Proceedings of the Standing Senate Committee on Foreign Affairs
Issue 18 - Evidence
OTTAWA, Tuesday, May 12, 1998
The Standing Senate Committee on Foreign Affairs met this day at 5:48 p.m. to
consider the consequences for Canada of the emerging European Monetary Union
and other related trade and investment matters.
Senator John B. Stewart (Chairman) in the Chair.
The Chairman: Honourable senators, we will turn to our second reference, which
deals with the consequences for Canada of the emerging European monetary
policy. This attracted a great deal of attention for the committee when we were
studying Canada's own relations in the changes with the European union. We have
before the committee today Mr. John D. Murray from the Bank of Canada.
Mr. Murray is a graduate of Queen's University, and he has a Ph.D. in Economics
from Princeton University. He taught at the University of British Columbia and
at the University of North Carolina, and he also lectured at Princeton.
In 1980, he joined the Bank of Canada as a senior economist with the Department
of Monetary and Financial Analysis. He served as research adviser in the
Monetary and Financial Analysis International Department from 1984 to 1987. In
1987, he was appointed Deputy Chief of the International Department. He is now
chief of that department, a position which he has held since 1990.
I know from his previous appearance before the committee that he is going to be
most useful to us today. We are interested in learning how the European
Economic and Monetary Union has advanced, and also in getting a current
analysis of the implications for Canada of the move toward the EMU. Mr. Murray,
we are listening attentively.
Mr. John D. Murray, Chief, International Department, Bank of Canada: As you may
know, there was an important meeting last weekend in Europe which settled some
important matters. Our timing, then, is very fortunate.
I have provided a detailed analysis of the EMU initiative, which also tries to
put it in historical perspective. As you know, this is really the next step in
a process that began with the Treaty of Rome in 1957. This has really been a
very revolutionary and logical progression.
I realize that you have already had a number of witnesses, and that you are
familiar with the issues, so there is something of a "coal to Newcastle"
aspect to this presentation. I did feel, however, that it would be useful to go
through the background, and some of the decisions that have been made. Please
stop me at any time, or redirect what I am saying if it is not suiting your
From a Canadian perspective, if you look at it in what I shall call narrow
economic terms, there may be less here than meets the eye. That is not to
denigrate the importance of the EMU initiative from a European perspective, or
maybe even from a Canadian perspective over the longer term. It is just that,
over the short term, as you look at our relations with Europe, and the impact
that this is likely to have on events within Europe, you may not notice much.
There are some risks that I will identify, but, from a Canadian vantage point,
the more important aspects of this whole initiative really involve the domestic
debate that it may rekindle. This debate will involve, firstly, alternative
currency arrangements in North America if the euro works in Europe. The euro
will serve as an important model or test case. Secondly, the debate will concern
the influence that it might have over the longer term, with regard to our
international presence. Right now, for example, we are a member of the G-7 and
the G-8. We participate in the summits. We are one of the senior members of the
world community; we are on the A list -- barely, but we are there.
The increasing integration of Europe, as you know, encouraged by this currency
union, may do something to unsettle that. In the near future, it might be more
reasonable to talk about a G-3: U.S., Japan, and Europe. The only odd country
out in that case, looking at the G-7, would be Canada. We may find ourselves
drawn evermore into a North American context; for other reasons, that is already
happening, to a certain degree. Those are the two important elements.
There would be lessons for Canada with regard to currency arrangements. Firstly,
should we have a common currency with the U.S., would the same logic that some
have used in Europe apply in North America? The second lesson would concern
what this would do, in a political sense, to our influence on the world stage.
Last weekend there was a meeting of the European Council, and three important
decisions were made. First, and most important, 11 countries were selected for
membership in the first wave. There are 15 countries in the EU, but only 11
were, or wanted to be, admitted at this stage. The four that were left behind
-- either by their own volition or through their failure to meet the Maastricht
criteria -- were Greece, which failed to meet the criteria, Sweden, the U.K.,
Senator Grafstein: And Norway.
Mr. Murray: Norway is not a member, so it was never in the running. It is
possible that it may ask for entry in the future, just as a lot of other
countries in central and Eastern Europe may ask first for membership in the EU,
and then later in the EMU.
Senator Grafstein: Denmark?
Mr. Murray: Yes. It has decided not to participate for the time being.
Senator Di Nino: If Greece failed, I am wondering if the others did as well. We
were given some information by the British High Commissioner which, I must
admit, sounded somewhat diplomatic.
Mr. Murray: The U.K. was one of the few countries that actually qualified on all
bases, except one, which is that a country was expected to have been a member
of the ERM, the exchange rate mechanism, for at least two years. It could have
gone in if it had wanted to, but it clearly did not. Britain dropped out in
1992, and has maintained a floating exchange rate against the other European
countries. I have a feeling, though, that if the U.K. had wanted to join EMU,
that requirement would have been waived. What I shall call "forgiving"
or "flexible" treatment has been accorded to many other countries.A
good example of this would be Germany, which technically did not meet the
Maastricht criteria on debt-to-GDP ratio. It was good on inflation. Its interest
rates were low, and its deficit to GDP was below 3 per cent. Its gross debt to
GDP was less than 60 per cent.
Senator Grafstein: Exchange was within the band?
Mr. Murray: Not in the case of the U.K.
There were other countries, such as Italy and Belgium, that clearly did not meet
the criteria. To give you an example, both of those countries had a gross debt
to GDP ratio in excess of 100 per cent -- they were very wide of the mark.
Greece was even further removed. It failed on almost all of the considerations.
Senator Di Nino: It is probably best to allow the witness to make his
presentation. Thank you for the answer.
Mr. Murray: The second major decision that was made last weekend was the most
contentious. It was decided that Duisenberg, a Dutchman, should be president of
the new European Central Bank, the ECB. He had been proposed more than a year
ago, and people thought that there had been common agreement on that.
Six to eight months ago, much to everyone's surprise, Chirac from France
suddenly announced that he would like to see Mr. Trichet, currently head of the
Banque du France, considered for the position. At the time, people were upset,
because everything had been arranged, but they believed that this would be
resolved long before last weekend. In the end it was not, and this became
something of an eleventh hour resolution, and was very acrimonious. A
compromise was effected, but a lot of finger-pointing and ill-will resulted.
It is now done. Duisenberg will be the president, although probably not for his
full eight-year term. It is understood that he will serve for four years. There
are five other members, for a total of six members on the executive board, and
they, together with 11 other representatives, who are the governors of the
respective national central banks, form the governing council for the ECB.
I mentioned an eight-year term. In order to provide for some continuity, these
appointments were initially for different terms. Officially, Duisenberg has
eight years, but Noyer has four. The others range from five, six, seven, or
eight years, and they will gradually be phased out. The important thing is,
that once this gets up and running, the regular term for everyone will be eight
years. That will be done on this staggered basis, which is designed to provide
some further insulation from political influence. An eight year term goes
beyond the term of all of the national governments.
A decision was also made on the selection of the central parities that will link
the 11 currencies, once the euro is introduced January 1, 1999. Again, not to
anyone's surprise, they chose to set these bilateral parities equal to the
current central parities within the European ERM. That was no great surprise,
so that is done.
What are some of the outstanding issues? Some of these are purely operational in
nature, and they are of more interest to a central banker like me than they are
to anyone else. I will list them, however, because one or two of them feed into
the risks that I will mention later.
Firstly, there has to be a transfer of responsibilities for monetary policy from
the national central banks to the ECB January 1, 1999. That should not be any
problem. They have to select the final conversion rates for the euro, but this
cannot be done until December 31, 1998. This is confusing and I shall go into
it, if you want. Even though last weekend they determined the bilateral parities
that would link the currencies of the 11 participating countries, that still
did not establish a value for the euro vis-à-vis the dollar and other
countries, such as the U.K., Denmark and Sweden, who will not immediately
participate because their currencies will continue to float.
There is a requirement that one ECU, which is the current unit of account in
Europe, has to equal one euro. Some of the countries that are in the ECU
basket, such as the U.K., Sweden and Denmark, will not participate in the euro;
things have to be reconfigured on December 31 based on the current exchange
rates. Therefore, although parities have been set for the 11 participating
countries, there are still some other undetermined rates, and those will not be
known until the day before the euro comes into effect.
Software and other technical problems related to the introduction of the euro
also need to be resolved. This is an enormous task, and you will not see the
cost of this conversion advertised in Europe. I am not just referring to the
printing and distribution of the new money, although that cost will be
significant, or to the cost or posting dual prices until 2002, because the
national currencies and the euro will be running in parallel. Things like
computer programs, invoicing systems, and accounting systems will represent an
enormous expense. In other presentations I have called this "the year 2000
problem squared." This has implications for us, but we shall get to that
Owing to the fact that they transact in these currencies, our banks will have to
face the year 2000 problem one year earlier. January 1, 1998, will be a
significant date for them. The banks have to have all of their programs set up
to handle this new currency.
There is also the matter of selecting an immediate target for European Central
Bank monetary policy. The ECB will be created next month, but so far no
determination has been made about how policy will be guided. The Bundesbank
wants the ECB to target monetary aggregates, as the Bundesbank now does. Others
want explicit inflation targets -- we have those, and so does the U.K. That is
yet to be determined.
The ECB has a very clear mandate, which is to pursue price stability. This is
its sole purpose, "price stability" has not yet been defined. There
is an expectation that it will be defined as a range between zero and 2 per
cent, but that has not been confirmed.
An additional concern is the determination of minimum reserve requirements for
commercial banks. Germany is very insistent that all of the commercial banks in
Europe be subject to a common minimum reserve requirement. Other countries do
not even have them at present, so there is some tension here.
Finally, for gold bugs, how much gold will the ECB hold? This is of great
concern to the gold market, because European banks hold so much gold. If the
ECB chose not to hold very much, a lot could be coming on the market soon. It
would not be in the interests of the national banks to dump it all at once, and
push the price against themselves. This gold overhang would still be a drag on
the market, however. We are gold producers, so we care, but we have been smart.
Canada, as you know, started selling gold at the peak, in 1980, and has ridden
it all the way down. That is one of the things that we have done well.
Let us look at the short-run risk to EMU. Things are going well, there certainly
is a lot more enthusiasm than I would have expected a year ago. Everyone
believed that it would happen, because of the political importance attached to
it. Even on the economic front, though, it seems more viable and desirable than
many people imagined it would be. Nevertheless, there are some short-run risks.
I would not want to exaggerate them, but there could be speculative attacks
between now and December 31/January 1 next year, when the final plug is put in.
People may take a run at these bilateral parities that have been established;
until you have actually converted and pegged, as a speculator you could
certainly score if you managed to budge those rates.
Senator Di Nino: Either way?
Mr. Murray: Yes. Nobody is really expecting any trouble, however, so I would not
want to give too much weight to that. The currencies seem to be in reasonable
alignment. If you look at the forward rates in financial markets now, there
does not seem to be a lot of tension.
There are some vestigial or underlying macroeconomic imbalances among some of
the member countries, however. Germany, France, and Italy have a large excess
supply.It indicates that they have some cyclical unemployment and excess
capacity to the extent of about 1.5 per cent to 2 per cent of their GDP. That
is how much room they have to grow before they hit full employment. As you can
see, there is remarkable similarity among the three major partners, so to that
degree there has been convergence -- at least they are all going into the EMU
at the same point of the business cycle.
Some of the other small countries, like the Netherlands, Finland, and Ireland,
actually face excess demand. The countries are linking their currencies, but
they are at different stages of the business cycle, and therefore require quite
different monetary policies. Ireland, Finland and Netherlands need tighter
monetary policy. Germany, France and Italy could still do with some stimulus to
push them to full employment. How does this play out? It probably will not play
out very well for the smaller countries.
There are some differences in opinion over how a group called the Euro 11
Council will exercise political oversight over the ECB. Steps have been taken
within the Maastricht Treaty to try and insulate the ECB from political
influence: clear mandate, an eight-year term for those serving on the executive
board, et cetera. France, over the last year, too, has made it very clear that
it would still like to have some political oversight over the ECB; Germany, of
course, is strongly opposed. We have to see how that plays out.
Finally, as a short-term risk in the run up to the EMU, there is going to be a
tremendous shake-up within the European banking community. This will not be
only over the next six or seven months, but over several years. Europe is
tremendously over-banked, and it has a very inefficient and fragmented
financial system. EMU will accelerate a rationalization process that had to
occur anyway. Italy, for example, has 900 banks. Within two or three years, it
is thought that that number will be down to 100 banks -- and declining. We have
seen the merger wave in North America. This is going to take place in Europe,
but in spades. This could be very painful, and it could impose serious losses.
The consumer will gain in the long run, but there will be a lot of
displacement, and a lot of people finding themselves unemployed. There could be
some financial instability within Europe as a consequence.
Let us consider the long-run benefits cost to Europe. You are well acquainted
with the principal benefits, such as the political integration. That, of course
was the real motivation -- the common currency would be another tie to bind
Europe closer together politically. The economic aspect was almost ancillary;
not unimportant, but secondary.
The second point here is, of course, reduced transaction costs, increased
efficiency, and the elimination of currency risk. There are various estimates,
but the highest is about 1 per cent of GDP reduction. More reasonable but still
optimistic numbers are in the order of 0.4 per cent of GDP savings, in the form
of reduced transaction costs, because you do not have to convert currencies
among the 11 countries. That is not insignificant, especially when you extend
that through time. If that happens every year, the cumulative figure is quite
Thirdly, stronger fiscal and monetary policy discipline, while perhaps not as
important for countries such as Germany, is very important for Italy, which has
been a very enthusiastic aspirant to the EMU club. In a way it is like
certification; it is an acknowledgement that it is on the A team. As well, there
has been so much political turmoil, and so much economic difficulty in Italy in
the post war period, that Italians just want someone, to put it strongly, to
handcuff their officials. The EMU imposes certain restrictions that should
promote better economic performance in many of these countries.
My fourth point is a positive one, at least from the European standpoint. I am
not so sure about the North American perspective. The end of U.S. hegemony and
the creation of new reserve currency will create a nicer global economic
balance. From a Canadian perspective, it may not be bad to have some balance
vis-à-vis the U.S.
There are some potential economic and political costs that would outweigh these
benefits, as you know. Foremost, there is the fact that one monetary policy now
has to suit all countries, and that may be a very awkward fit at times. We have
done a lot of work on this at the Bank of Canada. We have looked at something
called the "optimum currency area concept," where you look at an
economic region and ask, "Does this collection of regions, territories
make sense as a currency unit? Should they have a common currency?" We
have done such an analysis for Canada. We have looked at the regions within
Canada, and we have looked at the regions within North America and within
Europe. Based on historical experience, many European countries, to be frank,
should not consider joining. Norway and the U.K. are at the top of that list.
The U.K.'s decision to wait is a sensible one for a number of reasons. Norway
could not join, but even if it could, it should not. We also identified the
Netherlands. These are the countries for which oil has historically been very
important, and that has caused them to move in very different directions. Even
within Canada, we can think of Alberta. If one region in Canada had wanted its
own currency over the last 20 or 30 years, it would have been Alberta, because
it is different enough. A second region like that would be the Maritimes.
The differences between Canada and Europe are significant, but not so great that
one cannot trade on the other's experience. The Europeans look at us and see
that we can make a go of it, even though B.C. deals in lumber, Alberta in oil,
the Prairies in wheat, Ontario in cars, and the Atlantic provinces,
historically, deal in fish. This gives Europe some comfort. Europe may provide
some lessons for us in the future.
The most significant problems that Europe must face, however, are deep-seated
labour market imperfections and structural rigidities. The differences in
Europe would not be a problem if it had the sort of flexible labour markets,
wages, and prices that the U.S. enjoys, and that we also enjoy, to a degree.
Europe does not have that, so it already has two strikes against it: a common
monetary policy that has to fit this rather diverse group, and rigid labour
markets. Even Europe's use of fiscal policy will be more limited than in the
past, because the countries have to operate under something known as the
Stability and Growth Pact.
Germany did not want to join the EMU without assurances that the others would
not misbehave on the fiscal front. Some long-run fiscal conditions have
therefore been imposed which will constrain the behavior of these Europeans
countries and it may make it awkward, although not impossible to conduct
counter-cyclical fiscal policies.
Some commentators, including Marty Feldstein in the United States, believe that
the EMU is going to cause more political tension than anyone imagined; that it
will be a source of difficulty rather than an element of integration in Europe
in the future.
Let us turn to the implications for the world economy. If the optimists are
correct, we will we get faster economic growth in Europe; improved
productivity, reduced risks, reduced transaction costs, and that is good. That
will also help us; this is a win-win situation. Just because they are better off
does not mean that we will be worse off. If they grow, hopefully we will too.
The euro could be a new reserve currency, and that might produce a better
balance in the world financial system. As we all know, living beside the most
powerful country in the world is not always comfortable. When the American
currency is hit, ours is often dragged along too. We often get side-swiped by
the runs that other currencies take on the U.S. dollar. We are seen as like the
U.S. dollar, but a little weaker.
Is it possible that Frankfurt of Paris could become major financial centres,
displacing London? As you know, London is concerned. This probably would not
happen, but it is an issue.
Let us look at widespread unemployment in Europe. Unemployment rates are already
very high. Germany published its unemployment statistics for April last week,
and it was pleased that the unemployment rate had fallen to 11.4 per cent.
France is pleased that its unemployment rate, which peaked at about 12.5 per
cent, has stopped rising. If I remember correctly, it is now done to about 12.1
per cent. These countries are headed in the right direction, but these numbers
are still high. Earlier I mentioned the rigidities, and the tensions that can
occur. It is not clear how all of this is going to sort itself out, and they
still have a long way to go.
Without independent monetary policies, a fluid labour market, flexible domestic
wages and prices, and with restricted fiscal policies, the risk is that the
recourse might be trade protectionism, fortress Europe. That would hurt us. It
would not help them in the long run, and it would certainly hurt us. The
temptation could be there, however.
As Europe continues to look inward, some have suggested that there is a risk
that exchange rates may become more volatile. I do not believe this to be so.
We may see more aggressive foreign exchange market intervention by the European
countries, but we know that this does not work in the longer term. On a number
of occasions, the French have suggested what I shall call a resurrection of
Bretton Woods. This would be the re-establishment of a pegged exchange rate
system, made more convenient by virtue of the fact the there are now only three
main currencies: the euro, the U.S. dollar, and the yen. There are other
currencies on the margin, such as the Australian or Canadian dollar, but they
are minor players. This scheme could sound attractive. In Canada, however,
where we have had some success with flexible exchange rates, we would be a
little wary of how this battle of the titans within a managed exchange rate
system might play out and hurt us.
Let us now, and last, consider the implications for Canada. There are some
reasons why the impact on Canada might be minimal. First of all, we have very
limited trade flows with Europe, at least as compared to the U.S. and some
other areas. We are still talking about, $40 billion to 45 billion in exports,
however, so it is not insignificant.
As I said earlier, the EMU is about linking currencies and saving transaction
costs. An optimistic estimate might posit that this will save Europe 0.4 per
cent of GDP. In and of itself, that is not going to translate into lots of
extra exports for Canada.
There are other considerations. Some believe, and I would tend to agree with
them, that denominating everything in a common currency may well breed
competition across Europe, and promote a more efficient allocation of
resources, so that 0.4 per cent really understates the potential benefit. We
hope that this proves to be the case. Even if the growth in Europe is a lot
faster, as a consequence of the EMU, that is not going to do much for us; it is
going to help, it is not going to hurt.
We are in North America, and, over time, the U.S. is becoming more important to
us, not less important. With the free trade initiative across this hemisphere,
our orientation increasingly will be north-south as opposed to east-west, and
that may even include trade with Asia. Prior to the recent bad press, we were
hearing a great deal about growth in Asia. Asia will become more important to us
once they stabilize their economies, but I think that we will increasingly look
to the Western hemisphere. That is natural, and it is not bad. The EMU is
interesting to consider, but in hard economic terms from a Canadian
perspective, and over the short term, there probably is not much there.
Another reason that this may not greatly impact Canada is the evolutionary
nature of the transition to the EMU. We are not talking about a big leap here.
These are countries that have been planning this, as I mentioned, for 40 years,
and over the last 30 years, to varying degrees, they have already fixed their
currencies to one another. Some countries would occasionally fall off the wagon
and devalue, but by and large, moving to a common currency is not that big a
step for many of them. This is especially true in the case of Austria, the
Netherlands, and Belgium, which have had a lock to the D-mark for years.
There are short-run costs and concerns for us, as well as legal and accounting
considerations. You may have heard of "continuity of contract." When
these currencies disappear in the year 2002, what happens to contracts that
were denominated in, for example, D-marks? We have been told that this is not a
problem, but the possibility of nuisance cases cannot be dismissed.
More important, our financial institutions have to factor in the software
changes that I talked about, just as their European counterparts do. There will
also be a declining demand for currency traders, although some people may not
be sad to see this. It has been estimated that Europe will need 50,000 fewer
currency traders as a consequence of EMU. They will be included in the 0.4 per
cent saving to which I referred earlier. Looking further ahead, there will also
be displaced money market bond traders.
Let us now consider long-term benefits and potential costs. We trade with
Europe, and it is much more convenient to trade in one currency than it is to
trade in 11. That helps us. We will have greater efficiency and reduced
currency risk, but that is not terribly significant. What is potentially
significant, as I mentioned at the beginning, is the fact that the debate on
alternative currency arrangements within North America and within Canada may be
If the European experiment works, why not a common currency for North America?
We are very open. As you know, 40 per cent to 45 per cent of our GDP is
exported. We are one of the most open countries in the world -- more open than
many of the countries within Europe that are joining the EMU. Between 80 per
cent and 85 per cent of our exports are to the United States, and that figure is
growing. That is a large part of our GDP, over 30 per cent of our gross
national product. That is more than all the governments combined in Canada
contribute to GDP, so one can understand why a common currency might have some
However, Canada was the first country to opt for flexible exchange rates in the
1950s. Indeed, we were the only industrial country to do so. We pegged
temporarily in the 1960s, during the Diefen-dollar crisis, but we went off in
1970. We have been floating ever since, and we think for good reason. This is
not just for monetary policy independence, but also because of the insulation
that it gives our economy, as an important commodity producer and exporter. We
are subject to different shocks than the United States, and that has helped us
Europe is moving to a common currency in order to promote political integration.
Canada would have different feelings about this. We would not want to get into
a currency union, because it might lead to a political union. Our starting
point would also be very different. In Europe, there are a number of large
countries operating as equal partners, and they are willing to give smaller
countries a voice.
The situation with Canada and the U.S. would be very different. This would not
be like Italy, France and Germany deciding to form a money club, and then
inviting some other nations along. We would be more like Belgium and Germany
over the last few years, where Belgium has clearly had no say over German
monetary policy. It is very unlikely that we would be given a seat at the table.
The success of the euro may rekindle a debate about a North American currency,
but I do not know that it will go very far.
Within Canada, considerations has been given to alternative currency
arrangements because of the possibility of separation. In that eventuality, it
would provide a model. Groups in Quebec have certainly taken comfort from the
European initiative, and pointed to that as something that suggests a
Quebec-ROC partnership on the currency front could work in the event of
I mentioned the declining role for Canada in the G-7 and the G-8. That is a
possibility. Here, too, I would be a little dismissive of that, however. Even
if that does happen, it will not happen right away. European countries have
made it very clear that they still want a seat at the table. They are not
prepared to be represented by the president of the EC, or of the European
Parliament. They want their own voice. As long as they insist on sitting at the
table, I think that we can sit at the table.
If our international position is eroded, I do not think that it will be because
of the EMU. It will be because other countries are on the ascendancy, and some
of the old groups are becoming less relevant.
During the Asian crisis, people were surprised to learn that Indonesia has over
200 million people. We are talking about countries that are growing very
quickly, and that growth will continue, giving them an enormous population
base. Over the next 10 years this will change the dynamic in a more important
way than Europe will.
Some have suggested that trading in Canadian dollars will be more volatile,
because there will be fewer currencies post EMU with which to trade. Almost out
of boredom, idle trader would play with other currencies. I do not take that
possibility very seriously.
Based on population to GDP, foreign trade to GDP, and share of world merchandise
exports/imports, Table 3 in my brief shows you how the various groups would
stack up. The data is somewhat dated, as it comes from 1996. As you can see,
the population with which we are dealing is 373 million, which is larger than
the United States. The GDP is 8.6 trillion, compared to 7.3 trillion in the U.S.
Given the foreign trade to GDP ratio, Europe would be about as open as the
United States. Once you take away the intra-European trade, Europe as a unit
would have that.
Considering Europe's share of world merchandise exports, excluding
intra-European trade, it would be more important still. Japan is the third most
important economic entity -- a distant third, but still an important one. The
EC is about 16 times bigger than Canada in terms of GDP, more than 10 times our
size in population. They are big -- but they are already big. That is the point
I shall end on.
All that we are talking about is converting national currencies into a common
currency. As a central banker I get excited about that, but we must remember
that these countries are already there, and they are going to behave more or
less as they do now after January 1. EMU is a good move, potentially, at least
with regard to the microeconomic arguments, reduced transaction costs, and so
on. It is not overwhelming, however. There are macroeconomic risks in terms of
increased unemployment and reduced growth over the longer term, unless they
engage in some serious structural reform.
The Chairman: The U.K. is staying out, and we have still a fair amount of trade
with it, and a good deal of investment in it. The rest of western Europe is
going ahead with the EMU, but we are still tied to the United Kingdom. What, if
any, are the implications of the U.K.'s exclusion for Canada?
My other question is: Given the fact that we seem to have a good deal of
investment involvement in Ireland, which is going in, are there any
implications of that inclusion for Canada?
Mr. Murray: Those are both good questions, and they are related to one another.
Firstly, I do not think that the fact that the U.K. is staying out should pose a
big problem. Some have suggested that people will be more inclined to invest in
continental Europe than in the U.K. now, because Britain is an outsider, and
potentially more of a risk. As a consequence, the importance of the U.K. will
diminish the longer it stays out. This would be especially true, some suggest,
on the financial side, with regard to London's pre-eminent position as a
financial centre. It could go beyond that, though. To the extent that Canadians
have investment in the U.K. already, this could be prejudiced, because you will
find yourself in the wrong spot.
I am not too concerned about this, and my reasons are two-fold. The U.K. has
indicated that it will probably join, and I believe that it will. Secondly,
there may be some advantage to being an outsider. One of the things that has
really helped the U.K. in the last few years is its flexible exchange rate. It
has not been operating under the same onerous social charter and labour market
conditions that the other European countries have. This is why the Japanese
have chosen to invest in the U.K. instead of continental Europe. There could be
a net advantage to not being in the EMU. To put this in context, the U.K.'s
unemployment rate is less than 6 per cent, which is less than half of the rate
Your second question dealt with Ireland. This is where things could get a little
awkward, because a lot of Ireland's trade is with the U.K., but the U.K. is not
in. Imagine a situation where the euro is appreciating against all our other
currencies, carrying what was the Irish punt with it, and, more importantly,
Ireland finds its new currency appreciating against the British pound. The pound
had been very strong, until two weeks ago, when it started to head down.
Ireland could find its industries at a competitive disadvantage vis-à-vis
those in the U.K., and that would obviously affect Canadian investment in
Ireland, and the attractiveness of it. I am not saying that it will play that
way, but there is an awkwardness, because Ireland has received a lot of
Senator Bolduc: With its macro-economic policies plus potentialities, either its
monetary economics or interest rate policy, Britain can handle its interior
area. There may well be a greater economic stability there than anywhere else
Let us consider Italy, where the north is rich, and the south is poor. The same
monetary policy will be applied everywhere. In my opinion, the tension will
occur if the market rigidities are maintained. I think that the market rigidity
will go out. If that does not happen, we will have a social crisis. There is no
doubt about that.
In France, for example, they were not able to behave in a civilized manner. I am
speaking of the truckers, and many other groups. The government had various
instruments for handling social situations, but they will not have them now.
The national states will be fairly limited in their capacity to handle social
tensions. That is my feeling, and in that regard the U.K. will be in a wonderful
Mr. Murray: I would share many of those concerns. As you suggested, Europe has
consciously put the cart before the horse. It has decided to proceed with this
initiative, in part because the countries will then be forced to engage in more
serious structural adjustment to liberalize their labour markets. If it does
not work, however, if that is not a sufficient driving force, they are in a
potentially terrible situation.
That said, Italy, for example, is already in trouble because it already has to
make its own monetary policy suit both the north and the south.
Senator Bolduc: But they have some potential handling money?
Mr. Murray: Fiscal policy. This may appear to contradict or soften something I
said earlier, but it is important to note that, even though they do have to
operate under the Stability and Growth Pact in the future, it is not too
binding. It still allows some flexibility.
The countries can apply discretionary fiscal measures now, and the world should
not be grossly different after January 1, 1999. They will not have the sort of
capacity Canada or the U.S. have, to transfer large sums of money from New York
to Idaho, or Ontario to Newfoundland. That is a problem. However, they never
had that. Germany was never sending a lot money to Italy in the first place, so
they are not any worse off than they were.
You are comparing Italy's present ability to engage in stimulative fiscal
measures to its future ability to do so. Things may not be enormously
different, although they are a little more limited because of the Stability and
Growth Pact. Italy will not have the large-scale fiscal transfers that we have
had in North America, especially in Canada, but some would say that that is not
a bad thing.
Senator Grafstein: We have to look at two phases. This first is short-term
volatility as applied to Canada. My concern is that we have vulnerable interest
rates, and it strikes me that this change in Europe will provoke interest rate
changes. The pound is now getting hammered in the short-term. They will
obviously moderate, and try to move the interest rate up.
In trade, we are vulnerable to interest rates. Will that volatility not wash
back here, and have an impact? We are not vulnerable only to American interest
rates. We also must consider interest rates in Europe, as people search out
funds in which they want to invest. Is that not a concern? You say it is a
short-term problem, but I see it as an ongoing problem.
Mr. Murray: I am not even sure that it is a short-term problem. I admit that I
may be cavalier, but I have two thoughts. The first is that I do not think that
the introduction of the euro and the launch of EMU will dramatically change the
world from a Canadian perspective. We have already got the D-mark, which calls
the tune in Europe. We already have massive capital flows in all directions. I
think that we are talking about changes at the margin.
Secondly, although people often get frustrated by exchange rate movements and
interest rate movements, in the main, exchange rates tend to move in the right
direction. For example, until recently, the British pound was rising, as were
British interest rates, at a time when its economy was rapidly approaching full
employment, while Europe was very weak. A weak D-mark and a strong pound made a
lot of sense, because that monetary tightness in the U.K. was helping to effect
a soft landing.
There is a concern that the U.K. may be approaching or has moved beyond full
employment. Its economy is starting to ease, which is a good thing. The real
issue is whether Britain has had enough monetary tightness, or too much.
Without revealing all the details and forecasts of the bank, in the last six
months our view has been that British authorities may have actually tightened a
little too much. Looking ahead, things may slow a little faster in the United
Kingdom than people anticipate.
The fact that the pound is coming down now is probably a good thing, just as
growth is picking up in Germany, France and Italy. We have a very positive
forecast for them over the next year. Exchange rates often move in the right
We have been weak against the U.S. dollar, but that is because our economy has
been weaker than the U.S. economy. In fact, except for the British pound and
the U.S. dollar, we have probably been the third strongest currency in the
world. We have appreciated against everyone else except the U.K. pound and the
U.S. dollar, because we still have good growth. We still have significant
unemployment and are closing the gap. In this regard, it is important to note
that we like flexible exchange rates. In our view, that independence helps to
stabilize our economy. Without it, the British pound might not have appreciated
earlier, to slow growth, and the European currencies might not have been able
to be weak against the U.S. dollar, thereby helping to restimulate the growth of
their economies. The U.S. dollar could have been weaker, and the U.S. might
have grown even faster, and had an incredible inflationary surge.
Interest rates and exchange rates may appear to move in aberrant ways over the
short run, but in the main, they are doing what they have to do.
Senator Grafstein: When we were in Europe, we were left with the impression that
market rigidity and competitiveness were a great scheme by the Germans to avoid
confronting their political problems, which are market rigidity, social
contract, difficulty with the labour force, and the strong deutschmark. This is
a way for Germany to devalue the deutschmark, for it to be more competitive,
and for it to trigger an attack in its labour market rigidities. In other words,
it is a pretty sophisticated way, without confronting its political problems,
for Germany to hammer away at making its market more competitive.
If that is correct, it strikes me that Europe's products will be much more
competitive. In effect, the European countries can poach in the markets where
we have a toehold because of our soft dollar. When we spoke to Otto Pöhl,
that did seem to be the objective.
Mr. Murray: Yes.
Senator Grafstein: Are you not concerned about that? A massive and artful
devaluation of European currencies makes their value-added products much more
competitive. As an example, a BMW would, in effect, be worth less than a
Lincoln. That is not the case now, because there is about $25,000 or $30,000
between the two.
Mr. Murray: You are right, I am not as concerned, and it is for the reasons that
I stated earlier. Firstly, I am not convinced that this has been a German
objective. Secondly, the D-mark has already devalued against the U.S. dollar,
and for good reason, as I explained. Thirdly, you cannot permanently improve
your competitive position through a devaluation, and I shall explain why. If
Germany individually, or Europe collectively, decided, by whatever mean, to
reduce currency value against the U.S. dollar, it might work for a short time,
but you have to think about what supports that in the longer term.
To keep your currency down, you keep your interest rates low, and pump a lot of
money into your economy, so that, every time your currency tries to go up, you
are flooding your economy with money, and you are keeping interest rates as low
as you can. This works as long as you have excess capacity which you can fill.
If you had excess capacity and excess unemployment to start with, however, your
exchange rate would have been weak anyway; you did not have to promote it, as
you would have been pursuing stimulative policy for its own sake.
As soon as you approach full employment, and hit that structural barrier, you
have eliminated the cyclical component, and you will experience massive
domestic inflation. Therefore, even as your exchange rate is falling, your
inflation is going to be high, and that is going to price your products out of
world markets. Why? It is true that the U.S. dollar is high, but the American
inflation rate is about 1 per cent or 2 per cent, like ours. In the long run,
you inflate away your competitiveness if you try to maintain an undervalued
Your real competitive position always reasserts itself; you get the
competitiveness you deserve in the long run, only in this context, very
painfully, in the form a lot of domestic inflation. The message is, if you need
stimulus and you need to reduce unemployment, it will happen anyway. If you do
not, you are going to generate a lot of inflation, and price yourself out of
The problem in Europe is two-fold: many of the countries have unemployment rates
between 10 per cent and 12 per cent, except for the Netherlands and the U.K.
There is no doubt that part of that is cyclical; they have excess capacity.
Some of it is not cyclical, however; 8 per cent to 9 per cent is structural. It
is embedded in their system because of these labour market rigidities, and
generous social assistance programs. To take an example, if Germany is not
prepared to address these structures, it cannot push its unemployment rate
below 8 per cent or 9 per cent for a sustainable time, no matter what it does
to monetary policy or to its exchange rate. If it tries to, it is just going to
generate inflation, and again price itself out of world markets.
There could be short-term awkwardness for them and for us if they follow these
strategies. We care if they pursue bad policy, but in the long run it is not
going to work. They will not be better off if they decide to devalue, and
support it with an excessively expansionary monetary policy.
Senator Di-Nino: This is very interesting. The economist's dry and unusually
unintelligible language is quite different today.
Mr. Murray: This probably means that I am a bad economist.
Senator Di Nino: I believe that the effect on Canada in particular, and maybe
even on North America, will be greater than you are projecting. You painted a
picture of a group of nations which would be walking down the path in unison;
homogeneity with equal objectives in mind. I am not sure that the human element
has been factored into this yet. You just talked about the changes or
disruptions that have come about a couple of times in the last while because of
France's position on things.
I am not totally sure that the U.K. does not have some other reasons for not
going in at this time. The human factor may throw that nice picture that you
painted a little bit out of whack. I am not sure that that is being factored
in, and I wonder if you could make some comment on that?
Mr. Murray: I am glad you asked that, because I may have presented a more
positive picture than I intended. My best estimate is that things will not go
terribly, or badly. Therefore, from a Canadian perspective, there is not going
to be a great deal of change. They will be getting a common currency, but they
are already pegged to the D-mark. There are already tensions to varying degrees,
so the world is not dramatically different. It could be slightly better within
Europe, and the predictions of the euro proponents could be borne out, or the
predictions of the euro-sceptics could be realized, but I think that even the
downside is less serious than some have suggested.
On balance, I too tend to worry more about the downside: the frictions, some of
the tensions that may emerge, that could inhibit instead of stimulating
Europe's growth. That would be too bad. Even in that case, however, I would not
project a dramatic meltdown. Our trade would affected, because Europe would not
be growing as quickly, and there may be more frequent exchange market
dislocations and volatility. For better or worse, however, the U.S. is our most
important trading partner by a long shot, and Japan is our second. Europe is
important, but we are not like Ireland faced with the U.K., or Belgium or the
Netherlands dealing with Germany.
Senator Di Nino: I am concerned that we are looking at a much larger entity
which will be a competitive force, and perhaps a major competitive force --
much more so than it has been in separate units. As a whole, the EMU may take
part of North America's trade away.
I do not think that we should solely by concerned about Canada. In the EMU, you
have 337 million people; Canada and the U.S. together have 300 million people.
We are dealing with countries well advanced in modern technology, and which
have a capable, well-educated work-force, there are also other values, other
reasons. It will be much more competitive.
Could Europe affect the whole North American -- or the whole NAFTA -- market
Mr. Murray: The short answer is yes, but I am not worried. I shall explain why.
It is very common to think of international competitiveness in growth as a
zero-sum gain; if they do better, surely someone else must do worse. However,
one of the fundamental lessons of economics and international trade is that if
someone else does better, they have more income to buy your products.
There may be some dislocation in particular industries, but when things sort
themselves out, it is a win-win situation. Everyone is better off because the
world becomes fundamentally more productive and wealthier. That trickles down,
and everyone shares in that. In the long run, exchange rates and prices adjust
to ensure that people remain competitive. A country may have become more
competitive than it was before, and that may change relationships within
particular industries or companies. Eventually, though, things will sort
themselves out in a way that, at worst, will leave us no worse off. There is
actually a strong possibility that we will be better off, because foreigners
will want more of what we are producing.
I am more concerned about the political side, as opposed to the economic one. I
see more scope for mischief through misused political power and misguided
policy initiatives. It is one thing to deal with France; it is another thing to
deal with France times 11. The EMU will be big, and it will have to be listened
to. If the EMU wants fixed exchange rates, it will be in a position to effect
them whether the U.S. wants them or not; unilaterally, if the EMU is so
inclined. It could decide to peg the dollar, even if it were a bad idea.
This would also play out in other areas. If all of the countries agree that they
do not like what is happening, they could institute higher tariffs against
everyone else. Of course, this would already happen within the customs union
that the Common Market has set up, so that is not different. The EMU increases
political cohesiveness, however, and therefore the will to act in this manner.
The scope for mischief on the international stage might therefore be increased.
Senator Bolduc: We have not considered the role of the multinational
corporations, and I think that it is important to do so. Many of them are
American, and they are all over Europe now. For example, if Daimler-Benz is
connected with Chrysler, the ball game will be different for the Germans, but it
will also different for the Americans. I do not anticipate a fight. There will
be some fights, but generally speaking, major public policies are the products
of a revolution. For example, we had international trade agreements, while we
also had a lot of transnationals ready to say to the government, "Yes, I
think it is about time to settle that." That is the way the game is run, I
Mr. Murray: I agree, and I agree, moreover, that it could be a force for good --
that it provides a certain discipline. A multinational nature of enterprises
changes the face of political decisions; you are forced to become less
provincial. When it is not clear that your initiatives are necessarily
supporting anything you could reasonably call a domestic corporation, you do not
know who owns the shares. Everyone does. Shareholders are all over the world.
Who gets the profits?
What does it mean to talk about a domestic car company in Canada? We used to
think of them as the ones that the Americans owned.
Senator Andreychuk: I just wanted to ask a small question. What is going to
happen to the national central banks?
Mr. Murray: The national banks are going to remain in place, but it is not clear
what they are going to do. Some of them do have a supervisory responsibility in
regulatory matters, so that will occupy some of them. Others, like the
Bundesbank, do not have responsibility for financial markets and risk
regulation. What will they do?
They will help distribute the new currency. They help conduct monetary policy in
an operational sense, although this is all vague. They will have a voice and a
vote, around the table on the common European monetary policy.
Essentially, monetary policy will be set at the centre, and the national
authorities will have no clout beyond their votes at the table. It is very much
like the U.S. system in the Federal Reserve, where the regional governors get
to vote on a rotating basis. As you know, however, San Francisco cannot have an
independent monetary policy; there is one for the entire United States.
Therefore, I am not worried about the mischief that they may try to effect by
pursuing an independent monetary policy.
Your question is good one. The Banque de France has -- I shall guess the figure
-- 16,000 employees. If the bank is not doing monetary policy, what will those
people do? To put it into context, 1,400 people work at the Bank of Canada, and
that includes all of those who deal with currency, as well as with monetary
There will be a lot of idle central bankers, so there will be major downsizing.
The national banks will continue, but they will operate very much as the
regional feds in the United States do.
The Chairman: My questions are a bit different, and do not feel obliged to
answer them extensively. You spoke earlier about the rationalization of the
banking systems in some of these countries. First question: Would that also be
true of other financial institutions?
Mr. Murray: Yes, very much so.
The Chairman: There again, there will be unemployment of financial operators?
Mr. Murray: Oh yes.
The Chairman: In Canada, we rely very heavily on the office of the
Superintendent of Financial Institutions. Under this new regime, will there be
any change in how the regulation and superintendence of financial institutions
is performed in European countries, or will the status quo continue?
Mr. Murray: For now, it will continue unchanged. As your question suggests,
however, this may prove untenable.
The ECB has been given vague responsibility for the security of the European
financial system markets. It could be called broadly defined macro-stability.
As we normally think of them, all of the supervisory and regulatory
responsibilities will remain with the national authorities. There have already
been suggestions, however, that this will have to be reviewed in the future. In
Canada, we have found it difficult to operate with different provincial
security regulators, and this will also be true in Europe, of course, but to a
much greater extent. We, at least, have had the benefit of a common banking
supervisor in Canada.
The Chairman: We are most indebted to you, Mr. Murray. It has been a most useful
Mr. Murray: I would like to thank you again for inviting me.