| While the euro has been a success, work remains on creating a single market for financial services |
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| The introduction of the euro has helped lower a number of technical, regulatory and psychological barriers that in the past have segmented Europe's financial markets along national lines. Moreover, the recent compromise struck between the European Parliament and Commission on the Lamfalussy Report holds out the welcome prospect of faster progress on regulatory harmonization. However, the magnitude of what remains to be done should not be underestimated says Anne Kruger. |
Europe’s progress towards a single currency over the post-war period has been likened to the emotional roller coaster of a television soap opera: every advance accompanied by inflated rhetoric about Europe’s glorious future; every setback greeted with exaggerated predictions of conflict and disaster. But with the changeover to Euro notes and coins this year, the drama has successfully reached its season finale thanks to determined political leadership and economic convergence. The challenge now is to ensure that this positive political and economic momentum is maintained in the years to come and that monetary union delivers on its promise.
Fortunately, macroeconomic policy in the Euro area is built upon firm institutional foundations. Despite initial scepticism in some quarters, the European Central Bank has clearly established its independence and commitment to price stability. The ECB faced a difficult policy environment last year, with growth slowing and inflation above its target range. The ECB responded appropriately, lowering interest rates modestly to begin with and then responding more resolutely when September 11 unsettled financial markets and dealt a blow to business and consumer confidence.
We now appear to be at or near a turning point in global economic activity. This is always a particularly difficult juncture at which to set monetary policy. For now, the risks to medium-term price stability seem pretty evenly divided. If recovery proves sluggish, additional easing could be required. But the inflationary impact of an unexpectedly rapid recovery or a move away from wage moderation could argue for a touch on the brakes. For the time being, watchfulness is the key.
At the Lisbon Summit in March 2000, European leaders adopted the goal of creating over the next 10 years an economy with integrated, employment-generating, and smoothly functioning markets. This will be important not only to boost productivity growth, but in particular to increase the economy’s potential output by reducing structural unemployment. Progress to date has alas fallen short in a number of areas. We must hope that the creation of the euro and now its physical manifestation in notes and coins proves a spur to the area’s longstanding structural reform agenda. If policymakers allow the loosening of exchange rate and current account disciplines to enervate the reform process, then all Europe’s citizens will be the poorer for it.
Broader and deeper structural reform is required in a number of areas. For example, there is a broad consensus among economists that growth and job creation in Europe are hampered by labour market rigidities, by overstretched and expensive social security systems, and by subsidies that hinder efficiency and weaken fiscal positions. A study in the IMF’s World Economic Outlook of October 1997 suggested that more rapid structural reform could deliver a growth premium of about 5.5 percentage points over a 10-year period, helping reduce unemployment by 4 percentage points from a slow-reform baseline. To date, alas, this premium appears to have gone unclaimed.
Monetary union has already had a significant impact on Europe’s financial markets. As the Bank for International Settlements (among others) has noted, the introduction of the Euro has helped lower a number of technical, regulatory and psychological barriers that in the past have segmented Europe’s financial markets along national lines. Borrowers now have a larger investor base to draw upon. And investors are able to allocate funds to a wider range of instruments and locations. As market participants have taken advantage of these opportunities, we have already seen a deepening of financial markets in the Euro area and increasing cross border activity.
The influence of the single currency has been most visible in bond markets, which were already relatively international in their focus prior to monetary union. At the end of 2000, the stock of euro area government securities was nearly on a par with the US Treasury market at around $2.8 trillion. And, significantly, a growing proportion of bonds issued by euro-area governments are being held by non-residents. Having said this, the multiplicity of issuers in the euro area, and their different credit ratings, limit the liquidity of the market. Greater coordination of release dates, maturities, coupon sizes and other technical features of bond issues could help address this weakness.
Bond issues denominated in euros have been even more popular among private borrowers, both inside and outside the euro area. Widening the range of investor portfolios that can be tapped with a single bond issue, monetary union has helped reduce the cost of capital market financing by allowing issues of greater size.
But issuance continues to be dominated by banks rather than companies, which suggests the market has not yet reached full maturity. The market for high-yield bonds also continues to be hampered by differences in national legal frameworks, for example regarding default and documentation issues.
Monetary union has had a less visible impact on European equity markets. Sectoral factors now appear to be growing in importance relative to national differences in determining equity prices in the euro area. But evolution towards a truly pan-European equity market has been hampered by slow progress in bridging the gaps between existing equity trading infrastructures. Ongoing consolidation of Europe’s stock exchanges seems inevitable, but fraught with difficulty. Consolidating nationally focused clearing and settlement mechanisms is an important challenge.
In money markets, Europe has gained an integrated interbank market, underpinned by the efficient functioning of new payment systems. But integration in the collateralised repo market has proceeded more slowly, with markets remaining largely national and unevenly developed. Partly, this reflects different regulatory, legal and tax environments, as well as historical differences in market practices. As a result, for example, there is considerable legal uncertainty about the ownership of collateral in the case of default in a cross-border transaction.
To summarise, the deepening of European capital markets has been impressive, but uneven. In some segments, national legal traditions still stand in the way of creating a single capital market, with all the gains in liquidity and efficiency that could bring. The recent compromise struck between the European Parliament and Commission on the Lamfalussy Report holds out the welcome prospect of faster progress on regulatory harmonization. This could bring a single capital market much closer.
Europe’s leaders have overcome formidable obstacles in bringing monetary union about. But if monetary union is to enjoy high levels of public confidence and to be attractive to potential entrants then it will have to be seen to contribute to greater economic stability and higher living standards for Europe’s citizens. This means getting macroeconomic policy right and accelerating structural reform. No one should underestimate the magnitude of what has been achieved to date; but neither should anyone underestimate the magnitude of what remains to be done. |
Anne Krueger is first deputy managing director of the International Monetary Fund.
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| Article appeared in the March 2002 issue.
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