Bergström: The driving forces behind Economic and monetary union, EMU

Deputy Governor Villy Bergström held speeches today at a seminar for trade union representatives in Brunnsvik and at a meeting organised by the Study Promotion Association and JAK Bank in Orsa on the political and economic driving forces behind EMU.

"Many people consider EMU to be primarily a political project, rather than an economic one. They usually refer here to the plans for a monetary union gaining new momentum when Germany was on the brink of reunification and about to become the leading, dominant power in Europe. France's terms for agreeing to reunification were to bring about a monetary union and gain some influence over German monetary policy. Many economists expressed doubts about the construction from the start, but since the monetary union became a fact, an increasing number of them have shown a more positive attitude and some currently recommend membership of the union. Although the project is ultimately a political one, it has economic consequences," said Mr Bergström.

"The advantages are fairly obvious, such as avoiding handling different currencies when travelling or in cross-border trading. This is particularly important for smaller companies, which avoid the risk of exchange rate changes and the costs connected with handling different currencies and with currency hedging. A single currency also makes it easier for consumers to compare prices, which should lead to increased competition. However, this only applies to trade in the euro area, which amounts to around 40 per cent of Swedish foreign trade," said Mr Bergström.

"The disadvantages of a single currency are mainly connected to stabilisation policy. The interest rate and the currency will be the same for the whole area. If economic developments in small member countries such as Sweden deviate from those in the monetary union because, for instance, wages and prices increase at a different rate, problems may arise. It is no longer possible to compensate for this by strengthening or weakening the currency or by steering interest rates. This applies in particular if the country were to suffer a shock that affected only that particular country. The adjustment mechanisms available are flexible wages and prices, and fiscal policy. When interest rates and exchange rates are no longer available as economic policy instruments, the responsibility for stabilisation policy is transferred to fiscal policy. However, it should be emphasised that the differences between developments in the euro area and those in Sweden have not been very great. In recent years, Swedish economic policy has been aimed at sound central government finances and low inflation and it has mainly followed economic developments in the euro area," said Villy Bergström.

"The recent debate has nevertheless focussed on just those situations where the Swedish economy might differ from the average trend in the euro area. In these situations fiscal policy must shoulder greater responsibility for stabilising the Swedish economy. However, this is not without risk. When price rises and wage increases and a growing budget deficit no longer lead to higher interest rates, it is necessary to have other restrictions. There are already some regulations regarding the size of budget deficits and central government debt in the EU legislation, but this does not appear to be sufficient. Several of the large countries are dangerously close to these limits or have already exceeded them. To reduce the risk of a repeat of the problems in the 1970s and 1980s with rapidly increasing budget deficits, price and wage rises, it is necessary to have a credible framework for stabilisation policy similar to that for monetary policy," observed Mr Bergström.

"We stated in the Riksbank's response to the committee on 'Stabilisation policy in the monetary union' that one should examine whether it is possible to retain a clear target for economic policy, for instance, a national inflation target or some form of measure of capacity utilisation. The stabilisation policy decisions should continue to be based on an analysis of several different indicators. The important thing for credibility is that the motives for decisions and the forecasts on which they are based are reported in a clear and open manner. The current fiscal policy framework encompassing a surplus target and budget ceiling has played a decisive role in creating confidence in the Swedish economy. To go one step further and transfer some of the components of the monetary policy framework with clear targets for stabilisation policy could contribute to greater stability. It is also possible to separate stabilisation policy from the rest of fiscal policy by creating a clear process around it," said Mr Bergström.

"There are advantages and disadvantages to EMU membership and some of the stabilisation policy problems could be restricted through a clearer framework. However, it is not possible to entirely disregard these problems. For almost every argument in favour of EMU membership it is possible to find a counter-argument and vice versa. Those who see everything through rose-coloured spectacles and claim that EMU solves all problems are just as wrong as those who describe membership as total gloom and doom. Personally, when balancing arguments for and against full participation in Stage Three of EMU, I have attached special importance to the arguments pointing out that the insight and democratic control over the European Central Bank are insufficient. This was one of the arguments taken up by the Calmfors Commission and I believe it is an argument against EMU membership even now," concluded Villy Bergström.