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Jean-Claude Trichet (16): Collision course with President Chirac

The author in "the Golden Room" of the Bank of France in 1995.

The Exchange Rate Mechanism was rocked again in the summer of 1993. Inflation in post-reunification Germany put upward pressure on the nation's interest rates. This resulted in France having somewhat lower interest rates than Germany.

     To a British financial newspaper, this reversal epitomized the decline in the German currency's standing. Its headline asked, "DM, still an anchor currency?" Some commentators overreacted, suggesting the franc was going to replace the deutsche mark as the most credible currency of Europe.

     In a radio interview in late June, the French finance minister pressed the Bundesbank to cut interest rates. An enraged German government canceled a regular bilateral meeting scheduled to take place in Paris. The markets reacted relentlessly to the public quarrel between the governments of the two major economies. The European currencies, including the franc, came under progressively stronger selling pressure against the deutsche mark.

    It was France's longstanding position to abide by the ERM's rules and take whatever steps were needed to protect the mechanism. When the pressure became particularly intense in July, Prime Minister Edouard Balladur sent a letter to the leaders of other states participating in the system, saying Paris was ready to defend the ERM with short-term interventions on an unlimited scale. Indeed, France stepped in and bought enormous amounts of francs.

Pivotal meeting

On Aug. 1, European finance ministers and central bank governors convened in Brussels. Belgian Finance Minister Philippe Maystadt, who presided over the proceedings, observed that, the participants having failed to reach an agreement, the ERM currencies would be placed under a floating exchange rate regime the next day.  

     I will always remember how Kenneth Clarke, the British chancellor of the exchequer, reacted. Noting the pound was no longer part of the ERM, Clarke asked his colleagues to keep their composure, reflect on the situation and find a way to preserve the ERM.

     Germany had called for a major enlargement in the band in which the Continent's currencies were allowed to fluctuate with one another, to 7% to 8%. Jacques de Larosiere, the Banque de France governor, proposed a band twice as large. In the end, this was accepted by all of the participants.

     The next day, the market opened with fluctuation margins suddenly expanded from plus/minus 2.25% to plus/minus 15%.

     Initially, there were two opposing interpretations of our decision. The majority said we had accepted the demise of the ERM. The minority, including myself, maintained that we had found an innovative way to save the ERM in an emergency.

     The latter view proved to be correct over time, and there are three lessons to draw from the crisis:

  1. Do not let the markets think there are enormous profits to be made by destroying an exchange system.
  2. Give the markets free rein for a certain period, while preserving the essence of the system.
  3. Make as much money as possible in counterspeculation and teach speculators a lesson. Indeed, France's central bank made a profit on this occasion.

Clashing with the president

I became governor of the Banque de France that September. The position opened up because my predecessor, de Larosiere, moved to London to head the European Bank for Reconstruction and Development. To take the helm of the world's third-oldest central bank -- after those of Sweden and the U.K. -- was an extraordinary honor for me.

     Coinciding with my appointment as governor, the Banque de France gained full independence as lawmakers amended the constitution in a vote that garnered a greater-than three-fifths majority. This made accountability an issue: Any complaints, such as "interest rates are not low enough" or "inflation is too high," would henceforth be directed at the central bank, not the government.

     Furthermore, the central bank governor was now required to regularly report to parliament. For transparency, government representatives would attend all monetary policy meetings, though they would not have voting rights.

     In 1994, the Banque de France defined price stability as "a rise in consumer prices of less than 2% annually." This made it the first central bank in a big advanced economy to explicitly set 2% as an inflation yardstick -- one now used by the central banks of the U.S., Europe and Japan as well.

     To ensure transparency, I conducted press conferences when necessary and, on an almost weekly basis, held informal breakfast meetings with both domestic and foreign journalists. I also implemented opinion polls, one of which showed our monetary policy had the support of roughly two-thirds of respondents, from both the left and right of the political spectrum.

     But when Jacques Chirac became president in 1995, it was clear at the beginning that he was dissatisfied with the bank's approach. His new administration wanted to boost the economy through fiscal spending and called for an interest rate reduction. "I understand you are independent, but ...," he told me.

     I was as adamant as he was. "Mr. President," I said, "the monetary policy council will decide interest rates. Any monetary policy contradicting the goal of a credible franc would jeopardize the whole strategy we have pursued for the French economy, destabilize the ERM and, ultimately, cost heavily in terms of higher risk premiums on market interest rates."

     Occasionally, our discussions at the Elysee Palace grew heated. Public comments by the president and leaks to the press made our friction common knowledge. "They are locking horns again," The International Economy magazine commented at one point. This lasted until the President shifted policies to meet the euro criteria.

     All of this did not prevent us from having, from time to time, very interesting exchange of views on Japanese and Asian art and sculpture, of which he was a great admirer.

Jean-Claude Trichet is former president of the European Central Bank.

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