XVth anniversary of CEPR
London, 9 November 1998

Remarks by
Dominique Strauss-Kahn
Minister of Economy, Finance and Industry

I am very happy to be here tonight at the invitation of Anthony Loehnis and Richard Portes, and to have the privilege of addressing this distinguished audience on the occasion of the XVth anniversary of the Centre for Economic Policy Research. CEPR is an institution I have much sympathy for, for at least three reasons:

  • It is a truly European institution and a vivid illustration of the emergence of a pan-European civil society. Whenever we read a CEPR report, we hardly pay attention to the nationality of the authors. They can be British or French or Italian or Hungarian, but they work together and adopt a European perspective. Fifteen years ago, this was exceptional: European economic research was very segmented, and top researchers had much closer relations with their US colleagues than with their European counterparts. Today, thanks in large part to the dedication of Richard Portes, European co-operation has become a natural way of doing things ;

  • It has created a tradition of high-quality European policy-oriented research. When I left the academic world
    shortly before the creation of CEPR, researchers were frequently keen on avoiding any conclusion that might have a relevance for policy, while policy-makers frequently insisted that they had too many important things to do then to waste time talking to researchers. This has changed, and here also CEPR has played a key role in demonstrating that very serious research can be carried out on burning policy issues, and bring results that are of significant relevance in decision making;  

  • It contributes to the quality of the public debate on economic policy. It is my deep conviction that key economic options need to be debated in public, and that we can only ask our fellow citizens to endorse our choices if we accept an open confrontation of alternative views. The risk however is that when discussions develop, economic policy choices tend to become excessively politicized. By bringing non-partisan research to the attention of the public and the press, CEPR has also contributed to improving public awareness and to creating conditions for informed debates.

It is therefore a great pleasure for me to celebrate with you this anniversary. It is also a pleasure to be in London shortly after the British government expressed again its interest in joining the single currency and announced measures to prepare a possible entry of the UK into the monetary union. I am confident such a move would be in the best interest of Britain and its partners. It is my hope that it will take place in due time.

Tonight, I would like to focus on the domestic and international policy issues we are now facing in Europe. I shall briefly set out the challenges we are confronting. Then I will discuss the policy agenda of the new European left. I will next present my views on the macro-economic policy dilemma. And finally, I will discuss the international agenda.  

1. The challenges

The recent European summit of Pörtschach highlighted the degree of change there has been in Europe in the last 18 months. In Spring 1997, the euro was still a project with a less-than-certain future, continental Europe was still the laggard in a buoyant world economy, and the political landscape was still dominated by a (rather unholy) alliance of conservative politicians. Within a few months, all this has dramatically changed, for the better. But there is no time for rest and self-congratulations. On the contrary, I see at least three reasons why European policy-makers should especially feel the burden of their historic responsibility:

  • We are about to embark on one of the most ambitious economic ventures that can be imagined, the creation of the single currency. Thanks in large part to extensive CEPR research, there is a lot we know about EMU and the way it will work. But there is also much we do not know, if only because the actual working of rules and institutions cannot be tested in vitro. It is now our responsibility to make these institutions work, in order to ensure that the euro will be a success and that in a non-inflationary environment, it will contribute to stimulating growth and to alleviating Europe’s main plague, unemployment ;  

  • The recent financial crises are a strong reminder of the fragility of the world economic system. World growth has slowed down markedly, and much of what most economists had become used to taking for granted - the advance of globalisation, the endless growth of emerging economies, the merits of unfettered capital flows - is being challenged by events in Asia and elsewhere. Growth and financial stability in the world are at stake. And the foundations laid down at Bretton Woods, upon which the prosperity of the world economy has been based, are in urgent need of repair. As a region with a significant growth outlook, and as a founding father of the world financial institutions, Europe has a special responsibility in both respects ;  

  • Last but not least, today’s European governments exhibit a rare degree of intellectual homogeneity. Gone are the days when Margaret Thatcher’s Britain and François Mitterand’s France were implementing almost entirely opposite policies. Socialists or social democrats are in government in 13 of the 15 member states, and although some of them picture themselves as belonging to the left, while others prefer to speak of the centre-left, they have much in common. The European left has natural grounds to rejoice at this convergence, but we should not hide the fact that it also increases our responsibility: we shall be made accountable for our citizens’ prosperity, and there will be no scapegoat to blame.

A challenge of historic dimension. A crisis that highlights the emptiness of received wisdom. And a degree of unity that makes joint action possible. These are circumstances governments rarely face simultaneously. The stakes are high.

2. The economic doctrine of the New European Left

The first issue I would like to address is that of the economic doctrine of this new European left. I am amazed by the conservative tendency to caricature the socialist and social-democrats, and to picture us as old-style tax-and-spend politicians. I will not take too much time on our defence, but I would like to request the commentators to take a closer look at the intellectual apparatus of the European left. It has changed.

Since the late 1960s, when Milton Friedman wrote his famous paper on the role of monetary policy, the debate about economic policy has been dominated by the controversy between the apostles of markets and the advocates of government. This debate has not ended, because it cannot end, but it has lost vigour and substance. As Avinash Dixit put it in a recent book, « one must accept that markets and governments are both imperfect systems; that both are unavoidable features of reality; and that the operation of each is powerfully influenced by the other ». This is certainly common sense, but it is worth repeating in front of market fundamentalists, and when we address issues like growth and inflation in Europe, and the reform of the international financial architecture. The new European left does not consider free markets as icons you should either destroy or revere. It treats them as essential institutions of a modern economy, which governments should abstain from interfering in. But also as sometimes imperfect institutions, in the design of which governments may have to take their responsibility, in order to define and enforce basic rules - this is the role of competition policy - or for addressing imperfections arising from externalities or incompleteness. The European left has broken with a long-standing tradition of distrust for and interference in the markets. It no longer takes it for granted that governments have full information and are immune from the influence of specific interests. But it has also lost any complex it might have vis-à-vis the ideology of free markets and is ready to reform market structures when there is a case for it.

A similar attitude prevails in the macro-economic field. We are as committed as anyone to the culture of stability and of fiscal responsibility. Several left-wing governments paid a political price to demonstrate this commitment, as in my own country, where socialist governments under President Mitterand made a decisive turn towards disinflation and exchange rate stability. The same applies for example to Italy, where fiscal retrenchment was initiated and carried through by governments of the centre-left, especially that of Romano Prodi, as well as to several other European countries. This is after all only logical, because no one ever demonstrated that redistributing wealth through inflation or increasing public debt contribute to the objective of social justice. On the contrary, reckless public debt accumulation redistributes wealth away from future generations, undermines the state’s ability to invest for the future, and gives the private sector a misplaced incentive to invest in safe government assets rather than in more risky productive ones. I do not see any reason why the left should associate itself with policies that are detrimental to social justice and conducive to rent-seeking behaviour. It is therefore paradoxical that commentators continue to doubt the reality of our commitment. I would like to encourage researchers to carry out a systematic comparison of the recent macro-economic record of conservative and social democratic governments in Europe. I am confident that it would show that price stability and fiscal rectitude are in no way associated with the right.

However, this commitment does not mean that we consider that governments and central banks should overlook their role in the management of the economic cycle. Being committed to price stability does not imply that central banks should narrowly focus on prices, especially when inflation is low and falling. Nor does it mean that fiscal policy has no role to play in the framework of EMU. On the contrary, both theory and empirical evidence suggest that macro-economic policy becomes more effective when authorities do not depart from well-specified medium term objectives.

In both the micro and the macro field, our culture has therefore changed. And my (admittedly incomplete) reading of today’s economic research suggests to me that we are much more in tune with the results of contemporary economic research than most people realise. Archaism and modernity are not always where people tend to think they are.

3.   Economic policy and growth in Europe

Let me now build on this approach to address a more concrete issue, namely the macro-economic policy dilemma of today’s Europe.

The system we have constructed for macro-economic policy-making in the euro area lies on solid foundations: there is both a clear division of responsibilities between the fiscal authorities of the member states and the European monetary authority, and a clear definition of the objectives each player has to pursue. We have made the choice of having an independent central bank. Its autonomy vis-à-vis the national governments and the EU institutions, which results from an international treaty, is more solidly guaranteed than anywhere else in the world. I have every reason to be satisfied with this choice, which ensures that our policy system will deliver price stability. We have clearly enshrined in our treaty a fiscal policy code that emphasises the need for fiscal responsibility, and we have drafted secondary legislation that will make sure that member states will deliver on this commitment.  As I just said, this is a goal I entirely share. Finally, we have also created an institution for economic policy co-ordination, the Euro-11, which has made a promising start. Our task now is to make this system work in a context which is clearly different from the one the architects of Maastricht had in mind when they drafted the treaty.

The starting point can easily be summarised. Europe has for several quarters been feeling the effects of the Asian crisis. It is now experiencing a moderate growth shortfall and a significant drop in price inflation. The Russian crisis, the world-wide financial turmoil it has given rise to, and the still uncertain effects of this turmoil on the real economy, have led to a worsening of the short-term perspectives. Forecasts differ, but no one disputes that they are marred by downside risks. As the G7 communiqué recently emphasised, the balance of risks has shifted.

The question then is how these downside risks should be handled by macro-economic policy. Giving a correct answer to this question is of utmost importance, first because the world economic situation is undoubtedly serious, but also because a mistaken policy response would send a strong negative signal about the ability of EMU to address macro-economic policy challenges. This is why an intense policy debate has started in most European countries and, to many people’s surprise, in Germany. It is a very relevant debate. Put simply, the question we have to answer is whether we should go for a Reagan-Volcker lax budget/tight money policy mix, or rather for the opposite Clinton-Greenspan policy mix? While we should obviously keep all relevant differences in mind, I have no doubt that the appropriate policy combination for today’s Europe is much closer to the second than to the first.

The textbook answer to the question is in fact crystal clear: in the conditions we are now facing, the burden of maintaining conditions conducive to non-inflationary growth should fall on monetary policy, while in all countries where budgetary adjustment is still under way, fiscal policy should remain directed towards reducing the public deficit. This conclusion is hard to dispute, for at least four different reasons:

  • There is at present no visible threat to price stability in the Euro zone. The last 12 month figure for headline
    inflation is 1.0% in Euroland and 0.5% in France. And if there is any reason to worry, it is because even without taking any measurement bias into account, price inflation is now significantly below the European Central Bank’s stated inflation ceiling ;

  • Fiscal adjustment in Euroland has not yet been completed and needs to be carried through until we reach a sound fiscal situation, in which we are able to ensure that the public debt ratio remains stable over the cycle in countries where its level can be considered as appropriate, and declines in countries with an excessively high debt ratio, or whose public accounts are affected by the burden of implicit retirement liabilities. The opposite would threaten the required reversal of trends in public debt ratios, and thereby also affect the member states’ ability to resort to fiscal policy in the advent of asymmetric shocks ;  

  • The shock we are facing can be analysed as the combination of a symmetric negative demand shock and a (less pronounced) symmetric positive supply shock ; in this kind of situation, the common monetary policy is the appropriate instrument, as it is able to quickly counteract both supply and demand shocks in a fully symmetric fashion ; by contrast, relying on national fiscal policies to engineer a co-ordinated response would require considerable energy and might distract national governments from addressing the domestic issues they should focus on ; 

  • Economists, including Richard Portes, have for some time warned that in its early days the euro could be facing upward pressures arising from a shift in the demand for assets denominated in European currency. Recent developments tend to highlight this risk, as the initial situation is characterised by weakening output prospects in America and significant current account imbalances between the US and Europe. Whatever the magnitude of this possible effect, it is certainly not something macro economic policy should encourage through adopting a tight money / lax budget policy mix that could only foster an appreciation of the euro.

These four reasons lead me to conclude unambiguously in favour of a common monetary policy that remains faithful to its mandate of ensuring price stability, but simultaneously pays attention to maintaining conditions for non-inflationary growth, while fiscal policies remain directed towards achieving the required adjustment in public finances.

However, what in a country could be expected to be the natural outcome of an ordinary dialogue between the Minister of Finance and the governor of the Central Bank is much more demanding for Euroland, because it requires co-ordinating the decisions of 11 national governments and an independent central bank, in a situation where no one yet has concrete experience of the rules of the game. This is for us a significant challenge, because in the absence of effective co-ordination, doubts about the attitude of the other players might well lead the policy-makers of the Euro zone to adopt a less-than-optimal policy mix. The consequences of such a de facto choice could be severe, as already experienced on several occasions like the Reagan-Volcker experiment or German unification. It would also create a wrong precedent for the quality of policy-making in Europe.

It is precisely because we felt that situations of this kind could arise that right after the government of Lionel Jospin was formed, we emphasised the need for policy co-ordination in Europe and specifically proposed the creation of the Euro-11. The situation we are facing now is a strong reminder of the need for effective co-ordination institutions between the 11 governments of the Euro zone, and between them and the independent ECB. Only if we create an atmosphere of dialogue and mutual trust in the ability of the partners to deliver on their commitments, will the Euro zone be able to define and implement the policies that are appropriate in the present context. I am deeply convinced that we are able to face this challenge, and it is my firm intention to contribute to this dialogue and to the emergence of an adequate collective response.

Finding ways to ensure an appropriate policy mix is a key test for the EMU system. The efforts we have made since the late 1980s have created conditions for a long European cycle of growth, productive modernisation and price stability. Europe is ready for a new era. It is our historic responsibility to ensure that this occasion will not be missed 

Growth will however not just result from a right macro-economic policy mix. Whatever the role it has played in the disappointing performance of the European economy in the 1990s, no one can seriously deny that structural deficiencies played their part too. This is why the left should not mimic in reverse the error of the conservatives, who too frequently highlighted the primacy of structural issues and downplayed the role of macro-economic policy in creating a framework for growth. As Tony Blair and Gordon Brown like to emphasise, we should also draw up our own agenda for economic reform. By combining an appropriate policy mix and structural reforms, we will create conditions for a sustained reduction in unemployment in Europe. Restoring full employment in Europe - the only goal we can set ourselves - will be a long process and will require that we address all deficiencies that contribute to maintaining a high level of unemployment. The employment guidelines endorsed by the European Council after the French government had asked for a renewed European commitment to reduce unemployment have already proved a useful instrument. Gerhard Schröder’s strong emphasis on employment ensure that this attempt at outlining strategies and at distinguishing best practices will be carried further. Convergence towards the best inflation and public finance performance - benchmarking, as it is called in the private sector - has proved to be a very powerful force, to the benefit of all member states. As most governments now share a common employment priority, a similar race to achieve the best employment performance should now take place in Europe.

4. International financial and monetary stability

I would like to finish this presentation by discussing some of the international issues that are at the heart of our current difficulties. It is my deep conviction that the process of assessment and reform of the world monetary and financial architecture that was initiated a few months ago must be pursued and carried to its conclusion. It was given a new impetus on the occasion of the G7 and IMF meetings in Washington last month, but laying down renewed foundations for world growth and development will require significant further efforts. We cannot be satisfied with a system where, depending on random circumstances, the price countries have to pay for policy mistakes that are sometimes trivial and sometimes colossal; or with excessively sophisticated financial markets which prove incapable of approaching the performance of the financial system of the XIXth century, which for decades was able to transfer sizeable amounts of savings from countries with excess savings to investment-hungry territories.

The recurrence of crises whose costs frequently fall upon the poorest segments of the population does not only imply a very significant economic and social loss. It also undermines people’s confidence in the benefits of globalisation and their support for it. As I already said on the occasion of the Washington meetings, today the real alternative is no more between free markets and planned economies. It is between markets that function for the benefit of development, because they are organised, and a popular rejection of market liberalisation perceived as a factor of instability. Our end goal should not be to turn our back on globalisation, but rather to make it instrumental in fostering growth and development. Putting things more simply, we want more trade and capital flows, not less. There is clearly a need to stem sudden and destabilising capital inflows, but all countries in the world have a common interest in finding ways to ensure substantial financial flows to emerging and developing countries. This should be kept in mind when designing new guidelines and procedures. 

For all these reasons, we must now define and implement the reforms that are necessary to make international monetary and financial relations more robust and more friendly to growth and development. The way discussions have developed over the last few months suggests to me that the degree of consensus among the European and the G7 countries is now higher than it has been for a very long time, as illustrated by the recent G7 communiqué prepared at the initiative of Gordon Brown. No one anymore seriously disputes the need for greater transparency and disclosure requirements by institutions engaged in international financial transactions. No one challenges anymore the view that there are strong internal prerequisites to the liberalisation of capital markets in emerging countries, and that even when these prerequisites are met, caution and gradualism are highly advisable. No one any longer questions the need for a strong, politically legitimate and accountable IMF, with sufficient resources to deal with sudden capital outflows affecting large countries. No one denies that bringing the private sector on board in crisis resolution is necessary to limit the risk of bailing out imprudent investors with public funds. When these ideas were put forward a few months ago by academics, or by governments including the one I belong to, they were frequently deemed heretic by the free-market fundamentalists. They are now becoming part of a new international consensus, and we are in the process of defining the way of making them a reality. France has been active in making proposals, such as the transformation of the IMF interim committee into a real governing body, as illustrated by the paper calling for a European initiative that I circulated a few weeks ago. Europe has a very significant role to play in this process, and this is why Oskar Lafontaine and I recently decided to launch the preparation of a joint French-German paper that could serve as a basis for further European discussions. It is my hope that at the end of the year, the European Union will be able to endorse new proposals that we shall jointly submit to our international partners.

Let me now turn to exchange rate regimes and policies. The Asian crisis and subsequent developments raised serious questions about the appropriateness of our exchange rate arrangements. In the wake of the crises, these concerns were overshadowed by pressing financial ones, but we should not forget that the combination of a significant dollar appreciation and more or less rigid dollar peg policies in Asia was one of the direct reasons for the crisis. In this context, the emergence of the euro should be taken as an opportunity to review the exchange rate arrangements we have been living with, in industrialised as well as in emerging countries, and to discuss ways for improvement. This is an issue that has been strongly emphasised by the new German government, and I share this concern. I would like to outline four main tasks before us.

1.    The future international role of the euro and the exchange rate policy of the Euro zone have been extensively discussed by researchers, and are now increasingly becoming concrete policy issues. After years in which their energy has been almost entirely devoted to the internal organisation of EMU, European policy makers are increasingly focusing on the international side of it. The first step in this respect is to agree on an effective way of organising the external representation of the euro zone. We have made significant progress in recent months, and there are now a number of proposals on the table, especially the Belgian one. I am confident that we shall find a solution by the end of the year. My view is that a key requirement is, first of all, that major issues involving the euro are systematically discussed and agreed upon within the Euro-11. The external representation of the euro zone in co-operation fora such as the G7 could then be delegated to, for instance, a tandem consisting of the president of the Euro-11 and a vice-president. This tandem would be designated for one year in order to ensure that either the president or the vice-president is always a member of the G7. This would ensure that together with the president of the ECB, one of the European members of the G7 has at any given time authority to speak for the euro zone in international economic affairs. In this way, it would provide an answer to Henry Kissinger’s famous question about Europe’s phone number. We should also address the issue of the representation of the Euro-zone in the IMF and other international organisations.

2.    The second task is to reach an understanding on what will be the exchange rate policy of the euro. Research has extensively discussed whether or not the introduction of the euro will be conducive to international exchange rate stability, but the role of policy-makers is to ensure that it will be a building block towards more satisfactory exchange rate relations with our main partners. Our first priority should be to make sure that the birth of the euro, which will inevitably lead market participants to reconsider the allocation of their portfolio, will nevertheless take place in a stable international monetary environment, especially as regards the euro-dollar exchange rate. As I emphasised earlier, a key requirement to that end is that we adopt an appropriate policy mix in the euro zone. But we should also monitor developments in exchange markets, and stand ready to express views on these developments, as well as to make use if necessary of the provisions of art. 109 of the Maastricht treaty. There is in my view no contradiction between price stability and the reasonable degree of exchange rate stability we should be aiming at, but this will obviously require close co-operation between the ministers of the Euro-11, whose responsibility for exchange rate policy is clearly stated in the treaty, and the ECB, which has the duty of maintaining price stability. Our aim should be to make clear to our partners, and to the markets, that speculations about a ‘European benign neglect’ are entirely misplaced. I am fully convinced that the quality of our internal co-operation on exchange rate matters will greatly contribute to stabilising the expectations of market participants.

3.    An effective representation of the euro zone and a renewed understanding on the exchange rate policy of the euro are preconditions for the third task, which will be to discuss ways of improving international monetary relations with our G7 partners and the key emerging countries. Exchange rate fluctuations between two large currency blocks whose cycle are not synchronised is obviously a natural phenomenon that should not be resisted. But avoiding excessive exchange rate instability is also necessary. A reasonable degree of exchange rate stability between the dollar and the euro will not only be required on bilateral grounds. It will also be a public good for the world economy, that will benefit a large number of countries with diversified trade and financial relations. Europe and the US will have a joint responsibility in delivering this public good, and as I have already mentioned,  we should discuss with our American friends how best to avoid the coexistence of two large currency zones, whose degree of openness is limited, giving rise to a kind of ‘reciprocal benign neglect’.

4.    The fourth and last task should be for the international community to give thoughts to ways of improving exchange rate policies in the emerging countries. For each country, this encompasses both the degree of flexibility which is desirable, given the credibility of domestic monetary authorities, and the pegging regime which is appropriate, given the trade and investment patterns. A lesson of the crisis is certainly that for countries with a diversified trade structure, policies of rigidly pegging the currency to a particular international one can create severe difficulties. We should however not err in the opposite direction and draw from the crisis the conclusion that only floating exchange rate policies are appropriate. There is certainly room for further thinking here. For the EU, this means that we should have discussions with our neighbours in Central and Eastern Europe and the Mediterranean, in order to define with them how best to organise our monetary co-operation with them. It is in our best interest that the creation of an area of exchange rate stability benefits our partner countries.

The financial reform agenda I have outlined and the four concrete steps I have proposed for improving monetary relations should in my view be regarded as building blocks towards a more ambitious goal, which is to lay down renewed foundations for the international monetary and financial system. This is certainly a very ambitious goal, as historians tell us that in modern times, most attempts at organising international monetary relations have failed, except on two occasions: the Bretton Woods conference of 1944 and the Maastricht Treaty of 1991. Pessimists will draw from the past the lesson that we should let the world monetary system continue evolving of its own momentum. Those like me who consider that devising monetary and financial arrangements for the world economy of the XXIst century is too important a task to be indefinitely postponed, will draw from history the opposite conclusion: that it is a collective endeavour for a generation, as was the European construction for the Founding Fathers of the EU in the 1950s.  It is precisely because it will take a long time that we should initiate it without delay, and it is my ambition that together with Gordon Brown, Carlo Ciampi, Oskar Lafontaine, and other colleagues, we outline the foundations of this essential reform.

In this presentation, I have only made occasional references to CEPR research. I could however have mentioned, for each of the topics I have addressed, a stimulating paper or an innovative conference, which have helped sort out the issues and assess the policy options. This is an indication of CEPR’s very significant contribution to the formulation of international and European economic policy. The time, when policy-makers could ignore the results of research, has passed, if it has ever existed. You all know John Maynard Keynes’ famous statement about ‘practical men’ being ‘the slaves of some defunct economist’. As a practical man, I do not want to be the slave of a living economist either. But it is my strong belief that there is much to gain from a permanent dialogue between economists and policy-makers. If only for this reason, I wish that in the future CEPR will have the same success it has had in the last fifteen years.