April 26, 1997
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I am very pleased to introduce, to my right, Mr. Massimo Russo, until very recently Director of IMF's European I Department and now a special advisor to the Managing Director of the International Monetary Fund, with special responsibility for following developments with respect to EMU and advising the Managing Director on their implications for the international monetary system.
To my left, Mr. Jacques Artus, who as the Deputy Director of the European I Department, represents the geographic department that is most directly involved operationally with EMU issues on a day-to-day basis.
I will ask Mr. Russo to open with some introductory remarks and then we will turn to your questions. I would also just like to point out that we have copies of a speech by the Managing Director of the IMF, Mr. Michel Camdessus, from a conference organized here at the IMF on EMU and the international monetary system in March of this year; you might find that useful reference material.
The briefing is on the record, and I will now turn to Mr. Russo.
MR. RUSSO: Thank you for coming. Before I open the floor for discussion, I would like to make a few general remarks.
The years 1997 and 1998 are very important years for Europe. The decision will be made next spring on which countries will participate in Stage III of EMU. As the date of that decision approaches, attention has been focused on which countries are expected to satisfy the convergence criteria of the Maastricht Treaty. Doubts are raised in some cases concerning, in particular, the key criterion of the ratio of government deficit to GDP, and there has been speculation that the start of EMU could be postponed.
On these two points, I would like to make two remarks. First, the conditions for a successful start of EMU are largely in place, as Mr. Camdessus clearly stated in his speech at the conference on EMU.
The reduction in both the level and the dispersion of inflation rates has been remarkable. This decrease has also been reflected in the considerable reduction in long-term interest rate spreads, with all countries meeting the criterion of the Maastricht Treaty, except for Greece.
The projections of the World Economic Outlook also show that there has been major progress in the fiscal area. The World Economic Outlook notes that, on the basis of measures that have already been announced, almost all European Union (EU) countries except Greece would meet the treaty criterion or would need to take relatively small measures to achieve the target of a 3 percent deficit-to-GDP ratio.
Perhaps more important, structural deficits have been reduced considerably, and all countries, except, again, for Greece, have structural deficits below the 3 percent criterion, as indicated in a graph in the World Economic Outlook.
Second, we at the IMF believe that a delay in the start of Stage III would entail substantial dangers. It could lead to turbulence in the financial market and even risk shelving the project itself for an extended period of time, which would complicate the process of convergence or even make it impossible for some countries to continue with this process.
It's also important, however, that EMU start well and, therefore, the progress that is being made should be sustained; we invite the governments to take whatever appropriate measures are still necessary to make it possible for EMU to start on time and successfully.
We will now open the floor for questions. QUESTION (translated from Italian): First, what explains--and what do you think about--the differences between the projections of the IMF, which show that Italy, France, and Germany have deficits of 3.3 percent of GDP in 1997, and those of the European Commission, which show deficits of 3 percent for France and Germany and 3.2 percent for Italy? Second, what turbulence could this create in the financial market?
MR. RUSSO: First, let me answer the last question. We've seen no turbulence in the financial markets as of this date, and, since these figures have already been announced, the answer is already there: there is no turbulence in the financial markets. The financial markets make their own projections and have their own judgments, and both the projections of the IMF and those of the European Commission are only two of a number of projections that the markets take into account.
With respect to the first question, for those who know how these projections are made, differences of 0.1 percent of GDP or 0.2 percent of GDP are very much within the margins of error. We had some different assumptions or forecasts for GDP growth than the Commission. For Italy, for example, the Commission and the Italian government forecast growth of 1.2-1.3 percent for 1997; we forecast 1 percent.
So I would not worry about these differences, and, indeed, as I said at the beginning, this only shows that Italy is very close to achieving the criterion. Italy started with a deficit of almost 7 percent of GDP in 1996, so a deficit of 3 percent,--or 3.1, 3.2, or 3.3 percent--is a major effort in 1997, and the different projections are well within the margin of error.
With respect to the process of convergence in Italy, what I am more concerned about is that a good proportion of the adjustment in 1997 is due to measures that will exhaust their effect in 1997 or soon thereafter. This implies that, in order to maintain the deficit below 3 percent, new measures will have to be taken within the 1998 budget and in successive years.
That's why we have always advised and continue to advise the Italian government to adopt structural measures that will reduce on a permanent basis the growth of spending, to maintain it in line not only with the 3 percent Maastricht criterion but also with the requirement of the Growth and Stability Pact, which aims at a deficit well below the 3 percent Maastricht criterion.
QUESTION: You are recommending for the German government additional measures, as well, in order to come in with a 3 percent deficit at the end of the year. The political situation in Germany is such that it's probably very difficult to pass additional measures this summer. If that is true, and if Germany comes in above 3 percent--maybe at 3.3 percent, maybe even more--would you then recommend a delay or would you think the conditions are still there to start at the time that has been decided?
MR. RUSSO: We are not going to make that decision because we will not participate in the forum that will make that decision. We believe that, first, it should not be so difficult for Germany to take additional measures, if necessary, to make the 3 percent criterion in 1997 or to be very close--closer than 3.3 percent.
But even if the 3 percent target were not reached, a judgment would have to be made at that time--on the basis not only of developments in 1997 but also of developments in 1998 and 1999--on whether it would be more appropriate to postpone or to go ahead. The risks of postponing are important and large, as well as the risks of starting badly. But the differences that we can see in the convergence process, including in Germany, do not show that the risks of starting with levels close to what they are now are so great. That's what I said at the beginning of my statement.
MR. ARTUS: I don't have much to add, but I will stress that the German authorities have clearly indicated that, if the new estimate that will be prepared in May indicates a need for additional measures, they will take such measures.
Now, the deviations that we project are, indeed, very small, and, therefore, the kind of measures that could eliminate those deviations are also fairly small.
QUESTION: You mentioned the danger of delay. What is the danger of starting with a "softer" euro, of starting with a group composed of all 16 countries? After all, because of the political issues, you need a vote of two-thirds of the voting power of the EU.
MR. RUSSO: I don't see much risk of a situation developing in which political criteria will prevail that will weaken the euro. I think that the insistence expressed about meeting the criteria is aimed at ensuring that this will not happen. Very frankly, as an economist, I don't believe that a deficit of 3.1 percent of GDP makes the euro weak or a deficit of 2.9 percent makes the euro strong.
QUESTION: I have two questions, Mr. Russo. First, I didn't understand exactly whether you are worried about possible speculation in the financial markets over the next months. If you are worried about possible misalignments in the currencies and so on, what kind of measures or countermeasures do you suggest for European countries to put down this speculation?
The second question is on Italy. I would like to know what specific measures you suggest that Italy take now or in the next budget to guarantee that the deficit of 3 percent will be maintained also in 1998.
MR. RUSSO: To answer the first question, there are two periods that one has to look at from the point of view of possible speculative market behavior or turbulence in the market. One is the period between now and the spring of 1998, at which time the countries would be selected that are in a position to participate in EMU. Therefore, speculation by the markets will grow about whether countries will participate or not in EMU.
Then there is the second period, which goes from that moment in the spring of 1998 to January 1, 1999 or thereabouts, when the currencies will be permanently fixed. Speculation may develop about the rates at which the currencies will be permanently fixed, and there are discussions taking place now on how to handle that problem. Several proposals have been made by the President of the European Monetary Institute, Mr. Lamfalussy, and by other economists, and my understanding is that something will be done to address that issue. This fundamentally implies that, during that period, there will have to be very strict and close cooperation on monetary policies among the countries participating in EMU.
The market would have to be guided--and it can be done in various ways--toward the rates that will be fixed because those rates, in principle, will have to be the rates prevailing on the day before the fixing in the markets to ensure that the European currency unit (ECU) external value remains the same.
As for the speculation between now and the spring of 1998, the best way to react to that is to make sure that every country meets the convergence requirements, as every country that meets the requirements can join the system.
As far as Italy is concerned, there are no new measures or new issues to be discussed. The problem has been studied very well. It is a question of political will.
We all agree, I think, that tax increases in Italy are no longer available as an instrument to achieve deficit reduction because the ratio of taxes to GDP has increased to the level of 1993, making it one of the highest in Europe.
What are the items of spending that are important, given the compression that has already taken place? These are personnel spending, namely on government employees, and welfare spending, both on health and pensions. As you know, pensions are the area that absorbs most of the welfare spending in Italy, unlike other countries; expenditures here leave very little room for spending in other areas where there are really great needs.
So we would welcome the Italian government's starting and completing negotiations on adjusting the pension system and other social spending in a way that would permit Italy to remain within the 3 percent budget limit after 1997.
QUESTION: I would like to ask you one question about transition countries in Central and Eastern Europe. These countries want to have very close relations with the EU. What do you think will be the status of these countries after EMU begins?
MR. RUSSO: First, these countries are candidates for membership in the EU, which does not necessarily entail membership in EMU. However, I believe that any member of the EU will also probably aim at becoming a member of EMU at some stage.
I believe that, initially, the lack of convergence between those countries and the rest of the EMU members will not permit full membership in EMU. However, some agreement will be reached about how to achieve this over a period of time. During this interim period, managing the exchange rate relationship between the euro and the currencies of transition countries is feasible; there are historical precedents for this, particularly the European Monetary System (EMS) and the exchange rate mechanism (ERM).
Some of these countries' currencies are already essentially pegged to the deutsche mark; in your country, Croatia, in particular, the exchange rate follows very closely the deutsche mark and is pegged to it.
QUESTION: What about the inflation rate in transition countries?
MR. RUSSO: Inflation in those countries is now at the level where joining EMU is not possible, but there are important differences. The level of spending, the level of incomes in transition countries, the need to transform the economy and the ownership of the productive structures--all are quite different from the rest of Europe. So there is plenty for these countries to do in following the convergence process, first to attain membership in the EU and then to attain membership in EMU.
QUESTION: I'd like to hear a little bit more about how the euro is going to affect the working of the IMF, specifically its surveillance functions. How will the IMF conduct surveillance with EMU countries, with the European Central Bank (ECB) being responsible for monetary policy but fiscal policies still remaining with the individual countries? How can the Fund ensure the orderly workings of exchange rate mechanisms and exchange rates when each EMU member will still be able to run balance of payments surpluses or deficits with other countries, given that this capability will not be addressed within the framework of EMU?
And finally, an institutional question. The logic of having a euro or a common monetary union would require that EMU partners basically cede sovereignty to EMU. Nevertheless, those countries still remain individual members of the IMF. How are you going to resolve that tension?
MR. RUSSO: I thank you very much for this question because this is certainly in our minds also. It informs the work that we have been doing and will continue to do with greater intensity in the period ahead.
Surveillance first. Let me tell you that, even before the creation of EMU, we have already increased our multilateral surveillance, looking in particular very closely at the process of EMU. For instance, Mr. Artus, who recently headed missions to the European Commission and to the EMI in Frankfurt, and I have been discussing these issues with the authorities for the last three years. We have, as a result of these discussions, prepared documents for seminar discussions by the Board of the IMF. This is because EMU has not yet been established and competence in this field of policy remains with the central governments of these countries.
Now, with the creation of the ECB, the member countries will take the further step of ceding sovereignty to the EU. As you have indicated, when in our surveillance process we discuss the monetary policy of an EMU member, we will have to discuss that policy with the ECB, which will set the monetary policy for that member country.
But this is not a new thing for us. We do this also for two other groups of countries: members of the West African and Central African Economic and Monetary Union and members of the Central Bank of West African States. These groups each have a common central bank and a common currency, and monetary policy is set by each central bank for its members.
The difference is that, compared with the existing monetary unions in Africa, the ECB will have a greater economic impact on the world and cover a much larger area, with systemic implications for the rest of the world. Accordingly, our own surveillance of the ECB will have to be much more thorough and frequent, and we will have to look at the implications for the rest of the world of the policies that will be followed by the ECB, in the same way that we now look at the implications for the rest of the world of the Federal Reserve's monetary policy for the United States.
Now, as for the exchange rate relationships, there are two types. First, within EMU, there will be no exchange rate. There will be only one currency and thus one exchange rate vis-à-vis the rest of the world. Clearly, that exchange rate will be an important exchange rate, and we will monitor it as part of our surveillance on exchange rates. As we are in a regime of floating exchange rates, I'm sure that the ECB will choose to stay in that regime. Then there are the exchange rates of the countries associated with EMU.
With respect to the operations of the Fund, we are beginning to look into these issues, and I would prefer that Mr. Artus respond to this question because these issues have been discussed in the recent mission that he has headed to the European Commission in Brussels and to the EMI.
The use of the euro will raise various questions for the Fund, but the most important one is the one that you mentioned at the end, namely, who is going to be a member of the Fund? I want to tell you very clearly that this issue is not a very difficult one. It's very clear that the members of the Fund are countries, not central banks or monetary unions. So the European members of the Fund will remain members of the Fund as separate entities, but they will share a common central bank and a common currency, which carries with it certain implications.
Now, if the process of monetary and economic integration in Europe develops further and moves into the sphere of political integration, so that the union becomes more than just a monetary union, then the question that you are raising will arise. But I don't see that happening in the foreseeable future. Therefore, I don't think that this question is something that will be foremost in our mind. We will look much more closely at the more technical and more immediate issue of the operation of this new central bank.
QUESTION: How does the establishment of the ECB affect the work of the decision-making bodies of the IMF, for instance, the Interim Committee? Would the ECB be represented on the Interim Committee, for instance, and how would the ECB interact with the Executive Board? Have you thought about that?
MR. RUSSO: Yes these are very delicate issues. These issues have not yet been solved. However, I would look, for instance, at the example of what will happen at the Group of Seven (G-7) industrial country meetings. Will the ECB be present at the G-7 meetings, and who will be the counterpart of the ECB within the G-7 as far as the ministers of finance are concerned?
I would envisage that, when the Fund discusses ECB issues, the ECB could come to the Executive Board as an observer. I would certainly also see the ECB sitting at Interim Committee meetings in some capacity, but these are issues that have not yet been decided.
MR. ARTUS: On surveillance, we have had already a lot of discussions on how it could possibly be organized. In the case of the ECB, it's very clear that we will need to have regular missions to the ECB to discuss monetary policy. In fact, the surveillance of member countries will have to be done in a framework that takes into account those discussions with the ECB on euro-wide monetary policy.
Whether these discussions will take place once a year or twice a year, it's still very difficult to say. The important issue, of course, is, When European monetary policy is discussed by the Board of the Fund, should a representative of the ECB participate in the discussion or should the Executive Directors of European countries speak for the ECB? Those are issues that of course, have not yet been settled.
As far as fiscal policy is concerned, to the extent that an excessive deficit procedure will be implemented at the EU level, there will also need to be frequent discussions between the staff of the Fund and the staff of the European institutions.
So all of these things are under discussion. It's a little bit premature to examine them too closely at this stage because everybody is focused for obvious reasons on the beginning of EMU, and not so much on how it's going to work once it has started. But the discussions have started.
Similarly, we have just started discussing the implications of a European currency for operational activities in the Fund itself. What is the implication for the definition of the special drawing rights (SDR), for example? What about the use of currencies by the Fund? What does the concept of balance of payments mean for member countries, say Spain or France or Italy, once they are part of a monetary union? How do you define the balance of payments in such a situation? Many of our operations in the Fund use this concept of balance of payments.
For example, to use Fund resources itself depends on balance of payments need; how do you define balance of payments need? Under which conditions could a member country of EMU use Fund resources, and to do what?
So, all those discussions have started. They have started only over the past few months, however, and they will have to go on. We are still at a very early stage.
MR. RUSSO: Let me just add that these discussions have already taken place within the EU itself. A paper has just been issued by the European Commission dealing with the same aspects of EMU that bear on this issue. These discussions are going on simultaneously in the Monetary Committee of the EU and among the Board of Governors of the EMI.
QUESTION: Could I have just one clarification? Currently, each member of the Fund is entitled to the use of resources in case of need. Now, if the ECB is, in cooperation with the Economic and Financial Council (ECOFIN), in charge of maintaining an orderly exchange rate for the euro vis-à-vis the rest of the world, and if there is an attack on the euro, for instance, or a balance of payments deficit arising within the EMU region, would then the Fund be prepared to grant resources to the ECB in order to defend the euro? Has that issue been addressed?
MR. RUSSO: The Fund can and will lend resources only to a member country, but then the member can turn around and give those resources to the ECB to defend the currency, if it wished to.
As you know, even now, according to the rules that are being discussed within the ECB, exchange rate interventions can be performed by the national central banks. So there would be no objection if three, four, or five members of EMU--or the entire membership--came to the Fund to borrow. The Fund could lend to each national central bank and then the national central bank could use that currency for exchange rate intervention.
We could also lend to one country, if there were a need, as we lend to other members of the monetary unions that are part of the system now.
QUESTION: I was wondering whether there's any work going on in the Fund or maybe the World Bank on the effect of the introduction of the euro on developing countries. I don't mean so much the consequences in terms of more austerity and therefore increases in aid programs, for instance, but rather the effect of the introduction of the euro on the CFA franc, as the euro will replace the French franc vis-à-vis the CFA franc countries. Also, what about the effect of the euro on southern African countries that do not have a relationship with European currencies?
MR. ARTUS: First, to be quite specific, the CFA franc zone is based on an agreement between those countries and the French Treasury, and, therefore, it will not really be impacted at all by the introduction of an European currency. It's not the Bank of France that defends the CFA franc system; it is the French Treasury.
To take your broad question, which is more interesting, I think that once an European currency is established, there will be an incentive and an advantage for a number of countries, including many countries in the Middle East and North Africa, to develop preferential trade relations with Europe, and also to move closer to an European zone as far as exchange rates are concerned.
So there will probably be, over time, an incentive for many of those countries to peg their currencies to or follow closely the euro, to the extent, of course, that the euro will be a stable currency and that they will benefit from it in the same way that countries may have benefited--we were speaking, for example, of Croatia--in the past from pegging their currencies to or closely following the deutsche mark. But, obviously, a much larger zone will be involved.
We have started doing some work on the economic impact of the introduction of the euro on various groups of developing countries, but also and mainly, I must say, we have been focusing on Eastern European countries. These are topics on which we are going to issue various papers in forthcoming months, and I'm sure we won't be the only ones. But I would stress that, at least at first, we will look more closely into the implications for Eastern Europe than for the developing countries.
QUESTION: Will conversion of the debt, which is denominated now in the European currencies, into euros have an effect?
MR. ARTUS: Whether this conversion will have an effect depends on whether the real exchange rate of the euro behaves in a way that is different from the real exchange rates of the currencies in which the debt is currently denominated. This, of course, nobody can say. It's impossible to say whether the euro will have a tendency to appreciate more or less than the deutsche mark or the French franc.
The effect will also depend on whether the real interest rate on the euro will be higher or lower than the interest rates on the currencies in which the debt is now denominated. Again, nobody can tell ahead of time, but, yes, this conversion may have implications that cannot yet be forecast.
QUESTION: I wanted to go back to the speculation issue. Mr. Russo, you elaborated on the second period in which turbulence may arise; on the first period, you said simply that it's important that convergence toward the deficit criterion and things of that sort continue. Do you really think it's enough, or do you envisage a more active role to combat the possible speculation in Europe?
MR. RUSSO: If policies--and the fundamentals reflected in those policies--do not indicate that a country is converging toward the Maastricht criteria, I don't see what can be done. We have seen several episodes in Europe since September 1992 when markets have overwhelmed the defenses of the central banks, and I think that central banks in Europe have learned from these experiences and they are not going to repeat them again--and certainly not in this coming period.
I think that the best assurances against speculative attacks by the market are to not give any reason for those attacks to start and, therefore, to implement the measures that will permit convergence to be achieved and participation ensured. I don't see any gimmicks that can be adopted in the meantime to attain those objectives.
Clearly, the wide margins provide flexibility and temporary defenses, but they cannot be used for long periods because then they would put into the question the central rates, which presumably will be the rates that will be locked in when the euro is created.
Let me again emphasize that we judge the process of convergence as proceeding well and as being very close to achieving the target. I think that the big noise that has been made recently, in particular in the Italian press, about differences of tenths of a percent in fiscal deficit ratios is just noise.
QUESTION: Just to follow up on that, I wonder whether you could give us some more details on your 1998 forecast of fiscal deficit ratios for France and Italy, which I think are 3.4 percent for France and 4.1 percent for Italy. Could you first tell us a bit more about how you arrived at those figures, and second, given the trend in the Italian deficit for 1998, do you think that Italy really does have a serious chance of getting into EMU in the first wave?
MR. ARTUS: Well, I will start with France. In the case of France--as for all countries--we estimate the budget deficit on the basis of the policy measures that have already been adopted. Therefore, if now in the spring of 1997 we make an estimate for France for 1997 and for 1998, we will not take into account any new measures that the authorities might adopt either in the summer of 1997 or in the budget for 1998. Naturally, the budget for 1998 will incorporate new measures, but we don't know what these new measures will be. Therefore, it would not make sense for us to take into account measures that have not yet been decided.
Now, in the case of France, this is very important. Why? Because in 1997, the deficit is smaller by a significant amount because of the transfer with France Télécom, which is, of course, a once-and-for-all measure. Obviously, it will not take place again in 1998.
Therefore, making projections for 1998 without including the transfer for France Télécom and assuming no new measures whatsoever produces a large deficit, one that is significantly above 3 percent.
These calculations do not in any way imply that such a deficit will be recorded. The French authorities, in fact, have already announced that there will be a freeze on government expenditure in nominal terms. This has not been taken into account in our projections because, for the time being, it's only an objective as far as we are concerned.
Once the French authorities announce the 1998 budget and we know what cuts will be made to implement this freeze, then we will take it into account, but not one day before. What I'm explaining for France holds true for all countries; and this is why, at any point in time, we project for many countries deficits that are somewhat in excess of the objective.
In the case of France, this implies simply that the authorities will have to take more measures to achieve the 1998 target, but we believe that the amount of action needed is relatively small.
Of course, the authorities are fully aware of this, which is why the freeze on expenditure has already been announced.
MR. RUSSO: The same applies to Italy. The measures that have just been adopted in March in the context of the budget for 1997 are effective only for 1997. As these measures will not have effect in 1998, the deficit will automatically go up, and there is also the spending dynamic that I mentioned before to take into account.
But between now and then, the 1998 budget will have to be adopted, and there is time to adopt the measures that would bring the deficit in 1998 to below 3 percent.
This is why the European governments have agreed that, when they meet in the spring of 1998, they will take a decision on the basis of not only the results for 1997 but also the budget for 1998, taking into account both their original 1998 estimates and what has been implemented in the meantime. There will be four months in which those countries that met the requirement in 1997 with temporary measures can adopt additional measures, with a view to sustaining their progress in reducing the deficit beyond 1997.
QUESTION: The public debate on the fiscal criteria has focused very much on the deficit criterion, just as if this were the only one that has to be met--in other words, once you meet that, you're in. Public debate has largely neglected the other fiscal criterion, namely, the debt level criterion, which specifies 60 percent as a maximum public debt ratio.
Of course, there is room for interpretation of this criterion, but look, for example, at Belgium. The debt ratio there is twice as high as the ceiling. I wonder what kind of creative accounting will be used to get around this problem? Even Germany, which meets the 3 percent fiscal deficit criterion, has a public debt ratio that will be above 60 percent and is moving the wrong way. With Belgium, you could argue that the ratio is going down from its current ridiculously high level. But in Germany, the ratio is even going the wrong way. I wonder how this is going to be handled.
MR. ARTUS: I am absolutely sure that the debt criterion will very much be taken into account, but it has never been envisaged--nor does it make any sense--to interpret the debt criterion as meaning that if you are below 60 percent, you make it, but if you are above 60 percent, you don't make it. This is not a question of flexibility.
Right from the beginning, it was known that a number of countries, including Belgium, would not be below the 60 percent ceiling. There was no way it could be done. So the interpretation of the criterion from the beginning has always stressed that either a country should be below the 60 percent ceiling, or if it were not, that its ratio of debt to GDP should be declining at an acceptable rate. So the concept is more like this: How much progress is being made in reducing the debt ratio in cases where the ratio is 60 percent?
Ireland presents a clear-cut case. In the case of Ireland, the debt-to-GDP ratio is clearly above 60 percent, but the country has made and continues to make tremendous progress in reducing this ratio. Therefore, it has already been agreed that Ireland does not have an excessive deficit. This is, I repeat, a clear-cut example.
Now, there are more difficult cases to consider, such as Germany's. In the case of Germany, the debt ratio is slightly above 60 percent, but it is rising marginally. However, as specified in the Maastricht Treaty, exceptional circumstances can be taken into account. In the case of Germany, the exceptional circumstance was German unification and in that connection the transfer of debt from the Treuhandanstalt to the German government.
Now, it's not for me to tell you how the heads of the governments will look at it, but, clearly, the ratio of debt in Germany is only marginally above 60 percent. If you ask me as an economist whether the strength of the euro will depend on whether the debt ratio of Germany is 61 percent or 62 percent or 58 percent, I would have to say no: nobody would look at the possible impact of such small changes in the ratio on the strength of the euro.
The issue ultimately is whether there is a risk faced by the other member countries of EMU if one member has a problem servicing its public debt. Is there a risk of a bailout? This was initially and still is today the main concern behind the establishment of the debt-to-GDP ratio as a criterion.
QUESTION: Commenting on the World Economic Outlook the other day, Mr. Mussa, Director of the IMF's Research Department, said that monetary policy in Europe seems to be accommodating enough. However, there are some countries where the drop in inflation has created fairly high real interest rates. One such case is Italy, of course.
Do you look at high real interest rates as one of the possible hindrances to reaching faster growth, and therefore, achieving the Maastricht criteria, and do you see any room for lowering interest rates in these countries?
I was also wondering about the possible exchange rate turbulence. You mentioned that there are several solutions that have been put forward for fixing the parities. I was wondering whether you are personally in favor of bringing forward the date for fixing the parities in order to avoid turbulence.
MR. RUSSO: I agree with what Mr. Mussa said at his press conference, namely, for those countries whose exchange rates are very close to the deutsche mark and whose interest rates are very much a function of Germany's interest rates, monetary policy is accommodating. I think Mr. Mussa said there perhaps had been a window of opportunity in the past to have somewhat lower rates, but that the question did not arise now, given the forecasts for this group of countries and the recent information that we have, particularly from France and Germany.
Again, the situation of Italy is a bit different. In Italy, inflation has been reduced considerably, in fact, more than anybody, including the IMF, expected. This is in no small measure due to the wage behavior and the wage agreements, but also to the policy of the Bank of Italy, which has sought to establish its anti-inflation credentials in a very short period of time. This has resulted in a relatively tight monetary policy.
I am confident that, as the latest information on inflation confirms the major decline, the central bank will take this into account in deciding the short-term rates. Medium- and long-term rates in Italy have already declined significantly with the increasing credibility of Italy's inflation performance and its possible participation in EMU.
So when will it be appropriate for the central bank to act? Very frankly, this is a decision that we should leave to the central bank. It has the information and we do not.
There is another element in the picture now, which is that Italy has rejoined the ERM. Therefore, exchange rate developments will also have to be an important consideration in deciding what and when and how much to reduce or otherwise change the interest rate.
MR. ARTUS: On the second part of the question, on whether the fixing of the exchange rates should be brought forward, if you look at it from an extreme point of view, it cannot be done, namely, either you have one currency or you don't. One currency, one central bank, one exchange rate--it all goes together, and that's what takes place at the beginning of 1999. It does not take place in the spring of 1998, when membership in EMU is being decided.
However, there is a very important issue at stake here. There is, indeed, a risk that instability will arise between the date that the composition of EMU is decided and the date on which the membership has only one currency and one monetary policy.
How to handle this? It's quite likely that, at the time when the member countries are decided, the methodology for locking in each currency's exchange rate will also be decided.
Various methodologies have been discussed. One possible technique is to use some kind of moving average of the exchange rates: this is a proposal made by Mr. Lamfalussy, President of the EMI. It's also possible to announce on the first day that the central rate will be used. Various other alternatives are being considered right now.
But, yes, it probably will be, in my view, extremely useful to give in advance information to the market on how the rates will be fixed rather than leave the market without any information whatsoever.
The announcement of the methodology will then have direct implications for the degree of monetary cooperation among the member countries, even before the establishment of one monetary policy. However, it's very hard to believe that a number of countries will decide to form a monetary union in January 1999 without coordinating closely their monetary policies in the final six months of 1998. It is just unthinkable.
So it's very clear that, from a practical standpoint, coordination is going to become very close once a decision on participation has been made; it's also clear that there is not going to be a complete break in the system on January 1, 1999.
QUESTION: Two questions. First, do you think there should be a system of automatic economic stabilization among EMU member countries, as in the United States? Second, could the ultimate consequence for the IMF be that it has to be moved to Europe because of the introduction of EMU?
MR. RUSSO: Let me answer very quickly the last question. As I mentioned, the members of the IMF are the countries, so there will not be a unified quota for Europe to prompt that question. Even if a quota were set for EMU members as a group, that quota would be less than the sum of the quotas of the individual countries because trade between EMU members would disappear.
The size of this hypothetical quota would depend on how many countries join EMU in Stage III. But, as I said before, I don't think that this is an issue to be addressed in the foreseeable future.
As for the other question, there has been a lot of discussion about the need for a central fiscal policy in Europe, and comparisons have been made in that respect between Europe and the United States. There are, in particular, two comparisons that would indicate that the United States is better able to cope with its own monetary union of 50 states. One is labor mobility and labor flexibility, and the other is the central role of the federal government in deploying automatic stabilizers.
In Europe, the situation is different in both respects. First, there is no federal government with a large budget. But the member governments have large budgets, much larger than any of the states of the United States, per se. Therefore, these member governments would play a much larger stabilization role in their own areas than is possible for even California or Texas to play in the United States.
Labor mobility is more important. Labor mobility, because of language and tradition and culture, will be much lower in Europe than in the United States. That's a fact. But there is another issue that we have not touched on so far that is very important: the question of labor market flexibility in EMU.
Clearly, for EMU to function, much more flexible labor markets will be needed within each country and among countries because exchange rates will no longer serve as shock absorbers: shocks will have to be absorbed another way. Relative price movements will have to take place through movements in wages, and this is not possible now with the degree of rigidity that still exists in the labor markets of Europe.
So another condition for convergence and the successful implementation of EMU is much greater labor market flexibility in Europe, keeping in mind that Europe has different social preferences than the United States.
MR. ARTUS: I don't really have much to add. I think that, as far as stabilization is concerned, it's pretty clear that national budgets will be the key variable, which is why countries in the first place need to aim at very low budget deficits over the average of the cycle. By doing this, when there is a phase of weak economic activity, governments can take some measures to support economic activity. If there are already large budget deficits before the recession, there is obviously no room to take such measures.
The second point to be emphasized in this context is labor flexibility. It's not so much a question of expecting that Frenchmen are going to move to Germany or Germans to France, depending on the economic cycle. It's more a question of establishing flexible wage rates across countries and across industries.
This issue is not very different from the ones that we face today at the individual country level. It's pretty much the issue of labor mobility in Belgium between the two parts of Belgium or in Italy between the two parts of Italy.
Another factor that people don't usually focus on is that in many cases the lack of stability is present in the first place because of monetary policies that may have been followed, including by the central banks at the level of the member countries. That source of instability will, by definition, disappear, and this will not be a negligible change.
QUESTION: Just before the exchange rates will be fixed or locked in, as you say, to the euro, it is imaginable there will be a lot of volatility in financial markets, a kind of last attempt to make speculative profits. Do you see that as a real danger? And second, has there been any discussion of mechanisms or regulations to curb such a last attempt on speculation?
Several techniques or methodologies have been proposed, but it's not clear to me what extent you see this as a real danger and whether there has been such a discussion on mechanisms.
MR ARTUS: I don't think it's going to happen this way at all, but if you had a situation in which membership in EMU is decided in May 1998 but the market is told that it won't find out how exchange rates will be locked in before
January 1, 1999, then the risk of speculation would certainly not be negligible. This is obvious. Why? Because, as in the case of German unification, the choice of the exchange rate and the sustainability of that rate in the market will no longer depend on economic considerations.
The exchange rate between the French franc and the deutsche mark will no longer depend on the expected inflation rate in France and Germany in 1999 or the year 2000. It will be irrelevant. It will not depend on what is expected to happen to the balance of payments of France or Germany. It will not depend on what is expected to be German monetary policy or French monetary policy. All the economic factors that normally influence how markets determine the exchange rate will by definition disappear. Therefore, a tremendous amount of uncertainty about the exchange rate will be generated because, within a certain margin, the authorities can choose any exchange rate they want.
Now, this is potentially a source of instability. However, everybody knows this, which is why it's not going to happen. At the time that the membership of EMU is decided--but probably not before--information will be provided to the market on the approach to be followed by the member countries in locking in the exchange rate. It's only a question of exactly which methodology will be followed.
One possibility is to announce at that time that there really is no reason for the locked-in rate to deviate from the central rates.
Another possibility will be to lock in the exchange rate on the basis of the average of the actual market rates in the preceding period. Various methodologies can be used, but some announcement will have to be provided. The market cannot be left without information. It cannot be told that it will be a political decision, and that it will find out on January 1, 1999. Chaos would result.
MR. ANJARIA: Thank you very much.
[Transcript prepared from a tape recording.]
