There is no contradiction between the existence of ERM II and the hypothesis of the vanishing middle regime. Second, ERM II provides the credibility of a systems’ arrangement, built up in a Darwinian evolution, and flexibility through the wide fluctuation bands that may be necessary to achieve nominal convergence. The credibility derived by participating in the ERM II should not, however, be endangered by use of frequent adjustments of the central parity. As the ERM experiences of the 1980s and 1990s vividly demonstrated, frequent adjustments of central parities within a pegged regime are feasible only in the presence of capital controls. In today’s world of high capital mobility, exchange-rate changes are not instruments that policy-makers can use flexibly and costlessly. The more often they are used, the less can be the credibility of a pegged exchange-rate system. Third, the need of a consistent policy mix is crucial and has important implications in terms of how we need to view policy analysis. An implication of both the Mundell-Fleming model and Mundell’s famous assignment problem is that monetary policy and fiscal policy constitute two, separate policy instruments. Yet, the simple accounting fact that government expenditure has to be financed by either taxation, borrowing, and/or money creation, implies that any analysis of monetary policy must make consistent assumptions about fiscal policy. Monetary policy and fiscal policy, in other words, are not independent policy instruments. They must work in tandem on the road to EMU, and in EMU. Fourth, ultimately, a credible exchange-rate regime depends upon the trust evoked by governments. A governance structure that enforces the rule of law and sanctity of contracts and a political system that delivers credible, non-inflationary policies are prerequisites for the existence of a stable exchange-rate regime. Ladies and Gentlemen, thank you for your attention. | bank of greece | 2,003 | 3 |
Address by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the celebrations marking the 75th anniversary of the ... | Nicholas C Garganas: Why is the role of the central bank important? Address by Mr Nicholas C Garganas, Governor of the Bank of Greece, at the celebrations marking the 75th anniversary of the Bank of Greece, Athens, 3 November 2003. * * * Your Excellency the President of the Hellenic Republic Mr. Prime Minister, Your Beatitude, Ladies and Gentlemen, Allow me to thank you for having accepted our invitation to join us in today’s event. Let me also extend a warm welcome to Jean-Claude Trichet, who became President of the European Central Bank on November 1. This occasion marks Jean-Claude’s first official function outside of Frankfurt in his new position. Thank you for being with us today, Jean-Claude. We wish you every success in your new position. I also would like to extend a very warm welcome and a special thanks to my central bank colleagues from the European System of Central Banks as well as those from other parts of the world who have honored us with their presence for this celebration. This year we celebrate an important anniversary - the 75th year since the establishment of the Bank of Greece. During this period, the conventional wisdom about a central bank’s institutional role and about what a central bank can and should do has undergone enormous change. There has, however, been one constant underlying the responsibilities of a central bank - the importance of discharging these responsibilities to the health of the national economy. Why is the role of the central bank important? Because, an economy’s central bank is entrusted with safeguarding the value of the economy’s currency and with ensuring the soundness of its financial system. Safeguarding the value of the currency is not always an easy task. The correct answer to this challenge forms the basis of an efficiently running economy and of social cohesion. As John Maynard Keynes observed, “there is no subtler, no surer means of overturning the existing basis of society than to debauch the currency”. It would be comforting to find in the history of central banking a record of steady progress and orderly development from earliest antecedents to present knowledge. The facts, however, are different. The past 75 years have included remarkable achievements and some setbacks both globally and in the Greek economy. The role of the central bank in an economy’s fortunes - and misfortunes -is aptly demonstrated by the history of the Bank of Greece. During this sometimes turbulent period, the Bank of Greece demonstrated an ability to adapt to changing circumstances, often playing a leading role in providing solutions to the main economic problems of the day. Let me use the occasion of the Bank’s 75th anniversary to elaborate briefly. Following a period of monetary instability, in March 1927, the Greek government sought the assistance of the League of Nations to improve the health of the economy, to secure monetary stability and to help the Greek banking system function better. Negotiations with the League followed and a stabilisation plan was hammered out. Among the terms of the so-called Geneva Protocol, signed in September 1927, was the establishment of a central bank, exclusively responsible for issuing banknotes. Until that time, the National Bank of Greece, a private institution, had the privilege of issuing banknotes, which it waived in favour of the newly established central bank. The Bank of Greece commenced its operations in May 1928. The two main tasks assigned to the Bank, as specified in its Statute, were to ensure a stable currency and to regulate currency circulation. To this end, the Statute provided for the Bank to have reserve assets; it also set a strict limit on the financing of budgetary deficits by the central bank. The Bank of Greece could not have begun operating at a more difficult time. This was a time when the international monetary system was operating primarily under the gold-exchange standard. Effectively, the gold standard aimed at securing the stability of a currency by tying money supply to the gold reserves of the central bank, thus leaving little room for conducting an independent monetary policy. The gold standard has been described as nailing the domestic economy to a “cross of gold”. Today, many historians blame the gold standard for helping precipitate the Great Depression that began in 1929. Regardless, the global stock market crash of 1929 and the ensuing global financial crisis of September 1931 saw many countries driven off the gold standard. The new international environment was hardly a favorable one for a fledging central bank. Concerned about the instability that might follow in the absence of the gold standard -and with the recent period of monetary instability entrenched in their memories - the Greek authorities attempted to maintain the link to gold. The drachma, however, came under heavy selling pressures, and, in April 1932, Greece had to leave the gold standard. Leaving the gold standard made monetary policy a matter of the discretionary judgement of the authorities at the Bank of Greece. The new monetary regime opened up the possibility of the Bank playing a more active role in domestic economic affairs. The Bank was no longer bound by the discipline imposed by the gold standard. However, in common with most other central banks at the time, it pursued monetary and credit policies geared toward safeguarding price stability and ensuring a sustainable balance of payments; after all, this was in accordance with its Statute. In addition, the Bank sought to remedy the inefficiencies of under-developed money and capital markets by instituting measures to attract savings to the banking system and to improve credit allocation. In April 1941, the Axis Powers occupied Greece. For several years, London became the seat of both the exiled Greek government and the Bank of Greece, with the Bank’s gold secretly transferred to South Africa. Within occupied Greece, the economic situation became increasingly grim and hundreds of thousands of Greeks died of hunger. The Axis powers forced the country to pay not only for the upkeep of the occupying troops, but also for their military operations in Southeastern Europe. The puppet regime established by the occupiers forced the Bank of Greece to resort to the printing press. As a result, the country was beset with hyperinflation; between April 1941 and October 1944, the cost of living rose 2.3 billion times. In these difficult circumstances, the country’s economic system collapsed. To give another example of the magnitude of inflation during the occupation, let me mention that in November 1944, immediately after liberation, a so-called “new” drachma was introduced; it was set equal to 50 billion “old” drachmas! In March 1946, a stabilisation plan, which was part of the London Agreements, set up the Currency Committee, which was to become responsible for monetary, credit and exchange rate policies for several decades. This Committee consisted of five members, including the Minister of Coordination, the Minister of Finance, and the Governor of the Bank of Greece. The Committee was given control over the issuance of money, and the authority to allocate credit among sectors and activities as well as to determine lending terms. After suffering through World War II and the civil war, the economy was in ruins. The hyperinflation produced long-lasting effects on attitudes, and savers were unwilling to deposit their funds in the banking system. To help attract funds back to the banking system, the central bank sought to reestablish price stability. At the same time, the Bank of Greece was also called upon to support economic reconstruction and to help lay the foundations for growth. However, circumstances were difficult, since certain factors, including substantial expenditures on defense, social policy, and support of the agricultural sector, caused strong growth of the money supply. The Bank’s task was made even more difficult in view of the country’s underdeveloped financial markets. Yet, the Bank was successful in conducting a tight monetary policy. This, together with the decline in fiscal deficits, resulted in inflation falling dramatically, from over 40 per cent in 1948 to 5 per cent in 1952. This created suitable conditions for a reform in exchange rate policy. In April 1953 the drachma was devalued by 50 per cent against the US dollar and then joined the Bretton Woods system of pegged exchange rates. In the following year, another “new” drachma was introduced and set equal to 1,000 “old” drachmas. Coupled with the nominal anchor provided by the Bretton-Woods system and tightened fiscal policy, the “new drachma” played a key role in reducing inflation expectations. During the next fifteen years real GDP growth averaged 7 per cent, one of the highest in the world. At the same time, average inflation in Greece was less than 2.5 per cent, confirming that strong long-term growth is not feasible without price stability. The Bank of Greece not only helped restore and maintain monetary stability, but its interest-rate policy was decisive in channeling private saving to the banking system. The nominal anchor of the Bretton Woods system proved unsustainable in the long term. Pressures to finance the Vietnam war led to an expansionary monetary policy in the United States and inflationary pressures spilled over to the rest of the world. This, along with the inherent weaknesses of the arrangement, proved the undoing of the Bretton Woods system, which broke down in March 1973. Once again, the lesson that there is a need to separate monetary policy from political influences had to be re-learned. The drachma’s link to the US dollar was maintained up to the spring of 1975. The decades of the 1970s and the 1980s were difficult ones for policy makers worldwide. Among other things, they had to deal with two oil price shocks in 1973-74 and in 1978-79, an international debt crisis in the early 1980s in Latin America and a global stock market crash in 1987. Particularly during the 1970s, Keynesian ideas, which, to some extent, downplayed the connection between monetary policy and inflation, were at their peak. In Greece, during the second half of the 1970s and the 1980s, the central bank conducted monetary policy under difficult circumstances, as the policy mix was often inappropriate. Compounding the difficulty of the Bank’s task was the fact that the financial system operated under a complex framework of rules and provisions, which proved not only ineffective, but also distorted credit allocation and limited the scope for conducting an effective monetary policy. The abolition of the Currency Committee in 1982 and the transfer to the Bank of Greece of its functions in the fields of monetary, credit and exchange-rate policies as well as banking supervision marked the beginning of a new era in the Bank’s history. With broader responsibilities, beginning in the mid-1980s and until the mid-1990s, the Bank of Greece undertook the leading role in the deregulation of the financial system. Financial liberalisation was a gradual process, however, so that the lifting of controls could take place in tandem with the restructuring of the economy and thus avoid the potentially destabilising effects of abrupt and sharp reversals of international capital flows. This strategy proved wise; in the 1990s many Asian economies, which had not given sufficient consideration to sequencing, were exposed to severe financial crises. After financial liberalisation in Greece had been completed in the mid-1990s and up to entry into EMU and the adoption of the single monetary policy in January 2001, the Bank of Greece had at its disposal more effective and flexible market-oriented means of monetary control and was able to react quickly and effectively to changes in economic conditions. The supervisory functions of the Bank have also changed considerably, shifting from the task of ensuring commercial banks’ compliance with credit and exchange controls and regulations, to the monitoring and the evaluation of bank asset quality, and the solvency and capital adequacy of these financial institutions. During the late 1980s and the 1990s, a substantial shift occurred in thinking about the role of the central bank in the economy. Experience of past episodes of hyperinflation in various countries, as well as of moderate inflation, exemplified in the breakdown of the Bretton Woods system, led to the finding that monetary policy is not necessarily independent of the government of the day. Sometimes central banks have to finance government spending and this results in higher inflation and, ultimately, lower growth. Thus, the views that the goal of monetary policy should be to provide price stability and that the central bank should be made an independent institution in the pursuit of this goal gained ground. These ideas underpinned the monetary policy of the Bank of Greece in the 1990s as it sought to support the effort to satisfy the Maastricht Treaty criteria and to join the euro area on 1st January 2001. The Bank’s ability to attain its goals was considerably improved by the abolition of the monetary financing of the fiscal deficit, mandated under the Maastricht Treaty, in 1994, and the law, enacted in 1997, granting independence to the Bank of Greece with a mandate to achieve price stability. In an effort to bring down inflation, in the mid-1990s the Bank adopted a “hard-drachma policy”, under which the exchange rate was used as a nominal anchor. Real interest rates were kept at high levels to help ensure the success of this policy. The hard-drachma policy operated, at times, under difficult conditions, yet it proved highly credible and immensely successful. Ironically, the source of the difficulty was related partly to the success of the policy. The policy’s credibility led to enormous inflows of foreign capital, complicating the conduct of monetary policy. The Bank was able to neutralise these inflows, absorbing excess liquidity and thus buying time for other policies to adjust. Within three years of the policy, inflation was more than halved, falling to under 5 per cent, while economic growth accelerated sharply. The fiscal consolidation that took place beginning in the mid-1990s, and moderation in wage increases, contributed importantly to an increasingly-sustainable policy mix, enhancing the credibility of monetary policy. With the outbreak of the Asian financial crisis in late 1997, and its spread to other parts of the world, there were pressures on the drachma. The Bank of Greece initially raised interest rates to stem these pressures. Then, in March 1998, the drachma entered the Exchange Rate Mechanism of the European Monetary System, so that it could satisfy a Maastricht criterion, and was devalued to help maintain international competitiveness. Unlike the currency devaluations in many other countries around this time, the drachma’s devaluation was not followed by the aftershock of a banking and financial crisis. A well-supervised Greek banking sector, with adequate prudential regulations in place, limited the exposure of commercial banks to foreign currency risk and, therefore, safeguarded the financial system. In the years following the drachma’s entry into the ERM, the Bank of Greece maintained a tight monetary policy so that the inflation criterion of the Maastricht Treaty could be satisfied. Fiscal policy continued to be tightened and wage restraint was maintained. With an ever-more-balanced policy mix, real economic growth accelerated. The rest, is history. On 1 January 2001, Greece became the 12th member of the euro area, where price stability is entrusted to the independent European Central Bank and the Eurosystem. The Bank of Greece is now part of a larger family, the Eurosystem, and continues to exercise extremely important functions. It is an integral part of the Eurosystem, which comprises the European Central Bank and the national central banks of the euro area. The Governor of the Bank participates in the ECB’s Governing Council, which, among other things, sets monetary policy for the euro area. The Bank is responsible for implementing monetary policy in Greece and ensuring the smooth operation of the payments system, which it runs and which is part of the EU’s Target System. The Bank also is in charge of supervising the banking system and maintaining financial stability With the opening of financial borders in the euro area, these functions will take on added importance in the coming years. In carrying out its responsibilities successfully the Bank has benefited enormously, in the present and in the past, from an extremely well-trained and highly dedicated staff. In my view, this has been the key to its success. Such has been the journey of the Bank of Greece during the past 75 years. As you can see, in common with the experiences of other central banks, the journey has not been without bumps and turns along the way. Yet, the history of the Bank demonstrates that the Bank has always fulfilled its obligations and, in so doing, it has earned the trust of the Greek citizens. In the early part of the last century, the famous Swedish economist, Knut Wicksell, said that “Monetary history reveals the fact that folly has frequently been paramount; for it describes many fateful mistakes. On the other hand, it would be too much to say that mankind has learned nothing from these mistakes”. I might add that in recent years we have learned a great deal from the mistakes of the past. As confirmed by the history of the Bank of Greece, the role of central banks, both institutionally and in actual practice, has been upgraded in such a way that it contributes to the improvement of living standards. Ladies and Gentlemen, thank you for your attention. | bank of greece | 2,003 | 11 |
Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at the Second International Banking Forum for the Southeast European Markets Economist Conference, Athens, 4 December 2003. | Panayotis Thomopoulos: The financial environment in Southeast Europe Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at the Second International Banking Forum for the Southeast European Markets Economist Conference, Athens, 4 December 2003. * * * It is a great pleasure to address this Banking Forum at this juncture as I believe that the economies are turning the corner and can now start enjoying the benefits of stability and growth within the framework of closer ties with the European Union. After a difficult and hesitant start in the 1990s, there is now clear evidence that the transition economies of Southeastern Europe have improved their macroeconomic management and enhanced their financial systems so that they can look forward to sustained and high-quality growth. Greece, as the only member of the European Union in the region, has a clear interest in promoting the stability and growth of all our neighbors, and I can be proud that both the public and the private sectors of Greece have played a role in the emerging success story of Southeastern Europe. We see our neighbors' economies mainly as complementary to our own, not as competitors, and the many Greek businesses that are active in the region, especially in the financial sector, are proof of the increasing collaboration between my country and its neighbors. I believe that Greece will continue to make a positive contribution to the economies of the region, but, I must admit, that I draw comfort from the fact that Greece is now surrounded by open, dynamic economies, and I would add friendly countries. It would be an understatement to say that we have turned a page of our history. In effect, the collapse of communism ended not the thirty, or hundred years wars, but more than one thousand years of intrabalkan conflicts and Greece is fully supporting Balkan countries' E.U. membership, which would further strengthen the political and economic ties between all Balkan countries. Let me start with a short look at the international environment that the countries in Southeastern Europe are facing. The overall economic situation has improved significantly during the last few months. After months when expectations of a recovery were based mostly on so-called "soft data," like surveys of consumer and business confidence, we are now seeing real "hard data" that point to the resumption of growth in all the main regions of the world economy. All members of the EU have now emerged from recession, although the growth rate is not what we would have wished it to be. Growth in the eurozone should accelerate slowly, and within the next year the growth rate should gradually approach its potential, estimated at around 2 ? % per annum. The US, on the other hand, is growing fast, maybe too fast. Certainly, I do not wish to belittle the achievements of the American economy, especially its high productivity growth, but the continuation of the twin deficits are certainly a cause for concern, in that a sudden correction could have far-reaching implications for the international financial system. The US sees with benign neglect its twin deficits. On the one hand, it expects that continuing fast rate of growth would generate sufficient tax revenues over the medium term, which, in combination with the gradual phasing out of some tax relief measures, will reduce the deficit and, on the other hand, they expect the current balanced of payments correction to be realized via a devaluation of the US dollar, which would help the sustainability of the US recovery and generate higher profits in dollar terms from the US investments abroad. In summary, they don't expect an abrupt and substantial rise in interest rates, which would have had adverse effects both on the fiscal deficit and on consumer demand, thus precipitating a cyclical downturn. However, the European point of view, if I am allowed to summarize, is that an unsustainably fast growth rate, based on private and public borrowing is not good for anyone and the US cannot be an exception. The EU, and especially the eurozone, has played a constructive role in promoting a stable financial environment. The recent appreciation of the euro is an indication of the markets' confidence in our economies. I believe that a strong euro is good for Europe and the world, as it helps fight inflationary pressures and supports the confidence of consumers and producers. It is also clear that the eurozone cannot solve all the imbalances that threaten the stability of the international economy. I do not wish to enter the debate on whether the fiscal stimulus in the US was necessary two years ago, at the onset of the economic slowdown, but certainly it has to be reversed now as the US is growing at an unsustainable rate. At the same time, third countries, especially those in Asia, should contribute themselves by allowing market forces to play a greater role in the determination of their exchange rate, and by abandoning their mercantilistic attitudes. However I should mention that, there is an open debate whether a revaluation of the chinese renminbi is at present appropriate, given, on the one hand, the fact that it will make relatively small difference, as far as it concerns China's trade surplus, if the chinese wage expressed in US dollars from about 10% of the US or EU average wage rises to 15% or 20% as a result of the revaluation, and on the other hand, a revaluation could lead to a deterioration of the already Chinese banks' fragile conditions and would also make more expensive the acquisitions of Chinese factories, commercial sites, etc by foreign investors. One positive development that I cannot stress enough is the absence of any challenges to the financial stability in Europe and the US. Unlike the situation in the early 1990s, we have recently gone through a period of a prolonged and synchronized slowdown, made worse by geopolitical risks, with no major financial institution being impaired. There have been of course problems, especially in the European insurance sector, exacerbated by natural catastrophes, but all financial institutions have managed through. Undoubtedly, those who make mistakes, or are simply unfortunate, suffer in a market economy. Nonetheless, such problems, whenever they surfaced, were contained and did not have systemic repercussions that could threaten the macroeconomic stability of our economies. Indeed, in our E.U. economies we have long recognized the key role of the banking sector and its health has been a constant preoccupation of the authorities, especially of Central banks which, even those not directly involved in supervision, have a wider responsibility for the good functioning of the financial system as a whole and the payment systems. We have been building sound banks, which not only can withstand successfully cyclical pressures and other kinds of shocks, but also they bring crucial support to the economy when failures appear in other, less important, parts of the financial system. The bursting of the stock exchange bubbles and the subsequent substantial decline in their capitalization, in certain countries amounting to as much as 30 to 50% of GDP, produced relatively little damage and which was, moreover, contained thanks to the banking sector. Likewise, as a result also of what I would say, the least, "not very prudent policies" the significant losses of insurance and re-insurance companies in the last few years have been partly absorbed by the banking sector, which responded promptly to their needs for liquidity and capital injections. The banking sector in some countries has unwillingly assumed the responsibility for the well being of the financial sector as a whole, because it understands the danger of systemic risks, that can wreak havoc. I cannot pretend that there were not tensions here and there, or losses due to the write-offs of nonperforming loans, to plummeting share values and to laying off costs, but only a few banks posted operating losses and, moreover, those, as a rule, were relatively small. Even today, after three years of a downturn, the capital adequacy ratio, has remained well above the minimum 8% in almost all cases, and for the E.U. as a whole the average is above 10%, which underlines the good health of the banking system. Moreover, it is expected that it will continue to improve as the recovery gets underway. Here, I wish to repeat the very positive role of Central banks, which, almost all were over more than 50 years, and many of them still are the supervisory authorities. Indeed, central banks succeeded in creating a competitive and sound banking system in Europe during the last fifteen years or so, during a period characterized by liberalization in financial markets and intense competition both within Europe and from the US banks. The lesson I draw is that with the help of their natural interlocutor, the central banks, the private sector has become more adept in dealing with risks and the supervisors have learned from the mistakes of the past and improved their vigilance. Looking ahead, the new prudential practices to be introduced under Basel II will further improve our ability to deal with financial risks and better tailor our prudential requirements to each market's special needs. Another positive development is the diminishing danger of contagion, as we have seen after Argentina's default, which did not lead to widespread withdrawal of funds from emerging markets. This is particularly significant for the emerging market economies in Southeastern Europe, which look to a greater integration in the world economy without the fear of being hit by a crisis that originates elsewhere. All this of course, provided they maintain healthy fundamentals. Turning now to the developments in the Southeastern Balkans themselves, the present situation is a far cry from the bleak picture at the early stages of transition, more than a decade ago. Apart from often-bloody conflicts, hyperinflation and financial stability seemed endemic in the region only a few years ago. Regarding the financial sector, starting from an initial position with practically no commercial banks, the countries in the region faced problems that were often beyond their administrative and regulatory capabilities. Financial institutions were reformed with insufficient regulation and unclear focus and expansion was associated with improprieties, scandals and fraudulent schemes during the early stages of transition. Therefore, the financial sector was unable to attract deposits and develop extensive client networks. Finally, state banks were compelled to carry a high number of non-performing loans, which had been accumulated by the government subsidization programs to state run enterprises. The development of the financial sector was hampered at the beginning by inadequate macroeconomic management. Fiscal deficits were mostly excessive, and often monetized, and the inevitable outcome was high inflation. It is encouraging that in the last few years we can see clear evidence of maturity in economic management. The path to macroeconomic stabilization was different for every country. In the region we can now observe all types of monetary and exchange rate regimes, from formal euro-ization and currency boards linked to the euro, all the way to monetary targeting. This is proof, if proof was needed, that there is no single solution, to economic problems but that the policies of each country should be tailored to its specific needs. Going beyond the diversity of the region, at this point I would like to underline two characteristics of the financial system of practically all countries in the region, which are the result of their past, but will also shape their future developments. The first is extensive currency substitution. As a result of past inflation, but also because of the large numbers of people working abroad, foreign currencies, and especially the euro, play a large role and they have often become the main currency in use. One can gauge the degree of currency substitution by noting that in all countries in the region deposits in a foreign currency account for at least half of all bank deposits. One must add to this, money "kept under the mattress" and capital flight. Undoubtedly all these were a vote of no confidence in domestic policymakers. People showed their dissatisfaction with local financial institutions and monetary authorities by moving their savings abroad, or by using other, more stable currencies. This high degree of currency substitution can only be found in some Latin American countries and undermined the effectiveness of monetary policy. The ability of monetary authorities to extract seignorage was severely limited, and this is a partial justification of the high inflation rates. At the same time, monetary management became more difficult, as small shocks had a disproportionately big impact on inflation and the exchange rate. In some countries, namely Bulgaria, the extent of hyperinflation and currency substitution left little alternative to the authorities but to accept the reality and move to a hard peg in the form of a currency board linked initially to the Deutschemark and now to the euro. Similar regimes were also imposed on Bosnia, after the Dayton Accord, and Kosovo. The euro is an appropriate anchor for an exchangerate-based policy in these countries, as they are closely integrated with the countries of the eurozone. Most of their transactions, not only trade-related, but also workers' remittances, official transfers and financial transactions are with countries of the eurozone. A measure of macroeconomic success is the receding level of currency substitution. In 2002, the last year for which we have full data, bank deposits in foreign currencies fell as a proportion of total deposits in all countries in the region, sometimes quite fast in countries with strong performance in the context of monetary or inflation targeting, with only one exception. This is indicative of a growing trust in the domestic currency and the effectiveness of stabilization. It is all the more important that this achievement should not be squandered, and that prudent macroeconomic policies should continue. Nonetheless, I would like to warn of possible problems, especially in those countries that have tied their exchange rate to the euro, one way or another. The weakness of the euro until last year undoubtedly helped both their growth performance and their external competitiveness. From now, in a period of strong euro they will have to rely more on domestic productivity gains and structural adjustments to maintain their growth rates. In addition, and as growth takes hold in advanced economies, countries in the region will have to adjust to interest rates higher than their current historically low levels. An area where much remains to be done is the area of developing an efficient and stable financial system. In this respect, the economies in the region lag behind the other transition economies that are due to join the EU next year. The public sector still controls a substantial part of the banking system, and there is an obvious need to continue the efforts to privatize the remaining state-controlled banks. As in most transition economies, state interference has not been a stabilizing factor, quite the opposite. State controlled banks have often lost substantial sums in politically-motivated investments and have contributed to systemic crises in all those countries. As in other transition economies, we can foresee that an increasing number of banks will been taken over or become affiliated with foreign ones. Setting aside nationalistic prejudices, I think this should be seen as a welcome development as a whole, provided the foreign entrants are strong and wellsupervised financial institutions. In the acceding countries of Central Europe foreign banks already play a major role after the crises that hit those countries in the late 1990s, and the overall experience has been positive. (Foreign banks control more than 80% of the domestic market in a few central european acceding countries). Foreign banks bring with them many advantages, especially in the case of countries with a limited experience with sophisticated financial markets. At first, they have access to better know-how and technology. More importantly, they are mostly immune from political interference. While local participants are often intimidated or pressured to give loans to well-connected borrowers, foreign institutions generally feel stronger to resist such pressures. Also, foreign banks are considered "safer" by local depositors, who recognize that they are not manipulated by the political authorities, and who also understand that foreign banks are supervised by the more experienced supervisors at home. Finally, experience with other emerging markets shows that foreign banks are better able to withstand losses in cases something goes wrong. The international evidence shows that banks affiliated with ones from advanced economies have access to capital at lower cost than local ones and can be recapitalized faster and more easily than the others. Of course, foreign banks may have its disadvantages. Foreign-owned financial institutions may lack understanding of how the local market works. Indeed, it has been noted that such banks often tend to concentrate on financing affiliates of foreign firms, or only large local firms. There is thus a danger that local small and medium enterprises may find their access to credit curtailed. There is also the possibility that foreign-owned banks will alter their credit based not on the local conditions, but on the conditions in their home economies. Indeed, in Greece we have observed that foreign banks have entered the market and subsequently they expanded or left in a haphazard way, not on the basis of local conditions or profitability, but mostly on the basis of wider strategies whether to expand globally or not. Formally, we can say that this increases the correlation of emerging markets with the outside world. Research shows that the operations of financial multinationals are becoming a major channel for the transmission of business cycles. For that reason, economies in the Southeastern Europe will find that their economies are more and more affected by what is happening in the rest of Europe than with what is happening locally. Although at times of local euphoria you may regret being held back by the European business cycle, over time the benefits of becoming tied to the more stable economy of the eurozone will become overwhelming. This is especially so for countries that are applying for EU membership. Greater synchronization with the European cycle will smooth their path towards full membership. Foreign ownership of banks will also allow a greater risk diversification than what might be achievable by small local banks whose whole portfolio is locally invested. Foreign banks can thus behave in a less riskaverse way than local ones. The issue of financial stability and proper supervision is very important for us, at the Bank of Greece, as Greek firms have invested heavily in our neighboring countries. In most of them Greece is among the five biggest suppliers of foreign direct investment. Of course, this has to some extent caused delocation of greek companies, with a negative impact on investment and employment in Greece over the short to medium-term, but for an economy growing at almost 4% p.a. since 1997 and with an investment GDP ratio of 24% delocation does not pose a serious threat to its long term performance. Looking at the data in preparation for this speech, I was amazed by the number of branches of Greek banks in our neighboring countries. This shows that Greek banks have entered planning to offer a wide range of services and they see their future closely linked to the evolution of the host economies. They are not entering in order to concentrate in just a few lucrative activities and offer services to other Greek firms. The positive effects of the presence of foreign banks predicted by theory are supported by the experience of Greek banks in the countries of Southeastern Europe. Greek banks are already wellestablished in Bulgaria, Romania, Serbia-Montenegro, Albania and FYROM, representing at least 20 percent of the banking system according to assets and in some of them their share is between onethird and two thirds. Overall, they are better capitalized than their competitors, something that could be expected as they have access to a more diversified source of funds. Their better capitalization allows them to take somewhat higher risks, as shown by the fact their loans to the private sector are generally a higher share of their assets than for the average bank. Although they take somewhat more risk, they are profitable overall, more than their average competitors. This signifies that Greek banks in the region have some comparative advantage, either in the form of access to capital markets, or because of superior organization and know-how, and good understanding of local conditions. While Greek banks play a major role in the neighboring economies, their exposure to these economies is generally small. For no Greek banks does the exposure to Southeastern Europe exceed 3 percent. This is simply a reflection of the different levels of development in Greece and nearby countries. The result is that while Greek banks face little risks from their exposure to these economies, they themselves are important for the stability of the financial system in the Balkans. In the Bank of Greece we are well aware of this, and we take our responsibilities to our neighbors very seriously indeed. As home country supervisors we recognize that our ability to exert prudential supervision has effects beyond Greek borders. In recent years we have signed several agreements, in the form of memoranda of understanding, and we are discussing some further ones with other supervisors in the region in order to enhance our ability to ensure the stability of the banks under our jurisdiction. What is needed, beyond formal agreements, is the confidential and frank exchange of all information among supervisors in order to identify problems early on, before they become threatening. In this era, we should also be vigilant to avoid abuses of the financial system for illegal activities, such as money laundering and terrorism financing. Of course, we take comfort from the fact that the Greek banks that have expanded in the Balkans are quite strong, well above the necessary prudential ratios. Actually, the fact that Greek banks have been able to retain a very high share of their local market is also an indication that they have some comparative advantages that allow them to thrive in an internationally competitive environment. I must admit that our interest in the stability and growth of our neighbors is to some extent a reflection of selfish instincts. We realize that strong and growing economies in this region are not only useful for the Greek economy, but also a prerequisite for the political stability of the Balkans. I mentioned before that the presence of foreign financial firms in the Southeastern Europe would transform their business cycles. But it works the other way round. Greece's orientation toward the dynamic economies in our region has helped us somewhat weather better than most the recent economic slowdown. In a very specific way, one can see the growing interlinkages in the Balkans as evidence of how trade in goods and financial services can help growth and stability. Looking ahead, the challenges for our neighbors remain formidable. Now that the first steps towards stabilization and growth have been taken, what lies ahead is the more difficult issues of managing an emerging economy. Top of their priorities I would like to put the improvement of their governance structures, the further deregulation and privatization and the strengthening of the respect for property rights. I should end by saying that they can count on our continued support. | bank of greece | 2,003 | 12 |
Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at the Euro-Mediterranean Seminar, Eurosystem and Mediterranean country national central banks, organised by the Bank of Italy and the European Central Bank, Naples, 14-15 January 2004. | Panayotis Thomopoulos: Anti-inflationary exchange rate policy in Greece in the 1990s Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at the EuroMediterranean Seminar, Eurosystem and Mediterranean country national central banks, organised by the Bank of Italy and the European Central Bank, Naples, 14-15 January 2004. * * * I would like to thank the ECB and the Bank of Italy for the successful organization of this meeting. Greece has been for more than three thousand years at the cross-roads between North, South and Eastern Mediterranean countries and, we Greeks have been able to enrich our culture and ideas from our relationship with all the nations around the table and I am sure that to-day’s exchange of experiences will be to the mutual benefit of all present. I look forward to an even closer cooperation in the future between the Eurosystem, with the ECB taking the appropriate initiative, and the rest of the Central banks from the other regions of the Mediterranean. When the Maastricht treaty was signed, Greece was meeting all the criteria of a country in crisis. Stagflation, with mounting macro-economic imbalances, were the main characteristics of the economy. In the 15 years up to 1993, average inflation was almost 17%, GDP growth was barely 1% per annum, while the fiscal deficit was creeping upwards reaching some 13,5% of GDP by 1993 and pulling up the debt - to - GDP ratio to over 110%. It was, therefore, not surprising that the government’s commitment to prepare Greece for the satisfaction of the Maastricht criteria in 1999 and membership of the Euroarea by 2001 (2 years after its creation) was received with disbelief by almost all foreign and domestic observers. From the beginning of 1994, when the new stability oriented policy was initiated, a managed exchange rate was a key policy plank in the stabilization process and contributed importantly to disciplining economic agents and setting in motion wage and price restraint, which brought the rate of inflation down to some 2% on average in the twelve months to early 2000 thus making possible our Euroarea membership. Between end 1994 and early 1998, i.e. in the period preceding our ERM I membership, the Bank of Greece and the government had decided to follow a policy of managing the exchange rate by not allowing the drachma to depreciate as fast as was needed to compensate for the inflation differential vis-a-vis our trading partners. This was done purposefully in order to put a break on inflation and inflationary expectations, which in the past were strongly fed by the recurrent devaluations of the drachma, which, sometimes, more than fully accommodated the excessive wage and price rises. While there was some real appreciation of the drachma, the resulting disequilibrium was not as large as some argued, especially participants in the financial markets. Studies conducted by the Bank of Greece indicated that the real overvaluation of the currency was of the order of 10 percent after taking into account the Balassa-Samuelson effect and a number of other factors. This anti-inflationary exchange rate policy started having its impact on inflation after less than one year and was accompanied by other policy measures, with the result that domestic disequilibria were narrowing and our policy was gradually gaining credibility. This permitted the government to persuade the labor unions to abandon the backward looking wage indexation scheme, which by its nature had perpetuated the inflationary spiral for years and instead to move to forward looking wage increases, based on the continuously declining annual inflation target set by the government. Lower inflation was, in turn, facilitating fiscal consolidation as a result, of (a) the progressive narrowing of the very high interest rate risk premia on government debt and, (b) the actual decline in interest rates in line with inflation. As a consequence, government expenditure on interest payments fell from 13% of GDP in 1993 to less than 7% in 2001, when Greece joined the European Union. Falling inflation was also making our managed exchange rate easier to operate. However, we were conscious that an exchange rate adjustment would have to take place at the time of joining the ERM I, so as to offset the loss of external competitiveness reflecting the previous few years of real appreciation of the drachma. We had fixed 10% as an upper limit for the real appreciation, because, first, a moderate appreciation would not frighten the markets and, second, the subsequent necessary correction of the exchange rate would be limited. We were aiming at a limited correction that would not impact unfavorably on other macroeconomic variables, in particular inflation and would not generate expectations for further depreciations. Indeed, central banks which follow a managed exchange rate policy have to be very careful not to allow a big appreciation of the real exchange rate, that would subsequently open the stage for big speculative attacks, which because of the usual overreaction of markets could trigger capital flight. Indeed, there are numerous examples, starting with Argentina and going backwards, that capital flight on the one hand, deprives the domestic economy of much needed investable funds and, on the other hand, drives the exchange rate to abnormally low levels, which immediately set the stage for a wave of price rises and drive the economy into recession. If this situation is allowed to develop the original anti-inflationary exchange rate policy would ultimately cause much more damage than if a pure free floating policy was followed. Anti-inflationary exchange rate policies, which aim to eliminate imbalances and disequilibria, so as to improve domestic economic performance, inevitably entail a cost. There is no free lunch in a global and competitive world, especially when market makers are, sometimes, enticed by speculators and wild rumors. Indeed, for almost 4 years the cost, borne by the Bank of Greece, of sterilizing the excessive short-term capital inflows attracted by the high interest rate policy, in combination with the exchange rate policy amounted to almost ½% of GDP per annum. Furthermore, the government proceeded with fiscal consolidation and structural reforms as well as other measures which were introduced (notably extensive privatization) as a necessary complement to the anti-inflationary exchange rate policy. These policies underpinned the improvement in the functioning of the economy and gave a significant boost to business confidence. The determination with which the three Cs were pursued - consistent policies, continuity in policies and confidence building, after two to three years of hesitation, swayed the labor unions, businessman and the public at large to back the stabilization policies with the aim of entering the Euroarea as soon as possible. In addition to targeting the exchange rate, the Bank of Greece always kept a close watch on the growth of M3 and domestic credit expansion and through open market operations absorbed any excess liquidity, which, if it had been allowed to reach the real economy, could have aggravated inflationary pressures. Moreover, when necessary, we also imposed stricter terms on banks’ obligatory reserve requirement deposited at the bank of Greece, which were already relatively tight (an amount equal to 12% of deposits with the banking system and it can be noted that they were remunerated at a negative real interest). However, at the Bank of Greece we knew that this was not sufficient to ensure a smooth run up before entering first the ERM I and subsequently the Euroarea. Speculators are always waiting round the corner and, sometimes, markets may wish to test the country’s resolve to maintain its exchange rate targets. Therefore, we followed throughout the six years before entering the Euroarea a high interest rate policy so as first to keep foreign investors happy and keep their confidence but also in order to build a high level of foreign exchange reserves so as to be able to have sufficient reserves to thwart speculative attacks. Indeed, when the 1997 south-east Asian crisis spill over effects reached Greece in September-October and american hedge funds started speculating heavily (up to $2 billion daily) against the drachma and the word was spread that the drachma would devalue by as much as 28% we were able to defend our parity by drawing on our foreign exchange reserves and by raising interest rates temporarily, for a couple of days at a time. We were, however, concerned not to scare the markets, which might have perceived our moves as resulting from panic, and, therefore, we were very careful about how the policy tightening was presented. Instead of raising our intervention rate (lombard rate) from 19% to 330% we temporarily put a surcharge of 0,4% daily at the end of October. This move looked innocuous and passed smoothly, while penalizing heavily banks’ cost of borrowing. Accordingly, we sent the right signal to the market and this permitted us to eliminate the surcharge within a few days, so a quasi-normal situation was soon restored. We were also very careful in the way our foreign exchange interventions were executed. In most cases, we wanted to show our determination to defend the parity and, therefore, the Bank of Greece’s foreign exchange department intervened directly in the market but, sometimes, we judged that an intervention through a friendly foreign bank could be more persuasive and influence market sentiment better. Both the government and the Bank of Greece knew that our fundamentals were rapidly improving and our economy had entered a virtuous cycle of rapid growth, falling inflation and fiscal deficits and with relatively small current account deficits by past standards, so we did not hesitate even for a second, regarding our policies and goals. We became even more determined than before to continue our stabilization policies and defend the exchange rate so as not to delay our entry in to the Euroarea. Our determination paid off and foreign exchange markets after a few months of turbulence calmed down in early 1998. Conditions were then considered propitious to achieve our intermediate goal, to enter ERM I in calm waters accompanied by a small devaluation to correct the previous real appreciation. We succeeded in catching the markets by surprise and not being forced to make a devaluation under duress, with all its destabilizing effects. Moreover, the new ERM parity agreed with our EU partners was broadly consistent with Greece’s fundamentals and costs and productivity levels and satisfied the markets. And judging from Greece’s record of the last 6-7 years: an annual growth of GDP 3.9%, inflation at the end of 2003 at 3.1% only 1 percentage point above the Euroarea average, and a fiscal deficit at 1.5% of GDP in 2003, the exchange rate with which the drachma entered the ERM in 1998, and the subsequent conversion rate into the euro in 2001, were appropriate and reflected Greece’s overall competitive conditions. I would like to tell you how markets behave or rather misbehave: in the heat of speculation, many investment banks were spreading the word (even via the monthly bulletins they circulated and one of them through a teleconference in London) that there would be a devaluation of the drachma of up to 28%. We disproved the pessimistic views and the actual devaluation upon entering ERM I was 12,3%. Immediately afterwards market sentiment changed and the drachma traded at well above its central parity. As a result, the central parity was revalued later in January 2000 and the total devaluation by the time the drachma entered the Euro area was only 7,9%. The lesson that can be drawn from the greek experience is that a managed exchange rate policy needs to be consistent with the other policy planks, notably fiscal and structural policies which, in turn boost markets’ confidence and, therefore, facilitate the exchange rate policy. Confidence is crucial for the successful realization of the policy goals. As I mentioned above, the cost of sterilizing the excessive short term capital inflows (almost ½% of GDP) may appear at first sight too high, but the benefit of stabilization, notably the resulting sustainable investment-led high rate of GDP growth of almost 4% since 1997, which is expected to continue well into this decade, far outweigh any temporary sacrifice the economy incurred in order to fulfill our stabilization goals. The road to the Euro was not strewn with roses, it was not smooth and I don’t want to underestimate the difficulties. With regard to the sequence of policies and priorities, we took a calculated risk starting our stabilization policies by adopting a policy that allowed for a moderately appreciating real exchange rate. We walked on a tightrope, sometimes for months in a row, as there were occasional bouts of jitters based on market expectations, even until the last moment, that our Euroarea entry would be deferred or that we would join at a significantly depreciated rate. Accordingly, whereas our goals were ambitious, our policies erred on the side of caution. We made gradual adjustments and, as an insurance, always had at hand a sufficient large cushion of foreign exchange reserves and a relatively high interest rate differential vis-a-vis Euro rates, even until the last few weeks before entry into the Euroarea. | bank of greece | 2,004 | 2 |
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This dataset consists of central bankers speeches from 1997 to 2025 scrapped automatically from the Bank Of International Settlements website. Each speech is associated to a central bank, a date and a description (a metadata provided by the website). The dataset covers a wide range of topics in economics from monetary policies to world outlooks, financial stability, unemployment, fiscal policies...
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