The 11 countries are: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal and Spain.
In true EU-summit form, it could have been a non-event, had it not been for the political compromise regarding the ECB's head, forcing Wim Duisenberg - the financial markets' and central bankers' favourite - to commit himself 'voluntarily' to stepping down half-term through, giving way to France's choice, Trichet.
Short-term concern regarding the stability of the euro should be offset, however, by the 'hawkish'-leaning majority within the ECB governing council (out of 17 voting members, 12 are 'hawks' when considering their respective country's stage on the business cycle, while 9 are 'hawks' disregarding cyclical considerations), and the fact that Duisenberg will head the ECB during the crucial transition period.
In the longer-run, worries may arise due to the fact that the Waigel plan - aiming to secure a more stringent fiscal policy - was diluted. Furthermore, the increased commitment of finance ministers towards employment initiatives increases the risk of public spending in the future.
While the predominance of 'hawks' should help towards credibility and this, underpinning of the euro in the longer term, it does not change our low European interest rate scenario in the immediate future. Until the end of 1998, Germany's 'Bundesbank will still - by and large - set the tune, according to core Europe's cyclical needs.
In the period beyond, both cyclical considerations, but also budgetary negotiations in the member countries, will become crucial. Therefore, the more the Waigel plan is ultimately honoured, the less the need for undue increases in interest rates.
I. The ECB-head and fudging the eight-year term
"Sunday's ECB accord will help ensure that the single currency gets off to a stable start" (Theo Waigel, German Minister of Finance).
In the words of German chancellor Kohl it was "one of Europe's most difficult hours", but in the event a deal was brokered in the early hours of Sunday 3rd May. Ahead of the summit there had been a string of statements that no splitting of the eight year term at the held of the ECB would be allowed, but in practice this is exactly what happened.
The deal envisages that the widely supported Dutch candidate, Wim Duisenberg (currently the president of the European Monetary Institute, EMI), will take over as president of the ECB on 1st July 1998. At the same time, however, according to a carefully drafted statement Duisenberg wished - of his own free will and without pressure from any side - not to stay in office for the full term.
While the fudging of article 109a in the Maastricht Treaty leaves a bad taste to start with, any unduly negative reaction in the financial markets should be muted. While the fact that an agreement was reached at all should be viewed positively, a series of other factors should be considered when assessing the outcome.
Among the wider considerations:
- i) Any central bank is unlikely to operate in a political vacuum, and the ECB is no exception.
- ii) The legal framework underlying the ECB still provides for one of the most - if not the most - independent central bank's coming into existence on 1st July.
Considering the composition of the ECB board and other specifics of the current deal:
- iii) The composition of the ECB's governing council (which consists of the executive board appointed at the summit and the governors of the EMU-11 member countries' national banks) has a 'hawkish'-bias viewed from a both a cyclical and a structural perspective.
- iv) Duisenberg's intention is to stay in office throughout the transitional phase, namely until he can see through the introduction of Euro notes and coins (which is not due to happen until 2002). In practice, this gives Duisenberg four years to cement the credibility of the ECB.
- v) Furthermore, the date of his retirement is not cast in stone. Although Chirac insisted on a specific date being set, this would have contravened the treaty. While it is widely understood that Duisenberg will hand over having served half his term in office, i.e. by July 2002, his statement, nevertheless, leaves the door open: "(...) my decision not to stay in office for the full term was not made under pressure from any side. In the future too the decision to resign will remain solely with me. This must be clearly understood."
- vi) Assuming Duisenberg retires after four years, by July 2002, the succession at the helm of the ECB might be a less political issue, since by then France will have had both Presidential and Parliamentary elections (by mid-2002).
II. A hawkish ECB
Apart from nominating the president of the ECB, five more members have been nominated to the executive board. Together with the heads of the 11 national central banks, these 17 form the decision making ECB council. According to the Maastricht Treaty, each member of the governing council has one vote and decisions will be taken by simple majority. Below, we provide a brief description of the nominated executive board members and we also try to assess the leaning of the ECB's governing council, concluding that the inflation 'hawks' predominate.
Nominations to the ECB executive board and a brief description
Wim Duisenberg, 62, head of the European Monetary Institute (since 1997). Prior to this, head of the Dutch central bank, where he secured disinflation and pushed for sound economic policy. Known inflation hawk. Awarded an eight year term, but promised to step down "voluntarily" around mid-term.
Christian Noyer, 48, currently in no official function. Until 1997 treasury director of conservative French finance ministers (Balladur, Arthuis), who effected fiscal consolidation. Awarded four year term.
Ottmar Issing, 62, Bundesbank's prominent chief economist and economic professor specialised on monetary affairs. Leading Bundesbank hawk. Awarded eight year term.
Tommaso Padoa-Schioppa, 57, chief regulator of the Italian stock market. Prior to that leading member of the Bank of Italy and the Delors committee, which prepared blue print for EMU. Balanced monetary views. Awarded seven year term.
Eugenio Domingo Solans, 52, board member of the Bank of Spain since 1994. Prior to this career in private banking (Banco Zaragoza) and academic. Balanced monetary views, resisted Peseta devaluation in 1995. Awarded six year term.
Sirkka Hämäläinen, 59, Bank of Finland governor since 1992. Background: Central bank since 1961, head of economics department there and, for three years, of the Ministry of Finance. Known inflation hawk. Awarded five year term.
The staggered terms of the board members could be seen as an implicit invitation for the UK to join after 2002, when Duisenberg's early resignation would vacate a seat on the ECB-board (a formal arrangement to vacate a seat in order to accommodate the UK was objected by the French), coinciding with the end of the French vice-president's term in office.
This is in view of the UK government promising an EMU referendum after the next general election (expected in 2001), 2002 thus becoming a likely entry date. The same applies for Sweden, where officials indicated intentions to join after 2001, which could thus explain the relatively short term of the Finnish central bank governor Hämäläinen.
As regards ECB credibility, an official at the EMI once stated that this would not necessarily mean interest rates had to be increased from the outset, since credibility would be ensured by the sheer composition of the ECB board. After the election of the executive board at the summit, the 'hawkish' bias of the governing council seems to prove the point.
Of the six members on the executive board, four represent countries which are ahead on the economic business cycle and which require - if anything - higher interest rates. But even disregarding the cyclical needs of the individual countries, of the total 17 members of the governing council, nine are known inflation 'hawks'.
However, while the predominance of 'hawks' should help towards credibility and thus, underpinning of the Euro in the longer term, it does not change our low European interest rate scenario in the immediate future. Until the end of 1998, Germany's Bundesbank will still - by and large - set the tune, according to core Europe's cyclical needs. In the period beyond, both cyclical considerations, but also budgetary negotiations in the member countries will become crucial. Although Waigel's plan has been diluted (see next column), the more it is ultimately honoured by national budgets', the easier it will be for the ECB to prevent an undue increase in interest rates.
III. Finance ministersí resolve to fiscal consolidation unconvincing
On 1st May, prior to the EMU summit, the finance ministers agreed in a budget pledge statement to accelerate and secure fiscal stringency in EMU (Waigel plan), which was a pre-condition for the central banks to give their blessing to the EMU 11.
Officially, the agreement seems to have taken all of the Waigel points on board (see Euro 11 weekly, 3rd May).
Waigel plan for fiscal restraint
- the stability pact will come into force 1st July
- the fiscal targets in 1998 will be respected - if needed through timely corrective action
- 1999 budgets will get early considerations in view of the stability and growth pact
- windfall revenues - if economic conditions are better than expected - will be used as an opportunity to reinforce fiscal consolidation to achieve close to balance budgets
- the higher the debt/GDP ratio, the greater the consolidation effort
- debt management should reduce vulnerability
- medium term convergence programmes are to be submitted by the end of 1998
- EMU as such cannot be invoked to justify specific financial transfers
- the Euro 11 council will meet in the coming months
But the wording and the 'smallprint' imply a significantly more skeptical reading. Three areas for dilution appear obvious:
i) In contrast to the initial Waigel plan, there is no discussion over the extent to which windfall revenue gains/spending shortfalls should be used for debt reduction; it allows little room for finance ministers to ward off spending pressure, particularly ahead of elections. Alternatively, governments may deliberately use high growth forecasts to minimise the incidence of windfall profits
ii) The stipulation to shift borrowing up the curve is unbinding
iii) The link between fiscal policy and additional employment is most worrying. The obligations to secure social cohesion and draw up national employment initiatives, with respect to certain groups, may for the moment be an "innocuous" token concession to the French government. But employment spending may get much more weight, if the political conditions change also in Germany.
On balance, the fiscal pledge seems to be a goodwill declaration rather than a commitment to give the stability pact more teeth. Therefore, it is unlikely to reduce conflicts between governments and ECB and thus counter a more hawkish ECB bias. Overall, the close monitoring of national budgets will remain crucial.
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