monetary policy and the economy q3/04fa2d0969-1171-43dd-bf8a-ca3969f7be8… · quarterly review of...

Monetary Policy & the Economy

Quarterly Review of Economic Policy

O e s t e r r e i c h i s c h e Nat i ona l b a n k

E u r o s y s t e m

√

Q3/04

The OeNB�s quarterly publication Monetary Policy & the Economy (Geldpolitik &Wirtschaft)provides analyses of cyclical developments, macroeconomic forecasts, studies on centralbanking and economic policy topics as well as research findings from macroeconomic work-shops and conferences organized by the OeNB.

Editorial board:Josef Christl, Peter Mooslechner, Ernest Gnan, Eduard Hochreiter, Doris Ritzberger-Gru‹nwald,Gu‹nther Thonabauer, Michael Wu‹rz

Editors in chief:Peter Mooslechner, Ernest Gnan

Coordinator:Manfred Fluch

Editing:Oesterreichische Nationalbank, Economic Analysis Division

Translations:Dagmar Dichtl, Alexandra Edwards, Michaela Meth, Irene Mu‹hldorf, Ingeborg Schuch, Susanne Steinacher

Technical production:Peter Buchegger (design)OeNB Printing Office (layout, typesetting, printing and production)

Inquiries:Oesterreichische Nationalbank, Secretariat of the Governing Board and Public Relations1090 Vienna, Otto-Wagner-Platz 3Postal address: PO Box 61, 1011 Vienna, AustriaPhone: (+43-1) 40420-6666Fax: (+43-1) 40420-6696E-mail: [email protected]: www.oenb.at

Orders/address management:Oesterreichische Nationalbank, Documentation Management and Communications Services1090 Vienna, Otto-Wagner-Platz 3Phone: (+43-1) 40420-2345Fax: (+43-1) 40420-2398E-mail: [email protected]: www.oenb.at

Imprint:Publisher and editor:Oesterreichische Nationalbank1090 Vienna, Otto-Wagner-Platz 3Gu‹nther Thonabauer, Secretariat of the Governing Board and Public RelationsInternet: www.oenb.atPrinted by: Oesterreichische Nationalbank, 1090 Vienna' Oesterreichische Nationalbank 2004All rights reserved.May be reproduced for noncommercial and educational purposes with appropriate credit.

DVR 0031577

Analyses

Economic Recovery in the Euro Area and in Austria in a Dynamic GlobalEconomic Environment 6Antje Hildebrandt, Martin Schneider, Maria Antoinette Silgoner

Measures to Improve the Efficiency of the Operational Framework for Monetary Policy 22Michael Pfeiffer

Expansionary Fiscal Consolidations? An Appraisal of the Literature on Non-KeynesianEffects of Fiscal Policy and a Case Study for Austria 34Doris Prammer

The Draft Treaty Establishing a Constitution for Europe — Institutional Aspects ofMonetary Union 53Isabella Lindner, Paul Schmidt

Central and Eastern Europe — The Growth Market for Austrian Banks 63Peter Breyer

Highlights

�60 Years of Bretton Woods� — A Summary of the Bretton Woods Conference 90Christian Just, Franz Nauschnigg

Notes

Abbreviations 98Legend 100List of Studies Published in Monetary Policy & the Economy 101Periodical Publications of the Oesterreichische Nationalbank 103Addresses of the Oesterreichische Nationalbank 105

Opinions expressed by the authors of Studies do not necessarily reflect the official viewpointof the OeNB.

Monetary Policy & the Economy Q3/04 3�

Contents

Analyses

The world economic recovery is continuing at a slightly more subdued pace. In the U.S.A., weaker con-sumer spending contributed to a slowdown in growth momentum. At the end of June 2004, the FederalReserve abandoned its low interest rate policy and has since increased base rates by 50 basis points. InAsia, Japan�s economy is back on the road to recovery and China�s and Southeast Asia�s high growth ratesare by and large still on course.

Economic recovery in the euro area continued, albeit with marked divergences between countries.Growth is currently being fueled by external demand, in particular. The latest increase in crude oil pricestriggered a rise in inflation. The ECB�s projections paint a relatively upbeat picture of anticipated GDPgrowth. Although the outlook for price stability has deteriorated in the current climate of higher crudeprices, in the medium term the price stability target will most probably be met.

In Central and Eastern Europe, the economy continues to grow at a more dynamic pace than in theformer EU-15. The new EU Member States countries are now endeavoring to implement the next stepof integration — the introduction of the euro.

1 Slowdown in RobustWorld Economic Growth

1.1 U.S.A.: Fed Ends Low InterestRate Period at the End of June

Whereas U.S. economic growth in thefirst quarter of 2004 accelerated to4.5% (annualized on the previousquarter), it slowed to 2.8% in the sec-ond quarter. In particular, weakerconsumer spending (+1.6%, com-pared with +4.1% in the previousquarter), primarily attributable tothe steep rise in energy prices and toreduced automotive sales, and a sharpdeterioration in net exports contrib-uted to this decline in growth. By con-trast, private real estate investmentand a sharp increase in corporate in-vestment made a key contribution togrowth. The rise in public expendi-ture slowed down.

Although growth in the secondquarter of 2004 should not necessarilybe interpreted as entailing a trend re-versal, it could signify temporary slug-gishness. The latest data are contradic-tory: since mid-2003 the PurchasingManagers� index compiled by the In-stitute for Supply Management ISMhas outperformed its 10-year averageand has been well in excess of the50% mark, signaling growing goodsproduction. However, the index inAugust slipped from 62% to 59%:order intake and output were equally

responsible. Recent data for industrialoutput and private residential con-struction were fairly positive. By con-trast, the U.S. index of leading indica-tors suggests only moderate real GDPgrowth. According to the ConferenceBoard, the index deteriorated in Julyfor the second successive month, fall-ing 0.3% to 116 points (sharpest de-cline since February 2003). However,it is too early to say that the index�suptrend (which has persisted sinceMarch 2003) has now ended. Theforecasts widely assume real GDPgrowth of about 4.5% in 2004, whichis likely to weaken to some 3.75% in2005 (e.g. OECD and ConsensusForecasts). The upturn in the U.S.labor market slowed in June and July.Although the jobless rate in July dip-ped from 5.6% to 5.5%, job growthin both months was well below ex-pectations. Productivity growth in thesecond quarter decelerated by 2.9%on the previous quarter (+3.7%)and unit labor costs advanced by1.9%.

Consumer price gains in July 2004slowed to 3% year on year. At 1.8%year on year, the rise in the core rateover the same period was smaller thanin June (1.9%).

At the end of June, the FederalReserve abandoned its low interestrate policy of maintaining the Fed

Antje Hildebrandt,Martin Schneider,Maria Antoinette Silgoner

6 Monetary Policy & the Economy Q3/04�

Economic Recoveryin the Euro Area and in Austria in a

Dynamic Global Economic Environment

funds rate at 1% and increased it by 25basis points for the first time in fouryears. Further hikes by 25 basis pointseach followed in August and Septem-ber, taking the rate to 1.75%. It isthe Fed�s declared intention to in-crease base rates gradually.

One of the biggest risks currentlyfor U.S. economic growth is thepotential persistence of high energyprices, which could act to squeezegrowth in the second half of the year.Another risk factor would be a re-newed surge in core inflation, whichcould prompt the Federal Reserve tohike interest rates more sharply thanoriginally planned, leading to a fur-ther curb on rate-sensitive spending.Similarly, an unexpectedly steep risein interest rates could rein in con-sumption and investment sharply,since private households are currentlyrelatively deep in debt and the savingratio is low. In addition, the highcurrent account and budget deficits(of almost 5% and approximately4.5% of GDP in 2004, respectively)represent risks in the medium andlong term.

1.2 World Economic Growth Drivenby Asia and the U.S.A.

For the last nine quarters in a row,Japan�s economy has been on the roadto recovery, although growth lost con-siderable momentum in the secondquarter of 2004. Real GDP grew by0.4% compared with the previousquarter. Thanks to demand from Asia(especially China), exports performedrobustly, albeit with some signs ofweakness. By contrast, corporate in-vestment — a key engine for growth— was unexpectedly poor. Althoughthe relative weakness of domesticdemand cloud the overall picturesomewhat, private consumption could

prove positive in the next quarter andcould keep the recovery on course.

Improved consumer sentiment iscurrently supported by a brighter la-bor market. Since early 2003 the job-less rate has fallen from 5.5% to 4.6%in mid-2004. In general, an increas-ingly broadly based recovery is ex-pected this year. The Bank of Japan(BoJ) is standing by its almost zero in-terest rate policy. For 2004, both theBoJ and the IMF count on prices tofall, which would underpin hopes offinally beating deflation in the nearfuture. Looking at fiscal policy, con-tinued high budgetary deficits andtotal debt levels are a problem.However, plans to consolidate publicsector budgets should be seen in apositive light.

Despite high oil prices, economicrecovery in Asia (excluding Japan)has also continued in 2004, thanks tostronger exports and more animateddomestic demand. In China, the gov-ernment corrected its growth forecastfor 2004 down to 7%, signaling amore balanced economic growth tar-get. Nonetheless, data for the firstsix months of 2004 indicate continuedhigh levels of growth and rising infla-tion. Despite a decline in bank lend-ing, demand for investment continuedto strengthen. Whereas inflows ofshort-term foreign capital to Asia (ex-cluding Japan) are scant, since early2001 foreign currency reserves havealmost doubled. In the second quarterof 2004, however, hardly any foreignexchange reserves (China�s excepted)were boosted any longer in a bid toprevent further risks (arising from thissurplus liquidity) for prices and theeconomy. Economic recovery shouldbe used to expedite financial marketreforms that are currently draggingin certain countries.


Economic Recovery

in the Euro Area and in Austria in a


2 Euro Area: ModestRecovery Continues

2.1 GDP Growth Largely Bolsteredby Exports

Eurostat�s initial forecast for real GDPgrowth in the euro area in the secondquarter of 2004 indicates that theeconomy is continuing to grow at astable pace: real GDP rose by 0.5%quarter on quarter (first quarter of2004: 0.6%) and by 2.0% year onyear (fourth quarter of 2003: 1.3%).By countries, Finland registered thehighest growth (1%) on the previousquarter, followed by France and Bel-gium with 0.8% each. In Greece andthe Netherlands, however, real GDPslipped by 0.6% and 0.2%, respec-tively. In addition, the subcomponentsreflect marked differences betweencountries. For instance, GermanGDP growth in the second quarterwas driven almost entirely by netexports whereas growth momentumin France was determined primarilyby domestic demand.

Trends in gross fixed capital for-mation continue to look volatile.

After rising by 0.8% in the fourthquarter of 2003 (compared with theprevious quarter), this componentcontracted by 0.2% in the first quar-ter of 2004. For the second quarterof 2004, growth came to 0.1%. How-ever, it should be noted that the con-traction in the first quarter of 2004was primarily the result of a steepdecline in construction investmentin Germany, which continued to fallsharply in the second quarter of2004 as well. In the remaining coun-tries of the euro area, by contrast, in-vestment expanded.

After posting extremely low quar-terly growth rates since early 2001,stronger private household consump-tion growth resumed in the first(+0.6%) and second (+0.3%) quar-ters of 2004. Tax cuts in some euroarea countries are likely to have con-tributed to this development, boost-ing disposable income more sharply.However, leading indicators for con-sumption suggest that uncertainty stillprevails. According to the EuropeanCommission, consumer confidence

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Economic Recovery



has been stagnating since February2004. In July, it stood at —14 points,or still somewhat below its long-termaverage of —12 points. The reasons forthis are twofold: first, the labor mar-ket scenario remains unfavorable and,second, discussions about reforminghealthcare and pensions systems arefueling uncertainty and dampeningconsumer demand.

After a paltry rise of 0.1% in thefirst quarter of 2004, public sectorconsumption grew by a stronger0.6% in the second quarter. In partic-ular, high budget deficits in Europeare likely to have contributed to lowgrowth in the first quarter of 2004.The latest data available indicate thatseven euro area countries will exceedthe 3% deficit ceiling in 2004. Tocounter this development, some ofthese countries are curtailing publicsector consumption.

The growth momentum of ex-ports — interrupted in the fourthquarter of 2003 — continued. How-ever, imports also kept surging. As

in the first quarter of 2004, the con-tribution of net exports to growthwas 0.4% in the second quarter. Thesizeable contribution of net exportsto growth is due to growth differen-tials between the euro area and itstrading partners. The leading indica-tors for economic growth havepainted a relatively fickle picture inthe last few months. Since early ormid-July, they have all signaled an up-trend, which has now leveled off inthe last few months or, in some cases,even reversed gradually. This couldsuggest that the economic recoveryhas yet to stabilize properly.

2.2 Industrial Output Positive, LaborMarket Scenario Remains Tight

Since mid-2003 the growth rates ofseasonally adjusted industrial outputin the euro area have been on a steady,albeit extremely volatile, uptrend. At2.7%, year-on-year growth in June2004 was lower than in May. Com-pared with the previous month, indus-trial output in June declined by 0.4%,

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Economic Recovery



having climbed four times in a rowsince February. In view of the dataseries�wildly fluctuating performance,a trend reversal cannot be inferredfrom the latest development.

At 9.0%, the seasonally adjustedjobless rate remained stable fromApril to July 2004. The tight labormarket scenario can also be seen inthe steadily falling share of publicsector jobs (since early 2001) as apercentage of the total working popu-lation in the euro area. Since the sec-ond quarter of 2002, employment hasbeen growing very little. In the firstquarter of 2004, the increase in serv-ice sector employment just managedto offset the job cutbacks seen in othersectors. In the same period, labor pro-ductivity rose by 1.1% after more orless stagnating in previous quarters.

2.3 Energy Prices Are FuelingInflation Again

In the middle of August 2004, nomi-nal crude oil prices reached levelsnot seen since oil prices were firstrecorded. In August 2004 a barrel ofcrude (Brent) exceeded the previous

year�s level by 44%. Despite theserecord prices, the situation still defiescomparison with the 1970s and 1980s,as real oil prices were significantlyhigher at that time and price riseswere considerably steeper, with oilprices tripling in short order. Forthe euro area, the increase in oil prices— primarily quoted in U.S. dollars —was dampened on the whole by thedevelopment of the euro�s exchangerate against the U.S. dollar. Thus therise in oil prices quoted in euro inAugust 2004 was only 30% higheron a year-on-year basis.

The increase in oil prices can beattributed to the global economicrecovery and, in particular, to dy-namic demand from fast-growingcountries such as China and India.These factors also led to a steep risein price of other commodities, partic-ularly metals. The increase in crudeoil prices was also attributable, aboveall, to geopolitical uncertainties andconcerns about output losses in keyoil producing countries, which havea direct impact on prices, especiallysince the short-term production ca-

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Economic Recovery



pacity has almost been exhausted.Against this backdrop, the oil futuresmarkets are not anticipating prices todrop markedly over the comingmonths.

In May 2004 the increase in crudeoil prices triggered a jump in theHICP inflation rate from 2.0% to2.5%. In the months since, the contri-bution of energy prices to inflation hasbeen 0.5 percentage point. The factthat the inflation rate dropped backdown to 2.3% in July is due aboveall to the decline in the price growthof unprocessed foods. Inflation re-mained at 2.3% in August.

Since March 2004, core inflation(increase in HICP excluding energyand unprocessed foods) has hoveredaround 2.1%, or 0.2 percentage pointabove the rates posted since mid-2003. There are two contributingfactors: first, tobacco and narcoticsprices, which currently enjoy inflationrates of 14% as a result of tax in-creases on tobacco in several coun-tries, and second, the implications ofthe health reforms in Germany andthe Netherlands, which are reflectedin the prices for healthcare servicesand in pharmaceutical products. Ex-cluding all these factors, core inflationis likely to just exceed 1.5%.

2.4 Lending Growth Continuesin the Euro Area

The growth of loans to the privatesector in the euro area has steadily ac-celerated since March 2004 (July:6.2%). In addition, public-sectorlending is continuing to grow dynam-ically. This means the trend (visiblesince early 2003) of a gradual upturnin lending is continuing. More ani-mated lending growth, moreover, isprimarily attributable to increasedlending for residential construction.By contrast, consumer loans and loans

to nonfinancial corporations are grow-ing only sluggishly. The reason for therise in home loans is likely to be thelow level of long-term interest rates.

Since its low in May 2004, growthin money supply M3 has picked up tosome extent (July: 5.5%). In the pe-riod May to July 2004, the three-month average of growth rates was5.2%. In addition, a shifting of portfo-lios into longer-term and higher-riskinvestment vehicles should be underway. This may be concluded fromthe ongoing tepid growth in othershort-term deposits and in marketablefinancing instruments. Demand de-posits recently notched up highergrowth rates. The powerful expansionrates of cash and demand depositsmoreover point to healthy demandfor extremely liquid funds, due, inparticular, to the current low levelof interest rates.

2.5 The Euro Exchange RateFluctuates between 1.20 and 1.24per U.S. Dollar

Since attaining a high of USD/EUR1.29 on February 17, 2004, theUSD/EUR exchange rate has failedto reach comparable peaks. Since theend of May, the exchange rate hasranged between USD/EUR 1.20 toUSD/EUR 1.24. This narrow bandhas seen fairly pronounced fluctua-tions, for which fresh U.S. economicdata (particularly, the unexpectedlyhigh U.S. current account deficit)were also to blame. In addition tothese data, short-term speculativebuying and selling were also respon-sible. Whereas the EUR/USD ex-change rate between May and July2004 rose by an average of 5.3%compared with the same three-monthperiod in 2003, the increase in thenominal effective euro exchange ratewas only1.2% during the same period.


Economic Recovery



Long-term interest rates in theeuro area recently fell and stood at4.2% at the end of August, or closeto their level at the start of the year.This means the steep rise from Marchto May did not continue. The interestrate gap (favoring the U.S. dollar)which opened up during this periodhas narrowed again dramatically. Forthe most part, the decline in long-term interest rates should be attribut-

able to higher oil prices, which haveled to a heightened demand for bondsbecause of gloomier growth prospectsand greater uncertainty. At the sametime, long-term inflationary expecta-tions determined from surveys havebarely changed. Likewise, geopoliticaluncertainties, which make investing insafe segments attractive, act to sup-port the bond markets.

Since the start of this year, marketprices have moved sideways, albeit in aslight downtrend. They were hit by in-terest rate hikes (both implementedand expected), higher oil prices andgeopolitical uncertainties. These fac-tors are likely to have overshadowedcompany news, which has been up-beat on the whole.

2.6 Increasing Optimism forEconomic Growth

The European Commission�s short-term economic forecast anticipatesquarterly growth rates of 0.3% to0.7% for the last two quarters of2004, respectively. The outlook forthe coming months therefore remainscautious. Positive driving forces suchas the robust growth of the externaleconomic environment and favorablefinancing conditions are currently be-ing checked by the delayed effects ofeuro appreciation and the rise in oilprices.

The ECB has for the first timepublicly released its economic ex-perts� half-yearly (summer and win-ter) projections. These projectionsshould be seen as supplementing thoseprepared in the intervening quartersin collaboration with the economistsat both the ECB and the nationalcentral banks of the Eurosystem.The projections are published in theform of ranges so as to account foruncertainty to which every forecastis exposed.

Compared with the Eurosystem�sprojections prepared in June, theECB�s projections released in earlySeptember paint a somewhat moreupbeat picture of predicted GDPgrowth. Accordingly, real GDP shouldgrow by 1.6% to 2.2% in 2004 andby 1.8% to 2.8% in 2005. Robustexport growth should increasinglyfeed through to domestic demandand should boost the momentum ofinvestment and consumption growth.

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Economic Recovery



The jobless rate should start to fall in2005. In an environment of increasedoil prices, however, predicted pricetrends are somewhat higher than theywere in the June projections. For2004, ECB experts now anticipatean increase in the HICP within a rangeof 2.1% to 2.3%, with energy pricesmaking a significant contribution toinflation. In 2005 moderate domesticcost pressures and limited increasesin import prices (owing to delayedeuro appreciation effects) should offera more favorable environment forprice stability.The expectation of bothmodest wage growth and dynamicproductivity growth will act to sup-port prices. The inflation rate couldtherefore range between 1.3% and2.3% in 2005.

3 Economic Growth inCentral and EasternEurope: Bulgaria,Croatia and Romaniain Focus

3.1 Private Consumption GrowthNears Long-Term Trend Level

In the first quarter of 2004, economicgrowth in the new Member States ofthe European Union in Central Europe(Poland, Slovenia, Slovakia, the CzechRepublic and Hungary) ranged from alow of 3.1% year on year in the CzechRepublic to a high of 6.9% year onyear in Poland. In the same period,growth levels of the current accessioncountries1 (Bulgaria, Croatia and Ro-mania) also lay within this range. Infull-year 2003, by contrast, economicgrowth in all the new Central Euro-pean Member States was slower thanin the current accession countries.

Looking at growth dynamics fromthe demand side, the new EU Mem-ber States interestingly enough showa pattern that may be broadly charac-terized by the following common fea-tures.

First, compared with previous pe-riods, private consumption growth inthe first quarter of 2004 adjusted to-ward the long-term trend level. This

means the Czech Republic and Hun-gary saw a downward correction fromquite a high growth level, partly as aresult of fiscal consolidation measures.In Poland and Slovenia, private con-sumption growth accelerated fromcomparatively low levels, while in Slo-vakia it resumed at a moderate paceafter last year�s contraction.

1 In view of the European Council�s unconditional decision of June 2004 to enter into accession negotiations withCroatia, in this contribution the term �accession country� refers not only to Bulgaria and Romania, but also toCroatia, regardless of the fact that accession negotiations have not yet been formally opened.

Table 1

Real GDP Growth in Eastern Europe

1999 2000 2001 2002 2003 Q4 2003 Q1 2004

annual change in %

Poland 4.0 4.0 1.0 1.4 3.8 4.7 6.9Slovenia 5.6 3.9 2.7 3.4 2.3 2.5 3.7Slovakia 1.5 2.0 3.8 4.4 4.2 4.7 5.5Czech Republic 0.5 3.2 2.6 1.5 3.1 3.3 3.1Hungary 4.2 5.2 3.8 3.5 2.9 3.6 4.2

Bulgaria 2.4 5.4 4.1 4.9 4.3 4.9 5.3Croatia �0.9 2.9 4.4 5.2 4.3 3.3 4.2Romania �1.2 2.1 5.7 5.0 4.9 4.6 6.1

Source: Eurostat, national statistical office, wiiw.


Economic Recovery



Second, compared with previousperiods, the first quarter of 2004saw growth of gross fixed capital for-mation accelerate or resume (in coun-tries like Poland and Slovakia, whichhad suffered from investment contrac-tion). This said, the level of invest-ment growth is still comparativelylow in Poland and Slovakia. In general,demand for capital goods was sup-ported by the dynamic trend in ex-ports and by improved profitabilityin industry due to the decrease in unitlabor costs or to their rise at a lowerrate than producer prices.

Third, taking private consumptionand fixed capital formation trends to-gether, the contribution of total do-mestic demand to GDP growth in-creased in all countries with the ex-ception of Hungary, where the invest-ment take-off did not fully offset theslowdown in consumption.

Fourth, real export growth acceler-ated in almost all countries under re-view, except in Poland and Slovakia,where very powerful growth lostsome speed. Fifth, the combinationof high (or higher) export growthand the sizeable weight of exports asa percentage of total real GDP (rang-ing from 63% in Slovenia to 93% inthe Czech Republic) meant that thecontribution of exports to GDPgrowth was greater than that of totaldomestic demand. The only exceptionin this respect was Poland with anexport weight of a mere 32%, whichreflects the fact that Poland is the larg-est economy among these countries.

However, not all features of theeconomic growth of the new EUMember States in the first quarter of2004 are common features: importgrowth and the contribution of net ex-ports to GDP growth developed alongquite different lines. In the CzechRepublic and in Slovenia, both higher

domestic demand and higher exportgrowth pushed up import growth tosuch an extent that the contributionof net exports to growth remainednegative. In both countries, however,the deterioration of real net exportswas not reflected in the balance ofpayments, which even improved andposted a modest surplus. Driven byhigher export growth, Hungary�s im-port growth also accelerated. Thecontribution of net exports to growthwas close to zero. Despite strongerdomestic demand, lower exportgrowth in Poland and Slovakia damp-ened import growth, as a result ofwhich the contribution of net exportsremained positive. Moreover, this de-velopment was reflected in an im-proved balance of payments.

Turning to the current accessioncountries, Bulgaria reveals a growthpattern that is, at first glance, similarto that of the Czech Republic. In bothcountries, the corrective slowdown inconsumption growth was more thanoffset by investment growth and the re-sulting increase in domestic demandfueling higher import growth and lead-ing to a deterioration in net exports.However, this development was farmore pronounced in Bulgaria, withbooming investment demand (on theback of improved corporate profitabil-ity and a steep rise in loan demand) anda highly negative contribution togrowth by net exports, which was re-flected in a further deterioration ofthe goods and services balance. In Cro-atia and Romania, by contrast, the mo-mentum of economic growth differedsignificantly from the common featuresoutlined above for the new EU Mem-ber States in Central Europe. In Roma-nia, domestic demand did not advance,as the deceleration in gross fixed capitalformation growth more than offset thefurther rise in consumption growth. At


Economic Recovery



the same time, export growth de-clined. This combination of weaker(or constant) domestic demand andlower export growth dampened im-port growth. However, this slowdownwas not enough to keep net exportsfrom deteriorating further, which wasreflected in the further worsening ofthe goods and services balance. In thefirst quarter of 2004 theCroatian econ-omy continued to grow strongly. Al-though gross fixed capital formationadvanced at a far slower pace than inthe previous year, its contribution toGDP growth was similarly high to thatof private consumption. By contrast,net exports made a negative contribu-tion to growth of approximately onepercentage point.

3.2 Heterogeneous Price TrendsPrice trends have been quite hetero-geneous in the Central and EasternEuropean countries under review.Among the new Member States inCentral Europe, inflation rates (asmeasured by year-on-year changes ofconsumer prices in the second quarterof 2004) ranged from 2.5% in theCzech Republic to 8.0% in Slovakia.Among the current accession coun-

tries, inflation rates (in the firstquarter of 2004) ranged from 1.9%in Croatia to 6.4% in Bulgaria and13.6% in Romania.

In Hungary, Poland and in theCzech Republic, annual inflation rosein the first and second quarters of2004, relative to average annual infla-tion in the comparable period a yearago. In addition to higher energy pri-ces, this was primarily due to hikesin indirect taxes (related to EU acces-sion) and to increased food prices,which were also partly accession-re-lated.

By contrast, inflation decreased inSlovakia, where relatively low coreinflation (below 3.0%) dragged downheadline inflation, which was dis-torted by hikes in administered pricesand by tax changes. Inflation alsodeclined in Slovenia on the back oflower unit labor cost increases, attrib-utable to the gradual deindexation ofthe economy. Although inflation inRomania was lowered steadily in re-cent quarters, in Bulgaria it rosesteeply this year as a result of taxchanges, a strong expansion in lendingand rising food prices (owing to lastyear�s drought).

Table 2

Inflation in Eastern Europe:

Annual Change in the Consumer Price Index (HICP)

2000 2001 2002 2003 Q4 2003 Q1 2004 Q2 2004

annual change in %

Poland 10.1 5.3 1.9 0.7 1.4 1.8 3.4Slovenia 8.9 8.6 7.5 5.7 5.0 3.7 3.8Slovakia 12.2 7.2 3.5 8.5 9.4 8.2 8.0Czech Republic 3.9 4.5 1.4 �0.1 0.8 2.0 2.5Hungary 10.0 9.1 5.2 4.7 5.4 6.8 7.4

Bulgaria 10.3 7.4 5.8 2.3 4.7 6.4 6.7Croatia1 6.4 5.0 1.7 1.8 1.8 1.9 xRomania1 45.7 34.5 22.5 15.3 14.8 13.6 x

Source: Eurostat, national statistical office, wiiw.1 CPI.


Economic Recovery



3.3 Some Improved Rating Assess-ments for Sovereign Long-TermForeign Currency Debt

Among the countries under review,Slovenia has the highest ratingawarded by Moody�s and Standard &Poor�s for sovereign long-term foreigncurrency debt. Whereas for the lastten months Moody�s did not make

any changes to its ratings of the coun-tries under review, Standard & Poor�shas upgraded the ratings of severalcountries (Bulgaria, Slovenia and Slo-vakia) in 2004. These upgrades reflectthe improved economic scenario aswell as a more prudent fiscal policyand, in the case of Bulgaria, the pros-pect of EU membership in 2007.

Economic Forecasts for Central and Eastern European Countries

The OeNB establishes bi-annual forecasts of the economic development in the Czech Republic, Hungaryand Poland as well as in Russia. These three new EU countries account for more than three quarters ofthe total GDP of all new Member States and, hence, are representative for this part of the EuropeanUnion.2

When euro area growth was decelerating sharply during recent years, private consumption was themajor pillar of growth in the three new EU countries under study, which implies that their GDP growthrates outperformed that of the euro area, partly even considerably. The current economic recovery in theeuro area will stimulate export growth in the Czech Republic and in Hungary, in addition to the growthcontribution by private consumption. In Poland, the current upswing in the euro area will maintain exportgrowth at the high level of 2003 (when it was supported by the strong corrective depreciation of the zlotyin 2002—03), despite the re-appreciation of the zloty. Correspondingly, according to the present forecast,GDP growth will accelerate in the Czech Republic, Hungary and Poland in 2004 and 2005 and remain ata high level in 2006.

It can be assumed that integration into the single market will further stimulate both exports andimports, even though the short-term (one- to two-year) economic effects of EU accession are nearlyimpossible to quantify precisely ex-ante. Exports will be supported further by decreases in nominal unitwage costs in industry. Gross fixed capital formation will be stronger, too, as a result of export demand,direct EU accession effects, higher profitability in industry and a cut in corporate income tax rates. Thehigh (or higher) contribution of exports and investment to GDP growth as well as — in Poland — higher

Table 3

Ratings for Sovereign Long-Term Foreign Currency Debt1

Currency Moody�s Standard & Poor�s

Previous rating Latest change Current rating Previous rating letzte A‹ nderung Current rating

PLN Baa1 12. 11. 02 A2 BBB 15. 05. 00 BBB+SIT A2 12. 11. 02 Aa3 A+ 13. 05. 04 AA—SKK Baa3 12. 11. 02 A3 BBB 02. 03. 04 BBB+CZK Baa1 12. 11. 02 A1 A 05. 11. 98 A—HUF A3 12. 11. 02 A1 BBB+ 19. 12. 00 A—

BGN B1 05. 06. 03 Ba2 BB+ 24. 06. 04 BBB—HRK 01. 27. 97 Baa3 01. 17. 97 BBB—ROL B2 17. 06. 02 Ba3 BB— 17. 09. 03 BB

Source: Bloomberg.1 After the cutoff date fot this analysis, Standard & Poor�s raised Romania�s foreign currency rating from BB to BB+.

2 These forecasts, which are established together with the Suomen Pankki, the central bank of Finland, in partic-ular with respect to Russia, are based on preliminary global growth projections and technical assumptions con-cerning the oil price and the euro/U.S. dollar exchange rate which are prepared by the ECB for the Eurosystem atthe start of the process of the Broad Macroeconomic Projection Exercise. These underlying assumptions are pivotalto the forecasts presented here, as these three new EU countries have a strong export orientation towards the euroarea, and Russia is one of the major global oil producing countries.


Economic Recovery



private consumption growth will lead to an increase in import growth, adding to the direct impact of EUaccession on imports.

This year, private consumption will grow at a lower rate than in the previous year in the CzechRepublic and, in particular, in Hungary, where it grew at an especially high pace in 2003. Among otherthings, hikes in indirect tax rates are dampening private consumption. This is also one of the reasons whythe acceleration of private consumption growth (from a relatively lower level) will be fairly limitedin Poland.

More generally, the economic environment expected for the next couple of years will provide a win-dow of opportunity for fiscal consolidation measures. However, the upcoming elections (2005 in Poland,2006 in Hungary and in the Czech Republic) might work against such measures. The moderate declinein GDP growth forecast for 2006 in Poland rests on the assumption of major fiscal consolidation stepstaking place after the elections.

The risks to this forecast for the three new EU countries are, firstly, considerably weaker euro areagrowth and, secondly, strong monetary policy reactions by these countries� central banks to preventsecond-round effects of the recent inflation pick-up, which so far has been primarily supply side driven(e.g. energy prices, food prices, hikes in indirect tax rates related to EU accession). This could weakengross fixed capital formation growth in particular. Partly linked to this risk is the risk of an acceleratedcurrency appreciation, which would weaken the price competitiveness of exports and enhance importgrowth. In this respect, however, the U.S. dollar/euro exchange rate also plays a role that should notbe underestimated, in particular in the case of Poland.

In Russia, high economic growth will continue in 2004, driven by high energy and other raw materialprices. However, the high growth rates are attributable also to prudent monetary and fiscal policies, thestructural reforms implemented in recent years, political stability and, generally, economic actors�increased optimism. Assuming that the oil price will decrease moderately from the current high levelsand that the ruble will further appreciate in real terms, the forecast for Russia sees robust, but moder-ately declining GDP growth for 2004 to 2006.

Economic growth should be supported by all demand components throughout the forecast period.Private consumption growth should remain healthy, benefiting from wage increases, hikes in pensionsand higher profits. While fiscal policy — supported by higher oil prices — has been designed to be morerestrictive this year, a decrease in the fiscal surplus is planned for 2005. Gross fixed capital formationgrowth rates will continue to be high, albeit on the basis of a low starting level. Only slowly declininginflation and continuous nominal upward pressure on the exchange rate will imply a further realappreciation of the ruble. Thus, in addition to increased import demand resulting from strong eco-nomic growth, increasingly fierce cost-triggered import competition will take place. While this mayalso accelerate restructuring at the corporate level, it will probably lead to a decrease in net exportsinitially.

One of the major risk factors to this forecast is the oil price. It will continue to be a major risk factorfor growth, as the dependence of the Russian economy on the extraction and export of energy has risenfurther recently. Irrespective of the price development, capacity constraints (e.g. with respect to oilpipelines) may imply declining net exports. A further risk factor would be an excessively quick realappreciation of the ruble. This would have negative effects on the competitiveness of industrial exports,

Table 4

Three New EU Member Countries and Russia

Real GDP forecast of September 2004

2001 2002 2003 20041 20051 20061

Year-on-year change at constant prices, %

Poland 1.0 1.4 3.8 5.8 5.4 4.1Czech Republic 2.6 1.5 3.1 3.8 3.9 3.9Hungary 3.8 3.5 2.9 3.6 3.7 3.8

Russia 5.1 4.7 7.3 6.9 5.9 4.8

Source: Eurostat, OeNB, Bank of Finland.1 Forecast value.


Economic Recovery



as the gain in competitiveness resulting from the sharp depreciation during the severe financial crisisof 1998 has already been eroded nearly completely. The dragging on or even escalation of the Yukosaffair could increase the uncertainty regarding the authorities� respect for property rights and cloudthe investment climate. Finally, the turbulences in the summer of 2004 have demonstrated the fragilityof the banking sector.

4 Austria: Boom in Ex-ports Remains Mainstayof Economic Recovery

In the first half of 2004, Austria�s eco-nomic performance was driven by robustgrowth in exports. The forecast forgrowth in the second half of the yearis also optimistic. For both the thirdand fourth quarters of 2004, the OeNBeconomic indicator predicts real GDPgrowth of 0.5% quarter-on-quarter.

For the year 2004, this means a growthrate of 1.7%.

The first half of 2004 brought asignificant change in the breakdownof GDP growth. Whereas growth in2003 was driven by domestic demand(in particular, extremely dynamic in-vestment), exports were the mainstayof the economy in the first half of2004.

In the second quarter of 2004, realexports of goods and services grew byan annualized 25% on a quarterlybasis. Although growth rates such asthese cannot be expected in the quar-ters to come, exports in 2004 willclearly be the mainspring of the eco-nomic expansion. In the first half of2004, imports grew on the back of ex-port growth, in particular. In the sec-ond half of the year, import growthshould be driven more strongly by do-mestic demand.

In 2003, the rise in GDP waslargely fueled by investment. Aftertwo years of decline, investment activ-ity picked up sharply in early 2003.This can be primarily attributed tothe need for replacement investment.Total investment contracted slightlyfrom a high level in the first half of2004. However, this dip also reflectsthe fact that economic recovery hasstill not stabilized completely. Theboom in exports should, however,also be reflected in investment duringthe rest of 2004.

Table 5

Breakdown of Real GDP Growth in Austria

2003 2004Q1 2004Q2 2003 2004Q1 2004Q2

Annual change (annual figures) andquarterly change (quarterly figures), %

Contribution to GDP growth in percentage points

GDP 0,7 0,4 0,9 0,7 0,4 0,9Private consumption 1,4 0,3 0,5 0,8 0,1 0,3Public sector consumption 1,1 �0,1 �0,1 0,2 0,0 0,0Gross capital formation 5,8 �0,5 �0,8 1,3 �0,1 �0,2Exports 1,9 0,6 5,8 x x xImports 5,0 �0,7 4,0 x x xNet exports x x x �1,6 0,8 1,1Statistical discrepancy x x x 0,0 �0,4 �0,3

Source: Austrian Institute of Economic Research (WIFO), Eurostat.


Economic Recovery



Results of the OeNB Economic Indicator of September 2004:

Continued Robust Growth in the Second Half of 20043

The OeNB economic indicator forecasts continued robust economic growth in Austria in the secondhalf of 2004. For both the third and fourth quarters of 2004, it predicts real GDP growth in Austriaof 0.5% on a seasonally-adjusted quarterly basis. On a year-on-year basis, this means growth will quickento 2.1% and 2.3%, respectively. For full-year 2004, growth thus comes to 1.7%. Compared with theOeNB�s spring outlook, this means a revision of +0.2 percentage points. Growth will be fueled primarilyby dynamic exports. During the second half of 2004, however, domestic demand should also make agreater contribution to growth.

In view of continued modest em-ployment and wage growth, privateconsumption is relatively stable. Afurther acceleration in growth in thesecond half of 2004 does not, how-ever, look very likely. Public con-sumption growth is marked by ongo-ing consolidation efforts. In the firsthalf of 2004, public consumption de-clined marginally. In the second halfof the year, it is not expected to aug-ment significantly either.

The outlook for 2005 will dependabove all on how the world economicrecovery continues to develop.Whether euro area countries — in par-ticular, Germany — succeed in placinggrowth (driven primarily by exportsin the first half of 2004) on a broaderbasis is crucial for Austria. Failing this,growth can be expected to lose mo-

mentum in Austria as well. Althoughoil prices are currently at a high level,this should not jeopardize economicrecovery provided they do not risefurther considerably. However, theymay well have a certain dampeningeffect on cyclical developments.

4.1 Confidence Strengthens Furtherin Austria

Whereas euro area economic indica-tors are still trending unevenly, theeconomic climate in Austria has re-cently stabilized. Since spring 2003,the European Commission�s economicsentiment indicator has been in up-trend except for a setback towardthe end of 2003.

Confidence indicators provide acautious gauge of the breakdown ofGDP growth in the second half of

3 Since the first quarter of 2003, the OeNB economic indicator has been published four times a year. It forecastsreal GDP growth for the current quarter and the next (in each case, on a quarterly basis, using seasonally-adjusted data). The figures are based on the results of two econometric models: a state space model and a dynamicfactor model. Further details on the models employed can be found at www.oenb.at in the Monetary Policy andEconomics section. The next publication is scheduled for January 2005.

Table 6

Short-Term Outlook for Real GDP

for the Third and Fourth Quarters of 2004 (Seasonally Adjusted)2002 2003 2004

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

Quarterly change (annual rate) in %

0.5 2.1 1.3 1.5 1.4 0.1 0.6 0.8 0.7 1.8 2.1 2.3

Quarterly change in %

0.6 1.0 �0.2 0.0 0.5 �0.2 0.2 0.3 0.4 0.9 0.5 0.5

Annual change in %

1.3 (1.4)1 0.7 (0.7)1 1.7

Source: OeNB results of the OeNB economic indicator of September 2004, Austrian Institute of Economic Research (WIFO).1 Based on nonseasonally-adjusted and nonworking day-adjusted data.


Economic Recovery



2004. The order book for exportssuggests that deliveries abroad willcontinue to perform positively al-though growth rates as high as thosein the second quarter of 2004 willbe difficult to repeat. In the quarterlybusiness survey carried out by theAustrian Institute of Economic Re-search, WIFO, for the third quarterof 2004, capacity utilization was bet-ter than in the preceding survey. Thiscan be interpreted as a sign of step-ped-up investment. After surging inspring 2004, retail confidence fellback to its level at the start of the year,which makes a sharp uptick in con-sumption look rather unlikely.

4.2 Labor Market Starts To ImproveEmployment growth is acceleratingvisibly, albeit at a low level. Althoughthe unemployment rate is still high,the number of vacancies has beensurging since March 2004, indicatinga further improvement in the labormarket and a decline in joblessnessin the near future.

In 2004, employment statistics areparticularly difficult to interpret fortwo reasons. First, the number of in-dividuals drawing parental leave bene-fit continues to grow, underlining theimportance of the distinction betweenregistered employment and employ-ment adjusted for persons on parentalleave, in compulsory military trainingor registered in a training program ofthe Austrian Public EmploymentService. Hence, the (economicallyrelevant) adjusted employment figuresare lower than registered employmentfigures. Second, AMS (Austrian PublicEmployment Service) training partici-pants have been dropped from em-ployment statistics since early 2004,which means that actual employmentgrowth is distorted downward. In2004, both these effects will roughly

cancel each other out. Growth in reg-istered employment (year on year,January to August 2004) of 0.3% istherefore equivalent to approximatelythe number of actually newly createdjobs. In the first eight months of2004, growth in registered employ-ment accelerated from +0.1% inJanuary to +0.6% in August. Aggre-gated employment growth concealshighly divergent sectoral trends.Whereas jobs are being lost in indus-try, they are being created in the ter-tiary sector.

4.3 Oil Price Increase Triggers Risein Inflation

Price trends in 2004 have basicallybeen determined by the increase incrude oil prices. Inflation has conse-quently risen in the course of the year.At 2.2%, the rate of increase in theHarmonized Index of Consumer Pri-ces (HICP) reached its highest levelto date this year in August 2004. In2003 prices edged up by a mere1.3%. Compared with 2003, the rele-vance of certain subcomponents foraggregate inflation has changed per-ceptibly in 2004. In addition to en-ergy, services made the biggest contri-bution to inflation. Since early 2004,government measures (e.g. the in-crease in energy tax or the introduc-tion of the toll on freight vehicles)have added to inflation.

4.4 2003 Current Account Based onPayment Flows Almost Balanced

Vigorous export growth in the firsthalf of 2004 improved the balance ofgoods and services. At EUR 1.89 bil-lion, the current account surplus(based on payment flows) in the firstseven months of 2004 exceeded thatof the comparable period of the previ-ous year by EUR 0.28 billion. This iswholly attributable to a reduction in


Economic Recovery



the goods deficit. By contrast, the sur-plus on services (with its importantsubcategory of tourism) suffered onlya minimal decline. Finally, higher netpayments from investment incomeand transfers resulted in a current ac-count deficit. The current account(based on payment flows) turned froma surplus of EUR 0.02 billion in thefirst seven months of 2003 into a def-icit of EUR 0.67 billion in the com-parable period of 2004. The improve-ment in the merchandise balance isalso reflected in the foreign trade data

compiled by Statistics Austria. Thebalance moved from a deficit of EUR1.4 billion in the first six months of2003 into a surplus of EUR 0.4 billionin 2004. The merchandise trade defi-cit continued to deepen with the �old�EU Member States while the surpluswith the 10 new Member Statesremained more or less unchanged.By contrast, there was a markedimprovement in the balance withnon-EU countries (up by more thanEUR 2 billion to EUR 2.6 billion).


Economic Recovery



This study shows that strong interest rate expectations can have a massive short-term impact oncounterparties� bidding behavior if certain conditions for monetary policy operations are present. Thisincreases the probability of an undesirable reaction of potentially more volatile short-term money marketrates.

Therefore, during the first quarter of 2004 the Eurosystem took steps to counter such potential neg-ative repercussions on signaling the monetary policy stance. The modifications are to make an importantcontribution toward increasing the efficiency of the operational framework for monetary policy.

In another area — the risk control framework for eligible assets — the Eurosystem implementedmeasures to increase the precision and transparency of the valuation of these assets and adopted amore precise definition of the criteria for certain credit standards.

1 IntroductionThe Eurosystem�s principal monetaryinstruments are open market opera-tions and standing facilities. Openmarket operations ensure that theEuropean Central Bank (ECB), whichalways initiates these operations, pro-vides refinancing to the financialsector on a regular basis. The mostimportant type of open market oper-ations is short-term tenders1 (mainrefinancing operations, MROs).

The minimum bid rate for short-term tenders signals the Eurosystem�smonetary policy stance. For the inter-bank market, the minimum bid rate isan important indicator for overnightrates, which as a rule do not deviatesignificantly from the former.2

In addition to providing centralbank money on a regular basis, openmarket operations also serve as a toolto fine-tune liquidity conditions. Inthis way, the ECB reacts — if necessary— to imbalances in the money market,thus reducing the volatility of short-term money market interest rates.

Standing facilities, on the otherhand, are available to credit institu-tions at their own initiative. Counter-parties can use them to obtain short-term overnight liquidity (marginallending facility) or to deposit liquiditysurpluses (deposit facility).

An essential regulatory provisionis that most credit institutions are re-quired to maintain minimum reserves.To meet their minimum reserve re-quirements, credit institutions haveto hold 2% of certain deposit cate-gories on accounts with the nationalcentral banks. Compliance with re-serve requirements is determined onthe basis of the average of the end-of-calendar-day balances on the creditinstitutions� reserve accounts over amaintenance period. This allowscredit institutions to smooth out liq-uidity fluctuations within their reservemanagement system, which elimi-nates the necessity of daily compen-satory transactions in the moneymarket. As a result, the number oftransactions decreases, which in turnstabilizes short-term money marketrates.

As has been the case in past years,the ECB�s monetary policy deci-sions were implemented relativelysmoothly and without major incidentsin 2003:— The average volatility of short-

term money market interest ratesover the course of the year, meas-ured against the Euro OverNightIndex Average (EONIA), i.e. theeuro reference interest rate forovernight unsecured lending trans-

1 In these transactions, the ECB provides central bank money to the banking system in a predefined auction process.2 Short-term deviations from this general rule are possible in periods of temporary over- or underliquidity.

Michael Pfeiffer

Refereed byFriedrich Fritzer,Economic Analysis Division.


Measures to Improve the Efficiency of theOperational Framework for Monetary Policy

actions in the interbank market,was low. In particular, the spreadbetween the minimum bid rate inECB tender operations and theEONIA remained mostly stableat a low level. This suggests thatin most cases the liquidity situa-tion in the money market was bal-anced and that no serious tensionsoccurred.

— On average, recourse to bothstanding facilities — the deposit fa-cility and the marginal lending fa-cility — was at a low level. This isgenerally the case when credit in-stitutions� liquidity is adequate tomeet their needs, and the volatil-ity of money market interest ratesis insignificant.Overall, the operational frame-

work for monetary policy provedsuitable to ensure a stable supply ofcentral bank money to the bankingsector also in 2003. At the same time,the structure turned out to be flex-ible enough to react quickly andeffectively when faced with unfore-seen situations; a fact that is also evi-denced by the limited number offine-tuning operations that had to beconducted.

Despite a very balanced and stableoverall picture, there are occasionalsituations when temporary imbalancesin the money market emerge. Thesemay be caused when factors affectingliquidity (for instance, banknotes incirculation or certain central govern-ment transactions) take an unfore-seen development. As a result, thereis a temporary over- or undersupplyof liquidity to the market, and short-term interest rates react accordingly.

In addition, it is also possible thatinterest rate speculation leads tobidding behavior on the part of creditinstitutions that does not correspondto their actual liquidity requirements.

Some such situations occurred inparticular under the operationalframework for monetary policy thatwas in effect up to February 2004.The section below presents a shortanalysis of some examples of such sit-uations.

Another key factor within the op-erational framework for monetarypolicy is the fact that counterpartiesare only supplied with central bankliquidity against sufficient and ade-quate collateral. All collateral is sub-ject to certain criteria in order to beeligible for use in Eurosystem mone-tary policy operations. In addition,the Eurosystem applies specific risk-control measures to prevent losses inthe event that underlying assets haveto be realized owing to the default ofa counterparty. In recent years, thesemeasures have been increasingly re-fined and adjusted to the requirementsof modern financial markets. A fur-ther step in this direction came into ef-fect in the first quarter of 2004 and isdiscussed in chapter 4 of this study.

2 Temporary Imbalancesand Their Causes

It is important to note that this analy-sis focuses on the period following theswitch to variable rate tenders in theMROs.3

Each national central bank submitsa detailed set of data to the ECB on adaily basis, setting out the anticipateddevelopment of the autonomous liq-

3 Particularly in 2000, severe overbidding situations occurred in the context of the volume tender procedure, whichis based on a fixed interest rate, combined with strong market expectations of increasing interest rates. The fixedrate tender procedure does not involve market risk for the bidding bank. In response to this fact, the ECB decidedto switch to a variable rate tender procedure.


Measures to Improve the Efficiency of the

Operational Framework for Monetary Policy

uidity factors up to the end of the cur-rent minimum reserve maintenanceperiod. Autonomous liquidity factorsinclude, for example, banknotes in cir-culation or government activities af-fecting liquidity. On the basis of thesefactors, together with the current ag-gregate reserves of the credit institu-tions, the ECB calculates the liquidityneeds for the entire Eurosystem. Thiscalculation is used to determine therespective tender allotments.

An underbidding situation occurswhen the calculated liquidity require-ments of the counterparties cannot bemet because the bids submitted in thetender operation were not sufficient.Depending on the amount of the ensu-ing liquidity shortfall, this results inmore or less significant fluctuationsin money market interest rates.

Two episodes in March and in June2003 serve as examples of clear un-derbidding. In both of these cases,the shortage in the amount of liquiditythat would have ensured a smooth ful-fillment of minimum reserve require-ments was substantial: EUR 43 billionand EUR 20 billion, respectively.Since, by contrast, the annual averageminimum reserve requirement wasEUR 130 billion in 2003, these twocases deserve a closer look.

To analyze these temporary situa-tions, it is first necessary to briefly de-scribe how the operational frameworkfor monetary policy has been func-tioning up to now. Particular emphasismust be given to the following twokey factors:1) The minimum reserve system

with its maintenance period start-ing on the 24th calendar day of onemonth and ending on the 23rd cal-endar day of the following month.

2) The fact that the maturity of themain refinancing operations wastwo weeks.

The first factor is particularly rel-evant in the present context. As previ-ously mentioned, compliance withreserve requirements is determinedon the basis of the average of the dailybalances on the counterparties� re-serve accounts over the entire reservemaintenance period. This means thatthe credit institutions subject to mini-mum reserves have great flexibility formanaging their reserves. Dependingon their liquidity situation, but alsocontingent upon their assessment ofhow money market interest rates willdevelop, they will opt either for fron-tloading or backloading reserves.

A frontloading strategy is charac-terized by a liquidity surplus (moreminimum reserves are held thanthe necessary average amount) in thefirst half of the maintenance period,which is attributable either to liquid-ity inflows from the financial institu-tion�s activities at that time or to theanticipation of an interest rate hikein the second half of the maintenanceperiod.

In the opposite scenario, a creditinstitution that opts for backloadingeither expects liquidity inflows duringthe second half of the reserve mainte-nance period or an interest rate cut.Therefore, at the beginning of thereserve maintenance period, thecredit institution will hold less centralbank money than the required mini-mum reserve average. Instead, it willcompensate for the reserve deficitlater on, using either liquidity inflowsor — if the interest rates have in factbeen cut — by borrowing the shortfallat more favorable conditions in themoney market or from the ECB.

Under the facts and circumstancesdescribed above, the dates scheduledfor the ECB�s interest rate decisionsplay a crucial role in market partici-pants� decisions as to which strategy




to follow. Generally, the ECB Govern-ing Council assesses the monetary pol-icy stance at its first meeting of themonth. Accordingly, interest rate de-cisions are normally taken during thatmeeting.4

If this provision is embedded in aminimum reserve regime with a main-tenance period that begins on the

24th calendar day of each month andends on the 23rd calendar day of thefollowing month (that is, the �old�system), this implies that there isalways the possibility of a key interestrate change within a particular reservemaintenance period.

Chart 1 illustrates this point.

If market participants� expecta-tions of an imminent change in thekey interest rates gather momentum,direct consequences on credit institu-tions� bidding behavior in ECB tenderoperations are very likely to occur inthis scenario. Since, as described pre-viously, there is a close connectionbetween credit institutions� minimumreserve maintenance patterns andtheir bidding behavior, the biddingamounts (and the interest rates of-fered) in tender operations primarilydepend on the following two factors:the liquidity requirement and/or theanticipated liquidity conditions at theend of the reserve maintenance periodand the spread between short-termmoney market rates and the minimumbid rate for MRO tenders. Thesemoney market rates are of course also

influenced by interest rate expecta-tions for the immediate future.

Heterogeneous interest rate bidsfor MROs reflect, inter alia, credit in-stitutions�differing expectations aboutthe level of the marginal allotmentrate as well as their willingness to re-sort to riskier alternative refinancingoptions in the money market. Thesedecisions are obviously also influencedby the availability of eligible underly-ing assets, the anticipated credit riskpremium and their individual balancesheet structure.

The money market reference ratesfor the interest rates offered in tenderoperations are the short-term rates forunsecured deposits and increasingly,the EONIA swap rates,5 owing to thehigh liquidity of this market segment,as well as corresponding repo rates.

4 On November 8, 2001, it was announced that the Governing Council of the ECB would assess its monetary policystance, as a rule, only at its first meeting of each month. The exact schedule of these monthly meetings is publishedaround mid-year for the following year. The ECB may, however, deviate from this schedule if necessary.

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5 In an EONIA swap, a fixed-term interest rate is exchanged for the average of the EONIA rates over the course of acertain period, for example, one week. After the end of this period, the difference is usually paid out.




Basically, short-term money mar-ket rates (for example, the overnightrate) reflect the equilibria in themoney market and also, to a certaindegree, the expected level of theMRO minimum bid rate at the endof the reserve maintenance period,as well as the assessment as to whetherliquidity conditions at this point aretight or loose. If these conditions areassessed as neutral, which means thatthe market does not anticipate achange in the key ECB interest ratesand there is a high probability of nei-ther a liquidity shortfall nor a surplusat the end of the reserve maintenanceperiod, the difference between theovernight rate and the minimum bidrate for MROs is usually no more thana few basis points.

The earlier the market becomesaware of (or anticipates) probableimbalances, the earlier the short-termmoney market rate will deviate fromthe minimum bid rate. This amplitudenormally culminates on the last day ofthe reserve maintenance period be-cause then the most precise assess-ment regarding the amounts necessaryto adjust discrepancies between thelevel of reserves held and the mini-mum reserves required (borrowingdeficits/depositing surpluses throughthe Eurosystem�s standing facilities)is available.

The factors described above showthat expectations of imminent key in-terest rate changes can certainly leadto significant fluctuations in the bid-ding volume. Strong market expecta-tions of a key interest rate hike canthus result in a substantially higherbids submitted in MROs (as previ-ously mentioned, this phenomenonoccurred in the period from 1999through 2000). By contrast, expecta-tions of a key interest rate cut usuallylead to a marked decline in bids. In

this case, it is not possible to suffi-ciently adjust the bid rates (down-ward) in variable rate tenders becauseof the minimum bid rate. Instead, bid-ding interest will be regulated throughthe volume of bids. High expectationsof interest rate cuts tend to exert adownward pressure on short-termmoney market rates, which may causea temporarily fall below the minimumbid rate. This phenomenon has alsobeen observed during underbiddingepisodes.

Interestingly, however, the moneymarket rate can also rise considerablyabove the minimum bid rate as a di-rect result of significant underbidding,even though the market was anticipat-ing an interest rate cut (see chart 2).

This is caused by a temporary liq-uidity shortage against the requiredminimum reserve maintenance, whichin turn triggers an interest rate re-sponse that pushes the rate up andtemporarily increases volatility. Thisis a typical example of a situationwhich the market does not classify as�liquidity neutral� as previously de-fined and therefore reacts accordingly.Generally it can be assumed that thehigher the anticipated accumulatedliquidity shortage, the higher willbe the likelihood of a movement inshort-term interest rates. Such marketresponses can move short-term inter-est rates temporarily to just under thelevel of the marginal lending facility.

The ECB normally responded tosuch situations with increased allot-ments in subsequent tender opera-tions. In addition, so-called tendersplit operations were carried out onsome occasions. This means that anadditional operation with a maturityof one week was conducted in parallelto the regular MRO in order to re-align the volumes of the outstandingtender operations.




Nevertheless, credit institutionsfrequently used the marginal lend-ing facility, as the higher allotmentamounts did not necessarily coverthe entire shortfall.

In addition to interest rate ex-pectations during a given minimumreserve maintenance period, yet an-other aspect was relevant in thephased-out system: As a result of thetwo-week maturity of the MRO (withtenders on a weekly basis), at least thelast MRO within a minimum reservemaintenance period overlapped withthe subsequent one. This in turn couldresult in interest rate expectations forthe next reserve maintenance periodalready having an effect on the biddingbehavior during the current period.

From a central bank�s perspective,distortions of bidding behaviorprompted by speculation and the re-sulting tensions in the money marketwith phases of higher volatility are un-desirable because the MROs do notjust play a vital role in the regular sup-ply of the market with central bankmoney but are also important factorsin signaling the ECB�s monetary policystance.

In the current system of variablerate tenders, the minimum bid rateprovides this signaling function (dur-ing the period in which the MROswere conducted as fixed rate tenders,the fixed rate of the tenders had thisfunction).

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The greater volatility of short-term money market rates due to mar-ket participants� expectations, themore this signaling effect is endan-gered.

3 Measures to ReduceDistortions

In order to mitigate the previously de-scribed impacts of counterparties� ex-pectations on the money market, theECB Governing Council decided inearly 2003 to implement the follow-ing changes to the operational frame-work for monetary policy, whichcame into effect in the first quarterof 2004:6

3.1 Minimum ReserveSince — as previously described — thetiming of the minimum reserve main-tenance period was one of the majorfactors causing the imbalances experi-enced in the past, an obvious step wasto implement a change in the reservemaintenance schedule.

Under the new system, the re-serve maintenance period alwaysstarts on the settlement day of the

MRO following the meeting of theECB Governing Council at which themonthly assessment of the monetarypolicy stance is scheduled. As a com-plement to this redefinition of theminimum reserve maintenance pe-riod, changes in standing facility rateswill generally coincide with the startof a new reserve maintenance period.

This means that instead of startingand ending on fixed calendar days, thereserve maintenance periods dependon the schedule of ECB GoverningCouncil meetings. Consequently, themaintenance periods will vary inlength.

As to the calculation of the mini-mum reserve, it is crucial that underthe new system, the gap between thedate on which the reserve basis is cal-culated, i.e. the last day of the month,and the start of the reserve mainte-nance period is at least as long as un-der the previous system. For instance,a credit institution�s reserve require-ment for a maintenance period start-ing in April would be calculated usingits reserve base data from the end ofFebruary.

6 The measures implemented were influenced by the public consultation launched by the Eurosystem on October 7,2002, to gather the views of market participants on a set of planned technical measures designed to improve theefficiency of the operational framework for monetary policy.

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3.2 Tender OperationsAs previously mentioned, the allot-ment rhythm of MRO allotments wasalso a factor that fostered potential dis-tortions of bidding behavior in certainsituations. Because tender operationswith amaturity of twoweekswere con-ducted on a weekly basis, MROs regu-larly overlapped with the subsequentreserve maintenance periods.

Although the maturity of 14 dayscan be considered adequate for sup-plying central bank money to thefinancial sector, the ECB decided tosynchronize the maturity of MROsand new tender operations. Conse-quently, the maturity of the MROswas shortened from two weeks toone week.

A technical change was also imple-mented with regard to the longer-term refinancing operations (with amaturity of three months). Instead ofon the first Wednesday of each mini-mum reserve maintenance period likeunder the old system, they are nor-mally allotted on the last Wednesdayof each calendar month under thenew system.

3.3 Desired Effect of the Changesto the Framework

The combination of the changes out-lined above is to help remove expect-ations of interest changes during anyparticular maintenance period, giventhat changes in the ECB�s key interestrates will generally only apply to theforthcoming reserve maintenance pe-riod and that liquidity conditions willno longer spill over from one reservemaintenance period to the next. Fur-thermore, shortening the maturity ofthe MRO has solved the problem of

overlapping MROs (one refinancingoperation extending over two mini-mum reserve maintenance periods).

In technical terms, this means thatinterest rate speculation of the kindpreviously described will no longerbe relevant within the prevailingmaintenance period, which in turnstabilizes the conditions in which bid-ding in the main refinancing opera-tions takes place and thus reducesthe volatility of short-term moneymarket interest rates.

In addition, these measures willensure that the reserve maintenanceperiod always starts on a TARGEToperating day, while ending on anon-TARGET day will be very rare.

4 Risk Control MeasuresThe eligibility criteria applied to un-derlying assets provide another im-portant contribution to the smoothfunctioning of the Eurosystem�s mon-etary policy operations.

Eligible assets are divided into twocategories: tier one and tier two as-sets.7 Tier one consists of marketabledebt instruments fulfilling euro area-wide eligibility criteria specified bythe ECB. Tier two consists of market-able and non-marketable assets whichare of particular importance to na-tional financial markets and bankingsystems.

The most recent changes concernthe risk control measures that areapplied to the assets underlying Euro-system monetary policy operations8

and can be summarized as follows:Tier one assets were allocated to

one of four liquidity categories, witha specific valuation haircut to be as-signed to each category.

7 The ECB Governing Council has already committed to a decision to merge the two categories of assets into onesingle list.

8 The detailed provisions are set out in the �General Documentation on Eurosystem Monetary Policy Instrumentsand Procedures� (ECB, February 2004).




The following haircuts apply to inverse floating rate instruments9:

With regard to the haircut sched-ule for inverse floating rate instru-ments, a distinction between instru-ments with pre-fixed coupons and in-struments with post-fixed coupons isno longer necessary. The minimumhaircut applied to inverse floaters is

the haircut corresponding to thezero-to-one-year maturity bucket ofthe liquidity category or group towhich the instrument is assigned.

Differentiation of instruments ac-cording to liquidity categories was in-stituted because, as a rule, if it should

Table 1

Liquidity Categories for Tier One Assets

Category I Category II Category III Category IV

Central governmentdebt securities

Local and regional govern-ment debt securities

Traditional Pfandbrief-styledebt instruments

Asset-backed securities

Debt securitiesissuedby central banks

Jumbo Pfandbrief-styledebt instruments

Credit institutiondebt securities

Supranationaldebt securities

Debt instruments issuedby corporate and otherissuers

Agency debt instruments

Source: ECB.

Table 2

Levels of Valuation Haircuts Applied to Eligible Tier One Assets

in Relation to Fixed Coupon and Zero Coupon InstrumentsLiquidity categories

Residual maturity Category I Category II Category III Category IV

Fixed coupon Zero coupon Fixed coupon Zero coupon Fixed coupon Zero coupon Fixed coupon Zero coupon

Haircuts in %

0 to 1 year 0.5 0.5 1.0 1.0 1.5 1.5 2.0 2.01 to 3 years 1.5 1.5 2.5 2.5 3.0 3.0 3.5 3.53 to 5 years 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.05 to 7 years 3.0 3.5 4.5 5.0 5.5 6.0 6.5 7.07 to 10 years 4.0 4.5 5.5 6.5 6.5 8.0 8.0 10.0More than 10 years 5.5 8.5 7.5 12.0 9.0 15.0 12.0 18.0

Source: ECB.

9 An inverse floating rate instrument is a financial instrument where the rate of interest paid to the holder of theinstrument varies inversely with changes in a certain reference interest rate.

Table 3

Levels of Valuation Haircuts Applied to

Eligible Tier One Inverse Floating Rate InstrumentsResidual maturity Inverse floaters coupon

Haircuts in %

0 to 1 year 21 to 3 years 73 to 5 years 105 to 7 years 127 to 10 years 17More than 10 years 25

Source: ECB.




become necessary to realize (sell) in-struments with limited liquidity,markdowns and/or delays must be ex-pected. Consequently, an appropriatevaluation haircut, which is scaled upwith increasing residual maturity(the maturity buckets were slightly re-fined compared to the old frame-work), is deducted ex-ante from thecurrent market value of the instru-ments. This means that under theamended framework less liquid in-struments are subject to significantlygreater haircuts.

The classification of eligible tiertwo assets remains unchanged and dis-tinguishes between the following fourliquidity groups of eligible assets:1. marketable debt instruments with

limited liquidity;2. debt instruments with restricted

liquidity and special features;3. equities; and4. nonmarketable debt instruments,

including trade bills, bank loansand mortgage-backed promissorynotes.The valuation haircuts shown in ta-

ble 4 apply to tier two assets.

A valuation haircut of 22% is to beapplied to all eligible equities.

The following levels of valuationhaircuts apply to nonmarketable as-sets: Trade bills with a maturity ofup to six months are subject to a 4%haircut. Bank loans with a maturityof up to six months are subject to a12% haircut. Bank loans with a matur-ity between six months and two yearsare subject to a 22% haircut. Mort-gage-backed promissory notes aresubject to a 22% haircut.

Previously, the risk control frame-work for Eurosystem monetary policyoperations was based on two compo-nents: on the one hand, valuation hair-

cuts were applied to the price/valueof the assets provided as collateral,and on the other, initial margins wereapplied to the credit the ECB ex-tended to a counterparty under amonetary policy operation. In otherwords, if a participating bank wasallotted EUR 100 million in a tendertransaction, the basis for calculatingthe required collateral was EUR 100million plus the corresponding initialmargin (1% or 2%, depending onthe maturity of the operation). Thiswas the minimum amount which hadto be collateralized. The collateralvalue10 of these assets was calculatedon the basis of the current (market)

Table 4

Levels of Valuation Haircuts Applied to Eligible Tier Two Assets

Residual maturity Marketable debt instrumentswith limited liquidity

Debt instrumentswith restricted liquidity and special features

Fixed coupon Zero coupon Fixed coupon Zero coupon

Haircuts in %

0 to 1 year 2.0 2.0 4.0 4.01 to 3 years 3.5 3.5 8.0 8.03 bis 5 years 5.5 6.0 15.0 16.05 to 7 years 6.5 7.0 17.0 18.07 to 10 yearse 8.0 10.0 22.0 23.0More than 10 years 12.0 18.0 24.0 25.0

Source: ECB.

10 Credit institutions can transfer collateral assets to the central banks within the Eurosystem either in the form ofrepurchase agreements or in the form of collateralized loans.




value of the underlying assets less theappropriate haircuts. This concept ofdual protection was establishedbecause, at the time the single opera-tional framework for monetary policywas developed, the assets used inmonetary policy transactions werenot subject to daily valuation in alleuro area countries. As a result, itwas possible that assets were acceptedon the basis of prices that were no lon-ger current. Consequently, the Euro-system applied initial margins to offsetthis market risk. Since, by now, alleuro area countries value the assetsused for collateralizing Eurosystemcredit operations on a same-day basis,it is no longer necessary to apply aninitial margin to the amount of liquid-ity provided and this practice hastherefore been discontinued.

Furthermore, the trigger pointused in margin calls (the tolerancelevel for a shortfall in underlying as-sets which, if not attained, requiresthe participating central bank to de-mand additional assets or cash fromthe counterparty) was reduced from1.0% to 0.5%, bringing it in line withthe lowest level of protection pro-vided under the revised framework(initial margin = 0% and valuationhaircut = 0.5%).

In order to guarantee coherencebetween the new valuation haircutschedules for tier one eligible (i.e.marketable) assets and those for tiertwo eligible assets, the latter alsohad to be modified to take into ac-count both the discontinuation of ini-tial margins and the new maturitybuckets.

These changes represent anotherstep toward a more precise andtransparent valuation of underlyingassets.

For Austria, initial comparativeanalyses indicate the following:

The average valuation haircut ap-plied to the assets included in thepools held by Austrian counterpartiesseems to have increased only slightlyas a result of the amended provisions.The reason behind this is that sig-nificantly more than 50% of theinstruments (valued according to theirmarket value) fall under liquiditycategory 1 or are either instrumentswith limited liquidity or floating rateinstruments, which are subject tothe lowest haircut within the respec-tive liquidity category.

In addition to the valuation criteriafor eligible assets, the requirementsfor eligible guarantees were specifiedin greater detail. In some cases, forexample, a confirmation concerningthe legal validity, binding effect andenforceability of a guarantee will haveto be provided before the asset sup-ported by the guarantee can be con-sidered eligible.

5 ConclusionsThis study shows that strong interestrate expectations — in this particularcase, expectations of key ECB interestrate changes within a given minimumreserve maintenance period — canhave a massive short-term impact onthe counterparties� bidding behaviorif the operational framework for mon-etary policy is set up accordingly. Thisis particularly the case when the ma-turity of the ECB�s regular main refi-nancing operations and the minimumreserve requirements are organizedin such a way that tender operationsoverlap with the subsequent reservemaintenance period. This increasesthe probability of an undesirable reac-tion of short-term money marketrates, which may go hand in hand withheightened volatility.

The measures described herein areprimarily intended to counteract such




movements. As they have come intoeffect only recently, it is too soon toempirically analyze their full effect.It can be said, however, that the re-vised concept is a suitable means tofurther improve the already high effi-ciency of the operational frameworkfor monetary policy.

In another important area — theregulatory framework for eligibleunderlying assets — the Eurosystemimplemented measures to increasethe precision and transparency of thevaluation process and adopted a moreextensive definition of the criteria forcertain credit standards.

ReferencesECB. 2001. Bidding Behaviour of Counterparties in the Eurosystem�s Regular Open Market Operations. In:

Monthly Bulletin October. 59—72.

ECB. 2003. Changes to the Eurosystem�s Operational Framework for Monetary Policy. In: Monthly Bulletin

August. 45—59.

ECB. 2004. The Iimplementation of Monetary Policy in the Euro Area. General documentation on Euro-

system monetary policy instruments and procedures. February.

ECB Press release. 2003. Measures to Improve the Efficiency of the Operational Framework for

Monetary Policy. January.

ECB Press release. 2003. Amendments to the Risk Control Framework for Tier One and Tier Two

Eligible Assets. July.

ECB Press release. 2004. Phasing-in of the Changes to the Eurosystem�s Operational Framework for

Monetary Policy in Early 2004. January.




This paper reviews the key theoretical and empirical findings of the literature on non-Keynesian effectsof fiscal policy, or �expansionary fiscal consolidations.� Specifically, it seeks to identify why the empiricalevidence is rather ambiguous about the effects that fiscal contractions have on private consumption,investment, national saving and output.

The empirical evidence surveyed in this paper is found to provide no clear support for the existenceof expansionary fiscal consolidations. The safest conclusion seems to be that fiscal policy has lost someof its ability to stabilize the economy over the recent past.

Austria�s fiscal consolidation of 1995—1997, identified as expansionary by the European Commis-sion, is found to have relied significantly on one-off measures.

1 IntroductionIn the 1970s and early 1980s, in timesof low nominal growth rates and highnominal interest rates, many Euro-pean countries were running highdeficits, as a result of which publicdebt rose rapidly. The high debt, inturn, decreased the ability of fiscalpolicy to stabilize the economy, giventhe sharp rise in interest expenditure.To tackle this problem, governmentsinitiated fiscal adjustments in the late1980s. In the EU Member States,these efforts were reinforced in the1990s to ensure compliance with thefiscal criteria set out in the MaastrichtTreaty for participation in the thirdstage of Economic and MonetaryUnion (EMU). However, once thefounding members of the euro areahad been selected in 1998, consolida-tion efforts were relaxed.

Exacerbated by only very moder-ate growth since the turn of the mil-lennium, budget balances have con-sequently worsened considerably inEurope. In order to continue to meetthe fiscal criteria established by theMaastricht Treaty and the Stabilityand Growth Pact and given the im-plicit financial liabilities posed byageing populations, many EU MemberStates these days again face the need toimplement major fiscal consolida-tions. This is true even more so in

the light of EMU enlargement, sincesustainable public finances are typi-cally seen as the key prerequisite formonetary stability in EMU.

Policymakers are usually hesitantto introduce fiscal adjustments be-cause standard Keynesian textbookanalysis indicates that a fiscal contrac-tion will have a dampening effect onprivate consumption, output and em-ployment. Yet, there is no consensuson the size or even the sign of the ef-fects that fiscal policy has on economicactivity, since a number of studies sug-gest that a fiscal consolidation mighteven stimulate economic activity inthe short run, i.e. have �non-Keynes-ian� effects.

In Europe the idea of non-Keynes-ian effects of fiscal policy, also called�expansionary fiscal consolidations,�was first introduced by German poli-cymakers and economists in the1980s. The academic debate on ex-pansionary fiscal contractions did notstart until years later, sparked by Gia-vazzi and Pagano (1990), who studiedthe effects of fiscal policy in Denmarkand Ireland in the 1980s. According tothis much-cited paper, Denmark andIreland saw drastic reductions in thecyclically adjusted deficits followedby above-average economic growth.Numerous studies have since soughtto identify whether and under what

1 The author acknowledges comments from Sylvia Kaufmann, Markus Knell, Walpurga Ko‹hler-To‹glhofer, GeertLangenus and Sandro Momigliano.

Doris Prammer1

Refereed by Martin Zagler,Vienna University ofEconomics and BusinessAdministration, July 2004.


Expansionary Fiscal Consolidations?An Appraisal of the Literature on

Non-Keynesian Effects of Fiscal Policy anda Case Study for Austria

conditions fiscal contractions can gen-erate a favorable economic response.

This paper reviews the key theo-retical and empirical findings of theliterature on non-Keynesian effects.Specifically, it seeks to identify whythe empirical evidence is rather am-biguous about the effects of fiscal con-tractions on private consumption, in-vestment, national saving and output.While some studies find significantpositive effects of fiscal contractionson these macroeconomic variables,others fail to find any support forthe idea of non-Keynesian effects offiscal policy.

The paper is organized as follows.Section 2 presents a survey of theoret-ical work ranging from Keynesian tonon-Keynesian approaches. Section 3discusses empirical work focusing oncase studies and descriptive statistics.Section 4 reviews empirical regressionanalyses and discusses their results.Section 5 provides an Austrian casestudy based on the referred literature.Section 6 offers some concluding re-marks.

2 Some TheoreticalInsights: Contractionaryor Expansionary FiscalConsolidations?

2.1 Keynesian EffectsAccording to the traditional Keynes-ian textbook view a fiscal consolida-tion has short-run contractionary ef-fects on domestic demand, nationaloutput and employment. While cutsin government expenditure directlyreduce aggregate demand, tax in-creases dampen private consumptionindirectly by reducing disposable in-come. In the Keynesian model, the in-itial impact on output of a change infiscal variables is amplified by the fis-cal multiplier, which increases withthe marginal propensity to consume

out of disposable income. In theory,the Keynesian multiplier exceeds 1;with the ultimate effect on output be-ing larger for a change in governmentconsumption than for a change intaxes. Hence, even small changes infiscal policy will affect output, whichraises the potential of fiscal policy tostabilize the economy.

The exact size of this multiplier,i.e. to which degree crowding out/in through interest rates and opennessis experienced, hinges on the givenmoney market and the exchange rateregimes. If demand for money is verysensitive to the interest rate, changesin fiscal policy have a relatively largeeffect on output.

2.2 Ricardian EffectsThe ability of fiscal policy to affectoutput and its components, as out-lined by the standard Keynesian view,has been questioned by the Ricardianequivalence theorem.

The concept of equivalence assuch was first introduced by DavidRicardo (1820, reprinted 1951), whostated that for a given path of spend-ing, deficit financing (taking into ac-count the intertemporal governmentbudget constraint) is equivalent totax financing, and cannot be used toinfluence aggregate demand. Reac-quainting the economics communitywith this equivalence concept, RobertBarro (1974) postulated the follow-ing: Agents with rational expectationsrealize that even governments thatfinance some extra spending throughdeficits will eventually raise taxes tobe able to repay the borrowed funds.Therefore taxpayers, while beingmore liquid today because less moneyis taxed away, will not consume morebut save more to pay for the highertaxes that one day will come. Accord-ing to the Barro/Ricardo equivalence


Expansionary Fiscal Consolidations?

An Appraisal of the Literature on

Non-Keynesian Effects of Fiscal Policy and

a Case Study for Austria

theorem, deficits will thus affect nei-ther consumption nor the totalamount left for investment, implyingthat the tax multiplier in this modelis zero.

The assumptions on which the Ri-cardo/Barro theory is based are verystrong. Relaxing the necessary as-sumptions by allowing for imperfectforesight, liquidity constraints, distor-tionary taxation as well as nonaltruis-tic behavior with respect to bequestscan limit the degree of Ricardianequivalence. Most important, in theempirical literature, Ricardian equiva-lence is highly ambiguous, whichwould support Ricardo�s doubts thathis equivalence idea might not workin practice.

2.3 Neoclassical EffectsThe third �traditional� school ofthought explaining economic effectsof fiscal policy is the neoclassical para-digm. Neoclassical economics concep-tualizes agents as farsighted, rationalactors (like the Ricardian model) withfinite life spans (unlike the Ricardianmodel) and assumes individuals tooptimize consumption over their lifecycles. In this setup, budget deficitsmay shift the tax burden to future gen-erations, thus raising total life-timeconsumption for current consumers.Under the assumption of marketclearing, increased consumption im-plies a reduction in private saving,which in turn causes interest rates toadjust to reinforce balance on the cap-ital market. Thus, permanent deficitsin particular crowd out private capitalaccumulation, which Bernheim (1989)regards as highly detrimental for theeconomy. For Austria, Zagler (2002),following Elmdorf and Mankiw(1999) quantified the maximal level

effect on GDP that is caused by the re-duction in the capital stock — andhence implies reduced productionpossibilities — at 2.5% of GDP.

2.4 Non-Keynesian effects:The Expectational View

If a change in current fiscal policy istaken to as a signal for future fiscal ac-tion, fiscal adjustments may affect ag-gregate demand in a different waythan the conventional Keyenesianview would suggest. According tosuch an �expectational view of fiscalpolicy,� a fiscal contraction that is per-ceived to imply a permanent reduc-tion in government spending as a shareof GDP will fuel expectations of lowertaxes in the future. Future lower taxesincrease households� permanent in-come and thus are assumed to raisecurrent consumption and investmentsuch that aggregate demand increases,resulting in an upturn in output andemployment. Being in contrast toconventional Keynesian wisdom,these effects are called non-Keynesianeffects.

These ideas have also been intro-duced into neoclassical models inwhich individuals are infinitely livedand government consumption is purewaste. A fiscal adjustment designedto reduce wasteful government con-sumption clearly is associated withan increase in private wealth via re-duced future taxation and hence stim-ulates private consumption.

An added feature of the recent lit-erature on non-Keynesian effects isthat it has tried to model nonlinear ef-fects of fiscal policy. These modelscapture the switch of fiscal policy ef-fects from Keynesian effects to non-Keynesian effects (and vice versa), astriggered by the state of the economy.






2.4.1 Nonlinear Effects in aKeynesian Setup

Blanchard (1990), and later on alsoSutherland (1997) and Perotti (1999)introduced models in a Keynesiansetup where the effects of fiscal policyon economic variables, above all onprivate consumption, depend on thelevel of public debt. In such setups,fiscal policy exhibits the usual Keynes-ian effects on consumption at moder-ate levels of public debt and debt accu-mulation, but develops non-Keynesianeffects once debt reaches extreme val-ues. In such models, fiscal policy thusgives rise to nonlinear consumer be-havior.

The idea is that at high levels ofdebt, the amount of taxes necessaryto stabilize the debt position inducesa significant deadweight loss. Thehigher the tax rate required to consol-idate, the larger the disruptions gen-erated by the adjustment. So, if a con-solidation is expected not to inducesharp tax increases in the future topay back the debt, deadweight losseswill be lower. Hence, expected per-manent income increases, which pos-itively affects consumption — whichimplies that a fiscal consolidation canbe expansionary. Conversely, an ex-pansion program implemented whenthe debt ratio is already high is verylikely to trigger sharp tax increasesto ensure the sustainability of publicfinances, thereby reducing income inthe near future. In that case the effectof the tax hike on life-time income ismuch larger than the small positive ef-fect of fiscal transfers — which indi-cates that a fiscal expansion can becontractionary in these times.

As Blanchard (1990) and Suther-land (1997) assume finitely lived con-sumers, at low levels of debt, consum-ers perceive the next stabilization pro-gram in the distant future when they

are very unlikely to be alive. As theburden of future very distortionarytaxes is unlikely to fall on them, theydiscount future taxes heavily. Hence,the negative effects of a tax increasethat does occur outweigh the positiveeffects of increased sustainability ofpublic finances. Fiscal expansions ex-hibit the usual Keynesian effects onconsumption when the debt ratio islow, since an intergenerational shiftof taxes is still deemed possible.

In Perotti (1999) this nonlinear ef-fect of fiscal policy is the result of thecoexistence of liquidity constrainedand unconstrained individuals. Asconstrained individuals consume alltheir disposable income in each pe-riod, their consumption function ispurely Keynesian. For unconstrained,forward-looking rational consumersa change in government taxation mayexert a positive impact due to positivewealth effects from expected lowerdistortionary taxes. If the stimulus tooutput induced by an expenditure in-crease is not able to outweigh the neg-ative wealth effects generated byhigher distortionary taxation, con-sumption will decrease, i.e. non-Keynesian effects may prevail. Thesenon-Keynesian effects are stronger,the higher the debt level is, sincehigher financing needs imply higherdistortionary taxation.

Hence in this model both expendi-ture and revenue shocks have the usualKeynesian correlation with privateconsumption in normal times (i.e.when debt ratios are low) due to thereaction function of liquidity con-strained consumers. However, in ex-ceptional times the strong non-Keynesian reaction function of uncon-strained individuals might outweighthe Keynesian reaction function pro-vided unconstrained individuals ac-count for a high enough share in the






population. Thus the effect of a shockon consumption is the weighted effecton constrained and unconstrained in-dividuals and depends on the level ofgovernment debt.

2.4.2 Nonlinear Effects in aNeoclassical Setup

In contrast to the models presentedabove, Bertola and Drazen (1993) in-vestigate the possibility of nonlineareffects of fiscal policy, above all ofgovernment expenditure, in a neo-classical framework. In a neoclassicalsetup where consumers are infinitelylived and government consumptionis pure waste, every cut in govern-ment spending increases private con-sumption. Reduced governmentspending in these models implies a de-crease in the expected future tax bur-den, which in turn increases life-timedisposable income and private con-sumption. Therefore, in normal timesthe relationship between governmentconsumption and private consumptionis inverse.

However, as government spendingis on an upward path, a stabilizationprogram is necessary at specific trig-ger points to ensure the sustainabilityof public finances. At very high levelsof government spending, agents knowthat stabilization has to take place,which means that government spend-ing falls sharply. This cut induces ex-pectations that both future spendingand the discounted value of future ex-pected taxes will be lower. Therebyindividuals� wealth and private con-sumption are increased. Hence, a fur-ther rise of government spending in-creases the likelihood that stabilizationtakes place soon, which in turn indu-ces higher consumption.

Even though the model has a neo-classical structure, the result just pre-sented for very high values of govern-ment spending (close to the triggerpoint) has a Keynesian implication —namely that higher governmentspending induces higher private con-sumption. So in this model the neo-classical inverse relationship betweenprivate and government consumptionflattens out and even reverts shortlybefore consolidation episodes whenthe ratio of government spending/GDP increases further.

2.5 Nonlinear Effects:Further Credibility Effects

Among others2McDermott and West-cott (1996) highlight the wealth ef-fects on demand induced by changesin interest rates. A country facing highlevels of public debt or rapidly in-creasing public debt might face an in-terest rate premium on its debt, re-flecting the underlying inflation riskor default risk. If a consolidation isperceived to have a permanent debtreducing effect, the sustainability ofpublic finances becomes more credi-ble. Hence inflation expectations aswell as the default risk premiumshould be reduced, both resulting ina decrease of interest rates. Thisshould increase the market value ofconsumer�s portfolios — their wealth— and increase aggregate demand,and especially those demand compo-nents that are sensitive to interestrates.

Even though this channel allowsfor nonlinearities — at very high levelsof public debt a fiscal expansion mightincrease interest rates, thereby reduc-ing wealth and hence demand — it cru-cially hinges on the credibility of fiscal

2 Alesina and Perotti (1997a), Giavazzi and Pagano (1990, 1996), Perotti (1999), Ho‹ppner and Assenmacher-Wesche (2001).






policy. If there is doubt in the govern-ment�s ability to significantly decreasepublic debt, interest rates will mostlikely not change.

Furthermore, Auerbach (2002)hints that a theoretical foundation forthe very popular view of a simultane-ous decrease in real interest rates andhigher aggregate demand is hard toderive. Using a simple IS-LM model,he shows that an increase in aggregatedemand is usually accompanied by anincrease in interest rates — even whenexpectational effects are taken into ac-count. However, Auerbach (2002)qualifies his analysis as he allows forcreative amendments to the simpleIS-LM analysis, or supply-side effectsthat can bring about an increase in ag-gregate demand and a decrease in in-terest rates simultaneously.

2.6 Nonlinear Effects: The Supply SideAlesina et al. (2002) introduce a sup-ply-side model that emphasizes the la-bor market as the main transmissionchannel for fiscal policy.3 Accordingto this model an increase in govern-ment spending, more particularly inthe real compensation of governmentemployees, puts upward pressure onprivate sector wages. If unions arestrong enough to enforce their claims,an increase in the compensation ofgovernment employees or alterna-tively a hike in labor taxation increasesoverall unit labor cost. Standard as-sumptions on the link between themarginal profitability of capital andreal labor compensation show that anincrease in real compensation de-creases profits and the shadow valueof capital and hence curbs investment.Therefore the model explains an in-crease in private investment duringepisodes of fiscal contraction.

In contrast to the demand-sidemodels presented above, in this sup-ply-side model the reaction to fiscalpolicy does not hinge on initial fiscalconditions such as the level of debtor of government expenditure. Itrather depends on the compositionof the fiscal adjustment, namely onwhether consolidation is broughtabout by labor tax increases or by cutsin government spending, wage expen-diture in particular. At any rate, theAlesina et al. (2002) supply-sidemodel does not incorporate nonli-nearities due to the dynamics of fiscalvariables, but rather relies on nonlin-ear effects caused by changes in thecomposition.

2.7 Some Critical Comments on thePractical Relevance of Theory

As already mentioned above, the the-oretical rationale for the emergenceof non-Keynesian fiscal consolidationsin the models above hinges cruciallyon(a) the assumption of perfectly ra-

tional agents,(b) the credibility of the adjustment,

and(c) the composition of the adjust-

ment.The variable driving private con-

sumption behavior in all four modelsof the �expectational view� is the ef-fect current policy has on expecta-tions about future policy changes(such as a very high debt ratio). Thesepolicy changes are linked to the mate-rialization of a rare and momentousevent, and agents have to anticipatethe effects of this credibly changed fis-cal strategy.

In practice, however, buildingcredibility seems to be a particularlyslow and difficult process when it

3 For related work on that channel see Alesina and Perotti (1997b) and Lane and Perotti (2003).






comes to political decisions, since po-litical agents often face a time incon-sistency problem. This means that astrategy once adopted as the optimalstrategy may cease to be optimal andhas to be changed accordingly. Inother words, when the frameworkconditions change, a consolidationpolicy may have to be reversed. In ad-dition, changing governments oftenhave little incentives to commit totheir predecessors� actions, and oftenreverse at least part of their decisions;thereby not adding to the credibility offiscal adjustments. Therefore agentsthat are learning from past errors —one of the major features of rationalexpectations — might not be willingto give credit to any fiscal consolida-tion, since they know from past expe-rience that fiscal consolidations haveoften been reversed.

3 Empirical EvidenceThe empirical literature on non-Keynesian effects of fiscal policy isvery inhomogeneous not only withrespect to the results, but also withrespect to the approaches applied.The approaches currently used in theliterature can be grouped as follows:Case studies focusing on a small num-ber of countries (see section 3.1);descriptive studies on �successful fiscalconsolidations� (see section 3.2.1)and, drawing on the latter, cross-country studies investigating the char-acteristics of expansionary fiscal con-solidations, i.e. trying to identify/describe circumstances that supportthe emergence of non-Keynesian ef-fects (see section 3.2.2); and finallycross-country or panel regressionstesting econometrically for nonlinear-ities of the effects of fiscal policy onoutput and its components consump-

tion, investment or national saving(see section 4).

3.1 Empirical Literature: Case StudiesWith their case study on large budgetconsolidations in Ireland and Den-mark in the 1980s, Giavazzi and Pa-gano (1990) sparked the scholarly de-bate on nonlinear effects of fiscal pol-icy. Denmark and Ireland, first identi-fied by Giavazzi and Pagano ascountries that �are the two most strik-ing cases of �expansionary stabiliza-tion� in Europe,� (1990, non-technicalsummary) are cited throughout theliterature and have also made theirway into macroeconomic textbooks.

3.1.1 Denmark and IrelandGiavazzi and Pagano (1990)4 investiga-te in detail the periods of fiscal turn-around in Denmark in 1983—1986and in Ireland in 1982—1984 and1986—1989, periods in which the fullemployment deficit decreased by atleast 7% of GDP, respectively. In Den-mark, consolidation was followed by astrong expansion, as was the secondconsolidation round in Ireland(whereas after the first round, GDPgrowth had fallen considerably). Bothexpansionary consolidation periodswere accompanied by concomitantmonetary and exchange rate policies:an initial sizeable devaluation wasfollowed by a currency peg to theDeutsche mark, which resulted in adramatic decrease in nominal interestrates as well as disinflation. Further-more capital flows were liberalizedconsiderably and wage moderationhelped to improve competitiveness inboth countries.

At the same time, the two consol-idation patterns differ in terms ofcomposition: whereas the Danish gov-

4 Related work has been done by Alesina and Perotti (1997a).






ernment relied heavily on tax in-creases — mostly on direct taxation —the Irish consolidation was mostlyachieved on the expenditure side;brought about by lower governmenttransfers, a lower government wagebill and reduced investment. Simulta-neously, the tax base was broadenedwhile marginal tax rates on householdincome and corporate tax rates werereduced considerably.

As the overall findings were onlypartially supporting the existence ofnon-Keynesian effects the authorsstate that �part of the expansionary ef-fects of the fiscal contractions analysedhere must be attributed to the con-comitant monetary disinflation, [�]and the liberalisation of capital flows.�Nonetheless, they conclude: �thatthere are cases in which the �Germanview�5 has a serious claim to empiricalrelevance� (Giavazzi and Pagano,1990, p. 32).

Their conclusions are, however,highly controversial as fiscal policywas evidently not the major drivingforce behind the observed increasein growth rates. Summarizing themajor criticism6 Eichengreen (1998,p. 256) states: �For Denmark and Ire-land in the 1980s, for example, ana-lysts argue that fiscal consolidationoccurred during the period of thesoaring US dollar; the favourablecompetitiveness effects of these coun-tries� depreciating real exchange ratestherefore swamped the negative out-put effects of the contractionary fiscalimpulse.� For Ireland, Blanchard(2000, p. 337) adds that �Productivitywas increasing much faster than realwages, reducing the cost of labourfor firms. Attracted by tax breaks,low labour costs and an educated la-

bour force, many foreign firms werecoming to Ireland to create newplants.�

3.1.2 Other CountriesTaking into account some criticism, amore cautious subsequent study wasprovided by Alesina and Ardagna(1998), who focused on ten fiscal ad-justments in the 1980s and 1990s.Only two out of the ten were classi-fied as unambiguously expansive,namely Ireland 1987—1989 and Aus-tralia 1987. These consolidation epi-sodes share sizeable devaluations aswell as the policy of wage moderation,generating a boost in competitiveness.

Interestingly, the often cited caseof Denmark was only considered asmixed evidence, since even thoughduring the adjustment the economywas clearly expanding, in the immedi-ate aftermath Denmark experienced asevere downturn.

3.1.3 Interpretation of FindingsTo sum up the evidence of the casestudies referred to above, it seems thatthe effects of fiscal policy can hardlybe assessed on their own. As so manyextraordinary factors are affecting theeconomy at the same time it is difficultto filter out the effects of fiscal policykeeping a ceteris paribus assumption,since mostly a significant change in fis-cal policy was just part of a whole�policy package.� As Giavazzi and Pa-gano (1990, p. 33) state �This expan-sionary effect, however, cruciallyhinged upon the credibility of thefixed parity chosen by the monetaryauthorities: it is remarkable that inboth our cases of �expansionary con-tractions� the shift in fiscal and ex-change rate policy was preceded by a

5 The German view states that an exceptional fiscal consolidation positively affects aggregate demand.6 See also Barry (1991), Barry and Devereux (1995), and Andersen and Risager (1988).






sizeable devaluation.� Whether ac-companying structural reforms suchas changes in wage systems or in mon-etary policy were unintended or infact designed to minimize the adverseeffects of fiscal policy has not beenanalyzed. Furthermore, as the casestudies refer to specific countries invery specific situations, one shouldbe hesitant to generalize the patternsobserved in these countries.

3.2 Empirical Literature:Descriptive Evidence

Based on observations from the casestudies, attempts have been made toidentify systematic characteristics of

exceptional fiscal periods and theireffects on the economy.

A common theme of the closelyrelated strands of literature on thecharacteristics of �successful fiscal pol-icy� and on those of �non-Keynesian ef-fects� is the attempt to identify periodsof fiscal policy in which non-Keynesianeffects are likely to be observed.Clearly, that literature draws heavilyon the theoretical idea that non-Keynesian effects can only be ob-served in �exceptional� periods, whichare typically defined as periods withlarge changes in cyclically adjusted pri-mary balances, or alternatively periodsof large and growing debt.7

7 To give one example, the European Commission (2003) defines fiscal consolidation periods such that the cycli-cally adjusted primary budget balance improves by at least 2 percentage points of GDP at time t or by at least 1.5percentage points in each of two consecutive years.

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Naturally due to the arbitrarinessof the different definitions applied,the periods identified as exceptionalfiscal episodes in individual studiesvary considerably. Chart 1 indicatesyears which have been identified ascontractionary fiscal episodes in atleast half8 of the seven studies investi-gated, and hence can be considered asrobust fiscal episodes.9

A closer look at some of the —seemingly very robust — remaining�exceptional� episodes uncovers fur-ther problems with the methods usedand the underlying data. According toAlesina and Ardagna (1998) the con-solidation periods identified in Spainin the period 1986—1987 should beexcluded, since the improvement inthe budget balance reflects highgrowth rates rather than discretionaryfiscal policy measures. Due to meth-odological limitations of cyclical ad-justments, part of the changes in thebudget balance was incorrectly attrib-uted to discretionary fiscal policy.

However, the episodes identifiedas strong fiscal contractions are notonly subject to the definition appliedand cyclical adjustment methods, butalso to special influences — temporarymeasures — underlying the data. In therun-up to EMU, some EU countriesrelied particularly heavily on tempo-rary measures to improve their budgetbalances. Hence most likely, the epi-sodes identified in the different studiesare not very robust, neither with re-spect to the definitions chosen, norwith respect to taking account ofexternal/exogenous factors, such astemporary measures.

3.2.1 Successful Fiscal Policy EpisodesFurther refining the concept of con-solidation, part of the literature paysparticular attention to �successful fis-cal consolidations.� A successful con-solidation is interpreted such that thedebt/GDP ratio is reduced by a spe-cified amount during/after the con-solidation.

Even though this strand is not di-rectly assessing non-Keynesian effectsof fiscal policy, it is included in this lit-erature survey because, in a way, it haspaved the way for the descriptive liter-ature on non-Keynesian effects of fis-cal policy and because it is also(wrongly) used for policy advice onnon-Keynesian effects.

Alesina and Perotti (1995, 1996,1997a), McDermott and Westcott(1996), Alesina and Ardagna (1998),Alesina et al. (1998), Giavazzi andPagano (1990)10 and Zaghini (1999)divide the consolidation periods intoexpansionary and nonexpansionaryepisodes and investigate the underly-ing asymmetries of successful andunsuccessful adjustments. In addition,Ko‹hler-To‹glhofer and Zagler (2004)find that the very characteristics sup-porting the reduction of debt/GDPratio during consolidation periods alsokeep public finances on a sustainablepath during fiscal expansions.

The main and almost unambiguousfindings are that a successful fiscal ad-justment is characterized by expendi-ture cuts rather than tax increases.Furthermore, expenditure cuts in suc-cessful consolidations fall mostly oncuts in transfer payments and govern-ment wage expenditure. Consolida-

8 As a result, the chart may not fully reflect the episodes referred to in the text (Austria and Ireland being cases inpoint).

9 Contractionary episodes of the following studies were investigated: Afonso (2001), Alesina and Ardagna (1998),Alesina and Perotti (1995), Alesina and Perotti (1996), Giavazzi et al. (2000), McDermott and Westcott(1996), Zaghini (1999).

10 Not derived by comparative statistics, rather by regression.






tions that rely heavily on increases intaxes, above all direct taxes on house-holds and indirect taxes, and includevery little expenditure cuts, tend tobe unsuccessful. However, there isno consensus as to whether the sizeof the fiscal consolidation makes a dif-ference between successful and unsuc-cessful episodes.

With respect to differences inmacroeconomic variables betweensuccessful and unsuccessful consolida-tion periods, advocates of this litera-ture conclude that GDP growth ratesare higher in successful than in unsuc-cessful consolidations. Investmentbooms, private consumption grows,unit labor costs decrease and profitsincrease as well as trade balances im-prove during and after successful con-solidations.

As revenue and expenditure itemsare sensitive to the cycle, asymmetriesin the composition observed betweensuccessful and unsuccessful consolida-tions — such as less transfer paymentsduring and immediately after success-ful adjustments — might be due to dif-ferent positions in the cycle. Follow-ing Eichengreen (1998, p. 256) �Analternative interpretation, therefore,is that when there is sustained acceler-ation in growth for reasons having lit-tle to do with fiscal policy much of theinduced reduction in the deficit takesthe form of a fall in government trans-fers.�

Altogether, the literature on suc-cessful consolidations is mainly of adescriptive nature — simply comparingmean values, and therefore not able totake into account all possible correla-tions and causalities, as McDermottand Westcott state (1996, p. 741):�Given the interactions between eco-nomic growth and changes in publicdebt ratios, it is difficult to distinguishbetween the contribution of good

growth to successful consolidationsand the effect of successful consolida-tions in boosting demand andgrowth.�

3.2.2 Non-Keynesian Fiscal PolicyEpisodes

Drawing on the experiences of the lit-erature on successful consolidations,Alesina and Ardagna (1998), Alesinaet al. (2002) and the European Com-mission (2003) investigate the char-acteristics of expansionary fiscal con-solidation. They define periods ofexpansionary tight fiscal policy suchthat some measure of GDP growth(either actual growth, trend growthor the growth difference from G7average rates) is higher on averageduring and after the consolidationthan before.

In contrast to the literature onsuccessful fiscal consolidations, the fo-cus is now on the development ofGDP growth rather than on the devel-opment of the debt ratio. However,the characteristics identified to influ-ence the likelihood of expansionaryfiscal consolidations turn out to besimilar to those accompanying suc-cessful fiscal consolidations.

Whereas Alesina and Ardagna(1998) argue that expansionary ad-justments are much larger than con-tractionary ones, the European Com-mission (2003) suggests that the sizeof the adjustment is not significantlydifferent. At the same time, there isunambiguous consent among the au-thors that the composition of theadjustment plays a key role in deter-mining whether the adjustment willhave expansionary or nonexpansion-ary effects. Expenditure-based consol-idations are more likely to be expan-sionary than consolidation periodsbased on revenue increases. Alesinaand Ardagna (1998) and Alesina et






al. (2002) find that cuts in transferspending as well as in governmentwages are characteristic for expan-sionary fiscal consolidations; a state-ment that is not verified by the Euro-pean Commission, which does notfind a significant difference in the de-velopment of the compensation ofpublic employees.

Concerning the macroeconomicenvironment, the finding that growthis higher during expansionary consol-idations is not surprising, given thedefinition of expansionary consolida-tion chosen. When the definition ofexpansionary fiscal policy is condi-tioned on higher growth rates after aconsolidation, this is what one shouldactually be able to observe.

In order to avoid the argumentthat macroeconomic developmentsare mainly caused by accompanyingmonetary policy, the European Com-mission isolates so-called �pure expan-sionary consolidations,� which com-prise roughly half of their �expansion-ary fiscal consolidations.� These epi-sodes are characterized by fiscalconsolidations in which the averagechange in real short-term interestrates between t—1 and t+1 is nonneg-ative. However, for running the com-parative statistics, the European Com-mission does not apply this distinctionbut uses all episodes of expansionaryfiscal consolidations.

We extend the European Commis-sion statistics on pure expansionaryfiscal consolidations to assess the com-position and macroeconomic effects,once concomitant monetary policy isexcluded. The striking difference isthat compositional differences be-tween pure expansionary fiscal con-solidations and nonexpansionary con-solidations are no longer significant.Hence, it seems that it is not the com-position that is the driving factor be-

hind expansionary fiscal consolida-tions, but rather monetary policy.However, the macroeconomic envi-ronment is the same as under expan-sionary fiscal consolidations and sig-nificantly different from nonexpan-sionary fiscal consolidations.

4 Empirical EstimationsEmpirical tests of theoretical hypothe-ses of non-Keynesian effects employ anumber of different methods and fo-cus on various components of growth.Following various theories, the re-gressions intend to capture the wealtheffect that arises when the expectedsize of permanent income is altereddue to different expectations aboutthe tax path.

The variables on which non-Keynesian effects of fiscal policy areinvestigated are: The effects of fiscalpolicy on consumption (see section4.1); effects of fiscal policy on na-tional saving (see section 4.2.1); ef-fects of fiscal policy on investment(see section 4.2.2) and effects of fiscalpolicy on GDP (see section 4.3.4).

4.1 Effects of Fiscal Policyon Consumption

Van Aarle and Garretsen (2003),Afonso (2001), Hjelm (2002), Ho‹pp-ner and Assenmacher-Wesche (2001),Miller and Russek (2003), Perotti(1999) and Giavazzi and Pagano(1996) all focus on non-Keynesian ef-fects on a consumption function,mostly using cross-country/panel es-timations for (a subsample of) OECDcountries. Common to their estima-tion procedures is that they assumethe existence of two different re-gimes: a Keynesian regime prevailingduring �normal� times, and a non-Keynesian predominant in �excep-tional� times. Exceptional times aredefined in line with the ad hoc defini-






tions in the descriptive literature, ei-ther as large changes of cyclicallyadjusted primary balances; as strongfiscal contractions or expansions; oras times of high debt levels. Thesedistinct regimes are intended to repre-sent periods in which differentexpectations of the future tax pathsare prevailing. Hence, this switch inexpectations is empirically capturedby a sign reversion of the effects offiscal policy on macroeconomic varia-bles, which is in line with the theoryreferred to above. Econometrically,the authors introduce dummy varia-bles to capture the effects of the twodifferent regimes.

Reviewing the empirical literaturewith respect to the regression methodsapplied, this paper assesses the resultsby Giavazzi and Pagano (1996) to-gether with those of Aarle and Garret-sen (2003), since the latter replicatethe model designed by Giavazzi andPagano. Both studies estimate variousspecifications of that type; whereasGiavazzi and Pagano test the robust-ness of the equations with respect todifferent estimation techniques, vanAarle and Garretsen test the robust-ness with respect to various definitionsof exceptional fiscal episodes.

Depending on the different speci-fications applied, Giavazzi and Pagano(1996) find significant non-Keynesianeffects with respect to roughly one-quarter of the estimated fiscal varia-bles.11 Van Aarle and Garretsen (2003)— focusing on the effects of fiscal ad-justments of EU countries from1990—1998 — can hardly support theexistence of non-Keynesian effects offiscal policy on consumption, sincenone of the estimated regimes turns

out to differ significantly from theother.

The second group of authors —Afonso (2001), Miller and Russek(2003) and Perotti (1999) — are inter-ested not only in non-Keynesian ef-fects but also assess the possibility ofnonlinear effects of fiscal policy onconsumption during different re-gimes. These nonlinear effects indi-cate whether the original effect of fis-cal policy is changed — weakened —during exceptional times. Only in asecond step do the authors assesswhether the resulting non-linear ef-fects are truly non-Keynesian.

This paper compares their resultswith respect to three definitions ofexceptional fiscal episodes applied,namely a large change in the cyclicallyadjusted primary balance (Miller andRussek, 2003, Afonso, 2001); highdebt levels (Perotti, 1999); and strongfiscal contractions or expansions.Judging from table 1 below, govern-ment expenditures are more likely toexhibit nonlinear effects on privateconsumption than government reve-nues. However, the empirical evi-dence is rather inconclusive, not onlybecause the estimated effects in thestudies are mostly not significant,but comparing the partly contradict-ing conclusions of the studies con-sidered results in an even strongerinconclusiveness. Whereas Miller andRussek (2003) find only Keynesianeffects during fiscal contractions,Afonso (2001) reports non-Keynesianeffects during fiscal contractions. Incontrast to this, Miller and Russek(2003) report non-Keynesian effectsfor fiscal expansions, whereas Afonso(2001) does not find any evidence

11 The fiscal variables are tax changes, lagged taxes, transfer changes, lagged transfers, public consumption changes,lagged public consumption.






for non-Keynesian effects during ex-ceptional government expansions.

In contrast to these two analyses,Perotti (1999) finds not only non-linear effects between normal andexceptional times, but also non-Keynesian effects of government ex-penditure. Using a VAR frameworkto derive unexpected fiscal policyshocks, Perotti (1999) is only inter-ested in assessing the effects of theseshocks on private consumption, but�the results presented here have noth-ing to say about the effects of system-atic fiscal policy as a stabilizing tool�(Perotti, 2002, p. 2).

In contrast to the authors above,Ho‹ppner and Assenmacher-Wesche(2001) use a Markov-switching ap-proach, which allows for an endoge-nous determination of the two differ-ent regimes — Keynesian and non-Keynesian. Interestingly, the dates ofthe regime shifts do not correspondto any consolidation or expansion pe-riod identified in the literature, butthey all fall into periods of businesscycle downturns.

To sum up the results of the stud-ies discussed above, empirical evi-dence does not appear to give anunambiguous answer about the exis-tence of non-Keynesian effects on pri-vate consumption. Only a few out of alarge number of empirical estimationsin fact find non-Keynesian results onprivate consumption — not even taking

into account the problem of endoge-neity or concomitant monetary policy.

4.2 Effects of Fiscal Policy onNational Saving, Investment andGDP Growth

4.2.1 � on National SavingGiavazzi et al. (2000) find that the ef-fect of fiscal policy on national savingis at odds with the Ricardian equiva-lence theorem. Even though non-linearities in the national saving be-havior are observed during excep-tional times, the original effects dur-ing normal times are never reversedcompletely but continue to followthe traditional theory.

4.2.2 � on InvestmentAlesina et al. (2002) find that an in-crease in government spending duringexpansions reduces business invest-ment, which is consistent with thesupply-side model of the labor marketchannel. Taxes reduce investmentdynamics, but their effect is muchsmaller than that of government ex-penditure.

As fiscal consolidations usually in-corporate some kind of spending re-ductions, increases observed in pri-vate investment are to be attributedto the labor market channel of thesupply-side model. The fact that in-vestment rises even though govern-ment spending is cut, has also beenobserved in the descriptive analysis

Table 1

Effects of Fiscal Policy on Consumption

Exceptional episodes Fiscal contractions Fiscal expansions

expenditure revenue expenditure revenue expenditure revenue

Afonso EU-15 nonlinear non-Keynesian non-Keynesian non-Keynesian nonlinear Keynesian2001 panel (not sign.) (not sign.) (not sign.) (not sign.) (not sign.)

Miller und Russek OECD 19 not estimated not estimated Keynesian Keynesian nonlinear nonlinear2003 panel not estimated not estimated (sign.) (sign.) (not sign.) (not sign.)

Perotti OECD 19 non-Keynesian non-Keynesian not estimated not estimated not estimated not estimated1999 VAR (sign.) (? sign.)

Source: Author�s compilation.






of expansionary fiscal contractions. Inother words, since no structuralbreaks have been found, business in-vestment obviously does not react dif-ferently in normal and exceptional pe-riods. So what makes a difference interms of business investment growthis not the presence or absence of con-solidation measures, but rather thecomposition of fiscal policy in gen-eral. This might be the reason whythe authors question �the need for�special� theories for large versussmall changes in fiscal policy� (Alesinaet al., 2002, p. 586).

4.2.3 � on GDP GrowthProbably closest to the literature onconsumption are Miller and Russek(2003), since they explicitly differen-tiate between different regimes whenregressing the effects of fiscal policyon GDP growth. However, as theirevidence on non-Keynesian effects offiscal policy was rather inconclusive,the authors state that �The findingscast some doubt on the possibility thatunusual fiscal outcomes reflect somesystematic relationships in the macroeconomy. Rather, special circumstan-ces and conditions may dictate whenand where unusual fiscal outcomeemerge� (Miller and Russek, 2003,p. 57).

Without allowing for two differ-ent regimes, in particular not explic-itly allowing for exceptional times,von Hagen et al. (2001), Blanchardand Perotti (2002) and Perotti(2002) provide evidence that the im-pact of fiscal policy is generally rathersmall and decreasing over time. An

explicit distinction between pre-1980 and post-1980 effects in Perotti(2002) unveils that in the post-1980period, unexpected governmentspending shocks exert significantlynegative effects on output growthwithin the first three years after theshock in most of the investigatedcountries. On impact, fiscal policythus tends to exhibit the usual Keynes-ian effects. Hence, in the short termthe effects of fiscal policy mostly re-main Keynesian even from 1980 on-wards, which may change as time pro-gresses. Furthermore, as these studiesonly focus on the effects of shocks,evidence on the existence of non-Keynesian effects of fiscal policy —not only of fiscal innovations — re-mains rather weak.

5 Austrian Case StudyThis case study is intended to improveawareness of underlying methodologi-cal problems, in particular with re-spect to temporary measures. We as-sess the fiscal episode 1995—1997since this episode was identified asan expansionary fiscal consolidationbefore the third stage of EMU by theEuropean Commission.12

As in 1995 the cyclically adjustedprimary balance only improved by0.2 percentage points, and the consol-idation package was only introducedin April 1996, we concentrate ouranalysis on the more important years1996 and 1997.13

This consolidation package basi-cally relied on revenue-raising meas-ures such as abandoning exemptionsfrom wage and personal income taxa-

12 The period 1995-1997 was identified as expansionary with respect to the persistence criterion by the EC. Thiscriterion required that the primary cyclically adjusted budget balance improves by at least 3 percentage points ofGDP over three consecutive years and in each year the change in the primary cyclically adjusted budget balancecannot be below —0.5 percentage point of GDP. The periods chosen to assess the growth effects follow the method-ology of the European Commission.

13 For details on the consolidation packages please see Brandner and Diebalek (2000).






tion and the introduction of an energytax on electricity and natural gas. Atthe same time, expenditure measureswere enforced, including a virtualfreeze in nominal salaries, a reductionof the public payroll by 11,000 per-sons and cuts in the transfer system.In other words, the government optedfor a mixed consolidation package.

In 1997, moreover, one-off meas-ures contributed heavily to the im-provement of the primary cyclicallyadjusted budget balance. The privati-zation of ASFINAG (the public sectorroad construction company) and ofpublic utilities (providers of wastesewage disposal services and watersuppliers) reduced government nomi-nal investment expenditure from2.8% of GDP in 1996 to 2% ofGDP in 1997. Payments from PSK,the Austrian postal savings bank, andtelecommunication licensing proceedsprovided additional revenues of ap-proximately 0.5% of GDP. In otherwords, the strong tightening of the fis-cal stance was mainly an artefact re-sulting from one-off measures. Hadit not been for the additional revenuesand expenditure cuts arising fromone-off measures, 1995—1997 wouldnot even qualify as a consolidation pe-riod according to the European Com-mission�s definition in Austria. Fur-thermore, it is not yet clear whetheroutsourcing has indeed short-rungrowth effects.

Moreover, this strong consolida-tion was not long lasting at all, sincethe fiscal stance was relaxed quite sig-

nificantly in 1998, deteriorating to1.4% of GDP, which implies a deteri-oration of 1.1 percentage points from1997.

To analyze the timing of Austrianfiscal consolidations, this paper lookedat the growth rate cycles at the respec-tive periods. Interestingly enough, theconsolidation started in a period ofaccelerating growth rates, which im-plies that the consolidation couldprofit from good economic condi-tions. However, it seems that the fiscalconsolidations were not able to extendthe episodes of accelerated growth,but rather curbed them significantly,as the trough of the business cyclewas identified in 1998.

6 Concluding RemarksEven though the theoretical rationalefor the existence of non-Keynesianeffects of fiscal policy is straightfor-ward, its empirical relevance cruciallyhinges on whether consolidation ef-forts of governments are credible.However, gaining credibility — apartfrom being a tough challenge — is agradual process.

This might be one reason why theempirical evidence on expansionaryfiscal contractions is ratherweak. Someauthors find unambiguous evidencefor the existence of non-Keynesianeffects of fiscal innovations, but themajority of the papers comes up withrather inconclusive answers. Compar-ing the partly contradicting conclu-sions of the studies considered resultsin an even stronger inconclusiveness.

Table 2

Austria�s fiscal consolidation 1996—1997

Consolidation year Cyclically adjusted primary balance Average real GDP growth Cyclical condition

t�1 t tþ1 tþ2 (t�2)�(t�1) t�(tþ2) peak trough

1996 �0.7 0.70 2.50 1.40 2.00 2.80 1996 19981997 0.7 2.50 1.40 1.10 1.60 3.40 1996 1998

Source: Statistics Austria, Economic Cycle Institute.






The empirical evidence surveyedin this paper provides no clear supportfor the existence of expansionaryfiscal consolidations. The safest con-clusion seems to be that fiscal policyhas lost some of its ability to stabilizethe economy over the recent pastduring the 1990s. Possibly this dimin-ishing power of fiscal policy is associ-ated with the opening of economiesand the rather fast integration of good

markets in Europe together with theliberalization of capital markets.Moreover, the Maastricht Treaty andthe Stability and Growth Pact, whichchanged the fiscal framework in the1990s, as well as the debate on thesustainability of pension systems forageing societies may also have weak-ened the short-term effectiveness offiscal policy in stabilizing output andemployment.

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On June 18, 2004, the Intergovernmental Conference (IGC), constituted by the European Heads ofState or Government, reached an agreement on the Treaty establishing a Constitution for Europe whichprovides a new, consistent legal architecture for the EU. The legal and institutional framework for theEuropean System of Central Banks (ESCB), the European Central Bank (ECB) as well as for the singlemonetary policy is defined in both the constitutional provisions of Part I and the policy areas of Part IIIof the Constitutional Treaty. The Statute of the ESCB/ECB is attached to the Treaty as a protocol.

The constitutional provisions (Part I) not only define price stability as one of the EU�s generalobjectives, but also confirm the sui generis nature of the ECB as enshrined in the Treaty on EuropeanUnion. The Constitutional Treaty integrates the concept of �Eurosystem� and incorporates into primarylegislation that the euro be defined as currency unit and symbol of the Union.

In the field of monetary union (Part III), a number of new provisions, which only apply to the euroarea Member States, have been created. The procedure for amending the provisions on Economic andMonetary Union (EMU) have been simplified; however, this simplified amendment procedure does notapply to the constitutional provisions. Under certain circumstances, monetary policy decisions may betaken by super-qualified majority.

In principle, the Constitutional Treaty does not entail any change in substance in the field ofmonetary union and the amendments are largely of a technical nature. Thus, the framework conditionsfor monetary union as embodied in the Treaty on European Union have been reaffirmed.

1 IntroductionThe IGC started its proceedings onOctober 4, 2003, and at the EuropeanCouncil meeting in Brussels on June18, 2004, reached an agreement onthe Treaty establishing a Constitutionfor Europe.1 The final draft will besubmitted to the Member States forratification, and the ConstitutionalTreaty shall — from the present pointof view — enter into force on Novem-ber 1, 2006.

In accordance with Article 48 ofthe Treaty on European Union, theEuropean Central Bank (ECB) con-tributed to the IGC on institutionalchanges in the monetary area. TheGoverning Council of the ECB estab-lished a Task Force on the EU DraftConstitution which discussed thepossible implications for institutionalchanges on the ESCB/Eurosystem andthe ECB and developed the strategic

positioning of the Governing Councilof the ECB. On September 19, 2003,prior to the IGC, the GoverningCouncil of the ECB adopted an officialopinion on the relevant aspects of thenew Constitutional Treaty. Subse-quently, the President of the ECB,Jean-Claude Trichet, communicatedfurther monetary policy positions ofthe ECB Governing Council (ECB,2003c; ECB, 2004a) to the respectiveCouncil presidencies.

This article describes the aspectsof the Constitutional Treaty that arerelevant to the ESCB/Eurosystemand aims to analyze the implicationsof the amendments to the Treaty, tak-ing into account as much as possiblethe conclusions of the Working Partyof IGC Legal Experts, which revisedthe Constitutional Treaty at the tech-nical level, and the results of theECB Task Force discussions.2

1 In the following, the Treaty establishing a Constitution for Europe will be referred to as Constitutional Treaty.2 At the editorial close, the most recent material available to the authors was a consolidated version of the draft

Constitution (CIG 87/04; CIG 87/04 add1 and add2) already containing a continuous numbering of Treatyarticles.

Isabella Lindner,Paul Schmidt

Refereed byThomas Wagner,Legal Division.


The Draft Treaty Establishing aConstitution for Europe — Institutional Aspects

of Monetary Union

2 General Remarks2.1 The Architecture of the

Constitutional TreatyThe draft Constitution establishes aconsistent constitutional architecturereplacing the three-pillar structure ofthe set of existing treaties. Followinga preamble, the Constitutional Treatyis divided into four main parts and anumber of protocols, including theprotocol on the Statute of the ESCBand the ECB, as follows:— Part I �Constitutional Provisions,�— Part II �The Charter of Fundamen-

tal Rights of the Union,�— Part III �The Policies and Func-

tioning of the Union,�— Part IV �General and Final Provi-

sions.�Part I, Part III and the relevant

protocols contain the legal and insti-tutional underpinnings of the ESCB/Eurosystem, the ECB and the singlemonetary policy.

In this context, the questionemerged whether the constitutionalprovisions of Part I are supreme overPart II, Part III and Part IV. So far, theEuropean Court of Justice has consid-ered all parts of the Treaty on EuropeanUnion equal. However, the provisionsin Part I of the Constitutional Treaty,which, inter alia, specify the institu-tional framework, prevail over the pro-visions of the other parts in so far astheir amendment requires conveningan IGC. By contrast, �Internal Policiesand Action� (Part III, Title III) and thusalso the provisions on monetary unionare subject to a simplified amend-ment procedure. However, the ESCB/Eurosystem takes it for granted that

the various parts and titles as well asthe protocols of the ConstitutionalTreaty are basically considered equal.

In conclusion, the ConstitutionalTreaty encompasses two amendmentprocedures for the provisions on mon-etary union:— Regular amendment procedure: If

the amendments are comprehen-sive, the President of the Euro-pean Council shall call a Conven-tion3 which examines the proposaland adopts by consensus a recom-mendation to the IGC. Theamendments enter into force afterbeing ratified by all the MemberStates in accordance with their re-spective constitutional require-ments (Art. IV-443).4

— Simplified amendment procedure:�Internal Policies and Action�(Part III, Title III) and thus alsothe provisions on monetary unioncan be amended by a simplifiedamendment procedure. The Euro-pean Council may adopt a Euro-pean decision amending all or partof the above mentioned provision,acting by unanimity after consulta-tion of the European Parliamentand the Commission and, in themonetary area, the ECB. Such aEuropean decision does not comeinto force until it has been ap-proved by the Member States inaccordance with their respectiveconstitutional requirements. Theapplication of this procedure im-plies that some provisions of theConstitutional Treaty may beamended without calling a Con-vention or an IGC (Art. IV-445).

3 The European Council may decide by a simple majority, after obtaining the consent of the European Parliament,not to convene the Convention should this not be justified by the extent of the proposed amendments (Art. IV-443(2)).

4 If, two years after the signature of the treaty amending the Treaty establishing the Constitution, four fifths of theMember States have ratified it and one or more Member States have encountered difficulties in proceeding withratification, the matter shall be referred to the European Council (Art. IV-443 (4)).


The Draft Treaty Establishing a

Constitution for Europe — Institutional Aspects

of Monetary Union

2.2 Monetary Policy Decision-Makingby Qualified and �Super-Qualified� Majority

Current practice already requires aqualified majority in the Council fora large part of monetary policy deci-sions. The Constitutional Treaty doesnot provide for a significant extensionof the scope of qualified majority vot-ing. However, the Treaty stipulatesthat where Part III provides that theCouncil should act by unanimity, theEuropean Council may adopt a Euro-pean decision authorizing the Coun-cil (e.g. the Ecofin Council) to actby qualified majority5 (Art. IV-444).Under certain circumstances, deci-sions in the field of monetary unioncan be taken by �super-qualified� ma-jority. Decisions regarding the follow-ing areas relevant for monetary policynow require either a qualified or asuper-qualified majority:— So far, the Council has been able

to amend the ESCB/ECB Statuteon a recommendation from theECB and by qualified majority.An amendment proposed by theEuropean Commission would haverequired unanimity in the Coun-cil. The Constitutional Treaty laysdown that the Council decides ona proposal from the EuropeanCommission by qualified majorityand on a recommendation fromthe ECB by super-qualified major-ity6 (Article III-187(3)). Thisstrengthens the position of the Eu-ropean Commission vis-a‘-vis theECB.

— The Council, on a proposal fromthe Commission and after consult-ing the ECB, may adopt appropri-ate measures to ensure a unifiedrepresentation within the interna-tional financial institutions andconferences (Art. III-196(2)).Onlymembers of the Council repre-senting Member States whose cur-rency is the euro are entitled tovote; decisions are made by quali-fied majority.

— The President, the Vice Presidentand the other members of the Ex-ecutive Board of the ECB are ap-pointed by the European Council,acting by a qualified majority (Art.III-382 (2)).The higher blocking minority

threshold compared with the Treatyof Nice could make it more difficultto block majority decisions. The in-crease of both the super-qualifiedand the qualified majority thresholdsmight only slightly accelerate the deci-sion-making process in the Council.

2.3 EU Legislative ActsIn exercising the competences con-ferred on it in the ConstitutionalTreaty, the EU will use Europeanlaws, European framework laws,European regulations, European deci-sions, recommendations and opinions(Article I-33). When authorized todo so (Art. I-35), the ECB will adoptEuropean regulations and Europeandecisions as well as recommendationsand opinions (Art. III-190).

5 If the Council acts upon a proposal of the European Commission or the European Foreign Affairs Minister, fromNovember 1, 2009, this will require a qualified majority representing at least 55% of the Member States, i.e. atleast 15 Member States and at least 65% of the Union�s population. At least four Member States, representingmore than 35% of the Union�s population, are required to form a blocking minority.

6 If the Council acts upon a recommendation of the ECB in the field of EMU, from November 1, 2009, this willrequire a super-qualified majority representing at least 72% of the Member States comprising at least 65% ofthe Union�s population (Art. I-25(2), Conference, 2004).




of Monetary Union

The ECB may adopt Europeanregulations (formerly called regula-tions) for instance on the definitionand implementation of the singlemonetary policy, on payment andsettlement systems, on specific tasksrelating to prudential supervision ofcredit institutions, on the capital andthe capital subscription of the ECBor on the transfer of foreign reserveassets (see Article III-190.1(a)).

As European laws or frameworklaws are legislative acts, they haveprecedence over European regulationsadopted by the ECB. This is mainlyrelevant for those areas which do notexclusively fall within the fields ofcompetence of the ECB (e.g. paymentsystems).

3 Part I of theConstitutional Treaty:ConstitutionalProvisions

3.1 The Primary Objective ofPrice Stability

The Treaty on European Union de-fined the promotion of �non-inflation-ary growth� and �stable prices� as oneof the objectives of the Union. TheConstitutional Treaty now includes theconcepts �balanced economic growth�and �price stability� (Art. I-3). Part Ialso explicitly states the primaryobjective of the European System ofCentral Banks to maintain price stabil-ity (Art. I-30). Another reference toprice stability, which is the primaryobjective of the single monetary andexchange rate policy, can be foundunder Article III-177.

The application of the simplifiedamendment procedure for Part IIImade it even more important thatprice stability has been integrated inthe objectives laid down in Part I of

the Constitutional Treaty. This impliesthat price stability is not only an op-erational objective of the ESCB/Euro-system but an objective that is bindingfor both the Union and its MemberStates.

3.2 Monetary Policy — An ExclusiveCompetence of the Union

Article I-12 stipulates the division ofresponsibilities between the Unionand the Member States, according towhich the Union has exclusive compe-tence in the field of monetary policyfor the Member States whose cur-rency is the euro (Article I-13(c)).While the Union may legislate andadopt legally binding acts, the Mem-ber States may do so themselves onlyif so empowered by the Union orfor the implementation of Union acts(Article I-12 (1)).

The Constitutional Treaty doesnot provide a definition of the concept�monetary policy�. The ESCB/Euro-system has adopted a broad interpre-tation of the concept monetary policy,referring to Article III-185, whichdescribes the basic tasks to be carriedout through the ESCB.

Primary legislation now stipulatesthat the currency of the Union is theeuro, which is also listed under thesymbols of the Union (Article I-8).

3.3 The ECB as an InstitutionSui Generis

The Constitutional Treaty lists theECB, together with the Court ofAuditors and the advisory bodies7 as�the other Union institutions and advi-sory bodies� (Article I-30). However,when the institutional structure ofthe ESCB had been defined by theTreaty on European Union, the ECBhad deliberately not been classified

7 Committee of the Regions and the European Economic and Social Committee.




of Monetary Union

as an institution of the Community. Asthe draft Constitution does not list theECB among the political institutions,such as the Council, the EuropeanCommission or the European Parlia-ment, the ESCB/Eurosystem pre-sumes that the ECB is an institutionsui generis and that the new institu-tional classification of the ECB doesnot imply any substantial change.

Article I-30 defines the concept�ESCB� and, for the first time, alsothe concept �Eurosystem�. The Gov-erning Council of the ECB has usedthe term Eurosystem in its externalcommunication since 1998. The Eu-rosystem comprises the ECB and thenational central banks (NCBs) of theMember States which have adoptedthe euro.

The ESCB is governed by the deci-sion-making bodies of the ECB (theGoverning Council and the ExecutiveBoard) and pursues the primary objec-tive of maintaining price stability.Without prejudice to this objective,it supports the general economic pol-icies of the Union to contribute to therealization of the Union�s objectives.All other tasks of the ESCB are de-fined in Part III of the ConstitutionalTreaty and in the ESCB/ECB Statute.The Constitutional Treaty also statesthat the ECB has legal personality.The ECB has the exclusive right toauthorize the issuance of banknotes.

While the Treaty on EuropeanUnion emphasizes the independenceof both the NCBs and the ECB8, Arti-cle I-30 of the Constitutional Treatyonly refers to the independence ofthe ECB. In exercising its functionsand in administrating its funds the

ECB is independent. The Communityinstitutions, bodies and other agenciesas well as the governments of theMember States respect this principleof independence. Only Part III (Arti-cle III-188) — which can be revisedby a simplified amendment procedure— stipulates the independence of theNCBs.9

3.4 TransparencyThe Constitutional Treaty providesthe public with broader access todocuments. The Treaty on EuropeanUnion regulates public access to thedocuments of the European Parlia-ment,10 the Council, the EuropeanCommission; the ECB stipulates itsown transparency rules. The principleof transparency of the ConstitutionalTreaty (Article I-50 (3)) now also ap-plies to the ECB when carrying out itsadministrative tasks (Article III-399(1)). Restricting transparency to ad-ministrative tasks shall protect theECB against public access which couldnegatively affect its core functions.11

4 Part III of theConstitutional Treaty:The Policies and Func-tioning of the Union —Monetary Policy

The specific provisions on monetaryunion are incorporated in Part III,Title III, Chapter II of the Constitu-tional Treaty; they are subdivided into�Economic and Monetary Policy�,�Institutional Provisions�, �ProvisionsSpecific to Member States WhoseCurrency is the Euro� and �Transi-tional Provisions�. The sections onmonetary policy and the ESCB/Euro-

8 Article 108 Treaty on European Union.9 See section 2.2.10 Article 255 Treaty on European Union.11 See ECB, 2004.




of Monetary Union

system have been reorganized, i.e. thetransitional provisions no longer in-clude the provisions that referred tothe European Monetary Institute(EMI), the second stage of EMU andthe beginning of the third stage ofEMU. The specific provisions for theeuro area countries are summarizedunder a separate section. All otherprovisions are broadly in line withthe Treaty on European Union. Inprinciple, no changes in substancehave been made to provisions regard-ing monetary union; adaptations havebeen largely of a technical nature.

4.1 Monetary PolicyThe section on �monetary policy� de-scribes the objectives and tasks of theESCB and stipulates the ESCB�s pri-mary objective of maintaining pricestability12 (Article III-185). Contraryto the Treaty on European Union,the definition of the ESCB and the ref-erence to the legal personality of theECB have been omitted because theyare explicitly stipulated under ArticleI-30. In exercising their powers andcarrying out the tasks and duties con-ferred upon them by the Constitu-tional Treaty, the ECB and NCBs aresubject to the principle of freedomfrom any instruction (�Independence�,Article III-188).

4.2 Institutional ProvisionsThe section �Institutional Provisions�describes the coordination tasks andthe composition of the Economicand Financial Committee. The provi-sions regarding the Monetary Com-mittee (with advisory status), whichwas replaced by the Economic and

Financial Committee at the beginningof the third stage of EMU in 1999,have been canceled.

Title VI, �The Functioning of theUnion�, contains the general institu-tional provisions on the GoverningCouncil and the Executive Board ofthe ECB as well as on the participationof the President of the Council ofMinisters in Governing Council meet-ings, the participation of the ECBPresident in Ecofin Council meetingsand the relations between the ECBand the European Parliament (ArticleIII-382, Article III-383).

4.3 Provisions Specific to MemberStates Whose Currency is theEuro

The �Provisions Specific to MemberStates Whose Currency is the Euro�are summarized under a separate sec-tion in a clear and structured manner.These provisions include the measuresrelated to the surveillance and coordi-nation of Member States� budgetarydiscipline, the economic policy guide-lines as well as the external represen-tation of the euro. Only MemberStates of the euro area, which regu-larly hold Eurogroup meetings, areentitled to vote on these measures(Article III-194).

Arrangements for meetings be-tween ministers of Member States ofthe euro area are laid down in the Pro-tocol on the Eurogroup (Article III-195). The Eurogroup will continueto meet informally; to improve itsworking methods, it will elect a pres-ident for a term of two and a halfyears.

12 The Draft Treaty establishing a Constitution for Europe lists the articles that do not apply to countries with aderogation (Article III-197 (2) (c)). It lists the objectives and tasks of the ESCB and thus also the objective ofprice stability (Article III-185 (1-3, 5)). According to the ESCB/ECB Statute (Article 43.1 of the Statute),however, the objectives and tasks of the ESCB (Article 2 of the Statute) apply to the Member States with a der-ogation.




of Monetary Union

The Eurogroup, acting by a quali-fied majority13 on a proposal from theEuropean Commission and after con-sulting the ECB, takes decisions onthe external representation of theeuro (Article III-196). These decisionsare taken to establish common posi-tions and ensure unified representa-tion of the euro within the interna-tional financial institutions and confer-ences.

Furthermore, it is the exclusiveresponsibility of the Eurogroup toconclude agreements on an exchangerate system for the euro or generalorientations for the exchange rate pol-icy vis-a‘-vis non-euro area currencies.The same holds for decisions on theeuro central rates within the exchangerate mechanism (ERM II) and agree-ments on exchange-rate matters withcountries or international organiza-tions (Article III-326 in combinationwith Article III-197).

4.4 Transitional ProvisionsThe section �Transitional Provisions�contains regulations for MemberStates with a derogation, i.e. non-euroarea countries. The provisions onEMU that do not apply to MemberStates with a derogation include forexample the objectives and tasks ofthe ESCB/Eurosytem, the legal actsof the ECB or the appointment ofmembers of the Executive Board ofthe ECB (Article III-197).

The �Transitional Provisions� alsostipulate institutional regulations onthe General Council as the thirddecision-making body of the ECB,the definition of the convergence cri-teria14 as well as the provisions onthe abrogation of derogations afterthe convergence assessment. In ac-cordance with the latter provision,the Council decides by qualified ma-jority, after consulting the EuropeanParliament, after discussion in the Eu-ropean Council and on a proposalfrom the European Commission.What is new is that this decision isto be based on a recommendationfrom the euro area Member States,acting by qualified majority.

The euro area Member States andthe Member State concerned maydecide by a simple majority, after ob-taining the consent of the EuropeanParliament, to irrevocably fix the ex-change rate at which the euro is toreplace the currency of the MemberState concerned and to lay down othermeasures necessary for the introduc-tion of the euro (Article III-198).

Where a sudden crisis in the bal-ance of payments occurs, a MemberState with a derogation may begranted macro financial assistance ortake protective measures, such as thetemporary introduction of capital con-trols (Article III-201, Article III-202).

13 In cases in which only a limited number of Council members has the right to vote (i.e. increased collaboration oreuro area), the projected percentages will be inserted (and changed) in such a way that they will only apply tothose Council members who have the right to vote and only to the population of the Member States they represent.

14 In order to ensure continuity in assessing the exchange rate criterion, the Constitutional Treaty still contains areference to the no longer existing EMS.




of Monetary Union

5 Statute of the ESCBand the ECB

The ESCB/ECB Statute is attached tothe draft Constitution as a protocoland was technically adapted by theWorking Party of IGC Legal Experts(Conference, 2003a).15

— In line with Article I-30, Article 1of the Statute contains the concept�Eurosystem�.

— Regulations were renamed Euro-pean Regulations, Decisions wererenamed European Decisions (Ar-ticle 35), Community was re-placed by Union, �ECU� was re-placed by �Euro� and �EC Treaty�or �Treaty on European Union�were replaced by �Constitution�.

— Certain provisions on the estab-lishment of the ECB and the ESCB(Article 1.1, Article 14.1) as wellas the transition to the third stageof monetary union (Article 32.3,Article 50, and Article 51), theEMI protocol as well as the refer-ence to the seat of the ECB (Arti-cle 37) have been omitted in theprotocol.

6 ConclusionsRepresenting a new and consistent le-gal architecture, the ConstitutionalTreaty, is intended to enhance andstreamline decision-making in theEU-25, both at the European andthe international level.

However, the efficiency of the de-cision-making process of the Council,and thus of the Ecofin Council, maynot be improved substantially by theConstitutional Treaty. The increase

of the blocking minority thresholdcompared to the Treaty of Nice couldmake it more difficult to block major-ity decisions; the higher super-quali-fied and qualified majority thresholdis expected to accelerate the deci-sion-making process only slightly. Itremains to be seen to what extentthe European Council will make useof the newly created possibility ofwidening the scope for majority deci-sions in the Council in cases where theTreaty provides for unanimity.

Up to now, a considerable numberof decisions in the field of monetaryunion has been taken by qualifiedmajority. The Constitutional Treatyslightly strengthens the EuropeanCommission�s position to influencemonetary union: Proposals from theCommission to amend the ESCB/ECB Statute require a qualified major-ity in the Council whereas recommen-dations from the ECB require a super-qualified majority.

The introduction of the simplifiedamendment procedure which coversprovisions of Part III of the Constitu-tional Treaty is likely to have a veryfundamental impact on future devel-opments in monetary union. The con-stitutional provisions of Part I of theConstitutional Treaty, which affectmonetary union only to a small ex-tent, continue to be subject to thestandard procedure. This implies thatchanges in substance are less likelyto occur.

The Constitutional Treaty takesinto account the institutional develop-ments in the area of monetary union

15 Irrespective of the draft Constitution, the ECB Governing Council was prepared for the forthcoming enlargementin the euro area and the voting modalities were adapted according to a Council decision (European Council,2003) (Article 10.2 of the Statute). If there are more than 15 national central bank governors, the voting rightsof the members of the Council of the ECB will be limited to 21, which means that 6 permanent members of theExecutive Board of the ECB retain permanent voting rights and the 15 voting rights of the NCB governors willrotate. All members of the Governing Council who temporarily do not exercise a voting right will continue toattend meetings and will be able to participate actively in the discussions.




of Monetary Union

since the introduction of the euro.Thus, the Constitutional Treaty inte-grates the concept �Eurosystem� andincorporates the definition of the euroas the currency unit and one of thesymbols of the Union. The Eurogroupcontinues to meet informally; but theConstitutional Treaty formally recog-nizes in a protocol its existence. Fur-thermore, the Constitutional Treatydefines a number of new provisionswhich only apply to the euro areaMember States; it also defines areasof responsibility in which only euroarea Member States have the right tovote. All in all, these amendmentscontribute to a better understandingof the institutional structure andworkings of monetary union.

The Constitutional Treaty doesnot entail any changes in substancein the field of monetary union com-pared to the current legislation; mostamendments were of a technical na-ture only. It stipulates that one ofthe objectives of the Union is to main-tain price stability and confirms thesui generis nature of the ECB as en-shrined in the Treaty on European Un-ion. The tasks, mandate, status and le-gal and institutional framework of theECB and of the ESCB remain widelyunchanged. The framework condi-tions for monetary union as embodiedin the Treaty on European Union havebeen reaffirmed. Thus, as regardsmonetary policy, the EU-25 is wellprepared for the enlargement of theeuro area.

ReferencesConference of the Representatives of the Governments of the Member States (Confer-

ence). 2004. Treaty establishing a Constitution for Europe. CIG 87/04. August 6.

http://ue.eu.int/igcpdf/en/04/cg00/cg00086.en04.pdf.

Conference of the Representatives of the Governments of the Member States. 2004a. Pro-

tocols and Annexes I and II annexed to the Treaty establishing a Constitution for Europe. CIG 87/04

ADD1. August 6.

Conference of the Representatives of the Governments of the Member States (Confer-

ence). 2004b. Declarations to be annexed to the Final Act of the IGC and the Final Act. CIG

87/04 ADD2, August 6.

Conference of the Representatives of the Governments of the Member States. 2004c.Meet-

ing of Heads of State or Government. Brussels. June 17—18, 2004. CIG 85/04. June 18.


Conference of the Representatives of the Governments of the Member States. 2004d.Meet-

ing of Heads of State or Government. Brussels. June 17—18, 2004. CIG 81/04. June 16.


Deutsche Bundesbank. 2003. Zur Wa‹hrungsverfassung nach dem Entwurf einer Verfassung fu‹r die

Europa‹ische Union. Monatsbericht November. 67—71.

http://www.bundesbank.de/download/volkswirtschaft/monatsberichte/2003/200311mb.pdf.

Dvorsky, S. and I. Lindner. 2003. Anpassung der Stimmrechtsmodalita‹ten im EZB-Rat. In: Berichte und

Studien 2, OeNB. 144—153.

ECB. 2003. Letter from the ECB President to the President of the Convention regarding the draft Con-

stitutional Treaty. June 5. http://www.ecb.int/pub/pdf/pr030605_ecblettervge_en.pdf.

ECB. 2003a. The institutional setting for Economic and Monetary Union — Treaty foundations and practical

conduct of policy. In: Monthly Bulletin. February. 44—50. http://www.ecb.int/pub/pdf/mb200302en.pdf.




of Monetary Union

ECB. 2003b. Letter from the ECB President to the President of the Council of the European Union re-

garding the Opinion of the ECB of 19 September 2003 at the request of the Council of the European

Union on the draft Treaty establishing a Constitution for Europe. September 19.

http://www.ecb.int/pub/pdf/pr030922enletteren.pdf.

ECB. 2003c. Introduction of a new article into the Constitution to allow for the amendment of the

European System of Central Bank�s basic constitutional rules by a simplified procedure. CIG 58/03.

September 1.

http://www.ueitalia2003.it/NR/rdonlyres/0E235B7A-1C92-469A-A4D4-A737FB6D834D/0/

1124DocCIG5803_en.pdf.

ECB. 2004. Beschluss der Europa‹ischen Zentralbank u‹ber den Zugang der O‹ ffentlichkeit zu Dokumenten

der Europa‹ischen Zentralbank. ECB/2004/3. March 4.

http://www.ecb.int/pub/legal/l_08020040318de00420044.pdf.

ECB. 2004a. Letter from the ECB President to the President of the Council of the European Union regard-

ing negotiations on the draft Treaty establishing a Constitution for Europe. April 16.

http://www.ecb.int/pub/pdf/letter040427.en.pdf.

ECB. 2004b. The European Constitution and the ECB. Monthly Bulletin. August.

EuropeanConvention. 2003.Draft Treaty establishing a Constitution for Europe. CONV 850/03. July 18.

http://european-convention.eu.int/docs/Treaty/cv00850.de03.pdf.

Khan, D.-E. (ed.). 2001. Vertrag u‹ber die Europa‹ische Union mit sa‹mtlichen Protokollen und Erkla‹run-

gen. Vertrag zur Gru‹ndung der Europa‹ischen Gemeinschaft (EG-Vertrag) in den Fassungen von

Amsterdam und Nizza. Grundrechte-Charta der Europa‹ischen Union. Munich. Deutscher Taschenbuch

Verlag.

Kiekens, W. 2003. What kind of External Representation for the Euro? OeNB-Seminar: The European

Convention on the Future of Europe-Implications for Economic and Monetary Union. June 2.

http://www2.oenb.at/tagung/eu_konvent/index_p.htm.

La‹ufer, T. (ed.). 1994. Europa‹ische Union, Europa‹ische Gemeinschaft. Die Vertragstexte von Maastricht.

Bonn. Europa Union Verlag.

Lindner, I. and K. Olechowski-Hrdlicka. 2002. Institutionelle Auswirkungen der EU-Erweiterung im

Bereich der Wirtschafts- und Wa‹hrungspolitik. In: Berichte und Studien 2, OeNB. 177—193.

Council of the European Union (Council). 2003. Decision of the Council, meeting in the com-

position of the heads of state or government on an amendment to Atricle 10.2 of the Statute of

the European System of Central Banks and of the European Central Bank. 7205/03. March 21.

http://europa.eu.int/eur-lex/pri/de/oj/dat/2003/l_083/l_08320030401de00660068.pdf.




of Monetary Union

Although the Central and Eastern European banking market (excluding Russia) is relatively small withtotal assets of some EUR 350 billion (by comparison, total assets of banks operating in Austria weresome EUR 605 billion at the end of 2003), it is nevertheless a growth market. In addition to higher eco-nomic growth, the low degree of bank intermediation (about a third of its Western European equivalent)suggests strong growth potential for banks in Central and Eastern Europe (CEE) in the coming years.

Above-average growth potential, higher interest margins than in Western Europe and restructuringpotential have led Western European banks to invest heavily in the CEE banking sector. Approximately70% of the CEE banking market is currently controlled by Western European banking groups. Austrianbanks were among the first to invest in Central and Eastern European countries and are now some of thebest-known Western European banks in the region (market share in the region: about 22%). As early as2002 and 2003, steady expansion in the CEE region had a positive impact on the profitability of Austria�sconsolidated banking sector.

Favorable reports on the CEE banking market, however, often ignore potential risks. Key sources ofrisk in the Central and Eastern European banking market are macroeconomic imbalances, the riskof growing exchange rate volatility, credit risk, increasingly fierce competition and political risks.

1 OverviewWith total assets of some EUR 350billion, the Central and Eastern Euro-pean banking market1 remains a rela-tively small (by comparison total as-sets of banks operating in Austria weresome EUR 605 billion at the end of2003). The market is dominated byWestern European banks: the marketshare of foreign-controlled banks inthe CEE region is approximately70%. As CEE countries catch up,the hope for rapid growth and higher

profits has been and is one of the mainmotives for foreign investors to moveinto the Central and Eastern Europeanbanking market.

Table 1 shows the CEE bankingsector�s current edge over its WesternEuropean counterpart in terms ofprofitability. Apart from Poland(where a tough economic climate hasincreased loan losses), profitability inmost Central and Eastern Europeancountries has been far higher than inEU countries.

1 The Central and Eastern European banking market (CEE banking market) is defined to include Bosnia andHerzegovina, Bulgaria, Croatia, the Czech Republic, Hungary, Macedonia, Poland, Romania, Serbia andMontenegro, the Slovak Republic and Slovenia.

Table 1

Selected Key Figures of Central and Eastern European Banking

Markets at End-2003ROE after tax Cost-to-income ratio Solvency ratio Lending growth

%

Czech Republic 23.7 52.7 14.5 11.8Hungary 17.6 61.2 12.0 34.7Poland 6.2 68.6 13.7 9.3Slovak Republic 13.0 67.1 22.4 14.3Slovenia 12.8 62.5 11.6 13.8Croatia1 16.3 54.5 16.0 13.5EU bank2 10.7 65.7 12.4 4.0

Source: National central banks, BA-CA (2004).1 Data for Croatia: January to September 2003.2 EU banks: Weighted average of 27 major banks (BA-CA analysis of major EU banks in 2003).

Peter Breyer

Refereed by Zoltan Walko,Foreign Research Division.


Central and Eastern Europe —The Growth Market for Austrian Banks

1.1 Good Market Positionof Major Austrian Banks

Low profitability domestically (pricecompetition, strong focus on businessvolume), geographical proximity andhistorical ties, as well as above-averagegrowth and profit potential, were keyreasons for Austrian banks� pioneeringrole in investing in Central and East-ern Europe. According to estimatesof the Oesterreichische Nationalbank(OeNB), some 22% of the total assetsof Central and Eastern Europeanbanks (excluding Russia) are currentlyheld by Austrian banking groups (in-cluding Bank Austria Creditanstalt —BA-CA). This means Austrian banksare the biggest investors (well aheadof Italy and Belgium) in the Central

and Eastern European banking sector.Erste Bank, BA-CA and RaiffeisenZentralbank (RZB) are among themost active Western European banksoperating in the CEE region.2

Erste Bank, via its subsidiaries, isone of the biggest players in the CzechRepublic (Ceska« sporitelna), the Slo-vak Republic (Slovenska« sporitel�na),Croatia (Rijecka banka) and — nowthrough its acquisition of Postabank— also in Hungary.

BA-CA, via its subsidiaries, holdsa significant slice of the market in Po-land (Bank BPH), Croatia (Splitskabanka) and Bulgaria (Biochim) and isalso represented by subsidiaries inseven other CEE countries.

RZB has a very well-known brandname in CEE countries and controls asignificant share of the market in theSlovak Republic (Tatra banka), Cro-atia, Serbia, Romania, Bosnia andHerzegovina, and Albania. With sub-sidiaries in 15 countries, RZB hasthe most extensive marketing network

of all Western European banks repre-sented in Eastern Europe.

Major CEE operations are alsorun by O‹ VAG (subsidiaries in eightCEE countries), Hypo Alpe-AdriaBank (HAAB, primarily in Croatia)and BAWAG (Slovak Republic, CzechRepublic, Hungary).

2 By far the most important CEE markets for Austrian banks currently are the Czech Republic, the Slovak Repub-lic, Hungary, Poland, Slovenia and Croatia. The total assets of these banking markets were some EUR 310billion at the end of 2003.

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Central and Eastern Europe —

The Growth Market for Austrian Banks

1.2 Significant Contribution toIncome from CEE Countries

As early as 2002 and 2003, steadyexpansion in the CEE region had apositive impact on the profitability ofAustria�s consolidated banking sector.

Although the CEE segment accountedfor only some 12% of consolidatedtotal assets at the end of 2003, 23%of pretax profit was generated in theregion.

A breakdown of Austrian banks�business activities by region revealsthat the profitability of their CEE op-erations is currently far higher thanthat of purely Austrian business. At1.1%, return on assets (ROA: returnon assets = pretax profit/total assets)in the CEE segment handsomely ex-ceeded that of Austrian business(0.5%) in 2003. Higher profitabilitywas primarily due to wider margins,lower credit risk costs and cost savingsfollowing extensive restructuringmeasures. Significant CEE exposureis likely to have greatly helped Aus-trian banks weather the economicallydifficult years between 2001 and2003 better than German banks.

Will the CEE Banking SectorRemain more Profitable in theMedium Term?Austrian bank pundits on EasternEurope are convinced that high profitsin CEE countries will continue to begenerated in the coming years, basingtheir upbeat growth and profit out-look on three arguments:— Economic Growth: Low base levels

and EU accession should enablehigher economic growth to begenerated in CEE countries thanin Western Europe over the nextfew years.

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— Low Degree of Bank Intermediation:The intermediation of the bankingsector (measured as the ratio oftotal bank assets to GDP) in CEEcountries averages about 74%.This is less than a third of the valuefor the euro area and is equivalentto Austrian bank intermediation in

the mid-1960s. This, coupled withhigher economic growth, and on-balance sheet liquidity reserves(customer deposits being farhigher than loans granted) shouldoffer banks in CEE countriesstrong growth potential in theyears to come.

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— Higher Interest Margins: In addi-tion to successful restructuringmeasures, which were generallyimplemented following acquisi-tions by Western European banks,far higher interest margins wereprimarily responsible for CEEbanks� edge in terms of profitabil-ity.Although it is widely anticipatedthat interest margins in CEE coun-tries will converge towards the EUaverage on account of growingcompetition and lower countryrisk premiums, the extent towhich this alignment process willcontinue remains contentious.Some experts currently support

the view that the margin edge willbe maintained in CEE countriesover the medium term. They ar-gue that theoretically these mar-gins ought to be higher givenCEE countries� lack of previousloan loss experience and the re-sulting higher credit risk. In mostCEE countries, market shakeoutis, they contend, relatively welladvanced and the degree of bankconcentration on average higherthan in the EU. Interest marginsshould have converged towardsthe EU average far more rapidlyin the past few years.However, the theory that a marginedge can be maintained in the CEE

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area as a whole over the mediumterm looks doubtful. As early as2002 and 2003, net interest mar-gins narrowed in most CEE coun-tries. The fact that margins wereshrinking less dramatically thanexpected can be attributed pri-marily to shifts in the loan portfo-lio (the share of private bankingloans with higher margins in-creased while the share of inter-

bank claims and loans to large en-terprises decreased). Fiercer com-petition could also exert addi-tional pressure on interestmargins. In future, entry barriers— at least in the new EU MemberStates — are likely to be far lowerfor new competitors on accountof the European single passportregime.3

Identification of RisksFavorable reports on the CEE bankingmarket often ignore potential risks,against which strong growth and highprofits need to be offset.— Macroeconomic Imbalances: Most

countries in the CEE region arefaced with high budget deficitsand, in some cases, also with highcurrent account deficits (twin def-icits) and so depend very heavilyon the willingness of foreign in-vestors to fund these deficits.

— Exchange Rate Volatility: Runningtwin deficits while entering a re-strictive currency band (in therun-up to joining the euro) couldmake Central and Eastern Euro-pean currencies subject to specu-lation. Although the future partic-ipation of accession countries inERM II and the economic policydirectives linked to EU member-ship will give rise to certain stabi-lization effects, the attacks onWestern European currencies in

3 Under the European single passport regime, any bank registered in an EU Member State can open branches inanother EU country without having to undergo major formalities.

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the early 1990s should not be for-gotten. For instance, poor eco-nomic data and inappropriate eco-nomic measures in 2003 resulted

in a distinct increase in volatilityfor the Hungarian forint and Pol-ish zloty (in 2003 the Hungarianforint and the Polish zloty were

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devalued against the euro by 11%and 17%, respectively). In this re-spect, currency risks arising fromgrowing demand for foreign cur-

rency loans (particularly in coun-tries such as Hungary or Polandwhere interest rates are well abovethe EU average) are also a factor.4

— Credit Risk: The share of nonper-forming loans (NPLs) as a percent-age of total lending is far higher onaverage in CEE countries than inWestern Europe.5 However, thesehigh NPL ratios mostly date backto the 1990s when CEE countrieswere undergoing transition. Infact, fresh net risk provisions fellshort of the EU average by a widemargin in many CEE countriesfrom 2000 to 2003. This meantthat particularly in Hungary, theCzech Republic (in 2002 and2003) and the Slovak Republic

(where more provisions were re-leased than made), a far smallershare of operating income wasneeded for credit risk provisions.Despite relatively low credit riskcosts in recent years, two criticalquestions should be posed: first,whether the comparatively newand untested credit risk systemsof CEE banks will be able to copewith a possible lending boom; sec-ond, whether a large number ofloan losses will be the inevitableconsequence of a strong expansionin total lending.

4 Exchange rate risk also has a strong impact on Austrian parent banks via their CEE subsidiaries. Austrian bank-ing groups focus their foreign currency hedging strategies on their CEE subsidiaries� expected profits. The pre-ferred instrument to hedge these profits against currency fluctuations is foreign currency swaps.

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— Growing Competition: The ques-tion arises as to whether otherWestern European banks attractedby the growth and profit potentialof CEE countries will expand intothis region, thereby intensifyingcompetition (for instance, noU.K. bank is currently present inCEE countries). Will this causemargins to shrink more quicklythan expected? Since early May2004, entry barriers — at least inthe new EU Member States — havefallen dramatically. Henceforth,any bank registered in an EUMember State will be able to openbranches in new Member States

without a local banking license(European single passport re-gime).

— Frequent Change of Government,Political Instability: As a generalrule, governments have servedfor shorter periods of time inmany Central and Eastern Euro-pean countries than in the EU.This has been due to two factors:first, relatively fragmented partypolitical environments, with manypopulist parties (and, as a result,not very stable coalitions); second,the tendency on the part of votersnot to reelect ruling parties afterthey have served only a single

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period in office. It remains to beseen whether EU accession willfurther aggravate this trend andwhether parties with only rudi-mentary budgetary discipline will

enter coalition governments. Forinstance, radical opposition partiesin Poland have enjoyed tremen-dous popularity with voters inrecent months.

2 Banking Markets inSelected CEE Countries

2.1 HungaryThe total assets of banks operating inHungary are about EUR 51 billion.At the end of 2003, 218 banks wereregistered in the country. Most ofthese banks (about 180) are small co-operative banks, which are of minorimportance overall (market share:some 7%).6

At about 69%, the degree of bankintermediation in Hungary is some-what below the CEE average (74%),and the degree of concentration (mar-ket share of the five largest banks) isaround 57%. Foreign banks also playa leading role in Hungary. Followingthe privatization of Postabank andKonzumbank, approximately 82% ofHungarian bank assets are now con-trolled by foreign banks. However,OTP — the biggest Hungarian bankby far — remains independent and is al-most entirely privately owned.7

In the past few years the Hungar-ian banking market has witnessed adramatic growth in lending (according

to the PSZAF, private sector lendinggrew by 66% in 2003). Growth wasdriven by the introduction of govern-ment subsidies for housing finance in2001. Banking industry representa-tives estimate that government subsi-dies for home loans account for some70% of private households� demandfor government-subsidized homeloans. This makes Hungary the soleCEE country in which earnings fromhome loans make a significant contri-bution to the total income of thebanking sector.8 Budgetary problems(the running costs of the schemeamounted to around 1% of GDP)led to a sharp retrenchment in statesubsidies for home loans. As thismeasure was expected months in ad-vance, it met with a response antici-pating the change. As a result, demandfor subsidized home loans continuedto grow in 2003. Lending to whole-sale customers and foreign groups isbitterly contested and marked by fall-ing margins. Hungary�s small andmedium-sized enterprises (SMEs) stillfind it hard to obtain bank loans.

Table 2

Number of Governments since 1993

Latvia 12 Slovenia 7Lithuania 12 Slovak Republic 6Estonia 9 Czech Republic 5Poland 8 Hungary 5

Source: The Economist of March 11, 2004.

6 The figures relating to the Hungarian banking sector for 2003 are largely based on data provided by the Hun-garian Financial Market Supervisory Authority (PSZAF).

7 OTP is listed on the stock exchange and owned by both management and foreign investors. It should be mentionedthat the Hungarian government continues to hold a �golden share,� with which majority resolutions adopted bythe general meeting can be blocked (i.e. OTP�s disposal is subject to approval by the Hungarian government).

8 See The Economist of August, 21, 2003 (House party).




For 2004, growth in personalloans is expected to flag significantlyowing to the amended terms of homeloan subsidies and to the increase indomestic interest rates. Hungarianbanks are currently seeking to boostdemand for consumer lending bylaunching new products such as for-eign currency loans. Increasing the

demand for foreign currency loans —particularly by private households —could lead to risks arising for theHungarian banking sector.

The Hungarian banking sector isadequately capitalized (average sol-vency ratio: 12.0%) and has been veryprofitable in the past few years (2003ROAbefore tax: approximately 1.8%).

As already mentioned, OTP (totalassets: some EUR 11 billion) is by farthe leading bank in Hungary. It is oneof the biggest and most profitablebanks in the CEE region and, in recentyears, has also acquired banks in theSlovak Republic and in Bulgaria(OTP beat Erste Bank in the biddingrace for a Bulgarian bank, DSK). Hun-gary�s second-largest bank is K&Hbank (controlled by the Belgian KBC

and the Dutch ANB-Amro). MKB isdominated by Bayerische Landesbank(BAWAG has a minority interest),CIB by the Italian Intesa. The acquisi-tion of Postabank in October 2003(purchasing price: EUR 400 million)allowed Erste Bank to increase itsmarket share substantially. IncludingPostabank, Erste Bank�s market shareis approximately 8%.

Table 3

Selected Key Figures of the Hungarian Banking Sector

1999 2000 2001 2002

Number of banks1 43 42 41 38of which foreign banks 29 33 31 27Private banks� share of total assets (%) 92.2 92.3 90.9 89.2Share of nonperforming loans (%) 4.4 3.1 2.9 4.6Domestic personal loans (% of GDP) 25.8 30.2 31.5 34Stock market capitalization (% of GDP) 36.4 25.8 19.2 17.4EBRD index on bank reform (from 1 to 4+) 4.0 4.0 4.0 4.0

Quelle: EBRD.1 Excluding cooperative banks.

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Austrian Banks Control around 20%of the Hungarian Banking MarketSeven Austrian banks currently oper-ate in Hungary. The market share ofAustrian banks is about 20% overall(including Postabank). Following itsacquisition of Postabank, Erste Bankis now the biggest Austrian bank inHungary (the fifth largest in the coun-try with a market share of some 8%).Raiffeisen Bank Ungarn managed toovertake HVB Bank Ungarn this yearand is now just ahead of the latter asthe country�s sixth-largest bank (mar-ket share: approximately 6%). Exten-sive banking operations are also car-ried out by Volksbank and Porsche-bank in Hungary. Bank Burgenland,which only recently established a sub-sidiary in Sopron, and the bank Sa-mesch & Cie AG are represented byextremely small operations in the

Hungarian market (total assets of bothbanks: less than EUR 12 million). Ex-cluding Volksbank, all major Austrianbanks in Hungary generate far higherreturns than in their domestic market.

In May 2004 a consortium consist-ing of Wiener Bo‹rse (the Vienna stockexchange) and Austria�s major banksacquired the majority of shares inthe Budapest stock exchange.

In 2003 RZB�s subsidiary was themost successful Austrian bank in Hun-gary. Raiffeisen Bank Ungarn gener-ated not only strong lending growthbut also exceptionally high return onequity (ROE: 27.5%). The profitabil-ity of the BA-CA and Erste Bank sub-sidiaries was roughly around the Hun-garian average. By contrast, the profit-ability of the Volksbank subsidiary waspoor.

2.2 Czech RepublicWith total assets of some EUR 80 bil-lion, the Czech banking market is thesecond largest in the CEE region. Theratio of total assets to GDP shows thatthe Czech economy has a far higherdegree of bank intermediation(105%) than other CEE countries (ex-cept for Croatia). At 66%, the degreeof concentration (market share of the

five largest banks) similarly exceedsthe CEE average.9 The country�s big-gest banks are without exceptionowned by Western European bankinggroups. The share of foreign bank as-sets as a percentage of total Czechbank assets is estimated to be about90%.

Following the banking crisis of1999—2000 and the subsequent estab-

Table 4

Key Figures of Selected Austrian Banks� Subsidiaries in Hungary

at End-2003HVB Bank Ungarn Raiffeisen Bank Ungarn Erste Bank Ungarn Volksbank Ungarn

EUR million

Total assets 2,799 3,189 2,072 583Change on previous year (%) þ14.3 þ37.9 þ14.0 þ20.7Profit after tax 42 54 14 1Change on previous year (%) þ18.7 þ49.4 þ102.2 þ139.6

%

Return on equity1 15.1 27.5 18.3 3.3Cost-to-income ratio 50.7 49.6 68.5 84.4

Source: BA-CA, Erste Bank, RZB, O‹ VAG.1 ROE after tax: HVB Bank Ungarn and Erste Bank Ungarn; ROE before tax: Raiffeisen Bank Ungarn and Volksbank Ungarn.

9 The figures relating to the performance of the Czech banking sector in 2003 are largely based on data providedby Ceska« na«rodnı« banka (CNB — the Czech National Bank).




lishment of the government consoli-dation agency CCA, the big state-owned banks were successfully soldto foreign banking groups in 2000.Ample guarantees provided by theCCA were crucial to the success ofthe privatization. For instance, foreignbanking groups were granted the rightof transferring to the CCA within atwo-year period loans that were inpoor rating categories at the time oftakeover (ringfence agreement).

As early as 2002 and 2003, theCzech banking sector generated re-newed high profits (according to theCzech central bank, ROA after taxwas 1.2% in 2003). Furthermore, italso boasted extremely healthy capitaladequacy of 14.4% (preliminary fig-ure for 2003).

The transfer of NPLs to the CCAresulted in a sharp reduction in totallending in 2002 in particular. This,in turn, also led to an improvementin the quality of the loan portfolio(with the NPL ratio falling from19.4% to 9.4%). 2003 saw the col-lapse of two small banks (Unionbanka, Plzeo‘ska« banka), which didnot, however, have an impact on the

stability of the country�s financial mar-ket.

Czech banks continue to steer avery tight personal loans policy. Thebalance sheets of major Czech bankstend to be excessively liquid (depositsbeing far higher than total loans). Theshare of domestic personal loans as apercentage of GDP is one of thelowest in the region as a whole.10 Alarge proportion of deposits are stillinvested in low-yield governmentbonds. The aim over the next fewyears will be to redirect funds fromgovernment bonds to personal loans.In order to bolster the confidence ofprivate sector banks, the CNB estab-lished a Major Loans Register in No-vember 2002. In addition, a govern-ment-subsidized home loan schemewas launched.

Preliminary CNB figures for 2003indicate a recovery in demand forloans — particularly by private house-holds. Whereas lending to enterprisesstagnated at 2002 levels, loans toprivate households grew steeply(+35%), albeit from a low base.Overall, lending to nonbanks in2003 expanded by around 11%.

The Czech banking sector is domi-nated by three banks. With the take-over of IPB (a major bank on the vergeof collapse in June 2000), CSOB be-

came the market leader (market share:21%). CSOB is 82%-owned by theBelgian KBC. The second-largest bankin the country is Ceska« sporitelna, the

10 According to Standard & Poor�s estimates, the share of personal mortgage loans as a percentage of GDP in theCzech Republic at the end of 2003 ranges between 7% and 8% (the equivalent in the euro area at the end of2003 was around 34%).

Table 5

Selected Key Figures of the Czech Banking Sector

1999 2000 2001 2002

Number of banks 42 40 38 37of which foreign banks 27 26 26 26Private banks� share of total assets (%) 76.9 71.8 96.2 95.4Share of nonperforming loans (%) 21.5 19.3 13.7 9.4Domestic personal loans (% of GDP) 42.3 36.6 24.3 20.0Market capitalization (% of GDP) 22.3 20.9 15.3 21.0EBRD index on bank reform (from 1 to 4+) 3.0 3.0 3.0 3.0

Source: EBRD.




formerly state-owned savings bank(market share: 19%), of which themajority shareholder (98%) is ErsteBank. Closely following Ceska« spori-telna is Komere‘nıç banka, which is

controlled by the French Socie«te« Ge«n-e«rale (stake: 60%). Next, albeit trail-ing by a long margin, come the CzechBA-CA subsidiary, HVB-Bank and theCzech subsidiary of Commerzbank.

Market Share of Austrian Banks —Around 30%Five Austrian banks are currently rep-resented by their own subsidiaries inthe Czech banking market, accountingfor roughly 30% of total assets.

By far the biggest and most profit-able bank is Ceska« sporitelna, ErsteBank�s subsidiary. With an ROE of23.7% (2003), the Czech subsidiaryis also of crucial importance to theprofitability of the entire Erste Bankgroup. In 2003, Ceska« sporitelna gen-erated around 35% of Erste Bank�sconsolidated income.

HVB is the fourth-largest bank inthe country, specializing specificallyin corporate banking and leasing fi-nance. With an ROE of 11.6%, thesubsidiary�s profitability is relativelylow.

Although RZB sharply boosted theprofits of its subsidiary, Raiffeisenbanka.s., in 2003, the latter�s profitability(ROE: 12.1%) lagged behind the mar-ket average. The Raiffeisen group alsooperates Raiffeisen Stavebni spori-telna, a home loans specialist in theCzech Republic.

Volksbank operates VolksbankPrag, a small operation, which hasnevertheless expanded considerablyin the last few years. It was foundedin 1993 and focuses primarily onSMEs and infrastructure finance.Since the takeover of Interbanka inSeptember 2003 (the shares werebought by Bayerische Landesbank),BAWAG has also been active in theCzech banking market.

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2.3 Slovak RepublicWith 18 banks and cumulated totalassets of some EUR 24 billion11 theSlovak banking sector is comparablein size with its counterparts in Croatiaand Slovenia. The degree of bankintermediation was 83% at the endof 2003. After the banking crisis of1999—2001, the Slovak banking sectorwas almost completely privatized.About 96% of Slovak bank assets areowned by foreign banking groups.Following the market�s shakeout ofthe last few years, the banking marketin the Slovak Republic has becomevery concentrated. About 68% ofthe market is controlled by the fivelargest banks.12

Thanks to the transfer of NPLsto a government consolidation agency(between 1999 and 2001 some SKK112 billion, or about 13% of GDP,were transferred), the subsequentdisposal of banks to foreign bankinggroups and substantial cost savings,the Slovak banking sector weatheredthe crisis in 2002 (the banking sector�ssuccessful restructuring was praisedby the IMF).

As early as 2002, consolidated fig-ures indicated a sharp improvement incredit quality (the share of NPLs wasreduced from 24% to 11% in 2002).In 2003 the NPL ratio was furtherlowered to 9.1%.

Capital adequacy levels are strik-ingly high. With a solvency ratio of22%, the Slovak banking sector is morethan adequately capitalized. Profita-bility, which recovered in 2002, wasfurther improved in 2003. The returnon total assets (ROA after tax) edgedup from 1.1% to 1.2%. To be high-lighted is the fact that the profitabilityof the Slovak banking sector in 2002and 2003 was also positively influencedby the release of credit risk provisions.

Like the Czech banking sector,Slovak banks currently also have veryample liquidity. At the leading Slovakbanks, customer deposits are on aver-age approximately more than twice ashigh as loans granted. The largestbanks are currently endeavoring toboost demand for personal loans bystepping up their marketing activitiesand offering new products.

Table 6

Key Figures of Selected Austrian Banks� Subsidiaries

in the Czech Republic at End-2003

Ceska« Sporitelna HVB Prag S.A. Raiffeisenbank a.s. Volksbank Prag

EUR million

Total assets 17,095 4,072 1,847 587Change on previous year (%) þ3.6 þ3.2 þ5.3 þ14.5Profit after tax 241 41 6 4Change on previous year (%) þ26.3 þ16.6 þ187.5 þ220.9

%


Source: BA-CA, Erste Bank, RZB, O‹ VAG.1 ROE after tax: Ceska« Sporitelna and HVB Prag S. A.; ROE before tax: Raiffeisen a.s. and Volksbank Prag.

11 This figure also includes the foreign branches of the Czech CSOB in the Slovak Republic. Excluding CSOBbranches, the total assets of the Slovak banking sector would be around EUR 21 billion.

12 The figures employed are largely based on data provided by Na«rodna« banka Slovenska (NBS — Slovak NationalBank).




According to preliminary statisticsprovided by the Slovak central bank,lending to nonbanks in 2003 grewby some 14%. Whereas corporateloans basically remained at 2002levels, loans to private householdsrose steeply (+39%) in 2003. As in

2002, households� demand for loansfocused on government-subsidizedhome loans. In 2003, however, lowerlending rates also fueled stronggrowth in both consumer and creditcard lending.

In January 2001 Erste Bank ac-quired for EUR 411 million 87.2%of Slovenska« sporitelna, the Slovaksavings bank heavyweight (the sale of20% to the EBRD lowered ErsteBank�s stake to 67% shortly there-after).13 With a market share of some22%, Slovenska« sporitelna is the big-gest bank in the Slovak Republic.

The second largest is VUB, of which95% is controlled by the Italian Intesa.RZB enjoys approximately 14% of theSlovak banking market via Tatra banka,its subsidiary. The CSOB branch net-work (part of Czech CSOB) is ownedby the Belgian KBC. ING is the Slovaksubsidiary of the eponymous Dutchfinancial group.

Table 7

Selected Key Figures of the Slovak Banking Sector

1999 2000 2001 2002

Number of banks 25 23 19 18of which foreign banks 11 14 13 15Private banks� share of total assets (%) 49.3 50.9 95.1 97.1Share of nonperforming loans (%) 32.9 26.2 24.3 11.2Domestic personal loans (% of GDP) 40.5 37.6 27.6 25.2Market capitalization (% of GDP) 3.8 3.9 3.3 7EBRD index on bank reform (from 1 to 4+) 2.7 3.0 3.3 3.3

Source: EBRD.

13 In May 2004 the government�s remaining stake was bought by Erste Bank for EUR 72 million, which increasedErste Bank�s own stake to 80%.

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Austrian Banks Control morethan 40% of the Banking MarketFive Austrian banks currently operatein the Slovak Republic. Austrian banksare by far the biggest investors in theSlovak banking sector, controllingabout 40% of total assets.

The restructuring of Slovenska«sporitelna, Erste Bank�s subsidiary,was concluded in 2002, as was itscomplete integration into the group.Considerable progress was also madein operational terms in 2003. Thecost-to-income ratio improved from66.8% to 51.9%. Annual net profitwas increased by 121% to EUR 66million, and ROE came to an out-standing 19.2%. In 2003 the Bankposted robust growth in lending.Com-pared with the previous year, totallending grew by 50%. The fact thattotal assets climbed a mere 2.9% can

be attributed to the decline in inter-bank business.

Tatra banka also succeeded insharply boosting total lending in2003. However, both operating in-come and profit after tax were downslightly, albeit from a high level. Withan ROE of 19.4%, the profitability ofRZB�s Slovak subsidiary remainedvery healthy.

HVB Bank Slovakia, the BA-CAsubsidiary and the country�s sixth-largest bank, significantly boostedboth the loan portfolio and total assetsin 2003. However, operating profitand net profit for the year were down.At only 10%, ROE lagged behind theaverage of the Slovak banking market.

L�udova« Banka and Istrobanka —relatively small subsidiaries — are op-erated by O‹ VAG and BAWAG, respec-tively

2.4 PolandPoland is by far the biggest (and mostcompetitive) banking market in CEEcountries. The country�s bleak eco-nomic climate also currently makesit one of the most unprofitable bank-ing markets in the region. At theend of 2003, the consolidated totalassets of Polish banks were aboutEUR 111 billion (or some 32% of to-

tal CEE assets). The degree of bankintermediation (total assets as a per-centage of GDP) came to only 60%,or below the CEE average (74%).Mergers and acquisitions in the pastfew years have reduced the numberof banks. The market share of the fivelargest banks at the end of 2003 wasapproximately 52%.14

Table 8


in the Slovak Republic at End-2003

Slovenska« sporitelna HVB Bank Slovakia Tatra banka L� udova« Banka

EUR million

Total assets 5,060 1,185 3,316 661Change on previous year (%) þ2.9 þ20.0 þ13.6 �4.6Profit after tax 66 15 48 7Change on previous year (%) þ124.9 �17.7 �13.1 þ30.2

%


Source: BA-CA. Erste Bank, RZB, O‹ VAG.1 ROE after tax: Slovenska« sporitelana and HVB Bank Slovakia; ROE before tax: Tatra banka and L�udova« Banka.

14 For the figures (in the text) relating to the Polish banking sector, please also see �Summary evaluation of thefinancial situation of Polish banks,� Narodowy Bank Polski (NBP), June 2004.




Unlike in other CEE countries,privatization in Poland has not beencompletely finalized. The largest Pol-ish bank (PKO Bank Polski, marketshare: 17%) remains in state hands.The other major Polish banks arewithout exception under the controlof Western European and Americanbanking groups. The share of Polishbank assets owned by foreigners isabout 68%.

Slowing economic growth (2002real GDP growth was a mere 1.2%;signs of economic recovery only beganemerging in the second half of 2003),a growing number of insolvencies andweakening demand for credit by cor-porate customers had an extremelynegative impact on income in the Pol-ish banking sector in 2002 in particu-lar. Profits generated by Polish banksfell by around a third in 2002 (ROEat 5.8% was one of the lowest in theregion). Despite modest improve-ments in the second half of the year,profitability was still very low in2003. ROE improved only slightly to6.2% in 2003, still lagging behindcomparable figures in other CEEcountries by a wide margin. Poland�s

economy continued to recover in thefirst half of 2004. For 2004, profitsare widely expected to surge in thePolish banking sector.

Insolvencies and falling profits ofcorporate customers resulted in a fur-ther deterioration in the quality of theloan portfolio in 2002. The share ofNPLs as a percentage of total lendingincreased from 17.9% to 21.1% at theend of 2002.15 Although the share ofNPLs was still high (20.9%) at theend of 2003, lower net loan loss pro-visions (the share of net loan loss pro-visions as a percentage of operating in-come fell from 24.2% to 15.9% in2003) indicate an easing in credit risk.

Following stagnation in 2002,lending growth picked up pace againto some extent in 2003 (+9%). Inview of the continued low degree ofcredit penetration (at 15%, the shareof domestic personal loans as a per-centage of GDP remains one of thelowest in the CEE region; the shareof personal mortgage loans as a per-centage of GDP was only about 4%at the end of 2003), however, growthwas relatively weak.

An analysis of loan demand by seg-ment reveals a trend similar to that inother new Member States. Whereas

the demand for loans by enterprisesremains very restrained, traditionalretail products (such as mortgage

15 In the past, the NPL classification standard set by the NBP was far more stringent than those in other countries.Heavy criticism from banks and investors led to the NPL rule being amended in early 2004. Loans are nowclassified as NPLs if payments are 90 days in arrears. Market participants estimate that this will roughly halvethe share of NPLs as a percentage of total lending.

Table 9

Selected Key Figures of the Polish Banking Sector

1999 2000 2001 2002

Number of banks 77 74 71 62of which foreign banks 39 47 48 47Private banks� share of total assets (%) 75.1 76.1 75.6 73.4Share of nonperforming loans (%) 13.3 15 17.9 21.1Domestic personal loans (% of GDP) 18.7 18.1 18 15.2Market capitalization (% of GDP) 19.9 18.1 13.7 14.3EBRD index on bank reform (from 1 to 4+) 3.3 3.7 3.7 3.7

Source: EBRD, Narodowy Bank Polski.




loans, consumer loans) have bouncedback smartly. Robust growth in mort-gage-secured loans can also be attrib-uted to the growing popularity of for-eign currency loans.

With total assets of EUR 19.3 bil-lion, state-owned PKO PB is not onlyPoland�s largest bank but also the big-gest in the entire CEE region. Accord-ing to press reports, up to 30% ofPKO PB are to be privatized by theend of November 2004. In view ofthe political situation, however, it is

more than doubtful whether the pri-vatization will go ahead as planned.The stock exchange-listed Bank Pe-kao, in which the Italian UniCreditoholds a 53% stake, is the country�ssecond-largest bank. BA-CA holds71% in BPH-PBK, the third-largestPolish bank. The American Citibankowns 93% of Bank Handlowy, andING Bank S«la�ski is dominated by theDutch banking and insurance group,ING (ING holds 88% of the capital).

Relatively Few Austrian BanksPresent in PolandBA-CA and RZB are currently theonly two Austrian banks representedby their own subsidiaries in Poland.

Bank BPH, BA-CA�s subsidiary,has 3 million customers and a nationalnetwork of branches with a particu-larly strong market position in War-saw and Cracow. Bank BPH, with arecent market capitalization of EUR2.6 billion, is listed on the Warsawstock exchange. The bank�s profitabil-

ity suffered badly in 2001 and 2002 onthe back of merger activities (BPH,HVB�s subsidiary, was merged withPBK, BA�s subsidiary), the sluggishstate of the Polish economy and highloan losses. In 2003, restructuringmeasures (e.g. staff cuts of 28% inthe past few years), low risk costsand the disposal of financial assets im-proved performance. In 2003, profitafter tax increased by 35%. At 7.4%,however, ROE remained modest. Inaddition to Bank BPH, BA-CA also

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holds a stake in HypoVereinsbankPolen, which however only plays aminor role. In January 2004, BA-CAsold its holding in Gornoslaski Bankto Getin Holding (a Polish financialholding company) for EUR 50 million.

Despite its comparatively smallsize, Raiffeisen Bank Polen (RZB�ssubsidiary) has a well-known brand

name, particularly in the GreaterWarsaw area. This allowed it to ex-pand total lending by 16% in 2003in a difficult market environment. Itsprofitability is equally good: profit af-ter tax was sharply boosted from EUR2.7 million to EUR 17.6 million, andROE was a good 15.9%.

2.5 SloveniaThe total assets of the Slovenian bank-ing sector were some EUR 21 billionat the end of 2003. At about 90%,the degree of bank intermediation(as a ratio of total bank assets toGDP) is relatively high. The domi-nance of Nova Ljubljanska banka(NLB) — with a market share of 34%it is by far Slovenia�s biggest bank —means the degree of concentration isvery high: the five largest banks ofthe country account for 66% of bankassets. Compared with other CEEcountries, the state�s extremely largeshare of the Slovenian banking market(almost 50% of the banking sector isstill in state hands) and the limited in-fluence of foreign banks are striking.Only 19% of Slovenian bank assetsare majority-owned by foreign banks.Including equity interests, foreignbanks control a somewhat larger share

of the Slovenian banking sector: over-all, foreign banking groups hold some34% of the equity capital of the Slov-enian banking market.16

The fact that Slovenia has so farbeen spared a banking crisis (alsolikely to be the main reason for thestate�s large share of the banking mar-ket) is key to understanding the Slov-enian banking system. Unlike in othercountries of the region, demand forloans and leasing by private firmsand households has enjoyed a steadylong-term upwards trend as a result.At 41%, the share of domestic per-sonal loans as a percentage of GDPwas one of the highest in the CEEregion at the end of 2002.

Compared with other CEE coun-tries, the credit quality of the Sloven-ian banking sector is also very good.At 6.5%, the share of NPLs as a per-centage of total lending was one of

Table 10


in Poland at End-2003

Bank BPH Raiffeisen Bank Polen

EUR million

Total assets 9,345 1,859Change on previous year (%) �9.1 þ19.3Profit after tax 81 18Change on previous year (%) þ35.4 þ537.2

%

Return on equity1 7.4 15.9Cost-to-income ratio 66.6 77.8

Source: BA-CA. RZB.1 ROE after tax: Bank BPH; RIE before tax: Raiffeisen Bank Polen.

16 The figures relating to the Slovenian banking sector are based on data provided by the Slovenian central bank(Banka Slovenije) and the IMF staff report on financial system stability assessment, update of April 2004.




the lowest in Eastern Europe (onlyHungary and Croatia outperformedSlovenia in this respect). In 2003, amere 13% of operating incomeneeded to be used for additional riskcosts.

Lending growth (+10% in thefirst three quarters of 2003), moder-ate risk costs and very high margins(at 3.4%, Slovenia, despite a decline,

still has one of the highest net interestmargins in the region) were primarilyresponsible for the Slovenian bankingsector�s relatively good profitability(ROA: 1.0%). Capital adequacy iswell below comparable figures inother CEE countries. At 11.6%, thesolvency ratio is close to the averageof Western European banks (11.2%).

As already mentioned, NovaLjubljanska banka, with a marketshare of 33.6%, is the leading bankin Slovenia. NLB is owned by KBC(which holds a stake of 34%) andthe Slovenian state (further privatiza-tion is currently not envisaged, ac-cording to press reports). Nova Kre-

ditna banka — the country�s second-largest bank (market share: 10.8%)— is in state hands. Abanka is also ma-jority-owned by the state. The FrenchSocie«te« Ge«ne«rale holds a stake of 99%in SKB Banka (market share: 8.0%).Banka Koper is controlled by the Ital-ian San Paulo IMI.

Table 11

Selected Key Figures of the Slovenian Banking Sector

1999 2000 2001 2002

Number of banks 31 28 24 22of which foreign banks 5 6 5 6Private banks� share of total assets (%) 57.8 57.5 51.1 51.4Share of nonperforming loans (%) x 6.5 6.9 6.9Domestic personal loans (% of GDP) 38 38.7 40.4 41Stock market capitalization (% of GDP) 11.8 13.7 14.7 19.1EBRD index on bank reform (from 1 to 4+) 3.3 3.3 3.3 3.3

Source: EBRD, Banka Slovenije.

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Share of Austrian Banks as aPercentage of the Slovenian BankingMarket — Around 11%BA-CA, RZB, Hypo Alpe-Adria Bankand O‹ VAG are currently representedby their own subsidiaries in Slovenia.Ka‹rntner Sparkasse is represented bya branch in Slovenia. With a marketshare of 4.3%, the largest Austrianbank in Slovenia is BA-CA d.d. As ofOctober 2003, Raiffeisen Krekovabanka accounted for 2.5%, HypoAlpe-Adria Bank for 1.6%, and Volks-

bank-Ljudska banka for 1.3% of themarket.

Austria�s banks are currently pur-suing an aggressive expansion policyin Slovenia (retail and corporate busi-ness) and advertising on a large scale.In 2003 Austrian banks� lendinggrowth exceeded the market averageby a wide margin. Nevertheless, theprofitability of Austrian bank subsid-iaries in Slovenia has been relativelylow. At the end of 2003, the ROE ofall Austrian banks in Slovenia laggedbehind the Slovenian average.

2.6 CroatiaAccording to a news agency report,17

total assets of the Croatian bankingmarket increased by 16% to HRK203.8 billion (or around EUR 27billion). At 107%, the degree of bankintermediation in Croatia was thehighest in the CEE region. At 107%,the degree of bank intermediation inCroatia was the highest in the CEEregion.

In Croatia the private sectormakes greater use of the banking sec-tor for financing than in other CEEcountries. The share of loans to pri-vate firms and households amounts

to 41% of the country�s GDP. Follow-ing the banking crisis in 1998—99 andthe subsequent privatization of themajor state-owned banks, the Cro-atian banking sector has been almostcompletely controlled by Western Eu-ropean banks. Overall, foreign banksubsidiaries account for some 91%of Croatian bank assets. At around70%, the degree of concentration(market share of the five largest banks)is very high.18

The Croatian banking system wasmarked by healthy profitability in2002 and 2003 (ROA after the firstnine months of 2003: 1.6%) and

Table 12


in Slovenia at End-2003BA-CA d.d. Raiffeisen Krekova

bankaVolksbank-Ljudskabanka

EUR million

Total assets 970 541 303Change on previous year (%) þ26.7 þ32.4 þ49.0Profit after tax 7 1 0Change on previous year (%) �33.2 �71.9 �10.1

%

Return on equity1 9.8 1.9 1.7Cost-to-income ratio 59.4 90.8 90.8

Source: BA-CA. RZB, O‹ VAG.1 ROE after tax: BA-CA d.d.; ROE before tax: Raiffeisen Krekova banka and Volksbank-Ljudska banka.

17 According to a report by Austria Presse Agentur of June 24, 2004.18 For the figures (employed in the text) relating to the Croatian banking sector, please also see

http://www.hnb.hr/publikac/prezent/ebanking-sector.pdf, in particular.




sound capital adequacy (solvency:16.0%). The biggest risks in the Cro-atian banking system are stronggrowth in lending (largely financedby the buildup of net foreign debt)and the large share of foreign currencyas a percentage of customer deposits(68% as of July 2003).

The steep rise in lending (2001:+28.5%, 2002: +40.0%) can beattributed to dynamic economicgrowth (2002 GDP growth: +5.2%)and to copious inflows of liquidity intothe banking system. Considerableamounts of cash (primarily Deutschemarks) held outside the banking sys-tem until the end of 2001 had to bepaid into bank accounts for the pur-poses of euro conversion. Since theCroatian population left most of this

cash in their accounts, the commercialbanking sector suddenly found at itsdisposal additional liquidity of at leastEUR 2 billion.

To contain the risk of excessivelyexpansive lending growth, Hrvatskanarodna banka (HNB — Croatian Na-tional Bank) introduced measures de-signed to absorb liquidity in early2003. Commercial banks were ac-cordingly obliged to purchase HNBsecurities as soon as their lendinggrew by more than 16% per year (or4% per quarter). This measure re-duced lending growth to about 16%in 2003 (2002: 40%). Despite thelapse of lending growth limits as ofthe end of 2003, HNB does not ex-pect lending growth to accelerate ata fast place in 2004.

With a market share of 24.8%,Zagrebacka banka (ZABA) is the lead-ing bank in Croatia and ahead ofPrivredna banka Zagreb, which has amarket share of 18.0%. Zagrebackabanka is 82%-owned by the ItalianUniCredito (the remaining shares be-ing held by Allianz). Privredna bankaZagreb belongs to Intesa, the Italianbanking group (76%). Privrednabanka Zagreb is followed by four Aus-trian subsidiary banks, with almostidentical market share. Splitska banka,a subsidiary of BA-CA (merged with

HVB Croatia in the third quarter of2003) and Raiffeisenbank Austriad.d. each account for 9.1% of themarket. Erste & Steierma‹rkische Bank(merged with Rijecka banka, ErsteBank�s subsidiary, in the third quarterof 2003) has a market share of 9.0%.HAAB is represented in Croatia byHypo Alpe-Adria Bank d.d. (HAAB�sstake: 95%) and by Slavonska banka(HAAB�s stake: 72%), thereby con-trolling some 8.9% of the country�sbanking market.

Table 13

Selected Key Figures of the Croatian Banking Sector

1999 2000 2001 2002

Number of banks 53 43 43 46of which foreign banks 13 21 24 23Private banks� share of total assets (%) 60.2 94.3 95 96Share of non-performing loans (%) 20.6 19.8 15 11.5Domestic personal loans (% of GDP) 22.1 27.8 34.2 45Stock market capitalization (% of GDP) 14 14.5 16.8 16.1EBRD index on bank reform (from 1 to 4+) 3.0 3.3 3.3 3.7

Source: EBRD.




Market Share of Austrian Banks —Around 38%The five Austrian banking groups op-erating in Croatia are Erste Bank,BA-CA, RZB, HAAB and O‹ VAG.Their subsidiaries control roughly38% of Croatia�s bank assets.

In 2003 Austrian bank subsidiariesin Croatia continued to strengthentheir total assets. The extraordinarilystrong growth posted by Erste &Steierma‹rkische Bank d.d. (ErsteBank Kroatien) and by Splitska banka,BA-CA�s subsidiary, was due to merg-ers (Erste Bank merged Rijecka bankawith Erste & Steierma‹rkische Bank inthe third quarter of 2003; BA-CA

merged its two units, HVB Croatiaand Splitska banka).

The 2003 annual results for Raif-feisenbank Austria d.d. (ROE: 22.2%)indicate exceptionally high profitabil-ity. With a ROE of around 15%, ErsteBank�s subsidiary generated an ROEwhich is roughly equivalent to that ofthe Croatian banking sector. BA-CA�ssubsidiary continued to grow in 2003(its marketing network was expandedby 32 branches). At 12.8%, its ROEwas slightly below the market average.Despite considerably improved in-come, Volksbank d.d.�s ROE fell shortof the market average.

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Table 14


in Croatia at End-2003Splitska banka Erste Bank Kroatien Raiffeisenbank

Austria d.d.Volksbank d.d.

EUR million

Total assets 2,509 2,551 2,446 355Change on previous year (%) þ66.2 þ126.5 þ29 þ52.1Profit after tax 23 30 22 2Change on previous year (%) þ71.0 þ194.9 þ12.9 þ46.1

%


Source: BA-CA, Erste Bank, RZB, O‹ VAG.1 ROE after tax: Splitska banka and Erste Bank Kroatien; ROE before tax: Raiffeisenbank Austria d.d. and Volksbank d.d.




3 ConclusionsThe Central and Eastern Europeanbanking market (excluding Russia) isrelatively small with total assets ofsome EUR 350 billion (by compari-son, the total assets of banks operatingin Austria were some EUR 605 billionat the end of 2003).

The Eastern European bankingsector is a growth market. The lowdegree of bank intermediation (abouta third of its Western European coun-terpart), coupled with higher eco-nomic growth (EU accession could ac-celerate the CEE region�s catch-upprocess), should offer banks in Cen-tral and Eastern Europe strong growthpotential in the years to come.

Above-average growth potentialand high profit potential (higher inter-est margins than in Western Europeand restructuring potential) have ledWestern European banks to investheavily in the CEE banking sector.About 70% of the CEE banking mar-ket is currently estimated to be con-trolled by Western European bankinggroups.

Austrian banks were among thefirst to invest in Central and EasternEuropean countries and are now someof the best-known Western Europeanbanks in the region (market share inthe region: about 22%). BA-CA,Erste Bank and RZB are among themost active Western European banksoperating in CEE countries. As earlyas 2002 and 2003, steady expansionin the CEE region had a positive im-pact on the profitability of Austria�sconsolidated banking sector and was

primarily responsible for Austrianbanks outperforming German banksin the past few years.

Favorable reports on the CEEbanking market often fail to mentionthe potential risks, against whichstrong growth and high profits needto be offset. We consider the mainsources of risk in the Eastern Euro-pean banking market to be: macroeco-nomic imbalances, the risk of growingexchange rate volatility, credit risk(can relatively new and untestedcredit risk systems cope with a possi-ble lending boom?), increasinglyfierce competition (high profitabilitycould attract additional competitorsand cause margins to shrink morequickly than expected) and politicalrisks.

The key characteristics of CEEbanking markets are: the degree ofconcentration is relatively high (thefive largest banks enjoy a large marketshare); a majority of bank assets are inforeign ownership (about 70%); cus-tomer deposits are generally far higherthan loans granted (liquid balancesheets); the degree of intermediationis low (in particular, private sector aswell as small and medium-sized enter-prises are still largely financed outsidethe banking sector); the share of non-performing loans as a percentage oftotal lending is high; profitability isexcellent (profitability ratios are onaverage higher than those of WesternEuropean banks); and capital ade-quacy is good (this should fuel stronglending growth over the next fewyears).




ReferencesBank Austria Creditanstalt. 2003. Comparison of Banks in Central and Eastern Europe for 2002.

Vienna. September.

Bank Austria Creditanstalt. 2004. EU-Gro§banken — Bilanzanalyse 2003. Vienna. May.

Ceska« na«rodnı« banka — CNB. 2003. Banking Supervision 2002.

http://www.cnb.cz/en/bd_publikace_rz.php.

Economist. 2003. House party — Lavish subsidies lure hungry homebuyers. 21. August.

Economist. 2004. Happiness begins abroad — Unhappy voters make for unstable politics. 11. March.

European Central Bank. 2003a. EU Banking Sector Stability: Fall 2003. ECB. November.

European Central Bank. 2003b. Structural Analysis of the EU Banking Sector, Year 2002. ECB.

November.

European Central Bank. 2004. Monthly report for June 2004. ECB. June.

European Bank for Reconstruction and Development. 2003. Transition Report 2003. EBRD.

October.

European Bank for Reconstruction and Development. 2004. Transition Report 2003. EBRD.

March.

Hrvatska narodna banka — HNB. 2003. Banks Bulletin No. 7. Croatian National Bank. October.

Hrvatska narodna banka —HNB. 2004. Standard Presentation Format Q1/2004 (Banking sector: Rate

of Growth, Profitability, NPL). http://www.hnb.hr/publikac/prezent/ebanking-sector.pdf. Zagreb.

International Monetary Fund — IMF. 2004. Republic of Slovenia: Financial System Stability Assessment

Update. May. http//www.imf.org.

Magyar Nemzeti Bank — MNB. 2003. Report on Financial Stability. Budapest. December.

Narodowy Bank Polski — NBP. 2004. Summary Evaluation of the Financial Situation of Polish Banks

2003. NPB, Warsaw. June.

http://www.nbp.pl/en/publikacje/o_nadzorze_bankowym/synteza2003_en.pdf.

Oesterreichische Nationalbank — OeNB. 2004. Financial Stability Report 7. OeNB. Vienna. June.




Highlights

From June 20 to 22, 2004, the Oesterreichische Nationalbank (OeNB) and the New York-basedReinventing Bretton Woods Committee co-hosted an international conference in Vienna to commemo-rate the 60th anniversary of the Bretton Woods institutions — the International Monetary Fund (IMF) andthe World Bank.

At the conference, speakers delineated the evolution of the international financial system, outlinedfuture challenges and formulated possible solutions to crisis situations. Core issues included the gover-nance of the international financial system, the development and future role of exchange rate regimesand a crisis prevention and resolution toolkit.

In his introductory remarks, KlausLiebscher, governor of the OeNB,stressed the fundamental role theBretton Woods institutions, i.e. theIMF and theWorld Bank, play in main-taining the stability of the internationalfinancial system and in ensuring wel-fare and the stability of the global econ-omy. As platforms for internationalcooperation, the Bretton Woods insti-tutions fulfill an important functionespecially for smaller countries likeAustria, which may use these forumsto actively participate in internationalrule-making and crisis resolution proc-esses. With a view to the criticism theIMF, in particular, had to face afterthe Asian crisis, Mr. Liebscher statedthat, whenever justified, criticism hadbrought about a change in the waythe international financial institutionswork, as had been the case with capitalaccount liberalization. According toMr. Liebscher, this example shows thatthe Bretton Woods institutions do re-act to constructive suggestions for im-provement.

Furthermore, he underlined anumber of important functions theIMF and the World Bank fulfill:— Monitoring member states� eco-

nomic developments helps in-crease and maintain their livingstandard and prevents interna-tional financial crises.

— Therefore, economic standardsand codes have been establishedto facilitate member states� inte-gration into the global economy.

— Moreover, Financial Sector Assess-ment Programs (FSAPs) have beenimplemented to help analyzestrengths and vulnerabilities ofnational financial systems. (Austriahas recently conducted such a pro-gram with excellent results.)These and similar measures serve

to strengthen member states� econo-mies, enhance their resilience to crisesand thus curb the need for interna-tional financial assistance in crisis sit-uations.

In case a financial crisis does occur,the private sector is also called uponto assume responsibility for its invest-ment decisions. According to Mr.Liebscher, one important future chal-lenge will be the establishment of aregulatory framework that is to facili-tate the resolution of sovereign debtcrises.

Mr. Liebscher pointed out that an-other major task of the BrettonWoods institutions, and of the WorldBank in particular, is poverty reduc-tion. Although not a �development�institution in spirit and by design,the IMF, too, plays a significant rolein the efforts the international com-munity undertakes to eradicate pov-erty.

As an impressive example of thestrong track record of the BrettonWoods institutions, Mr. Liebschermentioned their contribution to thesuccessful transition process of formersocialist economies, above all in Cen-tral and Eastern Europe. Austria has

Christian Just,Franz Nauschnigg


�60 Years of Bretton Woods�A Summary of the Bretton Woods Conference

played an important part in this re-spect as well, and it continues to sup-port the Bretton Woods institutionsthrough technical cooperation proj-ects and as a sponsor of the JointVienna Institute.

According to Mr. Liebscher, theongoing discussion about reformingthe international financial institutionsshould be viewed as positive. How-ever, in his opinion such a reformshould not result in an expansion ofthe institutions� functions but ratherin a return to their core responsibili-ties.

As Marc Uzan, executive directorof the New York-based ReinventingBretton Woods Committee, pointedout, the international financial systemhas changed considerably since 1944.Instead of a system of fixed exchangerates among major currencies, thereis now a floating rate system, andglobal financial markets have replacedonce pervasive capital controls. Froma relatively small group of 35 coun-tries, IMF membership has expandedto include virtually every country inthe world. Particularly since the finan-cial crises of the 1990s, the debateover how to improve the internationalfinancial architecture and how tostrengthen the international financialsystem has intensified.

According to Mr. Uzan, integrat-ing the emerging markets into theglobal economy poses much greaterpolicy challenges than previously an-ticipated. One of the pivotal issuesconcerning the future developmentof the international financial systemwill be the exchange rate regime. De-spite recent movements toward moreflexible exchange rates, some impor-tant emerging economies, such asChina, continue to peg their rates toother currencies. Another major is-sue, according to Mr. Uzan, will be

the future role of the IMF. If countriesare to deal successfully with futurechallenges, they will need to reestab-lish the strong sense of internationalcooperation originally laid out in theBretton Woods agreements.

Panel I:The Governance of theInternational FinancialSystemZeti Akthar Aziz, governor of BankNegara Malaysia, the central bank ofMalaysia, also emphasized the impor-tance of international cooperation.Some immediate challenges, in heropinion, are unsustainable current ac-count imbalances and unstable capitalflows. She called for adjustments inthe international financial system andrecommended taking precautionarymeasures to prevent crises instead ofwaiting for the next crisis to takeeffect.

The keynote speaker of this panel,Jeffrey Shafer (Citigroup), discussedthe far-reaching changes the BrettonWoods system has experienced overthe last 60 years: fixed exchange rateshave been replaced by floating ex-change rates, capital controls havebeen removed to allow free cross-bor-der capital flows and, last but notleast, the euro has been introduced.Although requirements for the gover-nance of the international financialsystem may have changed, the IMFand the World Bank still constituteits core institutions. Sovereign statesremain key players in the system,but given their increasing interde-pendence, they have to cooperatemore closely. According to Mr. Shafer,major challenges comprise adjustingcurrent account imbalances, improv-ing financial sector surveillance andadapting the World Bank�s role tomatch higher liquidity in financial


�60 Years of Bretton Woods�

A Summary of the Bretton Woods Conference

markets. In this respect, he advocatedproviding grants rather than loans. Inaddition to that, ways of dealing withcountries whose debt levels havebecome unsustainable must be found.Concerning IMF governance, Mr. Sha-fer noted that the Executive Board ofthe IMF is no longer representative ofthe present geopolitical realities, withthe EU, in particular, being overrepre-sented and Asia being underrepre-sented. Although EU votes nearly out-number U.S. votes by two to one, theEU has less influence within the IMFthan the U.S.A. Furthermore, Mr.Shafer called for the establishment ofa G-4 consisting of the U.S.A., theeuro area, Japan and China.

Kurt Bayer (Austria), executive di-rector of the World Bank, gave anoverview of the tasks of the WorldBank, whose original mission was toreduce poverty and promote develop-ment. In Mr. Bayer�s opinion, theWorld Bank, together with regionaldevelopment banks and their special-ized institutions, still has the potentialto contribute immensely to fulfillingthis mission. Recently, strengtheningthe financial systems in developingand emerging economies has becomeeven more important, particularlywhen bearing in mind that the damagecaused by financial crises in thesecountries during the last few decadesequals the amount of official develop-ment assistance they received.

Kemal Dervis�, former Turkish min-ister of economic affairs, discussed thetwo fundamentalisms that character-ized the 20th century — central plan-ning and market fundamentalism —pointing to the fact that central plan-ning has been discredited because ofthe collapse of communism. Accord-ing to Mr. Dervis�, the market, whenleft on its own, is not able to distrib-ute all resources efficiently, but de-

pends on government support in ful-filling this task. State and market arethus complementary actors. Marketsmust be embedded in adequate frame-work conditions. Currently, this em-bedding exists at the national level,but not at the international level. InMr. Dervis�� opinion the IMF has akey responsibility to correct marketfailures at the international level andto provide public goods like financialstability. Its two main functions arecrisis resolution and the economicsurveillance of member states. Thesometimes excessive levels of publicdebt in emerging countries are notsustainable in the long run, especiallysince capital markets are highly vola-tile. Mr. Dervis� advocated providingIMF financial assistance also on along-term basis, as World Bank re-sources alone are insufficient in thiscontext. The problem with IMF con-ditionality is that its implementationmay lead to political problems in therespective countries.

Harold James, professor at Prince-ton University, pointed to the successof the Bretton Woods system, whichhad originally been based on threepillars: the IMF, the World Bank andan international trade organization,which was effectively established onlyin 1995, when the World Trade Or-ganization (WTO) was founded. Mr.James explained that there has beena converse development in the mone-tary domain and in trade. While themonetary order is moving away fromstrict rules, i.e. from a fixed exchangerate regime to a system of floatingrates, trade is experiencing a shifttowards more rules and regulations, asestablished by the WTO. Historically,exchange rate adjustments served tosolve trade problems, as was the casein the U.S.A. in 1971 and 1985. Ap-plying this kind of solution will be-




come increasingly difficult, as half theworld, i.e. the U.S.A. and Asia, haveentered into an informal BrettonWoods system, in which currenciesare pegged to the U.S. dollar. Whilethe volatility of capital flows in emerg-ing economies may create problems,one should not only bear in mindthe costs, but also the benefits of freecapital flows. History has shown thatrapidly growing economies often tendto be instable. In many cases IMF con-ditionality is hardly acceptable from apolitical point of view. Quoting thesituation in Austria in the 1920s asan example, Mr. James stated thatthe conditionality of the League of Na-tions had been too strict and had sub-sequently prompted other countriesto refrain from accepting financial as-sistance by the League of Nations.

Among the topics of the ensuingdiscussion was the issue of moral haz-ard. Participants stated that, whilemoral hazard may play an importantrole in the political discussion, no em-pirical proof of its existence has beenfound so far. Exchange rate manipula-tion — i.e. creating export advantagesby deliberately keeping exchange rateslow — has so far only been an issuewith Korea and Sweden, namely inthe 1980s. It could, however, becomea problem in China. With respect tothe question of governance, some dis-cussants advocated strengthening theIMF and World Bank boards of direc-tors rather than letting informalgroups take care of this issue, arguingthat the number of �G-x�s was toolarge already. The main problem withfinancial crises is that, in general, theyhave a particularly severe impact onthe poorest members of the popula-tion in developing and emergingcountries.

Panel II:Exchange Rate RegimesIn his introductory statement on ex-change rate regimes, Guillermo Ortiz,governor of the Banco de Me«xico,gave an account of Mexico�s experi-ence with exchange rate regimes sincethe mid-1990s. Mexico was the firstemerging market economy to imple-ment a flexible exchange rate regime,introducing floating rates in 1994 af-ter a sharp drop in foreign reservesfollowing interventions during theMexican crisis. Mr. Ortiz drew a pos-itive picture of Mexico�s experiencewith floating exchange rates.

Michael Bordo, professor atRutgers University, offered a historicalaccount of the evolution of exchangerate regimes. At the beginning of the20th century, there had been a cleartendency to join the gold standard, ifpossible. Now, at the beginning of the21st century, the consensus is shiftingtoward floating exchange rates. How-ever, in the period between WorldWar I and World War II, some coun-tries had negative experiences withflexible exchange rates because ofspeculations and beggar-thy-neighbordevaluations. Not until Milton Fried-man argued for floating exchange ratesdid flexible rates become a real eco-nomic policy option again. Mr. Bordoemphasized the credibility of economicpolicy as a key factor; while countriestraditionally pegged their exchangerates to other currencies and usedthem as nominal anchors, the newconsensus increasingly tends towarddomestic monetary anchors, mostlythrough inflation targeting. Emergingeconomies with fixed exchange ratesare prone to encounter difficulties, inparticular if they lack a lender of lastresort and if their capital markets arenot well developed, as external debtin foreign currency is likely to cause




currency mismatches and thus createsfinancing problems. According toBordo, in cases like these, devaluationsoften have no effect on the real econ-omy. When speaking of exchange rateregimes, one has to distinguish be-tween de jure and de facto regimes.The de jure regime applied by theIMF appears to hollow out intermedi-ary regimes — which de facto exist inmuch larger numbers — in favor of ei-ther fixed or floating exchange ratesystems. The historical performanceshows that pegs work well for develop-ing countries but not for advancedeconomies. The more advanced aneconomy is, the sooner it can switchto floating exchange rates.

Based on the European experi-ence, Josef Christl, executive directorof the OeNB, analyzed whether cur-rency unions might be an option forother regions, such as Latin Americaor Asia. In his remarks on optimumcurrency area criteria, Mr. Christlpointed out that for countries like Ar-gentina these criteria remain impor-tant and that their endogeneity mustnot be presupposed. Concerning thecosts and benefits of the EuropeanEconomic and Monetary Union, hestated that the success and sustainabil-ity of a monetary union depend notonly on a strong political will, but alsoon fiscal rules. Asia and Latin Americamay have taken the first steps of a Ba-lassa sequencing by establishing freetrade areas and customs unions; how-ever, Mr. Christl said that he was notyet convinced that these regions couldcurrently benefit from a monetary un-ion given their varying degrees of eco-nomic development and lack of polit-ical will. He considers the adoption ofinflation targeting a feasible monetarypolicy option for achieving macroeco-nomic stability and economic conver-gence, pointing to countries like Mex-

ico and Chile, which have attained rel-ative stability by applying this strategy.In concluding, Mr. Christl said thatthe EU experience with economicand monetary integration cannotserve as a blueprint for other regions.

Masahiro Kawai, professor at theUniversity of Tokyo, gave a presenta-tion on how East Asia could contrib-ute to a stable currency system. Ac-cording to Mr. Kawai, the Asian crisishas shown that regional financial ar-chitectures are needed to complementthe international financial architec-ture. In Asia, the regional architectureessentially involves the Chiang Mai In-itiative, the ASEAN+3 dialogue andthe Asian Bond Market Initiative.Deepening regional integration andmacroeconomic interdependencethroughout Asia require financial sta-bility at the regional level. It is this re-gional financial stability that Asianeeds to be able to play a role in inter-national economic relations commen-surate with its economic power. How-ever, the fear of losing national sover-eignty, the heterogeneity of the Asianeconomies and the peg to the U.S.dollar render closer cooperation diffi-cult. To Mr. Kawai, key prerequisitesfor promoting closer cooperation onthe basis of the IMF framework are,among others, stronger regional eco-nomic surveillance and an enhancedexchange rate policy coordinationbased on a G-3 (U.S. dollar, euroand Japanese yen) �currency snake�similar to the European currencysnake of the 1970s.

Panel III:Crisis Prevention andResolutionPedro Malan, former finance ministerof Brazil, emphasized how sharply cir-cumstances have changed since thecreation of the Bretton Woods system.




He quoted Hobsbawm, according towhom more changes have occurredsince the end of World War II thanin any other period of world history.It is important to remember the les-sons we can learn from history andto bear in mind the interplay betweenpast, present and future. We must ex-pect financial crises to occur in the fu-ture and be prepared to overcomethem in the best possible way. Ex-change rate regimes and fiscal ruleshave to be adapted to changing cir-cumstances; naturally, there can beno ideal regime that is valid for allcountries at all times. Mr. Malan par-ticularly stressed the importance ofgrowth strategies for developing andemerging economies and emphasizedthe role institutions play in this con-text, using the wordplay, �It�s institu-tions, stupid!�.

In Mr. Malan�s opinion there is abroad consensus that sustainable mac-roeconomic policies and stable —rather than fragile — financial systemsare needed, while institutional weak-nesses have to be eliminated. Address-ing economic problems in individualcountries is a key priority, but a num-ber of international issues have to besolved as well. One such issue is theasymmetric distribution of informa-tion between borrowers and lenders.A surge in debt after the first oil priceshock and a rise in interest rates orig-inating in the U.S.A. had triggered thedebt crisis of the 1980s, which wasnot overcome until the Brady Planwas introduced in 1989. In Mr. Ma-lan�s opinion, the Sovereign Debt Re-structuring Mechanism (SDRM) theIMF proposed is not an adequatemeans for resolving crises in emergingeconomies, in particular in his homecountry Brazil. Instead, he advocateda wider use of Collective ActionClauses (CACs) and stated that close

cooperation between the public andprivate sectors and international insti-tutions is essential. As a case in point,he described Brazil�s experience witha debt rollover: Brazil had negotiatedwith the private sector, but the meet-ings had taken place at the respectivecentral banks in the presence of anIMF representative. This cooperationhad been key to the initiative�s success.

Richard Portes, professor at theLondon Business School and Presidentof the Centre for Economic Policy Re-search (CEPR), summarized the statusquo in crisis resolution, pointing outthat while bailouts are not the pathto success, disorderly sovereign debtworkouts are very costly. Solving theIMF�s time inconsistency problem re-quires a clear regulatory frameworkon presumptive limits. The market it-self cannot provide a clear institu-tional framework for the orderly res-olution of government bankruptcies.The SDRM debate may not have pro-duced an international framework fordebt workouts; nevertheless, it hasspurred the debate and the searchfor alternatives, which comprise ap-plying CACs, reintroducing bond-holders� committees by establishing aNew York Club, and creating a medi-ation agency independent of the IMFto coordinate the Paris, London andNew York Clubs. This agency couldalso carry out other functions, suchas monitoring the compliance with acode of conduct. Mr. Portes also pre-sented a new proposal, suggesting thatthe IMF could act as a lender of firstresort and offer a facility similar to acontingent credit line, which a coun-try might use to fulfill its internationalobligations in the event of a liquiditycrisis.

Gertrude Tumpel-Gugerell, mem-ber of the Executive Board of theEuropean Central Bank, analyzed the




international crisis prevention toolkit.She particularly underlined the aspectof transparency, pointing out thatgreater transparency should make iteasier for market participants to assessrisks. Ms. Tumpel-Gugerell stressedthe IMF�s increased efforts to promotethe provision of data through theSpecial Data Dissemination Standard.She also emphasized that the BrettonWoods institutions have stepped uptheir efforts to achieve financial sta-bility, e.g. by establishing an Inter-national Capital Markets Departmentand by drawing up the Financial Sec-tor Assessment Programs (FSAPs).In addition, the IMF�s balance sheetapproach ensures that countries� bal-ance sheets are monitored moreclosely in order to detect mismatchesthat may affect their debt-servicingabilities. Ms. Tumpel-Gugerell con-tinued by saying that views were stillevolving on the appropriate balancebetween transparency and confiden-tiality. In her opinion, the questionwhether all the efforts mentionedhave actually improved crisis resil-ience remains an open issue. Shenoted that although there has beensome contagion, risk differentiationamong individual emerging econo-mies has increased.

Anne O. Krueger, first deputy man-aging director of the IMF, said that theIMF�s mission — to provide a stableinternational financial system as asound basis for promoting trade ex-pansion and economic growth — hasremained valid since its foundation in1944, but that the methods used toachieve this mission have changed. De-mands on the IMF have also altered,particularly since the capital accountcrises of the 1990s. Among other is-sues, Ms. Krueger focused on the pro-nounced changes in the IMF�s surveil-lance function and on its crisis resolu-tion toolkit. She quoted the enhancedtransparency in the dialogue betweenthe IMF, its members and the broaderpublic, the movement away from fixedexchange rates and an expanded defini-tion of macroeconomic stability amongthe major changes in the Fund�s sur-veillance work. Ms. Krueger under-lined the importance of CACs in crisisresolution, even though, in her opin-ion, it is still much too soon to evaluateto what extent CACs can improve theorderly resolution of sovereign debtcrises. By way of conclusion, she saidthat the IMF, just like the world econ-omy, is constantly evolving and that theFund should, where possible, try toremain at the cutting edge of globaleconomic developments.




ACH automated clearing houseAPSS Austrian Payment System Services GmbHARTIS Austrian Real Time Interbank Settlement

(the Austrian RTGS system)A-SIT Secure Information Technology Center — AustriaASVG Allgemeines Sozialversicherungsgesetz — General

Social Security ActA-Trust A-Trust Gesellschaft fu‹r Sicherheitssysteme im

elektronischen Datenverkehr GmbHATM automated teller machineATX Austrian Traded IndexBCBS Basel Committee on Banking Supervision (BIS)BIC Bank Identifier CodeBIS Bank for International SettlementsBOP balance of paymentsBSC Banking Supervision Committee (ESCB)CACs collective action clausesCEBS Committee of European Banking Supervisors (EU)CEE Central and Eastern EuropeCEECs Central and Eastern European countriesCESR Committee of European Securities RegulatorsCIS Commonwealth of Independent StatesCPI consumer price indexEBA Euro Banking AssociationEBRD European Bank for Reconstruction and

DevelopmentEC European CommunityECB European Central BankEcofin Council of Economics and Finance Ministers (EU)EEA European Economic AreaEFC Economic and Financial Committee (EU)EIB European Investment BankEMS European Monetary SystemEMU Economic and Monetary UnionEONIA Euro OverNight Index AverageERM II Exchange Rate Mechanism II (EU)ERP European Recovery ProgramESA European System of AccountsESAF Enhanced Structural Adjustment Facility (IMF)ESCB European System of Central BanksESRI Economic and Social Research InstituteEU European UnionEURIBOR Euro Interbank Offered RateEurostat Statistical Office of the European CommunitiesFATF Financial Action Task Force on Money LaunderingFed Federal Reserve SystemFFF Forschungsfo‹rderungsfonds fu‹r die Gewerbliche

Wirtschaft — Austrian Industrial ResearchPromotion Fund

FMA Financial Market Authority (for Austria)FOMC Federal Open Market Committee (U.S.A.)FSAP Financial Sector Assessment Program (IMF)FWF Fonds zur Fo‹rderung der wirtschaftlichen

Forschung — Austrian Science FundGAB General Arrangements to BorrowGATS General Agreement on Trade in ServicesGDP gross domestic product

GNP gross national productGSA GELDSERVICE AUSTRIA Logistik fu‹r Wert-

gestionierung und Transportkoordination GmbH(Austrian cash services company)

HICP Harmonized Index of Consumer PricesIBAN International Bank Account NumberIBRD International Bank for Reconstruction and

DevelopmentIDB Inter-American Development BankIFES Institut fu‹r empirische Sozialforschung GesmbH

(Institute for Empirical Social Research, Vienna)ifo ifo Institute for Economic Research, MunichIGC Intergovernmental Conference (EU)IHS Institut fu‹r Ho‹here Studien und Wissenschaftliche

Forschung — Institute for Advanced Studies, ViennaIIF Institute of International FinanceIIP international investment positionIMF International Monetary FundIRB internal ratings-basedISO International Organization for StandardizationIWI Industriewissenschaftliches Institut — Austrian

Institute for Industrial ResearchIT information technologyJVI Joint Vienna InstituteLIBOR London Interbank Offered RateM3 broad monetary aggregate M3MFI monetary financial institutionMRO main refinancing operationMO‹ AG Mu‹nze O‹ sterreich AG — Austrian MintMoU memorandum of understandingNCB national central bankO‹ BB O‹ sterreichische Bundesbahnen — Austrian Federal

RailwaysOeBS Oesterreichische Banknoten- und Sicherheitsdruck

GmbH — Austrian Banknote and Security PrintingWorks

OECD Organisation for Economic Co-operation andDevelopment

OeKB Oesterreichische Kontrollbank (Austria�s mainfinancial and information service provider for theexport industry and the capital market)

OeNB Oesterreichische Nationalbank (Austria�s centralbank)

OPEC Organization of the Petroleum Exporting CountriesORF O‹ sterreichischer Rundfunk — Austrian Broadcasting

CorporationO‹ BFA Austrian Federal Financing AgencyO‹ NACE Austrian Statistical Classification of Economic

ActivitiesPE-ACH pan-European automated clearing housePISA Programme for International Student Assessment

(OECD)POS point of salePRGF Poverty Reduction and Growth Facility (IMF)RTGS Real-Time Gross SettlementSDR Special Drawing Right (IMF)SDRM Sovereign Debt Restructuring Mechanism (IMF)SEPA Single Euro Payments Area


Abbreviations

SPF Survey of Professional ForecastersSTEP2 Straight-Through Euro Processing system offered by

the Euro Banking AssociationSTP straight-through processingSTUZZA Studiengesellschaft fu‹r Zusammenarbeit im

Zahlungsverkehr G.m.b.H. — Austrian ResearchAssociation for Payment Cooperation

S.W.I.F.T. Society for Worldwide Interbank FinancialTelecommunication

TARGET Trans-European Automated Real-time Grosssettlement Express Transfer

Treaty refers to the Treaty establishing the EuropeanCommunity

UNCTAD United Nations Conference on Trade andDevelopment

UNO United Nations OrganizationVaR Value at RiskWBI Wiener Bo‹rse IndexWEF World Economic ForumWIFO O‹ sterreichisches Institut fu‹r Wirtschaftsforschung —

Austrian Institute of Economic ResearchWIIW Wiener Institut fu‹r internationale Wirtschafts-

vergleiche — The Vienna Institute for InternationalEconomic Studies

WKO Wirtschaftskammer O‹ sterreich — Austrian FederalEconomic Chamber

WTO World Trade Organization


Abbreviations

— = The numerical value is zero. . = Data not available at the reporting datex = For technical reasons no data can be indicated0 = A quantity which is smaller than half of the unit indicatedfl = Mean value_ = New series

Note: Apparent arithmetical discrepancies in the tables are due to rounding.

Irrevocable euro conversion rate: EUR 1 = ATS 13.7603.


Legend

For further details on the following publications see www.oenb.at

Issue Q1/04Subdued Economic Activity in the Euro Area and Austria DespiteInternational RecoveryGerhard Fenz, Thomas Gruber, Wolfgang Pointner

Determinants of Long-Term Growth in Austria — A Call for a National GrowthStrategyErnest Gnan, Ju‹rgen Janger, Johann Scharler

Inflation Differentials in Europe: Past Experience and Future ProspectsBala«sz E«gert, Doris Ritzberger-Gru‹nwald, Maria Antoinette Silgoner

The International Financial Architecture: Official Proposals on CrisisResolution and the Role of the Private SectorChristian Just

The Impact of ATM Transactions and Cashless Payments on Cash Demandin AustriaHelmut Stix

Issue Q2/04

Global Recovery and Stable Domestic Economic Conditions SupportModerate Upswing — Economic Outlook for Austria from 2004 to 2006(Spring 2004)Gerhard Fenz, Johann Scharler, Martin Schneider

The Impact of Oil Price Changes on Growth and InflationMartin Schneider

Sectoral Specialization in Austria and in the EU-15Ju‹rgen Janger, Karin Wagner

The Role of Revaluation and Adjustment Factors in Pay-As-You-GoPension SystemsMarkus Knell

Financial Market Structure and Economic Growth: A Cross-CountryPerspectiveFriedrich Fritzer

The Role of Bank Lending in Market-Based and Bank-Based Financial SystemsSylvia Kaufmann, Maria Teresa Valderrama

Growth and Stability in the EU: Perspectives from the Lisbon Agenda —Results from the 32nd Economics ConferenceSylvia Kaufmann, Burkhart Raunig, Helene Schuberth


List of StudiesPublished in Monetary Policy & the Economy

Issue Q3/04

Economic Recovery in the Euro Area and in Austria in a Dynamic GlobalEconomic EnvironmentAntje Hildebrandt, Martin Schneider, Maria Antoinette Silgoner

Measures to Improve the Efficiency of the Operational Framework forMonetary PolicyMichael Pfeiffer

Expansionary Fiscal Consolidations? An Appraisal of the Literature onNon-Keynesian Effects of Fiscal Policy and a Case Study for AustriaDoris Prammer

The Draft Treaty Establishing a Constitution for Europe — InstitutionalAspects of Monetary UnionIsabella Lindner, Paul Schmidt

Central and Eastern Europe — The Growth Market for Austrian BanksPeter Breyer

�60 Years of Bretton Woods� — A Summary of the Bretton WoodsConferenceChristian Just, Franz Nauschnigg


List of Studies

Published in Monetary Policy & the Economy

For further details on the following publications see www.oenb.at

Statistiken — Daten & Analysen quarterly

This publication contains reports and analyses focusing on Austrian financialinstitutions, cross-border transactions and positions as well as financial flows.The contributions are in German, with executive summaries of the analysesin English. The statistical part covers tables and explanatory notes on a widerange of macroeconomic, financial and monetary indicators. The tables includ-ing additional information and data are also available on the OeNB�s website inboth German and English. This series also includes special issues on selectedstatistics topics that will be published at irregular intervals.

Monetary Policy & the Economy quarterly

This quarterly publication, issued both in German and English, offers analyses ofcyclical developments, medium-term macroeconomic forecasts and studies oncentral banking and economic policy topics. This publication also summarizesthe findings of macroeconomic workshops and conferences organized by theOeNB.

Financial Stability Report semiannual

The Financial Stability Report, issued both in German and English, containsfirst, a regular analysis of Austrian and international developments with animpact on financial stability and second, studies designed to provide in-depthinsights into specific topics related to financial market stability.

Focus on European Economic Integration semiannual

Focus on European Economic Integration, the successor publication to the Focuson Transition (published up to issue 2/2003), contains a wide range of materialon Central and Eastern European countries (CEECs), beginning with a topicaleconomic analysis of selected CEECs. The main part of the publication com-prises studies, on occasion several studies focusing on a special topic. The finalsection provides information about the OeNB�s CEEC-related activities andconferences as well as a statistical annex.

Annual Report annual

The Annual Report of the OeNB provides a broad review of Austrian monetarypolicy, economic conditions, new developments on the financial markets ingeneral and the financial market supervision in particular, the changing respon-sibilities of the OeNB and the role of the OeNB as an international partner incooperation and dialogue. It also contains the financial statements of the OeNB.

Economics Conference (Conference Proceedings) annual

The Economics Conference hosted by the OeNB represents an important inter-national platform for exchanging views on monetary and economic policyas well as financial market issues. It convenes central bank representatives,economic policy decision makers, financial market players, academics andresearchers. The conference proceedings comprise all papers, most of themin English.


Periodical Publicationsof the Oesterreichische Nationalbank

The Austrian Financial Markets annualThe publication The Austrian Financial Markets provides easy access to contin-uously updated information on the Austrian capital markets to the internationalinvestment community. The brochure is jointly edited by the OeNB and theOesterreichische Kontrollbank AG (OeKB).

Proceedings of OeNB Workshops recurrent

The proceeding of OeNB Workshops were introduced in 2004 and typically com-prise papers presented at OeNB workshops at which national and internationalexperts, including economists, researchers, politicians and journalists, discussmonetary and economic policy issues. Workshop proceedings are available inEnglish only.

Working Papers recurrent

The Working Paper series of the OeNB is designed to disseminate and provide aplatform for discussing findings of OeNB economists or outside contributors ontopics which are of special interest to the OeNB. To ensure the high quality oftheir content, the contributions are subjected to an international refereeingprocess. The opinions are strictly those of the authors and in no way committhe OeNB.

Conference on European Economic Integration(Conference Proceedings) annual

(formerly East-West Conference)This series, published by a renowned international publishing house, reflectspresentations made at the OeNB�s annual central banking conference onCentral, Eastern and Southeastern European issues and the ongoing EU enlarge-ment process.For further details see ceec.oenb.at

Newsletter of the Economic Analysisand Research Section quarterly

The English-language Newsletter of the Economic Analysis and Research Section isonly published on the Internet and informs an international readership aboutselected findings, research topics and activities of the Economic Analysis andResearch Section of the OeNB. This publication addresses colleagues from othercentral banks or international institutions, economic policy researchers, deci-sion makers and anyone with an interest in macroeconomics. Furthermore,the Newsletter offers information on publications, studies or working papersas well as events (conferences, lectures and workshops).For further details see hvw-newsletter.oenb.at


Periodical Publications

of the Oesterreichische Nationalbank

Postal address Telephone Telex

Head OfficeA 1090 Vienna PO Box 61 (+43-1) 404 20-0 (1) 114669 natbk

Otto-Wagner-Platz 3 A 1011 Vienna Fax: (+43-1) 404 20-2398 (1) 114778 natbk

Austria

Internet: www.oenb.at

Branch OfficesBregenz PO Box 340 (+43-5574) 49 61-0

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Austria

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Austria

Graz PO Box 8 (+43-316) 81 81 81-0

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Austria

Innsbruck (+43-512) 594 73-0

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Austria

Klagenfurt PO Box 526 (+43-463) 576 88-0

10.-Oktober-Stra§e 13 A 9010 Klagenfurt Fax: (+43-463) 576 88-99

Austria

Linz PO Box 346 (+43-732) 65 26 11-0

Coulinstra§e 28 A 4021 Linz Fax: (+43-732) 65 26 11-99

Austria

Salzburg PO Box 18 (+43-662) 87 12 01-0

Franz-Josef-Stra§e 18 A 5027 Salzburg Fax: (+43-662) 87 12 01-99

Austria

Representative OfficesOesterreichische Nationalbank (+44-20) 7623-6446

London Representative Office Fax: (+44-20) 7623-6447

5th floor, 48 Gracechurch Street

London EC3V 0EJ, United Kingdom

Oesterreichische Nationalbank (+1-212) 888-2334 (212) 422509 natb ny

New York Representative Office (+1-212) 888-2335

745 Fifth Avenue, Suite 2005 Fax: (+1-212) 888-2515

New York, N. Y. 10151, U.S.A.

Permanent Mission of Austria to the EU (+32-2) 285 48-41, 42, 43

Avenue de Cortenbergh 30 Fax: (+32-2) 285 48-48

B 1040 Brussels, Belgium

Permanent Mission to the OECD (+33-1) 53 92 23-39

3, rue Albe«ric-Magnard (+33-1) 53 92 23-44

F 75116 Paris, France Fax: (+33-1) 45 24 42-49


Addressesof the Oesterreichische Nationalbank

monetary policy and the economy q3/04fa2d0969-1171-43dd-bf8a-ca3969f7be8… · quarterly review of...

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