The euro area in the world economy - Developments in the first three years
In this Communication, the Commission takes stock of the first three years of economic and monetary union (EMU) and of the euro area in the global economic environment.
Commission communication "The euro area in the world economy - Developments in the first three years" [COM(2002) 332 final - Not published in the Official Journal].
The third stage of economic and monetary union (EMU) started on 1 January 1999. Three years later, the euro became a tangible reality as notes and coins were put into circulation. Completion of EMU is an historic event with repercussions that are profoundly re-shaping the economies of the Member States of the euro area.
Economic growth. After growing by an average of 3% during the first two years of EMU, the euro-area economy slowed down briefly in 2001 as a result of a number of factors including the hike in oil prices, the bursting of the speculative bubble on share markets and the events of 11 September.
Labour market. The situation on the labour market has improved in the last three years of the single currency. Some 6 million jobs have been created and this trend has even continued during the economic slowdown. The unemployment rate in the euro area fell to 8.3% in 2001 under the impact of structural reforms, wage restraint and economic growth.
Inflation. With inflation running at a subdued level of 1.1% in 1999, consumer prices rose, touching 2.5% in 2001 as a result of the hike in oil prices and the weakness of the euro against the US dollar. The increase in food prices caused by the BSE scare and the outbreak of foot-and-mouth disease contributed to this development.
Exchange rate. Following its launch on 1 January 1999, the euro fell by more than 20% against the US dollar but then regained some 10%. It is perceived as being under-valued. This has placed the euro-area economy in a strong position vis-à-vis its competitors, as the rise in exports and its positive contribution to gross domestic product (GDP) show.
Current-account balance and competitiveness. The euro-area's current-account balance continued to improve in 2001 to show a small surplus. The competitiveness situation varies between Member States: in the first three years of EMU, Germany, Greece and Austria saw an improvement. Fiscal policy and structural reforms remain the only ways of preventing problems relating to competitiveness and the current-account balance from accumulating.
Stability and Growth Pact. The Stability and Growth Pact sets the objective of public finance consolidation. The Member States have committed themselves to achieving budget surpluses by 2004. After 1999 the improvement in budgetary positions lost some momentum and the euro area's budget deficit actually increased in 2001. There are still two main challenges on the fiscal policy front: eliminating fiscal imbalances in order to cope with normal cyclical fluctuations and preparing European countries for population ageing by reducing societies' aggregate level of indebtedness.
Monetary policy. Monetary policy is now entrusted to the European Central Bank (ECB), whose primary objective, laid down by the Treaty, is price stability. According to the ECB, this stability is achieved when inflation remains below 2%. Monetary policy is based on two pillars: The first is money supply, with M3 being set at 4.5% by the ECB, while the second comprises numerous economic indicators such as cost and price indices, the exchange rate and real-economy indicators.
Interest rates. The ECB raised interest rates on several occasions in 2000 and 2001 on account of the inflationary pressures engendered by the hike in oil prices and the euro's depreciation against the dollar. However, following developments in the world economy in 2001 and in the aftermath of 11 September, the ECB reacted quickly and lowered interest rates.
Economic policy coordination. The central element of economic policy coordination is the broad economic policy guidelines (BEPGs), which are the annual guidelines addressed to Member States by the Council of Ministers. They provide guidance with regard to both the macroeconomic and the structural spheres. The objective is to improve the EU's economic growth potential and productivity.
The Eurogroup. The euro area has set up another coordination forum, the Eurogroup, which brings together the economics and finance ministers of the Member States that have adopted the euro. Their informal meetings take place on the eve of meetings within the Council of Ministers ("Ecofin") and allow a frank discussion of EMU-related issues.
EMU makes more evident the link between wage and employment trends. A loss of competitiveness is inevitable where the option of an exchange-rate adjustment is no longer available. Wage developments in one country in the euro area have repercussions on the area as a whole, notably via the inflation risk. The single currency increases price transparency and facilitates comparisons that may lead to "wage imitation".
Aggregate wage developments. The fight against inflation in Europe has affected wages as wage increases are indexed to prices. The dispersion of wage growth between countries has also diminished significantly over the past decade, but it is still pronounced, and this may be justified by different productivity levels.
Unemployment rate. Despite a marked reduction in unemployment in recent years, there are few signs of a significant re-acceleration of labour cost growth in the euro area. Real wage moderation has prevailed in almost all countries of the euro area. This has borne fruit and contributed to the dynamism in job creation. The unemployment rate has fallen from 11.5% to 8.5%. The bulk of this improvement is due to a decline in structural unemployment. It is to be noted that all the major economies of the euro area still have relatively high structural unemployment.
Social pacts. In a number of countries social pacts have helped create a favourable climate by setting in train negotiations between the public authorities and the social partners, thereby helping to sustain wage moderation. The risk of conflict between companies and their workforces is much lower. Wage flexibility has become more important for the smooth functioning of EMU. Differentiated agreements or some measure of decentralisation, e.g. in the form of "opening clauses", which take account of regional conditions or the conditions in the sector concerned or in the company concerned, have increased this flexibility.
Investment potential. The euro has clearly boosted investment potential in the euro area. First, it has eliminated the exchange-rate risk between twelve markets and has fostered competition within this integrated market. Second, financing conditions for firms have improved thanks to the faster integration of financial markets. EMU should also act as a catalyst for structural reforms in Member States, in particular on labour markets. Lastly, it has had a positive effect on interest rates via the policy of consolidating public finances.
Public and private investment. As a result of the privatisation policies pursued in the 1990s, the share of public investment in GDP has declined continuously. By contrast, business investment, in particular in information and communication technologies (ITC), has risen in recent years. The variation of investment rates between countries has been reduced considerably in the last ten years, suggesting convergence between the countries of the euro area. Since 1999, however, dispersion in investment rates has increased slightly, to some extent on account of more buoyant investment in the countries catching up.
Foreign direct investment. Foreign direct investment (FDI) was facilitated throughout the 1990s by the removal of numerous barriers as part of the process of European integration. Introduction of the euro furthered this development by eliminating exchange-rate variability and risks. Flows of FDI from and to the euro area have increased significantly, largely on account of the global expansion of firms and the associated mergers and acquisitions.
Effects of EMU. Exchange-rate volatility is a thing of the past. Thanks to policies of budgetary consolidation, short-term and long-term interest rates have been reduced. Financial, labour and product markets are expected to become even more flexible, enabling the euro area to improve investment conditions. A link exists between restrictive regulations and a poor investment rate. The euro area could, therefore, make the most of the opportunities afforded by EMU. Higher investment leads to enhanced growth potential in the euro area. This is particularly important if the adverse effects on long-term growth, such as the demographic outlook, are taken into account.
Overall developments. There has been a visible acceleration in the integration of financial markets in the wake of globalisation but also following the creation of a common regulatory framework and the changeover to the euro. The financial sector is experiencing a phase of rapid structural change, with integration being accompanied by general expansion and heightened competition. The exchange rate risk has disappeared, as have the costs resulting from fragmentation of the system. Market liberalisation and the introduction of the euro should facilitate business financing via calls on capital markets rather than bank financing.
Money markets. Market integration varies between segments. In the market for interbank deposits integration is virtually complete and the derivatives market is highly integrated. Against this, the secured money-market segments (private repurchase agreements, treasury bills, commercial paper and certificates of deposit, for example) remain less integrated. This state of affairs largely reflects the continuing differences between Member States' legislation. The Collateral Directive should improve this situation.
Bond markets. With the introduction of the euro, domestic bond markets have become integrated, resulting in a substantially more homogeneous euro-denominated bond market. Greater liquidity has been reflected in higher issuance volumes. Private-sector issuance has risen sharply to the detriment of sovereign issuance as a result of the policy of fiscal retrenchment. The growing number of mergers and acquisitions as well as UMTS auctions, often financed by bond issues, have contributed to the expansion of this segment of the financial market.
Government bonds. Sovereign issuance still accounts for some 40% of total issuance. There has been marked convergence in yields between Member States. Liquidity on this market is still, however, limited as government bonds are issued by twelve separate agencies with different issuance, strategies, procedures and instruments. Overall, the euro has emerged as the second most important currency for international bond issuance, after the US dollar.
Equity markets. The introduction of the euro has stimulated demand for cross-border equity investment in euros. Investors appear to be moving increasingly towards sector-based investments, to the detriment of purely country-based investments. The changeover to the euro has also been a factor in stimulating activity in the new-economy stock markets. The response of stock exchanges in Europe to European integration has been to adopt regrouping and merger strategies.
Venture capital. Venture capital often plays a key role in the initial stages of the lifecycle of a firm. The European Union has attempted to improve access to such financing for firms, including via the Risk Capital Action Plan (RCAP). European risk capital markets remain fragmented, with the bulk of investment being undertaken domestically. This partly reflects the continuing differences in regulatory, tax and legal infrastructures in the Member States. The bursting of the stock market bubble for technological companies led to a significant fall in venture capital investment.
Financial services. The market in Europe for corporate financial services is increasingly open to global competition. Banks have responded by restructuring and reorienting activities away from traditional bank lending towards "investment banking"-style activities, which consist in creating and selling new financial products, advising clients or structuring mergers and acquisitions. Consolidation has taken place mainly within national boundaries, where there has been an increase in industry concentration. Legal differences make a pan-European product range impractical at present.
The challenges ahead. The euro is one of the main factors in speeding up integration. Financial market integration has not yet been completed and must be continued in order to take advantage of the opportunities offered by integration. Savers and investors would benefit from broader choices at lower transaction costs. This translates into higher productivity and, consequently, higher economic growth. This is why successive European Council meetings have established the integration of financial markets as a priority of economic reform. The Financial Services Action Plan (FCAP), a package of 42 initiatives, should be implemented between now and 2005. The date for implementation of the Risk Capital Action Plan (RCAP) has been set for 2003.
THE EURO AS AN INTERNATIONAL CURRENCY
The US dollar is still the leading international currency, but the euro has become the world's second most important currency thanks to the size of the euro-area economy and to its stability, which reflects sound economic fundamentals.
International use. Prior to the introduction of euro notes and coins in 2002, the share of the euro in the invoicing of international transactions was estimated to be between 15% and 17% of the total. The US dollar remains the dominant currency for such transactions. The role of the euro as a payment currency should expand, notably at regional level. Use of the single currency for international payments has increased in the first three years and is expected to increase further following the introduction of notes and coins. The euro has become the second most important financing or investment currency. It accounts for just under 34% of transactions in these areas, and this also reflects the historically low interest rates in the euro area.
Anchor currency. Over fifty countries have tied their currencies to the euro via, among other things, managed exchange-rate arrangements or a currency board. They are located mainly in Europe and Africa, the main motivating factors being commercial and financial links and the EU accession process. The euro is also used as an intervention currency, this being closely linked to its role as an anchor currency. Most interventions are carried out under the new exchange-rate mechanism (ERM II). At present, only Denmark has tied its currency to the euro under this mechanism. Lastly, the euro is used as a store of value and is the second most important reserve currency held by central banks. In 2000 the US dollar accounted for 68% of all foreign-exchange reserves. The share of the euro has remain virtually unchanged in recent years.
Candidate countries. The candidate countries will have to take over the Community acquis and are required to participate in EMU. At the outset, they will benefit from a Treaty derogation until such time as they satisfy the convergence criteria. Before adopting the euro, they must have participated in ERM II for two years.
Global coordination. The single monetary and exchange-rate policies are the exclusive competence of the Community. As regards internal policy coordination, the Council (in this case, the Member States that have adopted the euro) decides on Community representation at international level. The Eurogroup defines common positions. Externally, as regards the International Monetary Fund (IMF) or the G7, for example, no decision has yet been taken by the Council of Ministers. The European Central Bank has been granted observer status at the IMF and within certain G7 working groups. EMU is, therefore, still in the making as regards the external side.