It gives me great pleasure to be able to present to the European Parliament the 1997 Annual Report of the European Monetary Institute (EMI). This was the fourth, and last, such publication by the EMI before it made way for the European Central Bank (ECB), which was established on 1 June 1998. I want to take this opportunity to review the preparations for European Economic and Monetary Union (EMU) leading up to the start of Stage Three on 1 January next year.
Preparatory work for Stage Three proceeded as planned in 1997. Since the start of 1994 the EMI, in close collaboration with the national central banks of the European Union, has undertaken the necessary technical preparations for the establishment of the European System of Central Banks (ESCB), the conduct of the single monetary policy and the creation of the single currency. These tasks will be completed by its successor, the ECB. Increasingly, the work undertaken has been of a more technical nature as the various preparations have drawn closer to completion. As in past years, the Annual Report described the activities of the EMI in a broad range of areas. Let me highlight the following:
The EMI published a report on monetary policy strategy in February 1997, identifying two potential strategies for Stage Three: intermediate monetary targeting and direct inflation targeting. However, it also highlighted that, irrespective of the final choice, there was a need for a clear definition of the objective of price stability and for specific targets against which the performance of the ESCB could be assessed; for a broad range of indicator variables to help assess risks to price stability (with a prominent role assigned to monetary aggregates); and for various tools for forecasting inflation and other key variables. Following this report, the EMI concentrated on developing the infrastructure necessary to support monetary policy decision-making, including developing a number of econometric tools for preparing policy decisions, such as an area-wide macroeconomic model and, in conjunction with national central banks (NCBs), a multi-country model.
The conceptual phase of preparatory work dealing with monetary policy instruments and procedures was concluded at the end of 1996, leading to publication in January 1997 of the so-called Framework Report (the full title is "The single monetary policy in Stage Three – specification of the operational framework"). The first half of 1997 was then devoted to defining the technical specifications for the ESCB’s operational framework, enabling the publication in September 1997 of a further report, entitled "The single monetary policy in Stage Three – General documentation on ESCB monetary policy instruments and procedures". Progress in terms of the technical features of monetary policy operation in 1997 related mainly to the procedures, time frame and calendar for ESCB tenders; to the settlement modalities of open market operations; and to the implications of the end-of-day procedures for the use of standing facilities. The EMI also carried out other preparatory work in this field, such as that on minimum reserve requirements, defining common eligibility criteria for monetary policy counterparties and eligible assets and setting up an effective liquidity management system.
In the area of foreign exchange policy, the European Council meeting in Amsterdam in June last year approved a resolution relating to the new exchange rate mechanism to be introduced in Stage Three, ERM II. The EMI finalised a draft agreement between the ECB and future non-euro area NCBs setting out the operating procedure, to be submitted to the ECB for endorsement. It continued work on the technical infrastructure to enable the system to operate from 1 January 1999. Implementation work was conducted to enable the ECB to execute foreign exchange intervention, focusing on the operational framework and information systems support. Likewise, work has been undertaken on transferring foreign reserve assets to the ECB at the start of Stage Three. Two draft proposals for a monitoring framework were prepared by the EMI; one on operations conducted by NCBs and another on transactions made by Member States. The EMI also conducted work on procedures for the computation and publication of reference exchange rates for the euro. And, as you will recall, it was possible in May of this year, following a decision by the European Council in Luxembourg last December, to pre-announce the bilateral rates of the currencies participating in the euro area.
As regards statistical preparations, work has focused on implementing and making more detailed the wide-ranging statistical requirements for Stage Three. For example, in 1997 the EMI published a provisional list (subsequently revised) of institutions forming the Monetary and Financial Institutions (MFI) sector; an addendum was released in December covering money market funds. It also published documents on money and banking and balance of payments statistics and work has begun with EUROSTAT on quarterly financial accounts.
In the field of payment systems, in September 1997 the EMI released a "Second progress report" on TARGET, addressing issues such as the operating time, pricing policies, provision of intraday liquidity to non-euro area NCBs and the role of the ECB in TARGET. Testing and implementation of TARGET is under way to enable this to be fully operational by late December. Both static and dynamic testing, and multilateral tests, have been completed and simulation tests are now being conducted under conditions as close to the future live environment as possible. In addition, the standards and underlying analysis for the use of Securities Settlements Systems were published in early January.
Preparation of euro banknotes has continued. In the course of 1997 final designs were developed from the draft designs which were chosen by the EMI Council in December 1996. Illustrations of the revised designs were published in July 1997. These designs have been transformed into printing plates in the first half of 1998. In order to ensure a smooth production of the euro banknotes, prototypes of the euro banknotes were manufactured in 1997 by eight different paper mills and ten different printing works. This project revealed that all the participating printing works should be in a position to produce all the euro banknote denominations to an equal standard of quality and with an identical appearance. Mass production of the euro banknotes will start in early 1999.
Finally, the EMI was actively involved in 1997 with other aspects of the changeover to the euro. To cite just a few examples, the EMI met with representatives of EU-wide banking and financial associations to discuss issues such as the replacement in contracts of price references that may lose their significance after the start of Stage Three and the replacement of existing interbank rates. Following encouragement given by the EMI to banking associations and money and foreign exchange markets to engage in the collective definition of euro area indicators, the Banking Federation of the European Union and the Financial Markets Association (the professional association of foreign exchange market dealers) announced the intention to compute and publish a euro area-wide indicator of interbank rates, to be called EURIBOR.
The initial composition of the euro area from 1 January 1999 onwards was decided in early May. The Annual Report briefly described the main characteristics of the euro area, based on available information.
There is still much work to be done in the remaining six months or so before the start of Stage Three. I began today by recalling that the establishment of the ECB and the ESCB took place barely six weeks ago, on 1 June 1998. Since then, we have been busy carrying forward the preparations for Stage Three. Both the General Council and the Governing Council have met, the latter twice.
In its meetings so far, the ECB has been concerned with many organisational issues, such as the allocation by the Executive Board of responsibilities among its members and giving us a new structure which suits the tasks of the ECB. It has, for example, agreed on the Rules of Procedure of the ECB, which will be published in the Official Journal of the European Communities. And it has approved the establishment of eleven ESCB committees to assist in the work of the ECB.
In terms of the preparatory work, at its first meeting the Governing Council agreed on the method to be applied for determining the NCBs’ percentage shares in the key for the ECB’s capital and the measures necessary for the paying up of the capital of the ECB. As a result, the ECB was endowed with an initial capital of slightly under EUR 4 billion at the start of July. The Governing Council also agreed on the framework for the organisation of the overall testing of ESCB-wide systems and procedures which will be conducted in the remaining six months before 1 January 1999. It also dealt with two specific issues relating to preparations for Stage Three: relating to TARGET and euro banknotes. On the former, a pricing policy was agreed. The main element of this is that a degressive tariff will be applied to payment transactions flowing through this system. Concerning the latter, it has been agreed that the initial supply of banknotes for the euro area should be produced largely following a decentralised approach, i.e. each of the eleven participating NCBs will be able to organise the production of euro banknotes needed to replace their national banknotes, either producing the relevant banknotes themselves or entering into bilateral pooling arrangements.
The second meeting of the Governing Council took place on Tuesday last week. The Governing Council decided on the introduction of a minimum reserve system. Among the functions that such a system can usefully perform, the contribution that it can make to stabilising money market interest rates and increasing the demand for central bank money by creating or enlarging a structural liquidity shortage in the market was considered by the Council to be particularly important. However, the Council also considered very carefully the implications of such a system for the banking sector. With this in mind, it decided that the minimum reserve holdings would be remunerated at a level corresponding to the rate of its main refinancing operations. The exact specification of the minimum reserve system, including the reserve ratio (which is currently defined within a range of 1.5-2.5%), will be decided by November 1998 at the latest.
A decision was also taken on the size and form of the initial transfer of foreign reserve assets to the ECB from participating NCBs. Without going into the details, the transfer amounts to around EUR 39.5 billion. The conditions for participation of non-euro area EU central banks and credit institutions in the TARGET (Trans-European Automated Real-time Gross settlement Express Transfer) system were also decided, taking into account the risks to the conduct of monetary policy that giving unlimited access to intraday credit to such institutions outside the euro area could bring. Therefore, non-euro area EU central banks will be able to provide collateralised intraday credit in euro to their credit institutions, but subject to a ceiling both at the level of the non-euro area EU central banks and at that of non-euro area credit institutions. There will also be a liquidity deadline, set at 5 p.m., for non-euro area credit institutions so that they do not incur an overnight overdraft in euro. The Council agreed on a number of legal instruments aimed at enhancing the protection of euro banknotes.
Finally, the Governing Council has adopted a number of ECB Recommendations for EU Council Regulations concerning the collection of statistical information by the ECB, the application of minimum reserves, and the powers of the ECB to impose sanctions. I would like to draw your attention to the Recommendation on statistics. This is of particular importance to the ECB because it will need to base its decisions on euro area-wide statistics, particularly, in this context, monetary and balance of payments statistics, which will be provided under this framework legislation. An ECB Regulation specifying in detail the actual reporting population and the statistical information which reporting institutions will be required to provide cannot be issued until the Council Regulation is enacted. These requirements have already been discussed over a considerable period of time, but a legal instrument will provide the necessary certainty to those who must meet them. There will be an opportunity for the ECOFIN Council to adopt the relevant text at its meeting in October. This would mean that we would appreciate it if the European Parliament could deliver an Opinion in the course of September.
To conclude, in my view, the thorough technical preparation carried out by the EMI during 1997, and in earlier years, enables us to look forward with confidence to the introduction of the single currency at the beginning of next year. This preparatory work is now being brought to completion by the ECB and the ESCB. However, the solid foundations which have been laid by the EMI should help the ECB and the ESCB to develop into a credible and powerful institution which will pursue its primary objective of maintaining price stability in the euro area in a determined manner. This, in turn, will provide the conditions necessary for sustained economic growth. The improvement in the economic situation in the EU seen last year, and which is expected to continue in 1998, may be considered to provide a very satisfactory starting-point for Monetary Union. However, Member States’ fiscal policies now need to be geared towards achieving the medium-term requirements of the Stability and Growth Pact as soon as possible. The benchmark for fiscal policies is clearly to achieve a budget which is in balance or in surplus – a surplus is needed especially for those countries with high debt to GDP ratios.
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