E U R O P E A N M O N E T A R Y I N S T I T U T E

May 1998

A N N U A L R E P O R T

1 9 9 7

II

© European Monetary Institute, 1998

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ISSN 1024-560X

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III

Foreword

Executive Summary 1

Chapter IEconomic, monetary and financial conditionsin the European Union

1 Economic and financial background in 19971.1 Major developments outside the EU 161.2 Macroeconomic developments in the EU 211.3 Achievements in macroeconomic convergence 26

2 Monetary policies in Member States2.1 Further convergence of interest rates 282.2 Monetary policies in individual Member States 29

3 Economic prospects and challenges3.1 Economic outlook for 1998-99 363.2 Monetary policies in the remainder of Stage Two 37

Chapter II

Preparatory work for Stage Three

1 Monetary policy1.1 Monetary policy strategy 421.2 Implementation of the single monetary policy 42

2 Foreign exchange policy2.1 The ERM II 462.2 Foreign exchange intervention and the management of the ECB’s foreign

reserve assets 462.3 Guidelines for the NCBs’ and Member States’ operations with their foreign

reserve assets 462.4 The euro reference exchange rates 472.5 The pre-announcement of the bilateral rates to be used in determining the

irrevocable conversion rates for the euro 47

3 Statistics3.1 Implementation of the statistical requirements for Stage Three 493.2 Organisation of statistical work at the European level 513.3 Legal aspects 523.4 Information systems infrastructure 52

4 Payment systems4.1 The TARGET system 534.2 Securities settlement systems 54

Contents

IV

5 Preparation of euro banknotes 56

6 Accounting issues 58

7 Information and communications systems 59

8 Banking supervision and financial stability 61

9 Legal issues9.1 Legal convergence 649.2 Secondary Community legislation 65

10 Changeover to the euro 66

11 Public information 69

Chapter III

Other tasks of the EMI

1 Oversight of the ECU Clearing and Settlement System1.1 Activities of the ECU Clearing and Settlement System in 1997 721.2 Preparatory work for Stage Three of EMU 72

2 Electronic money 74

3 Co-operation in the field of banking supervision and financial stability3.1 Performance and stability of the EU banking systems in the medium

and long term 763.2 The use of macroeconomic data in the supervisory process 783.3 Other issues 79

4 Administration of EMS mechanisms and Community loans4.1 EMS mechanisms 814.2 Community loans 81

5 Advisory functions 83

6 Monitoring of compliance with the prohibition on monetary financingand on privileged access 86

7 Co-operation with other institutions 87

Annual Accounts of the EMI 89

V

Annexes

Excerpts from the Convergence Report (March 1998) 100Joint Communiqué on the determination of the irrevocable conversionrates for the euro, dated 2 May 1998 107Glossary 112Chronology of monetary measures taken in the EU in 1997 121Other EMI publications 126

VI

List of Boxes, Tables and Charts*

Boxes

1 Evolution of the Asian crisis in 1997 19Table: Asset price changes in Asian markets 20

2 Characteristics of the euro area 38Table: Key characteristics of the euro area, 1997 39

3 Opinion of the EMI on the issuance of electronic money 74

Tables

1 Recent developments in real GDP growth 212 Composition of growth in the EU in 1997 233 Trade and current account balances in the EU 244 A comparison of national and EUROSTAT unemployment data 265 Economic indicators and the Maastricht Treaty convergence criteria 276 Monetary policy targets and guidelines of Member States 31

(a) Monetary aggregates - targets and guidelines(b) Formal inflation targets

7 Outstanding Community loans 828 Consultation procedures 839 ERM bilateral central rates to be used in determining the irrevocable

conversion rates for the euro 108

Charts

1 Main developments in major industrialised economies 182 Unemployment rates 253 Official and key interest rates 304 Short-term interest rate differentials against Germany 33

* Convention used in the Report:

Aggregate EU-15 figures in this report are generally constructed using purchasing parity exchange rates inorder to weight the individual national data. However, trade data use actual exchange rates in 1993. Ratesand indices (except CPI) are based on 1993 GDP weights, while CPI is based upon consumer spendingweights.

This report was finalised in early May 1998.

* Convention used in the tables:“ - ” Not applicable“ . ” Not available“ ...” Nil or negligible

VII

* In accordance with Community practice, countries are listed in this Report using the alphabetical order of thenational languages.

Abbreviations

Countries*

BE BelgiumDK DenmarkDE GermanyGR GreeceES SpainFR FranceIE IrelandIT ItalyLU LuxembourgNL NetherlandsAT AustriaPT PortugalFI FinlandSE SwedenUK United KingdomJP JapanUS United States of America

Currencies

E euroBEF/LUF Belgian/Luxembourg francDKK Danish kroneDEM Deutsche MarkGRD Greek drachmaESP Spanish pesetaFRF French francIEP Irish poundITL Italian liraNLG Dutch guilderATS Austrian schillingPTE Portuguese escudoFIM Finnish markkaSEK Swedish kronaGBP Pound sterlingJPY Japanese yenUSD US dollar

VIII

Back row (left to right): A. Fazio, P. Jaans, M. O’Connell, U. Bäckström, A. de Sousa,A. Verplaetse, J.-C. Trichet, N. Wellink, L. Papademos, K. Liebscher, E. George.

Front row: H. Tietmeyer, S. Hämäläinen, W. Duisenberg (President), L. Rojo (Vice-President), B. Andersen.

IX

Council of the EMI

A. Lamfalussy (until 30 June 1997) President of the EMIW. Duisenberg (as of 1 July 1997)

L. Rojo Banco de España andVice-President of the EMI

A. Verplaetse Nationale Bank van België/Banque Nationale de Belgique

B. Andersen Danmarks Nationalbank

H. Tietmeyer Deutsche Bundesbank

L. Papademos Bank of Greece

J.-C. Trichet Banque de France

M. O’Connell Central Bank of Ireland

A. Fazio Banca d’Italia

P. Jaans Institut Monétaire Luxembourgeois

W. Duisenberg (until 30 June 1997) De Nederlandsche BankN. Wellink (as of 1 July 1997)

K. Liebscher Oesterreichische Nationalbank

A. de Sousa Banco de Portugal

S. Hämäläinen Suomen Pankki

U. Bäckström Sveriges Riksbank

E. George Bank of England

X

Planning Section

Library Section

Translation Section

Premises Section

External Services Section

Financial Markets

Director General

President

Policy Division

General SecretariatMonetary, Economics

and Statistics Department

Senior AdviserInformation and Communications Systems Division

Personnel and Office Services Division

Support, Develop-ment and Infra-

structural Projects

ECB Projects and IT Planning

ESCB Projects

Stage Two Division

Administration Department

Press Office

Public InformationAdviser to the President

EMI Council Secretariat and

Archives

EMS/ECU Section

Legal Division

Recruitment and Personnel Policy

Section

Salaries and Benefits Section

Office Services and Security Section

Management Services Division

Controlling and Organisation Section

Accounting Section

E U R O P E A N M O N E T A R Y I N S T I T U T E

Economic and Monetary

Analysis Section

Fiscal Analysis

Country Analysis

Stage Three Division

Monetary Strategy Section

Monetary Framework Section

General Studies

Statistics Division

General Economic andFinancial Statistics

Statistical Information Systems and Divisional

Administration

Money and Banking Statistics Section

Balance of Payments and External Reserves

Statistics Section

Secretariat of the Working Group on EU Payment Systems and Securities

Settelment Systems

Payment Systems Policy Section

TARGET Section

Banking Supervisionand Risk Analysis

Internal Audit

Monetary Policy Sub-Committee

Secretariat

Information andCommunications

Systems Department

XI

EMI Management

A. Lamfalussy (until 30 June 1997) PresidentW. Duisenberg (as of 1 July 1997)

R. Raymond Director General

H. K. Scheller Secretary General,Head of General Secretariat

G. J. Hogeweg Head of Monetary, Economics andStatistics Department

P.-W. Schlüter Head of Administration Department

J. Etherington Head of Information and CommunicationsSystems Department

L. Hoogduin Adviser to the President

Back Row (left to right): J. Etherington, P.-W. Schlüter, G. J. Hogeweg, L. HoogduinFront Row: R. Raymond, W. Duisenberg, H. K. Scheller

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Financial Committee

L. Rojo Banco de España

J.-C. Trichet (until 31 August 1997) Banque de FranceH. Tietmeyer (as of 1 September 1997) Deutsche Bundesbank

E. George (until 31 August 1997) Bank of EnglandM. O’Connell (as of 1 September 1997) Central Bank of Ireland

Chairpersons of the Committee of Alternates,Sub-Committees and Working Groups

R. Raymond Committee of Alternates

J.-J. Rey Monetary Policy Sub-Committee

F. Saccomanni Foreign Exchange Policy Sub-Committee

T. de Swaan (until 5 January 1998) Banking Supervisory Sub-CommitteeE. Meister (as of 6 January 1998)

W. Hartmann Working Group on EU Payment Systems

A. Jarvis Working Group on Printing and Issuinga European Banknote

K. Hanau (until 14 April 1997) Working Group on StatisticsR. Álvarez (as of 15 April 1997)

H. Heemskerk Working Group on Accounting Issues

Y. Barroux (until 14 April 1997) Working Group on Information SystemsA. Nicolle (as of 15 April 1997)

J. Guill Working Group of Legal Experts

M. Caparello TARGET Audit Group

Financial CommitteeEMI CouncilCommittee of

Alternates

MonetaryPolicySub-

Committee

ForeignExchange

PolicySub-

Committee

BankingSupervisory

Sub-Committee

WorkingGroup

onEU Payment

Systems

WorkingGroupon the

EuropeanBanknote

WorkingGroup

onStatistics

WorkingGroup

onAccounting

Issues

WorkingGroup

onInformation

Systems

WorkingGroup

ofLegal

Experts

TARGETAuditGroup

Foreword

XIV

The Annual Report of the EuropeanMonetary Institute (EMI) for 1997 is thefourth and last such document to bepublished by the Institute. The final phase ofthe transition to Stage Three started withthe confirmation by the Heads of State orGovernment on 2/3 May 1998 of theMember States which fulfil the necessaryconditions for the adoption of the singlecurrency and the pre-announcement ofthe bilateral exchange rates to be used indetermining the irrevocable conversion ratesfor the euro. Since the beginning of 1994the EMI, in close collaboration with nationalcentral banks of the European Union (EU),has undertaken the necessary technicalpreparations for the establishment of theEuropean System of Central Banks (ESCB),the conduct of the single monetary policyfor the euro area and the creation of thesingle currency. This task will be completedby its successor, the European CentralBank (ECB).

As in past years, the Report describes theeconomic, monetary and financial situationin the EU in 1997, outlines the activities ofthe EMI and includes its annual accounts.

As regards the overall macroeconomicsituation in the EU, the recovery appears tobe gathering strength, and the crisis in Asiahas not apparently had a significant adverseeffect on economic growth to date. It is

particularly encouraging to see that domesticdemand is picking up across the EU and ismaking a major contribution to real GDPgrowth. That said, it is disappointing to notethat fixed investment growth remainshistorically weak in a number of countries,despite favourable underlying fundamentals.Moreover, the performance of the EUlabour market is still unsatisfactory. Thehigh levels of youth and long-termunemployment, as well as the lack ofsustained job creation, point to the structuralnature of a major part of EU unemploymentand the need for countervailing structuralmeasures to increase market flexibility.

Meanwhile, the rate of inflation in the EU in1997 was at its lowest level for many years,with an increasing number of countriesrecording inflation of 2% or less. By andlarge, the first stage of the upturn is notgiving rise to significant inflationary pressures,thus enabling low interest rates to bebroadly maintained in the majority of EUcountries and significant declines in interestrates to occur in a number of others. Forthe countries adopting the single currency,it will be essential to maintain thisenvironment of broad price stability and toensure that the emerging common level ofshort-term interest rates is consistent withprice stability in the euro area as a whole.

As highlighted in the EMI’s recentexaminat ion of macroeconomicconvergence, further challenges for thefuture relate to fiscal policy. In particular,with regard to the future euro area, it isimperative that all Member States shouldre-establish as soon as possible a degree ofbudgetary flexibility which will allow themto respond to adverse cyclical developments.Such flexibility will be ensured by achievinga fiscal position close to balance or insurplus over the medium term. In somecases substantial and persistent overall fiscalsurpluses will also be necessary in order toreduce the burden arising from very highratios of debt to GDP, render nationalbudgets less vulnerable to changes in interest

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rates and prepare for the impact on publicfinances of the ageing of the population.

Preparatory work for Stage Threeproceeded as planned in 1997 in strictcompliance with the timetable. From amongthe many areas in which we achievedsignificant results, I should like to mentionthe following in particular:

in the field of strategy, progress withregard to the identification of suitablecandidate strategies for Stage Three(elaborating an agreed set of keyelements which will characterise theESCB’s strategy) and the developmentof the analytical and econometricinfrastructure necessary to supportmonetary policy decision-making;

definition of the technical specificationfor the ESCB’s operational frameworkand the setting-up of the tools and ITsystems necessary for the implementationof the future monetary policy of theESCB;

marked progress towards theimplementation of the statist icalrequirements for the conduct of the

single monetary policy in Stage Three,thus enabling data compiled in line withthe new agreed basis to be madeavailable to the ECB during the courseof 1998;

finalisation of a draft agreement on theERM II, to be endorsed by the ECB;

progress with regard to organisationalaspects, implementation and testing ofthe ESCB’s IT infrastructure and theTARGET system; and

publication of the final designs for theeuro banknotes.

In its short life the EMI has carried outthorough technical preparations for StageThree of EMU which now enable us tolook forward with confidence to theintroduction of the single currency at thebeginning of 1999. The solid foundationslaid by the EMI should help the ESCB/ECBto develop into a strong institution whichwill pursue its primary objective ofmaintaining price stability in the euro areain a determined manner, thereby providingthe conditions necessary for sustainedeconomic growth.

Frankfurt, 5 May 1998

Wim DuisenbergPresident

XVI

Executive summary

2

Executive summary

The Annual Report 1997 is the last reportto be published by the European MonetaryInstitute (EMI). As in the previous threeAnnual Reports, the EMI aims to provide anoverview of all aspects related to its tasks asset out in the Treaty establishing theEuropean Community. 11111 In accordance withArticle 11 of the EMI Statute, the Reportcovers both economic, monetary andfinancial conditions in the Community up tothe end of 1997 and the activities of theEMI; it also presents the Institute’s annualaccounts. As in the past, the materialpresented in this year’s Report draws to asignificant extent on earlier, more extensiveEMI publications. In particular, in March1998 the EMI published its ConvergenceReport in fulfilment of Article 109j (1) of

the Treaty. Moreover, the “Second progressreport on the TARGET project” waspublished in September 1997 and in thesame month “The single monetary policy inStage Three: General documentation onESCB monetary policy instruments andprocedures” was issued. A list of documentspublished by the EMI in 1997 and early1998 is provided at the end of this Report.

The confirmation on 2/3 May 1998 by theHeads of State or Government of theMember States which will adopt the singlecurrency heralded the start of the finalphase of the transition to Stage Three,which includes the establishment of theESCB and the ECB and the liquidation ofthe EMI.

1 Economic, monetary and financial conditions in theEuropean Union

Economic and financial background in 1997

Global economic conditions continued tobe broadly favourable in 1997, with thenotable exception of developments in Asiaduring the latter half of the year. Initially,real GDP growth in the EU followed thepattern of subdued developments alsoobserved in early 1996. However, the paceof economic activity quickened thereafterand, from the second quarter onwards, thegrowth rate was significantly higher than inthe comparable period of 1996. The crisisin Asia did not have a significant adverseimpact on growth in 1997. Average realGDP growth for the EU is estimated tohave been 2.7%, which is significantly higherthan the rate of 1.7% recorded in 1996.The acceleration in activity was widespread,with stronger growth being recorded inalmost all EU countries, although therecontinued to be differences in the strengthof economic activity.

For the Union as a whole, the improvedreal growth performance in 1997 wasprincipally due to domestic demand. Forthe fourth successive year, net trade ingoods and services provided a positive,albeit small, stimulus to growth, underpinnedby subdued growth in relative unit labourcosts and, as a result, improvements incompetitiveness. The rise in domesticdemand was linked to an improvement ininvestment growth and an increase instockbuilding, while growth in privateconsumption was unchanged andgovernment consumption was weaker thanin 1996. However, continuing the pattern

1 References to the Treaty are references to theTreaty establishing the European Community,unless indicated otherwise. References to the EMIStatute or the ESCB/ECB Statute are references toProtocol No. 4 on the Statute of the EuropeanMonetary Institute and Protocol No. 3 on theStatute of the European System of Central Banksand of the European Central Bank respectively.These Protocols are attached to the Treaty andform an integral part thereof.

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observed since the early 1990s, fixedinvestment growth in 1997 - althoughstronger than in the previous year -continued to be below the levels typical ofpast decades, despite satisfactory profitmargins and a high level of industrialconfidence, as well as relatively high capacityutilisation rates for the manufacturing sector.Both exports and imports grew considerablymore strongly than in 1996, partly reflectingthe resurgence of growth within the EU(which increased intra-EU trade) andbuoyant economic conditions globally.

Against the background of strengtheningeconomic growth in the EU as a whole,employment has increased only marginally,while unemployment has remained stubbornlyhigh. The unemployment rate for the EU asa whole (measured on the basis ofEUROSTAT data) fell slightly during thecourse of 1997, from 10.8% in the fourthquarter of 1996 to 10.5% in the fourthquarter of 1997. Of particular concern arethe much higher levels of youth and long-term unemployment. The concentration ofunemployment in these categories as wellas the persistence of subdued employmentcreation point to the structural nature of amajor part of EU unemployment and to thecontinued need for structural measures.

Concerning achievements in macroeconomicconvergence, in accordance with Article109j (1) of the Treaty, at the end of March1998 the EMI presented its report to theEU Council on the progress made in thefulfilment by the Member States of theirobligations regarding the achievement ofEconomic and Monetary Union. ThisConvergence Report included anexamination of the achievement of a highdegree of sustainable convergence byreference to the fulfilment by each MemberState of the convergence criteria, as set outin the Treaty. It therefore covered theperformance of individual EU countries interms of the degree of price stability,government debt and deficit positions, long-term interest rates and exchange rates. The

summary of the examination of convergenceby the EMI, which included developmentsin 1997, is provided in an annex to thisAnnual Report.

Monetary policies in Member States

As regards monetary policies, the economicand financial environment in 1997 allowedfor a continuation of the convergence ofshort and long-term interest rates andbroadly stable exchange rates. The majorityof EU countr ies (namely Belg ium/Luxembourg, Denmark, Germany, France,the Netherlands, Austria, Finland andSweden) broadly maintained low interestrates. This mirrored a situation of pricestability against a background of narrowing- but generally still negative - output gaps,benign wage behaviour and theconsolidation efforts of fiscal authorities.Official and key interest rates remained atlow and closely aligned levels, althoughthey were raised to a small extent in theautumn in response to inflation risks. Theconcerted nature of these policy actionsstrengthened the cohesion among thosecountries with closely aligned interest rates.

Several other Member States (Spain, Italy,Portugal and initially also Greece) wereable to continue the process of reducinginterest rates in line with the degree ofconvergence of their overall economicfundamentals, notably in respect of theachievement of price stability, with thecountries referred to in the paragraphabove. Short and long-term interest rates inthese countries thus tended to follow adownward trend, progressively convergingtowards the lower level of the closelyaligned countries. Monetary policy in thetwo remaining EU countries (namely Irelandand the United Kingdom) was tightened,albeit to differing degrees, in response bothto buoyant economic and monetary growthand to heightened inflation risks againsta background of continued soundfundamentals. The widening of short-term

4

interest rate differentials against Germanywas accompanied by a further strongappreciation of the respective currenciesvis-à-vis the Deutsche Mark. Later in theyear, however, short-term interest rates inIreland began to decline relative toGermany and the Irish pound moved closerto its central rates in the ERM grid.

Economic prospects and challenges

Economic forecasts released by majorinternational organisations in spring 1998suggest that growth prospects for the EU in1998 and 1999 are favourable, as domesticdemand should strengthen further, offsettingto some extent an expected deteriorationin the external environment due to, interalia, the crisis in Asia. The continuation ofstabi l i ty-or iented monetary pol ic iescombined with wage moderation, with thelatter partly reflecting the persistence ofrelatively high rates of unemployment, andstill negative output gaps in certain countriesare expected to limit inflationary pressures.In addition, the decline in oil prices, providedthat it is by and large sustained, and thecounter-inflationary impact of the Asiancrisis - arising from a depreciation of certainAsian currencies and the moderation ofglobal growth - should contribute todampening inflationary pressures from theoutside. Risks to the inflation outlook relateto, inter alia, the possibility of a faster thanexpected pick-up in aggregate demand inthe EU and thus to a closing of output gaps,the development of wages, a furtherappreciation of the US dollar and, in thelight of the latest OPEC agreement, asustained reversal of the recent decline inoil prices. The main uncertainty with regardto the above outlook stems from theexternal environment. World output andtrade growth are expected to be weaker in1998 and 1999 than in 1997 owing to asharp decline in real GDP growth in partsof Asia, a modest slowdown in the USgrowth rate and a deterioration in theeconomic and financial situation in Japan.

The extent of the weakness in the externalenvironment arising from the turmoil inAsia will depend on the scope and timing ofthe adjustment of macroeconomic policiesin the countries affected and on the extentto which financial reforms are implemented.The possibility of further spillover effectscannot yet be ruled out. The contractionaryimpact of the Asian crisis on EU growthmay be partly offset by two factors: first, thedecline in long-term interest rates in the EUas well as in the United States - which islinked to, inter alia, investors’ reassessmentof the risk in emerging markets; and, second,the marked decline in commodity prices,which may contribute to a further rise inreal incomes.

With regard to convergence, an excerptfrom the EMI’s Convergence Report,published in March 1998, is provided in anannex to this Report. Therein, it is statedthat, notwithstanding recent achievements,further substantial consolidation is warrantedin most Member States in order to achievelasting compliance with the fiscal criteriaand the medium-term objective of having abudgetary position that is close to balanceor in surplus, as required by the Stabilityand Growth Pact. This applies in particularto Belgium, Germany, Greece, Spain, France,Italy, the Netherlands, Austria and Portugal,where deficits in 1998 are forecast to bebetween 1.6 and 2.9% of GDP. For most ofthese countries, these consolidationrequirements also apply when comparingthe fiscal deficit ratios as projected in theConvergence Programmes for 1999-2000with the medium-term objective of theStability and Growth Pact. Taking a broaderview on the sustainabil ity of f iscaldevelopments, the case for sustainedconsolidation over an extended period oftime, requiring substantial fiscal surpluses, isparticularly strong for those countries withdebt ratios of above 100% (Belgium, Greeceand Italy). This compares with significantoverall deficits in 1997 and the years before.In countries with debt ratios of significantlyabove 60% but below 80% of GDP, keeping

5

the deficit ratio at current levels would inmost cases not bring down the debt ratioto below 60% within an appropriate periodof time, which indicates the need forfurther, in some cases substant ia l ,consolidation.

In the remaining months of Stage Two, theprimary objective of the monetary policiesof the countries selected to participate inthe euro area is to ensure that the currentenvironment of broad price stability ismaintained for the euro area as a whole,thereby providing the ESCB with afavourable starting position. The majority ofcountries selected to participate in theeuro area have already achieved short-term interest rates which are closely alignedat a low level. The conditions in the firstpart of 1998 have allowed this commonposition to be firmly consolidated and theremaining members have been able tomaintain the downward trend in their keyinterest rates. This suggests that a de factocommon monetary policy stance is tendingto emerge in the selected euro areacountries, against a background of broadlystable prices and exchange rates. By theend of 1998 at the latest, those countries’short-term interest rates will have convergedto a common level which will be consistentwith the objective of maintaining pricestability in the euro area. This overallpattern of convergence in short-terminterest rates is consistent with a situationon the eve of Stage Three in which market

exchange rates between the countriesselected to participate in the euro area areequal to the pre-announced bilateralexchange rates which will be used indetermining the irrevocable conversion ratesfor the euro. These pre-announced bilateralexchange rates are consistent with economicfundamentals and are compatible withsustainable convergence.

During the remainder of Stage Two, theGoverning Council and the Executive Boardof the ECB will finalise the preparationsneeded for the conduct of the singlemonetary policy in the euro area as of1 January 1999. In the meantime, theparticipating national central banks will retaintheir national monetary powers. Theinstitutional changes entailed in theestablishment of the ESCB and the ECBprovide a suitable framework within whichthe participating national central banks willbe able to engage in close co-operationwith a view to co-ordinating their nationalmonetary policies in order to achieve theprimary objective of maintaining pricestability in the euro area. Furthermore, inaccordance with Article 44 of the ESCB/ECB Statute, the ECB is to take over thetasks of the EMI which still need to beperformed in Stage Three of EMU, giventhe existence of Member States with aderogation. The General Council of theECB is to assume responsibility for relationswith the national central banks of the non-euro area Member States.

2 Preparatory work for Stage Three

Monetary policy

In publishing its report on the “The singlemonetary policy in Stage Three - Elementsof the monetary policy strategy of theESCB” in February 1997, the EMI, havingreviewed a number of alternatives, identified

two strategies - intermediate monetarytargeting and direct inflation targeting - aspotential candidates for Stage Three. It alsoindicated that, regardless of the final choicemade in this respect by the ESCB, thestrategy would be characterised by five keyelements which are an indispensable part of

6

any strategy: the announcement of aquantified definition of the final objective ofprice stability and the announcement ofspecific targets against which its performancecan be assessed; the use of a broad set ofindicator variables in the setting of policy; aprivileged role for monetary aggregatesand, finally, the ESCB having at its disposalits own forecasts of inflation and othervariables. Following the publication of thisreport, work at the EMI in the field ofstrategy concentrated on the developmentof the infrastructure necessary to supportmonetary policy decision-making, includingthe development of various econometrictools and procedures for preparing policydecisions.

After the conceptual phase, which wasconcluded at the end of 1996, thepreparatory work deal ing with theinstruments and procedures necessary forimplementing the single monetary policywas devoted to defining the technicalspecifications for the ESCB’s operationalframework and to the setting-up of theESCB tools necessary for the implementationof the future monetary policy of the ESCB.

The main developments in terms of thetechnical features of the monetary policyoperations in 1997 relate to the procedures,time frame and calendar for ESCB tenders;to the settlement modalities of open marketoperations; and to the implications of theend-of-day procedures for the use ofstanding facilities. The preparatory worknecessary to enable the ESCB to applyminimum reserve requirements as from thestart of Stage Three, if the GoverningCouncil of the ECB decides in favour ofhaving such a system, is currently beingcarried out. This included the furtherelaboration of the draft EU CouncilRegulation on minimum reserves, the mainoperational mechanisms of the minimumreserves system and the specification of thepotential reserve base. Common eligibilitycriteria have been defined for thecounterparties and the eligible assets to be

used in monetary policy operations withthe ESCB. The risk control measures to beapplied in the use of these assets have alsobeen specified, taking into account marketpractices.

As monetary policy operations will beimplemented on a decentralised basis,the main preparatory work for theimplementation of monetary pol icyinstruments has been undertaken by theNCBs, for the technical infrastructure aswell as for the legal requirements. An ESCBinternal infrastructure is being prepared forthe execution of open market operations,and the EMI is developing the systemsrequired to establish and publish the lists ofindividual eligible assets, possibly with theexception of certain categories of non-marketable assets, and eligible counterparties.Another crucial project for the implementationof the single monetary policy is the setting-up of an effective system of liquiditymanagement relying on the exchange ofan integrated daily flow of informationbetween the NCBs and the ECB.

Foreign exchange policy

In the context of future foreign exchangepolicy co-operation between Member Statesparticipating in the euro area and other EUcountries, work has been conducted in1997 at the level of both the ECOFINCouncil and the EMI, in accordance withthe broad lines defined in a report the EMIsubmitted on this issue to the Dublin meetingof the European Council in December1996. The European Council held inAmsterdam in June 1997 approved aResolution relating to the new exchangerate mechanism to be introduced in StageThree of EMU. In parallel, the EMI hasfinalised the draft agreement between theECB and future non-euro area centralbanks, which lays down the operatingprocedures for the ERM II; the draftagreement will be submitted to the ECB forendorsement following its establishment.

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Implementation work on the conduct ofpotential foreign exchange interventionfocused on aspects related to the requiredoperational framework and informationsystems support, which will make it possiblefor the ESCB to execute intervention.Work has been undertaken in order tofacilitate the decision on the amount andthe modalities of the initial transfer offoreign reserve assets from the NCBs tothe ECB at the beginning of Stage Three, inaccordance with Article 30.1 of the ESCB/ECB Statute. Work has also been initiatedto prepare complementary Communitylegislation which will enable the ECB, inaccordance with Article 30.4 of the ESCB/ECB Statute, to make further calls on theNCBs’ foreign reserve assets beyond thelimit of E 50 billion set in Article 30.1. Amonitoring framework has been designedfor market transactions conducted by theNCBs with foreign reserve assets in excessof those transferred to the ECB with a viewto ensuring consistency with the euro areasingle monetary and foreign exchange ratepolicies. A similar monitoring frameworkwill be put in place for transactionsperformed by euro area Member Statesand changes in their foreign exchangeworking balances. The EMI has alsoconducted work to prepare procedures forthe computation and publication ofreference exchange rates for the euro.

The Luxembourg European Council held inDecember 1997 stated in its conclusionsthat “the bilateral exchange rates which willbe used to determine the conversion ratesof the euro will be announced on 3 May1998 for those Member States participatingin the euro from the start”. The JointCommuniqué issued on 2 May 1998 by theMinisters and central bank governors of theEU Member States participating in the euroarea, the European Commission and theEMI, as the forerunner of the ECB, clarifiesthat these rates are the ERM bilateralcentral rates and the method to be used on31 December 1998 for setting theirrevocable euro rates will be the regular

daily concertation procedure. The euroarea NCBs stand ready to ensure theequality between the market exchangerates ascertained in the concertationprocedure and the pre-announced ones.The exchange rates of the official ECU vis-à-vis the currencies of the euro areaMember States set through this procedurewill be adopted by the Council as theirrevocable conversion rates for the euroon and with effect from 1 January 1999.

Statistics

Wide-ranging statistical requirements forthe conduct of policy in Stage Three wereset out in documents released by the EMIin July 1996. Much of 1997 was spent inimplementing these requirements andclarifying points of detail where necessary.Though some areas of difficulty remain, theintroduction of the necessary statisticalchanges has proceeded smoothly on thewhole, and data on the new agreed basiscovering the future single currency areawill become available to the EMI/ECB duringthe course of 1998. Further considerationhas been given to the organisation ofstatistical work at the European level, inparticular in areas where the EMI/ECB andthe Commission (EUROSTAT) will shareresponsibility; the legal framework forstatistics in Stage Three has been furtherdeveloped; and by the end of 1997 most ofthe work on electronic data transmissionwithin the ESCB had been done, withprogress also in the development of theinternal systems to handle data in the ECB.

Payment systems

In the field of payment systems, the EMI’s“Second progress report on the TARGET(Trans-European Automated Real-timeGross settlement Express Transfer) project”which was released in September 1997provided further information on the progressmade with regard to organisational aspects

8

and the implementation of the system. Inparticular, it addressed the following issues:1) operating time; 2) pricing policies;3) intraday liquidity to non-euro area NCBs;4) the role of the ECB in TARGET; and5) TARGET implementation. TARGETtesting is well on track. A brochure describingthe main features of the TARGET systemwas released in May 1998 and a TARGEToperating days calendar will be publishedin August 1998.

In the field of securities settlement systems(SSSs), preparatory work focused on twomain aspects: the establishment of standardsfor the use of SSSs in ESCB credit operationsand the implementation of short-termsolutions for the cross-border use ofcollateral. The standards and the underlyinganalysis are described in the EMI’s reportentitled “Standards for the use of SecuritiesSettlement Systems in ESCB creditoperations”, which was released on 8 January1998. These standards cover three mainareas: legal issues, settlement and custodyrisks, and operational issues. Moreover, inJuly 1997 the EMI Council decided to adoptthe correspondent central banking model(CCBM) as an interim solution before theestablishment of appropriate links betweenSSSs in order to facilitate the cross-borderuse of collateral in ESCB operations(monetary policy and intraday creditoperations).

Preparation of euro banknotes

The draft designs for the euro banknoteswhich were chosen by the EMI Council inDecember 1996 were developed into finaldesigns in the course of 1997. Illustrationsof the revised designs were published inJuly 1997. These form the basis for theorigination work, in the context of whichthe designs are being transformed intoprinting plates in the first half of 1998. In1997, in order to identify potential problemsat the earliest possible stage, all thetechniques which will be used for euro

banknote production were tested withinthe context of a test banknote project. Theproject revealed that all the participatingprinting works should be in a position toproduce al l the euro banknotedenominations to an equal standard ofquality and with an identical appearance.With regard to protection of the eurobanknotes, the EMI Council has agreed touse the copyright © symbol on the eurobanknotes and, to increase efficiency incombating counterfeiting, to set up a jointinvestigation centre and a database oncounterfeit euro banknotes. The date forthe launch of the euro banknotes and coinshas been fixed at 1 January 2002. Withregard to Article 52 of the ESCB/ECBStatute, which commits the GoverningCouncil of the ECB to take the necessarymeasures to ensure that banknotesdenominated in currencies with irrevocablyfixed exchange rates are exchanged by theNCBs at their respective par value, amajority of the members of the EMI Councilhas reached a basic agreement on themechanisms which will be involved inexchanging and repatriating nationalbanknotes between 1999 and 2002.

Accounting issues

The preparatory work on the accountingframework to be used for the ESCB waslargely completed in 1997. This frameworkwill form the basis for the internal andexternal reporting of the ESCB and serveto ensure that liquidity management andstatistical requirements are met. Thetransition to Stage Three was also examinedand the necessary principles and techniqueswere developed. In addition, work iscontinuing on the method for allocatingmonetary income in order to prepare thedecisions to be taken by the GoverningCouncil of the ECB.

9

Information and communications systems

In the f ie ld of information andcommunications systems, the teleconferencereplacement project was successfullyimplemented. It enables several audioconferences to take place in parallelbetween the connected institutions.Furthermore, its underlying physicalinfrastructure will serve as the main networkplatform for the data transfers needed forthe majority of ESCB-wide informationsystems applications. An ESCB-widecommunications infrastructure providingsecure end-to-end file transfer and robustmessaging services was developed andbecame operational in May 1998. In 1997significant progress was made in thedevelopment of several ESCB-wide softwareapplications which will support the conductof monetary policy operations, foreignexchange market interventions and themanagement of the ECB’s foreign reserveassets. All these applications will beimplemented by mid-1998. The second halfof 1998 will be devoted to undertaking thetesting of all the systems and proceduresbetween the ECB and the NCBs. The EMICouncil approved a framework for a securitypolicy for the information systems of theESCB, aiming at guaranteeing an adequateand co-ordinated level of security.

Banking supervision and financial stability

The EMI has examined how in Stage Threeof EMU the ESCB can contribute to thesmooth conduct of the policies pursued bythe competent authorities in the fields ofbanking supervision and the stability of thefinancial system, under Article 105 (5) ofthe Treaty. Two main forms of contributionof the ESCB can be envisaged. First, theESCB and, in particular, the ECB willpromote co-operat ion among thesupervisory authorities and between themand the ESCB on relevant prudentialsupervisory issues, such as those of a

macro-prudential nature with a bearing onthe stability of financial institutions andmarkets. Second, the ESCB will providesupervisory authorities with informationstemming from its basic activity which couldbe useful for the supervisory function.Conversely, banking supervisors will beready to give supervisory information tothe ESCB which could be valuable for theESCB to perform its tasks as laid down inthe Treaty and the ESCB/ECB Statute.Moreover, Article 25 (1) of the ESCB/ECBStatute contemplates a specific and optionaladvisory task of the ECB on the scopeand implementation of the Communitylegislation on banking supervision and thestability of the financial system. In addition,Article 105 (4) of the Treaty, which providesfor a mandatory advisory task of the ECBon draft Community and national legislationfalling within the ECB’s field of competence,is likely to apply to, inter alia, certainlegislation on banking supervision and thestability of the financial system. Finally,Article 105 (6) of the Treaty envisages thepossibility of conferring upon the ECBspecific tasks concerning policies relating toprudential supervision. In this respect, it isfelt premature at this stage to envisage anytransfer of supervisory competencies fromnational authorities to the ECB.

Legal issues

In the legal area, the EMI further elaboratedits views on the adaptation of nationallegislation under Article 108 of the Treatywith a view to Treaty and ESCB/ECBStatute requirements for Stage Three in areport which was published in October1997. In doing so, it gave guidance tonational legislators in this adaptation processand at the same time laid the basis for its1998 Convergence Report in which, interalia, the compatibility of national legislation,including the statutes of the NCBs, with theTreaty and the ESCB/ECB Statute wasassessed.

10

Changeover to the euro

During 1997 preparatory work for thechangeover to the single currency gatheredconsiderable speed. The EMI continued tokeep track of developments as regards thechangeover, in order to assess whetherdiffering changeover preparations acrossMember States, owing to differences in thelocal organisational and infrastructuralenvironments, might have implications forthe single monetary policy to be conductedas from January 1999 onwards.

In the financial area, the EMI and the NCBshave encouraged market operators toconsider market-driven standardisationwithin Monetary Union. The EMI alsoprovided assistance in the establishment ofcommon market standards in the euroarea-wide money markets and foreignexchange markets . I t furthermorerecognised the need for a distinctive codifiedsymbol for the single currency and expressedits support for the symbol E , proposed bythe European Commission, as the logo forthe euro. With a view to assisting all thoseinvolved in preparing for the changeover,the EMI has improved the distribution of

relevant information, inter alia through itsWeb site.

Public information

Since its establishment on 1 January 1994 theEMI has fulfilled its reporting obligations inaccordance with Articles 7 and 11.3 of theEMI Statute by publishing reports on thestate of the preparations for Stage Three ofEMU, its activities and monetary and financialconditions in the Community. A list of EMIdocuments published since the beginning of1997 and the EMI’s Web site address areprovided at the end of this Report. The EMIrecognises that there is a need for the ESCBto ensure the transparency of its objectivesand policies in Stage Three and to fosterknowledge of its operations and tasks, thusenabling the financial community and thegeneral public to both understand and supportits policies. To this end, the EMI is developingan external communication policy - to bepresented for consideration by the GoverningCouncil of the ECB - on the most effectiveways in which to disseminate informationconcerning the activities of the ESCB.

3 Other tasks of the EMI

Oversight of the ECU Clearing and SettlementSystem

The EMI’s main focus has been to ensurethat adequate action is taken to improvethe system’s compliance with the safetystandards laid down in the 1990 G-10Report on Interbank Netting Schemes.

The EMI monitored in particular thepreparatory work conducted by the EBA onits Euro Clearing and Settlement System forStage Three of EMU (EURO 1). In addition,the EBA - in co-operation with the EMI - isfinalising the settlement arrangements in

accordance with an EMI Council decision toallow the EBA to open a central settlementaccount at the ECB. It may also open othersettlement accounts with those NCBs whichagree to provide such accounts. Only theBanque de France has indicated its intentionto open a local settlement account for theEBA (by June 1999).

Electronic money

In 1997 the EMI carried out a further studyof the impact on EU economies of theemergence of electronic money. It took

11

part icular account of new marketdevelopments and conducted a thoroughanalysis of their implications for monetarypolicy. The results of the study providedthe basis for the “Opinion of the EMICouncil on the issuance of electronicmoney” of 2 March 1998, the text of whichis reproduced in Box 3 of this Report.

Co-operation in the field of banking supervisionand financial stability

The EMI held consultations on a number ofissues falling within the competence ofnational central banks and affecting thestability of financial institutions and markets.First, a survey was conducted on a widerange of issues of potential relevance to thestability of the EU banking systems byfocusing on the current trends and possibledevelopments which are likely to occur inthese systems in the medium and longterm, both in general and with regard tothe establishment of EMU. Second, aninvestigation was carried out on the possibleuse of macroeconomic data in thesupervisory process and the links betweenmacroeconomic developments and fragilityin banking systems as a whole and at thelevel of individual institutions. Third, themost recent developments in industrypractice for bad and doubtful loans - withparticular focus on the new approachesbased on statistical methods - wereexamined with a view to assessing the mainprudential supervisory implications. Fourth,a first examination was undertaken of thepossible impact of the establishment ofEMU on the current EU prudentialsupervisory regime for credit institutions’liquidity. Finally, co-operation among theEU credit registers continued with a viewto pursuing the objective of the opening-upof the respective registers on a cross-border basis.

Administration of EMS mechanisms andCommunity loans

Greece joined the ERM with effect from16 March 1998, which entailed compulsoryparticipation in the ECU swap mechanismfrom that date. Since the Bank of Greecehad been participating in the mechanism ona voluntary basis since January 1986, ERMmembership had no implications for theEMI’s ECU swap operations.

In 1997 the EMI continued to receive fromborrowers, namely Greece and Italy, andto pay to creditors vis-à-vis the Communitythe sums due in respect of interest,commission and expenses on outstandingloans.

Advisory functions

In the framework of its advisory functions,during 1997 and the first quarter of 1998the EMI delivered opinions in fifty-twoconsultation procedures under Article 109f (6)and Article 5.3 of its Statute, in many caseson adaptations of statutes of NCBs underArticle 108 of the Treaty.

Monitoring of compliance with the prohibitionon monetary financing and on privileged access

In 1997 the EMI continued to monitorNCBs’ fulfilment of their obligations underArticles 104 and 104a of the Treaty andrelated Council Regulations and concludedthat the Treaty requirements continue tobe respected by the EU NCBs. Remainingimperfections which had appeared in thetransition to the new arrangements, as wellas technical problems which had occurredin the implementation of new regulations,were finally corrected at the beginning of1997.

12

Co-operation with other institutions

The EMI has continued its close co-operation with other bodies of the EuropeanUnion in a number of forms and at variouslevels. With regard to contacts withinstitutions outside the Community, the“concertation procedure” has remained avaluable forum for exchanging data amongforeign exchange experts. Important links

have been retained with the Bank forInternational Settlements, the OECD andthe central banks of the associated Centraland Eastern European countries. TheInternational Monetary Fund visited theEMI several times during the year and thefuture relationship between the ESCB andthe IMF was one of the main topics onwhich an exchange of views took place.

Chapter I

Economic, monetary and

f inancial condit ions in the

European Union

16

1 Economic and financial background in 1997

Whereas growth in Japan appeared to gainmomentum during 1996, it stalled during1997. Output fell sharply in the secondquarter, reflecting a decline in privatespending as the fiscal stance was tightened.Consumer confidence later deterioratedfurther owing to the financial turmoil inother Asian countries (see Box 1) and thebankruptcies of certain Japanese financialinstitutions. As a consequence of weakgrowth, the rate of unemployment rose to3.4%. The only stimulus to output growthwas provided by the external sector,reflecting the Japanese yen’s depreciationagainst the dollar and buoyant foreigndemand. The Bank of Japan’saccommodating monetary policy stancewas maintained, with the official discountrate remaining at a record low level of0.5% against the background of growthslowing to around 0.9%, while average CPIinflation remained relatively subduedthroughout the year, rising to 1.7%.

Financial turbulence emerged in Thailand inmid-1997; it quickly spread to a number ofother countries in South-East Asia, eventuallyalso reaching the Republic of Korea. Economicgrowth in eastern and southern Asia slowedas the financial turmoil in the region increaseduncertainty (see Box 1). In China, however, ahigh rate of output growth was sustained,while inflation remained subdued; meanwhile,activity weakened moderately in both Australiaand New Zealand.

The transition economies as a groupexperienced positive output growth in 1997for the first time since the beginning of the1990s, albeit of less than 2% on average.The Baltic States, Poland and Hungary allexperienced strong growth rates, while

2 Defined as those countries which have recordedan average rate of inflation of 10% or more thusfar in the 1990s (source: OECD EconomicOutlook, December 1997).

1.1 Major developments outsidethe EU

External environment remained robust

Global economic conditions continued to bebroadly favourable in 1997, with the notableexception of developments in Asia during thelatter half of the year. The volume of worldtrade in goods and services increased sharply,at an estimated rate of 9.4% in 1997, comparedwith 6.6% in 1996. World output growth in1997 amounted to 4.1% and output in theOECD countries is estimated to have risen by3.0%. Among the industrialised countries, themost noteworthy features were the relativeweakness of the Japanese economy and thecontinued strength of demand in the UnitedStates. In parallel to several years of sustainedgrowth in a number of OECD countries,inflation continued to be remarkably low andstable, with CPI inflation for the group(excluding the so-called high inflationcountries2) falling to 2% on average, thelowest figure for over three decades. Thisbenign outcome for inflation was underpinnedby a decline in oil prices during the course ofthe year and broadly stable non-oil commodityprices.

The United States continued to enjoy robustoutput and employment growth. Outputgrowth accelerated to 3.8% (see Chart 1),prompting a further decline in theunemployment rate to a trough of 4.6% inNovember 1997, its lowest level since 1973.At the same time, inflationary pressuresremained moderate, with CPI inflation decliningover the course of the year to reach anaverage of 2.3%. Rising productivity and fallingimport prices, owing to, inter alia, the strengthof the US dollar, were the main underlyingfactors, together with a modest tightening ofmonetary policy in the spring by the FederalReserve. The federal fiscal deficit was almosteliminated in 1997, partly due to a growth-induced surge in tax revenues.

17

Russia’s output appears to have grownmodestly. In the Czech Republic growthslowed sharply and the currency wasdevalued as a result of foreign exchangemarket pressures. The pace of economicgrowth in the developing countries wasmaintained at slightly below 6% in 1997,albeit with below-average growth in Africaof around 3%. Economic growth in Centraland South America, however, picked upconsiderably. Inflation in the developingcountries as a whole slowed to 8.5%, and inthe transition economies it fell below 30%.

Shifts in global foreign exchange markets

1997 was characterised by a strongappreciation of the US dollar againstboth the Deutsche Mark (by 15.2% toDEM 1.79) and the Japanese yen (by 11.8% toJPY 130). The year was also marked by asubstantial depreciation of certain Asiancurrencies (see Box 1).

Against the Deutsche Mark, the dollarappreciated from DEM 1.55 to DEM 1.79 inthe course of the year. This pattern reflectedfavourable prospects for the US economycompared with Germany and expectationsof the maintenance or widening of interestrate differentials, for instance when theUS Federal Reserve tightened monetarypolicy in late March 1997. The overallupward trend was temporarily interruptedbetween mid-August and early Novemberas expectations of a further tightening bythe Federal Reserve faded, while incipientprice pressures in Germany promptedmarkets to expect a monetary tightening(which indeed took place on 9 October).Thereafter, expectations of further tighteningin Germany diminished, enabling the dollarto recommence its ascent. During 1997 thedollar also appreciated markedly againstthe Japanese yen, from JPY 116 to JPY 130.Overall, the evolution of the dollar-yenrate reflected a pessimistic economicoutlook in Japan and, later in the year, thenegative repercussions on Japanese

competitiveness and financial stability of theturmoil in South-East Asia and the Republicof Korea as well as safe-haven flows intoUS dollars in connection with the Asiancrisis (see Box 1). Reflecting a short-livedimprovement in sentiment regardingeconomic recovery in Japan, thedepreciation of the Japanese yen wastemporarily interrupted in mid-year, whenthe yen appreciated sharply to levels closeto those recorded at the beginning of theyear.

In respect of changes in nominal effectiveexchange rates, the nominal effectiveexchange rate of the dollar against twenty-six trading partners appreciated by 13% in1997, while those of the Deutsche Markand the yen depreciated by 2.6% and 1.9%respectively. In the case of the UnitedStates, the large change in the nominaleffective exchange rate reflected thestrengthening of the dollar against both theyen and the Deutsche Mark and also thedepreciations of currencies in South-EastAsia and the Republic of Korea. Therelatively small effective depreciation of theyen reflected an offsetting movement againstthe South-East Asian currencies and theKorean won. In the case of Germany, thedepreciation of the Deutsche Mark againstthe dollar contrasted with broadly stableexchange rates vis-à-vis the Europeancurrencies, which carry a far greateraggregate weight than the non-Europeancurrencies in the overall effective exchangerate index.

International bond yields declined

In 1997 US bond yields fell by 68 basispoints from 6.43 to 5.75%, a developmentwhich masks two distinct phases during theyear. By mid-April yields had risen byalmost 60 basis points to reach a peak of6.98% against the background of a furthertightening of labour market conditions andaccelerating growth. The associatedexpectations of an increase in inflation

18

Main developments in major industrialised economies

Output growth(quarterly data; annual percentage changes)

EU-15

Japan

United States EU-15Japan

United States

Inflation rates(a)

(quarterly data; annual percentage changes)

GermanyJapan

United States

Official interest rates(b)

(end-month data; in percentages)

DEM/USD (LHS)JPY/USD (RHS)

Exchange rates(c)

(end-month data)

Chart 1

Source: National data.(a) EU-15 calculated using western Germany up to end-1993, unified Germany thereafter. Italy: Cost-of-living index. United Kingdom: CPI excluding mortgage interest payments (RPIX).(b) For Germany and Japan discount rate, for the United States federal funds target rate.(c) Deutsche Mark per dollar and Japanese yen per dollar.

1992 1993 1994 1995 1996 1997

-2

-1

0

1

2

3

4

5

6

-2

-1

0

1

2

3

4

5

6

1992 1993 1994 1995 1996 1997

1992 1993 1994 1995 1996 1997 1992 1993 1994 1995 1996 1997

-1

0

1

2

3

4

5

6

-1

0

1

2

3

4

5

6

1

0

2

3

4

5

6

7

8

9

0

1

2

3

4

5

6

7

8

9

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1.9

80

90

100

110

120

130

140

19

were reflected in a steepening of the slopeof the US yield curve and prompted a riseof 25 basis points in the Federal funds ratetowards the end of March, the first sinceFebruary 1995, taking the rate to 5.5%.However, the upward movement in long-term interest rates turned out to be short-lived as inflation outturns improved and itbecame evident that inflationary pressureshad remained subdued despite buoyantreal economy developments. The virtualelimination of the public sector deficit in theUnited States and the decline in the debtratio in 1997 further supported the declinein long-term interest rates. Towards theend of the year, the fall in yields acceleratedas the Asian financial crisis motivated safe-haven flows out of the region and intorelatively less risky assets such as US bonds.By this time, the crisis was also leading toexpectations that official interest rates in

the United States would not be raised,owing to the disinflationary impact of theturmoil as well as possible concerns regardingglobal financial stability.

Long-term interest rates in Japan declinedby 91 basis points during the year to reach1.66%, an unprecedentedly low level byboth domestic and international historicalstandards, while real long-term interestrates measured ex post became significantlynegative towards the end of the year andthe slope of the yield curve became lesssteep. This overall development reflectedexpectations that official interest rates wouldremain low despite an uptick in inflation;the latter was regarded as temporary giventhe concomitant deceleration in the paceof economic activity. The Asian financialcrisis also led to safe-haven flows out of theJapanese equity market and into bonds.

Box 1

Evolution of the Asian crisis in 1997

1997 witnessed unprecedented currency and financial market turmoil in a number of Asian countries.

Those most severely affected were Thailand, Indonesia, Malaysia and the Republic of Korea, although

others were not immune. One factor common to most of the affected countries prior to the crisis was a

loss of competitiveness arising from the peg to the US dollar and reflected in the persistence of current

account deficits (although other signs of macroeconomic disequilibrium were absent). Other common

features were fragile, poorly regulated and over-exposed f inancial systems and high levels of short-

term foreign currency denominated borrowing by the private sector, which was frequently used to

finance long-term investment, thus creating a significant maturity mismatch as well as a currency mismatch.

Severe pressures on the Thai baht led to the floating of the currency in July 1997, ending a 13-year

peg to a dollar-dominated basket. As a result of the loss of competitiveness, pressures emerged on

the currencies of other countries in the region, which led to major depreciations of the Philippine

peso, the Malaysian ringgit and the Indonesian rupiah in the same month. The crisis deepened in

October, as a stock market crash in Hong Kong led to widespread turbulence in capital markets. Even

though the Hong Kong dollar’s peg to the US dollar was maintained, the substantial fall in equity

prices led to further pressures on Asian currencies, including the Korean won, which had until then

been relatively unscathed. The marked subsequent depreciation of the Korean won against the US

dollar in November (and December) led to a further weakening of the currencies of the region.

Looking at developments in the second half of 1997 as a whole (see table), a number of common

characteristics were discernible. First, with the exception of the Hong Kong dollar, currencies depreciated

by significant margins vis-à-vis the US dollar. The large depreciations took on an almost self-perpetuating

character as increasing debt-service costs for the private sector and decisions to hedge external liabilities

only intensified exchange rate pressures. Second, short-term interest rates were raised by substantial

amounts in an effort to maintain currency pegs, and although interest rates subsequently declined at the

20

end of 1997, they remained above early July levels, reflecting expectations of further substantial exchange

rate depreciations. An increase in uncertainty was also evident from the significant increase in implied

volatility in over-the-counter option prices on these currencies. Third, stock market indices collapsed

by substantial amounts ranging from 10% to almost 50%. Besides reflecting monetary conditions, lower

expectations of future earnings and notably adverse financial conditions for firms, this development

was linked to the higher returns required by international investors in the face of heightened risk. The

fall in currencies and stock indices implied a general downgrading of the affected region by international

investors, with contagion and spillover effects operating in addition to changes in fundamentals.

In late 1997 the IMF offered substantial loan facilities to Thailand, Indonesia and the Republic of

Korea. The associated reform programmes require a tightening of monetary and f iscal policies and

the restructuring and strengthening of financial systems. These measures are aimed at restoring confidence

in the region by avoiding excessive currency depreciations, containing inflation and creating conditions

for the build-up of international reserves.

A number of channels may be discerned via which macroeconomic effects on these Asian economies

may be transmitted. These include: an income or wealth effect, operating through a contraction of

domestic demand in Asia as a result of falling share prices and exchange rates and a tighter monetary

and fiscal policy (but also influenced by effects resulting from a higher debt-service burden in US

dollars, the cutting of credit lines, capital outflows and higher interest rates); a confidence effect, whereby

a decline in the stock market and/or exchange rate can also prompt a more generally pessimistic view

of future prospects and thereby trigger still further reductions in demand; a long-term interest rate

effect linked to investors’ reassessment of risk in emerging markets and the prospects for higher inflation

following currency depreciation; and a price effect, which entails an increase in Asian competitiveness

tending to boost net exports, thus mitigating the contractionary effects of lower domestic demand.

The magnitude of the direct impact or effect on countries outside the region will depend on the share

of their trade with the Asian economies concerned and on the importance of trade in relation to

overall output (openness). Incomes, prof its and demand will be reduced through a deterioration in

the external balance as exports to the region fall. There may also be adverse wealth and confidence

effects and an effect operating through the balance sheets of the banking system, depending on

individual institutions’ exposure to the region. However, long-term interest rates may benefit from

lower inflation expectations. The f inal effect on the economies outside Asia, which may take some

time to be felt, will depend not only on the direct effect via trade and financial markets, but also on

the appropriateness and timeliness of any policy response which may be required and, not least, on

the flexibility of the real side of the economy, especially the labour market. The implications of the

crisis for monetary and economic developments in the EU are discussed further in Section 3.

Asset price changes in Asian markets(in percentages)

1 July 1997 to 31 December 1997

Equity market USD exchange rate

Hong Kong -29.4 0.0

Indonesia -45.1 -55.0

Malaysia -44.9 -35.0

Republic of Korea -46.6 -47.7

Singapore -22.8 -15.0

Thailand -34.5 -47.8

Source: Reuters.

21

1.2 Macroeconomic developments inthe EU

Real GDP growth in the EU accelerated

Initially, real GDP growth in the EU in 1997fol lowed the pattern of subdueddevelopments also observed in early 1996as unusually severe weather conditionsagain tended to depress construction in thefirst quarter. However, the pace ofeconomic activity quickened thereafter and,from the second quarter onwards, thegrowth rate was significantly higher than inthe comparable period of 1996. The crisisin Asia did not have a significant adverseimpact on growth in 1997. Average realGDP growth for the EU in 1997 is estimatedto have been 2.7%, which is significantlyhigher than the rate of 1.7% recorded in1996. The acceleration in activity was

widespread, with stronger growth beingrecorded in almost all EU countries (seeTable 1), although there continued to bedifferences in the strength of economicactivity. In Italy and Sweden output growth,although higher than in 1996, remainedbelow 2%, while in Belgium, Germany,France and Austria the rate was between2% and 3%. Real GDP growth in theremaining nine EU Member States wasabove 3%. Growth in Ireland was again thestrongest in the Union in 1997 at 10.3%. InFinland real GDP growth also acceleratedsharply to reach almost 6%.

The acceleration in activity during 1997 wasto a large extent underpinned by acontinuation of the favourable factors whichhad also characterised 1996: economicexpansion in North America remained robust(see also Section 1.1) and the price

Table 1

Recent developments in real GDP growth(percentage changes)

Annual rates(a) Quarterly rates(b)

1995 1996 1997(c) 1996 1997 1996 1997

Q4 Q1 Q2 Q3 Q4 Q4 Q1 Q2 Q3 Q4

Belgium 2.1 1.5 2.8 2.0 2.4 2.9 2.9 . 0.7 0.6 1.3 0.5 .

Denmark 3.1 3.5 3.4 3.1 2.0 4.3 2.6 4.4 -0.8 0.9 2.0 0.5 1.1

Germany 1.8 1.4 2.2 1.8 1.0 3.0 2.4 2.4 0.3 0.4 0.9 0.7 0.3

Greece 2.1 2.7 3.5 - - - - - - - - - -

Spain 2.7 2.3 3.4 2.8 3.2 3.4 3.5 3.6 0.8 0.9 0.8 0.9 0.9

France 2.1 1.5 2.4 2.3 1.3 2.6 2.7 3.2 0.3 0.3 1.1 0.9 0.8

Ireland 10.4 7.7 10.3 - - - - - - - - - -

Italy 2.9 0.7 1.5 -0.2 -0.9 1.9 2.2 2.8 -0.4 0.0 1.9 0.6 0.2

Luxembourg 2.7 3.5 4.8 . . . . . . . . . .

Netherlands 2.3 3.3 3.4 3.5 2.6 3.1 2.9 3.6 0.8 0.7 0.9 0.7 1.0

Austria 2.1 1.6 2.5 . . . . . . . . . .

Portugal 2.4 3.6 3.9 - - - - - - - - - -

Finland 5.1 3.6 5.9 6.0 4.0 7.1 6.4 6.2 1.4 0.0 3.1 1.7 1.1

Sweden 3.9 1.3 1.8 1.3 -1.2 2.9 2.0 3.3 0.6 -0.2 0.4 1.0 2.2

United Kingdom 2.7 2.2 3.3 2.8 3.1 3.5 3.6 2.8 1.2 0.8 0.8 0.8 0.3

EU-15 2.5 1.7 2.7 2.1 1.4 3.0 2.8 2.9 0.5 0.4 1.2 0.8 0.5

Source: National data.(a) Annual rates: Percentage change over the same period a year earlier.(b) Quarterly rates: Percentage change over the previous quarter, seasonally adjusted (for some countries also adjusted for working

day variations); not annualised.(c) Provisional.

22

competitiveness of most EU countriesimproved against that of their major non-EUtrading partners. Within the EU, low ordeclining inflation enabled most Member Statesto pursue policies characterised by relativelylow short-term nominal interest rates (seeSection 2), intra-EU exchange rates remainedgenerally stable and bond yields declined stillfurther. Consumer confidence improved toaround its long-term average, though thelevel and scale of improvements variedsignificantly across countries. Industrialconfidence also improved sharply and by theend of the year was well above its long-termaverage.

Stronger domestic demand, net exportsremained positive

For the Union as a whole, the improved realgrowth performance in 1997 was principallydue to domestic demand, which rose by2.2%, compared with 1.5% in the previousyear. For the fourth successive year, net tradein goods and services provided a positive,albeit small, stimulus to growth, underpinnedby subdued growth in relative unit labourcosts and, as a result, improvements incompetitiveness. The rise in domestic demandwas linked to an improvement in investmentgrowth and an increase in stockbuilding, whilegrowth in private consumption wasunchanged and government consumptionwas weaker than in 1996 (see Table 2).Whereas domestic demand rose by 3% ormore in many countries (Denmark, Greece,Ireland, Luxembourg, the Netherlands,Portugal, Finland and the United Kingdom), inGermany, France, Austria and Sweden growthin domestic demand was below 1.5%.

Private consumption growth in the EU hasbeen broadly constant since the 1992-93recession and has remained in the range of1½-2%. On the one hand, low growth of realhousehold disposable income combined withthe negative effects on confidence of highunemployment in some countries anduncertainty about the pattern of further fiscal

consolidation have tended to restrainconsumer spending. On the other, consumerconfidence has improved as economicprospects have brightened and wealth gainsfrom equity and, in some cases, propertyprices have accrued. The balance betweenthese factors varied sharply, as is illustrated bythe fact that in 1997 private consumptiongrew at 3% or more in Denmark, Spain,Ireland, the Netherlands, Portugal, Finlandand the United Kingdom, while in Germany,France and Austria it grew by less than 1%. Inthe United Kingdom private consumptiongrew by 4.5% in 1997, the highest rate since1988, partly spurred on by temporary factors(notably windfall gains arising from thedemutualisation of mortgage lendinginstitutions).

Reflecting the continued efforts of fiscalauthorities to restrain spending in the light ofthe need for consolidation, governmentconsumption in the EU increased by 0.5% in1997, thus resulting in a decline in the ratio toGDP. In Germany, Greece, Italy, Finland andSweden government consumption fell, whilein Spain and the United Kingdom it rose onlymarginally. By contrast, general governmentconsumption rose by 2.9% in Denmark, by3.9% in Luxembourg, by 3.3% in theNetherlands and by 3.0% in Portugal.

Continuing the pattern observed since theearly 1990s, fixed investment growth in 1997- although stronger than in the previous year -continued to be below the levels typical ofpast decades, despite satisfactory profit marginsand a high level of industrial confidence, aswell as relatively high capacity utilisation ratesfor the manufacturing sector. At the individualcountry level, investment growth in 1997stood at over 10% in Greece, Ireland,Luxembourg, Portugal and Finland, but wasalso strong in Denmark and the Netherlands.By contrast, investment rose by around 1%or less in Germany, France and Italy and fellby 4.8% in Sweden.

Both exports and imports grew considerablymore strongly than in 1996, partly reflecting

23

the resurgence of growth within the EU(which increased intra-EU trade) and buoyanteconomic conditions globally. Exports fromEU countries grew by 9.5% on average, whileimports grew by 8.5%. European Commissionfigures show that trade and current accountbalances for the EU improved further in 1997(see Table 3); the trade balance rose to 1.5%of EU GDP and the current account surplusincreased to 1.2% of EU GDP. Currentaccount balances (based on national data)improved strongly in France and theNetherlands as well as, although to a lesserextent, in Belgium, Germany, Spain, Finlandand the United Kingdom. By contrast, Denmarkexperienced a marked deterioration. Overall,

eleven Member States recorded currentaccount surpluses. In general, these surpluseswere linked to high and relatively stable netprivate saving (private saving less investment),while public sector positions tended toimprove sharply, reflecting ongoing fiscalconsolidation.

Employment generation remained weak, highunemployment persisted

Against the background of strengtheningeconomic growth in the EU as a whole,employment has increased only marginally,whi le unemployment has remained

Table 2

Composition of growth in the EU in 1997*(annual percentage change)

Real GDP

Domestic demand Trade

Consumption Fixed

General invest- Stock

Private government ment changes(a) Exports Imports

Belgium 2.8 2.3 2.2 1.1 5.6 -0.3 6.1 5.5

Denmark 3.4 4.2 4.1 2.9 7.2 -0.2 4.5 7.0

Germany 2.2 1.2 0.2 -0.4 0.2 1.1 10.7 7.0

Greece 3.5 3.8 2.5 -0.1 10.9 -0.1 5.2 5.9

Spain 3.4 2.7 3.1 0.7 4.7 -0.4 12.9 10.1

France 2.4 1.0 0.9 1.5 0.2 0.1 11.3 6.6

Ireland 10.3 7.9 7.1 2.7 13.6 0.2 18.1 16.3

Italy 1.5 2.5 2.4 -0.7 0.6 1.0 6.3 11.8

Luxembourg 4.8 4.7 2.5 3.9 14.1 0.4 6.0 6.1

Netherlands 3.4 3.3 3.2 3.3 6.0 0.0 10.5 10.6

Austria 2.5 1.2 0.2 0.9 3.6 -0.7 8.0 5.4

Portugal 3.9 5.3 3.1 3.0 13.1 0.1 8.0 11.1

Finland 5.9 4.1 3.1 -0.3 11.3 0.3 13.5 9.3

Sweden 1.8 0.4 2.0 -2.1 -4.8 0.7 12.8 11.7

United Kingdom 3.3 3.6 4.5 0.5 3.9 0.1 7.8 8.4

EU-15(b) 2.7 2.2 2.1 0.5 2.4 0.4 9.5 8.5

Memo item:

EU-15(b) (1996) 1.7 1.5 2.0 1.5 1.1 -0.3 4.9 3.7

Source: National data.* Data partly estimated.(a) As a contribution to growth.(b) The trade figures are a weighted average of the EU-15 countries’ data and, as such, do not exclude intra-EU trade.

24

stubbornly high. Total employment in theEU, at around 147 million, has not increasedsignificantly since the 1992-93 recession,despite EU-average real GDP growth overthis period of 2.4%. For example, totalemployment is estimated to have risen byonly around 0.5% in 1997, compared withincreases of around 1% in Japan and over2% in the United States. Moreover, thelabour force participation rate, at around67%, is lower than in either Japan or theUnited States. Unemployment in the EU,measured on a comparable basis, remainedmore than twice that in the United Statesand three times higher than in Japan. Ofparticular concern are the much higherlevels of youth and long-termunemployment. The concentration ofunemployment in these categories, as wellas the persistence of subdued employmentcreation, point to the structural nature of a

major part of EU unemployment and to thecontinued need for structural measures.

The unemployment rate for the EU as awhole (measured on the basis ofEUROSTAT data) fell slightly during thecourse of 1997, from 10.8% in the fourthquarter of 1996 to 10.5% in the fourthquarter of 1997 (see Chart 2) .Unemployment fell in most EU MemberStates, largely but not entirely in line withpatterns of relative growth, with markedreductions being observed in Denmark,Spain, Ireland, the Netherlands, Finland andthe United Kingdom. In Ireland theunemployment rate fell below the EUaverage for the first time in recent decades.In the Netherlands unemployment hadfallen to 5% by the end of the year.Unemployment also fell, albeit to a lesserdegree, in Belgium and Portugal. In contrast,

Table 3

Trade and current account balances in the EU*(as a percentage of GDP)

Trade balance Current account balance

1994 1995 1996 1997(a) 1994 1995 1996 1997(a)

Belgium(b) . 4.1 3.9 4.4 . 4.2 4.2 4.9

Denmark 4.1 2.9 3.5 2.8 1.8 1.0 1.7 0.6

Germany 2.2 2.5 2.8 3.3 -1.0 -0.9 -0.6 0.0

Greece -13.8 -15.0 -15.0 -15.1 -0.1 -2.5 -3.7 -4.0

Spain -3.9 -4.3 -3.8 -3.6 -0.8 1.2 1.3 1.5

France 0.7 0.9 1.2 2.2 0.6 0.7 1.3 2.9

Ireland 15.5 19.3 20.0 22.8 3.6 4.1 3.2 2.8

Italy 3.5 4.1 5.0 4.1 1.4 2.5 3.4 3.2

Luxembourg(b) -12.8 -12.0 -13.6 . 14.0 18.1 15.9 15.9

Netherlands 5.1 5.3 5.0 3.4 5.3 6.1 5.8 5.3

Austria -5.2 -3.8 -4.2 -2.7 -0.9 -2.0 -1.8 -1.9

Portugal -7.8 -6.8 -7.2 -8.1 -2.5 -0.2 -1.4 -2.0

Finland 6.6 8.6 7.7 8.5 1.3 4.1 3.8 5.1

Sweden 4.4 6.5 7.0 7.3 0.4 2.1 2.7 2.7

United Kingdom -1.5 -0.4 -1.0 -1.2 -0.3 -0.7 -0.4 0.3

EU-15(c) 0.6 1.0 1.3 1.5 0.0 0.4 0.8 1.2

Source: National data.* Surplus (+), deficit (-).(a) Provisional.(b) Corresponding f igures for BLEU are: for the trade balance: 2.7, 4.1, 3.9, 4.2; and for the current account

balance: 5.0, 5.1, 5.0, 5.3.(c) European Commission data (spring 1998 forecasts); national accounts definition.

25

Unemployment rates*(EUROSTAT definition; as a percentage of the labour force)

Source: EUROSTAT.* Seasonal adjusted data.(a) Unified Germany from January 1993 onwards.(b) National definition, as no complete monthly data are available on a comparable basis.(c) Revised definition from May 1997 onwards. (d) Prior to January 1995, the aggregate EU-12 is shown.

BelgiumDenmark

Germany(a)

Greece(b)SpainFrance Italy

Ireland

LuxembourgNetherlands

AustriaPortugal

Finland(c)

SwedenUnited KingdomEU-15(d)

Chart 2

1992 1993 1994 1995 1996 1997

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1992 1993 1994 1995 1996 1997

1992 1993 1994 1995 1996 1997

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1992 1993 1994 1995 1996 1997

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there was a further increase in the rate ofunemployment in Germany, largely reflectingdevelopments in eastern Germany, whereunemployment had risen to almost 20% bythe end of the year. Ongoing weakness inconstruction activity and a contraction inemployment promotion and vocationaltraining schemes mainly underlie thisdevelopment in eastern Germany. Overall,considerable differences continued to existbetween the unemployment rates acrossthe Union. In the fourth quarter of 1997the rate remained at or above 10% in fivecountries: Germany, Spain, France, Italy andFinland. Despite the marked declinesrecorded in Spain and Finland, theunemployment rates in these two countriesremained the highest in the EU.

The unemployment data from EUROSTATto which reference is made in the paragraphabove are calculated according to ILOrecommendations. These data are morecomparable than national data, but are notyet fully harmonised. In some cases, theydiffer markedly from the correspondingnational definitions (see Table 4). Inparticular, on an annual basis the EUROSTATestimates for 1997 are higher for Greece,Sweden and the United Kingdom and lowerfor Denmark, Germany, the Netherlands,Austria and Finland.

1.3 Achievements in macroeconomicconvergence

In accordance with Article 109j (1) of theTreaty, at the end of March 1998 the EMIpresented its report to the EU Council onthe progress made in the fulfilment by theMember States of their obligations regardingthe achievement of Economic and MonetaryUnion. This Convergence Report includedan examination of the achievement of ahigh degree of sustainable convergence byreference to the fulfilment by each MemberState of the convergence criteria, as set outin the Treaty. It therefore covered theperformance of individual EU countries interms of the degree of price stability,government debt and deficit positions, long-term interest rates and exchange rates. Inearly May 1998 the EU Council, meeting inthe composition of Heads of State orGovernment, confirmed which MemberStates had fulfilled the necessary conditionsfor the adoption of the single currency. Theoutcome of this meeting is reported inBox 2. A summary of the examination ofconvergence by the EMI, which includeddevelopments in 1997, is provided in anannex, which contains selected parts of theIntroduct ion and Summary of theConvergence Report. Data relating to theMaastricht Treaty convergence criteria(excluding the exchange rate criterion) areshown in Table 5.

BE DK DE GR ES FR IE IT LU NL AT PT FI SE UK EU

1996

National definition 9.8 8.7 10.4 7.5 22.2 12.3 11.5 12.1 3.3 6.6 7.0 7.3 15.8 8.0 7.5 11.0

EUROSTAT 9.7 6.9 8.8 9.6 22.1 12.4 11.6 12.0 3.3 6.3 4.3 7.3 15.4 10.0 8.2 10.8

1997

National definition 9.3 7.8 11.5 7.9 20.8 12.5 10.3 12.3 3.6 5.6 7.1 6.8 14.5 8.0 5.7 10.8

EUROSTAT 9.2 6.1 9.7 9.6 20.8 12.4 10.2 12.1 3.7 5.2 4.4 6.8 14.0 10.2 7.1 10.6

Table 4

A comparison of national and EUROSTAT unemployment data(as a percentage of the labour force)

Source: National data and EUROSTAT.

27

HICP Long-term General government General governmentinflation (a) interest rate (b) surplus (+) or deficit (-) (c) gross debt (c)

Belgium 1996 1.8 6.5 -3.2 126.91997 (d) 1.4 5.7 # -2.1 122.21998 (e) - - # -1.7 118.1

Denmark (f) 1996 2.1 7.2 # -0.7 70.61997 (d) 1.9 6.2 # 0.7 65.11998 (e) - - # 1.1 # 59.5

Germany 1996 1.2 6.2 -3.4 60.41997 (d) 1.4 5.6 # -2.7 61.31998 (e) - - # -2.5 61.2

Greece 1996 7.9 14.4 -7.5 111.61997 (d) 5.2 9.8 -4.0 108.71998 (e) - - # -2.2 107.7

Spain 1996 3.6 8.7 -4.6 70.11997 (d) 1.8 6.3 # -2.6 68.81998 (e) - - # -2.2 67.4

France 1996 2.1 6.3 -4.1 # 55.71997 (d) ** 1.2 ** 5.5 # -3.0 # 58.01998 (e) - - # -2.9 # 58.1

Ireland 1996 2.2 7.3 # -0.4 72.71997 (d) *** 1.2 *** 6.2 # 0.9 66.31998 (e) - - # 1.1 # 59.5

Italy 1996 4.0 9.4 -6.7 124.01997 (d) 1.8 6.7 # -2.7 121.61998 (e) - - # -2.5 118.1

Luxembourg 1996 *** 1.2 *** 6.3 # 2.5 # 6.61997 (d) 1.4 5.6 # 1.7 # 6.71998 (e) - - # 1.0 # 7.1

Netherlands 1996 1.4 6.2 # -2.3 77.21997 (d) 1.8 5.5 # -1.4 72.11998 (e) - - # -1.6 70.0

Austria 1996 1.8 6.3 -4.0 69.51997 (d) * 1.1 * 5.6 # -2.5 66.11998 (e) - - # -2.3 64.7

Portugal 1996 2.9 8.6 -3.2 65.01997 (d) 1.8 6.2 # -2.5 62.01998 (e) - - # -2.2 # 60.0

Finland 1996 ** 1.1 ** 7.1 -3.3 # 57.61997 (d) 1.3 5.9 # -0.9 # 55.81998 (e) - - # 0.3 # 53.6

Sweden 1996 * 0.8 * 8.0 -3.5 76.71997 (d) 1.9 6.5 # -0.8 76.61998 (e) - - # 0.5 74.1

United Kingdom 1996 2.5 7.9 -4.8 # 54.71997 (d) 1.8 7.0 # -1.9 # 53.41998 (e) - - # -0.6 # 52.3

Table 5

Economic indicators and the Maastricht Treaty convergence criteria(excluding the exchange rate criterion)

Source: European Commission.*, **, *** = first, second and third best performer in terms of price stability.# = general government deficit not exceeding 3% of GDP; general government gross debt not exceeding 60% of GDP.(a) Annual percentage changes.(b) In percentages. The harmonised series for Greece starts in mid-1997. Before this, data were based on available best proxies; for the period from

March to June 1997, yield data for long-term bonds with shorter maturities than the harmonised series were used; before that period, yields at issuefor long-term bonds with shorter maturities than the harmonised series were used.

(c) As a percentage of GDP.(d) Data for HICP inflation and long-term interest rate refer to the twelve-month period ending January 1998; European Commission (spring 1998

forecasts) for general government surplus or deficit and general government gross debt.(e) European Commission projections (spring 1998 forecasts) for general government surplus or deficit and general government gross debt.(f) General government gross debt figures are not adjusted for the assets held by the Danish Social Pension Fund against sectors outside general

government, nor for government deposits at the central bank for the management of foreign exchange reserves. According to statements 5 and 6relating to Council Regulation (EC) No. 3605/93 of 22 November 1993, the Council and the Commission agree that, for Denmark, these items shallbe specified in the presentation of general government gross debt. They totalled 9.6% of GDP in 1996 and 8.0% of GDP in 1997. In addition, thedata are not adjusted for the amounts outstanding in the government debt from the financing of public undertakings, which, according to statement3 relating to the aforementioned Regulation, will be subject to a separate presentation for the Member States. In Denmark this item amounted to5.2% of GDP in 1996 and 4.9% of GDP in 1997.

28

2 Monetary policies in Member States

This section describes the changes inmonetary conditions in individual EUcountries in 1997 and their monetary policyobjectives for 1998. It reflects the task ofthe EMI in Stage Two of EMU, which is tostrengthen co-operation between thenational central banks and the co-ordinationof the monetary policies of Member Stateswith a view to ensuring price stability. Inconnection with these responsibilities, theappropriateness and compatibility of currentmonetary and foreign exchange policieswere reviewed in regular discussions heldat the EMI. In the context of this review,account is taken of the conduct of policieswithin the exchange rate mechanism (ERM),of which all EU countries other thanGreece,3 Sweden and the United Kingdomwere members in 1997.

2.1 Further convergence of interestrates

The economic and financial environment in1997 allowed for a continuation of theconvergence of short and long-term interestrates and broadly stable exchange rates.The majority of EU countries (namelyBelgium/Luxembourg, Denmark, Germany,France, the Netherlands, Austria, Finlandand Sweden) broadly maintained low interestrates. This mirrored a situation of pricestability against a background of narrowing- but generally still negative - output gaps,benign wage behaviour and theconsolidation efforts of fiscal authorities.Official and key interest rates remained atlow and closely aligned levels, althoughthey were raised to a small extent in theautumn in response to inflation risks (seeChart 3 and the annex relating to thechronology of monetary measures). Theconcerted nature of these policy actionsstrengthened the cohesion among thosecountries with closely aligned interest rates.

Several other Member States (Spain, Italy,Portugal and initially also Greece) wereable to continue the process of reducinginterest rates in line with the degree ofconvergence of their overall economicfundamentals, particularly in respect of theachievement of price stability, with those ofthe countries referred to in the paragraphabove. Short and long-term interest rates inthese countries thus tended to follow adownward trend, progressively convergingtowards the lower level of the closelyaligned countries (see Chart 4). Monetarypolicy in the two remaining EU countries(namely Ireland and the United Kingdom)was tightened, albeit to differing degrees, inresponse both to buoyant economic andmonetary growth and to heightened inflationrisks against a background of continuedsound fundamentals. The widening of short-term interest rate differentials againstGermany was accompanied by a furtherstrong appreciation of the respectivecurrencies vis-à-vis the Deutsche Mark.Later in the year, however, short-terminterest rates in Ireland began to declinerelative to Germany and the Irish poundmoved closer to its central rates in the ERMgrid.4

The convergence process was supportedby the strong political commitment to EMUdemonstrated at the regular meetingsof the European Counci l and thecorresponding reduct ion in market

3 Effective from 16 March 1998, the Greek drachmajoined the exchange rate mechanism of theEMS at a central rate of GRD 357 to the ECU,which implied a depreciation of 14%. The Greekauthorities thereby committed themselves to aneconomic and monetary policy which will be firmlygeared to keeping inflation under control and on adownward trend.

4 Effective from 16 March 1998, the bilateralcentral rates of the Irish pound against other ERMcurrencies were revalued by 3%, bringing themclose to market rates.

29

uncertainty. Of particular importance wasthe understanding, reached at the informalECOFIN Council meeting in Mondorf-les-Bains in September 1997, that the bilateralexchange rates which will be used at thestart of Stage Three in determining theirrevocable conversion rates for the eurowould be pre-announced immediately afterthe selection of the countries which willadopt the single currency (see Box 2).Given the calm conditions on foreignexchange markets in Europe, an increasingnumber of market participants came toexpect that the pre-announced bilateralexchange rates would be equal or veryclose to the bilateral central rates of theERM. As a result, the market-led process ofthe convergence of exchange rates towardstheir ERM central rates and, as a corollary,the convergence of short-term interestrates gained further momentum.

2.2 Monetary policies in individualMember States

The Deutsche Bundesbank continued tomaintain a low interest rate environment in1997, reflecting the gradual return of broadmoney (M3) growth to a more satisfactorylevel and the subdued outlook for inflationin Germany. Over the summer, however,the appreciation of the US dollar andincreases in administered prices caused anupturn in import, producer and consumerprice inflation. With the aim of ensuring afurther deceleration of the rate of monetaryexpansion and to counter the risks to pricestability at an early stage, the Bundesbankdecided on 9 October 1997 to adopt asomewhat less accommodating monetarystance. The securities repurchase rate -which had remained at 3.0% since August1996 - was raised to 3.3%, while both theofficial discount rate and the lombard ratewere kept unchanged at 2.5% and 4.5%,respectively (see Chart 3).

At the end of 1996 the Bundesbank extendedthe time horizon of its monetary target in

terms of M3 from one year to two years inorder to take account of possible uncertaintiesin financial markets in the period of transitionto Stage Three. An annual rate of M3 growthof approximately 5% was targeted for both1997 and 1998. As an additional point ofreference for the shorter term, the targetrange for M3 growth in the fourth quarter of1997 was set at 3.5-6.5%. In December 1997the Bundesbank confirmed its two-yearmonetary target of around 5% per annum,but lowered the target corridor for 1998 to3-6%. At the same time it acknowledgedthat in the second half of 1998 its monetarytargeting strategy would have to takegreater account of aspects covering thewhole group of countries selected toparticipate in the euro area (see alsoSection 3).

Whereas in 1996 the outturn of 8.1% forM3 growth in the last quarter exceededthe 4-7% target range, the pace of monetaryexpansion steadily decelerated in the courseof 1997 so that, in the fourth quarter, M3growth was 4.7%, i.e. just below the centreof the 3.5-6.5% target corridor (seeTable 6 (a)). The deceleration of moneygrowth was the result of a weakening inlending to both the private and the publicsectors and a high net outflow of funds arisingfrom transactions between domestic non-banks and non-residents. In 1997 domesticnon-banks further reduced their cross-borderdeposits and ran down their portfolios ofmoney market certificates. Reflecting this, theM3 aggregate extended by cross-borderdeposits, short-term bank bonds andinvestments in money market funds grewmore slowly than M3 in 1997 (at a rate of4.4% in the fourth quarter of 1997, comparedwith a rate of 4.7% for M3).

On 9 October 1997 official and/or keyinterest rates were also raised by 0.2-0.3percentage point in parallel in Belgium/Luxembourg, Denmark, France, theNetherlands and Austria, whereby somecentral banks allowed for a small differentialwith equivalent German policy interest rates

30

Official and key interest rates(in percentages)

Chart 3

Source: National data. (Rates indicated are the most relevant for monetary policy in each country.) (a) End-of-week data, for Portugal beginning-of-week data. (b) End-of-month data.(c) Prior to 23 May 1997: Interest rate on advances.(d) If the announcement of the regular rate of supply of liquidity is suspended, the interest rate corresponds to the rates on occasional operations.(e) Prior to 3 March 1997: Minimum lending rate.

DE Lombard rate(a)

DE Repo rate(a)DE Discount rate(a)

1996 1997

1996 1997

1996 1997

1996 1997

1996 1997

1996 1997

1996 1997

1996 1997

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31

(see Chart 3). Suomen Pankki had alreadyraised its tender rate by 0.25 percentagepoint in mid-September and SverigesRiksbank increased its repo rate by thesame magnitude in mid-December. Thecorrespondence in the size, timing anddirection of the monetary policy measuresin these Member States reflected the closealignment of their short-term interest ratesin an environment of stable exchange rates,similar medium-term inflation prospects andlow long-term bond yields.

The Banque de France closed the smallremaining gap with the German repurchaserate by raising its intervention rate by 0.2percentage point to 3.3% in October. Thismeasure aimed at preserving a high level ofconfidence in the French franc, which inthe course of the year appreciated to itscentral rates against most other ERMcurrencies. From a domestic perspective,the slightly less accommodating stance alsoaimed at sustaining a non-inflationaryrecovery in the face of more dynamic

Table 6Monetary policy targets and guidelines of Member States

(a) Monetary aggregates - targets and guidelines(annual percentage changes*)

1996 1997 1998

Reference Target/ Outturn Target/ Outturn Target/

variable guideline(a) guideline(a) guideline(a)

Germany M3 4-7 8.1 3.5-6.5 4.7 3-6

Greece M3 6-9 9.3 6-9 9.5 .

Spain ALP ≤8 6.5 ≤7 3.7 .France M3(b) 5 -3.2 5 2.0 5

Italy M2 5 3.1 <5 9.7 ~5

United Kingdom M0 0-4 5.7 0-4 6.5 -

M4 3-9 9.8 3-9 11.1 -

Source: National data.* Fourth quarter-fourth quarter or December-December (United Kingdom: March-March).(a) Medium-term objectives for Spain and France. Monitoring ranges for the United Kingdom were suspended 6 May 1997 and the

Bank of England’s Monetary Policy Committee subsequently decided not to reinstate them for the time being.(b) M3 for 1996, also assessed by developments in the narrow and broader monetary aggregates thereafter (M1, M2, M3+P1).

1996 1997 1998

Target Target Outturn Target Outturn Target

variable(a)

Spain CPI 3.5-4(b) 3.6 <3 2.0 2

Finland CPIY ~2 0.2 ~2 0.7 ~2

Sweden CPI 2 ± 1 0.8 2 ± 1 0.8 2 ± 1

United Kingdom RPIX 1-4 2.9 ≤2.5(c) 2.8 2.5

(b) Formal inflation targets(annual percentage changes)

Source: National data.(a) CPI = Consumer price index. CPIY = CPI excluding indirect taxes, subsidies and capital costs for owner-occupied housing,

(mortgage interest payments and depreciation). RPIX = Retail price index excluding mortgage interest payments.(b) Applies to the first quarter of 1996.(c) Lower half of 1-4% range by spring 1997; 2.5% or less thereafter; target of 2.5% from June 1997 onwards.

32

money and credit developments than in1996. Over the medium term the Banquede France has been seeking an expansionof the money supply by 5%; in December1997 the monetary aggregates M1 and M2recorded annual growth rates of 6.6% and7.8%, respectively, compared with 0.8%and 3.6% in 1996. Whereas the contractionof M3 observed in 1996 continued in thefirst months of 1997, M3 began to recoverfrom the spring onwards, underpinned bythe pick-up in economic growth and anupturn in the demand for narrow money(see Table 6 (a)). The growth rate of grosstotal domestic debt, which is monitored asa prominent indicator of financing conditions,was 3.5% in December 1997, i.e. slightlyhigher than a year earlier.

The Belgian/Luxembourg franc again showeda high degree of stability vis-à-vis the DeutscheMark, while Belgian short-term interest rateswere maintained at slightly higher levels thanthose in Germany (see Chart 4). In Denmarkinflationary pressures intensified during theyear. As these were partly countered by fiscaltightening, the Danish krone nonethelessstrengthened its position within the ERM andthe positive three-month interest rate spreadagainst the Deutsche Mark narrowedsomewhat. During the year the Dutch guildermoved down to its central rate against theDeutsche Mark. De Nederlandsche Bankreacted by allowing short-term interest ratesto rise from just below German levels toaround par, which was seen as a welcomemovement in view of the buoyancy of theDutch economy. The exchange rate of theAustrian schilling remained very close to itscentral parity against the Deutsche Mark.Three-month interest rates in Austria wereclose to those in Germany, although inOctober the Oesterreichische Nationalbankset the repurchase rate at 3.2%, i.e. slightlybelow its German equivalent, in response tolower perceived domestic inflationary risks.

Although the average rate of underlyingconsumer price inflation in Finland stayedwell below 2% in 1997, an upward trend

was discernible in the course of the year,with inflationary pressures arising on accountof continued strong growth performanceand the strengthening of consumers’inflation expectations. Higher financial assetprices and housing prices were also viewedas a potential cause for concern. With aview to securing its objective of stabilisingunderlying inflation at (around) 2% (seeTable 6 (b)), Suomen Pankki raised itstender rate from 3.0 to 3.25% in mid-September. During 1997 the Finnish markkawas one of the stronger currencies withinthe ERM and three-month interest ratescould generally be maintained at a levelslightly below those in Germany.

Sweden was also confronted with risingconsumer price inflation during most of 1997,albeit from a very low level. Against thebackground of higher capacity utilisation andsome concerns over wage settlements,Sveriges Riksbank took the precautionarystep in December of increasing its securitiesrepurchase rate from 4.1 to 4.35% in order toadhere to the 2% inflation target (with amargin of 1 percentage point on either side).On balance, the Swedish short-term interestrate spread over Germany was broadly stableat around 1.1 percentage points.

Conditions in several other EU countriessupported a further reduction in interestrates. The Banco de España reduced itsintervention rate in steps from 6.25% at thestart of the year to 4.75% in December.This reflected the fact that consumer priceinflation in Spain was declining rapidly tostabilise at an average rate of 2.0%, i.e. wellin line with both the objective for 1997 ofkeeping it below 3% and the 2% targetannounced for 1998 (see Table 6 (b)). Thestable position of the Spanish peseta withinthe ERM, the deceleration of the growthof broad monetary aggregates (seeTable 6 (a)) and a supportive fiscal policyfurther assisted the downward trend inshort-term interest rates, which by year-end had declined to 1.2 percentage pointsabove those in Germany.

33

Short-term interest rate differentials against Germany(three-month interbank rates; in percentage points)

Source: National data.

Belgium (LHS)Denmark (LHS)

Greece (RHS) SpainFrance

Ireland

ItalyNetherlands

AustriaPortugal

FinlandSweden

United Kingdom

Chart 4

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Consumer price inflation in Italy continued itsdownward trend and stabilised at an averagerate of 1.7% for the year as a whole. Thisresult, which also reflected currency stabilityand progress in fiscal consolidation, was well inline with the Banca d’Italia’s intention, asstated in May 1996, to secure a rate ofinflation of less than 3% in 1997. For 1998 thecentral bank is seeking to keep inflation at 2%.Monetary growth clearly exceeded the centralbank’s reference ceiling of 5% (seeTable 6 (a)); however, the broad monetaryaggregate M2 was affected by major portfolioshifts in response to the low-inflationenvironment. The Banca d’Italia thereforemade a cautious reduction in both the discountrate and the fixed term advances rate by atotal of 2 percentage points to 5.5% and 7.0%respectively. At the end of 1997 the Italianthree-month interest rate had fallen to a levelof less than 2.4 percentage points above theequivalent rate in Germany (see Chart 4).

In Portugal the stable position of the Portugueseescudo within the ERM was underpinned bythe rapid decline in inflation to just above 2%and firm progress in fiscal consolidation. TheBanco de Portugal was thus able to lower itsofficial interest rates in several steps, steeringthe repo rate down from 6.7% at the beginningof 1997 to 5.3% by the end of the year.Against this background, the three-monthinterest rate spread over Germany narrowedto just over 1.5 percentage points.

The Bank of Greece announced that it wasaiming to reduce inflation further to 4.5% bythe end of 1997 and to below 3% by the endof 1998. For this purpose, a broadly stableexchange rate of the Greek drachma againstthe ECU and a rate of M3 growth within arange of 6-9% were targeted. With anoutcome for consumer price inflation of 4.7%in December 1997, the central bank virtuallyachieved its price objective. The favourabletrend in inflation enabled a further reductionin official interest rates to be made in the firstpart of the year, as the rapid expansion of M3could be explained by portfolio adjustmentslinked to fiscal changes and the abolition of

remaining short-term capital controls. In theautumn, however, the drachma was affectedby speculative pressures in the wake of thefinancial crisis in Asia (see Box 1). Althoughthe countermeasures taken by the centralbank were successful in stabilising the currencyin 1997, three-month interest rates ended theyear some 4 percentage points higher thanbefore the outbreak of the turmoil.

In the remaining two countries economicconditions in 1997 necessitated a divergentapproach. The exceptionally strongperformance of the Irish economy, as reflectedin buoyant money and credit growth, tighteninglabour market conditions and rising assetprices, continued unabated. The associatedinflation risks prompted the Central Bank ofIreland to raise its short-term facility rate by0.25 percentage point to 6.5% in early May.Although the Irish pound remained thestrongest currency within the ERM, it lostground vis-à-vis sterling. As a result, theeffective exchange rate showed a tendencyto depreciate, which further exacerbatedinflation risks. However, Ireland did notparticipate in the general round of officialinterest rate increases in October. Towardsthe end of the year, ahead of the selection inMay 1998 of the countries to participate inStage Three of EMU, short-term interest ratesin Ireland declined relative to those in Germanyand the Irish pound moved closer to its ERMcentral rates.

1997 witnessed a major revision of the UKmonetary policy framework. Immediatelyfollowing the May general election, thenew Government decided, inter alia, togrant operational independence for thesetting of interest rates to the Bank ofEngland while retaining responsibility fordefining the inflation target.5 Just in advance

5 In addition, the Government’s monitoring rangesfor the expansion of the monetary aggregates M0and M4 were suspended in May 1997 and theBank of England’s Monetary Policy Committeesubsequently decided not to reinstate them for thetime being.

35

of the announcement of this decision, theChancellor of the Exchequer raised thesecurit ies repurchase rate by 0.25percentage point to 6.25%. The newlyestablished Monetary Policy Committee ofthe Bank of England subsequently increasedthe securities repurchase rate in four stepsto 7.25% in November in order to keepthe outlook for underlying (RPIX) inflationin line with the Government’s objective of2.5% (as restated in June). This significant

monetary tightening was deemed necessaryin the light of the current and prospectivestrength of domestic demand, notwithstandingthe expected effects of tighter fiscal policy,the ending of windfal ls from thedemutualisation of mortgage lending institutionsand the appreciation of sterling. Thepersistence of strong monetary developmentsalso gave cause for concern about futureinflation.

36

3 Economic prospects and challenges

This section describes the prospects for theEU and the world economy, considers theconduct of monetary policies in the periodof transition to Stage Three of EMU andaddresses the creation of the ESCB and theECB. Box 2 outlines the characteristics ofthe future euro area, as defined by theoutcome of the meetings of the EU Councilon 2/3 May 1998, meeting in the compositionof Heads of State or Government, toconfirm which Member States fulfil thenecessary conditions for the adoption ofthe single currency.

3.1 Economic outlook for 1998-99

Economic forecasts released by majorinternational organisations in spring 1998suggest that growth prospects for the EU in1998 and 1999 are favourable, as domesticdemand should strengthen further, offsettingto some extent an expected deteriorationin the external environment due to, interalia, the crisis in Asia.

Real GDP growth in the EU, which hasbeen gaining momentum since the secondquarter of 1997, is expected to strengthenfurther as domestic demand continues toaccelerate in a number of EU countries.Consumer and business confidenceindicators are pointing in the same direction.This partly reflects the impact of a low levelof nominal interest rates, particularly at longmaturities, prevailing in an environment of,by and large, subdued inflationary pressures,where external competitiveness has beenmaintained or improved despite currencydepreciations in many Asian countries. Thisenvironment, combined with increasedcorporate profitability, particularly in theexport-oriented industries, is expected tobe conducive to investment growth. Privateconsumption is also projected to pick upfurther due to a rise in real wages andreduced uncertainty regarding employment

prospects in 1998 and 1999. With acontinued need for fiscal consolidation, theimpact of government consumption andinvestment on domestic demand is likely toremain limited. Despite the projectedimprovement in labour market conditions,the rate of unemployment is expected todecline only modestly in 1998 and 1999. Asustained reduction in the rate ofunemployment will depend crucially on theimplementation of structural reforms toaddress labour and product market rigidities.

As regards the outlook for inflation, thecontinuation of stability-oriented monetarypolicies combined with wage moderation,with the latter partly reflecting thepersistence of relatively high rates ofunemployment, and still negative outputgaps in certain countries are expected tolimit inflationary pressures. In addition, thedecline in oil prices, provided that it is byand large sustained, and the counter-inflationary impact of the Asian crisis -arising from a depreciation of certain Asiancurrencies and the moderation of globalgrowth - should contribute to dampeninginflationary pressures from the outside. Risksto the inflation outlook relate to, inter alia,the possibility of a faster than expectedpick-up in aggregate demand in the EU andthus to a closing of output gaps, thedevelopment of wages, a furtherappreciation of the US dollar and, in thelight of the latest OPEC agreement, asustained reversal of the recent decline inoil prices.

The main uncertainty with regard to theabove outlook stems from the externalenvironment. World output and tradegrowth are expected to be weaker in 1998and 1999 than in 1997 owing to a sharpdecline in real GDP growth in parts of Asia,a modest slowdown in the US growth rateand a deterioration in the economic andfinancial situation in Japan. The extent of

37

the weakness in the external environmentarising from the turmoil in Asia will dependon the scope and timing of the adjustmentof macroeconomic policies in the countriesaffected, and on the extent to whichfinancial reforms are implemented. Thepossibility of further spillover effects cannotyet be ruled out. The contractionary impactof the Asian crisis on EU growth may bepartly offset by two factors: first, the declinein long-term interest rates in the EU as wellas in the United States - which is linked to,inter alia, investors’ reassessment of the riskin emerging markets; and, second, themarked decline in commodity prices, whichmay contribute to a further rise in realincomes.

3.2 Monetary policies in theremainder of Stage Two

The primary objective of the monetarypolicies of the eleven countries selected toparticipate in the euro area in the remainingmonths of Stage Two is to ensure that thecurrent environment of broad price stabilityis maintained for the euro area as a whole,thereby providing the ESCB with afavourable starting position.

As outlined in Section 2, the majority ofcountries selected to participate in theeuro area have already achieved short-term interest rates which are closely alignedat a low level. The conditions in the firstpart of 1998 have allowed this commonposition to be firmly consolidated and theremaining members have been able tomaintain the downward trend in their keyinterest rates. This suggests that a de factocommon monetary policy stance is tendingto emerge in the selected euro areacountries, against a background of broadlystable prices and exchange rates. By theend of 1998 at the latest, those countries’short-term interest rates will have convergedto a common level which will be consistentwith the objective of maintaining pricestability in the euro area.

This overall pattern of convergence inshort-term interest rates is consistent witha situation on the eve of Stage Three inwhich market exchange rates between thecountries selected to participate in theeuro area are equal to the pre-announcedbilateral exchange rates which will be usedin determining the irrevocable conversionrates for the euro (see Annex). These pre-announced bilateral exchange rates areconsistent with economic fundamentalsand are compatible with sustainableconvergence.

The institutional background to the above-mentioned development has, of course,changed. The confirmation on 2/3 May 1998by the Heads of State or Government ofthe Member States which will adopt thesingle currency heralded the start of thefinal phase of the transition to Stage Three,which includes the establishment of theESCB and the ECB and the liquidation ofthe EMI. During the remainder of StageTwo, the Governing Council and theExecutive Board of the ECB will finalise thepreparations needed for the conduct of thesingle monetary policy in the euro area asof 1 January 1999 (see Chapter 2). In themeantime, the participating national centralbanks will retain their national monetarypowers. The institutional changes entailedin the establishment of the ESCB and theECB provide a suitable framework withinwhich the participating national central bankswill be able to engage in close co-operationwith a view to co-ordinating their nationalmonetary policies in order to achieve theprimary objective of maintaining pricestability in the euro area. Furthermore, inaccordance with Article 44 of the ESCB/ECB Statute, the ECB is to take over thetasks of the EMI which still need to beperformed in Stage Three of EMU, giventhe existence of Member States with aderogation. The General Council of theECB is to assume responsibility for relationswith the national central banks of the non-euro area Member States.

38

Box 2

Characteristics of the euro area

On 2/3 May 1998, on the basis of the Council recommendation and following the European Parliament’s

Opinion, the Council - meeting in the composition of Heads of State or Government - unanimously

decided that eleven Member States, namely, Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg,

The Netherlands, Austria, Portugal and Finland fulfil the necessary conditions for the adoption of the

single currency on 1 January 1999. These countries will therefore participate in the third stage of

Economic and Monetary Union.

The table below shows a range of indicators which highlight some of the key characteristics of the

euro area. This table provides an initial comparison for the year 1997 (or the latest year for which

data are available) between the euro area, the EU-15, the United States and Japan, thereby broadly

describing the euro area’s “starting position”. However, the f igures shown are estimates collected

from various sources, and further elaborated aggregate data will become available during the course

of 1998 or later, based on newly compiled statistics. Overall, the data highlight a significant change

compared with the environment previously prevailing in individual EU countries. The introduction

of the euro will create an area which will closely resemble the United States in terms of the magnitude

of its domestic economy and its degree of openness.

In terms of population, with around 290 million inhabitants, the euro area is somewhat larger than

the United States and more than twice the size of Japan. In a global context, it is a “large domestic

economy” which has a share of world GDP of almost 20%, thereby possessing a considerable purchasing

power matched only by that of the United States. Intra euro area exports account for almost 17% of

total world exports. Excluding these intra-area exports, the euro area still accounts for approximately

20% of world exports and thus in terms of its percentage of world exports is larger than either the

United States or Japan. Patterns of production are broadly similar to those of the United States and

Japan. However, the service sector is smaller than that of the United States, but larger than that of

Japan, whose economy still features a relatively preponderant manufacturing sector. Figures for general

government current receipts and expenditures show that the euro area has a larger public sector than

either the United States or Japan, with close to 50% of GDP accounted for by government expenditures.

The ratios of exports and imports to euro area-wide GDP, both standing somewhat above 10%, suggest

that the degree of openness of the euro area is comparable to that of the United States and Japan

(after adjusting for intra-area trade). This contrasts with the typical nature of individual EU countries,

as “small or medium-sized economies” with an average ratio of exports or imports to GDP of around

25% (although there are sizable variations across the individual countries within the euro area).

Figures for the value of debt securities, stock market capitalisation and bank assets show that the

combined weight of financial markets in the euro area is substantial, although the relative weight of

individual components differs. Compared with the United States and Japan, the weight of equity and

debt securities markets is lower and the relative importance of banking is far greater.

Considering a number of recent macroeconomic variables, real GDP growth for the euro area as a

whole was 2.5% in 1997. Reflecting different positions in the cycle, GDP growth in 1997 was markedly

different from that in the United States and Japan. Inflation in the euro area, as measured by the

harmonised index, was 1.6%, similar to the outturn for Japan, but below that for the United States.

The unemployment rate was significantly above that of both the United States and Japan. Short and

long-term nominal interest rates were lower in the fourth quarter of 1997 than they were in the United

States. Average general government debt and def icit f igures for the countries comprising the euro

area show debt and deficit ratios of 75.2% and 2.5% respectively (with significant differences among

Member States); on average, they were above those in the United States but below those in Japan

(where the debt ratio is nearly 100%). Finally, the current account balance, as for the EU as a whole,

was in surplus. This surplus was lower than in Japan and compares with a deficit in the United States.

39

Euro United

area EU-15 States Japan

Area (a) 1,000 km2 2,365.0 3,234.2 9,372.6 377.8

Population mn 290.4 374.1 267.9 126.0

GDP (as % of world GDP) (b) % 19.4 24.6 19.6 7.7

Nominal GDP ECU bn 5,548.1 7,132.3 6,896.5 3,708.4

Sectors of production (c)

Agriculture, fishing, forestry % of GDP 2.4 2.4 1.7 2.1

Industry (incl. construction) % of GDP 30.9 30.0 26.0 39.2

Services % of GDP 66.7 67.6 72.3 58.7

General government

Total current receipts % of GDP 47.0 46.3 36.7 32.6

Total expenditures % of GDP 49.6 48.7 37.0 36.0

Exports of goods (d) % of GDP 12.3 9.2 8.1 8.8

Imports of goods (d) % of GDP 11.0 8.6 10.6 6.9

Exports (as % of world exports) (e) % 19.5 . 14.8 9.7

Debt securities (f) ECU bn 5,347.1 6,632.5 8,450.4 4,071.9

% of GDP 102.7 102.8 157.2 103.7

Stock market capitalisation (g) ECU bn 1,620.7 2,889.4 5,244.0 2,804.4

% of GDP 31.1 44.8 97.6 71.4

Bank assets (h) ECU bn 10,082.5 12,479.7 4,211.0 6,217.3

% of GDP 202.8 201.2 74.6 157.4

Real GDP growth % 2.5 2.7 3.8 1.0

CPI inflation (i) % 1.6 1.7 2.3 1.7

Unemployment rate (as % of labour force) % 11.6 10.6 4.9 3.4

Short-term interest rate (j) % 4.4 5.1 5.6 0.7

Long-term interest rate (j) % 5.7 5.9 5.9 1.7

General government

Surplus (+) or deficit (-) % of GDP -2.5 -2.4 -0.3 -3.4

Gross debt (k) % of GDP 75.2 72.1 63.1 99.7

Current account balance % of GDP 1.7 1.2 -1.9 2.2

Key characteristics of the euro area, 1997

Source: European Commission (spring 1998 forecasts), unless otherwise stated.(a) Source: EUROSTAT.(b) 1996; at current prices and purchasing power standard.(c) 1993; at current prices. Source: OECD, Historical Statistics, 1960-1995.(d) 1996. Source: EUROSTAT. Data for euro area exclude intra euro area trade; data for EU-15 exclude intra EU-15 trade.(e) 1996; excluding intra euro area exports.(f) 1995. Source: IMF, International Capital Markets, November 1997. Domestic and international debt securities by

nationality of issuer. EMI calculation.(g) 1995. Source: IMF, International Capital Markets, November 1997. EMI calculation.(h) 1994. Source: IMF, International Capital Markets, November 1997. EMI calculation.(i) Euro area and EU-15: annual average, HICP inflation.(j) 1997 Q4. Source: National data. EMI calculation.(k) End-year data. Source for United States and Japan: IMF, World Economic Outlook, April 1998.

Chapter II

Preparatory work

for Stage Three

42

1 Monetary policy

1.1 Monetary policy strategy

In February 1997 the EMI published areport entitled “The single monetary policyin Stage Three - Elements of the monetarypolicy strategy of the ESCB”. Havingreviewed a number of alternative strategies,the report identified intermediate monetarytargeting and direct inflation targeting asthe basis for a potential strategy for StageThree. While noting that it would beneither necessary nor useful, at that point,to select a specific strategy, the report listeda number of key elements which should beviewed as an indispensable part of anystrategy: a clear definition of the finalobjective of price stability and of the specifictargets against which the performance ofthe ESCB could be assessed; the availabilityof a broad set of indicator variables to helpassess the risks to future price stability; aprominent role for monetary aggregates,provided that money demand in the euroarea is sufficiently stable in the long run; andtools enabling forecasts for inflation andother euro area economic variables to beproduced. In addition, the report notedthat monetary policy in Stage Three wouldalso require a comprehensive data set andanalytical capacities, including econometricmodels, to assist in the formulation ofpolicy.

Following publication of the above-mentioned report, work at the EMI in thefield of strategy concentrated on thepreparation of the infrastructure necessaryto support monetary policy decision-makingirrespective of the strategy to be chosen.Preparatory work was initiated on thedefinition of monetary aggregates for StageThree, the preparation of organisationaland methodological aspects of the ESCB’sforecasting procedures and the developmentof indicators of fiscal stance at the euroarea-wide level. EMI staff also carried outwork on a number of other topics, such as

the measurement of inflation and inflationexpectat ions, the leading indicatorproperties of financial variables and studiesof money and credit demand in the EU.

In the field of econometric modelling, amajor project was launched which wasconcerned with the development of anESCB multi-country macroeconomic modeland involved collaboration between theEMI and NCBs. In the course of the yearthe specification of the model was agreed,the supporting database constructed andwork commenced on the estimation of themodel, which is due to become available asan operational tool in the second half of1998. In addition, further work was carriedout by EMI staff on the development of aeuro area-wide macroeconomic modeldesigned to summarise the broad contoursof the average transmission mechanism ofmonetary policy in the euro area. This euroarea-wide model has already been used forforecasting and simulation purposes in thecontext of Stage Two co-ordinationexercises. Furthermore, a number ofstatistical tools to be used for forecastingpurposes were developed and refined byEMI staff.

1.2 Implementation of the singlemonetary policy

Instruments and procedures

The conceptual phase of the preparatorywork dealing with the instruments andprocedures necessary for implementing thesingle monetary policy in Stage Three wasconcluded at the end of 1996, thus leadingto the publication in January 1997 of anEMI report entitled “The single monetarypolicy in Stage Three - Specification of theoperational framework” (the “FrameworkReport”). The first half of 1997 was devotedto defining the technical specifications for

43

the ESCB’s operational framework and thiswork led to the publication in September1997 of an EMI report entitled “The singlemonetary policy in Stage Three - Generaldocumentation on ESCB monetary policyinstruments and procedures”. In the secondhalf of the year the detailed specification ofall the instruments and procedures, includingthe preparation of the relevant legal andtechnical infrastructure, progressed furtherand the setting-up of the ECB toolsnecessary for the implementation of thefuture monetary policy of the ESCB wasbegun. This work continued into early1998. The second half of 1998 will bedevoted to a thorough testing of theprocedures and systems to be used inStage Three.

The EMI Council has defined a set ofmonetary policy instruments that will bemade available to the ESCB. It is envisagedthat the ESCB will mainly use open marketoperations, but that it will also offer twostanding facilities. In addition, preparationsare being made to enable the ESCB toimplement a minimum reserve systemshould the Governing Council of the ECBdecide to do so.

As regards open market operations, thesewil l normal ly be based on tenderprocedures. Only outright operations andthe other types of operations used for fine-tuning purposes by the ESCB may beconducted through bilateral procedures.The procedures, time frame and calendarfor ESCB tenders have been designed insuch a way as to meet the requirements ofmoney market participants to the greatestpossible extent. For most open marketoperations, namely the main refinancingoperations, the longer-term refinancingoperations and, possibly, the issuance ofdebt certificates, the ESCB will use the so-called standard tenders. These tenders willbe executed within 24 hours of theirannouncement. The time frame for standardtenders foresees that the ESCB willannounce the tender results within

approximately two hours of the deadlinefor the submission of bids by financialinstitutions. In fine-tuning operations eitherbilateral operations or so-called quicktenders will be executed. Quick tenderswill be completed within around one hourof the announcement of the tender.

Despite the fact that bank holidays in theMember States differ, a calendar of regularESCB tender operations will be established,which will ensure that all counterparties inthe euro area will be able to participate inthe main and longer-term refinancingoperations conducted by the ESCB at alltimes.

The settlement of open market operationsbased on standard tenders will normallytake place on the first business day followingthe trade date. In contrast, fine-tuning openmarket operations will normally be settledon the trade date itself, in order to makesure that these operations have animmediate liquidity impact. For outrighttransactions and foreign exchange swaps,the ESCB will apply settlement dates in linewith market practice. While the ESCB willaim at settling the transactions related to itsopen market operations simultaneously inall Member States, the possibility cannot beruled out that the precise timing of thesettlement of open market operations duringthe course of the day will differ across theeuro area at the start of Stage Three,owing to some operational constraints onnational securities settlement systems.

With regard to the ESCB’s two standingfacilities, their use will largely be influenced bythe ESCB’s end-of-day procedures, which willbe of particular importance for the operationof the money markets. The normal closingtime for TARGET will be 6 p.m. ECB time. Atthat time, all the debit positions ofcounterparties will automatically be treated asa request for recourse to the marginal lendingfacility. NCBs will start their end-of-dayprocedures at 6.30 p.m. ECB time. This willalso be the deadline for requests to access

44

the ESCB’s deposit facility. These end-of-dayprocedures have been devised so as tomaximise the flexibil ity available tocounterparties, while at the same time bearingin mind the need to perform the ESCB’smonetary policy functions.

The EMI is currently carrying out thepreparatory work necessary to enable theESCB to impose minimum reserverequirements as from the start of StageThree. A proposal for a draft EU CouncilRegulation on minimum reserves waspublished as an annex to the EMI’s“Framework Report”. During 1997 the EMIdiscussed this draft Regulation in the contextof an informal discussion with the MonetaryCommittee. As a result, an amended textwill be formally presented to the EU Councilby the ECB shortly after its establishment, inaccordance with Article 106 (6) of theTreaty. The minimum reserve system wouldinclude an averaging mechanism that wouldallow counterparties to smooth temporaryliquidity shocks over the maintenanceperiod, which is envisaged to have a timespan of one month. With regard to thereserve base, the EMI has proposed thatminimum reserves may be applied to theliability items on the balance sheets ofinstitutions subject to reserve requirements.Some liabilities resulting from off-balancesheet items could also be included in thereserve base. The relevant liability items arereported for statistical purposes at the endof the calendar month preceding the startof the maintenance period. This does notimply that all these balance-sheet itemswould be subject to a positive reserve ratio,but merely that these would be the relevantand potential liability items if the GoverningCouncil of the ECB were to decide infavour of a minimum reserve system.

Eligible counterparties and assets

Common eligibility criteria have been definedfor the counterparties and the assets to beused in operations with the ESCB.

With regard to counterparties, if minimumreserves are applied, all institutions subjectto minimum reserve requirements will beeligible to access open market operationsand the two standing facilities. If no minimumreserves are applied, it is to be expectedthat the range of counterparties will broadlycorrespond to the range of creditinstitutions. Only for the purpose of fine-tuning operations will the ESCB deal with amore limited range of counterparties, forobvious reasons of efficiency. The ESCB’scounterparties will need to satisfy certainprudential and operational requirements. Inparticular, counterparties will have to befinancially sound institutions, subject toprudential supervision and able to participatein the relevant ESCB operations under thetechnical conditions set by the ESCB.

Eligible assets will be classified as either tierone or tier two assets. Tier one will consistof marketable debt instruments fulfillinguniform euro area-wide eligibility criteria.Tier two will consist of additional assets,marketable and non-marketable, which areof particular importance for national financialmarkets and banking systems and for whicheligibility criteria will be established by NCBs,subject to the minimum eligibility criteriaestablished by the ECB. All eligible assetswill be subject to specific risk controlmeasures. These risk control measures weredefined during the course of 1997, takinginto account market practices and reactionsto initial proposals from the EMI. For tierone instruments, risk control measures willconsist of initial margins, specific valuationhaircuts differentiated according to theresidual maturity and coupon structure ofthe debt instrument (implying that thevalue of the underlying asset will becalculated as the market value of the assetless a certain percentage (haircut)) andmargin calls aimed at ensuring over timethat the valuation of the underlying assetmatches the amount of liquidity providedplus the value of the initial margin. Riskcontrol measures for tier two assetscomplementing the initial margins will be

45

proposed by those NCBs which haveincluded such assets in their lists, and thesemeasures will have to be approved by theECB. The ESCB will aim to ensureconsistency in the application of the riskcontrol measures for tier two assets acrossthe euro area.

Preparatory work for the implementation ofmonetary policy instruments

As monetary policy will be implemented ona decentralised basis, with the ECB carryingout bilateral fine-tuning operations onlyunder exceptional circumstances, the mainpreparatory work for the introduction ofthe euro has been undertaken by theNCBs. This consists in their adapting thewhole set of monetary policy instrumentsand procedures used at present. The EMI isin charge of monitoring the implementationof this work and co-ordinating the projectsand developments.

In particular, the EMI is supervising thepreparation by each NCB of its own set oflegal requirements to be used in its relationswith monetary policy counterparties. Thisdocumentation is being prepared on thebasis of a common set of legal requirementsthat will help to ensure a level playing-fieldthroughout the euro area.

An ESCB internal IT infrastructure is currentlybeing prepared for the execution of bothtender operations and bilateral transactions.The processing of tender operations willrequire several sequential steps involvingintra-ESCB communication, while theprocessing of bilateral transactions willinvolve a real-time IT system connectingthe ECB and the NCBs.

In order to establish the lists of eligibleassets proposed by the NCBs and eligiblecounterparties for ESCB monetary policyoperations, the EMI is setting up systemswhich will compile all the relevantinformation, calculate the parameters ofrisk control measures and enable regularexchanges of information to be carried outwithin the ESCB. In addition, both the list ofindividual eligible assets, with the possibleexception of certain categories of non-marketable assets, and that of institutionssubject to reserve requirements will bemade available to the public.

Another crucia l project for theimplementation of the single monetarypolicy is the setting-up of an effectivesystem of liquidity management. It willrequire an integrated daily flow ofinformation between the NCBs and theECB, both with respect to liquidity forecastsand for the purpose of conductingdecentralised monetary policy operations.

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2 Foreign exchange policy

2.1 The ERM II

In the context of future foreign exchangepolicy co-operation between Member Statesparticipating in the euro area and other EUcountries, work was conducted in 1997 atthe level of both the ECOFIN Council andthe EMI, in accordance with the broad linesdefined in a report the EMI submitted onthis issue to the Dublin meeting of theEuropean Council in December 1996. TheEuropean Counci l meeting held inAmsterdam in June 1997 approved aResolution relating to the new exchangerate mechanism to be introduced in StageThree of EMU. In parallel, the EMI hasfinalised the draft agreement between theECB and future non-euro area NCBs,which lays down the operating proceduresfor the ERM II; the draft agreement will besubmitted to the ECB for endorsementfollowing its establishment in early summer1998. In the meantime the EMI has beencontinuing to work on the development ofthe technical infrastructure to enable thesystem to be operational as from 1 January1999.

2.2 Foreign exchange interventionand the management of theECB’s foreign reserve assets

In 1997 implementation work on theconduct of potential foreign exchangeintervention by the ECB focused on aspectsrelated to the required operationalframework and information systemssupport. The infrastructure currently beingdesigned will make it possible for the ESCBto execute intervention, both within andoutside the ERM II.

As regards the ECB’s foreign reservemanagement, the information systemssupport needed by the ECB for its strategicdecision-making processes is currently being

developed, including the setting of theoverall operational objectives in terms ofcurrency risk, interest rate risk, credit riskand liquidity risk. This technical infrastructurewill be used to convey the ECB’s decisionsto the NCBs, which could then be incharge of carrying out portfolio managementoperations in accordance with theseinstructions, pending a decision by theGoverning Council of the ECB.

In accordance with Article 30.1 of theESCB/ECB Statute, at the beginning ofStage Three NCBs will transfer foreignreserve assets up to an amount equivalentto E 50 billion to the ECB. Work has beenundertaken in order to facilitate the decisionon the amount that will actually betransferred and on the modalities of theinitial transfer of reserve assets. Likewise,work has been initiated to preparecomplementary Community legislationwhich will enable the ECB, in accordancewith Article 30.4 of the ESCB/ECB Statute,to make further calls on the NCBs’ foreignreserve assets beyond the l imit of E 50 billion set in Article 30.1.

2.3 Guidelines for the NCBs’ andMember States’ operations withtheir foreign reserve assets

While foreign reserve assets in excess ofthose transferred to the ECB at thebeginning of Stage Three will be held andmanaged by the NCBs, market transactionsconducted with those assets will bemonitored by the ECB with a view toensuring consistency with the singlemonetary policy and the foreign exchangepolicy of the euro area. A similar monitoringframework will be put in place fortransactions performed by euro areaMember States involving the use of theirforeign exchange working balances. Aframework has been elaborated on this

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issue, encompassing not only centralgovernments but also all public authoritieswithin the euro area. Hence in accordancewith Article 31 of the ESCB/ECB Statute,foreign exchange operations carried out bythe NCBs with their remaining foreignreserve assets, the amount of which exceedsa threshold to be set by the ECB, will besubject to prior approval by the ECB.Similarly, market transactions effected bythe Member States and changes in theirforeign exchange working balances will besubject to a prior notification procedure ifthe amount in question exceeds a thresholdto be set by the ECB. Through thisprocedure the ECB will be in a position todetermine, if deemed necessary, themodalities of such transactions. In addition,ex post reporting requirements have beendefined for both the euro area NCBs andthe Member States. The EMI has finalisedtwo draft proposals which will be submittedfor approval to the ECB: one encompassingoperations conducted by the NCBs andanother covering transactions made byMember States. In addition, an arrangementto be established between the EuropeanCommission and the ECB has been prepared,which will enable the ECB to be keptinformed, through notification and reportingprocedures, of the Commission’s foreignexchange operations.

2.4 The euro reference exchangerates

The EMI conducted work during 1997aimed at preparing procedures for thecomputation and publication of thereference exchange rates for the euro. InMarch 1997 a meeting on changeoverissues was held in Frankfurt between theEMI, the NCBs and EU-wide banking andfinancial associations. In this context, theEMI clarified its views on a number ofaspects: (i) its preference for the “certain”quotation method (i.e. E1 = x amount offoreign currency) for defining euroexchange rates; (ii) the notion that a euro

area-wide official fixing procedure involvingthe ECB and NCBs will not be required;and (iii) the need for the ESCB to computeand publish daily reference exchange ratesfor the euro. Further work on these issuesis currently under way in order to establishthe method to be used in determining theeuro reference exchange rates and otherprocedural aspects l inked to thedissemination of those rates.

2.5 The pre-announcement of thebilateral rates to be used indetermining the irrevocableconversion rates for the euro

The Luxembourg European Council held inDecember 1997 stated in its conclusionsthat “the bilateral exchange rates which willbe used to determine the conversion ratesfor the euro will be announced on3 May 1998 for those Member Statesparticipating in the euro from the start”.The Treaty requires that the formal adoptionof the irrevocable conversion rates for theeuro take place on 1 January 1999 upon aproposal by the Commission and afterconsulting the ECB. In addition, the fact thatsome of the ECU component currencies(the Danish krone, the Greek drachma andthe pound sterling) will not be participatingin the euro area from the start means thatit is not possible to announce the irrevocableeuro conversion rates for the participatingcurrencies. However, it was possible topre-announce the bilateral rates of thecurrencies participating in the euro areawhich will be used on 31 December 1998to set the irrevocable conversion rates forthe euro.

The Joint Communiqué6 issued on 2 May1998 by the Ministers and central bankgovernors of the EU Member Statesparticipating in the euro area, the EuropeanCommission and the EMI, as the forerunner

6 The official documentation is reproduced in anannex to this Annual Report.

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of the ECB, clarifies that these rates are theERM bilateral central rates for the currenciesof the euro area Member States. Themethod to be used on 31 December 1998to set the irrevocable conversion rates forthe euro wil l be the regular dailyconcertation procedure, which will takeplace at 11.30 a.m. on that day. Accordingto this procedure and in the context of ateleconference, the NCBs of the MemberStates will provide one another with theexchange rate of their respective currencyagainst the US dollar, once the NCBs haveascertained that the bilateral rates obtainedby crossing the respective US dollar ratesare equal to the pre-announced ERM

bilateral central rates. The euro area NCBsstand ready to ensure this equality, ifnecessary through the use of appropriatemarket techniques. The next step will involvethe final official ECU exchange rates againstthe EU currencies being set by multiplying(or dividing, depending on quotationconventions) the USD/ECU exchange rateby their respective US dollar exchangerate. The exchange rates of the officialECU vis-à-vis the currencies of the euroarea Member States will be adopted by theCouncil as the irrevocable conversion ratesfor the euro on and with effect from1 January 1999.

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3 Statistics

3.1 Implementation of the statisticalrequirements for Stage Three

The Treaty requires the EMI to make thestatistical preparations necessary to enablethe ESCB to perform its functions in StageThree.

A statement of these statistical requirements,the so-called implementation package, wasreleased in July 1996, and soon afterwardsNCBs started to discuss theirimplementation with national bankingassociations and other interested parties.The requirements were summarised in theEMI’s Annual Report 1996 and are notrepeated here except where necessary asbackground information to subsequentdevelopments.

Much of 1997 was spent implementingthese requirements and clarifying points ofdetail, where necessary. The EMI publishedprovisional lists of institutions forming theMonetary Financial Institutions (MFI) sector,in addition to documents covering moneyand banking and balance of paymentsstatistics in Member States. The EMI engagedin informal discussions concerning legalaspects of the statistical framework forStage Three and defined the specificationsfor a substantial part of the necessary ITinfrastructure.

Money and banking statistics

The EMI’s publication entitled “EuropeanMoney and Banking Statistical Methods”(April 1997) describes the statistical systemsin Member States in the field of money andbanking statistics as at the end of 1996.Meeting the requirements set out in theimplementation package will imply changesin all Member States. Two EU-widemonitoring exercises during the courseof 1997 recorded the progress made in

implementing these changes. In general, thechanges were being introduced withoutmajor difficulty. In some Member States theadoption of breakdowns by original maturityfor certain items on banks’ balance sheetsand the agreed 15 working day deadlinefor the transmission of national data to theECB were reported to have caused someinitial difficulties.

The definition of Monetary FinancialInstitutions is set out in the implementationpackage. MFIs will report a monthly balancesheet and more detai led quarterlyinformation, although smaller institutionsare exempt from some of the reportingrequirements. A provisional list of MFIs waspublished in September 1997. It mainlycomprised credit institutions as defined inCommunity law, in addition to certainother financial institutions corresponding tothe MFI definition, although not at thatstage including money market funds. Anaddendum to the provisional list, comprisingmoney market funds, was published inDecember 1997.

Following further testing and reviews, a finalversion of the list of MFIs was released inApril 1998. Comprising some 11,000institutions, it provides as homogeneous apopulation as possible for statistical purposes.It will facilitate the production of acomprehensive and consistent balance sheetof the money-creating sector in the singlecurrency area and support other importantstatistical applications such as the ESA 95. Itwill also be used in connection with theselection of counterparties for the monetarypolicy operations of the ESCB.

In close collaboration with the NCBs, theEMI prepared guidelines for the compilationof money and banking statistics coveringsome forty issues. The EMI also clarified thereporting requirements to be met by NCBs,since they form part of the MFI sector and

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contribute to monetary statistics. In theareas of interest rates and securities issuesstatistics, more extensive use will be madeof existing data sources for the time being.

The implementation package requires thefirst data compiled on the agreed new basisto be available for end-June 1998, andmonthly thereafter, with back data on theclosest possible approximation to it fromSeptember 1997 to be available bySeptember 1998. With the help of theNCBs, the EMI is preparing estimates forearlier periods; for most Member Statesthese cannot be exact because theharmonised balance sheet categories andgeographical breakdowns of externalpositions necessary for the correctcalculation of aggregates for the futuresingle currency area are not available in therequired detail for earlier periods.

Balance of payments statistics

EU Member States either adopted theprovisions of the 5th edition of the IMFBalance of Payments Manual in the courseof 1997 or intend to do so during 1998.The monthly key items for the balance ofpayments of the single currency area willconform as far as is practicable with thenew IMF Manual. The more detailed dataenvisaged for a quarterly and an annualbalance of payments (and for an annualstatement of the international investmentposition (IIP)) will be compatible with theIMF’s standard components. A large part ofthe necessary harmonisation of definitionswill be accomplished in the process.

The implementation package contains fewdetails concerning either the statisticaltreatment of derivatives in the balance ofpayments or the IIP. Both matters receivedclose attention from the EMI in 1997. Therequirements for the single currency areacorrespond to international standards asamended by international agreement. It willnevertheless take some time for uniformity

and full consistency to be achieved in someareas, especially in the treatment ofderivatives, the portfolio account in generaland the valuation of outstanding stocks.

Derivatives and the portfolio account alreadypresent difficulties in some national balancesof payments. Another difficulty which hasbeen noted in monitoring exercises istimeliness: only nine Member States wouldcurrently be able to meet a six-week deadlinefor all monthly key items. Ireland and theUnited Kingdom do not have a full balance ofpayments on a monthly basis at present; bothmade considerable progress in preparingestimates in 1997.

Balance of payments estimates for 1998covering key items for the future singlecurrency area will be compiled from datawithout breaking counterparties down intoresidents of countries participating in thesingle currency area and residents of othercountries, and so will take the form of anaggregation of net balances in each categoryof the national balances of payments. Thefirst IIP for end-1998 will also be compiledon a net basis.

Financial accounts

The implementation package foresees aneed for detailed information coveringfinancial transactions and balance sheets forthe single currency area to complementmonetary analysis and policy research. Thedocument suggests that it should be possibleto compile, within the conceptual frameworkset out in the ESA 95, a fairly full, thoughnot complete, account for the singlecurrency area from monetary, balance ofpayments and capital market statistics,drawing also on national financial accountsas far as possible. These data should becompiled on a quarterly basis in order tobe of real use to the ECB.

In 1997 the EMI established that it wouldindeed be possible to compile a quarterly

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set of financial accounts as described aboveand began work in order to design them.

Like the balance of payments, financialaccounts also represent an area in which itis agreed that the Commission (EUROSTAT)and the EMI share responsibility at theEuropean level. The approach to sharedresponsibility is summarised in Section 3.2on organisation.

Other economic and financial statistics

The implementation package states thatthere is a need for government financestatistics, as they measure an importantinfluence on monetary conditions; forstatistics on prices and costs, since theserelate directly to the ESCB’s primaryresponsibility to maintain price stability; andfor a wide range of economic statistics(relating to components of demand, output,the labour market, etc.), which provide thebackground for the conduct of monetarypolicy and foreign exchange operations.

All these statistics are the responsibility ofthe Commission (EUROSTAT) and the EMIis involved in their development in itscapacity as a closely interested user. Muchfurther work was done in 1997 toharmonise the treatment of governmentdeficit and debt statistics in order to makethe data comparable for the purpose ofassessing convergence under Article 109jof the Treaty. In March 1997 theCommission published the first harmonisedconsumer price statistics covering the EU.These statistics, combined to form anaggregate covering the euro area, are likelyto constitute the main measure of pricesmonitored by the ECB.

EU Member States have a legal commitmentto implement the requirements of the ESA 95starting in spring 1999. Although some MemberStates have derogations regarding certainparts of the ESA 95, this step will lead toincreased harmonisation in national accounts

statistics; preparatory work to this endproceeded in 1997. In addition, the EMI hasstrongly supported a Commission initiative toharmonise the frequency, timeliness andcoverage of a wide range of conjuncturalstatistics to the extent deemed necessary. Ashort-term statistics Regulation has recentlybeen enacted by the EU Council. This initiativewill take some time to become fully effective,however, because the Regulation allows delaysin implementation of up to five years.Meanwhile, arrangements are being made tospeed up the availability of national data.

3.2 Organisation of statistical workat the European level

The EMI’s Annual Reports for 1995 and1996 noted the agreed division ofresponsibility between the Commission(EUROSTAT) and the EMI. This includedshared responsibility for balance of paymentsstatistics and financial accounts.

During 1997 further consideration was givento the sharing of responsibility in theseareas. In the balance of payments, it hasbeen suggested that the Commission(EUROSTAT) should compile data relatingto most of the current account and thecapital account (in the new terminology),while it is expected that the ECB willcompile data relating to the financial account(in the new terminology) and the investmentincome part of the current account.Reflecting the Commission’s knowledge inthe area and its use of the data for certainpolicy purposes, both institutions will play arole in the compilation of direct investmentstatistics. A joint publication of data isenvisaged. This arrangement relates toquarterly and annual balance of paymentsdata; only the ECB is expected to beinvolved in the compilation of monthly keyitems.

In the area of financial accounts, the legalrequirement laid down in the ESA 95 is foran annual frequency. The EMI, and

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prospectively the ECB, will take the lead indeveloping quarterly financial accountsrelating to the single currency area followingthe approach described above and, togetherwith the Commission (EUROSTAT), willmonitor the implementation of the ESA 95in the area of financial accounts.

The EMI and the future ECB will continueto co-operate closely with the Commission(EUROSTAT) on all statistical matters ofcommon interest. The respective statisticalresponsibilities of the ECB and theCommission at the European level willneed to be formally agreed following theestablishment of the ECB.

3.3 Legal aspects

A draft EU Council Regulation concerningthe collection of statistics by the ECB waspublished in the EMI’s report entitled “Thesingle monetary policy in Stage Three -Specification of the operational framework”in January 1997.

During 1997 the EMI discussed this draftRegulation informally within an ad hocgroup of the Monetary Committee. SeniorEU statistical committees also commentedon it. The amended text will be formallypresented to the EU Council by the ECB

shortly after its establishment, in accordancewith Article 106 (6) of the Treaty.

In order to give effect to this EU CouncilRegulation concerning the collection ofstatistics, the ECB will need to issue legalinstruments in accordance with Article 34of the Statute.

3.4 Information systemsinfrastructure

The design of a system for electronic datatransmission within the ESCB was essentiallycompleted by summer 1997. By the end of1997 much of the implementation hadalready been completed, thus permittingthe first test electronic transmissions to takeplace in January 1998. The system uses theGESMES-CB message format, which isgenerally applicable for the purpose ofstatistical data exchange in time-seriesformat. It is likely to be widely used for theexchange of statistics between internationalorganisations.

In 1997 the EMI also started to prepare itsinternal systems in order for them to beable to receive, process and store the largeamounts of statistical data which the ECBwill need to handle in Stage Three.

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4 Payment systems

4.1 The TARGET system

In September 1997 the EMI released the“Second progress report on the TARGET(Trans-European Automated Real-timeGross settlement Express Transfer) project”.7

The report provided further information onthe progress made with regard to theorganisational aspects and implementationof the system. It mainly addressed thefollowing issues: 1) operating time; 2) pricingpolicies; 3) the provision of intraday liquidityto non-euro area NCBs; 4) the role of theECB in TARGET; and 5) TARGETimplementation.

With reference to the TARGET operatingtime, Christmas Day and New Year’s Daywill be the only two common holidays forTARGET, in addition to Saturdays andSundays. On all other days the TARGETsystem will be open, although NCBs will befree to close their domestic systems onnational holidays when the law or therespective banking community so require.Provided that at least two real-time grosssettlement (RTGS) systems are open, theInterlinking system between those systemswill also remain open. A calendar ofTARGET operating days for 1999 (includinga list of national RTGS closing days) will bepublished in August 1998. Moreover, it hasbeen agreed that the normal TARGEToperating hours will be from 7 a.m. to6 p.m. ECB time, i.e. the time in the placewhere the ECB is located.

The precise level of the fee to be charged forcross-border TARGET transactions will bedecided by the Governing Council of theECB. The fee is expected to be close to thelower end of the previously indicated rangeof E 1.50 to 3.00. In addition, a pricedifferentiation can be expected, which will bebased on volume and will result in an averageuser cost of well below E 1.50 for participantsmaking extensive use of TARGET.

7 An updated version of the technical annexesoriginally published in August 1996 (Interlinkingspecifications, a data dictionary and details of theminimum common performance features of RTGSsystems within TARGET) and a further technicalannex concerning end-of-day procedures weremade available to interested parties.

8 See the EMI’s report entitled “The singlemonetary policy in Stage Three - Specification ofthe operational framework”, which was publishedin January 1997.

9 The early cut-off time for customer paymentsapplies to all three mechanisms.

As the follow-up to a decision taken by theEMI Council in December 1996,8 threemechanisms are being prepared in order toprevent intraday credit, if provided by euroarea NCBs to non-euro area NCBs, fromspilling over into overnight credit.

The three mechanisms are as follows:

mechanism 1: high penalty rates forspillovers (supplemented by non-pecu-niary sanctions) and an early cut-offtime for customer payments both ineuro area and in non-euro area coun-tries;9

mechanism 2: limits (possibly set atzero) for intraday credit granted byeuro area NCBs to non-euro areaNCBs;

mechanism 3: an earlier cut-off time fornon-euro area TARGET participants(NCBs and credit institutions). In thiscase, the earlier cut-off time would notapply to the processing of payments bynon-euro area NCBs, but rather to theiruse of intraday credit in euro.

The decision on these issues will be takenby the Governing Council of the ECB.

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The ECB will be connected to TARGET viaits own payment mechanism (the ECBpayment mechanism, or EPM), throughwhich it will perform the following functions:

maintain accounts on behalf of itsinstitutional customers (excluding creditinstitutions);

process payments for itself and itscustomers;

provide settlement services to cross-border large-value net settlementsystems.

Moreover, the ECB will provide end-of-dayprocedures and possibly other controlmeasures for the TARGET system.

According to the schedule for TARGETtesting and implementation, before beingpermitted to migrate (in late 1998) withtheir Interlinking/RTGS components towardsTARGET production, the NCBs and theEMI/ECB have to complete the followingthree sets of tests: (i) static and dynamictests, (ii) multilateral tests, and (iii) simulationtests. All NCBs had started static testing byApril 1998. Fourteen RTGS systems havealready completed the static tests, twelvethe dynamic tests, and four have alsocompleted the multilateral tests.

A brochure providing a general descriptionof the TARGET system was published inMay 1998.

4.2 Securities settlement systems

In 1997 preparatory work focused on twomain aspects: the establishment of standardsfor the use of securities settlement systems(SSSs) in ESCB credit operations and theimplementation of short-term solutions forthe cross-border use of collateral.

Standards for using SSSs in ESCB creditoperations

The EMI and the EU NCBs have analysedthe settlement procedures for those assetswhich will be eligible for collateralising themonetary policy and payment systemsoperations of the ESCB. In particular, ESCBcredit operations will have to be conductedaccording to procedures which: (i) preventthe NCBs from bearing inappropriate risk inconducting monetary policy operations; and(ii) ensure the same level of safety for allNCBs’ operations settled throughout theEuropean Union. Within this framework,the EMI has outlined nine basic standardsagainst which the soundness of those SSSsto be used for the settlement of ESCBmonetary policy and intraday creditoperations will be assessed.

The standards and the underlying analysisare described in the EMI’s report entitled“Standards for the use of SecuritiesSettlement Systems in ESCB creditoperations”, which was released on 8 January1998. These standards cover three mainareas: legal issues, settlement and custodyrisks, and operational issues.

The first standard states that all SSSs andthe links between them should have asound legal basis, which will ensure thatboth the settlement of payments and thetransfer of securities are final and that therights of the ECB and the NCBs in respectof securities transferred or held within suchsystems for their account are adequatelyprotected. The second standard aims toensure that the cash leg of the settlement isconducted in central bank money. Standard3 focuses on the security of collateral heldin custody and states that SSSs should haveadequate safeguards to protect NCBs againstcustodial risk, for instance when third-partydepositories are used.

Standards 4 to 6 require that: (i) all SSSs besubject to regulation and/or control by acompetent authority; (ii) participants be

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aware of the risks of and access conditionsfor using the systems; and (iii) proper riskmanagement procedures be implementedin order to cope with the effects of thedefault of one or more participants.

Standard 7 concerns intraday settlementwith finality, which must be possible fromthe start of Stage Three of EMU. As a firststep, SSSs must ensure intraday finality forthe settlement of ESCB credit operations.This could be achieved by means of variousoperational mechanisms, such as: 1) RTGSsystems for securities transactions; 2) netsecurities settlement systems with severalprocessing cycles during the day; 3) thepre-depositing of securities (including pre-pledging) on operational safe custodyaccounts held with an NCB; or 4) the freeintraday delivery of securities. The choicebetween the four options will be left to theNCBs on the basis of the existinginfrastructures at the domestic level. As alonger-term objective, it is envisaged thatall SSSs will have to enable the ESCB tosettle its credit operations by means ofreal-t ime del ivery versus paymentsettlement facilities.

Standard 8 recommends operating hoursand days consistent with those of theTARGET system.

Finally, Standard 9 requires the technicalsystems to have an adequate level ofoperational reliability and adequate backupfacilities to be provided.

All the standards presented in the reportmust be met by SSSs by 1 January 1999,with the exception of the requirement forreal-t ime del ivery versus paymentsettlement facilities (Standard 7), whichshould be implemented by 1 January 2002.

On the basis of the results of the assessment,in September 1998 the ECB will publish alist of the SSSs to be used for ESCB creditoperations.

Mechanisms for the cross-border use ofcollateral in Stage Three of EMU

In July 1997 the EMI Council decided toadopt the correspondent central bankingmodel (CCBM) as an interim solution beforethe establishment of appropriate linksbetween SSSs in order to facilitate thecross-border use of collateral in ESCBoperations (monetary policy and intradaycredit operations). With the CCBM, liquidityis provided by the home central bank,based on collateral held on securitiesaccounts abroad.

The basic principle of the CCBM is thateach NCB will act as a correspondent (forthe delivery of securities) at the request ofany other NCB. Each NCB will thereforeneed to open an account for theadministration of securities for every otherNCB. Thus, when an ESCB counterparty(in country A) wishes to obtain credit, it willapproach its home NCB (NCB A), requestthe credit and offer collateral. In the eventthat the collateral is held in another country(country B), the counterparty will arrangefor the collateral to be delivered (this stepmay involve a custodian) or otherwisetransferred to a specified securities accountwith the NCB of country B (NCB B). NCBA will request that NCB B inform it upondelivery of the collateral and, onceconfirmation of the final, irrevocable deliveryof the collateral has been received by NCBA, the latter will release the credit to thecounterparty.

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5 Preparation of euro banknotes

In the course of 1997 final designs weredeveloped from the draft designs for theeuro banknotes which were chosen by theEMI Council in December 1996 (see theEMI’s Annual Report 1996, Chapter II,Section 5). Illustrations of the revised designswere published in July 1997. These formthe basis for the origination work, in thecontext of which the designs are beingtransformed into printing plates in the firsthalf of 1998. The selected draft designswere amended in order to meet a range ofdifferent requirements. First, the architecturalfeatures (gateways, windows and bridges)were reviewed so as to make sure thatthey would be representative of the relevantperiod, while at the same time notrepresenting any specific structure. Inaddition, the design of the European mapon the reverse side of the banknotes waschecked and adjusted in order to give anappropriate representation of the Europeancontinent. Second, a range of securityfeatures, some intended for the benefit ofthe general public and others to be usedfor authentication purposes in banknotesorting and accepting machines, wereintegrated into the designs. Moreover, testswere conducted to ensure that it would bepossible for the designs to be producedsuccessfully, i.e. in particular with the samevisual appearance, by the specific equipmentof the different EU printing works. Thetechnical specifications were finalised inaccordance with the decision by the EMICouncil that all the printing works whichcurrently print banknotes issued by thecentral banks of the Member Statesparticipating in the euro area should beinvolved in the production of the eurobanknotes.

In 1997, in order to identify potentialproblems at the earliest possible stage, allthe techniques which will be used for eurobanknote production were tested as partof a project to produce a test banknote.

Ten printing works and eight paper millsparticipated in the production of a prototypeeuro banknote which included almost allthe security features. The test banknoteproject revealed that all the participatingprinting works should be in a position toproduce al l the euro banknotedenominations to an equal standard ofquality and with an identical appearance. Azero-production run based on the latest,modified euro banknote designs will beconducted in autumn 1998 before massproduction starts in early 1999.

The quantity of euro banknotes to beprinted before the launch date of 1 January2002 will be determined by two factors:first, the quantity of banknotes required toreplace the stocks of national banknotes incirculation (launch stocks) in the participatingcountries and, second, the logistical stockswhich will be necessary to ensure that thebanknote changeover process operatessmoothly. On the basis of current estimates,a total of more than 12 billion banknoteswill be required for the EU Member Stateswhich will participate in the euro area fromthe start. Estimates will be updated annually.

The EMI is also undertaking preparatorywork in respect of the legal protection tobe given to the euro banknotes. The EMICouncil has already agreed that, with regardto copyright protection, the © symbolshould appear on the euro banknotes.Further aspects which are still underconsideration in this connection are, interalia, the need for harmonised rules regardingthe reproduction of euro banknotes; euroarea harmonised rules for the exchange ofdamaged banknotes; and ways in which toprevent and penalise the counterfeiting ofeuro banknotes.

With a view to increasing efficiency incombating counterfeiting, the EMI Councilhas agreed to set up a joint investigation

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centre and a database in which all technicaldata on counterfeit euro banknotes will bestored.

The date for the launch of the eurobanknotes and coins has been set at1 January 2002 (see Section 10 on thechangeover for more details). Preliminarydiscussions with European federations andassociations on the optimal length andtechnical features of the period of dualcirculation took place in all countries (exceptDenmark) as well as at the EMI. FinanceMinistries, Mints, NCBs, representativeconsumer and retailer organisations andcommercial banks were all involved in thediscussions at the national level.

There is a broad preference for a fairly rapidcash changeover, i.e. shorter than the periodof up to six months for which provision wasmade in the changeover scenario adopted bythe European Council in Madrid in December1995. The precise length of and conditionsfor the cash changeover within the overalltime frame remain a matter for decision bythe Member States. The ECB will continue toprovide a forum for the exchange of views, inparticular among NCBs, on how to preparethe logistics for the cash changeover at thenational level. The storage of euro banknotesand coins prior to the launch date will be anessential element to be considered in thisconnection. Other important aspects relateto the physical exchange of national currencyfor the euro banknotes and coins, thepreparation of automated teller machines(ATMs) and vending machines, and thedistribution to the public of euro banknotesand coins via retailers.

The EMI also continued its preparatory workfor the first three years of Stage Three, duringwhich only national banknotes and coins willcirculate. Article 52 of the ESCB/ECB Statuteprovides that: “Following the irrevocable fixingof exchange rates, the Governing Councilshall take the necessary measures to ensurethat banknotes denominated in currencieswith irrevocably fixed exchange rates are

exchanged by the national central banks attheir respective par values.” Against thisbackground a basic agreement was reachedon the mechanisms for exchanging andrepatriating national banknotes between 1999and 2002. This agreement commits a majorityof the NCBs of the Member States participatingin the euro area to implementing the followingthree measures between 1999 and 2002:

first, with regard to wholesale transactions,the NCBs party to the agreement willensure that in at least one of theircentral bank offices non-national euroarea banknotes will be either exchangedfor national banknotes or credited toan account; these banknotes will berepatriated to their NCB of issue;

second, with regard to retail transactions,the exchange of non-national euro areabanknotes for national banknotes at thecounters of the relevant NCBs will be freeof charge for the general public;

third, with regard to the repatriation ofnational banknotes to their NCB ofissue, NCBs will provide a free of chargeservice for their repatriation, unlessthey already levy a service charge oncommercial banks for the depositing ofnational banknotes at their counters.

Commercial banks and bureaux de change,although not bound by Article 52 of theStatute, will be obliged to apply the fixedconversion rates when exchanging the nationalbanknotes of the countries participating in theeuro area in accordance with the CouncilRegulation on the introduction of the euro(which was adopted on 3 May 1998).Commercial banks and bureaux de changewill also be obliged to display the level of anyhandling charge in a clear and transparentmanner as highlighted in the CommissionRecommendation concerning banking chargesfor conversion to the euro, dated 15 April1998.

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6 Accounting issues

The preparatory work on the accountingframework to be used for the ESCB waslargely completed in 1997. This frameworkwill form the basis for the internal andexternal reporting of the ESCB and serveto ensure that liquidity management andstatistical requirements are met. The basicprinciples, which were approved by theEMI Council in 1996, were expandedthrough the development of specifictechniques for the various assets and liabilitiesthat will feature in the ESCB.

The transition to Stage Three was alsoexamined and the necessary principles andtechniques were developed. The mainobjective was to make a clear distinctionbetween gains and losses (includingunrealised ones) arising before the start ofStage Three from subsequent ESCB gainsand losses. To this end an initial valuation of

NCB (and ECB) assets and liabilities will beperformed according to ESCB rules at thestart of Stage Three. Any gains or lossesarising from this exercise, together with anysuch items already on NCB accounts, willbe treated according to national accountingarrangements in force at the end of StageTwo. Gains and losses arising from theirrevocable fixing of the bilateral exchangerates between the participating currencieswill be treated as realised, as the relatedforeign exchange risk will cease to exist atthe start of Stage Three; again, the treatmentof these gains and losses will be subject tonational rules.

Work is continuing on the method forallocating monetary income in order toprepare the decisions to be taken by theGoverning Council of the ECB.

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7 Information and communications systems

In 1997, in co-operation with the NCBs,the EMI was able to significantly step up itsefforts to provide the information andcommunications systems support requiredfor a number of operational and policyfunctions - to be conducted within theESCB - which will involve the ECB and theNCBs.

Following the decision by the EMI Councilin November 1996 on its technical design,the teleconference replacement projectwas successfully implemented in October1997. The new teleconference system willenable several audio conferences to take

place in parallel between the ECB and theNCBs. Five10 non-EU central banks and theEuropean Commission are also connectedto the system. The teleconference systemprovides a secure means of communication,in particular for governors and monetarypolicy, foreign exchange market andpayment systems experts to discuss urgentmatters. In addition to the teleconferenceapplication itself, the implemented solutioncomprises an underly ing physicalinfrastructure that will serve as the mainnetwork platform for the data transfersneeded for the majority of ESCB-wideinformation systems applications:

* The TOP system will be used to conduct monetary policy open market tender operations; the BI system willbe used to monitor the ESCB’s bilateral interventions; and the ENSD system will be used for the exchange ofdata for non-statistical purposes.

10 Norges Bank, the Schweizerische Nationalbank,the Bank of Japan, the Bank of Canada and theFederal Reserve Bank of New York.

In May 1997, following an EU-wideprocurement tender process, the EMICouncil approved the conclusion of acontract for the supply and maintenanceof an ESCB-wide communicat ionsinfrastructure. This will provide secure end-to-end file transfer and robust messagingservices, using international and de factoindustry standard protocols and applications.

This infrastructure, known as the ESCB-Net, offers synchronous (real-time) andasynchronous communications servicesbetween all the ESCB institutions. With theexception of the Interlinking of the RTGS

Physical network platform

TOP*BI* ENSD*

Exchange of statistics

Teleconferencesystem

Foreign reserve

management

ESCB-Net communications infrastructure

Relevant ESCB procedures

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systems which form the TARGET system,all projects in preparation for Stage Threeof EMU and requiring new ESCB-wideexchanges of information will make use ofthe ESCB-Net. The ESCB-Net was fullyimplemented and tested by May 1998.

During the course of 1997 significantprogress was made in the development ofseveral ESCB-wide software applications.These applications will support the conductof monetary policy operations, foreignexchange market interventions and themanagement of the ECB’s foreign reserveassets. These include, in particular: (1) theTOP application, a system necessary for theESCB to conduct decentralised monetarypolicy open market operations based ontender procedures; (2) the BI application, asystem for the monitoring of decentralisedmonetary policy operations and bilateralforeign exchange interventions; (3) theENSD application, a system providinginformation systems support for theexchange of data within the ESCB for non-statistical purposes; (4) the informationsystems support for the ESCB’s statisticalfunctions, providing the background dataexchange necessary for the preparation ofthe ECB’s policy decisions; and (5) theinformation systems support necessary forthe decentralised management of theESCB’s foreign reserve assets. All theseapplications will be implemented by mid-1998. The second half of 1998 will bedevoted to undertaking the testing of allthe systems and procedures between theECB and the NCBs, both automated andclerical, required to ensure the successfuloperation of the ESCB.

Furthermore, the EMI and the NCBscontinued the preparatory work for theTARGET system. In order to minimise therisk of problems occurring at the start oflive operation of the new payment systemlinking the domestic real-time grosssettlement systems of the fifteen MemberStates and the ECB payment mechanism,an Interlinking test environment has beenestablished. In the second half of 1997static and dynamic tests were started whichinvolved a number of NCBs and the EMI.Further tests will be conducted throughout1998.

In order to guarantee and maintain anadequate and co-ordinated level of securityof the information systems to be used bythe ESCB, the EMI Council approved aframework for a security policy for theinformation systems of the ESCB. Thisframework establishes agreed responsibilitiesfor all parties involved in the development,implementation and use of informationsystems. The information systems securitypolicy defines common principles, roles andresponsibilities related to the managementand planning of the security of informationand communications systems in co-operation between the EMI and the NCBs.

During the course of 1997 the EMI set up alarge number of internal projects with theaim of selecting and implementingappropriate technology and systems toprovide the information systems supportnecessary for the ECB to conduct itsoperations successfully. These projects rangefrom improved office automation systemsand internal administrative systems to newor improved statistical and decision supportsystems.

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8 Banking supervision and financial stability

In Stage Three of EMU prudentialsupervision will remain a competence ofthe national authorities (either the NCB, ora non-central bank body or, in some cases,both together). In addition, the basic featuresof the prudential supervisory frameworkwithin the European Union - based on theharmonisation of the main national legislativeprovisions, the principle of “home countrycontrol” and cross-border co-operationamong supervisors - will not be modified.Nevertheless, besides the advisory functionof the ECB under Article 105 (4) of theTreaty (which is addressed in the lastparagraph of this section), the Treaty andthe ESCB/ECB Statute assign to the ESCB/ECB some functions related to the prudentialsupervision of credit institutions and thestability of the financial system which areexplicitly referred to in the following:

Article 105 (5) of the Treaty, whichstipulates that the ESCB shall contributeto the smooth conduct of policiespursued by the competent authoritiesrelating to the prudential supervision ofcredit institutions and the stability of thefinancial system;

Article 25 (1) of the ESCB/ECBStatute, which states that the ECBmay offer advice to and be consultedby the Council, the Commission andnational authorities on the scope andimplementation of Community legislationrelating to the prudential supervision ofcredit institutions and the stability of thefinancial system;

Article 105 (6) of the Treaty, whichenvisages the possibility of assigningto the ECB specific tasks concerningpolicies relating to the prudentialsupervision of credit institutions andother financial institutions (with theexception of insurance undertakings).

In general terms, the inclusion of the aboveprovisions in the Treaty and Statute wasjustified on three grounds. First, the ESCB,in the context of its macroeconomic activity,will oversee developments in financialmarkets and institutions and, therefore, willhave at its disposal information which couldbe useful for the supervisory function.Second, the pursuit of the primary objectiveof the ESCB (price stability) will need to besupported by the stability of the bankingand financial system, which is a majorobjective of supervisory authorities, alongwith the protection of depositors andinvestors. Third, there is a relationshipbetween the measures taken for monetarypolicy purposes and those intended topromote the stability of the banking andfinancial systems. The EMI has analysed thepossible implementation of these provisionswith the assistance of the BankingSupervisory Sub-Committee.

Article 105 (5) of the Treaty, which appliesonly to those Member States adopting theeuro, contemplates an obligation for theESCB to contribute to the smooth conductof policies pursued by the national authoritiesresponsible for the prudential supervisionof credit institutions and financial stability.Given the close links existing at the nationallevel between the monetary policy and theprudential supervisory functions, as well asthe assignment of responsibility for monetarypolicy to the ESCB, the main objective ofthe provision laid down in Article 105 (5) ofthe Treaty may be regarded as being toensure effective interaction between theESCB and the national supervisoryauthorities. The practical details of the wayin which this relationship will be conductedwill need to be defined in a pragmaticmanner in the light of the specific needsemerging in Stage Three. At present, twomain contributions on the part of the ESCBto national supervisory authorities can beidentified.

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First, the ESCB, and in particular the ECB,will play an active role in promoting co-operat ion among the EU nat ionalsupervisory authorities, irrespective of theorganisational model adopted in eachcountry, as well as between the nationalauthorities and the ESCB, with a view toachieving a common understanding onrelevant supervisory policy issues. It isenvisaged that such co-operation will relyon the assistance of a specific committeecomposed of representatives of NCBs andnational supervisory authorities and that itwill focus mainly on issues of a macro-prudential nature with a bearing on thestability of financial institutions and markets.Regardless of the fact that Article 105 (5)of the Treaty will apply only to thosecountries participating in the euro area, it isenvisaged that co-operation will generallyinvolve all EU supervisory authorities. ThisESCB function is expected to supplementthe framework for multilateral co-operationwithin the EU in the field of bankingsupervision and to interact smoothly withthe co-operation pursued within the otherbanking supervisory forums (the BankingAdvisory Committee and the Groupe deContact at the EU level and the BasleCommittee on Banking Supervision at theG-10 level).

Second, in the light of the relevant provisionsof the BCCI Directive concerning the flowof information between NCBs andsupervisory authorities, where appropriate,the ESCB will provide supervisory authoritieswith information on individual institutionsand markets obtained as a result of its basicactivities which could be helpful to thesupervisory function. Conversely, bankingsupervisors will be prepared to provide theESCB with supervisory information onindividual institutions which could be of useto the ESCB in the performance of its basictasks. A common understanding has beenreached among banking supervisors on thebasic features of the flow of information tothe ECB and to NCBs in their capacity asmonetary authorities. In general, although

the ESCB should not need supervisoryinformation for the purpose of its monetaryand foreign exchange policy operations asa rule, banking supervisors will be preparedto consider requests from the ESCB in thisarea. In addition, in view of the possiblesystemic implications, banking supervisorswill be prepared to inform the ESCB on acase-by-case basis should a banking crisisarise. Furthermore, banking supervisors willcollaborate with NCBs and the ECB inorder to detect non-compliance by any ofthe ESCB’s counterparties with theirobligations as laid down in the ESCB’s ruleson monetary policy instruments andprocedures, although ultimate responsibilityfor ensuring compliance will remain withthe competent NCB. With regard to theflow of information from banking supervisorsto NCBs acting as the overseers of paymentsystems, a basic agreement had alreadybeen reached.

Article 25 (1) of the ESCB/ECB Statute -which applies to all EU countries - providesfor a specific advisory function for the ECBin the field of Community legislation relatingto the prudential supervision of creditinstitutions and the stability of the financialsystem. This function will be optional innature and refers to the scope andimplementation of Community legislation inthe above-mentioned fields. This functionmay be regarded as an instrument bymeans of which the ECB would be able tocontribute to the prudential supervision ofcredit institutions and financial stability atthe Community and national levels. In thisrespect, the role played by the EuropeanCommission, with the assistance of theBanking Advisory Committee, in preparingnew proposals for directives in the sphereof banking legislation is clearly acknowledged.

Article 105 (6) of the Treaty - whichapplies to all EU countries - covers thepossibility of certain operational tasks in thefield of prudential supervision beingconferred upon the ECB. The right ofinitiative in this area lies with the Commission

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and the ECB is only involved in an advisorycapacity. At this stage it is felt that it wouldbe premature to envisage any transfer ofsupervisory powers from national authoritiesto the ECB.

Finally, Article 105 (4) of the Treaty (whichapplies to all EU countries with the exceptionof the United Kingdom) stipulates that theECB must be consulted on draft Communityand national legislative provisions fallingwithin its fields of competence. The precisescope of this provision will be identified in

the context of the Council Decision to beadopted by the EU Council, laying downthe limits and conditions under which theECB is to be consulted by the competentauthorities on draft national legislation inaccordance with the said article. Accordingto the draft Council Decision proposed bythe European Commission in February 1998,the ECB should be consulted on, inter alia,rules applicable to financial institutions insofaras they materially influence the stability offinancial institutions and markets.

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9 Legal issues

9.1 Legal convergence

Member States are obliged, in accordancewith Article 108 of the Treaty, to eliminateincompatibilities between their nationallegislation, on the one hand, and the Treatyand the ESCB/ECB Statute, on the other. InOctober 1997 the EMI published a reporton “Legal Convergence in the MemberStates of the European Union as at August1997” and in March 1998 it published itsConvergence Report prepared as requiredunder Article 109j (1) of the Treaty. Bothreports distinguished between the statutesof NCBs and other legislation which neededto be adapted in the light of the relevantTreaty and ESCB/ECB Statute provisions.With regard to the statutes of NCBs, adistinction was made between adaptationsin the area of central bank independenceand other adaptations to ensure thenecessary degree of integration of NCBs inthe ESCB.

On the basis of features of central bankindependence which had already beenelaborated in previous reports on theindependence of NCBs, in its October1997 Report the EMI identified certainprovisions in the statutes of NCBs which itconsidered to be incompatible with Treatyand ESCB/ECB Statute requirements oncentral bank independence and which, in itsview, should therefore be adapted. Most ofthe provisions related to the institutionalindependence of an NCB (the prohibitionof external influence, as laid down inArticle 107 of the Treaty) and the personalindependence of members of an NCB’sdecision-making bodies involved in theperformance of ESCB-related tasks (securityof tenure, as laid down in Article 14.2 ofthe ESCB/ECB Statute). Adaptations in thearea of the independence of NCBs mustcome into effect at the latest at the date ofthe establishment of the ECB.

Furthermore, the EMI pointed out theneed for the statutes of NCBs to beadapted in order to ensure the necessarydegree of integration of NCBs in the ESCB,in accordance with Article 14.3 of theESCB/ECB Statute. That Article states thatNCBs will become an integral part of theESCB and are required to comply with theECB’s guidelines and instructions.11 Thisimplies, in particular, that the statutes ofNCBs should not contain any provisionswhich are not in line with the exclusivecompetence of the ECB in certain areas orwhich, if adhered to by an NCB, wouldprevent that NCB from complying with therules adopted at the level of the ECB.Areas to which particular attention waspaid were: statutory objectives, tasks,instruments, organisation and financialprovisions (topics which correspond to theusual structure of the statutes of NCBs).Adaptations of the statutes of NCBs in thisrespect must come into effect at the startof Stage Three or, for Member States witha derogation or a special status, at the dateon which they adopt the single currency.

In its October 1997 Report the EMI paidparticular attention to completed orenvisaged adaptations with extensivereference to its opinions on suchadaptations which were delivered as part ofconsultation procedures under Article 109f(6) of the Treaty and Article 5.3 of theStatute of the EMI.

As far as the adaptation of legislation otherthan the statutes of NCBs was concerned,the EMI focused in particular on those lawswith an impact on the performance by anNCB of its ESCB-related tasks and laws in

11 In conjunction with Article 43.1 of the Statute,Article 14.3 implies that fully participating NCBswill become an integral part of the ESCB and thatthey will have to comply with guidelines andinstructions issued by the ECB.

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the monetary field, such as foreign exchangeacts and coinage acts.

In its Convergence Report of March 1998,inter alia, the EMI assessed the compatibilityof national legislation, including the statutesof NCBs, with Treaty and ESCB/ECB Statuterequirements for Stage Three. An excerptfrom the Introduction and summary part ofthe 1998 Convergence Report isincorporated as an Annex to this Report.

9.2 Secondary Communitylegislation

The EMI informally consulted the MonetaryCommittee on the following three draft ECBRecommendations for Council Regulations,which are to be adopted by the GoverningCouncil of the ECB under Article 42 of theESCB/ECB Statute: a draft ECBRecommendation for a Council Regulation(EC) concerning the collection of statisticalinformation by the ECB (see Section 3.3), adraft ECB Recommendation for a CouncilRegulation (EC) concerning the application ofminimum reserves by the ECB (see Section1.2) and a draft ECB Recommendation for a

Council Regulation (EC) concerning the powerof the ECB to impose sanctions. The latterRecommendation specifies the limits andconditions under which the ECB will beentitled to impose fines or periodic penaltypayments on undertakings as a result of theirfailure to comply with obligations laid down inits Regulations and Decisions.

In addition, the EMI contributed to thepreparation of other secondary Communitylegislation relating to the transition from theEMI to the ECB in the following areas: theconsultation of the ECB by nationalauthorities on draft legislative provisionsfalling within the competence of theECB; the statistical data to be used forthe determination of the key for subscriptionof the capital of the ECB; the conditionsand procedure for applying the tax for thebenefit of the European Communities; andthe categories of officials and other servantsof the European Communities to whomthe provisions of Article 12, the secondparagraph of Article 13 and Article 14 ofthe Protocol on the Privileges and Immunitiesof the Communities apply (see also ChapterIII, Section 5 below).

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10 Changeover to the euro

During 1997 preparatory work for thechangeover to the single currency gatheredconsiderable speed. In all EU MemberStates with the exception of Denmark12 adhoc co-ordination bodies were created,detailed changeover scenarios outlined, co-ordination between institutions andinterested parties organised, and anappropriate legal framework to complementthe relevant Community legislation prepared.The EMI continued to keep track ofdevelopments as regards the changeover,in order to assess whether differingchangeover preparations across MemberStates, owing to differences in the localorganisat ional and infrastructuralenvironments, might have implications forthe single monetary policy to be conductedas from January 1999 onwards.

In the f inancia l area, changeoverpreparations continue to be fuelled by acompetitively driven process involvingmarket operators and financial centres,both within and across countries. The EMIand the NCBs conducted a continuousdialogue with their respective bankingcommunities and other financial marketoperators on issues concerning theintroduction of the euro. The guidingprinciple applied by the monetary authoritiesis to leave responsibility for co-ordinatedaction in relation to the changeoverprimarily with the market operatorsthemselves, while being prepared to lendassistance where necessary. The EMI andthe NCBs have thus encouraged marketoperators to consider market-drivenstandardisation within Monetary Union.

In meetings between the EMI andrepresentatives of EU-wide banking andfinancial associations the following issues,inter alia, have been considered:

the replacement in contracts of pricereferences that may lose their economic

significance after the start of MonetaryUnion. The publication of national baserates by NCBs, at which central banktransactions are no longer effected, willcease from the start of Stage Three.National legislators may enact bindingrules to replace obsolete base rateswith new reference rates (preferablyfrom among those to be published bythe ESCB), should this be deemedappropriate;

the replacement of existing interbankrates (e.g. BIBOR, FIBOR, HELIBOR,MIBOR, PIBOR, RIBOR, etc.) with newdefinitions of euro area-wide publishedindicator rates. While the publication ofthese local rates on a euro area-widebasis cannot be legally prohibited, theEMI and the NCBs have encouragedbanking associations and money andforeign exchange markets operating inthe future euro area to engage in thecollective definition of euro area-wide indicators. In response to thispolicy message, in 1997 the BankingFederation of the European Union andthe professional association of foreignexchange market dealers (known asACI - The Financial Markets Association)announced its intention to compute andpublish a euro area-wide indicator ofinterbank rates, which is to be known asthe EURIBOR.13

The EMI also provided assistance in theestablishment of common market standardsin the euro area-wide money markets andforeign exchange markets. The EMI’spublications on the operational frameworkfor the single monetary policy provided

12 In Denmark work has been carried out in order toprepare for the situation of Denmark as a MemberState with a derogation.

13 The British Bankers’ Association has announced itsplans to publish a euro LIBOR.

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interested market operators withinformation on the money market andforeign exchange market procedures to befollowed by the ESCB. This information hasbecome a natural focal point for theadaptation of national standards and theelaboration of new common standards atthe European level.

Furthermore, the EMI offered furtherclarification to the markets concerning thefollowing:

the methods for quoting the euro onforeign exchange markets;

the publication by the ECB of referenceexchange rates;

the calendar of business days for theconduct of monetary policy and theoperation of TARGET.

In this connection the EU-wide bankingand financial associations submitted to theEMI a “Joint statement on marketconventions for the euro”, which lists themarket standards that will apply to tradingand settlement on the euro money, bondand foreign exchange markets. The jointstatement points out that the harmonisationof euro market conventions is desirable, asit would promote liquidity and transparencyin the new markets and prevent confusionand disputes involving euro trading andsettlement. The EMI Council welcomedand supported this initiative, observing thatthe implementation of such conventionswould enhance the integration of, andensure greater transparency in, the eurofinancial markets.

The EMI also assisted the EU-wide bankingand f inancia l associat ions in theestablishment of an effective overnight ratefor the euro area, known as the EONIA(euro overnight index average). Marketparticipants noted that private calculationof an effective overnight rate would beproblematic owing to the sensitivity of the

information that would need to be suppliedby individual banks for the computation ofsuch a rate. Against this background, theEMI Council decided to prepare for thecomputation of such a rate by the ESCB.Accordingly, the ESCB will take on thecomputational aspects related to thereference rate, relying on the panel andmethodology provided by the bankingassociations for the EURIBOR. Responsibilityfor publishing the reference rate will liewith the banking associations. Discussionsare under way between the EMI and therelevant associations so as to arrive at acollectively agreed procedure.

The EMI recognised the need for a distinctivecodified symbol for the single currency andexpressed its support for the symbol E ,proposed by the European Commission, asthe logo for the euro. A symbol to identifythe euro accords with the current use ofabbreviations in written language. It alsoprovides a distinctive sign for use in pricelists and other documents includingmonetary values which may be of particularhelp during the transition phase. The EMIencourages the inclusion of the E symbolin the standard character sets which arewidely used in the information technologyindustry.

A special section on changeover issues hasbeen included as part of the informationprovided on the EMI’s Web site (http://www.ecb.int). With a view to assisting allthose involved in preparing for thechangeover, the EMI has improved thedistribution of relevant information. Apartfrom the documents on changeover issuesapproved by the EMI Council in 1997, theWeb site also includes a bibliography and alist of more than 200 links to other Webpages which specifically offer informationon the changeover to the single currency.The links are divided into eleven categories:central banks; EU institutions; nationalgovernments; associations of the bankingand financial industry; credit institutions;stock exchanges, securities settlement

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systems and payment systems; associationsof enterprises, commerce and services;business consultancy firms; informationtechnology issues; newspapers, newsletters,magazines and bibliographies; and others.For each link, a summary is given of theinformation available on the relevant page.This information is updated on a regularbasis and thus provides a convenient datasource for all those involved in preparingfor the changeover.

In response to mounting public demand forfurther confirmation of the details of the

changeover to support preparatory work,the EMI Council and the EU Council decidedon 4 November 1997, for banknotes andcoins, that euro fiduciary money would beput into circulation in all participatingcountries as from 1 January 2002 onwards.This decision was taken after carefulconsideration of all possible options,including the possibility of having differentintroduction dates in the various participatingcountr ies . An extensive round ofconsultations took place, both at the nationaland at the EU-wide level, involving allinterested parties.

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11 Public information

Since its establishment on 1 January 1994the EMI has been working intensively toprepare the regulatory, organisational andlogistical framework necessary for the ESCBto perform its tasks in Stage Three of EMU.As part of this process, the EMI has fulfilledits reporting obligations in accordance withArticles 7 and 11.3 of the EMI Statute bypublishing reports on the state of thepreparations for Stage Three of EMU, on itsown activities and on monetary and financialconditions in the Community. In addition, inrecognition of the needs of the financialcommunity and of the general public, theEMI has over the past three years releaseda number of publications on its preparatorywork with a view to both reporting on itsactivities and offering readers guidance inplanning their own preparations. Thesepublications have ranged from generalinformation material on the EMI’s role andfunctions and on the draft designs for theeuro banknotes, to more technical reportsdealing with monetary policy, statistics,payment systems and various aspects of thechangeover to the single currency.

A list of all the documents published by theEMI since the beginning of 1997 appears atthe end of this Report. A similar list hasappeared in each of the EMI’s previousAnnual Reports.

In addition to producing its publications, inJanuary 1998 the EMI established a presenceon the Internet’s World Wide Web inorder to facilitate the EMI’s provision ofinformation to the general public. TheEMI’s Web site (http://www.ecb.int)provides access to the texts of recentspeeches and reports published by the EMI,and includes a special section on changeoverissues.

The EMI recognises that there is a need forthe ESCB to ensure the transparency of itsobjectives and policies in Stage Three and tofoster knowledge of its operations and tasks,thus enabling the financial community and thegeneral public to both understand and supportits policies. To this end, the EMI is developingan external communication policy - to bepresented for consideration by the GoverningCouncil of the ECB - on the most effectiveways in which to disseminate informationconcerning the activities of the ESCB.

Chapter III

Other tasks of the EMI

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1 Oversight of the ECU Clearing and Settlement System

The ECU Clearing and Settlement Systemfalls under the oversight of the EMI byvirtue of Article 109f (2), sixth indent, ofthe Treaty. The oversight of the ECUClearing and Settlement System has thefundamental objective of seeking to ensurethat the Euro Banking Association (EBA),which manages the system and whichsuperseded the ECU Banking Associationon 3 December 1997, takes the necessarymeasures to ensure that the system doesnot pose unacceptable risks either toparticipants in the system or to the ECU ordomestic markets in the EU. Within thisframework, the major line of action of theEMI is to ensure that adequate measuresare taken to improve the system’scompliance with the safety standards laiddown in the 1990 G-10 Report on InterbankNetting Schemes (the so-called “Lamfalussystandards”).

Moreover, during 1997 the EMI and theNCBs monitored the preparatory workconducted by the EBA on its Euro Clearingand Settlement System for Stage Three ofEMU (EURO 1).

1.1 Activities of the ECU Clearingand Settlement System in 1997

In 1997 the number of transactions declinedin comparison with 1996, while the valuerose slightly. The monthly average numberof daily transactions fell by over 6%, from6,383 in 1996 to 5,982 in 1997. Incomparison, the average daily turnoverrose from ECU 46.0 billion in 1996 toECU 46.9 billion in 1997.

The ECU Clearing and Settlement System(ECU 3) functioned quite smoothly during1997, on average completing settlementearlier in the day than in 1996. Settlementdelays occurred on only a handful of days,caused by either technical problems localised

at only one or a few clearing banks orsystem incidents affecting the network usedby the ECU Clearing and Settlement System.Two new software releases, which wereimplemented by S.W.I.F.T. in July andSeptember 1997, have now brought thesystem back to the required service level,and no network incidents have beenrecorded since.

In 1997 some enhancements to theactivation of the emergency liquidity facilitieswere introduced to ECU 3, i.e. the systemproviding for binding intraday limits. Inaddition, the clearing rules were amendedto allow for the orderly completion ofclearing should a clearing bank be unableto send its authenticated settlement messagefor purely technical reasons.

As part of their oversight functions the EMIand the NCBs studied a proposal putforward by the Exchange Clearing HouseOrganisation (ECHO) - to net contractsdenominated in ECU and to settle therelevant flows through the ECU Clearingand Settlement System - and no objectionwas raised to ECHO commencing operationin ECUs. In Stage Three ECHO is expectedto settle its euro operations via TARGET.

1.2 Preparatory work for StageThree of EMU

The EBA is in the process of defining thelegal structure and the liquidity and loss-sharing arrangements for EURO 1. Inaddition, the EBA - in co-operation withthe EMI and the NCBs - is finalising thesettlement arrangements in accordance withan EMI Council decision. The latter statesthat the EBA will open a central settlementaccount at the ECB. It may also open othersettlement accounts with those NCBs whichagree to provide such accounts. To date,only the Banque de France has indicated its

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intention to open a local settlement accountfor the EBA (by June 1999).

Finally, an arrangement to secure the timelysettlement of EURO 1 in the event of aparticipant failing to settle is being elaboratedby the EBA. A cash collateral pool coveringthe largest net debit exposure possible inthe system (E 1 billion) would serve thispurpose. In accordance with an EMI Councildecision, the ECB acts as the holder of thecash collateral pool for the EBA. In addition,liquidity and loss-sharing arrangements arebeing developed by the EBA to deal withmultiple defaults.

Since EURO 1 will be based on the sametechnical infrastructure and intraday riskmanagement features as the current ECU3, the EMI - in co-operation with the NCBs- reviewed ECU 3 in order to assess itscompliance with the Lamfalussy standardsas a starting-point for an assessment of thecompliance of EURO 1. Ongoing effortsbeing made by the EBA to improve ECU 3with a view to meeting the Lamfalussystandards should therefore be seen aspreparation for the introduction of a fullycompliant EURO 1.

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2 Electronic money

At present, electronic money is not awidespread phenomenon. However, thepossibility that its development could bemore pronounced in the long run cannotbe ruled out. Since the publication of the“Report to the Council of the EMI onPrepaid Cards” in May 1994, not only hasthe number of multi-purpose prepaid cardprojects greatly increased, but the use ofelectronic money for payments viacomputer networks (so-called networkmoney) has also started to develop.

In 1997 the EMI therefore carried out afurther study on the impact on EUeconomies of the emergence of electronicmoney. It took particular account of newmarket developments and conducted athorough analysis of their implications formonetary policy. The results of the studyprovided the basis for the “Opinion of theEMI Council on the issuance of electronicmoney” of 2 March 1998, which wastransmitted to the Commission, the text ofwhich is reproduced in Box 3 below.

Box 3

Opinion of the EMI Council on the issuance of electronic money1

1. At the present juncture, electronic money is not a widespread phenomenon. However, in the long

run a more pronounced development of electronic money cannot be ruled out.

2. The issuance of electronic money is likely to have significant implications for monetary policy in

the future. Therefore, EU central banks regard it as important to establish clear rules on the conditions

under which electronic money can be issued.

3. In 1994 the EMI Council recommended that only credit institutions (according to national law)

should be allowed to issue multi-purpose prepaid cards.2 However, this recommendation was not

implemented in all Member States. Against this background, the European Commission started in

1997 to work on a proposal for a European Parliament and Council Directive on the issuance of

electronic money by non-credit institutions, in particular with the objective of granting the European

passport to these institutions.

4. In the light of the developments over the past few years and further reflection on the matter, not

least with respect to monetary policy effectiveness and considerations of level playing-field, and

considering that funds collected for issuing electronic money are by nature redeemable, the EMI

Council regards as essential that the following minimum requirements be fulfilled, regardless of

the nature of the issuer of e-money:

- the meaning of “electronic money” must be clearly def ined and distinguished from “single-

purpose” or “limited-purpose” prepaid cards;

- issuers of electronic money must be subject to prudential supervision;

- the issuance must be subject to solid and transparent legal arrangements, technical security,

protection against criminal abuse, and statistics reporting;

- a legal requirement must be imposed that electronic money is redeemable at par, implying that

issuers must be in a position to convert electronic money into central bank money on request of

the holder of the electronic money;3

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- the possibility must exist for central banks to impose reserve requirements on all issuers of

electronic money, in particular in order to be prepared for a substantial development of electronicmoney with a material impact on monetary policy.

- In addition, an insurance scheme for electronic money schemes could be envisaged as a way toprotect the public.

5. Against this background, and in line with the 1994 recommendation of the EMI, the moststraightforward solution would be to limit the issuance of electronic money to credit institutions,as this would avoid changing the existing institutional setting for monetary policy and bankingbusiness. More specif ically, with a view to the transition to Monetary Union, the issuance ofelectronic money should be limited to “credit institutions as defined in Article 1 of the First BankingCo-ordination Directive” since Article 19.1 of the Statute of the ESCB, in its current wording,allows the ECB to impose reserve requirements only on these institutions in Stage Three of EMU.

6. At the same time, the EMI Council acknowledges that the definition of “credit institution” of theFirst Banking Co-ordination Directive requires an institution to “receive deposits or other repayablefunds from the public and grant credit for its own account”.4 The EMI would see great merit inpursuing an amendment to the First Banking Co-ordination Directive’s definition of “credit institution”to allow institutions which are not willing to enter into credit operations to issue electronic money.This would provide a level playing-field, in particular as it would ensure that all issuers of electronicmoney would be subject to an appropriate form of prudential supervision and fall under the rangeof institutions potentially subject to ECB reserve requirements.

7. Yet, as a transitional provision until the First Banking Co-ordination Directive is amended, theEMI Council would accept that those institutions already issuing electronic money, but which donot fall under the def inition of credit institution in the First Banking Co-ordination Directive,could continue to provide domestic payment services provided they are subject to the regulationsas defined in item 4 above, excluding, however, reserve requirements.5

8. Given the world-wide aspects of the issuance of electronic money, in particular network money,which carries the risk of delocation, the EMI stresses the need for international co-ordination inthis f ield.

Notes:1 The opinion was adopted by a large majority of EMI Council members, with the exception of Denmark, Sweden,

the United Kingdom and Luxembourg.2 The EMI’s 1994 “Report to the Council of the EMI on Prepaid cards” (p. 8) foresaw the possibility of allowing

some non-fully fledged credit institutions to issue multi-purpose prepaid cards under specific conditions inexceptional circumstances (e.g. in the case of schemes already in operation before the policy conclusions of thereport were drawn up).

3 The details of such a redeemability requirement have yet to be specified. (To avoid burdensome procedures, onemay, for example, consider imposing a fee or a threshold on minimum amounts before redemption can bedemanded by the holder of the electronic money instrument. In addition, logistical difficulties could possibly beovercome by allowing for redemption via bank deposits.)

4 The EMI Council also acknowledges the fact that national definitions of “credit institution” differ across MemberStates and that in some countries issuers of electronic money currently exist which do not fulfil the respectivenational definition of a credit institution.

5 As noted above, an exception was already foreseen in the EMI’s 1994 report on prepaid cards. The exceptionwas a permanent grandfathering clause for schemes which had already been established at that point in time. Itwould be necessary to examine whether such a permanent grandfathering clause could be maintained in arevised version of the First Banking Co-ordination Directive for such schemes, e.g. if their nature would make theapplication of the ensuing banking legislation less sensible.

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3 Co-operation in the field of banking supervision andfinancial stability

In accordance with Article 109f (2), fourthindent, of the Treaty, in 1997 the EMI heldconsultations on a number of issues fallingwithin the competence of NCBs andaffecting the stability of financial institutionsand markets. The most important topicsdiscussed were as follows.

3.1 Performance and stability of theEU banking systems in themedium and long term

A survey was conducted on a wide rangeof issues of potential relevance to thestability of the EU banking systems with aview to increasing the awareness of NCBsand banking supervisory authorities of bothcurrent trends in the EU banking systemsand developments which are likely to occurin the medium and long term, both ingeneral and in relation to the establishmentof EMU. The main findings of the survey aresummarised below.

Although some generalisation is inevitable,given that the situation may vary within andacross countries, the main trends relating tothe EU banking systems over the past fewyears can be identified as follows: (i) a declinein banks’ profitability; (ii) a narrowing ofinterest rate margins; (iii) a rise in non-interestincome; and (iv) a reduction in staff costs andthe number of staff. Although profitability didindeed increase in 1995 and 1996 in anumber of countries, this does not alter thebasic trend given that it reflects to a largeextent the favourable conditions prevailingin the capital markets. These trends canbe regarded as the combined effect ofseveral factors - financial liberalisation,disintermediation, internationalisation andtechnological change - all of which haveemerged in recent years and which areexpected to continue to shape the EUbanking systems in the years to come.

Notwithstanding the difficulties associated withmeasuring banking capacity, there are anumber of good reasons to assume thatexcess banking capacity exists in many EUcountries, although it has been acknowledgedthat a reduction in this excess has taken placeover the past few years. Informationtechnology can be regarded as having beenthe main driving force behind recent changesin capacity in the EU banking systems, both atthe retail and at the wholesale level. Thisfactor is expected to continue to exertpressure leading to further reductions inexcess banking capacity, especially in theretail sector, mainly through the developmentof both new distribution channels (“remotebanking”) and electronic money. This potentialdevelopment can be expected to affectprincipally branch networks and staffing levels.

Over the past few years the phenomenon ofbanking disintermediation - which can beregarded as the movement of services andfunctions away from the banking system andtowards other financial or non-financialintermediaries, economic agents or markets -has been very much in evidence. The EUbanking systems, although still growing, havebeen losing their relative share of financialintermediation to institutional investors(investment funds, insurance companies andpension funds). Credit institutions have reactedby establishing their own financial servicesgroups, either through direct equityparticipation in non-bank intermediaries or bymeans of agreements with them. Creditinstitutions have been able to play a majorrole in these financial groups, partly as a resultof their central role in financial transactionservices (money transmission, securitiessettlement and administration) and partlyowing to their size and capital strength. Thetrend towards disintermediation is expectedto continue in the future since institutionalinvestors will continue to grow, mainly onaccount of demographic and social changes

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(such as the ageing of the population and theincreasing number of wealthy individuals inthe EU countries).

With regard to the degree of concentration,the survey showed that this varied fromcountry to country and that the situationreflected both the size of national economies(with a tendency towards a higher level ofconcentration in the smaller countries anda lower level in the larger ones) and,possibly, different national strategies. It seemsthat the EU banking systems do not currentlysuffer from a lack of competition as a resultof concentration and that such competitionis particularly intense in internationalwholesale banking and syndicated lending.In the context of EU competition policy, itcan be argued that disintermediation andthe establishment of the Single Market andEMU may all be grounds for reconsideringthe definition of relevant markets for thepurpose of merger control. In particular,disintermediation may lead to a broaderdefinition from a product perspective andthe establishment of the Single Market andEMU may widen the geographical definitionof the market. Looking to the future, it isanticipated that there may be room forlarge-scale cross-border mergers given therelatively low concentration at the EUlevel.

EMU is expected to reinforce trends alreadyprevailing in the EU banking systems. EMUshould increase competition and strengthenthe need to restructure the EU bankingsystems, inter alia by means of a reductionin excess capacity. The ending of foreignexchange transactions between EMUcurrencies and of the related hedging activitywill, of course, have a negative impact onthe earnings of banks. In addition, EMU isexpected to favour the development ofdeeper and more liquid securities markets,which in turn might trigger the furtherdisintermediation of the banking systems.This process could be reinforced by thefact that institutional investors may benefitfrom the broader single currency area to

which the existing currency matching ruleswill apply. In relation to EMU, creditinstitutions are also expected to reconsiderand upgrade their strategies, proceduresand technologies. A three-layer EU bankingsystem is likely to emerge, in which: (i) thefirst layer would be composed of a largenumber of small, locally based institutions;(ii) the second layer would comprise EUregional players; and (iii) the third layerwould consist of very large EU-wide bankswhich consider themselves to be globalplayers. In general, the overall outlook inthe medium term is that pressure on banks’profitability is likely to increase with theestablishment of EMU. However, the actualimpact of this pressure will vary from onecredit institution to the next. Nonetheless,EMU is also expected to bring a number ofadvantages which could offset any negativeeffects overall. In particular, a more stableeconomic environment may stimulate banklending and reduce the risk of defaults byhaving a positive impact on credit risk,although there will inevitably be regionalvariations in activity which could affectcredit quality differentially. The TARGETsystem will make a significant contributionto the establishment of sound and efficientpayment systems by reducing systemic andliquidity risks. Credit institutions should alsobenefit from deeper and more liquid capitalmarkets as such a situation will reduce theirrisks and facilitate their risk managementactivities. In addition, it is likely that EMUwill lead to further harmonisation of thelegal and operational environment in whichcredit institutions operate.

The overall conclusion drawn from thesurvey findings is that the EU bankingsystems are already facing a period ofmajor change in the form of increasedcompetition, concentration and restructuringand that this process is expected to befurther intensified by the establishment ofEMU. Therefore, credit institutions are likelyto face pressure to improve their profitabilityand will have to strengthen their respectivecompetitive positions. For their part,

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supervisory authorities will have to step uptheir monitoring activities in order to be ina position to detect the weaker creditinstitutions and to ensure that they takesteps to adapt to the increasing pressure.The findings of the survey have been madeavailable to the international supervisoryforums.

3.2 The use of macroeconomic datain the supervisory process

As a follow-up to the work on supervisoryearly warning systems carried out in 1996(see the EMI’s Annual Report 1996), aninvestigation was carried out on the possibleuse of macroeconomic data in the supervisoryprocess and the links betweenmacroeconomic developments and fragility inthe banking systems both as a whole and atthe level of individual institutions. The mainobjective of this exercise was to identifypractical approaches which, through the useof macroeconomic data normally available toNCBs, could complement the analytical toolsused by banking supervisors to monitor boththe banking system and individual creditinstitutions. In more general terms, this initiativeshould be regarded as an attempt to continueimproving the effectiveness of supervisoryactivities and the efficient use of resources,particularly given the costs involved in managingbanking crises.

There are two ways in which macroeconomicdata could be used in the supervisory process.The first is based on the conduct of so-calledmacro-prudential analysis, which focuses onthe stability of the banking and financialsystems as a whole. This form of analysisestablishes relationships betweenmacroeconomic variables (such as GDP, theindebtedness of households and enterprises,the structure of risks in the banking system,etc.) and aggregated data obtained fromsupervisory reporting. The conduct of thisexamination normally consists of an assessmentof the current conditions in the bankingsystem and its possible future development.

Three main categories of macro-prudentialanalysis have been described, notably:(i) regular analysis to evaluate the conditionsin the banking system on a systematic basis;(ii) development analysis to address structuralaspects from a long-term perspective; and(iii) event analysis to study specific aspectswhich might have an impact on the stability ofthe banking system.

The second way in which macroeconomicdata can be used in the supervisory processrelates to the potential use of the findingsof macro-prudential analysis in the processof detecting potentially fragile credit andfinancial institutions. In general terms, thesystematic consideration by supervisors ofthe outcome of macro-prudential analysisshould enable them to perform theirmonitoring activities more effectively. Inparticular, supervisors should enhance theirability: (i) to detect individual institutionswhich are under strain; (ii) to prioritise thevarious aspects of their monitoring activities;and (iii) to develop communication withthe management of the institutions.Furthermore, it is clear that the findings ofmacro-prudential analysis might also beutilised in the context of the moresophisticated early warning systems adoptedby some banking supervisors. The possibilityof making direct use of macroeconomicdata or variables in the supervisory earlywarning process will be further investigated.

Drawing on actual experience, which is forthe time being confined to a limited numberof countr ies , some organisat ionalapproaches have been explored todetermine practical ways in which macro-prudential analysis could be conducted atthe national level, with a view to promotingthe more widespread performance of thisactivity. This work suggests that it would beuseful to conduct macro-prudential analysisat the EU level. The findings of the analysisrelat ing to the possible use ofmacroeconomic data in the supervisoryprocess have been made available to theinternational supervisory forums.

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3.3 Other issues

First, specific attention has been devoted torecent developments which have takenplace in industry-wide practice for theprovisioning for bad and doubtful loans.This was a follow-up to previous workconducted on the subject (see the EMI’sAnnual Report 1996) and focused on newapproaches to provisioning which creditinstitutions have started to use and whichare based on statistical methods. Inparticular, whereas traditional provisioningmethods are based on an item-by-itemevaluation and provisions are made on thebasis of a reduction in the value of theassets when tangible signals are detected,the new methods use a statistical approachto estimate the expected credit losses andthe corresponding loss provisions are postedas a liability (if the actual loss is greater thanexpected the difference is charged to theloss provision). The main impact of thisapproach is that it can smooth the effectsof credit losses on credit institutions’ profitsover the economic cycle. The survey onthe new approaches showed that, for thetime being at least, they are not widelyused by EU credit institutions. One reasonfor this is that EU accounting legislationrequires that provisions be made by meansof reducing the value of the assets on thebasis of an item-by-item evaluation.Nonetheless, in some non-EU countries(Canada, Switzerland and the United States)the use of the new methodologies is ormay become more common, not leastbecause it is in some cases endorsed by thesupervisory authorities. It is likely that thenew approaches will be addressed withinthe relevant international supervisory forumsin the context of discussions on prudentialsupervisory capital. The findings of thesurvey have been made available to theinternational supervisory forums.

Furthermore, the possible futuredevelopment of the current EU prudentialsupervisory regime for credit institutions’liquidity and the possible impact of the

establishment of EMU have been addressed.The prudential supervisory regime is basedon the following two elements: (i) theprudential rules governing credit institutions’liquidity as laid down in the Member Statesare not harmonised; and (ii) responsibilityfor supervising the liquidity position offoreign branches set up in the EU remainswith the host supervisor, in co-operationwith the home supervisor, in accordancewith Article 14 (2) of the Second BankingCo-ordination Directive. The current trendtowards the centralised management ofliquidity by credit institutions - which isexpected to be reinforced by theintroduction of the single currency - andthe need to maintain a fully effectivesupervisory function have both beenidentified as possible factors which mightnecessitate the revision of the currentregime and, in particular, a shift inresponsibility for foreign branches’ liquidityfrom the host to the home supervisor. Thefindings of this examination were broughtto the attent ion of the EuropeanCommission, which is competent to assess,with the assistance of the Banking AdvisoryCommittee, the need to amend current EUbanking legislation. The issue will have to bereassessed in the light of experience gainedfollowing the introduction of the euro andthe single monetary policy and their actualimpact on the liquidity management ofcredit institutions.

Finally, in 1997 co-operation continuedamong the credit registers operating inseven EU countries (Belgium, Germany,Spain, France, Italy, Austria and Portugal)and managed by NCBs, the main purposeof which is to record information on theoverall degree of indebtedness of borrowerswith a view to assisting credit and financialinstitutions in managing their credit risk. Themain objective of this co-operation remainsthe opening-up of the registers on a cross-border basis in order to grant access to theinformation stored in all the EU registers toreporting institutions established in the EUMember States. The achievement of this

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objective is deemed to be essential in orderto maintain the effectiveness of the registersin an environment characterised by thefurther integration of the EU banking andfinancial markets, which is also expected tobe reinforced by the establishment of EMU.At this stage, the opening-up of the registersis already possible in four cases, whereasthere are still legal obstacles to the opening-

up of the remaining three registers. TheNCBs concerned remain committed topromoting the adoption of the legislativeamendments and/or administrative measuresnecessary to lift these obstacles. Meanwhile,co-operation has focused on identifying themain features of the future exchange ofinformation among the registers.

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4 Administration of EMS mechanisms and Communityloans

The EMI’s operational tasks relate to theadministration of the mechanisms of theEuropean Monetary System (EMS) - the VeryShort-Term Financing mechanism (VSTF), theShort-Term Monetary Support mechanismand the creation of ECUs for the purpose ofimplementing the EMS Agreement - and theadministration of borrowing and lendingoperations concluded by the Communityunder the Medium-Term Financial Assistancemechanism.

4.1 EMS mechanisms

The EMI carries out operations associatedwith the creation, utilisation and remunerationof official ECUs. Official ECUs are issued toEU central banks against the contribution of20% of their gross gold holdings and US dollarreserves through revolving swaps.Contributions are compulsory for the EUcentral banks participating in the ERM andvoluntary for EU central banks not participatingin the ERM. The swap operations are renewedevery three months, which allows for thenecessary adjustments to be made in orderto: first, ensure that each EU central bank’scontribution to the EMI continues to representat least 20% of its gold and US dollar reserveholdings at the end of the month precedingthe renewal date; and, second, take accountof changes in the price of gold and in the USdollar exchange rate vis-à-vis the official ECU.The results of these operations are shown inthe Annual Accounts towards the end of thisReport.

Greece joined the ERM with effect from 16March 1998, which entailed compulsoryparticipation in the ECU swap mechanismfrom that date. Since the Bank of Greecehad been participating in the mechanism ona voluntary basis since January 1986, ERMmembership had no implications for theEMI’s ECU swap operations.

The amount of official ECUs issued by the EMIunder the latest three-month swap transaction,which took place on 12 January 1998, reachedECU 62.9 billion. Compared with January1997, the stock of ECUs increased by ECU2.7 billion. The increase was mainly due to:first, an appreciation of the US dollar againstthe ECU; and, second, an increase in the totalvolume of US dollar reserve contributionsfrom the EU central banks participating inECU swap operations with the EMI. Theincrease was partially offset by a fall in the goldprice and a decrease in the total volume ofgold contributions.

In addition to the creation of official ECUs,the EMI records in its books transfers ofECUs among the participating central banksand Other Holders. In 1997 no transferstook place between participating centralbanks. Transfers between participatingcentral banks and Other Holders resultedin net ECU positions of ECU 63.5 million,unchanged from the situation in 1996. Thisbalance reflects the acquisition of ECUs bythe Swiss National Bank through swapoperations with two EU central banksduring the period under review. The ECUmobilisation mechanism has not beenactivated since 1986. No use was made ofthe VSTF in 1997, nor of the Short-TermMonetary Support mechanism. The latterhas not been activated since 1974.

4.2 Community loans

In accordance with Article 109f (2) of theTreaty and Article 11 of Council Regulation(EEC) No. 1969/88 of 24 June 1988, theEMI administers the borrowing and lendingoperations concluded by the Communityunder the Medium-Term Financia lAssistance mechanism. The mechanismprovides for loans to be granted to MemberStates which are experiencing or are

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seriously threatened by difficulties in theirbalance of payments (current or capitalaccount). The EMI effects payments arisingfrom these borrowing and lendingoperations. It verifies the maturity dates laiddown in the borrowing and lendingcontracts for the payment of interest andrepayment of the principal and reports tothe Commission on the operations carriedout for the account of the EU.

In 1997 the EMI continued to receive fromborrowers, namely Greece and Italy, andto pay to creditors vis-à-vis the Communitythe sums due in respect of interest,commission and expenses on outstandingloans. The following table shows the totalof outstanding Community lendingoperations as at 31 December 1996 and1997.

Outstanding loans Outstanding loans Total outstanding

denominated in denominated in loans expressed in

Deutsche Mark ECUs ECUs

1996 1997 1996 1997 1996 1997

Greece - - 500 500 500 500

Italy 3,900 3,900 1,475 1,475 3,479 3,447

Total 3,900 3,900 1,975 1,975 3,979 3,947

Source: EMI.

Table 7Outstanding Community loans(as at year-end in millions)

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5 Advisory functions

Article 109f (6) of the Treaty and Article 5.3of the EMI Statute require that the EMI beconsulted by the Council of the EuropeanUnion or the responsible national authorities,as appropriate, on any proposed Communityor national legislation within its field ofcompetence. The limits and conditions ofconsultations on draft legislation by nationalauthorities are set out in Council Decision 93/717/EEC of 22 November 1993. Article 1 ofthis Decision states that “Member States shallconsult the EMI on any draft legislativeprovisions within its field of competencepursuant to Article 109f of the Treaty and inparticular on:

currency legislation, the status of theeuro and means of payment;

the status and powers of nationalcentral banks and the instruments ofmonetary policy;

the col lect ion, compi lat ion anddissemination of monetary, financial,banking and balance of paymentsstatistics;

clearing and payment systems, inparticular for cross-border transactions;

rules applicable to financial institutions,insofar as they influence the stability offinancial institutions and markets”.

Fifty-two requests for the EMI’s opinion werereceived in 1997 and the first quarter of 1998.Eleven requests concerned proposedCommunity legal acts and forty-oneconcerned national draft legislative provisionsfalling within the EMI’s field of competence.The consultations concerning the adaptationof the statutes of NCBs to meet therequirements of the Treaty were particularlyrelevant. The table below summarises theconsultation procedures in which the EMIdelivered opinions in 1997 and the firstquarter of 1998.Table 8

Consultation procedures in 1997

No. Originator Subject

1 European Commission Harmonised Index of Consumer Prices

2 Ireland Investment intermediaries

3 Greece Supervision of authorised foreign currency dealers

4 Belgium Prevention of the use of the financial system for money launderingpurposes

5 Belgium Financial instruments and securities clearing systems

6 Finland Netting in securities and foreign exchange transactions

7 Netherlands Prudential supervision

8 Netherlands Statute of De Nederlandsche Bank

9 EU Council Excessive deficit procedure

10 Germany Statute of the Deutsche Bundesbank

11 Netherlands Abolition of the retroactive effect in payment systems and securitiessettlement systems

12 Netherlands Legislation revoking the Act on the exchange rate of the guilder, as well asintroducing EMU-related amendments in the Act of external financialrelations and the Act of the supervision of security trade

13 EU Council Denominations of and technical specifications for the euro coins

14 EU Council Capital adequacy of investment firms and credit institutions

15 Greece Statute of the Bank of Greece

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16 Austria Participation of Austria in the new IMF borrowing arrangement

17 Italy Introduction of the euro

18 Portugal Statute of the Banco de Portugal

19 EU Council Short-term statistics

20 Ireland Statute of the Central Bank of Ireland

21 Austria Stock exchange

22 European Commission Minimum standards for the quality of HICP weights

23 EU Council Allocation of financial intermediation services indirectly measured withinthe European System of Integrated Economic Accounts (ESA)

24 Germany Introduction of the euro

25 Spain Statute of the Banco de España

26 Sweden Statute of Sveriges Riksbank

27 United Kingdom Statute of the Bank of England

28 United Kingdom Definition of the Money Market Contract

29 Finland Clearing and settlement of securities transfers

30 Austria Statute of the Oesterreichische Nationalbank and related legislation

31 Italy Statute of the Banca d’Italia and related legislation

No.No.No.No.No. OriginatorOriginatorOriginatorOriginatorOriginator SubjectSubjectSubjectSubjectSubject

1 Austria Introduction of the euro

2 Austria Introduction of the euro

3 Italy Codified law on finance

4 Belgium Protective measures for deposits and financial instruments

5 Spain Statute of the Banco de España

6 Finland Statute of Suomen Pankki

7 Italy Statute of the Banca d’Italia

8 Belgium Introduction of the euro

9 France Issuance and putting into circulation of money in the overseas territoriesof Mayotte and Saint Pierre and Miquelon, and protection of paymentand securities settlement systems

10 Denmark Margin collateral in connection with the clearing and settlement ofsecurities transactions

11 Portugal Introduction of the euro

12 France Statute of the Banque de France

13 Italy Statute of the Banca d’Italia

14 EU Council Consultation of the ECB by national authorities on draft legislativeprovisions

15 EU Council Statistical data to be used for the determination of the key forsubscription of the capital of the ECB

16 EU Council Conditions and procedure for applying the tax for the benefit of theEuropean Communities

17 EU Council Categories of officials and other servants of the European Communities towhom the provisions of Article 12, the second paragraph of Article 13and Article 14 of the Protocol on the Privileges and Immunities of theCommunities apply

18 Ireland Introduction of the euro

19 Netherlands Introduction of the euro

20 Ireland Investor compensation schemes

21 Belgium Statute of the National Bank of Belgium

Consultation procedures in the first quarter of 1998

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The EMI’s benchmark for the assessmentof the proposed legislation was primarily itscompatibility with the Treaty, while thepotential impact on future arrangementsfor Stage Three of EMU and, as appropriate,

the question as to whether the stability offinancial institutions and markets would beaffected by the legislation were alsoexamined.

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6 Monitoring of compliance with the prohibition onmonetary financing and on privileged access

In 1997 the EMI continued to monitorNCBs’ fulfilment of their obligations underArticles 104 and 104a of the Treaty andCouncil Regulations (EC) Nos. 3603/93 and3604/93.14 The European Commissionmonitors Member States’ compliance withthese provisions.

In 1997 the EU NCBs continued to respectthe Treaty requirements. Remainingimperfections which had appeared in thetransition to the new arrangements, as wellas technical problems which had occurred

in the implementation of new regulations,were finally corrected at the beginningof 1997.

The EMI also monitors NCBs’ secondarymarket purchases of public sector debtinstruments. The acquisition of debtinstruments of the public sector in thesecondary market - which, according toCouncil Regulation (EC) No. 3603/93, mustnot be used to circumvent the objective ofArticle 104 - is in general in compliancewith the Treaty.

14 For further background information on the legalframework of this topic see the EMI’s AnnualReport 1994, Chapter III B.

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7 Co-operation with other institutions

The EMI has continued its close co-operationwith other bodies of the European Union in anumber of forms and at various levels. ThePresident of the EU Council and a member ofthe European Commission have participatedin meetings of the EMI Council, and thePresident of the EMI has attended meetings ofthe EU Council whenever matters relating tothe objectives and tasks of the EMI have beendiscussed. This has included his attendance atinformal ECOFIN Council meetings, whereissues related to the irrevocable fixing ofconversion rates, the organisation of the EUCouncil’s dialogue with the ECB and the roleof the ESCB in the implementation of Article 109of the Treaty were discussed. In June 1997 thePresident appeared before the EuropeanParliament to present the EMI’s Annual Report1996 to a plenary session and to answerquestions related both to the monetary,economic and financial conditions in the Unionand to the activities of the EMI, focusing inparticular on the progress made by the EMI infulfilling its statutory obligation to undertake thepreparatory work necessary for Stage Threeof EMU. The main challenges facing the EMI inthe run-up to Stage Three of EMU and, inparticular, the technical preparations necessaryfor the timely establishment of the ESCB werethe key issues discussed when the Presidentappeared before the Sub-Committee onMonetary Affairs of the European Parliamentin October 1997. The same topics were onthe agenda when the President held anexchange of views with members of theEconomic and Social Committee of theEuropean Communities in November.

At the working level, senior representativesof the EMI have regularly attended themeetings of the Monetary Committee asobservers. Close working relationships havebeen maintained with the competentDirectorates General of the EuropeanCommission, representatives of which alsoattend meetings of some EMI working groups.In the field of prudential supervision, anagreement was reached between the EMI

and the European Commission in order tostrengthen co-operation between the twoinstitutions. According to this agreement, theEMI participates as an observer in the meetingsof the Banking Advisory Committee, whichassists the Commission in, inter alia, drawingup proposals for new Community bankinglegislation, while a representative of DirectorateGeneral XV takes part in the meetings of theEMI’s Banking Supervisory Sub-Committee.In the field of statistics the EMI has furtherenhanced its procedures for co-operationwith EUROSTAT (the European Commission’sstatistical office) and is represented by threemembers in the Committee on Monetary,Financial and Balance of Payments Statistics.Furthermore, the EMI has continued to co-operate with the national Mint Directorsrepresenting the institutions which will beresponsible for producing the euro coinswhich will circulate alongside the eurobanknotes as from 1 January 2002.

With regard to contacts with institutionsoutside the Community, the “concertationprocedure” has remained a valuable forumfor exchanging data among foreign exchangeexperts from central banks in the EU andthose in Canada, Japan, Norway, Switzerlandand the United States on exchange marketdevelopments, intervention and other officialforeign exchange transactions. Consultationson matters of common interest between theEMI and the central banks of Norway, Icelandand Switzerland have taken place. Importantlinks have also been retained with the Bankfor International Settlements (BIS). The IMFhas paid several visits to the EMI in thecontext of its regional surveillance activity andin order to exchange views on the futurerelationship between the ESCB and the IMF.The EMI also took part in meetings of theOECD Working Party No. 3. Furthermore,the EMI maintained its contact with thecentral banks of the associated Central andEastern European countries (CEECs) andother applicant countries.

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Annual Accounts of the EMI

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Balance Sheet as at 31 December 1997

ECUAssets

1997 1996

I EMS-related assets

Holdings of gold 26,228,410,973 27,816,645,173Holdings of US dollars 38,791,623,886 31,710,534,867

65,020,034,859 59,527,180,040

II Other assets

(1) Cash and bank sight accounts 24,164,570 11,013,442(2) Time deposits 597,499,982 628,044,375(3) Tangible assets 24,750,972 7,815,279(4) Other assets 2,345,761 841,986

648,761,285 647,715,082

Total assets (I and II) 65,668,796,144 60,174,895,122

Memorandum item:Forward claims in ECUs 65,020,034,859 59,527,180,040(from revolving quarterly swaps)

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ECULiabilities

1997 1996

I EMS-related liabilities

ECUs issued to EU central banks 65,020,034,859 59,527,180,040

65,020,034,859 59,527,180,040II Other liabilities

(1) Creditors and other liabilities 11,535,065 4,200,209(2) Provision for pensions and similar

obligations 6,130,620 3,742,631(3) Other provisions 11,120,462 7,074,292(4) Contributions from EU

central banks 615,573,495 615,573,495(pursuant to Article 16.2of the Statute)

(5) General reserve fund 17,124,455 12,536,150(6) Surplus/deficit for the year (12,722,812) 4,588,305

648,761,285 647,715,082

Total liabilities (I and II) 65,668,796,144 60,174,895,122

Memorandum item:Forward liabilities in gold andUS dollars 65,020,034,859 59,527,180,040(from revolving quarterly swaps)

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Profit and Loss Account for the year 1997

ECU

1997 1996

Income

Interest income 43,376,777 44,532,696

Total income 43,376,777 44,532,696

Expenses

Staff costs 24,926,562 18,157,530Other administrative expenses 28,613,295 18,936,144Depreciation of tangible assets 3,012,512 2,084,941

Total expenses 56,552,369 39,178,615

Extraordinary income 916,447 96,523Less: valuation loss (463,667) (862,299)

Surplus/deficit for the year (12,722,812) 4,588,305

Allocation of deficit

Offset against the general reserve fund 12,722,812

Frankfurt am Main,11 February 1998

EUROPEAN MONETARY INSTITUTE

W. DuisenbergPresident

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1. Accounting Policies

1.1 The annual accounts were drawn upin accordance with accounting principlesestablished by the Council of the EMIpursuant to Article 17.3 of its Statute, andare expressed in official ECUs.

1.2 Although the EMI, as a body of theEuropean Communities, is not subject tonational laws and regulations on accountingpractices, its accounting policies followinternat ional ly accepted accountingprinciples, unless specific EMI issues requireotherwise.

1.3 Notwithstanding the limited life ofthe EMI, the accounts have been preparedon a “going concern” basis. When the EMIgoes into liquidation on the establishmentof the ECB, all of its assets and liabilities willautomatically pass to the latter, which willthen liquidate the EMI in accordance withthe provisions of Article 23 of the Statuteof the EMI.

1.4 EMS-related assets and liabilities areshown at cost. Short-term discount securitiesare shown at cost plus accrued interest.Securities, other than short-term discountsecurities and financial fixed assets, areshown at year-end market value. Financialfixed assets are shown at acquisition costless any provision for a permanent diminutionin value. All other financial assets andliabilities are shown at nominal value.

1.5 Tangible assets are valued at cost lessdepreciation. Depreciation is calculated ona straight-line basis, beginning in the quarter

after acquisition, over the expectedeconomic lifetime of an asset, namely:

Equipment, furnitureand plant in building 10 years

Computers, relatedhardware, softwareand vehicles 4 years

1.6 Apart from EMS-related assets andliabilities and financial fixed assets, foreigncurrency translation of balance sheet itemsinto ECUs is based on the official ratespublished by the European Commissionapplying at 31 December 1997, or otherwiseon closing market rates for that date.Foreign currency transactions reflected inthe Profit and Loss Account are valued atthe average of daily official rates for theyear 1997. Translation of financial fixedassets denominated in foreign currencies isat the spot rates of exchange ruling on thedates of their acquisition.

1.7 Income and expenses are recognisedon an accruals basis. Unrealised gains arisingfrom the revaluation of assets vis-à-vis thepurchase price are not recognised as incomebut taken into a revaluation account; unrealisedlosses are charged against previous unrealisedgains in the revaluation account and anyremaining losses are charged against profit.

1.8 In accordance with Article 17.4 ofthe Statute, the Council has appointedC & L Deutsche Revision as independentexternal auditors.

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2. Notes on the Balance Sheet

2.1 EMS-related assets and liabilities

These items relate to the three-monthrevolving swaps of official ECUs created inexchange for EU centra l banks ’contributions to the EMI of 20% of theirgold and US dollar reserves. Theseoperations are described in Chapter III,Section 4, of the Report. The respectiveassets and liabilities are shown in the EMI’sbooks. The entries do not imply any interestpayments or receipts by the EMI. Intereston official reserves swapped for ECUscontinues to accrue to the underlyingowners. Interest on ECU holdings arisingout of swaps only becomes due where acentral bank’s holdings exceed its forwardECU liabilities; in such cases, payments arecovered by interest due from central bankswhose forward liabilities in ECUs exceedtheir holdings of ECUs.

2.2 Other assets

II (1) Cash and bank sight accounts: Workingcash balances were held on a currentaccount in Deutsche Mark, in whichcurrency almost all of the EMI’s day-to-daytransactions are payable. This account wasused exclusively to deal with payments andreceipts relating to the day-to-dayadministration of the EMI. Other cashbalances were held on a one-day noticeinterest-bearing account in Deutsche Markor were invested from time to time inTreasury bills of the Federal Republic ofGermany. No such securities were held asat 31 December 1997.

II (2) Time deposits: As stated in the AnnualReport for 1996, ECU 597.2 million of theresources contributed by the EU centralbanks pursuant to Article 16.2 of theStatute of the EMI was placed in timedeposits in January 1995 at a fixed term ofthree years to generate the income deemed

necessary to cover the EMI’s administrativeexpenses. These deposits, which constituteda financial fixed asset of the EMI, maturedon 30 December 1997. The proceedswere credited to a two-day notice interest-bearing account pending their reinvestmentin the first week of January 1998.

II (3) Tangible assets: Net of cumulativedepreciation of ECU 7.8 million thesecomprised, at year-end:

in ECUs

1997 1996

Special installations 2,065,988 3,632,708

Plant in building 7,225,869 3,671

Other equipment 2,184,088 1,858,180

Computers and

software 12,976,562 2,231,547

Other 298,465 89,173

Total 24,750,972 7,815,279

“Special installations” comprises the costs ofspecial additions and enhancements to thestandard fittings and capital plant andequipment within the EMI’s premises in theEurotower building in Frankfurt am Mainrequired to meet its particular operationalneeds. Following agreement of the finalamounts due to the contractors from theEMI for the work carried out in respect ofthese special installations in 1994 and 1995,for which provisions had been made, thebook value of this item was reviseddownwards by ECU 0.7 million. Thecorresponding provisions were released(see Note 3.3). There were significantincreases in the asset value of plant inbuilding and computers and software as theinstallation of ECB and ESCB systems startedduring the latter part of the year.

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II (4) Other assets: This item principallyincludes a claim against the German FederalMinistry of Finance in respect of recoverablevalue added and other indirect taxes paid ongoods and services. Such taxes are refundableunder the terms of Article 3 of the Protocolon the Privileges and Immunities of theEuropean Communities, which also applies tothe EMI by virtue of Article 21 of its Statute.

2.3 Other liabilities

II (1) Creditors and other liabilities: This itemprincipally comprises payments due tosuppliers, together with income taxdeducted at source from salaries pendingpayover to the European Communities,and accumulated pension contributions withinterest thereon repayable to staff. Membersof the staff contribute to the pensionscheme a percentage of their basic salary(matched by a contribution of twice thatamount by the EMI - see II (2) below); thestaff contribution is repayable at thetermination of the employment contracttogether with accrued interest thereon.

II (2) Provision for pensions and similarobligations: This item comprises theaccumulated contributions of the EMItowards the staff pension scheme. Thesecontributions are required to cover theeventual cost of severance grants and anyill-health pensions.

II (3) Other provisions: These comprise fundsset aside in respect of work carried out by

end-1997 on several major infrastructuralprojects currently still in progress for theECB and ESCB, the restoration of the EMI’spremises at the end of its lease, office rentaland service charge payments outstanding inrespect of 1997, and the production of theAnnual Report and the accounts for 1997.

II (4) Contributions from EU central banks:These represent the contributions madepursuant to Article 16.2 of the Statute bythe EU central banks, as detailed below:

Central bank ECU

Belgium 17,235,643

Denmark 10,464,542

Germany 138,808,404

Greece 12,311,159

Spain 54,476,907

France 104,644,800

Ireland 4,924,381

Italy 97,565,912

Luxembourg 923,360

Netherlands 26,161,252

Austria 14,162,957

Portugal 11,387,902

Finland 10,160,382

Sweden 17,857,642

United Kingdom 94,488,252

Total 615,573,495

II (5) General reserve fund: This representsaccumulated undistributed profits fromprevious years, less any losses incurred. Seealso Note 3.5.

II (6) Deficit for the year: See Note 3.5.

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3. Notes on the Profit and Loss Account

3.1 Income

Interest income: This item represents interestof ECU 42.3 million earned on the timedeposits and of ECU 1.1 million frominvestment of cash balances (see Notesunder “Other assets”).

3.2 Expenses

Staff costs: This item relates to salaries andallowances (ECU 21.3 million), and toemployer’s contributions to pensions andhealth and accident insurance (ECU 3.6million), in respect of staff employed by theEMI. Salaries and allowances of staff, includingemoluments of holders of seniormanagement positions, are modelled inessence on, and are comparable to, theremuneration scheme of the EuropeanCommunities.

Numbers of staff (as at 31 December)

1997 1996

Permanent staff

Senior management 7 6

Managerial 39 36

Professional 161 90

Support 127 85

Total 334 217

Staff on short-term contracts 13 4

The average number of permanent staffemployed during 1997 was 281, comparedwith 202 for 1996. During 1997 135permanent staff were recruited and 18 staffceased to be employed.

Other administrative expenses: These coverall other current expenses, viz. rents,maintenance of premises and equipment,goods and equipment of a non-capitalnature, professional fees, and other servicesand supplies, together with the expensesinvolved in the recruitment, relocation,installation and resettlement of staff.

3.3 Extraordinary income

This item represents extraordinary incomearising mainly from the release of provisionsmade in previous years in respect ofanticipated expenditure arising in thoseyears that are no longer required.

3.4 Valuation loss

The depreciation of the Deutsche Markagainst the ECU during 1997 resulted in anunrealised loss in the net value of assetsheld or denominated in Deutsche Mark. Inthe absence of a revaluation reserve, thefull amount of this loss has been chargedagainst profit.

3.5 Allocation of deficit

Pursuant to Article 17.6 of the Statute ofthe EMI, the deficit has been offset againstthe general reserve fund of the EMI.

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President and Councilof the European Monetary Institute

Frankfurt am Main

We have audited the accompanying financial statements of the European MonetaryInstitute. The Management of the European Monetary Institute is responsible for thepreparation of the accounts. It is our responsibility to form an independent opinion onthese accounts based on our audit, and to report our opinion to you.

We conducted our audit in accordance with International Standards of Auditing. An auditincludes examinations, on a test basis, of evidence relevant to the amounts and disclosuresin the accounts. It also includes an assessment of the significant estimates and judgementsmade in the preparation of the accounts, and of whether the accounting policies areappropriate to the European Monetary Institute’s circumstances and adequately disclosed.

In our opinion, the financial statements, which have been prepared under accountingpolicies set out in Section 1 of the notes on the accounts of the European MonetaryInstitute, give a true and fair view of the financial position of the European MonetaryInstitute at 31 December 1997 and the results of its operations for the year then ended.

Frankfurt am Main, 12 February 1998

C&L DEUTSCHE REVISIONAktiengesellschaftWirtschaftsprüfungsgesellschaft

(Wagener) (Kern)

Wirtschaftsprüfer Wirtschaftsprüfer

Annexes

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Excerpts from the Convergence Report (March 1998)

1 Convergence criteria

The criterion on price stability

Focusing on the performance of individualcountries, over the twelve-month referenceperiod ending January 1998 fourteenMember States (Belgium, Denmark,Germany, Spain, France, Ireland, Italy,Luxembourg, the Netherlands, Austria,Portugal, Finland, Sweden and the UnitedKingdom) had average HICP inflation ratesof below the reference value. This referencevalue was calculated by using theunweighted arithmetic average of the rateof HICP inflation in the three countries withthe lowest inflation rates, plus 1.5 percentagepoints. These three countries’ inflation rateswere 1.1% for Austria, 1.2% for France and1.2% for Ireland, and, adding 1.5 percentagepoints to the average of 1.2%, the referencevalue is 2.7%. HICP inflation in Greece was5.2%, considerably lower than in previousyears, but still well above the referencevalue (see Table 5).

Looking back over the period from 1990 to1997, the convergence of inflation ratescan be explained by a variety of commonfactors. In the first place, as is indicated foreach individual Member State, it reflects anumber of important policy choices, mostnotably the orientation of monetary policytowards price stability and the increasingsupport received from other policy areas,such as fiscal policies and the developmentof wages and unit labour costs. In addition,in most Member States the macroeconomicenvironment, in particular during the periodfollowing the cyclical downturn of 1993,has contributed to the easing of upwardpressure on prices. Finally, in many MemberStates broadly stable exchange rates andsubdued import price developments havehelped to dampen inflation. At the level ofindividual countries, it is apparent that agroup of Member States recorded relatively

similar inflation rates for most of the 1990s,while several others made particularly rapidprogress in 1996-97. Among the latter,annual CPI inflation in Spain, Italy andPortugal fell from 4-5½% in 1995 to around2% in 1997. These three Member Stateshave had twelve-month average HICPinflation rates of below the reference valuesince mid-1997. In Greece, HICP inflationfell from 7.9% in 1996 to 5.4% in 1997,while remaining considerably above thereference value.

Looking ahead to the near future, in mostcountries recent trends and forecasts forinflation tend to indicate that there is littleor no sign of immediate upward pressureon inflation. The risks for price stability areoften associated with a narrowing of theoutput gap, a tightening of labour marketconditions and increases in administeredprices or indirect taxes; in several countries,for the most part those which are furtherahead in the current cyclical upturn, therate of inflation is generally forecast to riseto somewhat above 2% during the period1998-99. This applies to Denmark, Spain,Ireland, the Netherlands, Portugal, Finlandand the United Kingdom. These MemberStates need to exercise firm control overdomestic price pressures with regard to,inter alia, wage and unit labour costs.Support is also required from fiscal policies,which need to react flexibly to the domesticprice environment.

The criterion on the government budgetaryposition

With regard to the performance of individualMember States in 1997, three countrieshave recorded fiscal surpluses (Denmark,Ireland and Luxembourg) and elevenMember States have achieved or maintaineddeficits at or below the 3% reference valuespecified in the Treaty (Belgium, Germany,

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Spain, France, Italy, the Netherlands, Austria,Portugal, Finland, Sweden and the UnitedKingdom). Only Greece recorded a deficitof 4.0%, which is still above the referencevalue. For 1998, fiscal surpluses or furtherreductions in deficit ratios are projected bythe Commission for nearly all MemberStates. The Greek deficit is expected to fallto 2.2% of GDP (see Table 5).

As regards government debt, in the threeMember States with debt-to-GDP ratios ofabove 100%, debt has continued to decline inrelation to GDP. In Belgium the debt ratio in1997 was 122.2%, i.e. 13.0 percentage pointslower than the peak in 1993; in Greece thedebt ratio in 1997 stood at 108.7%, i.e. 2.9percentage points below the latest peak in1996; and in Italy the debt ratio was 121.6%,i.e. 3.3 percentage points below the peak of1994. In the seven countries which in 1996had debt ratios significantly above 60% butbelow 80% of GDP, debt ratios also declined.This was particularly the case in Denmark,Ireland and the Netherlands, where debtratios in 1997 were 16.5, 30.0 and 9.1percentage points respectively below theirpeak levels of 1993, and stood at 65.1%,66.3% and 72.1% of GDP respectively; inSpain the debt ratio in 1997 declined by 1.3percentage points from its peak level of 1996to reach 68.8% of GDP; in Austria thecorresponding reduction amounted to 3.4percentage points, taking the debt ratio to66.1% of GDP. In Portugal the debt ratio was3.9 percentage points below its 1995 level,bringing the debt ratio to 62.0% of GDP.Finally, in Sweden the debt ratio was 2.4percentage points below its peak level of1994, reaching 76.6% of GDP in 1997. InGermany, which in 1996 had a debt ratio ofjust above the 60% reference value, the debtratio continued its upward trend and in 1997was 19.8 percentage points higher than in1991, standing at 61.3% of GDP. In 1997 fourcountries continued to have debt ratios ofbelow the 60% reference value (France,Luxembourg, Finland and the UnitedKingdom). In France the debt ratio continued

its upward trend to reach 58.0% of GDP in1997 (see Table 5).

For 1998 further reductions in debt-to-GDP ratios are projected by the Commissionfor all Member States which had debt ratiosof above 60% in 1997. In the cases ofDenmark, Ireland and Portugal, a reductionto a level at or below the reference value isforecast. As regards countries with debtratios of 50-60% of GDP in 1997, Finlandand the United Kingdom are anticipated toreduce their debt ratios further below 60%,whereas in France the debt ratio is expectedto increase marginally.

Overall, progress in reducing fiscal deficitand debt ratios has generally accelerated.However, (...) in a number of MemberStates measures with a temporary effecthave played a role in reducing deficits. Onthe basis of the evidence available to theEMI, the effects of such measures havebeen quantified at between 0.1 and1 percentage point, with the level varyingby country. To the extent that evidence isavailable, the magnitude of temporarymeasures in 1998 budgets has generallybeen reduced; in addition, as mentionedabove, forecasts for 1998 suggest in mostcases a further decline in deficit ratios.Reductions in debt ratios have benefited inpart from a number of financial operationsand transactions, such as privatisation, whichare reflected in the so-called “stock-flowadjustment” item (...). Such transactions areexpected to continue to play a role inseveral Member States.

Notwithstanding recent achievements,further substantial consolidation is warrantedin most Member States in order to achievelasting compliance with the fiscal criteriaand the medium-term objective of having abudgetary position that is close to balanceor in surplus, as required by the Stabilityand Growth Pact, effective from 1999onwards. This applies in particular toBelgium, Germany, Greece, Spain, France,Italy, the Netherlands, Austria and Portugal,

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where deficits in 1998 are forecast to bebetween 1.6 and 2.9% of GDP. For most ofthese countries, these consolidationrequirements also apply when comparingthe fiscal deficit ratios as projected in theConvergence Programmes for 1999-2000with the medium-term objective of theStability and Growth Pact.

Taking a broader view on the sustainabilityof fiscal developments, the case for sustainedconsolidation over an extended period oftime, requiring substantial fiscal surpluses, isparticularly strong for those countries withdebt ratios of above 100% (Belgium, Greeceand Italy). This compares with significantoverall deficits in 1997 and the years before.In countries with debt ratios of significantlyabove 60% but below 80% of GDP, keepingthe deficit ratio at current levels would notbring down the debt ratio to below 60%within an appropriate period of time, whichindicates the need for further, in somecases substantial, consolidation. Instead,realising the fiscal positions forecast for1998 by the European Commission andmaintaining a balanced budget from 1999onwards would reduce the debt ratio tobelow 60% over appropriate periods (Spain,the Netherlands and Austria). Sweden couldachieve the same result by realising thesurplus position forecast for 1998 andmaintaining it for several years thereafter.In Germany the debt ratio is forecast to bejust above 60% of GDP in 1998, whichcould allow it to be reduced to below thereference value as early as 1999 if balancedbudgets were achieved in that year. InDenmark, Ireland and Portugal current andforecast fiscal balances would allow thedebt ratio to be reduced to a level equal toor just below 60% as early as 1998. Finally,in France, where the debt ratio is justbelow 60% of GDP, complying with theStability and Growth Pact from 1999onwards would also ensure that the debtratio does not exceed the reference value.

It should be noted that in assessing budgetarypositions of EU Member States, the impact

on national budgets of transfers to andfrom the EC budget is not taken intoaccount by the EMI.

The exchange rate criterion

During the two-year reference period fromMarch 1996 to February 1998 ten currencies(the Belgian/Luxembourg franc, the Danishkrone, the Deutsche Mark, the Spanishpeseta, the French franc, the Irish pound,the Dutch guilder, the Austrian schilling andthe Portuguese escudo) have beenparticipating in the ERM for at least twoyears before this examination, as stated bythe Treaty. The periods of membership forthe Finnish markka and the Italian lira wereshorter, as these currencies joined andrejoined the exchange rate mechanism inOctober 1996 and November 1996respectively. Three currencies remainedoutside the ERM during the referenceperiod referred to in this Report, namelythe Greek drachma15 , the Swedish kronaand the pound sterling.

Each of the ten ERM currencies mentionedabove, with the exception of the Irishpound, has normally traded close to itsunchanged central rates against other ERMcurrencies, and some currencies (theBelgian/Luxembourg franc, the DeutscheMark, the Dutch guilder and the Austrianschilling) virtually moved as a bloc. Onoccasion, several currencies traded outsidea range close to their central rates.However, the maximum deviation, on thebasis of 10 business day moving averages,was limited to 3.5%, abstracting from thedevelopment of the Irish pound. In addition,the deviations were only temporary andmainly reflected transient movements ofthe Spanish peseta and the French franc (inearly 1996), the Portuguese escudo (atend-1996/early 1997) as well as the Finnish

15 (...) the Greek drachma was incorporated in theexchange rate mechanism of the EMS, effectivefrom 16 March 1998.

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markka (in early and mid-1997) vis-à-visother ERM currencies. An examination ofexchange rate volatility and short-terminterest rate differentials suggests thepersistence of relatively calm conditionsthroughout the reference period.

The Irish pound has normally tradedsignificantly above its unchanged centralrates against other ERM currencies; at theend of the reference period the Irish poundstood just over 3% above its central rates.16

In parallel, the degree of exchange ratevolatility vis-à-vis the Deutsche Markincreased until mid-1997 and short-terminterest rate differentials against those EUcountries with the lowest short-term interestrates widened over the same period. Morerecently, the former decreased and thelatter narrowed somewhat while remainingrelatively high.

In the case of the Italian lira, at thebeginning of the reference period, beforerejoining the ERM, it initially experienced asmall and temporary setback in its previousstrengthening trend, reaching a maximumdownward deviation of 7.6% below itsfuture central rate against one ERM currencyin March 1996. Thereafter, it resumed itsappreciation and tended towards its latercentral parities, moving for most of the timewithin a narrow range. In the case of theFinnish markka, also at the beginning of thereference period, before joining the ERM, itinitially continued its weakening movementapparent over the previous few months -which had interrupted the longer-termupward movement since 1993 - reaching amaximum downward deviation of 6.5%below its future central rate against oneERM currency in April 1996. Thereafter, itappreciated and generally traded within anarrow range around its later central parities.Since joining and rejoining the ERM inOctober and November 1996 respectively,both the Finnish markka and the Italian lirahave normally traded close to theirunchanged central rates against other ERMcurrencies. As was the case for other ERM

currencies, on occasion the Italian lira andthe Finnish markka traded outside a rangeclose to their central rates, but suchdeviations were limited and temporary. Inboth cases the relatively high degree ofexchange rate volatility against the DeutscheMark observed in earlier periods declinedto low levels over the reference period andshort-term interest rate differentials againstthose EU countries with the lowest short-term interest rates narrowed steadily in thecase of the Italian lira and were insignificantin the case of the Finnish markka.

The three currencies remaining outside theERM, namely the Greek drachma, theSwedish krona and the pound sterling, havenormally traded above their March 1996average bilateral exchange rates againstother EU currencies. Short-term interestrate differentials against those EU countrieswith the lowest short-term interest ratesremained wide in Greece, having narroweduntil mid-1997 and widened significantlysince November 1997, whereas they havenarrowed significantly in Sweden. In thecase of the pound sterling the short-terminterest rate differential tended to widen.

The long-term interest rate criterion

Over the twelve-month reference periodending January 1998, fourteen MemberStates (Belgium, Denmark, Germany, Spain,France, Ireland, Italy, Luxembourg, theNetherlands, Austria, Portugal, Finland,Sweden and the United Kingdom) hadaverage long-term interest rates of belowthe reference value. This reference valuewas calculated by using the unweightedarithmetic average of the long-term interestrates in the three countries with the lowestrates of HICP inflation, plus 2 percentagepoints. These three countries’ long-term

16 (...) the previous bilateral central rates of the Irishpound against other currencies of the exchangerate mechanism were revalued by 3%, effectivefrom 16 March 1998.

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interest rates were 5.6% for Austria, 5.5%for France and 6.2% for Ireland, and, adding2 percentage points to the average of 5.8%,the reference value is 7.8%. Representativelong-term interest rates in Greece, whichhave been comparable with yields in othercountries since June 1997, were 9.8% andthus stood well above the reference value(see Table 5).

Looking back over the period from 1990 to1997, long-term interest rates were broadlysimilar in a number of countries whenconsidered over the period as a whole.This applies to Belgium, Germany, France,Luxembourg, the Netherlands and Austria.In Denmark and Ireland long-term rateswere also relatively close to those in theabove-mentioned countries for most of theperiod. In Finland and Sweden the processof yield convergence accelerated from1994-95 onwards and both countries haverecorded limited differentials since around1996. In Spain, Italy and Portugal, whereyields were significantly higher for most ofthe 1990s, long-term interest rates declinedsteeply from 1995 onwards and movedbelow the reference value in either late1996 or early 1997. A significant reduction

was also seen in Greece. In the case of theUnited Kingdom, reflecting a differentposition in the cycle vis-à-vis continentalEuropean countries, a broad trend hasbeen observed since the early 1990s of,first, convergence with, and later divergencefrom the long-term interest rates prevailingin the countries with the lowest bondyields, although long-term interest ratedifferentials have narrowed more recently.

The broad patterns observed in membercountries are closely related to thedevelopments in inflation rates (see above),which have facilitated a general reduction inlong-term interest rates and a particularlymarked decline in the case of the formerlyhigh-yielding currencies. Other factorsunderlying this trend were the stability ofexchange rates in most cases and theimprovement in countries’ fiscal positions,thereby reducing risk premia. These underlyingdevelopments were seen by the markets asimproving the prospects for participation inStage Three of EMU - an element which mayin turn have played an independent role inaccelerating the narrowing of yield differentials,both directly and by further improving theprospects for price and exchange rate stability.

2 Compatibility of national legislation with the Treaty

2.1 Introduction

Article 108 of the Treaty states that MemberStates shall ensure, at the latest at the dateof the establishment of the ESCB, that theirnational legislation, including the statutes oftheir NCBs, is compatible with the Treatyand the Statute (“legal convergence”). Thisdoes not require the harmonisation ofNCBs’ statutes, but it implies that nationallegislation and statutes of NCBs need to beadjusted in order to make them compatiblewith the Treaty and the Statute. For thepurpose of identifying those areas wherethe adaptation of national legislation is

necessary, a distinction may be madebetween the independence of NCBs, thelegal integration of NCBs in the ESCB andlegislation other than statutes of NCBs.

Compatibility requires that the legislativeprocess be completed, i.e. that the respectiveact has been adopted by the national legislatorand that all further steps, for examplepromulgation, have been accomplished. Thisapplies to all legislation under Article 108.However, the above distinction betweendifferent areas of legislation is important whenit comes to determining the date on whichlegislation must enter into force. Many decisions

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which the Governing Council of the ECB andthe NCBs will take between the date of theESCB’s establishment and the end of 1998will predetermine the single monetary policyand its implementation within the euro area.Therefore, adaptations which relate to theindependence of an NCB need to becomeeffective at the latest at the date of theESCB’s establishment. Other statutoryrequirements relating to the legal integrationof NCBs in the ESCB need only enter intoforce at the moment that the integration ofan NCB in the ESCB becomes effective, i.e.the starting date of Stage Three or, in thecase of a Member State with a derogation ora special status, the date on which it adoptsthe single currency. The entry into force ofadaptations of legislation other than statutesof NCBs which are required to ensurecompatibility with the Treaty and the Statuteis dependent on the content of such legislationand therefore needs to be assessed on acase-by-case basis.

This Report provides, inter alia, anassessment on a country-by-country basisof the compatibility of national legislationwith the Treaty and the Statute.

2.2 Independence of NCBs

Central bank independence is essential forthe credibility of the move to MonetaryUnion and, thus, a prerequisite of MonetaryUnion. The institutional aspects of MonetaryUnion require monetary powers, currentlyheld by Member States, to be exercised in anew system, the ESCB. This would not beacceptable if Member States could influencethe decisions taken by the governing bodiesof the ESCB.

The Statute contemplates an important rolefor governors of NCBs (via their membershipof the Governing Council of the ECB) withregard to the formulation of monetary policyand for the NCBs with regard to the executionof the operations of the ESCB (see Article12.1 of the Statute, last paragraph). Thus, it

will be essential for the NCBs to beindependent in the performance of theirESCB-related tasks vis-à-vis external bodies.

The principle of the independence of NCBsis expressly referred to in Article 107 of theTreaty and Article 14.2 of the Statute.Article 107 contains a prohibition onattempts to influence the ECB, NCBs orthe members of their decision-makingbodies, and Article 14.2 provides for securityof tenure for such members.

The EMI has established a list of features ofcentral bank independence, distinguishingbetween features of an institutional, personaland financial nature.17

As regards institutional independence, rightsof third parties (e.g. government andparliament) to:

give instructions to NCBs or theirdecision-making bodies;

approve, suspend, annul or deferdecisions of NCBs;

censor an NCB’s decisions on legal grounds;

participate in the decision-makingbodies of an NCB with a right to vote; or

be consulted (ex ante) on an NCB’sdecisions

are incompatible with the Treaty and/orthe Statute and, thus, require adaptation.

With respect to personal independence,statutes of NCBs should ensure that:

governors of NCBs have a minimumterm of office of five years;

17 There is also a criterion of functional independence,but as NCBs will in Stage Three be integrated in theESCB, this is being dealt with in the framework ofthe legal integration of NCBs in the ESCB (seeparagraph 2.3 below).

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a governor of an NCB may not bedismissed for reasons other than thosementioned in Article 14.2 of the Statute(i.e. if he/she no longer fulfils the conditi-ons required for the performance of his/her duties or if he/she has been guilty ofserious misconduct);

other members of the decision-making bodies of NCBs involved in theperformance of ESCB-related taskshave the same security of tenure asgovernors;

no conflicts of interest will arise betweenthe duties of members of the decision-making bodies of NCBs vis-à-vis theirrespective NCB (and, additionally, ofgovernors vis-à-vis the ECB) and otherfunctions which members of the decision-making bodies involved in theperformance of ESCB-related tasks mayperform and which may jeopardise theirpersonal independence.

Financial independence requires that NCBscan avail themselves of the appropriatemeans to fulfil their mandate. Statutoryconstraints in this field must be accompaniedby a safeguard clause to ensure that ESCB-related tasks can be properly fulfilled.

2.3 The legal integration of NCBs inthe ESCB

The full participation of NCBs in the ESCBnecessitates measures in addition to thosedesigned to ensure independence. In particular,such measures may be necessary to enableNCBs to execute tasks as members of theESCB and in accordance with decisions takenby the ECB. The main areas of attention arethose where statutory provisions may forman obstacle to an NCB complying with therequirements of the ESCB or to a governorfulfilling his/her duties as a member of theGoverning Council of the ECB, or wherestatutory provisions do not respect the

prerogatives of the ECB. Thus the EMI’sassessment of the compatibility of the statutesof NCBs with the Treaty and the Statutefocuses on the following areas: statutoryobjectives, tasks, instruments, organisation,financial provisions and miscellaneous issues.

2.4 Legislation other than thestatutes of NCBs

The obligation of legal convergence underArticle 108 of the Treaty, which is incorporatedin a chapter entitled “Monetary Policy”, appliesto those areas of legislation which are affectedby the transition from Stage Two to StageThree. The EMI’s assessment of the compatibilityof national legislation with the Treaty and theStatute focuses in this respect on laws with animpact on an NCB’s performance of ESCB-related tasks and laws in the monetary field.Relevant legislation requiring adaptation is inparticular found in the following areas:banknotes, coins, foreign reserve management,exchange rate policy and confidentiality.

2.5 Compatibility of nationallegislation with the Treaty andthe Statute

All Member States except Denmark, whoselegislation does not require adaptation, haveintroduced, or are in an advanced process ofintroducing, changes in the statutes of theirNCBs, following the criteria laid down in theEMI’s Reports and in the EMI’s opinions. TheUnited Kingdom, which is exempt from theobligations under Article 108 of the Treaty, isin the process of introducing a new statute ofits NCB which, while providing a greater levelof operational central bank independence, isnot expressly intended to achieve the legalconvergence as required by the EMI for fullcompliance with the Treaty and the Statute.Throughout the European Union legislators,with the above exceptions, have undertakena legislative process intended to prepareNCBs for Stage Three of EMU.

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Joint Communiqué on the determination of the irrevocableconversion rates for the euro, dated 2 May 1998

In accordance with Article 109l (4) of theTreaty, the irrevocable conversion rates forthe euro will be adopted by the Council,upon a proposal from the Commission andafter consultation of the European CentralBank (ECB), on the first day of Stage Three,i.e. on 1 January 1999.

With a view to guiding markets in the run-up to Stage Three, the Ministers of theMember States adopting the euro as theirsingle currency, the Governors of theCentral Banks of these Member States, theEuropean Commission and the EuropeanMonetary Institute (EMI) have agreed onthe method for determining the irrevocableconversion rates for the euro at the startingdate of Stage Three.

The current ERM bilateral central rates ofthe currencies of the Member States which,on the first day of Stage Three, will adoptthe euro as their single currency, will beused in determining the irrevocableconversion rates for the euro. These ratesare consistent with economic fundamentalsand are compatible with sustainableconvergence among the Member Stateswhich will participate in the euro area. Thecentral banks of the Member States adoptingthe euro as their single currency will ensurethrough appropriate market techniques thaton 31 December 1998 the market exchange

rates, recorded according to the regularconcertation procedure used for calculatingthe daily exchange rates of the official ECU,are equal to the ERM bilateral central ratesas set forth in the attached parity grid.

The procedure agreed upon by all partiesto this Joint Communiqué will ensure thatthe adoption of the irrevocable conversionrates for the euro will by itself, as requiredby Article 109l (4) of the Treaty, notmodify the external value of the ECU,which will be replaced on a 1:1 basis by theeuro. The attached annex provides detailedinformation on this procedure. The finalofficial ECU exchange rates calculatedaccordingly and released on 31 December1998 will be proposed by the Commissionfor adoption by the Council on the first dayof Stage Three, i.e. on 1 January 1999, asthe irrevocable conversion rates for theeuro for the participating currencies.

In compliance with the legal framework forthe use of the euro, once the irrevocableconversion rate for the euro for eachparticipating currency has been adopted, itwill be the only rate which will be used forconversion either way between the euroand the national currency unit and also forconversions between national currencyunits.

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Table 9

ERM bilateral central rates to be used in determining the irrevocable conversion rates for the euro

DEM 100 = BEF/LUF ESP 100 = FRF 100 = IEP 1 = ITL 1000 = NLG 100 = ATS 100 = PTE 100 = FIM 100=

100 =

GERMANY:

DEM -

BELGIUM/

LUXEMBOURG:

BEF/LUF 2062.55

SPAIN:

ESP 8507.22 412.462

FRANCE:

FRF 335.386 16.2608 3.94237

IRELAND:

IEP 40.2676 1.95232 0.473335 12.0063

ITALY:

ITL 99000.2 4799.90 1163.72 29518.3 2458.56

NETHERLANDS:

NLG 112.674 5.46285 1.32445 33.5953 2.79812 1.13812

AUSTRIA:

ATS 703.552 34.1108 8.27006 209.774 17.4719 7.10657 624.415

PORTUGAL:

PTE 10250.5 496.984 120.492 3056.34 254.560 103.541 9097.53 1456.97

FINLAND:

FIM 304.001 14.7391 3.57345 90.6420 7.54951 3.07071 269.806 43.2094 2.96571 -

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1 Why can only bilateral rates be announced?

Article 109l (4) of the Treaty provides thatthe rates at which the euro will besubstituted for the currencies participatingin the euro area will be adopted at the startof Stage Three of the Economic andMonetary Union, i.e. on 1 January 1999.The adoption of the irrevocable conversionrates for the euro shall by itself not modifythe external value of the official ECU.Likewise, Article 2 of the Council Regulationof 17 June 1997 on certain provisionsrelating to the introduction of the eurostipulates that every reference in a legalinstrument to the official ECU shall bereplaced by a reference to the euro at arate of one euro to one ECU. Therefore,the irrevocable conversion rates for theeuro have to be identical to the value of

the official ECU expressed in units of theparticipating currencies on 31 December1998.

Since the ECU is a currency basket, whichincludes the Danish krone, the Greekdrachma and the pound sterling,18 it is notpossible to announce before the end of1998 the irrevocable conversion rates atwhich the euro shall be substituted for theparticipating currencies. However, it ispossible to announce the bilateral rates ofthe currencies participating in the euroarea which wi l l be used on31 December 1998 in computing theexchange rates of the official ECU and thusin computing the irrevocable euroconversion rates for these currencies.

2 Bilateral rates which will be used in determining the irrevocableconversion rates for the euro

the Joint Communiqué contains those rates.In order to avoid minor arithmeticalinconsistencies stemming from inversecalculations, it only includes one bilateral ratefor each pair of currencies, which will berelevant for the procedure to be followed on31 December 1998, as described below.

3 Calculation of the exchange rates of the official ECUon 31 December 1998

To calculate the exchange rates of theofficial ECU on 31 December 1998, theregular daily concertation procedure willbe used. According to this procedure, thecentral banks of the Member Statescommunicate the representative exchangerate of their respective currency against theUS dollar.

Three steps can be identified.

Step 1: Determination of the EU currencies’concertation exchange rates against the USdollar

At 11.30 a.m. (CET), the EU central banks,including those with currencies which arenot components of the ECU basket, provide

18 ECU basket currencies of Member States notparticipating in the euro area.

For currencies participating in the euro area,the current ERM bilateral central rates will beused in calculating the final official ECUexchange rates which will be adopted by theCouncil as the irrevocable conversion ratesfor the euro on the first day of Stage Three,i.e. on 1 January 1999. The table attached to

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to each other in the context of ateleconference, the US dollar exchangerate for their respective currencies. Theseexchange rates are recorded as discretevalues lying within the market bid-askspreads. While, as a rule, the discretevalues are equal to the mid-points of thebid-ask spreads, the EU central banks, as isallowed by the current concertationprocedure, will take into account the needto ascertain exchange rates expressed withsix significant digits, like for the pre-announced rates. The bilateral ratesbetween the euro area participatingcurrencies obtained by crossing19 therespective US dollar rates recorded by theEU central banks will be equal to the pre-announced ERM bilateral central rates, upto the sixth significant digit. The EU centralbanks participating in the euro area standready to ensure this equality, if necessary,through the use of appropriate markettechniques.

Step 2: Calculation of the exchange rate ofthe official ECU against the US dollar

The rates as recorded by the EU centralbanks are thereafter communicated by theNational Bank of Belg ium to theCommission, which uses them to calculatethe exchange rates of the official ECU. TheUSD/ECU exchange rate (expressed as1ECU = xUSD) is obtained by summing upthe US dollar equivalents of nationalcurrency amounts that compose the ECU.

Step 3: Calculation of the exchange rates ofthe official ECU against the EU currenciesparticipating in the euro area.

The official ECU exchange rates against theEU currencies are calculated by multiplyingthe USD/ECU exchange rate by theirrespective US dollar exchange rates. Thiscalculation is performed for all EU currencies,not only the ones which are componentsof the ECU basket.

These ECU exchange rates are rounded tothe sixth significant digit. Exactly the samemethod of calculation, including the roundingconvention, will be used in determining theirrevocable conversion rates for the eurofor the euro area currencies.

For illustrative purposes, the calculation ofthe official ECU exchange rates vis-à-vis allEU currencies on 31 December 1997 isshown below.

In compliance with the legal framework forthe use of the euro, once the irrevocableconversion rate for the euro for eachparticipating currency has been adopted, itwill be the only rate which will be used forconversion either way between the euroand the national currency unit and also forconversions between national currencyunits. Owing to rounding, the implicit bilateralrates which could be derived from theeuro conversion rates may not alwayscorrespond, up to the last (sixth) significantfigure, to the pre-announced ERM bilateralcentral rates referred to in this JointCommuniqué.

19 For example, FRF/DEM = FRF/USD : DEM/USD.

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Step 1 Step 2 Step 3

Amount of national USD exchange Equivalent in ECU exchange

currency units rate on dollars of rates

in the ECU basket 31 December 1997 national currency

(a) (b) amount (c) = (a):(b) (d) = (USD/ECU)*(b)

DEM 0.6242 1.7998 0.3487541 1.97632

BEF 3.301 36.92 0.0894095 40.7675

LUF 0.130 36.92 0.0035211 40.7675

NLG 0.2198 2.0172 0.1089629 2.22742

DKK 0.1976 6.8175 0.0289842 7.52797

GRD 1.440 282.59 0.0050957 312.039

ITL 151.8 1758.75 0.0863113 1942.03

ESP 6.885 151.59 0.0454186 167.388

PTE 1.393 183.06 0.0076095 202.137

FRF 1.332 5.9881 0.2224412 6.61214

GBP 0.08784 1.6561 0.1454718 @ 0.666755

IEP 0.008552 1.4304 0.0122328 @ 0.771961

USD/ECU 1.1042128*

FIM 5.4222 5.98726

ATS 12.59 13.9020

SEK 7.9082 8.73234

@ The dollar exchange rate for the GBP and IEP is the number of dollars per currency unit rather than the number of currency unitsper dollar. Column (c) is therefore calculated for each of these two currencies by multiplying the value in column (a) by that incolumn (b); and column (d) by dividing the dollar equivalent of the ECU (i.e. USD/ECU) by the rate in column (b).

* There is a difference of one unit (i.e. 1.1042128 instead of 1.1042127) in the last significant figure because the dollar equivalentsof national currency amounts are shown after rounding to the 7th decimal place, whereas an unrestricted number of digits is usedfor computation purposes.

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Glossary

Association of South-East Asian Nations (ASEAN): an international organisationestablished in 1967 which comprises Indonesia, Malaysia, the Philippines, Singapore, Thailand,since 1984 Brunei, since 1995 Vietnam and since 1997 Myanmar and Laos. Among the mainaims of ASEAN are the promotion of economic and social development in member countriesand economic co-operation and trade between members of ASEAN.

Bilateral central rate: the official exchange rate between any pair of ERM membercurrencies, around which the ERM fluctuation margins are defined.

Central credit register (CCR): information system designed to provide commercial creditinstitutions, central banks and other supervisory authorities with data regarding the indebtednessof firms and individuals vis-à-vis the whole banking system.

Central and Eastern European countries (CEECs): Community terminology used torefer to those countries of central and eastern Europe with which the European Community hasconcluded association treaties. These associated CEECs currently comprise Bulgaria, the CzechRepublic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, the Slovak Republic and Slovenia.In spring 1998 the Community launched the examination of the “acquis communautaire” with allCEECs while the accession negotiations have been opened only for the Czech Republic, Estonia,Hungary, Poland and Slovenia (and Cyprus).

Central securities depository (CSD): an entity which holds securities and which enablessecurities transactions to be processed by book entry. Physical securities may be immobilised bythe depository or securities may be dematerialised (i.e. so that they exist only as electronicrecords). In addition to safekeeping, a central securities depository may incorporatecomparison, clearing and settlement functions.

Collateral: assets pledged as a guarantee for the repayment of the short-term liquidity loanswhich credit institutions receive from the central banks, as well as assets received by centralbanks from credit institutions as part of repurchase operations.

Concertation procedure: framework within which central bank foreign exchange experts(from each EU Member State, Canada, Japan, Norway, Switzerland and the United States)participating in the Concertation Group exchange information about market developments. Theframework provides for regular daily telephone sessions and periodic meetings of central bankexperts.

Convergence criteria: criteria established in Article 109j (1) of the Treaty (anddeveloped further in Protocol No. 6). They relate both to economic performance with respectto price stability, government financial positions, exchange rates and long-term interest rates, aswell as to the compatibility of national legislation, including the statutes of NCBs, with the Treatyand the ESCB/ECB Statute. The reports produced under Article 109j (1) by the EuropeanCommission and the EMI examine the achievement of a high degree of sustainableconvergence by reference to the fulfilment by each Member State of these criteria as well as theabove compatibility.

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Convergence programmes: medium-term government plans and assumptions regardingthe development of key economic variables towards the achievement of the reference valuesindicated in the Treaty. Regarding budgetary positions, measures to consolidate fiscal balancesas well as underlying economic scenarios are highlighted. Convergence programmes normallycover the next three to four years, but are regularly updated during that time. They areexamined by the European Commission and the Monetary Committee. Their reportsserve as the basis for an assessment by the ECOFIN Council. After the start of Stage Three ofEconomic and Monetary Union, Member States with a derogation will continue to submitconvergence programmes, while countries which are members of the euro area will haveannual stability programmes, in accordance with the Stability and Growth Pact.

Correspondent banking: arrangement under which one bank provides payment and otherservices to another bank. Payments through correspondents are often executed throughreciprocal accounts (so-called nostro and loro accounts), to which standing credit lines may beattached. Correspondent banking services are primarily provided across international boundariesbut are also known as agency relationships in some domestic contexts. A loro account is theterm used by a correspondent to describe an account held on behalf of a foreign bank; theforeign bank would in turn regard this account as its nostro account.

Correspondent central banking model (CCBM): a facility for the cross-border use ofcollateral in ESCB credit operations. In the CCBM, national central banks would maintainsecurities accounts with each other. As a result, NCBs would be able to act as local custodiansfor each other.

Council (of the European Union): is made up of representatives of the governments ofthe Member States, normally the Ministers responsible for the matters under consideration(therefore often referred to as the Council of Ministers). The Council meeting in thecomposition of the Ministers of Finance and Economy is often referred to as the ECOFIN Council.In addition, the Council may meet in the composition of the Heads of State or of Government.See also European Council.

Debt ratio: the subject of one of the fiscal convergence criteria laid down in TreatyArticle 104c (2). It is defined as “the ratio of government debt to gross domestic product atcurrent market prices”, where government debt is defined in Protocol No. 5 (on the excessivedeficit procedure) as “total gross debt at nominal value outstanding at the end of the year andconsolidated between and within the sectors of general government”.

Deficit ratio: the subject of one of the fiscal convergence criteria named in TreatyArticle 104c (2). Defined as “the ratio of the planned or actual government deficit to grossdomestic product” at current market prices, where the government deficit is defined in ProtocolNo. 5 (on the excessive deficit procedure) as “net borrowing of the general government”.

Delivery versus payment system (or DVP, delivery against payment): a mechanismin a securities settlement system that ensures that the final transfer of one asset occurs ifand only if the final transfer of (an)other asset(s) occurs. Assets could include securities or otherfinancial instruments.

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EBA (ECU Banking Association, known as the Euro Banking Association sinceDecember 1997): interbank organisation created in 1985 with the support of Europeaninstitutions with the task of achieving three objectives: to promote the use of the ECU infinancial and commercial transactions; to manage and develop the ECU Clearing and SettlementSystem and to be a representative body and discussion forum for all matters related to the useof the ECU. Now developing a successor Euro Clearing and Settlement System to operate inStage Three of EMU.

ECB (European Central Bank): the ECB will have legal personality. It will ensure that thetasks conferred upon the ESCB are implemented either by its own activities pursuant to itsStatute or through the national central banks.

ECB Executive Board: the decision-making body of the ECB which will implementmonetary policy in accordance with the guidelines and decisions laid down by the ECBGoverning Council. It will be composed of the President, the Vice-President and two to fourother members, appointed from among persons of recognised standing and professionalexperience in monetary and banking matters by common accord of the governments of theMember States of the euro area at the level of the Heads of State or of Government, on arecommendation from the Council after it has consulted the European Parliament and theECB Governing Council.

ECB General Council: in addition to the ECB Governing Council and the ECBExecutive Board, the ECB’s third decision-making body. Composed of the ECB’s President,Vice-President and the governors of all EU national central banks. It will perform the tasksderiving from the situation in which not all EU Member States participate in the euro area rightfrom the start.

ECB Governing Council: composed of the members of the ECB Executive Board andthe governors of the national central banks of the countries participating in the euro area; itwill be the supreme decision-making body of the ECB which will adopt the guidelines and takethe decisions necessary to ensure the performance of the tasks entrusted to the ESCB underthe Treaty and the ESCB Statute.

ECOFIN: see Council (of the European Union).

Economic and Monetary Union (EMU): the Treaty describes the process of achievingeconomic and monetary union in the EU in three stages. Stage One of EMU started in July 1990and ended on 31 December 1993: it was mainly characterised by the dismantling of all internalbarriers to the free movement of capital within the EU. Stage Two of EMU began on 1 January1994. It provided, inter alia, for the establishment of the European Monetary Institute, theprohibition of monetary financing of and privileged access to financial institutions for the publicsector and the avoidance of excessive deficits. Stage Three will start on 1 January 1999, inaccordance with the decision pursuant to Article 109j (4), with the transfer of monetarycompetence to the ESCB and the creation of the euro.

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ECU (European Currency Unit): in its present definition (Council Regulation No. 3320/94 of 20 December 1994), the ECU is a basket made up of the sum of fixed amounts of twelveout of the fifteen currencies of the Member States. Article 109g of the Treaty states that thiscomposition shall not be changed until the start of Stage Three. The value of the ECU iscalculated as a weighted average of the value of its component currencies. As official ECU, itserves, inter alia, as the numeraire of the ERM and as a reserve asset for central banks. OfficialECUs are created by the EMI through three-month swap operations against one-fifth of the USdollar and gold assets held by the fifteen EU central banks. Private ECUs are ECU-denominatedfinancial instruments (e.g. bank deposits or securities) which are based on contracts which, as arule, make reference to the official ECU. The “theoretical” value of the private ECU is defined onthe basis of the value of the individual components of the ECU basket. However, the use of theprivate ECU is different from that of the official ECU and in practice the market value of theprivate ECU may diverge from its “theoretical” basket value. The replacement of the privateECU by the euro at the rate of one to one is laid down in Article 2 of the Council Regulationon some provisions relating to the introduction of the euro (see (EC) No. 1103/97 of June1997).

EEA (European Economic Area) countries: the EU Member States and Iceland,Liechtenstein and Norway.

Effective (nominal/real) exchange rates: in their nominal version, effective exchangerates consist of a weighted average of various bilateral exchange rates. Real effective exchangerates are nominal effective exchange rates deflated by a weighted average of foreign prices orcosts relative to domestic ones. They are thus measures of a country’s price and costcompetitiveness. The choice of currencies and weights reflects the economic issue beinganalysed. The most commonly used measures of effective exchange rates employ trade weights.

Electronic money (e-money): an electronic store of monetary value on a technical devicethat is used for making payments to undertakings other than the issuing institution withoutnecessarily involving bank accounts in the transaction, but as a prepaid bearer instrument.

EMS (European Monetary System): established in 1979 in accordance with theResolution of the European Council on the establishment of the EMS and related matters of5 December 1978. The Agreement of 13 March 1979 between the central banks of theMember States of the European Economic Community lays down the operating procedures forthe EMS. The objective is to create closer monetary policy co-operation between Communitycountries leading to a zone of monetary stability in Europe. The main components of the EMSare: the ECU; the exchange rate and intervention mechanism (ERM); and various creditmechanisms.

EMU: see Economic and Monetary Union.

ERM (Exchange Rate Mechanism): the exchange rate and intervention mechanism of theEMS defines the exchange rate of participating currencies in terms of a central rate vis-à-vis theECU. These central rates are used to establish a grid of bilateral exchange rates betweenparticipating currencies. Exchange rates are allowed to fluctuate around bilateral centralrates within the ERM fluctuation margins. These margins have been set at ±15% since2 August 1993. Pursuant to a bilateral agreement between Germany and the Netherlands,fluctuation margins between the Deutsche Mark and the Dutch guilder are maintained at±2.25%. Adjustments of central rates are subject to mutual agreement between all countriesparticipating in the ERM (see also realignment).

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ERM II: successor exchange rate arrangement to the present ERM, which will provide theframework for exchange rate policy co-operation between the euro area and Member Statesnot participating in the euro area from the start of Stage Three. Membership will be voluntary;nevertheless, EU Member States with a derogation can be expected to join the mechanism. Thebasic principles and operational features were agreed at the Dublin European Council on13 and 14 December 1996. A European Council Resolution on the establishment of anexchange rate mechanism in the third stage of EMU was adopted at the Amsterdam summit on16 and 17 June 1997, and a draft agreement between the ECB and non-euro area NCBs hasbeen finalised for adoption by the ECB after its establishment.

ERM fluctuation margins: floor and ceiling of bilateral exchange rates, within which ERMcurrencies are allowed to fluctuate.

ESCB (European System of Central Banks): the ESCB is composed of the ECB and thenational central banks of the Member States. Its primary objective is to maintain price stability.Its basic tasks are to define and implement the monetary policy of the euro area, to hold andmanage the official reserves of the participating Member States and conduct foreign exchangeoperations and to promote the smooth operation of payment systems in the euro area. TheESCB also contributes to the smooth conduct of policies pursued by the competent authoritiesrelating to the prudential supervision of credit institutions and the stability of the financial system.

euro: the name of the European currency adopted by the European Council at its meetingin Madrid on 15 and 16 December 1995 and used instead of the generic term “ECU” used bythe Treaty to refer to the European Currency Unit.

euro area: area covering those Member States which have adopted the euro as the singlecurrency in accordance with the Treaty and in which a single monetary policy will beconducted under the responsibility of the decision-making bodies of the ECB (ECBGoverning Council; ECB General Council; ECB Executive Board).

European Commission: institution of the European Community which ensures theapplication of the provisions of the Treaty, takes initiatives for Community policies, proposesCommunity legislation and exercises powers in specific areas. In the economic policy area, theCommission recommends broad guidelines for the economic policies in the Community andreports to the Council on economic developments and policies. It monitors public financesand initiates the procedure on excessive deficits. It consists of twenty members and includestwo nationals from Germany, Spain, France, Italy and the United Kingdom, and one from each ofthe other Member States. EUROSTAT is the Directorate General of the Commissionresponsible for the production of Community statistics through the collection and systematicprocessing of data, produced mainly by the national authorities within the framework ofcomprehensive five-yearly Community statistical programmes.

European Council: provides the European Union with the necessary impetus for itsdevelopment and defines the general political guidelines thereof. It brings together the Heads ofState or of Government of the Member States and the President of the EuropeanCommission. See also Council.

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European Parliament: consists of 626 representatives of the citizens of the Member States.It is a part of the legislative process, though with different prerogatives according to theprocedures through which EU law is to be enacted. In the framework of EMU, the Parliamenthas mainly consultative powers. However, the Treaty establishes certain procedures fordemocratic accountability of the ECB to the Parliament (presentation of the annual report,general debate on the monetary policy, hearings to the competent parliamentary committees).

Fiduciary money: refers to banknotes and coins. These means of payment are termed“fiduciary” because their value is based on the confidence and trust of the holder in the issuer ofthe currency.

Fixed rate tender: a tender procedure where the interest rate is specified in advance by thecentral bank and participating counterparties bid the amount of money they want to transact atthe fixed interest rate. See also variable rate tender.

Foreign exchange swap: simultaneous spot and forward transactions of one currency againstanother. The ESCB will execute open market monetary policy operations in the form offoreign exchange swaps where the NCBs (or the ECB) buy (or sell) euro spot against aforeign currency and at the same time sell (or buy) it back forward. This instrument will also beused in the management of the ESCB’s foreign reserves.

Funds transfer system (FTS): a formal arrangement, based on private contract or statutelaw, with multiple membership, common rules and standardised arrangements for thetransmission and the settlement of money obligations arising between the members.

Harmonised Index of Consumer Prices (HICP): Protocol No. 6 on the convergencecriteria referred to in Article 109j (1) of the Treaty establishing the European Communityrequires price convergence to be measured by means of the consumer price index on acomparable basis, taking into account differences in national definitions. Although currentconsumer price statistics in the Member States are largely based on similar principles, there areconsiderable differences of detail and these affect the comparability of the national results. Inorder to fulfil the Treaty requirement the European Commission (EUROSTAT), in closeliaison with the National Statistical Institutes and the EMI, has carried out conceptual work onthe harmonisation of consumer price statistics. The Harmonised Index of Consumer Prices isthe outcome of these efforts.

Harmonised long-term interest rates: Protocol No. 6 on the convergence criteriareferred to in Article 109j (1) of the Treaty establishing the European Community requiresinterest rate convergence to be measured by means of interest rates on long-term governmentbonds or comparable government securities, taking into account differences in nationaldefinitions. In order to fulfil the Treaty requirement the EMI has carried out conceptual work onthe harmonisation of long-term interest rate statistics and regularly collects the data fromnational central banks, on behalf of the European Commission (EUROSTAT). Fullyharmonised data are used in this report.

Interbank funds transfer system (IFTS): a funds transfer system in which most (orall) participants are credit institutions.

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Implementation package: in July 1996 the EMI Council approved the “Statisticalrequirements for Stage Three of Monetary Union” (the “Implementation package”). This publiclyavailable working document sets out in detail the statistics which will be required by the ECB indefining and conducting the single monetary policy. While dealing principally with money andbanking and balance of payments statistics, it also covers other financial statistics, price and costand government finance statistics, and background economic statistics.

Interlinking mechanism: one of the components of the architecture of the TARGETsystem. The term Interlinking is used to designate the infrastructures and the procedures whichlink domestic RTGS systems in order to process cross-border payments within TARGET.

Intervention at the limits: compulsory intervention carried out by central banks, thecurrencies of which are respectively at the floor and ceiling of their ERM fluctuationmargins.

Intra-marginal intervention: intervention carried out by a central bank to influence theexchange rate of its currency within its ERM fluctuation margins.

Large-value payments: payments, generally of very large amounts, which are mainlyexchanged between banks or between participants in the financial markets and usually requireurgent and timely settlement.

Links between securities settlement systems: the procedure between two securitiessettlement systems for the cross-border transfer of securities through a book-entry process(without physical transfer).

Loss-sharing rule (or loss-sharing agreement): an agreement between participants in atransfer system or a clearing house arrangement regarding the allocation of any loss arising whenone or more participants fail to fulfil their obligation; the arrangement stipulates how the loss willbe shared among the parties concerned in the event the agreement is activated.

Monetary Committee: a consultative Community body, composed of two membersappointed by each Member State in their personal capacity (normally one from the governmentand one from the central bank) and two representatives appointed by the EuropeanCommission. It was created in 1958 on the basis of Article 105 of the EEC Treaty. In orderto promote co-ordination of the policies of Member States to the full extent needed for thefunctioning of the internal market, Article 109c of the Treaty lists a set of areas where theMonetary Committee contributes to the preparation of the work of the Council. At the startof Stage Three (Economic and Monetary Union) the Monetary Committee will bedissolved and an Economic and Financial Committee will be created instead.

Monitoring Group: a group composed of foreign exchange experts from the EU centralbanks who review on a regular basis current economic and monetary developments and policiesin order to assess the functioning of the EMS.

Multi-purpose prepaid card: a prepaid card which can be used at the outlets of severalservice providers for a wide range of purposes, which has the potential to be used on a nationalor international scale but may sometimes be restricted to a certain area. Also known as anelectronic purse.

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Net settlement system (NSS): a funds transfer system, the settlement operations ofwhich are completed on a bilateral or multilateral net basis.

Quick tender: a tender procedure to be used by the ESCB for fine-tuning operations whenit is deemed desirable to have a rapid impact on the liquidity situation in the market. Quicktenders are executed within a time frame of one hour and are restricted to a limited set ofcounterparties.

Realignment: change in the ECU central rate and bilateral central rates of one orseveral currencies participating in the ERM.

Re-denomination of securities: the denomination of a security is the currency in which thepar value of the security is expressed (in most cases, the face value of a certificate). Re-denomination refers to a procedure through which the original denomination of a security,issued in national currency, is changed into the euro at the irrevocably fixed conversion rate.

Reference period: time intervals specified in Article 104c (2a) of the Treaty and inProtocol No. 6 on the convergence criteria for examining progress towards convergence.

Reference value: Protocol No. 5 of the Treaty on the excessive deficit procedure setsexplicit reference values for the deficit ratio (3% of GDP) and the debt ratio (60% of GDP),whereas Protocol No. 6 on the convergence criteria specifies the methodology for thecomputation of the reference values relevant for the examination of price and long-term interestrate convergence.

Remote access to an IFTS: the facility for a credit institution established in one country(“home country”) to become a direct participant in an interbank funds transfer system(IFTS) established in another country (“host country”) and, for that purpose, to have asettlement account in its own name with the central bank in the host country, if necessary,without having established a branch in the host country.

Reverse transaction: an operation whereby the central bank buys or sells assets under arepurchase agreement or conducts credit operations against collateral.

RTGS (real-time gross settlement) system: a settlement system in which processing andsettlement take place on an order-by-order basis (without netting) in real time (continuously).See also TARGET system.

Scriptural money: all money in book-entry form and therefore not circulating in the form ofbanknotes and coins.

Second Banking Co-ordination Directive: adopted on 15 December 1989 (89/646/EEC), which deals with the co-ordination of laws, regulations and administrative provisionsrelating to the taking-up and pursuit of the business of EU-based credit institutions. It amendsthe First Banking Co-ordination Directive adopted in 1977 (77/780/EEC).

Securities settlement system: a system which permits the transfer of securities either freeof payment or against payment.

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Settlement agent: an institution that manages the settlement process (e.g. the determinationof settlement positions, monitoring the exchange of payments, etc.) for transfer systems orother arrangements that require settlement.

Settlement risk: general term used to designate the risk that settlement in a transfer systemwill not take place as expected. This risk may comprise both credit and liquidity risk.

Standard tender: a tender procedure to be used by the ESCB in its regular open marketoperations or for the issuance of debt certificates. Standard tenders are carried out within atime frame of 24 hours. All counterparties fulfilling the general eligibility criteria are entitled tosubmit bids in standard tenders.

TARGET (Trans-European Automated Real-time Gross settlement ExpressTransfer) system: a payment system consisting of one real-time gross settlement (RTGS)system in each of the Member States participating in the euro area at the start of Stage Threeof Economic and Monetary Union. The national RTGS systems will be interconnectedthrough the Interlinking mechanism so as to allow same-day cross-border transfersthroughout the euro area. RTGS systems of non-euro area Member States may also beconnected to TARGET, provided that they are able to process euro.

Treaty: refers to the Treaty establishing the European Community. The Treaty was signed inRome on 25 March 1957 and entered into force on 1 January 1958. It established the EuropeanEconomic Community (EEC) and was often referred to as the “Treaty of Rome”. The Treaty onEuropean Union was signed in Maastricht (therefore often referred to as the “MaastrichtTreaty”) on 7 February 1992 and entered into force on 1 November 1993. It amended theEEC Treaty, which is now referred to as the Treaty establishing the European Community. TheTreaty on European Union will be amended by the “Amsterdam Treaty”, which was signed inAmsterdam on 2 October 1997 and is in the process of being ratified.

Variable rate tender: a tender procedure whereby the counterparties bid both the amountof money they want to transact with the central bank and the interest rate at which they want toenter into the transaction. See also fixed rate tender.

VSTF (Very Short-Term Financing): an EMS credit facility between central banks forfinancing interventions in ERM currencies.

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20 Dates of announcement of monetary measures.

Chronology of monetary measures taken in the EUin 199720

2 January The Oesterreichische Nationalbank starts conducting the regular weeklytender with a 14-day instead of a 7-day maturity and also introducessome changes in the structure of the refinancing lines.

13 January The Banco de Portugal lowers its repo rate by 0.2 percentage point to6.5%.

16 January The Banco de España reduces its official 10-day repurchase rate by0.25 percentage point to 6.0%.

21 January The Banca d’Italia reduces its discount and fixed term advances (orlombard) rates by 0.75 percentage point to 6.75% and 8.25%respectively.

30 January The Banque de France lowers its intervention rate by 0.05 percentagepoint to 3.1%.

12 February The Bank of Greece starts conducting regular weekly tender operationsin the form of interest rate tenders (American auction) or volumetenders for the collection of deposits from credit institutions and forsales/purchases of securities with a repurchase/resale agreement, bothwith a 14-day maturity. The first variable rate tender results in aweighted average allotment rate of 12.14%.

13 February The Banque de France announces that it will exempt from minimumreserve requirements all liabilities vis-à-vis non-banks which are related tosecurities repurchase transactions with a maturity of up to one year.

14 February The Bank of Greece lowers its discount and lombard rates by1 percentage point to 15.5% and 20.0% respectively, and the overnightintervention rate by 0.5 percentage point to 11.9%.

19 February The Bank of Greece’s weekly tender for 14-day deposits results in alowering of the weighted average allotment rate by 0.19 percentagepoint to 11.95%.

27 February De Nederlandsche Bank raises the rate on special advances by0.2 percentage point to 2.7%.

3 March The Bank of England introduces new daily intervention operations inorder to set official interest rates and to supply liquidity to the clearingbanks. These operations are extended to include gilt repo operationsand other types of eligible debt instruments, as well as a broader rangeof counterparties, by including banks (other than discount houses) andsecurities firms.

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10 March De Nederlandsche Bank raises the rate on advances by 0.5 percentagepoint to 2.5% and the rate on special advances by 0.2 percentage pointto 2.9%.

14 March The Banco de España reduces its 10-day repurchase rate by0.25 percentage point to 5.75%.

28 March The Bank of Greece introduces an (overnight) deposit facility. Depositsup to a global ceiling of GRD 300 billion are remunerated at a rate of11.9%, the remainder at 9.9%. The global ceiling is allocated amongcredit institutions on the basis of domestic market shares.

2 April The Bank of Greece conducts the weekly tender for 14-day deposits at afixed rate of 11.9%, which implies a reduction of 0.05 percentage point.

11 April The Banco de Portugal reduces its repo rate by 0.2 percentage point to6.3%, its liquidity absorption rate by 0.4 percentage point to 5.8% andits overnight credit facility rate by 0.5 percentage point to 7.8%.

15 April The Banco de España lowers its 10-day repurchase rate by0.25 percentage point to 5.5%.

28 April The Banco de España starts accepting pledging as a complement to itsrepo operations. Eligible assets for pledging are Banco de Españacertificates, public and private fixed income assets and non-bank shares.

1 May Danmarks Nationalbank abolishes the limits (which were introduced in1992) on the remuneration of the current account deposits thatmonetary policy counterparties maintain with the central bank.The Central Bank of Ireland raises its short-term lending facility rate by0.5 percentage point to 6.75%.

6 May The Bank of England announces an increase in the repo rate by0.25 percentage point to 6.25%. The Chancellor of the Exchequerannounces that the Bank of England has been granted operationalresponsibility for setting interest rates. Operational decisions will bemade by a new Monetary Policy Committee comprising the Governor,two Deputy Governors and six other members.

9 May The Banco de Portugal reduces its repo rate by 0.3 percentage point to6.0%, its liquidity absorption rate by 0.1 percentage point to 5.7% andits overnight credit facility rate by 0.1 percentage point to 7.7%.

12 May The Bank of Greece lowers its discount, lombard and overdraft rates by1 percentage point to 14.5%, 19.0% and 24.0% respectively.

16 May The Banco de España lowers its 10-day repurchase rate by0.25 percentage point to 5.25%.

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23 May De Nederlandsche Bank changes its monetary policy instruments: theaveraging facility is transferred from the advance facility to thecompulsory but remunerated cash reserve at the central bank, thevolume of which is set in advance for a period of four or five weeks; themaximum borrowing per bank under the advance facility changes fromaverage amounts over three months to fixed amounts with maturities ofat least one month and at most three months; the name of the advancefacility is changed to fixed advance facility, while the rate remainsunchanged at 2.5%; a marginal lending facility is introduced, the rate ofwhich is set at 4.5%; and the rate on special advances remains unchangedat 2.9%.

6 June The Bank of England raises the repo rate by 0.25 percentage point to6.5%.

27 June The Banca d’Italia reduces its discount and fixed term advances (orlombard) rates by 0.5 percentage point to 6.25% and 7.75%respectively. Furthermore, the remuneration of required reserves islowered from 5.5 to 4.5%.

10 July The Bank of England raises the repo rate by 0.25 percentage point to6.75%.

11 July De Nederlandsche Bank raises the rate on special advances by0.1 percentage point to 3.0%.The Banco de Portugal reduces its repo rate, its liquidity absorption rateand its overnight credit facility rate by 0.3 percentage point to 5.7%,5.4% and 7.4% respectively.

21 July The Banco de Portugal starts to accept private debt instruments ascollateral in its open market operations, provided that these meet certaincriteria.

24 July The Bank of Greece lowers both its deposit facility rates (basic and floorrates) by 0.3 percentage point to 11.6% and 9.6% respectively.

7 August The Bank of England raises its repo rate by 0.25 percentage point to7.0%.

14 August The Bank of Greece reduces its deposit facility rate (basic rate) by0.3 percentage point to 11.3% with effect from 18 August.

18 August The Banco de Portugal reduces its repo rate, its liquidity absorption rateand its overnight credit facility rate by 0.2 percentage point to 5.5%,5.2% and 7.2% respectively.

15 September Suomen Pankki increases its tender rate by 0.25 percentage point to3.25%.

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3 October The Banco de España lowers its 10-day repurchase rate by0.25 percentage point to 5.0%.

7 October The Bank of Greece reduces its deposit facility rate (basic rate) by0.4 percentage point to 10.9%.

9 October The Banque Nationale de Belgique raises its central rate and its rate onordinary end-of-day advances by 0.3 percentage point to 3.3% and4.55% respectively, whereas the discount rate is raised by0.25 percentage point to 2.75%.Danmarks Nationalbank raises its 14-day certificates of deposit rate andits discount rate by 0.25 percentage point to 3.75% and 3.5%respectively.The Deutsche Bundesbank announces that the next two securitiesrepurchase agreements (on 15 and 22 October) will be offered at afixed rate of 3.3% (an increase of 0.3 percentage point).The Banque de France raises its intervention rate by 0.2 percentage pointto 3.3%.De Nederlandsche Bank raises the rate on special advances by0.3 percentage point to 3.3% and the rate on fixed advances by0.25 percentage point to 2.75%.The Oesterreichische Nationalbank announces an increase in its repo rateof 0.2 percentage point to 3.2%.

24 October The Central Bank of Ireland announces that it will introduce averagingprovisions into its reserve requirements. In order to maximise the use ofthese averaging provisions, it will conduct weekly repo operations bytender with a fixed or variable rate and a two-week duration, beginningon 20 November.

31 October The Bank of Greece introduces a daily surcharge of 0.4% to apply - inaddition to the annual overdraft facility rate of 24% - to furtherincrements in the debit balances on banks’ current accounts with thecentral bank.

3 November Suomen Pankki reduces the maturity of its money market tenders fromone month to two weeks. The normal settlement day for these tenderswill be the banking day following the trade day. The maturity of theliquidity credit is reduced from seven days to one day. The limits on theamount of liquidity advanced under the marginal lending facility areabolished.

6 November The Bank of England raises its repo rate by 0.25 percentage point to7.25%.

18 November The Banco de Portugal reduces its repo rate by 0.2 percentage point to5.3%, and its liquidity absorption rate and its overnight credit facility rateby 0.3 percentage point to 4.9% and 6.9% respectively.

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20 November The Central Bank of Ireland starts conducting weekly tender operationswith a two-week maturity. The first repo operation is conducted at afixed rate of 6.19%.

11 December Sveriges Riksbank raises its repo rate by 0.25 percentage point to 4.35%,with effect from 16 December.

15 December The Banco de España lowers its 10-day repurchase rate by0.25 percentage point to 4.75%.

18 December The Deutsche Bundesbank sets the target range for M3 growth in 1998at 3-6%, compared with 3.5-6.5% in 1997.

23 December The Banca d’Italia lowers its discount and fixed term advances (orlombard) rates by 0.75 percentage point to 5.5% and 7.0% respectively.

29 December The Bank of Greece reduces from 0.4 to 0.2% the daily surcharge toapply - in addition to the annual overdraft facility rate of 24% - to furtherincrements in the debit balances on banks’ current accounts with thecentral bank.

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Other EMI publications21

“The single monetary policy in Stage Three - Specification of the operational framework”,January 1997.

“Payment systems in the European Union - Addendum incorporating 1995 figures” (“Blue Book”addendum), January 1997.

“The single monetary policy in Stage Three - Elements of the monetary policy strategy of theESCB”, February 1997.

“EU securities settlement systems - Issues related to Stage Three of EMU”, February 1997.

“Differences between national changeover scenarios and the potential need for harmonisedaction: Common policy messages”, March 1997.

“Developments in EU payment systems in 1996”, March 1997.22

“Recent developments in the use of the private ECU: statistical survey”, April 1997.23

“European money and banking statistical methods 1996”, April 1997.

“Annual Report 1996”, April 1997.

“Common market standards for money market and foreign exchange transactions: Updatedpolicy messages”, July 1997.

“Selection and further development of the euro banknote designs”, July 1997.

“The single monetary policy in Stage Three: General documentation on ESCB monetary policyinstruments and procedures”, September 1997.

“The European Monetary Institute”, September 1997.

“Sponsoring by the ESCB of an overnight reference interest rate in Stage Three of EMU”,September 1997.

“Second progress report on the TARGET project”, September 1997.

“Provisional list of Monetary Financial Institutions as at December 1996”, September 1997.

“Legal convergence in the Member States of the European Union - As at August 1997”,October 1997.

21 Since the beginning of 1997.22 A report relating to developments in 1995 was released in March 1996.23 The first edition of this annual review was published in February 1991.

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“Addendum to the provisional list of Monetary Financial Institutions. Money market funds as atDecember 1996”, December 1997.

“European Union Balance of Payments (Capital and Financial Account) Statistical Methods”,January 1998.

“Payment systems in the European Union - Addendum incorporating 1996 figures” (“Blue Book”addendum), January 1998.

“Standards for the use of Securities Settlement Systems in ESCB credit operations”,January 1998.

“Final List of Monetary Financial Institutions”, March 1998.

“Convergence Report - Report required by Article 109j of the Treaty establishing the EuropeanCommunity”, March 1998.

“List of Monetary Financial Institutions - As at December 1997”, April 1998.

“Money and Banking Statistics Sector Manual - Guidance for the statistical classification ofcustomers”, April 1998.

“Money and Banking Statistics Compilation Guide - Guidance provided to NCBs for thecompilation of money and banking statistics for submission to the ECB”, April 1998.24

“TARGET information brochure”, May 1998

EMI’s Web site: In January 1998 the EMI established a presence on the Internet’s World WideWeb in order to facilitate the EMI’s provision of information to the general public. The EMI’sWeb site (http://www.ecb.int) provides access to the texts of recent speeches and reportspublished by the EMI.

24 Addressed to NCBs; available for information to other interested parties.