Speech

The Euro: Engine for Prosperity EuropeanBankingandFinancialForum2001 CzechNationalBankCongressCenter Prague,CzechRepublic March27,2001 Iam delighted to be here at this conference, inglong-termpolicystrategyandnotjustinterms and especially delighted to be able to par- ofthepressuresoftheday.Ihavenotfollowed ticipate in this session. Before proceeding, theECBinfinedetail,buttometheBankhas though,Iwanttoemphasizethattheviews doneanexcellentjobinestablishingpoliciesthat I express are mine and do not necessarily reflect willonlybefullyunderstoodandappreciatedin official positions of the Federal Reserve System. thefuture. I retain full responsibility for any errors in what Creationoftheeurohasalreadyhadamajor I am about to say. impactinunifyingthecapitalmarketsofthemem- Thefirstthingtoemphasizeabouttheeurois bercountries.Interestratespreadshavenarrowed thatcreationofthisnewcurrencyandnewcentral dramaticallynowthatexchange-rateriskhasbeen bankisaremarkablepolitical,operational,and eliminated.I’velookedatanumberofcharts monetarypolicyachievement.WhenIcameto showingspreadsforgovernmentbondsissued theSt.LouisFedthreeyearsago,Ijoinedawellbyvariouseurocountriesanditisstrikinghow establishedorganizationwithalonghistory.Given spreadsagainstGermangovernmentbondshave mypersonalexperienceandallIhadtolearn,I narrowedwiththeintroductionoftheeuro. finditmind-bogglingtothinkaboutthechallenge Spreadswithintheeuroareanowreflectdifofestablishinganewcentralbankfromground ferencesindefaultriskandinmarketliquidity. zero.Therewasacertainamountofanguishlast Asaconsequence,capitalflowswithintheeuro yearastheeurodepreciatedagainstthedollar, areareflectfundamentalinvestmentconsiderabutthathappensfromtimetotimetothevery tionsratherthanspeculationonexchangerates bestcurrenciesintheworld.Thedollar,ofcourse, andpoliciesthatmightinterferewiththefree hasseenitsupsanddownsovertheyears.That flowofcapital.Capitalflowinginresponseto theeurowasbesetbynothingmoreseriousthan economicfundamentalswillsurelycreateamore aperfectlynormalperiodofweaknessisevidence ofjusthowremarkabletheachievementhasbeen. efficientuseofavailablecapital,whichisalways Itisobvious,butneverthelessworthrepeating, ascarceresource. thatbuildingtheinstitutionsandpracticesofthe Ibelievethatcreationoftheeurowillalso EuropeanCentralBankwilltaketime.Theway leadtoamoreefficientpatternoftradeingoods inwhichtheECBhandlestheproblemsandeven withinEurope.Investmentandproductiondecicrisesthatwillinevitablyarisewillshapefuture sionswilldependnowoncomparativeadvantage events.IamsurethattheleadershipoftheECB toagreaterdegreethanbefore.Withouttheuncerunderstandstheprecedentvalueofeverything taintyoverexchangerates,firmscanproceed thatisdone.Butobserversmaynotalwaysunder- withgreaterconfidencethattheirdecisionswill standthispoint,anditisworthemphasizingin notbeupendedbyprotectionistactionsmotivated thestrongestpossibletermsthateveryactionby byeffortstoinfluenceexchangeratesortooffset theECBneedstobeviewedaspartofadevelop- thecompetitiveeffectsofexchangeratechanges. 1

MISCELLANEOUS Ihavelongbeenanadvocateoffloating improvetheoddsonmaintainingpricestability exchangerates,apositionthatinitiallyreflected overthelongrun. thefactthatIdidmygraduateworkatthe Thecommoncurrencyobviouslyeliminates UniversityofChicagounderMiltonFriedman. certaintransactionscostsrelatedtoexchanging WhatIhavecometounderstandovertheyears— onecurrencyforanotherandhedgingcurrency andthisviewwasalwaysanimportantpartof risks.Thissortofmicroeconomicefficiencyisat Friedman’sthinkingoncurrencyissues—isthat theheartoftheeconomicgrowthprocess.Reducthecurrencyarrangementthatworksbestisthe ingcurrencyrisksandpricelevelinstabilities onethatpermitsandencouragesfreeandopen createsfavorableconditionsforhighereconomic tradeingoodsandcapital.Asitseconomicinte- growth,butdoesnotbyanymeansguarantee grationincreased,Europefoundthatfreelyfloat- suchgrowth.Itiscriticaltounderstandthathigher growthinEuropedoesnotdependonanexpaningexchangeratestoooftencreatedsharpchanges sionarymonetarypolicy,butinsteadonmicroincompetitiveconditions,whichmadeitdifficult economicreforms.Europeneedsmoreflexible tomaintainthemomentumtowardincreased labormarkets,amoreentrepreneurialbusiness tradeandcapitalopennesswithinEurope.Fixing environment,areducedburdenofgovernment ratestoadegreethroughsnakesandtunnelsdid regulations,andamoreefficientsystemoftaxes notworkwelleither,asevidencedbyexchange andsubsidiestocreateimprovedincentivesfor marketcrisesonseveraloccasions.Indeed,afixed growth. orsemi-fixedsystemworksmuchlesswellthan TheUnitedStates,althoughinbettershape freelyfloatingrates.Fullcurrencyunificationis onmanyofthemicroeconomicdimensionsthan surelymoreefficientandmorestablethansepa- Europe,needsexactlythesamereformstoincrease ratecurrencieswithfixedrates.Iffixedratesare itsgrowthrate.Therearesomanyopportunities trulyfixed,thereisnoreasontohaveseparate intheUnitedStatesandinEuropeforimproving currencies;iffixedrateschangefromtimetotime, efficiencythatIdonotknowwheretostartsuch theinstabilitydamagesefficienttradeandcapital alist. flows. Inclosing,Iwanttoemphasizeapointthat I’vespokenbrieflyaboutthefloatingrate IincludeinalmosteverypresentationImake. optionbecauseIdonotwanttoleavetheimpres- Theprimaryresponsibilityofacentralbankisto sionthatasingleunifiedcurrencyisthebest maintainlowandstableinflation,orpricestabilarrangementforallcountriesinallconditions. ityifyoupreferthatformulationofthesameidea. Thatisasubjectthatgoeswellbeyondthispanel Thatisthewayacentralbankcancontributeto discussion,however. achievingmaximumsustainableeconomic Fromaneconomicpolicyperspective,the growth.IntheEighthFederalReserveDistrict— mainargumentagainstthecreationoftheeuro theSt.LouisDistrict—Ihaveexplainedtoagrihasbeenthatacountrymightbelievethatitcould culturalaudiencesthatcreatingmoremoney createmorestableemploymentandamorestable cannotsolvetheproblemscreatedbyinadequate internalpricelevelbyemployinganindependent rainfall,orbythefactthatagriculturalcommodity monetarypolicy.Concerningpricestability,most priceshavebeentrendingdownfor150years countriesintheeuroarea—themajorpossible relativetootherpricesbecausefarmproductivity exceptionisGermany,ofcourse—believethat continuestooutpacetheincreaseinthedemand theeuropromisesmoreratherthanlessprice forfood.Ihaveexplainedtootheraudiencesthat stability.Whethertheeurowillachieveaprice printingmoremoney,orless,willdonothingto stabilityrecordasimpressiveastheDMdid,only solvetheelectricitydemand-supplyimbalance timewilltell.Clearly,though,theinstitutionsof inCalifornia.Norcanmonetarypolicyrelieve theECBhavebeendesignedtoachievethatend airportcongestionoranyofthousandsofother anditishardtoknowwhatelsemightbedoneto problemsthatdirectlyimpacteconomicgrowth. 2

TheEuro:EngineforProsperity Oftheseexamples,myfavoriteisthatprinting moneycan’tincreaserainfall,becausetheexampleissoobvious.Monetarypolicyissimplynot asubstituteforaddressingenvironmentaland otherdisputesthatmustberesolvedthrough politicalmeansif,tocontinuetheexample,we aretobuildmoredamstoprovideirrigation water.Alltoooften,peopleseemtobelievethat monetarypolicyisaneasywayouttocreate growth,whenitsimplyisn’tbecausemonetary policycannot,asIliketosay,maketherainfall. AsItravelaroundmydistrictIemphasize thateconomicdevelopmentdependsonmicroeconomicpoliciesthataresubstantiallyunder thecontroloflocalauthoritiesandlocalbusiness leaders.AlthoughnotobvioustomostEuropean observers,theUnitedStateshasmajorregional differencesinunemploymentratesandgrowth rates.WithintheEighthFederalReserveDistrict, forexample,somemarketsenjoyanunemploymentrateinthe2to3percentrangewhileothers haveanunemploymentrateinthe8to10percent range.Theseunemploymentratedifferencesare persistent,buttheycanbeaddressedbysuitable governmentpoliciesthatpromoteeconomic growth.Goodmonetarypolicycontributesenormouslytoeconomicgrowthbycreatingprice stability,butcannotbeexpectedtocreatethe microeconomicefficienciesthatareattheheart ofthegrowthprocess. 3