European Affairs

Winter 2001

 

Finance and Banking
Policy Implications of a Global Economy: A View from the ECB
Sirkka Hämäläinen
Member of the Executive Board, European Central Bank

 

In an age of global capital markets, the role of financial policy coordination is an issue that represents an increasing challenge for policy-makers. This is certainly true for central bankers, and especially for those whose currencies perform an international role.

On the one hand, our mandates and institutional objectives are defined in domestic terms, while on the other, the financial markets in which we operate to achieve those objectives are increasingly global.

This raises the question of whether we can achieve our domestic objectives with domestic policies, or whether the globalization of the economy calls for a similar globalization of economic policies.

I suggest that the globalization of financial markets requires reflection on the coordination of basic economic rules rather than the coordination of macro-economic policies as such. In the context of interdependent economies, global stability can be achieved if there is a similarity of policy objectives across different areas, but individual policymakers primarily concentrate on keeping their own houses in order. I shall try to clarify what I mean by this suggestion.

It may be a good idea to start by defining what globalization means. After all, cross-border economic transactions have always been part of our landscape. The degree of interdependence of our economies, the degree of internationalization of production, trade, and finance, are greater now than at any period in history, but they are not without precedent.

What may be different today is that when we use the new word "globalization," we are often referring to the "invisible" part of the economy - flows of finance and information, and exchanges of services rather than products. In the United States and Europe, these invisible sectors are becoming ever more important, and the speed of interaction has increased dramatically.

This is very significant because it represents a much stronger challenge to the concept of sovereignty than in earlier periods of history. Traditionally, the notion of sovereignty has been associated with the idea that economic activity conducted on the territory of a country is ultimately subject to the laws and regulations of that country. This implicitly assumes that it is possible to identify, and, to a certain degree, control the activity conducted in a country.

This, however, is increasingly difficult, if not impossible, with regard to the invisible or immaterial part of the economy. With the development of new technologies, information and financial transactions can circulate around the world in a matter of seconds. They cannot be stopped at national borders. "Globalization" can thus be taken to refer to activities that cannot be contained in the boundaries of traditional national legal and regulatory systems.

We should not underestimate the consequences of this development. Indeed, one reason why we welcome cross-border economic relationships between countries is that they promote the smooth functioning of "an open market economy, with free competition favoring an efficient allocation of resources."

These words are inscribed in the Treaty on the European Union, and underline our attachment to the principles of a free market economy. There is no questioning the U.S. attachment to the same principles.

We should remember, however, that a market economy is not only an economic model. It is also a model of social organization, based on a number of rules. I am referring not only to such basic elements as the respect of private property or the obligation to fulfill the terms of a contract, but also to more elaborate rules, such as the regulation of financial markets or of financial intermediaries.

Binding rules in these areas are essential to create a climate of discipline and confidence in the economic and financial system. Without confidence in the system, there is no real economic freedom. As some segments of economies have become global, it is sensible to ensure that, at the global level, there is a set of rules similar to those we take for granted at the national level.

One example, directly relevant to a central banker, is that the globalization of financial markets means that financial stability is no longer a domestic issue. This argues in favor of laying down laws or regulations to secure the smooth functioning and stability of the global financial system. It can be done either at the international level or in a coordinated way at the national level.

Many international bodies, such as the International Monetary Fund and the Bank for International Settlements, are working on this task. It is important that the rules they establish apply to all participants in the global financial system, whether those rules concern capital adequacy requirements, transparency or other topics. This represents an important and necessary field for cooperation among policymakers, not only in Europe and the United States, but all over the world.

In fact, our experience in Europe argues strongly in favor of such an approach. The process of European integration is different on many counts from the globalization of the world economy. In particular, European integration has been politically driven and has been taking place among countries that are relatively homogenous from a cultural, economic, and political point of view.

Yet, in spite of this homogeneity, there are national differences, and it was felt early on that economic integration could not be successful without a set of common rules. In Europe, such common rules are achieved through the use of EU legislation, which is imposed at a higher level than national laws.

In a world of interdependent economies, the primary concern of monetary as well as fiscal policy-makers should be to keep their own houses in order. This may seem paradoxical, in that I advocate the need for common rules beyond the national level in a number of fields. In addition, I represent the European Central Bank, which was established as a result of a decision by the participating countries to go beyond monetary policy coordination and adopt a single monetary policy.

In order to be able to introduce a single monetary policy, European countries had to meet a number of stringent conditions. The same would be true at the world level.

Paul Volcker, the former chairman of the U.S. Federal Reserve, has said: "If we are to have a truly global economy, a single world currency makes sense." He immediately added, however, that he would not live to see this single world currency, reflecting the view that on a world level we are still very far from fulfilling the stringent conditions and common rules needed in order to establish a universal currency.

So, what were the stringent conditions required to establish economic and monetary union, and a single currency, in Europe? First, of course, there had to be a high level of economic convergence, which was measured against a set of criteria that included inflation, long-term interest rates, public deficits, levels of public debt, and exchange rate stability.

Second, a strong consensus on the objective of monetary policy was necessary. Based on the negative experience of high inflation in many European countries in the 1970s and 1980s, a strong consensus had emerged that price stability should be the objective of monetary policy.

Third, there had to be a solid perception of common interests. The people of Europe had to agree not only on the objective of price stability, but also on the need to define this objective at the pan-European level. They had to be willing to exchange goods and services among themselves against a currency, the euro, which would not be linked to gold or to the power of the state, and which had no value other than the confidence they placed in it.

Fourth, there is a need for common fiscal policy objectives. Because the countries participating in the euro are attached to their national sovereignty, we do not have a single fiscal policy. Every country has its own fiscal policy. This also reflects the view among Europeans that fiscal policy is better defined at the national level.

This may be because of different perceptions of whether the emphasis of fiscal policy should be, for instance, education, defense or public transportation. It may also reflect different views on the degree of social security and welfare to be provided by public means.

There are also structural differences between European countries in areas such as labor market regulation and pension policies. So, according to the principle of subsidiarity, fiscal policy is decided at whatever level is most suitable, whether that level be national, regional, or local.

This, however, should in no way be misinterpreted as an obstacle to the smooth functioning of the single currency area. A centralized fiscal policy is not a requirement for the conduct of the single monetary policy, provided that the decentralized policies are efficiently coordinated. There is a broad agreement that fiscal policies should be "disciplined." This is the purpose of the EU's Stability and Growth Pact, which is quite similar to the U.S. concept of balanced budget legislation.

Borrowing a phrase from Charles de Gaulle, this is a situation of "independence in interdependence." In the context of interdependent economies, there is a similarity of goals (fiscal discipline), but independent implementation of the policy required to achieve these goals. This is conducive to the overall stability of the system.

The same reasoning is crucial for fiscal and, in particular, for monetary policies in the global economy, too. Indeed, the goals of monetary policy are broadly defined in similar terms in the United States, Japan, the euro area, and many other countries. There is a wide consensus that price stability should be the main objective of monetary policy.

Even though our goals are similar, however, there is no single, global policy goal. I think this argues strongly that, as we formulate our monetary policy stance, we should not accommodate international factors beyond the influence of external economic developments on domestic prices.

Rather, I firmly believe that by concentrating monetary policy on domestic price stability in each region of the global economy, monetary policymakers actually best contribute to alleviating global imbalances.

Again, this creates the situation of independence in interdependence described earlier. On the one hand, the globalization of our economies creates a situation of interdependence, because the balance of risks to price stability is also affected by external factors. On the other hand, a monetary policy geared toward domestic price stability must remain independent so that it has maximum flexibility to accommodate external, as well as internal, developments.

Mr. Volcker's prophecy may be right. We might one day have a single world currency with the same goals in all areas - not only similarities of policy objectives and agreement on basic rules. Here, Europe and the United States are approaching each other in many ways. The fiscal discipline and price stability goals are rather similar. Maybe European integration, in the same way as any other form of regional integration, can be seen as a step toward the ideal situation of a fully integrated world.

Whether and when this world will see the light of day is impossible to say. Such a vision, however, seems to most of us as impossible today as a European monetary union seemed 50 years ago when the process of European integration started.

The globalization of the economy, by contrast, is a reality today. Moreover, this is a situation that we must handle in the present. It is important to understand that the smooth functioning and stability of the global financial system requires that certain common rules be established at a global level.

It is also important that we recognize that global stability will be enhanced if the goals and aims of macroeconomic policies are as similar as possible across the different regions. I firmly believe that within this framework, the best contribution policymakers can make to global stability is to keep their own houses in order.