Notwithstanding the intergovernmental debates at a European level and the stated intention to undertake common initiatives, the instruments of employment policy remain in national hands, although only partly in the hands of governments. I regard this as appropriate because competition should not be suppressed from the labour market.

Adopting the appropriate policies of structural reform has proved extremely difficult in many key European countries, including my own and this one. Other countries, such as the Netherlands and the United Kingdom, have been more successful. Even the most successful experiences, however, have shown that reducing unemployment is a long and gradual process.
Although some countries started labour market reforms in the early 1980s, they only reaped the benefits in the 1990s.

Unemployment will thus remain with us in the years to come and I am convinced that it should be regarded as the greatest policy challenge not only by governments and labour organisations, but by the Eurosystem as well. Let me explain why.

An economy in which unemployment drags above 10 per cent for years is a sick economy, just like one in which public finances or inflation are chronically destroying savings. To operate in a sick economy is always a risk for the central bank and for the successful fulfilment of its primary mission. In the case of prolonged unemployment, the risk arises both on a functional and an institutional ground.

On a functional ground, i.e. from the point of view of the relationship between economic variables that models usually consider, a chronically weak economy is one in which expectations deteriorate, investments stagnate, consumption declines. Structural unemployment may increase the risk of a deflationary spiral because a longer expected duration of unemployment may imply that households respond more conservatively (in terms of increasing savings) in the face of a deflationary shock. Today, we see no signs of deflation. Markets and observers who pay attention to communications by the Eurosystem know that the monetary policy strategy of the euro area is symmetrical, equally attentive to inflation and deflation. Thus, they know that if that risk became reality, the Eurosystem would have to act, and would act. But we know that monetary policy is much less effective in countering deflation than it is in countering inflation.

A more insidious threat, however, may arise on the institutional ground. It comes from a chain of causation involving social attitudes, economic theory and policy, actual economic developments and institutional arrangements. Attitudes of society respond to economic situations and policies, which in turn depend on the state of development of economics.
Institutions, on their part, are influenced by attitudes of society. Both the course of economic thought and the practice of policy were lastingly altered by the Great Depression. The epitome of this historical event was the Keynesian revolution. In many countries the strong consensus about the primacy of price stability and the independence of the central bank was the outcome of the prolonged inflation suffered in the 1970s and 1980s. Here in
Germany, it is rooted in the experience of hyperinflation. Would such a consensus survive if high unemployment remained a chronic feature of key
European economies for many more years? And how would the position of the central bank change if that consensus faltered?

As central bankers primarily concerned with price stability, what can we do to cope with this challenge and to reduce the risks? My answer may seem disappointingly partial, as I do not think there is a miraculous medicine that monetary policy can provide. I would phrase it as follows.

Firstly, the central banker should be aware of the danger. He should know that in the future his principal objective may not receive, from the public, governments and parliaments the same strong support which has been the outcome of the two decades of high inflation. Since unemployment is what concerns the voters and the youngsters most, it may be increasingly necessary for him to play an educational role in explaining the benefits of a stable currency to those who have not directly experienced the costs of inflation. This is very much like the case of the post-war generations in
Europe which, being fortunate enough not to experience the horror of World
War II, need now to be reminded about the human costs of that terrible conflict.

Secondly, the central banker should avoid mistakes. It may seem obvious, but he should never forget that independence does not mean infallibility and that the likely new environment will offer no forgiveness for mistakes. A mistake would be the attempt to provide a substitute for the lack of structural policies by providing unnecessary monetary stimulus: it is not because the right medicine is neither supplied by the pharmacist nor demanded by the patient that the wrong medicine becomes effective.
Another mistake would be to give the impression that the central bank has a ceiling in mind for growth, rather than for inflation. On the contrary, the central bank should make it clear that any rate of non-inflationary growth is welcomed and would be accommodated, the higher the better.

Technically, this will not be an easy task. The analytical uncertainty surrounding estimates of potential output and its growth rate might lead the central banker to respond quite cautiously to evidence of shifts in the rate of non-inflationary growth. While such caution is certainly optimal from an inflation stabilisation point of view, it might be wrongly interpreted as a systematic deflationary bias by the public and the politicians. This is a clear case in which any progress made by scholars in refining the analytical tools of the economic profession will greatly help the central banker to achieve his goals without imposing unnecessary costs on society at large.

On the whole, however, it is part of the central banker's role to make the day-by-day decisions that, in the end, constitute monetary policy.
This responsibility can be neither transferred to, nor challenged by, policy makers responsible for other areas. Last week, the Eurosystem has made, for the first time in its life, an affirmative monetary policy decision by lowering its official rates. In this way, the Eurosystem has acted in line with its monetary policy strategy and made a significant contribution towards an economic environment in which the considerable growth potential of the euro area can be exploited in full. It is now the responsibility of other sectors of economic policy making to do their part by strictly adhering to the Stability and Growth Pact and implementing decisive structural reforms.

6. MANAGING FINANCIAL TRANSFORMATIONS

The third challenge consists in accompanying and surveying the rapid changes the European financial institutions and markets are undergoing, and will continue to undergo over the coming years, partly - but not exclusively - as a consequence of the euro.

It is sufficient to observe the US Federal Reserve System to understand the role the Eurosystem should play in the coming years: attention in monitoring changes in the financial system, active participation in the policy debate caused by such change, intense dialogue with both the Administration and Congress, influence exerted on opinions and decisions.

To a large extent the factors of change are technology determined, hence independent of the euro and even not specifically European.
Technology is the driving force of the transformation in banking and finance that modifies the traditional deposit loan structure of banks.
Technology also reshapes dramatically the back office and the communication with customers, thus producing massive over-branching and over-staffing in traditional banks. Also the globalisation of finance comes primarily from the combination of data processing and telecommunications.

Other changes are specifically European. Since universal banking has historically prevailed in continental Europe, the change from an institution-based to a market-based financial system is particularly significant in this part of the world. Similarly, the development of financial conglomerates is more pronounced in Europe than in the United
States or Japan. Typical of continental Europe are also the labour market rigidities that make the restructuring of banks so difficult and slow.

Finally, there are changes induced by the euro. The removal of currency specificity as a cause of national segmentation of the financial industry is causing a convulsive shake-up of both institutions and markets.
Since the beginning of this year, about ten banks ranking near the top of their respective national lists have concluded or started merger operations in France, Spain, Italy, the Netherlands, Belgium and Norway. In most
European countries stock exchanges and other organised markets, which were legally and structurally organised as providers of a public service, have been transformed into profit-driven private institutions and are now in a process of rapid concentration. In the coming two or three years the number of banks will shrink, the largest banks will become much larger, few financial centres and market networks will replace the present one-country one-centre configuration.

In any national system the central bank would actively monitor and even guide the course of such a transformation. It would do so along with the various agencies responsible for financial supervision and competition policy, and with an involvement of the executive power itself. Although largely determined by business decisions, these developments indeed involve the public interest in various ways.

Surveying and accompanying a profound transformation of the financial industry would be a difficult task for any central bank. For the Eurosystem it will represent a daunting challenge because it will put to the test an unprecedented articulation of the policy functions that are called for. Let me briefly explain this assertion.

The institutional setting of the euro area establishes a double separation between central banking and other public functions. Firstly, a functional separation, whereby banking supervision is now assigned to institutions that - even when they are national central banks - no longer exert independent monetary policy functions. Of this separation we have many previous examples (Germany, Japan, Sweden, now the UK, etc.). Much newer is a second, geographical, separation, whereby - with only the partial exception of competition policy - the area of jurisdiction of central banking does not coincide with the area of jurisdiction of the other public functions involved (banking supervision, regulation of the securities market, etc.).

Experts, including academic people, have so far focused attention on lender-of-last-resort functions and suggested that the new setting would not be able to act effectively in a crisis. I have argued elsewhere why this criticism seems unjustified. Here, I would like to suggest that the real challenge could come, in my opinion, from tensions between the national and the euro area interest in the process of financial transformation.

The process of industry transformation will inevitably involve aspects that have traditionally been considered as sensitive by public authorities: suppression of jobs, location of facilities and headquarters.
Financial transformation will also produce a hardening of competition and competition will be, to a considerable extent, one between national financial centers and industries, not only between individual banks or institutions. The propensity to defend national champions may prevail over the pursuit of efficiency. The risk for the Eurosystem to fall in the trap of an improper interplay between the EU and the national dimension of the public interest may become high. Like any central bank, the Eurosystem should be both active and neutral in the great transformation of "its" financial industry. The word "system" that is part of its own name refers, and should apply in practice, to the whole euro area.

7. COPING WITH A LACK OF POLITICAL UNION

The fourth challenge consists in coping with the lack of a political union. The relationship between monetary and political union and whether the latter should be a precondition for the former has been a central issue in the European debate well before the establishment of the Delors
Committee in 1988. While I do think that there is a lack of political union and that this lack constitutes a serious challenge for the Eurosystem, I also think that the expression "lack of political union" is often used in an unclear way that blurs the issue. Let me thus first consider two meanings of this expression with which I do not concur.

First, I do not concur with the idea that there is no political union in Europe today. It is not because the content and the competence of the
European Union are mainly economic, that its nature and historical role are not political. Even before the single currency, EU competence extended over virtually the whole Corpus Iuris of economic activity, from the establishment of "the free movement of goods, persons, services and capital" (the four freedoms proclaimed by Article 3 of the Treaty) to external economic relationships. To understand how very political these issues are, it should suffice to think about the place they take in the US political debate today, or have taken in the politics of our countries before the creation of the European Community. Moreover, the institutional architecture of the European Union is entirely that of a political system, not that of an international organisation based on intergovernmental co- operation: a legislative capacity that prevails over that of Member States, a judicial power, a directly elected Parliament.

Second, I do not concur with the idea that Monetary Union has developed outside the political process. Quite the contrary is true. The establishment of a single currency in the European Union has been achieved because of the strong political determination of elected governments over a full decade, from June 1988 to May 1998. It is significant that during that long period continuity has not been broken by repeated changes of political majority in virtually all countries except Germany. Technocrats, i.e. central bankers, have "only" played their role, crucial as it may be. They have provided expertise, from the drafting of the blueprint to the preparatory work for the actual start of the system. And, no less important, they have loyally accepted the limits of their role and recognised that the ultimate decisions have belonged to elected politicians. This is the meaning of the two statements of July 1988 and
March 1998 with which the Bundesbank has defined its position at the beginning and the end of the crucial decade. "In der Beschrдnkung zeigt sich der Meister".

The establishment of a single currency is a strongly political event in its genesis and a profound social and cultural change in its nature. As economists and central bankers we pay limited attention to notes and coins because they are a minor and endogenous component of the money stock. For many politicians, however, Monetary Union meant little else than a common banknote. They saw, better than us, that for the people money has to do with the perception of the society to which they belong and, ultimately, with their culture. As such, money goes well beyond the economic sphere of human action. Indeed, the act whereby we accept to provide goods or services to an unknown person in exchange for pieces of paper that have no intrinsic value is perhaps the most significant and widespread testimony of the social contract that binds people. This is why coinage and money printing have always been a prerogative of the State.

Yet, for two main reasons it remains true that Europe has a lack of political union. First, the European Union is still not the ultimate provider of internal and external security, the two key functions that constitute the raison d'кtre of the modern State. Second, EU institutions still fail to comply with the key constitutional principles that constitute the heritage of western democracies: foundation of the legislative and executive functions on the popular vote, majority principle, equilibrium of powers.

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