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26/11/2007
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Eνταξη της Κύπρου στη ζώνη του ευρώ
Ομιλία
Λουκά Δ. Παπαδήμου, Αντιπρόεδρου Ευρωπαϊκής Κεντρικής
Τράπεζας
Public
lecture by Lucas Papademos, Vice President of the ECB
at the Central Bank of Cyprus
Nicosia, 26 November 2007
I. Introduction
“A day will come when all the nations of this continent,
without losing their distinct qualities or their glorious
individuality, will fuse together in a higher unity and
form the European brotherhood. A day will come when the
only fields of battle will be markets opening up to trade
and minds opening up to ideas.” It was the French writer
Victor Hugo who proclaimed these almost prophetic words
back in 1849. It is also said that Hugo planted a tree in
the grounds of his residence and predicted that by the
time this tree matured a united Europe would have come
into being. The tree has grown impressively. And it is
about to get another solid branch and fresh leaves, as the
introduction of the euro in Cyprus in just over a month’s
time will mark a further significant step on the path
towards the integration of our continent. On such a
historic occasion, I am honoured to be addressing this
distinguished audience from the Central Bank of Cyprus,
public institutions, academia and the financial sector in
Cyprus. I would like to thank Governor Orphanides for his
invitation and warm welcome, as well as the Central Bank
of Cyprus, which has organised this event in close
cooperation with the Chamber of Commerce and Industry, the
School of Economics and Management of the University of
Cyprus, and the Association for Social Reforms (OPEK).
The euro will be a tangible part of life for the people of
Cyprus as of 1 January 2008. Its introduction crowns a
broad-based reform process and a successful convergence
effort, as well as thorough preparations for the
changeover. By adopting the euro, Cyprus will take an
irreversible step towards deeper economic and monetary
integration within the euro area. One way of looking at
this milestone in Cyprus’ history is to think of its entry
into Monetary Union as being similar to a marriage. The
partners should first think carefully about it, consider
the likely consequences and be aware that a marriage
implies not only privileges, but also commitments and
responsibilities. The partners need to be prepared and
ready to live together in good times and in bad times. In
fact, entering Monetary Union is like a marriage without
the option of separation or divorce. A country that joins
Europe’s Monetary Union and those already in it becomes
part of a “community with a common destiny”. In this
sense, the dynamism of the Cypriot economy, and the
welfare of its people, will be of relevance to all
countries sharing the single currency; and equally, the
stability and prosperity of the euro area will be of
importance to the people of Cyprus. Thus, the well-being
of the family as a whole should be in the minds of all of
its members.
In my remarks today, I would like to address three
interrelated issues concerning the implications of Cyprus’
joining the euro area family. I will start by briefly
recalling Cyprus’ economic achievements in the run-up to
its accession first to the European Union (EU) and then to
the euro area. I will then look at what is needed in order
for the euro area economy to function efficiently,
focusing on the appropriate conditions and policies that
will allow individual countries to fully reap the benefits
of euro adoption. Finally , I will comment on the state of
preparations for the introduction of the euro, indicating
the elements essential to a successful changeover to the
euro in this country.
II. What are the major economic achievements and current
policy challenges in Cyprus?
On its road to the euro, Cyprus has made remarkable
progress in improving the living standards of its people,
thanks to an extended period of stability-oriented
macroeconomic policies. Income per capita has gradually
been approaching that of the euro area, increasing from
74% of the euro area average in 1997 to 85% ten years
later, while the unemployment rate has remained fairly
low, standing at between 3.5% and 5% over the past decade.
Moreover, inflation in Cyprus has for a long time been
fairly well contained, standing at levels between 2% and
3% since 1997, with the exception of 2000 and 2003, when
strong increases were observed in energy and food prices.
This satisfactory and improved inflation performance over
the past few years largely reflects a prudent and
effective monetary policy, based on exchange rate
stability, supported by efforts to liberalise product
markets and network industries. It is, therefore, not a
surprise that Cyprus is among the first of the new EU
Member States to adopt the euro. And in many respects,
Cyprus can serve as an example for other countries as
regards the question of how to successfully pursue
economic reforms and convergence.
A key feature of the policy framework in Cyprus has been
its tradition of pegged exchange rate regimes, which dates
back to the country’s independence in 1960. Exchange rate
stability, which has been effectively supported by
consistent macroeconomic policies, has been instrumental
in the expansion of trade, especially with the EU and the
euro area, which is of particular value for a small and
open economy like Cyprus. [1] In the area of fiscal
policy, progress has been made. The public debt-to-GDP
ratio in Cyprus, which peaked at 70.3% in 2004, has
gradually been declining towards the 60% reference value
laid down in the Treaty. That said, further steps will be
necessary, not least in view of future challenges, such as
an ageing population, and Cyprus’ remaining fiscal
imbalances.
In conclusion, the key factors in Cyprus’ economic success
have been the fact that inflation has remained contained
and the favourable conditions for both real and nominal
convergence. It is, therefore, fair to say – and I am
pleased to say – that Cyprus is well prepared for its
accession to the euro area. Congratulations! However, a
strong commitment to both fiscal consolidation and further
structural reform remains essential in order to reap the
full benefits of being part of Europe’s Monetary Union.
After all, the purpose of achieving sustainable
convergence is not only the fulfilment of the Treaty
requirements for the adoption of the euro. It is equally
important to achieve sustainable convergence in order to
establish the necessary conditions for enhancing market
efficiency, preserving price stability and improving
economic welfare within Monetary Union. In other words, it
is not just about making the grade, it is about being
prepared for life. Non scholae, sed vitae discimus, Seneca
reminds us, and life within Monetary Union is the topic to
which I would now like to turn.
III. What are the necessary conditions for the successful
economic performance of the euro area as a whole and the
individual member countries?
The first point to stress is that the adoption of the euro
does not mark the end of the process of convergence to
stability. Of course, a high degree of convergence has
been achieved in order to join the euro area. At the same
time, a new life starts inside Monetary Union, implying
new opportunities and challenges for sustainable growth
and stability. So what kind of family is Cyprus joining?
What are the key features of the soon-to-be-enlarged euro
area economy?
III.i Economic performance of the euro area
Cyprus will enter a large economic area representing a
zone of monetary stability with low inflation and low
interest rates. Despite the large – almost unprecedented –
number of substantial and prolonged adverse price shocks
that have hit the euro area economy over the past few
years, notably strong and persistent increases in oil
prices, the ECB’s monetary policy has succeeded in keeping
inflation under control. Annual inflation rates have
remained in the vicinity of our quantitative definition of
price stability as embodied in our objective of keeping
price increases below, but close to, 2%. At the same time,
inflation volatility has, overall, declined considerably.
As a result of this favourable track record and the
credibility of the ECB’s monetary policy, long-term
inflation expectations in the euro area, for example those
derived from long-term bond yields, have remained solidly
anchored in line with price stability. This demonstrates
that market participants have confidence in the ECB’s
ability to credibly deliver price stability over the
medium and long term, in line with its Treaty mandate.
As a result of the ECB’s credible commitment to price
stability and the effectiveness of its monetary policy,
the euro area has benefited from favourable financing
conditions, with low inflation risk premia and low and
less volatile interest rates, both in nominal and real
terms, across the maturity spectrum. The elimination of
exchange rate variability between euro area countries has
reduced the volatility of the prices of internationally
traded goods. Overall, the degree of macroeconomic
stability enjoyed by the euro area over the eight years
since the launch of the single currency has been
remarkable, both by historical standards and when compared
with that of other major economies, such as the United
States.
Another important feature of the euro area economy is its
significant ongoing structural adjustment as a result of
the completion of the internal market, including the
increasing integration of financial markets, and the
implementation of reforms in most Member States aimed at
strengthening competition, increasing market flexibility
and efficiency, and raising labour utilisation. The
integration of markets and the creation of the single
European currency have had mutually reinforcing positive
effects.
More specifically, greater price transparency across the
euro area and reduced transaction and information costs
foster competition and promote trade, with favourable
effects on prices, investment and employment. As a result
of these effects and the impact of labour market reforms,
unemployment in the euro area has reached low levels not
seen for 25 years, with the unemployment rate having
declined sharply to stand at 7.3% in September 2007.
Monetary Union has also fostered financial integration
within the euro area, which – together with the use of the
euro as an international currency – has contributed to a
significant increase in savings, investment and funding
opportunities for euro area households and firms. Finally,
the euro area has been more resilient with regard to
external developments and less vulnerable to exchange rate
movements than its individual member countries were before
the introduction of the euro. The financial market turmoil
has also demonstrated that the ECB and the Eurosystem, as
a collegial team, have the capacity, when necessary, to
act in a decisive, swift and effective manner to ensure
that orderly conditions are preserved in money markets and
that the potential impact of financial shocks on the
economy is mitigated.
III.ii Economic divergence in the euro area
So far, I have looked only at the euro area as whole. As a
representative of a supranational institution, this is in
fact my privilege and duty. However, looking only at the
aggregate data for the euro area as a whole also has its
limitations, and average figures can conceal significant
differences in performance. There is some degree of
divergence in the economic performance of individual euro
area countries, especially as regards their inflation,
growth and competitiveness performance, and it is
important to understand the causes and potential
consequences of that divergence.
The level of dispersion seen in inflation rates in the
euro area has declined substantially since 1999, standing
at a level much lower than that of the previous decade,
and is now broadly similar to that observed in the United
States. [2] However, differences in growth rates among
euro area countries have diminished only marginally over
the past few decades, fluctuating, on average, around 2
percentage points, with no apparent upward or downward
trend. Again, the growth differentials observed across the
various regions of the United States are similar. With
regard to unit labour costs, which are a key determinant
of price competitiveness across countries, dispersion
among euro area economies has declined markedly over the
past few decades, and its magnitude is broadly in line
with what we are seeing in the United States. However, in
recent years we have observed some worrying developments.
Although inflation and growth differentials across the
euro area are not unusually large, we should nevertheless
seek to understand their causes and nature given their
potential implications for future economic performance. A
first significant finding of empirical analysis is that
the dispersion of growth rates across the euro area can
largely be explained by differences in trend output growth
– reflecting structural factors such as the effects of
reforms recently implemented – rather than different
cyclical developments. To the extent that such differences
in trend output growth are related to normal and positive
catching-up processes in the economies of some countries
or are the consequence of persistent idiosyncratic shocks,
they are not a cause for concern per se and need not have
longer-term detrimental effects on inflation, economic
activity and job creation. On the contrary, they may be
seen as a manifestation of a desirable equilibrating
mechanism, contributing to sustainable convergence among
euro area countries.
A second salient feature of the divergence observed in
economic performance across the euro area countries is its
persistence. Very often the same set of countries are
characterised by developments in key economic variables
that are systematically either above or below the euro
area average. This may suggest that the underlying
adjustment mechanisms in the euro area economies are not
functioning as smoothly or swiftly as they should. If the
persistence of higher than average inflation and stronger
than average unit labour cost growth reflects structural
rigidities in a country’s economy and the implementation
of inappropriate policies, this is a matter of concern
because of the likely adverse effects on competitiveness,
long-term growth and employment creation.
III.iii Necessary conditions and appropriate policies for
the efficient functioning of Monetary Union
To optimise the economic performance of Monetary Union, to
fully reap its potential benefits in terms of economic
dynamism and welfare, job creation and increased per
capita income, it is crucial to improve the functioning of
product, labour and financial markets. To this end,
well-designed and effectively implemented structural
reforms and sound fiscal policies are essential in all
euro area countries. Since monetary policy and the
exchange rate are no longer available at the national
level as policy instruments and a means of adjusting to
specific shocks and the challenges posed by globalisation,
other adjustment mechanisms become even more important.
In this context, wage and price flexibility plays a
pivotal role. The smooth functioning of the price
mechanism is a prerequisite for the efficient allocation
of resources across different sectors and over time. In
the same vein, the mobility of capital and labour across
countries and regions and between different sectors is of
particular importance in a monetary union. It is therefore
essential that governments establish an institutional
framework which allows the economic adjustment processes
to function efficiently and effectively, and which helps
to set appropriate incentives for economic agents and thus
enhances the overall growth performance of the economy.
In this respect, I am pleased to say that substantial
progress has been made over the past few years. Previous
labour market reforms, for example, have contributed to
robust employment growth and lower unemployment rates in
the euro area. In Cyprus, the labour market is already
relatively flexible, with significant flows of foreign and
seasonal workers, which exert a favourable influence on
economic activity and domestic unemployment and contain
inflationary pressures.
However, further progress is needed. In Cyprus, too,
additional structural reforms are essential. For instance,
the indexation mechanism for salaries should be overhauled
and ultimately eliminated in order to reduce the risk of
inflation inertia, which will eventually have adverse
effects on real income. Such reforms will, therefore, not
only make the economy less vulnerable to shocks, but also
improve the conditions for sustainable economic growth and
job creation. Of course, the implementation of reforms is
greatly facilitated if there is public acceptance of them.
This is a formidable challenge which should be effectively
addressed. President Woodrow Wilson observed that “the
most ardent reformers have had to learn that too far to
outrun the […] masses was to render themselves powerless”.
It is, therefore, crucial to explain clearly and
convincingly to the public that any short-term adjustment
costs associated with structural reforms will be more than
outweighed by their long-term benefits in terms of
stronger income and employment growth.
The other essential condition for the efficient
functioning of Monetary Union is the implementation of
sound fiscal policies. These contribute to a stable
macroeconomic environment, they provide room for manoeuvre
in order to cushion the effects of the business cycle and,
by reducing debt-servicing costs, and they allow
governments greater scope for pursuing economic and social
objectives. In recognition of these benefits, and in view
of the observed propensity of governments to spend more
than they receive in revenue, Monetary Union has been
complemented by a set of fiscal rules to ensure fiscal
discipline, notably the Stability and Growth Pact. Within
a monetary union, budgetary developments in one country
are a matter of common concern for all, because all
countries have to deal with the negative consequences of
inappropriate fiscal policies.
The Stability and Growth Pact allows for the effective
surveillance and coordination of Member States’ budgetary
policies. The Pact is based on a system of “peer support”
which should be positively embraced by national
governments in the planning and execution of their
budgets. For countries with fiscal imbalances, this
implies, for example, the use of windfall tax revenues for
fiscal consolidation rather than for additional spending
or tax cuts. Most importantly, the Pact provides the
appropriate policy framework for addressing
country-specific fiscal challenges.
In the case of Cyprus, the fiscal deficit has declined,
but the government has yet to reach its medium-term
budgetary objective. To this end, an annual improvement in
the structural balance of 0.5 percentage point of GDP is
necessary and required by the provisions of the Pact.
Budgetary plans for 2008 are difficult to reconcile with
this consolidation benchmark. The current favourable
macroeconomic environment provides a window of opportunity
for progress towards achieving a sound medium-term fiscal
position sooner rather than later. After all, as has been
said before, the best time to repair the roof is when the
sun is shining! Therefore, it would not be appropriate to
succumb to any siren songs urging the use of the current
strong revenues to finance increases in expenditure. A
structural weakening of the budgetary position will sow
the seeds of a rapid deterioration in public finances when
economic developments turn out to be less favourable than
expected.
Beyond this, there are further fiscal challenges which
should be kept in mind, for instance those related to the
projected substantial increases in public expenditure
pertaining to population ageing, which is in fact already
among the highest in the EU. It is, therefore, essential
that sufficient room for manoeuvre be created in public
finances before the demographic situation worsens.
Moreover, depending on the specific economic and fiscal
arrangements, a possible reunification of Cyprus could
impose substantial budgetary costs.
Another pertinent issue is the need to improve the quality
of public finances, which can help enhance business and
growth conditions and allow for a reduction in the overall
level of public spending. In Cyprus, as in many other euro
area countries, public expenditure is still high by
international standards. A leaner public sector could be
more efficient and, at the same time, more effective. In
this context, moderate wage developments that take into
account labour productivity growth, labour market
conditions and developments in competitor countries can
make an important contribution to fiscal consolidation and
employment growth.
To sum up, experience has shown that the economic
well-being of individual countries participating in
Monetary Union depends on their ability and willingness to
effectively implement sound fiscal policies and structural
reforms. As we know, there are a number of countries that
have managed to fully reap the benefits stemming from
membership of the euro area, while other countries have
performed in a less satisfactory manner than could
legitimately have been expected by their citizens. But
this undesirable outcome and policy failure is certainly
not the fault of the euro.
Finally, membership of the euro area also brings with it
the privileges and responsibilities of participation in
joint decision-making. As a member of the ECB’s Governing
Council, Governor Orphanides will also contribute to
decisions on the monetary policy stance. Likewise, the
staff of the Central Bank of Cyprus will be fully
integrated into the work of the Eurosystem committees,
working groups, task forces, etc. that play an important
role in the Eurosystem’s functioning. Naturally, we at the
ECB and in the Eurosystem are very pleased to have
Governor Orphanides as a new member of the Governing
Council and to welcome the Central Bank of Cyprus into the
“Eurosystem team”. Last, but by no means least, Cyprus, as
a euro area member country, will also be involved in the
decision-making as regards all other issues pertaining to
Monetary Union.
IV. What is needed for a successful changeover to the
euro?
Will the euro be a success story in Cyprus, too? I am
confident that it will be. But the extent of the success
will depend, as I have argued and as the experience of
other countries suggests, on several factors. It will
depend on whether the people in this country using the new
currency believe in its stability. In this respect, the
ability of the ECB to credibly deliver price stability for
the euro area as a whole should be reassuring. It will,
furthermore, depend on the implementation of appropriate
policies. And it will also depend on whether the people of
Cyprus have confidence in the safety and integrity of
their new currency. An important aspect in this context is
a smooth cash changeover to the euro – logistically, in
terms of public information and as regards the conversion
of prices.
I am pleased to say that with regard to the technical
aspects of the changeover, Cyprus is on the right track.
Numerous tasks involving many different areas of expertise
have either been completed or are being completed: the
selection of the designs for Cypriot euro coins, the
printing and distribution of notes, and the preparation
and translation of comprehensive campaign material to make
the people of Cyprus familiar with the visual appearance
and security features of the euro banknotes and coins, as
well as with the modalities of the cash changeover.
Unquestionably, a well-informed public is crucial for the
successful introduction of the new currency. Drawing on
the positive experience of previous changeovers, such as
that of Slovenia at the beginning of this year, various
communication channels are being used. There are ten
different publications in Greek, Turkish and English;
350,000 information leaflets are currently being
distributed to all Cypriot households; media seminars have
been organised. In all of this, we have paid particular
attention to vulnerable groups. I personally was
particularly impressed by the “talking cards”. Following
consultations with associations for the blind, we
developed an audio file which allows visually impaired
people to receive the relevant information on the cash
changeover and the euro.
The information campaign has been very intensive, not only
in terms of financial and human resources, but also in
terms of coordination efforts among all relevant parties,
including the Central Bank of Cyprus, the ECB, the Cypriot
Ministry of Finance and the European Commission. After the
changeover, we will evaluate the campaign, and I expect
that the countries seeking to join the euro area at a
later stage will be keen to learn from Cyprus’ experience.
In the remainder of this year, some final preparations are
still necessary. The delivery of coins, minted by the Bank
of Finland, and the delivery of banknotes, provided by the
Bank of Greece from the Eurosystem stock, has started. And
in a week’s time starter kits for the public will be
distributed. The dual circulation of the Cyprus pound and
the euro will last one month. Afterwards the euro will be
the sole legal tender in Cyprus, but Cyprus pound coins
can be exchanged for two more years and banknotes for ten
more years at the Central Bank of Cyprus.
Finally, let me reassure you that we are taking the
concerns of the people of Cyprus very seriously as regards
possible unwarranted price increases in the context of the
euro changeover. We have to monitor the situation
carefully to ensure that prices are converted properly and
the euro changeover does not provide an opportunity to
raise prices in an unjustified manner. Having seen the
positive outcome of price-watching in this country, it is
clear to me that Cypriots are vigilant consumers. We are
aware that food and oil prices have been rising noticeably
in recent weeks, and some people may come to attribute
these increases to the changeover to the euro. But let me
emphasise that this is not a phenomenon affecting only
Cyprus. All of the citizens of the euro area are,
regrettably, confronted with these price increases, which
are mainly due to supply constraints in international
markets. It might be easy to blame the euro. But it would
not be right! If anything, the euro has actually helped to
dampen the rise in oil prices, given its recent
appreciation on the foreign exchange markets.
V. Concluding remarks
In just over one month’s time, Cyprus will be part of the
euro area. It will join a large economic area that last
year accounted for around 15% of world GDP and is a zone
of monetary stability characterised by sound economic
fundamentals. The euro area economy is expected to
continue to grow at rates close to trend potential.
However, this positive outlook is currently surrounded by
heightened uncertainty and is subject to downside risks.
The ongoing process of risk reappraisal and repricing in
financial markets could be more protracted than previously
expected and may have a broader impact on financial
markets and the economy. This process can be seen as a
correction of the underpricing of risks seen in recent
years, especially those risks associated with particular
segments of the markets for credit and structured finance
products. At the same time, the tensions and volatility
experienced in some financial markets underline the
importance of effective methods and prudent practices in
the assessment and management of risk by financial
institutions and investors. This is essential in order to
ensure that the benefits of financial innovation for
market efficiency and economic growth are safeguarded by
means of adequate risk management and sufficient market
discipline. The ECB will continue to pay great attention
to financial market developments in the coming period and
will take the necessary measures to ensure the orderly
functioning of the money markets.
The outlook for price stability is also subject to a
number of upside risks. Inflation in the euro area, which
accelerated to 2.6% in October from 2.1% in September, is
expected to remain at an elevated level significantly
above 2% in the coming months, before moderating again in
the course of 2008. The acceleration of inflation in the
euro area is due to the unfavourable impact of
developments in energy and agricultural prices, which
could persist for some time. Moreover, there is a risk of
wage developments being stronger than has been seen to
date and stronger than currently expected, given the
existence of capacity constraints in some markets and the
improved labour market conditions. It is, therefore, of
the utmost importance that the increase in inflation does
not affect medium to long-term inflation expectations and
second-round effects are avoided.
The ECB is prepared to act in an effective and timely
manner to ensure that risks to price stability over the
medium term do not materialise and inflation expectations
remain firmly anchored in line with price stability. This
is all the more important at times of financial market
volatility and heightened uncertainty. At the same time,
given this uncertainty, continuous and very close
monitoring of all developments is necessary and a thorough
examination of additional information is warranted before
further conclusions are drawn regarding the monetary
policy stance needed to preserve price stability over the
medium term.
The current conjuncture seems to point to an
uncomfortable, though temporary, combination of higher
inflation and somewhat slower economic growth in the
coming months. Inflation risks and financial market
volatility confront us with significant challenges. It
should be clear, however, that the maintenance of price
stability over the medium term is the primary objective of
the ECB’s monetary policy. It should also be apparent that
being inside a monetary union provides an economy with a
shield that can help to weather a potential storm that
could adversely affect economic activity and inflation.
That said, the privilege of enjoying this protection and
its effectiveness are intertwined with the responsibility
of each country to keep its own house in order and make
its own contribution to the prosperity of the monetary
union as a whole. In other words, and to come back to my
initial metaphor, it is just like a real family, where the
joys and comfort of togetherness are complemented by
mutual commitments and shared responsibilities. With these
words, let me conclude: Congratulations again, and welcome
to the euro area family!
Κύπρο, καλωσόρισες!
________________________________________
[1] In 2006 export and import ratios stood at around 50%.
In the same year exports of goods to the euro area and the
EU accounted for 51% and 69% of total exports
respectively, compared with figures of 17% and 28% in
1997. The corresponding figures for imports as a
percentage of total imports were 55% and 67% in 2006,
compared with 34% and 48% in 1997.
[2] At the beginning of the 1990s the level of dispersion
of inflation rates across the euro area countries was, on
average, around 6 percentage points (standard deviation
measured in unweighted terms). In 2006 inflation
dispersion was only 0.7 percentage point. This implies
that dispersion in the euro area is currently broadly in
line with inflation dispersion among the key 14 US
Metropolitan Statistical Areas, where it has fluctuated
around 1% in the last two decades.
European Central Bank
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Press and Information Division
Kaiserstrasse 29, D-60311 Frankfurt am Main
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