07 December 2012

ECB/Draghi: A central banker's perspective on European economic convergence

The framework for convergence

With two exceptions, all EU members that are not yet in the euro area are expected to adopt the single currency on meeting certain convergence criteria. As you know, the Treaty defines these criteria along three dimensions.

The first dimension is the degree of nominal convergence with the euro area. This implies achieving price stability; ensuring the sustainability of the government’s financial position; realising sustainable convergence of long-term nominal interest rates; and maintaining a stable exchange rate between the national currency and the euro.

The Treaty also requires that nominal convergence is sustainable. This is not possible without it being underpinned by a high degree of real convergence. According to this second dimension, adopting the euro makes sense only if the economic structure of a prospective member has converged sufficiently towards the prevailing structures in the euro area...

The third dimension of convergence is institutional. The relevant national legislation, including the statute of the national central bank, needs to be compatible with the EU Treaties and the Statute of the European System of Central Banks (ESCB).

More generally, a lesson we have learned the hard way is that the strength of the institutional environment is crucial for the sustainability of economic integration and convergence. Improvements in the institutional environment entail, among other things, better regulations, better governance, better quality of statistics and a more business-friendly environment. Removing impediments to the efficient use of factors of production helps to enhance the growth potential of each country.

How to achieve a high degree of sustainable convergence?

There are four building blocks: monetary policy, structural policy, fiscal policy and financial policy.

In particular, the main objective of monetary policy should be price stability, and exchange rate policy should be treated as a matter of common interest...

The sustainability of nominal convergence is to a large extent conditional on a sufficient degree of structural, or real, convergence. A broad indicator of the degree of real convergence with the euro area is the catching-up of per capita incomes and price levels of new members with those of the euro area...

It is also crucial that the achievement of price stability is supported by sound fiscal positions, the third building block of convergence. Irresponsible fiscal policies can jeopardise credibility, as higher inflation becomes desirable to reduce the real value of government debt.

The fourth building block is financial policy. A sound banking sector, liquid and well-functioning capital markets are important for the sustainability of nominal convergence. On the one hand, well-functioning banking sectors and capital markets ensure efficient financing of capital accumulation in the economy, thus supporting potential output growth. On the other hand, they sustain the smooth functioning of the monetary policy transmission channels, such as the interest rate and bank lending channels. In this regard, financial sector vulnerabilities pose great challenges for the conduct of monetary policy.

Conclusion

The experiences of the past few years have shown that participation in a monetary union places important demands on national economic policies. Euro area governments are hard at work responding to those demands. They are correcting macro-economic imbalances. They are establishing a stronger framework of governance to keep countries on the path of sustainable convergence. And they are improving the institutional set-up underpinning monetary union.

For those EU members that have not yet adopted the euro, the challenge is to achieve a high degree of sustainable convergence with the euro area. This requires credible commitment on the part of their central banks to achieve price stability and treatment of exchange rate policies as a matter of common interest.

For the members of the euro area, the challenge is to achieve full compatibility of their economies with participation in monetary union. Product and labour markets must possess sufficient adjustment capacity to buffer shocks while maintaining high output and employment. It is in this area that progress is most needed.

Full speech

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