Reden und Präsentationen

Ladies and gentlemen,

It is a great honour for me to be here at this conference in Linz and to address this distinguished audience today. The topic I will elaborate on is the euro’s role as an international currency. In doing so, I will present some few theoretical considerations and will reconcile them with empirical evidence, particularly also on the euro’s role in Central and Eastern Europe.

The national use of a currency is mainly driven by legal aspects, as countries require their own currency to be legal tender within their jurisdiction. In contrast, the international use of a currency is mainly driven by market forces. 

So, what factors determine the international use of a currency? The economic literature has highlighted several aspects that apply to the issuing state or a monetary union: the stability of its monetary policy, the presence of well-functioning financial markets, the size of its economy and finally its strength and continuity.[1]

Let me briefly discuss these aspects and provide some evidence for the euro area:

If a currency is to be used internationally, confidence in its value must be high. One prerequisite for this is low and stable inflation. Besides, monetary policy should be predictable and consistent. The combination of low inflation in the past and expected low inflation in the future dampens nominal exchange rate fluctuations and facilitates agents’ economic planning. It thus supports a currency’s use as a medium of exchange and as a unit of account. Equally, low inflation rates minimize the cost of holding money balances, which supports the role of money as a store of value.

The European Economic and Monetary Union has a favourable record with respect to these factors. The European Central Bank (ECB) aims at maintaining price stability by keeping inflation rates below, but close to, 2% over the medium term. Inflation has been averaging just above 2%, despite oil prices having increased from some USD 10 per barrel in early 1999 to above USD 70 recently. As a result, the monetary policy of the Eurosystem has achieved credibility. Inter alia, this is reflected in the fact that inflation expectations are firmly anchored at levels consistent with the definition of price stability.

International investors, private or public, have a preference for liquid and safe financial instruments. Thus, another important prerequisite for a currency to be used internationally is that the issuing entity must have well developed financial markets, both in terms of depth (the secondary markets must be highly evolved) and in terms of breadth (a wide variety of financial instruments must be available). Of course, there must not be any form of capital controls.

Evidence collected by the ECB and the European Commission points out that the integration of financial markets has deepened considerably since the introduction of the euro, but its degree varies widely among markets. Generally, it can be said that the more advanced the integration of a market segment is, the closer this segment is to the single monetary policy and its instruments. In the money market financial integration in the euro area is nearly perfect. It has advanced considerably in the government bond market, it has also increased in the corporate bond and equity markets. But financial integration differs widely among various banking market segments, and it has just begun in terms of cross-border consolidation of financial institutions and is still an ongoing process in the euro area and in the EU. 

The more people use a particular currency, the higher the utility of this currency is in terms of its functions as unit of account and medium of exchange. Size matters also for the stability of an economic area, as shocks in a large economy often have less impact than shocks in a small economy. 

Indeed, shocks that are not directly related to the monetary union, for example geopolitical tensions or the terrorist attacks of September 11 can no longer result in unjustified exchange rate tensions within today’s euro area.

In terms of size, the euro area certainly has all the features of an internationally recognized currency with a significant weight: Total population of the euro area is about 312 million (that of the United States is 294 million, and Japan has a population of 128 million). Total gross domestic product of the euro area is EUR 7.7 trillion (compared to EUR 10.3 trillion in the US and EUR 3.3 trillion in Japan)[2] and it’s share in world exports amounts to 31.1%.[3] Even if one deducts intra-euro area trade, which represents roughly half of the euro area’s total exports, the openness in terms of international trade is substantially higher than that of the United States (10.4%) or Japan (5.7%).

Finally, also political stability and political strength of the issuing state has to be seen as an important factor for a strong international currency because it provides trust to users and investors of the currency. In this respect the euro area has a rather complex system of responsibilities and still has a rather short history.

The conduct of economic policy in the euro area is the responsibility of supranational institutions, such as the European Council, the European Parliament, the European Commission, and of course the ECB, on the one hand, and national institutions, most prominently when it comes to fiscal policy, on the other hand. This at first glance quite complex system has a clear legal framework with strong institutions. Admittedly, some weaknesses remain, but viewing the track record of European integration, there are good reasons to be optimistic about continuing progress in refining this economic policy system. Indeed, the euro area and its institutions have gained significant credibility in a rather short period of time. 

Given these favourable conditions, the euro has become the second most widely used currency within only a few years. Let me now present some evidence on its status as an international currency.

According to a survey conducted by the European Commission, the international perception of the euro has been strengthening continuously in all regions of the world. Selling euro cash for local currency presents no major difficulty. It is, however, more challenging to obtain euro cash. Of course, the closer you come to the euro area, the easier it is to exchange currency for euro cash. Public awareness of the euro has improved significantly in all regions. Because of their economic links to the EU, business sectors are generally much more familiar with the euro than the general public.

ECB reports confirm that certain facets of the euro’s role as an international currency continued to expand. Today, in around 37% of foreign exchange transactions the euro is involved, more than 30% of the total stock of international issues of debt securities and about 25% of the official foreign exchange reserves are denominated in euro. 

The euro has become increasingly important as a unit of account in international goods and service trade in the New Member States but also in other Eastern European, Central Asian and African countries. Some 50 countries have linked their exchange rate regimes in one way or the other to the euro. The trade orientation of many of these countries and their desire to anchor inflation expectations has led to the vital role of the euro in the monetary policy and exchange rate strategies. Even if the euro is not a formal or informal intermediate target, it serves as an important monetary policy indicator affecting, not at least, overall monetary conditions. Thus, the zone of stability of the euro area is extended to other countries – within the ERM II, within the EU and beyond.

Let me point out very clear that the Eurosystem takes a neutral stance on the internationalization of its currency. This means that the Eurosystem neither hinders nor actively promotes the development of the international role of the euro. Certainly, there are important potential gains to be reaped from a greater international role of the euro in terms of economic growth, deeper capital markets and seigniorage, which is the interest earned on the assets held by the Eurosystem against currency in circulation. 

However, external euro circulation also comes at a cost. Primarily, costs arise from expenses for the physical handling of cash needed to ensure the integrity of a globally used currency that is more easily targeted by counterfeiters. Other disadvantages could include the implied responsibility as an international lender of last resort or the potential loss of policy autonomy caused by the need to discourage sudden currency conversions.

Considering these arguments, it seems wise to let the international role of the euro be determined by the market. Global competition between currencies is a win-win game. The euro’s future international role will ultimately depend on the fundamentals already laid out: the actual stability orientation of monetary policy, the deepening of financial markets, the performance of the area’s economy and the success of the European integration process. In turn, market-driven internationalisation of the euro can generate further growth dynamics.  As the currencies of the world compete for stability, we will all gain stability.

With the euro assuming an important global role, more detailed analyses confirm a strong regional focus of this role, in particular in the euro area neighbouring regions. This regional concentration is of particular importance because the new EU Member States stand to introduce the euro at one point in time. Let me therefore use this opportunity to highlight some aspects of the role of the euro in Central and Eastern Europe.

In the 1990s, the Deutsche mark was used widely in those Central and Eastern European countries (CEECs) which, after a period of political and economic instability, had a high demand for foreign currencies. The Deutsche Bundesbank estimated the share of Deutsche mark circulating abroad at around one-third of the total cash in circulation, of which presumably the majority circulated in the CEECs.[4] The Austrian schilling also circulated to some extent in these countries.

Before the euro cash changeover, it was not clear whether the euro, as a new and unfamiliar currency, would enjoy the same degree of confidence as the Deutsche mark or other legacy currencies from the euro area. One scenario was that legacy currency holdings would be converted into other foreign currencies, notably the U.S. dollar. Another scenario was that foreign cash demand would be reduced in reaction to ongoing economic and political stabilization. Finally, the third scenario was that people would convert their legacy currency holdings into euro.

The Oesterreichische Nationalbank has commissioned surveys about foreign currency holdings in 5 Central and Eastern European countries (Czech Republic, Slovakia, Hungary, Slovenia and Croatia) since some time. The evidence of these surveys show thatin the course of the cash changeover, a substantial fraction of the stock of Deutsche mark, Austrian schilling and other euro area currencies which circulated in these five countries were exchanged into euro (about 51% of Slovenians, 33% of Czechs, 28% of Slovaks, 26% of Croats and 8% of Hungarians were holding euro cash balances by the end of 2005). Notably, in Slovakia, Slovenia und Hungary, this share is now higher than the corresponding Deutsche mark share was in the late 1990s. A similar development can also be observed for the amounts of euro that circulate in all five countries. Moreover , the OeNB surveys shows that people in Central and Eastern Europe have a high degree of confidence in the euro’s stability. The euro enjoys this high degree of confidence in our neighbouring countries because of credible and stability-oriented monetary policy of the ESCB.

The euro is not only widening its influence outside EMU, the euro area itself is going to enlarge. Let me elaborate a bit on this process.

By entering the European Union in 2004, the ten New Member States have also become members of Economic and Monetary Union. While they are not taking part in EMU to the full extent yet, as they cannot adopt the euro immediately, they are already required to observe a number of obligations embodied in the stability architecture of EMU.

While, in general, most of the advantages of monetary integration will increase with the scale of the euro area, it is crucial that countries are sufficiently prepared for this intensified integration before they adopt the euro. The Treaty establishing the European Community with its convergence criteria provides the appropriate framework to assess whether a country can be regarded as ready for monetary integration. The speed of further monetary integration must not compromise its quality. Decisions have to be taken in accordance with the Treaty on a case-by-case basis.

Just next week, the ECB and the European Commission will each present their convergence reports on Slovenia and Lithuania, who have asked for this assessment. The Council of the European Union is going to decide in due time whether these countries fulfil the criteria and whether they can join the euro area by January 2007. I ask for your understanding that I will not discuss the performance of these two countries or the pending decision by the Council at this stage. Let me just mention that a well prepared enlargement of the euro area, as laid out by the Treaty, will benefit all Member States and will continue the success story of European integration.

The European Economic and Monetary Union is an important pillar in a stability-oriented, global economy. After more than seven years, the euro is firmly established as the currency of over 300 million people. Its internal stability is evidenced by the fact that inflation has been steadily low from the very start, despite a sequence of negative price shocks (in particular a continuous surge in oil prices). As an international currency, the euro is second only to the US dollar. Let me draw an analogy by citing the Secretary of the Treasury of the Nixon administration, John Connally, who once said to his European colleagues, “The dollar is our currency, but your problem.” – I would say: “The euro is our currency, but everyone’s asset.”

The euro represents a unique experience in history. On the one hand, it is based on a clear supranational monetary order, whereby the European Central Bank has full sovereignty in conducting a single monetary policy for the euro area. On the other hand, political union is still limited and sovereignty remains predominantly national in many policy areas. This asymmetry has raised questions about the sustainability of such an institutional arrangement since well before European Monetary Union started on 1 January 1999. The “no” from the French and Dutch people on the Treaty establishing a Constitution for Europe triggered new interest in the prospects for Monetary Union and the future course of political union.

The continuous challenge for Europe has been to find the right balance between political, economic and monetary integration. This has been called the “triangle” between the state (or States!), the market and the currency. It has to be clear for all parties involved that the euro is a driver for a stable and prosperous European economy as well as a necessary strategic response to global competition and the challenges associated with it.

Baxter, Thomas C. Jr. (2004), Oversight of the Extended Custodial Inventory Program
http://www.newyorkfed.org/newsevents/speeches/2004/bax040520.html 

Cooper, Richard N. (2000), Key Currencies after the Euro. In: Robert Mundell; Armand Clesse, eds., The euro as a stabilizer in the international economic system. Boston; Dordrecht and London: Kluwer Academic, 2000, 177–201.

ECB (2005), Review of the International Role of the Euro. 
http://www.ecb.int/pub/pdf/other/euro-international-role2005en.pdf

European Commission (2005), Flash Eurobarometer 175 – TNS Sofres / EOS Gallup Europe. The euro, 4 years after the introduction of the banknotes and coins.
http://europa.eu.int/comm/public_opinion/flash/fl175_en.pdf

Mundell, Robert (2000), The Euro and the Stability of the International Monetary System. In: Robert Mundell; Armand Clesse, eds., The euro as a stabilizer in the international economic system. Boston; Dordrecht and London: Kluwer Academic, 2000, 57–84.

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Stix, Helmut (2004), The Euro in Central and Eastern Europe – Survey Evidence from Five Countries. CESifo-Forum 3. 33–38.

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