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The principal objective of the Stability and Growth Pact is to ensure budgetary discipline in the third stage. The Pact imposes the medium-term objective on all EU member states of a government budgetary position close to balance or in surplus. The euro countries shall prepare and publish stability programmes specifying their medium-term objectives and stating how these are intended to be achieved. The Pact provides for the imposition of sanctions on the euro countries, in the first instance a requirement for a non-interest-bearing deposit¹⁾, should such countries fail to take adequate measures to redress an excessive budget deficit. The deposit will be converted into a fine after two years if the budget situation has not improved sufficiently. However, in special cases a budget deficit exceeding 3 per cent of GDP can be considered exceptional and temporary, and the country may thus avoid sanctions. This will be the case if the deficit is the result of an unusual event outside the control of the country concerned or is due to a severe economic downturn whereby GDP in constant prices has fallen by at least 2 per cent.

The countries outside the euro area, including Denmark, are subject to the objectives and requirements of the Stability and Growth Pact on an equal footing with the participating countries, but will not be liable for sanctions in the event of non-compliance.

At the meeting of the European Council in Luxembourg in December 1997 the Heads of State or Government discussed the possibility of a further general strengthening of the coordination of economic policy in the third stage of EMU beyond the Stability and Growth Pact. It was decided that at informal meetings the ministers of the euro countries would have the opportunity to discuss topics of relevance to the euro countries. The Commission, and occasionally also the ECB, would have access to participate in these informal meetings. Countries which have not introduced the euro will only be able to participate in the meetings when the agenda includes subjects of common interest to the entire EU. The Luxembourg Summit did not clarify how and by whom issues of common interest would be defined. Formal decisions will still be taken by the ECOFIN Council. The conclusions from the Luxembourg Summit also state that the ECOFIN Council only in exceptional cases will issue general orientations for the exchange-rate policy, which will otherwise be managed by the ECB.

The legal framework for the introduction of the euro will consist of two Council regulations based on respectively Article 235 and Article 109 l, paragraph 4 of the Treaty. The first regulation, adopted in June 1997, contains provisions of significance to the single market and applies to all EU member states. According to the regulation the name of the single currency will be the euro and from the start of the third stage the ECU will be replaced by the euro at a rate of 1:1. Furthermore, the regulation stipulates the rules for rounding off on conversion and on the continuity of contracts on the transition from the national currencies to the euro. The second regulation applies only to the euro countries and therefore cannot be adopted finally until the participating countries are selected. The regulation includes provisions stipulating that as from the start of the third stage the currency of the participating countries shall be the euro and that during a transitional period the national currencies of those countries will be regarded as subdivisions of the euro. The regulation furthermore contains provisions for the redenomination as euro of outstanding contracts in the national currencies of the participating countries, e.g. conversion of a D-mark-denominated bond to a euro-denominated bond.

In July 1997 the EMI published the design of the euro banknotes. The winning design was selected after a design contest and was then further adjusted in order to incorporate security features. As a consequence of the Edinburgh Agreement Denmark did not participate in the contest. The general theme of the design was "Eras and Styles in Europe" which depicts important architectural periods of European history.

The euro banknotes are the responsibility of the EMI while the design of the euro coins is subject to the authority of the ECOFIN Council since in most countries the minting of coins is a government responsibility. The design of the euro coins was published at the Amsterdam Summit in June 1997 and the technical characteristics were determined at the subsequent meeting of the ECOFIN Council in July. However, final adoption awaits the selection of the euro countries. The design contest was for one side of the coins only, since already in 1996 it was agreed that national symbols would take up a large part of the reverse sides. Germany, France, Belgium and Austria have published their designs for the national sides of the coins and Ireland has announced that it will use its national coin symbol, the "harp", on the euro coins.

Preparation of the European Central Bank

The principal task of the EMI is to prepare for the European Central Bank, ECB, and the single monetary policy in the third stage. This work will be completed during the first half of 1998. The ECB is expected to be established soon after the decision on which countries are to be part of the euro area is taken. The EMI will then be dismantled.

The decision-making bodies of the ECB will be the Governing Council and the Executive Board. The Executive Board will be elected by the Heads of State or Government of the euro countries and will consist of a President and Vice President and up to four other members. The Governing Council will comprise the members of the Executive Board and the central-bank governors of the euro countries. The Executive Board will be responsible for the day-to-day operations of the ECB and will implement monetary policy in accordance with the decisions laid down by the Governing Council. The third decision-making body of the ECB will be the General Council consisting of the central-bank governors of all EU member states, as well as the President and Vice President of the Executive Board of the ECB.

Since Denmark has opted out from the third stage the Nationalbank will not be represented in the Governing Council and pursuant to the Treaty no Danes may be appointed to the Executive Board of the ECB. On the other hand, there is nothing to prevent the employment of Danes by the ECB. The Nationalbank will be a member of the General Council which will in the third stage take over the role of the EMI as the forum for cooperation between all EU central banks.

The preparation of the ECB has now reached a technical stage involving the preparation of accounting methods, statistics reporting requirements, etc. In the areas related to monetary policy and payment systems only very few issues await final clarification. Among other things it remains to be determined which financial institutions shall be subject to minimum reserve requirements if such are imposed by the ECB, and what rights the derogation countries will hold within the common payment system, TARGET, cf. p. 71.

Together with the national central banks the ECB will form the European System of Central Banks, ESCB. The primary objective of the ESCB is to maintain price stability in the euro area, which is interpreted as an annual inflation rate of between 0 and 2 per cent. The monetary-policy strategy to achieve this objective is not expected to be decided finally until the establishment of the ECB. However, there is consensus on limiting the options to monetary targeting or direct inflation targeting or possibly a combination of the two strategies.²⁾

The overall framework for the achievement of the monetary policy of the ESCB has already been determined. The monetary-policy instruments will be equivalent to those applied today in by far the most EU member states.³⁾ These are a standing marginal lending and deposit facility for the banks at interest rates respectively above and below the money-market rate. The ECB will steer the short-term interest rates within this interest-rate corridor by means of market operations. The most important instrument for market operations will be regular weekly repurchase agreements with a maturity of 14 days, while a minor part of the liquidity will be supplied via regular monthly repurchase agreements with a maturity of three months. In addition, fine-tuning operations, where liquidity is injected or absorbed, may be needed in case of unforeseen changes in the liquidity requirement. The ESCB will be able to inject liquidity by using such instruments as repurchase agreements, foreign-exchange swaps and direct purchase of securities. The instruments available to absorb liquidity include time deposits, reverse repurchase agreements, foreign-exchange swaps and direct sale of securities. Finally, the ESCB may influence the banks' total net liquidity position with the central bank in a more structural way, e.g. by issuing certificates of deposit. The purpose of this array of instruments is to keep the banks taken as one in a net debt position vis-ā-vis the central bank, thereby ensuring a constant liquidity requirement in the regular monetary-policy operations.

The ESCB's lending operations must always be based on "adequate" collateral. In the EMI agreement has been reached on which categories of securities may be eligible as collateral in monetary-policy operations. These securities are divided into two different groups - tier 1 and tier 2 securities. Tier 1 consists primarily of bonds, Treasury bills, certificates of deposit and other marketable assets. These securities must have a high credit rating, be issued in the EEA⁴⁾, be denominated in euro and be held in a securities depository in the euro area. Tier 2 comprises assets on national lists compiled by the individual national central banks according to the ECB's guidelines.

The regular market operations are based on an auction principle with either a fixed or variable interest rate. At an auction with a fixed interest rate the ECB will publish the rate of interest in advance and the participating banks will then state the amounts they wish to trade at that interest rate. At an auction with a variable interest rate the banks will state the interest rate at which they wish to trade and the size of the amounts required at that interest rate. On the basis of these bids the ECB will set a cut-off interest rate, so that all banks submitting bids at or above this rate of interest will receive liquidity at either the cut-off interest rate or their bid rate.

With regard to the ESCB's management of the foreign-exchange reserves and interventions, foreign-exchange options have been prepared to conduct foreign-exchange transactions centrally from the ECB as well as decentrally from the national central banks following instructions given by the ECB. The main part of the transactions is expected to be carried out on a decentralized basis. It has been decided to apply a limit-based system to the management of counterparty risks in foreign-exchange transactions, whereby an upper limit for the ECB's exposure will be fixed for each counterparty.

The EMI has drawn up a number of harmonization requirements for the area of statistics so that usable and internationally comparable statistics can be achieved. The core element is the compilation of statistics for the assets and liabilities of financial institutions subject to statistical reporting requirements, i.e. central banks, banks and mortgage-credit institutes, money-market funds, etc. Moreover, the national central banks are required to collect and report statistics on domestic interest rates, the balance of payments, etc. The statistical authorities in Denmark have chosen to implement parts of the statistics package in order to increase the international comparability of Danish financial statistics.

(to be continued)

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